PLUS THERAPEUTICS, INC. - Quarter Report: 2007 March (Form 10-Q)
SECURITIES
AND EXCHANGE COMMISSION
Washington,
D.C. 20549
_______________________
FORM
10-Q
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(Mark
One)
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ý
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QUARTERLY
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF
1934
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For
the quarterly period ended March 31, 2007
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OR
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o
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TRANSITION
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF
1934
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For
the transition period
from to
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Commission
file number 0-32501
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CYTORI
THERAPEUTICS, INC.
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(Exact
name of Registrant as Specified in Its
Charter)
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DELAWARE
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33-0827593
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(State
or Other Jurisdiction
of
Incorporation or Organization)
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(I.R.S.
Employer
Identification
No.)
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3020
CALLAN ROAD, SAN DIEGO, CALIFORNIA
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92121
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(Address
of principal executive offices)
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(Zip
Code)
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Registrant’s
telephone number, including area code:
(858) 458-0900
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||
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 (“the
Exchange Act”) 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. Yes ý
No o
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of
“accelerated filer” and “large accelerated filer” in Rule 12b-2 of the Exchange
Act. Large Accelerated
Filer o Accelerated
Filer o
Non-Accelerated Filer ý
Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act). Yes o No ý
As
of
April 30, 2007, there were 23,583,622 shares of the registrant’s common stock
outstanding.
CYTORI
THERAPEUTICS, INC.
|
PART
I
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FINANCIAL
INFORMATION
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Item
1.
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Financial
Statements
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|||
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|||
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Item
2.
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Item
3.
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|||
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Item
4.
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PART
II
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OTHER
INFORMATION
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Item
1.
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||
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Item
1A.
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Item
2.
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Item
3.
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Item
4.
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Item
5.
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Item
6.
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PART
I. FINANCIAL INFORMATION
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||||||||||||||||
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Item
1. Financial Statements
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||||||||||||||||
The
Board
of Directors and Stockholders
Cytori
Therapeutics, Inc.:
We
have
reviewed the accompanying consolidated condensed balance sheet of Cytori
Therapeutics, Inc. and subsidiaries (the Company) as of March 31, 2007, the
related consolidated condensed statements of operations and comprehensive
loss
for the three- month periods ended March 31, 2007 and 2006, and the statements
of cash flows for the three-month periods ended March 31, 2007 and 2006.
These
consolidated condensed financial statements are the responsibility of the
Company’s management.
We
conducted our review in accordance with the standards of the Public Company
Accounting Oversight Board (United States of America). A review of interim
financial information consists principally of applying analytical procedures
and
making inquiries of persons responsible for financial and accounting matters.
It
is substantially less in scope than an audit conducted in accordance with
the
standards of the Public Company Accounting Oversight Board (United States
of
America), the objective of which is the expression of an opinion regarding
the
financial statements taken as a whole. Accordingly, we do not express such
an
opinion.
Based
on
our review, we are not aware of any material modifications that should be
made
to the consolidated condensed financial statements referred to above for
them to
be in conformity with U.S. generally accepted accounting
principles.
We
have
previously audited, in accordance with standards of the Public Company
Accounting Oversight Board (United States of America), the consolidated balance
sheet of Cytori Therapeutics, Inc. and subsidiaries as of December 31, 2006,
and
the related consolidated statements of operations and comprehensive loss,
stockholders’ deficit, and cash flows for the year then ended (not presented
herein); and in our report dated March 29, 2007, we expressed an unqualified
opinion on those consolidated financial statements. In
our
opinion, the information set forth in the accompanying consolidated condensed
balance sheet as of December 31, 2006 is fairly stated in all material respects,
in relation to the consolidated balance sheet from which it has been
derived.
Note
2 of
the Company’s audited financial statements as of December 31, 2006 and for the
year then ended discloses that the Company derives a substantial portion
of its
revenues from related parties, and effective January 1, 2006, adopted Statement
of Financial Accounting Standards No. 123(R), ”Share-based Payment.” Our
auditors’ report on those financial statements dated March 29, 2006 includes an
explanatory paragraph referring to the matters in note 2 of those consolidated
financial statements. Note 6 of the Company’s unaudited interim financial
statements as of March 31, 2007 and for the three month periods ended March
31,
2007 and 2006 discloses that the Company derives a substantial portion of
its
revenues from related parties.
|
/s/
KPMG LLP
|
|
|
San
Diego, California
|
|
|
May
9, 2007
|
CYTORI
THERAPEUTICS, INC.
|
As
of March 31,
2007
|
As
of December 31,
2006
|
||||||
|
(unaudited)
|
|||||||
|
Assets
|
|||||||
|
Current
assets:
|
|||||||
|
Cash
and cash equivalents
|
$
|
21,701,000
|
$
|
8,902,000
|
|||
|
Short-term
investments, available-for-sale
|
2,761,000
|
3,976,000
|
|||||
|
Accounts
receivable, net of allowance for doubtful accounts
of
$3,000 and $2,000 in 2007 and 2006, respectively
|
233,000
|
225,000
|
|||||
|
Inventories,
net
|
212,000
|
164,000
|
|||||
|
Other
current assets
|
742,000
|
711,000
|
|||||
|
Total
current assets
|
25,649,000
|
13,978,000
|
|||||
|
Property
and equipment held for sale, net
|
460,000
|
457,000
|
|||||
|
Property
and equipment, net
|
4,028,000
|
4,242,000
|
|||||
|
Investment
in joint venture
|
74,000
|
76,000
|
|||||
|
Other
assets
|
417,000
|
428,000
|
|||||
|
Intangibles,
net
|
1,244,000
|
1,300,000
|
|||||
|
Goodwill
|
4,387,000
|
4,387,000
|
|||||
|
Total
assets
|
$
|
36,259,000
|
$
|
24,868,000
|
|||
|
Liabilities
and Stockholders’ Equity (Deficit)
|
|||||||
|
Current
liabilities:
|
|||||||
|
Accounts
payable and accrued expenses
|
$
|
5,059,000
|
$
|
5,587,000
|
|||
|
Current
portion of long-term obligations
|
949,000
|
999,000
|
|||||
|
Total
current liabilities
|
6,008,000
|
6,586,000
|
|||||
|
Deferred
revenues, related party
|
23,906,000
|
23,906,000
|
|||||
|
Deferred
revenues
|
2,389,000
|
2,389,000
|
|||||
|
Option
liability
|
1,100,000
|
900,000
|
|||||
|
Long-term
deferred rent
|
692,000
|
741,000
|
|||||
|
Long-term
obligations, less current portion
|
956,000
|
1,159,000
|
|||||
|
Total
liabilities
|
35,051,000
|
35,681,000
|
|||||
|
Commitments
and contingencies
|
|||||||
|
Stockholders’
equity (deficit):
|
|||||||
|
Preferred
stock, $0.001 par value; 5,000,000 shares authorized; (0) shares
issued
and outstanding in 2007 and 2006
|
—
|
—
|
|||||
|
Common
stock, $0.001 par value; 95,000,000 shares authorized; 25,428,778
and
21,612,243 shares issued and 22,555,944 and 18,739,409 shares outstanding
in 2007 and 2006, respectively
|
25,000
|
22,000
|
|||||
|
Additional
paid-in capital
|
123,726,000
|
103,053,000
|
|||||
|
Accumulated
deficit
|
(112,129,000
|
)
|
(103,460,000
|
)
|
|||
|
Treasury
stock, at cost
|
(10,414,000
|
)
|
(10,414,000
|
)
|
|||
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Accumulated
other comprehensive income
|
—
|
1,000
|
|||||
|
Amount
due from exercises of stock options
|
—
|
(15,000
|
)
|
||||
|
Total
stockholders’ equity (deficit)
|
1,208,000
|
(10,813,000
|
)
|
||||
|
Total
liabilities and stockholders’ equity (deficit)
|
$
|
36,259,000
|
$
|
24,868,000
|
|||
SEE
NOTES
TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
CYTORI
THERAPEUTICS, INC.
CONSOLIDATED
CONDENSED STATEMENTS OF OPERATIONS AND COMPREHENSIVE
LOSS
(UNAUDITED)
|
For
the Three Months Ended March 31,
|
|||||||
|
2007
|
2006
|
||||||
|
Product
revenues, related party
|
$
|
280,000
|
$
|
502,000
|
|||
|
Cost
of product revenues
|
225,000
|
454,000
|
|||||
|
Gross
profit
|
55,000
|
48,000
|
|||||
|
Development
revenues:
|
|||||||
|
Development,
related party
|
—
|
683,000
|
|||||
|
Development
|
—
|
142,000
|
|||||
|
Research
grants and other
|
45,000
|
5,000
|
|||||
|
45,000
|
830,000
|
||||||
|
Operating
expenses:
|
|||||||
|
Research
and development
|
4,996,000
|
5,176,000
|
|||||
|
Sales
and marketing
|
546,000
|
501,000
|
|||||
|
General
and administrative
|
3,166,000
|
3,216,000
|
|||||
|
Change
in fair value of option liabilities
|
200,000
|
(475,000
|
)
|
||||
|
Total
operating expenses
|
8,908,000
|
8,418,000
|
|||||
|
Operating
loss
|
(8,808,000
|
)
|
(7,540,000
|
)
|
|||
|
Other
income (expense):
|
|||||||
|
Interest
income
|
197,000
|
197,000
|
|||||
|
Interest
expense
|
(52,000
|
)
|
(58,000
|
)
|
|||
|
Other
expense, net
|
(4,000
|
)
|
(6,000
|
)
|
|||
|
Equity
loss from investment in joint venture
|
(2,000
|
)
|
(49,000
|
)
|
|||
|
Total
other income, net
|
139,000
|
84,000
|
|||||
|
Net
loss
|
(8,669,000
|
)
|
(7,456,000
|
)
|
|||
|
Other
comprehensive loss - unrealized loss
|
(1,000
|
)
|
(14,000
|
)
|
|||
|
Comprehensive
loss
|
$
|
(8,670,000
|
)
|
$
|
(7,470,000
|
)
|
|
|
Basic
and diluted net loss per common share
|
$
|
(0.43
|
)
|
$
|
(0.48
|
)
|
|
|
Basic
and diluted weighted average common shares
|
20,063,750
|
15,427,971
|
|||||
SEE
NOTES
TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
CYTORI
THERAPEUTICS, INC.
(UNAUDITED)
|
For
the Three Months Ended March 31,
|
|||||||
|
2007
|
2006
|
||||||
|
Cash
flows from operating activities:
|
|||||||
|
Net
loss
|
$
|
(8,669,000
|
)
|
$
|
(7,456,000
|
)
|
|
|
Adjustments
to reconcile net loss to net cash (used in) provided by operating
activities:
|
|||||||
|
Depreciation
and amortization
|
397,000
|
508,000
|
|||||
|
Warranty
provision
|
(17,000
|
)
|
—
|
||||
|
Increase
in allowance for doubtful accounts
|
1,000
|
—
|
|||||
|
Change
in fair value of option liabilities
|
200,000
|
(475,000
|
)
|
||||
|
Share-based
compensation expense
|
548,000
|
804,000
|
|||||
|
Equity
loss from investment in joint venture
|
2,000
|
49,000
|
|||||
|
Increases
(decreases) in cash caused by changes in operating assets and
liabilities:
|
|||||||
|
Accounts
receivable
|
(9,000
|
)
|
348,000
|
||||
|
Inventories
|
(48,000
|
)
|
35,000
|
||||
|
Other
current assets
|
(16,000
|
)
|
(206,000
|
)
|
|||
|
Other
assets
|
11,000
|
(16,000
|
)
|
||||
|
Accounts
payable and accrued expenses
|
(511,000
|
)
|
(814,000
|
)
|
|||
|
Deferred
revenues, related party
|
—
|
10,317,000
|
|||||
|
Deferred
revenues
|
—
|
(142,000
|
)
|
||||
|
Long-term
deferred rent
|
(49,000
|
)
|
208,000
|
||||
|
Net
cash (used in) provided by operating activities
|
(8,160,000
|
)
|
3,160,000
|
||||
|
Cash
flows from investing activities:
|
|||||||
|
Proceeds
from sale and maturity of short-term investments
|
16,060,000
|
22,218,000
|
|||||
|
Purchases
of short-term investments
|
(14,846,000
|
)
|
(24,647,000
|
)
|
|||
|
Purchases
of property and equipment
|
(130,000
|
)
|
(1,895,000
|
)
|
|||
|
Investment
in joint venture
|
—
|
(150,000
|
)
|
||||
|
Net
cash provided by (used in ) investing activities
|
1,084,000
|
(4,474,000
|
)
|
||||
|
Cash
flows from financing activities:
|
|||||||
|
Principal
payments on long-term obligations
|
(253,000
|
)
|
(213,000
|
)
|
|||
|
Proceeds
from exercise of employee stock options and warrants
|
227,000
|
506,000
|
|||||
|
Proceeds
from sale of common stock and warrants
|
19,901,000
|
—
|
|||||
|
Net
cash provided by financing activities
|
19,875,000
|
293,000
|
|||||
|
Net
increase (decrease) in cash and cash equivalents
|
12,799,000
|
(1,021,000
|
)
|
||||
|
Cash
and cash equivalents at beginning of period
|
8,902,000
|
8,007,000
|
|||||
|
Cash
and cash equivalents at end of period
|
$
|
21,701,000
|
$
|
6,986,000
|
|||
|
Supplemental
disclosure of cash flow information:
|
|||||||
|
Cash
paid during period for:
|
|||||||
|
Interest
|
$
|
49,000
|
$
|
54,000
|
|||
|
Taxes
|
2,000
|
1,000
|
|||||
|
Supplemental
schedule of non-cash investing and financing
activities:
|
|||||||
|
Receivable,
related party, included in deferred revenues, related
party
|
$
|
—
|
$
|
1,500,000
|
|||
|
Additions
to leasehold improvements included in accounts payable and accrued
expenses
|
—
|
504,000
|
|||||
SEE
NOTES
TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
CYTORI
THERAPEUTICS, INC.
NOTES
TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
MARCH
31, 2007
(UNAUDITED)
|
1.
|
Basis
of Presentation
|
Our
accompanying unaudited consolidated condensed financial statements as of
March
31, 2007 and for the three months ended March 31, 2007 and 2006 have been
prepared in accordance with accounting principles generally accepted in the
United States of America for interim financial information. Accordingly,
they do
not include all of the information and footnotes required by accounting
principles generally accepted in the United States of America for annual
financial statements. Our consolidated condensed balance sheet at December
31,
2006 has been derived from the audited financial statements at that date,
but
does not include all of the information and footnotes required by accounting
principles generally accepted in the United States of America for complete
financial statements. In the opinion of management, all adjustments (consisting
of normal recurring adjustments) considered necessary for a fair presentation
of
the financial position and results of operations of Cytori Therapeutics,
Inc.,
and our subsidiaries, have been included. Operating results for the three
months
ended March 31, 2007 are not necessarily indicative of the results that may
be
expected for the year ending December 31, 2007. For further information,
refer
to our consolidated financial statements for the year ended December 31,
2006
and footnotes thereto which were included in our Annual Report on Form 10-K,
dated April 2, 2007.
|
2.
|
Use
of Estimates
|
The
preparation of consolidated financial statements in conformity with accounting
principles generally accepted in the United States of America of America
requires management to make estimates and assumptions affecting the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements, and the reported amounts
of
revenue and expenses during the reporting period. Actual results could differ
from these estimates. Estimates and assumptions are reviewed periodically,
and
the effects of revisions are reflected in the consolidated financial statements
in the periods they are determined to be necessary.
Our
most
significant estimates and critical accounting policies involve recognizing
revenue, evaluating goodwill for impairment, accounting for product line
dispositions, valuing the Put option, determining the assertions used in
share-based compensation expense, valuing our deferred tax assets, and assessing
how to report our investment in Olympus-Cytori, Inc.
|
3.
|
Segment
Information
|
We
operate as two distinct operating segments - (a) Regenerative cell technology
and (b) MacroPore Biosurgery, which manufactures bioresorbable implants.
In the
past, our resources were managed on a consolidated basis. However, in an
effort
to better reflect our focus and significant progress in the development of
regenerative therapies, we evaluate and report our financial results in two
segments.
Our
regenerative cell technology segment is developing and seeks to commercialize
stem and regenerative cell therapies for cardiovascular disease, reconstructive
surgery, and many other serious, chronic, and life-threatening conditions
and
disorders. We plan to commercialize these therapies through the sale of the
Celution™ System, a device that quickly removes stem and regenerative cells from
a patient’s own adipose tissue, and its related single-use consumables.
Our
MacroPore Biosurgery unit manufactures and distributes the HYDROSORB™ family of
bioresorbable spine and orthopedic implants, which have been cleared by the
Food
& Drug Administration (“FDA”); it also develops Thin Film bioresorbable
implants for sale in Japan through Senko Medical Trading Company (“Senko”),
which has exclusive distribution rights to these products in Japan.
We
measure the success of each operating segment based on operating profits
and
losses and, additionally, in the case of the regenerative cell technology
segment, the achievement of key research objectives. In arriving at our
operating results for each segment, we use the same accounting policies as
those
used for our consolidated company and as described throughout this note.
However, segment operating results exclude allocations of company-wide general
and administrative costs, changes in fair value of our option liabilities,
and
restructuring charges, if applicable.
The
following tables provide information regarding the performance and assets
of our
operating segments:
|
For
the three months ended March 31,
|
|||||||
|
2007
|
2006
|
||||||
|
Revenues:
|
|||||||
|
Regenerative
cell technology
|
$
|
45,000
|
$
|
688,000
|
|||
|
MacroPore
Biosurgery
|
280,000
|
644,000
|
|||||
|
Total
revenues
|
$
|
325,000
|
$
|
1,332,000
|
|||
|
Segment
losses:
|
|||||||
|
Regenerative
cell technology
|
$
|
(5,351,000
|
)
|
$
|
(4,469,000
|
)
|
|
|
MacroPore
Biosurgery
|
(91,000
|
)
|
(330,000
|
)
|
|||
|
General
and administrative expenses
|
(3,166,000
|
)
|
(3,216,000
|
)
|
|||
|
Change
in fair value of option liabilities
|
(200,000
|
)
|
475,000
|
||||
|
Total
operating loss
|
$
|
(8,808,000
|
)
|
$
|
(7,540,000
|
)
|
|
|
As
of March
31,
|
As
of December 31,
|
||||||
|
2007
|
2006
|
||||||
|
Assets:
|
|||||||
|
Regenerative
cell technology
|
$
|
10,131,000
|
$
|
9,792,000
|
|||
|
MacroPore
Biosurgery
|
1,768,000
|
1,758,000
|
|||||
|
Corporate
assets
|
24,360,000
|
13,318,000
|
|||||
|
Total
assets
|
$
|
36,259,000
|
$
|
24,868,000
|
|||
|
4.
|
Assets
Held for Sale
|
We
have
begun to focus our efforts primarily on the regenerative cell therapy segment
of
our business. As a result, in 2006, the Board of Directors decided to divest
and
is actively pursuing a buyer (or buyers) for our spine and orthopedic MacroPore
Biosurgery assets as a means to fund our continuing efforts in our regenerative
cell therapy segment. This decision is based on the change in our strategic
focus as well as the continuing losses being realized from the MacroPore
Biosurgery segment. We expect to complete the disposal no later than the
third
quarter of 2007. As of March 31, 2007, the remaining assets were comprised
of
machinery and equipment used for manufacturing, with a net book value of
$460,000.
|
5.
|
Short-Term
Investments
|
We
invest
excess cash in highly liquid debt instruments of financial institutions and
corporations with strong credit ratings and in United States of America
government obligations. We have established guidelines relative to
diversification and maturities that maintain safety and liquidity. These
guidelines are periodically reviewed and modified to take advantage of trends
in
yields and interest rates.
