Note 1. Summary of Significant Accounting Policies

Principles of Consolidation

The accompanying unaudited condensed consolidated financial statements include those of Cerus Corporation and its subsidiary, Cerus Europe B.V. (collectively referred to hereinafter as Cerus or the Company) after elimination of all intercompany accounts and transactions. These condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP") for interim financial information and pursuant to the rules and regulations of the Securities and Exchange Commission, ("SEC"). Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management, all adjustments, consisting of normal recurring entries, considered necessary for a fair presentation have been made for the three and six months ended June 30, 2011. As previously reported in the Company's 2010 Annual Report on Form 10-K in "Note 18. Quarterly Financial Information" in the Notes to Consolidated Financial Statements, adjustments relating to the acquisition of certain assets from BioOne Corporation ("BioOne") were made to previously reported financial statements for the three and six months ended June 30, 2010. These adjustments reduced long-term assets and increased operating expenses by $0.1 million and $0.4 million for the three and six months ended June 30, 2010, respectively. Operating results for the three and six months ended June 30, 2011 are not necessarily indicative of the results that may be expected for the year ending December 31, 2011, or for any future periods.

These condensed consolidated financial statements and notes should be read in conjunction with the Company's audited financial statements and notes thereto for the year ended December 31, 2010, which were included in the Company's 2010 Annual Report on Form 10-K, filed with the SEC on March 16, 2011. The accompanying balance sheet as of December 31, 2010 has been derived from the Company's audited financial statements as of that date.

Use of Estimates

The preparation of financial statements requires management to make estimates, assumptions and judgments that affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosures of contingent assets and liabilities. On an ongoing basis, management evaluates its estimates, which are based on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. Actual results may differ from those estimates under different assumptions or conditions.

Revenue

In October 2009, the Financial Accounting Standards Board ("FASB,") issued updated revenue recognition guidance under Accounting Standards Codification ("ASC,") Topic 605 relating to revenue arrangements with multiple deliverables. Under the revised guidance, companies with revenue arrangements that have multiple deliverables must assess whether or not multiple deliverables exist under the revised guidance, how the deliverables should be separated and how the consideration should be allocated to the elements. In addition, the revised guidance requires an entity to allocate revenue in an arrangement using the best estimated selling price ("BESP,") of deliverables if a vendor does not have vendor specific objective evidence of selling price or third-party evidence, or TPE, of selling price. Each unit must have stand-alone value to the customer, similar to previous guidance. Effective January 1, 2011, the Company adopted the revised guidance for revenue recognition in accordance with the FASB, ASC Topic 605-25, "Revenue Recognition - Arrangements with Multiple Deliverables," on a prospective basis for applicable transactions originating or materially modified after December 31, 2010. This guidance does not change the units of accounting for the Company's revenue transactions. The adoption of this revised guidance did not have a material impact on the Company's results of operations for the three and six months ended June 30, 2011 nor is it currently anticipated to have a material impact on future periods.

Revenue is recognized when (i) persuasive evidence of an agreement with the funding party exists; (ii) services have been rendered or product has been delivered; (iii) pricing is fixed or determinable; and (iv) collection is probable.

The Company's main sources of revenues through June 30, 2011 were product revenue from sales of the INTERCEPT Blood System and United States government grants and awards.

Revenue related to product sales is generally recognized when the Company fulfills its obligations for each element of an agreement. For all INTERCEPT Blood System products, the Company uses a binding purchase order and signed sales contract as evidence of written agreement. The Company sells INTERCEPT Blood System for platelets and plasma directly to blood banks, hospitals, universities, government agencies, as well as to distributors in certain regions. Generally, the Company's contracts with its customers do not provide for open return rights, except within a reasonable time after receipt of goods in the case of defective or non-conforming product. Deliverables and the units of accounting vary according to the provisions of each purchase order or sales contract. For revenue arrangements with multiple elements, the Company evaluates whether the delivered elements have stand-alone value to the customer. Prior to adoption of ASU No. 2009-13, consideration received was allocated to elements that were identified as discrete units of accounting based on the relative fair value method. Beginning January 1, 2011, consideration received is allocated to elements that are identified as discrete units of accounting based on the BESP. The Company has determined that VSOE is not discernable due to the Company's limited history of selling its products and variability in its pricing. Since the Company's products are novel and unique and are not sold by others, third-party evidence of selling price is unavailable.

At June 30, 2011 and December 31, 2010, the Company had $0.1 million and $0.2 million, respectively, of short-term deferred revenue on its condensed consolidated balance sheets related to future performance obligations. Freight costs charged to customers are recorded as a component of revenue under ASC Topic 605, "Accounting for Shipping and Handling Fees and Costs." Value-added-taxes ("VAT") that the Company invoices to its customers and remits to governments, are recorded on a net basis, which excludes such VAT from product revenue.

Research and Development Expenses

The Company receives certain United States government grants that support the Company's efforts in defined research projects. These grants generally provide for reimbursement of approved costs incurred as defined in the various grants. Revenue associated with these grants is recognized as costs under each grant are incurred. In addition, accordance with ASC Topic 730, "Accounting for Research and Development Expenses," research and development expenses are charged to expense when incurred. Research and development expenses include salaries and related expenses for scientific personnel, payments to consultants, supplies and chemicals used in in-house laboratories, costs of research and development facilities, depreciation of equipment and external contract research expenses, including clinical trials, preclinical safety studies, other laboratory studies, process development and product manufacturing for research use.

