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REVA MEDICAL, INC. - 10-K - Management's Discussion and Analysis of Financial Condition and Results of Operations
[February 27, 2013]

REVA MEDICAL, INC. - 10-K - Management's Discussion and Analysis of Financial Condition and Results of Operations

(Edgar Glimpses Via Acquire Media NewsEdge) You should read the following discussion and analysis of our financial condition and results of operations in conjunction with the "Selected Consolidated Financial Data" and our consolidated financial statements and the related notes thereto that appear elsewhere in this Annual Report on Form 10-K. In addition to historical information, the following discussion and analysis includes forward-looking information that involves risks, uncertainties, and assumptions.

Actual results and the timing of events could differ materially from those anticipated by these forward-looking statements as a result of many factors, including those discussed under "Risk Factors" elsewhere in this Annual Report on Form 10-K. See also "Forward-Looking Statements" included elsewhere in this Annual Report on Form 10-K.

Overview We are a development stage medical device company working toward commercialization of our proprietary technologies to provide minimally invasive medical devices for treatment of conditions in the human body. Since the inception of our company in 1998, our efforts have been concentrated on the development of a stent for use in coronary applications. We currently are in the later stages of developing and clinically testing a bioresorbable drug-eluting coronary stent that we have named the ReZolve scaffold. We call ReZolve a scaffold because it is not a permanent device like a stent. In a clinical use, the scaffold is implanted by an interventional cardiologist during a minimally invasive surgery to a coronary artery location with a delivery catheter system.


The scaffold combines our proprietary stent design with a proprietary polymer that is metabolized and cleared from the body over time, leaving the body free of a permanently implanted device. We have developed our follow-on device, the ReZolve2 scaffold, which is lower profile and sheathless version of ReZolve and will become our commercial product when, and if, we complete clinical trials and receive required regulatory approvals. Our testing has demonstrated that ReZolve2 offers improved deliverability and increased scaffold strength over the ReZolve scaffold.

We believe that due to the risks and limitations associated with commercially available metal stents, bioresorbable stents will be the next major advance in coronary stent technology. Because we have designed our stent to provide the same benefits as traditional metal stents, but with the additional benefit of eliminating the need for a permanently implanted device, we believe that if we are able to complete development and clinical testing of the stent, if we are able to successfully implement manufacturing processes and procedures, and if it is approved for sale by the relevant regulatory authorities, our stent will enable us to compete effectively in the worldwide stent market. Worldwide revenues from coronary stent sales approximated $4.8 billion in 2012.

We have invested significant time and funds in the development of our bioresorbable scaffolds and have performed significant scientific research, engineering development, and testing of the stent in laboratory and - 43 --------------------------------------------------------------------------------- Table of Contents preclinical studies. We have tested and selected the polymer formulation, tested and selected the anti-restenotic drug and coating process, created and iterated the device design, and identified and implemented methods and processes to produce and test the stent. We designed and performed extensive preclinical tests that ranged from bench and engineering studies to in vitro and in vivo laboratory studies. As part of the development, in 2007 we enrolled patients in a small clinical study that proved the viability of our technology while confirming the areas needing further development and we have been advancing the product design and features since. We believe the results of these tests and studies show the technology to be safe and effective and that it is suitable for human clinical studies.

We began clinically testing the ReZolve scaffold with the initiation of a pilot study that enrolled 26 patients between December 2011 and July 2012. The study is designed to evaluate the safety and performance of ReZolve, with primary evaluation of patients at one, six, and 12 months following implant and annual follow-up for five years. Our ReZolve2 scaffold will be evaluated clinically in up to 125 patients to provide the data needed to apply for European CE Marking.

When, and if, we receive CE Mark approval we will be able to commercialize in Europe and various other countries outside the United States. Our efforts to generate revenue from our stent products will take several years, even if our clinical results are favorable.

In order to produce quantities of the stent large enough to accommodate clinical trial and commercial needs, when that time arrives, we will need to scale-up our manufacturing processes and expand our capabilities to allow for such things as additional stent dimensions. We began preliminary development of the methods and processes for the manufacturing scale-up and began work on the product's dimensional and other aspects in 2012.

