10-K 1 hsgx-10k_20181231.htm 10-K hsgx-10k_20181231.htm

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-K

 

(Mark One)

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2018

or

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: 001-36751

 

Histogenics Corporation

(Exact name of registrant as specified in its charter)

 

 

Delaware

04-3522315

(State or other jurisdiction of

incorporation or organization)

(I.R.S. Employer

Identification Number)

 

830 Winter Street, 3rd Floor

Waltham, Massachusetts

02451

(Address of principal executive offices)

(Zip Code)

(781) 547-7900

(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:  

Common Stock, $0.01 par value per share

The Nasdaq Stock Market LLC

(Title of each class)

(Name of each exchange on which registered)

Securities registered pursuant to Section 12(g) of the Act:

None

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  ☐    No  ☒

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes  ☐    No  ☒

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.    Yes  ☒    No  ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 229.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).    Yes  ☒    No  ☐

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.   ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer

Accelerated filer

 

 

 

 

Non-accelerated filer

  

Smaller reporting company

Emerging growth company

 

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.  

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).    Yes      No  

As of June 30, 2018, the last business day of the registrant’s last completed second quarter, the aggregate market value of the Common Stock held by non-affiliates of the registrant was approximately $63.6 million, based on the closing price of the registrant’s Common Stock, as reported by the Nasdaq Capital Market. For purposes of this disclosure, shares of Common Stock held by each executive officer, director, stockholders known by the registrant to be affiliates of such executive officers and directors based on public filings and stockholders known by the registrant to own 20% or more of the outstanding stock based on public filings and other information known to the registrant have been excluded since such persons may be deemed affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes.

As of March 20, 2019 there were 94,599,601 shares of the registrant’s Common Stock issued and outstanding.

 

 


Histogenics Corporation

Form 10-K

Table of Contents

 

 

 

Page

 

Part I

 

 

 

 

 

Special Note Regarding Forward-Looking Statements

2

 

 

 

 

Industry and Market Data

3

 

 

 

Item 1.

Business

4

 

 

 

Item 1A.

Risk Factors

20

 

 

 

Item 1B.

Unresolved Staff Comments

39

 

 

 

Item 2.

Properties

39

 

 

 

Item 3.

Legal Proceedings

39

 

 

 

Item 4.

Mine Safety Disclosures

39

 

Part II

 

 

 

 

Item 5.

Market for Registrant’s Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities

40

 

 

 

Item 6.

Selected Consolidated Financial Data

40

 

 

 

Item 7.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

41

 

 

 

Item 7A.

Qualitative and Quantitative Disclosures about Market Risk

55

 

 

 

Item 8.

Financial Statements and Supplementary Data

55

 

 

 

Item 9.

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

55

 

 

 

Item 9A.

Controls and Procedures

56

 

 

 

Item 9B.

Other Information

57

 

Part III

 

 

 

 

Item 10.

Directors, Executive Officers and Corporate Governance

58

 

 

 

Item 11.

Executive Compensation

73

 

 

 

Item 12.

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

83

 

 

 

Item 13.

Certain Relationships and Related Transactions, and Director Independence

85

 

 

 

Item 14.

Principal Accountant Fees and Services

88

 

Part IV

 

 

 

 

Item 15.

Exhibits and Financial Statements Schedules

89

 

 

 

Exhibit Index

89

 

 

Item 16.

Form 10-K Summary

92

 

 

Signatures

93

 

 

Index to Financial Statements

94

HISTOGENICS (and design), our logo design and NEOCART are our registered trademarks. Any other trademarks, registered marks and trade names appearing in this annual report on Form 10-K are the property of their respective holders. All other trademarks, trade names and service marks appearing in this annual report are the property of their respective owners.

 

 

 


 

PART I

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

Various statements in this report are “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements involve substantial risks and uncertainties. All statements, other than statements of historical facts, included in this report regarding our strategy, future operations, future financial position, projected costs, prospects, plans and objectives of management are forward-looking statements. These statements are subject to risks and uncertainties and are based on information currently available to our management. Words such as, but not limited to, “anticipate,” “believe,” “contemplates,” “continue,” “could,” “design,” “estimate,” “expect,” “intend,” “likely,” “may,” “ongoing,” “plan,” “potential,” “predict,” “project,” “will,” “would,” “seek,” “should,” “target,” or the negative of these terms and similar expressions or words, identify forward-looking statements. The events and circumstances reflected in our forward-looking statements may not occur and actual results could differ materially from those projected in our forward-looking statements. Meaningful factors which could cause actual results to differ include, but are not limited to:

 

our evaluation of strategic alternatives with a goal to enhance stakeholder value, including the possibility of a merger or sale of the Company, the sale of the Company’s assets in one or more transactions to one or more third parties or a liquidation and dissolution of the Company;

 

our ability to obtain funding for our operations;

 

our ability to establish and maintain development and commercialization partnerships;

 

our technology, manufacturing capacity, location and partners;

 

the accuracy of our estimates regarding expenses, capital requirements and need for additional financing;

 

updated or refined data based on continuing review and quality control analysis of clinical data, including the NeoCart Phase 3 clinical trial data;

 

our securities’ or industry analysts’ expectations regarding the commercial success of NeoCart, if approved, and the timing and success of any clinical trials we may initiate in the future;

 

the anticipated trends and challenges in our business and the market in which we operate;

 

our ability to retain key personnel;

 

regulatory developments in the United States and foreign countries; and

 

our plans for the use of our cash and cash equivalents.

All written and verbal forward-looking statements attributable to us or any person acting on our behalf are expressly qualified in their entirety by the cautionary statements contained or referred to in this section. We caution investors not to rely too heavily on the forward-looking statements we make or that are made on our behalf. We undertake no obligation, and specifically decline any obligation, to update or revise publicly any forward-looking statements, whether as a result of new information, future events or otherwise. You are advised, however, to consult any further disclosures we make on related subjects in any annual, quarterly or current reports that we may file with the Securities and Exchange Commission.

We encourage you to read the discussion and analysis of our financial condition and our consolidated financial statements contained in this annual report on Form 10-K. We also encourage you to read Item 1A of Part 1 of this annual report on Form 10-K, entitled “Risk Factors,” which contains a more complete discussion of the risks and uncertainties associated with our business. In addition to the risks described above and in Item 1A of this report, other unknown or unpredictable factors also could affect our results. There can be no assurance that the actual results or developments anticipated by us will be realized or, even if substantially realized, that they will have the expected consequences to, or effects on, us. Therefore no assurance can be given that the outcomes stated in such forward-looking statements and estimates will be achieved.

2


 

As used in this annual report on Form 10-K, the terms “Histogenics,” “Company,” “registrant,” “we,” “us,” and “our” mean Histogenics Corporation and its subsidiaries unless the context indicates otherwise.

INDUSTRY AND MARKET DATA

We obtained the industry, market and competitive position data used throughout this annual report on Form 10-K from our own internal estimates and research, as well as from industry and general publications, in addition to research, surveys and studies conducted by third parties in certain instances. Internal estimates are derived from publicly-available information released by industry analysts and third-party sources, our internal research and our industry experience, and are based on assumptions made by us based on such data and our knowledge of our industry and market, which we believe to be reasonable. In addition, while we believe the industry, market and competitive position data included in this annual report on Form 10-K are reliable and are based on reasonable assumptions, such data involves risks and uncertainties and are subject to change based on various factors, including those discussed in “Risk Factors.” These and other factors could cause results to differ materially from those expressed in the estimates made by the independent parties and by us.

 

3


 

ITEM  1.

BUSINESS

Overview

We historically focused on the development of restorative cell therapies (RCTs).  We use the term RCT to refer to a new class of products that are designed to offer patients rapid-onset pain relief and restored function through the repair of damaged or worn tissue. Our product, NeoCart®, is an innovative cell therapy that utilizes various aspects of our RCT platform to treat tissue injury in the field of orthopedics, specifically cartilage damage in the knee.

Recent Developments

In the third quarter of 2018, we announced that our Phase 3 clinical trial of NeoCart did not meet the primary endpoint of a statistically significant improvement in pain and function in a dual threshold responder analysis one year after treatment as compared to microfracture. In the modified Intent to Treat (mITT) population (which excludes those patients who were randomized but not treated with NeoCart), 74.2% of the NeoCart patients exhibited clinically meaningful improvements in pain and function compared to 62.0% of microfracture patients at one year (p=0.071). However, in this mITT population, patients treated with NeoCart achieved a statistically significant improvement in pain and function (p=0.018) six months after treatment as compared to patients treated with microfracture. In addition, NeoCart achieved a statistically significant improvement in pain and function at one year in certain patient populations including patients with lesion sizes greater than 2.2 cm2 and those with a Body Mass Index, or BMI, of greater than 28. Both NeoCart and microfracture were well tolerated and exhibited strong safety profiles.  

Based on the totality of the data, we initiated a dialogue with the United States Food and Drug Administration (FDA) in the third quarter of 2018 to discuss the regulatory path forward for NeoCart.  Our primary objective in these discussions was to determine whether the FDA would accept a submission of a Biologics License Application (BLA) for NeoCart without data from an additional clinical trial. We had a constructive dialogue with the FDA, which included requests for and review of additional statistical analyses, different subgroup analyses, and secondary endpoints.  These additional analyses, while compelling, did not change the conclusion that the NeoCart Phase 3 trial failed to meet its primary and secondary endpoints.

In December 2018, we received final feedback from the FDA indicating that while the NeoCart Phase 3 clinical trial resulted in certain compelling data, particularly the early response in pain and function and the data in certain lesion sizes, an additional Phase 3 clinical trial would need to be completed before the FDA would accept the submission of a BLA for NeoCart. The FDA indicated receptivity to novel clinical trial methodologies and regenerative medicine advanced therapy designations in order to support additional data for a future potential submission. However, considering the time and funding required to conduct such a trial, we discontinued the development of NeoCart and are not planning to submit a BLA.

Current Strategy

As a result of the FDA feedback, we initiated a process to evaluate strategic alternatives to maximize value for all of our stakeholders. We are conducting the process with the assistance of financial and legal advisors and are evaluating the full range of potential strategic alternatives, including but not limited to, acquisitions, business combinations, joint ventures, public and private capital raises and recapitalization and sale transaction options, including a sale of assets or intellectual property. Since these efforts may not be successful and given our limited cash reserves, we are also considering other possible alternatives, including a wind-down of operations and a liquidation and dissolution of the Company, or Chapter 11 bankruptcy protection to complete or execute a restructuring transaction or liquidation. Our strategic process is ongoing and includes a range of interactions with transaction counterparties. Thus, we believe it is in our stockholders’ best interest to allow sufficient opportunity to pursue and consummate one or more such transactions and to consider additional alternatives that may materialize in the future before making a decision regarding a liquidation of the Company. There is no guarantee that any cash (or other securities representing any value) will be returned to stockholders and there is the possibility that the Company’s common stock will be worthless in a bankruptcy, wind-down or other liquidation scenario.

In January and March 2019, we implemented restructuring plans that were approved by our Board of Directors (the Board) involving reductions in headcount to reduce operating costs and conserve cash, along with other cash

4


 

conservation measures relating to our facilities.  The positions eliminated as part of the restructuring plans together represented all but one member of our of our workforce, including our Chief Executive Officer, Chief Operating Officer, Chief Medical Officer and Chief Business Officer. We intend to engage, Mr. Adam Gridley, our Chief Executive Officer, Mr. Stephen Kennedy, our Chief Operating Officer, along with up to four additional employees as consultants to assist with our continuing evaluation of strategic alternatives. Mr. Gridley will retain his statutory titles of president, treasurer and secretary of the Company while he continues to provide consulting services to us, and will remain a director of the Company.

NeoCart Phase 3 Clinical Trial

The NeoCart Phase 3 clinical trial is believed to be the largest and first prospectively designed, randomized clinical trial in North America evaluating the safety and efficacy of a restorative cell therapy to treat knee cartilage damage. It is also believed to be the only trial with a dual threshold responder analysis endpoint.

As part of the prospective data analysis, we collected a variety of patient reported outcome endpoints, including all measures of the Knee Injury and Osteoarthritis Outcomes Score (KOOS) and the International Knee Documentation Committee (IKDC) score, which are validated, patient-centered assessments of pain and function that are commonly used in current clinical trials of cartilage therapies. On almost all of these measures, two of which are being utilized as primary endpoints in ongoing clinical trials by third parties in the U.S. for other therapies, NeoCart demonstrated statistically significant improvements versus microfracture at one and two years.

The Phase 3 clinical trial is the first study prospectively enrolled consistent with current FDA guidance, which provides for the use of microfracture as a comparator treatment in trials to repair knee cartilage damage. The published FDA guidance also specifically calls for a study population that, given the clinical limitations and variable results of microfracture, we believe provides more favorable results than what is typically seen in microfracture in both the literature and a real-world setting.

The primary endpoint for the Phase 3 clinical trial was a dual-threshold responder analysis measuring the improvement in KOOS pain and IKDC function scores for each patient treated with NeoCart compared to those treated with microfracture one year after the time of treatment. Dual-threshold responders were defined as patients who, relative to their baseline measurements, had at least a 12-point improvement in the KOOS pain sub-score assessment and a 20-point improvement in the IKDC subjective assessment. The trial also evaluated additional pain, quality of life, and function outcomes using all five measures of KOOS subscales, including Sports and Recreation. The change from baseline and the relative change between the NeoCart and microfracture arms was also measured at one year which contrasts with clinical trials of other products, either on the market or in development, that measured these changes at two years.

Demographics for both study arms were similar and represent a patient population that was intended to ensure that microfracture would respond favorably, including patients with an average age of approximately 39 years old and a Body Mass Index of approximately 27. Furthermore, the mean lesion size was 2.1 cm in the NeoCart arm and 1.8 cm in the microfracture arm. There were no other significant differences between the treatment arms.

The results with respect to the primary endpoint (dual threshold responder analysis one year after treatment) are summarized below:

 

 

  

NeoCart

 

 

Microfracture

 

 

 

 

  

 

 

 

  

Positive

Responders

 

  

Responder

Rate

 

 

Positive

Responders

 

  

Responder

Rate

 

 

Difference

 

  

 

 

ITT

  

 

121/170

 

  

 

71.2

 

 

49/79

 

  

 

62.0

 

 

9.2

 

  

 

p=0.1877

 

mITT

  

 

121/163

 

  

 

74.2

 

 

49/79

 

  

 

62.0

 

 

12.2

 

  

 

P=0.0714

 

As Treated

  

 

120/162

 

  

 

74.1

 

 

50/80

 

  

 

62.5

 

 

11.6

 

  

 

p=0.0735

 

Per Protocol

  

 

118/155

 

  

 

76.1

 

 

43/65

 

  

 

66.2

 

 

10.0

 

  

 

p=0.1362

 

 

5


 

Key additional findings from the clinical trial include:

NeoCart demonstrated statistically significant improvements in pain and function at both one and two years after treatment as measured by changes in the KOOS and IKDC scores.

KOOS pain score (mITT Population)

Change from Baseline

(NeoCart Baseline = 54.0; Microfracture Baseline = 52.4)

 

 

  

NeoCart

 

  

Microfracture

 

  

 

 

Visit

  

N

 

  

Mean

 

  

N

 

  

Mean

 

  

P-

Value

 

3-months

  

 

160

 

  

 

24.1

 

  

 

75

 

  

 

22.4

 

  

 

0.0487

*

6-months

  

 

157

 

  

 

28.6

 

  

 

75

 

  

 

27.0

 

  

 

0.0819

 

1-year

  

 

158

 

  

 

31.4

 

  

 

72

 

  

 

28.7

 

  

 

0.0239

*

2-years

  

 

87

 

  

 

32.2

 

  

 

34

 

  

 

28.9

 

  

 

0.0080

*

3-years

  

 

39

 

  

 

34.3

 

  

 

16

 

  

 

30.7

 

  

 

0.1071

 

 

*

Statistically significant

IKDC subjective knee exam score (mITT Population)

Change from Baseline

(NeoCart Baseline = 40.3; Microfracture Baseline = 40.0)

 

 

  

NeoCart

 

  

Microfracture

 

  

 

 

Visit

  

N

 

  

Mean

 

  

N

 

  

Mean

 

  

P-

Value

 

3-months

  

 

159

 

  

 

13.7

 

  

 

76

 

  

 

14.5

 

  

 

0.9686

 

6-months

  

 

156

 

  

 

24.4

 

  

 

74

 

  

 

22.4

 

  

 

0.1572

 

1-year

  

 

158

 

  

 

33.1

 

  

 

71

 

  

 

28.3

 

  

 

0.0126

*

2-years

  

 

87

 

  

 

35.3

 

  

 

34

 

  

 

30.2

 

  

 

0.0366

*

3-years

  

 

38

 

  

 

39.9

 

  

 

16

 

  

 

32.6

 

  

 

0.2691

 

 

*

Statistically significant

NeoCart is based on our RCT platform, which we believe has the potential to be used for a broad range of additional therapeutic indications and combines expertise in the following areas:

 

Cell therapy and processing: the handling of tissue biopsies and the extraction, isolation and expansion of the cells;

 

Biomaterials and Scaffold: three-dimensional biomaterials and structures that enable the proper delivery, distribution and organization of cells in their natural environment to support tissue formation;

 

Tissue engineering: the use of a combination of cells, engineering and biomaterials to improve or restore biological functions; and

 

Bioadhesives: natural, biocompatible materials that act as adhesives for biological tissue and allow for natural cell and tissue infiltration and integration with native cells.

6


 

Intellectual Property

Patent and trade secret protection is critical to our business. We protect our cell processing technology, materials science and products for tissue repair through a variety of methods, including seeking, maintaining and defending patents and other intellectual property intended to cover our products and compositions, their methods of use and processes for their manufacture, our platform technologies, our trade secrets and any other inventions that are commercially important to the development of our business. We actively seek patent protection in the United States and select foreign countries.

Our intellectual property portfolio is currently composed of 34 issued patents and 11 patent applications in the United States that we own, and 15 issued patents and one patent application in the United States that we license from academic institutions and business entities. We also have approximately 100 counterpart patent and patent applications owned or licensed in certain foreign jurisdictions. This portfolio of owned and in-licensed patents and patent applications covers aspects of: our implants, including NeoCart and our protein implants; our tissue engineering processor; our adhesives; our growth factors, methods of delivery of therapeutic agents and promoters for increased expression of protein; our method for treatment of ligament and tendon injuries; surgical tools for placing our implants; and our bone composites. The patents that cover the listed technologies have statutory expiration dates between 2019 and 2031.

We have entered into license agreements with various academic institutions and business entities to obtain the rights to use certain patents and patent applications for the development and commercialization of our technology and products. We also rely on know-how and continuing technological innovation to develop and maintain our proprietary position.

We license from Purpose Co., Ltd. (f/k/a Takagi Sangyo Co. Ltd. and f/k/a Takagi Industrial Co., Ltd.) (Purpose) an exclusive right to 39 issued patents and 6 pending patent applications worldwide relating to an exogenous tissue processor. Through this agreement, we have a sublicense to three issued U.S. patents and eight issued foreign patents owned by The Brigham and Women’s Hospital, Inc. (BWH) and Purpose that relate to methods of cultivating a cell or tissue of a living body to be cultivated inside a culture chamber and apparatuses for cultivating a cell or tissue. We also have an exclusive license to two issued U.S. patents and one pending U.S. patent application for restoration of articular cartilage matrix from the Board of Trustees of The Leland Stanford Junior University. The patents that have issued or may yet issue that have been licensed to us under these agreements will have statutory expiration dates between 2020 and 2031.

We have an exclusive license to a portfolio consisting of two families of issued patents and pending patent applications owned by Angiotech Pharmaceuticals (US), Inc. and Angiodevice International GmbH. This exclusivity is for the use of CT3, our proprietary adhesive, for use in combination with intellectual property for the repair of articular cartilage, ligament, meniscus or tendon damage. The patents relate to methods of preparing biocompatible gels, biocompatible gel-forming compositions, methods of treating tissues by administering biocompatible gel-forming compositions, composition for forming a matrix useful as a high strength medical sealant, biocompatible polymer device for use in treating tissues, systems for forming a high strength medical sealant, methods for providing a high strength medical sealant on a surface, methods for applying a sealing layer to a native tissue surface, methods for effecting surgical adhesion, and methods for providing a sealant coating on the surface of a synthetic implant. Any patents within this portfolio that have issued or may yet issue will have statutory expiration dates between 2019 and 2022.

We have an exclusive license to one patent family relating to growth factors and high level expression of heterologous proteins owned by Yeda Research and Development Co., Ltd. Any patents within this portfolio that have issued or may yet issue will have statutory expiration dates between 2021 and 2023.

We continually assess and refine our intellectual property strategy in order to fortify our position in our target markets. We cannot ensure that patents will be granted with respect to any of our pending owned or in-licensed patent applications or with respect to any patent applications we may own or license in the future, nor can we be sure that any of our existing owned or in-licensed patents or any patents we may own or license in the future will be useful in protecting our technology. Please see “Risk Factors—Risks Related to Our Intellectual Property” for additional information on the risks associated with our intellectual property strategy and portfolio.  

7


 

Material Technology License Agreements

MEDINET Co., Ltd.

In December 2017, we entered into a License and Commercialization Agreement (the MEDINET Agreement) with MEDINET Co., Ltd. (MEDINET) with regards to the commercialization of NeoCart in Japan. Pursuant to the terms of the MEDINET Agreement, we are eligible to receive up to an aggregate of approximately $86.9 million in milestone payments plus royalties, consisting of (i) a non-refundable upfront payment of $10.0 million which we received in January 2018, (ii) potential regulatory and development milestone payments of up to an aggregate of $10.5 million, (iii) overall sales-dependent milestones of up to an aggregate of $66.4 million and (iv) tiered royalties on net sales of NeoCart in Japan. In return for such consideration, we granted to MEDINET exclusive commercialization rights to NeoCart in Japan for the replacement or repair of damaged, worn or defective cartilage in humans and non-human animals.

The MEDINET Agreement will remain in effect until the later of (i) expiration of the last-to-expire valid and enforceable patent covering NeoCart in Japan and (ii) ten years from the first commercial sale of NeoCart in Japan. MEDINET has an option to extend the term for five years upon written notice to us prior to the end of the initial term. MEDINET has the right to terminate the MEDINET Agreement for any or no reason at any time, and we may terminate the MEDINET Agreement in the event MEDINET or one of its affiliates or sublicensees challenges a patent covering NeoCart in Japan. Additionally, either party may terminate the MEDINET Agreement for an uncured material breach by the other party or upon certain insolvency or bankruptcy proceedings involving the other party. We and MEDINET have agreed to indemnify each other for third-party claims arising out of either our or our affiliates’ willful misconduct or negligence, breaches of representations, warranties, covenants, obligations or agreements contained in the MEDINET Agreement, or MEDINET’s exploitation of NeoCart in its respective territory, subject to specified exclusions.

We and MEDINET have agreed to enter into supply, quality and pharmacovigilance agreements (the MEDINET Supply Agreements), pursuant to which MEDINET will purchase its requirements of NeoCart and the related biopsy kit from us. Pursuant to the terms of the MEDINET Agreement, the MEDINET Supply Agreements will contain provisions addressing several topics, including those set forth in the MEDINET Agreement.

Purpose Co., Ltd.

In May 2016, we amended our license agreement (the Amendment) with Purpose whereby we acquired the development and commercialization rights to NeoCart in Japan. Under the Amendment, we assumed sole responsibility for the development and commercialization of all or any portion our products in Japan. In addition, the amended agreement provides us with an exclusive, perpetual (with respect to patent rights, for the full term of each patent licensed) and sublicensable license, under Purpose’s patent rights and technology relating to their tissue processor, in Japan, to make, use, sell, import and otherwise exploit products or services covered by claims of such Purpose patents or Purpose’s technology, in connection with articular cartilage, ligaments, tendons and meniscus. The Amendment also terminates the license that Purpose held under the original license agreement to develop and commercialize Histogenics’ patents and technology in Japan.

Pursuant to the Amendment, we are obligated to pay Purpose payments of up to $10 million in the event certain milestones are satisfied as well as a royalty payment in the low single digits on the net sales in Japan for Histogenics products that rely on a Purpose patent or incorporate or necessarily rely upon any Purpose technology. Such royalty payment shall be reduced if the applicable Histogenics products do not rely on an outstanding Purpose patent.

The other terms of the agreement with Purpose remain in effect including our ability outside of Japan to (1) make, use and sell products or services covered by claims of Purpose’s patents and (2) use and create derivative works of Purpose’s technology for the design, development, manufacture, testing, support and commercialization of any product or service that incorporates or builds upon Purpose’s technology, in each case, only in connection with articular cartilage, ligaments, tendons and meniscus. Purpose retained the right to sell its single unit exogenous tissue processer machines to research institutes for general but noncommercial use anywhere in the world.

As part of our agreement with Purpose, they continue to manufacture and sell single unit exogenous tissue processor machines to us. In addition, Purpose exclusively sublicensed to us its rights and obligations under the BWH-Purpose

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license, as amended from time to time. Under the Purpose-BWH license agreement, BWH granted Purpose an exclusive, royalty-bearing, worldwide, sublicensable license, under its rights in licensed patents and patent applications co-owned by BWH and Purpose, to make, use and sell (1) apparatuses for cultivating a cell or tissue, (2) tissue or cell products made using such apparatuses, (3) tissue or cell products made using processes for cultivating a cell or tissue as disclosed in the licensed patents and patent applications and (4) any apparatus that cultivates cells or tissues using such processes, in each case, whose manufacture, use, or sale is covered by the claims of the licensed patents and patent applications, only for therapeutic use. BWH may terminate this agreement if Purpose, itself or through its sublicensees, does not achieve commercial distribution and sale of the licensed products in the United States by December 31, 2019. In return for extending the termination period through December 31, 2019 pursuant to an amendment effective November 2015, we agreed to pay BWH $50,000 in November 2015 and three annual payments of $30,000 on the anniversary of the effective date of such amendment for the three years thereafter.

Pursuant to our sublicense from Purpose, we are obligated to pay royalties and milestone payments and sublicense payments due on the BWH-Purpose license agreement. We have paid minimum royalty amounts of $200,000 and sublicense payments of $285,000 through December 31, 2018. Purpose agreed to pay BWH a royalty rate in the low single digits of our net sales of licensed products, subject to a minimum of $20,000 annually, until the license agreement terminates or until royalty payments no longer have to be made. Purpose is obligated to make one additional sublicense payment of $25,000 and milestone payments to BWH of (1) $75,000 upon the first patient treated in Phase 3 clinical trials for each licensed product or licensed process and (2) $75,000 upon final FDA approval for each licensed product or licensed process.

The agreement remains in effect for the life of the licensed patents, expected to be until October 19, 2028. Purpose may terminate the agreement by providing written notice to BWH at least 60 days in advance. BWH has the right to terminate the agreement if Purpose fails to make minimum royalty payments or other payments or otherwise breaches the agreement and such breach is not cured within 30 days of BWH providing notice to Purpose. Upon termination of the BWH-Purpose license agreement, our sublicense will convert to a nonexclusive license to Purpose’s interest in the licensed products or processes. Upon written notice to Purpose of our intent to stop using the technology sublicensed to us in the BWH-Purpose license, Purpose will reassume all responsibility under the BWH-Purpose license.

Angiotech Pharmaceuticals (US), Inc. and Angiodevice International GmbH

In May 2005, we entered into a worldwide license agreement with Angiotech Pharmaceuticals (US), Inc. and Angiodevice International GmbH (collectively, Angiotech) for the right, under Angiotech’s licensed patents and patent applications and technical information, to make, use and sell any product that includes both our intellectual property and CT3 for the repair of articular cartilage, ligament, meniscus or tendon damage, including related osteochrondal defects. The license excludes any product in which one nonliving ingredient is included in CT3 for the primary purpose of producing a physiological, metabolic or biological effect in mammals. The license grant was made exclusive under the fifth amendment to the license agreement that came into effect in August 2010. We have obligations to supply CT3 to Angiotech under certain terms and conditions, and Angiotech is entitled to use any data and results obtained from any clinical studies conducted by us with respect to CT3.

