SECURITIES AND EXCHANGE COMMISSION
FORM 10-Q
(Mark One)
x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED DECEMBER 31, 2003, OR | |
o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM _____ TO _____ |
Commission file number 0-22025
AASTROM BIOSCIENCES, INC.
Michigan | 94-3096597 | |
(State or other jurisdiction of | (I.R.S. employer | |
incorporation or organization) | identification no.) | |
24 Frank Lloyd Wright Dr. | ||
P.O. Box 376 |
Ann Arbor, Michigan | 48106 | |
(Address of principal executive offices) | (Zip code) |
(734) 930-5555
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 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
x - - Yes o - No
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes o No x
Indicate the number of shares outstanding of each of the issuers classes of common stock as of the latest practicable date.
COMMON STOCK, NO PAR VALUE (Class) |
71,916,141 Outstanding at February 13, 2004 |
1
AASTROM BIOSCIENCES, INC.
Quarterly Report on Form 10-Q
December 31, 2003
TABLE OF CONTENTS
Page | |||||
PART I - FINANCIAL INFORMATION |
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Item 1. Financial Statements - Unaudited |
|||||
a) Consolidated Condensed Balance Sheets as of June 30, 2003 and
December 31, 2003 |
3 | ||||
b) Consolidated Condensed Statements of Operations for the three and
six months ended December 31, 2002 and 2003 and for
the period from March 24, 1989 (Inception) to December 31, 2003 |
4 | ||||
c) Consolidated Condensed Statements of Cash Flows for the six months ended December 31, 2002
and 2003 and for the period from March 24, 1989 (Inception) to December, 2003 |
5 | ||||
d) Notes to Consolidated Condensed Financial Statements |
6 | ||||
Item 2. Managements Discussion and Analysis of Financial Condition and
Results of Operations |
10 | ||||
Item 3. Quantitative and Qualitative Disclosures About Market Risk |
28 | ||||
Item 4. Controls and Procedures |
28 | ||||
PART II - OTHER INFORMATION |
|||||
Item 1. Legal Proceedings |
29 | ||||
Item 2. Changes in Securities and Use of Proceeds |
29 | ||||
Item 3. Defaults Upon Senior Securities |
29 | ||||
Item 4. Submission of Matters to a Vote of Security Holders |
29 | ||||
Item 5. Other Information |
30 | ||||
Item 6. Exhibits and Reports on Form 8-K |
30 | ||||
SIGNATURES |
31 | ||||
EXHIBIT INDEX |
32 | ||||
CERTIFICATIONS |
33 |
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PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
AASTROM BIOSCIENCES, INC.
(a development stage company)
CONSOLIDATED CONDENSED BALANCE SHEETS
(Unaudited)
June 30, | December 31, | |||||||||
2003 | 2003 | |||||||||
Assets |
||||||||||
CURRENT ASSETS: |
||||||||||
Cash and cash equivalents |
$ | 10,512,000 | $ | 10,784,000 | ||||||
Receivables, net |
350,000 | 310,000 | ||||||||
Inventory, net |
806,000 | 628,000 | ||||||||
Other current assets |
185,000 | 489,000 | ||||||||
Total current assets |
11,853,000 | 12,211,000 | ||||||||
PROPERTY and EQUIPMENT, NET |
302,000 | 291,000 | ||||||||
Total assets |
$ | 12,155,000 | $ | 12,502,000 | ||||||
Liabilities and Shareholders Equity |
||||||||||
CURRENT LIABILITIES: |
||||||||||
Accounts payable and accrued expenses |
$ | 406,000 | $ | 367,000 | ||||||
Accrued employee benefits |
174,000 | 190,000 | ||||||||
Total current liabilities |
580,000 | 557,000 | ||||||||
SHAREHOLDERS EQUITY: |
||||||||||
Common stock, no par value; shares authorized 150,000,000;
shares issued and
outstanding 64,812,422 and 71,355,849, respectively |
114,951,000 | 120,562,000 | ||||||||
Deficit accumulated during the development stage |
(103,376,000 | ) | (108,617,000 | ) | ||||||
Total shareholders equity |
11,575,000 | 11,945,000 | ||||||||
Total liabilities and shareholders equity |
$ | 12,155,000 | $ | 12,502,000 | ||||||
The accompanying notes are an integral part of these financial statements.
3
AASTROM BIOSCIENCES, INC.
(a development stage company)
CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS
(Unaudited)
Three months ended | Six months ended | March 24, 1989 | ||||||||||||||||||||
December 31, | December 31, | (Inception) to | ||||||||||||||||||||
December 31, | ||||||||||||||||||||||
2002 | 2003 | 2002 | 2003 | 2003 | ||||||||||||||||||
REVENUES: |
||||||||||||||||||||||
Product sales and rentals |
$ | 161,000 | $ | 10,000 | $ | 168,000 | $ | 35,000 | $ | 717,000 | ||||||||||||
Grants |
125,000 | 366,000 | 211,000 | 641,000 | 6,989,000 | |||||||||||||||||
Research and development agreements |
10,000 | | 10,000 | | 2,030,000 | |||||||||||||||||
Total revenues |
296,000 | 376,000 | 389,000 | 676,000 | 9,736,000 | |||||||||||||||||
COSTS AND EXPENSES: |
||||||||||||||||||||||
Cost of product sales and rentals |
111,000 | 5,000 | 111,000 | 17,000 | 405,000 | |||||||||||||||||
Cost of product sales and rentals -
provision for obsolete and excess inventory |
171,000 | | 259,000 | 253,000 | 2,230,000 | |||||||||||||||||
Research and development |
1,432,000 | 1,455,000 | 2,817,000 | 2,811,000 | 89,959,000 | |||||||||||||||||
Selling, general and administrative |
902,000 | 1,356,000 | 2,015,000 | 2,921,000 | 31,048,000 | |||||||||||||||||
Total costs and expenses |
2,616,000 | 2,816,000 | 5,202,000 | 6,002,000 | 123,642,000 | |||||||||||||||||
LOSS FROM OPERATIONS |
(2,320,000 | ) | (2,440,000 | ) | (4,813,000 | ) | (5,326,000 | ) | (113,906,000 | ) | ||||||||||||
OTHER INCOME (EXPENSE): |
||||||||||||||||||||||
Other income |
| | | | 1,237,000 | |||||||||||||||||
Interest income |
33,000 | 37,000 | 74,000 | 85,000 | 5,287,000 | |||||||||||||||||
Interest expense |
| | | | (267,000 | ) | ||||||||||||||||
Other income |
33,000 | 37,000 | 74,000 | 85,000 | 6,257,000 | |||||||||||||||||
NET LOSS |
$ | (2,287,000 | ) | $ | (2,403,000 | ) | $ | (4,739,000 | ) | $ | (5,241,000 | ) | $ | (107,649,000 | ) | |||||||
NET LOSS PER SHARE
(Basic and Diluted) |
$ | (.05 | ) | $ | (.03 | ) | $ | (.10 | ) | $ | (.07 | ) | ||||||||||
Weighted average number of
shares outstanding (Basic and Diluted) |
48,550,000 | 71,294,000 | 46,718,000 | 70,978,000 | ||||||||||||||||||
The accompanying notes are an integral part of these financial statements.
4
AASTROM BIOSCIENCES, INC.
(a development stage company)
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
(Unaudited)
Six months ended | March 24, 1989 | ||||||||||||||
December 31, | (Inception) to | ||||||||||||||
December 31, | |||||||||||||||
2002 | 2003 | 2003 | |||||||||||||
OPERATING ACTIVITIES: |
|||||||||||||||
Net loss |
$ | (4,739,000 | ) | $ | (5,241,000 | ) | $ | (107,649,000 | ) | ||||||
Adjustments to reconcile net loss to net cash
used for operating activities: |
|||||||||||||||
Depreciation and amortization |
58,000 | 59,000 | 3,505,000 | ||||||||||||
Loss on property held for resale |
| | 110,000 | ||||||||||||
Amortization of discounts and premiums on investments |
| | (543,000 | ) | |||||||||||
Stock compensation expense |
159,000 | 425,000 | 1,424,000 | ||||||||||||
Inventory write downs and reserves |
259,000 | 253,000 | 2,230,000 | ||||||||||||
Stock issued pursuant to license agreement |
| | 3,300,000 | ||||||||||||
Changes in assets and liabilities: |
|||||||||||||||
Receivables |
(75,000 | ) | 40,000 | (334,000 | ) | ||||||||||
Inventory |
(177,000 | ) | (75,000 | ) | (2,954,000 | ) | |||||||||
Other current assets |
(182,000 | ) | (304,000 | ) | (489,000 | ) | |||||||||
Accounts payable and accrued expenses |
(104,000 | ) | (39,000 | ) | 367,000 | ||||||||||
Accrued employee benefits |
(5,000 | ) | 16,000 | 190,000 | |||||||||||
Net cash used for operating activities |
(4,806,000 | ) | (4,866,000 | ) | (100,843,000 | ) | |||||||||
INVESTING ACTIVITIES: |
|||||||||||||||
Organizational costs |
| | (73,000 | ) | |||||||||||
Purchase of short-term investments |
| | (62,124,000 | ) | |||||||||||
Maturities of short-term investments |
1,000,000 | | 62,667,000 | ||||||||||||
Capital expenditures |
(31,000 | ) | (48,000 | ) | (2,963,000 | ) | |||||||||
Proceeds from sale of property held for resale |
| | 400,000 | ||||||||||||
Net cash provided by (used for) investing activities |
969,000 | (48,000 | ) | (2,093,000 | ) | ||||||||||
FINANCING ACTIVITIES: |
|||||||||||||||
Issuance of preferred stock |
| | 51,647,000 | ||||||||||||
Issuance of common stock |
1,992,000 | 5,186,000 | 59,765,000 | ||||||||||||
Repurchase of common stock |
| | (49,000 | ) | |||||||||||
Payments received for stock purchase rights |
| | 3,500,000 | ||||||||||||
Payments received under shareholder notes |
| | 31,000 | ||||||||||||
Principal payments under capital lease obligations |
| | (1,174,000 | ) | |||||||||||
Net cash provided by financing activities |
1,992,000 | 5,186,000 | 113,720,000 | ||||||||||||
NET INCREASE (DECREASE) IN CASH
AND CASH EQUIVALENTS |
(1,845,000 | ) | 272,000 | 10,784,000 | |||||||||||
CASH AND CASH EQUIVALENTS AT
BEGINNING OF PERIOD |
8,605,000 | 10,512,000 | | ||||||||||||
CASH AND CASH EQUIVALENTS AT
END OF PERIOD |
$ | 6,760,000 | $ | 10,784,000 | $ | 10,784,000 | |||||||||
The accompanying notes are an integral part of these financial statements
5
AASTROM BIOSCIENCES, INC.