During course of our product development and testing, we have invented, co-invented, and licensed a portfolio of proprietary technologies. Our design-related technologies have been invented by our employees and consultants and our materials-related technologies have been either invented by our employees or licensed from, or co-invented with, Rutgers, The State University of New Jersey. We consider our patent portfolio to be significant and have invested considerable time and funds to develop and maintain it. Our goal is to perform feasibility tests on additional technologies in our patent portfolio at the same time we are finalizing our ReZolve2 scaffold and, if feasibility is proven, determine a course of development for potential products and, thus, provide a follow-on product pipeline.

During our development efforts, we have also pursued, tested, and abandoned development programs that we determined would not lead to feasible products or for which a product could not be developed in a timeframe that would allow for reasonable commercialization. The largest of these abandoned programs centered on development of a thin metal stent technology for use in small blood vessels.

Although abandoned in 2002 after approximately $13 million had been invested and used, this technology became the basis for the "slide & lock" mechanism we are currently using. Additionally, we licensed a potential anti-restenotic drug in 2001 with the intent to develop it for use as a stand-alone drug or as a complement to our stent product. Although the drug's development was abandoned in 2004 after we had invested approximately $6 million, the knowledge we gained from that program was used in our development of the drug coating for the ReZolve scaffolds. We also formed a wholly owned subsidiary in Germany in 2007 to facilitate our clinical trials and our planned commercialization of products; we have not used this subsidiary yet for any operating activities.

We have performed all of our research and development activities from one location in San Diego, California. As of December 31, 2012, we had 80 employees, a majority of which are degreed professionals and six of whom are PhDs. We leverage our internal expertise with contract research and preclinical laboratories, outside catheter manufacturing, and other outside services as needed. We have three clean rooms and multiple engineering and chemistry labs at our facility, in addition to our corporate and administrative office. We are ISO certified to the medical device standard 13485:2003 and intend to maintain the certification to support our commercialization plans.

We have not yet developed a product to a saleable stage and we have not, therefore, generated any product or other revenues. Our development efforts have been funded with a variety of capital received from angel investors, venture capitalists, strategic partners, hedge funds, and the proceeds from our IPO.

Since our inception, we have received approximately $154 million in equity proceeds and $29 million from issuance of notes payable (such notes payable were converted to common stock upon consummation of our IPO in December 2010). As of December 31, 2012, we had approximately $44 million in cash and investments available for operations. We have incurred substantial losses since our inception; as of December 31, 2012, we had accumulated a deficit of approximately $174 million. We expect our losses to continue for the next several years as we continue our development work and, if these efforts are successful and we are able to obtain approval to sell our products, we expect to commence commercial sales thereafter.

- 44 --------------------------------------------------------------------------------- Table of Contents Key Components of our Results of Operations Since we are still in a pre-revenue stage and our activities are focused on further developing and testing our bioresorbable coronary stent with the goal of commercially selling it, as well as performing minimal research and tests to determine the feasibility of other product possibilities, our operating results primarily consist of research and development expenses, including costs to perform clinical trials, and general and administrative expenses.

Research and Development Expenses: Our research and development expenses arise from a combination of internal and external costs. Our internal costs primarily consist of employee salaries and benefits, facility and other overhead expenses, and engineering and other supplies that we use in our labs for prototyping, testing, and producing our stents and other product possibilities. Our external costs primarily consist of contract research, engineering consulting, polymer production costs, polymer lasing costs, catheter system and anti-restenotic drug purchases, preclinical and clinical study expenses, and license fees paid for the technology underlying our polymer materials. All research and development costs are expensed when incurred. Through December 31, 2012, we have incurred approximately $103.5 million in research and development expenses since our inception, which represents approximately 74 percent of our cumulative operating expenses. We increased the level of our research and development activities in 2012 as we commenced human clinical trials. We expect a significant increase in our research and development expense in the future that will arise from clinical study costs for follow-on trials to provide data for a European CE Marking application of ReZolve2 and for development of final manufacturing processes and equipment as we prepare for commercialization.

General and Administrative Expenses: Our general and administrative expenses consist primarily of salaries and benefits for our executive officers and administrative staff, corporate office and other overhead expenses, legal expenses including patent filing and maintenance costs, audit and tax fees, investor relations and other public company costs, and travel expenses. Although our patent portfolio is one of our most valuable assets, we record legal costs related to patent development, filing, and maintenance as expense when the costs are incurred since the underlying technology associated with these assets is purchased or incurred in connection with our research and development efforts and the future realizable value cannot be determined. Through December 31, 2012, we have incurred approximately $35.9 million in general and administrative expenses since our inception, which represents approximately 26 percent of our cumulative operating expenses. We anticipate that we will continue to invest in patents at similar levels as we have in the past. Upon completion of our initial public offering ("IPO") in December 2010, we began to expand our corporate infrastructure including the addition of personnel and reporting systems, and also began to incur public company reporting and other costs. We anticipate that we will continue to expand our corporate infrastructure to support the needs of being a public company and to prepare for commercial sales of our products, which will increase our general and administrative expenses accordingly.

