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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K
(Mark one)
[X]ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
for the fiscal year ended December 31, 2001.
OR
[_]TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
for the transition period from to .
Commission File No. 1-10492
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ORASURE TECHNOLOGIES, INC.
(Exact Name of Registrant as Specified in Its Charter)
Delaware 36-4370966
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
150 Webster Street
Bethlehem, Pennsylvania 18015
(Address of Principal Executive (Zip Code)
Offices)
(610) 882-1820
(Registrant's Telephone Number, Including Area Code)
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.000001 par value per share
(Title of Class)
Indicate by check mark whether the Registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes [X] No [_]
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. [_]
State the aggregate market value of the voting and non-voting common equity
held by non-affiliates of the Registrant, as of March 22, 2002: $182,120,931
Indicate the number of shares outstanding of each of the Registrant's
classes of common stock, as of March 22, 2002: 37,442,541 shares.
Documents Incorporated by Reference:
Portions of Registrant's Definitive Proxy Statement for the 2002 Annual
Meeting of Stockholders are incorporated by reference into Part III of this
Report.
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TABLE OF CONTENTS
Page
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PART I
ITEM 1. Business...................................................... 1
ITEM 2. Properties.................................................... 26
ITEM 3. Legal Proceedings............................................. 27
ITEM 4. Submission of Matters to a Vote of Security Holders........... 27
PART II
Market for Registrant's Common Equity and Related Stockholder
ITEM 5. Matters....................................................... 28
ITEM 6. Selected Financial Data....................................... 28
Management's Discussion and Analysis of Financial Condition
ITEM 7. and Results of Operations..................................... 30
ITEM 7A. Quantitative and Qualitative Disclosures About Market Risk.... 40
ITEM 8. Financial Statements and Supplementary Data................... 40
Changes in and Disagreements with Accountants on Accounting
ITEM 9. and Financial Disclosure...................................... 40
PART III
ITEM 10. Directors and Executive Officers of the Registrant............ 41
ITEM 11. Executive Compensation........................................ 41
Security Ownership of Certain Beneficial Owners and
ITEM 12. Management.................................................... 41
ITEM 13. Certain Relationships and Related Transactions................ 41
PART IV
Exhibits, Financial Statement Schedules, and Reports on Form
ITEM 14. 8-K........................................................... 41
Statements contained in this Annual Report on Form 10-K regarding future
events or performance are "forward-looking statements" within the meaning of
the Private Securities Litigation Reform Act of 1995. The Company's actual
results could be quite different from those expressed or implied by the
forward-looking statements. Factors that could affect results are discussed
more fully under the Sections entitled, "Forward-Looking Statements" and "Risk
Factors," in Item 1 and elsewhere in this Report. Although forward-looking
statements help to provide complete information about the Company, readers
should keep in mind that forward-looking statements may not be reliable.
Readers are cautioned not to place undue reliance on the forward-looking
statements.
PART I
ITEM 1. Business.
On September 29, 2000, STC Technologies, Inc., a Delaware corporation
("STC"), and Epitope, Inc., an Oregon corporation ("Epitope"), were merged
(the "Merger") into OraSure Technologies, Inc. ("OraSure Technologies" or the
"Company"), a new corporation that was organized on May 5, 2000 under Delaware
law solely for the purposes of combining STC and Epitope and changing the
state of incorporation of Epitope from Oregon to Delaware. The companies were
merged pursuant to an Agreement and Plan of Merger, dated May 6, 2000, by and
among Epitope, STC and the Company. The stockholders of STC and Epitope
approved the Merger Agreement on September 29, 2000.
Epitope historically reported its financial results on the basis of a fiscal
year ending September 30, while STC previously reported its financial results
on a calendar year basis. Immediately prior to the Merger, Epitope adopted a
calendar year for financial reporting purposes. As a result, financial
information presented in this Report for 2001 and 2000 reflect results for the
calendar years ended December 31, 2001 and 2000, respectively. Since Epitope
did not adopt a calendar year reporting period until 2000, the financial
information for 1999 reflects the results of Epitope for the twelve-months
ended September 30, 1999 and the results of STC for the twelve months ended
December 31, 1999. See Note 1 to the Company's Financial Statements for a
discussion of the Merger and the change in fiscal year end.
