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FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
(x) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarter ended June 30, 2002
-----------------------------------
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 000-20805
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AROS CORPORATION
----------------
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
Delaware 23-2476415
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1290 Bay Dale Drive, PMB 351, Arnold, Maryland 21012
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(Address of principal executive offices) (Zip Code)
(410) 349-2431
--------------
(Registrant's telephone number, including area code)
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
17,045,131
----------
(Number of shares of common stock, $.01 par value per share,
outstanding as of July 31, 2002)
AROS CORPORATION
INDEX
PART I -- FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets as of June 30, 2002 (unaudited) and December
31, 2001
Consolidated Statements of Operations (unaudited) for the Three Months
Ended June 30, 2002 and 2001, Six Months Ended June 30, 2002 and 2001, and
the Period from December 21, 1989 to June 30, 2002
Consolidated Statements of Changes in Stockholders' Equity (Deficit) for
the Six Months Ended June 30, 2002 (unaudited) and Year Ended December 31,
2001
Consolidated Statements of Cash Flows (unaudited) for the Six Months Ended
June 30, 2002 and 2001 and the Period from December 21, 1989 to June 30,
2002
Notes to Consolidated Financial Statements (unaudited)
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Item 3. Quantitative and Qualitative Disclosures about Market Risk
PART II -- OTHER INFORMATION
Item 1. Legal Proceedings
Item 2. Changes in Securities and Use of Proceeds
Item 3. Defaults upon Senior Securities
Item 4. Submission of Matters to a Vote of Security Holders
Item 5. Other Information
Item 6. Exhibits and Reports on Form 8-K
Signatures
PART 1-FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
AROS CORPORATION
(A DEVELOPMENT STATE COMPANY)
CONSOLIDATED BALANCE SHEETS
(in thousands except share data)
JUNE 30, 2002 DECEMBER 31, 2001
(unaudited)
ASSETS
CURRENT ASSETS:
Cash $ 1 $ 1
Short-term investments 6,253 319
Receivables 31 136
Receivables from related parties 58 2
Interest receivable 3 -
Inventory 239 293
Prepaid expenses and other 241 29
------------- -----------
TOTAL CURRENT ASSETS 6,826 780
------------- -----------
Property and equipment, net 229 351
Other assets 50 50
------------- -----------
TOTAL ASSETS $ 7,105 $ 1,181
============= ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Bank overdraft $ - $ 34
Accounts payable 502 270
Accrued expenses 805 241
Current portion of notes payable and capital leases 5 5
------------- -----------
TOTAL CURRENT LIABILITIES 1,312 550
------------- -----------
Pension liability 120 -
Other liabilities 41 41
Long-term portion of notes payable and capital leases, including accrued
interest of $632 and $606 at June 30, 2002 and December 31, 2001,
respectively 6,687 8,331
Series A redeemable convertible preferred stock, $.01 par value; 30,000,000
shares authorized, liquidation preference of $6,855; and 15,298,350 shares
issued and outstanding as of June 30, 2002 6,855 --
STOCKHOLDERS' EQUITY:
Common stock prior to reverse merger and recapitalization -- 1
Series A through F preferred stock prior to reverse merger and
recapitalization -- 1
Common stock, $.01 par value; 30,000,000 authorized shares; 17,063,246
shares issued and 17,045,131 shares outstanding as of June 30, 2002 171 --
Series B convertible preferred stock, $.01 par value; 30,000,000 authorized
shares; 12,025,656 shares issued and outstanding as of June 30, 2002 120 --
Deferred stock compensation -- (2,930)
Accumulated other comprehensive loss (34) --
Additional paid-in capital 31,373 27,058
Accumulated deficit (39,540) (31,871)
------------- -----------
TOTAL STOCKHOLDERS' EQUITY (7,910) (7,741)
------------- -----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 7,105 $ 1,181
============= ===========
See accompanying Notes to Consolidated Financial Statements.
AROS CORPORATION
(A DEVELOPMENT STATE COMPANY)
CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
(In thousands, except per share data)
Period from
Three months ended Six months ended December 21, 1989
June 30, June 30, (inception) to
2002 2001 2002 2001 June 30, 2002
----------- ------------ ---------- ------------ -----------------
Revenues:
Sales $ 173 $ 43 $ 316 $ 218 $ 1,712
Royalties 3 -- 31 14 97
Grant and other revenue -- -- -- 433
----------- ------------ ---------- ------------ -----------
Total revenues 176 43 347 232 2,242
Expenses:
Costs of goods sold 304 69 579 344 2,122
Research and development 715 512 1,289 940 24,023
Selling, general and administrative 373 393 722 828 9,818
Compensation expense associated with
stock options and warrants 3,029 240 3,300 472 5,975
----------- ------------ ---------- ------------ -----------
Total expenses 4,421 1,214 5,890 2,584 41,938
----------- ------------ ---------- ------------ -----------
Operating loss (4,245) (1,171) (5,543) (2,352) (39,696)
Merger cost (402) -- (402) -- (402)
Interest income 4 2 5 8 1,150
Interest expense (1,618) (59) (1,729) (137) (2,643)
License fees -- -- -- -- 2,050
----------- ------------ ---------- ------------ -----------
Net loss $ (6,261) $ (1,228) $(7,669) $ (2,481) $ (39,541)
=========== ============ ========== ============ ===========
Basic and diluted net income (loss) per share:
Continuing operations $ (0.37) $ (0.07) $ (0.45) $ (0.15) $ (2.32)
=========== ============ ========== ============ ===========
Weighted average number of shares used for
calculation of net loss per share based on
shares outstanding after reverse merger and
recapitalization for all periods presented 17,045 17,045 17,045 17,045 17,045
=========== ============ ========== ============ ===========
See accompanying Notes to Consolidated Financial Statements.
AROS CORPORATION
(A DEVELOPMENT STATE COMPANY)
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (DEFICIT)
(IN THOUSANDS, EXCEPT FOR SHARE DATA)
Redeemable
Convertible Convertible Convertible Preferred
Preferred Series A Preferred Stock Series B
---------------------- ---------------------- ----------------------
Shares Amount Shares Amount Shares Amount
----------- ---------- ----------- ---------- ---------- -----------
Balance at December 31, 2001 4,481,835 $1
Issuance of Common Stock
Issuance of Convertible Preferred Stock for cash
and
conversion of bridge financing net of issuance
costs of
$138,070 5,564,047 1
Deferred stock compensation associated with stock
option
grants in 2002
Compensation expense associated with stock
options
outstanding
Effect of reverse merger and recapitalization:
Valuation of warrants associated with stock
options
outstanding
Valuation of beneficial conversion associated
with bridge
financing
Compensation expense associated with stock
options
outstanding recognized as a result of the
reverse merger
Conversion of convertible preferred shares to
Redeemable
Convertible Preferred Series A at
liquidation /
redemption value 15,298,350 $6,855 (5,564,047) (1)
Conversion of convertible preferred shares to
Common
Stock and Series B Preferred Shares (4,481,835) (1) 12,025,656 $120
Conversion of Subsidiary Common Stock into
Company Common Stock and Series B Preferred
Shares:
Elimination of Subsidiary Common Stock
Issuance of Company Common Stock
Company Common Stock and related equity held by
existing shareholders (net of 18,115 shares
held treasury)
Net (loss)
----------- ---------- ----------- ---------- ---------- -----------
Balance at June 30, 2002 15,298,350 $6,855 0 $0 12,025,656 $120
=========== ========== =========== ========== ========== ===========
Common Stock Additional
--------------------- Paid In Deferred Accumulated
Shares Amount Capital Compensation Deficit
---------- ---------- ------------ ----------------- --------------
Balance at December 31, 2001 2,528,044 $1 $27,058 ($30) ($31,871)
Issuance of Common Stock 301,930 1 104
Issuance of Convertible Preferred Stock for cash
and
conversion of bridge financing net of issuance
costs of
$138,070 6,716
Deferred stock compensation associated with stock
option
grants in 2002 370 (370)
Compensation expense associated with stock
options
outstanding 452
Effect of reverse merger and recapitalization:
Valuation of warrants associated with stock
options
outstanding 657
Valuation of beneficial conversion associated
with bridge
financing 843
Compensation expense associated with stock
options
outstanding recognized as a result of the
reverse merger 2,848
Conversion of convertible preferred shares to
Redeemable
Convertible Preferred Series A at
liquidation /
redemption value (6,854,906)
Conversion of convertible preferred shares to
Common
Stock and Series B Preferred Shares 297,146 3 (122)
Conversion of Subsidiary Common Stock into
Company Common Stock and Series B Preferred
Shares:
Elimination of Subsidiary Common Stock (2,829,974) (1) 1
Issuance of Company Common Stock 7,781,019 78 (78)
Company Common Stock and related equity held by
existing shareholders (net of 18,115 shares
held treasury) 8,966,966 89 2,678
Net (loss) (7,669)
---------- ---------- ------------ ----------------- --------------
Balance at June 30, 2002 17,045,131 $171 $31,373 $0 ($39,540)
========== ========== ============ ================= ==============
Total
Accumulated Shareholders'
Other (Net Capital
Comprehensive Deficiency)
Loss Equity
----------------- --------------
Balance at December 31, 2001 ($7,741)
Issuance of Common Stock 105
Issuance of Convertible Preferred Stock for cash
and
conversion of bridge financing net of issuance
costs of
$138,070 6,717
Deferred stock compensation associated with stock
option
grants in 2002
Compensation expense associated with stock
options
outstanding 452
Effect of reverse merger and recapitalization:
Valuation of warrants associated with stock
options
outstanding 657
Valuation of beneficial conversion associated
with bridge
financing 843
Compensation expense associated with stock
options
outstanding recognized as a result of the
reverse merger 2,848,
Conversion of convertible preferred shares to
Redeemable
Convertible Preferred Series A at
liquidation /
redemption value (6,855)
Conversion of convertible preferred shares to
Common
Stock and Series B Preferred Shares
Conversion of Subsidiary Common Stock into
Company Common Stock and Series B Preferred
Shares:
Elimination of Subsidiary Common Stock
Issuance of Company Common Stock
Company Common Stock and related equity held by
existing shareholders (net of 18,115 shares
held treasury) ($34) 2,733
Net (loss) (7,669)
----------------- --------------
Balance at June 30, 2002 ($34) ($7,910)
================= ==============
AROS CORPORATION
(A DEVELOPMENT STAGE COMPANY)
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
(in thousands)
PERIOD FROM
DECEMBER 21, 1989
SIX MONTHS ENDED JUNE 30, (INCEPTION) TO JUNE 30,
2002 2001 2002
----------------------------------------------------------
OPERATING ACTIVITIES
Net loss $(7,669) $(2,481) $(39,541)
Adjustments to reconcile net loss to net cash used in operating
activities:
Issuance of common stock to consultant for services -- -- 2
Issuance of common stock to founders for contributed patents -- -- 42
Issuance of Series B preferred stock upon conversion of interest
payable -- -- 6
Compensation expense associated with stock options 3,300 472 5,975
Amortization of debt discount for warrant and beneficial conversion
feature 1,500 -- 1,500
Reduction in payable to stockholder -- -- (76)
Depreciation and amortization 122 145 1,917
Loss on disposal of property and equipment -- -- 9
Interest expense converted to principal 140 137 752
Interest expense converted to equity 89 -- 89
Changes in operating assets and liabilities:
Other current assets and accounts receivables 46 78 (229)
Inventory 54 (176) (239)
Other assets -- -- (50)
Accounts payable, accrued liabilities and bank overdraft 452 10 997
Other liabilities -- 41 41
----------------------------------------------------------
Net cash provided by (used in) operating activities (1,966) (1,774) (28,805)
INVESTING ACTIVITIES
Purchases of property and equipment -- (10) (1,933)
Changes in short-term investments (2,982) 231 (3,308)
----------------------------------------------------------
Net cash provided by (used in) investing activities (2,982) 221 (5,241)
FINANCING ACTIVITIES
Proceeds from issuance of convertible preferred stock, net of offering
costs 3,857 -- 24,767
Proceeds from issuance of common stock 105 -- 301
Repayment on capital lease obligations (2) -- (108)
Proceeds from notes payable 988 1,550 11,410
Payments on notes payable -- -- (2,323)
----------------------------------------------------------
Net cash provided by (used in) financing activities 4,948 1,550 34,047
----------------------------------------------------------
--
Net (decrease) increase in cash -- (3) 1
Cash at beginning of period 1 4 --
----------------------------------------------------------
Cash at end of period $ 1 $ 1 $ 1
==========================================================
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION Non-cash disclosure:
Issuance of Series B convertible preferred stock upon
conversion of notes payable $ -- $ -- $ 300
Equipment purchased pursuant to capital leases -- 10 114
Cancellation of stock options with deferred stock compensation
associated -- -- 1,250
Net assets assumed in merger 2,733 -- 2,733
Conversion of bridge financing to equity 2,860 -- 2,860
Cash disclosure:
Cash paid for interest -- -- 310
See accompanying Notes to Consolidated Financial Statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(A DEVELOPMENT STATE COMPANY)
(UNAUDITED)
1. NATURE OF BUSINESS
Aros Corporation, a Delaware corporation, was incorporated as APACHE Medical
Systems, Inc. ("APACHE") on September 1, 1987. APACHE was a provider of
clinically based decision support information systems and consulting services
to the healthcare industry offering a comprehensive line of outcomes-based
products and services, encompassing software, hardware, and related consulting
and disease management information services. The Company sold or discontinued
all APACHE business and changed its name to Aros Corporation in 2001.
