UNITED
STATES SECURITIES AND EXCHANGE COMMISSION
 Washington,
D.C. 20549
 
  FORM
10-K
 
 (Mark
      One)ý
              
              ANNUAL
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934For
      the fiscal year ended December 31, 2008ORo
              
              TRANSITION
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934For
      the transition period
      from                        toCommission
      file number 0-32501
 
 CYTORI
THERAPEUTICS, INC.
 (Exact
name of Registrant as Specified in Its Charter)
 
 DELAWARE
              
              33-0827593(State
      or Other Jurisdiction
                of
      Incorporation or Organization)
              
              (I.R.S.
      Employer
                Identification
      No.)3020
      CALLAN ROAD, SAN DIEGO, CALIFORNIA
              
              92121(Address
      of principal executive offices)
              
              (Zip
      Code)
 
 Registrant’s
telephone number, including area code:(858) 458-0900
 
 Securities
registered pursuant to Section 12(b) of the Act:
 Common
stock, par value $0.001
 
 Securities
registered pursuant to Section 12(g) of the Act:
 None
 
 Indicate
by check mark if the registrant is a well-known seasoned issuer as defined in
Rule 405 of the Securities Act. Yes o  No ý
 
 Indicate
by check mark if the registrant is not required to file reports pursuant to
Section 13 or Section 15(d) of the Exchange Act.
 Yes o  No ý
 
 Indicate
by check mark whether the registrant: (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days.
 Yes ý  No o
 Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K is not contained herein, and will not be contained, to the best
of the registrant’s knowledge, in definitive proxy or information statements
incorporated by reference in
 Part III
of this Form 10-K or any amendment to this Form 10-K. ý
 
 Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting
company.  See definition of “large accelerated filer,” “accelerated
filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act
(Check one).
  Large
      Accelerated Filer   o
              Accelerated
      Filer ý
              Non-Accelerated
      Filer o
              Smaller
      reporting company o(Do
      not check if a smaller reporting company)
  Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act). Yes   o    No  ý
 
 The
aggregate market value of the common stock of the registrant held by
non-affiliates of the registrant on June 30, 2008, the last business day of the
registrant’s most recently completed second fiscal quarter, was $107,941,235
based on the closing sales price of the registrant’s common stock on June 30,
2008 as reported on the Nasdaq Global Market, of $6.48 per share.
 
 As of
February 28, 2009, there were 29,313,441 shares of the registrant’s common stock
outstanding.
 
 DOCUMENTS
INCORPORATED BY REFERENCE
 Portions
of the registrant’s definitive proxy statement for the 2009 Annual Meeting of
Stockholders, which will be filed with the Securities and Exchange Commission
within 120 days after the end of the year ended December 31, 2008, are
incorporated by reference in Part III, Items 10, 11, 12, 13 and 14 of this Form
10-K.
  
  
  
 
 TABLE
OF CONTENTS
 
 PART
      IItem 1.
              BusinessItem 1A.
              Risk FactorsItem 1B.
              Unresolved Staff CommentsItem 2.
              PropertiesItem 3.
              Legal ProceedingsItem 4.
              Submission of Matters to a Vote of Security
      HoldersPART
      IIItem 5.
              Market for Registrant’s Common Equity, Related
      Stockholder Matters and Issuer Purchases of Equity
      SecuritiesItem 6.
              Selected Financial
  DataItem 7.
              Management’s Discussion and Analysis of Financial
      Condition and Results of OperationsItem 7A.
              Quantitative and Qualitative Disclosures About
      Market RiskItem 8.
              Financial Statements and Supplementary
      DataItem 9.
              Changes in and Disagreements with Accountants on
      Accounting and Financial DisclosureItem 9A.
              Controls and ProceduresItem 9B.
              Other InformationPART
      IIIItem 10.
              Directors, Executive Officers and Corporate
      GovernanceItem 11.
              Executive CompensationItem 12.
              Security Ownership of Certain Beneficial Owners and
      Management and Related Stockholder MattersItem 13.
              Certain Relationships and Related Transactions, and
      Director IndependenceItem 14.
              Principal Accountant Fees and
      ServicesPART
      IVItem 15.
              Exhibits, Financial Statement
      Schedules
 
  
  
 PART I
 
 Item 1. Business
 
 General
 
 Cytori
Therapeutics, Inc., develops, manufactures, and sells medical products to enable
the practice of regenerative medicine. Regenerative medicine describes the
emerging field that aims to repair or restore lost or damaged tissue and cell
function. Our commercial activities are currently focused on cosmetic and
reconstructive surgery in Europe and Asia-Pacific, fulfilling the demand among
physicians in Europe and Asia Pacific for clinical grade stem and regenerative
cells, and stem and regenerative cell banking (cell preservation)
worldwide.  In addition, we are seeking to bring our products to
market in the United States as well as other countries. Our product pipeline
includes the development of potential new treatments for cardiovascular disease,
spinal disc degeneration, gastrointestinal disorders, liver and renal disease
and pelvic health conditions.
 
 The
foundation of our business is the patented Celution® System
family of products which processes patients’ cells at the bedside in real time.
Each member of the Celution® System
family of products consists of a central device, a related single-use consumable
used for each patient procedure, proprietary enzymes, and related
instrumentation. Our commercialization model is based on the sale of
Celution® Systems
and on generating recurring revenues from the single-use consumable
sets.
 
 Our
Celution® 800/CRS
System was introduced during 2008 into the European cosmetic and reconstructive
surgery market through a network of medical distributors. The Celution® 900/MB
is being marketed in Japan through our commercialization partner, Green Hospital
Supply, Inc. (Green Hospital Supply) as part of the comprehensive
StemSource® Cell
Bank, which prepares cells for cryopreservation in the event they may be used in
the future.
 
 The most
advanced therapeutic application in our product development pipeline is
cardiovascular disease. Currently, two cardiovascular clinical trials are being
conducted in Europe with adipose-derived stem and regenerative cells, processed
with the Celution®600
System, an earlier version of the Celution® 800/CV.
The Celution® 800/CV
has recently been introduced to these clinical sites. One of the clinical trials
is in patients suffering from chronic myocardial ischemia, a severe form of
chronic heart disease, and the other is in heart attack patients.
 
 In the
United States, our goal is to seek regulatory and marketing approval on the
Celution®700 System family of products.  We expect to finalize our U.S.
regulatory and clinical development strategy in 2009.
 
 Summary of
Celution®System Family
Regulatory Status
  Celution®Series
                Region
                Clinical
      Applications
                Regulatory
      Status
                Comments900/MB
                Japan
                Cell
      Banking
                Approved900/MB
                Greece
                Cell
      Banking
                CE
      Mark800/CRS
                Europe
                Cell
      Processing  for re-implantation or re-infusion into same patient
      (General Processing)
                CE
      Mark
                Post-marketing
      studies underway  for reconstructive surgeryEurope
                Seeking
      cosmetic & reconstructive claims
                In
      process800/CV
                Europe
                Will
      seek cardiovascular disease claims
                In
      clinical study800/GP
                Europe
                Will
      seek multiple specific surgical claims
                Pre-clinical
 
 3
 Summary
of Celution® System Family Regulatory Status (cont’d)
  Celution®
      Series
                  Region
                  Clinical
      Applications
                  Regulatory
      Status
                  Comments700/CRS
                  USA
                  Will
      seek reconstructive surgery claims
                  Pre-clinical700/CV
                  USA
                  Will
      seek cardiovascular disease claims
                  Pre-clinical700/GP
                  USA
                  Will
      seek multiple general surgical claims
                  Pre-clinical600
                  Europe
                  Cell
      Concentration
                  CE
      Mark
                  Two
      cardiac clinical trials underway: chronic and acute200
                  USA
                  Blood
      Processing
                  510
      (k) clearance
 Our
MacroPore Biosurgery operating segment manages the ThinFilm biomaterial product
line in Japan. We sold our non-Japan Thin Film business in 2004. Pending
regulatory approval in Japan, this product line would be distributed exclusively
through Senko Medical Trading Co. (“Senko”) for anti-adhesion applications, soft
tissue support, and minimization of the attachment of soft tissues throughout
the body.
 
 Reconstructive
Surgery
 
 The
Celution®800/CRS System is approved in Europe as a bedside device for separating
and concentrating a patient's stem and regenerative cells, which reside
naturally within their adipose (fat) tissue, so that these cells may be
re-injected back into that same patient.
 
 The
Celution®800/CRS System was introduced into the European and Asia-Pacific
reconstructive surgery market in the first quarter of 2008.  Our
distribution network covers the UK, France, Germany, Norway, Finland, Denmark,
Sweden, Austria and Switzerland through our commercialization partnership with
GE Healthcare, and Belgium, China, Greece, Indonesia, Israel, Italy, Korea,
Malaysia, Portugal, Singapore, Spain, Turkey and the Netherlands through a
network of independent distributors.
 
 We hope
to begin commercializing the Celution®800/CRS
System with indications for use for breast reconstruction for partial mastectomy
defects as early as 2010 pending supporting clinical data and expanded CE
certification. To support this goal, a 70-patient, multi-center study, RESTORE
II, was initiated in Europe in 2008.  The results from this study will
also be used to support reimbursement for such procedure.
 
 Market for Clinical-Grade
Cells
 
 The
Celution System is being sold to physicians to fulfill their demand for access
to clinical-grade stem and regenerative cells.  Celution is the only
such system broadly available in Europe today that can provide real time access
to cells, which can safely be administered to patients.  Availability
at the point of care enables physicians to apply cells across an array of
applications. Certain physicians may even choose to study patient outcomes
to understand the benefit of these cells under their own independently sponsored
and regulated studies.  Such ‘translational’ efforts are growing and
already represent applications as diverse as wound healing, radiation injury,
breast reconstruction, breast augmentation, HIV related facial wasting syndrome,
vocal cord paralysis, burn, urinary incontinence, fistula repair (and Crohn’s
disease), bone regeneration, cardiovascular applications, peripheral vascular
disease, renal insufficiency and acute kidney injury, and liver disease among
many others.  We expect the breadth of these applications will grow
significantly as physicians continue to adopt cell based regenerative medicine
into their treatment strategies based on the availability of safe clinical grade
cells at the point of care.
 
 StemSource®andCellBanking
 
 The
Celution® 900/MB
System is the foundation of our StemSource® Cell
Bank for cryopreserving patients’ adult stem and regenerative cells. The
StemSource® Cell Bank is being marketed to hospitals, tissue banks and stem cell
banking companies in Europe and Asia. With a StemSource® Cell
Bank on site, hospitals will be able to offer their patients the option
  4
  of
storing their adipose tissue-derived stem and regenerative cells and accessing
them as clinical applications are approved.
 
 The
StemSource® Cell Bank is being marketed in Japan, Korea, Taiwan and Thailand
exclusively by Green Hospital Supply, Inc.  The value of a
StemSource® Cell
Bank lies in the recurring revenue from processing and freezing.  It
starts with a tissue collection procedure, which may be performed during an
already planned surgery or a separate elective procedure. The cells are prepared
for storage using the Celution®900/MB
System, which automates the separation and concentration of stem and
regenerative cells from adipose tissue and thereby allows hospitals to more
affordably offer such service to patients.
 
 As part
of our agreement with Green Hospital Supply, we equally split revenues in Japan,
Korea, Taiwan and Thailand from the sale to hospitals of StemSource® Cell
Banks and single-use, per-procedure consumables.  Green Hospital
Supply is responsible for all sales and marketing while Cytori is responsible
for manufacturing the Celution®900/MB
System and sourcing all necessary equipment, including but not limited to
cryopreservation chambers, cooling and thawing devices, cell banking protocols
and the proprietary software and database application.
 
 Cytori
signed a commercialization partnership with GE Healthcare in January 2009, which
grants GE Healthcare exclusive rights to commercialize the Celution® System
in the U.K., France, Germany, Norway, Finland, Denmark, Sweden, Austria,
Switzerland, Belgium, the Netherlands and Luxembourg for clinical grade access
to stem and regenerative cells and stem cell banking.
 
 Cardiovascular
Disease
 
 We
currently have two clinical trials underway in Europe for adipose-derived stem
and regenerative cells processed with the Celution® 600 and
800 Systems, to study cardiovascular disease. In January 2007, we initiated a
clinical trial for chronic myocardial ischemia, a severe form of coronary artery
disease. In late 2007, we initiated a study for acute heart attacks, for which
enrollment is ongoing.  Enrollment for both trials is projected to be
completed in 2009.  Both are double-blind, placebo controlled safety
and feasibility studies, which will evaluate a variety of primary and secondary
safety and efficacy endpoints.
 
 We
believe there is significant need for new forms of treatment for cardiovascular
disease, which represents one of the largest healthcare market opportunities.
The American Heart Association estimates that in the United States of America
alone there are approximately 865,000 heart attacks each year and more than
13,000,000 people suffer from coronary heart disease.
 
 Celution®SystemPipeline
 
 Other
applications for the Celution® System
family of products under investigation include gastrointestinal disorders,
vascular disease, pelvic health conditions, and orthopedic and spinal
applications. Our scientists are, to a varying degree, investigating these
applications in pre-clinical models.
  Manufacturing
 
 The
Celution®800/CRS,
Celution®900/MB,
and related single-use consumables are being manufactured at Cytori’s
headquarters in San Diego, CA.  The completion of our internal
manufacturing facilities in 2007 is expected to enable us to meet anticipated
demand in 2009.
 
 In the
future, the next generation Celution®
device is expected to be manufactured through a joint venture arrangement
between Cytori and Olympus Corporation (“Olympus”), a global optics and life
science company.  Olympus-Cytori Inc. (the “Joint Venture”), enables Cytori
to access Olympus’ expertise in engineering, manufacturing and servicing of
sophisticated medical devices.  The Joint Venture will supply the
Celution® System
for all therapeutic applications solely to Cytori at a formula-based transfer
price. Cytori owns Celution® System
marketing rights for all therapeutic applications.
 
 Competition
 
 We
compete with multiple pharmaceutical, biotechnology and medical device companies
involved in the development and commercialization of medical technologies and
therapies.
 
 Regenerative
medicine is rapidly progressing, in large part through the development of
cell-based therapies or devices designed to isolate cells from human tissues.
Most efforts involve cell sources, such as bone marrow, embryonic and fetal
tissue, umbilical cord and peripheral blood, and skeletal muscle.  We
work exclusively with adult stem and regenerative cells from adipose
tissue.
  5
 
 Companies
working in this area include, among others, Aastrom Biosciences, Inc., Baxter
International, Inc., BioHeart, Inc., Cellerix SA, Genzyme, Inc., Geron
Corporation, Isolagen, Inc., MG Biotherapeutics (a joint venture between Genzyme
and Medtronic), Osiris Therapeutics, Inc., Stem Cells, Inc. and Tissue Genesis,
Inc. Many of our competitors and potential competitors have substantially
greater financial, technological, research and development, marketing, and
personnel resources than we do.  We cannot with any accuracy forecast
when or if these companies are likely to bring cell therapies to market for
indications that we are also pursuing.
 
 Some of
our competitors are also working with adipose-derived cells.  To the
best of our knowledge, none of these companies are currently conducting human
clinical trials. In addition, Cytori is aware of several surgeons who are
performing autologous fat transfers using manual methods, some of whom enrich
the fat with autologous adipose-derived cells.
 
 Companies
researching and developing cell-based therapies for cardiovascular disease
include, among others, Baxter, BioHeart, MG Biotherapeutics, and Osiris. Baxter
completed a Phase II study in the United States using stem cells extracted from
peripheral blood for chronic myocardial ischemia. BioHeart is conducting
multiple ongoing clinical trials in the United States and Europe for its
investigational product MyoCellTM, which are cultured autologous skeletal
myoblasts.  We are aware that BioHeart has disclosed its intentions to
develop heart attack treatments using adipose-derived cells. Osiris
Therapeutics, Inc. completed a Phase I clinical trial using allogeneic (donor),
mesenchymal stem cells, for acute myocardial infarction and is planning a
broader Phase II study.
 
 Research
and Development
 
 Research
and development expenses were $17,371,000, $20,020,000 and $21,977,000 for the
years ended December 31, 2008, 2007 and 2006, respectively. For 2008, majority
of the research and development expenses were related to our regenerative cell
technology.
 
 Our
research and development efforts in 2008 focused predominantly on the
following areas:
 
 ·
              Optimization
      of the design, functionality and manufacturing process for the
      Celution® System
      family of products, single-use consumables and related instrumentation for
      the entry of the device into the European reconstructive surgery market
      and the StemSource®
      Cell Banking market in Europe and
Asia-Pacific;
 
 ·
              Development
      of the infrastructure and logistics in partnership with Green Hospital
      Supply including building out a proprietary database and software
      application and optimizing proprietary protocols, resulting in the first
      sale in Japan of the StemSource®
      cell banking line to the University of
Kyoto;
 
 ·
              Preparation
      and initiation of a 70 patient European breast reconstruction
      post-marketing clinical study using the Celution®
      System. The study is taking place across several centers and will measure
      safety, volume retention as well as other metrics related to autologous
      fat transfers enriched with the Celution®
      System output to correct partial mastectomy
  defects;
 
 ·
              Implementation
      and continuing enrollment in two randomized, double blind, placebo
      controlled, cardiovascular disease clinical trials in Europe for chronic
      myocardial ischemia and heart
attacks.
 
 ·
              Preparation
      and submission of multiple regulatory filings in the United States,
      Europe, and Japan related to various cell processing systems under
      development;
 
 ·
              Conducting
      extensive pre-clinical safety and efficacy studies investigating the use
      of adipose-derived stem and regenerative cells for reconstructive surgery,
      spinal disc repair, renal failure, pancreatitis, stroke, and other
      therapeutic applications;
 
 ·
              Investigating
      the cellular and molecular properties, composition, and characteristics of
      stem and regenerative cells residing in adipose tissue towards improving
      our intellectual property position and towards understanding how to
      improve and control the therapeutic
products.
 
  6
  Customers
 
 Cytori
has established a network of distributors who offer our Celution® System,
instrumentation and consumables to surgeons and hospitals throughout Europe.
These distributors purchase the devices from Cytori at a contractually
agreed-upon transfer price. We also market our Celution® System
directly to customers in select countries within Europe. In addition, we offer
the Celution as part of the StemSource® Cell
Bank, a comprehensive suite of products to allow hospitals or tissue banks to
cryopreserve adipose-derived stem and regenerative cells.
 
 In July
2004, we entered into a Distribution Agreement with Senko under which we granted
to Senko an exclusive license to sell and distribute Thin Film products in
Japan. The sale of products through Senko commences upon “commercialization,”
which requires regulatory clearance from the Japanese regulatory authorities. We
are currently pursuing the required regulatory clearance. Following
commercialization, the Distribution Agreement has a five-year duration and is
renewable for an additional five years after reaching mutually agreed minimum
purchase guarantees.  In 2004, we sold all of our non-Japan Thin Film
business.
 
 Sales
by Geographic Region
 
 For the
year ended December 31, 2008, all of our product revenue came from sales of
Celution® 800/CRS
System to the European and Asia-Pacific reconstructive surgery market and
installation of our first StemSource® Cell
Bank in Greece. For the year ended December 31, 2007, our only product sales
came from our bioresorbable surgical implants.  As these were no
longer core to our business focus, we sold our remaining interest in this line
of business to Kensey Nash in May 2007 (excluding our Thin Film products in
Japan) and we no longer receive any revenue from the sales of those
products.  Prior to May 2007, we sold our products predominantly in
the United States and to a lesser extent internationally through
Medtronic.
 
 Regenerative
Cell Technology
 
 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 in Greece.  This product includes a combination of equipment and
service deliverables, some of which will be provided to the customer over
time.  We have recorded $4,528,000 in revenue during 2008 related to
our Celution® products
and StemSource®Cell
Bank.
 
 Additionally,
our consolidated balance sheet includes a line item entitled deferred revenues,
related party.  This account primarily consists of the consideration
we have received in exchange for future obligations that we have agreed to
perform on behalf of Olympus and the Joint Venture.  We recognize
deferred revenues, related party, as development revenue when certain
performance obligations are met.  Such revenue recognition results
from completion of certain milestones, such as completion of product development
efforts, regulatory filings and related pre-clinical and clinical
studies.  In 2008, 2007 and 2006, we recognized $774,000, $5,158,000
and $5,905,000 of revenue associated with our arrangements with Olympus,
respectively.
 
 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 stem and 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.  As part of this agreement, Olympus
could 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.  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.
 
 For the
year ended December 31, 2006, we recorded $310,000 in grant revenue related to
our agreement with the National Institutes of Health (“NIH”).  Under
this agreement, the NIH reimbursed us for “qualifying expenditures” related to
research on Adipose-Derived Cell Therapy for Myocardial Infarction. There was no
similar revenue in 2007 and 2008.
 
 For the
years ended December 31, 2008, 2007 and 2006, we recorded revenue of $47,000,
$85,000 and $102,000, respectively, related to cell processing equipment, and
adipose derived stem cell research products sold to various research
facilities.  We also recorded stem cell banking revenue of $4,000,
$4,000 and $7,000 for the years ended December 31, 2008, 2007 and 2006,
respectively, related to our U.S. StemSource® Cell
Bank offering for the processing and preservation of adipose-derived stem and
regenerative cells at our FDA and California state-licensed tissue bank
facility.
 
  7
  MacroPore
Biosurgery
 
 In 2007
and 2006 our product sales were $792,000 and $1,451,000, respectively, all of
which relate to the MacroPore Biosurgery segment.  These revenues were
primarily related to orders for our radiographically identifiable Spine System
products, marketed under the name MYSTIQUETM.  As noted above, we were
concerned about the level of commitment to these products from Medtronic, our
exclusive distributor, and we sold our intellectual property rights and tangible
assets related to our spine and orthopedic bioresorbable implant product line to
Kensey Nash in May 2007.
 
 Under a
distribution agreement with Senko, we are responsible for the completion of the
initial regulatory application to the MHLW (the Japanese equivalent of the U.S.
Food and Drug Administration).  We recognized development revenue
based on milestones defined within this agreement of $10,000 and $152,000 for
the years ended December 31, 2007 and 2006, respectively.  We did not
recognize any similar revenue in 2008.  We have not received any Thin
Film product revenue in Japan yet, and we sold all our non-Japan Thin Film
business in 2004.
 
 We
anticipate that our future international product revenues will increase as a
result of our Distribution Agreement with Senko to the extent our Thin Film
products reach commercialization in Japan.
 
 Planned
Capital Expenditures
 
 Although
capital expenditures may vary significantly depending on a variety of factors,
we may spend up to $1,000,000 on capital equipment purchases in 2009, although
we will diligently seek to spend much less.  These may be paid with
our available cash, or financed if appropriate.    (See
additional discussion regarding Liquidity at the beginning of Item 7,
Management’s Discussion and Analysis of Financial Condition and Results of
Operations.)
 
 Raw
Materials
 
 Raw
materials required to manufacture the Celution® System
family of products and disposables are commonly available from multiple sources,
and we have identified and executed supply agreements with our preferred
vendors.  Some specialty components are custom made for Cytori, and we
are dependent on the ability of these suppliers to deliver functioning parts in
a timely manner to meet the ongoing demand for our products.  There
can be no assurance that we will be able to obtain adequate quantities of the
necessary raw materials supplies within a reasonable time or at commercially
reasonable prices.  Interruptions in supplies due to price, timing, or
availability could have a negative impact on our ability to manufacture
products.
 
 Intellectual
Property
 
 Our
success depends in large part on our ability to protect our proprietary
technology, including the Celution® System
product platform, and to operate without infringing on the proprietary rights of
third parties. We rely on a combination of patent, trade secret, copyright and
trademark laws, as well as confidentiality agreements, licensing agreements and
other agreements, to establish and protect our proprietary rights. Our success
also depends, in part, on our ability to avoid infringing patents issued to
others. If we were judicially determined to be infringing on any third party
patent, we could be required to pay damages, alter our products or processes,
obtain licenses or cease certain activities.
 
 To
protect our proprietary medical technologies, including the Celution® System
platform and scientific discoveries, Cytori has has three issued U.S. patents
and six issued International patents.  In addition, we have 117 patent
applications pending worldwide. We are seeking patents on methods and systems
for processing adipose-derived stem and regenerative cells, on use of
adipose-derived stem and regenerative cells for a variety of therapeutic
indications, including their mechanisms of actions, and on compositions of
matter than include adipose-derived stem and regenerative cells.
 
 In June
2008, Cytori was issued U.S. Patent No. 7,390,484 (the ‘484
patent).  The ‘484 patent is a foundational  patent that
protects the Celution®
System  technology for processing adipose tissue to obtain a diverse
and mixed population of adipose derived  stem and regenerative cells.
The ‘484 patent establishes a strong barrier-to-entry against potential
competitors and provides critical market protection while we seek regulatory
approval in the United States.
 
 In
September 2008, Cytori was issued U.S. Patent No. 7,429,488 (‘the ‘488
patent).  The ‘488 patent protects Cytori’s Celution® System based
methods of generating adipose tissue derived stem and regenerative cell enhanced
fat grafts.  Cell enhanced fat grafts may be used in a variety of
cosmetic and reconstructive surgery applications, including breast
reconstruction following partial mastectomy, breast implant salvage, as well as
facial and other cosmetic applications.
  8
  In
January 2009, Cytori was issued  U.S. Patent No. 7,473,420 (‘the 420
patent).  The ‘420 patent protects  combinations of the
Celution System output with various additives including, but not limited to,
agents that promote cell differentiation such as growth factors, cytokines and
protein, demineralized bone, tissue or tissue fragments, biological or
artificial scaffolds, and immunosuppressive compounds.  These
additives may be combined with the Celution System output to increase efficacy,
optimize or localize cell delivery, enhance specific cell properties or promote
cell differentiation.
 
 Cytori
has also received six international patents.  Specifically, Cytori has
received patents in Korea and Singapore related to the Company’s current
Celution System devices, patents in Korea and Australia related to the Company’s
StemSource Cell Bank, and patents in Singapore and South Africa related to the
use of adipose derived stem and regenerative cells for cardiovascular
therapy.
 
 We are
also the exclusive, worldwide licensee of the Regents of the University of
California’s rights to U.S. Patent No. 6,777,231 (the ‘231 patent), U.S. Patent
No. 7,470,537 (the ‘537 patent), six issued international patents and 17 patent
applications pending worldwide.  The ‘231 patent covers isolated
adipose derived stem cells that can differentiate into two or more of a variety
of cell types.  The ‘231 patent has been construed to cover isolated
adipose derived stem cells in an environment substantially free of other
cellular materials found in adipose tissue.  The ‘537 patent, issued
in December 2009, covers a population of stem cells and progenitor cells which
can be obtained from adipose tissue and which express certain combinations of
cell surface markers.  Specifically, the ‘537 patent covers adipose
derived stem and progenitor cells that express certain combinations of Stro-1+,
CD29+, CD44+, CD71+, CD49d+, CD90+, CD105+, SH3, CD45-, CD31- and low or
undetectable levels of CD106.  International patents related to
isolated cells from adipose tissue have issued in Australia, Korea, Russia,
Singapore and South Africa.
 
 We cannot
assure that any of the pending patent applications will be issued, that we will
develop additional proprietary products that are patentable, that any patents
issued to us will provide us with competitive advantages or will not be
challenged by any third parties or that the patents of others will not prevent
the commercialization of products incorporating our technology. Furthermore, we
cannot assure that others will not independently develop similar products,
duplicate any of our products or design around our patents. U.S. patent
applications are not immediately made public, so we might be surprised by the
grant to someone else of a patent on a technology we are actively
using.
 
 Patent
law outside the United States is uncertain and in many countries is currently
undergoing review and revisions. The laws of some countries may not protect our
proprietary rights to the same extent as the laws of the U.S. Third parties may
attempt to oppose the issuance of patents to us in foreign countries by
initiating opposition proceedings. Opposition proceedings against any of our
patent filings in a foreign country could have an adverse effect on our
corresponding patents that are issued or pending in the U.S. It may be necessary
or useful for us to participate in proceedings to determine the validity of our
patents or our competitors’ patents that have been issued in countries other
than the U.S. This could result in substantial costs, divert our efforts and
attention from other aspects of our business, and could have a material adverse
effect on our results of operations and financial condition. We currently have
pending patent applications in Europe, Australia, Japan, Canada, China, Korea,
and Singapore, among others.
 
 Patent
litigation results in substantial costs to us and diversion of effort, and may
be necessary from time to time to enforce or confirm the ownership of any
patents issued or licensed to us or to determine the scope and validity of third
party proprietary rights. If our competitors claim technology also claimed by us
and prepare and file patent applications in the United States, we may have to
participate in interference proceedings declared by the U.S. Patent and
Trademark Office or a foreign patent office to determine priority of invention,
which could result in substantial costs to and diversion of effort, even if the
eventual outcome is favorable to us.
 
 In the
fourth quarter of 2004, the University of Pittsburgh filed a lawsuit naming all
of the inventors who had not assigned their ownership interest in U.S. Patent
6,777,231 to the University of Pittsburgh, seeking a determination that its
assignors, rather than the University of California’s assignors, are the true
inventors of Patent No. 6,777,231. If the University of Pittsburgh wins the
lawsuit, our license rights to this patent could be nullified or rendered
non-exclusive with respect to any third party that might license rights from the
University of Pittsburgh. On August 9, 2007, the United States District Court
granted the University of Pittsburgh’s motion for Summary Judgment in part,
determining that the University of Pittsburgh’s assignees were properly named as
inventors on Patent 6,777,231, and that all other inventorship issues shall be
determined according to the facts presented at trial.   The trial
was concluded in January 2008 and on June 9, 2008 the Court signed its final
order which we received on June 12, 2008.  The Court concluded that
the University of Pittsburgh’s assignors were the sole inventors of the ‘231
Patent.  The Court’s decision terminated UC’s rights to the ‘231
Patent.  Upon review of the Court’s findings, we believe that the
Court’s decision was in error and that work completed at the University of
California was critical to obtaining this patent.  The UC assignors
are appealing the decision.  If the UC assignors’ appeal of the
Court’s decision is successful, UC’s rights to the ‘231 Patent should be
reinstated.
  9
  We are
not named as a party to the lawsuit, but our president, Marc Hedrick, is one of
the inventors identified on the ‘231 Patent and therefore is a named individual
defendant.  Due to our license obligations to UC relating to the ‘231
Patent and other UC patent applications, we have provided substantial financial
and other assistance to the defense of the lawsuit. Since our current products
and products under development do not practice the ‘231 Patent, our primary
ongoing business activities and product development pipeline should not be
affected by the Court’s decision. Although the ‘231 Patent is unrelated to our
current products and product pipeline, we believe that the ‘231 Patent and/or
the other technology licensed from UC may have long term potential to be useful
for future product developments, and so we have elected to support UC’s legal
efforts in the appeal of the Court’s final order.  We have incurred
substantial legal costs as a result of the University of Pittsburgh lawsuit to
date, but we expect future costs will be minimal since the only remaining
expense will be related to the final argument of the appeal.  As a
named inventor on the patent, Marc Hedrick is entitled to receive from the UC up
to 7% of royalty payments made by a licensee (us) to UC.  This
agreement was in place prior to his employment with us.
  In
addition to patent protection, we rely on unpatented trade secrets and
proprietary technological expertise. We cannot assure you that others will not
independently develop or otherwise acquire substantially equivalent techniques,
somehow gain access to our trade secrets and proprietary technological expertise
or disclose such trade secrets, or that we can ultimately protect our rights to
such unpatented trade secrets and proprietary technological expertise. We rely,
in part, on confidentiality agreements with our marketing partners, employees,
advisors, vendors and consultants to protect our trade secrets and proprietary
technological expertise. We cannot assure you that these agreements will not be
breached, that we will have adequate remedies for any breach or that our
unpatented trade secrets and proprietary technological expertise will not
otherwise become known or be independently discovered by
competitors.
 
 Failure
to obtain or maintain patent protection, or protect trade secrets, for any
reason, third party claims against our patents, trade secrets or proprietary
rights, or our involvement in disputes over our patents, trade secrets or
proprietary rights, including involvement in litigation, could have a
substantial negative effect on the results of our operations, cash flows and
financial condition.
 
 Government
Regulation
 
 As newly
developed medical devices, our Celution® System family of products must receive
regulatory clearances or approvals from the European Union, the FDA and, from
other state governments prior to their sale.  Our current and future
Celution® Systems are or will be subject to stringent government regulation in
the United States by the FDA under the Federal Food, Drug and Cosmetic
Act.  The FDA regulates the design/development process, clinical
testing, manufacture, safety, labeling, sale, distribution, and promotion of
medical devices and drugs.  Included among these regulations are
pre-market clearance and pre-market approval requirements, design control
requirements, and the Quality System Regulations/Good Manufacturing
Practices.  Other statutory and regulatory requirements govern, among
other things, establishment registration and inspection, medical device listing,
prohibitions against misbranding and adulteration, labeling and post-market
reporting.
 
 The
Celution® System family of products must also comply with the government
regulations of each individual country in which the products are to be
distributed and sold. These regulations vary in complexity and can be as
stringent, and on occasion even more stringent, than US FDA regulations.
International government regulations vary from country to country and region to
region. For example, regulations in some parts of the world only require product
registration while other regions / countries require a complex product approval
process. Due to the fact that there are new and emerging cell therapy and cell
banking regulations that have recently been drafted and/or implemented in
various countries around the world, the application and subsequent
implementation of these new and emerging regulations have little to no
precedence. Therefore, the level of complexity and stringency is not known and
may vary from country to country, creating greater uncertainty for the
international regulatory process. Furthermore, government regulations can change
with little to no notice and may result in up-regulation of our product(s),
thereby, creating a greater regulatory burden for our cell processing and cell
banking technology products.
 
 The
regulatory process can be lengthy, expensive, and uncertain.  Before
any new medical device may be introduced to the United States of America market,
the manufacturer generally must obtain FDA clearance or approval through either
the 510(k) pre-market notification process or the lengthier pre-market approval
application (“PMA”) process.  It generally takes from three to 12
months from submission to obtain 510(k) pre-market clearance, although it may
take longer.  Approval of a PMA could take four or more years from the
time the process is initiated.  The 510(k) and PMA processes can be
expensive, uncertain, and lengthy, and there is no guarantee of ultimate
clearance or approval.  We expect that some of our future products
under development as well as Olympus-Cytori’s will be subject to the lengthier
PMA process.  Securing FDA clearances and approvals may require the
submission of extensive clinical data and supporting information to the FDA, and
  10
  there can
be no guarantee of ultimate clearance or approval.  Failure to comply
with applicable requirements can result in application integrity proceedings,
fines, recalls or seizures of products, injunctions, civil penalties, total or
partial suspensions of production, withdrawals of existing product approvals or
clearances, refusals to approve or clear new applications or notifications, and
criminal prosecution.
 
 Medical
devices are also subject to post-market reporting requirements for deaths or
serious injuries when the device may have caused or contributed to the death or
serious injury, and for certain device malfunctions that would be likely to
cause or contribute to a death or serious injury if the malfunction were to
recur.  If safety or effectiveness problems occur after the product
reaches the market, the FDA may take steps to prevent or limit further marketing
of the product.  Additionally, the FDA actively enforces regulations
prohibiting marketing and promotion of devices for indications or uses that have
not been cleared or approved by the FDA. In addition, modifications or
enhancements of products that could affect the safety or effectiveness or effect
a major change in the intended use of a device that was either cleared through
the 510(k) process or approved through the PMA process may require further FDA
review through new 510(k) or PMA submissions.
 
 Under the
terms of our Joint Venture Agreements with Olympus we are the party with the
primary responsibility for obtaining regulatory approvals to sell the
Olympus-Cytori, Inc. devices. To date we have prepared and submitted
multiple regulatory filings in the United States and Europe related to
various cell processing systems under development, which notably resulted in
receipt of a CE Mark on the Celution®800
System and 510(K) clearance in the United States for various related medical
technologies, including an autologous blood processing device.
 
 We must
comply with extensive regulations from foreign jurisdictions regarding safety,
manufacturing processes and quality.   These regulations,
including the requirements for marketing authorization, may differ from the
United States FDA regulatory scheme.  Specifically, in regard to our
Thin Film product line in Japan (distributed by Senko), we have been seeking
marketing authorization from the Japanese Ministry of Health, Labour and Welfare
for the past four years, but have not obtained approvals yet.
 
 Staff
 
 As of
December 31, 2008, we had 126 employees, including part-time and full-time
employees.  These employees are comprised of 20 employees in
manufacturing, 57 employees in research and development, 17 employees in sales
and marketing and 32 employees in management and finance and
administration.  From time to time, we also employ independent
contractors to support our operations.  Our employees are not
represented by any collective bargaining agreements and we have never
experienced an organized work stoppage.  A breakout by segment is as
follows:
 
 Regenerative
      Cell Technology
                    
                    Corporate
                    
                    TotalManufacturing
                    
                    20
                    
                    —
                    
                    20Research
      & Development
                    
                    57
                    
                    —
                    
                    57Sales
      and Marketing
                    
                    17
                    
                    —
                    
                    17General
      & Administrative
                    
                    —
                    
                    32
                    
                    32Total
                    
                    94
                    
                    32
                    
                    126
 
 
 Web
Site Access to SEC Filings
 
 We
maintain an Internet website at www.cytoritx.com. Through this site, we make
available free of charge our annual reports on Form 10-K, quarterly reports on
Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or
furnished pursuant to Section 13(a) of the Securities Exchange Act of 1934 as
soon as reasonably practicable after we electronically file such material with,
or furnish it to, the U.S. Securities and Exchange Commission (SEC). In
addition, we publish on our website all reports filed under Section 16(a) of the
Securities Exchange Act by our directors, officers and 10% stockholders. These
materials are accessible via the Investor Relations section of our website
within the “SEC Filings” link. Some of the information is stored directly on our
website, while other information can be accessed by selecting the provided link
to the section on the SEC website, which contains filings for our company and
its insiders.
 
 We file
electronically with the SEC our annual reports on Form 10-K, quarterly reports
on Form 10-Q and current reports on Form 8-K pursuant to Section 13(a) of the
Securities Exchange Act of 1934.  The SEC maintains an Internet site
that contains reports, proxy information and information statements, and other
information regarding issuers that file electronically with the
SEC.  The address of that website is http://www.sec.gov.  The
materials are also available at the SEC’s
  11
  Public
Reference Room, located at 100 F Street, Washington, D.C. 20549.  The
public may obtain information through the public reference room by calling the
SEC at 1-800-SEC-0330.
 
 Item 1A. Risk Factors
 
 In
analyzing our company, you should consider carefully the following risk factors
together with all of the other information included in this annual report on
Form 10-K.  Factors that could adversely affect our business,
operating results, and financial condition, as well as adversely affect the
value of an investment in our common stock,  include those discussed
below, as well as those discussed above in “Management’s Discussion and Analysis
of Financial Condition and Results of Operations” and elsewhere throughout this
annual report on Form 10-K.
 
 We are
subject to the following significant risks, among others:
  We need to raise more
cashin the very near
term
 
 We have
almost always had negative cash flows from operations.  Our business will
continue to result in a substantial requirement for research and development
expenses for several years, during which we may not be able to bring in
sufficient cash and/or revenues to offset these expenses.
 We  are required to raise capital from one or more
sources  in the very near term to continue our operations at or close
to the levels currently conducted.  We believe that without raising
additional capital  soon from accessible sources of financing, as well
as an increase in capital from our operations, we will not otherwise have
adequate funding to complete the development, pre-clinical activities, clinical
trials and marketing efforts required to successfully bring our current and
future products to market.  In addition, if we are not successful in
raising additional cash very soon we will be required to negotiate with
General Electric Capital Corporation (“GECC”) and Silicon Valley Bank (“SVB”) to
obtain an amendment to the cash liquidity requirements of the Loan and Security
Agreement dated October 14, 2008 (“Loan Agreement”). If we are not successful in
obtaining either the additional finding or cash liquidity relief then we will
likely very soon thereafter be in default under the Loan Agreement. If we are in
default or if our senior secured lenders otherwise assert that there has been an
event of default, they may seek to accelerate our senior secured loan and
exercise their rights and remedies under the Loan Agreement, including the sale
of our property and other assets.  In such event, we may be forced to file
a bankruptcy case or have an involuntary bankruptcy case filed against us or
otherwise liquidate our assets.  Any of these events would have a
substantial and material adverse effect on our business, financial condition,
results of operations, the value of our common stock and warrants and our
ability to raise capital.  There is no guarantee that adequate funds will
be available when needed from additional debt or equity financing, arrangements
with distribution partners, increased results of operations, or from other
sources, or on terms attractive to us.  Although we entered into a
$15,000,000 loan facility with GECC and SVB  in October 2008, we could not
access the remaining $7,500,000 under that facility as we were not able satisfy
certain financial conditions on or before December 12, 2008.  The inability
to obtain sufficient additional funds in the near term will at the least require
us to significantly delay, scale back, or eliminate some or all of our research
or product development, manufacturing operations, clinical or regulatory
activities having a substantial negative effect on our results of operations and
financial condition.
  Continued turmoil in the
economy could harm our business
  Negative
trends in the general economy, including trends resulting from an actual or
perceived recession, tightening credit markets, increased cost of commodities,
including oil, actual or threatened military action by the United States and
threats of terrorist attacks in the United States and abroad, could cause a
reduction of investment in and available funding for companies in certain
industries, including ours.  Our ability to raise capital has been and
may continue to be adversely affected by current credit conditions and the
downturn in the financial markets and the global economy.
  We have never been
profitable on an operational basis and expect significant operating losses for
the next few years
 
 We have
incurred net operating losses in each year since we started
business.  As our focus on the Celution® System
platform and development of therapeutic applications for its cellular output has
increased, losses have resulted primarily from expenses associated with research
and development activities and general and administrative
expenses.  While we are implementing cost reduction measures where
possible, we nonetheless expect to continue operating in a loss position on a
consolidated basis and that recurring operating expenses will be at high levels
for the next several years, in order to perform clinical trials, additional
pre-clinical research, product development, and marketing.  As a
result of our historic losses, we have historically been, and continue to be,
reliant on raising outside capital to fund our operations as discussed in
the prior risk factor.
  12
  Our business strategy is
high-risk
 
 We are
focusing our resources and efforts primarily on development of the Celution® System
family of products and the therapeutic applications of its cellular output,
which requires extensive cash needs for research and development
activities.  This is a high-risk strategy because there is no
assurance that our products will ever become commercially viable (commercial
risk), that we will prevent other companies from depriving us of market share
and profit margins by selling products based on our inventions and developments
(legal risk), that we will successfully manage a company in a new area of
business (regenerative medicine) and on a different scale than we have operated
in the past (operational risk), that we will be able to achieve the desired
therapeutic results using stem and regenerative cells (scientific risk), or that
our cash resources
 
 We must keep our joint
venture with Olympus operating smoothly
 
 Our
business cannot succeed on the currently anticipated timelines unless our Joint
Venture collaboration with Olympus goes well.  We have given
Olympus-Cytori, Inc. an exclusive license to manufacture future generation
Celution® System
devices.  If Olympus-Cytori, Inc. does not successfully develop and
manufacture these devices, we may not be able to commercialize any device or any
therapeutic products successfully into the market.  In addition,
future disruption or breakup of our relationship would be extremely costly to
our reputation, in addition to causing many serious practical
problems.
 
