Summary of Significant Accounting Policies

9 Months Ended

Sep. 30, 2012

Summary of Significant Accounting Policies [Abstract]

Summary of Significant Accounting Policies

NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

We have prepared the accompanying interim condensed consolidated financial statements in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, these financial statements and accompanying notes do not include all of the information and disclosures required by generally accepted accounting principles for complete financial statements. The financial statements include all adjustments (consisting of normal recurring adjustments) that management believes are necessary for the fair statement of the balances and results for the periods presented. These interim financial statement results are not necessarily indicative of the results to be expected for the full fiscal year or any future interim period.

The year-end condensed consolidated balance sheet at December 31, 2011 was derived from audited financial statements, and does not include all the disclosures required by accounting principles generally accepted in the United States. The financial statements and related disclosures have been prepared with the presumption that users of the interim financial statements have read or have access to the audited financial statements for the preceding fiscal year. Accordingly, these financial statements should be read in conjunction with the audited financial statements and notes thereto contained in our Form 10-K for the year ended December 31, 2011.

Reclassifications

Certain prior period amounts in the condensed consolidated statements of cash flows have been reclassified to conform to current period presentation. Such reclassification did not impact our net income (loss) or financial position.

Revenue Recognition

We recognize revenue when all of the following criteria are met: 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. Collaboration revenue, which is earned under license agreements with third parties, may include nonrefundable license fees, cost reimbursements and contingent milestones.

Before January 1, 2011, we evaluated license arrangements with multiple elements in accordance with Accounting Standards Codification, or ASC, 605-25 Revenue Recognition – Multiple-Element Arrangements. In October 2009, the Financial Accounting Standards Board, or FASB, issued Accounting Standards Update, or ASU, 2009-13 Revenue Arrangements with Multiple Deliverables, or ASU 2009-13, which amended the accounting standards for certain multiple element revenue arrangements to:

• provide updated guidance on whether multiple elements exist, how the elements in an arrangement should be separated, and how the arrangement consideration should be allocated to the separate elements;

• require an entity to allocate arrangement consideration to each element based on a selling price hierarchy, also called the relative selling price method, where the selling price for an element is based on vendor-specific objective evidence (“VSOE”), if available; third-party evidence (“TPE”), if available and VSOE is not available; or the best estimate of selling price (“ESP”), if neither VSOE nor TPE is available; and

• eliminate the use of the residual method and require an entity to allocate arrangement consideration using the selling price hierarchy.

The revenue allocated to each element is then recognized when the basic revenue recognition criteria are met for that element.

On January 1, 2011, we adopted ASU 2009-13 on a prospective basis. The new accounting standard for revenue recognition, if applied in the same manner to the year ended December 31, 2010, would not have any impact to total revenue and deferred revenue for that fiscal year as we did not have any collaboration revenue in fiscal 2010 or any deferred revenue as of December 31, 2010. The new accounting guidance for revenue recognition has not had a significant effect on total net revenue in periods after initial adoption, although the impact on the timing of revenue will vary depending on the evaluation of the elements of any new arrangements.

VSOE is based on the price charged when the element is sold separately and is the price actually charged for that deliverable. We typically are not able to establish VSOE for the elements of a license arrangement because each arrangement is unique, an arrangement typically consists of multiple elements and we have limited history of entering into license arrangements.

When VSOE cannot be established, we attempt to establish the selling price of the elements of a license arrangement based on TPE. TPE is determined based on a competitor’s price for similar deliverables when sold separately. We typically are not able to determine TPE for license arrangements, as they contain a significant level of differentiation such that the comparable pricing of a competitor’s license arrangement with similar functionality cannot be obtained, and we are therefore unable to reliably determine what a similar competitor’s license arrangement’s selling price would be on a standalone basis.

When we are unable to establish the selling price of an element using VSOE or TPE, we use the ESP in our allocation of the upfront payment. The objective of the ESP is to determine the price at which we would transact a sale if the element of the license arrangement were sold on a standalone basis.

Our process for determining ESPs involves management’s judgment. Our process considers multiple factors such as discounted cash flows, estimated direct expenses and other costs and available data, which may vary over time, depending upon the circumstances, and relate to each deliverable. If the estimated obligation period of one or more deliverables should change, the future amortization of the revenue would also change. We regularly review ESP and maintain internal controls over the establishment and updates of the estimates.

