UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q/A
AMENDMENT NO. 2
-----------
[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)
-------------
Delaware 14-1701513
------------------------------- -------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
10933 North Torrey Pines Road, La Jolla, California 92037
--------------------------------------------------- ----------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (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/A AMENDMENT NO. 2
FOR THE QUARTER ENDED JUNE 30, 1999
INDEX
-----
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
Signatures 18
<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.
DermEquip is a special purpose entity established to finance an expansion of
the Company's manufacturing facility. 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. See
Note 11 with respect to related party transactions with the Dermagraft Joint
Venture.
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. See Note 11 with respect
to related party transactions with the Cartilage Joint Venture.
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>
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,
-7-
<PAGE>
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 financial commitments for product development and
manufacturing processes are incurred.
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 - RELATED PARTY TRANSACTIONS
During the three and six months ended June 30, 1999 and 1998, the Company has
performed services for its Dermagraft and Cartilage Joint Ventures and has
manufactured products for the Dermagraft Joint Venture to sell to customers
or for use in clinical trials as described below (see Note 2). The Company
has a fifty percent interest in each of the Dermagraft and Cartilage Joint
Ventures.
Dermagraft Joint Venture
- ------------------------
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 peirods ended
June 30, 1999 and 1998, all product sales to related parties represent
products sold to the Dermagraft Joint Venture.
As a purpose of the Dermagraft Joint Venture is to share the costs of
manufacturing and commercializing the Company's Dermagraft and TransCyte
products between the joint venture's partners, product sales to the
Dermagraft Joint Venture are equal to the Company's cost of goods sold for
such products including period costs (except for the three and six-month
periods ended June 30, 1998 when the Company also sold TransCyte in the
United States and, therefore, absorbed period costs related to TransCyte).
Period costs reflect overhead costs related to excess production capacity
and include rent, depreciation and quality control, facilities, supplies and
other such costs to support or related to the excess production capacity.
Due to costs related to excess production capacity, the Dermagraft Joint
Venture immediately writes the inventory down to estimated market value at
the date of purchase, which is the net realizable value at which the joint
venture believes it will be able to sell the products to its cusomters. For
the three-month periods ended June 30, 1999 and 1998 such write downs totaled
$3,342,000 and $2,122,000, respectively, and were $6,000,000 and $4,348,000
for the six-month periods ended June 30, 1999 and 1998, respectively. To the
extent the Company does not sell such products to the Dermagraft Joint Venture,
it will be required to write such inventories down to net realizable value.
Cartilage Joint Venture
- -----------------------
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 Company's share of the above costs incurred by the Company and charged to
the Dermagraft and Cartilage Joint Ventures are reflected in the equity in
losses of joint ventures in the accompanying statement of operations and
totaled $5,995,000 and $2,477,000 in the three months ended June 30, 1999 and
1998, respectively, and $12,531,000 and $4,759,000 for the six months ended
June 30, 1999 and 1998, respectively.
NOTE 12 - 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 Notes 2 and 11 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. As
the Company sold TransCyte to third parties in 1998, TransCyte sales to the
joint venture were at a price negotiated between the Company and the Dermagraft
Joint Venture rather than total product costs, including period costs, as in
the 1999 periods. 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
-13-
<PAGE>
1999 also reflects higher revenues for conducting clinical trials for
Dermagraft and TransCyte of $835,000 and $1,496,000 in the three and
six-month periods ended June 30, 1999, respectively. See Notes 1 and 2 to
the consolidated financial statements.
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. Due to costs related to excess production
capacity, the Dermagraft Joint Venture immediately writes the inventory down
to estimated market value at the date of purchase, which is the net realizable
value at which the joint venture believes it will be able to sell the products
to its customers. For the three-month periods ended June 30, 1999 and 1998
such write downs totaled $3,342,000 and $2,122,000, respectively, and were
$6,000,000 and $4,348,000 for the six-month periods ended June 30, 1999 and
1998, respectively. To the extent the Company does not sell such products to
the Dermagraft Joint Venture, it will be required to write such inventories
down to net realizable value.
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 of $819,000 and $1,476,000, in the three and six-month periods
ended June 30, 1999, respectively, and higher facilities costs of $430,000 in
the six months ended June 30, 1999. These increases were partially offset by
lower product development costs of $493,000 and $991,000 in the three and
six-month periods ended June 30, 1999, respectively, and lower costs for
sponsored research of $92,000 in the six months ended June 30, 1999.
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 of $1,060,000
and $2,564,000 in the three and six-month periods ended June 30, 1999,
respectively, 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 of $47,000 and $762,000 and increased
legal fees of $79,000 and $194,000 in the three and six-month periods ended
June 30, 1999, respectively, and $110,000 in 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
and include costs incurred by the Company and charged to the Dermagraft and
Cartilage Joint Ventures totaling $5,995,000 and $2,477,000 for the three-
month periods ended June 30, 1999 and 1998, respectively, and $12,531,000
and $4,759,000 for the six-month periods ended June 30, 1999 and 1998,
respectively (see Note 11 to the consolidated financial statements.) 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 discussed above, 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 of approximately
$400,000 (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).
-14-
<PAGE>
Liquidity and Capital Resources
- -------------------------------
As of June 30, 1999, the Company had available working capital of
$6.1 million, a decrease of $14.4 million from December 31, 1998. The
decrease reflects the transfer of a $6.6 million loan from Smith & Nephew
from long-term to current (see Note 5 to the consolidated financial statements),
the use of $6.2 million of working capital to support operations and the net
investment in the Company's joint ventures with Smith & Nephew of $10.4
million, 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.
If, for any reason, Smith & Nephew were to terminate the Dermagraft Joint
Venture or, to a lesser extent, the Cartilage Joint Venture, the Company
would experience a substantial increase in the need for and use of its
working capital to support the commercialization and manufacture of its
Dermagraft and TransCyte products or the development or its orthopedic
cartilage products.
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 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 12 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
-15-
<PAGE>
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 $1.1 million as compared to December 31, 1998 principally
reflecting the use of $6.2 million to fund operations, $10.4 million to
support the Dermagraft and Cartilage Joint Ventures, $570,000 for capital
expenditures and $1.4 million for 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
by $1.2 million from year end 1998 as a result of accruals for clinical
studies and rent. The current portion of long-term debt at June 30, 1999 has
increased by $6.4 million 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 of $6.6 million
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
by $17 million in 1999 primarily as the $10 million Dermagraft loan from
Smith & Nephew was converted to equity and the $6.6 million 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, 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
-16-
<PAGE>
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, 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.
-17-
<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: September 15, 1999 /s/ Arthur J. Benvenuto
------------------ -------------------------------
Arthur J. Benvenuto
Chairman of the Board and
Chief Executive Officer
Date: September 15, 1999 /s/ Michael V. Swanson
------------------ --------------------------------
Michael V. Swanson
Senior Vice President and
Chief Financial Officer
-18-
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from the
Form 10-Q for the quarter ended June 30, 1999 and is qualified in its
entirety by reference to such financial statements.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-END> JUN-30-1999
<CASH> 15,466
<SECURITIES> 6,500
<RECEIVABLES> 0
<ALLOWANCES> 0
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5,040
0
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<EPS-DILUTED> (.25)
</TABLE>
