By Jason Napodano, CFA
On November 23, 2012, Organovo Holdings (NYSEMKT:ONVO) initiated a SEC filing with respect to certain warrants to purchase the company's common stock. The tender includes warrants to purchase an aggregate of approximately 14.51 million shares of common stock, comprised of three separate transactions:
- Bridge Warrants: 1.50 million warrants issued to investors participating in the company's bridge financing completed in November 2011.
- Investor Warrants: 11.65 million warrants issued to investors participating in the company's private placement transactions taking place in February and March 2012.
- Private Warrants: 1.35 million warrants issued to investors participating in the company's private placement transaction completed in 2011.
As per the terms of the tender offer, Organovo is amending the terms of these warrants. The amendments include making the following changes:
- Reduce the exercise price of all warrants from $1.00 per share to $0.80 per share.
- Shorten the exercise period so that all warrants expire concurrently with the expiration of the tender offer - 8:00 PM-EST on December 17, 2012
- Delete all price based anti-dilution provisions.
- And two additional provision to restrict short or forward sale ability of investors participating in the tender (a full explanation of these two final provisions can be found in the SEC filing).
The goal of the tender offer is simple - clean up the balance sheet and raise cash. Successfully completing the tender will put the company in a dramatically improved financial position and allow management at Organovo to seek an uplisting to the NASDAQ capital markets.
Clean Up The Balance Sheet
Organovo became public via a reverse merger in February 2012. Following the closing of the merger, Organovo completed three private placements raising gross proceeds of approximately $13.7 million to fund operations and facilitate the advancement of its bioprinting technology. Through the private placements, Organovo issued 15.25 million shares of common stock and 16.75 million five-year warrants to purchase common stock. These shares were registered via an S/1 filing that became effective in July 2012.
The warrants are carried on the balance sheet as "Warrant Liability." At the end of the first quarter 2012, the total warrant liability was $47.5 million. At the end of the second quarter 2012, the liability had grown to $80.58 million. We note this is a non-cash liability marked-to-market at the end of each quarter. As Organovo's stock price increases, the warrant liability also increases. The stock closed at $2.47 per share on March 31, 2012. It rose to $3.99 per share at the close of June 30, 2012. However, at the end of the third quarter, September 30, 2012, Organovo's stock closed at $2.05. Thus, the warrant liability plummeted to $35.47 million. Accordingly, Organovo booked a non-cash gain in the third quarter of $42.25 million. Valuation of the warrants is done using a Monte Carlo simulation modeling.
All of the above adjustments to income are non-cash. Despite the massive warrant re-valuations at the end of each quarter, Organovo burned only $0.8 million net cash in the third quarter 2012. Operating cash burn since inception (April 2007) is $11.7 million. We expect operating burn of around $2.0 million in the fourth quarter 2012. Yet, because of this massive non-cash warrant liability, Organovo's balance sheet as of September 30, 2012, (Form 10Q) lists a total liability of $36.5 million versus total assets of only $9.0 million. Thus, the stockholders' equity as of September 30, 2012 is -$27.4 million.
This creates a negative perception in the eyes of investors, even though delving into the financials one can learn that of the $36.5 million total liability, $35.5 million is non-cash accounting. Successfully tendering the 14.51 million warrants noted above from the three previous financings will work to dramatically improve the company's balance sheet. Based on our calculation, it eliminates approximately $22.5 million in non-cash warrant liability, which will immediately result in a $22.5 million gain to stockholders' equity. Stockholders' equity will go from -$27.4 million to -$4.9 million.
But there are further adjustments to the balance sheet - namely, an increase in cash. Cash at the end of the third quarter 2012 stood at $7.8 million. This accounted for the bulk of the $9.0 million in current assets. The exercising (or tendering) of all the above warrants could provide $11.5 million in cash to the company. As a result, cash at the end of the fourth quarter (December 31, 2012) would be $11.5 million higher. Factoring in a burn of $2.0 million (noted above), total cash should be roughly $17.3 million. This adjusts stockholders' deficit from $27.4 million to stockholders' equity +$4.6 million.
