Description of business and basis of presentation (Policies)

3 Months Ended

Mar. 31, 2013

Business — The Company is a biopharmaceutical company focused on the discovery and development of therapeutic products for diseases such as diabetes. The Company’s lead product candidate, AFREZZA (insulin human [rDNA origin]) inhalation powder, is an ultra rapid-acting insulin therapy in late-stage clinical investigation for the treatment of adults with type 1 or type 2 diabetes for the control of hyperglycemia.

Basis of Presentation

Basis of Presentation — The Company is considered to be in the development stage as its primary activities since incorporation have been establishing its facilities, recruiting personnel, conducting research and development, business development, business and financial planning, and raising capital. It is costly to develop therapeutic products and conduct clinical trials for these products. Since its inception through March 31, 2013 the Company has reported accumulated net losses of $2.1 billion, which include a goodwill impairment charge of $151.4 million, and cumulative negative cash flow from operations of $1.6 billion. At March 31, 2013, the Company’s capital resources consisted of cash and cash equivalents of $28.0 million and $125.4 million of available borrowings through September 30, 2013 under the loan agreement with an entity controlled by the Company’s principal stockholder, The Mann Group, LLC (“The Mann Group”) (see Note 9 — Related-party arrangements).

In October 2012, we sold in an underwritten public offering common stock and warrants resulting in net proceeds of $86.3 million and concurrently issued common stock and warrants to The Mann Group in exchange for cancellation of indebtedness under the amended and restated promissory note with The Mann Group (see Note 7 — Common and preferred stock and Note 9 — Related-party arrangements). To the extent that the trading price of our common stock exceeds the exercise price of the warrants on or about the expiration date of the public offering warrants and The Mann Group Warrants issued in October 2012, the warrant holders may potentially exercise such warrants during the fourth quarter of 2013. If the October 2012 public offering warrants are fully exercised, an additional $89.7 million in gross proceeds may become available. There can be no assurances that the trading price of our common stock will be greater than the exercise price of the warrants on or about the expiration date of the warrants due to a variety of factors, including the factors described under “Risks Related to Our Common Stock” in Item IA of Part II of this quarterly report on Form 10-Q, and there can be no assurances that the warrants will ever be exercised or that we will receive any proceeds from the exercise of the warrants.

On March 18, 2013, we entered into at-the-market issuance sales agreements (the “ATM Agreements”) with two sales agents, under which we may issue and sell shares of our common stock having an aggregate offering price of up to $50.0 million under each ATM Agreement (provided that in no event may we issue and sell more than $50.0 million of shares of our common stock under both ATM Agreements in the aggregate) from time to time through either of the sales agents. Neither we nor either of the sales agents has any obligation to sell shares of our common stock under the ATM Agreements. Any sales of common stock made under the ATM Agreements will be made in “at the market” offerings as defined in Rule 415 of the Securities Act of 1933, as amended. We have not yet issued any shares of our common stock under the ATM Agreements.

Based upon the Company’s current expectations, management believes the Company’s existing capital resources, including the available borrowings under the loan arrangement with The Mann Group and the proceeds that may be raised under the ATM agreements, will enable it to continue planned operations through at least the third quarter of 2013. However, the Company cannot provide assurances that its plans will not change or that changed circumstances will not result in the depletion of its capital resources more rapidly than it currently anticipates. The Company will need to raise additional capital, through the sale of equity or debt securities, a strategic business collaboration with a pharmaceutical company, the establishment of other funding facilities, licensing arrangements, assets sales or other means, in order to continue the development and commercialization of AFREZZA and other product candidates and to support its other ongoing activities. However, the Company cannot provide assurances that such additional capital will be available through the sale of equity or debt securities, a strategic business collaboration with a pharmaceutical company, the establishment of other funding facilities, licensing arrangements, asset sales or other means. On December 15, 2013, $115.0 million of aggregate principal under the 3.75% Senior Convertible Notes (the “2013 notes”) will mature (see Note 10 — Senior convertible notes) , and on January 1, 2014, the Company’s borrowings under the amended and restated promissory note with The Mann Group will mature. These factors raise substantial doubt about the Company’s ability to continue as a going concern. The financial statements do not include any adjustments that might result from the outcome of these uncertainties.

Fair Value of Financial Instruments

Fair Value of Financial Instruments — The carrying amounts of financial instruments, which include cash equivalents and accounts payable, approximate their fair values due to their relatively short maturities. The fair value of the note payable to related party cannot be reasonably estimated as the Company would not be able to obtain a similar credit arrangement in the current economic environment.