Other Expense and Income: Historically, a majority of our non-operating expenses consisted of interest expense that arose from our notes payable. The notes were issued to individuals and investment funds that also provided equity capital to us. All the notes, along with the accumulated accrued interest, converted into common stock upon our IPO in December 2010. Although the notes were issued between 2003 and 2006, the terms of the notes allowed us to accrue and record the interest due on them, but defer payment of both the principal balance and the interest. Through December 31, 2010, we recorded approximately $9.6 million of interest and $11.1 million in repayment premiums on our notes payable.

Additionally, in October 2010, we modified the conversion features of the notes payable, but did not repay or change any repayment terms of the notes. In accordance with applicable accounting requirements, the conversion feature modifications resulted in our recording $13.3 million of loss on extinguishment of notes payable and $2.3 million in interest income from amortization of note premium during the year ended December 31, 2010.

In conjunction with issuing our notes payable, we issued warrants to purchase preferred stock; these warrants were exercised for cash and on a net issuance basis upon consummation of our IPO in December 2010 and none remained outstanding at December 31, 2010. We recorded non-cash interest expense for the initial value of the warrants and recorded gains and losses for subsequent changes in fair value of the warrants. Through December 31, 2010, a total of $1.8 million in net expense has been recorded for these warrants.

Concurrent with the completion of our IPO, all of our outstanding convertible preferred stock, non-voting common stock, notes payable, and accrued interest on notes payable converted to common stock. Additionally, all outstanding warrants were exercised for common stock, either through a cash payment to us or on a net exercise basis. We also issued common stock for cumulative dividends on our Series H convertible preferred stock. A total of 22,419,771 shares of common stock were issued from these conversions, exercises, and dividends.

- 45 --------------------------------------------------------------------------------- Table of Contents Since our inception, when we have had excess cash on hand we have invested in short- and long-term high-quality marketable securities such as certificates of deposit and U.S. Treasury Bills. Earnings from these investments are recorded as interest income; through December 31, 2012, we have recorded a total of approximately $1.4 million in such interest income.

Critical Accounting Policies and Significant Estimates Our consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States. The preparation of our financial statements and related disclosures requires us to make estimates, assumptions, and judgments that affect the reported amounts of assets, liabilities, stockholders' equity, expenses, and the presentation and disclosures related to those items. We base our estimates and assumptions on historical experience and other factors that we believe to be reasonable under the circumstances. We evaluate our estimates and assumptions on an ongoing basis; changes in our estimates and assumptions are reasonably likely to occur from period to period. Additionally, actual results could differ significantly from the estimates we make. To the extent there are material changes in our estimates or material differences between our estimates and our actual results, our future financial statement presentation, financial condition, results of operations, and cash flows will be affected.

While our significant accounting policies are described in more detail in Notes 3 and 4 to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K, we believe the following accounting policies involve a greater degree of judgment and complexity than our other accounting policies and, therefore, are the most critical to understanding and evaluating our consolidated financial condition and results of operations.

Research and Development Costs: We expense research and development costs as incurred. Our preclinical and clinical study costs are incurred on a contract basis and generally span a period from a few months to longer than a year. We record costs incurred under these contracts as the work occurs and make payments according to contractual terms. Until a contract is completed, we estimate the amount of work performed and accrue for estimated costs that have been incurred but not paid. As actual costs become known, we adjust our accruals. We expect our clinical expense accruals to increase as we continue to initiate and enroll patients in clinical trials. We expect to make estimates as to the work performed throughout the term of these trials, each of which is expected to be five years or longer. As a public company, we are required to make these estimates in shorter time frames and with less actual data than we have in the past, which may result in our estimates being less accurate and subject to possible material changes in our accruals, which could also materially affect our results of operations within any fiscal period. To date, there have been no material changes in our research and development expense estimates, including our estimates for accrued clinical costs.

Stock-Based Compensation: We have granted stock options to employees and consultants for the purchase of common stock. These options generally have a ten-year life during which the option holder can exercise at any time, they generally vest over a four- or five-year service period, and their exercise price equals the fair market value of our common stock on the date they are granted.

