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Business

NOTE 1 BUSINESS

A.P. Pharma is a specialty pharmaceutical company focused on developing pharmaceutical products using our proprietary Biochronomer polymer-based drug delivery technology. The Biochronomer technology consists of bioerodible polymers designed to release drugs over a defined period of time. Our primary focus is on our lead product candidate, APF530, which is being developed for the prevention of chemotherapy-induced nausea and vomiting (CINV). APF530 utilizes our Biochronomer technology and is a long-acting formulation of granisetron. In May 2009, we filed a New Drug Application (NDA) with the U.S. Food and Drug Administration (FDA) seeking approval for APF530. During 2008, we completed a pivotal Phase 3 clinical trial for APF530 which was the basis for the application. Since receiving the Complete Response Letter in March 2010, we have been working to address the issues raised by the FDA. We met with the FDA in February and March 2011 to clarify the work needed to resubmit the NDA. Based on our discussions with the FDA and our assessment of the work remaining, we expect to resubmit the APF530 NDA in mid-2012. We intend to seek a collaborative arrangement to commercialize APF530 or anticipate obtaining additional funding and resources that would be required to launch APF530 without a partner.

We previously submitted Investigational New Drug (IND) applications for two product candidates, APF112 and APF580. Since 2009, further development of these product candidates has been deferred in order to focus both managerial and financial resources on the development of APF530. We are currently evaluating applications of our Biochronomer delivery technology, including APF112 and APF580, to determine potential pipeline candidates following the possible approval of APF530.

Summary of Significant Accounting Policies

12 Months Ended

Dec. 31, 2011

Summary of Significant Accounting Policies

NOTE 2 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation and Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Estimates were made relating to useful lives of fixed assets, valuation allowances, impairment of assets, accruals for research and development expenses and stock-based expenses. Actual results could differ materially from those estimates.

We have evaluated subsequent events through the date the audited financial statements were issued and determined that there were no subsequent events that required disclosure in the financial statements.

Liquidity

We have incurred significant operating losses and negative cash flows from operations and have an accumulated deficit of $160.2 million as of December 31, 2011. At December 31, 2011, we had cash and cash equivalents of $18.0 million. During 2011, we entered into two financing agreements which have provided capital to fund operations. In April 2011, we entered into definitive agreements for a convertible note financing, which served as a bridge loan to fund the Company's operations until additional financing was secured. The initial capital funding from the bridge loan was approximately $1.3 million, net of financing costs. The bridge loan investors have the right through May 2, 2013 to purchase an additional $3.0 million aggregate principal amount of Notes. In June 2011, we entered into definitive agreements for a private placement of units of common stock and warrants. The financing, which closed in July 2011, provided the Company with approximately $22.8 million of proceeds, net of issuance costs. The Company believes the capital generated through these financings is sufficient to fund its planned operations into 2013.

Our capital requirements going forward will depend on numerous factors including the number and characteristics of product development programs we pursue and the pace of each program; the scope, rate of progress, results and costs of preclinical testing and clinical trials; the time, cost and outcome involved in seeking regulatory approvals; scientific progress in our research and development programs; the magnitude and scope of our research and development programs; our ability to establish and maintain strategic collaborations or partnerships for research, development and clinical testing; manufacturing and marketing of our product candidates; the cost and timing of establishing sales, marketing and distribution capabilities for a specialty sales force if we commercialize any products independently; the cost of establishing clinical and commercial supplies of our product candidates and any products that we may develop; and general market conditions.

Cash Equivalents

We consider all highly liquid investments with a maturity from the date of purchase of less than three months to be cash equivalents. We have classified all our investments in certain debt securities as “available-for-sale.” As of December 31, 2011 and 2010, our available-for-sale securities consisted of money market funds primarily containing U.S. government-backed or collateralized overnight securities with original maturities of ninety days or less. The carrying value of our money market funds is included in cash equivalents and approximates their fair value. The Company’s bank accounts have been placed under a control agreement in accordance with the April 2011 convertible note financing (see Note 6).

Property and Equipment

Property and equipment is stated at cost less accumulated depreciation. Depreciation is computed using the straight-line method over the estimated useful lives of the assets as follows: equipment and machinery, three to five years; furniture and fixtures, five years; and leasehold improvements, over the shorter of the respective lease terms or the respective useful lives of the leasehold improvements.

Long-Lived Assets

As circumstances dictate, we evaluate whether changes have occurred that would require us to consider whether long-lived assets have been impaired. Recoverability of assets to be held and used is determined by comparing the undiscounted net cash flows of long-lived assets to their respective carrying values. If such assets are considered to be impaired, the amount of impairment to be recognized is measured by comparing the projected discounted cash flows using an appropriate discount rate to the asset’s carrying value.

Stock-Based Compensation

We account for share-based payment arrangements in accordance with ASC 718, Compensation – Stock Compensation and ASC 505-50, Equity – Equity Based Payments to Non-Employees, which requires the recognition of compensation expense, using a fair-value based method, for all costs related to share-based payments including stock options, restricted stock awards and stock issued under the employee stock purchase plan. These standards require companies to estimate the fair value of share-based payment awards on the date of the grant using an option-pricing model. See Note 8 for further discussion of our stock-based compensation plans.

Warrants Issued in Connection with Equity Financings

We generally account for warrants issued in connection with equity financings as a component of equity, unless there is a deemed possibility that we may have to settle warrants in cash.

Revenue Recognition

Our revenue arrangements with multiple deliverables are divided into separate units of accounting if certain criteria are met, including whether the delivered item has stand-alone value to the customer and whether there is objective and reliable evidence of the fair value of the undelivered items. The consideration we receive is allocated among the separate units based on their respective fair values, and the applicable revenue recognition criteria are considered separately for each of the separate units. For revenue arrangements entered into after June 15, 2010, management’s estimate of the selling price is considered when fair value is not determinable. Advance payments received in excess of amounts earned are classified as deferred revenue until earned. Milestone payments are recorded as revenue upon achievement of the milestone.

We record grant income as revenue if the grant is considered an integral part of our ongoing operations. In November 2010, we received a $244,000 non-taxable grant from the United States government under the Qualifying Therapeutics Discovery Project (QTDP) program for the APF530 project. Since the QTDP grant is not considered an integral part of our ongoing operations and the research and development costs were expended in a prior year, we have reported the amount as Other Income in the accompanying statements of operations.

Contract Revenue

We have licensing agreements that generally provide for a non-refundable license fee. The license agreements provide for us to earn future revenue through royalty payments. These non-refundable license fees are generally initially reported as deferred revenue and recognized as revenue over an appropriate period, depending on the license. Revenue recognized from deferred license fees is classified as Contract Revenue in the accompanying statements of operations.

Contract revenue relates to research and development arrangements that generally provide for us to invoice research and development fees based on full-time equivalent hours for each project. Revenue from these arrangements is recognized as the related development services are rendered. This revenue approximates the costs incurred.

Clinical Trial Accruals

Our expenses related to clinical trials are based on estimates of the services received and efforts expended pursuant to contracts with multiple research institutions and clinical research organizations that conduct and manage clinical trials on our behalf. Since the invoicing related to these services does not always coincide with our financial statement close process, we must estimate the level of services performed and fees incurred in determining the accrued clinical trial costs. The financial terms of these agreements are subject to negotiation and vary from contract to contract, which may result in uneven payment flows. Payments under the contracts depend on factors such as the successful enrollment of patients or achievement of certain events or the completion of portions of the clinical trial or similar conditions. Expenses related to clinical trials generally are accrued based on the level of patient enrollment and services performed by the clinical research organization or related service provider according to the protocol. We monitor patient enrollment levels and related activity to the extent possible and adjust our estimates accordingly. Historically these estimates have been reasonably accurate and no material adjustments have had to be made.