We paid $1.0 million to Angiotech to make the license grant under the agreement exclusive. In addition, we paid four annual patent fees of $50,000 each as of December 31, 2018. We are also obligated to pay an additional fee of $3.0 million within 30 days after we receive regulatory approval from the FDA for a licensed product. As further consideration for the license, we also agreed to pay royalties at percentage rates of single digits of net sales of NeoCart and certain other products. We were able to reduce royalties from percentage rates of net sales in the double digits to this rate after making revenue share reduction payments that totaled $2.0 million.

The agreement terminates on the earlier of May 12, 2035 and expiration of all royalty payment obligations under the agreement. Either party has the right to terminate the agreement if the other party materially breaches the agreement and fails to cure such breach within 30 days from the date of notice of such breach (ten days in the case of non-payment). We may also terminate the agreement by giving at least one year’s notice. Angiotech may also terminate the agreement if we or any of our affiliates or sublicensees challenge the validity of Angiotech’s patents rights or rights to improvements (or directly or indirectly support any such challenge), or if we are acquired by or merge with a third party that has developed or is marketing, or has an affiliate that has developed or is marketing, a competitive

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product prior to such acquisition or merger and the resulting or surviving entity post-acquisition or merger fails to either continue to develop or sell licensed product at a level reasonably similar to the development or sale that was occurring prior to the acquisition or merger, during the six-month period following the acquisition or merger. Competitive product means, in a given country, (1) a drug or biologic approved for marketing or in Phase 3 clinical development, (2) a 510(k), or foreign equivalent, device approved for marketing, or (3) an FDA Premarket Approval, or foreign equivalent, device approved for marketing or in pivotal study clinical development, other than a licensed product, that acts (or is being developed to act) for one or more target label indications substantially similar to one or more approved or target label indications for a licensed product.

Intrexon Corporation

In September 2014, we entered into an Exclusive Channel Collaboration (ECC) with Intrexon Corporation (Intrexon) governing a “channel collaboration” arrangement in which we intended to use Intrexon’s proprietary technology towards the design, identification, culturing and/or production of genetically modified cells (Technology). The ECC granted us an exclusive worldwide license to utilize Intrexon’s Technology to develop and commercialize allogeneic genetically modified chondrocyte cell therapeutics for the treatment or repair of damaged articular hyaline cartilage in humans.  

In December 2018, we and Intrexon entered into a mutual termination and release agreement (the Mutual Termination Agreement) pursuant to which we and Intrexon mutually agreed to terminate ECC.  Pursuant to the ECC, we were responsible for the research and development costs incurred by Intrexon associated with the development of product candidates under the collaboration. As of December 21, 2018, the date of termination, we had accrued approximately $3.0 million of research and development expenses under the ECC (the Accrued Expenses).  In connection with the Mutual Termination Agreement, in lieu of payment of the Accrued Expenses, we agreed to pay Intrexon an aggregate of up to $1.5 million, with $0.375 million paid at the time of entering into the Mutual Termination Agreement and $1.125 million payable within one year following any submission of a BLA to the FDA for NeoCart. We adjusted the accrued expenses to reflect a $1.125 million balance as of December 31, 2018 and recorded a gain on extinguishment of liability of $1.5 million.  

Competition

The cell therapy and regenerative medicine sector is characterized by innovative science, rapidly advancing technologies and a strong emphasis on proprietary products. While we believe that our technology, development experience, scientific knowledge and intellectual property portfolio provide us with competitive advantages, we face potential competition from many different sources, including major pharmaceutical, specialty pharmaceutical, biotechnology and regenerative medicine companies, academic institutions, governmental agencies and public and private research institutions.

The competitive landscape in the field of articular cartilage repair in the U.S. is emerging and has stimulated a substantial amount of interest from companies developing tissue repair solutions. Companies have employed a variety of approaches to meet the goals of cartilage repair. The approaches, which represent the scientific evolution of the field, can be generally categorized in five ways: (1) non-cell-based, such as Arthrosurface’s HemiCAP and Anika’s Hyalofast; (2) uncultured cell-based (with or without scaffold), such as Zimmer’s DeNovo NT, Arthrex’s BioCartilage and Osiris’ Cartiform, distributed exclusively with Arthrex; (3) cultured cell-based (without scaffold), such as ISTO’s RevaFlex; (4) cultured cell- and scaffold-based, such as Vericel’s MACI and the Aesculap division of B. Braun Medical’s NovoCart 3D; and (5) cultured cell- and scaffold-based incorporating tissue engineering, such as NeoCart.  

In Japan, a historical cultured cell-based product, known as JACC is sold by Japan Tissue Engineering Co., Ltd (J-TEC).  This product has some of the same limitations of first-generation autologous chondrocyte implantation products in the U.S. including limited efficacy, lengthy surgery and extended patient rehabilitation.  Several cultured cell and cultured cell and scaffold combinations are in various stages of clinical development in Japan, with the earliest potential new competitive entries in 2023.  

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Government Regulation

Regulatory Background on Autologous Cellular Products

The FDA does not apply a single regulatory scheme to human tissues and the products derived from human tissue. On a product-by-product basis, the FDA may regulate such products as drugs, biologics, or medical devices, in addition to regulating them as human cells, tissues, or cellular or tissue-based products (HCT/Ps), depending on whether or not the particular product triggers any of an enumerated list of regulatory factors. A fundamental difference in the treatment of products under these classifications is that the FDA generally permits HCT/Ps that do not trigger any of those regulatory factors to be commercially distributed without marketing approval. In contrast, products that trigger those factors, such as if they are more than minimally manipulated when processed or manufactured, are regulated as drugs, biologics, or medical devices and require FDA approval. The FDA has designated NeoCart as a biologic under the jurisdiction of the Center for Biologics Evaluation and Research and market access or approval will require BLA approval.

In 1997, the FDA began requiring a BLA for autologous cellular products and approved the already-marketed Carticel contingent on further clinical trials. In 2000, Carticel’s indication narrowed to second-line therapy for patients with inadequate response to prior treatment. As of December 2011, the FDA requires evidence of clinical efficacy against approved and validated endpoints and standard of care control arm as outlined in their final guidance on the subject of cartilage repair.

The grant of marketing authorization in the European Economic Area (EEA) for products containing viable human tissues or cells such as NeoCart is governed by Regulation 1394/2007/EC on advanced therapy medicinal products, read in combination with Directive 2001/83/EC of the European Parliament and of the Council, commonly known and the Community code on medicinal products. Regulation 1394/2007/EC lays down specific rules concerning the authorization, supervision and pharmacovigilance of gene therapy medicinal products, somatic cell therapy medicinal products and tissue engineered products. Manufacturers of advanced therapy medicinal products must demonstrate the quality, safety and efficacy of their products to the European Medicines Agency (EMA), which is required to provide an opinion regarding the application for marketing authorization. The European Commission grants or refuses marketing authorization in light of the opinion delivered by the EMA.

Applicants for marketing authorization for medicinal products in the EEA are required to submit applications for marketing authorization based on the ICH Common Technical Document and must demonstrate the safety, quality and efficacy of the medicinal product for which the marketing authorization is sought. The application must include the results of pre-clinical tests and clinical trials conducted with the medicinal product. The conduct of clinical trials in the EEA is governed by Directive 2001/20/EC which imposes obligations and procedures that are similar to those provided in applicable U.S. laws. The obligations provided in the European Union (EU) Good Clinical Practice rules and EU Good Laboratory Practice must also be respected during conduct of the trials. Clinical trials must be approved by the competent regulatory authorities and the competent Ethics Committees in the EU Member States in which the clinical trials take place. Moreover, applicants are required to demonstrate that studies have been conducted with the medicinal product in the pediatric population as provided by a Pediatric Investigation Plan approved by the Pediatric Committee of the EMA. Alternatively, confirmation that the applicant has obtained a waiver or deferral for the conduct of these studies must be provided.

Reimbursement

In both domestic and foreign markets, sales of any regulatory-approved products depend in part upon the availability of reimbursement from third-party payors. Third-party payors include government health programs, such as Medicare and Medicaid, private health insurers and managed care providers, and other organizations. Reimbursement policy involves coding, coverage and payment decisions and our business strategy is to produce the necessary information for optimal decision-making by payors.

Coding: While reimbursement policy for NeoCart is uncertain at this point, we believe that the existing Current Procedural Terminology, Healthcare Commission Procedure Coding System and International Classification of Diseases, Ninth Edition coding options for ACI are sufficiently broad that they could apply to NeoCart.

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Coverage: Our goal is to demonstrate improved health outcomes (e.g., improved patient outcomes and quality of life on several parameters, lower total costs including lower overall utilization of healthcare services and faster return to work) for patients receiving NeoCart compared to microfracture, an important element in securing coverage decisions by payors (Medicare and private payors).

Payment: Analysis of recent trends in ACI coverage (discharge data) suggest that patients between 18 and 64 years of age constitute the majority of the market for ACI, resulting in a market dominated by private payors. Only 10% to 20% of ACI patients are estimated to be 65 years of age and older. While limited data is available for private payor reimbursement of ACI, these payors typically reimburse inpatient procedures with bundling mechanisms similar to Medicare Severity Diagnosis Related Groups. In addition, some private payors also tend to use Medicare rates as benchmarks when setting their own fee schedules.

Government Regulation Overview

United States

Overview

In the United States, the FDA regulates biological products under the Federal Food, Drug, and Cosmetic Act and the Public Health Service Act and related regulations. Biological products are also subject to other federal, state, local, and foreign statutes and regulations. The FDA and comparable regulatory agencies in state and local jurisdictions and in foreign countries impose substantial requirements upon the clinical development, manufacture and marketing of biological products. These agencies and other federal, state, local, and foreign entities regulate research and development activities and the testing, manufacture, quality control, safety, effectiveness, packaging, labeling, storage, distribution, record keeping, reporting, approval, advertising and promotion of our products. Failure to comply with the applicable U.S. regulatory requirements at any time during the product development process, including clinical testing, approval process or after approval may subject an applicant to administrative or judicial sanctions.

Government regulation may delay or prevent marketing of product candidates for a considerable period of time and impose costly procedures upon our activities. The testing and approval process requires substantial time, effort, and financial resources, and we cannot be certain that the FDA or any other regulatory agency will grant approvals for NeoCart or any future product candidates on a timely basis, if at all. The FDA’s policies may change and additional government regulations may be enacted that could prevent or delay regulatory approval of NeoCart or any future product candidates or approval of new disease indications or label changes. We cannot predict the likelihood, nature or extent of adverse governmental regulation that might arise from future legislative, judicial, or administrative action, either in the United States or abroad.

Marketing Approval

The process required by the FDA before biological products may be marketed in the United States generally involves the following:

 

completion of nonclinical laboratory and animal tests according to good laboratory practices, and applicable requirements for the humane use of laboratory animals or other applicable regulations;

 

submission to the FDA of an Investigational New Drug Application (IND) which must become effective before human clinical trials may begin;

 

performance of adequate and well-controlled human clinical trials according to the FDA’s regulations commonly referred to as good clinical practices (GCP), and any additional requirements for the protection of human research patients and their health information, to establish the safety and efficacy of the proposed biological product for its intended use or uses;

 

submission to the FDA of a BLA for marketing approval that includes substantive evidence of safety, purity, and potency from results of nonclinical testing and clinical trials;

 

satisfactory completion of an FDA pre-approval inspection of manufacturing facilities where the biological product is produced to assess compliance with good manufacturing practices (GMP) to assure

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that the facilities, methods and controls are adequate to preserve the biological product’s identity, strength, quality and purity and, if applicable, the FDA’s current good tissue practices (GTP) for the use of human cellular and tissue products to prevent the introduction, transmission or spread of communicable diseases;

 

potential FDA audit of the nonclinical study sites and clinical trial sites that generated the data in support of the BLA; and

 

FDA review and approval, or licensure, of the BLA, which must occur before a biological product can be marketed or sold.

U.S. Biological Products Development Process

Before testing any biological product candidate in humans, the product candidate enters the nonclinical testing stage. Nonclinical tests include laboratory evaluations of product chemistry, toxicity and formulation, as well as animal studies to assess the potential safety and activity of the product candidate. The conduct of the nonclinical tests must comply with federal regulations and requirements including good laboratory practices.

Prior to commencing the first clinical trial, the clinical trial sponsor must submit the results of the nonclinical tests, together with manufacturing information, analytical data, any available clinical data or literature and a proposed clinical protocol, to the FDA as part of an initial IND. Some nonclinical testing may continue even after the IND is submitted. The IND automatically becomes effective 30 days after receipt by the FDA unless the FDA, within the 30-day time period, raises concerns or questions about the conduct of the clinical trial and places the clinical trial on a clinical hold. In such case, the IND sponsor must resolve any outstanding concerns with the FDA before the clinical trial may begin. Further, an Institutional Review Board (IRB) for each site proposing to conduct the clinical trial must review and approve the plan for any clinical trial before it commences at that site. An IRB is charged with protecting the welfare and rights of study subjects and considers such items as whether the risks to individuals participating in the clinical trials are minimized and are reasonable in relation to anticipated benefits. The IRB also approves the form and content of the informed consent that must be signed by each clinical trial subject or his or her legal representative and must monitor the clinical trial until completed. The FDA or IRB may impose clinical holds on a biological product candidate at any time before or during clinical trials due to safety concerns or non-compliance. If the FDA imposes a clinical hold, trials may not recommence without FDA or IRB authorization and then only under terms authorized by the FDA and IRB. Accordingly, we cannot be sure that submission of an IND will result in the FDA allowing clinical trials to begin or that, once begun, issues will not arise that will result in the suspension or termination of such trials.

Clinical trials involve the administration of the biological product candidate to healthy volunteers or patients under the supervision of qualified investigators, generally physicians not employed by or under the trial sponsor’s control. Clinical trials are conducted under protocols detailing, among other things, the objectives of the clinical trial, dosing procedures, subject selection and exclusion criteria, and the parameters to be used to monitor subject safety, including stopping rules that assure a clinical trial will be stopped if certain adverse events should occur. Each protocol and any amendments to the protocol must be submitted to the FDA as part of the IND and to the IRB.

For purposes of BLA approval, human clinical trials are typically conducted in three sequential phases that may overlap:

 

Phase 1—The biological product is initially introduced into healthy human patients and tested for safety. In the case of some products for severe or life-threatening diseases, especially when the product may be too inherently toxic to ethically administer to healthy volunteers, the initial human testing is conducted in patients. These trials may also provide early evidence on effectiveness.

 

Phase 2—These trials are conducted in a limited number of patients in the target population to identify possible adverse effects and safety risks, to preliminarily evaluate the efficacy of the product for specific targeted diseases and to determine dosage tolerance and optimal dosage. Multiple Phase 2 clinical trials may be conducted by the sponsor to obtain information prior to beginning larger and more expensive Phase 3 clinical trials.

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Phase 3—Phase 3 trials are undertaken to provide statistically significant evidence of clinical efficacy and to further evaluate dosage, potency and safety in an expanded patient population at multiple clinical trial sites. They are performed after preliminary evidence suggesting effectiveness of the product has been obtained, and are intended to establish the overall benefit-risk relationship of the investigational product and to provide an adequate basis for product approval and labeling.

Post-approval clinical trials, sometimes referred to as Phase 4 clinical trials, may be conducted after initial marketing approval. These trials may be required by the FDA as a condition of approval and are used to gain additional experience from the treatment of patients in the intended therapeutic indication, particularly for long-term safety follow-up. The FDA now has express statutory authority to require post-market clinical trials to address safety issues. All of these trials must be conducted in accordance with GCP requirements in order for the data to be considered reliable for regulatory purposes.

During all phases of clinical development, regulatory agencies require extensive monitoring and auditing of all clinical activities, clinical data and clinical trial investigators. Annual progress reports detailing the results of the clinical trials must be submitted to the FDA. Written IND safety reports must be promptly submitted to the FDA and the investigators for serious and unexpected adverse events; any findings from other studies, tests in laboratory animals or in vitro testing that suggest a significant risk for human patients; or any clinically important increase in the rate of a serious suspected adverse reaction over that listed in the protocol or investigator brochure. The sponsor must submit an IND safety report within 15 calendar days after the sponsor determines that the information qualifies for reporting. The sponsor also must notify the FDA of any unexpected fatal or life-threatening suspected adverse reaction within seven calendar days after the sponsor’s initial receipt of the information.

Phase 1, Phase 2 and Phase 3 clinical trials may not be completed successfully within any specified period, if at all. Regulatory authorities, a data safety monitoring board or the sponsor may suspend a clinical trial at any time on various grounds, including a finding that the participants are being exposed to an unacceptable health risk. Similarly, an IRB can suspend or terminate approval of a clinical trial at its institution if the clinical trial is not being conducted in accordance with the IRB’s requirements or if the biological product has been associated with unexpected serious harm to patients.

Our ongoing and planned clinical trials for our product candidates may not begin or be completed on schedule, if at all. Clinical trials can be delayed for a variety of reasons, including delays in:

 

obtaining regulatory approval to commence a trial;

 

reaching agreement with third-party clinical trial sites and their subsequent performance in conducting accurate and reliable trials on a timely basis;

 

obtaining IRB approval to conduct a trial at a prospective site;

 

recruiting patients to participate in a trial; and

 

supply of the biological product.

Typically, if a biological product is intended to treat a chronic disease, as is the case with NeoCart, safety and efficacy data must be gathered over an extended period of time, which can range from six months to three years or more. Success in early stage clinical trials does not ensure success in later stage clinical trials. Data obtained from clinical activities is not always conclusive and may be susceptible to varying interpretations, which could delay, limit or prevent regulatory approval.

Concurrent with clinical trials, companies usually complete additional animal studies and must also develop additional information about the physical characteristics of the biological product as well as finalize a process for manufacturing the product in commercial quantities in accordance with GMP requirements. To help reduce the risk of the introduction of adventitious agents with the use of biological products, the Public Health Service Act emphasizes the importance of manufacturing control for products whose attributes cannot be precisely defined. The manufacturing process must be capable of consistently producing quality batches of the product candidate and, among other things, the sponsor must develop methods for testing the identity, strength, quality, potency and purity of the final biological product. Additionally, appropriate packaging must be selected and tested and stability studies must be conducted to demonstrate that the biological product candidate does not undergo unacceptable deterioration over its shelf life.

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U.S. Review and Approval Processes

In order to obtain approval to market a biological product in the United States, a BLA must be submitted to the FDA that provides data establishing to the FDA’s satisfaction the safety, purity and potency of the investigational biological product for the proposed indication. The application includes all data available from nonclinical studies and clinical trials, including negative or ambiguous results as well as positive findings, together with detailed information relating to the product’s manufacture and composition, and proposed labeling, among other things. The testing and approval processes require substantial time and effort, and there can be no assurance that the FDA will accept the BLA for filing and, even if filed, that any approval will be granted on a timely basis, if at all.

Under the Prescription Drug User Fee Act (PDUFA), each BLA must be accompanied by a significant user fee and after approval, an approved biologic will also be subject to a program fee. The FDA adjusts the PDUFA user fees on an annual basis. According to the FDA’s fee schedule, the user fee for an application requiring clinical data, such as a BLA, will be $2.4 million for 2018. Fee waivers or reductions are available in certain circumstances, including a waiver of the application fee for the first application filed by a small business. Additionally, no user fees are assessed on BLAs for products designated as orphan drugs, unless the product also includes a non-orphan indication.

The FDA has 60 days from its receipt of a BLA to determine whether the application will be accepted for filing based on the FDA’s threshold determination that the application is sufficiently complete to permit substantive review. The FDA may refuse to file any BLA that it deems incomplete or not properly reviewable at the time of submission and may request additional information. In this event, the BLA must be resubmitted with the additional information. The resubmitted application also is subject to review before the FDA accepts it for filing. After the BLA is accepted for filing, the FDA reviews the BLA to determine, among other things, whether the proposed product is safe and potent, or effective, for its intended use, and has an acceptable purity profile, and whether the product is being manufactured in accordance with GMPs to assure and preserve the product’s identity, safety, strength, quality, potency, and purity, and biological product standards. The FDA may refer applications for novel biological products or biological products that present difficult questions of safety or efficacy to an advisory committee, typically a panel that includes clinicians and other experts, for review, evaluation and a recommendation as to whether the application should be approved and, if so, under what conditions. The FDA is not bound by the recommendations of an advisory committee, but it considers such recommendations carefully when making decisions.

Before approving a BLA, the FDA will inspect the facilities at which the product is manufactured. The FDA will not approve the product unless it determines that the manufacturing processes and facilities are in compliance with GMP requirements and adequate to assure consistent production of the product within required specifications. For a human cellular or tissue product, the FDA also will not approve the product if the manufacturer is not in compliance with the GTP. These are FDA regulations that govern the methods used in, and the facilities and controls used for, the manufacture of HCT/Ps, which are human cells or tissue intended for implantation, transplant, infusion, or transfer into a human recipient. The primary intent of the GTP requirements is to ensure that cell and tissue based products are manufactured in a manner designed to prevent the introduction, transmission and spread of communicable disease. FDA regulations also require tissue establishments to register and list their HCT/Ps with the FDA and, when applicable, to evaluate donors through screening and testing. Additionally, before approving a BLA, the FDA may inspect one or more clinical sites to assure that the clinical trials were conducted in compliance with IND study requirements and GCP. To assure GMP, GTP and GCP compliance, an applicant must incur significant expenditure of time, money and effort. If the FDA determines the manufacturing process or manufacturing facilities are not acceptable, it typically will outline the deficiencies and often will require the facility to take corrective action and provide documentation evidencing the implementation of such corrective action. This may significantly delay further review of the application. If the FDA finds that a clinical site did not conduct the clinical trial in accordance with GCP, the FDA may determine the data generated by the clinical site should be excluded from the primary efficacy analyses provided in the BLA and request additional testing or data. Additionally, notwithstanding the submission of any requested additional information, the FDA ultimately may decide that the application does not satisfy the regulatory criteria for approval.

The FDA also has authority to require a Risk Evaluation and Mitigation Strategy (REMS) from manufacturers to ensure that the benefits of a biological product outweigh its risks. A sponsor may also voluntarily propose a REMS as part of the BLA. The need for a REMS is determined as part of the review of the BLA. Based on statutory standards, elements of a REMS may include “dear doctor letters,” a medication guide, more elaborate targeted educational programs, and in some cases restrictions on distribution. These elements are negotiated as part of the BLA approval, and in some cases may delay the approval date. Once adopted, REMS are subject to periodic assessment and modification.

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After the FDA completes its initial review of a BLA, it will communicate to the sponsor that the biological product will either be approved, or it will issue a complete response letter to communicate that the BLA will not be approved in its current form. The complete response letter usually describes all of the specific deficiencies in the BLA identified by the FDA. The deficiencies identified may be minor, for example, requiring labeling changes, or major, for example, requiring additional clinical trials. Additionally, the complete response letter may include recommended actions that the applicant might take to place the applicant in a condition for approval. If a complete response letter is issued, the applicant may either resubmit the BLA, addressing all of the deficiencies identified in the letter, or withdraw the application.

The FDA may not grant approval on a timely basis, or at all. We may encounter difficulties or unanticipated costs in our efforts to secure necessary governmental approvals, which could delay or preclude us from marketing our products. The testing and approval process for a biological product usually takes several years to complete.

One of the performance goals agreed to by the FDA under PDUFA is to review 90% of standard BLAs within ten months of the 60-day filing date and 90% of priority BLAs within six months of the 60-day filing date, whereupon a review decision is to be made. The FDA does not always meet its PDUFA goal dates for standard and priority BLAs and its review goals are subject to change from time to time. The review process and the PDUFA goal data may be extended by three months if the FDA requests or the BLA applicant otherwise provides additional information or clarification regarding information already provided in the submission within the last three months before the PDUFA goal date.

Even if a product candidate receives regulatory approval, the approval may be limited to specific disease states, patient populations and dosages, or the indications for use may otherwise be limited, which could restrict the commercial value of the product. Further, the FDA may require that certain contraindications, warnings, or precautions be included in the product labeling. The FDA may impose restrictions and conditions on product distribution, prescribing or dispensing in the form of a risk management plan, or otherwise limit the scope of any approval. In addition, the FDA may require Phase 4 post-marketing clinical trials, designed to further assess a biological product’s safety and effectiveness, and testing and surveillance programs to monitor the safety of approved products that have been commercialized. Further, even after regulatory approval is obtained, later discovery of previously unknown problems with a product may result in the imposition of new restrictions on the product or even complete withdrawal of the product from the market. Delay in obtaining, or failure to obtain and maintain, regulatory approval for NeoCart, or obtaining approval but for significantly limited use, would harm our business.

FDA Post-Approval Requirements

Maintaining substantial compliance with applicable federal, state, local and foreign statutes and regulations requires the expenditure of substantial time and financial resources. Rigorous and extensive FDA regulation of biological products continues after approval, particularly with respect to GMP. We may rely, in the future, on third parties for the production of clinical and commercial quantities of any future products that we may commercialize. Manufacturers of our products are required to comply with applicable requirements in the GMP regulations, including quality control and quality assurance and maintenance of records and documentation. We cannot be certain that we or our present or future suppliers will be able to comply with the GMP and other FDA regulatory requirements. Other post-approval requirements applicable to biological products include reporting of GMP deviations that may affect the identity, potency, purity and overall safety of a distributed product, record-keeping requirements, reporting of adverse effects, reporting updated safety and efficacy information and complying with electronic record and signature requirements. After a BLA is approved, the product also may be subject to official lot release. As part of the manufacturing process, the manufacturer is required to perform certain tests on each lot of the product before it is released for distribution. If the product is subject to official release by the FDA, the manufacturer submits samples of each lot of product to the FDA together with a release protocol showing a summary of the history of manufacture of the lot and the results of all of the manufacturer’s tests performed on the lot. The FDA also may perform certain confirmatory tests on lots of some products, such as viral vaccines, before releasing the lots for distribution by the manufacturer. In addition, the FDA conducts laboratory research related to the regulatory standards on the safety, purity, potency and effectiveness of biological products.

Discovery of previously unknown problems or the failure to comply with the applicable regulatory requirements, by us or our suppliers, may result in restrictions on the marketing of a product or withdrawal of the product from the

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market as well as possible civil or criminal sanctions and adverse publicity. FDA sanctions could include refusal to approve pending applications, suspension or revocation of an approval, clinical hold, warning or untitled letters, product recalls, product seizures, total or partial suspension of production or distribution, injunctions, fines, refusals of government contracts, mandated corrective advertising or communications with doctors, debarment, restitution, disgorgement of profits or civil or criminal penalties. Any agency or judicial enforcement action could have a material adverse effect on us.

Biological product manufacturers and other entities involved in the manufacture and distribution of approved biological products are required to register their facilities with the FDA and certain state agencies, and are subject to periodic unannounced inspections by the FDA and certain state agencies for compliance with GMPs and other laws. In addition, changes to the manufacturing process or facility generally require prior FDA approval before being implemented and other types of changes to the approved product, such as adding new indications and additional labeling claims, are also subject to further FDA review and approval.

Labeling, Marketing and Promotion

The FDA closely regulates the labeling, marketing and promotion of biological products, including direct-to-consumer advertising, promotional activities involving the internet, and industry-sponsored scientific and educational activities. While doctors are free to prescribe any product approved by the FDA for any use, a company can only make claims relating to safety and efficacy of a biological product that are consistent with FDA approval, and the company is allowed to market a biological product only for the particular use and treatment approved by the FDA. In addition, any claims we make for our products in advertising or promotion must be appropriately balanced with important safety and risk information and otherwise be adequately substantiated. Failure to comply with these requirements can result in adverse publicity, warning letters, corrective advertising, injunctions, seizures, potential civil and criminal penalties and exclusion from government healthcare programs.