For options granted to employees, we determine the amount of compensation expense by estimating the fair value of each option on its date of grant and then we amortize that fair value on a straight-line basis over the period the employee provides service, which generally is the five-year expected life, and record the expense in our statement of operations as either research and development expense or general and administrative expense based on the employee's work classification. We estimate the fair value by using the Black-Scholes option pricing model, which requires use of subjective assumptions. The assumptions used represent our best estimates, but these estimates involve certain inherent uncertainties. For the model inputs, we use the estimated value of the underlying common stock, a risk-free interest rate that corresponds to the vesting period of the option, an expected life of the option ranging from 6.25 to 6.5 years, and an estimate of volatility based on the market trading prices of comparative peer companies. Additionally, we reduce the amount of recorded compensation expense to allow for potential forfeitures of the options; the forfeiture rate is based on our actual historical forfeitures and has ranged from approximately 2.5 percent to 5.3 percent. For options granted to consultants, we estimate the fair value at the date of grant and at each subsequent accounting date and record compensation expense in our statement of operations based on the fair value during the service period of the consultant, which is generally the five-year vesting period. We estimate the fair value by using the Black-Scholes option pricing model with the same approach to inputs and assumptions as we use to estimate the fair value of options granted to employees, except we use the remaining term as the expected life of the option. As a result of our use of estimates, if factors change and we use different assumptions, the amount of our stock-based compensation expense could be materially different in the future.

- 46 --------------------------------------------------------------------------------- Table of Contents During the past five years, we have granted options to purchase common stock to our employees, members of our board of directors, and outside consultants and have awarded restricted stock to our employees. We granted options to purchase 544,000 shares and awarded 33,000 shares of restricted stock in 2012. During 2011, we granted options to purchase 401,000 shares and awarded 5,000 shares of restricted stock. During the years ended December 31, 2008, 2009, and 2010 we granted options to purchase 643,500, 50,000, and 1,467,500 shares, respectively.

We expect to continue granting options at levels similar to that in 2012 and increase the level of restricted stock awards. Accordingly, we expect our stock-based compensation to continue to increase modestly in the future.

Critical Accounting Policies of Financial Statement Components Discontinued upon IPO: Concurrent with the completion of our IPO in December 2010, all of our outstanding convertible preferred stock, non-voting common stock, notes payable, and accrued interest on notes payable converted to common stock. Additionally, all outstanding warrants were exercised for common stock, either through a cash payment to us or on a net exercise basis. We also issued common stock for cumulative dividends on our Series H convertible preferred stock. Following are the significant accounting policies related to those debt and equity instruments, which have no effect on our financial statements after December 2010.

Notes Payable: We recorded our notes payable at their face values, accrued interest on the notes at their stated interest rates, and amortized or accreted any related discounts or premiums over the original term of a note using the effective interest method. When we amended a note, such as extending its maturity date, we performed an analysis based on applicable accounting guidelines to determine if the amendment results in an accounting impact. We first considered whether the amendment would qualify as a troubled debt restructuring. If the amendment was not considered a troubled debt restructuring, we considered whether the amendment should be accounted for as an extinguishment or a modification of debt. If the amendment was determined to be an extinguishment of a note, we removed the carrying value of the note, recording an extinguishment gain or loss to non-operating expense in our statement of operations, and recorded the note at its fair value as determined using the amended terms. We then amortized or accreted the difference between the fair value and the face value of the note over the amended term of the note using the effective interest method. If the note had an embedded conversion feature and the amendment is determined to be a modification of the note, as defined by accounting standards, then any increase in the fair value of the conversion feature resulting from the amendment was accounted for as a reduction in the carrying amount of the note (as an additional discount or reduction in premium) with a corresponding increase in additional paid-in capital. All amounts amortized or accreted over the term of a note were recorded as interest expense or interest income in our statement of operations. All notes payable and related accrued interest were converted to common stock upon our IPO Preferred Stock Warrant Liability: Periodically, we had issued warrants to purchase preferred stock in conjunction with issuing notes payable. When we issued a warrant to purchase preferred stock, we recorded the fair value of the warrant as a liability, as required by accounting standards, with the related expense amortized to interest in our statement of operations over the term of the note payable. The warrant liability was adjusted to its current fair value at each reporting date until the earlier of its exercise or the end of its contractual life. Our warrants had lives ranging from five to ten years. To determine the fair value of the warrant liability, we utilized the Black-Scholes option-pricing model, which required use of subjective assumptions. The assumptions used represented our best estimates, but these estimates involved inherent uncertainties. We used an estimate of the value of the underlying preferred stock, a life equal to the warrant's contractual life, risk-free interest rates that corresponded to the warrant's remaining life, and an estimate of volatility based on the market trading prices of comparative peer companies. All preferred stock warrants were exercised upon our IPO.

