Harvard Apparatus Regenerative Technology, Inc. - Quarter Report: 2019 September (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q

For the quarterly period ended September 30, 2019

For the transition period from to

Commission file number 001-35853 

BIOSTAGE, INC.

(Exact Name of Registrant as Specified in Its Charter)

(774) 233-7300

(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act: None

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

          x    YES         ¨    NO

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).

          x   YES         ¨   NO

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

          ¨   YES     x    NO 

As of November 8, 2019, there were 7,643,325 shares of common stock, par value $0.01 per share, outstanding.

Biostage Inc.

Form 10-Q

For the Quarter Ended September 30, 2019

INDEX

PART I. FINANCIAL INFORMATION

BIOSTAGE, INC.

CONSOLIDATED BALANCE SHEETS

(In thousands, except par value and share data)

See accompanying notes to unaudited consolidated financial statements. 

BIOSTAGE, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

(In thousands, except per share amounts)

See accompanying notes to unaudited consolidated financial statements.

BIOSTAGE, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(In thousands)

See accompanying notes to unaudited consolidated financial statements.

BIOSTAGE, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY

(Unaudited)
(In thousands)

See accompanying notes to unaudited consolidated financial statements.

BIOSTAGE, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY

(Unaudited)
(In thousands)

See accompanying notes to unaudited consolidated financial statements.

BIOSTAGE, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

Overview

Biostage, Inc. (Biostage or the Company) is a biotechnology company developing bioengineered organ implants based on the Company’s novel Cellspan^TM technology. The Company’s Cellspan technology is comprised of a biocompatible scaffold that is seeded with the recipient’s own stem cells. The Company believes that this technology may prove to be effective for treating patients across a number of life-threatening medical indications who currently have unmet medical needs. The Company is currently developing its Cellspan technology to treat life-threatening conditions of the esophagus, bronchus and trachea with the objective of dramatically improving the treatment paradigm for those patients. Since inception, the Company has devoted substantially all of its efforts to business planning, research and development, recruiting management and technical staff, and acquiring operating assets. The Company has one business segment and does not have significant costs or assets outside the United States.

On October 31, 2013, Harvard Bioscience, Inc. (Harvard Bioscience) contributed its regenerative medicine business assets, plus $15 million of cash, into Biostage (formerly “Harvard Apparatus Regenerative Technologies” at time of spin-off.) On November 1, 2013, the spin-off of the Company from Harvard Bioscience was completed. On that date, the Company became an independent company that operates the regenerative medicine business previously owned by Harvard Bioscience. The spin-off was completed through the distribution of all the shares of common stock of Biostage to stockholders of Harvard Bioscience (the “HBIO Distribution”).

The Company’s common stock is currently traded on the OTCQB Venture Market under the symbol “BSTG”.

Basis of Presentation

The consolidated financial statements reflect the Company’s financial position, results of operations and cash flows in conformity with accounting principles generally accepted in the United States (GAAP).

Going Concern

The Company has incurred substantial operating losses since its inception, and as of September 30, 2019 has an accumulated deficit of approximately $62.5 million and will require additional financing to fund future operations. The Company expects that its cash at September 30, 2019 of $1.1 million will enable it to fund its operating expenses and capital expenditure requirements through the middle of November 2019. Therefore, these conditions raise substantial doubt about the Company’s ability to continue as a going concern.

The Company will need to raise additional funds to fund its operations, including continuing regulatory requirements related to the Company’s first Investigational New Drug Application (IND) filed on October 29, 2019 for the Company’s adult esophageal disease product candidate, clinical trial costs if its IND is approved, and other operational activities. In the event the Company does not raise additional capital from outside sources in the near future, it may be forced to curtail or cease its operations. Cash requirements and cash resource needs will vary significantly depending upon the timing of the financial and other resource needs that will be required to complete ongoing development, pre-clinical and clinical testing of products, as well as regulatory efforts and collaborative arrangements necessary for the Company’s products that are currently under development. The Company will seek to raise necessary funds through a combination of public or private equity offerings, debt financings, other financing mechanisms, research grants, or strategic collaborations and licensing arrangements. The Company may not be able to obtain additional financing on favorable terms, if at all.

The Company’s operations will be adversely affected if it is unable to raise or obtain needed funding and such circumstance may materially affect the Company’s ability to continue as a going concern. The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern and therefore, the consolidated financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amount and classifications of liabilities that may result from the outcome of this uncertainty.

Net Loss Per Share

Basic net loss per share is computed using the weighted average number of common shares outstanding during the period. Diluted net loss per share is computed using the sum of the weighted average number of common shares outstanding during the period and, if dilutive, the weighted average number of potential shares of common stock, including the assumed exercise of stock options, warrants, and the impact of unvested restricted stock.

The Company applies the two-class method to calculate basic and diluted net loss per share attributable to common stockholders as its warrants to purchase common stock are participating securities.

The two-class method is an earnings allocation formula that treats a participating security as having rights to earnings that otherwise would have been available to common stockholders. However, the two-class method does not impact the net loss per share of common stock as the Company has been in a net loss position and the warrant holders do not participate in losses.

Basic and diluted shares outstanding are the same for each period presented as all common stock equivalents would be antidilutive due to the net losses incurred. 

Unaudited Interim Financial Information

The accompanying interim consolidated balance sheet as of September 30, 2019, consolidated interim statements of operations and stockholders’ equity for the three and nine months ended September 30, 2019 and 2018, and consolidated statements of cash flows for the nine months ended September 30, 2019 and 2018 are unaudited. The interim unaudited consolidated financial statements have been prepared in accordance with GAAP on the same basis as the annual audited financial statements and, in the opinion of management, reflect all adjustments necessary for a fair statement of the Company’s financial position as of September 30, 2019, its results of operations and stockholders’ equity for the three and nine-month periods ended September 30, 2019 and 2018, and its consolidated statements of cash flows for the nine months ended September 30, 2019 and 2018. The financial data and other information disclosed in these notes related to the three and nine-month periods ended September 30, 2019 and 2018 are unaudited. The results for the three and nine months ended September 30, 2019 are not necessarily indicative of results to be expected for the year ending December 31, 2019, any other interim periods or any future year or period.