General
OraSure Technologies develops, manufactures and markets oral fluid specimen
collection devices using proprietary oral fluid technologies and diagnostic
products including immunoassays and other in vitro diagnostic tests, and other
medical devices. These products are sold in the United States and certain
foreign countries to government agencies, clinical laboratories, physicians'
offices, hospitals, commercial and industrial entities, and various
distributors.
In vitro diagnostic testing is the process of analyzing constituents of oral
fluid, blood, urine and other bodily fluids or tissue for the presence of
specific substances or markers of infectious diseases or other conditions. In
vitro diagnostic tests are performed outside the body, in contrast to in vivo
tests which are performed directly on or within the body. The substance or
marker that a diagnostic test is intended to detect is generally referred to
as an analyte.
Immunodiagnostic testing is the leading method of in vitro testing for
antigens and antibodies. When an infectious disease caused by pathogens, such
as bacteria, viruses and fungi, or other substances are present, the body
responds by producing an antibody. Substances that stimulate production of
antibodies are generally referred to as antigens. An antibody binds
specifically with an antigen in a lock-and-key fashion that initiates a
biochemical reaction to attempt to neutralize and, ultimately, eliminate the
antigen. The ability of an antibody to bind with a specific antigen provides
the basis for immunodiagnostic testing.
Products
OraSure Technologies' business focuses on the following principal platform
technologies: (1) the OraSure(R) and Intercept(R) oral fluid collection
devices, (2) the OraQuick(R) rapid diagnostic test device, and (3) the new up-
1
converting phosphor technology ("UPT"), including its first application,
UPlink(TM), a lateral flow testing system for various analytes. In addition,
the Company sells certain other products, including the Histofreezer(R)
portable cryosurgical system, certain immunoassay tests and reagents for
insurance risk assessment, substance abuse testing and forensic toxicology
applications, an oral fluid Western Blot confirmatory test for the Human
Immunodeficiency Virus Type 1 ("HIV-1"), and the Q.E.D.(R) saliva alcohol
test.
OraSure(R)/Intercept(R) Collection Devices
The Company's OraSure(R) oral fluid collection device is used in conjunction
with screening and confirmatory tests for HIV-1 antibodies and other analytes.
The device consists of a small, treated cotton-fiber pad on a nylon handle
that is placed in a person's mouth for two to five minutes. The device
collects oral mucosal transudate ("OMT"), a serum-derived fluid that contains
higher concentrations of antibodies and analytes than saliva. As a result, OMT
testing is a highly accurate method for detecting HIV-1 infection and other
analytes. The Company believes that oral fluid testing has several significant
advantages over blood or urine-based testing systems for both health care
professionals and individuals being tested, including eliminating the risk of
needle-stick accidents, providing a noninvasive collection technique,
requiring minimal training to administer, providing rapid and efficient
collection in almost any setting, and eliminating the cost of administration
by a trained health care professional.
The Company has received approval from the U.S. Food and Drug Administration
("FDA") to sell the OraSure(R) oral fluid collection device for use with a
laboratory-based enzyme immunoassay ("EIA") screening test for HIV-1 antibody
detection. HIV-1 antibody detection using the OraSure(R) collection device
involves three steps: (1) collection of an oral fluid specimen using the
OraSure(R) device, (2) screening of the specimen for HIV-1 antibodies at a
laboratory with an EIA screening test, and (3) laboratory confirmation of any
positive screening test results with the OraSure(R) Western Blot HIV-1
confirmatory test (described below). A trained health care professional then
conveys test results and provides appropriate counseling to the individual who
was tested. The Company has also received FDA clearance for use of the
OraSure(R) collection device with EIAs to test for cocaine and cotinine (a
metabolite of nicotine) in oral fluid specimens.
The Company sells the OraSure(R) collection device in the insurance market
for screening life insurance applicants for HIV-1, cocaine and cotinine, and
in the public health market for HIV-1 testing.
