2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

The financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP") and reflect the following significant accounting policies. Management has determined that the Company operates in one segment: the development of pharmaceutical products on its own behalf or in collaboration with others.

Estimates and Uncertainties

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates. Significant items subject to such estimates and assumptions include the valuation of liability classified warrants and stock-based awards, long lived asset impairment, and revenue recognition.

Reclassifications

Certain prior year amounts have been reclassified to conform to current year presentation. These changes did not have a significant impact on the Company's net loss, assets, liabilities, shareholders' equity (deficit) or cash flows.

Cash and Cash Equivalents

The Company considers all highly liquid investments with an original maturity of 90 days or less from the date of purchase to be cash equivalents.

Accounts Receivable

Accounts receivable are stated at invoiced amount and do not bear interest. Because the accounts receivable are primarily from the U.S. government and historically no amounts have been written off, an allowance for doubtful accounts receivable is not considered necessary. The accounts receivable balance included $2,093,000 and $3,224,000 of receivables from the U.S. government that were unbilled at December 31, 2011 and 2010, respectively. $1,589,428 of the unbilled receivables at December 31, 2011 were billed to the U.S. government in January and February 2012.

Property and Equipment

Property and equipment is stated at cost and depreciated over the estimated useful lives of the assets, generally five years, using the straight-line method. Leasehold improvements are amortized over the shorter of the lease term or the estimated useful life of the asset, which is generally five years, using the straight-line method. Expenditures for repairs and maintenance are expensed as incurred. Expenditures that increase the useful life or value of the property and equipment are capitalized. Expenditures made for equipment specifically utilized and paid for by government research projects are expensed.

Amounts included in property and equipment are as follows:


	As of December 31,
	2011			2010
	(in thousands)
Lab equipment	$	6,920		$	6,207
Office equipment		1,295			1,188
Leasehold improvements		9,959			9,638
Building (formerly held for sale)		1,856			—

		20,030			17,033
Less accumulated depreciation		(15,765	)		(14,963	)

Property and equipment, net	$	4,265		$	2,070

In November 2009, the Company decided to outsource its large-scale manufacturing activities and listed for sale the industrial property it owns in Corvallis, Oregon. In connection with this decision, the Company classified the property as "Property held for sale" in the fourth quarter of 2009, ceased depreciating the property and recorded an impairment charge of $128,000 to reduce the carrying value of the property to fair market value less the costs to sell. The Company recorded similar impairment charges in 2011 and 2010 of $109,000 and $408,000, respectively. The Company, with the assistance of independent appraisals, periodically estimated the value of the property which is considered a Level 3 fair value measure. In November 2011, the Company leased approximately 70% of the building to a third party through March 31, 2017 at rates ranging from $14,500 per month to $15,500 per month. Under the terms of the agreement, the third party can terminate the lease in November 2014 upon proper notice and delivery of a termination fee. In addition, the third party has the option to purchase the building for prices ranging from $2.0 million to $2.2 million during the initial lease term. Upon entering into the lease agreement, the Company reclassified the carrying value of the building from "Property held for sale" to "Property and equipment" and began depreciating the building over 30 years which is the remaining term of the ground lease.

Depreciation expense was $838,000 in 2011, $1,217,000 in 2010 and $1,154,000 in 2009.

Patent Costs

Patent costs consist primarily of external legal costs, filing fees incurred to file patent applications and renewal fees on proprietary technology developed or licensed by the Company. Patent costs associated with applying for a patent, being issued a patent and annual renewal fees are capitalized. Costs to defend a patent and costs to invalidate a competitor's patent or patent application are expensed as incurred. Patent costs are amortized on a straight-line basis over the shorter of the estimated economic lives and the initial term of the patents, generally 20 years. Patent amortization expense was $462,000, $246,000 and $225,000 for the years ended December 31, 2011, 2010 and 2009, respectively. The Company also expensed the remaining net book value of previously capitalized patents that were later abandoned of $190,000, $766,000 and $347,000, in 2011, 2010 and 2009, respectively. The Company expects to incur amortization expense of approximately $415,000 per year over the next five years based on the unamortized patent costs as of December 31, 2011.

