ITEM 2 — Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis of our financial condition and results of operations should be read together with our financial statements and related notes appearing elsewhere in this Quarterly Report on Form 10-Q and our Prospectus filed pursuant to Rule 424(b) under the Securities Act of 1933, as amended (the “Securities Act”), with the Securities and Exchange Commission (the “SEC”) on April 7, 2011.
Forward Looking Statements
This quarterly report on Form 10-Q contains “forward-looking statements” that involve risks and uncertainties, as well as assumptions that, if they never materialize or prove incorrect could cause our results to differ materially from those expressed or implied by such forward-looking statements. The statements contained in this Quarterly Report on Form 10-Q that are not purely historical are forward-looking statements within the meaning of Section 27A of the Securities Act and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Forward-looking statements are often identified by the use of words such as, but not limited to, “anticipate,” “believe, “can,” “continue,” “could,” “estimate,” “expect,” “intend,” “may,” “will,” “plan,” “project,” “seek,” “should” “target,” “will,” “would,” and similar expressions or variations intended to identify forward-looking statements. These statements are based on the beliefs and assumptions of our management based on information currently available to management. Such forward-looking statements are subject to risks, uncertainties and other important factors that could cause actual results and the timing of certain events to differ materially from future results expressed or implied by such forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those identified below, and those discussed in the section titled “Risk Factors” included in our Prospectus filed pursuant to Rule 424(b) under the Securities Act with the SEC on April 7, 2011. Furthermore, such forward-looking statements speak only as of the date of this report. Except as required by law, we undertake no obligation to update any forward-looking statements to reflect events or circumstances after the date of such statements.
Overview
We are an autologous protein-therapeutics medical technology company, developing our Biopump Platform Technology to provide sustained protein therapy to potentially treat a range of chronic diseases and conditions.
Since our inception on January 27, 2000, we have focused our efforts on research and development and clinical trials and have received no revenue from product sales. We have funded our operations principally through equity and debt financings, participation from the Office of the Chief Scientist (“OCS”) in Israel and a collaborative agreement. Our operations to date have been primarily limited to organizing and staffing our company, developing the Biopump Platform Technology and its applications, developing and initiating clinical trials for our product candidates, and improving and maintaining our patent portfolio.
We have generated significant losses to date, and we expect to continue to generate losses as we progress towards the commercialization of our product candidates. We have incurred net losses of approximately $6.09 million and $47.92 million for the nine month period ended September 30, 2011 and for the period from inception through September 30, 2011, respectively. As of September 30, 2011, we had stockholders’ equity of approximately $4.68 million. We are unable to predict the extent of any future losses or when we will become profitable, if at all.
Although we have not yet generated revenues from product sales, we have begun generating income from partnering on development programs and we expect to continue to expand our partnering activity.
In October 2009, we signed a preclinical development and option agreement with a major international healthcare company that is a market leader in the field of hemophilia, representing our first collaboration agreement for the Biopump Platform Technology. Pursuant to this agreement, the healthcare company provided funding for preclinical development of our Biopump Platform Technology to produce and deliver the clotting protein Factor VIII for the sustained treatment of hemophilia. Under the terms of the collaboration agreement, we received $3.97 million. In October 2010 and July 2011, we and the healthcare company agreed on extensions of the agreement. During the extension periods, we assumed most of the funding responsibilities. During the term of the agreement, as extended, the healthcare company had the exclusive option, with an exercise price of $2.50 million, to negotiate a definitive agreement regarding a transaction related to the Factor VIII Biopump technology taking into account the relative contributions of the parties. Under the second extension, confirmatory studies were conducted implanting Factor VIII Biopumps in mice. The healthcare company agreed to bear $75,000 of the costs of these studies. The agreement, as extended, expired on September 30, 2011. We are in active discussions with the healthcare company regarding the terms for possible further collaboration.
United States Initial Public Offering (“IPO”):
On April 13, 2011 we completed the IPO of our Common stock and redeemable Common stock purchase warrants, both listed on the NYSE Amex. We issued 2,624,100 shares of Common stock, including 164,100 shares pursuant to the exercise of the underwriters’ over-allotment option, at a price of $4.54 per share and redeemable Common Stock purchase warrants to purchase 2,829,000 shares including 369,000 warrants pursuant to the exercise of the underwriters’ over-allotment option, at a price of $0.46 per warrant for total gross proceeds of $13.21 million or approximately $10.39 million in net proceeds after deducting underwriting discounts and commissions of $1.45 million and other offering costs of approximately $1.37 million.
