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FILED PURSUANT TO RULE 424(B)(1)
REGISTRATION NO. 333-35756
5,700,000 Shares
[LOGO]
Common Stock
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Regeneration Technologies, Inc. is offering 3,800,000 shares of common
stock, and the selling stockholder is offering 1,900,000 shares of our common
stock in our initial public offering. We will not receive any of the proceeds
from the sale of shares by the selling stockholder. No public market currently
exists for our common stock.
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Our common stock has been approved for quotation on the Nasdaq National
Market under the symbol "RTIX."
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Investing in our common stock involves a high degree of risk. See "Risk
Factors" beginning on page 4.
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Per Share Total
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Offering Price.............................................. $14.00 $79,800,000
Discounts and Commissions to Underwriters................... $ 0.98 $ 5,586,000
Offering Proceeds to Regeneration Technologies.............. $13.02 $49,476,000
Offering Proceeds to the Selling Stockholder................ $13.02 $24,738,000
</TABLE>
Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved of these securities or determined if this
prospectus is truthful or complete. Any representation to the contrary is a
criminal offense.
We have granted the underwriters the right to purchase up to an additional
855,000 shares of our common stock to cover any over-allotments. The
underwriters can exercise this right at any time within thirty days after this
offering. Banc of America Securities LLC expects to deliver the shares of common
stock to investors on August 15, 2000.
Banc of America Securities LLC
Lehman Brothers
Stephens Inc.
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August 10, 2000
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The BioCleanse-TM- Process
[Photograph of a cross section of a conventionally processed human femur, as
well as photograph of femur bone that has been cleansed with BioCleanse
technology.]
Processed femur before BioCleanse-TM-
Processed femur after BioCleanse-TM-
[Photograph of Class 100 packaging room.]
Class 100 packaging room: Cleaned, processed tissue being packaged for
distribution
BioCleanse-TM-: Advanced Allograft Processing
[Photograph of BioCleanse chamber]
BioCleanse-TM- chamber
[Photograph of processing room]
Processing room: Cleaning tissue in preparation for the BioCleanse-TM-
process
[Photograph of chemical mix unit]
Chemical mix unit
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TABLE OF CONTENTS
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PAGE
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Prospectus Summary.......................................... 1
Risk Factors................................................ 4
Forward-Looking Statements.................................. 13
Use of Proceeds............................................. 14
Dividend Policy............................................. 14
Capitalization.............................................. 15
Dilution.................................................... 16
Selected Consolidated Financial Data........................ 17
Management's Discussion and Analysis of Financial Condition
and Results of Operations................................. 19
Business.................................................... 30
Management.................................................. 55
Related Party Transactions.................................. 63
Principal and Selling Stockholders.......................... 65
Description of Capital Stock................................ 67
Shares Eligible for Future Sale............................. 70
Underwriting................................................ 72
Legal Matters............................................... 75
Experts..................................................... 75
Where You Can Find More Information......................... 75
Index to Consolidated Financial Statements.................. F-1
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PROSPECTUS SUMMARY
THIS SUMMARY HIGHLIGHTS INFORMATION CONTAINED ELSEWHERE IN THIS PROSPECTUS.
YOU SHOULD READ THE ENTIRE PROSPECTUS CAREFULLY, INCLUDING THE "RISK FACTORS"
SECTION AND OUR CONSOLIDATED FINANCIAL STATEMENTS AND THE ACCOMPANYING NOTES
INCLUDED ELSEWHERE IN THIS PROSPECTUS.
REGENERATION TECHNOLOGIES, INC.
We are a leader in the use of natural tissue and innovative technologies to
repair and promote the natural healing of human bone and other human tissues.
Using core human physiology--the basic biology of natural tissues as they
function in the body--our human tissue implants are improving surgical outcomes.
We process "allograft" tissue, which is tissue recovered from deceased human
donors, for biologic safety and implant mechanical characteristics. A surgeon
transplants these allografts into a patient's body to make the needed repair. By
contrast, an "autograft" procedure is one in which the surgeon harvests tissue
from one part of a patient's body for transplant to another part of the body to
make the needed repair. Our goal is to replace conventional implant approaches,
including metals, synthetics and autograft implants with allograft, and to
establish our allografts as the implant of choice for tissue repair.
We are a provider of comprehensive healing and natural tissue products in a
broad range of markets. In addition, we were the largest U.S. processor and
distributor of allografts that are precisely tooled for specific surgical uses,
in terms of revenues, for the year ended December 31, 1999. Our allografts are
distributed in all 50 states and in nine countries internationally. We are also
a processor of "conventional allografts," which are allografts that are not
tooled by the processor for a specific surgical use. We process human
musculoskeletal and other tissues, including bone, cartilage, tendon, ligament,
pericardial and cardiovascular tissue in producing our allografts. Surgeons then
use these tissues to repair and promote the healing of a wide variety of bone
and other tissue defects, including spinal vertebrae repair, musculoskeletal
reconstruction, fracture repair, repairs to the jaw and related tissues, urinary
incontinence and heart valve disorders. Our current grafts range from
conventional allografts to precision tooled grafting material, including bone
dowels, that are cylindrical-shaped round pins that join adjacent tissues,
wedges, pastes and pins, urological allografts and heart valves. During 1999, we
shipped over 90,000 processed allografts used in an estimated 60,000 procedures.
Often, surgeons use more than one allograft in a given procedure.
The overall market in the United States for tissue repair and healing
through the use of surgical implants, including metals, synthetics and
allografts, has grown considerably over the last several years, with revenues in
the orthopedic and cardiovascular segments of this market exceeding an estimated
$6.4 billion in 1999. In these segments, procedures using allografts, either
conventional graft, bone paste, or specialty tooled tissues, totaled over
310,000 during 1999, accounting for revenues of over $410.0 million. We believe
that the use of allografts will continue to increase and represent a growing
portion of the surgical implant market.
Processors of tissue supply allografts to hospitals and surgeons for use in
surgery. The need for tissue is increasing each year and currently is served by
approximately 30 tissue banks in the United States that process and/or
distribute bone or cardiovascular allografts. We have one of the most extensive
tissue recovery programs in the United States, recovering bone or cardiovascular
tissue from over 4,000 human donors during 1999, up from over 2,300 in 1998 and
1,500 in 1997. We believe our network of recovery groups accounted for
approximately 32% of the human tissue recovered for processing in the United
States during 1999.
We pursue a market-by-market approach to distribution of our allografts,
including strategic arrangements in order to increase our penetration in
selected markets. We have an alliance with Medtronic Sofamor Danek in the spinal
market, with Exactech, Inc. in portions of the bone paste market, and with C.R.
Bard, Inc. in the urological market.
Using our proprietary BioCleanse system, we believe we are the only
processor of human tissue currently able to safely process tissue in a single
system from multiple donors simultaneously. This system, which kills or
inactivates all classes of conventional pathogens, viruses, microbes, bacteria
and fungi, and which cleanses tissue both before and after processing, allows us
to safely process tissue
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from up to 100 donors at the same time, thereby significantly increasing the
efficiency of our tissue processing. In addition, our BioCleanse system is able
to remove blood, fats, lipids and other unwanted materials from the tissue we
process more successfully than traditional processing. We believe the removal of
blood, fat, lipids and other unwanted materials results in faster patient
healing since it eliminates the need for the patient's body to remove these
substances using natural processes following surgery. In contrast to traditional
tissue processing, our BioCleanse system also permits us to process tissue at
lower average cost and to safely and economically process tissue from donors and
age groups that might not have been feasible without BioCleanse.
We plan to continue to develop new allografts and technologies within the
orthopedics, urological and cardiovascular markets, and to develop additional
tissue-related technologies for other markets. To accomplish this, we intend to
continue to use our core technologies and processes which include precision
machined bone tissue, allograft bone pastes that stimulate the growth of new
bone, our proprietary BioCleanse system, segmentally demineralized bone
allografts which have been treated to remove unwanted materials, osteoarticular
grafts designed to fit specific surgical instruments, growth factors to
stimulate bone or tissue growth, allografts assembled from various smaller bone
pieces, xenograft, or animal tissue, and bone treated to significantly reduce
materials that could cause immune responses.
THE OFFERING
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Common stock offered by:
Regeneration Technologies, Inc....... 3,800,000 shares
Selling stockholder.................. 1,900,000 shares
Total............................ 5,700,000 shares
Common stock to be outstanding after
the offering......................... 21,308,562 shares
Use of proceeds........................ To fund continued research and development, to construct
and equip a new manufacturing facility, to construct
additional BioCleanse systems and other automated
processing systems, to expand our tissue recovery and
distribution activities, and for general corporate
purposes, including working capital. In addition, we may
use a portion of the proceeds to acquire businesses,
assets, technologies or product lines that complement our
existing business. We will not receive any proceeds from
the shares sold by the selling stockholder. See "Use of
Proceeds."
Nasdaq National Market Symbol.......... RTIX
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The above information excludes:
- 1,825,166 shares of our common stock subject to options granted under our
Omnibus Stock Option Plan and outstanding as of June 30, 2000 at a
weighted average exercise price of $4.29 per share;
- 226,930 shares of our common stock reserved for issuance upon the exercise
of warrants outstanding as of June 30, 2000 at a weighted average exercise
price of $5.65 per share; and
- 250,000 shares of our common stock we anticipate issuing when we complete
our acquisition of the Alabama Tissue Center following the completion of
this offering.
Unless otherwise indicated, the information in this prospectus assumes:
- that the underwriters will not exercise their over-allotment option;
- the conversion of 2,894,490 shares of outstanding preferred stock into
13,893,552 shares of common stock;
- a 4.8-for-1 stock split of our common stock effected August 8, 2000;
- the reorganization of our company as a Delaware corporation; and
- the completion of our acquisition of the tissue processing and
distribution business of the Alabama Tissue Center.
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SUMMARY CONSOLIDATED FINANCIAL DATA
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
You should read the following summary consolidated financial data together
with (i) the statements of revenues and direct costs and accompanying notes of
our predecessor business; (ii) our consolidated financial statements and
accompanying notes; and (iii) "Management's Discussion and Analysis of Financial
Condition and Results of Operations" included elsewhere in this prospectus.
Set forth below are the statement of operations data for the years ended
December 31, 1995, 1996 and 1997 and the period from January 1, 1998 to
February 11, 1998 for our predecessor business. In addition, set forth below are
statement of operations data for the period from February 12, 1998 to
December 31, 1998, the year ended December 31, 1999 and the six months ended
June 30, 1999 and 2000 and the balance sheet data as of June 30, 2000 (i) on an
actual basis and (ii) on an as-adjusted basis to give effect to the sale by us
of 3,800,000 shares of common stock in this offering at a price of $14.00 per
share, after deducting underwriting discounts and commissions and the estimated
offering expenses payable by us, and the application of net proceeds from this
offering.
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PERIOD FROM PERIOD FROM SIX MONTHS
JANUARY 1, FEBRUARY 12, ENDED
YEAR ENDED YEAR ENDED YEAR ENDED 1998 TO 1998 TO YEAR ENDED JUNE 30,
DECEMBER 31, DECEMBER 31, DECEMBER 31, FEBRUARY 11, DECEMBER 31, DECEMBER 31, ----------
1995 1996 1997 1998 1998 1999 1999
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STATEMENT OF OPERATIONS
DATA:
Total revenues........... $1,192 $2,291 $13,509 $2,826 $ 35,257 $ 73,020 $ 31,561
Net revenues............. 1,192 1,726 4,634 894 11,128 33,026 14,099
Total costs and
expenses............... 1,304 2,555 5,180 866 15,304 30,587 13,648
Operating (loss)
income................. (4,176) 2,439 451
Net (loss) income........ $ (4,142) $ 2,960 $ 155
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Net (loss) income per
common share--basic.... $ (1.12) $ 0.81 $ 0.04
Net (loss) income per
common share--diluted.. $ (1.12) $ 0.18 $ 0.01
Weighted average shares
outstanding--basic..... 3,686,770 3,669,970 3,672,790
Weighted average shares
outstanding--diluted... 3,686,770 16,636,791 15,936,747
Pro forma net income per
common share--basic.... $ 0.18
Pro forma net income per
common share--diluted.. $ 0.18
Pro forma weighted
average shares
outstanding--basic..... 16,161,269
Pro forma weighted
average shares
outstanding--diluted... 16,636,791
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SIX MONTHS
ENDED
JUNE 30,
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2000
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STATEMENT OF OPERATIONS
DATA:
Total revenues........... $ 54,079
Net revenues............. 25,144
Total costs and
expenses............... 22,859
Operating (loss)
income................. 2,285
Net (loss) income........ $ 1,219
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Net (loss) income per
common share--basic.... $ 0.34
Net (loss) income per
common share--diluted.. $ 0.07
Weighted average shares
outstanding--basic..... 3,629,400
Weighted average shares
outstanding--diluted... 18,312,307
Pro forma net income per
common share--basic.... $ 0.07
Pro forma net income per
common share--diluted.. $ 0.07
Pro forma weighted
average shares
outstanding--basic..... 17,522,952
Pro forma weighted
average shares
outstanding--diluted... 18,312,307
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<CAPTION>
AS OF JUNE 30, 2000
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ACTUAL AS ADJUSTED
BALANCE SHEET DATA: ---------- -----------
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Cash and cash equivalents................................... $ 763 $49,239
Working capital............................................. 12,600 61,076
Total assets................................................ 56,341 104,817
Long-term obligations, less current portion................. 3,912 3,912
Total stockholders' equity.................................. 17,113 65,589
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We originally incorporated in Florida on August 21, 1997 and began
operations on February 12, 1998 upon our separation from the University of
Florida Tissue Bank, Inc. Prior to the completion of this offering, we intend to
reorganize as a Delaware corporation. Our principal executive offices are
located at One Innovation Drive, Alachua, Florida 32615 and our telephone number
is (904) 418-8888. Our Web site is located at www.rtitechnology.com. The
information contained on our Web site should not be considered a part of this
prospectus.
Alloanchor-TM-, BioCleanse-TM-, Cornerstone-TM- SR, FasLata-TM- Fascia Lata
Allograft, MD-Series-TM- Threaded Bone Dowels, Opteform-TM-, Osteofil-TM-,
Precision-TM- Cortical Bone Wedge, Regenaderm-TM-, Regenafil-TM-,
Regenaform-TM-, Regeneration Technologies, Inc.-TM- and Tangent-TM- Cortical
Bone Wedge are some of our trademarks. Any other trademark, trade name or
service mark of any other company appearing in this prospectus belongs to its
holder.
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RISK FACTORS
THIS OFFERING AND AN INVESTMENT IN OUR COMMON STOCK INVOLVE A HIGH DEGREE OF
RISK. YOU SHOULD CONSIDER EACH OF THE RISKS AND UNCERTAINTIES DESCRIBED IN THIS
SECTION AND ALL OF THE OTHER INFORMATION IN THIS PROSPECTUS BEFORE DECIDING TO
INVEST IN OUR COMMON STOCK. ANY OF THE RISK FACTORS WE DESCRIBE BELOW COULD
SEVERELY HARM OUR BUSINESS, FINANCIAL CONDITION AND RESULTS OF OPERATIONS. THE
MARKET PRICE OF OUR COMMON STOCK COULD DECLINE IF ANY OF THESE RISKS OR
UNCERTAINTIES DEVELOP INTO ACTUAL EVENTS. YOU MAY LOSE ALL OR PART OF THE MONEY
YOU PAID TO BUY OUR COMMON STOCK.
WE HAVE A LIMITED OPERATING HISTORY, ARE AT AN EARLY STAGE OF DEVELOPMENT
AND MAY NOT SUCCEED OR CONTINUE TO BE PROFITABLE.
We incorporated in 1997 and commenced operations as an independent entity in
1998, and are at an early stage of development. Accordingly, we have a limited
operating history on which to base an evaluation of our business and prospects.
We expect our operating expenses to increase and we will need to generate
significant revenues to maintain profitability. We may not be able to achieve
growth in our revenues at levels which will sustain or increase profitability on
a quarterly or annual basis.
Many of the risks inherent in the development of a new enterprise will
affect our business, including:
- market acceptance of our existing and future allografts and technologies;
- our ability to continue to develop markets for our allografts and
technologies;
- our ability to raise sufficient capital to support the cost of
commercializing our current allografts and technologies and developing new
allografts and technologies to remain competitive; and
- our ability to attract and retain qualified management, sales, technical
and scientific staff.
It is difficult for us to predict our future results of operations due to
our limited operating history and the uncertain nature of our markets. As we
increase our operating expenses to continue our research and development, expand
manufacturing and add to our tissue recovery and distribution programs, these
expenditures may not result in increased revenues and we may incur sizable
losses.
WE DEPEND HEAVILY UPON A LIMITED NUMBER OF SOURCES OF HUMAN TISSUE, AND ANY
FAILURE TO OBTAIN TISSUE FROM THESE SOURCES IN A TIMELY MANNER WILL INTERFERE
WITH OUR ABILITY TO PROCESS AND DISTRIBUTE ALLOGRAFTS.
The University of Florida Tissue Bank, Inc., Tutogen Medical, Inc. and
Allograft Resources of Wisconsin collectively supplied us with approximately 58%
of the human tissue we obtained in the year ended December 31, 1999. The limited
supply of human tissue has at times limited our growth, and may not be
sufficient to meet our future needs. In addition, due to seasonal changes in
mortality rates, some scarce tissues that we use for our allografts are at times
in particularly short supply. We cannot be sure that our supply of tissue will
continue to be available at current levels or will be sufficient to meet our
needs. If we are no longer able to obtain tissue from these sources sufficient
to meet our needs, we may not be able to locate replacement sources of tissue on
commercially reasonable terms, if at all. Any interruption of our business
caused by the need to locate additional sources of tissue would significantly
hurt our revenues, which could cause the market price of our common stock to
decline. We expect our revenues would continue to suffer for at least as long as
needed tissue is in short supply.
OUR SUCCESS WILL DEPEND ON THE CONTINUED ACCEPTANCE OF OUR ALLOGRAFTS AND
TECHNOLOGIES BY THE MEDICAL COMMUNITY.
Our new allografts, technologies or enhancements to existing allografts may
never achieve broad market acceptance, which can be affected by numerous
factors, including:
- clinical acceptance of our allografts and technologies;
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- introduction of competitive tissue repair treatment options which render
our allografts and technologies too expensive or obsolete;
- lack of availability of third-party reimbursement; and
- our ability to train surgeons in the use of our allografts and
technologies.
Market acceptance will also depend on our ability to demonstrate that our
existing and new allografts and technologies are an attractive alternative to
existing tissue repair treatment options. Our ability to do so will depend on
surgeons' evaluations of the clinical safety, efficacy, ease of use, reliability
and cost-effectiveness of these tissue repair options and technologies. For
example, we believe that a small portion of the medical community has lingering
concerns over the risk of disease transmission through the use of allografts.
Furthermore, we believe that even if the medical community generally accepts our
allografts and technologies, recommendations and endorsements by influential
surgeons will be important to the commercial success of our allografts and
technologies. If our allografts and technologies are not broadly accepted in the
marketplace, we may not achieve a competitive position in the market.
IF WE FAIL TO ACHIEVE AND MAINTAIN THE HIGH PROCESSING AND MANUFACTURING
STANDARDS THAT OUR ALLOGRAFTS REQUIRE OR IF WE ARE UNABLE TO DEVELOP ADDITIONAL
MANUFACTURING CAPACITY, OUR COMMERCIAL OPPORTUNITY WILL BE REDUCED OR
ELIMINATED.
Our allografts require careful calibration and precise, high-quality
processing and manufacturing. Achieving precision and quality control requires
skill and diligence by our personnel. If we fail to achieve and maintain these
high processing and manufacturing standards, including avoiding manufacturing
errors, design defects or component failures:
- we could be forced to recall or withdraw our allografts;
- our allografts and technologies could fail quality assurance and
performance tests;
- production and deliveries of our allografts could be delayed or cancelled;
and
- our production costs could increase.
We can never completely eliminate the risk of errors, defects or failures.
Further, to be successful, we will need to increase our manufacturing capacity,
which we intend to do using a portion of the proceeds from this offering. It may
be difficult for us to increase our manufacturing capacity due to problems
related to yields, quality control and assurance, tissue availability, adequacy
of control policies and procedures, and lack of skilled personnel. If we are
unable to process and produce our allografts on a timely basis, at acceptable
quality and costs, and in sufficient quantities, or if we experience
unanticipated technological problems or delays in production, it will reduce our
revenues and the market price of our common stock could decline as a result.
RAPID TECHNOLOGICAL CHANGE WILL AFFECT US AND OUR CUSTOMERS, WHICH COULD
RESULT IN REDUCED DEMAND FOR OUR ALLOGRAFTS.
Technologies change rapidly in our industry and there are frequent
introductions of new technologies. For example, steady improvements have been
made in synthetic human tissue substitutes which compete with our allografts.
Unlike allografts, synthetic tissue technologies are not dependent on the
availability of human tissue. If one of our competitors successfully introduces
synthetic technologies using recombinant technologies, it could result in a
decline in demand for allografts. Although our growth strategy contemplates
introducing new allografts and technologies, including the use of recombinant
technologies, the development of these new allografts and technologies is a
complex and uncertain process, requiring a high level of innovation, as well as
the ability to accurately predict future technology and market trends. The
allografts we currently have in development will require significant additional
development, investment and testing. We may need to undertake costly and
time-consuming
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efforts to achieve these objectives. We may not be able to respond effectively
to technological changes and emerging industry standards, or to successfully
identify, develop or support new technologies or enhancements to existing
allografts in a timely and cost-effective manner, if at all. If we are unable to
achieve the improvements in our allografts necessary for their successful
commercialization, the demand for our allografts will suffer.
WE FACE INTENSE COMPETITION, WHICH COULD RESULT IN REDUCED ACCEPTANCE AND
DEMAND FOR OUR ALLOGRAFTS AND TECHNOLOGIES.
The medical technology/biotechnology industry is intensely competitive. We
compete with companies in the United States and internationally that engage in
the development and production of medical technologies and processes including:
- biotechnology, orthopedic, pharmaceutical, biomaterial, chemical and other
companies such as Johnson & Johnson, Osteotech and the Musculoskeletal
Tissue Foundation;
- academic and scientific institutions; and
- public and private research organizations.
Many of our competitors have much greater financial, technical, research,
marketing, sales, distribution, service and other resources than we have.
Moreover, our competitors may offer a broader array of tissue repair treatment
products and technologies or may have greater name recognition than we do in the
marketplace. For example, we compete with a number of divisions of Johnson &
Johnson, a company with significantly greater resources and brand recognition
than we have. Our competitors, including several development stage companies,
may develop or market technologies that are more effective or commercially
attractive than ours, or that may render our technologies obsolete. For example,
the successful development of a synthetic tissue product that permits remodeling
of bones could result in a decline in the demand for allograft-based products
and technologies.
Allograft implants compete with autograft, metals and synthetic tissues, as
well as with alternative medical procedures. For the foreseeable future, we
believe a significant number of surgeons will continue to choose to perform
autograft procedures when feasible, despite the necessity for performing a
second surgery. In addition, many members of the medical community will continue
to prefer the use of metals and synthetics due in part to their familiarity with
these products and the procedures required for their use. In order to compete
effectively in the marketplace, we intend to continue to pursue our strategies
of being an innovator in the industry, expanding our use of new technologies and
expanding our sales and marketing capabilities.
IF WE FAIL TO MAINTAIN OUR EXISTING STRATEGIC RELATIONSHIPS OR ARE UNABLE TO
IDENTIFY ADDITIONAL DISTRIBUTORS OF OUR ALLOGRAFTS, OUR REVENUES MAY DECREASE.
While we market a portion of our current technologies directly to our
customers, we currently derive the majority of our revenues through our
relationships with three companies, Medtronic Sofamor Danek, Exactech and C.R.
Bard. In the year ended December 31, 1999, we derived approximately 52% of our
net revenues from distribution assisted by management services provided by one
company, Medtronic Sofamor Danek. This company provides nearly all of the
instrumentation, surgeon training, distribution assistance and marketing
materials for our line of spinal allografts. If our relationship with this
distributor was terminated for any reason, our revenues would be materially and
adversely affected.
We may need to obtain the assistance of additional distributors to market
and distribute our new allografts and technologies, as well as to market and
distribute our existing allografts and technologies to new market segments or
geographical areas. We may not be able to find additional distributors who will
agree to market and distribute our allografts and technologies on commercially
reasonable terms, if at all. If we are unable to establish new distribution
relationships or renew our current distribution
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arrangements on favorable terms, our revenues may decline which could cause the
market price of our shares to decline.
OUR ALLOGRAFTS AND TECHNOLOGIES COULD BECOME SUBJECT TO SIGNIFICANTLY
GREATER REGULATION BY THE FDA, WHICH COULD DISRUPT OUR BUSINESS.
The U.S. Food and Drug Administration has statutory authority to regulate
allograft processing and allograft-based materials. The FDA has statutory
authority to regulate allograft processing, allograft-based materials and
facilities in which allografts are processed. For example, the FDA recently
inspected our facility and reviewed the steps that we took to validate the use
of our BioCleanse system for the simultaneous processing of tissue from multiple
donors. While the FDA left without noting any deficiencies, the FDA could
identify deficiencies in a future inspection. In addition, information gathered
from this inspection likely will be forwarded to FDA's Center for Biologics
Evaluation and Research, which could conclude that our system is improperly
validated or not otherwise in compliance with regulations applicable to it. Such
a finding potentially could disrupt our business, hurting our profitability.
Since 1997, the FDA has worked to establish a more comprehensive regulatory
framework for human tissue-based allografts. The framework under FDA
consideration would establish criteria for determining whether a particular
human tissue-based product will be classified as human tissue, a medical device
or biologic drug requiring premarket clearance or approval. The FDA currently
regulates our heart valve allografts as medical devices and we cannot be sure
that the FDA will not seek to regulate our other allografts as medical devices
or biologics in the future. If the FDA decides to do so, it could significantly
increase our cost of doing business which could hurt our revenues and operating
margins.
If the FDA decides to adopt and implement its proposed regulatory framework,
one or more of our current allografts would be regulated to a much greater
extent. In addition to our heart valve allografts, one or more of our allografts
in development may become subject to regulation as medical devices or biologic
drugs. For allografts regulated as medical devices, we will need to obtain
premarket clearance or approval through either the 510(k) premarket notification
process, or the FDA's premarket approval process. Some of our proposed grafts
will contain tissue derived from animals, commonly referred to as xenografts.
Xenografts also are subject to premarket review by the FDA.
To obtain the necessary approvals or clearances, we would be required to
submit premarket notifications, premarket approval applications and/or biologics
license applications. The clinical testing and preparation of required
applications would be time consuming and costly. In addition, the FDA could
decide not to approve our applications. The FDA could also require us to stop
marketing our current allografts pending their approval or clearance. The FDA
may require post-market testing and surveillance to monitor the effects of
approved allografts, may restrict the commercial applications of our allografts,
and may conduct periodic inspections of our facility and our suppliers'
facilities. The FDA may withdraw our product approvals or clearances if we do
not comply with its regulatory standards or if we encounter problems after the
initial marketing. If we encounter delays during the FDA approval process, the
period during which we have the exclusive right to commercialize any allografts
for which we have received patent protection may be shortened.
It is possible that others may make allegations against us or against donor
recovery groups or tissue banks, including those with which we have a
relationship, about non-compliance with applicable FDA regulations or other
relevant statutes and regulations. Allegations like these could cause regulators
or other authorities to take investigative or other action, or could cause
negative publicity for us or our industry generally. These actions or any
negative publicity could cause the market price of our shares to decline.
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IF OUR PATENTS AND THE OTHER MEANS WE USE TO PROTECT OUR INTELLECTUAL
PROPERTY PROVE TO BE INADEQUATE, OUR COMPETITORS COULD EXPLOIT OUR INTELLECTUAL
PROPERTY TO COMPETE MORE EFFECTIVELY AGAINST US.
The law of patents and trade secrets is constantly evolving and often
involves complex legal and factual questions. The U.S. government may deny or
significantly reduce the coverage we seek in our patent applications before or
after a patent is issued. We therefore cannot be sure that any particular patent
we apply for will be issued, that the scope of the patent protection will
exclude our competitors, that interference proceedings regarding any of our
patent applications will not be filed, or that we will achieve any other
competitive advantage from a patent. In addition, it is possible that one or
more of our patents will be held invalid if challenged or that others will claim
rights in or ownership of our patents and other proprietary rights. If any of
these events occur, our competitors may be able to use our intellectual property
and compete more effectively against us.
Because patent applications are secret until patents are actually issued and
the publication of discoveries in the scientific or patent literature lags
behind actual discoveries, we cannot be certain if our patent application was
the first application filed covering a particular invention. If another party's
rights to an invention are superior to ours, we may not be able to obtain a
license to use that party's invention on commercially reasonable terms, if at
all. In addition, our competitors, many of which have greater resources than we
do, could obtain patents that will prevent, limit or interfere with our ability
to make use of our inventions either in the United States or in international
markets. Further, the laws of some foreign countries do not always protect our
intellectual property rights to the same extent as do the laws of the United
States. Litigation or regulatory proceedings in the United States or foreign
countries also may be necessary to enforce our patent or other intellectual
property rights or to determine the scope and validity of our competitors'
proprietary rights. These proceedings can be costly, result in product
development delays, and divert our management's attention from our business.
We also rely upon unpatented proprietary techniques and processes in tissue
recovery, research and development, tissue processing and quality assurance. It
is possible that others will independently develop technology similar to ours or
otherwise gain access to or disclose our proprietary technologies. We may not be
able to meaningfully protect our rights in these proprietary technologies, which
would reduce our ability to compete.
In 1996, a law was passed in the United States that limits the enforcement
of patents covering the performance of surgical or medical procedures on a human
body. This law prevents medical practitioners and health care entities who
practice these procedures from being sued for patent infringement. Therefore,
depending upon how these limitations are interpreted by the courts, they could
have a material adverse effect on our ability to enforce any of our proprietary
methods or procedures deemed to be surgical or medical procedures.
THE CONFIDENTIALITY AGREEMENTS WE HAVE WITH OUR EMPLOYEES AND OTHERS MAY NOT
ADEQUATELY PREVENT DISCLOSURE OF TRADE SECRETS AND OTHER PROPRIETARY
INFORMATION, ALLOWING OUR COMPETITORS TO LEARN THIS INFORMATION AND COMPETE MORE
EFFECTIVELY AGAINST US.
Our policy is to execute confidentiality agreements with our employees and
consultants. These agreements generally require that all confidential
information be kept confidential even after the individual has left our
employment. These agreements also generally provide that inventions conceived by
the individual while he or she is one of our employees or consultants are our
exclusive property. It is possible, however, that these agreements will not
provide meaningful protection of our proprietary and other confidential
information. In addition, in some situations, these agreements may conflict
with, or be subject to, the rights of third parties with whom our employees or
consultants have prior employment or consulting relationships. We may be forced
to engage in costly and time-consuming litigation to determine the scope of and
to enforce our proprietary rights. Even if successful, any litigation could
divert our management's attention from our business.
8
<PAGE>
OUR SUCCESS WILL DEPEND IN PART ON OUR ABILITY TO OPERATE WITHOUT INFRINGING
ON OR MISAPPROPRIATING THE PROPRIETARY RIGHTS OF OTHERS, AND IF WE ARE UNABLE TO
DO SO WE MAY BE LIABLE FOR DAMAGES.
We cannot be certain that U.S. or foreign patents or patent applications of
other companies do not exist or will not be issued that would prevent us from
commercializing our allografts and technologies. Third parties may sue us for
infringing or misappropriating their patent or other intellectual property
rights. Intellectual property litigation is costly. If we do not prevail in
litigation, in addition to any damages we might have to pay, we could be
required to stop the infringing activity or obtain a license requiring us to
make royalty payments. It is possible that a required license will not be
available to us on commercially acceptable terms, if at all. In addition, a
required license may be non-exclusive, and therefore our competitors may have
access to the same technology licensed to us. If we fail to obtain a required
license or are unable to design around another company's patent, we may be
unable to make use of some of our technologies or distribute our allografts.
This could hurt our revenues and the market price of our shares.
WE OR OUR COMPETITORS MAY BE EXPOSED TO PRODUCT LIABILITY CLAIMS WHICH COULD
CAUSE US TO BE LIABLE FOR DAMAGES OR CAUSE INVESTORS TO THINK WE WILL BE LIABLE
FOR SIMILAR CLAIMS IN THE FUTURE.
The development of allografts and technologies for human tissue repair and
treatment entails an inherent risk of product liability claims, and substantial
product liability claims may be asserted against us. Although we have not
received any material product liability claims to date and have a $20.0 million
insurance policy with Steadfast Insurance Company of Delaware to cover these
claims should they arise, claims could arise in the future for which our
insurance will not be adequate. Moreover, insurance covering our business may
not always be available in the future on commercially reasonable terms, if at
all. If our insurance proves to be inadequate to pay a damage award, we may not
have sufficient funds to do so which would harm our financial condition. In
addition, successful product liability claims made against one of our
competitors could cause claims to be made against us or expose us to a
perception that we are vulnerable to similar claims. In addition, claims against
us, regardless of their merit or potential outcome, may also hurt our ability to
obtain surgeon endorsement of our allografts or to expand our business.
NEGATIVE PUBLICITY CONCERNING METHODS OF TISSUE RECOVERY AND SCREENING OF
DONOR TISSUE IN OUR INDUSTRY COULD REDUCE DEMAND FOR OUR ALLOGRAFTS AND IMPACT
THE SUPPLY OF AVAILABLE DONOR TISSUE.
Media reports or other negative publicity concerning both improper methods
of tissue recovery from donors and the risk of disease transmission from donated
tissue could limit widespread acceptance of our allografts. Unfavorable reports
of illegal tissue recovery practices, both in the United States and
internationally, as well as incidents of improperly processed tissue leading to
transmission of disease, may broadly affect the rate of future tissue donation
and market acceptance of allograft technologies. Potential patients may not
distinguish our allografts, technologies and the tissue recovery and processing
procedures we have in place, from those of our competitors or others engaged in
tissue recovery. In addition, families of potential donors may become reluctant
to agree to donate tissue to "for profit" tissue processors.
WE MAY NEED TO RAISE ADDITIONAL FUNDS TO OPERATE AND GROW OUR BUSINESS, AND
IF WE ARE UNABLE TO RAISE THESE FUNDS, OUR ABILITY TO EFFECT OUR BUSINESS
STRATEGY COULD BE DISRUPTED.
Pursuing our business strategy may require us to raise additional funds. At
present we do not believe we will need to raise additional capital solely to
operate our business. In addition, we have a line of credit facility in place
allowing us to borrow up to $6.0 million, with availability of $2.1 million
9
<PAGE>
as of June 30, 2000. However, the extent of our future capital requirements and
the adequacy of available funds will depend on numerous factors, including:
- market acceptance of our existing and future allografts and tissue-based
technologies;
- progress in our efforts to develop new allografts and tissue-based
technologies;
- our success in commercializing technologies we have in development; and
- the development of strategic distribution alliances.
If we decide to raise additional funds, we likely would do so through equity
or debt financings, strategic alliances or other sources. The terms of any
future equity financings may be dilutive to our stockholders and the terms of
any debt financings likely will contain restrictive covenants that limit our
ability to pursue particular courses of action, including paying dividends. Our
ability to obtain financing depends upon the status of our future business
prospects, as well as conditions prevailing in the capital markets.
IF WE ARE NOT SUCCESSFUL IN EXPANDING OUR DISTRIBUTION ACTIVITIES INTO
INTERNATIONAL MARKETS, WE WILL NOT BE ABLE TO PURSUE ONE OF OUR STRATEGIES FOR
INCREASING OUR REVENUES.
We plan to expand our operations outside the United States. To date, we have
distributed our allografts in Germany, Austria, Switzerland, South Korea,
Turkey, Greece, Spain, Portugal, Canada and the Netherlands, and we plan to
begin operating in France, the United Kingdom and Japan. In the year ended
December 31, 1999, international sales comprised approximately 2.6% of our net
revenues. Our international operations will be subject to a number of risks
which may vary from the risks we face in the United States, including:
- the need to obtain regulatory approvals in foreign countries before we can
offer our grafts and technologies for use;
- longer distribution-to-collection cycles, as well as difficulty in
collecting amounts owed to us;
- dependence on local distributors;
- limited protection of intellectual property rights;
- fluctuations in the values of foreign currencies; and
- political and economic instability.
If we are unable to effectively expand our operations in international
markets, we will not be able to pursue one of our most important strategies for
increasing our revenues.
OUR INDUSTRY IS SUBJECT TO GOVERNMENT REGULATION AND ANY INCREASED
REGULATIONS OF OUR CURRENT OR FUTURE ACTIVITIES COULD SIGNIFICANTLY INCREASE THE
COST OF DOING BUSINESS THEREBY REDUCING OUR PROFITABILITY.
Some aspects of our business are subject to local, state, federal or
international regulation. Changes in the laws or new interpretations of existing
laws could negatively affect our business, revenues or prospects, and increase
the costs associated with conducting our business. In particular, the
procurement and transplantation of allograft tissue is subject to federal
regulation under the National Organ Transplant Act, or NOTA, a criminal statute
that prohibits the purchase and sale of human organs, including bone and other
tissue. NOTA permits the payment of reasonable expenses associated with the
transportation, processing, preservation, quality control and storage of human
tissue, which are the types of services we perform. If in the future NOTA were
amended or interpreted in a way that makes us unable to include some of these
costs in the amounts we charge our customers, it could reduce our revenues and
therefore hurt our business. It is possible that more restrictive
interpretations
10
<PAGE>
or expansions of NOTA could be adopted in the future which could require us to
change one or more aspects of our business, at a substantial cost, in order to
continue to comply with this statute.
A variety of additional local, state, federal and international government
laws and regulations govern our business, including those relating to the
storage, handling, generation, manufacture and disposal of medical wastes from
the production of our allografts. While at present we believe we comply with
these laws and regulations, if we fail to conduct our business in compliance
with these laws and regulations, it could subject us to significant liabilities.
We carry $21.0 million of insurance that would cover some liabilities arising
from hazardous biological materials. We cannot be certain, however, that this
insurance will continue to be available.
IF THIRD PARTY PAYORS FAIL TO PROVIDE APPROPRIATE LEVELS OF REIMBURSEMENT
FOR THE USE OF OUR ALLOGRAFTS, OUR REVENUES WOULD BE ADVERSELY AFFECTED.
Political, economic and regulatory influences are subjecting the healthcare
industry in the United States to fundamental change. Any new federal or state
legislation could result in significant changes in the availability, delivery,
pricing and payment for healthcare services and products. While we cannot
predict what form any new legislation will take, it is possible that any
significant healthcare legislation, if adopted, could lower the amounts paid to
us for our services, which would decrease our revenues.
Our revenues depend largely on the reimbursement of patients' medical
expenses by government health care programs and private health insurers.
Governments and private insurers closely examine medical procedures
incorporating new technologies to determine whether the procedures will be
covered by payment, and if so, the level of payment which may apply. We cannot
be sure that third party payors will continue to reimburse us or provide payment
at levels which will be profitable to us.
OUR STOCK PRICE MAY DECLINE AFTER THIS OFFERING AND MAY BE VOLATILE IN THE
FUTURE.
The market for shares in newly public technology companies, particularly
medical device or biotechnology-related companies, is subject to extreme price
and volume fluctuations. Our shares will be exposed to these fluctuations. You
may not be able to resell any shares you buy from us at or above the initial
public offering price due to a number of factors, including:
- actual or anticipated fluctuations in our operating results;
- changes in investors' and securities analysts' expectations as to our
future financial performance or changes in financial estimates of
securities analysts;
- announcements of new allografts or product enhancements by us or our
competitors;
- technological innovations by us or our competitors;
- negative publicity concerning methods of tissue recovery and screening;
and
- the operating and stock price performance of comparable companies.
In addition, although our common stock will be quoted on the Nasdaq National
Market, an active trading market may not develop or sustain itself after this
offering.
OWNERSHIP OF OUR STOCK IS HEAVILY CONCENTRATED AND THESE STOCKHOLDERS WILL
CONTROL ALL MATTERS REQUIRING STOCKHOLDER APPROVAL AND MAY NOT MAKE DECISIONS
THAT ARE IN THE BEST INTERESTS OF ALL OF OUR STOCKHOLDERS.
