UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE YEAR ENDED DECEMBER 31, 1996
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER 0-016607
ADVANCED TISSUE SCIENCES, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 14-1701513
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(STATE OR OTHER JURISDICTION (I.R.S. EMPLOYER
OF INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
10933 NORTH TORREY PINES ROAD, LA JOLLA, CALIFORNIA 93027
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(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (619) 450-5730
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
COMMON STOCK, $.01 PAR VALUE
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(TITLE OF CLASS)
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Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
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
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As of March 15, 1997 there were 37,497,947 shares of Common Stock
outstanding.
The aggregate market value of the Common Stock of the Registrant held by
non-affiliates on March 15, 1997 was approximately $462,876,000.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Company's Proxy Statement for the Annual Meeting of
Stockholders to be held on May 20, 1997, as filed with the Commission pursuant
to Regulation 14A, are incorporated by reference into Part III of this report.
<PAGE>
PART I
ITEM 1. BUSINESS
INTRODUCTION
Advanced Tissue Sciences, Inc. (the "Company" or "Advanced Tissue
Sciences") is a leading tissue engineering company engaged in the development
of living human tissue products for therapeutic applications and is currently
focusing its efforts primarily on skin, cartilage and cardiovascular products.
Utilizing principles of cell biology, biochemistry and polymer science, the
Company has developed and is applying a proprietary core technology which
permits living human cells to be cultured ex vivo in a manner that allows the
cells to develop and assemble into functioning three-dimensional tissue. The
Company has successfully replicated a variety of human tissues and has a
number of products under various stages of development.
Advanced Tissue Sciences' objective is to redefine tissue repair and
transplantation by developing, manufacturing and marketing products produced
through tissue engineering. The Company's product strategy is to utilize its
patented core technology to develop multiple products which address unmet
therapeutic needs or offer improved, cost-effective alternatives to current
treatment modalities. By building upon its base of scientific knowledge
through the continued application of its proprietary core technology, the
Company believes it will be able to achieve significant synergies in the
development, clinical testing and manufacture of successive tissue products.
In addition, the Company is focusing its development programs on products
which are currently being or are expected to be regulated as medical devices.
Medical devices are generally subject to a shorter regulatory approval process
than biologics or pharmaceuticals.
Leading the Company's product development efforts are therapeutic skin
products which address the burn and diabetic ulcer markets. These products,
based on Dermagraft(R), a three-dimensional living human tissue designed by
the Company as a temporary or permanent replacement for human dermis, were
developed to treat conditions where the dermis (the inner skin layer) has been
injured or destroyed, such as in severe burns and chronic skin ulcers. The
dermis is essential to normal skin function and healing and, unlike epidermis
(the outer skin layer), does not regenerate into normal tissue after injury.
The Company's first commercial product, Dermagraft-TC(TM), was approved for
commercial sale by the U.S. Food and Drug Administration ("FDA") in March
1997. In December 1996, the Company submitted a Premarket Approval ("PMA")
application with the FDA for Dermagraft in the treatment of diabetic foot
ulcers. The FDA has accepted the PMA application for filing and has notified
the Company the Dermagraft PMA application will receive an expedited review.
The following table summarizes the applications and stages of development
of the Company's leading therapeutic products.
<TABLE>
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PRODUCT THERAPEUTIC INDICATION STATUS (1)
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BURNS:
Dermagraft-TC Temporary covering for severe burns Market
Dermagraft-TC Partial thickness burns Physician IDE
SKIN ULCERS:
Dermagraft-Ulcers Dermal replacement for diabetic foot PMA submitted (2)
ulcers
ORTHOPEDICS:
Articular Cartilage Repair of articular surfaces in joints IDE submitted
Meniscal Cartilage Meniscal repair and replacement Pilot preclinical
CARDIOVASCULAR:
Blood Vessels Blood vessel replacements Pilot preclinical
Heart Valves Heart valve replacements Pilot preclinical
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</TABLE>
(1) A "pilot clinical" trial denotes a human trial intended to evaluate a
product's safety and efficacy prior to beginning a pivotal clinical
trial. A "physician IDE" denotes limited human trials performed by a
physician to gain product experience in new or existing indications of
a product.
(2) The Company is currently enrolling fifty patients into a confirmatory
trial which will be submitted as an amendment to the marketing applica-
tion. See "Products - Skin Ulcer Products."
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<PAGE>
DERMAGRAFT-TC. Dermagraft-TC received marketing approval from the FDA in
March 1997. Dermagraft-TC has been developed as an alternative to human
cadaver skin to treat severely burned patients. Dermagraft-TC consists of a
dermal tissue with an ultrathin synthetic covering that acts as a protective
cover to help retain fluids and reduce the risk of infection until a
sufficient amount of the patient's own skin becomes available for grafting.
Of the approximately 2 million people who suffer burn injuries annually
in the United States, up to 13,000 are severely burned and require skin
grafts. The Company's Dermagraft-TC product is initially intended to address
the approximately 1,500 severely burned patients with burns exceeding 20% body
surface area. The Company estimates the United States market opportunity for
this indication to be approximately $30 million. Subject to approval, the
Company believes Dermagraft-TC may also be used to treat partial thickness
burns. See "Products - Burn Products."
DERMAGRAFT IN DIABETIC FOOT ULCERS. Dermagraft for the treatment of
diabetic foot ulcers is a dermal replacement product grown on a bioabsorbable
scaffold. It is designed to provide a healthy, metabolically active dermal
matrix in the ulcer to support wound closure. Approximately 800,000 diabetic
foot ulcers are treated in the United States each year. Based on data from
outside sources, it is estimated that the total United States market
opportunity for this targeted indication potentially exceeds $1 billion. The
Company has entered into a fifty-fifty joint venture with Smith & Nephew plc
("Smith & Nephew") for the worldwide commercialization of Dermagraft for this
indication. See "Collaborations and Strategic Alliances."
In February 1997, the FDA accepted for filing under its expedited review
process a PMA application requesting approval to market Dermagraft for the
treatment of diabetic foot ulcers. The PMA submission was based on results of
a pivotal clinical trial in which Dermagraft within a therapeutic range, or
dose, was shown to be significantly more effective in achieving complete
healing and in reducing time to healing. In the trial, product falling within
the therapeutic range produced a statistically significant improvement in the
primary endpoint, complete wound closure (p value = 0.01). In addition, these
patients achieved complete healing faster (p value = 0.01). Currently, an
additional fifty patients are being enrolled to confirm the equivalence of
Dermagraft product produced in this therapeutic range and according to final
commercial specifications. Data from this confirmatory clinical trial will be
submitted as an amendment to the PMA application. See "Products - Skin Ulcer
Products."
ORTHOPEDICS. In another application of its three-dimensional culture
system, the Company is developing tissue engineered cartilage for orthopedic
applications through a separate joint venture with Smith & Nephew. In
December 1996, the Company submitted an Investigational Device Exemption (an
"IDE") to the FDA requesting approval to begin a pilot clinical trial with
human tissue engineered articular cartilage for the repair of articular
surfaces in knee joints. The Company is in the process of preparing
additional information as requested by the FDA with respect to the IDE. If
approved by the FDA, the Company anticipates the pilot trial would begin in
the second half of 1997. Tissue engineered articular cartilage could provide
a significant opportunity to treat patients at an earlier stage of joint
degeneration, thereby delaying, or in some cases eliminating, the need for
total joint replacements. There are over 1.2 million arthroscopic procedures
for repair of the knee, including procedures involving articular cartilage,
meniscus and ligament performed annually in the United States. See
"Orthopedic Products."
CARDIOVASCULAR. Through the use of its tissue engineering technology,
Advanced Tissue Sciences is working on developing blood vessels and heart
valves which will grow and repair normally. The Company's tissue engineered
products may provide enhanced biocompatibility and improved durability which
may also reduce the likelihood of thromboembolic events and the associated
need for anticoagulant drugs required with currently available products. In
the United States over 900,000 Americans die each year from cardiovascular
disease. Each year, over 60,000 prosthetic heart valves are implanted and
approximately 430,000 vascular graft procedures are performed in the United
States. See "Products - Cardiovascular Products."
Advanced Tissue Sciences, Inc. was incorporated under the laws of the
State of Delaware in 1987. The Company maintains its executive offices at
10933 North Torrey Pines Road, La Jolla, California 92037, and its telephone
number at that address is (619) 450-5730. Financial information regarding the
Company's operating losses, research expenditures and identifiable assets can
be found in a separate section of this Annual Report on Form 10-K beginning on
page F-1.
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<PAGE>
PART I OF THIS REPORT AND MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS APPEARING IN A SEPARATE SECTION
OF THIS ANNUAL REPORT BEGINNING ON PAGE F-2 CONTAIN FORWARD-LOOKING STATEMENTS
WITHIN THE MEANING OF THE SECURITIES EXCHANGE ACT OF 1934. ACTUAL RESULTS
COULD DIFFER MATERIALLY FROM THOSE PROJECTED IN THE FORWARD-LOOKING STATEMENTS
AS A RESULT OF THE VARIOUS RISK FACTORS DESCRIBED IN PART I OF THIS REPORT.
PROPRIETARY CORE TECHNOLOGY
The Company's tissue engineering technology involves the controlled ex
vivo growth of living tissues and organs on three-dimensional support
structures. The Company believes that its technology represents a major
advance in medical science. Over the last several decades, technologies have
been developed that have made possible the growth of many of the over 200
different types of cells found in the human body in laboratory containers
filled with nutrient media. When grown on two-dimensional surfaces, the
ability of cells to interact and organize themselves into functioning tissues
is limited. In contrast, a three-dimensional framework allows cells to
develop and assemble into tissues that more closely resemble their
counterparts in the body.
In normal growth and development, the body uses specialized connective
tissue cells to form "stroma" or a living matrix that provides the
three-dimensional structure for each organ. Stroma also provides attachment
sites and produces growth factors that promote the development of organ cells
into functioning tissues. While the specific components and configuration of
stroma may differ from organ to organ, the basic principle of
three-dimensional stromal support applies to most organs in the body.
The Company has developed a proprietary core technology that combines the
principles of cell biology, biochemistry and polymer science to create a
three-dimensional living support stroma ex vivo. The support stroma is made
by first seeding organ-specific stromal cells (cell biology) onto a mesh
framework (polymer science) in an environment that simulates the body. The
cells attach, divide and secrete extracellular matrix proteins and growth
factors (biochemistry), using the mesh as a scaffolding. This process results
in a completely human stromal tissue that, in turn, supports the growth of
organ cells into functional tissue. Advanced Tissue Sciences has been issued
United States and European patents covering its core technology and numerous
patents related to applications of such technology. See "Patents and
Proprietary Rights."
The Company believes that its tissue engineered products may offer some
or all of the following benefits, depending upon the particular application of
the product:
* Physiological Human Tissue -- The Company's patented core technology
allows the cells to grow on a scaffold and develop into a three-dimensional
human tissue. The Company's products may then be transplanted as a
physiological tissue, as contrasted with the transplantation of cells or
scaffolds alone.
* Multiple Factors For Healing -- The human cells produce multiple growth
factors and tissue matrix proteins, all of which the Company believes are
important in the tissue repair process.
* Human Tissue -- The tissue matrix proteins naturally secreted by the
cells consist of human collagens, glycosaminoglycans and other human
proteins, rather than animal-derived matrix proteins, which may cause
allergic or immune reactions which can occur in response to animal-derived
matrix proteins.
* Safety Tested -- The human tissue materials used in the manufacture of
the Company's products are extensively tested at independent laboratories
for potential pathogens such as Hepatitis B and HIV. All final product is
tested for sterility by performing United States Pharmacopeia (U.S.P.)
sterility tests on each product's growth medium.
* Off-the-Shelf Products -- Medical research has shown that several
tissues, including dermal tissue and certain cartilage tissue applications,
are not subject to rejection by a recipient's body. These tissue
engineered products may, therefore, be utilized as universal, permanent
replacement products in such applications.
* Prolonged Shelf Life -- The Company's dermal products can be frozen for
long-term storage. Similarly, it is expected that cartilage and some of
the other tissues in development will be able to be cryopreserved for a
long shelf life.
* Ease of Use -- The Company's dermal products are easy for surgeons to
apply using routine surgical techniques. In addition, tissue engineered
cartilage is being developed to be delivered in a single arthroscopic
procedure.
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<PAGE>
PRODUCTS
The Company has a number of therapeutic tissue products which are in
various stages of commercialization, clinical trials, preclinical studies and
research. Currently, its primary product focus is directed toward skin (for
burns and ulcers), orthopedic cartilage and cardiovascular products. In
addition, based on available resources, clinical results, markets and other
cost benefit considerations, the Company intends to bring other potential
products to market in the future. The following table summarizes the
potential applications and status of these therapeutic products.
<TABLE>
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PRODUCT THERAPEUTIC INDICATION STATUS(1)(2)
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<S> <C> <C>
BURNS:
Dermagraft-TC Temporary covering for severe burns Market
Dermagraft-TC Partial thickness burns Physician IDE
Dermagraft-Burns Dermal replacement for severe burns Pilot clinical
Dermagraft-Epidermis Full thickness skin replacement for burns Pilot preclinical
SKIN ULCERS:
Dermagraft-Ulcers Dermal replacement for diabetic foot PMA submitted (3)
ulcers
Dermagraft-Ulcers Dermal replacement for pressure ulcers Pilot clinical
Dermagraft-Ulcers Dermal replacement for venous ulcers Pivotal clinical
ORTHOPEDICS:
Articular Cartilage Repair of articular surfaces in joints IDE submitted
Meniscal Cartilage Meniscal repair and replacement Pilot preclinical
Ligament Ligament repair or replacement Pilot preclinical
Tendon Tendon repair or replacement Pilot preclinical
Bone Bone grafting Pilot preclinical
CARDIOVASCULAR:
Blood Vessels Blood vessel replacements Pilot preclinical
Heart Valves Heart valve replacements Pilot preclinical
Stents Restenosis prevention Research
OTHER THERAPEUTIC TISSUES:
Reconstructive Applications -
Cartilage Facial reconstruction Pilot preclinical
Bone Facial reconstruction Pilot preclinical
Dermagraft Scar revision and temporary wrinkle removal Research
Liver Bridge to transplantation or replacement Pilot preclinical
Bone Marrow Universal bone marrow replacement Pilot preclinical
Pancreas Metabolically active tissue for
transplantation Pilot preclinical
Gastrointestinal Replacements/patches for gastrointestinal
tract Pilot preclinical
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</TABLE>
(1) A "pivotal clinical" trial denotes a human trial intended to support
an application to the FDA for approval to market a product. A "pilot
clinical" trial denotes a human trial intended to evaluate a product's
safety and efficacy prior to beginning a pivotal clinical trial. A
"physician IDE" denotes limited human trials performed by a physician
to gain product experience in new or existing indications of a product.
A "pivotal preclinical" trial denotes an animal trial intended to
support an application to the FDA for approval to commence human
clinical trials. "Pilot preclinical" trials denote animal trials
intended to evaluate a product's characteristics prior to beginning
pivotal preclinical trials. "Research" denotes product development
prior to studies in animal models.
(2) See "Burn Products," "Skin Ulcer Products," "Orthopedic Products" and
"Cardiovascular Products" with respect to those programs that are being
advanced, and those programs that may be advanced subject to the
availability of additional resources.
(3) The Company is currently enrolling fifty patients into a confirmatory
trial which will be submitted as an amendment to the marketing applica-
tion. See "Skin Ulcer Products - Diabetic Foot Ulcers."
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<PAGE>
BURN PRODUCTS
Although there have been many advances in the care and treatment of
severely burned patients, available alternatives remain fairly limited and
success is highly dependent on the skills of burn surgeons and nurses. As a
result of the need for improvements in patient care and the ability to closely
monitor product performance, the Company selected severe burns as the target
for its first therapeutic use of the Company's tissue engineering technology.
In addition, dermal tissue has several advantages over other tissues or organs
in that it is grown from fibroblasts, which are both readily available and not
subject to rejection by the body. The Company's burn products are also
regulated as devices and, therefore, are generally subject to a shorter
regulatory approval process than biologics. See "Government Regulation."
Currently, to treat large full thickness burns (where both the epidermis
and the dermis are destroyed), burn surgeons typically excise the damaged
tissue and cover the wound as soon as possible. Conventional treatment for
large full thickness burns usually involves the use of temporary coverings to
limit infection, reduce pain and prevent loss of body fluids, followed by
grafting of the patient's own skin ("autograft") as it becomes available. In
most cases, permanent closure of severe burn wounds is achieved with
autografts obtained by surgically harvesting areas of the patient's skin which
are still intact ("donor sites"). The dermis at the donor site is typically
"split" so that the removed graft consists of the entire epidermis and the
upper portion of the dermis (a "split-thickness" graft), leaving the bottom
portion of the dermis in the donor site to facilitate healing.
In extensive partial thickness burns in which both the epidermis and
dermis have not been destroyed grafting is not required. In partial thickness
burns the effort is to close the wound as quickly as possible to reduce pain,
the incidence of infection and scarring. Partial thickness burns are
generally treated with antimicrobial agents, the most common being silver
sulfadiazine which is applied topically. Dressings are generally changed one
or two times a day. At each dressing change the surgeons will typically
debride the wound.
BURN MARKET. Of the approximately 70,000 burn patients hospitalized
annually in the United States, up to 13,000 are severely burned and require
skin grafts. Initially, the Company's Dermagraft-TC and Dermagraft-Burns
would be expected to address the approximately 1,500 severely burned patients
requiring skin grafts with burns exceeding twenty percent of body surface
area. The Company estimates the total initial United States market
opportunity for this indication to be approximately $30 million. The Company
believes it may be able to expand into partial thickness burns and, if
additional benefits such as reduced scarring and a lower risk of disease
transmission are realized, may be able to address full thickness burns
involving less than twenty percent of body surface area.
