2. Summary of Significant Accounting Policies

Use of Estimates - The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United States (GAAP) requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. The Company bases its estimates and judgments on historical experience and on various other assumptions that it believes are reasonable under the circumstances. The amounts of assets and liabilities reported in the Company's balance sheets and the amounts of revenue and expenses reported for each periods presented are effected by estimates and assumptions, which are used for, but not limited to, the accounting for revenue recognition, stock-based compensation, income taxes, loss contingencies, the beneficial conversion charge, the warrant, fair value calculation, impairment of intangibles and long lived assets and accounting for research and development costs. Actual results could differ from those estimates.

Prior Period Reclassifications - Certain amounts in the prior years' consolidated financial statements have been reclassified to conform to the current-year presentation. Specifically, the Company allocated a portion of certain operating expenses from general and administrative expense to research and development expense in 2012 and recast prior year amounts to conform to the current year presentation for comparability purposes.

Investment Income and Interest Expense - Investment income consists of interest and dividend income earned on our cash, cash equivalents and short-term investments, along with realized gains (losses) on the sale of investments. Interest expense consists primarily of interest costs related to our debt and capital lease obligations.

Cash, Cash Equivalents and Short-Term Investments - The Company considers cash equivalents to be highly liquid investments with maturities of three months or less from the date of purchase. Short-term investments were available for sale and consisted primarily of short-term municipal bonds, U. S. treasuries and mutual funds. These securities were carried at fair value of the investment based on quoted market prices. The cost of the specific security sold is used to compute the gain or loss on the sale of the securities sold.

Fixed Assets, Net - Fixed assets are recorded at cost and are depreciated on a straight-line basis over the estimated useful lives of the assets. Estimated useful lives of three to seven years are used for computer equipment, laboratory equipment, office equipment and furniture and fixtures. Leasehold improvements are amortized over the shorter of the lease term or the estimated useful life of the asset. Long-lived assets, such as lab equipment, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to estimated undiscounted future cash flows expected to be generated by the asset. If the carrying amount of an asset exceeds its estimated future cash flows, then an impairment charge is recognized for the amount by which the carrying value of the asset exceeds the fair value of the asset.

Identifiable Intangible Assets and Goodwill - Identifiable intangible assets are measured at their respective fair values and are not amortized until commercialization. Once commercialization occurs, these intangible assets will be amortized over their estimated useful lives. The fair values assigned to our intangible assets are based on reasonable estimates and assumptions given available facts and circumstances. Unanticipated events or circumstances may occur that may require us to review the assets for impairment. Events or circumstances that may require an impairment assessment include negative clinical trial results, the non-approval of a new drug application by a regulatory agency, material delays in our development program or a sustained decline in market capitalization.

Indefinite-lived intangible assets are not subject to periodic amortization. Rather, indefinite-lived intangibles are reviewed for impairment by applying a fair value based test on an annual basis or more frequently if events or circumstances indicate impairment may have occurred. Events or circumstances that may require an interim impairment assessment are consistent with those described above. The Company performs its annual impairment test as of October 1 of each year.

The Company uses the income approach to derive the fair value of in-process research and development assets. This approach calculates fair value by estimating future cash flows attributable to the assets and then discounting these cash flows to a present value using a risk-adjusted discount rate. A market based valuation approach was not considered given a lack of revenues and profits for the Company. This approach requires significant management judgment with respect to unobservable inputs such as future volume, revenue and expense growth rates, changes in working capital use, appropriate discount rates and other assumptions and estimates. The estimates and assumptions used are consistent with the Company's business plans.

Debt Issuance Costs - Debt issuance costs are amortized using the effective interest rate method, and amortized to interest expense over the term of the debt. Debt issuance costs paid to the lender are reflected as a discount to the debt, and debt issuance costs paid to other third parties are reflected as other assets in the consolidated balance sheets.

Fair Value Measurements - The Company categorizes its financial assets and liabilities measured and reported at fair value in the financial statements on a recurring basis based upon the level of judgments associated with the inputs used to measure their fair value. Hierarchical levels, which are directly related to the amount of subjectivity associated with the inputs used to determine the fair value of financial assets and liabilities, are as follows:

·	Level 1 – Inputs are unadjusted, quoted prices in active markets for identical assets or liabilities at the measurement date.

·	Level 2 – Inputs (other than quoted prices included in Level 1) are either directly or indirectly observable for the assets or liability through correlation with market data at the measurement date and for the duration of the instrument's anticipated life.

·	Level 3 – Inputs reflect management's best estimate of what market participants would use in pricing the asset or liability at the measurement date. Consideration is given to the risk inherent in the valuation technique and the risk inherent in the inputs to the model.