After giving effect to this offering, our directors, executive officers, and
stockholders holding greater than 5% of our common stock beneficially will own
approximately 40.0% of our outstanding common stock. As a result, these
stockholders are able to control all matters requiring stockholder approval,
including the election of directors and approval of significant transactions.
This concentration
11
<PAGE>
of ownership may also have the effect of delaying or preventing a change in
control of our company, which could deny our stockholders the chance to realize
a premium on their shares.
PROVISIONS OF OUR GOVERNING DOCUMENTS AND DELAWARE LAW COULD DISCOURAGE
ACQUISITION PROPOSALS OR DELAY A CHANGE IN OUR CONTROL, AND THIS MAY ADVERSELY
AFFECT THE MARKET PRICE OF OUR COMMON STOCK OR DENY OUR STOCKHOLDERS A CHANCE TO
REALIZE A PREMIUM ON THEIR SHARES.
Our certificate of incorporation and by-laws contain anti-takeover
provisions, including those listed below, that could make it more difficult for
a third party to acquire control of us, even if that change in control would be
beneficial to our stockholders:
- our board of directors has the authority to issue common stock and
preferred stock and to determine the price, rights and preferences of any
new series of preferred stock without further stockholder approval;
- our board of directors is divided into three classes, with each class
serving staggered three-year terms;
- supermajority voting is required to amend key provisions of our
certificate of incorporation and by-laws;
- there are limitations on who can call special meetings of stockholders;
- stockholders may not take action by written consent; and
- in order to nominate a director or make a proposal at a stockholders'
meeting, a stockholder must give us advance notice.
In addition, provisions of Delaware law and our stock option plans may also
discourage, delay or prevent a change of control of our company or unsolicited
acquisition proposals.
OUR MANAGEMENT WILL HAVE BROAD DISCRETION AS TO THE USE OF PROCEEDS OF THIS
OFFERING AND IF MANAGEMENT DOES NOT USE THESE PROCEEDS EFFECTIVELY, WE MAY NOT
SUCCEED IN EXECUTING OUR BUSINESS STRATEGY AND INCREASING OUR REVENUES.
Our management will have broad discretion as to how to use the net proceeds
of this offering. You will be relying on the judgment of our management
regarding the application of the proceeds of this offering. The results and
effectiveness of the use of the proceeds are uncertain.
YOU WILL INCUR IMMEDIATE DILUTION IN THIS OFFERING.
The initial public offering price of our common stock is substantially
higher than the pro forma net tangible book value per share of our outstanding
shares of common stock immediately after this offering. Therefore, if you
purchase our common stock in this offering at the initial public offering price
of $14.00 per share, you will incur immediate dilution of $10.92 in the net
tangible book value per share from the price you pay for the shares you
purchase.
FUTURE SALES OF OUR COMMON STOCK COULD ADVERSELY AFFECT THE MARKET PRICE OF
OUR COMMON STOCK.
Sales of our common stock in the public market following this offering could
adversely affect the market price of our common stock since these sales could
cause an excess supply of available shares which typically results in lower
prices. Of the estimated 21,308,562 shares that will be outstanding upon the
completion of this offering:
- all of the 5,700,000 shares offered under this prospectus generally will
be freely tradable in the public market; and
- approximately 15,608,562 additional shares may be sold after the
expiration of the 180-day lock-up agreements entered into by our officers,
directors and existing stockholders.
12
<PAGE>
FORWARD-LOOKING STATEMENTS
This prospectus includes forward-looking statements. We based these
forward-looking statements on our current expectations and projections about
future events. Our actual results could differ materially from those discussed
in, or implied by, these forward-looking statements. Forward-looking statements
are identified by words such as "believe," "anticipate," "expect," "intend,"
"plan," "will," "may" and other similar expressions. In addition, any statements
that refer to expectations, projections or other characterizations of future
events or circumstances are forward-looking statements. Forward-looking
statements in these documents include, but are not necessarily limited to, those
relating to:
- our ability to obtain human tissue from our current and future sources;
- our ability to maintain or obtain protection for the know-how and
proprietary technologies necessary to develop, market and distribute our
technologies and allografts;
- current and future tissue repair or replacement treatment options offered
by our competitors;
- the state of government regulation of our allografts, processes and
technologies in the United States and internationally, and our ability to
comply with these regulations;
- our plans to develop and market new allografts and technologies; and
- our ability to carry out our business strategy.
Factors that could cause actual results or conditions to differ from those
anticipated by these and other forward-looking statements include those more
fully described in the "Risk Factors" section and elsewhere in this prospectus.
------------------------
YOU SHOULD RELY ONLY ON THE INFORMATION CONTAINED IN THIS PROSPECTUS. WE
HAVE NOT AUTHORIZED ANYONE TO PROVIDE YOU WITH DIFFERENT INFORMATION. WE ARE NOT
MAKING AN OFFER TO SELL THESE SECURITIES IN ANY JURISDICTION WHERE THE OFFER OR
SALE IS NOT PERMITTED. YOU SHOULD ASSUME THAT THE INFORMATION APPEARING IN THIS
PROSPECTUS IS ACCURATE AS OF THE DATE ON THE FRONT COVER OF THIS PROSPECTUS
ONLY. OUR BUSINESS, FINANCIAL CONDITION, RESULTS OF OPERATIONS AND PROSPECTS MAY
HAVE CHANGED SINCE THAT DATE.
13
<PAGE>
USE OF PROCEEDS
We estimate the net proceeds to us from our sale of 3,800,000 shares of
common stock, after deducting underwriting discounts and commissions and the
estimated offering expenses payable by us, will be approximately $48.5 million
based on the initial public offering price of $14.00 per share. We will not
receive any proceeds from the sale of shares by the selling stockholder. See
"Underwriting."
We intend to use the net proceeds of this offering in the following manner:
- $16.0 million for continued research and development of our existing as
well as new products;
- $9.0 million to construct and equip a new manufacturing facility on
recently acquired property;
- $8.0 million for construction of additional BioCleanse-systems and other
automation of our processing facility;
- $3.0 million to expand our tissue supply and distribution programs; and
- $12.5 million for general corporate purposes, including increases in
working capital.
In addition, we may also use a portion of the net proceeds from this
offering to acquire businesses, assets, technologies or product lines that
complement our existing business if we could make these acquisitions on terms
which we deem to be favorable. Other than our acquisition of the tissue
processing and distribution business of Alabama Tissue Center for 250,000 shares
of our common stock and up to $0.6 million in cash, which we intend to complete
following the completion of this offering, we do not have any commitments to
make any acquisition and have not allocated a specific amount of the net
proceeds for this purpose.
Our management will have significant flexibility in applying the net
proceeds of the offering. Pending any use as described above, we intend to
invest the net proceeds in short-term, interest-bearing investment-grade
instruments.
DIVIDEND POLICY
We have never declared nor paid any cash dividends on our capital stock. In
addition, our current credit facility restricts our ability to pay any dividends
and any future facility may contain similar restrictions. We currently
anticipate that we will retain any future earnings for the development and
operation of our business. Accordingly, we do not anticipate paying cash
dividends on our capital stock in the foreseeable future.
14
<PAGE>
CAPITALIZATION
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
The following table sets forth our capitalization as of June 30, 2000:
(i) on an actual basis; (ii) on a pro forma basis to reflect the conversion of
2,894,490 shares of preferred stock into 13,893,552 shares of common stock; and
(iii) on a pro forma as adjusted basis to reflect our sale of 3.8 million shares
of common stock at a price of $14.00 per share, and after deducting underwriting
discounts and commissions and the estimated offering expenses payable by us and
the application of the estimated net proceeds. This table should be read along
with "Management's Discussion and Analysis of Financial Condition and Results of
Operations" and our consolidated financial statements and accompanying notes
included elsewhere in this prospectus.
<TABLE>
<CAPTION>
AS OF JUNE 30, 2000
-----------------------------------
PRO FORMA
ACTUAL PRO FORMA AS ADJUSTED
--------- --------- -----------
<S> <C> <C> <C>
Long-term debt, including current portion................... $ 4,943 $ 4,943 $ 4,943
Stockholders' equity:
Series A preferred stock, $.001 par value, 1,777,348
shares authorized, issued and outstanding, actual; no
shares authorized, issued and outstanding, pro forma and
pro forma as adjusted................................... 2 -- --
Series B preferred stock, $.001 par value, 748,152 shares
authorized, issued and outstanding, actual; no shares
authorized, issued and outstanding, pro forma and pro
forma as adjusted....................................... 6,580 -- --
Series C preferred stock, $.001 par value, 368,990 shares
authorized, issued and outstanding, actual; no shares
authorized, issued and outstanding, pro forma and pro
forma as adjusted....................................... 10,000 -- --
Preferred stock, $.001 par value, no shares authorized,
issued and outstanding, actual; 5,000,000 shares
authorized and no shares issued and outstanding, pro
forma and pro forma as adjusted......................... -- -- --
Common stock, $.001 par value, 6,000,000 shares authorized
and 3,743,410 shares issued, actual; 50,000,000 shares
authorized and 17,636,962 shares issued, pro forma;
50,000,000 shares authorized and 21,436,962 shares
issued, pro forma as adjusted........................... 4 18 21
Additional paid-in capital.................................. 3,292 19,860 68,333
Retained earnings........................................... 37 37 37
Deferred compensation....................................... (2,607) (2,607) (2,607)
Due from stockholder-net of due to stockholder.............. (180) (180) (180)
Less treasury stock, 128,400 shares, actual, pro forma, and
pro forma as adjusted..................................... (15) (15) (15)
------- ------- -------
Total stockholders' equity................................ 17,113 17,113 65,589
------- ------- -------
Total capitalization.................................. $22,056 $22,056 $70,532
======= ======= =======
</TABLE>
The above information excludes:
- 1,825,166 shares of our common stock subject to options granted under our
Omnibus Stock Option Plan and outstanding as of June 30, 2000 at a
weighted average exercise price of $4.29 per share;
- 226,930 shares of our common stock reserved for issuance upon the exercise
of warrants outstanding as of June 30, 2000, at a weighted average
exercise price of $5.65 per share;
- 855,000 shares of our common stock issuable by us if the underwriters
exercise their over-allotment option; and
- 250,000 shares of our common stock we anticipate issuing when we acquire
the Alabama Tissue Center following the completion of this offering.
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<PAGE>
DILUTION
Our historical net tangible book value as of June 30, 2000 was $17,112,935,
or $4.73 per share of common stock. Our pro forma net tangible book value per
share as of June 30, 2000, after giving effect to the conversion of 2,894,490
outstanding shares of preferred stock into 13,893,552 shares of common stock,
was $0.98. Pro forma net tangible book value per share is equal to the amount of
our tangible net assets, less total liabilities, divided by the pro forma number
of shares of our common stock outstanding as of June 30, 2000. After giving
effect to the sale by us of 3.8 million shares of common stock at a price of
$14.00 per share, and after deducting underwriting discounts and commissions and
estimated offering expenses payable by us and applying the net proceeds from
this offering, our pro forma net tangible book value at June 30, 2000 would have
been $65,588,935, or $3.08 per share of our common stock. This amount represents
an immediate increase in our pro forma net tangible book value of $2.10 per
share to existing stockholders and an immediate dilution in net tangible book
value of $10.92 per share to new investors in this offering. To the extent any
outstanding options or warrants are exercised, there will be further dilution to
new investors. The following table illustrates this per share dilution:
<TABLE>
<S> <C> <C>
Initial public offering price per share..................... $14.00
Pro forma net tangible book value per share as of
June 30, 2000........................................... $ .98
Increase per share attributable to new investors.......... 2.10
------
Pro forma net tangible book value per share after this
offering.................................................. 3.08
------
Dilution per share to new investors......................... $10.92
======
</TABLE>
If the underwriters' over-allotment option is exercised in full, our pro
forma as adjusted net tangible book value at June 30, 2000 would have been
approximately $3.46 per share, representing an immediate increase in net
tangible book value of $2.48 per share to existing stockholders and an immediate
dilution in net tangible book value of $10.54 per share to new investors.
The following table summarizes, on a pro forma basis as of June 30, 2000,
the total number of shares of our common stock purchased from us, the total
consideration paid for these shares, and the average price per share paid by our
existing stockholders and by new investors purchasing shares in this offering:
<TABLE>
<CAPTION>
SHARES PURCHASED TOTAL CONSIDERATION AVERAGE
--------------------- ---------------------- PRICE PER
NUMBER PERCENT AMOUNT PERCENT SHARE
---------- -------- ----------- -------- ---------
<S> <C> <C> <C> <C> <C>
Existing stockholders....................... 17,508,562 82.2% $17,445,454 24.7% $ 1.00
New investors............................... 3,800,000 17.8 53,200,000 75.3 14.00
---------- ----- ----------- ------
Total..................................... 21,308,562 100.0% $70,645,454 100.0%
========== ===== =========== ======
</TABLE>
If the underwriters' over-allotment option is exercised in full, the number
of shares of common stock held by our existing stockholders will be reduced to
approximately 79.0% of the total number of shares of our common stock to be
outstanding after this offering, and will increase the number of shares of our
common stock held by the new investors to 4,655,000 shares, or approximately
21.0% of the total number of shares of our common stock to be outstanding
immediately after this offering.
The above information excludes:
- 1,825,166 shares of our common stock subject to options granted under our
Omnibus Stock Option Plan and outstanding as of June 30, 2000 at a
weighted average exercise price of $4.29 per share;
- 226,930 shares of our common stock reserved for issuance upon the exercise
of warrants outstanding as of June 30, 2000 at a weighted average exercise
price of $5.65 per share;
- 855,000 shares of our common stock issuable by us if the underwriters
exercise their over-allotment option; and
- 250,000 shares of our common stock we anticipate issuing when we acquire
the Alabama Tissue Center following the completion of this offering.
16
<PAGE>
SELECTED CONSOLIDATED FINANCIAL DATA
The statement of operations data set forth below for the years ended
December 31, 1995 and 1996 for our predecessor business have been derived from
the underlying accounting records of the University of Florida Tissue Bank. The
statement of operations data set forth below for the year ended December 31,
1997 and the period from January 1, 1998 to February 11, 1998 for our
predecessor business have been derived from our statements of revenues and
direct costs and accompanying notes, which have been audited by Deloitte &
Touche LLP, independent auditors, and are included elsewhere in this prospectus.
In addition, the statement of operations data set forth below for the period
from February 12, 1998, when we began operations, to December 31, 1998 and the
year ended December 31, 1999 and selected balance sheet data as of December 31,
1998 and 1999 have been derived from our consolidated financial statements and
accompanying notes, which have been audited by Deloitte & Touche LLP,
independent auditors, and are included elsewhere in this prospectus. The
statement of operations data set forth below for the six months ended June 30,
1999 and 2000 and selected balance sheet data as of June 30, 2000 have been
derived from our unaudited condensed consolidated financial statements and
accompanying notes included elsewhere in this prospectus. These unaudited
condensed consolidated financial statements have been prepared on the same basis
as the audited consolidated financial statements and, in our opinion, include
all adjustments and reclassifications (consisting only of normal recurring
adjustments and reclassifications) necessary to present fairly the financial
condition and results of operations for the periods presented. The following
items should be considered when comparing the selected consolidated financial
information from period to period: Beginning January 1, 1995, revenues from core
operations and cost of processing and distribution for the predecessor business
consisted of revenues from and costs of conventional tissue processing.
Beginning in August, 1996, the predecessor business began to distribute
precision tooled allografts and, therefore, revenues from core operations and
cost of processing and distribution for the predecessor business consisted of
both revenues for and costs of conventional tissue processing and distribution
of precision tooled allografts. During the year ended December 31, 1997, the
period from January 1, 1998 to February 11, 1998 and the period from
February 12, 1998 to December 31, 1998, revenues from core operations and cost
of processing and distribution consisted of revenues from and costs of
conventional tissue processing and distribution of precision tooled allografts.
Beginning in April, 1999, revenues from core operations included revenues for
direct distribution of conventional tissue into Florida and Georgia as well as
revenues for distribution of allografts that are precisely tooled for specific
surgical uses. The selected consolidated financial data set forth below should
be read along with "Management's Discussion and Analysis of Financial Condition
and Results of Operations," and our consolidated financial statements and
accompanying notes included elsewhere in this prospectus.
17
<PAGE>
SELECTED CONSOLIDATED FINANCIAL DATA
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
<TABLE>
PERIOD FROM PERIOD FROM
JANUARY 1, FEBRUARY 12,
YEAR ENDED YEAR ENDED YEAR ENDED 1998 TO 1998 TO YEAR ENDED
DECEMBER 31, DECEMBER 31, DECEMBER 31, FEBRUARY 11, DECEMBER 31, DECEMBER 31,
1995 1996 1997 1998 1998 1999
------------ ------------ ------------ ------------ ------------ --------------
<S> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenues from core operations:
Fees from tissue
distribution................ -- $ 706 $11,074 $2,416 $ 31,892 $ 70,783
Other revenues from core
operations.................. $1,192 1,585 2.435 410 3,365 2,237
------ ------ ------- ------ ---------- --------------
Total revenues................ 1,192 2,291 13,509 2,826 35,257 73,020
Management services fees........ -- 565 8,875 1,932 24,129 39,994
------ ------ ------- ------ ---------- --------------
Net revenues.................. 1,192 1,726 4,634 894 11,128 33,026
Cost of processing and
distribution.................. 903 1,987 3,344 590 9,845 19,172
------ ------ ------- ------ ---------- --------------
Gross profit.................. 289 (261) 1,290 304 1,283 13,854
Expenses:
Marketing, general and
administrative.............. 401 549 1,357 208 3,987 9,740
Research and development...... -- 19 479 68 1,472 1,675
------ ------ ------- ------ ---------- --------------
Total expenses................ 401 568 1,836 276 5,459 11,415
---------- --------------
Operating (loss) income......... (4,176) 2,439
Equity in income of
unconsolidated subsidiary..... -- --
Interest (expense) income:
Interest expense.............. (153) (285)
Interest income............... 187 187
---------- --------------
Total interest income
(expense)--net.............. 34 (98)
---------- --------------
(Loss) income before income tax
benefit....................... (4,142) 2,341
Income tax benefit (expense).... -- 619
---------- --------------
Net (loss) income............... $ (4,142) $ 2,960
========== ==============
Net (loss) income per common
share--basic.................. $ (1.12) $ 0.81
Net (loss) income per common
share--diluted................ $ (1.12) $ 0.18
Weighted average shares
outstanding--basic............ 3,686,770 3,669,970
Weighted average shares
outstanding--diluted.......... 3,686,770 16,636,791
Pro forma net income per common
share--basic.................. $ 0.18
Pro forma net income per common
share--diluted................ $ 0.18
Pro forma weighted average
shares outstanding--basic..... 16,161,269
Pro forma weighted average
shares outstanding--diluted... 16,636,791
<S> <C> <C>
SIX MONTHS ENDED
JUNE 30,
------------------------
1999 2000
---------- -----------
STATEMENT OF OPERATIONS DATA:
Revenues from core operations:
Fees from tissue
distribution................ $ 30,174 $ 53,216
Other revenues from core
operations.................. 1,387 863
---------- -----------
Total revenues................ 31,561 54,079
Management services fees........ 17,462 28,935
---------- -----------
Net revenues.................. 14,099 25,144
Cost of processing and
distribution.................. 8,990 13,119
---------- -----------
Gross profit.................. 5,109 12,025
Expenses:
Marketing, general and
administrative.............. 3,856 8,539
Research and development...... 802 1,201
---------- -----------
Total expenses................ 4,658 9,740
---------- -----------
Operating (loss) income......... 451 2,285
Equity in income of
unconsolidated subsidiary..... -- 5
Interest (expense) income:
Interest expense.............. (113) (267)
Interest income............... 90 131
---------- -----------
Total interest income
(expense)--net.............. (23) (136)
---------- -----------
(Loss) income before income tax
benefit....................... 428 2,154
Income tax benefit (expense).... (273) (935)
---------- -----------
Net (loss) income............... $ 155 $ 1,219
========== ===========
Net (loss) income per common
share--basic.................. $ 0.04 $ 0.34
Net (loss) income per common
share--diluted................ $ 0.01 $ 0.07
Weighted average shares
outstanding--basic............ 3,672,790 3,629,400
Weighted average shares
outstanding--diluted.......... 15,936,747 18,312,307
Pro forma net income per common
share--basic.................. $ 0.07
Pro forma net income per common
share--diluted................ $ 0.07
Pro forma weighted average
shares outstanding--basic..... 17,522,952
Pro forma weighted average
shares outstanding--diluted... 18,312,307
</TABLE>
<TABLE>
<CAPTION>
AS OF DECEMBER 31, AS OF JUNE 30,
------------------- ---------------
1998 1999 2000
BALANCE SHEET DATA: -------- -------- ---------------
<S> <C> <C> <C>
Cash and cash equivalents................................... $ 3,926 $ 7,536 $ 763
Working capital............................................. (13) 14,052 12,600
Total assets................................................ 19,268 48,538 56,341
Long-term obligations, less current portion................. 1,522 2,027 3,912
Total stockholders' (deficiency) equity..................... (1,431) 15,437 17,113
</TABLE>
18
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
OVERVIEW
We are a leader in the use of material tissue and innovative technologies to
repair and promote the natural healing of human bone and other human tissues. We
were the largest U.S. processor and distributor of allografts that are precisely
tooled for specific surgical uses in terms of revenues for the year ended
December 31, 1999. These allograft implants are used in surgical reconstruction,
bone healing and tissue repair, and are made from bone, cartilage, tendon,
ligament and other soft tissues recovered from deceased tissue donors primarily
through a national network of organ and tissue recovery agencies.
We were incorporated in 1997 as a wholly owned subsidiary of the University
of Florida Tissue Bank, Inc., or UFTB. We began operations on February 12, 1998
when UFTB contributed to us its allograft manufacturing and processing
operations, related equipment and technologies, distribution arrangements,
research and development activities and certain other assets in exchange for
shares of preferred stock. We also assumed various liabilities of UFTB that were
related to the transferred business. At approximately the same time, we sold
shares of preferred stock to a number of unrelated investors.
In addition, UFTB assigned to us various agreements to which it was party at
the time of the separation, including an agreement with Medtronic Sofamor Danek
under which that company was given the right to be the exclusive provider of
management services for our current line of allografts for use in spinal and
cranial medical procedures, including our bone dowels. Under this agreement, we
are required to pay Medtronic Sofamor Danek 70% of the amount charged for our
spinal allografts.
At approximately the time of our separation from UFTB, James M. Grooms, our
President and Chief Executive Officer and former officer of UFTB prior to our
separation from that entity, contributed his royalty rights in certain
intellectual property to us in exchange for shares of our preferred stock. We
recorded the assets acquired from UFTB and Mr. Grooms and the liabilities
assumed from UFTB at their historical cost basis since these were deemed to be
transactions between entities under common control.
On April 15, 1999, we changed our business strategy to distribute both
conventional allografts and allogratfts that are precisely tooled for specific
surgical uses. Prior to that time, we processed both conventional and precision
tooled allografts, but we only directly distributed the precision tooled
allograft, allowing UFTB to distribute the conventional tissue processed by us.
On April 15, 1999, as part of this change in business strategy, we entered into
a Programs Transfer Agreement with UFTB under which UFTB transferred to us its
recovery operations outside of Florida and Georgia, conventional allograft
distribution services, and its interests in agreements with various tissue
recovery programs in exchange for the offset of amounts owed to us by UFTB. Also
on that date, we entered into a Tissue Recovery Agreement with UFTB under which
UFTB functions as one of our tissue recovery agencies, supplying us with the
majority of the tissue it recovers. As of April 15, 1999, the total amounts owed
to us by UFTB was approximately $5.0 million. Under the terms of the agreements,
UFTB transferred to us its unprocessed donor tissue and conventional tissue with
a fair value of approximately $3.0 million and equipment and fixtures with a
fair value of approximately $0.1 million as a partial offset against the
existing amounts owed to us by UFTB. UFTB agreed to repay the remaining amounts
it owed to us by offsetting recovery fees from April 15, 1999 through June 30,
1999 against the outstanding balance, which fees, net of administrative costs,
were approximately $0.7 million, and making monthly payments through the end of
1999 to repay the remaining balance of approximately $1.2 million.
On November 1, 1999, we acquired the net assets of Georgia Tissue
Bank, Inc. along with certain equipment owned by a director of Georgia Tissue
Bank. We financed this acquisition with a cash
19
<PAGE>
payment of $0.5 million and promissory notes totaling $1.3 million. We recorded
our acquisition of the net assets of Georgia Tissue Bank under the purchase
method of accounting.
On April 27, 2000, we entered into an agreement to acquire the tissue
processing and distribution business of Alabama Tissue Center. Under that
agreement, we are obligated to issue to the seller 250,000 shares of our common
stock and $0.3 million in cash, with the possible payment of an additional $0.3
million in cash if specified milestones are achieved by the acquired business
following the acquisition.
All of our operations are located in the United States, although we
distribute our allografts to customers both within and outside the United
States. In 1999, 97.4% of our net revenues were from domestic tissue
distribution compared to 100% of our net revenues in 1998. We expect the portion
of our net revenues attributable to international revenues will increase in the
future.
In general, tissue recovery rates increase during the month of March and
decrease during the month of August. Although this seasonality in tissue
recovery affects the availability of donor tissue during these periods, it
historically has not affected our ability to continue processing available donor
tissue or supply needed allografts. We attempt to manage our business so that
these short-term reductions in donor tissue recoveries do not affect the
quarterly results of our business.
RESULTS OF OPERATIONS
The following table sets forth, in both dollars and as a percentage of net
revenues, the results of our operations for the periods indicated:
<TABLE>
<CAPTION>
PERIOD FROM
FEBRUARY 12, 1998 YEAR ENDED SIX MONTHS ENDED JUNE 30,
TO DECEMBER 31, DECEMBER 31, -------------------------------------------
1998 1999 1999 2000
------------------- ------------------- ------------------- -------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
(IN THOUSANDS)
STATEMENT OF OPERATIONS DATA:
Revenues from core operations:
Fees from tissue distribution..... $31,892 $70,783 $30,174 $53,216
Other revenues from core
operations...................... 3,365 2,237 1,387 863
------- ------- ------- -------
Total revenues...................... 35,257 73,020 31,561 54,079
Management services fees............ 24,129 39,994 17,462 28,935
------- ------- ------- -------
Net revenues........................ 11,128 100.0% 33,026 100.0% 14,099 100.0% 25,144 100.0%
Costs of processing and
distribution...................... 9,845 88.5 19,172 58.1 8,990 63.8 13,119 52.2
------- ----- ------- ----- ------- ----- ------- -----
Gross profit........................ 1,283 11.5 13,854 41.9 5,109 36.2 12,025 47.8
------- ----- ------- ----- ------- ----- ------- -----
Expenses:
Marketing, general and
administrative.................. 3,987 35.8 9,740 29.5 3,856 27.3 8,539 34.0
Research and development.......... 1,472 13.2 1,675 5.1 802 5.7 1,201 4.8
------- ----- ------- ----- ------- ----- ------- -----
Total expenses...................... 5,459 49.0 11,415 34.6 4,658 33.0 9,740 38.8
------- ----- ------- ----- ------- ----- ------- -----
Operating (loss) income............. (4,176) (37.5) 2,439 7.3 451 3.2 2,285 9.0
Equity in income of unconsolidated
subsidiary........................ -- -- -- -- -- -- 5 --
Interest (expense) income:
Interest expense.................. (153) (1.4) (285) (0.9) (113) (0.8) (267) (1.0)
Interest income................... 187 1.7 187 0.6 90 0.6 131 0.5
------- ----- ------- ----- ------- ----- ------- -----
Total interest income
(expense)--net.................... 34 0.3 (98) (0.3) (23) (0.2) (136) (0.5)
------- ----- ------- ----- ------- ----- ------- -----
(Loss) income before income tax
benefit........................... (4,142) (37.2) 2,341 7.0 428 3.0 2,154 8.5
Income tax benefit (expense)........ -- -- 619 1.9 (273) (1.9) (935) (3.7)
------- ----- ------- ----- ------- ----- ------- -----
Net (loss) income................... $(4,142) (37.2)% $ 2,960 8.9% $ 155 1.1% $ 1,219 4.8%
======= ===== ======= ===== ======= ===== ======= =====
</TABLE>
20
<PAGE>
SIX MONTHS ENDED JUNE 30, 2000 COMPARED TO SIX MONTHS ENDED JUNE 30, 1999
TOTAL REVENUES. Our total revenues increased by $22.5 million, or 71.2%, to
$54.1 million for the six months ended June 30, 2000 from $31.6 million for the
six months ended June 30, 1999.
Fees from tissue distribution increased by $23.0 million, or 76.2%, to
$53.2 million for the six months ended June 30, 2000 from $30.2 million for the
six months ended June 30, 1999. The increase in fees from tissue distribution
was due largely to an increase of $17.8 million in revenues from the
distribution of our spinal allografts, an increase of $3.2 million from the
distribution of conventional tissue and an increase of $2.0 million from the
distribution of other precision tooled allografts. The increase in our revenues
from spinal allografts was due primarily to the increase in volume from three
new spinal allografts we introduced in late 1998, plus a new allograft
introduced in late 1999. Conventional tissue revenues increased due to our
assumption of UFTB's conventional tissue distribution business in April 1999 and
the expansion of our conventional tissue business to a broader geographic range
during 2000. We also expanded our conventional tissue business internationally,
by adding new international distributors in Europe and Asia in the first six
months of 2000. Of the increase in our revenues from other precision tooled
allografts, $1.5 million was related to allografts we introduced in 1998 and
1999, with $0.5 million from two new allografts introduced in 2000. Other
revenues from core operations, which consist of tissue processing fees,
biomedical laboratory fees and manufacturing royalties, decreased by
$0.5 million to $0.9 million for the six months ended June 30, 2000 from
$1.4 million for the six months ended June 30, 1999. This decrease was due to
receiving no processing fees from UFTB as a result of our assumption of their
conventional tissue distribution business in April 1999 rather than continuing
to process UFTB's conventional tissue for a fee.
MANAGEMENT SERVICES FEES. Management services fees, which consist of
amounts paid to Medtronic Sofamor Danek for management services they provide to
assist in the distribution of our allografts, increased by $11.5 million, or
66.1%, to $28.9 million for the six months ended June 30, 2000 from
$17.4 million for the six months ended June 30, 1999. The increase in the
absolute amount of these fees was due to the greater revenues generated through
the management services of Medtronic Sofamor Danek. As a percentage of total
revenues, however, these fees decreased from 55.1% for the six months ended
June 30, 1999 to 53.4% for the six months ended June 30, 2000. This decrease in
management services fees as a percentage of total revenues was attributable to
the management services fees payable by us on certain of our allografts being
70% of revenues derived from distribution of allografts for which Medtronic
Sofamor Danek provides management services for the first six months of 2000
compared to 80% during a portion of the first six months of 1999. In addition,
an increase in distribution of our non-spinal allografts, for which we do not
pay a management services fee, contributed to the reduction in management
services fees as a percentage of total fees.
NET REVENUES. Our net revenues increased by $11.0 million, or 78.0%, to
$25.1 million for the six months ended June 30, 2000 from $14.1 million for the
six months ended June 30, 1999. As a percentage of total revenues, our net
revenues increased from 44.6% for the six months ended June 30, 1999 to 46.4%
for the six months ended June 30, 2000. This increase was due mainly to the
impact of distribution of our non-spinal allografts, for which we do not pay
management services fees.
COSTS OF PROCESSING AND DISTRIBUTION. Costs of processing and distribution
increased by $4.1 million, or 45.6%, to $13.1 million for the six months ended
June 30, 2000 from $9.0 million for the six months ended June 30, 1999. As a
percentage of net revenues, however, these costs decreased from 63.8% for the
six months ended June 30, 1999 to 52.2% for the six months ended June 30, 2000.
This reduction was attributable primarily to improvements in processing
efficiencies achieved through our introduction of automated processing
machinery, as well as efficiencies associated with increased volume. In
addition, the increase in our net revenues due to reduced management services
fees payable by us also resulted in a reduction of the percentage of our net
revenues attributable to costs of processing and distribution.
21
<PAGE>
MARKETING, GENERAL AND ADMINISTRATIVE EXPENSES. Marketing, general and
administrative expenses increased by $4.6 million, or 117.9%, to $8.5 million
for the six months ended June 30, 2000 from $3.9 million for the six months
ended June 30, 1999. Contributing to this increase was an increase of
$0.7 million in marketing and direct distribution payroll expense, as well as an
increase of $0.7 million in administrative payroll expenses to support the
growth of our business. Also contributing to the increase was a $0.1 million
increase in facilities expense during 2000 due to additional leased space being
leased by us during the period. Other cost increases included an increase in
distributor commissions, primarily on conventional tissue, of $0.8 million,
increased depreciation expense of $0.3 million for new equipment and the
corporate buildings purchased on March 30, 2000, increased royalties of
$0.1 million and increased professional fees and travel related expenses of
$0.6 million to support our distribution and marketing efforts. Georgia Tissue
Bank, acquired in November 1999 also added $0.5 million to these expenses. As a
percentage of net revenues, marketing, general and administrative expenses
increased from 27.7% for the six months ended June 30, 1999 to 34.0% for the six
months ended June 30, 2000. This increase as a percentage of net revenues was
due to adding additional personnel to support the expansion of our business in
2000.
RESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses
increased by $0.4 million, or 50.0%, to $1.2 million for the six months ended
June 30, 2000 from $0.8 million for the six months ended June 30, 1999. This
increase was due largely to our hiring additional personnel to develop new
allografts and technologies. We expense all research and development costs as
incurred. As a percentage of net revenues, research and development expenses
decreased from 5.7% for the six months ended June 30, 1999 to 4.8% for the six
months ended June 30, 2000. This decrease was due to our net revenues rising
without a commensurate increase in research and development expenses.
INTEREST INCOME AND EXPENSE--NET. Net interest expense for the six months
ended June 30, 2000 was $136,000 compared to net interest expense of $23,000 for
the six months ended June 30, 1999. The increase in the amount of interest we
paid was due largely to borrowings under our line of credit facility entered
into during the second quarter of 1999, as well as interest paid on a number of
capital leases entered into after the first quarter of 1999.
INCOME TAX EXPENSE. Income tax expense for the six months ended June 30,
2000 was $0.9 million versus $0.3 million for the six months ended June 30,
1999. The increase was due to the increase in income before taxes for the six
months ended June 30, 2000 versus the income before income tax for the three
months ended June 30, 1999.
YEAR ENDED DECEMBER 31, 1999 COMPARED TO FORTY-SIX WEEK PERIOD ENDED
DECEMBER 31, 1998
AMOUNTS STATED BELOW FOR THE PERIOD ENDED DECEMBER 31, 1998 INCLUDE ONLY
APPROXIMATELY TEN AND ONE-HALF MONTHS, OR 46 WEEKS, OF OPERATIONS, COMPARED TO A
FULL 12 MONTHS FOR THE YEAR ENDED DECEMBER 31, 1999.
TOTAL REVENUES. Our total revenues increased by $37.7 million, or 106.8%,
to $73.0 million for the year ended December 31, 1999 from $35.3 million for the
46 week period ended December 31, 1998.
Fees from tissue distribution increased by $38.9 million, or 121.9%, to
$70.8 million for the year 46 week ended December 31, 1999 from $31.9 million
for the 46 week period ended December 31, 1998. The increase in fees from tissue
distribution was due primarily to an increase of $26.7 million in revenues from
the distribution of our spinal allografts and from an increase of $8.0 million
from the distribution of conventional tissue which we began distributing in
April 1999 as a result of our change in business strategy. An additional
increase of $4.2 million came from the distribution of other precision tooled
allografts. The increase in our revenues from spinal allografts was due
primarily to our introduction of three new spinal allografts in late 1998.
Conventional tissue revenues increased due to our assumption of UFTB's
conventional tissue distribution business in April 1999. Of the increase in
22
<PAGE>
our revenues from precision tooled allografts, $3.6 million was related to the
introduction of five new allografts in 1998, and $0.6 million was related to the
introduction of four new allografts in 1999.
Other revenues from core operations, which consist of tissue processing
fees, biomedical laboratory fees and manufacturing royalties, decreased by
$1.2 million, or 33.5%, to $2.2 million for the year ended December 31, 1999
from $3.4 million for the 46 week period ended December 31, 1998. This decrease
was due largely to a reduction during 1999 of processing fees from UFTB as a
result of our assumption of their conventional tissue distribution business in
April 1999 rather than continuing to process its conventional tissue for a fee.
MANAGEMENT SERVICES FEES. Management services fees, which consist of
amounts paid to Medtronic Sofamor Danek for management services provided to
assist in the distribution of our allografts, increased by $15.9 million, or
66.0%, to $40.0 million for the year ended December 31, 1999 from $24.1 million
for the 46 week period ended December 31, 1998. The increase in the absolute
amount of these fees was due to the greater revenues generated through the
management services of Medtronic Sofamor Danek. As a percentage of total
revenues, however, these fees decreased from 68.4% for the 46 week period ended
December 31, 1998 to 54.8% for the year ended December 31, 1999. This decrease
in management services fees as a percentage of total revenues was attributable
to a decrease in the management services fees payable by us on certain of our
allografts from 80% of revenues derived from distribution of allografts for
which Medtronic Sofamor Danek provides management services to 70% during the
first quarter of 1999. In addition, an increase in distribution of our
non-spinal allografts, for which we do not pay a management services fee,
contributed to the reduction in management services fees as a percentage of
total fees.
NET REVENUES. Our net revenues increased by $21.9 million, or 197.3%, to
$33.0 million for the year ended December 31, 1999 from $11.1 million for the 46
week period ended December 31, 1998. As a percentage of total revenues, our net
revenues increased from 31.6% for the 46 week period ended December 31, 1998 to
45.2% for the year ended December 31, 1999. This increase was due mainly to the
impact of distribution of our non-spinal allografts, for which we do not pay
management services fees.
COSTS OF PROCESSING AND DISTRIBUTION. Costs of processing and distribution
increased by $9.4 million, or 95.9%, to $19.2 million for the year ended
December 31, 1999 from $9.8 million for the 46 week period ended December 31,
1998. As a percentage of net revenues, however, these costs decreased from 88.5%
for the 46 week period ended December 31, 1998 to 58.0% for the year ended
December 31, 1999. This reduction was attributable primarily to improvements in
processing efficiencies achieved through our introduction of automated
processing machinery, as well as efficiencies associated with increased volume.
In addition, the increase in our net revenues due to reduced management services
fees payable by us also resulted in a reduction of the percentage of our net
revenues attributable to costs of processing and distribution.
MARKETING, GENERAL AND ADMINISTRATIVE EXPENSES. Marketing, general and
administrative expenses increased by $5.7 million, or 142.3%, to $9.7 million
for the year ended December 31, 1999 from $4.0 million for the 46 week period
ended December 31, 1998. Contributing to this increase was an increase of
$1.1 million in marketing and direct distribution payroll expense, as well as an
increase of $0.7 million in administrative expenses to support the growth of our
business. Also contributing to the increase was a $0.7 million increase in
facilities expense during 1999 as we went from leasing one building at the
beginning of 1998 to two buildings in the last quarter of 1998. Other cost
increases included an increase in distributor commissions, primarily on
conventional tissue, of $1.2 million, increased depreciation expense of $0.4
million, increased royalties on conventional tissue of $0.3 million and
increased professional fees and travel related expenses of $0.9 million to
support our distribution and marketing efforts. As a percentage of net revenues,
marketing, general and administrative expenses decreased from 35.8% for the 46
week period ended December 31, 1998 to 29.5% for the year ended
23
<PAGE>
December 31, 1999. This decrease was due to our net revenues rising without a
commensurate increase in marketing, general and administrative expenses.
RESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses
increased by $0.2 million, or 13.3%, to $1.7 million for the year ended
December 31, 1999 from $1.5 million for the 46 week period ended December 31,
1998. This increase was due primarily to the hiring of additional personnel to
develop new allografts and technologies. We expense research and development
costs as incurred. As a percentage of net revenues, research and development
expenses decreased from 13.2% for the 46 week period ended December 31, 1998 to
5.1% for the year ended December 31, 1999. This decrease was due to our net
revenues rising without a commensurate increase in research and development
expenses.
