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ONVO > SEC Filings for ONVO > Form 10-K on 15-Mar-2013All Recent SEC Filings

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Form 10-K for ORGANOVO HOLDINGS, INC.


15-Mar-2013

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.

The following management's discussion and analysis should be read in conjunction with Organovo's historical consolidated financial statements and the related notes. This management's discussion and analysis contains forward-looking statements that involve risks and uncertainties, such as statements of our plans, objectives, expectations and intentions. Any statements that are not statements of historical fact are forward-looking statements. These forward-looking statements are subject to risks and uncertainties that could cause actual results or events to differ materially from those expressed or implied by the forward-looking statements in this Annual Report. Factors that could cause or contribute to such differences include, but are not limited to, those identified below and those discussed in the section entitled "Risk Factors" included elsewhere in this Annual Report. Except as required by applicable law we do not undertake any obligation to update forward-looking statements to reflect events or circumstances occurring after the date of this Annual Report.

The discussion and analysis of our financial condition and results of operations are based on our consolidated financial statements, which we have prepared in accordance with U.S. generally accepted accounting principles. The preparation of these financial statements requires Organovo to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the consolidated financial statements, as well as the reported revenues and expenses during the reporting periods. On an ongoing basis, Organovo evaluates such estimates and judgments, including those described in greater detail below. Organovo bases its estimates on historical experience and on various other factors that Organovo believes are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

Overview

We have developed and are commercializing a platform technology for the generation of functional human tissues that can be employed in drug discovery and development, biological research, and as therapeutic implants for the treatment of damaged or degenerating tissues and organs. We intend to introduce a paradigm shift in the approach to the generation of three-dimensional human tissues, by creation of constructs in 3D that have the potential to replicate native human biology. We can improve on previous technologies by moving away from monolayer 2D cell cultures and by enabling all or part of tissues we create to be constructed solely of cells. We believe our expertise in printing various fully cellular human tissues, as disclosed in peer-reviewed scientific publications, provides a strong foundation upon which other tissues can be built to replicate human biology and human disease. We believe that our broad and exclusive commercial rights to patented and patent-pending 3D bioprinting technology, combined with strengths in engineering and biology, put us in an ideal position to provide a wide array of products for use in research, drug discovery and regenerative medicine therapies.

Reverse Merger Transaction

On February 8, 2012, Organovo Acquisition Corp. ("Acquisition Corp."), a wholly-owned subsidiary of Organovo Holdings, Inc., merged (the "Merger") with and into Organovo, Inc., a privately held Delaware corporation ("Organovo"). Organovo was the surviving corporation of that Merger. As a result of the Merger, the Company acquired the business of Organovo, and will continue the existing business operations of Organovo as a wholly-owned subsidiary.

Simultaneously with the Merger, on the Closing Date, all of the issued and outstanding shares of Organovo common stock converted, on a 1 for 1 basis, into shares of the Company's common stock, par value $0.001 per share ("Common Stock"). Also on the Closing Date, all of the issued and outstanding options to purchase shares of Organovo Common Stock, all of the issued and outstanding Bridge Warrants (as defined below) to purchase shares of Organovo Common Stock, and other outstanding warrants to purchase Organovo Common Stock converted, respectively, into options (the "New Options"), new bridge warrants (the "New Bridge


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Warrants") and new warrants (the "New Warrants") to purchase shares of Common Stock. The New Bridge Warrants, the New Warrants and New Bridge Options were converted on a 1 for 1 basis. The New Options will be administered under Organovo's 2008 Equity Incentive Plan (the "2008 Plan"), which the Company assumed and adopted on the Closing Date in connection with the Merger.

Specifically, on the Closing Date, (i) 22,445,254 shares of Common Stock were issued to former Organovo stockholders; (ii) New Options to purchase 896,256 shares of Common Stock granted under the 2008 Plan were issued to optionees pursuant to the assumption of the 2008 Plan; (iii) New Warrants to purchase 1,309,750 shares of Common Stock at $1.00 per share were issued to holders of Organovo warrants; and (iv) New Bridge Warrants to purchase 1,500,000 shares of Common Stock at $1.00 per share were issued to Bridge Investors (as defined below).

