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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

(Mark One)

For the quarterly period ended June 30, 2002

OR

For the transition period from                            to                             

Commission file number 0-32501

MacroPore Biosurgery, Inc.
(Exact name of registrant as specified in its charter.)

Registrant's telephone number, including area code: (858) 458-0900

MacroPore, Inc
(Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report.)

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 ý    NO o

As of July 23, 2002, there were 13,931,406 shares of MacroPore Biosurgery's common stock outstanding.

MACROPORE BIOSURGERY, INC.

INDEX

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PART I    FINANCIAL INFORMATION

Item 1.    Financial Statements

Independent Accountants' Review Report

The Board of Directors and Shareholders of
MacroPore BioSurgery, Inc.:

We have reviewed the accompanying condensed balance sheet of MacroPore BioSurgery, Inc. (the Company) as of June 30, 2002, the related condensed statements of operations and comprehensive income (loss) for the three and six month periods ended June 30, 2002, and the related statement of cash flows for the six-month period ended June 30, 2002. These consolidated financial statements are the responsibility of the Company's management.

We conducted our review in accordance with standards established by the American Institute of Certified Public Accountants. A review of interim financial information consists principally of applying analytical procedures to financial data and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with auditing standards generally accepted in the United States of America, the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.

Based on our review, we are not aware of any material modifications that should be made to the consolidated financial statements referred to above for them to be in conformity with accounting principles generally accepted in the United States of America.

The financial statements of the Company as of and for the year ended December 31, 2001 were audited by other accountants whose report dated February 15, 2002, expressed an unqualified opinion on those consolidated financial statements. Such financial statements were not audited by us and, accordingly, we do not express an opinion or any form of assurance on the information set forth in the accompanying condensed balance sheet as of December 31, 2001. Additionally, the condensed statements of operations and comprehensive income (loss) for the three and six month periods ended June 30, 2001, and the related condensed statement of cash flows for the six-month period ended June 30, 2001 were not reviewed or audited by us and accordingly, we do not express an opinion or any form of assurance on them.

/s/ KPMG LLP

San Diego, California
August 2, 2002

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MACROPORE BIOSURGERY, INC.
CONDENSED BALANCE SHEETS

See notes to condensed financial statements

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MACROPORE BIOSURGERY, INC.
CONDENSED STATEMENTS OF OPERATION AND COMPREHENSIVE INCOME (LOSS)
(Unaudited)

See notes to condensed financial statements

3

MACROPORE BIOSURGERY, INC.
CONDENSED STATEMENTS OF CASH FLOWS
(Unaudited)

See notes to condensed financial statements

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MACROPORE BIOSURGERY, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS
JUNE 30, 2002
(Unaudited)

1.    Basis of presentation

The accompanying unaudited condensed financial statements for the three and six months ended June 30, 2002 and 2001 have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States for audited financial statements. The condensed balance sheet at December 31, 2001 has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation of the financial position and results of operations of MacroPore Biosurgery, Inc. ("MacroPore" or the "Company") have been included. Operating results for the three and six months ended June 30, 2002 are not necessarily indicative of the results that may be expected for the year ending December 31, 2002. For further information, refer to the financial statements for the year ended December 31, 2001 and footnotes thereto which were included in the Company's report on Form 10-K, dated March 22, 2002.

2.    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 affecting 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 revenue and expenses during the reporting period. Actual results could differ from estimates.

3.    Short-Term Investments

Investments are accounted for in accordance with Financial Accounting Standards Board (FASB) Statement of Financial Accounting Standards (SFAS) No. 115, "Accounting for Certain Investments in Debt and Equity Securities," which requires that the Company determine the appropriate classification of investments at the time of purchase based on management's intent. The Company's short-term investments are classified as available-for-sale investments and are stated at fair value, with net unrealized gains or losses, if any, net of tax, reported as a separate component of stockholders' equity. Realized gains or losses from the sale of investments, interest income and dividends are included in interest income in the accompanying statements of operations and comprehensive income (loss).

Management reviews the carrying values of its investments and writes down such investments to estimated fair value by a charge to operations when such review results in management's determination that an investment's impairment is considered to be other than temporary. The cost of securities sold is based on the specific identification method.

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4.    Inventories

Inventories include the cost of material, labor and overhead, and are stated at the lower of average cost, determined on the first-in, first-out (FIFO) method, or market. The Company periodically evaluates its on-hand stock and makes appropriate provision for any stock deemed excess or obsolete.

