Note 1. Overview and Summary of Significant Accounting Policies

Overview

Onyx Pharmaceuticals, Inc. ("Onyx" or "the Company") was incorporated in California in February 1992 and reincorporated in Delaware in May 1996. Onyx is a biopharmaceutical company dedicated to developing innovative therapies that target the molecular mechanisms that cause cancer. Through the Company's internal research programs and in conjunction with its collaborators, the Company is applying its expertise to develop and commercialize innovative therapies that target the molecular mechanisms that cause cancer. The Company's commercially available products are Nexavar® (sorafenib) tablets, Stivarga® (regorafenib) tablets and Kyprolis® (carfilzomib) for Injection. Nexavar® (sorafenib) tablets, is approved in multiple countries for unresectable liver cancer and advanced kidney cancer. Stivarga® (regorafenib) tablets, a Bayer compound, is approved in the United States for the treatment of metastatic colorectal cancer (mCRC) and for the treatment of advanced gastrointestinal stromal tumors (GIST); and is under regulatory review for mCRC in the European Union and Japan and for the treatment of GIST in Japan. Kyprolis® (carfilzomib) for Injection, is approved in the United States for the treatment of patients with multiple myeloma who have received at least two prior therapies including bortezomib and an immunomodulatory agent (IMiD), and have demonstrated disease progression on or within 60 days of completion of the last therapy. The Company has broadened its pipeline through its collaboration with Bayer; through its acquisition of anti-cancer compounds; and through the acquisition of rights to development-stage and novel anti-cancer agents.

Basis of Presentation

The consolidated financial statements include the accounts of Onyx and its wholly owned subsidiaries. All intercompany balances and transactions have been eliminated in consolidation. Certain prior period amounts have been reclassified to conform to current year presentation. There was no effect to net income (loss) or equity related to these reclassifications.

Business Combinations

The Company accounted for the acquisition of Proteolix Inc., or Proteolix, in accordance with Accounting Standards Codification ("ASC") Topic 805, Business Combinations. ASC Topic 805 establishes principles and requirements for recognizing and measuring the total consideration transferred to and the assets acquired, liabilities assumed and any non-controlling interests in the acquired target in a business combination. ASC Topic 805 also provides guidance for recognizing and measuring goodwill acquired in a business combination; requires purchased in-process research and development to be capitalized at fair value as intangible assets at the time of acquisition; requires acquisition-related expenses and restructuring costs to be recognized separately from the business combination; expands the definition of what constitutes a business; and requires the acquirer to disclose information that users may need to evaluate and understand the financial effect of the business combination.

Significant Accounting Policies, Estimates and Judgments

The preparation of these Consolidated Financial Statements in conformity with United States generally accepted accounting principles requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosures. On an ongoing basis, management evaluates its estimates, including critical accounting policies or estimates related to revenue recognition, liability for contingent consideration, the effect of business combinations, fair value measurements of tangible and intangible assets and liabilities, goodwill and other intangible assets, income taxes, inventory, stock-based compensation and research and development expenses. The Company bases its estimates on historical experience and on various other market specific and other relevant assumptions that management believes 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 significantly from these estimates.

Marketable Securities: Marketable securities consist primarily of corporate debt securities, corporate commercial paper, debt securities of United States government agencies, auction rate notes and money market funds and are classified as available-for-sale securities. Concentration of risk is limited by diversifying investments among a variety of industries and issuers. Available-for-sale securities are carried at fair value based on quoted market prices, with any unrealized gains and losses reported in accumulated other comprehensive income (loss). For securities with unobservable quoted market prices, such as the AAA rated auction rate securities collateralized by student loans that are included in our investment portfolio, the fair value of each of these securities is estimated utilizing a discounted cash flow analysis that considers interest rates, the timing and amount of cash flows, credit and liquidity premiums, and the expected holding periods of these securities. The unobservable inputs for these securities are the liquidity premium and expected holding period. The discount rates used in the cash flow analysis that includes the liquidity premium was 2%. An increase or decrease of 1% in the discount rate would have a $0.4 million change in the auction rate securities valuation. The expected holding period was 5.13 years. An increase or decrease of 1 year in the expected holding period would result in a negligible change in the auction rate securities valuation. Unrealized losses are charged against "investment income" when a decline in fair value is determined to be other-than-temporary. We review several factors to determine whether a loss is other-than-temporary. These factors include but are not limited to: (i) the extent to which the fair value is less than cost and the cause for the fair value decline, (ii) the financial condition and near-term prospects of the issuer, (iii) the length of time a security is in an unrealized loss position and (iv) our ability to hold the security for a period of time sufficient to allow for any anticipated recovery in fair value. We do not intend to sell our marketable securities and it is not likely that we will be required to sell our marketable securities prior to the recovery of their amortized cost bases. Available-for-sale securities with initial maturities of greater than one year are classified as long-term. The amortized cost of securities in this category is adjusted for amortization of premiums and accretion of discounts to maturity. Such amortization is included in interest income. The cost of securities sold or the amount reclassified out of accumulated other comprehensive income into earnings is based on the specific identification method. Realized gains and losses and declines in value judged to be other than temporary are included in the statements of operations. Interest earned and gains realized on marketable securities, amortization of discounts received and accretion of premiums paid on the purchase of marketable securities are included in investment income.

