UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
---------
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES AND EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER: 0-016607
ADVANCED TISSUE SCIENCES, INC.
(Exact name of registrant as specified in charter)
------------------
Delaware 14-1701513
------------------------------- -------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
10933 North Torrey Pines Road, La Jolla, California 92037
- ---------------------------------------------------- ----------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (619) 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 May 1, 1999 was 42,477,159.
<PAGE>
ADVANCED TISSUE SCIENCES, INC.
FORM 10-Q FOR THE QUARTER ENDED MARCH 31, 1999
INDEX
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Page
----
Part I - Financial Information
- ------------------------------
Item 1 - Financial Statements
Introduction to the Financial Statements 1
Consolidated Balance Sheets -
March 31, 1999 and December 31, 1998 2
Consolidated Statements of Operations -
Three Months Ended March 31, 1999 and 1998 3
Consolidated Statements of Cash Flows -
Three Months Ended March 31, 1999 and 1998 4
Consolidated Statement of Stockholders' Equity -
Three Months Ended March 31, 1999 5
Notes to the Consolidated Financial Statements 6-9
Item 2 - Management's Discussion and Analysis of Financial
Condition and Results of Operations 10-14
Item 3 - Quantitative and Qualitative Disclosures About
Market Risk 14
Part II - Other Information
- ----------------------------
Item 4 - Submission of Matters to a Vote of Security Holders 15
Item 5 - Factors That May Affect Future Results 15
Item 6 - Exhibits and Reports on Form 8-K 15
Signatures 16
<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.
The financial information presented in this Quarterly Report on Form 10-Q
reflects all adjustments, consisting only of normal recurring adjustments, which
are, in the opinion of management, necessary for a fair statement of the results
for the interim periods presented. The results for the interim periods are not
necessarily indicative of results to be expected for the full year.
-1-
<PAGE>
ADVANCED TISSUE SCIENCES, INC.
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
March 31, December 31,
1999 1998
------------ --------------
(Unaudited)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 21,568 $ 16,551
Short-term investments 6,500 6,503
Inventory 4,187 3,364
Other current assets 2,957 2,412
----------- ------------
Total current assets 35,212 28,830
Property - net 19,767 20,624
Patent costs - net 1,970 1,846
Other assets 2,063 2,685
----------- ------------
Total assets $ 59,012 $ 53,985
=========== ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 627 $ 894
Accrued expenses 5,748 4,805
Current portion of long-term debt and
capital lease obligations 12,638 2,689
Deferred revenue 10,050 --
----------- ------------
Total current liabilities 29,063 8,388
Long-term debt and capital lease obligations 16,853 27,260
Other long-term liabilities 695 558
Minority interest in consolidated subsidiary 180 252
----------- ------------
Total liabilities 46,791 36,458
----------- ------------
Redeemable Convertible Series B Preferred
Stock, $.01 par value; 1,000 shares auth-
orized; 100 shares issued and outstanding
at March 31, 1999 and December 31, 1998
(aggregate redemption and liquidation value
of $5,059 and $5,119 at March 31, 1999 and
December 31, 1998, respectively) 5,000 5,000
----------- ------------
Stockholders' equity:
Convertible Series B Preferred Stock, $.01
par value; 314 shares issued and outstanding
at March 31, 1999 and 350 shares at December
31, 1998 (aggregate redemption and liquidation
value of $15,885 and $17,917 at March 31, 1999
and December 31, 1998, respectively) -- --
Accrued cumulative preferred stock dividends 244 536
Common Stock, $.01 par value; 125,000,000 shares
authorized; issued and outstanding, 41,330,719
shares at March 31, 1999 and 40,353,524 shares
at December 31, 1998 413 403
Additional paid-in capital 231,245 230,963
Accumulated deficit (223,762) (218,456)
----------- ------------
8,140 13,446
Less note received in connection with sale of
Common Stock (919) (919)
----------- ------------
Total stockholders' equity 7,221 12,527
----------- ------------
Total liabilities and stockholders' equity $ 59,012 $ 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 March 31,
--------------------------------
1999 1998
------------- ---------------
(Unaudited)
<S> <C> <C>
Revenues:
Product sales -
Related parties $ 3,071 $ 2,415
Others -- 227
Contracts and fees -
Related parties 7,637 2,539
Others 162 125
------------ -------------
Total revenues 10,870 5,306
------------ -------------
Costs and expenses:
Research and development 4,169 3,921
Selling, general and administrative 3,380 3,873
Cost of goods sold 3,071 3,928
------------ -------------
Total costs and expenses 10,620 11,722
------------ -------------
Income (loss) from operations before
equity in losses of joint ventures 250 (6,416)
Equity in losses of joint ventures (5,457) (4,252)
------------ -------------
Loss from operations (5,207) (10,668)
Other income (expense):
Interest income and other 455 269
Interest expense (554) (556)
------------ -------------
Net loss (5,306) (10,955)
Dividends on preferred stock (255) --
------------ -------------
Net loss applicable to common stock $ (5,561) $ (10,955)
============ =============
Basic and diluted loss per common share $ (.14) $ (.28)
============ =============
Weighted average number of common shares
used in computation of basic and diluted
loss per common share 40,957 38,930
============ =============
</TABLE>
See accompanying notes to the consolidated financial statements.
