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SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

(Mark One)

Commission file number 0-22025

AASTROM BIOSCIENCES, INC.

(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 the number of shares outstanding of each of the issuer’s classes of common stock as of the latest practicable date.

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AASTROM BIOSCIENCES, INC.
Quarterly Report on Form 10-Q
December 31, 2002

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PART I - FINANCIAL INFORMATION

Item 1.      Financial Statements

AASTROM BIOSCIENCES, INC.
(a development stage company)

CONSOLIDATED CONDENSED BALANCE SHEETS
(Unaudited)

The accompanying notes are an integral part of these financial statements.

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AASTROM BIOSCIENCES, INC.
(a development stage company)

CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS
(Unaudited)

The accompanying notes are an integral part of these financial statements.

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AASTROM BIOSCIENCES, INC.
(a development stage company)

CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
(Unaudited)

The accompanying notes are an integral part of these financial statements.

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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 the development stage. We currently operate our business in one reportable segment – research and product development, conducted both on our 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 our products and our continued 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 financing are expected to fund currently planned activities into the first quarter (ending September 30, 2003) of fiscal year 2004 the Company will need to raise additional funds in order to complete its product development programs and commercialize its new 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 Company’s ability to raise additional capital and its overall success include, the rate and degree of progress for its product development programs, the liquidity and volatility of its equity securities, economic conditions affecting the public markets generally or some portion or all of the technology sector, regulatory and manufacturing requirements and uncertainties, technological developments by competitors and other factors. If the Company cannot raise such 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.

     The Company is currently pursuing additional sources of financing. If the Company cannot obtain significant additional funding prior to or during the fourth quarter of the fiscal year ending June 30, 2003, it will make substantial reductions in the scope and size of its operations, and may curtail activities, in order to conserve cash until such funding is obtained.

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2. Basis of Presentation

     The condensed consolidated financial statements included herein have been prepared by us 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 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, 2002, are not necessarily indicative of the results to be expected for the full year or for any other period.

     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.

     These financial statements should be read in conjunction with the audited financial statements and the notes thereto included in our 2002 Annual Report on Form 10-K, as filed with the Securities and Exchange Commission.

3. Shareholders’ Equity

     We obtained additional equity of $2,124,000 during the six months ended December 31, 2002 and issued 6,074,000 common shares in these transactions. These equity financings were transacted under our amended November 16, 2001 shelf registration and our Employee Stock Purchase Plan. Total offering costs were $132,000.

     In October 2002, we entered into a common stock purchase agreement with Fusion Capital Fund II, LLC, a Chicago-based institutional investor. Under the agreement, Fusion Capital may purchase up to $12 million of our common stock at market price over a period of time up to 24 months from October 2002, subject to our right to extend the agreement for six months. We control the timing and amount of common stock purchased by Fusion Capital subject to the minimum price and total amount limits specified in the agreements. Further information about this transaction and the definitive agreements are contained in our Current Report Form 8-K filed on November 27, 2002. As of December 31, 2002, no shares had been issued under this agreement. Subsequently, as of January 31, 2003 we have raised $307,000 and issued 722,600 shares through the agreement with Fusion.

4. 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

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per common share for the three and six months ended December 31, 2001 and 2002 is approximately 6,311,000 and 8,774,000, respectively.

5. Recent Accounting Developments

     In December 2002, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure”. Statement No. 148 amends FASB Statement No. 123, “Accounting for Stock-Based Compensation”, in regards to the disclosure requirements of Statement 123 for annual and interim reporting. SFAS No. 148 requires prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. SFAS No. 148 is effective for our Company beginning in the quarter ended March 31, 2003. We have not determined the impact on our financial statements.

6. Subsequent Events

     During February 2003, the warrants that were issued in February 2000 which as adjusted permitted the holder to purchase 2,614,386 shares of common stock expired. In a separate transaction the warrants that were outstanding to purchase 2,000,000 shares of common stock were cancelled.

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Item 2.     Management’s Discussion and Analysis of Financial Condition and Results of Operations

Overview of Aastrom

     We are a late-stage development company focused on human cell-based therapies. We have identified multiple paths to revenue based on our proprietary ex vivo cell production technology, including the near-term Cell Production Products business, and an active Prescription Cell Product pipeline for stem cell tissue repair and cancer and infectious disease treatments.