 We and
Olympus must overcome contractual and cultural barriers.  Our
relationship is formally measured by a set of complex contracts, which have not
yet been tested in practice.  In addition, many aspects of the
relationship will be non-contractual and must be worked out between the parties
and the responsible individuals.  The Joint Venture is intended to
have a long life, and it is difficult to maintain cooperative relationships over
a long period of time in the face of various kinds of
change.  Cultural differences, including language barrier to some
degree, may affect the efficiency of the relationship.
 
 Olympus-Cytori,
Inc. is 50% owned by us and 50% owned by Olympus.  By contract, each
side must consent before any of a wide variety of important business actions can
occur.  This situation possesses a risk of potentially time-consuming
and difficult negotiations which could at some point delay the Joint Venture
from pursuing its business strategies.
 
 Olympus
is entitled to designate the Joint Venture's chief executive officer and a
majority of its board of directors, which means that day-to-day decisions which
are not subject to a contractual veto will essentially be controlled by
Olympus.  In addition, Olympus-Cytori, Inc. may require more money
than its current capitalization in order to complete development and production
of future generation devices.  If we are unable to help provide future
financing for Olympus-Cytori, Inc., our relative equity interest in
Olympus-Cytori, Inc. may decrease.
 
 Furthermore,
under a License/Joint Development Agreement among Olympus-Cytori, Inc., Olympus,
and us, Olympus will have a primary role in the development of Olympus-Cytori,
Inc.’s next generation devices.  Although Olympus has extensive
experience in developing medical devices, this arrangement will result in a
reduction of our control over the development and manufacturing of the next
generation devices.
 
 We have a limited operating
history; operating results and stock price can be volatile like many life
science companies
 
 Our
prospects must be evaluated in light of the risks and difficulties frequently
encountered by emerging companies and particularly by such companies in rapidly
evolving and technologically advanced biotech and medical device
fields.  Due to limited operating history and the transition from the
MacroPore biomaterials to the regenerative medicine business, comparisons of our
year-to-year operating results are not necessarily meaningful and the results
for any periods should not necessarily be relied upon as an indication of future
performance.  All 2007 product revenues came from our spine and
orthopedics implant product line, which we sold in May 2007.
 
 From time
to time, we have tried to update our investors’ expectations as to our operating
results by periodically announcing financial guidance.  However, we
have in the past been forced to revise or withdraw such guidance due to lack of
visibility and predictability of product demand.
 
 We are vulnerable to
competition and technological change, and also to physicians’
inertia
 
 We
compete with many domestic and foreign companies in developing our technology
and products, including biotechnology, medical device, and pharmaceutical
companies.  Many current and potential competitors have substantially
greater financial, technological, research and development, marketing, and
personnel resources.  There is no assurance that
  13
  our
competitors will not succeed in developing alternative products that are more
effective, easier to use, or more economical than those which we have developed
or are in the process of developing, or that would render our products obsolete
and non-competitive.  In general, we may not be able to prevent others
from developing and marketing competitive products similar to ours or which
perform similar functions. 
 Competitors
may have greater experience in developing therapies or devices, conducting
clinical trials, obtaining regulatory clearances or approvals, manufacturing and
commercialization.  It is possible that competitors may obtain patent
protection, approval, or clearance from the FDA or achieve commercialization
earlier than we can, any of which could have a
 
 We
compete against cell-based therapies derived from alternate sources, such as
bone marrow, umbilical cord blood and potentially embryos.  Doctors
historically are slow to adopt new technologies like ours, whatever the merits,
when older technologies continue to be supported by established
providers.  Overcoming such inertia often requires very significant
marketing expenditures or definitive product performance and/or pricing
superiority.
 
 We expect
physicians’ inertia and skepticism to also be a significant barrier as we
attempt to gain market penetration with our future products. We believe we will
need to finance lengthy time-consuming clinical studies (so as to provide
convincing evidence of the medical benefit) in order to overcome this inertia
and skepticism particularly in reconstructive surgery, cell preservation, the
cardiovascular area and many other indications.
 
 Most products are
pre-commercialization, which subjects us to development and marketing
risks
 
 We are in
a relatively early stage of the path to commercialization with many of our
products.  We believe that our long-term viability and growth will
depend in large part on our ability to develop commercial quality cell
processing devices and useful procedure-specific consumables, and to establish
the safety and efficacy of our therapies through clinical trials and
studies.  With our Celution®
platform, we are pursuing new approaches for reconstructive surgery,
preservation of stem and regenerative cells for potential future use, therapies
for cardiovascular disease, gastrointestinal disorders and spine and orthopedic
conditions.  There is no assurance that our development programs will
be successfully completed or that required regulatory clearances or approvals
will be obtained on a timely basis, if at all.
 
 There is
no proven path for commercializing the Celution® System
platform in a way to earn a durable profit commensurate with the medical
benefit.  Although we began to commercialize our reconstructive
surgery products in Europe and certain Asian markets, and our cell banking
products in Japan, Europe, and certain Asian markets in 2008, additional market
opportunities for our products and/or services are likely to be another two to
five years away.
 
 Successful
development and market acceptance of our products is subject to developmental
risks, including failure of inventive imagination, ineffectiveness, lack of
safety, unreliability, failure to receive necessary regulatory clearances or
approvals, high commercial cost, preclusion or obsolescence resulting from third
parties’ proprietary rights or superior or equivalent products, competition from
copycat products, and general economic conditions affecting purchasing
patterns.  There is no assurance that we or our partners will
successfully develop and commercialize our products, or that our competitors
will not develop competing technologies that are less expensive or
superior.  Failure to successfully develop and market our products
would have a substantial negative effect on our results of operations and
financial condition.
 
 The timing and amount of
Thin Film revenues from Senko are uncertain
 
 The sole
remaining product line in our MacroPore Biosurgery segment is our Japan Thin
Film business.  Our right to receive royalties from Senko, and to
recognize certain deferred revenues, depends on the timing of MHLW approval for
commercialization of the product in Japan.  We have no control over
this timing and our previous expectations have not been met.  Also,
even after commercialization, we will be dependent on Senko, our exclusive
distributor, to drive product sales in Japan.
 
 There is
a risk that we could experience with Senko some of the same problems we
experienced in our previous relationship with Medtronic, which was the exclusive
distributor for our former bioresorbable spine and orthopedic implant product
line.
  14
  We have limited
manufacturing experience
 
 We have
limited experience in manufacturing the Celution® System
platform or its consumables at a commercial level.  With respect to
our Joint Venture, although Olympus is a highly capable and experienced
manufacturer of medical devices, there can be no guarantee that the
Olympus-Cytori Joint Venture will be able to successfully develop and
manufacture the next generation Celution® device
in a manner that is cost-effective or commercially viable, or that development
and manufacturing capabilities might not take much longer than currently
anticipated to be ready for the market.
 
 Although
we have begun introduction of the Celution® 800 and
Celution®
900-based StemSource® Cell
Bank in 2008, we cannot assure that we will ®
 
 In the
event that the Olympus-Cytori Joint Venture is not successful, Cytori may not
have the resources or ability to self-manufacture sufficient numbers of devices
and consumables to meet market demand, and this failure may substantially extend
the time it would take for us to bring a more advanced commercial device to
market. This makes us significantly dependant on the continued dedication and
skill of Olympus for the successful development of the next generation
Celution®
device.
 
 We may not be able to
protect our proprietary rights
 
 Our
success depends in part on whether we can maintain our existing patents, obtain
additional patents, maintain trade secret protection, and operate without
infringing on the proprietary rights of third parties.
 
 Our
amended regenerative cell technology license agreement with the Regents of the
University of California, or the UC, contains certain developmental milestones,
which if not achieved could result in the loss of exclusivity or loss of the
license rights. The loss of such rights could impact our ability to develop
certain regenerative cell technology products.  Also, our power as
licensee to successfully use these rights to exclude competitors from the market
is untested.  In addition, further legal risk arises from a lawsuit
filed by the University of Pittsburgh in the United States District Court, or
the Court, naming all of the inventors who had not assigned their ownership
interest in Patent 6,777,231, which we refer to as the ‘231 Patent, to the
University of Pittsburgh, seeking a determination that its assignors, rather
than UC’s assignors, are the true inventors of ‘231 Patent.  On June
12, 2008, we received the Court’s final order concluding that the University of
Pittsburgh’s assignors were the sole inventors of the ‘231 Patent, which
terminates UC’s rights to this patent unless the decision of the Court is
overturned.  The UC assignors are appealing the Court’s decision and a
Notice of Appeal was filed on July 9, 2008.  We are the exclusive,
worldwide licensee of the UC’s rights under this patent in humans, which relates
to adult stem cells isolated from adipose tissue that can differentiate into two
or more of a variety of cell types. If the UC assignors do not prevail on
appeal, our license rights to this patent will be permanently lost.
 
 There can
be no assurance that any of our pending patent applications will be approved or
that we will develop additional proprietary products that are patentable. There
is also no assurance that any patents issued to us will provide us with
competitive advantages, will not be challenged by any third parties, or that the
patents of others will not prevent the commercialization of products
incorporating our technology.  Furthermore, there can be no guarantee
that others will not independently develop similar products, duplicate any of
our products, or design around our patents.
 
 Our
commercial success will also depend, in part, on our ability to avoid infringing
on patents issued to others.  If we were judicially determined to be
infringing on any third-party patent, we could be required to pay damages, alter
our products or processes, obtain licenses, or cease certain
activities.  If we are required in the future to obtain any licenses
from third parties for some of our products, there can be no guarantee that we
would be able to do so on commercially favorable terms, if at
all.  U.S. patent applications are not immediately made public, so we
might be surprised by the grant to someone else of a patent on a technology we
are actively using.  As noted above as to the University of Pittsburgh
lawsuit, even patents issued to us or our licensors might be judicially
determined to belong in full or in part to third parties.
 
 Litigation,
which would result in substantial costs to us and diversion of effort on our
part, may be necessary to enforce or confirm the ownership of any patents issued
or licensed to us, or to determine the scope and validity of third-party
proprietary rights.  If our competitors claim technology also claimed
by us and prepare and file patent applications in the United States of America,
we may have to participate in interference proceedings declared by the U.S.
Patent and Trademark Office or a foreign patent office to determine priority of
invention, which could result in substantial costs to and diversion of effort,
even if the eventual outcome is favorable to us. Any such
litigation or interference proceeding, regardless of outcome, could be expensive
and time-consuming.
  15
  In
addition to patents, which alone may not be able to protect the fundamentals of
our regenerative cell business, we also rely on unpatented trade secrets and
proprietary technological expertise.  Our intended future cell-related
therapeutic products, such as consumables, are likely to fall largely into this
category.  We rely, in part, on confidentiality agreements with our
partners, employees, advisors, vendors, and consultants to protect our trade
secrets and proprietary technological expertise. There can be no guarantee that
these agreements will not be breached, or that we will have adequate remedies
for any breach, or that our unpatented trade secrets and proprietary
technological expertise will not otherwise become known or be independently
discovered by competitors.
 
 Failure
to obtain or maintain patent protection, or protect trade secrets, for any
reason (or third-party claims against our patents, trade secrets, or proprietary
rights, or our involvement in disputes over our patents, trade secrets, or
proprietary rights, including involvement in litigation), could have a
substantial negative effect on our results of operations and financial
condition.
 
 We may not be able to
protect our intellectual property in countries outside the United
States
 
 Intellectual
property law outside the United States is uncertain and in many countries is
currently undergoing review and revisions.  The laws of some countries
do not protect our patent and other intellectual property rights to the same
extent as United States laws.  This is particularly relevant to us as
we currently conduct most of our clinical trials outside of the United
States.  Third parties may attempt to oppose the issuance of patents
to us in foreign countries by initiating opposition proceedings. Opposition
proceedings against any of our patent filings in a foreign country could have an
adverse effect on our corresponding patents that are issued or pending in the
U.S. It may be necessary or useful for us to participate in proceedings to
determine the validity of our patents or our competitors’ patents that have been
issued in countries other than the U.S. This could result in substantial costs,
divert our efforts and attention from other aspects of our business, and could
have a material adverse effect on our results of operations and financial
condition. We currently have pending patent applications in Europe, Australia,
Japan, Canada, China, Korea, and Singapore, among others.
 
 We and Olympus-Cytori, Inc.
are subject to intensive FDA regulation
 
 As newly
developed medical devices, Celution® System
family of products must receive regulatory clearances or approvals from the FDA
and, in many instances, from non-U.S. and state governments prior to their
sale.  The Celution® System
family of products is subject to stringent government regulation in the United
States by the FDA under the Federal Food, Drug and Cosmetic Act.  The
FDA regulates the design/development process, clinical testing, manufacture,
safety, labeling, sale, distribution, and promotion of medical devices and
drugs.  Included among these regulations are pre-market clearance and
pre-market approval requirements, design control requirements, and the Quality
System Regulations/Good Manufacturing Practices.  Other statutory and
regulatory requirements govern, among other things, establishment registration
and inspection, medical device listing, prohibitions against misbranding and
adulteration, labeling and post-market reporting.
 
 The
regulatory process can be lengthy, expensive, and uncertain.  Before
any new medical device may be introduced to the United States of America market,
the manufacturer generally must obtain FDA clearance or approval through either
the 510(k) pre-market notification process or the lengthier pre-market approval
application, or PMA, process.  It generally takes from three to 12
months from submission to obtain 510(k) pre-market clearance, although it may
take longer.  Approval of a PMA could take four or more years from the
time the process is initiated.  The 510(k) and PMA processes can be
expensive, uncertain, and lengthy, and there is no guarantee of ultimate
clearance or approval.  We expect that some of our future products
under development as well as Olympus-Cytori’s will be subject to the lengthier
PMA process.  Securing FDA clearances and approvals may require the
submission of extensive clinical data and supporting information to the FDA, and
there can be no guarantee of ultimate clearance or approval.  Failure
to comply with applicable requirements can result in application integrity
proceedings, fines, recalls or seizures of products, injunctions, civil
penalties, total or partial suspensions of production, withdrawals of existing
product approvals or clearances, refusals to approve or clear new applications
or notifications, and criminal prosecution.
 
 Medical
devices are also subject to post-market reporting requirements for deaths or
serious injuries when the device may have caused or contributed to the death or
serious injury, and for certain device malfunctions that would be likely to
cause or contribute to a death or serious injury if the malfunction were to
recur.  If safety or effectiveness problems occur after the product
reaches the market, the FDA may take steps to prevent or limit further marketing
of the product.  Additionally, the FDA actively enforces regulations
prohibiting marketing and promotion of devices for indications or uses that have
not been cleared or approved by the FDA.
  16
 There can
be no guarantee that we will be able to obtain the necessary 510(k) clearances
or PMA approvals to market and manufacture our other products in the United
States of America for their intended use on a timely basis, if at
all.  Delays in receipt of or failure to receive such clearances or
approvals, the loss of previously received clearances or approvals, or failure
to comply with existing or future regulatory requirements could have a
substantial negative effect on our results of operations and financial
condition.
  To sell in international
markets, we will be subject to intensive regulation in foreign
countries
 
 In
cooperation with our distribution partners, we intend to market our current and
future products both domestically and in many foreign markets. A number of risks
are inherent in international transactions.  In order for us to market
our products in Europe, Canada, Japan and certain other non-U.S. jurisdictions,
we need to obtain and maintain required regulatory approvals or clearances and
must comply with extensive regulations regarding safety, manufacturing processes
and quality.  For example, we still have not obtained regulatory
approval for our Thin Film products in Japan.  These regulations,
including the requirements for approvals or clearances to market, may differ
from the FDA regulatory scheme.  International sales also may be
limited or disrupted by political instability, price controls, trade
restrictions and changes in tariffs.  Additionally, fluctuations in
currency exchange rates may adversely affect demand for our products by
increasing the price of our products in the currency of the countries in which
the products are sold.
 
 There can
be no assurance that we will obtain regulatory approvals or clearances in all of
the countries where we intend to market our products, or that we will not incur
significant costs in obtaining or maintaining foreign regulatory approvals or
clearances, or that we will be able to successfully commercialize current or
future products in various foreign markets.  Delays in receipt of
approvals or clearances to market our products in foreign countries, failure to
receive such approvals or clearances or the future loss of previously received
approvals or clearances could have a substantial negative effect on our results
of operations and financial condition.
 
 Changing, New and/or
Emerging Government Regulations
 
 Government
regulations can change without notice. Given that fact that Cytori operates in
various international markets, our access to such markets could change with
little to no warning due to a change in government regulations that suddenly
up-regulate our product(s) and create greater regulatory burden for our cell
therapy and cell banking technology products.
 
 Due to
the fact that there are new and emerging cell therapy and cell banking
regulations that have recently been drafted and/or implemented in various
countries around the world, the application and subsequent implementation of
these new and emerging regulations have little to no precedence. Therefore, the
level of complexity and stringency is not known and may vary from country to
country, creating greater uncertainty for the international regulatory
process.
 
 Health Insurance
Reimbursement Risks
 
 New and
emerging cell therapy and cell banking technologies, such as those provided by
the Celution® System
family of products, may have difficulty or encounter significant delays in
obtaining health care reimbursement in some or all countries around the world
due to the  novelty of our cell therapy and cell banking technology
and subsequent lack of existing reimbursement schemes / pathways. Therefore, the
creation of new reimbursement pathways may be complex and lengthy with no
assurances that such reimbursements will be successful. The lack of health
insurance reimbursement or reduced or minimal reimbursement pricing may have a
significant impact on our ability to successfully sell our cell therapy and cell
banking technology product(s) into a county or region.
 
 Market Acceptance of New
Technology
 
 New and
emerging cell therapy and cell banking technologies, such as those provided by
the Celution® System
family of products, may have difficulty or encounter significant delays in
obtaining market acceptance in some or all countries around the world due to the
novelty of our cell therapy and cell banking technologies. Therefore, the market
adoption of our cell therapy and cell banking technologies may be slow and
lengthy with no assurances that significant market adoption will be successful.
The lack of market adoption or reduced or minimal market adoption of our cell
therapy and cell banking technologies may have a significant impact on our
ability to successfully sell our product(s) into a country or
region.
 
 We and/or the Joint Venture
have to maintain quality assurance certification and manufacturing
approvals
 
 The
manufacture of our Celution® System
will be, and the manufacture of any future cell-related therapeutic products
would be, subject to periodic inspection by regulatory authorities and
distribution partners.  The manufacture of devices and
  17
    Failure
to comply with such regulations or a potential delay in attaining compliance may
adversely affect our manufacturing activities and could result in, among other
things, injunctions, civil penalties, FDA refusal to grant pre-market approvals
or clearances of future or pending product submissions, fines, recalls or
seizures of products, total or partial suspensions of production, and criminal
prosecution.  There can be no assurance after such occurrences that we
will be able to obtain additional necessary regulatory approvals or clearances
on a timely basis, if at all.  Delays in receipt of or failure to
receive such approvals or clearances, or the loss of previously received
approvals or clearances could have a substantial negative effect on our results
of operations and financial condition.
 
 We depend on a few key
officers
 
 Our
performance is substantially dependent on the performance of our executive
officers and other key scientific staff, including Christopher J. Calhoun, our
Chief Executive Officer, and Marc Hedrick, MD, our President.  We rely
upon them for strategic business decisions and guidance. We believe that our
future success in developing marketable products and achieving a competitive
position will depend in large part upon whether we can attract and retain
additional qualified management and scientific personnel.  Competition
for such personnel is intense, and there can be no assurance that we will be
able to continue to attract and retain such personnel.  The loss of
the services of one or more of our executive officers or key scientific staff or
the inability to attract and retain additional personnel and develop expertise
as needed could have a substantial negative effect on our results of operations
and financial condition.
 
 We may not have enough
product liability insurance
 
 The
testing, manufacturing, marketing, and sale of our regenerative cell products
involve an inherent risk that product liability claims will be asserted against
us, our distribution partners, or licensees.  There can be no
guarantee that our clinical trial and commercial product liability insurance is
adequate or will continue to be available in sufficient amounts or at an
acceptable cost, if at all.  A product liability claim, product
recall, or other claim, as well as any claims for uninsured liabilities or in
excess of insured liabilities, could have a substantial negative effect on our
results of operations and financial condition.  Also, well-publicized
claims could cause our stock to fall sharply, even before the merits of the
claims are decided by a court.
 
 Our charter documents
contain anti-takeover provisions and we have adopted a Stockholder Rights Plan
to prevent hostile takeovers
 
 Our
Amended and Restated Certificate of Incorporation and Bylaws contain certain
provisions that could prevent or delay the  acquisition of the Company
by means of a tender offer, proxy contest, or otherwise.  They could
discourage a third party from attempting to acquire control of Cytori, even if
such events would be beneficial to the interests of our
stockholders.  Such provisions may have the effect of delaying,
deferring, or preventing a change of control of Cytori and consequently could
adversely affect the market price of our shares. Also, in 2003 we adopted a
Stockholder Rights Plan of the kind often referred to as a poison pill. The
purpose of the Stockholder Rights Plan is to prevent coercive takeover tactics
that may otherwise be utilized in takeover attempts. The existence of such a
rights plan may also prevent or delay a change in control of Cytori, and this
prevention or delay adversely affect the market price of our
shares.
 
 We pay no
dividends
 
 We have
never paid in the past, and currently do not intend to pay any cash dividends in
the foreseeable future.
 
 Item 1B. Unresolved Staff Comments
 
 Not
applicable.
 
 Item 2. Properties
 
 We
currently lease 91,000 square feet located at 3020 and 3030 Callan Road, San
Diego, California.  The related rent agreement bears rent at a rate of
$1.15 per square foot, with annual increases of 3%.  The lease term is
57 months,
  18
  commencing
on October 1, 2005 and expiring on June 30, 2010.  We also
lease 4,027 square feet of office space located at 9-3 Otsuka 2-chome,
Bunkyo-ku, Tokyo, Japan.  The agreement provides for rent at a rate of
$4.38 per square foot, expiring on November 30, 2009.  We also entered
into a new lease during the second quarter of 2008 for 900 square feet of office
space located at Via Gino Capponi n. 26, Florence, Italy.  The lease
agreement provides for rent at a rate of $2.63 per square foot, expiring on
April 22, 2014.  Additionally, we’ve entered into several lease
agreements for corporate housing for our employees on international
assignments.  For these properties, we pay an aggregate of
approximately $144,000 in rent per month.
 
 Item 3. Legal Proceedings
 
 From time
to time, we have been involved in routine litigation incidental to the conduct
of our business. As of December 31, 2008, we were not a party to any material
legal proceeding.  We are not formally a party to the University of
Pittsburgh patent litigation.  However, we are responsible for
reimbursing certain related litigation costs.  On June 12, 2008, we
received the Court’s final order concluding that the University of Pittsburgh’s
assignors were the sole inventors of the ‘231 Patent.  The UC assignors are
appealing the Court’s decision.  Since our current products and
products under development do not practice the ‘231 Patent, our primary ongoing
business activities and product development pipeline should not be affected by
the Court’s decision. Although the ‘231 Patent is unrelated to our current
products and product pipeline, we believe that the ‘231 Patent and/or the other
technology licensed from UC may have long term potential to be useful for future
product developments, and so we have elected to support UC’s legal efforts in
the appeal of the Court’s final order.
 
 Item 4. Submission of Matters to a Vote of Security
Holders
 
 None.
 
  19
  PART
II
 
 Item 5. Market for Registrant’s Common Equity, Related
Stockholder Matters and Issuer Purchases of Equity Securities
 
 Market
Prices
 
 From
August 2000 (our initial public offering in Germany) through September 2007 our
common stock was quoted on the Frankfurt Stock Exchange under the symbol “XMPA”
(formerly XMP). In September 2007 our stock closed trading on the Frankfurt
Stock Exchange.  Effective December 19, 2005, we began trading on the
Nasdaq Capital Market under the symbol “CYTX,” and have since transferred to the
Nasdaq Global Market effective February 14, 2006. The following table shows the
high and low sales prices for our common stock for the periods indicated, as
reported by the Nasdaq Stock Market. These prices do not include retail markups,
markdowns or commissions.
 
 Nasdaq Stock Exchange
 
 High
                      
                      Low2007Quarter
      ended March 31, 2007
                      
                      $
                      7.00
                      
                      $
                      4.56Quarter
      ended June 30, 2007
                      
                      $
                      6.69
                      
                      $
                      5.36Quarter
      ended September 30, 2007
                      
                      $
                      6.67
                      
                      $
                      4.85Quarter
      ended December 31, 2007
                      
                      $
                      6.50
                      
                      $
                      4.882008Quarter
      ended March 31, 2008
                      
                      $
                      6.44
                      
                      $
                      4.62Quarter
      ended June 30, 2008
                      
                      $
                      8.56
                      
                      $
                      4.75Quarter
      ended September 30, 2008
                      
                      $
                      7.97
                      
                      $
                      5.00Quarter
      ended December 31, 2008
                      
                      $
                      5.65
                      
                      $
                      1.76
 
 All of
our outstanding shares have been deposited with DTCC since December 9,
2005.
 
 As of
February 28, 2009, we had approximately 22 registered holders of our common
stock.  In addition, we are aware that there are at least 4,480
beneficial holders of our common stock.  Because many of our shares
are held by brokers and other institutions on behalf of stockholders, we are
unable to estimate the total number of individual stockholders represented by
these record holders.
 
 Dividends
 
 We have
never declared or paid any dividends and do not anticipate paying any in the
foreseeable future.
 
 Equity
Compensation Plan Information
 
 Plan Category
                                    
                                    Number of securities to be issued
                                      upon exercise of outstanding
                                      options, warrants and rights
                                    
                                    Weighted-average exercise price
                                      of outstanding options, warrants
                                      and rights
                                    
                                    Number
      of securities remaining
                                      available
      for future issuance under equity compensation
                                      plans (excluding securities reflected
      in column(a))(a)
                                    
                                    (b)
                                    
                                    (c)Equity
      compensation plans approved by security holders (1)
                                    
                                    3,810,395
                                    
                                    $
                                    4.65
                                    
                                    —Equity
      compensation plans not approved by security holders (2)
                                    
                                    2,118,312
                                    
                                    $
                                    5.68
                                    
                                    2,190,450Total
                                    
                                    5,928,707
                                    
                                    $
                                    5.02
                                    
                                    2,190,450
 ________________________________________
 (1)
              The
      1997 Stock Option and Stock Purchase Plan expired on October 22,
      2007.
 (2)
              The
      maximum number of shares shall be cumulatively increased on the first
      January 1 after the Effective Date, August 24, 2004, and each January 1
      thereafter for 9 more years, by a number of shares equal to the lesser of
      (a) 2% of the number of shares issued and outstanding on the immediately
      preceding December 31, and (b) a number of shares set by the
      Board.
  20
  Comparative
Stock Performance Graph
 
 The
following graph shows how an initial investment of $100 in our common stock
would have compared to an equal investment in the Nasdaq Composite Index and the
Amex Biotechnology Index during the period from December 31, 2003, through
December 31, 2008. The performance shown is not necessarily indicative of future
price performance.
  
 
 
 Item 6. Selected Financial Data
 
 The
selected data presented below under the captions “Statements of Operations
Data,” “Statements of Cash Flows Data” and “Balance Sheet Data” for, and as of
the end of, each of the years in the five-year period ended December 31, 2008,
are derived from, and should be read in conjunction with, our audited
consolidated financial statements. The consolidated balance sheets as of
December 31, 2008 and 2007, and the related consolidated statements of
operations and comprehensive loss, stockholders’ equity (deficit), and cash
flows for each of the years in the three-year period ended December 31, 2008,
which have been audited by KPMG LLP, an independent registered public accounting
firm, and their report thereon, are included elsewhere in this annual report.
The consolidated balance sheets as of December 31, 2006, 2005 and 2004, and the
related consolidated statements of operations and comprehensive loss,
stockholders’ equity (deficit), and cash flows for the years ended December 31,
2005 and 2004, which were also audited by KPMG LLP, are included with our annual
reports previously filed.
 
 
 
 
 
  21
  The
information contained in this table should also be read in conjunction with
“Management’s Discussion and Analysis of Financial Condition and Results of
Operations” and the financial statements and related notes thereto included
elsewhere in this report (in thousands except share and per share
data):
 
 2008
                                    
                                    
                                    2007
                                    
                                    
                                    2006
                                    
                                    
                                    2005
                                    
                                    
                                    2004Statements
      of Operations Data:Product
      revenues:Sales
      to related party
                                    
                                    $
                                    28
                                    
                                    
                                    $
                                    792
                                    
                                    
                                    $
                                    1,451
                                    
                                    
                                    $
                                    5,634
                                    
                                    
                                    $
                                    4,085Sales
      to third parties
                                    
                                    
                                    4,500
                                    
                                    
                                    
                                    —
                                    
                                    
                                    
                                    —
                                    
                                    
                                    
                                    —
                                    
                                    
                                    
                                    2,2374,528
                                    
                                    
                                    
                                    792
                                    
                                    
                                    
                                    1,451
                                    
                                    
                                    
                                    5,634
                                    
                                    
                                    
                                    6,322Cost
      of product revenues
                                    
                                    
                                    1,854
                                    
                                    
                                    
                                    422
                                    
                                    
                                    
                                    1,634
                                    
                                    
                                    
                                    3,154
                                    
                                    
                                    
                                    3,384Gross
      profit (loss)
                                    
                                    
                                    2,674
                                    
                                    
                                    
                                    370
                                    
                                    
                                    
                                    (183
                                    )
                                    
                                    
                                    2,480
                                    
                                    
                                    
                                    2,938Development
      revenues:Development,
      related party
                                    
                                    
                                    774
                                    
                                    
                                    
                                    5,168
                                    
                                    
                                    
                                    6,057
                                    
                                    
                                    
                                    51
                                    
                                    
                                    
                                    158Other,
      related party
                                    
                                    
                                    1,500
                                    
                                    
                                    
                                    —
                                    
                                    
                                    
                                    —
                                    
                                    
                                    
                                    —
                                    
                                    
                                    
                                    —Research
      grants and other
                                    
                                    
                                    51
                                    
                                    
                                    
                                    89
                                    
                                    
                                    
                                    419
                                    
                                    
                                    
                                    320
                                    
                                    
                                    
                                    3382,325
                                    
                                    
                                    
                                    5,257
                                    
                                    
                                    
                                    6,476
                                    
                                    
                                    
                                    371
                                    
                                    
                                    
                                    496Operating
      expenses:Research
      and development
                                    
                                    
                                    17,371
                                    
                                    
                                    
                                    20,020
                                    
                                    
                                    
                                    21,977
                                    
                                    
                                    
                                    15,450
                                    
                                    
                                    
                                    10,384Sales
      and marketing
                                    
                                    
                                    4,602
                                    
                                    
                                    
                                    2,673
                                    
                                    
                                    
                                    2,055
                                    
                                    
                                    
                                    1,547
                                    
                                    
                                    
                                    2,413General
      and administrative
                                    
                                    
                                    11,727
                                    
                                    
                                    
                                    14,184
                                    
                                    
                                    
                                    12,547
                                    
                                    
                                    
                                    10,208
                                    
                                    
                                    
                                    6,551Change
      in fair value of option liabilities
                                    
                                    
                                    1,060
                                    
                                    
                                    
                                    100
                                    
                                    
                                    
                                    (4,431
                                    )
                                    
                                    
                                    3,645
                                    
                                    
                                    
                                    —Restructuring
      charge
                                    
                                    
                                    —
                                    
                                    
                                    
                                    —
                                    
                                    
                                    
                                    —
                                    
                                    
                                    
                                    —
                                    
                                    
                                    
                                    107Equipment
      impairment charge
                                    
                                    
                                    —
                                    
                                    
                                    
                                    —
                                    
                                    
                                    
                                    —
                                    
                                    
                                    
                                    —
                                    
                                    
                                    
                                    42Total
      operating expenses
                                    
                                    
                                    34,760
                                    
                                    
                                    
                                    36,977
                                    
                                    
                                    
                                    32,148
                                    
                                    
                                    
                                    30,850
                                    
                                    
                                    
                                    19,497Total
      operating loss
                                    
                                    
                                    (29,761
                                    )
                                    
                                    
                                    (31,350
                                    )
                                    
                                    
                                    (25,855
                                    )
                                    
                                    
                                    (27,999
                                    )
                                    
                                    
                                    (16,063
                                    )Other
      income (expense):Gain
      on sale of assets
                                    
                                    
                                    —
                                    
                                    
                                    
                                    1,858
                                    
                                    
                                    
                                    —
                                    
                                    
                                    
                                    5,526
                                    
                                    
                                    
                                    —Gain
      on the sale of assets, related party
                                    
                                    
                                    —
                                    
                                    
                                    
                                    —
                                    
                                    
                                    
                                    —
                                    
                                    
                                    
                                    —
                                    
                                    
                                    
                                    13,883Interest
      income
                                    
                                    
                                    230
                                    
                                    
                                    
                                    1,028
                                    
                                    
                                    
                                    708
                                    
                                    
                                    
                                    299
                                    
                                    
                                    
                                    252Interest
      expense
                                    
                                    
                                    (420
                                    )
                                    
                                    
                                    (155
                                    )
                                    
                                    
                                    (199
                                    )
                                    
                                    
                                    (137
                                    )
                                    
                                    
                                    (177
                                    )Other
      income (expense)
                                    
                                    
                                    (40
                                    )
                                    
                                    
                                    (46
                                    )
                                    
                                    
                                    (27
                                    )
                                    
                                    
                                    (55
                                    )
                                    
                                    
                                    15Equity
      loss in investments
                                    
                                    
                                    (45
                                    )
                                    
                                    
                                    (7
                                    )
                                    
                                    
                                    (74
                                    )
                                    
                                    
                                    (4,172
                                    )
                                    
                                    
                                    —Net
      loss
                                    
                                    $
                                    (30,036
                                    )
                                    
                                    $
                                    (28,672
                                    )
                                    
                                    $
                                    (25,447
                                    )
                                    
                                    $
                                    (26,538
                                    )
                                    
                                    $
                                    (2,090
                                    )Basic
      and diluted net loss per share
                                    
                                    $
                                    (1.12
                                    )
                                    
                                    $
                                    (1.25
                                    )
                                    
                                    $
                                    (1.53
                                    )
                                    
                                    $
                                    (1.80
                                    )
                                    
                                    $
                                    (0.15
                                    )Basic
      and diluted weighted average common shares
                                    
                                    
                                    26,882,431
                                    
                                    
                                    
                                    22,889,250
                                    
                                    
                                    
                                    16,603,550
                                    
                                    
                                    
                                    14,704,281
                                    
                                    
                                    
                                    13,932,390Statements
      of Cash Flows Data:Net
      cash used in operating activities
                                    
                                    $
                                    (33,389
                                    )
                                    
                                    $
                                    (29,995
                                    )
                                    
                                    $
                                    (16,483
                                    )
                                    
                                    $
                                    (1,101
                                    )
                                    
                                    $
                                    (12,574
                                    )Net
      cash provided by investing activities
                                    
                                    
                                    (393
                                    )
                                    
                                    
                                    5,982
                                    
                                    
                                    
                                    591
                                    
                                    
                                    
                                    911
                                    
                                    
                                    
                                    13,425Net
      cash provided by (used in) financing activities
                                    
                                    
                                    34,928
                                    
                                    
                                    
                                    26,576
                                    
                                    
                                    
                                    16,787
                                    
                                    
                                    
                                    5,357
                                    
                                    
                                    
                                    (831
                                    )Net
      increase (decrease) in cash
                                    
                                    
                                    1,146
                                    
                                    
                                    
                                    2,563
                                    
                                    
                                    
                                    895
                                    
                                    
                                    
                                    5,167
                                    
                                    
                                    
                                    20Cash
      and cash equivalents at beginning of year
                                    
                                    
                                    11,465
                                    
                                    
                                    
                                    8,902
                                    
                                    
                                    
                                    8,007
                                    
                                    
                                    
                                    2,840
                                    
                                    
                                    
                                    2,820Cash
      and cash equivalents at end of year
                                    
                                    $
                                    12,611
                                    
                                    
                                    $
                                    11,465
                                    
                                    
                                    $
                                    8,902
                                    
                                    
                                    $
                                    8,007
                                    
                                    
                                    $
                                    2,840Balance
      Sheet Data:Cash,
      cash equivalents and short-term investments
                                    
                                    $
                                    12,611
                                    
                                    
                                    $
                                    11,465
                                    
                                    
                                    $
                                    12,878
                                    
                                    
                                    $
                                    15,845
                                    
                                    
                                    $
                                    13,419Working
      capital
                                    
                                    
                                    10,090
                                    
                                    
                                    
                                    4,168
                                    
                                    
                                    
                                    7,392
                                    
                                    
                                    
                                    10,459
                                    
                                    
                                    
                                    12,458Total
      assets
                                    
                                    
                                    25,609
                                    
                                    
                                    
                                    21,507
                                    
                                    
                                    
                                    24,868
                                    
                                    
                                    
                                    28,166
                                    
                                    
                                    
                                    25,470Deferred
      revenues, related party
                                    
                                    
                                    16,474
                                    
                                    
                                    
                                    18,748
                                    
                                    
                                    
                                    23,906
                                    
                                    
                                    
                                    17,311
                                    
                                    
                                    
                                    —Deferred
      revenues
                                    
                                    
                                    2,445
                                    
                                    
                                    
                                    2,379
                                    
                                    
                                    
                                    2,389
                                    
                                    
                                    
                                    2,541
                                    
                                    
                                    
                                    2,592Option
      liabilities
                                    
                                    
                                    2,060
                                    
                                    
                                    
                                    1,000
                                    
                                    
                                    
                                    900
                                    
                                    
                                    
                                    5,331
                                    
                                    
                                    
                                    —Deferred
      gain on sale of assets
                                    
                                    
                                    —
                                    
                                    
                                    
                                    —
                                    
                                    
                                    
                                    —
                                    
                                    
                                    
                                    —
                                    
                                    
                                    
                                    5,650Long-term
      deferred rent
                                    
                                    
                                    168
                                    
                                    
                                    
                                    473
                                    
                                    
                                    
                                    741
                                    
                                    
                                    
                                    573
                                    
                                    
                                    
                                    80Long-term
      obligations, less current portion
                                    
                                    
                                    5,044
                                    
                                    
                                    
                                    237
                                    
                                    
                                    
                                    1,159
                                    
                                    
                                    
                                    1,558
                                    
                                    
                                    
                                    1,128Total
      stockholders’ equity (deficit)
                                    
                                    $
                                    (7,717
                                    )
                                    
                                    $
                                    (9,400
                                    )
                                    
                                    $
                                    (10,813
                                    )
                                    
                                    $
                                    (6,229
                                    )
                                    
                                    $
                                    12,833
  22
  Item 7.  Management’s Discussion and
Analysis of Financial Condition and Results of Operations
 
 CAUTIONARY
STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
 
 This
report contains certain statements that may be deemed “forward-looking
statements” within the meaning of United States of America securities
laws.  All statements, other than statements of historical fact, that
address activities, events or developments that we intend, expect, project,
believe or anticipate and similar expressions or future conditional verbs such a
will, should, would, could or may occur in the future are forward-looking
statements. Such statements are based upon certain assumptions and assessments
made by our management in light of their experience and their perception of
historical trends, current conditions, expected future developments and other
factors they believe to be appropriate.
 
 These
statements include, without limitation, statements about  our anticipated
expenditures, including those related to clinical research studies, and general
and administrative expenses;  the potential size of the market for our
products,  future  development and/or expansion of our products
and therapies in our markets,  ability to generate  product
revenues or effectively manage our gross profit margins; our ability to obtain
regulatory clearance; expectations as to our future performance; the future
impact and ongoing appeal with respect to the ‘231 patent
litigation,  the “Liquidity and Capital Resources” section of this
report, including our need for additional financing and the availability
thereof; and the potential enhancement of our cash position through development,
marketing, and licensing arrangements.   Our actual results will
likely differ, perhaps materially, from those anticipated in these
forward-looking statements as a result of various factors, including: our need
and ability to raise additional cash, our joint ventures, risks associated
with  laws or regulatory requirements applicable to us, market
conditions, product performance, unforeseen litigation, and competition within
the regenerative medicine field,  to name a few. The forward-looking
statements included in this report are subject to a number of additional
material risks and uncertainties, including but not limited to the risks
described our filings with the Securities and Exchange Commission and under the
“Risk Factors” section in Part I above.
 