On the closing date of the IPO (April 13, 2011), $0.57 million of 2009 Debentures were automatically converted at a conversion price of $2.724 per share of Common stock into an aggregate 209,656 shares of Common stock and we issued 5-year warrants to purchase 84,693 shares of Common stock at an initial exercise price of $4.99 per share in connection with the conversion of the 2009 Debentures. On the same date, $4.00 million of 2010 Debentures were automatically converted at a conversion price of $3.405 per share of Common stock into an aggregate 1,198,242 shares of Common stock.
In connection with the Company’s IPO, the exercise price of certain warrants and options which were initially issued with round-down protection mechanism were adjusted based upon the share value as determined in the IPO.
Financial Operations Overview
Research and Development Expense
Research and development expense from inception through September 30, 2011 consists of: (i) internal costs associated with our development activities; (ii) payments we make to third party contract research organizations, contract manufacturers, investigative sites, and consultants; (iii) technology and intellectual property license costs; (iv) manufacturing development costs; (v) personnel related expenses, including salaries, benefits, travel, and related costs for the personnel involved in product development; (vi) activities related to regulatory filings and the advancement of our product candidates through preclinical studies and clinical trials; and (vii) facilities and other allocated expenses, which include direct and allocated expenses for rent, facility maintenance, as well as laboratory and other supplies. All research and development costs are expensed as incurred.
Conducting a significant amount of development is central to our business model. Through September 30, 2011, we incurred approximately $28.96
million in gross research and development expenses since our inception on January 27, 2000. Product candidates in later-stage clinical development generally have higher development costs than those in earlier stages of development, primarily due to the significantly increased size and duration of the clinical trials. We plan to increase our research and development expenses for the foreseeable future in order to complete development of our two most advanced product candidates, the EPODURE Biopump and the INFRADURE Biopump, and our earlier-stage research and development projects.
The process of conducting pre-clinical studies and clinical trials necessary to obtain regulatory approval is costly and time consuming. The probability of success for each product candidate and clinical trial may be affected by a variety of factors, including, among others, the quality of the product candidate’s early clinical data, investment in the program, competition, manufacturing capabilities and commercial viability. As a result of these uncertainties, together with the uncertainty associated with clinical trial enrollments and the risks inherent in the development process, we are unable to determine the duration and completion costs of current or future clinical stages of our product candidates or when, or to what extent, we will generate revenues from the commercialization and sale of any of our product candidates. Development timelines, probability of success and development costs vary widely. We are currently focused on developing our most advanced product candidates, the EPODURE Biopump, the INFRADURE Biopump and the HEMODURE Biopump.
Research and development expenses are shown net of participation by third parties. The excess of the recognized amount received from the healthcare company over the amount of research and development expenses incurred during the relevant period for the project related to the collaboration agreement was recognized as other income within operating income.
General and Administrative Expense
General and administrative expense consists primarily of salaries and other related costs, including stock-based compensation expense, for persons serving in our executive, finance and accounting functions. Other general and administrative expense includes facility-related costs not otherwise included in research and development expense, costs associated with industry and trade shows, and professional fees for legal services and accounting services. We expect that our general and administrative expenses will increase as we add personnel and are subject to the reporting obligations applicable to public companies in the United States. Since our inception on January 27, 2000 through September 30, 2011, we spent $25.18 million on general and administrative expense.
Other Income
We have not generated any product revenue since our inception, but, since the signing of our first collaboration agreement on October 22, 2009, have received $3.90 million through September 30, 2011 of which $2.90 million has been recognized as other income. This amount represents the excess of payments received over the direct R&D costs related to the project under the collaborative agreement.
Financial income and expense
Financial expense consists primarily of convertible debentures valuations as well as warrant valuations, interest and amortization of beneficial conversion feature of convertible note, and interest incurred on debentures.
Financial income consists primarily of interest-earned on our cash and cash equivalents and marketable securities.
Results of Operations for the periods of Nine Months Ended September 30, 2011 and 2010
Research and Development Expenses, net
Gross research and development expenses for the nine months ended September 30, 2011 were $4.50 million, increasing from $2.38 million for the same period in 2010 due to an increase in the use of materials and sub-contractors in connection with our phase I/II EPODURE clinical trial in 2011, increased expenses in developing our Factor VIII Biopump, and preparations for the trial of INFRADURE, including the production of a GMP vector; as well as an increase in R&D personnel, and patent expenses.