The Company's use of estimates in recording accrued liabilities for research and development activities (described previously in this Note under the heading "Use of Estimates") affects the amounts of research and development expenses recorded and revenue recorded from development funding and government grants and collaborative agreements. Actual results may differ from those estimates under different assumptions or conditions.

Cash, Cash Equivalents and Short-Term Investments

The Company considers all highly liquid investments with original maturities of three months or less from the date of purchase to be classified as cash equivalents. Investments with original maturities of greater than three months but less than one year from the date of purchase are classified as short-term investments. These investments primarily consist of marketable debt securities, which including money market instruments, United States government agency securities and corporate debt securities, and are classified as available-for-sale.

In accordance with ASC Topic 320, "Accounting for Certain Investments in Debt and Equity Securities," the Company has classified all debt securities as available-for-sale at the time of purchase and reevaluates such designation as of each balance sheet date. Available-for-sale securities are carried at estimated fair value based on quoted market prices. Unrealized gains and losses derived by changes in the estimated fair value of available-for-sale securities are recorded in "Accumulated other comprehensive income" on the Company's condensed consolidated balance sheets. Realized gains and losses from the sale or maturity of available-for-sale investments are recorded in "Other income (expense), net" on the Company's condensed consolidated statements of operations. The cost of securities sold is based on the specific identification method. The Company reports the amortization of any premium and accretion of any discount resulting from the purchase of debt securities as a component of interest expense.

The Company also reviews all of its marketable securities on a regular basis to evaluate whether any security has experienced an other-than-temporary decline in fair value. Other-than-temporary declines in market value are recorded in "Other expense, net" on the Company's condensed consolidated statements of operations.

As of June 30, 2011, the Company also maintained a certificate of deposit for approximately $0.2 million with a domestic bank. The Company holds this certificate of deposit for any potential decommissioning resulting from the Company's possession of radioactive material. The certificate of deposit is held to satisfy the financial surety requirements of the California Department of Health Services and is recorded as restricted cash on its condensed consolidated balance sheets at June 30, 2011 and December 31, 2010.

 

Concentration of Credit Risk

Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of cash equivalents, short-term investments and accounts receivable.

Substantially all of the Company's cash, cash equivalents and short-term investments are maintained pursuant to the Company's investment policy at a major financial institution of high credit standing. The Company monitors the financial credit worthiness of the issuers of its investments and limits the concentration in individual securities and type of investments that exist within its investment portfolio. Generally, all of the Company's remaining investments carry high credit quality ratings, which is in accordance with its investment policy. At June 30, 2011, the Company does not believe there is significant financial risk from non-performance by the issuers of the Company's cash equivalents and short-term investments.

Concentrations of credit risk with respect to trade receivables exist to the full extent of amounts presented in the condensed consolidated balance sheets. On a regular basis, including at the time of sale, the Company performs credit evaluations of its customers. Generally, the Company does not require collateral from its customers to secure accounts receivable. To the extent that the Company determines specific invoices or customer accounts may be uncollectible, the Company reserves against the accounts receivable on its balance sheet and records a charge on its condensed consolidated statement of operations. The Company had recorded allowances for potentially uncollectible accounts receivable of approximately $0.1 million at both June 30, 2011 and December 31, 2010. Actual collection losses may differ from management's estimate, and such differences could have a material impact to the Company's financial position and results of operations.

The Company had three customers each accounting for more than 10% of the Company's outstanding trade receivables, which accounted for approximately 57% and 54% of outstanding trade receivables at June 30, 2011 and December 31, 2010, respectively. To date, the Company has not experienced collection difficulties from these customers.

Inventories

Inventory consisted of work-in-process and finished goods only. Finished goods include INTERCEPT disposable kits, UVA illumination devices ("illuminators"), and certain replacement parts for the illuminators. Platelet and plasma system disposable kits generally have two-year life from the date of manufacture. Illuminators and replacement parts do not have regulated expiration dates. Work-in-process includes certain components that are manufactured over a protracted length of time, which can exceed one year, before being incorporated and assembled by Fenwal, Inc. ("Fenwal") into the finished INTERCEPT disposable kits.

Inventory is recorded at the lower of cost, determined on a first-in, first-out basis, or market value. The Company frequently reviews the composition of inventory to identify obsolete, slow-moving or otherwise unsalable items. To the extent unsalable items are observed and there is no alternative use, the Company writes-down its inventory to net realizable value in the period that it is first recognized. The write-down of its inventory to net realizable value establishes a new cost basis and will be maintained even if certain circumstances suggest that the inventory is recoverable in subsequent periods. Costs associated with the write-down of inventory are recorded in "Cost of product revenue" on the Company's condensed consolidated statements of operations. At June 30, 2011 and December 31, 2010, the Company had $0.2 million and $0.4 million, respectively, reserved for potential obsolete or expiring product.

Property and Equipment, net

Property and equipment is comprised of furniture, equipment, information technology hardware and software and is recorded at cost. At the time the property and equipment is ready for its intended use, it is depreciated on a straight-line basis over the estimated useful lives of the assets (generally three to five years). Leasehold improvements are amortized on a straight-line basis over the shorter of the lease term or the estimated useful lives of the improvements.

Goodwill and Intangible Assets, net

Goodwill and intangible assets, net is derived at the time of a business acquisition, in which the Company assigns the total consideration transferred to the acquired assets based on each asset's fair value and any residual amount becomes goodwill, an indefinite life intangible asset. Intangible assets, net, which include the INTERCEPT Asia license, are subject to periodic amortization over the estimated useful life of ten years. The amortization of the Company's intangible assets, net, is recorded in "Amortization of intangible assets" on the Company's condensed consolidated statements of operations.

