<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarter ended: 0-19871
-------
September 30, 1998 Commission File Number
CYTOTHERAPEUTICS, INC.
----------------------
(Exact name of registrant as specified in its charter)
DELAWARE 94-3078125
-------- ----------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) identification No)
701 GEORGE WASHINGTON HIGHWAY
LINCOLN, RI 02865
-----------------
(Address of principal executive offices including zip code)
(401) 288-1000
--------------
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding twelve months (or for such shorter periods that the registrant was
required to file such reports) and (2) has been subject to such filing
requirements for the past 90 days. Yes___X____ No_________
At October 31, 1998, there were 18,379,475 shares of Common Stock, $.01 par
value, issued and outstanding. There were no issued and outstanding shares of
Preferred Stock.
Page 1 of 14
<PAGE>
CYTOTHERAPEUTICS, INC.
INDEX
PART I. FINANCIAL INFORMATION Page Number
- ----------------------------- -----------
Item 1. Financial Statements
Condensed Consolidated Balance Sheets (unaudited)
September 30, 1998 and December 31, 1997 3
Condensed Consolidated Statements of Operations (unaudited)
Three and nine months ended September 30, 1998 and 1997 4
Condensed Consolidated Statements of Cash Flows (unaudited)
Nine months ended September 30, 1998 and 1997 5
Notes to Condensed Consolidated Financial Statements (unaudited) 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 7-12
PART II. OTHER INFORMATION
- --------------------------
Item 1. Legal Proceedings 13
Item 6. Exhibits and Reports on Form 8-K 13
SIGNATURES 14
Page 2 of 14
<PAGE>
PART I - ITEM 1 - FINANCIAL STATEMENTS
CYTOTHERAPEUTICS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
September 30, 1998 December 31, 1997
------------------ -----------------
<S> <C> <C>
Assets
Current assets:
Cash and cash equivalents $9,289,600 $15,941,701
Marketable securities 7,596,571 13,108,497
Receivables from collaborative agreement 196,908 150,880
Other current assets 1,211,891 978,314
----------- -----------
Total current assets 18,294,970 30,179,392
Property, plant and equipment, net 8,766,945 7,922,751
Other assets 6,473,198 6,199,323
----------- -----------
Total assets $33,535,113 $44,301,466
=========== ===========
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable and accrued expenses $2,969,686 $4,109,351
Deferred revenue 8,448 16,144
Current maturities of capitalized lease obligations 305,000 419,095
Current maturities of long term debt 1,000,000 658,986
----------- -----------
Total current liabilities 4,283,134 5,203,576
Capitalized lease obligations, less current maturities 3,326,250 3,552,500
Long term debt, less current maturities 750,000 555,525
Redeemable common stock 5,248,610 5,583,110
Common stock to be issued 48,375 506,600
Stockholders' equity
Common stock 177,586 175,262
Additional paid in capital 122,690,018 121,472,844
Accumulated deficit (101,470,844) (91,036,254)
Deferred compensation (1,528,991) (1,702,820)
Unrealized gain (loss) on marketable securities 10,975 (8,877)
----------- -----------
Total stockholders' equity 19,878,744 28,900,155
----------- -----------
Total liabilities and stockholders' equity $33,535,113 $44,301,466
=========== ===========
</TABLE>
See accompanying notes to condensed consolidated financial statements.
Page 3 of 14
<PAGE>
PART I - ITEM 1 - FINANCIAL STATEMENTS
CYTOTHERAPEUTICS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
(unaudited) Three Months Ended Nine Months Ended
September 30, September 30,
1998 1997 1998 1997
----------- ------------ ------------ ------------
<S> <C> <C> <C> <C>
Revenue from collaborative arrangements $2,539,557 $1,798,552 $6,289,120 $8,740,038
Operating expenses:
Research and development 4,282,313 4,636,541 13,699,332 13,735,768
Acquired research and development -- 8,312,422 -- 8,312,422
General and administrative 1,281,076 1,377,468 3,692,331 4,858,815
----------- ------------ ------------ ------------
5,563,389 14,326,431 17,391,663 26,907,005
----------- ------------ ------------ ------------
Loss from operations (3,023,832) (12,527,879) (11,102,543) (18,166,967)
Other income (expense):
Investment income 280,965 409,900 1,026,461 1,526,299
Interest expense (124,813) (51,047) (358,508) (297,141)
Other income (expense) -- 21,420 -- (89,360)
----------- ------------ ------------ ------------
156,152 380,273 667,953 1,139,798
----------- ------------ ------------ ------------
Net loss ($2,867,680) ($12,147,606) ($10,434,590) ($17,027,169)
=========== ============ ============ ============
Net loss per share ($0.16) ($0.73) ($0.57) ($1.03)
=========== ============ ============ ============
Shares used in calculation 18,275,784 16,629,152 18,224,748 16,533,152
=========== ============ ============ ============
</TABLE>
See accompanying notes to condensed consolidated financial statements.
