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 JUNE 30, 1999
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)
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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
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (858) 713-7300
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 August 1, 1999 was 52,432,205.
<PAGE>
ADVANCED TISSUE SCIENCES, INC.
FORM 10-Q FOR THE QUARTER ENDED JUNE 30, 1999
INDEX
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Part I - Financial Information
- ------------------------------
Page
------
Item 1 - Financial Statements
Introduction to the Financial Statements 1
Consolidated Balance Sheets -
June 30, 1999 and December 31, 1998 2
Consolidated Statements of Operations -
Three and Six Months Ended June 30, 1999 and 1998 3
Consolidated Statements of Cash Flows -
Six Months Ended June 30, 1999 and 1998 4
Consolidated Statement of Stockholders' Equity -
Six Months Ended June 30, 1999 5
Notes to the Consolidated Financial Statements 6-11
Item 2 - Management's Discussion and Analysis of Financial
Condition and Results of Operations 12-17
Item 3 - Quantitative and Qualitative Disclosures About Market Risk 17
Part II - Other Information
- ----------------------------
Item 2 - Change in Securities 18
Item 4 - Submission of Matters to a Vote of Security Holders 18
Item 5 - Factors That May Affect Future Results 18-28
Item 6 - Exhibits and Reports on Form 8-K 29
Signatures 30
<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, 1998
and Quarterly Report on Form 10-Q for the three months ended March 31, 1999.
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>
June 30, December 31,
1999 1998
----------- ------------
(Unaudited)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 15,466 $ 16,551
Short-term investments 6,500 6,503
Inventory 4,649 3,364
Other current assets 2,438 2,412
----------- -----------
Total current assets 29,053 28,830
Property - net 18,606 20,624
Patent costs - net 2,028 1,846
Other assets 2,591 2,685
----------- -----------
Total assets $ 52,278 $ 53,985
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 1,192 $ 894
Accrued expenses 6,047 4,805
Current portion of long-term debt and
capital lease obligations 9,110 2,689
Deferred revenue 6,633 --
----------- -----------
Total current liabilities 22,982 8,388
Long-term debt and capital lease obligations 10,282 27,260
Other long-term liabilities 146 558
Minority interest in consolidated subsidiary 174 252
----------- -----------
Total liabilities 33,584 36,458
----------- -----------
Redeemable Convertible Series B Preferred Stock,
$.01 par value; 1,000 shares authorized;
100.8 shares issued and outstanding at
June 30, 1999 and 100 shares at December 31,
1998 (aggregate redemption value of $5,358 and
$5,119 at June 30, 1999 and December 31, 1998,
respectively and liquidation value of $5,103
and $5,119 at June 30, 1999 and December 31,
1998, respectively) 5,040 5,000
----------- -----------
Stockholders' equity:
Convertible Series B Preferred Stock,
$.01 par value; no shares issued and
outstanding at June 30, 1999 and 350
shares at December 31, 1998 (aggregate
redemption and liquidation value of $17,917
at December 31, 1998) -- --
Accrued cumulative preferred stock dividends 63 536
Common Stock, $.01 par value; 125,000,000
shares authorized; issued and outstanding,
52,196,257 shares at June 30, 1999 and
40,353,524 shares at December 31, 1998 522 403
Additional paid-in capital 243,753 230,963
Accumulated deficit (228,688) (218,456)
----------- -----------
15,650 13,446
Less note received in connection with sale
of Common Stock and deferred compensation
applicable to Common Stock (1,996) (919)
----------- -----------
Total stockholders' equity 13,654 12,527
----------- -----------
Total liabilities and stockholders' equity $ 52,278 $ 53,985
=========== ===========
</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 June 30, Six Months Ended June 30,
----------------------------- ---------------------------
1999 1998 1999 1998
------------ ------------ ------------ -----------
(Unaudited)
<S> <C> <C> <C> <C>
Revenues:
Product sales -
Related parties $ 3,617 $ 2,063 $ 6,688 $ 4,478
Others -- 293 -- 520
Contracts and fees -
Related parties 7,324 1,974 14,961 4,513
Others 181 103 343 228
----------- ----------- ---------- ----------
Total revenues 11,122 4,433 21,992 9,739
----------- ----------- ---------- ----------
Costs and expenses:
Research and development 3,958 3,844 8,127 7,765
Selling, general and administrative 2,791 4,343 6,171 8,216
Cost of goods sold 3,617 3,032 6,688 6,960
----------- ----------- ---------- ----------
Total costs and expenses 10,366 11,219 20,986 22,941
----------- ----------- ---------- ----------
Income (loss) from operations before
equity in losses of joint ventures 756 (6,786) 1,006 (13,202)
Equity in losses of joint ventures (4,998) (4,637) (10,455) (8,889)
----------- ----------- ---------- ----------
Loss from operations (4,242) (11,423) (9,449) (22,091)
Other income (expense):
Interest income and other (151) 31 304 300
Interest expense (533) (595) (1,087) (1,151)
----------- ----------- ---------- ----------
Net loss (4,926) (11,987) (10,232) (22,942)
Dividends on preferred stock (176) -- (431) --
----------- ----------- ---------- ----------
Net loss applicable to common stock $ (5,102) $ (11,987) $ (10,663) $ (22,942)
=========== =========== ========== ==========
Basic and diluted loss per share $ (.11) $ (.30) $ (.25) $ (.59)
=========== =========== ========== ==========
Weighted average number of common
shares used in computation of basic
and diluted loss per share 45,522 39,324 43,252 39,128
=========== =========== ========== ==========
</TABLE>
See accompanying notes to the consolidated financial statements.
-3-
<PAGE>
ADVANCED TISSUE SCIENCES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
Six Months Ended June 30,
---------------------------
1999 1998
------------ ------------
(Unaudited)
<S> <C> <C>
Operating activities:
Net loss $ (10,232) $ (22,942)
Adjustments to reconcile net loss to
cash used in operating activities:
Depreciation and amortization 2,390 2,326
Compensation for services paid in
stock, options or warrants 79 809
Equity in losses of joint ventures 10,455 8,889
Other adjustments to net loss 516 297
Deferred revenue 6,633 --
Change in assets and liabilities:
Inventory (1,285) 689
Other current assets (26) (1,255)
Accounts payable 298 406
Accrued expenses 1,242 (1,647)
---------- -----------
Net cash provided by (used in)
operating activities 10,070 (12,428)
----------- -----------
Investing activities:
Purchases of short-term investments (6,000) (3,972)
Maturities and sales of short-term investments 6,003 1,972
Acquisition of property (570) (2,496)
Investment in joint ventures (13,770) (10,050)
Distribution from joint ventures 3,325 1,175
Patent application costs (210) (131)
Other long-term assets 28 991
----------- -----------
Net cash used in investing activities (11,194) (12,511)
----------- -----------
Financing activities:
Proceeds from borrowings 840 2,558
Payments of borrowings (1,397) (748)
Net proceeds from sale of Common Stock 1,003 20,000
Repurchase of Common Stock (457) --
Options and warrants exercised 5 852
Other long-term obligations 45 156
----------- -----------
Net cash provided by financing
activities 39 22,818
----------- -----------
Net decrease in cash and cash equivalents (1,085) (2,121)
Cash and cash equivalents at beginning of period 16,551 15,086
----------- -----------
Cash and cash equivalents at end of period $ 15,466 $ 12,965
=========== ===========
</TABLE>
See accompanying notes to the consolidated financial statements.
-4-
<PAGE>
ADVANCED TISSUE SCIENCES, INC.
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
Preferred Stock Common Stock
------------------- ---------------------
Shares Amount Shares Amount
-------- -------- ----------- --------
<S> <C> <C> <C> <C>
Balance, December 31, 1998 350 $ -- 40,353,524 $ 403
Sale of Common Stock 165,975 2
Issuance of Common Stock for debt
and accrued interest 2,800,595 28
Conversion of Preferred Stock (309) 7,865,798 79
Transfer of Preferred Stock to
Redeemable Preferred Stock (41) --
Repurchase of Common Stock (463,154) (5)
Preferred Stock dividends 396,919 4
Restricted Common Stock
awarded for services 300,000 3
Options exercised 776,600 8
Net loss
-------- -------- ---------- --------
Balance, June 30, 1999 -- $ -- 52,196,257 $ 522
======== ======== ========== ========
</TABLE>
<TABLE>
<CAPTION>
Accrued Total
Additional Dividends/ Stock-
Paid-In Accumulated Note Rec./ holders'
Capital Deficit Def. Compen. Equity
------------ ------------- -------------- ----------
<S> <C> <C> <C> <C>
Balance, December 31, 1998 $ 230,963 $ (218,456) $ (383) $ 12,527
Sale of Common Stock 998 1,000
Issuance of Common Stock for
debt and accrued interest 10,776 10,804
Conversion of Preferred Stock 1,926 2,005
Transfer of Preferred Stock to
Redeemable Preferred Stock (2,045) (2,045)
Repurchase of Common Stock (1,762) (1,767)
Preferred Stock dividends 468 (472) --
Restricted Common Stock
awarded for services 1,122 (1,078) 47
Options exercised 1,307 1,315
Net loss (10,232) (10,232)
----------- ----------- ------------ ---------
Balance, June 30, 1999 $ 243,753 $ (228,688) $ (1,933) $ 13,654
=========== =========== ============ =========
</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, which is on the market in the United States, and for
the treatment of diabetic foot ulcers, which is in clinical trials in the United
States and on the market in Canada, the United Kingdom and several other
European countries. Both products are being commercialized through a joint
venture with Smith & Nephew plc ("Smith & Nephew").
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.
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).
Revenue Recognition - Revenues from product sales to third parties are
recognized when products are shipped, the risk of ownership has passed to the
purchaser, and the Company has no further specified performance obligations.
Revenues from product sales to related parties are recognized at such time as
the related party is contractually obligated to purchase the product,
generally upon the completion of manufacture. Such product sales to the
Dermagraft Joint Venture are equal to the Company's cost (see Note 2).