Additionally, New Warrants to purchase 100,000 shares of Common Stock at $1.00 per share were issued to a former noteholder of Organovo in connection with the repayment at the Closing Date of a promissory note in the principal amount of $100,000.

The Merger was treated as a recapitalization of the Company for financial accounting purposes. The historical financial statements of Organovo Holdings, Inc. before the Merger were replaced with the historical financial statements of Organovo before the Merger.

Before the Merger, Organovo Holdings, Inc.'s Board of Directors and stockholders adopted the 2012 Equity Incentive Plan (the "2012 Plan"). The 2012 Plan provides for the issuance of up to 6,553,986 shares, or approximately 11% of our December 31, 2012 outstanding Common Stock, to executive officers, directors, advisory board members and employees. In addition, we assumed and adopted the 2008 Plan, and as described above option holders under that plan were granted New Options to purchase Common Stock. No further options will be granted under the 2008 Plan. The parties have taken all actions necessary to ensure that the Merger was treated as a tax free exchange under Section 368(a) of the Internal Revenue Code of 1986, as amended.

As of March 1, 2013, the Company had 62,237,772 total issued and outstanding shares of Common Stock, and five year warrants for the opportunity to purchase an additional 7,359,149 shares of Common Stock at exercise prices ranging from $1.00 to $3.24 per share. If all warrants were exercised on a cash basis, the Company would realize approximately $8.1 million in additional gross proceeds.

Critical Accounting Policies

Our consolidated financial statements, which appear under Item 8 of Part II have been prepared in accordance with accounting principles generally accepted in the United States, which require that we make certain assumptions and estimates and, in connection therewith, adopt certain accounting policies. Our significant accounting policies are set forth in Note 1 to our consolidated financial statements. Of those policies, we believe that the policies discussed below may involve a higher degree of judgment and may be more critical to an accurate reflection of our financial condition and results of operations.

Revenue Recognition

The Company's revenues are derived from collaborative research agreements, National Institute of Health ("NIH") and U.S. Treasury Department Grants, the sale of bioprinter related products and services, and license agreements.

The Company recognizes revenue when the following criteria have been met:
(i) persuasive evidence of an arrangement exists; (ii) services have been rendered or product has been delivered; (iii) price to the customer is fixed and determinable; and (iv) collection of the underlying receivable is reasonably assured.

Billings to customers or payments received from customers are included in deferred revenue on the balance sheet until all revenue recognition criteria are met.


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Product Revenue

The Company recognizes product revenue at the time of shipment to the customer, provided all other revenue recognition criteria have been met. The Company recognizes product revenues upon shipment to distributors, provided that (i) the price is substantially fixed or determinable at the time of sale; (ii) the distributor's obligation to pay the Company is not contingent upon resale of the products; (iii) title and risk of loss passes to the distributor at time of shipment; (iv) the distributor has economic substance apart from that provided by the Company; (v) the Company has no significant obligation to the distributor to bring about resale of the products; and (vi) future returns can be reasonably estimated. For any sales that do not meet all of the above criteria, revenue is deferred until all such criteria have been met. The Company's collaboration revenue consists of license and collaboration agreements that contain multiple elements, including non-refundable upfront fees, payments for reimbursement of third-party research costs, payments for ongoing research, payments associated with achieving specific development milestones and royalties based on specified percentages of net product sales, if any. The Company considers a variety of factors in determining the appropriate method of revenue recognition under these arrangements, such as whether the elements are separable, whether there are determinable fair values and whether there is a unique earnings process associated with each element of a contract.

Collaborative and License Revenue

The Company recognizes revenue from research funding under collaboration agreements when earned on a "proportional performance" basis as research hours are incurred. The Company performs services as specified in each respective agreement on a best-efforts basis, and is reimbursed based on labor hours incurred on each contract. The Company initially defers revenue for any amounts billed, or payments received, in advance of the services being performed and recognizes revenue pursuant to the related pattern of performance, based on total labor hours incurred relative to total labor hours estimated under the contract.