Research and Development

Research and development consists of costs incurred for company-sponsored and collaborative research and development expenses. These costs consist primarily of employee salaries and other personnel-related expenses, facility-related expenses, laboratory consumables, polymer development manufacturing, clinical and pre-clinical related services performed by clinical research organizations, research institutions and other outside service providers.

Research and development expenses under collaborative agreements approximate the revenue recognized, excluding milestone and up-front payments received under such arrangements.

Net Income (Loss) Per Share

Basic income (loss) per share is estimated based on the weighted-average number of common shares outstanding. Diluted income (loss) per share is calculated using the weighted-average number of common shares outstanding and other dilutive securities. Dilutive securities are not included in the computation of diluted net loss per share if the inclusion of these potentially dilutive securities is anti-dilutive (see Note 9).

Concentrations of Credit Risk

Financial instruments that potentially subject us to concentrations of credit risk consist primarily of cash equivalents. We invest excess cash in a variety of high-grade short-term, interest-bearing securities. This diversification of risk is consistent with our policy to ensure safety of principal and maintain liquidity.

Segment and Geographic Information

Our operations are confined to a single business segment, the design and commercialization of polymer technologies for pharmaceutical and other applications. Substantially all of our revenues are derived from customers within the United States.

Comprehensive Income (Loss)

ASC 220, Comprehensive Income, requires that an entity’s change in equity or net assets during a period from transactions and other events from non-owner sources be reported. We report unrealized gains or losses on our available-for-sale securities as other comprehensive income (loss). Total other comprehensive income (loss) has been disclosed on the statement of stockholders’ equity.

Recent Accounting Pronouncements

In June 2011, the Financial Accounting Standards Board (FASB) issued ASU 2011-05, Comprehensive Income (Topic 220): Presentation of Comprehensive Income. ASU 2011-05 eliminates the option to present the components of other comprehensive income as part of the statement of changes in stockholders’ equity and, instead, requires separate statements of comprehensive income. The amendment is effective for fiscal years and interim periods within those years, beginning after December 15, 2011. In October 2011, the FASB decided that the specific requirement to present items that are reclassified from other comprehensive income to net income alongside their respective components of net income and other comprehensive income will be deferred. In December 2011, the FASB issued ASU 2011-12, Comprehensive Income (Topic 220): Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05. Those requirements will be effective for public entities for fiscal years and interim periods within those years beginning after December 15, 2011. We do not expect the adoption of ASU 2011-05 to impact our financial position and results of operations.

Fair Value Measurements

12 Months Ended

Dec. 31, 2011

Fair Value Measurements

NOTE 3 FAIR VALUE MEASUREMENTS

We follow the provisions of ASC 820-10, Fair Value Measurements and Disclosures, which defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles and requires certain disclosures about fair value measurements. Broadly, the ASC 820-10 framework clarifies that fair value is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or liability.

As a basis for considering such assumptions, ASC 820-10 establishes a three tier value hierarchy which prioritizes the inputs used in measuring fair value as follows: Level 1) observable inputs such as quoted prices in active markets; Level 2) inputs other than the quoted prices in active markets that are observable either directly or indirectly; and Level 3) unobservable inputs in which there is little or no market data, which require us to develop our own assumptions. The hierarchy requires us to use observable market data, when available, and to minimize the use of unobservable inputs when determining fair value.

On a recurring basis, we measure our available-for-sale securities at fair value. We used quoted prices in active markets (Level 1) to measure our cash equivalents at fair value on a recurring basis in our balance sheets at December 31, 2011 and 2010. Cash equivalents consist of highly rated money market funds with maturities of ninety days or less and purchased daily at par value with specified yield rates. Due to the high ratings and short-term nature of these funds, we consider the values of all cash equivalents as Level 1 inputs.

The carrying amounts reported in the balance sheets for accounts receivable, accounts payable and accrued expenses approximate fair value because of the short-term nature of these items.

The entire disclosure for the fair value of financial instruments (as defined), including financial assets and financial liabilities (collectively, as defined), and the measurements of those instruments as well as disclosures related to the fair value of non-financial assets and liabilities. Such disclosures about the financial instruments, assets, and liabilities would include: (1) the fair value of the required items together with their carrying amounts (as appropriate); (2) for items for which it is not practicable to estimate fair value, disclosure would include: (a) information pertinent to estimating fair value (including, carrying amount, effective interest rate, and maturity, and (b) the reasons why it is not practicable to estimate fair value; (3) significant concentrations of credit risk including: (a) information about the activity, region, or economic characteristics identifying a concentration, (b) the maximum amount of loss the entity is exposed to based on the gross fair value of the related item, (c) policy for requiring collateral or other security and information as to accessing such collateral or security, and (d) the nature and brief description of such collateral or security; (4) quantitative information about market risks and how such risks are managed; (5) for items measured on both a recurring and nonrecurring basis information regarding the inputs used to develop the fair value measurement; and (6) for items presented in the financial statement for which fair value measurement is elected: (a) information necessary to understand the reasons for the election, (b) discussion of the effect of fair value changes on earnings, (c) a description of [similar groups] items for which the election is made and the relation thereof to the balance sheet, the aggregate carrying value of items included in the balance sheet that are not eligible for the election; (7) all other required (as defined) and desired information.

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Property and Equipment

12 Months Ended

Dec. 31, 2011

Property and Equipment

NOTE 4 PROPERTY AND EQUIPMENT

Property and equipment consist of the following (in thousands):

December 31,	2011			2010

Leasehold improvements	$	1,338		$	1,338
Furniture and equipment		3,302			3,178
Construction-in-progress		718			—

Total property and equipment		5,358			4,516
Accumulated depreciation		(4,283	)		(4,159	)

Property and equipment, net	$	1,075		$	357

Depreciation expense amounted to $179,000, $227,000 and $356,000 for the years ended December 31, 2011, 2010 and 2009, respectively. At December 31, 2011, construction-in-progress relates to equipment purchases.

The entire disclosure for long-lived, physical assets that are used in the normal conduct of business to produce goods and services and not intended for resale. Examples include land, buildings, machinery and equipment, and other types of furniture and equipment including, but not limited to, office equipment, furniture and fixtures, and computer equipment and software. This disclosure may include property plant and equipment accounting policies and methodology, a schedule of property, plant and equipment gross, additions, deletions, transfers and other changes, depreciation, depletion and amortization expense, net, accumulated depreciation, depletion and amortization expense and useful lives, income statement disclosures, assets held for sale and public utility disclosures.

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Accrued Expenses

12 Months Ended

Dec. 31, 2011

Accrued Expenses

NOTE 5 ACCRUED EXPENSES

Accrued expenses consist of the following (in thousands):

December 31,	2011		2010

Project costs	$	555	$	271
Accrued compensation		555		113
Other		388		77

Total	$	1,498	$	461

Convertible Notes to Related Parties

12 Months Ended

Dec. 31, 2011

Convertible Notes to Related Parties

NOTE 6 CONVERTIBLE NOTES TO RELATED PARTIES

In April 2011, we entered into a Securities Purchase Agreement (Purchase Agreement) with certain institutional investors (Purchasers), including a fund affiliated with Kevin Tang, who is on our Board of Directors, for a private placement of up to $4.5 million in Senior Secured Convertible Notes due 2021 (Notes). Pursuant to the Purchase Agreement, the Company may issue up to $4.5 million aggregate principal amount of Notes, which are convertible into shares of the Company's common stock at a rate of 25,000 shares for every $1,000 of principal and accrued interest due under the Notes (Conversion Shares). The initial funding from the bridge loan was approximately $1.3 million, net of financing costs. The Purchasers may also purchase up to an additional $3.0 million aggregate principal amount of Notes from time to time, with such right expiring upon the second anniversary of the initial closing date. The holders of the Notes may require prepayment of the Notes at any time beginning on or after May 2, 2012 at the holders’ option.

The Notes are secured by substantially all of the assets of the Company, including placing the Company’s bank accounts under a control agreement. The Notes initially bore interest at 20% per annum, payable quarterly in cash or in additional principal amount of Notes at the election of the Purchasers. In June 2011, the interest rate was lowered to 6% per annum effective July 1, 2011 in the Amended Secured Convertible Note Agreement.