Common Stock Warrants: We had issued warrants to purchase common stock only in conjunction with issuances of convertible preferred stock; those warrants had five-year lives. When we issued a warrant to purchase common stock, we recorded the fair value of the warrant on the date of issuance as a component of stockholders' equity and reduced the recorded proceeds of the related preferred stock by an equal amount. To determine the fair value of a common warrant, we utilized the same approach as we used to value warrants issued to purchase preferred stock. All of our common stock warrants were exercised upon our IPO.

- 47 - -------------------------------------------------------------------------------- Table of Contents Fair Value of Stock: Because our stock was not publicly traded prior to our initial public offering in December 2010, its fair value was determined by our board of directors on various dates, including the dates we granted options to purchase common stock. Our board, which includes members who were experienced in valuing the securities of early-stage companies, considered a number of subjective and objective factors in their determination, including: • the prices of our convertible preferred stock sold to outside investors in arm's-length transactions, and the rights, preferences, and privileges of each series of stock; • our results of operations, our financial position, the status of our research and development efforts, including preclinical trial results, and the length of time until occurrence of clinical trials and a commercial product; • the market values of medical device companies that were in a stage of development or industry similar to us; • the lack of liquidity of both our preferred and common stock as a private company; • contemporaneous valuations performed by an unrelated valuation specialist in accordance with methodologies outlined in the AICPA Practice Aid Valuation of Privately-Held-Company Equity Securities Issued as Compensation; • the likelihood and timing of achieving a liquidity event, such as an initial public offering, given prevailing market conditions; and, • the material risks related to our business.

We believe our historical fair value estimates of our common and preferred stock were reasonable and consistent with the AICPA valuation guidance for private companies. In connection with preparing our financial statements for our IPO, we reassessed the estimated fair values of our stock for financial reporting purposes for the period from January 1, 2009 through the date of our initial public offering and incorporated our conclusions into our contemporaneous valuations during that period. We reviewed the valuation models and the related inputs we were using and, due to the proximity of the initial public offering, determined that a probability weighted expected return model ("PWERM") was more appropriate and would provide a better estimate of the value of our stock than the option pricing method we had used previously. Accordingly, we applied the PWERM model to reassess our common stock fair values for 2009 and to calculate the values for 2010. The type and timing of each potential liquidity event used for the 2010 valuations were heavily influenced by the commencement of our IPO process while the December 31, 2009 valuation was based on our best estimate at the time of the type and timing of a liquidity event for the Company. Since we had no corporate milestones during 2009 or 2010 that would significantly affect the valuation of our stock, we ratably increased the values during 2009 and 2010. We used these reassessed fair values as inputs in our valuations of options to purchase common stock and warrants to purchase common and preferred stock for the years ended December 31, 2009 and 2010 and in our deemed dividend calculations during 2010.

Results of Operations Comparison of the Years Ended December 31, 2011 and 2012 Year Ended December 31, % 2011 2012 Change (in thousands) Research and development expense $ 13,401 $ 15,822 18 % General and administrative expense $ 7,695 $ 8,043 5 % Interest income $ 188 $ 92 (51 )% Research and development expense increased $2.4 million, or 18 percent, for the year ended December 31, 2012 compared to the year ended December 31, 2011. The increase was due to several factors. Personnel costs, including benefits, bonuses, and stock-based compensation, increased $768,000 primarily due to an approximate 30 percent increase in headcount for engineering, operations, and quality assurance employees. Clinical costs increased $605,000 as we enrolled and monitored patients in our pilot clinical study and prepared and submitted applications for our next clinical study. Preclinical study costs increased $479,000 as a result of continuing costs on our long-term studies and the addition of new applied studies undertaken to test and validate the ReZolve device. Facilities - 48 - -------------------------------------------------------------------------------- Table of Contents costs increased $347,000 due to rent, utility, and related expenses from the addition of lab and operating space. Depreciation increased $259,000 due to the addition of lab equipment and leasehold improvements. Material costs, including scaffold components and catheter delivery systems, increased $117,000 as we produced supplies for clinical enrollment and continued advanced design and delivery system work. Offsetting these increases, engineering consulting services decreased $59,000 between years due to the timing of process and design work. The remainder of the change in research and development expenses between years resulted from individually immaterial changes in lab supplies and quality control expenses.

