UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES AND EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 1996
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM _____ TO _____
COMMISSION FILE NUMBER: 0-016607
ADVANCED TISSUE SCIENCES, INC.
(Exact name of registrant as specified in charter)
Delaware 14-1701513
--------------------------- ----------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
10933 North Torrey Pines Road, La Jolla, California 92037
--------------------------------------------------- ---------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (619) 450-5730
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days.
Yes X No
----- -----
The number of shares of the Registrant's Common Stock, par value $.01 per
share, outstanding at April 30, 1996 was 37,147,323.
<PAGE>
ADVANCED TISSUE SCIENCES, INC.
(A DEVELOPMENT STAGE COMPANY)
FORM 10-Q FOR THE QUARTER ENDED MARCH 31, 1996
INDEX
Page
----
Part I - Financial Information
- ------------------------------
Item 1 - Financial Statements
Introduction to the Financial Statements 1
Consolidated Balance Sheet -
March 31, 1996 and December 31, 1995 2
Consolidated Statement of Operations -
Three Months Ended March 31, 1996 and 1995
and Cumulative January 21, 1986 (inception)
to March 31, 1996 3
Consolidated Statement of Cash Flows -
Three Months Ended March 31, 1996 and 1995
and Cumulative January 21, 1986 (inception)
to March 31, 1996 4
Consolidated Statement of Stockholders' Equity -
Three Months Ended March 31, 1996 5
Notes to the Consolidated Financial Statements 6-8
Item 2 - Management's Discussion and Analysis of Financial
Condition and Results of Operations 9-11
Part II - Other Information
- ----------------------------
Item 6 - Exhibits and Reports on Form 8-K 12
Signature 12
<PAGE>
PART I - FINANCIAL INFORMATION
ITEM 1 - FINANCIAL STATEMENTS
INTRODUCTION TO THE FINANCIAL STATEMENTS
The financial statements have been prepared by Advanced Tissue Sciences,
Inc. (the "Company"), without audit, pursuant to the rules and regulations of
the Securities and Exchange Commission. Certain information and footnote
disclosures normally included in financial statements prepared in accordance
with generally accepted accounting principles have been condensed or omitted
pursuant to such rules and regulations. The Company believes that the
disclosures are adequate to make the information presented not misleading when
read in conjunction with the financial statements and the notes thereto
included in the Company's Annual Report on Form 10-K for the year ended
December 31, 1995.
The financial information presented in this Quarterly Report on Form 10-Q
reflects all adjustments, consisting only of normal recurring adjustments,
which are, in the opinion of management, necessary for a fair statement of the
results for the interim periods presented. The results for the interim
periods are not necessarily indicative of results to be expected for the full
year.
The discussion in this Quarterly Report on Form 10-Q, particularly those
relating to strategic alliances, potential acceleration of the use of working
capital (principally to fund increased research and development, and general
and administrative expenses), and commercialization of the Company's products,
are forward-looking statements involving risks and uncertainties within the
meaning of the Securities Act of 1933 and the Securities and Exchange Act
of 1934. No assurance can be given that the Company will successfully
complete clinical trials, obtain FDA approval, scale-up manufacturing
processes, successfully market such products, achieve the milestones required
to receive additional funding, or enter into new strategic alliances. These
and other risks are detailed in publicly available filings with the
Securities and Exchange Commission such as the Company's Annual Report on
Form 10-K for the year ended December 31, 1995 and Registration Statement
on Form S-3 (File No. 333-01185) and in the quarterly report to stockholders
dated May 1996. The forward-looking statements herein are qualified in their
entirety by reference to the risks and risk factors described in such reports
and registration statement.
-1-
<PAGE>
ADVANCED TISSUE SCIENCES, INC.
(A Development Stage Company)
CONSOLIDATED BALANCE SHEET
Dollars in Thousands
<TABLE>
<CAPTION>
March 31, December 31,
1996 1995
------------ ------------
(Unaudited)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 40,032 $ 18,929
Short-term investments 9,998 --
Prepaid expenses 718 820
Other current assets 1,337 1,214
---------- ----------
Total current assets 52,085 20,963
Property - net 8,318 8,332
Patent costs - net 1,055 1,032
Other assets 1,781 814
---------- ----------
Total assets $ 63,239 $ 31,141
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of obligations under
capital leases $ 12 $ 11
Accounts payable 1,040 1,183
Accrued expenses 4,458 4,022
---------- ----------
Total current liabilities 5,510 5,216
---------- ----------
Obligations under capital leases 22 25
---------- ----------
Stockholders' equity:
Preferred Stock, $.01 par value; 1,000,000
shares authorized; none issued -- --
Common Stock, $.01 par value; 50,000,000
shares authorized; issued and outstanding,
36,912,223 shares at March 31, 1996 and
33,885,928 shares at December 31, 1995 369 339
Additional paid-in capital 181,969 143,161
Deficit accumulated during development stage (123,712) (116,681)
---------- ----------
58,626 26,819
Less note received in connection with the
sale of Common Stock (919) (919)
---------- ----------
Total stockholders' equity 57,707 25,900
---------- ----------
Total liabilities and stockholders' equity $ 63,239 $ 31,141
========== ==========
See the accompanying notes to the consolidated financial statements.
</TABLE>
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<PAGE>
ADVANCED TISSUE SCIENCES, INC.
(A Development Stage Company)
CONSOLIDATED STATEMENT OF OPERATIONS
In Thousands, Except Per Share Amounts
(Unaudited)
<TABLE>
<CAPTION>
Cumulative
January 21,
1986
Three Months Ended March 31, (inception)
---------------------------- to March 31,
1996 1995 1996
---------- --------- ------------
<S> <C> <C> <C>
Revenues:
Sales $ 302 $ 261 $ 5,178
Contracts and fees 658 561 7,668
Interest and other 267 283 7,050
---------- --------- ----------
Total revenues 1,227 1,105 19,896
---------- --------- ----------
Costs and expenses:
Research and development 5,229 4,406 70,189
Selling, general and administrative 1,922 1,460 33,700
Professional and consulting 628 468 10,902
Cost of goods sold 478 346 6,441
Interest 1 2 550
In-process technology and other -- -- 21,826
---------- --------- ----------
Total costs and expenses 8,258 6,682 143,608
---------- --------- ----------
Net loss $ (7,031) $ (5,577) $ (123,712)
========== ========= ==========
Net loss per share $ (.21) $ (.18)
========== =========
Weighted average number of common
shares used in computation of
net loss per share 34,061 30,571
========== =========
See the accompanying notes to the consolidated financial statements.
</TABLE>
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<PAGE>
ADVANCED TISSUE SCIENCES, INC.