Summary of Significant Accounting Policies

The accounting policies underlying the accompanying unaudited consolidated financial statements are those set forth in Note 2 to the consolidated financial statements for the year ended December 31, 2018 included in the Company’s Annual Report on Form 10-K.

SBIR Award

On March 28, 2018, the Company was awarded a Fast-Track Small Business Innovation Research (SBIR) grant by the Eunice Kennedy National Institute of Child Health and Human Development of the National Institutes of Health (NIH) to support testing of pediatric Cellspan Esophageal Implants. The award for Phase I, which was earned over the nine months ended September 30, 2018, provided for the reimbursement for up to $0.2 million of qualified research and development costs. 

On October 26, 2018, the Company was awarded Phase II of the SBIR grant for $1.1 million to support development, testing, and translation to the clinic through September 2019. The Company has recognized $0.6 million from Phase II as of September 30, 2019 and plans to discuss carryover funding with the NIH for the $0.5 million of the Phase II award not incurred. The Phase II grant includes an additional $0.5 million for future period support through September 2020, subject to availability of funding and satisfactory progress on the project. Accordingly, the SBIR grant has the potential to provide a total award of $1.8 million if carryover funding is allowed.

Grant income is recognized when qualified research and development costs are incurred and recorded in other income (expense), net in the consolidated statements of operations. When evaluating grant revenue from the SBIR grant, the Company considered accounting requirements under the Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) 606, Revenue From Contracts With Customers. The Company concluded that ASC 606 did not apply as there is no exchange of goods or services or an exchange of intellectual property between the parties; therefore, the Company presents grant income in other income. The Company recognized $0.5 million of grant income from the Phase II award during the nine months ended September 30, 2019 and $0.2 million of grant income from the Phase I award during the nine months ended September 30, 2018.

Restricted Cash

Restricted cash consists of $50,000 held as collateral for the Company’s credit card program as of September 30, 2019 and December 31, 2018. The Company’s statements of cash flows include restricted cash with cash when reconciling the beginning-of-period and end-of-period total amounts shown on such statements.

A reconciliation of the cash and restricted cash reported within the balance sheet that sum to the total of the same amounts shown in the statements of cash flows is as follows:

Recently Adopted Accounting Pronouncements

In June 2018, the FASB issued ASU 2018-07, Improvements to Nonemployee Share-Based Payment Accounting (ASU 2018-07). The new standard simplifies the accounting for share-based payments to nonemployees by aligning it with the accounting for share-based payments to employees, with certain exceptions. The Company adopted ASU 2018-07 as required on January 1, 2019, and its adoption did not have any material impact on the Company’s consolidated results of operations.

In July 2017, the FASB issued ASU 2017-11, Earnings Per Share, Distinguishing Liabilities from Equity, Derivatives and Hedging (Part I) Accounting for Certain Financial Instruments with Down Round Features, (Part II) Replacement of the Indefinite Deferral for Mandatorily Redeemable Financial Instruments of Certain Nonpublic Entities and Certain Mandatorily Redeemable Noncontrolling Interests with a Scope Exception (ASU 2017-11). This guidance is intended to reduce the complexity associated with accounting for certain financial instruments with characteristics of liabilities and equity. Specifically, a down round feature would no longer cause a freestanding equity-linked financial instrument (or an embedded conversion option) to be considered “not indexed to an entity’s own stock” and therefore accounted for as a derivative liability at fair value with changes in fair value recognized in current earnings. Down round features are most often found in warrants and conversion options embedded in debt or preferred equity instruments. In addition, the guidance re-characterized the indefinite deferral of certain provisions on distinguishing liabilities from equity to a scope exception with no accounting effect. The Company adopted ASU 2017-11 as of the required effective date of January 1, 2019, and the adoption of ASU 2017-11 did not have a material impact on its consolidated financial statements and related disclosures.

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842), a new standard issued to increase transparency and comparability among organizations related to their leasing activities. This standard established a right-of-use model that requires all lessees to recognize right-of-use assets and lease liabilities on their balance sheet that arise from leases as well as provide disclosures with respect to certain qualitative and quantitative information related to a company's leasing arrangements to meet the objective of allowing users of financial statements to assess the amount, timing and uncertainty of cash flows arising from leases.

The FASB subsequently issued the following amendments to ASU 2016-02 that have the same effective date and transition date: ASU 2018-01, Leases (Topic 842): Land Easement Practical Expedient for Transition to Topic 842, ASU 2018-10, Codification Improvements to Topic 842, Leases, ASU 2018-11, Leases (Topic 842): Targeted Improvements, ASU 2018-20, Narrow-Scope Improvement for Lessors, and ASU 2019-01, Leases (Topic 842): Codification Improvements. The Company adopted these amendments with ASU 2016-02 (collectively, the new leasing standards) effective January 1, 2019 using the modified retrospective transition approach with no restatement of prior periods or cumulative adjustment to accumulated deficit. Upon adoption, the Company elected the package of transition practical expedients, which allowed the Company to carry forward prior conclusions related to whether any expired or existing contracts are or contain leases, the lease classification for any expired or existing leases and initial direct costs for existing leases. The Company also elected the practical expedient to not reassess certain land easements and made an accounting policy election to not recognize leases with an initial term of 12 months or less within its consolidated balance sheet and to recognize those lease payments on a straight-line basis in its consolidated statements of operations over the lease term.

Upon adoption of the new leasing standards on January 1, 2019, the Company recognized a right-of-use asset of approximately $0.2 million and a corresponding operating lease liability of approximately $0.2 million, which are included in the Company’s consolidated balance sheet. The adoption of the new leasing standards did not have an impact on the Company’s consolidated statements of operations.

The Company determines if an arrangement is a lease at contract inception. Operating lease assets represent the Company’s right to use an underlying asset for the lease term and operating lease liabilities represent its obligation to make lease payments arising from the lease. Operating lease assets and liabilities are recognized at the commencement date of the lease based upon the present value of lease payments over the lease term. When determining the lease term, the Company includes options to extend or terminate the lease when it is reasonably certain that the Company will exercise that option. The Company uses the implicit rate when readily determinable and uses its incremental borrowing rate when the implicit rate is not readily determinable based upon the information available at the commencement date in determining the present value of the lease payments. Since the Company does not have similar term secured borrowing arrangements as its lease arrangements and, therefore, its incremental borrowing rate is not readily determinable, the Company used an incremental borrowing rate based on the lowest grade of debt available in the marketplace for the same term as the associated lease.

The lease payments used to determine the Company’s operating lease assets may include lease incentives, stated rent increases and escalation clauses linked to rates of inflation when determinable and are recognized in the Company’s right-of-use assets in the Company’s consolidated balance sheets.

The Company’s operating leases are reflected in right-of-use assets, current portion of operating lease liability and operating lease liability, net of current portion, in the Company’s consolidated balance sheets. Lease expense for minimum lease payments is recognized on a straight-line basis over the lease term.

For additional information on the adoption of the new leasing standards, see Note 7, Leases, to the consolidated financial statements.

Recently Issued Accounting Pronouncements

In August 2018, the FASB issued ASU 2018-13, Fair Value Measurement (Topic 820), Disclosure Framework – Changes to the Disclosure Requirement for Fair Value Measurement. This ASU removes, modifies and adds certain disclosure requirements of ASC Topic 820. The ASU is effective for all entities for fiscal years, and interim periods within those fiscal years, beginning after December 31, 2019. The Company is currently evaluating the impact that the adoption of this standard may have on the Company’s consolidated financial statements.

Other accounting standards that have been issued or proposed by the FASB or other standards-setting bodies that do not require adoption until a future date are not expected to have a material impact on the Company’s financial statements upon adoption. 

On January 3, 2018, the Company issued 50,000 shares of common stock to Connecticut Children’s Medical Center (Connecticut Children’s) at $2.00 per share and warrants to purchase 75,000 shares of common stock at an exercise price of $2.00 per share, in exchange for aggregate gross proceeds of $100,000 in a private placement transaction of unregistered shares. The warrants were immediately exercisable and expire in January 2023. The Company allocated $51,000 of consideration to the warrants using the relative fair-value method and included such amount in additional paid-in capital. The Company classified these warrants as equity as the warrants do not have any redemption features nor a right to put for cash that is outside the control of the Company. Connecticut Children’s Chief Executive Officer, James Shmerling, is a member of the Company’s Board of Directors as well as the Board of Directors of Connecticut Children’s.

On February 20, 2018, the Company issued 302,115 shares of common stock to an investor at a purchase price of $3.31 per share for aggregate gross and net proceeds of approximately $1.0 million in an unregistered private placement transaction.

On May 23, 2018, the Company issued 1,000,000 shares of common stock to two new investors at a purchase price of $3.60 per share for aggregate gross and net proceeds of approximately $3.6 million and $3.4 million, respectively, in an unregistered private placement. Following the issuance of these shares, the holders of Series D preferred stock exercised their right to convert all of their 3,108 outstanding shares of Series D preferred stock into 1.554 million shares of common stock as provided for under the Series D preferred stock agreement.

On June 29, 2018, the Company issued 250,000 shares of common stock to an investor at a purchase price of $3.60 per share for aggregate gross and net proceeds of approximately $0.9 million and $0.8 million, respectively, in an unregistered private placement transaction.

On January 31, 2019, the Company issued 500,000 shares of its common stock to an investor in connection with the exercise of 500,000 warrants, which were previously issued on December 27, 2017, at $2.00 per share in exchange for total gross proceeds in the amount of $1.0 million.

On April 24, 2019 and May 3, 2019, the Company issued a total of 500,000 shares of its common stock to an investor in connection with the exercise of 500,000 warrants, which were previously issued on December 27, 2017, at $2.00 per share in exchange for total gross proceeds in the amount of $1.0 million.

On June 12, 2019, the Company issued a total of 345,174 shares of its common stock and warrants to purchase 345,174 shares of common stock to a group of investors at an exercise price of $3.70 per share, in exchange for aggregate gross proceeds of approximately $1.3 million. The Company allocated approximately $0.7 million to common stock and $0.6 million to the warrants to purchase common stock using the relative fair value method approach. The Company classified these warrants on its consolidated balance sheets as equity as the warrants do not have any redemption features nor a right to put for cash that is outside the control of the Company, and valued using the Black-Scholes model based on the following inputs:

On August 30, 2019 and September 4, 2019, the Company issued a total of 595,000 shares of its common stock to a group of investors in connection with the assignment and exercise of 595,000 warrants, which were previously issued on December 27, 2017, at $2.00 per share in exchange for total gross proceeds in the amount of approximately $1.2 million.

On September 30, 2019, the Company issued a total of 30,000 shares of its common stock to a group of investors in connection with the assignment and exercise of 30,000 warrants, which were previously issued on December 27, 2017, at $2.00 per share in exchange for total gross proceeds in the amount of $60,000.

During the nine months ended September 30, 2019, the Company issued a total of 3,506 shares of its common stock to employees due to the vesting of restricted stock units.

Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date.

The Company utilizes a valuation hierarchy for disclosure of the inputs to the valuations used to measure fair value that prioritizes the inputs into three broad levels. Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities. Level 2 inputs are quoted prices for similar assets and liabilities in active markets or inputs that are observable for the asset or liability, either directly or indirectly through market corroboration, for substantially the full term of the financial instrument. Level 3 inputs are unobservable inputs based on the Company’s own assumptions used to measure assets and liabilities at fair value. A financial asset or liability’s classification within the hierarchy is determined based on the lowest level input that is significant to the fair value measurement.

The Company had no assets or liabilities classified as Level 2 as of September 30, 2019 and December 31, 2018. The Company’s restricted cash that serves as collateral for the Company’s credit card program is held in a demand money market account and is measured at fair value based on quoted prices, which are Level 1 inputs. The Company classifies warrants to purchase common stock that are accounted for as liabilities as Level 3 liabilities, as discussed below.

The following fair value hierarchy table presents information about the Company’s financial assets and liabilities measured at fair value on a recurring basis as of September 30, 2019:

The following fair value hierarchy table presents information about the Company’s financial assets and liabilities measured at fair value on a recurring basis as of December 31, 2018:

The following table presents a reconciliation of the Company’s liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the nine months ended September 30, 2019:

There were no transfers between Level 1, Level 2 and Level 3 in any of the periods reported.

The Company has re-measured the warrant liability to estimated fair value at inception, prior to modification and at each reporting date using the Black-Scholes option pricing model with the following weighted average assumptions:

Biostage 2013 Equity Incentive Plan

The Company maintains the 2013 Equity Incentive Plan (as amended, the Plan) for the benefit of certain of its officers, employees, non-employee directors, and other key persons (including consultants and advisory board members). All options and awards granted under the Plan consist of the Company’s shares of common stock. In May 2018, the Company’s shareholders approved the increase of the number of shares of the Company’s common stock available for issuance pursuant to the Plan by 1,600,000 shares, which increased the total shares authorized to be issued under the Plan to 2,098,000.

The Company also issued equity awards under the Plan at the time of the HBIO Distribution to all holders of Harvard Bioscience equity awards as part of an adjustment (the Adjustment Awards) to prevent a loss of value due to the HBIO Distribution. Compensation expense recognized under the Plan relates to service provided by employees, board members and a non-employee of the Company. There was no required compensation associated with the Adjustment Awards to employees who remained at Harvard Bioscience, and as of September 30, 2019 there was no unrecognized compensation costs since all the Adjustment Awards were fully vested.

The Company has granted options to purchase common stock and restricted stock units (RSUs) under the Plan. Stock option and restricted stock unit activity during the nine months ended September 30, 2019 was as follows:

The Company uses the Black-Scholes option pricing model to value its stock options. The weighted average assumptions for valuing options granted during the nine months ended September 30, 2019 were as follows: 

The Company’s outstanding stock options include 475,650 performance-based awards that have vesting provisions subject to the achievement of certain business milestones. As of September 30, 2019, the Company deemed the achievement of one of the performance-based milestones totaling 95,131 shares probable for accounting purposes and recognized $253,000 of the total $269,000 expense associated with this milestone during the three months ended September 30, 2019. Total unrecognized compensation expense for the remaining 380,519 performance-based awards is approximately $1.1 million. No expense has been recognized for these awards as of September 30, 2019 given that the milestone achievements for these awards have not yet been deemed probable for accounting purposes.

In June 2019, the Company modified certain options to purchase common stock for an employee, resulting in recording $92,000 of share-based compensation.

The Company recorded share-based compensation expense in the following expense categories of its consolidated statements of operations:

First Pecos Breach Notice

In June 2017, the Company entered into a binding Memorandum of Understanding with First Pecos, LLC (First Pecos), pursuant to which the Company agreed to issue to First Pecos in a private placement 485,000 shares of its common stock on a post-reverse split basis at a purchase price of $6.30 per share or, to the extent First Pecos, following the transaction, would own more than 19.9% of the Company’s common stock, shares of a new class of preferred stock of the Company with a per-share purchase price of $1,000.

In October 2017, as a result of the First Pecos failure to deliver the Purchase Price to the Company following satisfaction of all closing conditions in the Purchase Agreement, the Company delivered a notice to First Pecos and its manager, Leon “Chip” Greenblatt III, stating that First Pecos was in breach of the Purchase Agreement. None of the shares of common stock, shares of preferred stock or warrants were issued to First Pecos. Also in October 2017, First Pecos delivered a notice to the Company stating that, as a result of alleged breaches by the Company of its obligations pursuant to the Purchase Agreement, First Pecos terminated the Purchase Agreement and demanded that the Company pay a $500,000 termination fee pursuant to the terms of the Purchase Agreement.

The Company believes that it was not in breach of the Purchase Agreement at any time, and that the First Pecos notice was unjustified and without any legal merit or factual basis. Accordingly, the Company believes that First Pecos was not entitled to terminate the Purchase Agreement, and was not entitled to any termination fee thereunder, as the failure to consummate the Pecos Placement resulted from the First Pecos breach of the Purchase Agreement. The Company has not accrued for this liability as the Company believes the claim to be without merit.

Other

On April 14, 2017, representatives for the estate of a deceased individual filed a civil lawsuit in the Suffolk Superior Court, in Boston, Massachusetts, against the Company and Harvard Bioscience. The complaint alleges that the decedent’s injury and death were caused by two tracheal implants that incorporated synthetic trachea scaffolds and a biologic component combined by the implanting surgeon with a bioreactor, and surgically implanted in the decedent in two surgeries performed in 2012 and 2013. The civil complaint seeks a non-specific sum of money to compensate the plaintiffs. This civil lawsuit relates to the Company’s first-generation trachea scaffold technology for which the Company discontinued development in 2014, and not to the Company’s current Cellspan technology nor to its lead development product candidate, the Cellspan Esophageal Implant. The Company intends to vigorously defend this case. While the Company believes that such claim lacks merit, the Company is unable to predict the ultimate outcome of such litigation. In accordance with a separation and distribution agreement between Harvard Bioscience and the Company relating to the spin-off, the Company would be required to indemnify Harvard Bioscience against losses that Harvard Bioscience may suffer as a result of this litigation. The Company has been informed by its insurance provider that the case has been accepted as an insurable claim under the Company’s product liability insurance policy. The Company does not believe a loss is probable at this time and therefore has not accrued any amounts for this contingent liability.

From time to time, the Company may be involved in various claims and legal proceedings arising in the ordinary course of business. Other than the above matter, there are no such matters pending that the Company expects to be material in relation to its business, financial condition, results of operations, or cash flows.

The Company leases laboratory and office space, and certain equipment with remaining terms ranging from 1 year to 4 years. The laboratory and office arrangement is under a sublease with Harvard Bioscience that currently extends through May 31, 2020 and automatically renews annually for a one-year period unless the Company or Harvard Bioscience provides a notice of termination within one hundred and eighty days prior to May 31 of each year. The equipment lease, which has a term through April 2023, includes the purchase or return of the equipment, or continuation of the lease for 6-month intervals at the end of the lease, at the Company’s sole discretion.

All of the Company’s leases qualify as operating leases. The following table summarizes the presentation of the Company’s operating leases in its consolidated balance sheets:

The following table summarizes the effect of lease costs in the Company’s condensed consolidated statements of operations:

The minimum lease payments for the next five years and thereafter are expected to be as follows:

The weighted average remaining lease term and weighted average discount rate of the Company’s operating leases are as follows:

Due to Related Party

In connection with the Company’s private placement transaction in December 2017, an investor placed a deposit in the amount of $0.3 million with the Company, which was repaid in January 2018.

The following potential common shares were excluded from the calculation of diluted net loss per share attributable to common stockholders for the nine months ended September 30, 2019 and 2018 because including them would have had an anti-dilutive effect:

The Company did not provide for any income taxes in its statement of operations for the three and nine months ended September 30, 2019 and 2018. The Company has provided a valuation allowance for the full amount of its net deferred tax assets because, at September 30, 2019 and December 31, 2018, it was more likely than not that any future benefit from deductible temporary differences and net operating loss and tax credit carryforwards would not be realized.

The Company has not recorded any amounts for unrecognized tax benefits as of September 30, 2019 or December 31, 2018. As of September 30, 2019, and December 31, 2018, the Company had no accrued interest or tax penalties recorded related to income taxes. The Company is subject to U.S. federal income tax and Massachusetts state income tax. The statute of limitations for assessment by the IRS and state tax authorities is open for all periods from inception through December 31, 2018; currently, no federal or state income tax returns are under examination by the respective taxing authorities.

Under the provisions of the Internal Revenue Code, the net operating loss and tax credit carryforwards are subject to review and possible adjustment by the IRS and state tax authorities. Net operating loss and tax credit carryforwards may become subject to an annual limitation in the event of certain cumulative changes in the ownership interest of significant shareholders over a three-year period in excess of 50 percent, as defined under Sections 382 and 383 of the Internal Revenue Code, respectively, as well as similar state provisions. This could limit the amount of tax attributes that can be utilized annually to offset future taxable income or tax liabilities. The amount of the annual limitation is determined based on the value of the Company immediately prior to the ownership change. Subsequent ownership changes may further affect the limitation in future years. The Company has recently completed several equity financing transactions which have either individually or cumulatively resulted in a change in control as defined by Sections 382 and 383 of the Internal Revenue Code, or could result in a change in control in the future. The Company does not believe the impact of any limitation on the use of its net operating loss or credit carryforwards will have a material impact on the Company’s consolidated financial statements since the Company has a full valuation allowance against its deferred tax assets due to the uncertainty regarding future taxable income for the foreseeable future.

For all periods through September 30, 2019, the Company generated research credits but has not conducted a study to document the qualified activities. This study may result in an adjustment to the Company’s research and development credit carryforwards; however, until a study is completed and any adjustment is known, no amounts are being presented as an uncertain tax position. A full valuation allowance has been provided against the Company’s research and development credits and, if an adjustment is required, this adjustment would be offset by an adjustment to the deferred tax asset established for the research and development credit carryforwards and the valuation allowance.

On November 11, 2019, the Company issued a total of 75,000 shares of its common stock to Connecticut Children’s in connection with the exercise of a total of 75,000 warrants, which were previously issued on January 3, 2018, at $2.00 per share for total gross proceeds in the amount of $150,000. See Note 3.

The Company has performed an evaluation of subsequent events through the time of filing this Quarterly Report on Form 10-Q with the SEC, and has determined that there are no such events to report other than those already disclosed.

Forward Looking Statements

This Quarterly Report on Form 10-Q contains statements that are not statements of historical fact and are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 (the “Exchange Act”). The forward-looking statements are principally, but not exclusively, contained in “Item 2: Management’s Discussion and Analysis of Financial Condition and Results of Operations.” Forward-looking statements include, but are not limited to, statements about management’s confidence or expectations, and our plans, objectives, expectations and intentions that are not historical facts. In some cases, you can identify forward-looking statements by terms such as “may,” “will,” “should,” “could,” “would,” “expects,” “plans,” “anticipates,” “believes,” “goals,” “sees,” “estimates,” “projects,” “predicts,” “intends,” “think,” “potential,” “objectives,” “optimistic,” “strategy,” and similar expressions intended to identify forward-looking statements. These statements reflect our current views with respect to future events and are based on assumptions and subject to risks and uncertainties. Given these uncertainties, you should not place undue reliance on these forward-looking statements. Factors that may cause our actual results to differ materially from those in the forward-looking statements include our ability to access debt and equity markets and raise additional funds when needed; the success of our collaborations, clinical trials and pre-clinical development efforts and programs, which success may not be achieved on a timely basis or at all; our ability to obtain and maintain regulatory approval for our implant products, bioreactors, scaffolds and other devices we pursue, including for the esophagus or airway, which approvals may not be obtained on a timely basis or at all; the number of patients who can be treated with our products; the amount and timing of costs associated with our development of implant products, bioreactors, scaffolds and other devices; our failure to comply with regulations and any changes in regulations; unpredictable difficulties or delays in the development of new technology; our collaborators or other third parties we contract with, including with respect to conducting any clinical trial or pre-clinical development efforts, not devoting sufficient time and resources to successfully carry out their duties or meet expected deadlines; our ability to attract and retain qualified personnel and key employees and retain senior management; potential liability exposure with respect to our products; the availability and price of acceptable raw materials and components from third-party suppliers; difficulties in obtaining or retaining the management and other human resource competencies that we need to achieve our business objectives; increased competition in the field of regenerative medicine and bioengineering, and the financial resources of our competitors; our ability to obtain and maintain intellectual property protection for our device and product candidates; our inability to implement our growth strategy; the control our principal stockholders can exert based on holding a majority of voting power; plus factors described under the heading “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2018 filed with the Securities and Exchange Commission (the “SEC”) on March 29, 2019 or described in our other public filings. Our results may also be affected by factors of which we are not currently aware. We may not update these forward-looking statements, even though our situation may change in the future, unless we have obligations under the federal securities laws to update and disclose material developments related to previously disclosed information.

Overview

We are a biotechnology company developing bioengineered organ implants based on our novel Cellspan^TM technology. Our Cellspan technology is comprised of a biocompatible scaffold that is seeded with the recipient’s own stem cells. This technology is being developed to treat life-threatening conditions of the esophagus, trachea and bronchus with the objective of dramatically improving the treatment paradigm for those patients.

We believe that our Cellspan technology will provide surgeons with new ways to address damage to the esophagus, bronchus, and trachea due to congenital abnormalities, trauma, infection or cancer.

The Cellspan Esophageal Implant (CEI) product candidates are our lead development product candidates. We are pursuing two development programs that address conditions of the esophagus: esophageal atresia (EA) in pediatric patients and esophageal disease in adult patients. EA is a congenital condition where the child’s esophagus is underdeveloped and does not extend completely from the mouth to the stomach. Our Cellspan esophageal product candidates are each intended to provide a surgical solution to stimulate regeneration of a segment of the esophagus missing due to a congenital abnormality or following surgical removal to establish or reestablish the organ’s continuity and integrity.

We believe that a pediatric CEI may provide pediatric surgeons with a better procedure to treat EA that would result in a connected esophagus with higher success rates, lower complications and lower overall costs to the healthcare system. Approximately one in 4,000 babies in the U.S. is born with EA. When a long segment of the esophagus is lacking, the current standard of care is a series of surgical procedures where surgical sutures are applied to both ends of the esophagus in an attempt to stretch them together so they can be connected at a later date. This process can take weeks and the procedure can result in serious complications and may carry high rates of failure. Such approach also requires, in time, at least two separate surgical interventions. In addition to the current standard of care being complex, it is an expensive procedure because the baby will normally be in the hospital for several months throughout the process. Other current options include the use of the child’s stomach that would be pulled up, or a piece of the patient’s intestine that would be moved to the gap, to allow a connection to the mouth. We are working to develop a CEI product candidate to address pediatric EA, to provide a simpler, more effective and potentially organ-sparing solution.

A portion of all patients diagnosed with esophageal cancer are treated via a surgical procedure known as an esophagectomy. The current standard of care for an esophagectomy requires a complex surgical procedure that involves moving the patient’s stomach or a portion of their colon into the chest to replace the portion of esophagus resected by the removal of the tumor. These current procedures have high rates of complications, can lead to a severely diminished quality of life, and require costly ongoing care. Our CEIs aim to simplify the procedure, reduce complications, result in a better quality of life and reduce the overall cost of these patients to the healthcare system.

We believe that, of our two current programs, the CEI program to treat pediatric EA may provide a shorter time to a commercial product and the greater overall potential value in the U.S. market. In addition to providing a novel solution for a great medical need, approval of our pediatric EA product candidate may result in receipt of a priority review voucher, which if achieved, could potentially provide significant value in the future. We have continued to advance the CEI adult program and filed an Investigational New Drug Application (IND) with the U.S. Food and Drug Administration (FDA) for that product on October 29, 2019. In January 2019, we submitted a meeting request to the FDA to seek guidance regarding our pediatric program through their Initial Targeted Engagement for Regulatory Advice on CBER Products (INTERACT) program, and the FDA responded to us noting that our pediatric indication is the same indication as our CEI adult program. Based on the FDA response, following the approval of our first IND and treatment of a few adult patients in our CEI adult program, we plan to submit a protocol amendment to include pediatric patients with esophageal atresia since the FDA requires a higher safety profile before treating pediatric patients. In parallel, we plan to develop an endoscopic version of the CEI in order to treat a greater number of patients with esophageal disease earlier in their disease progression.

Our products are currently in development and have not yet received regulatory approval for sale anywhere in the world.

Financial Status and Need for Additional Funds

We continue to pursue both of our esophageal programs and anticipate our 2019 cash burn needs to be similar or slightly lower than our 2018 burn.

Operating Losses and Cash Requirements

We have incurred substantial operating losses since our inception, and as of September 30, 2019 had an accumulated deficit of approximately $62.5 million, which will require us to seek additional financing to fund future operations. We expect that our cash on hand at September 30, 2019 of $1.1 million will enable us to fund our operating expenses and capital expenditure requirements through the middle of November 2019. As discussed in Note 1 to the consolidated financial statements, these conditions raise substantial doubt about our ability to continue as a going concern.

We are currently investing significant resources in the development of products for use by clinicians in the field of regenerative medicine, including bioengineering. We will need to raise additional funds in future periods to fund our operations. In the event that we do not raise additional capital from outside sources in the near future, we may be forced to further curtail or cease our operations. Cash requirements and cash resource needs will vary significantly depending upon the timing of the financial and other resource needs that will be required to complete ongoing development, regulatory and clinical efforts, continued pre-clinical testing of products, and collaborative arrangements necessary for our products that are currently under development. We will seek to raise necessary funds through a combination of public or private equity offerings, debt financings, other financing mechanisms, or strategic collaborations and licensing arrangements. We may not be able to obtain additional financing on terms favorable to us, if at all. Our operations will be adversely affected if we are unable to raise or obtain needed funding and such circumstance would materially affect our ability to continue as a going concern. 

Capital Transactions

During 2018 we completed the following private placements:

During 2019 we had the following capital transactions:

Small Business Innovation Research Grant

On March 28, 2018, we were awarded a Fast-Track Small Business Innovation Research (SBIR) grant by the Eunice Kennedy National Institute of Child Health and Human Development of the National Institutes of Health (NIH) to support testing of the pediatric CEI. The award for Phase I, which was executed and earned through the third quarter of 2018, provided for the reimbursement of up to $0.2 million of qualified research and development costs.

On October 26, 2018, we were awarded Phase II of the SBIR grant for $1.1 million to support development, testing, and translation to the clinic through September 2019. We have recognized $0.6 million from Phase II as of September 30, 2019 and plan to discuss carryover funding with the NIH for the $0.5 million of the Phase II award not incurred. The Phase II grant includes an additional $0.5 million for future period support through September 2020, subject to availability of funding and satisfactory progress on the project. Accordingly, the SBIR grant has the potential to provide a total award of $1.8 million if carryover funding is allowed. We have recognized $0.9 million of grant income under the SBIR program from March 28, 2018 through September 30, 2019, including $0.5 million during the nine months ended September 30, 2019.

Headcount

Following the failure to receive the funding with respect to a Securities Purchase Agreement in August 2017, and in an effort to conserve cash, we completed a reduction in headcount of 20 persons during October and November 2017. Following the capital raises in December 2017 and January 2018 described above we re-hired several of our former employees into key positions in January 2018, and have since made additional hires. We disclosed in our Current Report on Form 8-K dated June 17, 2019 that our Chief Financial Officer resigned from his role effective June 14, 2019. We are currently in the process of evaluating our options to fill the position. At September 30, 2019, we had 15 employees, of whom fourteen were full-and one was part-time.

Results of Operations

Components of Operating Loss

Research and development expense. Research and development expense consists of salaries and related expenses, including share-based compensation, for personnel and contracted consultants, and various materials and other costs to develop our products, primarily: synthetic organ scaffolds, including investigation and development of materials and investigation and optimization of cellularization, and 3D organ bioreactors, as well as studies of cells and cell behavior. Other research and development expenses include the costs of outside service providers and material costs for prototype and test units and outside laboratories and testing facilities performing cell growth and materials experiments, and expenses for other preclinical research. In addition, we are incurring costs to compile and submit our IND to the FDA, and prepare for clinical readiness. We expense research and development costs as incurred.

Selling, general and administrative expense. Selling, general and administrative expense consists primarily of salaries and other related expenses, including share-based compensation, for personnel in executive, accounting, information technology and human resources roles. Other costs include professional fees for legal and accounting services, insurance, investor relations and facility costs.

Other Income (Expense)

Grant income. Grant income reflects income earned under an SBIR grant. Grant income is recognized when qualified research and development costs are incurred.

Changes in fair value of warrant liability. Changes in fair value of warrant liability represent the change in the fair value of common stock warrants since the date of issuance based on the remeasurement of such warrants at the end of each reporting period until the liability is settled. We use the Black-Scholes pricing model to value the outstanding warrant liability.

Comparison of the three months ended September 30, 2019 to the three months ended September 30, 2018

Research and Development Expense

Research and development expense increased approximately 24% to $1.6 million for the three months ended September 30, 2019 compared to $1.3 million for the comparable three-month period in 2018. This was due primarily to an increase of $0.2 million in consulting expenses related to IND preparation, and a $0.2 million increase in share-based compensation, partially offset by a $0.1 million decrease in all other expenses. With the filing of our IND on October 29, 2019, we expect our research and development costs to increase significantly in 2020 due to the start of a clinical trial, assuming approval of our IND by the FDA and to the extent we have funds available.

Selling, General and Administrative Expense

Selling, general and administrative expense was virtually unchanged at $0.9 million for the three months ended September 30, 2019 compared to the same period in 2018. This was due primarily to a decrease of $0.2 million in employee costs, business taxes, and Board of Director fees, partially offset by a $0.2 million increase in share-based compensation.

Grant income

Grant income for qualified expenditures from an SBIR grant increased by $46,000, or approximately 51%, to $136,000 for the three months ended September 30, 2019 compared to $90,000 for the comparable three-month period in 2018.

Change in fair value of warrant liability

The change in the fair value of the warrant liability resulted in other expense of $14,000 for the three months ended September 30, 2019 compared to other income of $49,000 in the same period in 2018. The other expense for the three months ended September 30, 2019 was due primarily to an increase in the price of the underlying common stock during the third quarter of 2019. The income for the three months ended September 30, 2018 was due primarily to a decrease in the price of the underlying common stock as of September 30, 2018, offset in part by an increase in the volatility of the common shares.

Comparison of the nine months ended September 30, 2019 to the nine months ended September 30, 2018

Research and Development Expense

Research and development expense increased approximately 45% to $4.0 million for the nine months ended September 30, 2019 compared to $2.8 million for the comparable nine-month period in 2018. This was due primarily to an increase of $0.4 million in consulting expenses related to IND preparation, a $0.3 million increase in payroll-related costs attributed to the hiring of additional research professionals in 2018, a $0.3 million increase in share-based compensation, and a $0.2 million increase in other operating expenses.

Selling, General and Administrative Expense

Selling, general and administrative expense increased approximately 7% to $3.2 million compared to $3.0 million for the same period in 2018. This was due primarily to an increase of $0.6 million in share-based compensation mainly due to option grants issued to our Board of Directors and the separation of our Chief Financial Officer in June 2019. This increase was partially offset by $0.2 million of lower business exit taxes mainly related to the dissolution of European operations and a $0.2 million reduction in all other expenses.

Grant income

Grant income for qualified expenditures from an SBIR grant increased by $248,000, or approximately 110%, to $473,000 for the nine months ended September 30, 2019 compared to $225,000 for the comparable nine-month period in 2018.

Change in fair value of warrant liability

The change in the fair value of the warrant liability resulted in other expense of $5,000 for the nine months ended September 30, 2019 compared to other expense of $171,000 in the same period in 2018. The other expense for the nine months ended September 30, 2019 was due primarily to an increase in the price of the underlying common shares during the nine months ended September 30, 2019. The expense for the nine months ended September 30, 2018 was due primarily to an increase in the price and volatility of the underlying common shares during the nine months ended September 30, 2018.

Financial Condition, Liquidity and Capital Resources

Sources of liquidity.  We have incurred operating losses since inception, and as of September 30, 2019 we had an accumulated deficit of approximately $62.5 million. We are currently investing significant resources in the development and commercialization of our products for use by clinicians and researchers in the field of regenerative medicine. As a result, we expect to incur operating losses and negative operating cash flows for the foreseeable future. We expect that our cash at September 30, 2019 of $1.1 million will enable us to fund our operating expenses and capital expenditure requirements through the middle of November 2019.

Operating activities.  Net cash used in operating activities of $4.6 million for the nine months ended September 30, 2019 was due primarily to our net loss of $6.7 million, partially offset by $1.5 million non-cash expenses related to share-based compensation and depreciation, and $0.6 million of cash provided from working capital due to the timing of prepaid expenses and accounts payable.

Net cash used in operating activities of $5.5 million for the nine months ended September 30, 2018 was due primarily to our net loss of $5.7 million, in addition to approximately $0.6 million of cash used for working capital, offset by $0.8 million add-back of non-cash expenses related to share-based compensation, depreciation, and the change in the fair value of our warrant liability.

Investing activities.  Net cash used in investing activities for the nine months ended September 30, 2019 was due to $118,000 of equipment purchases.

Net cash used in investing activities of $63,000 during the nine months ended September 30, 2018 reflected $127,000 of property, plant and equipment additions, offset in part by $64,000 of cash received from the sale of property, plant and equipment.

Financing activities. Net cash generated from financing activities of $4.5 million during the nine months ended September 30, 2019 consisted of $1.3 million of net proceeds received from private placement transactions that resulted in the issuance of 345,174 shares of our common stock and warrants to purchase 345,174 shares of common stock to a group of investors at an exercise price of $3.70 per share, and $3.2 million received from the issuance of 1,625,000 shares of our common stock to a group of investors in connection with the exercise of a portion of the warrants issued on December 27, 2017.

Net cash generated from financing activities of $5.0 million during the nine months ended September 30, 2018 consisted of the net proceeds of $5.3 million received from private placement transactions that resulted in the issuance of 1,602,115 shares of our common stock at an average purchase gross price of $3.495 per share, partially offset by the repayment of a $0.3 million deposit to an investor related to the private placement transaction from December 2017.

Critical Accounting Policies and Estimates

The critical accounting policies and estimates underlying the accompanying unaudited consolidated financial statements are those set forth in Part II, Item 7 included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2018, which was filed with the SEC on March 29, 2019.

We do not have any material foreign currency exchange risks, we do not enter into derivative agreements, we do not have any off balance-sheet arrangements, and we do not have any interest rate risks. Additionally, we have no debt outstanding.

Evaluation of Disclosure Controls and Procedures

As required by Rules 13a-15(e) and 15d-15(e) under the Exchange Act, our management, under the supervision and with the participation of our Chief Executive Officer and Principal Financial Officer, conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures as of September 30, 2019. Based upon the evaluation described above, our Chief Executive Officer and Principal Financial Officer have concluded that they believe our disclosure controls and procedures were effective as of the end of the period covered by this Quarterly Report on Form 10-Q.

Changes in Internal Control over Financial Reporting

During the period covered by this report, we have concluded that there were no changes during the fiscal quarter in our internal control over financial reporting, as defined in Rule 13a-15(f) and 15d-15(f) under the Exchange Act, which have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION

From time to time, we may be involved in various claims and legal proceedings arising in the ordinary course of business. Other than the ongoing civil lawsuit described in Item 3 of Part I of our Annual Report on Form 10-K filed with the SEC on March 29, 2019, there are no such matters pending that we expect to be material in relation to our business, financial condition, and results of operations or cash flows.

In addition to the risk factor below and the other risks described herein, Item 1A of Part I of our Annual Report on Form 10-K for the year ended December 31, 2018, filed with the SEC on March 29, 2019, contains risk factors identified by the Company. Except for the risk factor below, the other risks described herein, and except to the extent additional factual information disclosed in this Quarterly Report on Form 10-Q relates to such risk factors, there have been no material changes in the risk factors described in such Item 1A.

Financial and Operating Risks

Our financial status creates doubt whether we will continue as a going concern. We will need additional funds in the immediate future and our operations will be adversely affected if we are unable to obtain needed funding, including that we would be forced to curtail or cease our operations.

Such factual information described in this filing includes that we expect that our cash on hand to enable us to fund our operating expenses and capital expenditure requirements only through the middle of November 2019. As discussed in Note 1 to the consolidated financial statements, these conditions raise substantial doubt about our ability to continue as a going concern.  As such, we will need additional funds in the immediate future and our operations will be adversely affected if we are unable to obtain needed funding.  If we do not raise additional capital from outside sources in the immediate future, we would be forced to curtail or cease our operations. We are currently seeking and will continue to seek financings from other existing and/or new investors to raise necessary funds through a combination of public or private equity offerings. We may also pursue debt financings, other financing mechanisms, strategic collaborations and licensing arrangements. We may not be able to obtain additional financing on terms favorable to us, if at all. In addition, general market conditions, as well as the effects of laws and regulations on foreign investment in the United States under the jurisdiction of the Committee on Foreign Investment in the United States (CFIUS), and other agencies and related regulations, including the Foreign Investment Risk Review Modernization Act (FIRRMA), adopted in August 2018, may make it difficult for us to seek financing from the capital markets. Any additional equity financings could result in significant dilution to our stockholders and possible restrictions on subsequent financings. Debt financing, if available, could result in agreements that include covenants limiting or restricting our ability to take certain actions, such as incurring additional debt, making capital expenditures or paying dividends. Other financing mechanisms may involve selling intellectual property rights, payment of royalties or participation in our revenue or cash flow. In addition, in order to raise additional funds through strategic collaborations or licensing arrangements, we may be required to relinquish certain rights to some or all of our technologies or products.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by undersigned thereunto duly authorized.

Date: November 13, 2019