-3-
<PAGE>
ADVANCED TISSUE SCIENCES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
Three Months Ended March 31,
----------------------------------
1999 1998
-------------- ----------------
(Unaudited)
<S> <C> <C>
Operating activities:
Net loss $ (5,306) $ (10,955)
Adjustments to reconcile net loss
to cash used in operating activities:
Depreciation and amortization 1,197 1,147
Compensation for services paid in
stock options or warrants 35 --
Equity in losses of joint ventures 5,457 4,252
Other adjustments to net loss 126 115
Deferred revenue 10,050 --
Change in assets and liabilities:
Inventory (823) 837
Other current assets (545) (2,239)
Accounts payable (267) 111
Accrued expenses 943 (1,403)
------------- --------------
Net cash provided by (used in)
operating activities 10,867 (8,135)
------------- --------------
Investing activities:
Purchases of short-term investments (5,000) (3,972)
Maturities and sales of short-term
investments 5,003 --
Acquisition of property (337) (1,639)
Investment in joint ventures (6,370) (4,350)
Distribution from joint ventures 2,241 --
Patent application costs (137) (34)
Other long-term assets (782) 626
------------- --------------
Net cash used in investing
activities (5,382) (9,369)
------------- --------------
Financing activities:
Proceeds from borrowings 240 1,705
Payments of borrowings (698) (50)
Net proceeds from sale of Common Stock -- 20,000
Options and warrants exercised -- 844
Other long-term obligations (10) 78
------------- --------------
Net cash provided by (used in)
financing activities (468) 22,577
------------- --------------
Net increase in cash and cash equivalents 5,017 5,073
Cash and cash equivalents at beginning
of period 16,551 15,086
------------- --------------
Cash and cash equivalents at end
of period $ 21,568 $ 20,159
============= ==============
</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
Conversion of Preferred Stock (36) -- 743,005 8
Preferred Stock dividends 234,190 2
Net loss ------- --------- ---------- --------
Balance, March 31, 1999 314 $ -- 41,330,719 $ 413
======= ========= ========== ========
</TABLE>
<TABLE>
<CAPTION>
Accrued Total
Additional Dividends/ Stock-
Paid-In Accumulated Note holders'
Capital Deficit Receivable Equity
------------ ------------- ------------ ----------
<S> <C> <C> <C> <C>
Balance, December 31, 1998 $ 230,963 $ (218,456) $ (383) $ 12,527
Conversion of Preferred Stock (8) --
Preferred Stock dividends 290 (292) --
Net loss (5,306) (5,306)
----------- ------------ ----------- ---------
Balance, March 31, 1999 $ 231,245 $ (223,762) $ (675) $ 7,221
=========== ============ =========== =========
</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 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. Revenues from product sales to related
parties (see Note 2) 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. 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 ended March 31,
1999.
NOTE 2 - STRATEGIC ALLIANCES
In April 1996, the Company entered into an agreement with Smith & Nephew to form
a 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
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.
-6-
<PAGE>
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 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-month period ended March 31, 1999, the Company recognized revenues of
$4,950,000 related to such payment. This amount is included in contract
revenues for the period.
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 months ended March 31, 1999 and 1998, the Company recognized
$7,014,000 and $1,710,000, respectively, in contract revenues for research and
development activities performed for the Dermagraft Joint Venture. In addition,
during the three months ended March 31, 1999 and 1998, product sales to related
parties include products sold to the Dermagraft Joint Venture of $3,071,000 and
$2,415,000, respectively. 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 months
ended March 31, 1999, the Company recognized $623,000 in contract revenues for
research and development activities performed for the Cartilage Joint Venture
compared with $829,000 for the corresponding period of 1998.
The results of operations of the joint ventures for the three months ended March
31, 1999 and 1998 are as follows (in thousands):
1999 1998
-------- --------
Dermagraft Joint Venture
- -------------------------
Net sales $ 467 $ 75
Cost of goods sold 4,474 2,528
Other costs and expenses 4,780 4,529
Net loss 8,787 7,036
Cartilage Joint Venture
- -------------------------
Costs and expenses $ 1,165 $ 1,475
Net loss 1,165 1,475
-7-
<PAGE>
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 March 31, 1999 and December 31, 1998 (in thousands):
March 31, December 31,
1999 1998
----------- ------------
Raw materials and supplies $ 3,370 $ 2,965
Work-in-process 817 399
--------- ---------
$ 4,187 $ 3,364
========= ==========
NOTE 4 - 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.
