NOTES TO UNAUDITED CONSOLIDATED FINANCIAL
STATEMENTS
1. Overview and Basis of Presentation
Overview
Biostage, Inc., formerly Harvard Apparatus
Regenerative Technology, Inc. (“Biostage” or the “Company”) is a biotechnology company developing bioengineered
organ implants based on our novel Cellframe
TM
technology. Our Cellframe technology
is comprised of a biocompatible scaffold that is seeded with the recipient’s own stem cells. We believe that this technology
may prove to be effective for treating patients across a number of life-threatening medical indications who currently have unmet
medical needs. We are currently developing our Cellframe technology to treat life-threatening conditions of the esophagus, bronchus
or trachea with the objective of dramatically improving the treatment paradigm for those patients.
Since inception, the Company has devoted
substantially all of its efforts to business planning, research and development, recruiting management and technical staff, and
acquiring operating assets.
The Company changed its name from Harvard
Apparatus Regenerative Technology, Inc. to Biostage, Inc. on March 31, 2016. All references to the Company have been changed to
Biostage in the accompanying consolidated financial statements and notes thereto.
Basis of Presentation
The financial statements reflect the Company’s
financial position, results of operations and cash flows in conformity with accounting principles generally accepted in the United
States (“GAAP”).
Earnings per Share
Basic net loss per share is computed using
the weighted average number of common shares outstanding during the period. Diluted net loss per share is computed using the sum
of the weighted average number of common shares outstanding during the period and, if dilutive, the weighted average number of
potential shares of common stock, including the assumed exercise of stock options and warrants and unvested restricted stock.
The Company applied the two-class method
to calculate basic and diluted net loss per share attributable to common stockholders for the three and nine months ended September
30, 2016, as its warrants to purchase common stock are participating securities.
The two-class method is an earnings allocation
formula that treats a participating security as having rights to earnings that otherwise would have been available to common stockholders.
However, the two-class method does not impact the net loss per share of common stock as the Company was in a net loss position
for the three and nine months ended September 30, 2016 and warrant holders do not participate in losses.
Basic and diluted shares outstanding are
the same for each period presented as all common stock equivalents would be antidilutive due to the net losses incurred.
Reclassification
Sales and marketing expenses of $0.1 million
and $0.3 million for the three and nine months ended September 30, 2015, respectively, have been reclassified to selling, general
and administrative expenses to conform to the 2016 presentation.
Unaudited Interim Financial Information
The accompanying interim balance sheet
as of September 30, 2016 and consolidated interim statements of operations and comprehensive loss and cash flows for the nine months
ended September 30, 2016 and 2015 are unaudited. The interim unaudited consolidated financial statements have been prepared in
accordance with GAAP on the same basis as the annual audited financial statements and, in the opinion of management, reflect all
adjustments necessary for a fair statement of the Company’s financial position as of September 30, 2016 and its results
of operations and cash flows for the nine months ended September 30, 2016 and 2015. The financial data and other information
disclosed in these notes related to the three month period ended September 30, 2016 and 2015 are unaudited. The results for the
nine months ended September 30, 2016 are not necessarily indicative of results to be expected for the year ending December 31,
2016, any other interim periods or any future year or period.
2. Summary of Significant Accounting Policies and Recently
Issued Accounting Pronouncements
Summary of Significant Accounting Policies
The accounting policies underlying the
accompanying unaudited consolidated financial statements are those set forth in Note 2 to the financial statements for the year
ended December 31, 2015 included in the Company’s Annual Report on Form 10-K, and additionally the following accounting policy
for warrants issued during the nine months ended September 30, 2016.
Warrant Accounting
The Company classifies a warrant to purchase
shares of its common stock as a liability on its consolidated balance sheets as this warrant is a free-standing financial instrument
that may require the Company to transfer consideration upon exercise. Each warrant is initially recorded at fair value on date
of grant using the Black-Scholes model and net of issuance costs, and it is subsequently re-measured to fair value at each subsequent
balance sheet date. Changes in fair value of the warrant are recognized as a component of other income (expense), net in the consolidated
statement of operations and comprehensive loss. The Company will continue to adjust the liability for changes in fair value until
the earlier of the exercise or expiration of the warrant.