On June 21, 2002 Aros Corporation ("Aros" or the "Company") acquired ReGen
Biologics, Inc. ("ReGen" or the "Subsidiary"), a privately held tissue
engineering company that designs, develops, manufactures and markets minimally
invasive human implants and medical devices for the repair and regeneration of
damaged human tissue, which merged with the Company on June 21, 2002. The
merger included all of ReGen's business and operating activities and
employees. The Company continues ReGen's business out of ReGen's current
headquarters in Franklin Lakes, New Jersey. ReGen's business will comprise
substantially all of the business conducted by Aros for the foreseeable
future. Accordingly, discussions of the Company's business is, in effect, a
discussion of ReGen's operations. Hereinafter, the merged entity is referred
to as the Company.
Pursuant to the merger, Aros has issued approximately 35.4 million shares of
its capital stock to former ReGen stockholders in exchange for all of the
issued and outstanding stock of ReGen. In addition, Aros has assumed ReGen's
outstanding stock options and warrants to purchase up to an aggregate of
approximately 11 million shares of Aros Common Stock and 1.2 million shares of
Aros Series B Convertible Preferred Stock on a post merger basis. Following
the merger, former ReGen stockholders own approximately 80% of Aros
outstanding capital stock.
ReGen Biologics, Inc., a Delaware corporation, was incorporated in California
on December 21, 1989 and reincorporated in Delaware on June 28, 1990 for the
purpose of research and development and, ultimately, the sale of
collagen-based technologies and products to stimulate re-growth of tissues
that, under natural conditions, do not regenerate adequately in humans.
ReGen has two products currently being marketed, the Sharp Shooter Tissue
Repair System ("SharpShooter") and the Collagen Meniscus Implant ("CMI").
ReGen's activities to date have consisted principally of raising capital,
conducting research and development activities, developing and marketing and
obtaining regulatory approval for its products. The CMI and Sharp Shooter in
2000 each received the CE Mark for distribution in the European Economic
Community. The Sharp Shooter in 2000 received marketing clearance for sale in
the United States by the United States Food and Drug Administration ("FDA").
ReGen is in the final stages of enrollment for its CMI clinical trial in the
United States. ReGen will continue to require additional capital to complete
the U.S. CMI clinical trial, further develop its products and further develop
sales and distribution channels for its products around the world.
Accordingly, ReGen is still considered a development stage enterprise.
Management believes that ReGen will emerge from development stage when the CMI
product is available for sale in the U.S. and/or sales of all of its products
have reached a volume that will provide for positive gross margin.
2. BASIS OF PRESENTATION
The accompanying consolidated financial statements were prepared by the Company
in accordance with accounting principles generally accepted in the United States
and pursuant to the rules and regulations of the Securities and Exchange
Commission. The financial information included herein is unaudited. However, in
the opinion of the Company's management, all adjustments (which include normal
recurring adjustments) considered necessary for a fair presentation have been
made. Certain information and footnote disclosures normally included in annual
financial statements prepared in accordance with accounting principles generally
accepted in the United States have been condensed or omitted pursuant to such
rules and regulations, but the Company believes that the disclosures made are
adequate to make the information presented not misleading. For more complete
financial information, these financial statements should be read in conjunction
with the audited financial statements and notes thereto of the Subsidiary for
the year ended December 31, 2001 included in the Form 8-K amendment, to be filed
with the Commission on or before September 4, 2002. Results for interim periods
are not necessarily indicative of the results for any other interim period or
for the full fiscal year.
The acquisition of the Subsidiary, completed as of June 21, 2002 has been
recorded for accounting purposes as a reverse merger and recapitalization,
whereby the Subsidiary is assumed to be the accounting acquirer of the
Company. For purposes of this filing and future filings, the historical
financial statements of the Subsidiary including related notes have replaced
the prior historical financial statements of the Company. The historical
financial statements as of June 30, 2001 of the subsidiary reflect a
recapitalization for the equivalent number of shares received in the merger
for all equity securities. On the date of the merger between the Subsidiary
and the Company, the assets and liabilities of the Company are merged into the
historical balance sheet of the Subsidiary for consolidated financial
statement purposes as if the Subsidiary had acquired the Company. The common
and preferred stock of the Subsidiary that
was outstanding at the date of the merger is replaced with the common and
preferred stock (along with additional paid in capital) of the Company
including those shares issued to consummate the merger. The historical
retained earnings deficits of the Subsidiary carry forward into the merged
company. See Note 16 for a further discussion of the terms of the merger.
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
CASH AND SHORT-TERM INVESTMENTS
The Company considers all highly liquid investments purchased with a maturity
of 90 days or less at the date of acquisition to be cash equivalents. The
Company places its cash and short-term investments with two financial
institutions and invests primarily in overnight investments, which may include
U.S. government agency notes, commercial paper, and money market accounts. To
date, the Company has not experienced losses on investments in these
instruments.
Management determines the appropriate classification of securities at the time
of purchase and reevaluates such designation as of each balance sheet date.
Estimated fair value amounts are determined by the Company using available
market information and appropriate valuation methodologies. However, judgment
is required in interpreting market data to develop the estimates of fair
value.
Bank overdrafts represent net outstanding checks.
INVENTORIES
Inventories are valued at the lower of actual cost or market, using the
first-in, first-out (FIFO) method.
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost. Depreciation of computer, office,
laboratory, and manufacturing equipment is calculated using the straight-line
method over the estimated useful lives (three to five years), and leasehold
improvements are amortized on a straight-line basis over the shorter of their
estimated useful lives or the lease term.
INCOME TAXES
The Company provides for income taxes in accordance with the asset and
liability method, prescribed by Statement of Financial Accounting Standards
(SFAS) No. 109, Accounting for Income Taxes. Under this method, deferred tax
assets and liabilities are determined based on differences between financial
reporting and tax basis of assets and liabilities and are measured using the
enacted tax rates and laws that will be in effect when the differences are
expected to reverse.
STOCK BASED COMPENSATION
The Company accounts for its stock-based compensation in accordance with the
Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to
Employees, (APB 25) using the intrinsic value method. The Company has made pro
forma disclosures required by SFAS No. 123, Accounting for Stock Based
Compensation, (SFAS 123) using the fair value method.
REVENUE RECOGNITION
Revenues from sales of products are recognized when goods are shipped. Amounts
billed to customers for shipping and handling are included in revenues.
Shipping and handling costs are included in costs of good sold.
If determinable at the time results are published by the Company, royalties
are recognized when the licensee has sold the product to the end user and the
Company has fulfilled its obligations under the applicable agreement. If not
determinable at the time results are published, royalties are recognized in
the period they become determinable.
License fees represent payments received from distributors for exclusive
perpetual licenses to sell the Company's products in various geographic areas
(see Note 8). These fees are recognized as other income when all performance
criteria in the underlying agreement have been met.
RESEARCH AND DEVELOPMENT COSTS
All research and development costs are charged to expense as incurred.
PATENT AND LICENSING COSTS
The Company records costs incurred to obtain patents and licenses as research
and development expense.
ADVERTISING COSTS
All advertising costs are expensed as incurred. During the three months ended
June, 2002 and 2001, the Company expensed approximately $41,650 and $4,263,
respectively, as advertising costs.
COMPREHENSIVE INCOME (LOSS)
Comprehensive income includes all changes in stockholders' equity during a
period except those resulting from investments by owners and distributions to
owners. The Company's other comprehensive income comprises a minimum pension
liability and unrealized gains and losses on short-term investments, which
have been immaterial to date, and total comprehensive loss closely
approximated net loss in each fiscal period presented.
FAIR VALUE OF FINANCIAL INSTRUMENTS AND CONCENTRATIONS
The carrying amount of the Company's notes payable approximates fair value.
The carrying amount of the Company's cash, short-term investments,
receivables, receivables from related parties, accounts payables and accrued
expenses approximates fair value due to their short-term nature.
The Company currently has two principal customers (see Note 8), which market
and sell the Company's two current products. Customer A has the license to
sell the Sharp Shooter product. Customer B, which is also a shareholder of the
Company, has the license to sell the CMI product outside of the United States.
Concentrations of receivables and revenues by customer as of and for the three
and six months ended June 30, 2002 and 2001 are as follows:
THREE MONTHS ENDED THREE MONTHS ENDED SIX MONTHS ENDED SIX MONTHS ENDED
JUNE 30, 2002 JUNE 30, 2001 JUNE 30, 2002 JUNE 30, 2001
----------------------------------------------------------------------------------------
Accounts receivable:
Customer A 33% 100% 33% 100%
Customer B 67% --% 67% --%
Sales revenues:
Customer A 58% 67% 67% 44%
Customer B 42% 33% 33% 66%
Royalties:
Customer A 100% 100% 100% 100%
USE OF ESTIMATES
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management to make
estimates and assumptions that affect the amounts reported in the financial
statements and accompanying notes. Actual results could differ from those
estimates.
