Fair Value Accounting

9 Months Ended

Sep. 30, 2012

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 September 30, 2012 and December 31, 2011 (in thousands):

September 30, 2012	Level 1		Level 2		Level 3		Total
Assets
Money market funds	$	24,807	$	—	$	—	$	24,807
Liabilities
Contingent consideration liability	$	—	$	—	$	10,500	$	10,500
Total liabilities	$	—	$	—	$	10,500	$	10,500

December 31, 2011	Level 1		Level 2		Level 3		Total
Assets
Money market funds	$	12,619	$	—	$	—	$	12,619
Available for sale debt securities
Corporate debt securities	$	—	$	2,001	$	—	$	2,001
Total available for sale debt securities	$	—	$	2,001	$	—	$	2,001
Total assets	$	12,619	$	2,001	$	—	$	14,620
Liabilities
Contingent consideration liability	$	—	$	—	$	16,500	$	16,500
Total liabilities	$	—	$	—	$	16,500	$	16,500

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 September 30, 2012 and December 31, 2011 (in thousands):

September 30, 2012	Amortized Cost			Fair Value			Unrealized Gain/(Loss)
Money market funds	$	24,807		$	24,807		$	—
Less amounts classified as cash equivalents		(24,807	)		(24,807	)		—
Total marketable securities	$	—		$	—		$	—
December 31, 2011	Amortized Cost			Fair Value			Unrealized Gain/(Loss)
Money market funds	$	12,619		$	12,619		$	—
Corporate debt securities		2,001			2,001			—
Total		14,620			14,620			—
Less amounts classified as cash equivalents		(12,619	)		(12,619	)		—
Total marketable securities	$	2,001		$	2,001		$	—

The Company had no sales of marketable securities during the three or nine months ended September 30, 2012 or 2011. As of September 30, 2012, 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 ADASUVE (Staccato loxapine), AZ-104 (Staccato loxapine, low-dose) 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 ADASUVE, AZ-104 and AZ-002, 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 flow assumptions for ADASUVE in the United States (“U.S.”) and Canada continue to be based on the terms of the agreements with Biovail Laboratories International SRL (“Biovail”) signed in February 2010 and multiple internal product sales forecasts, as the Company expects that any potential partnership agreement for ADASUVE in the U.S. and Canada would have similar terms to that of the Biovail agreements, despite these agreements being terminated in October 2010. The timing and extent of the projected cash flows for ADASUVE for the territories licensed to Grupo Ferrer are based on the Grupo Ferrer agreement, as amended (see Note 9). The timing and extent of the projected cash flows for the remaining territories for ADASUVE and worldwide territories for 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 products and 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 measurements 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, European Medicines Agency approval or non-approval of the Company’s submissions, the timing and terms of any strategic partnership agreement, and the commercial success of ADASUVE, 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 nine months ended September 30, 2011, the Company modified the assumptions regarding the timing and/or probability of certain cash flows to reflect the completion of the Grupo Ferrer licensing agreement (see Note 9). The changes in these assumptions and the effect of the passage of three and nine months on the present value computation resulted in an increase to the net loss of $3,000,000, or $0.42 per share, for the three months ended September 30, 2011 and an increase to the net loss of $3,300,000 or $0.50 per share for the nine months ended September 30, 2011.

During the three and nine months ended September 30, 2012, the Company modified the assumptions regarding the timing and extent of certain cash flows primarily to reflect the three month extension of the FDA’s review of the Company’s ADASUVE New Drug Application (“NDA”) from February 4, 2012 to May 4, 2012 and the receipt of the CRL for the ADASUVE NDA in May 2012. This change in assumptions and the effects of the passage of time on the present value computation resulted in an increase to the net loss of $200,000, or $0.02 per share, for the three months ended September 30, 2012 and a decrease to the net loss of $1,000,000 or $0.09 per share for the nine months ended September 30, 2012.

The following table represents a reconciliation of the change in the fair value measurement of the contingent consideration liability for the three and nine months ended September 30, 2012 and 2011 (in thousands):

	Three Months Ended September 30,				Nine Months Ended September 30,
	2012		2011		2012			2011
Beginning balance	$	10,300	$	12,800	$	16,500		$	12,500
Payments made				—		(5,000	)		—
Adjustments to fair value measurement		200		3,000		(1,000	)		3,300
Ending balance	$	10,500	$	15,800	$	10,500		$	15,800

Financing Obligations

The Company has estimated the fair value of its financing obligations (see Note 7) using the net present value of the payments discounted at an interest rate that is consistent with its estimated current borrowing rate for similar long-term debt. The Company believes the estimates used to measure the fair value of the financing obligations constitute Level 3 inputs.

At September 30, 2012 and December 31, 2011, the estimated fair value of our financing obligations was $7,713,000 and $11,720,000, respectively and had book values of $7,994,000 and $12,280,000, respectively. Our payment commitments associated with these debt instruments may vary with changes in interest rates and are comprised of interest payments and principal payments. The fair value of our debt will fluctuate with movements of interest rates, increasing in periods of declining rates of interest and declining in periods of increasing rates of interest.