(A Development Stage Company)
CONSOLIDATED STATEMENT OF CASH FLOWS
Dollars in Thousands
(Unaudited)
<TABLE>
<CAPTION>
Cumulative
January 21,
1986
Three Months Ended March 31, (inception)
---------------------------- to March 31,
1996 1995 1996
--------- --------- ----------
<S> <C> <C> <C>
Operating activities:
Net loss $ (7,031) $ (5,577) $ (123,712)
Adjustments to reconcile net
loss to cash used in operating
activities:
Depreciation and amortization 412 291 5,353
Write-off of acquired in-process
technology -- -- 21,000
Compensation for services paid in
stock, stock options or warrants 62 -- 1,610
Other adjustments to net loss 45 3 541
Change in assets and liabilities:
Prepaid expenses and other current
assets (21) (17) (2,055)
Other assets (154) (7) (781)
Accounts payable (143) (754) 1,040
Accrued expenses 436 336 4,458
--------- --------- ----------
Net cash used in operating
activities (6,394) (5,725) (92,546)
--------- --------- ----------
Investing activities:
Purchases of short-term
investments (9,998) (787) (134,402)
Maturities and sales of short-
term investments -- 6,767 124,404
Acquisition of property (392) (266) (11,571)
Patent application costs (74) (34) (1,388)
--------- --------- ----------
Net cash provided by (used in)
investing activities (10,464) 5,680 (22,957)
--------- --------- ----------
Financing activities:
Proceeds from borrowings -- -- 529
Payments of borrowings (2) (2) (2,909)
Net proceeds from sale of equity 37,720 -- 148,429
Options and warrants exercised 243 8 8,675
Purchase of options and other -- -- 811
--------- --------- ----------
Net cash provided by financing
activities 37,961 6 155,535
--------- --------- ----------
Net increase (decrease) in cash
and cash equivalents 21,103 (39) 40,032
Cash and cash equivalents at the
beginning of period 18,929 12,417 --
--------- --------- ----------
Cash and cash equivalents at the
end of period $ 40,032 $ 12,378 $ 40,032
========= ========= ==========
See the accompanying notes to the consolidated financial statements.
</TABLE>
-4-
<PAGE>
ADVANCED TISSUE SCIENCES, INC.
(A Development Stage Company)
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
In Thousands, Except Per Share Amounts
(Unaudited)
<TABLE>
<CAPTION>
Deficit
Accumulated Total
Common Stock Additional During Stock-
--------------- Paid-In Development Note holders'
Shares Amount Capital Stage Receivable Equity
------ ------ --------- ----------- ----------- ---------
<S> <C> <C> <C> <C> <C> <C>
Balance, December 31,
1995 33,886 $ 339 $ 143,161 $(116,681) $ (919) $ 25,900
Sales of Common Stock
for cash less expenses
of $2,656 (at $13.25
per share) (Note 3) 3,000 30 37,064 37,094
Warrants issued as
commitment fee
under equity line
(at $10.50 per
share) (Note 3) 875 875
Valuation adjust-
ment of Common
Stock issued in
private place-
ment less expenses
of $51 (Note 3) 626 626
Options exercised (at
$3.38 to $11.75 per
share) 26 243 243
Net loss (7,031) (7,031)
------ ------ --------- ---------- --------- ---------
Balance March 31, 1996 36,912 $ 369 $ 181,969 $ (123,712) $ (919) $ 57,707
====== ====== ========= ========== ========= =========
See the accompanying notes to the consolidated financial statements.
</TABLE>
-5-
<PAGE>
ADVANCED TISSUE SCIENCES, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 1 - BASIS OF PRESENTATION
Organization - Advanced Tissue Sciences, Inc. is a development stage, tissue
engineering company engaged in the growth of human tissues and organs for
therapeutic applications. Using its proprietary three-dimensional culture
system, the Company has successfully replicated a variety of human tissues,
including skin, cartilage, bone marrow and liver. The Company's leading
therapeutic products are tissue engineered skin products for the treatment of
severe burns, for which the Company has submitted an application for marketing
approval in the United States to the Food and Drug Administration, and for
diabetic foot ulcers, which is in multi-site human clinical trials in the
United States and France.
Principles of Consolidation - The consolidated financial statements include
the accounts of the Company's wholly owned subsidiaries. The Company's fifty
percent interest in the Advanced Tissue Sciences-Smith & Nephew joint venture
for the development of tissue engineered cartilage for orthopedic applications
is accounted for under the equity method (see Note 2). All intercompany
accounts and transactions have been eliminated.
NOTE 2 - STRATEGIC ALLIANCES
In April 1996, the Company entered into an agreement with Smith & Nephew plc
("Smith & Nephew") to form a fifty-fifty joint venture for the worldwide
commercialization of Dermagraft (R), the Company's tissue engineered dermal
replacement, in the treatment of diabetic foot ulcers (the "Dermagraft Joint
Venture"). Upon signing, Smith & Nephew paid an upfront fee of $10 million
and agreed to pay the Company up to an additional $60 million on the
achievement of certain milestones. Smith & Nephew is a worldwide health
care company with extensive sales and distribution capabilities. It
manufactures a wide range of tissue repair products, principally
addressing the areas of bone, joints, skin and other soft tissue. Under the
agreement, the Dermagraft Joint Venture will be responsible for the further
development, manufacturing, marketing and sales of Dermagraft for diabetic
foot ulcers and will have a right of first refusal to develop Dermagraft
for several other indications. The Company has retained rights to develop
Dermagraft for burns and for plastic and reconstructive surgery. The
companies have agreed to complete definitive agreements and to share equally
in the expenses and revenues of the Dermagraft Joint Venture beginning
January 1, 1997. As part of the agreement, Smith & Nephew has also agreed
to loan the Company up to $10 million during 1997.
St. Jude Medical, Inc. ("St. Jude Medical") and the Company entered into a
joint development agreement under which the parties conducted a series of
feasibility studies to evaluate applications of the Company's tissue
engineering technology to create or improve heart valve replacements in
February 1994 and, in January 1995, the agreement was extended to December 31,
1995. The Company recognized $203,000 in funding from St. Jude Medical in
three months ended March 31, 1995. As provided in the joint development
agreement, in early 1996, St. Jude Medical elected not to enter into a
licensing agreement with the Company for tissue engineered heart valves. As a
result, the Company is in discussions with other companies for a broader
strategic alliance with respect to its cardiovascular products. The Company
is unable to predict with any certainty whether it will be able to enter into
any such alliance.
In 1994, Smith & Nephew and the Company began a separate joint venture for the
development of tissue engineered cartilage for orthopedic applications (the
"Cartilage Joint Venture"). Under the Cartilage Joint Venture, Smith & Nephew
is contributing the first $10 million in funding. The Cartilage Joint Venture
incurred a net loss of $1,256,000 in the three-month period ended March 31,
1996, bringing total expenditures of the joint venture funded by Smith &
Nephew to $5,213,000 from inception to March 31,1996. Cartilage Joint
Venture revenues and expenditures in excess of $10 million will be shared
equally by the partners. During the three months ended March 31, 1996 and
1995, the Company recognized $648,000 and $358,000, respectively, in contract
revenue for research and development activities performed for the Cartilage
Joint Venture.