We
evaluate our investments in accordance with the provisions of Statement of
Financial Standards (“SFAS”) No. 115, “Accounting for Certain Investments in
Debt and Equity Securities.” Based on our intent, our investment policies, and
our ability to liquidate debt securities, we classify short-term investment
securities within current assets. Available-for-sale securities are carried
at
fair value, with unrealized gains and losses reported as accumulated other
comprehensive income (loss) within stockholders’ equity. The amortized cost
basis of debt securities is periodically adjusted for amortization of premiums
and accretion of discounts to maturity. Such amortization is included as
a
component of interest income or interest expense. The amortized cost basis
of
securities sold is based on the specific identification method and all such
realized gains and losses are recorded as a component within other income
(expense). Based on such evaluation, management has determined that all
investment securities (other than those classified as cash equivalents) are
properly classified as available-for-sale.
We
review
the carrying values of our investments and write down such investments to
estimated fair value by a charge to the statements of operations when the
severity and duration of a decline in the value of an investment is considered
to be other than temporary. The cost of securities sold or purchased is recorded
on the settlement date.
At
March
31, 2007, the excess of carrying cost over the fair value of our short-term
investments is immaterial.
|
6.
|
Summary
of Significant Accounting
Policies
|
Inventories
Inventories
include the cost of material, labor, and overhead, and are stated at the
lower
of average cost, determined on the first-in, first-out (FIFO) method, or
market.
We periodically evaluate our on-hand stock and make appropriate provisions
for
any stock deemed excess or obsolete. We expense excess manufacturing costs,
that
is, costs resulting from lower than “normal” production levels.
No
inventory provisions were recorded during the first quarter of 2007 or
2006.
Property
and Equipment
Property
and equipment is stated at cost, net of accumulated depreciation. Depreciation
expense is provided for on a straight-line basis over the estimated useful
lives
of the assets, or the life of the lease, whichever is shorter, and range
from
three to seven years. When assets are sold or otherwise disposed of, the
cost
and related accumulated depreciation are removed from the accounts and the
resulting gain or loss is included in operations. Leasehold improvements
are
amortized on a straight-line basis over the shorter of the estimated useful
life
of the asset or the lease term. Maintenance and repairs are charged to
operations as incurred.
Revenue
Recognition
Product
Sales
We
sell
our (non-Thin Film) MacroPore Biosurgery products to Medtronic, Inc., a related
party, under a Distribution Agreement dated January 5, 2000 and amended December
22, 2000 and October 8, 2002, as well as a Development and Supply Agreement
dated January 5, 2000 and amended December 22, 2000 and September 30, 2002.
These revenues are classified as product revenues, related party in our
statements of operations.
We
recognize revenue on product sales to Medtronic only after both (a) the receipt
of a purchase order from Medtronic and (b) shipment of ordered products to
Medtronic, as title and risk of loss pass upon shipment.
On
occasion, we will offer Medtronic extended payment terms. In these
circumstances, we do not recognize revenues under these arrangements until
the
payment becomes due or is received, if that occurs earlier. Moreover, we
warrant
that our products are free from manufacturing defects at the time of shipment.
We have recorded a reserve for the estimated costs we may incur under our
warranty program.
License/Distribution
Fees
If
separable under Emerging Issues Task Force Issue 00-21, “Revenue Arrangements
with Multiple Deliverables” (“EITF 00-21”), we recognize any upfront payments
received from license/distribution agreements as revenues ratably over the
period in which the customer benefits from the license/distribution agreement.
To
date,
we have not received any upfront license payments that are separable under
EITF
00-21. Accordingly, such license revenues have been combined with other
elements, such as research and development activities, for purposes of revenue
recognition. For instance, we account for the license fees and milestone
payments under the Distribution Agreement with Senko as a single unit of
accounting. Similarly, we have attributed the upfront fees received under
the
arrangements with Olympus Corporation, a related party, to a combined unit
of
accounting comprising a license we granted to Olympus-Cytori, Inc. (the “Joint
Venture”), a related party, as well as development services we agreed to perform
for this entity.
In
the
first quarter of 2006, we granted Olympus an exclusive right to negotiate
a
commercialization collaboration for the use of adipose stem and regenerative
cells for a specific therapeutic area outside of cardiovascular disease.
In
exchange for this right, we received $1,500,000 from Olympus, which is
non-refundable but may be applied towards any definitive commercial
collaboration in the future. As part of this agreement, Olympus will conduct
market research and pilot clinical studies in collaboration with us over
a 12 to
18 month period for the therapeutic area. The $1,500,000 payment was received
in
the second quarter of 2006 and recorded as deferred revenues, related party.
The
deferred revenues, related party, will be recognized as revenue in the statement
of operations either (i) in connection with other consideration received
as part
of a definitive commercial collaboration in the future, or (ii) when the
exclusive negotiation period expires.
In
the
third quarter of 2004, we entered into a Distribution Agreement with Senko.
Under this agreement, we granted to Senko an exclusive license to sell and
distribute certain Thin Film products in Japan and received a $1,500,000
upfront
license fee from them in return for this right. We have recorded the $1,500,000
received as a component of deferred revenues in the accompanying balance
sheet.
Half of the license fee is refundable if the parties agree commercialization
is
not achievable and a proportional amount is refundable if we terminate the
arrangement, other than for material breach by Senko, before three years
post-commercialization.
Research
and Development
We
earn
revenue for performing tasks under research and development agreements with
both
commercial enterprises, such as Olympus and Senko, and governmental agencies
like the National Institutes of Health (“NIH”). Revenue earned under development
agreements is classified as either research grant or development revenues
in our
statements of operations, depending on the nature of the arrangement. The
costs
associated with earning these revenues are typically recorded as research
and
development expense.
We
received a total of $22,000,000 from Olympus and Olympus-Cytori, Inc. during
2005 in two separate but related transactions (see note 13). Approximately
$4,689,000 of this amount related to common stock that we issued, as well
as two
options we granted, to Olympus. Moreover, during the first quarter of 2006,
we
received $11,000,000 from the Joint Venture upon achieving the CE Mark on
the
Celution™ System. Considering the $4,689,000 initially allocated to the common
stock issued and the two options, we recorded upfront fees totaling $28,311,000
as deferred revenues, related party. In exchange for these proceeds, we agreed
to (a) provide Olympus-Cytori, Inc. an exclusive and perpetual license to
our
therapeutic device technology, including the Celution™ System and certain
related intellectual property, and (b) perform future development services
related to commercializing the Celution™ System (see note 13). As noted above,
the license and development services are not separable under EITF 00-21.
Accordingly, we will recognize the $28,311,000 allocated to deferred revenues,
related party, using a proportional performance methodology, that is, as
we
complete substantive milestones related to the development component of the
combined accounting unit. As of March 31, 2007, we have recognized $5,905,000
of
the deferred revenues, related party as development revenues. All related
development costs are expensed as incurred and are included in research and
development expense on the statement of operations. No milestones were met
related to the future development services during the first quarter of 2007
and
therefore, no revenues were recognized.
In
the
third quarter of 2004, we entered into a Distribution Agreement with Senko.
Under this agreement, we granted to Senko an exclusive license to sell and
distribute certain Thin Film products in Japan. We have also earned or will
be
entitled to earn additional payments under the Distribution Agreement based
on
achieving the following defined research and development
milestones:
| · |
In
2004, we received a non-refundable payment of $1,250,000 from Senko
after
filing an initial regulatory application with the Japanese Ministry
of
Health, Labour and Welfare (“MHLW”) related to the Thin Film product line.
We initially recorded this payment as deferred revenues of
$1,250,000.
|
| · |
Upon
the achievement of commercialization (i.e., regulatory approval by
the
MHLW), we will be entitled to an additional nonrefundable payment
of
$250,000.
|
Of
the
amounts received and deferred, we recognized development revenues of $0 and
$142,000 in the three months ended March 31, 2007 and 2006, respectively,
representing the fair value of the completed milestones relative to the fair
value of the total efforts expected to be necessary to achieve regulatory
approval by the MHLW. As noted above, the license and the milestone components
of the Senko Distribution Agreement are accounted for as a single unit of
accounting. This single element includes a $1,500,000 license fee which is
potentially refundable. We have recognized, and will continue to recognize,
the
non-contingent fees allocated to this combined deliverable as we complete
performance obligations under the Distribution Agreement with Senko.
Accordingly, we expect to recognize approximately $1,139,000 (consisting
of
$889,000 in deferred revenues plus a non-refundable payment of $250,000 to
be
received upon commercialization) in revenues associated with this milestone
arrangement in 2007. We will not recognize the potentially refundable portion
of
the fees until the right of refund expires.
|
7.
|
Long-Lived
Assets
|
In
accordance with SFAS No. 144, “Accounting for Impairment or Disposal of
Long-Lived Assets,” we assess certain long-lived assets, such as property and
equipment and intangible assets other than goodwill, for potential impairment
when there is a change in circumstances that indicates carrying values of
assets
may not be recoverable. Such long-lived assets are deemed to be impaired
when
the undiscounted cash flows expected to be generated by the asset (or asset
group) are less than the asset’s carrying amount. Any required impairment loss
would be measured as the amount by which the asset’s carrying value exceeds its
fair value, and would be recorded as a reduction in the carrying value of
the
related asset and a charge to operating expense. During the three months
ended
March 31, 2007 and 2006, we had no impairment losses associated with our
long-lived assets.
|
8.
|
Share-Based
Compensation
|
During
the first quarter of 2007, we issued to our officers and directors stock
options
to purchase up to 410,000 shares of our common stock, with 48-month vesting
for
our officers and 24-month vesting for our directors. The grant date fair
value
of option awards granted to our officers and directors was $3.82 and $3.70
per
share, respectively. The resulting share-based compensation expense of
$1,480,000, net of estimated forfeitures, will be recognized as expense over
the
respective vesting period.
|
9.
|
Income
Taxes
|
On
July
13, 2006, the Financial Accounting Standards Board (“FASB”) issued Financial
Interpretation No. 48 (“FIN 48”), “Accounting for Uncertainty in Income Taxes -
An Interpretation of FASB Statement No. 109.” FIN 48 clarifies the accounting
for uncertainty in income taxes recognized in an entity’s financial statements
in accordance with SFAS No. 109 (“SFAS 109”), “Accounting for Income Taxes,” and
prescribes a recognition threshold and measurement attributes for financial
statement disclosure of tax positions taken or expected to be taken on a
tax
return. Under FIN 48, the impact of an uncertain income tax position on the
income tax return must be recognized at the largest amount that is
more-likely-than-not to be sustained upon audit by the relevant taxing
authority. An uncertain income tax position will not be recognized if it
has
less than a 50% likelihood of being sustained. Additionally, FIN 48 provides
guidance on derecognition, classification, interest and penalties, accounting
in
interim periods, disclosure, and transition. FIN 48 is effective for fiscal
years beginning after December 15, 2006.
We
adopted the provisions of FIN 48 on January 1, 2007. There were no unrecognized
tax benefits as of the date of adoption. As a result of the implementation
of
FIN 48, we did not recognize an increase in the liability for unrecognized
tax
benefits. There are no unrecognized tax benefits included in the balance
sheet
that would, if recognized, affect the effective tax rate.
Our
practice is to recognize interest and/or penalties related to income tax
matters
in income tax expense. We had $0 accrued for interest and penalties on our
balance sheet as of March 31, 2007 and December 31, 2006, and have recognized
$0
in interest and/or penalties in our statement of operations for the first
quarter of 2007.
With
limited exception, we are subject to taxation in the U.S. and California
jurisdictions. Our tax years for 1997 and forward are subject to examination
by
the U.S. and California tax authorities due to the carryforward of unutilized
net operating losses and research and development credits.
The
adoption of FIN No. 48 did not impact our financial condition, results of
operations, or cash flows. At January 1, 2007, we had net deferred tax assets
of
$38,505,000. The deferred tax assets are primarily composed of federal and
state
tax net operating loss carryforwards and federal and state research and
development (“R&D”) credit carryforwards. Due to uncertainties surrounding
our ability to generate future taxable income to realize these assets, a
full
valuation allowance has been established to offset our deferred tax asset.
Additionally, the future utilization of our net operating loss and R&D
credit carryforwards to offset future taxable income may be subject to a
substantial annual limitation as a result of ownership changes that may have
occurred previously or that could occur in the future. We are in the process
of
updating our Section 382/383 analysis through the period ending December
31,
2006. We have not yet determined whether such an ownership change has occurred,
however, the Company is currently working to complete a Section 382/383 analysis
regarding the limitation of the net operating losses and research and
development credits. Similarly, we plan to complete an R&D credit analysis
regarding the calculation of the R&D credit. When these analyses are
completed, we plan to update our unrecognized tax benefits under FIN No.
48.
Therefore, we expect that the unrecognized tax benefits may change within
12
months of this reporting date. At this time, we cannot estimate how much
the
unrecognized tax benefits may change. Due to the existence of the
valuation allowance, future changes in our unrecognized tax benefits will
not impact our effective tax rate.
|
10.
|
Loss
per Share
|
We
compute loss per share based on the provisions of SFAS No. 128, “Earnings per
Share.” Basic per share data is computed by dividing net income or loss
available to common stockholders by the weighted average number of common
shares
outstanding during the period. Diluted per share data is computed by dividing
net income or loss available to common stockholders by the weighted average
number of common shares outstanding during the period increased to include,
if
dilutive, the number of additional common share equivalents that would have
been
outstanding if potential common shares had been issued using the treasury
stock
method. Potential common shares were related entirely to outstanding but
unexercised options for all periods presented.
We
have
excluded all potentially dilutive securities from the calculation of diluted
loss per share attributable to common stockholders for the first quarter
ended
March 31, 2007 and 2006, as their inclusion would be antidilutive. Potentially
dilutive common shares excluded from the calculations of diluted loss per
share
were 6,284,764 and 8,249,001 for the first quarter of 2007 and 2006,
respectively.
|
11.
|
Commitments
and Contingencies
|
We
have
entered into agreements, which have provisions for cancellation, with various
clinical research organizations for pre-clinical and clinical development
studies. Under the terms of these agreements, the vendors provide a variety
of
services including conducting pre-clinical development research, enrolling
patients, recruiting patients, monitoring studies, and data analysis. Payments
under these agreements typically include fees for services and reimbursement
of
expenses. The timing of payments due under these agreements is estimated
based
on current schedules of pre-clinical and clinical studies in progress. As
of
March 31, 2007, we have pre-clinical research study obligations of $382,000
(all
of which are expected to be completed within a year) and clinical research
study
obligations of $6,411,000 ($5,220,000 of which are expected to be completed
within a year).
We
are
subject to various claims and contingencies related to legal proceedings.
Due to
their nature, such legal proceedings involve inherent uncertainties including,
but not limited to, court rulings, negotiations between affected parties,
and
governmental actions. Management assesses the probability of loss for such
contingencies and accrues a liability and/or discloses the relevant
circumstances, as appropriate. Management believes that any liability to
us that
may arise as a result of currently pending legal proceedings will not have
a
material adverse effect on our financial condition, liquidity, or results
of
operations as a whole.
Refer
to
note 12 for a discussion of our commitments and contingencies related to
our
interactions with the University of California.
Refer
to
note 13 for a discussion of our commitments and contingencies related to
our
transactions with Olympus, including (a) our obligation to the Joint Venture
in
future periods and (b) certain put and call rights embedded in the arrangements
with Olympus.
|
12.
|
License
Agreement
|
On
October 16, 2001, StemSource, Inc. entered into an exclusive worldwide license
agreement with the Regents of the University of California (“UC”), licensing all
of UC’s rights to certain pending patent applications being prosecuted by UC and
(in part) by the University of Pittsburgh, for the life of these patents,
with
the right of sublicense. The exclusive license relates to an issued patent
(“Patent 6,777,231”) and various pending applications relating to
adipose-derived stem cells. In November 2002, we acquired StemSource, and
the
license agreement was assigned to us.
The
agreement, which was amended and restated in September 2006 to better reflect
our business model, calls for various periodic payments until such time as
we
begin commercial sales of any products utilizing the licensed technology.
Upon
achieving commercial sales of products or services covered by the UC license
agreement, we will be required to pay variable earned royalties based on
the net
sales of products sold. Minimum royalty amounts will increase annually with
a
plateau in the fourth year. In addition, there are certain due diligence
milestones that are required to be reached as a result of the agreement.
Failure
to fulfill these milestones may result in a reduction of or loss of the specific
rights to which the effected milestone relates.
In
connection with the amendment of the agreement in the third quarter of 2006,
we
agreed to issue 100,000 shares of our common stock to UC in the fourth quarter
of 2006. At the time the agreement was reached, our shares were trading at
$4.87
per share. The expense was charged to general and administrative
expense.
Additionally,
we are obligated to reimburse UC for patent prosecution and other legal costs
on
any patent applications contemplated by the agreement. In particular, the
University of Pittsburgh filed a lawsuit in the fourth quarter of 2004, naming
all of the inventors who had not assigned their ownership interest in Patent
6,777,231 to the University of Pittsburgh. It was seeking a determination
that
its assignors, rather than UC’s assignors, are the true inventors of Patent
6,777,231. This lawsuit has subjected us to and could continue to subject
us to
significant costs and, if the University of Pittsburgh wins the lawsuit,
our
license rights to this patent could be nullified or rendered non-exclusive
with
respect to any third party that might license rights from the University
of
Pittsburgh. Accordingly, it could have a negative effect on us if the University
of Pittsburgh were to win the lawsuit.
We
are
not named as a party to the lawsuit, but our president, Marc Hedrick, is
one of
the inventors identified on the patent and therefore is a named individual
defendant. We are providing substantial financial and other assistance to
the
defense of the lawsuit.
In
the
three months ended March 31, 2007 and 2006, we expensed $62,000 and $505,000,
respectively, for legal fees related to this license. These expenses have
been
classified as general and administrative expense in the accompanying
consolidated financial statements. We believe that the amount accrued as
of
March 31, 2007 is a reasonable estimate of our liability for the expenses
incurred to date.
|
13.
|
Transactions
with Olympus Corporation
|
Initial
Investment by Olympus Corporation in Cytori
In
the
second quarter of 2005, we entered into a Common Stock Purchase Agreement
(the
“Purchase Agreement”) with Olympus under which we received $11,000,000 in cash
proceeds.
Under
this agreement, we issued 1,100,000 newly issued shares of common stock to
Olympus. In addition, we also granted Olympus an immediately exercisable
option
to acquire 2,200,000 shares of our common stock at $10 per share, which expired
on December 31, 2006. Before its expiration, we accounted for this grant
as a
liability in accordance with EITF 00-19, “Accounting for Derivative Financial
Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock”
because from the date of grant through the expiration, we would have been
required to deliver listed common stock to settle the option shares upon
exercise.
At
the
time we entered into the Purchase Agreement, we estimated the fair value
of the
option liability to be $186,000 based on the following assumptions:
| · |
Contractual
term of 1.67 years,
|
| · |
Risk-free
interest rate of 3.46%, and
|
| · |
Estimated
share-price volatility of 59.7%.
|
The
$11,000,000 in total proceeds we received in the second quarter of 2005 exceeded
the sum of (i) the market value of our stock as well as (ii) the fair value
of
the option at the time we entered into the share purchase agreement. The
$7,811,000 difference between the proceeds received and the fair values of
our
common stock and option liability is recorded as a component of deferred
revenues, related party, in the accompanying balance sheet.