ADOPTION OF NEW ACCOUNTING PRONOUNCEMENTS
In June 2001, the Financial Accounting Standards Board issued SFAS No. 141,
entitled, Business Combinations. This statement prohibits the use of the
pooling-of-interests method of accounting for business combinations initiated
after June 30, 2001 and applies to all business combinations accounted for
under the purchase method that are completed after June 30, 2001. This
statement was adopted on January 1, 2002, and did not have an impact on the
Company's consolidated financial statements.
Also in June 2001, the FASB issued SFAS No. 142, entitled, Goodwill and Other
Intangible Assets. This statement eliminates the amortization of goodwill, and
requires goodwill to be reviewed periodically for impairment. This statement
also requires the useful lives of previously recognized intangible assets to
be reassessed and the remaining amortization periods to be adjusted
accordingly.
This statement is effective for fiscal years beginning after December 15,
2001, for all goodwill and other intangible assets recognized on the Company's
consolidated balance sheets at that date, regardless of when the assets were
initially recognized. This statement was adopted on January 1, 2002, and did
not have an impact on the Company's consolidated financial statements.
In August 2001, the FASB issued SFAS No. 144, entitled, Accounting for the
Impairment or Disposal of Long-Lived Assets. SFAS No. 144 supercedes SFAS No.
121, entitled, Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to be Disposed of, but retains its fundamental provisions
for recognizing and measuring impairment of long-lived assets to be held and
used. This statement also requires that all long-lived assets to be disposed
of by sale are carried at the lower of carrying amount or fair value less cost
to sell, and that depreciation should cease to be recorded on such assets.
SFAS No. 144 standardizes the accounting and presentation requirements for all
long-lived assets to be disposed of by sale, superceding previous guidance for
discontinued operations of business segments. This statement is effective for
fiscal years beginning after December 15, 2001. This statement was adopted on
January 1, 2002, and did not have an impact on the Company's consolidated
financial statements.
ACCOUNTING PRINCIPLES ISSUED BUT NOT YET ADOPTED
In August 2001, FASB issued SFAS No. 143, "Accounting for Asset Retirement
Obligations." This statement is effective for fiscal years beginning after
June 15, 2002. SFAS No. 143 provides accounting requirements for obligations
associated with the retirement of tangible long-lived assets and the
associated asset retirement costs. Under the statement, the asset retirement
obligation is recorded at fair value in the period in which it is incurred by
increasing the carrying amount of the related long-lived asset. The liability
is accreted to its present value in each subsequent period and the capitalized
cost is depreciated over the useful life of the related asset. The Company
does not expect that implementation of this statement will have a significant
impact on its consolidated financial statements.
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements
No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical
Corrections." This statement eliminates the current requirement that gains and
losses on debt extinguishment must be classified as extraordinary items in the
income statement. Instead, such gains and losses will be classified as
extraordinary items only if they are deemed to be unusual and infrequent, in
accordance with the current GAAP criteria for extraordinary classification. In
addition, SFAS 145 eliminates an inconsistency in lease accounting by
requiring that modifications of capital leases that result in reclassification
as operating leases be accounted for consistent with sale-leaseback accounting
rules. The statement also contains other 46 nonsubstantive corrections to
authoritative accounting literature. The changes related to debt
extinguishment will be effective for fiscal years beginning after May 15,
2002, and the changes related to lease accounting will be effective for
transactions occurring after May 15, 2002. The Company does not expect that
implementation of this statement will have a significant impact on its
consolidated financial statements.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities," which addresses accounting for
restructuring and similar costs. SFAS No. 146 supersedes previous accounting
guidance, principally Emerging Issues Task Force ("EITF") Issue No. 94-3. This
statement is to be applied prospectively to exit or disposal activities
initiated after December 31, 2002. SFAS No. 146 requires that the liability
for costs associated with an exit or disposal activity be recognized when the
liability is incurred. Under EITF No. 94-3, a liability for an exit cost was
recognized at the date of a company's commitment to an exit plan. SFAS No. 146
also establishes that the liability should initially be measured and recorded
at fair value. The Company does not expect that implementation of this
statement will have a significant impact on its consolidated financial
statements.
RECLASSIFICATIONS
Certain fiscal 2001 and inception to December 31, 2001 balances have been
reclassified to conform to the current year's presentation.
3. SHORT-TERM INVESTMENTS
At June 30, 2002 and December 31, 2001, all investments are debt securities
classified as available-for-sale, and, accordingly, are carried at fair value,
which approximates amortized cost. The cost of securities sold is based on the
specific identification method, when applicable. The Company had $6,253,906
and $319,452 of short-term investments invested in U.S. government agency
notes as of June 30, 2002 and December 31, 2001, respectively. The Company did
not have any material realized or unrealized gains or losses at June 30, 2002
and December 31, 2001 and for the periods then ended.
4. PROPERTY AND EQUIPMENT
Property and equipment consist of the following:
JUNE 30, 2002 DECEMBER 31, 2001
---------------------------------------
Computer equipment $ 214,582 $ 214,582
Office equipment 101,326 101,326
Laboratory equipment 374,203 374,203
Manufacturing equipment 241,412 241,412
Leasehold improvements 1,198,404 1,198,404
---------------------------------------
2,129,927 2,129,927
Less accumulated depreciation and amortization (1,900,703) (1,778,703)
---------------------------------------
$ 229,224 $ 351,224
=======================================
5. INVENTORY
Inventory consists of the following:
JUNE 30, 2002 DECEMBER 31, 2001
---------------------------------------
Raw material $ 66,178 $ 63,989
Work in process 83,982 65,116
Finished goods 88,879 163,431
---------------------------------------
$ 239,039 $ 292,536
=======================================
6. NOTES PAYABLE
CREDIT AGREEMENT AND 2000 CREDIT AGREEMENT
On November 30, 1998, the Subsidiary entered into a Credit Facility (Credit
Agreement) with a shareholder. The Credit Agreement provided for financing up
to $2,042,600. As of June 30, 2002, the Subsidiary has drawn the entire amount
available. This facility originally was scheduled to mature on December 1,
2003 and bears interest that compounds annually, at LIBOR, adjusted annually,
ranging from 2.39% - 6.67% through the fiscal period June 30, 2002. Accrued
interest on this note is due upon maturity of the underlying principal. During
2002, this Credit Agreement was amended to extend the maturity date of the
facility to the earlier of 36 months from the date the Subsidiary receives FDA
approval for its CMI product, or December 31, 2009. On the due date, the
Subsidiary may, at its option and subject to certain conditions, require any
unpaid debt be converted to equity.
On March 15, 2000 the Subsidiary entered into another Credit Facility (2000
Credit Agreement) with the same shareholder as the Credit Agreement. The 2000
Credit Agreement provided for financing up to $4,000,000. As of June 30, 2002,
the Subsidiary has drawn the entire amount available. This facility originally
was scheduled to mature on March 14, 2005, and bears interest, that compounds
annually, at LIBOR, adjusted annually, ranging from 2.06% - 7.21% through the
fiscal period June 30, 2002. Accrued interest on this note is due upon
maturity of the underlying principal. During 2002, this 2000 Credit Agreement
was amended to extend the maturity date of the facility to the earlier of 36
months from the date the Company receives FDA approval for its CMI product, or
December 31, 2009. On the due date, the Company may, at its option and subject
to certain conditions, require any unpaid debt be converted to equity.
In connection with the Credit Agreement and the 2000 Credit Agreement, the
lender has obtained a security interest in certain of the Company's
intellectual properties.
As of June 30, 2002, the Credit Agreement and 2000 Credit Agreement, with
combined principal of $6,042,600 and accrued interest of approximately
$6632,000 mature on the earlier to occur of 36 months from the date the
Company receives FDA approval for its CMI product, or December 2009.
BRIDGE LOAN AGREEMENT AND 2002 BRIDGE LOAN AGREEMENT
On April 13, 2001 the Subsidiary entered into a bridge loan agreement (Bridge
Loan Agreement) with existing shareholders and a third party, whereby the
lenders were committed to make available up to $3,000,000, dependent upon
terms outlined in the Bridge Loan Agreement, in exchange for convertible
subordinated notes. Based on the outcome of these terms, $1,673,591 became
available under the Bridge Loan Agreement and was deposited into an escrow
account. In addition to the principal, the Subsidiary was able to borrow
interest accrued on the principal while the proceeds were held in escrow. As
of June 21, 2001, the Company had borrowed $1,680,687 under the Bridge Loan
Agreement. Interest compounded annually at Prime plus one percent, or 9.0% and
was due upon maturity of the underlying principal. In accordance with the
terms of these notes, the outstanding principal and accrued interest were
converted into Series G Convertible Preferred Stock of the Subsidiary and
ultimately into Series A Convertible Preferred Stock of Aros (see further
discussion below). In addition, upon conversion of the notes, the terms of
warrants attached to the notes became fixed (see further discussion below).
In March 2002 the Subsidiary entered into $1 million of convertible
subordinated promissory notes (Notes) with related parties. The Notes mature
in March 2003 and accrued interest at Prime plus 1%, or 5.75%. In accordance
with the terms of these notes, the outstanding principal and accrued interest
were converted into Series G Convertible Preferred Stock of the Subsidiary and
ultimately into Series A Convertible Preferred Stock of Aros (see further
discussion below). In addition, upon conversion of the notes, the terms of
warrants attached to the notes became fixed (see further discussions below).
On June 21, 2002, the Subsidiary issued 5,564,048 shares of Series G
Convertible Preferred Stock (Series G Stock) to existing shareholders of the
Subsidiary for $1.2321 per share. Cash of $4,000,000 was received for
3,246,490 of the shares issued. The remaining 2,317,558 shares were issued
upon conversion of the borrowings under the Bridge Loan Agreement and Notes,
principle and accrued interest from 2001 and 2002 financings with a value of
approximately $2,860,000. Subsequent to the conversion of these notes payable
into Series G Stock, and also on June 21, 2002, in connection with the merger
of ReGen and Aros, the Series G Stock was exchanged for Series A Convertible
Preferred Stock of Aros Corporation at a rate of 2.7495 Aros Series A Stock
for each share of ReGen Series G Stock, resulting in 6,372,126 shares of Aros
Series A Stock.