There is no right to convert the Notes to the extent that after giving effect to such conversion, the holder would beneficially own in excess of 9.99% of the Company's outstanding common stock after the conversion. Each holder of the Notes can increase or decrease this beneficial ownership conversion limit by written notice to the Company, which will not be effective until 61 days after delivery of the notice.

The Company is in compliance with all debt-related covenants at December 31, 2011. Upon the occurrence of an event of default, holders of the Notes have the right to require the Company to redeem all or a portion of their Notes.

Pursuant to the Purchase Agreement, the Company agreed to file a registration statement registering for resale the Conversion Shares. In May 2011, the Company filed a registration statement on Form S-1 registering these shares for resale; the registration statement was declared effective on July 29, 2011.

Concurrent with the approval of the offer and sale of the Notes, the Board of Directors approved the termination of the Company's Preferred Shares Rights Agreement (Rights Agreement), effective immediately prior to the initial closing date. Under the Rights Agreement, preferred stock purchase rights were distributed to stockholders of record as of January 2, 2007 and to each person who acquires the company stock thereafter. The rights were exercisable only upon the acquisition, or the acquisition of the right to acquire, by a person or group of affiliated or associated persons, of 20% or more (34% for Tang Capital Partners, LP and 30% for Baker Brothers Investments) of the outstanding shares of the company's common stock. These rights were terminated as a result of the termination of the Rights Agreement. The Rights Agreement had not been triggered as of that date.

The Notes contain an embedded conversion feature which was in-the-money on the issuance date. Based on an effective fixed conversion price of $0.04 per share, the total conversion benefit at issuance exceeded the loan proceeds. Therefore, a full debt discount was recorded in an amount equal to the face value of the Notes on the issuance date and the Company began amortizing the resultant debt discount over the 10-year term of the Notes. During fiscal year 2011, accrued interest of approximately $73,000 was paid-in-kind and rolled into the Note principal balance, which resulted in an additional debt discount of approximately $73,000. For the year ended December 31, 2011, interest expense relating to the stated rate was approximately $97,000, and interest expense relating to the amortization of the debt discount was approximately $103,000.

As of December 31, 2011, the carrying value of the Notes was approximately $103,000, which is comprised of the $1,573,000 Note principal less debt discount of $1,470,000. Accrued interest on the principal balance was approximately $24,000 at December 31, 2011.

The entire disclosure for information about short-term and long-term debt arrangements, which includes amounts of borrowings under each line of credit, note payable, commercial paper issue, bonds indenture, debenture issue, own-share lending arrangements and any other contractual agreement to repay funds, and about the underlying arrangements, rationale for a classification as long-term, including repayment terms, interest rates, collateral provided, restrictions on use of assets and activities, whether or not in compliance with debt covenants, and other matters important to users of the financial statements, such as the effects of refinancing and noncompliance with debt covenants.

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Commitments and Contingencies

12 Months Ended

Dec. 31, 2011

Commitments and Contingencies

NOTE 7 COMMITMENTS AND CONTINGENCIES

Our lease for office, warehouse and laboratory space expires in 2016. We also lease certain office equipment under operating lease arrangements, which expire in 2013. Our future minimum lease payments under these non-cancelable operating leases for facilities and equipment are as follows (in thousands):

	Minimum
For the Years Ended December 31,	Payments
2012	$	715
2013		716
2014		735
2015		747
2016		705
Total	$	3,618

Total rental expense for facilities and equipment was $591,000, $555,000 and $568,000 for the years ended December 31, 2011, 2010 and 2009, respectively.

As part of the sale of our cosmeceutical and toiletry business to RP Scherer Corporation in July 2000, we guaranteed a minimum gross profit percentage on RP Scherer’s sales of products to Ortho Dermatologics (Ortho) and Dermik Laboratories, Inc. (Dermik) (see Note 10).

As permitted under Delaware law and in accordance with our bylaws, we indemnify our officers and directors for certain events or occurrences while the officer or director is or was serving at our request in such capacity. The term of the indemnification period is for the officer’s or director’s lifetime. The maximum amount of potential future indemnification is unlimited; however, we have a director or officer insurance policy that limits our exposure and may enable us to recover a portion of any future payments. We believe the fair value of these indemnification agreements is minimal. Accordingly, we have not recorded any liabilities for these agreements as of December 31, 2011.

In the normal course of business, we provide indemnifications of varying scope under our agreements with other companies, typically our clinical research organizations, investigators, clinical sites, suppliers and others. Pursuant to these agreements, we generally indemnify, hold harmless, and agree to reimburse the indemnified parties for losses suffered or incurred by the indemnified parties in connection with use or testing of our products or product candidates or with any U.S. patent or any copyright or other intellectual property infringement claims by any third party with respect to our products. The term of these indemnification agreements is generally perpetual. The potential future payments we could be required to make under these indemnification agreements is unlimited. Historically, costs related to these indemnification provisions have been immaterial. We also maintain various liability insurance policies that limit our exposure. As a result, we believe the fair value of these indemnification agreements is minimal. Accordingly, we have not recorded any liabilities for these agreements as of December 31, 2011.

The entire disclosure for commitments and contingencies.

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Stockholders' Equity

12 Months Ended

Dec. 31, 2011

Stockholders' Equity

NOTE 8 STOCKHOLDERS’ EQUITY

Amendments to Articles of Incorporation

In June 2011, we amended our certificate of incorporation to increase the number of shares of authorized common stock to 1,500,000,000, par value $0.01 per share. Prior to the amendment, the number of shares of authorized common stock was 100,000,000, par value $0.01 per share. The certificate of amendment was approved by a majority of our stockholders on June 29, 2011.

Private Placements

In October 2009, in a private placement, we sold 7,954,543 shares of our common stock at $0.88 per share and warrants to purchase 3,977,270 shares of our common stock, exercisable through January 7, 2015, at $0.88 per share (Private Placement). The purchasers paid $0.125 per underlying share for the warrants. Additionally, the purchasers had the right to purchase up to an additional 5,165,286 shares at $0.97 per share prior to May 14, 2010 and paid $0.125 per underlying share for the right to purchase such additional shares. Total proceeds were approximately $7.9 million, after deducting costs associated with the issuance. We were required to prepare and file Form S-3 registration statements, as permissible under SEC rules and regulations, beginning within 30 days of October 22, 2009, with the SEC for the purpose of registering for resale of the securities sold in this Private Placement. We filed a Form S-3 covering 7,532,617 shares on November 6, 2009, which was declared effective by the SEC on November 17, 2009. However, if we fail to keep any registration statements continuously effective, we may be obligated to pay to the holders of the shares and warrants liquidated damages in the amount of 1% per month of the purchase price for the shares and warrants, up to a maximum cap of 8% of such purchase price. In addition, in connection with the closing of the Private Placement, Baker Brothers Investments was granted the right to designate a representative to our board of directors. In February 2010, Stephen R. Davis was appointed to our board of directors as the Baker Brothers Investments designee. Mr. Davis resigned effective February 23, 2011.

On May 14, 2010, the right of the investors to purchase up to an additional 5,165,286 shares of our common stock at $0.97 per share under the Private Placement expired unexercised. Additionally, the right granted to Baker Brothers Investments to designate an additional representative to our board of directors should they exercise their right to purchase designated additional shares of our common stock under the terms of the securities purchase agreements relating to the Private Placement also expired on May 14, 2010. On June 30, 2010, we filed a Form S-3 covering the remaining 421,926 shares of our common stock related to the October 2009 Private Placement and the 3,977,270 shares of our common stock underlying the warrants, which was declared effective by the SEC on July 8, 2010.