INTEREST INCOME AND EXPENSE--NET. Net interest expense for the year ended
December 31, 1999 was $98,000 compared to net interest income of $34,000 for the
46 week period ended December 31, 1998. The increase in the amount of interest
we paid was due primarily to borrowings under our line of credit facility
entered into during 1999, as well as interest paid on a number of capital leases
entered into during 1999.
INCOME TAX BENEFIT. In 1998 we recorded a valuation allowance with respect
to a deferred tax asset since we believed at the time that it was unlikely to be
realized. In 1999, as a result of achieving positive net income for that year,
this valuation allowance was reversed resulting in an income tax benefit of $0.6
million for 1999.
FORTY-SIX WEEK PERIOD ENDED DECEMBER 31, 1998 COMPARED TO THE PREDECESSOR
BUSINESS YEAR ENDED DECEMBER 31, 1997
AMOUNTS STATED BELOW FOR THE PERIOD ENDED DECEMBER 31, 1998 INCLUDE ONLY
APPROXIMATELY TEN AND ONE-HALF MONTHS OF OPERATIONS, OR 46 WEEKS, COMPARED TO A
FULL 12 MONTHS FOR THE PREDECESSOR BUSINESS YEAR ENDED DECEMBER 31, 1997.
TOTAL REVENUES. Our total revenues increased by $21.8 million, or 161.5%,
to $35.3 million for the 46 week period ended December 31, 1998 from
$13.5 million for the predecessor business year ended December 31, 1997.
Fees from tissue distribution increased by $20.8 million, or 187.4%, to
$31.9 million for the 46 week period ended December 31, 1998 from $11.1 million
for the predecessor business year ended December 31, 1997. The increase in fees
from tissue distribution was due largely to an increase of $19.3 million in
revenues from the distribution of our spinal allografts, an increase of
$1.1 million from the distribution of conventional tissue and an increase of
$0.4 million from the distribution of other precision tooled allografts. The
increase in our revenues from spinal allografts was due primarily to the
increase in sales volume from our original spinal allograft, which increased
from $11.1 million to $27.8 million. Three new spinal allografts introduced in
late 1998 added $2.6 million to the 1998 revenue. Conventional tissue revenues
increased due to our having donor tissue sources other than UFTB from which
conventional tissue could be produced. In 1997 the predecessor business received
from UFTB donor tissue which could be used to produce only spinal allografts.
The increase in our revenues from precision tooled allografts was due to the
introduction in 1998 of five new allografts. Other revenues from core
operations, which consist of tissue processing fees, biomedical laboratory fees
and manufacturing royalties, increased by $1.0 million to $3.4 million for the
46 week period ended December 31, 1998 from $2.4 million for the predecessor
business year ended December 31, 1997. This increase was largely due to a
$0.7 million increase in biomedical laboratory fees and a $0.3 million increase
in manufacturing royalties.
MANAGEMENT SERVICES FEES. Management services fees increased by
$15.2 million, or 170.8%, to $24.1 million for the 46 week period ended
December 31, 1998 from $8.9 million for the predecessor
24
<PAGE>
business year ended December 31, 1997. The increase in the absolute amount of
these fees was due to the significantly higher revenues from spinal allografts
generated through the management services of Medtronic Sofamor Danek.
NET REVENUES. Our net revenues increased by $6.5 million, or 141.3%, to
$11.1 million for the 46 week period ended December 31, 1998 from $4.6 million
for the predecessor business year ended December 31, 1997. As a percentage of
total revenues, our net revenues decreased from 34.1% for the predecessor
business year ended December 31, 1997 to 31.4% for the 46 week period ended
December 31, 1998. This decrease was due mainly to the impact of the
significantly higher revenues from our spinal allografts, for which we pay
management services fees and therefore receive less net revenue.
COSTS OF PROCESSING AND DISTRIBUTION. Costs of processing and distribution
increased by $6.5 million, or 197.0%, to $9.8 million for the 46 week period
ended December 31, 1998 from $3.3 million for the predecessor business year
ended December 31, 1997. As a percentage of net revenues, these costs increased
from 71.7% for the predecessor business year ended December 31, 1997, to 88.3%
for the 46 week period ended December 31, 1998. This increase was due primarily
to added costs to increase production volumes and the start up costs to produce
new allografts and technologies.
MARKETING, GENERAL AND ADMINISTRATIVE EXPENSES. Marketing, general and
administrative expenses increased by $2.6 million, or 185.7%, to $4.0 million
for the 46 week period ended December 31, 1998 from $1.4 million for the
predecessor business year ended December 31, 1997. Contributing to this increase
was $0.3 million for our new marketing department, as well as $2.3 million in
administrative costs required to support the new company, including additional
staffing and an increase in facilities expense due to additional leased space to
support our growth.
RESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses
increased by $1.0 million, or 200.0%, to $1.5 million for the 46 week period
ended December 31, 1998 from $0.5 million for the predecessor business year
ended December 31, 1997. This increase was due largely to the hiring of
additional personnel and related costs to develop new allografts and
technologies. We expense research and development costs as incurred. As a
percentage of net revenues, research and development expenses increased from
10.9% for the predecessor business year ended December 31, 1997 to 13.5% for the
46 week period ended December 31, 1998. This increase was due to the significant
increase in research and development expenses in 1998 to advance our technology
and develop new allografts.
QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
The following tables present unaudited quarterly statement of operations
data in both dollars and as percentages of net revenues for the third and fourth
quarters for the fiscal period ended December 31, 1998, each of the quarters for
the fiscal period ended December 31, 1999 and for the quarters ended March 31,
2000 and June 30, 2000. This information is unaudited, but in our opinion has
been prepared substantially on the same basis as the audited consolidated
financial statements which appear elsewhere in this prospectus. All necessary
adjustments, consisting only of normal recurring adjustments, have been included
in the amounts to present fairly the unaudited quarterly results. You should
read the quarterly data presented below in conjunction with our consolidated
financial statements and the accompanying notes appearing elsewhere in this
prospectus. You should not view the results of operations for any quarter as an
indication of the results of operations for any future period.
25
<PAGE>
<TABLE>
<CAPTION>
QUARTER ENDED
----------------------------------------------------------------------------------
SEPTEMBER 30, DECEMBER 31, MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31,
1998 1998 1999 1999 1999 1999
------------- ------------ --------- -------- ------------- ------------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenues from core operations:
Fees from tissue distribution.... $ 8,794 $10,057 $13,901 $16,273 $18,938 $21,671
Other revenues from core
operations..................... 897 778 919 468 426 424
------- ------- ------- ------- ------- -------
Total revenues................. 9,691 10,835 14,820 16,741 19,364 22,095
Management services fees........... 6,685 7,427 8,617 8,845 10,682 11,850
------- ------- ------- ------- ------- -------
Net revenues..................... 3,006 3,408 6,203 7,896 8,682 10,245
Costs of processing and
distribution..................... 2,791 3,631 4,398 4,592 4,725 5,457
------- ------- ------- ------- ------- -------
Gross profit................... 215 (223) 1,805 3,304 3,957 4,788
------- ------- ------- ------- ------- -------
Expenses:
Marketing, general and
administrative................. 1,118 1,598 1,673 2,183 2,541 3,343
Research and development......... 484 503 376 426 506 367
------- ------- ------- ------- ------- -------
Total expenses................. 1,602 2,101 2,049 2,609 3,047 3,710
------- ------- ------- ------- ------- -------
Operating income (loss)............ (1,387) (2,324) (244) 695 910 1,078
Equity in income of unconsolidated
subsidiary....................... -- -- -- -- -- --
Interest (expense) income:
Interest expense................. (36) (60) (57) (56) (76) (96)
Interest income.................. 57 66 67 23 4 93
------- ------- ------- ------- ------- -------
Total interest (expense)
income-net................... 21 6 10 (33) (72) (3)
------- ------- ------- ------- ------- -------
Income (loss) before income tax
(expense) benefit................ (1,366) (2,318) (234) 662 838 1,075
Income tax (expense) benefit....... -- -- -- (273) (369) 1,261
------- ------- ------- ------- ------- -------
Net income (loss).................. $(1,366) $(2,318) $ (234) $ 389 $ 469 $ 2,336
======= ======= ======= ======= ======= =======
<CAPTION>
QUARTER ENDED
--------------------
MARCH 31, JUNE 30,
2000 2000
--------- --------
(IN THOUSANDS)
<S> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenues from core operations:
Fees from tissue distribution.... $25,555 $27,661
Other revenues from core
operations..................... 528 335
------- -------
Total revenues................. 26,083 27,996
Management services fees........... 14,279 14,656
------- -------
Net revenues..................... 11,804 13,340
Costs of processing and
distribution..................... 6,327 6,792
------- -------
Gross profit................... 5,477 6,548
------- -------
Expenses:
Marketing, general and
administrative................. 4,093 4,446
Research and development......... 515 686
------- -------
Total expenses................. 4,608 5,132
------- -------
Operating income (loss)............ 869 1,416
Equity in income of unconsolidated
subsidiary....................... 7 (2)
Interest (expense) income:
Interest expense................. (108) (159)
Interest income.................. 90 41
------- -------
Total interest (expense)
income-net................... (18) (118)
------- -------
Income (loss) before income tax
(expense) benefit................ 858 1,296
Income tax (expense) benefit....... (394) (541)
------- -------
Net income (loss).................. $ 464 $ 755
======= =======
</TABLE>
<TABLE>
<CAPTION>
QUARTER ENDED
----------------------------------------------------------------------------------
SEPTEMBER 30, DECEMBER 31, MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31,
1998 1998 1999 1999 1999 1999
------------- ------------ --------- -------- ------------- ------------
<S> <C> <C> <C> <C> <C> <C>
PERCENTAGE OF NET REVENUES:
Net revenues........................ 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
Costs of processing and
distribution...................... 92.8 106.5 70.9 58.2 54.4 53.3
----- ----- ----- ----- ----- -----
Gross profit.................... 7.2 (6.5) 29.1 41.8 45.6 46.7
Expenses:
Marketing, general and
administrative.................. 37.2 46.9 27.0 27.6 29.3 32.6
Research and development.......... 16.1 14.8 6.1 5.4 5.8 3.6
----- ----- ----- ----- ----- -----
Total expenses.................. 53.3 61.7 33.1 33.0 35.1 36.2
----- ----- ----- ----- ----- -----
Operating income (loss)............. (46.1) (68.2) (4.0) 8.8 10.5 10.5
Equity in income of unconsolidated
subsidiary........................ -- -- -- -- -- --
Interest (expense) income:
Interest expense.................. (1.2) (1.7) (0.9) (0.7) (0.9) (0.9)
Interest income................... 1.9 1.9 1.1 0.3 0.0 0.9
----- ----- ----- ----- ----- -----
Total interest (expense)
income-net.................... 0.7 0.2 0.2 (0.4) (0.9) (0.0)
----- ----- ----- ----- ----- -----
Income (loss) before income tax
(expense) benefit................. (45.4) (68.0) (3.8) 8.4 9.6 10.5
Income tax (expense) benefit........ -- -- -- (3.5) (4.3) 12.3
----- ----- ----- ----- ----- -----
Net income (loss)................... (45.4)% (68.0)% (3.8)% 4.9% 5.3% 22.8%
===== ===== ===== ===== ===== =====
<CAPTION>
QUARTER ENDED
--------------------
MARCH 31, JUNE 30,
2000 2000
--------- --------
<S> <C> <C>
PERCENTAGE OF NET REVENUES:
Net revenues........................ 100.0% 100.0%
Costs of processing and
distribution...................... 53.6 50.9
----- -----
Gross profit.................... 46.4 49.1
Expenses:
Marketing, general and
administrative.................. 34.7 33.3
Research and development.......... 4.4 5.2
----- -----
Total expenses.................. 39.1 38.5
----- -----
Operating income (loss)............. 7.3 10.6
Equity in income of unconsolidated
subsidiary........................ 0.0 0.0
Interest (expense) income:
Interest expense.................. (0.9) (1.2)
Interest income................... 0.8 0.3
----- -----
Total interest (expense)
income-net.................... (0.1) (0.9)
----- -----
Income (loss) before income tax
(expense) benefit................. 7.2 9.7
Income tax (expense) benefit........ (3.3) 4.0
----- -----
Net income (loss)................... 3.9% 5.7%
===== =====
</TABLE>
Our quarterly operating results have fluctuated significantly since we began
operations. One of the primary reasons for these fluctuations is our historical
and current dependence upon our MD-Series Threaded Bone Dowels. In an effort to
smooth these fluctuations, we have attempted to diversify the allografts we
offer, including the introduction of eight new allografts during 1998. While
these new allografts accounted for only $2.9 million of total revenues during
1998, they accounted for $31.3 million of the $37.7 million increase in our 1999
total revenues. Also accounting for a portion of
26
<PAGE>
the increase in our total revenues for 1999 was an increase of $8.0 million in
conventional tissue revenues when we assumed UFTB's conventional tissue
processing business in April 1999.
Our revenue diversification efforts also favorably impacted our gross profit
as a percentage of net revenues, which increased from 11.5% of our net revenues
in 1998 to 41.9% in 1999. Adding to this impact was a decrease in the first
quarter of 1999 in the management services fees we paid to Medtronic Sofamor
Danek for a number of our spinal allografts from 80% to 70%. The impact of this
decrease was an effective increase in the net revenues from each allograft
distributed through that company without any change in direct costs. Also
increasing our 1999 gross margin was an increase in distribution of our bone
paste allografts for the spinal market, which bear lower management services
fees.
In order to permit the expansion of our business and increase revenues, we
incurred additional manufacturing costs and material usage in the fourth quarter
1998. The result of these activities was a negative gross margin of $0.2 million
or 6.5% of net revenues during the fourth quarter of 1998. These additional
costs included higher payroll costs of approximately $0.2 million due to the
hiring of additional personnel and approximately $0.3 million for additional lab
testing, packaging and tools and equipment. We also incurred higher material
costs of $0.4 million due to higher material usage during the early phases of
production.
In addition to the higher manufacturing costs incurred in the fourth quarter
of 1998, we also hired additional marketing, distribution and administrative
staff in the second through fourth quarters of 1998 to support the anticipated
growth in our business. These staff increases and related costs contributed to
our operating losses in the second through fourth quarters of 1998 and in the
first quarter of 1999.
LIQUIDITY AND CAPITAL RESOURCES
Since we began operations, we have financed our operations primarily through
the sale of preferred stock, totaling $6.4 million in net proceeds in 1998 and
$10.0 million in net proceeds in 1999.
Our net cash used in operating activities increased by $9.9 million to
$6.5 million for the year ended December 31, 1999 from net cash provided by
operating activities of $3.4 million for the 46 week period ended December 31,
1998. This increase was largely due to the payment of a $4.5 million
non-refundable fee by Medtronic Sofamor Danek during 1998 related to our
agreement with that company and an increase in our working capital of
approximately $5.5 million for the year ended December 31, 1999. For accounting
purposes, we deferred the $4.5 million fee we received from Medtronic Sofamor
Danek and we are recognizing it on a straight-line basis over the 20-year life
of the agreement. Our net cash used in operating activities was $4.3 million for
the six months ended June 30, 2000, a change of $1.1 million from net cash used
in operating activities of $3.2 million for the six months ended June 30, 1999.
During the six months ended June 30, 2000, cash was provided by net income of
$1.2 million and an increase in accounts payable of $2.2 million. Uses of cash
during that period included a $3.9 million increase in accounts receivable and a
$4.4 million increase in inventory.
Our net cash used in investing activities increased by $1.0 million to
$2.9 million for the year ended December 31, 1999 from $1.9 million for the 46
week period ended December 31, 1998. This increase was due primarily to the $0.5
million we paid for the net assets of Georgia Tissue Bank, plus an increase of
$0.5 million in the amount paid for the purchase of property, plant and
equipment during 1999. During the year ended December 31, 1999, $0.8 million of
cash was used in the purchase of property, plant and equipment largely related
to our BioCleanse processing facility. Our net cash used in investing activities
increased by $2.1 million to $2.9 million for the six months ended June 30, 2000
from $0.8 million for the six months ended June 30, 1999. This increase was due
primarily to the $1.4 million we paid for our acquisition of the buildings and
land we previously leased, and the acquisition of additional land for expansion.
In order to finance these purchases, we entered into a 20-year term loan in the
amount of $2.8 million, collateralized by the property. The remainder of the
27
<PAGE>
purchase price was financed with a portion of the proceeds from our sale of
preferred stock during 1999.
Net cash provided by financing activities increased by $10.6 million to
$13.0 million for the year ended December 31, 1999 from $2.4 million for the
46 week period ended December 31, 1998. This increase was due primarily to the
$10.0 million in net proceeds we realized from our sale of preferred stock
during 1999, $2.8 million in net borrowings under our credit facility, and
$0.7 million in proceeds due from a stockholder. In 1998, we received
$6.6 million of proceeds from our sale of preferred stock and financed $3.8
million in receivables from UFTB. Net cash provided by financing activities for
the six months ended June 30, 2000 was $0.4 million, compared to $0.1 million
for the six months ended June 30, 1999. A $1.1 million increase in borrowings
under our line of credit during the first six months of 2000 was the primary
increase in cash from financing activities.
Our credit facility permits us to borrow up to $6.0 million on a revolving
basis and is collateralized by our accounts receivable. This credit facility
expires in September 2000. As of June 30, 2000, we had excess borrowing capacity
of $2.1 million under this facility.
On March 30, 2000, we purchased the buildings and land that we currently
occupy, plus an additional 20.8 acres of land for future expansion. The purchase
price for the two buildings and 6.2 acres on which they are situated was
$3.6 million, with the additional parcel of land costing approximately
$0.6 million. In order to finance the purchase, we entered into a 20-year term
loan in the amount of $2.8 million, collateralized by the property. The
remainder of the purchase price was financed with a portion of the proceeds from
our sale of preferred stock during 1999. We continue to lease approximately
18,000 square feet of space in buildings adjacent to those we purchased and
8,800 square feet of warehouse space. On June 7, 2000 we started construction of
new manufacturing and administrative buildings on the land purchased on
March 30, 2000. Total estimated cost to construct and equip the new facilities
is $25.2 million. We intend to finance $16.2 million of the cost with additional
long-term debt and the balance of $9.0 million from the proceeds of this
offering.
We currently believe that the net proceeds from this offering, cash from
operations and our existing cash and cash equivalents will be sufficient to meet
our anticipated cash requirements for at least the next 12 months. At present,
we do not believe we will need to raise additional capital solely to operate our
business. Nevertheless, the completion of one or more acquisitions by us could
affect our need for capital.
IMPACT OF INFLATION
Inflation generally affects us by increasing our cost of labor, equipment
and processing tools and supplies. We do not believe that the relatively low
rates of inflation experienced in the United States since the time we began
operations has had any material effect on our business.
INTEREST RATE RISK
We are subject to market risk from exposure to changes in interest rates
based upon our financing, investing and cash management activities. We use a
balanced mix of debt maturities along with both fixed-rate debt, variable-rate
debt and derivative financial instruments (interest rate swaps) to manage our
exposure to changes in interest rates. We do not expect changes in interest
rates to have a material adverse effect on our income or our cash flows in 2000.
However, we cannot assure you that interest rates will not significantly change
in 2000. We do not enter into derivatives or other financial instruments for
trading or speculative purposes.
Our interest rate swap arrangement involves the exchange of variable
interest rate payments, based on the 30-day LIBOR plus 150 basis points, without
exchanging the notional principal amount. Payments or receipts on the agreement
are recorded as adjustments to interest expense. At June 30,
28
<PAGE>
2000, we had an outstanding swap agreement, maturing March 30, 2005, with a
notional amount of $2.8 million. Under the agreement we receive a fixed interest
rate of 8.35%. The interest will remain fixed until the 30-day LIBOR is
determined to be greater than or equal to 8%, at which time the interest rate
will revert to the 30 day LIBOR plus 150 basis points. The counter party to this
swap arrangement is a major financial institution.
The fair value of this interest rate swap agreement represents the estimated
receipt or payment that would be made to terminate the agreement. At June 30,
2000, we would have paid approximately $32,000 to terminate the agreement. An
increase of 100 basis points in the yield curve would not result in an increased
penalty to us as LIBOR would still be less than 8% and our interest rate would
still be equal to 8.35%.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
The Financial Accounting Standards Board recently issued Statement of
Financial Accounting Standards No. 137, ACCOUNTING FOR DERIVATIVE INSTRUMENTS
AND HEDGING ACTIVITIES--DEFERRAL OF EFFECTIVE DATE OF FASB STATEMENT NO. 133.
SFAS No. 137 defers for one year the effective date of SFAS No. 133, ACCOUNTING
FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES. The rule now will apply to
all fiscal quarters of all fiscal years beginning after June 15, 2000. SFAS
No. 137 permits early adoption as of the beginning of any fiscal quarter after
its issuance. SFAS No. 133 will require us to recognize all derivatives on our
balance sheet at fair value. Derivatives that are not hedges must be adjusted to
fair value through income. If the derivative is a hedge, depending on the nature
of the hedge, changes in the fair value of derivatives will either be offset
against the change in fair value of the hedged assets, liabilities, of firm
commitments through earnings or recognized in other comprehensive income until
the hedged item is recognized in earnings. The ineffective portion of a
derivative's change in fair value will be immediately recognized in earnings. We
have not completed our evaluation of the impact of SFAS No. 133, if any, on our
consolidated financial statements.
29
<PAGE>
BUSINESS
INDUSTRY OVERVIEW
Defects in bone and other human tissue can be caused by a variety of sources
including trauma, congenital defect, infectious disease, cancer and other
disease conditions. The prevalent method used by surgeons to repair and promote
the healing of defective tissue is surgery, principally through the use of
surgical implants. When considering a surgical procedure for tissue repair,
surgeons and patients face a number of treatment options including metals and
synthetics, "autograft" tissue, "allograft" tissue and "xenograft" tissue. An
autograft procedure is one in which the surgeon harvests tissue from one part of
a patient's body for transplant to another part of the body to make the needed
repair. In contrast to autograft, allograft tissues are recovered from deceased
human donors, processed for biologic safety and implant mechanical
characteristics and then transplanted by a surgeon into the patient's body to
make the needed repair. Procedures using xenograft tissue, while not widely used
in the United States other than for heart valves, involve recovering animal
tissue, typically from cattle or pigs, and then transplanting that recovered
tissue into the patient's body.
The overall market in the United States for tissue repair and healing
through the use of surgical implants, including metals, synthetics and
allografts, has grown considerably over the last several years, with revenues in
the orthopedic and cardiovascular segments of this market exceeding
$6.4 billion in 1999. In these segments, procedures using allografts, either
conventional graft, bone paste, or specialty tooled tissues, totaled over
310,000 during 1999, accounting for revenues of over $410.0 million. We believe
that the use of allografts will continue to increase and represent a growing
portion of the surgical implant market.
Processors of tissue supply allografts consisting of bone tissue and various
soft tissues, including cardiovascular and connective tissues, to hospitals and
surgeons for use in surgery. The need for tissue is increasing each year and
currently is served by approximately 30 tissue banks in the United States that
process and/or distribute bone or cardiovascular allografts. We believe there
will continue to be an increase in the use of surgical implants for tissue
repair and healing, and in particular allograft implants. Reasons supporting
this belief include:
- the aging of the baby boom generation will result in a greater percentage
of the population requiring tissue repair products;
- as life expectancies increase overall, the need for tissue repair products
will increase;
- as patients and their families become increasingly proactive in
determining the nature of the health care they receive and as they
increasingly use the Internet to research health care alternatives,
pressure will increase on medical providers for more natural healing
alternatives;
- continuing emphasis placed on health and fitness in our society will
continue to drive the growth of sports medicine-related tissue repair and
tissue healing;
- increasing awareness of the safety and benefits of allografts will
increase the acceptance of allografts by surgeons and patients; and
- as the federal and state governments continue to promote organ and tissue
donation, more allograft tissue will become available.
TISSUE REPAIR TREATMENT OPTIONS
METALS AND SYNTHETICS. Historically, the medical community turned to metals
and other synthetics for implant procedures, in part because they can be
precisely tooled for specific surgical uses within the body. These metal and
synthetic implants also can be designed for use with instrument sets designed
specifically for the implant procedure. This permits faster and more precise
surgeries, with the patient
30
<PAGE>
spending less time on the operating table, and allows the surgeon to use a
uniform process that can be repeated easily.
Metal and synthetic technologies, however, have several shortcomings. One of
the principal drawbacks to the use of these materials is that they do not
promote bone "remodeling." As part of normal skeletal growth and maintenance,
human bones renew themselves by a continual process of breakdown and build-up
known as "remodeling," the same process involved in the natural healing of
fractures. Metal is stiffer than bone and its use in orthopedics can cause
"stress shielding," where the bone adjoining the metal does not remodel densely
enough and becomes weak and fragile or disappears altogether. This problem can
be of particular concern to elderly patients who are more likely to suffer from
osteoporosis. Also, a small percentage of patients display sensitivity to
certain kinds of metals, such as nickel. Additionally, a number of synthetics
tend to break down in the body and slowly drift from their initial implant
position. Finally, metal pins and screws used in sports medicine procedures and
small bone repairs have a number of disadvantages including a potentially
painful removal process, uncertainty over the long-term consequences of a hard
metal implant adjacent to joints, and inflammation of the surrounding natural
tissues due to breakdown of metal implants over time.
XENOGRAFT. While used in other parts of the world, including Europe, the
use of xenograft, or animal tissue, is not prevalent in the United States other
than for heart valve replacements. One of the reasons for this is a higher risk
of immune system response to implanted xenograft tissue due principally to the
greater difficulty in cleansing the tissue before implant of all the substances
that can cause an immune response. An additional reason for limited use of
xenograft tissue in the United States is the perceived risk of disease
transmission. One area, however, in which the use of xenograft tissue within the
United States is prevalent is in the cardiovascular market. This is due mainly
to its long accepted use in this market and the reduced difficulty in cleaning
this particular type of tissue due to its thinness.
AUTOGRAFT AND ALLOGRAFT. In order to overcome the drawbacks to the use of
metals, other synthetics and xenograft tissue, surgeons increasingly use
autograft and allograft procedures. Autografts and allografts, in contrast to
metals and synthetics, are not only "osteoconductive," meaning they provide a
scaffold for new bone to attach itself to, but can be "osteoinductive" as well,
meaning they stimulate the growth of new bone. Historically, however, allograft
and autograft procedures were not as easy to perform as procedures using metals
and other synthetics since grafting procedures often required the surgeon to
shape the transplant tissue by hand, using standard operating room instruments
before implanting the tissue. This requirement generally increases the amount of
time spent in surgery.
In addition to a lack of pre-tooling, a significant drawback to autograft
procedures is that they require an additional and potentially dangerous surgery
to harvest the tissue from a second site in the patient's body. In approximately
20% of autograft procedures, a patient's tissues surrounding the site where
tissue is harvested becomes diseased and dies, a condition known as morbidity.
Approximately one out of four morbidity complications is considered serious.
Additional complications involved with autograft procedures include infection,
pain, nerve and arterial injury, joint instability and hernia. Moreover, a
patient may not have sufficient quantities of quality autograft tissue in other
parts of his or her body available for transplant, a particular problem for
elderly patients, who are more likely to suffer from osteoporosis which can
compromise the quality of transplanted autograft tissue. Balanced against these
disadvantages is the belief among some surgeons that a patient's own tissue will
remodel better than allograft, as well as the lingering concern over the safety
of allograft.
Since the introduction of modern, precision tooled, processed allograft
implants, however, more surgeons are turning to allograft procedures to treat
musculoskeletal and other tissue defects. Among the reasons for this shift are
that patients can enjoy the benefits of an implant that promotes bone growth and
better healing without having to undergo the potentially risky second surgery to
obtain
31
<PAGE>
autograft tissue for transplant. In addition, surgeons increasingly prefer
allograft implants since, with the introduction of precision tooled allografts
and accompanying custom implant surgical instruments, allograft implants now
share the same convenience and ease-of-use advantages as metals and synthetics
without the shortcomings. Also, concerns within the medical community about the
transmission of HIV and other infectious diseases through the use of allograft
largely have been addressed and more surgeons now accept allograft as safe and
effective. Finally, patients and their families are increasingly proactive in
determining the nature of the healthcare they receive, due in part to the
availability of healthcare information on the Internet, and increasingly prefer
natural healing alternatives such as allograft.
An historical limitation within the tissue processing industry has been the
requirement that tissue processing be done using clean room technology on a
donor-by-donor basis in order to eliminate the risk of cross contamination of
other donor tissue potentially caused by contaminated tissue from just one
donor. As a result, traditional tissue processors must process donor tissue in a
labor intensive process requiring extensive use of custom machinery and tools to
create allograft implants.
ALLOGRAFT MARKETS
The allograft market is limited by the supply of available cadaveric donor
tissue. Of the 3.6 million deaths that occurred during 1999 in the United
States, of which we believe 50% would have been eligible to donate tissue, less
than 0.4% actually resulted in donated tissue.
The allograft market can be broken down into a number of distinct segments,
including orthopedic, urological and cardiovascular. The following table
contains selected U.S. information for 1999 about the portions of these segments
that can be addressed through the use of allograft implants:
<TABLE>
<CAPTION>
MARKET TOTAL ALLOGRAFT ALLOGRAFT
PROCEDURES PROCEDURES REVENUES
ORTHOPEDIC ---------- ---------- --------------
<S> <C> <C> <C>
Spinal Fusion...................................... 445,000 113,000 $226.0 million
Sports Medicine.................................... 870,000 52,000 $ 73.0 million
Oral-Maxillofacial................................. 67,900 15,000 $ 4.5 million
Conventional Tissue................................ 485,000 125,000 $ 66.0 million
UROLOGICAL(1)
Slings............................................. 250,000 37,000 $ 33.0 million
CARDIOVASCULAR(2)
Heart Valves....................................... 95,000 6,500 $ 41.0 million
</TABLE>
------------------------------
(1) Data for 1998.
(2) Data for 1997.
ORTHOPEDIC MARKETS
The market for orthopedic tissue can be broken down into the following
distinct segments:
- Spinal Fusion. The spinal market includes approximately 6.0 million
people in the United States who seek treatment for back pain each year, of
which approximately 650,000 to 700,000 result in surgery. Of this number,
approximately 445,000 in 1999 resulted in a spinal fusion, the fusing
together of two or more vertebra, approximately 90% of which included the
use of an autograft or allograft implant. Surgeons commonly use autograft
or allograft implants to induce fusion in metal or bone spinal fusions.
Surgeons also frequently use bone paste allografts as part of these
procedures. The U.S. market for spinal fusions, including metals,
synthetics, autograft and allograft, has grown considerably over the last
several years. Total revenues in the United States for spinal fusions grew
from approximately $484.6 million in 1997 to $735.7 million in
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<PAGE>
1999. Over the same period, the number of spinal fusion procedures
performed in the United States grew from approximately 312,000 in 1997 to
approximately 445,000 in 1999. Of these 445,000 procedures, approximately
113,000 involved the use of an allograft implant, accounting for
approximately $226.0 million in revenues.
- Sports Medicine. The sports medicine market includes a number of
segments, including arthroscopy, powered shavers, soft goods, video
imaging and "procedure-specific" surgeries. The procedure-specific segment
of this market that can be addressed through the use of allograft implants
includes repairs to the anterior cruciate ligament, or ACL, rotator cuff,
labrum, meniscus, posterior cruciate ligament, small bone repair,
osteochondral repairs and the surgical sectioning of bones, known as
osteotomies. The number of procedures performed in the United States in
the arthroscopy and procedure-specific segments of this market has grown
from approximately 2.6 million in 1997 to over 3.0 million in 1999. The
U.S. market for procedure-specific surgeries in the sports medicine market
that used an implant has grown at a 6% average annual rate between 1997
and 1999. During 1999, there were approximately 870,000 procedure-
specific surgeries in the United States that used an implant. Of these
870,000 procedures, approximately 52,000 involved the use of an allograft
implant, accounting for approximately $73.0 million in revenues. We
believe a significant number of surgical procedures that surgeons
currently treat only by abrasion or removal of soft tissue could benefit
from allograft technologies, including a portion of the approximately
400,000 chondroplasty procedures performed in the United States in 1999.
Worldwide, the procedure-specific segment of the sports medicine market
grew from approximately $315.0 million in 1997 to approximately
$360.0 million in 1999.
- Oral-Maxillofacial. The oral-maxillofacial market includes surgeries of
the nose, face, jaw and mouth, including surgery for diseases of the jaw
and related tissues. These surgeries typically are either cosmetic or to
treat disease or injury. As with the sports medicine market, the aging
population is fueling growth in this market by increasing demand for bone
pastes used in jaw reconstruction and for support of dental implants as an
alternative to dentures. Total revenues in the United States from
oral-maxillofacial implants grew from approximately $195.0 million in 1997
to $224.0 million in 1999. During 1999, surgeons performed approximately
67,900 oral-maxillofacial procedures in the United States, of which
approximately 15,000 involved the use of an allograft implant, accounting
for approximately $4.5 million in revenues.
- Conventional Tissue. The conventional allograft market encompasses
tissues used in orthopedic surgery that have not been precision tooled and
for which custom surgical instrumentation does not exist. Uses of
conventional allograft include osteoarticular grafts for hip and knee
reconstruction, ground bone and bone chips for trauma and bone filler,
fashioned bone for various orthopedic procedures and soft tissue for
ligament repair. During 1999, surgeons performed approximately 485,000
procedures in the United States, of which approximately 125,000 involved
the use of an allograft implant, accounting for approximately
$66.0 million in revenues.
UROLOGICAL MARKET
The urological allograft market includes tissue implant procedures to treat
urinary incontinence, primarily among older women. Urinary incontinence is a
problem for more than 17 million Americans, approximately 85% of them women. A
widely used procedure for treatment of this condition is re-suspension of the
bladder neck with a "sling" of fibrous material. This sling can be made from
synthetic materials or from various natural tissues. During 1998, approximately
250,000 procedures made use of this sling technique in the United States, of
which approximately 37,000 involved the use of an allograft implant, accounting
for approximately $33.0 million in revenues. Although urinary incontinence can
be improved in eight out of ten cases, less than half of those afflicted seek
treatment.
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CARDIOVASCULAR MARKET
The cardiovascular allograft market includes transplantation of human heart
valves as an alternative to mechanical, synthetic or xenograft substitutes.
Surgeons performed an estimated 349,000 heart valve and vascular graft
procedures for which allograft would be appropriate in the United States in
1997, of which 95,000 were heart valve replacement procedures. Of the
approximately 69,000 heart valve replacements for which more detailed data are
available, approximately 6,500, or 9.4%, were performed using allograft. Total
revenues in the United States from heart valve replacement procedures using
allograft during 1997 totaled approximately $41.0 million.
COMPANY OVERVIEW
We are a leader in the use of natural tissues and innovative technologies to
repair and promote the natural healing of human bone and other human tissues.
Using core human physiology--the basic biology of natural tissues as they
function in the body--our human tissue implants are improving surgical outcomes.
Our goal is to replace conventional implant approaches, including metals,
synthetics and autograft implants, with allograft, and to establish our
allografts as the implant of choice for tissue repair. We are a provider of
comprehensive healing and natural tissue products in a broad range of markets.
In addition, we are the largest processor and distributor in the United States
of allografts that are precisely tooled for specific surgical uses in terms of
revenues for the year ended December 31, 1999. Our distributors distribute our
allografts in all 50 states and in nine countries internationally. We are also a
processor of "conventional allografts," which are allografts that are not tooled
by the processor for a specific surgical use.
We process human musculoskeletal and other tissue, including bone,
cartilage, tendon, ligament, pericardial and cardiovascular tissue in producing
our allografts. Surgeons then use these tissues to repair and promote the
healing of a wide variety of bone and other tissue defects, including spinal
vertebrae repair, musculoskeletal reconstruction, fracture repair, repairs to
the jaw and related tissues, urinary incontinence and heart valve disorders. Our
current grafts range from conventional allografts to grafting material, which is
precisely tooled for specific surgical uses, including bone dowels, wedges,
pastes and pins, urological allografts and heart valves. During 1999, we shipped
over 90,000 processed allografts, used in an estimated 60,000 procedures. Often,
surgeons use more than one allograft in a given procedure.
We have one of the most extensive tissue recovery programs in the United
States, recovering bone or cardiovascular tissue from over 4,000 human donors
during 1999, up from over 2,300 in 1998 and 1,500 in 1997. We believe our
network of recovery groups accounted for approximately 32% of the human tissue
recovered for processing in the United States during 1999.
The following table outlines the markets we serve and the amount and
percentage of our revenues, net of management services fees, from core
operations during 1998 and 1999 for these markets:
<TABLE>
<CAPTION>
NET REVENUES FROM NET REVENUES FROM
CORE OPERATIONS CORE OPERATIONS
MARKET DURING 1998 DURING 1999
------ ------------------------ -------------------------
<S> <C> <C> <C> <C>
Spinal Fusion................................... $6,246,000 80.4% $17,079,000 55.5%
Sports Medicine................................. 222,000 2.9 2,537,000 8.2
Oral-Maxillofacial.............................. 0 0.0 191,000 0.6
Conventional Tissue............................. 1,112,000 14.3 9,026,000 29.3
Urological Sling................................ 183,000 2.4 1,956,000 6.4
---------- ------ ----------- ------
Total....................................... $7,763,000 100% $30,789,000 100%
</TABLE>
34
<PAGE>
In addition, we will enter the cardiovascular market through our acquisition
of the tissue processing and distribution business of Alabama Tissue Center,
which had approximately $0.5 million in revenues during 1999.
We pursue a market-by-market approach to distribution of our allografts,
including strategic arrangements in order to increase our penetration in
selected markets. We have an alliance with Medtronic Sofamor Danek in the spinal
market, with Exactech, Inc. in portions of the bone paste market, and with C.R.
Bard, Inc. in the urological market.
Using our proprietary BioCleanse system, we believe we are the only
processor of human tissue currently able to safely process tissue in a single
system from multiple donors simultaneously. This system, which kills or
inactivates all classes of conventional pathogens, viruses, microbes, bacteria
and fungi, and which cleanses tissue both before and after processing, allows us
to safely process tissue from up to 100 donors at the same time thereby
significantly increasing the efficiency of our tissue processing. In addition,
our BioCleanse system is able to remove blood, fats, lipids and other unwanted
materials from the tissue we process more successfully than traditional
processing. We believe the removal of blood, fat, lipids and other unwanted
materials results in faster patient healing since it eliminates the need for the
patient's body to remove these substances using natural processes following
surgery. In contrast to traditional tissue processing, our BioCleanse system
also permits us to process tissue at lower average cost and to process tissue
safely and economically from donors and age groups that might not have been
feasible without BioCleanse.
OUR STRATEGY
Our strategy is to be the leading worldwide provider of natural tissue-based
technologies that repair and promote the healing of human bone and other tissue.
The following are the key elements of our strategy:
CONTINUE PRODUCT INNOVATION TO CREATE NEW ALLOGRAFTS AND PROCEDURES. We
pioneered the development of allograft bone tissue implants that are precisely
tooled for specific surgical uses. We plan to continue to use this expertise to
strengthen and build upon our existing platform of allografts and procedures
within our core markets, and to enter or create new markets for our current and
future allografts. We do this by fostering innovation in our research personnel
and product development staff. We also set corporate goals that stimulate
product innovation, such as launching at least one new allograft every quarter
within each of our markets.
IDENTIFY ADDITIONAL SURGICAL APPLICATIONS FOR OUR TECHNOLOGIES AND
PRODUCTS. While we intend to continue to introduce new grafts into our
traditional core markets of orthopedics, urology and cardiovascular, we also
intend to use our expertise in the area of natural tissue implants to develop
new technologies and to enter new markets, including the use of allografts
processed from skin for reconstructive and cosmetic procedures. We plan to make
use of our existing infrastructure, including our research and development
capabilities and sales and marketing infrastructure, in order to establish our
presence in these growing markets. In addition, we plan to make selective
acquisitions in order to develop or expand our presence within particular
markets, such as our recent agreement to acquire the tissue processing and
distribution business of the Alabama Tissue Center which will allow us to enter
the cardiovascular market.