A collection device substantially similar to the OraSure(R) device comprises
the Company's Intercept(R) oral fluid drug testing service. The Company has
received FDA clearance to use the Intercept(R) collection device with
laboratory-based EIAs to test for drugs of abuse commonly identified by the
National Institute for Drug Abuse ("NIDA") as the NIDA-5 (i.e., cannabinoids
(marijuana), cocaine, opiates, amphetamines, and phencyclidine ("PCP")), and
for barbiturates and methadone. The Company also sells, or arranges for a
third party vendor to sell, equipment required by its laboratory customers to
test oral fluid specimens collected with the Intercept(R) device. Intercept(R)
is sold in the workplace testing, public health, criminal justice and drug
rehabilitation markets.
The Company believes that the Intercept(R) service has several advantages
over certain competing products for drugs-of-abuse testing, including its
lower cost, non-invasive nature, safety, mobility and accuracy, the ease of
maintaining a chain-of-custody, the treatment of test subjects with greater
dignity, no requirement for specially-prepared collection facilities, and
difficulty of sample adulteration. The availability of an oral fluid test is
intended to allow workplace administrators to test for employee impairment on
demand, eliminate scheduling costs, and streamline the testing process.
OraQuick(R) Rapid Test
OraQuick(R) is the Company's rapid test platform designed to test an oral
fluid, whole blood or serum/plasma sample for the presence of various
antibodies or analytes. The device includes a porous flat pad used to collect
an oral fluid specimen. After collection, the pad is inserted into a vial
containing a pre-measured amount of
2
developer solution and allowed to develop. When whole blood is to be tested, a
loop collection device is used to collect a drop of blood and mix it in the
developer solution, after which the collection pad is inserted into the
solution. The specimen and solution then flow through the testing device where
test results are observable in approximately 20 minutes. The OraQuick(R)
device is a screening test and requires a confirmation test where a positive
result is obtained.
The Company's first product utilizing this technology is the OraQuick(R) HIV
device, a rapid test for the presence of antibodies against HIV. On June 23,
2000, the Company received approval for an Investigational Device Exemption
("IDE") from the FDA authorizing the commencement of formal clinical trials
for the OraQuick(R) HIV device. Due to the critical need for an FDA-approved
rapid HIV test, the Company, after consultation with the FDA and the Centers
for Disease Control and Prevention ("CDC"), submitted an initial application
on June 29, 2001 for pre-market approval for testing of whole blood for HIV-1.
The Company expects to submit an application to the FDA for approval of an
OraQuick(R) test for HIV-1 in oral fluid in 2002.
The CDC has identified several key areas for use of the OraQuick(R) HIV
device in the United States, including certain public hospitals in U.S.
metropolitan areas with a relatively high incidence of HIV infection in
pregnant women, AIDS service organizations, community-based organizations,
outreach programs, and selected hospital emergency departments and outpatient
clinics. Under a treatment IDE, the OraQuick(R) device is being used in the
CDC's Maternal Infant Rapid Intervention at Delivery Project (MIRIAD) to test
pregnant women in five U.S. metropolitan areas. The goal of this project is to
identify those individuals who would benefit from the administration of
nevirapine, a drug used to reduce mother-to-child HIV-1 transmission. The
OraQuick(R) device was also selected for use in the CDC's LIFE Initiative, an
international effort to address the AIDS epidemic in certain African
countries, focusing on areas such as preventing mother-to-child transmission,
secondary transmitted disease prevention, HIV prevention for youth, and blood
safety systems.
At the CDC's Rapid Diagnostic's Meeting in February 2001, the CDC released
the most recent results of its ongoing multi-product, rapid HIV test study,
which was conducted independently from the Company's clinical trials used for
its FDA submission. These results indicated a 100% sensitivity and 99.5%
specificity for the OraQuick(R) device with whole blood samples. In addition,
at the 9th Conference on Retroviruses and Opportunistic Infections in February
2002, the CDC released additional clinical results which indicated a 98.6%
sensitivity and 98.9% specificity for the OraQuick(R) device with oral fluid
samples. Sensitivity is a measure of the accuracy in detecting positive
samples and specificity is a measure of the accuracy in measuring negative
samples.
In July 2000, the Company introduced the OraQuick(R) HIV device for sale
outside the United States at the International AIDS Conference in Durban,
South Africa. Clinical tests for the OraQuick(R) HIV device using oral fluid
specimens have been completed in Thailand, with the results demonstrating 100%
sensitivity and 99.9% specificity. The World Health Organization is presently
evaluating the OraQuick(R) HIV device.
