Form 10KSB for MULTICELL TECHNOLOGIES INC.
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28-Feb-2005
Annual Report
Item 6. MANAGEMENT'S DISCUSSION AND ANALYSIS
Overview
MultiCell Technologies, Inc. (the Company) (OTCBB-MUCL) is a global leader in producing immortalized human liver cells (hepatocytes). Based on our liver technology, the Company intends to develop therapeutic products for the treatment of liver disease and other diseases.
In August, 2003, MultiCell signed an exclusive sales, manufacture and distribution agreement for the use of two of its cell lines by XenoTech, an unrelated party. The agreement, which is for a term of seven years, required XenoTech to make an initial non refundable payment of $800,000 to MultiCell in August 2003. This payment represented consideration for and a guarantee of Nosan's (XenoTech's distributor) right of first negotiation for distribution rights for the Asia Pacific Rim, should MultiCell successfully complete the development of its cell lines for the production of proteins, other cellular constituents and or drug like molecules. Additional consideration under the August 2003 agreement included a $700,000 royalty prepayment. This prepayment is an advance against the minimum royalty payment of $800,000 for the first royalty period, which was 16 months, culminating on November 30, 2004. The subsequent 5 royalty periods will be 12 months and the last royalty period will be 8 months. XenoTech must bear all the costs for its manufacturing and sales activities and make specified minimum periodic royalty payments that total $18 million over the 7 year term of the agreement to maintain distribution exclusivity. The agreement requires XenoTech to make royalty payments to MultiCell of 17.5% of net sales for the direct sale of its cells and 34% of net sales derived from any sublicense agreement. XenoTech has distribution agreements with numerous companies for a variety of pharmaceutical and laboratory products and also performs contract research for pharmaceutical companies. These services position XenoTech to distribute our cell lines. They utilize direct sales presentations, telemarketing, and direct mail to promote and sell our cells. Additionally, since XenoTech has a number of respected scientists and have developed compelling efficacy data for our cells, they frequently give presentations at conferences that help develop sales leads.
Even with the agreement with XenoTech, we have operated and will continue to operate by minimizing expenses. Our largest expenses relate to personnel and meeting the legal and reporting requirements of being a public company. By utilizing consultants whenever possible, and asking employees to manage multiple responsibilities, operating costs are kept low. Additionally, a number of employees and our Board of Directors receive Company stock in lieu of cash as all or part of their compensation to help in the effort to minimize monthly cash flow.
We intend to gradually add scientific and support personnel. We want to add specialists for our key research areas. These strategic additions will help us expand our product offerings leading us to additional revenues and profits. Of course as revenues increase, administrative personnel will be necessary to meet the added workload. Other expenses, such as sales and customer service, will increase commensurate with increased revenues. The Company's current research and development efforts focus on development of future cell line products and redesign of existing products. Due to the ongoing nature of this research, we are unable to ascertain with certainty the total estimated completion dates and costs associated with this research. As with any research efforts, there is uncertainty and risk associated with whether these efforts will produce results in a timely manner so as to enhance the Company's market position. Company sponsored research and development costs related to future products and redesign of present products is expensed as incurred. For the years ended November 30, 2004 and 2003, research and development costs were $804,761 and $482,309, respectively. Research and development costs are expensed as incurred and include such costs as salaries, employee benefits, costs determined utilizing the Black-Scholes option-pricing model for options issued to the Scientific Advisory Board, and supplies.
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The Application of Critical Accounting Policies
Use of Estimates - The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Research and Development - Company sponsored research and development costs related to future products and redesign of present products are expensed as incurred. Such costs are offset by proceeds from research grants.
License Agreements - costs incurred to obtain license agreements are capitalized and amortized on a straight-line basis over the term of the respective agreement.
Revenue Recognition - The Company's revenues have been generated primarily from contractual research and royalties on the license for the sale of cells through its sale and distribution agreement with XenoTech LLC (XenoTech). Management believes such sources of revenue will be part of the Company's ongoing operations. In recognizing revenues the Company applies the guidance provided by SEC Staff Accounting Bulletin Topic 13, Revenue Recognition (Topic 13). Under the provisions of Topic 13, the Company recognizes revenue from commercial and government research agreements as services are performed, provided a contractual arrangement exists, the contract price is fixed or determinable and the collection of the contracted amounts is probable. In situations where the Company receives payment in advance of the performance of services, such amounts are deferred and recognized as revenue as the related services are performed. Deferred revenues associated with services expected to be performed within the 12-month period subsequent to the balance sheet date are classified as current liabilities. Deferred revenues associated with services expected to be performed at a later date are classified as non-current liabilities.