In June 2011, we entered into a Securities Purchase Agreement with certain purchasers (Securities Purchase Agreement), pursuant to which we agreed to sell for an aggregate price of $24.0 million, 160,000,006 shares of our common stock (Shares) and warrants to purchase 80,000,005 shares of our common stock (Warrants) with an exercise price of $0.18 per share (2011 Private Placement). The 2011 Private Placement closed on July 1, 2011. For each Share purchased, the investors received one Warrant to purchase 0.5 shares of common stock (together, a Unit), at a purchase price of $0.15 per Unit. The Warrants became exercisable on July 1, 2011, the date of issuance, and expire on the fifth anniversary of that date. The Warrants may be exercised for cash only or, if a registration statement is not then effective and available for the resale of the shares of common stock issuable upon exercise of the Warrants, by surrender of such Warrant, or a portion of such Warrant, by way of cashless exercise. There is no right to exercise the Warrants to the extent that after giving effect to such exercise the holder would beneficially own in excess of 9.99% of the outstanding shares of common stock following such exercise (or such other limit as may be designated by any particular purchaser). Each holder of the Warrants can amend or waive the foregoing limitation by written notice to us, with such waiver taking effect only upon the expiration of a 61-day notice period.

Under the terms of the Securities Purchase Agreement, on July 29, 2011, we filed a registration statement with the SEC to register for resale the Shares and the shares of common stock issuable upon the exercise of the Warrants (collectively, the Registrable Securities). The registration statement was declared effective on August 4, 2011. If we fail to keep the registration statement continuously effective for a designated time (with limited exceptions), we may be obligated to pay to the holders of the Registrable Securities liquidated damages in an amount equal to 1.0% per month of such holder's pro rata interest in the total purchase price of the 2011 Private Placement.

We received advance proceeds of approximately $20.3 million as of June 30, 2011. The remaining $3.7 million was received in July 2011 when the financing closed. Total proceeds are reported net of issuance costs of approximately $1.2 million as of December 31, 2011. The Shares and Warrants were recorded as equity at their relative fair values on the issuance date.

Shareholders’ Rights Plan

On December 18, 2006, we entered into a Preferred Shares Rights Agreement (the Rights Agreement). As part of this agreement, preferred stock purchase rights (the rights) were distributed to stockholders of record as of January 2, 2007 and to each person who acquired the company stock thereafter. The rights were exercisable only upon the acquisition, or the acquisition of the right to acquire, by a person or group of affiliated or associated persons, of 20% or more of the outstanding shares of the company’s common stock. In connection with the Private Placement in October 2009, we amended the Rights Agreement to permit Tang Capital Partners and Baker Brothers Investments, both purchasers under the Private Placement, to each beneficially own up to 34% and 30%, respectively, of our outstanding common stock. We had initially reserved 200,000 shares of preferred stock pursuant to the exercise of these rights, which would expire on December 31, 2016.

Concurrent with the approval of the offer and sale of the Convertible Notes in April 2011 (see Note 6), the Board of Directors approved the termination of the Rights Agreement effective immediately prior to the initial closing date. The rights were terminated as a result of the termination of the Rights Agreement. The Rights Agreement had not been triggered as of that date.

Stock-Based Compensation Plans

We have two types of stock-based compensation plans, which consist of an employee stock purchase plan and three stock option plans.

In 1997, our stockholders approved our 1997 Employee Stock Purchase Plan (the Purchase Plan). In December 2007, May 2009 and June 2011, our stockholders authorized increases in the number of shares reserved for issuance under the Purchase Plan by 100,000, 200,000 and 500,000 shares, respectively, for a total of 1,000,000 shares reserved at December 31, 2011. Under the terms of the Purchase Plan, employees can elect to have up to a maximum of 10% of their base earnings withheld to purchase our common stock. The purchase price of the stock is 85% of the lower of the closing prices for our common stock on: (i) the first trading day in the enrollment period, as defined in the Purchase Plan, in which the purchase is made, or (ii) the purchase date. The length of the enrollment period may not exceed a maximum of six months. Our compensation committee modified the Purchase Plan such that beginning in May 2008, the length of all offering periods was decreased from 24 months to six months. Enrollment dates are the first business day of May and November and the first enrollment date was April 30, 1997. Approximately 40% of eligible employees participated in the Purchase Plan in 2010. Under the Purchase Plan, we issued 77,982, 48,921 and 99,294 shares in 2011, 2010 and 2009, respectively. The weighted-average fair value per share of purchase rights granted during 2011, 2010 and 2009 was $0.20, $0.30 and $0.30, respectively. The weighted-average exercise price per share of the purchase rights exercised during 2011, 2010 and 2009 was $0.20, $0.61 and $0.42, respectively. We had 531,176, 109,158 and 158,079 shares reserved for issuance under the Purchase Plan at December 31, 2011, 2010 and 2009, respectively.

We currently have three stock option plans from which we can grant options and restricted stock awards to employees, officers, directors and consultants. In December 2007, the stockholders approved our 2007 Equity Incentive Plan (the 2007 Plan). In May 2010 and June 2011, our stockholders approved amendments to our 2007 Equity Incentive Plan to increase the maximum number of shares of common stock available for grant by 2,000,000 and 90,000,000 shares of common stock, respectively, resulting in an aggregate of 95,000,000 shares of common stock authorized for issuance pursuant to awards granted under our 2007 Equity Incentive Plan. We also grant stock options and restricted stock awards under the 2002 Stock Incentive Plan (the 2002 Plan) and the Non-Qualified Stock Plan (the NQ Plan). We are authorized to issue up to 425,000 shares under the 2002 Plan, 100,000 of which were approved by stockholders in May 2006, and 2,062,500 shares under the NQ Plan, a plan that has not undergone stockholder approval and can only be utilized to grant stock options and restricted stock awards as inducements to attract new employees, to which 1,000,000 shares were added by the Board of Directors in September 2007, and an additional 1,000,000 shares were added in July 2008. The options to purchase our common stock are granted with an exercise price which equals fair market value of the underlying common stock on the grant dates and expire no later than ten years from the date of grant. The options are exercisable in accordance with vesting schedules that generally provide for them to be fully vested and exercisable four years after the date of grant. Any shares that are issuable upon exercise of options granted that expire or become unexercisable for any reason without having been exercised in full are available for future grant and issuance under the same stock option plan.

As discussed in Note 1, we adopted ASC 718-20 on January 1, 2006. Accordingly, we record stock-based compensation expense based on the grant date or purchase date fair value of stock options and purchase rights issued to employees in conjunction with our stock option plans or the Purchase Plan. We also record compensation expense for warrants and stock options issued to non-employees and restricted stock awards to employees and directors.

The fair value of each employee and director grant of options to purchase common stock and purchase rights under the Purchase Plan is estimated on the date of the grant using the Black-Scholes option-pricing model assuming no dividends and the following weighted-average assumptions:

	2011			2010			2009
Expected term (years):
Stock options		5.00			6.00			6.00
Employee Stock Purchase Plan		.50			.50			.50
Risk-free interest rate:
Stock options		1.6	%		2.6	%		1.8	%
Employee Stock Purchase Plan		0.8	%		0.2	%		0.5	%
Volatility:
Stock options		106	%		164	%		205	%
Employee Stock Purchase Plan		142	%		92	%		129	%

The expected term is based on historical data. The expected term for the Purchase Plan is based on the weighted-average purchase period of the Purchase Plan. The expected volatility is based on our historical stock prices, and the estimated forfeiture rate of the options is based on historical data.

The Black-Scholes option valuation model requires the input of highly subjective assumptions, including the expected life of the award and stock price volatility. The assumptions listed above represent management’s best estimates, but these estimates involve inherent uncertainties and the application of management judgment. As a result, if other assumptions had been used, our recorded stock-based compensation expense could have been materially different.

