LifeCell Corporation 10-Q 9-30-06

3.	Inventories

Inventories consist of the following:

	September 30, 2006		December 31, 2005
	(dollars in thousands)
Unprocessed tissue and materials	$	11,469	$	7,730
Tissue products in-process		3,453		1,688
Tissue products available for distribution		5,226		3,118
Total inventories	$	20,148	$	12,536

4.	Fixed Assets

Fixed assets consist of the following:

	September 30, 2006			December 31, 2005
	(dollars in thousands)
Machinery and equipment	$	9,536		$	7,864
Leasehold improvements		15,142			8,346
Computer hardware, furniture and fixtures		4,021			3,459
Computer software		2,134			2,046
		30,833			21,715
Accumulated depreciation and amortization		(14,642	)		(12,444	)
Fixed assets, net	$	16,191		$	9,271

5.	Income Taxes

The tax provision represents Federal and state income taxes. The Company’s effective tax rate was 46.7% and 35.3%, respectively, for the three months ended September 30, 2006 and 2005, and was 44.9% and 35.6%, respectively, for the nine months ended September 30, 2006 and 2005. The effective tax rate differs from the U.S. Federal statutory rate primarily due to the impact of stock-based compensation, which cannot be recognized for tax purposes unless the stock options are exercised as a disqualifying disposition, and state income taxes, net of the federal benefit. In the nine months ended September 30, 2006 and 2005, the Company recognized $4.3 million and $7.2 million, respectively, of deferred tax assets related to the exercise of employee stock options, which were recorded as a direct credit to stockholder’s equity and therefore had no impact on the Company’s tax provision.

6.	Stock-Based Compensation

The LifeCell Corporation Equity Compensation Plan (“Plan”) was adopted by the Company’s board of directors in June 2005 and was approved by its stockholders in July 2005. The Compensation Committee of the Company’s board of directors administers the Plan. The Plan authorizes the issuance of various forms of stock-based awards including incentive and non-statutory stock options, stock purchase rights, stock appreciation rights, and restricted and unrestricted stock awards. Stock-based awards for employees generally vest over four years and have a ten year life. A total of 5,850,000 shares may be issued under the Plan through March 1, 2010. At September 30, 2006, there were 1,882,000 shares available for future awards under the Plan.

Stock Options

The Company estimates the fair value of stock options using the Black-Scholes option-pricing model. The Company estimates volatility by considering both implied volatility derived from publicly traded options to purchase LifeCell common stock and historical stock volatility. As allowed by Staff Accounting Bulletin (SAB) No. 107, Share-Based Payment, the Company elected to use the simplified method for estimating expected term equal to the midpoint between the vesting period and the contractual term. The Company believes that the valuation technique and the approach utilized to develop the underlying assumptions are appropriate in determining the estimated fair value of the Company’s stock options granted. Estimates of fair value are not intended to predict actual future events or the value ultimately realized by persons who receive equity awards.

The fair value of stock options granted during each of the periods was estimated on the grant date using the Black-Scholes option-pricing model with the following assumptions:

	Nine Months Ended September 30,
	2006	2005
Volatility	69.6%	79.4%-81.0%
Expected term (years)	5.67-6.25	6.25
Risk free interest rate	4.1% - 5.0%	3.7% - 4.4%
Expected dividend yield	0.0%	0.0%

A summary of stock option activity for the nine months ended September 30, 2006 is as follows:

	Number of Shares			Weighted Average Exercise Price		Weighted Average Remaining Contractual Life		Aggregate Intrinsic Value (in thousands)
Outstanding at December 31, 2005		2,257,000		$	6.71
Granted		474,000		$	21.34
Exercised		(667,000	)	$	4.25			$	11,635
Forfeited or canceled		(49,000	)	$	13.86
Outstanding at September 30, 2006		2,015,000		$	10.80		7.6 years	$	43,157

Exercisable at September 30, 2006		605,000		$	6.15		6.9 years	$	15,777

During the first nine months of 2006, the weighted average grant date fair value of stock options granted, calculated using the Black-Scholes option-pricing model, was $14.01 per share.

In connection with the stock option exercised during the nine months ended September 30, 2006, the Company received cash proceeds of $2.9 million.

Restricted Stock

A summary of restricted stock activity for the nine months ended September 30, 2006 is as follows:

	Non-vested Number of shares			Weighted Average Grant-Date Fair Value
Balance at December 31, 2005		647,000		$	17.03
Granted		121,000		$	21.58
Vested		(75,000	)	$	16.90
Balance at September 30, 2006		693,000		$	17.84

At September 30, 2006, there was $15.5 million of total unrecognized compensation costs related to non-vested stock options and restricted stock, which is expected to be recognized over a weighted average period of 2.4 years.