Recently Issued Accounting Pronouncements
In August 2014, the Financial Accounting
Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-15, “
Disclosure
of Uncertainties about an Entity’s Ability to Continue as a Going Concern,”
to provide guidance on management’s
responsibility in evaluating whether there is substantial doubt about a company’s ability to continue as a going concern
and to provide related footnote disclosures. This update is effective for annual periods ending after December 15, 2016, and
interim periods within annual periods beginning after December 15, 2016. Early application is permitted for annual or interim
reporting periods for which the financial statements have not previously been issued. The Company has not adopted ASU 2014-15 and
does not expect the adoption to have a significant impact on the Company’s consolidated financial statements or related disclosures.
In February 2016, the FASB, issued ASU,
2016-02-
Leases (Topic 842)
. The ASU 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 is currently evaluating the impact that the adoption of ASU 2016-02 will have on the
Company’s consolidated financial statements or related disclosures.
In March 2016, the FASB issued ASU 2016-09,
Stock Compensation - Improvements to Employee Share-Based
Payment Accounting,
(“ASU 2016-09”), which simplifies several aspects of the accounting for share-based payment
transactions, including the income tax consequences, classification of awards as either equity or liabilities, classification on
the statement of cash flows and policy elections on the impact for forfeitures. ASU 2016-09 is effective for fiscal years beginning
after December 15, 2017 and interim periods within annual periods beginning after December 15, 2018. The Company has not
adopted ASU 2016-09 and does not expect the adoption to have a significant impact on the Company’s consolidated financial
statements or related disclosures.
3. Capital Stock, Financing and Liquidity
Capital Stock
On May 19, 2016, the Company closed on
a Securities Purchase Agreement (the “Purchase Agreement”) for the sale by the Company of 2,836,880 shares of the Company’s
common stock at a purchase price of $1.7625 per share and the issuance of warrants to purchase 1,418,440 shares of common stock
at an exercise price of $1.7625 per warrant for gross proceeds of $5.0 million or $4.6 million, net of issuance costs. Additionally,
the Company issued the placement agent warrants to purchase 141,844 shares of common stock to the placement agent for the offering
at an exercise price of $1.7625 per warrant. The warrants are initially exercisable commencing November 19, 2016 through their
expiration date of May 19, 2021.
On February 18, 2015, the Company closed
an underwritten public offering of 2,070,000 registered shares of its common stock, at a price to the public of $1.75 per share,
and 695,857 registered shares of its $0.01 par Series B Convertible Preferred Stock (“Series B”) at a price to the
public of $8.75 per share. Gross proceeds from the offering were $9.7 million and underwriters’ fees and issuance costs totaled
$1.1 million. Thus, the Company generated net proceeds of $8.6 million from the underwritten public offering.
The Series B was convertible into five
shares of common stock at the option of the holder, subject to certain limitations related to the holder’s ownership percentage
of the Company’s outstanding common stock. The Series B voted with the common stock on all matters on an as-converted basis,
and had no preference to the common shares in respect of dividends, voting, liquidation or otherwise.
During 2015, all outstanding shares of
Series B were converted to common stock, including 205,279 shares of Series B which were converted into 1,026,395 shares of common
stock during the nine months ended September 30, 2015.
3. Capital Stock, Financing and Liquidity (continued)
Aspire Purchase Agreement
On December 15, 2015, the Company entered
into a common stock purchase agreement (the “Aspire Purchase Agreement”), with Aspire Capital Fund, LLC, (“Aspire
Capital”), under which Aspire Capital is committed to purchase up to an aggregate of $15.0 million of the Company’s
common stock over the approximately 30-month term of the Purchase Agreement. In consideration for entering into the Aspire Purchase
Agreement, concurrently with the execution of the Aspire Purchase Agreement, the Company issued Aspire Capital 150,000 shares of
our common stock as a commitment fee (the “Commitment Shares”).