Stock-based compensation expense recorded for awards granted under the stock option plans and the Purchase Plan, net of estimated forfeitures, was as follows (in thousands, except per share amounts):

For the Years Ended December 31,	2011		2010		2009

Research and development	$	819	$	398	$	260
General and adminstrative		1,071		1,351		877

Total	$	1,890	$	1,749	$	1,137

Impact on basic and diluted net loss per common share	$	0.02	$	0.04	$	0.03

In 2010, we recorded additional stock-based compensation expense as a result of accelerated vesting of stock options in connection with the resignation of our former chief executive officer. No tax benefit was recognized related to stock-based compensation expense since we have incurred operating losses and we have established a full valuation allowance to offset all the potential tax benefits associated with our deferred tax assets.

The following table summarizes option activity for the years ended December 31, 2011, 2010 and 2009:

	2011								2010					2009
						Weighted-		Aggregate
					Weighted-	Average		Intrinsic					Weighted-					Weighted-
					Average	Remaining		Value as of					Average					Average
					Exercise	Contractual		December 31,					Exercise					Exercise
		Shares			Price	Term (Years)		2011		Shares			Price		Shares			Price

Outstanding at beginning of year		3,217,240		$	1.49					3,092,417		$	1.91		2,701,073		$	2.38
Granted		48,070,000			0.26					1,087,700			1.45		991,500			0.67
Exercised		—			—					(37,786	)		1.24		(27,651	)		0.71
Expired or Forfeited		(1,180,953	)		1.63					(925,091	)		2.85		(572,505	)		2.02
Outstanding at end of year		50,106,287			0.31	9.42	$	14,000		3,217,240			1.49		3,092,417			1.91

Options exercisable at year end		6,740,497			0.53	8.92	$	—		1,316,567			1.72		1,316,567			3.11

Options vested or expected to vest		49,434,997			0.31	9.42	$	13,715

Shares available for future grant at year end		44,261,608								2,039,549					1,959,758

Weighted-average fair value of stock options granted during the year				$	0.21							$	1.39				$	0.67

As of December 31, 2011, there was approximately $9.5 million of total unrecognized compensation expense related to unvested stock options. This expense is expected to be recognized over a weighted-average period of 3.45 years. Cash received from option exercises for the years ended December 31, 2011, 2010 and 2009 was $0, $47,000 and $20,000, respectively. The total intrinsic value of options exercised in the year ended December 31, 2011, 2010 and 2009 was $0, $5,000, and $7,000, respectively.

The following table summarizes information about stock options outstanding at December 31, 2011:

	OPTIONS OUTSTANDING						OPTIONS EXERCISABLE
			Weighted-
			Average		Weighted-				Weighted-
			Remaining		Average				Average
Range of	Number		Contractual		Exercise		Number		Exercise
Exercise Prices	Outstanding		Life (Years)		Price		Exercisable		Price

$0.19 - $0.19		350,000		9.99	$	0.19		—	$	—
$0.26 - $0.26		47,720,000		9.52		0.26		5,345,839		0.26
$0.60 - $6.20		1,989,848		7.10		1.27		1,348,219		1.38
$6.40 - $6.40		18,876		3.95		6.40		18,876		6.40
$6.52 - $6.52		5,813		3.03		6.52		5,813		6.52
$6.96 - $6.96		2,500		4.42		6.96		2,500		6.96
$7.00 - $7.00		5,000		1.67		7.00		5,000		7.00
$9.36 - $9.36		2,500		0.39		9.36		2,500		9.36
$9.80 - $9.80		9,250		2.04		9.80		9,250		9.80
$11.756 - $11.756		2,500		2.40		11.76		2,500		11.76

$0.19 - $11.756		50,106,287		9.42	$	0.31		6,740,497	$	0.53

As of December 31, 2011, there were no unvested restricted stock awards granted to employees and directors. The compensation cost that has been expensed in the statements of operations for the restricted stock awards issued to employees and directors and stock issued in lieu of fees was $98,000, $385,000 and $375,000 for 2011, 2010 and 2009, respectively.

The following table summarizes unvested restricted stock awards activity for the year ended December 31, 2011:

				Weighted-Average
				Grant Date
	Shares			Fair Value

Outstanding at beginning of year		318,758		$	0.85
Awarded		—
Released		(143,835	)	$	0.73
Forfeited		(174,923	)	$	0.94

Outstanding at end of year		—		$	0.00

In November 2009, our Board of Directors extended the vesting period for certain restricted stock awards granted in May 2009 from December 31, 2009 to January 2, 2010. The modification of the restricted stock awards did not result in additional compensation expense.

The following table summarizes information about the Company’s warrants outstanding at December 31, 2011:

	Number of Shares Exercisable		Exercise Price			Expiration Date

Issued to PIPE investors in October 2009		3,977,270	$	0.88		1/7/2015
Issued to PIPE investors in July 2011		80,000,005	$	0.18		7/1/2016
Other		150,000	$	0.19		8/10/2014
Total warrants outstanding at December 31, 2011		84,127,275	$	0.21	*

* Average exercise price

Common Stock Reserved for Future Issuance

As of December 31, 2011, the Company had reserved shares of common stock for future issuance as follows:

	No. of Shares

Issuance upon exercise of outstanding stock options		50,106,287
Issuance of future grants under stock option plans		44,261,608
Issuance of future grants under employee stock purchase plan		531,176
Issuance of common stock related to convertible notes*		200,359,458
Issuance upon exercise of warrants		84,127,275

Total		379,385,804


* Assumes additional $3.0 million principal amount of notes purchased as of
January 1, 2012 and all interest payments are paid-in-kind

The entire disclosure for shareholders' equity, comprised of portions attributable to the parent entity and noncontrolling interest, if any, including other comprehensive income (as applicable). Including, but not limited to: (1) balances of common stock, preferred stock, additional paid-in capital, other capital and retained earnings; (2) accumulated balance for each classification of other comprehensive income and total amount of comprehensive income; (3) amount and nature of changes in separate accounts, including the number of shares authorized and outstanding, number of shares issued upon exercise and conversion, and for other comprehensive income, the adjustments for reclassifications to net income; (4) rights and privileges of each class of stock authorized; (5) basis of treasury stock, if other than cost, and amounts paid and accounting treatment for treasury stock purchased significantly in excess of market; (6) dividends paid or payable per share and in the aggregate for each class of stock for each period presented; (7) dividend restrictions and accumulated preferred dividends in arrears (in aggregate and per share amount); (8) retained earnings appropriations or restrictions, such as dividend restrictions; (9) impact of change in accounting principle, initial adoption of new accounting principle and correction of an error in previously issued financial statements; (10) shares held in trust for Employee Stock Ownership Plan (ESOP); (11) deferred compensation related to issuance of capital stock; (12) note received for issuance of stock; (13) unamortized discount on shares; (14) description, terms, and number of warrants or rights outstanding; (15) shares under subscription and subscription receivables, effective date of new retained earnings after quasi-reorganization and deficit eliminated by quasi-reorganization and, for a period of at least ten years after the effective date, the point in time from which the new retained dates; and (16) retroactive effective of subsequent change in capital structure.

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-LegacyDoc This reference is SUPERSEDED by the Accounting Standards Codification effective for interim and annual periods ending after September 15, 2009. This reference is included to help users transition from the previous accounting hierarchy and will be removed from future versions of this taxonomy.

Reference 5: http://www.xbrl.org/2003/role/presentationRef
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Reference 6: http://www.xbrl.org/2003/role/presentationRef
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Reference 7: http://www.xbrl.org/2003/role/presentationRef
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Reference 8: http://www.xbrl.org/2003/role/presentationRef
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Net Loss Per Share

12 Months Ended

Dec. 31, 2011

Net Loss Per Share

NOTE 9 NET LOSS PER SHARE

The following options, unvested restricted stock awards and warrants were outstanding as of December 31, 2011, 2010 and 2009, but were not included in the computation of diluted net loss per share since the inclusion of these potentially dilutive securities would have been anti-dilutive for the periods presented (in thousands):

For the Years Ended December 31,	2011		2010		2009

Number of options outstanding		50,106		3,217		3,092
Number of unvested restricted stock awards outstanding		—		319		140
Number of warrants outstanding		84,127		3,977		3,977
Common stock related to convertible notes outstanding		39,331		—		—

Discontinued Operations

12 Months Ended

Dec. 31, 2011

Discontinued Operations

NOTE 10 DISCONTINUED OPERATIONS

Cosmeceutical and Toiletry Business

On July 25, 2000, we completed the sale of certain technology rights for our cosmeceutical and toiletry business to RP Scherer Corporation (RP Scherer), a subsidiary of Cardinal Health, Inc.