7.	Net Income per Common Share

The following table sets forth the computation of basic and diluted net income per common share:

	Three Months Ended September 30,				Nine Months Ended September 30,
	2006		2005		2006		2005
	(dollars and shares in thousands, except per share data)
Net income	$	5,072	$	2,504	$	14,243	$	8,213

Weighted average common shares outstanding		32,894		31,720		32,699		30,459
Denominator for basic net income per common share		32,894		31,720		32,699		30,459

Effect of dilutive securities:
Common stock		892		1,836		906		2,023
Warrants		-		51		-		639
Restricted stock		298		127		249		42
Denominator for diluted net income per common share		34,084		33,734		33,854		33,163

Basic net income per common share	$	0.15	$	0.08	$	0.44	$	0.27

Diluted net income per common share	$	0.15	$	0.07	$	0.42	$	0.25

The calculation of net income per share for the quarters ended September 30, 2006 and 2005 excludes stock options to purchase 490,000 shares of common in 2006 and 22,000 shares of common stock in 2005 because their inclusion would have been anti-dilutive. The calculation of net income per share for the nine months ended September 30, 2006 and 2005 excludes stock option to purchase 563,000 shares of common stock in 2006 and 103,000 shares of common stock in 2005 because their inclusion would be anti-dilutive.

8.	Comprehensive Income

The components of comprehensive income, net of tax, were as follows:

	Three Months Ended September 30,					Nine Months Ended September 30,
	2006		2005			2006		2005
		(dollars in thousands)

Net income	$	5,072	$	2,504		$	14,243	$	8,213
Other comprehensive income (loss):
Change in net unrealized holding loss on available for sale investments		60		(7	)		25		(4	)
Comprehensive income		5,132		2,497			14,268		8,209

9.	Commitments and Contingencies

Litigation

In November 2003, a complaint was filed in the Circuit Court of Fairfax, Virginia captioned Sun Hee Jung v. Yongsook Victoria Suh, M.D., Victoria Plastic Surgery Center, Inc. and LifeCell Corporation. The matter was a product liability action for personal injury damages allegedly arising from the use of one of the Company’s products. The case was dismissed without prejudice in December 2004 when the plaintiff elected to take a voluntary non-suit in this action. The plaintiff had six months from the date of the Order of Non-Suit to re-file the case, or the case would have been dismissed with prejudice and forever barred. The complaint was re-filed in May 2005. The re-filed case was dismissed with prejudice by the Court and a final judgment order was entered for the Company in June 2006. In August 2006, the plaintiff filed a Petition for Appeal with the Supreme Court of Virginia. In September 2006, the Company filed a Brief in Opposition with the Court in response to the Plaintiff’s Petition for Appeal.

In September 2005, the Company recalled certain human tissue based products because the organization which recovered the tissue, Biomedical Tissue Services, Ltd. (“BTS”), did not follow FDA requirements for donor consent and/or screening to determine if risk factors for communicable diseases existed. The Company promptly notified FDA and all relevant hospitals and medical professionals. FDA subsequently determined that patients who received tissue implants prepared from BTS donor tissue might be at a heightened risk of communicable disease transmission, and recommended those patients receive appropriate testing. The Company has worked closely with FDA to execute the product recall and to set up a LifeCell-sponsored testing program. The Company has not received any donor tissue from BTS after September 2005.

The Company has been named, along with BTS and many other defendants, in several lawsuits that relate to this matter. With the exception of the cases discussed below, the suits purport to serve as class actions for persons receiving transplants who are not physically injured, but instead seek medical monitoring and/or damages for emotional distress. Another defendant filed a series of motions to consolidate all class action cases in one venue as a Multi District Litigation (“MDL”). The MDL motion was granted and all of the federal cases were sent to New Jersey for consolidated handling. The Company has been successful in obtaining a voluntarily dismissal of every such class action.

There is one case filed in a Superior Court of North Carolina, Guilford County (“Sanders”) which specifically identifies the Company’s product and additionally names as defendants those medical professionals and hospitals involved in the transplant. The plaintiff in Sanders also seeks medical monitoring and damages for emotional distress, but does not seek any class remedy. The Company is attempting to transfer Sanders to the MDL.

A second case was filed in the Superior Court in Cook County, Illinois (“Castello”) which also specifically identified the Company’s product and additionally names BTS and its owner as defendants. Although the pleadings are some what vague, it appears the case does not allege any present personal injury. The Company is attempting to transfer Castello to the MDL.

A third case was filed in State Court in Tennesse (“Wells”), which case also seeks compensatory damages for emotional distress caused by the Company’s products. This case has been transferred to the MDL without objection.

In October 2006, seven other cases were filed in Federal and State courts of New Jersey (“Davis”, “Lane”, “Luck”, “Nutter”, “Tompkins”, “Turpyn” and “Wirkler”). Each plaintiff seeks compensatory damages for emotional distress and only name the Company as the source of the product at issue. Davis, Lane, Luck and Nutter were filed in Federal court and will be part of the MDL. The other three cases are in New Jersey State court and cannot be transferred to the MDL.