-6-
<PAGE>
NOTE 3 - CAPITAL STOCK
Public Offering - In March 1996, the Company sold 3,000,000 shares of Common
Stock at $13.25 per share in an underwritten public offering. In addition, in
April 1996, the underwriters partially exercised the over-allotment option
related to the offering and purchased an additional 223,800 shares of Common
Stock at $13.25 per share. In total, the Company received net proceeds of
$40.0 million from the offering. As the over-allotment option was exercised
subsequent to the end of the first quarter, net proceeds of $2.8 million from
such exercise are not reflected in the accompanying balance sheet.
Equity Line - In February 1996, the Company entered into an investment
agreement (the "Investment Agreement") with a newly formed investment group
for an equity line which allows the Company to access up to $50 million
through sales of its Common Stock. The equity line will remain available for
a period of two years. The decision to draw any funds under the Investment
Agreement and the timing of any such draw are solely at the Company's
discretion.
The Investment Agreement provides that the Company can obtain up to $15
million at any one time through the sale of Common Stock. Any sales against
the equity line will be at a five percent discount to the average low sales
prices of the Company's Common Stock over a specified period of time as
determined by market volume at the time of the draw. The Company's ability to
draw under the Investment Agreement is subject to certain conditions
including, but not limited to, registration of the shares, a minimum trading
price of $2.00 per share, and certain limitations on the number of shares of
Common Stock held by the investment group at any point in time.
As a commitment fee for keeping the equity line available for the two-year
period, the Company issued a warrant to the investment group exercisable for
175,000 shares of Common Stock at an exercise price of $10.50 per share.
Under the Investment Agreement and the warrant, a registration statement
pertaining to the warrant shares is to be filed by the earlier of 180 days
from the date of the warrant or before any funds are drawn under the
Investment Agreement.
Private Placement - In July 1995, the Company completed a series of private
placements. The initial purchase price for the shares was $6.86 per share,
representing an 11.5% discount to the closing bid price of the Company's
Common Stock on June 7, 1995. However, as provided in the placements, the
initial purchase price was adjusted to result in a price per share to the
investors equal to 88.5% of the average closing price of the Common Stock over
agreed-upon valuation periods. The final valuation period for 385,569 of the
shares purchased in the private placement ended in January 1996, resulting in
a final purchase price of $8.62 per share and additional net proceeds of
$626,000 to the Company.
NOTE 4 - NET LOSS PER SHARE
The net loss per share for the three-month periods ended March 31, 1996 and
1995 is based on the weighted average number of shares of Common Stock
outstanding during the periods. Shares to be issued under options have not
been included in the calculation of the net loss per share in any period as
their effect is antidilutive.
NOTE 5 - CASH FLOW INFORMATION
Non-cash activity during the three months ended March 31, 1996 included the
issuance of a warrant exercisable for Common Stock as a commitment fee for a
two-year equity line (see Note 3). The commitment fee of 1.75% of the equity
line, or $875,000, was negotiated between the Company and the investment group
providing the equity line and represents the estimated fair market value of
the warrant. The value of the warrant is being amortized to expense on a
straight line basis over the commitment period. There were no significant
non-cash transactions in the three-month period ended March 31, 1995.
Net cash from operating activities reflects cash payments for interest expense
of approximately $1,000 and $2,000 in the three-month periods ended March 31,
1996 and 1995, respectively. Cash payments for interest expense for the
period January 26, 1986 (inception) to March 31, 1996 have totaled $601,000.
-7-
<PAGE>
NOTE 6 - STOCK OPTIONS
The following table summarizes activity under the Company's 1992 Stock
Option/Stock Issuance Plan (the "1992 Plan") and for other options and
warrants exercisable for Common Stock during the three months ended March 31,
1996:
1992 Plan Other Options and Warrants
----------------------- --------------------------
Number Price Per Number Price Per
of Shares Share of Shares Share
----------- --------- ----------- -------------
Outstanding
December 31, 1995 2,317,515 $1.69 - 16.88 1,460,299 $1.47- 10.13
Granted 1,145,650 $7.63 - 13.50 175,000 $10.50
Exercised (16,295) $3.38 - 11.75 (10,000) $8.13
Canceled (5,680) $8.00 - 15.38 --
--------- ------------- ---------
Outstanding
March 31, 1996 3,441,190 $1.69 - 16.88 1,625,299 $1.47- 10.50
========= =========
-8-
<PAGE>
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Advanced Tissue Sciences is a development stage company engaged in the
development and manufacture of living human tissue products for therapeutic
applications. The Company has incurred, and expects to continue to incur,
substantial and increasing expenditures in support of the development and
clinical trials of its Dermagraft (R) products for burn and skin ulcer
applications, in developing manufacturing systems and facilities for the
production and commercialization of Dermagraft, in building its sales and
marketing capabilities, and in advancing other applications of the Company's
core technology. In addition to its Dermagraft skin products, the Company
is focusing its resources on the development of tissue engineered cartilage
and cardiovascular products.
These activities have been supported by a variety of strategic
relationships over the past several years. In May 1994, the Company entered
into a joint venture with Smith & Nephew plc ("Smith & Nephew") for the
worldwide development, manufacture and marketing of human tissue engineered
cartilage for orthopedic applications. Over the past two years, the Company
worked with St. Jude Medical, Inc. ("St. Jude Medical") on the development of
tissue engineered heart valves. In early 1996, St. Jude Medical elected not
to enter into a licensing agreement and, accordingly, the Company is currently
funding all of its cardiovascular research and development activities
internally. See Note 2 to the consolidated financial statements. Since
September 1992, the Company has sponsored early stage research programs at the
Massachusetts Institute of Technology ("MIT") and Children's Hospital in
Boston ("Children's Hospital") directed toward the tissue engineering of
cartilage, liver and numerous other tissues and several polymer technologies.
Results of Operations
- ---------------------
Revenues were $1,227,000 and $1,105,000 for the three-month periods ended
March 31, 1996 and 1995, respectively, as both contract revenues and sales
increased. During the quarter ended March 31, 1996, the Company recognized
contract revenues of $648,000 for research and development of orthopedic
applications of tissue engineered cartilage performed for its joint venture
with Smith & Nephew, as compared to $358,000 in the corresponding quarter of
1995. Contract revenues from the joint venture with Smith & Nephew are
expected to continue to exceed 1995 levels throughout the balance of the year.