General and administrative expense increased $348,000, or five percent, for the year ended December 31, 2012 compared to the year ended December 31, 2011. A combination of items contributed to this increase. Personnel costs, including benefits, bonuses, and stock-based compensation expense, increased $604,000 due to headcount additions for accounting and IT personnel, an increase of $222,000 in year end bonuses to officers under our bonus program, and an increase of $195,000 in stock compensation from ongoing option grants and restricted stock awards. Travel costs increased $84,000 primarily due to our clinical activities.

Marketing costs decreased $289,000 between years because non-recurring product and corporate branding activities in 2011 were not repeated in 2012. The remainder of the change in general and administrative expenses between periods was due to individually immaterial changes in legal and patent fees, investor relations costs, office supplies, depreciation, and other overhead expenses.

Interest income decreased $96,000 for the year ended December 31, 2012 compared to the year ended December 31, 2011, as a result of lower cash and investment balances combined with lower rates at which we earned interest due to general economic conditions.

Comparison of the Years Ended December 31, 2010 and 2011 Year Ended December 31, % 2010 2011 Change (in thousands) Research and development expense $ 6,826 $ 13,401 96 % General and administrative expense $ 3,292 $ 7,695 >100 % Interest income $ 116 $ 188 62 % Interest expense $ 1,549 $ - (100 %) Interest income from amortization of notes payable premium $ 2,283 $ - (100 %) Loss on extinguishment of notes payable $ 13,285 $ - (100 %) Gain (loss) on change in fair value of preferred stock warrant liability $ (990 ) $ - (100 %) Other income (expense) $ 36 $ - (100 %) Cumulative dividends on Series H convertible preferred stock $ 7,200 $ - (100 %) Research and development expense increased $6.6 million, or 96 percent, for the year ended December 31, 2011 compared to the year ended December 31, 2010. The increase was due to several factors. Personnel costs, including recruitment costs and stock-based compensation expense, increased $2.5 million primarily due to increased headcounts for engineering, manufacturing, and clinical employees.

Stent material costs increased $1.4 million primarily due to polymer and lasing needs in 2011 as design finalization, preclinical testing, and manufacturing process development required greater quantities. During 2010 our expenses were reduced by the award of a non-recurring U.S. federal government grant of $714,000 for reimbursement of research and development costs; we had no corresponding receipts in 2011. Preclinical study costs increased $710,000 in 2011 as a result of additional quantities and varieties of studies performed to test the stent. Other engineering and testing costs, including lab supplies and consultants, increased $580,000 in support of the testing and manufacturing development efforts. Clinical costs increased $322,000 as we prepared and submitted requests for trial approval and began site selection and activities.

The remainder of the change in research and development expenses between periods is due to increases in facilities costs and other individually immaterial items.

General and administrative expense increased $4.4 million, or more than 100 percent, for the year ended December 31, 2011 compared to the year ended December 31, 2010. Stock-based compensation expense increased $1.6 million primarily due to stock option grants made to senior executives and non-employee directors in October 2010. Salary and benefits increased $808,000 due to increased headcount. We employed a chief executive officer in August 2010 and added five other administrative positions, including a financial controller, in 2011 to support - 49 - -------------------------------------------------------------------------------- Table of Contents public company reporting and other needs; personnel overhead and benefits, taxes, and other costs range between 15 percent and 20 percent of salary costs.

Legal fees increased $393,000 primarily as a result of greater patent maintenance and foreign filing costs and greater general counsel costs related to both U.S. and Australian public company reporting requirements. Travel and entertainment expenses increased $258,000 due to increased travel outside the U.S. for shareholder relations and clinical trial preparation. Audit fees increased $229,000 due to public company requirements. Marketing costs increased $473,000 due to tradeshow, trademarking and branding initiatives in 2011 to support entry into clinical trials. Board costs were $190,000 and investor relations and related costs of being a public company were $401,000 in 2011; we had minimal corresponding costs in the prior year period. The remainder of the change in general and administrative expenses between periods was due to increases in general office, insurance, and other expenses.

Interest income increased $72,000 for the year ended December 31, 2011 compared to the year ended December 31, 2010, primarily as a result of interest earned on proceeds from our IPO that was completed in December 2010.