 We encourage you to read our Risk
Factors descriptions carefully.  We caution you not to place undue reliance
on the forward-looking statements contained in this report.  These
statements, like all statements in this report, speak only as of the date of
this report (unless an earlier date is indicated) and we undertake no obligation
to update or revise the statements except as required by law.  Such
forward-looking statements are not guarantees of future performance and actual
results will likely differ, perhaps materially, from those suggested by such
forward-looking statements.
 
 Liquidity
 
 We
incurred losses of $30,036,000, $28,672,000 and $25,447,000 for the years ended
December 31, 2008, 2007, and 2006 respectively.  We have an
accumulated deficit of $162,168,000 as of December 31, 2008.  Additionally,
we have used net cash of $33,389,000, $29,995,000 and $16,483,000 to fund our
operating activities for years ended December 31, 2008, 2007, and 2006,
respectively.To date these
operating losses have been funded primarily from outside sources of invested
capital.
 
 During
2008, we initiated our commercialization activities while simultaneously
pursuing available financing sources to support operations and
growth.  We have had, and continue to have, an ongoing need to raise
additional cash from outside sources to fund our operations.  However,
our ability to raise capital has been adversely affected by current credit
conditions and the downturn in the financial markets and the global
economy.  Accordingly, the combination of these facts raises
substantial doubt as to the Company’s ability to continue as a going
concern.  The accompanying consolidated financial statements and
financial statement schedule have been prepared assuming that the Company will
continue as a going concern.  If we are unsuccessful in our efforts to
raise outside capital in the near term, we will be required to significantly
reduce our research, development, and administrative operations, including
reduction of our employee base, in order to offset the lack of available
funding.
 
 We are
pursuing financing opportunities in both the private and public debt and equity
markets as well as through strategic corporate partnerships.  We have an
established history of raising capital through these platforms, and we are
currently involved in negotiations with multiple parties.  Our efforts in
2008 to raise capital have taken longer than we initially anticipated.  We
were however, successful in August 2008, and 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. In
October 2008, we entered into a secured Loan Agreement with General Electric
Capital Corporation and Silicon Valley Bank (“Lenders”) to borrow up to
$15,000,000.  An initial term loan of $7,500,000, less fees and
expenses, was funded on
  23
  October
14, 2008.  We could not access the remaining $7,500,000 under this
facility as we were not able to meet certain financial prerequisites that had
been established by the Lenders.
 
 We expect
to continue to utilize our cash and cash equivalents to fund operations through
at least the next few months, subject to minimum cash and cash liquidity
requirements of the Loan and Security Agreement with the Lenders, which requires
that we maintain at least three months of cash on hand to avoid an event of
default under the Loan and Security Agreement.  We continue to seek
additional cash through product revenues, strategic collaborations, and future
sales of equity or debt securities.  Although there can be no assurance
given, we hope to successfully complete one or more additional financing
transactions and corporate partnerships in the near-term. Without this
additional capital, current working capital and cash generated from sales and
containment of operating costs will not provide adequate funding for research,
sales and marketing efforts, clinical and preclinical trials, and product
development activities at their current levels. If such efforts are not
successful, we will need to significantly reduce or curtail our research and
development and other operations and this could negatively affect our ability to
achieve corporate growth goals.  Specifically, we have prepared an
operating plan (plan) that calls for us to reduce operations to focus almost
entirely on the supply of current products to existing or new distribution
channels.  This plan would result in reductions to our current sales and
marketing headcount (total headcount was 17 at December 31, 2008) as well as a
reduction in manufacturing headcount (total headcount of 20 at December 31,
2008).  In addition, as part of the plan, there would be minimal
expenditures for ongoing scientific research, product development or clinical
research.  This impacts research and development headcount (total headcount
was 57 at December 31, 2008), external subcontractor expenditures, capital
outlay and general and administrative expenditures related to the supervision of
such activities.  In parallel, we would significantly reduce
administrative staff (the general and administrative headcount was 32 at
December 31, 2008) and salaries consistent with the overall reduction in scope
of operations.  In aggregate, such reductions could result in eliminations
of roles for the majority of the Company’s current staff and the deferral or
elimination of all ongoing development projects until such time that cash
resources were available from operations or outside sources to re-establish
development and growth plans.  Management is currently reviewing
contractual obligations related to the pre-clinical and clinical commitments
along with minimum purchase requirements to include deferral of such commitments
as part of this plan.  While management is actively pursuing its near
term financial and strategic alternatives it is also, in parallel, continuing to
evaluate the timing of implementation of the alternative operating plan and the
initiation of the identified reductions. Based on the impact of the reductions
described above and a full year impact of other actions taken by management in
Q3 and Q4 of 2008, the cash operating requirements in the near term would be
reduced to a range of $1.0 to $1.2 million per month.
 
 Overview
 
 Cytori
Therapeutics, Inc. manufactures, develops, and internationally commercializes
innovative medical technologies, which allow physicians to practice regenerative
medicine.  The Company’s main product is the Celution® System, which
is the first and only broadly available device that provides clinical grade
autologous stem and regenerative cells in real-time. This device processes a
patient’s own stem and regenerative cells at the bedside so their cells may be
redelivered during the same surgical procedure. Our commercialization model is
based on the sale of the Celution® System and generating recurring revenue
thereafter from the sale of single-use consumables used in every patient
procedure and on sales of related instrumentation and ancillary
products.
 
 Commercial
activities are currently focused on marketing the Celution® cell processing
system and related family of products across three areas. The first is cosmetic
and reconstructive surgery in Europe and Asia-Pacific. The second is to fulfill
the demand among physicians in Europe and Asia Pacific for access to clinical
grade stem and regenerative cells. The third is to market the Celution-based
StemSource® Cell Bank worldwide to hospitals and tissue banks so they can in
turn offer patients the opportunity to cyropreserve their own adipose-derive
stem and regenerative cells.
 
 The more
therapeutic applications that are developed for the Celution® System
and its cellular output, the more opportunities we will have to offer the
Celution® System
and related consumable sets to hospitals, clinics, and physicians. For this
reason, we are developing and allowing others to develop additional applications
for the Celution® System,
which include cardiovascular disease, for which two human clinical trials are
underway, renal failure, orthopedic damage, gastrointestinal disorders, and
pelvic health conditions, among others.
 
 In the
first quarter of 2008, we launched the first commercial generation Celution® System
product platform. Throughout the year and into 2009, we broadened our
commercialization efforts and expanded our network of distribution partners.
This included the opening of a sales and training center in Europe designed to
educate physicians on the technology and its benefits, as well as promote sales
within the region. To support future sales efforts, we initiated a 70 patient
post-marketing study in Europe last year, with the goal of expanding claims and
seeking reimbursement for the use of the
  24
  Celution® System
in post-partial mastectomy defect reconstruction. Final results from this study
are expected to be reported in 2010.
 
 In
partnership with Olympus Corporation, we made significant progress during 2008
toward finalizing the second commercial generation Celution
System.  Currently, we manufacture the first commercial generation
Celution® System
and consumables at our corporate headquarters and provide all servicing for the
device through our regional offices.
 
 Also
during 2008, we were granted several U.S. and International patents and patent
allowances, which cover various aspects of the Celution® System
technology and applications of the Celution® System
output. These developments further protect our proprietary rights and
competitive position. Lastly, during 2008 we continued enrollment of our
European cardiovascular disease clinical trials, which represent our most
advanced product pipeline application. Enrollment for both studies should be
completed in 2009 with results available as early as 2010.
 
 Our
strategy for the future, in this current financial environment with a new
product that has multiple potential applications, is to focus the majority of
our financial resources on activities that will promote immediate sales of the
Celution System. In Europe and Asia Pacific, this entails continued investment
in the RESTORE II study to support reimbursement and includes maintaining our
level of investment into sales and marketing activities. In the United States,
we are continuing to seek regulatory and marketing approval of the Celution® 700
System family of products. We expect to finalize our U.S. regulatory and
clinical development strategy in 2009.
 
 The
market for clinical grade cells requires substantially fewer resources as the
majority of the commercialization efforts are assumed by our distribution
partners. This allows us to further expand the installed-base of Celution®
Systems. We expect the breadth of these applications for which the device is
used in this market will grow significantly as physicians continue to adopt cell
based regenerative medicine into their treatment strategies based on the
availability of safe clinical grade cells at the point of care.
 
 The
StemSource Cell Bank business is being offered through our commercialization
partner Green Hospital Supply in Japan, Korea, Taiwan and Thailand, and is being
offered by GE Healthcare in select European countries. We believe growth in the
cell bank business in 2009 within Asia Pacific will be driven by hospitals where
a device is already installed as part of an investigator-initiated study, and
where physicians are already familiar with the use of the system and its
benefits. The commercialization activities are performed predominantly by our
distributors, however we continue to serve in a consulting capacity to assist as
needed in sales and service.
 
 Coinciding
with our increased investment in commercial activities is a planned reduction in
preclinical research and cardiovascular disease development expenses. Because we
have passed the feasibility stage and are now manufacturing commercial products,
we have less reliance going forward on basic and preclinical development
activities. Preclinical research will continue at a base level required to
fulfill demands for potential partnerships, expanding intellectual property, and
supporting commercial activities. For cardiovascular disease, we plan to
complete enrollment in these studies, report data in late 2009 and/or early 2010
at which point we will either seek a co-development partner or pursue further
development in a measured way until such time as we have the adequate financial
resources to invest in pivotal European studies and U.S. clinical
trials.
 
 Cytori’s
business objectives for 2009 and beyond include the following:
 
 ·
              Exceed
      global Celution® System and StemSource sales target of $10 million in
      2009
 ·
              Expand
      global distribution network in Europe and Asia-Pacific and related sales
      impact
 ·
              Expand
      Celution® System product claims to include general and plastic surgery
      procedures
 ·
              Expand
      Celution® System reimbursement in
Europe
 ·
              Substantial
      reduction in total operating
expenses
 ·
              Complete
      enrollment of RESTORE II in the second quarter of
  2009
 ·
              Report
      preliminary RESTORE II results as early as the fourth quarter of 2009 on
      patients who have been followed for six months at the time of
      analysis
 ·
              Introduce
      complementary cosmetic and reconstructive surgery products in the U.S. in
      the third quarter of 2009
 ·
              Finalize
      U.S. regulatory and clinical development and regulatory
      strategy
 ·
              Complete
      enrollment in cardiovascular studies (PRECISE & APOLLO) and report
      results in 2010
  25
  Olympus
Partnership
 
 On
November 4, 2005, we entered into a strategic development and manufacturing
joint venture agreement and other related agreements (“JV Agreements”) with
Olympus Corporation (“Olympus”).  As part of the terms of the JV
Agreements, we formed a joint venture, Olympus-Cytori, Inc. (the “Joint
Venture”), to develop and manufacture future generation devices based on our
Celution® System
platform.
 
 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 device technology, including the Celution®
      System platform and certain related intellectual property, to the Joint
      Venture for use in future generation devices.  These devices
      will process and purify adult stem and regenerative cells residing in
      adipose (fat) 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 first generation Celution®
      System platform in January 2006, we received an additional $11,000,000
      development milestone payment from the Joint
  Venture.
 
 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, 2008 and 2007, the fair value of the Put
was $2,060,000 and $1,000,000, respectively.  Fluctuations in the Put
value are recorded in the 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 on the balance sheet in the caption option
liability.
 
 The
following assumptions were employed in estimating the value of the
Put:
 
 December
      31, 2008
                        
                        
                        December
      31, 2007
                        
                        
                        November
      4, 2005Expected
      volatility of Cytori
                        
                        
                        68.00
                        %
                        
                        
                        60.00
                        %
                        
                        
                        63.20
                        %Expected
      volatility of the Joint Venture
                        
                        
                        68.00
                        %
                        
                        
                        60.00
                        %
                        
                        
                        69.10
                        %Bankruptcy
      recovery rate for Cytori
                        
                        
                        21.00
                        %
                        
                        
                        21.00
                        %
                        
                        
                        21.00
                        %Bankruptcy
      threshold for Cytori
                        
                        $
                        16,740,000
                        
                        
                        $
                        9,324,000
                        
                        
                        $
                        10,780,000Probability
      of a change of control event for Cytori
                        
                        
                        2.80
                        %
                        
                        
                        2.17
                        %
                        
                        
                        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
                        
                        
                        2.25
                        %
                        
                        
                        4.04
                        %
                        
                        
                        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.
 
 The Joint
Venture currently has exclusive access to our technology for the development,
manufacture, and supply of the devices (second generation and beyond) for all
therapeutic applications.  Once a later generation Celution® System is
developed and approved by regulatory agencies, the Joint Venture would sell such
systems exclusively to us at a formula-based transfer price; we have retained
marketing rights to the second generation devices for all therapeutic
applications of adipose stem and regenerative cells.
 
 We have
worked closely with Olympus’ team of scientists and engineers to design the
future generations of the Celution® System
so that it will contain certain product enhancements and that can be
manufactured in a streamlined manner.
 
 In August
2007, we entered into a License and Royalty Agreement with the Joint Venture
which provides us the ability to commercially launch the Celution®System
platform earlier than we could have otherwise done so under the terms of the
  26
  Joint
Venture Agreements.  The Royalty Agreement allows for the sale of the
Cytori-developed Celution® System
platform, including the Celution® 800/CRS
and Celution® 900/MB,
until such  time as the Joint Venture’s products are commercially
available for the same market served by the Cytori platform, subject to a
reasonable royalty that will be payable to the Joint Venture for all such
sales.
 
 We
account for our investment in the Joint Venture under the equity method of
accounting.
 
 Other
Related Party Transactions
 
 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 stem and 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.  As part of this agreement, Olympus
could 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.  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.
 
 On
February 8, 2008, we agreed to sell 2,000,000 shares of unregistered common
stock to Green Hospital Supply, Inc. for $12,000,000 cash, or $6.00 per share,
in a private stock placement.  On February 29, 2008, we closed the
first half of the private placement with Green Hospital Supply, Inc. and
received $6,000,000.  We closed the second half of the private
placement on April 30, 2008 and received the second payment of
$6,000,000.
 
 In August
2008, we received an additional $6,000,000 from Olympus in a private placement
of 1,000,000 unregistered shares of our common stock and a warrant to purchase
an additional 500,000 shares of our common stock at an original exercise price
of $8.50 per share.  The purchase price was $6.00 per unit (with each
unit consisting of one share and 50% warrant coverage).  The warrant
is exercisable anytime after February 11, 2009 and will expire on August 11,
2013.
 
 MacroPore
Biosurgery
 
 Spine and orthopedic
products
 
 By
selling substantially all of our spine and orthopedic surgical implant business
to Kensey Nash Corporation in the second quarter of 2007, we have completed our
transition away from the bioresorbable product line for which we were originally
founded.
 
 Thin Film Japan Distribution
Agreement
 
 In 2004,
we sold the majority of our Thin Film business to MAST Biosurgery
AG.  We retained all rights to Thin Film business in Japan (subject to
a purchase option of MAST, which expired in May 2007), and we received back from
MAST a license of all rights to Thin Film technologies in the spinal field,
exclusive at least until 2012, and the field of regenerative medicine,
non-exclusive on a perpetual basis.
 
 In the
third quarter of 2004, we entered into a Distribution Agreement with Senko
Medical Trading Company.  Under this agreement, we granted to Senko an
exclusive license to sell and distribute certain Thin Film products 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.  The Distribution Agreement with Senko
commences upon “commercialization.”  Commercialization will occur when
one or more Thin Film product registrations are completed with the Japanese
Ministry of Health, Labour and Welfare, or MHLW.  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.
 
 We
received a $1,500,000 upfront license fee from Senko.  We have
recorded the $1,500,000 received as a component of deferred revenues in the
accompanying consolidated condensed balance sheet.  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.
 
 Under the
Distribution Agreement, we will also be entitled to earn additional payments
from Senko based on achieving defined milestones.  On September 28,
2004, we notified Senko of completion of the initial regulatory application to
the MHLW for the Thin Film product.  As a result, we became entitled
to a nonrefundable payment of $1,250,000, which we received in October 2004 and
recorded as a component of deferred revenues.  We did not recognize
any development
  27
  revenues
with respect to Senko during the year ended December 31, 2008.  To
date we have recognized a total of $371,000 in development revenues ($10,000,
$152,000, $51,000, and $158,000 for the years ended December 31, 2007, 2006,
2005, and 2004, respectively) related to this agreement.
 
 Capital
Requirements and Liquidity
 
 Research
and development for the Celution® System product platform and clinical
applications of adipose-derived stem and regenerative cell therapies has been
and will continue to be very costly.  As a result, we expect to
continue incurring losses in the near future.  We will focus our efforts on
substantially reducing research and development expenses, pre-clinical research,
and general and administrative activities throughout 2009 as we conclude our
clinical trials ( initiated in 2007) and complete the transition to a focus on
manufacturing and sale of our Celution® 800/CRS for reconstructive
surgery.
 
 Over 99%
of our 2008 research and development expenses of $17,371,000 were related to our
regenerative cell technology business, and the majority of those were related to
optimizing the Celution®800/CRS
for reconstructive surgery research and development of cardiovascular disease
applications.  We believe research and development expenses will be
substantially reduced in 2009 (See additional discussion of liquidity at the
beginning of Management Discussion and Analysis).  We plan to fund
this anticipated research and development from: existing cash and short-term
investments; payments, if any, related to potential Celution® System platform
commercialization partnerships; payments, if any, related to potential
biomaterial divestitures; potential research grants; and sale of common stock
through potential future financings. (See additional discussion regarding
Liquidity at the beginning of Item 7, Management’s Discussion and Analysis of
Financial Condition and Results of Operations.)
 
 As of
December 31, 2008, we had cash and cash equivalents on hand of $12,611,000 and
an accumulated deficit of $162,168,000.
 
 Results
of Operations
 
 Product
revenues
 
 Product
revenues in 2008 relate to our regenerative cell technology segment and
consisted of revenues from our Celution® System
products and Celution®
StemSource® Cell
Bank.  Product revenues in 2007 and 2006 relate to our MacroPore
Biosurgery segment and consisted of revenues from our spine and orthopedic
products.
 
 The
following table summarizes the components for the years ended December 31, 2008,
2007, and 2006:
 
 Years
      ended2008
                          
                          
                          2007
                          
                          
                          2006Regenerative cell
      technology:Celution®
      ProductsRelated
      party
                          
                          $
                          28,000
                          
                          
                          $
                          —
                          
                          
                          $
                          —Third
      party
                          
                          
                          4,500,000
                          
                          
                          
                          —
                          
                          
                          
                          —MacroPore
      Biosurgery:Spine
      and orthopedic products
                          
                          
                          —
                          
                          
                          $
                          792,000
                          
                          
                          $
                          1,451,000Total
      product revenues
                          
                          $
                          4,528,000
                          
                          
                          $
                          792,000
                          
                          
                          $
                          1,451,000%
      attributable to Medtronic
                          
                          
                          —
                          
                          
                          
                          100
                          %
                          
                          
                          100
                          %%
      attributable to Olympus
                          
                          
                          0.6
                          %
                          
                          
                          —
                          
                          
                          
                          —
 
 
 Beginning
in March of 2008, we began sales and shipments of our Celution®800/CRS
System to the European and Asia-Pacific reconstructive surgery
markets.  Assuming all other applicable revenue recognition criteria
have been met, revenue for these product sales will be recognized upon delivery
to the customer, as all risks and rewards of ownership have been substantively
transferred to the customer at that point.  For product sales to
customers who arrange for and manage all aspects of the shipping process, we
recognize revenue upon shipment from our facilities.  For product
sales that include a combination of equipment, services, or other multiple
deliverables that will be provided in the future, we defer an estimate of the
fair value of those future deliverables from product revenue until such
deliverables have been provided or earned.  Shipping and handling
costs that are billed to our customers are classified as revenue.  As
of December 31, 2008 we had $66,000 of shipped product orders that did not reach
final destination until 2009.  Revenue for these items is expected to
be
  28
  recognized
in the quarter ending March 31, 2009.  Additionally, we deferred
$67,000 as an estimate of the fair value of future deliverables from product
revenue and will recognize when such deliverables have been provided or
earned.
 
 Spine and
orthopedic product revenues represent sales of bioresorbable implants used in
spine and orthopedic surgical procedures.  We sold substantially all
of this line of business to Kensey Nash in May 2007.
 
 The future:  We
expect to continue to generate regenerative cell technology product revenues
during 2009 from Celution® 800/CRS and consumable sales in Europe and we expect
to generate product revenues from StemSource® Cell Bank sales in Japan through
our distribution partner Green Hospital Supply, Inc. We expect to have product
revenues related to our MacroPore Biosurgery segment again when
commercialization of the Thin Film products in Japan occurs and we begin Thin
Film shipments to Senko, pending regulatory approval.
 
 Cost of product
revenues
 
 Cost of
product revenues for 2008 relates to sales of Celution® System
products and a StemSource® Cell
Bank in our regenerative cell technology segment and includes material,
manufacturing labor, and overhead costs.  Cost of product revenues for
2007 and 2006 relates to spine and orthopedic products in our MacroPore
Biosurgery segment and includes material, manufacturing labor, overhead costs,
and an inventory provision, if applicable.  The following table
summarizes the components of our cost of revenues for the years ended December
31, 2008, 2007 and 2006:
 
 Years
      ended2008
                    
                    
                    2007
                    
                    
                    2006Regenerative cell
      technology:Cost
      of product revenues
                    
                    $
                    1,811,000
                    
                    
                    $
                    —
                    
                    
                    $
                    —Share-based
      compensation
                    
                    
                    43,000
                    
                    
                    
                    —
                    
                    
                    
                    —Total
      regenerative cell technology
                    
                    
                    1,854,000
                    
                    
                    
                    —
                    
                    
                    
                    —MacroPore
      Biosurgery:Cost
      of product revenues
                    
                    
                    —
                    
                    
                    
                    403,000
                    
                    
                    
                    1,472,000Share-based
      compensation
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    88,000Share-based
      compensation
                    
                    
                    —
                    
                    
                    
                    19,000
                    
                    
                    
                    74,000Total
      MacroPore Biosurgery
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —422,000
                    
                    
                    
                    1,634,000Total
      cost of product revenues
                    
                    $
                    1,854,000
                    
                    
                    $
                    422,000
                    
                    
                    $
                    1,634,000Total
      cost of product revenues as % of product revenues
                    
                    
                    40.9
                    %
                    
                    
                    53.3
                    %
                    
                    
                    112.6
                    %
 
 
 Regenerative
cell technology:
  ·
              The
      increase in cost of product revenues for the year ended December 31, 2008
      as compared to the same periods in 2007 and 2006 was due to Celution®
      System product sales which commenced in 2008.  Cost of sales
      included an economic benefit of approximately $347,000 related to material
      cost and labor/overhead previously expensed as research and development
      prior to commercialization date of March 1, 2008 that was sold during the
      year ended December 31, 2008.  Cost of product revenues as a
      percentage of product revenues was 40.9% for the year ended December 31,
      2008.
  ·
              Cost
      of product revenues included approximately $43,000 of share-based
      compensation expense for the year ended December 31,
      2008.  There was no share-based compensation expense for the
      years ended December 31, 2007 and 2006.  For further details,
      see share-based compensation discussion
below.
 
 MacroPore
Biosurgery:
 
 ·
              The
      decrease in cost of product revenues for the year ended December 31, 2008
      as compared to the same period in 2007 was due to our sale of
      substantially all of the spine and orthopedic product line in May
      2007.  The decrease in cost of product revenues for the year
      ended December 31, 2007 as compared to the same period in 2006 was due to
      a decrease in production and sales in anticipation of the product line
      sale in May 2007.
  29
  ·
              Cost
      of product revenues includes approximately $0, $19,000 and $74,000 of
      stock-based compensation expense for the years ended December 31, 2008,
      2007 and 2006, respectively.   For further details, see
      stock-based compensation discussion
below.
 
 ·
              During
      the years ended December 31, 2008, 2007 and 2006, we recorded a provision
      of $0, $0, and $88,000, respectively, related to excess and slow-moving
      inventory. In 2006, this inventory was produced in anticipation of
      stocking orders from Medtronic which did not
  materialize.
 
 The future.  We
expect to see a nominal decrease of gross profit margin for the regenerative
cell technology segment as the balance of production inventory on hand that was
previously expensed as research and development cost decreases. We expect to
incur costs related to our MacroPore products if and when commercialization is
achieved for our Japan Thin Film product line.
 
 Development
revenues
 
 The
following table summarizes the components of our development revenues for the
years ended December 31, 2008, 2007, and 2006:
 
 
 Years
      ended2008
                    
                    
                    2007
                    
                    
                    2006Regenerative cell
      technology:Milestone
      revenue (Olympus)
                    
                    $
                    774,000
                    
                    
                    $
                    5,158,000
                    
                    
                    $
                    5,905,000Other
      revenue (Olympus)
                    
                    
                    1,500,000
                    
                    
                    
                    —
                    
                    
                    
                    —Research
      grant (NIH)
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    310,000Regenerative
      cell storage services
                    
                    
                    4,000
                    
                    
                    
                    4,000
                    
                    
                    
                    7,000Other
                    
                    
                    47,000
                    
                    
                    
                    85,000
                    
                    
                    
                    102,000Total
      regenerative cell technology
                    
                    
                    2,325,000
                    
                    
                    
                    5,247,000
                    
                    
                    
                    6,324,000MacroPore
      Biosurgery:Development
      (Senko)
                    
                    
                    —
                    
                    
                    
                    10,000
                    
                    
                    
                    152,000Total
      development revenues
                    
                    $
                    2,325,000
                    
                    
                    $
                    5,257,000
                    
                    
                    $
                    6,476,000
 
 Regenerative
cell technology:
 
 ·
              We
      recognize deferred revenues, related party, as development revenue when
      certain performance obligations are met (i.e., using a proportional
      performance approach).  During the year ended December 31, 2008,
      we recognized $774,000 of revenue associated with our arrangements with
      Olympus.  The revenue recognized in 2008 was a result of
      completing two study milestones in the first
  quarter.
 
 Additionally,
we recognized $1,500,000 of other development revenue that relates to the
agreement we entered into on February 23, 2006, in which we granted Olympus an
exclusive right to negotiate a commercialization collaboration for the use of
adipose stem and 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.  As part of this agreement, Olympus
could 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.  Accordingly, on December 31, 2008, we recognized $1,500,000
as other development revenue and reduced our deferred, related party balance for
the same amount.
 
 During
the year ended December 31, 2007, we recognized $5,158,000 of revenue associated
with our arrangements with Olympus.  The revenue recognized in 2007
was a result of completing a pre-clinical study milestone in the second quarter
and completing a development milestone in the third quarter.  During
the year ended December 31, 2006, we recognized $5,905,000 of revenue associated
with our arrangements with Olympus.  The revenue recognized in 2006
was a result of completing a pre-clinical study milestone in the first quarter,
receiving a CE mark for the Celution® 600 System, and reaching three additional
milestones in the fourth quarter.  One milestone related to the
completion of a pre-clinical study while the other two were results of product
development efforts.
  30
  ·
              The
      research grant revenue related to our agreement with the National
      Institutes of Health (“NIH”).  Under this arrangement, the NIH
      reimbursed us for “qualifying expenditures” related to research on
      Adipose-Derived Cell Therapy for Myocardial Infarction.  To
      receive funds under the grant arrangement, we were required to (i)
      demonstrate that we incurred “qualifying expenses,” as defined in the
      grant agreement between the NIH and us, (ii) maintain a system of
      controls, whereby we can accurately track and report all expenditures
      related solely to research on Adipose-Derived Cell Therapy for Myocardial
      Infarction, and (iii) file appropriate forms and follow appropriate
      protocols established by the NIH.
 
 During
the year ended December 31, 2006, we incurred $479,000 in expenditures, of which
$310,000 were qualified.  We recognized a total of $310,000 in
revenues for the year ended December 31, 2006, which included allowable grant
fees as well as cost reimbursements.  Our work under this NIH
agreement was completed in 2006; as a result, there were no comparable revenues
or costs in 2008 and 2007.
 
 MacroPore
Biosurgery (Thin Film):
 
 Under a
Distribution Agreement with Senko we are entitled to earn payments based on
achieving the following defined milestones:
 
 ·
              Upon
      notifying Senko of completion of the initial regulatory application to the
      MHLW for the Thin Film product, we were entitled to a nonrefundable
      payment of $1,250,000.  We so notified Senko on
      September 28, 2004, received payment in October of 2004, and recorded
      deferred revenues of $1,250,000.  As of December 31, 2006, of
      the amount deferred, we have recognized development revenues of $371,000
      ($10,000 in 2007, $152,000 in 2006, $209,000 prior to
    2006).
 
 ·
              In
      addition, we also received a $1,500,000 license fee that was recorded as a
      component of deferred revenues in the accompanying balance
      sheet.  Because the $1,500,000 in license fees is potentially
      refundable, such amounts will not be recognized as revenues until the
      refund rights expire.  Specifically, 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
      are also entitled to a non-refundable payment of $250,000 once we achieve
      commercialization.
 
 The future:  We
expect to recognize additional development revenues from our regenerative cell
technology segment during 2009, as the anticipated completion for the next phase
of our Joint Venture and other Olympus product development performance
obligations is in 2009.  If we are successful in achieving certain
milestone points related to these activities, we may recognize approximately
$1,200,000 in revenues in 2009.  The exact timing of when amounts will
be reported in revenue will depend on internal factors (for instance, our
ability to complete certain contributions and obligations that we have agreed to
perform) as well as external considerations, including obtaining certain
regulatory clearances and/or approvals related to the Celution®
System.  The cash for these contributions and obligations was received
when the agreement was signed and no further related cash payments will be made
to us.
 
 We will
continue to recognize revenue from the Thin Film development work we are
performing on behalf of Senko, based on the relative fair value of the
milestones completed as compared to the total efforts expected to be necessary
to obtain regulatory clearance from the MHLW.  We are still awaiting
regulatory clearance from the MHLW in order for initial commercialization to
occur.  Accordingly, we expect to recognize approximately $1,129,000
(consisting of $879,000 in deferred revenues plus a non-refundable payment of
$250,000 to be received upon commercialization) in revenues associated with this
milestone arrangement if and when regulatory approval is
achieved.  Moreover, we expect to recognize $500,000 per year
associated with deferred Senko license fees over a three-year period following
commercialization, if achieved, as the refund rights associated with the license
payment expire.
 
  31
  Research and development
expenses
 
 Research
and development expenses include costs associated with the design, development,
testing and enhancement of our products, regulatory fees, the purchase of
laboratory supplies, pre-clinical studies, and clinical studies.  The
following table summarizes the components of our research and development
expenses for the years ended December 31, 2008, 2007 and 2006:
 
 Years
      ended2008
                    
                    
                    2007
                    
                    
                    2006Regenerative cell
      technology:Regenerative
      cell
      technology
                    
                    $
                    14,319,000
                    
                    
                    $
                    12,889,000
                    
                    
                    $
                    11,967,000Development
      milestone (Joint Venture)
                    
                    
                    2,546,000
                    
                    
                    
                    6,293,000
                    
                    
                    
                    7,286,000Research
      grants
      (NIH)
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    479,000Stock-based
      compensation
                    
                    
                    501,000
                    
                    
                    
                    645,000
                    
                    
                    
                    1,015,000Total
      regenerative cell technology
                    
                    
                    17,366,000
                    
                    
                    
                    19,827,000
                    
                    
                    
                    20,747,000MacroPore
      Biosurgery:Bioresorbable
      polymer implants
                    
                    
                    —
                    
                    
                    
                    111,000
                    
                    
                    
                    1,027,000Development
      milestone (Senko)
                    
                    
                    —
                    
                    
                    
                    80,000
                    
                    
                    
                    178,000Thin
      Film related
      research
                    
                    
                    5,000
                    
                    
                    
                    —
                    
                    
                    
                    —Stock-based
      compensation
                    
                    
                    —
                    
                    
                    
                    2,000
                    
                    
                    
                    25,000Total
      MacroPore
      Biosurgery
                    
                    
                    5,000
                    
                    
                    
                    193,000
                    
                    
                    
                    1,230,000Total
      research and development expenses
                    
                    $
                    17,371,000
                    
                    
                    $
                    20,020,000
                    
                    
                    $
                    21,977,000
 
 Regenerative
cell technology:
 
 ·
              Regenerative
      cell technology expenses relate to the development of a technology
      platform that involves using adipose tissue as a source of autologous
      regenerative cells for therapeutic applications.  These
      expenses, in conjunction with our continued development efforts related to
      our Celution®
      System, result primarily from the broad expansion of our research and
      development efforts enabled by the funding we received from Olympus in
      2005 and 2006 and from other investors during the last few
      years.  Labor-related expenses, not including share-based
      compensation, decreased by $1,494,000 for the year ended December 31, 2008
      as compared to the same period in 2007 primarily due to the decrease in
      headcount for our research and development department as a result of
      achievement of commercialization and transfer of employees from research
      and development to the manufacturing department.  Professional
      services expense increased by $310,000 from 2007 to 2008, primarily due to
      increased use of consultants and temporary labor during the year ended
      December 31, 2008.  Pre-clinical and clinical study expense
      decreased by $1,023,000 from 2007 to 2008 primarily due to a reduction in
      pre-clinical study activity as we focus on our clinical studies. 
      Additionally, although the overall cost of a clinical trial is generally
      higher than for a preclinical study, such costs are typically spread out
      over a longer period of time.  Expenses for supplies increased
      by $352,000 from 2007 to 2008, primarily due to timing of use of inventory
      supplies for research purposes and purchases of production supplies prior
      to the related product line
commercialization.
 
 ·
              Professional
      services expense (including pre-clinical and clinical study costs)
      decreased by $1,163,000 from 2006 to 2007, of which $422,000 was
      attributed to a decrease in pre-clinical and clinical study expense
      primarily due to a transition in focus from pre-clinical studies to
      clinical studies.  Rent and utilities expense decreased by
      $316,000 from 2006 to 2007 primarily due the termination of leases at our
      Top Gun location in San Diego, CA.  These decreases were offset
      by an increase in travel expense of $389,000 and an increase in repair and
      maintenance expense of $382,000 from 2006 to
  2007.
 
 ·
              Expenditures
      related to the Joint Venture with Olympus, which are included in the
      variation analysis above, include costs that are necessary to support the
      commercialization of future generation devices, including the next
      generation Celution® device.  These development activities,
      which began in November 2005, include performing pre-clinical and clinical
      studies, 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, 2008, 2007 and 2006, costs associated with the development of the
      device were $2,546,000, $6,293,000 and $7,286,000,
      respectively.  These expenses were comprised of $1,310,000,
      $3,217,000 and $3,663,000 in labor and related benefits, $706,000,
      $1,973,000 and $2,405,000 in consulting and other professional services,
      $111,000, $567,000 and $872,000 in supplies and $419,000, $536,000 and
      $346,000 in other miscellaneous expense,
  respectively.
  32
  ·
              In
      2004, we entered into an agreement with the NIH to reimburse us for up to
      $950,000 (Phase I $100,000 and Phase II $850,000) in “qualifying
      expenditures” related to research on Adipose-Derived Cell Therapy for
      Myocardial Infarction. For the year ended December 31, 2006, we incurred
      $479,000 of direct expenses relating entirely to Phase I and
      II.  Of these expenses, $169,000 were not reimbursed in
      2006.  To date, we have incurred $1,125,000 of direct expenses
      ($180,000 of which were not reimbursed) relating to both Phases I and II
      of the agreement.  There were no comparable expenditures in 2008
      and 2007 as our work under this NIH agreement was completed during
      2006.
 
 ·
              Stock-based
      compensation for the regenerative cell technology segment of research and
      development was $501,000, $645,000 and $1,015,000 for the years ended
      December 31, 2008, 2007 and 2006, respectively. See stock-based
      compensation discussion below for more
details.
 
 MacroPore
Biosurgery:
 
 ·
              Our
      bioresorbable surgical implants platform technology is used for
      development of spine and orthopedic products and Thin Film
      products.  Research and development expenses for bioresorbable
      polymer implants substantially decreased in 2007 and were essentially
      ceased by 2008, due to the termination of spine and orthopedics product
      research upon sale of substantially all of this product line in May
      2007.
 
 ·
              Under
      a distribution agreement with Senko, we are responsible for the completion
      of the initial regulatory application to the MHLW and commercialization of
      the Thin Film product line in Japan.  Commercialization occurs
      when one or more Thin Film product registrations are completed with the
      MHLW.  During the years ended December 31, 2007 and 2006, we
      incurred $80,000 and $178,000, respectively, of expenses related to this
      regulatory and registration process.  We did not incur any
      expenses related to this regulatory and registration process for the year
      ended December 31, 2008.
 
 ·
              Share-based
      compensation for the MacroPore Biosurgery segment of research and
      development for the years ended December 31, 2007 and 2006 was $2,000 and
      $25,000, respectively.  There were no share-based compensation
      expenses for the MacroPore Biosurgery segment of research and development
      for the year ended December 31, 2008.  See share-based
      compensation discussion below for more
details.
 
 The future:  Our
strategy is to substantially reduce our research and development expenditures in
2009 and we anticipate expenditures in this area to be well below the
expenditures in 2008 as we shift our focus toward  manufacturing and
sales. (See additional discussion regarding Liquidity at the beginning of Item
7, Management’s Discussion and Analysis of Financial Condition and Results of
Operations.)
 
 Sales and marketing
expenses
 
 Sales and
marketing expenses include costs of marketing personnel, tradeshows, physician
training, and promotional activities and materials.  Before the sale
of our spine and orthopedic implant product line in May 2007, Medtronic was
responsible for the distribution, marketing, and sales support of our spine and
orthopedic devices.  The following table summarizes the components of
our sales and marketing expenses for the years ended December 31, 2008, 2007 and
2006:
 
 Years
      ended2008
                          
                          
                          2007
                          
                          
                          2006Regenerative cell
      technology:International
      sales and marketing
                          
                          $
                          4,065,000
                          
                          
                          $
                          2,231,000
                          
                          
                          $
                          1,271,000Stock-based
      compensation
                          
                          
                          361,000
                          
                          
                          
                          265,000
                          
                          
                          
                          517,000Total
      regenerative cell technology
                          
                          
                          4,426,000
                          
                          
                          
                          2,496,000
                          
                          
                          
                          1,788,000MacroPore
      Biosurgery:General
      corporate marketing
                          
                          
                          —
                          
                          
                          
                          21,000
                          
                          
                          
                          154,000International
      sales and marketing
                          
                          
                          176,000
                          
                          
                          
                          156,000
                          
                          
                          
                          104,000Stock-based
      compensation
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          9,000Total
      MacroPore Biosurgery
                          
                          
                          176,000
                          
                          
                          
                          177,000
                          
                          
                          
                          267,000Total
      sales and marketing
                          
                          $
                          4,602,000
                          
                          
                          $
                          2,673,000
                          
                          
                          $
                          2,055,000
  33
  Regenerative
Cell Technology:
 
 ·
              The
      increase in international sales and marketing expense for the year ended
      December 31, 2008 as compared to the same period in 2007 was mainly
      attributed to the increase in salary and related benefits expense of
      $974,000, not including share-based compensation, an increase in travel
      related expenses of $321,000, and an increase in printing, supplies, and
      postage of $155,000, which are due to our emphasis in seeking strategic
      alliances and/or co-development partners for our regenerative cell
      technology as well as sales and marketing efforts related to our
      commercialization activities.
 
 The
increase in international sales and marketing expense for the year ended
December 31, 2007 as compared to same period in 2006 was mainly attributed to
the increase in salary and related benefits expense of $409,000, as well as
other increases due to our regenerative cell technology strategy.
 
 ·
              Stock-based
      compensation for the regenerative cell segment of sales and marketing for
      the year ended December 31, 2008, 2007 and 2006 was $361,000, $265,000 and
      $517,000, respectively.  See stock-based compensation discussion
      below for more details.
 
 MacroPore
Biosurgery:
 
 ·
              General
      corporate marketing expenditures relate to expenditures for maintaining
      our corporate image and reputation within the research and surgical
      communities relevant to bioresorbable
      implants.   Expenditures in this area declined to $0 in
      2008 from $21,000 in 2007 and $154,000 in 2006 as we focused on our
      regenerative cell technology business and shifted our focus from our spine
      and orthopedic implant business.
 
 ·
              International
      sales and marketing expenditures relate to costs associated with
      developing an international bioresorbable Thin Film distributor and
      supporting a bioresorbable Thin Film sales office in
  Japan.
 
 ·
              Stock-based
      compensation for the MacroPore Biosurgery segment of sales and marketing
      for the years ended December 31, 2006 was $9,000.  There was no
      stock-based compensation for the MacroPore Biosurgery segment of sales and
      marketing for the years ended December 31, 2008 and 2007.  See
      stock-based compensation discussion below for more
  details.
 
 The future.  We
expect sales and marketing expenditures related to the regenerative cell
technology to be maintained at or near current levels as we continue to expand
our base of distribution partners, strategic alliances and co-development
partners, as well as market our Celution® System
and StemSource® Cell
Bank. (See additional discussion regarding Liquidity at the beginning of Item 7,
Management’s Discussion and Analysis of Financial Condition and Results of
Operations.)
 