Research and development expenses, net for the nine months ended September 30, 2011 were $3.57 million, increasing from $1.13 million for the same period in 2010. In addition to the increase in the gross R&D expenses, as detailed above, $0.94 million
participation from the OCS and a third party was recorded during this period, compared with $1.25 million received from the OCS and a third party in the comparative period in 2010.
General and Administrative Expenses
General and administrative expenses for the nine months ended September 30, 2011 were $3.71 million, decreasing slightly from $3.73 million for the same period in 2010.
Other Income
Other income for the nine months ended September 30, 2011 was zero as compared with $2.03 million for the same period in 2010. The income in 2010 was recognized in connection with our first collaboration agreement signed in October 2009. The excess of the recognized amount received from the healthcare company over the amount of research and development expenses incurred during the period for that agreement was reflected as other income.
Financial Income and Expenses
Financial expenses for the nine months ended September 30, 2011 were $0.20 million, decreasing from $1.38 million for the same period in 2010. This decrease of $1.18 million was mainly due the change in valuation of the convertible debentures.
Financial income for the nine months ended September 30, 2011 was $1.40 million, increasing from $0.96 million for the same period in 2010. The increase of $0.44 million was primarily due to the change in valuation of the warrant liability.
Results of Operations for the periods of Three Months Ended September 30, 2011 and 2010
Research and Development Expenses, net
Gross research and development expenses for the three months ended September 30, 2011 were $1.79 million, increasing from $1.01 million for the same period in 2010 due to an increase in the use of materials and sub-contractors in connection with our phase I/II EPODURE clinical trial in 2011, increased expenses in developing our Factor VIII Biopump, and preparations for the trial of INFRADURE, including the production of a GMP vector; as well as an increase in R&D personnel, and patent expenses.
Research and development expenses, net for the three months ended September 30, 2011 were $1.35 million, increasing from $0.44 million for the same period in 2010. The increase in the gross R&D expenses, as detailed above, was partially offset by
$0.43 million participation from the OCS and a third party recorded during this period, compared with $0.58 received from the OCS and a third party in the comparative period in 2010.
General and Administrative Expenses
General and administrative expenses for the three months ended September 30, 2011 were $1.88 million, decreasing from $2.62 million for the same period in 2010 primarily due to stock-based compensation and fundraising expenses recorded in the three months ended September 30, 2010.
Other Income
Other income for the three months ended September 30, 2011 was zero as compared with $0.73 million for the same period in 2010. The income in 2010 was recognized in connection with our first collaboration agreement signed in October 2009. As explained above, the excess of the recognized amount received from the healthcare company over the amount of research and development expenses incurred during the period for that agreement was reflected as other income.
Financial Income and Expenses
Financial expenses for the three months ended September 30, 2011 were $0.27 million, decreasing from $2.20 million for the same period in 2010. This decrease of $1.93 million was mainly due to the change in valuation of the warrant liability and the convertible debentures.
Financial income for the three months ended September 30, 2011 was $0.07 million, decreasing from $0.91 million for the same period in 2010. The decrease of $0.84 million was primarily due to the change in foreign currency exchange rates.
Liquidity and Capital Resources
Sources of Liquidity
We have financed our operations primarily through a combination of equity, debt issues and grants from the OCS and other third parties.
We recorded $5.3 million from inception through September 30, 2011 from the OCS in development grants of which $0.2 million was received during the nine months ended September 30, 2011.
In the nine months ended September 30, 2011, options and warrants were exercised
in consideration of $0.04 million and 350,060 shares of common stock were issued.
On April 13, 2011 we completed our IPO in the United States of our Common stock and redeemable Common stock-purchase warrants which are both listed on the NYSE Amex. The Company issued 2,624,100 shares of Common stock, including 164,100 shares pursuant to the exercise of the underwriters’ over-allotment option, at a price of $4.54 per share and redeemable Common stock purchase warrants to purchase 2,829,000 shares including 369,000 warrants pursuant to the exercise of the underwriters’ over-allotment option, at a price of $0.46 per warrant for total gross proceeds of $13.21 million or approximately $10.39 million in net proceeds after deducting underwriting discounts and commissions of $1.45 million and other offering costs of approximately $1.37 million.
On the closing date of the IPO (April 13, 2011) $0.57 million of 2009 Debentures were automatically converted at a conversion price of $2.724 per share of common stock into an aggregate amount of 209,656 shares and the Company issued 5-year warrants to purchase 84,693 shares at an initial exercise price of $4.99 per share in connection with the conversion of the 2009 Debentures. On the same date, $4.00 million of 2010 Debentures were automatically converted at a conversion price of $3.405 per share into an aggregate amount of 1,198,242 shares.
