UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
---------
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES AND EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ________ TO _________
COMMISSION FILE NUMBER: 0-016607
ADVANCED TISSUE SCIENCES, INC.
(Exact name of registrant as specified in charter)
----------
Delaware 14-1701513
------------------------------- -------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
10933 North Torrey Pines Road, La Jolla, California 92037
- --------------------------------------------------- ----------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (619) 450-5730
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days.
Yes X No
--- ---
The number of shares of the Registrant's Common Stock, par value $.01 per
share, outstanding at April 30, 1998 was 39,323,373.
<PAGE>
ADVANCED TISSUE SCIENCES, INC.
FORM 10-Q FOR THE QUARTER ENDED MARCH 31, 1998
INDEX
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Page
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Part I - Financial Information
- ------------------------------
Item 1 - Financial Statements
Introduction to the Financial Statements 1
Consolidated Balance Sheets -
March 31, 1998 and December 31, 1997 2
Consolidated Statements of Operations -
Three Months Ended March 31, 1998 and 1997 3
Consolidated Statements of Cash Flows -
Three Months Ended March 31, 1998 and 1997 4
Consolidated Statement of Stockholders' Equity -
Three Months Ended March 31, 1998 5
Notes to the Consolidated Financial Statements 6-8
Item 2 - Management's Discussion and Analysis of Financial
Condition and Results of Operations 9-11
Part II - Other Information
- ----------------------------
Item 5 - Factors That May Affect Future Results 12
Item 6 - Exhibits and Reports on Form 8-K 12-13
Signatures 13
<PAGE>
PART I - FINANCIAL INFORMATION
------------------------------
ITEM 1 - FINANCIAL STATEMENTS
INTRODUCTION TO THE FINANCIAL STATEMENTS
The financial statements have been prepared by Advanced Tissue Sciences,
Inc. (the "Company"), without audit, pursuant to the rules and regulations of
the Securities and Exchange Commission. Certain information and footnote
disclosures normally included in financial statements prepared in accordance
with generally accepted accounting principles have been condensed or omitted
pursuant to such rules and regulations. The Company believes that the
disclosures are adequate to make the information presented not misleading when
read in conjunction with the financial statements and the notes thereto
included in the Company's Annual Report on Form 10-K for the year ended
December 31, 1997.
The financial information presented in this Quarterly Report on Form 10-Q
reflects all adjustments, consisting only of normal recurring adjustments,
which are, in the opinion of management, necessary for a fair statement of the
results for the interim periods presented. The results for the interim
periods are not necessarily indicative of results to be expected for the full
year.
-1-
<PAGE>
ADVANCED TISSUE SCIENCES, INC.
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
March 31, December 31,
1998 1997
------------ ------------
(Unaudited)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 13,186 $ 15,086
Short-term investments 12,945 2,000
Receivables from related parties 2,120 332
Inventory 3,806 4,643
Receivables from related parties 2,120 332
Other current assets 1,514 1,063
----------- ----------
Total current assets 33,571 23,124
Property - net 23,648 23,190
Patent costs - net 1,631 1,608
Other assets 2,010 2,538
----------- ----------
Total assets $ 60,860 $ 50,460
=========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of long-term debt and
capital lease obligations $ 2,838 $ 1,939
Accounts payable 1,069 958
Accrued expenses 5,608 7,011
----------- ----------
Total current liabilities 9,515 9,908
Long-term debt and capital lease obligations 26,913 26,157
Other long-term liabilities 323 245
Minority interest in consolidated subsidiary 254 184
----------- ----------
Total liabilities 37,005 36,494
----------- ----------
Stockholders' equity:
Preferred Stock, $.01 par value; 1,000,000
shares authorized; none issued -- --
Common Stock, $.01 par value; 100,000,000
shares authorized; issued and outstanding,
39,323,373 shares at March 31, 1998 and
37,673,983 shares at December 31, 1997 393 377
Additional paid-in capital 210,507 189,679
Accumulated deficit (186,126) (175,171)
----------- ----------
24,774 14,885
Less note received in connection with
sale of Common Stock (919) (919)
----------- ----------
Total stockholders' equity 23,855 13,966
----------- ----------
Total liabilities and stockholders'
equity $ 60,860 $ 50,460
=========== ==========
</TABLE>
See accompanying notes to the consolidated financial statements.