Revenue Arrangements with Multiple Deliverables

The Company occasionally enters into revenue arrangements that contain multiple deliverables. Judgment is required to properly identify the accounting units of the multiple deliverable transactions and to determine the manner in which revenue should be allocated among the accounting units. Moreover, judgment is used in interpreting the commercial terms and determining when all criteria of revenue recognition have been met for each deliverable in order for revenue recognition to occur in the appropriate accounting period. For multiple deliverable agreements, consideration is allocated at the inception of the agreement to all deliverables based on their relative selling price. The relative selling price for each deliverable is determined using Vendor Specific Objective Evidence (VSOE) of selling price or third-party evidence of selling price if VSOE does not exist. If neither VSOE nor third-party evidence of selling price exists, the Company uses its best estimate of the selling price for the deliverable.

The Company recognizes revenue for delivered elements only when it determines there are no uncertainties regarding customer acceptance. While changes in the allocation of the arrangement consideration between the units of accounting will not affect the amount of total revenue recognized for a particular sales arrangement, any material changes in these allocations could impact the timing of revenue recognition, which could affect the Company's results of operations.

NIH Grant Revenues

Revenues from the NIH grants are based upon internal and subcontractor costs incurred that are specifically covered by the grants, and where applicable, an additional facilities and administrative rate that provides funding for overhead expenses. These revenues are recognized when expenses have been incurred by subcontractors and as the Company incurs internal expenses that are related to the grants.


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Allowance for Doubtful Accounts

When we begin to sell commercial product we expect to establish a reserve for estimated sales returns that will be recorded as a reduction to revenue. That reserve will be maintained to account for future return of products sold in the current period. The reserve will be reviewed quarterly and will be estimated based on an analysis of our historical experience related to product returns.

Derivative Financial Instruments

The Company does not use derivative instruments to hedge exposures to cash flow, market or foreign currency risks.

The Company reviews the terms of convertible debt and equity instruments it issues to determine whether there are derivative instruments, including an embedded conversion option that is required to be bifurcated and accounted for separately as a derivative financial instrument. In circumstances where the convertible instrument contains more than one embedded derivative instrument, including the conversion option, that is required to be bifurcated, the bifurcated derivative instruments are accounted for as a single, compound derivative instrument. Also, in connection with the sale of convertible debt and equity instruments, the Company may issue freestanding warrants that may, depending on their terms, be accounted for as derivative instrument liabilities, rather than as equity.

Derivative instruments are initially recorded at fair value and are then revalued at each reporting date with changes in the fair value reported as non-operating income or expense. When the convertible debt or equity instruments contain embedded derivative instruments that are to be bifurcated and accounted for as liabilities, the total proceeds allocated to the convertible host instruments are first allocated to the fair value of all the bifurcated derivative instruments. The remaining proceeds, if any, are then allocated to the convertible instruments themselves, usually resulting in those instruments being recorded at a discount from their face value.

Fair Value Measurements

Financial assets and liabilities are measured at fair value, which is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Valuation techniques used to measure fair value must maximize the use of observable inputs and minimize the use of unobservable inputs. The following is a fair value hierarchy based on three levels of inputs, of which the first two are considered observable and the last unobservable, that may be used to measure fair value:

Level 1 - Quoted prices in active markets for identical assets or liabilities.

Level 2 - Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

Level 3 - Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

The Company uses Level 3 inputs for its valuation methodology for the warrant derivative liabilities. The estimated fair values were determined using a Monte Carlo option pricing model based on various assumptions. The Company's derivative liabilities are adjusted to reflect estimated fair value at each period end, with any decrease or increase in the estimated fair value being recorded in other income or expense accordingly, as adjustments to fair value of derivative liabilities.