The three months ended March 31, 1995 also included contract revenues of
$203,000 related to research performed under the agreement with St. Jude
Medical for the development of tissue engineered heart valves as discussed
above. Sales of the Company's Skin2(R) laboratory testing kits increased
$41,000 to $302,000 in the quarter ended March 31, 1996 as compared to the
corresponding quarter in 1995. Product sales generally fluctuate based on
the number and timing of validation studies initiated either by the Company
or third parties. Product sales include revenues received under validation
studies of $86,000 and $37,000 in the three-month periods ended March 31,
1996 and 1995, respectively.
Research and development expenditures increased $823,000 to $5,229,000
in the quarter ended March 31, 1996 as compared to the corresponding period
in 1995. The increase in research and development costs primarily reflects
higher costs associated with the operation and maintenance of the Company's
manufacturing facility, expenditures in support of the scale up of Dermagraft
manufacturing processes, and increased levels of research and development in
support of the Company's orthopedic cartilage joint venture with Smith &
Nephew as discussed above. Increased costs for the operation of the
manufacturing facility reflect that the facility was not completed and
clinical production did not begin in the facility until mid-1995. Costs have
increased in support of the cartilage joint venture primarily with respect to
accelerating process development activities and preclinical studies.
Specifically, the increased research and development costs are principally
reflected in higher costs for engineering services, operating costs of and
depreciation associated with the manufacturing facility and additional
personnel. Expenditures for research and development are expected to continue
to be incurred at levels higher than in 1995 throughout the balance of 1996.
Selling, general and administrative costs were $1,922,000 for the
three months ended March 31, 1996, as compared to $1,460,000 in the
corresponding period of the prior year. The increase in selling, general and
-9-
<PAGE>
administrative expenses primarily reflects higher salaries and relocation
costs and amortization of the commitment fee associated with the equity line
established in February 1996 (see Note 3 to the consolidated financial
statements). Selling, general and administrative costs are expected to
continue to increase as the Company begins to build its sales and marketing
capabilities in anticipation of approval of Dermagraft-TC (TM). There can
be no assurance however that the Food and Drug Administration will accept
the Company's application for marketing approval for filing, that the
product will be approved or that the Company will be able to successfully
market the product.
Professional and consulting costs for legal, accounting and other
consulting services incurred in the three months ended March 31, 1996 and 1995
were $628,000 and $468,000, respectively. The 1996 quarter included higher
fees for legal services related to the equity line, strategic alliances and
intellectual property, for regulatory and marketing consultants and for the
recruitment of personnel. The 1995 quarter included higher fees for
consultants in support of corporate development activities.
Cost of goods sold represents direct and indirect costs of manufacturing
the Company's Skin2 laboratory testing kits. Cost of goods sold is net of the
costs of products transferred to research and development for use in
developing additional applications of the Company's testing kits. The cost of
such products is included in research and development expenses based upon
estimated direct and indirect production costs assuming planned production
capacity.
Liquidity and Capital Resources
- -------------------------------
In March 1996, the Company sold 3,000,000 shares of Common Stock at
$13.25 in an underwritten public offering. In addition, in April 1996, the
underwriters partially exercised the over-allotment option related to the
offering and purchased an additional 223,800 shares of Common Stock at $13.25
per share. In total, the Company received net proceeds of $40.0 million from
the offering. See Note 3 to the consolidated financial statements.
As of March 31, 1996, the Company had available working capital of
$46,575,000, an increase of $30,828,000 from December 31, 1995. The increase
principally reflects the proceeds from the sale of the Company's Common Stock,
net of funds used in operations and for capital expenditures. Subsequent to
March 31, 1996, the Company has received an additional $10 million fee from
Smith & Nephew (see Note 2 to the consolidated financial statements) and net
proceeds of $2.8 million from exercise of the over-allotment option referred
to above. Capital expenditures were $392,000 in the first three months of
1996. The Company expects to use working capital at an accelerated rate
during 1996 as it continues to incur substantial research and development
expenses (including costs associated with clinical trials and the development
of manufacturing processes), growing costs in anticipation of product
commercialization, and additional expenditures for capital equipment
(including increased expenditures for manufacturing equipment) and patents.
In addition to available working capital, the Company has entered into a
two-year equity line which could provide up to $50 million in funding. See
Note 3 to the consolidated financial statements. Any decision to draw any
funds under the equity line and the timing of any such draw are solely at the
Company's discretion. The Company has agreed it will not draw on the equity
line during the six-month period following the close of the March public
offering. The Company currently believes it has sufficient funds to support
its operations into 1997.
The Company continually reviews its product development activities in an
effort to allocate its resources to those products the Company believes have
the greatest commercial potential. Factors considered by the Company in
determining the products to pursue include projected markets and need,
potential for regulatory approval and reimbursement under the existing health
care system as well as anticipated health care reforms, technical feasibility,
expected and known product attributes and estimated costs to bring the product
to market. Based on these and other factors which the Company considers
relevant, the Company may from time to time reallocate its resources among its
product development activities. Additions to products under development or
changes in products being pursued can substantially and rapidly change the
Company's funding requirements.
-10-
<PAGE>
To the extent necessary, further sources of funds may include existing or
future strategic alliances or other joint venture arrangements which provide
funding to the Company, and additional public or private offerings of debt or
equity securities, among others. The Company is also continuing to explore
alternatives for obtaining resources for its in vitro laboratory testing
business. There can be no assurance, however, that any additional funds will
be available when needed or on terms favorable to the Company, or that the
Company will be successful in entering into any other strategic alliances or
joint ventures.
Financial Condition
- -------------------
Cash and cash equivalents, short-term investments and stockholders'
equity as of March 31, 1996 have increased from December 31, 1995 reflecting
net proceeds received from the sale of the Company's Common Stock in the March
1996 public offering, which was partially offset by funds used in operations
and for capital expenditures. Other assets have increased over the same
period reflecting the prepayment of the commitment fee associated with the
equity line (see Note 3 to the consolidated financial statements). Accrued
expenses have increased from December 31, 1996 to March 31, 1996 primarily
reflecting higher accruals for engineering services and sponsored research.
-11-
<PAGE>
PART II - OTHER INFORMATION
---------------------------
ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
Exhibit
No. Title Method of Filing
------- ----- ----------------
10.1 Heads of Agreement between the Company and Filed Herewith
Smith & Nephew plc dated April 29, 1996
10.2 Form of Special Addendum to Certain Employee Filed Herewith
Stock Option Agreements
27 Financial Data Schedule Filed Herewith
(b) Reports on Form 8-K
The Company filed a Current Report on Form 8-K dated February 9, 1996
under Item 5 reporting it had entered into an investment agreement (the
"Investment Agreement") with Ramius Hatteras Partners, L.P., a newly
formed, single purpose investment group, for an equity line which allows the
Company to access up to $50 million through sales of its Common Stock. The
equity line is to remain available for a period of two years from the date
of the Investment Agreement.
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
ADVANCED TISSUE SCIENCES, INC.