 General and administrative
expenses
 
 General
and administrative expenses include costs for administrative personnel, legal
and other professional expenses and general corporate expenses.  The
following table summarizes the general and administrative expenses for the years
ended December 31, 2008, 2007, and 2006:
  Years
      ended2008
                          
                          
                          2007
                          
                          
                          2006General
      and administrative
                          
                          $
                          10,375,000
                          
                          
                          $
                          12,805,000
                          
                          
                          $
                          10,967,000Stock-based
      compensation
                          
                          
                          1,352,000
                          
                          
                          
                          1,379,000
                          
                          
                          
                          1,580,000Total
      general and administrative expenses
                          
                          $
                          11,727,000
                          
                          
                          $
                          14,184,000
                          
                          
                          $
                          12,547,000
 
 ·
              General
      and administrative expense, for the year ended December 31, 2008 as
      compared to the same period in 2007 decreased by $2,457,000.  An
      overall decrease in general and administrative expenses (excluding
      share-based compensation) occurred primarily from a decrease in legal fees
      related to the ‘231 Patent (see below) of $1,793,000 and decrease
      in  salary and related benefit expense, excluding share-based
      compensation) of $729,000 for the year ended December 31, 2008 as compared
      to the same periods in 2007.
  34
 
 ·
              General
      and administrative expense, for the year ended December 31, 2007 as
      compared to the same period in 2006 increased by
      $1,637,000.  This was primarily a result of increases in salary
      and related benefit expense of $802,000 and increases in professional
      services of $1,160,000, offset by a decrease in stock-based compensation
      of $201,000 for the year ended December 31, 2007 as compared with
      2006.  The increase in salary and related benefit expense was
      mainly attributed to an increase in headcount.  The increase in
      professional services was mainly attributed to an increase of $266,000 in
      consulting services, increases in accounting fees of $196,000, and an
      increase in legal expenses of $863,000, partly incurred in connection with
      the 231 Patent (see below), offset by a decrease in other professional
      services of $165,000.  In addition, we incurred a non-recurring
      fee of $322,000 related to our February 2007 sale of common
      stock.
 
 ·
              We
      have incurred substantial legal expenses in connection with the University
      of Pittsburgh’s lawsuit.  Although we are not litigants and are
      not responsible for any settlement costs, if we are not successful in
      overturning the Court’s decision on the ‘231 Patent, our license rights to
      the ‘231 Patent will be lost.  Since our current products and
      products under development do not practice the ‘231 Patent, our primary
      ongoing business activities and product development pipeline should not be
      affected by the Court’s decision. Although the ‘231 Patent is unrelated to
      our current products and product pipeline, we believe that the ‘231 Patent
      and/or the other technology licensed from UC may have long term potential
      to be useful for future product developments, and so we have elected to
      support UC’s legal efforts in the appeal of the Court’s final
      order.  The amended license agreement we signed with UC in the
      third quarter of 2006 clarified that we are responsible for patent
      prosecution and litigation costs related to this lawsuit.  In
      the years ended December 31, 2008, 2007 and 2006, we expensed $625,000,
      $2,418,000 and $2,189,000, respectively, for legal fees related to this
      license.   Our legal expenses related to this lawsuit and
      the appeal will fluctuate depending upon the activity incurred during each
      period.
 
 ·
              Stock-based
      compensation related to general and administrative expense for the years
      ended December 31, 2007, 2006 and 2005 was $1,352,000, $1,379,000 and
      $1,580,000, respectively.  See stock-based compensation
      discussion below for more details.
 
 The future.  We
expect general and administrative expenses to be further reduced in 2009
compared to the prior three years as we are seeking ways to minimize these
expenses where possible.  (See additional discussion regarding
Liquidity at the beginning of Item 7, Management’s Discussion and Analysis of
Financial Condition and Results of Operations.)
 
 Stock-based compensation
expenses
 
 As noted
previously, we adopted SFAS 123R on January 1, 2006.
 
 Stock-based
compensation expenses include charges related to options issued to employees,
directors and non-employees.  Prior to January 1, 2006, the
stock-based compensation expenditures connected to options granted to employees
and directors (in their capacity as board members) is the difference between the
exercise price of the stock based awards and the market value of our underlying
common stock on the date of the grant.  Unearned employee stock-based
compensation is amortized over the remaining vesting periods of the options,
which generally vest over a four-year period from the date of
grant.  From January 1, 2006 onwards, we adopted FASB No. 123 (revised
2004), “Share-based payments.”  Under this pronouncement, we measure
stock-based compensation expense based on the grant-date fair value of any
awards granted to our employees.  Such expense is recognized over the
period of time that employees provide service to us and earn all rights to the
awards.
 
  35
  Stock-based
compensation expense related to options to purchase common stock issued to
non-employees is the fair value of the stock on the date of issuance, even if
such stock contains sales restrictions.  The following table
summarizes the components of our stock-based compensation for the years ended
December 31, 2008, 2007 and 2006:
 
 Years
      ended2008
                          
                          
                          2007
                          
                          
                          2006Regenerative cell
      technology:Cost
      of product revenues
                          
                          $
                          43,000
                          
                          
                          $
                          —
                          
                          
                          $
                          —Research
      and development related
                          
                          
                          501,000
                          
                          
                          
                          645,000
                          
                          
                          
                          1,015,000Sales
      and marketing related
                          
                          
                          361,000
                          
                          
                          
                          265,000
                          
                          
                          
                          517,000Total
      regenerative cell technology
                          
                          
                          905,000
                          
                          
                          
                          910,000
                          
                          
                          
                          1,532,000MacroPore
      Biosurgery:Cost
      of product revenues
                          
                          
                          —
                          
                          
                          
                          19,000
                          
                          
                          
                          74,000Research
      and development related
                          
                          
                          —
                          
                          
                          
                          2,000
                          
                          
                          
                          25,000Sales
      and marketing related
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          9,000Total
      MacroPore Biosurgery
                          
                          
                          —
                          
                          
                          
                          21,000
                          
                          
                          
                          108,000General
      and administrative related
                          
                          
                          1,352,000
                          
                          
                          
                          1,379,000
                          
                          
                          
                          1,580,000Total
      stock-based compensation
                          
                          $
                          2,257,000
                          
                          
                          $
                          2,310,000
                          
                          
                          $
                          3,220,000
 
 Regenerative
cell technology:
 
 ·
              Of
      the $910,000 charge to stock-based compensation for the year ended
      December 31, 2007, $6,000 related to award modifications for the
      termination of the employment of our Vice President of Research,
      Regenerative Cell Technology. The charge reflects the incremental fair
      value of (a) the accelerated unvested stock options and (b) the extended
      vested stock options (over the fair value of the original awards at the
      modification date).  There will be no further charges related
      these modifications.
 
 ·
              In
      the first quarter of 2006, we issued 2,500 shares of restricted common
      stock to a non-employee scientific advisor.  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 $18,000 recorded in
      the first quarter of 2006 constitutes the entire expense related to this
      grant, and no future period charges will be reported.  The
      scientific advisor also receives cash consideration as services are
      performed.
 
 General
and Administrative:
 
 ·
              During
      the first quarter of 2008, we issued to our officers and directors stock
      options to purchase up to 450,000 shares of our common stock, with a
      four-year graded vesting schedule for our officers and two-year graded
      vesting for our directors. The grant date fair value of option awards
      granted to our officers and directors was $2.73 per share. The resulting
      share-based compensation expense of $1,230,000, net of estimated
      forfeitures, will be recognized as expense over the respective service
      periods.
 
 ·
              During
      the first quarter of 2007, we issued to our officers and directors stock
      options to purchase up to 410,000 shares of our common stock, with a
      four-year vesting schedule for our officers and 24-month graded vesting
      for our directors. The grant date fair value of option awards granted to
      our officers and directors was $3.82 and $3.70 per share, respectively.
      The resulting share-based compensation expense of $1,480,000, net of
      estimated forfeitures, will be recognized as expense over the respective
      vesting periods.
 
 ·
              Of
      the $1,379,000 charge to stock-based compensation for the year ended
      December 31, 2007, $58,000 related to award modifications for the
      termination of the employment of two employees.  The charge
      reflects the incremental fair value of (a) the accelerated unvested stock
      options and (b) the extended vested stock options (over the fair value of
      the original awards at the modification date).  There will be no
      further charges related these
modifications.
 
 During
the second quarter of 2007, we made company-wide stock option grants to our
non-executive employees to purchase 213,778 shares of our common stock, subject
to a four-year graded vesting schedule. The grant date fair value for the awards
was $3.65 per share. The resulting share-based compensation expense of $739,000,
net of estimated forfeitures, will be recognized as expense over the respective
vesting periods.
  36
  Of the
$3,220,000 charge to stock-based compensation for the year ended December 31,
2006, $420,000 related to extensions and cancellations of awards previously
granted to (a) our former Senior Vice President of Finance and Administration,
who retired in May 2006, and (b) (i) our former Senior Vice President, Business
Development, (ii) our former Vice President, Marketing and Development, and
(iii) the position of a less senior employee, whose positions were eliminated
during 2006.  The charge reflects the incremental fair value of the
extended vested stock options over the fair value of the original awards at the
modification date as well as the acceleration of unrecognized compensation cost
associated with cancelled option awards that would have been recognized if the
four individuals continued to vest in their options until the end of their
employment term.  There will be no further charges related to these
modifications.
 
 The future.  We
will continue to grant options (which will result in an expense) to our
employees and, as appropriate, to non-employee service providers.  In
addition, previously-granted options will continue to vest in accordance with
their original terms.  As of December 31, 2008, the total compensation
cost related to non-vested stock options not yet recognized for all our plans is
approximately $3,494,000. These costs are expected to be recognized over a
weighted average period of 1.67 years.
 
 Change in fair value of
option liabilities
 
 The
following is a table summarizing the change in fair value of option liabilities
for the years ended December 31, 2008, 2007 and 2006:
 
 Years
      ended2008
                    
                    
                    2007
                    
                    
                    2006Change
      in fair value of option liability.
                    
                    $
                    —
                    
                    
                    $
                    —
                    
                    
                    $
                    (3,731,000
                    )Change
      in fair value of put option liability
                    
                    
                    1,060,000
                    
                    
                    
                    100,000
                    
                    
                    
                    (700,000
                    )Total
      change in fair value of option liabilities.
                    
                    $
                    1,060,000
                    
                    
                    $
                    100,000
                    
                    
                    $
                    (4,431,000
                    )
 
 ·
              We
      granted Olympus an option to acquire 2,200,000 shares of our common stock
      in 2005.  The exercise price of the option shares was $10 per
      share.  We had accounted for this grant as a liability because
      had the option been exercised, we would have been required to deliver
      listed shares of our common stock to settle the option
      shares.  In accordance with EITF 00-19, “Accounting for
      Derivative Financial Instruments Indexed to, and Potentially Settled in, a
      Company’s Own Stock,” the fair value of this option was re-measured at the
      end of each quarter, using the Black-Scholes option pricing model, with
      the movement in fair value reported in the statement of operations as a
      change in fair value of option liabilities.  This option expired
      unexercised on December 31, 2006.
 
 ·
              In
      reference to the Joint Venture, 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 us
      at the higher of (a) $22,000,000 or (b) the Put’s fair
      value.  The value of the Put has been classified as a
      liability.
 
 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.
 
  37
  The
following assumptions were employed in estimating the value of the
Put:
 
 December
      31, 2008
                      
                      
                      December
      31, 2007
                      
                      
                      December
      31, 2006Expected
      volatility of Cytori
                      
                      
                      68.00
                      %
                      
                      
                      60.00
                      %
                      
                      
                      66.00
                      %Expected
      volatility of the Joint Venture
                      
                      
                      68.00
                      %
                      
                      
                      60.00
                      %
                      
                      
                      56.60
                      %Bankruptcy
      recovery rate for Cytori
                      
                      
                      21.00
                      %
                      
                      
                      21.00
                      %
                      
                      
                      21.00
                      %Bankruptcy
      threshold for Cytori
                      
                      $
                      16,740,000
                      
                      
                      $
                      9,324,000
                      
                      
                      $
                      10,110,000Probability
      of a change of control event for Cytori
                      
                      
                      2.80
                      %
                      
                      
                      2.17
                      %
                      
                      
                      1.94
                      %Expected
      correlation between fair values of Cytori and the Joint Venture in the
      future
                      
                      
                      99.00
                      %
                      
                      
                      99.00
                      %
                      
                      
                      99.00
                      %Risk
      free interest rate
                      
                      
                      2.25
                      %
                      
                      
                      4.04
                      %
                      
                      
                      4.71
                      %
 
 The future.  The
Put has no expiration date.  Accordingly, we will continue to
recognize a liability for the Put until it is exercised or until the
arrangements with Olympus are amended.
 
 Other income
(expense)
 
 Gain on
sale of assets was $1,858,000 for the year ended December 31,
2007.  There was no gain on sale of assets for the years ended
December 31, 2008 and 2006.
 
 In May
2007, we sold to Kensey Nash our intellectual property rights and tangible
assets related to our spine and orthopedic bioresorbable implant product line, a
part of our MacroPore Biosurgery business.  Excluded from the sale was
our Japan Thin Film product line.  We received $3,175,000 in cash
related to the disposition.  The assets comprising the spine and
orthopedic product line transferred to Kensey Nash were as follows:
 
 Carrying
      Value Prior to DispositionInventory
                    
                    $
                    94,000Other
      current assets
                    
                    
                    17,000Assets
      held for sale
                    
                    
                    436,000Goodwill
                    
                    
                    465,000$
                    1,012,000
 
 We
incurred expenses of $109,000 in connection with the sale during the second
quarter of 2007.  As part of the disposition agreement, we were
required to provide training to Kensey Nash representatives in all aspects of
the manufacturing process related to the transferred spine and orthopedic
product line, and to act in the capacity of a product manufacturer from the
point of sale through August 2007.  Because of these additional
manufacturing requirements, we deferred $196,000 of the gain related to the
outstanding manufacturing requirements, and we recognized $1,858,000 as a gain
on sale in the statement of operations during the second quarter of
2007.  These manufacturing requirements were completed in August 2007
as planned, and the associated costs were classified against the deferred
balance, reducing it to zero.  No further costs or adjustments
relating to this product line sale are anticipated.
 
 The
revenues and expenses related to the spine and orthopedic product line
transferred to Kensey Nash for the years ended December 31, 2007 and 2006 were
as follows:
 
 For
      the years ended December 31,2007
                    
                    
                    2006Revenues
                    
                    $
                    792,000
                    
                    
                    $
                    1,451,000Cost
      of product revenues
                    
                    
                    (422,000
                    )
                    
                    
                    (1,634,000
                    )Research
      & development
                    
                    
                    (113,000
                    )
                    
                    
                    (1,052,000
                    )Sales
      & marketing
                    
                    
                    (21,000
                    )
                    
                    
                    (163,000
                    )
 
 
 
 The future.  No
additional gains will be recognized related to either sale.
 
  38
  Financing
items
 
 The
following table summarizes interest income, interest expense, and other income
and expenses for the years ended December 31, 2008, 2007 and 2006:
 
 Years
      ended2008
                    
                    
                    2007
                    
                    
                    2006Interest
      income
                    
                    $
                    230,000
                    
                    
                    $
                    1,028,000
                    
                    
                    $
                    708,000Interest
      expense
                    
                    
                    (420,000
                    )
                    
                    
                    (155,000
                    )
                    
                    
                    (199,000
                    )Other
      income (expense)
                    
                    
                    (40,000
                    )
                    
                    
                    (46,000
                    )
                    
                    
                    (27,000
                    )Total
                    
                    $
                    (230,000
                    )
                    
                    $
                    827,000
                    
                    
                    $
                    482,000
 
 ·
              Interest
      income decreased for the year December 31, 2008 as compared to the same
      period in 2007 due to a decrease in interest rates and cash balance
      available for investment.  Interest income increased in 2007 as
      compared to 2006 due to a larger balance of funds available for
      investment, as a result of (i) the sale of common stock and common stock
      warrants under the shelf registration statement in February 2007, (ii)
      proceeds from the common stock private placement to Green Hospital Supply,
      Inc. in April 2007, and (iii) proceeds from the sale of our bioresorbable
      spine and orthopedic surgical implant product line to Kensey Nash in May
      2007.
 
 ·
              Interest
      expense increased in 2008 as compared to 2007 due to interest incurred as
      well as non-cash amortization of debt issuance costs and debt discount
      associated with a new term loan.  In October 2008, we entered
      into a secured Loan Agreement with General Electric Capital Corporation
      and Silicon Valley Bank (“Lenders”) to borrow up to
      $15,000,000.  An initial term loan of $7,500,000, less fees and
      expenses, funded on October 14, 2008.  Interest expense
      decreased in 2007 as compared to 2006 due to the lower principal balances
      on our long-term equipment-financed borrowings, which were fully repaid in
      2008.
 
 ·
              The
      changes in other income (expense) in 2008, 2007 and 2006 resulted
      primarily from changes in foreign currency exchange
  rates.
 
 The
future.   Interest income earned in 2009 will be dependent
on our levels of funds available for investment as well as general economic
conditions.  We expect interest expense to increase in 2009 as we
continue to repay the term loan balance.
 
 Equity loss from investment
in Joint Venture
 
 The
following table summarizes equity loss from investment in joint venture for the
years ended December 31, 2008, 2007 and 2006:
 
 Years
      ended2008
                    
                    
                    2007
                    
                    
                    2006Equity
      loss from investment in joint venture
                    
                    $
                    (45,000
                    )
                    
                    $
                    (7,000
                    )
                    
                    $
                    (74,000
                    )
 
 The
losses relate entirely to our 50% equity interest in the Joint Venture, which we
account for using the equity method of accounting.
 
 The future.  We do
not expect to recognize significant losses from the activities of the Joint
Venture in the foreseeable future.  Over the next two to three years,
the Joint Venture is expected to incur labor costs related to the development of
our second generation commercial system as well as general and administrative
expenses, offset by royalty and other revenue expected to be generated by our
current Celution® 800/CRS and future generationdevices.  Though
we have no obligation to do so, we plan to contribute funding to the Joint
Venture to cover any costs should the Joint Venture deplete its cash
balance.
 
  39
  Liquidity
and Capital Resources
 
 Short-term and long-term
liquidity
 
 The
following is a summary of our key liquidity measures at December 31, 2008, 2007
and 2006:
 
 Years
      ended2008
                          
                          
                          2007
                          
                          
                          2006Cash
      and cash equivalents
                          
                          $
                          12,611,000
                          
                          
                          $
                          11,465,000
                          
                          
                          $
                          8,902,000Short-term
      investments, available for sale
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          3,976,000Total
      cash and cash equivalents and short-term investments, available for
      sale
                          
                          $
                          12,611,000
                          
                          
                          $
                          11,465,000
                          
                          
                          $
                          12,878,000Current
      assets
                          
                          $
                          17,225,000
                          
                          
                          $
                          12,238,000
                          
                          
                          $
                          13,978,000Current
      liabilities
                          
                          
                          7,135,000
                          
                          
                          
                          8,070,000
                          
                          
                          
                          6,586,000Working
      capital
                          
                          $
                          10,090,000
                          
                          
                          $
                          4,168,000
                          
                          
                          $
                          7,392,000
 
 In order
to continue the operations of our regenerative cell business at or near current
levels, we will need to raise additional capital in the very near
term.
 
 During
2008, we initiated our commercialization activities while simultaneously
pursuing available financing sources to support operations and
growth.  We have had, and continue to have, an ongoing need to raise
additional cash from outside sources to fund our operations.  However,
our ability to raise capital has been adversely affected by current credit
conditions and the downturn in the financial markets and the global
economy.  Accordingly, the combination of these facts raises
substantial doubt as to the Company’s ability to continue as a going
concern.  The accompanying consolidated financial statements and
financial statement schedule have been prepared assuming that the Company will
continue as a going concern.  If we are unsuccessful in our efforts to
raise outside capital in the near term, we will be required to significantly
reduce our research, development, and administrative operations, including
reduction of our employee base, in order to offset the lack of available
funding.
 
 We are
pursuing financing opportunities in both the private and public debt and equity
markets as well as through strategic corporate partnerships.  We have
an established history of raising capital through these platforms, and we are
currently involved in negotiations with multiple parties.  Our efforts
in 2008 to raise capital have taken longer than we initially
anticipated.  However, in August 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. In
October 2008, we entered into a secured Loan agreement with General Electric
Capital Corporation and Silicon Valley Bank (“Lenders”) to borrow up to
$15,000,000.  An initial term loan of $7,500,000, less fees and
expenses, was funded on October 14, 2008.  We could not access the
remaining $7,500,000 under this facility as we were not able to meet certain
financial prerequisites that had been established by the Lenders.
 
 We expect
to continue to utilize our cash and cash equivalents to fund operations through
at least the next few months, subject to minimum cash and cash liquidity
requirements of the Loan and Security Agreement with the Lenders, which requires
that we maintain at least three months of cash on hand to avoid an event of
default under the Loan and Security Agreement.  We continue to seek
additional cash through product revenues, strategic collaborations, and future
sales of equity or debt securities.  Although there can be no assurance
given, we hope to successfully complete one or more additional financing
transactions and corporate partnerships in the near-term. Without this
additional capital, current working capital and cash generated from sales and
containment of operating costs will not provide adequate funding for research,
sales and marketing efforts, clinical and preclinical trials, and product
development activities at their current levels. If such efforts are not
successful, we will need to significantly reduce or curtail our research and
development and other operations and this could negatively affect our ability to
achieve corporate growth goals.  Specifically, we have prepared an
operating plan (plan) that calls for us to reduce operations to focus almost
entirely on the supply of current products to existing or new distribution
channels.  This plan would result in reductions to our current sales and
marketing headcount (total headcount was 17 at December 31, 2008) as well as a
reduction in manufacturing headcount (total headcount of 20 at December 31,
2008).  In addition, as part of this plan, there would be minimal
expenditures for ongoing scientific research, product development or clinical
research.  This impacts research and development headcount (total headcount
was 57 at December 31, 2008), external
  40
  subcontractor
expenditures, capital outlay and general and administrative expenditures related
to the supervision of such activities.  In parallel, we would
significantly reduce administrative staff (the general and administrative
headcount was 32 at December 31, 2008) and salaries consistent with the overall
reduction in scope of operations.  In aggregate, such reductions could
result in eliminations of roles for the majority of the Company’s current staff
and the deferral or elimination of all ongoing development projects until such
time that cash resources were available from operations or outside sources to
re-establish development and growth plans.  Management is currently
reviewing contractual obligations related to the pre-clinical and clinical
commitments along with minimum purchase requirements to include deferral of such
commitments as part of this plan.  While management is actively
pursuing its near term financial and strategic alternatives it is also, in
parallel, continuing to evaluate the timing of implementation of the alternative
operating plan and the initiation of the identified reductions. Based on the
impact of the reductions described above contemplated by the plan and a full
year impact of other actions taken by management in Q3 and Q4 of 2008, the cash
operating requirements in the near term would be reduced to a range of $1.0 to
$1.2 million per month.
 
 From
inception to December 31, 2008, we have financed our operations primarily
by:
 
 ·
              Issuing
      stock in pre-IPO transactions, a 2000 initial public offering in Germany,
      and stock option exercises,
 
 ·
              Generating
      revenues,
 
 ·
              Selling
      the bioresorbable implant CMF product line in September
    2002,
 
 ·
              Selling
      the bioresorbable implant Thin Film product line (except for the territory
      of Japan), in May 2004,
 
 ·
              Licensing
      distribution rights to Thin Film in Japan, in exchange for an upfront
      license fee in July 2004 and an initial development milestone payment in
      October 2004,
 
 ·
              Obtaining
      a modest amount of capital equipment long-term
  financing,
 
 ·
              Selling
      1,100,000 shares of common stock to Olympus under an agreement which
      closed in May 2005,
 
 ·
              Receiving
      upfront and milestone fees from our Joint Venture with Olympus, which was
      entered into in November 2005,
 
 ·
              Receiving
      funds in exchange for granting Olympus an exclusive right to negotiate in
      February 2006,
 
 ·
              Receiving
      $16,219,000 in net proceeds from a common stock sale under the shelf
      registration statement in August
2006,
 
 ·
              Receiving
      $19,901,000 in net proceeds from the sale of common stock plus common
      stock warrants under the shelf registration statement in February
      2007,
 
 ·
              Receiving
      $6,000,000 in net proceeds from a private placement to Green Hospital
      Supply, Inc. in April 2007, and
 
 ·
              Receiving
      gross proceeds of $3,175,000 from the sale of our bioresorbable spine and
      orthopedic surgical implant product line to Kensey Nash in May
      2007.
 
 ·
              Receiving
      $12,000,000 in net proceeds from a private placement to Green Hospital
      Supply, Inc. during first half
2008.
 
 ·
              Receiving
      $17,000,000 in gross proceeds in August 2008 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.
  ·
              Obtaining
      a term loan of $7,500,000 from General Electric Capital Corporation and
      Silicon Valley Bank (Lenders) in October
2008.
  41
  In
January 2006, we also received an additional $11,000,000 upon our receipt of a
CE mark for the Celution® 600 and received an additional $1,500,000 in the first
half of 2006 in exchange for the grant to Olympus of an exclusive right to
negotiate a commercialization collaboration for the use of adipose stem and
regenerative cells for a specific therapeutic area outside of cardiovascular
disease.
 
 In August
2006, we sold 2,918,000 shares of our common stock at $5.75 per share for an
aggregate of approximately $16,800,000.  Olympus purchased $11,000,000
of these shares and the remaining balance was purchased by certain institutional
investors.  We received proceeds of $16,219,000, net of related
offering costs and fees.
 
 In
February 2007, we sold units consisting of 3,746,000 shares of common stock and
1,873,000 common stock warrants (with an exercise price of $6.25 per share) to
institutional and accredited investors.  We received proceeds of
approximately $19,901,000, net of related offering costs and fees.
 
 We
received net proceeds of $6,000,000 from the sale of 1,000,000 shares of common
stock to Green Hospital Supply, Inc. in a private placement in April
2007.
 
 In May
2007, we successfully divested substantially all of our spine and orthopedic
product line to Kensey Nash for gross proceeds of $3,175,000.
 
 On
February 8, 2008, we agreed to sell 2,000,000 shares of unregistered common
stock to Green Hospital Supply, Inc., a related party, for $12,000,000 cash, or
$6.00 per share in a private stock placement.  On February 29, 2008,
we closed the first half of the private placement with Green Hospital Supply,
Inc. and received $6,000,000.  We closed the second half of the
private placement on April 30, 2008 and received the second payment of
$6,000,000. As of December 31, 2008, Green Hospital Supply, Inc. holds
approximately 10.2% of our issued and outstanding shares.
 
 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.
 
 On
October 14, 2008, General Electric Capital Corporation and Silicon Valley Bank
(together, the “Lenders”) funded a term loan in the amount of $7,500,000 less
fees and expenses.  In connection with the loan facility, on October
14, 2008, we issued to each Lender a warrant to purchase up to 89,074 shares of
our common stock at an exercise price of $4.21 per share.  These
warrants are immediately exercisable and will expire on October 14,
2018.
 
 Our cash
requirements for 2009 and beyond will depend on numerous factors, including our
successful restructuring of our operating plan and business strategies as
described above.  Under our previous operating plan, we would have
expected to incur research and development expenses at high levels in our
regenerative cell platform for an extended period of time.  Under the
new plan, we will seek to reduce these expenditures as much as
possible.
 
 The
following summarizes our contractual obligations and other commitments at
December 31, 2008, and the effect such obligations could have on our liquidity
and cash flow in future periods (see additional discussion regarding Liquidity
at the beginning of Item 7, Management’s Discussion and Analysis of Financial
Condition and Results of Operations):
 
 Payments
      due by periodContractual
      Obligations
                  
                  Total
                  
                  
                  Less
      than 1
                    year
                  
                  
                  1
      – 3 years
                  
                  
                  3
      – 5 years
                  
                  
                  More
      than
                    5
      yearsLong-term
      obligations
                  
                  $
                  7,914,000
                  
                  
                  $
                  2,047,000
                  
                  
                  $
                  5,847,000
                  
                  
                  $
                  20,000
                  
                  
                  $
                  —Interest
      commitment on long-term obligations
                  
                  
                  1,376,000
                  
                  
                  
                  741,000
                  
                  
                  
                  628,000
                  
                  
                  
                  7,000
                  
                  
                  
                  —Operating
      lease obligations
                  
                  
                  2,746,000
                  
                  
                  
                  1,754,000
                  
                  
                  
                  899,000
                  
                  
                  
                  85,000
                  
                  
                  
                  8,000Minimum
      purchase requirements
                  
                  
                  2,125,000
                  
                  
                  
                  850,000
                  
                  
                  
                  1,275,000
                  
                  
                  
                  —
                  
                  
                  
                  —Pre-clinical
      research study obligations
                  
                  
                  563,000
                  
                  
                  
                  563,000
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —Clinical
      research study obligations
                  
                  
                  5,839,000
                  
                  
                  
                  4,000,000
                  
                  
                  
                  1,839,000
                  
                  
                  
                  —
                  
                  
                  
                  —Total
                  
                  $
                  20,563,000
                  
                  
                  $
                  9,955,000
                  
                  
                  $
                  10,488,000
                  
                  
                  $
                  112,000
                  
                  
                  $
                  8,000
 
  42
  Net cash
(used in) provided by operating, investing and financing activities for the
years ended December 31, 2008, 2007 and 2006, is summarized as
follows:
 
 Years
      Ended2008
                      
                      
                      2007
                      
                      
                      2006Net
      cash used in operating activities
                      
                      $
                      (33,389,000
                      )
                      
                      $
                      (29,995,000
                      )
                      
                      $
                      (16,483,000
                      )Net
      cash provided by (used in)  investing activities
                      
                      
                      (393,000
                      )
                      
                      
                      5,982,000
                      
                      
                      
                      591,000Net
      cash provided by financing activities
                      
                      
                      34,928,000
                      
                      
                      
                      26,576,000
                      
                      
                      
                      16,787,000
 
 Operating
activities
 
 Net cash
used in operating activities for all periods presented resulted primarily from
expenditures related to our regenerative cell research and development
efforts.
 
 Research
and development efforts, other operational activities, and a comparatively small
amount of product sales generated a $30,036,000 net loss for the year ended
December 31, 2008.  The cash impact of this loss was $33,389,000,
after adjusting for the $774,000 of deferred revenue, related party, recognized
in 2008, for which cash was received in earlier years, $1,533,000 of
depreciation and amortization, a $1,060,000 change in the value of our put
option, $2,257,000 non-cash stock based compensation expense, and $178,000 of
non-cash amortization of deferred financing costs and debt discount along with
other changes in working capital due to timing of product shipments (accounts
receivable) and payment of liabilities.
 
 Research
and development efforts, other operational activities, and a comparatively small
amount of product sales generated a $28,672,000 net loss for the year ended
December 31, 2007.  The cash impact of this loss was $29,995,000,
after adjusting for the $5,158,000 of deferred revenue, related party,
recognized in 2007, for which cash was received in earlier years, $1,858,000 of
gain on sale of assets, $1,616,000 of depreciation and $2,310,000 non-cash stock
based compensation expense, along with other changes in working capital due to
timing of product shipments (accounts receivable) and payment of
liabilities.
 
 Research
and development efforts, other operational activities, and a comparatively small
amount of product sales generated a $25,447,000 net loss for the year ended
December 31, 2006.  The cash impact of this loss was $16,483,000,
after adjusting for the $11,000,000 cash we received in 2006 from the Joint
Venture upon obtaining the CE Mark in the first quarter of 2006, the $1,500,000
received from Olympus mentioned above, $2,120,000 of non-cash depreciation and
amortization, $3,220,000 non-cash stock based compensation expense, and
$4,431,000 non-cash change in the fair value of option liabilities, along with
other changes in working capital due to timing of product shipments and payment
of liabilities.
 
 Investing
activities
 
 Net cash
used by investing activities for the year ended December 31, 2008 resulted
primarily from purchases of property and equipment.
 
 Net cash
provided by investing activities for the year ended December 31, 2007 resulted
primarily from net proceeds from the purchase and sale of short-term investments
and proceeds from the sale of assets, offset in part by purchases of property
and equipment.
 
 Net cash
provided by investing activities for the year ended December 31, 2006 resulted
primarily from net proceeds from the purchase and sale of short-term
investments, offset in part by expenditures for leasehold
improvements.
 
 Capital
spending is essential to our product innovation initiatives and to maintain our
operational capabilities.  For the years ended December 31, 2008, 2007
and 2006, we used cash to purchase $393,000, $563,000 and $3,138,000,
respectively, of property and equipment to support manufacturing of our
bioresorbable implants and for the research and development of the regenerative
cell technology platform.  The increase in 2006 capital spending was
caused primarily by expenditures for leasehold improvements made to our new
facilities.
 
 Financing
Activities
 
 The net
cash provided by financing activities for the year ended December 31, 2008
related mainly to the private issuance of 2,000,000 shares of unregistered
common stock to Green Hospital Supply, Inc. for $12,000,000 and the private
  43
  placement
offering 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 for approximately $17,000,000 in gross proceeds, of which
Olympus Corporation acquired 1,000,000 unregistered shares and 500,000 common
stock warrants in exchange for $6,000,000 of the total proceeds
raised.  Additionally, in October 2008, we obtained a term loan in the
amount of $7,500,000, less fees and expenses, from General Electric Capital
Corporation and Silicon Valley Bank (together, the “Lenders”).
 
 The net
cash provided by financing activities for the year ended December 31, 2007
related mainly to the issuance of common stock and common stock warrants under
the shelf registration statement in exchange for net proceeds of $19,901,000 as
well as a common stock private placement made with Green Hospital Supply, Inc.
for net proceeds of $6,000,000.  Net cash proceeds provided by
financing activities also included proceeds from the exercise of employee stock
options, offset to some extent by principal payments on long-term
obligations.
 
 The net
cash provided by financing activities for the year ended December 31, 2006
related mainly to the issuance of 2,918,255 shares of our common stock in
exchange for $16,219,000, net of related expenses.  Net cash provided
by financing activities also included proceeds from the exercise of employee
stock options, offset by principal payments on long-term
obligations.
 
 Critical
Accounting Policies and Significant Estimates
 
 The
preparation of financial statements in conformity with accounting principles
generally accepted in the United States requires us to make estimates and
assumptions that affect the reported amounts of our assets, liabilities,
revenues and expenses, and that affect our recognition and disclosure of
contingent assets and liabilities.
 
 While our
estimates are based on assumptions we consider reasonable at the time they were
made, our actual results may differ from our estimates, perhaps
significantly.  If results differ materially from our estimates, we
will make adjustments to our financial statements prospectively as we become
aware of the necessity for an adjustment.
 
 We
believe it is important for you to understand our most critical accounting
policies.  These are our policies that require us to make our most
significant judgments and, as a result, could have the greatest impact on our
future financial results.
 
 Revenue
Recognition
 
 We derive
our revenue from a number of different sources, including but not limited
to:
 
 ·
              Fees
      for achieving certain defined milestones under research and/or development
      arrangements.
 
 ·
              Product
      sales, and
 
 ·
              Payments
      under license or distribution
agreements.
 
 A number
of our revenue generating arrangements are relatively simple in nature, meaning
that there is little judgment necessary with regard to the timing of when we
recognize revenues or how such revenues are presented in the financial
statements.
 
 However,
we have also entered into more complex arrangements, including but not limited
to our contracts with Olympus, Senko, and the NIH.  Moreover, some of
our non-recurring transactions, such as our disposition of the majority of our
Thin Film business to MAST, contain elements that relate to our revenue
producing activities.
 
 As a
result, some of our most critical accounting judgments relate to the
identification, timing, and presentation of revenue related activities. These
critical judgments are as follows:
 
 Multiple-element
arrangements
 
 Some of
our revenue generating arrangements contains a number of distinct revenue
streams, known as “elements.”  For example, our Distribution Agreement
with Senko contains direct or indirect future revenue streams related
to:
 
 ·
              A
      distribution license fee (which was paid at the outset of the
      arrangement),
 
 ·
              Milestone
      payments for achieving commercialization of the Thin Film product line in
      Japan,
  44
  ·
              Training
      for representatives of Senko,
 
 ·
              Sales
      of Thin Film products to Senko, and
 
 ·
              Royalty
      payments on future product sales made by Senko to its end
      customers.
 
 Emerging
Issues Task Force Issue 00-21, “Revenue Arrangements with Multiple Deliverables”
(“EITF 00-21”), governs whether each of the above elements in the arrangement
should be accounted for individually, or whether the entire contract should be
treated as a single unit of accounting.
 
 EITF
00-21 indicates that individual elements may be separately accounted for only
when:
 
 ·
              The
      delivered element has stand alone value to the
  customer,
 
 ·
              There
      is objective evidence of the fair value of the remaining undelivered
      elements, and
 
 ·
              If
      the arrangement contains a general right of return related to any products
      delivered, delivery of the remaining goods and services is probable and
      within the complete control of the
seller.
 
 In the
case of the Senko Distribution Agreement, we determined that (a) the milestones
payments for achieving commercialization and (b) the future sale of Thin Film
products to Senko were “separable” elements.  That is, each of these
elements, upon delivery, will have stand alone value to Senko and there will be
objective evidence of the fair value of any remaining undelivered elements at
that time.  The arrangement does not contain any general right of
return, and so this point is not relevant to our analysis.
 
 On the
other hand, we concluded that (a) the upfront distribution license fee, (b) the
revenues from training for representatives of Senko, and (c) the payments in the
form of royalties on future product sales are not separable elements under EITF
00-21.
 
 In
arriving at our conclusions, we had to consider whether our customer, Senko,
would receive stand alone value from each delivered element.  We also,
in some cases, had to support the fair value of certain undelivered
elements.  Finally, we had to make assumptions about how the
non-separable elements of the arrangement are earned, particularly the estimated
period over which Senko will benefit from the arrangement (refer to the
“Recognition” discussion below for further background).
 
 We also
agreed to perform elements under the November 4, 2005 agreements we signed with
Olympus, including:
 
 ·
              Granting
      the Joint Venture (which Olympus is considered to control) an exclusive
      and perpetual manufacturing license to our device technology, including
      the Celution® System platform and certain related intellectual property;
      and
 
 ·
              Completing
      certain pre-clinical and clinical studies, assisting with product
      development and seeking regulatory approval and/or clearances toward
      commercialization of the Celution® System
  platform.
 
 We
concluded that the license and development services must be accounted for as a
single unit of accounting.  In reaching this conclusion, we determined
that the license would not have stand alone value to the Joint
Venture.  This is because Cytori is the only party that could be
reasonably expected to perform certain development contributions and
obligations, including product development assistance, certain agreed regulatory
filings and generally associated pre-clinical and clinical studies necessary for
the Joint Venture to derive value from the license.
 
  45
  Recognition
 
 Besides
determining whether to account separately for components of a multiple-element
arrangement, we also use judgment in determining the appropriate accounting
period in which to recognize revenues that we believe (a) have been earned and
(b) are realizable.  The following describes some of the recognition
issues we have considered during the reporting period.
 
 ·
              Product
      Revenues
 
 o
              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
arrangement.  Revenue for these product sales will be recognized upon
delivery to the customer, as all risks and rewards of ownership have been
substantively transferred to the customer at that point.  For
Celution® 800/CRS
System 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, in
accordance with Emerging Issues Task Force (EITF) Issue No. 00-10, “Accounting
for Shipping and Handling Fees and Costs” (“EITF 00-10”).  Delivery
occurs when goods are shipped and title of risk of loss transfer to the
customer, in accordance with the terms specified in the arrangement with the
customer.  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 product.
 
 For those
sales that include multiple deliverables, we allocate revenue based on the
relative fair values of the individual components as determined in accordance
with EITF 00-21.  When more than one element such as product
maintenance or technical support services are included in an arrangement, we
allocate revenue between the elements based on each element’s relative fair
value, provided that each element meets 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 allocate revenue first to the fair value of
the undelivered elements and allocate the residual revenue to the delivered
elements.  Deferred service revenue is recognized ratably over the
period the services are provided.  In the absence of fair value for an
undelivered element, the arrangement is 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.
 
 An
allowance for doubtful accounts is maintained for estimated losses resulting
from the inability of our customers to make required payments.  This
reserve is determined by analyzing specific customer accounts and applying
historical loss rates to the aging of remaining accounts receivable
balances.  If the financial condition of our customer were to
deteriorate, resulting in tehir inability to pay their accounts when due,
additional reserves might be required.
 
 Before
the disposal of substantially all of our bioresorbable spine and orthopedic
product line in May 2007, we sold our (non-Thin Film) MacroPore Biosurgery
products to Medtronic, Inc., a related party.  We recognized revenue
on product sales to Medtronic upon shipment of ordered products to Medtronic, as
title and risk of loss were transferred at that point.  In May 2007,
we sold to Kensey Nash our intellectual property rights and tangible assets
related to our bioresorbable spine and orthopedic product line.
 
