CYTORI THERAPEUTICS, INC., 10-K filed on 3/13/2012
Annual Report
Document And Entity Information (USD $)
12 Months Ended
Dec. 31, 2011
Feb. 29, 2012
Jun. 30, 2011
Entity Registrant Name
CYTORI THERAPEUTICS, INC. 
 
 
Entity Central Index Key
0001095981 
 
 
Current Fiscal Year End Date
--12-31 
 
 
Entity Well-known Seasoned Issuer
No 
 
 
Entity Voluntary Filers
No 
 
 
Entity Current Reporting Status
Yes 
 
 
Entity Filer Category
Accelerated Filer 
 
 
Entity Public Float
 
 
$ 227,294,414 
Entity Common Stock, Shares Outstanding
 
57,928,606 
 
Document Fiscal Year Focus
2011 
 
 
Document Fiscal Period Focus
FY 
 
 
Document Type
10-K 
 
 
Amendment Flag
false 
 
 
Document Period End Date
Dec. 31, 2011 
 
 
CONSOLIDATED BALANCE SHEETS (USD $)
Dec. 31, 2011
Dec. 31, 2010
Current assets:
 
 
Cash and cash equivalents
$ 36,922,000 
$ 52,668,000 
Accounts receivable, net of reserves of $474,000 and of $306,000 in 2011 and 2010, respectively
2,260,000 
2,073,000 
Inventories, net
3,318,000 
3,378,000 
Other current assets
837,000 
834,000 
Total current assets
43,337,000 
58,953,000 
Property and equipment, net
1,711,000 
1,684,000 
Restricted cash and cash equivalents
350,000 
350,000 
Investment in joint venture
250,000 
459,000 
Other assets
1,772,000 
566,000 
Intangibles, net
192,000 
413,000 
Goodwill
3,922,000 
3,922,000 
Total assets
51,534,000 
66,347,000 
Current liabilities:
 
 
Accounts payable and accrued expenses
5,334,000 
6,770,000 
Current portion of long-term obligations
2,487,000 
6,453,000 
Total current liabilities
7,821,000 
13,223,000 
Deferred revenues, related party
3,520,000 
5,512,000 
Deferred revenues
5,244,000 
4,929,000 
Warrant liability
627,000 
4,987,000 
Option liability
1,910,000 
1,170,000 
Long-term deferred rent
504,000 
398,000 
Long-term obligations, net of discount, less current portion
21,962,000 
13,255,000 
Total liabilities
41,588,000 
43,474,000 
Commitments and contingencies
   
   
Stockholders' equity (deficit):
 
 
Preferred stock, $0.001 par value; 5,000,000 shares authorized; -0- shares issued and outstanding in 2010 and 2009
Common stock, $0.001 par value; 95,000,000 shares authorized; 56,594,683 and 51,955,265 shares issued and 56,594,683 and 51,955,265 shares outstanding in 2011 and 2010, respectively
57,000 
52,000 
Additional paid-in capital
252,338,000 
232,819,000 
Accumulated deficit
(242,449,000)
(209,998,000)
Total stockholders' equity (deficit)
9,946,000 
22,873,000 
Total liabilities and stockholders' equity (deficit)
$ 51,534,000 
$ 66,347,000 
CONSOLIDATED BALANCE SHEETS (Parenthetical) (USD $)
Dec. 31, 2011
Dec. 31, 2010
Current assets:
 
 
Accounts receivable, reserves
$ 474,000 
$ 306,000 
Stockholders' equity (deficit):
 
 
Preferred stock, par value (in dollars per share)
$ 0.001 
$ 0.001 
Preferred stock, shares authorized (in shares)
5,000,000 
5,000,000 
Preferred stock, shares issued (in shares)
Preferred stock, shares outstanding (in shares)
Common stock, par value (in dollars per share)
$ 0.001 
$ 0.001 
Common stock, shares authorized (in shares)
95,000,000 
95,000,000 
Common stock, shares issued (in shares)
56,594,683 
51,955,265 
Common stock, shares outstanding (in shares)
56,594,683 
51,955,265 
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS (USD $)
12 Months Ended
Dec. 31, 2011
Dec. 31, 2010
Dec. 31, 2009
Product revenues:
 
 
 
Related party
$ 0 
$ 590,000 
$ 591,000 
Third party
7,983,000 
7,664,000 
5,246,000 
Total product revenues
7,983,000 
8,254,000 
5,837,000 
Cost of product revenues
3,837,000 
3,908,000 
3,394,000 
Gross profit
4,146,000 
4,346,000 
2,443,000 
Development revenues:
 
 
 
Development, related party
1,992,000 
2,122,000 
8,840,000 
Research grants and other
21,000 
251,000 
53,000 
Total development revenues
2,013,000 
2,373,000 
8,893,000 
Operating expenses:
 
 
 
Research and development
10,904,000 
9,687,000 
12,231,000 
Sales and marketing
13,560,000 
11,040,000 
6,583,000 
General and administrative
14,727,000 
12,570,000 
10,415,000 
Change in fair value of warrants
(4,360,000)
(1,285,000)
4,574,000 
Change in fair value of option liability
740,000 
30,000 
(920,000)
Total operating expenses
35,571,000 
32,042,000 
32,883,000 
Operating loss
(29,412,000)
(25,323,000)
(21,547,000)
Other income (expense):
 
 
 
Interest income
9,000 
9,000 
20,000 
Interest expense
(2,784,000)
(2,052,000)
(1,427,000)
Other income (expense), net
(55,000)
23,000 
(218,000)
Equity loss from investment in joint venture
(209,000)
(151,000)
(44,000)
Total other income (expense)
(3,039,000)
(2,171,000)
(1,669,000)
Net loss
$ (32,451,000)
$ (27,494,000)
$ (23,216,000)
Basic and diluted net loss per common share (in dollars per share)
$ (0.61)
$ (0.60)
$ (0.65)
Basic and diluted weighted average common shares (in shares)
53,504,030 
45,947,966 
35,939,260 
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT) (USD $)
Total
Common Stock [Member]
Additional Paid-in Capital [Member]
Accumulated Deficit [Member]
Treasury Stock [Member]
Accumulated Other Comprehensive Income (Loss) [Member]
Amount due From Exercises of Stock Options[Member]
Balance at Dec. 31, 2008
$ (7,717,000)
$ 31,000 
$ 161,214,000 
$ (162,168,000)
$ (6,794,000)
$ 0 
$ 0 
Balance (in shares) at Dec. 31, 2008
 
31,176,275 
 
 
1,872,834 
 
 
Cumulative effect of change in accounting for certain warrants
(1,698,000)
(4,578,000)
2,880,000 
Stock-based compensation expense
2,649,000 
2,649,000 
Issuance of common stock under stock option plan (in shares)
 
203,707 
 
 
 
 
 
Issuance of common stock under stock option plan
410,000 
410,000 
Issuance of common stock under stock warrant agreement (in shares)
 
46,154 
 
 
 
 
 
Issuance of common stock under stock warrant agreement
121,000 
 
121,000 
Sale of common stock (in shares)
 
8,613,123 
 
 
 
 
 
Sale of common stock, net
21,860,000 
9,000 
21,851,000 
 
Sale of treasury stock
3,933,000 
(2,861,000)
6,794,000 
Sale of treasury stock (in shares)
 
 
 
 
(1,872,834)
 
 
Net loss
(23,216,000)
(23,216,000)
Balance at Dec. 31, 2009
(3,658,000)
40,000 
178,806,000 
(182,504,000)
Balance (in shares) at Dec. 31, 2009
 
40,039,259 
 
 
 
 
 
Stock-based compensation expense
3,055,000 
3,055,000 
Issuance of common stock under stock option plan (in shares)
 
378,705 
 
 
 
 
 
Issuance of common stock under stock option plan
1,393,000 
1,393,000 
Issuance of common stock under stock warrant agreement (in shares)
 
2,208,730 
 
 
 
 
 
Issuance of common stock under stock warrant agreement
5,735,000 
2,000 
5,733,000 
Sale of common stock (in shares)
 
9,328,571 
 
 
 
 
 
Sale of common stock, net
43,563,000 
10,000 
43,553,000 
Allocation of fair value for debt-related warrants
279,000 
279,000 
Net loss
(27,494,000)
(27,494,000)
Balance at Dec. 31, 2010
22,873,000 
52,000 
232,819,000 
(209,998,000)
Balance (in shares) at Dec. 31, 2010
51,955,265 
51,955,265 
 
 
 
 
 
Stock-based compensation expense
3,316,000 
3,316,000 
Issuance of common stock under stock option plan (in shares)
 
222,283 
 
 
 
 
 
Issuance of common stock under stock option plan
767,000 
767,000 
Issuance of common stock under stock warrant agreement (in shares)
 
340,873 
 
 
 
 
 
Issuance of common stock under stock warrant agreement
2,082,000 
1,000 
2,081,000 
Sale of common stock (in shares)
 
4,076,262 
 
 
 
 
 
Sale of common stock, net
13,092,000 
4,000 
13,088,000 
Allocation of fair value for debt-related warrants
267,000 
267,000 
Net loss
(32,451,000)
(32,451,000)
Balance at Dec. 31, 2011
$ 9,946,000 
$ 57,000 
$ 252,338,000 
$ (242,449,000)
$ 0 
$ 0 
$ 0 
Balance (in shares) at Dec. 31, 2011
56,594,683 
56,594,683 
 
 
 
 
 
CONSOLIDATED STATEMENTS OF CASH FLOWS (USD $)
12 Months Ended
Dec. 31, 2011
Dec. 31, 2010
Dec. 31, 2009
Cash flows from operating activities:
 
 
 
Net loss
$ (32,451,000)
$ (27,494,000)
$ (23,216,000)
Adjustments to reconcile net loss to net cash used in operating activities:
 
 
 
Depreciation and amortization
855,000 
931,000 
1,681,000 
Amortization of deferred financing costs and debt discount
711,000 
703,000 
709,000 
Warranty provision (reversal)
(23,000)
Increase (reduction) in allowance for doubtful accounts
483,000 
460,000 
663,000 
Change in fair value of warrants
(4,360,000)
(1,285,000)
4,574,000 
Change in fair value of option liability
740,000 
30,000 
(920,000)
Stock-based compensation
3,316,000 
3,055,000 
2,649,000 
Equity loss from investment in joint venture
209,000 
151,000 
44,000 
Increases (decreases) in cash caused by changes in operating assets and liabilities:
 
 
 
Accounts receivable
(670,000)
(902,000)
(986,000)
Inventories
60,000 
(777,000)
(446,000)
Other current assets
(3,000)
36,000 
41,000 
Other assets
(1,206,000)
(110,000)
75,000 
Accounts payable and accrued expenses
(1,436,000)
811,000 
413,000 
Deferred revenues, related party
(1,992,000)
(2,122,000)
(8,840,000)
Deferred revenues
315,000 
2,541,000 
(57,000)
Long-term deferred rent
106,000 
398,000 
(168,000)
Net cash used in operating activities
(35,323,000)
(23,574,000)
(23,807,000)
Cash flows from investing activities:
 
 
 
Purchases of property and equipment
(560,000)
(610,000)
(221,000)
Cash invested in restricted cash
(350,000)
Investment in joint venture
(330,000)
Net cash used in investing activities
(560,000)
(1,290,000)
(221,000)
Cash flows from financing activities:
 
 
 
Principal payments on long-term obligations
(4,529,000)
(5,454,000)
(2,053,000)
Proceeds from long-term obligations
9,444,000 
20,000,000 
Debt issuance costs and loan fees
(719,000)
(559,000)
Proceeds from exercise of employee stock options and warrants
2,849,000 
7,128,000 
531,000 
Proceeds from sale of common stock
13,286,000 
45,486,000 
23,196,000 
Costs from sale of common stock
(194,000)
(1,923,000)
(1,336,000)
Proceeds from sale of treasury stock
3,933,000 
Net cash provided by financing activities
20,137,000 
64,678,000 
24,271,000 
Net (decrease) increase in cash and cash equivalents
(15,746,000)
39,814,000 
243,000 
Cash and cash equivalents at beginning of year
52,668,000 
12,854,000 
12,611,000 
Cash and cash equivalents at end of year
36,922,000 
52,668,000 
12,854,000 
Cash paid during period for:
 
 
 
Interest
2,031,000 
1,226,000 
739,000 
Final payment fee on long-term debt
419,000 
205,000 
Supplemental schedule of non-cash investing and financing activities:
 
 
 
Fair value of warrants allocated to additional paid-in capital
267,000 
279,000 
Additions to fixed assets included in accounts payable and accrued expenses
 
481,000 
Capital equipment lease
$ 79,000 
$ 0 
$ 0 
Organization and Operations
Organization and Operations
1.
Organization and Operations

The Company

Cytori Therapeutics, Inc. is developing cell therapies based on autologous adipose-derived stem and regenerative cells (ADRCs) to treat cardiovascular disease and repair soft tissue defects. Our scientific data suggest ADRCs improve blood flow, moderate the immune response and keep tissue at risk of dying alive. As a result, we believe these cells can be applied across multiple “ischemic” conditions. These therapies are made available by our proprietary device, the Celution® System, which automates the extraction and preparation of clinical grade ADRCs at the point-of-care.