Stock-Based Compensation - Statement of Financial Accounting Standards No. 123 (SFAS 123), Accounting for Stock-Based Compensation provides for the use of a fair value based method of accounting for stock-based compensation. However, SFAS 123 has allowed an entity to continue to measure compensation costs related to stock and stock options issued to employees using the intrinsic value method of accounting prescribed by Accounting Principles Board Opinion No. 25 (APB 25), Accounting for Stock issued to Employees. Entities electing to continue to use the intrinsic value method must make pro forma disclosures of net income or loss and earnings or loss per share as if a fair value method of accounting had been applied. The Company has elected to continue to account for its stock-based compensation to employees under APB 25. In accordance with the provisions of SFAS 123, all other issuances of common stock, stock options, warrants or other equity instruments to employees and non-employees as the consideration for goods or services received by the Company are accounted for based on the fair value of the equity instruments issued (unless the fair value of the consideration received can be more reliably measured). Generally, the fair value of any options, warrant or similar equity instruments issued will be estimated based on the Black-Scholes option pricing model. SFAS123 has been significantly revised as explained below.
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Long-Lived Assets - Long-lived assets that do not have indefinite lives, such as property and equipment and license agreements, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Impairment losses are recognized when events or changes in circumstances indicate that the undiscounted cash flows estimated to be generated by such assets are less than their carrying value and, accordingly, all or a portion of such carrying value may not be recoverable. Impairment losses for assets to be held and used are then measured based on the excess, if any, of the carrying amounts of the assets over their fair values. Long-lived assets to be disposed of in a manner that meets certain criteria are stated at the lower of their carrying amounts or fair values less costs to sell and are no longer depreciated.
RECENT ACCOUNTING PRONOUCEMENTS
In May 2003, the FASB issued Statement of Financial Accounting Standards No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity (SFAS 150). SFAS 150 establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. SFAS 150 was effective for interim periods beginning after June 15, 2003. The Company does not believe this accounting pronouncement will have a material impact on the financial statements for fiscal 2005.
In December 2004, the Financial Accounting Standards Board (the FASB) issued Statement of Financial Accounting Standards No.123(R)(SFAS 123R), Share Based Payments, which amends SFAS 123 and will be effective for public companies that are small business filers for interim or annual periods beginning after December 15, 2005. The new standard will require us to expense employee stock options and other share-based payments. The FASB believes the use of a binomial lattice model for option valuation is capable of more fully reflecting certain characteristics of employee share options compared to the Black-Scholes options pricing model. The new standard may be adopted in one of three ways - the modified prospective transition method, a variation of the modified prospective transition method or the modified retrospective transition method. We are currently evaluating how we will adopt the standard and evaluating the effect that the adoption of SFAS 123(R) will have on our financial position and results of operations.
In December 2004, the FASB issued SFAS No. 153 Exchange of Nonmonetary Assets, an amendment of APB Opinion No. 29". The guidance in Accounting Principles Board Opinion No. 29, Accounting for Nonmonetary Transactions (APB 29) is based on the principle that exchanges of nonmonetary assets should be measured based on the fair value of assets exchanged. The guidance in APB 29, however, included certain exceptions to that principle. SFAS 153 amends APB 29 to eliminate the exception for nonmonetary exchanges of similar productive assets that do not have commercial substance. A nonmonetary exchange has commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange. SFAS 153 is effective for nonmonetary exchanges occurring in fiscal periods beginning after June 15, 2005. The adoption of SFAS 153 is not expected to have a material impact on our financial position and results of operations.
Results of Operations.
The following discussion is included to describe our consolidated financial position and results of operations. The consolidated financial statements and notes thereto contain detailed information that should be referred to in conjunction with this discussion.
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Year Ended November 30, 2004, Compared to Year Ended November 30, 2003
Revenue. Total revenue increased to $759,925 for the fiscal year ended November 30, 2004 compared to $365,166 for the fiscal year ended November 30, 2003. The 2004 revenues are attributable primarily to the $800,000 license fee that is being recognized over the seven-year agreement period and the $800,000 minimum royalty recognized as royalty revenue over the 16-month period from the inception of the license and distribution agreement with XenoTech in August 2003. We have negotiated a license agreement with Pfizer allowing them to continue to use our cell lines for research now that the collaborative research project that took place in 2002 has been completed that also generated revenues in 2004 and 2003.
