3. Significant Accounting Policies

Basis of Presentation

The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries Biocontrol Limited, Ampliphi d.o.o., and AmpliPhi Australia Pty Ltd. All significant intercompany accounts and transactions have been eliminated.

Use of Estimates

The preparation of consolidated financial statements in conformity with U.S. generally accepted accounting principles (“U.S. GAAP”) requires management to make estimates and assumptions that affect the amounts reported in its consolidated financial statements and accompanying notes. On an ongoing basis, management evaluates these estimates and judgments, which are based on historical and anticipated results and trends and on various other assumptions that management believes to be reasonable under the circumstances. By their nature, estimates are subject to an inherent degree of uncertainty and, as such, actual results may differ from management’s estimates.

Cash and Cash Equivalents

Cash and cash equivalents consist primarily of deposits with commercial banks and financial institutions. Cash equivalents include short-term investments that have a maturity at the time of purchase of three months or less, are readily convertible into cash and have an insignificant level of valuation risk attributable to potential changes in interest rates.

Accounts Receivable

Accounts receivable amounts are stated at their face amounts less any allowance for doubtful accounts. Provisions for doubtful accounts are estimated based on assessment of the probable collection from specific customer accounts and other known factors. For the years ended December 31, 2016 and 2015, the provisions for doubtful accounts were immaterial.

Property and Equipment

Property and equipment consists of computer and laboratory equipment, software, office equipment, furniture and leasehold improvements and is recorded at cost. Maintenance and repairs that do not improve or extend the lives of the respective assets are expensed to operations as incurred. Upon disposal, retirement, or sale of an asset, the related cost and accumulated depreciation is removed from the accounts and any resulting gain or loss is included in the results of operations. Property and equipment are depreciated on a straight-line basis over their estimated useful lives. The Company’s estimated useful life for property and equipment is as follows:



		Estimated Useful Lives
Laboratory equipment		5 – 10 years
Office and computer equipment		3 – 5 years
Leasehold improvements		Shorter of lease term or useful life

The Company reviews long-lived assets for impairment when events or changes in circumstances indicate the carrying value of the assets may not be recoverable. Recoverability is measured by comparison of the book values of the assets to future net undiscounted cash flows that the assets or the asset groups are expected to generate. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the book value of the assets exceed their fair value, which is measured based on the projected discounted future net cash flows arising from the assets or asset groups. No impairment losses have been recorded since inception.

Prepaid Expenses and Other Current Assets

Prepaid expenses and other current assets consist primarily of prepaid insurance, deferred licensing costs and deposits.

Goodwill

The Company accounts for goodwill in accordance with provisions in Accounting Standards Codification (“ASC”) No. 350, Goodwill and Other Intangible Assets, which require that goodwill be tested for impairment at least annually. Goodwill is not amortized, but is reviewed for impairment annually or more frequently if indicators of impairment are present. We determine whether goodwill may be impaired by comparing the carrying value of our single reporting unit, including goodwill, to the fair value of the reporting unit. If the fair value is less than the carrying amount, a more detailed analysis is performed to determine whether goodwill is impaired. The impairment loss, if any, is measured as the excess of the carrying value of the goodwill over the implied fair value of the goodwill and is recorded in our consolidated statements of operations.

The Company’s accounting policy is to perform the annual impairment assessment of goodwill as of December 31 each year. As of December 31, 2016, the Company had a compressed market capitalization, less than the carrying amount of goodwill. The Company estimated the fair value in step one of the goodwill impairment test based on the income approach which included discounted cash flows. The fair value measurements utilized to perform the impairment analysis are categorized within Level 3 of the fair value hierarchy. Significant management judgment is required in the forecast of future operating results that are used in the Company’s impairment analysis. The estimates the Company used are consistent with the plans and estimates that it uses to manage its business. Significant assumptions utilized in the Company’s income approach model included the probability of success of our research and development programs, timing of commercialization of these programs, as well as anticipated growth rates.