Under the terms of the agreement with RP Scherer, we guaranteed a minimum gross profit percentage on RP Scherer’s combined sales of products to Ortho and Dermik (Gross Profit Guaranty). In July 2011, Valeant Pharmaceuticals announced it was acquiring both Ortho and Dermik. The guaranty period initially commenced on July 1, 2000 and was to end on the earlier of July 1, 2010 or the end of two consecutive guaranty periods where the combined gross profit on sales to Ortho and Dermik equals or exceeds the guaranteed gross profit (Two Period Test). The Gross Profit Guaranty expense totaled $944,000 for the first seven guaranty years and in those years profits did not meet the Two Period Test. Effective March 2007, in conjunction with a sale of assets by RP Scherer’s successor company to an Amcol International subsidiary (Amcol), a new agreement was signed between us and Amcol to provide continuity of product supply to Ortho and Dermik. This new agreement potentially extends the Gross Profit Guaranty period an additional two years to July 1, 2013, unless it is terminated earlier with the Two Period Test. Amcol has indicated that its costs differ from those it charged historically to the RP Scherer successor company to produce the products. We have requested documentation from Amcol to substantiate actual costs. Until we receive confirmation of these amounts, we have accrued the full amount Amcol represents it is currently owed. As there is no minimum amount of Gross Profit Guaranty due, no accrual for the guaranty is estimable for future years. A liability of $1.1 million related to the current amount due under the Gross Profit Guaranty is recorded in accrued disposition costs as of December 31, 2011, although we have not paid this amount to date due to our inability to substantiate the amounts claims by Amcol. As of the date of filing of this report, our dispute with Amcol over the Gross Profit Guaranty has been submitted to an independent accountant for resolution.

We completed the sale of certain technology rights for our topical pharmaceutical and cosmeceutical product lines and other assets (cosmeceutical and toiletry business) in July 2000.

The cosmeceutical and toiletry business is reported as discontinued operations for all periods presented in the accompanying Statements of Operations. Income (loss) from discontinued operations represents primarily the gain (loss) attributable to changes in estimates of our cosmeceutical and toiletry business that was sold to RP Scherer on July 25, 2000, as follows (in thousands):

For the years ended December 31,	2011			2010			2009
Cosmeceutical and Toiletry Business:
Change in estimates for guarantees	$	(379	)	$	(150	)	$	68

There was no revenue relating to discontinued operations for the years ended December 31, 2011, 2010 and 2009.

Basic and diluted income (loss) per common share from discontinued operations was $0 for the years ended December 31, 2011, 2010 and 2009.

As of December 31, 2011 and 2010, accrued disposition cost of $1.1 million and $0.7 million, respectively, represents accruals for gross profit guarantees related to discontinued operations.

The entire disclosure for the facts and circumstances leading to the completed or expected disposal, manner and timing of disposal, the gain (loss) recognized in the income statement and the income statement caption that includes that gain (loss), amounts of revenues and pretax profit or loss reported in discontinued operations, the segment in which the disposal group was reported, and the classification (whether sold or classified as held for sale) and carrying value of the assets and liabilities comprising the disposal group. Includes all disposal groups, including those classified as components of the entity (discontinued operations).

Reference 1: http://www.xbrl.org/2003/role/presentationRef
-Publisher FASB
-Name Statement of Financial Accounting Standard (FAS)
-Number 144
-Paragraph 43-48
-LegacyDoc This reference is SUPERSEDED by the Accounting Standards Codification effective for interim and annual periods ending after September 15, 2009. This reference is included to help users transition from the previous accounting hierarchy and will be removed from future versions of this taxonomy.

Reference 2: http://www.xbrl.org/2003/role/presentationRef
-Publisher FASB
-Name Accounting Standards Codification
-Topic 360
-SubTopic 10
-Section 50
-Paragraph 3
-URI http://asc.fasb.org/extlink&oid=6391110&loc=d3e2941-110230

Reference 3: http://www.xbrl.org/2003/role/presentationRef
-Publisher FASB
-Name Accounting Standards Codification
-Topic 205
-SubTopic 20
-Section 50
-Paragraph 1
-URI http://asc.fasb.org/extlink&oid=6360339&loc=d3e1361-107760

Reference 4: http://www.xbrl.org/2003/role/presentationRef
-Publisher FASB
-Name Accounting Standards Codification
-Topic 205
-SubTopic 20
-Section 50
-Paragraph 5
-URI http://asc.fasb.org/extlink&oid=6360339&loc=d3e1510-107760

Reference 5: http://www.xbrl.org/2003/role/presentationRef
-Publisher FASB
-Name Accounting Standards Codification
-Topic 205
-SubTopic 20
-Section 45
-Paragraph 5
-URI http://asc.fasb.org/extlink&oid=6892542&loc=d3e1020-107759

Reference 6: http://www.xbrl.org/2003/role/presentationRef
-Publisher FASB
-Name Accounting Standards Codification
-Topic 205
-SubTopic 20
-Section 45
-Paragraph 4
-URI http://asc.fasb.org/extlink&oid=6892542&loc=d3e1012-107759

Reference 7: http://www.xbrl.org/2003/role/presentationRef
-Publisher FASB
-Name Accounting Standards Codification
-Topic 205
-SubTopic 20
-Section 45
-Paragraph 3
-URI http://asc.fasb.org/extlink&oid=6892542&loc=d3e957-107759

Reference 8: http://www.xbrl.org/2003/role/presentationRef
-Publisher FASB
-Name Accounting Standards Codification
-Topic 205
-SubTopic 20
-Section 50
-Paragraph 3
-URI http://asc.fasb.org/extlink&oid=6360339&loc=d3e1474-107760

Reference 9: http://www.xbrl.org/2003/role/presentationRef
-Publisher FASB
-Name Accounting Standards Codification
-Topic 360
-SubTopic 10
-Section 45
-Paragraph 5
-URI http://asc.fasb.org/extlink&oid=6390789&loc=d3e2443-110228

Reference 10: http://www.xbrl.org/2003/role/presentationRef
-Publisher FASB
-Name Accounting Standards Codification
-Topic 205
-SubTopic 20
-Section 50
-Paragraph 2
-URI http://asc.fasb.org/extlink&oid=6360339&loc=d3e1436-107760

Defined Contribution Plan

12 Months Ended

Dec. 31, 2011

Defined Contribution Plan

NOTE 11 DEFINED CONTRIBUTION PLAN

We have a defined contribution plan (401k) covering substantially all of our employees. In the past three calendar years, we made matching cash contributions equal to 50% of each participant’s contribution during the plan year up to a maximum amount equal to the lesser of 3% of each participant’s annual compensation or $7,350 for the years 2011, 2010 and 2009, and such amounts were recorded as expense in the corresponding years. We may also contribute additional discretionary amounts to the defined contribution plan as we may determine. For the years ended December 31, 2011, 2010 and 2009, we contributed to the plan approximately $46,000, $51,000 and $76,000, respectively. No discretionary contributions have been made to the plan since its inception.

The entire disclosure for pension and other postretirement benefits.

Reference 1: http://www.xbrl.org/2003/role/presentationRef
-Publisher FASB
-Name Statement of Financial Accounting Standard (FAS)
-Number 132R
-Paragraph 5
-Subparagraph a
-LegacyDoc This reference is SUPERSEDED by the Accounting Standards Codification effective for interim and annual periods ending after September 15, 2009. This reference is included to help users transition from the previous accounting hierarchy and will be removed from future versions of this taxonomy.