Revenues under collaborative research and licensing agreements, including
nonrefundable up-front fees and milestone payments where the Company has
continuing financial commitments, are recognized as costs are incurred over
the related period of the agreement. Revenues from government grants are
recognized based on the performance requirements of the grant or as the grant
expenditures are incurred.
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 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 its products.
Reclassification - Certain reclassifications have been made to prior year
amounts to conform to the presentation for the three months and six months ended
June 30, 1999.
NOTE 2 - STRATEGIC ALLIANCES
Smith & Nephew Joint Ventures
- -----------------------------
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"). 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. At that time, the Company retained the exclusive right to market
TransCyte(TM), a temporary covering for severe and partial-thickness burns,
in the United States, while the Dermagraft Joint Venture was granted the right
to market
-6-
<PAGE>
TransCyte for other skin wounds in the United States. In August 1998, the
Company and Smith & Nephew further expanded the Dermagraft Joint Venture to
include exclusive rights to TransCyte for severe and partial-thickness burns in
the United States effective October 1998. 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.
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 also received an additional $15
million as consideration for expanding the joint venture in January 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. The $15 million payment is being recognized into revenue as the
related financial commitments are met. In the three and six months ended June
30, 1999, the Company recognized revenues of $4,417,000 and $9,367,000,
respectively, related to such payment. This amount is included in contract
revenues for each of the respective periods.
In the expanded joint venture, the Company and Smith & Nephew 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 TransCyte in the treatment of venous
and pressure ulcers. In addition, the Company will fund certain manufacturing
and distribution costs and certain costs related to post-market studies of
TransCyte through December 1999. However, such manufacturing and distribution
costs are to be returned to the Company out of future gross margin or net
profits, if any, from sales of TransCyte for burns in the United States. Under
the expanded joint venture, the Company will continue to manufacture and Smith &
Nephew will continue to market and sell the joint venture's products.
During the three and six-month periods ended June 30, 1999 and 1998, the Company
recognized $6,650,000 and $1,431,000 in the three-month periods and $13,664,000
and $3,141,000 in the six-month periods, respectively, in contract revenues for
research and development activities performed for the Dermagraft Joint Venture.
In addition, during the three and six-month periods ended June 30, 1999, product
sales to related parties represent products sold to the Dermagraft Joint
Venture. Such product sales to the Dermagraft Joint Venture are equal to the
Company's cost of goods sold for such products.
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 and six
months ended June 30, 1999, the Company recognized $674,000 and $1,297,000,
respectively, in contract revenues for research and development activities
performed for the Cartilage Joint Venture compared with $543,000 and $1,372,000
during the corresponding periods of 1998.
The results of operations of the joint ventures for the three and six months
ended June 30, 1999 and 1998 are as follows (in thousands):
<TABLE>
<CAPTION>
Three Months Ended June 30, Six Months Ended June 30,
--------------------------- -------------------------
1999 1998 1999 1998
------------ ------------ ------------ -----------
<S> <C> <C> <C> <C>
Dermagraft Joint Venture
- ------------------------
Net sales $ 561 $ 51 $ 1,028 $ 126
Cost of goods sold 3,095 2,389 7,569 4,971
Other costs and expenses 4,644 6,246 9,424 10,775
Net loss 7,178 8,584 15,965 15,620
Cartilage Joint Venture
- -----------------------
Costs and expenses $ 1,310 $ 999 $ 2,475 $ 2,474
Net loss 1,310 999 2,475 2,474
</TABLE>
-7-
<PAGE>
Inamed Agreements
- -----------------
In May 1999, Advanced Tissue Sciences, Inc. and Inamed Corporation ("Inamed")
entered into a binding letter of intent for a strategic alliance for the
development and marketing of several of Advanced Tissue Sciences' human-based,
tissue-engineered products for aesthetic and certain reconstructive
applications. Specifically, Inamed licensed rights to further develop,
manufacture and sell tissue engineered products for use in cosmetic surgery,
cartilage for plastic and reconstructive surgery, and extracellular matrix for
use in breast reconstruction. In addition, Inamed also received an option to
license rights to use extracellular matrix, including human collagen, from
Advanced Tissue Sciences' three-dimensional culture system for soft tissue
augmentation (wrinkles and cosmetic correction) and as a bulking agent for the
treatment of urinary incontinence. Inamed Corporation is a global surgical and
medical device company engaged in the development, manufacturing and marketing
of medical devices for plastic and reconstructive, bariatric and general surgery
markets.
Under the agreement between the parties, in exchange for worldwide licensing
rights, Inamed agreed to pay Advanced Tissue Sciences a series of payments
totaling $6 million, including $3 million to purchase Advanced Tissue Sciences'
common stock. As provided under the agreement, the Company received $2 million
in payments in May 1999. The licensing payments and the stock purchases will be
made over the next six months. Inamed will also receive five-year warrants to
purchase up to 300,000 shares of common stock. See Note 6. In addition to
royalties on product sales, Advanced Tissue Sciences may potentially receive up
to a total of $6 million in milestones based on product approvals in the United
States.
If the option for the additional two indications is exercised, Advanced Tissue
Sciences will also receive another $4 million, including $2 million for
licensing rights, and $2 million for Advanced Tissue Sciences' common stock.
Inamed would also be entitled to receive an additional five-year warrant to
purchase up to 200,000 shares of Advanced Tissue Sciences' common stock. See
Note 6. In addition, Advanced Tissue Sciences could potentially receive up to a
total of $4 million in milestones based on product approvals.
Advanced Tissue Sciences will be responsible for the funding and development
of the products and the related manufacturing processes while Inamed will be
responsible for clinical and regulatory activities. Advanced Tissue Sciences,
or an affiliate may elect to manufacture the products developed under the
agreement. Fees for licensing rights and milestone payments will be recognized
into revenues as the related commitments for product development and
manufacturing processes are met.
NOTE 3 - INVENTORIES
Inventories manufactured for sale to the Dermagraft Joint Venture are stated at
cost, principally standard costs which approximate actual costs on a first-in,
first-out basis reflecting the price at which such goods will be sold to the
joint venture (see Note 2). Inventories consist of the following components as
of June 30, 1999 and December 31, 1998 (in thousands):
June 30, December 31,
1999 1998
------------ ------------
Raw materials and supplies $ 3,849 $ 2,965
Work-in-process 800 399
--------- ----------
$ 4,649 $ 3,364
========= ==========
NOTE 4 - CONTINGENCIES - LEGAL PROCEEDINGS
During 1998, several lawsuits were filed in the United States District Court for
the Southern District of California against the Company and two of its officers.
The lawsuits alleged violations of the federal securities laws arising out of
alleged misstatements and alleged failures to disclose certain material facts
concerning the clinical trials and obtaining United States Food and Drug
Administration approval of Dermagraft for the treatment of diabetic foot ulcers.
The lawsuits purported to seek damages on behalf of a class of shareholders who
purchased Advanced Tissue Sciences, Inc. Common Stock during the period
generally from January 13, 1997 through June 11, 1998. On May 3, 1999, the
class action was voluntarily dismissed by lead plaintiffs' counsel. No payment
was made by the Company and the voluntary dismissal terminates the action.
-8-
<PAGE>
NOTE 5 - LONG-TERM DEBT
In June 1999, a $10 million loan and accrued interest payable to Smith & Nephew
related to the Dermagraft Joint Venture was converted into 2,800,595 shares of
the Company's common stock. As provided under the loan agreement, the Company
had the option to pay the loan in cash or common stock. The loan was due and
payable in less than a year. In addition, during 1999, the Company has borrowed
$840,000 from Smith & Nephew pursuant to a commitment that is 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 $6.5 million had been drawn as of June 30, 1999. The loan is
due and payable in June 2000. Debt and other long-term obligations as of June
30, 1999 and December 31, 1998 were as follows (in thousands):
June 30, December 31,
1999 1998
------------ --------------
Chase loan $ 12,800 $ 14,080
Smith & Nephew notes:
Dermagraft Joint Venture -- 10,000
Cartilage Joint Venture 6,525 5,685
Capital lease obligations and other 67 184
Less current portion (9,110) (2,689)
---------- ----------
$ 10,282 $ 27,260
========== ==========
NOTE 6 - CAPITAL STOCK
In February 1999, the common stockholders of the Company approved an amendment
to the Company's Restated Certificate of Incorporation to increase the number of
authorized shares of common stock from 100,000,000 shares to 125,000,000 shares.
In addition, during the six months ended June 30, 1999, 309 shares of the
Company's Convertible Series B Preferred Stock and 40 shares of the Company's
Redeemable Convertible Series B Preferred Stock were converted into 7,865,798
shares of common stock at an average price of $2.22 per share. The Company
has also notified the holders of its Series B Preferred Stock of its election
to redeem for cash at 105% of liquidation value any preferred shares submitted
for conversion from July 1, 1999 to September 30, 1999 at a conversion price
equal to or below $3.58 per share. The Company may withdraw the election on
five days advance notice. As a result, all of the Company's Convertible Series
B Preferred stock has been reflected as redeemable in the consolidated balance
sheet as of June 30, 1999.
In May 1999, as part of an agreement between Inamed Corporation and the Company,
Inamed purchased 165,975 shares of the Company's common stock for $1 million or
approximately $6.03 per share. Under the agreement, Inamed will purchase a total
of $3 million of Advanced Tissue Sciences' common stock at $6 per share, or at
an average of the then current trading price of the common stock plus $3 per
share, whichever is higher. Inamed is to also receive five-year warrants to
purchase up to 300,000 shares of common stock at a price per share equal to
twice the price per share paid by Inamed for the $3 million of Advanced Tissue
Sciences' common stock. Further, should Inamed exercise an option for
additional product indications, Inamed would purchase $2 million of the
Company's common stock and would receive a five-year warrant to purchase up to
200,000 shares of the Company's common stock. The common stock would be
priced at $6.00 per share or at an average of the then current trading price
of the common stock plus $3.00 per share whichever is higher, and the
warrant exercise price would be equal to twice the price per share of
the common stock. Inamed has agreed to hold any investment in Advanced Tissue
Sciences' common stock until at least October 2002. See Note 2.
