-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, FwwEpyXjDqJ7t8zjLI6+HwKt+JFZGmXXFTBeMOuLHeoVEE65LBHvt04YLY/3yumD GFc7gy3zAvg5N9bO1btXrw== 0000829549-01-500007.txt : 20010511 0000829549-01-500007.hdr.sgml : 20010511 ACCESSION NUMBER: 0000829549-01-500007 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 1 CONFORMED PERIOD OF REPORT: 20010331 FILED AS OF DATE: 20010510 FILER: COMPANY DATA: COMPANY CONFORMED NAME: ADVANCED TISSUE SCIENCES INC CENTRAL INDEX KEY: 0000829549 STANDARD INDUSTRIAL CLASSIFICATION: BIOLOGICAL PRODUCTS (NO DIAGNOSTIC SUBSTANCES) [2836] IRS NUMBER: 141701513 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 000-16607 FILM NUMBER: 1627477 BUSINESS ADDRESS: STREET 1: 10933 N TORREY PINES RD CITY: LA JOLLA STATE: CA ZIP: 92037 BUSINESS PHONE: 6197137300 MAIL ADDRESS: STREET 1: 10933 NORTH TORREY PINES ROAD STREET 2: 10933 NORTH TORREY PINES ROAD CITY: LA JOLLA STATE: CA ZIP: 92037 FORMER COMPANY: FORMER CONFORMED NAME: MARROW TECH INC DATE OF NAME CHANGE: 19911230 10-Q 1 q13-01.txt FORM 10-Q 3/31/01 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 Exchange Act of 1934 For the quarterly period ended March 31, 2001 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 May 4, 2000 was 64,203,358. ADVANCED TISSUE SCIENCES, INC. FORM 10-Q FOR THE QUARTER ENDED March 31, 2001 INDEX Part I - Financial Information Page - ------------------------------ ---- Item 1 - Financial Statements - ----------------------------- Introduction to the Financial Statements..................... 1 Consolidated Balance Sheets - March 31, 2001 and December 31, 2000....................... 2 Consolidated Statements of Operations - Three Months Ended March 31, 2001 and 2000................. 3 Consolidated Statements of Cash Flows - Three Months Ended March 31, 2001 and 2000................. 4 Notes to the Consolidated Financial Statements............... 5-7 Item 2 - Management's Discussion and Analysis of Financial Condition and Results of Operations........................ 8-12 Item 3 - Quantitative and Qualitative Disclosures About Market Risk................................................ 12 Part II - Other Information - --------------------------- Item 5 - Other Information......................................... 13-19 Item 6 - Exhibits and Reports on Form 8-K.......................... 20 Signatures............................................................ 20 PART I - FINANCIAL INFORMATION ITEM 1 - Financial Statements INTRODUCTION TO THE FINANCIAL STATEMENTS The financial statements have been prepared by Advanced Tissue Sciences, Inc. 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 under such rules and regulations. We believe that the disclosures are adequate to make the information presented not misleading when read together with the financial statements and the notes included in our Annual Report on Form 10-K, for the year ended December 31, 2000. Results for the interim periods are not necessarily indicative of results to be expected for the full year. Dermagraft(R) and NouriCel(TM) are our trademarks. TransCyte(R) is a registered trademark of our joint venture partner, Smith & Nephew. This Form 10-Q may also include trademarks and trade names owned by other parties, and all other trademarks and trade names mentioned in this Form 10-Q are the property of their respective owners. 1 ADVANCED TISSUE SCIENCES, INC. CONSOLIDATED BALANCE SHEETS (Dollars in Thousands, Except Per Share Amounts) March 31, December 31, 2001 2000 ------------ ------------ ASSETS (Unaudited) Current assets: Cash and cash equivalents $ 17,685 $ 24,197 Short-term investments 2,473 6,854 Receivable from joint ventures 2,264 1,474 Inventory 6,640 5,773 Other current assets 2,260 1,814 ---------- --------- Total current assets 31,322 40,112 Property - net 12,958 13,681 Patent costs - net 2,360 2,320 Other assets 2,847 2,993 ---------- --------- Total assets $ 49,487 $ 59,106 ========== ========= LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable $ 658 $ 1,075 Payable to joint ventures 291 565 Accrued expenses 4,824 5,391 Current portion of long-term debt and capital lease obligations 7,992 7,999 ---------- --------- Total current liabilities 13,765 15,030 Long-term debt and capital lease obligations 5,760 6,400 Other long-term liabilities 1,898 1,874 ---------- --------- Total liabilities 21,423 23,304 ---------- --------- Stockholders' Equity: Common Stock, $.01 par value; 125,000,000 shares authorized; 64,202,641 and 64,200,941 shares issued and outstanding at March 31, 2001 and December 31, 2000 642 642 Additional paid-in capital 301,618 301,168 Note received in connection with sale of Common Stock and deferred compensation applicable to Common Stock (1,601) (1,672) Accumulated deficit (272,594) (264,333) Accumulated other comprehensive loss (1) (3) ---------- --------- Total stockholders' equity 28,064 35,802 ---------- --------- Total liabilities and stockholders' equity $ 49,487 $ 59,106 ========== ========= See accompanying notes to the consolidated financial statements. 2 ADVANCED TISSUE SCIENCES, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (In Thousands, Except Per Share Amounts) Three Months Ended March 31, ---------------------------- 2001 2000 ------------ ------------- (Unaudited) Revenues: Product sales - Related parties $ 3,302 $ 3,622 Contracts and fees - Related parties 1,028 2,754 Others 651 1,034 ---------- ----------- Total revenues 4,981 7,410 Costs and expenses: Research and development 3,074 3,901 Cost of goods sold 3,305 3,622 Selling, general and administrative 4,036 4,615 ---------- ----------- Total costs and expenses 10,415 12,138 Loss from operations before equity in losses of joint ventures (5,434) (4,728) Equity in losses of joint ventures (2,959) (3,713) Loss from operations (8,393) (8,441) Other income (expense): Interest income and other 374 602 Interest expense (242) (460) ---------- ---------- Net loss (8,261) (8,299) Dividends on preferred stock -- (48) Net loss applicable to common stock $ (8,261) $ (8,347) ========== ========== Basic and diluted loss per common share $ (.13) $ (.14) ========== ========== Weighted average number of common shares used in computation of basic and diluted loss per common share 64,202 58,183 ========== ========== See accompanying notes to the consolidated financial statements. 3 ADVANCED TISSUE SCIENCES, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (In Thousands) Three Months Ended March 31, ---------------------------- 2001 2000 ------------ ------------- (Unaudited) Operating activities: Net loss $ (8,261) $ (8,299) Adjustments to reconcile net loss to cash used in operating activities: Depreciation and amortization 917 1,077 Compensation for services paid in stock, options or warrants 533 2,127 Equity in losses of joint ventures 2,959 3,713 Other adjustments to net loss (21) (21) Deferred revenue -- (899) Changes in assets and liabilities: Receivables from joint ventures (790) (6,348) Inventory (867) 4,125 Other current assets (446) (55) Accounts payable (417) (185) Payable to joint ventures (274) (517) Accrued expenses (567) (749) ----------- ---------- Net cash (used in) operating activities (7,234) (6,031) ----------- ---------- Investing activities: Purchases of short-term investments (2,471) (2,000) Maturities and sales of short-term investments 6,852 2,997 Acquisition of property (173) (74) Investment in joint ventures (2,918) (3,495) Distributions from joint ventures 143 591 Patent application costs (63) (110) Other long-term assets (30) (507) ----------- ---------- Net cash provided by (used in) investing activities 1,340 (2,598) ----------- ---------- Financing activities: Proceeds from borrowings -- 1,000 Payments of borrowings (647) (645) Restricted cash -- 5,000 Options and warrants exercised 5 7,583 Long-term obligations and other 24 (112) ----------- ---------- Net cash provided by (used in) financing activities (618) 12,826 Net (decrease) increase in cash and cash equivalents (6,512) 4,197 Cash and cash equivalents at beginning of period 24,197 16,091 ----------- ---------- Cash and cash equivalents at end of period $ 17,685 $ 20,288 =========== ========== See accompanying notes to the consolidated financial statements. 