Reference 2: http://www.xbrl.org/2003/role/presentationRef
-Publisher FASB
-Name Statement of Financial Accounting Standard (FAS)
-Number 132R
-Paragraph 5
-Subparagraph b
-LegacyDoc This reference is SUPERSEDED by the Accounting Standards Codification effective for interim and annual periods ending after September 15, 2009. This reference is included to help users transition from the previous accounting hierarchy and will be removed from future versions of this taxonomy.

Reference 3: http://www.xbrl.org/2003/role/presentationRef
-Publisher FASB
-Name Statement of Financial Accounting Standard (FAS)
-Number 132R
-Paragraph 5
-Subparagraph h
-LegacyDoc This reference is SUPERSEDED by the Accounting Standards Codification effective for interim and annual periods ending after September 15, 2009. This reference is included to help users transition from the previous accounting hierarchy and will be removed from future versions of this taxonomy.

Reference 4: http://www.xbrl.org/2003/role/presentationRef
-Publisher FASB
-Name Statement of Financial Accounting Standard (FAS)
-Number 132R
-Paragraph 5
-Subparagraph q
-LegacyDoc This reference is SUPERSEDED by the Accounting Standards Codification effective for interim and annual periods ending after September 15, 2009. This reference is included to help users transition from the previous accounting hierarchy and will be removed from future versions of this taxonomy.

Reference 5: http://www.xbrl.org/2003/role/presentationRef
-Publisher FASB
-Name Statement of Financial Accounting Standard (FAS)
-Number 132R
-Paragraph 8
-Subparagraph m
-LegacyDoc This reference is SUPERSEDED by the Accounting Standards Codification effective for interim and annual periods ending after September 15, 2009. This reference is included to help users transition from the previous accounting hierarchy and will be removed from future versions of this taxonomy.

Reference 6: http://www.xbrl.org/2003/role/presentationRef
-Publisher FASB
-Name Statement of Financial Accounting Standard (FAS)
-Number 106
-Paragraph 518
-LegacyDoc This reference is SUPERSEDED by the Accounting Standards Codification effective for interim and annual periods ending after September 15, 2009. This reference is included to help users transition from the previous accounting hierarchy and will be removed from future versions of this taxonomy.

Reference 7: http://www.xbrl.org/2003/role/presentationRef
-Publisher FASB
-Name Statement of Financial Accounting Standard (FAS)
-Number 87
-Paragraph 264
-LegacyDoc This reference is SUPERSEDED by the Accounting Standards Codification effective for interim and annual periods ending after September 15, 2009. This reference is included to help users transition from the previous accounting hierarchy and will be removed from future versions of this taxonomy.

Reference 8: http://www.xbrl.org/2003/role/presentationRef
-Publisher FASB
-Name Emerging Issues Task Force (EITF)
-Number 03-2
-Paragraph 8
-LegacyDoc This reference is SUPERSEDED by the Accounting Standards Codification effective for interim and annual periods ending after September 15, 2009. This reference is included to help users transition from the previous accounting hierarchy and will be removed from future versions of this taxonomy.

Reference 9: http://www.xbrl.org/2003/role/presentationRef
-Publisher AICPA
-Name Accounting Principles Board Opinion (APB)
-Number 30
-Paragraph 26
-LegacyDoc This reference is SUPERSEDED by the Accounting Standards Codification effective for interim and annual periods ending after September 15, 2009. This reference is included to help users transition from the previous accounting hierarchy and will be removed from future versions of this taxonomy.

Reference 10: http://www.xbrl.org/2003/role/presentationRef
-Publisher FASB
-Name FASB Staff Position (FSP)
-Number FAS106-2
-Paragraph 20, 21, 22
-LegacyDoc This reference is SUPERSEDED by the Accounting Standards Codification effective for interim and annual periods ending after September 15, 2009. This reference is included to help users transition from the previous accounting hierarchy and will be removed from future versions of this taxonomy.

Reference 11: http://www.xbrl.org/2003/role/presentationRef
-Publisher FASB
-Name Statement of Financial Accounting Standard (FAS)
-Number 158
-Paragraph 7, 21, 22
-LegacyDoc This reference is SUPERSEDED by the Accounting Standards Codification effective for interim and annual periods ending after September 15, 2009. This reference is included to help users transition from the previous accounting hierarchy and will be removed from future versions of this taxonomy.

Reference 12: http://www.xbrl.org/2003/role/presentationRef
-Publisher FASB
-Name Statement of Financial Accounting Standard (FAS)
-Number 132R
-Paragraph 5, 6, 7, 8
-LegacyDoc This reference is SUPERSEDED by the Accounting Standards Codification effective for interim and annual periods ending after September 15, 2009. This reference is included to help users transition from the previous accounting hierarchy and will be removed from future versions of this taxonomy.

Reference 13: http://www.xbrl.org/2003/role/presentationRef
-Publisher FASB
-Name Implementation Guide (Q and A)
-Number FAS88
-Paragraph 63
-LegacyDoc This reference is SUPERSEDED by the Accounting Standards Codification effective for interim and annual periods ending after September 15, 2009. This reference is included to help users transition from the previous accounting hierarchy and will be removed from future versions of this taxonomy.

Reference 14: http://www.xbrl.org/2003/role/presentationRef
-Publisher FASB
-Name Accounting Standards Codification
-Topic 715
-URI http://asc.fasb.org/topic&trid=2235017

Income Taxes

12 Months Ended

Dec. 31, 2011

Income Taxes

NOTE 12 INCOME TAXES

We had an income tax benefit of $122,000 in 2009 from the carryback of the net operating loss under the Worker, Home ownership, and Business Assistance Act of 2009, which among other things suspended the 90% limitation on utilization of net operating loss for alternative minimum tax purposes. There is no provision for 2011 and 2010 because we have incurred operating losses.

Deferred income taxes reflect the net tax effects of net operating loss and tax credit carryovers and temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of our deferred tax assets are as follows (in thousands):

December 31,	2011			2010

Deferred Tax Assets:
Net operating loss carryforwards	$	6,700		$	22,800
Research credits		2,100			3,200
Stock compensation expense		600			900
Other		900			700
Total deferred tax assets		10,300			27,600
Valuation allowance		(10,300	)		(27,600	)
Net deferred tax assets	$	—		$	—

Realization of our deferred tax assets is dependent upon our future taxable income, if any, the timing and amount of which are uncertain. Accordingly, our deferred tax assets have been fully offset by a valuation allowance. The valuation allowance decreased by $17.3 million during 2011 and increased by $0.7 million and $5.8 million during 2010 and 2009, respectively.

As of December 31, 2011, we had federal and California net operating loss carryforwards of $17.1 million and $15.8 million, respectively, and federal and California research and development tax credit carryforwards of $0.1 million and $3.0 million, respectively. Of the carryforwards, federal and California net operating loss carryforwards of $12.4 million and $10.9 million, respectively, are subject to annual limitations and will be available from 2012 through 2031, as a result of federal ownership change limitations. The federal and state net operating losses and the federal research and development credit carryforwards expire at various dates beginning in the years 2012 through 2031, if not utilized. The state research credits have no expiration date.

Federal and state laws limit the use of net operating loss and tax credit carryforwards in certain situations where changes occur in the stock ownership of a company. We conducted an analysis of our stock ownership under Internal Revenue Code Section 382 and have reported our deferred tax assets related to net operating loss and research credit carryforwards after recognizing change of control limitations in 2007 and 2011. The limitation of our federal and state carryforwards associated with previous net operating loss and research credit carryforwards, and the associated reduction in our deferred tax assets, was offset by a reduction in our valuation allowance. Utilization of our remaining net operating loss and research and development credit carryforwards may still be subject to substantial annual limitations due to ownership change limitations after December 31, 2011. Such an annual limitation could result in the expiration of the net operating loss and research and development credit carryforwards available as of December 31, 2011 before utilization.