Anti-Kickback and False Claims Laws

In the United States, the research, manufacture, distribution, sale and promotion of biological products are potentially subject to regulation by various federal, state and local authorities in addition to the FDA, including the Centers for Medicare & Medicaid Services, other divisions of the U.S. Department of Health and Human Services (for example, the Office of Inspector General), the U.S. Department of Justice, state Attorneys General, and other federal, state and local government agencies. For example, sales, marketing and scientific/educational grant programs must comply with the Anti-Kickback Statute, the False Claims Act, the privacy regulations promulgated under the Health Insurance Portability and Accountability Act and similar state laws. Pricing and rebate programs must comply with the Medicaid Drug Rebate Program requirements of the Omnibus Budget Reconciliation Act, and the Veterans Health Care Act. If products are made available to authorized users of the Federal Supply Schedule of the General Services Administration, additional laws and requirements apply. All of these activities are also potentially subject to federal and state consumer protection and unfair competition laws.

As noted above, in the United States, we are subject to complex laws and regulations pertaining to healthcare “fraud and abuse,” including the Anti-Kickback Statute, the False Claims Act and other state and federal laws and regulations. The Anti-Kickback Statute makes it illegal for any person, including a biological product manufacturer (or a party acting on its behalf), to knowingly and willfully solicit, receive, offer, or pay any remuneration that is intended to induce the referral of business, including the purchase or order of an item for which payment may be made under a federal healthcare program, such as Medicare or Medicaid. Violations of this law are punishable by up to five years in prison, criminal fines, administrative civil money penalties and exclusion from participation in federal healthcare programs. In addition, many states have adopted laws similar to the Anti-Kickback Statute. Some of these state prohibitions apply to the referral of patients for healthcare services reimbursed by any insurer, not just federal healthcare programs such as Medicare and Medicaid. Due to the breadth of these federal and state anti-kickback laws and the potential for additional legal or regulatory change in this area, it is possible that our future sales and marketing practices or our future relationships with physicians might be challenged under anti-kickback laws, which could harm us. Because we intend to commercialize products that could be reimbursed under a federal healthcare program and other governmental healthcare programs, we plan to develop a comprehensive compliance program that establishes internal controls to facilitate adherence to the rules and program requirements to which we will or may become subject.

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The False Claims Act prohibits anyone from, among other things, knowingly presenting, or causing to be presented, for payment to federal programs (including Medicare and Medicaid) claims for items or services, including biological products, that are false or fraudulent. Although we likely would not submit claims directly to payers, manufacturers can be held liable under these laws if they are deemed to “cause” the submission of false or fraudulent claims by, for example, providing inaccurate billing or coding information to customers or promoting a product off-label. In addition, our future activities relating to the reporting of wholesaler or estimated retail prices for our products, the reporting of prices used to calculate Medicaid rebate information and other information affecting federal, state and third-party coverage and reimbursement for our products and the sale and marketing of our products, are subject to scrutiny under this law. For example, pharmaceutical companies have been prosecuted under the False Claims Act in connection with their off-label promotion of drugs. Penalties for a False Claims Act violation include three times the actual damages sustained by the government, plus mandatory civil penalties of between $5,500 and $11,000 for each separate false claim, the potential for exclusion from participation in federal healthcare programs, and, although the federal False Claims Act is a civil statute, conduct that results in a False Claims Act violation may also implicate various federal criminal statutes. If the government were to allege that we were, or convict us of, violating these false claims laws, we could be subject to a substantial fine and may suffer a decline in our stock price. In addition, private individuals have the ability to bring actions under the False Claims Act and certain states have enacted laws modeled after the False Claims Act.

There are also an increasing number of state laws that require manufacturers to make reports to states on pricing and marketing information. Many of these laws contain ambiguities as to what is required to comply with the laws. In addition, beginning in August 2013, a similar federal requirement requires manufacturers to track and report to the federal government certain payments made to physicians and teaching hospitals made in the previous calendar year. These laws may affect our sales, marketing, and other promotional activities by imposing administrative and compliance burdens on us. In addition, given the lack of clarity with respect to these laws and their implementation, our reporting actions could be subject to the penalty provisions of the pertinent state, and soon federal, authorities.

Other Regulations

We are also subject to numerous federal, state and local laws relating to such matters as safe working conditions, manufacturing practices, environmental protection, fire hazard control and disposal of hazardous or potentially hazardous substances. We may incur significant costs to comply with such laws and regulations now or in the future.

EU and EEA

Marketing authorization in the EU for products containing viable human tissues or cells such as NeoCart is governed by Regulation 1394/2007/EC on advanced therapy medicinal products, read in combination with Directive 2001/83/EC of the European parliament and of the Council, commonly known as the Community code on medicinal products. Regulation 1394/2007/EC establishes specific rules concerning the authorization, supervision and pharmacovigilance of gene therapy medicinal products, somatic cell therapy medicinal products and tissue engineered products. Manufacturers of advanced therapy medicinal products must demonstrate the quality, safety and efficacy of their products to the EMA which is required to provide an opinion regarding the application for marketing authorization. The European Commission grants or refuses marketing authorization in light of the opinion delivered by the EMA.

Applicants for marketing authorizations for medicinal products in the EEA are required to submit applications for marketing authorization in a form that is based on the ICH Common Technical Document, and must demonstrate the safety, quality and efficacy of the medicinal product for which the marketing authorization is sought. The application must include the results of pre-clinical tests and clinical trials conducted with the medicinal product.

The conduct of clinical trials in the EEA is governed by Directive 2001/20/EC which imposes obligations and procedures that are similar to those provided in applicable U.S. laws. The EU Good Clinical Practice rules and EU Good Laboratory Practice obligations must also be respected during conduct of the trials. Clinical trials must be approved by the competent regulatory authorities and the competent Ethics Committees in the EU Member States in which the clinical trials take place.

Moreover, applicants are required to provide evidence that studies have been conducted with the medicinal product in the pediatric population as provided by a Pediatric Investigation Plan approved by the Pediatric Committee of the

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EMA. Alternatively, confirmation that the applicant has obtained a waiver or deferral for the conduct of these studies must be provided. Cell-based products must also comply with Directive 2004/23/EC of the European Parliament and of the Council of March 31, 2004 on setting standards of quality and safety for the donation, procurement, testing, processing, preservation, storage and distribution of human tissues and cells (Tissues and Cells Directive). This Directive describes the conditions and quality requirements which must be applied when sourcing the cells intended for manufacturing of the cell-based medicinal product. The EU Member States have transposed the Tissues and Cells Directive into their national laws.

Locally different interpretations of the Tissue and Cells Directive have occurred during adoption of the national legal implementations by individual EU Member States. This has led to some inconsistency of approach leading to additional complexity in complying with the all-over requirements in this already difficult regulatory field.

Given the specific nature of cell-based products, the clinical development paths are less standardized than for classic pharmaceutical or biological products. Phase 1 studies are often not relevant, in particular for autologous cell-based products, since cells often need to be directly implanted into a tissue defect only present in patients. As cellular therapy Phase 3 studies are very complex to organize, often limited numbers of patients can be enrolled and follow up times can be very long, so that the design and execution of these large confirmatory trials might not always be possible to the classical extent. Upfront discussions and agreement with the regulatory authorities are an important criterion to success. It is also expected that new regulatory guidance will become available in the near future, more clearly describing the regulatory expectations.

Employees

As of December 31, 2018, we employed 49 full-time employees, including four in research and development, seven in clinical development and regulatory, 29 in manufacturing and quality control and assurance, and nine in executive, general and administrative. In January 2019 and March 2019, we implemented restructuring plans approved by our Board involving reductions in headcount to reduce operating costs and conserve cash, along with other cash conservation measures. The positions eliminated together represented all but one member of our workforce, including our Chief Executive Officer, Chief Operating Officer, Chief Medical Officer and Chief Business Officer. We intend to engage, Mr. Adam Gridley, our Chief Executive Officer, Mr. Stephen Kennedy, our Chief Operating Officer, along with up to four additional employees as consultants to assist with our continuing evaluation of strategic alternatives. Mr. Gridley will retain his statutory titles of president, treasurer and secretary of the Company while he continues to provide consulting services to us, and will remain a director of the Company. We have never had a work stoppage, and none of our employees is represented by a labor organization or under any collective bargaining arrangements.

Corporate Information

We were originally incorporated as a Massachusetts corporation in 2000. In 2006, we underwent a corporate reorganization pursuant to which we were incorporated as a Delaware corporation. Our principal offices are located at 830 Winter Street, 3rd Floor, Waltham, Massachusetts 02451, and our telephone number is (781) 547-7900. Our website address is www.histogenics.com. Our website and the information contained on, or that can be accessed through, our website shall not be deemed to be incorporated by reference in, and are not considered part of, this annual report. You should not rely on any such information in making your decision whether to purchase our common stock.

Available Information

We file annual, quarterly, and current reports, proxy statements, and other documents with the Securities and Exchange Commission (SEC) under the Securities Exchange Act of 1934, as amended (the Exchange Act). The SEC maintains an Internet website, www.sec.gov, that contains reports, proxy and information statements, and other information regarding issuers, including us, that file electronically with the SEC.

Copies of each of our filings with the SEC on Form 10-K, Form 10-Q and Form 8-K and all amendments to those reports, can be viewed and downloaded free of charge at our website, www.histogenics.com as soon as reasonably practicable after the reports and amendments are electronically filed with or furnished to the SEC.

Our code of ethics, other corporate policies and procedures, and the charters of our Audit Committee, Compensation Committee and Nominating/Corporate Governance Committee are available through our website at www.histogenics.com.

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ITEM 1A.

RISK FACTORS

Investing in our common stock involves risk. You should carefully consider the risks described below as well as all the other information in this report, including the consolidated financial statements and the related notes appearing at the end of this annual report on Form 10-K, before making an investment decision. The risks and uncertainties described below are not the only risks and uncertainties we face. Additional risks and uncertainties not presently known to us or that we currently deem immaterial also may impair our business operations. If any of the following risks actually occur, our business, results of operations and financial condition could suffer. In that event the trading price of our common stock could decline, and you may lose all or part of your investment. The risks discussed below also include forward-looking statements and our actual results may differ substantially from those discussed in these forward-looking statements.

Risks Relating to Our Evaluation of Strategic Alternatives

Our exploration and pursuit of strategic alternatives may not be successful.

Based on the results of our Phase 3 clinical study of NeoCart and feedback from the U.S. Food and Drug Administration (the FDA) regarding a potential Biologics License Application (BLA) submission, we determined to cease all further development of NeoCart and implemented operating cost reductions and organizational restructurings, including recent reductions in our workforce, to preserve our cash resources and better align our organization with our current operating plan. Our strategic focus has shifted to the identification and evaluation of a range of potential strategic alternatives designed to maximize stockholder value. We have retained Canaccord Genuity LLC to advise and assist us in this review, along with legal advisors. Potential strategic alternatives that may be explored or evaluated as part of this process include the potential for an acquisition, merger, business combination, licensing and/or other strategic transaction involving Histogenics. Despite devoting significant efforts to identify and evaluate potential strategic transactions, the process may not result in any definitive offer to consummate a strategic transaction, or, if we receive such a definitive offer, the terms may not be as favorable as anticipated or may not result in the execution or approval of a definitive agreement. Even if we enter into a definitive agreement, we may not be successful in completing a transaction or, if we complete such a transaction, it may not enhance stockholder value or deliver expected benefits.

If we do not successfully consummate a strategic transaction, our Board of Directors may decide to pursue a liquidation and dissolution of our company. In such an event, the amount of cash available for distribution to our stockholders will depend heavily on the timing of such liquidation as well as the amount of cash that will need to be reserved for commitments and contingent liabilities.

There can be no assurance that the process to identify a strategic transaction will result in a successfully consummated transaction. If a transaction is not completed, our Board of Directors (the Board) may decide to pursue a dissolution and liquidation of our company, which may be done under the protection of the bankruptcy laws or under Delaware state dissolution laws. In such an event, the amount of cash available for distribution to our stockholders will depend heavily on the timing of such decision and, ultimately, such liquidation, since the amount of cash available for distribution continues to decrease as we fund our operations while we evaluate our strategic alternatives. In addition, if our Board were to approve and recommend, and our stockholders were to approve, a dissolution and liquidation of our company, we would be required under Delaware corporate law to pay our outstanding obligations, as well as to make reasonable provisions for contingent and unknown obligations, prior to making any distributions in liquidation to our stockholders. Our commitments and contingent liabilities may include: (i) regulatory and clinical obligations remaining under our Phase 3 clinical trial for NeoCart; (ii) payment of our lease obligations in the normal course of business or negotiated one-time termination fees in the event we determine that a wind-up of operations is in the best interests of the Company and our stockholders; (iii) obligations under our employment and related agreements with certain employees that provide for severance and other payments following a termination of employment occurring for various reasons, including a change in control of our Company; (iv) payments made related to potential investigations or litigation against us, and other various claims and legal actions arising in the ordinary course of business; and (v) payment of liabilities generated from our business operations. As a result of this requirement, a portion of our assets may need to be reserved pending the resolution of such obligations. In addition, we may be subject to litigation or other claims related to a liquidation and dissolution of our Company. If a liquidation and dissolution were pursued, our Board, in consultation with its legal and financial advisors, would need to evaluate these matters and make a determination about a reasonable amount to

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reserve. Accordingly, holders of our common stock and other securities could lose all or a significant portion of their investment in the event of a liquidation, dissolution or winding up of our company.

If we are successful in completing a strategic transaction, we may be exposed to other operational and financial risks.

Although there can be no assurance that a strategic transaction will result from the process we have undertaken to identify and evaluate strategic alternatives, the negotiation and consummation of any such transaction will require significant time on the part of our management, and the diversion of management’s attention may disrupt our business. The negotiation and consummation of any such transaction may also require more time or greater cash resources than we anticipate and expose us to other operational and financial risks, including:

 

increased near-term and long-term expenditures;

 

exposure to unknown liabilities;

 

higher than expected transaction or integration costs;

 

incurrence of substantial debt or dilutive issuances of equity securities to fund future operations;

 

write-downs of assets or goodwill or incurrence of non-recurring, impairment or other charges;

 

additional severance costs and retention payments;

 

difficulty and cost in combining the operations and personnel of any acquired business with our operations and personnel;

 

impairment of relationships with key suppliers or customers of any acquired business due to changes in management and ownership; or

 

inability to retain key employees of our company or any acquired business.

Any of the foregoing risks could have a material adverse effect on our business, financial condition and prospects.

Following our recent reductions in force, we may not have resources or the required expertise to enable a potential strategic partner to develop NeoCart, which may impair its value.

Because of the specialized scientific nature of our business and the unique properties of NeoCart, our ability to preserve the option to resume NeoCart development is highly dependent upon our ability to attract and retain qualified scientific and technical personnel, consultants and advisors. Some of the potential strategic partners with whom we are evaluating a transaction place a high value on the NeoCart development program overall and the ability to resume NeoCart development activities.  However, our ongoing restructuring efforts resulted in the elimination of all of our research and development, clinical operations and manufacturing staff. The loss of their services will significantly delay or prevent any resumption of the research and development of NeoCart should a strategic partner choose to resume those activities in the future.

Should a partner need to recruit additional personnel in order to resume research and development activities, such partner would need to hire additional qualified scientific personnel to perform research and development, as well as personnel with expertise in clinical testing, government regulation, manufacturing, marketing and sales, which may place a strain on its managerial, operational, regulatory compliance, financial and other resources. Historically, we have also relied on consultants and advisors to assist in formulating our research and development strategy and adhering to complex regulatory requirements and a potential strategic partner may need to re-engage some of those consultants and advisors should such partner want to resume the development of NeoCart. There is significant competition for qualified individuals from numerous pharmaceutical and biotechnology companies, universities and other research institutions. There can be no assurance that a strategic partner will be able to attract and retain such individuals in the future, on acceptable terms, if at all. The failure to attract and retain qualified personnel, consultants and advisors could delay or prevent a partner’s ability to commercialize NeoCart, which would have a material adverse effect on our ability to consummate a transaction with such partner.

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We may experience difficulties, delays or unexpected costs and not achieve anticipated benefits and savings from our recently announced corporate restructuring plans, and our restructuring activities may adversely affect our ability to consummate a strategic transaction that enhances stockholder value.

In order to better align our resources with our operational needs going forward and based on the results of our Phase 3 clinical study of NeoCart and feedback from the FDA regarding a potential BLA submission, we reduced our workforce in January 2019 and again in March 2019 leaving one remaining employee as of the end of March 2019. As part of this corporate restructuring and our focus on the identification and evaluation of strategic alternatives, we also discontinued our research activities and focused on the completion and close-out of any ongoing clinical trial activities. While we intend to engage our Chief Executive Officer, our Chief Operating Officer and up to four additional employees as consultants to assist with our continuing evaluation of strategic alternatives, these reductions in force resulted in the loss of numerous long-term employees, the loss of institutional knowledge and expertise, and the reallocation of certain job responsibilities, all of which could negatively affect operational efficiencies and increase our operating expenses such that we may not fully realize anticipated savings from the restructuring, and could significantly impair our ability to successfully complete a potential strategic transaction on terms that are favorable to our stockholders, or at all.

We are substantially dependent on our remaining employee and consultants to facilitate the consummation of a strategic transaction.

In connection with our restructuring in January 2019 and a further restructuring in March of 2019, we terminated all but one employee.  Our ability to successfully complete a strategic transaction depends in large part on our ability to retain the consulting services of certain of our former personnel, particularly Adam Gridley, our President and Chief Executive Officer, Jonathan Lieber, our Interim Chief Financial Officer, and Stephen Kennedy, our Executive Vice President and Chief Operating Officer. Despite our efforts to retain these individuals as consultants following their separation of service from the Company, one or more may terminate their engagement with us on short notice. The loss of the services of any of these individuals could potentially harm our ability to evaluate and pursue strategic alternatives, as well as fulfill our reporting obligations as a public company.

We may not realize any additional value in a strategic transaction for our intellectual property.

The market capitalization of our company is or may be below the value of our cash, cash equivalents and marketable securities. Although our most advanced product candidate, NeoCart, failed to meet its primary endpoint, we believe that data from preclinical and clinical studies of NeoCart support potential further investigation and development of NeoCart and our underlying proprietary intellectual property relating to scaffolds and CT3. However, potential counterparties in a strategic transaction involving our Company may place minimal or no value on these assets, given the limited data regarding their potential application. Further, the development and any potential commercialization of NeoCart will require substantial additional funding associated with conducting the necessary clinical testing and obtaining regulatory approval. Consequently, any potential counterparty in a strategic transaction involving our company may choose not to spend additional resources and continue development of NeoCart and may attribute little or no value, in such a transaction, to NeoCart or our other intellectual property.

We may become involved in securities class action litigation that could divert management’s attention and harm the company’s business, and insurance coverage may not be sufficient to cover all costs and damages.

In the past, securities class action litigation has often followed certain significant business transactions, such as the sale of a company or announcement of any other strategic transaction, or the announcement of negative events, such as negative results from clinical trials. These events may also result in investigations by the Securities and Exchange Commission. We may be exposed to such litigation or investigation even if no wrongdoing occurred. Litigation and investigations are usually expensive and divert management’s attention and resources, which could adversely affect our business and cash resources and our ability to consummate a potential strategic transaction or the ultimate value our stockholders receive in any such transaction.

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Although we have ceased all further development of NeoCart and our other potential product candidates, if we were to resume research and development activities, we would require substantial additional funding. Raising additional capital may cause dilution to our existing stockholders, restrict our operations or require us to relinquish rights to our technologies or to a product candidate.

We currently do not have any external source of funds and do not expect to generate any revenue. We believe that our existing cash, cash equivalents and marketable securities and interest thereon will be sufficient to fund our projected operating requirements under our current operating plan, which is to seek a strategic alternative to maximize stockholder value, and into the middle of 2019. We have based our estimates on assumptions that may prove to be wrong, and we may use our available capital resources sooner than we currently expect if our operating plans change. If our current operating plans change and we determine to pursue further research and development activities, we will require substantial additional funding to operate, and would expect to finance these cash needs through a combination of equity offerings, debt financings, government or other third-party funding and licensing or collaboration arrangements.

To the extent that we raise additional capital through the sale of equity or convertible debt, the ownership interests of our stockholders will be diluted. In addition, the terms of any equity or convertible debt we agree to issue may include liquidation or other preferences that adversely affect the rights of our stockholders. Convertible debt financing, if available, may involve agreements that include covenants limiting or restricting our ability to take specific actions, such as incurring additional debt, making capital expenditures, and declaring dividends, and may impose limitations on our ability to acquire, sell or license intellectual property rights and other operating restrictions that could adversely impact our ability to conduct our business.

Additional funds may not be available when we need them on terms that are acceptable to us, or at all. If adequate funds are not available to us on a timely basis, we may be required to further curtail or cease our operations or we may have to relinquish valuable rights to our technologies, any future revenue streams, research programs or product candidates, or grant licenses on terms that may not be favorable to us.

Risks Related to Our Historical Business

The FDA has indicated an additional Phase 3 clinical trial for NeoCart would be required before the FDA would consider accepting a BLA submission for NeoCart.

On December 20, 2018, we had a telephonic meeting with senior members of the FDA. Based on the feedback received from the FDA, while the NeoCart Phase 3 clinical trial resulted in certain compelling data, the FDA indicated that an additional Phase 3 clinical trial would need to be completed before it would accept a submission of a BLA for NeoCart. The FDA indicated receptivity to novel clinical trial methodologies and regenerative medicine advanced therapy designations in order to support additional data for a future potential submission. However, considering the time and funding required to conduct such a trial, we discontinued the development of NeoCart and do not plan to submit a BLA.

We have historically been a clinical-stage cell therapy company with a limited operating history of developing late-stage product candidates. There is a limited amount of information about us upon which to evaluate our product candidates and business prospects, making an investment in our common stock unsuitable for many investors.

We have historically been a clinical-stage company focused on the development of restorative cell therapies (RCTs). We use the term RCT to refer to a new class of products we are developing that are designed to offer patients rapid-onset pain relief and restored function through the repair of damaged or worn tissue. We were formed in 2000 and have a limited operating history. Since inception we have devoted substantially all of our resources to the development of our cell therapy technology platform, the clinical and preclinical advancement of our product candidates, the creation, licensing and protection of related intellectual property rights and the provision of general and administrative support for these operations. We have not yet obtained regulatory approval for any product candidates in any jurisdiction or generated any significant revenues from product sales. We have discontinued our development of NeoCart and we are currently evaluating strategic alternatives, as described elsewhere in these Risk Factors.

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We have incurred significant losses since our inception and anticipate that we will continue to incur substantial losses for the next several years.

We have incurred net losses in each year since our inception, including net losses of $8.6 million in 2018 and $26.4 million in 2017. As of December 31, 2018 we had an accumulated deficit of $216.8 million. We anticipate that our existing cash, cash equivalents and marketable securities will be sufficient to fund our operations into the the middle of 2019. Accordingly, these factors, among others, raise substantial doubt about our ability to continue as a going concern. The amount of our future net losses will depend, in part, on the amount and timing of our expenses. These net losses have had, and will continue to have, an adverse effect on our stockholders’ equity and working capital.

Our inability to utilize our net operating loss carryforwards before they expire may adversely affect our results of operations and financial condition.

As of December 31, 2018 we had federal and state net operating loss carryforwards of approximately $67 million and $67 million, respectively, which may be utilized against future federal and state income taxes. In general, a corporation that undergoes an “ownership change” is subject to limitations on its ability to utilize its pre-change net operating loss carryforwards (NOLs) to offset future taxable income. In general, an ownership change occurs if the aggregate stock ownership of certain stockholders, generally stockholders beneficially owning five percent or more of our common stock, applying certain look-through and aggregation rules, increases by more than 50% over such stockholders’ lowest percentage ownership during the testing period, generally three years. Purchases of our common stock in amounts greater than specified levels, which will be beyond our control, could create a limitation on our ability to utilize our NOLs for tax purposes in the future. In addition, the closing of a strategic transaction may result in the limitation of our NOLs, which may affect the value we receive in such a strategic transaction. Limitations imposed on our ability to utilize NOLs could cause us to pay U.S. federal and state income taxes earlier than we would otherwise be required if such limitations were not in effect and could cause such NOLs to expire unused. Furthermore, we may not be able to generate sufficient taxable income to utilize our NOLs before they expire beginning in 2037. In addition, at the state level there may be periods during which the use of NOLs is suspended or otherwise limited, which would accelerate or may permanently increase state taxes owed. If any of these events occur, we may not derive some or all of the expected benefits from our NOLs, and our results of operations and financial condition may be adversely affected as a result.

We may fail to comply with any of our obligations under existing agreements pursuant to which we license rights or technology, which could result in the loss of rights or technology that are material to our business and as a result possibly material to a potential strategic partner.

We are a party to several technology licenses that are important to our business including material licenses from Purpose Co., Ltd., Angiotech Pharmaceuticals (US), Inc. and Angiodevice International GmbH. The rights licensed under these agreements, including rights relating to our tissue processor and bioadhesives are material to our cell therapy technology platform and the continued development of NeoCart and any future product candidates a strategic partner may choose to develop. These licenses impose various commercial, contingent payment, royalty, insurance, indemnification and other obligations on us. If we fail to comply with these obligations, the licensor may have the right to terminate the license, in which event we would lose valuable rights under our license agreements and the ability to develop or commercialize product candidates. Any termination or reversion of our rights to under the foregoing agreements may have a material adverse effect on our business, prospects and results of operations and could significantly impair our ability to successfully complete a potential strategic transaction on terms that are favorable to our stockholders, or at all.

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We may face product liability claims and, if successful claims are brought against us, we may incur substantial liability and costs. If the use of our product candidates harms patients, or is perceived to harm patients even when such harm is unrelated to our product candidates, our regulatory approvals could be revoked or otherwise negatively impacted and we could be subject to costly and damaging product liability claims.

The use of NeoCart in clinical trials exposes us to the risk of product liability claims. Product liability claims might be brought against us by participants in clinical trials, consumers, healthcare providers, pharmaceutical companies or others selling or otherwise coming into contact with our product candidates and any products for which we obtain marketing approval. There is a risk that NeoCart could result in future adverse events in patients who were previously treated, and that such adverse events may not be detected for a long period of time. Such events could subject us to costly litigation, and if we cannot successfully defend against product liability claims require us to pay substantial amounts of money to injured patients. In addition, regardless of merit or eventual outcome, product liability claims may result in:

 

increased costs due to related litigation;

 

distraction of management’s attention from our primary business;

 

substantial monetary awards to patients or other claimants; and

 

potential impairment of our ability to successfully complete a potential strategic transaction.

We carry product liability insurance that we believe is sufficient in light of our historical clinical programs; however, we may not be able to maintain insurance coverage at a reasonable cost or in sufficient amounts to protect us against losses due to liability. On occasion, large judgments have been awarded in class action lawsuits based on cell or tissue therapies or medical treatments that had unanticipated adverse effects. In addition, under some of our agreements with clinical trial sites, we were required to indemnify the sites and their personnel against product liability and other claims. A successful product liability claim or series of claims brought against us or any third parties whom we are required to indemnify could cause our stock price to decline further and, if judgments exceed our insurance coverage, could adversely affect our results of operations and business.

We do not carry insurance for all categories of risk that our business may encounter and we may not be able to receive or maintain insurance with adequate levels of coverage. Any significant uninsured liability may require us to pay substantial amounts, which would adversely affect our financial position and results of operations and could significantly impair our ability to successfully complete a potential strategic transaction on terms that are favorable to our stockholders, or at all.

Changes in government funding for the FDA and other government agencies could hinder their ability to hire and retain key leadership and other personnel, properly administer drug innovation, or prevent new products and services from being developed or commercialized by our life science tenants, which could negatively impact our business.

The ability of the FDA to review and approve new products can be affected by a variety of factors, including budget and funding levels, government closures or shutdowns, the ability to hire and retain key personnel, and statutory, regulatory, and policy changes. Average review times at the agency have fluctuated in recent years as a result. In addition, government funding of other government agencies that fund research and development activities is subject to the political process, which is inherently fluid and unpredictable. Budgetary pressures and or the closure of the federal government may result in a reduced ability by the FDA to perform its role. Specifically, over the last several years, the U.S. government has shut down several times and certain regulatory agencies, such as the FDA, have had to furlough critical employees. If a prolonged government shutdown occurs, it could delay the ability of a prospective strategic partner to discuss any potential regulatory path forward for NeoCart and as a result delay a potential strategic transaction.