The Company’s discounted cash flows required management judgment with respect to forecasted sales, launch of new products, gross margins, selling, general and administrative expenses, and capital expenditures and the selection and use of an appropriate discount rate. For purposes of calculating the discounted cash flows, the Company estimated future revenue based on projected commercialization time, market penetration rate and probabilities of success for each of the research and development programs. Future cash flows were then discounted to present value at a discount rate of 16.8%. Terminal value is not incorporated in the analysis due to the nature of the pharmaceutical and bioscience products. The Company's market capitalization was also considered in assessing the reasonableness of the Company’s fair value as determined in step one of the goodwill impairment test. The Company’s assessment resulted in a fair value that was lower than the Company’s carrying value of net assets at December 31, 2016.

Based upon step one of the impairment test, the Company determined that its goodwill was impaired and that step two of the test was required to measure the amount of goodwill impairment. As a result of step two, the Company recorded a charge of $7.6 million, representing the write-off of the entire balance of goodwill, in the operating section of the statement of operations, for the year ended December 31, 2016.

In Process Research and Development

In Process Research & Development (IPR&D) assets represent capitalized incomplete research projects that we acquired through business combinations. Such assets are initially measured at their acquisition date fair values, and accounted for as indefinite-lived intangible assets, subject to impairment testing until completion or abandonment of research and development efforts associated with the projects. Upon successful completion of each project, we make a determination as to the then remaining useful life of the intangible asset and begin amortization. We periodically re-evaluate whether continuing to characterize the asset as indefinite-lived is appropriate.

We review our indefinite-lived intangibles, including IPR&D assets, for impairment at least annually. The authoritative accounting guidance provides an optional qualitative assessment for any indicators that indefinite-lived intangible assets are impaired. If it is determined that it is more likely than not that the indefinitely-lived intangible assets, including IPR&D, are impaired, fair value of the indefinite-lived intangible assets is compared with the carrying amount and impairment is recorded for any excess of the carrying amount over the fair value of the indefinite-lived intangible assets.

The Company estimated the fair value of our IPR&D assets based on the income approach which included discounting expected net cash flows associated with the assets to a net present value. The fair value measurements utilized to perform the impairment analysis of IPR&D are categorized within Level 3 of the fair value hierarchy. Significant management judgment is required in the forecast of future operating results that are used in the Company’s impairment analysis. The estimates the Company used are consistent with the plans and estimates that it uses to manage its business. Significant assumptions utilized in the Company’s income approach model included timing of clinical studies and regulatory approvals, the probability of success of our research and development programs, timing of commercialization of these programs, forecasted sales, gross margin, selling, general and administrative expenses, capital expenditures, as well as anticipated growth rates. Management also determined that 16.8% was an appropriate discount rate to estimate the fair value of our IPR&D assets.

As a result of the impairment analysis performed, management concluded that our IPR&D assets of $5.2 million related to the 2012 acquisition of SPH’s know-how and phage libraries which are being utilized in our lead product candidate for development of a treatment for S. aureus infections was not impaired. Our IPR&D assets of $7.3 million related to the 2011 acquisition of Biocontrol’s know-how and phage library, which are being utilized in the development of our treatment of P. aeruginosa infections, were impaired. The Company recorded an impairment charge of $2.0 million, representing the excess of carrying amount over the fair value, within loss from operations for the year ended December 31, 2016.

Patents

Patents are recorded at fair value and are amortized using the straight-line method over their estimated useful lives. As of December 31, 2016, the gross amount of our patent assets was $493,000 with accumulated amortization of $186,000. Annual patent amortization expense for the next five years and thereafter are estimated as follows:



	Patent
	Amortization
2017	$	31,000
2018		31,000
2019		31,000
2020		31,000
2021		31,000
Thereafter through December 2026		152,000
Total patent amortization expense	$	307,000

Stock-Based Compensation

The Company records compensation expense associated with stock options in accordance with the authoritative guidance for stock-based compensation. The cost of employee services received in exchange for an award of an equity instrument is measured at the grant date, based on the estimated fair value of the award, and is recognized as expense on a straight-line basis, net of estimated forfeitures, over the requisite service period of the award. Share-based compensation expense recognized during the period is based on the value of the portion of share-based payment awards that is ultimately expected to vest during the period. Share-based compensation expense for an award with a performance condition is recognized when the achievement of such performance condition is determined to be probable. If the outcome of such performance condition is not determined to be probable or is not met, no compensation expense is recognized and any previously recognized compensation expense is reversed. Share-based compensation expense recognition is based on awards ultimately expected to vest and is reduced for estimated forfeitures. The authoritative guidance requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates.

Warrants, Preferred Shares Conversion Feature and Derivative Liabilities

The Company accounts for warrants and derivative instruments and preferred shares conversion feature under the applicable accounting guidance which requires the warrant and the preferred share features to be recorded as liabilities and adjusted to fair value at each reporting period. Changes in fair value of warrant and derivative liabilities are recorded as non-operating income or loss in the consolidated statements of operations.

Foreign Currency Translations and Transactions

The functional currency of our wholly owned subsidiaries is the U.S. dollar.

Revenue Recognition

The Company generates revenue from sub-licensing agreements from our former gene therapy program. Revenue under technology licenses typically consists of nonrefundable, up-front license fees, technology access fees, royalties on product sales, and various other payments. The Company classifies advance payments received in excess of amounts earned as deferred revenue.

Research and Development Costs

Research and development costs include salaries, costs of outside collaborators and outside services, allocated facility, occupancy and utility expenses, which are partially offset by the benefit of Australian government tax rebates. The Company expenses research and development costs as incurred.

Income Taxes

We utilize the asset and liability method of accounting for income taxes. Deferred income taxes are recognized for the future tax consequences of temporary differences using enacted statutory tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Temporary differences include the difference between the financial statement carrying amounts and the tax bases of existing assets and liabilities and operating loss and tax credit carryforwards. The effect on deferred taxes of a change in tax rates is recognized in income in the period that includes the enactment date. We assess the likelihood that our deferred tax assets will be recovered from future taxable income. Valuation allowances are provided if based upon the weight of available evidence, it is more likely than not that some or all of the deferred tax assets will not be realized.

Our income tax returns are based on calculations and assumptions that are subject to examination by the Internal Revenue Service and other tax authorities. In addition, the calculation of our tax liabilities involves dealing with uncertainties in the application of complex tax regulations. We recognize liabilities for uncertain tax positions based on a two-step process. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates that it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any. The second step is to measure the tax benefit as the largest amount that is more than 50% likely of being realized upon settlement. As of December 31, 2016 and 2015, the Company has unrecognized tax benefits related to its domestic research tax credits of approximately $2.1 million and $2.1 million, respectively.

Basic and Diluted Net (Loss) Income per Common Share

Basic net (loss) income per common share is computed by dividing the net (loss) income attributable to common stockholders, less the impact under the two-class method of the preferred stockholders’ participation rights in the Company’s undistributed earnings, by the weighted average number of common shares outstanding during the period, excluding the dilutive effect of preferred stock, warrants to purchase common stock, and stock options.

Diluted net (loss) income per share of common stock is computed by dividing 1) the net (loss) income attributable to common stockholders, adjusted by income (loss) related to potential diluted preferred stock and warrants to purchase shares of our common stock by the sum of 2) the weighted average number of shares of common stock outstanding during the period plus the potential dilutive effects of preferred stock, warrants to purchase common stock, stock options outstanding during the period calculated in accordance with the treasury stock method, and any additional dilutive instruments, although these shares, options and warrants and dilutive instruments are excluded if their effect is anti-dilutive.

Reverse Stock Split

On August 3, 2015, the Company filed Articles of Amendment to Amended and Restated Articles of Incorporation with the Secretary of State of the State of Washington that effected a 1-for-50 (1:50) reverse stock split of its common stock, par value $0.01 per share, effective August 7, 2015. On August 3, 2015, the Company also increased its authorized common stock from 445,000,000 to 670,000,000 shares. The par value of its common stock was unchanged at $0.01 per share, post-split. All warrant, stock option, and per share information in the consolidated financial statements gives retroactive effect to the 1-for-50 reverse stock split that was effected on August 7, 2015.

Reclassification

Certain prior period amounts have been reclassified to conform to the current period presentation.

Recent Accounting Pronouncements

In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606). The ASU creates a single source of revenue guidance for companies in all industries. The new standard provides guidance for all revenue arising from contracts with customers and affects all entities that enter into contracts to provide goods or services to their customers, unless the contracts are within the scope of other accounting standards. It also provides a model for the measurement and recognition of gains and losses on the sale of certain nonfinancial assets. This guidance, as amended, must be adopted using either a full retrospective approach for all periods presented or a modified retrospective approach and will be effective for fiscal years beginning after December 15, 2017 with early adoption permitted. The Company plans to adopt this ASU on January 1, 2018, and is in the process of evaluating the impact of adopting the guidance on its consolidated financial statements.

In August 2014, the FASB issued ASU No. 2014-15, Presentation of Financial Statements-Going Concern (Subtopic 205-40): Disclosure of Uncertainties about an Entity's Ability to Continue as a Going Concern, which defines management's responsibility to assess an entity's ability to continue as a going concern, and to provide related footnote disclosures if there is substantial doubt about its ability to continue as a going concern. The pronouncement is effective for annual reporting periods ending after December 15, 2016 with early adoption permitted. The Company adopted this ASU as of December 31, 2016 and conformed its footnote disclosure in accordance with the disclosure requirements under this standard.

In February 2015, the FASB issued ASU 2016-02, Leases (Topic 842), which amends the FASB Accounting Standards Codification and creates Topic 842, "Leases." The new topic supersedes Topic 840, "Leases," and increases transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and requires disclosures of key information about leasing arrangements. The guidance is effective for reporting periods beginning after December 15, 2018. ASU 2016-02 mandates a modified retrospective transition method. The Company has not yet evaluated the potential impact of adopting the guidance on its consolidated financial statements.

In November 2015, the FASB issued ASU 2015-17, Balance Sheet Classification of Deferred Taxes. The ASU is part of a simplification initiative aimed at reducing complexity in accounting standards. Current U.S. GAAP requires the deferred taxes for each jurisdiction (or tax-paying component of a jurisdiction) to be presented as a net current asset or liability and net noncurrent asset or liability. To simplify presentation, the new guidance requires that all deferred tax assets and liabilities, along with any related valuation allowance, be classified as noncurrent on the balance sheet. The standard is effective for public entities for annual reporting periods beginning after December 15, 2016, and interim periods therein. Early adoption is permitted. The adoption of this guidance is not expected to have a material impact on the Company's consolidated financial statements.

In March 2016, the FASB issued ASU 2016-09, Improvements to Employee Share-Based Payment Accounting, which amends Accounting Standards Codification (“ASC”) Topic 718, Compensation - Stock Compensation. ASU 2016-09 simplifies several aspects of the accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. ASU 2016-09 is effective for fiscal years beginning after December 15, 2016, and interim periods within those fiscal years. The Company is in the process of evaluating the potential impact of adopting the guidance on its consolidated financial statements.

In August 2016, the FASB issued ASU 2016-15, Cash Flow Statements, Classification of Certain Cash Receipts and Cash Payments , which addresses eight specific cash flow classification issues with the objective of reducing diversity in practice. The amendments are effective for public business entities for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. Early adoption is permitted. The adoption of this guidance is not expected to have a material impact on the Company's consolidated financial statements.

In January 2017, the FASB issued ASU 2017-04, Intangibles – Goodwill and Other, Simplifying the Accounting for Goodwill Impairment. ASU 2017-04 removes Step 2 of the goodwill impairment test, which requires a hypothetical purchase price allocation. A goodwill impairment will now be the amount by which a reporting unit’s carrying value exceeds its fair value, not to exceed the carrying amount of goodwill. All other goodwill impairment guidance will remain largely unchanged. Entities will continue to have the option to perform a qualitative assessment to determine if a quantitative impairment test is necessary. This new guidance will be applied prospectively, and is effective for calendar year end companies in 2020. Early adoption is permitted for any impairment tests performed after January 1, 2017. Adoption of this ASU is not expected to have a material impact on the Company’s consolidated financial statements.