DERMAGRAFT-TC. Patients with extensive full thickness burns have only a
limited amount of undamaged skin which can be used as donor sites for
autografts. This shortage of donor sites prevents rapid closure of the burn
wounds leaving the patient susceptible to infections and fluid loss, both of
which can be life-threatening. When sufficient autograft is not available,
human cadaver skin is often used as a temporary covering for excised burns.
However, cadaver skin may transmit infection and is immunologically rejected
generally within several weeks of application. As a result, the patient may
require additional surgical procedures to cover the wound, increasing the
overall cost of treatment. Rejection can also give rise to complicating
infections of the burn wounds. In addition, repeated applications of cadaver
skin can cause more rapid rejection. Removal of cadaver skin prior to
autografting can be difficult and cause significant bleeding.
As an alternative to human cadaver skin, the Company has developed
Dermagraft-TC. Dermagraft-TC consists of Dermagraft dermal tissue with an
ultra-thin synthetic covering that acts as a temporary epidermis which helps
to retain fluids and prevent infections of the wound bed. As with cadaver
skin, Dermagraft-TC must ultimately be removed from the wound bed prior to
grafting. However, the Company believes that Dermagraft-TC offers significant
advantages over cadaver skin. Cadaver skins has a host of limitations, such
limited availability, the potential for immunological rejections that
necessitate repeat applications, significant bleeding and inflammation of the
wound bed and the potential for disease transmission. However, the human
tissue materials used in the
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manufacture of Dermagraft products, including Dermagraft-TC, are extensively
tested for potential pathogens such as Hepatitis B and HIV.
In March of 1997, the FDA gave the Company approval under its expedited
review process to begin commercial sales of Dermagraft-TC in the United States
for use as a temporary covering for severe burn wounds. The approval followed
the recommendation of an independent panel of outside experts convened by the
FDA. The panel's recommendation was based on a pivotal clinical trial which
demonstrated that Dermagraft-TC was successful in adequately preparing the
wound bed for successful autografting, performing equal to or better than the
cadaver skin control (p value < 0.0001). In addition, Dermagraft-TC performed
significantly better than the control with respect to important secondary
endpoints such as ease of removal, amount of excision required, amount of
bleeding upon excision and overall satisfaction rating as a temporary covering
among clinical investigators (p value < 0.05). Under the approval, the
Company is to conduct post-marketing surveillance to generate additional
information relative to infection rates.
In an ongoing pilot clinical trial under a physician's IDE, Dermagraft-TC
is being evaluated as an alternative to silver sulfadiazine in the treatment
of patients with limited to moderate partial thickness burns. In the trial,
Dermagraft-TC is affixed to the burns with adhesive strips and remains until
the wound is closed. Dermagraft-TC is being compared to silver sulfadiazine
with twice daily dressing changes and wound debridement per the burn center's
standard practice. Although limited, in results reported to date in seven
patients, Dermagraft-TC has shown a substantially reduced time to 90% healing
or epithelialization (p value = 0.002), less than half the time to heal with
the silver sulfadiazine control treatment. Dermagraft-TC may offer several
advantages in the treatment of partial thickness burns. As compared to silver
sulfadiazine, Dermagraft-TC could eliminate the pain, time and cost associated
with once or twice daily dressing changes and debridement. More rapid healing
would also reduce the costs and time associated with treatment. In addition,
accelerated healing could potentially improve the quality and reduce the
hypertropic scarring often seen in these burn wounds.
The Company also has an agreement with Battelle, a contract research
laboratory, and the U.S. Army Institute of Chemical Defense to begin
preclinical feasibility testing of Dermagraft-TC in the treatment of chemical
burns. In this preclinical study, Dermagraft-TC and cadaver tissue will be
placed on chemical wounds for a period of two weeks, followed by autografts
over the sites. The study is designed to determine if Dermagraft-TC will
adhere as well as cadaver skin and that subsequent autografts take over the
Dermagraft-TC sites. The feasibility study is expected to continue through
1997. FDA approval will be required before Dermagraft-TC could be made
available to the military for use in treating chemical burns.
Dermagraft-TC is a new treatment alternative and is the first therapeutic
product to be commercially introduced by the Company. As such, the Company
faces certain risks and uncertainties in the commercialization of such
product, including the risk that the Company will not be able to manufacture
commercial quantities of Dermagraft-TC at a reasonable cost, successfully
market the product for its approved indication, gain marketing approvals for
any additional indications or in any additional countries, or gain any
significant degree of market acceptance of Dermagraft-TC. See "Manufacturing
and Supply," "Sales and Marketing" and "Competition."
DERMAGRAFT-BURNS. The Company also developed a Dermagraft product
("Dermagraft-Burns") to provide a supporting dermal replacement in the
treatment of severely burned patients. The Company believes that
Dermagraft-Burns could potentially offer many benefits over current burn
treatment options.
* Stronger attachment -- Skin grafts lacking a dermal component often have
an insufficient base for attachment of the epidermis, leaving the patient
with a poorly anchored skin graft that is fragile and prone to blistering.
Dermagraft-Burns supplies a dermal base upon which epidermis can attach and
grow, and is therefore expected to produce a more durable epidermal
attachment.
* Thinner grafts -- Dermagraft-Burns may allow surgeons to use thinner
autografts that consist primarily of epidermis, thus sparing the dermis
at the patient's donor sites. Thin-graft donor sites have been shown to
heal more quickly with less discomfort to the patient and with signifi-
cantly better cosmetic and functional results. For larger burns which
require multiple surgical procedures, more rapid healing of donor sites
would also allow the surgeon to harvest grafts more frequently, thereby
shortening the patient's overall hospital stay.
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<PAGE>
* Reduced scarring -- Scar formation in normal wound healing is, in part, a
consequence of insufficient dermis. By providing a dermal surface beneath
meshed autografts, Dermagraft-Burns may reduce scarring at the burn site,
thereby improving cosmetic appearance and functional outcome.
Under an IDE approved by the FDA in October 1990, the Company conducted a
randomized, multi-center clinical trial of Dermagraft-Burns enrolling
seventy-six patients in twelve participating centers from January 1991 to
April 1992. An interim analysis of preliminary clinical results was
encouraging, indicating that Dermagraft-Burns attached and vascularized
reliably on a variety of wound beds and allowed epithelialization from meshed
grafts of the patient's own skin, although in some patients the "take", or
attachment and survival, of the autograft placed over Dermagraft-Burns was not
as high as on control sites. In the interest of optimizing the take of
overlying autografts, the Company developed enhanced versions of
Dermagraft-Burns. The Company enrolled fourteen additional patients in three
centers using enhanced versions of Dermagraft-Burns under supplements to the
original IDE.
To avoid competing for enrollment with the pivotal trial of
Dermagraft-TC, and in consideration of the Company's resources, no patients
have been enrolled in the Dermagraft-Burns trials since mid-1994. At this
time, the Company is focusing it resources on Dermagraft-TC and cannot predict
when or if it will continue clinical trials of its Dermagraft-Burns product.
DERMAGRAFT-EPIDERMIS. The Company has explored a variety of concepts
involving a Dermagraft product for burns providing both an epidermal and a
dermal layer, that could be used as a full thickness skin replacement.
Research has been performed using modifications of the Company's current burn
products in combination with a patient's own epidermal cells. Epidermal cells
can be expanded into sheets from a small specimen of the patient's skin using
a variety of published techniques, and are now sometimes used in patients
whose burns are so extensive that sufficient autograft skin cannot be
harvested. However, cultured epidermal sheets lack dermal support.
Although the Company has continued to evaluate alternatives for a full
thickness burn product, it has not devoted substantial resources to this
investigation over the past year. The Company cannot predict with any
certainty at this time whether it will choose to devote resources to a full
thickness burn product in 1997 or elect to advance any specific alternative
for a full thickness burn product.
SKIN ULCER PRODUCTS
Based on its initial experience with Dermagraft-Burns, chronic skin
ulcers were also selected as one of the Company's first therapeutic targets.
The Company believes that Dermagraft-Ulcers may provide a healthy,
metabolically active dermal matrix in the ulcer bed that will support growth
of the patient's epidermis from the edges of the wound and promote wound
closure. Dermagraft-Ulcers may therefore reduce the time required to heal
these wounds and potentially reduce the need for skin grafting and
reconstructive procedures. Using Dermagraft, the Company is able to benefit
from the experience it has gained from the development of the Dermagraft-Burns
product, including the use of common raw materials (i.e., cell source,
scaffolds, growth media), manufacturing processes, freezing procedures,
storage methods and packaging concepts. No safety concerns or incidents of
immunologic rejections have been observed with any Dermagraft-based product.
Dermagraft-Ulcers is regulated by the FDA as a medical device.
Traditionally, there have been two approaches to skin ulcer treatment.
The most common treatment for less advanced ulcers is to allow normal healing
to occur by using dressings and topical medications to protect the wound.
Even when successful, this therapy can require many months of repeated
treatments to achieve healing. The second approach utilizes conventional skin
grafts and is typically used for more advanced skin ulcers. The difficulty of
healing donor sites and the risks associated with general anesthesia in the
elderly, who suffer the large majority of chronic skin ulcers, often prevents
the use of skin grafts. Both treatment approaches have a high failure rate.
The Company has developed Dermagraft-Ulcers, a bioengineered, human dermal
skin replacement, to treat three types of skin ulcers: diabetic ulcers,
pressure ulcers and venous ulcers.
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<PAGE>
ULCER MARKET. Over 2,800,000 cases of chronic, slow-healing or
non-healing skin ulcers are treated in the United States each year. In these
wounds, skin breaks down as a result of disruption of blood flow to the skin
caused either by prolonged pressure over a localized area or by chronic
diseases which affect the circulatory or peripheral nervous systems. In many
of these patients, skin ulcers are open, often painful, wounds which are
resistant to healing for many months or years. In part because current
therapies for skin ulcers are often ineffective, the treatment of skin ulcers
is an expensive process. Individual patient treatment can cost thousands of
dollars per year. Published sources estimate that the United States health
care system spends more than $5 billion each year for the treatment of chronic
skin ulcers.
Approximately 800,000 diabetics in the United States suffer from chronic,
non-healing diabetic foot ulcers each year, 400,000 of which represent the
Company's initial target market. It is estimated that diabetes leads to over
55,000 limb amputations annually in the United States. Based on data from
outside sources, it is estimated that the total United States market for
treating diabetic foot ulcers exceeds $1 billion. In addition, it is
estimated that approximately 1,500,000 patients are affected by pressure
ulcers and approximately 500,000 patients are diagnosed with venous ulcers in
the United States each year.
DIABETIC FOOT ULCERS. Many diabetic patients experience circulatory
deficiencies and decreased nerve sensation in their legs and feet, which
prevent them from shifting their weight in response to wound-provoking
pressure. The patient may be unaware of some injuries and can leave wounds
unattended for days, resulting in an ulcer. Once the ulcer forms, it may heal
poorly due to the effects of diabetes on normal healing processes. Unhealed
diabetic ulcers can result in gangrenous infection that may lead to amputation
of the limb.
In December 1996, the Company submitted, and in February 1997 the FDA
accepted for filing under its expedited review process, a PMA application
requesting approval to market Dermagraft for the treatment of diabetic foot
ulcers. The PMA submission was based on results of a pivotal clinical trial,
as described below, in which Dermagraft within a therapeutic range, or dose,
was shown to be significantly more effective in achieving complete healing and
in reducing time to healing than the standard of care used in the control
treatment. Currently, an additional fifty patients are being enrolled to
confirm the equivalence of Dermagraft product produced in this therapeutic
range and according to final commercial specifications. Data from this
confirmatory clinical trial will be submitted as an amendment to the PMA
application.
In late 1994, under a supplement to its IDE, the Company was given
approval to enroll up to 250 patients in twenty centers in the United States
in a single blinded and randomized pivotal clinical trial. In January 1996,
to insure a sufficient number of evaluable patients in the treatment, the FDA
approved the enrollment of up to an additional fifteen to twenty-five patients
in each of the treatment and control groups in the trial. In this pivotal
trial, each patient in the treatment group received a dosing regimen of one
piece of Dermagraft per week for up to eight weeks. The primary endpoint of
the trial, complete wound closure, was evaluated over a period of twelve
weeks. Patients in the trial are also being followed for a total of
thirty-two weeks to assess safety and any Dermagraft effect on reducing
recurrence.
A total of 281 patients were enrolled in the pivotal clinical trial,
resulting in 240 evaluable patients, all of which are to be included in
evaluating the safety of Dermagraft. As discussed above, the PMA submission
is based on the efficacy of Dermagraft falling within a therapeutic range
identified from the clinical trial. Patients receiving Dermagraft product
within this therapeutic range represented a majority but not all the evaluable
patients in the trial. In the trial, product falling within the therapeutic
range produced a statistically significant improvement in the primary
endpoint, complete wound closure (p value = 0.01). In addition, these
patients achieved complete healing faster (p value = 0.01).
In April 1996, the Company entered into a fifty-fifty joint venture with
Smith & Nephew (the "Dermagraft Joint Venture") for the worldwide
commercialization of Dermagraft for the treatment of diabetic foot ulcers. As
part of its global marketing strategy, the Dermagraft Joint Venture is working
to gain approval in other countries in North America, Western Europe and the
Pacific Rim. See "Collaborations and Strategic Alliances."
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The Company is also in the processes of completing a clinical trial in
France for Dermagraft-Ulcers in the treatment of diabetic foot ulcers. The
French government has helped to fund the trial and has adopted a new
regulatory designation which the Company believes may facilitate the
commercialization and reimbursement of the Company's tissue engineered
products. If successful, safety and efficacy from both the French and United
States trials will be used to support an application for marketing approval
from the French government.
There can be no assurance given that the Company's enrollment of
additional patients in the United States will not delay the evaluation of the
PMA or change the outcome of the pivotal clinical trial on which the PMA was
based, that the FDA will concur with the Company's analysis or conclusion
regarding the data obtained from such trial, or that Company will ultimately
gain FDA approval or approval in any other country to commercialize its
Dermagraft-Ulcers product. See "Government Regulation." In addition, if the
Company does successfully gain approval or is able to introduce its
Dermagraft-Ulcers products into certain countries where it is not currently
regulated, there can be no assurance that the Company will be able to
manufacture commercial quantities of its Dermagraft-Ulcers product at a
reasonable cost, that the Dermagraft Joint Venture will successfully market
the Dermagraft-Ulcers product or that the Dermagraft-Ulcers product will gain
any significant degree of market acceptance. Failure of the Company to gain
FDA approval to commercialize its Dermagraft-Ulcers product in a timely
manner, or if approved, to achieve significant market acceptance of such
product would have a material adverse effect on the Company's business,
financial condition and future results of operations. See "Stage of Product
Development," "Third Party Reimbursement," "Manufacturing and Supply," "Sales
and Marketing" and "Competition."
PRESSURE ULCERS. Pressure ulcers are common in hospital and nursing home
patients. Pressure ulcers form in skin that is continually compressed under
the weight of a bedridden or wheelchair-bound patient, who does not
periodically turn or roll to relieve the compressed skin. The compressed skin
does not receive blood flow for hours at a time, ultimately forming a wound.
Severe pressure ulcers frequently must be closed by use of skin grafts or
major reconstructive surgery.
During 1994, the Company completed a pilot clinical trial of fifty
patients segregated into three dosing groups and one control group. The group
showing the best results received two pieces of Dermagraft-Ulcers every two
weeks for a total of eight pieces. Wound closure was evaluated over a period
of twelve weeks. Complete wound healing was achieved in 46% of these patients
as compared to 25% in the control group. Although the Company believes the
results from the pilot trial to be encouraging, it does not currently expect
to initiate a pivotal clinical trial of Dermagraft-Ulcers until additional
resources become available. The Dermagraft Joint Venture has a first right of
refusal to develop this indication of Dermagraft-Ulcers.
VENOUS ULCERS. Venous ulcers result when damage to the valves of the
deep leg veins reduces their ability to return blood to the upper body,
leading to pooling of blood in the legs and subsequent breakdown of the skin.
Venous ulcers that do not respond to medical treatment often must be closed
surgically by the use of skin grafts.
The Company received FDA approval and began a pilot clinical trial with a
single application of Dermagraft-Ulcers in October 1991. Based on the pilot
trial, a pivotal clinical trial of a single application of the
Dermagraft-Ulcers product began in February 1993. Enrollment of 210 patients
in the clinical trial was completed in November 1993. Patients in the trial
were tracked for a period of twenty-four weeks to evaluate wound closure. An
interim analysis was completed in April 1994 in order to determine whether the
number of patients enrolled would be sufficient to prove efficacy. This
interim analysis indicated there were no significant differences between the
patients in the control group and those treated with a single dose of
Dermagraft-Ulcers.
Analysis of the six-month follow-up data from patients in the venous
ulcer trial did, however, show a statistically significant (p<0.05) difference
in the recurrence rate of Dermagraft-treated patients (6%) versus control
patients (20%). As noted above for diabetic foot ulcers, an important goal in
the treatment of chronic skin ulcers is to prevent the recurrence of the
wound, which both lowers the cost of treatment and improves overall patient
care. The Company has also investigated the potential application of multiple
doses of Dermagraft-Ulcers in the treatment of venous ulcers, however its
evaluation of cost benefit information indicates that multiple doses may not
be cost effective.