Date: May 13, 1996 /s/ Arthur J. Benvenuto
---------------- -------------------------------
Arthur J. Benvenuto
Chairman of the Board and Chief
Executive Officer
Date: May 13, 1996 /s/ Michael V. Swanson
---------------- --------------------------------
Michael V. Swanson
Vice President, Finance and
Administration
-12-
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EXHIBIT 10.1
HEADS OF AGREEMENT
This Agreement is entered into as of April 29, 1996, by and between
Advanced Tissue Sciences, Inc., a Delaware corporate ("ATS"), and Smith &
Nephew plc, a company organized under the laws of the United Kingdom, with
respect to the following facts:
A. ATS and Smith & Nephew, plc, or it affiliates ("S&N") have worked
together successfully in another venture over the past two years, and the
parties desire to enter into a new venture.
B. ATS has patent rights and other proprietary rights to a tissue
engineered skin product known as "Dermagraft (R)" which may be useful in a
variety of medical applications, including the treatment of diabetic foot
ulcers. ATS presently is in the final phase of human clinical trials in
anticipation of a request to obtain FDA approval for marketing in the U.S.
the Dermagraft product for treatment of diabetic foot ulcers.
C. ATS and S&N desire to form a new 50/50 joint venture company (the
"Company"), to be owned equally between ATS and S&N. By mutual agreement, the
parties may form one or more companies pursuant to this Agreement, which
multiple companies are referred to herein collectively as the Company. The
purpose and focus of the Company will be to complete development of the
Dermagraft product for the treatment of diabetic foot ulcers, and to
manufacture, market and sell the Dermagraft product for the treatment of
diabetic foot ulcers. Except as specified herein, the Company may perform
some of these activities directly, and/or the Company may subcontract the
performance of some of these activities to other parties, including ATS and
S&N or their affiliates.
D. The purpose of this Agreement is to evidence the principal terms
of the parties' agreement for this new joint venture company. It is
understood that customary definitive agreements containing additional details
and provisions will be prepared and signed subsequently, in order to further
implement the parties' agreement as set forth in this Agreement.
WHEREFORE, the parties hereto mutually agree to the following principal
terms for the formation and operation of a new joint venture company:
1. Product: Dermagraft and all improvements and extensions.
2. Field of Use: Treatment of diabetic foot ulcers.
1
<PAGE>
3. Territory: Worldwide
4. Company Structure:
a. The legal form, terms and structure of the Company will be
determined subsequently by the parties.
b. ATS and S&N will share equally all revenues, costs and
funding of the Company from and after January 1, 1997. Prior to said date,
ATS shall be responsible for the applicable costs.
c. The Company will manage and finance all aspects of the joint
venture business, including product development, clinical trials,
manufacturing, marketing and sales.
5. Selling and Marketing:
a. Under the governance of the Company's Executive Board (as
described in Section 11 below), the Company will establish a worldwide
marketing team comprising individuals from both ATS and S&N.
b. Unless otherwise approved by the Company's Executive Board,
national marketing and selling will be subcontracted to S&N. ATS and S&N
will charge selling and marketing expenses at cost, including reasonable
and appropriate overhead costs allocated in a manner approved by the Company's
Executive Board, to the Company.
c. ATS and S&N intend to hire The Wilkerson Group to give input
and recommendations concerning the Company's business, including without
limitation, topics such as (i) characterizing the roles of each party in
selling and marketing Dermagraft (including the development of a "technical"
sales force which may be subcontracted to ATS to provide specific and
technical information relative to Dermagraft), and (ii) developing a business
plan for the commercialization of Dermagraft in the U.S. and/or Europe.
6. Manufacturing: ATS will continue to manufacture Dermagraft at
ATS's facility in the U.S., under contract with the Company. Any additional
manufacturing facilities will be approved by the Company's Executive Board
and will be under the control and responsibility of ATS with the oversight
of the Executive Board. ATS will charge manufacturing expenses at cost,
including reasonable and appropriate overhead costs allocated in a manner
approved by the Company's Executive Board, to the Company. Additionally, the
parties will determine an appropriate and reasonable mechanism (i) to repay
2
<PAGE>
ATS for manufacturing facility capital expenditures to date (and equal
sharing of manufacturing facility expenditures going forward), or (ii) to
reimburse ATS the costs of depreciation for the manufacturing facility (at
reasonable rates to be agreed to by the Company's Executive Board), plus
interest at LIBOR plus four points on the reducing net book value of the
manufacturing facility.
7. License of Technology:
a. ATS will enter into a License Agreement, pursuant to which
ATS will grant to the Company (perhaps via or with S&N) exclusive, worldwide
license rights to the ATS patents and technology to make, use and sell
Dermagraft for the treatment of diabetic foot ulcers.
b. The Company will pay any "pass through" royalties owed on
the MIT Technology, but the Company will not pay any additional royalties
to ATS.
c. S&N (perhaps via the Company) will pay to ATS the
commencement fees and milestone payments as specified in Section 8 below.
d. The License Agreement will contain provisions similar to
the license agreement for the ATS/S&N cartilage joint venture.
8. Commencement Fees and Milestone Payments: S&N (perhaps via
the Company) will pay directly to ATS the following sums, with respect to
ATS's patents and technology:
a. Commencement Fees:
Event Fee
----- ---
Upon signing this Agreement,
with respect to ATS's patents
and technology: US $10 million
b. Milestone Payments:
Event Fee
----- ---
i) Receive PMA approval in U.S. $5 million
3
<PAGE>
ii) Within 24 months after the PMA
approval, obtain U.S. Medicare
reimbursement at an average
purchase price of a minimum of
$375 per piece of Dermagraft $5 million
iii) $100 million worldwide annual sales $10 million
iv) $200 million worldwide annual sales $10 million
v) $300 million worldwide annual sales $10 million
vi) $400 million worldwide annual sales $10 million
vii) $500 million worldwide annual sales $10 million
Said annual sales relate to sales obtained in any twelve month period.
The payments to be made to ATS pursuant to Section 8 will be structured in a
manner to permit S&N (i) to amortize such payments for tax purposes, and (ii)
to split the payments by territorial right, so long as said structuring does
not materially adversely affect ATS or the Company.
9. Loan to ATS:
a. S&N shall make loan advances to ATS aggregating up to $10
million, in increments of at least $1 million, anytime during calendar year
1997. At its election, ATS may access any or all of the $10 million loan
at an interest rate equal to LIBOR plus four points.
b. ATS will pay on a quarterly basis, in arrears, the accrued
interest at the rate of LIBOR plus one point; and the remaining interest
equal to three ponts shall accrue and be payable at the end of three years
from each loan advance.
c. The principal plus any unapid accrued interest will be
payable at the end of three years from each loan advance.
d. Repayment of principal and/or interest may be in the form
of cash or ATS common stock, at ATS' election. If ATS elects to repay some
or all of the loan in the form of common stock, such stock will be registered
and priced at the then current market value.