 ·
              Upfront
      License Fees/Milestones
 
 o
              As
      part of the Senko Distribution Agreement, we received an upfront license
      fee upon execution of the arrangement, which, as noted previously, was not
      separable under EITF 00-21.  Accordingly, the license has been
      combined with the development (milestones) element to form a single
      accounting unit.  This single element of $3,000,000 in fees
      includes $1,500,000 which is potentially refundable.  We have
      recognized, and will continue to recognize, the non-contingent fees
      allocated to this combined element as revenues as we complete each of the
      performance obligations associated with the milestones component of this
      combined deliverable.  Note that the timing of when we have
      recognized revenues to date does not
  46
 correspond
      with the cash we received upon achieving certain
      milestones.  For example, the first such milestone payment for
      $1,250,000 became payable to us when we filed a commercialization
      application with the Japanese regulatory authorities.  However,
      we determined that the payment received was not commensurate with the
      level of effort expended, particularly when compared with other steps we
      believe are necessary to commercialize the Thin Film product line in
      Japan.  Accordingly, we did not recognize the entire $1,250,000
      received as revenues, but instead all but $371,000 of this amount is
      classified as deferred revenues.  Approximately $371,000
      ($10,000 in 2007, $152,000 in 2006, $51,000 in 2005 and $158,000 in 2004)
      has been recognized to date as development revenues based on our estimates
      of the level of effort expended for completed milestones as compared with
      the total level of effort we expect to incur under the arrangement to
      successfully achieve regulatory approval of the Thin Film product line in
      Japan.  These estimates were subject to judgment and there may
      be changes to these estimates as we continue to seek regulatory
      approval.  In fact there can be no assurance that
      commercialization in Japan will ever be achieved, as we have yet to
      receive approval from the MHLW for the Thin Film
  product.
 o
              We
      also received upfront fees as part of the Olympus arrangements (although,
      unlike in the Senko agreement, these fees were
      non-refundable).  Specifically, in exchange for an upfront fee,
      we granted the Joint Venture an exclusive, perpetual license to certain of
      our intellectual property and agreed to perform additional development
      activities.  This upfront fee has been recorded in the liability
      account entitled deferred revenues, related party, on our consolidated
      balance sheet.  Similar to the Senko agreement, we expect to
      recognize revenues from the combined license/development accounting unit
      as we perform our obligations under the agreements, as this represents our
      final obligation underlying the combined accounting
      unit.  Specifically, we have recognized revenues from the
      license/development accounting unit using a “proportional performance”
      methodology, resulting in the de-recognition of amounts recorded in the
      deferred revenues, related party, account as we complete various
      milestones underlying the development services.  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.  Revenue
      will be recognized as the above mentioned R&D milestones are
      completed.  We established the R&D milestones based upon our
      development obligations to the JV and the specific R&D support
      activities to be performed to achieve these obligations.  Our
      R&D milestones consist of the following primary performance
      categories:  product development, regulatory approvals, and
      generally associated pre-clinical and clinical
      trials.   Within each category are milestones that take
      substantive effort to complete and are critical pieces of the overall
      progress towards completion of the next generation product, which we are
      obligated to support within the agreements entered into with
      Olympus.  To determine whether substantive effort was required
      to achieve the milestones, we considered the external costs, required
      personnel and relevant skill levels, the amount of time required to
      complete each milestone, and the interdependent relationships between the
      milestones, in that the benefits associated with the completion of one
      milestone generally support and contribute to the achievement of the
      next.  Determination of the relative values assigned to each
      milestone involved substantial judgment.  The assignment process
      was based on discussions with persons responsible for the development
      process and the relative costs of completing each milestone.  We
      considered the costs of completing the milestones in allocating the
      portion of the “deferred revenues, related party” account balance to each
      milestone.  Management believes that, while the costs incurred
      in achieving the various milestones are subject to estimation, due to the
      high correlation of such costs to outputs achieved, the use of external
      contract research organization (“CRO”) costs and internal labor costs as
      the basis for the allocation process provides management the ability to
      accurately and reasonably estimate such costs.  The accounting
      policy described above could result in revenues being recorded in an
      earlier accounting period than had other judgments or assumptions been
      made by us.
  ·
              Government
      Grants
 
 o
              We
      are at times eligible to receive grants from the NIH related to various
      research activities.  Revenues derived from reimbursement of
      direct out-of-pocket expenses for research costs associated with grants
      are recorded in compliance with EITF Issue No. 99-19, “Reporting
      Revenue Gross as a Principal Versus Net as an Agent”, and EITF
      Issue No. 01-14, “Income Statement Characterization of Reimbursements
      Received for “Out-of-Pocket” Expenses Incurred”.  In accordance with
      the criteria established by these EITF Issues,
  47
 the
      Company records grant revenue for the gross amount of the
      reimbursement.  The costs associated with these reimbursements are
      reflected as a component of research and development expense in the
      consolidated statements of operations.  Additionally, research
      arrangements we have with NIH, as well commercial enterprises such as
      Olympus and Senko, are considered a key component of our central and
      ongoing operations.  Moreover, the government obtains rights
      under the arrangement, in the same manner (but perhaps not to the same
      extent) as a commercial customer that similarly contracts with us to
      perform research activities.  For instance, the government and
      any authorized third parties may use our federally funded research and/or
      inventions without payment of royalties to us.  Accordingly, the
      inflows from such arrangements are presented as revenues in the
      consolidated statements of
operations.
 Our
policy was to recognize revenues under the NIH grant arrangement as the lesser
of (i) qualifying costs incurred (and not previously recognized), plus our
allowable grant fees for which we are entitled to funding or (ii) the amount
determined by comparing the outputs generated to date versus the total outputs
expected to be achieved under the research arrangement.
 
 Goodwill
Impairment Testing
 
 In late
2002, we purchased StemSource, Inc. and recognized over $4,600,000 in goodwill
associated with the acquisition, of which $3,922,000 remains on our balance
sheet as of December 31, 2008.  As required by Statement of Financial
Accounting Standard No. 142, “Goodwill and Other Intangible Assets” (“SFAS
142”), we must test this goodwill at least annually for impairment as well as
when an event occurs or circumstances change such that it is reasonably possible
that impairment may exist.  Moreover, this testing must be performed
at a level of the organization known as the reporting unit.  A
reporting unit is at least the same level as a company’s operating segments, and
sometimes even one level lower.  Our two reporting units are the same
as our two operating segments.
 
 Specifically,
the process for testing goodwill for impairment under SFAS 142 involves the
following steps:
 
 ·
              Company
      assets and liabilities, including goodwill, are allocated to each
      reporting unit for purposes of completing the goodwill impairment
      test.
 
 ·
              The
      carrying value of each reporting unit – that is, the sum of all of the net
      assets allocated to the reporting unit – is then compared to its fair
      value.
 
 ·
              If
      the fair value of the reporting unit is lower than its carrying amount,
      goodwill may be impaired – additional testing is
  required.
 
 The
application of the goodwill impairment test involves a substantial amount of
judgment.  For instance, SFAS 142 requires that assets and liabilities
be assigned to a reporting unit if both of the following criteria are
met:
 
 ·
              The
      asset will be employed in or the liability relates to the operations of a
      reporting unit.
 
 ·
              The
      asset or liability will be considered in determining the fair value of the
      reporting unit.
 
 We
developed mechanisms to assign company-wide assets like shared property and
equipment, as well as company-wide obligations such as borrowings under our GE
loan facility, to our two reporting units.  In some cases, certain
assets were not allocable to either reporting unit and were left
unassigned.
 
 In 2007,
all goodwill that previously had been assigned to our MacroPore Biosurgery
reporting unit was derecognized as a result of our sale of our spine and
orthopedic product line to Kensey Nash.  Accordingly, there was no
need to test this component of our business for goodwill impairment in 2008 and
2007.
 
 Also, in
2008, we completed our goodwill impairment testing for our regenerative cell
technology reporting unit using an income-based approach incorporating
discounted projections of estimated future cash flows as well as a market-based
approach.  We concluded that the fair value of this unit exceeded its
carrying value, and that none of our reported goodwill was
impaired.
 
 Again,
the manner in which we assigned assets, liabilities, and goodwill to our
reporting units, as well as how we determined the fair value of such reporting
units, involves significant uncertainties and estimates.  The
judgments employed may have an effect on whether a goodwill impairment loss is
recognized.
  48
  Variable
Interest Entity (Olympus-Cytori Joint Venture)
 
 FASB
Interpretation No. 46 (revised 2003), “Consolidation of Variable Interest
Entities - An Interpretation of ARB No. 51” (“FIN 46R”) requires a variable
interest entity (“VIE”) to be consolidated by its primary
beneficiary.  Evaluating whether an entity is a VIE and determining
its primary beneficiary involves significant judgment.
 
 We
concluded that the Olympus-Cytori Joint Venture was a VIE based on the following
factors:
 
 ·
              Under
      FIN 46R, an entity is a VIE if it has insufficient equity to finance its
      activities.  We recognized that the initial cash contributed to
      the Joint Venture formed by Olympus and Cytori ($30,000,000) would be
      completely utilized by the first quarter of 2006.  Moreover, it
      was highly unlikely that the Joint Venture would be able to obtain the
      necessary financing from third party lenders without additional
      subordinated financial support – such as personal guarantees by one or
      both of the Joint Venture stockholders.  Accordingly, the joint
      venture will require additional financial support from Olympus and Cytori
      to finance its ongoing operations, indicating that the Joint Venture is a
      VIE.  In fact, we contributed $300,000 and $150,000 in the
      fourth quarter of 2007 and first quarter of 2006, respectively, to fund
      the Joint Venture’s ongoing
operations.
 
 ·
              Moreover,
      Olympus has a contingent put option that would, in specified
      circumstances, require Cytori to purchase Olympus’s interests in the Joint
      Venture for a fixed amount of $22,000,000.  Accordingly, Olympus
      is protected in some circumstances from absorbing all expected losses in
      the Joint Venture.  Under FIN 46R, this means that Olympus may
      not be an “at-risk” equity holder, although Olympus clearly has decision
      rights over the operations of the Joint
Venture.
 
 Because
the Joint Venture is undercapitalized, and because one of the Joint Venture’s
decision makers may be protected from losses, we have determined that the Joint
Venture is a VIE under FIN 46R.
 
 As noted
previously, a VIE is consolidated by its primary beneficiary.  The
primary beneficiary is defined in FIN 46R as the entity that would absorb the
majority of the VIE’s expected losses or be entitled to receive the majority of
the VIE’s residual returns (or both).
 
 Significant
judgment was involved in determining the primary beneficiary of the Joint
Venture.   Under FIN 46R, we believe that Olympus and Cytori are
“de facto agents” and, together, will absorb more than 50% of the Joint
Venture’s expected losses and residual returns.  Ultimately, we
concluded that Olympus, and not Cytori, was the party most closely related with
the joint venture and, hence, its primary beneficiary.  Our conclusion
was based on the following factors:
 
 ·
              The
      business operations of the Joint Venture will be most closely aligned to
      those of Olympus (i.e., the manufacture of
  devices).
 
 ·
              Olympus
      controls the Board of Directors, as well as the day-to-day operations of
      the Joint Venture.
 
 The
application of FIN 46R involves substantial judgment.  Had we
consolidated the Joint Venture, though, there would be no effect on our net loss
or shareholders’ equity at December 31, 2008 or for the year then
ended.  However, certain balance sheet and income statement captions
would have been presented in a different manner.  For instance, we
would not have presented a single line item entitled investment in joint venture
in our balance sheet but, instead, would have performed a line by line
consolidation of each of the Joint Venture’s accounts into our financial
statements.
 
 Net
Operating Loss and Tax Credit Carryforwards
 
 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
$61,965,000 as of December 31, 2008 to reflect the estimated amount of deferred
tax assets that may not be realized. We increased our valuation allowance by
approximately $11,529,000 during the year ended December 31, 2008. 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, 2008, we had federal and state tax loss carryforwards of
approximately $117,177,000 and $98,679,000 respectively.  The federal
and state net operating loss carryforwards begin to expire in 2019 and
2011 respectively, if unused.  At December 31, 2008, we had
federal and state tax credit carryforwards of approximately $3,364,000 and
$3,043,000
  49
  respectively.  The
federal credits will begin to expire in 2017, if unused, and $160,000 of the
state credits will begin to expire in 2009 if unused.  The remaining
state credits carry forward indefinitely.  In addition, we had a
foreign tax loss carryforward of $4,142,000 and $93,000 in Japan and Italy,
respectively.
 
 The
Internal Revenue Code limits the future availability of net operating loss and
tax credit carryforwards that arose prior to certain cumulative changes in a
corporation’s ownership resulting in a change of control of Cytori. Due to prior
ownership changes as defined in IRC Section 382, a portion of our net operating
loss and tax credit carryforwards are limited in their annual
utilization.  In September 1999, we experienced an ownership change
for purposes of the IRC Section 382 limitation.  As of December 31,
2008, these pre-change net operating losses and credits are fully
available.
  Additionally,
in 2002 when we purchased StemSource, we acquired federal and state net
operating loss carryforwards of approximately $2,700,000 and $2,700,000
respectively.  This event triggered an ownership change for purposes
of IRC Section 382.  It is estimated that the pre-change net operating
losses and credits will be fully available by 2008.
 
 We have
completed an update to our IRC Section 382 study analysis through April 17,
2007.  We have not had any additional ownership changes based on this
study.
 
 Recent
Accounting Pronouncements
 
 In July
2006, FASB issued Interpretation No. 48, Accounting for Uncertainty in
Income Taxes—An Interpretation of FASB Statement No. 109 (“FIN
48”).  FIN 48 clarifies the accounting for uncertainty in income taxes
recognized in an entity’s financial statements in accordance with FASB Statement
No. 109, Accounting for Income Taxes, and prescribes a recognition
threshold and measurement attributes for financial statement disclosure of tax
positions taken or expected to be taken on a tax return. Under FIN 48, the
impact of an uncertain income tax position on the income tax return must be
recognized at the largest amount that is more-likely-than-not to be sustained
upon audit by the relevant taxing authority.  An uncertain income tax
position will not be recognized if it has less than a 50% likelihood of being
sustained.  Additionally, FIN 48 provides guidance on derecognition,
classification, interest and penalties, accounting in interim periods,
disclosure and transition.
  On January 1, 2008, we adopted certain
provisions of SFAS No. 157, “Fair Value Measurements” (“SFAS
157”).  SFAS 157 provides a single definition of fair value and a
common framework for measuring fair value as well as new disclosure requirements
for fair value measurements used in financial statements.  SFAS 157
applies to reported balances that are required or permitted to be measured at
fair value under existing pronouncements; accordingly, the standard does not
require any new fair value measurements of reported balances.
  In February 2008, the FASB issued Staff
Position “Effective Date
of FASB Statement No. 157” (FSP No. 157-2), which delayed the adoption date
until January 1, 2009 for non-financial assets and liabilities that are measured
at fair value on a non-recurring basis, such as goodwill and identifiable
intangible assets. We do not expect the adoption of the SFAS 157 for
non-financial assets and liabilities to have a material impact on our
consolidated financial position or results of operations.
  On
January 1, 2008, we also adopted SFAS No. 159, “The Fair Value Option for
Financial Assets and Financial Liabilities” (“SFAS 159”), which permits
companies to choose to measure many financial instruments and certain other
items at fair value.  However, we have not elected to measure any
additional financial instruments or other items at fair value under the
provisions of this standard.
  In March
2007, the FASB ratified the consensus reached by the Emerging Issues Task Force
(EITF) on Issue No. 07-3, “Accounting for Nonrefundable Advance Payments for
Goods or Services Received for Use in Future Research and Development
Activities” (“EITF 07-3”).  EITF 07-3 states that nonrefundable
advance payments for future research and development activities should be
deferred and capitalized.  Such amounts should be recognized as an
expense as the goods are delivered or the related services are
performed.  The guidance is effective for all periods beginning after
December 15, 2007, which we adopted effective January 1, 2008.  The
adoption of EITF 07-3 did not have a significant effect on our consolidated
financial statements.
 
 In
December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in
Consolidated Financial Statements - an Amendment of ARB No. 51” ("SFAS
160").  SFAS 160 establishes new accounting and reporting standards
for the noncontrolling interest in a subsidiary and for the deconsolidation of a
subsidiary. SFAS 160 is effective for annual periods beginning on or after
December 15, 2008.  We do not believe that the adoption of SFAS 160
will have a significant effect on our consolidated financial
statements.
  50
  In
December 2007, the FASB issued SFAS No. 141 (revised 2007), “Business
Combinations” ("SFAS 141R").  SFAS 141R retains the fundamental
requirements of Statement No. 141 to account for all business combinations using
the acquisition method (formerly the purchase method) and for an acquiring
entity to be identified in all business combinations.  However, the
new standard requires the acquiring entity in a business combination to
recognize all the assets acquired and liabilities assumed in the transaction;
establishes the acquisition-date fair value as the measurement objective for all
assets acquired and liabilities assumed; and requires the acquirer to disclose
the information they need to evaluate and understand the nature and financial
effect of the business combination.  SFAS 141R is effective for
acquisitions made on or after the first day of annual periods beginning on or
after December 15, 2008.  We do not believe that the adoption of SFAS
141R will have a significant effect on our consolidated financial
statements.
 
 In
December 2007, the FASB ratified the consensus reached by the Emerging Issues
Task Force on EITF Issue 07-1, “Accounting for Collaborative Arrangements”
(“EITF 07-1”).  EITF 07-1 requires collaborators to present the
results of activities for which they act as the principal on a gross basis and
report any payments received from (made to) other collaborators based on other
applicable GAAP or, in the absence of other applicable GAAP, based on analogy to
authoritative accounting literature or a reasonable, rational, and consistently
applied accounting policy election.  The guidance is effective for
fiscal years beginning after December 15, 2008.  We are currently in
the process evaluating whether the adoption of EITF 07-1 will have a significant
effect on our consolidated financial statements.
 
 In June
2008, the FASB ratified the consensus on EITF Issue No. 07-5, “Determining
Whether an Instrument (or Embedded Feature) Is Indexed to an Entity’s Own
Stock”(“EITF
07-5”). EITF 07-5 provides aframework for
evaluating the terms of a particular instrument to determine whether such
instrument is considered a derivative financial instrument.  EITF 07-5 is
effective for financial statements issued for fiscal years beginning after
December 15, 2008 and must be applied by recording a cumulative effect
adjustment to the opening balance of retained earnings (or other appropriate
components of equity) as of the date of adoption. We anticipate the adoption of
EITF 07-5 will result is the recognition of a liability for the warrants issued
in August 2008 as part of our private placement of common stock of approximately
$2.9 million and a corresponding increase in stockholders’ deficit as of January
1, 2009. Future changes in the fair value of the warrant liability will be
recognized as a component of earnings (loss).
 
 In
October 2008, the FASB issued Staff Position “Determining the Fair Value of a
Financial Asset When the Market for That Asset Is Not Active” (FSP No.
157-3).  FSP No. 157-3 clarifies the application of SFAS 157 in a
market that is not active and provides an example to illustrate key
considerations in determining the fair value of a financial asset when market
for that financial asset is not active.  This guidance is effective
upon issuance, including prior periods for which financial statements have not
been issued.  The adoption of FSP No. 157-3 did not have a significant
effect on our consolidated financial statements.
 
 In April
2008, the FASB issued FASB Staff Position (“FSP”) FAS 142-3, “Determination of
the Useful Life of Intangible Assets.”This FSP amends the
factors that should be considered in developing renewal or extension assumptions
used to determine the useful life of a recognized intangible asset under FASB
Statement No. 142, Goodwill
and Other Intangible Assets. The intent of this FSP is to improve the
consistency between the useful life of a recognized intangible asset under
Statement 142 and the period of expected cash flows used to measure the fair
value of the asset under FASB Statement No. 141R, and other U.S. generally
accepted accounting principles. This FSP is effective for our interim and annual
financial statements beginning after November 15, 2008. We do not expect the
adoption of this FSP will have a material impact on the our financial
statements.
 
 Item 7A. Quantitative and Qualitative Disclosures
About Market Risk
 
 We are
exposed to market risk related to fluctuations in interest rates and in foreign
currency exchange rates.
 
 Interest
Rate Exposure
 
 We are
not subject to market risk due to fluctuations in interest rates on our
long-term obligations as they bear a fixed rate of interest.  Our
exposure relates primarily to short-term investments, including funds classified
as cash equivalents.  Investment securities are subject to market rate
risk as their fair value will fall if market interest rates
increase.  If market interest rates were to increase immediately and
uniformly by 100 basis points from the levels prevailing at December 31, 2008,
for example, and assuming average investment duration of seven months, the fair
value of the portfolio would not decline by a material amount.  We do
not use derivative financial instruments to mitigate the risk inherent in these
securities.  However, we do attempt to reduce such risks by generally
limiting the maturity date of such securities, diversifying our investments and
limiting the amount of credit exposure with any one issuer.  While we
do not always have the intent, we do
  51
  currently
have the ability to hold these investments until maturity and, therefore,
believe that reductions in the value of such securities attributable to
short-term fluctuations in interest rates would not materially affect our
financial position, results of operations or cash flows.  Changes in
interest rates would, of course, affect the interest income we earn on our cash
balances after re-investment.
 
 Foreign
Currency Exchange Rate Exposure
 
 Our
exposure to market risk due to fluctuations in foreign currency exchange rates
relates primarily to our activities in Europe and Japan.  Transaction
gains or losses resulting from cash balances and revenues have not been
significant in the past and we are not engaged in any hedging activity in the
Euro, the Yen or other currencies.  Based on our cash balances and
revenues derived from markets other than the United States for the year ended
December 31, 2008, a hypothetical 10% adverse change in the Euro or Yen against
the U.S. dollar would not result in a material foreign currency exchange
loss.  Consequently, we do not expect that reductions in the value of
such sales denominated in foreign currencies resulting from even a sudden or
significant fluctuation in foreign exchange rates would have a direct material
impact on our financial position, results of operations or cash
flows.
 
 Notwithstanding
the foregoing, the indirect effect of fluctuations in interest rates and foreign
currency exchange rates could have a material adverse effect on our business,
financial condition and results of operations.  For example, foreign
currency exchange rate fluctuations may affect international demand for our
products.  In addition, interest rate fluctuations may affect our
customers’ buying patterns.  Furthermore, interest rate and currency
exchange rate fluctuations may broadly influence the United States and foreign
economies resulting in a material adverse effect on our business, financial
condition and results of operations.
 
 Under our
Japanese Thin Film agreement with Senko, we would receive payments in the nature
of royalties based on Senko’s net sales, which would be Yen
denominated.
  52
  
 Item 8. Financial Statements and Supplementary
      DataReports of Independent Registered Public
      Accounting
      FirmConsolidated Balance Sheets as of December 31,
      2008 and
      2007Consolidated Statements of Operations and Comprehensive Loss
      for the years ended December 31, 2008, 2007 and
    2006Consolidated Statements of Stockholders’ Equity
      (Deficit) for the years ended December 31, 2008, 2007 and
      2006Consolidated Statements of Cash Flows for the years ended
      December 31, 2008, 2007 and 2006Notes to Consolidated Financial
      Statements
 
  53
  
 
 PART
      I.  FINANCIAL INFORMATIONItem
      1.  Financial Statements
 
 Reportof Independent Registered Public Accounting
Firm
 
 The Board
of Directors and Stockholders
 Cytori
Therapeutics, Inc.:
  We have
audited the accompanying consolidated balance sheets of Cytori Therapeutics,
Inc. (the Company) and subsidiaries as of December 31, 2008 and 2007, and
the related consolidated statements of operations and comprehensive loss,
stockholders’ equity (deficit), and cash flows for each of the years in the
three-year period ended December 31, 2008. In connection with our audits of
the consolidated financial statements, we have also audited the accompanying
schedule of valuation and qualifying accounts. These consolidated financial
statements and financial statement schedule are the responsibility of the
Company’s management. Our responsibility is to express an opinion on these
consolidated financial statements and financial statement schedule based on our
audits.
  We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
  In our
opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the financial position of Cytori Therapeutics, Inc.
and subsidiaries as of December 31, 2008 and 2007, and the results of their
operations and their cash flows for each of the years in the three-year period
ended December 31, 2008, in conformity with U.S. generally accepted
accounting principles. Also, in our opinion, the related financial statement
schedule, when considered in relation to the basic consolidated financial
statements taken as a whole, presents fairly, in all material respects, the
information set forth therein.
  The
accompanying consolidated financial statements and financial statement schedule
have been prepared assuming that the Company will continue as a going concern.
As discussed in note 1 to the consolidated financial statements, the Company has
suffered recurring losses from operations and has a net capital deficiency that
raise substantial doubt about its ability to continue as a going concern. The
Company’s research and development activities have historically required
substantial capital resources and its ability to raise capital has been
adversely affected by current economic conditions.  Management’s plans
in regard to these matters are also described in note 1. The consolidated
financial statements and financial statement schedule do not include any
adjustments that might result from the outcome of this uncertainty.
  We also
have audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), Cytori Therapeutics, Inc.’s internal control
over financial reporting as of December 31, 2008, based on criteria
established in Internal
Control – Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO), and our report dated
March 6, 2009, expressed an unqualified opinion on the effectiveness of the
Company’s internal control over financial reporting.
  
 /s/
      KPMG LLP
 San
Diego, California
 March 6,
2009
 
  54
   Report
of Independent Registered Public Accounting Firm
  The Board
of Directors and Stockholders
 Cytori
Therapeutics, Inc.:
  We have
audited Cytori Therapeutics, Inc.’s internal control over financial reporting as
of December 31, 2008, based on criteria established in Internal Control — Integrated
Framework issued by the Committee of Sponsoring Organizations of the
Treadway Commission (COSO).Cytori Therapeutics, Inc.'s management is responsible for maintaining
effective internal control over financial reporting and for its assessment of
the effectiveness of internal control over financial reporting, included in the
accompanying Management’s Report on Internal Control Over Financial Reporting
(Item 9A). Our responsibility is to express an opinion on the Company’s internal
control over financial reporting based on our audit.
  We
conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether effective
internal control over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of internal control over
financial reporting, assessing the risk that a material weakness exists, and
testing and evaluating the design and operating effectiveness of internal
control based on the assessed risk. Our audit also included performing such
other procedures as we considered necessary in the circumstances. We believe
that our audit provides a reasonable basis for our opinion.
  A
company's internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with U.S. generally accepted accounting principles. A company's internal control
over financial reporting includes those policies and procedures that (1) pertain
to the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (2)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with U.S. generally
accepted accounting principles, and that receipts and expenditures of the
company are being made only in accordance with authorizations of management and
directors of the company; and (3) provide reasonable assurance regarding
prevention or timely detection of unauthorized acquisition, use, or disposition
of the company’s assets that could have a material effect on the financial
statements.
  Because
of its inherent limitations, internal control over financial reporting may not
prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
  In our
opinion, Cytori Therapeutics, Inc. maintained, in all material respects,
effective internal control over financial reporting as of December 31, 2008,
based on criteria established in Internal Control—Integrated Framework issued
by the Committee of Sponsoring Organizations of the Treadway Commission
(COSO).
  We also
have audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), the consolidated balance sheets of Cytori
Therapeutics, Inc. as of December 31, 2008 and 2007, and the related
consolidated statements of operations and comprehensive loss, stockholders’
equity (deficit), and cash flows for each of the years in the three-year period
ended December 31, 2008, and our report dated March 6, 2009, expressed an
unqualified opinion on those consolidated financial statements.
  
  /s/
      KPMG LLP
 San
Diego, California
 March 6,
2009
  55
  CYTORITHERAPEUTICS, INC.
 CONSOLIDATED BALANCE
SHEETS
 
 As of December 31,2008
                        
                        
                        2007AssetsCurrent
      assets:Cash
      and cash equivalents
                        
                        $
                        12,611,000
                        
                        
                        $
                        11,465,000Accounts
      receivable, net of allowance for doubtful accounts of $122,000 and $1,000
      in 2008 and 2007, respectively
                        
                        
                        1,308,000
                        
                        
                        
                        9,000Inventories,
      net
                        
                        
                        2,143,000
                        
                        
                        
                        —Other
      current assets
                        
                        
                        1,163,000
                        
                        
                        
                        764,000Total
      current assets
                        
                        
                        17,225,000
                        
                        
                        
                        12,238,000Property
      and equipment, net
                        
                        
                        2,552,000
                        
                        
                        
                        3,432,000Investment
      in joint venture
                        
                        
                        324,000
                        
                        
                        
                        369,000Other
      assets
                        
                        
                        729,000
                        
                        
                        
                        468,000Intangibles,
      net
                        
                        
                        857,000
                        
                        
                        
                        1,078,000Goodwill
                        
                        
                        3,922,000
                        
                        
                        
                        3,922,000Total
      assets
                        
                        $
                        25,609,000
                        
                        
                        $
                        21,507,000Liabilities
      and Stockholders’ DeficitCurrent
      liabilities:Accounts
      payable and accrued expenses
                        
                        $
                        5,088,000
                        
                        
                        $
                        7,349,000Current
      portion of long-term obligations
                        
                        
                        2,047,000
                        
                        
                        
                        721,000Total
      current liabilities
                        
                        
                        7,135,000
                        
                        
                        
                        8,070,000Deferred
      revenues, related party
                        
                        
                        16,474,000
                        
                        
                        
                        18,748,000Deferred
      revenues
                        
                        
                        2,445,000
                        
                        
                        
                        2,379,000Option
      liability
                        
                        
                        2,060,000
                        
                        
                        
                        1,000,000Long-term
      deferred rent
                        
                        
                        168,000
                        
                        
                        
                        473,000Long-term
      obligations, less current portion
                        
                        
                        5,044,000
                        
                        
                        
                        237,000Total
      liabilities
                        
                        
                        33,326,000
                        
                        
                        
                        30,907,000Commitments
      and contingenciesStockholders’
      deficit:Preferred
      stock, $0.001 par value; 5,000,000 shares authorized; -0- shares issued
      and outstanding in 2008 and 2007
                        
                        
                        —
                        
                        
                        
                        —Common
      stock, $0.001 par value; 95,000,000 shares authorized; 31,176,275 and
      25,962,222 shares issued and 29,303,441 and 24,089,388 shares outstanding
      in 2008 and 2007, respectively
                        
                        
                        31,000
                        
                        
                        
                        26,000Additional
      paid-in capital
                        
                        
                        161,214,000
                        
                        
                        
                        129,504,000Accumulated
      deficit
                        
                        
                        (162,168,000
                        )
                        
                        
                        (132,132,000
                        )Treasury
      stock, at cost
                        
                        
                        (6,794,000
                        )
                        
                        
                        (6,794,000
                        )Amount
      due from exercises of stock
      options
                        
                        
                        —
                        
                        
                        
                        (4,000
                        )Total
      stockholders’ deficit
                        
                        
                        (7,717,000
                        )
                        
                        
                        (9,400,000
                        )Total
      liabilities and stockholders’ deficit
                        
                        $
                        25,609,000
                        
                        
                        $
                        21,507,000
 
 THE
ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL
STATEMENTS
  56
  CYTORITHERAPEUTICS, INC.
 CONSOLIDATED STATEMENTS OF
OPERATIONS AND COMPREHENSIVE LOSS
 
 For the Years Ended December 31,2008
                    
                    
                    2007
                    
                    
                    2006Product
      revenues:Related
      party
                    
                    $
                    28,000
                    
                    
                    $
                    792,000
                    
                    
                    $
                    1,451,000Third
      party
                    
                    
                    4,500,000
                    
                    
                    
                    —
                    
                    
                    
                    —4,528,000
                    
                    
                    
                    792,000
                    
                    
                    
                    1,451,000Cost
      of product revenues
                    
                    
                    1,854,000
                    
                    
                    
                    422,000
                    
                    
                    
                    1,634,000Gross
      profit (loss)
                    
                    
                    2,674,000
                    
                    
                    
                    370,000
                    
                    
                    
                    (183,000
                    )Development
      revenues:Development,
      related party
                    
                    
                    774,000
                    
                    
                    
                    5,158,000
                    
                    
                    
                    5,905,000Other,
      related party
                    
                    
                    1,500,000
                    
                    
                    
                    —
                    
                    
                    
                    —Development
                    
                    
                    —
                    
                    
                    
                    10,000
                    
                    
                    
                    152,000Research
      grants and other
                    
                    
                    51,000
                    
                    
                    
                    89,000
                    
                    
                    
                    419,0002,325,000
                    
                    
                    
                    5,257,000
                    
                    
                    
                    6,476,000Operating
      expenses:Research
      and development
                    
                    
                    17,371,000
                    
                    
                    
                    20,020,000
                    
                    
                    
                    21,977,000Sales
      and marketing
                    
                    
                    4,602,000
                    
                    
                    
                    2,673,000
                    
                    
                    
                    2,055,000General
      and administrative
                    
                    
                    11,727,000
                    
                    
                    
                    14,184,000
                    
                    
                    
                    12,547,000Change
      in fair value of option liabilities
                    
                    
                    1,060,000
                    
                    
                    
                    100,000
                    
                    
                    
                    (4,431,000
                    )Total
      operating expenses
                    
                    
                    34,760,000
                    
                    
                    
                    36,977,000
                    
                    
                    
                    32,148,000Operating
      loss
                    
                    
                    (29,761,000
                    )
                    
                    
                    (31,350,000
                    )
                    
                    
                    (25,855,000
                    )Other
      income (expense):Gain
      on sale of assets
                    
                    
                    —
                    
                    
                    
                    1,858,000
                    
                    
                    
                    —Interest
      income
                    
                    
                    230,000
                    
                    
                    
                    1,028,000
                    
                    
                    
                    708,000Interest
      expense
                    
                    
                    (420,000
                    )
                    
                    
                    (155,000
                    )
                    
                    
                    (199,000
                    )Other
      expense, net
                    
                    
                    (40,000
                    )
                    
                    
                    (46,000
                    )
                    
                    
                    (27,000
                    )Equity
      loss from investment in joint venture
                    
                    
                    (45,000
                    )
                    
                    
                    (7,000
                    )
                    
                    
                    (74,000
                    )Total
      other income (loss)
                    
                    
                    (275,000
                    )
                    
                    
                    2,678,000
                    
                    
                    
                    408,000Net
      loss
                    
                    
                    (30,036,000
                    )
                    
                    
                    (28,672,000
                    )
                    
                    
                    (25,447,000
                    )Other
      comprehensive income (loss) - unrealized holding income
    (loss)
                    
                    
                    —
                    
                    
                    
                    (1,000
                    )
                    
                    
                    17,000Comprehensive
      loss
                    
                    $
                    (30,036,000
                    )
                    
                    $
                    (28,673,000
                    )
                    
                    $
                    (25,430,000
                    )Basic
      and diluted net loss per common share
                    
                    $
                    (1.12
                    )
                    
                    $
                    (1.25
                    )
                    
                    $
                    (1.53
                    )Basic
      and diluted weighted average common shares
                    
                    
                    26,882,431
                    
                    
                    
                    22,889,250
                    
                    
                    
                    16,603,550
 
 
 THE
ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL
STATEMENTS
  57
  CYTORITHERAPEUTICS, INC.
 CONSOLIDATED STATEMENTS OF
STOCKHOLDERS’ EQUITY (DEFICIT)
 FOR
THE YEARS ENDED DECEMBER 31, 2008, 2007 AND 2006
 
 Accumulated
                                                                              
                                                                              
                                                                              Amount
      dueAdditional
                                                                              
                                                                              
                                                                              
                                                                              
                                                                              
                                                                              
                                                                              
                                                                              
                                                                              
                                                                              
                                                                              
                                                                              Other
                                                                              
                                                                              
                                                                              FromCommon
      Stock
                                                                              
                                                                              
                                                                              Paid-in
                                                                              
                                                                              
                                                                              Accumulated
                                                                              
                                                                              
                                                                              Treasury
      Stock
                                                                              
                                                                              
                                                                              Comprehensive
                                                                              
                                                                              
                                                                              Exercises
      ofShares
                                                                              
                                                                              
                                                                              Amount
                                                                              
                                                                              
                                                                              Capital
                                                                              
                                                                              
                                                                              Deficit
                                                                              
                                                                              
                                                                              Shares
                                                                              
                                                                              
                                                                              Amount
                                                                              
                                                                              
                                                                              Income
      (Loss)
                                                                              
                                                                              
                                                                              Stock
      Options
                                                                              
                                                                              
                                                                              TotalBalance
      at December 31, 2005
                                                                              
                                                                              
                                                                              18,194,283
                                                                              
                                                                              
                                                                              $
                                                                              18,000
                                                                              
                                                                              
                                                                              $
                                                                              82,196,000
                                                                              
                                                                              
                                                                              $
                                                                              (78,013,000
                                                                              )
                                                                              
                                                                              
                                                                              2,872,834
                                                                              
                                                                              
                                                                              $
                                                                              (10,414,000
                                                                              )
                                                                              
                                                                              $
                                                                              (16,000
                                                                              )
                                                                              
                                                                              $
                                                                              —
                                                                              
                                                                              
                                                                              $
                                                                              (6,229,000
                                                                              )Stock-based
      compensation expense
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              3,202,000
                                                                              
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              3,202,000Issuance
      of common stock under stock option plan
                                                                              
                                                                              
                                                                              397,205
                                                                              
                                                                              
                                                                              
                                                                              1,000
                                                                              
                                                                              
                                                                              
                                                                              934,000
                                                                              
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              935,000Compensatory
      common stock awards
                                                                              
                                                                              
                                                                              2,500
                                                                              
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              18,000
                                                                              
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              18,000Sale
      of common stock
                                                                              
                                                                              
                                                                              2,918,255
                                                                              
                                                                              
                                                                              
                                                                              3,000
                                                                              
                                                                              
                                                                              
                                                                              16,216,000
                                                                              
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              16,219,000Stock
      issued for license amendment
                                                                              
                                                                              
                                                                              100,000
                                                                              
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              487,000
                                                                              
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              487,000Amount
      due from exercises of stock options
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              (15,000
                                                                              )
                                                                              
                                                                              
                                                                              (15,000
                                                                              )Unrealized
      gain on investments
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              17,000
                                                                              
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              17,000Net
      loss for the year ended December 31, 2006
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              (25,447,000
                                                                              )
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              (25,447,000
                                                                              )Balance
      at December 31, 2006
                                                                              
                                                                              
                                                                              21,612,243
                                                                              
                                                                              
                                                                              
                                                                              22,000
                                                                              
                                                                              
                                                                              
                                                                              103,053,000
                                                                              
                                                                              
                                                                              
                                                                              (103,460,000
                                                                              )
                                                                              
                                                                              
                                                                              2,872,834
                                                                              
                                                                              
                                                                              
                                                                              (10,414,000
                                                                              )
                                                                              
                                                                              
                                                                              1,000
                                                                              
                                                                              
                                                                              
                                                                              (15,000
                                                                              )
                                                                              
                                                                              
                                                                              (10,813,000
                                                                              )Stock-based
      compensation expense
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              2,310,000
                                                                              
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              2,310,000Issuance
      of common stock under stock option plan
                                                                              
                                                                              
                                                                              604,334
                                                                              
                                                                              
                                                                              
                                                                              1,000
                                                                              
                                                                              
                                                                              
                                                                              1,863,000
                                                                              
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              1,864,000Sale
      of common stock
                                                                              
                                                                              
                                                                              3,745,645
                                                                              
                                                                              
                                                                              
                                                                              3,000
                                                                              
                                                                              
                                                                              
                                                                              19,898,000
                                                                              
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              19,901,000Sale
      of treasury stock
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              2,380,000
                                                                              
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              (1,000,000
                                                                              )
                                                                              
                                                                              
                                                                              3,620,000
                                                                              
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              6,000,000Amount
      due from exercises of stock options
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              11,000
                                                                              
                                                                              
                                                                              
                                                                              11,000Unrealized
      loss on investments
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              (1,000
                                                                              )
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              (1,000
                                                                              )Net
      loss for the year ended December 31, 2007
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              (28,672,000
                                                                              )
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              (28,672,000
                                                                              )Balance
      at December 31, 2007
                                                                              
                                                                              
                                                                              25,962,222
                                                                              
                                                                              
                                                                              
                                                                              26,000
                                                                              
                                                                              
                                                                              
                                                                              129,504,000
                                                                              
                                                                              
                                                                              
                                                                              (132,132,000
                                                                              )
                                                                              
                                                                              
                                                                              1,872,834
                                                                              
                                                                              
                                                                              
                                                                              (6,794,000
                                                                              )
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              (4,000
                                                                              )
                                                                              
                                                                              
                                                                              (9,400,000
                                                                              )Stock-based
      compensation expense
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              2,257,000
                                                                              
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              2,257,000Issuance
      of common stock under stock option plan
                                                                              
                                                                              
                                                                              388,536
                                                                              
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              790,000
                                                                              
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              790,000Sale
      of common stock
                                                                              
                                                                              
                                                                              4,825,517
                                                                              
                                                                              
                                                                              
                                                                              5,000
                                                                              
                                                                              
                                                                              
                                                                              28,099,000
                                                                              
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              28,104,000Amount
      due from exercises of stock options
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              4,000
                                                                              
                                                                              
                                                                              
                                                                              4,000Allocation
      of fair value for debt warrants
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              564,000
                                                                              
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              564,000Net
      loss for the year ended December 31, 2008
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              (30,036,000
                                                                              )
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              —
                                                                              
                                                                              
                                                                              
                                                                              (30,036,000
                                                                              )Balance
      at December 31, 2008
                                                                              
                                                                              
                                                                              31,176,275
                                                                              
                                                                              
                                                                              $
                                                                              31,000
                                                                              
                                                                              
                                                                              $
                                                                              161,214,000
                                                                              
                                                                              
                                                                              $
                                                                              (162,168,000
                                                                              )
                                                                              
                                                                              
                                                                              1,872,834
                                                                              
                                                                              
                                                                              $
                                                                              (6,794,000
                                                                              )
                                                                              
                                                                              $
                                                                              —
                                                                              
                                                                              
                                                                              $
                                                                              —
                                                                              
                                                                              
                                                                              $
                                                                              (7,717,000
                                                                              )
 
 
 THE
ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL
STATEMENTS
  58
  CYTORITHERAPEUTICS, INC.
 CONSOLIDATED STATEMENTS OF CASH
FLOWS
 
 For the Years Ended December 31,2008
                                
                                
                                2007
                                
                                
                                2006Cash
      flows from operating activities:Net
      loss
                                
                                $
                                (30,036,000
                                )
                                
                                $
                                (28,672,000
                                )
                                
                                $
                                (25,447,000
                                )Adjustments
      to reconcile net loss to net cash used in operating
      activities:Depreciation
      and amortization
                                