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Although the Company does not currently intend to pursue the use of
Dermagraft-Ulcers as a treatment to reduce the recurrence of venous ulcers, it
may do so in the future based on further cost benefit analysis and subject to
the availability of resources. The Dermagraft Joint Venture has a first right
of refusal to develop this indication of Dermagraft-Ulcers.
ORTHOPEDIC PRODUCTS
Many of the product development and manufacturing systems developed by
the Company for its existing skin products apply to the growth of orthopedic
tissues. The Company believes that its core technology and proprietary
manufacturing systems allow regulation of critical environmental factors,
including oxygen tension, pressure and media composition, that may provide the
necessary conditions for the production of a high tensile-strength cartilage
capable of withstanding the high shear and load forces present in human
joints. Similar to the skin, the Company believes, and scientific research
supports, that tissue engineered cartilage products will be non-immunogenic.
In addition, orthopedic applications of tissue engineered products are
numerous, justifying the commitment of resources and providing potential for a
substantial economic return.
Traumatic injuries often cause permanent damage to tissues in human
joints such as cartilage, ligaments, tendon and bone. The body has a limited
ability to repair these tissues on its own, and there are few treatment
options available to replace damaged tissue. The Company is focusing its
initial product development efforts on tissue engineered cartilage. Cartilage
serves diverse functions in many parts of the body such as providing a gliding
surface for smooth joint motion (articular cartilage), and serving to absorb
both impact and load-force transmitted to the axial skeleton (meniscus). In
many cases, damage to cartilage tissue subsequently leads to further
deterioration and osteoarthritis which can eventually require a total joint
replacement.
The Company is developing its orthopedic cartilage products through its
joint venture with Smith & Nephew (the "Cartilage Joint Venture"). See
"Collaborations and Strategic Alliances." The joint venture also has a right
of first negotiation to develop other tissue engineered products for
orthopedic applications such as ligament, tendon and bone.
ORTHOPEDIC MARKETS. In the United States each year, there are over 1.2
million arthroscopic procedures of the knee performed, including procedures
involving articular cartilage, meniscus and ligaments. By intervening early
in the degenerative process, the Company hopes to delay or perhaps even avoid
some of the 230,000 total knee replacement surgeries performed annually in the
United States. There are an additional 400,000 arthroscopic procedures
performed each year in the United States in joints such as the shoulder,
elbow, wrist, hip and ankle which could also be candidates for the Company's
articular cartilage products.
ARTICULAR CARTILAGE. Articular (joint) cartilage covers the opposing
surfaces of all moving joints in the body. Even small defects in the
articular cartilage can cause pain and restriction of joint motion. These
defects greatly increase the probability of degenerative cartilage problems,
such as arthritis, later in life. The primary treatment for these articular
defects is to trim away intruding cartilage fragments via arthroscopy which
increases joint mobility but does not prevent long-term degenerative changes.
Injuries resulting from sports trauma are a common cause of these cartilage
defects. To the Company's knowledge, other than autologous transplants of the
patient's own cells, there are no commercially available products either
synthetic or natural which can replace damaged cartilage in the human body.
Tissue engineered articular cartilage could provide a significant opportunity
to treat patients at an earlier stage of joint degeneration, thereby delaying,
or in some cases eliminating, the need for total joint replacements. Products
to repair articular cartilage may ultimately be used in any joint in the body,
such as knees, shoulders, elbows, wrists, hips and ankles.
In December 1996, the Company, as part of the Cartilage Joint Venture
with Smith & Nephew, submitted an IDE requesting approval to begin a human
pilot clinical trial with human tissue engineered articular cartilage for the
repair of articular surfaces in knee joints. The Company is in the process of
preparing additional information as requested by the FDA with respect to the
IDE. If approved by the FDA, the Company anticipates the pilot trial would
begin in the second half of 1997.
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The IDE submission is based on a preclinical safety study using a small
animal model. Through nine months of follow-up, no adverse events were
observed with the product indicating the safety of the implant Additionally,
significant improvement in the repair of defects was observed in grafted
versus ungrafted control sites (p value < 0.02). The grafted tissue had
significantly more hyaline-like appearance, greater content of sulfate
glycosaminoglycans and smoother articular surface as compared to the untreated
defects. These results have demonstrated the safety of the product and also
that the repair tissue is of better quality and more closely resembles
adjacent normal tissue than allowing the defects to heal by natural processes.
The Cartilage Joint Venture has also performed a normal healing study using a
large animal model. The results of this study thus far have demonstrated that
untreated defects heal with scar tissue, as has been shown in humans, and,
therefore, the model may be representative of the effects of tissue engineered
cartilage on progression of degenerative joint diseases.
MENISCAL CARTILAGE. The meniscus is a cushion that acts as a shock
absorber in the knee which is frequently damaged or destroyed by sports injury
or other trauma. Current repair procedures for avascular meniscal injuries
have limited success in producing a long-term repair. The Company believes
that its tissue engineering approach could offer a benefit in the repair and
eventual total replacement of the meniscus. The Cartilage Joint Venture has
conducted collaborative preclinical studies with scientists under a sponsored
research program which has shown that successful repair was achieved using
tissue engineered meniscal allografts, in comparison to failure to heal in a
control group. In pilot preclinical studies, further sponsored research
performed at Children's Hospital in Boston ("Children's Hospital") showed that
tissue engineered meniscus can be generated and may be used for total meniscal
replacement.
LIGAMENT/TENDON. Frequently, sports injuries involve damage to ligaments
and tendons, particularly injury to the anterior cruciate ligament. The
Company has successfully utilized degradable polymers shaped into tendon-like
structures combined with fibroblasts to engineer a living ligament. Research
work on the optimization of this technique for replacement of ligament and
tendon is continuing in collaboration with scientists at the Massachusetts
Institute of Technology ("MIT") and Children's Hospital. Through this
sponsored research, the Company is exploring growth conditions that may allow
it to grow tissue engineered ligament and tendon with biomechanical properties
similar to those found in human body.
BONE. In collaboration with researchers at MIT and Children's Hospital,
the Company has successfully grown tissue engineered bone. Research has shown
that three-dimensional bone grown ex vivo secreted extracellular matrix
proteins and retained biomechanical properties analogous to those tissues in
the human body, eliminating the need for extracting bone from other areas of
the patient's body. The use of tissue engineered bone to replace long bones,
such as the femur, has been successful in preclinical studies.
CARDIOVASCULAR PRODUCTS
Cardiac fibroblasts are closely related to the dermal fibroblasts the
Company uses to manufacture its existing skin products; therefore, many of the
methods and systems developed by the Company for these products may be
applicable to the growth of cardiac fibroblasts as well. Although additional
research must be performed, the Company also believes it may be possible to
use dermal fibroblasts in place of cardiac fibroblasts in tissue engineered
products for cardiovascular applications. In addition to the cardiac
fibroblasts, the interior of blood vessels, and the valves and chambers of the
heart, are lined with endothelial cells. Matrix proteins and growth factors
secreted by fibroblasts may induce endothelial cell migration, which is
important to avoid clotting and the build up of plaque, or atherosclerosis.
The Company believes its cardiovascular products will be regulated as medical
devices, similar to its skin and cartilage products.
CARDIOVASCULAR MARKET. According to the American Heart Association, over
900,000 Americans die each year from cardiovascular disease. Approximately 60
million people suffer from some form of the disease. An aging population is
likely to increase the incidence of these diseases and the need for cost
effective treatments in the future. While there are many effective treatments
for these patients, there are also many problems to be overcome such as
biocompatibility, durability and availability. Tissue engineered
cardiovascular products, such as heart valves, blood vessels and stents, may
potentially solve some of these issues. Each year, over
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60,000 prosthetic heart valves are implanted and over 430,000 vascular graft
procedures are performed in the United States.
BLOOD VESSELS. Vascular grafts are used to repair or replace segments of
arterial and venous blood vessels that are weakened, damaged or obstructed due
to trauma or disease such as aneurysms and atherosclerosis. Grafts are either
autografts (the patient's own veins or arteries), prosthetic grafts made of
synthetic materials such as polyesters or other composite materials, or
non-viable preserved biological tissue from cadavers or other species. The
harvesting of autografts requires extensive surgery which is time consuming,
costly and traumatic. In addition, patients requiring multiple bypass
surgeries may not have enough suitable vessels to harvest. Cyropreserved
allograft veins from cadavers are sometimes used, but availability is limited
and patency rates are lower than autograft vessels. Prosthetic vascular
grafts are generally used for large or medium diameter (>6mm) grafts as small
diameter synthetic grafts have generally demonstrated poor performance.
Prosthetic vascular grafts often show insufficient tissue integration and
re-endothelization. Problems associated with small diameter synthetic grafts
include stenosis (or a narrowing), pseudoaneurysm formation, and acute
occlusion due to platelet aggregation.
Many companies are attempting to develop small diameter vascular grafts
(3mm to 5mm) with characteristics similar to biological grafts. These
companies are employing a variety of technologies to reduce thrombosis and
promote a rapid ingrowth of tissue such as different weaves and knits,
chemical coatings and gelatins, and freeze drying. Advanced Tissue Sciences'
research has focused on using specialized polymer constructs, bioreactor
design and colonization techniques to create a completely human vessel.
Bioreactors have been developed to generate the cyclical radial pressure
similar to that encountered in the body to stimulate the cells to align
concentrically, absorbing stress as in a normal vasculature and to establish a
configuration native to blood vessels. This should allow the cells to secrete
the matrix proteins in a manner more likely to withstand the pressure the
vessel will be exposed to in vivo. These matrix proteins, along with various
growth factors which are naturally secreted by the grafts, should also induce
endothelial cell migration and tissue remodeling.
The Company, through a collaboration with The Georgia Institute of
Technology ("Georgia Tech"), has performed biomechanical property tests and
immunohistochemical analysis of the bioengineered blood vessels demonstrating
an increase in tissue strength over time in culture and the synthesis of
elastin and other matrix proteins, both of which are essential to blood vessel
formation and function. In addition, through sponsored research MIT and
Children's Hospital, feasibility studies have been performed with a small
diameter (3.0mm to 3.5mm) bioengineered blood vessel. These bioengineered
blood vessels were created by seeding a synthetic biodegradable tube with
fibroblasts and several other cells types. The blood vessels have been
implanted into large animal models and have shown normal function up to eight
weeks. The tissue engineered blood vessels have also been easy to handle and
suture.
HEART VALVES. The valves open and close with every beat of the heart.
When a valve becomes damaged or diseased, the heart must work harder to pump
the same volume of blood. As the condition worsens, the valve has to be
replaced. Currently, either mechanical or porcine valves are used to replace
the native human valves; however, each has its drawbacks. With mechanical
valves, patients are required to take anticoagulant medication for the rest of
their lives to reduce the likelihood of thromboembolic events (i.e., blood
clots). Porcine valves have problems with durability and calcification,
frequently requiring additional and costly surgery to implant replacement
valves.
During 1996, the Company continued preclinical studies to develop tissue
engineered valves on synthetic scaffolds under sponsored research performed by
researchers at MIT and Children's Hospital. Preclinical trials demonstrated
the feasibility of utilizing tissue engineering to create heart valves using a
three-dimensional biodegradable scaffolding. In these feasibility studies,
tissue engineered valve leaflets were created by seeding a synthetic
biodegradable fiber matrix with fibroblasts, endothelial and other cells. The
tissue engineered leaflets were then implanted in large animals which were
followed for up to eleven weeks. The leaflets tolerated surgical handling and
sutures, and were found to increase in size to accommodate for valve growth
over the period of implant. Additionally, the valve exhibited no evidence of
stenosis and had trivial, clinical
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insignificant, regurgitation. Total protein and collagen analysis showed the
development of an extracellular matrix, including elastin, and histologies of
the constructs resembled native tissue.
STENTS. Stents are generally synthetic materials that are inserted in a
vessel after angioplasty (the mechanical removal of an occlusion by the
insertion and inflation of a balloon catheter) in an attempt to prevent
restenosis or re-occlusion of the vessel. Without stent intervention
approximately 40% of patients will experience restenosis of the vessel within
two years of plaque removal. Using a living, bioengineered stent comprised
of healthy human cells could potentially provide a more stable vascular
lining, thereby preventing or reducing thrombosis or restenosis.
OTHER THERAPEUTIC TISSUES
Many other organ tissues have been successfully grown using the Company's
technology that could potentially be developed into therapeutic products.
Commercialization of these or other tissues, such as pancreas,
gastrointestinal and blood/brain barrier tissues, is dependent on a number of
factors, including the Company's assessment of each tissue type's market
potential and the availability of sufficient resources, either internally or
through collaborations with future corporate partners.
RECONSTRUCTIVE APPLICATIONS. There may be several applications for the
Company's cartilage and bone products in reconstructive surgery.
Reconstructive implants offer an important alternative at a time when silicon,
Teflon, and other implant materials are being taken off the market. Under the
Company's sponsored research agreement with MIT and Children's Hospital,
researchers have performed pilot preclinical studies with engineered cartilage
and bone for reconstructive applications.
CARTILAGE. Studies sponsored by the Company have shown that cartilage
implants retain their shape for up to one year after implantation into the
facial regions of animals. In addition, researchers in this collaboration
have developed an injectable cartilage product that has been successfully
utilized to construct total ear and nose implants. Such implants have
persisted in animals for over twelve months. An injectable cartilage may also
be useful for cartilage augmentation, total meniscus replacement, and
intravertebral disc repair.
BONE. An engineered bone tissue, under collaborative development with
scientists at MIT and Children's Hospital, could be useful in joint
replacement, bone grafting and facial bone reconstruction. Scientists have
shown that three-dimensional bone grown in vitro secreted extracellular matrix
proteins and retained biomechanical properties analogous to those tissues in
the human body, eliminating the need for extracting bone from other areas of
the patient's body. Research has also advanced in the growth of
bone/cartilage composites which could offer additional solutions to
reconstructive surgery. Studies have shown that full thickness cranial bone
defects in animals can be corrected by implantation of tissue engineered bone.
Scientists at Children's Hospital have also been successful in using tissue
engineering to make complete joints consisting of bone, cartilage and
ligaments and, in addition, have successfully replaced long bones, such as the
femur, in preclinical studies.
LIVER. The liver is the body's major metabolic organ. The only
treatment for liver failure today is a liver transplant and currently there is
an insufficient supply of transplantable livers. It is currently estimated
that 35,000 people die each year from chronic liver disorders, including many
who are waiting for a transplant, while only 3,500 liver transplants are
performed each year.
Advanced Tissue Sciences has demonstrated the ability to culture
enzymatically active animal and human liver cells (hepatocytes) in long-term
cultures. The Company's system allows for the active growth of liver cells
which retain their ability to manufacture a variety of liver proteins and
enzymes required for normal hepatic function. The Company has reported
successful engraftment and persistence of liver tissue implanted in various
regions in rats, including subcutaneous, intraperitoneal, and supra hepatic
sites. In addition, the Company has conducted pilot preclinical trials that
involved implantation of engineered liver tissue into both small and large
animal models. In these trials, the implants have functioned well for
approximately three months (the duration of the experiment).
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BONE MARROW. Bone marrow is ultimately responsible for the production of
all of the body's blood and immune cells. The Company believes that a
universal bone marrow cultured ex vivo could be used as a replacement in
patients whose bone marrow has been damaged or destroyed during radiation or
chemotherapy treatments. The Company has successfully replicated animal and
human bone marrow and natural killer cells (an anti-cancer cell component of
the immune system) and has conducted pilot preclinical trials involving the
infusion of replicated bone marrow cells. In addition, the Company has also
grown and grafted bone marrow cultures with high percentages of stem cells on
biodegradable polymer scaffolds.
SKIN2(R) LABORATORY TESTING KITS. During 1996, the Company manufactured
and sold its Skin2 in vitro laboratory testing kits containing
compartmentalized squares of living human skin tissue to cosmetic,
petrochemical, household product and pharmaceutical companies to test products
for cytotoxicity, irritancy, corrosivity and phototoxicity. In September
1996, the Company announced that it was discontinuing the sale of its Skin2
product line and focusing all of its resources on its therapeutic programs.
Although the Company was a leader in the in vitro testing business and
continuously broadened applications of its products, the market for in vitro
laboratory testing products was evolving too slowly for the Company to
continue to devote its resources to this business.
STAGE OF PRODUCT DEVELOPMENT
Although Dermagraft-TC has been approved for commercial sale and
Dermagraft for the treatment of diabetic ulcers is in advanced stages of
pivotal clinical trials, the remainder of the Company's other products are at
earlier stages of research, development and testing. These products will
require significant additional research and development, including extensive
preclinical and clinical testing, and regulatory approvals prior to
commercialization. All of the Company's products are subject to the risks of
failure inherent in the development of products based on innovative
technologies. Such risks include the possibilities that any or all of these
products are found to be unsafe or ineffective or otherwise fail to receive
necessary regulatory approvals, that products are uneconomical to market, that
third parties may hold proprietary rights that preclude the Company from
marketing its products, or that the Company's products fail to achieve market
acceptance in light of competing technologies and products. See "Products,"
"Patents and Proprietary Rights," "Competition" and "Government Regulation."
THIRD PARTY REIMBURSEMENT
The Company's ability to commercialize products successfully may depend
in part on the extent to which reimbursement for the costs of such products
and related treatments will be available from government health administration
authorities, private health insurers and other organizations. Government and
other third-party payors are increasingly attempting to contain health care
costs by limiting both coverage and the level of reimbursement for new
products approved for marketing by the FDA, and by refusing, in some cases, to
provide any coverage for uses of approved products for indications for which
the FDA has not granted marketing approval. Initiatives to reduce the federal
deficit and to reform health care delivery are increasing these cost
containment efforts. As managed care organizations continue to expand as a
means of containing health care costs, the Company believes there may be
attempts by such organizations to restrict the use or delay authorization to
use new products, such as those being developed by the Company, pending
completion of cost/benefit analyses of such products by those managed care
organizations.