Cash Flows
We had cash and cash equivalents of $7.57 million at September 30, 2011, $4.78 million at September 30, 2010 and $2.86 million at December 31, 2010. The increase in our cash balance during the first nine months of 2011 was primarily the result of the IPO during the period.
The increase in our cash balance during the first nine months of 2010 was primarily the result of the proceeds from the issuance of convertible debentures and shares of common stock during that period.
Net cash used in operating activities of $5.46 million for the nine months ended September 30, 2011 primarily reflected our cash expenses for our operations. Net cash used in operating activities of $2.28 million for the nine months ended September 30, 2010 primarily reflected our cash expenses for our operations in addition to increases in prepaid expenses and deferred issuance expenses and decreases in accounts payable and accrued expenses.
Our cash used in investing activities relates mainly to our purchases of property and equipment.
Net cash provided by financing activities was $10.43 million and $6.61 million for the nine months ended September 30, 2011 and 2010, respectively.
Our cash flows from financing activities during the nine months ended September 30, 2011 are primarily the result of the IPO from which the net proceeds were approximately $10.39 million.
Our cash flows from financing activities during the nine months ended September 30, 2010 were primarily net cash proceeds of $2.08 million from the issuance of shares and $4.00 million from the issuance of convertible debentures.
Funding Requirements
We expect to enter into licensing or other commercialization agreements for all or parts of applications of our Biopump Platform Technology to fund our continuing operations. If we are unable to enter into such agreements on terms acceptable to us, we will continue to incur losses from operations for the foreseeable future. We expect to incur increasing research and development expenses, including expenses related to the hiring of personnel and additional clinical trials, as we further develop the EPODURE Biopump, the INFRADURE Biopump and the HEMODURE Biopump. We expect that our general and administrative expenses will also increase as we expand our finance and administrative staff, add infrastructure, and incur additional costs related to being a public company in the United States, including investor relations programs, and increased professional fees. Our future capital requirements will depend on a number of factors, including the timing and outcome of clinical trials and regulatory approvals, the costs involved in preparing, filing, prosecuting, maintaining, defending, and enforcing patent claims and other intellectual property rights, the acquisition of licenses to new products or compounds, the status of competitive products, the availability of financing, and our success in developing markets for our product candidates.
Without taking into account any revenue we may receive as a result of licensing or other commercialization agreements we are pursuing, we believe that the net proceeds we received from our initial public offering will be sufficient to enable us to fund our operating expenses and capital expenditure requirements through the second quarter of 2012. We have based this estimate on assumptions that may prove to be wrong and we could use our available resources sooner than we currently expect. Because of the numerous risks and uncertainties associated with the development and commercialization of our product candidates, we are unable to estimate the amounts of increased capital outlays and operating expenditures associated with our current and anticipated clinical trials.
We do not anticipate that we will generate revenue from the sale of products for at least five years; however, we do intend to seek licensing or other commercialization agreements similar to our agreement relating to the development of a Biopump producing Factor VIII. We anticipate that the funds received as a result of such agreements may be sufficient to fund our operations in the future. In the absence of additional funding or adequate funding from commercialization agreements, we expect our continuing operating losses to result in increases in our cash used in operations over the next several quarters and years.
Absent significant corporate collaboration and licensing arrangements, we will need to finance our future cash needs through public or private equity offerings, or debt financings. We do not currently have any commitments for future external funding. We may need to raise additional funds more quickly if one or more of our assumptions prove to be incorrect or if we choose to expand our product development efforts more rapidly than we presently anticipate, and we may decide to raise additional funds even before we need them if the conditions for raising capital are favorable. We may seek to sell additional equity or debt securities or obtain a bank credit facility. The sale of additional equity or debt securities, if convertible, could result in dilution to our stockholders. The incurrence of indebtedness would result in increased fixed obligations and could also result in covenants that would restrict our operations.
These conditions raise doubt about our ability to continue as a going concern. Our plans include seeking additional investments and commercial agreements to continue our operations. However, there is no assurance that we will be successful in our efforts to raise the necessary capital and/or reach such commercial agreements to continue our planned research and development activities.