Page 4 of 14
<PAGE>
PART I - ITEM 1 - FINANCIAL STATEMENTS
CYTOTHERAPEUTICS, INC.
CONDENSED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Nine Months Ended
(unaudited) September 30,
1998 1997
---------------------------
<S> <C> <C>
Cash flows from operating activities:
Net earnings (loss) ($10,434,590) ($17,027,169)
Adjustments to reconcile net earnings (loss) to
net cash used for operating activities:
Depreciation and amortization 1,617,494 1,452,212
Acquired research and development -- 8,312,422
Compensation expense relating to the grant
of stock options 405,739 39,515
Loss on sale of fixed assets -- 1,434
Changes in operating assets and liabilities (1,352,414) (1,225,959)
------------ ------------
Net cash used in operating activities (9,763,771) (8,447,545)
------------ ------------
Cash flows from investing activities:
Proceeds from sale of marketable securities 20,701,919 15,020,093
Purchases of marketable securities (15,183,133) (12,576,903)
Purchase of property, plant and equipment (2,101,121) (6,452,886)
Proceeds from the sale of fixed assets -- 3,926
Acquisition of other assets (696,002) (611,479)
------------ ------------
Net cash provided by (used in) investing activities 2,721,663 (4,617,249)
------------ ------------
Cash flows from financing activities:
Proceeds from the exercise of stock options 194,863 577,673
Proceeds from financing transactions 1,259,300 --
Principal payments under capitalized lease obligations
and mortgage payable (1,064,156) (807,677)
------------ ------------
Net cash provided by (used in) financing activities 390,007 (230,004)
------------ ------------
Effect of exchange rate on cash and cash equivalents -- (232,264)
------------ ------------
Decrease in cash and cash equivalents (6,652,101) (13,527,062)
Cash and cash equivalents, January 1 15,941,701 19,921,584
------------ ------------
Cash and cash equivalents, September 30 $9,289,600 $6,394,522
============ ============
</TABLE>
See accompanying notes to condensed financial statements.
Page 5 of 14
<PAGE>
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
September 30, 1998 and 1997
NOTE 1. BASIS OF PRESENTATION
The accompanying unaudited, condensed consolidated financial statements
have been prepared by the Company in accordance with generally accepted
accounting principles for interim financial information and with the
instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly,
they do not include all of the information and footnotes required by
generally accepted accounting principles for complete financial
statements. In the opinion of management, the accompanying financial
statements include all adjustments, consisting of normal recurring
accruals considered necessary for a fair presentation of the financial
position, results of operations and cash flows for the periods presented.
Results of operations for the three and nine months ended September 30,
1998 are not necessarily indicative of the results that may be expected
for the entire fiscal year ended December 31, 1998.
The December 31, 1997 information is derived from the audited financial
statements and footnotes included in the Company's Annual Report to
Stockholders and the Annual Report on Form 10-K filed with the Securities
and Exchange Commission.
NOTE 2. NET LOSS PER SHARE
Net loss per share is computed using the weighted average number of shares
of common stock outstanding. Common equivalent shares from stock options
and warrants are excluded as their effect is antidilutive.
NOTE 3. ADOPTION OF NEW ACCOUNTING PRONOUNCEMENT
As of January 1, 1998, the Company adopted Statement 130, Reporting
Comprehensive Income. Statement 130 establishes new rules for reporting
and display of comprehensive income and its components; however, the
adoption of this Statement had no impact on the Company's net income or
shareholders' equity. Statement 130 requires unrealized gains or losses on
the Company's available-for-sale securities and foreign currency
translation adjustments, which prior to adoption were reported separately
in shareholders' equity to be included in other comprehensive income.