In June 1999, certain officers of the Company exercised employee stock options
for 775,000 shares of common stock. The purchase price of $1.3 million and
withholding taxes of approximately $457,000 was paid by the delivery of 463,154
shares of the Company's common stock. See Note 8 regarding stock options,
warrants and restricted stock awards.
-9-
<PAGE>
NOTE 7 - BASIC AND DILUTED LOSS PER SHARE
Basic earnings per common share are determined based on the weighted average
number of shares outstanding during the period. Diluted earnings per common
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 common share for the six months ended June
30, 1999 and 1998 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 and preferred stock 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 common share for the periods presented. The net loss applicable to
common shares used in the calculation of basic and diluted loss per common share
for the three and six months ended June 30, 1999 includes dividends of $176,000
and $431,000, respectively, accrued or paid on the Company's Convertible Series
B Preferred Stock during such periods.
NOTE 8 - STOCK INCENTIVE PLANS
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 six months ended June 30, 1999:
<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, 1998 3,897,722 $8.62 1,509,640 $ 7.44
Granted 1,387,025 $2.88 100,000 $12.05
Exercised (776,600) $1.69 -- --
Canceled (107,036) $7.44 -- --
--------- ---------
Outstanding, June 30, 1999 4,401,111 $8.06 1,609,640 $ 7.73
========= =========
</TABLE>
In May 1999, the Company's Chairman and Chief Executive Officer was awarded
300,000 shares of restricted common stock under the 1997 Plan. Subject to
meeting certain requirements including continued service, 50,000 shares will
vest annually and the remaining 150,000 shares will vest at the end of three
years or, if earlier, upon approval of Dermagraft for the treatment of diabetic
foot ulcers in the United States. The difference between the market price at
the grant date and the purchase price is being recognized as compensation
expense by the Company ratably over the restricted periods. During the six
months ended June 30, 1999, the Company recognized $44,000 of related expense.
NOTE 9 - LEASE COMMITMENTS
In May 1999, the Company terminated a 15-year lease agreement for additional
research and administrative space and consolidated its activities into two
existing facilities substantially reducing its lease commitments for facilities.
The following is a summary of the operating lease commitments as of June 30,
1999 (in thousands):
OPERATING
LEASES
---------
Year Ending December 31:
1999 $ 2,773
2000 2,476
2001 932
2002 512
---------
Total minimum lease payments $ 6,693
=========
-10-
<PAGE>
NOTE 10 - SUPPLEMENTAL CASH FLOW INFORMATION
During 1999, non-cash financing activities have included the repayment of a $10
million loan and accrued interest payable through the issuance of common stock
(see Note 5) and the exercise of stock options by the delivery of common stock
in payment of the exercise price (see Note 6). The Company also issued a
restricted stock award under the 1997 Plan (see Note 8).
NOTE 11 - SUBSEQUENT EVENTS
Registration Statement
- ----------------------
In July 1999, the Company filed a registration statement with the Securities and
Exchange Commission for an offering of 5,000,000 shares of common stock. The
common stock is being offered directly by the Company.
Inamed Payments
- ---------------
As provided in the agreement between the parties, the Company received an
additional $3 million payment from Inamed in July 1999 bringing the total
payments under the agreement to $5 million. The $3 million payment is not
reflected on the accompanying consolidated balance sheet. See Note 2.
-11-
<PAGE>
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
This Quarterly Report on Form 10-Q may contain predictions, estimates and
other forward-looking statements that involve a number of risks and
uncertainties, including those discussed under Item 5 below. This outlook
represents our current judgment on the future direction of our business. Such
risks and uncertainties could cause actual results to differ materially from any
future performance suggested below. We undertake no obligation to release
publicly the results of any revisions to these forward-looking statements to
reflect events or circumstances arising after the date of this Quarterly Report.
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, TransCyte(TM) for the temporary covering of severe
and partial-thickness burns and Dermagraft(R) for the treatment of severe
skin ulcers. In addition to its TransCyte 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, TransCyte, as a temporary covering for full-thickness, or third degree
burns. In addition, in October 1997, the Company received FDA approval to
market TransCyte for partial-thickness, or second degree, burns in the United
States. Through September 1998, TransCyte was marketed for burns by Advanced
Tissue Sciences through a direct sales force in the United States. As of
October 1998, TransCyte is being marketed in the United States and throughout
the rest of the world for burn and other wound care applications under a joint
venture with Smith & Nephew plc ("Smith & Nephew").
Dermagraft for the treatment of diabetic foot ulcers was approved for sale
in Canada in August 1997 and was introduced in the United Kingdom and several
other European countries late in 1997 through the joint venture with Smith &
Nephew. The Company also submitted a Premarket Approval (PMA) application to
the FDA for approval to market Dermagraft for the treatment of diabetic foot
ulcers in the United States. In January 1998, an FDA advisory panel recommended
approval of Dermagraft with the condition that the Company perform a
post-marketing study to confirm efficacy and provide physician training.
However, in June 1998, the FDA decided the PMA application was not approvable
without supportive data from an additional controlled clinical trial. The
Company received approval from the FDA to begin the clinical trial in August
1998 and is performing the requested clinical trial. Based on the clinical
plan, the Company believes the additional data could be available for submission
in twelve to eighteen months after trial initiation, assuming a reasonable rate
of patient enrollment and data consistent with its previous PMA submission.
In October 1998, the FDA approved the Company's application for a Treatment
Investigational Device Exemption (IDE) for Dermagraft, allowing the Company to
make Dermagraft for the treatment of diabetic foot ulcers available to selected
centers in the United States under an approved clinical protocol. The Treatment
IDE is a new regulatory provision for devices that (1) permits companies to
make available promising new products to patients with serious diseases for
which there is no satisfactory alternative, and (2) allows companies to recover
the costs of manufacturing and distributing the product. The Treatment IDE is
being conducted concurrently with the ongoing clinical trial of Dermagraft in
the treatment of diabetic foot ulcers in the United States.
On May 10, 1999, Advanced Tissue Sciences, Inc. and Inamed Corporation
("Inamed") entered into a binding letter of intent for a strategic alliance for
the development and marketing of several of Advanced Tissue Sciences'
human-based, tissue-engineered products for aesthetic and certain reconstructive
applications. Specifically, Inamed licensed rights to further develop,
manufacture and sell tissue engineered products for use in cosmetic surgery,
cartilage for plastic and reconstructive surgery, and extracellular matrix for
use in breast reconstruction. In addition, Inamed also received an option to
license rights to use extracellular matrix, including human collagen, from
Advanced Tissue Sciences' three-dimensional culture system for soft tissue
augmentation (wrinkles and cosmetic correction) and as a bulking agent for the
treatment of urinary incontinence. Advanced Tissue Sciences will be responsible
for the development of the products and the related manufacturing processes
while Inamed will be responsible for clinical and regulatory activities.
Advanced Tissue Sciences will have the right to manufacture the products
developed under the agreement. See Note 2 to the consolidated financial
statements.
-12-
<PAGE>
In April 1996, the Company entered into an agreement with Smith & Nephew to
form a joint venture (the "Dermagraft Joint Venture") for the worldwide
commercialization of Dermagraft in the treatment of diabetic foot ulcers. Under
the joint venture agreement, all expenses and revenues associated with the
development and commercialization of Dermagraft for diabetic foot ulcers from
January 1997 are 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. In August
1998, the Company and Smith & Nephew expanded the Dermagraft Joint Venture
further to include exclusive rights to TransCyte for full and partial-thickness
burns in the United States effective October 1998. 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 TransCyte in the treatment of venous
ulcers and pressure ulcers. In addition, the Company will fund certain
manufacturing and distribution costs and certain costs related to post-market
studies of TransCyte through December 1999. 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.
The Company has incurred, and expects to continue to incur, substantial
expenditures in support of the commercialization, development and clinical
trials of its TransCyte and Dermagraft products for burn and skin ulcer
applications, for manufacturing systems and in advancing other applications of
the Company's core technology. In particular, the Company will incur, either
directly or through the Dermagraft Joint Venture, substantial and increasing
costs for the additional clinical trial of Dermagraft in the treatment of
diabetic foot ulcers and in support of clinical trials and post-market studies
of Dermagraft and TransCyte in venous, pressure and diabetic foot ulcers and for
full and partial-thickness burns. The Company will also incur additional
costs for development of products and manufacturing processes under its
strategic alliance with Inamed; however, such costs are expected to be
substantially offset by the recognition of licensing fees and milestone
payments received from Inamed.
Results of Operations
- ---------------------
Product sales totaled $3,617,000 and $6,688,000 for the three months and
six months ended June 30, 1999, respectively, as compared to sales of $2,356,000
and $4,998,000 in the corresponding periods of 1998. During these periods all
product sales were to related parties, except TransCyte sales of $293,000 and
$520,000 for the three and six months ended June 30, 1998, respectively, made
through the Company's direct sales force in the United States to third party
customers. As discussed above, TransCyte sales and marketing activities were
transferred from the Company to the Dermagraft Joint Venture effective October
1998. Product sales to related parties reflect sales of Dermagraft and
TransCyte to the Dermagraft Joint Venture at cost (see Note 2 to the
consolidated financial statements). Accordingly, the Company now manufactures
Dermagraft and TransCyte to meet the Dermagraft Joint Venture's forecasted
requirements. As a result, sales to related parties in the three and six-month
periods ended June 30, 1999 reflect costs to manufacture Dermagraft and
TransCyte including period costs, while sales to related parties in the three
and six-month periods ended June 30, 1998 include costs to manufacture
Dermagraft and TransCyte but do not include period costs for TransCyte. Growth
in sales in 1999 and beyond will continue to be sensitive to the Dermagraft
Joint Venture's success in obtaining regulatory approvals and product
reimbursement from both national healthcare systems and private insurers.