4 ADVANCED TISSUE SCIENCES, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) NOTE 1 - BASIS OF PRESENTATION The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three-month period ended March 31, 2001 are not necessarily indicative of the results that may be expected for the year ending December 31, 2001. The balance sheet at December 31, 2000 has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. For further information, refer to the consolidated financial statements and footnotes included in our Annual Report on Form 10-K for the year ended December 31, 2000. The consolidated financial statements include the accounts of Advanced Tissue Sciences, its wholly owned subsidiaries and DermEquip, L.L.C., a limited liability company owned jointly with Smith & Nephew. DermEquip is a special purpose entity established to finance an expension of our manufacturing facility. All intercompany accounts and transactions have been eliminated. Our other interests in joint ventures with Smith & Nephew are accounted for under the equity method. NOTE 2 - SMITH & Nephew Joint Ventures In 1994, we entered into a joint venture with Smith & Nephew plc for the development of tissue-engineered cartilage for orthopedic applications, the NeoCyte Joint Venture. In 1996, we entered into a separate agreement with Smith & Nephew to form the Dermagraft Joint Venture for the worldwide commercialization of Dermagraft for the treatment of diabetic foot ulcers. In January 1998, we agreed with Smith & Nephew to expand the Dermagraft Joint Venture to include venous ulcers, pressure ulcers, burns and other skin tissue wounds. The Dermagraft Joint Venture agreement was restructured in 2000. The results of operations of the joint ventures for the three months ended March 31, 2001 and 2000 are as follows (in thousands): Three Months Ended March 31, ---------------------------- 2001 2000 ------------ ------------- Dermagraft Joint Venture Net sales $ 904 $ 732 Cost of goods sold 3,217 2,924 Other costs and expenses 3,124 3,550 Net loss (5,437) (5,741) NeoCyte Joint Venture Costs and expenses $ 277 $ 1,443 Net loss (277) (1,443) 5 NOTE 3 - INVENTORIES Inventories consist of the following components as of March 31, 2001 and December 31, 2000 (in thousands): March 31, December 31, 2001 2000 ------------ ------------- Raw materials and supplies $ 5,086 $ 5,021 Work-in-process 980 683 Finished goods 574 69 ----------- ----------- $ 6,640 $ 5,773 =========== =========== NOTE 4 - CAPITAL STOCK In May 1999, our Chairman and Chief Executive Officer exercised an employee stock option. The purchase price was paid through the issue of an interest-bearing, full recourse promissory note. In July 1999, we extended the repayment terms on the note. As a result of the extension, the stock options exercised through the issuance of the note were accounted for as variable stock options which could result in significant increases and decreases in compensation expense subject to variability in our stock price. In September 2000 the outstanding principal and interest of $1,265,000 was repaid by our Chairman and Chief Executive Officer and we guaranteed a personal loan obtained by the Chairman and Chief Executive Officer from a third party, for a like amount. The third party loan was collateralized by the shares exercised through the stock options, and its maintenance was dependent upon our share price maintaining a certain value. Following a decline in our share price, in October 2000 we honored our guarantee to the third party and re-established a note from our Chairman and Chief Executive Officer. The note receivable and accrued interest of approximately $1.3 million at March 31, 2001 and at December 31, 2000, are included in stockholders' equity in the accompanying balance sheets. NOTE 5 - BASIC AND DILUTED LOSS PER SHARE Basic earnings per share are determined based on the weighted average number of shares outstanding during the period. Diluted earnings per share include the weighted average number of shares outstanding and give effect to potentially dilutive common shares such as options and warrants outstanding. Both the basic and diluted loss per common share for the three month periods ended March 31, 2001 and 2000 are based on the weighted average number of shares of our common stock outstanding during the periods. Potentially dilutive securities include options, warrants and restricted stock outstanding and debt and convertible preferred stock, however, such securities have not been included in the calculation of the diluted loss per share as their effect is antidilutive. Since such securities are antidilutive, there is no difference between basic and diluted loss per share for any of 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, 2000 includes dividends of $48,000 accrued on our Convertible Series B Preferred Stock during the same period. There were no such dividends accrued or paid in the three months ended March 31, 2001. NOTE 6 - RELATED PARTY TRANSACTIONS During the three month periods ended March 31, 2001 and 2000, we performed services for the Dermagraft and NeoCyte Joint Ventures and manufactured products for the Dermagraft Joint Venture to sell to customers or for use in clinical trials as described below. We have a fifty percent interest in each of the Dermagraft and NeoCyte Joint Ventures. Dermagraft Joint Venture - ------------------------ Product sales to related parties includes products sold to the Dermagraft Joint Venture. In addition, we recognize amounts in contract revenues for research and development, marketing and other activities performed for the Joint Venture. During the three months ended March 31, 2001 and 2000 such amounts totaled (in thousands): March 31, March 31, 2001 2000 --------- --------- Products sold to the Dermagraft Joint Venture $ 3,302 $ 3,622 Contract Revenues for activities performed $ 887 $ 1,792 6 As a purpose of the Dermagraft Joint Venture is to share the costs of manufacturing Dermagraft and TransCyte, product sales to the Dermagraft Joint Venture reflect our cost of goods sold for such products including period costs. 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 customers. During the three months ended March 31, 2001 and 2000, such write-downs by the Dermagraft Joint Venture totaled (in thousands): March 31, March 31, 2001 2000 --------- --------- Dermagraft Joint Venture inventory write-downs $ 2,511 $ 2,128 NeoCyte Joint Venture - --------------------- We recognized amounts in contract revenues for research and development activities performed for the NeoCyte Joint Venture. During the three months ended March 31, 2001 and 2000, such amounts totaled (in thousands): March 31, March 31, 2001 2000 --------- --------- Contract Revenues for activities performed for NeoCyte Joint Venture $ 141 $ 962 Our share of the costs incurred by us and charged to the Dermagraft and NeoCyte Joint Ventures are reflected in the equity in losses of joint ventures in the accompanying statement of operations. For the three months ended March 31, 2001 and 2000, such costs charged totaled (in thousands): March 31, March 31, 2001 2000 --------- --------- Charged to Dermagraft and NeoCyte Joint Ventures $ 2,186 $ 2,993 7 ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS This report may contain predictions, estimates and other forward-looking statements that involve a number of risks and uncertainties. 