(A development stage company)
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Unaudited)
1. Organization
Aastrom Biosciences, Inc. (Aastrom) was incorporated in March 1989 (Inception), began employee-based operations in 1991, and is in late-stage development. The Company operates its business in one reportable segment research and product development, conducted both on its own behalf and in connection with various collaborative research and development agreements with others, involving the development and sale of processes and products for the ex vivo production of human cells for use in cell therapy.
Successful future operations are subject to several technical and business risks, including satisfactory product development, obtaining regulatory approval and market acceptance for developed products and the Companys ability to obtain future funding.
The Company is subject to certain risks related to the operation of its business and development of its products and product candidates. While available cash and investments are expected to finance currently planned activities at least through the end of fiscal year 2004, the Company will need to raise additional funds in order to complete its product development programs and commercialize its first product candidates. The Company cannot be certain that such funding will be available on favorable terms, if at all. Some of the factors that will impact the Companys ability to raise additional capital include, but are not limited to, the rate and degree of progress demonstrated in its product development programs, the liquidity and volatility of its equity securities, regulatory and manufacturing requirements and uncertainties, technological developments by competitors, and the general availability of capital in the private and public debt and equity market. If the Company cannot raise additional funds, it may not be able to develop or enhance products, take advantage of future opportunities, or respond to competitive pressures or unanticipated requirements, which would negatively impact its business, financial condition and results of operations.
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2. Basis of Presentation
The condensed consolidated financial statements included herein have been prepared by the Company without audit according to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles in the United States have been omitted pursuant to such rules and regulations. The financial statements reflect, in the opinion of management, all adjustments (consisting only of normal, recurring adjustments) necessary to present fairly the financial position and results of operations as of and for the periods indicated. The results of operations for the three and six months ended December 31, 2003, are not necessarily indicative of the results to be expected for the full year or for any other period.
These financial statements should be read in conjunction with the audited financial statements and the notes thereto included in our 2003 Annual Report on Form 10-K for the year ended June 30, 2003, as filed with the Securities and Exchange Commission.
The consolidated financial statements include the accounts of Aastrom and its wholly-owned subsidiary, Zellera AG (Zellera), which is located in Berlin, Germany (collectively, the Company). All significant inter-company transactions and accounts have been eliminated in consolidation.
Certain previously reported statement of operations amounts have been reclassified to conform to the current period presentation. In March 2003, the Company began segregating cost of product sales relating to the obsolescence of inventory. These costs previously were included in the Cost of product sales and rentals. These reclassifications had no impact on previously reported net loss, shareholders equity or cash flows.
3. Stock-Based Employee Compensation
The Company has a stock incentive plan that is described more fully in Note 3 to the consolidated financial statements included in our Annual Report on Form 10-K for the year ended June 30, 2003. The Company accounts for this plan under the recognition and measurement principles of APB Opinion No. 25, Accounting for Stock Issued to Employees and related Interpretations. The following table illustrates the effect on net loss and net loss per share if the Company had applied the fair value recognition provisions of Statement of Financial Accounting Standards (SFAS) No. 123, Accounting for Stock-Based Compensation:
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Three Months Ended December 31, | Six Months Ended December 31, | ||||||||||||||||||||||
2002 | 2003 | 2002 | 2003 | ||||||||||||||||||||
Reported net loss |
$ | (2,287,000 | ) | $ | (2,403,000 | ) | $ | (4,739,000 | ) | $ | (5,241,000 | ) | |||||||||||
Add: | Stock-based employee compensation expenses included in reported net loss, net of related tax effects | | | | 372,000 | ||||||||||||||||||
Deduct: | Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects | (193,000 | ) | (227,000 | ) | (425,000 | ) | (457,000 | ) | ||||||||||||||
Pro forma net loss |
$ | (2,480,000 | ) | $ | (2,630,000 | ) | # | $ | (5,164,000 | ) | $ | (5,326,000 | ) | ||||||||||
Net loss per common share: |
|||||||||||||||||||||||
As reported |
$ | (0.05 | ) | $ | (0.03 | ) | $ | (0.10 | ) | $ | (0.07 | ) | |||||||||||
Pro forma |
$ | (0.05 | ) | $ | (0.04 | ) | $ | (0.11 | ) | $ | (0.08 | ) |
4. Shareholders Equity
During the six months ended December 31, 2003, the Company issued 6,405,840 shares of common stock to multiple investors: 26,053 shares of common stock to employees as part of the Employee Stock Purchase Plan and 111,534 shares of common stock through the exercise of certain warrants, for net proceeds of approximately $5,186,000. As part of one of these transactions, the Company issued warrants to private placement investors, exercisable for 4 years to purchase up to 1,264,706 shares of common stock at a price of $1.23 per share, as well as warrants to purchase up to 1,011,765 shares of common stock at $1.50 per share prior to October 31, 2003 that expired, unexercised. In addition, warrants to purchase 303,529 shares of common stock were issued to a private placement agent, exercisable for 4 years at a price of $1.23 per share. The Company also issued warrants to two individuals, who performed investor and public relations services, exercisable for one year to purchase up to an aggregate of 100,000 shares of common stock at a price of $0.50 per share.
5. Net Loss Per Common Share
Net loss per common share is computed using the weighted-average number of common shares outstanding during the period. Common equivalent shares are not included in the per share calculation where the effect of their inclusion would be anti-dilutive. The aggregate number of common equivalent shares that have been excluded from the computations of net loss per common share for the quarter and six months ended December 31, 2002 and 2003 is approximately 8,744,000 and 5,959,000, respectively.
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6. Recent Accounting Pronouncements
In January 2003, the FASB issued Interpretation No. 46, Consolidation of Variable Interest Entities, an interpretation of ARB No. 51. This interpretation provides guidance on: 1) the identification of entities for which control is achieved through means other than through voting rights, known as variable interest entities (VIEs); and 2) which business enterprise is the primary beneficiary and when it should consolidate the VIE. This new model for consolidation applies to entities: 1) where the equity investors (if any) do not have a controlling financial interest; or 2) whose equity investment at risk is insufficient to finance that entitys activities without receiving additional subordinated financial support from other parties. In addition, this interpretation requires that both the primary beneficiary and all other enterprises with a significant variable interest in a VIE make additional disclosures. For VIEs created or acquired prior to February 1, 2003, the provisions of the interpretation were initially to be applied no later than the beginning of the first interim or annual reporting period beginning after June 15, 2003, with a subsequent deferral period of application no later than December 15, 2003. Certain disclosures were effective immediately. The adoption of Interpretation No. 46, as of December 15, 2003, did not have a material impact on the financial position or results of operations of Aastrom.
In May 2003, Emerging Issues Task Force Issue No. 00-21 (EITF 00-21), Accounting for Revenue Arrangements with Multiple Deliverables was finalized. This EITF issue addresses certain aspects of accounting by a vendor for arrangements under which it will perform multiple revenue-generating activities. The guidance in the consensus is effective for revenue arrangements entered into in fiscal periods beginning after June 15, 2003. The adoption of this standard did not have a material impact on the financial position or results of operations of Aastrom.
In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity. SFAS No. 150 requires that an issuer classify certain financial instruments within its scope as a liability (or an asset in some circumstances). The adoption of this standard will not impact the current financial position or results of operations of Aastrom.
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Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
Overview
We are a late-stage development company that is focused on the development of processes and products for the ex vivo production and sale of human cell products for use in cell therapy.
We develop proprietary Prescription Cell Products (PCP) for the regenerative repair of damaged human tissues and other medical disorders. Our lead PCP products are Tissue Repair Cells (TRC), which are a unique mixture of bone marrow-derived stem and progenitor cells, produced ex vivo. TRCs have been proven safe in patients and to effectively generate normal human tissues in clinical trials.
We have also completed the development of our proprietary AastromReplicell System, which is a patented, integrated system of instrumentation and single-use consumable kits for the commercial production of human cells. The AastromReplicell System technology is used to manufacture our proprietary PCP products and can be sold independently as a platform for therapeutic cell production, the basis of our Cell Production Products (CPP) business. We currently market our CPP dendritic cell vaccine products in Europe and in the United States. Our strategy provides multiple paths to revenue, with the CPP business generating early revenue to augment the planned therapeutic PCP pipeline.