For the three months ended September 30, 1998 and 1997, total
comprehensive loss amounted to $2,853,000 and $12,138,000. For the
first nine months of 1998 and 1997, total comprehensive loss amounted
to $10,415,000 and $17,100,000.
Page 6 of 14
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion of the financial condition and results of operations of
the Company for the three and nine months ended September 30, 1998 and 1997
should be read in conjunction with the accompanying unaudited, condensed
consolidated financial statements and the related footnotes thereto.
This report may contain certain forward-looking statements regarding, among
other things, the Company's results of operations, the progress of the Company's
product development and clinical programs, the need for, and timing of,
additional capital and capital expenditures, partnering prospects, the need for
additional intellectual property rights, effects of regulations, the need for
additional facilities and potential market opportunities. The Company's actual
results may vary materially from those contained in such forward-looking
statements because of risks to which the Company is subject, such as risks of
delays in research, development and clinical testing programs, obsolescence of
the Company's technology, lack of available funding, competition from third
parties, intellectual property rights of third parties, failure of the Company's
collaborators to perform, regulatory constraints, litigation and other risks to
which the Company is subject. See "Cautionary Factors Relevant to
Forward-Looking-Information" filed herewith as Exhibit 99 and incorporated
herein by reference.
Overview
Since its inception in August 1988, the Company has been primarily engaged in
research and development of human therapeutic products. No revenues have been
derived from the sale of any products, and the Company does not expect to
receive revenues from product sales for at least several years. The Company
expects that its research and development expenditures will increase in future
years as research and product development efforts accelerate and clinical trials
are initiated or broadened. The Company has incurred annual operating losses
since inception and expects to incur substantial operating losses in the future.
As a result, the Company is dependent upon revenues from collaborative research
arrangements with corporate sponsors, and upon external financing from equity
and debt offerings to finance its operations. The Company's results of
operations have varied significantly from year to year and from quarter to
quarter, and may vary significantly in the future due to the occurrence of
material, nonrecurring events, including without limitation, the receipt of
one-time, nonrecurring licensing and milestone payments.
Page 7 of 14
<PAGE>
Results of Operations
Three months ended September 30, 1998 and 1997
Revenues from collaborative arrangements for the third quarter of 1998 totaled
$2,540,000, which included $750,000 of increased support from Astra AB for the
Company's pain program, compared to $1,799,000 in the corresponding quarter of
1997.
Research and development expenses totaled $4,282,000 for the three months ended
September 30, 1998, compared with $4,637,000 for the same period in 1997.
Acquired research and development consists of a one-time charge of $8,312,000
related to the acquisition of StemCells, Inc. in the third quarter of 1997.
General and administrative expenses were $1,281,000 for the three months ended
September 30, 1998, compared with $1,377,000 for the same period in 1997.
Interest income for the three months ended September 30, 1998 and 1997 was
$281,000 and $410,000, respectively. The decrease in interest income in 1998 is
attributable to the lower average investment balances, $19,478,000 vs.
$28,612,000 in the third quarter of 1998 and 1997, respectively.
Interest expense was $125,000 for the three months ended September 30, 1998,
compared with $51,000 for the same period in 1997. The increase from 1997 to
1998 is attributable to the capitalization of interest for the new facility in
1997 in the amount of $112,000.
Net loss for the three months ended September 30, 1998 was $2,868,000, or $0.16
per share, as compared to net loss of $12,148,000, or $0.73 per share, for the
comparable period in 1997. The consolidated results for the third quarter of
1998 reported above include a $690,000 net loss attributable to StemCells, Inc.,
the Company's wholly owned subsidiary. The consolidated results for the third
quarter of 1997 reported include a $485,000 net loss for the quarter
attributable to Modex Therapeutiques SA, the Company's partially owned
subsidiary, as well as a one-time charge of $8,312,000 related to the Company's
acquisition of StemCells, Inc.
Page 8 of 14
<PAGE>
Results of Operations
Nine months ended September 30, 1998 and 1997
Revenues from collaborative arrangements for the nine months ended September 30,
1998 and 1997 were $6,289,000 and $8,740,000, respectively. Revenues for the
first nine months of 1997 included a one-time milestone payment of $3,000,000
from Astra AB, the Company's collaborator on its pain management program.