Goodwill is not amortized but instead is subject to an impairment test performed on an annual basis, or more frequently if events or changes in circumstances indicate that they may be impaired. The Company evaluates goodwill on an annual basis as of the end of the third quarter of each fiscal year. The test for goodwill impairment is a two-step process. The first step compares the fair value of each reporting unit with its respective carrying amount, including goodwill. If the fair value of the reporting unit exceeds its carrying amount, goodwill of the reporting unit is not considered impaired and, therefore, the second step of the impairment test is unnecessary. The second step, which is used to measure the amount of impairment loss, compares the implied fair value of each reporting unit's goodwill with the respective carrying amount of that goodwill. If the carrying amount of the reporting unit's goodwill exceeds the implied fair value of that goodwill, an impairment loss is recognized in an amount equal to that excess. Management has determined that it operates as a single reporting unit and therefore evaluates goodwill impairment at the enterprise level. There were no impairment charges during the three or six months ended June 30, 2011.

See Note 5 in the Notes to condensed consolidated financial statements for further information regarding the valuation of goodwill and intangible assets, net.

Long-lived Assets

The Company evaluates its long-lived assets for impairment by continually monitoring events and changes in circumstances that could indicate carrying amounts of its long-lived assets may not be recoverable. When such events or changes in circumstances occur, the Company assesses recoverability by determining whether the carrying value of such assets will be recovered through the undiscounted expected future cash flows. If the expected undiscounted future cash flows are less than the carrying amount of these assets, the Company then measures the amount of the impairment loss based on the excess of the carrying amount over the fair value of the assets. The Company did not recognize impairment charges related to its long-lived assets during the three and six months ended June 30, 2011 and 2010.

Foreign Currency Remeasurement

The functional currency of the Company's foreign subsidiary is the United States Dollar. Monetary assets and liabilities denominated in foreign currencies are remeasured in United States Dollars using the exchange rates at the balance sheet date. Non-monetary assets and liabilities denominated in foreign currencies are remeasured in United States Dollars using historical exchange rates. Revenues and expenses are remeasured using average exchange rates prevailing during the period. Remeasurements are recorded in the Company's condensed consolidated statements of operations. The Company recorded foreign currency losses of $0.3 million and $1.0 million during the three months ended June 30, 2011 and 2010, respectively, and $1.1 million during the six months ended June 30, 2010. The Company recorded foreign currency gains of $0.4 million during the six months ended June 30, 2011.

Stock-Based Compensation

The Company accounts for stock-based compensation in accordance with ASC Topic 718, "Compensation – Stock Compensation." Stock-based compensation expense is measured at the grant date based on the fair value of the award and is recognized as expense on a straight-line basis over the requisite service period, which is the vesting period, and is adjusted for estimated forfeitures. To the extent that stock options contain performance criteria for vesting, stock-based compensation is recognized once the performance criteria are probable of being achieved.

For stock-based awards issued to non-employees, the Company follows ASC Topic 505-50, "Equity Based Payment to Non-Employees" and considers the measurement date at which the fair value of the stock-based award is measured to be the earlier of 1) the date at which a commitment for performance by the grantee to earn the equity instrument is reached or 2) the date at which the grantee performance is complete. The Company recognizes stock-based compensation expense for the fair value of the vested portion of the non-employee stock-based awards in its condensed consolidated statements of operations.

See Note 10 in the Notes to condensed consolidated financial statements for further information regarding the Company's stock-based compensation assumptions and expenses.

Warrant Liability

In August 2009 and November 2010, the Company issued warrants to purchase an aggregate of 2.4 million and 3.7 million shares of common stock, respectively. The material terms of the warrants were identical under each issuance except for the exercise price, date issued and expiration date. The fair value of these outstanding warrants, calculated using the binomial-lattice option-pricing model, is classified as a liability on the condensed consolidated balance sheets and is adjusted at each subsequent reporting period, until the warrants are exercised or are modified to remove the provisions which require this treatment. Gains and losses from warrant revaluation are recorded in "Loss from revaluation of warrant liability" on the condensed consolidated statements of operations. During the three and six months ended June 30, 2011, the Company recorded non-cash charges of $0.3 million and $1.6 million, respectively, associated with changes in the fair value of the warrants from December 31, 2010. During the three and six months ended June 30, 2010, the Company recorded non-cash charges of $0.7 million and $1.6 million, respectively, associated with changes in the fair value of the warrants from December 31, 2009. Upon the exercise or modification to remove the provisions which require the warrants to be treated as a liability, the fair value of the warrants will be reclassified from liabilities to stockholders' equity and no further adjustment to the fair value would be made in subsequent periods.

See Note 9 in the Notes to condensed consolidated financial statements for further information regarding the Company's valuation of warrant liability.

Other Comprehensive Income

The components of comprehensive loss include net loss and other comprehensive income. The Company's only component of other comprehensive income for the three and six months ended June 30, 2011 and 2010 consisted of unrealized gains from the Company's available-for-sales short-term investments. Other comprehensive income is reported as a separate component of stockholders' equity.