In accordance with the terms of the Bridge Loan Agreement and the Notes, on
June 21, 2002, the Subsidiary issued 782,602 five year warrants for common
stock exercisable for $1.2321 per share, calculated based upon 25% of the
principle and interest outstanding on the 2001 notes and 50% of the principle
and interest outstanding on the 2002 notes payable as of June 21, 2002,
divided by $1.2321 per share (the purchase price per share paid for the Series
G Stock). In connection with the Merger of ReGen and Aros, these warrants were
assumed by Aros. Subsequent to the merger, the warrants became exercisable for
2,151,765 shares of Aros Common Stock at a price of $0.43 per share. In
accordance with the terms of the Bridge Loan Agreement and the Notes, the
exercise price and number of shares exercisable under the warrants was not
known until the consummation of the Series G financing. Therefore, no value
had previously been assigned to the warrants or the beneficial conversion
feature of the Bridge Loan Agreement and the Notes. At June 21, 2002 the value
of the warrants issues was established as $656,788 and the value of the
beneficial conversion was established as $843,566. The sum of these amounts
was recorded as a reduction of the borrowings outstanding (debt discount) and
an increase in additional paid in capital on June 21, 2002. The warrants and
beneficial conversion are fully vested, therefore the entire amount of the
debt discount was recorded as interest expense on June 21, 2002.
7. CAPITAL LEASES
Future payments under capital lease obligations at June 30, 2002 and December
31, 2001 are as follows:
JUNE 30, 2002 DECEMBER 31, 2002
CAPITAL LEASES CAPITAL LEASES
------------------- ----------------------
2002 $5,006 $5,245
2003 -- 2,714
------------------- ----------------------
5,006 7,959
Amounts representing interest (1,544) (2,292)
------------------- ----------------------
$3,462 $5,667
=================== ======================
Included in property and equipment at June 30, 2002 and December 31, 2001 is
$10,489 related to the capital lease. This lease has a 2-year term and an
imputed interest rate of 8.3%.
8. LICENSE AGREEMENTS
PRODUCT DISTRIBUTION LICENSE AGREEMENTS
In February 1996, the Subsidiary entered into a perpetual product distribution
agreement (1996 Product Distribution Agreement) for the Collagen Meniscus
Implant (CMI) with a shareholder of the Subsidiary, who is also the holder of
the majority of the Subsidiary's long-term debt. The Subsidiary received a
nonrefundable, non-creditable $750,000 licensing fee in February 1996 in
exchange for the granting of exclusive distribution and marketing rights
outside the United States of America for the product under development.
An additional $1,000,000 was recognized as revenue during 2001 under the
milestone provisions as adjusted by a new agreement between the parties during
2001. This payment is also nonrefundable and non-creditable. The Subsidiary
may be due additional milestone fees in future years based on the achievement
of future sale volumes by the shareholder/creditor under this agreement. Also,
under this agreement, the Subsidiary will be reimbursed by the
shareholder/creditor for all expenses it incurs in connection with obtaining
regulatory approval for the CMI outside the United States of America. At June
30, 2002 and December 31, 2001, the Subsidiary had a receivable from the
shareholder of approximately $0 and $0, respectively.
In January 2002, the Subsidiary entered into an amendment to its 1996 Product
Distribution Agreement. The amendment provides for (i) further definition and
certain changes to the 1996 Product Distribution Agreement, including
marketing activities and annual sales minimums and (ii) restructure of its
Credit Agreement and 2000 Credit Agreement, calling for repayment of such
credit agreements to occur at the earlier of 36 months from the date the
Subsidiary receives FDA approval for its CMI product, or December 31, 2009. On
the due date, the Subsidiary may, at its option and subject to certain
conditions, require any unpaid debt be converted to equity.
During 2000, the Subsidiary entered into an exclusive distribution agreement
with a distributor granting the distributor exclusive rights to sell the Sharp
Shooter product throughout the world. The Company received and recognized as
license fee income a $300,000 nonrefundable, non-creditable license fee in
2000. This agreement continues in force so long as the distributor meets
certain minimum sales volume quotas. The distributor is obligated to pay the
Subsidiary a royalty on net sales of products sold at a rate of between 10%
and 12%. For the six month period ended June 30, 2002 and year ended December
31, 2001, the amount of royalty income under this agreement was $31,041 and
$56,030, respectively. The distributor is also required to pay a minimum
royalty in order to maintain the exclusive distributor status. To meet the
minimum royalty's requirement, the distributor would have owed an additional
$98,500 through June 30, 2002. Management has determined that based on the
current status of negotiations with the distributor over possible
modifications to the agreement, that these amounts do not meet the criteria
for revenue recognition and have therefore not been included in revenue in
either year.
TECHNOLOGY LICENSE AGREEMENTS
In April 1997, the Subsidiary entered into an agreement with a member of its
Board of Directors and Modified Polymer Components, Inc. (MPC) to obtain an
exclusive license to certain patent rights used in connection with the Sharp
Shooter. The Subsidiary paid $100,000 in 1997 in license fees ($80,000 to the
member of the Board of Directors and $20,000 to MPC). Such fees were charged
to research and development expense as the related technology was considered
by the Subsidiary to be in the development stage, and such technology had no
alternative future use. The Subsidiary is required to pay a royalty of up to
6%, consisting of a royalty of up to 4.8% to the member of the Board of
Directors and up to1.2% to an assignee of MPC of net sales on products sold
incorporating the licensed technology. In 2000, MPC assigned its rights to
this royalty contract to a third-party. For the period and year ended June 30,
2002 and December 31, 2001, $8,398 and $14,814, respectively was charged to
expense under this agreement. At June 30, 2002 and December 31, 2001, $964 and
$9,656, respectively, was accrued under this agreement.
In 1995, the Subsidiary entered into an exclusive license agreement with an
employee pursuant to which the employee granted the Subsidiary an exclusive
worldwide right and license to certain technology considered by the Subsidiary
to be a candidate for use in products of the Subsidiary, including the rights
to certain patents and to any products resulting from the use of such
technology and/or patents. Under the exclusive license agreement, the
Subsidiary agreed to pay the employee a license issue fee of $250,000 in five
equal installments of $50,000 per year. The Subsidiary is also required to pay
a royalty of: (a) 6% on products covered by a valid patent claim; (b) 3% on
products not covered by a valid patent claim; and (c) 50% of royalties
actually received by the Subsidiary from sublicensees who are not affiliates.
The Subsidiary completed its payments under this license agreement during
fiscal 2000. In addition, the Subsidiary paid all costs incurred by the
employee prior to August 24, 1995 for filing, prosecuting and maintenance of
licensed patents, in the amount of $50,000. The exclusive license agreement
will expire on the later to occur of ten years from the commercial sale of any
licensed product (as defined in the agreement) or the date of expiration of
the last to expire patent covered in the agreement.
In 1990, the Subsidiary entered into an agreement with the Massachusetts
Institute of Technology (MIT) to obtain an exclusive license to certain patent
rights relating to the use of biodegradable materials for regeneration of
tissue. The Subsidiary paid $25,000 to MIT in 1990 as license fees. The
Subsidiary is required to pay MIT a royalty of the lesser of 6% of net sales
or 10% of the gross margin, as defined, on sales of products covered under the
agreement, except that no amounts will be due MIT for products that are also
covered under the agreement with Neomorphics, Inc. (Neomorphics) discussed
below.
In 1990, the Subsidiary entered into a sublicense agreement with Neomorphics
for certain products previously licensed to Neomorphics by MIT (and also in
the MIT agreement discussed above). The Subsidiary was required to pay an
annual maintenance fee of $10,000 per year in connection with the sublicense.
The Subsidiary was also required to pay Neomorphics a royalty of 4% of its net
sales of the sublicensed products. The annual license maintenance fees were
creditable against royalties due. The amounts paid to MIT and Neomorphics were
included as part of research and development expense in the periods in which
such payments were made. The related patent expired in 2001 and, accordingly,
no royalty payments will be due under this agreement or the MIT agreement
after 2001.
9. COMMITMENTS AND CONTINGENCIES
The Company leases its corporate headquarters in Franklin Lakes, New Jersey
under a non-cancelable operating lease that expires on March 31, 2003, has a
month-to-month operating lease agreement for office space in Vail, Colorado
and leases space in Redwood City, California for its manufacturing operations
under a non-cancelable operating lease that expires in May 2003. In January
2002, the Company signed a one-year lease for the office space in Vail,
Colorado at a rate of $2,801 per month. The Company sub-leases a portion of
the manufacturing facility at a rate of $41,290 per month, which was recorded
as an offset to rent expense. The sub-lease expires in May 2003. Total net
rent expense was approximately $97,090 for 2001.
Future minimum lease payments are as follows at December 31, 2001:
2002 $ 331,517
2003 153,929
2004 -
2005 -
-------------------
$ 485,446
===================
The Company has employment agreements with an officer of the Company providing
for minimum aggregate annual compensation of approximately $275,000 per annum.
The contract can be terminated by either party upon a ninety-day notification.
Additionally, such employment agreement provides for various incentive
compensation payments as determined by the Company's Board of Directors.
During 2001and 2002, the Company shipped certain components of the Sharp
Shooter that were later identified to have the potential to become
non-sterile. These items are being returned to the Company in 2002. Also
during 2002, the Company detected residue from its packaging vendor on certain
of its CMI packaging materials. The Company identified and discarded all CMI
product with the potential for the presence of this material. The Company has
estimated the cost related to these items to be approximately $55,000 for
the 2001 shipments and $75,398 for the 2002 shipments and the cost of
discarded CMI product. These amounts were accrued in the period that the
product shipped.
10. EMPLOYEE BENEFIT PLANS
The Company sponsors a profit sharing plan ("Plan") intended to qualify under
Section 401(k) of the Internal Revenue Code. All employees are eligible to
participate in the Plan after three months of service. Employees may
contribute a portion of their salary to the Plan, subject to annual
limitations imposed by the Internal Revenue Code. The Company may make
matching or discretionary contributions to the Plan at the discretion of the
Board of Directors, but has made no such contribution to date. Employer
contributions generally vest over seven years.
Aros sponsors a defined benefit pension plan ("Pension Plan") covering all
former employees of National Health Advisors, a subsidiary of Aros acquired in
1997. The Pension Plan was amended to freeze benefit accruals and the entry of
new participants effective October 31, 1997. The sale of the Company's APACHE
business in 2001 resulted in the termination of all remaining participants in
the Pension Plan. Because this plan was part of Aros and is now frozen no
expense associated with the plan is included in the accompanying financial
statements. The Company does not anticipate that any expense will be
recognized for this plan in future years.
The benefits under the Pension Plan are based on final average compensation
and are offset by each employee's interest in the Company's profit sharing
plan. The Company's funding policy is to contribute annually an amount that
can be deducted for federal income tax purposes and meets minimum-funding
standards, using an actuarial cost method and assumptions, which are different
from those used for financial reporting.
Roll forwards of the benefit obligation, fair value of plan assets and a
reconciliation of the pension plan's funded status at November 30, 2001, the
measurement date, and significant assumptions follow (in thousands):
2001
--------
CHANGE IN BENEFIT OBLIGATION
Beginning of the year............................... $ 190,000
Service cost..................................... --
Interest cost.................................... 12,000
Plan changes and other...........................
