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SECURITIES AND EXCHANGE COMMISSION

Form 10-K

Commission file number 000-20805

ReGen Biologics, Inc.

Registrant’s telephone number, including area code:

Securities registered pursuant to Section 12(b) of the Act:

Securities registered pursuant to Section 12(g) of the Act:

Title of Class

Common Stock $.01 par value per share

      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 þ          No o

      Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. þ

      Indicate by a check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2).     Yes o          No þ

      The aggregate market value of the voting common equity held by non-affiliates of the registrant as of June 28, 2002 was approximately $2,770,776. The number of outstanding shares of the registrant’s Common Stock as of March 6, 2003 was 29,070,786.

DOCUMENTS INCORPORATED BY REFERENCE

      Certain portions of the definitive proxy statement to be used in connection with the annual meeting of stockholders, to be held on May 22, 2003, and to be mailed to stockholders of record as of March 25, 2003, are incorporated by reference into Part III of this Form 10-K.

REGEN BIOLOGICS, INC.

INDEX

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PART I

Item 1.     Business

OVERVIEW

      ReGen Biologics, Inc. (“ReGen” or the “Company”), formerly named 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. In connection with the acquisition discussed below, as of November 12, 2002, Aros Corporation changed its name to ReGen Biologics, Inc. and began trading under the new ticker symbol RGBI, effective November 20, 2002.

      On June 21, 2002 ReGen Biologics, Inc. (“ReGen”, or the “Company”) acquired RBio, Inc. (“RBio” or the “Subsidiary”), formerly named ReGen Biologics, Inc., 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. The merger included all of RBio’s business and operating activities and employees. The Company continues RBio’s business out of RBio’s current headquarters in Franklin Lakes, New Jersey. RBio’s business will comprise substantially all of the business conducted by ReGen for the foreseeable future. Accordingly, discussions of the Company’s business are, in effect, a discussion of RBio’s operations. Hereinafter, the merged entity is referred to as ReGen or the Company.

      Pursuant to the merger, ReGen issued approximately 35.4 million shares of its capital stock to former RBio stockholders in exchange for all of the issued and outstanding stock of RBio. In addition, ReGen assumed RBio’s outstanding stock options and warrants to purchase up to an aggregate of approximately 12.2 million shares of ReGen capital stock on a post merger basis. Following the merger, former RBio stockholders held approximately 80% of the outstanding capital stock of the Company.

      RBio, Inc., formerly 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 manufacture and sale of collagen-based technologies and products to stimulate re-growth of tissue that, under natural conditions, does not regenerate adequately in humans. On November 12, 2002, the Subsidiary changed its name to RBio, Inc.

      The Company developed a proprietary collagen based matrix technology, which has been clinically proven to regenerate lost or damaged tissue. This technology produces a scaffold, which promotes the natural re-growth of tissue into the implanted matrix. The matrix material then absorbs, leaving native tissue in its place. The Company chose to initially adapt this technology in the orthopedic area, which offers a substantial unmet need and large market size.

      The Company developed and currently markets outside the U.S., the Collagen Meniscus Implant (“CMI”). This implant product for the meniscus of the human knee is the Company’s first application of its tissue re-growth technology. Patients with a damaged meniscus frequently undergo an arthroscopic surgical procedure known as a partial meniscectomy, removing the damaged tissue, leaving the patient with less meniscus to support the knee and protect the patient from further complications or injury. For many of these patients, the CMI presents a surgical alternative, with the potential to re-grow much of the tissue otherwise lost in these procedures, allowing the patient to return to a more active lifestyle than otherwise may have been possible. In 2002, the Company estimates that there were approximately 1.1 million partial meniscectomy procedures performed worldwide, of which approximately 783,000 were in the United States.

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      The Company has also developed and markets the SharpShooter Tissue Repair System (“SharpShooter”), a suturing device used to facilitate the surgical implant of the CMI, as well as to perform other similar arthroscopic meniscus repair procedures.

      The CMI and SharpShooter in 2000 each received the CE Mark for distribution in the European Economic Community. In 2002, the CMI was cleared for marketing in Australia and Chile, and in 2000, the Sharp Shooter received marketing clearance for sale in the United States by the United States Food and Drug Administration (“FDA”). In the fourth quarter of 2002 the Company completed the required enrollment and related surgical procedures for its CMI clinical trial in the United States.

      The U.S. CMI clinical trial is a multicenter pivotal trial consisting of 288 patients, 14 centers and 23 surgeons. All patients are expected to complete two years of follow-up prior to ReGen’s submission of the results in its Pre-market Approval Application (“PMA”) to the FDA. The Company expects the two-year clinical follow-up exams will be completed in the fourth quarter of 2004, with submission of the completed PMA to the FDA shortly thereafter. To date, the Company has collected two-year clinical results on over 60% of the patients in the CMI trial. The following graphs provide a preliminary analysis with respect to two clinical measurements. The graphs presented below also include a summary of data on eight Feasibility Study patients who received the CMI, with five-year clinical follow-up.

      Graph 1 — These two diagrams represent medial menisci of the human knee. The upper diagram (Post Partial Meniscectomy) shows the average amount of meniscus loss for the eight Feasibility Study CMI patients. These patients have lost 62% of their medial meniscus leaving them with 38% of the original meniscus remaining. The CMI was implanted in the area of meniscus loss. The lower diagram (Post CMI (1 & 5 years)) shows that one year after the CMI was implanted these patients have gained almost double (38% vs. 75%) the amount of meniscus tissue. A follow-up five-year re-look surgery on the eight CMI Feasibility Study patients showed that they have maintained their 75% tissue volume through five years.