Lastly, another type of class action was filed in Federal Court in Rochester, New York (“Kennedy-McInnis”) which seeks compensatory damages from BTS and all processing defendants, including LifeCell, which received and used BTS-originated tissue. Plaintiffs are the next-of-kin of the donors who did not authorize BTS to remove the tissue at issue. Presently, plaintiffs are objecting to the transfer to the MDL litigation. Last week, another similar class action was filed in State Court in New York (“Graves”). It has been removed to Federal court and transfer to the MDL will also be sought.

The Company intends to vigorously defend each case. The Company will pursue dismissal of all class action cases which do not identify its product being at issue. The Company believes it is not currently possible to estimate the likelihood of an unfavorable outcome and/or the impact, if any, the ultimate resolution of these cases could have on the Company’s operations, financial position or cash flow. The Company maintains insurance coverage for events and in amounts that it deems appropriate. There can be no assurance that the level of insurance maintained will be sufficient to cover the claims or that the all of the claims will be covered by the terms of any insurance.

Item 2.

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

The following discussion of our results of operations and financial condition should be read in conjunction with the Financial Statements and Notes included in Part I. “Financial Information”.

This report contains forward looking statements made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995 under Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended.

Forward-looking statements include statements with respect to our beliefs, plans, objectives, goals, expectations, anticipations, assumptions, estimates, intentions, and future performance, and involve known and unknown risks, uncertainties and other factors, which may be beyond our control, and which may cause our actual results, performance or achievements to be materially different from future results, performance or achievements expressed or implied by such forward-looking statements.

All statements other than statements of historical fact are statements that could be forward-looking statements. You can identify these forward-looking statements through our use of words such as “may,” “will,” “can” “anticipate,” “assume,” “should,” “indicate,” “would,” “believe,” “contemplate,” “expect,” “seek,” “estimate,” “continue,” “plan,” “point to,” “project,” “predict,” “could,” “intend,” “target,” “potential,” and other similar words and expressions of the future.

Forward-looking statements may not be realized due to a variety of factors, including, without limitation:

•

the failure to maintain or increase revenues from the sale of our AlloDerm products;

•

the failure to comply with government regulations, including the FDA;

•

claims for damages by third-parties, including product liability claims;

•

our dependence on a limited number of sources for human cadaveric tissue;

•

negative publicity about the use of donated human tissue in medical procedures;

•

our ability to increase market penetration of our current products and to develop and commercialize new products;

•

changes in third party reimbursement practices;

•

the failure of third party sales representatives and distributors to adequately promote, market and sell our products;

•

our inability to protect our intellectual property;

•

the effects of competition; and

•

the other factors listed under “Risk Factors” in our annual report on Form 10-K for the year ended December 31, 2005 and other reports that we file with the Securities and Exchange Commission.

All forward-looking statements are expressly qualified in their entirety by this cautionary notice. You are cautioned not to place undue reliance on any forward-looking statements, which speak only as of the date of this report. We have no obligation, and expressly disclaim any obligation, to update, revise or correct any of the forward-looking statements, whether as a result of new information, future events or otherwise. We have expressed our expectations, beliefs and projections in good faith and we believe they have a reasonable basis. However, we cannot assure you that our expectations, beliefs or projections will result or be achieved or accomplished.

Supervision and Regulation — Securities and Exchange Commission

We maintain a website at www.lifecell.com. We make available free of charge on our website all electronic filings with the SEC (including proxy statements and reports on Forms 8-K, 10-K and 10-Q and any amendments to these reports) as soon as reasonably practicable after such material is electronically filed with or furnished to the SEC. The SEC maintains an internet site (http://www.sec.gov) that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC.

We have also posted policies, codes and procedures that outline our corporate governance principles, including the charters of the board’s audit, compensation, nominating and corporate governancecommittees, and our Code of Ethics covering directors and all employees and the Code of Ethics for senior financial officers on our website. These materials also are available free of charge in print to stockholders who request them in writing. The information contained on our website does not constitute a part of this report.

Our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and all other documents filed by us or with respect to our securities with the Securities and Exchange Commission are available free of charge through our website at www.lifecell.com. The information contained on our website does not constitute a part of this report.

In the following discussions, most percentages and dollar amounts have been rounded to aid the presentation. As a result, all such figures are approximations.

General and Background

We develop and market human tissue based products for use in reconstructive, orthopedic and urogynecologic surgical procedures to repair soft tissue defects. Our patented technology produces a unique regenerative human tissue matrix -- a complex three-dimensional structure that contains vascular channels, proteins and growth factor binding sites -- that provides a template for the regeneration of normal human tissue. Our current products include: AlloDerm®, for plastic reconstructive, general surgical, burn and periodontal procedures; Cymetra®, a particulate form of AlloDerm suitable for injection; GraftJacket® and GraftJacket® Xpress, for orthopedic applications and lower extremity wounds; AlloCraft™DBM, for bone grafting procedures; and Repliform®, for urogynecologic surgical procedures. We market AlloDerm for plastic reconstructive, general surgical and burn applications through our direct sales organization. Our strategic sales and marketing partners include: Wright Medical Group, Inc. for GraftJacket and GraftJacket Xpress; Stryker Corporation for AlloCraftDBM; Boston Scientific for Repliform; and BioHorizons for periodontal applications of AlloDerm. Our research and development initiatives include programs designed to extend the use of our current regenerative tissue matrix products into new surgical applications, as well as leveraging our core technology to other tissues, including tissues recovered from non-human sources. We have a variety of research and development programs designed to expand our product line in the rapidly growing biologic market. Such programs include the investigation of novel biologics, alone or in combination with our regenerative tissue matrix.