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 report. Advanced Tissue Sciences, Inc. is engaged in the development and manufacture of human-based tissue products for tissue repair and transplantation using our proprietary tissue engineering technology. Our leading products are tissue-engineered skin products, TransCyte for the temporary covering of severe and partial-thickness burns, and Dermagraft for the treatment of severe skin ulcers. In addition, we are focusing our resources on the development of tissue-engineered products for other wound care, aesthetic and reconstructive, cardiovascular and orthopedic applications. These other applications include human collagen and our nutrient solution, NouriCel, in development for aesthetic and reconstructive applications. Since 1996 we have shared in a joint venture, the Dermagraft Joint Venture, with Smith & Nephew plc for the worldwide commercialization of Dermagraft in the treatment of diabetic foot ulcers. In 1998, we 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 TransCyte for full and partial-thickness burns. We received marketing approval for TransCyte in the United States from the FDA in 1997, as a temporary covering for severe, full-thickness, or third degree burns and for partial-thickness, or second degree burns. Until September 1998, we marketed TransCyte for burns through a direct sales force in the United States, however, subsequent to the expansion of the Dermagraft Joint Venture in 1998, TransCyte was and will continue to be marketed in the United States and throughout the rest of the world for burn and other wound care applications under the Dermagraft Joint Venture. Dermagraft for the treatment of diabetic foot ulcers was approved for sale in Canada and was introduced by the Dermagraft Joint Venture in the United Kingdom and several other European countries in 1997. We also submitted a Pre-market Approval, or PMA, application to the FDA for approval to market Dermagraft for the treatment of diabetic foot ulcers in the United States. In 1998 the FDA decided the PMA application was not approvable without supportive data from an additional controlled clinical trial. The additional clinical trial began in late 1998, and in February 2000, the FDA approved an application for an amendment to the Investigational Device Exemption, or IDE, for the trial. Based on the data from the interim analysis, which we announced in December 1999, the IDE was amended to revise the enrollment criteria and the statistical plan for data analysis. The amended IDE allowed for the modification of the study inclusion criteria to limit future enrollment to patients with ulcers of greater than six weeks duration. In addition, the amended statistical plan allowed us to integrate the interim analysis data from the clinical trial with additional data generated subsequently from patients with ulcer duration of greater than six weeks. By August of 2000, statistical significance was reached for the primary endpoint in the additional trial in Dermagraft for the treatment of diabetic foot ulcers and a PMA application was submitted to the FDA. The data demonstrated that in difficult-to-heal chronic ulcers, with duration greater than six weeks at the time of screening, Dermagraft healed significantly more ulcers than the control treatment. In February 2001, we received a letter from the FDA stating that the FDA had completed its initial review of the PMA application and requesting clarification and additional information. We are continuing to work with the FDA to provide the additional information requested. In addition to the clinical trial, since October 1998 Dermagraft has been used in the treatment of diabetic foot ulcers in the United States after the FDA approved our application for a Treatment Investigational Device Exemption, or Treatment IDE, allowing us 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 regulatory provision for devices that permits companies to make available promising new products to patients with serious diseases for which there is no satisfactory alternative, and also allows companies to recover the costs of manufacturing and distributing the product. As a result of delays in the commerical introduction of Dermagraft in the United States, in 2000 we agreed with Smith & Nephew to restructure specified payments associated with the Dermagraft Joint Venture. The FDA's request for an additional clinical trial substantially increased the partner's investments necessitating the 8 restructuring. The objective of the restructuring was to defer the potential payment of specified milestones by Smith & Nephew while providing us a royalty stream and an opportunity to increase our long-term return from the venture. In addition to the Dermagraft Joint Venture, since 1994 we have shared in a separate joint venture with Smith & Nephew, the NeoCyte Joint Venture, for the worldwide development, manufacture and marketing of human tissue engineered cartilage for orthopedic applications. We are sharing equally with Smith & Nephew in the expenses of the joint venture. During 2000, an IDE was submitted to the FDA requesting approval to begin pilot human clinical studies of human tissue engineered cartilage. The FDA raised agency jurisdictional issues as to whether or not this product should be regulated as a medical device or biologic, as well as questions about the preclinical studies. We continue to work closely with the FDA to address these issues. In May 1999, we entered into a strategic alliance with Inamed Corporation for the development and marketing of several of our human-based, tissue-engineered products for aesthetic and certain reconstructive applications. Under the related agreements, Inamed licensed rights to further develop, manufacture and sell certain of our tissue-engineered products such as human collagen for use in wrinkle correction and as a bulking agent for the treatment of urinary incontinence, cartilage for plastic and reconstructive surgery, and extracellular matrix for use in breast reconstruction and other soft tissue augmentation. We received certain payments in 1999 and will be entitled to royalties on the future sales of our tissue-engineered products by Inamed. We will be responsible for the development of the products and the related manufacturing processes while Inamed will be responsible for clinical and regulatory activities. We, or an affiliate, have the right to manufacture the products developed for Inamed. In September 2000, we signed a license and supply agreement with Biozhem Cosmeceuticals, Inc. Under the agreement, we granted a license to use and will sell NouriCel to Biozhem. NouriCel is a patent-pending by-product of our tissue engineering processes, to be used in Biozhem's branded skin care products. As well as a selling price for sales of NouriCel to Biozhem, we will be entitled to specified milestone payments and future royalties on sales of Biozhem's products in the skin care marketplace. Additionally, we were granted warrants to purchase Biozhem common stock at specified prices in future time periods. In October 2000, we signed a license and supply agreement with SkinMedica, Inc. Under this agreement, we granted a license to use and will sell NouriCel to SkinMedica, to be used in SkinMedica's branded skin care products sold through a network of dermatologists and plastic surgeons. We will be entitled to a selling price for sales of NouriCel to SkinMedica and to specified milestone payments and future royalties on sales of SkinMedica's products in the skin care marketplace. We were also granted warrants to purchase SkinMedica common stock at specified prices in future time periods. In September 2000, we were awarded a $2 million Advanced Technology Program grant from the National Institute of Standards and Technology, or NIST, for development of a tissue-engineered Ischemic Repair Device to induce vascularization of and restore function to tissues and organs with reduced blood supplies, or ischemia. The grant commenced in 2000 and is payable over three years. This grant follows a $2 million award in October 1997 from NIST to fund collaborative cardiovascular research with the University of California, San Diego that began in 1998 and will be completed in the second quarter of 2001. Also in September 2000, we were awarded a grant in excess of $800,000 from the National Institutes of Health and the National Institute of Dental and Craniofacial Research to develop tissue-engineered cartilage for the treatment of temporomandibular disorders. Payments under the grant are payable over four years. We have incurred and expect to continue to incur, either directly or through the Dermagraft Joint Venture, substantial expenditures in support of the commercialization, development, clinical trials and post-market studies of TransCyte and Dermagraft for burn and skin ulcer applications, for manufacturing systems and in advancing other applications of our core technology. We also expect to incur additional costs for the development of products and manufacturing processes under our strategic alliance with Inamed, additional costs for the development and clinical trials of tissue-engineered cartilage products through the NeoCyte Joint Venture, costs for products we may develop for cardiovascular applications, and costs which may be associated with other products which we may undertake from time to time. Our agreements with our current strategic alliance partners are structured to share some or all of these costs as well as to provide us with income from milestone payments, royalties and licensing fees for the respective products. 