The Company has supported health economics studies and research and is
developing cost offset or cost/benefit models with respect to its
Dermagraft-TC and Dermagraft products in an effort to help obtain appropriate
and adequate third party coverage and reimbursement for these products.
However, these products are novel and as such are subject to inherent
uncertainty in the area of reimbursement. There can be no assurance that
adequate government or private payor coverage or levels of reimbursement will
be available for any of the Company's products or for the Company to maintain
price levels sufficient for the realization of an appropriate return on its
investment in such products. Failure to obtain sufficient coverage and
reimbursement levels for uses of the Company's products could have a material
adverse effect on the market acceptance of such products.
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PRODUCT LIABILITY
The use of any of the Company's products, whether for commercial
applications or during clinical trials, exposes the Company to an inherent
risk of product liability claims in the event such products cause injury,
disease or result in adverse effects. Such liability might result from claims
made directly by health care institutions, contract laboratories or others
selling or using such products. The Company currently maintains product
liability insurance coverage; however, there can be no assurance that the
level or breadth of any insurance coverage will be sufficient to fully cover
potential claims. Such insurance can be expensive and difficult to obtain.
There can be no assurance that adequate insurance coverage will be available
in the future at an acceptable cost, if at all, or in sufficient amounts to
protect the Company against such liability. The obligation to pay any product
liability claim in excess of whatever insurance the Company is able to acquire
could have a material adverse effect on the business, financial condition and
future prospects of the Company.
The Company's tissue repair and transplantation products are complex and
must be manufactured under well-controlled and sterile conditions, in addition
to meeting strict product release criteria. Any manufacturing errors or
defects, or uncorrected impurity or variation in a raw material could affect
the quality and safety of the Company's products. In such event, the Company
could be required to undertake a market withdrawal or recall of the affected
products. There can be no assurance a product recall will not occur. The
cost of a market withdrawal or product recall could be significant and could
have a material adverse effect on the Company's business, financial condition
and results of operations. See "Manufacturing and Supply."
COLLABORATIONS AND STRATEGIC ALLIANCES
The Company's strategy for the development, clinical testing, manufacture
and commercialization of certain of its proposed tissue replacement products
includes entering into various collaborations with corporate partners,
licensees and others. The Company has entered into a number of collaborative
arrangements in connection with its product development activities.
SMITH & NEPHEW PLC. In April 1996, the Company entered into an agreement
with Smith & Nephew to form a fifty-fifty joint venture for the worldwide
commercialization of Dermagraft, the Company's tissue engineered dermal
replacement, for the treatment of diabetic foot ulcers (the "Dermagraft Joint
Venture"). 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. The Dermagraft Joint Venture also has a right of first
refusal to develop Dermagraft for several other indications, such as for
pressure sores or venous ulcers. The Company has retained rights to develop
Dermagraft for burns and for plastic and reconstructive surgery.
Upon signing the agreement, Smith & Nephew paid the Company an up front
fee of $10 million and agreed to pay the Company up to an additional $60
million on the achievement of certain milestones. As part of the agreement,
Smith & Nephew has also agreed to loan the Company up to $10 million during
1997 at the Company's election. The companies have agreed to share equally in
the expenses and revenues of the Dermagraft Joint Venture beginning January 1,
1997.
A PMA application requesting approval to market Dermagraft for the
treatment of diabetic foot ulcers was submitted in December 1996 and accepted
for filing by the FDA under its expedited review process in February 1997.
Currently, an additional fifty patients are being enrolled to confirm the
equivalence of Dermagraft product produced in this therapeutic range and
according to final commercial specifications. Data from this confirmatory
clinical trial will be submitted as an amendment to the PMA application.
Under the terms of the Dermagraft Joint Venture agreement, Advanced Tissue
Sciences will be responsible for supervising the manufacturing of Dermagraft.
Smith & Nephew's existing wound care sales force and distribution network in
over ninety countries will be used to market the product. See "Products -
Skin Ulcer Products."
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In 1994, Smith & Nephew and the Company entered into a separate
fifty-fifty joint venture for the worldwide development, manufacture and
marketing of human tissue engineered cartilage for orthopedic applications
(the Cartilage Joint Venture"). Under the agreement, Smith & Nephew is
contributing the first $10 million in Cartilage Joint Venture funding and the
Company has contributed certain technology licenses. Joint venture revenues
and expenditures over the first $10 million will be shared equally by the
partners. In addition, the Company has access to a $10 million loan from
Smith & Nephew under pre-negotiated terms should it so elect to fund the
Company's share of the joint venture's expenditures. The Cartilage Joint
Venture also has the right of first negotiation to develop tissue engineered
bone, tendon and ligament for orthopedic applications. Advanced Tissue
Sciences has retained all rights to non-orthopedic cartilage applications.
Under the terms of the Cartilage Joint Venture agreement, Advanced Tissue
Sciences will be responsible for supervising the manufacturing of the
cartilage tissue products. The joint venture will execute the research and
development program, develop a worldwide marketing plan, and will utilize
Smith & Nephew's established selling and distribution network to market the
products. Smith & Nephew Endoscopy, a world leader in arthroscopy, is
separately responsible for developing and manufacturing instrumentation that
could be used for the arthroscopic insertion of the joint venture's cartilage
products. The Cartilage Joint Venture's initial product development efforts
are being focused on the repair or replacement of damaged articular and
meniscus cartilage in knee joints. In December 1996, the Company submitted an
IDE application to the FDA for approval to begin pilot clinical trial with
human tissue engineered articular cartilage for the repair of articular
surfaces in knee joints. See "Products - Orthopedic Products."
ST. JUDE MEDICAL. In February 1994, the Company and St. Jude Medical
entered into an agreement to pursue the joint development of tissue engineered
heart valves. During the collaboration, the parties conducted a series of
feasibility studies to evaluate applications of Advanced Tissue Sciences'
tissue engineering technology to create or improve heart valve replacements by
leveraging the knowledge gained with fibroblast-based products from
Dermagraft. Although the feasibility studies were successful, in early 1996,
St. Jude Medical elected not to enter into a licensing agreement for tissue
engineered heart valves. St. Jude Medical indicated that it was focusing its
research efforts on acellular product designs that encourage host cell
ingrowth. During 1996, the Company funded the development of tissue
engineered heart valves through sponsored research at Children's Hospital.
UNIVERSITY OF FLORIDA/GENENTECH, INC. Under a license agreement entered
into in November 1992, the Company obtained exclusive worldwide rights to a
stem cell proliferation factor ("SCPF") from the University of Florida
Research Foundation, Inc., an affiliate of the University of Florida. SCPF is
believed to stimulate the growth of hematopoietic stem cells, the cells
responsible for repopulating red blood cells and cells of the immune system.
Under the license agreement, the Company is responsible for costs and
maintenance fees related to the filing of patent applications arising out of
the sponsored research and will be required to pay royalties on the sales of
any patented, SCPF-related products. Subject to compliance with the terms of
the agreement, the license extends for the life of certain SCPF-related
patents. In October 1995, the Company entered into an Evaluation and Option
Agreement granting Genentech Inc. ("Genentech") an option to license rights to
SCPF. Under the agreement, Genentech had a one year option to exclusively
license rights for in vivo applications of SCPF outside Asia. At the end of
the option period, Genentech elected not to exercise the option.
MASSACHUSETTS INSTITUTE OF TECHNOLOGY/CHILDREN'S HOSPITAL IN BOSTON. In
connection with an acquisition in September 1992, the Company entered into
sponsored research and license agreements with MIT and Children's Hospital.
Under the research agreement, the Company agreed to sponsor research conducted
at MIT and Children's Hospital for a minimum of $1 million per annum through
1997. The research agreement may be renewed annually for four additional
years. Under the license agreement, the Company has rights to certain
existing and future MIT and Children's Hospital patents and technology which
relate to tissue engineering, organ transplantation and polymer science. The
Company is responsible for patent application costs and the related
maintenance fees applicable to inventions derived from the sponsored research.
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GEORGIA TECH. Georgia Tech is recognized as having a leading academic
program in biomedical engineering. The Company has entered into a one-year
research agreement providing for the investigation of the effect of fluid flow
on chondrocyte metabolism. The relationship between the Company and Georgia
Tech is further strengthened by the Company's participation in an internship
program for students in the Bioengineering Program at Georgia Tech. In
addition, the Company is an active member of the Georgia Tech Educational
Partners Program.
Although the Company believes that its partners in these collaborations
have an economic motivation to succeed in performing their contractual
responsibilities, the amount and timing of resources to be devoted to these
activities are not within the control of the Company. Moreover, the
collaboration agreements generally provide that they may be terminated by the
collaborator prior to their expiration under circumstances that are outside
the control of the Company. In addition, there can be no assurance that these
collaborators will pay any additional option or license fees to the Company or
that they will develop or market any products under the agreements. Finally,
if the Company's collaboration agreements are terminated prior to their
expiration or if the other parties to such agreements fail to adequately
perform, there can be no assurance that submission of products for regulatory
approval will not be delayed or that the Company's ability to deliver products
on a timely basis will not be impaired.
The Company is particularly dependent on Smith & Nephew with respect to
the Dermagraft Joint Venture and the Cartilage Joint Venture. The failure or
loss of that strategic alliance could have a material adverse effect on the
Company's ability to successfully complete the development and testing of the
products covered thereby or to successfully penetrate the markets for such
products.
The Company continually seeks and considers collaborative arrangements to
obtain funding for the development of its products. Such arrangements may
involve the issuance of additional equity or debt securities and marketing
rights to the funding party. The Company may seek collaborative arrangements
and separate funding for its programs which may include joint ventures, third
party equity investments or other financing structures. There can be no
assurance however that the Company will be able to negotiate additional
collaborative arrangements in the future on acceptable terms, if at all, or
that such collaborative arrangements will be successful. To the extent that
the Company chooses not to or is unable to establish such arrangements, it
would experience increased capital requirements to undertake research,
development and marketing of its proposed products at its own expense. In
addition, the Company may encounter significant delays in introducing its
proposed products into certain markets or find that the development,
manufacture or sale of its proposed products in such markets is adversely
affected by the absence of such collaborative agreements.
RESEARCH AND DEVELOPMENT
The Company has invested a substantial portion of its resources into
research related to the Company's core technology, the development and
clinical trials of products related to such technology, and the development of
manufacturing systems and processes. The Company has incurred research and
development costs of $23,699,000, $18,498,000 and $16,459,000 in the years
ended December 31, 1996, 1995 and 1994, respectively, of which approximately
$3,564,000, $2,378,000, and $913,000 represent costs incurred for customer
sponsored research. The Company expects to continue to incur substantial
research and development costs related to its core technology, clinical trials
of products related to such technology and the development of manufacturing
processes and systems.
The Company has established its own research and development laboratory
facilities, is collaborating with academic and medical institutions, and has
entered into agreements with several other major companies and institutions to
assist in developing or marketing its technology. In the event the Company is
unable to obtain or maintain these arrangements, the Company may need to
expand its own facilities for research and development, clinical testing and
marketing. The Company may also enter into additional arrangements with third
parties for certain proposed applications of its technology; however, there
can be no assurance that such arrangements can
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<PAGE>
be obtained. The failure to obtain or maintain such arrangements on desirable
terms could have an adverse impact on the Company.
MANUFACTURING AND SUPPLY
Advanced Tissue Sciences has and is continuing to develop proprietary
manufacturing systems to produce the Company's tissue replacement products.
These systems are intended to allow for the maintenance of sterility and
result in the manufacture of highly reproducible living tissues. To date, the
Company has constructed and validated a commercial facility for the
manufacture of its Dermagraft-TC product. This manufacturing facility passed
an FDA inspection in November 1996, as required before product approval for
marketing. The Company is also in the process of expanding and validating its
commercial scale manufacturing facility for Dermagraft. Both the
Dermagraft-TC and Dermagraft products must be manufactured in compliance with
the good manufacturing practices ("GMPs") requirements prescribed by the FDA.
Any significant delays in the completion of validation or regulatory
inspection could have a material adverse effect on the ability of the Company
to ultimately market its products on a timely and profitable basis, and on the
Company's ability to conduct its business.
Each Dermagraft product is grown in a bioreactor which is being optimized
to allow for the uniform growth, freezing, shipping and storage of the tissue.
The manufacturing process has been designed to enable the Company to grow
multiple pieces of tissue at the same time in a consistent growth environment.
The Company worked with Fluor Daniel, Inc. in the design, fabrication and
installation of commercial scale process systems for the manufacture of the
Dermagraft products. The Company believes much of the design of the
Dermagraft manufacturing process could be useful in manufacturing other tissue
replacement products as well.
Although most of the raw materials used in the manufacture of the
Company's Dermagraft products are available from more than one supplier,
changes in certain critical components (such as the polymers used in
Dermagraft) could cause the FDA to require the Company to prove equivalency of
the materials or potentially to modify or perform additional clinical trials
for the Dermagraft products, which could have the effect of postponing the
completion of clinical trials associated with that product or of restricting
product available for sale. To date, the Company has not experienced
difficulty in obtaining necessary raw materials.
The mesh framework used by the Company in its Dermagraft-Burns and
Dermagraft-Ulcers products is available under a supply agreement with only one
FDA-approved manufacturing source. Similarly, the synthetic mesh framework
used by the Company in its Dermagraft-TC product is available under a supply
agreement with a different FDA-approved manufacturing source. Because the FDA
approval process requires manufacturers to specify their proposed suppliers of
active ingredients and certain component parts and packaging materials in
their applications, FDA approval of a new supplier would be required if these
materials become unavailable from the current supplier.
Although the Company has not experienced difficulty acquiring these
materials for the manufacture of its Dermagraft products for clinical trials,
no assurance can be given that interruptions in supplies will not occur in the
future or that the Company would not have to obtain substitute vendors for
these materials. Any significant supply interruption would adversely affect
the Company's clinical trials as well as its product development and marketing
programs. In addition, an uncorrected impurity or supplier's variation in a
raw material, either unknown to the Company or incompatible with the Company's
manufacturing process, could have a material adverse effect on the Company's
ability to manufacture products.
The Company's research and development activities and operations involve
the controlled use of small quantities of radioactive compounds, chemical
solvents and other hazardous materials. In addition, the Company's business
involves the growth of human tissues. Although the Company believes that its
safety procedures for handling and disposing of such materials comply with the
standards prescribed by federal, state and local regulations, the risk of
accidental contamination or injury from these materials cannot be completely
eliminated. In the event of such an accident, the Company could be held
liable for any damages that result and any liability could have a material
adverse effect on the business, financial condition and future prospects of
the Company.
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SALES AND MARKETING
Dermagraft-TC is being marketed through a direct sales force in the
United States where the markets are concentrated in specialized trauma units
or burn centers. Eighty of the approximately 140 specialized trauma units and
burn centers in the United States treat approximately seventy-five percent of
all burn patients. The Company is in the process of determining whether it
will market Dermagraft-TC with a direct sales force, due to the highly
concentrated nature of the market, or through individual distributors in
Europe and other foreign markets. Working with burn experts, the Company has
also developed reimbursement strategies and financial impact analyses for use
in the marketing of Dermagraft-TC.
The Company estimates that there are approximately 800,000 diabetic foot
ulcer patients treated each year in the United States. More than half of
those ulcer patients are treated by podiatrists, with approximately ten
percent of all podiatrists accounting for the treatment of over forty percent
of these patients. Dermagraft for diabetic foot ulcers will be marketed by
Smith & Nephew through the Dermagraft Joint Venture. The Company believes
that doctors and third party payors recognize the high cost of treating
diabetic foot ulcers. An economic model supporting the product's cost
effectiveness is expected to be available at the time of commercial
introduction. See "Collaborations and Strategic Alliances."
Achieving marketing acceptance for the Company's products will require a
substantial commitment of the Company's financial and personnel resources.
The Company's ability to achieve market acceptance of its Dermagraft-TC
product will also depend on its ability to establish an effective internal
sales and marketing organization. Neither the Company or its joint venture
partner has direct experience selling, marketing or obtaining reimbursement
for selling tissue engineered products such as the Dermagraft products and,
accordingly, there can be no assurance that the Company or its joint venture
partner will be successful in these efforts.
PATENTS AND PROPRIETARY RIGHTS
The Company's ability to compete effectively will depend, in part, on its
ability to maintain the proprietary nature of its technology and manufacturing
processes. The Company relies on patents, trade secrets and know-how to
maintain its competitive position. To date, the Company owns eighteen issued
patents in the United States. In addition, fourteen foreign counterparts to
some of the United States patents have issued in several foreign countries.
The United States patents expire at various times between 2005 and 2014.
In October 1990, the Company received a United States patent on its core
technology. This product patent covers three-dimensional living stromal
tissue produced by culturing stromal cells in vitro on a biocompatible
framework. The stromal tissue provides the growth factors and structural
proteins used in the Company's three-dimensional matrix to grow organ tissues.
This patent expires in October 2007. In September 1995, the Company was
granted a corresponding patent by the European Patent Office covering a
three-dimensional stroma tissue and its use to grow skin, bone marrow and
liver tissue. The patent will expire in October 2012.
In November 1993, the Company received a United States patent relating to
Dermagraft, covering both three-dimensional dermal tissue and full thickness
skin tissue cultured on living stromal tissue prepared in vitro and, in August
1995, received a patent covering the growth and implantation of its Dermagraft
dermal skin replacement. These patents expire in November 2010 and August
2012, respectively. In October 1995, a United States Patent was issued
relating to Dermagraft-TC. This product patent covers a variety of
transitional burn coverings which use a synthetic membrane with an attached
dermal component. This patent will expire in October 2012.