Critical Accounting Policies / Estimates

Effective January 1, 2006, we adopted the provisions of Statement of Financial Accounting Standards No. 123R, “Share-Based Payment” (“SFAS 123R”) which establishes accounting for equity instruments exchanged for employee service. We utilize the Black-Scholes option pricing model to estimate the fair value of employee stock based compensation at the date of grant, which requires the input of highly subjective assumptions, including expected volatility and expected life. Further, as required under SFAS 123R, we now estimate forfeitures for options granted, which are not expected to vest. Changes in these inputs and assumptions can materially affect the measure of estimated fair value of our share-based compensation. These assumptions are subjective and generally require significant analysis and judgment to develop. When estimating fair value, some of the assumptions will be based on, or determined from, external data and other assumptions may be derived from our historical experience with stock-based payment arrangements. The appropriate weight to place on historical experience is a matter of judgment, based on relevant facts and circumstances.

We estimated volatility by considering both implied volatility derived from publicly traded options to purchase LifeCell common stock and historical stock volatility. As allowed by Staff Accounting Bulletin (SAB) No. 107, Share-Based Payment, we have opted to use the simplified method for estimating expected term equal to the midpoint between the vesting period and the contractual term. We estimate forfeitures using historical employee turn-over rates. Our estimates of forfeitures will be adjusted over the requisite service period based on the extent to which actual forfeitures differ, or are expected to differ, form their estimate.

For the nine months ended September 30, 2006, there were no other changes to our critical accounting policies as identified in our annual report of Form 10-K for the year ended December 31, 2005.

Results of Operations

Three Months Ended September 30, 2006 and 2005

Revenues

Total revenues for the three months ended September 30, 2006 increased 44% to $35.3 million compared to $24.5 million for the same period in 2005. The increase was primarily attributable to a 45% increase in product revenues to $35.1 million in the current period as compared to $24.3 million in the prior year.

Revenues generated from the use of our products in reconstructive surgical procedures increased 50% to $30.7 million in the three months ended September 30, 2006 compared to $20.5 million in the same period in 2005. The growth was primarily driven by increased demand for AlloDerm in complex hernia repair and breast reconstruction procedures. AlloDerm revenues increased 55% to $29.9 million in the three months ended September 30, 2006 compared to $19.3 million in the same period of 2005.

Orthopedic product revenue grew 25% to $2.4 million in the three months ended September 30, 2006 from $2.0 million in 2005. This revenue growth resulted primarily from increased demand for our GraftJacket products. GraftJacket revenues were $2.0 million in 2006 compared to $1.5 million in the same period in 2005.

Revenues generated from the use of our Repliform product in urogynecologic surgical procedures increased 9% to $2.0 million in the three months ended September 30, 2006 compared to $1.8 million for the same period in 2005.

Our independent sales and marketing agents and distributors generated 16% of our total product revenue in the three months ended September 30, 2006 compared to 19% in the same period in 2005. Boston Scientific and Wright Medical each represented 6% of our total product revenues in 2006 compared to 7% and 6%, respectively, for the same period in 2005. No other individual independent sales agent or distributor generated more than 5% of our total product revenues in the three months ended September 30, 2006.

Research grant revenues were $162,000 in the third quarter of 2006 compared to $272,000 in 2005. This decrease was primarily due to a decrease in research spending on projects funded by approved research grants, since research grant revenues are recognized when qualified expenses are incurred. As of September 30, 2006, approximately $1.1 million of approved grant funding was available to fund future research and development expenses through the end of 2006.

Costs and expenses

Costs and expenses for the quarter ended September 30, as a percentage of product revenue were:

	2006					2005
(dollars in thousands)	Dollars		%			Dollars		%
Cost of products sold	$	10,524		30	%	$	8,551		35	%
Research and development		4,180		12	%		3,013		12	%
General and administrative		4,832		14	%		3,170		13	%
Selling and marketing		7,021		20	%		6,230		25	%
Total costs and expenses	$	26,557		75	%	$	20,964		85	%

Effective January 1, 2006, we adopted Statement of Financial Accounting Standards No. 123 (revised 2004), “Share-Based Payment,” (“SFAS 123R”) which requires the measurement and recognition of compensation expense for all share-based payment awards made to our employees and directors, including stock options and restricted stock, based on estimated fair values. We elected to adopt the modified prospective transition method as provided by SFAS 123R and, accordingly, prior year results have not been restated. Stock-based compensation expense recognized under SFAS 123R for the three months ended September 30, 2006 was $2.6 million. Detail of the stock-based compensation expense by financial statement caption including the stock-based compensation as a percentage of revenue was as follows:

	Three Months Ended September 30, 2006
(dollars in thousands)	Dollars		%
Cost of products sold	$	223		1	%
Research and development		624		2	%
General and administrative		1,263		4	%
Selling and marketing		507		1	%
Total stock-based compensation	$	2,617		7	%

Cost of products sold for the three months ended September 30, 2006 was $10.5 million, or 30% of product revenues, compared to cost of products sold of $8.6 million, or 35% of product revenue for the same period in 2005. In the third quarter of 2005 cost of products sold was negatively impacted by a $1.4 million write-off of inventory associated with a product recall. In addition, a $469,000 reserve was established to cover estimated product returns and other costs related to a previously announced product recall.

Total research and development expenses increased 39% to $4.2 million in the three months ended September 30, 2006 compared to $3.0 million for the same period in 2005. The increase was primarily attributable to: (i) stock-based compensation expense, (ii) payroll and related expenses associated with increased headcount and annual merit increases, and (iii) operating supplies. Our research and development initiatives include programs designed to extend the use of our current regenerative tissue matrix products into new surgical applications, as well as leveraging our core technology to other tissues, including tissues recovered from non-human sources. A significant amount of our research in 2006 will be focused on the development of an animal-based version of our human-based regenerative tissue products. Pre-clinical evaluation is on going and we plan to seek FDA approval to commence clinical evaluation in 2007. We also have a variety of research and development programs designed to expand our product line in the rapidly growing biologic market. Such programs include the investigation of novel biologics, alone or in combination with our regenerative tissue matrix.

General and administrative expenses increased 52% to $4.8 million in the three months ended September 30, 2006 compared to $3.2 million for the same period in 2005. The increase was primarily attributable to (i) stock-based compensation expense, (ii) increases in payroll and related expenses associated with increased headcount and annual merit increases, and (iii) increases in professional fees primarily related to recruiting.

Selling and marketing expenses increased 13% to $7.0 million for the three months ended September 30, 2006 compared to $6.2 million for the same period in 2005. The increase was primarily attributable to: (i) stock-based compensation expense, (ii) higher selling expenses, principally payroll, commissions and travel and entertainment resulting from the expansion of our direct sales force and (iii) an increase in marketing and medical education program expenses for AlloDerm. Our independent sales and marketing agents are paid agency fees based on the amount of product revenues they generate for us. Selling and marketing expenses included agent fees of $924,000 and $805,000, respectively, in the three months ended September 30, 2006 and 2005. The increase in agent fees resulted from an increase in revenue generated through our independent sales and marketing agents.

Interest and other income, net

Interest and other income, net increased $501,000 in the three months ended September 30, 2006 compared to 2005 due to an increase in interest income resulting from a higher level of invested cash and higher rate of return.

Income tax provision

The provision for income taxes was $4.4 million in the quarter ended September 30, 2006 compared to $1.4 million in the same period in 2005 resulting in an effective income tax rate of a 46.7% and 35.3%, respectively. The increase in the effective tax rate was primarily due to the recognition of stock-based compensation expense for incentive stock options, which cannot be recognized for tax purposes until the stock options are exercised and a decrease in tax benefits associated with research and development tax credits. In addition, during the third quarter of 2005, we recognized a $185,000 income tax benefit resulting from a change in the projected tax rate. Although we recorded a tax provision in 2006 and 2005, we are not required to pay regular federal income taxes until such time as our net operating losses and tax credit carryforwards are exhausted or expire. As of September 30, 2006, we had a net operating loss carry forward (“NOL”) for federal income tax purposes of $25.3 million.

Nine Months Ended September 30, 2006 and 2005

Revenues

Total revenues for the nine months ended September 30, 2006 increased 52% to $102.1 million compared to $67.1 million for the same period in 2005. The increase was primarily attributable to a 53% increase in product revenues to $101.3 million in the current period as compared to $66.3 million in the prior year.

Revenues generated from the use of our products in reconstructive surgical procedures increased 60% to $88.3 million in the nine months ended September 30, 2006 compared to $55.4 million in the same period in 2005. The growth was primarily driven by increased demand for AlloDerm in complex hernia repair and breast reconstruction procedures. AlloDerm revenues increased 65% to $85.5 million in the nine months ended September 30, 2006 compared to $51.8 million in the same period of 2005.

Orthopedic product revenue grew 20% to $6.9 million in the nine months ended September 30, 2006 from $5.8 million in 2005. This revenue growth resulted primarily from increased demand for our GraftJacket products. GraftJacket revenues were $5.8 million in 2006 compared to $4.6 million in the same period in 2005.

Revenues generated from the use of our Repliform product in urogynecologic surgical procedures increased 18% to $6.0 million in the nine months ended September 30, 2006 compared to $5.1 million for the same period in 2005.