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Legislative or regulatory healthcare reforms in the United States and abroad may make it more difficult and costly for a future partner to obtain regulatory approval of NeoCart and to produce, market and distribute NeoCart if an approval is obtained.

From time to time, legislation is drafted and introduced in Congress that could significantly change the statutory provisions governing the regulatory approval, manufacture and marketing of regulated products or the reimbursement thereof. In addition, FDA regulations and guidance are often revised or reinterpreted by the FDA in ways that may significantly affect NeoCart or any other products that a strategic partner may choose to develop. Any new regulations or revisions or reinterpretations of existing regulations may impose additional costs or lengthen review times of NeoCart or any future product candidates. Recent presidential and congressional elections in the U.S. could result in significant changes in, and uncertainty with respect to, legislation, regulation and government policy that could significantly impact our business and the health care industry. We cannot determine what effect changes in regulations, statutes, legal interpretation or policies, when and if promulgated, enacted or adopted may have on our business in the future. Such changes could, among other things, require:

 

changes to manufacturing methods;

 

additional studies, including clinical studies;

 

recall, replacement, or discontinuance of NeoCart;

 

the payment of additional taxes; or

 

additional record keeping.

Each of these requirements would likely entail substantial time and cost and could adversely harm the future prospects for our business and our financial results which could impair our ability to successfully complete a potential strategic transaction on terms that are favorable to our stockholders, or at all.

We have identified material weaknesses in our internal controls over financial reporting and may identify additional material weaknesses in the future that may cause us to fail to meet our reporting obligations or result in material misstatements of our financial statements.

Our management team is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements in accordance with U.S. generally accepted accounting principles. A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting such that there is a reasonable possibility that a material misstatement of annual or interim financial statements will not be prevented or detected on a timely basis.

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We have identified a material weakness in our internal controls relating to the accounting for transactions that are either highly complex and/or unusual in nature. In such instances, we seek to augment our internal accounting capabilities by obtaining assistance from third-parties who have greater expertise in such areas. Examples of situations such as these include (but are not limited to) the determination of the initial and periodic fair value of warrants that are liability classified and the accounting treatment for the termination of the Company’s collaboration agreement with Intrexon Corporation (“Intrexon”). For example, during the third quarter of 2018, we identified a material weakness in our internal controls relating to the valuation of the warrant liability. Because the valuation of the warrants is exceedingly complex and requires highly specialized skills to perform and review, we use the assistance of a third-party service provider to perform such valuation. In the third quarter of 2018, the third-party service provider made an error in the valuation that was not detected by management in its review process but was identified by our independent registered public accounting firm. In the fourth quarter of 2018, we identified a material weakness in our internal controls related to the accounting treatment for the contingent liability associated with the termination agreement entered into with Intrexon which terminated the Company’s collaboration agreement with Intrexon. In this instance, we concluded after numerous discussions with our independent registered public accounting firm that we had incorrectly accounted for the contingent liability. In both cases these items were discovered prior to the issuance of the financial statements. The identified material weakness did not result in a misstatement to our consolidated financial statements or disclosures; however, it could result in misstatements of certain account balances (such as warrant liability, change in fair value of warrant liability and accrued expenses due to Intrexon) or disclosures that would result in a material misstatement to the annual or interim consolidated financial statements that would not be prevented or detected. We have implemented additional review procedures, including engaging a second third-party service provider to assist in our review of the work of the third-party service provider preparing the warrant valuation analysis and will seek to implement a similar procedure for other unusual or complex transactions going forward.

We cannot assure you that we will not have additional material weaknesses or significant deficiencies in our internal control over financial reporting. If we identify any other material weaknesses or significant deficiencies that may exist, the accuracy and timing of our financial reporting may be adversely affected, we may be unable to maintain compliance with securities law requirements regarding timely filing of periodic reports in addition to applicable stock exchange listing requirements. These could result in a material decline in our stock price and could significantly impair our ability to successfully complete a potential strategic transaction on terms that are favorable to our stockholders, or at all.

Our internal computer systems, or those of our development partners, third-party clinical research organizations or other contractors or consultants, may fail or suffer security breaches, which could result in a material disruption of our product development programs.

Despite the implementation of security measures, our internal computer systems and those of our development partners, third-party clinical research organizations, data management organizations and other contractors and consultants are vulnerable to damage from computer viruses, unauthorized access, natural disasters, terrorism, war and telecommunication and electrical failures. While we have not experienced any such system failure, accident or security breach to date, if such an event were to occur and cause interruptions in our operations, it could result in a material disruption of our programs. For example, the loss of any NeoCart clinical trial data could result in delays in our regulatory approval efforts and significantly increase our costs to recover or reproduce the data. To the extent that any disruption or security breach results in a loss of or damage to our data or applications or other data or applications relating to our technology or product candidates, or inappropriate disclosure of confidential or proprietary information, we could incur liabilities and the further development NeoCart or any future product candidates could be delayed.

We rely on email and other messaging services in connection with our operations. We may be targeted by parties using fraudulent spoofing and phishing emails to misappropriate passwords, payment information or other personal information or to introduce viruses through Trojan horse programs or otherwise through our networks, computers, smartphones, tablets or other devices. Despite our efforts to mitigate the effectiveness of such malicious email campaigns through a variety of control and non-electronic checks, spoofing and phishing may damage our business and increase our costs. We do not currently maintain a cyber insurance policy. Any of these events or circumstances could materially adversely affect our business, financial condition and operating results and could significantly impair our ability to successfully complete a potential strategic transaction on terms that are favorable to our stockholders, or at all.

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We use hazardous chemicals and biological materials in our business. Any claims relating to improper handling, storage or disposal of these materials could be time consuming and costly. We may incur significant costs complying with environmental laws and regulations.

Our research and development and manufacturing processes involve the controlled use of hazardous materials, including chemicals and biological materials. Our operations produce hazardous waste products. We cannot eliminate the risk of accidental contamination or discharge and any resultant injury from these materials. We may be sued for any injury or contamination that results from our use or the use by third parties of these materials, and our liability may exceed our insurance coverage and our total assets. Federal, state and local laws and regulations govern the use, manufacture, storage, handling and disposal of these hazardous materials and specified waste products, as well as the discharge of pollutants into the environment and human health and safety matters.

Compliance with environmental laws and regulations may be expensive and may impair our research, development and production efforts. If we fail to comply with these requirements, we could incur substantial costs, including civil or criminal fines and penalties, clean-up costs or capital expenditures for control equipment or operational changes necessary to achieve and maintain compliance. In addition, we cannot predict the impact on our business of new or amended environmental laws or regulations or any changes in the way existing and future laws and regulations are interpreted and enforced.

Our employees or consultants may engage in misconduct or other improper activities, including noncompliance with regulatory standards and requirements and insider trading.

We are exposed to the risk of employee and consultant fraud or other misconduct. Misconduct by employees or consultants could include intentional failures to comply with the regulations of the FDA or foreign regulators, failure to provide accurate information to regulatory authorities, failure to comply with manufacturing standards we have established, failure to comply with federal and state health care fraud and abuse laws and regulations in the United States and abroad, failure to report financial information or data accurately, and failure to comply with our own internal company policies. In particular, sales, marketing and business arrangements in the healthcare industry are subject to extensive laws and regulations intended to prevent fraud, misconduct, kickbacks, self-dealing and other abusive practices. These laws and regulations may restrict or prohibit a wide range of pricing, discounting, marketing and promotion, sales commission, customer incentive programs and other business arrangements. Employee or consultant misconduct could also involve the improper use of information obtained in the course of clinical trials, which could result in regulatory sanctions and cause harm to our reputation. We have adopted a code of business conduct and ethics, but it is not always possible to identify and deter employee misconduct, and the precautions we take to detect and prevent this activity may not be effective in controlling unknown or unmanaged risks or losses or in protecting us from governmental investigations or other actions or lawsuits stemming from a failure to comply with these laws or regulations. If any such actions are instituted against us, and we are not successful in defending ourselves or asserting our rights, those actions could have a significant impact on our business, including the imposition of significant fines or other sanctions.

In addition, during the course of our operations our directors, executives, employees and consultants may have access to material, nonpublic information regarding our business, our results of operations or potential transactions we are considering. We may not be able to prevent a director, executive, employee or consultant from trading in our common stock on the basis of, or while having access to, material, nonpublic information. If a director, executive, employee or consultant was to be investigated or an action was to be brought against a director, executive, employee or consultant for insider trading, it could have a negative impact on our reputation and our stock price. Such a claim, with or without merit, could also result in substantial expenditures of time and money and divert attention of our management team from other tasks important to the success of our business.

Costs associated with being a public reporting company are significant, and public reporting requirements divert significant company resources and management attention.

We are subject to the reporting requirements of the Exchange Act and the other rules and regulations of the SEC. Compliance with the various reporting and other requirements applicable to public reporting companies requires considerable time, attention of management and financial resources and we will need to maintain such compliance in order to complete certain of the strategic alternatives currently under evaluation by our Board.

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Further, the listing requirements of Nasdaq require that we satisfy certain corporate governance requirements relating to director independence, distributing annual and interim reports, stockholder meetings, approvals and voting, soliciting proxies, conflicts of interest and a code of conduct. Our management and other personnel will need to devote a substantial amount of time to ensure that we comply with all of these requirements. Moreover, the reporting requirements, rules and regulations will increase our legal and financial compliance costs and will make some activities more time-consuming and costly. These reporting requirements, rules and regulations, coupled with the increase in potential litigation exposure associated with being a public company, could also make it more difficult for us to obtain certain types of insurance, including directors’ and officers’ insurance, on acceptable terms.

Our business is subject to the risks of earthquakes, fire, power outages, floods and other catastrophic events, and to interruption by manmade problems such as terrorism. If any of our manufacturing, processing or storage facilities are damaged or destroyed, our business and prospects would be adversely affected.

A significant natural disaster, such as an earthquake, fire or flood, or a significant power outage, could have a material adverse impact on our business, operating results and financial condition. If any of our manufacturing, processing or storage facilities, or any of the equipment in such facilities were to be damaged or destroyed, it may result a lack of any definitive offer to consummate a strategic transaction, or, if we receive such a definitive offer, the terms may not be as favorable as anticipated or may not result in the consummation of a transaction.

We have historically produced materials for our clinical trials at our manufacturing facilities located in Waltham, Massachusetts, and produced our critical raw materials for use in NeoCart production in our facilities located in Lexington, Massachusetts. If these facilities or the equipment in them are significantly damaged or destroyed, a strategic partner may not be able to quickly or inexpensively replace such manufacturing capacity. In addition, natural disasters could affect our third-party service providers’ and manufacturers ability to perform services and provide materials for us or a strategic partner on a timely basis. If these third parties do not successfully carry out their contractual duties or meet expected deadlines, our efforts to complete a strategic transaction may be impeded. For example, acts of terrorism could cause disruptions in our business or the business of our third-party service providers, partners, customers or the economy as a whole which could significantly impair our ability to successfully complete a potential strategic transaction on terms that are favorable to our stockholders, or at all.

We are increasingly dependent on information technology systems, infrastructure and data.

We are increasingly dependent upon information technology systems, infrastructure and data. Our computer systems may be vulnerable to service interruption or destruction, malicious intrusion and random attack. Security breaches pose a risk that sensitive data, including intellectual property, clinical data, trade secrets or personal information may be exposed to unauthorized persons or to the public. Cyber-attacks are increasing in their frequency, sophistication and intensity, and have become increasingly difficult to detect. Cyber-attacks could include the deployment of harmful malware, denial-of service, social engineering and other means to affect service reliability and threaten data confidentiality, integrity and availability. Our key business partners face similar risks, and a security breach of their systems could adversely affect our security posture. While we continue to invest data protection and information technology, there can be no assurance that our efforts will prevent service interruptions, or identify breaches in our systems, that could adversely affect our business and operations and/or result in the loss of critical or sensitive information or the illegal transfer of funds to unknown persons, which could result in financial, legal, business or reputational harm. Any of these issues could significantly impair our ability to successfully complete a potential strategic transaction on terms that are favorable to our stockholders, or at all.

Risks Related to Regulatory Approval

We are subject to numerous U.S. federal and state laws pertaining to health care fraud and abuse, including anti-kickback, self-referral, false claims and fraud laws, and any violation by us of such laws could result in fines or other penalties.

The Foreign Corrupt Practices Act and similar worldwide anti-bribery laws generally prohibit companies and their intermediaries from making improper payments to non-U.S. officials for the purpose of obtaining or retaining business. We cannot assure you that our internal control policies and procedures will protect us from reckless or negligent acts committed by our employees, future distributors, partners, collaborators or agents. Violations of these

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laws, or allegations of such violations, could result in fines, penalties or prosecution and have a negative impact on our business, results of operations and reputation.

Risks Related to Our Intellectual Property

Our ability to execute a strategic transaction may depend on our ability to protect our intellectual property and our proprietary technologies.

Our ability to execute a strategic transaction may depend in part on our ability to maintain patent protection and trade secret protection for our product candidates, proprietary technologies and their uses as well as our ability to operate without infringing upon the proprietary rights of others. There can be no assurance that our patent applications or those of our licensors will result in additional patents being issued or that issued patents will afford sufficient protection against competitors with similar technology, nor can there be any assurance that the patents issued will not be infringed, designed around, or invalidated by third parties. Even issued patents may later be found unenforceable or may be modified or revoked in proceedings instituted by third parties before various patent offices or in courts. The degree of future protection for our proprietary rights is uncertain. Only limited protection may be available and may not adequately protect our rights or permit us to gain or keep any competitive advantage. This failure to properly protect the intellectual property rights relating to these product candidates could have a material adverse effect on our financial condition and results of operations and ability to consummate a transaction.

Composition-of-matter patents are generally considered to be the strongest form of intellectual property protection as such patents provide protection without regard to any method of use. We cannot be certain that the claims in our patent applications covering composition-of-matter of our product candidates will be considered patentable by the U.S. Patent and Trademark Office and courts in the United States or by the patent offices and courts in foreign countries, nor can we be certain that the claims in our issued composition-of-matter patents will not be found invalid or unenforceable if challenged. Method-of-use patents protect the use of a product for the specified method. This type of patent does not prevent a competitor from making and marketing a product that is identical to our product for a use that is outside the scope of the patented method. Moreover, even if competitors do not actively promote their product for our targeted indications, physicians may prescribe these products “off-label.” Although off-label prescriptions may infringe or contribute to the infringement of method-of-use patents, the practice is common and such infringement is difficult to prevent or prosecute.

The patent application process is subject to numerous risks and uncertainties, and there can be no assurance that we or any of our future development partners will be successful in protecting our product candidates by obtaining and defending patents. These risks and uncertainties include the following:

 

The U.S. Patent and Trademark Office and various foreign governmental patent agencies require compliance with a number of procedural, documentary, fee payment and other provisions during the patent process. There are situations in which noncompliance can result in abandonment or lapse of a patent or patent application, resulting in partial or complete loss of patent rights in the relevant jurisdiction. In such an event, competitors might be able to enter the market earlier than would otherwise have been the case.

 

Patent applications may not result in any patents being issued.

 

Patents that may be issued or in-licensed may be challenged, invalidated, modified, revoked, circumvented, found to be unenforceable, or otherwise may not provide any competitive advantage.

 

Our competitors, many of whom have substantially greater resources than we do and many of whom have made significant investments in competing technologies, may seek or may have already obtained patents that will limit, interfere with, or eliminate our ability to make, use and sell our potential product candidates.

 

There may be significant pressure on the U.S. government and international governmental bodies to limit the scope of patent protection both inside and outside the United States for treatments that prove successful, as a matter of public policy regarding worldwide health concerns.

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Countries other than the United States may have patent laws less favorable to patentees than those upheld by U.S. courts, allowing foreign competitors a better opportunity to create, develop, and market competing product candidates.

In addition, we rely on the protection of our trade secrets and proprietary know-how. Although we have taken steps to protect our trade secrets and unpatented know-how, including entering into confidentiality agreements with third parties, and confidential information and inventions agreements with employees, consultants and advisors, third parties may still obtain this information or may come upon this or similar information independently. If any of these events occurs or if we otherwise lose protection for our trade secrets or proprietary know-how, the value of this information may be greatly reduced.

If we or any of our future development or collaborative partners are sued for infringing intellectual property rights of third parties, it will be costly and time consuming, and an unfavorable outcome in that litigation could have a material adverse effect on our business.

Our success also depends on our ability and the ability of our current or future development or collaborative partners to develop, manufacture, market and sell our product candidates without infringing upon the proprietary rights of third parties. Numerous U.S. and foreign-issued patents and pending patent applications owned by third parties exist in the fields in which we are developing product candidates, some of which may contain claims that overlap with the subject matter of our intellectual property or are directed at our product candidates, technologies or methods of manufacture. When we become aware of patents held by third parties that may implicate the manufacture, development or commercialization of our product candidates, we evaluate our need to license rights to such patents. If we need to license rights from third parties to manufacture, develop or commercialize our product candidates, there can be no assurance that we will be able to obtain a license on commercially reasonable terms or at all. Failure to obtain a license on commercially reasonable terms or at all could impair our ability to successfully complete a potential strategic transaction on terms that are favorable to our stockholders, or at all.

Because patent applications can take many years to issue there may be currently pending applications, unknown to us, that may later result in issued patents upon which our product candidates or proprietary technologies may infringe. Similarly, there may be issued patents relevant to our product candidates of which we are not aware.

There is a substantial amount of litigation involving patent and other intellectual property rights in the biologics industry generally. If a third-party claims that we or any of our licensors, suppliers or development partners infringe upon a third-party’s intellectual property rights, we may have to:

 

seek to obtain licenses that may not be available on commercially reasonable terms, if at all;

 

abandon an infringing product candidate or redesign our products or processes to avoid infringement;

 

pay substantial damages including, in an exceptional case, treble damages and attorneys’ fees, which we may have to pay if a court decides that the product candidate or proprietary technology at issue infringes upon or violates the third-party’s rights;

 

pay substantial royalties or fees or grant cross-licenses to our technology; or

 

defend litigation or administrative proceedings that may be costly whether we win or lose, and which could result in a substantial diversion of our financial and management resources.

We may be involved in lawsuits to protect or enforce our patents or the patents of our licensors, which could be expensive, time consuming and unsuccessful.

Third parties may infringe upon our patents or the patents of our licensors. To counter infringement or unauthorized use, we may be required to file infringement claims, which can be expensive and time consuming. An adverse result in any litigation or defense proceedings could put one or more of our patents at risk of being invalidated, found to be unenforceable or interpreted narrowly and could put our patent applications at risk of not issuing. Furthermore, because of the substantial amount of discovery required in connection with intellectual property litigation, there is a risk that some of our confidential information could be compromised by disclosure during this type of litigation.

Most of our competitors are larger than we are and have substantially greater resources. They are, therefore, likely to be able to sustain the costs of complex patent litigation longer than we could. In addition, the uncertainties

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associated with litigation could have a material adverse effect on our ability to raise the funds necessary to continue our clinical trials, continue our internal research programs, in-license needed technology, or enter into development partnerships that would help us bring our product candidates to market.

In addition, any future patent litigation, interference or other administrative proceedings will result in additional expense and distraction of our personnel. An adverse outcome in such litigation or proceedings may expose us, or any of our future development partners to loss of our proprietary position, expose us to significant liabilities or require us to seek licenses that may not be available on commercially acceptable terms, if at all. Failure to obtain a license on commercially reasonable terms or at all could impair our ability to successfully complete a potential strategic transaction on terms that are favorable to our stockholders, or at all.

Our issued patents could be found invalid or unenforceable if challenged in court which could have a material adverse effect on our business could impair our ability to successfully complete a potential strategic transaction.

If we or any of our future development partners were to initiate legal proceedings against a third party to enforce a patent covering one of our product candidates or one of our future product candidates, technologies or methods of manufacture, the defendant could counterclaim that our patent is invalid or unenforceable. In patent litigation in the United States, defendant counterclaims alleging invalidity or unenforceability are commonplace. Grounds for a validity challenge could be an alleged failure to meet any of several statutory requirements, including lack of novelty, obviousness or non- enablement. Grounds for an unenforceability assertion could be an allegation that someone connected with prosecution of the patent withheld relevant information from the U.S. Patent and Trademark Office, or made a misleading statement, during prosecution. Third parties may also raise similar claims before the U.S. Patent and Trademark Office even outside the context of litigation. The outcome following legal assertions of invalidity and unenforceability is unpredictable. With respect to the validity question, for example, we cannot be certain that there is no invalidating prior art, of which we and the patent examiner were unaware during prosecution. If a defendant were to prevail on a legal assertion of invalidity or unenforceability, we would lose at least part, and perhaps all, of the patent protection on such product candidate. Such a loss of patent protection would have a material adverse impact on our business and could impair our ability to successfully complete a potential strategic transaction on terms that are favorable to our stockholders, or at all.

We may be subject to claims that our consultants or independent contractors have wrongfully used or disclosed alleged trade secrets of their other clients or former employers to us, which could subject us to costly litigation.

As is common in the biotechnology industry, we engage the services of consultants to assist us in the development of our product candidates. Many of these consultants were previously employed at, or may have previously or may be currently providing consulting services to, other biotechnology or pharmaceutical companies, including our competitors or potential competitors. We may become subject to claims that our company or a consultant inadvertently or otherwise used or disclosed trade secrets or other information proprietary to their former employers or their former or current clients. Litigation may be necessary to defend against these claims. Even if we are successful in defending against these claims, litigation could result in substantial costs and be a distraction to our management team and could impair our ability to successfully complete a potential strategic transaction on terms that are favorable to our stockholders, or at all.

Changes in U.S. patent law could diminish the value of patents in general, which could materially impair our ability to protect our product candidates.

As is the case with other biotechnology companies, our success is heavily dependent on intellectual property, particularly patents. Obtaining and enforcing patents in the biotechnology industry involve technological and legal complexity. Therefore, obtaining and enforcing biotechnology patents is costly, time consuming and inherently uncertain. In addition, Congress recently passed patent reform legislation. The Supreme Court has ruled on several patent cases in recent years, either narrowing the scope of patent protection available in certain circumstances or weakening the rights of patent owners in certain situations. In addition to increasing uncertainty with regard to our ability to obtain patents in the future, this combination of events has created uncertainty with respect to the value of patents, once obtained. Depending on decisions by the U.S. Congress, the federal courts and the U.S. Patent and Trademark Office, the laws and regulations governing patents could change in unpredictable ways that would weaken our ability to obtain new patents or to enforce our existing patents and patents we might obtain in the future.

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We may not be able to protect our intellectual property rights throughout the world which could materially, negatively affect our business.

Filing, prosecuting and defending patents on product candidates in all countries throughout the world would be prohibitively expensive, and our intellectual property rights in some countries outside the United States can be less extensive than those in the United States. In addition, the laws of some foreign countries do not protect intellectual property rights to the same extent as federal and state laws in the United States. Consequently, we may not be able to prevent third parties from practicing our inventions in all countries outside the United States, or from selling or importing products made using our inventions in and into the United States or other jurisdictions. Competitors may use our technologies in jurisdictions where we have not obtained patent protection to develop their own products and further, may export otherwise infringing products to territories where we have patent protection, but enforcement is not as strong as that in the United States. These products may compete with our product candidates and our patents or other intellectual property rights may not be effective or sufficient to prevent them from competing.

Many companies have encountered significant problems in protecting and defending intellectual property rights in foreign jurisdictions. The legal systems of certain countries, particularly certain developing countries, do not favor the enforcement of patents and other intellectual property protection, particularly those relating to biotechnology, which could make it difficult for us to stop the infringement of our patents or marketing of competing products in violation of our proprietary rights generally. Proceedings to enforce our patent rights in foreign jurisdictions could result in substantial costs and divert our efforts and attention from other aspects of our business, could put our patents at risk of being invalidated or interpreted narrowly and our patent applications at risk of not issuing and could provoke third parties to assert claims against us. We may not prevail in any lawsuits that we initiate and the damages or other remedies awarded, if any, may not be commercially meaningful. Accordingly, our efforts to enforce our intellectual property rights around the world may be inadequate to obtain a significant commercial advantage from the intellectual property that we develop or license and may adversely affect our business and could significantly impair our ability to successfully complete a potential strategic transaction on terms that are favorable to our stockholders, or at all.

If our trademarks and trade names are not adequately protected, then we may not be able to build name recognition in our markets of interest and our business may be adversely affected.

Our registered or unregistered trademarks or trade names may be challenged, infringed, circumvented or declared generic or determined to be infringing on other marks. We may not be able to protect our rights to these trademarks and trade names, which we need to build name recognition by potential partners or customers in our markets of interest. Over the long term, if we are unable to establish name recognition based on our trademarks and trade names, then we may not be able to compete effectively and our business may be adversely affected.

Risks Related to Our Common Stock

We received deficiency letters in October 2018 and December 2018 from the Nasdaq Listing Qualifications Department (the Staff) of the Nasdaq Stock Market LLC (Nasdaq) notifying the Company that it was not in compliance with Nasdaq Listing Rule 5550(a)(2) and Nasdaq Listing Rule 5550(b)(2). If we were to fail to regain compliance, our shares could be delisted from the Nasdaq Capital Market, which could materially reduce the liquidity of our common stock and have an adverse effect on our market price. A delisting could limit our strategic alternatives and ability to consummate a potential transaction.

On October 17, 2018, we received a deficiency letter from the Staff notifying us that, for the 30 consecutive business days prior to October 17, 2018, the closing bid price for our common stock had closed below a minimum $1.00 per share required for continued listing on The Nasdaq Capital Market pursuant to Nasdaq Listing Rule 5550(a)(2) (Rule 5550(a)(2)). The Nasdaq deficiency letter has no immediate effect on the listing of our common stock, and our common stock will continue to trade on The Nasdaq Capital Market under the symbol “HSGX” at this time.

In accordance with Nasdaq Listing Rule 5810(c)(3)(A), we have been given 180 calendar days, or until April 15, 2019 to regain compliance with Rule 5550(a)(2). If we choose to implement a reverse stock split, we must complete the split no later than ten business days prior to April 15, 2019 to regain compliance. If at any time before April 15, 2019, the bid price of our common stock closes at $1.00 per share or more for a minimum of 10 consecutive

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business days (an Automatic Compliance Event), the Staff will provide written confirmation that we have achieved compliance with Rule 5550(a)(2).

If we do not regain compliance with Rule 5550(a)(2) by April 15, 2019, we may be afforded a second 180 calendar day period to regain compliance. To qualify, we would be required to meet the continued listing requirement for market value of publicly held shares and all other initial listing standards for The Nasdaq Capital Market, except for the minimum bid price requirement. In addition, we would be required to notify Nasdaq of our intent to cure the deficiency during the second compliance period, which may include, if necessary, implementing a reverse stock split.

If we do not regain compliance with Rule 5550(a)(2) by April 15, 2019, and we are not eligible for an additional compliance period at that time, the Staff will provide notice to us that our securities will be subject to delisting. At that time, we may appeal the Staff’s delisting determination to a Nasdaq Listing Qualifications Panel (Panel). We would remain listed pending the Panel’s decision.

Further, on December 19, 2018, we received a deficiency letter from the Staff notifying us that for the last 30 consecutive business days prior to December 18, 2018, the market value of our listed securities were less than $35 million, which does not meet the requirement for continued listing on The Nasdaq Capital Market under Nasdaq Listing Rule 5550(b)(2) (Rule 5550(b)(2)). In accordance with Nasdaq Listing Rule 5810(c)(3)(C), Nasdaq has provided us with 180 calendar days, or until June 17, 2019, to regain compliance with Rule 5550(b)(2). If we regain compliance with Rule 5550(b)(2), Nasdaq will provide written confirmation to us and close the matter. If we do not regain compliance with this requirement by June 17, 2019, we will receive written notification from the Staff that our securities are subject to delisting. At that time, we may appeal the delisting determination to a Hearing Panel.