                                
                                1,533,000
                                
                                
                                
                                1,616,000
                                
                                
                                
                                2,120,000Amortization
      of deferred financing costs and debt discount
                                
                                
                                178,000
                                
                                
                                
                                —
                                
                                
                                
                                —Inventory
      provision
                                
                                
                                —
                                
                                
                                
                                70,000
                                
                                
                                
                                88,000Warranty
      provision (reversal)
                                
                                
                                (44,000
                                )
                                
                                
                                (65,000
                                )
                                
                                
                                (23,000
                                )Increase
      (reduction) in allowance for doubtful accounts
                                
                                
                                121,000
                                
                                
                                
                                (1,000
                                )
                                
                                
                                (7,000
                                )Change
      in fair value of option liabilities
                                
                                
                                1,060,000
                                
                                
                                
                                100,000
                                
                                
                                
                                (4,431,000
                                )Gain
      on sale of assets
                                
                                
                                —
                                
                                
                                
                                (1,858,000
                                )
                                
                                
                                —Stock-based
      compensation
                                
                                
                                2,257,000
                                
                                
                                
                                2,310,000
                                
                                
                                
                                3,220,000Stock
      issued for license amendment
                                
                                
                                —
                                
                                
                                
                                —
                                
                                
                                
                                487,000Equity
      loss from investment in joint venture
                                
                                
                                45,000
                                
                                
                                
                                7,000
                                
                                
                                
                                74,000Increases
      (decreases) in cash caused by changes in operating assets and
      liabilities:Accounts
      receivable
                                
                                
                                (1,420,000
                                )
                                
                                
                                217,000
                                
                                
                                
                                598,000Inventories
                                
                                
                                (2,143,000
                                )
                                
                                
                                —
                                
                                
                                
                                6,000Other
      current assets
                                
                                
                                (147,000
                                )
                                
                                
                                (70,000
                                )
                                
                                
                                (90,000
                                )Other
      assets
                                
                                
                                (63,000
                                )
                                
                                
                                (40,000
                                )
                                
                                
                                30,000Accounts
      payable and accrued expenses
                                
                                
                                (2,217,000
                                )
                                
                                
                                1,827,000
                                
                                
                                
                                281,000Deferred
      revenues, related party
                                
                                
                                (2,274,000
                                )
                                
                                
                                (5,158,000
                                )
                                
                                
                                6,595,000Deferred
      revenues
                                
                                
                                66,000
                                
                                
                                
                                (10,000
                                )
                                
                                
                                (152,000
                                )Long-term
      deferred rent
                                
                                
                                (305,000
                                )
                                
                                
                                (268,000
                                )
                                
                                
                                168,000Net
      cash used in operating activities
                                
                                
                                (33,389,000
                                )
                                
                                
                                (29,995,000
                                )
                                
                                
                                (16,483,000
                                )Cash
      flows from investing activities:Proceeds
      from the sale and maturity of short-term investments
                                
                                
                                5,739,000
                                
                                
                                
                                28,007,000
                                
                                
                                
                                67,137,000Purchases
      of short-term investments
                                
                                
                                (5,739,000
                                )
                                
                                
                                (24,032,000
                                )
                                
                                
                                (63,258,000
                                )Proceeds
      from the sale of assets
                                
                                
                                —
                                
                                
                                
                                3,175,000
                                
                                
                                
                                —Costs
      from sale of assets
                                
                                
                                —
                                
                                
                                
                                (305,000
                                )
                                
                                
                                —Purchases
      of property and equipment
                                
                                
                                (393,000
                                )
                                
                                
                                (563,000
                                )
                                
                                
                                (3,138,000
                                )Investment
      in joint venture
                                
                                
                                —
                                
                                
                                
                                (300,000
                                )
                                
                                
                                (150,000
                                )Net
      cash provided by (used in) investing activities
                                
                                
                                (393,000
                                )
                                
                                
                                5,982,000
                                
                                
                                
                                591,000Cash
      flows from financing activities:Principal
      payments on long-term obligations
                                
                                
                                (958,000
                                )
                                
                                
                                (1,200,000
                                )
                                
                                
                                (952,000
                                )Proceeds
      from long-term obligations
                                
                                
                                7,500,000
                                
                                
                                
                                —
                                
                                
                                
                                600,000Debt
      issuance costs
                                
                                
                                (513,000
                                )
                                
                                
                                —
                                
                                
                                
                                —Proceeds
      from exercise of employee stock options
                                
                                
                                795,000
                                
                                
                                
                                1,875,000
                                
                                
                                
                                920,000Proceeds
      from sale of common stock
                                
                                
                                28,954,000
                                
                                
                                
                                21,500,000
                                
                                
                                
                                16,780,000Costs
      from sale of common stock
                                
                                
                                (850,000
                                )
                                
                                
                                (1,599,000
                                )
                                
                                
                                (561,000
                                )Proceeds
      from sale of treasury stock
                                
                                
                                —
                                
                                
                                
                                6,000,000
                                
                                
                                
                                —Net
      cash provided by financing activities
                                
                                
                                34,928,000
                                
                                
                                
                                26,576,000
                                
                                
                                
                                16,787,000Net
      increase in cash and cash equivalents
                                
                                
                                1,146,000
                                
                                
                                
                                2,563,000
                                
                                
                                
                                895,000Cash
      and cash equivalents at beginning of year
                                
                                
                                11,465,000
                                
                                
                                
                                8,902,000
                                
                                
                                
                                8,007,000Cash
      and cash equivalents at end of year
                                
                                $
                                12,611,000
                                
                                
                                $
                                11,465,000
                                
                                
                                $
                                8,902,000
 
  59
  
 For the Years Ended December 31,2008
                    
                    
                    2007
                    
                    
                    2006Supplemental
      disclosure of cash flows information:Cash
      paid during period for:Interest
                    
                    $
                    180,000
                    
                    
                    $
                    160,000
                    
                    
                    $
                    201,000Taxes
                    
                    
                    —
                    
                    
                    
                    2,000
                    
                    
                    
                    1,000Supplemental
      schedule of non-cash investing and financing activities:Fair
      value of warrants allocated to additional paid in capital
                    
                    $
                    564,000
                    
                    
                    $
                    —
                    
                    
                    $
                    —Final
      payment fee of the long-term debt
                    
                    
                    375,000Amount
      due from exercise of stock options
                    
                    
                    —
                    
                    
                    
                    4,000
                    
                    
                    
                    15,000
 
 
 THE
ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL
STATEMENTS
 
 
  60
  
 CYTORITHERAPEUTICS, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 DECEMBER
31, 2008
 
 
 1.
              Organization
      and Operations
 
 The
Company
 
 Cytori
Therapeutics, Inc., develops, manufactures and sells medical technologies to
enable the practice of regenerative medicine. Our commercial activities are
currently focused on reconstructive surgery in Europe and stem cell banking
(cell preservation) in Japan and we are seeking to bring our products to market
in the United States as well as other countries. Our product pipeline is
developing potential new treatments for cardiovascular disease, orthopedic
damage, gastrointestinal disorders, and pelvic health.
 
 Our Thin
Film product line will be marketed exclusively in Japan by Senko Medical Trading
Co. (“Senko”) following regulatory approval of the product in
Japan.
 
 We have
two subsidiaries located in Japan and Italy.
 
 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.
 
 For the
years ended December 31, 2007 and 2006, we recorded bioresorbable product
revenue from Medtronic of $792,000 and $1,451,000, respectively, which
represented 13.1% and 18.3% of total product and development revenues,
respectively.  We sold substantially all of our bioresorbable spine
and orthopedic surgical implant product line to Kensey Nash in May
2007.   There was no bioresorbable product revenue recorded in
2008.
 
 Liquidity
and Capital Availability
 
 We
incurred losses of $30,036,000, $28,672,000 and $25,447,000 for the years ended
December 31, 2008, 2007, and 2006 respectively.  We have an
accumulated deficit of $162,168,000 as of December 31, 2008.  Additionally,
we have used net cash of $33,389,000, $29,995,000 and $16,483,000 to fund our
operating activities for years ended December 31, 2008, 2007, and 2006,
respectively.To date these
operating losses have been funded primarily from outside sources of invested
capital.
 
 During
2008, we initiated our commercialization activities while simultaneously
pursuing available financing sources to support operations and
growth.  We have had, and continue to have, an ongoing need to raise
additional cash from outside sources to fund our operations.  However,
our ability to raise capital has been adversely affected by current credit
conditions and the downturn in the financial markets and the global
economy.  Accordingly, the combination of these facts raises
substantial doubt as to the Company’s ability to continue as a going
concern.  The accompanying consolidated financial statements have been
prepared assuming that the Company will continue as a going
concern.  If we are unsuccessful in our efforts to raise outside
capital in the near term, we will be required to significantly reduce our
research, development, and administrative operations, including reduction of our
employee base, in order to offset the lack of available funding.
  61
  We are
pursuing financing opportunities in both the private and public debt and equity
markets as well as through strategic corporate partnerships.  We have an
established history of raising capital through these platforms, and we are
currently involved in negotiations with multiple parties.  Our efforts in
2008 to raise capital have taken longer than we initially anticipated.  In
August 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. In
October 2008, we entered into a secured Loan Agreement with General Electric
Capital Corporation and Silicon Valley Bank (“Lenders”) to borrow up to
$15,000,000.  An initial term loan of $7,500,000, less fees and
expenses, was funded on October 14, 2008.  We could not access the
remaining $7,500,000 under this facility as we were not able to meet certain
financial prerequisites that had been established by the Lenders.
 
 We expect
to continue to utilize our cash and cash equivalents to fund operations through
at least the next few months, subject to minimum cash and cash liquidity
requirements of the Loan and Security Agreement with the Lenders, which requires
that we maintain at least three months of cash on hand to avoid an event of
default under the Loan and Security Agreement.  We continue to seek
additional cash through product revenues, strategic collaborations, and future
sales of equity or debt securities.  Although there can be no assurance
given, we hope to successfully complete one or more additional financing
transactions and corporate partnerships in the near-term. Without this
additional capital, current working capital and cash generated from sales and
containment of operating costs will not provide adequate funding for research,
sales and marketing efforts, clinical and preclinical trials, and product
development activities at their current levels. If such efforts are not
successful, we will need to significantly reduce or curtail our research and
development and other operations and this could negatively affect our ability to
achieve corporate growth goals.  Specifically, we have prepared an
operating plan (plan) that calls for us to reduce operations to focus almost
entirely on the supply of current products to existing or new distribution
channels.  In addition, as part of this plan, there would be minimal
expenditures for ongoing scientific research, product development or clinical
research.  This impacts research and development headcount, external
subcontractor expenditures, capital outlay and general and administrative
expenditures related to the supervision of such activities.  In
parallel, we would significantly reduce administrative staff and salaries
consistent with the overall reduction in scope of operations.  In
aggregate, such reductions could result in eliminations of roles for the
majority of the Company’s current staff and the deferral or elimination of all
ongoing development projects until such time that cash resources were available
from operations or outside sources to re-establish development and growth
plans.  Management is currently reviewing contractual obligations related
to the pre-clinical and clinical commitments along with minimum purchase
requirements to include deferral of such commitments as part of this
plan.  While management is actively pursuing its near term financial
and strategic alternatives it is also, in parallel, continuing to evaluate the
timing of implementation of the alternative operating plan and the initiation of
the identified reductions.
 
 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, accounting for product line dispositions, valuing our
put option arrangement with Olympus Corporation (Put option) (see notes 3 and
4), 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., valuing allowance 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
periodically, and the effects of revisions are reflected in the consolidated
financial statements in the periods they are determined to be
necessary.
 
 Presentation
 
 Certain
prior period amounts have been reclassified to conform to current period
presentation.
 
 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 $11,718,000 and $10,502,000 as of December 31,
2008 and 2007, respectively.  We maintain our cash at insured
financial
  62
  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.  We believe that the risk is not
significant.
 
 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 that maintain safety and liquidity. These
guidelines are periodically reviewed and modified to take advantage of trends in
yields and interest rates.
 
 We
evaluate our investments in accordance with the provisions of Statement of
Financial Standards (“SFAS”) No. 115, “Accounting for Certain Investments in
Debt and Equity Securities.”  Based on our intent, our investment
policies and our ability to liquidate debt securities, we classify short-term
investment securities within current assets. Available-for-sale securities are
carried at fair value, with unrealized gains and losses reported as accumulated
other comprehensive income (loss) within stockholders’ equity. The amortized
cost basis of debt securities is periodically adjusted for amortization of
premiums and accretion of discounts to maturity. Such amortization is included
as a component of interest income or interest expense. The amortized cost basis
of securities sold is based on the specific identification method and all such
realized gains and losses are recorded as a component within other income
(expense).  We review the carrying values of our investments and write
down such investments to estimated fair value by a charge to the statements of
operations when the severity and duration of a decline in the value of an
investment is considered to be other than temporary.  The cost of
securities sold or purchased is recorded on the settlement date.
 
 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, 2008 and 2007.
 
 Fair
Value of Financial Instruments
 
 The
carrying amounts of our cash and cash equivalents, accounts receivable, accounts
payable and accrued expenses approximate their fair value due to the short-term
nature of these balances.  The carrying amounts of our current portion
of long-term obligations and long-term obligations approximate fair value as the
terms and rates of interest for these instruments approximate terms and market
rates of interest currently available to us for similar instruments. Our option
liability is already reported at its fair value based on established option
pricing theory and assumptions (notes 3 and 4).  Short-term
investments are also reported at fair value in the financial
statements.
 
 Inventories
 
 Inventories
include the cost of material, labor, and overhead, and are stated at the lower
of average 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.
 
 Our
inventory balance as of December 31, 2008 includes the cost of materials on hand
as of December 31, 2008 that we purchased on or after March 1,
2008.  March 1, 2008 is considered our commercialization date based on
completion of final development activities associated with our Celution® 800/CRS
System products.  All materials purchased prior to the
commercialization date were expensed as research and development expense during
the period they were purchased, of which $78,000 (with a net book value of $0)
was on hand as of December 31, 2008 to be utilized in future
manufacturing.
 
 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
 
 In
accordance with SFAS No. 144, “Accounting for Impairment or Disposal of
Long-Lived Assets,” 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
  63
  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
 
 SFAS No.
142, “Goodwill and Other Intangible Assets,” establishes financial accounting
and reporting standards for acquired goodwill and other intangible
assets.  Under SFAS No. 142, goodwill and indefinite-lived intangible
assets are not amortized but are reviewed at least annually for impairment.
Separable intangible assets that have finite useful lives will continue to be
amortized over their respective useful lives.
 
 SFAS No.
142 requires that goodwill be tested for impairment on at least an annual basis
or whenever events or changes in circumstances indicate that the carrying value
of goodwill may not be recoverable. We completed this testing as of November 30,
2008, and concluded that no impairment existed.
 
 In 2007,
all goodwill that had been assigned to our MacroPore Biosurgery reporting unit
was derecognized during our sale of substantially all of our spine and
orthopedic product line to Kensey Nash (see note 5).
 
 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, 2008 and 2007 are as
follows:
 
 December 31, 2008Regenerative
                      Cell Technology
                    
                    
                    MacroPore
                      Biosurgery
                    
                    
                    TotalOther
      intangibles, net:Beginning
      balance
                    
                    $
                    1,078,000
                    
                    
                    $
                    —
                    
                    
                    $
                    1,078,000Amortization
                    
                    
                    (221,000
                    )
                    
                    
                    —
                    
                    
                    
                    (221,000
                    )Ending
      balance
                    
                    
                    857,000
                    
                    
                    
                    —
                    
                    
                    
                    857,000Goodwill,
      net:Beginning
      balance
                    
                    
                    3,922,000
                    
                    
                    
                    —
                    
                    
                    
                    3,922,000Disposal
      of assets
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —Ending
      balance
                    
                    
                    3,922,000
                    
                    
                    
                    —
                    
                    
                    
                    3,922,000Total
      goodwill and other intangibles, net
                    
                    $
                    4,779,000
                    
                    
                    $
                    —
                    
                    
                    $
                    4,779,000Cumulative
      amortization of other intangible assets
                    
                    $
                    1,359,000
                    
                    
                    $
                    —
                    
                    
                    $
                    1,359,000
 
 
 December 31, 2007Regenerative
                      Cell Technology
                    
                    
                    MacroPore
                      Biosurgery
                    
                    
                    TotalOther
      intangibles, net:Beginning
      balance
                    
                    $
                    1,300,000
                    
                    
                    $
                    —
                    
                    
                    $
                    1,300,000Amortization
                    
                    
                    (222,000
                    )
                    
                    
                    —
                    
                    
                    
                    (222,000
                    )Ending
      balance
                    
                    
                    1,078,000
                    
                    
                    
                    —
                    
                    
                    
                    1,078,000Goodwill,
      net:Beginning
      balance
                    
                    
                    3,922,000
                    
                    
                    
                    465,000
                    
                    
                    
                    4,387,000Disposal
      of assets
                    
                    
                    —
                    
                    
                    
                    (465,000
                    )
                    
                    
                    (465,000
                    )Ending
      balance
                    
                    
                    3,922,000
                    
                    
                    
                    —
                    
                    
                    
                    3,922,000Total
      goodwill and other intangibles, net
                    
                    $
                    5,000,000
                    
                    
                    $
                    —
                    
                    
                    $
                    5,000,000Cumulative
      amortization of other intangible assets
                    
                    $
                    1,138,000
                    
                    
                    $
                    —
                    
                    
                    $
                    1,138,000
 
  64
  As of
December 31, 2008, future estimated amortization expense for these other
intangible assets is expected to be as follows:
 
 2009
                    
                    222,0002010
                    
                    222,0002011
                    
                    222,0002012
                    
                    191,000$
                    857,000
 
 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
arrangement.  Revenue for these product sales will be recognized upon
delivery to the customer, as all risks and rewards of ownership have been
substantively transferred to the customer at that point.  For
Celution® 800/CRS
System 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, in
accordance with Emerging Issues Task Force (EITF) Issue No. 00-10, “Accounting
for Shipping and Handling Fees and Costs” (“EITF 00-10”).  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
product.
 
 For those
sales that include multiple deliverables, we allocate revenue based on the
relative fair values of the individual components as determined in accordance
with EITF Issue No. 00-21, “Revenue Arrangements with Multiple Deliverables”
(“EITF 00-21”).  When more than one element such as product
maintenance or technical support services are included in an arrangement, we
allocate revenue between the elements based on each element’s relative fair
value, provided that each element meets 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 allocate revenue first to the fair value of
the undelivered elements and allocate the residual revenue to the delivered
elements.  Deferred service revenue is recognized ratably over the
period the services are provided.  In the absence of fair value for an
undelivered element, the arrangement is 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.
 
 An
allowance for doubtful accounts is maintained for estimated losses resulting
from the inability of our customers to make required payments.  This
reserve is determined by analyzing specific customer accounts and applying
historical loss rates to the aging of remaining accounts receivable
balances.  If the financial condition of our customer were to
deteriorate, resulting in their inability to pay their accounts when due,
additional reserves might be required.
 
 Before
the disposal of substantially all of our bioresorbable spine and orthopedic
product line in May 2007, we sold our (non-Thin Film) MacroPore Biosurgery
products to Medtronic, Inc.  We recognized revenue on product sales to
Medtronic upon shipment of ordered products to Medtronic, as title and risk of
loss were transferred at that point.  In May 2007, we sold to Kensey
Nash our intellectual property rights and tangible assets related to our
bioresorbable spine and orthopedic product line (see note 5).
 
 License/Distribution
Fees
 
 We
recognize any upfront payments received from license/distribution agreements as
revenues over the period in which the customer benefits from the
license/distribution agreement.
 
 To date,
we have not received any upfront license payments that are separable under EITF
00-21.  Accordingly, such license revenues have been combined with
other elements, such as research and development activities, for purposes of
revenue recognition.  For instance, we account for the license fees
and milestone payments under the Distribution Agreement with Senko as a single
unit of accounting.  Similarly, we have attributed the upfront fees
received under the arrangements with Olympus Corporation, a related party (see
note 3), to a single unit of accounting comprising a license we granted to
Olympus-Cytori, Inc. (the “Joint Venture”), a related party, as well as
development services we agreed to perform for this entity.
 
 In the
first quarter of 2006, we granted Olympus an exclusive right to negotiate a
commercialization collaboration for the use of adipose stem and regenerative
cells for a specific therapeutic area outside of cardiovascular
disease.  In exchange for this right, we received $1,500,000 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
  65
  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 the
third quarter of 2004, we 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 received a
$1,500,000 upfront license fee from them in return for this right.  We
recorded the $1,500,000 received as deferred revenues in the accompanying
consolidated balance sheets.  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 are currently
pursuing the required regulatory clearance in order to initiate
commercialization.
 
 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 presented in compliance with EITF Issue No. 99-19,
“Reporting Revenue Gross as a Principal Versus Net as an Agent,” and EITF Issue
No. 01-14, “Income Statement Characterization of Reimbursements Received for
“Out-of-Pocket” Expenses Incurred.”  In accordance with the criteria
established by these EITF Issues, we record grant revenue for the gross amount
of the reimbursement.  The costs associated with these reimbursements
are reflected as a component of research and development expense in our
consolidated 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 consolidated statements of
operations.
 
 We
received a total of $22,000,000 from Olympus and Olympus-Cytori, Inc. during
2005 in two separate but related transactions (see note
3).  Approximately $4,689,000 of this amount related to common stock
that we issued, as well as two options we granted, to
Olympus.  Moreover, during the first quarter of 2006, we received
$11,000,000 from the Joint Venture upon achieving the CE Mark on the Celution®
600.  The difference between the proceeds received and the fair values
of the common stock and option liability 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 (or
“JV”), rather than additional equity investment in
Cytori.  Considering the $4,689,000 initially allocated to the common
stock issued and the two options, 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 therapeutic device technology, including the Celution® System platform
and certain related intellectual property, and (b) provide future development
contributions related to commercializing the Celution® System
platform.  As noted above, the license and development services are
not separable under EITF 00-21.  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.  Revenue will be recognized as the above mentioned R&D
milestones are completed.
 
 We
established the R&D milestones based upon our development obligations to the
JV and the specific R&D support activities to be performed to achieve these
obligations.  Our R&D milestones consist of the following primary
performance categories:  product development, regulatory approvals,
and generally associated pre-clinical and clinical
trials.   Within each category are milestones that take
substantive effort to complete and are critical pieces of the overall progress
towards completion of the next generation product, which we are obligated to
support within the agreements entered into with Olympus.
 
 To
determine whether substantive effort was required to achieve the milestones, we
considered the external costs, required personnel and relevant skill levels, the
amount of time required to complete each milestone, and the interdependent
relationships between the milestones, in that the benefits associated with the
completion of one milestone generally support and contribute to the achievement
of the next.
 
 Determination
of the relative values assigned to each milestone involved substantial
judgment.  The assignment process was based on discussions with
persons responsible for the development process and the relative costs of
completing each milestone.
  66
  We
considered the costs of completing the milestones in allocating the portion of
the “deferred revenues, related party” account balance to each
milestone.  Management believes that, while the costs incurred in
achieving the various milestones are subject to estimation, due to the high
correlation of such costs to outputs achieved, the use of external contract
research organization costs and internal labor costs as the basis for the
allocation process provides management the ability to accurately and reasonably
estimate such costs.
 
 Of the
amounts received and deferred, we recognized development revenues of $774,000
and $5,158,000 in the years ended December 31, 2008 and 2007,
respectively.  All related development costs are expensed as incurred
and are included in research and development expense on the statement of
operations.
 
 In the
third quarter of 2004, we 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.  We have
also earned or will be entitled to earn additional payments under the
Distribution Agreement based on achieving the following defined research and
development milestones:
 
 ·
              In
      2004, we received a nonrefundable payment of $1,250,000 from Senko after
      filing an initial regulatory application with the Japanese Ministry of
      Health, Labour and Welfare (“MHLW”) related to the Thin Film product
      line.  We initially recorded this payment as deferred revenues
      of $1,250,000.
 
 ·
              Upon
      the achievement of commercialization (i.e., regulatory approval by the
      MHLW), we will be entitled to an additional nonrefundable payment of
      $250,000.
 
 Of the
amounts received and deferred, we recognized development revenues of $10,000 and
$152,000 in the years ended December 31, 2007 and 2006, respectively,
representing the fair value of the completed milestones relative to the fair
value of the total efforts expected to be necessary to achieve regulatory
approval by the MHLW.  There was no development revenue recognized
during the year ended December 31, 2008.  As noted above, the license
and the milestone components of the Senko Distribution Agreement are accounted
for as a single unit of accounting.  This single element includes a
$1,500,000 license fee which is potentially refundable.  We have
recognized, and will continue to recognize, the non-contingent fees allocated to
this combined deliverable as we complete performance obligations under the
Distribution Agreement with Senko.  We will not recognize the
potentially refundable portion of the fees until the right of refund
expires.  See note 6 for further details.  Accordingly, we
expect to recognize approximately $1,129,000 (consisting of remaining $879,000
in deferred revenues plus a non-refundable payment of $250,000 to be received
upon commercialization) in revenues associated with this milestone arrangement
if and when commercialization is achieved.  We will not recognize the
potentially refundable portion of the fees ($1,500,000) until the right of
refund expires.
 
 Under our
agreement with the NIH, we were reimbursed for “qualifying expenditures” related
to research on adipose-derived cell therapy for myocardial
infarction.  To receive funds under the grant arrangement, we were
required to (i) demonstrate that we incurred “qualifying expenses,” as defined
in the grant agreement between the NIH and us, (ii) maintain a system of
controls, whereby we could accurately track and report all expenditures related
solely to research on Adipose-Derived Cell Therapy for Myocardial Infarction,
and (iii) file appropriate forms and follow appropriate protocols established by
the NIH.  When we were reimbursed for costs incurred under grant
arrangements with the NIH, we recognized revenues for the lesser
of:
 
 ·
              Qualifying
      costs incurred (and not previously recognized) to date, plus any allowable
      grant fees for which we are entitled to funding from the NIH;
      or
 
 ·
              The
      outputs generated to date versus the total outputs expected to be achieved
      under the research arrangement.
 
 For the
year ended December 31, 2006, we recognized NIH grant revenue of
$310,000.  Our work under this NIH agreement was completed in 2006; as
a result, there were no comparable revenues or costs in 2008 and
2007.
 
 Warranty
 
 For the
bioresorbable spine and orthopedic products, we provided a limited warranty
under our agreements with our customers for products that fail to comply with
product specifications. We have recorded a reserve for estimated costs we may
incur under our warranty program.  In May 2007, we sold to Kensey Nash
our intellectual property rights and tangible assets related to our
bioresorbable spine and orthopedic product line.
 
 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
ensuring that the products will be free of defects.
  67
  We
believe that the rigorous nature of the testing and compliance efforts serves to
minimize the likelihood of defects in material or workmanship to a level
substantially less than “probable”, and a warranty estimate is not justified at
this time. Accordingly, we did not record a warranty reserve for our
Celution® 800/CRS
System and StemSource® Cell
Bank product line during the year ended December 31, 2008.
 
 The
following summarizes the movements in our warranty obligations, which is
included in accounts payable and accrued expenses, at December 31, 2008, 2007
and 2006:
 
 As of
                              January 1,
                            
                            
                            Additions/
                              (Deductions) to
                              expenses
                            
                            
                            Claims
                            
                            
                            As of
                              December 31,2008:Warranty
      obligations
                            
                            $
                            67,000
                            
                            
                            $
                            (44,000
                            )
                            
                            $
                            —
                            
                            
                            $
                            23,0002007:Warranty
      obligations
                            
                            $
                            132,000
                            
                            
                            $
                            (65,000
                            )
                            
                            $
                            —
                            
                            
                            $
                            67,0002006:Warranty
      obligations
                            
                            $
                            155,000
                            
                            
                            $
                            (23,000
                            )
                            
                            $
                            —
                            
                            
                            $
                            132,000
 
 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, pre-clinical and clinical studies. Included in these expenditures are
salaries and benefits related to these efforts (excluding stock based
compensation), which were approximately $6,189,000 in 2008.
 
 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, 2008, 2007 and 2006, costs associated with the
development of the device were $2,546,000, $6,293,000 and $7,286,000,
respectively.
 
 Our
agreement with the NIH entitled us to qualifying expenditures of up to $950,000
for Phase I and Phase II related to research on Adipose-Derived Cell Therapy for
Myocardial Infarction. We incurred $479,000 ($169,000 of which were not
reimbursed) of direct expenses for the year ended December 31, 2006. There were
no comparable expenditures in 2008 and 2007 as our work under the NIH agreement
was completed during 2006.
 
 Under a
Distribution Agreement with Senko we are responsible for the completion of the
initial regulatory application to the MHLW and commercialization of the Thin
Film product line in Japan. During the years ended December 31, 2007 and 2006,
we incurred $80,000 and $178,000, respectively, of expenses related to this
regulatory and registration process. We did not incur any expenses related to
this regulatory and registration process during the year ended December 31,
2008.  We are currently pursuing the required regulatory clearance in
order to initiate commercialization.
 
 Deferred
Financing Costs and Other Debt-Related Costs
  Deferred
financing costs are capitalized and amortized to interest expense over the term
of its 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 in
accordance with Accounting Principle Board No. 14 (APB 14), “Accounting for Convertible Debt and
Debt Issued with Stock Purchase Warrants.” The fair value of the warrant
issued to the Lenders is calculated utilizing the Black-Scholes option-pricing
model. We are amortizing 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 is accelerated.
 
  68
  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 deferred tax assets.
 
 Stock
Based Compensation
 
 Accounting
Policy
 
 On
January 1, 2006, we adopted the provisions of Financial Accounting Standards
Board Statement No. 123R, “Share-Based Payment” (“SFAS 123R”) using the modified
prospective transition method. SFAS 123R requires us to measure all share-based
payment awards granted after January 1, 2006, including those with employees, at
fair value.  Under SFAS 123R, the fair value of stock options and
other equity-based compensation must be recognized as expense in the statements
of operations over the requisite service period of each award.
 
 In
addition, beginning January 1, 2006, we have recognized compensation expense
under SFAS 123R for the unvested portions of outstanding share-based awards
previously granted under our (a) 2004 Equity Incentive Plan and (b) 1997 Stock
Option and Stock Purchase Plan, over the periods these awards continue to
vest.  This compensation expense is recognized based on the fair
values and attribution methods that were previously disclosed in our prior
period financial statements under Financial accounting Standards Board Statement
No. 123, “Accounting for Stock-Based Compensation” (“SFAS 123”).
 
 Other
Comprehensive Income (Loss)
 
 Comprehensive
income (loss) is the total of net income (loss) and all other non-owner changes
in equity. Other comprehensive income (loss) refers to these revenues, expenses,
gains, and losses that, under generally accepted accounting principles, are
included in comprehensive income (loss) but excluded from net income
(loss).
 
 During
the years ended December 31, 2007 and 2006, our only element of other
comprehensive income (loss) resulted from unrealized gains (losses) on
available-for-sale investments, which are reflected in the consolidated
statements of stockholders’ equity as accumulated other comprehensive income
(loss).  We did not have any comparable other comprehensive income
(loss) during the year ended December 31, 2008.
 
 Segment
Information
 
 We report
our financial results based on two distinct operating segments – (a)
Regenerative cell technology and (b) MacroPore Biosurgery, which manufactures
bioresorbable implants.
 
 Our
regenerative cell technology segment develops, manufactures and sells medical
technologies to enable the practice of regenerative medicine with an initial
focus on reconstructive surgery and cell banking.  Our
commercialization model is based on the sale of Celution® Systems and their
related harvest and delivery instrumentation, and on generating recurring
revenues from single-use consumable sets utilized during each patient
procedure.
 
 Our
MacroPore Biosurgery unit develops Thin Film bioresorbable implants for sale in
Japan through Senko Medical Trading Company (“Senko”), which has exclusive
distribution rights to these products in Japan.  Also, until after the
second quarter of 2007, the MacroPore Biosurgery segment manufactured and
distributed the HYDROSORBTM family
of spine and orthopedic implants.
 
 We
measure the success of each operating segment based on operating profits and
losses and, additionally, in the case of the regenerative cell technology
segment, the achievement of key research objectives.  In arriving at
our operating results for each segment, we use the same accounting policies as
those used for our consolidated company and as described throughout this
note.   However, segment operating results exclude allocations of
company-wide general and administrative costs and changes in fair value of our
option liabilities.
 
 During
the second half of 2007, we had minimal activity in the MacroPore Biosurgery
operating segment as a result of sale in May 2007 to Kensey Nash of the
intellectual property rights and tangible assets related to the spine and
orthopedic bioresorbable implant product line.  However, due to
production and sales activity in the MacroPore Biosurgery operating segment
prior to the sale to Kensey Nash, we have reported two operating segments
through December 31, 2008.
  69
  Prior
year results presented below have been developed on the same basis as the
current year amounts.  For all periods presented, we did not have any
intersegment transactions.
 
 The
following tables provide information regarding the performance and assets of our
operating segments:
 
 Years ended December 31,2008
                          
                          
                          2007
                          
                          
                          2006Revenues:Regenerative
      cell technology
                          
                          $
                          6,853,000
                          
                          
                          $
                          5,247,000
                          
                          
                          $
                          6,324,000MacroPore
      Biosurgery
                          
                          
                          —
                          
                          
                          
                          802,000
                          
                          
                          
                          1,603,000Total
      revenues
                          
                          $
                          6,853,000
                          
                          
                          $
                          6,049,000
                          
                          
                          $
                          7,927,000Segment
      operating income (losses):Regenerative
      cell technology
                          
                          
                          (16,793,000
                          )
                          
                          $
                          (17,075,000
                          )
                          
                          $
                          (16,211,000
                          )MacroPore
      Biosurgery
                          
                          
                          (181,000
                          )
                          
                          
                          9,000
                          
                          
                          
                          (1,528,000
                          )General
      and administrative expenses
                          
                          
                          (11,727,000
                          )
                          
                          
                          (14,184,000
                          )
                          
                          
                          (12,547,000
                          )Changes
      in fair value of option liabilities
                          
                          
                          (1,060,000
                          )
                          
                          
                          (100,000
                          )
                          
                          
                          4,431,000Total
      operating loss
                          
                          $
                          (29,761,000
                          )
                          
                          $
                          (31,350,000
                          )
                          
                          $
                          (25,855,000
                          )
  As of December 31,2008
                      
                      
                      2007Assets:Regenerative
      cell technology
                      
                      $
                      13,240,000
                      
                      
                      $
                      11,591,000MacroPore
      Biosurgery
                      
                      
                      —
                      
                      
                      
                      —Corporate
      assets
                      
                      
                      12,369,000
                      
                      
                      
                      9,916,000Total
      assets
                      
                      $
                      25,609,000
                      
                      
                      $
                      21,507,000
  We
derived our revenues from the following products, research grants, development
and service activities:
 
 Years ended December 31,2008
                    
                    
                    2007
                    
                    
                    2006Regenerative
      cell technology:Product
      revenues:Celution®
      products
                    
                    $
                    4
      ,528,000
                    
                    
                    $
                    —
                    
                    
                    $
                    —Development
      revenues:Milestone
      revenue (Olympus)
                    
                    
                    774,000
                    
                    
                    
                    5,158,000
                    
                    
                    
                    5,905,000Other
      (Olympus)
                    
                    
                    1,500,000
                    
                    
                    
                    —
                    
                    
                    
                    —Research
      grant (NIH)
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    310,000Regenerative
      cell storage services
                    
                    
                    4,000
                    
                    
                    
                    4,000
                    
                    
                    
                    7,000Other
                    
                    
                    47,000
                    
                    
                    
                    85,000
                    
                    
                    
                    102,000Total
      regenerative cell technology
                    
                    
                    6,853,000
                    
                    
                    
                    5,247,000
                    
                    
                    
                    6,324,000MacroPore
      Biosurgery:Product
      revenues:Spine
      & orthopedic products
                    
                    
                    —
                    
                    
                    
                    792,000
                    
                    
                    
                    1,451,000Development
      revenues
                    
                    
                    —
                    
                    
                    
                    10,000
                    
                    
                    
                    152,000Total
      MacroPore Biosurgery
                    
                    
                    —
                    
                    
                    
                    802,000
                    
                    
                    
                    1,603,000Total
      revenues
                    
                    $
                    6,853,000
                    
                    
                    $
                    6,049,000
                    
                    
                    $
                    7,927,000
 
 The
following table provides geographical information regarding our sales to
external customers:
 
 For the Years Ended
      December 31,
                      
                      U.S. Revenues
                      
                      
                      Non-U.S. Revenues
                      
                      
                      Total Revenues2008
                      
                      $
                      2,290,000
                      
                      
                      $
                      4,563,000
                      
                      
                      $
                      6,853,0002007
                      
                      $
                      6,010,000
                      
                      
                      $
                      39,000
                      
                      
                      $
                      6,049,0002006
                      
                      $
                      7,827,000
                      
                      
                      $
                      100,000
                      
                      
                      $
                      7,927,000
 
 At
December 31, 2008 and 2007, our long-lived assets, net of depreciation,
excluding goodwill and intangibles (all of which are in the U.S.), are located
in the following jurisdictions:
 
 As of
      December 31,
                    
                    U.S. Domiciled
                    
                    
                    Non-U.S. Domiciled
                    
                    
                    Total2008
                    
                    $
                    3,197,000
                    
                    
                    $
                    408,000
                    
                    
                    $
                    3,605,0002007
                    
                    $
                    3,932,000
                    
                    
                    $
                    337,000
                    
                    
                    $
                    4,269,000
 
 Loss
Per Share
 
 We
compute loss per share based on the provisions of SFAS No. 128, “Earnings Per
Share.” Basic per share data is computed by dividing net income or loss
available 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 available to common stockholders by the
  70
  weighted
average number of common shares outstanding during the period increased to
include, if dilutive, the number of additional common share equivalents that
would have been outstanding if potential common shares had been issued using the
treasury stock method. Potential common shares were related entirely to
outstanding but unexercised option awards and warrants for all periods
presented.
 
 We have
excluded all potentially dilutive securities from the calculation of diluted
loss per share attributable to common stockholders for the years ended December
31, 2008, 2007 and 2006, as their inclusion would be antidilutive. Potentially
dilutive common shares excluded from the calculations of diluted loss per share
were 9,393,574, 7,880,098 and 5,934,029 for the years ended December 31, 2008,
2007 and 2006, respectively.
 
 Recent
Accounting Pronouncements
 
 In July
2006, FASB issued Interpretation No. 48, Accounting for Uncertainty in
Income Taxes—An Interpretation of FASB Statement No. 109 (“FIN
48”).  FIN 48 clarifies the accounting for uncertainty in income taxes
recognized in an entity’s financial statements in accordance with FASB Statement
No. 109, Accounting for Income Taxes, and prescribes a recognition
threshold and measurement attributes for financial statement disclosure of tax
positions taken or expected to be taken on a tax return. Under FIN 48, the
impact of an uncertain income tax position on the income tax return must be
recognized at the largest amount that is more-likely-than-not to be sustained
upon audit by the relevant taxing authority.  An uncertain income tax
position will not be recognized if it has less than a 50% likelihood of being
sustained.  Additionally, FIN 48 provides guidance on derecognition,
classification, interest and penalties, accounting in interim periods,
disclosure and transition.
  On
January 1, 2008, we adopted certain provisions of SFAS No. 157, “Fair Value
Measurements” (“SFAS 157”).  SFAS 157 provides a single definition of
fair value and a common framework for measuring fair value as well as new
disclosure requirements for fair value measurements used in financial
statements.  SFAS 157 applies to reported balances that are required
or permitted to be measured at fair value under existing pronouncements;
accordingly, the standard does not require any new fair value measurements of
reported balances.
  In February 2008, the FASB issued Staff
Position “Effective Date
of FASB Statement No. 157” (FSP No. 157-2), which delayed the adoption date
until January 1, 2009 for non-financial assets and liabilities that are measured
at fair value on a non-recurring basis, such as goodwill and identifiable
intangible assets. We do not expect the adoption of the SFAS 157 for
non-financial assets and liabilities to have a material impact on our
consolidated financial position or results of operations.
  On
January 1, 2008, we also adopted SFAS No. 159, “The Fair Value Option for
Financial Assets and Financial Liabilities” (“SFAS 159”), which permits
companies to choose to measure many financial instruments and certain other
items at fair value.  However, we have not elected to measure any
additional financial instruments or other items at fair value under the
provisions of this standard.
  In March
2007, the FASB ratified the consensus reached by the Emerging Issues Task Force
(EITF) on Issue No. 07-3, “Accounting for Nonrefundable Advance Payments for
Goods or Services Received for Use in Future Research and Development
Activities” (“EITF 07-3”).  EITF 07-3 states that nonrefundable
advance payments for future research and development activities should be
deferred and capitalized.  Such amounts should be recognized as an
expense as the goods are delivered or the related services are
performed.  The guidance is effective for all periods beginning after
December 15, 2007, which we adopted effective January 1, 2008.  The
adoption of EITF 07-3 did not have a significant effect on our consolidated
financial statements.
 
 In
December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in
Consolidated Financial Statements - An Amendment of ARB No. 51” ("SFAS
160").  SFAS 160 establishes new accounting and reporting standards
for the noncontrolling interest in a subsidiary and for the deconsolidation of a
subsidiary. SFAS 160 is effective for annual periods beginning on or after
December 15, 2008.  We do not believe that the adoption of SFAS 160
will have a significant effect on our consolidated financial
statements.
 