Income Taxes

The Company accounts for income taxes using an asset and liability approach in accordance with ASC Topic 740 "Accounting for Income Taxes". Under this method, deferred tax assets and liabilities are determined based on differences between the financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. ASC Topic 740 requires derecognition of tax positions that do not have a greater than 50% likelihood of being recognized upon review by a taxing authority having full knowledge of all relevant information. Use of a valuation allowance as described in ASC Topic 740 is not an appropriate substitute for the derecognition of a tax position. The Company did not have any recorded liabilities for unrecognized tax benefits at June 30, 2011 or December 31, 2010. The Company recognizes accrued interest and penalties related to unrecognized tax benefits in its income tax expense. To date, the Company has not recognized any interest and penalties in its condensed consolidated statements of operations, nor has its accrued for or made payments for interest and penalties. The Company continues to carry a full valuation allowance on all of its deferred tax assets. Although the Company believes it more likely than not that a taxing authority would agree with its current tax positions, there can be no assurance that the tax positions the Company has taken will be substantiated by a taxing authority if reviewed. The Company's tax years 2006 through 2010 remain subject to examination by the taxing jurisdictions.

Net Loss Per Share

Basic loss per share is computed by dividing net loss by the weighted average number of common shares outstanding for the period. Diluted loss per share uses the same weighted average number of common shares outstanding for the period as calculated for the basic loss per share as the inclusion of any commons stock equivalents would be anti-dilutive. If the Company earned net income, diluted earnings per share would assume conversion of all potentially dilutive securities, such as stock options, convertible preferred stock, warrants and restricted stock units.

The following table sets forth the reconciliation of the numerator and denominator used in the computation of basic and diluted net loss per common share for the three and six months ended June 30, 2011 and 2010 (in thousands, except per share amounts):

 

		Three Months Ended								Six Months Ended
		June 30,								June 30,
		2011				2010				2011				2010
Numerator:
Net loss		($	6,313	)		($	5,559	)		($	11,323	)		($	10,832	)
Denominator:
Basic weighted average number of common shares outstanding			47,620				38,940				47,530				38,880
Effect of dilutive potential common shares resulting from convertible preferred stock, stock options, restricted stock units, warrants and ESPP shares			0				0				0				0
Diluted weighted average number of common shares outstanding			47,620				38,940				47,530				38,880
Net loss per common share:
Basic		($	0.13	)		($	0.14	)		($	0.24	)		($	0.28	)
Diluted		($	0.13	)		($	0.14	)		($	0.24	)		($	0.28	)

The table below presents stock options, convertible preferred stock, warrants and restricted stock units that are excluded from the diluted net loss per common share due to their anti-dilutive effect for the three and six months ended June 30, 2011 and 2010 (shares in thousands):

 

		Three Months Ended								Six Months Ended
		June, 30								June, 30
		2011				2010				2011				2010
Weighted average of anti-dilutive common shares			13,635				9,102				13,592				9,206

 

Guarantee and Indemnification Arrangements

The Company recognizes the fair value for guarantee and indemnification arrangements issued or modified by the Company after December 31, 2002. In addition, the Company monitors the conditions that are subject to the guarantees and indemnifications, in order to identify if a loss has occurred. If the Company determines it is probable that a loss has occurred, then any such estimable loss would be recognized under those guarantees and indemnifications. Some of the agreements that the Company is a party to, contain provisions that indemnify the counter party from damages and costs resulting from claims that the Company's technology infringes the intellectual property rights of a third party or claims that the sale or use of the Company's products have caused personal injury or other damage or loss. The Company has not received any such requests for indemnification under these provisions and has not been required to make material payments pursuant to these provisions.

The Company generally provides for a one-year warranty on certain of its INTERCEPT blood-safety products covering defects in materials and workmanship. The Company accrues costs associated with warranty obligations when claims become known and are estimable. There have been very few warranty costs incurred through June 30, 2011, and the company is unaware of any future warranty claims. Accordingly, at June 30, 2011 and December 31, 2010, the Company did not accrue for any potential future warranty costs.

Fair Value of Financial Instruments

The Company applies the provisions of fair value relating to its financial assets and liabilities. The carrying amounts of accounts receivables, accounts payable, and other accrued liabilities approximate their fair value due to the relative short-term maturities. Based on the borrowing rates currently available to the Company for loans with similar terms, the Company believes the fair value of long-term debt approximates their carrying amounts. The Company measures and records certain financial assets and liabilities at fair value on a recurring basis, including its available-for-sale securities and warrant liability. The Company classifies instruments within Level 1 if quote prices are available in active markets, which include its money market funds as the maturity of money market funds are relatively short and the carrying amount is a reasonable estimate of fair value. The Company classifies instruments in Level 2 if the instruments are valued using observable inputs to quoted market prices, benchmark yields, reported trades, broker/dealer quotes or alternative pricing sources with reasonable levels of price transparency. These instruments include the Company's available-for-sale securities related to United States government agencies and corporate debt securities. The available-for-sale securities are held by a custodian who obtains investment prices from a third party pricing provider that uses standard inputs to models which vary by asset class. The Company classifies instruments in Level 3 if one or more significant inputs or significant value drivers are unobservable, which include its warrant liability.

See Note 2 in the Notes to condensed consolidated financial statements for further information regarding the Company's valuation on financial instruments.