9 Results of Operations - --------------------- Product sales were $3,302,000 for the three months ended March 31, 2001, which compared to sales of $3,622,000 in the corresponding period of 2000. Product sales are to related parties and reflect sales of Dermagraft and TransCyte to the Dermagraft Joint Venture at cost. Revenues from contracts and fees were $1,679,000 for the three months ended March 31, 2001, compared to $3,788,000 for the corresponding period of 2000. This decrease is partially due to the recognition of $899,000 in the three months ended March 31, 2000 in licensing payments previously received from Inamed in 1999. No such payments were recognized in 2001. Other contract and fee revenues are principally for research and development activities performed for the Dermagraft and NeoCyte Joint Ventures. Revenues for research and development were reduced by $1,726,000 in the first quarter of 2001 compared to 2000, primarily due to the completion of the additional clinical trial of Dermagraft in the treatment of diabetic foot ulcers. An increase of $516,000 in grant revenue partially offset the decrease in revenue from research and development activities performed for the Joint Ventures. Research and development expenditures decreased to $3,074,000 in the three months ended March 31, 2001, from $3,901,000 in the corresponding period of 2000. The decrease primarily reflects expenditure reductions of $763,000 due to the completion of the additional clinical trial of Dermagraft in the treatment of diabetic foot ulcers and a decrease of $902,000 in research and development expenditures for the NeoCyte Joint Venture. These reductions are partially offset by an increase of $431,000 in research and development costs for work performed under research grants and $327,000 related to the development of cosmeceutical products. Cost of goods sold of $3,305,000 for the three months ended March 31, 2001 decreased from $3,622,000 in the corresponding period of 2000. Cost of goods sold represents the cost of TransCyte and Dermagraft sold to the Dermagraft Joint Venture. As a result of the FDA's decision to require additional clinical data for Dermagraft in the treatment of diabetic foot ulcers, we are continuing to incur significant costs associated with excess production capacity within our manufacturing facility. 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 period ended March 31, 2001 such write-downs were $2,511,000 compared to $2,128,000 in the corresponding period of 2000. To the extent that we do not sell such products to the Dermagraft Joint Venture, we would be required to write such inventories down to net realizable value. Selling, general and administrative costs were $4,036,000 for the three months ended March 31, 2001 as compared to $4,615,000 in the corresponding period of 2000. During the three month period ended March 31, 2001, we recorded expense of $444,000, compared to $1,991,000 in the corresponding period of 2000, related to compensation expense for a variable stock option. These amounts are non-cash transactions and relate to stock options exercised in 1995 by our Chairman and Chief Executive Officer for which we issued a loan that is being accounted for as a variable stock option, which can result in significant increases and decreases in compensation expense subject to the variability of our stock price. The decrease in non-cash expense is offset by an increase of $968,000 in other selling, general and administrative costs for the three months ended March 31, 2001 compared to the same period in 2000. This increase is primarily related to salary expenses and one-time recruitment and relocation costs of $609,000 resulting from senior management additions that were made in 2001 and the fourth quarter of 2000. In addition, outside service costs for consultants, legal services and accounting services increased by $202,000 as a result of planning and business development initiatives that were undertaken in the first quarter of 2001. These initiatives and their related costs are expected to continue for the balance of 2001. Equity in losses of joint ventures were $2,959,000 for the three month period ended March 31, 2001 and $3,713,000 for the corresponding period in 2000. These amounts represent our share of losses of the Dermagraft and NeoCyte Joint Ventures. The joint venture losses were lower in 2001 due to a $1,893,000 savings in research and development costs. This reduction in research and development costs is primarily associated with the completion of the additional clinical trial of Dermagraft in the treatment of diabetic foot ulcers and decreased spending by the NeoCyte Joint Venture. Higher selling and marketing costs partially offset the decrease in research and development costs. 10 The equity in losses of joint ventures includes costs incurred by us and charged to the Dermagraft and NeoCyte Joint Ventures totaling $2,186,000 for the three-month period ended March 31, 2001 and $2,993,000 for the three-month period ended March 31, 2000. Interest income and other was $374,000 in the three months ended March 31, 2001, as compared to $602,000 in the corresponding period of 2000. The decrease primarily results from the reduction of interest earning assets reflected in the consolidated balance sheets. Interest expense was $242,000 in the three months ended March 31, 2001 as compared to $460,000 in the corresponding period of 2000. The decrease in interest expense primarily reflects the repayment of a $10 million loan from Smith & Nephew in September 2000, partially offset by $5.4 million of borrowings from the Dermagraft Joint Venture. Liquidity and Capital Resources - ------------------------------- To date, we have funded our operating and capital expenditures primarily through the sale of equities, contract revenues, funding from strategic partners, government grants, product sales and lease financing transactions. Cash and cash equivalents at March 31, 2001 decreased by approximately $6.5 million from December 31, 2000. Major outflows included the use of $7.2 million to fund operations, a net investment of $2.8 million to support the Dermagraft and NeoCyte Joint Ventures, $600,000 for payment of debt and $200,000 for capital expenditures. These outflows have been partially offset by $4.3 million in net proceeds from short-term investments. Receivables from joint ventures from December 31, 2000 to March 31, 2001 increased by $790,000, primarily as a result of the timing of payments. Inventory increased by $867,000, largely as a result of collagen production in 2001. Long-term debt at March 31, 2001 decreased by $647,000 from December 31, 2000, primarily reflecting payments made under the Chase loan, a loan used by DermEquip to purchase manufacturing assets. The timing of payments made to the Dermagraft Joint Venture reduced payables by joint ventures by $274,000 during the first quarter of 2001. We expect to continue to expend cash as we incur substantial research and development expenses, additional costs in support of clinical trials, general and administrative costs in support of product commercialization, and expenditures for capital equipment and patents. In addition, under the terms of our agreements with Smith & Nephew, we have agreed to fund our share of the costs of the Dermagraft and NeoCyte Joint Ventures. We have also agreed to fund specified costs to develop products, and related manufacturing processes, which will be marketed by Inamed under the terms of our licensing agreement. These uses of cash are expected to be only partially offset by revenues received from the Dermagraft and NeoCyte Joint Ventures with Smith & Nephew, from the Inamed alliance and from other potential revenue sources. If, for any reason, Smith & Nephew were to terminate the Dermagraft Joint Venture or, to a lesser extent, the NeoCyte Joint Venture, we would experience a substantial increase in the need for and use of our cash to support the commercialization and manufacture of Dermagraft and TransCyte, or the development of orthopedic cartilage products. Our cash requirements are dependent upon a number of factors, including the