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Stock-Based Compensation

For purposes of calculating stock-based compensation, we estimate the fair value of stock options using a Black-Scholes option-pricing model. The determination of the fair value of share-based payment awards utilizing the Black-Scholes model is affected by our stock price and a number of assumptions, including expected volatility, expected life, risk-free interest rate and expected dividends. The expected volatility is based on the historical volatility of our common stock over the most recent period commensurate with the estimated expected term of the stock options. The expected life of the stock options is based on historical and other economic data trended into the future. The risk-free interest rate assumption is based on observed interest rates appropriate for the expected terms of our stock options. The dividend yield assumption is based on our history and expectation of no dividend payouts. If factors change and we employ different assumptions, stock-based compensation expense may differ significantly from what we have recorded in the past. If there is a difference between the assumptions used in determining stock-based compensation expense and the actual factors which become known over time, specifically with respect to anticipated forfeitures, we may change the input factors used in determining stock-based compensation costs for future grants. These changes, if any, may materially impact our results of operations in the period such changes are made.

Results of Operations

Overview

Organovo was founded in Delaware in April 2007. Activities since the Company's inception through 2012 were devoted primarily to developing a platform technology for the generation of functional human tissues that can be employed in drug discovery and development, biological research, and as therapeutic implants for the treatment of damaged or degenerating tissues and organs.

As of December 31, 2012, the Company had devoted substantially all of its efforts to product development, raising capital and building infrastructure. The Company has not realized significant revenues from its planned principal operations. Accordingly, the Company is considered to be in the development stage.

Comparison of the years ended December 31, 2012 and 2011

Revenues

2012 total revenues of $1.2 million increased $0.2 million, or 20%, over 2011 revenues of $1.0 million. That increase was due to a $0.3 million increase in collaborative agreement revenues, and a $0.1 million increase in grant revenues, partially offset by a $0.2 million reduction in product revenues. While grant revenues are not expected to increase significantly in 2013, they will represent a portion of total revenues while the Company focuses efforts on collaborative agreements and continued development of research tools.

Operating Expenses

Operating expenses increased approximately $7.2 million, or 218%, in 2012 over 2011, from $3.3 million in 2011 to $10.5 million in 2012. Most significantly, relative to the prior year, the Company invested in infrastructure and outside services to support its transition from private ownership to a publicly owned and traded corporation. As expected in such transition, incremental initiatives were established in investor outreach, corporate governance, and SEC financial reporting. Non-payroll related incremental public company expenses incurred in 2012 were approximately $3.2 million. Moreover, the Company invested in building its executive, research, and development staff, increasing payroll related expenses by $2.0 million or 154% over 2011, from $1.3 million to $3.3 million. The increase in payroll-related expenses accounted for approximately 28% of total year-to-year increase in operating expenses. Stock-based compensation expense increased by approximately $1.4 million compared to the prior year under the 2012 Equity Incentive Plan with awards granted related to increased headcount in line with expanded operations. Additionally, the Company consolidated and relocated its facilities to a larger space to accommodate its growing research operations staff at an incremental cost over 2011 of approximately $0.3 million.


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Research and Development Expenses

2012 research and development expenses of $3.4 million increased by approximately $2.0 million, or 143%, over 2011 expenses of $1.4 million as the Company increased its research staff to support its obligations under certain collaborative research agreements and to expand product development efforts in preparation for research-derived revenues. Full-time research and development staffing increased from eight scientists and engineers as of December 31, 2011 to nineteen as of December 31, 2012.

Selling, General and Administrative Expenses

Selling, general and administrative expenses grew from $1.7 million in 2011 to $7.1 million in 2012, an increase of $5.4 million or 318%. Expense increases were driven by non-recurring charges associated with the financing, increased payroll and facilities expenses and our transition from operating in a private company environment to operating in a publicly traded corporation. As expected in such transition, incremental initiatives were established in investor outreach, corporate governance, and SEC financial reporting. Non-payroll related incremental public company expenses incurred in 2012 were approximately $3.2 million including non-recurring charges associated with the Merger and the Private Placements completed during the year. In addition, expanded staff increased payroll and facilities expenses in 2012 over 2011 levels with general and administrative staff increasing from four full-time employees as of December 31, 2011 to ten full-time employees as of December 31, 2012. This increase was primarily due to the addition of two executive positions and a small number of accounting and administrative staff. In addition, existing executive officers received salary increases as approved by the Board of Directors, reflecting the increased responsibilities assumed as a result of becoming a publicly traded company and success on growth initiatives.