Graph 1. Tissue Re-Growth

      Graph 2 — The Tegner Activity Score is a validated method for assessing patient activity levels. A Tegner score of 0 means that the patient is disabled, while a score of 10 means that he is performing sports at a professional level. The graph below shows the Tegner Activity scores for the CMI and control patients in the Multicenter Clinical Trial (MCT) and for the eight CMI patients in the Feasibility Study. Patient activity levels were measured pre-injury, pre-surgery and at one, two and five years post surgery. The solid line shows that the CMI patients in the MCT returned almost to their pre-injury activity level

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Graph 2. Patient Activity Level

      Important Disclosure about Clinical Results: The graphs provided above reflect data from an ongoing U.S. clinical trial and these data have not been reviewed by the U.S. Food and Drug Administration. These results represent a limited data set regarding selected measurements being gathered in the trial. Although the CMI is approved and distributed in Europe, Australia and Chile, it is not approved for sale in the U.S., and the Company is making no claim regarding its safety, effectiveness or its potential for FDA approval.

      The Company 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, the Company is still considered a development stage enterprise. Management believes that the Company will emerge from the development stage when the CMI product is available for sale in the U.S. or sales of all of its products have reached a volume that will provide for positive gross margin.

Employees

      As of December 31, 2002, we had 15 employees, 2 of which were part-time employees. We have no unionized employees and do not have any collective bargaining agreements. We believe our relationship with our employees is good.

      See Management’s Discussion and Analysis of Financial Conditions and Results of Operations for further discussion.

Item 2.     Properties

      We do not own any real estate or improvements. Our corporate offices and production facility are located in Franklin Lakes, New Jersey and Redwood City, CA in approximately 2,700 and 15,021 square

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      Our facilities are adequate for present operations.

Item 3.     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.

      The Company held its Annual Meeting of Stockholders on Tuesday, November 26, 2002. The stockholders elected Gerald E. Bisbee, Jr., Ph.D., Alan Baldwin, Richard Fritschi, Robert G. McNeil, Ph.D., and J. Richard Steadman, M.D. as directors to serve for a term of one year or until their respective successors are duly elected and qualified. The stockholders voted on the following additional matters which were proposed for consideration at the annual meeting:

	•	the increase in the number of authorized shares of our common stock from 30,000,000 to 130,000,000 and the number of authorized shares of our preferred stock from 30,000,000 to 60,000,000;
	•	the approval of the change of our corporate name to ReGen Biologics, Inc. and the accompanying ticker symbol change;
	•	the 1 for 6 reverse stock split of all authorized common stock and preferred stock, which becomes effective only upon subsequent authorization by the Company’s Board of Directors;
	•	the election of Gerald E. Bisbee, Jr., Ph.D., Alan Baldwin, Richard Fritschi, Robert G. McNeil, Ph.D., and J. Richard Steadman, M.D. as directors for the next year;
	•	the approval of the proposal to amend our Employee Stock Option Plan;
	•	the approval of the proposal to amend our Non-Employee Director Stock Option Plan; and
	•	the ratification of the appointment of Ernst & Young LLP as our independent auditors for the current fiscal year.

Election of Directors:

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PART II

      Until February 12, 2001, the Company’s common stock was traded on the Nasdaq SmallCap Market under the symbol AMSI. On February 13, 2001, the Company’s common stock began trading on the OTC Bulletin Board under the symbol AMSI. On July 3, 2001, the ticker was changed to AROS and then on November 20, 2002 the ticker was changed to RGBI. The following table sets forth, for the periods indicated, the range of high and low sale prices for the common stock as reported by the Nasdaq SmallCap Market and the OTC Bulletin Board.

      As of March 6, 2003, the Company had 141 holders of record of its common stock.

      The Company has never paid or declared any cash dividends and does not anticipate paying cash dividends on its common stock in the foreseeable future. The amount and timing of any future dividends will depend on the future business direction of the Company, general business conditions encountered by the Company, as well as the financial condition, earnings and capital requirements of the Company and such other factors as the Company’s Board of Directors may deem relevant.

(1)	As of December 31, 2002.

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      The selected consolidated financial data set forth below with respect to our consolidated statements of operations for the years ended December 31, 2002, 2001 and 2000 and with respect to the consolidated balance sheets as of December 31, 2002 and 2001 have been derived from audited consolidated financial statements included as part of this Annual Report on Form 10-K. The statements of operations data for the years ended December 31, 1999 and 1998 and the balance sheet data as of December 31, 2000, 1999 and 1998 are derived from audited financial statements not included in this Annual Report on Form 10-K. The following selected consolidated financial data should be read in conjunction with the consolidated financial statements and notes thereto included elsewhere in this Annual Report on Form 10-K. All periods have been reclassified to account for the reverse merger and recapitalization between ReGen and RBio.

SELECTED CONSOLIDATED FINANCIAL DATA

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BUSINESS DEVELOPMENTS

      On June 21, 2002, ReGen Biologics, Inc. (“ReGen”, the “Company”) acquired RBio, Inc. (“RBio”, 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. The merger included all of RBio’s business and operating activities and employees. The Company will continue RBio’s business out of RBio’s current headquarters in Franklin Lakes, New Jersey.