achievement and timing of regulatory approvals and third-party reimbursement, the timing and expense of preclinical and clinical studies, sales and marketing efforts by our partners, new technological innovations, market acceptance of our products and potential products and the establishment of new strategic alliances. We currently believe we have sufficient funds to support our planned operations into the fiscal year 2002. The further development of our technology and commercialization of our products, as well as any further development of manufacturing capabilities or the establishment of any additional sales, marketing and distribution capabilities, will require the commitment of substantial funds. Sources of funds may include payments from alliances with Smith & Nephew and Inamed. We may also pursue additional public or private offerings of debt or equity securities. Additional funding could potentially be obtained through new strategic alliances or other collaborative arrangements, or through the extension of existing strategic alliances. However, funds from the sources outlined above may not be available when needed or on terms favorable to us, under existing arrangements 11 or otherwise, and we may not be successful in entering into any other strategic alliances or collaborative arrangements. We continually review our product development activities in an effort to allocate available resources to those products we believe have the greatest commercial potential. Factors considered by us in determining the products to pursue include projected market demand, potential for regulatory approval and reimbursement, if required, 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 that we consider relevant, we may from time to time reallocate resources among product development activities. Additions to products under development or changes in products being pursued can substantially and rapidly change our funding requirements. ITEM 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK We are exposed to changes in interest rates primarily from our long-term debt arrangements and, secondarily, our investments in certain securities. Under our current policies, we do not use interest rate derivative instruments to manage exposure to interest rate changes. We believe 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 our interest sensitive financial instruments at March 31, 2001. 12 PART II - OTHER INFORMATION ITEM 5 - OTHER INFORMATION FACTORS THAT MAY AFFECT FUTURE RESULTS The following is a summary description of some of the many risks we face in our business. You should carefully review these risks in evaluating our business and the businesses of our subsidiaries. You should also consider the other information described in this report. RISKS RELATED TO OUR BUSINESS - ----------------------------- WE HAVE A HISTORY OF LOSSES AND MAY NOT BECOME PROFITABLE. To date, we have experienced significant operating losses in funding the research, development, testing and marketing of our products and expect to continue to incur substantial operating losses. To March 31, 2001, we had incurred cumulative net operating losses of $272.6 million. Our ability to achieve profitability depends in part upon our ability to successfully manufacture and market Dermagraft and TransCyte for skin ulcers and burns, and to manufacture collagen and our nutrient solution for aesthetic applications. We may never achieve a profitable level of operations or even if we achieve profitability, we may not be able to sustain it on an ongoing basis. IF OUR OPERATING RESULTS FLUCTUATE SIGNIFICANTLY, IT COULD MATERIALLY ADVERSELY AFFECT YOUR INVESTMENT AND OUR ABILITY TO RAISE ADDITIONAL CAPITAL. We expect our operating results to fluctuate from quarter to quarter based upon when we incur expenses and receive revenues from product sales, contract fees, milestones and other fees. We believe some of these fluctuations may be significant, and you could lose all or some of your investment. IF OUR PRODUCTS FAIL IN CLINICAL STUDIES, WE WILL BE UNABLE TO OBTAIN FDA APPROVAL AND WILL NOT BE ABLE TO SELL THOSE PRODUCTS. To sell our products that are under development, and our existing products for additional applications, we must receive regulatory approvals. To obtain those approvals, we must conduct clinical studies demonstrating that our products are safe and effective, which can be expensive and time-consuming. We may be unable to obtain FDA approval on a timely basis, if at all. If we cannot obtain FDA approval for a product or any additional application of a product, that product cannot be sold and revenues will suffer. Early in 1998, an FDA Advisory Panel recommended the FDA approve Dermagraft for marketing in the United States for the treatment of diabetic foot ulcers. The Advisory Panel's recommendation included certain conditions we would have needed to satisfy after the commercial introduction of Dermagraft. However, in June 1998, the FDA requested we complete an additional controlled clinical trial to support our application for approval to market Dermagraft for the treatment of diabetic foot ulcers. The clinical trial began in late 1998 and the results of a planned interim analysis of data from this trial were announced in December 1999. These data showed that, although statistical significance was not achieved at the interim analysis, Dermagraft was healing more ulcers than the control treatment in those diabetic foot ulcers having a duration of greater than six weeks. In February 2000, the FDA approved an application for an amendment to the Investigational Device Exemption, or IDE, for the clinical trial of Dermagraft in the treatment of diabetic foot ulcers. Based on the data presented to the FDA in December 1999, the IDE has been amended to revise the enrollment criteria and the statistical plan for data analysis. Enrollment in this additional clinical trial has been completed and we submitted our PMA application for approval of Dermagraft for the treatment of diabetic foot ulcers to the FDA in August 2000. In February 2001, we received a letter from the FDA stating that the FDA has completed its initial review of the PMA application and requesting clarification and additional information. We are continuing to work with the FDA to provide the additional information requested. However, the FDA may never approve our application. 13 Dermagraft may not be successful in future clinical trials. Current or future clinical studies of Dermagraft or our other products may be delayed or halted for various reasons, including: o the product is not effective, or physicians think that it is not effective; o patients experience severe side effects during treatment; o patients do not enroll in the study at the rate we expect; or o product supplies are not sufficient to treat the patients in the study. In addition, the FDA and foreign regulatory authorities have substantial discretion in the approval process. The FDA and foreign regulatory authorities may not agree that we have demonstrated that Dermagraft, or any of our other products, are safe and effective after we complete clinical trials. WE WILL NEED ADDITIONAL FUNDS TO SUPPORT OPERATIONS. IF WE ARE UNABLE TO OBTAIN THEM, WE WOULD BE UNABLE TO COMPLETE OUR PRODUCT DEVELOPMENT PROGRAMS AND WOULD HAVE TO REDUCE OR CEASE OPERATIONS, OR ATTEMPT TO SELL SOME OR ALL OF OUR OPERATIONS OR TO MERGE WITH ANOTHER ENTITY. The further development of our technology and products as well as any further development of manufacturing capabilities or the establishment of additional sales, marketing and distribution capabilities will require the commitment of substantial funds. Our existing working capital will not be sufficient to meet our needs. Potential sources of additional funds include payments from our alliances with Smith & Nephew and Inamed Corporation. If, for any reason, Smith & Nephew were to terminate the Dermagraft Joint Venture or, to a lesser extent, the NeoCyte Joint Venture, we would experience a substantial increase in the need for and use of our working capital to support the commercialization and manufacture of our Dermagraft and TransCyte products or the development of our orthopedic cartilage products, and we would need to pursue other means to obtain funds, such as public or private offerings of debt or equity securities, collaborative