Management has provided guidance for net cash burn of $7 to $8 million in 2013. If all warrants are tendered, Organovo would have over two years of cash on hand. In the past we've written that with the signing of one or two more research collaborations, Organovo could achieve break-even operations in 2015. The warrants are already outstanding and in the money. They are already dilutive. The opportunity to raise $11.5 million in cash with no additional dilution to shareholders is exciting.
Management at Organovo has said in the past it seeks to uplist from the OTCQX to a major exchange. Financial and liquidity listing requirements for the NASDAQ Capital Markets require stockholder equity of +$4.0 million, a market value of publicly held shares of $15.0 million, a market value of listed securities of $50.0 million, 1 million publicly held shares, and a bid or closing price above $2 per share if net tangible assets exceed $2 million and a three-year operating history.
Below we look at how Organovo qualifies for listing on the NASDAQ-CM if the tender offer is successful.
Thus, a successful tender allows management at Organovo to pursue uplisting to the NASDAQ-CM, creating greater liquidity and tradability for the stock, along with improved perception from institutional investors.
One final point: we remind investors that the 14.51 million warrants above had a call provision whereby if Organovo's stock traded above $2.50 for 20 consecutive trading days, the company could call the warrants. This created somewhat of a ceiling for the shares, making it hard for the stock to break out and hold above $2.50 over the past year.
Executing On The Model
An improved cash position and clean balance sheet should help Organovo attract greater investor attention in 2013. Organovo has an almost science fiction-like 3D bioprinting platform. The best way for investors to understand what Organovo does is to view this company sponsored video.
What Is Bioprinting?
Bioprinting is still a relatively new and evolving technology. As a result, bioprinters may be constructed in various configurations. However, the process is essentially the same - bioprinters output cells from a printer head that moves left and right, back and forth, up and down, in order to place the cells in the desired location. The goal is to produce layers of living cells in a desired form with function.
Similar to inkjet printers, cells are printed in tiny spheres or cylinders ("bio-ink") to minimize their interfacial area. Contiguously placed spheres fuse with the same kinetics as liquid drops. Thus, the concept of bioprinting relies on the demonstrated principle that groups of individual cells will self-assemble to generate aggregates, through the actions of cell surface proteins that bind to each other and form junctions in between cells. Furthermore, if two or more compatible self-assembled aggregates are placed in close proximity, under the proper conditions they will fuse to generate larger, more complex structures. As noted above, the physical properties of bio-ink are analogous to those that drive fusion of liquid droplets.
When the cells are stacked onto an extruded mold, scientists have shown that tissue liquidity can be employed to engineer 3D living structures of specific shape. In particular, spheroidal cell aggregates can be used as discrete units to build simple toroidal (or short tubular) cellular structures. This can be accomplished by placing the aggregates along a circle stacked between dissolvable bio-paper (Example 1). The structure is built upward, like a skyscraper one floor at a time. Cells can also be painted to create a sheet structure (Example 2).
As development progresses, tissues transition from a dynamic viscous liquid state to a more static semi-solid state, largely driven by the compartmentalized organization of cellular components and production within the organized tissue of extracellular matrix proteins that provide the mature tissue with the biomechanical properties required for tissue-specific function.
Organovo's NovoGen MMX Bioprinter is a novel, fully automated (custom graphic user interface), hardware and software platform developed specifically to meet today's challenges in biological research and bioprinting. The device enables the fabrication of three-dimensional (3D) primary human or other living mammalian cells into tissue, with tremendous cellular viability and biology that is superior to even an animal model. Organovo's NovoGen MMX mechanical extruder enables the fabrication of three-dimensional tissue constructs in a wide variety of geometries (tubular structures, networked sheets, etc...) The speed and precision of this instrument enables the production of small-scale tissue models for drug discovery as well as various drug absorption and toxicology assays.
The Organovo machine primarily uses stem cells extracted from adult bone marrow and fat as the precursors, but the company has demonstrated that any mammalian primary cell (even non-stem cells) will work in the printer. However, stem cells can be coaxed into differentiating into many other types of cells by the application of appropriate growth factors. The process takes place at near physiological conditions. Plus, the entire unit fits easily into a standard biosafety cabinet, eliminating the need to purchase ancillary equipment or make facility modifications to maintain sterility of bioprinted tissues during the printing process.