During the three months ended June 30, 2001, the Company recorded an inventory provision of approximately $1,228,000 for excess and obsolete inventory related to the Company's craniofacial skeleton implant and instrument products. The provision for excess and obsolete inventory was due to an anticipated reduction in expected future revenues of these products. This provision includes inventory held on-hand as of June 30, 2001.

5.    Long-Lived Assets

The Company assesses potential impairments to its long-lived assets when there is a change in circumstances that indicate carrying values of assets may not be recovered. An impairment loss is recognized when the undiscounted cash flows expected to be generated by an asset is less than its carrying amount. Any required impairment loss would be measured as the amount by which the asset's carrying value exceeds its fair value, and would be recorded as a reduction in the carrying value of the related asset and a charge to operating expense. The Company has not incurred any such loss.

6.    Revenue Recognition

The Company sells its products to distributors and hospitals. The Company has agreements with its distributors that title and risk of loss pass upon shipment of the products to the distributor. The Company warrants that its products are free from manufacturing defects at the time of shipment to the distributor. Revenue is recognized upon shipment of products to distributors following receipt and acceptance of a distributor's purchase order. Revenue from sales to hospitals is recognized upon delivery of the product.

Revenue from license agreements is recognized ratably over the term of the agreement, provided no significant obligations remain.

Substantially all of the Company's revenues are from Medtronic, a shareholder of the Company, under its distribution agreement dated January 5, 2000.

7.    Stock Based Compensation

In February 2002 the Company issued 50,000 fully vested stock options to non-employees for consulting services rendered. The fair value of the grants was estimated using the Black-Scholes option-pricing model with the following weighted average assumptions: expected dividend yield of 0.0%, risk-free interest rate ranging from 3.87% to 4.03%, expected volatility of 108.0% and expected life of 4 years. As a result, the Company recorded stock based compensation expense of $109,000 in the three months ended March 31, 2002.

In March 2002 an officer of the Company retired and upon retirement, the Company accelerated vesting and modified the exercise period of certain stock options. These options were remeasured using the fair market value of the Company's common stock at the date of modification over the exercise price or previously remeasured price of the stock options. The remeasurement resulted in additional $58,000 of stock based compensation expense and $34,000 of unearned compensation

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cost, being accelerated and charged to stock based compensation expense in the three months ended March 31, 2002.

8.    Earnings (Loss) Per Share

The Company computes earnings (loss) per share based on the provision of SFAS No. 128 "Earnings Per Share." Basic per share data is computed by dividing income (loss) available to common stockholders by the weighted average number of common shares outstanding during the period. Weighted average shares exclude shares of unvested common stock subject to repurchase by the Company. Diluted per share data is computed by dividing net income (loss) available to common stockholders by the weighted average number of common shares outstanding during the period increased to include, if dilutive, the number of additional common share equivalents that would have been outstanding if potential common shares had been issued using the treasury stock method. No common share equivalents were included for the periods presented as their effect would be anti-dilutive.

The Company has excluded all potentially dilutive securities from the calculation of diluted loss per share attributable to common stockholders for the three and six months ended June 30, 2002 and 2001 as their inclusion would be antidilutive. The number of potential common shares excluded from the calculations of diluted loss per share was 4,117,057 and 4,054,667 for the three and six months ended June 30, 2002 and 3,479,778 and 3,781,835 for the three and six months ended June 30, 2001.

9.    Reclassification

Certain amounts reported in the Company's Statement of Operations and Comprehensive Income for the three and six months ended June 30, 2001 have been reclassified to conform to the presentation for the three and six months ended June 30, 2002.

10.    Composition of Certain Financial Statement Captions

Inventories

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Accounts Payable and Accrued Expenses

11.    Long-Term Notes Receivable, Related Party

On February 26, 2002, the Company extended loans to two of its directors, who also serve as officers, in the aggregate amount of $478,000, for the purchase of shares of the Company's common stock from another of the Company's stockholders. The loans carry an annual interest rate of 5.75%, subject to adjustment once a year on the anniversary of the issuance date of the loan based on prime plus one percent. The loans are secured by a pledge of all of the stock purchased with the proceeds of the loan, are full recourse and mature in February 2005.