Research and development expenses totaled $13,699,000 for the nine months ended
September 30, 1998, compared with $13,736,000 for the same period in 1997.
Acquired research and development consists of a one-time charge of $8,312,000
related to the acquisition of StemCells, Inc. in the third quarter of 1997.
General and administrative expenses were $3,692,000 for the nine months ended
September 30, 1998, compared with $4,859,000 for the same period in 1997. The
decrease of $1,166,000 or 24%, from 1997 to 1998 was primarily attributable to a
reduction in legal fees, recruiting and relocation expenses and fewer employees.
StemCells, Inc., the Company's wholly owned subsidiary, contributed $24,000 of
general and administrative expenses for the period ended September 30, 1998,
while Modex Therapeutiques SA, the Company's formerly 50% owned subsidiary,
contributed $410,000 for the same period in 1997.
Interest income for the nine months ended September 30, 1998 and 1997 was
$1,026,000 and $1,526,000, respectively. The average investment balances were
$25,769,000 and $34,608,000 for the first nine months of 1998 and 1997,
respectively.
Interest expense was $359,000 for the nine months ended September 30, 1998,
compared with $297,000 for the same period in 1997.
Net loss for the nine months ended September 30, 1998 was $10,435,000, or $0.57
per share, as compared to a net loss of $17,027,000, or $1.03 per share, for the
comparable period in 1997.
Liquidity and Capital Resources
Since its inception, the Company has financed its operations through the sale of
common and preferred stock, the issuance of long-term debt and capitalized lease
obligations, revenues from collaborative agreements, research grants and
interest income.
Page 9 of 14
<PAGE>
The Company had unrestricted cash, cash equivalents and marketable securities
totaling $16,886,000 at September 30, 1998. Cash equivalents and marketable
securities are invested in agencies of the U.S. government, investment grade
corporate bonds and money market funds.
In May 1996, the Company secured an equipment loan facility with a bank in the
amount of $2,000,000. The Company has borrowed $2,000,000 under this agreement
as of September 30, 1998. The loan required interest-only payments for the first
two years; principal payments are payable over a three-year period which began
in August 1998. The loan is secured by equipment purchased with the proceeds of
the credit facility.
In November 1996, the Company signed collaborative development and licensing
agreements with Genentech, Inc. relating to the development of products using
the Company's technology to deliver certain of Genentech's proprietary growth
factors to treat Parkinson's disease, Huntington's disease and amyotrophic
lateral sclerosis ("ALS").
Under the terms of the agreement for Parkinson's disease, Genentech purchased
829,171 shares of common stock for $8,300,000 to fund development of products to
treat Parkinson's disease. Additional equity purchases and other funding by
Genentech is available for future clinical development as determined by the
parties. Genentech has the right, in its discretion, to terminate the
Parkinson's program at specified milestones in the program. If the Parkinson's
program is terminated and the funds the Company received from the sale of stock
to Genentech pursuant to the Parkinson's agreement exceed the expenses incurred
by the Company in connection with such studies by more than $1 million,
Genentech has the right to require the Company to repurchase from Genentech
shares of Company Common Stock having a value equal to the amount of the
overfunding, based upon the share price paid by Genentech. As such, the Common
Stock purchased by Genentech is classified as Redeemable Common Stock until such
time as the related funds are expended on the program. On May 21, 1998,
Genentech exercised its right to terminate the collaboration and negotiations
are currently underway to determine the balance of Redeemable Common Stock to be
redeemed in accordance with the agreement.
In March 1995, the Company signed a collaborative research and development
agreement with Astra AB for the development and marketing of certain
encapsulated-cell products to treat pain. Astra made an initial, nonrefundable
payment of $5,000,000, a milestone payment of $3,000,000 in the first quarter of
1997 which was recognized as revenue in the second quarter of 1997 and may make
up to $13,000,000 in additional payments subject to the achievement of certain
development milestones. Under the agreement, the Company is
Page 10 of 14
<PAGE>
obligated to conduct certain research and development pursuant to a four-year
research plan agreed upon by the parties. Over the term of the research plan,
the Company expects to receive annual research payments from Astra of $5 million
to $7 million. Subject to the successful development of such products and
obtaining necessary regulatory approvals, Astra is obligated to conduct all
clinical trials of products arising from the collaboration and to seek approval
for their sale and use. Astra has the exclusive worldwide right to market
products covered by the agreement. Until the later of either the last to expire
of all patents included in the licensed technology or a specified fixed term,
the Company is entitled to a royalty on the worldwide net sales of such products
in return for the license granted to Astra and the Company's obligation to
manufacture and supply such products. Astra has the right to terminate the
original agreement at any time after April 1, 1998. In May 1998, Astra AB agreed
to increase the annual research and development payments from $7 million to $8.5
million for the calendar year 1998. This increase in funding is being recognized
as revenue in the 3rd and 4th quarters of 1998.