CONTINUE PROCESS INNOVATION TO ESTABLISH PRODUCT DIFFERENTIATION. We intend
to continue to reevaluate and enhance the processes we use in our business to
increase efficiency and maintain our competitive advantage. Our proprietary
BioCleanse system allows us to safely process, sterilize and virally inactivate
tissue from up to 100 donors at the same time. In addition to the efficiencies
and other advantages our BioCleanse technology permits, it provides us with a
number of significant research and development advantages, including the
opportunity to introduce growth factor agents into our allografts.
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<PAGE>
Additionally, we intend to continue to introduce greater automation into the
processing of our allografts in order to further enhance efficiencies and reduce
processing costs.
EXPAND OUR EXTENSIVE TISSUE RECOVERY PROGRAM AND EMPLOY NEW TECHNOLOGIES TO
MAKE BETTER USE OF EXISTING TISSUE SUPPLIES. We intend to continue our strategy
of entering into alliances with tissue recovery sources to ensure continued
growth of our tissue availability and to introduce these sources to successful
tissue recovery programs within our alliance to raise the level of tissue
donation. We also intend to make selective acquisitions, such as our recent
acquisition of Georgia Tissue Bank, to further enhance our tissue recovery
efforts. Additionally, we plan to expand our tissue recovery efforts
internationally to support our projected growth in those markets. We also seek
to increase the availability of donor tissue by further improving the efficiency
of our tissue processing procedures and by continuing our efforts to increase
the level of tissue donation. We will continue to instill in our employees and
alliance partners our philosophy of honoring the gift of tissue donation and
using that gift responsibly to help as many patients as possible. Finally, we
plan to supplement the supply of human tissue through the use of alternative
tissues, such as tissue from cattle and pigs.
EXPAND OUR SALES AND MARKETING CAPABILITIES. We believe a significant
opportunity exists to expand distribution of our grafts and technologies. We
intend to continue to expand our presence both domestically and internationally
by increasing the level of our sales and marketing activities, in the countries
in which we presently operate, as well as in additional countries. We plan to
continue to enter into new distribution relationships, expand existing
distribution relationships, and increase our internal sales and marketing
capabilities to increase our penetration in the markets we serve. In addition,
we intend to continue to educate and support the medical community by creating
an Internet-based ordering and information system for surgeons. Traditional
order placement will remain in place but as e-commerce becomes increasingly
important within the medical community, we believe our on-line ordering system
will provide a fast and convenient means for surgeons to place orders and obtain
information. The level and detail of information made available through our Web
site will be adjusted based upon need, resulting in an on-line product which is
educational and useful to the medical community.
PRODUCTS AND PRODUCTS IN DEVELOPMENT
OVERVIEW
We process human musculoskeletal and other tissue, including bone,
cartilage, tendon, ligament, pericardial and cardiovascular tissue, in producing
our line of proprietary allografts. Our current tissues range from
conventionally processed bone and soft tissue to bone implants that are
precisely tooled for specific surgical uses, soft tissue, urological allografts
and heart valves. The service fees we charge for our allografts vary
extensively, ranging from a list service fee of less than $200 to in excess of
$7,000 per allograft. Our most commonly used precision-tooled spinal allografts
have listed services fees ranging from approximately $1,000 to $2,000. The
following table summarizes our current allograft offerings in each of the
markets we serve, current distribution of these allografts and the products and
technologies we have in development:
36
<PAGE>
<TABLE>
<CAPTION>
PRODUCTS AND
TECHNOLOGIES IN
MARKET CURRENT ALLOGRAFTS CURRENT DISTRIBUTION DEVELOPMENT
------ ------------------ -------------------- ----------------------------
<S> <C> <C> <C>
ORTHOPEDICS
Spinal -MD-Series Threaded Bone -Medtronic Sofamor Danek -Demineralized and partially
Dowels demineralized cortical bone
-Cornerstone SR Wedge -Bovine versions of existing
-Tangent Cortical Bone Wedge precision tooled allografts
-Precision Cortical Bone Wedge
------------------------------------------------------------------------------------------------------------------------
Sports Medicine -Interference screws -Network of independent -Soft tissue tacks
-Pre-shaped bone-tendon-bone distributors -Non-frozen, viable
ligament osteochondral grafts
-Meniscus -Suture anchors
-Pins -Preshaped achilles and
quadricep tendons
-Ligament alternatives
-Soft threaded interference
screws
-Wedge used for knee re-
alignment
------------------------------------------------------------------------------------------------------------------------
Bone Paste -Osteofil Injectable Bone -Pastes for spinal market -Bone pastes for use in
Paste through Medtronic Sofamor vertebroplasty
-Opteform Moldable Bone Paste Danek -Non-frozen injectable bone
-Osteofil ICM Bone Paste with -Other bone pastes through paste
cortical cancellous chips network of independent
distributors
-Certain pre-molded bone
forms through Exactech
------------------------------------------------------------------------------------------------------------------------
Conventional Tissue -Frozen femoral heads -Network of independent -Pre-ground femoral heads
-Demineralized bone matrix distributors
-Cortical cancellous chips and
cancellous chips
-Fibular wedges
-Iliac crest wedges
-Bulk allograft segments
-Non-precision tooled
ligaments and tendons
------------------------------------------------------------------------------------------------------------------------
Oral-Maxillofacial -Regenafil Injectable Bone -Direct distribution -Demineralized plates for
Paste facial surgery
-Regenaform Moldable Bone -Orbital floor repair system
Paste -Regenaderm dermal membrane
-Pericardium membrane
------------------------------------------------------------------------------------------------------------------------
OTHER MARKETS
Urological -FasLata Fascia Lata -C.R. Bard -Dermis-based urological
slings
-Soft tissue anchors
------------------------------------------------------------------------------------------------------------------------
Cardiovascular -Heart valves -Network of independent -Pulmonic patches
distributors
</TABLE>
37
<PAGE>
ORTHOPEDIC ALLOGRAFTS
SPINAL. Our principal spinal allografts are our patented MD-Series Threaded
Bone Dowels, our patent-pending Cornerstone SR Wedge, Tangent Cortical Bone
Wedge and Precision Cortical Bone Wedge. These allografts, which are precisely
tooled for specific surgical uses, are eventually replaced by the patient's own
bone through the remodeling process, typically over a one- to two-year period.
During 1999, we shipped more than 43,000 spinal allografts, excluding bone
pastes, which accounted for approximately $14.1 million of our net revenues.
Surgeons use our MD-Series Threaded Bone Dowels to help restore the
anatomical relationships between the disc, facet joints, vertebral bodies and
the open spaces within vertebral bodies, known as foramina. As a result of
injury, abnormal wear and tear, or the aging process, damage or degenerative
changes to the vertebral disc and facet joints may occur and progress over time.
Among other things, this can result in pinched nerves, disc injury and severe
pain. Several important features of our MD-Series dowels assist in
reestablishing spinal stability and reducing pain. First, our dowels are
threaded, providing rigid interface above and below the vertebral body, allowing
the surgeon to restore normal alignment and provide greater stability. This
alignment and stability following surgery contributes to reducing pain, greater
functionality and reduced risk of reoccurrence. Second, the cylindrical shape of
our dowels, together with accompanying threads, provides greater surface area
contact at the junction between our graft and the patient's bone, which improves
healing. Third, the pre-cut precision size and shape of each graft helps in
reducing surgical time. Evolving from our early unthreaded spinal dowel, our
present line of dowel allografts is suitable for higher load bearing situations,
making them more useful for areas such as the lumbar spine.
Our Cornerstone SR Wedge, as with our MD-Series dowels, is used in similar
cases in the cervical area of the spine, but is tapped or impacted in place, not
threaded. Our Tangent Cortical Bone Wedge and Precision Cortical Bone Wedge
allografts are also tapped in place. Both grafts are specially designed and
contoured to promote stability and minimize disruption of the posterior portions
of the spine.
We currently have several spinal allografts in development, including
demineralized and partially demineralized cortical bone for ligaments for use in
fixating the vertebral bodies following a spinal fusion surgery, as well as
versions of existing precision tooled allografts derived from cattle tissue.
SPORTS MEDICINE. We focus on the highest volume procedures in the sports
medicine market, primarily shoulder and knee procedures. Our principal sports
medicine allografts are our patented and patent-pending interference screws for
knee realignment, patent-pending pre-shaped bone-tendon-bone ligaments, meniscus
allografts for kneecaps and pins. These grafts, used for the repair of
sports-related injuries such as a torn anterior cruciate ligament, are precision
tooled to fit surgeons' requirements. This allows the surgeon to perform the
procedure without having to custom shape the implant material. Many of our
sports medicine allografts also are designed for specific instrumentation,
making them easier and/or faster to implant. These grafts can also be
osteoinductive, meaning they promote the growth of new bone. During 1999, we
shipped approximately 2,500 sports medicine allografts, excluding bone pastes,
which accounted for approximately $0.3 million of our net revenues.
We currently have several sports medicine allografts in development,
including soft tissue tacks used for reconstruction of soft tissue tears such as
rotator cuff injuries, non-frozen osteochondral allografts used for repair of
articulating surfaces and joints, bone suture anchors used for securing sutures
to bone, pre-shaped achilles tendons and quadriceps tendons. We are also
developing ligament alternatives made from under-used tissue with demineralized
tissue technology for use as ligament and tendon replacements, as well as soft
threaded interference screws and wedges used for knee re-alignment. At the same
time, we are developing the customized instrumentation to be used by surgeons
implanting our sports medicine allografts.
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<PAGE>
BONE PASTE. Surgeons use our bone paste allografts, moldable and
injectable, principally in fracture treatment, bone and joint reconstruction and
periodontal applications, such as jaw repairs. Our principal products in this
market are our patent-pending Osteofil Injectable Bone Paste and our patent-
pending Opteform Moldable Bone Paste, both of which are composed of
demineralized bone matrix and biologic gel carrier made from biological
materials. Our Opteform Moldable Bone Paste and new patent-pending Osteofil ICM
Bone Paste also include hard bone matter, known as cortical cancellous chips.
Importantly, all of our bone pastes are osteoinductive and every batch is tested
for osteoinductivity before release. In addition, our bone pastes are uniquely
"sticky" and not water soluble and therefore will not easily disperse or migrate
within a patient's body, a potential problem with other currently available bone
pastes.
In addition, our Osteofil Injectable Bone Paste is dispensable through a
syringe, an advantage not shared by all bone pastes. Our bone pastes have a
gel-like consistency which hardens at or below body temperature. Our Opteform
Moldable Bone Paste, which is pliable before hardening, is shaped in molded
forms useful for general orthopedic applications, typically hip and knee
replacements. During 1999, we shipped more than 19,000 bone paste allografts,
which accounted for approximately $5.2 million of our net revenues.
We currently have several bone paste allografts in development, including
pastes for the potential use in vertebroplasty, which is the repair of
degenerated vertebral bodies. We are also currently in the final stages of
development of bone pastes that can be stored and distributed at room
temperature and then mixed in the surgical arena, eliminating the need to keep
the material frozen prior to use.
CONVENTIONAL ALLOGRAFTS. Our conventional allograft business includes a
wide variety of allograft categories including our osteoarticular grafts, such
as our frozen femoral heads which are derived from the top portion of the femur
and is used for cancer treatment procedures and hip and knee reconstruction. We
also produce certain types of blended and milled bone allografts, such as our
demineralized bone matrix, cortical cancellous chips and ground cancellous
chips, used in total hip and knee replacements and for various injuries.
Additionally, we produce various types of fashioned bone, such as our fibular
wedges and iliac crest wedges, used for various orthopedic procedures, as well
as various soft tissue implants used for ligament and articulating surface
repair, such as ligaments and tendons that are not precisely tooled for a
specific use.
This growing market is important to us since it allows us to make the best
possible use of the gift of tissue donation and allows us to convert a
significant portion of the conventional allografts we distribute into precision
tooled allografts. We currently have a pre-ground femoral head allograft in
development to be used in hip revision surgery. During 1999, we shipped more
than 16,000 conventional allografts, which accounted for approximately
$9.0 million of our net revenues.
ORAL-MAXILLOFACIAL ALLOGRAFTS. Our principal oral-maxillofacial products
are our patent-pending Regenafil Injectable Bone Paste, our patent-pending
Regenaform Moldable Bone Paste and our pericardium membranes. Our Regenafil and
Regenaform bone pastes are similar to our Osteofil and Opteform bone pastes.
These allografts have a number of uses in oral-maxillofacial medicine, including
use in procedures to rebuild portions of the jaw to permit the use of dental
implants. Prior to the use of these allografts, many patients receiving dental
implants would instead be limited to dentures or bone would have to be harvested
from their hip to complete the reconstruction. Suregons use our pericardium
membrane, which is made from the sac enclosing the heart, to cover the site
where bone paste, or autograft or allograft bone chips, have been placed,
preventing the growth of unwanted tissue from filling the space and allowing the
bone to remodel. During 1999, we shipped more than 1,500 oral-maxillofacial
allografts, which accounted for approximately $0.2 million of our net revenues.
We currently have several oral-maxillofacial allografts in development,
including demineralized plates that could be used in place of metal plating in
oral and maxillofacial surgery, an orbital floor
39
<PAGE>
repair system for facial reconstruction and Regenaderm, our planned skin-derived
membrane for use in the oral-maxillofacial market.
UROLOGICAL ALLOGRAFTS
Our principal allograft in the urological market is our FasLata, which
surgeons use primarily to treat urinary incontinence through re-suspension of
the bladder neck. This graft is fashioned as a "sling," processed from fascia
lata, the fibrous tissue covering the large muscles. Prior to the use of sling
procedures, there was not an effective treatment for urinary incontinence which
is caused by a specific defect to the urethra. Demand for useable tissue in this
market far exceeds the supply. Additional applications we are developing for
tissue in this market are soft tissue "anchors" which are precision tooled from
hard bone, and slings fashioned from alternative tissue such as skin. During
1999, we shipped more than 12,000 urological sling allografts, which accounted
for approximately $1.9 million of our net revenues.
CARDIOVASCULAR ALLOGRAFTS
Our principal cardiovascular allograft is our heart valve allograft, which
surgeons use to replace a patient's own heart valve during coronary surgery.
Additional applications we are developing for tissue in this market are pulmonic
patches used for the repair of faulty arteries, and veins for vascular tissue
replacement, such as blood vessels. We are acquiring the tissue processing and
distribution business of Alabama Tissue Center which shipped approximately 70
cardiovascular allografts, generating approximately $0.5 million in revenues for
that year.
TISSUE RECOVERY
BACKGROUND
Tissue recovery is the actual removal of tissue from a donor. Tissue
recovery personnel recover tissue within 24 hours following a donor's death
using surgical instruments and sterilization techniques similar to those used in
hospitals for routine surgery. Techniques for recovery emphasize minimizing any
physical alteration of a donor's body. Recovered tissue is placed on wet or dry
ice and then transported by the recovery personnel to the tissue bank.
Under U.S. law, human tissue cannot be sold. However, the law permits the
recovery of some costs, such as those involved in recovering, processing and
storing tissue and for the advancement of tissue processing technologies, the
types of activities in which we are involved.
Our network of donor recovery groups recovers a variety of tissue types from
donors including tissue from the fibula, femur, tibia, humerus, ilium,
pericardium, fascia lata, and hearts for valve recovery. We screen recovered
tissue in numerous ways to guard against transmittable diseases. This screening
process includes evaluation of risk on the basis of donor lifestyle, interviews
with the donor's family and physical examination of the donor. We also perform
biomedical testing at various stages during the processing of tissue, using FDA
licensed and other tests for known viruses and pathogens.
In addition to screening for safety of the tissue, tissue banks develop
screening criteria to help them decide what tissue grafts may be processed from
each donor. We believe our biomechanical and tissue suitability screening
standards are unique in the industry. Unlike traditional tissue bank guidelines,
which include arbitrary criteria such as the donor's age as a determinant of
suitability, our standards and criteria are based on scientifically validated
testing and studies. Tissue from each donor is first examined, including
radiographic and physical examination. In addition, for each type of precision
tooled graft to be produced, we perform a biomechanical evaluation. Depending
upon the type of graft, this evaluation may include tests for impact and stretch
fatigue, static compression and torque, and pull-out strength. For our bone
pastes, we test each batch in animals to ensure that the paste remodels bone, a
step we believe is not taken by any other tissue bank. Our scientific screening
40
<PAGE>
standards, together with our tissue processing technology, allow us to make use
of this recovered tissue to the fullest extent possible. They also ensure the
suitability of the tissue to be used for the graft being processed. For example,
we routinely reject some weight-bearing grafts from donors under the age of 50
since our tests indicate those grafts would not have adequate biomechanical
properties, while traditional screening protocols used by other processors might
accept any donor under the age of 55. Unlike traditional screening protocols,
our screening standards allow a greater range of age among donors, and our
BioCleanse system permits us to safely and economically process tissue even from
lower-yielding donors. This provides the maximum benefit for the donor family as
well as the donor recipient.
TISSUE RECOVERY EXPANSION
We have one of the most extensive tissue recovery programs in the United
States, recovering tissue from over 4,000 donors during 1999, compared to 2,300
in 1998 and 1,500 in 1997. At present, there are approximately 30 tissue banks
in the United States that process and/or distribute bone or cardiovascular
allografts, the majority of which also function as donor recovery groups. Donor
recovery groups typically promote tissue donation, educate hospitals and other
institutions regarding tissue donations, support the family of the donor, and
physically recover and transport the donated tissue. Donor services group staff
members are trained to understand and deal with the emotional elements involved
in interacting and supporting the families of donors at their time of loss.
Of the approximately 80 donor recovery groups in the United States that
recover bone tissue, we have sourcing arrangements with more than 35 including
the University of Florida Tissue Bank, Inc., Tutogen Medical, Inc., Allograft
Resources of Wisconsin, Inc., Allosource, Inc., Community Tissue Services Dayton
and Tissue Banks International. Of these 35 donor recovery groups, we have
exclusive agreements with five, non-exclusive agreements with 16, and exclusive
management services agreements with four. The remaining ten groups work with us
on a non-contract basis or through relationships with other recovery groups in
the network. This extensive supply alliance allowed us to ship over 90,000
processed allografts during 1999, used by surgeons in an estimated 60,000
procedures. Often, surgeons use more than one allograft in a given procedure.
Our agreements with the University of Florida Tissue Bank, Inc., Tutogen
Medical, Inc. and Allograft Resources of Wisconsin, Inc. provided us with 58% of
our tissue supply during 1999. In particular, our exclusive relationship with
the University of Florida Tissue Bank continues to provide us with a large
supply of tissue for processing and distribution. Our tissue recovery agreement
with the University of Florida Tissue Bank, Inc. has a term of 10 years,
expiring in April 2009 our a recovery agreement with Tutogen Medical, Inc. has a
term of 5 years expiring in September 2003, subject to a provision for automatic
renewal for one year. Our management services agreement with Allograft Resources
of Wisconsin has a term of 10 years expiring in June 2008, with the option to
extend the agreement for an additional 5 years. We plan to continue to expand
our recovery programs in order to support our future growth by adding additional
donor recovery groups to our supply alliance, particularly those presently
acting as exclusive suppliers to others in the industry. Additionally, we may
consider acquiring additional tissue banks to further increase supply, such as
our recent acquisition of Georgia Tissue Bank.
During 1999, of the more than 3.6 million deaths in the United States, of
which we believe 50% would have been eligible to donate tissue, less than 0.4%
actually resulted in donated tissue. To the extent possible, we work with
management of the tissue banks with which we have relationships to assist them
in increasing the level of tissue donation. In areas where we have had active
involvement with donor recovery groups over an extended period of time, we have
increased the recovery rate to in excess of 4.0%. This involvement may include
entering into a management services agreement with these tissue banks. While the
terms of these agreements vary, often they involve assisting with the design or
improvement of the tissue bank's donor services group to increase the level of
donation.
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Our strategy is to further expand our tissue recovery operations in our
targeted regions, which include Florida/Georgia, Indiana/Michigan and New York,
through increased professional and public education. We also plan to continue to
establish relationships with medical examiners, hospitals and funeral homes in
these areas. We presently have agreements with 10 donor recovery groups within
these three targeted regions, two of which are management services agreements.
We have a four member team operating in each of these regions consisting of one
representative from each of sales, marketing, donor services, and our
subsidiary, Georgia Tissue Bank. These teams are responsible for providing
services to the recovery groups presently under management services agreements
and also for entering into management services agreements with other donor
recovery groups in these regions.
Internationally, we currently are involved in expanding tissue recovery
relationships in seven countries in order to support our planned international
growth. In addition, we currently process tissue from Europe under our agreement
with Tutogen. We also have planned joint efforts with foreign partners for
tissue recovery in Spain, Portugal, France, Austria, Switzerland and Italy.
Tissue recovery internationally presents a number of different challenges than
in the United States, including different laws, societal pressures and local
customs.
We also plan to continue to recover tissue though affiliations with funeral
homes, which involve presenting families of the deceased with the option of
tissue donation and supplying them with the information necessary to make an
informed decision. While we reimburse funeral homes for use of their facilities
and materials, the principal incentive for funeral homes to participate in an
affiliation with us is their ability to offer families of deceased the chance to
help others through the gift of tissue donation. Since approximately two-thirds
of all deaths occur outside of a hospital, we believe our strategy of recovering
donor tissue from funeral homes to be important to increasing the overall level
of tissue donation. Tissue recovered from funeral homes is subject to the same
requirement as in a hospital setting, that it be recovered within 24 hours
following a donor's death.
We also are exploring the use of tissue from cattle in the orthopedics
markets and have arrangements to procure tissue from a "closed herd" of cattle.
This closed herd is one for which the source, age and lineage of each animal has
been documented for more than seven years, with health and pedigree records
reviewed and managed so that no animal of the herd has been suspected of a
disease threatening to humans, and in which each animal is kept separated from
animals not in the closed herd. We already use small amounts of gelatin derived
from pigs in the production of our bone pastes.
Donor recovery groups are part of relatively complex relationships. They
deal with donor families, are regulated by the FDA and are often affiliated with
hospitals, universities or organ procurement groups. Our relationship with donor
recovery groups can be affected by some of the factors that affect these donor
recovery groups and this could have an impact on the supply of tissue to us. For
example, during March 2000, we became aware of letters from an anonymous source
being circulated which made allegations against Allograft Resources of
Wisconsin, or ARW, one of the donor recovery groups with which we have a
management services agreement. One of these letters was addressed to the FDA and
included specific alleged violations of federal regulations by ARW, including
claims that tissue recipient safety had been compromised. We promptly dispatched
a team to visit ARW to review its donor records and safety procedures. We also
contacted the FDA and a team of FDA auditors conducted its own inspection of
ARW. In addition, the board of directors of ARW engaged a law firm to interview
every employee and a number of former employees of ARW about the allegations
made.
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The FDA's inspection resulted in the issuance of an inspection notice, and
none of the observations noted by the FDA raised concerns over the safety of ARW
tissue relating to the issues raised in the anonymous letters. The FDA made six
observations, however, concerning documentation and record keeping, and proposed
corrective actions. None of the FDA, our own internal investigation nor the law
firm engaged by ARW found evidence to support the safety allegations made
against ARW. We plan to continue monitoring the situation with ARW, as well as
the other donor recovery groups with which we have recovery arrangements.
TISSUE PROCESSING
Following recovery of tissue using recovery techniques designed to minimize
physical alteration of the donor's body, recovered tissue is placed on wet or
dry ice and then transported by the recovery personnel to the tissue bank. After
the recovered tissue arrives at the tissue bank, we place the donor tissue in
freezer storage until we complete applicable quality assurance procedures and
protocols, including review and approval by one of our in-house medical
directors, each of whom is a medical doctor. We then move donor tissue into
processing based upon the demand for some of the recoverable tissues.
We surgically process tissue into numerous individual types of implantable
allografts, with each graft being sized, evaluated and labeled. Some allografts
have a much higher demand than do others, and those generally are distributed as
soon as we complete processing and quality assurance. We store the remaining
implantable allografts at our facility, awaiting distribution on an as-needed
basis.
A variety of allografts can be derived from a single bone. For example, from
a femur, we can produce a number of allografts including bone dowels,
interference screws, wedges and bone pastes. The following illustration shows
some of the allografts that can be produced from the femur:
[LOGO]
Other than a number of conventional grafts, bone pastes and soft tissue
which are processed using conventional techniques, we process donor tissue
initially through our proprietary BioCleanse system to begin the sterilization
process and to remove all blood, fat, lipids and other unwanted materials. We
believe the removal of blood, fat, lipids and other unwanted materials results
in faster patient healing since it eliminates the need for the patient's body to
remove these substances using natural processes following surgery. Our
BioCleanse tissue processing system is a proprietary, multi-step, patent-pending
tissue cleansing process, using ultrasonic, temperature, and pressure cycle
controls.
Our validation studies of the BioCleanse system show this process kills or
inactivates all classes of conventional pathogens, viruses, including HIV,
microbes, bacteria and fungi present in the tissue, while retaining the tissue's
useful properties. Specifically, the scope of the validation we performed on our
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BioCleanse system included viral inactivation studies demonstrating complete
clearance of relevant enveloped and non-enveloped viruses including HIV,
hepatitis A, porcine parvovirus, bovine viral diarrhea virus and pseudorabies.
Additionally, the validation study showed that the system effectively eliminates
both endogenous and adventitious microbial contamination produced internally
within the tissue or accidentally introduced. The validation included testing
against a panel of known microorganisms including BACILLUS STEAROTHERMOPHILUS,
recognized as the most resistant microbial species. The BioCleanse process also
was shown to remove greater than 99.99% of blood and fat from allograft
material. The resulting tissue passes the United States Pharmacopia standard
test for sterility and has been validated to attain a Sterility Assurance Level
of 10(-6). Testing of the BioCleansed allografts for mechanical properties and
biological compatability for use in patients demonstrated that the functionality
of the allograft was not impaired by the BioCleanse process. Based on these
studies, our BioCleanse technology produces sterile allografts, which we believe
to be the safest processed donor tissue in the industry. We believe the
effectiveness of BioCleanse in inactivating viruses such as HIV and other
harmful pathogens helps to lessen the fears of disease transmission associated
with allograft procedures.
Because the BioCleanse system is completely automated, we are able to
reproduce our sterilization results in every group of tissue that we process.
Our BioCleanse technology is also cost-effective since we can safely process the
tissue of up to 100 donors simultaneously in our system, eliminating the risk of
cross contamination to a less than one in one million probability. We believe we
are the only tissue processor able to safely process tissue in a single system
from multiple donors simultaneously.
Tissue to be precisely tooled for creating our line of specialized
allografts is removed from inventory after initial BioCleanse processing. Our
processing and manufacturing facilities include four class 10 certified clean
rooms, six class 100 clean rooms and four class 1000 clean rooms. We recently
introduced the use of automated machinery in the precision tooling of our line
of proprietary allografts, a task previously performed by our staff of tissue
technicians using customized tools and equipment. This increased use of
automation allows us to produce allografts which are precisely tooled for
specific surgical uses faster and more efficiently, while significantly reducing
processing costs. Automation also results in higher quality precision tooled
allografts since our machines are able to reduce the risk of human error by
repeating accurately and uniformly the tooling process countless times, instead
of each graft being the product of the tissue technician's skill.
Our tissue processing equipment also includes our proprietary lathes which
use hydro-infused drilling technology and custom tooling employed to thread our
cortical dowels and produce bone paste. Other custom equipment includes
clean-room milling machines, saws, grinders, dies and mills. After our operators
and technicians precision tool the donor tissue, we repeat the BioCleanse
process to complete the sterilization process. We are ISO 9001 certified, an
internationally recognized standard of quality assurance in product design,
development and production. Our biomedical laboratory is certified under the
Clinical Laboratory Improvements Act, or CLIA. CLIA is intended to ensure the
quality and reliability of clinical laboratories in the United States by
mandating specific standards in the areas of personnel qualification,
administration, participation in proficiency testing, patient test management,
quality control, quality assurance and inspections.
MARKETING AND DISTRIBUTION
In the spinal market, we plan to continue our strategic alliance with
Medtronic Sofamor Danek. We have two management services agreements with that
company under which they provide management services to assist in the
distribution and marketing of our spinal allografts and our Osteofil bone paste
for spinal uses. Medtronic Sofamor Danek's 350 sales representatives interact
directly with surgeons, providing the necessary instrumentation, customer
support, surgeon education and training, and marketing for our current spinal
allografts. In exchange for its management services, we pay Medtronic Sofamor
Danek service fees. Under the agreement for management services on our
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bone pastes, the amount of this service fee is 60% of the amount charged to each
customer until November 1, 2000, after which the fee increases to 65%. This
agreement expires in May 2018 or the expiration of our bone paste patent,
whichever occurs later. Under the agreement for management services on our
current line of spinal allografts, we pay Medtronic Sofamor Danek a service fee
equal to 70% of the amount charged to each customer. Under this agreement,
Medtronic Sofamor Danek also has the right for 60 days to require us to license
to them on an exclusive basis any new allografts or other developments relating
to spinal and cranial medical procedures. This agreement expires in July 2021.
Under these agreements, subject to some exceptions, Medtronic Sofamor Danek also
has exclusive rights to provide management services to assist in the
distribution of our spinal and cranial allografts internationally, though it has
not exercised this right to date.
Our allografts are distributed in all 50 states and in nine countries
internationally. In the United States, we have 23 independent distributors,
which distribute our allografts through approximately 150 sales representatives,
specializing in general orthopedics, complemented by our internal sales and
marketing staff of 26 people. Internationally, we have six distributors which
distribute our allografts through approximately 320 sales representatives. We
pursue a market-by-market approach to distribution, including strategic
relationships in selected markets, in order to increase our penetration of these
markets.
In the general orthopedics market, we have an agreement with Exactech, Inc.
for the distribution of our pre-molded bone pastes in the United States.
Exactech distributes our pre-molded bone pastes through its network of 50 sales
agencies using approximately 139 sales representatives. Under this agreement, we
receive a distribution fee from Exactech equal to 32.5% of the amount charged by
Exactech to its customers. Exactech has the right to distribute any improvements
related to our bone pastes which we may develop in the future, subject to the
terms of this agreement. This agreement automatically terminates if we do not
receive distribution fees for any period of time longer than six months.
Additionally, we have the right to terminate this agreement if the amount paid
to us under the agreement during any calendar year falls below a minimum
specified amount. We also distribute our sports medicine allografts through our
network of 23 independent distributors and 150 independent sales representatives
who distribute directly to hospitals and surgeons in their exclusive territory.
Our distribution arrangements entitle these distributors to receive a commission
for the revenues they generate and to maintain their status as the exclusive
distributor in their territory if they reach a specified annual quota.
We distribute our bone pastes not used in the spinal and portions of the
sports medicine markets through our network of 23 independent distributors
specializing in general orthopedics. We also are considering creating a direct
sales force in key U.S. markets to increase revenues from our Osteofil
Injectable Bone Paste.
For conventional tissue distribution, we use our network of 23 independent
distributors with more than 150 independent sales representatives. Distributors
and sales representatives receive a commission for the revenues they generate
and have the right to maintain their status as the exclusive distributor in
their territory if they reach a specified annual quota. Our recent acquisition
of Georgia Tissue Bank significantly increased the size of our distribution
organization for conventional allografts.
We use direct distribution for the oral-maxillofacial market, with an
emphasis on the periodontal market. We use direct mail product information
sheets, and we attend trade shows to increase the exposure of our allografts.
Our six person marketing staff supports these marketing efforts by speaking at
various clinics and universities.
In the urological market, we have an exclusive distribution agreement with
C.R. Bard providing for the marketing and distribution of our urological
allografts. Under this agreement, we ship our urological allografts directly to
C.R. Bard's customers. In return, we receive reimbursement for shipping charges
and a transfer fee equal to 40% of the amount charged to the customer. In order
to remain
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our exclusive distributor of these allografts, C.R. Bard must meet a specific
annual distribution quota. C.R. Bard has an exclusive 90-day right to negotiate
an agreement for the distribution of any new technology, invention, process or
application we may develop in the future for the treatment of "urinary voiding
dysfunction or pelvic tissue defects." This agreement expires in June 2008,
subject to a provision providing for automatic renewal.
In the cardiovascular market, we intend to distribute our heart valve
allografts through one or more distributors, initially within the southern
United States and then expanding to other regions after obtaining adequate
supply of tissue.
Our current and planned international distribution strategies vary by
market, as well as within each country in which we operate. For example, we
distribute only a portion of our line of allografts within each country. We
recently signed distribution agreements with distributors in several key markets
internationally. These include Plus Endoprothetik in Germany, Austria and
Switzerland, Korean Bone Bank in South Korea, Best Medical, Ltd. in Turkey,
Medical Development S.A., in Greece, ACORN Ltd. and UFTB Italia in Italy, and CH
Werfen in Spain and Portugal.
We intend to enter into additional markets around the world, including
France, the United Kingdom and Japan. During 1999, 2.6% of our net revenues were
derived from international markets.
RESEARCH AND DEVELOPMENT
We plan to continue to develop new allografts and technologies within the
orthopedics, urological and cardiovascular markets, and to develop additional
tissue-related technologies for other markets. To accomplish this, we intend to
continue to make use of our core technologies and processes, which include:
- hard bone precisely tooled for specific surgical uses;
- allograft bone pastes that are osteoinductive, meaning they promote the
growth of new bone;
- our patent-pending proprietary BioCleanse system;
- segmentally demineralized bone allografts;
- viable osteoarticular grafts designed to fit specific surgical
instruments;
- growth factors that can be added to allografts to stimulate bone or tissue
growth;
- allografts assembled from various smaller bone pieces; and
- xenograft or animal tissue treated to reduce material that could cause
immune responses.
We believe that these core processes and technologies, including our
BioCleanse system, have far reaching uses in new markets including the use of
tissue implants for growth factor delivery.
As of June 30, 2000, our research and development staff consisted of 22
professional and technical personnel, including three with PhDs or MD/PhDs and
six with masters of science degrees, in disciplines such as mechanical
engineering, materials sciences, biochemistry, biomedical sciences, biomaterials
and organic chemistry. Our research and development staff work closely with
surgeons in the development of new techniques and procedures related to tissue
healing.
PRODUCT DEVELOPMENT PROJECTS
We are involved in numerous development projects, including new machined
orthopedic allografts for the spine and sports medicine areas which allow us to
expand our existing line of allografts. Among our current product development
projects are:
- Interference Screw ST--This "soft" threaded interference screw would
represent an expansion to our current offerings in the ACL reconstruction
market.
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- Preshaped Tendons for Reconstruction--Achilles and quadriceps tendons with
pre-shaped bone blocks attached to the tendon intended to allow for easier
replacements and reduced surgical time.
- Alloanchor RC--Targeted at the shoulder market, this allograft, similar to
a "suture anchor" which could represent an allograft alternative to
current metal suture anchors, as well as "resorbable" suture anchors that
dissolve within a patients' body.
- Osteofil II--A version of our Osteofil bone paste that can be transported
and stored at room temperature by separating the elements of the paste and
then allowing for mixing in the surgical room.
- Osteochondral plugs--These non-frozen viable allografts could be available
in a range of plug sizes for knee repairs and will represent a new method
for transplanting fresh donor cartilage.
- Tibialis tendons--An increasing popular solution for ACL reconstruction,
this graft could simplify the current surgical procedures for repair of
this tendon.
- Suture anchor extensions--These grafts are further adaptions of our
Alloanchor RC suture anchor, designed in smaller sizes for other
procedures in the shoulder and small joints.
- HTO wedges--This graft is designed for correction of lower extremity
misalignment, a cause of loading imbalances in the knee. This precision
tooled allograft would reduce the amount of "customization" normally
required in this procedure.
- Soft tissue tacks--These bone tacks will be used to reattach soft tissue
to bone. The allograft tack achieves surgical repairs without the need for
suture.
- Complementary instrumentation--We are designing instruments for use with
our allografts during the surgical procedure to ease the demands of the
surgical procedure.
- Pre-ground femoral heads--This allograft, used in hip revision surgery,
should reduce the amount of time spent in surgery by freeing surgeons from
the necessity of grinding tissue taken from the top of the femur in the
operating room.
- Dermis-based urological sling--Our BioCleanse process is, in addition to a
tissue cleaning process, a decellularizing process. Studies are underway
to determine the effectiveness of the BioCleanse process in producing a
skin-based decellularized allograft which could be used for "sling
procedures" such as urinary slings, duraplasties, pleuralplasties, gastric
patches, burn treatment, and reconstructive facial surgery.
RESEARCH AND TECHNOLOGY PROJECTS
We also are working on a number of long-term research and technology
projects that we believe have potential. Each of these projects, however, is at
a very early stage and we cannot be sure that we will ever develop a working
technology from this research. Among our current long-term research and
technology projects are:
- Tendon replacement--This patent-pending technology would reconfigure hard,
cortical bone tissue into a tendon-like structure with tendon-like
strength. Until now, most natural tissue tendons used in sports medicine
are transplanted tendons, either autograft or allograft. Allograft
tendons, however, continually are in short supply. The replacement under
development has a wide range of applications, and would remodel from bone
into the patient's own tendon over time.
- Composite allograft--This technology involves the joining of two or more
separate pieces of machined bone. This allows for a wider range of design
configurations and potentially could result in higher yields per tissue
donor since the bone's anatomy would no longer be a limiting factor in the
size and shape of a given allograft.
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- Demineralized strip/plate for facial applications--We are researching
methods for processing bone into plates and strips that are somewhat
flexible, yet retain a degree of stiffness, using demineralization or
partial demineralization. These plates and strips, especially useful in
surgeries for children, could then be used for a variety of
oral-maxillofacial applications including orbital floor and nasal
reconstruction.
- Reduced antigenicity bovine bone--We are conducting tests and validations
on the use of our BioCleanse system to reduce antigenic materials
(materials that can cause a rejection or immune response) from tissue
taken from cattle, from which a variety of grafts could potentially be
processed. We are pursuing CE Mark and 510(k) clearance for bovine
versions of the Cornerstone SRs, Tangents, Precision ALIFs, Interference
screws, suture anchors and CT.
MEDICAL ADVISORY BOARD
Our Medical Advisory Board is made up of doctors, surgeons and medical
experts who meet periodically as a group to provide us with advice on industry
trends in product development and surgical techniques. Our Medical Advisory
Board also works with members of our research and development staff in the
development of new allografts and tissue technologies. Currently, this board has
eight members, representing a broad range of experience in fields relevant to
our technologies and technologies under development. Members of our Medical
Advisory Board receive per-diem consulting fees, including payment for
attendance at meetings and reimbursement of expenses. Members also may receive
royalty rights on any inventions they contribute through their service with the
board. Current members are:
DENNIS ARMSTRONG, M.D. has been a private practicing orthopedic surgeon
since 1977. Prior to entering private practice, Dr. Armstrong completed an
orthopedic residency at Henry Ford Hospital from 1974 until 1977. Dr. Armstrong
received a B.S. from Michigan State University and an M.D. from Wayne State
School of Medicine.
KELVIN G.M. BROCKBANK, PH.D. has served as President of KGB
Associates, Inc., a consulting company on research and development opportunities
relating to implantable devices, tissue engineering and tissue transplantation
since 1996. From 1994 until 1995, Dr. Brockbank served as Vice President of
Research and Development for Edward's Cardio Vascular Surgery Division of Baxter
Healthcare Corporation. From 1985 until 1994, he served as Director of Research
and Development at CryoLife, Inc. Dr. Brockbank holds a B.A. and an M.A. from
Trinity College Dublin and a Ph.D. in Experimental Pathology from the Medical
University of South Carolina.
JEFFREY HOLLINGER, D.D.S., PH.D. is a professor of Surgery, Anatomy and
Developmental Biology at the Oregon Health Sciences University School of
Medicine, a position he has held since 1993. He also serves as President and
Director of Research at the Northwest Wound Healing Center. From 1980 until
1993, Dr. Hollinger was employed by the U.S. Army Institute of Dental Research
where he served as the Director of the bone program from 1982 until 1993, Chief
of Physiology from 1980 until 1993, and Acting Chief of the Departments of Oral
and Maxillofacial Surgery, Pathology and Biochemistry from 1982 until 1985.
Dr. Hollinger received a B.A. from Hofstra University and a D.D.S. and Ph.D.
from the University of Maryland.