Our commercial production pathway of our Prescription Cell Products is enabled through the AastromReplicell System platform. This proprietary and automated clinical cell production system combines patented GMP-compliant automated cell production with patented single pass perfusion.
Single pass perfusion is our technology for growing large quantities of highly robust human cells outside the body. These cells include adult stem cells, immune system cells, and cells for forming solid tissues such as bone.
Prescription Cell Products
We are leveraging our ex vivo cell production technology for a growing Prescription Cell Product pipeline focused on two areas: Tissue Repair Cells (TRCs) for stem cell-derived tissue repair and regeneration, and Therapeutic Cells (TCs) for immune system-directed attacks on certain cancers and other infectious diseases. Of these, our principal current focus is on TRCs.
Tissue Repair Cells
The clinical trial direction of our studies has been influenced by observations that our bone marrow cell products may be suitable as a treatment for bone and blood vessel regeneration, each of which represents a substantial market opportunity. In reviewing the pre-
10
clinical and clinical data for our bone marrow cell products (termed Tissue Repair Cells or TRCs) in various Aastrom supported trials, we have noted a substantial increase in the cell types that can generate connective tissues including bone and cartilage. In addition, our bone marrow cell product has been given to one patient, on a compassionate basis, with a congenital genetic defect (hypophosphatasia) which results in a lethal condition of abnormal bone and cartilage formation. The results of compassionate use treatment, now published in the Journal of Bone and Mineral Research, demonstrated sustained bone formation in the child.
Using the AastromReplicell System, TRCs are grown from a small sample of a patients bone marrow. Once administered back to the patient, the cells are intended to generate normal tissue. The primary TRC application we are initially pursuing is bone grafting (spinal fusions, long bone fractures or jaw bone reconstruction). In August 2003, the FDA approved our Investigational New Drug (IND) application to begin a multi-center Phase I/II clinical trial for bone grafting. Our bone grafting clinical trials have recently been initiated in the U.S. and Europe for the treatment of tibial non-union fractures, and we expect to announce additional clinical sites for this application. The initiation of European clinical trials for dental implants have been delayed pending the finalization of applicable cell production licensing requirements.
We also believe that the stem cell components of our TRCs may be useful for other medical indications, including the regeneration of vascular tissues and cartilage.
Therapeutic Cells
We are developing TC products using human cells to cause the patients immune system to attack certain cancers and other infectious diseases. Blood-derived dendritic cells, which are the bodys crucial mobilizers of the immune T-Cells response, are cultured in the AastromReplicell System to produce our proprietary Dendricell. After being exposed to a particular biological signal, or antigen, the Dendricell may act to trigger a cell-mediated immune response against the patients cancer cells. The first Dendricell clinical trial was initiated at Duke University for a colorectal cancer vaccine in December 2003. Additional trials with academic collaborators are planned, including a trial at Stanford University for a multiple myeloma cancer vaccine.
Cell Production Products
Our Cell Production Products operation markets and sells our AastromReplicell System and DC-I (dendritic cells for fusion and transfection), DCV-I (complex antigen-loaded dendritic cells) and DCV-II (peptide-loaded dendritic cells) cell production kits to academic researchers and companies that are developing cancer vaccines. We expect that the recent commercialization of our automated cell production instruments and cell-specific production kits will enable us to generate revenues, although we are not yet able to project the market size or potential revenues or revenue growth for these products. The European Union has recently issued new directives that may affect the manufacturing of cell products and clinical trials. These changes have delayed or in some cases temporarily halted dendritic cell clinical trials in
11
Europe, which has reduced the number of customer opportunities and affected our progress in our Cell Production Products business.
In addition to our consumable DC-I, DCV-I and DCV-II cell product kits, we have begun marketing our automated cell production instruments in Europe and the United States for research use. Through Zellera AG, Aastroms wholly owned subsidiary located in Berlin, Germany, we are actively coordinating country-specific sub-distributorships and service networks in Europe.
While we have initiated marketing activities in Europe for the CE Marked SC-I, DC-I, DCV-I and the DCV-II products, at this point in our current business development, we cannot project when we will generate positive cash flows from our consolidated operations. In the next two to three years, we expect that our revenue sources will consist of sales from our Cell Production Product operation to academic and commercial research centers, grant revenue, research funding and licensing fees from potential future corporate collaborators. To date, we have financed our operations primarily through public and private sales of our equity securities. As a development-stage company, we have never been profitable and do not anticipate having net income unless and until significant product sales commence. Achieving this objective will require significant additional funding. Our ability to achieve profitability on a sustained basis, if at all, or to obtain the required funding to achieve our operating objectives, or complete additional corporate partnering transactions is subject to a number of risks and uncertainties. Please see the section entitled Certain Business Considerations.
Our programs currently use bone marrow, cord blood and blood cells as starting sources of cells. As such, federal support of other factors relating to embryonal stem cell research have no direct impact on our current product programs.
Strategic Relationships
In June 2003, we announced a strategic alliance with the Musculoskeletal Transplant Foundation (MTF) to jointly develop and commercialize innovative treatments for the regeneration of tissues such as bone and cartilage. The collaboration aligns us with the leading provider of allograft, or donor-derived tissue, materials (matrices) with a focus on forming a coordinated business and clinical approach for new products and treatments needed in orthopedic medicine.
Under the terms of the alliance, Aastrom and MTF will coordinate and fund the development of products that are based on combinations of MTFs matrices and our Tissue Repair Cells (TRCs). The companies will share in certain development and clinical trial expenses of these treatment approaches and products, and will adopt a coordinated promotion and marketing strategy for future products.
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Critical Accounting Policies
There are several accounting policies that we believe are significant to the presentation of our consolidated financial statements. The most significant accounting policies include those related to inventory, revenue recognition and accounts receivable.
Inventory. We value our inventory, that consists primarily of finished components of our lead product, the AastromReplicell Cell Production System, at the lower of cost (specific identification using the first in, first out method) or market. Furthermore, we regularly review inventory quantities on hand and record a provision to write down obsolete and excess inventory to its estimated net realizable value. Based on the aging of inventory at each period end, we utilize a systematic approach to determine our reserve for obsolete and excess inventory. Under this systematic approach, inventory that is less than twelve months old, based on the receipt date, will be carried at full value. Inventory quantities in excess of twelve months old are reserved over a six-month period, until the items are either sold or fully reserved. We feel this approach is appropriate given our limited product sales history and the risk associated with our ability to recover the inventory as we are still in the process of establishing our product market. Future technological changes, new product development and actual sales results could result in additional obsolete and excess inventory on hand. This could have a significant impact on the value of our inventory and our reported operating results.
Revenue recognition. We generate revenue from grants and research agreements, collaborative agreements, product sales and rentals and licensing arrangements. Revenue from grants and research agreements is recognized on a cost reimbursement basis consistent with the performance requirements of the related agreements. Revenue from collaborative agreements is recognized when the scientific or clinical results stipulated in the agreement have been met and there are no other ongoing obligations on our part. Revenue from product sales is recognized when title to the product transfers and there are no remaining obligations that will affect the customers final acceptance of the sale, generally after installation and training. If there are remaining obligations, including training or installation (which we believe to be significant), revenue is recognized upon completion of these obligations. Revenue from licensing fees under licensing agreements is recognized as revenue when there are no future performance obligations remaining with respect to such fees. Payments received before all obligations are fulfilled are classified as deferred revenue.
Accounts receivable. We make estimates evaluating collectibility of accounts receivable. We continuously monitor collections and payments from our customers and maintain an allowance for estimated credit losses based on any specific customer collection issues we have identified. While such credit issues have not been significant, there is no assurance that we will continue to experience the same credit losses in the future.
The summary of significant accounting policies should be read in conjunction with our consolidated financial statements and related notes and this discussion of our results of operations, as well as in conjunction with our audited financial statements contained in our 2003 Annual Report on Form 10-K.
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Results of Operations
Total revenues, consisting of grant funding and product sales and rentals, for the quarter and six months ended December 31, 2003 were $376,000 and $676,000, respectively, compared to $296,000 and $389,000 for the same periods in 2002. Grant revenues increased for the quarter and six months ended December 31, 2003 to $366,000 and $641,000, respectively, over $125,000 and $211,000 for the same periods in 2002. Grant revenues have increased from the prior year periods as a result of additional grant awards from the National Institutes of Health. Product sales and rentals decreased to $10,000 and $35,000 for the quarter and six months ended December 31, 2003, respectively, from $161,000 and $168,000 for the same periods in 2002. This decrease is primarily due to extended internal evaluations at potential customer sites that have delayed sales of our instrumentation and therapy kits in fiscal year 2004. We continue to pursue grant-funded programs as well as actively pursuing European and domestic sales and marketing opportunities.
Total costs and expenses for the second fiscal quarter ended December 31, 2003 increased to $2,816,000, compared to $2,616,000 for the same quarter in fiscal year 2003. Costs and expenses during the second quarter of fiscal year 2004 included an increase in selling, general and administrative expenses to $1,356,000 from $902,000 for the same quarter in fiscal year 2003. This increase reflects continued expansion of marketing activities to further our commercialization efforts in Europe and additional costs relating to capital raising efforts that are not related to specific transactions. Research and development expenses for the second quarter ended December 31, 2003 increased slightly to $1,455,000 from $1,432,000 in the comparable period of fiscal year 2003. Cost of product sales and rentals declined to $5,000 in the second quarter of fiscal year 2004 from $111,000 in the second quarter of fiscal year 2003 due to the decline in volume of product sales. The non-cash provision for obsolete and excess AastromReplicellTM System inventory declined from $171,000 in the second quarter of fiscal year 2003 to zero in the second quarter of fiscal year 2004 because as of September 30, 2003, we had written the carrying value of all of our AastromReplicellTM System inventory down to zero.