Curtailment...................................... (8,000)
Actuarial loss (gain)............................ 143,000
--------
End of the year..................................... $ 337,000
========
CHANGE IN FAIR VALUE OF ASSETS
Beginning of the year............................... $ 315,000
Actual return on plan assets..................... (100,000)
Employer contributions........................... 2,000
--------
End of the year..................................... $ 217,000
========
RECONCILIATION OF FUNDED STATUS
(Under)/over funded status.......................... $(120,000)
Unrecognized net actuarial loss (gain).............. --
--------
Accrued pension cost................................ $(120,000)
========
SIGNIFICANT ASSUMPTIONS:
Discount rate....................................... 6.26%
Expected return on plan assets...................... 6.26%
Rate of compensation increase....................... 5.00%
Because the Pension Plan is frozen, accrued pension costs at June 30, 2002
remains $120,000.
11. RELATED PARTY TRANSACTIONS
The Company has a cost reimbursement agreement with a shareholder of the
Company. For the period and year ended June 30, 2002 and December 31, 2001,
the Company is entitled to reimbursement of approximately $0 and $74,000,
respectively, in developmental costs, all of which has been received year to
date.
For the fiscal periods ended June 30, 2002 and December 31, 2001 33% and 77%,
respectively of the Company's revenues were from sales to Sulzer Medica USA
Holding Company, a related party.
At June 30, 2002 and December 31, 2001, approximately $8,000 and $21,000 of
accounts payables were due to related parties. In addition, as of December 31,
2001 and June 30, 2002 the Company had approximately $30,000 and $45,000
payable to Umidi + Company, Inc. of which Brion Umidi is the principle
stockholder. Mr. Umidi was hired by the Company as the Company's Senior Vice
President and Chief Financial Officer on July 15, 2002.
12. STOCKHOLDERS' EQUITY
CONVERTIBLE PREFERRED STOCK
Convertible preferred stock at December 31, 2001 and 2000 is as follows:
LIQUIDATION DESIGNATED SHARES ISSUED AND OUTSTANDING
--------------------------------------
SERIES PREFERENCE SHARES JUNE 30, 2002 DECEMBER 31, 2001
- ------------------------------------------------------------------------------------------------
A $0.4481 15,309,822 15,298,350 ---
B $0.4592 13,232,798 12,025,656 ---
------------------------------------------------------
Total preferred stock 28,542,620 27,324,006 ---
======================================================
The holders of Series A, and B convertible preferred stock (the "Series A
Stock" and "Series B Stock") are entitled to non-cumulative dividends if and
when such dividends are declared by the Board of Directors. No dividends have
been declared to date. In the event of any liquidation, dissolution, or
winding up of the Company, the holders of Series A and B Stock are entitled to
receive an amount per share equal to their liquidation preference, equal the
purchase price of Series A and B Stock, plus any declared but unpaid dividends
and subject to adjustment for stock splits and similar adjustments.
The holders of Series A and B Stock each have one vote for each full share of
common stock into which their respective shares of preferred stock are
convertible on the record date for the vote.
At the option of the holder, the Series A Stock are convertible into common
stock on a one-for-one basis, subject to adjustment for stock splits and
similar adjustments of the Series A Stock, and will automatically convert into
common stock concurrent with the closing of an underwritten public offering of
common stock under the Securities Act of 1933 in which the Company receives at
least $5,000,000 in gross proceeds at a valuation of at least $25,000,000.
At the option of the holder, the Series B Stock is convertible into common
stock on a one-for-one basis, subject to adjustment for stock splits and
similar adjustments of the Series B Stock, and will automatically convert into
common stock concurrent with the earlier to occur of (i) the closing of an
underwritten public offering of common stock under the Securities Act of 1933
in which the Company receives at least $5,000,000 in gross proceeds at a
valuation of at least $25,000,000, and (ii) at such time as the Company's
certificate of incorporation is amended to increase the number of authorized
shares of Common Stock of the Company sufficient to permit the issuance of
that number of shares of Common Stock into which all issued and outstanding
shares of Series B Stock are convertible.
Beginning on the 7th anniversary of the issuance and delivery of the Series A
Stock, or June 21, 2009, the Series A Stock shall be subject to redemption at
option of the holders of not less than a majority of the Series A Stock at a
per share redemption price equal to
the liquidation value of the Series A Stock at the time of redemption. The
liquidation value will equal the purchase price of the Series A Stock plus any
declared, but unpaid dividends and taking into account any stock splits or
similar adjustments to the Series A Stock. The Company shall redeem not less
than all of the Series A Stock at the Redemption Price, pro-rata among all of
the holders of the Series A Stock, in one-third (1/3) increments on each of
the 7th, 8th and 9th anniversaries of the issuance and delivery of the Series
A Stock.
The Company has agreed to reserve sufficient shares of its common stock for
the conversion of its outstanding Series A and B Stock, once such common
shares have been authorized at the next annual meeting of the Company's
stockholders.
STOCK OPTIONS
The Company has elected to follow Accounting Principles Board Opinion No. 25,
Accounting for Stock Issued to Employees (APB 25), and related interpretations
in accounting for its employee stock options because, as discussed below, the
alternative fair value accounting provided for under SFAS 123 requires use of
option valuation models that were not developed for use in valuing employee
stock options. Under APB 25, when the exercise price of the Company's employee
stock options equals or exceeds the market price of the underlying stock on
the date of grant, no compensation expense is recognized.
The Black-Scholes option valuation model was developed for use in estimating
the fair value of traded options that have no vesting restrictions and are
fully transferable. In addition, option valuation models require the input of
highly subjective assumptions, including the expected stock price volatility.
Because the Company's employee stock options have characteristics
significantly different from those of traded options and because changes in
the subjective input assumptions can materially affect the fair value
estimate, in management's opinion, the existing models do not necessarily
provide a reliable single measure of the fair value of its employee stock
options.
The effect of applying the FASB statement's minimum-value method to the
Company's stock option grants resulted in pro forma net loss of $9,045,429 and
a pro forma net loss per share of $(.53) for the year ended June 30, 2002.
This pro forma net loss includes the impact of immediate vesting of all
outstanding options and warrants on June 21, 2002 in connection with the
reverse merger and recapitalization. Future pro forma operating results may be
materially different from actual amounts reported.
The fair value of the Company's stock-based awards to employees was estimated
assuming the following weighted-average assumptions:
6 MONTHS ENDED
JUNE 30, 2002
------------------
Expected volatility 83%
Expected life of options in years 10 YEARS
Risk-free interest rate 4%
Expected dividend yield -
The Company has an Employee Stock Option Plan (the Plan) that provides up to
2,700,000 options to be issued to employees, and non-employees (other than
non-employee directors) of the Company. No option grants were made to
employees during 2002. All options are subject to forfeiture until vested and
unexercised options expire on the tenth anniversary of the year granted.
Vesting is generally over five years. All employee stock options issued by the
Company have been granted with exercise prices equal to or greater than the
fair market value of the common stock on the date of grant; accordingly, the
Company has recorded no compensation expense related to such grants. At June
30, 2002, options for 2,551,888 shares were available for grant under the
Plan. The Company has reserved 2,700,000 shares of common stock for issuance
under the Plan.
In April 1996, the Company adopted its Non-Employee Director Option Plan (the
Director Option Plan), pursuant to which non-employee directors of the Company
will be granted an option to purchase 2,500 shares of common stock on January
1, of each calendar year for each year of service. The exercise price of such
options shall be at the fair market value of the Company's common stock on the
date of grant. Options become fully vested and exercisable on the December 31,
immediately following the date on which the option is granted. Stock options
granted under the Director Option Plan may not be transferred other than by
will or by the laws of descent and distribution. The Board of Directors may
terminate the Director Option Plan at any time. Upon the occurrence of a
Change of Control, as defined in the Director Option Plan, all outstanding
unvested options under the Director Option Plan immediately vest. As of June
30, 2002, 17,500 shares were outstanding and 52,500 were available for grant
under the Director Option Plan. The Company has reserved 70,000 shares of
common stock for issuance under the Director Option Plan.
In May 1999, the Company adopted its Non-Employee Director Supplemental Stock
Option Plan (the Director Supplemental Option Plan) that provides up to
500,000 options to be issued to the Directors of the Company as amended. The
exercise price of such options shall not be less than the fair market value of
the Company's common stock on the date of grant. The Board of Directors may
terminate the Director Supplemental Option Plan at any time. Upon occurrence
of a Change in Control as defined in the Director Supplemental Option Plan,
all outstanding unvested options under the Director Supplemental Option Plan
vest immediately. As of June 30, 2002, options for 175,400 shares were
outstanding and 324,600 shares were available for grant under the Director
Supplemental Option Plan. The Company has reserved 500,000 shares of common
stock for issuance under the Director Supplemental Option Plan.
During the six months ended June 30, 2002 the Company granted options to
purchase 5,000 common shares at exercise prices of $0.0825, which was
considered to be equal to the fair market value at the date of grant.
In accordance with the merger between the Company and the Subsidiary, the
Company assumed all outstanding options of the Subsidiary, such that
immediately after the merger, options for the stock of the Subsidiary became
options for the stock of the Company. As of June 30, 2002, options assumed
from the Subsidiary included options for 8,165,957 shares of the Company's
common stock, at an average exercise price of $0.38 and exercise prices
ranging from $0.13 to $0.53.
During the six months ended June 30, 2002, the Subsidiary granted the
equivalent of 1,787,175 shares of the Company's common stock at an exercise
price of $0.13 per share, which was considered to be below the fair market
value of the common stock on the date of grant.
All options assumed from the Subsidiary were fully vested upon the effective
date of the merger, June 21, 2002.
In accordance with APB 25, compensation expense has been recognized as the
difference between the exercise prices of these options at their respective
grant dates and management's estimate of fair value for financial reporting
purposes of common stock based on the vesting schedules of the options. Prior
to the merger, the Subsidiary recorded $451,684 of compensation expense during
the six months ended June 21, 2002. In connection with the merger, all options
vested thus the Subsidiary recorded an additional $2,8487,320 of compensation
expense on the day of the merger, all of which is attributable to the options
assumed from the Subsidiary.
A summary of activity under the Company's stock option plans is as follows:
OPTIONS OUTSTANDING
---------------------------------------------------
WEIGHTED-
NUMBER OF PRICE PER AVERAGE PRICE
SHARES SHARE PER SHARE
Balance at December 31, 2001 2,255,943 $0.45 - $1.45 $1.34
---------------------------------------------------
Conversion of ReGen December 31,2001 to 6,202,715 $0.16 - $0.53 $0.49
Aros Options
Aros balance at December 31, 2001 1,146,268 $0.08 - $13.00 $4.26
Aros options granted 5,000 $0.08 $0.08
ReGen options granted 2,788,092 $0.13 - $0.53 $0.15
ReGen options exercised (824,850) $0.13 $0.13
Aros options canceled (388,968) $0.08 - $13.00 $2.24
------------------
Balance at June 30, 2002 8,928,257 $0.08 - $13.00 $0.82
===================================================
As of June 30, 2002, all outstanding options of the Company were fully
exercisable. The weighted average fair value of options granted during 2002
was $409,322, estimated using the Black-Scholes option valuation model under
the assumptions outlined earlier in this footnote.
