4. 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 fair value hierarchy for our financial assets (cash equivalents, marketable securities and restricted cash) by major security type and contingent consideration liability measured at fair value on a recurring basis as of March 31, 2016 and December 31, 2015 (in thousands):

March 31, 2016	Level 1		Level 2		Level 3		Total
Assets
Money market funds	$	4,408	$	—	$	—	$	4,408
Total assets	$	4,408	$	—	$	—	$	4,408
Liabilities
Contingent consideration liability	$	—	$	—	$	2,600	$	2,600
Total liabilities	$	—	$	—	$	2,600	$	2,600

December 31, 2015	Level 1		Level 2		Level 3		Total
Assets
Money market funds	$	6,806	$	—	$	—	$	6,806
Total assets	$	6,806	$	—	$	—	$	6,806
Liabilities
Contingent consideration liability	$	—	$	—	$	2,800	$	2,800
Total liabilities	$	—	$	—	$	2,800	$	2,800

Cash equivalents and marketable securities

The amortized cost, fair value and unrealized gain/(loss) for our financial assets by major security type as of March 31, 2015 and December 31, 2015 are as follows (in thousands):

	Amortized						Unrealized
March 31, 2016	Cost			Fair Value			Gain/(Loss)
Money market funds	$	4,408		$	4,408		$	—
Total		4,408			4,408			—
Less amounts classified as cash equivalents		(4,408	)		(4,408	)		—
Total marketable securities	$	—		$	—		$	—

	Amortized						Unrealized
December 31, 2015	Cost			Fair Value			Gain/(Loss)
Money market funds	$	6,806		$	6,806		$	—
Total		6,806			6,806			—
Less amounts classified as cash equivalents		(6,806	)		(6,806	)		—
Total marketable securities	$	—		$	—		$	—

We had no sales of marketable securities during the three months ended March 31, 2016 or 2015.

Contingent Consideration Liability

In connection with the exercise of our option to purchase all of the outstanding equity of Symphony Allegro, Inc., or Allegro, in 2009, we are obligated to make contingent cash payments to the former Allegro stockholders related to certain payments received by us from future collaboration agreements pertaining to ADASUVE/AZ-104 (Staccato loxapine) or AZ-002 (Staccato alprazolam). In order to estimate the fair value of the liability associated with the contingent cash payments, we 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 collaborations and assumed royalties received from future product sales. Based on these estimates, we computed the estimated payments to be made to the former Allegro stockholders. Payments were assumed to terminate in accordance with current agreement terms or, if no agreements exist, upon the expiration of the related patents.

The projected cash flow assumptions for ADASUVE in the United States are based on internally and externally developed product sales forecasts. The timing and extent of the projected cash flows for ADASUVE for the territories in which ADASUVE is licensed to Ferrer, or the Ferrer Territories are based on a Collaboration, License and Supply Agreement we executed with Ferrer in October 2011, or the Ferrer Agreement. 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 most recently negotiated collaboration agreements.

We 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 collaboration 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 our estimated weighted average cost of capital, or WACC. Our WACC considered our cash position, competition, risk of substitute products, and risk associated with the financing of the development projects. We have used a discount rate of 20% since the fourth quarter of 2014 to reflect our current estimated WACC based on our current financial condition, market capitalization and our estimated increase in borrowing costs.

The fair value measurement of the contingent consideration liability 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 our assumptions in measuring fair value.

We record 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, the timing and terms of any collaboration agreement, clinical trial results, approval or non-approval of any future regulatory submissions 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, our results of operations and financial position for the impacted period.

During the three months ended March 31, 2016, we updated the discounted cash flow model to reflect adjusted U.S. ADASUVE milestones and royalties with any future U.S. collaborator and adjusted sales milestones for ADASUVE in the Ferrer Territories. These changes resulted in our recognizing a non-operating, non-cash gain of $200,000, or $0.009 per share during the three months ended March 31, 2016.

During the three months ended March 31, 2015, we updated the discounted cash flow model to reflect adjusted ADASUVE sales projections and the projected timing of the receipt of certain milestone payments. As part of this process, we received updated projections from our collaboration partners in late March, 2015 that indicated sales of ADASUVE would be lower in 2015 and 2016 than had been anticipated in the various projections and scenarios used to estimate the contingent consideration liability in previous periods. As a result of these lower projected sales and the decision to suspend our commercial production operations (see Note 12), we reevaluated the rate at which we believe sales will increase, the amount of peak sales, the period of time it will take to reach peak sales, the number of years at which peak sales would be achieved, and the related impact on the amount and timing of related royalties and milestones to be received. This evaluation resulted in a decrease to projected sales and the related milestones and royalties under the high, medium, and low sales scenarios and a heavier weighting to the lower sales scenario. These changes on the discounted cash flow model resulted in a decrease to our net loss of $14,833,000, or $0.75 per share, for the three months ended March 31, 2015. A payment of $867,000 was made during the same period to the former Allegro stockholders.

The following table represents a reconciliation of the change in the fair value measurement of the contingent consideration liability for the three months ended March 31, 2016 and 2015 (in thousands):

	Three Months Ended
	March 31,
	2016			2015
Beginning balance	$	2,800		$	30,800
Payments made		—			(867	)
Adjustments to fair value measurement		(200	)		(14,833	)
Ending balance	$	2,600		$	15,100

Financing Obligations

We have estimated the fair value of our financing obligations (Refer to Note 8 –Financing Obligations) using the net present value of the payments discounted at an interest rate that is consistent with our estimated current borrowing rate for similar long-term debt. We believe the estimates used to measure the fair value of the financing obligations constitute Level 3 inputs.

At March 31, 2016 and December 31, 2015, the estimated fair value of our financing obligations was $50,028,000 and $52,151,000, respectively, and had book values of $67,953,000 and $67,967,000, 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 estimated 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. In addition, the fair value of our royalty securitization financing will be affected by the timing and amount of U.S. ADASUVE royalties and milestones.