We entered into a Collaboration Agreement with Allergan, Inc. in January 2011 which requires us to provide multiple deliverables, including: a license to commercialize LEVADEX, clinical and regulatory work necessary for FDA approval of the first indication for LEVADEX (acute treatment of migraine in adults), manufacturing process development for LEVADEX, an option to include Canada in the territory in which Allergan can promote LEVADEX, and participation in various committees jointly with Allergan throughout the term of the Collaboration Agreement. These deliverables are non-contingent in nature. We received an upfront cash payment of $60.0 million from Allergan upon execution of the Collaboration Agreement. In accordance with ASU 2009-13, we evaluated whether there is standalone value for each of the various non-contingent deliverables. We have determined that the license delivered by us and other non-contingent deliverables do not have standalone value separate from each other, based on contractual limitations in the Collaboration Agreement that restrict Allergan from using the license for its intended purpose without other non-contingent deliverables from us.

We believe that since the license does not have standalone value, it must be combined with all the remaining non-contingent deliverables because the license would not be fully delivered for its intended purpose unless we continue to perform our obligation to participate in the various committees jointly with Allergan. Accordingly, all of the non-contingent deliverables are treated as a single unit of accounting, and we have combined the delivered license with the remaining non-contingent deliverables for accounting purposes. As a result, revenue relating to the $60.0 million upfront cash payment was deferred and will be recognized on a straight-line basis over the term of the Collaboration Agreement through 2028, which represents the estimated obligation period of the participation in the various joint committees, the non-contingent deliverable with the longest term.

The Collaboration Agreement also contains contingent deliverables that do not relate to the non-contingent deliverables identified above. For example, we will collaborate and share expenses with Allergan to develop LEVADEX for additional indications separate from and in addition to the first indication. Any reimbursements from Allergan to us for shared expenses relating to contingent deliverables are recorded in our financial statements in the quarters in which the cost sharing occurs.

Milestone payments relating to contingent deliverables, such as the acceptance for filing by the FDA of our NDA for LEVADEX, are recognized as revenue in their entirety upon our achievement of a substantive milestone and when the respective revenue recognition criteria are met. A milestone is substantive if the consideration earned from the achievement of the milestone (i) is consistent with performance required to achieve the milestone or the increase in value to the delivered item, (ii) relates solely to past performance and (iii) is reasonable relative to all of the other deliverables and payments within the arrangement.

Stock-Based Compensation

Effective January 1, 2006, we adopted ASC 718 Compensation – Stock Compensation, or ASC 718, using the prospective transition method, which requires the measurement and recognition of compensation expense for all stock-based payment awards granted, modified and settled to our employees and directors after January 1, 2006. ASC 718 requires companies to estimate the fair value of the stock-based payment awards on the date of grant using an option-pricing model. Our financial statements reflect the impact of ASC 718. We chose the “straight-line” attribution method for allocating compensation costs and recognized the fair value of each stock option on a straight-line basis over the requisite service period.

For restricted stock units, or RSUs, with time-based vesting, the fair value is based on the closing price of our common stock on the date of grant. We measure compensation expense for these RSUs at fair value on the date of grant and recognize the expense over the expected vesting period, after considering the estimated forfeitures.

For RSUs with performance-based vesting, the fair value is based on the closing price of our common stock on the date of grant. A probability assessment that performance goals will be achieved is made quarterly. The compensation expense is recognized over the vesting period, and is adjusted periodically for forfeiture rate and any changes to our probability assessment of the number of performance-based RSUs expected to vest as a result of our achievement of the performance goals.

Concentration of Credit Risk and Other Risks and Uncertainties

We invest cash that is not currently being used for operational purposes in accordance with our investment policy. The policy allows for the purchase of debt securities such as those issued by the U.S. government and its agencies and subject to certain concentration limits by corporations. We also strive to limit risk by specifying a minimum credit quality for corporate debt securities of A1/P1 for commercial paper and AAA for other securities. The maximum maturity for these securities does not exceed 12 months. We believe our established guidelines for investment of our excess cash maintains safety and liquidity through our policies on diversification and investment maturity. Our cash and cash equivalent balances can be in excess of federally insured amounts.