We have four subsidiaries located in Japan, Italy, Switzerland and India that have been established primarily to support our sales and marketing activities in these regions.

Principles of Consolidation

The consolidated financial statements include our accounts and those of our subsidiaries. All significant intercompany transactions and balances have been eliminated. Management evaluates its investments on an individual basis for purposes of determining whether or not consolidation is appropriate. In instances where we do not demonstrate control through decision-making ability and/or a greater than 50% ownership interest, we account for the related investments under the cost or equity method, depending upon management's evaluation of our ability to exercise and retain significant influence over the investee. Our investment in the Olympus-Cytori, Inc. joint venture has been accounted for under the equity method of accounting (see note 3 for further details).

Certain Risks and Uncertainties

We have a limited operating history and our prospects are subject to the risks and uncertainties frequently encountered by companies in the early stages of development and commercialization, especially those companies in rapidly evolving and technologically advanced industries such as the biotech/medical device field. Our future viability largely depends on our ability to complete development of new products and receive regulatory approvals for those products. No assurance can be given that our new products will be successfully developed, regulatory approvals will be granted, or acceptance of these products will be achieved. The development of medical devices for specific therapeutic applications is subject to a number of risks, including research, regulatory and marketing risks. There can be no assurance that our development stage products will overcome these hurdles and become commercially viable and/or gain commercial acceptance.

Capital Availability

We incurred net losses of $32,451,000, $27,494,000 and, $23,216,000 for the years ended December 31, 2011, 2010 and 2009, respectively. We have an accumulated deficit of $242,449,000 as of December 31, 2011. Additionally, we have used net cash of $35,323,000, $23,574,000 and $23,807,000 to fund our operating activities for years ended December 31, 2011, 2010 and 2009, respectively. To date, these operating losses have been funded primarily from outside sources of invested capital.

Management recognizes the need to generate positive cash flows in future periods and/or to obtain additional capital from various sources. In the continued absence of positive cash flows from operations, no assurance can be given that we can generate sufficient revenue to cover operating costs or that additional financing will be available to us and, if available, on terms acceptable to us in the future.

During 2011 and 2010, we expanded our commercialization activities while simultaneously pursuing available financing sources to support operations and growth. We have had, and we will likely continue to have, an ongoing need to raise additional cash from outside sources to fund our operations for 2012 and beyond. If we cannot do so when required, we would need to reduce our research, development, and administrative operations, including reductions of our employee base, in order to offset lack of available funding. We continue to evaluate available financing opportunities as part of our normal course of business.

Summary of Significant Accounting Policies
Summary of Significant Accounting Policies
2.
Summary of Significant Accounting Policies

Use of Estimates

The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions affecting 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 revenue and expenses during the reporting period. Our most significant estimates and critical accounting policies involve recognizing revenue, evaluating goodwill for impairment, valuing our put option arrangement with Olympus Corporation, valuing warrants, determining the assumptions used in measuring share-based compensation expense, valuing our deferred tax assets, assessing how to report our investment in Olympus-Cytori, Inc., and valuing allowances for doubtful accounts and inventories.

Actual results could differ from these estimates. Current economic conditions, including illiquid credit markets and volatile equity markets, contribute to the inherent uncertainty of such estimates. Management's estimates and assumptions are reviewed regularly, and the effects of revisions are reflected in the consolidated financial statements in the periods they are determined to be necessary.

Cash and Cash Equivalents

We consider all highly liquid investments with maturities of three months or less at the time of purchase to be cash equivalents. Investments with original maturities of three months or less that were included with and classified as cash and cash equivalents totaled $30,646,000 and $39,807,000 as of December 31, 2011 and 2010, respectively. We maintain our cash at insured financial institutions. The combined account balances at each institution periodically exceed FDIC insurance coverage, and as a result, there is a concentration of credit risk related to amounts in excess of FDIC limits.

Short-term Investments

We invest excess cash in money market funds, highly liquid debt instruments of financial institutions and corporations with strong credit ratings, and in United States government obligations. We have established guidelines relative to diversification and maturities to maintain safety and liquidity. These guidelines are periodically reviewed and modified to take advantage of trends in yields and interest rates. After considering current market conditions, and in order to minimize our risk, management has elected to invest all excess funds in money market funds and other highly liquid investments that are appropriately classified as cash equivalents as of December 31, 2011 and December 31, 2010.

Restricted Cash and Cash Equivalents

Restricted cash consists of cash and cash equivalents held in a letter of credit account pursuant to a lease agreement entered into on April 2, 2010 (amended November 4, 2011) for leasing of property at 3020 and 3030 Callan Road, San Diego, California. The lease agreement required us to execute a letter of credit for $350,000 naming the landlord as a beneficiary. The letter of credit was issued in July 2010 and required us to maintain $350,000 as restricted cash for the duration of the lease, which expires October 31, 2017, provided that the amount of the letter of credit can be reduced to $262,500 in July 2013, and to $175,000 in July of 2014.

Accounts Receivable

Accounts receivable are recorded at the invoiced amount and do not bear interest. Amounts collected on accounts receivable are included in net cash provided by operating activities in the consolidated statements of cash flows. The Company maintains an allowance for doubtful accounts for estimated losses inherent in its accounts receivable portfolio. In establishing the required allowance, management considers historical losses adjusted to take into account current market conditions and our customers' financial condition, the amount of receivables in dispute, and the current receivables aging and current payment patterns. Account balances are charged off against the allowance after all means of collection have been exhausted and the potential for recovery is considered remote.
 
Inventories

Inventories include the cost of material, labor, and overhead, and are stated at the lower of cost, determined on the first-in, first-out (FIFO) method, or market. We periodically evaluate our on-hand stock and make appropriate provisions for any stock deemed excess or obsolete. Manufacturing costs resulting from lower than “normal” production levels are expensed as incurred.

Property and Equipment

Property and equipment are stated at cost, net of accumulated depreciation. Depreciation expense, which includes the amortization of capitalized leasehold improvements, is provided for on a straight-line basis over the estimated useful lives of the assets, or the life of the lease, whichever is shorter, and range from three to five years. When assets are sold or otherwise disposed of, the cost and related accumulated depreciation are removed from the accounts and the resulting gain or loss is included in operations. Maintenance and repairs are charged to operations as incurred.

Impairment

We assess certain of our long-lived assets, such as property and equipment and intangible assets other than goodwill, for potential impairment when there is a change in circumstances that indicates carrying values of assets may not be recoverable. Such long-lived assets are deemed to be impaired when the undiscounted cash flows expected to be generated by the asset (or asset group) are less than the asset's carrying amount. Any required impairment loss would be measured as the amount by which the asset's carrying value exceeds its fair value, and would be recorded as a reduction in the carrying value of the related asset and a charge to operating expense. We recognized no impairment losses during any of the periods presented in these financial statements.

Goodwill and Intangibles

Goodwill is not amortized but instead is tested annually for impairment at the reporting unit level, or more frequently when events or changes in circumstances indicate that fair value of the reporting unit has been reduced to less than its carrying value. We perform our impairment test annually during the fourth quarter. In September 2011, the FASB issued revised guidance to simplify how entities test goodwill for impairment. Under the revised guidance, entities have the option to first assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step goodwill impairment test described in Accounting Standards Codification Topic 350. If, after assessing qualitative factors, an entity determines it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, then performing the two-step impairment test is unnecessary. If deemed necessary, a two-step test is used to identify the potential impairment and to measure the amount of goodwill impairment, if any. The first step is to compare the fair value of the reporting unit with its carrying amount, including goodwill. If the fair value of the reporting unit exceeds its carrying amount, goodwill is considered not impaired; otherwise, there is an indication that goodwill may be impaired and the amount of the loss, if any, is measured by performing step two. Under step two, the impairment loss, if any, is measured by comparing the implied fair value of the reporting unit goodwill with the carrying amount of goodwill. We completed this assessment as of November 30, 2011, and concluded that no impairment existed.

Separable intangible assets that have finite useful lives will continue to be amortized over their respective useful lives. Intangibles, consisting of patents and core technology purchased in the acquisition of StemSource, Inc. in 2002, are being amortized on a straight-line basis over their expected lives of ten years.
 
The changes in the carrying amounts of other indefinite and finite-life intangible assets and goodwill for the years ended December 31, 2011 and 2010 are as follows:

   
December 31, 2011
 
Other intangibles, net:
   
Beginning balance
 $413,000 
Amortization
  (221,000 )
Ending balance
  192,000 
      
Goodwill, net:
    
Beginning balance
  3,922,000 
Increase (decrease)
  - 
Ending balance
  3,922,000 
      
Total goodwill and other intangibles, net
 $4,114,000 
      
Cumulative amortization of other intangible assets
 $2,024,000 


   
December 31, 2010
 
Other intangibles, net:
   
Beginning balance
 $635,000 
Amortization
  (222,000 )
Ending balance
  413,000 
      
Goodwill, net:
    
Beginning balance
  3,922,000 
Increase (decrease)
  - 
Ending balance
  3,922,000 
      
Total goodwill and other intangibles, net
 $4,335,000 
      
Cumulative amortization of other intangible assets
 $1,803,000 

As of December 31, 2011, future estimated amortization expense for these other intangible assets is expected to be as follows:

2012
 
 192,000
 
   
$
192,000
 

Warrant Liability

Effective January 1, 2009, we changed our method of accounting for certain common stock purchase warrants with exercise price reset features due to the adoption of a new accounting standard. These warrants were issued in connection with our August 2008 private placement of 2,825,517 unregistered shares of common stock and 1,412,758 common stock warrants. The warrants had an original exercise price of $8.50 and expire in August 2013. Under the new standard, these warrants previously recognized in stockholders' equity (deficit) are now accounted for as fair value liabilities, with changes in fair value included in net earnings (loss).

The cumulative effect of the adoption is to present these warrants as liabilities on the date of the adoption as if they had been accounted for as liabilities since the warrants were issued. As a result on January 1, 2009, we recognized a $1.7 million long-term warrant liability, a $2.9 million decrease in accumulated deficit and a corresponding decrease in additional paid-in capital of $4.6 million. The fair value of these warrants increased to $6.3 million as of December 31, 2009, as a result of a $4.6 million loss from the change in fair value of warrants for the year ended December 31, 2009. The fair value of these warrants decreased to $5.0 million as of December 31, 2010, as a result of a $1.3 million gain from the change in fair value of warrants for the year then ended. The fair value of these warrants decreased to $0.6 million as of December 31, 2011, as a result of a $4.4 million gain from the change in fair value of warrants for the year then ended.
 