Each major category of financial assets and liabilities measured at fair value on a recurring basis are categorized in the tables below based upon the lowest level of significant input to the valuations. The fair value hierarchy also requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.

Financial instruments in Level 1 generally include US treasuries and mutual funds listed in active markets. Financial instruments in Level 2 generally include municipal bonds listed in secondary markets.

The following table presents assets and liabilities measured at fair value as of December 31,2012 and December 31,2011 (in thousands).

	Fair Value Measurements at Reporting Date Using
		Quoted Prices in	Quoted Prices in
		Active Markets for	Inactive Markets for	Significant
		Identical Assets	Identical Assets	Unobservable Inputs
	Total	(Level 1)	(Level 2)	(Level 3)
As of December 31, 2012:
Assets:
Cash and cash equivalents	$90,782	$90,782	$-	$-
Certificate of deposit	2,153	2,153	-	-
	$92,935	$92,935	$-	$-

As of December 31, 2011:
Assets:
Cash and cash equivalents	$14,848	$14,848	$-	$-
Mutual funds	56,163	56,163	-	-
Government agency bonds	5,261	-	5,261	-
Certificate of deposit	2,085	2,085	-	-
	$78,357	$73,096	$5,261	$-

The Company's cash and cash equivalents and short-term investments, excluding government agency bonds, permit daily redemption and the fair values of these investments are based upon the quoted prices in active markets provided by the holding financial institutions. The Company's investment in government agency bonds permitted daily redemption and the fair values of these investments are based upon the quoted prices in inactive markets by the holding financial institutions. The cash equivalents consist of liquid investments with a maturity of three months or less from the date of purchase and the short-term investments consist of instruments with maturities greater than three months. The certificate of deposit matures in July 2013.

We recognize transfers between levels within the fair value hierarchy, if any, at the end of each quarter. There were no significant transfers in or out of Level 1, Level 2 or Level 3 during 2012. During 2011, approximately $27.0 million was transferred from Level 2 assets into Level 1 to be utilized in the Company's operating activities.

As of December 31,2012, the Company held no securities that were in an unrealized loss or gain position. During 2012, the Company realized a net gain of $0.8 million from the sale of short term investments.

As of December 31,2011, the Company held two securities that were in an unrealized loss position with a total estimated fair value of $12.6 million and a gross unrealized loss of approximately $0.2 million. The net unrealized gain of $0.5 million is reported in accumulated other comprehensive income in the stockholder's equity section of the Company's balance sheet. Unrealized gains and losses for 2011 are as follows (in thousands):

	Amortized Cost	Gross Unrealized Gains	Gross Unrealized Losses	Estimated Fair Value
Mutual funds	$55,718	$652	$(207)	$56,163
Government agency bonds	5,256	5	-	5,261
	$60,974	$657	$(207)	$61,424

The Company reviews the status of each security quarterly to determine whether an other-than-temporary impairment has occurred. In making our determination, we consider a number of factors, including: (1) the significance of the decline, (2) whether the securities were rated below investment grade, (3) how long the securities have been in an unrealized loss position, and (4) our ability and intent to retain the investment for a sufficient period of time for it to recover.

Concentration of Credit Risk - Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of cash, cash equivalents and short-term investments. The Company places its cash equivalents with high credit-quality financial institutions and invests its short-term investments in US treasury securities, mutual funds and government agency bonds. The Company has established guidelines relative to credit ratings and maturities that seek to maintain safety and liquidity.

The Company sources its raw materials from single suppliers. In addition, the production of the Company's product candidate is performed by a sole manufacturer. The inability of the suppliers or manufacturer to fulfill supply requirements of the Company could materially impact future operating results. A change in the relationship with the suppliers or manufacturer, or an adverse change in their business, could materially impact future operating results.

Revenue Recognition – The Company's revenues in 2011 were from (1) $3.4 million of cost recovery revenues from the use of IPLEX® in an Expanded Access Program (EAP) the Company established in Italy to provide IPLEX® to physicians for use in their patients with Amyotrophic Lateral Sclerosis (ALS) (this program was discontinued in December 2011), and (2) a $1.0 million non-refundable upfront license payment received from Eleison Pharmaceuticals, Inc. (Eleison") for the licensing of the Company's lipid-complexed cisplatin and/or liposomal cisplatin products and technology to Eleison. We recorded this revenue during 2011 as we had the contractual right to receive it and we have no continuing involvement under this licensing agreement.

The Company recognizes revenues when all of the following four criteria are present: persuasive evidence of an arrangement exists; delivery has occurred or services have been rendered; the fee is fixed or determinable; and collectability is reasonably assured.