At September 30, 2012, our collaboration with Allergan accounted for 100% of our accounts receivable. For the three and nine months ended September 30, 2012 and 2011, our collaboration with Allergan accounted for 100% of our collaboration revenue.

We do not own or operate manufacturing facilities for clinical or commercial manufacture of our product candidates. We rely on our contract manufacturers for items such as drug substance and drug packaging, including the components of the TEMPO inhaler, the device used to administer certain of our drug candidates, including LEVADEX. If our contract manufacturers fail to deliver the required commercial quantities of finished product on a timely basis and at commercially reasonable prices and we are unable to find one or more replacement manufacturers capable of production at a substantially equivalent cost, in substantially equivalent volumes and quality and on a timely basis, we would likely be unable to meet demand for our products and we would lose potential revenue. It may take a significant period of time to establish an alternative source of supply for our product candidates.

Our product candidates require approval from the FDA or other international regulatory agencies prior to commencing commercial sales. There can be no assurance that our product candidates will receive any of these required approvals. If we are denied such approvals or such approvals are delayed, our results of operations, financial position and future cash flows may be materially adversely affected.

Net Income (Loss) per Share

Basic net income (loss) per common share and diluted net income (loss) per common share are presented in conformity with ASC 260 Earnings per Share, for all periods presented. Basic net income (loss) per share is computed by dividing net income (loss) attributable to common stockholders by the weighted average number of shares of common stock outstanding during the period. Diluted net income (loss) per share is computed using the weighted average number of shares of common stock outstanding and potential shares assuming the dilutive effect of outstanding stock options, warrants, common stock issuable pursuant to our employee stock purchase plan, or ESPP, and RSUs with time-based vesting using the treasury stock method.

The following table presents the calculation of weighted average shares of common stock used in the computations of basic and diluted income (loss) per share amounts presented in the accompanying condensed consolidated statements of operations (in thousands, except per share amounts):

	Three Months Ended September 30,					Nine Months Ended September 30,
	2012			2011		2012			2011
Net income (loss) attributed to common stockholders	$	(12,622	)	$	8,183	$	(43,757	)	$	(19,119	)
Basic:
Weighted average common shares used in computing basic net income (loss) per common share		33,369			30,440		31,569			30,329
Basic income (loss) per common share	$	(0.38	)	$	0.27	$	(1.39	)	$	(0.63	)
Diluted:
Weighted average common shares used in computing basic net income (loss) per common share		33,369			30,440		31,569			30,329
Add: Weighted average stock options		—			1,158		—			—
Add: Weighted average warrants		—			13		—			—
Add: Weighted average ESPP		—			—		—			—
Add: Weighted average RSUs with time-based vesting		—			—		—			—
Weighted average common shares used in computing diluted net income (loss) per common share		33,369			31,611		31,569			30,329
Diluted income (loss) per common share	$	(0.38	)	$	0.26	$	(1.39	)	$	(0.63	)

The following outstanding common stock options, RSUs with time-based vesting, common stock issuable pursuant to our ESPP and warrants to purchase common stock were excluded from the computation of diluted net loss per share for the periods presented because including them would have had an anti-dilutive effect. The RSUs with performance-based vesting were also excluded from the computation of diluted net loss per share because they were contingently issuable shares (in thousands):

	Three Months Ended September 30,				Nine Months Ended September 30,
	2012		2011		2012		2011
Options to purchase common stock		4,980		1,570		4,980		4,386
RSUs with time-based vesting		293		142		293		156
Common stock issuable pursuant to the ESPP		54		—		54		35
Warrants to purchase common stock		27		—		27		27
RSUs with performance-based vesting		35		39		35		39

New Accounting Standard Adopted

Effective January 1, 2012, we adopted revised guidance related to the presentation of comprehensive income that increases comparability between U.S. GAAP and International Financial Reporting Standards. This guidance eliminates the current option to report other comprehensive income, or OCI, and its components in the statement of changes in stockholders’ equity. We adopted this guidance during the first quarter of 2012 and elected to disclose OCI in a single continuous statement during interim reporting periods.