Upon execution of the Aspire Purchase Agreement,
the Company sold to Aspire Capital 500,000 shares of common stock at $2.00 per share (the “Initial Purchase Shares”),
which resulted in net proceeds of approximately $0.9 million. Pursuant to the Aspire Purchase Agreement and Registration Rights
Agreement, the Company registered 2,688,933 shares of its common stock. This includes the Commitment Shares and the initial purchase
shares issued to Aspire Capital and 2,038,933 shares of common stock which the Company may issue to Aspire Capital in the future.
Under the approximately 30-month term of
the Aspire Purchase Agreement, on any trading day on which the closing sale price of the Company’s common stock exceeds $0.50,
the Company had the right, in its sole discretion, to direct Aspire Capital to purchase up to 150,000 shares of the Company’s
common stock per trading day, at a per share price calculated by reference to the prevailing market price of the Company’s
common stock. In addition, the Company had the right, from time to time in its sole discretion, to sell Aspire Capital an amount
of stock equal to up to 30% of the aggregate shares of the Company’s common stock traded on the Nasdaq Capital Market on
the next trading day, subject to a maximum number of shares which the Company may determine and a minimum trading price. The purchase
price per purchase share pursuant to such purchase notices were calculated by reference to the prevailing market price of the Company’s
common stock.
There were no trading volume requirements
or restrictions under the Aspire Purchase Agreement, and the Company controlled the timing and amount of any sales of our common
stock to Aspire Capital. There were no monetary penalties for the Company failing to maintain effectiveness of registration. Aspire
Capital had no right to require any sales by the Company, but was obligated to make purchases from us as the Company directs in
accordance with the Aspire Purchase Agreement. There were no limitations on use of proceeds, financial or business covenants, restrictions
on future financings, rights of first refusal, participation rights, penalties or liquidated damages in the Purchase Agreement.
Additionally, Aspire Capital could hedge its position in the Company’s common stock.
On May 12, 2016, the Company issued 150,000
shares of common stock under this arrangement in exchange for gross proceeds of $371 thousand or $349 thousand, net of issuance
costs.
The Company terminated the Aspire Purchase
Agreement effective as of May 17, 2016. The agreement was terminated by the Company without any penalty or cost to the Company.
Liquidity
The Company has incurred substantial operating losses since its inception, and as of September 30, 2016
has an accumulated deficit of approximately $33.0 million. The Company expects
to continue to incur operating losses and negative cash flows from operations in 2016 and in future years. Management believes
that the Company’s cash at September 30, 2016 will be sufficient to meet the Company’s obligations through December
31, 2016 and into early 2017. These conditions raise substantial doubt about the Company’s ability to continue as a going
concern.
The Company will need to raise additional
funds in future periods to fund its operations. Cash requirements and cash resource needs will vary significantly depending upon
the timing and the financial and other resource needs that will be required to complete ongoing development and pre-clinical and
clinical testing of products as well as regulatory efforts and collaborative arrangements necessary for the Company’s products
that are currently under development. The Company will seek to raise necessary funds through a combination of publicly or private
equity offerings, debt financings, other financing mechanisms, or strategic collaborations and licensing arrangements. The Company
may not be able to obtain additional financing on terms favorable to us, if at all.
The Company’s operations will be
adversely affected if it is unable to raise or obtain needed funding and may materially affect the Company’s ability to continue
as a going concern. The accompanying consolidated financial statements have been prepared assuming that the Company will continue
as a going concern and therefore, the financial statements do not include any adjustments to reflect the possible future effects
on the recoverability and classification of assets or the amount and classifications of liabilities that may result from the outcome
of this uncertainty.
4. Fair Value Measurements
Fair value is defined as the exchange price
that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market
for the asset or liability in an orderly transaction between market participants on the measurement date.
During the year ended December 31, 2015, the Company had no assets or liabilities requiring fair
value measurements. As discussed in Note 3, on May 19, 2016, the Company closed on the Purchase Agreement for the sale by the Company
of shares of the Company’s common stock and the issuance of warrants to purchase 1,418,440 shares of common stock at an exercise
price of $1.7625 per warrant. Additionally, the Company issued the placement agent warrants to purchase 141,844 shares of Common
Stock at an exercise price of $1.7625 per warrant. The warrants are initially exercisable commencing November 19, 2016 through
their expiration date of May 19, 2021. The liability associated with those warrants was initially recorded at fair value in
the Company’s consolidated balance sheet upon issuance, and subsequently re-measured each fiscal quarter. The changes in
the fair value between issuance and September 30, 2016 recorded as a component of other income (expense), net in the consolidated
statement of operations and comprehensive loss.