The Company intends to market the OraQuick(R) HIV device, either directly or
through distributors, in the hospital, physician office and public health
markets in the United States and internationally. Agreements with distributors
will be necessary for the Company to fully exploit domestic and international
opportunities.
The Company initially intends to sell an OraQuick(R) device for the
detection of HIV-1 in the United States and certain developed countries, and
an OraQuick(R) device for the detection of both HIV-1 and the Human
Immunodeficiency Virus Type 2 ("HIV-2') in certain foreign countries. The
Company may need to obtain licenses or other rights under, or to enter into
distribution or other business arrangements in connection with, certain
patents related to HIV-2 and lateral flow technology, in order to market the
OraQuick(R) HIV device in the United States and certain other countries. See
the Section entitled "Risk Factors--Patent Issues Affecting OraQuick(R)" for a
further discussion of these issues.
3
UPT(TM) and UPlink(TM)
Up-Converting Phosphor Technology. Up-Converting Phosphor Technology
("UPT(TM)") is a proprietary label detection platform being developed by the
Company that uses phosphor particles to detect minute quantities of various
substances. UPT(TM) utilizes the same particle shell that is coated onto a
television screen, but the internal chemistry of the particle has been
changed. These changes result in a particle that is excited by infrared light
as compared to an ultraviolet light source for television. The Company and its
research partners have developed phosphorescent particles that up-convert
infrared light to visible light, which the Company believes is a platform
technology with broad applications.
Phosphor particles have been used for decades in television screens and in
fluorescent light bulbs. When high energy ultraviolet light strikes the
phosphor-coated area in a screen or bulb, it excites the particles and low
energy visible colored light is produced. The Company's patented improvements
on this base technology employ chemical changes inside the phosphor particles
so that low energy infrared light can be used to produce a high energy visible
colored signal and is the basis for UPT(TM). This use of infrared light to
create a colored signal is called up-conversion as opposed to down-conversion,
which occurs in phosphors designed to be used with ultraviolet light.
The use of infrared light to excite the phosphor particles and produce a
colored light signal creates an important competitive advantage for the
technology in biological systems, especially human clinical diagnostics.
Existing enzyme or fluorescent-based assays employ visible or ultraviolet
light to generate the signals from the enzyme substrate or fluorescent
molecules used as reporter signals in these systems. The disadvantage of using
light in the visible or ultraviolet portion of the spectrum is that often
molecules in the cells or samples for analysis can also produce colored light
(background interference) from these excitation sources. When this occurs, a
non-specific signal is generated which dilutes or obscures the signal of
interest for the diagnostic test being administered. Because up-conversion
does not occur in nature, biological samples and specimens will not produce
light and, therefore, will not cause background interference when excited by
infrared light.
The Company believes that UPT(TM) overcomes some of the limitations of other
diagnostic detection methods and offers features not commercially available
today. The fact that UPT(TM) testing produces zero background interference
dramatically increases the potential sensitivity of any test system. In
addition, UPT(TM) offers the following other key competitive features:
. Ability to detect biological markers for several substances
simultaneously through the use of phosphor particles having various
colors (i.e. multiplexing)
. Creation of a permanent test record not subject to fading
. Applicability to a variety of instrument platforms
. Compatibility with alternative testing matrices such as oral fluid,
blood or others
. Ability to miniaturize the test platform
The Company has reached important milestones in the development of UPT(TM),
including improving the manufacturing process to produce UPT(TM) particles,
working to optimize UPT(TM) particle coating techniques, producing four
distinct colors of UPT(TM) particles to permit multiplexing, demonstrating
initial feasibility for the use of UPT(TM) particles in infectious disease,
cancer, and limited DNA detection applications, and developing a UPT(TM)
collector, test cassette, and analyzer for oral fluid testing for drugs of
abuse.
UPlink(TM). UPlink(TM) is the Company's first product application based on
UPT(TM). UPlink(TM) is designed to be a rapid, point-of-care system utilizing
a collector, lateral flow test cassette, and analyzer, which provides
instrument-read quantitative results in about 10 minutes on a variety of
samples, including oral fluid, blood, serum, urine and stool samples.