-2-
<PAGE>
ADVANCED TISSUE SCIENCES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
Three Months Ended March 31,
----------------------------------
1998 1997
------------ -------------
(Unaudited)
<S> <C> <C>
Revenues:
Product sales -
Related parties $ 2,415 $ --
Others 227 --
Contracts and fees -
Related parties 2,539 2,639
Others 125 10
----------- ------------
Total revenues 5,306 2,649
----------- ------------
Costs and expenses:
Research and development 3,854 4,968
Selling, general and administrative 3,612 3,120
Professional and consulting 328 674
Cost of goods sold 3,928 --
----------- ------------
Total costs and expenses 11,722 8,762
----------- ------------
Loss from operations before equity in
losses of joint ventures (6,416) (6,113)
Equity in losses of joint ventures (4,252) (1,707)
----------- ------------
Loss from operations (10,668) (7,820)
Other income (expense):
Interest income and other 269 293
Interest expense (556) (5)
----------- ------------
Net loss $ (10,955) $ (7,532)
=========== ============
Basic and diluted loss per share $ (.28) $ (.20)
=========== ============
Weighted average number of common
shares used in computation of basic
and diluted loss per share 38,930 37,488
=========== ============
</TABLE>
See accompanying notes to the consolidated financial statements.
-3-
<PAGE>
ADVANCED TISSUE SCIENCES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
Three Months Ended March 31,
--------------------------------
1998 1997
------------ -------------
(Unaudited)
<S> <C> <C>
Operating activities:
Net loss $ (10,955) $ (7,532)
Adjustments to reconcile net loss
to cash used in operating activities:
Depreciation and amortization 1,147 510
Equity in losses of joint ventures 4,252 1,707
Other adjustments to net loss 115 56
Change in assets and liabilities:
Receivables from related parties (1,788) (1,606)
Inventory 837 (789)
Other current assets (451) 645
Accounts payable 111 363
Accrued expenses (1,403) (676)
----------- ----------
Net cash used in operating
activities (8,135) (7,322)
----------- ----------
Investing activities:
Purchases of short-term investments (11,945) --
Maturities and sales of short-term
investments 1,000 998
Acquisition of property (1,639) (3,012)
Investment in joint ventures (4,350) (1,905)
Patent application costs (34) (90)
Other long-term assets 626 (561)
----------- ----------
Net cash used in investing
activities (16,342) (4,570)
----------- ----------
Financing activities:
Proceeds from borrowings 1,705 10,000
Payments of borrowings (50) (5)
Net proceeds from sale of equity 20,000 --
Options exercised 844 301
Other long-term obligations 78 --
----------- ----------
Net cash provided by financing
activities 22,577 10,296
----------- ----------
Net decrease in cash and cash equivalents (1,900) (1,596)
Cash and cash equivalents at beginning
of period 15,086 27,907
----------- ----------
Cash and cash equivalents at end of period $ 13,186 $ 26,311
=========== ==========
</TABLE>
See accompanying notes to the consolidated financial statements.
-4-
<PAGE>
ADVANCED TISSUE SCIENCES, INC.
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(IN THOUSANDS)
<TABLE>
<CAPTION>
Total
Additional Stock-
Common Stock Paid-In Accumulated Note holders'
------------------
Shares Amount Capital Deficit Receivable Equity
-------- -------- ---------- ----------- ---------- --------
(Unaudited)
<S> <C> <C> <C> <C> <C> <C>
Balance, December 31, 1997 37,674 $ 377 $ 189,679 $ (175,171) $ (919) $ 13,966
Sale of Common Stock 1,533 15 19,985 20,000
Options exercised 116 1 843 844
Net loss (10,955) (10,955)
------ ------- --------- ---------- --------- ---------
Balance, March 31, 1998 39,323 $ 393 $ 210,507 $ (186,126) $ (919) $ 23,855
====== ======= ========= ========== ========= =========
</TABLE>
See accompanying notes to the consolidated financial statements.