      Pursuant to the merger, ReGen issued approximately 35.4 million shares of its capital stock to former RBio stockholders in exchange for all of the issued and outstanding stock of RBio. In addition, ReGen assumed RBio’s outstanding stock options and warrants to purchase up to an aggregate of approximately 12.2 million shares of ReGen capital stock on a post merger basis. Following the merger, former RBio stockholders held approximately 80% of the Company’s outstanding capital stock. Following the Company’s annual stockholders meeting on November 26, 2002, the Company filed an amendment to its certificate of incorporation, increasing the number of authorized shares of Common Stock of the Company sufficient to permit the conversion of its Series B preferred stock into Common. In accordance with the terms and conditions of the Series B preferred stock, all such stock was automatically converted into Common stock, on a one for one basis, as of the filing of the Company’s amended certificate of incorporation on December 13, 2002.

      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 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 of the Notes to Consolidated Financial Statements for a further discussion of the terms of the merger.

      ReGen Biologics, Inc., formerly 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. In connection with the acquisition of the Subsidiary, the Company changed its name to ReGen Biologics, Inc. in 2002.

      RBio, Inc., formerly 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 tissue that, under natural conditions, does not regenerate adequately in humans. On November 12, 2002 ReGen Biologics, Inc. changed its name to RBio, Inc.

      Through its Subsidiary, the Company developed a proprietary collagen based matrix technology, which has been clinically proven to regenerate lost or damaged tissue. This technology produces a scaffold, which promotes the natural re-growth of tissue into the implanted matrix. The matrix material then absorbs, leaving native tissue in its place. The Company chose to initially adapt this technology in the orthopedic area, which offers a substantial unmet need and large market size.

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      The Company developed and currently markets outside the U.S., the Collagen Meniscus Implant (“CMI”). This implant product for the meniscus of the human knee is the Company’s initial application of its tissue re-growth technology. Patients with a damaged meniscus frequently undergo an arthroscopic surgical procedure known as a partial meniscectomy, removing the damaged tissue, leaving the patient with less meniscus to support the knee and protect the patient from further complications or injury. For many of these patients, the CMI presents a surgical alternative, with the potential to re-grow much of the tissue otherwise lost in these procedures, allowing the patient to return to a more active lifestyle than otherwise may have been possible. In 2002, the Company estimates that there were approximately 1.1 million partial meniscectomy procedures performed worldwide, of which approximately 783,000 were in the United States.

      The Company has also developed and markets the SharpShooter Tissue Repair System (“SharpShooter”), a suturing device used to facilitate the surgical implant of the CMI, as well as to perform other similar arthroscopic meniscus repair procedures.

      The CMI and SharpShooter in 2000 each received the CE Mark for distribution in the European Economic Community. In 2002, the CMI was cleared for marketing in Australia and Chile, and in 2000, the Sharp Shooter received marketing clearance for sale in the United States by the United States Food and Drug Administration (“FDA”). In the fourth quarter of 2002 the Company completed the required enrollment and related surgical procedures for its CMI clinical trial in the United States.

      The Company 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, the Company is still considered a development stage enterprise. Management believes that the Company will emerge from the development stage when the CMI product is available for sale in the U.S. or sales of all of its products have reached a volume that will provide for positive gross margin.

      The Company is in the early stages of marketing and distribution for its current products. Market acceptance will require, among other things, adoption of these new products by the surgeons who perform these types of procedures and (particularly for the CMI product) by the patients who would receive the implant.

      The Company’s two current products, the CMI and SharpShooter, are marketed and distributed under contract with two orthopedic product focused distribution companies. Centerpulse Orthopedics, Ltd. (NYSE: CEP), formerly Sulzer Medica, is the exclusive distributor of the CMI outside the United States, and Linvatec Corporation, a division of Conmed, Inc. (NASDAQ: CNMD) is currently the worldwide distributor of the SharpShooter.

      In February 1996, the Subsidiary entered into a perpetual product distribution agreement (1996 Product Distribution Agreement) with Centerpulse, in which the Subsidiary granted exclusive distribution and marketing rights outside the United States of America for the CMI. In January 2002, the Subsidiary entered into an amendment to its 1996 Product Distribution Agreement, providing for among other things, annual sales minimums and restructuring of its credit agreements with the distributor. This amendment provides for minimum sales units of the CMI during 2002 and 2003, and establishes a process for setting minimum sales in future periods. Beginning in 2003, if the distributor fails to meet the sales minimums, the Company may at its option elect to (i) require payment by the distributor for the difference between actual and minimum sales, (ii) convert the distribution rights to non-exclusive, or (iii) buy back the distribution rights in full at a price equal to 50% of the distributor’s marketing costs to that date. See Note 9, License Agreements for further details regarding the Company’s product distribution license agreements.

      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. This agreement continues in force, so long as the distributor meets certain minimum sales volume quotas. If the minimum sales quotas are not met, the Company has the option to require payment of the royalties that would have been due, or convert the distributors rights to non-exclusive. To meet the minimum royalty requirement, the distributor would have owed an additional $98,500 related to sales quotas in 2000 and

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      The Company operates an ISO 9001 certified production facility in Redwood City, CA, where its CMI product is manufactured. The CMI product is based upon the Company’s type I collagen based tissue re-growth technology, using bovine tendon as a primary raw material. The Company obtains its tendon material through a specialized supplier, which sources that material based upon specification requirements defined by the Company. The bovine material is readily available through U.S. based slaughterhouses. The SharpShooter Tissue Repair System is a medical instrument, which includes several components, all of which are manufactured for the Company by third parties. The Company oversees the manufacturing and coordinates the supply of these components from its production facility in Redwood City, CA. Given the resources available to the Company, it has relied upon a limited number of these third party manufacturers. In certain cases the Company may incur additional costs or experience delays in filling customer orders due to difficulties in obtaining these components from these manufacturers.