Where the Company has continuing performance obligations under the terms of a collaborative arrangement, non-refundable upfront license payments received upon contract signing are recorded as deferred revenue and recognized as revenue as the related activities are performed. The period over which these activities are to be performed is based upon management's estimate of the development period. Changes in management's estimate could change the period over which revenue is recognized. Research and/or development payments are recognized as revenues as the related research and/or development activities are performed and when the Company has no continuing performance obligations related to the research and development payment received.

Where the Company has no continuing involvement under a collaborative arrangement, the Company records nonrefundable license fee revenues when the Company has the contractual right to receive the payment, in accordance with the terms of the collaboration agreement, and records milestones upon appropriate notification to the Company of achievement of the milestones by the collaborative partner.

The Company recognizes revenue from milestone payments when earned, provided that (i) the milestone event is substantive and its achievability was not reasonably assured at the inception of the agreement and (ii) the Company does not have ongoing performance obligations related to the achievement of the milestone earned. Milestone payments are considered substantive if all of the following conditions are met: the milestone payment (a) is commensurate with either the vendor's performance to achieve the milestone or the enhancement of the value of the delivered item or items as a result of a specific outcome resulting from the vendor's performance to achieve the milestone, (b) relates solely to past performance, and (c) is reasonable relative to all of the deliverables and payment terms (including other potential milestone consideration) within the arrangement. Any amounts received under the agreement in advance of performance, if deemed substantive, are recorded as deferred revenue and recognized as revenue as the Company completes its performance obligations.

With regard to recognizing revenue for multiple deliverable revenue arrangements, each deliverable within a multiple-deliverable revenue arrangement is accounted for as a separate unit of accounting if both of the following criteria are met: (1) the delivered item or items have value to the customer on a standalone basis and (2) for an arrangement that includes a general right of return relative to the delivered item(s), delivery or performance of the undelivered item(s) is considered probable and substantially in our control.

In addition, multiple deliverable revenue arrangement consideration is allocated at the inception of an arrangement to all deliverables using the relative selling price method. The Company also applies a selling price hierarchy for determining the selling price of a deliverable, which includes (1) vendor-specific objective evidence, if available, (2) third-party evidence, if vendor-specific objective evidence is not available, and (3) estimated selling price if neither vendor-specific nor third-party evidence is available.

Deferred revenue associated with a non-refundable payment received under a collaborative agreement that is terminated prior to its completion results in an immediate recognition of the deferred revenue.

Research and Development - Research and development expenses consist primarily of salaries, benefits and other related costs, including stock based compensation, for personnel serving in our research and development functions, and other internal operating expenses, the cost of manufacturing our drug candidate, including the medical devices for drug delivery, for clinical study, the cost of conducting clinical studies, and the cost of conducting preclinical and research activities. The Company's expenses related to manufacturing its drug candidate and medical devices for clinical study are primarily related to activities at contract manufacturing organizations that manufacture ARIKACE and the medical devices for the Company's use. The Company's expenses related to clinical trials are primarily related to activities at contract research organizations that conduct and manage clinical trials on the Company's behalf. These contracts set forth the scope of work to be completed at a fixed fee or amount per patient enrolled. Payments under these contracts primarily depend on performance criteria such as the successful enrollment of patients or the completion of clinical trial milestones as well as time-based fees. Expenses are accrued based on contracted amounts applied to the level of patient enrollment and to activity according to the clinical trial protocol. Nonrefundable advance payments for goods or services that will be used or rendered for future research and development activities are deferred and capitalized. Such amounts are then recognized as an expense as the related goods are delivered or the services are performed, or when the goods or services are no longer expected to be provided.

Stock-Based Compensation – The Company recognizes stock-based compensation expense for awards of equity instruments to employees and directors based on the grant-date fair value of those awards. The grant-date fair value of the award is recognized as compensation expense ratably over the requisite service period, which generally equals the vesting period of the award, and if applicable, is adjusted for expected forfeitures. Stock-based compensation expense is included in both research and development expenses and general and administrative expenses in the Consolidated Statements of Comprehensive Loss. For awards deemed to be granted outside of the Company's 2000 Stock Incentive Plan, the Company uses liability accounting. These awards are classified as a liability and are remeasured at fair value at the end of each reporting period. Changes in fair value are included in compensation expense in the Consolidated Statements of Comprehensive Loss (see additional disclosures related to awards granted outside of the 2000 Stock Incentive Plan in Footnote 10, Stock-Based Compensation).

Income Taxes - The Company accounts for income taxes under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss carry forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.

A valuation allowance is recorded to reduce the deferred tax assets to the amount that is expected to be realized. In evaluating the need for a valuation allowance, we take into account various factors, including the expected level of future taxable income and available tax planning strategies. If actual results differ from the assumptions made in the evaluation of our valuation allowance, we record a change in valuation allowance through income tax expense in the period such determination is made.