In 1996, nine patents were issued in the United States relating to the
core patent covering various human cell types. These patents allow for a
variety of tissue engineered products that may be used for therapeutic
applications. These patents will expire in 2013. Additionally, in February
1997, a patent covering a protein to accelerate skin wound healing was issued
to the Company. This patent will expire in February 2014.
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Two United States patents have been issued relating to the Company's
laboratory testing kits. These patents cover the use of a variety of living
tissues produced by the Company's tissue replication technology and expire in
July 2008 and November 2009. The Company's other two issued United States
patents cover bone marrow transplantation techniques which will expire in 2005
and a process patent for growing cells under the core technology which will
expire in December 2012.
The Company has filed additional United States and foreign patent
applications relating to its technology. In addition, the Company has certain
licensing rights to United States and foreign patents and patent applications
filed by MIT related to cell growth and organ regeneration and repair, and
biodegradable polymers, subject to certain limitations as to applicable
tissues and fields of use, and by the University of Florida related to SCPF.
See "Collaborations and Strategic Alliances."
There can be no assurance that any applications will result in issued
patents or that any current or future issued or licensed patents, trade
secrets or know-how will afford protection against competitors with similar
technologies or processes, or that any patents issued will not be infringed
upon or designed around by others. In addition, there can be no assurance
that others will not independently develop proprietary technologies or
processes which are the same as or substantially equivalent to those of the
Company. The Company could also incur substantial costs in defending itself
in suits brought against it on such patents or in bringing suits to protect
the Company's patents or patents licensed by the Company against infringement.
The Company protects its proprietary technology and processes in part by
confidentiality agreements with its collaborative partners, employees and
consultants. There can be no assurance that these agreements will not be
breached, that the Company will have adequate remedies for any breach, or that
the Company's trade secrets will not otherwise become known or independently
discovered by competitors.
COMPETITION
The biomedical technology industry is subject to rapid, unpredictable and
significant technological change. Competition from universities, research
institutions and pharmaceutical, chemical and biotechnology companies is
intense. Many competitors or potential competitors have greater financial
resources, research and development capabilities and manufacturing and
marketing experience than the Company. In general, the first biomedical
product to be commercialized for a particular therapeutic indication is often
at a significant competitive advantage relative to later entrants to the
market. Accordingly, the relative speed with which the Company can develop
products, complete clinical trials, obtain regulatory approvals and develop
commercial manufacturing capability may be determinative factors in
establishing the Company's competitive position. The Company's ability to
attract and retain qualified scientific, manufacturing, marketing and other
personnel, obtain and maintain patent protection and secure funding are also
expected to be key competitive factors for the Company.
In the field of tissue engineering and the treatment of damaged or
diseased tissue, the Company competes with several companies which are
developing various tissue replacement products, including skin substitutes and
cultured cartilage. In addition, the Company is aware of a number of
biotechnology, pharmaceutical, medical device and chemical companies that are
developing other types of products as alternatives to tissue replacement for a
variety of indications, including burns and chronic skin ulcers. These
treatments employ a variety of approaches such as growth factors, tri-peptides
and completely synthetic materials.
In the area of burns, the Company competes primarily with cadaver skin or
porcine tissue. The Company is also aware of several companies that have
developed technologies involving processed cadaver skin used as a dermal
replacement (LifeCell Corporation), or sheets of epidermis grown from the
patient's own skin (Genzyme Tissue Repair and Cell Culture Technology). These
products have not required FDA approval and are, therefore, currently
available on the market for the treatment of severe burns. Integra Life
Sciences ("Integra") is marketing Integra Artificial Skin, consisting of a
bovine collagen and glycosaminoglycan matrix
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with a synthetic polymer covering, for the treatment of burn wounds. In
addition, the Company is aware that Ortec International, Inc. is currently in
clinical trials with its composite cultured skin product for the treatment of
burn wounds. Several other companies are also developing or plan to develop
growth factors as a treatment for partial thickness or small full-thickness
wounds.
In the area of diabetic foot ulcers, Chiron Corporation ("Chiron"), in
collaboration with a division of Johnson & Johnson, submitted a Biologics
Licensing Application with the FDA for its platelet-derived growth factor
("PDGF") for the treatment of diabetic foot ulcers in January of 1997. In
addition, Organogenesis, Inc. ("Organogenesis") has begun clinical trials for
the use of Apligraf, a product using cultured human cells seeded onto a bovine
collagen matrix, for the treatment of diabetic foot ulcers. Organogenesis has
already submitted a PMA application for Apligraf in the treatment of venous
leg ulcers and has been granted expedited review by the FDA for that
indication.
With respect to cartilage repair, Genzyme Tissue Repair is currently
selling a service to process a patient's own cartilage cells as a treatment
for articular defects in the knee. The Company is aware that Integra and
Osiris Therapeutics, Inc. are also engaged in research on cultured cartilage
products. The Company is not aware of any competitor that is developing an
off-the-shelf, human cartilage tissue that can be arthroscopically inserted.
For all of its products, the Company expects to compete primarily on the
uniqueness of its technology and product features, on the quality and
cost-effectiveness of its products, and on the timing of commercial
introduction. The Company believes that its tissue engineered products may
have many attributes that differentiate it from other competitors including
that the Company's products are human based tissue products designed to be
available "off-the-shelf" to the end-users. However, other factors such as
its ability to secure regulatory approval for its products, to implement
production and marketing plans and to secure adequate capital resources, will
also impact its competitive position. There can be no assurance that the
Company will have the resources to compete successfully with such companies or
that competition generally will not adversely affect the Company's results of
operations or ability to successfully market its products.
GOVERNMENT REGULATION
Regulation by governmental authorities in the United States and foreign
countries is a significant factor in the manufacture and marketing of the
Company's proposed products and in its ongoing research and product
development activities. The Company's preclinical studies and clinical trials
and the manufacturing and marketing of its products are subject to extensive,
costly and rigorous regulation by various governmental authorities in the
United States and other countries. Many of the Company's proposed products
will require regulatory approval prior to commercialization. In particular,
human therapeutic products are subject to rigorous preclinical and clinical
testing as a condition of approval by the FDA and by similar authorities in
foreign countries. The process of obtaining required regulatory approvals by
the FDA and other regulatory authorities often takes many years, is expensive
and can vary significantly based on the type, complexity and novelty of the
product. There can be no assurance that any products developed by the
Company, independently or in collaboration with others, will meet applicable
regulatory criteria to receive the required approvals for manufacturing and
marketing.
In the United States, the FDA regulates clinical testing, the
manufacture, distribution and promotion of medical devices and biologics
pursuant to the Federal Food, Drug, and Cosmetic Act (the "FDC Act") and
regulations promulgated thereunder. The Company's Dermagraft products and
cartilage products are subject to regulation as medical devices. The
Company's other tissue replacement products, currently in various stages of
development, could be regulated either as medical devices or as biologic
products. Legislative and regulatory initiatives concerning the regulation of
tissue and organ transplants are ongoing and could possibly affect the future
regulation of the Company's tissue engineered products. It is not possible at
the present time to predict accurately either the time frame for such action,
or the ultimate effect that such initiatives could have, if any, on the
products under development by the Company. Unlike PMA submissions for medical
devices, the FDA has no regulatory time limit within which it must review and
act upon submissions treated as biologics. As a result,
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the time period for final action often takes several years from submission,
usually exceeding that expected for a PMA application.
To obtain FDA approval to market medical devices similar to those under
development by the Company, the FDA requires proof of safety and efficacy in
human clinical trials performed under an Investigational Device Exemption (an
"IDE"). An IDE application must contain preclinical test data demonstrating
the safety of the product for human investigational use, information on
manufacturing processes and procedures, and proposed clinical protocols. If
the IDE application is approved, human clinical trials may begin. The results
obtained from these trials, if satisfactory, are accumulated and submitted to
the FDA in support of a PMA application. Premarket approval from the FDA is
required before commercial distribution of devices similar to those under
development by the Company is permitted in the United States.
The PMA application must be supported by extensive data, including
preclinical and human clinical trial data, to prove the safety and efficacy of
the device. By regulation, the FDA has 180 days to review a PMA application
and during that time an advisory committee may evaluate the application and
provide recommendations to the FDA. While the FDA has responded to PMA
applications within the allotted time period, reviews more often occur over a
significantly protracted period, usually eighteen to thirty-six months, and a
number of devices for which a PMA application was submitted by other companies
have never been cleared for marketing. This is a lengthy and expensive
process and there can be no assurance that such FDA approval will be obtained.
In addition, even though the Company has been informed by the FDA that
the Company's Dermagraft product for the treatment of diabetic foot ulcers
will receive expedited review from the agency, there can be no assurance that
such status will accelerate the review process or that such status will not be
rescinded by the FDA if other products performing substantially the same
functions are approved by the FDA prior to the Company receiving its approval.
There can be no assurance that the FDA will concur with the Company's analysis
or conclusions with respect to the data included in the PMA application or
that the FDA will ultimately approve the Dermagraft PMA application in a
timely fashion, if at all. Moreover, even if such approval is obtained,
post-approval regulation of the Company's products could result in the
withdrawal, suspension or limitation of approvals or limit the further
marketing of the Company's products. Delays in obtaining United States or
foreign approval could result in substantial additional costs to the Company
and adversely affect the Company's competitive position. In addition, delays
in regulatory approvals that may be encountered by corporate collaborators or
other licensees of the Company could adversely affect the Company's ability to
receive royalties.
The Company has constructed and validated a commercial manufacturing
facility for its Dermagraft-TC product. This manufacturing facility passed an
FDA inspection in November 1996. In addition, the Company is in the process
of expanding and validating commercial scale manufacturing for its Dermagraft
product. This facility must be registered, inspected, and licensed by various
regulatory authorities, including the California Department of Health and
Human Services, and must comply with FDA's GMP requirements. There can be no
assurance that the facility will be found to comply with GMPs and other
requirements and that necessary regulatory approvals will be obtained on a
timely basis, if at all.
With respect to the manufacture of products for which premarket approval
is granted, the Company will be subject to routine inspection by the FDA and
certain state agencies, including the California Department of Health and
Human Services, for compliance with GMP requirements, adverse event reporting
requirements, and other applicable regulations. There can be no assurance
that the Company will not incur significant costs to comply with laws and
regulations in the future or that laws and regulations will not have a
material adverse effect upon the Company's business, financial condition, or
results of operations.
Whether regulated by the FDA as a medical device or biologic, or
otherwise by any state or foreign authorities, the approval process for any of
the Company's products is expensive and time consuming and no assurance can be
given that any regulatory agency will grant its approval. The inability to
obtain, or delays in obtaining, such approval would adversely affect the
Company's ability to commence marketing therapeutic applications of its
technology. There is no assurance that the Company will have sufficient
resources to
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complete the required testing and regulatory review processes. Furthermore,
the Company is unable to predict the extent of adverse governmental regulation
which might arise from future United States or foreign legislative or
administrative action. In addition, any products distributed by the Company
pursuant to the above authorizations are subject to pervasive and continuing
regulation by the FDA. Labeling and promotional activities are subject to
scrutiny by the FDA and, in certain instances, by the Federal Trade
Commission. The export of devices also is subject to regulation in certain
instances.
The Company is also subject to various federal, state and local laws,
regulations and recommendations relating to such matters as safe working
conditions, laboratory and manufacturing practices and the use, handling and
disposal of hazardous or potentially hazardous substances used in connection
with the Company's research and development work. Although the Company
believes it is in compliance with these laws and regulations in all material
respects, there can be no assurance that the Company will not be required to
incur significant costs to comply with environmental laws or regulations in
the future.
EMPLOYEES
As of February 1, 1997, the Company employed 196 people, of whom 68 were
engaged in research and development, 72 in operations, and 56 in sales,
marketing and administrative functions. The Company's staff includes
seventeen employees with Ph.D. or M.D. degrees. None of the Company's
employees are represented by a labor union, and the Company believes that its
employee relations are good.
The Company's success will depend in large part upon its ability to
attract and retain qualified scientific, management, marketing and sales
personnel as well as the continued contributions of its existing senior
management and scientific and technical personnel. The Company faces strong
competition for such personnel and there can be no assurance that the Company
will be able to attract or retain such individuals. In particular, the loss
of the services of either Arthur J. Benvenuto, the Company's Chairman and
Chief Executive Officer, or Dr. Gail K. Naughton, its President and Chief
Operating Officer, would have a material adverse effect on the Company.
ITEM 2. PROPERTIES
The Company leases approximately 85,000 square feet of space at its
headquarters facility, of which approximately 96% is allocated to
manufacturing and research. The leases for this facility expire in September
2000, subject to an option to renew for an additional five years. In
addition, the Company leases approximately 6,900 square feet of manufacturing
and research space on a month to month basis; however, the Company is in
negotiations for a long-term lease for this space. The Company also leases
approximately 38,000 square feet which is used for both research and
administration. This lease expires in July 1998 but may be extended for up to
one year. The Company is currently considering alternatives for additional
research and administrative space to replace this facility in 1998 and to
support the Company's future growth. The Company's facilities are all located
in La Jolla and San Diego, California.
The Company believes that its property and equipment are generally well
maintained, in good operating condition and, as noted above, adequate for its
current needs. See "Manufacturing and Supply."
ITEM 3. LEGAL PROCEEDINGS
There is no material litigation pending against the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to vote of security holders during the
quarter ended December 31, 1996.
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PART II
ITEM 5. MARKET FOR THE COMPANY'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
MARKET INFORMATION
The Company's Common Stock is traded on the National Association of
Securities Dealers Automated Quotation ("Nasdaq") National Market under the
symbol ATIS. The last reported high and low sales prices as reported for the
Company's Common Stock by Nasdaq for the last two fiscal years are set forth
below.
<TABLE>
<CAPTION>
HIGH LOW
------- -------
YEAR ENDED DECEMBER 31, 1996:
<S> <C> <C>
First Quarter $14 1/4 $ 9 1/4
Second Quarter 18 3/4 13 1/4
Third Quarter 18 11 3/8
Fourth Quarter 20 9 9/16
YEAR ENDED DECEMBER 31, 1995:
First Quarter $ 9 1/8 $ 7
Second Quarter 10 3/8 5 9/16
Third Quarter 14 5/8 9 3/4
Fourth Quarter 11 5/8 8 1/2
</TABLE>
The last sale price of the Company's Common Stock as reported on the
Nasdaq National Market on March 25, 1997 was $11 9/16. The market price of
the Company's Common Stock, like that of the securities of other
biotechnology companies, has fluctuated significantly in recent years and is
likely to fluctuate in the future. From time to time the market for
securities of biotechnology companies has in fact experienced significant
price and volume fluctuations that are unrelated to the operating performance
of such companies. In addition, announcements by the Company or others
regarding scientific discoveries, technological innovations, commercial
products, patents or proprietary rights, the progress of clinical trials or
government regulation, public concern as to the safety of devices or drugs,
the issuance of securities analysts' reports and general market conditions may
all have a significant effect on the market price of the Common Stock.
Fluctuations in financial performance from period to period also may have a
significant impact on the market price of the Common Stock.
HOLDERS
As of December 31, 1996, there were 1,283 holders of record of the
Company's Common Stock.
DIVIDENDS
The Company has never paid cash dividends on its Common Stock and does
not expect to pay any cash dividends in the foreseeable future.
ITEM 6. SELECTED FINANCIAL DATA
The selected financial data of the Company appears in a separate section
of this Annual Report on Form 10-K on page F-1.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Management's discussion and analysis of financial condition and results
of operations appears in a separate section of this Annual Report on Form 10-K
beginning on page F-2.
-24-
<PAGE>
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Company's financial statements and schedules, as listed under Item
14, appear in a separate section of this Annual Report on Form 10-K beginning
on page F-6.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
During the two years prior to the date of the most recent financial
statements and the subsequent interim period, the Company has not had a change
in its independent auditors nor have there been any disagreements between the
Company and its independent auditors.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The sections titled "Directors and Nominees" and "Executive Officers"
appearing in the Company's Proxy Statement for the 1997 Annual Meeting of
Stockholders are incorporated herein by reference. The section titled
"Compliance with Section 16(a) of the Securities Act of 1934" reporting a
delinquent filing under such Section 16(a) and appearing in the Company's
Proxy Statement for the 1997 Annual Meeting of Stockholders is also
incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
The section titled "Executive Compensation" appearing in the Company's
Proxy Statement for the 1997 Annual Meeting of Stockholders is incorporated
herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The section titled "Principal Stockholders" appearing in the Company's
Proxy Statement for the 1997 Annual Meeting of Stockholders is incorporated
herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The section titled "Certain Transactions" appearing in the Company's
Proxy Statement for the 1997 Annual Meeting of Stockholders is incorporated
herein by reference.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a)(1) Financial Statements:
--------------------
The following financial statements of the Company are included in a
separate section of this Annual Report on Form 10-K commencing on the pages
referenced below:
<TABLE>
<CAPTION>
Page
----
<S> <C>
Consolidated Balance Sheets as of December 31, 1996 and 1995 F-6
Consolidated Statements of Operations for the Years Ended
December 31, 1996, 1995 and 1994 F-7
Consolidated Statements of Cash Flows for the Years Ended
December 31, 1996, 1995 and 1994 F-8
Consolidated Statements of Stockholders' Equity for the
Years Ended December 31, 1996, 1995 and 1994 F-9
Notes to the Consolidated Financial Statements F-10 to F-18
Report of Ernst & Young LLP, Independent Auditors F-19
</TABLE>
-25-
<PAGE>
(2) Financial Statement Schedules:
-----------------------------
All schedules have been omitted, since they are not applicable, not
required or the information is included in the financial statements or the
notes thereto.