The December 2018 deficiency letter did not result in the delisting of our common stock from The Nasdaq Capital Market. To regain compliance with Rule 5550(b)(2), the market value of our listed securities must meet or exceed $35 million for a minimum of ten consecutive business days during the 180-day grace period ending on or before June 17, 2019 (Nasdaq has the discretion to monitor compliance for as long as 20 consecutive business days before deeming us in compliance). We could also regain compliance with Nasdaq’s alternative continued listing requirements by having stockholders’ equity of $2.5 million or more, or net income from continuing operations of $500,000 in the most recently completed fiscal year.

A delisting would also likely make it more difficult for us to obtain financing through the sale of our equity. Any such sale of equity would likely be more dilutive to our current stockholders than would be the case if our shares were listed.

We may not satisfy The Nasdaq Capital Market’s other requirements for continued listing. If we cannot satisfy these requirements, Nasdaq could delist our common stock and could limit our strategic alternatives and ability to consummate a potential transaction.

Our common stock is listed on The Nasdaq Capital Market under the symbol “HSGX”. To continue to be listed on Nasdaq, we are required to satisfy a number of conditions. Other than the deficiency letter discussed in the immediately prior risk factor, we previously received two letters from Nasdaq, with the first letter in November 2016 notifying us of our failure to maintain a minimum market value of listed securities of $50,000,000 for the 30 consecutive business days. We subsequently regained compliance with this listing standard in March 2017. The second letter in May 2017 notified us of our failure to maintain a minimum of $10,000,000 in stockholders’ equity as required for companies trading on The Nasdaq Global Market. In response to the second letter, we transferred our securities to The Nasdaq Capital Market in June 2017 to regain compliance with the minimum stockholders’ equity requirement.

We cannot assure you that we will be able to satisfy the Nasdaq listing requirements in the future. If we are delisted from Nasdaq, trading in our shares of common stock may be conducted, if available, on the “OTC Bulletin Board Service” or, if available, via another market. In the event of such delisting, an investor would likely find it significantly more difficult to dispose of, or to obtain accurate quotations as to the value of the shares of our common stock, and our ability to raise future capital through the sale of the shares of our common stock or other securities convertible into or exercisable for our common stock could be severely limited. A determination could also then be made that our common stock is a “penny stock” which would require brokers trading in our common stock to adhere to more stringent rules and possibly result in a reduced level of trading. This could have a long-term impact on our ability to raise future capital through the sale of our common stock.

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The trading price of our common stock has been, and is likely to continue to be, volatile, and you might not be able to sell your shares at or above the price you paid.

Our stock price has been and will likely continue to be volatile for the foreseeable future. The realization of any of the risks described in these risk factors or other unforeseen risks could have a dramatic and adverse effect on the market price of our common stock. The trading price of our common stock is likely to continue to be highly volatile and could be subject to wide fluctuations in response to various factors, some of which are beyond our control. These factors include those discussed elsewhere in this “Risk Factors” section and others such as:

 

our ability to consummate a strategic transaction, the value of such transaction including whether it is deemed to enhance stockholder value or deliver expected benefits;

 

announcements about us or about our competitors including clinical trial results, regulatory approvals, or new product candidate introductions and the revenue and growth potential of such new products;

 

developments concerning our current or future development partners, licensors or product candidate manufacturers;

 

litigation and other developments relating to our patents or other proprietary rights or those of our competitors;

 

conditions in the pharmaceutical or biotechnology industries, regulations or concerns related to cell and gene therapies, and the economy as a whole;

 

governmental regulation and legislation;

 

the recruitment or departure of members of our Board, management team or other key personnel;

 

changes in our operating results;

 

any changes in the financial projections we may provide to the public, our failure to meet these projections, or changes in recommendations by any securities analysts that elect to follow our common stock;

 

any change in securities analysts’ estimates of our performance, or our failure to meet analysts’ expectations;

 

the expiration of market standoff or contractual lock-up agreements;

 

sales or potential sales of substantial amounts of our common stock; and

 

price and volume fluctuations in the overall stock market or resulting from inconsistent trading volume levels of our shares.

In recent months and years, the stock market in general, and the market for pharmaceutical and biotechnological companies in particular, has experienced extreme price and volume fluctuations that have often been unrelated or disproportionate to changes in the operating performance of the companies whose stock is experiencing those price and volume fluctuations. In addition, Brexit or actions taken by the current presidential administration and Congress could adversely affect United States, European or worldwide economic or market conditions and could contribute to instability and volatility in global financial markets. Broad market and industry factors may seriously affect the market price of our common stock, regardless of our actual operating performance.

Our quarterly operating results may fluctuate substantially, which may cause the price of our common stock to fluctuate substantially.

We expect our quarterly operating results to be subject to fluctuations. Our net income or loss and other operating results may be affected by numerous factors, including:

 

our ability to execute on a strategic transaction;

 

derivative instruments recorded at fair value, including but not limited to the change in fair value of warrants issued in connection with a private placement we completed in 2016 and warrants issued in our 2018 public offering;

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asset impairments, severance costs, lease termination costs, transaction and other costs triggered by a wind down of our operations; and  

 

any lawsuits in which we may become involved.

If our quarterly operating results fall below the expectations of investors or securities analysts, the price of our common stock could decline substantially. Furthermore, any quarterly fluctuations in our operating results may, in turn, cause the price of our stock to fluctuate substantially.

We expect our stock price to continue to be volatile, and securities class action litigation has often been instituted against companies following periods of volatility of their stock price or after the announcement of a change in control transaction. Any such litigation, if instituted against us, could result in substantial costs and a diversion of our management’s attention and resources.

In the past, following periods of volatility in the overall market and the market price of a particular company’s securities, securities class action litigation has often been instituted against these companies. This litigation, if instituted against us, could result in substantial costs and a diversion of our management’s attention and resources. This litigation, if instituted against us could also impair our ability to successfully complete a potential strategic transaction on terms that are favorable to our stockholders, or at all.

If securities analysts do not publish research, publish unfavorable research about our business or cease coverage of our company, our stock price and trading volume could decline.

The trading market for our common stock will depend in part on the research and reports that securities and industry analysts publish about us or our business. In the event one or more of the analysts who covers us downgrades our stock or publishes unfavorable research about our business, or if our clinical trials or operating results fail to meet the analysts’ expectations, our stock price would likely decline. Recently, several securities analysts ceased coverage of our company, and if one or more of the remaining analysts ceases coverage of our company or fails to publish reports on us regularly, demand for our stock could decrease, which could cause our stock price and trading volume to decline.

Raising additional funds by issuing securities or through licensing or lending arrangements may cause dilution to our existing stockholders, restrict our operations or require us to relinquish proprietary rights.

To the extent that we raise additional capital by issuing equity securities, the share ownership of existing stockholders will be diluted. Any future debt financing may involve covenants that restrict our operations, including limitations on our ability to incur liens or additional debt, pay dividends, redeem our stock, make certain investments, and engage in certain merger, consolidation, or asset sale transactions. In addition, if we seek funds through arrangements with collaborative partners, these arrangements may require us to relinquish rights to some of our technologies or product candidates or otherwise agree to terms unfavorable to us.

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We have never paid and do not intend to pay cash dividends and, consequently, your ability to achieve a return on your investment will depend on appreciation in the price of our common stock.

We have never paid cash dividends on any of our capital stock, and we currently intend to retain future earnings, if any, to fund the development and growth of our business. Therefore, you are not likely to receive any dividends on our common stock for the foreseeable future or at all. Since we do not intend to pay dividends, your ability to receive a return on your investment will depend on any future appreciation in the market value of our common stock. There is no guarantee that our common stock will appreciate or even maintain the price at which you have purchased it.

Provisions in our amended and restated certificate of incorporation and amended and restated bylaws and Delaware law might discourage, delay or prevent a change in control of our company or changes in our management and, therefore, depress the market price of our common stock.

Our certificate of incorporation and bylaws contain provisions that could depress the market price of our common stock by acting to discourage, delay or prevent a change in control of our company or changes in our management that the stockholders of our company may deem advantageous. These provisions among other things:

 

establish a classified board of directors so that not all members of our board are elected at one time;

 

permit the board of directors to establish the number of directors;

 

provide that directors may only be removed “for cause”;

 

require super-majority voting to amend some provisions in our certificate of incorporation and bylaws;

 

authorize the issuance of “blank check” preferred stock that our board of directors could use to implement a stockholder rights plan;

 

eliminate the ability of our stockholders to call special meetings of stockholders;

 

prohibit stockholder action by written consent, which requires all stockholder actions to be taken at a meeting of our stockholders;

 

provide that the board of directors is expressly authorized to make, alter or repeal our bylaws; and

 

establish advance notice requirements for nominations for election to our board of directors or for proposing matters that can be acted upon by stockholders at annual stockholder meetings.

In addition, Section 203 of the Delaware General Corporation Law may discourage, delay or prevent a change in control of our company. Section 203 imposes certain restrictions on merger, business combinations and other transactions between us and holders of 15% or more of our common stock.

We are an emerging growth company and the extended transition period for complying with new or revised financial accounting standards and reduced disclosure and governance requirements applicable to emerging growth companies could make our common stock less attractive to investors.

We are an emerging growth company. Under the Jumpstart Our Business Startups Act, emerging growth companies can delay adopting new or revised accounting standards until such time as those standards apply to private companies. We plan to avail ourselves of this exemption from new or revised accounting standards and, therefore, we may not be subject to the same new or revised accounting standards as other public companies that are not emerging growth companies.

For as long as we continue to be an emerging growth company, we also intend to take advantage of certain other exemptions from various reporting requirements that are applicable to other public companies, including reduced disclosure obligations regarding executive compensation in our periodic reports and proxy statements, exemptions from the requirements of holding a nonbinding advisory stockholder vote on executive compensation and any golden parachute payments not previously approved, exemption from the requirement of auditor attestation on our internal control over financial reporting and exemption from any requirement that may be adopted by the Public Company Accounting Oversight Board regarding mandatory audit firm rotation or a supplement to the auditor’s

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report providing additional information about the audit and the financial statements (auditor discussion and analysis). If we do, the information that we provide stockholders may be different than what is available with respect to other public companies.

Investors could find our common stock less attractive because we will rely on these exemptions, which may make it more difficult for investors to compare our business with other companies in our industry. If some investors find our common stock less attractive as a result, there may be a less active trading market for our common stock and our stock price may be more volatile. In addition, it may be difficult for us to raise additional capital as and when we need it. If we are unable to do so, our financial condition and results of operations could be materially and adversely affected.

We will remain an emerging growth company until the earliest of: (1) the end of the fiscal year in which the market value of our common stock that is held by non-affiliates exceeds $700.0 million as of the end of the second fiscal quarter; (2) the end of the fiscal year in which we have total annual gross revenue of $1.0 billion or more during such fiscal year; (3) the date on which we issue more than $1.0 billion in non-convertible debt in a three-year period or (4) December 31, 2019, the end of the fiscal year following the fifth anniversary of the completion of our initial public offering.

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ITEM 1B.

UNRESOLVED STAFF COMMENTS

Not applicable.

ITEM 2.

PROPERTIES

Our corporate headquarters are currently located in Waltham, Massachusetts, for which we have a lease until December 2024, renewable for one five-year term. We lease approximately 25,472 square feet of office, manufacturing and laboratory space, including 5,700 square feet of cGMP clean room space that is outfitted for NeoCart manufacturing. This facility also houses our quality staff, including quality control testing, necessary to support any NeoCart manufacturing.

Additionally, we lease approximately 16,601 square feet of laboratory and manufacturing space, along with related office space, in Lexington, Massachusetts. The term of the Lexington lease expires on October 1, 2022 and can be extended for one five-year period thereafter. This facility includes clean room space that can be utilized for production of our CT3 adhesive components, our collagen scaffold and the collagen raw material used to produce the scaffold and components of the CT3 adhesive. This facility also includes necessary space for quality operations, including necessary quality control testing.

ITEM 3.LEGAL PROCEEDINGS

From time to time, we may become subject to legal proceedings, claims and litigation arising in the ordinary course of business. We currently are not a party to any threatened or pending litigation and do not have contingency reserves established for any litigation liabilities. However, third parties might allege that we are infringing their patent rights or that we are otherwise violating their intellectual property rights, including trade names and trademarks. Such third parties may resort to litigation. We accrue contingent liabilities when it is probable that future expenditures will be made and such expenditures can be reasonably estimated.  Regardless of the outcome, litigation can have an adverse impact on us because of defense and settlement costs, diversion of management resources and other factors.

ITEM 4.

MINE SAFETY DISCLOSURES

Not applicable.

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PART II

ITEM 5.

MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED SHAREHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Our common stock has been trading on The Nasdaq Capital Market or The Nasdaq Global Market under the symbol “HSGX” since our initial public offering in December 2014. Prior to that time, there was no established public trading market for our common stock. The following table sets forth, for the periods indicated, the range of high and low sale prices of our common stock as reported by

 

Year ending December 31, 2017

 

High

 

 

Low

 

First Quarter:

 

$

2.24

 

 

$

1.45

 

Second Quarter:

 

 

1.89

 

 

 

1.59

 

Third Quarter:

 

 

2.19

 

 

 

1.60

 

Fourth Quarter:

 

 

2.37

 

 

 

1.72

 

Year ending December 31, 2018

 

High

 

 

Low

 

First Quarter:

 

$

3.04

 

 

$

2.07

 

Second Quarter:

 

 

2.97

 

 

 

2.07

 

Third Quarter:

 

 

2.92

 

 

 

0.53

 

Fourth Quarter:

 

 

1.00

 

 

 

0.09

 

 

Holders

As of March 18, 2019, there were 11 holders of record of our common stock. The number of holders of record of our common stock does not reflect the number of beneficial holders whose shares are held by depositors, brokers or other nominees.

Dividends

We have not declared or paid any cash dividends on our common stock since our inception. We do not plan to pay dividends in the foreseeable future. We currently intend to retain earnings, if any, to finance our operations. Consequently, stockholders will need to sell shares of our common stock to realize a return on their investment, if any.

Securities Authorized for Issuance under Equity Incentive Plans

Information regarding securities authorized for issuance under equity incentive plans will be contained in our Proxy Statement for the 2018 Annual Meeting of Stockholders to be filed with the SEC within 120 days after the end of the fiscal year ended December 31, 2018, under the captions “Equity Compensation Plan Information” and “Security Ownership of Certain Beneficial Owners and Management” and is incorporated herein by reference pursuant to General Instruction G(3) to Form 10-K.

ITEM 6.

SELECTED CONSOLIDATED FINANCIAL DATA

As a smaller reporting company, we are not required to provide this information.

 

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ITEM 7.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis should be read in conjunction with our audited annual consolidated financial statements and the related notes that appear elsewhere in this annual report on Form 10-K. This discussion contains forward-looking statements reflecting our current expectations that involve risks and uncertainties. Actual results may differ materially from those discussed in these forward-looking statements due to a number of factors, including those set forth in the section entitled “Risk Factors” and elsewhere in this annual report on Form 10-K. For further information regarding forward-looking statements, please refer to the “Special Note Regarding Forward-Looking Statements” at the beginning of Part I of this annual report on Form 10-K.

Overview

We historically focused on the development of restorative cell therapies (RCTs).  We use the term RCT to refer to a new class of products that are designed to offer patients rapid-onset pain relief and restored function through the repair of damaged or worn tissue. Our product, NeoCart®, is an innovative cell therapy that utilizes various aspects of our RCT platform to treat tissue injury in the field of orthopedics, specifically cartilage damage in the knee.

NeoCart is based on our RCT platform, which we believe has the potential to be used for a broad range of additional therapeutic indications and combines expertise in the following areas:

 

Cell therapy and processing: the handling of tissue biopsies and the extraction, isolation and expansion of the cells;

 

Biomaterials and Scaffold: three-dimensional biomaterials structures that enable the proper delivery, distribution and organization of cells in their natural environment to support tissue formation;

 

Tissue engineering: the use of a combination of cells, engineering and biomaterials to improve or restore biological functions; and

 

Bioadhesives: natural, biocompatible materials that act as adhesives for biological tissue and allow for natural cell and tissue infiltration and integration with native cells.

In the third quarter of 2018, we announced that our Phase 3 clinical trial of NeoCart did not meet the primary endpoint of a statistically significant improvement in pain and function in a dual threshold responder analysis one year after treatment as compared to microfracture. In the modified Intent to Treat (mITT) population (which excludes those patients who were randomized but not treated with NeoCart), 74.2% of the NeoCart patients exhibited clinically meaningful improvements in pain and function compared to 62.0% of microfracture patients at one year (p=0.071). However, in this mITT population, patients treated with NeoCart achieved a statistically significant improvement in pain and function (p=0.018) six months after treatment as compared to patients treated with microfracture. In addition, NeoCart achieved a statistically significant improvement in pain and function at one year in certain patient populations including patients with lesion sizes greater than 2.2 cm2 and those with a Body Mass Index, or BMI, of greater than 28. Both NeoCart and microfracture were well tolerated and exhibited strong safety profiles.  

Based on the totality of the data, we initiated a dialogue with the United States Food and Drug Administration (FDA) in the third quarter of 2018 to discuss the regulatory path forward for NeoCart. Our primary objective in these discussions was to determine whether the FDA would accept a submission of a Biologics License Application (BLA) for NeoCart without data from an additional clinical trial. We had a constructive dialogue with the FDA, which included requests for and review of additional statistical analyses, different subgroup analyses, and secondary endpoints. These additional analyses, while compelling, did not change the conclusion that the NeoCart Phase 3 trial failed to meet its primary and secondary endpoints. In December 2018, we received final feedback from the FDA indicating that while the NeoCart Phase 3 clinical trial resulted in certain compelling data, particularly the early response in pain and function and the data in certain lesion sizes, an additional Phase 3 clinical trial would need to be completed before the FDA would accept the submission of a BLA for NeoCart. The FDA indicated receptivity to novel clinical trial methodologies and regenerative medicine advanced therapy designations in order to support additional data for a future potential submission. However, considering the time and funding required to conduct such a trial, we discontinued the development of NeoCart and are not planning to submit a BLA.

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As a result of the FDA feedback, we initiated a process to evaluate strategic alternatives to maximize value for all of our stakeholders. The process is being conducted with the assistance of financial and legal advisors and is evaluating the full range of potential strategic alternatives, including but not limited to, acquisitions, business combinations, joint ventures, public and private capital raises and recapitalization and sale transaction options, including a sale of assets or intellectual property. Since these efforts may not be successful and given our limited cash reserves, we are also considering other possible alternatives, including a wind-down of operations, or Chapter 11 bankruptcy protection to complete or execute a restructuring transaction or liquidation. There is no guarantee that any cash (or other securities representing any value) will be returned to stockholders and there is the possibility that the Company’s common stock will be worthless in a bankruptcy, wind-down or other liquidation scenario. In January 2019 and March 2019, we implemented restructuring plans that were approved by our Board involving reductions in headcount to reduce operating costs. The positions eliminated together represented all but one employee, and included our Chief Executive Officer, Chief Operating Officer, Chief Medical Officer and Chief Business Officer. We intend to engage, Mr. Adam Gridley, our Chief Executive Officer, Mr. Stephen Kennedy, our Chief Operating Officer, along with up to four additional employees as consultants to assist with our continuing evaluation of strategic alternatives.

We have devoted substantially all of our resources to the development of our RCT platform, the preclinical and clinical advancement of our product candidates, the creation and protection of related intellectual property and the provision of general and administrative support for these operations. We have funded our operations primarily through the private placement of preferred stock and convertible promissory notes, commercial bank debt, sales of common stock and our collaboration with MEDINET.

We have never been profitable and incurred net losses in each year since inception. Our accumulated deficit was $216.8 million as of December 31, 2018. Substantially all of our net losses resulted from costs incurred in connection with our research and development programs and from general and administrative costs associated with our operations. Our net losses may fluctuate significantly from quarter to quarter and year to year.

We do not expect to generate any future revenue from product sales until we successfully complete development and obtain regulatory approval for NeoCart. If we seek and obtain regulatory approval for NeoCart, we expect to incur significant commercialization expenses related to product sales, marketing, manufacturing and distribution. Accordingly, we will seek to fund our operations through public or private equity or debt financings or other sources. However, we may be unable to raise additional funds or enter into such other arrangements when needed on favorable terms or at all. Our failure to raise capital or enter into such other arrangements when needed would have a negative impact on our financial condition.

Financial Operations Overview

We conduct operations in two geographic regions: Histogenics Corporation, a Delaware corporation, at our facilities in Waltham and Lexington, Massachusetts, and ProChon Biotech Ltd. (ProChon) in Tel Aviv, Israel. We own 100% of the voting shares of ProChon. As the nature of the products, customers and methods to distribute products are the same and the nature of the regulatory environment, the production processes and historical and estimated future margins are similar, the two operations have been aggregated into one reporting segment.

In September 2016, we completed a private placement (the Private Placement) where we issued 2,596,059 shares of our common stock at a per share price of $2.25 and 24,158.8693 shares of our newly-created Series A Convertible Preferred Stock, which shares of preferred stock are convertible into approximately 10,737,275 shares of common stock. The Series A Convertible Preferred Stock became convertible into shares of our common stock following approval of the private placement by our stockholders in the fourth quarter of 2016. As of December 31, 2018, 400.4910 shares of Series A Convertible Preferred Stock that are convertible into 177,996 shares of common stock were outstanding. The net proceeds after deduction of placement agent fees and other transaction-related expenses were $27.6 million. As part of the Private Placement, the investors received warrants to purchase up to 13,333,334 shares of our common stock at an exercise price of $2.25 per share (the 2016 Warrants). The 2016 warrants include a cashless-exercise feature that may be exercised solely in the event there is no effective registration statement registering, or no current prospectus available for, the resale of the shares of common stock underlying the warrants as of the six-month anniversary of the closing of the Private Placement. The 2016 warrants became exercisable following approval of the Private Placement by our stockholders in the fourth quarter of 2016 and expire five years after the date of such stockholder approval.

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In January 2018, we completed an underwritten registered direct offering of 2,691,494 shares of common stock at a price of $2.35 per share. The total net proceeds of the offering were $5.7 million after deducting underwriter’s discounts and commissions, and expenses related to the offering.

In March 2018, we entered into an equity distribution agreement (the Equity Distribution Agreement) with Canaccord Genuity Inc. (Canaccord), pursuant to which we may, from time to time, sell shares of our common stock (the Shares), having an aggregate offering price of up to $10 million through Canaccord, as our sales agent. The Shares will be offered and sold by us pursuant to our previously filed and currently effective Registration Statement on Form S-3 (Reg. No. 333-216741) (the Registration Statement). The Shares may only be offered and sold by means of a prospectus, including a prospectus supplement, forming part of the effective Registration Statement. Sales of the common stock, if any, will be made at market prices by methods deemed to be an “at the market offering” as defined in Rule 415 promulgated under the Securities Act of 1933, as amended (the Securities Act), including sales made directly on The Nasdaq Capital Market, on any other existing trading market for the common stock, or to or through a market maker other than on an exchange. During the year ended December 31, 2018, we sold an aggregate of 6,633,903 shares of common stock and received $4.5 million after deducting commissions.

On October 10, 2018, we closed an underwritten public offering of 26,155,000 shares of our common stock and warrants to purchase up to 19,616,250 shares of common stock (the 2018 Warrants), at a combined purchase price of $0.65 per share of common stock and accompanying warrant. The gross proceeds from this offering were $17.0 million, before deducting underwriting discounts and commissions, and offering expenses payable by us.  The 2018 Warrants were exercisable immediately upon issuance at a price of $0.70 per share of common stock and have a term of five years commencing on the date of issuance.

In the first quarter of 2019, we and certain holders of the 2016 Warrants (the Participating 2016 Holders) entered into a Warrant Amendment and Exercise Agreement (the 2016 Exercise Agreement) pursuant to which we agreed to reduce the exercise price of the 2016 Warrants held by such Participating 2016 Holders from $2.25 to $0.01 per share (the 2016 Reduced Exercise Price) in consideration for the exercise of the 2016 Warrants held by such Participating 2016 Holders in full at the 2016 Reduced Exercise Price for cash. In connection with the exercise of the 2016 Warrants by the Participating 2016 Holders, we received aggregate gross proceeds of approximately $0.1 million. After the exercise of the 2016 Warrants held by the Participating 2016 Holders, 2016 Warrants to purchase approximately 508,714 shares of the Company’s Common Stock remain outstanding.

Also in the first quarter of 2019, we reduced the exercise price of the 2018 Warrants from $0.70 to $0.01 per share (the 2018 Reduced Exercise Price) and all of the holders of the 2018 Warrants (the Participating 2018 Holders) entered into a Warrant Exercise Agreement (the 2018 Exercise Agreement) pursuant to which in consideration for the 2018 Reduced Exercise Price, the Participating 2018 Holders agreed to exercise the 2018 Warrants held by such Participating 2018 Holders in full at the 2018 Reduced Exercise Price for cash. In connection with the exercise of the 2018 Warrants by the Participating 2018 Holders, we received aggregate gross proceeds of approximately $0.2 million.

The consolidated financial statements and the following information include the accounts of Histogenics, ProChon and Histogenics Securities Corporation. All intercompany accounts and transactions have been eliminated in consolidation.

Revenue

We did not generate any revenue in 2018 or 2017 and do not expect to generate any revenue from product sales in the future unless we successfully complete the development of NeoCart and receive approval from the FDA to market NeoCart. As of December 31, 2018, we have recorded $10 million in deferred revenue relating to the upfront payment from MEDINET.  

Research and Development Expenses

Research and development expenses consist of development costs associated with our RCT platform and development programs. These costs are expensed as incurred and include:

 

compensation and employee-related costs including stock-based compensation;

 

costs incurred under clinical trial agreements with investigative sites;

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costs to acquire, develop and manufacture preclinical study and clinical trial materials;

 

costs associated with conducting our preclinical, clinical and regulatory activities, including fees paid to third-party professional consultants and service providers;

 

costs for laboratory supplies and laboratory equipment;

 

charges associated with the achievement of certain preclinical and financial milestones pursuant to our licenses for our bioadhesive, and our tissue engineering processor; and

 

facilities, depreciation and other expenses including allocated expenses for rent and maintenance of facilities.

We expect our research and development expenses to decline in the future due to our decision to suspend the development of NeoCart and the restructuring plans we implemented in January 2019 and March 2019.

We cannot determine with certainty the timing and costs of initiation, the duration and the completion of current or future preclinical studies and clinical trials of our product candidates. Clinical and preclinical development timelines, the probability of success and related development costs can differ materially from expectations. In addition, we cannot forecast when future collaboration arrangements will be secured, if at all, and to what degree such arrangements would affect our development plans and capital requirements.

We do not track research and development expenses by product. We do not allocate general equipment and supply costs, facilities, depreciation and other miscellaneous expenses to specific projects.

General and Administrative Expenses

General and administrative expenses consist primarily of salaries and employee-related costs, including stock-based compensation and travel expenses for our employees in the executive, finance, sales and marketing, and human resource functions. Other general and administrative expenses include facility-related costs, professional fees for accounting, legal services and directors, consulting expenses and expenses associated with obtaining and maintaining patents.

Total Other Income (Expense), Net

Total other income (expense), net consists primarily of changes in liabilities that are held at fair value; interest income earned on cash, cash equivalents and marketable securities; interest expense on our equipment loan that matured and was fully repaid in the second quarter of 2018; and the extinguishment of liability related to Intrexon Corporation.

Critical Accounting Policies and Significant Judgments and Estimates

Our management’s discussion and analysis of our consolidated financial condition and results of operations are based on our consolidated financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles. The preparation of these consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses and the disclosure of contingent assets and liabilities in our consolidated financial statements. On an ongoing basis, we evaluate our estimates and judgments, including those related to accrued expenses and stock-based compensation and the fair value of the warrants issued in connection with our 2016 Private Placement and 2018 underwritten public offering. We base our estimates on historical experience, known trends and events, and various other factors that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

While our significant accounting policies are described in more detail in the notes to our consolidated financial statements appearing elsewhere in this annual report on Form 10-K, we believe the following accounting policies to be most critical to the significant judgments and estimates used in the preparation of our consolidated financial statements.