Revenues from contracts and fees were $7,505,000 and $15,304,000 for the
three and six months ended June 30, 1999, respectively, compared to $2,077,000
and $4,741,000 for the corresponding periods of 1998. These revenues are
principally for research and development and other activities performed for the
Dermagraft and Cartilage Joint Ventures. The increase in 1999 over the prior
year periods primarily reflects the recognition of $4,417,000 and $9,367,000,
respectively, in the three and six-month periods ended June 30, 1999 in revenue
related to a $15 million payment received in January 1999 associated with the
expansion of the Dermagraft Joint Venture. The increase in 1999 also reflects
higher revenues for conducting clinical trials of Dermagraft. See Notes 1 and 2
to the consolidated financial statements.
-13-
<PAGE>
Cost of goods sold of $3,617,000 and $6,688,000, respectively, for the
three and six months ended June 30, 1999 compares to $3,032,000 and $6,960,000
in the corresponding periods in 1998. Cost of goods sold represents the cost of
TransCyte and Dermagraft sold to the Dermagraft Joint Venture and, in 1998, to
third parties. Less overhead was capitalized into inventory in 1998 reflecting
higher forecasted production levels in anticipation of and preparation for the
expected launch of Dermagraft for the treatment of diabetic foot ulcers in the
United States. However, costs and volume were subsequently scaled back based on
the FDA's request for an additional clinical trial as discussed above and,
therefore, more overhead is being capitalized into inventory in 1999. As a
result of the FDA's decision to require additional clinical data for Dermagraft
in the treatment of diabetic foot ulcers, the Company expects to continue to
incur significant costs associated with excess production capacity within its
manufacturing facility in 1999.
Research and development expenditures increased to $3,958,000 and
$8,127,000 in the three and six months ended June 30, 1999, respectively, as
compared to $3,844,000 and $7,765,000 in the corresponding periods of 1998. The
increase in research and development costs primarily reflects higher costs for
clinical trials and facilities, partially offset by lower costs for sponsored
research.
Selling, general and administrative costs were $2,791,000 and $6,171,000
for the three and six months ended June 30, 1999, respectively, as compared to
$4,343,000 and $8,216,000 in the corresponding periods of the prior year. The
decrease primarily reflects lower selling and marketing costs as a result of the
transfer of sales and marketing activities for TransCyte in the United States to
the Dermagraft Joint Venture in October 1998. The impact of the lower selling
and marketing costs was partially offset by higher facility costs, increased
legal fees and costs for a special meeting of stockholders held in February 1999
(see Note 6 to the consolidated financial statements).
Equity in losses of joint ventures were $4,998,000 and $10,455,000 for the
three and six months ended June 30, 1999, respectively, compared to $4,637,000
and $8,889,000 for the corresponding periods of 1998. These amounts represent
the Company's share of losses of the Dermagraft and Cartilage Joint Ventures.
The increase in 1999 losses reflects manufacturing and distribution costs
associated with the transfer of sales and marketing of TransCyte in the United
States to the Dermagraft Joint Venture, as well as support of clinical trials
for Dermagraft in the treatment of diabetic foot ulcers and for venous ulcers.
Interest income and other was a net expense of $151,000 and net income of
$304,000 in the three and six months ended June 30, 1999, respectively, as
compared to income of $31,000 and $300,000 in the corresponding periods of 1998.
The net expense in the three months ended June 30, 1999 reflects fees related to
the early termination of a long-term lease facility (see Note 9 to the
consolidated financial statements). Except for these fees, the increases in the
1999 periods were due primarily to higher average cash balances during 1999 and
a decline in Smith & Nephew's share of the earnings of a jointly-owned,
consolidated subsidiary (see Note 1 to the consolidated financial statements).
Liquidity and Capital Resources
- -------------------------------
As of June 30, 1999, the Company had available working capital of
$6,071,000, a decrease of $14,371,000 from December 31, 1998. The decrease
reflects the transfer of a loan from Smith & Nephew from long-term to current
(see Note 5 to the consolidated financial statements), the use of working
capital to support operations and the net investment in the Company's joint
ventures with Smith & Nephew, partially offset by the $15 million payment
received in January 1999 associated with the expansion of the Dermagraft Joint
Venture (see Note 2 to the consolidated financial statements). Capital
expenditures and patent application costs were $570,000 and $210,000,
respectively, during the first half of 1999. The Company expects to continue
to use working capital as it incurs substantial research and development
expenses, additional costs in support of clinical trials, general and
administrative costs in support of product commercialization, expenditures
for capital equipment and patents, and in support of the Dermagraft and
Cartilage Joint Ventures and its strategic alliance with Inamed. These uses
of working capital are expected to be only partially offset by revenues
received from the Dermagraft and Cartilage Joint Ventures with Smith & Nephew
and from the Inamed alliance.
In addition to available working capital, under the agreement with Inamed,
Inamed has agreed to make Advanced Tissue Sciences a series of payments totaling
$6 million, including $3 million to purchase Advanced
-14-
<PAGE>
Tissue Sciences' common stock. A payment of $2 million was received in May
1999 and is reflected in the accompanying consolidated balance sheet, $3 million
was subsequently received in July 1999 and $1 million remains due before the end
of 1999. Further, if Inamed exercises the option to license the additional two
indications, Advanced Tissue Sciences will also be entitled to receive another
$4 million in 1999. See Note 2 to the consolidated financial statements.
The Company has also entered into an equity line with an investor group
which could provide up to $50 million in funding through the sale of Common
Stock pursuant to drawings made from time to time by the Company. Subject to
certain conditions, the equity line is available through February 2000. Any
drawing by the Company under the equity line may not exceed $15 million and, in
any event, the investor group may, in its sole discretion, refuse to fund any
drawing if such drawing, when aggregated with other drawings within the
preceding three months and other Company securities held by the investor group,
would result in the investor group owning more than 4.9% of the outstanding
shares of common stock. Any shares sold under the equity line will be sold at a
5% discount to the average low trading price of the Company's common stock over
a specified period as determined by market volume. A drawing cannot be made
during the pricing period for an earlier drawing under the equity line. In
addition, the Company may not effect a drawing under the equity line if the
common stock is trading at less than $2 per share, trading of the common stock
on the Nasdaq National Market has been suspended or the common stock has been
delisted from the Nasdaq National Market, or there is not in effect a
registration statement under the Securities Act of 1933 covering the issuance
and resale of the common stock to be issued pursuant to the drawing. Subject to
these conditions, any decision to draw any funds under the equity line and the
timing of any such draw are solely at the Company's discretion.
The Company currently believes it has sufficient funds, including those
available under the equity line, from available borrowings and through its
strategic alliances, to support its operations through 1999. The Company has
notified the holders of its Convertible Series B Preferred Stock that it will
redeem for cash at 105% of liquidation value any preferred share submitted for
conversion at a conversion price at or below $3.58 per share through September
30, 1999 (see Note 6 to the consolidated financial statements). If all of the
outstanding shares of Series B Preferred Stock were submitted for conversion
during this period, the Company could be required to use approximately $5.4
million to redeem such shares. In July 1999, the Company filed a registration
statement with the Securities and Exchange Commission for an offering of
5,000,000 shares of common stock (see Note 11 to the consolidated financial
statements). These shares are being offered directly and there can be no
assurance the Company will successfully complete this offering. Further sources
of funds which the Company may pursue 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 that funds from these
sources or those outlined above 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 June 30, 1999
decreased by $1,088,000 as compared to December 31, 1998 principally reflecting
the use of cash to fund operations, to support the Dermagraft and Cartilage
Joint Ventures, for capital expenditures and the payment of debt, substantially
offset by the $15 million payment in January 1999 associated with the expansion
of the Dermagraft Joint Venture and the $2 million payment received in May 1999
from Inamed for license fees and the purchase of common stock (see Note 2 to the
consolidated financial statements). Accrued expenses at June 30, 1999 increased
from year end 1998 as a result of
-15-
<PAGE>
accruals for clinical studies and rent. The current portion of long-term debt
at June 30, 1999 has increased from December 31, 1998 reflecting the fact that
the Cartilage loan from Smith & Nephew is due and payable in June 2000 (see Note
5 to the consolidated financial statements). Deferred revenue as of June 30,
1999 reflects the portion of the $15 million payment related to the expansion of
the Dermagraft Joint Venture and a $1 million payment related to the Inamed
licensing agreement yet to be recognized (see Notes 1 and 2 to the consolidated
financial statements). Long-term debt has decreased significantly in 1999 as
the Dermagraft loan from Smith & Nephew was converted to equity and Cartilage
loan discussed above has been transferred to current liabilities (see Note 5 to
the consolidated financial statements). Preferred stock as of June 30, 1999
reflects the private placement of the Convertible Series B Preferred Stock in
July 1998 less conversions (see Note 6 to the consolidated financial
statements).
Year 2000 Compliance
- --------------------
The Year 2000 ("Y2K") issue is a situation which results from computer
systems and software products being coded using two digits rather than four to
define the applicable years. The Company's computer systems and software
products utilize embedded technology that is time-sensitive and may recognize a
date as the year 1900 rather than the year 2000 which could cause computer
system failures and errors leading to a disruption in business operations. The
Y2K issue could affect not only the Company's operations but also the operations
of its business partners, customers, suppliers and regulatory agencies among
others.
In response to the risks presented by the Y2K issue, the Company developed
and is implementing a Y2K compliance plan. The Company has approached the Y2K
issue in two specific phases. Phase I involves the review and analysis of
computer systems, software products, equipment and vendor relationships
considered critical to the Company's operations. Phase II involves the review
and analysis of computer systems, software products, equipment and vendor
relationships not considered critical to the Company's operations. In both
phases, qualified independent consultants are being utilized to achieve
compliance goals. The Company currently estimates that the cost of Phase I and
II activities to be less than $200,000, respectively, exclusive of internal
manpower costs. These costs are primarily for consulting services and equipment
upgrades and are not material to the Company's financial condition or results of
operations.