PAUL LAROCHELLE, M.D. has been a practicing orthopedic surgeon at the
Brevard Orthopedic Clinic since 1989. From 1988 until 1995, Dr. LaRochelle was
the recipient of six fellowships. He received a B.A. in Ecology and Marine
Sciences from Cornell University in 1977. He holds a MDCM from McGill
University.
N. RAY LEE, D.D.S. has been an Assistant Clinical Professor in the Division
of Oral and Maxillofacial Surgery at the Medical College of Virginia since 1986
and an Assistant Clinical Professor at Eastern Virginia Medical School since
1985. Dr. Lee served as the Director of the Division of Oral
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Medicine at the Eastern Virginia Medical School from 1985 until 1987 and an
Instructor in Advanced Trauma Life Support from 1987 until 1995. Dr. Lee holds a
B.S. in Biology from The College of William and Mary and a D.D.S. from Baylor
College of Dentistry.
JACK MCCARTHY, M.D. has been in private practice as an orthopedic surgeon
and a clinical instructor at the University of Nebraska since 1987.
Dr. McCarthy received the Hand Fellowship from Washington University for the
1986/1987 year. Dr. McCarthy holds a B.A. in Natural Science from St. John's
University and an M.D. from the University of Iowa.
HAROLD TU, D.M.D., M.D. has been a practicing Oral and Maxillofacial surgeon
since 1982. In addition, Dr. Tu has been an Associate Professor of Surgery in
the Department of Surgery at the University of Nebraska Medical Center since
1988. Dr. Tu holds a D.M.D. from the University of Oregon Dental School and an
M.D. from the University of Nebraska School of Medicine.
JEFFREY VISOTSKY, M.D. has been an Assistant Professor of Clinical
Orthopedic Surgery at Northwestern University since 1990 and a Clinical
Associate Professor of Orthopedic Surgery and Rehabilitation Medicine at the
University of Chicago since 1992. Dr. Visotsky has been an instructor in the
Physicians Assistant Department at Finch University of Health Sciences of the
Chicago Medical School since 1997 and a Special Consultant to the Division of
Specialized Care for Children at the University of Chicago since 1999.
Dr. Visotsky holds a B.S. from Tulane University and an M.D. from Northwestern
University Medical School.
INTELLECTUAL PROPERTY
Our business depends upon the significant know-how and proprietary
technology we have developed. To protect this know-how and proprietary
technology, we rely on a combination of trade secret laws, patents, trademark
and confidentiality agreements with our employees and others. The effect of
these intellectual property rights is to define zones of exclusive use of the
covered intellectual property.
We presently hold three patents covering our MD-Series cortical bone dowel
and our interface screw technology and two allowed patent applications covering
our segmentally demineralized graft, stent and conduit technology in the United
States and one foreign patent covering our MD-Series cortical bone dowel
technology. The duration of patent rights generally is 20 years from the date of
filing of priority application, while trademarks, once registered, essentially
are perpetual. We also have 18 patent applications pending and 13 patent
continuations pending in the United States and 40 corresponding patents pending
in various foreign countries, including in Canada, Mexico, Japan, Australia and
the European Union. Our patents and patents pending cover 19 allografts or
technologies that are important to our business. In addition, we rely on our
substantial body of know-how, including proprietary techniques and processes in
tissue recovery, research and development, tissue processing and quality
assurance. The following table shows the allografts and technologies for which
we have patents or pending applications. A number of our technologies, such as
our BioCleanse technology, are applicable to multiple markets.
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<TABLE>
<CAPTION>
<S> <C> <C>
COMMERCIAL APPLICATION PROPRIETARY ALLOGRAFTS PROPRIETARY TECHNOLOGIES
---------------------------- ---------------------------- ----------------------------
General Tissue Healing and Reduced antigenicity BioCleanse
Processing implants Assembled implants Implant perfusion
Growth factor extraction
Carriers for growth factors
Spinal MD-Series cortical dowel Processes for making MD
SR cervical implant Series dowels
Segmental demineralized Various methods of making,
implants. processing, using implants
Sports Medicine Interference screw Process of ACL
Segmental demineralized reconstruction
tendons Various methods of making,
Segmental demineralized processing, using implants
ligaments
Segmental demineralized
cartilage
Suture anchor
Tissue tape
Cartilage derived
morphogenic
protein
Bone-tendon-bone implants
Bone Paste Bone Paste
Bone paste tape
Oral-Maxillofacial Segmental demineralized
plates
Urological and Demineralized vessel grafts
Cardiovascular &
stents
</TABLE>
COMPETITION
Competition in the bone and tissue healing industry is intense and subject
to rapid technological change and evolving industry requirements and standards.
Generally, competitors within the industry compete on the basis of design of
related instrumentation, efficacy of products, relationships with the surgical
community, depth of range of implants and pricing. Allograft implants compete
with autograft, metals and synthetic tissues, as well as with alternative
medical procedures. For the foreseeable future, we believe a significant number
of surgeons will continue to choose to perform autograft procedures when
feasible, despite the necessity of performing a second operation. In addition,
many members of the medical community will continue to prefer to use metals and
synthetics due in part to their familiarity with the products and the procedures
required for their use. While synthetics are not osteoinductive, we believe that
researchers will eventually develop methods for permitting the combination of
synthetic tissue with recombinant growth stimulating materials in order to
create an osteoinductive synthetic tissue. We and a number of other companies
are conducting research intended to develop this technology.
In the spinal market, we compete against other companies that produce and
distribute implants and grafts that promote spinal fusion. Spinal fusion
products can be metal-based fusion cages or allograft implants. Our principal
metals-based competitors include SpineTech, Surgical Dynamics, Medtronic Sofamor
Danek and Acromed, a division of Johnson & Johnson. Our principal allograft-
based competitors include Synthes, DePuy Orthopaedics, a division of Johnson &
Johnson, and Osteotech.
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In the sports medicine market, we compete against companies in the anchor
and screw segment of the market and against companies in the allograft implant
segment of the market. In the anchor and screw segment, our principal
competitors include Mitek Products, a division of Johnson & Johnson, Arthrex,
Acufex, a division of Smith & Nephew Endoscopy and Linvatec, a division of
Conmed. In the allograft implant segment, our principal competitors include
CryoLife and the Musculoskeletal Tissue Foundation.
Our bone pastes compete against human tissue-derived and synthetic bone
fillers. In the human tissue-derived bone paste market, our principal
competitors include Osteotech, Gen-Sci Regeneration Sciences and Wright Medical
Technology. In the synthetic-derived bone filler market, we principally compete
against Interpore International and Wright Medical Technology.
In the oral-maxillofacial market, we compete principally against companies
that provide human-derived bone paste or synthetic bone fillers, and against
companies that make periodontal membranes. Among our competitors producing human
tissue derived oral-maxillofacial bone paste include Osteotech and Gen-Sci
Regeneration Sciences. Among our competitors producing synthetic bone pastes
include Geistlich Pharma AG and Interpore International. Competitors producing
periodontal membranes include Gore Medical Products, a division of W.L. Gore &
Associates, Geistlich Pharma AG and LifeCell.
Our principal competitors in the conventional allograft market include the
Musculoskeletal Tissue Foundation, the American Red Cross Tissue Services,
Allosource and LifeNet. Among the companies that market devices used for soft
tissue anchoring in bladder neck suspensions are Mentor, Ethicon, a division of
Johnson & Johnson, Boston Scientific, Smith & Nephew and C.R. Bard.
In the heart valve market, we face competition from non-profit tissue banks
that cryopreserve and distribute human tissue, as well as from companies that
market mechanical, porcine and bovine heart valves for implantation. St. Jude
Medical is the leading supplier of mechanical heart valves and has a marketing
and distribution arrangement with a tissue bank that supplies them with
cryopreserved human heart valves. Edwards Lifesciences, until recently a
division of Baxter International, is the leading supplier of porcine heart
valves. CryoLife is the leading supplier of cryopreserved human heart valves and
at least two other tissue banks offer cryopreserved human heart valves,
including the American Red Cross Tissue Services.
GOVERNMENT REGULATION
Government regulation plays a significant role in the processing and
distribution of allografts. The production, testing, labeling, storage, record
keeping, approval, advertising and promotion of allografts are governed or
influenced by the Food, Drug, and Cosmetic Act, the Public Health Service Act,
and other federal and state statutes and regulations. Failure to comply with
applicable requirements could result in fines, injunctions, civil penalties,
recall or seizure of products, suspension of production, inability to market
current products, criminal prosecution, and refusal of the government to
authorize the marketing of new products.
We currently market allografts that are subject to the FDA's "Human Tissue
Intended for Transplantation" regulation. Under this regulation, we are required
to perform donor screening and infectious disease testing and to document this
screening and testing for each tissue we process. The FDA has authority under
the rule to inspect human tissue processing facilities, and to detain, recall,
or destroy tissues for which appropriate documentation is not available. We are
not required to obtain premarket clearance from the FDA for products that meet
the regulation's definition of "human tissue."
Some human tissues, such as heart valve allografts, corneal lenticules and
dura mater, are regulated by the FDA as medical devices. However, the FDA
permits entities that processed and
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<PAGE>
distributed heart valve allografts before June 26, 1991 to continue distributing
heart valve allografts without obtaining 510(k) clearance or pre-market approval
from the FDA. Our heart valve allografts are covered by this "grandfather"
policy. It is likely that in the future the FDA will regulate additional
allografts as medical devices. For allografts regulated as medical devices, we
will need to obtain premarket clearance or approval through either the 510(k)
premarket notification process, or the FDA's premarket approval, or PMA,
process. Under the 510(k) premarket notification process, we would submit an
application containing data which demonstrate the "substantial equivalence" of
our product to a device marketed prior to the enactment of the Medical Device
Amendments of 1976 or to a device legally marketed after that statute's
enactment. The FDA may request submission of clinical information in support of
the 510(k). The collection of data and preparation of a 510(k) application can
be costly and time consuming.
The FDA sometimes rejects 510(k) notices or sometimes the use of a 510(k)
notice may not be appropriate, requiring use of the PMA process. In addition, if
a medical device is not substantially equivalent to a pre-1976 device, use of
the PMA process is required. The PMA process is more complex, costly and time
consuming than the 501(k) clearance procedure. To obtain premarket approval, we
would be required to submit extensive preclinical and clinical data to the FDA.
Upon completion and analysis of clinical studies, we then would be required to
assemble and submit a PMA describing the preclinical, clinical, manufacturing
and other data. Typically, the FDA also inspects the manufacturing facility for
compliance with good manufacturing practice regulations. Review and approval of
a PMA can take several years and some PMAs are never approved.
If clinical trials are to be conducted, we may be required to obtain FDA
approval of an investigational device exemption application, or IDE. An IDE
typically contains data from laboratory and animal testing and a description of
the proposed study methods and clinical protocol. We must conduct our clinical
studies according to a written protocol under the oversight of an institutional
review board at each site where the study will be conducted, and our
investigators must adhere to good clinical practices.
Some human tissue-based products, such as cellular therapies, are regulated
by the FDA as biologics. While we do not at present market any allografts
regulated as biologics, we may do so in the future. Before a biologic may be
marketed, the FDA must approve a biologics license application, or BLA. An
applicant must support a BLA with extensive data, including the results of
preclinical and clinical testing which demonstrate that the product meets
prescribed safety and efficacy standards. Before conducting required clinical
testing with a biologic, we would be required to submit an investigational new
drug application to the FDA. We would be required to conduct all clinical
studies in accordance with an FDA approved protocol, subject to oversight by one
or more institutional review boards. Clinical studies such as these may take
several years and the FDA or sponsor may temporarily or permanently suspend a
clinical study at any time. Upon completion and analysis of clinical trials, we
would be required to submit a BLA containing the results of our clinical trials
and other information, including a complete description of the manufacturing and
control procedures. FDA review and approval of a BLA can take several years.
Products marketed under the approvals and clearances described above are
subject to pervasive and continuing regulation by the FDA. To the extent our
allografts are regulated by the FDA, we would be required to register as a
manufacturer and to manufacture these allografts in registered facilities and in
accordance with good manufacturing practices. We would also be subject to
post-marketing surveillance and reporting requirements. In addition, our
manufacturing facilities and processes would be subject to periodic FDA
inspection. Our labeling and promotional activities would be subject to scrutiny
by the FDA and, in certain instances, by the Federal Trade Commission. The
export of devices and biologics is also subject to regulation.
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<PAGE>
Our tissue processing generates by-products classified as medical hazardous
waste by the U.S. Environmental Protection Agency and the Florida Department of
Environmental Protection. We segregate the material and properly dispose of it
in compliance with applicable environmental regulations.
We also are licensed by the states of New York, Florida, California and
Maryland. These states are concerned primarily with ensuring proper donor
screening, including screening for HIV and viral hepatitis. The state of New
York also regulates the processing of tissue. We received a waiver from certain
New York requirements after presenting information about the use of our
BioCleanse system with pooled donor tissues.
EMPLOYEES
As of June 30, 2000, we had a total of 346 employees. The following chart
shows the number of our employees involved in the various aspects of our
business:
<TABLE>
<CAPTION>
DEPARTMENT NUMBER OF EMPLOYEES
---------- -------------------
<S> <C>
Tissue Processing and Manufacturing....................... 190
Tissue Recovery........................................... 38
Sales and Marketing....................................... 29
Research and Development.................................. 22
General and Administrative................................ 67
</TABLE>
FACILITIES
Our physical facilities, located in Alachua, Florida, include two
company-owned buildings comprising 45,000 square feet, as well as leased space
in nearby buildings. These facilities include 20 clean-rooms for tissue
processing and packaging, freezers for storage of tissue and laboratory
facilities. We currently house our BioCleanse processing and laboratory
operations in approximately 15,000 square feet of space which we currently lease
for approximately $18,000 per month. This lease expires in February 2002. We
sublease 3,855 square feet of space in the buildings we own to the University of
Florida Tissue Bank for approximately $5,000 per month, on a month-to-month
basis. We also lease 8,800 square feet of warehouse space at a rate of $4,500
per month under a lease expiring in June 2002. We have the option to extend this
lease for an additional year.
Our wholly owned subsidiary, Georgia Tissue Bank, operates from a leased
building in Atlanta, Georgia comprising 9,300 square feet, with three
clean-rooms for tissue processing and packaging, and freezers for tissue
storage. This lease has a three-year term, expiring in October 2002. The current
rent under this lease is $12,365 per month.
We plan to construct and equip a new 110,000 square foot facility on
approximately 21 acres of recently acquired property adjacent to our existing
facilities. We intend for this new facility to meet the FDA's "common good
manufacturing practices" requirements. We believe the new facility will increase
our capacity for tissue processing while allowing us to process tissue more
economically. We also believe this new facility will allow us to be designated
as an FDA approved medical device manufacturer. We expect to begin construction
of this new facility during the third quarter of 2000.
LEGAL PROCEEDINGS
EXACTECH LITIGATION
On June 22, 1999, Exactech, Inc. filed a complaint against us, the
University of Florida Tissue Bank, and 19 of our medical distributors and sales
agents. The complaint alleges that we have breached a license agreement under
which Exactech has certain rights to distribute our bone pastes. UFTB
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<PAGE>
assigned this agreement to us as part of our separation from that entity. The
court granted our motion to enforce an arbitration provision in the agreement,
and the matter is now in arbitration. Only we, Exactech and UFTB remain as
parties in the arbitration. We and Exactech each conducted discovery, including
the exchange of documents and the taking of depositions. The dispute relates to
the scope of rights transferred under the license agreement. We maintain that
the scope of rights transferred to Exactech was narrow, while Exactech asserts
that it has broad rights to distribute a range of allograft bone products
processed by us. At present, the arbitrator has not set a hearing date for the
arbitration. Exactech alleges it suffered monetary damages but has never placed
a dollar value on these alleged damages. We further believe that, even if this
arbitration results in an outcome unfavorable to us, it would not have a
material adverse effect on our business, financial condition or results of
operations.
OSTEOTECH LITIGATION
On February 25, 1999, we, UFTB and Medtronic Sofamor Danek filed a complaint
in U.S. District Court against Osteotech, Inc. Our complaint alleges that
Osteotech is infringing upon two patents for our Diaphysical Cortical Dowel.
UFTB licenses these patents to us on an exclusive basis and we then sublicense
these patents to Medtronic Sofamor Danek. We are seeking injunctive relief
against Osteotech preventing it from continuing to distribute products that
infringe either patent. We are also seeking monetary damages in an amount based
on the profit we believe we would have made if our patents were never infringed
by Osteotech. Currently, the parties are conducting discovery and a trial date
has not yet been set. We do not anticipate a trial in this matter during 2000.
Our legal expenses in this action are being reimbursed to us by Medtronic
Sofamor Danek.
From time to time, we are party to various legal proceedings incident to
operating a company of our size which we do not deem to be material to our
financial conditions or the operation of our business.
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MANAGEMENT
OUR EXECUTIVE OFFICERS, KEY EMPLOYEES AND DIRECTORS
Our executive officers, key employees and directors, and each of their ages
and positions as of June 30, 2000 are as follows:
<TABLE>
<CAPTION>
NAME AGE POSITION
---- -------- --------
<S> <C> <C>
James M. Grooms........................ 40 President, Chief Executive Officer and Chairman
Richard R. Allen....................... 48 Chief Financial Officer, Secretary and Treasurer
James P. Abraham....................... 41 Vice President of Sales
Thomas E. Brewer....................... 52 Vice President of Marketing
Nancy R. Holland....................... 53 Vice President of Donor Services
Frederick C. Preiss.................... 50 Vice President of Operations
Thomas W. Sander....................... 47 Director of Research and Development
C. Randall Mills, Ph.D. ............... 28 Director of Regulatory and Technical Affairs
Herman Baer, M.D. ..................... 67 In-house Medical Director
Edward S. McIntyre, M.D. .............. 52 In-house Medical Director
David J. Selman, M.D. ................. 42 In-house Medical Director
Philip R. Chapman...................... 39 Director
Peter F. Gearen, M.D. ................. 52 Director
Michael J. Odrich...................... 36 Director
Anthony C. Phillips.................... 54 Director
Daniel L. Weber........................ 69 Director
</TABLE>
JAMES M. GROOMS has been our President, Chief Executive Officer and Chairman
since we began operations in February 1998. From 1995 until joining us, he
served as President and Chief Executive Officer of University of Florida Tissue
Bank, Inc. Mr. Grooms served as the director of the University of Florida Tissue
Bank from 1992 until 1995. Prior to joining the University of Florida Tissue
Bank, Mr. Grooms was employed with CryoLife, Inc. from 1989 until 1992 where he
served as Manager of the Orthopedic Laboratory from 1989 until 1992 and Manager
of the Cardiovascular Laboratory during 1991. From 1987 until 1989, Mr. Grooms
served as Manager of Operations and Manager of Technology at Osteotech, Inc.
Mr. Grooms was the inventor of certain of our intellectual property rights to
key aspects of our allograft technology. Mr. Grooms holds a B.S. in Biology from
Old Dominion University.
RICHARD R. ALLEN has been our Chief Financial Officer, Secretary and
Treasurer since we began operations in February 1998. From 1997 until joining
us, Mr. Allen served as director of Finance and Business Development for the
University of Florida Tissue Bank. From 1990 until 1996, Mr. Allen served as
Chief Financial Officer of Sabine, Inc., a manufacturer of digital audio
equipment. In addition, from 1994 until 1996, Mr. Allen served as a principal of
Strategies 2000, Inc. and he was a principal of Fidelity Business
Consultants, Inc. from 1988 until 1997. Strategies 2000 and Fidelity Business
Consultants are consulting firms specializing in technology development and
licensing. Mr. Allen has been a partner in certified public accounting firms and
holds two bachelor degrees from the University of Florida, including a B.S. in
Accounting.
JAMES P. ABRAHAM has been our Vice President of Sales since June 1999. He
was our Director of Sales from December 1998 until June 1999. From 1994 until
joining us in December 1998, Mr. Abraham served as Vice President of Sales and
Marketing at Encore Orthapedics, Inc. Prior to 1994, he held a number of
positions including the National Sales Director for Intermedics, a division of
Sulzer Medica, Vice President of Marketing and then Executive Vice President of
Sales and Marketing for Implant Technology Inc., Director of Sales for
Orthomet, Inc., a manufacturer of orthopedic medical devices, and a Regional
Sales Trainer for Stryker Corporation. Mr. Abraham holds a B.A. degree in
business administration and finance from Creighton University.
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<PAGE>
THOMAS E. BREWER has been our Vice President of Marketing since 1999 and our
Director of Marketing from 1998 until 1999. Mr. Brewer held several positions at
Stryker Corporation including general management from 1996 until 1998, European
Marketing Director for Stryker Europe from 1993 until 1996 and various other
management positions from 1988 until 1993. From 1980 until 1988, he held various
marketing positions with Bard Biomedical, a division of C.R. Bard, Inc.
Mr. Brewer holds a B.A. from Hobart College, an M.B.A. from Widener University
and has completed additional graduate work at Syracuse University.
NANCY R. HOLLAND has served as our Vice President of Donor Services since we
began operations in February 1998. She has also served as the President, Chief
Executive Officer and member of the board of directors of UFTB since 1985,
although she has submitted her resignation to UFTB effective July 2000.
Ms. Holland was a National Accounts Manager for CryoLife, Inc. From 1986 until
1990, she served as the Executive Director of the American Council on
Transplantation and from 1983 to 1989 as the Executive Director of the American
Blood Commission.
FREDERICK C. PREISS joined us in November 1998 and has been our Vice
President of Operations since May 1999. From 1996 until 1998, Mr. Preiss was a
private consultant in the medical device industry and from 1994 until 1996, he
served as Executive Vice President of Operations of Wright Medical Technologies.
From 1990 until 1994, he served as Vice President of Manufacturing and
Engineering at U.S. Surgical Corporation. Mr. Preiss holds a B.S. in engineering
and business administration from the University of New Haven.
THOMAS W. SANDER has been our Director of Research and Development since we
began operations in February 1998. From 1996 until 1997, Mr. Sander was Vice
President Research and Development with Howmedica Leibinger, Inc. and from 1991
until 1995, he was Senior Director with U.S. Surgical Corporation. Mr. Sander
holds a B.S. in engineering analysis/bio-engineering from Clemson University and
a Masters in Biomedical Engineering from Tulane University.
C. RANDALL MILLS, PH.D. has served as our Director of Regulatory and
Technical Affairs since January 2000. From 1998 until 1999, he served as our
Senior Technical Affairs Manager. Dr. Mills was with the University of Florida
Tissue Bank from 1994 until 1998, most recently as a clinical laboratory
supervisor. Dr. Mills holds a B.S. in microbiology and physiology from the
University of Florida. He completed his post-graduate training in clinical
pathology at the Shands Hospital of the University of Florida, where he also
received his Ph.D.
DR. HERMAN BAER has been one of our In-house Medical Directors since we
began operations in February 1998. Dr. Baer has been a Professor of Pathology at
the University of Florida School of Medicine since 1998, where he has also
served as Director of Autopsy Services in the Department of Pathology since
1981. Dr. Baer holds an M.D. from the University of Basle in Switzerland.
DR. EDWARD S. MCINTYRE has been one of our In-house Medical Directors since
November 1999. Dr. McIntyre has been in private practice in Gainesville, Florida
for over ten years. Dr. McIntyre holds a B.A. from Temple University and an M.D.
from the Medical School of the University of Texas.
DR. DAVID J. SELMAN has been one of our In-house Medical Directors since
February 2000. Dr. Selman has been in private practice since 1986. Dr. Selman
holds an M.S. in Bioengineering from the University of Michigan, where he also
earned his M.D.
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<PAGE>
PHILIP R. CHAPMAN has served as a member of our Board of Directors since we
began operations in February 1998. He is the President of Venad Administrative
Services, Inc. and has been a General Partner of Adler & Company since 1995.
From 1991 until 1995, he served as a Principal of Adler & Company. From 1981
until 1989, Mr. Chapman served as a Senior Consultant at Booz Allen & Hamilton
International. Mr. Chapman is also a director of Shells Seafood
Restaurants, Inc. He holds a B.S. and an M.B.A. from Columbia University.
PETER F. GEAREN, M.D. has served as a member of our Board of Directors since
we began operations in February 1998. Dr. Gearen was Chief of Staff at the
Shands Hospital at the University of Florida and served as Assistant Dean of
Clinical Affairs at the University of Florida College of Medicine, from 1992
until 1999. He also has been an Associate Professor at the University of Florida
College of Medicine since 1993. Dr. Gearen is also a director of Motion
Engineering, Inc. He holds a B.A. from Spring Hill College and an M.D. from the
Stritch Loyola Medical School.
MICHAEL J. ODRICH has served as a member of our Board of Directors since we
began operations in February 1998. Mr. Odrich has served as a director of Active
Software, Inc. since 1997 and PEMSTAR, Inc. since 1998. Since 1986, he has held
various banking positions at Lehman Brothers Inc. Currently, he is a Managing
Director, head of the venture capital business and has served as the President
of Lehman Brothers Venture Associates since 1999. Mr. Odrich holds a B.A. from
Stanford University and received an M.B.A. from Columbia University.
ANTHONY C. PHILLIPS has served as a member of our Board of Directors since
1998. Mr. Phillips has served as President, Chief Executive Officer and a
director of Raymedica, Inc. since 1995. From 1991 to 1995, he was Senior Vice
President, Worldwide Marketing for CryoLife International, Inc., and from 1989
to 1991, was Vice President, Marketing and Strategic Planning for
Organogenesis, Inc. Mr. Phillips holds a B.S. from the University of Tennessee.
DANIEL L. WEBER has served as a member of our Board of Directors since 1999.
He has served as President and Chief Executive Officer of Marley Manufacturing
Corporation since 1986.
BOARD OF DIRECTORS AND EXECUTIVE OFFICERS
Our board of directors is comprised of six directors. Upon the completion of
this offering, our board of directors will be divided into three classes, with
the members of the respective classes serving for staggered three-year terms.
The initial terms of our current directors in these classes will expire upon the
election and qualification of directors at our 2001, 2002 and 2003 annual
meetings of stockholders. At each annual meeting of stockholders, directors will
be re-elected or elected for full three-year terms. All executive officers are
elected by, and serve at the discretion of, the board of directors. There are no
family relationships among any of our executive officers or directors.
COMMITTEES OF THE BOARD OF DIRECTORS
The audit committee of our board of directors is charged with the
responsibility of reviewing our audited financial statements and accounting
practices, and considering and recommending the appointment of independent
accountants for both audit functions and for advisory and other consulting
services. The audit committee is comprised of Messrs. Chapman, Phillips and
Gearen.
The compensation committee of our board of directors is charged with
reviewing and approving the compensation and benefits for our key executive
officers, administering our employee benefit plans and making recommendations to
the full board of directors regarding these matters. The compensation committee
is comprised of Messrs. Chapman and Phillips.
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<PAGE>
DIRECTOR COMPENSATION
Our directors who are also our employees or officers do not receive any
compensation specifically related to their activities as directors, other than
reimbursement for expenses incurred relating to their attendance at meetings of
the board of directors. Our directors who are not also our employees are
eligible to receive a stipend of $1,000 per meeting, as well as reimbursement
for their expenses incurred relating to their attendance at meetings of the
board of directors. Under our Omnibus Stock Option Plan, at the discretion of
our board of directors or compensation committee, our directors also are
eligible to receive awards of non-qualified stock options. In each of 1998 and
1999, our directors who are not also employees received a grant of an option to
purchase 14,400 shares of our common stock.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
No member of our compensation committee has been an employee of ours. None
of our executive officers serves as a member of the board of directors or
compensation committee of any other entity that has one or more executive
officers serving as a member of our board of directors or our compensation
committee.
EMPLOYMENT AGREEMENTS
We entered into an employment agreement with Mr. Grooms in February 1998.
Mr. Grooms' current annual base salary is $225,000. The agreement expires in
February 2003. The agreement provides for Mr. Grooms' reimbursement for
automobile expenses and a $1,000,000 life insurance policy for Mr. Grooms'
beneficiaries. Under the employment agreement, Mr. Grooms agreed to devote 100%
of his working time to our business and affairs. Mr. Grooms also received
108,730 shares of our common stock. If we terminate Mr. Grooms' employment
without "cause," within the meaning of the employment agreement, he will be
entitled to severance pay in an amount equal to his then-current annual salary
and will be precluded from competing with us for a period of one year following
the termination of employment. If we terminate Mr. Grooms' employment for
"cause," he will not be entitled to any severance pay, but still will be
precluded from competing with us for the same one year period.
We entered into an employment agreement with Mr. Allen in February 1998. Mr.
Allen's current annual base salary is $150,000. The agreement expires in
February 2003. Under the employment agreement, Mr. Allen agreed to devote 100%
of his working time to our business and affairs. Under the agreement, Mr. Allen
also received 576,000 shares of our common stock. These shares are subject to a
stock restriction agreement. If we terminate Mr. Allen's employment without
"cause," within the meaning of the employment agreement, he will be precluded
from competing with us in the southeastern United States for a period of one
year following the termination. If we terminate Mr. Allen's employment for
"cause," Mr. Allen will be precluded from competing with us for a period of two
years following the termination.
We entered into an employment agreement with Mr. Abraham in November 1998.
Mr. Abraham's current annual base salary is $150,000. Mr. Abraham is eligible to
receive an annual bonus in an amount to be determined by the board of directors
provided we achieve certain specified revenue levels. The agreement expires in
November 2003. Under the employment agreement, Mr. Abraham agreed to devote 100%
of his working time to our business and affairs. When he entered into the
employment agreement with us, Mr. Abraham received an option to purchase 84,000
shares of our common stock. The option is subject to a stock option restriction
agreement under which one fifth of the options vest on each anniversary of the
date of the grant. If we terminate Mr. Abraham's employment without "cause,"
within the meaning of the employment agreement he will be entitled to receive
severance pay in an amount equal to one-half of his then-current annual salary
and will be precluded from competing with us for a period of one year following
the termination. In the event of
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<PAGE>
termination for "cause," Mr. Abraham will not be entitled to severance pay, but
will be precluded from competing with us for three years following the
termination.
We entered into an employment agreement with Mr. Brewer in June 1998. Mr.
Brewer's current annual base salary is $155,400. The agreement expires in
June 2003. Under the employment agreement, Mr. Brewer agreed to devote 100% of
his working time to our business and affairs. Mr. Brewer received an option to
purchase 216,000 shares of our common stock at the time he entered into the
employment agreement. This option is subject to a stock option agreement under
which one fifth of the options vest on each anniversary of the date of the
grant. If we terminate Mr. Brewer's employment without "cause," within the
meaning of the employment agreement, he will be entitled to severance pay in an
amount equal to one-half his then-current annual salary and he will be precluded
from competing with us for a period of two years following the termination. In
the event of termination for "cause," Mr. Brewer will not be entitled to
severance pay but will be precluded from competing with us for the two years
following the termination.
We entered into an employment agreement with Mr. Preiss in November 1998.
Mr. Preiss' current annual base salary is $150,000 for serving as our Vice
President of Operations. The agreement expires in November 2003. Under the
employment agreement, Mr. Preiss agreed to devote 100% of his working time to
our business and affairs. We awarded Mr. Preiss an option to purchase 84,000
shares of our common stock at the time he entered into his employment agreement
with us. If we terminate Mr. Preiss' employment without "cause," within the
meaning of the employment agreement, he will be entitled to severance pay in an
amount equal to one-half of his then-current annual salary, to be paid out
monthly, and he will be precluded from competing with us for a period of one
year following the termination. If we terminate Mr. Preiss' employment with us
for "cause," Mr. Preiss will not be entitled to severance pay but will be
precluded from competing with us for a period of three years following the
termination.
EXECUTIVE COMPENSATION
The following table sets forth for the periods indicated salary and certain
other compensation paid or accrued by us for our Chief Executive Officer and the
four other most highly compensated executive officers whose total salary and
bonus exceeded $100,000 for services rendered to us during 1999.
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
ANNUAL COMPENSATION LONG-TERM COMPENSATION AWARDS
------------------------------ -----------------------------------
NUMBER OF SECURITIES
RESTRICTED UNDERLYING
NAME AND PRINCIPAL POSITION YEAR(1) SALARY BONUS STOCK AWARDS OPTIONS(#)
--------------------------- -------- -------- -------- ------------ --------------------
<S> <C> <C> <C> <C> <C>
James M. Grooms.....................
President, Chief Executive Officer 1999 $202,304 -- -- --
and Chairman 1998 164,770 -- $ 19,254 --
Richard R. Allen....................
Chief Financial Officer, Secretary 1999 131,733 -- -- --
and Treasurer 1998 113,114 -- 102,000 --
James P. Abraham.................... 1999 150,000 $56,362 -- --
Vice President of Sales 1998 18,697 -- -- 84,000
Thomas E. Brewer.................... 1999 155,400 -- -- --
Vice President of Marketing 1998 105,029 -- -- 216,000
Frederick C. Preiss................. 1999 131,733 -- -- 132,000
Vice President of Operations 1998 -- -- -- 84,000
</TABLE>
------------------------
(1) Compensation for 1998 is for the period from February 12, 1998, the date we
began operations, through December 31, 1998.
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STOCK OPTION GRANTS
The following table sets forth information concerning the grant of options
to purchase shares of our common stock during 1999 to each of the persons named
in the summary compensation table above.
<TABLE>
<CAPTION>
POTENTIAL REALIZABLE
VALUE AT ASSUMED
PERCENT OF ANNUAL RATES OF STOCK
NUMBER OF TOTAL OPTIONS PRICE APPRECIATION
SECURITIES GRANTED TO FOR OPTION TERM(3)
UNDERLYING EMPLOYEES EXERCISE PRICE EXPIRATION ---------------------
NAME OPTIONS(1) IN 1999 ($/SH)(2) DATE 5% 10%
---- ---------- ------------- -------------- ---------- --------- ---------
<S> <C> <C> <C> <C> <C> <C>
James M. Grooms................... -- -- -- -- -- --
Richard R. Allen.................. -- -- -- -- -- --
James P. Abraham.................. -- -- -- -- -- --
Thomas E. Brewer.................. -- -- -- -- -- --
Frederick C. Preiss............... 132,000 21% $3.13 9/09 $259,419 $657,419
</TABLE>
------------------------
(1) Options vest and become exercisable 20% per year over the five-year period
beginning on the date of grant.
(2) The exercise price for each option was equal to the fair market value of our
common stock as determined by the board of directors on the date of grant.
In determining the fair market value of our common stock on the date of
grant, our board of directors considered many factors, including:
- valuations prepared by an independent appraiser;
- the fact that option grants involved illiquid securities in a
non-reporting company;
- the prices of shares of our preferred stock issued by us to third party
investors in arm's-length transactions;
- the rights, preferences and privileges of the preferred stock over the
common stock;
- our performance and operating results at the time of grant;
- our stage of development and business strategy; and
- the likelihood that our common stock underlying these options would ever
become liquid such as through an initial public offering or a sale of our
company.
(3) These amounts represent hypothetical gains that could be achieved for the
respective options if exercised at the end of the option term. These gains
are based on assumed rates of stock price appreciation of 5.0% and 10.0%
compounded annually from the date the respective options were granted to
their expiration dates. These assumptions are not intended to forecast
future appreciation of our stock price. The potential realizable value
computation does not take into account federal or state income tax
consequences of option exercises or sales of appreciated stock. If we used
the actual initial public offering price of $14.00 per share as the base to
compute the potential option values assuming annual rates of stock price
appreciation of 5.0% and 10.0%, the hypothetical gain that could be achieved
would be $2,596,440 and $4,379,760, respectively.
The following table sets forth at December 31, 1999 the number of options
held by each of the executive officers named in the summary compensation table.
In the year ended December 31, 1999, none of the officers named in the summary
compensation table exercised any options.
<TABLE>
<CAPTION>
NUMBER OF SECURITIES VALUE OF UNEXERCISED
UNDERLYING UNEXERCISED IN-THE-MONEY OPTIONS
SHARES ACQUIRED VALUE OPTIONS AT YEAR END AT YEAR END($)
NAME OR EXERCISED REALIZED EXERCISABLE/UNEXERCISABLE EXERCISABLE/UNEXERCISABLE
---- ----------------- ----------------- ------------------------- -------------------------
<S> <C> <C> <C> <C>
James M. Grooms................... -- -- --/-- --/--
Richard R. Allen.................. -- -- --/-- --/--
James P. Abraham.................. -- -- 16,800/67,200 $ 42,000/$168,000
Thomas E. Brewer.................. -- -- 43,200/172,800 108,000/432,000
Frederick C. Preiss............... -- -- 16,800/199,200 42,000/257,375
</TABLE>
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INDEMNIFICATION OF DIRECTORS AND EXECUTIVE OFFICERS AND LIMITATION OF LIABILITY
Our Certificate of Incorporation includes a provision that eliminates the
personal liability of our directors for monetary damages for breach of fiduciary
duty as a director, except for liability:
- for any breach of the director's duty of loyalty to us or our
stockholders;
- for acts or omissions not in good faith or that involve intentional
misconduct or a knowing violation of law;
- under Section 174 of the Delaware General Corporation Law regarding
unlawful dividends and stock purchases; and
- for any transaction from which the director derived an improper personal
benefit.
Our Certificate of Incorporation also provides that:
- we must indemnify our directors, officers, other employees and agents to
the fullest extent permitted by the Delaware General Corporation Law,
subject to certain very limited exceptions; and
- we must pay expenses of our directors, and may pay expenses of our
officers, other employees, agents or trustees, incurred in their capacity
as a directors, officer, employees, agent or trustee in connection with a
legal proceeding before the final disposition of such proceeding.
These provisions are permitted under the Delaware General Corporation Law.
In addition, our Bylaws provide that we must indemnify our directors and
officers to the fullest extent permitted by the Delaware General Corporation
Law.
We intend to enter into indemnification agreements with each of our
directors and executive officers in order to give them additional contractual
rights regarding the scope of our indemnification obligations and to provide
additional procedural protections. In addition, we maintain directors' and
officers' insurance providing indemnification for our directors, officers and
management employees for liabilities arising as a result of their employment
with us. We believe that these indemnification provisions and agreements are
necessary to attract and retain qualified directors and officers.
The limitation of liability and indemnification provisions in our
Certificate of Incorporation and Bylaws may discourage stockholders from
bringing a lawsuit against directors for breach of their fiduciary duty. They
may also reduce the likelihood of derivative litigation against directors and
officers, even though such an action, if successful, might otherwise benefit us
and our stockholders. Furthermore, a stockholder's investment may be adversely
affected to the extent we pay the costs of settlement and damage awards against
directors and officers under indemnification provisions.
Except as otherwise described in this prospectus, there is at present no
pending litigation or proceeding involving any of our directors, officers, or
employees regarding which indemnification is sought, nor are we aware of any
threatened litigation that may result in claims for indemnification.
OMNIBUS STOCK OPTION PLAN
In July 1998, our board of directors and stockholders adopted the
Regeneration Technologies, Inc. Omnibus Stock Option Plan. A maximum of
4,406,400 shares have been authorized for issuance pursuant to the plan. Through
June 30, 2000, we issued options to purchase 1,825,166 shares of our common
stock to our directors, officers, employees and various third parties who
provide services to us. Of these options, 167,408 currently are exercisable. The
exercise prices of the options granted under the Omnibus Stock Option Plan range
from $1.30 to $13.54. The exercise price for each option grant was set at the
fair market value of the shares of our common stock on the date of grant, as
determined by our board of directors. The purposes of the plan are to promote
our long-term growth and
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profitability by providing key personal with incentives to improve stockholder
value and to enable us to attract, retain and reward skilled employees. There
are an additional 2,581,234 shares of common stock available for issuance under
the plan.
The plan allows for the discretionary grant of restricted stock,
non-qualified stock options, incentive stock options as defined in Section 422
of the Internal Revenue Code of 1986 and other stock-based awards. Any award of
an incentive stock option is limited to our employees and the employees of our
subsidiaries. The exercise price per share may not be less than 100% of the fair
market value of such shares on the date the option is granted.
The plan is administered by our board of directors or any committee it may
designate for this purpose. The board makes the determinations with respect to
awards under the plan, including which eligible individuals are to receive
awards under the plan and the specific terms, vesting conditions, if any, and
number of shares of stock to which each award related. Additionally, the board
may grant awards with different terms and conditions and also may accelerate the
vesting of outstanding awards and options at any time. At the time the options
are granted, the board will set the price at which options can be exercised.