Substantial additional funds will be required to support the Company's research
and development programs, for acquisition of technologies and intellectual
property rights, for preclinical and clinical testing of its anticipated
products, pursuit of regulatory approvals, acquisition of capital equipment,
expansion of laboratory and office facilities, establishment of production
capabilities and for general and administrative expenses. Until the Company's
operations generate significant revenues from product sales, cash reserves and
proceeds from equity and debt offerings, and funding from collaborative
arrangements will be used to fund operations.
The Company intends to pursue opportunities to obtain additional financing in
the future through equity and debt financings, lease agreements related to
capital equipment, grants and collaborative research arrangements. The source,
timing and availability of any future financing will depend principally upon
equity market conditions, interest rates and, more specifically, on the
Company's continued progress in its exploratory, preclinical and clinical
development programs. There can be no assurance that such funds will be
available on favorable terms, if at all.
The Company expects that its existing capital resources, revenues from
collaborative agreements and income earned on invested capital will be
sufficient to fund its operations into the second half of 2000. The Company's
cash requirements may vary, however, depending on numerous factors. Lack of
necessary funds may require the Company to: delay, scale back or eliminate some
or all of its research and product development programs; and/or reduce its
capital expenditures; and/or license its potential products or technologies to
third parties.
Page 11 of 14
<PAGE>
Year 2000
The year 2000 problem results from the fact that computer programs were often
written using two digits rather than four to define the applicable year.
Computer programs that have date-sensitive software may recognize a date using
"00" as the year 1900 rather than the year 2000. The Company has tested its
material software applications to determine whether each program is prepared to
accommodate date information for the year 2000 and beyond. The Company found all
of its material software programs to be year 2000 compliant and does not
anticipate any significant disruption of its operations as a result of the
failure of any of its software programs to be year 2000 compliant.
The Company is also testing the status of its facilities systems such as phones,
voice mail, heating/air conditioning, electricity and security systems and its
laboratory and manufacturing equipment to determine if they are year 2000
compliant. The Company expects to complete this testing in the first quarter of
1999. If any of the systems or equipment is found not to be year 2000 compliant,
the Company intends to either seek to repair the systems or equipment to cause
it to be year 2000 compliant or replace such systems or equipment with year 2000
compliant products. The cost to repair or replace any such system or equipment
that is not year 2000 compliant could be material. The Company is also polling
its major vendors and suppliers to determine if they are year 2000 compliant and
to identify any potential issues. Each of the suppliers and vendors that has
responded to the Company's inquiry has confirmed either orally or in writing
that it does not believe that its sales of products or provision of services to
the Company will be interrupted as a result of the year 2000 issue. There can be
no assurance that the failure of one or more of the Company's major supplier's
to be year 2000 compliant will not have an adverse effect on the Company's
operations or financial results.
Page 12 of 14
<PAGE>
PART II - ITEM 1
LEGAL PROCEEDINGS
None.
PART II - ITEM 6
EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
Exhibit 99 - Cautionary Factors Relevant to Forward-Looking-Information.
(b) Reports on Form 8-K
The Registrant filed a Current Report on Form 8-K on August 3, 1998 with
respect to the adoption of a Shareholder Rights Plan.
Page 13 of 14
<PAGE>
SIGNATURE
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.
CYTOTHERAPEUTICS, INC.