Since these warrants do not qualify for hedge accounting, all future changes in the fair value of the warrants will be recognized currently in earnings until such time as the warrants are exercised or expire. These warrants are not traded in an active securities market, and as such, we estimated the fair value of these warrants using an option pricing model using the following assumptions:

 
 
As of
December 31, 2011
   
As of
December 31, 2010
 
Expected term
 
1.61 years
   
2.61 years
 
Common stock market price
 
$
2.20
   
$
5.19
 
Risk-free interest rate
 
 
0.19
%
 
 
0.82
%
Expected volatility
 
 
69.98
%
 
 
86.03
%
Resulting fair value (per warrant)
 
$
0.32
   
$
2.50
 

Expected volatility is based primarily on historical volatility. Historical volatility was computed using daily pricing observations for recent periods that correspond to the expected term of the warrants. We believe this method produces an estimate that is representative of our expectations of future volatility over the expected term of these warrants. We currently have no reason to believe future volatility over the expected remaining life of these warrants is likely to differ materially from historical volatility. The expected life is based on the remaining term of the warrants. The risk-free interest rate is the interest rate for treasury constant maturity instruments published by the Federal Reserve Board that is closest to the expected term of the warrants. The fair value of these warrants also incorporates our assumptions about future equity issuances and their impact to the down-round protection feature.

Revenue Recognition

Product Sales

We recognize revenue from product sales when the following fundamental criteria are met: (i) persuasive evidence of an arrangement exists, (ii) delivery has occurred, (iii) the price to the customer is fixed or determinable and (iv) collection of the resulting accounts receivable is reasonably assured.

For all sales, we use a binding purchase order or a signed agreement as evidence of an arrangement. Revenue for these product sales is recognized upon delivery to the customer, as all risks and rewards of ownership have been substantively transferred to the customer at that point. For sales to customers who arrange for and manage the shipping process, we recognize revenue upon shipment from our facilities. Shipping and handling costs that are billed to our customers are classified as revenue. The customer's obligation to pay and the payment terms are set at the time of delivery and are not dependent on the subsequent use or resale of our products.

For sales prior to January 1, 2011 that included multiple deliverables, we allocated revenue based on the relative fair values of the individual components. When more than one element such as product maintenance or technical support services were included in an arrangement, we allocated revenue between the elements based on each element's relative fair value, provided that each element met the criteria for treatment as a separate unit of accounting (an item is considered a separate unit of accounting if it has value to the customer on a standalone basis and there is objective and reliable evidence of the fair value of the undelivered items). Fair value is generally determined based upon the price charged when the element is sold separately. In the absence of fair value for a delivered element, we allocated revenue first to the fair value of the undelivered elements and allocated the residual revenue to the delivered elements. Fair values for undelivered elements were determined based on vendor-specific objective evidence as well as market participant quotes for similar services. In the absence of fair value for an undelivered element, the arrangement was accounted for as a single unit of accounting, resulting in a deferral of revenue recognition for delivered elements until all undelivered elements have been fulfilled. Deferred service revenue is recognized ratably over the period the services are provided.

Beginning in 2011, for sales that include multiple deliverables, such as sales of our StemSource® Cell Bank (cell bank), we account for products or services (deliverables) separately rather than as a combined unit. Stem cell banks typically consist of a complex array of equipment and proprietary knowledge, and services, including one or more StemSource® devices, a cryogenic freezer, measuring and monitoring equipment, and a database patient tracking system. In addition, we typically provide consulting services, installation and training services concurrent with the installation of the cell bank. Web hosting and technical and maintenance services are generally provided for a period of up to one year subsequent to the date of sale. The FASB guidance of the Codification establishes a selling price hierarchy for determining the selling price of a deliverable, which is based on: (a) vendor-specific objective evidence (“VSOE”); (b) third-party evidence (“TPE”); or (c) management estimates. This guidance also eliminates the residual method of allocation and requires that arrangement consideration be allocated at the inception of the arrangement to all deliverables using the relative selling price method. For our cell bank sales, we establish relative selling prices for all deliverables based on vendor-specific quotes for comparable services when available. In the absence of VSOE, we use competitors' products or services considered largely interchangeable with our own or management best estimate. A substantial amount of consulting services are provided to customers before the equipment installation and training has been completed, and therefore we treat this as a separate unit of accounting. The equipment with installation and initial training activities are treated as separate units of accounting. Also of standalone value to customers is the transfer of the proprietary knowledge, most notably in the form of standard operating procedures, and any license or exclusivity rights associated with the agreements. Revenue for the various deliverables is calculated and recognized based on the relative selling prices of each deliverable. Future services such as web hosting and ongoing maintenance are deferred and recognized into income during the year following the installation. There would have been no material impact to our financial statements in 2010 had we applied this guidance retrospectively.
 
Concentration of Significant Customers

For the year ended December 31, 2011, our sales were concentrated with respect to one direct customer, which comprised 14% of our product revenue recognized for the year ended December 31, 2011. Our Asia-Pacific and North America region sales accounted for 67% of our product revenue recognized for the year ended December 31, 2011. Additionally, two direct customers accounted for 27% of total outstanding accounts receivable as of December 31, 2011.

Our Asia-Pacific and North America region sales accounted for 79% of our product revenue recognized for the year ended December 31, 2010. Additionally, two customers accounted for 26% of total outstanding accounts receivable as of December 31, 2010.

Research and Development

We earn revenue for performing tasks under research and development agreements with both commercial enterprises, such as Olympus and Senko, and governmental agencies like the National Institutes of Health (“NIH”). Revenue earned under development agreements is classified as either research grant or development revenues depending on the nature of the arrangement. Revenues derived from reimbursement of direct out-of-pocket expenses for research costs associated with grants are recorded as research grant and other within development revenues. Research grant revenue is recorded at the gross amount of the reimbursement. The costs associated with these reimbursements are reflected as a component of research and development expense in our statements of operations. Additionally, research and development arrangements we have with commercial enterprises such as Olympus and Senko are considered a key component of our central and ongoing operations. Accordingly, when recognized, the inflows from such arrangements are presented as revenues in our statements of operations.

We received funds from Olympus and Olympus-Cytori, Inc. during 2005 and 2006. We recorded upfront fees totaling $28,311,000 as deferred revenues, related party. In exchange for these proceeds, we agreed to (a) provide Olympus-Cytori, Inc. an exclusive and perpetual license to our Celution® System device technology and certain related intellectual property, and (b) provide future development contributions related to commercializing the Celution® System platform. The license and development services are not separable and as a result the recognition of this deferred amount requires achievement of service related milestones, under a proportional performance methodology. If and as such revenues are recognized, deferred revenue will be decreased. Proportional performance methodology was elected due to the nature of our development obligations and efforts in support of the Joint Venture (“JV”), including product development activities and regulatory efforts to support the commercialization of the JV products. The application of this methodology uses the achievement of R&D milestones as outputs of value to the JV. We received up-front, non-refundable payments in connection with these development obligations, which we have broken down into specific R&D milestones that are definable and substantive in nature, and which will result in value to the JV when achieved. As our research and development efforts progress, we periodically evaluate, and modify if necessary, the milestone points in our proportional performance model to ensure that revenue recognition accurately reflects our best estimate of substantive value deliverable to the JV. Revenue will be recognized as the above mentioned R&D milestones are completed. Of the amounts received and deferred, we recognized development revenues of $1,992,000, $2,122,000, and $8,840,000 for the years ended December 31, 2011, 2010 and 2009, respectively. All related development costs are expensed as incurred and are included in research and development expense on our statements of operations. To date under the contract, of the $28,311,000 originally deferred, we have recognized a total of $24,791,000 through December 31, 2011.
 
Under a Distribution Agreement with Senko, we granted to Senko an exclusive license to sell and distribute certain Thin Film products in Japan. We have also earned or will be entitled to earn additional payments under the Distribution Agreement based on achieving certain defined and substantive research and development milestones. There was no development revenue recognized related to this agreement during the years ended December 31, 2011, 2010 or 2009, respectively.

Warranty

Beginning in March 2008, we began sales and shipments of our Celution® 800/CRS System to the European and Asia-Pacific reconstructive surgery market. In September 2008, we completed installation of our first StemSource® Cell Bank. We are selling medical device equipment for use with humans, which is subjected to exhaustive and highly controlled specification compliance and fitness testing and validation procedures before it can be approved for sale to help ensure that the products will be free of defects. We believe that the rigorous nature of the testing and compliance efforts serves to minimize the likelihood of defects in material or workmanship such that recognition of a warranty obligation is not justified at this time. Accordingly, we have not recorded a warranty reserve for our Celution® 800/CRS System and StemSource® Cell Bank product line during the years ended December 31, 2011, 2010 and 2009.

Research and Development

Research and development expenditures, which are charged to operations in the period incurred, include costs associated with the design, development, testing and enhancement of our products, regulatory fees, the purchase of laboratory supplies, and pre-clinical and clinical studies as well as salaries and benefits for our research and development employees.

Also included in research and development expenditures are costs incurred to support research grant reimbursement and costs incurred in connection with our development arrangements with Olympus and Senko.

Expenditures related to the Joint Venture with Olympus include costs that are necessary to support the commercialization of future generation devices based on our Celution® System platform. These development activities, which began in November 2005, include performing pre-clinical and clinical trials, seeking regulatory approval, and performing product development related to therapeutic applications for adipose stem and regenerative cells for multiple large markets. For the years ended December 31, 2011, 2010 and 2009, costs associated with the development of the device were $396,000, $2,221,000 and $2,713,000.

Our agreement with the NIH entitled us to qualifying expenditures of up to $250,000 related to research on Adipose Tissue-Derived Cells for Vascular Cell Therapy, which expired in August 2009. We incurred $49,000 of direct expenses for the year ended December 31, 2009. There were no comparable expenditures in 2011 and 2010.

Deferred Financing Costs and Other Debt-Related Costs

Deferred financing costs are capitalized and amortized to interest expense over the term of the associated debt instrument. We evaluate the terms of the debt instruments to determine if any embedded or freestanding derivatives or conversion features exist. We allocate the aggregate proceeds of the debt between the warrants and the debt based on their relative fair values. The fair value of the warrant issued to the Lenders was calculated utilizing the Black-Scholes option pricing model. We are accreting the resultant discount over the term of the debt through maturity date using the effective interest method. If the maturity of the debt is accelerated because of default or early debt repayment, then the amortization or accretion would be accelerated.

Income Taxes

Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carry forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income (loss) in the years in which those temporary differences are expected to be recovered or settled. Due to our history of loss, a full valuation allowance was recognized against our deferred tax assets.
 
Stock Based Compensation

We recognize the fair value method of all share-based payment awards granted after January 1, 2006, in our statements of operations over the requisite vesting period of each award. We estimate the fair value of these options using the Black-Scholes option pricing model using assumptions for expected volatility, expected term, and risk-free interest rate. Expected volatility is based primarily on historical volatility and is computed using daily pricing observations for recent periods that correspond to the expected term of the options. The expected life is based on the expected term of the options. The risk-free interest rate is the interest rate for treasury instruments with maturities that approximate the expected term.

Segment Information

For the years ended December 31, 2011, 2010 and 2009, all of our financial results relate to regenerative cell technology, therefore we report our results as a single segment.

Loss Per Share

Basic per share data is computed by dividing net income or loss applicable to common stockholders by the weighted average number of common shares outstanding during the period. Diluted per share data is computed by dividing net income or loss applicable to common stockholders by the weighted average number of common shares outstanding during the period increased to include, if dilutive, the number of additional common shares that would have been outstanding as calculated using the treasury stock method. Potential common shares were related entirely to outstanding but unexercised options and warrants for all periods presented.

We have excluded all potentially dilutive securities, including unvested performance-based restricted stock, from the calculation of diluted loss per share attributable to common stockholders for the years ended December 31, 2011, 2010, and 2009, as their inclusion would be antidilutive. Potentially dilutive common shares excluded from the calculations of diluted loss per share were 19,476,425, 18,926,093 and 20,123,889 for the years ended December 31, 2011, 2010 and 2009, respectively.