 In
December 2007, the FASB issued SFAS No. 141 (revised 2007), “Business
Combinations” ("SFAS 141R").  SFAS 141R retains the fundamental
requirements of Statement No. 141 to account for all business combinations using
the acquisition method (formerly the purchase method) and for an acquiring
entity to be identified in all business combinations.  However, the
new standard requires the acquiring entity in a business combination to
recognize all the assets acquired and liabilities assumed in the transaction;
establishes the acquisition-date fair value as the measurement objective for all
assets acquired and liabilities assumed; and requires the acquirer to disclose
the information they need to evaluate and understand the nature and financial
effect of the business combination.  SFAS 141R is effective for
acquisitions made on or after the first day of annual periods beginning on or
after December 15, 2008.  We do not believe that the adoption of SFAS
141R will have a significant effect on our consolidated financial
statements.
  71
  In
December 2007, the FASB ratified the consensus reached by the Emerging Issues
Task Force on EITF Issue 07-1, “Accounting for Collaborative Arrangements”
(“EITF 07-1”).  EITF 07-1 requires collaborators to present the
results of activities for which they act as the principal on a gross basis and
report any payments received from (made to) other collaborators based on other
applicable GAAP or, in the absence of other applicable GAAP, based on analogy to
authoritative accounting literature or a reasonable, rational, and consistently
applied accounting policy election.  The guidance is effective for
fiscal years beginning after December 15, 2008.  We are currently in
the process evaluating whether the adoption of EITF 07-1 will have a significant
effect on our consolidated financial statements.
 
 In
October 2008, the FASB issued Staff Position “Determining the Fair Value of a
Financial Asset when the Market for That Asset is not Active” (FSP No.
157-3).  FSP No. 157-3 clarifies the application of SFAS 157 in a
market that is not active and provides an example to illustrate key
considerations in determining the fair value of a financial asset when market
for that financial asset is not active.  This guidance is effective
upon issuance, including prior periods for which financial statements have not
been issued.  The adoption of FSP No. 157-3 did not have a significant
effect on our consolidated financial statements.
 
 In June
2008, the FASB ratified the consensus on EITF Issue No. 07-5, “Determining
Whether an Instrument (or Embedded Feature) Is Indexed to an Entity’s Own
Stock”(“EITF
07-5”). EITF 07-5 provides aframework for
evaluating the terms of a particular instrument to determine whether such
instrument is considered a derivative financial instrument.  EITF 07-5 is
effective for financial statements issued for fiscal years beginning after
December 15, 2008 and must be applied by recording a cumulative effect
adjustment to the opening balance of retained earnings (or other appropriate
components of equity) as of the date of adoption. We anticipate the adoption of
EITF 07-5 will result is the recognition of a liability for the warrants issued
in August 2008 as part of our private placement of common stock of approximately
$2.9 million and a corresponding increase in stockholders’ deficit as of January
1, 2009.  Future changes in the fair value of the warrant liability
will be recognized as a component of earnings (loss).
  In April
2008, the FASB issued FASB Staff Position (“FSP”) FAS 142-3, “Determination of
the Useful Life of Intangible Assets.” This FSP amends the
factors that should be considered in developing renewal or extension assumptions
used to determine the useful life of a recognized intangible asset under FASB
Statement No. 142, Goodwill
and Other Intangible Assets. The intent of this FSP is to improve the
consistency between the useful life of a recognized intangible asset under
Statement 142 and the period of expected cash flows used to measure the fair
value of the asset under FASB Statement No. 141R, and other U.S. generally
accepted accounting principles. This FSP is effective for our interim and annual
financial statements beginning after November 15, 2008. We do not expect the
adoption of this FSP will have a material impact on the our financial
statements.
 
 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 balance
sheet.  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.  If and such revenues are recognized, deferred revenue
will be decreased (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.
  72
  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, 2008, Olympus holds approximately 13.7% (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 device technology, including the Celution® System platform
      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”) pursuant
to FASB Interpretation No. 46 (revised 2003), “Consolidation of Variable
Interest Entities - an interpretation of ARB No. 51” (“FIN 46R”), 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, 2008, the carrying value of our
investment in the Joint Venture is $324,000.
 
 We are
under no obligation to provide additional funding to the Joint Venture, but may
choose to do so.  We contributed $300,000 and $150,000 to the Joint
Venture during 2007 and 2006, respectively.  The Company made no
contribution during 2008.
 
 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, 2008 and 2007, the fair value of the Put
was $2,060,000 and $1,000,000, 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.
 
  73
  The
following assumptions were employed in estimating the value of the
Put:
 
 December
      31, 2008
                      
                      
                      December
      31, 2007
                      
                      
                      November
      4, 2005Expected
      volatility of
      Cytori
                      
                      
                      68.00
                      %
                      
                      
                      60.00
                      %
                      
                      
                      63.20
                      %Expected
      volatility of the Joint Venture
                      
                      
                      68.00
                      %
                      
                      
                      60.00
                      %
                      
                      
                      69.10
                      %Bankruptcy
      recovery rate for
      Cytori
                      
                      
                      21.00
                      %
                      
                      
                      21.00
                      %
                      
                      
                      21.00
                      %Bankruptcy
      threshold for
      Cytori
                      
                      $
                      16,740,000
                      
                      
                      $
                      9,324,000
                      
                      
                      $
                      10,780,000Probability
      of a change of control event for Cytori
                      
                      
                      2.80
                      %
                      
                      
                      2.17
                      %
                      
                      
                      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
                      
                      
                      2.25
                      %
                      
                      
                      4.04
                      %
                      
                      
                      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 technology for the development, manufacture,
and supply of the devices (second generation and beyond) for all therapeutic
applications.  Once a later generation Celution® System is developed
and approved by regulatory agencies, the Joint Venture may sell such systems
exclusively to us at a formula-based transfer price; we have retained marketing
rights to the second and all subsequent generation 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 and because no commercial
devices have yet been developed to trigger the forecast requirement, we estimate
that the fair value of this guarantee is de minimis as of December 31,
2008.
 
 In August
2007 we entered into a License and Royalty Agreement with the Joint
Venture.  This Royalty Agreement provides us the ability to
commercially launch the Celution® System
platform earlier than we could have otherwise done so under the terms of the
Joint Venture Agreements.  The Royalty Agreement allows for the sale
of the Cytori systems, including Celution® 800/CRS
and Celution® 900/MB,
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.  During the year ended December 31, 2008, in
connection with our sales of our Celution® 800/CRS
System products to the European and Asia-Pacific reconstructive surgery market,
we incurred approximately $157,000 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 condensed statement of
operations.
 
 Deferred
revenues, related party
 
 As of
December 31, 2008, 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.
 
  74
  Condensed
financial information for the Joint Venture
 
 A summary
of the unaudited condensed financial information for the Joint Venture as of
December 31, 2008 and 2007 and for the years ended December 31, 2008, 2007, and
2006 and reconciliation from the net loss of the joint venture to Cytori’s
equity loss from investment in joint venture is as follows:
 
 December
      31, 2008
                      
                      
                      December
      31, 2007(Unaudited)
                      
                      
                      (Unaudited)Balance
      SheetsAssets:Cash
                      
                      $
                      646,000
                      
                      
                      $
                      713,000Amounts
      due from  related party
                      
                      
                      24,000
                      
                      
                      
                      —Prepaid
      insurance
                      
                      
                      9,000
                      
                      
                      
                      9,000Computer
      equipment and software, net
                      
                      
                      20,000
                      
                      
                      
                      24,000Total
      assets
                      
                      $
                      699,000
                      
                      
                      $
                      746,000Liabilities
      and Stockholders’ Equity:Accrued
      expenses
                      
                      $
                      36,000
                      
                      
                      $
                      27,000Amounts
      due to related
      party
                      
                      
                      16,000
                      
                      
                      
                      72,000Stockholders’
      equity
                      
                      
                      647,000
                      
                      
                      
                      647,000Total
      liabilities and stockholders’ equity
                      
                      $
                      699,000
                      
                      
                      $
                      746,000
 
 
 Years
      ended December 31,2008
                                  
                                  
                                  2007
                                  
                                  
                                  2006Statements
      of Operation
                                  
                                  (Unaudited)
                                  
                                  
                                  (Unaudited)
                                  
                                  
                                  (Unaudited)Revenues:Royalty
      revenue
                                  
                                  $
                                  157,000
                                  
                                  
                                  $
                                  —
                                  
                                  
                                  $
                                  —Operating
      expenses:Research
      and development expense
                                  
                                  
                                  —
                                  
                                  
                                  
                                  —
                                  
                                  
                                  
                                  11,000,000General
      and administrative expense:Accounting
      and other corporate services
                                  
                                  
                                  75,000
                                  
                                  
                                  
                                  40,000
                                  
                                  
                                  
                                  172,000Quality
      system services
                                  
                                  
                                  64,000
                                  
                                  
                                  
                                  36,000
                                  
                                  
                                  
                                  -Other
                                  
                                  
                                  24,000
                                  
                                  
                                  
                                  10,000
                                  
                                  
                                  
                                  2,000Operating
      expenses
                                  
                                  
                                  163,000
                                  
                                  
                                  
                                  86,000
                                  
                                  
                                  
                                  11,174,000Operating
      loss
                                  
                                  
                                  (6,000
                                  )
                                  
                                  
                                  (86,000
                                  )
                                  
                                  
                                  (11,174,000
                                  )Other
      income (expense):Interest
      income
                                  
                                  
                                  5,000
                                  
                                  
                                  
                                  7,000
                                  
                                  
                                  
                                  -Net
      loss
                                  
                                  $
                                  (
      1,000
                                  )
                                  
                                  $
                                  (79,000
                                  )
                                  
                                  $
                                  (11,174,000
                                  )Reconciliation
      to equity loss from investment in joint ventureNet
      loss
                                  
                                  $
                                  (
      1,000
                                  )
                                  
                                  $
                                  (79,000
                                  )
                                  
                                  $
                                  (11,174,000
                                  )Intercompany
      eliminations
                                  
                                  
                                  88,000
                                  
                                  
                                  
                                  (65,000
                                  )
                                  
                                  
                                  (11,026,000
                                  )Net
      loss after intercompany eliminations
                                  
                                  
                                  (89,000
                                  )
                                  
                                  
                                  (14,000
                                  )
                                  
                                  
                                  (148,000
                                  )Cytori’s
      percentage of interest in joint venture
                                  
                                  
                                  50
                                  %
                                  
                                  
                                  50
                                  %
                                  
                                  
                                  50
                                  %Cytori’s
      equity loss from investment in joint
                                    venture
                                  
                                  $
                                  (45,000
                                  )
                                  
                                  $
                                  (7,000
                                  )
                                  
                                  $
                                  (74,000
                                  )
  4.       Fair
Value Measurements
  As
discussed in note 2, Fair Value of Financial Instruments, we adopted SFAS 157 on
January 1, 2008.  SFAS 157 emphasizes that fair value is a
market-based measurement, not an entity-specific
measurement.  Therefore, a fair value measurement should be determined
based on the assumptions that market participants would use in pricing the asset
or liability.  SFAS 157 establishes 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, with Level 1 having the highest priority and
Level 3 having the lowest:
  ·
                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.
  75
   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 MeasurementsDecember
      31, 2008
                    
                    
                    Level
      1
                    
                    
                    Level
      2
                    
                    
                    Level
      3Assets:Cash
      equivalents
                    
                    $
                    11,718,000
                    
                    
                    $
                    11,718,000
                    
                    
                    $
                    —
                    
                    
                    $
                    —Liabilities:Put
      option liability
                    
                    $
                    (2,060,000
                    )
                    
                    $
                    —
                    
                    
                    $
                    —
                    
                    
                    $
                    (2,060,000
                    )
  We use
quoted market prices to determine the fair value of our cash equivalents, which
consist of money market funds and other highly liquid, exchange-traded fixed
income and equity securities, and therefore these are classified in Level 1 of
the fair value hierarchy.
  Our put
option liability (see note 3) is valued 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
      endedPut
      option liability
                      
                      December
      31, 2008
                      
                      
                      December
      31, 2007Beginning
      balance
                      
                      $
                      (1,000,000
                      )
                      
                      $
                      (900,000
                      )Increase  in
      fair value recognized in operating expenses
                      
                      
                      (1,060,000
                      )
                      
                      
                      (100,000
                      )Ending
      balance
                      
                      $
                      (2,060,000
                      )
                      
                      $
                      (1,000,000
                      )
 
 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 condensed balance sheet as of
December 31, 2008.
 
 5.
              Gain
      on Sale of Assets
 
 Spine
& Orthopedics Product Line
 
 In May
2007, we sold to Kensey Nash our intellectual property rights and tangible
assets related to our spine and orthopedic bioresorbable implant product line, a
part of our MacroPore Biosurgery business.  Excluded from the sale was
our Japan Thin Film product line.  We received $3,175,000 in cash
related to the disposition.  The assets comprising the spine and
orthopedic product line transferred to Kensey Nash were as follows:
 
 Carrying
      Value Prior to DispositionInventory
                    
                    $
                    94,000Other
      current assets
                    
                    
                    17,000Assets
      held for sale
                    
                    
                    436,000Goodwill
                    
                    
                    465,000$
                    1,012,000
 
 We
incurred expenses of $109,000 in connection with the sale during the second
quarter of 2007.  As part of the disposition agreement, we were
required to provide training to Kensey Nash representatives in all aspects of
the manufacturing process related to the transferred spine and orthopedic
product line, and to act in the capacity of a product manufacturer from the
point of sale through August 2007.  Because of these additional
manufacturing requirements, we deferred $196,000 of the gain related to the
outstanding manufacturing requirements, and we recognized $1,858,000 as a gain
on sale in the statement of operations during the second quarter of
2007.  These manufacturing requirements were completed in August 2007
as planned, and the associated costs were classified against the deferred
balance, reducing it to zero.  No further costs or adjustments
relating to this product line sale were incurred subsequent to August
2007.
  76
  The
revenues and expenses related to the spine and orthopedic product line
transferred to Kensey Nash for the years ended December 31, 2007 and 2006 were
as follows:
 
 Years
      ended December 31,2007
                      
                      
                      2006Revenues
                      
                      $
                      792,000
                      
                      
                      $
                      1,451,000Cost
      of product revenues
                      
                      
                      (422,000
                      )
                      
                      
                      (1,634,000
                      )Research
      & development
                      
                      
                      (113,000
                      )
                      
                      
                      (1,052,000
                      )Sales
      & marketing
                      
                      
                      (21,000
                      )
                      
                      
                      (163,000
                      )
  6.
                Thin
      Film Japan Distribution Agreement
 In the
third quarter of 2004, we 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.  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.
 
 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.
 
 At the
inception of this arrangement, we received a $1,500,000 license fee which was
recorded as deferred revenues in 2004.  We have also received
$1,250,000 in milestone payments from Senko. See “Revenue Recognition” under
note 2 above for our policies with regard to the timing of when these amounts
will be recognized as revenues.
 
 As part
of the Thin Film sales agreement we granted MAST a right to acquire our Thin
Film-related interest in Japan.  This right expired unexercised on May
31, 2007.
 
 7.
              Short-term
      Investments
 
 We did
not have any short-term investments as of December 31, 2008 and 2007, as all our
excess cash is included with cash and cash equivalents in the accompanying
consolidated balance sheets.
 
 Proceeds
from sales and maturity of short term investments for the years ended December
31, 2008, 2007 and 2006 were $5,739,000, $28,007,000 and $67,137,000,
respectively. Gross realized losses for such sales were approximately $1,000 for
the year ended December 31, 2006.  There were no gross realized losses
for such sales for the years ended December 31, 2008 and 2007.
 
  77
  8.
              Composition
      of Certain Financial Statement
Captions
 
 Inventories,
net
 
 As of
December 31, 2008 and 2007, inventories, net, were comprised of the
following:
 
 December
      31,
                      
                      
                      December
      31,2008
                      
                      
                      2007Raw
      materials
                      
                      $
                      712,000
                      
                      
                      $
                      —Work
      in process
                      
                      
                      347,000
                      
                      
                      
                      —Finished
      goods
                      
                      
                      1,084,000
                      
                      
                      
                      —$
                      2,143,000
                      
                      
                      $
                      —
 
 Other
Current Assets
 
 As of
December 31, 2008 and 2007, other current assets were comprised of the
following:
 
 December
      31,
                    
                    
                    December
      31,2008
                    
                    
                    2007Prepaid
      insurance
                    
                    $
                    208,000
                    
                    
                    $
                    287,000Prepaid
      other
                    
                    
                    390,000
                    
                    
                    
                    411,000Capitalized
      debt issuance costs, current
                    
                    
                    252,000
                    
                    
                    
                    —Other
      receivables
                    
                    
                    313,000
                    
                    
                    
                    66,000$
                    1,163,000
                    
                    
                    $
                    764,000
 
 Property
and Equipment, net
 
 As of
December 31, 2008 and 2007, property and equipment, net, were comprised of the
following:
 
 December
      31,
                        
                        
                        December
      31,2008
                        
                        
                        2007Manufacturing
      and development equipment
                        
                        $
                        2,996,000
                        
                        
                        $
                        2,833,000Office
      and computer equipment
                        
                        
                        2,665,000
                        
                        
                        
                        2,430,000Leasehold
      improvements
                        
                        
                        3,125,000
                        
                        
                        
                        3,124,0008,786,000
                        
                        
                        
                        8,387,000Less
      accumulated depreciation and amortization
                        
                        
                        (6,234,000
                        )
                        
                        
                        (4,955,000
                        )$
                        2,552,000
                        
                        
                        $
                        3,432,000
 
 Accounts
Payable and Accrued Expenses
 
 As of
December 31, 2008 and 2007, accounts payable and accrued expenses were comprised
of the following:
 
 December
      31,
                        
                        
                        December
      31,2008
                        
                        
                        2007Accrued
      legal fees
                        
                        $
                        1,196,000
                        
                        
                        $
                        2,749,000Accrued
      R&D studies
                        
                        
                        1,110,000
                        
                        
                        
                        1,263,000Accounts
      payable
                        
                        
                        464,000
                        
                        
                        
                        479,000Accrued
      vacation
                        
                        
                        774,000
                        
                        
                        
                        816,000Accrued
      bonus
                        
                        
                        —
                        
                        
                        
                        886,000Accrued
      expenses
                        
                        
                        842,000
                        
                        
                        
                        623,000Deferred
      rent
                        
                        
                        305,000
                        
                        
                        
                        265,000Warranty
      reserve
                        
                        
                        23,000
                        
                        
                        
                        67,000Accrued
      accounting fees
                        
                        
                        302,000
                        
                        
                        
                        131,000Accrued
      payroll
                        
                        
                        72,000
                        
                        
                        
                        70,000$
                        5,088,000
                        
                        
                        $
                        7,349,000
 
  78
  9.
              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
      Leases2009
                        
                        
                        1,754,0002010
                        
                        
                        814,0002011
                        
                        
                        85,0002012
                        
                        
                        60,0002013
                        
                        
                        25,0002014
                        
                        
                        8,000Total
                        
                        $
                        2,746,000
 
 On May
24, 2005, we entered into a lease for 91,000 square feet of space located at
3020 and 3030 Callan Road, San Diego, California.  The majority of our
operations are located in this facility.  The agreement bears monthly
rent at an initial rate of $1.15 per square foot, with annual increases of
3%.  The lease term is 57 months, commencing on October 1, 2005 and
expiring on June 30, 2010.  Payments for our Callan Road location
commenced in June 2006.
 
 We also
lease 4,027 square feet of office space located at 9-3 Otsuka 2-chome,
Bunkyo-ku, Tokyo, Japan.  The agreement bears rent at a rate of $4.38
per square foot, for a term of two years expiring on November 30,
2009.
 
 Additionally,
we entered into a new lease during the second quarter of 2008 for a 900 square
feet of office space located at Via Gino Capponi n. 26, Florence,
Italy.  The lease agreement provides for rent at a rate of $2.63 per
square foot, expiring on April 22, 2014.  Additionally, we’ve entered
into several lease agreements for corporate housing for our employees on
international assignments.
 
 Rent
expense, which includes common area maintenance, for the years ended December
31, 2008, 2007 and 2006 was $2,015,000, $1,992,000 and $2,397,000,
respectively.
 
 We have
entered into agreements with various clinical 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 pre-clinical development 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, 2008, we have pre-clinical research
study obligations of $563,000 (all of which are expected to be complete within a
year) and clinical research study obligations of $5,839,000 ($4,000,000 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 minimum purchase requirements
clause.  As of December 31, 2008, we have minimum purchase obligations
of $2,125,000 ($850,000 of which are to be expected to complete 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 10 for a discussion of our commitments and contingencies related to our
interactions with the University of California.
 
 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.
 
  79
  10.
              License
      Agreement
 
 On
October 16, 2001, StemSource, Inc. entered into an exclusive worldwide license
agreement with the Regents of the University of California or UC, licensing all
of UC’s rights to certain pending patent applications being prosecuted by UC and
(in part) by the University of Pittsburgh, for the life of these patents, with
the right of sublicense.  The exclusive license relates to an issued
patent number 6,777,231, which we refer to as the ‘231 Patent, and various
pending applications relating to adipose-derived stem cells.  In
November 2002, we acquired StemSource, and the license agreement was assigned to
us.
 
 The
agreement, which was amended and restated in September 2006 to better reflect
our business model, calls for various periodic payments until such time as we
begin commercial sales of any products utilizing the licensed
technology.  Upon achieving commercial sales of products or services
covered by the UC license agreement, we will be required to pay variable earned
royalties based on the net sales of products sold.  Minimum royalty
amounts will increase annually with a plateau in 2015.  In addition,
there are certain due diligence milestones that are required to be reached as a
result of the agreement.  Failure to fulfill these milestones may
result in a reduction of or loss of the specific rights to which the affected
milestone relates.
 
 In
connection with the amendment of the agreement in the third quarter of 2006, we
agreed to issue 100,000 shares of our common stock to UC in the fourth quarter
of 2006.  At the time the agreement was reached, our shares were
trading at $4.87 per share.  The expense was charged to general and
administrative expense.
 
 Additionally,
we are obligated to reimburse UC for patent prosecution and other legal costs on
any patent applications contemplated by the agreement.  In particular,
the University of Pittsburgh filed a lawsuit in the fourth quarter of 2004,
naming all of the inventors who had not assigned their ownership interest in the
‘231 Patent to the University of Pittsburgh.  It was seeking a
determination that its assignors, rather than UC’s assignors, are the true
inventors of the ‘231 Patent.  This lawsuit has subjected us to and
will likely continue to subject us to significant costs and
expenses.
 
 On August
9, 2007, the United States District Court, or the Court, granted the University
of Pittsburgh’s motion for Summary Judgment in part, determining that the
University of Pittsburgh’s assignors were properly named as inventors on the
‘231 Patent, and that all other inventorship issues shall be determined
according to the facts presented at trial.  The trial was concluded in
January 2008 and on June 9, 2008 the Court signed its final order which we
received on June 12, 2008.  The Court concluded that the University of
Pittsburgh’s assignors were the sole inventors of the ‘231
Patent.  The Court’s decision terminated UC’s rights to the ‘231
Patent.  Upon review of the Court’s findings, we believe that the
Court’s decision was in error.  The UC assignors have agreed to appeal
the decision and a Notice of Appeal was filed on July 9, 2008.  If the
UC assignors’ appeal of the Court’s decision is successful, UC’s rights to the
‘231 Patent should be reinstated.
 
 We are
not named as a party to the lawsuit, but our president, Marc Hedrick, is one of
the inventors identified on the ‘231 Patent and therefore is a named individual
defendant.  Due to our license obligations to UC relating to the ‘231
Patent and other UC patent applications, we have provided substantial financial
and other assistance to the defense of the lawsuit. Since our current products
and products under development do not practice the ‘231 Patent, our primary
ongoing business activities and product development pipeline should not be
affected by the Court’s decision. Although the ‘231 Patent is unrelated to our
current products and product pipeline, we believe that the ‘231 Patent and/or
the other technology licensed from UC may have long term potential to be useful
for future product developments, and so we have elected to support UC’s legal
efforts in the appeal of the Court’s final order.
 
 In the
years ended December 31, 2008, 2007 and 2006, we expensed $625,000, $2,418,000
and $2,189,000, respectively, for legal fees related to this
license.  These expenses have been classified as general and
administrative expense in the accompanying consolidated financial
statements.  We believe that the $896,000 accrued as of December 31,
2008 is a reasonable estimate of our liability for the unpaid expenses incurred
through December 31, 2008.
 
 11.
              Long-term
      Obligations
 
 On
October 14, 2008, we entered into a Loan and Security Agreement with General
Electric Capital Corporation and Silicon Valley Bank (together, the “Lenders”)
pursuant to which the Lenders agreed to make term loans to the Company in the
aggregate principal amount of $15,000,000, and secured by property and assets of
the Company.  An initial term loan of $7,500,000, less fees and
expenses, funded on October 14, 2008.  The term loan accrues interest
at a fixed rate of 10.58% per annum and is payable over a 37-month
period.  At maturity of each term loan, we will also make a final
payment equal to 5% ($375,000) of the term loan, and treated it as a discount to
the loan.  We may incur additional fees if we elect to prepay a term
loan.  In connection with the loan facility, on October 14, 2008, we
issued to each Lender a warrant to purchase up to 89,074 shares of our common
stock at an exercise price of $4.21 per share.  These warrants are
immediately exercisable and will expire on October 14, 2018.  We could
not access the remaining $7,500,000 under this facility as we were not able to
meet certain financial prerequisites that had been established by the
Lenders.
  80
  We
allocated the aggregate proceeds of the term loan between the warrants and the
debt obligations based on their relative fair values in accordance with
Accounting Principle Board No. 14 (APB 14), “ Accounting for Convertible
Debt and Debt Issued with Stock Purchase Warrants .”  The fair value
of the warrant issued to the Lenders is calculated utilizing the Black-Scholes
option-pricing model. We are amortizing the resultant discount of $564,000 over
the term of the loan using the effective interest method, with effective
interest rate being 21.28%. If the maturity of the debt is accelerated because
of defaults or conversions, then the amortization is accelerated. We were in
compliance with our financial and non-financial covenants as of December 31,
2008.  As of December 31, 2008, unamortized balance of the aggregate
debt discount is $823,000.
 
 Additional
details relating to the above term loan that is outstanding as of December 31,
2008, are presented in the following table:
 
 Origination Date
                      
                      Original
      Loan Amount
                      
                      
                      Interest
                        Rate
                      
                      
                      Current
                        Monthly
                        Payment*
                      
                      Term
                      
                      Remaining
                        Principal
                        (Face
      Value)October
      2008
                      
                      $
                      7,500,000
                      
                      
                      
                      10.58
                      %
                      
                      $
                      71,000
                      
                      37
      Months
                      
                      $
                      7,500,000
 ________________________________________
 *           Current
payment is interest only (starting March 2009 monthly payment will be $263,000
which includes principal and interest)
 
 As of
December 31, 2008, the future contractual principal payments on all of our
promissory notes are as follows:
 
 For
      the Years Ending December 31,2009
                        
                        $
                        2,047,0002010
                        
                        
                        2,706,0002011
                        
                        
                        2,747,000Total
                        
                        $
                        7,500,000
  Reconciliation
      of Face Value to Book ValueTotal
      debt and lease obligation, including final payment fee (Face
      Value)
                            
                            $
                            7,914,000Less:
      Debt Discount
                            
                            
                            (823,000
                            )Total:
                            
                            
                            7,091,000Less:
      Current Portion
                            
                            
                            (2,047,000
                            )Long-Term
      Obligation
                            
                            $
                            5,044,000
 
 Additionally,
we entered into a capital lease for the printers for our main
building.   We recorded value of the leased printers in our
property, plant, and equipment balance and accrued $39,000 in long term
obligations, respectively.
 
 Our
interest expense for the years ended December 31, 2008, 2007 and 2006 (all of
which related to the loan entered into October 2008 and promissory notes issued
in connection with our Amended Master Security Agreement, which was fully repaid
in 2008) was $420,000, $155,000 and $199,000, respectively.  For the
year ended December 31, 2008, interest expense is calculated using the effective
interest method, therefore it is inclusive of non-cash amortization in the
amount of $178,000 related to the amortization of the debt discount and
capitalized loan fees.
 
 12.
              Income
      Taxes
 
 Due to
our net loss position for the years ended December 31, 2008, 2007 and 2006, 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, 2008, 2007, and 2006.
 
  81
  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, 2008, 2007 and
2006 is as follows:
 
 2008
                      
                      
                      2007
                      
                      
                      2006Income
      tax expense (benefit) at federal statutory rate
                      
                      
                      (34.00
                      )%
                      
                      
                      (34.00
                      )%
                      
                      
                      (34.00
                      )%Stock
      based
      compensation
                      
                      
                      0.56
                      %
                      
                      
                      0.92
                      %
                      
                      
                      0.99
                      %Credits
                      
                      
                      (1.67
                      )%
                      
                      
                      (4.87
                      )%
                      
                      
                      (2.72
                      )%Change
      in federal valuation
      allowance
                      
                      
                      38.38
                      %
                      
                      
                      41.62
                      %
                      
                      
                      34.52
                      %Equity
      loss on investment in Joint Venture
                      
                      
                      0.06
                      %
                      
                      
                      0.01
                      %
                      
                      
                      0.12
                      %Other,
      net
                      
                      
                      (3.33
                      )%
                      
                      
                      (3.68
                      )%
                      
                      
                      1.09
                      %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, 2008 and
2007 are as follows:
 
 2008
                      
                      
                      2007Deferred
      tax assets:Allowances
      and reserves
                      
                      $
                      84,000
                      
                      
                      $
                      55,000Accrued
      expenses
                      
                      
                      452,000
                      
                      
                      
                      582,000Deferred
      revenue and gain on sale of assets
                      
                      
                      4,950,000
                      
                      
                      
                      5,910,000Stock
      based compensation
                      
                      
                      2,965,000
                      
                      
                      
                      2,528,000Net
      operating loss carryforwards
                      
                      
                      48,265,000
                      
                      
                      
                      37,704,000Income
      tax credit carryforwards
                      
                      
                      4,665,000
                      
                      
                      
                      4,140,000Capitalized
      assets and other
                      
                      
                      371,000
                      
                      
                      
                      284,000Property
      and equipment, principally due to differences in
    depreciation
                      
                      
                      549,000
                      
                      
                      
                      —62,301,000
                      
                      
                      
                      51,203,000Valuation
      allowance
                      
                      
                      (61,965,000
                      )
                      
                      
                      (50,435,000
                      )Total
      deferred tax assets, net of allowance
                      
                      
                      336,000
                      
                      
                      
                      768,000Deferred
      tax liabilities:Property
      and equipment, principally due to differences in
    depreciation
                      
                      
                      —
                      
                      
                      
                      (338,000
                      )Intangibles
                      
                      
                      (336,000
                      )
                      
                      
                      (430,000
                      )Other
                      
                      
                      —
                      
                      
                      
                      —Total
      deferred tax liability
                      
                      
                      (336,000
                      )
                      
                      
                      (768,000
                      )Net
      deferred tax assets (liability)
                      
                      $
                      —
                      
                      
                      $
                      —
 
 We have
established a valuation allowance against our net deferred tax asset due to the
uncertainty surrounding the realization of such assets. Management periodically
evaluates the recoverability of the deferred tax asset. 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 $61,965,000 as of December 31, 2008 to reflect the estimated amount of
deferred tax assets that may not be realized. We increased our valuation
allowance by approximately $11,529,000 for the year ended December 31, 2008. The
valuation allowance includes approximately $579,000 related to stock option
deductions, the benefit of which will be credited to equity if ever
utilized.
 
 At
December 31, 2008, we had federal and state tax net operating loss carryforwards
of approximately $117,177,000 and $98,679,000, respectively. The federal and
state net operating loss carryforwards begin to expire in 2019 and 2011,
respectively, if unused. At December 31, 2008, we had federal and state tax
credit carryforwards of approximately $3,364,000 and $3,043,000, respectively.
The federal credits will begin to expire in 2017, if unused, and $160,000 of the
state credits will begin to expire in 2009 if unused. The remaining state
credits carry forward indefinitely.  In addition, we had a foreign tax
loss carryforward of $4,142,000 and $93,000 in Japan and Italy,
respectively.
 
 The
Internal Revenue Code limits the future availability of net operating loss and
tax credit carryforwards that arose prior to certain cumulative changes in a
corporation’s ownership resulting in a change of our control. Due to prior
ownership changes as defined in IRC Section 382, a portion of the net operating
loss and tax credit carryforwards are limited in their annual utilization. In
September 1999, we experienced an ownership change for purposes of the IRC
Section 382 limitation. As of December 31, 2007, these pre-change net operating
losses and credits are fully available.
 
 Additionally,
in 2002 when we purchased StemSource, we acquired federal and state net
operating loss carryforwards of approximately $2,700,000 and $2,700,000,
respectively. This event triggered an ownership change for purposes of IRC
Section 382. It is estimated that the pre-change net operating losses and
credits will be fully available by 2008.
 
 We have
completed an update to our IRC Section 382 study analysis through April 17,
2007.  We have not had any additional ownership changes based on this
study.
  82
  As a
result of the adoption of SFAS 123R, we recognize windfall 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 occurring from January 1, 2006 onward.  At December 31, 2008,
deferred tax assets do not include $1,193,000 of excess tax benefits from
stock-based compensation.
 
 We
adopted FIN 48 on January 1, 2007.  There were no unrecognized tax
benefits as of the date of adoption.
 
 Following
is a tabular reconciliation of the unrecognized tax benefits activity during
2008:
 
 Unrecognized
      Tax Benefits – December 31, 2007
                    
                    $
                    716,000Gross
      increases – tax positions in prior period
                    
                    
                    —Gross
      decreases – tax positions in prior period
                    
                    
                    —Gross
      increase – current-period tax positions
                    
                    
                    236,000Settlements
                    
                    
                    —Lapse
      of statute of limitations
                    
                    
                    —Unrecognized
      Tax Benefits – December 31, 2008
                    
                    $
                    952,000
 
 None of
the amount included in the FIN 48 liability 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,
2008.
 
 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 gross FIN 48 liability within
the next twelve months.
 
 13.
              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 2008, 2007 and
2006.
 
 14.
              Stockholders’
      Deficit
 
 Preferred
Stock
 
 We have
authorized 5,000,000 shares of $.001 par value preferred stock, with no shares
outstanding as of December 31, 2008 and 2007. 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
 
 In
February 2007, we completed a registered direct public offering of units
consisting of common stock and warrants.  We received net proceeds of
$19,901,000 from the sale of units consisting of 3,746,000 shares of common
stock and 1,873,000 common stock warrants (with an exercise price of $6.25 per
share and a five-year exercisability period) under our shelf registration
statement.
 
 On
February 8, 2008, we agreed to sell 2,000,000 shares of unregistered common
stock to Green Hospital Supply, Inc., a related party, for $12,000,000 cash, or
$6.00 per share in a private stock placement.  On February 29, 2008,
we closed the first half of the private placement with Green Hospital Supply,
Inc. and received $6,000,000.  We closed the second half of the
private placement on April 30, 2008 and received the second payment of
$6,000,000. As of December 31, 2008, Green Hospital Supply, Inc., a related
party, holds approximately 10.2% (unaudited) of our issued and outstanding
shares.
  83
  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.
 
 We have
accounted for the warrants as permanent equity, consistent with EITF 00-19,
“Accounting for Derivative Financial Instruments Indexed to, and Potentially
Settled in, a Company’s Own Stock”.  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 warrant holder can only exercise through the
cashless exercise feature of the warrant agreement.
 
 In June
2008, the FASB ratified the consensus on EITF Issue No. 07-5, “Determining
Whether an Instrument (or Embedded Feature) Is Indexed to an Entity’s Own
Stock”(“EITF
07-5”). EITF 07-5 provides aframework for
evaluating the terms of a particular instrument to determine whether such
instrument is considered a derivative financial instrument.  EITF 07-5 is
effective for financial statements issued for fiscal years beginning after
December 15, 2008 and must be applied by recording a cumulative effect
adjustment to the opening balance of retained earnings (or other appropriate
components of equity) as of the date of adoption. We anticipate the adoption of
EITF 07-5 will result is the recognition of a liability for the warrants issued
in August 2008 as part of our private placement of common stock of approximately
$2.9 million and a corresponding increase in stockholders’ deficit as of January
1, 2009. Future changes in the fair value of the warrant liability will be
recognized as a component of earnings (loss).
 
 Warrant
Adjustments
 
 Our
issuance of warrants with an exercise price of $4.21 per share to the Lenders,
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, the common stock warrants issued on August
11, 2008, are currently exercisable for 1,413,896 shares of our common stock at
an exercise price of $8.49 per share.
 
 Treasury
Stock
 
 On August
11, 2003, the Board of Directors authorized the repurchase of up to 3,000,000
shares of our common stock in the open market, from time to time until August
10, 2004 at a purchase price per share not to exceed €15.00, based on the
exchange rate in effect on August 11, 2003. During 2003, we repurchased 614,099
shares of our Common Stock at an average cost of $3.69 per share for a total of
$2,266,000.
 
 In 2003,
we sold 150,500 shares of treasury stock for $542,000 at an average price of
$3.60 per share. The basis of the treasury stock sold was the weighted average
purchase price or $3.67 per share with the difference of $10,000 accounted for
as a reduction to additional paid-in capital.
 
 On
December 6, 2003, we exchanged 1,447,755 shares of common stock (all listed on
the Frankfurt Stock Exchange) held in our treasury for 1,447,755 of our unlisted
outstanding common stock issued to former StemSource shareholders. $104,000 was
accounted for as a charge against additional paid-in capital relating to the
difference between the weighted average purchase price and fair market value of
the listed shares held in treasury at the time of the exchange.
 
 In 2004,
we repurchased 27,650 shares of our common stock for $76,000 on the open market
at a price of $2.75 per share. Additionally in 2004, we repurchased 262,602
shares of our common stock for $976,000 from a former director and officer of
StemSource at a price of $3.72 per share.
 
 Our
repurchase program expired on August 10, 2004. We have no plans to initiate a
new repurchase program at this time.
 
 In April
2007, we sold 1,000,000 shares of unregistered common stock from our treasury to
Green Hospital Supply, Inc. for $6,000,000 cash, or $6.00 per
share.  The basis of the treasury stock sold was the weighted average
purchase price, or $3.62 per share, and the difference of $2.38 per share, or
$2,380,000, was accounted for as an increase to additional paid-in
capital.
 
 15.
              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
  84
  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 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.
 
 16.
              Stock-based
      Compensation
 
 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, 2008, there are
2,190,450 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.
 
 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.
 
 Generally,
awards issued under the 2004 Plan or the 1997 Plan are subject to four-year
vesting, and have a contractual term of 10 years.  Most awards 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.
 
  85
  A summary
of activity for the year ended December 31, 2008 is as follows:
 
 Options
                    
                    
                    Weighted
      Average Exercise PriceBalance
      as of January 1, 2008
                    
                    
                    6,007,275
                    
                    
                    $
                    4.85Granted
                    
                    
                    534,250
                    
                    
                    $
                    5.21Exercised
                    
                    
                    (388,536
                    )
                    
                    $
                    2.04Expired
                    
                    
                    (146,777
                    )
                    
                    $
                    6.50Cancelled/forfeited
                    
                    
                    (77,505
                    )
                    
                    $
                    5.68Balance
      as of December 31, 2008
                    
                    
                    5,928,707
                    
                    
                    $
                    5.02
 
 Options
                      
                      
                      Weighted
      Average Exercise Price
                      
                      
                      Weighted
      Average Remaining Contractual Term (years)
                      
                      
                      Aggregate
      Intrinsic ValueBalance
      as of December 31, 2008
                      
                      
                      5,928,707
                      
                      
                      $
                      5.02
                      
                      
                      
                      5.34
                      
                      
                      $
                      936,815Vested
      and expected to vest at December 31, 2008
                      
                      
                      5,825,490
                      
                      
                      $
                      5.00
                      
                      
                      
                      5.29
                      
                      
                      $
                      933,678Vested
      and exercisable at December 31, 2008
                      
                      
                      4,775,056
                      
                      
                      $
                      4.85
                      
                      
                      
                      4.62
                      
                      
                      $
                      901,759
 
 The
following table summarizes information about options outstanding as of December
31, 2008:
 
 Options
      Outstanding
                        
                        
                        Options
      ExercisableRange of Exercise Price
                        
                        
                        Number
      of Shares
                        
                        
                        Weighted
                          Average
                          Exercise
                          Price
                        
                        
                        Weighted
                          Average
                          Remaining
                          Contractual Life
                          in Years
                        
                        
                        Number
      of Shares
                        
                        
                        Weighted
                          Average
                          Exercise
                          PriceLess
      than $2.00
                        
                        
                        
                        32,218
                        
                        
                        $
                        0.72
                        
                        
                        
                        0.5
                        
                        
                        
                        32,218
                        
                        
                        $
                        0.72$
                        2.00
      – 3.99
                        
                        
                        
                        1,538,168
                        
                        
                        $
                        3.06
                        
                        
                        
                        3.7
                        
                        
                        
                        1,488,784
                        
                        
                        $
                        3.07$
                        4.00
      – 5.99
                        
                        
                        
                        2,759,822
                        
                        
                        $
                        4.76
                        
                        
                        
                        6.4
                        
                        
                        
                        1,989,179
                        
                        
                        $
                        4.56$
                        6.00
      – 7.99
                        
                        
                        
                        1,265,332
                        
                        
                        $
                        6.84
                        
                        
                        
                        5.1
                        
                        
                        
                        1,013,064
                        
                        
                        $
                        6.89$
                        8.00
      – 9.99
                        
                        
                        
                        256,167
                        
                        
                        $
                        8.67
                        
                        
                        
                        6.9
                        
                        
                        
                        174,811
                        
                        
                        $
                        8.68More
      than $10.00
                        
                        
                        
                        77,000
                        
                        
                        $
                        13.18
                        
                        
                        
                        1.2
                        
                        
                        
                        77,000
                        
                        
                        $
                        13.185,928,707
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        4,775,056
 
 The total
intrinsic value of stock options exercised was $1,849,000, $1,758,000, and
$1,913,000 for the years ended December 31, 2008, 2007 and 2006,
respectively.
 