----------------------
(Name of Registrant)
November 13, 1998 /s/ John S. McBride
- ----------------- -------------------
(Date) Executive Vice President and Chief
Financial Officer
(principal financial officer and
principal accounting officer)
Page 14 of 14
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> SEP-30-1998
<CASH> 9,289,600
<SECURITIES> 7,596,571
<RECEIVABLES> 0
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 18,294,970
<PP&E> 17,139,755
<DEPRECIATION> 8,372,810
<TOTAL-ASSETS> 33,535,113
<CURRENT-LIABILITIES> 4,283,134
<BONDS> 4,076,250
0
0
<COMMON> 177,586
<OTHER-SE> 19,701,158
<TOTAL-LIABILITY-AND-EQUITY> 33,535,113
<SALES> 0
<TOTAL-REVENUES> 6,289,120
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 17,391,663
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 358,508
<INCOME-PRETAX> (10,434,590)
<INCOME-TAX> 0
<INCOME-CONTINUING> (10,434,590)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (10,434,590)
<EPS-PRIMARY> (.57)
<EPS-DILUTED> (.57)
</TABLE>
<PAGE>
EXHIBIT 99
CAUTIONARY FACTORS RELEVANT TO FORWARD-LOOKING INFORMATION
CytoTherapeutics, Inc. (the "Company") wishes to caution readers that
the following important factors, among others, in some cases have affected and
in the future could affect the Company's results and could cause actual results
and needs of the Company to vary materially from forward-looking statements made
in this Annual Report by the Company on the basis of management's current
expectations. The business in which the Company is engaged is rapidly changing,
extremely competitive and involves a high degree of risk, and accuracy with
respect to forward-looking projections is difficult.
Early Stage Development; History of Operating Losses - Substantially all of the
Company's revenues to date have been derived, and for the foreseeable future
substantially all of the Company's revenues will be derived, from collaborative
agreements, research grants and income earned on invested funds. The Company
will incur substantial operating losses in the future as the Company conducts
its research, development, clinical trial and manufacturing activities. There
can be no assurance that the Company will achieve revenues from product sales or
become profitable.
Future Capital Needs; Uncertainty of Additional Funding - The development of the
Company's products will require the commitment of substantial resources to
conduct the time-consuming research, preclinical development and clinical trials
that are necessary for regulatory approvals and to establish production and
marketing capabilities, if such approvals are obtained. The Company will need to
raise substantial additional funds to continue its product development efforts
and intends to seek such additional funds through partnership, collaborative or
other arrangements with corporate sponsors, public or private equity or debt
financings, or from other sources. Future cash requirements may vary from
projections based on changes in the Company's research and development programs,
progress in preclinical and clinical testing, the Company's ability to enter
into, and perform successfully under, collaborative agreements, competitive and
technological advances, the need to obtain proprietary rights owned by third
parties, facilities requirements, regulatory approvals and other factors. Lack
of necessary funds may require the Company to delay, reduce or eliminate some or
all of its research and product development programs or to license its potential
products or technologies to third parties. No assurance can be given that
funding will be available when needed, if at all, or on terms acceptable to the
Company.
Uncertainties of Clinical Development and New Mode of Therapy - None of the
Company's proposed products has been approved for commercial sale or entered
Phase III clinical trials. Even if the Company's proposed products appear to be
promising at an early stage of research or development such products may later
prove to be ineffective, have adverse side effects, fail to receive necessary
regulatory approvals, be difficult or uneconomical to manufacture or market on a
commercial scale, be adversely affected by government price controls or
limitations on reimbursement, be precluded from commercialization by proprietary
rights of third parties, by regulatory restrictions, or be subject to
significant competition from other products. There can be no assurance that the
Company will be able to demonstrate, as required, that its implants, on a
consistent basis and on a commercial scale, among other things: (i) successfully
isolate transplanted cells from the recipient's immune system; (ii) remain
biocompatible with the tissue into which they are implanted, including, for
certain implants, brain tissue; (iii) adequately maintain the viability of cells
contained within the membrane for a sufficiently long time to be efficacious and
commercially viable; (iv) safely permit the therapeutic substances produced by
the cells within the membrane to pass through the membrane unto the patient in
controlled doses for extended
-1-
<PAGE>
periods; and (v) are sufficiently durable for the intended indication. While
clinicians have generally had little difficulty in retrieving the Company's
implants, there have been cases where the implant broke on attempted explant.
The Company has changed its implantation procedure and is continuing a program
of developing stronger implants. In addition, the viability of implanted
encapsulated cells varies depending of the cell type, the implantation location
and other factors. Lack of viability could restrict certain of the Company's
programs to indications where long-term delivery of the therapeutics substances
is not required. There can also be no assurance that the products that may be
generated in the Company's stem cell programs will: (i) survive and persist in
the desired locations, (ii) provide the therapeutic benefits intended, (iii)
properly differentiate and integrate into existing tissue in the desired manner,
or (iv) not cause tumors or other side effects.