12.    Subsequent Event

On July 12, 2002, the Company loaned $1,000,000 to StemSource, Inc. ("StemSource") in exchange for a convertible promissory note ("Note") and a warrant to purchase 100,000 shares of StemSource common stock. The Note has an annual interest rate of 8% and matures on October 31, 2002. The outstanding principal balance and unpaid accrued interest on this Note may be converted, at the option of the Company, into shares of StemSource Series B Preferred Stock at the closing of StemSource's next Series B Preferred Stock financing transaction or series of financing transactions in which the aggregate gross proceeds to StemSource equal or exceed two million dollars. As of June 30, 2002, the Company had a 13.4% ownership interest in StemSource.

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Item 2.    Management's Discussion And Analysis Of Financial Condition And Results Of Operations

        This report contains certain statements that may be deemed "forward-looking statements' within the meaning of United States securities laws. All statements, other than statements of historical fact, that address activities, events or developments that we intend, expect, project, believe or anticipate will or may occur in the future are forward-looking statements. Such statements are based upon certain assumptions and assessments made by our management in light of their experience and their perception of historical trends, current conditions, expected future developments and other factors they believe to be appropriate. The forward-looking statements included in this report are also subject to a number of material risks and uncertainties, including but not limited to, the risks described in Exhibit 99.1 "Risk Factors". We encourage you to read those descriptions carefully. We caution investors not to place undue reliance on the forward-looking statements contained in this report. These statements, like all statements in this report, speak only as of the date of this report (unless another date is indicated) and we undertake no obligation to update or revise the statements except as required by law. Such forward-looking statements are not guarantees of future performance and actual results will likely differ, perhaps materially, from those suggested by such forward-looking statements.

Overview

        We were initially formed as a California general partnership in July 1996, and incorporated in the State of Delaware in May 1997. We develop, manufacture and market bioresorbable surgical implants to aid in the reconstruction, repair and regeneration of bone and the healing of soft tissues throughout the body, as well as related instruments and accessories used in connection with our implants. Our bioresorbable implants are used in craniomaxillofacial, neurological, orthopedic and reconstructive surgery. We have also developed a bioresorbable surgical film that we began marketing in June 2002 for use in a wide variety of soft tissue surgical applications.

        Our bioresorbable products are made from a copolymer composed of a lactic acid similar to that which occurs naturally in the human body. The lactic acid copolymer maintains its strength during the healing process, while slowly breaking down in the body through hydrolysis into lactic acid molecules and ultimately metabolizing into carbon dioxide and water, which are then released from the body through the lungs and the kidneys. We believe that our products are easier to use and more cost-effective than products made from alternative materials, such as titanium or other metals.

        We have received regulatory clearance or approval to market and sell some of our products in the United States, Canada, Europe and other countries. We entered into an exclusive worldwide agreement with Medtronic, Inc. in January 2000, for the global marketing and distribution of some of our products for use in the craniofacial skeleton. The agreement also contemplates possible distribution by Medtronic of our products for use in other parts of the body. We also entered into an agreement to co-develop bioresorbable implants for use in spinal fixation, stabilization and fusion applications with Medtronic and supply any such new implants to Medtronic as the distributor.

        We are required to obtain from the Food and Drug Administration regulatory clearance of our products that we market in the United States. In addition, we must obtain marketing authorization for our products that we market in Europe, Canada, Mexico and certain other non-U.S. jurisdictions. During 2001 and 2002, we received regulatory clearance or marketing authorization for our products from various jurisdictions, for the following indications:

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the use of our MacroPore OS Spine bone graft containment system in spinal fusion procedures



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the use of our MacroPore ENT Reconstruction Film in ear, nose and throat applications for the prevention of postsurgical adhesions in the nasal cavity, guided tissue regeneration, nasal splinting and tympanic membrane repair

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the use of our OS Trauma system for the reconstruction of weak bony tissues in musculoskeletal procedures and the standalone reconstruction of iliac crest and rib anatomy



•

the use of our MacroPore LP system in reconstructive surgery to correct pediatric skeletal birth defects and in cranial reconstruction



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the use of our MacroPore IB system as a cement restrictor in specified musculoskeletal applications



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the expanded use of some of our product lines, including MacroPore FX, MacroPore PS and MacroPore NS, for specified craniomaxillofacial procedures in the United States and Europe



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the use of our fixation products in craniomaxillofacial applications



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the use of our MacroPore TS Surgi-Wrap™ product line in craniomaxillofacial applications



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the use of our MacroPore TS Surgi-Wrap™ film for wound support and soft tissue reinforcement throughout the entire human body



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the use of our MacroPore TS Surgi-Wrap™ products as an adhesion barrier for cardiothoracic, spinal, peritoneal and OB/GYN procedures in Europe



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the use of our MacroPore TS Surgi-Wrap™ products for hernia repair and soft tissue repair throughout the body in Europe

        We are also developing additional products for use in spinal fusion procedures, soft tissue repair, anti-adhesion products, neurosurgery plating, long-bone repair, among other things. These future products may require further development and regulatory clearance or approval, potentially including clinical trials, prior to marketing and commercial use.