Recently Adopted Accounting Pronouncements

In October 2009, the FASB issued an update to the revenue recognition topic of the Codification. The update addresses the accounting for multiple-deliverable arrangements to enable vendors to account for products or services (deliverables) separately rather than as a combined unit. This guidance establishes a selling price hierarchy for determining the selling price of a deliverable, which is based on: (a) vendor-specific objective evidence; (b) third-party evidence; or (c) estimates. This guidance also eliminates the residual method of allocation and requires that arrangement consideration be allocated at the inception of the arrangement to all deliverables using the relative selling price method. In addition, this guidance significantly expands required disclosures related to a vendor's multiple-deliverable revenue arrangements. The update 2009-13 is effective prospectively for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010 and early adoption is permitted. The adoption of this standard did not have a material impact on our consolidated financial statements.

In April 2010, the FASB issued additional guidance for revenue recognition to provide criteria that should be met for determining whether the milestone method of revenue recognition is appropriate. A vendor can recognize as revenue, in its entirety, consideration that is contingent upon achievement of a milestone in the period in which the milestone is achieved only if the milestone meets all criteria to be considered substantive. The guidance for the milestone method of revenue recognition is effective on a prospective basis for milestones achieved in fiscal years, and interim periods within those years, beginning on or after June 15, 2010. The adoption of this standard did not have a material impact on our consolidated financial statements.

In January 2010, the FASB issued an update which provides guidance to improve disclosures about fair value measurements. This guidance amends previous guidance on fair value measurements to add new requirements for disclosures about transfers into and out of Levels 1 and 2 and separate disclosures about purchases, sales, issuances, and settlements relating to Level 3 measurement on a gross basis rather than on a net basis as previously required. This update also clarifies existing fair value disclosures about the level of disaggregation and about inputs and valuation techniques used to measure fair value. This guidance is effective for annual and interim periods beginning after December 15, 2009, except for the requirement to provide the Level 3 activities of purchases, sales, issuances, and settlements on a gross basis, which will be effective for annual and interim periods beginning after December 15, 2010. Early application is permitted and, in the period of initial adoption, entities are not required to provide the amended disclosures for any previous periods presented for comparative purposes. This update did not have a material impact on our consolidated financial statements.
 
In March 2010, the FASB issued an update to clarify that an employee share-based payment award with an exercise price denominated in the currency of a market in which a substantial portion of the equity securities trades should not be considered to contain a condition that is not a market, performance, or service condition. Therefore, an entity would not classify an award with such a feature as a liability if it otherwise qualifies as equity. Affected entities are required to record a cumulative catch-up adjustment for all awards outstanding as of the beginning of the annual period in which the guidance is adopted. This update did not have a material impact on our consolidated financial statements.

In September 2011, the FASB issued an update that allows companies to assess qualitative factors to determine whether they need to perform the two-step quantitative goodwill impairment test. Under the option, an entity no longer would be required to calculate the fair value of a reporting unit unless it determines, based on that qualitative assessment, that it is more likely than not that its fair value is less than its carrying amount. The guidance is effective for interim and annual goodwill impairment tests performed for fiscal years beginning after December 15, 2011 although early adoption is permitted. As of December 31, 2011, we elected for early adoption and this update did not have a material impact on our consolidated financial statements.

Recent Accounting Pronouncements

In May 2011, the FASB revised the fair value measurement and disclosure requirements to align the requirements under GAAP and International Financial Reporting Standards (“IFRS”). The guidance clarifies the FASB's intent about the application of existing fair value measurements and requires enhanced disclosures, most significantly related to unobservable inputs used in a fair value measurement that is categorized within Level 3 of the fair value hierarchy. The guidance is effective prospectively during interim and annual periods beginning after December 15, 2011. We do not expect the adoption of this guidance to have a material impact on our consolidated financial statements.
Transactions with Olympus Corporation
Transactions with Olympus Corporation
3.
Transactions with Olympus Corporation

Initial Investment by Olympus Corporation in Cytori

In 2005, we entered into a common stock purchase agreement (the “Purchase Agreement”) with Olympus in which we received $11,000,000 in cash proceeds. Under the Purchase Agreement, we issued 1,100,000 shares of common stock to Olympus. In addition, we also granted Olympus an immediately exercisable option to acquire 2,200,000 shares of our common stock at $10 per share, which expired on December 31, 2006. Before its expiration, we accounted for this option as a liability.

The $11,000,000 in total proceeds we received in the second quarter of 2005 exceeded the sum of (i) the market value of our stock as well as (ii) the fair value of the option at the time we entered into the share purchase agreement. The $7,811,000 difference between the proceeds received and the fair values of our common stock and option liability is recorded as a component of deferred revenues, related party in the accompanying consolidated balance sheets. This difference was recorded as deferred revenue since, conceptually, the excess proceeds represent a prepayment for future contributions and obligations of Cytori for the benefit of the Joint Venture (see below), rather than an additional equity investment in Cytori. The recognition of this deferred amount is based on achievement of related milestones, under a proportional performance methodology. As such revenues are recognized, deferred revenue is reduced (see note 2 – Revenue Recognition).

In a separate agreement entered into on February 23, 2006, we granted Olympus an exclusive right to negotiate a commercialization collaboration for the use of adipose regenerative cells for a specific therapeutic area outside of cardiovascular disease. In exchange for this right, we received a $1,500,000 payment from Olympus, which was non-refundable but could be applied towards a definitive commercial collaboration in the future. As part of this agreement, Olympus would conduct market research and pilot clinical studies in collaboration with us for the therapeutic area up to December 31, 2008 when this exclusive right expired. The $1,500,000 payment was received in the second quarter of 2006 and recorded as deferred revenues, related party. Accordingly, on December 31, 2008, we recognized $1,500,000 as other development revenue and reduced our deferred revenues, related party balance for the same amount.
 
In August 2006, we received an additional $11,000,000 from Olympus for the issuance of approximately 1,900,000 shares of our common stock at $5.75 per share under the shelf registration statement filed in May 2006. The purchase price was determined by our closing price on August 9, 2006.

On August 11, 2008, we raised approximately $17,000,000 in gross proceeds from a private placement of 2,825,517 unregistered shares of common stock and 1,412,758 common stock warrants (with an original exercise price of $8.50 per share) to a syndicate of investors including Olympus Corporation, who acquired 1,000,000 unregistered shares and 500,000 common stock warrants in exchange for $6,000,000 of the total proceeds raised.

As of December 31, 2011, Olympus holds approximately 7.09% (unaudited) of our issued and outstanding shares. Additionally, Olympus has a right, which it has not yet exercised, to designate a director to serve on our Board of Directors.

Formation of the Olympus-Cytori Joint Venture

On November 4, 2005, we entered into a joint venture and other related agreements (the “Joint Venture Agreements”) with Olympus. The Joint Venture is owned equally by Olympus and us.

Under the Joint Venture Agreements:

 
·
Olympus paid $30,000,000 for its 50% interest in the Joint Venture. Moreover, Olympus simultaneously entered into a License/Joint Development Agreement with the Joint Venture and us to develop a second generation commercial system and manufacturing capabilities.

 
·
We licensed our Celution® System device technology and certain related intellectual property, to the Joint Venture for use in future generation devices. These devices will process and purify regenerative cells residing in adipose tissue for various therapeutic clinical applications. In exchange for this license, we received a 50% interest in the Joint Venture, as well as an initial $11,000,000 payment from the Joint Venture; the source of this payment was the $30,000,000 contributed to the Joint Venture by Olympus. Moreover, upon receipt of a CE mark for the Celution® 600 in January 2006, we received an additional $11,000,000 development milestone payment from the Joint Venture.

We have determined that the Joint Venture is a variable interest entity (VIE), but that Cytori is not the VIE's primary beneficiary. Accordingly, we have accounted for our interests in the Joint Venture using the equity method of accounting, since we can have significant influence over the Joint Venture's operations. At December 31, 2011, the carrying value of our investment in the Joint Venture is $250,000.

We are under no obligation to provide additional funding to the Joint Venture, but may choose to do so. We contributed $330,000 during 2010. The Company made no contributions during 2011 and 2009.

Put/Calls and Guarantees

The Shareholders' Agreement between Cytori and Olympus provides that in certain specified circumstances of insolvency or if we experience a change in control, Olympus will have the rights to (i) repurchase our interests in the Joint Venture at the fair value of such interests or (ii) sell its own interests in the Joint Venture to Cytori at the higher of (a) $22,000,000 or (b) the Put's fair value.

As of November 4, 2005, the fair value of the Put was determined to be $1,500,000. At December 31, 2011 and 2010, the fair value of the Put was $1,910,000 and $1,170,000, respectively. Fluctuations in the Put value are recorded in the consolidated statements of operations as a component of change in fair value of option liabilities. The fair value of the Put has been recorded as a long-term liability in the caption option liability in our consolidated balance sheets.

The valuations of the Put were completed using an option pricing theory based simulation analysis (i.e., a Monte Carlo simulation). The valuations are based on assumptions as of the valuation date with regard to the market value of Cytori and the estimated fair value of the Joint Venture, the expected correlation between the values of Cytori and the Joint Venture, the expected volatility of Cytori and the Joint Venture, the bankruptcy recovery rate for Cytori, the bankruptcy threshold for Cytori, the probability of a change of control event for Cytori, and the risk free interest rate.
 
The following assumptions were employed in estimating the value of the Put:

   
December 31, 2011
  
December 31, 2010
  
November 4, 2005
 
           
Expected volatility of Cytori
  76.07 %  73.00 %  63.20 %
Expected volatility of the Joint Venture
  76.07 %  73.00 %  69.10 %
Bankruptcy recovery rate for Cytori
  28.00 %  28.00 %  21.00 %
Bankruptcy threshold for Cytori
 $8,594,000  $5,842,000  $10,780,000 
Probability of a change of control event for Cytori
  3.33 %  3.43 %  3.04 %
Expected correlation between fair values of Cytori and the Joint Venture in the future
  99.00 %  99.00 %  99.00 %
Risk free interest rate
  1.89 %  3.30 %  4.66 %

The Put has no expiration date. Accordingly, we will continue to recognize a liability for the Put and mark it to market each quarter until it is exercised or until the arrangements with Olympus are amended.

Olympus-Cytori Joint Venture

The Joint Venture has exclusive access to our Celution® System device technology for the development, manufacture, and supply of such systems to us. Once the second generation Celution® System is developed and approved by regulatory agencies, the Joint Venture will exclusively supply us with these systems at a formula-based transfer price. We have retained all marketing rights (subject to our various distribution arrangements) to sell the Celution® System devices for all therapeutic applications of adipose regenerative cells.

As part of the various agreements with Olympus, we will be required, following commercialization of the Joint Venture's Celution® System or Systems, to provide monthly forecasts to the Joint Venture specifying the quantities of each category of devices that we intend to purchase over a rolling six-month period. Although we are not subject to any minimum purchase requirements, we are obliged to buy a minimum percentage of the products forecasted by us in such reports. Since we can effectively control the number of devices we will agree to purchase, we estimate that the fair value of this guarantee is de minimis as of December 31, 2011.

In August 2007, we entered into a License and Royalty Agreement with the Joint Venture. This Royalty Agreement provides us the ability to commercialize the Celution® System platform earlier than we could have otherwise done so under the terms of the Joint Venture Agreements. The Royalty Agreement enables Cytori to manufacture the Cytori systems, including Celution® 800/CRS, until such time as the Joint Venture's products are commercially available, subject to a reasonable royalty that will be payable to the Joint Venture for all such sales. In November 2007, we amended our License/Commercial Agreement with the Joint Venture to provide the continuance of our right to early commercialization on substantially the same terms after the three year term of the License and Royalty agreement. During the years ended December 31, 2011, 2010 and 2009, in connection with our sales of our Celution® 800/CRS System products to the European and Asia-Pacific reconstructive surgery market, we incurred approximately $166,000, $253,000 and $242,000, respectively, in royalty cost related to our agreement with the Joint Venture. This cost is included as a component of cost of product revenues in our consolidated statements of operations.