The Company utilizes a valuation hierarchy
for disclosure of the inputs to the valuations used to measure fair value. This hierarchy prioritizes the inputs into three broad
levels as follows. Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities. Level 2
inputs are quoted prices for similar assets and liabilities in active markets or inputs that are observable for the asset or liability,
either directly or indirectly through market corroboration, for substantially the full term of the financial instrument. Level
3 inputs are unobservable inputs based on the Company’s own assumptions used to measure assets and liabilities at fair value.
A financial asset or liability’s classification within the hierarchy is determined based on the lowest level input that is
significant to the fair value measurement.
The Company had no assets or liabilities
classified as Level 1 or Level 2. The Company has concluded that the warrants issued in connection with the Purchase
Agreement, meet the definition of a liability under
ASC 480 Distinguishing liabilities From Equity
and has classified the
liability as Level 3.
The Company has re-measured the liability
to estimated fair value at September 30, 2016, using the Black-Scholes option pricing model with the following assumptions:
|
|
September
30, 2016
|
|
Risk-free interest rate
|
|
|
1.18
|
%
|
Expected volatility
|
|
|
73.8
|
%
|
Expected term
|
|
|
5.2 years
|
|
Expected dividend yield
|
|
|
0
|
%
|
The following fair value hierarchy table
presents information about the Company’s financial assets and liabilities measured at fair value on a recurring basis as
of September 30, 2016:
|
|
Fair Value Measurement as of September 30, 2016
|
|
|
|
(In thousands)
|
|
|
|
Level 1
|
|
|
Level 2
|
|
|
Level 3
|
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Warrant liability
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
846
|
|
|
$
|
846
|
|
Total
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
846
|
|
|
$
|
846
|
|
The following table presents a reconciliation
of the Company’s liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3)
for the nine months ended September 30, 2016:
|
|
Warrant Liability
|
|
|
|
(in thousands)
|
|
Balance at December 31, 2015
|
|
$
|
-
|
|
Issuance of warrants
|
|
|
1,281
|
|
Change in fair value upon re-measurement
|
|
|
(435
|
)
|
Balance at September 30, 2016
|
|
$
|
846
|
|
There were no transfers between Level 1
and Level 2 in any of the periods reported.
5. Related Party Transactions
On October 31, 2013, Harvard Bioscience,
Inc. (“Harvard Bioscience”) contributed its regenerative medicine business assets, plus $15 million of cash, into Biostage
(the “Separation”). On November 1, 2013, the spin-off of the Company from Harvard Bioscience was completed. On that
date, the Company became an independent company that operates the regenerative medicine business previously owned by Harvard Bioscience.
The spin-off was completed through the distribution to Harvard Bioscience stockholders of all the shares of common stock of Biostage
(the “Distribution”).
At the time of the Separation, the Company
entered into a 10-year product distribution agreement with Harvard Bioscience under which each company will become the exclusive
distributor for the other party for products such other party develops for sale in the markets served by the other. In addition,
Harvard Bioscience has agreed that except for certain existing activities of its German subsidiary, to the extent that any Harvard
Bioscience businesses desires to resell or distribute any bioreactor that is then manufactured by the Company, the Company will
be the exclusive manufacturer of such bioreactors and Harvard Bioscience will purchase such bioreactors from the Company. Since
inception of the Company, sales to Harvard Bioscience accounted for 100% of the Company’s revenues and receivables.
From inception through April 17, 2015,
Harvard Bioscience was considered to be a related party to the Company because David Green, the Company’s former Chairman
and CEO, was also a director of Harvard Bioscience. After Mr. Green’s April 17, 2015 resignation as Chairman and CEO of the
Company, Harvard Bioscience is no longer considered a related party. Mr. Green service on the Company’s board of directors
ended on May 26, 2016 but Mr. Green remains a member of the Board of Directors of Harvard Bioscience. Related party rent expenses
with Harvard Bioscience for the period of January 1, 2015 through September 30, 2015, were $51,000.