Interest expense, interest income from amortization of notes payable premium, loss on extinguishment of notes payable and the change in the fair value of preferred stock warrant liability were zero in 2011 due to the conversion to common stock of all outstanding notes payable and the exercise of all warrants upon our IPO in December 2010.

Other income and expense remained relatively immaterial in 2011 and did not change significantly compared to 2010. This income or expense primarily arises from gains and losses in foreign currency exchange rates when we purchase goods or services from foreign suppliers and our purchasing activity did not change significantly in 2011.

The cumulative dividends on Series H stock were paid in common stock and the underlying preferred stock was converted to common stock upon consummation of our IPO in December 2010. As a result, there were no dividends or related financial effects in 2011.

Liquidity and Capital Resources Sources of Liquidity We are considered a "development stage" enterprise, as we have not yet generated revenues from the sale of products. Although we have been researching and developing new technologies and product applications and we initiated a pilot clinical trial in 2011, we do not anticipate having a product available for sale for at least the next two years. Until revenue is generated from a saleable product, we expect to continue to incur substantial operating losses and experience significant net cash outflows. We have incurred losses since our inception in June 1998 and, through December 31, 2012, we had an accumulated deficit of approximately $173.6 million.

In December 2010 we completed an IPO of our common stock on the Australian Securities Exchange in the form of CHESS Depositary Interests, or "CDIs," primarily to investors in Australia, the United States, Hong Kong, and London.

We issued 7,727,273 shares of common stock at $10.91 per share (equivalent to A$11.00 per share, or A$1.10 per CDI) for gross proceeds of $84.3 million. We incurred $8.1 million in net issuance costs in connection with our IPO.

Concurrent with the completion of our IPO, all of our outstanding convertible preferred stock, non-voting common stock, notes payable, and accrued interest on notes payable converted to common stock. Additionally, all outstanding warrants were exercised for common stock, either through a cash payment to us or on a net exercise basis. We also issued common stock for cumulative dividends on our Series H convertible preferred stock. A total of 22,419,771 shares of common stock were issued from these conversions, exercises, and dividends.

Based on our current operating plans, we believe that our cash and investments as of December 31, 2012 of $44.1 million, which represents the remaining proceeds from our IPO, will be sufficient to meet our capital and operating needs beyond the next year and will be sufficient to satisfy our liquidity requirements and provide sufficient working capital to carry out our business objectives during that time.

- 50 - -------------------------------------------------------------------------------- Table of Contents Cash Flows Below is a summary of our cash flows from operating activities, investing activities, and financing activities for the periods indicated.

Year Ended December 31, 2010 2011 2012 (in thousands) Net cash used for operating activities $ (8,719 ) $ (16,876 ) $ (18,562 ) Net cash used for investing activities $ (300 ) $ (6,165 ) $ (2,045 ) Net cash provided by financing activities $ 83,535 $ 455 $ 322 Effect of foreign exchange rates $ (2 ) $ - $ - Net increase (decrease) in cash and cash equivalents $ 74,514 $ (22,586 ) $ (20,285 ) Net Cash Flow from Operating Activities Net cash used for operating activities during 2010 primarily reflects the net loss of $23.5 million, cash used of $372,000 for changes in operating assets and liabilities, and non-cash interest income of $734,000. These items were offset by non-cash expenses of $13.3 million for extinguishment of notes payable, $990,000 from the change in the fair value of the preferred stock warrant liability, $471,000 of depreciation and amortization, and $1.1 million of stock-based compensation and other expense.

Net cash used for operating activities during 2011 primarily reflects the net loss of $20.9 million, offset by non-cash expenses of $3.1 million for stock-based compensation, $452,000 of depreciation and amortization, $464,000 from changes in operating assets and liabilities, and $28,000 of other non-cash expense.

Net cash used for operating activities during 2012 primarily reflects the net loss of $23.8 million, offset by non-cash expenses of $3.5 million for stock-based compensation, $959,000 from changes in operating assets and liabilities, $677,000 of depreciation and amortization, and $81,000 of other non-cash expense.

Net Cash Flow from Investing Activities Net cash used for investing activities in 2010 consisted of the purchase of property and equipment. Net cash used for investing activities during 2011 primarily consisted of $5.2 million for purchases of investments and $945,000 for purchases of property and equipment. Net cash used for investing activities during 2012 primarily consisted of the purchase of property and equipment.