During the fourth quarter of 2010, partial development was completed on the Joint Venture's Celution® System to be used for research purposes only. Although not yet available for commercial sale, the Joint Venture sold systems to Cytori (see product revenue and cost of product revenue below) are for use in an upcoming clinical trial.

Deferred revenues, related party

As of December 31, 2011, the deferred revenues, related party account primarily consists of the consideration we have received in exchange for contributions and obligations that we have agreed to on behalf of Olympus and the Joint Venture (less any amounts that we have recognized as revenues in accordance with our revenue recognition policies set out in note 2). These contributions include product development, regulatory approvals, and generally associated pre-clinical and clinical trials to support the commercialization of the Celution® System platform. Our obligations also include maintaining the exclusive and perpetual license to our device technology, including the Celution® System platform and certain related intellectual property.
 
Condensed financial information for the Joint Venture

A summary of the unaudited condensed financial information for the Joint Venture as of December 31, 2011 and 2010 and for the years ended December 31, 2011, 2010 and 2009 and reconciliation of net income (loss) of the joint venture to Cytori's equity loss from investment in joint venture is as follows:

   
December 31, 2011
  
December 31, 2010
 
   
(Unaudited)
  
(Unaudited)
 
Balance Sheets
      
Assets:
      
Cash
 $69,000  $183,000 
Amounts due from related party
  104,000   632,000 
Prepaid insurance
  19,000   16,000 
Computer equipment and software, net
  797,000   995,000 
Total assets
 $989,000  $1,826,000 
          
Liabilities and Stockholders' Equity:
        
Accrued expenses
 $48,000  $77,000 
Amounts due to related party
  95,000   509,000 
Stockholders' equity
  846,000   1,240,000 
Total liabilities and stockholders' equity
 $989,000  $1,826,000 
 
   
Years ended December 31,
 
   
2011
  
2010
  
2009
 
Statements of Operations
 
(Unaudited)
  
(Unaudited)
  
(Unaudited)
 
           
Product revenue
 $90,000  $458,000  $- 
              
Cost of product revenue
  87,000   458,000   - 
              
Gross profit
  3,000   -   - 
              
Royalty revenue
  166,000   253,000   242,000 
              
Operating expenses:
            
Research and development
  -   14,000   - 
General and administrative:
            
Accounting and other corporate services
  164,000   88,000   75,000 
Quality system services
  145,000   135,000   63,000 
Depreciation expense for tooling equipment
  230,000   130,000   - 
Other
  23,000   33,000   26,000 
Operating expenses
  562,000   400,000   164,000 
Operating income (loss)
  (393,000)  (147,000)  78,000 
Other income (expense):
            
Interest income
  -   1,000   1,000 
Net income (loss)
 $(393,000) $(146,000) $79,000 
              
Reconciliation of net income (loss) to equity loss from investment in joint venture
            
Net income (loss)
 $(393,000) $(146,000) $79,000 
Intercompany eliminations
  25,000   156,000   167,000 
Net loss after intercompany eliminations
  (418,000)  (302,000)  (88,000)
Cytori's percentage of interest in joint venture
  50%  50%  50%
Cytori's equity loss from investment in joint venture
 $(209,000) $(151,000) $(44,000)
Fair Value Measurements
Fair Value Measurements
4.
Fair Value Measurements

Fair value measurements are market-based measurements, not entity-specific measurements. Therefore, fair value measurements are determined based on the assumptions that market participants would use in pricing the asset or liability. We follow a three-level hierarchy to prioritize the inputs used in the valuation techniques to derive fair values. The basis for fair value measurements for each level within the hierarchy is described below:

·  Level 1: Quoted prices in active markets for identical assets or liabilities.
·  Level 2: Quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations in which all significant inputs are observable in active markets.
·  Level 3: Valuations derived from valuation techniques in which one or more significant inputs are unobservable in active markets.

The following table provides a summary of the recognized assets and liabilities that we measure at fair value on a recurring basis:

   
Balance as of
  
Basis of Fair Value Measurements
 
   
December 31, 2011
  
Level 1
  
Level 2
  
Level 3
 
Assets:
            
Cash equivalents
 $30,646,000  $30,646,000  $-  $- 
                  
Liabilities:
                
Put option liability
 $(1,910,000) $-  $-  $(1,910,000)
Warrant liability
 $(627,000) $-  $-  $(627,000)


   
Balance as of
  
Basis of Fair Value Measurements
 
   
December 31, 2010
  
Level 1
  
Level 2
  
Level 3
 
Assets:
            
Cash equivalents
 $39,807,000  $39,807,000  $-  $- 
                  
Liabilities:
                
Put option liability
 $(1,170,000) $-  $-  $(1,170,000)
Warrant liability
 $(4,987,000) $-  $-  $(4,987,000)

We use quoted market prices to determine the fair value of our cash equivalents, which consist of money market funds and therefore these are classified in Level 1 of the fair value hierarchy.

We value our put liability (see note 3) using an option pricing theory based simulation analysis (i.e., a Monte Carlo simulation). Assumptions are made with regard to the market value of Cytori and the estimated fair value of the Joint Venture, the expected correlation between the values of Cytori and the Joint Venture, the expected volatility of Cytori and the Joint Venture, the bankruptcy recovery rate for Cytori, the bankruptcy threshold for Cytori, the probability of a change of control event for Cytori, and the risk free interest rate. Because some of the inputs to our valuation model are either not observable quoted prices or are not derived principally from or corroborated by observable market data by correlation or other means, the put option liability is classified as Level 3 in the fair value hierarchy.

The following table summarizes the change in our Level 3 put option liability value:

   
Year ended
  
Year ended
 
Put option liability
 
December 31, 2011
  
December 31, 2010
 
        
Beginning balance
 $(1,170,000 ) $(1,140,000 )
Decrease (increase) in fair value recognized in operating expenses
  (740,000 )  (30,000 )
Ending balance
 $(1,910,000 ) $(1,170,000 )

Common stock purchase warrants issued in connection with our August 2008 private equity placement do not trade in an active securities market, and as such, we estimate the fair value of these warrants using the option pricing model. Some of the significant inputs are observable in active markets, such as common stock market price, volatility, and risk free rate. The fair value of these warrants also incorporate our assumptions about future equity issuances and their impact to the down-round protection feature. Because some of the inputs to our valuation model are either not observable quoted prices or are not derived principally from or corroborated by observable market data by correlation or other means, the warrant liability is classified as Level 3 in the fair value hierarchy.
 
The following table summarizes the change in our Level 3 warrant liability value:

   
Year ended
  
Year ended
 
Warrant liability
 
December 31, 2011
  
December 31, 2010
 
        
Beginning balance
 $(4,987,000 ) $(6,272,000 )
Decrease (increase) in fair value recognized in operating expenses
  4,360,000   1,285,000 
Ending balance
 $(627,000 ) $(4,987,000 )

No other assets or liabilities are measured at fair value on a recurring basis, or have been measured at fair value on a non-recurring basis subsequent to initial recognition, on the accompanying consolidated balance sheet as of December 31, 2011.
Fair Value
Fair Value
5.
Fair Value

Financial Instruments

We disclose fair value information about all financial instruments, whether or not recognized in the balance sheet, for which it is practicable to estimate fair value. The disclosures of estimated fair value of financial instruments at December 31, 2011 and 2010, were determined using available market information and appropriate valuation methods. Considerable judgment is necessary to interpret market data and develop estimated fair value. The use of different market assumptions or estimation methods may have a material effect on the estimated fair value amounts.

The carrying amounts for cash and cash equivalents, accounts receivable, inventories, other current assets, accounts payable, accrued expenses and other liabilities approximate fair value due to the short-term nature of these instruments.

We utilize quoted market prices to estimate the fair value of our fixed rate debt, when available. If quoted market prices are not available, we calculate the fair value of our fixed rate debt based on a currently available market rate assuming the loans are outstanding through maturity and considering the collateral. In determining the current market rate for fixed rate debt, a market spread is added to the quoted yields on federal government treasury securities with similar terms to the debt.

At December 31, 2011 and 2010, the aggregate fair value and the carrying value of the Company's fixed rate long-term debt were as follows:

   
December 31, 2011
  
December 31, 2010
 
              
   
Fair Value
  
Carrying Value
  
Fair Value
  
Carrying Value
 
              
Fixed rate long-term debt
 $24,211,000  $24,341,000  $19,782,000  $19,679,000 

Carrying value is net of debt discount of $1,847,000 and $1,321,000 as of December 31, 2011 and 2010, respectively.

Nonfinancial Assets and Liabilities

We apply fair value techniques on a non-recurring basis associated with: (1) valuing potential impairment losses related to goodwill which are accounted for pursuant to the authoritative guidance for intangibles-goodwill and other; and (2) valuing potential impairment losses related to long-lived assets which are accounted for pursuant to the authoritative guidance for property, plant and equipment.

All of our goodwill is associated with regenerative cell technology, and we determine the fair value based on a combination of inputs including the market capitalization of the company, as well as Level 3 inputs such as discounted cash flows which are not observable from the market, directly or indirectly. We conduct our goodwill impairment analysis annually as of November 30 each year, or upon the occurrence of certain triggering events. No such triggering events occurred during the year ended December 31, 2011. Historically, the fair value has significantly exceeded its carrying value.

We test for the impairment of our long-lived assets when triggering events occur and such impairment, if any, is measured at fair value. The inputs for fair value of our long lived assets would be based on Level 3 inputs as data used for such fair value calculations would be based on discounted cash flows using market place participant assumptions. No triggering events occurred during the year ended December 31, 2011.
Thin Film Japan Distribution Agreement
Thin Film Japan Distribution Agreement
6.
Thin Film Japan Distribution Agreement

The Company has entered into a Distribution Agreement with Senko. Under this agreement, we granted to Senko an exclusive license to sell and distribute certain Thin Film products in Japan and are responsible for the completion of the initial regulatory application to the MHLW and commercialization of the Thin Film product line in Japan. Specifically, the license covers Thin Film products with the following indications:

 
·
Anti-adhesion,

 
·
Soft tissue support, and

 
·
Minimization of the attachment of soft tissues throughout the body.

The Distribution Agreement with Senko commences upon “commercialization.” Essentially, commercialization occurs when one or more Thin Film product registrations are completed with the MHLW. As of December 31, 2011 commercialization has not yet occurred. Following commercialization, the Distribution Agreement has a duration of five years and is renewable for an additional five years after reaching mutually agreed minimum purchase guarantees.

The Distribution Agreement also provides for us to supply certain products to Senko at fixed prices over the life of the agreement once we have received approval to market these products in Japan. In addition to the product price, Senko will also be obligated to make royalty payments to us of 5% of the sales value of any products Senko sells to its customers during the first three years post-commercialization. We are currently pursuing the required regulatory clearance in order to initiate commercialization.

At the inception of this arrangement, we received a $1,500,000 license fee which was recorded as deferred revenues in 2004. Half of the license fee is refundable if the parties agree commercialization is not achievable and a proportional amount is refundable if we terminate the arrangement, other than for material breach by Senko, before three years post-commercialization. We have also received $1,250,000 in milestone payments from Senko. We have also earned or will be entitled to earn additional payments under the Distribution Agreement based on achieving the defined research and development milestones. We recognized no development revenue recognized during the years ended December 31, 2011, 2010 and 2009 under this agreement.
Composition of Certain Financial Statement Captions
Composition of Certain Financial Statement Captions
7.
Composition of Certain Financial Statement Captions

Inventories, net

As of December 31, 2011 and 2010, inventories, net, were comprised of the following:

   
December 31,
 
   
2011
  
2010
 
        
Raw materials
 $1,503,000  $2,311,000 
Work in process
  790,000   410,000 
Finished goods
  1,025,000   657,000 
   $3,318,000  $3,378,000 
 
Other Current Assets

As of December 31, 2011 and 2010, other current assets were comprised of the following:

   
December 31,
 
   
2011
  
2010
 
   
 
  
 
 
Prepaid insurance
 $234,000  $230,000 
Prepaid other
  372,000   477,000 
Other receivables
  231,000   127,000 
   $837,000  $834,000 

Property and Equipment, net

As of December 31, 2011 and 2010, property and equipment, net, were comprised of the following:

   
December 31,
 
   
2011
  
2010
 
   
 
  
 
 
Manufacturing and development equipment
 $4,268,000  $4,035,000 
Office and computer equipment
  2,177,000   2,137,000 
Leasehold improvements
  3,255,000   3,125,000 
    9,700,000   9,297,000 
Less accumulated depreciation and amortization
  (7,989,000)  (7,613,000)
   $1,711,000  $1,684,000 

Depreciation expense totaled $618,000, $710,000 and $1,458,000 for the years ended December 31, 2011, 2010, and 2009, respectively.