agreements or extensions of existing arrangements. We may not satisfy the milestones for additional funds under the joint ventures with Smith & Nephew or the alliance with Inamed. We also may not be able to obtain adequate funds under other existing or future arrangements when such funds are needed or, if available, on terms acceptable to us. Insufficient funds may require us to delay, scale back or eliminate certain of our research and product development programs, license third parties the right to commercialize products or technologies that we would otherwise commercialize ourselves, or attempt to merge with another entity or otherwise reduce or cease operations. OUR PRODUCTS MAY NOT BE ACCEPTED BY THE MARKET, AND MAY NOT BE SUCCESSFULLY COMMERCIALIZED BECAUSE PHYSICIANS AND PATIENTS MAY NOT PURCHASE OR USE THEM. Our products are based on new and innovative technologies and the medical community or the general population may not broadly purchase or use our products as alternatives to existing methods of treatment. Sales of our products may be adversely affected by: o their respective cost; o concerns related to efficacy; o the effectiveness of alternative methods of treatment; and o the insufficiency of third-party reimbursement. Any future negative events or other unfavorable publicity involving the use of our products could also adversely affect acceptance of our products. Both we and Smith & Nephew have limited direct experience marketing or obtaining third-party reimbursement for these types of products. Additionally, TransCyte, has been marketed and sold in the United States since 1997. To date it has not achieved widespread commercial acceptance in the United States. Similarly, Dermagraft has only been sold internationally and may never achieve commercial acceptance in the United States even if it receives FDA approval. 14 WE RELY ON THIRD PARTIES TO MARKET, DEVELOP AND SELL OUR PRODUCTS AND THOSE THIRD PARTIES MAY NOT PERFORM SUCCESSFULLY. OUR DEPENDENCE ON THIRD PARTIES AND OUR LACK OF SALES AND MARKETING PERSONNEL COULD LIMIT OUR ABILITY TO DEVELOP OUR PRODUCTS OR TO GENERATE REVENUES FROM PRODUCT SALES. We are relying on Smith & Nephew, Inamed Corporation and others to market our products both domestically and internationally. Our success in generating market acceptance of Dermagraft and TransCyte will depend on the marketing efforts of Smith & Nephew. Market acceptance of human collagen will depend in part on the marketing efforts of Inamed Corporation. We cannot control the amount and timing of resources that Smith & Nephew, Inamed or others may devote to marketing and selling our products. In addition, the Dermagraft and NeoCyte Joint Venture agreements provide that they may be terminated before their expiration under certain circumstances that are outside our control. If Smith & Nephew does not perform its obligations as expected or if Smith & Nephew has a strategic shift in its business focus, it would be difficult for us to successfully complete the development efforts of the Dermagraft Joint Venture and NeoCyte Joint Venture. Our failure to achieve broad use of Dermagraft for the treatment of diabetic foot ulcers and, to a lesser extent, TransCyte for burn care and human collagen for aesthetic applications, would hurt our ability to generate revenues and any future profits. To the extent that we choose not to or are unable to establish such arrangements, we would experience increased capital requirements to undertake research, development and marketing of our proposed products at our own expense. If we are unable to meet these expenses we may be unable to continue our operations. IF WE ARE UNABLE TO PROTECT OUR INTELLECTUAL PROPERTY, WE MAY BE UNABLE TO PREVENT OTHER COMPANIES FROM USING OUR TECHNOLOGY IN COMPETITIVE PRODUCTS. IF WE INFRINGE THE INTELLECTUAL PROPERTY RIGHTS OF OTHERS, WE MAY BE PREVENTED FROM DEVELOPING OR MARKETING OUR PRODUCTS. Our ability to compete effectively will depend, in part, on our ability to maintain the proprietary nature of our technology and manufacturing processes. Our competitors may develop products that are similar to or the same as our products and market those products after our patents expire, or may design around our existing patents. If this happens, sales of our products would suffer and our ability to generate revenues will be severely impacted. Furthermore, patents may be issued to others that prevent the manufacture or sale of our products. We may have to pay significant fees or royalties to license those patents to continue marketing our products. This would cause any future profits on sales of our products to decline. Our dependence upon having exclusive rights to the technology covered under our owned or licensed patents and patent applications is subject to the following risks: o applications may not result in issued patents; o current or future issued or licensed patents, trade secrets or know-how may not afford protection against competitors with similar technologies or processes; o any patents issued may be infringed upon or be designed around by others, or be challenged and invalidated; and o others may independently develop technologies or processes that are the same as or substantially equivalent to ours. In addition to patent protection, we also rely on trade secrets, know-how and technology advances. We enter into confidentiality agreements with our employees and others, but these agreements may not be effective in protecting our proprietary information. Others may independently develop substantially equivalent information or obtain access to our know-how. Litigation, which is very expensive, may be necessary to enforce or defend our patents or rights and may not end favorably for us or, even if successful, may consume enormous financial and management resources. Any of our licenses, patents or other intellectual property may be challenged, invalidated, canceled, infringed or circumvented and may not provide any competitive advantage to us. 15 IF THE THIRD-PARTY SUPPLIERS THAT SUPPLY THE MATERIALS NECESSARY TO MANUFACTURE OUR PRODUCTS DO NOT SUPPLY QUALITY MATERIALS IN A TIMELY MANNER, IT MAY DELAY OR IMPAIR OUR ABILITY TO DEVELOP AND COMMERCIALIZE PRODUCTS ON A TIMELY AND COMPETITIVE BASIS OR ADVERSELY AFFECT OUR POTENTIAL FUTURE PROFITABILITY. Although most of the raw materials used in the manufacture of our Dermagraft and TransCyte products are available from more than one supplier, changes in certain critical components could cause the FDA to require us to prove equivalency of the materials or potentially to modify or perform additional clinical trials for our Dermagraft and TransCyte products, which could have the effect of restricting our ability to commercialize our products. The mesh framework used by us in the manufacture of Dermagraft is available from only one FDA-qualified manufacturing source. Similarly, the synthetic mesh framework used by us in the manufacture of TransCyte is available from only one FDA-qualified manufacturing source. Because the FDA approval process requires manufacturers to specify their proposed suppliers of active ingredients and certain component parts and packaging materials in their applications, FDA approval of a new supplier would be required if these materials become unavailable from the current suppliers. Interruptions in supplies for the manufacture of our Dermagraft and TransCyte products may occur in the future and we may have to obtain substitute vendors for these materials. Any significant supply interruption would delay our clinical trials as well as our product development and marketing programs. In addition, an uncorrected impurity or supplier's variation in a raw material, either unknown to us or incompatible with our manufacturing process, could prevent or delay our ability to manufacture products. These delays would have an adverse effect on our revenues. IF OUR PRODUCTS THAT ARE IN AN EARLY STAGE OF DEVELOPMENT ARE NEVER SUCCESSFULLY COMMERCIALIZED, WE MAY NOT HAVE REVENUES TO CONTINUE OPERATIONS. We have products that are in an early stage of development. To date, only TransCyte has been approved for commercial sale and only Dermagraft has advanced to clinical trials in the United States. However, Dermagraft still requires further marketing approvals from the FDA, and all of our other products are at earlier stages