New Accounting Pronouncements

In May 2011, the FASB issued updated fair value measurement guidance under ASU No. 2011-14 "Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs," surrounding changes in the valuation premise of highest and best use of an asset, the application of premiums and discounts, and enhanced disclosure requirements. Under ASU No. 2011-14, the measurement of fair value of financial instruments will primarily be measured at the level of the unit of account whereas it was historically able to utilize the valuation premise of highest and best use of an asset, which can be applied primarily to measuring the fair value of nonfinancial assets only going forward. In addition, the application of blockage factors and other premiums and discounts in a fair value measurement will be prohibited in the valuation of all fair value levels of the hierarchy. The new disclosure requirements include, but are not limited to, further qualitative and quantitative discussions regarding level 3 fair value measurements, specifically significant unobservable inputs used, description of the valuation processes and sensitivity analysis, the disclosure of any transfers and the reasons thereof between levels 1 and 2, and the determination of assets and liabilities that are not recorded at fair value to be categorized under the fair value hierarchy. The updated fair value measurement guidance is effective for interim and annual periods beginning after December 15, 2011, which will begin for the Company on January 1, 2012. The Company does not anticipate that the additional disclosure requirements will have a material impact on the condensed consolidated financial statements.

In June 2011, the FASB issued ASU No. 2011-05 "Presentation of Comprehensive Income," which eliminates the presentation of other comprehensive income from the consolidated statements of stockholders' equity. Instead, companies would have the option to display net income and other comprehensive income in two separate, but consecutive statements or combine net income and other comprehensive income in one continuous statement, which would be referred to the consolidated statements of comprehensive income. The new presentation requirements under this guidance are effective for interim and annual periods beginning after December 15, 2011, which will begin for the Company on January 1, 2012, and retrospective application is required for all periods presented. The Company does not anticipate that the additional disclosure requirements will have a material impact on the condensed consolidated financial statements.

Note 3. Cash, Cash Equivalents and Short-Term Investments

The following is a summary of cash, cash equivalents and short-term investments at June 30, 2011 (in thousands):

 

		Carrying Value				Gross Unrealized Gain				Fair Value
Cash and cash equivalents:
Cash		$	10,568			$	0			$	10,568
Money market funds			6,599				0				6,599
Total cash and cash equivalents			17,167				0				17,167
Short-term investments:
Corporate debt securities			0				0				0
United States government agency securities			612				1				613
Total short-term investments			612				1				613
Total cash, cash equivalents and short-term investments		$	17,779			$	1			$	17,780

The following is a summary of cash, cash equivalents and short-term investments at December 31, 2010 (in thousands):

 

		Carrying Value				Gross Unrealized Gain				Fair Value
Cash and cash equivalents:
Cash		$	22,770			$	0			$	22,770
Money market funds			6,178				0				6,178
Total cash and cash equivalents			28,948				0				28,948
Short-term investments:
Corporate debt securities			14				59				73
United States government agency securities			939				49				988
Total short-term investments			953				108				1,061
Total cash, cash equivalents and short-term investments		$	29,901			$	108			$	30,009

Cash equivalents and short-term investments consisted of the following by original contractual maturity (in thousands):

 

		June 30, 2011								December 31, 2010
		Carrying Value				Fair Value				Carrying Value				Fair Value
Due in one year or less		$	6,599			$	6,599			$	6,178			$	6,178
Due greater than three years and less than five years			612				613				953				1,061
Total cash equivalents and short-term investments		$	7,211			$	7,212			$	7,131			$	7,239

The maturities of certain short-term investments were estimated primarily based upon assumed prepayment features and credit enhancement characteristics.

Gross realized gains from the sale or maturity of available-for-sale investments were minimal during the three and six months ended June 30, 2011 and 2010. The Company did not record any gross realized losses from the sale or maturity of available-for-sale investments during the three and six months ended June 30, 2011 and 2010, nor did it record losses on investments experiencing an other-than-temporary decline in fair value during the three and six months ended June 30, 2011. The Company recorded minimal losses on investments experiencing an other-than-temporary decline in fair value for the three and six months ended June 30, 2010.

Note 4. Inventories

Inventories consisted of the following (in thousands):

 

		June 30, 2011				December 31, 2010
Work-in-process		$	3,866			$	2,652
Finished goods			6,102				3,305
Total inventories		$	9,968			$	5,957

Note 5. Goodwill and Intangible Assets, net

Goodwill

During the three and six months ended June 30, 2011, there were no impairment charges recognized and the Company did not dispose of or recognize additional goodwill. As a result, at both June 30, 2011 and December 31, 2011, the carrying amount of goodwill was $1.3 million, which resulted from the August 2010 acquisition of certain assets from BioOne, a privately held Japanese company established to develop technologies to improve the safety of blood products in Asia.

Intangible Assets, net

The following is a summary of intangible assets, net at June 30, 2011 (in thousands):

 

		Gross Carrying Amount				Accumulated Amortization				Net Carrying Amount
Acquisition-related intangible assets:
License - INTERCEPT Asia		$	2,017			($	168	)		$	1,849
Total intangible assets		$	2,017			($	168	)		$	1,849

The following is a summary of intangible assets, net at December 31, 2010 (in thousands):

 

		Gross Carrying Amount				Accumulated Amortization				Net Carrying Amount
Acquisition-related intangible assets:
License - INTERCEPT Asia		$	2,017			($	67	)		$	1,950
Total intangible assets		$	2,017			($	67	)		$	1,950

The Company recognized $0.05 million and $0.1 million in amortization expense related to intangible assets for the three and six months ended June 30, 2011. During the three and six months ended June 30, 2011, there were no impairment charges recognized and the Company did not renew or extend the term of the acquired intangible assets.