Accounts Payable and Accrued Expenses

As of December 31, 2011 and 2010, accounts payable and accrued expenses were comprised of the following:

   
December 31,
 
   
2011
  
2010
 
   
 
  
 
 
Accrued legal fees
 $829,000  $646,000 
Accrued R&D studies
  534,000   1,227,000 
Accounts payable
  272,000   601,000 
Accrued vacation
  908,000   760,000 
Accrued bonus
  866,000   1,045,000 
Accrued expenses
  1,572,000   2,077,000 
Deferred rent
  37,000   17,000 
Accrued accounting fees
  90,000   135,000 
Accrued payroll
  226,000   262,000 
   $5,334,000  $6,770,000 
Commitments and Contingencies
Commitments and Contingencies
8.
Commitments and Contingencies

We have contractual obligations to make payments on leases of office, manufacturing, and corporate housing space as follows:

Years Ending December 31,
 
Operating
Leases
 
     
2012
 $1,879,000 
2013
  1,913,000 
2014
  1,766,000 
2015
  1,821,000 
2016
  1,867,000 
2017
  1,590,000 
Total
 $10,836,000 

Rent expense, which includes common area maintenance, for the years ended December 31, 2011, 2010 and 2009 was $2,524,000, $2,186,000 and $2,198,000, respectively.
 
We have entered into agreements with various research organizations for pre-clinical and clinical development studies, which have provisions for cancellation. Under the terms of these agreements, the vendors provide a variety of services including conducting research, enrolling patients, recruiting patients, monitoring studies and data analysis. Payments under these agreements typically include fees for services and reimbursement of expenses. The timing of payments due under these agreements was estimated based on current schedules of pre-clinical and clinical studies in progress. As of December 31, 2011, we have pre-clinical research study obligations of $60,000 (all of which are expected to be complete within a year) and clinical research study obligations of $13,800,000 ($3,250,000 of which are expected to be complete within a year). Should the timing of the pre-clinical and clinical trials change, the timing of the payment of these obligations would also change.

During 2008, we entered into a supply agreement with a minimum purchase requirements clause. As of December 31, 2011, we have minimum purchase obligations of $2,191,000 ($1,341,000 of which are expected to be paid within a year).

We are subject to various claims and contingencies related to legal proceedings. Due to their nature, such legal proceedings involve inherent uncertainties including, but not limited to, court rulings, negotiations between affected parties and governmental actions. Management assesses the probability of loss for such contingencies and accrues a liability and/or discloses the relevant circumstances, as appropriate. Management believes that any liability to us that may arise as a result of currently pending legal proceedings will not have a material adverse effect on our financial condition, liquidity, or results of operations as a whole.

Refer to note 3 for a discussion of our commitments and contingencies related to our transactions with Olympus, including (a) our obligation to the Joint Venture in future periods and (b) certain put and call rights embedded in the arrangements with Olympus.

Refer to note 6 for a discussion of our commitments and contingencies related to our arrangements with Senko.

Refer to note 9 for a discussion of our commitments and contingencies related to our long-term obligations.
Long-term Obligations
Long-term Obligations
9.
Long-term Obligations

On September 9, 2011 we entered into a Second Amendment to the Amended and Restated Loan and Security Agreement (loan agreement) with General Electric Capital Corporation (GECC), Silicon Valley Bank (SVB) and Oxford Finance Corporation (together, the “Lenders”), pursuant to which the Lenders increased the prior term loan made to the Company to a principal amount of $25.0 million (Term Loan), subject to the terms and conditions set forth in the loan agreement. The Term Loan accrues interest at a fixed rate of 9.87% per annum. Pursuant to the loan agreement, we are required to make (i) twelve (12) equal consecutive monthly principal payments of $20,833 on the first day of each calendar month, commencing on October 1, 2011, (ii) twenty-nine (29) equal consecutive monthly principal payments of $825,000 on the first day of each calendar month, commencing on October 1, 2012, and (iii) and one (1) final principal payment of $825,000 on March 1, 2015. In addition, the maturity date of the Term Loan has been extended until March 1, 2015, and at maturity of the Term Loan, the Company will make a final payment fee equal to 5% ($1,250,000) of the Term Loan. We may incur additional fees if we elect to prepay the Term Loan. In connection with the Term Loan, on September 9, 2011, we issued to the Lenders warrants to purchase up to an aggregate of 132,891 shares of our common stock at an exercise price of $3.01 per share. These warrants are immediately exercisable and will expire on September 9, 2018.

The Term Loan amended the Amended and Restated Loan and Security Agreement, of which an aggregate balance of approximately $15.6 million remained outstanding along with a prorated final payment fee of $419,000. The net proceeds of the Term Loan, after payment of lender fees and expenses, were approximately $8.6 million.

We accounted for this amendment as debt modification since the terms of the amended Term Loan and the Original Term Loan were not substantially different and as present value of cash flows of the modified instrument (using a net method of comparing the present value of cash flows related to the lowest common principal balance between the old and the new loans) was within 10% of the original debt instrument. Accordingly, the fees associated with the amended Term Loan of $300,000, final payment fee of $1,250,000, and the existing unamortized debt discount from the Original Term Loan of $332,000 will be amortized as an adjustment of interest expense over the term of the Amended Term Loan using the effective interest method.
 
We allocated the aggregate proceeds of the Term Loan between the warrants and the debt obligations based on their relative fair values. The fair value of the warrants issued to the Lenders is calculated utilizing the Black-Scholes option pricing model. We are amortizing the relative fair value of the warrants as a discount of $267,000 over the term of the loan using the effective interest method, with an effective interest rate of 13.63%. If the maturity of the debt is accelerated due to an event of default, then the amortization would be accelerated. The Term Loan is collateralized by the tangible assets of the company, including a security interest in substantially all of its existing and after-acquired assets, excluding its intellectual property assets; provided however, that if the Company does not maintain certain cash ratios, the security interest automatically will be deemed to include the Company's intellectual property assets. As of December 31, 2011, we were in compliance with our financial and non-financial covenants.

Additional details relating to the above term loan that is outstanding as of December 31, 2011, are presented in the following table:

Origination Date
 
Original Loan
Amount
  
Interest
Rate
  
Current
Monthly
Payment*
 
Term
 
Remaining
Principal
(Face Value)
 
                
September 2011
 $25,000,000   9.87 % $225,622 
42 Months
 $24,938,000 
________________________________________
 
*
Current monthly payment is inclusive of interest and principal

As of December 31, 2011, the future contractual principal and final fee payments on all of our debt and lease obligations are as follows:

Years Ending December 31,
   
     
2012
 $2,693,000 
2013
  9,927,000 
2014
  9,921,000 
2015
  3,749,000 
2016
  6,000 
Total
 $26,296,000 

Reconciliation of Face Value to Book Value as of December 31, 2011
   
     
Total debt and lease obligations, including final payment fee (Face Value)
 $26,296,000 
Less: Debt discount
  (1,847,000 )
Total:
  24,449,000 
Less: Current portion
  (2,487,000 )
Long-term obligation
 $21,962,000 

Our interest expense for the years ended December 31, 2011, 2010 and 2009 (most of which related to the loan entered into September 2011, June 2010 and October 2008 was $2,784,000, $2,052,000 and $1,427,000, respectively. Interest expense is calculated using the effective interest method, therefore it is inclusive of non-cash amortization in the amount of $711,000, $703,000 and $709,000, respectively, related to the amortization of the debt discount and capitalized loan fees.
Income Taxes
Income Taxes
10.
Income Taxes

Due to our net losses for the years ended December 31, 2011, 2010 and 2009, and since we have recorded a full valuation allowance against deferred tax assets, there was no provision or benefit for income taxes recorded. There were no components of current or deferred federal or state income tax provisions for the years ended December 31, 2011, 2010 and 2009.
 
A reconciliation of the total income tax provision tax rate to the statutory federal income tax rate of 34% for the years ended December 31, 2011, 2010 and 2009 is as follows:

   
2011
  
2010
  
2009
 
Income tax expense (benefit) at federal statutory rate
  (34.00) %  (34.00) %  (34.00) %
Income tax expense (benefit) at state statutory rate
  (3.36) %  (2.62) %  (2.61) %
Mark to market permanent adjustment
  (5.02) %  (1.71) %  7.21 %
Change in federal valuation allowance
  45.72 %  40.47 %  8.16 %
Change in State Rate
  (3.29) %  0.00 %  24.55 %
Deferred revenue
  (2.09) %  (2.82) %  (0.28) %
Other, net
  2.04 %  0.68 %  (3.03) %
    0.00 %  0.00 %  0.00 %

The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities as of December 31, 2011 and 2010 are as follows:

   
2011
  
2010
 
Deferred tax assets:
      
Allowances and reserves
 $292,000  $217,000 
Accrued expenses
  587,000   540,000 
Deferred revenue
  3,276,000   3,164,000 
Stock based compensation
  4,886,000   3,860,000 
Net operating loss carryforwards
  73,774,000   61,398,000 
Income tax credit carryforwards
  5,569,000   5,242,000 
Property and equipment, principally due to differences in depreciation
  707,000   821,000 
Other
  181,000   0 
    89,272,000   75,242,000 
Valuation allowance
  (89,200,000)  (74,994,000)
          
Total deferred tax assets, net of allowance
  72,000   248,000 
          
Deferred tax liabilities:
        
Intangibles
  (72,000)  (151,000)
Capitalized Assets and other
  0   (97,000)
          
Total deferred tax liability
  (72,000)  (248,000)
          
Net deferred tax assets (liability)
 $-  $- 

We have established a valuation allowance against our net deferred tax assets due to the uncertainty surrounding the realization of such assets. We periodically evaluate the recoverability of the deferred tax assets. At such time as it is determined that it is more likely than not that deferred assets are realizable, the valuation allowance will be reduced. We have recorded a valuation allowance of $89,200,000 as of December 31, 2011 to reflect the estimated amount of deferred tax assets that may not be realized. We increased our valuation allowance by approximately $14,206,000 during the year ended December 31, 2011. The valuation allowance includes approximately $579,000 related to stock option deductions, the benefit of which, if realized, will eventually be credited to equity and not to income.

At December 31, 2011, we had federal, California, and Massachusetts tax loss carryforwards of approximately $193,511,000, $127,557,000, and $164,000 respectively. The federal and state net operating loss carryforwards begin to expire in 2019 and 2012 respectively, if unused. At December 31, 2011, we had federal and state tax credit carryforwards of approximately $3,808,000 and $3,594,000 respectively. The federal credits will begin to expire in 2017, if unused, and the state credits carry forward indefinitely. In addition, we had a foreign tax loss carryforward of $10,694,000 in Japan, $1,226,000 in Italy, $1,295,000 in Switzerland, and $51,000 in India.

Pursuant to the Internal Revenue Code (“IRC”) of 1986, as amended, specifically IRC §382 and IRC §383, our ability to use net operating loss and R&D tax credit carry forwards to offset future taxable income is limited if we experience a cumulative change in ownership of more than 50% within a three-year period. We have completed an ownership change analysis pursuant to IRC Section 382 through April 17, 2007. We did not have any ownership change limitations based on that study. If ownership changes within the meaning of IRC Section 382 are identified as having occurred subsequent to April 17, 2007, the amount of remaining tax carry forwards available to offset future taxable income in future years may be significantly restricted or eliminated.
 