-5-
<PAGE>
ADVANCED TISSUE SCIENCES, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
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 tissue repair and 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 temporary covering of severe and
partial-thickness burns, approved for marketing in the United States by the
U.S. Food and Drug Administration (the "FDA"), and for the treatment of
diabetic foot ulcers, for which the Company has filed an application with the
FDA for marketing approval in the United States.
Principles of Consolidation - The consolidated financial statements include
the accounts of the Company, its wholly owned subsidiaries and DermEquip,
L.L.C. ("DermEquip"), a limited liability company owned jointly with Smith &
Nephew plc ("Smith & Nephew"). All intercompany accounts and transactions
have been eliminated. The Company's other interests in joint ventures with
Smith & Nephew are accounted for under the equity method (see Note 2).
Reclassification - Certain reclassifications have been made to prior year
amounts to conform to the presentation for the three months ended
March 31, 1998.
NOTE 2 - 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(R), the Company's tissue engineered dermal skin replacement, for
the treatment of diabetic foot ulcers (the "Dermagraft Joint Venture"). Smith
& Nephew is a worldwide healthcare 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. In January 1998, the Company and Smith & Nephew expanded the
Dermagraft Joint Venture to include venous ulcers, pressure ulcers, burns and
other skin tissue wounds. The Company retained the exclusive right to market
Dermagraft-TC(R), a temporary covering for full and partial-thickness burns,
in the United States, while the Dermagraft Joint Venture has the right to
market Dermagraft-TC for other skin wounds in the United States.
As consideration for entering into the Dermagraft Joint Venture, Advanced
Tissue Sciences received a $10 million up front fee in 1996. In addition, as
a part of the agreement to expand the joint venture, Smith & Nephew purchased
$20 million, or 1,533,115 newly-issued shares, of the Company's Common Stock
at approximately $13.05 per share in January 1998. The Company will also
receive an additional $15 million, directly or through the Dermagraft Joint
Venture, upon the earlier of (i) FDA approval for the marketing of Dermagraft
in the treatment of diabetic foot ulcers or (ii) January 4, 1999, and could
receive, subject to the achievement of certain milestones related to
regulatory approvals, reimbursement and sales levels, further payments of up
to $136 million.
In the expanded joint venture, the Company and Smith & Nephew will continue to
share equally in the expenses and revenues of the Dermagraft Joint Venture,
except the Company will fund the first $6 million of expenses for conducting
clinical trials and for regulatory support of Dermagraft and Dermagraft-TC in
the treatment of venous and pressure ulcers. The Company will continue to
manufacture and Smith & Nephew will continue to market and sell the joint
venture's products. During the three months ended March 31, 1998 and 1997,
the Company recognized $1,710,000 and $1,695,000, respectively, in contract
revenues for research and development activities performed for the Dermagraft
Joint Venture. In addition, during the quarter ended March 31, 1998, the
Company sold the Dermagraft Joint Venture $2,415,000 of Dermagraft and
Dermagraft-TC product, which was equal to the Company's cost of goods sold for
such products.
-6-
<PAGE>
In 1994, Smith & Nephew and the Company entered into 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 contributed the first $10 million in funding and the Company
contributed certain technology licenses. The Cartilage Joint Venture's total
funding since inception reached $10 million in January 1997 and, as provided
in the joint venture agreement, the Company and Smith & Nephew are sharing
equally in Cartilage Joint Venture revenues and expenditures. During the
three months ended March 31, 1998, the Company recognized $829,000 in contract
revenues for research and development activities performed for the Cartilage
Joint Venture compared with $944,000 for the corresponding period of 1997.