Total costs and expenses for the six months ended December 31, 2003 increased to $6,002,000 compared to $5,202,000 for the same period in fiscal year 2003. The increase is primarily due to selling, general and administrative expenses that increased to $2,921,000 for the six month period ended December 31, 2003 from $2,015,000 in the comparable period of fiscal year 2003. This is the result of continued marketing efforts in Europe, additional costs relating to capital raising, a non-cash charge of $53,000 relating to certain warrants issued in August 2003 for public and investor relation services and a $372,000 non-cash charge related to an employee performance-based stock option that vested in September 2003. We experienced only a small decrease in research and development expenses to $2,811,000 for the six months ended December 31, 2003 from $2,817,000 in the comparable period of fiscal year 2003. Research and product development activities are continuing in the areas of dendritic-cell based vaccines, tissue regeneration and preparation for our pending bone grafting trials in the United States and Europe. Cost of product sales and rentals declined to $17,000 in the first six
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months of fiscal year 2004 from $111,000 in the first six months of fiscal year 2003 due to the decline in the volume of product sales. The non-cash provision for obsolete and excess AastromReplicellTM System inventory declined from $259,000 in the first six months of fiscal year 2003 to $253,000 in the first six months of fiscal year 2004 because as of September 30, 2003, we had written the carrying value of all of our AastromReplicellTM System inventory down to zero.
Interest income was $37,000 and $85,000 for the quarter and six months ended December 31, 2003, respectively, compared to $33,000 and $74,000 for the same periods in fiscal year 2003. The fluctuations in interest income are due primarily to corresponding changes in the level of cash, cash equivalents and short-term investments during the periods which offset decreases in yields from our investments.
Our net loss increased to $2,403,000, and decreased to $.03 per common share for the quarter ended December 31, 2003 compared to a net loss of $2,287,000, or $.05 per common share for the same period in fiscal year 2003. Similarly, for the six months ended December 31, 2003, our net loss increased to $5,241,000, and decreased to $.07 per common share compared to $4,739,000, or $.10 per common share for the same period in fiscal year 2003. This increase in net loss is primarily the result of increased costs and expenses offset on a per share basis by an increase in the weighted average number of common shares outstanding resulting from the additional equity financing, as addressed in the Liquidity and Capital Resources discussion below.
Liquidity and Capital Resources
We have financed our operations since inception primarily through public and private sales of equity securities, which, from inception through December 31, 2003, have totaled approximately $121 million and, to a lesser degree, through grant funding, payments received under research agreements and collaborations and interest earned on cash, cash equivalents, and short-term investments. These financing sources have historically allowed us to maintain adequate levels of cash and other liquid investments to continue our operations at planned levels.
Our combined cash, cash equivalents and short-term investments totaled $10,784,000 at December 31, 2003, an increase of $272,000 from June 30, 2003. The primary uses of cash, cash equivalents and short-term investments during the six months ended December, 2003 included $4,866,000 to finance our operations and working capital requirements. The primary source of cash, cash equivalents and short-term investments was from equity financing transactions, of $5,186,000. This equity financing was obtained under multiple transactions and the Employee Stock Purchase Plan.
Our future cash requirements will depend on many factors, including continued scientific progress in our research and development programs, the scope and results of clinical trials, the time and costs involved in obtaining regulatory approvals, the costs involved in filing, prosecuting and enforcing patents, competing technological and market developments and the
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cost of product commercialization. We do not expect to generate a positive cash flow from operations for at least the next several years due to the expected spending for research and development programs and the cost of commercializing our product candidates. We intend to seek additional funding through research and development, or distribution and marketing, agreements with suitable corporate collaborators, grants and through public or private financing transactions. Successful future operations are subject to several technical and business risks, including our continued ability to obtain future funding, satisfactory product development, obtaining regulatory approval and market acceptance for our products. We expect that our available cash and financing will be sufficient to fund currently planned activities through our 2004 fiscal year (ending June 30, 2004). However, in order to grow and expand our business, and to introduce our new product candidates into the marketplace, we will need to raise additional funds. We are currently pursuing additional sources of financing. We will also need additional funds or a collaborative partner, or both, to finance the research and development activities of our product candidates for the expansion of additional cell types. We expect that our primary sources of capital for the foreseeable future will be through collaborative arrangements and through the public or private sale of our debt or equity securities. These estimates are forward-looking statements based on certain assumptions, which could be negatively impacted by the matters discussed under Certain Business Considerations and under the caption Business Risks in our 2003 Annual Report on Form 10-K. There can be no assurance that such collaborative arrangements, or any public or private financing, will be available on acceptable terms, if at all, or can be sustained. Several factors will affect our ability to raise additional funding, including, but not limited to, market volatility of our common stock and economic conditions affecting the public markets generally or some portion or all of the technology sector. If adequate funds are not available, we may be required to delay, reduce the scope of, or eliminate one or more of our research and development programs, which may have a material adverse affect on our business. See Business Risks and Notes to Consolidated Financial Statements in our 2003 Annual Report on Form 10-K and Notes to Consolidated Financial Statements and Certain Business Considerations included herein.
New Accounting Standards
In January 2003, the FASB issued Interpretation No. 46, Consolidation of Variable Interest Entities, an interpretation of ARB No. 51. This interpretation provides guidance on: 1) the identification of entities for which control is achieved through means other than through voting rights, known as variable interest entities (VIEs); and 2) which business enterprise is the primary beneficiary and when it should consolidate the VIE. This new model for consolidation applies to entities: 1) where the equity investors (if any) do not have a controlling financial interest; or 2) whose equity investment at risk is insufficient to finance that entitys activities without receiving additional subordinated financial support from other parties. In addition, this interpretation requires that both the primary beneficiary and all other enterprises with a significant variable interest in a VIE make additional disclosures. For VIEs created or acquired prior to February 1, 2003, the provisions of the interpretation were initially to be applied no later than the beginning of the first interim or annual reporting period beginning after June 15, 2003, with a subsequent deferral period of application no later than December
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15, 2003. Certain disclosures were effective immediately. The adoption of Interpretation No. 46, as of December 15, 2003, did not have a material impact on the financial position or results of operations of Aastrom.
In May 2003, Emerging Issues Task Force Issue No. 00-21 (EITF 00-21), Accounting for Revenue Arrangements with Multiple Deliverables was finalized. This EITF issue addresses certain aspects of accounting by a vendor for arrangements under which it will perform multiple revenue-generating activities. The guidance in the consensus is effective for revenue arrangements entered into in fiscal periods beginning after June 15, 2003. The adoption of this standard did not have a material impact on the financial position or results of operations of Aastrom.
In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity. SFAS No. 150 requires that an issuer classify certain financial instruments within its scope as a liability (or an asset in some circumstances). The adoption of this standard will not impact the current financial position or results of operations of Aastrom.
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Certain Business Considerations
Our past losses and expected future losses cast doubt on our ability to operate profitably.
We were incorporated in 1989 and have experienced substantial operating losses since inception. As of December 31, 2003, we have incurred cumulative net losses totaling approximately $108 million. These losses have resulted principally from costs incurred in the research and development of our cell culture technologies and the AastromReplicell System, general and administrative expenses, and the prosecution of patent applications. We expect to incur significant operating losses until product sales increase, primarily owing to our research and development programs, including pre-clinical studies and clinical trials, and the establishment of marketing and distribution capabilities necessary to support commercialization efforts for our products. We cannot predict with any certainty the amount of future losses. Our ability to achieve profitability will depend, among other things, on successfully completing the development of our product candidates, obtaining regulatory approvals, establishing manufacturing, sales and marketing arrangements with third parties, and raising sufficient funds to finance our activities. We may not be able to achieve or sustain profitability.
Failure to obtain and maintain required regulatory approvals would severely limit our ability to sell our products.
We must obtain the approval of the FDA before commercial sales of our cell product candidates may commence in the United States, which we believe will be the largest market for our products. We may also be required to obtain additional approvals from foreign regulatory authorities to continue or increase our sales activities of cells and equipment in those jurisdictions. If we cannot demonstrate the safety, reliability and efficacy of our product candidates, or of the cells produced in such products, we may not be able to obtain required regulatory approvals. Patients receiving cells produced with our technologies and product candidates may not demonstrate long-term engraftment in a manner comparable to cells obtained from current hematopoietic stem cell therapy procedures. If we cannot demonstrate the safety or efficacy of our technologies and product candidates, including long-term sustained engraftment, or if one or more patients die or suffer severe complications, the FDA or other regulatory authorities could delay or withhold regulatory approval of our product candidates.
Finally, even if we obtain regulatory approval of a product, that approval may be subject to limitations on the indicated uses for which it may be marketed. Even after granting regulatory approval, the FDA and regulatory agencies in other countries continue to review and inspect marketed products, manufacturers and manufacturing facilities, which may create additional regulatory burdens. Later discovery of previously unknown problems with a product, manufacturer or facility may result in restrictions on the product or manufacturer, including a withdrawal of the product from the market. Further, regulatory agencies may establish additional regulations that could prevent or delay regulatory approval of our products.