The expected annual amortization expense of the intangible assets, net at June 30, 2011 are $0.1 million for the remaining six months of 2011, $0.2 million each subsequent year thereafter through December 31, 2019 and $0.1 million in 2020.

Note 6. Accrued Liabilities

Accrued liabilities consisted of the following (in thousands):

 

		June 30, 2011				December 31, 2010
Accrued compensation and related		$	1,299			$	1,861
Accrued inventory			1,847				1,424
Accrued contract and other accrued expenses			2,188				2,718
Total accrued liabilities		$	5,334			$	6,003

Note 7. Commitments and Contingencies

Operating Leases

The Company leases its office facilities and certain equipment under non-cancelable operating leases with initial terms in excess of one year that require the Company to pay operating costs, property taxes, insurance and maintenance. These facility leases generally contain renewal options and provisions adjusting the lease payments if those renewal options are exercised. The Company's facility leases qualify as operating leases and as such, are not included on its condensed consolidated balance sheets.

Royalties

The Company is obligated to pay royalties on certain INTERCEPT product sales based on a percentage of net sales generated. The royalty rates vary by product, with a rate of 10% of net sales for the platelet system, 3% for the plasma system, 5% for the red blood cells, or the red blood cell system, and 6.5% for UVA illuminator devices, or illuminators.

Purchase Commitments

The Company is party to agreements with certain providers for certain components of INTERCEPT blood safety system which the Company purchases from third party manufacturers and supplies to Fenwal at no cost for use in manufacturing finished disposable kits. Certain of these agreements require minimum purchase commitments from the Company.

Note 8. Long-term Note Payable

Long-term note payable at June 30, 2011 consisted of the following (in thousands):

 

		Principal				Unamortized Discount				Total
Current portion of long-term debt		$	1,935			($	59	)		$	1,876
Long-term debt			2,181				(22	)			2,159
Total long-term note payable		$	4,116			($	81	)		$	4,035

Long-term note payable at December 31, 2010 consisted of the following (in thousands):

 

		Principal				Unamortized Discount				Total
Current portion of long-term debt		$	1,822			($	75	)		$	1,747
Long-term debt			3,178				(47	)			3,131
Total long-term note payable		$	5,000			($	122	)		$	4,878

On March 31, 2010, the Company entered into a growth capital facility agreement and immediately issued a senior secured long-term note payable for $5.0 million. The note issued under the agreement is secured by all of the Company's assets, except intellectual property. The note carries a fixed interest rate of 12.04%, with interest only payments for the first nine months and then equal principal and interest payments for an additional 30 months. In connection with issuing the note, the Company paid an upfront facility fee of $0.1 million and incurred closing costs of $0.1 million. The combined facility fee and closing costs have been recorded as a discount to the note payable and will be amortized as a component of interest expense using the effective interest method over the term of the note (discount is based on an implied interest rate of 13.84%). In addition, the Company agreed to pay a $0.4 million closing fee upon maturity of the note, which will be accreted to interest expense using the effective interest method over the life of the note. In March 2011, the Company entered into an amendment to its growth capital facility. Under the terms of the amendment, the Company may borrow an additional $5.0 million through September 30, 2011. The terms of the additional $5.0 million note would be identical to the first note issued under the growth capital facility except the Company would not incur any additional upfront facility fees. In addition, the amendment modifies the covenants under which the Company must comply. Under the amended agreement, 2011 revenues, on a trailing six-month basis, are required to be at least 80% of projected revenues. Revenues for 2012 and beyond are required to be at least €5.7 million per quarter. Non-compliance with the covenants could result in the principal of the note becoming due and payable. As of June 30, 2011, the Company was in compliance with financial covenants set forth in the amended growth capital facility.

 

Principal and interest payments on the long-term note payable at June 30, 2011 for each of the following five years are as follows (in thousands):

 

Year ended December 31,
2011			1,163
2012			2,326
2013			1,782
2014			0
2015			0

Note 9. Stockholders' Equity

Series B Preferred Stock

Fenwal holds 3,327 shares of the Company's Series B preferred stock. The holder of Series B preferred stock has no voting rights, except with respect to the authorization of any class or series of stock having preference or priority over the Series B preferred stock as to voting, liquidation or conversion or with respect to the determination of fair market value of non-publicly traded shares received by the holder of Series B preferred stock in the event of a liquidation, or except as required by Delaware law. At any time, the holder may convert each share of Series B preferred stock into 100 shares of the Company's common stock. If all shares of Series B preferred stock were converted to common stock, 332,700 shares of common stock would be issued, which represents approximately 1% of the outstanding common stock of the Company at June 30, 2011. The Company has the right to redeem the Series B preferred stock prior to conversion for a payment of $9.5 million.

Common Stock and Associated Warrant Liability

In August 2009, the Company received net proceeds of approximately $12.1 million, after deducting placement agent's fees and stock issuance costs of approximately $1.1 million, from a registered direct offering of 6.0 million units. Each unit sold consisted of one share of common stock and a warrant to purchase 4/10 of a share of common stock. Each unit was sold for $2.20, resulting in the issuance of 6.0 million shares of common stock and warrants to purchase 2.4 million shares of common stock, exercisable at an exercise price of $2.90 per share. The warrants contain certain provisions that, under certain circumstances, which may be out of the Company's control, could require the Company to pay cash to settle the exercise of the warrants or may require the Company to redeem the warrants.