        We continue to seek patent protection for our new products as evidenced by our recent receipt of a U.S. patent for the design of our high torque, bioresorbable StarBurst Screws, which are used in many of our products.

        We incurred net losses of $4,537,000 for the six months ended June 30, 2002, $11,207,000 for the year ended December 31, 2001 and $8,645,000 for the year ended December 31, 2000. As of June 30, 2002, we had an accumulated deficit of $31,636,000. These net losses resulted to a large extent from expenses associated with developing bioresorbable implant designs, performing preclinical studies, preparing submissions to the FDA and foreign regulatory agencies, expanding marketing and distribution channels, further developing our manufacturing capabilities, securing intellectual property rights and trademarks and supporting our status as a public company. We expect to expend substantial financial resources to expand marketing, training and customer support needed to generate and support higher sales, obtain additional regulatory clearances and to develop new products. This investment is likely to result in continued operating losses for the foreseeable future until operational efficiencies are reached.

        For the six months ended June 30, 2002, revenues of $3,350,000 or 87.8% came from sales of our bioresorbable implant products for use in musculoskeletal and craniomaxillofacial applications, revenues of $167,000 or 4.4% came from sales of instruments and accessories used by surgeons to form, mold and manipulate our bioresorbable products during surgical procedures, and $300,000 or 7.8% of our revenues came from a license agreement and a special project with Medtronic. The musculoskeletal and craniomaxillofacial revenues for the six months ended June 30, 2002 were $2,217,000 and $1,133,000, respectively.

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Results of Operations

Three months ended June 30, 2002 compared to three months ended June 30, 2001

        Revenues.    For the three months ended June 30, 2002, revenues were $2,707,000 compared to $768,000 for the three months ended June 30, 2001, an increase of $1,939,000, or 252.5%. The increase in revenues in the three months ended June 30, 2002 was attributable to a $1,977,000 increase in sales of bioresorbable implant products for use in musculoskeletal applications of which $1,544,000 related to an initial inventory purchase. The revenue increase was partially offset by a $38,000 decrease in craniomaxillofacial revenues. Revenues attributable to Medtronic, which owns approximately 6.6% of our outstanding common stock, represented 99.7% of our revenues for the three months ended June 30, 2002, compared to 98.2% for the three months ended June 30, 2001.

        Cost of revenues.    For the three months ended June 30, 2002, cost of revenues was $981,000 or 36.2% of revenues, compared to $255,000 or 33.2% of revenues for the three months ended June 30, 2001. Cost of revenues includes material, manufacturing labor and overhead costs. The increase in cost as a percentage of revenues was primarily attributable to increased labor cost and our inability to absorb some of our fixed manufacturing overhead costs due to excess capacity.

        Inventory provision.    For the three months ended June 30, 2001, the Company recorded an inventory provision of $1,228,000 or 159.9% of revenues, for which there was no comparable charge in the three months ending June 30, 2002. The inventory provision was a result of identified excess and obsolete craniofacial skeleton implant and instrument products inventory.

        Gross profit (loss).    For the three months ended June 30, 2002, gross profit was $1,726,000 or 63.8% of revenues, compared to $(715,000) or (93.1)% of revenues for the three months ended June 30, 2001. Excluding the inventory provision, the gross profit would have been $513,000 or 66.8% of revenues in the three months ended June 30, 2001. The decrease in gross profit, excluding the inventory provision, as a percentage of revenues was primarily attributable to increased labor cost and the inability to absorb fixed manufacturing overhead costs, as discussed above.