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 Note 3 “Summary of Significant Accounting Policies” of 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, the seller’s price to the buyer is fixed or determinable and collection of such revenue is reasonably assured. The Company generally recognizes revenue from product sales upon the shipment of such products to its distributors. Title of product passes to the customers FOB origin.

      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.

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. 93% of inventory is being carried at market. Work in process is calculated by estimating the number of units that will be successfully converted to

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Product Recall

      During 2001 and 2002, the Company shipped certain components of the SharpShooter that were later identified to have the potential to become non-sterile. The Company instituted a recall of such product components during 2002. A warranty reserve associated with the recall of these products in 2001 and 2002 was estimated based on the costs to be incurred to recall and rework the product. Based upon these estimates, the Company established a warranty reserve equal to a total of $127,000, including approximately $55,000 recorded in 2001 for 2001 shipments and $72,000 recorded in 2002 for 2002 shipments. The original recall plan was to involve reworking product that had been sold, with the Company bearing the cost of the rework, but the customer retaining title of the product. At the time of the recall, an accrual for the estimated recall and rework costs was recorded. This accrual was updated in the second and third quarters of 2002 as more information about the cost of rework and the quantity of product involved became known. The reworked packaging design to correct the issue that led to the recall requires FDA approval before the reworked products can be returned to the customer. Due to length of time required to receive this approval and therefore return the reworked product to the customer, the Company agreed to take title of the returned product in the fourth quarter of 2002. As a result, the Company received and included in inventory a total of 6,084 units of the SharpShooter component. 100% of these units will be reworked and will become available for sale. The reserve (of $127,000) has been subtracted from the carrying amount of the returned inventory, resulting in a net value of approximately $15,000. Costs incurred and paid to rework the returned inventory will be included in inventory to the extent of the original carrying amount. A credit of approximately $144,000 was issued to the customer in the fourth quarter of 2002. The Company has recorded this credit as a reduction of revenue during the fourth quarter of 2002. The FDA has agreed to the rework plan and has given approval to start the rework process. The rework plan indicated that 99% of the distributors’ customers acknowledged that all unused products have been returned. The Company has recorded these returns as a reduction of revenue during the fourth quarter 2002. The amounts recorded as the estimated costs associated with the recall have been estimated based on the best information currently available. Completion of the rework and FDA approval of the reworked packaging may involve additional costs which can not currently be anticipated. Any such additional costs would be recorded when management becomes aware of the factors which may require the additional costs. Outside of the returns associated with the product recall described above, the Company’s history of product returns has been insignificant.

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, clinical trials, regulatory compliance and filings, validation of processes, start up costs to establish commercial manufacturing capabilities and related facilities, supplies and other expenses.

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 referred 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

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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 at the time of the merger 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 legal and accounting fees and an estimate of the costs to be incurred to register the unregistered securities distributed to the former shareholders of the Subsidiary in connection with the merger. Management’s estimate of these costs was $402,000 and had been expensed in the second quarter during 2002. A change in the estimate due to additional accounting and legal fees of $113,000 has been made and expensed in the third quarter of 2002, increasing the total estimated costs associated with the merger to $515,000.

Income Taxes

      The Company had a net operating loss carryforwards at December 31, 2002 of approximately $33.4 million and a research and development tax credit of approximately $410,000. 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 reverse merger and recapitalization completed on June 21, 2002.

RESULTS OF OPERATIONS

Year Ended December 31, 2002 Compared to Year Ended December 31, 2001

      REVENUE. Revenue increased $291,000 or 59% to approximately $781,000 for the year ended December 31, 2002 from approximately $490,000 for the same period in 2001. The increase in revenues was driven by a significant increase in units sold of the CMI product to Centerpulse Orthopedics, Ltd, primarily resulting from an increase in end user sales in the European market. During the year, Centerpulse established sales organizations in the initial European distribution markets of Italy, Germany, Spain and Switzerland. CMI sales increased $177,600 or 231% to approximately $254,400 for the year ended December 31, 2002 from $76,800 during 2001. CMI units sold increased by 387 units (or 242%) to 547 for the year ended December 31, 2002 from 160 for the same period in 2001. SharpShooter sales increased $165,300 or 54% to approximately $469,500 for the year ended December 31, 2002 from approximately $304,200 for the same period 2001, primarily due to an increase in the number of units sold. SharpShooter units sold increased by approximately 1,000 units (or 71%) to 2,403 for the year ended December 31, 2002 from 1,408 for the same period in 2001. SharpShooter sales have been reported net of the $144,000 credit issued in the fourth quarter of 2002 due to the recalled units. Sales to and royalties received from Linvatec Corporation accounted for approximately 60% of revenue for the year ended December 31, 2002 and approximately 65% for the prior year ended December 31, 2001.