4
<PAGE>
e. It ATS defaults on any payment of principal or interest when
due, and said default is not cured within ten days after ATS receives a
written notice of default and demand for payment, then the entire amount of
principal and accrued interest shall become immediately due and payable upon
the demand of S&N.
10. Use of Names:
a. In the event ATS enters into a partnership or other joint
enterprise of any kind with a third party for other wound care indications,
the name "Dermagraft" will not be used for such product.
b. However, if ATS markets such products on its own, ATS will
have the right to use the name Dermagraft, so long as the product does not
create conflicts in the marketplace (e.g., allowing physicians to use either
ATS' or the Company's product "off label" in violation of either party's
rights to a particular indication).
c. ATS retains the right to use the name Dermagraft-TC (TM).
d. Notwithstanding the foregoing, while the Company is still
operating and proceeding in the ordinary course of business, and ATS still
remains as an owner of the Company, ATS will not compete with the Company's
products for the treatment of diabetic foot ulcers.
11. Governance:
a. The Company will be governed by an Executive Board
comprising equal numbers of ATS and S&N representatives, with equal decision
making authority.
b. A mutually agreed upon General Manager will be hired to run
the Company, who will report directly to the Executive Board.
c. Deadlock decisions at the Executive Board level will be
referred to the CEOs of ATS and S&N for resolution, prior to any arbitration.
12. First Refusal for Other Products:
a. ATS grants to the Company a 90-day right of first refusal
to commercialize Dermagraft for other wound care indications, excluding
those indications described in Section 12c hereof.
5
<PAGE>
b. This right of first refusal applies only if ATS plans to
enter into an alliance or other joint enterprise of any kind with a third
party for such commercialization. ATS will offer to S&N the right to
participate in such commercialization on the same terms upon which the third
party intends to participate. In the event that S&N does not exercise its
right of first refusal within the 90-day period after it receives such offer,
then ATS would have the right to enter into the transaction with the third
party upon such terms or other terms more favorable to ATS; provided that if
ATS does not enter into such transaction with such third party within 180
days, then S&N's right of first refusal again will apply to the transaction.
This right of first refusal does not apply if ATS pursues such
commercialization on its own.
c. ATS retains the rights to use Dermagraft and Dermagraft-TC
for burns and in plastic and reconstructive surgery.
13. Plan and Budget:
a. ATS and S&N intend that a draft business plan and budget
will be prepared for review, revision and approval by the Company's Executive
Board. Said business plan and budget will recommend reasonable cost
allocations for the subcontracted activities.
b. The Executive Board will approve the operating budget for
the Company, and determine the amount and timing for ATS and S&N to make
contributions of operating funds. Such contributions will be on an equal
basis.
c. The parties have targeted an operating loss for the
Company for calendar year 1997 of not more than $3.2 million, depending on and
subject to decisions by the Executive Board concerning various
commercialization activities.
14. Definitive Agreements: The following definitive agreements to
implement the foregoing principal provisions shall be drafted and mutually
approved by ATS and S&N as follows:
a. Entity organizational documents.
b. License Agreement, from ATS to the Company.
c. Loan Agreement, between ATS and S&N.
ATS and S&N shall use good faith and reasonable efforts to draft, mutually
approve and sign the definitive agreements as soon as is reasonably feasible.
6
<PAGE>
With respect to matters for the definitive agreements which are not
addressed in this Agreement (e.g., termination, intellectual property,
indemnity, and product liability), the parties will first look to the concepts
set forth in the parties' cartilage joint venture for guidance. In the event
of a termination of the joint venture contemplated hereby prior to the
execution and delivery of definitive agreements, Ernst & Young, as auditors of
both parties, will be asked to arbitrate informally the terms of such
termination on the basis of the cartilage joint venture termination
provisions.
In due course, under the governance of the Company's Executive
Board, the Company may enter into additional agreements in the future, such as
for i) Administrative Services, ii) Research, iii) Clinical Trials, iv)
Manufacturing, v) Marketing and Sales, vi) Technical Sales Force, etc. Said
additional agreements shall be on terms consistent with the provisions of this
Agreement.
15. Governing Law: This Agreement shall be construed in accordance
with the laws of the State of Delaware.
16. Arbitration: Any disputes arising with respect to this
Agreement shall be resolved through binding arbitration by a single, qualified
arbitrator selected from a list of three candidates furnished by the president
of HIMA. If the president of HIMA is unwilling or unable to provide a list of
candidates, the candidates shall be proposed by the American Arbitration
Association, Chicago, Illinois from its Complex Dispute Panel. The
arbitration proceedings shall be conducted in accordance with the then current
Commercial Rules of Arbitration of the American Arbitration Association, or in
accordance with such other rules or procedures as the arbitrator may specify.
The arbitration shall take place in Chicago, Illinois, USA. Each party will
bear all of its own arbitration expenses, plus one-half of the arbitrator's
fee.
17. Public Announcement; Upon signing this Agreement, the parties
shall jointly issue the mutually approved press release, in the form attached
hereto. Except for the foregoing, neither party hereto, nor its affiliates
or representatives, shall make or cause to be made any public disclosure or
other announcement with respect to the transactions contemplated hereby
except with the prior written consent of the other party hereto, or except
as may be required by applicable law.
7
<PAGE>
IN WITNESS WHEREOF, the parties have executed and delivered this
Agreement as of the date set forth above.
ADVANCED TISSUE SCIENCES, INC.
By: /s/ Arthur J. Benvenuto
__________________________
SMITH & NEPHEW, PLC
By: /s/ John H. Robinson
__________________________
8
EXHIBIT 10.2
FORM OF
SPECIAL ADDENDUM
TO
STOCK OPTION AGREEMENT
The following provisions are hereby incorporated into, and are hereby
made a part of, that certain Stock Option Agreement dated ____________ (the
"Option Agreement") by and between Advanced Tissue Sciences, Inc. (the
"Corporation") and _______________ ("Optionee") evidencing the stock option
(the "Option") granted on such date to Optionee to purchase ______ shares of
the Corporation's common stock (the "Option Shares") under the terms of the
Corporation's 1992 Stock Option/Stock Issuance Plan (or the Corporation's
predecessor Stock Option and Appreciation Plan), and such provisions shall be
effective immediately.
PART ONE -- SPECIAL ACCELERATION PROVISIONS
1. Should there occur an Involuntary Termination of Optionee's
employment with the Corporation (or any successor entity) within twelve (12)
months following a Corporate Transaction in which the Option is assumed or
replaced, then the Option (or replacement grant), to the extent outstanding at
the time but not otherwise fully exercisable for all the Option Shares, shall
automatically accelerate so that the Option shall immediately become
exercisable for all the Option Shares at the time subject to the Option and
may be exercised for any or all of those Option Shares as fully vested shares
of Common Stock or other vested securities. The Option shall remain so
exercisable until the earlier of (i) the specified expiration date of the
option term or (ii) the sooner termination of the Option in accordance with
the provisions of the Option Agreement applicable to the Optionee's cessation
of employment or service with the Corporation.