Revenue Recognition

Government Research Contract Revenue. Substantially all of the Company's revenue is generated from U.S. government research contracts and grants. See "Note 7—U.S. Government Contracts." The Company's contracts with the U.S. government are cost plus contracts providing for reimbursed costs which include overhead and general and administrative costs and a target fee. The Company recognizes revenue from U.S. government research contracts during the period in which the related expenses are incurred and presents such revenues and related expenses gross in the consolidated financial statements.

License Arrangements. License arrangements may consist of non-refundable upfront license fees, data transfer fees, research reimbursement payments, exclusive licensed rights to patented or patent pending compounds, technology access fees, various performance or sales milestones and future product royalty payments. Some of these arrangements are multiple element arrangements. The Company defers recognition of non-refundable upfront fees if it has continuing performance obligations without which the technology, right, product or service conveyed in conjunction with the non-refundable fee has no utility to the licensee that is separate and independent of Company performance under the other elements of the arrangement. In addition, if the Company has continuing involvement through research and development services that are required because its know-how and expertise related to the technology is proprietary to the Company, or can only be performed by the Company, then such up-front fees are deferred and recognized over the period of continuing involvement.

Research and Development

Research and development expense consists of costs associated with research activities as well as costs associated with the Company's product development efforts, conducting preclinical studies, and clinical trial and manufacturing costs.

Direct research and development expenses associated with the Company's programs include clinical trial site costs, clinical manufacturing costs, costs incurred for consultants and other outside services, such as data management and statistical analysis support, and materials and supplies used in support of the clinical programs. Indirect costs of the Company's clinical program include salaries, stock based compensation, and an allocation of the Company's facility costs.

Research and development expenses are expensed as incurred.

Stock Compensation

The Company issues stock options to certain employees, officers and directors. GAAP requires companies to account for stock options using the fair value method, which results in the recognition of compensation expense over the vesting period of the awards. See "Note 3—Stock Compensation" for additional information.

Income Taxes

The Company follows the asset and liability method of accounting for income taxes. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered and settled. A valuation allowance is recorded to reduce the net deferred tax asset to zero because it is more likely than not that the net deferred tax asset will not be realized. The Company recognizes the effect of income tax positions only if those positions are more likely than not of being sustained upon an examination.

Fair Value of Financial Instruments

The Company measures at fair value certain financial assets and liabilities in accordance with a hierarchy of valuation techniques based on whether the inputs to those valuation techniques are observable or unobservable. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect the Company's market assumptions. There are three levels of inputs that may be used to measure fair-value:

•

Level 1—quoted prices for identical instruments in active markets;

•

Level 2—quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-derived valuations in which all significant inputs and significant value drivers are observable in active markets; and

•

Level 3—valuations derived from valuation techniques in which one or more significant value drivers are unobservable.

The Company's assets and liabilities measured at fair value on a recurring basis consisted of the following as of the date indicated:


	Fair Value Measurement as of December 31, 2011
	Total		Level 1		Level 2		Level 3
	(in thousands)
Cash equivalents	$	39,904	$	39,904	$	—	$	—

Total assets	$	39,904	$	39,904	$	—	$	—


	Fair Value Measurement as of December 31, 2010
	Total		Level 1		Level 2		Level 3
	(in thousands)
Cash equivalents	$	33,589	$	33,589	$	—	$	—

Total assets	$	33,589	$	33,589	$	—	$	—


	Fair Value Measurement as of December 31, 2011
	Total		Level 1		Level 2		Level 3
	(in thousands)
Warrants	$	5,446	$	—	$	—	$	5,446

Total liabilities	$	5,446	$	—	$	—	$	5,446


	Fair Value Measurement as of December 31, 2010
	Total		Level 1		Level 2		Level 3
	(in thousands)
Warrants	$	39,111	$	—	$	—	$	39,111

Total	$	39,111	$	—	$	—	$	39,111

A reconciliation of the change in value of the Company's warrants for the years ended December 31, 2011, 2010 and 2009 is as follows:


	Fair Value Measurements Using Significant Unobservable Inputs (Level 3)
	2011			2010		2009
	(in thousands)
Balance at January 1	$	39,111		$	27,609	$	1,254
Change in value of warrants		(33,022	)		11,502		9,198
Reclassification to shareholders' equity upon exercise of warrants		(643	)		—		—
Issuances		—			—		17,157

Balance at December 31	$	5,446		$	39,111	$	27,609

See "Note 9—Warrants" for additional information related to the determination of fair value of the warrants.