There has been increasing regulatory concern about the risks of animal cell
transplantation, or xenotransplantation. Concern has focused on the use of cells
derived from cows (such as are used in the Company's pain program) and cells
from primates and pigs. The United Kingdom has adopted a moratorium on
xenotransplantation pending further research and discussion; the EC Commission
has introduced a ban on the use of "high-risk material" from cattle and sheep in
the Member States of the European Union in the manufacture of pharmaceuticals
(this ban would apparently not include the type of cells used in the Company's
pain program). In addition, the FDA has proposed guidelines which impose
significant constraints on the conduct of clinical trials utilizing
xenotransplantion and are likely to significantly affect the cost of producing
the Company's products using nonhuman cells; such costs could make the Company's
products cost more to produce than the Company receives for their production.
Furthermore, the FDA has published a "Proposed Approach to Regulation of
Cellular and Tissue-Based Products" which relates to the use of human cells. The
Company cannot presently determine the effects of such actions nor what other
actions might be taken. Restrictions on the testing or use of cells, whether
human or nonhuman, as human therapeutics could adversely affect the Company's
product development programs and the Company itself. See "Government
Regulation."
Dependence on Outside Parties - The Company's strategy for the research,
development, commercialization and marketing of its products contemplates that
the Company will enter into various arrangements with corporate sponsors,
pharmaceutical companies, universities, research groups and others. There is no
assurance that the Company will be able to enter into any additional
arrangements on terms acceptable to the Company, or successfully perform its
obligations under its existing or any additional arrangements. If any of the
Company's collaborators fails to perform its obligations in a timely manner or
terminate their agreement with the Company, the development or commercialization
of the Company's product candidate or research program under such collaborative
agreement may be adversely affected. Moreover, the Company is particularly
dependent on its pain program partner, Astra AB, because changes in the
development of this particular program may significantly affect the Company's
stock price. In addition, because of the Company's obligation to repurchase
certain of the stock it sold to Genentech in connection with certain
termination's of the Parkinson's Agreement, any such termination could have an
adverse effect on the Company's liquidity.
Need for and Uncertainty of Obtaining Patent Protection - Patent protection for
products such as those the Company proposes to develop is highly uncertain and
involves complex factual and evolving legal questions. No assurance can be given
that any patents issued or licensed to the Company will not be challenged,
invalidated or circumvented, or that the rights granted under such patents will
provide competitive advantages to the Company.
Existence of Third Party Patents and Proprietary Rights; Need to Obtain Licenses
- - A number of pharmaceutical, biotechnology and other companies, universities
and research institutions have filed patent applications or have been issued
patents relating to cell therapy and encapsulation and other technologies
potentially relevant to or required by the Company's expected products. The
Company cannot predict which, if any, of such applications will issue as patents
or
<PAGE>
the claims which might be allowed. The Company is aware that a number of
entities have filed applications relating to stem and/or progenitor cells. The
Company is also aware of a number of third-party patent applications and patents
relating to cell encapsulation or claiming use of genetically modified cells to
treat disease, disorder or injury. In particular, the Company is aware of a
third-party U.S. patent which relates the use of cells for alleviating chronic
pain in humans and of two issued U. S. patents claiming certain methods for
treating defective, diseased or damaged cells in the mammalian CNS by grafting
genetically modified cells. The Company cannot predict the effect of existing
patent applications and patents on future unencapsulated products. In addition,
the Company is aware of third-party patents and patent applications claiming
rights to the neurotrophic factors (such as CNTF, NT 4/5, Neurturin, and CT-1)
which the Company hopes to deliver with its technology, and to the production of
these factors through the use of genetically modified cells. The Company expects
to use genetically modified cells to produce these factors for use in its
encapsulated products and expects that it may wish to genetically modify its
stem/progenitor cells. The Company may also be required to seek licenses in
regard to other cell lines, the techniques used in creating or obtaining such
cell lines, the materials used in the manufacture of its implants or otherwise.
