Significant Accounting Policies

9 Months Ended

Sep. 30, 2011

Significant Accounting Policies

Significant Accounting Policies

2.              Significant Accounting Policies

Unaudited Interim Financial Statements

The accompanying unaudited condensed financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“US GAAP”) for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by US GAAP for complete financial statements. In the opinion of management, these statements include all adjustments (consisting of normal recurring adjustments) considered necessary to present a fair statement of our results of operations, financial position and cash flows. Operating results for any interim period are not necessarily indicative of the results that may be expected for the full year. This Quarterly Report on Form 10-Q should be read in conjunction with our financial statements and footnotes included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2010.

Use of Estimates

The preparation of financial statements in conformity with US GAAP requires us to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes.  Due to the inherent uncertainty involved in making those assumptions, actual results could differ from those estimates.  We believe that the most significant estimates that affect our financial statements are those that relate to revenue recognition associated with our collaborative agreements, deferred tax assets, inventory valuation, share-based compensation, and the non cash charge associated with the extension of the expiration date of an outstanding warrant discussed below in Note 8.

Revenue Recognition

Our Therapeutics segment generates revenues from collaborative agreements, research licenses, and a government contract. We evaluate revenues from agreements that have multiple elements to determine whether the components of the arrangement represent separate units of accounting. To recognize a delivered item in a multiple element arrangement, the delivered items must have value on a standalone basis and the delivery or performance must be probable and within our control for any delivered items that have a right of return. The determination of whether multiple elements of a collaboration agreement meet the criteria for separate units of accounting requires us to exercise judgment.

Revenues from research licenses and government contracts are recognized as earned upon either the incurring of reimbursable expenses directly related to the particular research plan or the completion of certain development milestones as defined within the terms of the agreement. Payments received in advance of research performance are designated as deferred revenue. Non-refundable upfront license fees and certain other related fees are recognized on a straight-line basis over the development periods of the contract deliverables. Fees associated with substantive at risk performance based milestones are recognized as revenue upon their completion, as defined in the respective agreements. Incidental assignment of technology rights is recognized as revenue as it is earned and received.

In October 2008, we entered into a Collaboration Agreement with Genzyme Corporation (“Genzyme”), now a wholly owned subsidiary of Sanofi (NYSE: SYN), for the development and commercialization of our biologic drug candidates, Prochymal® and Chondrogen®. Under this agreement, Genzyme has made non-contingent, non-refundable cash payments to us, totaling $130.0 million. The agreement provides Genzyme with certain rights to intellectual property developed by us, and requires that we continue to perform certain development work related to the subject biologic drug candidates. We have evaluated the deliverables related to these payments, and concluded that the various deliverables represent a single unit of accounting. For this reason, we have deferred the recognition of revenue related to the upfront payments, and are amortizing these amounts to revenue on a straight-line basis over the estimated delivery period of the required development services, which extend through the first quarter of 2012.

We recognized $10.0 million of revenue in the each of the first three fiscal quarters of both 2011 and 2010 related to the amortization of the upfront payments. The balance of the non-refundable payments we received from Genzyme, $13.3 million, has been recorded as current deferred revenue as of September 30, 2011. The agreement also provides for contingent milestone payments of up to $1.25 billion in the aggregate, as well as royalties to be paid to us on any sales by Genzyme. Consistent with our revenue recognition policies, we will recognize revenue from these contingent milestone payments for which we have no continuing performance obligations upon achievement of the related milestone. For any milestone payments for which we have a continuing performance obligation, the milestone payments will be deferred and recognized as revenue over the term of the related performance obligations.

In 2007, we partnered with Genzyme to develop Prochymal as a medical countermeasure to nuclear terrorism and other radiological emergencies. In January 2008, we were awarded a contract from the United States Department of Defense (“DoD”) pursuant to which we are seeking, in partnership with Genzyme, to develop and stockpile Prochymal for the repair of gastrointestinal injury resulting from acute radiation exposure. We began recognizing revenue under this contract in 2008, and completed our work under the contract during 2010. We have not recognized any revenue associated with this contract during fiscal 2011. Contract revenue was recognized as the related costs are incurred, in accordance with the terms of the contract. We recognized $360,000 and $470,000 in revenue from the DoD contract during the three and nine months ended September 30, 2010, respectively. We have not pursued further opportunities pursuant to this collaboration with Genzyme. Furthermore, other than certain ancillary provisions, the agreement with Genzyme expired in July 2009.

In October 2007, we entered into a collaborative agreement with the Juvenile Diabetes Research Foundation (“JDRF”) to conduct a Phase 2 clinical trial evaluating Prochymal as a treatment for type 1 diabetes mellitus. This collaborative agreement provides for JDRF to provide up to $4.0 million of contingent milestone funding to support the development of Prochymal for the preservation of insulin production in patients with newly diagnosed type 1 diabetes mellitus. The contingent milestone payments under the agreement are amortized to revenue on a straight line basis over the duration of our obligations under the collaborative agreement as they are received and earned. We have received all $4.0 million of the contingent milestones, and are amortizing the funding received over the duration of our obligations, resulting in approximately $200,000 of revenue in each of the first three fiscal quarters of both 2011 and 2010 under the agreement with JDRF. The remaining deferred revenue under this agreement has been recorded as $240,000 of current deferred revenue as of September 30, 2011.

We have also entered into strategic agreements with other pharmaceutical companies focusing on the development and commercialization of our stem cell drug products. For example, in 2003, we entered into an agreement with JCR Pharmaceuticals Co., Ltd. (“JCR”) pertaining to hematologic malignancy (graft versus host disease) drugs for distribution in Japan.  Under such agreements, we receive fees for licensing the use of our technology. We recognized $1.0 million of revenue during the first fiscal quarter of 2010 from JCR upon the achievement of a milestone event specified in the agreement.

Our Therapeutics segment also earns royalty revenues and cost reimbursement under our adult expanded access program.  Royalties are earned on the sale of human mesenchymal stem cells sold for research purposes. We recognize this revenue as sales are made. Such royalty revenue was immaterial during the three months ended September 30, 2011 and approximately $65,000 for the nine months then ended.  Such royalty revenues totaled $70,000 and $218,000 during the three and nine months ended September 30, 2010, respectively.  During the nine months ended September 30, 2011, we received $75,000 in cost reimbursement for Prochymal used in our adult expanded access program, all of which had been earned prior to the third fiscal quarter of 2011.

As discussed in Note 4- Segment Reporting below, in 2010 we began operations of our Biosurgery segment, focused on developing high-end biologic products for use in wound healing and surgical procedures.  We commenced the manufacturing of our first Biosurgery product, Grafix®, a regenerative wound care product, during the first quarter of 2010.  During the first and second quarters of 2010, we distributed the product only for initial clinical evaluation. We launched the product for limited commercial sale during the third quarter of 2010, and revenues on such sales are recognized when the product is shipped to the customer.  We began distribution of a second Biosurgery product, Ovation® in early fiscal 2011. Due to the nature of the products and the manufacturing process, all sales are final.  We recognized revenues of approximately $331,000 and $498,000 from the sales of Biosurgery products during the three and nine months ended September 30, 2011, respectively.  We recognized revenues of approximately $99,000 from the sales of Biosurgery products during the third quarter of 2010 following commercial launch of our first product.

Research and Development Costs

We expense internal and external research and development (“R&D”) costs, including costs of funded R&D arrangements and the manufacture of clinical batches of our biologic drug candidates used in clinical trials, in the period incurred.

Beginning in 2010, with the creation of our Biosurgery segment, we began to separately track research and development costs by segment.  Total research and development costs for each of our operating segments are as follows:

	Three Months Ended September 30,				Nine Months Ended September 30,
	2011		2010		2011		2010
Total Research & Development Costs	($000s)		($000s)		($000s)		($000s)
Therapeutics segment	$	4,411	$	4,639	$	12,520	$	15,231
Biosurgery segment	607		821		2,418		3,245
Total R&D costs -	$	5,018	$	5,460	$	14,938	$	18,476

We do not track internal development costs by project within the Therapeutics segment.  We do, however, track external research and development costs by project, which were as follows:

	Three Months Ended September 30,					Nine Months Ended September 30,
	2011		2010			2011		2010
External R&D Costs By Indication	($000s)		($000s)			($000s)		($000s)
Acute myocardial infarction	$	1,865	$	1,574		$	4,973	$	3,432
Treatment-resistant GvHD	325		(151		)	618		3,004
Refractory Crohn’s disease	358		230			1,239		731
Other therapeutic programs	114		367			201		1,427
Therapeutics external R&D costs -	2,662		2,020			7,031		8,594
Biosurgery external R&D costs -	207		209			705		1,251
Total external R&D costs -	$	2,869	$	2,229		$	7,736	$	9,845

Income per Common Share

Basic income per common share is calculated by dividing net income by the weighted average number of common shares outstanding during the period.  Diluted income per common share adjusts basic income per share for the potentially dilutive effects of common share equivalents, using the treasury stock method, and includes the incremental effect of shares that would be issued upon the assumed exercise of stock options and warrants.

Diluted income per common share for the three and nine months ended September 30, 2011 excludes the 1,000,000 shares issuable upon the exercise of an outstanding “out-of the money” warrant, and approximately 1,376,000 and 1,123,000 shares, respectively, issuable upon the exercise of “out-of the money” stock options, as their effect is anti-dilutive.

Similarly, diluted income per common share for the three and nine months ended September 30, 2010 excludes the 1,000,000 shares issuable upon the exercise of an outstanding “out-of the money” warrant and approximately 884,000 and 811,000 shares, respectively, issuable upon the exercise of “out-of the money” stock options, as their effect is anti-dilutive.

A reconciliation of basic to diluted weighted average common shares outstanding for the applicable periods is as follows:

	Three Months Ended		Nine Months Ended
	September 30,		September 30,
	2011	2010	2011	2010
	(000s)	(000s)	(000s)	(000s)
Basic weighted average common shares outstanding	32,826	32,789	32,818	32,781
Dilutive weighted average options outstanding	295	311	304	314
Dilutive weighted average warrants outstanding	—	—	—	—
Diluted weighted average common shares outstanding	33,121	33,100	33,121	33,095

Investments Available for Sale and Other Comprehensive Income (Loss)

Investments available for sale consist primarily of marketable securities with maturities less than one year. Investments available for sale are valued at their fair value, with unrealized gains and losses reported as a separate component of stockholders’ equity in accumulated other comprehensive income. All realized gains and losses on our investments available for sale are recognized in results of operations as other income.

Investments available for sale are evaluated periodically to determine whether a decline in their value is “other than temporary.” The term “other than temporary” is not intended to indicate a permanent decline in value. Rather, it means that the prospects for near term recovery of value are not necessarily favorable, or that there is a lack of evidence to support fair values equal to, or greater than, the carrying value of the security. We review criteria such as the magnitude and duration of the decline, as well as the reasons for the decline, to predict whether the loss in value is other than temporary. If a decline in value is determined to be other than temporary, the carrying value of the security is reduced and a corresponding charge to earnings is recognized.

Share-Based Compensation

We account for share-based payments using the fair value method.

We recognize all share-based payments to employees in our financial statements based on their grant date fair values, calculated using the Black-Scholes option pricing model. Compensation expense related to share-based awards is recognized on a straight-line basis for each vesting tranche based on the value of share awards that are expected to vest on the grant date, which is revised if actual forfeitures differ materially from original expectations.  Awards of shares of our common stock to non-employee directors are valued at the closing price on the grant date.

A summary of option activity under both of our stock-based compensation plans for the nine months ended September 30, 2011 is presented below.

	Number of Shares		Weighted Average Exercise Price Per Share		Weighted Average Remaining Term (in Years)	Aggregate Intrinsic Value
						$(000)
Outstanding at January 1, 2011	1,349,261		$	9.75	6.89	$	2,357
Granted at market value	445,000		6.85
Exercised	(8,439	)	2.57			34
Forfeited	(68,000	)	8.89			22
Outstanding at September 30, 2011	1,717,822		9.07		6.97	1,456
Exercisable at September 30, 2011	878,134		9.55		5.31	1,454

The weighted average grant date fair value of options granted during the nine months ended September 30, 2011 was $3.51 per share.  We received approximately $22,000 in cash from the exercise of options during the nine months ended September 30, 2011.

As of September 30, 2011, approximately 406,000 shares of common stock remain available for future share awards under our Amended and Restated 2006 Omnibus Plan.

Share-based compensation expense (including director compensation, but excluding the non cash expense related to the extension of the expiration date of our warrant, as detailed in Note 8 below) included in our statements of operations for the three and nine months ended September 30, 2011 and 2010 is allocable to our research and development and general and administrative activities as follows:

	Three Months Ended September 30,				Nine Months Ended September 30,
	2011		2010		2011		2010
	($000)		($000)		($000)		($000)
Research and development	$	182	$	248	$	656	$	667
General and administrative	165		178		685		614
Total	$	347	$	426	$	1,341	$	1,281

As of September 30, 2011, there was approximately $1.7 million of total unrecognized share-based compensation cost related to options granted under our plans, which will be recognized over a weighted-average period of less than one year, as the options vest.

Supplemental Cash Flow Information

A summary of our supplemental disclosures of cash flow information for the nine months ended September 30, 2011 and 2010, is as follows:

	Nine Months Ended September 30,
	2011		2010
	($000)		($000)
Supplemental disclosure of cash flows information:
Cash paid for interest	$	—	$	—
Cash paid for income taxes	—		1,635

Recent Accounting Guidance Not Yet Adopted at September 30, 2011

In May 2011, ASU 2011-4, Fair Value Measurement (Topic 820)— Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs (“ASU 2011-4”) was issued to standardize requirements for measuring and disclosing fair value information under U.S. GAAP and IFRS.  This guidance primarily changes the wording used to describe disclosure requirements under U.S. GAAP, but is not intended to change the application of those requirements.  ASU 2011-4 is effective for interim or annual periods beginning after December 15, 2011 with early adoption not permitted. Since ASU 2011-4 changes the wording used to describe the fair value disclosure requirements, but does not materially change the actual requirements, the adoption of ASU 2011-4 will not have a material impact on our financial statements.

In June 2011, ASU 2011-5, Comprehensive Income (Topic 220)— Presentation of Comprehensive Income (“ASU 2011-5”) was issued to increase the prominence of items reported in other comprehensive income. Specifically, this guidance requires entities to report all non owner changes in stockholders’ equity in either a single continuous statement of comprehensive income or in two separate, but consecutive, statements  This guidance eliminates the current financial reporting option for an entity to report the components of other comprehensive income as a part of the statement in changes in stockholders’ equity.  Further, this guidance requires presentation of all reclassification adjustments between net income and other comprehensive income on the face of the financial statements.  ASU 2011-5 is effective for interim or annual periods beginning after December 15, 2011, with early adoption permitted.  We will be required to change the format of our financial statements when this guidance becomes effective, and are currently evaluating which of the two permissible formats to use.  The adoption of ASU 2011-5 will not have a material impact on our financial position or results of operations.

In July 2011, ASU 2011-7, Health Care Entities (Topic 954)— Presentation and Disclosure of Patient Service Revenue, Provision for Bad Debts, and Allowance for Doubtful Accounts for Certain Health Care Entities (“ASU 2011-7”) was issued to increase the transparency of net patient service revenue and the related allowance for doubtful accounts for health care entities. Specifically, this guidance requires entities to report the provision for bad debts associated with patient service revenue as a deduction from patient service revenues as opposed to as an operating expense.  This guidance also requires enhanced disclosures regarding the accounting policies for revenues and assessing bad debts.  ASU 2011-7 is effective for interim or annual periods beginning after December 15, 2011, with early adoption permitted.  The adoption of ASU 2011-7 will not have a material impact on our financial position or results of operations.