Principal Uncertainties Related to Potential Future Milestone Payments
We have acquired the exclusive worldwide right to make commercial use of certain patents in connection with the development and commercialization of our product candidate to produce clotting Factor VIII through a license granted by the Regents of the University of Michigan (Michigan). The Michigan license agreement contains milestone payments, license fees, milestone payments, royalties and sub-license fees as follows:
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an initial license fee of $25,000;
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an annual license fee in arrears of $10,000 rising to $50,000 following the grant by the Company of a sublicense or (if sooner) from the 6th anniversary of the effective date of the Licence Agreement;
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staged milestone payments of $750,000 (in aggregate), of which $400,000 will be recoupable against royalties;
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royalties at an initial rate of 5% of net sales, reducing by a percentage point at predetermined thresholds to 2% upon cumulative net sales exceeding $50,000,000;
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Sublicense fees at an initial rate of 6% of sublicensing revenues, reducing by a percentage point at predetermined thresholds to 4%. upon cumulative sublicensing revenues exceeding $50,000,000; and
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Patent maintenance costs.
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The exclusive worldwide license is expected to expire in 2026 upon the expiration of the last to expire of the patent rights licensed. As of the balance sheet date, we have paid the initial license fee and patent maintenance costs. No royalties or sub-license fees have yet accrued. Additionally, we cannot estimate when we will begin selling any products that would require us to make any such royalty payments. Whether we will be obligated to make royalty payments in the future is subject to the success of our product development efforts and, accordingly, is inherently uncertain.
Critical Accounting Policies
Our management’s discussion and analysis of our financial condition and results of operations is based on our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities and expenses. On an ongoing basis, we evaluate these estimates and judgments, including those described below. We base our estimates on our historical experience and on various other assumptions that we believe to be reasonable under the circumstances. These estimates and assumptions form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results and experiences may differ materially from these estimates.
The following accounting policies are the most critical to aid you in fully understanding and evaluating our reported financial results and affect the more significant judgments and estimates that we use in the preparation of our financial statements.
Convertible Debentures
We irrevocably elected to initially and subsequently measure the convertible debentures issued in 2009 and 2010 entirely at fair value, in accordance with ASC 825-10. As a result, we did not separate the embedded derivative instrument from the host contract and account for it as a derivative instrument. The convertible debentures were subject to remeasurement at each balance sheet date, and any change in fair value was recognized as a component of financial income (expense), net in the statements of operations. We estimated the fair value of these convertible debentures at the respective balance sheet dates using the Binomial option pricing model. We used a number of assumptions to estimate the fair value, including the remaining contractual terms of the convertible debentures, risk-free interest rates, expected dividend yield and expected volatility of the price of the underlying common stock.
During the nine months ended September 30, 2011, we recorded financial income of $0.04 million to reflect the decrease in the fair value of the convertible debentures as opposed to $1.26 million recorded during the nine month period ended September 30, 2010.
Liability in Respect of Warrants
In 2010 we issued warrants with an exercise price denominated in British Pounds Sterling which differs from the functional currency we use. In addition, the exercise price of such warrants is subject to downward adjustment. In addition, in 2006 and 2007, we issued warrants that included price protection in the event of sales of securities below the then current exercise price. In accordance with ASC 815-40-15-7I, we classified these warrants as a liability at their fair value. The warrants liability will be remeasured at each reporting period until exercised or expired. The decrease in the fair value of the warrants during the nine months ended September 30, 2011 and 2010 of $1.32 million and $0.90 million, respectively, are reported in the Statements of Operations as financial income.
We estimate the fair value of these warrants at the respective balance sheet dates using the Binomial option pricing model. We use a number of assumptions to estimate the fair value, including the remaining contractual terms of the warrants, risk-free interest rates, expected dividend yield and expected volatility of the price of the underlying common stock. These assumptions could differ significantly in the future, thus resulting in variability of the fair value which would impact the results of operations in the future.
Stock-Based Compensation
We account for stock options according to the Financial Accounting Standards Board Accounting Standards Codification No. 718 (ASC 718) “Compensation – Stock Compensation.” Under ASC 718, share-based compensation cost is measured at grant date, based on the estimated fair value of the award, and is recognized as an expense over the employee’s requisite service period on a straight-line basis.
We account for stock options granted to non-employees on a fair value basis using an option pricing method in accordance with ASC 718. The initial non-cash charge to operations for non-employee options with vesting are revalued at the end of each reporting period based upon the change in the fair value of the options and amortized to consulting expense over the related vesting period.