The Company uses a comprehensive model for how it measures, presents and discloses an uncertain tax position taken or expected to be taken in a tax return. The Company may recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by taxing authorities, based solely on the technical merits of the position. The tax benefits recognized in the financial statements from such a position should be measured based on the largest benefit that has a greater than 50% likelihood to be sustained upon ultimate settlement. The Company has no uncertain tax positions as of December 31, 2012 that qualify for either recognition or disclosure in the consolidated financial statements.

The Company's policy for interest and penalties related to income tax exposures is to recognize interest and penalties as a component of the income taxes on continuing operations in the Consolidated Statements of Comprehensive Loss.

Net Income (Loss) Per Common Share - Basic net income (loss) per common share is computed by dividing net income (loss) attributable to common stockholders by the weighted average number of common shares outstanding during the period. Diluted net income (loss) per common share is computed by dividing net income (loss) attributable to common stockholders by the weighted average number of common shares and other dilutive securities outstanding during the period. Potentially dilutive securities from stock options, the restricted stock units and the warrant would be antidilutive as the Company incurred a net loss. Potentially dilutive common shares resulting from the assumed exercise of outstanding stock options and warrants are determined based on the treasury stock method.

The following table sets forth the reconciliation of the weighted average number of shares attributable to common stockholders used to compute basic net income (loss) per share for the years ended December 31, 2012, 2011 and 2010.

	Year Ended December 31,
	2012	2011	2010
	(in thousands except per share amounts)
Numerator:
Net income (loss) attributable to common stockholders	$(41,374)	$(68,839)	$(6,434)
Denominator:
Weighted average common shares used in calculation of basic net income (loss) per share:	26,545	23,348	13,250
Effect of dilutive securities:
Common stock options	-	-	-
Restricted stock and restricted stock units	-	-	-
Common stock warrant	-	-	-
Weighted average common shares outstanding used in calculation of diluted net income (loss) per share	26,545	23,348	13,250
Net income (loss) attributable to common stockholders per share:
Basic and Diluted	$(1.56)	$(2.95)	$(0.49)

The following potentially dilutive securities have been excluded from the computations of diluted weighted-average common shares outstanding as of December 31,2012,2011 and 2010 as their effect would have been anti-dilutive (in thousands).

	2012	2011	2010
Warrants to purchase common stock	330	158	158
Stock options to purchase common stock	1,818	892	214
Restricted stock and restricted stock units	216	487	-

Segment Information - The Company currently operates in one business segment, which is the development and commercialization of inhaled therapies for patients with serious lung infections. A single management team that reports to the Chief Executive Officer comprehensively manages the entire business. The Company does not operate separate lines of business with respect to its products or product candidates. Accordingly, the Company does not have separate reportable segments.

Recently Adopted Accounting Pronouncements - In June 2011, an Accounting Standards Update was issued that eliminates the current option to report other comprehensive income (loss) and its components in the statement of stockholders' equity. Instead, an entity will be required to present items of net income and other comprehensive income (loss) in one continuous statement or in two separate, but consecutive, statements. This standard became effective retrospectively for the Company on January 1,2012. As this accounting standard relates only to the presentation of other comprehensive income (loss), the adoption of the standard did not have an impact on the Company's consolidated financial statements.

In May 2011, an amendment to an accounting standard was issued that amends the fair value measurement guidance and includes some expanded disclosure requirements. The most significant change is the disclosure information required for Level 3 (see Note 2) measurements based on unobservable inputs. This amendment became effective for the Company on January 1,2012 and its adoption did not impact the Company's consolidated financial statements.

Recently Issued Accounting Pronouncements - In February 2013, an Accounting Standards Update that requires companies to present either in a single note or parenthetically on the face of the financial statements, the effect of significant amounts reclassified from each component of accumulated other comprehensive income (loss) based on its source and the income statement line items affected by the reclassification. This guidance is effective for annual and interim reporting periods beginning after December 15,2012. The Company believes the adoption of this standard will not have a material impact on its consolidated financial statements.

In July 2012, an Accounting Standards Update was issued that allows companies to assess qualitative factors to determine the likelihood of indefinite-lived intangible asset impairment and whether it is necessary to perform the quantitative impairment test currently required. This guidance is effective for annual and interim impairment tests performed for fiscal years beginning after September 15,2012, with early adoption permitted. The Company believes the adoption of this standard will not have a material impact on its consolidated financial statements.

In December 2011, an Accounting Standards Updatewas issued that requires disclosure of information about offsetting and related arrangements to enable users of the Company's consolidated financial statements to understand the effect of those arrangements on the Company's financial position. The new guidance is effective for annual reporting periods beginning on or after January 1,2013, and interim periods within those annual periods. The disclosures required are to be applied retrospectively for all comparative periods presented. Upon adoption, the Company does not expect that this standard will materially impact our disclosures included in our consolidated financial statements.