We recognize tax benefits associated with the exercise of stock options directly to stockholders' equity only when realized. Accordingly, deferred tax assets are not recognized for net operating loss carryforwards resulting from windfall tax benefits. At December 31, 2011, deferred tax assets do not include $1,225,000 of excess tax benefits from stock-based compensation.

We changed our accounting method of accounting for uncertain tax positions on January 1, 2007. We had no unrecognized tax benefits as of the date of adoption.

Following is a tabular reconciliation of the unrecognized tax benefits activity during the years ended December 31, 2011, 2010 and 2009:

   
2011
  
2010
  
2009
 
Unrecognized Tax Benefits – Beginning
 $1,166,000  $1,115,000  $952,000 
Gross increases – tax positions in prior period
  -   -   4,000 
Gross decreases – tax positions in prior period
  -   (49,000)  - 
Gross increase – current-period tax positions
  138,000   100,000   159,000 
Settlements
  -   -   - 
Lapse of statute of limitations
  -   -   - 
Unrecognized Tax Benefits – Ending
 $1,304,000  $1,166,000  $1,115,000 

None of the amount included in our liability for uncertain tax benefits if recognized would affect the Company's effective tax rate, since it would be offset by an equal reduction in the deferred tax asset valuation allowance. The Company's deferred tax assets are fully reserved.

The Company did not recognize interest related to unrecognized tax benefits in interest expense and penalties in operating expenses as of December 31, 2011.

The Company's material tax jurisdictions are United States and California. The Company is currently not under examination by the Internal Revenue Service or any other taxing authority.

The Company's tax years for 1999 and forward can be subject to examination by the United States and California tax authorities due to the carryforward of net operating losses and research development credits.

The Company does not foresee material changes to its liability for uncertain tax benefits within the next twelve months.
Employee Benefit Plan
Employee Benefit Plan
11.
Employee Benefit Plan

We implemented a 401(k) retirement savings and profit sharing plan (the “Plan”) effective January 1, 1999. We may make discretionary annual contributions to the Plan, which is allocated to the profit sharing accounts based on the number of years of employee service and compensation. At the sole discretion of the Board of Directors, we may also match the participants' contributions to the Plan. We made no discretionary or matching contributions to the Plan in 2011, 2010 and 2009.
Stockholders' Equity (Deficit)
Stockholders' Equity (Deficit)
12.
Stockholders' Equity (Deficit)

Preferred Stock

We have authorized 5,000,000 shares of $.001 par value preferred stock, with no shares outstanding as of December 31, 2011 and 2010. Our Board of Directors is authorized to designate the terms and conditions of any preferred stock we issue without further action by the common stockholders.
 
Common Stock

On March 10, 2009, we raised approximately $10,000,000 in gross proceeds from sale to institutional investors of a total of 4,771,174 shares of our common stock and warrants to purchase up to a total of 6,679,644 additional shares of our common stock at a purchase price of $2.10 per unit, with each unit consisting of one (1) share and one and four-tenths (1.4) warrants. The warrants will not be exercisable until six months after the date of issuance and will expire five years after the date the warrants are first exercisable. The warrants will have an exercise price of $2.59 per share, which was the consolidated closing bid price of the Company's common stock on March 9, 2009, as reported by NASDAQ. The shares and the warrants are immediately separable and will be issued separately. We have accounted for the warrants as a component of stockholders' deficit. The warrants must be settled through a cash exercise whereby the warrant holder exchanges cash for shares of Cytori common stock, unless the exercise occurs when the related registration statement is not effective, in which case the warrantholder can only exercise through the cashless exercise feature of the warrant agreement.

On May 14, 2009, we raised approximately $4,252,000 in gross proceeds from a private placement of 1,864,783 shares of our common stock and warrants to purchase up to a total of 3,263,380 additional shares of our common stock at a purchase price of $2.28 per unit, with each unit consisting of one (1) share and one and three-fourths (1.75) warrants. The warrants are exercisable immediately and will expire five years after the date of issuance. The warrants will have an exercise price of $2.62 per share. We have accounted for the warrants as a component of stockholders' deficit.

Additionally, on June 19, 2009, we entered into a common stock purchase agreement with Seaside 88, LP relating to the offering and sale of a total of up to 7,150,000 shares of our common stock. The agreement required us to issue and Seaside to buy 275,000 shares of our common stock once every two weeks, subject to the satisfaction of customary closing conditions. Upon completions of our scheduled closings pursuant to the agreement with Seaside 88, LP in June 2010, we raised approximately $30,172,000 in aggregate gross proceeds from this transaction from the sale of 7,150,000 shares of our common stock between June 2009 and June 2010, of which $17,314,000 in gross proceeds from the sale of 3,300,000 shares was raised during 2010. We have accounted for each of the completed closings as a component of stockholders' deficit.

In October 2010, we entered into an underwriting agreement with Jefferies & Company, relating to the issuance and sale of 4,600,000 shares of our common stock. This price to the public in this offering was $4.50 per share and the underwriter has agreed to purchase the shares from us at a price of $4.23 per share. The transaction was completed on October 13, 2010 raising approximately $20,700,000 in gross proceeds before deducting underwriting discounts and commissions and other offering expenses payable by us.

On December 13, 2010 we raised $10,000,000 in gross proceeds from a sale of 1,428,571 shares of unregistered common stock to Astellas Pharma Inc. for $7.00 per share in a private stock placement. Pursuant to the terms of the purchase agreement, we granted Astellas Pharma Inc. a two year right of first refusal to enter into a development and commercialization collaboration with us regarding the use of our technology, on a worldwide basis, for the treatment of liver conditions. In addition, we have agreed to use reasonable efforts to file a registration statement with the Securities and Exchange Commission to register the shares of common stock for resale upon the request of Astellas Pharma Inc. We also granted Astellas Pharma Inc. a non-voting observer seat on our Board of Directors and the right to designate a representative member to our Scientific Advisory Board. The $10,000,000 in total proceeds we received exceeded the market value of our stock at the completion of the purchase agreement. The $2,526,000 difference between the proceeds received and the fair market values of our common stock is recorded as a component of deferred revenues in the accompanying balance sheet. This difference was recorded as deferred revenue since, conceptually, the excess proceeds represent a value paid by Astellas Pharma Inc. attributable to the scientific advisory board seat, the non-voting observer seat on our Board of Directors, and the two year right of first refusal to enter into a development and commercialization collaboration with us regarding the use of our technology, on a worldwide basis, for the treatment of liver conditions, rather than an additional equity investment in Cytori. The recognition of this deferred amount is expected to occur upon the earlier of the expiration of the two year period or the termination of the agreement.

On July 11, 2011, we entered into a common stock purchase agreement with Seaside 88, LP relating to the offering and sale of a total of up to 6,326,262 shares of our common stock. The agreement requires us to issue and Seaside to buy 1,326,262 shares of our common stock at an initial closing and 250,000 shares of our common stock once every two weeks, commencing 30 days after the initial closing, for up to an additional 20 closings, subject to the satisfaction of customary closing conditions. At the initial closing, the offering price was $4.52, which equaled to 88% of our common stock's volume-weighted average trading prices, or VWAP, during the ten-day trading period immediately prior to the initial closing date, raising approximately $6,000,000 in gross proceeds. At subsequent closings, the offering price will equal 90.25% of our common stock's volume-weighted average trading prices during the ten-day trading period immediately prior to each subsequent closing date. We raised approximately $13,286,000 in gross proceeds from the sale of 4,076,262 shares in our scheduled closings through December 31, 2011.
 
Warrant Adjustments

Our March 2009 offering of 4,771,174 shares of our common stock and warrants to purchase up to a total of 6,679,644 additional shares of our common stock with an exercise price of $2.59 per share, our May 2009 equity offering of 1,864,783 shares of our common stock and warrants to purchase up to a total of 3,263,380 additional shares of our common stock with an exercise price of $2.62 per share, our closings with Seaside 88, LP through December 31, 2011, our October 2010 offering of 4,600,000 shares of our common stock and our December 2010 sale of 1,428,571 shares of our common stock triggered an adjustment to the exercise price and number of shares issuable under the warrants issued to investors in our August 2008 private placement financing. As a result, as of December 31, 2011, the common stock warrants issued on August 11, 2008 are currently exercisable for 1,990,282 shares of our common stock at an exercise price of $5.82 per share.

Treasury Stock

As part of our equity offering on March 10, 2009, we sold our remaining 1,872,834 shares of common stock from our treasury for $3,933,000 cash, or $2.10 per share. The cost basis of the treasury stock sold was at a weighted average purchase price, or $3.63 per share, resulting in a loss of $1.53 per share, or $2,861,000 in aggregate, and was accounted for as a reduction of additional paid-in capital.
Stockholders Rights Plan
Stockholders Rights Plan
13.
Stockholders Rights Plan

On May 28, 2003, the Board of Directors declared a dividend distribution of one preferred share purchase right (a “Right”) for each outstanding share of our common stock. The dividend is payable to the stockholders of record on June 10, 2003, and with respect to shares of common stock issued thereafter until the Distribution Date (as defined below) and, in certain circumstances, with respect to shares of common stock issued after the Distribution Date. Except as set forth below, each Right, when it becomes exercisable, entitles the registered holder to purchase from us one one-thousandth (1/1000th) of a share of our Series RP Preferred Stock, $0.001 par value per share (the “Preferred Stock”), at a price of $25.00 per one one-thousandth (1/1000th) of a share of Preferred Stock, subject to adjustment. Each share of the Preferred Stock would entitle the holder to our common stock with a value of twice that paid for the Preferred Stock. The description and terms of the Rights are set forth in a Rights Agreement (the “Rights Agreement”) between us and Computershare Trust Company, Inc., as Rights Agent, dated as of May 29, 2003, and as amended on May 12, 2005 and August 28, 2007.

The Rights attach to all certificates representing shares of our common stock outstanding, and are evidenced by a legend on each share certificate, incorporating the Rights Agreement by reference. The Rights trade with and only with the associated shares of our common stock and have no impact on the way in which holders can trade our shares. Unless the Rights Agreement was to be triggered, it would have no effect on the Company's consolidated balance sheet or income statement and should have no tax effect on the Company or its stockholders. The Rights Agreement is triggered upon the earlier to occur of (i) a person or group of affiliated or associated persons having acquired, without the prior approval of the Board, beneficial ownership of 15% or more (20% or more for certain shareholders) of the outstanding shares of our common stock or (ii) 10 days, or such later date as the Board may determine, following the commencement of or announcement of an intention to make, a tender offer or exchange offer the consummation of which would result in a person or group of affiliated or associated persons becoming an Acquiring Person (as defined in the Rights Agreement) except in certain circumstances (the “Distribution Date”). The Rights are not exercisable until the Distribution Date and will expire at the close of business on May 29, 2013, unless we redeem them earlier.
Stock-based Compensation
Stock-based Compensation
14.
Stock-based Compensation

During 1997, we adopted the 1997 Stock Option and Stock Purchase Plan (the “1997 Plan”), which provides for the direct award or sale of shares and for the grant of incentive stock options (“ISOs”) and non-statutory options to employees, directors or consultants. The 1997 Plan, as amended, provides for the issuance of up to 7,000,000 shares of our common stock. The exercise price of ISOs cannot be less than the fair market value of the underlying shares on the date of grant. ISOs can be granted only to employees. The 1997 Plan expired on October 22, 2007.
 
During 2004, we adopted the 2004 Equity Incentive Plan (the “2004 Plan”), which provides our employees, directors and consultants the opportunity to purchase our common stock through non-qualified stock options, stock appreciation rights, restricted stock units, or restricted stock and cash awards. The 2004 Plan initially provides for issuance of 3,000,000 shares of our common stock, which number may be cumulatively increased (subject to Board discretion) on an annual basis beginning January 1, 2005, which annual increase shall not exceed 2% of our then outstanding stock. As of December 31, 2011, there are 1,050,036 securities remaining and available for future issuances under 2004 Plan, which is exclusive of securities to be issued upon an exercise of outstanding options, warrants, and rights.
 