In November 2010, the Company received net proceeds of approximately $19.7 million, after deducting underwriting discounts and commissions and stock issuance costs of approximately $1.3 million, from an underwritten public offering of 7.4 million units. Each unit sold consisted of one share of common stock and a warrant to purchase 1/2 of a share of common stock. Each unit was sold for $2.85, resulting in the issuance of 7.4 million shares of common stock and warrants to purchase 3.7 million shares of common stock, exercisable at an exercise price of $3.20 per share. The warrants contain certain provisions that, under certain circumstances that may be out of the Company's control, could require the Company to pay cash to settle the exercise of the warrants or may require the Company to redeem the warrants.

The fair value of the August 2009 and November 2010 warrants is recorded on the consolidated condensed balance sheets as a liability pursuant to "Accounting for Derivative Instruments and Hedging Activities" and "Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity" Topics of ASC and will be adjusted to fair value at each financial reporting date thereafter until the earlier of exercise or expiration, at which time, these warrants would be reclassified into stockholders' equity.

These offerings were made pursuant to the Company's shelf registration statement on Form S-3.

2009 Warrants

The warrants issued in August 2009 are exercisable for a period of five years from the issue date. The fair value on the date of issuance of the warrants was determined to be $2.8 million using the binomial-lattice option valuation model applying the following assumptions: (i) a risk-free rate of 2.48%, (ii) an expected term of 5.0 years, (iii) no dividend yield and (iv) a volatility of 77%.

At June 30, 2011, the fair value of the warrants issued in August 2009 was determined to be approximately $3.9 million using the binomial-lattice option valuation model applying the following assumptions: (i) a risk-free rate of 0.81%, (ii) an expected term of 3.15 years, (iii) no dividend yield and (iv) a volatility of 81%.

2010 Warrants

The warrants issued in November 2010 are exercisable beginning on May 10, 2011 and are exercisable for a period of five years from the issue date. The fair value on the date of issuance of the warrants was determined to be $5.8 million using the binomial-lattice option valuation model applying the following assumptions: (i) a risk-free rate of 1.23%, (ii) an expected term of 5.0 years, (iii) no dividend yield and (iv) a volatility of 85%.

 

At June 30, 2011 the fair value of the warrants issued in November 2010 was determined to be approximately $6.2 million using the binomial-lattice option valuation model applying the following assumptions: (i) a risk-free rate of 1.29%, (ii) an expected term of 4.37 years, (iii) no dividend yield and (iv) a volatility of 74%.

For the three months ended June 30, 2011 and 2010, due to the increase in fair value of the warrants, the Company recorded losses of $0.3 million and $0.6 million, respectively, on its condensed consolidated statement of operations within non-operating income (expense), net. For the six months ended June 30, 2011 and 2010, due to the increase in fair value of the warrants, the Company recorded losses of $1.6 million for each period on its condensed consolidated statement of operations within non-operating income (expense), net. At June 30, 2011, no warrants had been exercised.

At-the-Market Agreement

In June 2011, the Company entered into an agreement (the "Sales Agreement") with McNicoll, Lewis & Vlak LLC ("MLV"), which allows the Company to offer and sell shares of its common stock up to an aggregate price of $20.0 million through MLV. In conjunction with the sales agreement, MLV will act as the Company's sales agent and will receive compensation based on an aggregate of 3% of the gross proceeds on the sale price per share of its common stock. Any sales made pursuant to the sale agreement are deemed an "at-the-market" offering and would be made pursuant to the Company's shelf registration statement on Form S-3. The Company did not place common stock under the Sales Agreement during the three months ended June 30, 2011.

Stockholder Rights Plan

In October 2009, the Company's Board of Directors adopted an amendment to its 1999 stockholder rights plan, commonly referred to as a "poison pill," to reduce the exercise price, extend the expiration date and revise certain definitions under the plan. The stockholder rights plan is intended to deter hostile or coercive attempts to acquire the Company. The stockholder rights plan enables stockholders to acquire shares of the Company's common stock, or the common stock of an acquirer, at a substantial discount to the public market price should any person or group acquire more than 15% of the Company's common stock without the approval of the Board of Directors under certain circumstances. The Company has designated 250,000 shares of Series C Junior Participating preferred stock for issuance in connection with the stockholder rights plan.

Note 10. Stock-Based Compensation

The Company maintains an equity incentive plan to provide long-term incentives for employees, contractors, and members of its Board of Directors. The plan allows for the issuance of non-statutory and incentive stock options, restricted stock, restricted stock units, stock appreciation rights, other stock-related awards, and performance awards which may be settled in cash, stock, or other property. The Company also maintains an active employee stock purchase plan within the meaning of Section 423(b) of the Internal Revenue Code. Under the Purchase Plan, the Company's Board of Directors may authorize participation by eligible employees, including officers, in periodic offerings.

The Company has granted restricted stock units to its Senior Management. Subject to each grantee's continued employment, shares underlying the grants vest in three annual installments and are issuable at the end of the three-year vesting term.

The Company currently uses the Black-Scholes option pricing model to determine the fair value of stock options and employee stock purchase plan shares. The Black-Scholes option pricing model is affected by the Company's stock price, as well as assumptions regarding a number of complex and subjective variables, which include the expected term of the grants, the Company's expected stock price volatility, actual and projected employee stock option exercise behaviors, including forfeitures, the risk-free interest rate and expected dividends.