4
In March 2000, the Company signed a research and development agreement with
Drager Safety AG & Co. KGaA (formerly Drager Sicherheitstechnik GmbH)
("Drager"), a European manufacturer and supplier of medical and safety
technology products for health care and industrial applications, to develop
and optimize an UPlink(TM) system for rapid detection of drugs of abuse in
oral fluid. The UPlink(TM) system developed with Drager is expected to be
marketed initially to law enforcement officials as a system for rapidly
assessing whether an operator or passenger in a motor vehicle is under the
influence of one or more drugs of abuse (the "roadside market") and ultimately
to certain military, criminal justice, and workplace testing markets. As part
of the research and development agreement, the Company received a non-
refundable fee and will receive additional fees upon achievement of technical
milestones. Upon successful completion of such research and development
activities, Drager has the option to become the Company's exclusive
distributor of the UPlink(TM) drugs of abuse rapid detection system in Europe
and certain other countries in the markets described above.
In June 2001, the Company submitted an application for 510(k) clearance from
the FDA for its UPlink(TM) analyzer and six oral fluid drugs-of-abuse assays--
cocaine, opiates, amphetamines, methamphetamine, PCP and marijuana. The FDA
subsequently requested additional data for the analyzer and each of the six
drug assays. On January 31, 2002, the Company resubmitted to the FDA an
application containing the additional data for the UPlink(TM) analyzer and the
assay for opiates, and expects to resubmit one or more applications for the
remaining UPlink(TM) assays in 2002. The UPlink(TM) drug testing system is
expected initially to be marketed by the Company in the United States in the
unregulated criminal justice market. After receipt of FDA clearance for all of
the six oral fluid drugs-of-abuse assays, this product will be marketed by the
Company or its distributors in the regulated workplace market in the United
States.
In September 2000, OraSure Technologies signed a research and development
agreement with Meridian Bioscience, Inc. (formerly Meridian Diagnostics, Inc.)
("Meridian"), a medical diagnostics company. Under this agreement, the Company
and Meridian plan to develop a broad range of UPlink(TM) point-of-care tests
for the rapid detection of parasites, and gastrointestinal and upper
respiratory diseases. Pursuant to a related supply agreement, Meridian will
serve as a worldwide distributor of the analyzers and lateral flow cassettes
developed under the research and development agreement. The Company has
received and is eligible in the future to receive payments upon achievement of
certain milestones and royalties from the sale of the analyzers and testing
devices. OraSure Technologies has commenced work on the development of two
tests under the research and development agreement and expects Meridian to
submit an application for FDA 510(k) clearance of the first such test in 2002.
UPlink(TM) products developed with Meridian will be manufactured by the
Company and are expected to be marketed by Meridian in the hospital market.
Histofreezer(R)
In 1991, the Company became the exclusive United States distributor of the
Histofreezer(R) portable cryosurgical system, a low-cost alternative to liquid
nitrogen and other eradication methods for removal of warts and other benign
skin lesions. In June 1998, the Company acquired the Histofreezer(R) product
from Koninklijke, Utermohlen, N.V., The Netherlands. As part of the
acquisition, the Company established a sales office in Reeuwijk, The
Netherlands, and is selling the Histofreezer(R) product through a dealer
network in more than 20 countries worldwide.
The Histofreezer(R) product mixes two environmentally friendly cryogenic
gases in a small aerosol canister. When released, these gases are delivered to
a specially designed foam bud, cooling the bud to -50(degrees) C. The frozen
bud is then applied to the lesion for 15 to 40 seconds (depending on the type
of lesion) creating localized destruction of the target area. Histofreezer(R)
is sold in several canister sizes. Sales of this product have been targeted to
primary care physicians such as pediatricians, general and family
practitioners, and other physician segments that traditionally referred
patients to dermatologists to remove warts. The Company has established a
national network of distributors to reach the physician office market in the
United States.
5
Immunoassay Tests and Reagents
The Company develops and sells immunoassay tests in two formats, MICRO-PLATE
and AUTO-LYTE(R), to meet the specific needs of its customers.