With respect to Phase I, all required system modifications have been made
to computer servers, operating systems and telecommunication network equipment.
The Company has identified several pieces of manufacturing and laboratory
equipment and facility access control systems that are being upgraded. The cost
of these upgrades is included in the cost estimate for Phase I presented above.
The Company believes that all significant Y2K problems relating to computer
systems, product software and vendor relationships considered critical to the
Company's operations have been identified and specific plans are in place to
assure Y2K compliance thus reducing the risk of a critical Y2K failure or error.
In Phase II, the Company has identified approximately 150 non-critical
items to be tested for Y2K compliance, and will need to assess approximately 260
vendor relationships. While these systems and relationships are not considered
critical to the Company's business operations, every reasonable effort has been
made to identify and correct those that are not Y2K compliant. The Company is
in the process of completing its review and testing of these systems and
vendors.
The Company expects to complete its formal contingency plan relative to
undetected Y2K problems prior to December 1999. At the current time, there
does not appear to be any critical piece of equipment for which backup cannot be
provided. The worst case scenario would likely involve adding additional
short-term labor to perform repetitive manufacturing tasks. There could also be
some incremental costs of replacing current testing capabilities if the
Company's on-site test equipment should fail. While these extra costs have not
yet been estimated, they would not be expected to have a material impact on the
Company's financial condition or operating results.
The foregoing Y2K discussion contains forward-looking statements within the
meaning of the Private Securities Litigation Reform Act of 1995. Such
statements, including, without limitation, estimated costs and timelines to
complete certain actions, are based on management's best current estimates,
which were derived utilizing numerous assumptions about future events, including
the continued availability of certain resources,
-16-
<PAGE>
representations received from third parties and other factors. However, there
can be no guarantee that these estimates will be achieved, and actual results
could differ materially from those anticipated. Specific factors that might
cause such material differences include, but are not limited to, the ability to
identify and remediate all relevant Y2K issues, results of Y2K testing, adequate
resolution of Y2K issues by third-party vendors and suppliers of goods and
services to the Company, unanticipated system costs, the adequacy of and ability
to develop and implement contingency plans and similar uncertainties. In
addition, there can be no assurance the Company will identify all the Y2K issues
or that, once identified, the actions undertaken by the Company will be adequate
to resolve the issues.
ITEM 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is exposed to changes in interest rates primarily from its
long-term debt arrangements and, secondarily, its investments in certain
securities. Under its current policies, the Company does not use interest rate
derivative instruments to manage exposure to interest rate changes. The Company
believes that a hypothetical 100 basis point adverse move in interest rates
along the entire interest rate yield curve would not materially affect the fair
value of the Company's interest sensitive financial instruments at June 30,
1999.
-17-
<PAGE>
PART II - OTHER INFORMATION
---------------------------
ITEM 2 - CHANGE IN SECURITIES
On May 17, 1999, as part of an agreement between the Company and Inamed
Corporation, the Company sold 165,975 shares of Advanced Tissue Sciences' common
stock pursuant to Regulation D under the Securities Act of 1933 ("Regulation D")
to Inamed for $1 million or approximately $6.03 per share. As part of this stock
purchase Inamed Corporation also received five-year warrants to purchase up to
100,000 shares of common stock at approximately $12.05 per share. The foregoing
summary is qualified in its entirety by reference to the Company's Current
Report on Form 8-K dated May 10, 1999 and the exhibit attached thereto.
On June 18, 1999, 2,800,595 shares of Advanced Tissue Sciences' common stock
were issued to Smith & Nephew SNATS, Inc. pursuant to Regulation D as payment of
a $10 million loan plus accrued interest of $804,000. The conversion price was
approximately $3.86 per share.
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Company's Annual Meeting of Stockholders was held on May 25, 1999.
During the Annual Meeting, the stockholders elected the following nominees to
the Company's Board of Directors to serve for the term of one year or until
their successors have been elected and qualified. The votes of the stockholders
for each of the director nominees was as follows:
Nominee In Favor Withheld
------------------------ ------------ ------------
Arthur J. Benvenuto 38,852,371 493,003
Dr. Gail K. Naughton 38,871,371 474,003
Jerome E. Groopman, M.D. 38,924,501 420,873
Jack L. Heckel 38,814,311 531,063
Ronald L. Nelson 38,833,507 511,867
Dayton Ogden 38,825,257 520,117
David S. Tappan, Jr. 38,808,757 536,617
Dr. Gail R. Wilensky 38,905,362 440,012
The stockholders also approved the appointment of Ernst & Young LLP as
independent auditors for the fiscal year ending December 31, 1999 with
38,898,353 shares in favor of the proposal, 226,764 shares opposed and 220,257
shares abstaining.
Broker non-voting did not occur with regard to either of the above matters
brought before the Annual Meeting.
ITEM 5 - FACTORS THAT MAY AFFECT FUTURE RESULTS
The following is a summary description of some of the many risks we face in
our business. You should carefully review these risks in evaluating our business
and the businesses of our subsidiaries. You should also consider the other
information described in this report.
RISKS RELATED TO OUR BUSINESS
- -----------------------------
OUR PRODUCTS MAY NOT SUCCESSFULLY COMPLETE CLINICAL TRIALS REQUIRED FOR
COMMERCIALIZATION.
We believe that our profitability and growth over the next several years
will depend in large part upon broad market acceptance of Dermagraft for the
treatment of diabetic foot ulcers and, to a lesser extent, of TransCyte in the
United States and the key international markets targeted by Smith & Nephew.
Early in 1998, an FDA Advisory Panel recommended the FDA approve Dermagraft for
marketing in the United States for the treatment of diabetic foot ulcers. The
Advisory Panel's recommendation included certain conditions we would have needed
to satisfy after the commercial introduction of Dermagraft.
-18-
<PAGE>
However, in June 1998, the FDA requested we complete an additional
controlled clinical trial to support our application for approval to market
Dermagraft for the treatment of diabetic foot ulcers. We are currently
conducting this additional pivotal clinical trial. Commercial introduction
within the United States is subject to successful completion of the additional
clinical trial. Assuming successful completion of the clinical trial, we will
still need to apply and receive FDA approval before we can market Dermagraft for
the treatment of diabetic foot ulcers in the United States.
We have received FDA approval to market TransCyte for first and second
degree burns and have been marketing that product since March 1997.
Internationally, the Dermagraft Joint Venture is selling Dermagraft for diabetic
foot ulcers and TransCyte for burns as allowed under regulatory requirements or
as we receive regulatory approvals. Accordingly, the commercial acceptance of
Dermagraft for the treatment of diabetic foot ulcers has not been tested in the
United States, and both Dermagraft and TransCyte have only been marketed and
sold for a limited period of time.
Substantially all of our products under development and many of the
additional applications of our existing products will require successful
clinical trials to support the regulatory approvals required before our products
can be commercialized.
WE WILL NEED ADDITIONAL FUNDS TO SUPPORT OPERATIONS. IF WE ARE UNABLE TO OBTAIN
THEM, WE WOULD HAVE TO REDUCE OR CEASE OPERATIONS, OR ATTEMPT TO SELL SOME OR
ALL OF OPERATIONS OR TO MERGE WITH ANOTHER ENTITY.
The further development of our technology and products as well as any
further development of manufacturing capabilities or the establishment of
additional sales, marketing and distribution capabilities will require the
commitment of substantial funds. Our existing working capital will not be
sufficient to meet our needs. Potential sources of additional funds include
payments from our alliances with Smith & Nephew and Inamed Corporation, our
borrowing capacity under the cartilage joint venture with Smith & Nephew, and
our access to funds under an equity line. In addition, we may pursue additional
public or private offerings of debt or equity securities or other means. We
could also acquire additional funding through collaborative arrangements or the
extension of existing arrangements. With the equity line, we believe such
sources of funds will be sufficient to meet our present operating and capital
requirements for at least the next twelve months.
We cannot provide assurance that we will satisfy the milestones for
additional funds under the joint ventures with Smith & Nephew or the Inamed
alliance. We also cannot provide assurance that adequate funds will be
available under other existing or future arrangements when such funds are needed
or, if available, on terms acceptable to us. In certain circumstances, funds
under the equity line could be limited or, in some cases, completely
unavailable. Limitations on the equity line include:
- any draw by us under the equity line may not exceed $15 million;
- draws by us within any three-month period cannot exceed 4.9% of the
outstanding shares of our common stock;
- the investor group does not have to accept any draw which would result
in such group owning more than 4.9% of the outstanding shares of our
common stock; and
- we cannot draw against the equity line during the pricing period for
an earlier draw.
In addition, we may not effect a drawing under the equity line if:
- our common stock is trading at less than $2 per share;
- trading of our common stock on the Nasdaq National Market has been
suspended;
- our common stock has been delisted from the Nasdaq National Market; or
- we do not have in effect a registration statement under the Securities
Act of 1933 covering the issuance and resale of the common stock to be
issued pursuant to the draw.
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Insufficient funds may require us to delay, scale back or eliminate certain
of our research and product development programs or that we license third
parties the right to commercialize products or technologies that we would
otherwise commercialize ourselves or that we attempt to merge with another
entity.
OUR PRODUCTS MAY NOT ACHIEVE THE MARKET ACCEPTANCE REQUIRED FOR SUCCESSFUL
COMMERCIALIZATION.
Our products are based on new and innovative technologies and we cannot
provide assurance that either the medical community or the general population
will broadly accept such products as alternatives to existing methods of
treatment. The acceptance of our products may be adversely affected by:
- their respective cost;
- concerns related to efficacy;
- the effectiveness of alternative methods of treatment; and
- the insufficiency of third-party reimbursement.
Any future reported adverse events or other unfavorable publicity involving
patient outcomes from the use of our products could also adversely affect
acceptance of our products. Both we and Smith & Nephew have limited direct
experience marketing or obtaining third-party reimbursement for these types of
products.