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Revenue Recognition

In May 2014, the Financial Accounting Standards Board (the FASB) issued a new standard related to revenue recognition, Accounting Standards Updated (ASU) No. 2014-09, Revenue from Contracts with Customers. This new accounting standard replaced most current U.S. GAAP guidance on this topic and eliminated most industry-specific guidance. It provides a unified model to determine when and how revenue is recognized. The core principle is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration for which the entity expects to be entitled in exchange for those goods or services.  Entities may adopt the new standard either retrospectively to all periods presented in the financial statements (the full retrospective method) or as a cumulative-effect adjustment as of the date of adoption (modified retrospective method) in the year of adoption without applying to comparative years’ financial statements.  Further, in August 2015, the FASB issued ASU No. 2015-14, Revenue from Contracts with Customers: Deferral of the Effective Date, to defer the effective adoption date by one year to December 15, 2017 for annual reporting periods beginning after that date and permitted early adoption of the standard, but not before fiscal years beginning after the original effective date of December 15, 2016.  We elected to early adopt the guidance in 2017 using the modified retrospective method. 

Revenue is recognized when, or as, performance obligations are satisfied, which occurs when control of the promised products or services is transferred to customers.  Revenue is measured as the amount of consideration we expect to receive in exchange for transferring products or services to a customer (transaction price). To the extent that the transaction price includes variable consideration, we estimate the amount of variable consideration that should be included in the transaction price utilizing the most likely amount method.  Variable consideration is included in the transaction price if, in our judgment, it is probable that a significant future reversal of cumulative revenue under the contract will not occur.  Estimates of variable consideration and determination of whether to include estimated amounts in the transaction price are based largely on an assessment of our anticipated performance and all information (historical, current and forecasted) that is reasonably available.

 

If the contract contains a single performance obligation, the entire transaction price is allocated to the single performance obligation. Contracts that contain multiple performance obligations require an allocation of the transaction price to each performance obligation based on a relative standalone selling price basis unless the transaction price is variable and meets the criteria to be allocated entirely to a performance obligation or to a distinct service that forms part of a single performance obligation. Our revenues are generated primarily through collaborative research, development and commercialization agreements. The terms of these agreements may contain multiple promises which may include: (i) licenses to our technology; (ii) services related to the transfer and update of know-how; and (iii) manufacturing supply services. Payments to the us under these arrangements typically include one or more of the following: non-refundable upfront license fees; milestone payments; royalties on future product sale; and fees for manufacturing supply services. None of our contracts as of December 31, 2018 contained a significant financing component.

 

We assess the promises to determine if they are distinct performance obligations. Once the performance obligations are determined, the transaction price is allocated based on a relative standalone selling price basis. Milestone payments and royalties are typically considered variable consideration at the outset of the contract and are recognized in the transaction price either upon occurrence or when the constraint of a probable reversal is no longer applicable.

Collaboration Revenue

 

No revenue has been recognized as of December 31, 2018. The collaboration and license agreements are within the scope of Accounting Standards Codification (ASC) 606 Revenue from Contracts with Customers.

 

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In determining the appropriate amount of revenue to be recognized as we fulfill our obligations under the agreements, we perform the following steps: (i) identification of the promised goods or services in the contract; (ii) determination of whether the promised goods or services are performance obligations including whether they are distinct in the context of the contract; (iii) measurement of the transaction price, including the constraint on variable consideration; (iv) allocation of the transaction price to the performance obligations; and (v) recognition of revenue when (or as) we satisfy each performance obligation.  As part of the accounting for the arrangement, we must develop assumptions that require judgment to determine the stand-alone selling price for each performance obligation identified in the contract.  We use key assumptions to determine the stand-alone selling price, which may include market conditions, reimbursement rates for personnel costs, development timelines and probabilities of regulatory success.

 

Licenses of intellectual property: If the license to our intellectual property is determined to be distinct from the other performance obligations identified in the arrangement, we recognize revenues from non-refundable, up-front fees allocated to the license when the license is transferred to the customer and the customer is able to use and benefit from the license.  For licenses that are bundled with other promises, we utilize judgment to assess the nature of the combined performance obligation to determine whether the combined performance obligation is satisfied over time or at a point in time and, if over time, the appropriate method of measuring progress for purposes of recognizing revenue from non-refundable, up-front fees.  We evaluate the measure of progress each reporting period and, if necessary, adjust the measure of performance and related revenue recognition.

 

Manufacturing Supply Services: If the promise to supply products for clinical and/or commercial development are determined to be distinct from the other performance obligations identified in the arrangement, we recognize revenues from the fees allocated to the supply when or as the supply is transferred to the customer, generally upon delivery to the customer. If the promise to supply products for clinical and/or commercial development are not determined to be distinct from the other performance obligations identified in the arrangement, we utilize judgement to assess the nature of the combined performance obligation to determine whether the combined performance obligation is satisfied over time or at a point in time and, if over time, the appropriate method of measuring progress for purposes of recognizing revenue, including amounts from non-refundable, up-front fees.  We evaluate the measure of progress each reporting period and, if necessary, adjust the measure of performance and related revenue recognition.

 

Milestone Payments: At the inception of each arrangement that includes developmental and regulatory milestone payments, we evaluate whether the achievement of each milestone specifically relates to our effort to satisfy a performance obligation or transfer a distinct good or service within a performance obligation. If the achievement of a milestone is considered a direct result of our efforts to satisfy a performance obligation or transfer a distinct good or service and the receipt of the payment is based upon the achievement of the milestone, the associated milestone value is allocated to that distinct good or service and revenue is recognized in the period in which the milestone is achieved. If the milestone payment is not specifically related to our effort to satisfy a performance obligation or transfer a distinct good or service, we evaluate the milestone to determine whether the milestone is considered probable of being reached and estimate the amount to be included in the transaction price using either the most likely amount or the expected value method.  If it is probable that a significant revenue reversal would not occur, the associated milestone value is included in the transaction price to be allocated.  At the end of each subsequent reporting period, we re-evaluate the probability of achievement of such development milestones and any related constraint, and if necessary, adjust our estimate of the overall allocation.  Any such adjustments are recorded on a cumulative catch-up basis, which would affect license, collaboration and other revenues and earnings in the period of adjustment.

 

Royalties: For arrangements that include sales-based or usage-based royalties, including milestone payments based on the level of sales, and the license is deemed to be the predominant item to which the royalties relate, we will recognize revenue at the later of:  (i) when the related sales occur; or (ii) when the performance obligation to which some or all of the royalty has been allocated has been satisfied (or partially satisfied).

46


 

Income Taxes

We utilize the asset and liability method of accounting for income taxes. Under this method, deferred tax assets and liabilities are determined based on the difference between the financial statement carrying amounts and tax basis of assets and liabilities using enacted tax rates in effect for years in which temporary differences are expected to reverse. We provide a valuation allowance when it is more likely than not that deferred tax assets will not be realized. We recognize the benefit of an uncertain tax position that has been taken or we expect to take on income tax returns if such tax position is more likely than not to be sustained.

We follow the authoritative guidance regarding accounting for uncertainty in income taxes, which prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. These unrecognized tax benefits relate primarily to issues related to the timing of certain income and deductions for federal income tax purposes. We apply a variety of methodologies in making these estimates which include advice and studies performed by independent subject matter experts, evaluation of public actions taken by the U.S. Internal Revenue Service and other taxing authorities, as well as our own industry experience. We provide estimates for unrecognized tax benefits which may be subject to material adjustments until matters are resolved with taxing authorities or statutes expire. If our estimates are not representative of actual outcomes, our results of operations could be materially impacted.

We continue to maintain a valuation allowance against our deferred tax assets due to our assessment that their realization is not certain. We periodically evaluate the likelihood of the realization of deferred tax assets and reduce the carrying amounts of these deferred tax assets by a valuation allowance to the extent we believe a portion will not be realized. We consider many factors when assessing the likelihood of future realization of deferred tax assets, including our recent cumulative earnings experience by taxing jurisdiction, expectations of future taxable income, carryforward periods available to us for tax reporting purposes, various income tax strategies and other relevant factors. Significant judgment is required in making this assessment and, to the extent future expectations change, we would assess the recoverability of our deferred tax assets at that time. If we determine that the deferred tax assets become realizable in a future period, we would record material adjustments to income tax expense that period.

TAX REFORM

On December 22, 2017, the Tax Cuts and Jobs Act (the “TCJA”) was signed into United States law. The TCJA includes a number of changes to existing tax law, including, among other things, a permanent reduction in the federal corporate income tax rate from 34% to 21%, effective as of January 1, 2018, as well as limitation of the deduction for net operating losses to 80% of annual taxable income and elimination of net operating loss carrybacks, in each case, for losses arising in taxable years beginning after December 31, 2017 (though any such net operating losses may be carried forward indefinitely). The tax rate change resulted in (i) a reduction in the gross amount of our deferred tax assets recorded as of December 31, 2017, without an impact on the net amount of its deferred tax assets, which are recorded with a full valuation allowance, and (ii) no income tax expense or benefit being recognized as of the enactment date of the TCJA.

The staff of the Securities and Exchange Commission issued Staff Accounting Bulletin No. 118 to address the application of U.S. GAAP in situations when a registrant does not have the necessary information available, prepared or analyzed (including computations) in reasonable detail to complete the accounting for certain income tax effects of the TCJA. In connection with the initial analysis of the impact of the TCJA, the Company remeasured its deferred tax assets and liabilities based on the rates at which they are expected to reverse in the future, which is generally 21%. The remeasurement of our deferred tax assets and liabilities was offset by a corresponding change in the valuation allowance for the year ended December 31, 2017. As a result, there was no impact to our consolidated statements of operations and comprehensive loss as a result of the reduction in tax rates. The other provisions of the TCJA did not have a material impact on the Company’s consolidated financial statements. Our final determination of the TCJA impact and the remeasurement of its deferred assets and liabilities was completed prior to the deadline of one year from the enactment of the TCJA.  For the year ended December 31, 2018, there were no material changes to the analysis originally performed as of December 31, 2017    

 

47


 

Uncertain Income Tax Positions

We record uncertain tax positions on the basis of a two-step process whereby (1) we determine whether it is more likely than not that the tax positions will be sustained on the basis of the technical merits of the positions and (2) for those tax positions that meet the more-likely-than-not recognition threshold, we recognize the largest amount of tax benefit that is more than 50% likely to be realized upon ultimate settlement with the related tax authority. We recognize interest and penalties related to unrecognized tax benefits within income tax expense. Any accrued interest and penalties are included within the related tax liability. A reconciliation of the beginning and ending pre-tax amounts of uncertain tax positions is as follows:

 

 

 

Tax Positions

 

 

 

(in thousands)

 

Balance at December 31, 2016

 

$

(562

)

Reductions based on tax positions related to the period

 

 

123

 

Federal rate revision

 

 

136

 

Balance at December 31, 2017

 

 

(303

)

Reductions based on tax positions related to the period

 

 

 

Federal rate revision

 

 

 

Balance at December 31, 2018

 

$

(303

)

 

The uncertain tax positions giving rise to the unrecognized tax benefits of $0.3 million at December 31, 2018 relate to the timing of certain income and deductions for federal income tax purposes. The reversal of unrecognized tax benefits would not have any impact on the effective tax rate in future periods and are not expected to create cash tax liability upon settlement due to our ability to utilize both pre-change and post-change NOLs to offset their impact.

Accrued Expenses

As part of the process of preparing our consolidated financial statements, we are required to estimate our accrued expenses. This process involves reviewing open contracts and purchase orders, communicating with our personnel to identify services that have been performed on our behalf and estimating the level of service performed and the associated cost incurred for the service when we have not yet been invoiced or otherwise notified of the actual cost. The majority of our service providers invoice us monthly in arrears for services performed or when contractual milestones are met. We make estimates of our accrued expenses as of each balance sheet date in our consolidated financial statements based on facts and circumstances known to us at that time. We periodically confirm the accuracy of our estimates with the service providers and make adjustments if necessary. Examples of estimated accrued research and development expenses include fees payable to:

 

clinical research organizations and investigative sites in connection with clinical trials;

 

vendors in connection with preclinical development activities;

 

vendors related to product manufacturing, development, and distribution of clinical materials; and

 

professional service fees for consulting and related services.

We base our expense accruals related to clinical trials on our estimates of the services received and efforts expended pursuant to our contract arrangements. The financial terms of these agreements are subject to negotiation, vary from contract to contract and may result in uneven payment flows and expense recognition. Payments under some of these contracts depend on factors such as the successful enrollment of patients and the completion of clinical trial milestones. In accruing service fees, we estimate the time period over which services will be performed and the level of effort to be expended in each period. If the actual timing of the performance of services or the level of effort varies from our estimate, we adjust the accrual or prepaid accordingly. Our understanding of the status and timing of services performed relative to the actual status and timing of services performed may vary and may result in our reporting changes in estimates in any particular period.

48


 

Although we do not expect our estimates to be materially different from amounts actually incurred, if our estimates of the status and timing of services performed differs from the actual status and timing of services performed, we may report amounts that are too high or too low in any particular period. To date, there have been no material differences from our estimates to the amount actually incurred.

Impairment of Long-Lived Assets

Long-lived assets consist primarily of property and equipment. We test long-lived assets for impairment at year end or whenever events or circumstances present an indication of impairment. If the sum of expected future cash flows (undiscounted and without interest charges) of the long-lived assets is less than the carrying amount of such assets, the assets would be written down to their estimated fair value based on the present value of expected future cash flows and an impairment loss would be recognized in earnings. Based on the triggering event that occurred in December 2018, we deemed the value of our fixed assets to be impaired and wrote-off $4.3 million in net book value of such assets.

Impairment of Intangible Assets

We test intangible assets for impairment at year end or whenever events or circumstances present an indication of impairment. If the sum of expected future cash flows (undiscounted and without interest charges) of the intangible assets is less than the carrying amount of such assets, an impairment loss would be recognized in earnings in “impairment of goodwill and intangible assets.” The intangible assets would be written down to the estimated fair value, calculated based on the present value of expected future cash flows. Our intangible assets consisted of in-process research and development (IPR&D) obtained through the acquisition of ProChon and the AT Grade license and are fully impaired.  

Financial Instruments Indexed to and Potentially Settled in the Our Common Stock

We evaluate all financial instruments issued in connection with its equity offerings when determining the proper accounting treatment for such instruments in our financial statements. We consider a number of generally accepted accounting principles under U.S. GAAP to determine such treatment and evaluates the features of the instrument to determine the appropriate accounting treatment. We utilize the Probability Weighted Expected Return Method (PWERM), Option Pricing Model (OM) or other appropriate methods to determine the fair value of its derivative financial instruments such as the warrant liability. For financial instruments indexed to and potentially settled in our common stock that are determined to be classified as liabilities on the consolidated balance sheet, changes in fair value are recorded as a gain or loss in our consolidated statement of operations with the corresponding amount recorded as an adjustment to the liability on its consolidated balance sheet.

Stock-Based Compensation

We account for grants of stock options and restricted stock based on their grant date fair value and recognize compensation expense over their vesting period. We estimate the fair value of stock options as of the date of grant using the Black-Scholes option pricing model and, if issued, restricted stock based on the fair value of the underlying common stock as determined by management or the value of the services provided, whichever is more readily determinable.

Stock-based compensation expense represents the cost of the grant date fair value of employee stock option grants recognized over the requisite service period of the awards (usually the vesting period) on a straight-line basis, net of estimated forfeitures. The expense is adjusted for actual forfeitures at year end. Stock-based compensation expense recognized in the financial statements is based on awards that are ultimately expected to vest.

The Black-Scholes option pricing model requires us to make certain assumptions and estimates concerning our stock price volatility, the rate of return of risk-free investments, the expected term of the awards, and our anticipated dividends. We utilize the volatility from an analysis of peer group companies used in the Black-Scholes model, as we do not believe we have sufficient historical data to support the assumption of utilizing only our stock price volatility.

49


 

We account for stock options and restricted stock awards to non-employees using the fair value approach. Stock options and restricted stock awards granted to non-employees are subject to periodic revaluation over their vesting terms.

On October 1, 2018, the Compensation Committee of the Board of Directors approved a repricing (the Repricing) of 3,807,779 stock options (the Options) granted prior to September 1, 2018 pursuant to our 2013 Equity Incentive Plan and our 2012 Equity Incentive Plan to executive officers, employees and consultants of the Company. The Options had exercise prices between $0.75628 and $9.97 per share, which were reduced to $0.568 per share (the closing price of the Company’s common stock on The Nasdaq Capital Market on October 1, 2018). The number of shares, vesting schedules and expiration period of the Options were not altered. Options to purchase the Company’s common stock held by non-employee members of the Board were not subject to the Repricing and remain unchanged. The impact to the Company’s financial statements in 2018 was immaterial.

Other Company Information

JOBS Act

On April 5, 2012, the Jumpstart Our Business Startups Act (JOBS Act) was enacted. Section 107 of the JOBS Act permits an “emerging growth company” to delay the adoption of new or revised accounting standards until those standards would otherwise apply to private companies. We plan to avail ourselves of this exemption from new or revised accounting standards and, therefore, we may not be subject to the same new or revised accounting standards as other public companies that are not emerging growth companies.

For so long as we are an “emerging growth company,” we intend to rely on exemptions relating to: (1) providing an auditor’s attestation report on our system of internal control over financial reporting pursuant to Section 404(b) of the Sarbanes-Oxley Act and (2) complying with any requirement that may be adopted by the Public Company Accounting Oversight Board regarding mandatory audit firm rotation or a supplement to the auditor’s report providing additional information about the audit and the financial statements, known as the auditor discussion and analysis. We will remain an emerging growth company until the earliest of (a) the last day of the fiscal year in which we have total annual gross revenue of $1.0 billion or more, (b) December 31, 2019, the last day of our fiscal year following the fifth anniversary of the date of the completion of our initial public offering, (c) the date on which we have issued more than $1.0 billion in non-convertible debt during the previous three years and (d) the date on which we are deemed to be a large accelerated filer under the rules of the SEC.

Net Operating Loss Carryforwards

Utilization of the net operating loss (NOL) and research and development credit carryforwards may be subject to a substantial annual limitation due to ownership change limitations that have occurred or that could occur in the future, as required by Section 382 and 383 of the Internal Revenue Code (Code), as well as similar state and foreign provisions. These ownership changes may limit the amount of NOL and research and development credit carryforwards that can be utilized annually to offset future taxable income and tax, respectively. In general, an “ownership change” as defined by Section 382 of the Code results from a transaction or series of transactions over a three-year period resulting in an ownership change of more than 50% of the outstanding stock of a company by certain stockholders. We have completed a study to assess whether an ownership change has occurred or whether there have been multiple ownership changes since our formation. The results of this study indicated we experienced ownership changes, as defined by Section 382 of the Code, in each of 2006, 2011, 2012, 2013, and 2016. We have not recorded $52.9 million of NOLs that as a result of the 2017 ownership change will expire unused.

As of December 31, 2018, and 2017, we had U.S. federal NOL carryforwards of $67 million and $44 million respectively, which may be available to offset future income tax liabilities and expire at various dates through 2037. As of December 31, 2018, and 2017, we also had U.S. state NOL carryforwards of $67 million and $43.7 million, respectively, which may be available to offset future income tax liabilities and expire at various dates through 2037. At December 31, 2018 and 2017, we also had $26.4 million and $26.3 million, respectively, of foreign NOL carryforwards which may be available to offset future income tax liabilities, which carryforwards do not expire.

As of December 31, 2018, we have provided a full valuation allowance for net deferred tax assets.

50


 

Recent Accounting Pronouncements  

In November 2018, the FASB issued ASU No. 2018-18, Collaborative Arrangements (Topic 808): Clarifying the Interaction between Topic 808 and Topic 606. The amendments in this update provide guidance on whether certain transactions between collaborative arrangement participants should be accounted for with revenue under Topic 606. The guidance also provides more comparability in the presentation of revenue for certain transactions between collaborative arrangement participants. For public business entities, the amendments in this update are effective for fiscal years and interim periods within those fiscal years, beginning after December 15, 2019.  Early adoption is permitted, including adoption in any interim period, for public business entities for periods for which financial statements have not yet been issued. The Company is currently evaluating the impact that the adoption of this guidance will have on the Company’s consolidated financial statements and related disclosures.

In August 2018, the FASB issued ASU No. 2018-13, Fair Value Measurement (Topic 820): Changes to the Disclosure Requirements for Fair Value Measurement. The amendments in this update modify the disclosure requirements on fair value measurements based on the concepts in the Concepts Statement, including the consideration of costs and benefits. The amendments in this update are effective for all entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019 with early adoption permitted upon issuance of this Update. The Company is currently evaluating the impact that the adoption of this guidance will have on the Company’s consolidated financial statements and related disclosures.

In August 2018, the SEC adopted the final rule under SEC Release No. 33-10532, Disclosure Update and Simplification. This final rule amends certain disclosure requirements that are redundant, duplicative, overlapping, outdated or superseded. In addition, the amendments expand the disclosure requirements on the analysis of stockholders’ equity for interim financial statements. Under the amendments, an analysis of changes in each caption of stockholders’ equity presented in the balance sheet must be provided in a note or separate statement. The analysis should present a reconciliation of the beginning balance to the ending balance of each period for which a statement of comprehensive income is required to be filed. This final rule is effective for the Company for all filings made on or after November 5, 2018. The SEC staff clarified that the first presentation of the changes in shareholders’ equity may be included in the first Form 10-Q for the quarter that begins after the effective date of the amendments. The adoption of the final rule did not have a material impact on the Company’s consolidated financial statements.

In June 2018, the FASB issued ASU No. 2018-07, Compensation-Stock Compensation (Topic 718): Improvements to Nonemployee Share-Based Payment Accounting. This update is to simplify the aspects of accounting for nonemployee shared based payment transactions for acquiring goods or services from nonemployees. The amendments in this update are effective for fiscal years beginning after December 15, 2018, including interim periods within that year. The Company has concluded that this guidance has no impact on the Company’s consolidated financial statements and related disclosures.

In July 2017, the FASB issued ASU No. 2017-11, Earnings Per Share (Topic 260): Distinguishing Liabilities from Equity (Topic 480); Derivatives and Hedging (Topic 815): (PART I) Accounting for certain financial instruments with down round features. This update addresses the complexity of accounting for certain financial instruments with down round features. The guidance is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. The Company has concluded that this guidance has no material impact on the presentation of its results of operations, financial position and disclosures.

51


 

In May 2017, the FASB issued ASU No. 2017-09, Compensation-Stock Compensation (Topic 718): Scope of Modification Accounting. This standard provides guidance on changes to the terms or conditions of a share-based payment award that requires an entity to apply modification accounting. The guidance is effective prospectively for annual periods beginning after December 15, 2017, and for interim periods and annual periods thereafter. The Company has concluded that this guidance has no material impact on the presentation of its results of operations, financial position and disclosuresIn November 2016, the FASB issued ASU 2016-18, Statement of Cash Flows: Restricted Cash (ASU 2016-18). The amendments in this update require that amounts generally described as restricted cash and restricted cash equivalents be included within cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. ASU 2016-18 was effective January 1, 2018.  As a result of adopting ASU 2016-18, the Company includes its restricted cash balance in the cash and cash equivalents reconciliation of operating, investing and financing activities.  The following table provides a reconciliation of cash, cash equivalents, and restricted cash within the statement of financial position that sum to the total of the same such amounts shown in the statement of cash flows.

 

 

As of December 31,

 

 

2018

 

 

2017

 

 

(in thousands)

 

Cash and cash equivalents

$

15,542

 

 

$

7,081

 

Restricted cash

 

137

 

 

 

137

 

Total cash, cash equivalents, and restricted cash shown in the statement of cash

   flows

$

15,679

 

 

$

7,218

 

 

In February 2016, the FASB issued ASU No. 2016-02- Leases (Topic 842). This standard requires companies to recognize on the balance sheet the assets and liabilities for the rights and obligations created by leased assets. ASU 2016-02 will be effective for the Company in the first quarter of 2019, with early adoption permitted. The Company estimates that it will recognize approximately $8 million to $10 million of right-of-use assets and corresponding lease liabilities on the balance sheet upon adoption. However, the population of contracts subject to balance sheet recognition and their initial measurement remains under evaluation; and the final impact on the balance sheet will depend on the lease portfolio at the time of adoption. The Company does not expect that adoption will have a material impact on its results of operations or statement of cash flows.

In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606), which requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. In the fourth quarter of 2017, the Company early adopted ASC 606 and this standard applies to all contracts with customers, except for contracts that are within the scope of other standards, such as leases, insurance, collaboration arrangements and financial instruments. The Company had only one revenue arrangement as of the adoption date. Topic 606 requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. Topic 606 provides a five-step model for determining revenue recognition for arrangements that are within the scope of the standard: (i) identify the contract(s) with a customer; (ii) identify the performance obligations in the contract; (iii) determine the transaction price; (iv) allocate the transaction price to the performance obligations in the contract; and (v) recognize revenue when (or as) the entity satisfies a performance obligation. The Company only applies the five-step model to contracts when it is probable that the entity will collect the consideration it is entitled to in exchange for the goods or services it transfers to the customer. At contract inception, once the contract is determined to be within the scope of Topic 606, the Company assesses the goods or services promised within each contract and determines those that are performance obligations, and assesses whether each promised good or service is distinct. The Company then recognizes as revenue the amount of the transaction price that is allocated to the respective performance obligation when (or as) the performance obligation is satisfied. For a complete discussion of accounting for revenues, see Note 2, Revenue Recognition.

52


 

Results of Operations

Years Ended December 31, 2018 and 2017

The following table summarizes the results of our operations for the years ended December 31, 2018 and 2017:

 

 

 

December 31,

 

 

Change

 

 

 

 

2018

 

 

2017

 

 

$

 

 

%

 

 

 

 

(in thousands)

 

 

 

 

 

Research and development expenses

 

$

15,634

 

 

$

15,566

 

 

$

68

 

 

 

0

 

%

General and administrative expenses

 

 

10,204

 

 

 

9,384

 

 

 

820

 

 

 

9

 

 

Loss due to asset impairment

 

 

4,270

 

 

 

 

 

 

4,270

 

 

 

100

 

 

Other income (expense), net

 

 

21,465

 

 

 

(1,464

)

 

 

22,929

 

 

 

(1,566

)

 

 

Revenue. We did not record any revenue for the years ended December 31, 2018 and 2017. We do not expect to generate any product sales revenue in the future unless we successfully complete the development of NeoCart and receive approval from the FDA to market NeoCart. As of December 31, 2018, we have recorded $10 million in deferred revenue relating to the upfront payment from MEDINET.  

Research and Development Expenses. Research and development expenses were $15.6 million for the year ended December 31, 2018 as compared to $15.5 million for the year ended December 31, 2017. The increase in research and development expenses of $0.1 million was primarily due to an increase in consulting expense of $1.6 million, an increase in materials costs of $0.9 million and an increase in repairs and maintenance expense of $0.3 million which were partially offset by a $1.8 million decline in clinical trial costs, a $0.6 million decline in depreciation expense and a $0.5 million decline in salaries and benefits. We expect our research and development expenses to decline in 2019 in connection with our decision to suspend the development of NeoCart and our related restructuring plans that we implemented in January 2019 and March 2019.

General and Administrative Expenses. General and administrative expenses were $10.2 million for the year ended December 31, 2018 as compared to $9.4 million for the year ended December 31, 2017. The increase in expense of $0.8 million was primarily due to an increase in professional fees of $0.6 million, an increase in facility-related expenses of $0.6 million and an increase in public relations expense of $0.1 million which were partially offset by a decrease in depreciation expense of $0.5 million. We expect our general and administrative expenses to decline in 2019 due to the restructuring plans that we implemented in January 2019 and March 2019.

Loss due to Asset Impairment. The loss due to asset impairment of $4.3 million for the year ended December 31, 2018 was in connection with the impairment of long-term assets.