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Any changes in the governmental regulatory classifications of our products could prevent, limit or delay our ability to market or develop our products.
The FDA establishes regulatory requirements based on the classification of a product. Although the AastromReplicell System is considered to be unregulated manufacturing equipment in the U.S. the FDA may reconsider this and classify the System as a Class III medical device, or the FDA may ultimately choose to regulate the AastromReplicell System under another category. Because our product development programs are designed to satisfy the standards applicable to medical devices and biological licensure for our cellular products, any change in the regulatory classification or designation would affect our ability to obtain FDA approval of our products. The AastromReplicell System is used to produce different cell mixtures, and each of these cell mixtures will, under current regulations be regulated as biologic products, which require a biologic license application (BLA).
The European Union has recently issued new directives that may affect the manufacturing of cell products and clinical trials. These changes have delayed or in some cases temporarily halted dendritic cell clinical trials in Europe, which has reduced the number of customer opportunities and affected our progress in our Cell Production Products business. The recent changes to the European Union Medicinal Products Prime Directive shifted patient-derived cells to the medicinal products category. These new laws may delay some of our current planned clinical trials in Europe.
Our inability to complete our product development activities successfully would severely limit our ability to operate or finance operations.
Commercialization in the United States of our cell product candidates will require substantial clinical trials. While we have commenced initial marketing on a limited basis of the AastromReplicell System in Europe, we believe that the United States will be the largest market for our products. We may not be able to successfully complete development of our product candidates, or successfully market our technologies or product candidates. We, and any of our potential collaborators, may encounter problems and delays relating to research and development, regulatory approval and intellectual property rights of our technologies and product candidates. Our research and development programs may not be successful, and our cell culture technologies and product candidates may not facilitate the production of cells outside the human body with the expected result. Our technologies and product candidates may not prove to be safe and efficacious in clinical trials, and we may not obtain the requisite regulatory approvals for our technologies or product candidates and the cells produced in such products. If any of these events occur, we may not have adequate resources to continue operations for the period required to resolve the issue delaying commercialization and we may not be able to raise capital to finance our continued operation during the period required for resolution of that issue.
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We may not be able to raise the required capital to conduct our operations and develop our products.
We will require substantial capital resources in order to conduct our operations and develop our products. In October 1999, we were forced to reduce operations based on our declining level of capital resources and our limited financing alternatives available at that time. The previous reduction in our operating activities has delayed our product development programs. We expect that our available cash and financing will be sufficient to fund currently planned activities through our 2004 fiscal year (ending June 30, 2004). However, in order to grow and expand our business, and to introduce our new product candidates into the marketplace, we will need to raise additional funds. We will also need additional funds or a collaborative partner, or both, to finance the research and development activities of our product candidates for the expansion of additional cell types. Accordingly, we are continuing to pursue additional sources of financing.
Our future capital requirements will depend upon many factors, including:
| continued scientific progress in our research and development programs; | ||
| costs and timing of conducting clinical trials and seeking regulatory approvals; | ||
| competing technological and market developments; | ||
| our ability to establish additional collaborative relationships; and | ||
| the effect of commercialization activities and facility expansions if and as required. |
Because of our long-term funding requirements, we are likely to access the public or private equity markets if and whenever conditions are favorable, even if we do not have an immediate need for additional capital at that time. Further, we may enter into financing transactions at rates, which are at a substantial discount to market. This additional funding may not be available to us on reasonable terms, or at all. If adequate funds are not available in the future, we may be required to further delay or terminate research and development programs, curtail capital expenditures, and reduce business development and other operating activities.
The issuance of additional common stock for funding has the potential for substantial dilution.
As noted above, we will need additional equity funding to provide us with the capital to reach our objectives. At current market prices, such an equity issuance would cause a substantially larger number of shares to be outstanding and would dilute the ownership interest of existing stockholders.
Our stock price has been volatile and future sales of substantial numbers of our shares could have an adverse affect on the market price of our shares.
The market price of shares of our common stock has been volatile, ranging in closing price between $0.25 and $1.77 during the twelve month period ended December 31, 2003. The price of our common stock may continue to fluctuate in response to a number of events and factors, such as:
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| clinical trial results; | ||
| the amount of our cash resources and our ability to obtain additional funding; | ||
| announcements of research activities, business developments, technological innovations or new products by us or our competitors; | ||
| entering into or terminating strategic relationships; | ||
| changes in government regulation; | ||
| disputes concerning patents or proprietary rights; | ||
| changes in our revenues or expense levels; | ||
| public concern regarding the safety, efficacy or other aspects of the products or methodologies we are developing; | ||
| reports by securities analysts; and | ||
| status of the investment markets. |
Any of these events may cause the price of our shares to fall, which may adversely affect our business and financing opportunities. In addition, the stock market in general and the market prices for biotechnology companies in particular have experienced significant volatility that often has been unrelated to the operating performance or financial conditions of such companies. These broad market and industry fluctuations may adversely affect the trading price of our stock, regardless of our operating performance or prospects.
We must successfully complete our clinical trials to be able to market certain of our products.
To be able to market Prescription Cell Products in the United States, we must demonstrate, through extensive preclinical studies and clinical trials, the safety and efficacy of our processes and product candidates, for application in the treatment of humans. If our clinical trials are not successful, our products may not be marketable.
Our ability to complete our clinical trials in a timely manner depends on many factors, including the rate of patient enrollment. Patient enrollment can vary with the size of the patient population, the proximity of suitable patients to clinical sites, perceptions of the utility of cell therapy for the treatment of certain diseases and the eligibility criteria for the study. We have experienced delays in patient accrual in our previous and current clinical trials. If we experience future delays in patient accrual, we could experience increased costs and delays associated with clinical trials, which would impair our product development programs and our ability to market our products. Furthermore, the FDA monitors the progress of clinical trials and it may suspend or terminate clinical trials at any time due to patient safety or other considerations.
Even if we obtain regulatory approvals to sell our products, lack of commercial acceptance could impair our business.
We are seeking to obtain regulatory approval to market stem cell tissue repair and regeneration treatments, and cancer and infectious disease treatments. Even if we obtain all required regulatory approvals, we cannot be certain that our products and processes will be
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adopted at a level that would allow us to operate profitably. Our tissue repair products will face competition from existing, and/or potential other new treatments in the future which could limit revenue potential. It may be necessary to increase the yield and/or cell type purity, for certain of our AastromReplicellTM System cell processes to gain commercial acceptance. Our technologies or product candidates may not be employed in all potential applications being investigated, and any reduction in applications would limit the market acceptance of our technologies and product candidates and our potential revenues.
Failure of third parties to manufacture component parts or provide limited source supplies, or imposition of additional regulation, would impair our new product development and our sales activities.
We rely solely on third parties such as Astro, Moll, Cambrex and Amgen to manufacture our product candidates, component parts and growth factors and other materials used in the cell expansion process. We would not be able to obtain alternate sources of supply for many of these items on a short-term basis. If any of our key manufacturers or suppliers fail to perform their respective obligations or if our supply of growth factors, components or other materials is limited or interrupted, we would not be able to conduct clinical trials or market our product candidates on a timely and cost-competitive basis, if at all.
Furthermore, some of the compounds used by us in our current bone marrow or cord blood cell expansion processes involve the use of animal-derived products. Suppliers or regulatory authorities may limit or restrict the availability of such compounds for clinical and commercial use. Any restrictions on these compounds would impose a potential competitive disadvantage for our products. Regulatory authorities in the EU are reviewing the safety issues related to the use of animal derived materials which we currently use in our production process. It is unknown at this time what actions, if any, the authority may take as to animal derived materials specific to medicinal products distributed in the EU. Our inability to develop or obtain alternative compounds would harm our product development and commercialization efforts.
Finally, we may not be able to continue our present arrangements with our suppliers, supplement existing relationships, establish new relationships or be able to identify and obtain the ancillary materials that are necessary to develop our product candidates in the future. Our dependence upon third parties for the supply and manufacture of these items could adversely affect our ability to develop and deliver commercially feasible products on a timely and competitive basis.
Our stock may be delisted from Nasdaq, which could affect its market price and liquidity.
We are required to meet certain financial tests (including a minimum bid price for our common stock of $1.00) to maintain the listing of our common stock on the Nasdaq Stock Market. Our common stock may be recommended for delisting (subject to any appeal we would file) if we do not maintain compliance with the Nasdaq requirements within specified periods and subject to permitted extensions. If our common stock were delisted, it could be
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more difficult to buy or sell our common stock and to obtain accurate quotations, and the price of our stock could suffer a material decline. Delisting would also impair our ability to raise capital.
Given our limited internal sales and marketing capabilities, we need to develop increased internal capability or collaborative relationships to sell, market and distribute our products.
While we have commenced initial marketing on a limited basis of the AastromReplicell System and SC-I, DC-I, DCV-I and DCV-II cell production kits in Europe and domestically for research use, we have only limited internal sales, marketing and distribution capabilities. We intend to get assistance to market our products through collaborative relationships with companies with established sales, marketing and distribution capabilities. While we have entered into such arrangements with respect to Switzerland, Turkey and Italy, we will need to establish additional relationships to be able to achieve the market coverage we desire. Our inability to develop and maintain those relationships would limit our ability to market, sell and distribute our products. Our inability to enter into successful, long-term relationships could require us to develop alternate arrangements at a time when we need sales, marketing or distribution capabilities to meet existing demand.
If we do not keep pace with our competitors and with technological and market changes, our products may become obsolete and our business may suffer.