     Our core technology is based on the Company’s proprietary AastromReplicell™ System, an integrated system of instrumentation and single-use consumable kits that implements our patented Single-Pass Perfusion process in a fully automated closed-loop culturing system to optimize cell growth and viability. This system provides nutrients to cells by mimicking the natural cell-growth environment, and enabling cells to grow effectively while retaining high biological function, without various cloning approaches. Our programs currently use bone marrow, cord blood and blood cells as starting sources of cells. As such, federal support or other factors relating to embryonal stem cell research have no direct impact on our current product programs. In addition, this system provides GMP-compliant manufacturing and automated process control for the commercial-scale production of human cells. We do not believe that any other comparable system currently exists.

     Our Cell Production Products business has created a path to near-term revenue. The 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 will be sold to academic researchers and companies that are developing cancer vaccines. The recent commercialization of our automated cell production instruments and cell-specific production kits is expected to generate revenues and if these revenues meet our expectations, they should bring our Cell Production Products business to profitability during calendar year 2003.

     In addition, 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.

     Using the AastromReplicell™ System, TRCs are grown from a small sample of a patient’s bone marrow and, once administered back to the patient, are intended to generate normal tissue. The primary applications being developed for our TRCs are our OCG-I therapy for bone grafting (fusions, fractures or dental defects), the OC-I therapy for osteoporosis, and the SC-I therapy for autologous bone marrow transplants in lymphoma patients. The SC-I product has been CE-Marked in Europe and is currently being marketed there. In the United States, the SC-I therapy has reached Phase III trials. The OC-I therapy is currently in a Phase I/II clinical trial, and the OCG-I therapy is expected to enter a Phase I/II trial soon. We also believe that the stem cell

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components of our TRCs may be useful for other medical indications, including the regeneration of cardiac and vascular tissues. Our CB-I clinical trials are expected to be closed out. We have no plans to continue this product development activity at this time.

     We are developing our pipeline of TC products using human cells to create vaccines to attack certain cancers and other infectious diseases. Blood-derived dendritic cells, which are the body’s crucial mobilizers of the immune response, or T-cells, which act to fight disease, are cultured in the AastromReplicell™ System to produce our proprietary Dendricell™. After being exposed to a particular biological signal, or antigen, the Dendricell™ acts as an anti-cancer or anti-viral vaccine, triggering a cell-mediated immune response in a patient against the cancer cells or viri. The first Dendricell™ clinical trials are planned at Stanford University for a multiple myeloma cancer vaccine and at Duke University for a colorectal cancer vaccine. In addition, we are in the pre-clinical stage for a T-cell therapeutic targeting the Epstein-Barr Virus.

     In addition to our consumable SC-I, CB-I, DC-I and DCV-I therapy kits, we have begun marketing our automated cell production instruments in Europe, and have made them available for research or clinical use under Device Master File in the United States. Through Zellera AG, Aastrom’s wholly owned subsidiary located in Berlin, Germany, we are actively coordinating country-specific sub-distributorships and service networks in Europe.

     We are led by a seasoned management team, which is advised by our well-respected Technology Review Board, comprising senior medical, financial and marketing executives with extensive knowledge of the technology and industry. Management has successfully engineered our transition from our genesis as a medical device manufacturer to a contributor and developer in the broader and more lucrative therapeutic sector.

     Since our inception, we have been in the development stage and engaged in research and product development, conducted principally on our own behalf, but also in connection with various collaborative research and development agreements with others. We commenced our initial pilot-scale product launch in Europe of the AastromReplicell™ System with the SC-I kit in April 1999. At approximately this same time, data was released at international meetings that resulted in the majority of the patients who would otherwise have been candidates for the SC-I product, to no longer require the use of the product. This loss of market for the SC-I caused us to reorganize our operations and suspend all marketing activities in October 1999, pending the receipt of additional financing and the completion of the reorganization process. While we’ve initiated marketing activities in Europe for the CE Marked SC-I, DC-I and the DCV-I products, we do not expect to generate positive cash flows from our consolidated operations for at least the next two to three years and then only if more significant product sales commence. Until that time, we expect that our revenue sources will consist of sales from our Cell Production Product business to academic and commercial research centers, grant revenue and research funding, milestone payments and licensing fees from potential future corporate collaborators. To date, we have financed our operations 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, which is unlikely to occur until we obtain significant additional funding. Through December 31, 2002, we have accumulated losses

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of approximately $98 million. There can be no assurance that we will be able to achieve profitability on a sustained basis, if at all, obtain the required funding, or complete a corporate partnering or acquisition transaction.

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 and revenue recognition.

     Inventory. We value our inventory that consists primarily of finished components of our lead product, the AastromReplicell™ System, at the lower of cost (specific identification using first in, first out) 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 generally 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 risks 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 and product sales and rentals. 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 customer’s final acceptance of the sale, generally after installation and training. If there are