Other Income (Expense), Net. Other income (expense), net was $21.5 million for the year ended December 31, 2018 as compared to ($1.5) million for the year ended December 31, 2017. The $22.9 million increase was primarily due to the reduction of the fair value of warrant liability of $20.6 million and a $1.5 million gain on extinguishment of liability which were partially offset by warrant expense of $0.8 million related to our underwritten equity offering in October 2018.

Liquidity and Capital Resources

As of December 31, 2018, we had an accumulated deficit of $216.8 million. We have historically funded our consolidated operations primarily through the proceeds from the sale of common stock, the private placement of preferred stock and convertible notes and commercial bank debt. As of December 31, 2018, we had cash, cash equivalents and marketable securities of $15.5 million. We believe our existing cash and cash equivalents will be sufficient to fund our projected cash needs into the middle of 2019.

53


 

The following table sets forth a summary of the net cash flow activity for each of the periods indicated:

 

 

 

December 31,

 

 

Change

 

 

 

 

2018

 

 

2017

 

 

$

 

 

%

 

 

 

 

(in thousands)

 

 

 

 

 

 

 

 

 

 

Net cash used in operating activities

 

$

(15,777

)

 

$

(23,020

)

 

$

7,243

 

 

 

(31

)

%

Net cash used in investing activities

 

 

(1,113

)

 

 

(1,230

)

 

 

117

 

 

 

(10

)

 

Net cash provided by (used in) financing activities

 

 

25,351

 

 

 

(577

)

 

 

25,928

 

 

 

(4,494

)

 

Net increase (decrease) in cash and cash equivalents

 

$

8,461

 

 

$

(24,827

)

 

$

33,288

 

 

 

(134

)

%

 

Operating Capital Requirements

We anticipate that we will continue to incur losses for the next several years. We are subject to all risks incident to the development of new therapeutic products, and we may encounter unforeseen expenses, difficulties, complications, delays and other unknown factors that may adversely affect our business. We anticipate that we will need substantial additional funding in the future if we continue our operations.

We believe our existing cash and cash equivalents will be sufficient to fund our projected cash needs into the middle of 2019. Until we can generate a sufficient amount of revenue from the sale or licensing of our products, if ever, we expect to finance future cash needs through public or private equity or debt offerings. Additional capital may not be available on reasonable terms, if at all. If we are unable to raise additional capital in sufficient amounts or on terms acceptable to us, we may have to further scale back or discontinue our operations. If we raise additional funds through the issuance of additional debt or equity securities, it could result in dilution to our existing stockholders, increased fixed payment obligations and the existence of securities with rights that may be senior to those of our common stock. If we incur indebtedness, we could become subject to covenants that would restrict our operations and potentially impair our competitiveness, such as limitations on our ability to incur additional debt, limitations on our ability to acquire, sell or license intellectual property rights and other operating restrictions that could adversely impact our ability to conduct our business. Any of these events could significantly harm our business, financial condition and prospects.

Our forecast of the period of time through which our financial resources will be adequate to support our operations is a forward-looking statement and involves risks and uncertainties, and actual results could vary as a result of a number of factors. We have based this estimate on assumptions that may prove to be wrong, and we could utilize our available capital resources sooner than we currently expect. If we cannot expand our operations or otherwise capitalize on our business opportunities because we lack sufficient capital, our business, financial condition and results of operations could be materially adversely affected.

Operating Activities

Cash used in operating activities decreased $7.2 million to $15.8 million for the year ended December 31, 2018 from $23.0 million for the year ended December 31, 2017. During the year ended December 31, 2018, the net cash used in operating activities of $15.8 million consisted primarily of our net loss of $8.6 million adjusted for non-cash items, including a decrease in fair value of warrants of $20.6 million, an increase in deferred revenue of $10.0 million, a decrease in operating assets and liabilities of $2.8 million, a $4.3 million loss from the impairment of long term assets, a $1.5 million gain on extinguishment of liability, $1.6 million in stock-based compensation expense, a $0.7 million decrease in deferred rent and lease incentive, $0.7 million in warrant expense and $0.5 million in depreciation expense. During the year ended December 31, 2017, the net cash used for operating activities of $23.0 million consisted primarily of our net loss of $26.4 million adjusted for non-cash items, including the increase in fair value of warrants of $1.5 million, $1.5 million in depreciation expense, $1.6 million in stock-based compensation expense, a $0.7 million decrease in operating assets and liabilities and a $0.5 million decrease in deferred rent and lease incentive.

Investing Activities

Cash used in investing activities decreased $0.1 million to $1.1 million for the year ended December 31, 2018 from $1.2 million for the year ended December 31, 2017. The difference was primarily related to purchases of property and equipment of $2.0 million partially offset by maturities of marketable securities of $0.9 million.

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Financing Activities

Cash provided by financing activities increased $26.0 million to $25.4 million for the year ended December 31, 2018 due to the issuance of common stock of $25.5 million.

Loan and Security Agreements

Equipment Loan

In July 2014, we entered into a loan and security agreement with Silicon Valley Bank, which provides for a line of credit to finance certain equipment purchases up to an aggregate of $1.75 million through March 31, 2015. The line has been fully drawn and is payable in 36 monthly installments of principal and interest commencing six months following the date of the draw with an annual interest rate of 2.75% plus the greater of 3.25% and the prime rate in effect at the time of each draw, as published in the Wall Street Journal. The outstanding balance was fully paid as of May 2018.

In accordance with the terms of the equipment line of credit, we issued a warrant to Silicon Valley Bank in July 2014 to purchase 6,566 shares of our common stock at an exercise price per share of $7.99.

Off-Balance Sheet Arrangements

We did not have any off-balance sheet arrangements during the periods presented, and we do not currently have, any off-balance sheet arrangements, as defined in the rules and regulations of the SEC.

ITEM 7A.

QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK

Not applicable.

ITEM 8.

FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The consolidated financial statements and related consolidated financial statement schedules required to be filed are indexed on page 97 and are incorporated herein.

ITEM 9.

CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

Not applicable.

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ITEM 9A.

CONTROLS AND PROCEDURES

Conclusion Regarding the Effectiveness of Disclosure Controls and Procedures

Our management is responsible for establishing and maintaining disclosure controls and procedures (as defined in Rules 13a-15(e) or 15d-15(e)) under the Securities Exchange Act of 1934, as amended(the “Exchange Act”), that are designed to ensure that information we are required to disclose in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include controls and procedures designed to ensure that information required to be disclosed by us in the reports we file or submit under the Exchange Act is accumulated and communicated to our management, including our principal executive officer and principal financial officer, to allow timely decisions regarding required disclosure.

Under the supervision and with the participation of management, including our principal executive officer and principal financial officer, we carried out an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to paragraph (b) of Exchange Act Rules 13a-15 or 15d-15 as of December 31, 2018. Based upon our evaluation, our principal executive officer and principal financial officer have concluded that our disclosure controls and procedures were not effective as of December 31, 2018 as a result of the material weakness described below.

We have identified a material weakness in our internal controls relating to the accounting for transactions that are either highly complex and/or unusual in nature. In such instances, we seek to augment our internal accounting capabilities by obtaining assistance from third-parties who have greater expertise in such areas. Examples of situations such as these include (but are not limited to) the determination of the initial and periodic fair value of warrants that are liability classified and the accounting treatment for the termination of the Company’s collaboration agreement with Intrexon Corporation (“Intrexon”).

For example, during the third quarter of 2018, we identified a material weakness in our internal controls relating to the valuation of the warrant liability. Because the valuation of the warrants is exceedingly complex and requires highly specialized skills to perform and review, we use the assistance of a third-party service provider to perform such valuation. In the third quarter of 2018, the third-party service provider made an error in the valuation that was not detected by management in its review process but was identified by our independent registered public accounting firm. In the fourth quarter of 2018, we identified a material weakness in our internal controls related to the accounting treatment for the contingent liability associated with the termination agreement entered into with Intrexon which terminated the Company’s collaboration agreement with Intrexon. In this instance, we concluded after numerous discussions with our independent registered public accounting firm that we had incorrectly accounted for the contingent liability. In both cases these items were discovered prior to the issuance of the financial statements.

A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of our annual or interim financial statements will not be prevented or detected on a timely basis. The identified material weakness did not result in a misstatement in our final consolidated financial statements or disclosures; however, it could result in misstatements of certain account balances (such as warrant liability and change in fair value of warrant liability or the accrued expenses due to Intrexon) or disclosures that would result in a material misstatement to the annual or interim consolidated financial statements that would not be prevented or detected. We have implemented additional review procedures, including engaging a second third-party service provider to assist in our review of the work of the third-party service provider preparing the warrant valuation analysis and will seek to implement a similar procedure for other unusual or complex transactions going forward. Our principal executive officer and principal financial officer believe that the remediation activities we have put in place will remediate the material weakness in the future.

Management’s Report on Internal Control over Financial Reporting

Our management is responsible for establishing and maintaining adequate “internal control over financial reporting” for the Company, as that term is defined in Rule 13a-15(f) and Rule 15d-15(f) under the Exchange Act. Our internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of our consolidated financial statements for external purposes in accordance

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with U.S. generally accepted accounting principles. Internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with U.S. generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the company’s assets that could have a material effect on the financial statements. Because of its inherent limitations, a system of internal control over financial reporting can provide only reasonable assurances and may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with policies and procedures may deteriorate.

Under the supervision of our Audit Committee and with the participation of management, including our principal executive officer and principal financial officer, we evaluated the effectiveness, as of December 31, 2018, of our internal control over financial reporting. In making this assessment, management used the criteria set forth in the “Internal Control-Integrated Framework” (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO Framework). Based on its evaluation under the COSO Framework, our management has concluded that our internal control over financial reporting was not effective as of December 31, 2018 as a consequence of the material weaknesses described above.

As a result, we implemented additional review procedures, including engaging a second third-party service provider to assist in our review of the work of the third-party service provider preparing the warrant valuation analysis and intend to implement a similar procedure for other unusual or complex transactions going forward. We believe these actions will be sufficient to remediate the identified material weakness and strengthen our internal control over financial reporting, as well as our disclosure controls and procedures. However, while certain remediation steps have been completed in the fourth quarter of 2018, the enhanced controls relating thereto are not all yet fully operational, and we may determine to take additional measures to address our control deficiencies or to modify the remediation plans described above. The identified material weakness in our internal control over financial reporting will not be considered remediated until the new controls are fully implemented, in operation for a sufficient period of time, tested and concluded by management to be designed and operating effectively.

Changes in Internal Control Over Financial Reporting

Except as described above, there have been no changes in our internal control over financial reporting identified in connection with the evaluation required by paragraph (d) of Exchange Act Rule 13a-15 or 15d-15 that occurred during our most recently completed fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Limitations on the Effectiveness of Controls

Control systems, no matter how well conceived and operated, are designed to provide a reasonable, but not an absolute, level of assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, have been detected. Because of the inherent limitations in any control system, misstatements due to error or fraud may occur and not be detected.

ITEM 9B.

OTHER INFORMATION

None.

 

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PART III

ITEM 10.

DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

EXECUTIVE OFFICERS AND DIRECTORS

Executive Officers

The following table sets forth the name, age and position of each of our executive officers as of the date of this Annual Report on Form 10-K. Information as of the date of this Annual Report on Form 10-K about the number of shares of common stock beneficially owned by each of the individuals designated as an executive officer as of the date of this Annual Report on Form 10-K, whether held directly or indirectly, appears below under the heading “Equity Security Ownership of Certain Beneficial Owners and Management.”

 

Name

Age

Current Positions

Adam Gridley

46

President, Chief Executive Officer, Treasurer and Director(2)

Steven Kennedy

62

Executive Vice President and Chief Operating Officer(2)

Jonathan Lieber

49

Interim Chief Financial Officer

 

(1)

Pursuant to a reduction in force approved by the Board in March 2019, Mr. Gridley’s employment with us will terminate effective March 22, 2019. Mr. Gridley will retain his statutory titles of president, treasurer and secretary of the Company while he continues to provide consulting services to us, and will remain a director of the Company.  In connection with the execution of the separation entered into with Mr. Gridley in connection with his termination, we and Mr. Gridley also intend to enter into a consulting agreement pursuant to which Mr. Gridley will provide consulting services to us through at least June 30, 2019 for an hourly fee of $250.  

(2)

Pursuant to a reduction in force approved by the Board in March 2019, Mr. Kennedy’s employment with us will terminate effective March 22, 2019. In connection with the execution of the separation entered into with Mr. Kennedy in connection with his termination, we and Mr. Kennedy also intend to enter into a consulting agreement pursuant to which Mr. Kennedy will provide consulting services to us through at least June 30, 2019 for an hourly fee of $220.  

Directors

The following table includes the name, age position, class and term expiration year for each of our directors and is current as of the date of this Annual Report on Form 10-K. Information about the number of shares of common stock beneficially owned by each director, whether held directly or indirectly, as of the date of this Annual Report on Form 10-K, appears below under the heading “Equity Security Ownership of Certain Beneficial Owners and Management.”

 

Name

Age

Position

Class

Term Expiration Year

Joshua Baltzell

49

Chairman of the Board

Class I

2021

David Gill

64

Director

Class III

2020

Adam Gridley

46

President, Chief Executive Officer, Treasurer and Director(1)

Class II

2019

Michael Lewis

60

Director

Class II

2019

Kevin Rakin

58

Director

Class I

2021

Susan B. Washer

57

Director

Class II

2019

 

(1)

Pursuant to a reduction in force approved by the Board in March 2019, Mr. Gridley’s employment with us will terminate effective March 22, 2019. Mr. Gridley will retain his statutory titles of president, treasurer and secretary of the Company while he continues to provide consulting services to us, and will remain a director of the Company.  Mr. Gridley will not be eligible to receive compensation under the Company’s non-employee director compensation program.

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The following paragraphs provide information, as of the date of this Annual Report on Form 10-K, about our current executive officers and directors:

Biographical Information – Executive Officers

Adam Gridley has served as our Chief Executive Officer and President since May 2014. Pursuant to a reduction in force approved by the Board in March 2019, Mr. Gridley’s employment with us will terminate effective March 22, 2019. Mr. Gridley will retain his statutory titles of president, treasurer and secretary of the Company while he continues to provide consulting services to us, and will remain a director of the Company.  In connection with the execution of the separation entered into with Mr. Gridley in connection with his termination, we and Mr. Gridley also intend to enter into a consulting agreement pursuant to which Mr. Gridley will provide consulting services to us through at least June 30, 2019. Mr. Gridley previously served from October 2012 until May 2014 as Senior Vice President of Technical Operations at Merz North America, Inc., the North American business unit of Merz, Inc., a privately held pharmaceuticals company. From September 2011 to October 2012, he was Senior Vice President, Operations & Product Development responsible for global research and development and manufacturing for Merz Aesthetics, Inc., a global business unit of Merz, Inc., and from July 2010 to September 2011, Mr. Gridley held the position of Senior Vice President, Product Development at Merz. From September 2008 to July 2010, Mr. Gridley was Senior Vice President, Corporate Development for BioForm Medical, Inc., a publicly traded company acquired by Merz, Inc. Mr. Gridley holds a B.S. and an M.B.A. from the University of Denver. We believe that Mr. Gridley’s qualifications to serve as a director of the Company include his extensive experience as an executive in the biotechnology industry and his prior service as a senior-level executive in both early stage and mature biotechnology companies.

Stephen Kennedy has served as our Executive Vice President and Chief Operating Officer since October 2017 and previously served as our Chief Technology Officer from July 2015 to October 2017 and our Senior Vice President of Technical Operations from August 2013 to July 2015. Pursuant to a reduction in force approved by the Board in March 2019, Mr. Kennedy’s employment with us will terminate effective March 22, 2019. In connection with the execution of the separation entered into with Mr. Kennedy in connection with his termination, we and Mr. Kennedy also intend to enter into a consulting agreement pursuant to which Mr. Kennedy will provide consulting services to us through at least June 30, 2019. From May 2011 to August 2013, Mr. Kennedy served as the Executive Vice President, Research and Development, at Mascoma Corporation, a biofuel company. Mr. Kennedy served as Executive Director of the Novartis/MIT Center for Continuous Manufacturing at the Massachusetts Institute of Technology from October 2010 to May 2011. Mr. Kennedy also served as Senior Vice President of Biologics Operations at Genzyme Corporation from 2008 to October 2010, after having held a variety of technical operations positions with the company beginning in 1992. Prior to this, Mr. Kennedy managed process development at Genencor International in Helsinki, Finland from 1989 to 1992. Mr. Kennedy has a B.S. from the University of Michigan, an M.S. from the University of Rochester and an M.B.A. from Boston University.

Jonathan Lieber has served as our Interim Chief Financial Officer since December 2018 and previously served as our Chief Financial Officer from July 2015 to December 2018. Prior to joining us, Mr. Lieber was Senior Vice President and Chief Financial Officer of Metamark Genetics, Inc., a privately held, urology-focused, molecular diagnostics company, from January 2014 to June 2015. From September 2012 to September 2013, Mr. Lieber served as the Chief Financial Officer and Treasurer of Repligen Corporation, a manufacturer and supplier of high-value consumables to the life sciences industry. From June 2009 to May 2012, Mr. Lieber served as Chief Financial Officer and Treasurer of Xcellerex, Inc., a privately held company engaged in the manufacture and sale of capital equipment and related consumables to the biopharmaceutical industry. Mr. Lieber received an M.B.A. in finance from the Stern School of Business of New York University and a B.S. in business administration from Boston University.

Biographical Information – Directors

Joshua Baltzell has served as a member of the Board since July 2012. Mr. Baltzell is a Venture Partner at Split Rock Partners, and also serves as a Venture Partner at SightLine Partners. He has been with Split Rock since 2004 and with SightLine since 2014. Mr. Baltzell has over 20 years of experience in the healthcare industry. Prior to his tenure in the venture capital industry, Mr. Baltzell held roles as an investment banker at Piper Jaffray Companies from 2000 to 2002, where he focused primarily on mergers and acquisitions in the medical device sector, as well as

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various marketing and business development positions with SCIMED and Boston Scientific. Mr. Baltzell currently serves on the boards of Magnolia Medical, ViewPoint Medical and Colorescience. Mr. Baltzell holds a B.A. in economics from St. Olaf College and an M.B.A. from the University of Minnesota’s Carlson School of Management. We believe that Mr. Baltzell’s qualifications to serve as a director of the Company include his extensive experience in the venture capital industry, his investment banking experience in the healthcare and medical device industries with both publicly and privately held companies and his significant prior board experience.

David Gill has served as a member of the Board since February 2015. Mr. Gill served as the President and Chief Financial Officer of EndoChoice, Inc., a medical device company focused on gastrointestinal disease, from April 2016 through the sale of the company to Boston Scientific in November 2016 and as Chief Financial Officer from August 2014 to April 2016.  Previously, he served as the Chief Financial Officer of INC Research (now known as Syneos Health), a clinical research organization, from February 2011 to August 2013 after having served as a board member and its audit committee chairman from 2007 to 2010.  Mr. Gill also currently serves on the boards of Melinta Therapeutics, Inc. (f/k/a Cempra, Inc.), Evolus, Inc., Strata Skin Sciencess, Inc. and YmAbs Therapeutics, Inc. Earlier in his career, Mr. Gill served in a variety of senior executive leadership roles for several publicly-traded companies, including NxStage Medical, CTI Molecular Imaging, Inc., Interland Inc. and Novoste Corporation. Mr. Gill holds a B.S. degree, cum laude, in accounting from Wake Forest University and an M.B.A. degree, with honors, from Emory University, and was formerly a certified public accountant. We believe that Mr. Gill’s qualifications to serve as a director of the Company include his extensive experience as an executive in the life sciences industry and his extensive prior service as a director of other public and private mature life sciences companies.

Michael Lewis has served as a member of the Board since May 2011. Mr. Lewis has more than 25 years of experience in the investment management and retail industries. Mr. Lewis is currently Chairman of Oceana Investment Corporation Limited, a private U.K. investment company. Mr. Lewis currently serves as Chairman of Strandbags Holdings Pty Limited, an Australian retail company comprising some 300 stores, and Chairman and Non-Executive Director of The Foschini Group Limited, a South African retail company with some 4,000 stores. Mr. Lewis serves on the board of United Trust Bank Limited, a U.K.-based bank, and served on the Supervisory Board of Axel Springer AG in Germany from 2007 to September 2012. Mr. Lewis previously worked for Ivory and Sime, a money manager based in Scotland, and Lombard Odier, a money manager based in England. He has an undergraduate degree and a postgraduate degree from the University of Cape Town. We believe Mr. Lewis’ qualifications to serve as a director of the Company include his extensive experience in money management and as an investor and director of biomedical and other companies.

Kevin Rakin has served as a member of the Board since October 2012. Mr. Rakin is a co-founder and Partner at HighCape Partners, a growth equity life sciences fund where he has served since November 2013. From June 2011 to November 2012, Mr. Rakin was the President of Regenerative Medicine at Shire plc, a leading specialty biopharmaceutical company. Mr. Rakin currently serves on a number of boards, including Oramed Pharmaceuticals, Inc., Cheetah Medical Inc. and TELA Bio, Inc. Mr. Rakin holds an M.B.A. from Columbia University and received his graduate and undergraduate degrees in Commerce from the University of Cape Town, South Africa. We believe that Mr. Rakin’s qualifications to serve as a director of the Company include his extensive experience as an executive in the biotechnology industry as well as his service in positions in various companies as a chief executive officer, chief financial officer and president and his involvement in public and private financings and mergers and acquisitions in the biotechnology industry.

Susan B. Washer has served as a member of the Board since April 2018. Ms. Washer is the President and Chief Executive Officer of Applied Genetic Technologies Corporation (AGTC), where she has served in such capacity since March 2002 and as a member of its board of directors since November 2003. Ms. Washer was also AGTC’s chief operating officer from October 2001 to March 2002. From June 1994 to October 2001, Ms. Washer led two entrepreneurial firms including serving as president and chief executive officer of Scenic Productions and as the Founding Executive Director and then Business Advisor for the North Florida Technology Innovation Center, a public-private organization financing and providing services to entrepreneurial companies licensing STEM based technology from Florida universities. Ms. Washer currently serves on the board of directors of Biotechnology Innovation Organization (BIO) and the Alliance for Regenerative Medicine. Previously, Ms. Washer served as chairman of the BioFlorida board and the Southeast BIO board and continues her involvement with both organizations as a member of their respective boards. From October 1983 to June 1994, Ms. Washer served in various research and pharmaceutical management positions with Abbott Laboratories and Eli Lilly and Company. Ms. Washer received a B.S. in biochemistry from Michigan State University and an M.B.A. from the University of Florida. We believe that Ms. Washer’s qualifications to serve as a director of the Company include her education

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and professional background in science and business management, her years of experience in the pharmaceutical and biotechnology industries and her service as a senior executive of early and late stage biotechnology companies.

CORPORATE GOVERNANCE

Independence of the Board of Directors

As required under Nasdaq listing standards, a majority of the members of a listed company’s board of directors must qualify as “independent,” as affirmatively determined by the board of directors. Consistent with these regulations, after review of all relevant transactions or relationships between each director, or any of his family members, and the Company, its senior management and its independent registered public accounting firm, the Board has determined that all of our directors are independent directors within the meaning of applicable Nasdaq listing standards, except for Mr. Gridley, our Chief Executive Officer.

Information Regarding the Board of Directors and its Committees

As required under Nasdaq listing standards, our independent directors meet in regularly scheduled executive sessions at which only independent directors are present. Mr. Baltzell, Chairman of the Board, presides over these executive sessions. Dr. Kong resigned from the Board effective February 22, 2019. Mr. Baltzell was appointed as the Chairman of the Board effective February 22, 2019.

The Board has an Audit Committee (the Audit Committee), a Compensation Committee (the Compensation Committee), a Nominating/Corporate Governance Committee (the Nominating/Corporate Governance Committee) and a Special Committee (the Special Committee). The following table provides membership and meeting information for each of the Board’s committees during 2018:

 

Committee

 

Chairman

 

Members

 

Number of Committee

Meetings in 2018

 

Audit Committee

 

David Gill

 

John H. Johnson(1) and

Kevin Rakin

 

 

6

 

Compensation Committee

 

John H. Johnson(2)

 

Joshua Baltzell,

Kevin Rakin and Susan Washer(3)

 

 

7

 

Nominating/Corporate Governance Committee

 

Garheng Kong, M.D.,

Ph.D.(4)

 

Joshua Baltzell and

Michael Lewis

 

 

3

 

Special Committee

 

Garheng Kong, M.D.,

Ph.D.(5)

 

Joshua Baltzell,

David Gill and

John H. Johnson

 

 

4

 

 

(1)

Mr. Johnson resigned from the Board effective February 27, 2019. Ms. Washer was appointed to the Audit Committee effective February 27, 2019.

(2)

Mr. Johnson resigned from the Board effective February 27, 2019. Mr. Baltzell was appointed as the chairman of the Compensation Committee effective February 27, 2019.

(3)

Ms. Washer was appointed to the Compensation Committee effective February 27, 2019.

(4)

Dr. Kong resigned from the Board effective February 22, 2019. Mr. Baltzell was appointed as the Chairman of the Board and Chairman of the Nominating/Corporate Governance Committee effective February 22, 2019.

(5)

Dr. Kong resigned from the Board effective February 22, 2019. Mr. Baltzell was appointed as the Chairman of the Special Committee effective February 22, 2019.

 

Below is a description of each committee of the Board. The Board has determined that each member of the Audit Committee, Compensation Committee, Nominating/Corporate Governance Committee and Special Committee meets applicable rules and regulations regarding “independence,” and that each such member is free of any relationship that would interfere with his individual exercise of independent judgment with regard to the Company.

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Audit Committee

The Audit Committee of the Board oversees the quality and integrity of the Company’s financial statements and other financial information provided to the Company’s stockholders, the retention and performance of the Company’s independent accountants, the effectiveness of the Company’s internal controls and disclosure controls and the Company’s compliance with ethics policies and SEC and related regulatory requirements. Pursuant to the Audit Committee charter, the functions of the Audit Committee include, among other things: (1) appointing, approving the compensation of and assessing the independence of our registered public accounting firm; (2) overseeing the work of our registered public accounting firm, including through the receipt and consideration of reports from such firm; (3) reviewing and discussing with management and the registered public accounting firm our annual and quarterly financial statements and related disclosures; (4) monitoring our internal control over financial reporting and our disclosure controls and procedures; (5) meeting independently with our registered public accounting firm and management; (6) furnishing the audit committee report required by SEC rules; (7) reviewing and approving or ratifying any related person transactions; and (8) overseeing our risk assessment and risk management policies. Our Audit Committee charter is available on the “Investors” section of our corporate website located at http://ir.histogenics.com. Three directors comprised the Audit Committee as of December 31, 2018: Mr. Gill (the Chairman of the Audit Committee), Mr. Johnson and Mr. Rakin. Mr. Johnson resigned from the Board effective February 27, 2019. Ms. Washer was appointed to the Audit Committee effective February 27, 2019. The Audit Committee met six times during 2018. In addition, the members of the Audit Committee met informally in conjunction with each regularly scheduled quarterly Board meeting and at other times throughout the year to discuss a variety of matters.

All members of our Audit Committee meet the requirements for financial literacy under the applicable rules and regulations of the SEC and Nasdaq. The Board has determined that Messrs. Gill and Rakin are “audit committee financial experts” as defined by applicable SEC rules and have the requisite financial sophistication as defined under the applicable Nasdaq rules and regulations.

The Board annually reviews the Nasdaq listing standards definition of independence for Audit Committee members and has determined that all members of our Audit Committee are independent (as independence is currently defined in applicable Nasdaq listing standards and Rule 10A-3 promulgated under the Exchange Act).