The following table summarizes information about outstanding options at June
30, 2002:
WEIGHTED-
AVERAGE REMAINING
PRICE PER CONTRACTUAL
SHARE SHARES LIFE IN YEARS
- ---------------------------------------------------------------------
$0.00 - $0.50 2,780,793 7.37
$0.51 - $1.00 5,672,664 6.79
$1.01 - $2.00 46,694 6.77
$2.01 - $13.00 428,106 4.04
-------------------
8,928,257
-------------------
WARRANTS
In August 1997 and September 1997, the Subsidiary issued in connection with
the Series E financing, warrants to purchase the equivalent of 249,350 shares
of the Company's common stock at $0.53 per share. These warrants were extended
for an additional 5 years to August 2007 by the Aros Board on August 8, 2002
and were fully exercisable as of June 30, 2002.
In conjunction with the 2000 credit agreement, the Subsidiary issued warrants
to purchase the equivalent of 412,425 shares of the Company's common stock at
$1.64 per share. The warrants expire on August 7, 2005. These warrants can be
exercised by the holder to the extent that the Holder's ownership of the
Company on a fully diluted basis does not exceed 19.9%. At June 30, 2002, the
holders of the warrants owned approximately 12.5% of the Company on a fully
diluted basis and were fully exercisable.
In March 2001, Aros issued 1,000,000 warrants for the Company's common stock
to the stockholders of MetaContent, Inc. at an exercise price of $0.50 per
share. The warrants expire March 19, 2011. At June 30, 2002, the warrants were
fully exercisable.
In connection with the 2001 and 2002 Bridge Loans, and subsequent Series G
Convertible Preferred financing, entered into between the Subsidiary and
certain of its shareholders, the Subsidiary issued the equivalent of 2,151,765
warrants for the Company's common shares at an exercise price of $0.45 per
share.
In accordance with the terms of the Bridge Loan Agreement and the Notes, the
exercise price and number of shares exercisable under the warrants was not
known until the consummation of the Series G financing. Therefore, no value
had previously been assigned to the warrants or the beneficial conversion
feature of the Bridge Loan Agreement and the Notes. At June 21, 2002 the value
of the warrants issues was established as $656,788 and the value of the
beneficial conversion was established as $843,566. The sum of these amounts
was recorded as a reduction of the borrowings outstanding (debt discount) and
an increase in additional paid in capital on June 21, 2002. The warrants and
beneficial conversion are fully vested, therefore the entire amount of the
debt discount was recorded as interest expense on June 21, 2002.
13. INCOME TAXES
The Company had differences in reporting expenses for financial statement
purposes and income tax purposes. The provision for income taxes consists of:
YEAR ENDED DECEMBER 31,
2001
-------------------------
Current $ -
Deferred (1,663,321)
Valuation allowance 1,663,321
-------------------------
$ -
=========================
The provision for income taxes can be reconciled to the income tax that would
result from applying the statutory rate to the net loss before income taxes as
follows:
YEAR ENDED DECEMBER
31, 2001
-----------------------
Tax at statutory rate $ (1,472,506)
State taxes (198,978)
Permanent items 8,163
Increase in valuation allowance 1,663,321
-----------------------
$ -
=======================
The significant components of the Company's deferred income tax assets and
liabilities are as follows:
DECEMBER 31, 2001
----------------------
Deferred tax assets:
Net operating loss carryforward $ 12,090,721
R&D credit carryforward 401,782
----------------------
12,492,503
Valuation allowances (12,492,503)
----------------------
$ -
======================
The net operating loss carryforward at December 31, 2001 was approximately
$31.3 million and the research and development tax credit was approximately
$402,000. The federal net operating loss and credit carryforwards will begin
to expire in 2006, if not utilized. The state net operating loss and credit
carryforwards started to expire in 2000, and will continue to expire if not
utilized. The utilization of net operating loss carryforwards may be limited
due to changes in the ownership of the Company, and the effect of the merger
completed on June 21, 2002 may further impair the Company's ability to use the
net operating loss carryforwards.
14. BASIC AND DILUTED LOSS PER SHARE
The Company implemented SFAS No. 128, "Earnings Per Share," which requires
dual presentation of basic and diluted earnings per share. Basic loss per
share includes no dilution and is computed by dividing net loss available to
common stockholders, by the weighted average number of common shares
outstanding for the period. Diluted loss per share includes the potential
dilution that could occur if securities or other contracts were exercised or
converted into common stock. Options and warrants outstanding were not
included in the computation of diluted loss per share, as their effect would
be anti-dilutive. Diluted loss per share and basic loss per share are
identical for all periods presented.
For all periods presented, basic and diluted loss per share is calculated
using the number of shares outstanding after the reverse merger and
recapitalization.
15. FINANCINGS AND CAPITAL TRANSACTIONS
On June 21, 2002, the Subsidiary amended and restated its Certificate of
Incorporation to provide for the following:
The creation of Series G Convertible Preferred Stock (Series G Stock) with
19,200,000 shares authorized.
The rights of the Subsidiary's existing Series A Convertible Preferred Stock,
Series B Convertible Preferred Stock, Series C Preferred Convertible Stock,
Series D Convertible Preferred Stock, Series E Convertible Preferred Stock,
Series F Convertible Preferred Stock and Series G Convertible Preferred Stock
(collectively referred to as the "Preferred Stock") were amended and
established as follows:
DIVIDEND RIGHTS: If the Subsidiary shall at any time declare and pay any
dividend in the form of cash, stock or property on the outstanding Common
Stock, it shall at the same time and on the same terms declare and pay a
dividend in the same form on the outstanding Preferred Stock at a rate
assuming all Preferred Stock were converted into Common Stock immediately
prior to the dividend declaration.
LIQUIDATION RIGHTS: In the event of any liquidation, dissolution or winding up
of the Subsidiary, holders of the Preferred Stock shall be entitled to
receive, before any amount shall be paid to holders of Common Stock, an amount
per share equal to $1.00 for Series A, $3.00 for Series B, $4.50 for Series C,
$7.25 for Series D, $7.25 for Series E, $8.73 for Series F and $1.23 for
Series G plus all accrued and unpaid dividends, if any.
VOTING RIGHTS: The holders of Preferred Stock are entitled to vote upon any
matter submitted to the stockholders for a vote. Such holders shall each have
one vote for each full share of Common Stock into which their respective
shares of Preferred Stock are convertible on the record date for the vote.
Holders of Preferred Stock shall vote as a single class.
CONVERSION RIGHTS: Shares of Preferred Stock can be converted into shares of
Common Stock at the option of the holder and automatically upon the
occurrences of the closing of an offering pursuant to an effective
registration statement pursuant to which Common Stock is sold to the public by
the Subsidiary in a public offering registered under the Securities Act of
1933 at a per share public offering price of not less than $10 and a aggregate
public offering price of at least $7,500,000. In addition, in the event of a
merger or sale of the Subsidiary, the holders of Preferred Stock may elect to
have their shares treated as converted. Each share of Preferred Stock is
converted into the number of Common Shares that results from dividing the
Conversion Price as defined, by the liquidation value per share (see above).
Initially, the Conversion Price is equal to the liquidation value per share
and can never exceed the liquidation value per share. Adjustments to the
Conversion Price are required in the event of the issuance of additional
shares of stock of the Subsidiary, stock splits, dividends and
recapitalizations.
On June 21, 2002, the Subsidiary issued 5,564,047 shares of Series G
Convertible Preferred Stock (Series G Stock) to existing shareholders of the
Subsidiary for $1.2321 per share. Cash of $4,000,000 was received for
3,246,490 of the shares issued. The remaining 2,317,557 shares were issued
upon conversion of notes payable and accrued interest from 2001 and 2002
financings with a value of $2,855,465.
16. MERGER WITH REGEN CORPORATION
On June 21, 2002, the Company approved a merger of the Subsidiary into Aros
Acquisition Corporation, a wholly owned subsidiary of Aros. Aros discontinued
its operations in 2001 and has been evaluating alternatives to best utilize
its assets.
The outstanding shares of Common Stock, Preferred Stock and options and
warrants to acquire Common Stock and Preferred Stock of the Subsidiary have
been converted into equity instruments of Aros as follows:
COMMON STOCK: Each share of the Subsidiary's Common Stock has been converted
into 2.7495 shares of unregistered common stock of Aros.
SERIES A, SERIES B, SERIES C, SERIES D, SERIES E AND SERIES F PREFERRED STOCK:
Each share of the Subsidiary's Series A, Series B, Series C, Series D, Series
E and Series F Convertible Preferred Stock has been converted into 0.0663
shares of unregistered, fully paid, non-assessable Aros Common Stock (Aros
Common Stock) plus 2.6832 shares of unregistered, fully paid, non-assessable
Aros Series B Convertible Preferred Stock (Aros Series B Stock).
SERIES G PREFERRED STOCK: Each share of the Subsidiary's Series G Preferred
Stock has been converted to 2.7495 shares of unregistered, fully paid,
non-assessable shares of Aros Series A Convertible Preferred Stock (Aros
Series A Stock).
STOCK OPTIONS AND WARRANTS: Immediately prior to the merger, the Subsidiary
accelerated the vesting of all options such that at the time of the merger,
all stock options and warrants were fully vested. Each option and each warrant
to purchase the Subsidiary's Common Stock has been assumed by Aros and
converted into options and warrants, respectively, to acquire Aros Common
Stock. Each option and warrant shall be exercisable for that number of shares
of Aros Common Stock equal to the product of the number of shares of the
Subsidiary's Common Stock that were purchasable under such Subsidiary option
multiplied by 2.7495, and rounded to the nearest whole number of shares of
Aros Common Stock. Each warrant to purchase the Company's Series C Convertible
Preferred Stock was assumed by Aros and converted into warrants to purchase
0.0663 shares of Aros Common Stock and 2.6832 shares of Aros Series B Stock.
The per share exercise price for shares of Aros Common Stock or Aros Series B
Stock issuable upon exercise of such assumed Company options and warrants
shall be equal to the quotient determined by dividing the exercise price per
share of Subsidiary Common Stock or Series C Convertible Preferred Stock, as
applicable, at which such Subsidiary options and warrants were exercisable by
2.7495.
All shares issued to holders of Subsidiary Common Stock and Preferred Stock
and issued under the Company stock options and warrants assumed by Aros are
unregistered.
Aros and the receiving shareholders have entered into a Registration Rights
Agreement under which Aros, at its option, can register the unregistered
shares in whole or part. Holders of unregistered shares can request, subject
to certain limitations, and Aros is required to make a best commercial efforts
to, register blocks of unregistered shares beginning 90 days after the Form
10-K for the year ending December 31, 2002 of Aros is filed. Aros is required
to bear the cost of all such registrations except that in an underwritten
offering, the holder of the shares will bear any underwriting discounts and
commissions, if any, and transfer taxes relating to the registration.
Upon completion of this merger, holders of the Subsidiary's Common Stock and
Preferred Stock control approximately 80% of the voting rights of the combined
company. As such, the Subsidiary is the deemed acquirer for purposes of
accounting for this merger.