Net Cash Flow from Financing Activities Net cash provided by financing activities during 2010 consisted of $84.3 million in cash proceeds from issuance of common stock upon our initial public offering, $263,000 in cash proceeds from exercises of warrants, and we paid $8.5 million in costs related to our initial public offering. Also during 2010, we received net proceeds of $7.5 million from the sale of our Series H convertible preferred stock, net of repurchases. Net cash provided by financing activities during 2011 comprises the refund of $422,000 for taxes withheld from our IPO proceeds in the prior year and $33,000 in proceeds from the issuance of common stock upon exercise of employee stock options. Net cash provided by financing activities during 2012 consists of proceeds from the issuance of common stock upon exercise of employee stock options.

Operating Capital and Capital Expenditure Requirements To date, we have not commercialized any products. We do not anticipate generating any revenue unless and until we successfully obtain CE Mark or FDA marketing approval for, and begin selling, the ReZolve2 scaffold or one of our other product possibilities. We anticipate that we will continue to incur substantial net losses for the next several years as we continue our development work, conduct and complete preclinical and clinical trials, expand our corporate infrastructure, prepare to commercially manufacture and sell our products, and collect cash from sales of our product(s).

We believe that our existing cash and cash equivalents will be sufficient to meet our anticipated cash requirements during the next year, and beyond. If our available cash and cash equivalents are insufficient to satisfy our liquidity requirements before we are able to maintain our operations from our cash inflows, or if we develop additional products or pursue additional applications for our products, we may seek to sell additional equity or debt securities, or obtain a credit facility. The sale of additional equity and debt securities may result in additional dilution to our - 51 --------------------------------------------------------------------------------- Table of Contents stockholders. If we raise additional funds through the issuance of debt securities, these securities could have rights senior to those of our common stock and could contain covenants that would restrict our operations. We may require additional capital beyond our currently forecasted amounts. For example, we will need to raise additional funds in order to build our sales force and commercialize our products. Any such required additional capital may not be available on reasonable terms, if at all. If we are unable to obtain additional financing, we may be required to reduce the scope of, delay, or eliminate some or all of our planned clinical trials, research, development, and commercialization activities, which could materially harm our business.

Our forecasts for the period of time through which our financial resources will be adequate to support our operations and the costs to complete development of products are forward-looking statements and involve risks and uncertainties, and actual results could vary materially and negatively as a result of a number of factors. We have based these estimates on assumptions that may prove to be wrong, and we could utilize our available capital resources sooner than we currently expect.

Because of the numerous risks and uncertainties associated with the development of medical devices, such as our ReZolve scaffolds, we are unable to estimate the exact amounts of, or timing of, capital outlays and operating expenditures necessary to complete development, continue ongoing preclinical studies, conduct human clinical trials, successfully deliver a commercial product to market, and collect on our trade receivables. Our future funding requirements will depend on many factors, including, but not limited to: • the time and effort it will take to successfully complete testing of the ReZolve2 scaffold; • the scope, enrollment rate, and costs of our human clinical trials; • the time and effort it will take to identify, develop, and scale-up manufacturing processes; • the scope of research and development for any of our other product opportunities; • the cost of filing and prosecuting patentable technologies and defending and enforcing our patent and other intellectual property rights; • the terms and timing of any collaborative, licensing, or other arrangements that we may establish; • the requirements, cost, and timing of regulatory approvals; • the cost and timing of establishing sales, marketing, and distribution capabilities; • the cost of establishing clinical and commercial supplies of our products and any products that we may develop; • the effect of competing technological and market developments; and, • the cost and ability to license technologies for future development.

Future capital requirements will also depend on the extent to which we acquire or invest in businesses, products, and technologies, although we currently have no commitments or agreements relating to any of these types of transactions.

Contractual Obligations, Commitments, and Contingencies The following table summarizes our outstanding contractual obligations as of December 31, 2012: Payments Due by Period Less than More than 1 Year 1-3 Years 3-5 Years 5 Years Total (in thousands) Operating lease obligations $ 607 $ 1,270 $ 1,401 $ 60 $ 3,338 Purchase obligations 162 20 - - 182 Total contractual obligations $ 769 $ 1,290 $ 1,401 $ 60 $ 3,520 - 52 - -------------------------------------------------------------------------------- Table of Contents Off-Balance Sheet Arrangements We do not have any off-balance sheet arrangements.

Recent Accounting Pronouncements None.

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