The provision for income taxes differs from the amount computed by applying the U.S. federal statutory tax rate (34% in 2011, 2010 and 2009) to income taxes as follows (in thousands):

December 31,	2011			2010			2009

Tax benefit computed at 34%	$	(4,017	)	$	(2,498	)	$	(3,450	)
Stock compensation expense		148			173			79
Other		70			84			1
AMT credit		—			—			(122	)
NOL not benefitted		3,799			2,241			3,370

Tax Provision (Benefit)	$	—		$	—		$	(122	)

We follow the provisions of ASC 740-10-50, Accounting for Uncertainty in Income Tax Provisions. A reconciliation of the beginning and ending amounts of unrecognized tax benefits is as follows (in thousands):

December 31,	2011		2010		2009
Unrecognized tax benefit:
At the beginning of the period	$	120	$	120	$	120
Gross increases – tax positions in the current period		—		—		—
Gross decreases – tax positions in the current period		—		—		—
At the end of the period	$	120	$	120	$	120

The unrecognized tax benefit, if recognized in full, would result in adjustments to deferred taxes and the related valuation allowance. We do not currently anticipate any significant changes to the unrecognized tax benefits in 2012. Our policy is to recognize interest and penalties accrued on any unrecognized tax benefits as a component of tax expense. To date, we have not used the unrecognized tax benefits to reduce any of our past tax obligations. As a result, we had no accrual for the payment of interest and penalties related to the unrecognized tax benefits. As of December 31, 2011, our tax returns were subject to future examination in the U.S. federal and state tax jurisdictions for the tax years 1996 through 2011, due to net operating losses and research credits that are being carried forward.

The entire disclosure for income taxes. Disclosures may include net deferred tax liability or asset recognized in an enterprise's statement of financial position, net change during the year in the total valuation allowance, approximate tax effect of each type of temporary difference and carryforward that gives rise to a significant portion of deferred tax liabilities and deferred tax assets, utilization of a tax carryback, and tax uncertainties information.

Reference 1: http://www.xbrl.org/2003/role/presentationRef
-Publisher SEC
-Name Regulation S-X (SX)
-Number 210
-Section 08
-Paragraph h
-Article 4

Reference 2: http://www.xbrl.org/2003/role/presentationRef
-Publisher FASB
-Name Statement of Financial Accounting Standard (FAS)
-Number 109
-Paragraph 136, 172
-LegacyDoc This reference is SUPERSEDED by the Accounting Standards Codification effective for interim and annual periods ending after September 15, 2009. This reference is included to help users transition from the previous accounting hierarchy and will be removed from future versions of this taxonomy.

Reference 3: http://www.xbrl.org/2003/role/presentationRef
-Publisher FASB
-Name Statement of Financial Accounting Standard (FAS)
-Number 109
-Paragraph 43, 44, 45, 46, 47, 48, 49
-LegacyDoc This reference is SUPERSEDED by the Accounting Standards Codification effective for interim and annual periods ending after September 15, 2009. This reference is included to help users transition from the previous accounting hierarchy and will be removed from future versions of this taxonomy.

Reference 4: http://www.xbrl.org/2003/role/presentationRef
-Publisher FASB
-Name Accounting Standards Codification
-Topic 740
-SubTopic 10
-Section 50
-Paragraph 15
-URI http://asc.fasb.org/extlink&oid=6907707&loc=d3e32718-109319

Reference 5: http://www.xbrl.org/2003/role/presentationRef
-Publisher FASB
-Name Accounting Standards Codification
-Topic 740
-SubTopic 10
-Section 50
-Paragraph 9
-URI http://asc.fasb.org/extlink&oid=6907707&loc=d3e32639-109319

Reference 6: http://www.xbrl.org/2003/role/presentationRef
-Publisher FASB
-Name Accounting Standards Codification
-Topic 235
-SubTopic 10
-Section S99
-Paragraph 1
-Subparagraph (SX 210.4-08.(h))
-URI http://asc.fasb.org/extlink&oid=6881521&loc=d3e23780-122690

Reference 7: http://www.xbrl.org/2003/role/presentationRef
-Publisher FASB
-Name Accounting Standards Codification
-Topic 740
-SubTopic 10
-Section 50
-Paragraph 2
-URI http://asc.fasb.org/extlink&oid=6907707&loc=d3e32537-109319

Reference 8: http://www.xbrl.org/2003/role/presentationRef
-Publisher FASB
-Name Accounting Standards Codification
-Topic 740
-SubTopic 10
-Section 50
-Paragraph 3
-URI http://asc.fasb.org/extlink&oid=6907707&loc=d3e32559-109319

Significant Agreements

12 Months Ended

Dec. 31, 2011

Significant Agreements

NOTE 13 SIGNIFICANT AGREEMENTS

Merial Limited

In September 2009, we entered into a world-wide license and development agreement with Merial Limited (Merial), a world leading animal health company, for a long acting pain management product for companion animals. Under the terms of the new agreement, we received a nonrefundable upfront license fee and would receive development funding and potential future milestone payments and royalties following commercialization.

Under the license and development agreement, we were obligated to perform reimbursable development services and provide any improvements related to the licensed technology during the six-year development period. We recognized the upfront license fee ratably over the development period, and recognized revenue from the development services when the services were rendered. Any milestone payments would be recognized when receipt of the payments is probable.

In May 2011, we received notice of termination from Merial due to their concerns about the commercial potential of the product under development in the animal health market. We recognized $0.6 million, $1.3 million and $0.2 million in revenue related to development services to Merial for the years ended 2011, 2010 and 2009, respectively. The remaining balance of deferred revenue related to the upfront license fee of $0.1 million was recognized as revenue in the quarter ended June 30, 2011, upon termination of the licensing agreement by Merial.

Paul Royalty Fund

On January 18, 2006, we sold our rights to royalties on sales of Retin-A Micro® and Carac®, effective October 1, 2005, to an affiliate of the Paul Royalty Fund for $30.0 million. Proceeds of $25.0 million were received upon the closing of the transaction and used primarily to fund the Phase 3 pivotal trial of APF530, our drug candidate for the prevention of both acute and delayed CINV. Subsequent $2.5 million payments were received in both 2007 and January 2010 upon the achievement of certain milestones.

RHEI Pharmaceuticals, Inc.

On October 1, 2006, we entered into an agreement with RHEI Pharmaceuticals, Inc. (RHEI) in which we granted them an exclusive license to develop and market APF530 in Greater China. We received a license fee upon the signing of the contract, which was recorded as deferred revenue on the balance sheet, and were due additional milestone payments upon the achievement of certain regulatory events.

Following the announcement of acceptance for filing of an NDA for our APF530 product candidate by the FDA on July 20, 2009, RHEI became contractually obligated to pay us a milestone payment. RHEI did not make such milestone payment in the time required under the terms of our agreement, and we provided RHEI with notice of its cure period. RHEI remained in default of this payment and, as a result, we elected to terminate the agreement for cause on September 29, 2009. No material termination penalties applied to us for the termination of the agreement.

Revenue of $1.0 million, previously deferred in conjunction with the RHEI agreement, was recognized in 2009 as a result of the termination and is included in contract revenue.

Tabular disclosure of significant agreements under research and development arrangements accounted for as a contract to perform research and development for others (including royalty arrangements, purchase provisions, license agreements, and commitments to provide additional funding), aggregated by similar arrangements or individually if necessary to understand the effects on the financial statements. Include also the amount of costs incurred under a research and development arrangement accounted for as a contract to perform research and development for others. Aggregation of similar arrangements by type may be appropriate. Include also the amount of compensation earned (contract income) under a research and development arrangement accounted for as a contract to perform research and development for others. Aggregation of similar arrangements by type may be appropriate.

+ References + Details

Quarterly Results of Operations (Unaudited)

12 Months Ended

Dec. 31, 2011