Total stock-based compensation recognized on the Company's condensed consolidated statements of operations for the three and six months ended June 30, 2011 and 2010, was as follows (in thousands):

 

		Three Months Ended June 30,								Six Months Ended June  30,
		2011				2010				2011				2010
Stock-based compensation expense by caption:
Research and development		$	111			$	99			$	220			$	162
Selling, general and administrative			340				374				703				636
Total stock-based compensation expense		$	451			$	473			$	923			$	798

 

The Company did not record any stock-based compensation associated with the stock options exercisable for 50,000 shares of Common Stock with performance based vesting during the three and six months ended June 30, 2011 and 2010 as the performance criteria was not probable of being achieved. These performance-based stock options remain outstanding at June 30, 2011.

Activity under the Company's equity incentive plans is set forth below (in thousands except per share amounts):

 

						Weighted
						Average
						Exercise
		Number of Options				Price per
		Outstanding				Share
Balances at December 31, 2010			7,007			$	6.42
Granted			723				2.66
Cancelled			(728	)			14.24
Exercised			(11	)			0.94
Balances at June 30, 2011			6,991			$	5.22

Note 11. Comprehensive Loss

Comprehensive loss and its components for the three and six months ended June 30, 2011, and 2010 were as follows (in thousands):

 

		Three Months Ended								Six Months Ended
		June 30,								June 30,
		2011				2010				2011				2010
Net loss		($	6,313	)		($	5,559	)		($	11,323	)		($	10,832	)
Other comprehensive loss:
Net unrealized loss on available-for-sale securities			(22	)			39				(107	)			86
Comprehensive loss		($	6,335	)		($	5,520	)		($	11,430	)		($	10,746	)

Note 12. Development and License Agreements

Agreements with Fenwal, Related Party

In December 2009, the Company and Baxter International Inc. ("Baxter") entered into a settlement agreement regarding disputed amounts for certain transition services provided in 2006 by Baxter in conjunction with the transfer of commercialization rights to the Company. In consideration for agreeing to the settlement, with both parties waiving all rights and obligations, the Company agreed to pay Baxter $0.5 million, which was recorded as a payable on its December 31, 2009 consolidated balance sheet, and subsequently paid by the Company in 2010.

As a result of Baxter's sale of its transfusion therapies division in 2007 to Fenwal, the Company has certain agreements with Fenwal which require the Company to pay royalties on future INTERCEPT Blood System product sales at royalty rates that vary by product: 10% of product sales for the platelet system, 3% for the plasma system and 5% for the red blood cell system, and 6.5% on sales of illuminators. During the three months ended June 30, 2011 and 2010, the Company made royalty payments to Fenwal of $0.5 million and $0.4 million, respectively, and $1.0 million and $0.8 million during the six months ended June 30, 2011 and 2010, respectively. At June 30, 2011 and December 31, 2010, the Company owed royalties to Fenwal of $0.6 million and $0.5 million, respectively.

In December 2008, the Company extended its agreement with Fenwal to manufacture finished disposable kits for the platelet and plasma systems through December 31, 2013. Under the amended manufacturing agreement, the Company pays Fenwal a set price per kit, which is established annually, plus a fixed surcharge per kit. In addition, volume driven manufacturing overhead is to be paid or refunded if actual manufacturing volumes are lower or higher than the estimated production volumes. The Company made payments to Fenwal of $4.1 million and $1.3 million relating to the manufacturing of the Company products during the three months ended June 30, 2011, and 2010, respectively, and $6.3 million and $4.7 million during the six months ended June 30, 2011 and 2010, respectively. At June 30, 2011 and December 31, 2010, the Company owed Fenwal $3.4 million and $2.3 million, respectively, for INTERCEPT disposable kits manufactured.

 

Cooperative Agreements with the United States Armed Forces

Since February 2001, the Company has received awards under cooperative agreements with the Army Medical Research Acquisition Activity division of the Department of Defense. The Company received these awards in order to develop its pathogen inactivation technologies for the improved safety and availability of blood that may be used by the United States Armed Forces for medical transfusions. Under the conditions of the agreements, the Company is conducting research on the inactivation of infectious pathogens in blood, including unusual viruses, bacteria and parasites that are of concern to the United States Armed Forces. This funding supports advanced development of the Company's red blood cell system. The Company recognized $0 and $0.2 million of revenue under these agreements during the three months ended June 30, 2011, and 2010, respectively, and $0.4 million and $0.5 million for the six months ended June 30, 2011 and 2010, respectively.

Note 13. Segment, Customer and Geographic Information

At June 30, 2011 and 2010, the Company operated only one segment, blood safety. The Company's chief executive officer is the chief operating decision maker who evaluates performance based on the net revenues and operating loss of the blood safety segment.

During the three and six months ended June 30, 2011 and 2010, the Company had the following significant customers listed as a percentage of product revenue:

 

		Three Months Ended								Six Months Ended
		June 30,								June 30,
		2011				2010				2011				2010
Movaco, S.A. (Spain and other EU countries)			27	%			15	%			27	%			20	%
Etablissement Francais du Sang (France)			15	%			19	%			20	%			22	%
Service Francophone du Sang (Belgium)			*				12	%			*				13	%
Delrus Inc. (CIS countries)			*				21	%			*				16	%

 

*	Represents an amount less than 10% of product revenue.

Each of the above customers operates in a country outside of the United States. During both the six months ended June 30, 2011 and 2010, the Company also recognized government grants and cooperative agreement revenue which represented 4% of total revenue in each period. During the three months ended June 30, 2010, the Company recognized government grants and cooperative agreement revenue which represented 3% of total revenue. No revenue was recognized from government grants and cooperative agreement during the three months ended June 30, 2011.