Option holders do not and will not have any rights as stockholders until
they have exercised their options. The number of shares of our common stock
covered by awards will be adjusted in the event of any stock split, merger,
recapitalization or similar corporate event. This plan has a term of ten years,
expiring in July 2009.
YEAR 2000 INCENTIVE COMPENSATION PLAN
In January 2000, our board of directors and stockholders adopted the
Regeneration Technologies, Inc. Year 2000 Incentive Compensation Plan. If we
achieve certain profit levels, the plan allows for the creation of an incentive
pool and eligible employees receive cash awards from the pool on the basis of
individual and departmental goals. The board of directors reviews and approves
the Incentive Compensation Plan annually and our Chief Financial Officer
administers the plan.
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RELATED PARTY TRANSACTIONS
LEGAL RELATIONSHIPS WITH THE UNIVERSITY OF FLORIDA TISSUE BANK
SEPARATION FROM UFTB
We began operations on February 12, 1998 when the University of Florida
Tissue Bank or UFTB, contributed to us its allograft manufacturing and
processing operations, related equipment and technologies, distribution
arrangements, research and development activities and certain other assets. We
also assumed certain liabilities of UFTB that were related to the transferred
business. Various agreements relating to the transferred business to which UFTB
was a party also were assigned to us at that time, including one of our two
current management services agreements with Medtronic Sofamor Danek. At
approximately the same time, we sold shares of our preferred stock to a number
of unrelated investors and issued additional shares of our preferred stock to
UFTB in exchange for the assets it contributed to us. Immediately prior to this
offering, UFTB beneficially owned approximately 16.4% of our outstanding voting
equity securities. Dr. Peter F. Gearen, one of our directors, presently is an
Associate Professor at the University of Florida, which controls UFTB.
At approximately the same time as our separation from UFTB, James M. Grooms,
our Chief Executive Officer, President and Chairman, who served as an officer of
UFTB prior to our separation, contributed his royalty rights in certain
intellectual property to us in exchange for shares of our preferred stock. We
recorded the assets acquired from UFTB and Mr. Grooms and the liabilities
assumed from UFTB at their historical cost basis since these were deemed to be
transactions between entities under common control.
UFTB is our largest tissue supply source. The tax-exempt status of UFTB
requires our relationship with UFTB to be conducted at arm's length. For this
reason, our relationship with UFTB is pursuant to a Tissue Recovery Agreement
which is designed to provide for arm's-length charges for services between the
two companies. Under the agreement, UFTB supplies certain of its tissues
exclusively to us. Additionally, we have a right of first refusal on other
tissues which UFTB is not currently providing to us. We pay UFTB recovery fees
as reimbursement for expenses it incurs in tissue recovery procedures. The
amount of the recovery fee depends upon the type and amount of tissue recovered.
We incurred charges of approximately $2.4 million during 1998 and $5.3 million
during 1999 under this agreement. This agreement expires in April 2009.
Nancy R. Holland, our Vice President of Donor Services, currently serves as
the Chief Executive Officer and a director UFTB. Ms. Holland delivered a notice
of her resignation from UFTB effective July 2000. Ms. Holland recuses herself
from decisions by UFTB's board of directors with respect to UFTB's relationship
with us. We paid Ms. Holland $70,756 in 1998 and $75,000 in 1999. UFTB paid
Ms. Holland $90,276 in 1998 and $75,000 in 1999.
ASSUMPTION OF CONVENTIONAL ALLOGRAFT DISTRIBUTION BUSINESS OF UFTB
On April 15, 1999, we entered into a Programs Transfer Agreement with UFTB
under which UFTB transferred to us its recovery operations outside of Florida
and Georgia, conventional allograft distribution services, and its interests in
agreements with various tissue recovery programs in exchange for the offset of
amounts owed to us by UFTB. Also on that date, we entered into a Tissue Recovery
Agreement with UFTB under which UFTB functions as one of our tissue recovery
agencies, supplying to us the majority of the tissue it recovers. As of
April 15, 1999, the total amounts owed to us by UFTB was approximately
$5.0 million. Under the terms of the agreements, UFTB transferred to us its
unprocessed donor tissue and conventional tissue with a fair value of
approximately $3.0 million and equipment and fixtures with a fair value of
approximately $0.1 million as a partial offset against the existing amounts owed
to us by UFTB. UFTB paid us the remaining amounts by offsetting recovery fees
from April 15, 1999 through June 30, 1999 against the outstanding balance, which
fees, net of
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<PAGE>
administrative costs, were approximately $0.7 million, and made monthly payments
through the end of 1999 to repay the remaining balance of approximately
$1.2 million. Prior to this transfer to us of UFTB's tissue recovery operations,
we charged UFTB approximately $3.5 million during 1998 and approximately
$2.6 million during 1999 for tissue processing services.
We also share facilities, overhead and various personnel with UFTB, the
terms of which we believe are no less favorable than those we would obtain in an
arms-length relationship.
LEGAL RELATIONSHIP WITH MEDTRONIC SOFAMOR DANEK
The two management services agreements between us and Medtronic Sofamor
Danek grant to that company exclusive worldwide rights to provide management
services to assist in the distribution of our bone pastes for spinal uses and
our current line of spinal allografts, including our MD-Series threaded and
non-threaded dowels, tapered dowels and other spinal allografts. We pay to
Medtronic Sofamor Danek management services fees as a percentage of the amount
charged to customers for the allografts we distribute into these markets. We
incurred charges under these agreements aggregating approximately $24.1 million
during 1998 and approximately $40.0 million during 1999. These agreements
terminate in May 2018 and July 2021. During 1999, Medtronic Sofamor Danek
purchased shares of our preferred stock for an aggregate purchase price of
$5.0 million. Upon the completion of this offering, these shares will represent
approximately 4.2% of our outstanding voting equity securities. E. Ronald
Pickard, one of our former directors, served as President of Medtronic Spinal
and Neurological Group, a division of Medtronic Sofamor Danek until July 2000.
Prior to the merger of Sofamor Danek Group and Medtronics, Mr. Pickard served in
various executive capacities at Sofamor Danek Group, including as Chairman of
the Board and Chief Executive Officer.
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<PAGE>
PRINCIPAL AND SELLING STOCKHOLDERS
The following table sets forth information regarding the beneficial
ownership of our common stock as of June 30, 2000, and adjusted to give to the
offering, by: (i) each person known to beneficially own more than 5% of the
outstanding shares of our common stock; (ii) each of our directors; (iii) each
executive officer named in the summary compensation table; and (iv) all
executive officers and directors as a group. Unless indicated otherwise, the
address of the beneficial owners is: c/o Regeneration Technologies, Inc., One
Innovation Drive, Alachua, Florida 32615.
<TABLE>
<CAPTION>
SHARES BENEFICIALLY
OWNED PRIOR TO SHARES BENEFICIALLY
OFFERING(1) NUMBER OF OWNED AFTER OFFERING
-------------------- SHARES --------------------
NAME OF BENEFICIAL OWNER NUMBER PERCENT OFFERED NUMBER PERCENT
------------------------ --------- -------- --------- --------- --------
<S> <C> <C> <C> <C> <C>
James M. Grooms............................... 1,608,000 9.2% -- 1,608,000 7.5%
Richard R. Allen.............................. 480,000 2.7 -- 480,000 2.3
James P. Abraham(2)........................... 16,800 * -- 16,800 *
Thomas E. Brewer(2)........................... 86,400 5.8 -- 86,400 4.7
Frederick C. Preiss(2)........................ 16,800 * -- 16,800 *
Philip R. Chapman(3).......................... 1,007,073 5.8 -- 1,007,073 4.7
Peter F. Gearen(2)............................ 4,800 * -- 4,800 *
Michael J. Odrich(4).......................... 1,619,885 9.3 -- 1,619,885 7.6
Anthony C. Philips(2)......................... 4,800 * -- 4,800 *
Daniel L. Weber(2)............................ 4,800 * -- 4,800 *
Nancy R. Holland.............................. 997,018 5.7 -- 997,018 4.7
The University of Florida Tissue Bank, Inc.... 2,880,000 16.4 -- 2,880,000 13.5
One Innovation Drive
Alachua, Florida 32615(5)
The University of Florida Research 2,880,000 16.4 1,900,000 980,000 4.6
Foundation..................................
P.O. Box 100215
Gainesville, Florida 32610(6)
LB I Group Inc................................ 1,619,885 9.3 -- 1,619,885 7.6
Lehman Brothers Inc.
3 World Financial Center
New York, New York 10285(4)
Euro-America-II, L.P.......................... 965,246 5.5 -- 965,246 4.5
Venad Administrative Services, Inc.
342 Madison Avenue, Suite 807
New York, New York 10173(7)
Stephens-Regeneration LLC..................... 1,016,880 5.8 -- 1,016,880 4.7
111 Center Street, Suite 2500
Little Rock, Arkansas 72201(8)
Medtronic Asset Mgt., Inc..................... 996,274 5.7 -- 996,274 4.7
7000 Central Avenue, N.E.
Minneapolis, Minnesota 55402(9)
All executive officers and directors as a
group (11 persons)(10)...................... 5,846,376 33.1 -- 5,846,376 27.3
</TABLE>
------------------------
* Represents beneficial ownership of less than 1%.
(SEE FOOTNOTES ON NEXT PAGE)
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<PAGE>
(1) Percentage ownership is based on 17,508,562 shares outstanding as of
June 30, 2000. Shares of common stock subject to options currently
exercisable or exercisable within 60 days of March 31, 2000 are deemed
outstanding for the purpose of computing the percentage ownership of the
person holding such options but are not deemed outstanding for the purpose
of computing the percentage ownership of any other person.
(2) Represents options to purchase shares of common stock.
(3) Includes an option to purchase 768 shares of common stock and includes
965,246 shares held by Euro-America-II, L.P. (see note 7 below).
Mr. Chapman disclaims beneficial ownership of all shares other than those
held in his name.
(4) Includes an option to purchase 4,800 shares of common stock. We have been
advised that Michael J. Odrich has investment control with respect to shares
of our stock held by LB I Group Inc., a wholly-owned subsidiary of Lehman
Brothers Holdings Inc. Mr. Odrich disclaims beneficial ownership of all
shares other than those held in his name.
(5) The University of Florida Tissue Bank, Inc. is a not-for-profit corporation
that exists as a direct support organization for the benefit of the
University of Florida. The University of Florida appoints the board of
directors of the University of Florida Tissue Bank, Inc.
(6) The University of Florida Research Foundation is a charitable foundation
operated on behalf of the University of Florida to maintain investments of
gifts and bequests to the University of Florida.
(7) Includes an option to purchase 2,688 shares of common stock. The general
partner of Euro-America-II, L.P. is Euro-America Venture Partners, LLC. The
members of Euro-America Venture Partners, LLC are (1) SIGEFI, a French
entity, (2) EuroCal Venture Management, LLC, an entity controlled by Jacques
Vallee and (3) Adler Partners, L.P., a partnership whose partners are
Frederick R. Adler, Philip R. Chapman and Jay S. Nickse.
(8) We have been advised that Stephens Group Inc. is the sole manager of
Stephens-Regeneration LLC and that Jon E.M. Jacoby has investment control
with respect to shares of our stock held by that entity.
(9) We have been advised that Michael D. Ellwein has investment control with
respect to shares of our stock held by Medtronic Asset Mgt., Inc.
(10) Includes options to purchase 139,968 shares of common stock.
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DESCRIPTION OF CAPITAL STOCK
Upon the completion of this offering, our authorized capital stock will
consist of 50,000,000 shares of common stock, $.001 par value, and 5,000,000
shares of preferred stock, $.001 par value.
COMMON STOCK
As of June 30, 2000, 17,508,562 shares of our common stock were outstanding
and held of record by 102 stockholders after giving effect to the conversion of
all outstanding shares of preferred stock. Based upon the number of shares
outstanding at June 30, 2000, following the issuance of the 3,800,000 shares of
our common stock we are offering under this prospectus, there will be 21,308,562
shares of common stock outstanding and no shares of preferred stock upon the
completion of this offering.
Subject to preferences that may be applicable to any preferred stock
outstanding at the time, the holders of outstanding shares of common stock are
entitled to receive dividends out of assets legally available therefor at such
times and in such amounts as the board of directors from time to time may
determine. Holders of common stock are entitled to one vote for each share held
on all matters submitted to a vote of stockholders. Cumulative voting for the
election of directors is not authorized by our certificate of incorporation,
which means that the holders of a majority of the shares voted can elect all of
the directors then standing for election. Holders of our common stock are not
entitled to preemptive rights and our common stock is not subject to conversion
or redemption. Upon our liquidation, dissolution or winding-up, the assets
legally available for distribution to stockholders shall be distributed ratably
among the holders of our common stock after payment of liquidation preferences,
if any, on any outstanding shares of preferred stock and payment of other claims
of creditors.
There is currently no public market for our common stock. Our common stock
has been approved for quotation on the Nasdaq National Market under the symbol
"RTIX."
PREFERRED STOCK
Upon the completion of this offering, we will not have any shares of
preferred stock outstanding. Our 5,000,000 authorized shares of preferred stock
may by issued in one or more series without further stockholder authorization,
and our board of directors is authorized to fix and determine the terms,
limitations and relative rights and preferences of the preferred stock, to
establish series of preferred stock and to fix and determine the variations
between these series. If we issue preferred stock, it would have priority over
our common stock with respect to dividends and to other distributions, including
the distribution of assets upon liquidation, and we may be obligated to
repurchase or redeem our preferred stock. Our board of directors can issue
preferred stock without the further approval of our common stockholders. Any
preferred stock we issue may have voting and conversion rights which could
adversely affect the rights of holders of our common stock. In addition to
having a preference with respect to dividends or liquidation proceeds, if
preferred stock is issued, it may be entitled to the allocation of capital gains
from the sale of our assets. We do not have any present plans to issue any
shares of preferred stock.
WARRANTS
As of June 30, 2000 we had outstanding warrants to purchase an aggregate of
226,930 shares of our common stock at a weighted average exercise price of
$5.65.
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REGISTRATION RIGHTS
Under the terms of an agreement between us and certain of our stockholders,
these stockholders are entitled to certain rights with respect to the
registration of these shares under the Securities Act of 1933 commencing
180 days after the completion of this offering. If we receive from the required
number of holders of these shares a written request to effect a registration
with respect to all or a part of their shares, we must use our best efforts to
effect a registration, provided the offering price for these shares in the
aggregate is at least $5,000,000. We are obligated to effect only two of these
registrations.
When we become eligible to use a registration statement on Form S-3, our
stockholders may request that we file a registration statement on Form S-3
covering all or a portion of their shares, provided that the aggregate public
offering price is at least $500,000.
In addition, these and certain of our other stockholders have "piggyback"
registration rights. If we propose to register any common stock under the
Securities Act, other than pursuant to the registration rights described above,
these stockholders may require us to include all or a portion of their
securities in that registration.
We would bear all registration expenses incurred in connection with any of
the above registrations. Each of these stockholders participating in any
registration would pay their own underwriting discounts, selling commissions and
stock transfer taxes applicable to the sale of their securities.
STOCKHOLDERS' AGREEMENT
We have entered into a stockholders' agreement with our current
stockholders. The stockholders have agreed to vote their shares of our voting
capital stock so as to cause the board of directors to consist of seven persons,
five of which are to be approved by holders of our preferred stock outstanding
prior to this offering. This agreement terminates upon the completion of this
offering.
DELAWARE ANTI-TAKEOVER LAW AND CERTAIN CHARTER PROVISIONS
Under Section 203, certain "business combinations" between a Delaware
corporation with shares that generally are publicly traded or held of record by
more than 2,000 stockholders, and an "interested stockholder" are prohibited for
a three-year period following the date that such stockholder became an
interested stockholder, unless:
- the corporation has elected in its certificate of incorporation or bylaws
not to be governed by the Delaware anti-takeover law;
- the business combination was approved by the board of directors of the
corporation before the other party to the business combination became an
interested stockholder;
- upon consummation of the transaction that made it an interested
stockholder, the interested stockholder owned at least 85% of the voting
stock of the corporation outstanding at the commencement of the
transaction, excluding voting stock owned by directors who are also
officers or held in employee stock plans in which the employees do not
have a right to determine confidentially whether to tender or vote stock
held by the plan; or
- the business combination was approved by the board of directors of the
corporation and ratified by 66 2/3% of the voting stock which the
interested stockholder did not own. The three-year prohibition does not
apply to certain business combinations proposed by an interested
stockholder following the announcement or notification of certain
extraordinary transactions involving the corporation and a person who had
not been an interested stockholder during the previous three years or who
became an interested stockholder with the approval of a majority of the
corporation's directors. The term "business combination" is defined
generally to include
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mergers or consolidations between a Delaware corporation and an interested
stockholder, transactions with an interested stockholder involving the
assets or stock of the corporation or its majority-owned subsidiaries and
transactions which increase an interested stockholder's percentage
ownership of stock. The term "interested stockholder" is defined generally
as a stockholder who becomes beneficial owner of 15% or more of a Delaware
corporation's voting stock. We have not elected in our certificate of
incorporation or bylaws not to be governed by the Delaware anti-takeover
law. Section 203 could have the effect of delaying, deferring or
preventing a change in control of Regeneration Technologies.
Our certificate of incorporation provides for the division of our board of
directors into three classes, as nearly equal in size as possible, with each
class beginning its three-year term in different years. Any director may be
removed only for cause by the vote of a majority of the shares entitled to vote
for the election of directors.
In addition, provisions of our certificate of incorporation and bylaws
summarized in the following paragraphs may have an anti-takeover effect and may
delay, defer or prevent a tender offer or takeover attempt that a stockholder
might consider in its best interest, including those attempts that might result
in a premium over the market price for the shares held by our stockholders.
STOCKHOLDER ACTION; SPECIAL MEETING OF STOCKHOLDERS
Our bylaws provide that our stockholders may not take action by written
consent, but only at an annual or special meeting of stockholders. Our bylaws
further provide that special meetings of our stockholders may be called only by
the chairman of our board of directors or a majority of our board of directors.
SUPERMAJORITY VOTING PROVISIONS
Our certificate of incorporation provides that the affirmative vote of at
least 66 2/3% of our stockholders is required to amend the provisions of our
certificate of incorporation and bylaws relating to the election of our board of
directors, stockholder action by written consent and the calling of special
meetings.
AUTHORIZED BUT UNISSUED SHARES
The authorized but unissued shares of our common stock and preferred stock
are available for future issuance without stockholder approval. These additional
shares may be used for a variety of corporate purposes, including future public
offerings to raise additional capital, corporate acquisitions and employee
benefit plans. The existence of authorized but unissued common stock and
preferred stock could render more difficult or discourage an attempt to obtain
control of our company by means of a proxy contest, tender offer, merger or
otherwise.
LIMITATION OF LIABILITY AND INDEMNIFICATION MATTERS
We intend to enter into indemnification agreements with our current
directors and executive officers. These agreements may have the practical effect
in some cases of eliminating our stockholders' ability to collect monetary
damages from our directors. We believe that these contractual agreements and the
provisions in our certificate of incorporation and bylaws are necessary to
attract and retain qualified persons as directors and officers.
TRANSFER AGENT AND REGISTRAR
The transfer agent and registrar for our common stock is Continental Stock
Transfer & Trust Company.
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SHARES ELIGIBLE FOR FUTURE SALE
Prior to the offering, there has been no public market for our common stock,
and we cannot predict the effect, if any, that market sales of shares or the
availability of any shares for sale will have on the market price of the common
stock prevailing from time to time. Sales of substantial amounts of common
stock, or the perception that such sales could occur, could adversely affect the
market price of our common stock and our ability to raise capital through a sale
of our securities.
Upon completion of this offering, we will have 21,308,562 shares of common
stock outstanding (or 22,163,562 shares if the underwriters over-allotment
option is exercised in full) of which 15,608,562 will be "restricted shares."
These shares will be eligible for sale in the public market as follows:
<TABLE>
<CAPTION>
NUMBER OF SHARES DATE
---------------- ----------------------------------------------------------------------------
<S> <C>
0.......................... After 90 days from the date of this prospectus
15,608,562................. After 180 days from the date of this prospectus (subject, in some cases, to
volume limitations)
</TABLE>
The 5,700,000 shares (or up to 6,555,000 shares if the underwriters'
over-allotment option is exercised in full) of common stock sold in this
offering will be freely tradable without further restriction or further
registration under the Securities Act, except for shares purchased by an
affiliate (as this term is defined in the Securities Act) of ours, which will be
subject to the limitations of Rule 144 under the Securities Act. Subject to
certain contractual limitations, holders of restricted shares generally will be
entitled to sell these shares in the public securities market without
registration either pursuant to Rule 144 or any other applicable exemption under
the Securities Act.
In general, under Rule 144 under the Securities Act, a person (or persons
whose shares are aggregated) who has beneficially owned restricted securities
within the meaning of Rule 144 for at least one year, and including the holding
period of any prior owner except an affiliate, would be entitled to sell within
any three-month period a number of shares that does not exceed the greater of
one percent of the then outstanding shares of our common stock or the average
weekly trading volume of our common stock on the Nasdaq National Market during
the four calendar weeks preceding such sale. Sales under Rule 144 are also
subject to certain manner of sale provisions, notice requirements and the
availability of current public information about our company. Any person (or
persons whose shares are aggregated) who is not deemed to have been our
affiliate at any time during the three months preceding a sale, and who has
beneficially owned shares for at least two years (including any period of
ownership of preceding non-affiliated holders), would be entitled to sell such
shares under Rule 144(k) without regard to the volume limitations, manner of
sale provisions, public information requirements or notice requirements. An
"affiliate" is a person that directly, or indirectly through one or more
intermediaries, controls, or is controlled by, or under common control with, an
issuer.
Within approximately 180 days after the date of this prospectus, we intend
to file one or more registration statements on Form S-8 under the Securities Act
to register 4,406,400 shares of common stock subject to outstanding stock
options or reserved for issuance under our equity compensation plans. Upon
completion of this offering, options to purchase approximately 1,825,166 shares
will be outstanding under our equity compensation plans.
Our directors and officers and some of our stockholders who hold 19,368,380
shares in the aggregate (including options and warrants to purchase common
stock) have entered into lock-up agreements pursuant to which they have agreed
that they will not sell other than in connection with this offering, directly or
indirectly, any shares of common stock without the prior written consent of Banc
of America Securities LLC for a period of 180 days from the date of this
prospectus.
70
<PAGE>
Under the terms of an agreement between us and the holders of shares of our
preferred stock, the preferred stockholders are entitled to certain rights with
respect to the registration of these shares under the Securities Act commencing
180 days after the completion of this offering. If we receive from the holders
of at least 40% of any class of preferred stock a written request to effect a
registration with respect to all or a part of their shares, we must use our best
efforts to effect such a registration, provided the shares owned by the
requesting stockholders cover at least 33% of the then outstanding class of
security of the offering price in the aggregate is at least $5,000,000. We are
only obligated to effect two of these registrations.
When we become eligible to utilize a registration statement on Form S-3 to
register an offering of our securities, these stockholders may request that we
file a registration statement on Form S-3 covering all or a portion of their
shares, provided that the aggregate public offering price is at least $500,000.
In addition, certain of our stockholders have certain "piggyback" registration
rights. If we propose to register any common stock under the Securities Act,
other than pursuant to the registration rights above, these stockholders may
require us to include all or a portion of their securities in such registration.
We are obligated to use our best efforts to effect this registration.
71
<PAGE>
UNDERWRITING
Regeneration Technologies and the selling stockholder are offering the
shares of common stock described in this prospectus through a number of
underwriters. Banc of America Securities LLC, Lehman Brothers Inc., and
Stephens Inc. are the representatives of the underwriters. Regeneration
Technologies and the selling stockholder have entered into a firm commitment
underwriting agreement with the representatives. Subject to the terms and
conditions of the underwriting agreement, Regeneration Technologies and the
selling stockholder have agreed to sell to the underwriters, and the
underwriters have each agreed to purchase the number of shares of common stock
listed next to its name in the following table:
<TABLE>
<CAPTION>
UNDERWRITER NUMBER OF SHARES
----------- ----------------
<S> <C>
Banc of America Securities LLC.............................. 2,360,000
Lehman Brothers Inc......................................... 1,300,000
Stephens Inc................................................ 660,000
Chase H&Q................................................... 120,000
CIBC WORLD MARKETS CORP..................................... 120,000
Dain Rauscher Incorporated.................................. 120,000
Donaldson, Lufkin & Jenrette Securities Corporation......... 120,000
Fleetboston Robertson Stephens Inc.......................... 120,000
J.P. Morgan Securities Inc.................................. 120,000
Prudential Securities Incorporated.......................... 120,000
William Blair & Company, L.L.C.............................. 60,000
Roth Capital Partners, Inc.................................. 60,000
Fahnestock & Co. Inc........................................ 60,000
John G. Kinnard & Company, Incorporated..................... 60,000
Morgan Keegan & Company, Inc................................ 60,000
Pacific Crest Securities.................................... 60,000
Pennsylvania Merchant Group................................. 60,000
Sandler O'Neill & Partners L.P.............................. 60,000
H.C. Wainwright & Co., Inc.................................. 60,000
---------
Total..................................................... 5,700,000
=========
</TABLE>
The underwriters initially will offer shares to the public at the price
specified on the cover page of this prospectus. The underwriters may allow to
some dealers a concession of not more than $0.55 per share. The underwriters
also may allow, and any dealers may reallow, a concession of not more than $0.10
per share to some other dealers. If all the shares are not sold at the initial
public offering price, the underwriters may change the offering price and the
other selling terms. The common stock is offered subject to a number of
conditions, including:
- receipt and acceptance of our common stock by the underwriters; and
- the right to reject orders in whole or in part.
The underwriters have an option to buy up to 855,000 additional shares of
common stock from Regeneration Technologies to cover sales of shares by the
underwriters which exceed the number of shares specified in the table above, and
will be sold by Regeneration Technologies in the event that the option is not
exercised in full. The underwriters have 30 days to exercise this option. If the
underwriters exercise this option, they will each purchase additional shares
approximately in proportion to the amounts specified in the table above.
Regeneration Technologies will pay the expenses associated with the exercise of
the overallotment option.
72
<PAGE>
The following table shows the per share and total underwriting discounts and
commissions to be paid to the underwriters assuming both no exercise and full
exercise of the underwriters' option to purchase 855,000 additional shares.
<TABLE>
<CAPTION>
PAID BY REGENERATION
TECHNOLOGIES
---------------------------
NO EXERCISE FULL EXERCISE
----------- -------------
<S> <C> <C>
Per share............................................ $ 0.98 $ 0.98
Total................................................ $3,724,000 $4,561,900
</TABLE>
<TABLE>
<CAPTION>
PAID BY SELLING STOCKHOLDER
----------------------------
NO EXERCISE FULL EXERCISE
------------ -------------
<S> <C> <C>
Per share............................................ $ 0.98 $ --
Total................................................ $ 1,862.00 $ --
</TABLE>
Regeneration Technologies and substantially all holders of its stock prior
to this offering, as well as substantially all holders of stock options and
warrants, have entered into lock-up agreements with the underwriters. Under
those agreements, Regeneration Technologies and those holders of stock, options
and warrants may not dispose of or hedge any Regeneration Technologies common
stock or securities convertible into or exchangeable for shares of Regeneration
Technologies common stock unless permitted to do so by Banc of America
Securities LLC. These restrictions will be in effect for a period of 180 days
after the date of this prospectus. At any time and without notice, Banc of
America Securities LLC may, in its sole discretion, release all or some of the
securities from these lock-up agreements.
Regeneration Technologies and the selling stockholder will indemnify the
underwriters against liabilities, including liabilities under the Securities
Act. If Regeneration Technologies and the selling stockholder are unable to
provide this indemnification, they will contribute to payments the underwriters
may be required to make in respect of those liabilities.
In connection with this offering, the underwriters may purchase and sell
shares of common stock in the open market. These transactions may include:
- short sales;
- stabilizing transactions; and
- purchases to cover positions created by short sales.
Short sales involve the sale by the underwriters of a greater number of
shares than they are required to purchase in this offering. Stabilizing
transactions consist of bids or purchases made for the purpose of preventing or
retarding a decline in the market price of the common stock while this offering
is in progress.
The underwriters may also impose a penalty bid. This means that if the
representatives purchase shares in the open market in stabilizing transactions
or to cover short sales, the representatives can require the underwriters that
sold those shares as part of this offering to repay the underwriting discount
received by them.
The underwriters may engage in activities that stabilize, maintain or
otherwise affect the price of the common stock, including:
- over-allotment;
- stabilization;
- syndicate covering transactions; and
- imposition of penalty bids.
73
<PAGE>
As a result of these activities, the price of the common stock may be higher
than the price that otherwise might exist in the open market. If the
underwriters commence these activities, they may discontinue them at any time.
The underwriters may carry out these transactions on the Nasdaq National Market,
in the over-the-counter-market or otherwise.
The underwriters do not expect sales to discretionary accounts to exceed
five percent of the total number of shares of common stock offered by this
prospectus.
Prior to this offering, there has been no public market for the common stock
of Regeneration Technologies. The initial public offering price has been
negotiated between Regeneration Technologies, the selling stockholder and the
representatives. Among the factors considered in these negotiations were:
- the history of, and prospects for, Regeneration Technologies and the
industry in which it competes;
- the past and present financial performance of Regeneration Technologies;
- an assessment of Regeneration Technologies' management;
- the present state of Regeneration Technologies' development;
- the prospects for future earnings of Regeneration Technologies;
- the prevailing market conditions of the applicable United States
securities market at the time of this offering;
- market valuations of publicly traded companies that Regeneration
Technologies and the representatives believe to be comparable to
Regeneration Technologies; and
- other factors deemed relevant.
An affiliate of Banc of America Securities LLC is the lender under our
$6.0 million revolving line of credit facility and our $2.8 million 20-year
mortgage, and also provides to us services related to treasury management,
derivative transactions and institutional investments. In addition, affiliates
of Lehman Brothers Inc. and Stephens Inc., representatives of the underwriters,
beneficially own approximately 1,615,085 and 1,016,880 shares of our common
stock, respectively.
In March 2000, an affiliate of Stephens Inc., an affiliate of Lehman
Brothers Inc. and Dr. Michael Lewis, a consultant to Lehman Brothers, purchased
20,606, 36,730 and 730 shares of our common stock, respectively, at a per share
price of $2.71. The National Association of Securities Dealers, Inc. has advised
the underwriters that it considers the spread between the price per share in
this offering and the effective price per share in the March 2000 transactions
to be additional underwriting compensation.
The underwriters, at our request, have reserved for sale to our employees,
affiliates and strategic partners at the initial public offering price up to
five percent of the shares being offered by this prospectus. The sale of shares
to our employees, affiliates and strategic partners will be made by Banc of
America Securities LLC. We do not know if our employees, affiliates or strategic
partners will choose to purchase all or any portion of these reserved shares,
but any purchases they do make will reduce the number of shares available to the
general public. If all of these reserved shares are not purchased, the
underwriters will offer the remainder to the general public on the same terms as
the other shares offered by this prospectus.
74
<PAGE>
LEGAL MATTERS
Fulbright & Jaworski L.L.P., New York, New York will pass on the validity of
the common stock offered by this prospectus for us. Frederick R. Adler, of
counsel to Fulbright & Jaworski L.L.P., may be deemed to beneficially own an
aggregate of 1,451,160 shares of our common stock directly, through one or more
trusts or by virtue of Mr. Adler's indirect control of Euro-America-II, L.P.,
one of our stockholders. Mintz, Levin, Cohn, Ferris, Glovsky and Popeo, P.C.,
Boston, Massachusetts, will pass upon certain legal matters in connection with
this offering for the underwriters.
EXPERTS
The Consolidated Financial Statements of Regeneration Technologies, Inc. and
Subsidiary and the Statements of Revenues and Direct Costs of the Predecessor
Business of Regeneration Technologies, Inc. included in this prospectus and the
related financial statement schedule included elsewhere in the registration
statement have been audited by Deloitte & Touche LLP, independent auditors, as
stated in their reports appearing herein and elsewhere in the registration
statement, and are included in reliance upon the reports of such firm given upon
their authority as experts in accounting and auditing.
WHERE YOU CAN FIND MORE INFORMATION
We have filed a registration statement on Form S-1 with the Securities and
Exchange Commission for the common stock we are offering by this prospectus.
This prospectus does not include all of the information contained in the
registration statement. You should refer to the registration statement and its
exhibits for additional information. Whenever we make reference in this
prospectus to any of our contracts, agreements or other documents, the
references are not necessarily complete and you should refer to the exhibits
attached to the registration statement for copies of the actual contract,
agreement or other document. When we complete this offering, we will also be
required to file annual, quarterly and special reports, proxy statements and
other information with the Securities and Exchange Commission.
We intend to furnish our stockholders with annual reports containing
financial statements audited by an independent accounting firm, and to make
available quarterly reports containing unaudited financial information for the
first three quarters of each fiscal year.
You can read our Securities and Exchange Commission filings, including the
registration statement, over the Internet at the Securities and Exchange
Commission's web site at http://www.sec.gov. You may also read and copy any
document we file with the Securities and Exchange Commission at its public
reference facilities at 450 Fifth Street, N.W., Washington, D.C. 20549; Seven
World Trade Center, Suite 1300, New York, New York 10048; and Citicorp Center,
500 West Madison Street, Suite 1400, Chicago, Illinois 60661-2511. You may also
obtain copies of these documents at prescribed rates by calling the Public
Reference Section of the Securities and Exchange Commission at 1-800-SEC-0330
for further information on the operation of the public reference facilities.
75
<PAGE>
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
--------
<S> <C>
CONSOLIDATED FINANCIAL STATEMENTS OF REGENERATION
TECHNOLOGIES, INC. AND SUBSIDIARY
Independent Auditors' Report................................ F-2
Consolidated Balance Sheets--December 31, 1998 and 1999..... F-3
Consolidated Statements of Operations--Period from February
12, 1998 to
December 31, 1998 and Year Ended December 31, 1999........ F-4
Consolidated Statements of Stockholders' (Deficiency)
Equity--Period from
February 12, 1998 to December 31, 1998 and Year Ended
December 31, 1999....................................... F-5
Consolidated Statements of Cash Flows--Period from February
12, 1998 to
December 31, 1998 and Year Ended December 31, 1999........ F-6
Notes to Consolidated Financial Statements.................. F-7
UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS OF
REGENERATION TECHNOLOGIES, INC. AND SUBSIDIARY
Unaudited Condensed Consolidated Balance Sheet--June 30,
2000...................................................... F-24
Unaudited Condensed Consolidated Statements of
Operations--Six Months Ended June 30, 1999 and 2000....... F-25
Unaudited Condensed Consolidated Statement of Stockholders'
Equity--Six Months Ended June 30, 2000.................... F-26
Unaudited Condensed Consolidated Statements of Cash
Flows--Six Months Ended June 30, 1999 and 2000............ F-27
Notes to Unaudited Condensed Consolidated Financial
Statements................................................ F-28
CONSOLIDATED SUPPLEMENTAL SCHEDULE
Independent Auditors' Report................................ F-31
Supplemental Schedule....................................... F-32
STATEMENTS OF REVENUES AND DIRECT COSTS OF THE PREDECESSOR BUSINESS
OF REGENERATION TECHNOLOGIES, INC.
Independent Auditors' Report................................ F-33
Statements of Revenues and Direct Costs for the Year Ended
December 31, 1997 and the Period from January 1, 1998 to
February 11, 1998......................................... F-34
Notes to Statements of Revenues and Direct Costs............ F-35
</TABLE>
F-1
<PAGE>
INDEPENDENT AUDITORS' REPORT
To the Board of Directors of Regeneration Technologies, Inc.:
We have audited the accompanying consolidated balance sheets of Regeneration
Technologies, Inc. and subsidiary (the "Company") as of December 31, 1998 and
1999, and the related consolidated statements of operations, stockholders'
(deficiency) equity and cash flows for the period from February 12, 1998 (date
operations began) to December 31, 1998 and for the year ended December 31, 1999.
These financial statements are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements based
on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. 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, such consolidated financial statements present fairly, in all
material respects, the financial position of the Company as of December 31, 1998
and 1999, and the results of its operations and its cash flows for the period
from February 12, 1998 (date operations began) to December 31, 1998 and for the
year ended December 31, 1999 in conformity with accounting principles generally
accepted in the United States of America.
/S/ DELOITTE & TOUCHE LLP
Certified Public Accountants
Tampa, Florida
March 22, 2000
(April 27, 2000 as to Note 18
and June 16, 2000 as to Note 19)
F-2
<PAGE>
REGENERATION TECHNOLOGIES, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------
1998 1999
----------- -----------
<S> <C> <C>
ASSETS
Current Assets:
Cash and cash equivalents................................. $ 3,925,880 $ 7,536,287
Accounts receivable--less allowance of $38,500 in 1998 and
$335,087 in 1999........................................ 5,901,870 15,506,750
Product inventories....................................... 4,111,432 15,639,329
Supply inventories........................................ 245,417 592,780
Prepaid and other current assets.......................... 661,237 1,174,644
Deferred tax asset........................................ 164,738 747,997
----------- -----------
Total current assets.................................. 15,010,574 41,197,787
Property, plant and equipment--net.......................... 4,125,988 5,812,783
Deferred tax asset--net of valuation allowance of $1,534,183
in
1998 and $0 in 1999....................................... 53,033 1,229,613
Other assets--net........................................... 77,935 298,131
----------- -----------
$19,267,530 $48,538,314
=========== ===========
LIABILITIES AND STOCKHOLDERS' (DEFICIENCY) EQUITY
Current Liabilities:
Accounts payable.......................................... $13,290,436 $21,056,808
Accrued expenses.......................................... 1,122,997 2,178,191
Current portion of deferred revenue (Note 2).............. 225,000 225,000
Line of credit............................................ -- 2,787,475
Current portion of long-term debt......................... 384,647 898,735
----------- -----------
Total current liabilities............................. 15,023,080 27,146,209
Long-term debt--less current portion........................ 1,482,249 2,026,796
Deferred revenue (Note 2)................................... 4,153,000 3,928,000
Other liabilities........................................... 40,000 --
----------- -----------
Total liabilities..................................... 20,698,329 33,101,005
----------- -----------
Commitments and contingencies (Notes 13, 15 and 18)
Stockholders' (deficiency) equity:
Series A Preferred stock, $.001 par value; 1,777,348
shares
authorized, issued and outstanding...................... 1,777 1,777
Series B Preferred stock, $.001 par value; 748,152 shares
authorized, issued and outstanding; at liquidation
value................................................. 6,580,000 6,580,000
Series C Preferred stock, $.001 par value; 368,990 shares
authorized, issued and outstanding; at liquidation
value................................................. -- 10,000,000
Common stock, $.001 par value; 6,000,000 shares
authorized; 3,699,130 shares issued; 3,674,410 and
3,665,530 shares outstanding, respectively 3,699 3,699
Additional paid-in capital................................ 457,188 444,224
Accumulated deficit....................................... (4,141,947) (1,182,454)
Deferred compensation..................................... (531,351) (399,907)
Note receivable from stockholder.......................... (2,136,741) --
Due from stockholder--net of due to stockholder........... (1,658,961) (4,332)
Less treasury stock--24,720 and 33,600 shares,
respectively............................................ (4,463) (5,698)
----------- -----------
Total stockholders' (deficiency) equity............... (1,430,799) 15,437,309
----------- -----------
$19,267,530 $48,538,314
=========== ===========
</TABLE>
See notes to consolidated financial statements.