Our independent sales and marketing agents and distributors generated 16% of our total product revenue in the nine months ended September 30, 2006 compared to 20% in 2005. Boston Scientific and Wright Medical each represented 6% of our total product revenues in 2006 compared to 8% and 7%, respectively, for the same period in 2005. No other individual independent sales agent or distributor generated more than 5% of our total product revenues in the nine months ended September 30, 2006.

Research grant revenues, were $741,000 in the first nine months of 2006 compared to $823,000 in 2005.

Costs and expenses

Costs and expenses for the nine months ended September 30, as a percentage of product revenue were:

	2006					2005
(dollars in thousands)	Dollars		%			Dollars		%
Cost of products sold	$	29,834		29	%	$	21,286		32	%
Research and development		11,611		11	%		7,699		11	%
General and administrative		13,856		14	%		8,334		12	%
Selling and marketing		22,823		22	%		17,635		26	%
Total costs and expenses	$	78,124		77	%	$	54,954		82	%

Effective January 1, 2006, we adopted Statement of Financial Accounting Standards No. 123 (revised 2004), “Share-Based Payment,” (“SFAS 123R”) which requires the measurement and recognition of compensation expense for all share-based payment awards made to our employees and directors including stock options and restricted stock based on estimated fair values. We elected to adopt the modified prospective transition method as provided by SFAS 123R and, accordingly, prior year results have not been restated. Stock-based compensation expense recognized under SFAS 123R for the nine months ended September 30, 2006 was $6.5 million. Detail of the stock-based compensation expense by financial statement caption including the stock-based compensation as a percentage of revenue was as follows:

	Nine Months Ended September 30, 2006
(dollars in thousands)	Dollars		%
Cost of products sold	$	467		*
Research and development		1,507		1	%
General and administrative		3,212		3	%
Selling and marketing		1,273		1	%
Total stock-based compensation	$	6,459		6	%

*Less than 1%

Cost of products sold for the nine months ended September 30, 2006 was $29.8 million, or 29% of product revenues, compared to cost of products sold of $21.3 million, or 32% of product revenue for the same period in 2005. In the third quarter of 2005 cost of products sold was negatively impacted by a $1.4 million write-off of inventory associated with a previously announced product recall. In addition, a $469,000 reserve was established to cover estimated product returns and other costs related to the product recall.

Total research and development expenses increased 51% to $11.6 million in the nine months ended September 30, 2006 compared to $7.7 million for the same period in 2005. The increase was primarily attributable to: (i) payroll and related expenses associated with increased headcount and annual merit increases, (ii) stock-based compensation expense, (iii) operating supplies, and (iv) professional fees and expenses related to animal studies. Our research and development initiatives include programs designed to extend the use of our current regenerative tissue matrix products into new surgical applications, as well as leveraging our core technology to other tissues, including tissues recovered from non-human sources. A significant amount of our research in 2006 will be focused on the development of an animal-based version of our human-based regenerative tissue products. Pre-clinical evaluation is ongoing and we plan to seek FDA approval to commence clinical evaluation in 2007. We also have a variety of research and development programs designed to expand our product line in the rapidly growing biologic market. Such programs include the investigation of novel biologics, alone or in combination with our regenerative tissue matrix.

General and administrative expenses increased 66% to $13.9 million in the nine months ended September 30, 2006 compared to $8.3 million for the same period in 2005. The increase was primarily attributable to: (i) stock-based compensation expense, (ii) increases in payroll and related expenses associated with increased headcount and annual merit increases, (iii) increases in professional fees primarily related to business development activities and accounting services and (iv) an increase in insurance premiums.

Selling and marketing expenses increased 29% to $22.8 million for the nine months ended September 30, 2006 compared to $17.6 million for the same period in 2005. The increase was primarily attributable to: (i) higher selling expenses, principally payroll, commissions and travel and entertainment resulting from the expansion of our direct sales force, (ii) stock-based compensation expense and (iii) an increase in marketing and medical education program expenses for AlloDerm. Selling and marketing expenses included agent fees of $2.8 million and $2.5 million, respectively, in the nine months ended September 30, 2006 and 2005. The increase in agent fees resulted from an increase in revenue generated through our independent sales and marketing agents.

Interest and other income, net

Interest and other income, net increased $1.3 million in the nine months ended September 30, 2006 compared to the same period in 2005 due to an increase in interest income resulting from a higher level of invested cash and higher rate of return.

Income tax provision

The provision for income taxes was $11.6 million in the nine months ended September 30, 2006 compared to $4.5 million in the same period in 2005 resulting in an effective income tax rate of a 44.9% and 35.6%, respectively. The increase in the effective tax rate was primarily due to the recognition of stock-based compensation expense for incentive stock options, which cannot be recognized for tax purposes until the stock options are exercised and a decrease in tax benefits associated with research and development tax credits. In addition, during the first nine months of 2005, we recognized an income tax benefit resulting from a change in the projected tax rate totaling $481,000. Although we recorded a tax provision in 2006 and 2005 we are not required to pay regular federal income taxes until such time as our net operating losses and tax credit carry forwards are exhausted or expire.