The market for our products is very competitive, is subject to rapid technological changes and varies for different individual products. For each of our potential products, we believe that there are potentially many competitive approaches being pursued, including some by private companies for which information is difficult to obtain.
Many of our competitors have significantly greater resources, more product candidates and have developed product candidates and processes that directly compete with our products. Our competitors may have developed, or could in the future develop, new technologies that compete with our products or even render our products obsolete. As an example, in the past, published studies have suggested that hematopoietic stem cell therapy may have limited clinical benefit in the treatment of breast cancer, which was a significant portion of the overall hematopoietic stem cell transplant market. This resulted in a substantial decline in the market for the AastromReplicell System with our SC-I kit.
Our products are designed to improve and automate the processes for producing cells used in therapeutic procedures. Even if we are able to demonstrate improved or equivalent results, researchers and practitioners may not use our products and we will suffer a competitive disadvantage. As a result, we may be unable to recover the net book value of our inventory. Finally, to the extent that others develop new technologies that address the targeted application for our products, our business will suffer.
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If we cannot attract and retain key personnel, then our business will suffer.
Our success depends in large part upon our ability to attract and retain highly qualified scientific and management personnel. We face competition for such personnel from other companies, research and academic institutions and other entities. Further, in an effort to conserve financial resources, we have implemented reductions in our work force on two separate occasions. As a result of these and other factors, we may not be successful in hiring or retaining key personnel. The Company has a key man life insurance policy for R. Douglas Armstrong, the Chairman, Chief Executive Officer and President of Aastrom. Our inability to replace any other lost key employee could harm our operations.
If our patents and proprietary rights do not provide substantial protection, then our business and competitive position will suffer.
Our success depends in large part on our ability to develop or license and protect proprietary products and technologies. However, patents may not be granted on any of our pending or future patent applications. Also, the scope of any of our issued patents may not be sufficiently broad to offer meaningful protection. In addition, our issued patents or patents licensed to us could be successfully challenged, invalidated or circumvented so that our patent rights would not create an effective competitive barrier. Furthermore, we rely on three exclusive, world-wide licenses relating to the production of human cells granted to us by the University of Michigan for certain of our patent rights. If we materially breach such agreements or otherwise fail to materially comply with such agreements, or if such agreements expire or are otherwise terminated by us, we may lose our rights under the patents held by the University of Michigan. At the latest, these licenses will terminate when the patent underlying the license expires. The first of these underlying patents will expire on March 21, 2012. We also rely on trade secrets and unpatentable know-how that we seek to protect, in part, by confidentiality agreements with our employees, consultants, suppliers and licensees. These agreements may be breached, and we might not have adequate remedies for any breach. If this were to occur, our business and competitive position would suffer.
Intellectual property litigation could harm our business.
Our success will also depend in part on our ability to develop commercially viable products without infringing the proprietary rights of others. Although we have not been subject to any filed infringement claims, other patents could exist or could be filed which would prohibit or limit our ability to market our products or maintain our competitive position. In the event of an intellectual property dispute, we may be forced to litigate. Intellectual property litigation would divert managements attention from developing our products and would force us to incur substantial costs regardless of whether we are successful. An adverse outcome could subject us to significant liabilities to third parties, and force us to curtail or cease the development and sale of our products and processes.
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The government maintains certain rights in technology that we develop using government grant money and we may lose the revenues from such technology if we do not commercialize and utilize the technology pursuant to established government guidelines.
Certain of our and our licensors research have been or are being funded in part by government grants. As a result of such funding, the U.S. Government has certain rights in the technology developed with the grant. These rights include a non-exclusive, paid-up, world-wide license to use the technology for any governmental purpose. In addition, the government has the right to require us to grant an exclusive license to use the developed technology to a third party if the government determines that:
| we have not taken adequate steps to commercialize such technology; | ||
| such action is necessary to meet public health or safety needs; or | ||
| such action is necessary to meet requirements for public use under federal regulations. |
In these instances, we would not receive revenues on the products we developed. Additionally, technology that was partially funded by a federal research grant is subject to the following government rights:
| products using the technology which are sold in the United States are to be manufactured substantially in the United States, unless a waiver is obtained; | ||
| the government may force the granting of a license to a third party who will make and sell the needed product if we do not pursue reasonable commercialization of a needed product using the technology; and | ||
| the U.S. Government may use the technology for its own needs. |
If we fail to meet these guidelines, we would lose our exclusive rights to these products and we would lose potential revenue derived from the sale of these products.
The market for our products will be heavily dependent on third party reimbursement policies.
Our ability to successfully commercialize our product candidates will depend on the extent to which government healthcare programs, such as Medicare and Medicaid, as well as private health insurers, health maintenance organizations and other third party payors will pay for our products and related treatments. Reimbursement by third party payors depends on a number of factors, including the payors determination that use of the product is safe and effective, not experimental or investigational, medically necessary, appropriate for the specific patient and cost-effective. Reimbursement in the United States or foreign countries may not be available or maintained for any of our product candidates. If we do not obtain approvals for adequate third party reimbursements, we may not be able to establish or maintain price levels sufficient to realize an appropriate return on our investment in product development. Any limits on reimbursement available from third party payors may reduce the demand for, or negatively affect the price of, our products. For example, in the past, published studies have suggested that stem cell transplantation for breast cancer, that constituted a significant portion
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of the overall stem cell therapy market, at the time, may have limited clinical benefit. The lack of reimbursement for these procedures by insurance payors would negatively affect the marketability of our products.
Potential product liability claims could affect our earnings and financial condition.
We face an inherent business risk of exposure to product liability claims in the event that the use of the AastromReplicell System during research and development efforts, including clinical trials, or after commercialization results in adverse affects. As a result, we may incur significant product liability exposure, which could exceed existing insurance coverage. We may not be able to maintain adequate levels of insurance at reasonable cost and/or reasonable terms. Excessive insurance costs or uninsured claims would increase our operating loss and affect our financial condition.
Our corporate documents and Michigan law contain provisions that may make it more difficult for us to be acquired.
Our Board of Directors has the authority, without shareholder approval, to issue additional shares of preferred stock and to fix the rights, preferences, privileges and restrictions of these shares without any further vote or action by our shareholders. This authority, together with certain provisions of our charter documents, may have the affect of making it more difficult for a third party to acquire, or of discouraging a third party from attempting to acquire control of our company. This affect could occur even if our shareholders consider the change in control to be in their best interest.
Forward-looking statements
This report contains certain forward-looking statements within the meaning of Section 27A of the Securities Act and Section 21E of the Securities Exchange Act. These forward-looking statements include statements regarding:
| potential strategic collaborations with others; | ||
| future capital needs; | ||
| product development and marketing plan; | ||
| clinical trial plans and anticipated results; | ||
| anticipation of future losses; | ||
| replacement of manufacturing sources; | ||
| commercialization plans; and | ||
| revenue expectations and operating results. |
These statements are subject to risks and uncertainties, including those set forth in this Certain Business Considerations section, and actual results could differ materially from those expressed or implied in these statements. In some cases, you can identify these statements by our use of forward-looking words such as may, will, should, anticipate, expect, estimate, plan, believe, potential, or intend. All forward-looking statements
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included in this report are made as of the date hereof. We assume no obligation to update any such forward-looking statement or reason why actual results might differ.
These business considerations, and others, are discussed in more detail and should be read in conjunction with the Business Risks discussed in our 2003 Annual Report of Form 10-K.
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Item 3. Quantitative and Qualitative Disclosures About Market Risk
As of December 31, 2003, our cash and cash equivalents included money market securities and commercial paper. Due to the short duration of our investment portfolio, an immediate 10% change in interest rates would not have a material effect on the fair market value of our portfolio, therefore, we would not expect our operating results or cash flows to be affected to any significant degree by the effect of a sudden change in market interest rates on our securities portfolio.
Our sales to customers in foreign countries are denominated in U.S. dollars. Accordingly, we are not directly exposed to significant market risks from currency exchange rate fluctuations. We believe that the interest rate risk related to our accounts receivable is not significant. We manage the risk associated with these accounts through periodic reviews of the carrying value for non-collectibility and establishment of appropriate allowances in connection with our internal controls and policies. We do not enter into hedging or derivative instruments.