WE RELY ON THIRD PARTIES TO MARKET AND SELL OUR PRODUCTS AND THOSE THIRD PARTIES
MAY NOT PERFORM SUCCESSFULLY.
We are relying on Smith & Nephew and others to market our products both
domestically and internationally. Our success in generating market acceptance
of Dermagraft and TransCyte will depend on the marketing efforts of Smith &
Nephew. We cannot control the amount and timing of resources that Smith &
Nephew or others may devote to marketing and selling our skin products. We
cannot assure Smith & Nephew will perform its obligations under the Dermagraft
Joint Venture as expected. Our failure to achieve broad acceptance of
Dermagraft for the treatment of diabetic foot ulcers and, to a lesser extent,
TransCyte for burn care, would have a material adverse effect on our business,
financial condition and results of operations.
IF WE ARE NOT ABLE TO CONTROL THE AMOUNT AND TIMING OF RESOURCES OUR CURRENT AND
FUTURE COLLABORATORS DEVOTE TO OUR PROGRAMS OR POTENTIAL PRODUCTS, THEN OUR
PRODUCT DEVELOPMENT COULD BE DELAYED OR TERMINATED. THIS WOULD ADVERSELY AFFECT
OUR BUSINESS.
We are particularly dependent on Smith & Nephew with respect to the
Dermagraft and the cartilage joint ventures. The amount and timing of resources
to be devoted to such performance are not within our control, and we cannot
assure that Smith & Nephew will perform its obligations as expected. The
Dermagraft and cartilage joint ventures would be materially and adversely
affected if Smith & Nephew had a strategic shift in its business focus. In
addition, the Dermagraft and cartilage joint venture agreements provide that
they may be terminated prior to their expiration under certain circumstances
that are outside our control. A termination of such agreements, or a failure of
Smith & Nephew to adequately perform its obligations thereunder, would have a
material adverse effect on our ability to successfully complete the development
and testing of the products covered thereby and to successfully penetrate the
markets for such products. Any such event could have a material adverse effect
on our business, financial condition and results of operations.
We continually seek and consider collaborative arrangements to obtain
funding for the development of our products, such as our recent alliance with
Inamed Corporation. These arrangements may involve the issuance of additional
equity or debt securities and marketing rights to the funding party. We may
seek collaborative arrangements and separate funding for our programs which may
include joint ventures, third party equity investments or other financing
structures. To the extent that we choose not to or are unable to establish such
arrangements, we would experience increased capital requirements to undertake
research, development and marketing of our proposed products at our own expense.
In addition, we may encounter significant delays in introducing our proposed
products into certain markets or find that the development, manufacture or sale
of our proposed products in such markets is adversely affected by the absence of
such collaborative agreements.
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OUR OPERATIONS ARE NOT CURRENTLY PROFITABLE.
To date, we have experienced significant operating losses in funding the
research, development, testing and marketing of our products and expect to
continue to incur substantial operating losses. To June 30, 1999, we had
incurred cumulative net operating losses of $228.7 million. Our ability to
achieve profitability depends in part upon our ability, either independently or
in collaboration with Smith & Nephew and others, to successfully manufacture and
market Dermagraft and TransCyte for skin ulcers and burns. There can be no
assurance that we will ever achieve a profitable level of operations or that
profitability, if achieved, can be sustained on an ongoing basis.
IF OUR PRODUCTS ARE NOT EFFECTIVELY PROTECTED BY VALID, ISSUED PATENTS OR IF WE
ARE NOT OTHERWISE ABLE TO PROTECT OUR PROPRIETARY INFORMATION, WE WILL NOT BE
ABLE TO MAINTAIN A COMPETITIVE POSITION AND IT WOULD HARM OUR BUSINESS.
Our ability to compete effectively will depend, in part, on our ability to
maintain the proprietary nature of our technology and manufacturing processes.
We rely on patents, trademarks, trade secrets and know-how to maintain our
competitive position. We own and license over fifty United States and foreign
patents. The United States patents expire at various times between 2005 and
2016.
We cannot provide assurance that:
- any applications will result in issued patents;
- any current or future issued or licensed patents, trade secrets or
know-how will afford protection against competitors with similar
technologies or processes,
- any patents issued will not be infringed upon or designed around by
others; or
- others will not independently develop technologies or processes that
are the same as or substantially equivalent to ours.
We could also incur substantial costs in defending ourselves in suits
brought against us on such patents or in bringing suits to protect our patents
or patents we license against infringement. In addition to patent protection,
we rely on trade secrets, know-how and technological advances which we seek to
protect in part by confidentiality agreements with our collaborative partners,
employees and consultants. We cannot provide assurance that these agreements
will not be breached, that we will have adequate remedies for any breach, or
that our trade secrets will not otherwise become known or independently
discovered by competitors.
WE DEPEND ON THIRD-PARTY SUPPLIERS TO SUPPLY THE MATERIALS NECESSARY TO
MANUFACTURE OUR PRODUCTS WHICH MAY DELAY OR IMPAIR OUR ABILITY TO DEVELOP AND
COMMERCIALIZE PRODUCTS ON A TIMELY AND COMPETITIVE BASIS OR ADVERSELY AFFECT OUR
POTENTIAL FUTURE PROFITABILITY.
Although most of the raw materials used in the manufacture of our
Dermagraft and TransCyte products are available from more than one supplier,
changes in certain critical components could cause the FDA to require us to
prove equivalency of the materials or potentially to modify or perform
additional clinical trials for our Dermagraft and TransCyte products, which
could have the effect of restricting our ability to commercialize our products.
The mesh framework used by us in the manufacture of Dermagraft is available
under a supply agreement with only one FDA-approved manufacturing source.
Similarly, the synthetic mesh framework used by us in the manufacture of
TransCyte is only 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.
We cannot give any assurance that interruptions in supplies for the
manufacture of our Dermagraft and TransCyte products will not occur in the
future or that we will not have to obtain substitute vendors for these
materials. Any significant supply interruption would adversely affect our
clinical trials as well as our product development and marketing programs. In
addition, an uncorrected impurity or supplier's variation in a raw material,
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either unknown to us or incompatible with our manufacturing process, could have
a material adverse effect on our ability to manufacture products.
MANY OF OUR PRODUCTS ARE IN AN EARLY STAGE OF DEVELOPMENT AND MAY NEVER BE
SUCCESSFULLY COMMERCIALIZED WHICH WOULD HAVE AN ADVERSE IMPACT ON YOUR
INVESTMENT AND OUR BUSINESS.
Although TransCyte has been approved for commercial sale and clinical
trials are underway using Dermagraft for the treatment of diabetic foot ulcers
in the United States, our other products are at earlier stages of research,
development and testing. These products, including additional indications for
Dermagraft and TransCyte, will require significant additional research and
development, including extensive preclinical and clinical testing, and
regulatory approvals prior to commercialization. In addition, even assuming
successful completion of the additional Dermagraft clinical trial, we cannot
provide assurance that the FDA will approve the marketing of Dermagraft.
All of our 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 will be found to be unsafe or ineffective
or otherwise fail to receive necessary regulatory approvals;
- our products are uneconomical to market;
- third parties may hold legal rights that preclude us from marketing
such products; or
- our products fail to achieve market acceptance in light of competing
technologies and products.
RISKS RELATED TO OUR INDUSTRY
- -----------------------------
WE ARE SUBJECT TO EXTENSIVE GOVERNMENT REGULATION IN OUR INDUSTRY AND MAY FAIL
TO RECEIVE REGULATORY APPROVAL WHICH COULD PREVENT OR DELAY THE COMMERCIALIZ-
ATION OF OUR PRODUCTS.
Regulation by governmental authorities in the United States and foreign
countries is a significant factor in manufacturing, marketing, researching and
developing our products. Our preclinical studies, clinical trials,
manufacturing and marketing is subject to extensive, costly and rigorous
regulation by various governmental authorities in the United States and other
countries. Most of our 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. We cannot give any assurance that any
products we develop, independently or in collaboration with others, will receive
the required approvals for manufacturing and marketing.
In the United States, the FDA regulates the clinical testing, manufacture,
distribution and promotion of medical devices, biologics and pharmaceuticals
pursuant to the Federal Food, Drug and Cosmetic Act or the FDC Act and related
regulations. Our TransCyte, Dermagraft and cartilage products are subject to
regulation by the FDA as medical devices. Our other tissue replacement
products, currently in various stages of development, could be regulated as
medical devices, biologic products or pharmaceutical products. Legislative and
regulatory initiatives concerning the regulation of tissue and organ transplants
are ongoing and could possibly affect the future regulation of our
tissue-engineered products. We cannot accurately predict the time frame for
such action or the ultimate effect of any such initiatives on the products we
are developing. Unlike 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, the time period for final action often takes
several years from submission, usually exceeding that expected for a device
application.
To obtain FDA approval to market medical devices that are not substantially
equivalent to existing devices, the FDA requires proof of safety and efficacy in
human clinical trials. Clinical trials are performed under an Investigational
Device Exemption or 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,
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and proposed clinical protocols. If the FDA approves an IDE application, human
clinical trials may begin. If the results of these trials are satisfactory,
they are accumulated and submitted to the FDA in support of an application for
approval to market the product. The FDA must give prior approval or clearance
before commercial distribution of medical devices in the United States.
The application for approval for marketing of a medical device must be
supported by extensive data, including preclinical and human clinical trial
data, to prove the safety and efficacy of the device. The application contains
information about the device and its components including, among other things,
manufacturing, labeling and promotion. By regulation, the FDA has 180 days to
review the application. During that time an advisory panel may evaluate the
application and provide recommendations to the FDA. While the FDA has responded
to applications within the allotted time period, reviews more often occur over a
significantly protracted period, often twelve to thirty-six months. A number of
devices for which companies have submitted applications were never cleared for
marketing. The FDA often significantly exceeds the 180-day review time because
it may need additional information or clarification of information provided.