Compensation Committee

The Compensation Committee of the Board reviews and approves the design of, assesses the effectiveness of and administers compensation programs for officers and employees, including our equity incentive plans. Pursuant to the Compensation Committee charter, the functions of the Compensation Committee include: (1) evaluating the performance of our chief executive officer and determining the chief executive officer’s salary and contingent compensation based on his or her performance and other relevant criteria; (2) identifying the corporate and individual objectives governing the chief executive officer’s compensation; (3) approving the compensation of our other executive officers; (4) making recommendations to the Board with respect to director compensation; (5) reviewing and approving the terms of material agreements between us and our executive officers; (6) overseeing and administering our equity incentive plans and employee benefit plans; (7) reviewing and approving policies and procedures relating to the perquisites and expense accounts of our executive officers; (8) preparing the annual Compensation Committee report required by SEC rules; and (9) conducting a review of executive officer succession planning, as necessary, reporting its findings and recommendations to the Board and working with the Board in evaluating potential successors to executive officer positions. In accordance with Nasdaq listing standards and our amended and restated Compensation Committee charter, the Board has granted our Compensation Committee the authority and responsibility to retain or obtain the advice of compensation consultants, legal counsel and other compensation advisers, the authority to fund such advisers, and the responsibility to consider the independence factors specified under applicable law and any additional factors the Compensation Committee deems relevant. Our Compensation Committee charter is available on the “Investors” section of our corporate website located at http://ir.histogenics.com.

In addition, the Compensation Committee has adopted additional internal policies and procedures relating to administration of the Company’s equity incentive plans, including the following:

 

Members of the Compensation Committee receive initial and periodic training from an independent consultant with expertise in compensation management matters concerning the Company’s operative

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equity incentive plans and compensation procedures as well as general best practices for compensation committees.

 

With the assistance of legal counsel, the Compensation Committee conducts reviews of the Compensation Committee’s charter, the Company’s equity incentive plans and the Compensation Committee’s current practices, procedures and controls and has developed equity compensation compliance procedures and a checklist of key plan provisions to be reviewed prior to the issuance and delivery of equity awards. Among other things, the checklist addresses: (1) the expiration date of the applicable equity incentive plan or any portion thereof; (2) the overall shares available under the applicable plan; (3) any annual limitations on awards as set forth in the applicable equity incentive plan; (4) prior grants made to proposed recipients during any relevant period; and (5) the proper recording of the equity grants in accordance with the terms of the applicable equity incentive plan. The Compensation Committee has designated the Company’s Chief Financial Officer and Vice President of Finance to monitor compliance with the foregoing compliance procedures and checklists (the Compliance Monitor).

 

In advance of the Compensation Committee’s first meeting each year, the Compliance Monitor provides the Compensation Committee information on the following: (1) the aggregate number of shares available for issuance under each equity incentive plan still in effect; (2) the expiration date for each such equity incentive plan; (3) the annual limit on equity grants to any one individual under each equity incentive plan; and (4) the number of shares covered by awards already granted to each of the Company’s executive officers under the Company’s equity incentive plans. The Compensation Committee reviews this information prior to making any equity compensation award to any executive officer.

 

Prior to the dissemination of the Company’s annual proxy statement released in conjunction with the annual meeting of stockholders, the Board (or an appropriate committee thereof), with the assistance of legal counsel, verifies that all awards made under, amendments or proposed amendments of, and summaries or descriptions of, the Company’s equity compensation plans have been disclosed accurately and properly in such proxy statement.

 

With the assistance of legal counsel, the Compensation Committee formally reviews and approves all disclosures in the Company’s SEC filings concerning executive officer and director compensation matters before the documents are publicly filed.

 

In the event of a proposed or contemplated stock split, reverse stock split or any other change to the Company’s capitalization, the Board will receive guidance from outside legal counsel on the effect of such capitalization change on the Company’s equity incentive plans, if any, including but not limited to the aggregate and annual limitations of those equity incentive plans.

 

The Board will seek stockholder approval of any amendment made to the Company’s equity incentive plans in the Company’s next annual meeting of stockholders following the amendment if such approval is required by the terms of such equity incentive plan, applicable Delaware law, SEC regulations or Nasdaq governance rules and listing standards.

 

The Board receives periodic reports on the Company’s compliance with its procedures, policies and guidelines for issuing equity awards. These reports are prepared and made with the input of the Compliance Monitor, the Compensation Committee and outside legal counsel.

Four directors comprised the Compensation Committee of the Board as of December 31, 2018: Mr. Johnson (the Chairman of the Compensation Committee), Mr. Baltzell, Mr. Rakin and Ms. Washer. Mr. Johnson resigned from the Board effective February 27, 2019. Mr. Baltzell was appointed as Chairman of the Compensation Committee effective February 27, 2019. The Compensation Committee met seven times during 2018 and acted twice by written consent. In addition, the members of the Compensation Committee met informally in conjunction with each regularly scheduled quarterly Board meeting and at other times throughout the year to discuss a variety of matters.

The Board has determined that all members of the Compensation Committee are independent (as independence is currently defined in the Nasdaq listing standards). In addition, each of our directors serving on our Compensation Committee satisfies the heightened independence standards for members of a compensation committee under Nasdaq listing standards. Each member of this committee is also a non-employee director, as defined pursuant to

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Rule 16b-3 promulgated under the Exchange Act, and an outside director, as defined pursuant to Section 162(m) of the Internal Revenue Code of 1986, as amended (the Code).

Our Chief Executive Officer and our Interim Chief Financial Officer often participate in the Compensation Committee’s meetings. Neither of them participates in the determination of their own respective compensation or the compensation of directors. However, Mr. Gridley does make recommendations to the Compensation Committee regarding the amount and form of the compensation of the other executive officers and key employees, and he often participates in the Compensation Committee’s deliberations about their compensation. No other executive officers participate in the determination of the amount or form of the compensation of executive officers or directors.

The Compensation Committee has retained Radford, an independent compensation consulting firm, since January 2015. In February 2018, Radford presented a summary executive compensation report to the Compensation Committee. Radford previously provided the Compensation Committee with data about the compensation paid by our peer group of companies and other employers who compete with the Company for executives, updated the Compensation Committee on new developments in areas that fall within the Compensation Committee’s jurisdiction and was available to advise the Compensation Committee regarding all of its responsibilities. The consultant serves at the pleasure of the Compensation Committee, rather than the Company, and the consultant’s fees are approved by the Compensation Committee. In February 2018, our Compensation Committee assessed the independence of Radford pursuant to applicable SEC rules and Nasdaq listing standards and concluded that the work of Radford has not raised any conflict of interest.

Compensation Committee Interlocks and Insider Participation

None of the members of the Compensation Committee is or has ever been an officer or employee of the Company. No executive officer of the Company serves as a member of the Board or compensation committee of any other entity that has one or more executive officers serving as a member of the Board or our Compensation Committee.

Nominating/Corporate Governance Committee

Our Nominating/Corporate Governance Committee identifies, evaluates and recommends nominees to the Board and committees of the Board, conducts searches for appropriate directors and evaluates the performance of the Board and of individual directors. Pursuant to the Nominating/Corporate Governance Committee charter, the functions of the Nominating/Corporate Governance Committee include, among other things: (1) identifying, evaluating and making recommendations to the Board and our stockholders concerning nominees for election to the Board, to each of the Board’s committees and as committee chairs; (2) annually reviewing the performance and effectiveness of the Board and developing and overseeing a performance evaluation process; (3) annually evaluating the performance of management, the Board and each Board committee against their duties and responsibilities relating to corporate governance; (4) annually evaluating adequacy of our corporate governance structure, policies and procedures; and (5) providing reports to the Board regarding the Committee’s nominations for election to the Board and its committees. Our Nominating/Corporate Governance Committee charter is available on the “Investors” section of our corporate website located at http://ir.histogenics.com. Three directors comprised the Nominating/Corporate Governance Committee as of December 31, 2018: Dr. Kong (the Chairman of the Nominating/Corporate Governance Committee), Mr. Baltzell and Mr. Lewis. Dr. Kong resigned from the Board effective February 22, 2019. Mr. Baltzell was appointed as the Chairman of the Nominating/Corporate Governance Committee effective February 22, 2019. The Nominating/Corporate Governance Committee met three times during 2018. In addition, the members of the Nominating/Corporate Governance Committee met informally in conjunction with each regularly scheduled quarterly Board meeting and at other times throughout the year to discuss a variety of matters.

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The Nominating/Corporate Governance Committee believes that candidates for director should have certain minimum qualifications, including being able to read and understand basic financial statements and having a general understanding of the Company’s industry and market. The Nominating/Corporate Governance Committee also considers other factors it deems appropriate, including, but not limited to:

 

the candidate’s relevant expertise and experience upon which to offer advice and guidance to management;

 

the candidate having sufficient time to devote to the affairs of the Company;

 

the candidate having a proven track record in his or her field;

 

the candidate’s ability to exercise sound business judgment;

 

the candidate’s commitment to vigorously represent the long-term interests of our stockholders;

 

whether or not a conflict of interest exists between the candidate and our business;

 

whether the candidate would be considered independent under applicable Nasdaq and SEC standards;

 

the current composition of the Board; and

 

the operating requirements of the Company.

In conducting this assessment, the Nominating/Corporate Governance Committee considers diversity, gender, age, skills and such other factors as it deems appropriate given the then-current needs of the Board and the Company, to maintain a balance of knowledge, experience and capability. While diversity and variety of experiences and viewpoints represented on the Board should always be considered, the Nominating/Corporate Governance Committee believes that a director nominee should not be chosen nor excluded solely or largely because of race, color, gender, national origin or sexual orientation or identity.

In the case of incumbent directors whose terms of office are set to expire, the Nominating/Corporate Governance Committee reviews such directors’ overall service to the Company during their term, including the number of meetings attended, level of participation, quality of performance and any other relationships and transactions that might impair such directors’ independence.

When there is a vacancy on the Board, the Nominating/Corporate Governance Committee uses its network of contacts to compile a list of potential candidates, but may also engage, if it deems it appropriate, a professional search firm. The Nominating/Corporate Governance Committee conducts any appropriate and necessary inquiries into the backgrounds and qualifications of possible candidates after considering the function and needs of the Board. The Nominating/Corporate Governance Committee meets to discuss and consider such candidates’ qualifications and then selects a nominee for recommendation to the Board by majority vote.

The Nominating/Corporate Governance Committee will consider director candidates recommended by stockholders and evaluate them using the same criteria as candidates identified by the Board or the Nominating/Corporate Governance Committee for consideration. If a stockholder of the Company wishes to recommend a director candidate for consideration by the Nominating/Corporate Governance Committee, the stockholder recommendation should be delivered to the Corporate Secretary of the Company at the principal executive offices of the Company pursuant to the terms and conditions of the Bylaws. The stockholder recommendation must, among other things, set forth:

 

for each person whom the stockholder proposes to nominate for election or reelection as a director, all information relating to such person as would be required to be disclosed in solicitations of proxies for the election of such nominees as directors pursuant to Regulation 14A promulgated under the Exchange Act and such person’s written consent to serve as a director if elected;

 

as to the stockholder giving the notice and the beneficial owner, if any, on whose behalf the nomination or proposal is made: (1) the name and address of such stockholder, as they appear on the Company’s books, and of such beneficial owner; (2) the class and number of shares of the Company that are owned beneficially and of record by such stockholder and such beneficial owner and a representation that the stockholder will notify the Company in writing of the class and number of such shares owned

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beneficially and of record as of March 1, 2019 for the meeting promptly following the later of March 1, 2019 or the date notice of March 1, 2019 is first publicly disclosed; (3) whether either such stockholder or beneficial owner intends to deliver a proxy statement and form of proxy to holders of, in the case of a proposal, at least the percentage of the Company’s voting shares required under applicable law to carry the proposal or, in the case of a nomination or nominations, a sufficient number of holders of the Company’s voting shares to elect such nominee or nominees; and (4) whether and the extent to which any derivative instrument, swap, option, warrant, short interest, hedge or profit interest or other transaction has been entered into by or on behalf of such stockholder with respect to stock of the Company and whether any other agreement, arrangement or understanding (including any short position or any borrowing or lending of shares of stock) has been made by or on behalf of such stockholder, the effect or intent of any of the foregoing being to mitigate loss to, or to manage risk of stock price changes for, such stockholder or to increase or decrease the voting power or pecuniary or economic interest of such stockholder with respect to stock of the Company;

 

any option, warrant, convertible security, stock appreciation right, or similar right with an exercise or conversion privilege or a settlement payment or mechanism at a price related to any class or series of shares of the Company or with a value derived in whole or in part from the value of any class or series of shares of the Company, whether or not such instrument or right shall be subject to settlement in the underlying class or series of capital stock of the Company or otherwise (a Derivative Instrument) directly or indirectly owned beneficially by such stockholder and any other direct or indirect opportunity to profit or share in any profit derived from any increase or decrease in the value of shares of the Company and a representation that the stockholder will notify the Company in writing of any such Derivative Instrument in effect as of March 1, 2019 for the meeting promptly following the later of March 1, 2019 or the date notice of March 1, 2019 is first publicly disclosed;

 

a description of any agreement, arrangement or understanding with respect to the proposal of business between or among such stockholder and the beneficial owner, if any, on whose behalf the proposal is made, any of their respective affiliates or associates, and any others acting in concert with any of the foregoing and a representation that the stockholder will notify the Company in writing of any such agreements, arrangements or understandings in effect as of March 1, 2019 for the meeting promptly following the later of March 1, 2019 or the date notice of March 1, 2019 is first publicly disclosed;

 

a representation that the stockholder is a holder of record of stock of the Company entitled to vote at such meeting and intends to appear in person or by proxy at the meeting to propose such business; and

 

any other information that is required to be provided by the stockholder pursuant to Section 14 of the Exchange Act and the rules and regulations promulgated thereunder in such stockholder’s capacity as a proponent of a stockholder proposal.

In addition, the Bylaws require that the stockholder recommendation shall set forth as to each person whom the stockholder proposes to nominate for election or reelection as a director: (1) the name, age, business address and residence address of the person; (2) the principal occupation or employment of the person; (3) the class, series and number of shares of capital stock of the Company that are owned beneficially and of record by the person; (4) a statement as to the person’s citizenship; (5) the completed and signed representation and agreement described above; (6) any other information relating to the person that is required to be disclosed in solicitations for proxies for election of directors pursuant to Section 14 of the Exchange Act; (7) such person’s written consent to being named in the proxy statement as a nominee and to serving as a director if elected; and (8) whether and the extent to which any derivative instrument, swap, option, warrant, short interest, hedge or profit interest or other transaction has been entered into by or on behalf of such person with respect to stock of the Company and whether any other agreement, arrangement or understanding (including any short position or any borrowing or lending of shares of stock) has been made by or on behalf of such person, the effect or intent of any of the foregoing being to mitigate loss to, or to manage risk of stock price changes for, such person or to increase or decrease the voting power or pecuniary or economic interest of such person with respect to stock of the Company.

We believe that each of our directors and nominees brings a strong background and set of skills to the Board, giving the Board, as a whole, an appropriate balance of the knowledge, experience, attributes, skills and expertise. In addition, seven of our eight directors are independent under Nasdaq standards (Mr. Gridley, our Chief Executive Officer, being the only exception as he is a Company employee) and our Nominating/Corporate Governance

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Committee believes that all eight directors are independent of the influence of any particular stockholder or group of stockholders whose interests may diverge from the interests of our stockholders as a whole. We believe that our directors have a broad range of personal characteristics including leadership, management, biotechnology, pharmaceutical, business, marketing and financial experience and abilities to act with integrity, with sound judgment and collegially, to consider strategic proposals, to assist with the development of our strategic plan and oversee its implementation, to oversee our risk management efforts and executive compensation and to provide leadership, to commit the requisite time for preparation and attendance at board and committee meetings and to provide required expertise on the Board committees. As described above, the Nominating/Corporate Governance Committee has recommended the members of the Board for their directorships. In evaluating such directors, our Nominating/Corporate Governance Committee has reviewed the experience, qualifications, attributes and skills of our directors and nominees, including those identified in the biographical information set forth above in the section entitled “Biographical Information – Directors.” The Nominating/Corporate Governance Committee believes that the members of the Board offer insightful and creative views and solutions with respect to issues facing the Company. In addition, the Nominating/Corporate Governance Committee also believes that the members of the Board function well together as a group. The Nominating/Corporate Governance Committee believes that the above-mentioned attributes and qualifications, along with the leadership skills and other experiences of the members of the Board described in further detail above under the section entitled “Biographical Information – Directors,” provide the Company with the perspectives and judgment necessary to guide the Company’s strategies and monitor their execution.

Special Committee

The Special Committee was officially formed on September 5, 2018 as our Board considered various strategic alternatives for the Company, but had also met on an interim, ad hoc basis for several months prior such formation (though with no authority to review or approve specific transactions during such interim period). The Special Committee was delegated the exclusive power and authority (1) consider, evaluate and comprehensively review the Company’s strategic options, including, but not limited to, potential strategic partnerships or transactions, cost reductions, reorganization, wind-down, liquidation or bankruptcy (collectively, without limitation, the Strategic Options); (2) take into consideration the Company’s risk profile and the potential impact of any Special Committee recommendation on the Company’s business model and strategic plan; (3) periodically report its recommendations relating to the Strategic Options to the full Board; and (4) perform such other duties as may be requested by the Board.

Four directors comprised the Special Committee as of December 31, 2018: Dr. Kong (the Chairman of the Special Committee), Mr. Baltzell, Mr. Gill and Mr. Johnson.  Dr. Kong resigned from the Board effective February 22, 2019. Mr. Baltzell was appointed as the Chairman of the Special Committee effective February 22, 2019.  The Special Committee met four times during 2018. In addition, the members of the Special Committee met informally more than a dozen times throughout the year (including prior to becoming a formal board committee) to discuss a variety of matters, including reviewing and assessing strategic alternatives for the Company in the fourth quarter of 2018 following the suspension of our NeoCart program .

Separation of CEO and Chairman of the Board Roles

The Board separates the positions of Chairman of the Board and Chief Executive Officer. Separating these positions allows our Chief Executive Officer to focus on our day-to-day business, while allowing the Chairman of the Board to lead the Board in its fundamental role of providing advice to and independent oversight of management. The Board recognizes the time, effort, and energy that the Chief Executive Officer is required to devote to his position in the current business environment, as well as the commitment required to serve as our Chairman of the Board, particularly as the Board’s oversight responsibilities continue to grow. We believe that having separate positions and having an independent outside director serve as Chairman of the Board is the appropriate leadership structure for the Company at this time.

Meetings of the Board of Directors

The Board met nine times during 2018 and acted three times by written consent. Each director attended 75% or more of the aggregate of the meetings of the Board and of the committees on which he or she served, held during the

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period for which he or she was a director or committee member, other than Mr. Rakin who attended 67% of the meetings of the Board (but attended 75% or more of the committees on which he served).

Director Attendance at Annual Meetings of Stockholders

Directors are encouraged, but not required, to attend our annual stockholder meetings. All of our directors attended our 2018 Annual Meeting of Stockholders.

Stockholder Communications with the Board of Directors

Stockholders may communicate with the Board, including the independent members of the Board, by sending a letter to Histogenics Corporation, 830 Winter Street, 3rd Floor, Waltham, MA 02451, Attention: Corporate Secretary. Each such communication should set forth (1) the name and address of such stockholder, as they appear on the Company’s books and, if the shares of the Company’s stock are held by a nominee, the name and address of the beneficial owner of such shares, and (2) the number of shares of the Company’s stock that are owned of record by such record holder and beneficially by such beneficial owner. The Corporate Secretary will review all communications from stockholders, but may, in his sole discretion, disregard any communication that he believes is not related to the duties and responsibilities of the Board. If deemed an appropriate communication, the Corporate Secretary will submit a stockholder communication to a chairman of a committee of the Board, or a particular director, as appropriate.

The Board has also adopted internal policies and procedures, with the assistance of outside legal counsel, for responding to communications from the Company’s stockholders, including litigation demand letters (a Litigation Demand), which provide that:

 

any Litigation Demand is promptly forwarded to the independent Chairman of the Board and outside legal counsel;

 

investigations of any Litigation Demand will be directed and supervised by one or more disinterested and independent (i.e., non-management) members of the Board and such supervision will not be delegated to any member of the Company’s management team (though in appropriate cases members of management may otherwise assist an investigation);

 

the Board has standing authority to retain and be advised by disinterested and independent outside legal counsel and other advisers, as needed;

 

the Board may authorize a special demand review committee to investigate a Litigation Demand, which committee would ensure the preparation of a written record of the resolution creating the demand review committee, its purpose, composition, structure, duties, responsibilities and scope of authority; and

 

upon completion of its investigation, the Board will receive a recommendation from the independent and disinterested members of the Board who investigated the Litigation Demand and vote on whether to adopt that recommendation and inform the demanding stockholder accordingly.

The Board’s Litigation Demand policy notes that every Litigation Demand situation is unique and that flexibility is required in responding thereto. Failure to adhere to any of the particular processes above is not deemed a breach of any Board member’s fiduciary duties.

Code of Business Conduct

We have adopted a Code of Business Conduct that applies to each of our directors, officers and employees, including our principal executive officer, principal financial officer, principal accounting officer or controller and persons performing similar functions. The Code of Business Conduct addresses various topics, including: (1) compliance with applicable laws, rules and regulations; (2) conflicts of interest; (3) public disclosure of information; (4) insider trading; (5) corporate opportunities; (6) competition and fair dealing; (7) gifts; (8) discrimination, harassment and retaliation; (9) health and safety; (10) record-keeping; (11) confidentiality;

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(12) protection and proper use of company assets; (13) payments to government personnel; and (14) the reporting of illegal and unethical behavior.

The Code of Business Conduct is available on the “Investors” section of our corporate website located at http://ir.histogenics.com. Any waiver of the Code of Business Conduct for an executive officer or director may be granted only by the Board or a committee thereof and must be timely disclosed as required by applicable law. We intend to disclose future amendments to certain provisions of our Code of Business Conduct, or waivers of those provisions, applicable to any principal executive officer, principal financial officer, principal accounting officer or controller, or persons performing similar functions on our website, www.histogenics.com.

We have implemented whistleblower procedures that establish formal protocols for receiving and handling complaints from employees. Any concerns regarding accounting or audit matters reported under these procedures will be communicated promptly to the Audit Committee.

Risk Oversight

The Board has responsibility for the oversight of the company’s risk management processes and, either as a whole or through its committees, regularly discusses with management our major risk exposures, their potential impact on our business and the steps we take to manage them. The risk oversight process includes the Board receiving regular reports from Board committees and members of senior management to enable the Board to understand the Company’s risk identification, risk management and risk mitigation strategies with respect to areas of potential material risk, including operations, finance, legal, regulatory, strategic, cybersecurity and reputational risk.

The Audit Committee reviews information regarding liquidity and operations, and oversees our management of financial risks. Periodically, the Audit Committee reviews our policies with respect to risk assessment, risk management, loss prevention and regulatory compliance. Oversight by the Audit Committee includes direct communication with our external independent auditors and discussions with management regarding significant risk exposures and the actions management has taken to limit, monitor or control such exposures. The Compensation Committee is responsible for assessing whether any of our compensation policies or programs has the potential to encourage excessive risk-taking. The Nominating/Corporate Governance Committee manages risks associated with the independence of the Board, corporate disclosure practices and potential conflicts of interest. While each committee is responsible for evaluating certain risks and overseeing the management of such risks, the entire Board is regularly informed through committee reports about such risks. Matters of significant strategic risk are considered by the Board as a whole.

The oversight of risk within the Company is an evolving process requiring the Company to continually look for opportunities to further embed systematic enterprise risk management into ongoing business processes within the Company. The Board encourages management to continue to drive this evolution.

Employee Compensation Risks

As part of its oversight of the Company’s executive compensation program, the Compensation Committee considers the impact of the Company’s executive compensation program, and the incentives created by the compensation awards that it administers, on the Company’s risk profile. In addition, the Compensation Committee reviews the compensation policies and procedures for all employees, including the incentives that they create and factors that may reduce the likelihood of excessive risk taking, to determine whether they present a significant risk to the Company. The Compensation Committee has determined that, for all employees, our Company’s compensation programs are not reasonably likely to have a material adverse effect on the Company.

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Director Compensation

The Board adopted a non-employee director policy effective as of the date of our initial public offering and subsequently amended and restated such policy in June 2015 and June 2017. The table below sets forth the provisions of the Amended and Restated Compensation Program for Non-Employee Directors.

 

Term

 

Compensation

 

Annual Cash Retainer(1)

 

$

40,000

 

Chairman of Board(1)

 

Additional annual retainer of $20,000

 

Chair of Audit Committee(1)

 

Additional annual retainer of $10,000

 

Chair of Compensation Committee(1)

 

Additional annual retainer of $7,500

 

Chair of Nominating/Corporate Governance Committee(1)

 

Additional annual retainer of $7,500

 

Chair of Special Committee(1)

 

Additional monthly retainer of $3,000

 

Non-Chair Member of Audit Committee(1)

 

Additional annual retainer of $5,000

 

Non-Chair Member of Compensation Committee(1)

 

Additional annual retainer of $3,750

 

Non-Chair Member of Nominating/Corporate Governance

   Committee(1)

 

Additional annual retainer of $3,750

 

Non-Chair Member of Special Committee(1)

 

Additional monthly retainer of $2,500

 

Initial Option Grant

 

Option to purchase up to 25,000 shares of our

common stock(2)

 

Annual Option Grant

 

Option to purchase 25,000 shares of our common

stock following each annual meeting of

stockholders(3)

 

 

(1)

All annual cash retainer fees are paid in four quarterly payments.

(2)

Option vests and becomes exercisable with respect to 8.33% of the option shares for each three-month period after the date of grant, except that in the event of a change in control or a director’s death or disability, the option will accelerate and become immediately exercisable.

(3)

Option vests and becomes exercisable with respect to 8.33% of the option shares for each one-month period following the date of grant, except that in the event of a change in control or a director’s death or disability, the option will accelerate and become immediately exercisable.

All stock option grants to non-employee directors will have an exercise price per share equal to the fair market value of one share of our common stock on the date of grant and will be subject to the terms of our 2013 Equity Incentive Plan. Each option granted under our Amended and Restated Compensation Program for Non-Employee Directors that is not fully vested will become fully vested upon a change in control of our Company or if the non-employee director’s service terminates due to death.

We currently have a policy to reimburse our non-employee directors for travel, lodging and other reasonable expenses incurred in connection with their attendance at board and committee meetings.

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Director Compensation Table for Year Ended December 31, 2018

The following table sets forth information regarding compensation earned by each of our non-employee directors during the fiscal year ended December 31, 2018.

 

Name (1)

 

Fees Earned or Paid in Cash ($)

 

 

Option Awards ($)

 

 

Total ($)

 

Garheng Kong, M.D., Ph.D.(2)

 

$

70,000

 

 

$

54,677

 

 

$

124,677

 

Josh Baltzell

 

 

49,583

 

 

 

54,677

 

 

 

104,260

 

David Gill

 

 

52,083

 

 

 

54,677

 

 

 

106,760

 

John Johnson(3)

 

 

54,583

 

 

 

54,677

 

 

 

109,260

 

Michael Lewis

 

 

40,469

 

 

 

54,677

 

 

 

95,146

 

Kevin Rakin

 

 

48,750

 

 

 

54,677

 

 

 

103,427

 

Susan Washer (4)

 

 

20,052

 

 

 

52,282

 

 

 

72,334

 

 

(1)

Mr. Gridley was not eligible in 2018 to receive any compensation from us for his service as a director pursuant to our Amended and Restated Compensation Program for Non-Employee Directors because Mr. Gridley is a Company employee.

(2)

Dr. Kong resigned from the Board effective February 22, 2019.

(3)

Mr. Johnson resigned from the Board effective February 27, 2019.

(4)

Ms. Washer was appointed to the Board on April 16, 2018.

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The following table sets forth information regarding outstanding option awards held by each of our non-employee directors as of December 31, 2018.

 

 

 

Option Awards

Name

 

Number of

Securities

Underlying

Unexercised

Options (#)

Exercisable

 

 

Number of

Securities

Underlying

Unexercised

Options (#)

Unexercisable

 

 

Option

Exercise

Price ($)

 

 

Option Expiration

Date

Garheng Kong, M.D., Ph.D.(5)

 

 

20,000

 

 

 

 

 

 

6.86

 

 

June 24, 2025(1)

 

 

 

10,000

 

 

 

 

 

 

1.58

 

 

December 16, 2026(1)