of research, development and testing. These products, including additional indications for Dermagraft and TransCyte, will require significant additional research and development, as well as extensive preclinical and clinical testing. Since our products are based on innovative technologies, there are many reasons why our products may not advance beyond their early stage of development. These reasons include the possibilities that: o any or all of these products will be found to be unsafe or ineffective or otherwise fail to receive necessary regulatory approvals; o our products are uneconomical to market; o third parties may hold legal rights that preclude us from marketing such products; or o our products fail to achieve market acceptance because of competing technologies and products. RISKS RELATED TO OUR INDUSTRY - ----------------------------- IF WE FAIL TO OBTAIN REGULATORY APPROVAL TO COMMERCIALLY MANUFACTURE OR SELL ANY OF OUR PRODUCTS, OR IF APPROVAL IS DELAYED, IT COULD INCREASE THE COST OF PRODUCT DEVELOPMENT, OR ULTIMATELY PREVENT OR DELAY OUR ABILITY TO SELL OUR PRODUCTS AND GENERATE REVENUES. We and our development and commercial partners are subject to extensive government regulation. The FDA and other state and foreign regulatory authorities require rigorous preclinical testing, clinical trials and other product approval procedures for our products. Numerous regulations also govern the manufacturing, safety, labeling, storage, record keeping, reporting and marketing of our products. The process of obtaining these approvals and complying with applicable government regulations is time consuming and expensive. The FDA and other state or foreign regulatory authorities have limited experience with our technology and products. As a result, our products are susceptible to requests for clinical modifications or additional supportive data, or changes in regulatory policy, which could substantially extend the test period for our products resulting in delays or rejections. Even after substantial time and expense, we may not be able to obtain regulatory product approval by the FDA or any 16 equivalent state or foreign authorities. If we obtain regulatory product approval, the approval may limit the uses for which we may market the product. For example, in June 1998, the FDA indicated that our marketing application for Dermagraft for the treatment of diabetic foot ulcers was not approvable without supportive data from an additional clinical trial. We reached the primary endpoint in the additional clinical trial and submitted a PMA to the FDA in August, 2000, however, if we do not subsequently receive FDA approval it will prevent or at least delay sales of Dermagraft in the United States. In addition, although the FDA has classified TransCyte as a medical device, the state of California and the state of New York have notified us that we must register as a tissue bank to manufacture or distribute TransCyte in those states. Although some states do not regulate tissue banks, there are certain other states besides California and New York that do. Such states could take a position similar to California and New York with regard to the regulatory status of TransCyte. In June 1997, we submitted a petition to the FDA requesting an advisory opinion that the FDA's federal regulation of this product as a medical device preempts conflicting New York laws from regulating the product as banked human tissue. In January 2000, the FDA denied our petition to preempt applicable New York laws, determining that state legislation would prevail. In view of the FDA's decision, the Company has initiated discussions at the individual state level, beginning with the state of California in an attempt to resolve this matter. Unless the outcome of these discussions concludes otherwise, we and our customers will be subjected to a costly new layer of regulation. In addition, under the laws of some states that regulate tissue, including New York and Florida, the sale of human tissues for valuable consideration is prohibited. We are currently distributing TransCyte in California and New York under tissue banking licenses. Due to the similarities of our products, regulations applicable to TransCyte are also expected to apply to our Dermagraft product and potentially to our NeoCyte product as well. In 2000, an IDE was submitted to the FDA requesting approval to begin pilot human clinical studies using tissue-engineered cartilage for articular resurfacing of the knee joint, under the NeoCyte Joint Venture. The FDA raised agency jurisdictional issues as to whether or not this product should be regulated as a medical device or biologic, as well as questions about the preclinical studies. After regulatory approval is obtained, our product, its manufacture and related manufacturing facilities will be subject to continual review and periodic inspections. Any subsequent discovery of previously unknown problems with a product, manufacturer or facility may result in restrictions on the product or manufacturer, including withdrawal of the product from the market. For example, after inspecting the manufacturing facility early in 1998 in conjunction with our application for the approval of Dermagraft for the treatment of diabetic foot ulcers, the FDA notified us of numerous objectionable conditions under a Form FDA 483 list of observations. These observations concerned our manufacturing processes and systems for Dermagraft and TransCyte. In March 1998, the FDA issued a warning letter requiring us to investigate and correct the conditions identified by the FDA. In September 1998, we successfully completed a re-inspection by the FDA of our manufacturing facility and quality systems. However, we must continue to pass future facility inspections by the FDA and foreign regulatory authorities. Our research and development activities and operations involve the controlled use of small quantities of radioactive compounds, chemical solvents and other hazardous materials. In addition, our business involves the growth of human tissues. If an accident occurs, we could be held liable for any damages that result. In addition, these research activities and operations are subject to continual review under the Occupational Safety and Health Act, the Environmental Protection Act, the Toxic Substances Control Act, the Resource Conservation and Recovery Act and other federal, state or local laws and regulations which impact our ability to develop and market our products. HEALTHCARE REFORM MEASURES AND REIMBURSEMENT PROCEDURES MAY PREVENT US FROM OBTAINING AN ADEQUATE LEVEL OF REIMBURSEMENT FOR OUR PRODUCTS THAT IN TURN WOULD DECREASE OUR ABILITY TO GENERATE REVENUES. Our ability to commercialize products successfully will depend in part on the extent to which reimbursement for the costs of such products and related treatments will be available from government health administration authorities, private health insurers and other organizations. In the United States, government and other third-party payors are increasingly attempting to contain healthcare costs by limiting both coverage and the level of reimbursement for new products. In some cases, such payors may refuse to provide any coverage for uses of approved products for indications that the FDA has not granted marketing approval. Initiatives to reform healthcare delivery are increasing these cost containment efforts. As managed care organizations continue to 17 expand as a means of containing healthcare costs, we believe there may be attempts by such organizations to restrict the use of, delay authorization to use, or limit coverage and the level of reimbursement for, new products, such as those being developed and commercialized by us, pending completion of cost/benefit analyses of such products by those managed care organizations. Internationally, where national healthcare systems are prevalent, little, if any, funding may be available for new products, and cost containment and cost reduction efforts can be more pronounced than in the United States. Our TransCyte and Dermagraft products are novel and as such are subject to inherent uncertainty in the area of reimbursement. Adequate government or private payor coverage or levels of reimbursement may not be available for any of our products and we may not be able to maintain price levels sufficient for the