The results of operations of the joint ventures for the three months ended
March 31, 1998 and 1997 are as follows (in thousands):
<TABLE>
<CAPTION>
Dermagraft Joint Venture Cartilage Joint Venture
------------------------ -----------------------
1998 1997 1998 1997
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Sales $ 75 $ -- $ -- $ --
Cost of goods sold 2,528 -- -- --
Other costs and expenses 4,529 2,109 1,475 1,863
Net loss 7,036 2,109 1,475 1,863
</TABLE>
NOTE 3 - INVENTORIES
Inventories are stated at the lower of cost, principally standard costs which
approximate actual costs on a first-in, first-out basis, or market and consist
of the following components as of March 31, 1998 and December 31, 1997 (in
thousands):
March 31, December 31,
1998 1997
--------- ------------
(Unaudited)
Raw materials and supplies $ 3,135 $ 3,295
Work-in-process 532 347
Finished goods 139 1,001
--------- ---------
$ 3,806 $ 4,643
========= =========
NOTE 4 - LONG-TERM DEBT
In March 1998, DermEquip borrowed an additional $1.4 million under the term
loan agreement with The Chase Manhattan Bank (the "Chase Loan") bringing
borrowings under the Chase Loan to $16 million, the total amount available
under the facility. During 1997, the Company borrowed $3.4 million from Smith
& Nephew pursuant to a commitment as a part of the agreement to form the
Cartilage Joint Venture (see Note 2). Under the terms of that joint venture
agreement, the Company may borrow up to a total of $10 million of which $3.4
million had been drawn as of March 31, 1998. Debt and other long-term
obligations as of March 31, 1998 and December 31, 1997 were as follows (in
thousands):
MARCH 31, DECEMBER 31,
1998 1997
------------- ------------
Chase Loan $ 16,000 $ 14,600
Smith & Nephew notes:
Dermagraft Joint Venture 10,000 10,000
Cartilage Joint Venture 3,400 3,400
Capital leases and other 351 96
Less current portion (2,838) (1,939)
---------- ----------
$ 26,913 $ 26,157
========== ==========
-7-
<PAGE>
NOTE 5 - BASIC AND DILUTED LOSS PER SHARE
As required, the Company adopted Financial Accounting Standards Board
Statement No. 128, "Earnings Per Share," ("FAS No. 128") for the year ended
December 31, 1997. FAS No. 128 changes the method used to calculate earnings
per share and requires the restatement of all prior periods reported. Under
FAS No. 128, the Company is required to present basic and diluted earnings per
share if applicable. Basic earnings per share are determined based on the
weighted average number of shares outstanding during the period. Diluted
earnings per share include the weighted average number of shares outstanding
and give effect to potentially dilutive common shares such as options and
warrants outstanding.
Both the basic and diluted loss per share for the three months ended March 31,
1998 and 1997 are based on the weighted average number of shares of Common
Stock outstanding during the periods. Potentially dilutive securities include
options and warrants outstanding and debt convertible into Common Stock;
however, such securities have not been included in the calculation of the
diluted loss per share as their effect is antidilutive. Since such securities
are antidilutive, there is no difference between basic and diluted loss per
share for the two periods presented and there was no change in the loss per
share for the quarter ended March 31, 1997.
NOTE 6 - EQUITY LINE EXTENSION
In February 1998, the Company extended an Investment Agreement (the
"Investment Agreement") under which the Company may access up to $50 million
through an equity line until February 1999. In connection with the extension,
the Company granted the investment group a warrant to purchase 50,000 shares
of Common Stock at an exercise price of $14.00 per share. The Company
originally entered into the Investment Agreement for a two-year period in
February 1996. 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 its Common Stock to the investment
group. Any sales against the equity line will be at a five percent discount
to the average low sales prices of the Company's Common Stock over a specified
period of time as determined by market volume at the time of the draw. The
Company's ability to draw under the Investment Agreement is subject to certain
conditions including, but not limited to, registration of the shares, a
minimum trading price of $2.00 per share, and certain limitations on the
number of shares of Common Stock held by the investment group at any point in
time.
NOTE 7 - STOCK OPTIONS
The following table summarizes activity under the Company's 1997 Stock
Incentive Plan (the "1997 Plan") and for other options and warrants for Common
Stock for the three months ended March 31, 1998:
<TABLE>
<CAPTION>
1997 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, 1997 4,115,150 $10.26 1,459,640 $7.21
Granted 187,285 $13.08 50,000 $14.00
Exercised (116,275) $7.27 -- --
Canceled (57,808) $14.64 -- --
--------- ---------
Outstanding, March 31, 1998 4,128,352 $10.41 1,509,640 $7.44
========= =========
</TABLE>
-8-
<PAGE>
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Advanced Tissue Sciences, Inc. (the "Company" or "Advanced Tissue
Sciences") is engaged in the development and manufacture of human-based tissue
products for tissue repair and transplantation using its proprietary tissue
engineering technology. The Company's leading therapeutic products are tissue
engineered skin products, Dermagraft-TC(R) for the temporary covering of
severe and partial-thickness burns and Dermagraft(R) for the treatment of
severe skin ulcers. 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.
In March 1997, the Company received marketing approval in the United
States from the U.S. Food and Drug Administration (the "FDA") for its first
therapeutic product, Dermagraft-TC, as a temporary covering for severe,
full-thickness burns. In addition, in October 1997, the Company received FDA
approval to market Dermagraft-TC for partial-thickness burns in the United
States. Dermagraft-TC is being marketed by Advanced Tissue Sciences through a
direct sales force in the United States. Dermagraft-TC will be marketed
throughout the rest of the world and for certain applications other than burns
in the United States under a recently expanded joint venture with Smith &
Nephew plc ("Smith & Nephew"). The Company has also submitted an application
to the FDA for approval to market its dermal skin replacement product,
Dermagraft for the treatment of diabetic foot ulcers. Dermagraft was approved
for sale in Canada in August 1997 and was launched in the United Kingdom and
several other European countries late in 1997 through the joint venture with
Smith & Nephew.
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 commercialization of Dermagraft for diabetic foot ulcers
are being shared equally by the joint venture partners. In January 1998,
Advanced Tissue Sciences and Smith & Nephew expanded the Dermagraft Joint
Venture to include additional technology for the treatment of skin tissue
wounds and applications such as venous ulcers, pressure ulcers and burns.
Under the expanded joint venture, Advanced Tissue Sciences and Smith & Nephew
will continue to share equally in the expenses and revenues of the Dermagraft
Joint Venture, except the Company will fund the first $6 million in expense
for conducting clinical trials and regulatory support of Dermagraft and
Dermagraft-TC in the treatment of venous ulcers and pressure ulcers. See Note
2 to the consolidated financial statements.
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. In January 1997, the joint venture partners
began sharing equally in the Cartilage Joint Venture's expenses. See Note 2
to the consolidated financial statements.
In October 1997, the Company was awarded a $2 million Advanced Technology
Program grant from the National Institute of Standards and Technology to fund
collaborative cardiovascular research with the University of California, San
Diego over a three-year period. Funding under the grant began in 1998. From
1993 through 1997, the Company has sponsored at least $1 million in 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. The Company has substantially reduced its commitment to
MIT and Children's Hospital in 1998; however, additional research is being
sponsored at several other academic institutions.
The Company has incurred, and expects to continue to incur, substantial
expenditures in support of the commercialization, development and clinical
trials of its Dermagraft-TC and Dermagraft products for burn and skin ulcer
applications, for manufacturing systems, for sales and marketing and launching
products, and in advancing other applications of the Company's core
technology.
Results of Operations
- ---------------------
Product sales totaled $2,642,000 for the three months ended March 31,
1998. Product sales to related parties reflect sales of Dermagraft and
Dermagraft-TC to the Dermagraft Joint Venture at cost (see Note 2 to the
consolidated
-9-
<PAGE>
financial statements). Sales to outside customers of $227,000 in 1998 are
from sales of Dermagraft-TC . There were no sales to outside customers in the
first quarter of 1997, as Dermagraft-TC was first introduced in April 1997 for
full-thickness burns and in October 1997 for partial-thickness burns. In
addition to product attributes and competition, growth in sales in 1998 and
beyond will be sensitive to success in obtaining product reimbursement from
both national healthcare systems and private insurers.
Dermagraft-TC sales declined to $227,000 in the quarter ended March 31,
1998 from $353,000 in the fourth quarter of 1997. Following an inspection of
its manufacturing facility by the FDA in late March 1998, the Company initiated
the voluntary recall of certain product lots of Dermagraft-TC and Dermagraft
which complied with finished product specifications, but contained a raw
material that was out of specification. As a result of the recall, sales in
both the first and second quarter of 1998 have been affected by the
availability of product. The Company has responded to the issues raised
during the facility inspection and is continuing to manufacture and, based on
availability, ship and sell Dermagraft and Dermagraft-TC. It cannot be
predicted with any certainty what effect the recall may have on future sales
of Dermagraft-TC and Dermagraft. In addition, there can be no assurance the
Company will be able to satisfy the FDA's concerns, that the FDA will not
raise additional issues or that other actions will not be taken.
Revenues from contracts and fees were $2,664,000 for the three months
ended March 31, 1998 compared to $2,649,000 for the corresponding 1997 period.
These revenues are derived from research and development and other activities
performed for the Dermagraft and Cartilage Joint Ventures. See Note 2 to the
consolidated financial statements.
Cost of goods sold for the three months ended March 31, 1998 represents
the cost of the Company's Dermagraft-TC product sold domestically and the cost
of Dermagraft-TC and Dermagraft sold to the Dermagraft Joint Venture.
Products are being sold to the Dermagraft Joint Venture at cost to manufacture
including period costs. The Company initiated production of Dermagraft in its
commercial facility in January 1998 and, accordingly, cost of goods sold has
begun to reflect costs associated with that facility such as depreciation and
overhead. Cost of goods sold for the three months ended March 31, 1998 also
includes approximately $380,000 related to the product recall discussed above.
Since there were no sales of Dermagraft-TC and Dermagraft during the first
three months of 1997, there were no cost of goods sold in that quarter.
Research and development expenditures decreased by $1,114,000, or 22%,
from the prior year quarter to $3,854,000 for the three months ended March 31,
1998. The decrease in research and development costs primarily reflects lower
costs for both clinical trials and production for clinical trials of
Dermagraft-TC and Dermagraft and for the development of commercial
manufacturing processes.
Selling, general and administrative costs increased 16% to $3,612,000 for
the three months ended March 31, 1998 as compared to $3,120,000 for the
corresponding quarter in 1997. The increase in selling, general and
administrative expenses principally reflects higher costs associated with
supporting the Dermagraft Joint Venture.
Professional and consulting costs for legal, accounting and other
consulting services incurred in the three months ended March 31, 1998 were
$328,000 as compared to $674,000 for the corresponding quarter of 1997. This
decrease primarily reflects lower legal fees in 1998 and fees for
Dermagraft-related marketing consultants.
Equity in losses of joint ventures was $4,252,000 and $1,707,000 for the
three months ended March 31, 1998 and 1997, respectively. These amounts
represent the Company's share of losses of the Dermagraft and Cartilage Joint
Ventures. The increase in 1998 primarily reflects increased product costs and
selling, general and administrative expenses in the Dermagraft Joint Venture.
As discussed above, the Company initiated production of Dermagraft in its
commercial facility in January 1998. As the Company sells products to the
Dermagraft Joint Venture at its cost to manufacture, costs of the commercial
facility began to be recognized in cost of goods sold for the Dermagraft Joint
Venture in the first quarter of 1998. Selling, general and administrative
expenses in the Dermagraft Joint Venture have increased to support the
commercial introduction of Dermagraft in certain markets. The joint ventures'
losses are expected to continue to increase in 1998 as Dermagraft is
commercially introduced in additional markets, as venous and pressure ulcers
enter into clinical trials and as orthopedic cartilage research and
development efforts continue.
-10-
<PAGE>
Interest expense was $556,000 for the three months ended March 31, 1998
as compared to $5,000 in the corresponding quarter in 1997. The increase
reflects interest expense on borrowings from Smith & Nephew and The Chase
Manhattan Bank. See Note 4 to the consolidated financial statements.
Liquidity and Capital Resources
- -------------------------------
As of March 31, 1998, the Company had available working capital of
$24,056,000, an increase of $10,840,000 from December 31, 1997. The increase
in working capital principally reflects $20 million from the sale of equity
(see Note 2 to the consolidated financial statements) and funds received from
borrowings (see Note 4 to the consolidated financial statements) offset by
funds used in operations, in support of the Dermagraft and Cartilage Joint
Ventures and for capital expenditures. Capital expenditures of $1,639,000 in
the first three months of 1998 relate primarily to the expansion of the
Company's manufacturing facility and for related process equipment.
The Company expects to use working capital at an accelerated rate as it
continues to incur substantial research and development expenses and selling,
general and administrative costs in support of product commercialization, in
funding its joint ventures with Smith & Nephew and for capital expenditures
and patents. These increases are expected to be only partially offset by
revenues received from the Cartilage and Dermagraft Joint Ventures with Smith
& Nephew.
In addition to available working capital, the Company has entered into an
equity line which could provide up to $50 million in funding through the sale
of Common Stock and, subject to certain conditions, is available through
February 1999 (see Note 6 to the consolidated financial statements). Any
decision to draw any funds under the equity line and the timing of any such
draw are solely at the Company's discretion. Also, under the expanded
Dermagraft Joint Venture, Smith & Nephew will pay the Company $15 million,
directly or through the Dermagraft Joint Venture, upon the earlier of (i) FDA
approval for the marketing of Dermagraft in the treatment of diabetic foot
ulcers or (ii) January 4, 1999 (see Note 2 to the consolidated financial
statements).
The Company currently believes it has sufficient funds, including those
available under the equity line, from available borrowings and through its
joint venture arrangements, to support its operations through 1998. 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 funds will
be available when needed or on terms favorable to the Company, under existing
arrangements or otherwise, 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
healthcare system as well as anticipated healthcare 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, cash equivalents and short-term investments as of March 31, 1998
increased from December 31, 1997 reflecting proceeds from the sale of Common
Stock to Smith & Nephew and funds received from a bank borrowing partially
offset by the use of cash to fund operations and capital expenditures during
the quarter. Inventory levels decreased during the quarter from the year end
1997 level primarily due to the product recall discussed above. Receivables
from related parties increased during the quarter ended Marcy 31, 1998
from the year end 1997 level principally due to receivables from the sales
of Dermagraft to the Dermagraft Joint Venture. Accrued expenses at March 31,
1998 declined from year end 1997 primarily due to reductions in amounts
accrued for sponsored research and for joint venture obligations. Debt
increased by $1.7 million primarily reflecting an additional borrowing under
the term loan facility with The Chase Manhattan Bank (see Note 4 to the
consolidated financial statements).
-11-
<PAGE>
PART II - OTHER INFORMATION
---------------------------
ITEM 5 - FACTORS THAT MAY AFFECT FUTURE RESULTS
This Quarterly Report on Form 10-Q includes a number of forward-looking
statements that involve risks and uncertainties within the meaning of the
Securities Act of 1933 and the Securities Exchange Act of 1934, including,
without limitation, those relating to strategic alliances (including
potential milestone payments and revenues from its joint ventures with
Smith & Nephew), potential acceleration of the use of working capital, the
sufficiency and availability of funds to support opertions, and
commercialization of the Company's products. In particular, since the FDA
advisory panel meeting in January 1998 at which the panel recommended FDA
approval of the Company's pending premarket approval ("PMA") application for
Dermagraft(R) for the treatment of diabetic foot ulcers (subject to the
Company performing a post-marketing study to confirm product efficacy and
provide physician training), the FDA has continued to raise concerns about
approving such PMA application based on the Company's analysis of the data
presented and the use of a post-marketing study to confirm efficacy. In
addition, following an inspection of the Company's manufacturing facility in
March 1998, the FDA notified the Company of numerous objectionable
observations with respect to the Company's manufacturing and quality
assurance processes and systems for Dermagraft and Dermagraft-TC(R). The
Company has provided a response to the FDA regarding the manufacturing and
quality assurance issues raised by the FDA and is engaged in discussions with
the FDA regarding the FDA's issues with respect to the Company's PMA
application. There can be no assurance that the Company will be able to
satisfy the FDA's concerns, that the FDA will not raise additional issues,
or that other actions will not be taken by the FDA with respect to the
Company's manufacturing and quality assurance processes and systems or its
PMA application. Moreover, sales of Dermagraft and Dermagraft-TC may be
affected while the Company addresses the manufacturing and quality assurance
issues raised by the FDA. No assurance can be given that the Company will
successfully obtain FDA or other regulatory approvals of Dermagraft (or that
any such approvals will be obtained on a timely basis), scale up
manufacturing processes, launch its products within reasonable timeframes
obtain reimbursement for, or successfully commercialize any such products,
achieve the milestones for future funding under its joint venture with
Smith & Nephew, or obtain additional funding from other sources on
favorable terms, if at all. These and other risks are detailed in the
Company's Annual Report on Form 10-K for the year ended December 31, 1997.
The forward-looking statements are qualified in their entirety by
reference to the risks and risk factors described in such reports. Actual
results may differ materially from those currently anticipated as a result
of such risks.
ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits - None
(b) Reports on Form 8-K
The Company filed a Current Report on Form 8-K dated January 14, 1998
under Item 5 reporting it had entered into a binding letter of intent (the
"Heads of Agreement") to expand its fifty-fifty joint venture with Smith &
Nephew plc ("Smith & Nephew") to include venous ulcers, pressure ulcers, burns
and other skin wounds. The joint venture (the "Dermagraft Joint Venture") was
originally formed in April 1996 for the worldwide commercialization of
Dermagraft(R), the Company's tissue engineered dermal skin replacement, for
the treatment of diabetic foot ulcers. The Company retained the exclusive
right, and will continue to market, Dermagraft-TC(R) as a temporary covering
for full and partial thickness burns in the United States, while the
Dermagraft Joint Venture has the right to market Dermagraft-TC for other skin
wounds in the United States. Under the Heads of Agreement, Smith & Nephew
purchased $20 million, or 1,533,115 newly-issued shares, of the Company's
Common Stock at approximately $13.05 per share.
-12-
<PAGE>
On January 26, 1998, the Company filed a Current Report on Form 8-K under
Item 5 reporting that it had extended the term of its investment agreement
(the "Investment Agreement") with Hatteras Partners, L.P., formerly known as
Ramius Haterras Partners L.P., to February 9, 1999. The Investment Agreement
provides for an equity line which allows the Company to access up to $50
million through sales of its Common Stock. The decision to draw any funds
under the Investment Agreement and timing of any such draw is solely at the
Company's discretion. Other than extending the term for an additional year,
the Amendment did not materially change the terms of the Investment Agreement.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
ADVANCED TISSUE SCIENCES, INC.
Date: May 11, 1998 /s/ Arthur J. Benvenuto
--------------- -------------------------------
Arthur J. Benvenuto
Chairman of the Board and
Chief Executive Officer
Date: May 11, 1998 /s/ Michael V. Swanson
--------------- -------------------------------
Michael V. Swanson
Vice President, Finance and
Administration
-13-
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