F-3
<PAGE>
REGENERATION TECHNOLOGIES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
PERIOD FROM YEAR ENDED
FEBRUARY 12, 1998 DECEMBER 31,
TO DECEMBER 31, 1998 1999
-------------------- ------------
<S> <C> <C>
Revenues from core operations:
Fees from tissue distribution............................. $31,892,098 $ 70,783,005
Other revenues from core operations....................... 3,365,387 2,237,051
----------- ------------
Total revenues.......................................... 35,257,485 73,020,056
Management services fees.................................... 24,129,406 39,994,069
----------- ------------
Net revenues............................................ 11,128,079 33,025,987
Costs of processing and distribution........................ 9,844,771 19,172,398
----------- ------------
Gross profit............................................ 1,283,308 13,853,589
----------- ------------
Expenses:
Marketing, general and administrative..................... 3,986,946 9,739,790
Research and development.................................. 1,472,410 1,675,019
----------- ------------
Total expenses.......................................... 5,459,356 11,414,809
----------- ------------
Operating (loss) income..................................... (4,176,048) 2,438,780
----------- ------------
Interest (expense) income:
Interest expense.......................................... (152,631) (285,166)
Interest income........................................... 186,732 187,017
----------- ------------
Total interest income (expense)--net.................... 34,101 (98,149)
----------- ------------
(Loss) income before income tax benefit..................... (4,141,947) 2,340,631
Income tax benefit.......................................... -- 618,862
----------- ------------
Net (loss) income........................................... $(4,141,947) $ 2,959,493
=========== ============
Net (loss) income per common share--basic................... $ (1.12) $ 0.81
=========== ============
Net (loss) income per common share--diluted................. $ (1.12) $ 0.18
=========== ============
Weighted average shares outstanding--basic.................. 3,686,770 3,669,970
Weighted average shares outstanding--diluted................ 3,686,770 16,636,791
Pro forma net income per common share--basic................ $ 0.18
============
Pro forma net income per common share--diluted.............. $ 0.18
============
Pro forma weighted average shares outstanding--basic........ 16,161,269
Pro forma weighted average shares outstanding--diluted...... 16,636,791
</TABLE>
See notes to consolidated financial statements.
F-4
<PAGE>
REGENERATION TECHNOLOGIES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' (DEFICIENCY) EQUITY
<TABLE>
<CAPTION>
PREFERRED STOCK ADDITIONAL
----------------------------------- COMMON PAID-IN ACCUMULATED DEFERRED
A B C STOCK CAPITAL DEFICIT COMPENSATION
-------- ---------- ----------- -------- ---------- ----------- ------------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance, February 12, 1998........ $ -- $ -- $ -- $ -- $ -- $ -- $ --
Net liabilities assumed in
separation from UFTB.......... -- -- -- -- (39,643) -- --
Issuance of Series A Preferred
stock to related parties...... 1,777 -- -- -- (1,777) -- --
Sale of Series B Preferred
stock......................... -- 6,580,000 -- -- -- -- --
Stock issuance costs............ -- -- -- -- (152,790) -- --
Issuance of common stock to
employees..................... -- -- -- 3,699 651,398 -- (655,097)
Forfeited treasury stock........ -- -- -- -- -- -- 4,463
Vested deferred compensation.... -- -- -- -- -- -- 119,283
Amounts advanced to
stockholder................... -- -- -- -- -- -- --
Payments received from
stockholder................... -- -- -- -- -- -- --
Net loss........................ -- -- -- -- -- (4,141,947) --
------ ---------- ----------- ------ --------- ----------- ---------
Balance, December 31, 1998........ 1,777 6,580,000 -- 3,699 457,188 (4,141,947) (531,351)
Purchased and forfeited treasury
stock......................... -- -- -- -- (639) -- 1,620
Stock options granted in lieu of
director and consulting
fees.......................... -- -- -- -- 20,428 -- --
Settlement of amounts due from
stockholder by transfer of
assets........................ -- -- -- -- -- -- --
Amounts advanced to
stockholder................... -- -- -- -- -- -- --
Payments received from
stockholder................... -- -- -- -- -- -- --
Sale of Series C Preferred
stock......................... -- -- 10,000,000 -- -- -- --
Stock issuance costs............ -- -- -- -- (32,753) -- --
Vested deferred compensation.... -- -- -- -- -- -- 129,824
Net income...................... -- -- -- -- -- 2,959,493 --
------ ---------- ----------- ------ --------- ----------- ---------
Balance, December 31, 1999........ $1,777 $6,580,000 $10,000,000 $3,699 $ 444,224 $(1,182,454) $(399,907)
====== ========== =========== ====== ========= =========== =========
<CAPTION>
NOTE
RECEIVABLE
FROM DUE FROM TREASURY
STOCKHOLDER STOCKHOLDER STOCK TOTAL
----------- ----------- -------- -----------
<S> <C> <C> <C> <C>
Balance, February 12, 1998........ $ -- $ -- $ -- $ --
Net liabilities assumed in
separation from UFTB.......... -- -- -- (39,643)
Issuance of Series A Preferred
stock to related parties...... -- -- -- --
Sale of Series B Preferred
stock......................... -- -- -- 6,580,000
Stock issuance costs............ -- -- -- (152,790)
Issuance of common stock to
employees..................... -- -- -- --
Forfeited treasury stock........ -- -- (4,463) --
Vested deferred compensation.... -- -- -- 119,283
Amounts advanced to
stockholder................... (2,136,741) (4,045,335) -- (6,182,076)
Payments received from
stockholder................... -- 2,386,374 -- 2,386,374
Net loss........................ -- -- -- (4,141,947)
----------- ----------- ------- -----------
Balance, December 31, 1998........ (2,136,741) (1,658,961) (4,463) (1,430,799)
Purchased and forfeited treasury
stock......................... -- -- (1,235) (254)
Stock options granted in lieu of
director and consulting
fees.......................... -- -- -- 20,428
Settlement of amounts due from
stockholder by transfer of
assets........................ 2,136,741 983,255 -- 3,119,996
Amounts advanced to
stockholder................... -- (7,404,149) -- (7,404,149)
Payments received from
stockholder................... -- 8,075,523 -- 8,075,523
Sale of Series C Preferred
stock......................... -- -- -- 10,000,000
Stock issuance costs............ -- -- -- (32,753)
Vested deferred compensation.... -- -- -- 129,824
Net income...................... -- -- -- 2,959,493
----------- ----------- ------- -----------
Balance, December 31, 1999........ $ -- $ (4,332) $(5,698) $15,437,309
=========== =========== ======= ===========
</TABLE>
See notes to consolidated financial statements.
F-5
<PAGE>
REGENERATION TECHNOLOGIES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
PERIOD FROM YEAR ENDED
FEBRUARY 12, 1998 DECEMBER 31,
TO DECEMBER 31, 1998 1999
-------------------- ------------
<S> <C> <C>
Cash flows from operating activities:
Net (loss) income......................................... $(4,141,947) $ 2,959,493
Adjustments to reconcile net (loss) income to net cash
provided by (used in) operating activities:
Depreciation and amortization expense................... 360,336 801,094
Bad debt expense........................................ 38,500 171,587
Amortization of deferred revenue........................ (122,000) (225,000)
Deferred income taxes................................... (217,771) (1,759,839)
Deferred compensation and nonqualified option........... 119,283 151,872
Loss on disposal of property, plant, and equipment...... -- 4,526
Changes in assets and liabilities--cash provided by
(used in) (excluding effects of acquisition):
Accounts receivable................................... (2,404,808) (9,417,525)
Product and supply inventories........................ (3,082,972) (6,715,835)
Prepaid and other current assets...................... (555,265) (240,032)
Other assets.......................................... (40,435) (230,196)
Accounts payable...................................... 7,760,983 7,391,042
Accrued expenses...................................... 1,122,997 673,468
Deferred revenue...................................... 4,500,000 --
Other liabilities..................................... 40,000 (40,000)
----------- -----------
Net cash provided by (used in) operating
activities........................................ 3,376,901 (6,475,345)
----------- -----------
Cash flows from investing activities:
Cash paid for purchase of assets--net of cash received.... -- (484,725)
Purchase of property, plant, and equipment................ (1,870,385) (2,380,808)
----------- -----------
Net cash used in investing activities............... (1,870,385) (2,865,533)
----------- -----------
Cash flows from financing activities:
Payments on capital lease and note obligations............ (212,144) (472,936)
Stock issuance costs...................................... (152,790) (32,753)
Amounts advanced to stockholder........................... (4,045,335) (7,404,149)
Payments received from stockholder........................ 2,386,374 8,075,523
Increase in note receivable from stockholder.............. (2,136,741) --
Line of credit borrowings--net............................ -- 2,787,475
Purchase of treasury stock................................ -- (1,875)
Proceeds from sales of Series B Preferred stock........... 6,580,000 --
Proceeds from sales of Series C Preferred stock........... -- 10,000,000
----------- -----------
Net cash provided by financing activities........... 2,419,364 12,951,285
----------- -----------
Net increase in cash and cash equivalents................... 3,925,880 3,610,407
Cash and cash equivalents, beginning of period.............. -- 3,925,880
----------- -----------
Cash and cash equivalents, end of period.................... $ 3,925,880 $ 7,536,287
=========== ===========
</TABLE>
See notes to consolidated financial statements.
F-6
<PAGE>
REGENERATION TECHNOLOGIES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
PERIOD FROM FEBRUARY 12, 1998 (DATE OPERATIONS BEGAN) TO DECEMBER 31, 1998
AND THE YEAR ENDED DECEMBER 31, 1999
1. ORGANIZATION
Regeneration Technologies, Inc. ("RTI"), was incorporated in Florida on
August 22, 1997, and began operations on February 12, 1998, following a
contribution of assets to RTI by the University of Florida Tissue Bank, Inc.
("UFTB"). At the time of the separation, UFTB contributed certain assets
(including certain intellectual property) to RTI and RTI assumed certain related
liabilities in exchange for 1,200,000 shares of Series A Preferred stock (see
Note 10). In addition, an officer of UFTB contributed his royalty rights in
certain intellectual property to RTI in exchange for 577,348 shares of Series A
Preferred stock. RTI recorded the assets acquired and the liabilities assumed
from UFTB and the assets acquired from the officer of UFTB at their historical
cost basis as these were deemed to be transactions between entities under common
control. As such, the $39,643 of net liabilities assumed resulted in a charge to
additional paid-in capital. The historical costs of the individual assets
acquired and liabilities assumed by RTI at the date of the separation from UFTB
are presented below:
<TABLE>
<S> <C>
Accounts receivable......................................... $ 3,535,562
Inventories and supplies.................................... 1,273,877
Prepaid expenses............................................ 105,972
Property, plant, and equipment.............................. 1,732,777
Intangible assets........................................... 50,000
Accounts payable............................................ (5,529,455)
Capital lease obligations................................... (1,208,376)
-----------
Net liabilities assumed..................................... $ (39,643)
===========
</TABLE>
Simultaneous with the separation of RTI from UFTB, certain third parties
invested approximately $6.6 million in exchange for 748,152 shares of Series B
Preferred stock.
During 1999, RTI's wholly owned subsidiary, Georgia Tissue Bank ("GTB"),
acquired the net assets of the National Tissue Bank Network, Georgia Tissue
Bank, Inc. ("NTBN") along with certain equipment owned by a director of NTBN
(see Note 6).
RTI and GTB (collectively, the "Company") process human musculoskeletal
tissue received from various tissue recovery agencies. The processing transforms
the tissue into either conventional or precision tooled allografts, some of
which are patented. These allografts are distributed domestically and
internationally, for use in spinal vertebrae repair, musculoskeletal
reconstruction and fracture repair. The processed tissue includes cortical
dowels, cervical implants, cortical bone interference screws, and bone paste
grafts.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION--The consolidated financial statements include
the accounts of RTI and its wholly owned subsidiary GTB (see Note 6). All
material intercompany balance and transactions have been eliminated in
consolidation.
CASH AND CASH EQUIVALENTS--The Company considers all funds in banks and
overnight sweep accounts with an original maturity of three months or less to be
cash and cash equivalents.
PRODUCT AND SUPPLY INVENTORIES--Product and supply inventories are stated at
the lower of cost or market, with cost determined by the first-in, first-out
method. The Company estimates the amount of
F-7
<PAGE>
REGENERATION TECHNOLOGIES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
PERIOD FROM FEBRUARY 12, 1998 (DATE OPERATIONS BEGAN) TO DECEMBER 31, 1998
AND THE YEAR ENDED DECEMBER 31, 1999
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
inventory that will not pass the quality control process based upon the
Company's historical rejection percentages and, accordingly, records a writedown
of inventory. Any inventory deemed to be obsolete is written off at the time the
determination is made.
PROPERTY, PLANT, AND EQUIPMENT--Property, plant, and equipment are stated at
cost less accumulated depreciation and amortization. The cost of equipment under
capital leases and leasehold improvements is amortized on the straight-line
method over the shorter of the lease term or the estimated useful life of the
asset. Depreciation is computed on the straight-line method over the following
estimated useful lives of the assets:
<TABLE>
<S> <C>
Production equipment 8 to 10 years
Leasehold improvements 8 to 10 years
Office equipment, furniture, and fixtures 5 to 7 years
Computer hardware and software 3 years
</TABLE>
OTHER ASSETS--Other assets consist of patents and trademarks. Patents and
trademarks are amortized on the straight-line method over the shorter of the
remaining protection period or estimated useful life.
RESEARCH AND DEVELOPMENT COSTS--Research and development costs are expensed
as incurred. Research and development costs for the periods ended December 31,
1998 and 1999 were $1,472,410 and $1,675,019, respectively.
REVENUE RECOGNITION--On December 3, 1999, the staff of the Securities and
Exchange Commission issued Staff Accounting Bulletin No. 101, "Revenue
Recognition in Financial Statements" ("SAB 101"), that summarizes the staff's
views in applying generally accepted accounting principles to revenue
recognition in financial statements. The accounting and disclosure requirements
that are described in SAB 101 apply to all registrants. The Company has adopted
the requirements of SAB 101.
Revenue is recognized at the time the Company ships the processed tissue.
Revenues are reported gross of any management services fees the Company incurs
related to the distribution of its products. Any other revenues directly related
to the Company's core operations are recognized when all significant contractual
obligations have been satisfied.
The Company permits returns of tissue in accordance with the terms of
contractual agreements with customers if the tissue is returned in a timely
manner, in unopened packaging and from the normal channels of distribution.
Allowances for returns are provided for based upon analysis of the Company's
historical patterns of returns matched against the sales from which they
originated. Historical product returns have been within the amounts reserved.
A $4,500,000 nonrefundable, up-front fee received from Sofamor Danek Group
in the period ended December 31, 1998 is being deferred and recognized as
revenue over the 20 year life of the exclusive management services agreement
with Sofamor Danek Group on a straight-line basis. This revenue is shown in the
consolidated statements of operations in other revenues from core operations.
INCOME TAXES--The Company accounts for income taxes under the asset and
liability approach specified by Statement of Financial Accounting Standards
("SFAS") No. 109, ACCOUNTING FOR INCOME TAXES. SFAS No. 109 requires the
recognition of deferred tax assets and liabilities for the expected
F-8
<PAGE>
REGENERATION TECHNOLOGIES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
PERIOD FROM FEBRUARY 12, 1998 (DATE OPERATIONS BEGAN) TO DECEMBER 31, 1998
AND THE YEAR ENDED DECEMBER 31, 1999
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
future tax consequences of events that have been recognized in the Company's
consolidated financial statements or tax returns by applying enacted statutory
rates applicable to future years to differences between financial statement
carrying amounts and the tax basis of existing assets and liabilities.
STOCK-BASED COMPENSATION PLANS--In October 1995, the Financial Accounting
Standards Board issued SFAS No. 123, ACCOUNTING FOR STOCK-BASED COMPENSATION,
which is effective for fiscal years beginning after December 15, 1995. Under
SFAS No. 123, the Company may elect to recognize stock-based compensation
expense based on the fair value of the awards or to account for stock-based
compensation under Accounting Principles Board ("APB") Opinion No. 25,
ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES, and disclose in the consolidated
financial statements the effects of SFAS No. 123 as if the recognition
provisions were adopted. The Company has adopted the recognition provisions of
APB Opinion No. 25.
EARNINGS PER SHARE--Basic earnings per share ("EPS") is computed by dividing
earnings available to common shareholders by the weighted average number of
common shares outstanding for the periods. Diluted EPS reflects the potential
dilution of securities that could share in the earnings. Pro forma basic and
diluted EPS assumes the conversion of all preferred stock to common stock that
will occur upon the closing of an underwritten offering and distribution of
common stock to the general public pursuant to a Registration Statement filed
with and declared effective by the Securities and Exchange Commission (a
"Qualified Offering"). A reconciliation of the number of common shares used in
calculation of basic and diluted EPS is presented below:
<TABLE>
<CAPTION>
PERIOD FROM PRO FORMA
FEBRUARY 12, 1998 TO YEAR ENDED YEAR ENDED
DECEMBER 31, 1998 DECEMBER 31, 1999 DECEMBER 31, 1999
-------------------- ----------------- -----------------
(UNAUDITED)
<S> <C> <C> <C>
Basic shares................ 3,686,770 3,669,970 16,161,269
Effect of dilutive
securities:
Stock options............. -- 475,522 475,522
Conversion of preferred
stock................... -- 12,491,299 --
--------- ---------- ----------
Diluted shares.............. 3,686,770 16,636,791 16,636,791
========= ========== ==========
</TABLE>
The conversion of preferred stock to common stock was not included in the
computation of diluted EPS for the period ended December 31, 1998 as the
inclusion would be antidilutive. Options to purchase approximately 576,283
shares of common stock at prices ranging from $3.80 to $5.65 per share were
outstanding as of December 31, 1999 but were not included in the computation of
diluted EPS for the year ended December 31, 1999 because the options' exercise
price was greater than the average market price of the common shares.
USE OF ESTIMATES--The preparation of consolidated financial statements in
conformity with generally accepted accounting principles requires management to
make estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosures of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.
IMPAIRMENT OF LONG-LIVED ASSETS--Periodically, the Company evaluates the
recoverability of the net carrying value of its property, plant and equipment
and its intangible assets by comparing the carrying
F-9
<PAGE>
REGENERATION TECHNOLOGIES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
PERIOD FROM FEBRUARY 12, 1998 (DATE OPERATIONS BEGAN) TO DECEMBER 31, 1998
AND THE YEAR ENDED DECEMBER 31, 1999
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
values to the estimated future undiscounted cash flows. A deficiency in these
cash flows relative to the carrying amounts is an indication of the need for a
write-down due to impairment. The impairment write-down would be the difference
between the carrying amounts and the fair value of these assets. A loss on
impairment would be recognized by a charge to earnings.
FAIR VALUE OF FINANCIAL INSTRUMENTS--The estimated fair value of amounts
reported in the consolidated financial statements has been determined by using
available market information and appropriate valuation methodologies. The
carrying value of all current assets and current liabilities approximates fair
value because of their short-term nature. The fair value of capital lease
obligations approximates the carrying value, based on current market prices.
NEW ACCOUNTING STANDARDS--The Financial Accounting Standards Board recently
issued SFAS No. 137, ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING
ACTIVITIES--DEFERRAL OF EFFECTIVE DATE OF FASB STATEMENT NO. 133 ("SFAS
No. 137"). SFAS No. 137 defers for one year the effective date of SFAS No. 133,
ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES ("SFAS No. 133").
The rule now will apply to all fiscal quarters of all fiscal years beginning
after June 15, 2000. SFAS No. 137 permits early adoption as of the beginning of
any fiscal quarter after its issuance. SFAS No. 133 will require the Company to
recognize all derivatives on the balance sheet at fair value. Derivatives that
are not hedges must be adjusted to fair value through income. If the derivative
is a hedge, depending on the nature of the hedge, changes in the fair value of
derivatives will either be offset against the change in fair value of the hedged
assets, liabilities, of firm commitments through earnings or recognized in other
comprehensive income until the hedged item is recognized in earnings. The
ineffective portion of a derivative's change in fair value will be immediately
recognized in earnings. The Company has not completed its evaluation of the
impact of SFAS No. 133, if any, on the financial statements.
RECLASSIFICATION--Certain 1998 amounts have been reclassified to conform to
the 1999 presentation.
3. PRODUCT INVENTORIES
Product inventories by stage of completion are as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------
1998 1999
---------- -----------
<S> <C> <C>
Unprocessed donor tissue............................ $ 459,263 $ 2,341,998
Tissue in process................................... 2,305,805 3,453,513
Implantable donor tissue............................ 1,346,364 9,744,493
Nontissue inventory for resale...................... -- 99,325
---------- -----------
$4,111,432 $15,639,329
========== ===========
</TABLE>
F-10
<PAGE>
REGENERATION TECHNOLOGIES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
PERIOD FROM FEBRUARY 12, 1998 (DATE OPERATIONS BEGAN) TO DECEMBER 31, 1998
AND THE YEAR ENDED DECEMBER 31, 1999
4. PROPERTY, PLANT AND EQUIPMENT
Property, plant, and equipment are as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------
1998 1999
---------- ----------
<S> <C> <C>
Leasehold improvements............................... $ 640,796 $1,116,467
Production equipment................................. 1,821,159 3,170,518
Office equipment, furniture, and fixtures............ 385,180 517,860
Computer hardware and software....................... 261,639 1,038,959
Equipment under capital lease........................ 1,365,050 1,107,909
---------- ----------
4,473,824 6,951,713
Less accumulated depreciation and amortization....... 347,836 1,138,930
---------- ----------
$4,125,988 $5,812,783
========== ==========
</TABLE>
5. OTHER ASSETS
Other assets are as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------
1998 1999
-------- --------
<S> <C> <C>
Patents and trademarks................................... $50,000 $223,971
Other.................................................... 40,435 96,660
------- --------
90,435 320,631
Less accumulated amortization............................ 12,500 22,500
------- --------
$77,935 $298,131
======= ========
</TABLE>
6. ASSET PURCHASE
On November 1, 1999, GTB acquired the assets and existing liabilities of
NTBN and certain equipment owned by Dr. Charles Garrison, a director of NTBN.
The purpose of the transaction was to expand the Company's ability to produce
conventional tissue grafts and expand donor recovery and tissue distribution in
areas outside of the Company's existing network for donor recovery and tissue
distribution.
The acquisition was recorded under the purchase method of accounting and,
accordingly, the purchase price was allocated to the assets and liabilities on
the basis of estimated fair market value on
F-11
<PAGE>
REGENERATION TECHNOLOGIES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
PERIOD FROM FEBRUARY 12, 1998 (DATE OPERATIONS BEGAN) TO DECEMBER 31, 1998
AND THE YEAR ENDED DECEMBER 31, 1999
6. ASSET PURCHASE (CONTINUED)
the date of purchase. The fair value of the assets and liabilities at the date
of acquisition recorded in conjunction with the transaction is as follows:
<TABLE>
<S> <C>
Accounts receivable......................................... $ 358,942
Inventories................................................. 2,129,429
Property, plant, and equipment.............................. 3,410
Accounts payable............................................ (375,330)
Accrued liabilities......................................... (381,726)
----------
Net assets acquired, excluding cash......................... 1,734,725
Cash........................................................ 15,275
----------
Net assets acquired......................................... $1,750,000
==========
Purchase financed by:
Cash payment................................................ $ 500,000
Notes payable--stated rate of 6.50% due November 2002
(effective rate of 9.25%)................................. 680,753
Note payable--9.25% due November 2002 convertible to common
stock (see Note 18)....................................... 500,000
Note payable--9.25% due November 2002....................... 69,247
----------
Total financing............................................. $1,750,000
==========
</TABLE>
The unaudited pro forma results assuming GTB had been acquired on
February 12, 1998 are approximately as follows:
<TABLE>
<CAPTION>
PERIOD FROM
FEBRUARY 12, 1998 TO YEAR ENDED
DECEMBER 31, 1998 DECEMBER 31, 1999
-------------------- -----------------
<S> <C> <C>
Total revenues............................. $39,900,000 $77,000,000
Net (loss) income.......................... (3,700,000) 3,200,000
Net (loss) income per share--basic......... $ (1.00) $ 0.87
</TABLE>
The pro forma information does not necessarily reflect the actual results
that would have occurred nor is it necessarily indicative of future results of
operations of the combined companies.
7. LONG-TERM DEBT
Long-term debt is as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------
1998 1999
---------- ----------
<S> <C> <C>
Notes payable, 6.5%.................................. $ -- $ 663,577
Note payable, 9.25%.................................. -- 487,896
Note payable, 9.25%.................................. -- 67,571
Capital leases....................................... 1,866,896 1,706,487
---------- ----------
Total................................................ 1,866,896 2,925,531
Less current portion................................. 384,647 898,735
---------- ----------
Long-term portion.................................... $1,482,249 $2,026,796
========== ==========
</TABLE>
F-12
<PAGE>
REGENERATION TECHNOLOGIES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
PERIOD FROM FEBRUARY 12, 1998 (DATE OPERATIONS BEGAN) TO DECEMBER 31, 1998
AND THE YEAR ENDED DECEMBER 31, 1999
7. LONG-TERM DEBT (CONTINUED)
Contractual maturities of long-term debt are as follows:
<TABLE>
<S> <C>
2000........................................................ $ 898,735
2001........................................................ 983,733
2002........................................................ 753,013
2003........................................................ 150,467
2004........................................................ 48,054
Thereafter.................................................. 91,529
----------
$2,925,531
==========
</TABLE>
The notes payable relate to the assets purchased from NTBN and are
collateralized by the assets purchased. All notes are due in November 2002 (see
Note 6). The $487,896 note payable is convertible into common stock of the
Company at the Series C Preferred stock price, as if converted, of $5.65 (see
Note 18).
The capital leases have interest rates ranging from 9.05% to 10% and are
collateralized by the related equipment and are due from 2002 through 2006 (see
Note 13).
8. LINE OF CREDIT
In March 1999, the Company entered into a revolving line of credit for an
amount not to exceed $2,000,000 expiring in March 2000. This line of credit was
subsequently replaced in September 1999 with a new line not to exceed $6,000,000
expiring in September 2000. The line of credit is to be utilized for the purpose
of supporting accounts receivable, with accounts receivable also serving as the
collateral for the line of credit. The interest rate associated with this line
of credit is the 30-day LIBOR rate plus 150 basis points. At December 31, 1999,
the interest rate of the line of credit is 7.97%.
The credit line agreement contains various restrictive covenants, which
limit among other things, indebtedness, loans, acquisitions, dividends and stock
purchases. In addition, the Company must satisfy certain financial ratios
including a fixed charge ratio of 1.10 to 1.00 or greater and funded debt to
earnings before interest, taxes, depreciation and amortization of not greater
than 4.00 to 1.00. The Company was in compliance with all covenants and
financial ratios at December 31, 1999.
The total amount outstanding on the line of credit December 31, 1999 was
$2,787,475.
F-13
<PAGE>
REGENERATION TECHNOLOGIES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
PERIOD FROM FEBRUARY 12, 1998 (DATE OPERATIONS BEGAN) TO DECEMBER 31, 1998
AND THE YEAR ENDED DECEMBER 31, 1999
9. INCOME TAXES
The income tax expense consisted of the following components:
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------
1998 1999
--------- -----------
<S> <C> <C>
Current:
Federal............................................ $ 179,055 $ 966,623
State.............................................. 38,716 174,354
--------- -----------
Total current........................................ 217,771 1,140,977
--------- -----------
Deferred:
Federal............................................ (179,055) (1,590,075)
State.............................................. (38,716) (169,764)
--------- -----------
Total deferred....................................... (217,771) (1,759,839)
--------- -----------
Total provision...................................... $ -- $ (618,862)
========= ===========
</TABLE>
The components of the deferred tax assets and liabilities consisted of the
following at December 31:
<TABLE>
<CAPTION>
1998 1999
DEFERRED INCOME TAX DEFERRED INCOME TAX
---------------------- ----------------------
ASSET LIABILITY ASSET LIABILITY
---------- --------- ---------- ---------
<S> <C> <C> <C> <C>
Current:
Uniform capitalization of inventory cost...... $ 170,419 $ -- $ 611,576 $ --
Inventory reserve............................. 9,563 -- 74,738 --
Accrued reserves.............................. 74,160 -- 164,882 --
State taxes................................... -- (89,404) -- (103,199)
---------- --------- ---------- ---------
Total current................................... 254,142 (89,404) 851,196 (103,199)
========== ========= ========== =========
Noncurrent:
Depreciation.................................. -- (145,826) -- (412,108)
Amortization.................................. 3,731 -- 1,285 --
Unearned revenue.............................. 1,729,311 -- 1,640,436 --
Valuation allowance........................... (1,534,183) -- -- --
---------- --------- ---------- ---------
Total noncurrent................................ 198,859 (145,826) 1,641,721 (412,108)
---------- --------- ---------- ---------
Total........................................... $ 453,001 $(235,230) $2,492,917 $(515,307)
========== ========= ========== =========
</TABLE>
The valuation allowance for deferred tax assets was $1,534,183 and $0,
respectively, for the periods ended December 31, 1998 and 1999. The net change
in the total valuation allowance was a decrease of $1,534,183 for the year ended
December 31, 1999. The reduction was attributable to projections of future
taxable income whereby management believes it is more likely than not that the
Company will recognize the benefits of the net deductible temporary differences,
which generated the deferred tax asset.
F-14
<PAGE>
REGENERATION TECHNOLOGIES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
PERIOD FROM FEBRUARY 12, 1998 (DATE OPERATIONS BEGAN) TO DECEMBER 31, 1998
AND THE YEAR ENDED DECEMBER 31, 1999
9. INCOME TAXES (CONTINUED)
The Company established a valuation allowance in the period ended
December 31, 1998 of $1,534,183. Management determined that it was more likely
than not that the deferred tax asset in excess of the amount of current taxes
paid in that year would not be realized.
The effective tax rate differs from the statutory federal income tax rate
for the following reasons:
<TABLE>
<CAPTION>
1998 1999
-------- --------
<S> <C> <C>
Statutory federal rate...................................... (34.00)% 34.00 %
State income taxes--net of federal tax benefit.............. (3.57) 4.10
Meals and entertainment..................................... 0.53 1.00
Stock compensation expense.................................. 1.13 1.89
Research and experimentation credit......................... (1.14) (2.30)
Change in valuation allowance............................... 37.05 (65.55)
Miscellaneous............................................... -- 0.42
------ ------
Effective tax rate.......................................... -- % (26.44)%
====== ======
</TABLE>
10. STOCKHOLDERS' EQUITY
PREFERRED STOCK--Series A and B Preferred stocks are on parity with each
other regarding dividends and liquidation, and are senior to the Company's
common stock. Dividends, when and if declared by the Board of Directors, are
cumulative and accrue at 6% of the preferred stock face value of $13,934,408 for
the Series A Preferred stock (1,777,348 shares at $7.84 per share) and
$6,580,000 for the Series B Preferred stock (748,152 shares at $8.80 per share).
The Series A Preferred stock has been recorded at its par value rather than its
face and liquidation value because the issuance of the Series A Preferred stock
resulted from a transaction between entities under common control (see Note 1).
The aggregate amount of cumulative Preferred dividends in arrears as of
December 31, 1998 and 1999 is $1,090,453 and $2,321,317, respectively.
Liquidation cannot occur unless approved by 75% of the Series A Preferred
stockholders and 75% of the Series B Preferred stockholders, in which event, the
Series A Preferred stockholders would receive the intellectual property rights
originally contributed to the Company in exchange for the Series A Preferred
shares, and the Series B Preferred stockholders would receive the $6,580,000
originally paid to the Company (see Note 1).
Series A and B Preferred stocks have voting rights equal to the number of
whole shares of common stock into which the preferred stocks can be converted.
Series A Preferred stock is convertible at any time into common shares at a
price of $1.63 per share and Series B Preferred stock is convertible at any time
into common shares at a price of $1.83 per share.
Series C Preferred stock is senior to the Series A and B Preferred stocks
and common stock as to dividends and upon liquidation. Dividends, when and if
declared by the Board of Directors, are cumulative and accrue at 6% of the
preferred stock value of $10,000,000 (368,990 shares at $27.10 per share). The
aggregate amount of cumulative preferred dividends in arrears as of
December 31, 1999 is $135,000. Liquidation cannot occur unless approved by 75%
of the Series C Preferred stockholders, in which event, the Series C Preferred
stockholders would receive the $10,000,000 originally paid to the Company.
Series C Preferred stock has voting rights equal to the number of whole shares
of common
F-15
<PAGE>
REGENERATION TECHNOLOGIES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
PERIOD FROM FEBRUARY 12, 1998 (DATE OPERATIONS BEGAN) TO DECEMBER 31, 1998
AND THE YEAR ENDED DECEMBER 31, 1999
10. STOCKHOLDERS' EQUITY (CONTINUED)
stock into which the preferred stock can be converted. Series C Preferred stock
is convertible at any time into common shares at a price of $5.65 per share.
Holders of Series C Preferred stock were issued warrants to purchase up to
221,395 shares of common stock for a period of one year from the date of
issuance at a purchase price of $5.65 per share. Under the Black Scholes model,
the fair value of these warrants was determined to be approximately $400,000.
The fair value of the warrants is included in Series C Preferred stock in the
accompanying consolidated balance sheets.
The Series A, B and C Preferred stocks automatically convert to common stock
at their respective per share prices upon the closing of a Qualified Offering.
The Company's Board of Directors has not declared, nor do they intend to
declare, the cumulative preferred dividends on the Series A, B and C Preferred
shares. Upon the closing of a Qualified Offering, the cumulative preferred
dividends will be cancelled and will not be paid out. In addition, no adjustment
to the price at which the Series A, B and C Preferred shares are to be converted
to common shares shall be made for any cumulative preferred dividends.
COMMON STOCK--The common stock's voting, dividend, and liquidation rights
are subject to and qualified by the rights of the holders of the preferred
stocks. Common stockholders are entitled to one vote for each share held at all
stockholder meetings. Common stock is not redeemable.
STOCK OPTION PLANS--In July 1998, the Company adopted a stock option plan
(the "Plan") which provides for the grant of incentive and nonqualified stock
options to key employees, including officers and directors of the Company. The
option price per share may not be less than 100% of the fair market value of
such shares on the date such option is granted. At December 31, 1999, options to
acquire up to 4,406,400 shares of common stock may be granted pursuant to the
Plan.
Stock option activity is summarized as follows at December 31, 1998 and
1999:
<TABLE>
<CAPTION>
WEIGHTED
AVERAGE
NUMBER OF EXERCISE
SHARES PRICE
--------- --------
<S> <C> <C>
Outstanding at February 1998............................. --
Granted................................................ 705,192 $ 1.30
---------
Outstanding at December 31, 1998......................... 705,192 1.30
Granted................................................ 618,768 2.85
Canceled............................................... (23,112) 1.30
---------
Outstanding at December 31, 1999......................... 1,300,848 $ 2.06
=========
</TABLE>
Outstanding options under the Plan vest over a three- to five-year period.
Options expire ten years from the date of grant. As of December 31, 1999,
154,238 options were exercisable with a weighted-average exercise price of
$1.30.
The weighted average fair value of options granted during the periods ended
December 31, 1998 and 1999 was $1.30 and $2.87, respectively.
F-16
<PAGE>
REGENERATION TECHNOLOGIES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
PERIOD FROM FEBRUARY 12, 1998 (DATE OPERATIONS BEGAN) TO DECEMBER 31, 1998
AND THE YEAR ENDED DECEMBER 31, 1999
10. STOCKHOLDERS' EQUITY (CONTINUED)
The following is a summary of stock options outstanding and exercisable as
of December 31, 1999:
<TABLE>
<CAPTION>
WEIGHTED AVERAGE
EXERCISE OPTIONS REMAINING OPTIONS
PRICE OUTSTANDING CONTRACTUAL LIFE (YEARS) EXERCISABLE
-------- ----------- ------------------------ -----------
<S> <C> <C> <C>
$ 1.30 826,800 3.67 154,238
1.88 60,120 4.32 --
3.13 147,600 4.46 --
3.80 266,328 4.78 --
--------- -------
1,300,848 154,238
========= =======
</TABLE>
Remaining non-exercisable options as of December 31, 1999 become exercisable
as follows:
<TABLE>
<CAPTION>
<S> <C>
2000..................................... 278,592
2001..................................... 278,592
2002..................................... 250,992
2003..................................... 231,389
2004..................................... 107,045
---------
1,146,610
=========
</TABLE>
Since the Company applies APB Opinion No. 25 in accounting for its stock
options, no compensation cost has been recognized for the options granted to
employees because the exercise price equaled the fair market value on the date
of the grant. Had compensation cost been determined on the basis of fair value
pursuant to SFAS No. 123, net income (loss) would have been affected as follows
for the periods ended December 31, 1998 and 1999:
<TABLE>
<CAPTION>
1998 1999
----------- ----------
<S> <C> <C>
Net (loss) income, as reported...................... $(4,141,947) $2,959,493
Net (loss) income, pro forma........................ (4,290,985) 2,836,759
Net (loss) income per common share--basic, as
reported.......................................... $ (1.12) $ 0.81
Net (loss) income per common share--basic, pro
forma............................................. $ (1.16) $ 0.77
Net (loss) income per common share--dilutive, as
reported.......................................... $ (1.12) $ 0.18
Net (loss) income per common share--dilutive, pro
forma............................................. $ (1.16) $ 0.17
</TABLE>
The fair value of each grant was estimated using the minimum value method
with the following weighted-average assumptions used for grants during the year
ended December 31, 1999:
<TABLE>
<S> <C>
Dividend yield.............................................. --
Risk free interest rate..................................... 4.6%-5.92%
Option term................................................. 4.77 years
</TABLE>
F-17
<PAGE>
REGENERATION TECHNOLOGIES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
PERIOD FROM FEBRUARY 12, 1998 (DATE OPERATIONS BEGAN) TO DECEMBER 31, 1998
AND THE YEAR ENDED DECEMBER 31, 1999
10. STOCKHOLDERS' EQUITY (CONTINUED)
STOCK AWARDS--The Company awarded 3,699,130 shares of common stock to
various key employees at the beginning of the Company's operations. These shares
of common stock, which were valued at $0.18 per share, vest over a five-year
period. At the date of issuance, $655,097 in deferred compensation was recorded
by the Company. Compensation expense of approximately $119,000 and $131,000 was
recognized for these stock awards for the periods ended December 31, 1998 and
1999, respectively.
11. RETIREMENT BENEFITS
The Company has a qualified 401(k) plan available to all employees who meet
certain eligibility requirements. The 401(k) plan allows the employee to
contribute 20% of the employee's salary up to the maximum allowed under the
Internal Revenue Code. The Company has the discretion to make matching
contributions up to 6% of the employee's earnings. For the periods ended
December 31, 1998 and 1999, the Company's contributions to the plan were $83,846
and $156,203, respectively.
12. CONCENTRATIONS OF RISK
The Company's principal concentration of risk is related to its limited
distribution channels. In 1998, nearly all of the Company's revenues are related
to the distribution efforts of four independent companies, with approximately
95% of its revenues coming from one of the distribution companies. In 1999, the
Company expanded to include more revenue from direct distribution. The amount of
revenue from direct distribution was approximately 15% with 80% of the remaining
revenue coming from one of the distribution channels.
The Company's operations are dependent on the availability of bone and
related connective tissue from human donors. The Company relies on the efforts
of independent procurement agencies to educate the public and increase the
willingness to donate bone tissue. These procurement agencies may not be able to
obtain sufficient donors to meet present or future demands.
13. COMMITMENTS AND CONTINGENCIES
MANUFACTURING RIGHTS--The Company has licensed manufacturing rights for some
of its products. Under the agreement, the Company has agreed to accept and
reimburse the processor for items that meet the Company's quality control
guidelines.
PREPAID INVENTORY--In an effort to increase the Company's supply of donor
tissue, the Company has agreed to fund several tissue recovery agencies, in
exchange for the first right of refusal for any donor tissue recovered. During
1998 and 1999, the Company had advanced $1,249,383 and $2,245,842 respectively
to the tissue recovery agencies and recouped $754,750 and $1,988,318
respectively in donor tissue. At December 31, 1998 and 1999, the Company has yet
to recover $494,633 and $733,733 respectively of its expenditures through donor
tissue recovery. Prepaid inventory is classified in prepaid and other assets in
the accompanying balance sheets. The Company has no ownership or control in
these agencies, and funding can be discontinued at any time when donor tissue is
no longer being supplied.