During the nine months ended September
30, 2015, the Company recognized $165,000 in recruiting expense related to professional search fees to RobinsonButler, an executive
recruiting consultancy firm where Tom Robinson, a member of the Company’s Board of Directors, is a partner. RobinsonButler
was retained by the Company’s Board of Directors to complete the search for the Company’s CEO and President.
6. Stock-Based Compensation
Biostage 2013 Equity Incentive Plan
The Company maintains the 2013 Equity Incentive
Plan (the “Plan”) for the benefit of certain of its officers, employees, non-employee directors, and other key persons
(including consultants and advisory board members). All options and awards granted under the Plan consist of the Company’s
shares of common stock.
The Company also issued equity awards under
the Plan at the time of the Distribution to all holders of Harvard Bioscience equity awards as part of an adjustment (the “Adjustment”)
to prevent a loss of value due to the Distribution.
Compensation expense recognized under the
Plan relates to service provided by employees, board members and a non-employee of the Company. There was no required compensation
associated with the Adjustment awards to employees who remained at Harvard Bioscience.
The Company has granted options to purchase
common stock and restricted stock units under the Plan. Stock option activity during the nine months ended September 30, 2016 was
as follows:
|
|
Amount
|
|
|
Weighted-average
exercise price
|
|
|
|
|
|
|
|
|
Outstanding at December 31, 2015
|
|
|
3,253,118
|
|
|
$
|
3.29
|
|
Granted
|
|
|
915,000
|
|
|
|
1.58
|
|
Canceled
|
|
|
(288,817
|
)
|
|
|
3.69
|
|
Outstanding at September 30, 2016
|
|
|
3,879,301
|
|
|
$
|
2.86
|
|
6. Stock-Based Compensation (continued)
The Company uses the Black- Scholes model to value its stock options. Weighted average estimated value
of stock options granted using the Black-Scholes model during the nine months ended September 30, 2016 was $1.04. The weighted
average assumptions for valuing those options granted were as follows:
Expected volatility
|
|
|
74.26
|
%
|
Expected dividends
|
|
|
0.00
|
%
|
Expected term in years
|
|
|
6.13
|
|
Risk-free rate
|
|
|
1.50
|
%
|
There was no material restricted stock
unit activity during the nine months ended September 30, 2016.
The Company recorded total stock-based
compensation during the three and nine months ended September 30 as follows:
|
|
Three Months Ended September 30,
|
|
|
Nine Months Ended September 30,
|
|
|
|
2016
|
|
|
2015
|
|
|
2016
|
|
|
2015
|
|
|
|
(in thousands)
|
|
|
(in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Research and development
|
|
$
|
198
|
|
|
$
|
182
|
|
|
$
|
535
|
|
|
$
|
555
|
|
General and administrative
|
|
|
164
|
|
|
|
246
|
|
|
|
492
|
|
|
|
3,057
|
|
Total stock-based compensation
|
|
$
|
362
|
|
|
$
|
428
|
|
|
$
|
1,027
|
|
|
$
|
3,612
|
|
Included in the above table is stock-based
compensation related to the Harvard Bioscience Plan, which is described below.
Harvard Bioscience Stock Option and Incentive Plan
Harvard Bioscience maintains the Third
Amended and Restated 2000 Stock Option and Incentive Plan (as amended, the “Harvard Bioscience Plan”) for the benefit
of certain of its officers, directors and employees. In connection with the Separation, those employees of Harvard Bioscience who
became employees of Biostage were allowed to continue vesting in their stock-based awards of stock options and restricted stock
units granted under the Harvard Bioscience Plan. Accordingly, the Company recognizes compensation expense as services are provided
by those employees.
7. Commitments and Contingencies
From time to time, the Company may be involved
in various claims and legal proceedings arising in the ordinary course of business. There are no such matters pending that the
Company expects to be material in relation to its business, financial condition, and results of operations or cash flows.