NOTE 5 - LONG-TERM DEBT
In March 1999, the Company borrowed an additional $240,000 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 $5.9 million had
been drawn as of March 31, 1999. Debt and other long-term obligations as of
March 31, 1999 and December 31, 1998 were as follows (in thousands):
March 31, December 31,
1999 1998
----------- ------------
Chase Loan $ 13,440 $ 14,080
Smith & Nephew notes:
Dermagraft Joint Venture 10,000 10,000
Cartilage Joint Venture 5,925 5,685
Obligations under capital
leases and other 126 184
Less current portion (12,638) (2,689)
----------- ------------
$ 16,853 $ 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 three months ended March 31, 1999, approximately 36
shares of the Company's Convertible Series B Preferred Stock were converted into
743,005 shares of Common Stock at an average price of $2.44 per share. See Note
9.
-8-
<PAGE>
NOTE 7 - BASIC AND DILUTED LOSS PER COMMON 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 three months ended
March 31, 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 months ended March 31, 1999 includes
dividends of $255,000 accrued or paid on the Company's Convertible Series B
Preferred Stock during such period.
NOTE 8 - STOCK OPTIONS
The following table summarizes activity under the Company's 1997 Stock Incentive
Plan (the "1997 Plan") and for other options and warrants for Common Stock for
the three months ended March 31, 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 69,560 $2.59 -- --
Exercised -- -- -- --
Canceled (54,889) $8.66 -- --
--------- ---------
Outstanding, March 31, 1999 3,912,393 $8.51 1,509,640 $7.44
========= =========
NOTE 9 - SUBSEQUENT EVENTS
In April 1999, 44 shares of the Company's Convertible Series B Preferred Stock
were converted into 1,027,736 shares of Common Stock at an average price of
$2.14 per share.
-9-
<PAGE>
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Advanced Tissue Sciences, Inc. (the "Company" or "Advanced Tissue
Sciences") is engaged in the development and manufacture of human-based tissue
products for tissue repair and transplantation using its proprietary tissue
engineering technology. The Company's leading therapeutic products are
tissue-engineered skin products, 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 has begun 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 from 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.
In April 1996, the Company entered into an agreement with Smith & Nephew to
form a fifty-fifty joint venture (the "Dermagraft Joint Venture") for the
worldwide commercialization of Dermagraft in the treatment of diabetic foot
ulcers. 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.
-10-
<PAGE>
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.
Results of Operations
- ---------------------
Product sales totaled $3,071,000 for the three months ended March 31, 1999
as compared to product sales of $2,642,000 for the same period in 1998. During
these periods all product sales were to related parties, except TransCyte sales
of $227,000 made through the Company's direct sales force in the United States
during the first quarter of 1998. 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-month period ended March 31, 1999 reflect costs to manufacture Dermagraft
and TransCyte including period costs, while sales to related parties in the
three-month period ended March 31, 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 $7,799,000 for the three months ended
March 31, 1999 increasing from $2,664,000 in the corresponding 1998 period.
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 period primarily reflects the recognition of approximately
$5 million 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.
Cost of goods sold for the three months ended March 31, 1999 were
$3,071,000 as compared to $3,928,000 for the corresponding period in 1998. The
reduction in cost of goods sold principally results from an increase in the
capitalization of overhead into inventory in 1999. 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. Costs and
volume were subsequently scaled back based on the FDA's need for an additional
clinical trial as discussed above. Cost of goods sold for the three months
ended March 31, 1998 also includes approximately $380,000 related to a product
recall. 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.
Research and development expenditures in the three months ended March 31,
1999 increased by 6% to $4,169,000 as compared to $3,921,000 for the three
months ended March 31, 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 decreased 13% to $3,380,000 for
the three months ended March 31, 1999 as compared to $3,873,000 for the
corresponding period in 1998. 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 was $5,457,000 and $4,252,000 for the
three months ended March 31, 1999 and 1998, respectively. These amounts
represent the Company's share of losses of the Dermagraft and Cartilage Joint
Ventures. The increase in 1999 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.
-11-
<PAGE>
Interest income and other was $455,000 for the three months ended March 31,
1999 as compared to $269,000 in the corresponding quarter in 1998. The increase
is due in part to higher average cash balances during the first quarter of 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 March 31, 1999, the Company had available working capital of
$6,149,000, a $14,293,000 decrease from the $20,442,000 available at December
31, 1998. The decrease reflects the transfer of the Dermagraft loan 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).
The Dermagraft loan is due on March 31, 2000 and is payable in cash or common
stock at the election of the Company. Capital expenditures and patent
application costs were $337,000 and $137,000, respectively, during the first
quarter 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. 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.