      COST OF GOODS SOLD. Cost of goods sold increased by approximately $339,000 to approximately $1.0 million for the year ended December 31, 2002 from approximately $700,000 for the year ended December 31, 2001. This increase is related to the increase sales of the CMI and SharpShooter products for the year ended December 31, 2002, together with the impact of a warranty reserve recorded during the same period. For the years ended December 31, 2002 and 2001 respectively,

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      RESEARCH AND DEVELOPMENT. Research and development expenses increased to approximately $2.2 million, for the year ended December 31, 2002 from approximately $2.1 million for the same period in 2001. Research and development expenses have increased due to an increase in the costs associated with the enrollment stage of the U.S. CMI clinical trial, which was completed in the fourth quarter of 2002.

      BUSINESS DEVELOPMENT, GENERAL AND ADMINISTRATIVE. Business development, general and administrative expenses were $2.1 million for the year ended December 31, 2002, compared with $1.6 million for the same period in 2001. These costs include the costs of marketing, business development, corporate operations, finance and accounting, and other general expenses, and have increased primarily as a result of the merger and the costs associated with regulatory reporting and other necessary activities of being a public company, which would not have been reflected in the 2001 operating results.

      COMPENSATION EXPENSE ASSOCIATED WITH STOCK OPTIONS AND WARRANTS. Compensation expense associated with stock options and warrants was $3.3 million for the year ended December 31, 2002, compared to $1.2 million for the year ended December 31, 2001. The 2002 amount includes the impact of the accelerated vesting of all outstanding stock options of the Subsidiary at the time of the reverse merger and recapitalization.

      NON-OPERATING INCOME (EXPENSE). Non-operating income (expense) consists of merger costs, interest and other income, rental income, interest expense and license fees. The merger cost totaled approximately $515,000 and $0 for the year ended December 31, 2002 and 2001, respectively. Interest and other income increased to approximately $66,000 for the year ended December 31, 2002 from $12,000 for the same period in 2001. This increase was primarily the result of receipt of funds, which related to a previously discontinued product line of approximately $37,000. Rental income increased by approximately $47,000 to approximately $195,000 for the year ended December 31, 2002 from approximately $148,000 for the same period in 2001. The increase was primarily due to a second amendment to the sublease agreement which increased the square footage allocated to the sublessee from 6,775 square feet in 2001 to 8,258 square feet in 2002. Interest expense increased $1.4 million for the year ended December 31, 2002 from the same period in 2001. The increase was primarily a result of the interest expense associated with the debt discount and beneficial conversion feature related to the bridge loan financing and conversion during the second quarter of 2002. Income from license fees decreased by $1 million to $0 for the year ended December 31, 2002. The decrease was due to the performance criteria in the underlying agreement having been meet in 2001. License fees are not recurring.

Year Ended December 31, 2001 Compared to Year Ended December 31, 2000

      REVENUE. Revenue decreased $482,000 or 50% to approximately $490,000 for the year ended December 31, 2001 from approximately $972,000 for the same period in 2000. This decrease was due to a reduction in sales orders for both the CMI and SharpShooter products. CMI sales were down by approximately $167,000 and SharpShooter sales were down by approximately $364,000 in 2001. Sales orders for both products were down in 2001 as a result of customers purchasing larger quantities in 2000 in order to stock initial inventory requirements.

      COST OF GOODS SOLD. Cost of goods sold decreased by approximately $143,000 to approximately $700,000 for the year ended December 31, 2001 from approximately $843,000 for the year ended December 31, 2000. This decrease is related to the decrease in sales of the CMI and SharpShooter

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      RESEARCH AND DEVELOPMENT. Research and development expenses decreased to approximately $2.1 million, for the year ended December 31, 2001 from approximately $2.7 million for the same period in 2000. Research and development expenses decreased primarily due to (i) a reduction in start-up costs associated with manufacturing the CMI and (ii) an intentional reduction in new product development spending for cash management purposes.

      BUSINESS DEVELOPMENT, GENERAL AND ADMINISTRATIVE. Business development, general and administrative expenses were $1.6 million for the year ended December 31, 2001, compared with $1.6 million for the same period in 2000. These costs include the costs of marketing, business development, corporate operations, finance and accounting, and other general expenses.

      COMPENSATION EXPENSE ASSOCIATED WITH STOCK OPTIONS AND WARRANTS. Compensation expense associated with stock options and warrants was $1.2 million for the year ended December 31, 2001 compared with $1.2 million for the same period in 2000. This expense predominantly includes the amortization of deferred stock compensation attributable to the issuance of stock options.

      NON-OPERATING INCOME (EXPENSE). Non-operating income (expense) consists of interest and other income, rental income, interest expense and license fees. Interest and other income decreased to approximately $12,000 for the year ended December 31, 2001 from $18,000 for the same period in 2000. This decrease was primarily the result of a decrease in cash and short-term investments during 2001. Rental income increased by approximately $75,000 to approximately $148,000 for the year ended December 31, 2001 from approximately $73,000 for the same period in 2000. The increase was primarily due to an amendment in the sublease agreement which called for an increase in the sublease rental rate per square foot from $1.93 per square foot per month in 2000 to $5.00 per square foot per month in 2001. Interest expense increased $110,000 for the year ended December 31, 2001 from the same period in 2000. The increase was primarily a result of the interest expense associated with the bridge loan financing obtained during 2001 of approximately $1.7 million. The license fees increased by $700,000 to $1 million for the year ended December 31, 2001 from $300,000 for the year ended December 31, 2000. The increase was due to certain performance criteria in the underlying agreement consummated in 2001 having been met. The 2001 agreement contained higher payment provisions than that of the 2000 agreement. License fees are not recurring.