AUTO-LYTE(R) tests are sold in the form of bottles of liquid reagents. The
reagents are run on commercially available laboratory-based automated
analytical instruments which are manufactured by a variety of third parties.
AUTO-LYTE(R) is typically used in high volume, automated, commercial reference
laboratories to detect certain drugs or chemicals in urine. Test results are
produced quickly, allowing for high throughput.
In the MICRO-PLATE kit, the sample to be tested is placed into a small
plastic receptacle, called a microwell, along with the reagents. The result of
the test is determined by the color of the microwell upon completion of the
reaction. Controlling the reaction involves the use of a variety of reagents
by laboratory personnel. Test results are analyzed by any of a variety of
commercially available laboratory instruments which may also be provided by
the Company. OraSure Technologies has used this testing format to develop
tests that detect substances in urine, serum, sweat, and oral fluid specimens.
OraSure Technologies currently markets the MICRO-PLATE oral fluid test for
use in screening life insurance applicants to test for two of the most
important underwriting risk factors: cocaine and cotinine (a metabolite of
nicotine). The Company sells the reagents to insurance testing laboratories,
which provide the laboratory testing to insurance companies, often in
combination with the OraSure(R) oral fluid collection device. AUTO-LYTE(R)
tests are marketed for use in testing urine samples for cocaine and cotinine
and for performing a variety of urine chemistries for insurance risk
assessment purposes.
The Company also develops, manufactures, and sells toxicology and drugs-of-
abuse tests in the MICRO-PLATE format. These MICRO-PLATE tests can be
performed on commonly used instruments and can detect drugs in urine, serum,
and sweat specimens. MICRO-PLATE tests are also used as part of the
Intercept(R) product line to detect drugs-of-abuse in oral fluid specimens.
The Company's toxicology and drugs-of-abuse test products are currently sold
in the forensic toxicology, criminal justice, drug rehabilitation, and
workplace testing markets.
Whenever possible, the Company enters into multi-year sales agreements with
its customers. These agreements generally are entered into with a laboratory
which has agreed to purchase a minimum number of tests over a two-to-five-year
period. The Company also offers these customers the option of a reagent rental
agreement pursuant to which the Company sells the tests at an increased price
over a fixed period of time, which includes an additional equipment charge in
exchange for providing the customer with the required analytical laboratory
equipment.
Western Blot HIV-1 Confirmatory Test
The Company markets an oral fluid Western Blot HIV-1 confirmatory test that
received FDA approval in 1996. This test uses the original specimen collected
with the OraSure(R) oral fluid collection device to confirm positive results
of initial OraSure(R) HIV-1 screening tests. The oral fluid Western Blot HIV-1
confirmatory test is marketed under an exclusive arrangement with bioMerieux
Inc. (formerly Organon Teknika Corporation) ("BMX").
In February 2001, the Company announced the indefinite suspension of the
production of EPIblot(R), a serum-based Western Blot HIV-1 confirmatory test.
The serum Western Blot product accounted for approximately 5% of the Company's
2000 revenue, but had been consistently unprofitable because of low production
yields and the high cost of quality control. The discontinuation of this
product had no effect on the manufacturing or sale of the Company's oral fluid
Western Blot HIV-1 confirmatory test.
6
Q.E.D.(R) Saliva Alcohol Test
The Q.E.D.(R) saliva alcohol test is an on-site, cost-effective test device
that is an alternative to breath or blood alcohol testing. The test is a
quantitative, saliva-based method for the detection of ethanol, and has been
cleared for sale by the FDA and the U.S. Department of Transportation ("DOT").
In 1997, the product also received a waiver under the Clinical Laboratory
Improvement Act of 1988. Each Q.E.D.(R) test kit contains a collection stick
which is used to collect a sample of saliva and a disposable detection device
that displays results in a format similar to a thermometer. The Q.E.D.(R)
device is easy to operate and instrumentation is not required to read the
result. The product has a testing range of 0 to 0.145% blood alcohol, and
produces results in approximately two minutes.