F-18
<PAGE>
REGENERATION TECHNOLOGIES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
PERIOD FROM FEBRUARY 12, 1998 (DATE OPERATIONS BEGAN) TO DECEMBER 31, 1998
AND THE YEAR ENDED DECEMBER 31, 1999
13. COMMITMENTS AND CONTINGENCIES (CONTINUED)
FOREIGN INVESTMENT--In August 1998, the Company received a 30% ownership in
UFTB-Italia for no consideration and, therefore, recorded a $0 investment in
UFTB-Italia. The 30% ownership in UFTB-Italia was given to provide the Company
incentive to assist UFTB-Italia in their future efforts to develop a tissue bank
business in Italy, which would include recovery, processing and distribution of
tissue. UFTB-Italia is an entity created in late 1998, which had no operations
as of December 31, 1998. As of December 31, 1999, UFTB-Italia has only
distributed tissue and has not begun to recover or process tissue. The Company
is required to provide certain training to UFTB-Italia, however UFTB-Italia must
reimburse the Company for all costs of travel, housing, meals and related
expenses. The Company would bear the salary cost of Company personnel providing
the training. As of December 31, 1999, salary costs incurred by the Company for
training provided to UFTB-Italia are immaterial. Additionally, the Company has
not accrued salary costs for future training to be provided to UFTB-Italia as it
is not probable whether any additional training will be provided and the salary
costs of such training cannot be reasonably estimated. The Company has recorded
this investment on the equity basis. As of December 31, 1998 and 1999, the
Company has not recorded its share of the losses from its interest in
UFTB-Italia due to the insignificance of such amounts for each of these periods
and because such loss recognition would reduce the Company's investment below
zero. As of December 31, 1999, the Company had $172,405 of outstanding accounts
receivable due from UFTB-Italia. Total tissue distributions to UFTB-Italia in
1999 were $223,704.
LEASES--The Company leases various buildings, office equipment and fixtures
under non-cancelable operating leases for various periods. The Company also
leases various equipment under capital leases that are included in property,
plant, and equipment in the accompanying balance sheets.
Future minimum lease commitments under noncancelable leases as of
December 31, 1999 are as follows:
<TABLE>
<CAPTION>
CAPITAL OPERATING
LEASES LEASES
---------- ----------
<S> <C> <C>
2000................................................. $ 660,534 $ 918,981
2001................................................. 660,534 916,464
2002................................................. 385,377 897,966
2003................................................. 172,541 762,327
2004................................................. 59,850 808,977
Thereafter........................................... 99,749 1,526,734
---------- ----------
2,038,585 $5,831,449
==========
Less amounts representing interest................... 332,098
----------
Present value of net minimum lease payments.......... $1,706,487
==========
</TABLE>
Rent expense for the periods ended December 31, 1998 and 1999 was $262,698
and $748,473, respectively.
F-19
<PAGE>
REGENERATION TECHNOLOGIES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
PERIOD FROM FEBRUARY 12, 1998 (DATE OPERATIONS BEGAN) TO DECEMBER 31, 1998
AND THE YEAR ENDED DECEMBER 31, 1999
13. COMMITMENTS AND CONTINGENCIES (CONTINUED)
EMPLOYMENT AGREEMENTS--As of December 31, 1999, the Company had employment
contracts with six officers of the Company, providing for total annual payments
of approximately $815,000 through fiscal year 2003.
14. RELATED PARTIES
The Company has certain related party transactions with UFTB. Through
April 15, 1999, UFTB recovered whole donor tissue and distributed conventional
tissue. The Company processed this tissue for UFTB for a fee and compensated
UFTB for the nonconventional tissue retained from the whole donor tissue. On
April 15, 1999, the Company entered into two new agreements under which UFTB
transferred to the Company all rights to conventional tissue distribution and
national recovery programs, permitting UFTB to focus primarily on tissue
recovery and UFTB settled amounts due to the Company. As of April 15, 1999, the
total due from UFTB and the note receivable from UFTB was $4,963,865. Under the
terms of the agreements, UFTB transferred its unprocessed donor tissue and
conventional tissue with a fair value of $3,030,154 and equipment and fixtures
with a fair value of $89,842 for a total non-cash asset transfer of $3,119,996
to the Company as an offset against the existing due from stockholder and note
receivable from stockholder. Additionally, UFTB agreed to repay the remaining
balance by (a) offsetting recovery fees from April 15, 1999 through June 30,
1999 against the outstanding balance, which fees, net of administrative costs,
were $656,547, and (b) making monthly payments through the end of 1999 to repay
the remaining balance of $1,187,322. As of December 31, 1999, UFTB has repaid
all amounts owed to the Company in accordance with the terms of the two new
agreements entered into on April 15, 1999. Any future UFTB due from/due to
amounts will be collected/repaid in a timely manner.
In addition to these operating transactions, the Company shares facilities,
overhead and certain personnel with UFTB. The Company has an employment
agreement with Nancy R. Holland, Vice President of Donor Services, under which
she is required to devote 50% of her working time to the Company. Ms. Holland
also serves as the Chief Executive Officer and as a director of UFTB.
Ms. Holland recuses herself from decisions by UFTB's board of directors with
respect to UFTB's relationship with the Company. Annual compensation under the
employment agreement was $70,756 in 1998 and $75,000 in 1999. Ms. Holland also
received compensation from UFTB of $90,276 in 1998 and $75,000 in 1999.
The following is a summary of transactions and balances with UFTB as of and
for the periods ended December 31, 1998 and 1999:
<TABLE>
<CAPTION>
1998 1999
---------- ----------
<S> <C> <C>
Due from UFTB, net of amounts due to UFTB................... $1,658,961 $ 4,332
Note receivable from UFTB................................... 2,136,741 --
Tissue recovery fees and support services charged by UFTB to
the Company............................................... 2,386,374 5,344,475
Processing fees, tissue fees, and support services charged
to UFTB by the Company.................................... 3,467,014 2,592,347
</TABLE>
F-20
<PAGE>
REGENERATION TECHNOLOGIES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
PERIOD FROM FEBRUARY 12, 1998 (DATE OPERATIONS BEGAN) TO DECEMBER 31, 1998
AND THE YEAR ENDED DECEMBER 31, 1999
14. RELATED PARTIES (CONTINUED)
In January 1999, a stockholder with a 50% ownership in the Series C
Preferred shares acquired Sofamor Danek Group. The following is a summary of
transactions and balances with Sofamor Danek Group as of and for the periods
ended December 31, 1998 and 1999:
<TABLE>
<CAPTION>
1998 1999
----------- -----------
<S> <C> <C>
Tissue distribution revenue under management services
Agreement (included in fees from tissue distribution)..... $30,471,573 $57,228,310
Management services fees.................................... 24,129,406 39,994,069
Deferred revenue recognized (included in other revenues from
core operations).......................................... 122,000 225,000
Administrative costs reimbursed by Sofamor Danek Group
(included in marketing, general and administrative
expense).................................................. 326,130 435,674
Management services fees payable (included in accounts
payable).................................................. 10,951,359 17,523,809
Deferred revenue............................................ 4,378,000 4,153,000
</TABLE>
In February 2000, Dr. Garrison (see Note 6) exercised his option to convert
a portion of the $500,000 9.25% note issued by the Company into common stock of
the Company (see Note 18). Dr. Garrison is providing Medical Director services
to GTB on a consulting basis under a three-year contract, which ends
November 1, 2002. Annual compensation under the contract is $100,740 in year
one, $104,340 in year two and $108,084 in year three. Dr. Garrison also owns the
building in which GTB leases space. Monthly rental in year one is $12,365,
$12,860 in year two and $13,374 in year three. The following is a summary of
transactions and balances with Dr. Garrison as of and for the year ended
December 31, 1999.
<TABLE>
<S> <C>
Payments on GTB leased premises (includes one month
deposit).................................................. $ 37,095
Payments for Medical Director fees.......................... 16,790
Principal and interest payments on notes.................... 30,957
Notes payable............................................... 1,219,043
</TABLE>
15. LEGAL ACTIONS
On June 22, 1999, Exactech, Inc. ("Exactech") filed a complaint and petition
for injunctive relief in Circuit Court against the Company, UFTB and 19 medical
distributors and sales agents of the Company. The complaint alleged the Company
was marketing and distributing bone paste allografts in violation of an
agreement between UFTB and Exactech, which agreement had been assigned by UFTB
to the Company. The Company denied the charges in the Exactech complaint, and
the court has remanded all counts listed in the lawsuit to binding arbitration.
The arbitration is ongoing; consequently, management cannot estimate the impact
on the Company's business or financial operations.
F-21
<PAGE>
REGENERATION TECHNOLOGIES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
PERIOD FROM FEBRUARY 12, 1998 (DATE OPERATIONS BEGAN) TO DECEMBER 31, 1998
AND THE YEAR ENDED DECEMBER 31, 1999
16. SUPPLEMENTAL CASH FLOW INFORMATION
Selected cash payments and noncash activities are as follows:
<TABLE>
<CAPTION>
PERIOD FROM YEAR ENDED
FEBRUARY 12, 1998 DECEMBER 31,
TO DECEMBER 31, 1998 1999
-------------------- ------------
<S> <C> <C>
Interest paid during the period............................. $152,631 $ 285,166
Noncash capital lease obligations........................... $870,662 $ 281,571
Net liabilities assumed upon start of operations............ $ 39,643 $ --
Issuance of founders' common shares......................... $650,634 $ --
Issuance of Preferred A stock to related parties............ $ 1,777 $ --
Noncash settlement of note receivable and amount due from
stockholder............................................... $ -- $3,119,996
Notes payable issued to acquire GTB......................... $ -- $1,250,000
</TABLE>
17. SEGMENT DATA
The Company processes human musculoskeletal tissue received from various
tissue recovery agencies and distributes the tissue through various channels.
This one line of business represents 100% of consolidated fees from tissue
distribution and is comprised of three primary product lines: spinal allografts,
other precision tooled allografts and conventional tissue. The following table
presents fees from tissue distribution by each of the Company's three primary
product lines:
<TABLE>
<CAPTION>
PERIOD FROM
FEBRUARY 12, 1998 YEAR ENDED
TO DECEMBER 31, 1998 DECEMBER 31, 1999
--------------------- ------------------
<S> <C> <C>
Fees from tissue distribution:
Spinal allografts...................................... $30,374,959 $57,073,386
Other precision tooled allografts...................... 404,963 4,683,051
Conventional tissue.................................... 1,112,176 9,026,568
----------- -----------
Total................................................ $31,892,098 $70,783,005
=========== ===========
</TABLE>
The Company distributes their products both within and outside the United
States. During the periods ended December 31, 1998 and 1999, 100% and 97.4%,
respectively, of net revenues came from the United States. Foreign net revenues
of 2.6% during the year ended December 31, 1999 came primarily from Europe.
18. SUBSEQUENT EVENTS
As part of the agreement to purchase the assets of NTBN, Dr. Garrison was
given the option to convert a $500,000 note due November 2002 or any portion of
the note into Common Stock of the Company at the Series C Preferred stock
convertible price of $5.65. The option to convert the $500,000 note was
exercisable at any time within ninety (90) days from the approval of the board
of directors. The ninety (90) days expired on or about February 22, 2000. On
February 15, 2000 Dr. Garrison exercised his option on 44,280 shares equivalent
to $250,000. Dr. Garrison received 5,534 warrants to
F-22
<PAGE>
REGENERATION TECHNOLOGIES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
PERIOD FROM FEBRUARY 12, 1998 (DATE OPERATIONS BEGAN) TO DECEMBER 31, 1998
AND THE YEAR ENDED DECEMBER 31, 1999
18. SUBSEQUENT EVENTS (CONTINUED)
purchase common stock for $5.65 per share upon the exercise of his options. The
value of the shares is a reduction of the $500,000 note payable, the balance of
which at December 31, 1999 was $487,896. The balance of the note on
February 15, 2000 was $462,236. After exercising the stock conversion option,
the $212,236 remaining balance of the note will be repaid by April 2001, as the
monthly payments will remain at the original amount until the note is paid off.
On March 30, 2000, the Company purchased the buildings and land (6.19 acres)
the Company occupied under lease, plus an additional 20.82 acres of land for
future expansion. The purchase price for the two buildings and 6.19 acres was
$3,600,000 with the additional 20.82 acres priced at $624,600. The Company
received a 20 year term loan in the amount of $2,800,000 to finance the purchase
of the buildings and the 6.19 acres of land. Interest on the loan is at 30 day
LIBOR plus 150 basis points. Simultaneous with entering into the $2,800,000 term
loan, the Company entered into a swap agreement with a commercial bank which
fixes its interest rate at 8.35%. The interest rate will remain fixed until the
30 day LIBOR is determined to be greater than or equal to 8%, at which time the
interest rate will revert to the 30-day LIBOR plus 150 basis points. Payments or
receipts on the agreement are recorded as adjustment to interest expense. The
effective notional amount of the swap at March 30, 2000 was $2,800,000. The term
loan is collateralized by the land and buildings. The term loan agreement
contains various restrictive covenants, which limit among other things, leases,
indebtedness, loans, and acquisitions. In addition the Company must satisfy
certain financial ratios including fixed charge ratio at 1.25 to 1.00 or greater
and funded debt to earnings before interest, taxes, depreciation and
amortization of not greater than 4.00 to 1.00. The $1,424,600 balance of the
amounts due for the building with 6.19 acres and additional 20.82 acres is
financed from the $10,000,000 raised from the sale of Series C Preferred stock.
On April 27, 2000, the Company entered into a definitive agreement to
acquire the net assets of a division of the University of Alabama Health
Services Foundation, which has been doing business as the Alabama Tissue Center
("ATC"), in Birmingham, Alabama. The acquisition will be financed by a cash
payment of $250,000 and the issuance of $3,500,000 in shares of the Company's
common stock, valued at the Company's initial public offering price, plus an
additional cash payment of $250,000 upon the achievement of certain milestones,
with total possible consideration valued at $4,000,000. The acquisition of ATC
will be accounted for under the purchase method of accounting.
19. COMMON STOCK SPLIT
On June 16, 2000, the Company approved a stock split resulting in an
exchange of 1 share for 4.8 shares of common stock issued and outstanding. All
share and per share amounts have been retroactively adjusted for this split.
20. MERGER INTO DELAWARE CORPORATION (UNAUDITED)
The Company anticipates that it will merge into a newly formed Delaware
corporation prior to the consummation of the offering.
******
F-23
<PAGE>
REGENERATION TECHNOLOGIES, INC. AND SUBSIDIARY
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEET
<TABLE>
PRO FORMA
ASSETS JUNE 30, 2000 JUNE 30, 2000
----------- -----------
<S> <C> <C>
Current Assets:
Cash and cash equivalents................................. $ 762,902
Accounts receivable--less allowance of $359,102........... 19,297,240
Product inventories....................................... 19,693,859
Supply inventories........................................ 911,579
Prepaid and other current assets.......................... 2,450,564
Deferred tax asset........................................ 984,120
-----------
Total current assets.................................... 44,100,264
Property, plant and equipment--net.......................... 10,560,483
Deferred tax asset.......................................... 1,129,863
Other assets--net........................................... 550,044
-----------
$56,340,654
===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable.......................................... $23,272,600
Accrued expenses.......................................... 3,110,327
Current portion of deferred revenue....................... 225,000
Line of credit............................................ 3,860,946
Current portion of long-term debt......................... 1,031,084
-----------
Total current liabilities............................... 31,499,957
Long-term debt--less current portion........................ 3,912,262
Deferred revenue............................................ 3,815,500
-----------
Total liabilities....................................... 39,227,719
-----------
Commitments and contingencies
Stockholders' equity:
Series A Preferred stock, $.001 par value; 1,777,348
shares authorized, issued and outstanding............... 1,777 --
Series B Preferred stock, $.001 par value; 748,152 shares
authorized, issued and outstanding; at liquidation
value................................................... 6,580,000 --
Series C Preferred stock, $.001 par value; 368,990 shares
authorized, issued and outstanding; at liquidation
value................................................... 10,000,000 --
Common stock, $.001 par value; 6,000,000 shares
authorized; 3,743,410 shares issued; 3,615,010 shares
outstanding; 17,636,962 shares issued pro forma......... 3,744 17,637
Additional paid-in capital................................ 3,292,387 19,860,271
Retained earnings......................................... 36,927 36,927
Deferred compensation..................................... (2,607,020) (2,607,020)
Due from stockholder--net of due to stockholder........... (180,132) (180,132)
Less treasury stock--128,400 shares....................... (14,748) (14,748)
----------- -----------
Total stockholders' equity.............................. 17,112,935 17,112,935
----------- -----------
$56,340,654
===========
</TABLE>
See notes to unaudited condensed consolidated financial statements.
F-24
<PAGE>
REGENERATION TECHNOLOGIES, INC. AND SUBSIDIARY
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
SIX MONTHS ENDED JUNE 30,
-------------------------
1999 2000
----------- -----------
<S> <C> <C>
Revenues from core operations:
Fees from tissue distribution............................. $30,174,870 $53,215,515
Other revenues from core operations....................... 1,386,421 862,988
----------- -----------
Total revenues.......................................... 31,561,291 54,078,503
Management services fees.................................... 17,461,975 28,934,549
----------- -----------
Net revenues............................................ 14,099,316 25,143,954
Costs of processing and distribution........................ 8,989,720 13,119,202
----------- -----------
Gross profit............................................ 5,109,596 12,024,752
----------- -----------
Expenses:
Marketing, general and administrative..................... 3,856,062 8,538,982
Research and development.................................. 802,264 1,201,078
----------- -----------
Total expenses.......................................... 4,658,326 9,740,060
----------- -----------
Operating income............................................ 451,270 2,284,692
Equity in income of unconsolidated subsidiary............... -- 4,693
Interest (expense) income:
Interest expense.......................................... (113,178) (266,940)
Interest income........................................... 90,306 131,128
----------- -----------
Total interest expense--net............................. (22,872) (135,812)
----------- -----------
Income before income tax expense............................ 428,398 2,153,573
Income tax expense.......................................... (273,387) (934,192)
----------- -----------
Net income.................................................. $ 155,011 $ 1,219,381
=========== ===========
Net income per common share--basic.......................... $ 0.04 $ 0.34
=========== ===========
Net income per common share--diluted........................ $ 0.01 $ 0.07
=========== ===========
Weighted average shares outstanding--basic.................. 3,672,790 3,629,400
Weighted average shares outstanding--diluted................ 15,936,747 18,312,307
</TABLE>
<TABLE>
<S> <C>
Pro forma net income per common share--basic................ $ 0.07
===========
Pro forma net income per common share--diluted.............. $ 0.07
===========
Pro forma weighted average shares outstanding--basic........ 17,522,952
Pro forma weighted average shares outstanding--diluted...... 18,312,307
</TABLE>
See notes to unaudited condensed consolidated financial statements.
F-25
<PAGE>
REGENERATION TECHNOLOGIES, INC. AND SUBSIDIARY
UNAUDITED CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
(ACCUMULATED
PREFERRED STOCK ADDITIONAL DEFICIT)
----------------------------------- COMMON PAID-IN RETAINED DEFERRED
A B C STOCK CAPITAL EARNINGS COMPENSATION
-------- ---------- ----------- -------- ---------- ------------ ------------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance, December 31, 1999........ $1,777 $6,580,000 $10,000,000 $3,699 $ 444,224 $(1,182,454) $ (399,907)
Issuance of stock options....... -- -- -- -- 2,603,925 -- (2,603,925)
Purchase and forfeited treasury
stock......................... -- -- -- -- (3,400) -- 8,387
Conversion of note to Common
Stock......................... -- -- -- 45 249,962 --
Amounts advanced to
stockholder................... -- -- -- -- -- -- --
Payments received from
stockholder................... -- -- -- -- -- -- --
Stock issuance costs............ -- -- -- -- (2,324) -- --
Vested deferred compensation.... -- -- -- -- -- -- 388,425
Net income...................... -- -- -- -- -- 1,219,381 --
------ ---------- ----------- ------ ---------- ----------- -----------
Balance June 30, 2000............. $1,777 $6,580,000 $10,000,000 $3,744 $3,292,387 $ 36,927 $(2,607,020)
====== ========== =========== ====== ========== =========== ===========
<CAPTION>
DUE FROM TREASURY
STOCKHOLDER STOCK TOTAL
----------- -------- -----------
<S> <C> <C> <C>
Balance, December 31, 1999........ $ (4,332) $ (5,698) $15,437,309
Issuance of stock options....... -- -- --
Purchase and forfeited treasury
stock......................... -- (9,050) (4,063)
Conversion of note to Common
Stock......................... -- -- 250,007
Amounts advanced to
stockholder................... (3,472,278) -- (3,472,278)
Payments received from
stockholder................... 3,296,478 -- 3,296,478
Stock issuance costs............ -- -- (2,324)
Vested deferred compensation.... -- -- 388,425
Net income...................... -- -- 1,219,381
----------- -------- -----------
Balance June 30, 2000............. $ (180,132) $(14,748) $17,112,935
=========== ======== ===========
</TABLE>
See notes to unaudited condensed consolidated financial statements.
F-26
<PAGE>
REGENERATION TECHNOLOGIES, INC. AND SUBSIDIARY
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
SIX MONTHS ENDED JUNE 30,
---------------------------
1999 2000
------------ ------------
<S> <C> <C>
Cash flows from operating activities:
Net income................................................ $ 155,011 $ 1,219,381
Adjustments to reconcile net income to net cash used in
operating activities:
Depreciation and amortization expense................... 348,912 693,285
Bad debt expense........................................ 62,264 147,159
Amortization of deferred revenue........................ (112,500) (112,500)
Deferred income taxes................................... (68,569) (136,373)
Deferred compensation................................... 65,063 401,624
Equity in income of unconsolidated subsidiary........... -- (4,693)
Changes in assets and liabilities--cash (used in)
provided by:
Accounts receivable................................... (3,612,203) (3,937,649)
Product and supply inventories........................ (3,038,102) (4,373,329)
Prepaid and other current assets...................... 276,115 (845,730)
Other assets.......................................... (13,255) (252,473)
Accounts payable...................................... 1,585,450 2,215,792
Accrued expenses...................................... 1,240,943 726,935
Other liabilities..................................... (40,000) --
----------- -----------
Net cash used in operating activities............... (3,150,871) (4,258,571)
----------- -----------
Cash flows from investing activities--
Purchase of property, plant, and equipment................ (825,757) (2,926,789)
----------- -----------
Cash flows from financing activities:
Payments on capital lease and note obligations............ (207,213) (466,110)
Stock issuance costs...................................... (125) (2,324)
Amounts advanced to stockholder........................... (3,868,296) (3,472,278)
Payments received from stockholder........................ 2,997,685 3,296,478
Line of credit borrowings--net............................ 1,129,010 1,073,471
Purchase of treasury stock................................ (313) (17,262)
----------- -----------
Net cash provided by financing activities........... 50,748 411,975
----------- -----------
Net decrease in cash and cash equivalents................... (3,925,880) (6,773,385)
Cash and cash equivalents, beginning of period.............. 3,925,880 7,536,287
----------- -----------
Cash and cash equivalents, end of period.................... $ 0 $ 762,902
=========== ===========
</TABLE>
See notes to unaudited condensed consolidated financial statements.
F-27
<PAGE>
REGENERATION TECHNOLOGIES, INC. AND SUBSIDIARY
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SIX MONTHS ENDED JUNE 30, 1999 AND 2000
1. ORGANIZATION
Regeneration Technologies, Inc. ("RTI") and its wholly owned subsidiary,
Georgia Tissue Bank ("GTB") (collectively, the "Company") process human
musculoskeletal tissue received from various tissue recovery agencies. The
processing transforms the tissue into either conventional or precision tooled
allografts, some of which are patented. These allografts are distributed
domestically and internationally, for use in spinal vertebrae repair,
musculoskeletal reconstruction and fracture repair. The processed tissue
includes cortical dowels, cervical implants, cortical bone interference screws,
and bone paste grafts.
2. BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements have
been prepared in accordance with the rules and regulations of the Securities and
Exchange Commission relating to interim financial statements. These unaudited
condensed consolidated financial statements do not include all disclosures
provided in the annual consolidated financial statements. The condensed
consolidated financial statements should be read in conjunction with the
consolidated financial statements and notes thereto contained in the
consolidated financial statements for the year ended December 31, 1999 as
presented in this document and filed with the Securities and Exchange
Commission. All adjustments of a normal recurring nature, which, in the opinion
of management, are necessary to present a fair statement of results for the
interim periods, have been made. Results of operations are not necessarily
indicative of the results to be expected for the full year.
The consolidated financial statements include the accounts of RTI and its
wholly owned subsidiary GTB. All material intercompany balances and transactions
have been eliminated in consolidation.
3. PRODUCT INVENTORIES
Product inventories by stage of completion are as follows:
<TABLE>
<S> <C>
Unprocessed donor tissue.................................... $ 2,760,408
Tissue in process........................................... 6,249,936
Implantable donor tissue.................................... 10,491,515
Nontissue inventory for resale.............................. 192,000
-----------
$19,693,859
===========
</TABLE>
4. EARNINGS PER SHARE
Basic earnings per share ("EPS") is computed by dividing earnings available
to common shareholders by the weighted average number of common shares
outstanding for the periods. A reconciliation of the number of common shares
used in calculation of basic and diluted EPS and pro
F-28
<PAGE>
REGENERATION TECHNOLOGIES, INC. AND SUBSIDIARY
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SIX MONTHS ENDED JUNE 30, 1999 AND 2000
4. EARNINGS PER SHARE (CONTINUED)
forma basic and diluted EPS (assuming the conversion of all preferred stock to
common stock that will occur upon a Qualified Offering) is presented below:
<TABLE>
<CAPTION>
PRO FORMA
SIX MONTHS
ENDED
SIX MONTHS ENDED JUNE 30, JUNE 30,
-------------------------- -----------
1999 2000 2000
----------- ------------ -----------
<S> <C> <C> <C>
Basic shares........................... 3,672,790 3,629,400 17,522,952
Effect of dilutive securities:
Stock options........................ 141,557 789,355 789,355
Conversion of preferred stock........ 12,122,400 13,893,552 --
---------- ----------- -----------
Diluted shares......................... 15,936,747 18,312,307 18,312,307
========== =========== ===========
Net income............................. $ 155,011 $ 1,219,381 $ 1,219,381
========== =========== ===========
Basic EPS.............................. $ 0.04 $ 0.34 $ 0.07
========== =========== ===========
Diluted EPS............................ $ 0.01 $ 0.07 $ 0.07
========== =========== ===========
</TABLE>
5. SUPPLEMENTAL CASH FLOW INFORMATION
<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 30,
---------------------
1999 2000
-------- ----------
<S> <C> <C>
Interest paid during the period....................... $113,178 $ 266,940
Noncash capital lease obligations..................... $167,822 $ 216,532
Conversion of note payable to common stock............ $ -- $ 250,007
Notes payable issued to acquire land and buildings.... $ -- $2,800,000
Reduction in capital lease obligation upon purchase of
building............................................ $ -- $ 282,600
Reduction in straight-line rent accrual upon purchase
of building......................................... $ -- $ 224,989
Noncash insurance financing........................... $406,859 $ 430,189
Issuance of stock options............................. $ -- $2,603,925
</TABLE>
6. SEGMENT DATA
The Company processes human musculoskeletal tissue received from various
tissue recovery agencies and distributes the tissue through various channels.
This one line of business represents 100% of consolidated fees from tissue
distribution and is comprised of three primary product lines: spinal
F-29
<PAGE>
REGENERATION TECHNOLOGIES, INC. AND SUBSIDIARY
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SIX MONTHS ENDED JUNE 30, 1999 AND 2000
6. SEGMENT DATA (CONTINUED)
allografts, other precision tooled allografts and conventional tissue. The
following table presents fees from tissue distribution by each of the Company's
three primary product lines:
<TABLE>
<CAPTION>
SIX MONTHS ENDED JUNE 30,
---------------------------
1999 2000
------------ ------------
<S> <C> <C>
Fees from tissue distribution:
Spinal allografts................................ $24,640,568 $42,458,296
Other precision tooled allografts................ 1,902,403 3,860,955
Conventional tissue.............................. 3,631,899 6,896,264
----------- -----------
Total.......................................... $30,174,870 $53,215,515
=========== ===========
</TABLE>
7. SIGNIFICANT EVENTS
On March 30, 2000, the Company purchased the buildings and land (6.19 acres)
the Company occupied under lease, plus an additional 20.82 acres of land for
future expansion. The purchase price for the two buildings and 6.19 acres was
$3,600,000 with the additional 20.82 acres priced at $624,600. The Company
received a 20-year term loan in the amount of $2,800,000 to finance the purchase
of the buildings and the 6.19 acres of land. Interest on the loan is at the
30-day LIBOR plus 150 basis points. Simultaneous with entering into the
$2,800,000 term loan, the Company entered into a swap agreement with a
commercial bank which fixes its interest rate at 8.35%. The interest rate will
remain fixed until the 30-day LIBOR is determined to be greater than or equal to
8%, at which time the interest rate will revert to the 30-day LIBOR plus 150
basis points. The effective notional amount of the swap at March 30, 2000 was
$2,800,000. The term loan is collateralized by the land and buildings. The term
loan agreement contains various restrictive covenants, which limit among other
things, leases, indebtedness, loans, and acquisitions. In addition the Company
must satisfy certain financial ratios including fixed charge ratio at 1.25 to
1.00 or greater and funded debt to earnings before interest, taxes, depreciation
and amortization of not greater than 4.00 to 1.00. The $1,424,600 balance of the
amount due for the building with 6.19 acres and additional 20.82 acres is
financed from the $10,000,000 raised from the sale of Series C Preferred stock
in late 1999.
On April 27, 2000, the Company entered into a definitive agreement to
acquire the net assets of a division of the University of Alabama Health
Services Foundation, which has been doing business as the Alabama Tissue Center
("ATC"), in Birmingham, Alabama. The acquisition will be financed by a cash
payment of $250,000 and the issuance of $3,500,000 in shares of the Company's
common stock, valued at the Company's initial public offering price, plus an
additional cash payment of $250,000 upon the achievement of certain milestones,
with total possible consideration valued at $4,000,000. The acquisition of ATC
will be accounted for under the purchase method of accounting.
On June 7, 2000 the Company started construction of new manufacturing and
administrative buildings on the land purchased on March 30, 2000. Total
estimated cost to construct and equip the new facilities is $25.2 million. The
Company intends to finance $16.2 million of the cost with additional long-term
debt and the balance of $9.0 million from the initial public offering proceeds.
F-30
<PAGE>
INDEPENDENT AUDITORS' REPORT
To the Board of Directors of Regeneration Technologies, Inc.:
We have audited the consolidated financial statements of Regeneration
Technologies, Inc. and subsidiary (the "Company") as of December 31, 1998 and
1999, and for the period from February 12, 1998 (date operations began) to
December 31, 1998 and for the year ended December 31, 1999, and have issued our
report thereon dated March 22, 2000 (April 27, 2000 as to Note 18 and June 16,
2000 as to Note 19) (included elsewhere in this Registration Statement). Our
audits also included the accompanying consolidated financial statement schedule.
The consolidated financial statement schedule is the responsibility of the
Company's management. Our responsibility is to express an opinion based on our
audits. In our opinion, such consolidated 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.
/s/ DELOITTE & TOUCHE LLP
CERTIFIED PUBLIC ACCOUNTANTS
Tampa, Florida
March 22, 2000
(April 27, 2000 as to Note 18
and June 16, 2000 as to Note 19)
F-31
<PAGE>
REGENERATION TECHNOLOGIES, INC. AND SUBSIDIARY
SCHEDULE II
VALUATION AND QUALIFYING ACCOUNTS
PERIOD FROM FEBRUARY 12, 1998 (DATE OPERATIONS BEGAN)
TO DECEMBER 31, 1998 AND THE YEAR ENDED DECEMBER 31, 1999
<TABLE>
<CAPTION>
BALANCE AT CHARGED TO CHARGED TO BALANCE AT
BEGINNING COSTS AND OTHER END OF
DESCRIPTION OF PERIOD EXPENSES ACCOUNTS DEDUCTIONS PERIOD
----------- ---------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C>
Period Ended December 31, 1998:
Allowance for doubtful accounts...... $ -- $ 38,500 $ -- $ -- $ 38,500
Year Ended December 31, 1999:
Allowance for doubtful accounts...... 38,500 171,587 125,000(a) -- 335,087
</TABLE>
------------------------
(a) Represents allowance for doubtful accounts on accounts receivable acquired
from National Tissue Bank Network, Georgia Tissue Bank, Inc.
F-32
<PAGE>
INDEPENDENT AUDITORS' REPORT
To the Board of Directors of Regeneration Technologies, Inc.:
We have audited the accompanying statements of revenues and direct costs of the
predecessor business of Regeneration Technologies, Inc. (the "Company"), a part
of the University of Florida Tissue Bank, Inc., for the year ended December 31,
1997 and for the period from January 1, 1998 through February 11, 1998. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the statement of
revenues and direct costs is free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the statements of revenues and direct costs. An audit also includes assessing
the accounting principles used and significant estimates made by management, as
well as evaluating the overall statements of revenues and direct cost
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the statements of revenues and direct costs present fairly, in
all material respects, the revenues and direct costs of the Company for the year
ended December 31, 1997 and for the period from January 1, 1998 through
February 11, 1998, in conformity with accounting principles generally accepted
in the United States of America.
As more fully described in Note 2 to the statements of revenues and direct
costs, the Company was operated as a part of the University of Florida Tissue
Bank, Inc. As a result, certain expense allocations have not been made in the
accompanying statements of revenues and direct costs.
/s/ DELOITTE & TOUCHE LLP
Certified Public Accountants
Tampa, Florida
April 17, 2000
F-33
<PAGE>
PREDECESSOR BUSINESS OF REGENERATION TECHNOLOGIES, INC.
(PART OF THE UNIVERSITY OF FLORIDA TISSUE BANK, INC.)
STATEMENTS OF REVENUES AND DIRECT COSTS
<TABLE>
<CAPTION>
PERIOD FROM
YEAR ENDED JANUARY 1, 1998
DECEMBER 31, 1997 TO FEBRUARY 11, 1998
----------------- --------------------
<S> <C> <C>
Revenues from core operations:
Fees from tissue distribution............................ $11,074,265 $2,416,260
Other revenues from core operations...................... 2,434,499 410,244
----------- ----------
Total revenues......................................... 13,508,764 2,826,504
Management services fees................................... 8,875,067 1,932,056
----------- ----------
Net revenues........................................... 4,633,697 894,448
Costs of processing and distribution....................... 3,344,136 590,742
----------- ----------
Gross profit........................................... 1,289,561 303,706
----------- ----------
Expenses:
Direct marketing, general and administrative expenses.... (1,356,949) (207,438)
Research and development expenses........................ (478,473) (68,237)
----------- ----------
Total expenses......................................... (1,835,422) (275,675)
----------- ----------
Revenues (less than) in excess of direct costs............. $ (545,861) $ 28,031
=========== ==========
</TABLE>
See notes to statements of revenues and direct costs.
F-34
<PAGE>
PREDECESSOR BUSINESS OF REGENERATION TECHNOLOGIES, INC.
(PART OF THE UNIVERSITY OF FLORIDA TISSUE BANK, INC.)
NOTES TO STATEMENTS OF REVENUES AND DIRECT COSTS
YEAR ENDED DECEMBER 31, 1997
AND PERIOD FROM JANUARY 1, 1998 TO FEBRUARY 11, 1998
1. ORGANIZATION
Regeneration Technologies, Inc., was incorporated in Florida on August 22,
1997, and began operations on February 12, 1998, following a contribution of
assets by the University of Florida Tissue Bank, Inc. ("UFTB") of the
Predecessor Business of Regeneration Technologies, Inc. (the "Company"). The
Company processed human musculoskeletal tissue received from various tissue
recovery agencies. The Company's processing transformed the tissue into either
conventional or precision tooled allografts, some of which were patented. These
allografts were distributed domestically and internationally, for use in spinal
vertebrae repair, musculoskeletal reconstruction and fracture repair. The
processed tissue included cortical dowels, cervical implants, cortical bone
interference screws, and bone paste grafts.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION--The accompanying statements of revenues and direct
costs reflect the operations of the Company, operating as a part of UFTB, and
may not necessarily be indicative of the financial results had the Company been
operating as a separate entity. Allocations for interest and income taxes
incurred by UFTB are not included in these statements, as a reasonable
methodology for allocation could not be made, and any allocation may not be
indicative of the actual costs incurred by the Company.
INVENTORIES--Product and supply inventories were stated at the lower of cost
or market, with cost determined by the first-in, first-out method.
PROPERTY, PLANT AND EQUIPMENT--Property, plant and equipment were stated at
cost less accumulated depreciation and amortization. The cost of equipment under
capital leases and leasehold improvements was amortized on the straight-line
method over the shorter of the lease term or the estimated useful life of the
asset. Depreciation was computed on the straight-line method over the following
estimated useful lives of the assets:
<TABLE>
<S> <C>
Production equipment........................................ 8 to 10 years
Leasehold improvements...................................... 8 to 10 years
Office equipment, furniture, and fixtures................... 5 to 7 years
Computer hardware and software.............................. 3 years
</TABLE>
Depreciation and amortization expense was approximately $252,447 for the year
ended December 31, 1997 and $48,272 for the period from January 1, 1998 to
February 11, 1998.
RESEARCH AND DEVELOPMENT COSTS--Research and development costs were expensed
as incurred.
REVENUE RECOGNITION--Revenue was recognized at the time the Company shipped
the processed tissue. Revenues were reported gross of any management services
fees the Company incurred to distribute its products. Any other revenues
directly related to the Company's core operations were recognized when all
significant contractual obligations were satisfied.
USE OF ESTIMATES--The preparation of the accompanying statements of revenues
and direct costs in conformity with generally accepted accounting principles
required management to make estimates and
F-35
<PAGE>
PREDECESSOR BUSINESS OF REGENERATION TECHNOLOGIES, INC.
(PART OF THE UNIVERSITY OF FLORIDA TISSUE BANK, INC.)
NOTES TO STATEMENTS OF REVENUES AND DIRECT COSTS (CONTINUED)
YEAR ENDED DECEMBER 31, 1997
AND PERIOD FROM JANUARY 1, 1998 TO FEBRUARY 11, 1998
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
assumptions that affected the reported amounts of revenues and direct expenses
during the reporting period. Actual results could differ from those estimates.
3. CONCENTRATIONS OF RISK
The Company's principal concentration of risk was related to its limited
distribution channels. During 1997 and the period from January 1, 1998 to
February 11, 1998, approximately 90% of the Company's revenues came from one of
the distribution companies.
4. COMMITMENTS AND CONTINGENCIES
CAPITAL LEASE OBLIGATIONS--Future minimum lease payments on capital lease
obligations as of December 31, 1997 were as follows:
<TABLE>
<S> <C>
1998........................................................ $ 342,942
1999........................................................ 342,942
2000........................................................ 342,942
2001........................................................ 147,214
----------
Total....................................................... 1,176,040
Less amount representing interest........................... (272,130)
----------
$ 903,910
==========
</TABLE>
Future minimum lease payments on capital lease obligations as of February 11,
1998 approximated those represented by the schedule above.
OPERATING LEASE OBLIGATIONS--The Company leased office equipment under
various operating leases expiring through 2001. On January 1, 1998, the Company
entered into an additional operating lease for office equipment.
Future minimum operating lease payments required under noncancelable
operating lease agreements as of December 31, 1997 and February 11, 1998 were
not significant. Rent expense relating to operating leases for the year ended
December 31, 1997 and for the period from January 1, 1998 through February 11,
1998 were approximately $2,900 and $375, respectively.
MANUFACTURING RIGHTS--The Company licensed manufacturing rights for some of
its products. Under the agreement, the Company agreed to accept and reimburse
the processor for items that met the Company's quality control guidelines.
* * * * * *
F-36
<PAGE>
Regeneration Technologies, Inc.
Product Families
[Photograph of spinal allografts]
Spinal allografts
[Photograph of sports medicine allografts]
Sports medicine allografts
[Photograph of oral/maxillofacial allografts]
Oral/Maxillofacial allografts
[Photograph of urological allografts]
Urological allografts
[Photograph of conventional tissue]
Conventional tissue
[Photograph of cardiovascular allograft]
Cardiovascular allograft
<PAGE>
------------------------------------------------------------
------------------------------------------------------------
5,700,000 Shares
[LOGO]
------------
Prospectus
August 10, 2000
-------------------
Banc of America Securities LLC
Lehman Brothers
Stephens Inc.
Until September 5, 2000, all dealers that buy, sell or trade our common
stock may be required to deliver a prospectus, regardless of whether they are
participating in this offering. This is in addition to the obligation of dealers
to deliver a prospectus when acting as underwriters and with respect to their
unsold allotments or subscriptions.
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