(3) Exhibits:
--------
<TABLE>
<CAPTION>
Exhibit
No. Title Method of Filing
- ------- ----- ----------------
<S> <C> <C>
3.1 Restated Certificate of Incorporation of Incorporated by Reference to Exhibit 4.1
Advanced Tissue Sciences, Inc. as in Effect to the Registrant's Registration
on July 2, 1992 Registration Statement No. 33-50156 on
Form S-8
3.2 Restated By-Laws of the Registrant Dated Incorporated by Reference to Exhibit 3
September 17, 1991 to the Registrant's Form 10-Q for the
Quarter Ended October 31, 1991
4.1 Rights Agreement, Dated as of January 6, 1995, Incorporated by Reference to Exhibit 1
between the Company and Chemical Trust Company to the Registrant's Current Report on
of California, including the Certificate of Form 8-K Dated January 5, 1995
Determination for the Series A Junior
Participating Preferred Stock as Exhibit A,
the form of Summary of Rights to Right
Certificate as Exhibit B and the Purchase
Preferred Shares as Exhibit C
4.2 Investment Agreement between Advanced Tissue Incorporated by Reference to Exhibit 4.1
Sciences, Inc. and Ramius Hatteras Partners, to the Registrant's Current Report on
L.P., Dated February 9, 1996 Form 8-K Dated February 9, 1996
10.1 Form of Indemnification Agreement Between the Incorporated by Reference to Exhibit 10.6
Company and Each of the Directors of the Company to the Registrant's Annual Report on
Form 10-K for the Year Ended
January 31, 1991
10.2 Nonqualified Stock Option Agreement, Dated Incorporated by Reference to Exhibit 19.1
June 3, 1991 between the Company and to the Registrant's Form 10-Q for the
Arthur J. Benvenuto Quarter Ended July 31, 1991
10.3 Nonqualified Stock Option Agreement, Dated Incorporated to Reference to Exhibit 19.2
June 3, 1991 between the Company and to the Registrant's Form 10-Q for the
Dr. Gail K. Naughton Quarter Ended July 31, 1991
10.4** Advanced Tissue Sciences, Inc. 1992 Stock Incorporated by Reference to Exhibit 99.1
Option/Stock Issuance Plan to the Registrant's Registration Statement
No. 33-82310 on Form S-8
10.5 Form of Special Addendum to Certain Employee Incorporated by Reference to Exhibit 10.1
Stock Option Agreements to the Registrant's Form 10-Q for the
Quarter Ended March 31, 1996
10.6(a)* Licensing Agreement between the Massachusetts Incorporated by Reference to Exhibit 10.8(a)
Institute of Technology and Advanced Tissue to the Registrant's Transition Report on
Sciences, Inc. Dated July 24, 1992 Form 10-K for the Eleven Months Ended
December 31, 1992
</TABLE>
-26-
<PAGE>
<TABLE>
<CAPTION>
Exhibit
No. Title Method of Filing
- ------- ----- ----------------
<S> <C> <C>
10.6(b)* Sponsored Research Agreement between the Incorporated by Reference to Exhibit 10.8(b)
Massachusetts Institute of Technology and to the Registrant's Transition Report on
Advanced Tissue Sciences, Inc. Dated Form 10-K for the Eleven Months Ended
July 24, 1992 December 31, 1992
10.7* Agreement between the Advanced Tissue Sciences, Incorporated by Reference to Exhibit 10.1
Inc. and Smith & Nephew plc Dated May 6, 1994 to the Registrant's Form 10-Q for the
Quarter Ended March 31, 1994
10.8 Heads of Agreement between the Company and Incorporated by Reference to Exhibit 10.1
Smith & Nephew plc Dated April 29, 1996 to the Registrant's Form 10-Q for the
Quarter Ended March 31, 1996
21 Subsidiaries of the Registrant Filed Herewith
23 Consent of Ernst & Young LLP, Independent
Auditors Filed Herewith
27 Financial Data Schedule Filed Herewith
___________________
</TABLE>
* The Company has requested confidential treatment with respect to certain
portions of these documents.
** Key employees (including officers and directors), non-employee Board
members and independent consultants are eligible to participate in the
1992 Stock Option/Stock Issuance Plan.
(b) Reports on Form 8-K
-------------------
The Company filed a Current Report on Form 8-K dated October 14, 1996
under Item 5 reporting it had issued a press release containing information on
the results of its pivotal clinical trial in the United States of Dermagraft
in the treatment of diabetic foot ulcers. The Company also reported that it
was preparing, and planned to submit, a Premarket Approval application for
Dermagraft for the treatment of diabetic foot ulcers to the U.S. Food and Drug
Administration in December 1996.
-27-
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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: March 26, 1997 By: /s/ Arthur J. Benvenuto
------------------- ----------------------------
Arthur J. Benvenuto
Chairman of the Board of Directors
and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been executed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<S> <C> <C>
/s/ Arthur J. Benvenuto Chairman of the Board of Directors March 26, 1997
- ------------------------- and Chief Executive Officer
Arthur J. Benvenuto (principal executive officer)
/s/ Dr. Gail K. Naughton Director, President and Chief March 26, 1997
- ------------------------- Operating Officer
Dr. Gail K. Naughton
/s/ Michael V. Swanson Vice President, Finance and March 26, 1997
- ------------------------- Administration (principal financial
Michael V. Swanson and accounting officer)
/s/ Jerome E. Groopman, M.D. Director March 26, 1997
- -----------------------------
Jerome E. Groopman, M.D.
/s/ Dayton Ogden Director March 26, 1997
- --------------------------
Dayton Ogden
/s/ Jack L. Heckel Director March 26, 1997
- --------------------------
Jack L. Heckel
/s/ David S. Tappan, Jr. Director March 26, 1997
- --------------------------
David S. Tappan, Jr.
/s/ Dr. Gail R. Wilensky Director March 26, 1997
- ---------------------------
Dr. Gail R. Wilensky
</TABLE>
-28-
<PAGE>
SELECTED FINANCIAL DATA
See Note 1 to the accompanying consolidated financial statements for a
discussion of the basis of presentation. This summary of selected financial
data should be read in conjunction with the consolidated financial statements
and notes presented on pages F-6 to F-18.
<TABLE>
<CAPTION>
Eleven
Year Ended December 31, Months Ended
------------------------------------------------- December 31,
1996 1995 1994 1993 1992 (1)
---------- ---------- ---------- ---------- ------------
(In thousands, except for per share amounts)
<S> <C> <C> <C> <C> <C>
Revenues:
Product sales (2) $ 1,018 $ 1,177 $ 1,042 $ 1,401 $ 755
Contracts and fees (3) 13,574 2,388 923 3,493 62
Interest and other 2,370 1,185 1,250 972 1,393
Research and development
expenses 23,699 18,498 16,459 13,810 5,666
Net loss (2) (3) (4) (22,401) (23,125) (22,775) (17,691) (31,990)
Net loss per share (2)(3)(4) $ (.61) $ (.72) $ (.75) $ (.67) $ (1.40)
Weighted average shares used
in the calculation of net
loss per share 36,556 32,266 30,250 26,453 22,896
</TABLE>
<TABLE>
<CAPTION>
December 31,
--------------------------------------------------------------
1996 1995 1994 1993 1992
---------- ---------- ---------- ---------- ----------
(In thousands)
<S> <C> <C> <C> <C> <C>
Cash, cash equivalents and
short-term investments $ 40,217 $ 18,929 $ 22,033 $ 21,693 $ 34,970
Working capital 35,984 15,747 19,037 17,529 34,404
Total assets 56,501 31,141 33,426 30,363 40,096
Long-term debt 61 25 36 46 --
Accumulated deficit (139,082) (116,681) (93,556) (70,781) (53,090)
Stockholders' equity 48,380 25,900 28,350 24,863 38,089
- ----------
</TABLE>
(1) The Company changed from a January 31 fiscal year to a December 31
calendar year in 1992 resulting in an eleven-month reporting period
ended December 31, 1992.
(2) In September 1996, the Company announced its decision to discontinue
sales of its Skin2(R) laboratory testing kits and took a charge of
approximately $1 million associated with the closure of this business.
(3) In April 1996, the Company signed an agreement to form a joint venture
with Smith & Nephew plc for the worldwide commercialization of
Dermagraft(R) for diabetic foot ulcers. In connection with the agree-
ment, the Company received a $10 million payment which is included in
contracts and fees for the year ended December 31, 1996.
(4) Includes a nonrecurring charge for acquired in-process technology of
$21.4 million related to an acquisition in the eleven-month period ended
December 31, 1992.
F-1
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Advanced Tissue Sciences, Inc. (the "Company") is engaged in the
development and manufacture of living human tissue products for therapeutic
applications using its proprietary tissue engineering technology. In the
first quarter of 1997, the Company received marketing approval from the U.S.
Food and Drug Administration (the "FDA") and began selling its first
therapeutic product, Dermagraft-TC(TM), a temporary covering for severe
burns. In anticipation of the approval, the Company began building its
sales and marketing capabilities and manufacturing product for inventory
during the second half of 1996.
In December 1996, the Company, in conjunction with its joint venture
partner, Smith & Nephew plc ("Smith & Nephew"), also submitted an application
for approval to market the Company's dermal skin replacement product,
Dermagraft(R) for the treatment of diabetic foot ulcers. The joint venture
is currently enrolling fifty patients into a confirmatory trial which will be
submitted as an amendment to the marketing application, and is performing
additional trials in selected European countries. In addition to its
Dermagraft-TC and Dermagraft skin products, the Company is focusing its
resources on the development of tissue engineered cartilage and cardiovascular
products.
The Company has incurred, and expects to continue to incur, substantial
and increasing expenditures in support of the commercialization, development
and clinical trials of its Dermagraft-TC and Dermagraft 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. These activities have been supported by a variety
of strategic relationships over the past several years.
As noted above, in April 1996, the Company entered into an agreement with
Smith & Nephew to form a fifty-fifty joint venture (the "Dermagraft Joint
Venture") for the worldwide commercialization of Dermagraft in the treatment
of diabetic foot ulcers. Beginning in January 1997, all expenses and revenues
associated with the development and commerialization of Dermagraft for
diabetic foot ulcers will be shared equally by the joint venture partners. In
May 1994, the Company and Smith & Nephew entered into a separate, fifty-fifty
joint venture (the "Cartilage Joint Venture") for the worldwide development,
manufacture and marketing of human tissue engineered cartilage for orthopedic
applications. Smith & Nephew has been responsible for funding the first $10
million in costs incurred in the Cartilage Joint Venture. Beginning in
January 1997, the joint venture partners will share equally in the Cartilage
Joint Venture's expenses. See Note 3 to the consolidated financial
statements.
In 1994 and 1995, 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. 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. See Notes 3 and 8 to
the consolidated financial statements.
In September 1996, the Company announced its decision to discontinue
sales of its Skin2(R) laboratory testing kits and took a charge of
approximately $1 million associated with the closure of this business. See
Note 4 to the consolidated financial statements.
RESULTS OF OPERATIONS
Year Ended December 31, 1996 as Compared to the Year Ended December 31, 1995
Revenues increased to $16,962,000 in 1996 from $4,750,000 in 1995. The
increase in 1996 primarily reflects a $10 million up front fee from Smith &
Nephew upon signing the agreement to enter into the Dermagraft Joint Venture.
In 1996, the Company also recognized contract revenues of $3,564,000 for
research
F-2
<PAGE>
and development of orthopedic applications of tissue engineered cartilage
performed for the Cartilage Joint Venture, as compared to $1,548,000 in 1995.
In 1995, contract revenues also included $830,000 related to research
performed under the development agreement with St. Jude Medical.
Sales of the Company's Skin2 laboratory testing kits decreased to
$1,018,000 in 1996 compared to $1,177,000 in 1995. As discussed above, the
Company discontinued sales of its Skin2 products in 1996. Interest income in
1996 increased to $2,360,000 from $1,171,000 reflecting higher cash balances
due to funds raised in a March 1996 public offering and from the up front fee
discussed above.
Research and development expenditures increased 28% in 1996 to
$23,699,000 from $18,498,000 in 1995 due to 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 Cartilage
Joint Venture. 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 and rent.
Selling, general and administrative costs were $10,911,000 in 1996, a 78%
increase from $6,115,000 in 1995. The year ended December 31, 1996 includes
charges of approximately $1,000,000 associated with the closing of the
Company's In Vitro Laboratory Testing ("IVLT") business. The increase in
selling, general and administrative expenses also reflects (i) costs related
to building sales and marketing capabilities in anticipation of marketing
approval of Dermagraft-TC and for Dermagraft; (ii) amortization of the
commitment fee associated with the equity line established in February 1996
(see Note 9 to the consolidated financial statements); (iii) increased
salaries and personnel; and (iv) higher relocation costs.
Professional and consulting costs for legal, accounting and other
consulting services incurred in 1996 were $3,378,000 compared to $1,897,000 in
1995. The increase in professional and consulting fees in 1996 principally
reflects fees paid to financial advisors and consultants related to forming
the Dermagraft Joint Venture and evaluating alternatives for the Company's
IVLT business. Professional and consulting costs for 1996 also 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.
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. As noted above, the Company has discontinued its IVLT business.
Year Ended December 31, 1995 as Compared to the Year Ended December 31, 1994
Revenues increased $1,535,000 to $4,750,000, or approximately 48%, during
1995 as compared to 1994. In 1995, the Company recognized contract revenues
of $1,548,000 and $830,000, respectively, from the Cartilage Joint Venture and
from St. Jude Medical for research performed related to orthopedic
applications of cartilage tissue and tissue engineered heart valves, as
compared to $893,000 from the Cartilage Joint Venture in 1994. The Company
internally funded its cardiovascular research in 1994. Revenues for 1995 also
reflect a $74,000 decrease in interest income as compared to 1994 as higher
rates earned on invested funds were more than offset by lower average invested
balances.
Sales of the Company's Skin2 laboratory testing kits increased $135,000,
or approximately 13%, in 1995 as compared to 1994. Sales in 1994 were limited
by product availability due to manufacturing issues in the second and third
quarters. Product sales fluctuated depending on the number and timing of
validation studies initiated either by the Company or third parties. Product
sales include revenues received under validation
F-3
<PAGE>
studies of $379,000 and $259,000 in 1995 and 1994, respectively. Revenues in
1994 also include approximately $51,000 in deferred sales which were
recognized upon regulatory approval of the Skin2 kits for use in classifying
corrosive materials.
Research and development expenditures increased approximately 12% from
$16,459,000 in 1994 to $18,498,000 in 1995. The increase in research and
development costs reflected higher costs associated with the use and
validation of the Company's commercial manufacturing facility, the production
of Dermagraft products for clinical trials and the scale up of the Dermagraft
manufacturing processes. In addition, the Company incurred higher costs in
support of the development of orthopedic cartilage and cardiovascular products
for the Cartilage Joint Venture and St. Jude Medical research programs
discussed above. The increased costs in 1995 are principally reflected in
higher costs for outside engineering services and overhead. These increases
were partially offset by lower costs for preclinical studies of Dermagraft and
of liver tissues, and for research related to a stem cell growth factor.
Selling, general and administrative costs were $6,115,000 in 1995, a
decline of $330,000, or approximately five percent, from $6,445,000 in 1994.
The decrease in selling, general and administrative expenses primarily
reflects a slightly lower headcount and a decrease in associated costs.
Professional and consulting costs for legal, accounting and other
consulting services were $1,897,000 in 1995 as compared to $1,718,000 in 1994.
The increase of $179,000, or approximately 10%, in 1995 reflects fees for
consultants in support of corporate development activities and higher fees for
recruiting personnel partially offset by lower fees for scientific
consultants. The year 1994 also included higher fees for legal matters,
primarily as a result of corporate development activities.
LIQUIDITY AND CAPITAL RESOURCES
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
approximately $40.0 million from the offering. See Note 9 to the consolidated
financial statements.
As of December 31, 1996, the Company had available working capital of
$35,984,000 compared to $15,747,000 at year end 1995. The increase in 1996
principally reflects the proceeds from the sale of the Company's Common Stock
and a $10 million fee from Smith & Nephew, net of funds used in operations and
for capital expenditures. Capital expenditures were $3,104,000 in 1996
compared to $1,476,000 in 1995.
The Company expects to use working capital at an accelerated rate over
the next twelve months as it continues to incur substantial research and
development expenses (including costs associated with clinical trials and the
development of manufacturing processes), increasing selling, general and
administrative costs in anticipation of product commercialization, and
additional expenditures for capital equipment (including increased
expenditures for manufacturing facilities and equipment) and patents. These
increases are expected to be only partially offset by revenues received from
the cartilage and Dermagraft joint ventures with Smith & Nephew. The closure
of the IVLT business is not expected to materially change the use of working
capital as substantially all of its resources have been redeployed into the
Company's therapeutic programs.
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 9 to the consolidated financial statements). Any decision to draw funds
under the equity line and the timing of any such draw are solely at the
Company's discretion. The Company currently believes it has sufficient funds,
including those available under the equity line and from borrowings available
under its joint venture arrangements, to support its operations through 1997.
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. There can be no assurance, however, that any
additional funds will be
F-4
<PAGE>
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.
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.