Liquidity and Capital Resources

At September 30, 2006, we had $9.9 million in cash and cash equivalents, $57.0 million in short-term marketable securities and $2.5 million in long-term marketable securities. Working capital increased to $97.3 million at September 30, 2006 from $73.2 million at December 31, 2005. The increase in working capital resulted primarily from increases in short-term investments, accounts receivable, and inventories, partially offset by a decrease in cash and cash equivalents and an increase in accounts payable.

We generated $23.3 million of cash from operating activities for the nine months ended September 30, 2006 compared to $11.6 million for the same period in 2005. The increase in cash from operating activities in 2006, as compared to 2005, was principally due to higher net income after adjustments for non-cash items and normal increases in accounts payable and accrued liabilities associated with our growth. Such increases were partially offset by a planned increase in inventories to support anticipated growth, and a normal increase in receivables associated with higher revenue. Although we recorded a tax provision in 2006 and 2005, we are not required to pay regular federal income taxes until such time as our net operating losses and tax credit carryforwards are exhausted or expire.

Capital expenditures were $9.1 million in 2006 and consisted primarily of leasehold improvements related to a facility expansion and the purchase of manufacturing and computer equipment.

Our financing activities generated $7.2 million for the nine months ended September 30, 2006 compared to $6.1 million for the same period in 2005. In 2006, the cash generated from financing activities resulted from cash proceeds received from the exercise of common stock options and the related excess tax benefits realized. In 2005, the cash generated from financing activities resulted from cash proceeds received from the exercise of common stock options and warrants.

The following table reflects a summary of our contractual cash obligations as of September 30, 2006:

	Payments Due by Period
	Total		Less than one year		1 to 2 years		3 to 4 years		After 5 years
Operating leases	$	3,829	$	919	$	1,838	$	1,072	$	-
Licensing agreement		1,750		250		500		500		500
Total contractual cash obligations	$	5,579	$	1,169	$	2,338	$	1,572	$	500

Purchase orders or contracts for the purchase of raw materials and other goods and services are not included in the table above. We are not able to determine the aggregate amount of such purchase orders that represent contractual obligations, as purchase orders may represent authorizations to purchase rather than binding agreements. Although we have entered into contracts for services, the obligations under these contracts were not significant and the contracts generally contain clauses allowing for cancellation without significant penalty.

At the end of 2005, we commenced a facility expansion at our Branchburg, New Jersey facility to increase office space and processing capacity. Capital expenditures associated with the facility expansion for the balance of 2006 are estimated to be approximately $2.5 million.

We believe that our current cash resources together with anticipated product revenues and committed research and development grant funding will be sufficient to finance our planned operations, research and development programs and fixed asset requirements in the foreseeable future. However, we may need additional funds to meet our long-term strategic objectives, including the completion of potential acquisitions. We have no commitments for any future funding and there can be no assurance that we will be able to obtain additional funding in the future through debt or equity financings, collaborative arrangements or other sources on terms acceptable to us, or at all. Any additional equity financing may be dilutive to stockholders, and debt financing, if available, may involve significant restrictive covenants.

Item 3.

Quantitative and Qualitative Disclosures About Market Risk.

We are exposed to changes in interest rates primarily from our investments in certain marketable securities, consisting principally of fixed income debt securities. Although our investments are available for sale, we generally hold such investments to maturity. Our investments are stated at fair value, with net unrealized gains or losses on the securities recorded as accumulated other comprehensive income (loss) in shareholders’ equity. Net unrealized gains and losses were not material at September 30, 2006 or 2005.

Item 4.

Controls and Procedures.

Disclosure controls and procedures.

During the first nine months of 2006, our management, including the principal executive officer and principal financial officer, evaluated our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934) related to the recording, processing, summarization and reporting of information in our reports that we file with the SEC. These disclosure controls and procedures have been designed to ensure that material information relating to us, including our subsidiaries, is made known to our management, including these officers, by other of our employees, and that this information is recorded, processed, summarized, evaluated and reported, as applicable, within the time periods specified in the SEC’s rules and forms. Due to the inherent limitations of control systems, not all misstatements may be detected. These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. Our controls and procedures can only provide reasonable, not absolute, assurance that the above objectives have been met.

Based on their evaluation as of September 30, 2006, our principal executive officer and principal financial officer have concluded that our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934) are effective to reasonably ensure that the information required to be disclosed by us in the reports that we file or submit under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms.

Changes in internal controls over financial reporting.

There have been no changes in our internal control over financial reporting that occurred during the reporting period to which this Quarterly Report on Form 10-Q relates that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II.

OTHER INFORMATION

Item 1.

Legal Proceedings

Item 1a.

Risk Factors

There were no material changes in any risk factors previously disclosed in our Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 8, 2006.

Item 6.