In addition to available working capital, the Company has 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 the foregoing, 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 joint
venture arrangements, to support its operations through 1999. The Company is
also pursuing further sources of funds to include existing or future strategic
alliances or other joint venture arrangements which provide funding to the
Company, and additional public or private offerings of debt or equity
securities, among others. There can be no assurance, however, that funds 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.
-12-
<PAGE>
Financial Condition
- -------------------
Cash, cash equivalents and short-term investments as of March 31, 1999
increased by $5,014,000 from December 31, 1998 principally reflecting the $15
million payment in January 1999 associated with the expansion of the Dermagraft
Joint Venture (see Note 2 to the consolidated financial statements), partially
offset by the use of cash to fund operations, to support the Dermagraft and
Cartilage Joint Ventures, for capital expenditures and the payment of debt.
Accrued expenses at March 31, 1999 increased from year end 1998 as a result of
accruals for clinical studies and rent. Deferred revenue as of March 31, 1999
reflects the portion of the $15 million payment related to the expansion of the
Dermagraft Joint Venture yet to be recognized ( Notes 1 and 2 to the
consolidated financial statements). Preferred stock at March 31, 1999 reflects
the private placement of the Convertible Series B Preferred Stock in July 1998.
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 currently 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 is approximately $175,000 and $100,000, respectively, exclusive of
internal manpower costs. These estimated 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 which still need to be upgraded.
These upgrades should be in place by mid-year 1999 and 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 by mid-year 1999 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 will be
made to identify and correct those that are not Y2K compliant. The Company
expects to complete Phase II by mid-year 1999.
The Company has not yet completed its formal contingency plan relative to
undetected Y2K problems; however, 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
-13-
<PAGE>
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.
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 March 31,
1999.
-14-
<PAGE>
PART II - OTHER INFORMATION
---------------------------
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Company held a Special Meeting of the Stockholders of Advanced Tissue
Sciences, Inc. on February 16, 1999, such meeting having been adjourned from
January 27, 1999 in order to obtain a quorum. During the Special Meeting the
Company's stockholders approved the following proposals:
1) the issuance by the Company of shares of Common Stock upon conversion of,
or as dividends on, its Series B Convertible Preferred Stock to comply
with certain rules of the Nasdaq Stock Market; and
2) to amend the Company's Restated Certificate of Incorporation to increase
the number of authorized shares of Common Stock, $.01 par value per share,
from 100,000,000 shares to 125,000,000 shares.
With respect to Proposal 1, 19,692,798 shares were voted in favor of the
proposal, 2,073,611 shares were opposed and 402,569 shares abstained.
Concerning Proposal 2, 20,180,812 shares were voted in favor of the proposal,
2,233,714 shares were opposed and 361,432 shares abstained.
ITEM 5 - FACTORS THAT MAY AFFECT FUTURE RESULTS
This Quarterly Report on Form 10-Q includes a number of forward-looking
statements that involve risks and uncertainties within the meaning of the
Securities Act of 1933 and the Securities Exchange Act of 1934, including,
without limitation, those relating to strategic alliances (including potential
milestone payments and revenues from joint ventures), the use of working
capital, the sufficiency and availability of funds to support operations,
additional clinical trials, Y2K readiness and commercialization of the Company's
products.
In particular, the Company will need to successfully complete an additional
controlled clinical trial of Dermagraft in the treatment of diabetic foot ulcers
and submit a revised premarket approval application to the FDA. No assurance
can be given that the Company will successfully complete the clinical trial, the
clinical trial will be completed within any specific timeframe or the Company
will obtain FDA or other regulatory approvals of Dermagraft (or that any such
approvals will be obtained on a timely basis). In addition, there can be no
assurance the Company can successfully scale up manufacturing processes, launch
its products within reasonable timeframes, obtain reimbursement for, or
successfully commercialize any such products. Further, there can be no
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
the Company.
These and other risks are detailed in the Company's publicly available filings
with the Securities and Exchange Commission including the Company's Annual
Report on Form 10-K for the year ended December 31, 1998. Actual results may
differ materially from those currently anticipated as a result of such risks.
ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
Exhibit
No. Title Method of Filing
------- --------- ----------------
27 Financial Data Schedule Filed With Electronic
Copy Only
(b) Reports on Form 8-K - None
-15-
<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: May 13, 1999 /s/ Arthur J. Benvenuto
---------------- ---------------------------------
Arthur J. Benvenuto
Chairman of the Board and
Chief Executive Officer
Date: May 13, 1999 /s/ Michael V. Swanson
---------------- ----------------------------------
Michael V. Swanson
Vice President, Finance and
Administration
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This schedule contains summary financial information extracted from the
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entirety by reference to such financial statements.
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