Also, based on deficiencies in the application or its interpretation of the
information provided, the FDA may determine that additional clinical trials are
required. The process is lengthy and expensive and we cannot give any assurance
that we will obtain FDA approval for the marketing of our products.
If the FDA's evaluation of the application for marketing is favorable, the
FDA typically issues a letter requiring the applicant's agreement to specific
conditions (e.g., changes in labeling) or specific additional information to
secure final approval. Once the requirements are satisfied, the FDA will issue
an approval for marketing the device for specific indications, which can be more
limited than those originally sought by the manufacturer. It can also include
post-approval conditions that the FDA believes are necessary to ensure the
safety and effectiveness of the device. These may include restrictions on
labeling, promotion, sale and distribution. Failure to comply with the
conditions of approval can result in adverse enforcement action, including the
loss or withdrawal of the approval. Even after approval, a new application or a
supplement is required if there is a modification to the device, its labeling or
its manufacturing process.
FDA regulations also require a manufacturer to inform the FDA whenever
there is reasonable evidence to suggest that one of its devices may have caused
or contributed to death or serious injury, or where one of its devices
malfunctions and, if the malfunction were to recur, the device would be likely
to cause or contribute to a death or serious injury.
In December 1996, we submitted an application requesting approval of
Dermagraft for the treatment of diabetic foot ulcers. In February 1997, the FDA
accepted the application for filing. We based the submission on the results of
a pivotal clinical trial from patients receiving Dermagraft within a therapeutic
range identified retrospectively from the trial. Patients receiving Dermagraft
within the therapeutic range represented a majority but not all the evaluable
patients in the trial. We believe the data from patients receiving Dermagraft
within the therapeutic range demonstrate a statistically significant improvement
in complete healing at twelve and thirty-two weeks. For all evaluable patients,
although statistical significance was not seen at twelve weeks in the pivotal
clinical trial, a statistically significant improvement in complete healing as
compared to the control treatment was seen at thirty-two weeks.
In January 1998, the General and Plastic Surgery Devices Panel of the
Medical Devices Advisory Committee to the FDA recommended that the FDA approve
Dermagraft for the treatment of diabetic foot ulcers in the United States. The
recommendation included conditions that we perform a post-marketing study to
confirm product efficacy at twelve weeks and provide physician training. During
the advisory panel meeting, certain panel members and representatives of the FDA
raised questions and concerns regarding the use and nature of the retrospective
analyses we perform in identifying the therapeutic range. Nevertheless, the
advisory panel recommended approval of the product by a vote of seven to two.
One of the dissenting panel members voted against the recommendation on the
grounds that a post-marketing study was too burdensome.
After the advisory panel meeting, the FDA continued to raise concerns about
approving our application based on our retrospective efficacy analysis of the
twelve week data and the use of a post-marketing study to confirm efficacy at
twelve weeks. In June 1998, the FDA indicated the marketing application was not
approvable without
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supportive data from an additional clinical trial. We are currently conducting
the additional clinical trial of Dermagraft in the treatment of diabetic foot
ulcers as requested by the FDA.
We have constructed a commercial manufacturing facility for our TransCyte
and Dermagraft products. This facility must be registered, inspected, and
licensed by various regulatory authorities, including the California Department
of Health and Human Services. The facility also must comply with the FDA's
regulations for quality systems, which elaborate testing, control, documentation
and other quality assurance procedures. The manufacturing facility was
initially inspected and found to be satisfactory by the FDA in 1996, prior to
the approval of TransCyte for the treatment of full-thickness burns. After
inspecting the manufacturing facility early in 1998 in conjunction with our
application for the approval of Dermagraft for the treatment of diabetic foot
ulcers, the FDA notified us of numerous objectionable conditions under a Form
FDA 483 list of observations. These observations concerned our manufacturing
processes and systems for Dermagraft and TransCyte. In March 1998, the FDA
issued a warning letter requiring us to investigate and correct the conditions
identified by the FDA. In September 1998, we successfully completed a
reinspection by the FDA of our manufacturing facility and quality systems.
In general, if as a result of FDA inspections, adverse event reports or
information derived from any other source, the FDA believes we are not in
compliance with laws or regulations or that our products pose a significant
health risk, the FDA can take the following actions:
- refuse to approve pending applications for marketing;
- withdraw previously approved applications for marketing;
- require notification to users regarding risks;
- request corrective labeling, promotional or advertising materials;
- issue warning letters;
- require companies to temporarily suspend marketing or undertake
product recalls;
- impose civil penalties; or
- institute legal proceedings to detain or seize products, enjoin future
violations, or seek criminal penalties against us, our officers or
employees.
The FDA may not impose civil penalties unless the violations involve a
significant or knowing departure from the requirements of the FDC Act or a risk
to public health. The FDA provides manufacturers with an opportunity to be
heard prior to the assessment of civil penalties. If the FDA imposes civil
penalties, judicial review is available.
With respect to the manufacture of products for which approval is granted,
we 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 quality regulations, adverse event reporting requirements, and
other applicable regulations. Congress has also approved the Food and Drug
Administration Modernization Act of 1997 or the Modernization Act. The
Modernization Act makes changes to the device provisions of the FDC Act, and
other provisions in the Modernization Act affect the regulation of devices.
Among other things, the changes affect:
- FDA approval processes;
- device standards and data requirements;
- procedures relating to humanitarian and breakthrough devices;
- tracking and post-market surveillance;
- accredited third party review; and
- the dissemination of off label information.
We cannot predict how or when these changes will be implemented or what
effect the changes will have on the regulation of our products. We cannot give
any assurance that we 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 our business, financial condition or results of operations.
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Although the FDA has classified TransCyte as a medical device, the State of
California and the State of New York have notified us that we must register as a
tissue bank in order to manufacture or distribute TransCyte in those states.
Although many states do not regulate tissue banks, there are certain other
states besides California and New York that do. Such states could take a
position similar to California and New York with regard to the regulatory status
of TransCyte. In June 1997, we submitted a request to the FDA for an advisory
opinion that the FDA's regulation of this product as a medical device preempts
New York from regulating it as human tissue under a different licensing scheme.
Both New York and California have provided written submissions to the FDA urging
the agency to deny our request. To date, the FDA has not ruled. If states are
permitted to regulate TransCyte as a human tissue, we and our customers could be
subjected to a costly new layer of regulation. In addition, under the laws of
some states that regulate tissue, including New York and Florida, the sale of
human tissues for valuable consideration is prohibited. We are currently
distributing TransCyte in the State of New York under a provisional tissue
banking license. Due to the similarities of the products, regulations
applicable to TransCyte are also expected to apply to our Dermagraft product as
well.
Whether regulated by the FDA as a medical device or biologic, or otherwise
by any state or foreign authorities, the approval process for all of our
products is expensive and time consuming. We cannot give any assurance that the
FDA or any regulatory agency will grant its approval. The inability to obtain,
or delays in obtaining, such approvals would adversely affect our ability to
commence marketing therapeutic applications of our technology. We cannot give
any assurance that we will have sufficient resources to complete the required
testing and regulatory review processes. Furthermore, we are 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 we distribute 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.
Our research and development activities and operations involve the
controlled use of small quantities of radioactive compounds, chemical solvents
and other hazardous materials. In addition, our business involves the growth of
human tissues. We believe that our safety procedures for handling and disposing
of such materials comply with the standards prescribed by federal, state and
local regulations. However, the risk of accidental contamination or injury from
these materials cannot be completely eliminated. In the event of such an
accident, we could be held liable for any damages that result. This liability
could have a material adverse effect on our business, financial condition and
results of operations.
We also are subject to various federal, state and local laws, regulations
and recommendations relating to such matters as safe working conditions,
laboratory and manufacturing practices. Although we believe we are in
compliance with these laws and regulations in all material respects, we cannot
give any assurance that we will not be required to incur significant costs to
comply with such laws or regulations in the future.
HEALTHCARE REFORM MEASURES AND REIMBURSEMENT PROCEDURES ARE UNCERTAIN AND MAY
ADVERSELY IMPACT THE COMMERCIALIZATION OF OUR PRODUCTS.
Our ability to commercialize products successfully will 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. In the United States,
government and other third-party payors are increasingly attempting to contain
healthcare costs by limiting both coverage and the level of reimbursement for
new products approved for marketing by the FDA. In some cases, such payors may
refuse to provide any coverage for uses of approved products for indications
that the FDA has not granted marketing approval. Initiatives to reform
healthcare delivery are increasing these cost containment efforts. As managed
care organizations continue to expand as a means of containing healthcare costs,
we believe there may be attempts by such organizations to restrict the use of,
delay authorization to use, or limit coverage and the level of reimbursement
for, new products, such as those being developed and commercialized by us,
pending completion of cost/benefit analyses of such products by those managed
care organizations. Internationally, where national healthcare systems are
prevalent, little if any funding may be available for new products, and cost
containment and cost reduction efforts can be more pronounced than in the United
States.
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We have supported health economics studies and research and have developed
cost offset or cost-effectiveness models with respect to our TransCyte 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. We cannot provide assurance that adequate government or private
payor coverage or levels of reimbursement will be available for any of our
products or that we will be able to maintain price levels sufficient for the
realization of an appropriate return on our investment in such products.
Failure to obtain sufficient coverage and reimbursement levels for uses of our
products could have a material adverse effect on the market acceptance of such
products and our business, financial condition and results of operations.
In connection with its review of our application for approval of Dermagraft
in the treatment of diabetic foot ulcers, the FDA has approved our application
for a Treatment Investigational Device Exemption or a "Treatment IDE." The
Treatment IDE is a new regulatory provision for devices that permits companies
to make available promising new products under an agreed protocol to patients
with serious diseases for which there is no satisfactory alternative. Under a
Treatment IDE, companies are allowed to recover manufacturing and distribution
costs. We cannot provide assurance, however, that we will be successful in
obtaining reimbursement under the Treatment IDE.
WE FACE INTENSE COMPETITION IN OUR INDUSTRY, WHICH COULD RENDER OUR POTENTIAL
PRODUCTS LESS COMPETITIVE OR OBSOLETE AND COULD HARM OUR COMPETITIVE POSITION.
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 we do. 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 we can develop products, complete clinical trials,
obtain regulatory approvals and develop commercial manufacturing capability may
affect our competitive position. Our ability to attract and retain qualified
scientific, manufacturing, marketing and other personnel, obtain and maintain
patent protection and secure funding are also key competitive factors for our
business.
In the field of tissue engineering and the treatment of damaged or diseased
tissue, we compete with several companies that are developing various tissue
replacement products, including skin substitutes and cultured cartilage. In
addition, we are 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, we compete primarily with cadaver skin or porcine
tissue. We are also aware of several companies that have developed technologies
involving processed cadaver skin used as a dermal replacement, such as LifeCell
Corporation, or sheets of epidermis grown from the patient's own skin, such as
Genzyme Tissue Repair and Cell Culture Technology. Integra Life Sciences or
Integra has Integra Artificial Skin consisting of a bovine or animal-derived
matrix with a synthetic covering, for the treatment of burn wounds. In June
1999, Integra announced that Johnson & Johnson Medical obtained worldwide
exclusive marketing and sales rights, excluding Japan, to Integra Artificial
Skin. In addition, we are aware that Ortec International, Inc. has completed a
pilot clinical trial with its composite cultured skin product, consisting of two
types of skin cells, fibroblasts and keratinocytes, on a bovine or
animal-derived collagen sponge, for the treatment of burn wounds. Several other
companies are also developing or plan to develop growth factors as a treatment
for second degree or small first degree burns.
In the area of diabetic foot ulcers, Chiron Corporation and the
Ortho-McNeil division of Johnson & Johnson have received FDA approval and are
marketing a platelet-derived growth factor for the treatment of diabetic foot
ulcers. In addition, Organogenesis, Inc. has completed clinical trials for the
use of Apligraf, a product using cultured human cells seeded onto an
animal-derived (bovine) matrix, for the treatment of diabetic foot ulcers.
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Organogenesis received FDA approval to market Apligraf in the treatment of
venous ulcers or "leg ulcers" in May 1998. Organogenesis has also entered into
an alliance with Novartis Pharma AG for the marketing of Apligraf.
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
defects in the knee. We are also aware that Integra and Osiris Therapeutics,
Inc. are engaged in research on cultured cartilage products. We are not aware
of any competitor that is developing an off-the-shelf, human cartilage tissue.
We believe that our tissue-engineered products may have many attributes
that differentiate them from other competitor's products, including the fact
that our products are human-based tissue products designed to be available
"off-the-shelf" to the end-users. However, other factors such as our ability to
secure regulatory approval for our products, to implement production and
marketing plans, and to secure adequate capital resources will also impact our
competitive position. In addition, for all of our products, we expect to
compete primarily on:
- the uniqueness of our technology and product features;
- on the quality and cost-effectiveness of our products; and
- on the timing of commercial introduction.
We cannot provide assurance we will have the resources to compete
successfully or that competition will not adversely affect our results of
operations or ability to successfully market our products.
IF WE ARE NOT ABLE TO ATTRACT AND RETAIN KEY PERSONNEL AND ADVISORS, IT MAY
ADVERSELY AFFECT OUR ABILITY TO OBTAIN FINANCING OR DEVELOP OUR PRODUCTS.
Our success will depend in large part upon our ability to attract and
retain qualified scientific, administrative and management personnel as well as
the continued contributions of our existing senior management and scientific and
technical personnel. We face strong competition for such personnel and we
cannot give any assurance that we will be able to attract or retain such
individuals. In particular, if we lose the services of either Arthur J.
Benvenuto, our Chairman and Chief Executive Officer, or Dr. Gail K. Naughton,
our President and Chief Operating Officer, it will have a material adverse
effect on our business.
OUR STOCK PRICE IS SUBJECT TO SIGNIFICANT FLUCTUATIONS, WHICH COULD ADVERSELY
AFFECT OUR ABILITY TO RAISE ADDITIONAL CAPITAL WHICH COULD IN TURN DELAY
COMMERCIALIZATION OF OUR PRODUCTS.
The market price of our 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 often unrelated to the operating performance of such
companies. The market price of our common stock may be affected by
announcements regarding:
- the results of research or scientific discoveries by us or others;
- progress or the results of preclinical and clinical trials;
- new technological innovations;
- the approval and commercialization of products;
- changes in government regulation;
- developments concerning rights;
- litigation and related developments; or
- public perception regarding the safety of our products.
Fluctuations in our financial performance from period to period, the
issuance of analysts' reports and general market conditions also may have a
significant impact on the market price of our common stock.
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IF WE BECOME SUBJECT TO PRODUCT LIABILITY CLAIMS, IT MAY RESULT IN REDUCED
DEMAND FOR OUR PRODUCTS OR DAMAGES THAT EXCEED OUR INSURANCE LIMITATIONS.
The use of any of our products, whether for commercial applications or
during clinical trials, exposes us 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 healthcare
institutions, contract laboratories or others selling or using such products.
We currently maintain product liability insurance coverage; however, such
insurance coverage might not be sufficient to fully cover any potential claims.
Such insurance can be expensive and difficult to obtain. We cannot provide
assurance that adequate insurance coverage will be available in the future at an
acceptable cost, if at all, or in sufficient amounts to protect us against any
such liability. Any product liability claim in excess of insurance coverage
could have a material adverse effect on our business, financial condition and
results of operations.
Our 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, either unknown or
undetected by us, could affect the quality and safety of our products. If any
of the defects were material, we could be required to undertake a market
withdrawal or recall of the affected products. We cannot provide assurance a
product recall or withdrawal will not occur. The cost of a market withdrawal or
product recall could be significant and could have a material adverse effect on
our business, financial condition and results of operations.
IF WE FAIL TO BE YEAR 2000 OR "Y2K" COMPLIANT IT COULD HARM OUR BUSINESS.
The Y2K issue is a situation that results from computer systems and
software products being coded using two digits rather than four to define the
applicable year. Our computer systems and software products utilize embedded
technology that is time-sensitive and may recognize a date as the year 1900
rather than the year 2000 which could cause computer system failures and errors
leading to a disruption of our business operations. The Y2K issue could affect
not only our operations but also the operations of our business partners,
customers, suppliers and regulatory agencies among others. For a further
discussion see Part I, Item 2, "Management's Discussion and Analysis of
Financial Condition and Results of Operations."
RISKS RELATED TO FINANCING
- --------------------------
FUTURE SALES OF OUR COMMON STOCK IN THE PUBLIC MARKET COULD LOWER OUR STOCK
PRICE AND IMPAIR OUR ABILITY TO RAISE FUNDS IN NEW STOCK OFFERINGS.
The market price of our Common Stock could drop due to sales of a large
number of shares of our Common Stock or the perception that these sales could
occur. Such sales also might make it more difficult for us to sell equity
securities in the future at a price that we deem appropriate.
OUR CHARTER DOCUMENTS AND STOCKHOLDER RIGHTS PLAN MAY PREVENT TRANSACTIONS THAT
COULD BE BENEFICIAL TO YOU.
Our stockholder rights plan and provisions in our certificate of
incorporation and bylaws may discourage transactions involving an actual or
potential change in our ownership, including transactions in which you might
otherwise receive a premium for your shares over the then-current market prices.
These provisions also may limit our stockholder's ability to approve
transactions that they deem to be in their best interest. In addition, our
Board of Directors may issue shares of preferred stock without any further
action by stockholders. Such issuances may have the effect of delaying or
preventing a change in our ownership.
-28-
<PAGE>
ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
Exhibit
No. Title Method of Filing
------- ----- ----------------
3.1 Restated Certificate of Incorporation Incorporated by Reference
of Advanced Tissue Sciences, Inc. to Exhibit 3.1 to the
as in effect on February 16, 1999 Registrant's Annual Report
on Form 10-K for the Year
Ended December 31, 1998
3.2 Restated By-Laws of the Registrant Incorporated by Reference
Dated September 17, 1991 to Exhibit 3 to the
Registrant's Form 10-Q for
the Quarter Ended
October 31, 1991
3.3 Certificate of Designations, Incorporated by Reference
Preferences and Rights of Series B to Exhibit 3.1 to the
Convertible Preferred Stock of Registrant's Current Report
Advanced Tissue Sciences, Inc. on Form 8-K dated
July 10, 1998
10.1* Heads of Agreement between Advanced Incorporated by Reference
Tissue Sciences, Inc. and INAMED to Exhibit 10.1 to the
Corporation Dated May 10, 1999 Registrant's Current Report
on Form 8-K dated
May 10, 1999
27 Financial Data Schedule Filed With Electronic Copy
Only
__________
* The Company has requested confidential treatment with respect to certain
portions of this document.
(b) Reports on Form 8-K
The Company filed a Current Report on Form 8-K dated May 10, 1999 under Item 5
reporting that the Company and Inamed Corporation ("Inamed") entered into a
binding letter of intent for a strategic alliance for the development and
marketing of several of Advanced Tissue Sciences' human-based, tissue-engineered
products for aesthetic and certain reconstructive applications. Specifically,
Inamed licensed rights to further develop, manufacture and sell tissue
engineered products for use in cosmetic surgery, cartilage for plastic and
reconstructive surgery, and extracellular matrix for use in breast
reconstruction. In addition, Inamed also received an option to license rights
to use extracellular matrix, including human collagen, from Advanced Tissue
Sciences' three-dimensional culture system for soft tissue augmentation
(wrinkles and cosmetic correction) and as a bulking agent for the treatment of
urinary incontinence.
-29-
<PAGE>
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: August 13, 1999 /s/ Arthur J. Benvenuto
--------------- -------------------------------
Arthur J. Benvenuto
Chairman of the Board and
Chief Executive Officer
Date: August 13, 1999 /s/ Michael V. Swanson
--------------- --------------------------------
Michael V. Swanson
Senior Vice President and
Chief Financial Officer
-30-
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