Summary of Significant Accounting Policies (Policies)

6 Months Ended

Jun. 30, 2012

Basis of Presentation

Our condensed consolidated financial statements include the accounts of PharmAthene, Inc. and its wholly-owned subsidiaries PharmAthene Canada, Inc. and PharmAthene UK Limited, collectively referred to herein as “PharmAthene”, “we”, “us”, “our” or the “Company.” All significant intercompany transactions and balances have been eliminated in consolidation. Our condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States (“U.S. GAAP”). In the opinion of management, the accompanying unaudited condensed consolidated financial statements include all adjustments, consisting of normal recurring adjustments, which are necessary to present fairly our financial position, results of operations and cash flows. The unaudited condensed consolidated balance sheet at December 31, 2011 has been derived from audited consolidated financial statements at that date. The interim results of operations are not necessarily indicative of the results that may occur for the full fiscal year. Certain information and footnote disclosure normally included in the financial statements prepared in accordance with U.S. GAAP have been condensed or omitted pursuant to instructions, rules and regulations prescribed by the U.S. Securities and Exchange Commission. We believe that the disclosures provided herein are adequate to make the information presented not misleading when these condensed consolidated financial statements are read in conjunction with the Consolidated Financial Statements and Notes included in our Annual Report on Form 10-K for the year ended December 31, 2011, filed with the Securities and Exchange Commission. We currently operate in one business segment. Certain amounts within current assets in the 2011 financial statements have been reclassified to conform to the current year’s presentation.

Use of Estimates

Use of Estimates

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

Foreign Currency Translation

Foreign Currency Translation

The functional currency of our wholly owned foreign subsidiaries located in Canada and the United Kingdom is their local currency. Assets and liabilities of our foreign subsidiaries are translated into United States dollars based on exchange rates at the end of the reporting period. Income and expense items are translated at the weighted average exchange rates prevailing during the reporting period. Translation adjustments are accumulated in a separate component of stockholders’ equity. Transaction gains or losses are included in the determination of net loss.

Cash and Cash Equivalents

Cash and Cash Equivalents

Cash and cash equivalents are stated at cost which approximates market value. We consider all highly liquid investments with original maturities of three months or less to be cash equivalents.

Revolving Line of Credit & Term Loan

Revolving Line of Credit & Term Loan

As discussed in Note 6, we entered into a loan agreement with General Electric Capital Corporation (“GE Capital”) in March 2012. As part of that agreement, we issued stock purchase warrants to GE Capital that expire in March 2022. The fair value of the warrants was charged to additional paid-in capital, resulting in a debt discount at the date of issuance. The debt discount is being amortized over the term of the loan agreement using the effective interest method. Financing costs incurred in connection with this agreement are being amortized over the term of the agreement using the effective interest method.

Significant Customers and Accounts Receivable

Significant Customers and Accounts Receivable

Our primary customers are the Biomedical Advanced Research and Development Authority (“BARDA”), the U.S. Department of Defense (the “DoD”), and the National Institutes of Health (“NIH”). As of June 30, 2012 and December 31, 2011, the Company’s trade receivable and unbilled receivable balances were comprised solely of receivables from these customers.

Revenue Recognition

Revenue Recognition

We generate our revenue from different types of contractual arrangements: cost-plus-fee contracts, cost reimbursable grants and fixed price contracts. Costs consist primarily of direct subcontractor and internal labor charges incurred plus an allocation of fringe benefits, overhead and general and administrative expenses as defined in each contract.

Revenues on cost-plus-fee contracts are recognized in an amount equal to the costs incurred during the period plus an estimate of the applicable fee earned. The estimate of the applicable fee earned is determined by reference to the contract: if the contract defines the fee in terms of risk-based milestones and specifies the fees to be earned upon the completion of each milestone, then the fee is recognized when the related milestones are earned, as further described below; otherwise, pursuant to the terms of the cost-plus fee contract, we estimate the fee earned in a given period by using a proportional performance method based on costs incurred during the period as compared to total estimated project costs and application of the resulting fraction to the total project fee specified in the contract.

Under the milestone method of revenue recognition, milestone payments, including milestone payments for fees, contained in research and development arrangements are recognized as revenue when: (i) the milestones are achieved; (ii) no further performance obligations with respect to the milestone exist; (iii) collection is reasonably assured; and (iv) substantive effort was necessary to achieve the milestone. Milestones are considered substantive if all of the following conditions are met: (1) it is commensurate with either our performance to meet the milestone or the enhancement of the value of the delivered item or items as a result of a specific outcome resulting from our performance to achieve the milestone, (2) it relates solely to past performance, and (3) the value of the milestone is reasonable relative to all the deliverables and payment terms (including other potential milestone consideration) within the arrangement. If a milestone is deemed not to be substantive, the Company recognizes the portion of the milestone payment as revenue that correlates to work already performed; the remaining portion of the milestone payment is deferred and recognized as revenue as the Company completes its performance obligations.

For fixed price contracts without substantive milestones as described above, revenue is recognized on the percentage-of-completion method in accordance with the applicable accounting guidance for long term contracts. The percentage-of-completion method recognizes income as the contract progresses; recognition of revenue and profits generally related to the costs incurred in providing the services required under the contract. The use of the percentage-of-completion method depends on the ability to make reasonable dependable estimates. The fact that circumstances may necessitate frequent revision of estimates does not indicate that the estimates are unreliable for the purpose for which they are used. Estimating is an integral part of our business activities, and there may be a necessity to revise estimates on contracts continually as the work progresses. As a result, amounts invoiced may differ from revenue recognized. Amounts invoiced to customers in excess of revenue recognized are reflected on the balance sheet as deferred revenue, a component of accrued expenses and other liabilities. We recorded approximately $19 thousand and $0.5 million as deferred revenue as of June 30, 2012 and December 31, 2011.