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QUARTERLY RESULTS

      The following table sets forth certain unaudited quarterly financial data for fiscal 2002 and 2001. This unaudited information has been prepared on the same basis as the audited information included elsewhere in this annual report and includes all adjustments necessary to present fairly the information set forth therein. The amounts presented below have been adjusted from previously reported amounts to reflect the reverse merger and recapitalization between ReGen and RBio. The operating results for any quarter are not necessarily indicative of results for any future period:

      The Company’s fourth quarter 2002 revenue is lower than previous quarters in part due to the credit issued in the amount of approximately $144,000, resulting from the recall of the SharpShooter components initiated in the second quarter of 2002. The Company’s fourth quarter 2002 cost of goods sold is lower than previous quarters primarily from the effects of recording the inventory from the product recall and lower levels of production.

LIQUIDITY AND CAPITAL RESOURCES

      Cash and short-term investments were approximately $3.5 million as of December 31, 2002 compared with approximately $320,000 as of December 31, 2001. The increase in cash and short term investments is the result of approximately $5.0 million in cash proceeds from Bridge Financings and the issuance of

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             The reverse merger and recapitalization between ReGen and RBio resulted in the conversion of all equity securities of the Subsidiary into equity securities of the Company. Prior to the reverse merger, net monetary assets of ReGen approximated $2.7 million, including cash equal to approximately $3.0 million.

             Cash used in operating activities of approximately $4.7 million, resulted from a net loss of approximately $10.0 million, offset by significant non-cash expenses, including approximately $3.3 million in compensation expenses associated with stock options and approximately $1.5 million of amortization relating to the debt discount for the warrant and beneficial conversion feature. Other non-cash items and changes in working capital assets and liabilities resulted in an increase in operating cash of approximately $414,000.

             During the year ended December 31, 2002, the Company invested $201,000 into short-term investments and purchased $6,000 of property and equipment.

             During the 12-month period ending December 31, 2002, the Company incurred operating losses of approximately $8.0 million and used approximately $4.7 million in cash for operating activities. Through December 31, 2002, the Company has incurred cumulative net losses of approximately $42.3 million and used approximately $31.6 million in cash for operating activities. The Company anticipates that it will continue to incur net losses that will require additional financing until, at the earliest, the Company receives FDA approval for its CMI product and is able to market the CMI product in the United States. In the fourth quarter of 2002 the Company completed the required enrollment and related surgical procedures for its CMI clinical trial in the United States. All patients are expected to complete two years of follow-up prior to ReGen’s submission of the results in its Pre-market Approval Application (“PMA”) to the FDA. The Company expects these two-year clinical follow-up exams will be completed in the fourth quarter of 2004, with submission of the completed PMA to the FDA shortly thereafter. The process of review by the FDA is uncertain, but ReGen expects that the FDA will issue its ruling in 2005. Should the FDA approve the CMI for sale in the U.S., sales of the CMI in the U.S. will not occur until, at the earliest, in late 2005.

             Although the CMI is approved and distributed in Europe, Australia and Chile, it is not approved for sale in the U.S., and the Company is making no claim regarding its safety, effectiveness or its potential for FDA approval.

             In addition to regulatory related hurdles, in order to approach a position of positive operating earnings and cash flow, the Company will need to effectively address various other operating issues, including special reimbursement provisions for the surgeons and facilities that will be responsible for implanting the Company’s CMI or other future products. While the Company is actively working to address these issues, there is no guarantee that the Company will be able to obtain special reimbursement provisions, or obtain them in any given time frame.

             The Company is actively pursuing additional permanent equity capital in order to support ongoing operations, and believes it requires one or more such financings before it will be in a position to support itself through positive operating earnings and cash flow. The Company expects a financing to occur by September 30, 2003, or before such time as current cash reserves are depleted. This financing is necessary to fund operations through 2003 at the current level. Certain existing investors in the Company, who have invested in previous rounds of financing, have indicated their interest in participating in the next financing. The Company has received a written commitment from one of its existing shareholders for an investment in the next financing subject to certain conditions which are customary in such a commitment. While the Company has been successful in the past in obtaining the necessary capital to support its operations, there is no guarantee that the Company will be able to obtain additional equity capital under commercially reasonable terms and conditions, or at all.

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Contractual Obligations and Commercial Commitments

      The following table reflects a summary of our contractual obligations as of December 31, 2002:

      The Company expects to enter into a three-year lease extension for its manufacturing operations in Redwood City, CA under commercially reasonable rates, terms and conditions. The current lease for this facility expires in May 2003.

      The Company did not have any material commercial commitments at December 31, 2002.

RISK FACTORS

      ReGen has no significant operating history from the newly combined operations and will be operating in a new, specialized and highly competitive field. While ReGen has operated in the healthcare industry, prior to the merger with RBio, Inc. in June of 2002, we have not been a participant in RBio’s market space. The ability of ReGen to successfully provide the guidance and management needed to continue and grow the business on an ongoing basis has not yet been established and cannot be assured. Our business is subject to all of the risks inherent in the operation of the acquired business of RBio, including but not limited to potential delays in the development of products, the need for regulatory approvals of certain of its products and devices, uncertainties of the healthcare marketplace and reimbursement levels of insurers and similar governmental programs, unanticipated costs and other uncertain market conditions. In addition, ReGen may encounter substantial costs and delays involved in the integration of ReGen and RBio, including perceived adverse changes in business focus by either company, potential conflicts in important industry relationships, the loss of key employees and the diversion of management’s attention from other ongoing business concerns. ReGen cannot predict with any certainty the degree of success our combined operations will have in achieving our financial objectives.