Revenue Recognition

Revenue is recognized when the related costs are incurred and the four basic criteria of revenue recognition are met: (1) persuasive evidence of an arrangement exists; (2) delivery has occurred or services have been rendered; (3) the fee is fixed or determinable; and (4) collectability is reasonably assured. Determination of criteria (3) and (4) are based on management's judgments regarding the nature of the fee charged for products or services delivered and the collectability of those fees. Where the revenue recognition criteria are not met, we defer the recognition of revenue by recording deferred revenue until such time that all criteria under the provision are met.

Product Revenue. The Company sells Kyprolis through a limited number of distributors, and title and risk of loss transfer upon receipt by these distributors. Health care providers order Kyprolis through these distributors. During the initial launch period, we defer the recognition of revenue until the product is sold to the health care providers, the end customers, due to the inherent uncertainties in estimating normal channel inventory at the distributors. As of December 31, 2012, the Company had a deferred revenue balance of $9.8 million related to Kyprolis and recorded this amount as a liability in our Consolidated Balance Sheet.

Product sales are recorded net of estimated government-mandated rebates and chargebacks, distribution fees, estimated product returns and other deductions.

	Chargebacks			Rebates and Other		Distribution Fees and Returns			Total

	(In thousands)
Balance as of December 31, 2011	$	-		$	-	$	-		$	-
Provision related to current period sales		9,668			1,946		3,544			15,158
Credits/ Payments		(3,960	)		-		(1,258	)		(5,218	)

Balance as of December 31, 2012	$	5,708		$	1,946	$	2,286		$	9,940

Chargebacks, Government Rebates and Other Deductions: The Company estimates reductions to product sales for qualifying federal and state government programs including discounted pricing offered to Public Health Services, or PHS, as well as government-managed Medicaid programs. The Company's reserve for PHS is based on actual chargebacks that distributors have claimed for reduced pricing offered to the health care providers. The Company's reserve for Medicaid is based upon statutorily-defined discounts, estimated payor mix, expected sales to qualified healthcare providers, and our expectation about future utilization. The Company also provided financial assistance to qualifying patients that are underinsured, or cannot cover the cost of commercial coinsurance amounts, through a patient assistance program, Onyx 360. Onyx 360 is available to patients in the U.S. and its territories who meet various financial need criteria. Government rebates that are invoiced directly to us are recorded in accrued liabilities on our Consolidated Balance Sheet. For qualified programs, including Chargebacks, that can purchase our products through distributors at a lower contractual government price, the distributors charge back to us the difference between their acquisition cost and the lower contractual government price, which we record as allowances against accounts receivable on our Consolidated Balance Sheet.

Distribution Fees and Product Returns: The Company has written contracts with its customers that include terms for distribution-related fees. The Company records distribution fees due to its customers based on the number of units sold to health care providers. Consistent with industry practice, the Company offers its customers a limited right to return product purchased directly from the Company, which is principally based upon the product's expiration date. The Company will accept returns for expired product during the three months prior to and after the product expiration date, on product that had been sold to the health care providers. Product returned is generally not resalable given the nature of the Company's products and method of administration. The Company has developed estimates for Kyprolis product returns based upon historical industry information regarding product return rates of comparable products, including Nexavar, our other oncology product; inventory levels in the distribution channel; and other relevant factors. To date, actual Kyprolis product returns have been negligible.

Contract Revenue from Collaborations. Revenue from nonrefundable, up-front license or technology access payments under license and collaboration agreements that are not dependent on any future performance by the Company under the arrangements is recognized when such amounts are earned. If the Company has continuing obligations to perform, such fees are recognized over the period of continuing performance obligation.

Revenue from Multiple Element Arrangements. The Company accounts for multiple element arrangements, such as license and development agreements in which a customer may purchase several deliverables. The Company evaluates how the deliverables in an arrangement should be separated and how the consideration should be allocated. The Company allocates revenue to each non-contingent element based upon the relative selling price of each element. When applying the relative selling price method, the Company determines the selling price for each deliverable using vendor-specific objective evidence (VSOE) of selling price, if it exists, or third-party evidence (TPE) of selling price, if it exists. If neither VSOE nor TPE of selling price exist for a deliverable, the Company uses best estimated selling price (BESP) for that deliverable. Revenue allocated to each element is then recognized based on when the basic four revenue recognition criteria are met for each element. Refer to Note 5 for further details.

The Company may continue to enter into multiple element arrangements, such as license and development agreements, in which a customer may purchase several deliverables. For these multiple element arrangements, the Company allocates revenue to each non-contingent element based upon the relative selling price of each element. When applying the relative selling price method, the Company determines the selling price for each deliverable using VSOE of selling price or TPE of selling price, if either exists. If neither VSOE nor TPE of selling price exist for a deliverable, the Company uses BESP for that deliverable. Revenue allocated to each element is then recognized based on when the basic four revenue recognition criteria are met for each element.

Revenue from Collaboration Agreement. The Company records its share of the pre-tax commercial profit generated from the collaboration with Bayer, reimbursement of its shared marketing costs related to Nexavar and royalty revenue in one line item, "Revenue from collaboration agreement." The Company's portion of shared collaboration research and development expenses is not included in the line item "Revenue from collaboration agreement," but is reflected under operating expenses. According to the terms of the collaboration agreement, the companies share all research and development, marketing, and non-U.S. sales expenses. The Company and Bayer each bear their own U.S. sales force and medical science liaison expenses related to Nexavar. These costs, which are related to the Company's U.S. sales force and medical science liaisons, are recorded in selling, general and administrative expenses. Bayer recognizes all revenue under the Nexavar collaboration and incurs the majority of expenses relating to the development and marketing of Nexavar.

The Company is highly dependent on Bayer for timely and accurate information regarding any revenues realized from sales of Nexavar and the costs incurred in developing and selling it, in order to accurately report its results of operations. For the periods covered in the financial statements presented, there have been no significant or material changes to prior period estimates of revenues and expenses. However, if the Company does not receive timely and accurate information or incorrectly estimates activity levels associated with the collaboration of Nexavar at a given point in time, the Company could be required to record adjustments in future periods and may be required to restate its results for prior periods.

Royalty revenue: We recognize revenue from royalties based on licensees' sales of its products or products using its technologies. Royalties are recognized as earned in accordance with the contract terms when royalties from licensees can be reasonably estimated and collectability is reasonably assured. If royalties cannot be reasonably estimated or collectability of a royalty amount is not reasonably assured, royalties are recognized as revenue when the cash is received.

Research and Development

Research and development costs are charged to expense when incurred. The major components of research and development costs include clinical manufacturing costs, preclinical study expenses, clinical trial expenses, consulting and other third-party costs, salaries and employee benefits, stock-based compensation expense, supplies and materials and allocations of various overhead and occupancy costs. Preclinical study expenses include, but are not limited to, costs incurred for the laboratory evaluation of a product candidate's chemistry and its biological activities and costs incurred to assess the potential safety and efficacy of a product candidate and its formulations. Clinical trial expenses include, but are not limited to, investigator fees, site costs, comparator drug costs and clinical research organization costs. In the normal course of business, we contract with third parties to perform various clinical trial activities in the on-going development of potential products. The financial terms of these agreements are subject to negotiation and variation from contract to contract and may result in uneven payment flows. Payments under the contracts depend on factors such as the achievement of certain events, the successful enrollment of patients and the completion of portions of the clinical trial or similar conditions. Our cost accruals for clinical trials are based on estimates of the services received and efforts expended pursuant to contracts with numerous clinical trial sites, cooperative groups and clinical research organizations. The objective of our accrual policy is to match the recording of expenses in our financial statements to the actual services received and efforts expended. As such, expense accruals related to clinical trials are recognized based on our estimate of the degree of completion of the event or events specified in the specific clinical study or trial contract. We monitor service provider activities to the extent possible; however, if we incorrectly estimate activity levels associated with various studies at a given point in time, we could be required to record adjustments to research and development expenses in future periods.

Manufacturing costs are a component of research and development expenses and include costs associated with third-party contractors for validation and commercial batch production, process technology transfer, quality control and stability testing, raw material purchases, overhead expenses and facilities costs. We previously recorded these manufacturing-related expenses as research and development as incurred because these costs did not meet the definition of an inventory asset, as future use could not be determined based upon the uncertainty of whether Kyprolis would be approved for marketing in the United States by the FDA. Inventories include owned items that are held for sale in the ordinary course of business, that are in process of production for sale, or that will be consumed in the production of goods or services that will be held for sale. On July 20, 2012, the FDA approved Kyprolis for marketing in the United States. Therefore, we are now capitalizing certain manufacturing costs, following the regulatory approval, as an inventory asset that would previously have been expensed as research and development costs, in cases where the manufacturing costs meet the definition of an inventory asset.

In instances where we enter into agreements with third parties for clinical trials and other consulting activities, up-front payment amounts are capitalized and expensed as services are performed or as the underlying goods are delivered. If we do not expect the services to be rendered or goods to be delivered, any remaining capitalized amounts for non-refundable up-front payments are charged to expense immediately. Amounts due under such arrangements may be either fixed fee or fee for service, and may include upfront payments, monthly payments and payments upon the completion of milestones or receipt of deliverables.

Non-refundable option payments, including those previously made under our agreement with S*BIO, that do not have any future alternative use are recorded as research and development expense. Not all research and development costs are incurred by us. A portion of our total research and development expenses, approximately 23% in 2012, 31% in 2011 and 49% in 2010, relates to our cost sharing arrangement with Bayer and represents our share of the research and development costs incurred by Bayer. As a result of the cost sharing arrangement between us and Bayer, there was a net reimbursable amount of $72.9 million, $79.2 million and $78.8 million to Bayer for the years ended December 31, 2012, 2011 and 2010, respectively. Such amounts were recorded based on invoices and estimates we receive from Bayer. When such invoices have not been received, we must estimate the amounts owed to Bayer based on discussions with Bayer. For the periods covered in the financial statements presented, there have been no significant or material differences between actual amounts and estimates. However, if we underestimate or overestimate the amounts owed to Bayer, we may need to adjust these amounts in a future period, which could have an effect on earnings in the period of adjustment.

Stock-Based Compensation

The Company accounts for stock-based compensation of stock options granted to employees and directors and of employee stock purchase plan shares by estimating the fair value of stock-based awards using the Black-Scholes option-pricing model and amortizing the fair value of the stock-based awards granted over the applicable vesting period. The Black-Scholes option pricing model includes assumptions regarding dividend yields, expected volatility, expected option term and risk-free interest rates. The Company estimates expected volatility based upon a combination of historical and implied stock prices. The risk-free interest rate is based on the U.S. treasury yield curve in effect at the time of grant. The expected option term calculation incorporates historical employee exercise behavior and post-vesting employee termination rates. The Company accounts for stock-based compensation of restricted stock award grants by amortizing the fair value of the restricted stock award grants, which is the grant date market price, over the applicable vesting period. Compensation cost for restricted stock and stock option awards that contain performance or market conditions is based on the grant date fair value of the award. Compensation expense is recorded over the implicit or explicit requisite service period based on management's best estimate as to whether it is probable that the shares awarded are expected to vest. Previously recognized compensation expense is fully reversed if performance targets are not satisfied. The Company assesses the probability of the performance indicators being met on a continuous basis and records compensation expense from that date, over the remainder of the requisite service period.

Net income (loss) for the years ended December 31, 2012, 2011 and 2010 includes employee stock-based compensation expense of $35.3 million, or $0.54 per diluted share, $26.4 million, or $0.41 per diluted share, and $22.1 million, or $0.35 per diluted share, respectively. As of December 31, 2012, the total unrecorded stock-based compensation expense for unvested stock options, net of expected forfeitures, was $53.5 million, which is expected to be amortized over a weighted-average period of 2.7 years. As of December 31, 2012, the total unrecorded expense for unvested restricted stock awards and units, net of expected forfeitures, was $10.0 million, which is expected to be amortized over a weighted-average period of 1.3 years.

All stock option awards to non-employees are accounted for at the fair value of the consideration received or the fair value of the equity instrument issued, as calculated using the Black-Scholes model. The Company recorded compensation expense related to option grants to non-employees of $2.6 million, $0.6 million and $0.7 million for the years ended December 31, 2012, 2011 and 2010, respectively.

The assumptions used in computing the fair value of stock-based awards reflect the Company's best estimates, but involve uncertainties relating to market and other conditions, many of which are outside of the Company's control. In addition, the Company's estimate of future stock-based compensation expense will be affected by a number of items including the Company's stock price, the number of stock options the Company's board of directors may grant in future periods, as well as a number of complex and subjective valuation adjustments and the related tax effect. As a result, if other assumptions or estimates had been used, the stock-based compensation expense that was recorded for the years ended December 31, 2012, 2010 and 2010 could have been materially different. Furthermore, if different assumptions are used in future periods, stock-based compensation expense could be materially impacted in the future.

Net Income (Loss) Per Share

Basic net income (loss) per share amounts for each period presented were computed by dividing net income (loss) by the weighted-average number of shares of common stock outstanding. Diluted net income (loss) per share for each period presented was computed by dividing net income (loss) plus interest on dilutive convertible senior notes by the weighted-average number of shares of common stock outstanding during each period plus all additional common shares that would have been outstanding assuming dilutive potential common shares had been issued for dilutive convertible senior notes and other dilutive securities.

Dilutive potential common shares for dilutive convertible senior notes are calculated based on the "if-converted" method. Under the "if-converted" method, when computing the dilutive effect of convertible senior notes, the numerator is adjusted to add back the amount of interest and debt issuance costs recognized in the period and the denominator is adjusted to add back the amount of shares that would be issued if the entire obligation is settled in shares. As of December 31, 2012, the Company's outstanding indebtedness consisted of its 4.0% convertible senior notes due 2016, or the 2016 Notes.

Dilutive potential common shares also include the dilutive effect of the common stock underlying in-the-money stock options and are calculated based on the average share price for each period using the treasury stock method. Under the treasury stock method, the exercise price of an option, the average amount of compensation cost, if any, for future service that the Company has not yet recognized when the option is exercised, are assumed to be used to repurchase shares in the current period. Dilutive potential common shares also reflect the dilutive effect of unvested restricted stock units.

The computations for basic and diluted net income (loss) per share were as follows:

	Year Ended December 31,

	2012			2011		2010
	(In thousands, except per share amounts)
Numerator:
Net income (loss) — basic	$	(187,787	)	$	76,110	$	(84,847	)
Add: interest and issuance costs related to convertible senior notes		-			-		-

Net income (loss) — diluted	$	(187,787	)	$	76,110	$	(84,847	)

Denominator:
Weighted average common shares outstanding — basic		65,148			63,422		62,618
Dilutive effect of stock options		-			588		-

Weighted average common shares outstanding and dilutive potential common shares — diluted		65,148			64,010		62,618

Net income (loss) per share:
Basic	$	(2.88	)	$	1.20	$	(1.35	)

Diluted	$	(2.88	)	$	1.19	$	(1.35	)

Under the "if-converted" method, 5.8 million potential common shares relating to the 2016 Notes were not included in diluted net income (loss) per share for the years ended December 31, 2012, 2011 and 2010 because their effect would be anti-dilutive. Diluted net income (loss) per share does not include the effect of 2.5 million, 4.3 million and 5.1 million stock-based awards that were outstanding during the years ended December 31, 2012, 2011 and 2010. These stock-based awards were not included in the computation of diluted net income (loss) per share because the proceeds received, if any, from such stock-based awards combined with the average unamortized compensation costs were greater than the average market price of the Company's common stock, and, therefore, their effect would have been antidilutive.

Income Taxes

We use the assets and liability method to account for income taxes in accordance with ASC 740-10, Income Taxes. Under this method, deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities. At each balance sheet date, we evaluate the available evidence about future taxable income and other possible source of realization of deferred tax assets, and record a valuation allowance that reduces the deferred tax assets to an amount that represents management's best estimate of the amount of such deferred tax assets that more likely than not will be realized. Deferred tax assets and liabilities are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enacted date.

The Company follows the authoritative guidance under ASC 740, which clarifies the accounting for uncertainty in tax positions recognized in the financial statements. ASC 740 provides that a tax benefit from an uncertain tax position may be recognized when it is more likely that not that the position will be sustained upon examination, including resolutions of any related appeals or litigation processes, based on the technical merits. Income tax position must meet a more-likely-than-not recognition threshold at the effective date to be recognized upon the adoption of ASC 740 and in subsequent periods. This interpretation also provides guidance on measurement, derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition.

The Company's policy for classifying interest and penalties associated with unrecognized income tax benefits is to include such items as tax expense.

Cash and Cash Equivalents

The Company considers all highly liquid investments with a maturity from the date of purchase of three months or less to be cash equivalents. Cash equivalents are carried at cost, which approximates fair value.

Marketable Securities

Marketable securities consist primarily of corporate debt securities, corporate commercial paper, debt securities of United States government agencies, auction rate notes and money market funds and are classified as available-for-sale securities. Concentration of risk is limited by diversifying investments among a variety of industries and issuers. Available-for-sale securities are carried at fair value based on quoted market prices, with any unrealized gains and losses reported in accumulated other comprehensive income (loss). For securities with unobservable quoted market prices, such as the AAA rated auction rate securities collateralized by student loans that are included in our investment portfolio, the fair value of each of these securities is estimated utilizing a discounted cash flow analysis that considers interest rates, the timing and amount of cash flows, credit and liquidity premiums, and the expected holding periods of these securities. The unobservable inputs for these securities are the liquidity premium and expected holding period. Unrealized losses are charged against "investment income" when a decline in fair value is determined to be other-than-temporary. We review several factors to determine whether a loss is other-than-temporary. These factors include but are not limited to: (i) the extent to which the fair value is less than cost and the cause for the fair value decline, (ii) the financial condition and near-term prospects of the issuer, (iii) the length of time a security is in an unrealized loss position and (iv) our ability to hold the security for a period of time sufficient to allow for any anticipated recovery in fair value. We do not intend to sell our marketable securities and it is not likely that we will be required to sell our marketable securities prior to the recovery of their amortized cost bases. Available-for-sale securities with initial maturities of greater than one year are classified as long-term. The amortized cost of securities in this category is adjusted for amortization of premiums and accretion of discounts to maturity. Such amortization is included in interest income. The cost of securities sold or the amount reclassified out of accumulated other comprehensive income into earnings is based on the specific identification method. Realized gains and losses and declines in value judged to be other than temporary are included in the statements of operations. Interest earned and gains realized on marketable securities, amortization of discounts received and accretion of premiums paid on the purchase of marketable securities are included in investment income.

Fair Value Measurements

In accordance with ASC Subtopic 820-10, Fair Value Measurements and Disclosures, the carrying amounts of certain financial instruments of the Company, including cash equivalents, marketable securities and liabilities for contingent consideration, continue to be valued at fair value. ASC Subtopic 820-10 defines fair value and provides guidance for using fair value to measure assets and liabilities and is applicable whenever assets or liabilities are required or permitted to be measured at fair value.

The fair value estimates presented in this report reflect the information available to the Company as of December 31, 2012. See Note 9, "Fair Value Measurements."

Concentration of Credit Risk

Financial instruments that potentially subject the Company to concentration of credit risk consist principally of accounts receivable, cash equivalents and marketable securities.

We sell Kyprolis through a limited number of distributors, and title and risk of loss transfer upon receipt by these distributors. Health care providers order Kyprolis through these distributors. During 2012, 99% of our net Kyprolis product revenues were generated by three distributors. Despite the significant concentration of distributors, the demand for Kyprolis is driven primarily by patient therapy requirements and we do not believe we are dependent upon any individual distributor with respect to Kyprolis sales. Due to the pricing of Kyprolis, the specialty distributors and pharmacies generally carry a very limited inventory, resulting in sales of Kyprolis being closely tied to end-user demand.

The Company invests cash that is not required for immediate operating needs principally in money market funds and corporate securities. At December 31, 2012, our investment portfolio includes $8.6 million AAA rated securities with an auction reset feature ("auction rate securities") that are collateralized by student loans. Since February 2008, these types of securities have experienced failures in the auction process. However, a limited number of these securities have been redeemed at par by the issuing agencies. As a result of the auction failures, interest rates on these securities reset at penalty rates linked to LIBOR or Treasury bill rates. The penalty rates are generally higher than interest rates set at auction. Based on the overall failure rate of these auctions, the frequency of the failures, the underlying maturities of the securities, a portion of which are greater than 30 years, and our belief that the market for these student loan collateralized instruments may take in excess of twelve months to fully recover, we have classified the auction rate securities with a par value of $8.6 million as non-current marketable securities on the accompanying Consolidated Balance Sheet as December 31, 2012. We have determined the fair value to be $8.3 million for these securities, based on a discounted cash flow model, and have reduced the carrying value of these marketable securities by $0.3 million through accumulated other comprehensive income (loss) instead of earnings because we have deemed the impairment of these securities to be temporary. Further adverse developments in the credit market could result in an impairment charge through earnings in the future. The discounted cash flow model used to value these securities is based on a specific term and liquidity assumptions. An increase in either of these assumptions could result in a $0.4 million decrease in value. Alternatively, a decrease in either of these assumptions could result in a $0.4 million increase in value.

Derivative Instruments

The Company established a foreign currency hedging program beginning in 2010. The objective of the program is to mitigate the foreign exchange risk arising from transactions or cash flows that have a direct or underlying exposure in non-U.S. Dollar denominated currencies in order to reduce volatility in the Company's cash flow and earnings. From time to time, the Company hedges a certain portion of anticipated Nexavar-related cash flows owed to the Company with options, typically no more than one year into the future. The underlying exposures, both revenue and expenses, in the Nexavar program are denominated in currencies other than the U.S. Dollar, primarily the Euro and Japanese Yen. For purposes of calculating the cash flows due to or due from the Company each quarter, the foreign currencies are converted into U.S. dollars based on average exchange rates for the reporting period. The Company does not enter into derivative financial contracts for speculative purposes.

In accordance with ASC 815, Derivatives and Hedging, all derivative instruments, such as foreign currency option contracts, are recognized on the Consolidated Balance Sheet at fair value. Changes to the fair value of derivative instruments are recorded in current earnings or accumulated other comprehensive gain (loss) each period, depending on whether or not the derivative instrument is designated as part of a hedging transaction and, if it is, the type of hedging transaction. For a derivative to qualify as a hedge at inception and throughout the hedged period, the Company formally documents the nature and relationships between the hedging instruments and hedged item. The Company assesses, both at inception and on an on-going basis, whether the derivative instruments that are used in cash flow hedging transactions are highly effective in offsetting the changes in cash flows of hedged items. The Company assesses hedge ineffectiveness on a quarterly basis and records the gain or loss related to the ineffective portion of derivative instruments, if any, to current earnings. If the Company determines that a forecasted transaction is no longer probable of occurring, it discontinues hedge accounting and any related unrealized gain or loss on the derivative instrument is recognized in current earnings. Changes in the fair value of derivative instruments that are not designated as part of a hedging transaction are recognized in current earnings. Refer to Note 8 for further information.

Inventories

Inventories are stated at the lower of cost or market. Cost is determined based on actual cost. If inventory costs exceed expected market value due to obsolescence or quantities in excess of expected demand, reserves are recorded for the difference between cost and market value. These reserves are determined based on estimates.

Property and Equipment

Property and equipment are stated on the basis of cost. Depreciation is calculated using the straight-line method over the estimated useful lives of the respective assets, generally two to five years. Leasehold improvements are amortized over the lesser of the lease term or the estimated useful lives of the related assets, generally five to seven years.

Deferred Rent and Lease Incentives

Deferred rent and lease incentives consists of the difference between cash payments and the recognition of rent expense on a straight-line basis for the buildings the Company occupies. The leases provide for fixed increases in minimum annual rental payments, as well as rent free periods. The total amount of rental payments due over the lease terms are being charged to rent expense ratably over the life of the leases. Tenant improvement allowances are recorded as a deferred rent liability and are amortized over the term of the lease as a reduction to rent expense.

Indefinite-lived Intangible Assets — In-process Research and Development

Indefinite-lived intangible assets related to in-process research and development costs, or IPR&D, are considered to be indefinite-lived until the completion or abandonment of the associated research and development efforts. During the period the assets are considered indefinite-lived, they will not be amortized but will be tested for impairment on an annual basis and between annual tests if the Company becomes aware of any events occurring or changes in circumstances that would indicate a reduction in the fair value of the IPR&D projects below their respective carrying amounts. If and when development is complete, which generally occurs if and when regulatory approval to market a product is obtained, the associated assets would be deemed finite-lived.

Finite-lived Intangible Assets:

Finite-lived intangible assets related to intangible assets reclassified from indefinite-lived intangible assets, following the FDA approval of Kyprolis for marketing in the United States. The Company amortizes finite-lived intangible assets, using the straight-line method, over their estimated useful life. The estimated useful life of 13 years was used for the intangible asset related to Kyprolis in the U.S. based on the remaining patent life. The Company reviews this finite-lived intangible asset for impairment when facts or circumstances indicate a reduction in the fair value below its carrying amount.

Goodwill

Goodwill represents the excess of the consideration transferred over the estimated fair values of assets acquired and liabilities assumed in a business combination. Goodwill is not amortized but is tested for impairment on an annual basis and between annual tests if the Company becomes aware of any events occurring or changes in circumstances that would indicate a reduction in the fair value of the goodwill below its carrying amount.

Liability for Contingent Consideration

In addition to the initial cash consideration paid to former Proteolix stockholders, the first earn-out payment made in April 2010 of $40.0 million and the second earn-out payment made in September 2012 of $80.0 million, the Company may be required to pay up to an additional $365.0 million in earn-out payments upon the receipt of certain regulatory approvals and the satisfaction of other milestones. These earn-out payments will become payable in up to three additional installments, upon the achievement of regulatory approvals in the U.S. and Europe within pre-specified timeframes for Kyprolis. In accordance with ASC Topic 805, Business Combinations , the Company determined the fair value of this liability for contingent consideration on the acquisition date using a probability weighted income approach. Future changes to the fair value of the contingent consideration will be determined each period and charged to expense in the "Contingent consideration" expense line item in the Consolidated Statements of Operations under operating expenses. Refer to Liability for Contingent Consideration in Note 7 for further information.

Convertible Senior Notes

In August 2009, the Company issued, through an underwritten public offering, $230.0 million aggregate principal amount of 4.0% convertible senior notes due 2016. The 2016 Notes are accounted for in accordance with ASC Subtopic 470-20, Debt with Conversion and Other Options. Under ASC Subtopic 470-20, issuers of certain convertible debt instruments that have a net settlement feature and may be settled in cash upon conversion, including partial cash settlement, are required to separately account for the liability (debt) and equity (conversion option) components of the instrument. The carrying amount of the liability component of the 2016 Notes, as of the issuance date, was computed by estimating the fair value of a similar liability issued at 12.5% effective interest rate, which was determined by considering the rate of return investors would require in the Company's capital structure as well as taking into consideration effective interest rates derived by comparable companies. The amount of the equity component was calculated by deducting the fair value of the liability component from the principal amount of the 2016 Notes and resulted in a corresponding increase to debt discount. Subsequently, the debt discount is being amortized as interest expense through the maturity date of the 2016 Notes.

Segment Reporting

The Company operates in one segment — the discovery and development of novel cancer therapies.

Recent Accounting Pronouncements

In February 2013, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") No. 2013-02, "Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income." Under this standard, entities will be required to disclose additional information with respect to changes in accumulated other comprehensive income (AOCI) balances by component and significant items reclassified out of AOCI. Expanded disclosures for presentation of changes in AOCI involve disaggregating the total change of each component of other comprehensive income (for example, unrealized gains or losses on available for sale marketable securities) as well as presenting separately for each such component the portion of the change in AOCI related to (1) amounts reclassified into income and (2) current-period other comprehensive income. Additionally, for amounts reclassified into income, disclosure in one location would be required, based upon each specific AOCI component, of the amounts impacting individual income statement line items. Disclosure of the income statement line item impacts will be required only for components of AOCI reclassified into income in their entirety. Therefore, disclosure of the income statement line items affected by AOCI components such as net periodic benefit costs would not be included. The disclosures required with respect to income statement line item impacts would be made in either the notes to the consolidated financial statements or parenthetically on the face of the financial statements. This ASU is effective beginning January 1, 2013. Because this standard only impacts presentation and disclosure requirements, its adoption will not have a material impact on the Company's consolidated results of operations or financial condition.

In July 2012, the FASB issued ASU No. 2012-02, "Testing Indefinite-Lived Intangible Assets for Impairment." Under this standard, entities testing long-lived intangible assets for impairment now have an option of performing a qualitative assessment to determine whether further impairment testing is necessary. If an entity determines, on the basis of qualitative factors, that the fair value of the indefinite-lived intangible asset is more-likely-than-not less than the carrying amount, the existing quantitative impairment test is required. Otherwise, no further impairment testing is required. This ASU is effective beginning January 1, 2013, with early adoption permitted. The Company's early adoption of this guidance in 2012 did not have an impact on our consolidated financial statements. Additional information on impairment testing can be found in Note 7.