        Research and development expenses.    For the three months ended June 30, 2002, research and development expenses excluding related stock based compensation expenses were $1,388,000, compared to $1,512,000 for the three months ended June 30, 2001, a decrease of $124,000, or 8.2%. Research and development expenses include costs associated with the design, development, testing and enhancement of our products, regulatory fees, the purchase of laboratory supplies and clinical trials. The decrease in research and development expenses in the three months ended June 30, 2002 was primarily attributable to lower personnel costs of $122,000, which was associated with the completion of research relating to new product lines in the fourth quarter of 2001. In addition, stock based compensation expense related to research and development was $25,000 for the three months ended June 30, 2002, compared to $30,000 for the three months ended June 30, 2001. For further information regarding stock based compensation, you should read the discussion under the section entitled "Stock based compensation expenses." We expect research and development spending to increase for the remainder of the year ending December 31, 2002 as we expand our product development efforts and seek further regulatory approvals.

        Sales and marketing expenses.    For the three months ended June 30, 2002, sales and marketing expenses excluding related stock based compensation expenses were $1,026,000, compared to $1,367,000 for the three months ended June 30, 2001, a decrease of $341,000, or 24.9%. Sales and marketing expenses include costs for marketing personnel, tradeshow expenses, and promotional activities and materials. The decrease in sales and marketing expenses in the three months ended June 30, 2002 was primarily attributable to a $221,000 decrease in labor and associated costs relating to our sales force and other cost reductions of $120,000 related to tradeshow expenses, promotional activities and materials expenses for the promotion of product lines. In addition, stock based compensation expense

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related to sales and marketing was $34,000 for the three months ended June 30, 2002 and $62,000 for the three months ended June 30, 2001. For further information regarding stock based compensation, you should read the discussion under the section entitled "Stock based compensation expenses." We expect sales and marketing expenses to increase for the remainder of the year ending December 31, 2002 as we expand our sales and marketing efforts related to the introduction of new bioresorbable products.

        General and administrative expenses.    For the three months ended June 30, 2002, general and administrative expenses excluding related stock based compensation expenses were $855,000, compared to $977,000 for the three months ended June 30, 2001, a decrease of $122,000, or 12.5%. General and administrative expenses include costs for administrative personnel, legal and other professional expenses and general corporate expenses. The decrease in general and administrative expenses in the three months ended June 30, 2002 of $122,000 was primarily attributable to lower labor, accounting and legal expenses. In addition, stock based compensation related to general and administrative expenses was $216,000 for the three months ended June 30, 2002, compared to $278,000 for the three months ended June 30, 2001. For further information regarding stock based compensation, you should read the discussion under the section entitled "Stock based compensation expenses." We expect general and administrative expenses in absolute dollars to remain at current levels for the remainder of the year ending December 31, 2002.

        Stock based compensation expenses.    For the three months ended June 30, 2002, non-cash stock based compensation expenses were $275,000, compared to $370,000 for the three months ended June 30, 2001, a decrease of $95,000, or 25.7%. Stock based compensation results from options issued to employees and non-employees. Unearned stock based compensation is amortized over the remaining vesting periods of the options, which generally vest over a four year period from the date of grant. The overall decrease in stock based compensation is related to 2001 accelerated vesting and modification to compensatory stock options granted to employees and consultants. The decrease of $5,000 in research and development stock based compensation expense related to normal amortization of the unearned compensation over the vesting period. The decrease of $28,000 in sales and marketing stock based compensation expense resulted from the rehiring of certain members of our sales force during the three months ended June 30, 2001. These employees held stock options that continued to vest during the termination period and these options were remeasured as of the rehire date and additional compensation expense was recorded in the three months ended June 30, 2001. The decrease of $62,000 in general and administrative stock based compensation expense was primarily due to additional expenses recorded in the three months ended June 30, 2001 as a result of accelerating vesting of certain stock options to a consultant.

        Interest income.    For the three months ended June 30, 2002, interest income was $263,000, compared to $622,000 for the three months ended June 30, 2001, a decrease of $359,000, or 57.7%. The decrease in interest income resulted from lower interest rates and a decrease in the funds we had available for investments.

        Interest and other (expenses).    For the three months ended June 30, 2002, interest and other expenses were $9,000, compared to $(6,000) for the three months ended June 30, 2001. The decrease in interest and other (expense) related to the additional interest expense on our long-term debt obligations being offset by foreign currency gains.

        Equity loss in investment.    For the three months ended June 30, 2002, our equity loss in investment was $57,000, compared to $17,000 for the three months ended June 30, 2001.    We account for our investment in StemSource, Inc., which we purchased in May 2001, under the equity method of accounting.

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