Cash equivalents consist of highly liquid investments with original or remaining maturities of 90 days or less at the time of purchase, that are readily convertible into cash. As of March 31, 2013 and December 31, 2012, the Company held $28.0 million and $61.8 million, respectively of cash and cash equivalents, consisting primarily of money market funds of $25.7 million and $60.8 million, respectively, and the remaining in non-interest bearing checking accounts. The fair value of these money market funds was determined by using quoted prices for identical investments in an active market (Level 1 in the fair value hierarchy).

The following is a summary of the carrying values and estimated fair values of the 2013 notes and the Company’s senior convertible notes due in 2015 (the “2015 notes”) (in millions).


	March 31, 2013				December 31, 2012
	Carrying value		Estimated fair value		Carrying value		Estimated fair value
Notes due 2013	$	114.6	$	102.2	$	114.4	$	81.9
Notes due 2015	$	97.8	$	83.8	$	97.6	$	63.2

The Company concluded that The Mann Group Common Stock Purchase Agreement entered into in February 2012 (see Note 7 — Common and preferred stock) represented a contingent forward purchase contract that met the definition of a derivative instrument in accordance with ASC 815 Derivatives and Hedging (“ASC 815”). Of the 31,250,000 shares issuable pursuant to The Mann Group Common Stock Purchase Agreement, the portion of the derivative instrument representing 14.7 million shares were recorded as equity (“Equity Portion”) as they met the criteria for equity classification under ASC 815-40 Derivatives and Hedging, Contracts in an Entity’s Own Stock. The remaining 16.5 million shares (“Non-Equity Portion”) required classification outside of equity as the Company did not have sufficient available shares at the time of issuance. The Company revalued the Non-Equity Portion of the forward purchase contract at each reporting date and recorded a fair value adjustment within “Other income (expense).” The estimated fair value of the 2013 notes was calculated based on quoted prices in an active market (Level 1 in the fair value hierarchy). The estimated fair value of the 2015 notes was calculated based on model-derived valuations whose inputs were observable, such as the Company’s stock price, and non-observable, such as the Company’s longer-term historical volatility (Level 3 in the fair value hierarchy). As there is no current observable market for the 2015 notes, the Company determined the estimated fair value using a convertible bond valuation model within a lattice framework. The convertible bond valuation model combined expected cash outflows with market-based assumptions regarding risk-adjusted yields, stock price volatility and recent price quotes and trading information regarding Company issued debt instruments and shares of common stock into which the notes are convertible.

The estimated fair value of The Mann Group Common Stock Purchase Agreement entered into in February 2012 was based on a forward purchase contract valuation (Level 3 in the fair value hierarchy). The fair value of the forward purchase contract is highly sensitive to the discount applied for lack of marketability and the stock price, and changes in this discount and/or the stock price caused the value of the forward purchase contract to change significantly. The Company recognized the change in fair value of $(336,000) in “Other income (expense)” for the three months ended March 31, 2012. The Company revalued the Non-Equity Portion using a forward contract valuation formula, in which the forward contract was estimated to be equal to the valuation date stock price minus the strike price discounted to the valuation date using a risk-free rate of 0.08% at issuance and 0.06% at March 31, 2012. As the shares which would be received upon settlement were unregistered, the Company applied a discount for lack of marketability of 2.57% at issuance and 1.64% at March 31, 2012 based on quantitative put models, adjusted to take into account qualitative factors, including the fact that the Company’s stock was publicly traded and the fact that there was no contractual restriction on the unregistered shares being registered.

The following roll-forward provides a summary of changes in fair value of the Company’s Level 3 forward purchase contract (in thousands):


	Three months ended March 31, 2013		Three months ended March 31, 2012
Beginning balance	$	—	$	—
Issuance		—		1,080
Unrealized gain/(loss) included in other income (expense)		—		(336	)

Ending balance	$	—	$	744

Recently Issued Accounting Standards

Recently Issued Accounting Standards — In February 2013, the FASB issued ASU 2013-02, Comprehensive Income (Topic 220) – Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income. These amendments do not change the current requirements for reporting net income or other comprehensive income in the financial statements. These amendments provide for additional disclosure requirements for amounts reclassified out of accumulated other comprehensive income. These amendments are effective prospectively for interim and annual periods beginning after December 15, 2012. Early adoption is permitted. Effective January 1, 2013, the Company adopted the new requirements as set forth in ASU 2013-02 in the disclosure of comprehensive income on the Company’s consolidated financial statements. The adoption of the new requirements did not have a significant impact on the Company’s consolidated financial statements.