We have negative cash flow and may not have sufficient cash to continue operations or, even if we can continue operations, to effectively manage our working capital requirements and fund our operations for the period required to achieve profitability.

      We do not know with certainty whether our cash reserves and any cash flows from operations or financing will be sufficient to fund our operations beyond 2003. The report of our independent auditor, Ernst & Young LLP, on our 2002 financial statements contained in this report contains an explanatory paragraph describing conditions that raise substantial doubt about our ability to continue as a going concern. We have limited cash and credit available, and may be unable to raise additional financing or establish additional lines of credit to meet our anticipated and unanticipated working capital requirements. In the event we raise capital via equity financing, our existing stockholders could experience significant dilution. If adequate funds are not available to satisfy either short- or long-term capital requirements, we might be required to significantly limit our operations or delay or abandon some of our planned future

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	•	our ability to increase revenues;
	•	the rate at which we expand or contract our sales and marketing operations;
	•	the extent to which we expand or contract our products;
	•	the timing of, and extent to which we are faced with, unanticipated marketing or medical challenges or competitive pressures;
	•	our ability to successfully transfer liability for or restructure long-term facility leases for facilities that exceed our present capacity needs;
	•	the amount and timing of leasehold improvements and capital equipment purchases; and
	•	the response of competitors to our products.

Unanticipated fluctuations in quarterly operating results could affect our stock price.

      The quarterly revenues and operating results of ReGen 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, and avoid costs associated with the recall of defective or potentially defective products, the ability of our vendors to effectively and timely deliver 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 and should not be relied upon as an indication of its future performance. These fluctuations could cause the trading price of our stock to be negatively affected. ReGen’s quarterly operating results have varied substantially in the past and may vary substantially in the future. In addition, the stock market has been very volatile, particularly on the OTC Bulletin Board, where our stock is quoted. This volatility is often not related to the operating performance of companies listed thereon and will probably continue in the foreseeable future.

ReGen is subject to government regulation, which may adversely affect our businesses.

      ReGen is subject to various laws, regulations, regulatory actions and court decisions that may have negative effects on its ability to conduct our business. ReGen is also subject to regulation by the U.S. Food and Drug Administration for certain of our products and devices. In particular, the CMI product has not yet been approved by the FDA, and there is no guarantee that such approval will be obtained. Should the FDA approve the CMI for sale in the U.S., sales of the CMI will not occur until, at the earliest, late 2005. In addition, our products and devices will be subject to regulation by the European Union’s equivalents of the FDA, as well as possible regulation in other countries as the Company’s market expands. In addition, federal medical programs such as Medicare and Medicaid have separate regulatory processes and procedures which will ultimately affect reimbursement for the Company’s products. Changes in these and other aspects of the state, federal and international regulatory environment surrounding industry participants could adversely affect the ability of ReGen to attain its corporate objectives.

Our products may not be accepted by the market and may not be successfully commercialized.

      Our products are based on new and innovative technologies, and the medical community or the general population may not broadly purchase or use our products as alternatives to existing methods of

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      Our products may occasionally fail to meet performance criteria. Although we conduct extensive testing on our products, our products may not always perform as expected. Such performance failures could result in, among other things:

	•	harm to patients;
	•	litigation;
	•	product recalls;
	•	loss of revenues and customers;
	•	diversion of our resources;
	•	damage to our reputation; or
	•	increased warranty and insurance costs.

      We maintain insurance to protect us against certain claims associated with the use of our products, but there can be no assurance that our insurance coverage would adequately cover any claims brought against us. The occurrence of any of these events and other consequences, particularly if not covered by our insurance, could have a material adverse effect on our business, financial condition and results of operations.

We may encounter difficulties developing new products.

      We have historically devoted significant resources to research and development and believe that significant continuing development efforts will be required to sustain our operations and grow our business. There can be no assurance that we will successfully develop or market new products, or that we will be able to do so in a timely manner.

ReGen may not be able to adequately protect its intellectual property.

      ReGen’s ability to develop and maintain the proprietary aspects of our combined business is critical for our future success. To protect our proprietary technology, ReGen relies primarily on a combination of confidentiality protections, contractual requirements, trade secret protections, and patent, copyright and trademark filings for our products and methods.

      Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy aspects of the products of the combined Company or to obtain and use information that ReGen regards as proprietary. Policing such infringements is not always possible. In addition, the laws of some foreign countries do not protect proprietary rights to as great an extent as do the laws of the U.S. ReGen’s means of protecting proprietary rights may not be adequate, and our competitors may independently develop, design or duplicate similar materials, processes, products or designs.

Our success depends upon our ability to recruit and retain qualified personnel.

      Our success depends, in part, upon our ability to attract and retain qualified operating personnel. Competition for skilled personnel in the areas of R&D, production, marketing and other areas is highly

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ReGen will need to obtain financing in the future, which may be difficult.