In August 2011, stockholders approved 2011 Employee Stock Purchase Plan (ESPP), with a maximum of 500,000 shares of our common stock to be issued under this plan.  Under the ESPP, eligible employees may purchase shares of our common stock through payroll deductions, which may not exceed 15% of an employee's compensation.  The price at which shares are sold under the ESPP is established by the duly appointed committee of the Board but may not be less than 90% of the lesser of the fair market value per share of our common stock on the offering date or on the purchase date. As of December 31, 20011, there were no stock issuances under this plan and no stock-based compensation was recorded for this plan for the year then ended. 
 
Stock Options

Generally, options issued under the 2004 Plan or the 1997 Plan are subject to four-year vesting, and have a contractual term of 10 years. Most options contain one of the following two vesting provisions:

 
·
12/48 of a granted award will vest after one year of service, while an additional 1/48 of the award will vest at the end of each month thereafter for 36 months, or

 
·
1/48 of the award will vest at the end of each month over a four-year period.

A summary of activity for the year ended December 31, 2011 is as follows:

   
Options
  
Weighted
Average
Exercise Price
 
Balance as of January 1, 2011
  7,050,689  $5.19 
Granted
  1,113,950  $5.20 
Exercised
  (200,755 ) $3. 82 
Expired
  (397,496 ) $7.12 
Cancelled/forfeited
  (109,204 ) $4.65 
Balance as of December 31, 2011
  7,457,184  $5.13 

   
Options
  
Weighted
Average
Exercise Price
  
Weighted
Average
Remaining
Contractual
Term (years)
  
Aggregate
Intrinsic Value
 
Balance as of December 31, 2011
  7,457,184  $5.13   5.53  $34,450 
Vested and expected to vest at December 31, 2011
  7,417,443  $5.13   5.52  $34,271 
Exercisable at December 31, 2011
  5,636,839  $5.02   4.57  $22,181 

The total intrinsic value of stock options exercised was $541,000, $1,529,000 and $682,000 for the years ended December 31, 2011, 2010 and 2009, respectively.

The fair value of each option awarded during the year ended December 31, 2011, 2010 and 2009 was estimated on the date of grant using the Black-Scholes-Merton option valuation model based on the following weighted-average assumptions:

   
Years ended December 31,
 
   
2011
  
2010
  
2009
 
Expected term
 
5.5 years
  
5 years
  
5 years
 
Risk-free interest rate
  1.95 %  2.22 %  1.94 %
Volatility
  72.36 %  72.81 %  66.80 %
Dividends
  -   -   - 
Resulting weighted average grant date fair value
 $3.24  $4.02  $2.34 

We calculated the expected term of our stock options based on our historical data. The expected term is calculated for and applied to all employee awards as a single group as we do not expect (nor does historical data suggest) substantially different exercise or post-vesting termination behavior amongst our employee population.

We estimate volatility based on the historical volatility of our daily stock price over the period preceding grant date commensurate with the expected term of the option.
 
The weighted average risk-free interest rate represents the interest rate for treasury constant maturity instruments published by the Federal Reserve Board. If the term of available treasury constant maturity instruments is not equal to the expected term of an employee option, we use the weighted average of the two Federal Reserve securities closest to the expected term of the employee option.

The dividend yield has been assumed to be zero as we (a) have never declared or paid any dividends and (b) do not currently anticipate paying any cash dividends on our outstanding shares of common stock in the foreseeable future.

Restricted Stock Awards

Generally, restricted stock awards issued under the 2004 Plan are subject to a vesting period that coincides with the fulfillment of service requirements for each award and have a contractual term of 10 years. These awards are amortized to compensation expense over the estimated vesting period based upon the fair value of our common stock on the award date.

A summary of activity for the year ended December 31, 2011 is as follows:

   
Restricted
Stock Awards
  
Weighted
Average Grant
Date Fair Value
 
Balance as of January 1, 2011
  40,269  $4.88 
Granted
  61,000  $5.74 
Exercised/Released
  (21,528 ) $4.71 
Balance as of December 31, 2011
  79,741  $5.59 


   
Options
  
Weighted
Average
Exercise Price
  
Weighted
Average
Remaining
Contractual
Term (years)
  
Aggregate
Intrinsic Value
 
Balance as of December 31, 2011
  79,741  $5.59   9.0  $175,430 
Vested and expected to vest at December 31, 2011
  79,741  $5.59   9.0  $175,430 
Exercisable at December 31, 2011
  48,241  $4.94   8.9  $106,130 

Performance-Based Restricted Stock Awards

We granted 246,225 performance-based restricted stock awards under the 2004 Equity Incentive Plan in February 2011. The awards provide certain employees until January 1, 2012 to achieve certain performance goals established by the Compensation Committee. The performance goals are weighted based on the following achievements: obtaining certain FDA clearance or approval (40%), achieving a targeted revenue increase for the fiscal year ended December 31, 2011 (20%), and entering into a major collaboration for development and/or commercialization of the Company's products (40%). To the extent that any of the performance goals are partially achieved, the Compensation Committee maintains the discretion to continue the vesting of all or a portion of the awards following January 1, 2012. Once earned, the awards will remain unvested until January 1, 2013. Termination of employment prior to vesting will result in the forfeiture of any earned (as well as unearned) awards. Effective January 2012, the outstanding awards ceased vesting based upon decision of the Compensation Committee that performance criteria has not been met as of January 1, 2012. No compensation expense was recognized related to these awards during the year ended December 31, 2011. The following table summarizes activity with respect to such awards during the year ended December 31, 2011:

   
Restricted
Stock Awards
  
Weighted
Average Grant-
Date Fair Value
 
Outstanding at January 1, 2011
  0    
Granted
  246,225  $5.82 
Vested
  0     
Cancelled/forfeited
  0     
Outstanding at December 31, 2011
  246,225  $5.82 
Vested at December 31, 2011
  0     
 
The following summarizes the total compensation cost recognized for the stock options and restricted stock awards in the accompanying financial statements:

   
Years ended December 31,
 
   
2011
  
2010
  
2009
 
           
Total compensation cost for share-based payment arrangements recognized in the statement of operations (net of tax of $0)
 $3,316,000  $3,055,000  $2,649,000 

As of December 31, 2011, the total unamortized compensation cost related to outstanding unvested stock options and restricted stock awards for all of our plans is approximately $5,782,000. These costs are expected to be recognized over a weighted average period of 1.72 years.

Cash received from stock option and warrant exercises for the years ended December 31, 2011, 2010 and 2009 was approximately $2,849,000, $7,128,000 and $531,000, respectively. No income tax benefits have been recorded related to the stock option exercises as the benefits have not been realized in our income tax returns.

To settle stock options and restricted stock awards, we will issue new shares of our common stock. At December 31, 2011, we have an aggregate of 24,462,062 shares authorized and available to satisfy option exercises under our plans.

Non-Employee Stock Based Compensation

During the third quarter of 2009, we issued 25,000 shares of restricted common stock to a non-employee consultant. The stock is restricted in that it cannot be sold for a specified period of time. There are no vesting requirements. Because the shares issued are not subject to additional future vesting or service requirements, the stock-based compensation expense of $92,000 recorded in the third quarter of 2009 constitutes the entire expense related to this grant, and no future period charges will be incurred.

Related Party Transactions
Related Party Transactions
15.
Related Party Transactions

During the year ended December 31, 2010, we recognized $583,000 in product revenues, related party, from our sales transactions through our distribution partner, Green Hospital Supply, Inc. During the first quarter of 2009, we sold a StemSource® Cell Bank in Japan through our distribution partner, Green Hospital Supply, Inc. for $600,000. The sale was completed pursuant to our Master Cell Banking and Cryopreservation Agreement, effective August 13, 2007, with Green Hospital Supply, Inc. No similar sales occurred during the year ended December 31, 2011. As of December 31, 2011, 2010 and 2009, Green Hospital, Inc. was a beneficial owner of more than five percent of our outstanding shares of common stock.

During the year ended December 31, 2011, 2010 and 2009, we incurred approximately $166,000, $253,000 and $242,000 in royalty costs in connection with our sales of our Celution® 800/CRS System products to the European and Asia-Pacific reconstructive surgery market, pursuant to our License and Royalty Agreement and the Amended License/Commercial Agreement with the Olympus-Cytori, Inc. joint venture, respectively. As of December 31, 2011, 2010 and 2009, Olympus Corporation was a beneficial owner of more than five percent of our outstanding shares of common stock.

Additionally, refer to note 3 for a discussion of related party transactions with Olympus.
Subsequent Events
Subsequent Events
16.
Subsequent Events

We have evaluated events after the balance sheet date of December 31, 2011 and up to the date we filed this report.

Subsequent to the quarter ended December 31, 2011, we completed four scheduled closings with Seaside 88, LP during the period of January 1, 2012 through our filing date raising in aggregate approximately $3,740,000 in gross proceeds from the sale of 1,250,000 shares of our common stock in connection with the agreement we entered into with Seaside 88, LP on July 11, 2011.

Quarterly Information (unaudited)
Quarterly Information (unaudited)
17.
Quarterly Information (unaudited)

The following unaudited quarterly financial information includes, in management's opinion, all the normal and recurring adjustments necessary to fairly state the results of operations and related information for the periods presented.

   
For the three months ended
 
   
March 31,
2011
  
June 30,
2011
  
September 30,
2011
  
December 31,
2011
 
              
Product revenues
 $1,362,000  $2,411,000  $2,134,000  $2,076,000 
Gross profit
  520,000   1,302,000   1,192,000   1,132,000 
Development revenues
  1,235,000   11,000   5,000   762,000 
Operating expenses
  12,998,000   5,685,000   9,020,000   7,868,000 
Other income (expense)
  (829,000 )  (766,000 )  (512,000 )  (932,000 )
Net loss
 $(12,072,000 ) $(5,138,000 ) $(8,335,000 ) $(6,906,000 )
Basic and diluted net loss per share
 $(0.23 ) $(0.10 ) $(0.15 ) $(0.13 )


   
For the three months ended
 
   
March 31,
2010
  
June 30,
2010
  
September 30,
2010
  
December 31,
2010
 
              
Product revenues
 $2,266,000  $2,091,000  $1,519,000  $2,378,000 
Gross profit
  1,336,000   1,208,000   599,000   1,203,000 
Development revenues
  2,143,000   7,000   65,000   158,000 
Operating expenses
  5,555,000   6,257,000   10,255,000   9,975,000 
Other income (expense)
  (371,000 )  (335,000 )  (826,000 )  (639,000 )
Net loss
 $(2,447,000 ) $(5,377,000 ) $(10,417,000 ) $(9,253,000 )
Basic and diluted net loss per share
 $(0.06 ) $(0.12 ) $(0.23 ) $(0.19 )
SCHEDULE II VALUATION AND QUALIFYING ACCOUNTS
SCHEDULE II VALUATION AND QUALIFYING ACCOUNTS
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS

For the years ended December 31, 2011, 2010 and 2009
(in thousands of dollars)

   
Balance at
beginning of
year
  
Additions (A)
  
Deductions (B)
  
Other (C)
  
Balance at
end of year
 
Allowance for doubtful accounts
               
Year ended December 31, 2011
 $306  $483  $(256) $(59) $474 
Year ended December 31, 2010
 $751  $460  $( 1,014) $109  $306 
Year ended December 31, 2009
 $122  $663  $(34) $-  $751 

 
(A)
Includes increases to allowances for doubtful accounts, net of any equipment recovered
 
(B)
Includes write off of uncollectible accounts receivable, net of any equipment recovered
 
(C)
Includes collections fees incurred and product sales amounts deferred that do not meet revenue recognition criteria, net of cash received