Note 3 – Summary of Significant Accounting Policies

Basis of Presentation

The accompanying interim unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the U.S. for interim financial information in accordance with the instructions to Form 10‑Q. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the U.S. for complete consolidated financial statements. In the opinion of management, all adjustments (consisting of normally recurring accruals) considered for fair presentation have been included. Operating results for the three and six months ended June 30, 2015 are not necessarily indicative of the results that may be expected for the year ending December 31, 2015. There have been no changes to our critical accounting policies since December 31, 2014. For a discussion of our accounting policies, see, Note 3, “Accounting Policies and Recent Accounting Pronouncements,” in the Notes to Consolidated Financial Statements in our 2014 Form 10-K. Readers are encouraged to review those disclosures in conjunction with this Quarterly Report on Form 10-Q.

Use of Estimates

The preparation of financial statements, in conformity with accounting principles generally accepted in the U.S., requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Accrued Severance and Retention Costs

A liability for employee severance and retention benefits is recognized when (1) management has committed to a plan of termination; (2) the plan provides sufficient details, such as the employees affected, amounts to be paid, and expected dates of termination and payment; (3) it is unlikely that significant changes to the plan will be made or that the plan will be withdrawn; and (4) the plan has been communicated to employees.

In September 2013, we implemented an employee severance and retention plan for employees at our Totowa Facility to minimize employee turnover and encourage employees to remain with us through any potential plant closing. The plan provided for severance for non-union employees and retention bonuses for management. An additional 12 employees were subject to a collective bargaining agreement under which they were eligible to receive severance payments when the Totowa Facility closed.

In April 2015, we implemented a restructuring plan to voluntarily cease the commercialization of SURFAXIN and focus our resources on the development of our aerosolized KL4 surfactant pipeline for respiratory diseases, beginning with AEROSURF. As part of the restructuring plan, we ceased manufacturing activities at our Totowa Facility, which we closed upon the expiration of our lease on June 30, 2015.

The severance cost for all impacted employees is $2.9 million, of which $1.1 million was accrued as of March 31, 2015 for Totowa employees under the September 2013 severance and retention plan. The remaining $1.8 million was charged during the three months ended June 30, 2015 ($0.9 million to research and development expenses and $0.9 million to selling, general and administrative expenses). We paid $1.8 million of the severance and retention benefits during the three months ended June 30, 2015. The remaining $1.1 million will be paid through June 30, 2016.

Long-lived assets

Our long-lived assets, primarily consisting of manufacturing and laboratory equipment, are reviewed for impairment when events or changes in circumstances indicate the carrying amount of an asset may not be recoverable, or its estimated useful life has changed significantly. When the undiscounted cash flows of an asset are less than its carrying value, an impairment is recorded and the asset is written down to estimated value. In the second quarter of 2015, we closed the Totowa Facility and sold manufacturing equipment for total cash proceeds of $0.3 million, resulting in a $0.1 million loss from the sale and disposal of these assets.

Research and development expense

We account for research and development expense by the following categories: (a) product development and manufacturing, (b) medical and regulatory operations, and (c) direct preclinical and clinical programs. Research and development expense includes personnel, facilities, manufacturing and quality operations, pharmaceutical and device development, research, clinical, regulatory, other preclinical and clinical activities and medical affairs. Research and development costs are charged to operations as incurred.

Net loss per common share

Basic net loss per share is computed by dividing net loss by the weighted average number of common shares outstanding for the period. Diluted net loss per common share is computed by giving effect to all potentially dilutive securities outstanding for the period.

For the quarters ended June 30, 2015 and 2014, the number of shares of common stock potentially issuable upon the exercise of stock options and warrants was 21.3 million and 20.9 million shares, respectively. As of June 30, 2015 and 2014, 21.3 million and 16.4 million shares of common stock potentially issuable upon the exercise of stock options and warrants were excluded from the computation of diluted net loss per common share because their impact would have been anti-dilutive.

In accordance with Accounting Standards Codification Topic 260 (ASC 260), Earnings per Share, when calculating diluted net loss per common share, a gain associated with the decrease in the fair value of warrants classified as derivative liabilities results in an adjustment to the net loss; and the dilutive impact of the assumed exercise of these warrants results in an adjustment to the weighted average common shares outstanding. We utilize the treasury stock method to calculate the dilutive impact of the assumed exercise of warrants classified as derivative liabilities.

(in thousands)	Three Months Ended June 30,						Six Months Ended June 30,
	2015			2014			2015			2014

Numerator:
Net loss as reported	$	(11,326	)	$	(10,623	)	$	(23,505	)	$	(22,099	)
Less: income from change in fair value of warrant liability		(469	)		(1,447	)		(438	)		(1,820	)
Numerator for diluted net loss per common share	$	(11,795	)	$	(12,070	)	$	(23,943	)	$	(23,919	)

Denominator:
Basic weighted average common shares outstanding		85,753			85,061			85,671			84,766
Dilutive common shares from assumed warrant exercises		–			821			–			1,345
Diluted weighted average common shares outstanding		85,753			85,882			85,671			86,111

We do not have any components of other comprehensive income (loss).

Recent accounting pronouncements

In April 2015, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2015-03, Simplifying the Presentation of Debt Issuance Costs, which requires an entity to present debt issuance costs in the balance sheet as a direct deduction from the carrying amount of the corresponding debt liability, consistent with debt discounts. The guidance would not address situations in which debt issuance costs do not have an associated debt liability or exceed the carrying amount of the associated debt liability (e.g., an undrawn or partially drawn line of credit). The new standard is effective for us in the annual period ending December 31, 2016, including interim periods within that annual period. Early adoption is permitted and the standard is to be applied retrospectively. We are evaluating the effect that ASU 2015-03 will have on our consolidated financial statements and related disclosures.