The carrying amounts reported in the balance sheets for accounts receivable, accounts payable, and other current monetary assets and liabilities approximate fair value because of the immediate or short-term maturity of these financial instruments.

Rent Expense

The Company's operating leases for its Corvallis, Oregon and Bothell, Washington facilities provide for scheduled annual rent increases throughout each lease's term. In accordance with GAAP, the Company recognizes the effects of the scheduled rent increases on a straight-line basis over the full term of the leases, which expire in 2020 for the Corvallis, Oregon facility and in 2014 and 2012 for the Company's Bothell, Washington facilities.

During 2011, the Company recognized $7,000 less in rent expense than the amount paid per the lease agreements and for 2010 and 2009, additional rent expense of $33,000 and $230,000, respectively, was recognized due to the amortization of future scheduled rent increases.

Commitments and Contingencies

As of December 31, 2011, the Company was not a party to any material legal proceedings with respect to itself, its subsidiaries, or any of its material properties. In the normal course of business, the Company may from time to time be named as a party to various legal claims, actions and complaints, including matters involving employment, intellectual property, effects from the use of therapeutics utilizing its technology, or others. It is impossible to predict with certainty whether any resulting liability would have a material adverse effect on the Company's financial position, results of operations or cash flows.

Long-Lived Asset Impairment

Long-lived assets held and used by the Company and intangible assets with determinable lives are reviewed for impairment whenever events or circumstances indicate that the carrying amount of assets may not be recoverable in accordance with GAAP. The Company evaluates recoverability of assets to be held and used by comparing the carrying amount of an asset to future net undiscounted cash flows to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured as the amount by which the carrying amount of the assets exceeds the fair value of the assets. Such reviews assess the fair value of the assets based upon estimates of future cash flows that the assets are expected to generate.

In November 2009, the Company decided to outsource its large-scale manufacturing activities and listed for sale the industrial property it owns in Corvallis, Oregon. The Company with the assistance of independent appraisals, determined the fair value of the property less costs to sell and reduced its carrying value by $109,000, $408,000 and $128,000 in 2011, 2010 and 2009, respectively. The Company considers the property valuation a Level 3 fair value measure. In November 2011, the Company leased approximately 70% of the property to a third party as described previously under Property and Equipment.

The Company conducts periodic evaluations of the value of its patents. Pursuant to these evaluations, the Company recorded charges of $190,000, $766,000 and $347,000 in 2011, 2010 and 2009, respectively, for previously capitalized costs related to patents that were abandoned.

Recent Accounting Pronouncements

In January 2010, the Financial Accounting Standards Board ("FASB"), issued guidance to amend the disclosure requirements related to recurring and nonrecurring fair value measurements. Other than requiring additional disclosures, adoption of this new guidance did not have a material impact on the Company's financial statements.

In April 2010, the FASB issued guidance on applying the milestone method of revenue recognition for milestone payments for achieving specific performance measures when those payments are related to uncertain future events. The guidance is effective on a prospective basis to milestones achieved in fiscal years, and interim periods within those years, beginning January 1, 2011. The adoption of this new guidance did not have a material impact on the Company's financial statements.

In April 2011, the FASB issued guidance to achieve common fair value measurement and disclosure requirements between GAAP and International Financial Reporting Standards. This guidance amends current fair value measurement and disclosure guidance to include increased transparency around valuation inputs and investment categorization. The guidance is effective for fiscal years and interim periods beginning after December 15, 2011. The Company does not believe its adoption of this new guidance in the first quarter of 2012 will have a material impact on its financial statements.

In June 2011, the FASB issued guidance regarding presentation of other comprehensive income in the financial statements. This guidance will eliminate the option under GAAP to present other comprehensive income in the statement of changes in equity. Under the guidance, the Company will have the option to present the components of net income and comprehensive income in either one or two consecutive financial statements. The guidance is effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. The adoption of this new guidance in the first quarter of 2012 is not expected to have a material impact on the Company's financial statements.