FINANCIAL CONDITION
Cash and cash equivalents, short-term investments and stockholders'
equity as of December 31, 1996 have increased significantly from year end 1995
reflecting net proceeds received from the sale of the Company's Common Stock
in the March 1996 public offering and the funds received from Smith & Nephew
as discussed above, which were partially offset by funds used in operations
and for capital expenditures. Other current assets have increased from year
end 1995 to year end 1996 as inventory was manufactured in anticipation of the
marketing approval of Dermagraft-TC. Other current assets and other assets
have also increased over the same period reflecting the prepayment of a
commitment fee through the issuance of warrants, amounts receivable from the
Cartilage Joint Venture for research and development activities, and advance
payments under a sponsored research program. Accounts payable have increased
from year end 1995 to year end 1996 primarily due to product development and
marketing expenses while accrued expenses have increased year to year as a
result of higher accruals for salaries and benefits, clinical studies and
professional fees.
F-5
<PAGE>
ADVANCED TISSUE SCIENCES, INC.
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
December 31,
-------------------------
1996 1995
---------- ----------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 27,907 $ 18,929
Short-term investments 12,310 --
Prepaid expenses 1,058 820
Other current assets 2,769 1,214
--------- ---------
Total current assets 44,044 20,963
Property - net 9,734 8,332
Patent costs - net 1,310 1,032
Other assets 1,413 814
--------- ---------
Total assets $ 56,501 $ 31,141
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of obligations under capital
leases $ 23 $ 11
Accounts payable 2,232 1,183
Accrued expenses 5,805 4,022
--------- ---------
Total current liabilities 8,060 5,216
--------- ---------
Obligations under capital leases 61 25
--------- ---------
Commitments and contingencies (Notes 7 and 8)
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, 37,474,677
shares at December 31, 1996 and 33,885,928
shares at December 31, 1995 375 339
Additional paid-in capital 188,006 143,161
Accumulated deficit (139,082) (116,681)
--------- ---------
49,299 26,819
Less note received in connection with the
sale of Common Stock (Note 9) (919) (919)
--------- ---------
Total stockholders' equity 48,380 25,900
--------- ---------
Total liabiities and stockholder's equity $ 56,501 $ 31,141
========= =========
</TABLE>
See accompanying notes to the consolidated financial statements.
F-6
<PAGE>
ADVANCED TISSUE SCIENCES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------------------
1996 1995 1994
---------- ---------- ----------
<S> <C> <C> <C>
Revenues:
Product sales $ 1,018 $ 1,177 $ 1,042
Contracts and fees 13,574 2,388 923
Interest and other 2,370 1,185 1,250
--------- --------- ---------
Total revenues 16,962 4,750 3,215
--------- --------- ---------
Costs and expenses:
Research and development 23,699 18,498 16,459
Selling, general and administrative 10,911 6,115 6,445
Professional and consulting 3,378 1,897 1,718
Cost of goods sold 1,369 1,359 1,360
Interest 6 6 8
--------- --------- ---------
Total costs and expenses 39,363 27,875 25,990
--------- --------- ---------
Net loss $ (22,401) $ (23,125) $ (22,775)
========= ========= =========
Net loss per share $ (.61) $ (.72) $ (.75)
========= ========= =========
Weighted average number of common
shares used in the computation of
net loss per share 36,556 32,266 30,250
========= ========= =========
</TABLE>
See accompanying notes to the consolidated financial statements.
F-7
<PAGE>
ADVANCED TISSUE SCIENCES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
Year Ended December 31,
------------------------------------
1996 1995 1994
---------- ---------- ----------
<S> <C> <C> <C>
Operating activities:
Net loss $ (22,401) $ (23,125) $ (22,775)
Adjustments to reconcile net loss to cash
used in operating activities:
Depreciation and amortization 1,774 1,421 1,102
Compensation or services paid in stock
or stock options and warrants 976 55 --
Other adjustments to net loss 66 212 38
Changes in assets and liabilities:
Prepaid expenses and other current assets (1,793) 10 (754)
Other assets (114) (663) 200
Accounts payable 1,049 (667) 512
Accrued expenses 1,783 842 (928)
--------- --------- ---------
Net cash used in operating activities (18,660) (21,915) (22,605)
--------- --------- ---------
Investing activities:
Purchases of short-term investments (45,730) (5,363) (35,196)
Sales of short-term investments 33,420 14,979 28,965
Acquisition of property (3,104) (1,476) (3,145)
Patent application costs (356) (323) (164)
--------- --------- ---------
Net cash provided by (used in)
investing activities (15,770) 7,817 (9,540)
--------- --------- ---------
Financing activities:
Payments of borrowings (12) (10) (8)
Net proceeds from sale of equity 40,253 19,515 26,197
Options exercised 3,167 1,105 65
--------- --------- ---------
Net cash provided by financing
activities 43,408 20,610 26,254
--------- --------- ---------
Net increase (decrease) in cash and cash
equivalents 8,978 6,512 (5,891)
Cash and cash equivalents at beginning of
year 18,929 12,417 18,308
--------- --------- ---------
Cash and cash equivalents at end of year $ 27,907 $ 18,929 $ 12,417
========= ========= =========
</TABLE>
See accompanying notes to the consolidated financial statements.
F-8
<PAGE>
ADVANCED TISSUE SCIENCES, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(IN THOUSANDS)
<TABLE>
<CAPTION>
Common Stock Additional Total
---------------------- Paid-In Accumulated Note Stockholders'
Shares Amount Capital Deficit Receivable Equity
------------ -------- ------------ ----------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
Balance, December 31, 1993 27,107 $ 271 $ 95,373 $ (70,781) $ 24,863
Sale of Common Stock 2,875 29 21,168 21,197
Sale of Common Stock to St. Jude
Medical, Inc. 563 6 4,994 5,000
Options and warrants exercised 24 65 65
Net loss (22,775) (22,775)
-------- -------- --------- ---------- ----------
Balance, December 31, 1994 30,569 306 121,600 (93,556) 28,350
Sale of Common Stock 2,614 26 19,489 19,515
Options and warrants exercised 703 7 2,017 $ (919) 1,105
Options granted for services 55 55
Net loss (23,125) (23,125)
--------- -------- --------- ---------- --------- ----------
Balance, December 31, 1995 33,886 339 143,161 (116,681) (919) 25,900
Sale of Common Stock 3,224 32 39,595 39,627
Warrants issued as commitment fee
under equity line 875 875
Valuation adjustment of Common Stock
issued in private placement 626 626
Warrants granted for services 500 500
Options and warrants exercised 365 4 3,249 3,253
Net loss (22,401) (22,401)
---------- -------- --------- ---------- --------- ----------
Balance, December 31, 1996 37,475 $ 375 $ 188,006 $ (139,082) $ (919) $ 48,380
========== ======== ========= ========== ========= ==========
</TABLE>
See accompanying notes to the consolidated financial statements.
F-9
<PAGE>
ADVANCED TISSUE SCIENCES, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - BASIS OF PRESENTATION
Organization - Advanced Tissue Sciences, Inc. (the "Company") is a tissue
engineering company utilizing its proprietary technology to develop and
manufacture human-based tissue products for transplantation. The Company is
focusing on the worldwide commercialization of skin, cartilage and
cardiovascular products. The Company's leading therapeutic products are
tissue engineered skin products for the treatment of severe burns, approved
for marketing in the United States by the Food and Drug Administration
("FDA"), and for diabetic foot ulcers, for which the Company has filed an
application with the FDA for marketing approval and is performing multi-site
clinical trials in the United States.
Principles of Consolidation - The consolidated financial statements include
the accounts of the Company and its wholly owned subsidiaries. The Company's
interest in joint ventures with Smith & Nephew plc ("Smith & Nephew") are
accounted for under the equity method (see Note 3). All intercompany accounts
and transactions have been eliminated.
Use of Estimates - The preparation of 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
related disclosures at the date of the financial statements, and the amounts
of revenues and expenses reported during the period. Actual results could
differ from those estimates.
Dependence on Certain Suppliers - The mesh frameworks used by the Company in
its therapeutic products are sourced from single manufacturers. Any
significant supply interruption would adversely affect the Company's product
manufacturing. In addition, an uncorrected impurity or supplier's variation
in raw material, either unknown to the Company or incompatible with the
Company's manufacturing process, could have a material adverse effect on the
Company's ability to manufacture its products.
Transition from Development Stage Company - In prior years, the Company has
reported as a development stage company. With the commercial introduction of
its first therapeutic product, Dermagraft-TC, Advanced Tissue Sciences has
begun reporting as an operating company.
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Cash Equivalents and Short-term Investments - Cash equivalents consist
primarily of investments in commercial paper and obligations issued or
guaranteed by the United States Government with maturities of three months or
less at the date of acquisition. Cash equivalents were approximately
$27,880,000 and $18,622,000 as of December 31, 1996 and 1995, respectively.
Short-term investments consist primarily of investments in commercial paper
and obligations issued or guaranteed by the United States Government with
maturities of one year or less but more than three months at the date of
acquisition. Cash equivalents and short-term investments are stated at
amortized cost, which approximates market value. As of December 31, 1996 and
1995, the Company's cash equivalents and short-term investments were
classified as available-for-sale and consisted of (in thousands):
<TABLE>
<CAPTION>
1996 1995
-------- --------
<S> <C> <C>
Debt securities of U.S. Government agencies $ 23,574 $ 13,051
United States treasury bills 7,799 2,682
Commercial paper 5,479 2,889
Money market funds 3,353 --
-------- --------
Total cash equivalents and short-term
investments $ 40,205 $ 18,622
======== ========
</TABLE>
F-10
<PAGE>
These investments all mature in less than one year. There were no significant
unrealized or realized gains or losses related to such securities during the
years ended December 31, 1996 or 1995.
Property is recorded at cost and is depreciated using estimated useful lives
which range from 5 to 10 years. For financial statement purposes,
depreciation is generally computed using the straight-line method. For tax
purposes, depreciation is generally computed by accelerated methods on
allowable useful lives. Amortization of capitalized leases is included with
depreciation expense.
Patents - The Company owns and has patents pending in the United States and
abroad to protect the processes and products being developed by the Company.
Direct patent application and maintenance costs related to patents issued are
amortized over the estimated useful life of the patent, generally 17 years.
Such costs related to pending applications are deferred until the patent is
issued or charged to operations at the time a determination is made not to
pursue an application. Patents are presented net of accumulated amortization
of approximately $170,000 and $134,000 as of December 31, 1996 and 1995,
respectively. Patent application and maintenance costs related to licensing
agreements are expensed as incurred.
Revenue Recognition - Revenues from product sales are recognized when products
are shipped. Revenues under collaborative research agreements are recognized
over the period specified in the related agreement. Revenues from government
grants are recognized based on the performance requirements of the grant or as
the grant expenditures are incurred. Expenses related to such agreements and
grants are classified as research and development expenses.
Research and Development Costs are expensed as incurred. Such costs include
proprietary research and development activities and expenses associated with
collaborative research agreements.
Net Loss Per Share is based on the weighted average number of shares of Common
Stock issued and outstanding. Shares to be issued under options and warrants
have not been included in the calculation of the net loss per share in any
period as their effect is antidilutive.
New Accounting Standard - In October 1995, the Financial Accounting Standards
Board issued Statement No. 123, "Accounting for Stock-Based Compensation"
("FAS No. 123"). FAS No. 123, effective for financial statements for fiscal
years beginning after December 15, 1995, prescribes accounting and reporting
standards for all stock-based compensation plans, including employee stock
options, restricted stock, employee stock purchase plans and stock
appreciation rights. FAS No. 123 allows the Company to continue to follow
Accounting Principles Board (APB) Opinion No. 25, "Accounting for Stock Issued
to Employees," which the Company has elected to do, but requires additional
disclosure relating to outstanding stock option grants. Under APB Opinion No.
25, compensation expense relating to employee stock options is determined
based on the excess of the market price of the Company's stock over the
exercise price on the date of grant and does not require the recognition of
compensation expense for stock issued under plans defined as noncompensatory.
Adoption of the "fair value method" for determining compensation expense
relating to employee stock option plans under FAS No. 123 would require
recognition of compensation expense for virtually all options based on their
computed "fair value" on the date of grant (see Note 10).
NOTE 3 - STRATEGIC ALLIANCES
In April 1996, the Company entered into an agreement with Smith & Nephew to
form a fifty-fifty joint venture for the worldwide commercialization of
Dermagraft, the Company's tissue engineered dermal replacement, for the
treatment of diabetic foot ulcers (the "Dermagraft Joint Venture"). Upon
signing, Smith & Nephew paid an up front 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
F-11
<PAGE>
has retained rights to develop Dermagraft for burns and for plastic and
reconstructive surgery. The companies are sharing equally in the expenses and
revenues of the Dermagraft Joint Venture effective January 1, 1997. As part
of the agreement, Smith & Nephew has also agreed to loan the Company up to $10
million during 1997.
In May 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 and the Company has
contributed certain technology licenses. The Cartilage Joint Venture incurred
a net loss of $6,833,000 in the year ended December 31, 1996, bringing total
expenditures of the joint venture funded by Smith & Nephew to $9,590,000 from
inception to December 31, 1996. Cartilage Joint Venture revenues and
expenditures in excess of $10 million will be shared equally by the partners.
The joint venture also has a right of first negotiation to develop tissue
engineered bone, tendon and ligament for orthopedic applications. The Company
has retained all non-orthopedic cartilage tissue rights. In 1996, 1995 and
1994, the Company recognized $3,564,000, $1,548,000 and $893,000,
respectively, in contract revenues for research and development activities
performed for the Cartilage Joint Venture.
In February 1994, 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.
Separately, St. Jude Medical and the Company entered into a Common Stock
Purchase Agreement (see Note 9). In January 1995, the agreement was extended
to December 31, 1995 and the Company received $830,000 in funding in 1995 for
research on tissue engineered heart valves. 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. The Company is currently funding all of its cardiovascular research
and development activities.
NOTE 4 - IN VITRO LABORATORY TESTING BUSINESS
In March 1996, the Company entered into a consulting agreement with J.P.
Morgan Capital Corporation ("Morgan") whereby Morgan assisted the Company with
respect to various strategic business and financial alternatives for its In
Vitro Laboratory Testing ("IVLT") business. With Morgan's assistance, the
Company explored various alternatives for the IVLT business, including the
possible sale of the business. However, in September 1996, the Company
announced that it was closing the IVLT business and would focus all of its
resources on its therapeutic programs. Although the Company was a leader in
the in vitro testing business and continuously broadened applications of it
products, the market for in vitro laboratory testing products was evolving too
slowly for the Company to continue to devote its resources to this business.
The statement of operations for the year ended December 31, 1996 includes
charges of approximately $1.0 million for costs associated with the closure of
the IVLT business (substantially all of which are reflected in selling,
general and administrative expenses). Exclusive of these charges, costs
associated with operations of the IVLT business were $2,528,000, $2,913,000,
and $3,227,000 for the years ended December 31, 1996, 1995 and 1994,
respectively.
NOTE 5 - PROPERTY
The major classes of property as of December 31, 1996 and 1995 are as follows
(in thousands):
<TABLE>
<CAPTION>
1996 1995
-------- --------
<S> <C> <C>
Equipment $ 8,763 $ 6,772
Furniture and fixtures 578 413
Leasehold improvements 5,972 5,696
Equipment under capital leases 116 55
Construction in progress 555 --
-------- --------
15,984 12,936
Less accumulated depreciation and amortization (6,250) (4,604)
-------- --------
Property - net $ 9,734 $ 8,332
======== ========
</TABLE>
F-12
<PAGE>
NOTE 6 - ACCRUED EXPENSES
Accrued expenses as of December 31, 1996 and 1995 consisted of (in thousands):
<TABLE>
<CAPTION>
1996 1995
-------- --------
<S> <C> <C>
Salaries and benefits $ 2,173 $ 1,144
Clinical studies 1,245 865
Sponsored research 915 946
Professional fees 396 94
Product and process engineering 139 243
Other 937 730
-------- --------
$ 5,805 $ 4,022
======== ========
NOTE 7 - LEASE COMMITMENTS
Operating lease commitments relate primarily to the Company's manufacturing,
research and administrative facilities. The leases for the Company's primary
facility, which include manufacturing, research and administrative facilities,
expire in September 2000; however, these leases include an option to extend
the term for an additional five years. These leases include the cost of some
of the utilities and certain services, and provide for annual rental increases
ranging from a minimum of 3% to a maximum of 7% based on changes in the
Consumer Price Index. The Company also leases another facility for research
and administration. This lease has a two-year term and expires in July 1998;
however, the Company has options to extend the term of the lease for up to one
year. The lease includes the operating costs for the facility and provides
for a 4% annual rent increase.
The following is a summary of the annual future minimum capital and operating
lease commitments as of December 31, 1996 (in thousands):
</TABLE>
<TABLE>
<CAPTION>
CAPITAL OPERATING
LEASES LEASES
-------- ----------
<S> <C> <C>
Year Ending December 31:
1997 $ 31 $ 3,406
1998 29 2,660
1999 15 1,991
2000 15 1,538
2001 13 --
Thereafter -- --
------- ---------
Total minimum lease payments 103 $ 9,595
=========
Less amount representing interest (19)
-------
Present value of net minimum lease payments $ 84
=======
</TABLE>
Rental expense charged to operations under operating leases for facilities and
equipment for the years ended December 31, 1996, 1995 and 1994 amounted to
approximately $2,778,000, $1,982,000 and $1,812,000, respectively.
NOTE 8 - COMMITMENTS AND CONTINGENCIES
Under research and licensing agreements with the Massachusetts Institute of
Technology ("MIT") and Children's Hospital in Boston ("Children's Hospital"),
the Company has agreed to sponsor research for a minimum of $1 million in
calendar year 1997. The Company is also responsible for patent application
costs and associated maintenance fees related to inventions under these and
other licensing agreements. In addition, the Company has consulting
agreements with the two principal scientists at MIT and Children's Hospital,
whereby the Company has agreed to pay each such scientist a consulting fee of
$146,000 per annum through September 1997. The parties have the right to
terminate these agreements under certain circumstances.