2. The exercisability of the Option shall automatically accelerate
upon the occurrence of a Change in Control, and the Option, to the extent
outstanding at the time but not otherwise fully exercisable for all the Option
Shares, shall immediately become exercisable for all the Option Shares at the
time subject to the Option and may be exercised for any or all of those shares
as fully vested shares of Common Stock or other vested securities. The Option
shall remain so exercisable until the earlier of (i) the specified
expiration date of the option term or (ii) the sooner termination of the
Option in accordance with the provisions of the Option Agreement applicable to
the Optionee's cessation of employment or service with the Corporation.
<PAGE>
3. Notwithstanding the provisions of Paragraphs 1 and 2 above, the
number of Option Shares as to which the Option shall accelerate upon an
Involuntary Termination following a Corporate Transaction or upon a Change in
Control may be subject to reduction, in accordance with the provisions of Part
Two of this Addendum, if full acceleration of this Option would otherwise,
when added to the present value of certain other payments in the nature of
compensation which become due and payable to Optionee in connection with the
Corporate Transaction or Change in Control, result in the payment to Optionee
of an excess parachute payment under Internal Revenue Code Section 280G(b).
The determination of any such excess parachute payment shall be made by the
Plan Administrator in accordance with the guidelines set forth in Part Two of
this Addendum, and such determination shall be final, binding and conclusive.
4. For purposes of this Addendum, the following definitions shall be
in effect:
A CHANGE IN CONTROL shall be deemed to occur in the event of a
change in ownership or control of the Corporation effected through either of
the following transactions:
(i) the acquisition, directly or indirectly, by any person or
related group of persons (other than the Corporation or a person that
directly or indirectly controls, is controlled by, or is under common control
with, the Corporation) of beneficial ownership (within the meaning of Rule
13d-3 of the Securities Exchange Act of 1934, as amended) of securities
possessing more than fifty percent (50%) of the total combined voting power
of the Corporation's outstanding securities pursuant to a tender or exchange
offer made directly to the Corporation's stockholders which the Corporation's
Board of Directors (the "Board") does not recommend such stockholders to
accept, or
(ii) a change in the composition of the Board over a period of
twenty-four (24) consecutive months or less such that a majority of the Board
members ceases, by reason of one or more contested elections for Board
membership, to be comprised of individuals who either (A) have been Board
members continuously since the beginning of such period or (B) have been
elected or nominated for election as Board members during such period by at
least a majority of the Board members described in clause (A) who were still
in office at the time such election or nomination was approved by the Board.
A CORPORATE TRANSACTION shall be deemed to occur in the event of any
of the following stockholder-approved transactions to which the Corporation is
a party:
(i) a merger or consolidation in which securities possessing more
than fifty percent (50%) of the total combined voting power of the
Corporation's outstanding securities are transferred to a person or persons
different from the persons holding those immediately prior to such
transaction; or
2
<PAGE>
(ii) the sale, transfer or other disposition of all or
substantially all of the assets of the Corporation in liquidation or
dissolution of the Corporation, or
An INVOLUNTARY TERMINATION shall mean the termination of Optionee's
employment with the Corporation (or any successor entity) by reason of:
(i) Optionee's involuntary dismissal or discharge by the
Corporation for reasons other than Misconduct, or
(ii) Optionee's voluntary resignation following (A) any change
in Optionee's title, position, authority or responsibilities (including
reporting responsibilities) which represents an adverse change from his/her
title, position, authority or responsibilities (including reporting
responsibilities) in effect immediately prior to the Change in Control, the
assignment to Optionee of any material duties or responsibilities
inconsistent with his/her title, position, authority or responsibilities in
effect immediately prior to the Change in Control, or any removal of Optionee
from, or failure to appoint or reelect him/her to, any position or title
he/she held immediately prior to the Change in Control, including membership
on the Board of Directors, except to the extent any such changes are
attributable to the Optionee's disability, retirement, death or for
Misconduct; (B) a reduction in Optionee's level of compensation (including
base salary, fringe benefits and participation in any corporate-performance
based bonus or incentive programs); or (C) a relocation of Optionee's place
of employment outside of San Diego County, provided and only if such change,
reduction or relocation is effected by the Corporation without Optionee's
consent.
MISCONDUCT shall mean the commission of any act of fraud,
embezzlement or dishonesty by Optionee, any unauthorized use or disclosure by
Optionee of confidential information or trade secrets of the Corporation (or
any successor entity) or any other intentional misconduct by Optionee
adversely affecting the business or affairs of the Corporation (or any
successor entity) in a material manner.
PART TWO -- DETERMINATION OF SECTION 280G LIMITATION
1. The following definitional provisions are to be utilized in making
all determinations and calculations with respect to any parachute payments to
which Optionee may be entitled in connection with a Corporate Transaction or
Change in Control:
3
<PAGE>
ACTUAL AVERAGE COMPENSATION shall mean Optionee's average W-2 wages
and other compensation received from the Corporation for the five (5) calendar
years (or such fewer number of actual calendar years of employment with the
Corporation) completed immediately prior to the calendar year in which the
Corporate Transaction or Change in Control is effected. Any W-2 wages or
other compensation for a partial year of employment with the Corporation shall
be annualized, in accordance with the frequency with which such wages are paid
during such partial year, before inclusion within Actual Average Compensation.
If any of Optionee's compensation from the Corporation during such five
(5)-year or shorter period was not included in Optionee's W-2 wages for U.S.
income tax purposes, either because Optionee was not a U.S. citizen or
resident or because such compensation was excludable from income as foreign
earned income under Code Section 911 or as pre-tax income under Code Section
125 or 402(g), then such compensation shall nevertheless be included in Actual
Average Compensation to the same extent as if it were part of Optionee's W-2
wages.
CODE shall mean the Internal Revenue Code of 1986, as periodically
amended.
FAIR MARKET VALUE shall mean, with respect to any shares of the
Corporation's Common Stock subject to any accelerated Option, the closing
selling price per share on the date in question on the NASDAQ National Market.
If there is no reported selling price on the date in question, then the Fair
Market Value shall be the closing selling price on the last preceding date for
which such quotation exists.
OPTION shall mean this Option and any other option held by Optionee
under the Corporation's 1992 Stock Option/Stock Issuance Plan, or any
successor plan (collectively the "1992 Plan") or the Corporation's predecessor
Stock Option and Appreciation Plan (the "Predecessor Plan") and outstanding at
the time of the Corporate Transaction or Change in Control.