For the purpose of valuing options and warrants granted to our employees, non-employees and directors and officers during the nine months ended September 30, 2011 and 2010, we used the Binomial options pricing model. To determine the risk-free interest rate, we utilized the U.S. Treasury yield curve in effect at the time of grant with a term consistent with the expected term of our awards. We estimated the expected life of the options granted based on anticipated exercises in the future periods assuming the success of our business model as currently forecast. The expected dividend yield reflects our current and expected future policy for dividends on our common stock. The expected stock price volatility for our stock options was calculated by examining historical volatilities for publicly traded industry peers as we do not have sufficient trading history for our common stock. We will continue to analyze the expected stock price volatility and expected term assumptions as more historical data for our common stock becomes available. Given the senior nature of the roles of our employees, directors and officers, we currently estimate that we will experience no forfeitures for those options currently outstanding.
Off-Balance Sheet Arrangements
Pursuant to our license agreement with Yissum Research Development Company of the Hebrew University (“Yissum”), Yissum granted us a license of certain patents for commercial development, production, sub-license and marketing of products to be based on its know-how and research results. In consideration, we agreed to pay Yissum the following amounts, provided, however, that the total aggregate payment of royalties and sub-license fees by us to Yissum shall not exceed $10 million:
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Non-refundable license fee of $0.4 million to be paid in three installments, as follows:
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$0.05 million when the accrued investments in us by any third party after May 23, 2005 equal at least $3 million (paid in 2007);
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$0.15 million when the accrued investments in us by any third party after May 23, 2005 equal at least $12 million (paid in second quarter of 2010); and
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$0.2 million when the accrued investments in us by any third party after May 23, 2005 equal at least $18 million (paid in April 2011).
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Royalties at a rate of 5% of net sales of product incorporating the licensed technology; and
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Sub-license fees at a rate of 9% of sublicense considerations received by us.
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In 2007, we signed an agreement with Baylor College of Medicine (BCM) whereby BCM granted us a non-exclusive worldwide license to use, market, sell, lease and import certain technology (BCM technology), by way of any product process or service that incorporates, utilizes or is made with the use of the BCM technology. In consideration we agreed to pay BCM the following amounts:
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a one time, non-refundable license fee of $25,000 which was paid in 2007;
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an annual non-refundable maintenance fee of $20,000;
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a one-time milestone payment of $75,000 upon FDA clearance or equivalent of clearance for therapeutic use. As of the balance sheet date, we have not achieved FDA clearance; and
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an installment of $25,000 upon our executing any sub-licenses in respect of the BCM technology.
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All payments to BCM are recorded as research and development expenses. The license agreement shall expire (unless terminated earlier for default or by us at our discretion) on the first day following the tenth anniversary of our first commercial sale of licensed products. After termination, we will have a perpetual, royalty free license to the BCM technology.
Under agreements with the OCS in Israel regarding research and development projects, our Israeli subsidiary is committed to pay royalties to the OCS at rates between 3.5% and 5% of the income resulting from this research and development, at an amount not to exceed the amount of the grants received by our subsidiary as participation in the research and development program, plus interest at LIBOR. The obligation to pay these royalties is contingent on actual income and in the absence of such income no payment is required. As of September 30, 2011, the aggregate contingent liability amounted to approximately $5.3 million.
Pursuant to an agreement we entered into on February 11, 2011 (effective as of January 31, 2011), the Regents of the University of Michigan (Michigan) have granted an exclusive worldwide license for patent rights relating to certain uses of variants of clotting Factor VIII. The License Agreement covers a portfolio of 2 issued and 3 pending patents. In consideration we agreed to pay Michigan the following amounts:
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an initial license fee of $25,000;
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an annual license fee in arrears of $10,000 rising to $50,000 following the grant by us of a sublicense or (if sooner) from the 6th anniversary of the effective date of the licence agreement;
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staged milestone payments of $750,000 (in aggregate), of which $400,000 will be recoupable against royalties;
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royalties at an initial rate of 5% of net sales, reducing by a percentage point at predetermined thresholds to 2% upon cumulative net sales exceeding $50,000,000;
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sublicense fees at an initial rate of 6% of sublicensing revenues, reducing by a percentage point at predetermined thresholds to 4%. upon cumulative sublicensing revenues exceeding $50,000,000; and
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patent maintenance costs.
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The exclusive worldwide license is expected to expire in 2026 upon the expiration of the last to expire of the patent rights licensed.
Subsequent Events
In October 2011, warrants to purchase 344,071 shares of Common stock at an exercise price of $3.85 were exercised using the cashless exercise mechanism and warrants to purchase 6,494 shares of Common stock at an exercise price of $3.85 were exercised for a total cash consideration of $25,000. A total of 30,074 shares were issued. Also in October 2011, unexercised warrants to purchase a total of 76,398 shares of Common stock expired.