F-13
<PAGE>
The Company seeks to protect its proprietary technology through the use of
various aspects of United States and foreign patent law and contractual
arrangements. The Company owns eighteen United States patents and has patent
applications pending both in the United States and internationally. However,
there can be no assurance that the Company's patents or patent applications
will afford protection against competitors with similar technology, nor can
there be any assurance that the Company's present patents will not be
infringed upon or designed around by others.
As of December 31, 1996, the Company had entered into commitments of
approximately $3.4 million in connection with the expansion of its
manufacturing facilities and for related process equipment. These
expenditures are expected to be made during 1997. The Company is currently
pursuing financing for a portion of this expenditures with its joint venture
partner, Smith & Nephew; however, there can be no assurance such funding will
be obtained or will be available on terms favorable to the Company.
NOTE 9 - CAPITAL STOCK
The Company is authorized to issue 50,000,000 shares of Common Stock, of which
37,474,677 shares were outstanding as of December 31, 1996, and 1,000,000
shares of Preferred Stock, of which there are no shares outstanding. The
Board of Directors of the Company is authorized to designate the rights,
preferences and limitations for any issuance of Preferred Stock. As of
December 31, 1996, the Company had 5,518,000 shares of Common Stock reserved
for issuance under options and warrants.
In January 1995, the Company adopted a Shareholder Rights Plan and pursuant
thereto issued one preferred share purchase right ("Right") on each
outstanding share of Common Stock. The Rights are exercisable only if a
person or group acquires, or makes a tender offer to acquire, 15% or more of
the Company's Common Stock. In connection with the adoption of the
Shareholder Rights Plan, the Company's Board of Directors designated and
reserved 500,000 shares of the Company's authorized Preferred Stock as Series
A Junior Participating Preferred Stock, par value $.01 per share (the "Series
A Preferred Stock"). The Rights have no voting privileges and expire on
January 6, 2005.
When exercisable, each Right entitles its holder to buy one-hundredth of a
share of the Series A Preferred Stock at an exercise price of $55, subject to
certain antidilution adjustments. In addition, if at any time after the
Rights become exercisable, should (i) the Company be acquired in a merger or
other business combination transaction, or sell 50% or more of its
consolidated assets or earnings power, each Right will entitle its holder to
purchase a number of the acquiring company's common shares having a market
value at the time of twice the Right's exercise price or (ii) a person or
group acquire 15% or more of the Company's outstanding Common Stock, each
Right will entitle its holder, other than the acquirer, to purchase, at the
Right's then-current exercise price, a number of shares of the Company's
Common Stock having a market value of twice the Right's exercise price. The
rights are redeemable for one cent per Right at any time up to and including
ten days after the acquisition of 15% of the then outstanding Common Stock.
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 approximately $40.0
million from the offering.
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
F-14
<PAGE>
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.
In June and July 1995, the Company completed a series of private placements
issuing a total of 2,614,432 shares of its Common Stock. 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 purchase price per share to the investors equal to 88.5% of the
average closing price of the Common Stock over agreed-upon valuation periods.
In total, the Company received net proceeds of $20.3 million. In connection
with the placements, the Company also issued warrants to purchase 235,299
shares of Common Stock. The final purchase prices of the shares issued in the
private placements and the exercise prices for the warrants range from $8.11
to $8.62.
In May 1995, the Company's Chairman of the Board and Chief Executive Officer
exercised an employee stock option for 550,000 shares of Common Stock at an
exercise price of $1.67 per share. The purchase price of $918,500 was paid
with a promissory note bearing interest at 6.75% per annum with principal and
interest due in May 1998. The note receivable is deducted from stockholders'
equity in the accompanying balance sheet.
In January 1994, the Company sold 2,500,000 shares of its Common Stock at
$8.00 per share through a public offering. In February 1994, the underwriters
exercised an over-allotment option to purchase an additional 375,000 shares of
Common Stock at $8.00 per share. In total, the Company received net proceeds
of approximately $21.5 million from the offering. Also in February 1994, St.
Jude Medical, Inc. and the Company entered into a Common Stock Purchase
Agreement whereby St. Jude Medical purchased 563,380 shares of the Company's
Common Stock for $5 million or $8.875 per share.
NOTE 10 - EMPLOYEE BENEFIT PLANS
The Company's Stock Option/Stock Issuance Plan (the "1992 Plan") provides for
the grant of incentive stock options, non-qualified stock options and stock
issuances to employees and consultants and automatic 50,000-share grants to
non-employee directors, currently to a maximum of 4,450,000 shares of Common
Stock. The Company has elected to continue to account for its employee stock
option plans under APB Opinion No. 25 rather than adopt FAS No. 123 (see Note
2).
Under the 1992 Plan, all employees are granted stock options on their date of
employment and on promotion. The number of shares granted is based on the
employee's position and responsibilities. The options granted generally
become exercisable in equal annual amounts over five years. The options
generally have a term of ten years as long as the employee remains in the
service of the Company. The Company intends to make additional annual grants
to employees beginning in 1997. Directors receive an automatic grant of
50,000 shares upon joining the Board and generally every third year
thereafter. The options generally become exercisable in equal annual amounts
over three years and have a term of ten years assuming continued service on
the Board.
In addition to the 1992 Plan, the Company has issued options and warrants to
directors, consultants, employees and others as compensation for services.
These options vest and are exercisable over a variety of periods as determined
by the Company's Board of Directors.
F-15
<PAGE>
The following table summarizes activity under the 1992 Plan and for other
options and warrants for Common Stock for the years ended December 31, 1996,
1995 and 1994:
<TABLE>
<CAPTION>
1992 Plan Other Options and Warrants
------------------------ --------------------------
Weighted Weighted
Number Average Price Number Average Price
of Shares Per Share of Shares Per Share
--------- ------------- --------- -------------
<S> <C> <C> <C> <C>
Outstanding, December 31, 1993 2,432,513 $6.61 1,825,000 $4.98
Granted 256,950 $7.35 83,334 $6.00
Exercised (12,950) $7.91 (10,000) $1.69
Canceled (380,165) $9.01 -- --
--------- ---------
Outstanding, December 31, 1994 2,296,348 $6.37 1,898,334 $5.04
Granted 304,925 $7.95 235,299 $8.39
Exercised (112,783) $8.25 (590,000) $1.85
Canceled (170,975) $10.05 (83,334) $6.00
--------- ---------
Outstanding, December 31, 1995 2,317,515 $6.28 1,460,299 $6.81
Granted 1,660,450 $14.05 275,000 $10.50
Exercised (99,290) $8.87 (265,659) $8.61
Canceled (104,974) $8.10 -- --
--------- ---------
Outstanding, December 31, 1996 3,773,701 $9.58 1,469,640 $7.18
========= =========
</TABLE>
The weighted average fair value of options granted was $9.60 and $5.29 under
the 1992 Plan and $5.00 and $4.05 for other options and warrants in 1996 and
1995, respectively. Included in other options and warrants granted during
1996 is a warrant issued to an investment group exercisable for 175,000 shares
of Common Stock at an exercise price of $10.50 per share as a commitment fee
for keeping the equity line available for a two-year period (see Note 9). In
addition, as a fee for consulting services, the Company also issued a warrant
exercisable for 100,000 shares of Common Stock at an exercise price of $10.50
per share in 1996 (see Note 4).
The following table summarizes by price ranges the number of shares, weighted
average exercise price and weighted average life (in years) of options and
warrants exercisable and outstanding as of December 31, 1996.
<TABLE>
<CAPTION>
Exercisable Total Outstanding
------------------------------- -------------------------------
Weighted Average Weighted Average
Number of --------------------- Number of ---------------------
Price Range Shares Exercise Price Life Shares Exercise Price Life
- --------------- --------- -------------- ---- --------- -------------- ----
<S> <C> <C> <C> <C> <C> <C>
1992 Plan:
$1.69 775,000 $ 1.69 2.5 775,000 $ 1.69 2.5
$3.25 - 3.63 51,540 $ 3.55 3.2 51,540 $ 3.55 3.2
$4.13 - 5.75 123,607 $ 4.82 5.6 187,551 $ 5.09 6.6
$5.88 - 8.63 202,215 $ 8.07 6.2 366,900 $ 7.93 6.7
$8.75 - 13.00 541,170 $10.06 6.2 800,210 $10.16 6.8
$13.13 - 18.50 20,340 $14.95 5.2 1,583,200 $14.20 9.2
$19.63 -- -- -- 9,300 $19.63 9.8
--------- ---------
Total 1992 Plan 1,713,872 $ 5.52 5.5 3,773,701 $ 9.58 8.1
========= =========
Other Options and Warrants:
$1.47 - 1.69 310,000 $ 1.48 1.5 310,000 $ 1.48 1.5
$4.50 10,000 $ 4.50 3.7 10,000 $ 4.50 3.7
$8.11 - 10.50 1,149,640 $ 8.71 6.0 1,149,640 $ 8.71 6.0
--------- ---------
Total Other 1,469,640 $ 7.18 5.8 1,469,640 $ 7.18 5.8
========= =========
</TABLE>
F-16
<PAGE>
The following table reflects the Company's pro forma net loss and net loss per
share for the years ended December 31, 1996 and 1995 had the expense
provisions of FAS No. 123 been implemented (in thousands except per share
amounts):
<TABLE>
<CAPTION>
1996 1995
---------- ----------
<S> <C> <C>
Net loss:
As reported $ (22,401) $ (23,125)
Pro forma (27,971) (24,574)
Net loss per share:
As reported $ (.61) $ (.72)
Pro forma (.77) (.76)
</TABLE>
Because the Statement 123 method of accounting has not been applied to options
granted prior to January 1, 1995, the above pro forma information may not be
representative of that to be expected in future years.
The fair value of each option grant has been estimated on the date of grant
using the Black-Scholes option pricing model. The following weighted average
assumptions were used for grants made under the 1992 Plan in 1996 and 1995:
(i) risk-free interest rates of 5.3% and 6.7%, respectively; (ii) expected
lives of seven years for both years; and (iii) volatility of 64% for both
years. The estimated value of warrants issued in 1996 for services was based
on the value of the services rendered. The Black-Scholes option pricing model
was also used to estimate value of other options and warrants issued in 1995
with the following weighted average assumptions used: (i) risk-free interest
rate of 5.9%; (ii) expected life of two years; and (iii) volatility of 64%.
It is assumed that no dividends are paid on the stock.
During the years ended December 31, 1996 and 1995, $86,000 and $55,000,
respectively, were charged to expense in connection with options granted to
employees and consultants reflecting amortization of the difference between
the fair market value of the shares at the date of grant and the grant price
over the vesting period.
The Company has a 401(k) Plan (the "401(k) Plan") under which employees
meeting certain eligibility requirements may elect to participate and
contribute to the 401(k) Plan. Under the 401(k) Plan, the Company may elect
to match a discretionary percentage of contributions. No such matching
contributions have been made to the 401(k) Plan since its inception.
NOTE 11 - INCOME TAXES
The Company has federal and California net operating loss carryforwards of
approximately $133 million and $28 million, respectively, as of December 31,
1996. The difference between the federal and California operating tax loss
carryforwards principally results from the Company not having operations in
California until late 1989, a fifty percent limitation on California loss
carryforwards and the capitalization of certain research and development
expenses for California purposes. As of December 31, 1996, the Company also
has federal and California research and development tax credit carryforwards
of approximately $4.1 million and $1.5 million, respectively and has
California manufacturer's investment tax credit carryforwards of approximately
$314,000. The federal net operating loss and research and development tax
credit carryforwards will begin expiring in 2001, the California research and
development tax credit carryforwards will begin expiring in 2004, and the
California manufacturer's investment tax credit carryforward will begin
expiring in 2002, unless previously utilized. California net operating loss
carryforwards of approximtely $14.1 million and $5.3 million will expire in
1997 and 1998, respectively, if not utilized.
Utilization of future net operating loss carryforwards could be limited if
certain cumulative changes in the Company's ownership were to occur. Included
in the federal net operating loss carryforwards, and subject to an annual
limitation, are approximately $5 million of losses related to an acquisition.
F-17
<PAGE>
Net deferred tax assets have been completely offset by a valuation allowance
as realization of the deferred tax assets is uncertain. During the year ended
December 31, 1996, the valuation allowance increased by $11,267,000.
Significant components of the Company's net deferred tax assets as of December
31, 1996 and 1995 are as follows (in thousands):
<TABLE>
<CAPTION>
December 31,
-------------------------
1996 1995
---------- ----------
<S> <C> <C>
Deferred tax assets:
Net operating loss carryforwards $ 48,409 $ 39,913
Tax credit carryforwards 5,200 4,389
Capitalized research and development 3,771 2,166
Other 1,271 791
--------- ---------
Total deferred tax assets 58,651 47,259
--------- ---------
Deferred tax liabilities:
Patent expense (539) (414)
--------- ---------
Total deferred tax liability (539) (414)
--------- ---------
Net deferred tax assets before valuation
allowance 58,112 46,845
Valuation allowance (58,112) (46,845)
--------- ---------
Net deferred tax assets $ -- $ --
========= =========
</TABLE>
Approximately $6.5 million of the valuation allowance for deferred tax assets
relates to benefits of stock option deductions which, when and if recognized,
will be allocated directly to additional paid-in capital.
NOTE 12 - SUPPLEMENTAL CASH FLOW INFORMATION
The following summarizes the significant non-cash investing and financing
activities of the Company and provides other supplemental cash flow
information.
Non-cash financing and investing activities during the year ended December 31,
1996 included the issuance of warrants exercisable for Common Stock as a
commitment fee and for consulting services, and the financing of $60,000 of
equipment through a capital lease. The commitment fee of 1.75% of the equity
line (see Notes 9 and 10), or $875,000, was negotiated between the Company and
the investment group providing the equity line and represents the estimated
fair value of the warrant. The warrant granted for consulting services has
been valued at an estimated fair market value of $500,000 representing the
estimated fair market value of the services to be provided as negotiated
between the parties (see Notes 4 and 10). The value of the warrants are being
amortized over the commitment period and over the period the services were
provided. During the year ended December 31, 1995, a promissory note was
delivered as payment for the exercise of a stock option (see Note 9). Other
non-cash activities have included the issuance of compensatory stock options
to employees and consultants (see Note 10).
Net cash from operating activities reflects cash payments for interest expense
of approximately $6,000, $6,000 and $8,000 for the years ended December 31,
1996, 1995 and 1994, respectively.
F-18
<PAGE>
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
The Board of Directors and Stockholders
Advanced Tissue Sciences, Inc.
We have audited the accompanying consolidated balance sheets of Advanced
Tissue Sciences, Inc. as of December 31, 1996 and 1995, and the related
consolidated statements of operations, stockholders' equity and cash flows for
each of the three years in the period ended December 31, 1996. 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 generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Advanced Tissue
Sciences, Inc. at December 31, 1996 and 1995, and the consolidated results of
its operations and its cash flows for each of the three years in the period
ended December 31, 1996, in conformity with generally accepted accounting
principles.
ERNST & YOUNG LLP
San Diego, California
January 24, 1997
F-19
<PAGE>
EXHIBIT 21
ADVANCED TISSUE SCIENCES, INC.
SUBSIDIARIES
<TABLE>
<CAPTION>
Subsidiary State of Incorporation Ownership
- --------------- ---------------------- ---------
<S> <C> <C>
ATS Orthopedics, Inc. California 100%
Segenix, Inc. Delaware 100%
</TABLE>
F-20
<PAGE>
EXHIBIT 23
CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
We consent to the incorporation by reference in the Registration Statements
(Form S-8 No. 33-39446) pertaining to the 1987 Incentive Stock Option and
Appreciation Plan, 1990 Stock Option Plan for Non-Employee Directors and
Options Granted to Certain Officers, Directors, Consultants and Scientific
Advisory Board Members under Written Compensation Agreements; (Form S-8 No.
33-48044) pertaining to Options Granted Certain Officers, Directors,
Consultants and Scientific Advisory Board Members under Written Compensation
Agreements; (Form S-8 No. 33-50156 and No. 33-82310) pertaining to the 1992
Stock Option/Stock Issuance Plan; (Form S-3 No. 33-55520, No. 33-61935 and No.
333-08659) pertaining to the registration of shares of Advanced Tissue
Sciences Common Stock of our report dated January 24, 1997 with respect to the
consolidated financial statements of Advanced Tissue Sciences, Inc. included
in the Annual Report (Form 10-K) for the year ended December 31, 1996.
ERNST & YOUNG LLP
San Diego, California
March 24, 1997
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from the
Form 10-K for the year ended December 31, 1996 and is qualified in its
entirety by reference to such financial statements.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-END> DEC-31-1996
<CASH> 27,907
<SECURITIES> 12,310
<RECEIVABLES> 0
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 44,044
<PP&E> 15,984
<DEPRECIATION> 6,250
<TOTAL-ASSETS> 56,501
<CURRENT-LIABILITIES> 8,060
<BONDS> 61
0
0
<COMMON> 375
<OTHER-SE> 48,005
<TOTAL-LIABILITY-AND-EQUITY> 56,501
<SALES> 1,018
<TOTAL-REVENUES> 16,962
<CGS> 1,369
<TOTAL-COSTS> 1,369
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 6
<INCOME-PRETAX> (22,401)
<INCOME-TAX> 0
<INCOME-CONTINUING> (22,401)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (22,401)
<EPS-PRIMARY> (.61)
<EPS-DILUTED> (.61)
</TABLE>
