Fair Value Accounting

6 Months Ended

Jun. 30, 2011

Fair Value Accounting [Abstract]

Fair Value Accounting

3. Fair Value Accounting

Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Valuation techniques used to measure fair value must maximize the use of observable inputs and minimize the use of unobservable inputs. Three levels of inputs, of which the first two are considered observable and the last unobservable, may be used to measure fair value. The three levels are:

• Level 1 — Quoted prices in active markets for identical assets or liabilities.

• Level 2 — Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or 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.

The following table represents the Company’s fair value hierarchy for its financial assets (cash equivalents, and marketable securities) by major security type and liability measured at fair value on a recurring basis as of June 30, 2011 and December 31, 2010 (in thousands):

June 30, 2011	Level 1		Level 2		Level 3		Total
Assets
Money market funds	$	12,318	$	—	$	—	$	12,318
Available for sale debt securities Corporate debt securities		—		25,290		—		25,290
Total available for sale debt securities	$	—	$	25,290	$	—	$	25,290
Total assets	$	12,318	$	25,290	$	—	$	37,608
Liabilities
Contingent consideration liability	$	—	$	—	$	12,800	$	12,800
Total liabilities	$	—	$	—	$	12,800	$	12,800

December 31, 2010	Level 1		Level 2		Level 3		Total
Assets
Money market funds	$	12,750	$	—	$	—	$	12,750
Available for sale debt securities Corporate debt securities	$	—	$	12,997	$	—	$	12,997
Government-sponsored enterprises		—		14,781		—		14,781
Total available for sale debt securities	$	—	$	27,778	$	—	$	27,778
Total assets	$	12,750	$	27,778	$	—	$	40,528
Liabilities
Contingent consideration liability	$	—	$	—	$	12,500	$	12,500
Total liabilities	$	—	$	—	$	12,500	$	12,500

Cash equivalents and marketable securities

The following table outlines the amortized cost, fair value and unrealized gain/(loss) for the Company’s financial assets by major security type as of March 31, 2010 and December 31, 2010 (in thousands):

					Unrealized
June 30, 2011	Amortized Cost		Fair Value		Gain/(Loss)
Money market funds	$	12,318	$	12,318	$	—
Corporate debt securities		25,273		25,290		17
Total	$	37,591	$	37,608	$	17

					Unrealized
December 31, 2010	Amortized Cost		Fair Value		Gain/(Loss)
Money market funds	$	12,750	$	12,750	$	—
Corporate debt securities		12,994		12,997		3
Government-sponsored enterprises		14,782		14,781		(1	)
Total	$	40,526	$	40,528	$	2

The Company had no sales of marketable securities during the three or six months ended June 30, 2011 or 2010. As of June 30, 2011, all of the Company’s marketable securities have a maturity of less than one year.

The Company’s available-for-sale debt securities are valued utilizing a multi-dimensional relational model. Inputs, listed in approximate order of priority for use when available, include benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers and reference data.

Contingent Consideration Liability

In connection with the exercise of the Company’s option to purchase all of the outstanding equity of Symphony Allegro, Inc. (“Allegro”), the Company is obligated to make contingent cash payments to the former Allegro stockholders related to certain payments received by the Company from future partnering agreements pertaining to AZ-004/104 (Staccato loxapine) or AZ-002 (Staccato alprazolam). In order to estimate the fair value of the liability associated with the contingent cash payments, the Company prepared several cash flow scenarios for the three product candidates, AZ-004, AZ-002 and AZ-104, which are subject to the contingent payment obligation. Each potential cash flow scenario consisted of assumptions of the range of estimated milestone and license payments potentially receivable from such partnerships and assumed royalties received from future product sales. Based on these estimates, the Company computed the estimated payments to be made to the former Allegro stockholders. Payments were assumed to terminate upon the expiration of the related patents.

The projected cash flows for AZ-004 in the U.S. and Canada continue to be based on terms similar to those noted in the agreements with Biovail Laboratories International SRL (“Biovail”) signed in February 2010 and multiple internal product sales forecasts, as the Company has assumed for purposes of estimating the contingent consideration liability that any potential partnership agreement for AZ-004 in the U.S. and Canada will have similar terms and structures to that of the Biovail agreements, despite these agreements being terminated in October 2010. The timing and extent of the projected cash flows for AZ-004 outside of the U.S. and Canada, AZ-002 and AZ-104 were based on internal estimates for potential milestones and multiple product royalty scenarios and are also consistent in structure to the Biovail agreements as the Company expects future partnerships for these product candidates to have similar structures.

The Company then assigned a probability to each of the cash flow scenarios based on several factors, including: the product candidate’s stage of development, preclinical and clinical results, technological risk related to the successful development of the different drug candidates, estimated market size, market risk and potential partnership interest to determine a risk adjusted weighted average cash flow based on all of these scenarios. These probability and risk adjusted weighted average cash flows were then discounted utilizing the Company’s estimated weighted average cost of capital (“WACC”). The Company’s WACC considered the Company’s cash position, competition, risk of substitute products, and risk associated with the financing of the development projects. The Company determined the discount rate to be 18% and applied this rate to the probability adjusted cash flow scenarios.

This fair value measurement is based on significant inputs not observed in the market and thus represents a Level 3 measurement. Level 3 instruments are valued based on unobservable inputs that are supported by little or no market activity and reflect the Company’s assumptions in measuring fair value.

The Company records any changes in the fair value of the contingent consideration liability in earnings in the period of the change. Certain events including, but not limited to, clinical trial results, U.S. Food and Drug Administration (“FDA”) approval or non-approval of the Company’s submissions, the timing and terms of any strategic partnership agreement, and the commercial success of AZ-004, AZ-104 or AZ-002 could have a material impact on the fair value of the contingent consideration liability, and as a result, the Company’s results of operations and financial position.

During the three and six months ended June 30, 2011, the Company modified the assumptions regarding the timing of certain cash flows. The changes in these assumptions and the effect of the passage of three and six months on the present value computation, result in a $300,000 increase to the contingent consideration liability in the three and six months ended June 30, 2011. The changes in these assumptions resulted in a decrease to earnings per share of less than $0.01 for the three and six months ended June 30, 2011.

The following table represents a reconciliation of the change in the fair value measurement of the contingent consideration liability for the three months and six months ended June 30, 2011 and 2010 (in thousands):

	Three Months Ended				Six Months Ended
	June 30,				June 30,
	2011		2010		2011		2010
Beginning balance	$	12,500	$	18,060	$	12,500	$	24,838
Payments made		—		—		—		(7,500	)
Adjustments to fair value measurement		300		449		300		1,171
Ending balance	$	12,800	$	18,509	$	12,800	$	18,509