OPTION PARACHUTE PAYMENT shall mean, with respect to each Option (or
installment thereof) which is accelerated under the 1992 Plan or the
Predecessor Plan upon the Optionee's Involuntary Termination following a
Corporate Transaction or upon a Change in Control, the portion of that Option
deemed to be a parachute payment under Code Section 280G and the Treasury
Regulations issued thereunder. The portion of such Option which is
categorized as an Option Parachute Payment shall be calculated in accordance
with the valuation provisions established under Code Section 280G and the
applicable Treasury Regulations and shall include an appropriate dollar
adjustment to reflect the lapse of Optionee's obligation to remain in the
Corporation's employment as a condition to the vesting of the accelerated
installment. In no event, however, shall the Option Parachute Payment
attributable to any Option (or accelerated installment) exceed the spread (the
excess of the Fair Market Value of the accelerated option shares over the
option exercise price payable for those shares).
4
<PAGE>
OTHER PARACHUTE PAYMENTS shall mean any payments in the nature of
compensation (other than the Option Parachute Payments) to which Optionee may
become entitled in connection with the Corporate Transaction or Change in
Control, whether payable at that time or upon Optionee's subsequent
termination of employment with the Corporation, and which accordingly qualify
as parachute payments within the meaning of Code Section 280G(b)(2) and the
Treasury Regulations issued thereunder.
PRESENT VALUE shall mean the value, determined as of the effective
date of the Corporate Transaction or Change in Control, of any payment in the
nature of compensation which Optionee becomes entitled to receive from the
Corporation in connection therewith, including (without limitation) the
aggregate Option Parachute Payment attributable to the Options held by
Optionee and all Other Parachute Payments to which Optionee is entitled. The
Present Value of any such payment which is not otherwise due and payable at
the time of the Corporate Transaction or Change in Control shall be determined
in accordance with the provisions of Code Section 280G(d)(4), utilizing a
discount rate equal to one hundred twenty percent (120%) of the applicable
Federal rate in effect at the time of such determination, compounded
semi-annually to the effective date of the Corporate Transaction or Change in
Control.
2. The number of Option Shares as to which this Option shall
accelerate upon an Involuntary Termination following a Corporate Transaction
or upon a Change in Control shall, in accordance with the order of priority
established in Paragraph 5, be reduced to the extent necessary to assure that
the aggregate Option Parachute Payment and all Other Parachute Payments to
which Optionee may become entitled in connection with such Corporate
Transaction or Change in Control does not exceed the greater of the
following two amounts:
(i) Optionee's Actual Average Compensation multiplied by 2.99, or
(ii) the greatest after-tax dollar amount payable to Optionee as
Option Parachute Payments and Other Parachute Payments after taking into
account the excise tax liability Optionee will incur under Code Section 280G
in connection with those payments.
3. In the event there is any dispute with Optionee as to whether one
or more payments to which Optionee may become entitled in connection with a
Corporate Transaction or Change in Control constitute Option Parachute
Payments or Other Parachute Payments, such dispute shall be resolved as
follows:
- In the event temporary, proposed or final Treasury Regulations in
effect at the time under Code Section 280G (or applicable judicial decisions)
5
<PAGE>
specifically address the status of any such payment or the method of valuation
therefor, the characterization afforded to such payment by the Regulations
(or such decisions) shall, together with the applicable valuation
methodology, be controlling.
- In the event the Regulations (or applicable judicial decisions) do
not address the status of any payment in dispute, the matter shall be
submitted for resolution to independent counsel mutually acceptable to the
Corporation and Optionee ("Independent Counsel"). The resolution reached by
Independent Counsel shall be final and controlling; provided, however, that
if in the judgment of Independent Counsel the status of the payment in
dispute can be resolved through the obtainment of a private letter ruling
from the Internal Revenue Service, a formal and proper request for such
ruling shall be prepared and submitted by Independent Counsel, and the
determination made by the Internal Revenue Service in the issued ruling shall
be controlling. All expenses incurred in connection with the retention of
Independent Counsel and (if applicable) the preparation and submission of the
ruling request shall be shared equally by the Corporation and Optionee.
- In the event the Regulations (or applicable judicial decisions) do
not address the appropriate valuation methodology for any payment in dispute,
the value thereof shall, at the Independent Counsel's election, be determined
through an independent third-party appraisal, and the expenses incurred in
obtaining such appraisal shall be shared equally by the Corporation and
Optionee.
4. If the existence of one or more payments is in dispute under
Paragraph 3, Optionee shall be permitted to exercise this Option or any other
Option at any time prior to the expiration or sooner termination of the option
term; provided all securities purchased under such Options shall, together
with the exercise price paid for those securities, be held in escrow by the
Corporation. To the extent such purchased securities are held in escrow,
Optionee shall have the right to (i) direct the sale of such shares, provided
the sale proceeds are immediately deposited in escrow, (ii) exercise all
voting rights with respect to such securities and (iii) receive dividends
declared on such securities, provided such dividends are immediately deposited
in escrow.
5. Once any required determinations under Paragraph 3 have been made,
then to the extent the aggregate Option Parachute Payment attributable to the
Options which would otherwise accelerate upon Optionee's Involuntary
Termination following a Corporate Transaction or upon a Change in Control
would, when added to the Other Parachute Payments to which Optionee is
entitled, exceed the applicable Paragraph 2 limitation, the number of Option
Shares for which Options are to be accelerated shall be reduced in the
following order of priority:
First, those Options which would otherwise generate the highest
Option Parachute Payments upon their acceleration shall not accelerate.
6
<PAGE>
Then, to the extent one or more Options may have been exercised on
an accelerated basis, those exercises shall be rescinded (with the Options
generating the highest Option Parachute Payments to be the first to be
rescinded) by refunding to Optionee the exercise price paid for the purchased
securities and returning those securities (plus any cash dividends paid
thereon) to the Corporation. To the extent the securities purchased under the
accelerated Options shall have been sold while held in escrow, the sale
proceeds attributable to those securities shall be allocated as follows: first
an amount not to exceed the exercise price paid for such securities shall be
refunded to Optionee, and then the balance of the proceeds (together with any
cash dividends paid on those securities) shall be returned to the Corporation.
To the extent any Options do not accelerate upon a Change in Control
by reason of the limitations in effect under this Special Addendum, those
Option shall remain outstanding and continue to become exercisable for the
remaining option shares in accordance with the normal exercise/vesting
schedule in effect for each such Option, until the earlier of (i) the
expiration date of the option term or (ii) the sooner termination of such
Option in accordance with the terms of the applicable option agreement.
Except as modified and supplemented by this Special Addendum, all
the terms and conditions of the Option Agreement shall continue in full force
and effect.
IN WITNESS WHEREOF, Advanced Tissue Sciences, Inc. has caused this
Addendum to be executed by its duly-authorized officer, and Optionee has
executed this Addendum, all as of the Effective Date specified below.
ADVANCED TISSUE SCIENCES, INC.
By:
---------------------------
Title:
-------------------------
-------------------------------
OPTIONEE
EFFECTIVE DATE:_______________, 1996
7