The Aros Series A Stock has rights and terms that provide for certain
preferences in the event of liquidation to the Aros Series B Stock and Aros
Common Stock. Additionally, the Aros Series A Stock has mandatory conversion
features upon certain circumstances including but not limited to a qualified
offering that results in cash proceeds to Aros of at least $5,000,000 and
assumes a minimum valuation of the Subsidiary of at least $25,000,000 and the
Aros Series A Stock is redeemable at the option of the holder subject to
certain conditions at any date from and after the date of the seventh
anniversary of the issuance and delivery of the Aros Series A Stock at the
liquidation value.
The Aros Series B Stock has rights and terms that provide for certain
preferences in the event of liquidation to the Aros Common Stock.
Additionally, the Aros Series B Stock has mandatory conversion features upon
certain circumstances including but not limited to a qualified offering that
results in cash proceeds to Aros of at least $5,000,000 and assumes a minimum
valuation of the Subsidiary of at least $25,000,000 or at such time as Aros's
certificate of incorporation is amended to increase the number of authorized
shares of Aros Common Stock sufficient to permit for the issuance of that
number of shares of Aros Common Stock into which all issued and outstanding
shares of Aros Series B Stock are convertible.
On June 20, 2002, the closing price for Aros Common Stock was $0.28 per share.
The merger was accounted for as a reverse merger with the Subsidiary being the
deemed accounting acquirer. The assets and liabilities of the Company at the
acquisition date comprised $2.95 million in cash, $211,846 in prepaid and
other assets and $430,165 in accounts payable, accrued expenses and other
liabilities. The fair values of these assets and liabilities approximate their
book values at the acquisition date. Because the Company was essentially a
non-operating entity at the time of the merger, the merger was considered a
capital transaction in substance and no goodwill was recorded. The assets and
liabilities of the Company were merged with the assets and liabilities of the
Subsidiary as of the merger date. As the Subsidiary is the deemed accounting
acquirer, its assets and liabilities remain at historical costs. The
accompanying financial statements reflect the historical financial statements
of the Subsidiary and the results of operations and assets and liabilities of
the Company from the merger date.
Costs associated with the merger include estimated legal and accounting fees
and an estimate of the costs to be incurred to register the unregistered
shares distributed to the former shareholders of the Subsidiary in connection
with the merger. Management's estimate of these costs totaling $402,000 has
been expensed in the period ended June 30, 2002.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
BUSINESS DEVELOPMENTS
On June 21, 2002, Aros Corporation ("Aros", the "Company") acquired ReGen
Biologics, Inc. ("ReGen", the "Subsidiary"), a privately held tissue
engineering company that designs, develops, manufactures and markets minimally
invasive human implants and medical devices for the repair and regeneration of
damaged human tissue, which merged with the Company on June 21, 2002. The
merger included all of ReGen's business and operating activities and
employees. The Company will continue ReGen's business out of ReGen's current
headquarters in Franklin Lakes, New Jersey.
Pursuant to the merger, Aros has issued approximately 35.4 million shares of
its capital stock to former ReGen stockholders in exchange for all of the
issued and outstanding stock of ReGen. In addition, Aros will assume ReGen's
outstanding stock options and warrants to purchase up to an aggregate of
approximately 11 million shares of Aros Common Stock and 1.2 million shares of
Aros Preferred Series B Convertible Preferred Stock on a post merger basis.
Following the merger, former ReGen stockholders will own approximately 80% of
Aros outstanding capital stock.
Aros Corporation, a Delaware corporation, was incorporated as APACHE Medical
Systems, Inc. ("APACHE") on September 1, 1987. APACHE was a provider of
clinically based decision support information systems and consulting services
to the healthcare industry offering a comprehensive line of outcomes-based
products and services, encompassing software, hardware, and related consulting
and disease management information services. The Company sold or discontinued
all APACHE business and changed its name to Aros Corporation in 2001.
ReGen Biologics, Inc., a Delaware corporation, was incorporated in California
on December 21, 1989 and reincorporated in Delaware on June 28, 1990 for the
purpose of research and development and, ultimately, the sale of
collagen-based technologies and products to stimulate re-growth of tissues
that, under natural conditions, do not regenerate adequately in humans.
ReGen has two products currently being marketed, the Sharp Shooter Tissue
Repair System ("SharpShooter") and the Collagen Meniscus Implant ("CMI").
ReGen's activities to date have consisted principally of raising capital,
conducting research and development activities, developing and marketing and
obtaining regulatory approval for its products. The CMI and Sharp Shooter in
2000 each received the CE Mark for distribution in the European Economic
Community. The Sharp Shooter in 2000 received marketing clearance for sale in
the United States by the United States Food and Drug Administration (FDA).
ReGen is in the final stages of enrollment for its CMI clinical trial in the
United States. ReGen will continue to require additional capital to complete
the U.S. CMI clinical trial, further develop its products and further develop
sales and distribution channels for its products around the world.
Accordingly, ReGen is still considered a development stage enterprise.
Management believes that ReGen will emerge from development stage when the CMI
product is available for sale in the U.S. and/or sales of all of its products
have reached a volume that will provide for positive gross margin.
The Company's two current products, the SharpShooter and CMI, are marketed and
distributed by two companies. Centerpulse (formerly Sulzer Medica) is the
exclusive distributor of the CMI outside the United State, and Linvatec, a
division of Conmed, Inc. is currently the exclusive worldwide distributor of
the SharpShooter.
CRITICAL ACCOUNTING POLICIES
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.
We have identified below some of our more significant accounting policies
followed by the Company in preparing the accompanying consolidated financial
statements. For further discussion of our accounting policies see Footnote 3
"Summary of Significant Accounting Policies" in the Notes to Consolidated
Financial Statements.
REVENUE RECOGNITION
We recognize revenue in accordance with the provisions of Staff Accounting
Bulletin No. 101, Revenue Recognition in Financial Statements, whereby revenue
is not recognized until it is realized or realizable and earned. Revenue is
recognized when all of the following criteria are met: persuasive evidence of
an arrangement exists, delivery has occurred or services have been rendered,
the seller's price to the buyer is fixed or determinable and collectibility is
reasonably assured.
The Company receives royalties from its licensees. Royalties are generally due
under the license agreements when the licensee sells the product to a third
party. If determinable at the time results are published by the Company,
royalties are recognized when the licensee has sold the product to the end
user and the Company has fulfilled its obligations under the applicable
agreement. If not determinable at the time results are published, royalties
are recognized in the period they become determinable.
License fees represent payments received from distributors for exclusive
perpetual licenses to sell the Company's products in various geographic areas.
These fees are recognized as other income when all performance criteria in the
underlying agreement have been met. Generally, license fees for existing
license arrangements are not recurring.
The Company's history of product returns has been insignificant, therefore no
reserve for returns and allowances has been provided. Reserves for product
recalls in 2001 and 2002 were estimated based on the costs to be incurred to
recall and rework the product.
INVENTORY VALUATION
Inventory is valued at the lower of cost or market. Market is based on current
sales of product to existing customers reduced by an estimate of cost to
dispose.
RESEARCH AND DEVELOPMENT COSTS
Research and development costs are expensed as incurred. We will continue to
incur research and development costs as we continue our product development
activities and pursue regulatory approval to market our products. Research and
development costs have, and will continue to include expenses for internal
development personnel, supplies and facilities, clinical trials, regulatory
compliance and filings, validation of processes and start up costs to
establish commercial manufacturing capabilities.
STOCK BASED COMPENSATION
The Company has accounted for its stock-based compensation in accordance with
Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to
Employees. No expense is recognized for options issued to employees where the
exercise price is equal to or greater than the market value of the underlying
security. Expense is recognized in the financial statements for options issued
to employees where the option price is below the fair value of the underlying
security, for options issued to non-employees and for options and warrants
issued in connection with financing and equity transactions (collectively
revered to as "compensatory options"). For periods prior to the merger of the
Company with the Subsidiary, expense associated with compensatory options and
warrants has been measured based on management's estimate of the fair value of
the underlying security (which in turn is based on management's estimate of
the fair value of the Subsidiary).
MERGER AND RELATED COSTS
The merger of the Company and the Subsidiary on June 21, 2002 has been
accounted for as a reverse merger whereby the Subsidiary is the deemed
accounting acquirer. The historical financial statements of the Subsidiary
replace the financial statements of the Company in this filing and future
filings. As the Subsidiary is the deemed accounting acquirer, its assets and
liabilities remain at historical costs. The assets and liabilities of the
Company comprised only cash, prepaid expenses and accrued liabilities. The
fair value of these assets was equal to their historical cost. Because the
Company was essentially a non-operating entity at the time of the merger, the
merger was considered a capital transaction in substance and no goodwill was
recorded. The assets and liabilities of the Company were merged with the
assets and liabilities of the Subsidiary as of the acquisition date.
Costs associated with the merger include estimated legal and accounting fees
and an estimate of the costs to be incurred to register the unregistered
shares distributed to the former shareholders of the Subsidiary in connection
with the merger. Management's estimate of these costs has been expensed in the
period ended June 30, 2002.
RESULTS OF OPERATIONS
THREE AND SIX MONTHS ENDED JUNE 30, 2002 AND JUNE 30, 2001
REVENUE. Revenues increased $133,000 or 310% to approximately $176,000 during
the three months ended June 30, 2002 from approximately $43,000 for the same
period 2001. Revenues increased $115,000 or 50% to $347,000 during the six
months ended June 30, 2002 from $232,000 for the same period 2001. The
increase in revenues resulted primarily from a significant increase in sales
of the SharpShooter product to Linvatec Corporation and the royalties
associated with the sales of the SharpShooter by Linvatec to its customers.
Linvatec accounted for greater than 50% of revenue for the three and six
months ended June 30, 2002 and CenterPulse (formerly Sulzer Medica) accounted
for greater than 60% of revenue for the three and six months ended June 30,
2001.
COST OF GOODS SOLD. Cost of goods sold increased by approximately $235,000 for
the three and six months ended June 30, 2002. This increase is related to the
increase sales of the SharpShooter for the same period, together with the
impact of a warranty reserve recorded during the first quarter of 2002.
SharpShooter costs accounted for $204,651 and $142,663 and the warranty
accrual accounted for $0 and $75,398 in the three and six month periods.
RESEARCH AND DEVELOPMENT. Research and development expenses for the three and
six months ended June 30, 2002 increased to $715,000 and $1.3 million, from
approximately $512,000 and $940,000 for the same periods in 2001. Research and
development expenses have increased due to several factors, including (i) an
increase in the costs associated with the enrollment stage of the CMI clinical
trial currently being conducted in the United States, (ii) an increase in the
manufacturing costs unassociated with the production of products for resale,
and (iii) an increase in the cost of patent development and maintenance costs.
SELLING, GENERAL AND ADMINISTRATIVE. Selling, general and administrative
expenses were $373,000 and $722,000 for the three and six months ended June
30, 2002, respectively, compared with from $393,000 and $828,000 for the same
periods in 2001. These costs include the costs of marketing, business
development, corporate operations, finance and accounting, and other general
expenses.
COMPENSATION EXPENSE. Compensation expense associated with stock options and
warrants increased significantly from $240,000 for the three months ended June
30, 2001 to $3.0 million for the same period in 2002. The 2002 amount includes
the impact of the accelerated vesting of all outstanding stock options of
ReGen at the time of the merger with Aros.
