2. Summary of Significant Accounting Policies

Revenue Recognition

We recognize revenue when (i) persuasive evidence of an arrangement exists; (ii) delivery has occurred or services have been rendered; (iii) the fee is fixed or determinable; and (iv) collectability is reasonably assured. Prior to the second quarter of 2013, our revenue consisted primarily of amounts earned from collaboration agreements and under research grants with the National Institutes of Health. Beginning in the second quarter of 2013, we also have revenue from product sales and beginning in the second quarter of 2014, royalties from the sale of our products by our collaborators.

For collaboration agreements, revenues for non-refundable upfront license fee payments, where we continue to have performance obligations, are recognized as performance occurs and obligations are completed. Revenues for non-refundable upfront license fee payments where we do not have significant future performance obligations are recognized when the agreement is signed and the payments are due.

For multiple element arrangements, such as collaboration agreements in which a collaborator may purchase several deliverables, we account for each deliverable as a separate unit of accounting if both of the following criteria are met: (i) the delivered item or items have value to the customer on a standalone basis; and (ii) 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. We evaluate how the consideration should be allocated among the units of accounting and allocate revenue to each non-contingent element based upon the relative selling price of each element. We determine the relative selling price for each deliverable using (i) vendor-specific objective evidence, or VSOE, of selling price if it exists; (ii) third-party evidence, or TPE, of selling price if it exists; or (iii) our best estimated selling price for that deliverable if neither VSOE nor TPE of selling price exists for that deliverable. We then recognize the revenue allocated to each element when the four basic revenue criteria described above are met for each element.

For milestone payments received in connection with our collaboration agreements, we have elected to adopt the milestone method of accounting under Financial Accounting Standards Board Accounting Standards Codification 605-28, Milestone Method. Under the milestone method, revenues for payments which meet the definition of a milestone will be recognized as the respective milestones are achieved.

We recognize product revenue as follows:

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Persuasive Evidence of an Arrangement. We currently sell product through license and supply agreements with Ferrer and Teva Pharmaceuticals USA, Inc., or Teva. Persuasive evidence of an arrangement is generally determined by the receipt of an approved purchase order from the collaborator in connection with the terms of the related license and supply agreements.

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Delivery. Typically, ownership of the product passes to the collaborator upon shipment. Our current license and supply agreements also provide our collaborators with an acceptance period during which they may reject any product which does not conform to agreed-upon specifications. Because ADASUVE is a new product, a new technology and our first product to be commercialized, and because we do not have a history of producing product to collaborator specifications, we will not consider delivery to have occurred until after the collaborator acceptance period has ended or the collaborator has positively accepted the product. Once we have demonstrated over the course of time an ability to reliably produce the product to collaborator specifications, we will consider delivery to have occurred upon shipment in the absence of any other relevant shipment or acceptance terms.

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Sales Price Fixed or Determinable. Sales prices for product shipments are determined by license and supply agreements and documented in purchase orders. After the collaborator acceptance period has ended or the collaborator has positively accepted the product, our collaborators do not have any product return or replacement rights, including for expired products.

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Collectability. Payment for the product is contractually obligated under the license and supply agreements. We will monitor payment histories for our collaborators and specific issues as they arise to determine whether collection is probable for a specific transaction and defer revenue as necessary.

Royalty revenue from our collaboration agreements will be recognized as we receive information from our collaborators regarding product sales and collectability is reasonably assured.

Significant management judgment is used in the determination of revenue to be recognized and the period in which it is recognized.

Inventory

Inventory is stated at standard cost, which approximates actual cost, determined on a first-in first-out basis, not in excess of market value. Inventory includes the direct costs incurred to manufacture products combined with allocated manufacturing overhead, which consists of indirect costs, including labor and facility overhead. We are in the early stages of commercialization and have incurred significantly higher than normal indirect costs in the production of our inventory due to start-up manufacturing costs and low production volumes. The carrying cost of inventory is reduced so as to not be in excess of the market value of the inventory as determined by the contractual transfer prices to Ferrer and Teva. The excess over the market value is expensed to cost of goods sold. All costs associated with the ADASUVE manufacturing process incurred prior to regulatory approval and the beginning of commercial manufacturing were expensed as a component of research and development expense. If information becomes available that suggests that all or certain of the inventory may not be realizable, we may be required to expense a portion, or all, of the capitalized inventory into cost of goods sold. Inventory, which is stated at the lower of cost or estimated market value, consists of the following at September 30, 2014 and December 31, 2013 (in thousands):


	September 30, 2014		December 31, 2013
Raw materials	$	3,543	$	3,044
Work in process		—		—
Finished goods		871		403

Total inventory	$	4,414	$	3,447

New Accounting Pronouncement

In August 2014, the Financial Accounting Standards Board issued Accounting Standards Update (“ASU”) No. 2014-15, Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern (“ASU 2014-15”). ASU 2014-15 requires management to evaluate whether there is substantial doubt about an entity’s ability to continue as a going concern and to provide related footnote disclosures. In doing so, companies will have reduced diversity in the timing and content of footnote disclosures than under the current guidance. ASU 2014-15 is effective for the Company in the first quarter of 2016 with early adoption permitted. The Company does not believe the impact of adopting ASU 2014-15 on its consolidated financial statements will be material.

In May 2014 the Financial Accounting Standards Board, or FASB, issued the Accounting Standards Update, or ASU, No. 2014-09, Revenue from Contracts with Customers (Topic 606), that will supersede nearly all existing revenue recognition guidance under US GAAP. The core principle of the guidance is that an entity should recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. The standard will be effective for public entities for annual and interim periods beginning after December 15, 2016.

Entities can choose to apply the standard using either the full retrospective approach or a modified retrospective approach. Entities electing the full retrospective adoption will apply the standard to each period presented in the financial statements. This means that entities will have to apply the new guidance as if it had been in effect since the inception of all its contracts with customers presented in the financial statements. Entities that elect the modified retrospective approach will apply the guidance retrospectively only to the most current period presented in the financial statements. This means that entities will have to recognize the cumulative effect of initially applying the new standard as an adjustment to the opening balance of retained earnings at the date of initial application. The new revenue standard will be applied to contracts that are in progress at the date of initial application.

We plan to adopt the new standard on January 1, 2017. We have not yet evaluated which adoption method we plan to use or the potential effect the new standard will have on our consolidated financial statements.