The cells are formed into droplets, or "bio-ink," at 100-500 microns in diameter and containing 10,000-30,000 cells each. The droplets retain their shape well and pass easily through the inkjet printing process. Bio-ink can be created from a wide variety of cell lines, including primary cells, stromal cells, epithelial cells, endothelial cells, and progenitor cells. Bio-ink production begins with the creation of a thick cell paste comprised of a slurry of cells and the other necessary components required to be part of the final tissue composition. After a maturation period, the bio-ink is loaded into the bioprinter, which then dispenses these building blocks in the geometry specified by the user through a printing head.
A second printing head is used to deposit a sugar-based hydrogel bio-compatible scaffolding. This does not stick to nor interfere with the cells. Once the printing is complete, the structure is left for a day or two to allow the droplets to fuse together. For tubular structures, such as blood vessels, the hydrogel is printed in the center and around the outside of the ring of each cross-section before the cells are added. When the part has matured, the hydrogel is peeled away from the outside and pulled from the center like a piece of string.
The bio-printer is also capable of using other types of cells and support materials. The machine, for example, can be used to place liver cells on a pre-built liver-shaped scaffold or to form layers of lining and connective tissue that would grow into a tooth. By allowing creation of three-dimensional biological structures, NovoGen MMX creates functional human tissue that is superior to current disease and / or animal models.
A key distinguishing feature of Organovo's platform is the ability to generate three-dimensional constructs that have all or some of their components comprised entirely of cells. The fully cellular feature of the NovoGen MMX technology enables architecturally and compositionally defined 3D human tissues to be generated for in vitro use in drug discovery and development to potentially replicate the functional biology of a solid, fully cellular tissue.
Below is a representation of the potential for the NovoGen MMX bioprinter. Cells can be printed in layered fashion (A) to create tubular structures (B) of various shapes and thicknesses (C). In addition to flexibility in tube diameter and wall thickness, the bioprinter can be programed to construct branched macrovascular structures (D) in as little as five to seven days.
The tissue structures created by Organovo's NovoGen MMX Bioprinter have the potential to create a paradigm shift in the approach to the generation of three-dimensional human tissue and the replication of clinical assay testing with respect to native human biology. Organovo's device improves on previous technologies by moving away from monolayer 2D cell cultures and by enabling all or part of the tissues created to be constructed solely of cells. This accomplishes two important advancements with respect to tissue biology:
First, the 3D structure allows the cells to behave as if they were in their native environment. Cells are surrounded by other cells in native form. This is a vast improvement over the previous flat tissue model where cells had little to no interaction other than in a two-dimensional sense.
Second, removing the presence of foreign, non-native polymers in the final tissue construct allows the cells to build their own extracellular matrix for support (e.g. collagen, laminin).
We believe that Organovo's NovoGen MMX Bioprinter is uniquely positioned to provide three-dimensional human tissue for use in drug discovery and development, as well as a broad array of tissue suitable for therapeutic use in regenerative medicine applications. Specifically, the NovoGen MMX Bioprinter has the ability to:
1) Produce highly specialized three-dimensional human tissues that can be utilized to model a specific tissue physiology or pathophysiology. The company has demonstrated the ability to create human blood vessel constructs, and to create fully human tissue containing capillary structures. This has the potential to broaden the scope and scale of 3D tissues that can be generated, and to facilitate the development of disease models in such areas as cardiovascular disease, oncology and fibrosis.
2) Facilitate biological research through absorption/distribution/metabolism/ excretion (ADME) testing used to determine which factors enhance or inhibit how a potential drug compound reaches the blood stream. For example, distribution of a compound can be affected by binding to plasma proteins; age, genetics and other factors can influence metabolism of a compound; and the presence of certain disease states can have effects on excretion of a compound. Many companies perform ADME studies utilizing various cell-based assays or automated bioanalytical techniques.
Drug metabolism and pharmacokinetics (DMPK) testing is a subset of ADME. Determining the DMPK properties of a drug helps the drug developer to understand its safety and efficacy.