As revenue is recognized in accordance with the terms of the contracts, related amounts are recorded as unbilled accounts receivable in our consolidated balance sheets. As specific contract invoices are generated and sent to our customers in accordance with a contract, invoiced amounts are transferred out of unbilled accounts receivable and into billed accounts receivable. Invoicing frequency and payment terms for cost-plus-fee contracts with our customers are defined within each contract, but are typically monthly invoicing with 30-60 day payment cycles.

We analyze each cost reimbursable grant to determine whether we should report such reimbursements as revenue or as an offset to our expenses incurred. For the three months ended June 30, 2012 and 2011, we recorded approximately $0.4 million and $0.1 million, respectively, of costs reimbursed by the government as an offset to research and development expenses. For the six months ended June 30, 2012 and 2011, we recorded approximately $1.0 million and $0.4 million, respectively, of costs reimbursed by the government as an offset to research and development expenses.

Share-Based Compensation

Share-Based Compensation

We expense the estimated fair value of share-based awards granted to employees under our stock compensation plans. The fair value of restricted stock grants is determined based on the closing price of our common stock on the award date and is recognized ratably as expense over the requisite service period. The fair value of stock option grants is determined using the Black-Scholes option pricing model. The Black-Scholes model considers, among other factors, the expected life of the award and the expected volatility of the Company’s stock price. The value of the award that is ultimately expected to vest is recognized as compensation expense on a straight line basis over the employee’s requisite service period.

Employee share-based compensation expense recognized in the three months ended June 30, 2012 and 2011 was calculated based on awards ultimately expected to vest and has been reduced for estimated forfeitures at a rate of approximately 12% for both 2012 and 2011, based on historical forfeitures.

Share-based compensation expense for the three months ended June 30, 2012 and 2011 was:

	2012		2011

Research and development	$	127,076	$	216,997
General and administrative		384,965		327,703
Total share-based compensation expense	$	512,041	$	544,700

During the three months ended June 30, 2012, we granted 185,000 options to employees and nonemployee directors and made no restricted stock grants. During the three months ended June 30, 2011, we granted 208,000 options to employees and nonemployee directors and made no restricted stock grants. At June 30, 2012, we had total unrecognized share-based compensation expense related to unvested awards of approximately $2.9 million, net of estimated forfeitures, which we expect to recognize as expense over a weighted-average period of 2.1 years.

Share-based compensation expense for the six months ended June 30, 2012 and 2011 was:

	2012		2011

Research and development	$	244,143	$	458,431
General and administrative		816,562		796,894
Total share-based compensation expense	$	1,060,705	$	1,255,325

During the six months ended June 30, 2012, we granted 200,948 options to employees and nonemployee directors and made no restricted stock grants. During the six months ended June 30, 2011, we granted 304,000 options to employees and nonemployee directors and made no restricted stock grants.

Income Taxes

Income Taxes

We account for income taxes using the asset and liability approach, which requires the recognition of future tax benefits or liabilities on the temporary differences between the financial reporting and tax bases of our assets and liabilities. For interim periods, we recognize an income tax provision (benefit) based on an estimated annual effective tax rate expected for the entire year, plus or minus discrete income tax amounts. A valuation allowance is established when necessary to reduce deferred tax assets to the amounts expected to be realized. We also recognize a tax benefit from uncertain tax positions only if it is “more likely than not” that the position is sustainable based on its technical merits. Our policy is to recognize interest and penalties on uncertain tax positions as a component of income tax expense. We consider discontinued operations for purposes of determining the amount of tax benefits that result from a loss from continuing operations.

Income tax expense was approximately $16 thousand and $0.2 million for the three and six months ended June 30, 2012, respectively. No income tax expense was recorded in 2011. Income tax expense in 2012 resulted from the difference between the treatment of goodwill for income tax purposes and for U.S. GAAP. The Company recorded a deferred tax liability, which cannot offset deferred tax assets, and a corresponding income tax expense. This deferred tax liability is included in our condensed consolidated balance sheet in other noncurrent liabilities.

Basic and Diluted Net Loss Per Share

Basic and Diluted Net Loss Per Share

Basic loss per share is computed by dividing consolidated net loss by the weighted average number of shares of common stock outstanding during the quarter, excluding unvested restricted stock.

For periods of net income when the effects are not anti-dilutive, diluted earnings per share is computed by dividing our net income by the weighted average number of shares outstanding and the impact of all potential dilutive common shares, consisting primarily of stock options, unvested restricted stock and stock purchase warrants. The dilutive impact of our dilutive potential common shares resulting from stock options and stock purchase warrants is determined by applying the treasury stock method.

For the periods of net loss, diluted loss per share is calculated similarly to basic loss per share because the impact of all potentially dilutive shares of common stock is anti-dilutive due to the net losses. A total of approximately 11.6 million and approximately 10.9 million potential dilutive shares have been excluded in the calculation of diluted net loss per share in the three and six months ended June 30, 2012 and 2011, respectively, because their inclusion would be anti-dilutive.

Recent Accounting Pronouncements

Recent Accounting Pronouncements

We have evaluated all Accounting Standards Updates through the date the unaudited condensed consolidated financial statements were issued and believe the adoption of these will not have a material impact on our results of operations or financial position.