SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-K

 

 

 

 

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

 

None

 

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

 

Common stock, par value $0.001

 

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

 

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 the 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.  o

 

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

 

The aggregate market value of the common stock of the registrant held by non-affiliates of the registrant on June 30, 2003, the last business day of the registrant’s most recently completed second fiscal quarter was $43,281,045 based on the average of the reported high and low sales price of the registrant’s common stock on June 30, 2003 as reported on the Frankfurt Stock Exchange, of 3.22 Euros, or $3.68 per share, based on the exchange rate in effect as of such date.

 

As of January 31, 2004, there were 13,932,460 shares of the registrant’s common stock outstanding.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Portions of the registrant’s definitive proxy statement for the 2004 Annual Meeting of Stockholders,  which will be filed with the Securities and Exchange Commission within 120 days after the end of the year ended December 31, 2003, are incorporated by reference in Part III, Items 10, 11, 12, 13 and 14 of this Form 10-K.

 

 

TABLE OF CONTENTS

 

		Page
Item 1.	Business	4
Item 2.	Properties	16
Item 3.	Legal Matters	16
Item 4.	Submission of Matters to a Vote of Security Holders	16
Item 5.	Market for Registrant’s Common Equity and Related Stockholder Matters	17
Item 6.	Selected Financial Data	18
Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	20
Item 7A.	Quantitative and Qualitative Disclosures About Market Risk	38
Item 8.	Financial Statements and Supplementary Data	39
Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.	67
Item 9A.	Controls and Procedures	67
Item 10.	Directors and Executive Officers of the Registrant	68
Item 11.	Executive Compensation	68
Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters	68
Item 13.	Certain Relationships and Related Transactions	68
Item 14.	Principal Accountant Fees and Services	68
Item 15.	Exhibits, Financial Statement Schedules and Reports on Form 8-K	69

 

 

Item 1.  Business

 

General

 

MacroPore Biosurgery, Inc., (MacroPore) was initially formed as a California general partnership in July 1996, and incorporated in the State of Delaware in May 1997.

 

We are focused on research, development and commercialization of regenerative medicine technologies.  We have two principal technology platforms: bioresorbable technology and regenerative cell technology, with which we currently target two of the largest markets in medicine, spine and orthopedic bone repair and cardiovascular tissue repair.

 

To date, we have introduced three bioresorbable product lines that are marketed in the United States, Canada, Europe and other countries.  These product lines include:

 

1.               Spine and orthopedics surgical implants (includes HYDROSORB™ bioresorbable product families), which address surgical procedures including graft containment for spinal and other musculoskeletal applications and are marketed by Medtronic Sofamor Danek, a division of Medtronic, Inc. (Medtronic);

 

2.               Thin films surgical implants (includes SurgiWrap™ bioresorbable products), which are used for soft tissue indications and;

 

3.               Craniomaxillofacial “CMF” surgical implants, which consists of bioresorbable bone fixation implants for the face and skull, and associated instruments and accessories.

 

The CMF product line was sold to Medtronic Neurologic Technologies, a division of Medtronic, Inc., (Medtronic), in 2002; and we have agreed to sell our bioresorbable thin film product line (with certain exclusions) to Medicis Ventures Management GmbH in 2004.

 

Additionally, we are conducting research and development for an autologous cell-based technology for the regeneration and repair of damaged tissues. We are currently targeting the repair of heart and vascular tissues that are damaged after a myocardial infarction (heart attack) and other diseases.

 

Bioresorbable Technology

 

Our bioresorbable implants are made from a polylactide copolymer composed of lactic acid similar to that which occurs naturally in the human body.  The polymer implant maintains its strength during the healing process, while slowly breaking down in the body through hydrolysis.  The polymer fragments into single lactic acid molecules, and the lactic acid molecules are then metabolized by the liver into carbon dioxide and water, and released from the body through the lungs.

 

By polymerizing lactic acid and taking advantage of thermoplastic properties, we can create bioresorbable products that can be easily shaped, sized and applied to varying anatomical structures.  We believe the benefits of using a bioresorbable material in bone healing and regenerative applications include:

 

•                Provides initial and intermediate stability during healing

 

•                Eliminates long-term complications with metal implants related to stress shielding or migration

 

•                Avoids the disadvantages of radiographic interference typically encountered with metallic implants

 

•                Provides a bone / implant interface without an intervening fibrous tissue layer

 

•                Eliminates the disadvantages of unpredictable bone remodeling in comparison to allograft (cadaver) bone

 

•                Eliminates issues related to risk of disease transmission and limited supply, as well as the public perception issues associated with the use of allograft tissue

 

The spine and orthopedic bioresorbable implant product line, which includes HYDROSORB™, was introduced in 2002 by

 

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our distribution partner Medtronic Sofamor Danek and became our leading product line that same year.  It consists of five unique surgical implants, which accounted for a majority of our product revenues in 2003.  The products have received FDA clearance in the United States for certain graft containment applications, and have received the CE Mark in Europe for spinal interbody fusion procedures.  The products are manufactured by us and distributed exclusively through Medtronic Sofamor Danek.

 

The spine and orthopedic product line resulted from a Development and Supply Agreement that we entered into with Medtronic in January 2000.  The agreement was to co-develop bioresorbable implants for use in spinal fixation, stabilization and fusion applications and supply any such new implants to Medtronic Sofamor Danek as the distributor.  We amended the agreement in 2002 extending the term to 2012.

 

We have also developed and brought to market the thin films product line, which includes the SurgiWrap™ and CardioWrap™ families of bioresorbable surgical thin films.  In 2001 we received our first regulatory clearances from the FDA to market our SurgiWrap™ bioresorbable film for reinforcement of soft tissues and as a bridging material where indicated.  Some of the uses include, but are not limited to, repair of fascial defects including vaginal prolapse repair, colon and rectal prolapse repair, and reconstruction of the pelvic floor.

 

In 2003, we started to shift our strategy for the commercialization of bioresorbable thin films away from a direct sales force toward a distributor sales representative model in the United States.  2003 also saw expansion of regulatory claims, which included:

 

•                  MacroPore SurgiWrap™ MAST Bioresorbable Sheet to support and reinforce soft tissues and to minimize tissue attachment to the device in case of contact with the viscera (organs of the body)

 

•                  MacroPore CardioWrap™ Surgical Bioresorbable Film to repair the pericardium in patients that may require reoperation within 6 months

 

On December 13, 2003 we entered into an agreement with Medicis Ventures Management GmbH to sell substantially all the assets of our bioresorbable thin film product line for $7,000,000 cash at closing, a secured one-year note for $5,000,000, and a $200,000 milestone payment for a specific regulatory approval.  In addition, we would receive a nonexclusive, perpetual, worldwide, royalty-free license to the thin film technology for the regenerative-medicine field of use, and a worldwide exclusive, royalty-free license to thin-polymeric-film implants for spinal surgery, and the parties would enter into a temporary business development and revenue sharing agreement for the territory of Japan.  We also agreed to act as Medicis’ back-up supplier of the thin film bioresorbable implant products for one year after the closing of the sale of the product line.

 

In September 2002 we sold substantially all of the assets of our CMF product line to Medtronic, and granted them an exclusive license to certain related intangible assets, along with exclusive rights to the use of our bioresorbable implants for repair of the bone harvest site in the iliac crest.  In addition, we provided them the right to use our new faster-resorbing polymer (FRP) bioresorbable implant system when development is complete, and granted them access to relevant improvements in the technology for a period of five years. In February 2004, we completed and received payment on a successful 20-patient, 12-month study related to the FRP system entitling us to a $5,000,000 milestone payment related to the sale of the CMF business unit to Medtronic in 2002.

 

In February of 2004 we received a $5,000,000 payment for successfully completing a 12-month, 20-patient analysis of new faster-resorbing polymer (FRP) CMF products, which brings the total amount received under the agreement to $19,000,000.  Of this, $4,000,000 was used to purchase a waiver of the right of first offer to market our bioresorbable films in certain fields from Medtronic.  We expect to receive the last remaining milestone payment between $1,000,000 and $2,000,000 in 2004 upon the successful transfer of manufacturing know-how to Medtronic Neurologic Technologies.  We do not expect to receive significant back-up supplier-related revenues from Medtronic Neurologic Technologies after the second quarter of 2004.

 

We are also developing additional products for use in spinal fusion / reconstruction procedures 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.

 

Regenerative Cell Technology

 

In 2003 we began development of a medical system to process autologous adipose (fat) tissue.  This system could potentially allow physicians to isolate, concentrate and deliver regenerative cells at the point-of-care for multiple tissue-specific medical applications.  These research applications include, peripheral vascular disease, cardiovascular tissue repair, bone regeneration, wound

 

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healing, and soft tissue augmentation.  Our primary research focus is the repair of cardiovascular tissues that are damaged after a myocardial infarction.

 

Our approach is based on research findings which indicate that adipose (fat) tissue is a rich source of regenerative cells.  These cells have demonstrated in preclinical research that they have the ability to repair injured tissues.  Regenerative cells from adipose tissue are of three primary kinds: adult stem cells, endothelial progenitor cells and growth factor producing cells.  We acquired access to this technology and the underlying intellectual property in 2002, when we purchased StemSource, Inc. (StemSource), a company that specialized in bioengineering research and technology.

 

Adipose-derived regenerative cells possess many advantages over other cell therapy and stem cell technologies.  We believe the prospective benefits of using cells derived from adipose tissue for the regeneration of one’s own tissue include:

 

•                  A demonstrated ability to differentiate into a variety of tissues, in vitro

 

•                  Adipose tissue is expendable and accessible

 

•                  Potential benefits could encompass a variety of medical applications

 

•                  By using one’s own cells, the recipient can avoid the problems of disease transmission and rejection associated with donor tissue

 

The acquisition of StemSource has also provided us a California state-licensed tissue bank facility for the preservation of extracted regenerative cells.  Typically arranged through a patient’s physician, cell banking is the process by which regenerative cells, taken from a liposuction or other procedure, are stored (cryopreserved) in a liquid nitrogen freezer at -320°F (-196°C) exclusively for the particular patient who banked them.  The banked cells, frozen in suspended animation, can be preserved for the life of the individual.

 

Products and Services

 

We manufacture our bioresorbable implant products solely in the United States at our San Diego facility.  We have not yet developed regenerative cell related products or services for commercial use except for our cell banking service, which is being offered on a limited basis, to surgical patients undergoing liposuction procedures.

 

We currently market our bioresorbable technology product lines in the United States, Europe and/or other countries for the repair and regeneration of tissue.  All HYDROSORB™ branded products are manufactured by us and distributed exclusively by Medtronic Sofamor Danek.  HYDROSORB™ is a trademark of Medtronic. We provide a range of support services to our customers, to distributors and to surgeons including:

 

•                  Producing promotional, educational and instructional materials and literature

 

•                  Producing scientific publications

 

•                  Demonstrating our products

 

•                  Training at our San Diego headquarters

 

•                  Teaching regional and on-site training seminars and symposia

 

•                  Providing support personnel to advise surgeons during surgery on the use of our products

 

Plan of Operation

 

During 2004, we intend to focus our efforts on:

 

•                  Expanding the portfolio of MacroPore Biosurgery products sold by Medtronic Sofamor Danek,

 

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•                  Driving technology adoption through increased clinical evidence demonstrating the advantages of bioresorbable products over metal and allograft

 

•                  Achieving revenue gains in Europe from potential synergistic use of HYDROSORB™ in combination with Medtronic’s bone growth protein, INFUSE^®

 

•                  Determining the optimal methods for separating and handling regenerative cells derived from adipose tissue

 

•                  Determining the optimal methods of delivery and dosages of our adipose-derived regenerative cells

 

•                  Expanding collaborations and agreements with academic and corporate researchers engaged in regenerative medicine research

 

•                  Applying for additional research grants through the National Institutes of Health (NIH) through the Small Business Innovation Research (SBIR) program

 

•                  Developing strategic partnerships with companies in markets that would benefit from our regenerative cell platform

 

•                  Continuing preclinical research to advance toward clinical studies

 

•                  Developing a commercial system for therapeutic application of adipose derived regenerative cells

 

Research and Development

 

Our bioresorbable research and development team is focused on developing bioresorbable devices, processes, and technologies that facilitate the repair and regeneration of bone and other tissues.  Additional biomaterials research will target differing resorption rates, strength profiles, designs, and handling characteristics for various soft tissues, spinal, orthopedic, and other musculoskeletal applications.

 

In 2003, our biomaterials research and development efforts resulted in expanded applications of our bioresorbable thin film products, as well as several new spine and reconstructive products in conjunction with our distributor Medtronic Sofamor Danek.  Much of our ongoing biomaterials research and testing is focused on mechanical property and polymer characterization for better understanding of the performance of our new and existing products.

 

Through the acquisition of StemSource, in 2002, we began our focus on regenerative cell research and technology including ongoing development of proprietary methods for using adipose-derived regenerative cells clinically.  Potential clinical applications for these adipose-derived regenerative cells include cardiac and vascular healing, bone healing and regeneration, and plastic and reconstructive surgery, and many others.  In addition to our ongoing regenerative cell research, we are developing an integrated system for extracting, concentrating, and delivering therapeutic regenerative cells to patients.  These have been the primary focus areas of our Regenerative Cell Technology (formerly “Biologics”) research group in 2003.  We have also developed and established a licensed tissue bank that is being used for the long-term storage and preservation of regenerative cells, a service we offer through a network of participating surgeons in the U.S.

 

Notable research and development accomplishments of our Regenerative Cell Technology group in 2003 include:

 

•                  Significant advances in our understanding of the functionality of regenerative cells in myocardial (heart) injury applications

 

•                  Development of a quantitative assay test for adipose tissue-derived regenerative cells

 

•                  Optimization of Regenerative Cell Processing

 

•                  Significant progress in the development of an integrated cell extraction and processing system

 

•                  Applied for and awarded a $100,000 research grant for our regenerative cell research from the National Institutes of Health (NIH) through the Small Business Innovation Research (SBIR) program. We have additional applications pending through the SBIR program

 

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•                  Participation in sponsored research programs with University of California, Los Angeles (UCLA) and Cedars-Sinai Medical Center, both in Los Angeles, California

 

•                  Addition of a histology research and cell analytics group to support preclinical programs

 

In 2003 we relocated our StemSource laboratory, staff and equipment to San Diego.  We have made considerable investments in new facilities, equipment and personnel during the year as well.  We have added full time scientists, laboratory assistants, and engineers to the research and development team.  In early 2004 we added additional support personnel including an in-house patent attorney to the group.

 

Customers

 

Medtronic is our primary distributor and our principal customer, directly accounting for $12,893,000 or 91.5%, $8,605,000, or 93.9% and $5,547,000, or 98.2% of our revenues for the years ended December 31, 2003, 2002 and 2001, respectively.  We also sell some of our products directly to end users, hospitals and internationally through distributors.

 

We entered into a five-year distribution agreement and a five-year development and supply agreement with Medtronic in January 2000.  Under the distribution agreement, Medtronic agreed to purchase all of its bioresorbable implant products for use in the reconstruction or fixation of the craniomaxillofacial (skull and face) bones, exclusively from us.  In turn, we granted Medtronic exclusive rights in the United States and exclusive rights worldwide, except for rights granted under our then-existing distribution agreements with other distributors, to market, distribute and sell all of our bioresorbable implant products, devices, systems and instruments solely for use in the reconstruction or fixation of the cranial or facial skeleton.  Under this distribution agreement with Medtronic, we were allowed to enter into a distribution agreement with another distributor for distribution rights to any of our products other than those used in the cranial or facial skeleton, as long as we first presented Medtronic with the right to distribute these other products.  If we failed to come to terms with Medtronic, or if Medtronic did not wish to distribute these other products, we were allowed to enter into a distribution agreement with a third party distributor on the same or more favorable terms than those we offered to Medtronic.

 

Under our development and supply agreement, we co-develop bioresorbable implants with Medtronic for spinal or reconstructive fixation, stabilization and fusion.  Medtronic has exclusive worldwide rights to market and sell all of the products that we co-develop.  We and Medtronic will each own an undivided, one-half interest in any inventions we jointly develop.

 

In September 2002 we sold substantially all of the assets of our CMF product line to Medtronic, and granted them an exclusive license to certain related intangible assets, along with exclusive rights to the use of our bioresorbable implants for repair of the bone harvest site in the iliac crest.  In addition, we provided them the right to use our new faster-resorbing polymer (FRP) bioresorbable implant system when development is complete, and granted them access to relevant improvements in the technology for a period of five years. In February 2004, we completed and received payment on a successful 20-patient, 12-month study related to the FRP system entitling us to a $5,000,000 milestone payment related to the sale of the CMF business unit to Medtronic in 2002.

 

Also in September 2002, Medtronic agreed to remove the contractual right of first offer for distributorship of our bioresorbable thin film products in various types of surgery outside of the spinal field.  Medtronic continues to retain its right of first offer for distributorship to our other products in all fields until January 5, 2005, and our bioresorbable plates and mesh for orthopedic applications until January, 2006.  In addition, we agreed to extend the term of our existing global co-development and supply agreement with Medtronic for spinal implants to 2012.

 

Thin Film

 

During the summer of 2002, a direct sales force was recruited, trained, and placed in the field throughout the United States with a focus on introducing the SurgiWrap™ bioresorbable thin film products to the marketplace.  Through their efforts, sales of the bioresorbable thin film products in the U.S. reached $806,000 in 2003.  A parallel effort was coordinated from Europe to organize a network of independent distributors to represent the bioresorbable thin film products outside of the U.S.  This distributor sales model generated $361,000 sales in 2003.

 

In 2003, we started to shift our strategy for the commercialization of bioresorbable thin films away from a direct sales force toward a distributor sales representative model in the United States.

 

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Market and Competition

 

We compete with many other companies in developing and marketing our technology and products.  In the spine and orthopedic market, we compete primarily with titanium products, although we believe that an increasing number of other companies are developing, or are offering, bioresorbable bone fixation systems. Stryker Inc. and Synthes are two companies that we are aware of who produce both bioresorbable and titanium implants.  Additionally, surgeons have historically been slow to adopt the use of new medical device technologies as alternatives for long-established, well-marketed devices, such as metallic bone fixation methods.

 

We have not yet developed regenerative cell related products or services for commercial use except for our cell banking service, which is being offered on a limited basis, to surgical patients undergoing liposuction procedures.  While we are not currently aware of any other provider of cell banking comparable to our own, there are various companies engaged in umbilical cord blood banking and bone marrow banking.

 

The field of regenerative cell technology and services is rapidly progressing, with many corporations and universities exploring the clinical potential.  Most of these organizations are involved in stem cell research using sources other than adipose (fat) tissue such as: embryonic and fetal derived stem cells, and blood, bone marrow, muscle and skin derived adult stem cells.

 

We believe that adipose tissue is an ideal source of regenerative cells for therapeutic use due to the expendability and accessibility of adipose tissue, as well as the high yield and high quality of stem and other regenerative cells obtainable from this source.  Many other cell sources are difficult to harvest and/or do not yield a high number.  These sources also generally require the cells to be expanded in culture before clinical application.  We are only aware of one other company, Cognate Therapeutics, that has any commercial program in adipose derived stem cells.

 

We are aware that several companies including Genzyme, Baxter, and BioHeart are currently involved in stem cell related clinical trials focused on myocardial infarction and congestive heart failure.  Osiris Therapeutics and Aastrom are involved in clinical trials using cultured human mesenchymal stem cells.  Baxter, Inc. is involved in a pilot clinical trial using blood-derived stem and progenitor cells. There are several other companies currently conducting preclinical research on potential stem cell therapies.  We cannot with any accuracy forecast when or if these companies are likely to bring cell therapies to market.

 

Many of our competitors and potential competitors have substantially greater financial, technological, research and development, marketing and personnel resources than we do.  These competitors may also have greater experience in developing products, conducting clinical trials, obtaining regulatory approvals, and manufacturing and marketing such products.  Some of these competitors may obtain patent protection, approval or clearance by the FDA or from foreign countries, or may achieve product commercialization earlier than us, any of which could materially adversely affect our business or results of operations.  We cannot be assured that our competitors will not succeed in developing alternative technologies and products that are more effective, easier to use or more economical than those which have been or are being developed by us or that would render our technology and products obsolete and noncompetitive in these fields.  In addition, even if our products are technologically superior, it is possible that competitors’ superior marketing power could defeat us in the marketplace.  Furthermore, under the terms of our marketing agreement with Medtronic, Medtronic may pursue parallel development of other technologies or products, which may result in Medtronic developing additional products that will compete with our products.

 

Sales by Geographic Region

 

We sell our products predominantly in the United States and to a lesser extent internationally through independent distributors.  International sales may be limited or disrupted by political instability, price controls, acts of war, trade restrictions and changes in tariffs.  Our existing distribution agreements all provide for payment in U.S. dollars and we intend to include similar payment provisions in future distribution agreements.  Fluctuations in currency exchange rates may adversely affect demand for our products by increasing the price of our products relative to the currency of the countries in which the products are sold.

 

For the year end ended December 31, 2003, we recorded $14,088,000 in revenues, including $13,727,000 of product sales in the United States and $361,000 of product sales outside the United States.  For the year ending December 31, 2002, we recorded $9,166,000 in revenues, including $8,854,000 of product sales in the United States and $312,000 of product sales outside the United States.  For the year ending December 31, 2001, we recorded $5,648,000 in revenues, including $4,954,000 of product sales in the United States and $694,000 of product sales outside the United States.

 

Working Capital

 

We generally build products to order although for selected products we may from time to time maintain an inventory of approximately six to twelve months.  Although capital expenditures may vary significantly depending on a variety of factors, including sales, we presently intend to spend approximately $1,300,000 on capital equipment purchases in 2004 of which a portion

 

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may be paid with our current cash reserve.

 

Raw Materials

 

We currently purchase the high molecular weight, medical grade, lactic acid copolymer used in manufacturing most of our products, from a single qualified source, B.I. Chemicals, Inc.  Although we have a contract with B.I. Chemicals, which guarantees continuation of supply through August 15, 2005, we cannot guarantee that they will elect to continue the contract beyond that date, or that they will not elect to discontinue the manufacture of the material.  They have agreed that if they discontinue manufacturing they will either find a replacement supplier, or provide us with the necessary technology to self-manufacture the material, either of which could mean a substantial increase in material costs.  Also, despite this agreement, they might fail to fulfill their obligations.  Under the terms of the contract, B.I. Chemicals, Inc. may choose to raise their prices upon nine months prior notice which may also result in a substantially increased material cost.  Although we believe that we would be able to obtain the material from at least one other source in the event of a failure of supply, there can be no assurance that we will be able to obtain adequate increased commercial quantities of the necessary high quality within a reasonable period of time or at commercially reasonable rates.  Lack of adequate commercial quantities or inability to develop alternative sources meeting regulatory requirements at similar prices and terms within a reasonable time or any interruptions in supply in the future could have a significant negative effect on our ability to manufacture products, and, consequently, could have a material adverse effect on the results of our operations and financial condition.

 

Intellectual Property

 

Our success depends in large part on our ability to protect our proprietary technology and information, and operate without infringing on the proprietary rights of third parties.  We rely on a combination of patent, trade secret, copyright and trademark laws, as well as confidentiality agreements, licensing agreements and other agreements, to establish and protect our proprietary rights.  Our success also depends on our ability to obtain patents on our technology.

 

We have eight United States patents relating to four of our primary bioresorbable implant products and technology.  We also have two Australian patents relating to our bioresorbable mesh, one Australian patent for the design of our high torque bioresorbable screws and another Australian patent related to our membrane with tissue guiding surface corrugations.  Our three U.S. patents for the design of our macro-porous bioresorbable sheets were issued in July 1999 and August 2001.  Our three U.S. patents for the design of our high torque bioresorbable screws were issued in August 2001, February 2002 and November 2002.  Our U.S patent related to our membrane with tissue guiding surface corrugations was issued May 2002.  Our most recent U.S. patent issued on March 2003 and is related to our bioresorbable barrier film for the control of postsurgical adhesions.  Our four Australian patents issued in August 2000, January 2003 and September 2003.  Each of our patents will expire 20 years from the filing date of the original patent application.

 

We have filed applications for 37 additional United States patents, as well as 43 corresponding international patent applications, relating to our technology.  As part of the StemSource acquisition we were granted certain exclusive and non-exclusive perpetual license rights to four U.S. patent applications and fourteen international patent applications through a license agreement with the Regents of the University of California. We cannot assure you that any of the pending patent applications will be issued, that we will develop additional proprietary products that are patentable, that any patents issued to us will provide us with competitive advantages or will not be challenged by any third parties or that the patents of others will not prevent the commercialization of products incorporating our technology.  Furthermore, we cannot assure you that others will not independently develop similar products, duplicate any of our products or design around our patents.

 

Litigation may also be necessary to enforce any patents issued or licensed to us or to determine the scope and validity of third party proprietary rights.  If our competitors claim technology also claimed by us and prepare and file patent applications in the United States, we may have to participate in interference proceedings declared by the U.S. Patent and Trademark Office to determine priority of invention.  Any such litigation and/or interference proceedings, could result in substantial costs to us and divert our management’s attention from our business operations, even if the eventual outcome is favorable to us.  Litigation could subject us to significant liabilities to third parties and require disputed rights to be licensed from third parties or require us to cease using certain technology.

 

Patent law outside the United States is uncertain and in many countries is currently undergoing review and revisions.  The laws of some countries may not protect our proprietary rights to the same extent as the laws of the U.S. Third parties may attempt to oppose the issuance of patents to us in foreign countries by initiating opposition proceedings.  Opposition proceedings against any of our patent filings in a foreign country could have an adverse effect on our corresponding patents that are issued or pending in the U.S.  It may be necessary or useful for us to participate in proceedings to determine the validity of our, or our competitors’ patents that have been issued in countries other than the U.S.  This could result in substantial costs, divert our efforts and attention from other aspects of our business, and could have a material adverse effect on our results of operations and financial condition.

 

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In addition to patent protection, we rely on unpatented trade secrets and proprietary technological expertise.  We cannot assure you that others will not independently develop or otherwise acquire substantially equivalent techniques, or otherwise gain access to our trade secrets and proprietary technological expertise or disclose such trade secrets, or that we can ultimately protect our rights to such unpatented trade secrets and proprietary technological expertise.  We rely, in part, on confidentiality agreements with our marketing partners, employees, advisors, vendors and consultants to protect our trade secrets and proprietary technological expertise.  We cannot assure you that these agreements will not be breached, that we will have adequate remedies for any breach or that our unpatented trade secrets and proprietary technological expertise will not otherwise become known or be independently discovered by competitors.  Our failure to obtain or maintain patent and trade secret protection, for any reason, could have a material adverse effect on our results of operations and financial condition.

 

Government Regulation

 

Most medical devices for use in humans, including our bioresorbable protective sheets, plates, screws and tacks, are subject to stringent government regulation in the United States by the Food and Drug Administration, or “FDA,” under the federal Food, Drug and Cosmetic Act, or “FDC” Act.  The FDA regulates the clinical testing, manufacture, safety, labeling, sale, distribution and promotion of medical devices.  Included among these regulations are premarket clearance, premarket approval, and Quality System Regulation, or “QSR,” requirements.  Other statutory and regulatory requirements govern, among other things, registration and inspection, medical device listing, prohibitions against misbranding and adulteration, labeling and postmarket reporting.  The regulatory process may be lengthy, expensive and uncertain.  Securing FDA approvals and clearances may require us to submit extensive clinical data and supporting information to the FDA.  Failure to comply with applicable requirements can result in application integrity proceedings, fines, recalls or seizures of products, injunctions, civil penalties, total or partial suspensions of production, withdrawals of existing product approvals or clearances, refusal to approve or clear new applications or notifications, and criminal prosecution.

 

Under the FDC Act, medical devices are classified into Class I, Class II or Class III devices, based on their risks and the control necessary to reasonably ensure their safety and effectiveness.  Class I devices are subject to general controls such as labeling, premarket notification and adherence to QSR requirements.  Class II devices are subject to general controls, and may be subject to specific controls such as performance standards, postmarket surveillance and patient registries.  Class II devices require premarket notification to the FDA in the form of a 510(k) application that demonstrates the new device to be “substantially equivalent” to an existing FDA 510(k) cleared device.  Generally, Class III devices, which include certain life-sustaining, life-supporting and implantable devices or new devices which have been found not to be substantially equivalent to certain legally marketed devices, must receive premarket approval from the FDA.  All of our implant products to date are Class II medical devices.

 

Before any new Class II or III medical device may be introduced to the market, the manufacturer generally must obtain either premarket clearance through the 510(k) premarket notification process or premarket approval through the lengthier Premarket Approval Application, or “PMA,” process.  The FDA will grant a 510(k) premarket notification if the submitted data establishes that the proposed device is “substantially equivalent” to a legally marketed Class I or Class II medical device The FDA may request data, including clinical studies, before it can make a determination of substantial equivalence.  It generally takes from three to 12 months from submission to obtain 510(k) premarket clearance, although it may take longer.  There is no assurance that clearance will be granted.  We must file a PMA if one of our products is found not to be substantially equivalent to a legally marketed Class II device or if it is a Class III device for which the FDA requires PMAs.  A PMA must be supported by extensive data to demonstrate the safety and effectiveness of the device, including laboratory, preclinical and clinical trial data, as well as extensive manufacturing information.  Before initiating human clinical trials on devices that present a significant risk, we must first obtain an Investigational Device Exemption, or IDE, for the proposed medical device.  Obtaining FDA approval of the Investigational Device Exemption allows the sponsor to begin the collection of clinical data according to a protocol that must be approved by the FDA. Several factors influence the overall time frame of the IDE process.  These include: the number of patients required for statistical significance, the requirement for a pilot (safety) study in advance of initiating a pivotal study, and the duration of follow-up required before the IDE can be closed and the PMA prepared for submission to FDA. This follow-up period typically ranges from 12-24 months on the last patient to be enrolled in the study.  Toward the end of the PMA review process, the FDA will generally conduct an inspection of our manufacturing facilities to ensure compliance with QSRs.  Approval of a PMA could take up to one or more years from the date of submission of the application or petition, however, the entire process of IDE submission /approval, clinical data collection, patient follow-up, PMA preparation and approval typically requires 4 years or more.  The PMA process can also be expensive and uncertain, and there is no guarantee of ultimate approval.

 

Modifications or enhancements of products that could affect the safety or effectiveness or effect a major change in the intended use of a device that was either cleared through the 510(k) process or approved through the PMA process may require further FDA review through new 510(k) or PMA submissions.

 

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As a medical device manufacturer, we are subject to periodic inspections by the FDA to ensure that devices continue to be manufactured in accordance with QSR requirements.  We are also subject to postmarket reporting requirements for deaths or serious injuries when a device may have caused or contributed to death or serious injury, and for certain device malfunctions that would be likely to cause or contribute to a death or serious injury if the malfunction were to recur.  Postmarket reporting also may be required for certain corrective actions undertaken for distributed devices.  If safety or effectiveness problems occur after the product reaches the market, the FDA may take steps to prevent or limit further marketing of the product.  Additionally, the FDA actively enforces regulations prohibiting marketing of devices for indications or uses that have not been cleared or approved by the FDA.

 

Under the terms of our development and supply agreement with Medtronic, Medtronic is responsible for preparing and filing applications for, and obtaining regulatory approval of the products we co-develop for use in spinal fixation, stabilization or fusion applications.  We or our marketing partners may not be able to obtain necessary 510(k) clearances or PMA approvals to market the products we are developing in the United States for their intended use on a timely basis, if at all.

 

Product lines marked by an asterisk (*) have been sold to Medtronic PS Medical for all craniomaxillofacial (sk