Toxicology (TOX) testing is a further requirement to determine the detrimental effects of a particular drug on specific tissues. This is a particularly attractive area for testing liver toxicity, which can be difficult to model in cell culture assays because the cells flatten out resulting in altered gene expression. The cells essentially stop functioning as liver cells within 24 hours of culture. A 3D living human tissue makes it possible to test the toxicity of an experimental compound in a way that more closely mimics the reaction within a living organism over a longer period of time.
We believe that the NovoGen MMX Bioprinter is positioned to deliver highly differentiated products for use in traditional cell-based ADME/TOX/DMPK studies. Products in this arena may replace or complement traditional cell-based assays that typically employ primary hepatocytes, intestinal cell lines, renal epithelial cells and cell lines grown in a traditional two-dimensional format.
Importantly, the combination of tissue-like three-dimensionality and human cellular components is believed to provide an advantage over non-human animal systems toward predicting in vivo human outcomes. We expect Organovo to be in position to launch its first products here - such as 48- or 96-well toxicology kits - in 2014. We see this as a potential $20 to $30 million opportunity.
The two focused efforts above offer up an enormous opportunity for Organovo. The life-science tools market is growing at 7% CAGR, and cell biology is the largest segment projected at over $14+ billion in 2012. However, an even more exciting opportunity exists for Organovo via implementation into regenerative medicine practices.
3) Provide the architectural precision and flexibility to facilitate the optimization, development, and clinical use of three-dimensional tissue constructs for use in regenerative medicine. The NovoGen MMX Bioprinter offers a next-generation strategy whereby three-dimensional structures can be generated without the use of scaffolding or biomaterial components. The ultimate goal is to enable fully cellular constructs to be generated in a configuration compatible with surgical modes of delivery, thereby enabling restoration of significant functional mass to a damaged tissue or organ.
A key component to management's business strategy is to pursue collaboration agreements with drug development companies that will allow Organovo to further develop the 3D bioprinting technology and the potential uses of the cellular structures and tissues that can be produced with the technology. The company plans to develop research products with its 3D bioprinting technology that can be offered to third parties involved in drug discovery.
Organovo's goal is to leverage the ability of the NovoGen MMX Bioprinter, either in 3D modeling a specific tissue physiology or pathophysiology, enhanced ADME/TOX/DMPK studies, or in regenerative medicine applications, and form strategic alliances that generate revenue and further push the technology forward. Under these collaboration agreements, Organovo and the partner company will conduct research to pursue drug discovery utilizing the three-dimensional cellular structures developed with the NovoGen MMX Bioprinter technology.
The pharmaceutical industry spends over $50 billion per year on R&D, yet only produces some 20 new drugs that are approved by the U.S. FDA. Many drugs fail in preclinical or clinical testing due to a lack of understanding on physiology, pathophysiology, or unforeseen toxicity. This is because currently drug therapy research and testing generally involves testing drug candidates and therapies on monolayer two dimensional cell cultures that attempt to mimic damaged or degenerating tissues. Organovo's technology creates three-dimensional cellular structures, which enhance and facilitate drug discovery.
In December 2010, Organovo entered into a $600,000 collaborative research agreement with Pfizer (NYSE:PFE) to develop specific three-dimensional tissue based drug discovery assays in two therapeutic areas utilizing the NovoGen MMX Bioprinter technology. To date, Pfizer has paid the company $525,000 under the agreement ($75,000 in the third quarter 2012) and management anticipates completing the research plan in 2012, thus we model the final $75,000 under the current collaboration to be recorded in the fourth quarter 2012.
Once complete, we expect that Organovo and Pfizer will enter into larger-scale collaboration that will provide the opportunity for Organovo to earn upfront, development, regulatory, and sales-related milestones, as well as royalties on commercialized products under the collaboration at Pfizer.