OTHER INCOME. Other income increased to $4,000 for the three months ended June
30, 2002 from $2,000 for the same period in 2001. We recognized this increase
due to an increase in interest income resulting from an increase in short-term
investments.
INTEREST EXPENSE. Interest expense increased from $59,000 to $1.6 million for
the three months ended and $137,000 to $1.7 million for the six months ended
June 30, 2001 to the same period in 2002 due to the accrual of interest
payable and related beneficial conversion of bridge loans into Series G
Convertible Preferred stock of ReGen, and the valuation of warrants issued in
connection with the conversion of the ReGen bridge loans to preferred stock.
See note 6 of the notes to consolidated financial statements for a full
description of the bridge loans and associated warrants and beneficial
conversion.
LIQUIDITY AND CAPITAL RESOURCES
Cash and short-term investment were $6.25 million as of June 30, 2002 compared
with $320,000 as of December 31, 2001. The increase in cash and short term
investments is the result of approximately $4.95 million in cash proceeds from
Bridge Financings and the issuance of equity securities and approximately
$2.95 million in cash and short-term investment from the reverse merger and
recapitalization transaction between ReGen and Aros. The cash proceeds from
Bridge Financings includes approximately $1 million from debt issued in March
of 2002. This debt along with existing Bridge Financing and accrued interest
which in the aggregate approximated $2.86 million was converted to Series G
Convertible Preferred Stock of ReGen on June 21, 2002 and subsequently into
Series A Redeemable Convertible Preferred Stock of the Company. The cash
proceeds from the issuance of equity securities includes $105,000 in cash
received from the issuance of ReGen Common Stock and $3.86 received from the
issuance of additional Series G Convertible Preferred Stock of ReGen.
The reverse merger and recapitalization between ReGen and Aros resulted in the
conversion of all ReGen equity securities into equity securities of the
Company and provided the Company with access to the existing cash balance of
Aros of approximately $2.95 million. Net monetary assets of Aros approximated
$2.73 million.
The increases in cash and short-term investments discussed above is offset by
cash used in operating activities during the six months ended June 30, 2002 of
approximately $1.96 million.
The Company anticipates that its cash and short-term investments will be
sufficient to meet its planned ongoing operating and working capital
requirements for the next twelve months. Through June 30, 2002, the Company
has incurred cumulative net operating losses of approximately $39.5 million.
The Company anticipates that it will continue to incur net operating losses
that will require additional financing to fund operation at the earliest until
the Company receives FDA approval for its CMI product and is able to
market the CMI product in the United States. The Company is currently nearing
completion of enrollment for the clinical trial of its CMI product. There can
be no assurance that such financing can be obtained, or obtained on terms
acceptable to the Company.
SAFE HARBOR FOR FORWARD-LOOKING STATEMENTS
Cautionary Note Regarding Forward-Looking Statements
Such statements are based on the current expectations and beliefs of the
managements of Aros and ReGen and are subject to a number of factors and
uncertainties that could cause actual results to differ materially from those
described in the forward-looking statements, including those discussed in the
Risk Factors section of Aros' most recent annual report on Form 10K, as
amended, on file with the Securities and Exchange Commission. Aros' filings
with the SEC are available to the public from commercial document-retrieval
services and at the Web site maintained by the SEC at http://www.sec.gov.
Statements in this filing, which are not historical facts, are forward-looking
statements under provisions of the Private Securities Litigation Reform Act of
1995. All forward-looking statements involve risks and uncertainties. We wish
to caution readers that the following important factors, among others, in some
cases have affected, and in the future could affect our actual results and
could cause our actual results in fiscal 2002 and beyond to differ materially
from those expressed in any forward-looking statements made by us or on our
behalf.
Important factors that could cause actual results to differ materially include
but are not limited to our ability to complete the CMI clinical trial and
obtain FDA approval, our ability to raise obtain additional financing, the
ability of our distribution partners to effectively market and sell our
products, the timely collection of our accounts receivable, our ability to
attract and retain key employees, our ability to timely develop new products
and enhance existing products, the occurrence of certain operating hazards and
uninsured risks, our ability to protect proprietary information and to obtain
necessary licenses on commercially reasonable terms, the impact of
governmental regulations, changes in technology, marketing risks and one time
events on our business and our ability to adapt to economic, political and
regulatory conditions affecting the healthcare industry.
Our quarterly revenues and operating results have varied significantly in the
past and are likely to vary from quarter to quarter in the future. Quarterly
revenues and operating results may fluctuate as a result of a variety of
factors, including the ability of our distribution partners to market and sell
our products, variable customer demand for our products and services, our
investments in research and development or other corporate resources, our
ability to effectively and consistently manufacture our products, the ability
of our vendors to effectively and timely delivery necessary materials and
product components, acquisitions of other companies or assets, the timing of
new product introductions, changes in distribution channels, sales and
marketing promotional activities and trade shows and general economic
conditions. Further, due to the relatively fixed nature of most of our costs,
which primarily include personnel costs as well as facilities costs, any
unanticipated shortfall in revenue in any fiscal quarter would have an adverse
effect on our results of operations in that quarter. Accordingly, our
operating results for any particular quarterly period may not necessarily be
indicative of results for future periods.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company's obligations as of June 30, 2002 include debt instruments equal
to (i) $350,000 in principle with fixed rate interest payable at a rate equal
to 7%, which the Company believes approximates fair value, and (ii)
approximately $5.7 million in principle with variable rate interest payable at
rates ranging from 2.06% to 7.21%, adjusted annually based upon 1% over the 1
year LIBOR at the anniversary of the loans. All principle and accrued interest
under these loans mature on the earlier of 36 months from the date the Company
receives FDA approval for its CMI product, or December 31, 2009.
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company is a defendant from time to time in lawsuits incidental to its
business. The Company is not currently subject to, and none of its properties
are subject to, any material legal proceedings.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits.
The following Exhibits are filed herewith and made a part hereof:
EXHIBIT NO. DESCRIPTION
2.1 Agreement and Plan of Merger by and among ReGen Biologics, Inc.,
Aros Corporation and Aros Acquisition Corporation dated as of
June 7, 2002
2.2 Agreement and Plan of Merger among the Company, NHA Acquisition
Corporation, National Health Advisors, Ltd., Scott A. Mason and
Donald W. Seymour dated as of June 2, 1997 (5)
2.3 Agreement and Plan of Merger among the Company and MetaContent,
Inc. dated as of March 21, 2001 (2)
2.4 Asset Purchase Agreement between Cerner Corporation and the
Company dated as of April 7, 2001 (3)
2.5 Amendment No. 1 to Asset Purchase Agreement by and between Cerner
Corporation and the Company dated as of June 11, 2001 (3)
3.1 Amended and Restated Certificate of Incorporation (1)
3.2 Certificate of Amendment to the Certificate of Incorporation (5)
3.3 Amended and Restated By-Laws (4)
4.1 Specimen Common Stock Certificate (6)
4.2 Rights Agreement between the Company and First Chicago Trust
Company of New York, dated as of May 6, 1997 (7)
4.3 APACHE Medical Systems, Inc. Employee Stock Option Plan (1)
4.4 APACHE Medical Systems, Inc. Employee Stock Option Plan, Amended
and Restated Effective May 12, 1999 (8)
4.5 APACHE Medical Systems, Inc. Non-Employee Director Option Plan
(1)
4.6 Registration Agreement between the Company and Certain
Stockholders, dated December 28, 1995 (6)
4.7 Amendment No. 1 to Rights Agreement between the Company and
Equiserve Trust Company, N.A., dated as of June 7, 2002
4.8 Nonqualified Stock Option Agreement between the Company and The
Cleveland Clinic Foundation, dated August 19, 1994 (6)
4.9 Registration Agreement between the Company and each of Iowa
Health Centers, P.C. d/b/a Iowa Heart Center, P.C., Mercy
Hospital Medical Center, Mark A. Tannenbaum, M.D. and Iowa Heart
Institute dated January 7, 1997 (9)
4.10 Nonqualified Stock Option Agreements between the Company and each
of Iowa Health Centers, P.C. d/b/a Iowa Heart Center, P.C., Mercy
Hospital Medical Center and Mark A. Tannenbaum, M.D., dated
January 7, 1997 (10)
4.11 Form of Nonqualified Director Stock Option Agreement (11)
4.12 APACHE Medical Systems, Inc. Employee Stock Option Plan, Amended
and Restated February 23, 1998, including forms of Incentive
Stock Option Agreement and Nonqualified Stock Option Agreement
(11)
4.13 APACHE Medical Systems, Inc. Non-Employee Director Supplemental
Stock Option Plan, Amended and Restated effective May 12, 1999
(8)
4.14 APACHE Medical Systems, Inc. Non-Employee Director Supplemental
Stock Option Plan, Amended and Restated effective January 1, 2000
(7)
4.15 APACHE Medical Systems, Inc. Non-Employee Director Supplemental
Stock Option Plan, Amended and Restated effective December 9,
2000 (4)
4.16 APACHE Medical Systems, Inc. Non-Employee Director Supplemental
Stock Option Plan, Amended and Restated effective December 9,
2000 (4)
21 Subsidiaries of the registrant
23 Consent of Ernst & Young LLP
99.1 Certification of Chief Executive Officer
99.2 Certification of Chief Financial Officer
** Confidential portions omitted and supplied separately to the
Securities and Exchange Commission staff
(1) Incorporated herein by reference to the Company's Report on Form
10-Q for the quarter ended June 30, 1997 (File No. 0-20805)
(2) Incorporated herein by reference to the Company's Report on Form
10-Q/A for the quarter ended March 31, 2001 (File No. 0-20805)
(3) Incorporated herein by reference to the Company's Report on Form
8-K dated April 12, 2001 (File No. 0-20805)
(4) Incorporated herein by reference to the Company's Report on Form
10-K for the year ended December 31, 2000 (File No. 0-20805)
(5) Incorporated herein by reference to the Company's Report on Form
10-Q for the quarter ended June 30, 2001 (File No. 000-20805)
(6) Incorporated herein by reference to the Company's Registration
Statement on Form S-1 (File No. 333-04106)
(7) Incorporated herein by reference to the Company's Current Report
on Form 8-K filed on June 4, 1997 (File No. 0-20805)
(8) Incorporated herein by reference to the Company's Report on Form
10-Q for the quarter ended March 31, 1999 (File No. 0-20805)
(9) Incorporated herein by reference to the Company's Current Report
on Form 8-K filed on January 14, 1997 (File No. 0-20805)
(10) Incorporated herein by reference to the Company's Report on Form
10-Q for the quarter ended March 31, 1997 (File No. 0-20805)
(11) Incorporated herein by reference to the Company's Report on Form
10-K for the year ended December 31, 1997 (File No. 0-20805)
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.
Date: AROS CORPORATION
/s/ G. E. BISBEE, Jr. Gerald E.
Bisbee, Jr.
President
Authorized signatory and
Chief Accounting Officer
END OF FILING