In
August
2006, we received an additional $11,000,000 from Olympus for the issuance
of
approximately 1,900,000 shares of our common stock at $5.75 per share under
the
shelf registration statement filed in May 2006. The purchase price was
determined by our closing price on August 9, 2006.
As
of
March 31, 2007, Olympus holds approximately 13.36% of our issued and outstanding
shares. Additionally, Olympus has a right, which it has not yet exercised,
to
designate a director to serve on our Board of Directors.
Formation
of the Olympus-Cytori Joint Venture
On
November 4, 2005, we entered into a joint venture and other related agreements
(the “Joint Venture Agreements”) with Olympus. The Joint Venture is owned
equally by Olympus and us.
Under
the
Joint Venture Agreements:
| · |
Olympus
paid $30,000,000 for its 50% interest in the Joint Venture. Moreover,
Olympus simultaneously entered into a License/Joint Development Agreement
with the Joint Venture and us to develop a second generation commercial
system and manufacturing capabilities.
|
| · |
We
licensed our device technology, including the Celution™ System and certain
related intellectual property, to the Joint Venture for use in future
generation devices. These devices will process and purify adult stem
and
regenerative cells residing in adipose tissue for various therapeutic
clinical applications. In exchange for this license, we received
a 50%
interest in the Joint Venture, as well as an initial $11,000,000
payment
from the Joint Venture; the source of this payment was the $30,000,000
contributed to the Joint Venture by Olympus. Moreover, upon receipt
of a
CE Mark for the first generation Celution™ System in January 2006, we
received an additional $11,000,000 development milestone payment
from the
Joint Venture.
|
We
have
determined that the Joint Venture is a variable interest entity (“VIE”) pursuant
to FASB Interpretation No. 46 (revised 2003), “Consolidation of Variable
Interest Entities - An Interpretation of ARB No. 51” (“FIN 46R”), but that
Cytori is not the VIE’s primary beneficiary. Accordingly, we have accounted for
our interests in the Joint Venture using the equity method of accounting,
since
we can exert significant influence over the Joint Venture’s operations. At March
31, 2007, the carrying value of our investment in the Joint Venture is $74,000.
We
are
under no obligation to provide additional funding to the Joint Venture, but
may
choose to do so. In the first quarter of 2006, we contributed $150,000 to
the
Joint Venture.
Put/Calls
and Guarantees
The
Shareholders’ Agreement between Cytori and Olympus provides that in certain
specified circumstances of insolvency or if we experience a change in control,
Olympus will have the rights to (i) repurchase our interests in the Joint
Venture at the fair value of such interests or (ii) sell its own interests
in
the Joint Venture to Cytori at the higher of (a) $22,000,000 or (b) the Put’s
fair value.
As
of
November 4, 2005, the fair value of the Put was determined to be $1,500,000.
At
March 31, 2007 and December 31, 2006, the fair value of the Put was $1,100,000
and $900,000, respectively. Fluctuations in the Put value are recorded in
the
statements of operations as a component of change in fair value of option
liabilities. The Put itself, which is perpetual, has been recorded as a
long-term liability in the caption Option liability in the balance
sheet.
The
valuations of the Put were completed by an independent valuation firm using
an
option pricing theory-based simulation analysis (i.e., a Monte Carlo
simulation). The valuations are based on assumptions as of the valuation
date
with regard to the market value of Cytori and the estimated fair value of
the
Joint Venture, the expected correlation between the values of Cytori and
the
Joint Venture, the expected volatility of Cytori and the Joint Venture, the
bankruptcy recovery rate for Cytori, the bankruptcy threshold for Cytori,
the
probability of a change of control event for Cytori, and the risk-free interest
rate.
The
following assumptions were employed in estimating the value of the
Put:
|
March
31, 2007
|
December
31, 2006
|
November
4, 2005
|
||||||||
|
Expected
volatility of Cytori
|
63.00
|
%
|
66.00
|
%
|
63.20
|
%
|
||||
|
Expected
volatility of the Joint Venture
|
63.00
|
%
|
56.60
|
%
|
69.10
|
%
|
||||
|
Bankruptcy
recovery rate for Cytori
|
21.00
|
%
|
21.00
|
%
|
21.00
|
%
|
||||
|
Bankruptcy
threshold for Cytori
|
$
|
10,660,000
|
$
|
10,110,000
|
$
|
10,780,000
|
||||
|
Probability
of a change of control event for Cytori
|
2.23
|
%
|
1.94
|
%
|
3.04
|
%
|
||||
|
Expected
correlation between fair values of Cytori and the Joint Venture
in the
future
|
99.00
|
%
|
99.00
|
%
|
99.00
|
%
|
||||
|
Risk-free
interest rate
|
4.65
|
%
|
4.71
|
%
|
4.66
|
%
|
||||
The
Put
has no expiration date. Accordingly, we will continue to recognize a liability
for the Put and mark it to market each quarter until it is exercised or until
the arrangements with Olympus are amended.
Olympus-Cytori
Joint Venture
The
Joint
Venture has exclusive access to our technology for the development, manufacture,
and supply of the devices (second generation and beyond) for all therapeutic
applications. Once a second generation Celution™ System is developed and
approved by regulatory agencies, the Joint Venture may sell such systems
exclusively to us at a formula-based transfer price; we have retained marketing
rights to the second generation devices for all therapeutic applications
of
adipose stem and regenerative cells.
As
part
of the various agreements with Olympus, we will be required, following
commercialization of the Celution™ System, to provide monthly forecasts to the
Joint Venture specifying the quantities of each category of devices that
we
intend to purchase over a rolling six-month period. Although we are not subject
to any minimum purchase requirements, we are obliged to buy a minimum percentage
of the products forecasted by us in such reports. Since we can effectively
control the number of devices we will agree to purchase and because no
commercial devices have yet been developed to trigger the forecast requirement,
we estimate that the fair value of this guarantee is de minimis as of March
31,
2007.
Deferred
revenues, related party
As
of
March 31, 2007, the deferred revenues, related party account primarily consists
of the consideration we have received in exchange for future services that
we
have agreed to perform on behalf of Olympus and the Joint Venture. These
services include completing pre-clinical and clinical studies, product
development and seeking regulatory approval for the treatment of various
therapeutic conditions with adult stem and regenerative cells residing in
adipose tissue. These services also include providing an exclusive and perpetual
license to our device technology, including the Celution™ System and certain
related intellectual property.
Pursuant
to EITF 00-21, we have concluded that the license and development services
must
be accounted for as a single unit of accounting. Refer to note 6 for a full
description of our revenue recognition policy.
|
14.
|
Common
Stock and Warrant Offering
|
In
February 2007, we completed a registered direct public offering of units
consisting of common stock and warrants. We received net proceeds of $19,901,000
from the sale of units consisting of 3,746,000 shares of common stock and
1,873,000 common stock warrants (with an exercise price of $6.25 per share
and a
five-year exercisability period) under our shelf registration
statement.
|
15.
|
Subsequent
Event
|
In
March
2007, we entered into a Common Stock Purchase Agreement to sell 1,000,000
shares
of unregistered common stock to Green Hospital Supply, Inc. for $6,000,000
cash.
We agreed to seek Securities and Exchange Commission registration of the
shares
for resale if so requested. The closing of the purchase and sale of the shares
occurred on April 12, 2007.
Item
2. Management’s Discussion and Analysis of Financial Condition and
Results of Operations
CAUTIONARY
STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
This
report contains certain statements that may be deemed “forward-looking
statements” within the meaning of United States of America securities laws. All
statements, other than statements of historical fact, that address activities,
events or developments that we intend, expect, project, believe or anticipate
will or may occur in the future are forward-looking statements. Such statements
are based upon certain assumptions and assessments made by our management
in
light of their experience and their perception of historical trends, current
conditions, expected future developments and other factors they believe to
be
appropriate. The forward-looking statements included in this report are also
subject to a number of material risks and uncertainties, including but not
limited to the risks described under the “Risk Factors” section in Part II
below.
We
encourage you to read those descriptions carefully. We caution you not to
place
undue reliance on the forward-looking statements contained in this report.
These
statements, like all statements in this report, speak only as of the date
of
this report (unless an earlier date is indicated) and we undertake no obligation
to update or revise the statements except as required by law. Such
forward-looking statements are not guarantees of future performance and actual
results will likely differ, perhaps materially, from those suggested by such
forward-looking statements.
Overview
Regenerative
Cell Technology
Cytori
is
developing the Celution™ System, an innovative medical device that removes a
patient's own stem and regenerative cells from their fat tissue so that these
cells can be delivered to the same patient in about an hour. The
commercialization model will be based on the sale of the system and related
single-use therapeutic sets that are tailored to each therapeutic application.
We are focused initially on bringing applications to market for reconstructive
surgery and cardiovascular disease. Success is dependent on conducting
well-designed clinical trials that demonstrate patient benefit and support
reimbursement and physician adoption, gaining regulatory clearance for the
Celution™ System, and building out our commercialization and manufacturing
infrastructure.
The
Celution™ System may potentially be applied to other important therapeutic
areas, which include gastrointestinal disorders, peripheral vascular disease,
spinal disc repair, renal failure, and urinary incontinence. For this reason,
a
significant part of our strategy is to seek commercialization partnerships
with
medical device or pharmaceutical companies that possess development expertise
and have sales forces dedicated to specific therapeutic areas. The goal is
to
broaden the number of applications for which the Celution™ System may be sold,
accelerate the development of applications outside of our core expertise,
and
bring in capital through partnering agreements that will offset development
costs of reconstructive surgery and cardiovascular disease applications.
Breast
Reconstruction
During
the first quarter of 2007, we continued to make progress toward commercializing
the Celution™ System in Europe in early 2008 for reconstructive surgery. This is
the first therapeutic application for which we will commercialize the Celution™
System. In February, we entered into an agreement with our first distributor,
who will be responsible for selling the system in Italy, Spain, and Portugal.
We
expect to add distributors for other countries throughout Europe during 2007
to
further build out the distribution network. In parallel, we are building
out our
internal manufacturing capabilities so that we will be able to meet anticipated
demand in 2008 until the Olympus-Cytori Joint Venture, described below, will
assume device manufacturing.
Also,
this year we will initiate a company-sponsored clinical study to evaluate
efficacy in breast reconstruction following partial mastectomy. The results
of
this study are intended to primarily support reimbursement for the product
as
used in this procedure as well as allow us to market the Celution™ System
specifically for this application, which represents a narrow subset of the
reconstructive surgery market. In Europe, there are 300,000 patients diagnosed
with breast cancer each year and an estimated 60% are considered eligible
for a
partial mastectomy. Approximately 3 million women in Europe alive today have
already been diagnosed with breast cancer. This includes women who are newly
diagnosed, in active treatment, have completed active treatment, and those
living with progressive symptoms of their disease.
Cardiovascular
Disease
In
January of 2007, we started a clinical trial for chronic ischemia, a severe
form
of coronary artery disease. It is a 36-patient safety and feasibility study
evaluating adipose stem and regenerative cells as a treatment for chronic
ischemia. The patients’ cells are extracted from their adipose tissue using the
Celution™ System, and then injected into the injured oxygen-deprived areas of
their hearts through a specially designed catheter. The patients will be
evaluated for six months after treatment. The study is being conducted at
Gregorio Marañón Hospital in Madrid, Spain and led by Drs. Francisco J.
Fernández-Avilés and Emerson Perin. Enrollment for this trial remains on track
and full results are expected to be reported in the second half of
2008.
We
expect
to start a clinical trial in heart attack patients in the second quarter
of
2007. This trial will be a 48-patient safety and feasibility study to evaluate
adipose stem and regenerative cells as a treatment for heart attacks. The
patients’ cells will be extracted from their adipose tissue using the Celution™
System and injected into their coronary artery. The patients will be evaluated
six months after treatment. Full results are expected to be reported in the
fourth quarter of 2008. The study will be conducted at Thoraxcenter, Erasmus
Medical Center Hospital in Rotterdam, the Netherlands, and is being led by
Dr.
Patrick Serruys.
The
American Heart Association estimates that in the United States of America
alone,
there are approximately 1.2 million heart attacks each year and more than
5.2
million people suffer from a form of chronic heart disease. Given the size
of
this market and the pre-clinical data demonstrating functional improvement,
cardiovascular disease represents a very important application for our Celution™
System and we believe that outcome of the clinical data from these safety
and
feasibility studies could have a significant impact on our future operations.
Olympus
Partnership
On
November 4, 2005, we entered into a strategic development and manufacturing
joint venture agreement and other related agreements (“JV Agreements”) with
Olympus Corporation (“Olympus”). As part of the terms of the JV Agreements, we
formed a joint venture, Olympus-Cytori, Inc. (the “Joint Venture”), to develop
and manufacture future generation devices based on our Celution™ System.
Under
the
Joint Venture Agreements:
| · |
Olympus
paid $30,000,000 for its 50% interest in the Joint Venture. Moreover,
Olympus simultaneously entered into a License/Joint Development Agreement
with the Joint Venture and us to develop a second generation commercial
system and manufacturing capabilities.
|
| · |
We
licensed our device technology, including the Celution™ System and certain
related intellectual property, to the Joint Venture for use in future
generation devices. These devices will process and purify adult stem
and
regenerative cells residing in adipose tissue for various therapeutic
clinical applications. In exchange for this license, we received
a 50%
interest in the Joint Venture, as well as an initial $11,000,000
payment
from the Joint Venture; the source of this payment was the $30,000,000
contributed to the Joint Venture by Olympus. Moreover, upon receipt
of a
CE Mark for the first generation Celution™ System in January 2006, we
received an additional $11,000,000 development milestone payment
from the
Joint Venture.
|
Put/Calls
and Guarantees
The
Shareholders’ Agreement between Cytori and Olympus provides that in certain
specified circumstances of insolvency or if we experience a change in control,
Olympus will have the rights to (i) repurchase our interests in the Joint
Venture at the fair value of such interests or (ii) sell its own interests
in
the Joint Venture to Cytori at the higher of (a) $22,000,000 or (b) the Put’s
fair value.
The
Put
has no expiration date. Accordingly, we will continue to recognize a liability
for the Put and mark it to market each quarter until it is exercised or until
the arrangements with Olympus are amended.
Olympus-Cytori
Joint Venture
The
Joint
Venture has exclusive access to our technology for the development, manufacture,
and supply of the devices (second generation and beyond) for all therapeutic
applications. Once a second generation Celution™ System is developed and
approved by regulatory agencies, the Joint Venture may sell such systems
exclusively to us at a formula-based transfer price; we have retained marketing
rights to the second generation devices for all therapeutic applications
of
adipose stem and regenerative cells.
In
2006,
we worked closely with Olympus’ team of scientists and engineers to design
future generations of the Celution™ System that contain certain product
enhancements and that can be manufactured in a streamlined manner. For the
remainder of 2007, the Joint Venture will continue its efforts with the goal
of
scale-up manufacturing available in late 2008.
Other
Related-Party Transactions
In
a
separate agreement entered into on February 23, 2006, we granted Olympus
an
exclusive right to negotiate commercialization collaboration for the use
of
adipose stem and regenerative cells for a specific therapeutic area outside
of
cardiovascular disease. In exchange for this right, we received a $1.5 million
payment from Olympus. As part of this agreement, Olympus will conduct market
research and pilot clinical studies in collaboration with us over a 12 to
18
month period for the therapeutic area.
In
the
third quarter of 2006, we received net proceeds of $16,219,000 from the sale
of
common stock pursuant to a shelf registration statement, of which Olympus
purchased $11,000,000.
MacroPore
Biosurgery
Spine
and orthopedic products
We
manufacture bioresorbable implants used in spine and orthopedic procedures.
Medtronic is the sole distributor of these products but due to a substantial
decrease in their orders of this product, we experienced losses for our
MacroPore Biosurgery segment for the first quarter of 2007 and are actively
pursuing a buyer (or buyers) for this line of business.
Thin
Film Japan Distribution Agreement
In
2004,
we sold the majority of our Thin Film business to MAST, Biosurgery, AG (“MAST”).
Even
after consummation of the 2004 Thin Film asset sale to MAST, we retained
all
rights to Thin Film business in Japan (subject to a purchase option of MAST,
as
described later below), and we received back from MAST a license of all rights
to Thin Film technologies in the:
| · |
Spinal
field, exclusive at least until 2012, and
|
| · |
Field
of regenerative medicine, non-exclusive on a perpetual
basis.
|
In
the
third quarter of 2004, we entered into a Distribution Agreement with Senko.
Under this agreement, we granted to Senko an exclusive license to sell and
distribute certain Thin Film products in Japan. Specifically, the license
covers
Thin Film products with the following indications:
| · |
Anti-adhesion,
|
| · |
Soft
tissue support, and
|
| · |
Minimization
of the attachment of soft tissues.
|
The
Distribution Agreement with Senko commences upon “commercialization.” In
simplest terms, commercialization occurs when one or more Thin Film product
registrations are completed with the Japanese Ministry of Health, Labour
and
Welfare (“MHLW”).
Following
commercialization, the Distribution Agreement has a duration of five years
and
is renewable for an additional five years after reaching mutually agreed
minimum
purchase guarantees.
We
received a $1,500,000 upfront license fee from Senko. We have recorded the
$1,500,000 received as a component of deferred revenues in the accompanying
balance sheet. Half of the license fee is refundable if the parties agree
commercialization is not achievable and a proportional amount is refundable
if
we terminate the arrangement, other than for material breach by Senko, before
three years post-commercialization.
Under
the
Distribution Agreement, we will also be entitled to earn additional payments
from Senko based on achieving defined milestones. On September 28, 2004,
we
notified Senko of completion of the initial regulatory application to the
MHLW
for the Thin Film product. As a result, we became entitled to a nonrefundable
payment of $1,250,000, which we received in October 2004 and recorded as
a
component of deferred revenues. We recognized $0 and $142,000 in development
revenues in the first quarter of 2007 and 2006, respectively.
The
previously mentioned 2004 sale agreement granted MAST a “Purchase Right” to
acquire, at any time before May 31, 2007, our Thin Film-related interests
and
rights for Japan. If MAST chooses to exercise the Purchase Right between
now and
May 31, 2007, the exercise price of the Purchase Right will be equal to the
fair
market value of the Japanese business, but in no event will be less than
$3,000,000. Moreover, until May 31, 2007, MAST has a right of first refusal
to
match the terms of any outside offer to buy our Japanese Thin Film
business.
Liquidity
As
our
regenerative cell technology business is still in the development stage and
requires large amounts of cash, it is important that we maintain sufficient
liquidity to support our future cash needs. We ended the first quarter of
2007
with $21.7 million in cash and cash equivalents, which included approximately
$20 million that was raised from an equity offering in February 2007, net
of
fees and expenses. After the end of the quarter, we received $6.0 million
from
the sale of 1.0 million shares to Green Hospital Supply, Inc. under a strategic
equity agreement.
Results
of Operations
The
net
loss for the first quarter of 2007 was $8.7 million, which consists of $5.0
million in research and development expenses and $3.2 million in general
and
administrative expenses. This compares to a net loss of $7.5 million in the
first quarter of 2006. The increased net loss for the first quarter of 2007
reflects expenses related to preparations for commercialization, including
build-out of our manufacturing capability, as well as costs associated with
clinical trials. We believe that our operating losses will be greater in
the
first half of the year and continue to expect our net operating loss for
2007
will be approximately $25 million.
Product
revenues
Product
revenues relate to our MacroPore Biosurgery segment and include revenues
from
our spine and orthopedic products. The following table summarizes the components
for the three months ended March 31, 2007 and 2006:
|
For
the three months ended March 31,
|
|||||||||||||
|
2007
|
2006
|
$
Differences
|
%
Differences
|
||||||||||
|
Spine
and orthopedics products
|
$
|
280,000
|
$
|
502,000
|
$
|
(222,000
|
)
|
(44.2
|
)%
|
||||
|
%
attributable to Medtronic
|
100
|
%
|
100
|
%
|
|||||||||
Spine
and
orthopedic product revenues represent sales of bioresorbable implants used
in
spine and orthopedic surgical procedures. These revenues were primarily related
to orders during the three months ended March 31, 2007 for our radiographically
identifiable Spine System products, marketed under the name MYSTIQUE™, which
Medtronic, our sole distributor of spine and orthopedic products, launched
in
the third quarter of 2005. Subsequent to the product launch, Medtronic has
substantially decreased its orders of this product. We experienced losses
for
our MacroPore Biosurgery segment for the three months ended March 31,
2007.
Note
that
Medtronic owns approximately 4.43% of our outstanding common stock as of
March
31, 2007.
The
future.
Our
revenue from spine and orthopedic products is dependent upon the market’s
adoption of our technology, which is largely dependent upon Medtronic’s
marketing efforts and pricing strategies. Therefore our visibility of the
size
and timing of HYDROSORB™ and MYSTIQUE™ orders is limited. Since we rely on
Medtronic’s ability and commitment to build and expand the market share for our
products and we have been disappointed in the past by their effort at such,
it
is possible that we will not receive more than minimal orders for the MYSTIQUE™
portion of the HYDROSORB™ product line during the remainder of 2007. Since it is
unlikely that we will see significant sales of the current non-MYSTIQUE™
products any time in the future, it is likely that we will see losses in
our
Medtronic-dependent MacroPore Biosurgery business going forward. We have
decided
to divest this business line and are actively pursuing a buyer (or buyers)
for
this business line.
All
product revenues are currently attributable to Medtronic as domestic Thin
Film
revenues ceased in 2004. This may change when commercialization of the Thin
Film
products in Japan occurs and we begin Thin Film shipments to Senko, which
we
believe will happen in the latter part of 2007.
Cost
of product revenues
Cost
of
product revenues relates to spine and orthopedic products in our MacroPore
Biosurgery segment and includes material, manufacturing labor, overhead costs,
and an inventory provision, if applicable. The following table summarizes
the
components of our cost of revenues for the three months ended March 31, 2007
and
2006:
|
For
the three months ended March 31,
|
|||||||||||||
|
2007
|
2006
|
$
Differences
|
%
Differences
|
||||||||||
|
Cost
of product revenues
|
$
|
215,000
|
$
|
428,000
|
$
|
(213,000
|
)
|
(49.8
|
)%
|
||||
|
Share-based
compensation
|
10,000
|
26,000
|
(16,000
|
)
|
(61.5
|
)%
|
|||||||
|
Total
cost of product revenues
|
$
|
225,000
|
$
|
454,000
|
(229,000
|
)
|
(50.4
|
)%
|
|||||
|
Total
cost of product revenues as % of product revenues
|
80.4
|
%
|
90.4
|
%
|
|||||||||
MacroPore
Biosurgery:
|
·
|
Our
product revenues are currently generated only through sales of
bioresorbable products and therefore, cost of revenues is related
only to
our MacroPore Biosurgery segment.
|
|
·
|
The
decrease in cost for the three months ended March 31, 2007 as compared
to
the same period in 2006 was due to a decrease in production of
MacroPore
Biosurgery products. This was, however, partially offset by fixed
labor
and overhead costs that were incurred regardless of the level of
production. As MacroPore Biosurgery product revenues have declined,
gross
margins have been negatively affected by fixed costs.
|
|
·
|
Cost
of product revenues includes approximately $10,000 and $26,000
of
share-based compensation expense for the three months ended March
31, 2007
and 2006, respectively. For further details, see share-based compensation
discussion below.
|
The
future.
Ceasing
to manufacture the Craniomaxillofacial (“CMF”) product line and the non-Japan
bioresorbable Thin Film product line, combined with the poor rate of orders
from
Medtronic, deprives us of economies of scale and has and will continue to
negatively impact our margins. We do not expect demand for our HYDROSORB™
MYSTIQUE™ products, which depends largely on Medtronic’s marketing efforts, to
increase in the future.
In
an
effort to reduce overhead costs related to the MacroPore Biosurgery segment,
we
have accelerated termination of two of our building leases. As a result,
one of
our leases terminated in April 2007 and we will be renting only a small portion
of the other building during the first half of 2007.
As
mentioned above, it appears that the spine and orthopedics business is not
succeeding under our stewardship. As a result, our Board of Directors has
decided to divest and is actively pursuing a buyer (or buyers) for these
assets.
Development
revenues
The
following table summarizes the components of our development revenues for
the
three months ended March 31, 2007 and 2006:
|
For
the three months ended March 31,
|
|||||||||||||
|
2007
|
2006
|
$
Differences
|
%
Differences
|
||||||||||
|
Regenerative
cell technology:
|
|||||||||||||
|
Development
(Olympus)
|
$
|
—
|
$
|
683,000
|
$
|
(683,000
|
)
|
—
|
|||||
|
Research
grant (NIH)
|
—
|
4,000
|
(4,000
|
)
|
—
|
||||||||
|
Regenerative
cell storage services and other
|
45,000
|
1,000
|
44,000
|
4,400.0
|
%
|
||||||||
|
Total
regenerative cell technology
|
45,000
|
688,000
|
(643,000
|
)
|
(93.5
|
)%
|
|||||||
|
MacroPore
Biosurgery:
|
|||||||||||||
|
Development
(Senko)
|
—
|
142,000
|
(142,000
|
)
|
—
|
||||||||
|
Total
development revenues
|
$
|
45,000
|
$
|
830,000
|
$
|
(785,000
|
)
|
(94.6
|
)%
|
||||
Regenerative
cell technology:
|
·
|
We
recognize deferred revenues, related party, as development revenue
when
certain performance obligations are met (i.e., using a proportional
performance approach). During the three months ended March 31,
2007 and
2006, we recognized $0 and $683,000, respectively, of revenue associated
with our arrangements with Olympus. The revenue recognized in the
first
quarter of 2006 was a result of completion of a pre-clinical study
and a
milestone payment upon receipt of a CE Mark for the first generation
Celution™ System.
|
|
·
|
The
research grant revenue relates to an agreement with NIH. Under
this
arrangement, the NIH reimburses us for “qualifying expenditures” related
to research on Adipose-Derived Cell Therapy for Myocardial Infarction.
To
receive funds under the grant arrangement, we are required to (i)
demonstrate that we incurred “qualifying expenses,” as defined in the
grant agreement between the NIH and us, (ii) maintain a system
of
controls, whereby we can accurately track and report all expenditures
related solely to research on Adipose-Derived Cell Therapy for
Myocardial
Infarction, and (iii) file appropriate forms and follow appropriate
protocols established by the NIH.
|
Our
policy is to recognize revenues under the NIH grant arrangement as the lesser
of
(i) qualifying costs incurred (and not previously recognized), plus our
allowable grant fees for which we are entitled to funding or (ii) the amount
determined by comparing the outputs generated to date versus the total outputs
expected to be achieved under the research arrangement.
We
recorded a total of $4,000 in revenues for the three months ended March 31,
2006, which include allowable grant fees as well as cost reimbursements.
During
the three months ended March 31, 2006, we incurred $4,000 of costs, of which
all
were qualified. Our work under this NIH agreement was completed in 2006;
as a
result, there were no comparable revenues or costs in 2007.
MacroPore
Biosurgery:
Under
a
Distribution Agreement with Senko we are entitled to earn payments based
on
achieving the following defined milestones:
|
·
|
Upon
notifying Senko of completion of the initial regulatory application
to the
MHLW for the Thin Film product, we were entitled to a nonrefundable
payment of $1,250,000. We so notified Senko on September 28, 2004,
received payment in October 2004, and recorded deferred revenues
of
$1,250,000. As of March 31, 2007, of the amount deferred, we have
recognized development revenues of $358,000 ($0 in 2007, $149,000
in 2006,
$51,000 in 2005, and $158,000 in 2004).
|
|
·
|
Under
this agreement, we also received a $1,500,000 license fee that
was
recorded as a component of deferred revenues in the accompanying
balance
sheet. We are also entitled to a nonrefundable payment of $250,000
once we
achieve commercialization. Because the $1,500,000 in license fees
is
potentially refundable, such amounts will not be recognized as
revenues
until the refund rights expire. Specifically, half of the license
fee is
refundable if the parties agree commercialization is not achievable
and a
proportional amount is refundable if we terminate the arrangement,
other
than for material breach by Senko, before three years
post-commercialization.
|
The
future.
We
expect to recognize revenues from our regenerative cell technology segment
during 2007 as we complete certain pre-clinical studies and certain phases
of
our product development performance obligations. If we are successful in
achieving certain milestone points related to these activities, we will
recognize approximately $2,500,000 in revenues during the remainder of 2007.
The
exact timing of when amounts will be reported in revenue will depend on internal
factors (for instance, our ability to complete the service obligations we
have
agreed to perform) as well as external considerations, including obtaining
the
necessary regulatory approvals for various therapeutic applications related
to
the Celution™ System. The cash for these performance obligations was received
when the agreement was signed and no further related cash payments will be
made
to us.
We
will
continue to recognize revenue from the development work we are performing
on
behalf of Senko, based on the relative fair value of the milestones completed
as
compared to the total efforts expected to be necessary to obtain regulatory
clearance from the MHLW. Obtaining regulatory clearance from the MHLW for
initial commercialization is expected in 2007. Accordingly, we expect to
recognize approximately $1,139,000 (consisting of $889,000 in deferred revenues
plus a non-refundable payment of $250,000 to be received upon commercialization)
in revenues associated with this milestone arrangement in 2007. Moreover,
we
expect to recognize $500,000 per year associated with deferred Senko license
fees over a three-year period following commercialization as the refund rights
associated with the license payment expire.
Research
and development expenses
Research
and development expenses include costs associated with the design, development,
testing and enhancement of our products, regulatory fees, the purchase of
laboratory supplies, pre-clinical studies and clinical studies. The following
table summarizes the components of our research and development expenses
for the
three months ended March 31, 2007 and 2006:
|
For
the three months ended March 31,
|
|||||||||||||
|
2007
|
2006
|
$
Differences
|
%
Differences
|
||||||||||
|
Regenerative
cell technology:
|
|||||||||||||
|
Regenerative
cell technology
|
$
|
3,235,000
|
$
|
3,067,000
|
$
|
168,000
|
5.5
|
%
|
|||||
|
Development
milestone (Joint Venture)
|
1,505,000
|
1,353,000
|
152,000
|
11.2
|
%
|
||||||||
|
Research
grants (NIH)
|
—
|
69,000
|
(69,000
|
)
|
—
|
||||||||
|
Share-based
compensation
|
152,000
|
279,000
|
(127,000
|
)
|
(45.5
|
)%
|
|||||||
|
Total
regenerative cell technology
|
4,892,000
|
4,768,000
|
124,000
|
2.6
|
%
|
||||||||
|
MacroPore
Biosurgery:
|
|||||||||||||
|
Bioresorbable
polymer implants
|
102,000
|
317,000
|
(215,000
|
)
|
(67.8
|
)%
|
|||||||
|
Development
milestone (Senko)
|
1,000
|
78,000
|
(77,000
|
)
|
(98.7
|
)%
|
|||||||
|
Share-based
compensation
|
1,000
|
13,000
|
(12,000
|
)
|
(92.3
|
)%
|
|||||||
|
Total
MacroPore Biosurgery
|
104,000
|
408,000
|
(304,000
|
)
|
(74.5
|
)%
|
|||||||
|
Total
research and development expenses
|
$
|
4,996,000
|
$
|
5,176,000
|
$
|
(180,000
|
)
|
(3.5
|
)%
|
||||
Regenerative
cell technology:
|
·
|
Regenerative
cell technology expenses relate to the development of a technology
platform that involves using adipose tissue as a source for autologous
regenerative cells for therapeutic applications. These expenses,
in
conjunction with our continued development efforts related to our
Celution™ System, result primarily from the broad expansion of our
research and development efforts enabled by the funding we received
from
Olympus in 2005 and 2006. Labor-related expenses, not including
share-based compensation, decreased by $52,000 for the three months
ended
March 31, 2007 as compared to the same period in 2006. Professional
services expense, which includes pre-clinical study costs, decreased
by
$210,000 for the three months ended March 31, 2007 as compared
to the same
period in 2006. This was due to decreases in temporary labor and
the use
of consultants. Clinical study costs increased by $194,000 for
the quarter
ended March 31, 2007 as compared to the same period in 2006. Rent
and
utilities expense decreased by $32,000 in the three months ended
March 31,
2007 as compared to 2006 due to the new lease terms at our Top
Gun
location. Other supplies increased by $151,000 during the three
months
ended March 31, 2007 as compared to 2006. Other notable increases
included
an increase in the category of repairs and maintenance of $147,000
and
depreciation expense increases of $14,000 for the three months
ended March
31, 2007, as compared to the same period in 2006.
|
| · |
Expenditures
related to the Joint Venture with Olympus, which are included in
the
variation analysis above, include costs that are necessary to support
the
commercialization of future generation devices based on our Celution™
System. These development activities, which began in November 2005,
include performing pre-clinical and clinical studies, seeking regulatory
approval, and performing product development related to therapeutic
applications for adipose stem and regenerative cells for multiple
large
markets. For the three months ended March 31, 2007 and 2006, costs
associated with the development of the device were $1,505,000 and
$1,353,000, respectively. These expenses were composed of $891,000
and
$699,000 in labor and related benefits, $306,000 and $358,000 in
consulting and other professional services, $190,000 and $225,000
in
supplies and $118,000 and $71,000, respectively, in other miscellaneous
expense.
|
| · |
In
2004, we entered into an agreement with the NIH to reimburse us for
up to
$950,000 (Phase I $100,000 and Phase II $850,000) in “qualifying
expenditures” related to research on Adipose-Derived Cell Therapy for
Myocardial Infarction. For the three months ended March 31, 2006,
we
incurred $69,000 of direct expenses relating entirely to Phase II
($65,000
of which were not reimbursed). Our work under this NIH agreement
was
completed during 2006; as a result, there were no comparable costs
in
2007.
|
| · |
Share-based
compensation for the regenerative cell technology segment of research
and
development was $152,000 and $279,000 for the three months ended
March 31,
2007 and 2006, respectively. See share-based compensation discussion
below
for more details.
|
MacroPore
Biosurgery:
|
·
|
Our
bioresorbable polymer surgical implants platform technology is
used for
development of spine and orthopedic products. The decrease in research
and
development costs associated with bioresorbable polymer implants
for the
three months ended March 31, 2007 as compared with the same period
in 2006
was due primarily to our shift in focus to our regenerative cell
technology segment. Labor and related benefits expense, not including
share-based compensation, decreased by $89,000 for the three months
ended
March 31, 2007, respectively, as compared to the same periods in
2006.
This was due to a redistribution of labor resources from one segment
to
the other as well as a reduction in force in the third quarter
of
2006.
|
|
·
|
Under
a Distribution Agreement with Senko, we are responsible for the
completion
of the initial regulatory application to the MHLW and commercialization
of
the Thin Film product line in Japan. Commercialization occurs when
one or
more Thin Film product registrations are completed with the MHLW.
During
the three months ended March 31, 2007 and 2006, we incurred $1,000
and
$78,000, respectively, of expenses related to this regulatory and
registration process.
|
|
·
|
Share-based
compensation for the MacroPore Biosurgery segment of research and
development for the three months ended March 31, 2007 and 2006
was $1,000
and $13,000, respectively. See share-based compensation discussion
below
for more details.
|
The
future.
Our
strategy is to continue to increase our research and development efforts
in the
regenerative cell field and we anticipate expenditures in this area of research
to total approximately $22,000,000 to $24,000,000 in 2007. We are researching
therapies for cardiovascular disease as well as new approaches for aesthetic
and
reconstructive surgery, gastrointestinal disorders and spine and orthopedic
conditions. The expenditures have and will continue to primarily relate to
developing therapeutic applications and conducting pre-clinical and clinical
studies on adipose-derived stem and regenerative cells.
We
continue to reduce research and development expenditures in the bioresorbable
technology platform. We anticipate minimal further expenditures in this area
of
research in 2007. We are currently pursuing a buyer (or buyers) for this
segment
of our business.
Sales
and marketing expenses
Sales
and
marketing expenses include costs of marketing personnel, tradeshows, and
promotional activities and materials. Medtronic is responsible for the
distribution, marketing, and sales support of our spine and orthopedic devices.
The following table summarizes the components of our sales and marketing
expenses for the three months ended March 31, 2007 and 2006:
|
For
the three months ended March 31,
|
|||||||||||||
|
2007
|
2006
|
$
Differences
|
%
Differences
|
||||||||||
|
Regenerative
cell technology:
|
|||||||||||||
|
International
sales and marketing
|
$
|
434,000
|
$
|
287,000
|
$
|
147,000
|
51.2
|
%
|
|||||
|
Share-based
compensation
|
70,000
|
102,000
|
(32,000
|
)
|
(31.4
|
)%
|
|||||||
|
Total
regenerative cell technology
|
504,000
|
389,000
|
115,000
|
29.6
|
%
|
||||||||
|
MacroPore
Biosurgery:
|
|||||||||||||
|
General
corporate marketing
|
13,000
|
82,000
|
(69,000
|
)
|
(84.1
|
)%
|
|||||||
|
International
sales and marketing
|
29,000
|
23,000
|
6,000
|
26.1
|
%
|
||||||||
|
Share-based
compensation
|
—
|
7,000
|
(7,000
|
)
|
—
|
||||||||
|
Total
MacroPore Biosurgery
|
42,000
|
112,000
|
(70,000
|
)
|
(62.5
|
)%
|
|||||||
|
Total
sales and marketing expenses
|
$
|
546,000
|
$
|
501,000
|
$
|
45,000
|
9.0
|
%
|
|||||
Regenerative
Cell Technology:
|
·
|
International
sales and marketing expenditures for the three months ended March
31, 2007
and 2006 relate primarily to salaries expense for employees involved
in
business development. The main emphasis of these newly-formed functions
is
to seek strategic alliances and/or co-development partners for
our
regenerative cell technology, which we began to focus on in the
third
quarter of 2005.
|
|
·
|
Share-based
compensation for the regenerative cell segment of sales and marketing
for
the three months ended March 31, 2007 and 2006 was $70,000 and
$102,000,
respectively. See share-based compensation discussion below for
more
details.
|
MacroPore
Biosurgery:
|
·
|
General
corporate marketing expenditures relate to expenditures for maintaining
our corporate image and reputation within the research and surgical
communities relevant to bioresorbable implants. Expenditures in
this area
continue to decrease as we focus more on our regenerative cell
technology
business.
|
|
·
|
International
sales and marketing expenditures relate to costs associated with
developing an international bioresorbable Thin Film distributor
and
supporting a bioresorbable Thin Film sales office in Japan.
|
|
·
|
Share-based
compensation for the MacroPore Biosurgery segment of sales and
marketing
for the three months ended March 31, 2007 and 2006 was $0 and $7,000,
respectively. See share-based compensation discussion below for
more
details.
|
The
future.
We
expect sales and marketing expenditures related to the regenerative cell
technology to increase as we continue to expand our pursuit of strategic
alliances and co-development partners, as well as market our Celution™ System,
which is expected to be commercialized in 2008.
General
and administrative expenses
General
and administrative expenses include costs for administrative personnel, legal
and other professional expenses, and general corporate expenses. The following
table summarizes the general and administrative expenses for the three months
ended March 31, 2007 and 2006:
|
For
the three months ended March 31,
|
|||||||||||||
|
2007
|
2006
|
$
Differences
|
%
Differences
|
||||||||||
|
General
and administrative
|
$
|
2,851,000
|
$
|
2,839,000
|
$
|
12,000
|
0.4
|
%
|
|||||
|
Share-based
compensation
|
315,000
|
377,000
|
(62,000
|
)
|
(16.4
|
)%
|
|||||||
|
Total
general and administrative expenses
|
$
|
3,166,000
|
$
|
3,216,000
|
$
|
(50,000
|
)
|
(1.6
|
)%
|
||||
|
·
|
Salaries
and other related benefits (not including share-based compensation)
increased by $140,000 for the three months ended March 31, 2007,
as
compared to the same period in 2006. Travel and entertainment expense
increased by $24,000 for the three months ended March 31, 2007
as compared
to the same period in 2006. Shipping and postage expense decreased
by
$31,000 for the three months ended March 31, 2007.
|
|
·
|
We
have incurred substantial legal expenses in connection with the
University
of Pittsburgh’s 2004 lawsuit. Although we are not litigants and are not
responsible for any settlement costs, if the University of Pittsburgh
wins
the lawsuit our license rights to the patent in question could
be
nullified or rendered non-exclusive and our regenerative cell strategy
could be affected. The amended UC license agreement signed in the
third
quarter of 2006 clarified that we are responsible for all patent
prosecution and litigation costs related to this lawsuit. For the
three
months ended March 31, 2007 and 2006, we expensed $62,000 and $505,000,
respectively, related to this lawsuit. Our legal expenses related
to this
lawsuit will fluctuate depending upon the activity incurred during
each
period.
|
|
·
|
Share-based
compensation related to general and administrative expense for
the three
months ended March 31, 2007 and 2006 was $315,000 and $377,000,
respectively. See share-based compensation discussion below for
more
details.
|
The
future.
We
expect general and administrative expenses of approximately $9,000,000 to
$11,000,000 in 2007. We are seeking ways to minimize the ratio of these expenses
to research and development expenses. As a result, we have begun efforts
to
restrain general and administrative expenses.
We
expect
to continue to incur substantial legal expenses in connection with the
University of Pittsburgh’s 2004 lawsuit.
Share-based
compensation expenses
We
adopted SFAS 123R on January 1, 2006. The following table summarizes the
components of our share-based compensation for the three months ended March
31,
2007 and 2006:
|
For
the three months ended March 31,
|
|||||||||||||
|
2007
|
2006
|
$
Differences
|
%
Differences
|
||||||||||
|
Regenerative
cell technology:
|
|||||||||||||
|
Research
and development-related
|
$
|
152,000
|
$
|
279,000
|
$
|
(127,000
|
)
|
(45.5
|
)%
|
||||
|
Sales
and marketing-related
|
70,000
|
102,000
|
(32,000
|
)
|
(31.4
|
)%
|
|||||||
|
Total
regenerative cell technology
|
222,000
|
381,000
|
(159,000
|
)
|
(41.7
|
)%
|
|||||||
|
MacroPore
Biosurgery:
|
|||||||||||||
|
Cost
of product revenues
|
10,000
|
26,000
|
(16,000
|
)
|
(61.5
|
)%
|
|||||||
|
Research
and development-related
|
1,000
|
13,000
|
(12,000
|
)
|
(92.3
|
)%
|
|||||||
|
Sales
and marketing-related
|
—
|
7,000
|
(7,000
|
)
|
—
|
||||||||
|
Total
MacroPore Biosurgery
|
11,000
|
46,000
|
(35,000
|
)
|
(76.1
|
)%
|
|||||||
|
General
and administrative-related
|
315,000
|
377,000
|
(62,000
|
)
|
(16.4
|
)%
|
|||||||
|
Total
share-based compensation
|
$
|
548,000
|
$
|
804,000
|
$
|
(256,000
|
)
|
(31.8
|
)%
|
||||
Most
of
the expenses in both periods related to the vesting of stock option awards
to
employees. In the first quarter of 2006, we granted 2,500 shares of restricted
common stock to a non-employee scientific advisor. Because the shares granted
are not subject to additional future vesting or service requirements, the
share-based compensation expense of $18,000 recorded in the first quarter
of
2006 constitutes the entire expense related to these grants, and no future
period charges will be reported. The stock is restricted only in that it
cannot
be sold for a specified period of time. There are no vesting requirements.
The
scientific advisor also receives cash consideration as services are performed.
The
future.
We will
continue to grant options (which will result in an expense) to our employees
and, as appropriate, to non-employee service providers. In addition, previously
-granted options will continue to vest in accordance with their original
terms.
As of March 31, 2007, the total compensation cost related to non-vested stock
options not yet recognized for all our plans is approximately $5,102,000.
These
costs are expected to be recognized over a weighted average period of 1.88
years.
Change
in fair value of option liabilities
The
following is a table summarizing the change in fair value of option liabilities
for the three months ended March 31, 2007 and 2006:
|
For
the three months ended March 31,
|
|||||||||||||
|
2007
|
2006
|
$
Differences
|
%
Differences
|
||||||||||
|
Change
in fair value of option liability
|
$
|
—
|
$
|
(375,000
|
)
|
$
|
375,000
|
—
|
|||||
|
Change
in fair value of put option liability
|
200,000
|
(100,000
|
)
|
300,000
|
300.0
|
%
|
|||||||
|
Total
change in fair value of option liabilities
|
$
|
200,000
|
$
|
(475,000
|
)
|
$
|
675,000
|
142.1
|
%
|
||||
| · |
We
granted Olympus an option to acquire 2,200,000 shares of our common
stock
which expired December 31, 2006. The exercise price of the option
shares
was $10 per share. We had accounted for this grant as a liability
because
had the option been exercised, we would have been required to deliver
listed shares of our common stock to settle the option shares. In
accordance with EITF 00-19, the fair value of this option was re-measured
at the end of each quarter, using the Black-Scholes option pricing
model,
with the movement in fair value reported in the statement of operations
as
a change in fair value of option liabilities.
|
| · |
In
reference to the Joint Venture, the Shareholders’ Agreement between Cytori
and Olympus provides that in certain specified circumstances of insolvency
or if we experience a change in control, Olympus will have the rights
to
(i) repurchase our interests in the Joint Venture at the fair value
of
such interests or (ii) sell its own interests in the Joint Venture
to us
at the higher of (a) $22,000,000 or (b) the Put’s fair value. The Put
value has been classified as a liability.
|
The
valuations of the Put were completed by an independent valuation firm using
an
option pricing theory-based simulation analysis (i.e., a Monte Carlo
simulation). The valuations are based on assumptions as of the valuation
date
with regard to the market value of Cytori and the estimated fair value of
the
Joint Venture, the expected correlation between the values of Cytori and
the
Joint Venture, the expected volatility of Cytori and the Joint Venture, the
bankruptcy recovery rate for Cytori, the bankruptcy threshold for Cytori,
the
probability of a change of control event for Cytori, and the risk-free interest
rate.
The
following assumptions were employed in estimating the value of the
Put:
|
March
31, 2007
|
December
31, 2006
|
November
4, 2005
|
||||||||
|
Expected
volatility of Cytori
|
63.00
|
%
|
66.00
|
%
|
63.20
|
%
|
||||
|
Expected
volatility of the Joint Venture
|
63.00
|
%
|
56.60
|
%
|
69.10
|
%
|
||||
|
Bankruptcy
recovery rate for Cytori
|
21.00
|
%
|
21.00
|
%
|
21.00
|
%
|
||||
|
Bankruptcy
threshold for Cytori
|
$
|
10,660,000
|
$
|
10,110,000
|
$
|
10,780,000
|
||||
|
Probability
of a change of control event for Cytori
|
2.23
|
%
|
1.94
|
%
|
3.04
|
%
|
||||
|
Expected
correlation between fair values of Cytori and the Joint Venture
in the
future
|
99.00
|
%
|
99.00
|
%
|
99.00
|
%
|
||||
|
Risk-free
interest rate
|
4.65
|
%
|
4.71
|
%
|
4.66
|
%
|
||||
The
future.
The Put
has no expiration date. Accordingly, we will continue to recognize a liability
for the Put until it is exercised or until the arrangements with Olympus
are
amended.
Income
taxes
On
July
13, 2006, the FASB issued FIN 48, which clarifies the accounting for uncertainty
in income taxes recognized in an entity’s financial statements in accordance
with SFAS 109, and prescribes a recognition threshold and measurement attributes
for financial statement disclosure of tax positions taken or expected to
be
taken on a tax return. Under FIN 48, the impact of an uncertain income tax
position on the income tax return must be recognized at the largest amount
that
is more-likely-than-not to be sustained upon audit by the relevant taxing
authority. An uncertain income tax position will not be recognized if it
has
less than a 50% likelihood of being sustained. Additionally, FIN 48 provides
guidance on derecognition, classification, interest and penalties, accounting
in
interim periods, disclosure, and transition. FIN 48 is effective for fiscal
years beginning after December 15, 2006.
We
adopted the provisions of FIN 48 on January 1, 2007. There were no unrecognized
tax benefits as of the date of adoption. As a result of the implementation
of
FIN 48, we did not recognize an increase in the liability for unrecognized
tax
benefits. There are no unrecognized tax benefits included in the balance
sheet
that would, if recognized, affect the effective tax rate.
Our
practice is to recognize interest and/or penalties related to income tax
matters
in income tax expense. We had $0 accrued for interest and penalties on our
balance sheet as of March 31, 2007 and December 31, 2006, and have recognized
$0
in interest and/or penalties in our statement of operations for the first
quarter of 2007.
With
limited exception, we are subject to taxation in the U.S. and California
jurisdictions. Our tax years for 1997 and forward are subject to examination
by
the U.S. and California tax authorities due to the carryforward of unutilized
net operating losses and research and development credits.
The
adoption of FIN No. 48 did not impact our financial condition, results of
operations or cash flows. At January 1, 2007, we had net deferred tax assets
of
$38,505,000 million. The deferred tax assets are primarily composed of federal
and state tax net operating loss carryforwards and federal and state R&D
credit carryforwards. Due to uncertainties surrounding our ability to generate
future taxable income to realize these assets, a full valuation allowance
has
been established to offset our deferred tax asset. Additionally, the future
utilization of our net operating loss and R&D credit carryforwards to offset
future taxable income may be subject to a substantial annual limitation as
a
result of ownership changes that may have occurred previously or that could
occur in the future. We are in the process of updating our Section 382/383
analysis through the period ending December 31, 2006. We have not yet determined
whether such an ownership change has occurred, however, the Company is currently
working to complete a Section 382/383 analysis regarding the limitation of
the
net operating losses and research and development credits. Similarly, we
plan to
complete an R&D credit analysis regarding the calculation of the R&D
credit. When these analyses are completed, we plan to update our unrecognized
tax benefits under FIN No. 48. Therefore, we expect that the unrecognized
tax
benefits may change within 12 months of this reporting date. At this time,
we
cannot estimate how much the unrecognized tax benefits may change.
Due to the existence of the valuation allowance, future changes in our
unrecognized tax benefits will not impact our effective tax
rate.
Financing
items
The
following table summarizes interest income, interest expense, and other income
and expense for the three months ended March 31, 2007 and 2006:
|
For
the three months ended March 31,
|
|||||||||||||
|
2007
|
2006
|
$
Differences
|
%
Differences
|
||||||||||
|
Interest
income
|
$
|
197,000
|
$
|
197,000
|
$
|
—
|
—
|
||||||
|
Interest
expense
|
(52,000
|
)
|
(58,000
|
)
|
6,000
|
(10.3
|
)%
|
||||||
|
Other
income (expense)
|
(4,000
|
)
|
(6,000
|
)
|
2,000
|
(33.3
|
)%
|
||||||
|
Total
|
$
|
141,000
|
$
|
133,000
|
$
|
8,000
|
6.0
|
%
|
|||||
| · |
There
was no change to interest income in the first quarter of 2007 as
compared
with the same period in 2006. This was due to similar amounts of
funds
available for investment during the respective quarters.
|
| · |
Interest
expense decreased in 2007 as compared to 2006 due to lower principal
balances on our long-term equipment-financed borrowings offset by
an
additional promissory note of approximately $600,000 executed in
December
2006.
|
| · |
The
changes in other income (expense) in the first quarter of 2007 as
compared
to the same period in 2006 resulted primarily from changes in foreign
currency exchange rates.
|
The
future.
Interest income earned in 2007 will be dependent on our levels of funds
available for investment as well as general economic conditions. We expect
interest expense to remain relatively consistent during the remainder of
2007.
Equity
loss from investment in Joint Venture
The
following table summarizes our equity loss from investment in joint venture
for
the three months ended March 31, 2007 and 2006:
|
For
the three months ended March 31,
|
|||||||||||||
|
2007
|
2006
|
$
Differences
|
%
Differences
|
||||||||||
|
Equity
loss in investment
|
$
|
(2,000
|
)
|
$
|
(49,000
|
)
|
$
|
47,000
|
(95.9
|
)%
|
|||
The
losses in 2007 and 2006 relate entirely to our 50% equity interest in the
Joint
Venture, which we account for using the equity method of
accounting.
The
future.
We do
not expect to recognize significant losses from the activities of the Joint
Venture in the foreseeable future. Over the next two to three years, the
Joint
Venture is expected to incur modest general and administrative expenses,
offset
by royalty income expected to begin in 2008 when Cytori commercializes the
Celution™ System in Europe. Though we have no obligation to do so, we and
Olympus plan to jointly fund the Joint Venture to cover any costs should
the
Joint Venture deplete its cash balance.
Liquidity
and Capital Resources
Short-term
and long-term liquidity
The
following is a summary of our key liquidity measures at March 31, 2007 and
December 31, 2006:
|
March
31,
|
December
31,
|
$ |
%
|
||||||||||
|
2007
|
2006
|
Differences
|
Differences
|
||||||||||
|
Cash
and cash equivalents
|
$
|
21,701,000
|
$
|
8,902,000
|
$
|
12,799,000
|
143.8
|
%
|
|||||
|
Short-term
investments, available for sale
|
2,761,000
|
3,976,000
|
(1,215,000
|
)
|
(30.6
|
)%
|
|||||||
|
Total
cash and cash equivalents and short-term investments, available
for
sale
|
$
|
24,462,000
|
$
|
12,878,000
|
$
|
11,584,000
|
90.0
|
%
|
|||||
|
Current
assets
|
$
|
25,649,000
|
$
|
13,978,000
|
$
|
11,671,000
|
83.5
|
%
|
|||||
|
Current
liabilities
|
6,008,000
|
6,586,000
|
(578,000
|
)
|
(8.8
|
)%
|
|||||||
|
Working
capital
|
$
|
19,641,000
|
$
|
7,392,000
|
$
|
12,249,000
|
165.7
|
%
|
|||||
In
order
to provide greater financial flexibility and liquidity, and in view of the
substantial cash needs of our regenerative cell business during its development
stage, we have an ongoing need to raise additional capital. In the third
quarter
of 2006, we received net proceeds of $16,219,000 from the sale of common
stock
pursuant to a shelf registration statement, of which Olympus purchased
$11,000,000; the remaining shares were purchased by other institutional
investors. Additionally,
in the first quarter of 2007, we
received net proceeds of $19,901,000 from the sale of units consisting of
3,746,000 shares of common stock and 1,873,000 common stock warrants (with
an
exercise price of $6.25 per share) under the shelf registration
statement.
Also,
near the end of the first quarter of 2007, we entered into an agreement to
sell
1,000,000 shares of common stock to Green Hospital Supply, Inc. in a private
placement. We received $6,000,000 related to this sale in April 2007.
We
also
implemented certain cost containment measures and are actively pursuing a
buyer
(or buyers) for our spine and orthopedics business. With consideration of
these
endeavors as well as existing funds, cash generated by operations, and other
accessible sources of financing, we believe our cash position is adequate
to
satisfy our working capital, capital expenditures, debt service, and other
financial commitments at least through March 31, 2008.
From
inception to March 31, 2007, we have financed our operations primarily
by:
| · |
Issuing
our stock in pre-IPO transactions, in our 2000 initial public offering
in
Germany, and upon stock option exercises,
|
| · |
Generating
revenues,
|
| · |
Selling
the bioresorbable implant CMF product line in September
2002,
|
| · |
Selling
the bioresorbable implant Thin Film product line (except for the
territory
of Japan), in May 2004,
|
| · |
Entering
into a Distribution Agreement for the distribution rights to Thin
Film in
Japan, in which we received an upfront license fee in July 2004 and
an
initial development milestone payment in October
2004,
|
| · |
Obtaining
a modest amount of capital equipment long-term
financing,
|
| · |
Issuing
1,100,000 shares of common stock to Olympus under a Stock Purchase
Agreement which closed in May 2005,
|
| · |
Entering
into a collaborative arrangement with Olympus in November 2005, including
the formation of a joint venture called Olympus-Cytori, Inc.,
|
| · |
Receiving
funds in exchange for granting Olympus an exclusive right to negotiate
in
February 2006,
|
| · |
Receiving
net proceeds of $16,219,000 from the sale of common stock under our
shelf
registration statement in August 2006,
|
| · |
Receiving
net proceeds of $19,901,000 from the sale of common stock and common
stock
warrants under the shelf registration statement in February
2007.
|
| · |
Receiving
net proceeds of $6,000,000 from the common stock private placement
to
Green Hospital Supply, Inc., in April 2007.
|
We
don’t
expect significant capital expenditures during the remainder of 2007; however,
if necessary, we may borrow under our Amended Master Security
Agreement.
Any
excess funds will be invested in short-term available-for-sale investments.
Our
cash
requirements for 2007 and beyond will depend on numerous factors, including
the
resources we devote to developing and supporting our investigational cell
therapy products, market acceptance of any developed products, regulatory
approvals, and other factors. We expect to incur research and development
expenses at high levels in our regenerative cell platform for an extended
period
of time and have therefore positioned ourselves to expand our cash position
through actively pursuing co-development and marketing agreements, research
grants, and licensing agreements related to our regenerative cell technology
platform. Further, we are actively pursuing a buyer (or buyers) for our
MacroPore Biosurgery spine and orthopedics assets. This decision is based
on the
change in our strategic focus as well as the continuing negative profit margins
being realized from the MacroPore Biosurgery segment.
The
following summarizes our contractual obligations and other commitments at
March
31, 2007, and the effect such obligations could have on our liquidity and
cash
flow in future periods:
|
Payments
due by period
|
||||||||||||||||
|
Contractual
Obligations
|
Total
|
Less
than 1
year
|
1
- 3 years
|
3
- 5 years
|
More
than
5
years
|
|||||||||||
|
Long-term
obligations
|
$
|
1,905,000
|
$
|
949,000
|
$
|
956,000
|
$
|
—
|
$
|
—
|
||||||
|
Interest
commitment on long-term obligations
|
228,000
|
153,000
|
75,000
|
—
|
—
|
|||||||||||
|
Operating
lease obligations
|
4,647,000
|
1,549,000
|
3,098,000
|
—
|
—
|
|||||||||||
|
Pre-clinical
research study obligations
|
382,000
|
382,000
|
—
|
—
|
—
|
|||||||||||
|
Clinical
research study obligations
|
6,411,000
|
5,220,000
|
1,191,000
|
—
|
—
|
|||||||||||
|
Total
|
$
|
13,573,000
|
$
|
8,253,000
|
$
|
5,320,000
|
$
|
—
|
$
|
—
|
||||||
Cash
(used in) provided by operating, investing, and financing activities for
the
three months ended March 31, 2007 and 2006 is summarized as
follows:
|
For
the three months ended March 31,
|
|||||||
|
2007
|
2006
|
||||||
|
Net
cash (used in) provided by operating activities
|
$
|
(8,160,000
|
)
|
$
|
3,160,000
|
||
|
Net
cash provided by (used in) investing activities
|
1,084,000
|
(4,474,000
|
)
|
||||
|
Net
cash provided by financing activities
|
19,875,000
|
293,000
|
|||||
Operating
activities
Net
cash
(used in) provided by operating activities for all periods presented resulted
primarily from expenditures related to our regenerative cell research and
development efforts.
Research
and development efforts, other operational activities, and a comparatively
small
amount of product sales generated a $8,669,000 net loss for the three months
ended March 31, 2007. The cash impact of this loss was $8,160,000, after
adjusting for the change in share-based compensation of $548,000, other
adjustments including material non-cash activities, such as depreciation
and
amortization, and changes in working capital due to timing of product shipments
(accounts receivable) and payment of liabilities.
Research
and development efforts, other operational activities, and a comparatively
small
amount of product sales generated a $7,456,000 net loss for the three months
ended March 31, 2006. The cash impact of this loss was cash provided of
$3,160,000, after adjusting for the $10,317,000 we received from Olympus
in that
quarter, as discussed previously. Other adjustments include material non-cash
activities, such as depreciation and amortization, changes in the fair value
of
the Olympus option liabilities, share-based compensation expense, and equity
loss from investment in Joint Venture, as well as changes in working capital
due
to the timing of product shipments (accounts receivable) and payment of
liabilities.
Investing
activities
Net
cash
provided by investing activities for the three months ended March 31, 2007
resulted primarily from net proceeds from the purchase and sale and maturity
of
short-term investments.
Net
cash
used in investing activities for the three months ended March 31, 2006 resulted
primarily from the purchases of short-term investments, as well as expenditures
for leasehold improvements.
Capital
spending is essential to our product innovation initiatives and to maintain
our
operational capabilities. For the three months ended March 31, 2007 and 2006,
we
used cash to purchase $130,000 and $1,895,000, respectively, of property
and
equipment, primarily, to support the research and development of the
regenerative cell technology platform. The high level of 2006 capital spending
was caused primarily by expenditures for leasehold improvements made to our
new
Callan Road facilities.
Financing
Activities
The
net
cash provided by financing activities for the three months ended March 31,
2007
related mainly to the issuance of 3,746,000 shares of our common stock and
1,873,000 common stock warrants in exchange for approximately $19,901,000
(net).
The
net
cash provided by financing activities for the year ended March 31, 2006 related
mainly to the exercise of employee stock options offset by the principal
payments on long-term obligations.
Critical
Accounting Policies and Significant Estimates
The
preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires us to make estimates
and assumptions that affect the reported amounts of our assets, liabilities,
revenues, and expenses, and that affects our recognition and disclosure of
contingent assets and liabilities.
While
our
estimates are based on assumptions we consider reasonable at the time they
were
made, our actual results may differ from our estimates, perhaps significantly.
If results differ materially from our estimates, we will make adjustments
to our
financial statements prospectively as we become aware of the necessity for
an
adjustment.
We
believe it is important for you to understand our most critical accounting
policies. These are policies that require us to make our most significant
judgments and, as a result, could have the greatest impact on our future
financial results.
Revenue
Recognition
We
derive
our revenue from a number of different sources, including but not limited
to:
| · |
Fees
for achieving certain defined milestones under research and/or development
arrangements,
|
| · |
Product
sales, and
|
| · |
Payments
under license or distribution agreements.
|
A
number
of our revenue-generating arrangements are relatively simple in nature, meaning
that there is little judgment necessary with regard to the timing of when
we
recognize revenues or how such revenues are presented in the financial
statements.
However,
we have also entered into more complex arrangements, including but not limited
to our contracts with Olympus and Senko. Moreover, some of our non-recurring
transactions, such as our disposition of the majority of our Thin Film business
to MAST, contain elements that relate to our product revenue-producing
activities.
As
a
result, some of our most critical accounting judgments relate to the
identification, timing, and presentation of revenue-related activities. These
critical judgments are discussed further in the paragraphs that
follow.
Multiple
-elements
Some
of
our revenue-generating arrangements contain a number of distinct revenue
streams, known as “elements.” For example, our Distribution Agreement with Senko
contains direct or indirect future revenue streams related to:
| · |
A
distribution license fee (which was paid at the outset of the
arrangement),
|
| · |
Milestone
payments for achieving commercialization of the Thin Film product
line in
Japan,
|
| · |
Training
for representatives of Senko,
|
| · |
Sales
of Thin Film products to Senko, and
|
| · |
Payments
in the nature of royalties on future product sales made by Senko
to its
end customers.
|
EITF
00-21 governs whether each of the above elements in the arrangement should
be
accounted for individually, or whether the entire contract should be treated
as
a single unit of accounting.
EITF
00-21 indicates that individual elements may be separately accounted for
only
when:
| · |
The
delivered element has stand-alone value to the customer,
|
| · |
There
is objective evidence of the fair value of the remaining undelivered
elements, and
|
| · |
If
the arrangement contains a general right of return related to any
products
delivered, and delivery of the remaining goods and services is probable
and within the complete control of the seller.
|
In
the
case of the Senko Distribution Agreement, we determined that (a) the milestone
payments for achieving commercialization and (b) the future sale of Thin
Film
products to Senko were “separable” elements. That is, each of these elements,
upon delivery, will have stand-alone value to Senko and there will be objective
evidence of the fair value of any remaining undelivered elements at that
time.
The arrangement does not contain any general right of return, and so this
point
is not relevant to our analysis.
On
the
other hand, we concluded that (a) the upfront distribution license fee, (b)
the
revenues from training for representatives of Senko, and (c) the payments
in the
form of royalties on future product sales are not separable elements under
EITF
00-21.
In
arriving at our conclusions, we had to consider whether our customer, Senko,
would receive stand-alone value from each delivered element. We also, in
some
cases, had to look to third-party evidence to support the fair value of certain
undelivered elements - notably, training - since we as a company do not
routinely deliver this service on a stand-alone basis. Finally, we had to
make
assumptions about how the non-separable elements of the arrangement are earned,
particularly the estimated period over which Senko will benefit from the
arrangement (refer to the “Recognition” discussion below for further
background).
We
also
agreed to perform multiple services under the November 4, 2005 agreements
we
signed with Olympus, including:
| · |
Granting
the Joint Venture (which Olympus is considered to control) an exclusive
and perpetual manufacturing license to our device technology, including
the Celution™ System and certain related intellectual property;
and
|
| · |
Performing
development activities in relation to certain therapeutic applications
associated with our Celution™ System, including completing pre-clinical
and clinical trials, seeking regulatory approval as appropriate,
and
assisting with product development.
|
We
concluded that the license and development services must be accounted for
as a
single unit of accounting. In reaching this conclusion, we determined that
the
license would not have stand-alone value to the Joint Venture. This is because
Cytori is the only party that could be reasonably expected to perform the
development services, including pre-clinical and clinical studies, regulatory
filings, and product development, necessary for the Joint Venture to derive
any
value from the license.
Recognition
Besides
determining whether to account separately for components of a multiple-element
arrangement, we also use judgment in determining the appropriate accounting
period in which to recognize revenues that we believe (a) have been earned
and
(b) are realizable. The following describes some of the recognition issues
we
have considered during the reporting period:
| · |
Upfront
License Fees/Milestones
|
| o |
As
part of the Senko Distribution Agreement, we received an upfront
license
fee upon execution of the arrangement, which, as noted previously,
was not
separable under EITF 00-21. Accordingly, the license has been combined
with the development (milestones) element, which was separable, to
form a
single accounting unit. This single element of $3,000,000 in fees
includes
$1,500,000 which is potentially refundable. We have recognized, and
will
continue to recognize, the non-contingent fees allocated to this
combined
element as revenues as we complete each of the performance obligations
associated with the milestones component of this combined deliverable.
Note that the timing of when we have recognized revenues to date
does not
correspond with the cash we received upon achieving certain milestones.
For example, the first such milestone payment for $1,250,000 became
payable to us when we filed a commercialization application with
the
Japanese regulatory authorities. However, we determined that the
payment
received was not commensurate with the level of effort expended,
particularly when compared with other steps we believe are necessary
to
commercialize the Thin Film product line in Japan. Accordingly, we
did not
recognize the entire $1,250,000 received as revenues, but instead
all but
$361,000 of this amount is classified as deferred revenues. Approximately
$361,000 ($152,000 in 2006, $51,000 in 2005, and $158,000 in 2004)
has
been recognized to date as development revenues based on our estimates
of
the level of effort expended for completed milestones as compared
with the
total level of effort we expect to incur under the arrangement to
successfully achieve regulatory approval of the Thin Film product
line in
Japan. These estimates were subject to judgment and there may be
changes
in estimates regarding the total level of effort as we continue to
seek
regulatory approval. In fact, there can be no assurance that
commercialization in Japan will ever be achieved, although our latest
understanding is that regulatory approval will be received in
2007.
|
| o |
We
also received upfront fees as part of the Olympus arrangements (although,
unlike in the Senko agreement, these fees were non-refundable).
Specifically, in exchange for an upfront fee, we granted the Joint
Venture
an exclusive, perpetual license to certain of our intellectual property
and agreed to perform additional development activities. This upfront
fee
has been recorded in the liability account entitled deferred revenues,
related party, on our consolidated balance sheet. Similar to the
Senko
agreement, we have elected an accounting policy to recognize revenues
from
the combined license/development accounting unit as we perform the
development services, as this represents our final obligation underlying
the combined accounting unit. Specifically, we plan to recognize
revenues
from the license/development accounting unit using a “proportional
performance” methodology, resulting in the derecognition of amounts
recorded in the deferred revenues, related party account as we complete
various milestones underlying the development services. For instance,
we
have recognized and will continue to recognize some of the deferred
revenues, related party, as revenues, related party, when we complete
a
pre-clinical trial or obtain regulatory approval in a specific
jurisdiction. Determining what portion of the deferred revenues,
related
party balance to recognize as each milestone is completed involves
substantial judgment. In allocating the balance of the deferred revenues,
related party, to various milestones, we had in-depth discussions
with our
operations personnel regarding the relative value of each milestone
to the
Joint Venture and Olympus. We also considered the cost of completing
each
milestone relative to the total costs we plan to incur in completing
all
of the development activities, since we believe that the relative
cost of
completing a milestone is a reasonable proxy for its fair value.
The
accounting policy described above could result in revenues being
recorded
in an earlier accounting period than had other judgments or assumptions
been made by us.
|
| · |
Government
Grants
|
| o |
We
are eligible to receive grants from the NIH related to our research
on
adipose-derived cell therapy to treat myocardial infarctions. There
are no
specific standards under U.S. Generally Accepted Accounting Principles
(“GAAP”) that prescribe the recognition or classification of these grants
in the statement of operations. Absent such guidance, we have established
an accounting policy to recognize NIH grant revenues at the lesser
of:
|
| § |
Qualifying
costs incurred (and not previously recognized), plus any allowable
grant
fees, for which Cytori is entitled to grant funding;
or,
|
| § |
The
amount determined by comparing the research outputs generated to
date
versus the total outputs that are expected to be achieved under the
entire
arrangement.
|
| o |
Our
accounting policy could theoretically defer revenue recognition beyond
the
period in which we have earned the rights to such fees. However,
we
selected this accounting policy to counteract the possibility of
recognizing revenues from the NIH arrangement too early. For instance,
if
our policy permitted revenues to be recognized solely as qualifying
costs
were incurred, we could alter the amount of revenue recognized by
incurring more or less cost in a given period, irrespective of whether
these costs correlate to the research outputs generated. On the other
hand, if revenue recognition were based on output measures alone,
it would
be possible to recognize revenue in excess of costs actually incurred;
this is not appropriate since qualifying costs remain the basis of
our
funding under the NIH grant. The application of our accounting policy,
nonetheless, involves significant judgment, particularly in estimating
the
percentage of outputs realized to date versus the total outputs expected
to be achieved under the grant
arrangement.
|
Presentation
We
have
presented amounts earned under our NIH research arrangement as research grant
revenue. We believe that the activities underlying the NIH agreement constituted
a portion of our ongoing major or central operations. Moreover, the government
obtains rights under the arrangement in the same manner (but perhaps not
to the
same extent) as a commercial customer that similarly contracts with us to
perform research activities. For instance, the government and any authorized
third parties may use our federally funded research and/or inventions without
payment of royalties to us.
Goodwill
Impairment Testing
In
late
2002, we purchased StemSource, Inc. and recognized over $4,600,000 in goodwill
associated with the acquisition, of which $4,387,000 remains on our balance
sheet as of March 31, 2007. As required by Statement of Financial Accounting
Standard No. 142, “Goodwill and Other Intangible Assets” (“SFAS 142”), we must
test this goodwill at least annually for impairment as well as when an event
occurs or circumstances change such that it is reasonably possible that
impairment may exist. Moreover, this testing must be performed at a level
of the
organization known as the reporting unit. A reporting unit is at least the
same
level as a company’s operating segments, and sometimes even one level lower. Our
two reporting units are, in fact, our two operating segments.
Specifically,
the process for testing goodwill for impairment under SFAS 142 involves the
following steps:
| · |
Company
assets and liabilities, including goodwill, are allocated to each
reporting unit for purposes of completing the goodwill impairment
test.
|
| · |
The
carrying value of each reporting unit - that is, the sum of all of
the net
assets allocated to the reporting unit - is then compared to its
fair
value.
|
| · |
If
the fair value of the reporting unit is lower than its carrying amount,
goodwill may be impaired - additional testing is required.
|
When
we
last completed our goodwill impairment testing in 2006, the fair values of
our
two reporting units each exceeded their respective carrying values. Accordingly,
we determined that none of our reported goodwill was impaired.
The
application of the goodwill impairment test involves a substantial amount
of
judgment. For instance, SFAS 142 requires that assets and liabilities be
assigned to a reporting unit if both of the following criteria are
met:
| · |
The
asset will be employed in or the liability relates to the operations
of a
reporting unit.
|
| · |
The
asset or liability will be considered in determining the fair value
of the
reporting unit.
|
We
developed mechanisms to assign company-wide assets like shared property and
equipment, as well as company-wide obligations such as borrowings under our
GE
loan facility, to our two reporting units. In some cases, certain assets
were
not allocable to either reporting unit and were left unassigned.
The
most
complex and challenging asset to assign to each reporting unit was our acquired
goodwill. As noted previously, all of our recorded goodwill was generated
in
connection with our acquisition of StemSource in 2002. However, when we first
acquired StemSource, we determined that a portion of the goodwill related
to the
MacroPore Biosurgery reporting unit. The amount of goodwill allocated
represented our best estimate of the synergies (notably future cost savings
from
shared research and development activities) that the MacroPore Biosurgery
reporting unit would obtain by virtue of the acquisition.
Finally,
with the consultation and assistance of a third party, we estimated the fair
value of our reporting units by using various estimation techniques. In
particular, in 2006, we estimated the fair value of our MacroPore Biosurgery
reporting unit based on an equal weighting of the market values of comparable
enterprises and discounted projections of estimated future cash flows. Clearly,
identifying comparable companies and estimating future cash flows as well
as
appropriate discount rates involve judgment. On the contrary, we estimated
the
fair value of our regenerative cell reporting unit solely using an income
approach, as we believe there are no comparable enterprises on which to base
a
valuation. The assumptions underlying this valuation method involve a
substantial amount of judgment, particularly since our regenerative cell
business has yet to generate any revenues and does not have a commercially
viable product. The combined value of our goodwill is consistent with the
market’s valuation.
Again,
the manner in which we assigned assets, liabilities, and goodwill to our
reporting units, as well as how we determined the fair value of such reporting
units, involves significant uncertainties and estimates. The judgments employed
may have an effect on whether a goodwill impairment loss is recognized.
Dispositions
In
2004,
we sold most of the assets and intellectual property rights in our (non-Japan)
Thin Film product line to MAST.
As
is
common in the life sciences industry, the sale agreements contained provisions
beyond the simple transfer of net assets to the acquiring enterprises for
a
fixed price. Specifically, as part of the arrangement, we also agreed to
perform
the following services:
| · |
Provide
training to MAST personnel on production and other aspects of the
Thin
Film product lines, and
|
| · |
Provide
a back-up supply of Thin Film products to MAST, at cost, for a specified
period of time.
|
Disposing
of assets and product lines is not one of our core ongoing or central
activities. Accordingly, determining the appropriate accounting for these
transactions involved some of our most difficult, subjective, and complex
judgments. In particular, we made assumptions around the appropriate manner
and
timing in which to recognize the gain on disposal for each transaction in
the
statement of operations.
We
initially deferred recognition of the gain related to our disposition of
certain
Thin Film assets, which occurred in May 2004. Again, the Asset Purchase
Agreement governing the Thin Film sale obligated us to perform certain actions
for the benefit of the buyer - MAST - for a defined period of time, such
as
serving as a back-up supplier. We concluded, due to the arbitration proceedings
settled in August 2005 that we completed our remaining performance obligations
during the third quarter of 2005. Accordingly, we recognized the remaining
deferred gain on sale of assets as gain on sale of assets.
We
also
recognized a portion of the deferred gain when we sold products to MAST under
the back-up supply agreement in 2004. Refer to the “Revenue Recognition” section
of this Critical Accounting Policies and Significant Estimates discussion
for
further details.
Variable
Interest Entity (Olympus-Cytori Joint Venture)
FASB
Interpretation No. 46 (revised 2003), “Consolidation of Variable Interest
Entities - An Interpretation of ARB No. 51” (“FIN 46R”) requires a variable
interest entity (“VIE”) to be consolidated by its primary beneficiary.
Evaluating whether an entity is a VIE and determining its primary beneficiary
involves significant judgment.
In
concluding that the Olympus-Cytori Joint Venture was a VIE, we considered
the
following factors:
| · |
Under
FIN 46R, an entity is a VIE if it has insufficient equity to finance
its
activities. We recognized that the initial cash contributed to the
Joint
Venture formed by Olympus and Cytori ($30,000,000) would be completely
utilized by the first quarter of 2006. Moreover, it was highly unlikely
that the Joint Venture would be able to obtain the necessary financing
from third-party lenders without additional subordinated financial
support
- such as personal guarantees by one or both of the Joint Venture
stockholders. Accordingly, the Joint Venture will require additional
financial support from Olympus and Cytori to finance its ongoing
operations, indicating that the Joint Venture is a VIE. In fact,
in the
first quarter of 2006, we contributed $150,000 each to fund the Joint
Venture’s ongoing operations.
|
| · |
Moreover,
Olympus has a contingent put option that would, in specified
circumstances, require Cytori to purchase Olympus’s interests in the Joint
Venture for a fixed amount of $22,000,000. Accordingly, Olympus is
protected in some circumstances from absorbing all expected losses
in the
Joint Venture. Under FIN 46R, this means that Olympus may not be
an
“at-risk” equity holder, although Olympus clearly has decision rights over
the operations of the Joint Venture.
|
Because
the Joint Venture is undercapitalized, and because one of the Joint Venture’s
decision makers may be protected from losses, we have determined that the
Joint
Venture is a VIE under FIN 46R. Because of the complexities in applying FIN
46R,
it is reasonable to expect that others may reach a different
conclusion.
As
noted
previously, a VIE is consolidated by its primary beneficiary. The primary
beneficiary is defined in FIN 46R as the entity that would absorb the majority
of the VIE’s expected losses or be entitled to receive the majority of the VIE’s
residual returns (or both).
Significant
judgment was involved in determining the primary beneficiary of the Joint
Venture. Under FIN 46R, we believe that Olympus and Cytori are “de facto agents”
and, together, will absorb more than 50% of the Joint Venture’s expected losses
and residual returns. Ultimately, we concluded that Olympus, and not Cytori,
was
the party most closely related with the joint venture and, hence, its primary
beneficiary. Our conclusion was based on the following factors:
| · |
The
business operations of the Joint Venture will be most closely aligned
to
those of Olympus (i.e., the manufacture of devices),
and
|
| · |
Olympus
controls the Board of Directors, as well as the day-to-day operations
of
the Joint Venture.
|
The
application of FIN 46R involves substantial judgment, and others may arrive
at
the conclusion that Cytori should consolidate the Joint Venture. Had we
consolidated the Joint Venture, though, there would be no effect on our net
loss
or shareholders’ equity at December 31, 2006 or for the year then ended.
However, certain balance sheet and income statement captions would have been
presented in a different manner. For instance, we would not have presented
a
single line item entitled investment in joint venture in our balance sheet,
but
instead would have performed a line by line consolidation of each of the
Joint
Venture’s accounts into our financial statements.
Recent
Accounting Pronouncements
In
September 2006, the SEC issued Staff Accounting Bulletin No. 108, “Considering
the Effects of Prior Year Misstatements when Quantifying Misstatements in
Current Year Financial Statements” (“SAB 108”). SAB 108 provides interpretive
guidance on how the effects of prior -year uncorrected misstatements should
be
considered when quantifying misstatements in the current year financial
statements. SAB 108 requires registrants to quantify misstatements using
both an
income statement (“rollover”) and balance sheet (“iron curtain”) approach and
evaluate whether either approach results in a misstatement that, when all
relevant quantitative and qualitative factors are considered, is material.
If
prior year errors that had been previously considered immaterial now are
considered material based on either approach, no restatement is required
so long
as management properly applied its previous approach and all relevant facts
and
circumstances were considered. If prior years are not restated, the cumulative
effect adjustment is recorded in opening accumulated earnings (deficit) as
of
the beginning of the fiscal year of adoption. SAB 108 is effective for fiscal
years ending on or after November 15, 2006, with earlier adoption encouraged.
The adoption of SAB 108 has not had a significant effect on our financial
statements.
In
September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (“SFAS
157”). SFAS 157 defines fair value, establishes a framework for measuring fair
value, and expands disclosure of fair value measurements. SFAS 157 applies
under
other accounting pronouncements that require or permit fair value measurements
and, accordingly, does not require any new fair value measurements. SFAS
157 is
effective for financial statements issued for fiscal years beginning after
November 15, 2007. We do not believe that the adoption of SFAS 157 will have
a
significant effect on our financial statements.
We
are
exposed to market risk related to fluctuations in interest rates and in foreign
currency exchange rates.
Interest
Rate Exposure
We
are
not subject to market risk due to fluctuations in interest rates on our
long-term obligations as they bear a fixed rate of interest. Our exposure
relates primarily to short-term investments. These short-term investments,
reported at an aggregate fair market value of $2,761,000 as of March 31,
2007,
consist primarily of investments in debt instruments of financial institutions
and corporations with strong credit ratings and United States of America
government obligations. These securities are subject to market rate risk
as
their fair value will fall if market interest rates increase. If market interest
rates were to increase immediately and uniformly by 100 basis points from
the
levels prevailing at March 31, 2007, for example, and assuming average
investment duration of seven months, the fair value of the portfolio would
not
decline by a material amount. We do not use derivative financial instruments
to
mitigate the risk inherent in these securities. However, we do attempt to
reduce
such risks by generally limiting the maturity date of such securities,
diversifying our investments, and limiting the amount of credit exposure
with
any one issuer. While we do not always have the intent, we do currently have
the
ability to hold these investments until maturity and, therefore, believe
that
reductions in the value of such securities attributable to short-term
fluctuations in interest rates would not materially affect our financial
position, results of operations, or cash flows. Changes in interest rates
would,
of course, affect the interest income we earn on our cash balances after
re-investment.
Foreign
Currency Exchange Rate Exposure
Our
exposure to market risk due to fluctuations in foreign currency exchange
rates
relates primarily to our cash balances in Europe and Japan. Transaction gains
or
losses resulting from cash balances and revenues have not been significant
in
the past and we are not engaged in any hedging activity in the Euro, the
Yen or
other currencies. Based on our cash balances and revenues derived from markets
other than the United States of America for the quarter ended March 31, 2007,
a
hypothetical 10% adverse change in the Euro or Yen against the U.S. dollar
would
not result in a material foreign currency exchange loss. Consequently, we
do not
expect that reductions in the value of such sales denominated in foreign
currencies resulting from even a sudden or significant fluctuation in foreign
exchange rates would have a direct material impact on our financial position,
results of operations, or cash flows.
Notwithstanding
the foregoing, the indirect effect of fluctuations in interest rates and
foreign
currency exchange rates could have a material adverse effect on our business,
financial condition, and results of operations. For example, foreign currency
exchange rate fluctuations may affect international demand for our products.
In
addition, interest rate fluctuations may affect our customers’ buying patterns.
Furthermore, interest rate and currency exchange rate fluctuations may broadly
influence the United States of America and foreign economies, resulting in
a
material adverse effect on our business, financial condition, and results
of
operations.
Under
our
Japanese Thin Film agreement with Senko, we would receive payments in the
nature
of royalties based on Senko’s net sales, which would be Yen denominated. We
expect such sales or royalties to begin in 2007.
Item
4. Controls and Procedures
Christopher
J. Calhoun, our Chief Executive Officer, and Mark E. Saad, our Chief Financial
Officer, after evaluating the effectiveness of our “disclosure controls and
procedures” (as defined in Securities Exchange Act Rule 13a-15(e)), have
concluded that as of March 31, 2007, our disclosure controls and procedures
are
effective.
PART
II. OTHER INFORMATION
From
time
to time, we have been involved in routine litigation incidental to the conduct
of our business. As of March 31, 2007, we were not a party to any material
legal
proceeding. We are not formally a party to the University of Pittsburgh patent
litigation. However, we are responsible for reimbursing certain related
litigation costs.
In
analyzing our company, you should consider carefully the following risk factors
together with all of the other information included in this quarterly report
on
Form 10-Q. Factors that could adversely affect our business, operating results,
and financial condition, as well as adversely affect the value of an investment
in our common stock, include those discussed below, as well as those discussed
above in “Management’s Discussion and Analysis of Financial Condition and
Results of Operations” and elsewhere throughout this quarterly report on Form
10-Q.
We
are
subject to the following significant risks, among others:
We
will need to raise more cash in the future
We
have
almost always had negative cash flows from operations. Our regenerative cell
business will continue to result in a substantial requirement for research
and
development expenses for several years, during which it could bring in no
significant cash and/or revenues. Our spine and orthopedics products business
has performed poorly and we are actively seeking to divest these assets.
There
can be no guarantee that adequate funds for our operations from any additional
debt or equity financing, our operating revenues, arrangements with distribution
partners, or from other sources will be available when needed or on terms
attractive to us. The inability to obtain sufficient funds would require
us to
delay, scale back, or eliminate some or all of our research or product
development programs, manufacturing operations, clinical studies or regulatory
activities, or to license third parties to commercialize products or
technologies that we would otherwise seek to develop ourselves, thus having
a
substantial negative effect on our results of operations and financial
condition.
We
have never been profitable on an operational basis and we expect to have
significant operating losses for the next few years
We
have
incurred net operating losses in each year since we started doing business.
These losses have resulted primarily from expenses associated with our research
and development activities and general and administrative expenses. Losses
related to our development of regenerative cell technology are expected to
keep
us in a loss position on a consolidated basis for several years. We anticipate
that our recurring operating expenses will be at high levels for the next
few
years, due to the continued need to fund our clinical research program as
well
as additional pre-clinical research.
Our
business strategy is high-risk
We
are
focusing our resources and efforts primarily on our regenerative cell technology
and its cash needs for research and development activities. This is a high-risk
strategy because there can be no assurance that our regenerative cell technology
will ever be developed into commercially viable products (commercial risk),
that
we will be able to preclude other companies from depriving us of market share
and profit margins by selling products based on our inventions and developments
(legal risk), that we will be able to successfully manage a company in a
different business and on a different scale than we have operated in the
past
(operational risk), that we will be able to achieve the desired therapeutic
results using regenerative cells (scientific risk), or that our cash resources
will be adequate to develop the regenerative cell technology until it becomes
profitable, if ever (financial risk). We are using our cash in one of the
riskiest industries in the economy (strategic risk). This may make our stock
an
unsuitable investment for some investors.
The
financial risk in this strategy is significant, particularly since our
bioresorbable products are not currently independently cash-flow-positive.
Our
spine and orthopedics implants business has declined significantly nd we
are
actively pursuing a buyer (or buyers) for this line of business.
We
must keep our joint venture with Olympus operating smoothly
Our
regenerative cell business cannot succeed on the current timelines unless
our
joint venture collaboration with Olympus goes well. We have given
Olympus-Cytori, Inc. an exclusive license to our regenerative cell therapeutic
device technology for use in future generation devices. If Olympus-Cytori,
Inc.
does not successfully develop and manufacture future generation devices for
sale
to us, we may not be able to commercialize any device or any therapeutic
products successfully into the market. In addition, any future disruption
in or
breakup of our relationship with Olympus would be extremely costly to our
reputation, in addition to causing many serious practical problems.
We
and
Olympus must overcome contractual and cultural barriers as we work together.
Our
relationship is formally measured by a set of complex contracts, which have
not
yet been tested in practice. In addition, many aspects of the relationship
will
be essentially non-contractual and must be worked out between the parties
and
the responsible individuals over time. The Joint Venture is intended to have
a
long life, and it is difficult to maintain cooperative relationships over
a long
period of time from a far distance in the face of various kinds of change.
Cultural differences, including a language barrier to some degree, may affect
the efficiency of the relationship as well.
Olympus-Cytori,
Inc. is 50% owned by us and 50% owned by Olympus. By contract, each side
must
consent before any of a wide variety of important business actions can occur.
This situation possesses a risk of potentially time-consuming and difficult
negotiations which could at some point delay the Joint Venture from pursuing
its
business strategies.
Olympus
is entitled to designate the Joint Venture's chief executive officer and
a
majority of its board of directors, which means that day-to-day decisions
which
are not subject to a contractual veto will essentially be controlled by Olympus.
In addition, Olympus-Cytori, Inc. will need more money than its initial
capitalization in order to finalize development of and production of the
future
generation devices. If we are unable to help provide future financing for
Olympus-Cytori, Inc., our relative equity interest in Olympus-Cytori, Inc.
may
decrease.
Furthermore,
under a License/Joint Development Agreement among Olympus-Cytori, Inc., Olympus,
and us, Olympus will have a primary role in the development of Olympus-Cytori,
Inc.’s future generation devices. Although Olympus has extensive experience in
developing medical devices, this arrangement will result in a reduction of
our
control over the development and manufacturing of the future generation
devices.
We
rely on Medtronic to distribute our spine and orthopedics biomaterials products,
but Medtronic’s level of commitment to our products historically has been poor
and we are not succeeding in this line of business
We
have
limited control over sales, marketing, and distribution of our biomaterials
products. Our strategy for sales and marketing of our bioresorbable products
included entering into an agreement with Medtronic, a company with a large
distribution network, to market many of our current and certain future products
incorporating our technology. The sale of hard-tissue-fixation bioresorbable
implant products to our distribution partner, Medtronic, has constituted
the
majority of our revenues.
We
remain
significantly dependent on Medtronic to generate sales revenues for all of
our
spine and orthopedics bioresorbable products. The amount and timing of resources
which may be devoted to the performance of Medtronic’s contractual
responsibilities are not within our control. There can be no guarantee that
Medtronic will perform its obligations as expected or pay us any additional
option or license fees. There is also no guarantee that it will market any
new
products under the distribution agreements or that we will derive any
significant revenue from such arrangements. Medtronic’s sale of our products to
end customers in 2004 through 2007, and its rate of product orders placed
with
us in the same periods, disappointed our expectations.
We
remain
significantly disappointed with the marketing efforts of Medtronic for our
non-MYSTIQUE™ products at this time. We recorded an inventory provision for
slow-moving non-MYSTIQUE™ inventory in the second, third, and fourth quarters of
2005 as well as in the second and third quarters of 2006. We are also becoming
concerned about Medtronic’s commitment to MYSTIQUE™.
Our
dependence upon Medtronic to market and sell our bioresorbable products places
us in a position where we cannot accurately predict the extent to which our
products will be actively and effectively marketed, depriving us of some
of the
reliable data we need to make optimal operational and strategic decisions.
The
results of this business line in each year from 2004 through 2007 have been
below our internal expectations.
Although
Medtronic has exclusive distribution rights to our co-developed spinal implants,
it also distributes other products that are competitive to ours. Medtronic
might
choose to develop and distribute existing or alternative technologies in
preference to our technology in the spine, or preferentially market competitive
products that can achieve higher profit margins. We suspect that this has
in
fact been happening.
There
can
be no assurance that our interests will coincide with those of Medtronic
or that
disagreement over rights or technology or other proprietary interests will
not
occur. The loss of the marketing services provided by Medtronic (or the failure
of Medtronic to satisfactorily perform these marketing services), or the
loss of
revenues generated by Medtronic, could have a substantial negative effect
on our
ability or willingness to continue our spine and orthopedics biomaterials
business. Indeed, it seems the problems we have already experienced with
Medtronic may be intractable. Accordingly, we are actively seeking divestiture
or other strategic alternatives for the business.
Senko
has
not yet begun to distribute our Thin Film products in Japan; and if and when
they do, we cannot be assured that they will be successful.
We
have a limited operating history; our operating results can be
volatile
Our
prospects must be evaluated in light of the risks and difficulties frequently
encountered by emerging companies and particularly by such companies in rapidly
evolving and technologically advanced fields such as the biotechnology and
medical device fields. Due to our limited operating history, and the development
stage status of our regenerative cell business, comparisons of our year-to-year
operating results are not necessarily meaningful and the results for any
periods
should not necessarily be relied upon as an indication of future performance.
Since our limited operating history makes the prediction of future results
difficult or impossible, our recent revenue results should not be taken as
an
indication of any future growth or of a sustainable level of revenue. Operating
results will also be affected by our transition away from our revenue-generating
medical device business and the focus of the vast majority of our resources
into
the development of the regenerative cell business.
Moreover,
our operating results can vary substantially from our previously published
financial guidance (such as occurred in the second quarter of 2004), from
analyst expectations, and from previous periodic results for many reasons,
including the timing of product introductions and distributor purchase orders.
Also, our stock price is likely to be disproportionately affected by changes
which generally affect the economy, the stock market, or the medical device
and
biotechnology industries.
From
time
to time, we have tried to influence our investors’ expectations as to our
operating results by periodically announcing financial guidance. However,
we
have in the past been forced to revise or withdraw such guidance due to lack
of
visibility and predictability of product demand. This lack of visibility
and
predictability of product demand for our bioresorbable implant products is
likely to occur in the future as well.
We
are
vulnerable to competition and technological change, and also to physicians’
inertia
We
compete with many domestic and foreign companies in developing our technology
and products, including biotechnical, medical device, pharmaceutical, and
biopharmaceutical companies. Many of our competitors and potential competitors
have substantially greater financial, technological, research and development,
marketing, and personnel resources than we do. There can be no assurance
that
our competitors will not succeed in developing alternative technologies and
products that are more effective, easier to use, or more economical than
those
which we have developed or are in the process of developing, or that would
render our technology and products obsolete and non-competitive in these
fields.
In general, we may not be able to preclude other companies from developing
and
marketing competitive regenerative cell therapies or bioresorbable products
that
are similar to ours or perform similar functions.
These
competitors may also have greater experience in developing therapeutic
treatments, conducting clinical trials, obtaining regulatory clearances or
approvals, manufacturing and commercializing therapeutic or biomaterials
products. It is possible that certain of these competitors may obtain patent
protection, approval, or clearance from the FDA or achieve commercialization
earlier than we, any of which could have a substantial negative effect on
our
business. Finally, Olympus, Medtronic and our other partners might pursue
parallel development of other technologies or products, which may result
in a
partner developing additional products that will compete with our
products.
We
also
compete with other types of regenerative cell therapies, such as bone
marrow-derived cell therapies and potentially embryonic-derived therapies.
Our
biomaterials business competes with manufacturers of traditional
non-bioresorbable implants, such as titanium implants. Doctors have historically
been slow to adopt new technologies such as ours, whatever the merits, when
older technologies continue to be supported by established providers. Overcoming
such inertia often requires very significant marketing expenditures or
definitive product superiority.
We
expect
physicians’ inertia and skepticism to also be a significant barrier as we
attempt to gain market penetration with our future regenerative cell products.
We believe we will need to finance lengthy time-consuming clinical studies
(so
as to provide convincing evidence of the medical benefit) in order to overcome
this inertia and skepticism.
Our
regenerative cell technology products are pre-commercialization, which subjects
us to development and marketing risks
We
are in
a relatively early stage of the path to commercialization with many of our
products. We believe that our long-term viability and growth will depend
in
large part on our ability to develop commercial quality cell processing devices
and useful procedure-specific consumables, and to establish the safety and
efficacy of our therapies through clinical trials and studies. We are presently
pursuing therapies for cardiovascular disease as well as new approaches for
aesthetic and reconstructive surgery, gastrointestinal disorders and spine
and
orthopedic conditions. There can be no assurance that our development programs
will be successfully completed or that required regulatory clearances or
approvals will be obtained on a timely basis, if at all.
There
is
no proven path for commercializing our regenerative cell technology in a
way to
earn a durable profit commensurate with the medical benefit. Although we
are
working to develop proprietary therapeutic products which optimize or enhance
the benefit of autologous stem and regenerative cells for a variety of
particular indications, most of our cell-related products and/or services
are at
least two to five years away.
Moreover,
the successful development and market acceptance of our technologies and
products are subject to inherent developmental risks, including failure of
inventive imagination, ineffectiveness or lack of safety, unreliability,
failure
to receive necessary regulatory clearances or approvals, high commercial
cost,
and preclusion or obsolescence resulting from third parties’ proprietary rights
or superior or equivalent products, and competition from copycat products,
as
well as general economic conditions affecting purchasing patterns. There
can be
no assurance that we or our partners will be able to successfully develop
and
commercialize our technologies or products, or that our competitors will
not
develop competing technologies that are less expensive or otherwise superior
to
ours. The failure to successfully develop and market our new regenerative
cell
technologies would have a substantial negative effect on our results of
operations and financial condition.
We
have limited manufacturing experience
We
have
no experience in manufacturing the Celution™ System at a commercial level, and
although Olympus is a highly capable and experienced manufacturer of medical
devices, there can be no guarantee that the Olympus-Cytori joint venture
will be
able to successfully develop and manufacture the Celution™ System in a manner
that is cost-effective or commercially viable, or that development and
manufacturing capabilities might not take much longer than currently anticipated
to be ready for the market.
In
the
event that the Olympus-Cytori joint venture is not successful, Cytori may
not
have the resources or ability to self-manufacture commercially viable devices,
and in any event this failure may substantially extend the time it would
take
for us to bring a commercial device to market. This makes us significantly
dependant on the continued dedication and skill of Olympus for the successful
development of the Celution™ System.
In
addition, as a company we have limited experience in manufacturing the type
of
cell-related therapeutic products which we intend to introduce in 2008.
In
addition, the future of our biomaterials business success is significantly
dependent on our ability to manufacture our bioresorbable implants in commercial
quantities, in compliance with regulatory requirements, and in a cost-effective
manner. Production of some of our products in commercial-scale quantities
may
involve unforeseen technical challenges and may require significant scale-up
expenses for additions to facilities and personnel. There can be no guarantee
that we will be able to achieve large-scale manufacturing capabilities for
some
of our biomaterials products or that we will be able to manufacture these
products in a cost-effective manner or in quantities necessary to allow us
to
achieve profitability. Our 2002 sale of CMF production assets to Medtronic
and
our 2004 sale of the (non-Japan) Thin Film product line deprived us of some
economies of scale in manufacturing. Current demand for spine and orthopedics
products from Medtronic is so low that economies of scale are lacking in
regard
to that product line as well.
We
have to maintain quality assurance certification and manufacturing
approvals
The
manufacture of our bioresorbable products is, and the manufacture of the
Celution™ System for regenerative cells will be, and the manufacture of any
future cell-related therapeutic products would be, subject to periodic
inspection by regulatory authorities and distribution partners. The manufacture
of devices and products for human use is subject to regulation and inspection
from time to time by the FDA for compliance with the FDA’s Quality System
Regulation (“QSR”) requirements, as well as equivalent requirements and
inspections by state and non-U.S. regulatory authorities. There can be no
guarantee that the FDA or other authorities will not, during the course of
an
inspection of existing or new facilities, identify what they consider to
be
deficiencies in our compliance with QSRs or other requirements and request,
or
seek, remedial action.
Failure
to comply with such regulations or a potential delay in attaining compliance
may
adversely affect our manufacturing activities and could result in, among
other
things, injunctions, civil penalties, FDA refusal to grant pre-market approvals
or clearances of future or pending product submissions, fines, recalls or
seizures of products, total or partial suspensions of production, and criminal
prosecution. There can be no assurance that we will be able to obtain additional
necessary regulatory approvals or clearances on a timely basis, if at all.
Delays in receipt of or failure to receive such approvals or clearances,
or the
loss of previously received approvals or clearances could have a substantial
negative effect on our results of operations and financial
condition.
We
depend on a sole source supplier for our crucial raw material for our
bioresorbable products
We
currently purchase the high molecular weight, medical grade, lactic acid
copolymer used in manufacturing most of our bioresorbable products from a
single
qualified source. Although we have a contract with B.I. Chemicals, Inc.,
which
guarantees continuation of supply through August 15, 2008, we cannot guarantee
that they will elect to continue the contract beyond that date, or that they
will not elect to discontinue the manufacture of the material. They have
agreed
that if they discontinue manufacturing, they will either find a replacement
supplier, or provide us with the necessary technology to self-manufacture
the
material, either of which could mean a substantial increase in material costs.
Also, despite this agreement, they might fail to do these things for us.
Under
the terms of the contract, B.I. Chemicals, Inc. may choose to raise their
prices
upon six months’ prior notice, which may also result in a substantially
increased material cost. Although we believe that we would be able to obtain
the
material from at least one other source in the event of a failure of supply,
there can be no assurance that we will be able to obtain adequate increased
commercial quantities of the necessary high quality within a reasonable period
of time or at commercially reasonable rates. Lack of adequate commercial
quantities or the inability to develop alternative sources meeting regulatory
requirements at similar prices and terms within a reasonable time, or any
interruptions in supply in the future could have a significant negative effect
on our ability to manufacture products and, consequently, could have a material
adverse effect on our results of operations and financial
condition.
We
may
not be able to protect our proprietary rights
Our
success depends in part on whether we can obtain additional patents, maintain
trade secret protection, and operate without infringing on the proprietary
rights of third parties.
Our
recently amended regenerative cell technology license agreement with the
Regents
of the University of California contains certain developmental milestones,
which
if not achieved could result in the loss of exclusivity or loss of the license
rights. The loss of such rights could impact our ability to develop certain
regenerative cell technology products. Also, our power as licensee to
successfully use these rights to exclude competitors from the market is
untested. In addition, further legal risk arises from a lawsuit filed by
the
University of Pittsburgh naming all of the inventors who had not assigned
their
ownership interest in Patent 6,777,231 to the University of Pittsburgh, seeking
a determination that its assignors, rather than the University of California’s
assignors, are the true inventors of Patent 6,777,231. We are the exclusive,
worldwide licensee of the University of California’s rights under this patent,
which relates to adult stem cells isolated from adipose tissue that can
differentiate into two or more of a variety of cell types. If the University
of
Pittsburgh wins the lawsuit, our license rights to this patent could be
nullified or rendered non-exclusive with respect to any third party that
might
license rights from the University of Pittsburgh, and our regenerative cell
strategy could be impacted.
We
have
various U.S. patents for the design of our bioresorbable plates and high
torque
screws and devices and we have filed applications for numerous additional
U.S.
patents, as well as certain corresponding patent applications outside the
United
States of America, relating to our technology. However, we believe we cannot
patent our use of the lactic acid copolymer for surgical implants, nor are
many
of our particular implants generally patentable.
There
can
be no assurance that any of the pending patent applications will be approved
or
that we will develop additional proprietary products that are patentable.
There
is also no assurance that any patents issued to us will provide us with
competitive advantages, will not be challenged by any third parties, or that
the
patents of others will not prevent the commercialization of products
incorporating our technology. Furthermore, there can be no guarantee that
others
will not independently develop similar products, duplicate any of our products,
or design around our patents.
Our
commercial success will also depend, in part, on our ability to avoid infringing
on patents issued to others. If we were judicially determined to be infringing
on any third-party patent, we could be required to pay damages, alter our
products or processes, obtain licenses, or cease certain activities. If we
are
required in the future to obtain any licenses from third parties for some
of our
products, there can be no guarantee that we would be able to do so on
commercially favorable terms, if at all. U.S. patent applications are not
immediately made public, so we might be surprised by the grant to someone
else
of a patent on a technology we are actively using. As noted above as to the
University of Pittsburgh lawsuit, even patents issued to us or our licensors
might be judicially determined to belong in full or in part to third
parties.
Litigation,
which would result in substantial costs to us and diversion of effort on
our
part, may be necessary to enforce or confirm the ownership of any patents
issued
or licensed to us, or to determine the scope and validity of third-party
proprietary rights. If our competitors claim technology also claimed by us
and
prepare and file patent applications in the United States of America, we
may
have to participate in interference proceedings declared by the U.S. Patent
and
Trademark Office or a foreign patent office to determine priority of invention,
which could result in substantial costs to and diversion of effort, even
if the
eventual outcome is favorable to us.
Any
such
litigation or interference proceeding, regardless of outcome, could be expensive
and time-consuming. We have been incurring substantial legal costs as a result
of the University of Pittsburgh lawsuit, and our president, Marc Hedrick,
is a
named individual defendant in that lawsuit because he is one of the inventors
identified on the patent. As a named inventor on the patent, Marc Hedrick
is
entitled to receive from the Regents of the University of California up to
7% of
royalty payments made by a licensee (us) to the Regents of the University
of
California. This agreement was in place prior to his employment with
us.
In
addition to patents, which alone may not be able to protect the fundamentals
of
our regenerative cell and bioresorbable businesses, we also rely on unpatented
trade secrets and proprietary technological expertise. Our intended future
cell-related therapeutic products, such as a consumables, are likely to fall
largely into this category. We rely, in part, on confidentiality agreements
with
our partners, employees, advisors, vendors, and consultants to protect our
trade
secrets and proprietary technological expertise. There can be no guarantee
that
these agreements will not be breached, or that we will have adequate remedies
for any breach, or that our unpatented trade secrets and proprietary
technological expertise will not otherwise become known or be independently
discovered by competitors.
Failure
to obtain or maintain patent protection, or protect trade secrets, for any
reason (or third-party claims against our patents, trade secrets, or proprietary
rights, or our involvement in disputes over our patents, trade secrets, or
proprietary rights, including involvement in litigation), could have a
substantial negative effect on our results of operations and financial
condition.
We
may
not be able to protect our intellectual property in countries outside the
United
States of America
Intellectual
property law outside the United States of America is uncertain and in many
countries is currently undergoing review and revisions. The laws of some
countries do not protect our patent and other intellectual property rights
to
the same extent as United States of America laws. We currently have pending
patent applications in Europe, Australia, Japan, Canada, China, Korea, and
Singapore, among others.
We
are, and Olympus-Cytori, Inc. will be, subject to intensive FDA
regulation
As
newly
developed medical devices, our and Olympus-Cytori’s regenerative cell
harvesting, isolation and delivery devices, and our bioresorbable implants
must
receive regulatory clearances or approvals from the FDA and, in many instances,
from non-U.S. and state governments prior to their sale. Our and
Olympus-Cytori’s current and future regenerative cell harvesting, isolation and
delivery devices and bioresorbable implants are subject to stringent government
regulation in the United States of America by the FDA under the Federal Food,
Drug and Cosmetic Act. The FDA regulates the design/development process,
clinical testing, manufacture, safety, labeling, sale, distribution, and
promotion of medical devices and drugs. Included among these regulations
are
pre-market clearance and pre-market approval requirements, design control
requirements, and the Quality System Regulations/Good Manufacturing Practices.
Other statutory and regulatory requirements govern, among other things,
establishment registration and inspection, medical device listing, prohibitions
against misbranding and adulteration, labeling and post-market
reporting.
The
regulatory process can be lengthy, expensive, and uncertain. Before any new
medical device may be introduced to the United States of America market,
the
manufacturer generally must obtain FDA clearance or approval through either
the
510(k) pre-market notification process or the lengthier pre-market approval
application (“PMA”) process. It generally takes from three to 12 months from
submission to obtain 510(k) pre-market clearance, although it may take longer.
Approval of a PMA could take four or more years from the time the process
is
initiated. The 510(k) and PMA processes can be expensive, uncertain, and
lengthy, and there is no guarantee of ultimate clearance or approval. We
expect
that some of our future products under development as well as Olympus-Cytori’s
will be subject to the lengthier PMA process. Securing FDA clearances and
approvals may require the submission of extensive clinical data and supporting
information to the FDA, and there can be no guarantee of ultimate clearance
or
approval. Failure to comply with applicable requirements can result in
application integrity proceedings, fines, recalls or seizures of products,
injunctions, civil penalties, total or partial suspensions of production,
withdrawals of existing product approvals or clearances, refusals to approve
or
clear new applications or notifications, and criminal prosecution.
Medical
devices are also subject to post-market reporting requirements for deaths
or
serious injuries when the device may have caused or contributed to the death
or
serious injury, and for certain device malfunctions that would be likely
to
cause or contribute to a death or serious injury if the malfunction were
to
recur. If safety or effectiveness problems occur after the product reaches
the
market, the FDA may take steps to prevent or limit further marketing of the
product. Additionally, the FDA actively enforces regulations prohibiting
marketing and promotion of devices for indications or uses that have not
been
cleared or approved by the FDA.
There
can
be no guarantee that we will be able to obtain the necessary 510(k) clearances
or PMA approvals to market and manufacture our other products in the United
States of America for their intended use on a timely basis, if at all. Delays
in
receipt of or failure to receive such clearances or approvals, the loss of
previously received clearances or approvals, or failure to comply with existing
or future regulatory requirements could have a substantial negative effect
on
our results of operations and financial condition.
To
sell in international markets, we will be subject to intensive regulation
in
foreign countries
In
cooperation with our distribution partners, we intend to market our current
and
future products both domestically and in many foreign markets. A number of
risks
are inherent in international transactions. In order for us to market our
products in Europe, Canada, Japan and certain other non-U.S. jurisdictions,
we
need to obtain and maintain required regulatory approvals or clearances and
must
comply with extensive regulations regarding safety, manufacturing processes
and
quality. For example, we still have not obtained regulatory approval for
our
Thin Film products in Japan. These regulations, including the requirements
for
approvals or clearances to market, may differ from the FDA regulatory scheme.
International sales also may be limited or disrupted by political instability,
price controls, trade restrictions and changes in tariffs. Additionally,
fluctuations in currency exchange rates may adversely affect demand for our
products by increasing the price of our products in the currency of the
countries in which the products are sold.
There
can
be no assurance that we will obtain regulatory approvals or clearances in
all of
the countries where we intend to market our products, or that we will not
incur
significant costs in obtaining or maintaining foreign regulatory approvals
or
clearances, or that we will be able to successfully commercialize current
or
future products in various foreign markets. Delays in receipt of approvals
or
clearances to market our products in foreign countries, failure to receive
such
approvals or clearances or the future loss of previously received approvals
or
clearances could have a substantial negative effect on our results of operations
and financial condition.
We
depend on a few key officers
Our
performance is substantially dependent on the performance of our executive
officers and other key scientific staff, including Christopher J. Calhoun,
our
Chief Executive Officer, and Marc Hedrick, MD, our President. We rely upon
them
for strategic business decisions and guidance. We believe that our future
success in developing marketable products and achieving a competitive position
will depend in large part upon whether we can attract and retain additional
qualified management and scientific personnel. Competition for such personnel
is
intense, and there can be no assurance that we will be able to continue to
attract and retain such personnel. The loss of the services of one or more
of
our executive officers or key scientific staff or the inability to attract
and
retain additional personnel and develop expertise as needed could have a
substantial negative effect on our results of operations and financial
condition. Two executive officers left us in 2006, one in connection with
a
summer 2006 reduction of our headcount by 18%.
Companies
which make personnel cuts sometimes find the resulting loss of experience
and
lack of coverage can cause important business problems.
We
may
not have enough product liability insurance
The
testing, manufacturing, marketing, and sale of our regenerative cell and
bioresorbable implant products involve an inherent risk that product liability
claims will be asserted against us, our distribution partners, or licensees.
There can be no guarantee that our clinical trial and commercial product
liability insurance is adequate or will continue to be available in sufficient
amounts or at an acceptable cost, if at all. A product liability claim, product
recall, or other claim, as well as any claims for uninsured liabilities or
in
excess of insured liabilities, could have a substantial negative effect on
our
results of operations and financial condition. Also, well-publicized claims
could cause our stock to fall sharply, even before the merits of the claims
are
decided by a court.
Our
charter documents contain anti-takeover provisions and we have adopted a
Stockholder Rights Plan to prevent hostile takeovers
Our
Amended and Restated Certificate of Incorporation and Bylaws contain certain
provisions that could prevent or delay the acquisition of the Company by
means
of a tender offer, proxy contest, or otherwise. They could discourage a third
party from attempting to acquire control of the Company, even if such events
would be beneficial to the interests of our stockholders. Such provisions
may
have the effect of delaying, deferring, or preventing a change of control
of the
Company and consequently could adversely affect the market price of our shares.
Also, in 2003 we adopted a Stockholder Rights Plan, of the kind often referred
to as a poison pill. The purpose of the Stockholder Rights Plan is to prevent
coercive takeover tactics that may otherwise be utilized in takeover attempts.
The existence of such a rights plan may also prevent or delay a change in
control of the Company, and this prevention or delay adversely affect the
market
price of our shares.
We
pay
no dividends
We
currently do not intend to pay any cash dividends for the foreseeable future.
None
None
Item
5. Other
Information
Material
Agreements
None
Properties
On
May
24, 2005, we entered into a lease for 91,000 square feet located at 3020
and
3030 Callan Road, San Diego, California. We moved the majority of our operations
to this new facility during the second half of 2005 and the first quarter
of
2006. The agreement bears rent at a rate of $1.15 per square foot, with annual
increases of 3%. The lease term is 57 months, commencing on October 1, 2005
and
expiring on June 30, 2010.
Our
lease
on the facility located at 6740 Top Gun Street, San Diego, California was
amended and terminated on December 31, 2006. We will continue to occupy a
portion of the building and pay rent to the new lessee until June 30, 2007.
We
also lease 4,027 square feet of office space located at 9-3 Otsuka 2-chome,
Bunkyo-ku, Tokyo, Japan. The agreement bears rent at a rate of $3.66 per
square
foot, expiring on November 30, 2007.
On
the
properties stated above, we pay an aggregate of approximately $193,000 in
rent
per month.
Staff
As
of
March 31, 2007, we had 130 full-time equivalent employees, comprised of 4
employees in manufacturing, 83 employees in research and development, 6
employees in sales and marketing, and 37 employees in management and finance
and
administration. From time to time, we also employ independent contractors
to
support our administrative organizations. Our employees are not represented
by
any collective bargaining unit and we have never experienced a work stoppage.
A
breakout by segment is as follows:
|
Regenerative
Cell Technology
|
MacroPore
Biosurgery
|
Corporate
|
Total
|
||||||||||
|
Manufacturing
|
—
|
4
|
—
|
4
|
|||||||||
|
Research
& Development
|
82
|
1
|
—
|
83
|
|||||||||
|
Sales
and Marketing
|
6
|
—
|
—
|
6
|
|||||||||
|
General
& Administrative
|
—
|
—
|
37
|
37
|
|||||||||
|
Total
|
88
|
5
|
37
|
130
|
|||||||||
|
10.42
|
Placement
Agency Agreement, dated August 9, 2006, between Cytori Therapeutics,
Inc.
and Piper Jaffray & Co. (filed as Exhibit 10.34 to our Form 8-K
Current Report as filed on August 15, 2006 and incorporated by
reference
herein)
|
|
10.43
|
Financial
Services Advisory Engagement Letter, between Cytori Therapeutics,
Inc. and
WBB Securities, LLC.(filed as Exhibit 10.2 to our Form 8-K Current
Report
as filed on February 26, 2007 and incorporated by reference
herein)
|
|
10.44
|
Form
of Subscription Agreement, between Cytori Therapeutics, Inc.
and Investor
(filed as part of the Free Writing Prospectus as filed on February
26,
2007 and incorporated by reference herein)
|
|
10.45
|
Form
of Warrant (filed as part of the Free Writing Prospectus as filed
on
February 26, 2007 and incorporated by reference herein)
|
|
10.46
|
Common
Stock Purchase Agreement, dated March 28, 2007, between Cytori
Therapeutics, Inc. and Green Hospital Supply, Inc. (filed
herewith)
|
|
15.1
|
Letter
re unaudited interim financial information.
|
|
31.1
|
Certification
of Chief Executive Officer Pursuant to Securities Exchange Act
Rule
13a-14(a), as Adopted Pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002.
|
|
31.2
|
Certification
of Chief Financial Officer Pursuant to Securities Exchange Act
Rule
13a-14(a), as Adopted Pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002.
|
|
32.1
|
Certification
pursuant to 18 U.S.C. Section 1350/ Securities Exchange Act Rule
13a-14(b), as Adopted Pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002.
|
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 the undersigned thereunto
duly authorized, in San Diego, California, on May 11, 2007.
|
CYTORI
THERAPEUTICS, INC.
|
||
|
By:
|
/s/
Christopher J. Calhoun
|
|
|
Dated:
May 11, 2007
|
Christopher
J. Calhoun
|
|
|
Chief
Executive Officer
|
||
|
By:
|
/s/
Mark E. Saad
|
|
|
Dated:
May 11, 2007
|
Mark
E. Saad
|
|
|
Chief
Financial Officer
|
||