Other Income (Expense)

The $32.2 million increase in other expenses as compared to 2011 was primarily related to the non-cash transaction costs associated with the Merger, the 2012 Private Placement, and the Tender Offer loss on the inducement to exercise warrants. We issued warrants to purchase 6,099,195 shares of our common stock to the placement agent and warrants to purchase 15,247,987 of our common stock to investors in the Private Placement. The warrants issued to the placement agent and Private Placement investors were determined to be derivative liabilities as a result of the anti-dilution provisions in the warrant agreements that may result in an adjustment to the warrant exercise price. We revalue the derivative liability on each subsequent balance sheet date until the securities to which the derivatives liabilities relate are exercised or expire. The fair value of warrant liabilities in excess of proceeds received was $19.0 million, while the change in fair value of warrant liabilities was $9.9 million. Financing transaction costs in excess of proceeds received was $2.1 million, the loss on inducement to exercise warrants under the Tender Offer was $1.9 million, and our interest expense was $1.1 million. 2012 interest expense was primarily comprised of non-cash components including accretion of debt discounts and amortization of deferred financing costs. The $2.1 million of interest expense in 2011 was primarily comprised of non-cash components including $1.2 million in amortization of debt discounts, $0.6 million fair value of warrants issued in connection with the 2011 Exchange Agreement (see Note 5) and amortization of deferred financing costs of $0.1 million.

Various factors are considered in the pricing models we use to value the warrants, including the Company's current stock price, the remaining life of the warrants, the volatility of the Company's stock price, and the risk free interest rate. Future changes in these factors will have a significant impact on the computed fair value of the warrant liability. As such, we expect future changes in the fair value of the warrants to continue to vary significantly from quarter to quarter.

Financial Condition, Liquidity and Capital Resources

Since its inception, the Company has primarily devoted its efforts to research and development, business planning, raising capital, recruiting management and technical staff, and acquiring operating assets. Accordingly, the Company is considered to be in the development stage.


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Since inception, the Company incurred negative cash flows from operations. As of December 31, 2012, the Company had cash and cash equivalents of $14.8 million and an accumulated deficit of $50.2 million. The Company also had negative cash flow from operations of $9.7 million during the year ended December 31, 2012. The increase in the net cash used in operating activities for the year ended December 31, 2012 was primarily due to our increased net loss.

At December 31, 2012, we had total current assets of $15.9 million and current liabilities of $22.0 million, resulting in a working capital deficit of $6.1 million. At December 31, 2011, we had total current assets of $1.0 million and current liabilities of $2.0 million, resulting in a working capital deficit of $1.0 million.

Net cash used in investing activities was $0.4 million and $0.1 million for the years December 31, 2012 and 2011, respectively. The increased use of net cash in investing activities was primarily due to purchases of equipment for the research lab.

Net cash provided by financing activities was $24.6 million and $2.1 million, for the years ended December 31, 2012 and 2011, respectively. The increase in cash provided by financing activities in 2012 was primarily due to proceeds received from the issuance of common stock and the exercise of warrants during the year. During February and March 2012, the Company received gross proceeds of $13.7 million from the private placement of equity securities. On February 8, February 29, and March 16, 2012, the Company completed the first, second and final closings, respectively, of the private placement offering. In these three closings, the Company issued 6,525,887 Units, 1,806,100 Units, and 6,916,000 Units, respectively, to accredited investors at a price of $1.00 per Unit, including the conversion of $1.5 million of principal and $25,379 of accrued interest under certain bridge promissory notes issued in 2011. The first closing was conducted simultaneously with the completion of the Company's merger (the "Merger") with Organovo, Inc. Each Unit consisted of one share of common stock of the Company, $0.001 par value per share and a five-year warrant to purchase one share of common stock at $1.00 per share. Total net proceeds were $11.6 million (or $12.8 million, including the conversion of the bridge promissory notes referred to above). In addition, the Company consummated its . . .

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