      In the future, ReGen will need to raise additional funds through equity or debt financing, collaborative relationships or otherwise. ReGen’s future capital requirements will depend on many factors, including, but not limited to, the adoption rate and sales of our products, completion of our CMI clinical trial, competing technological and market developments, the ability to establish collaborative relationships, the cost of goods and marketing and advertising costs. Moreover, because of ReGen’s potential long-term capital requirements, we may access the public or private equity markets whenever conditions appear to us to be favorable, even if we do not have an immediate need for additional capital at that time. There can be no assurance that any such additional funding will be available when needed or on terms favorable to ReGen, if at all.

Our future operating results may be harmed by economic, political and other risks relating to international sales.

      To date, significant portions of our revenues result from sales outside the United States. Our distributors who sell products in international markets are subject to the laws and regulations of the foreign jurisdictions in which they operate and in which our products are sold. A number of risks are inherent in international sales and operations. For example, the volume of international sales may be limited by the imposition of government controls, export license requirements, political and/or economic instability, military and political conflicts, trade restrictions, changes in tariffs, difficulties in managing international operations, import restrictions and fluctuations in foreign currency exchange rates.

Sales of our products are largely dependent upon third party reimbursement and our performance may be harmed by health care cost containment initiatives.

      In the U.S. and other markets, health care providers, such as hospitals and physicians, that purchase health care products, such as our products, generally rely on third party payers, including Medicare, Medicaid and other health insurance and managed care plans, to reimburse all or part of the cost of the health care product. Reimbursement by third party payers may depend on a number of factors, including the payer’s determination that the use of our products is clinically useful and cost-effective, medically necessary and not experimental or investigational. Since reimbursement approval is required from each payer individually, seeking such approvals can be a time consuming and costly process which, in the future, could require us or our marketing partners to provide supporting scientific, clinical and cost-effectiveness data for the use of our products to each payer separately. Significant uncertainty exists as to the reimbursement status of newly approved health care products, and third party payers are increasingly attempting to contain the costs of health care products and services by limiting both coverage and the level of reimbursement for new therapeutic products and by refusing in some cases to provide coverage for uses of approved products for disease indications for which the FDA has not granted marketing approval. There can be no assurance that third party reimbursement coverage will be available or adequate for any products or services developed by us.

Disruption of our manufacturing could adversely affect our business, financial condition and results of operations.

      Our results of operations are dependent upon the continued operation of our manufacturing facility in Redwood City, California. The operation of biomedical manufacturing plants involves many risks, including the risks of breakdown, failure or substandard performance of equipment, the occurrence of natural and other disasters, and the need to comply with the requirements of directives of government agencies, including the FDA. In addition, we rely on a single supplier for certain of our raw materials and purchased product components, and a small number of suppliers for a number of other materials required for the manufacturing and delivery of our products. The occurrence of material operational problems could have a

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SAFE HARBOR FOR FORWARD-LOOKING STATEMENTS

Cautionary Note Regarding Forward-Looking Statements

      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. Such statements are based on the current expectations and beliefs of the managements of ReGen and RBio 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 this Form 10-K. 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 2003 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 obtain additional financing, the ability of our distribution partners to effectively market and sell our products, our ability to procure product components and effectively produce products for resale, our ability to control production quantities and inventory in order to avoid unanticipated costs such as outdated inventory, 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, other unforeseen events that may impact 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, and avoid costs associated with the recall of defective or potentially defective 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, facilities and related 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.

      Our 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.

Item 7a.     Quantitative and Qualitative Disclosures About Market Risk

      The Company’s obligations as of December 31, 2002 include debt instruments equal to (i) $350,000 in principal with fixed rate interest payable, and (ii) approximately $5.7 million in principal with variable rate interest payable at rates ranging from 1.27% to 2.93%, adjusted annually based upon the 1 year LIBOR at the anniversary of the loans. The book value of the variable rate debt approximates fair value. The fair value of the fixed rate debt instrument based on the Company’s estimate of its current incremental borrowing rate of 200-400 basis points above the prime rate is approximately $218,000 for

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Item 8.     Financial Statements

REPORT OF INDEPENDENT AUDITORS

Board of Directors

      We have audited the accompanying consolidated balance sheets of Regen Biologics, Inc. (a development stage company) (formerly known as Aros Corporation) as of December 31, 2002 and 2001, and the related consolidated statements of operations, stockholders’ equity (deficit) and Series A redeemable convertible preferred stock, and cash flows for each of the three years in the period ended December 31, 2002 and for the period from December 21, 1989 (inception) to December 31, 2002. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

      We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

      In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Regen Biologics, Inc. (a development stage company) as of December 31, 2002 and 2001, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2002, and for the period from December 21, 1989 (inception) to December 31, 2002 in conformity with accounting principles generally accepted in the United States.

      The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As more fully described in Note 1, the Company will require additional funding during 2003 to progress towards the complete development of its primary product and meet its obligations as they become due. Certain of the Company’s current significant shareholders have indicated their intention to provide additional funding. The Company is pursuing such additional funding, but does not yet have an unconditional commitment. These conditions raise substantial doubt about the Company’s ability to continue as a going concern. Management’s plans in regard to these matters are also described in Note 1. The financial statements do not include any adjustments to reflect the possible future effect on the recoverability classification of assets or the amounts and classifications of liabilities that may result from the outcome of this uncertainty.

/S/ ERNST & YOUNG LLP

Baltimore, Maryland

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REGEN BIOLOGICS, INC.

CONSOLIDATED BALANCE SHEETS

See accompanying Notes to Consolidated Financial Statements.

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REGEN BIOLOGICS, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS