NOTES
TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
MARCH
31, 2007
(UNAUDITED)
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.
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.
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
|
|
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.
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.
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.
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.
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.
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:
|
·
|
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:
|
|
·
|
O
ur
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,
|
|
·
|
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,
|
|
·
|
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:
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A
distribution license fee (which was paid at the outset of the
arrangement),
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Milestone
payments for achieving commercialization of the Thin Film product
line in
Japan,
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Training
for representatives of Senko,
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Sales
of Thin Film products to Senko, and
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Payments
in the nature of royalties on future product sales made by Senko
to its
end customers.
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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:
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The
delivered element has stand-alone value to the customer,
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There
is objective evidence of the fair value of the remaining undelivered
elements, and
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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.
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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:
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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
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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.
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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:
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Upfront
License Fees/Milestones
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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.
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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.
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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:
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Qualifying
costs incurred (and not previously recognized), plus any allowable
grant
fees, for which Cytori is entitled to grant funding;
or,
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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.
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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.
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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:
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Company
assets and liabilities, including goodwill, are allocated to each
reporting unit for purposes of completing the goodwill impairment
test.
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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.
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If
the fair value of the reporting unit is lower than its carrying amount,
goodwill may be impaired - additional testing is required.
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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:
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The
asset will be employed in or the liability relates to the operations
of a
reporting unit.
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The
asset or liability will be considered in determining the fair value
of the
reporting unit.
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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:
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Provide
training to MAST personnel on production and other aspects of the
Thin
Film product lines, and
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Provide
a back-up supply of Thin Film products to MAST, at cost, for a specified
period of time.
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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:
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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.
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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.
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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:
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The
business operations of the Joint Venture will be most closely aligned
to
those of Olympus (i.e., the manufacture of devices),
and
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Olympus
controls the Board of Directors, as well as the day-to-day operations
of
the Joint Venture.
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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.