realization of an appropriate return on our investment in such products. Failure to obtain sufficient coverage and reimbursement levels for uses of our products could decrease the market acceptance of such products. DISCOVERIES OR DEVELOPMENT OF NEW TECHNOLOGIES BY OUR COMPETITORS OR OTHERS MAY MAKE OUR PRODUCTS LESS COMPETITIVE OR MAKE OUR PRODUCTS OBSOLETE. The biomedical technology industry is subject to rapid, unpredictable and significant technological change. Competition from universities, research institutions and pharmaceutical, chemical and biotechnology companies is intense. Many competitors or potential competitors have greater financial resources, research and development capabilities and manufacturing and marketing experience than we do. In general, the first biomedical product to be commercialized for a particular therapeutic indication is often at a significant competitive advantage relative to later entrants to the market. Accordingly, the relative speed with which we can develop products, complete clinical trials, obtain regulatory approvals and develop commercial manufacturing capability may affect our competitive position. Other factors such as our ability to secure regulatory approval for our products, to implement production and marketing plans, and to secure adequate capital resources will also impact our competitive position. We may not have the resources to compete successfully. IF WE ARE UNABLE TO ATTRACT KEY PERSONNEL AND ADVISORS OR IF OUR CURRENT MANAGEMENT AND TECHNICAL PERSONNEL LEAVE THE COMPANY, IT MAY ADVERSELY AFFECT OUR ABILITY TO OBTAIN FINANCING OR TO DEVELOP OUR PRODUCTS. Our success will depend in large part upon our ability to attract and retain qualified scientific, administrative and management personnel as well as the continued contributions of our existing senior management and scientific and technical personnel. We face strong competition for such personnel and we may be unable to attract or retain such individuals. In particular, if we lose the services of either Arthur J. Benvenuto, our Chairman and Chief Executive Officer, or Dr. Gail K. Naughton, our President, it will limit our ability to achieve our business objectives and could make it difficult to raise additional funds or to attract partners. WE MAY NOT HAVE ADEQUATE INSURANCE AND IF WE BECOME SUBJECT TO PRODUCT LIABILITY CLAIMS, IT MAY RESULT IN REDUCED DEMAND FOR OUR PRODUCTS OR DAMAGES THAT EXCEED OUR INSURANCE LIMITATIONS. The use of any of our products, whether for commercial applications or during clinical trials, exposes us to an inherent risk of product liability claims if such products cause injury, disease or result in adverse effects. Such liability might result from claims made directly by healthcare institutions, contract laboratories or others selling or using such products. We currently maintain product liability insurance coverage; however, such insurance coverage might not be sufficient to fully cover any potential claims. Such insurance can be expensive and difficult to obtain. Adequate insurance coverage may not be available in the future at an acceptable cost, if at all, or in sufficient amounts to protect us against any such liability. Any product liability claim in excess of insurance coverage would have to be paid out of our cash reserves which would have a detrimental effect on our financial condition. DISCOVERY OF PREVIOUSLY UNKNOWN PROBLEMS WITH A PRODUCT, MANUFACTURER, OR FACILITY, COULD RESULT IN PRODUCT RECALLS OR WITHDRAWALS AND SIGNIFICANTLY REDUCE OUR RESOURCES. Our tissue repair and transplantation products are complex and must be manufactured under well-controlled and sterile conditions, in addition to meeting strict product release criteria. Any manufacturing errors or defects, or uncorrected impurity or variation in a raw material, either unknown or undetected by us, could affect the quality and safety of our products. If any of the defects were material, we could be required to undertake a market withdrawal or recall of the affected products. The cost of a market withdrawal or product recall could significantly reduce our resources. 18 ADDITIONAL RISKS - ---------------- OUR STOCK PRICE COULD CONTINUE TO BE VOLATILE AND ANY INVESTMENT COULD SUFFER A DECLINE IN VALUE, ADVERSELY AFFECTING OUR ABILITY TO RAISE ADDITIONAL CAPITAL WHICH COULD IN TURN DELAY COMMERCIALIZATION OF OUR PRODUCTS. The market price of our common stock has fluctuated significantly in recent years and is likely to fluctuate in the future. For example, from April 1998 to March 2001, our common stock has closed as high as $12.13 per share and as low as $1.97 per share. Factors contributing to this volatility have included: o the timing of approval and commercialization of products; o the results of research or scientific discoveries by us or others; o progress or the results of preclinical and clinical trials; o new technological innovations; o developments concerning technology rights; o litigation and related developments; and o public perception regarding the safety and efficacy of our products. Fluctuations in our financial performance from period to period, the issuance of analysts' reports and general industry and market conditions also tend to have a significant impact on the market price of our common stock. FUTURE SALES OF OUR SECURITIES IN THE PUBLIC MARKET COULD LOWER OUR STOCK PRICE AND IMPAIR OUR ABILITY IN NEW STOCK OFFERINGS TO RAISE FUNDS TO CONTINUE OPERATIONS. The market price of our securities could drop due to sales of a large number of our securities or the perception that these sales could occur. Such sales also might make it more difficult for us to sell equity securities in the future at a price that we deem appropriate. OUR CHARTER DOCUMENTS AND STOCKHOLDER RIGHTS PLAN MAY PREVENT US FROM PARTICIPATING IN TRANSACTIONS THAT COULD BE BENEFICIAL TO STOCKHOLDERS. Our stockholder rights plan and provisions in our amended and restated certificate of incorporation and by-laws may discourage transactions involving an actual or potential change in our ownership, including transactions in which you might otherwise receive a premium for your shares over the then-current market price. These provisions also may limit our stockholder's ability to approve transactions that they deem to be in their best interest. In addition, our Board of Directors may issue shares of preferred stock without any further action by stockholders. Such share issuances may have the effect of delaying or preventing a change in our ownership. 19 ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits
Exhibit No. Title Method of Filing ----------- ----- ---------------- 3.1 Amended and Restated Certificate of Incorporated by Reference to Exhibit 3.1 to the Incorporation of the Company Company's Form 10-Q for the Quarter Ended June 30, 2000 3.2 Restated By-Laws of the Company Incorporated by Reference to Exhibit 3.2 to the Company's Form 10-Q for the Quarter Ended June 30, 2000 4.1 Rights Agreement, dated as of January 6, 1995, Incorporated by Reference to Exhibit 1 to the between the Company and Chemical Trust Company Company's Current Report on Form 8-K dated January of California, including the Certificate of 5, 1995 Determination for the Series A Junior Participating Preferred Stock as Exhibit A, the Form of Summary of Rights to Right Certificate as Exhibit B and the Purchase Preferred Shares as Exhibit C 4.2 First Amendment to Rights Agreement entered into Incorporated by Reference to Exhibit 1 to the as of November 8, 1999, between ChaseMellon Company's Form 8-A, as amended, dated November 10, Shareholder Services, L.L.C. and Advanced Tissue 1999 Sciences, Inc. 4.3 Second Amendment to Rights Agreement entered Incorporated by Reference to Exhibit 1 to the into as of December 13, 1999, between Company's Form 8-A, as amended, dated March 28, ChaseMellon Shareholder Services, L.L.C. and 2000 Advanced Tissue Sciences, Inc.
(b) Reports on Form 8-K None 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 8, 2001 /s/ Arthur J. Benvenuto -------------------- ------------------------------- Arthur J. Benvenuto Chairman of the Board, Chief Executive Officer Date: May 8, 2001 /s/ Nikhil A. Mehta -------------------- ------------------------------- Nikhil A. Mehta Senior Vice President, Finance and Chief Financial Officer 21 -----END PRIVACY-ENHANCED MESSAGE-----