In October 2011, Organovo entered into a $1,365,000 research agreement with United Therapeutics to establish and conduct a research program to discover treatments for pulmonary hypertension using the NovoGen MMX Bioprinter technology. The initial term of the collaboration is for 30 months or the completion of the contracted research. Organovo granted United Therapeutics an option to acquire from a worldwide, royalty-bearing license in certain intellectual property created under the research agreement solely for use in the treatment or prevention of pulmonary hypertension and all other lung diseases. If enacted, the license would provide for certain milestone payments and minimum annual royalties and sales-based royalties to Organovo. To date, Organovo has recognized a total of $916,800 in payments from United Therapeutics (including $298,800 in the third quarter 2012).
Organovo's goal is to sign additional licensing and collaboration partnerships over the next several years. The company's collaborative agreements generally have a term of one to three years. Management's goals are to obtain certain upfront payments and milestone payments throughout the term related to the research and development obligations under the agreement. In addition, the collaboration agreements provide for a future licensing arrangement between Organovo and its partner, with royalties payable to Organovo if the drug development company is successful in identifying a drug candidate or therapy utilizing the NovoGen MMX Bioprinter technology.
We expect that the company will be able to secure additional licensing and collaboration partnerships that each provides $1 to $2 million in upfront payments, with upwards of $10 million in back-end payments and low-single digit royalties on sales of commercialized products. We expect that revenue over the next several years may remain lumpy, as are the revenue of technology-licensing collaborations, but history shows that companies with potentially breakthrough research and development technology often start out under-appreciated until one or more of the collaborations prove fruitful.
Cell Assay Models
Above, we noted the opportunity for Organovo to launch cell assay kits into the drug discovery market for things like ADME/TOX/DMPK studies. The old model of 2D cell assay presents challenges that we believe Organovo's 3D model can solve. The company is currently working on cell assay kits, in 96-well plates, which the company plans to launch as new catalog products in 2014 and 2015.
Traditionally, high-throughput screening (HTS) for cancer drug discovery involves direct molecular target screening and 2D cell-based assays. Direct molecular target screening provides valuable insight into binding affinity and functional inhibition; however, HTS provides limited information on drug interaction within a complex cellular environment. Conversely, 2D cell-based assays provide good analysis on cellular response, but often the cellular response in vitro (in a petri dish) does not emulate the actual tissue function in vivo. The classic example is in heterotypic microenvironment of solid tumors. The combination of HTS and 2D assays often leads to low success rates and high costs in preclinical drug discovery.
Organovo's 3D tissue-culture system is designed to bridge the gap between preclinical animal modeling and human clinical trials. The process provides a more dynamic and true representation of target drugs' interactions in a natural biology.
The company is currently working on the development of cell assay kits for sale into the pharmaceutical research market (both academic and institutional), with a target of launching the first kits in 2014. Examples of potential products include 3D liver toxicology assays. Liver toxicology is a major roadblock in human clinical trials, mainly because no one has yet to develop a good preclinical assay.
When plated onto a petri dish, liver cells flatten out and cease to function as liver cells within 24 hours. As a result, 2D liver toxicology assays give a significant number of false negatives. Organovo is working on proving that in-vitro 3D liver tissue constructs function as liver cells for significantly longer periods of time, providing for a better representation of in vivo drug interaction. Other applications include testing new medications for lung fibrosis and cancer.
The life-science tools market is growing at 7% CAGR, and is expected to eclipse $40 billion in 2012. Scientia Advisors recently completed market research for Organovo that concluded the cell assay market could approach $500 million in 2018. Organovo is currently conducting research in this area, looking to publish data confirming the theory that 3D liver cells provide a better representation of what pharmaceutical companies can expect in human clinical trials than the current 2D models that exist today. Once the data are published, Organovo can use the peer-reviewed publication to market the new product. Organovo expects to have new data with respect to the 3D liver cell assay product in April 2013 at the Experimental Biology conference.
We see a significant opportunity for Organovo to create 3D cell assays and start introducing them to the market in 2014. We model the launch of one new major cell biology assay kit coming to market every year starting in 2014. We see each product as a potential $20 to $30 million opportunity for the company, and there are probably a dozen products within cell toxicology alone that the company can create.
We expect the company's top-line to be lumpy, but eventually take off in a hockey-stick like ramp starting in 2015. We expect costs to remain low, as management looks to partner with larger organizations and academic institutions. All this should make Organovo an attractive investment for long-term shareholders.
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