Item 4. Controls and Procedures
(a) | Under the supervision and with the participation of our management, including our President and Chief Financial Officer, we evaluated the effectiveness of our disclosure controls and procedures, as such term is defined under Rule 13a-15(e) promulgated under the Securities and Exchange Act of 1934, as amended. Based on this evaluation, our President and Chief Financial Officer concluded that our disclosure controls and procedures are effective as of the end of the period covered by this quarterly report. | ||
(b) | There have been no significant changes (including corrective actions with regard to significant deficiencies or material weaknesses) in our internal controls or in other factors that could significantly affect these controls subsequent to the date of the evaluation referenced in paragraph (a) above. |
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PART II - OTHER INFORMATION
Item 1. Legal Proceedings
From time to time we receive threats or may be subject to litigation matters incidental to our business. However, we are not currently a party to any material pending legal proceedings. |
Item 2. Changes in Securities and Use of Proceeds
During the quarter ended December 31, 2003 we issued shares of common stock on two occasions upon exercise of previously issued warrants. 80,000 of the shares were sold for $0.50 per share and 31,534 of the warrants were issued upon conversion of existing warrants to purchase 68,700 shares. The shares of common stock were issued in private transactions to purchasers who acquired these securities for investment purposes and were exempt from registration pursuant to Section 4(2) of the Securities Act. |
Item 3. Defaults Upon Senior Securities
None. |
Item 4. Submission of Matters to a Vote of Security Holders
(a) | The Annual Meeting of Shareholders of Aastrom Biosciences, Inc. was held on November 12, 2003. | ||
(b) | At the 2003 Annual Meeting of Shareholders, votes were cast on matters submitted to the shareholders, as follows: | ||
Proposal 1: Election of two directors whose terms expire at the 2006 Annual Meeting of Shareholders. |
NOMINEE | FOR | WITHHELD | ||||||
R. Douglas Armstrong |
61,592,670 | 797,293 | ||||||
Joseph A. Taylor |
61,619,256 | 270,707 |
In addition to the election of the above referenced directors, the following individuals continue as directors; Susan Wyant, as a Class I Director, whose term expires at the 2004 Annual Meeting of Shareholders; Mary Lincoln Campbell and Arthur F. Staubitz, as Class II Directors, whose terms expire at the 2005 Annual Meeting of Shareholders. |
29
Proposal 2: Approve the amendment to the 2001 Stock Option Plan to increase by 2,000,000 the maximum number of shares of common stock that may be issued under the plan. |
FOR | AGAINST | ABSTAIN | ||||||
9,506,763 |
3,725,121 | 254,188 |
Proposal 3: Approve the amendment to allow for an amendment of the Companys Articles of Incorporation to increase the number of authorized shares of common stock up to 250,000,000. |
FOR | AGAINST | ABSTAIN | ||||||
58,407,889 |
3,624,604 | 343,472 |
Proposal 4: Approve the selection of PricewaterhouseCoopers LLP as the Companys independent accountants for the year ending June 30, 2004. |
FOR | AGAINST | ABSTAIN | ||||||
61,737,868 |
409,009 | 227,086 |
Item 5. Other Information
None. |
Item 6. Exhibits and Reports on Form 8-K
(a) | Exhibits | ||
See Exhibit Index. | |||
(b) | Reports on Form 8-K | ||
During the quarter ended December 31, 2003 we submitted the following reports on Form 8-K: |
(1) | November 11, 2003 (1st Quarter Earnings Release) | ||
(2) | December 11, 2003 (Press Release relating to the initiation of a Phase I clinical trial, in collaboration with investigators at Duke University Medical Center) |
30
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.
AASTROM BIOSCIENCES, INC. | ||
Date: February 13, 2004 | /s/ R. Douglas Armstrong | |
|
||
R. Douglas Armstrong, Ph.D. | ||
President, Chief Executive Officer | ||
(Principal Executive Officer) | ||
Date: February 13, 2004 | /s/ Alan M. Wright | |
|
||
Alan M. Wright | ||
Sr. Vice President Administrative & Financial | ||
Operations, Chief Financial Officer | ||
(Principal Financial and Accounting Officer) |
31
EXHIBITS
Exhibit Number | Description | |
3.1* | Restated Articles of Incorporation of the Company, as amended | |
3.2 ** | Bylaws of the Company | |
31 | Rules 13a-14(a) and 14(d)-14a Certifications | |
32 | Section 1350 Certifications | |
99 | Audit Committee Charter, as revised |
* | Incorporated by reference to the Companys Quarterly Report of Form 10-Q for the quarter ended September 30, 2003. | |
** | Incorporated by reference to the Companys Registration Statement on Form S-1 (No. 333-15415), declared effective on February 3, 1997. |
32
EXHIBIT 31 CERTIFICATION I, R. Douglas Armstrong, certify that: 1. I have reviewed this Quarterly Report on Form 10-Q of Aastrom Biosciences, Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; (b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and (c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: February 13, 2004 /s/ R. Douglas Armstrong - ---------------------------------- R. Douglas Armstrong, Ph.D. President, Chief Executive Officer (Principal Executive Officer) CERTIFICATION I, Alan M. Wright, certify that: 1. I have reviewed this Quarterly Report on Form 10-Q of Aastrom Biosciences, Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; (b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and (c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: February 13, 2004 /s/ Alan M. Wright - ----------------------------------------- Alan M. Wright Sr. Vice President Administrative & Financial Operations, Chief Financial Officer (Principal Financial and Accounting Officer)
EXHIBIT 32 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Quarterly Report of Aastrom Biosciences, Inc. (the "Company") on Form 10-Q for the quarter ended December 31, 2003, as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, R. Douglas Armstrong, President and Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 ("Section 906"), that: (1) The Report fully complies with the requirements of section 13(a) of the Securities Exchange Act of 1934 (15 U.S.C. 78m); and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. February 13, 2004 /s/ R. Douglas Armstrong - -------------------------------------------- R. Douglas Armstrong, Ph.D. President, Chief Executive Officer (Principal Executive Officer) A signed original of this written statement required by Section 906, or other document authenticating, acknowledging, or otherwise adopting the signature that appears in typed form within the electronic version of this written statement required by Section 906, has been provided to Aastrom Biosciences, Inc. and will be retained by Aastrom Biosciences, Inc. and furnished to the Securities and Exchange Commission or its staff upon request. CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Quarterly Report of Aastrom Biosciences, Inc. (the "Company") on Form 10-Q for the quarter ended December 31, 2003, as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Alan M. Wright, Senior Vice President and Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 ("Section 906"), that: (1) The Report fully complies with the requirements of section 13(a) of the Securities Exchange Act of 1934 (15 U.S.C. 78m); and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. February 13, 2004 /s/ Alan M. Wright - ------------------------------------ Alan M. Wright Sr. Vice President Administrative & Financial Operations, Chief Financial Officer (Principal Financial and Accounting Officer) A signed original of this written statement required by Section 906, or other document authenticating, acknowledging, or otherwise adopting the signature that appears in typed form within the electronic version of this written statement required by Section 906, has been provided to Aastrom Biosciences, Inc. and will be retained by Aastrom Biosciences, Inc. and furnished to the Securities and Exchange Commission or its staff upon request.
EXHIBIT 99 AASTROM BIOSCIENCES, INC. CHARTER OF THE AUDIT COMMITTEE OF THE BOARD OF DIRECTORS I STATEMENT OF POLICY This Charter specifies the scope of the responsibilities of the Audit Committee (the "Committee") of the Board of Directors (the "Board") of Aastrom Biosciences, Inc. (the "Company"), and the manner in which those responsibilities shall be performed, including its structure, processes, and membership requirements. The primary purpose of the Committee is to oversee the accounting and financial reporting processes of the Company and the audits of the Company's financial statements. The Committee shall also review the qualifications, independence and performance, and approve the terms of engagement, of the Company's independent auditor and prepare any reports required of the Committee under rules of the Securities and Exchange Commission ("SEC"). Consistent with these tasks, the Committee shall encourage continuous improvement of, and shall foster adherence to, the Company's financial policies, procedures and practices at all levels. The Committee's primary duties and responsibilities are to: - Retain the independent auditor, evaluate their independence, qualifications and performance, and approve the terms of engagement for audit services and non-audit services. In all events, it is the Audit Committee that has the ultimate authority and responsibility to select, evaluate and, where appropriate, replace the Company's outside auditors. - Review with management and the independent auditor, as appropriate, the Company's financial reports and other financial information provided by the Company to any governmental body or the public, and the Company's compliance with legal and regulatory requirements. - Establish and observe complaint procedures regarding accounting, internal auditing controls and auditing matters. - Serve as an independent and objective party to monitor the Company's financial reporting process and internal control systems. - Provide an open avenue of communication among the outside auditors, financial and senior management, and the Board. The Company shall provide appropriate funding, as determined by the Committee, to permit the Committee to perform its duties under this Charter, to compensate its advisors and to compensate any registered public accounting firm engaged for the purpose of rendering or issuing an audit report or related work or performing other audit, review or attest services for the Company. The Committee, at its discretion, has the authority to initiate investigations, and hire legal, accounting or other outside advisors or experts to assist the Committee, as it deems necessary to fulfill its duties under this Charter. The Committee may also perform such other activities consistent with this Charter, the Company's Bylaws and governing law, as the Committee or the Board deems necessary or appropriate. II ORGANIZATION AND MEMBERSHIP REQUIREMENTS The Committee shall be comprised of three or more directors as determined by the Board, each of whom shall satisfy the independence and experience requirements of The Nasdaq Stock Market listing standards; provided, however, that one director who does not meet the independence criteria of Nasdaq, but is not a current employee or officer (or an immediate family member of an employee or officer), may be appointed to the Committee, subject to the approval of the Board, pursuant to and subject to the limitations under the "exceptional and limited circumstances" exceptions contained in the Nasdaq listing standards. In addition, the Committee shall not include any member who: - has participated in the preparation of the financial statements of the Company or any current subsidiary at any time during the past three years; or - accepts any consulting, advisory, or other compensatory fee, directly or indirectly, from the Company, other than in his or her capacity as a member of the Committee, the Board, or any other committee of the Board; or - is an affiliate of the Company or any subsidiary of the Company, other than a person who would be considered to be an affiliate solely by being a director and who meets the independence requirements of The Nasdaq Stock Market. All members of the Committee must be able to read and understand fundamental financial statements, including a balance sheet, income statement, and cash flow statement. In addition, at least one member must have past employment experience in finance or accounting, professional certification in accounting, or other comparable experience or background resulting in the individual being financially sophisticated, which may include being or having been a chief executive, chief financial, or other senior officer with financial oversight responsibilities. The members of the Committee shall be appointed, and may be removed or replaced, by the Board. Unless the Board elects a chairperson, the members of the Committee may designate a chairperson by majority vote of the full Committee membership. The Committee may delegate duties or responsibilities to subcommittees or to one member of the Committee. III MEETINGS/REVIEWS The Committee shall meet from time to time as it deems necessary, but not less frequently than quarterly. A majority of the members shall represent a quorum of the Committee, and any action approved by at least a majority of the members shall represent the valid action of the Committee. The Committee shall meet with management, other directors and the independent auditor in executive session at any time it deems appropriate. The Committee shall meet with the independent auditor and management on a quarterly basis to review the Company's financial statements and financial reports. The Committee shall maintain written minutes of its meetings. IV COMMITTEE AUTHORITY AND RESPONSIBILITIES To fulfill its responsibilities and duties the Committee shall: A. OVERSIGHT OF THE COMPANY'S INDEPENDENT AUDITOR 1. Be directly and solely responsible for the appointment, compensation, retention and oversight of any independent auditor (including resolution of disagreements between management and the independent auditor regarding financial reporting) engaged by the Company for the purpose of preparing or issuing an audit report or related work, with each such auditor reporting directly to the Committee. 