Operating Expenses. Total operating expenses increased to $2,750,146 for the fiscal year ended November 30, 2004, from $1,973,887 for the fiscal year ended November 30, 2003, representing an increase of $776,259. Research and development expenses increased in fiscal year 2004 by $322,452, primarily attributable to an increase in research activity, reduced by grant proceeds of $103,058, and the Company issuance of options to purchase 900,000 shares of the Company's common stock to its Scientific Advisory Board that had a fair value of $192,763. Selling, general and administrative expenses increased by $450,455 in the fiscal year 2004, primarily attributable to the cost associated with the issuance of stock purchase warrants and options to the Board of Directors and for other consulting services. Depreciation and amortization did not change materially in fiscal year 2004 from 2003.
Other Income (Expense). Interest expense for the fiscal year ended November 30, 2004 was $85,950, which represents a decrease of $119,194 from the fiscal year ended November 30, 2003. Amortization of debt discount for the year ended November 30, 2004 was $60,368, representing a decrease of $190,983 from the fiscal year ended November 30, 2003. These decreases were attributable to a reduction in the outstanding debt through payments and conversions of convertible notes and accrued interest into the Company's common stock. Interest income for the fiscal year ended November 30, 2004 was $59,141 as compared to $63,971 in the prior fiscal year.
Net loss. Net loss for the fiscal year ended November 30, 2004, was $1,738,996 compared to a net loss of $1,984,053 for the prior year, representing a decrease in net loss of $245,057. The decrease in the net loss for the fiscal year ended November 30, 2004 was attributable to an increase in revenue, and the recognition of a reversal of a note receivable valuation allowance in the amount of $305,000, offset by an increase in research and development expenses and the costs of the issuance of stock purchase warrants and options to the Board of Directors and for financial consulting services. The net loss applicable to common stockholders for the fiscal year ended November 30, 2004 included a one-time non-cash charge of $1,721,144 due to the beneficial conversion feature attributable to the difference between the purchase price and the fair value of the common stock to which the Series I preferred stock issued in July 2004 is convertible.
Liquidity and Capital Resources.
The Company's cash needs have been managed primarily through the issuance of debt or equity instruments. During the fiscal year ended November 30, 2004, we had a net loss of $1,738,996. At November 30, 2004, we had cash of $1,311,879. As a result primarily of the inclusion of non-cash charges for consulting and services paid through the issuance of common stock and options and warrants with a fair value of $1,229,092 and depreciation and amortization of property and equipment and a license agreement of $169,739, net of the effects of deferred income of $654,349 recognized in revenue, our cash used in operating activities totaled $1,454,986. During the fiscal year, we were able to issue preferred stock for aggregate proceeds, net of issuance costs of $1,714,149, make net repayments of loans of $202,500, convert other notes and accrued interest of $594,406 to common stock and receive proceeds of $215,710 from the exercise of options and warrants. As described in Note 15 of the financial statements, on February 10, 2005 the Company completed a private placement offering for $4,000,000, thereby substantially improving its liquidity.
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Research Agreements
In October 2002, MultiCell Technologies was awarded a Phase I Small Business Innovation Research (SBIR) grant from the National Institutes of Health to study the production of therapeutic plasma proteins by immortalized, non-tumorigenic human hepatocytes. The aim of the SBIR award is to compare the function of MultiCell's hepatocyte-derived products to recombinant and plasma-derived therapeutic plasma proteins. The grant is for $139,314 and was completed in December 2004.
Notes Payable
During fiscal year 2004, the Company received a total of $78,500 from convertible promissory notes with interest accruing at 10% per annum. The principal and interest are payable from three to five years after the inception of the notes. The lenders may convert the principal and any unpaid interest due into the Company's common stock. The conversion prices vary from $.10 to $.20 per share. Additionally, the Company issued common stock warrants to the lenders exercisable at $.10 per share. However, the Company did not increase additional paid-in capital based on the fair value of the warrants or reduce the carrying value of the convertible promissory notes payable, because at the time of issuance, the fair value of the warrants was immaterial.
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