There can be no assurance that the Company will be able to establish
collaborative arrangements or obtain licenses to the foregoing technology or to
other necessary or desirable technology on acceptable terms, if at all, or that
the patents underlying any such licenses will be valid and enforceable. See
"Patents, Proprietary Rights and Licenses" in the Company's Annual Report on
Form 10-K.
Government Regulation - The Company's research, preclinical development and
clinical trials, as well as the manufacturing and marketing of its potential
products, are subject to extensive regulation by governmental authorities in the
United States and other countries. The process of obtaining FDA and other
required regulatory approvals is lengthy, expensive and uncertain. There can be
no assurance that the Company or its collaborators will be able to obtain the
necessary approvals to commence or continue clinical testing or to manufacture
or market its potential products in anticipated time frames, if at all. In
addition, several legislative proposals have been made to reform the FDA. If
such proposals are enacted they may result in significant changes in the
regulatory environment the Company faces. These changes could result in
different, more costly or more time consuming approval requirements for the
Company's products, in the dilution of FDA resources available to review the
Company's products, or in other unpredictable consequences. See "Government
Regulation"
Sources of Cells and Other Materials - The Company's potential products require
genetically engineered cell lines or living cells harvested from animal or human
sources. There can be no assurance that the Company will successfully identify
or develop sources of the cells required for its potential products and obtain
such cells in quantities sufficient to satisfy the commercial requirements of
its potential products. These supply limitations may apply, in particular, to
primary cells which must be drawn directly from animal or human sources, such as
the bovine adrenal chromaffin cells currently used in the Company's product for
the treatment of pain. As an alternative to primary cells, the Company is
developing products based on the use of genetically altered cells. Intellectual
property rights to important genetic constructs used in developing such cells,
including the constructs used to develop cells producing neurotrophic factors,
are or may be claimed by one or more companies, which could prevent the Company
from using such cells. In addition, many suppliers of materials used by the
Company in its media, implants, and other components have restricted the use of
such materials for implantation into humans; if the Company cannot obtain the
necessary materials for its implants, the Company would be adversely affected.
Manufacturing Uncertainties - The Company's pilot manufacturing plant, may not
have sufficient capacity to permit the Company to produce all the products for
all of the clinical trials it anticipates developing. In addition, the Company
has not developed the capability to commercially manufacture any of its proposed
products and is unaware of any other company which has
<PAGE>
manufactured any membrane-encapsulated cell product on a commercial scale. There
can be no assurance that the Company will be able to develop the capability of
manufacturing any of its proposed products at a cost or in the quantities
necessary to make a commercially viable product, if at all.
Competition - Competitors of the Company are numerous and include major
pharmaceutical and chemical companies, biotechnology companies, universities and
other research institutions. Currently, several of these competitors market and
sell therapeutic products for the treatment of chronic pain, Parkinson's disease
and other CNS conditions. In addition, most of the Company's competitors have
substantially greater capital resources, experience in obtaining regulatory
approvals and, in the case of commercial entities, experience in manufacturing
and marketing pharmaceutical products, than the Company. A number of other
companies are attempting to develop methods of delivering therapeutic substances
within or across the blood brain barrier. There can be no assurance that the
Company's competitors will not succeed in developing technologies and products
that are more effective than those being developed by the Company or that would
render the Company's technology and products obsolete or non-competitive. See
"Competition."
Dependence on Key Personnel - The Company is highly dependent on the principal
members of its management and scientific staff and certain of its outside
consultants. Loss of the services of any of these individuals could have a
material adverse effect on the Company's operations. In addition, the Company's
operations are dependent upon its ability to attract and retain additional
qualified scientific and management personnel. There can be no assurance the
Company will be able to attract and retain such personnel on acceptable terms
given the competition among pharmaceutical, biotechnology and health care
companies, universities and research institutions for experienced personnel.
Reimbursement and Health Care Reform - In both domestic and foreign markets,
sales of the Company's potential products will depend in part upon the
availability and amounts of reimbursement from third-party health care payor
organizations, including government agencies, private health care insurers and
other health care payors such as health maintenance organizations and
self-insured employee plans. There is considerable pressure to reduce the cost
of therapeutic products. There can be no assurance that reimbursement will be
provided by such payors at all or without substantial delay, or, if such
reimbursement is provided, that the approved reimbursement amounts will provide
sufficient funds to enable the Company to sell its products on a profitable
basis. See "Reimbursement and Health Cost Control."