2. Periodically review and discuss with the independent auditor (i) the matters required to be discussed by Statement on Auditing Standards No. 61, as amended, and (ii) any formal written statements received from the independent auditor consistent with and in satisfaction of Independence Standards Board Standard No. 1, as amended, including without limitation, descriptions of (x) all relationships between the auditor and the Company, (y) any disclosed relationships or services that may impact the independent auditor's objectivity and independence, and (z) whether any of the Company's senior finance personnel were recently employed by the independent auditor. 2 3. Evaluate annually the qualifications, performance and independence of the independent auditor, including a review of whether the independent auditor's quality-control procedures are adequate and a review and evaluation of the lead partner of the independent auditor, taking into account the opinions of management, and report to the Board on its conclusions, together with any recommendations for additional action. Obtain and review annually a report from the independent auditor describing (i) the auditor's internal quality-control procedures, and (ii) any material issues raised by the most recent internal quality-control review or peer reviews or by any inquiry or investigation by governmental or professional authorities within the preceding five years respecting one or more independent audits carried out by the firm, and any steps taken to deal with such issues. 4. Consult with the independent auditor to assure the rotation of the lead audit partner having primary responsibility for the audit and the audit partner responsible for reviewing the audit every five years and consider issues related to the timing of such rotation and the transition to new lead and reviewing partners, and report to the Board on its conclusions. 5. Approve in advance the engagement of the independent auditor for all audit services and non-audit services, based on independence, qualifications and, if applicable, performance, and approve the fees and other terms of any such engagement; provided, however, that (i) the Committee may establish pre-approval policies and procedures for any engagement to render such services, provided that such polices and procedures (x) are detailed as to particular services, (y) do not involve delegation to management of the Committee's responsibilities hereunder, and (z) provide that, at its next scheduled meeting, the Committee is informed as to each such service for which the independent auditor is engaged pursuant to such policies and procedures, and (ii) the Committee may delegate to one or more members of the Committee the authority to grant pre-approvals for such services, provided that (a) the decisions of such member(s) to grant any such pre-approval shall be presented to the Committee at its next scheduled meeting, and (b) the Committee has established policies and procedures for such pre-approval of services consistent with the requirements of clauses (i)(x) and (y) above. 6. Discuss with the independent auditor prior to the audit the planning and staffing of the audit. 7. Approve as necessary the termination of the engagement of the independent auditor. 8. Regularly review with the independent auditor any significant difficulties encountered during the course of the audit, any restrictions on the scope of work or access to required information and any significant disagreement among management and the independent auditor in connection with the preparation of the financial statements. Review with the independent auditor any accounting adjustments that were noted or proposed by the auditor but that were "passed" (as immaterial or otherwise), any communications between the audit team and the independent auditor's national office respecting auditing or accounting issues presented by the engagement, any "management" or "internal control" letter or schedule of unadjusted differences issued, or proposed to be issued, by the auditor to the Company, or any other material written communication provided by the auditor to the Company's management. 9. Review with the independent auditor the critical accounting policies and practices used by the Company, all alternative treatments of financial information within generally accepted accounting principles ("GAAP") that the independent auditor has discussed with management, the ramifications of the use of such alternative disclosures and treatments and the treatment preferred by the independent auditor. 3 B. REVIEW OF FINANCIAL REPORTING, POLICIES AND PROCESSES 1. Review and discuss with management and the independent auditor (i) the Company's annual audited financial statements (ii) at the Committee's discretion, any reports or other financial information submitted to any governmental body or the public, and (iii) any certification, report, opinion or review rendered by the independent auditor, and recommend to the Board whether the audited financial statements should be included in the Company's annual report on Form 10-K. 2. Review and discuss with management and the independent auditor the Company's quarterly financial statements. These reviews should include a discussion of the outside auditor's judgment of the quality of the Company's accounting and any uncorrected misstatements that were noted as a result of the auditor's quarterly review. 3. Review and discuss with management and the independent auditor the Company's disclosure under "Management's Discussion and Analysis of Financial Condition and Results of Operations" appearing in the Company's periodic reports. 4. Periodically meet separately with management and with the independent auditor. 5. Review with management and the independent auditor any significant judgments made in management's preparation of the financial statements and the view of each as to appropriateness of such judgments. 6. Review with management its assessment of the effectiveness and adequacy of the Company's internal control structure and procedures for financial reporting ("Internal Controls"). Once a management report (and independent auditor attestation) is required by the SEC rules, review with the independent auditor the attestation to and report on the assessment made by management, and consider with management and the independent auditor whether any changes to the Internal Controls are appropriate in light of management's assessment or the independent auditor's attestation. 7. Review with management its evaluation of the Company's procedures and controls designed to assure that information required to be disclosed in its periodic public reports is recorded, processed, summarized and reported in such reports within the time periods specified by the SEC for the filing of such reports ("Disclosure Controls"), and consider whether any changes are appropriate in light of management's evaluation of the effectiveness of such Disclosure Controls. 8. Review and discuss with management and the independent auditor any off-balance sheet transactions or structures and their effect on the Company's financial results and operations, as well as the disclosure regarding such transactions and structures in the Company's public filings. 9. Review with management and the independent auditor the effect of regulatory and accounting initiatives on the financial statements. Review any major issues regarding accounting principles and financial statement presentations, including any significant changes in selection of an application of accounting principles. Consider and approve, if appropriate, changes to the Company's auditing and accounting principles and practices as suggested by the independent auditor or management. 10. Review any special audit steps adopted in light of any material control deficiencies. Review with the independent auditor and management the extent to which changes or improvements in financial or accounting practices, as approved by the Committee, have been implemented. 4 11. Periodically consult with the outside auditors out of the presence of management about internal controls and the accuracy of the Company's financial statements. 12. Provide oversight and review the Company's asset management policies, including an annual review of the Company's investment policies and performance for cash and short-term investments C. RISK MANAGEMENT, RELATED PARTY TRANSACTIONS, LEGAL COMPLIANCE AND ETHICS 1. Review with the chief executive and chief financial officer of the Company any report on significant deficiencies in the design or operation of the Internal Controls that could adversely affect the Company's ability to record, process, summarize or report financial data, any material weaknesses in Internal Controls identified to the auditors, and any fraud, whether or not material, that involves management or other employees who have a significant role in the Company's Internal Controls. 2. Review and approve any related-party transactions, after reviewing each such transaction for potential conflicts of interests and other improprieties. 3. Establish procedures for the receipt, retention and treatment of complaints received by the Company regarding accounting, internal accounting controls or auditing matters, and the confidential, anonymous submission by employees of the Company of concerns regarding questionable accounting or auditing matters. Adopt, as necessary, appropriate remedial measures or actions with respect to such complaints or concerns. 4. Consider and present to the Board for adoption a Code of Conduct for all employees and directors, which meets the requirements of Item 406 of the SEC's Regulation S-K, and provide for and review prompt disclosure to the public of any change in, or waiver of, the Code of Conduct. Review the Code of Conduct periodically and recommend such changes to the Code of Conduct as the Committee shall deem appropriate, and adopt procedures for monitoring and enforcing compliance with the Code of Conduct. 5. Discuss with management and the independent auditor any correspondence with regulators or governmental agencies that raise material issues regarding the Company's financial statements or accounting policies. 6. Discuss guidelines and policies to govern the process by which risk assessment and management is undertaken and handled. Discuss with management the Company's major financial risk exposures and the steps management has taken to monitor and control such exposures. 7. Review and report to the Board on material litigation, material government investigations and compliance with applicable legal requirements and the Company's Code of Conduct. 8. Prepare the report required by the rules of the SEC to be included in the Company's annual proxy statement. 9. Develop and implement an annual performance evaluation of the Committee. 10. Regularly report to the Board on the Committee's activities, recommendations and conclusions. 11. Review and reassess the adequacy of this Charter as appropriate, and recommend any proposed changes to the Board for approval. 5 12. Ensure that management has set an appropriate corporate "tone" for quality financial reporting, sound business practices and ethical behavior. 13. Review management's monitoring of compliance with the Foreign Corrupt Practices Act. 14. Review, with the Company's counsel, legal compliance matters including corporate securities trading policies. 15. Perform any other activities consistent with this Charter, the Company's Bylaws and governing law, as the Committee or the Board deems necessary or appropriate. 16. If necessary, initiate special investigations. If appropriate, hire special counsel or experts to assist the Committee. 6