Exhibits

31.1

Certification of our Chief Executive Officer, Paul G. Thomas, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

31.2

Certification of our Chief Financial Officer, Steven T. Sobieski, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

32.1

Certification of our Chief Executive Officer, Paul G. Thomas and Chief Financial Officer, Steven T. Sobieski, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

		LIFECELL CORPORATION


Date: October 25, 2006		By:/s/ Paul G. Thomas
		Paul G. Thomas
		Chairman of the Board,
		President and Chief Executive Officer
		(Principal Executive Officer)

Date: October 25, 2006		By: /s/ Steven T. Sobieski
		Steven T. Sobieski
		Vice President, Finance
		Chief Financial Officer and Secretary
		(Principal Financial Officer)

Date: October 25, 2006		By: /s/ Bradly C. Tyler
		Bradly C. Tyler
		Controller
		(Principal Accounting Officer)

	Delaware		76-0172936
	(State or other jurisdiction of		(IRS Employer
	incorporation or organization)		Identification No.)

	September 30,			December 31,
	2006			2005
ASSETS
Current assets
Cash and cash equivalents	$	9,888		$	21,272
Short-term investments		57,007			26,795
Receivables, less allowance of $261 in 2006 and $156 in 2005		19,851			15,786
Inventories		20,148			12,536
Prepayments and other		1,309			885
Deferred tax assets		10,164			10,660
Total current assets		118,367			87,934

Investments in marketable securities		2,501			--
Fixed assets, net		16,191			9,271
Deferred tax assets		2,576			8,057
Other assets, net		1,707			1,736
Total assets	$	141,342		$	106,998

LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities
Accounts payable	$	11,879		$	6,680
Accrued liabilities		9,199			8,248
Total current liabilities		21,078			14,928

Commitments and contingencies

Stockholders’ equity
Undesignated preferred stock, $.001 par value, 1,817,795 shares authorized; none issued and outstanding		--			--
Common stock, $.001 par value, 48,000,000 shares authorized; 33,640,000 and 32,841,000 shares issued and outstanding in 2006 and 2005		34			33
Additional paid-in capital		132,399			118,473
Accumulated other comprehensive income (loss)		30			5
Accumulated deficit		(12,199	)		(26,441	)
Total stockholders’ equity		120,264			92,070
Total liabilities and stockholders’ equity	$	141,342		$	106,998

	Nine months ended September 30,
	2006			2005
Cash flows from operating activities:
Net income	$	14,243		$	8,213
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		2,238			2,007
Deferred taxes		10,294			4,119
Excess tax benefit from stock-based compensation		(4,310	)		-
Stock-based compensation		6,458			677
Provision for bad debt		135			98
Inventory write-off		-			1,402
Inventory net realizable value provision		288			655
Reserve for product returns		-			469
Loss on disposal of fixed assets		4			-
Changes in operating assets and liabilities:
Receivables		(4,200	)		(4,148	)
Inventories		(7,620	)		(4,803	)
Prepayments and other		(424	)		(669	)
Accounts payable and accrued liabilities		6,149			3,578

Net cash provided by operating activities		23,255			11,598

Cash flows from investing activities:
Proceeds from maturities and sale of investments		4,875			6,870
Purchases of investments		(37,570	)		(8,915	)
Capital expenditures		(9,133	)		(2,026	)
Intangible assets		-			(1,250	)

Net cash used in investing activities		(41,828	)		(5,321	)

Cash flows from financing activities:
Proceeds from exercise of common stock options		2,879			6,053
Excess tax benefit from stock-based compensation		4,310			-

Net cash provided by financing activities		7,189			6,053

Net increase (decrease) in cash and cash equivalents		(11,384	)		12,330
Cash and cash equivalents at beginning of period		21,272			10,084

Cash and cash equivalents at end of period	$	9,888		$	22,414

Supplemental disclosure of cash flow information:
Cash paid during the period for interest	$	-		$	3
Cash paid during the period for income taxes	$	175		$	475

	Three Months Ended September 30, 2005			Nine Months Ended September 30, 2005
	(dollars in thousands, except per share data)
Net income, as reported	$	2,504		$	8,213
Add: Total stock-based compensation expense included in reported net income, net of related tax effects		436			436
Less: Total stock-based compensation expense determined under fair value based method for all awards, net of related tax effects		(1,076	)		(2,106	)
Net Income, Pro forma	$	1,864		$	6,543

Basic net income per common share
As reported	$	0.08		$	0.27
Pro forma	$	0.06		$	0.21

Diluted net income per common share
As reported	$	0.07		$	0.25
Pro forma	$	0.06		$	0.20

	Three Months Ended September 30, 2006			Nine Months Ended September 30, 2006
	(dollars in thousands)
Cost of products sold	$	223		$	467
Research and development		624			1,507
General and administrative		1,263			3,212
Selling and marketing		507			1,273
Stock-based compensation expense, before tax		2,617			6,459

Income tax benefit		(789	)		(1,915	)
Net compensation expense	$	1,828		$	4,544