 The fair
value of each option awarded during the year ended December 31, 2008, 2007, and
2006 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 31,2008
                      
                      
                      2007
                      
                      
                      2006Expected
      term
                      
                      5
      years
                      
                      
                      6
      years
                      
                      
                      6
      yearsRisk-free
      interest rate
                      
                      
                      2.83
                      %
                      
                      
                      4.59
                      %
                      
                      
                      4.50
                      %Volatility
                      
                      
                      59.62
                      %
                      
                      
                      74.61
                      %
                      
                      
                      78.61
                      %Dividends
                      
                      
                      —
                      
                      
                      
                      —
                      
                      
                      
                      —Resulting
      weighted average grant date fair value
                      
                      $
                      2.77
                      
                      
                      $
                      3.74
                      
                      
                      $
                      5.26
 
 Through
December 31, 2007, the expected term assumption was estimated using the
“simplified method,” as described in Staff Accounting Bulletin No. 107,
“Share-Based Payment” (“SAB 107”).  This method estimates the expected
term of an option based on the average of the vesting period and the contractual
term of an option award.   Starting January 1, 2008, following
the guidance of Staff Accounting Bulletin No. 110, “Share-Based Payment” 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.  The fair value of each option awarded during
the year ended December 31, 2008 was estimated assuming an expected term of 5.0
years.
 
 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
  86
  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.
 
 The
following summarizes the total compensation cost recognized in the accompanying
financial statements:
 
 Years
      ended December 31,2008
                    
                    
                    2007
                    
                    
                    2006Total
      compensation cost for share-based payment arrangements recognized in the
      statement of operations (net of tax of $0)
                    
                    $
                    2,257,000
                    
                    
                    $
                    2,310,000
                    
                    
                    $
                    3,220,000
 
 As of
December 31, 2008, the total compensation cost related to non-vested stock
options not yet recognized for all of our plans is approximately $3,494,000.
These costs are expected to be recognized over a weighted average period of 1.67
years.
 
 In
calculating the fair value of option awards granted after January 1, 2006, we
generally used the same methodologies and assumptions employed prior to our
adoption of SFAS 123R.  For instance, our estimate of expected
volatility is based exclusively on our historical volatility, since we have
granted options that vest purely based on the passage of time and otherwise meet
the criteria to exclusively rely on historical volatility, as set out in SAB
107.  We did, however, change our policy of attributing the cost of
share-based payment awards granted after January 1, 2006 from the “graded
vesting approach” to the “straight-line” method. We believe that this change
more accurately reflects the manner in which our employees vest in an option
award.
 
 Cash
received from stock option and warrant exercises for the years ended December
31, 2008, 2007 and 2006 was approximately $795,000, $1,875,000, and $920,000,
respectively.  SFAS 123R requires that cash flows resulting from
tax deductions in excess of the cumulative compensation cost recognized for
options exercised (excess tax benefits) be classified as cash inflows provided
by financing activities and cash outflows used in operating
activities.  No income tax benefits have been recorded related to the
stock option exercises.  SFAS 123R prohibits recognition of tax
benefits for exercised stock options until such benefits are
realized.  As we presently have tax loss carryforwards from prior
periods and expect to incur tax losses in 2008, we are not able to benefit from
the deduction for exercised stock options in the current reporting
period.
 
 In
November 2005, the FASB issued Staff Position (FSP) No. FAS 123(R)-3,
“Transition Election Related to Accounting for Tax Effects of Share-Based
Payment Awards” (FSP 123R-3). We have elected to adopt the alternative
transition method provided in the FSP 123R-3 for calculating the tax effects of
stock-based compensation pursuant to SFAS 123R. The alternative transition
method includes simplified methods to establish the beginning balance of the
APIC pool related to the tax effects of employee stock-based compensation, and
to determine the subsequent impact on the APIC pool and Consolidated Statements
of Cash Flows of the tax effects of employee stock-based compensation awards
that are outstanding upon adoption of SFAS 123R.
 
 To settle
stock option awards that will be exercised, we will issue new shares of our
common stock.  At December 31, 2008, we have an aggregate of
64,104,526 shares authorized and available to satisfy option exercises under our
plans.
 
 Cash used
to settle equity instruments granted under share-based payment arrangements
amounted to $0 in all periods presented.
 
 Award
Modifications
 
 On August
2, 2007, our Senior Vice President – Research - Regenerative Cell Technology
(“VP”) terminated employment with us.  We paid the former VP a lump
sum cash severance payment of $66,667 and extended the exercise period of his
35,000 vested stock options through December 31, 2007.  In addition to
the cash severance payment, we recorded stock based compensation expense of
$5,741 in the third quarter of 2007, which reflects the incremental fair value
of the extended vested stock options (over the fair value of the original awards
at the modification date).
 
 In
connection with the sale of our HYDROSORBTM spine and orthopedics surgical
implant product line, we eliminated the positions of two less senior employees
on August 31, 2007.  At the time these positions were eliminated, we
(a) accelerated the vesting of 2,084 unvested stock options held by these two
employees, and (b) extended the exercise period of 37,292 vested stock options
owned by them through December 31, 2008.  16,041 unvested stock
options held by these two employees were forfeited.
 
 In
connection with the above modifications and in accordance with SFAS 123R, we
recorded additional stock based compensation expense of $58,402 in the year
ended December 31, 2007, as a component of general and
administrative.  This charge constitutes the entire expense related to
the modification of these options, and no future period charges will be
required.
  87
  Marshall
G. Cox retired from our board of directors (and his employment by the Company
thereby ceased) on May 3, 2007.  We subsequently entered into a
consulting agreement with Mr. Cox whereby he will continue to provide services
to the Company through March 1, 2009.  Subject to his continued
service to the Company, all of Mr. Cox’s outstanding stock options previously
granted to him in his capacity as a director will continue to vest and be
exercisable, in accordance with their original terms.  As of May 3,
2007, Mr. Cox held a total of 91,250 unvested stock options.  After
May 3, 2007, the fair value of Mr. Cox’s unvested stock options will be
remeasured each reporting period until they fully vest.  There was no
additional stock based compensation expense recorded as a result of the
modification of Mr. Cox’s options.
 
 In May
2006, our Senior Vice President of Finance and Administration, Treasurer, and
Principal Accounting Officer terminated full-time employment with
us.  In connection with his full-time employment termination, we
extended the exercise period of his 204,997 vested stock options as of May 31,
2006 to December 31, 2007.  Moreover, we entered into a part-time
employment agreement with him according to which all stock option vesting ceased
as of May 31, 2006, resulting in the cancellation of 75,003 non-vested stock
options on May 31, 2006.
 
 In
connection with a broader reduction in force, we eliminated the positions of our
Senior Vice President, Business Development, and Vice President, Marketing &
Development, on July 25, 2006.  We subsequently entered into
short-term employment agreements with the individuals formerly holding these
positions.  These individuals continued to provide service to us
following the elimination of their former positions on July 25,
2006.  At the time these positions were eliminated, 142,686 non-vested
stock options held by these two employees were forfeited.  Moreover,
subject to certain restrictions, we extended the exercise period for 328,564
vested stock options held by these employees to December 31, 2007.
 
 We also
eliminated the position of a less senior employee on July 31,
2006.  Simultaneously, we continued the individual’s employment in a
new capacity; however, we cancelled 8,125 non-vested stock options held by this
individual on July 31, 2006.
 
 In
connection with the above modifications and in accordance with SFAS 123R, we
recorded additional expense of $567,000 in the year ended December 31, 2006, as
components of research and development, general and administrative and sales and
marketing expense.  This charge constitutes the entire expense related
to these options, and no future period charges will be required.
 
 Non-Employee
Stock Based Compensation
 
 In the
fourth quarter of 2007, we granted an option to purchase 22,500 shares of our
common stock to a non-employee scientific advisor.  The stock option
has a contractual term of 10 years and 7,500 shares vested on May 31, 2008, with
two remaining tranches of 7,500 shares each to vest on May 31, 2009 and 2010,
subject to the individual’s continued service to the Company.  This
scientific advisor will also be receiving cash consideration as services are
performed.  We will remeasure the fair value of this advisor’s
unvested stock options each reporting period until they fully vest, and the
resulting stock based compensation expense will be recorded as a component of
research and development expenses.
 
 17.
              Related
      Party Transactions
 
 Refer to
note 3 for a discussion of related party transactions with Olympus and note 14
for a discussion of related party transactions with Green Hospital Supply,
Inc.
 
  88
  18.
              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 endedMarch 31,
                      2008
                    
                    
                    June 30,
                      2008
                    
                    
                    September 30,
                      2008
                    
                    
                    December 31,
                      2008Product
      revenues
                    
                    $
                    153,000
                    
                    
                    $
                    1,404,000
                    
                    
                    $
                    2,319,000
                    
                    
                    $
                    652,000Gross
      profit
                    
                    
                    93,000
                    
                    
                    
                    729,000
                    
                    
                    
                    1,671,000
                    
                    
                    
                    181,000Development
      revenues
                    
                    
                    811,000
                    
                    
                    
                    12,000
                    
                    
                    
                    1,000
                    
                    
                    
                    1,501,000Operating
      expenses
                    
                    
                    9,232,000
                    
                    
                    
                    9,113,000
                    
                    
                    
                    8,481,000
                    
                    
                    
                    7,934,000Other
      income
                    
                    
                    55,000
                    
                    
                    
                    (41,000
                    )
                    
                    
                    (8,000
                    )
                    
                    
                    (281,000
                    )Net
      loss
                    
                    $
                    (8,273,000
                    )
                    
                    $
                    (8,413,000
                    )
                    
                    $
                    (6,817,000
                    )
                    
                    $
                    (6,533,000
                    )Basic
      and diluted net loss per share
                    
                    $
                    (0.34
                    )
                    
                    $
                    (0.33
                    )
                    
                    $
                    (0.24
                    )
                    
                    $
                    (0.22
                    )
 
 
 For the three months endedMarch 31,
                      2007
                    
                    
                    June 30,
                      2007
                    
                    
                    September 30,
                      2007
                    
                    
                    December 31,
                      2007Product
      revenues
                    
                    $
                    280,000
                    
                    
                    $
                    512,000
                    
                    
                    $
                    —
                    
                    
                    $
                    —Gross
      profit
                    
                    
                    55,000
                    
                    
                    
                    315,000
                    
                    
                    
                    —
                    
                    
                    
                    —Development
      revenues
                    
                    
                    45,000
                    
                    
                    
                    1,814,000
                    
                    
                    
                    3,373,000
                    
                    
                    
                    25,000Operating
      expenses
                    
                    
                    8,908,000
                    
                    
                    
                    8,245,000
                    
                    
                    
                    8,983,000
                    
                    
                    
                    10,841,000Other
      income
                    
                    
                    139,000
                    
                    
                    
                    2,120,000
                    
                    
                    
                    282,000
                    
                    
                    
                    137,000Net
      loss
                    
                    $
                    (8,669,000
                    )
                    
                    $
                    (3,996,000
                    )
                    
                    $
                    (5,328,000
                    )
                    
                    $
                    (10,679,000
                    )Basic
      and diluted net loss per share
                    
                    $
                    (0.43
                    )
                    
                    $
                    (0.17
                    )
                    
                    $
                    (0.22
                    )
                    
                    $
                    (0.44
                    )
 
  Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure
 
 Not
applicable.
 
 Item 9A. Controls and Procedures
 
 Evaluation
of Disclosure Controls and Procedures
 
 We
maintain disclosure controls and procedures that are designed to ensure that
information required to be disclosed in our reports filed or furnished pursuant
to the Exchange Act is recorded, processed, summarized and reported within the
time periods specified in the Securities and Exchange Commission’s rules and
forms, and that such information is accumulated and communicated to our
management, including our Chief Executive Officer and Chief Financial Officer,
as appropriate, to allow for timely decisions regarding required
disclosure.  In designing and evaluating the disclosure controls and
procedures, management recognizes that any controls and procedures, no matter
how well designed and operated, can provide only reasonable assurance of
achieving the desired control objectives, and management necessarily is required
to apply its judgment in evaluating the cost-benefit relationship of possible
controls and procedures.
 
 As
required by Rule 13a-15(b) under the Exchange Act, we carried out an evaluation,
under the supervision and with the participation of our management, including
our Chief Executive Officer and Chief Financial Officer, of the effectiveness of
the design and operation of our disclosure controls and procedures as of the end
of the period covered by this Annual Report of Form 10-K.  Based on
the foregoing, our Chief Executive Officer and Chief Financial Officer concluded
that our disclosure controls and procedures were effective and were operating at
a reasonable assurance level as of December 31, 2008.
 
 Management’s
Report on Internal Control Over Financial Reporting
 
 Our
management is responsible for establishing and maintaining adequate internal
control over financial reporting, as such term is defined in Exchange Act Rule
13a-15(f).  Under the supervision and with the participation of our
management, including our Chief Executive Officer and Chief Financial Officer,
we have conducted an evaluation of the effectiveness of our internal control
over financial reporting based on the framework in Internal Control - Integrated
Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission. Because of its inherent limitations, internal control over financial
reporting may not prevent or detect misstatements.  Also, projections
of any evaluation of effectiveness to future periods are subject to the risk
that controls may become inadequate because of changes in conditions, or that
the degree of compliance with
  89
  the
policies or procedures may deteriorate.  Based on our evaluation under
the framework in Internal Control - Integrated Framework, our management
concluded that our internal control over financial reporting was effective as of
December 31, 2008.
 
 The
effectiveness of our internal control over financial reporting as of December
31, 2008 has been audited by KPMG LLP, an independent registered public
accounting firm, as stated in their report which is included
herein.
 
 Changes
in Internal Control over Financial Reporting
 
 There
have been no changes in our internal control over financial reporting during the
quarter ended December 31, 2008 that have materially affected, or are reasonably
likely to materially affect, our internal control over financial
reporting.
 
 Item 9B. Other Information
 
 None.
 
  90
  PART
III
 
 Item 10. Directors, Executive Officers and Corporate
Governance
 
 The
information called for by Item 10 is incorporated herein by reference to the
material under the captions “Election of Directors” and “Directors, Executive
Officers and Corporate Governance” in our proxy statement for our 2009 annual
stockholders’ meeting, which will be filed with the SEC on or before April 30,
2009.
 
 Item 11. Executive Compensation
 
 The
information called for by Item 11 is incorporated herein by reference to the
material under the caption “Executive Compensation” in our proxy statement for
our 2009 annual stockholders’ meeting, which will be filed with the SEC on or
before April 30, 2009.
 
 Item 12. Security Ownership of Certain Beneficial Owners
and Management and Related Stockholder Matters
 
 The
information called for by Item 12 is incorporated herein by reference to the
material under the caption “Security Ownership of Certain Beneficial Owners and
Management” in our proxy statement for our 2009 annual stockholders’ meeting,
which will be filed with the SEC on or before April 30, 2009.
 
 Item 13. Certain Relationships and Related Transactions,
and Director Independence
 
 The
information called for by Item 13 is incorporated herein by reference to the
material under the caption “Information Concerning Directors and Executive
Officers- Certain Relationships and Related Transactions” in our proxy statement
for our 2009 annual stockholders’ meeting, which will be filed with the SEC on
or before April 30, 2009.
 
 Item 14. Principal Accountant Fees and
Services
 
 The
information called for by Item 14 is incorporated herein by reference to the
material under the caption “Principal Accountant Fees and Services” in our proxy
statement for our 2009 annual stockholders meeting, which will be filed with the
SEC on or before April 30, 2009.
 
  91
  PART
IV
 
 Item 15. Exhibits, Financial Statement
Schedules
 
 
 
 (a)
      (1)
              Financial
      StatementsReports of KPMG LLP, Independent Registered
      Public Accounting FirmConsolidated Balance Sheets as of December 31,
      2008 and 2007Consolidated Statements of Operations and Comprehensive Loss
      for the years ended December 31, 2008, 2007 and
    2006Consolidated Statements of Stockholders’ Equity
      (Deficit) for the years ended December 31, 2008, 2007 and
      2006Consolidated Statements of Cash Flows for the years ended
      December 31, 2008, 2007 and 2006Notes to Consolidated Financial
      Statements
  (a)
      (2)
                  Financial
      Statement Schedules
 SCHEDULE
II — VALUATION AND QUALIFYING ACCOUNTS
 
 For the
years ended December 31, 2008, 2007 and 2006
 (in
thousands of dollars)
 
 Balance at
                        beginning of
                        year
                      
                      
                      Additions/(Reductions)
                        ((charges)/ credits to
                        expense)
                      
                      
                      Charged to
                        Other
                        Accounts
                      
                      
                      Deductions
                      
                      
                      Balance at
                        end of yearAllowance for doubtful
    accountsYear
      ended December 31, 2008
                      
                      $
                      1
                      
                      
                      $
                      121
                      
                      
                      $
                      —
                      
                      
                      $
                      —
                      
                      
                      $
                      122Year
      ended December 31, 2007
                      
                      $
                      2
                      
                      
                      $
                      1
                      
                      
                      $
                      —
                      
                      
                      $
                      (2
                      )
                      
                      $
                      1Year
      ended December 31, 2006
                      
                      $
                      9
                      
                      
                      $
                      —
                      
                      
                      $
                      —
                      
                      
                      $
                      (7
                      )
                      
                      $
                      2
 
  92
  Table
of Contents
  (a)
      (3)
                  Exhibits
 Exhibit
                  Number
                
                Description2.5
                
                Asset
      Purchase Agreement  dated  May 30, 2007, by and
      between Cytori Therapeutics, Inc. and MacroPore Acquisition Sub, Inc
      (filed as Exhibit 2.5 to our Form 10-Q Quarterly Report as
      filed on August 14, 2007 and incorporated by reference
    herein)3.1
                
                Amended
      and Restated Certificate of Incorporation (filed as Exhibit 3.1
      to our Form 10-Q Quarterly Report as filed on August 13, 2002 and
      incorporated by reference herein)3.2
                
                Amended
      and Restated Bylaws of Cytori Therapeutics, Inc. (filed as
      Exhibit 3.2 to our Form 10-Q Quarterly Report, as filed on
      August 14, 2003 and incorporated by reference herein)3.3
                
                Certificate
      of Ownership and Merger (effecting name change to Cytori Therapeutics,
      Inc.) (filed as Exhibit 3.1.1 to our Form 10-Q, as filed on November 14,
      2005 and incorporated by reference herein)4.1
                
                Rights
      Agreement, dated as of May 19, 2003, between Cytori Therapeutics, Inc. and
      Computershare Trust Company, Inc. as Rights Agent, which includes: as
      Exhibit A thereto, the Form of Certificate of Designation, Preferences and
      Rights of Series RP Preferred Stock of Cytori Therapeutics, Inc.; as
      Exhibit B thereto, the Form of Right Certificate; and, as Exhibit C
      thereto, the Summary of Rights to Purchase Series RP Preferred Stock
      (filed as Exhibit 4.1 to our Form 8-A which was filed on May 30, 2003 and
      incorporated by reference herein)4.1.1
                
                Amendment
      No. 1 to Rights Agreement dated as of May 12, 2005, between Cytori
      Therapeutics, Inc. and Computershare Trust Company, Inc. as Rights Agent
      (filed as Exhibit 4.1.1 to our Form 8-K, which was filed on May 18, 2005
      and incorporated by reference herein).4.1.2
                
                Amendment
      No. 2 to Rights Agreement, dated as of August 28, 2007, between us and
      Computershare Trust Company, N.A. (as successor to Computershare Trust
      Company, Inc.), as Rights Agent (filed as Exhibit 4.1.1 to our Form 8-K,
      which was filed on September 4, 2007 and incorporated by reference
      herein).10.1#
                
                Amended
      and Restated 1997 Stock Option and Stock Purchase Plan (filed as
      Exhibit 10.1 to our Form 10 registration statement, as amended,
      as filed on March 30, 2001 and incorporated by reference
      herein)10.1.1#
                
                Board
      of Directors resolution adopted November 9, 2006 regarding determination
      of fair market value for stock option grant purposes (incorporated by
      reference to Exhibit 10.10.1 filed as exhibit 10.10.1 to our Form 10-K
      Annual Report, as filed on March 30, 2007 and incorporated by
      reference  herein)10.2+
                
                Development
      and Supply Agreement, made and entered into as of January 5, 2000, by
      and between the Company and Medtronic (filed as Exhibit 10.4 to our
      Form 10 registration statement, as amended, as filed on June 1,
      2001 and incorporated by reference herein)10.3+
                
                Amendment
      No. 1 to Development and Supply Agreement, effective as of
      December 22, 2000, by and between the Company and Medtronic (filed as
      Exhibit 10.5 to our Form 10 registration statement, as amended,
      as filed on June 1, 2001 and incorporated by reference
      herein)10.4+
                
                License
      Agreement, effective as of October 8, 2002, by and between the Company and
      Medtronic PS Medical, Inc. (filed as Exhibit 2.2 to our Current
      Report on Form 8-K which was filed on October 23, 2002 and
      incorporated by reference herein)10.5+
                
                Amendment
      No. 2 to Development and Supply Agreement, effective as of September
      30, 2002, by and between the Company and Medtronic, Inc. (filed as
      Exhibit 2.4 to our Current Report on Form 8-K which was filed on
      October 23, 2002 and incorporated by reference herein)10.7
                
                Amended
      Master Security Agreement between the Company and General Electric
      Corporation, September, 2003 (filed as Exhibit 10.1 to our
      Form 10-Q Quarterly Report, as filed on November 12, 2003 and
      incorporated by reference herein)10.8#
                
                Asset
      Purchase Agreement dated May 7, 2004 between Cytori Therapeutics, Inc. and
      MAST Biosurgery AG (filed as Exhibit 2.1 to our Form 8-K Current Report,
      as filed on May 28, 2004 and incorporated by reference
      herein.)10.8.1
                
                Settlement
      Agreement dated August 9, 2005, between MAST Biosurgery AG, MAST
      Biosurgery, Inc. and the Company (filed as Exhibit 10.26 to our Form 10-Q,
      which was filed on November 14, 2005 and incorporated by reference
      herein)10.9#
                
                Offer
      Letter for the Position of Chief Financial Officer dated June 2, 2004
      between the Company and Mark Saad (filed as Exhibit 10.18 to our
      Form 10-Q Quarterly Report, as filed on August 16, 2004 and
      incorporated by reference herein)10.10#
                
                2004
      Equity Incentive Plan of Cytori Therapeutics, Inc. (filed as
      Exhibit 10.1 to our Form 8-K Current Report, as filed on August
      27, 2004 and incorporated by reference herein)10.10.1#
                
                Board
      of Directors resolution adopted November 9, 2006 regarding determination
      of fair market value for stock option grant purposes (filed as
      Exhibit 10.10.1 to our Form 10-K Annual Report, as filed on
      March 30, 2007 and incorporated by reference herein)10.11
                
                Exclusive
      Distribution Agreement, effective July 16, 2004 by and between the Company
      and Senko Medical Trading Co. (filed as Exhibit 10.25 to our
      Form 10-Q Quarterly Report, as filed on November 15, 2004 and
      incorporated by reference herein)10.12#
                
                Notice
      and Agreement for Stock Options Grant Pursuant to Cytori Therapeutics,
      Inc. 1997 Stock Option and Stock Purchase Plan; (Nonstatutory) (filed as
      Exhibit 10.19 to our Form 10-Q Quarterly Report, as filed on
      November 15, 2004 and incorporated by reference herein)10.13#
                
                Notice
      and Agreement for Stock Options Grant Pursuant to Cytori Therapeutics,
      Inc. 1997 Stock Option and Stock Purchase Plan; (Nonstatutory) with Cliff
      (filed as Exhibit 10.20 to our Form 10-Q Quarterly Report, as
      filed on November 15, 2004 and incorporated by reference
      herein)10.14#
                
                Notice
      and Agreement for Stock Options Grant Pursuant to Cytori Therapeutics,
      Inc. 1997 Stock Option and Stock Purchase Plan; (Incentive) (filed as
      Exhibit 10.21 to our Form 10-Q Quarterly Report, as filed on
      November 15, 2004 and incorporated by reference herein)10.15#
                
                Notice
      and Agreement for Stock Options Grant Pursuant to Cytori Therapeutics,
      Inc. 1997 Stock Option and Stock Purchase Plan; (Incentive) with Cliff
      (filed as Exhibit 10.22 to our Form 10-Q Quarterly Report, as
      filed on November 15, 2004 and incorporated by reference
      herein)10.16#
                
                Form
      of Options Exercise and Stock Purchase Agreement Relating to the 2004
      Equity Incentive Plan (filed as Exhibit 10.23 to our Form 10-Q
      Quarterly Report, as filed on November 15, 2004 and incorporated by
      reference herein)10.17#
                
                Form
      of Notice of Stock Options Grant Relating to the 2004 Equity Incentive
      Plan (filed as Exhibit 10.24 to our Form 10-Q Quarterly Report,
      as filed on November 15, 2004 and incorporated by reference
      herein)10.18#
                
                Separation
      Agreement and General Release dated July 15, 2005, between John K. Fraser
      and the Company (filed as Exhibit 10.25 to our Form 10-Q Quarterly Report
      as filed on November 14, 2005 and incorporated by reference
      herein)10.19#
                
                Consulting
      Agreement dated July 15, 2005, between John K. Fraser and the Company
      (filed as Exhibit 10.28 to our Form 10-Q Quarterly Report as filed on
      November 14, 2005 and incorporated by reference herein)10.20
                
                Agreement
      Between Owner and Contractor dated October 10, 2005, between Rudolph and
      Sletten, Inc. and the Company (filed as Exhibit 10.20 to our Form 10-K
      Annual Report as filed on March 30, 2006 and incorporated by reference
      herein)10.21#
                
                Severance
      Agreement and General Release dated August 10, 2005, between Sharon V.
      Schulzki and the Company (filed as Exhibit 10.27 to our Form 10-Q
      Quarterly report as filed on November 14, 2005 and incorporated by
      reference herein)10.22
                
                Common
      Stock Purchase Agreement dated April 28, 2005, between Olympus Corporation
      and the Company (filed as Exhibit 10.21 to our Form 10-Q Quarterly Report
      as filed on August 15, 2005 and incorporated by reference
      herein)10.23
                
                Sublease
      Agreement dated May 24, 2005, between Biogen Idec, Inc. and the Company
      (filed as Exhibit 10.21 to our Form 10-Q Quarterly Report as filed on
      August 15, 2005 and incorporated by reference herein)10.24#
                
                Employment
      Offer Letter to Doug Arm, Vice President of Development—Biologics, dated
      February 1, 2005 (filed as Exhibit 10.21 to our Form 10-Q Quarterly Report
      as filed on August 15, 2005 and incorporated by reference
      herein)10.25#
                
                Employment
      Offer Letter to Alex Milstein, Vice-President of Clinical Research, dated
      May 1, 2005 (filed as Exhibit 10.21 to our Form 10-Q Quarterly Report as
      filed on August 15, 2005 and incorporated by reference
    herein)10.26#
                
                Employment
      Offer Letter to John Ransom, Vice-President of Research, dated November
      15, 2005 (filed as Exhibit 10.26 to our Form 10-K Annual Report as filed
      on March 30, 2006 and incorporated by reference herein)10.27+
                
                Joint
      Venture Agreement dated November 4, 2005, between Olympus Corporation and
      the Company (filed as Exhibit 10.27 to our Form 10-K Annual Report as
      filed on March 30, 2006 and incorporated by reference
    herein)10.28+
                
                License/
      Commercial Agreement dated November 4, 2005, between Olympus-Cytori, Inc.
      and the Company (filed as Exhibit 10.28 to our Form 10-K Annual Report as
      filed on March 30, 2006 and incorporated by reference
    herein)10.28.1
                
                Amendment
      One to License/ Commercial Agreement dated November 14, 2007, between
      Olympus-Cytori, Inc. and the Company (filed as Exhibit 10.28.1 to our Form
      10-K Annual Report as filed on March 14, 2008 and incorporated by
      reference herein).10.29+
                
                License/
      Joint Development Agreement dated November 4, 2005, between Olympus
      Corporation, Olympus-Cytori, Inc. and the Company (filed as Exhibit 10.29
      to our Form 10-K Annual Report as filed on March 30, 2006 and incorporated
      by reference herein)10.29.1
                
                Amendment
      No. 1 to License/ Joint Development Agreement dated May 20, 2008, between
      Olympus Corporation, Olympus-Cytori, Inc. and the Company (filed as
      Exhibit 10.29.1 to our Form 10-Q Quarterly Report as filed on August 11,
      2008 and incorporated by reference herein).10.30+
                
                Shareholders
      Agreement dated November 4, 2005, between Olympus Corporation and the
      Company (filed as Exhibit 10.30 to our Form 10-K Annual Report as filed on
      March 30, 2006 and incorporated by reference herein)10.31+
                
                Exclusive
      Negotiation Agreement with Olympus Corporation, dated February 22, 2006
      (filed as Exhibit 10.31 to our Form 10-Q Quarterly Report as filed on May
      15, 2006 and incorporated by reference herein)10.32
                
                Common
      Stock Purchase Agreement, dated August 9, 2006, by and between Cytori
      Therapeutics, Inc. and Olympus Corporation (filed as Exhibit 10.32 to our
      Form 8-K Current Report as filed on August 15, 2006 and incorporated by
      reference herein)10.33
                
                Form
      of Common Stock Subscription Agreement, dated August 9, 2006 (Agreements
      on this form were signed by Cytori and each of respective investors in the
      Institutional Offering) (filed as Exhibit 10.33 to our Form 8-K Current
      Report as filed on August 15, 2006 and incorporated by reference
      herein)10.34
                
                Placement
      Agency Agreement, dated August 9, 2006, between Cytori Therapeutics, Inc.
      and Piper Jaffray & Co. (filed as Exhibit 10.34 to our Form 8-K
      Current Report as filed on August 15, 2006 and incorporated by reference
      herein)10.35#
                
                Stock
      Option Extension Agreement between Bruce A. Reuter and Cytori
      Therapeutics, Inc. effective July 25, 2006 (filed as Exhibit 10.35 to our
      Form 10-Q Quarterly Report as filed on November 145, 2006 and incorporated
      by reference herein)10.36#
                
                Stock
      Option Extension Agreement between Elizabeth A. Scarbrough and Cytori
      Therapeutics, Inc. effective July 25, 2006 (filed as Exhibit 10.36 to our
      Form 10-Q Quarterly Report as filed on November 14, 2006 and incorporated
      by reference herein)10.37#
                
                Employment
      Agreement between Bruce A. Reuter and Cytori Therapeutics, Inc. effective
      July 25, 2006 (filed as Exhibit 10.37 to our Form 10-Q Quarterly Report as
      filed on November 14, 2006 and incorporated by reference
      herein)10.38#
                
                Employment
      Agreement between Elizabeth A. Scarbrough and Cytori Therapeutics, Inc.
      effective July 25, 2006 (filed as Exhibit 10.38 to our Form 10-Q Quarterly
      Report as filed on November 14, 2006 and incorporated by reference
      herein)10.39+
                
                Exclusive
      License Agreement between us and the Regents of the University of
      California dated October 16, 2001 (filed as Exhibit 10.10 to our Form 10-K
      Annual Report as filed on March 31, 2003 and incorporated by reference
      herein)10.39.1
      +
                
                Amended
      and Restated Exclusive License Agreement, effective September 26, 2006, by
      and between The Regents of the University of California and Cytori
      Therapeutics, Inc. (filed as Exhibit 10.39 to our Form 10-Q Quarterly
      Report as filed on November 14, 2006 and incorporated by reference
      herein)10.40#
                
                Stock
      Option Extension Agreement between Charles Galetto and Cytori
      Therapeutics, Inc. signed on May 24, 2006 and effective as of June 1, 2006
      (filed as Exhibit 10.20 to our Form 10-Q Quarterly Report as filed on
      August 14, 2006 and incorporated by reference herein)10.41#
                
                Part-time
      Employment Agreement between Charles Galetto and Cytori Therapeutics, Inc.
      signed on May 24, 2006 and effective as of June 1, 2006 (filed as Exhibit
      10.21 to our Form 10-Q Quarterly Report as filed on August 14, 2006 and
      incorporated by reference herein)10.42
                
                Placement
      Agency Agreement, dated February 23, 2007, between Cytori Therapeutics,
      Inc. and Piper Jaffray & Co. (filed as Exhibit 10.1 to our
      Form   8-K Current Report as filed on February 26, 2007 and
      incorporated by reference herein).10.43
                
                Financial
      services advisory engagement letter agreement, dated February 16, 2007,
      between Cytori Therapeutics, Inc. and WBB Securities, LLC (filed as
      Exhibit 10.2 to our Form 8-K Current Report as filed on February 26, 2007
      and incorporated by reference herein)10.44
                
                Form
      of Subscription Agreement, dated February 23, 2007 (filed as Exhibit 10.3
      to our Form 8-K Current Report as filed on February 26, 2007 and
      incorporated by reference herein)10.45
                
                Form
      of Warrant to be dated February 28, 2007 (filed as Exhibit 10.4 to our
      Form 8-K Current Report as filed on February 26, 2007 and incorporated by
      reference herein)10.46
                
                Common
      Stock Purchase Agreement, dated March 28, 2007, by and between Cytori
      Therapeutics, Inc. and Green Hospital Supply, Inc. (filed as Exhibit 10.46
      to our Form  10-Q Quarterly Report as filed on May 11, 2007 and
      incorporated by reference herein).10.47
                
                Consulting
      Agreement, dated May 3, 2007, by and between Cytori Therapeutics, Inc. and
      Marshall G. Cox. (filed as Exhibit 10.47 to our Form  10-Q
      Quarterly Report as filed on August 14, 2007 and incorporated by reference
      herein).10.48+
                
                Master
      Cell Banking and Cryopreservation Agreement, effective August 13, 2007, by
      and between Green Hospital Supply, Inc.and Cytori
      Therapeutics, Inc. (filed as Exhibit 10.48 to our Form 10-Q Quarterly
      Report as filed on November 13, 2007 and incorporated by reference
      herein).10.48.1
                
                Amendment
      No. 1 to Master Cell Banking and Cryopreservation Agreement, effective
      June 4, 2008, by and between Green Hospital Supply, Inc. and the Company
      (filed as Exhibit 10.48.1 to our Form 8-K Current Report as filed on June
      10, 2008 and incorporated by reference herein).10.49+
                
                License
      & Royalty Agreement, effective August 23, 2007, by and between
      Olympus-Cytori, Inc.and Cytori
      Therapeutics, Inc.  (filed as Exhibit 10.49 to our Form 10-Q
      Quarterly Report as filed on November 13, 2007 and incorporated by
      reference herein).10.50
                
                General
      Release Agreement, dated August 13, 2007, between John Ransom and Cytori
      Therapeutics, Inc. (filed as Exhibit 10.49 to our Form 10-Q Quarterly
      Report as filed on November 13, 2007 and incorporated by reference
      herein).10.51
                
                Common
      Stock Purchase Agreement, dated February 8, 2008, by and between Green
      Hospital Supply, Inc.and Cytori
      Therapeutics, Inc. (filed as Exhibit 10.51 to our Form 8-K Current Report
      as filed on February 19, 2008 and incorporated by reference
      herein).10.51.1
                
                Amendment
      No. 1 to Common Stock Purchase Agreement, dated February 29, 2008, by and
      between Green Hospital Supply, Inc. and Cytori Therapeutics, Inc. (filed
      as Exhibit 10.51.1 to our Form 8-K Current Report as filed on February 29,
      2008 and incorporated by reference herein).10.52#
                
                Agreement
      for Acceleration and/or Severance, dated January 31, 2008, by and between
      Christopher J. Calhounand Cytori
      Therapeutics, Inc. (filed as Exhibit 10.52 to our Form 10-K Annual Report
      as filed on March 14, 2008 and incorporated by reference
      herein).10.53#
                
                Agreement
      for Acceleration and/or Severance, dated January 31, 2008, by and between
      Marc H. Hedrickand Cytori
      Therapeutics, Inc. (filed as Exhibit 10.53 to our Form 10-K Annual Report
      as filed on March 14, 2008 and incorporated by reference
      herein).10.54#
                
                Agreement
      for Acceleration and/or Severance, dated January 31, 2008, by and between
      Mark E. Saadand Cytori
      Therapeutics, Inc. (filed as Exhibit 10.54 to our Form 10-K Annual Report
      as filed on March 14, 2008 and incorporated by reference
      herein).10.55
                
                Common
      Stock Purchase Agreement, dated August 7, 2008, by and between the Company
      and Olympus Corporation (filed as Exhibit 10.32 to our current report on
      Form 8-K filed on August 8, 2008 and incorporated by reference
      herein).10.55.1
                
                Amendment
      No. 1 to Common Stock Purchase Agreement, dated August 8, 2008, by and
      between the Company and Olympus Corporation (filed as Exhibit 10.32.1 to
      our current report on Form 8-K filed on August 14, 2008 and incorporated
      by reference herein).10.56
                
                Securities
      Purchase Agreement, dated August 7, 2008, by and among the Company and the
      Purchasers identified on the signature pages thereto (filed as Exhibit
      10.33 to our current report on Form 8-K filed on August 8, 2008 and
      incorporated by reference herein).10.57
                
                Form
      of Warrant to Purchase Common Stock issued on August 11, 2008 pursuant to
      the Securities Purchase Agreement, dated August 7, 2008, by and among the
      Company and the Purchasers identified on the signature pages thereto
      (filed as Exhibit 10.34 to our current report on Form 8-K filed on August
      8, 2008 and incorporated by reference herein).10.58
                
                Registration
      Rights Agreement, dated August 7, 2008, by and among the Company and the
      Purchasers identified on the signature pages thereto (filed as Exhibit
      10.35 to our current report on Form 8-K filed on August 8, 2008 and
      incorporated by reference herein).10.59
                
                Loan
      and Security Agreement, dated October 14, 2008, by and among the Company,
      General Electric Capital Corporation, and the other lenders signatory
      thereto (filed herewith).10.60
                
                Promissory
      Note issued by the Company in favor of General Electric Capital
      Corporation or any subsequent holder thereof, pursuant to the Loan and
      Security Agreement dated October 14, 2008  (filed
      herewith).10.61
                
                Warrant
      to Purchase Common Stock issued by the Company on October 14, 2008 in
      favor of GE Capital Equity Investments, Inc., pursuant to the Loan and
      Security Agreement dated October 14, 2008 (filed
  herewith).10.62
                
                Warrant
      to Purchase Common Stock issued by the Company on October 14, 2008 in
      favor of Silicon Valley Bank, pursuant to the Loan and Security Agreement
      dated October 14, 2008 (filed herewith).14.1
                
                Code
      of Ethics (filed as Exhibit 14.1 to our Annual Report on
      Form 10-K which was filed on March 30, 2004 and incorporated by
      reference herein)23.1
                
                Consent
      of KPMG LLP, Independent Registered Public Accounting Firm (filed
      herewith).31.1
                
                Certification
      of Principal Executive Officer Pursuant to Securities Exchange Act Rule
      13a-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of
      2002 (filed herewith).31.2
                
                Certification
      of Principal Financial Officer Pursuant to Securities Exchange Act Rule
      13a-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of
      2002 (filed herewith).32.1
                
                Certifications
      Pursuant to 18 U.S.C. Section 1350/ Securities Exchange Act Rule
      13a-14(b), as adopted pursuant to Section 906 of the Sarbanes - Oxley Act
      of 2002 (filed herewith).
 _______________________________________
 +      Portions
of these exhibits have been omitted pursuant to a request for confidential
treatment.
 
 #      Indicates
management contract or compensatory plan or arrangement.
 
  93
  SIGNATURES
 
 Pursuant
to the requirements of Section 13 or 15(d) of the Securities Exchange Act of
1934, the registrant has duly caused this registration statement to be signed on
its behalf by the undersigned, thereunto duly authorized.
 
 CYTORI
      THERAPEUTICS, INC.By:
              /s/
      Christopher J. CalhounChristopher
      J. CalhounChief
      Executive OfficerMarch
      6, 2009
 
 Pursuant
to the requirements of the Securities Exchange Act of 1934, this annual report
has been signed below by the following persons on behalf of the registrant and
in the capacities and on the dates indicated.
 
 SIGNATURE
              
              TITLE
              
              DATE/s/
      Ronald D. Henriksen
              
              Chairman
      of the Board of Directors
              
              March
      6, 2009Ronald
      D. Henriksen/s/
      Christopher J. Calhoun
              
              Chief
      Executive Officer, Vice-Chairman, Director (Principal Executive
      Officer)
              
              March
      6, 2009Christopher
      J. Calhoun/s/
      Marc H. Hedrick, MD
              
              President,
      Director
              
              March
      6, 2009Marc
      H. Hedrick, MD/s/
      Mark E. Saad
              
              Chief
      Financial Officer (Principal Financial Officer)
              
              March
      6, 2009Mark
      E. Saad/s/
      John W. Townsend
              
              Chief
      Accounting Officer
              
              March
      6, 2009John
      W. Townsend/s/
      David M. Rickey
              
              Director
              
              March
      6, 2009David
      M. Rickey/s/
      Rick Hawkins
              
              Director
              
              March
      6, 2009Rick
      Hawkins/s/
      E. Carmack Holmes, MD
              
              Director
              
              March
      6, 2009E.
      Carmack Holmes, MD/s/
      Paul W. Hawran
              
              Director
              
              March
      6, 2009Paul
      W. Hawran
 
  94