ITEM 3 — Quantitative and Qualitative Disclosures about Market Risk
Not required.
ITEM 4 — Controls and Procedures
Evaluation of disclosure controls and procedures
As required by Exchange Act Rule 13a-15(b), in connection with the filing of this Quarterly Report on Form 10-Q, we carried out an evaluation, under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) as of the end of the period covered by this Quarterly Report on Form 10-Q. Based on this evaluation, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures were effective as of September 30, 2011, the end of the period covered by this report.
Changes in Internal Control Over Financial Reporting
There were no changes in our internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) during the quarter ended September 30, 2011 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
PART II — OTHER INFORMATION
ITEM 1 — Legal Proceedings
We are not currently a party, as plaintiff or defendant, to any legal proceedings which, individually or in the aggregate, are expected by us to have a material effect on our business, financial condition or results of operation if determined adversely to us.
ITEM 1A — Risk Factors
There are no material changes from the risk factors previously disclosed in our Prospectus dated April 7, 2011 and filed pursuant to Rule 424(b) under the Securities Act with the SEC on April 11, 2011.
ITEM 2 — Unregistered Sale of Equity Securities and Use of Proceeds
Recent Sales of Unregistered Securities
In the third quarter of 2011, the following securities were sold by the registrant without registration under the Securities Act. The securities described below were deemed exempt from registration under the Securities Act in reliance upon Section 4(2) of the Securities Act and Regulation D thereunder. There were no underwriters employed in connection with any of these transactions. Proceeds from these equity financings were spent on general and administrative expenses, including salaries and other related costs, and research and development expenses.
Common Stock Issued Directly
In September 2011, the Company issued 12,500 shares of Common stock to a consultant in compensation for investor relation services.
Common Stock Issued Upon Exercise of Outstanding Warrants and Options
In August 2011, three investors exercised warrants to purchase a total of 137,517 shares of Common stock at an exercise price of $3.85 per share using the cashless exercise mechanism. The investors were issued a total of 22,472 shares.
In September 2011, a director of the Company exercised options to purchase 45,701 shares of Common stock at an exercise price of $2.49 per share using the cashless exercise mechanism. The director was issued 16,197 shares of Common stock as a result of the option exercise.
Options and Warrants Issued
In July 2011, the Company granted an employee 40,000 options exercisable at a price of $3.64 per share. The options have a 10-year term and vest in four equal annual tranches of 10,000 each. The options were granted under the 2006 Stock Incentive Plan (the “Stock Incentive Plan”).
In July 2011, the Company issued warrants to purchase 50,000 shares of Common stock at an exercise price of $4.01 to consultants in compensation for financial advisory services.
In August 2011, the Company issued warrants to purchase 150,000 shares of Common stock at an exercise price of $4.80 to a consultant in compensation for financial advisory services.
In September 2011, the Company granted an employee 11,429 options exercisable at $3.86 per share. The options have a 10-year term and vest in equal tranches over four years. The options were granted under the Stock Incentive Plan.
Use of Proceeds from Registered Securities
On April 7, 2011, a registration statement on Form S-1 (File No. 333-170425) relating to our initial public offering in the United States was declared effective by the SEC. From the effective date of the registration statement through September 30, 2011, approximately $2,920,000 of the net proceeds from this offering were used for working capital and general corporate purposes, including the payment of regular compensation to our directors and officers. Pending use of the remaining net proceeds as described above, we have invested the net proceeds in short-term interest-bearing investment grade securities. There has been no material change in the planned use of proceeds from this offering from that described in the final prospectus dated April 7, 2011 filed by us with the SEC pursuant to Rule 424(b).
Purchases of Equity Securities by the Issuer and Affiliated Purchasers
None.
ITEM 3 — Defaults Upon Senior Securities
None.
ITEM 4 — [Removed and Reserved.]
ITEM 5 — Other Information
On November 9, 2011, Medgenics Medical Israel Ltd. (“MMI”), a wholly owned subsidiary of the Company, entered into a Resignation Agreement (the “Agreement”) with Dr. Baruch Stern relating to Dr. Stern’s resignation as the Chief Scientific Officer of the Company.
Pursuant to the Agreement, Dr. Stern’s resignation as Chief Scientific Officer of the Company was effective on November 9, 2011; however, the employment relationship between MMI and Dr. Stern will not be terminated until the date that is 14 and one-half months after the date of the Agreement, unless earlier terminated by Dr. Stern as described below. During the 3 months following the date of the Agreement (the “First Period”), Dr. Stern agreed to make himself available to MMI to assist with the transfer of his responsibilities. During the First Period, Dr. Stern will continue to be paid his salary in full, including payments for managers’ insurance (“bituach minahlim”), study fund (“keren hishtalmut”) and accumulated vacation, as well as continued use of a company car. Managers’ insurance and the study fund are customary benefits provided to all employees based in Israel (other than those in very junior positions). A management insurance fund is a combination of severance savings (in accordance with Israeli law), defined contribution tax-qualified pension savings and disability insurance premiums. A study fund is a savings fund of pre-tax contributions to be used after a specified period of time for educational or other permitted purposes. In aggregate, Dr. Stern will be entitled to receive approximately NIS 51,098 (US$13,942) each month during the First Period.
Consistent with his employment agreement, the Agreement provides that during the remaining 11 and one-half months following the expiration of the First Period (the “Second Period”), Dr. Stern will be released from his work duties while MMI will continue to pay his salary in full, including payments for managers’ insurance and the study fund, but excluding accumulation of vacation days. In aggregate, Dr. Stern will be entitled to receive approximately NIS 47,973 (US$13,090) each month during the Second Period.
Dr. Stern may terminate his employment relationship with MMI during the Second Period (prior to the expiration of the Second Period) upon giving 30 days’ advance written notice to MMI. In that case, MMI agreed to pay Dr. Stern’s salary for the remainder of the Second Period, taking into account payments for managers’ insurance and the study fund, in a lump sum.
Upon termination of the employment relationship between MMI and Dr. Stern, the Agreement provides that Dr. Stern will return his company car to MMI and the final account will be settled, including the release of the managers’ insurance policy and the study fund. The severance pay accumulated in the managers’ insurance policy will be deducted from the severance pay due to Dr. Stern under Israeli law, and MMI will pay the difference to Dr. Stern.
The Agreement also provides that, subject to the fulfillment of the obligations of the other party under the Agreement, neither party will have any additional claims and/or demands on the other party. The parties also agreed that, from the beginning of the Second Period, Dr. Stern will be available to provide MMI with professional advice in areas and for financial remuneration that will be agreed upon separately.
The foregoing description of the Agreement is qualified in its entirety by reference to the Agreement, a copy of which is filed as Exhibit 10.2 to this Quarterly Report on Form 10-Q and incorporated by reference herein.
ITEM 6 — Exhibits
Exhibit No.
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Description
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3.1
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Amended and Restated Certificate of Incorporation (previously filed as Exhibit 3.1 to the Company’s Registration Statement on Form S-1 filed November 5, 2010 (File No. 333-170425) and incorporated herein by reference).
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3.2
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Certificate of Amendment to Amended and Restated Certificate of Incorporation (previously filed as Exhibit 3.2 to the Company’s Registration Statement on Form S-1 filed November 5, 2010 (File No. 333-170425) and incorporated herein by reference).
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3.3
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Amended and Restated By-Laws (previously filed as Exhibit 3.3 to the Company’s Amendment No. 4 to Registration Statement on Form S-1 filed February 22, 2011 (File No. 333-170425) and incorporated herein by reference).
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3.4
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Amendment to Amended and Restated By-Laws (previously filed as Exhibit 3.1 to the Company’s Current Report on Form 8-K filed April 11, 2011 (File No. 001-35112) and incorporated herein by reference).
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10.1
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Employment Agreement, effective as of July 1, 2011, between the Company and Clarence L. “Butch” Dellio (previously filed as Exhibit 10.1 to the Company’s Current Report on Form 8-K filed September 8, 2011 (File No. 001-35112) and incorporated herein by reference).
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10.2
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Resignation Agreement dated as of November 9, 2011 between Dr. Baruch Stern and Medgenics Medical Israel Ltd. (filed herewith).
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31.1
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Certification of Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (filed herewith).
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31.2
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Certification of Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (filed herewith).
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32.1
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Certification of Principal Executive Officer and Principal Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (furnished herewith).
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101
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Interactive Data File (furnished herewith).
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
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MEDGENICS, INC.
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Date: November 10, 2011
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By:
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/s/ Andrew L. Pearlman
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Andrew L. Pearlman
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President and Chief Executive Officer
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(Principal Executive Officer)
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Date: November 10, 2011
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By:
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/s/ Phyllis Bellin
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Phyllis Bellin
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Director of Finance and Administration
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(Principal Accounting and Financial Officer)
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