The markets for alcohol testing are relatively small and fragmented with a
broad range of legal and procedural barriers to entry. Markets range from law
enforcement testing to workplace testing of employees in safety sensitive
occupations. The Q.E.D.(R) test has been successfully adopted by end users in
the petroleum, heavy construction, trucking, and retail industries because it
is a cost-effective, portable, easy-to-administer, quantitative testing
method. Typical usage situations include pre-employment, random, post-
accident, reasonable-cause, and return-to-duty testing.
Products Under Development
OraSure(R)/Intercept(R) Applications
Oral mucosal transudate contains many constituents found in blood and serum,
although in lower concentrations. The Company therefore believes the
OraSure(R) and Intercept(R) devices are a platform technology with a wide
variety of potential applications, where laboratory testing is available. For
example, the OraSure(R) device may be useful for the diagnosis of a variety of
infectious diseases or conditions in addition to HIV-1, such as viral
hepatitis and diabetes. OraSure Technologies has entered into an agreement
with LabOne, Inc. to develop a laboratory-based oral fluid screening test for
Hepatitis C using the OraSure(R) collection device. The Company is developing
an alcohol assay and has an application pending with the FDA for 510(k)
clearance of an assay for benzodiazepine, each of which would be used in
connection with the Intercept(R) drug testing service. Based on a reassessment
of marketability, the Company has discontinued development of an improved
formulation of the OraSure(R) device, known as OraSure(R) II, and a
laboratory-based oral fluid screening test for syphilis.
OraQuick(R) Platform
The Company believes that OraQuick(R) has significant potential as a rapid
test for physicians' offices, hospitals, and other professional use. Like the
OraSure(R) device, the Company believes that OraQuick(R) provides a platform
technology that can be modified for detection of a variety of infectious
diseases in addition to HIV, such as viral hepatitis and other diseases.
The National Institutes of Health ("NIH") previously approved a grant of
approximately $1 million to fund Phase II of the Company's project to develop
a screening and confirmation test for syphilis. Although initially intended to
fund a lab-based test using the OraSure(R) collection device, the NIH approved
the use of this grant instead for development of a screening test for syphilis
using the OraQuick(R) platform. During the first quarter of 2002, the Company
reevaluated the marketability of a syphilis test and, based on that
reevaluation, has elected to terminate this project.
UPT(TM) and UPlink(TM) Development
The Company is in the final stages of developing the UPlink(TM) drugs-of-
abuse rapid detection system under its agreement with Drager and for its own
commercial applications in the United States. The Company has commenced
development of two tests for infectious diseases and expects to commence
development of
7
additional tests for other infectious diseases under its agreement with
Meridian. The Company has identified other potential applications of UPT(TM),
including human clinical testing for cancer, allergies, and thyroid and
cardiac conditions, therapeutic drug monitoring, biological warfare testing,
food and environmental testing, pharmaceutical research, genomics and
pharmacogenomics, veterinary testing, and surgical imaging. In addition, the
Company is studying the feasibility of using UPT(TM) labels for the detection
of infectious diseases with DNA probes. The Company has not yet chosen which
potential UPT(TM) applications to pursue or the manner in which these
opportunities will be pursued, but believes it will need to enter into
partnering arrangements with other entities to exploit the potential of
UPT(TM).
Western Blot HIV-1 Confirmatory Test
The Company believes its existing oral fluid Western Blot confirmatory test
for HIV-1 can be used for testing of serum plasma specimens and is
contemplating expanding the use of this product for these applications.
Whether the Company elects to do so will depend on a further assessment of the
market for these applications, the Company's ability to overcome the low
production yields and quality control issues which led to the discontinuation
of its Serum Western Blot HIV-1 confirmatory test in 2001, and the Company's
ability to obtain FDA approval for these new uses.
Research and Development
In 2001, research and development activities focused on the continued
development of the UPlink(TM) analyzer, test cassette and collector, the
development of certain UPlink(TM) drugs of abuse and infectious disease
assays, DNA feasibility studies, and clinical trials for the OraQuick(R) rapid
HIV-1 test.
The Company supplements its own research and development activities by
funding external research. The Company has funded research at Leiden
University, SRI International, Lehigh University and certain other entities,
and intends to continue funding external research.
Research and development expenses totaled approximately $9.4 million in
2001, $10.4 million in 2000 and $5.6 million in 1999.
Sales and Marketing
The Company's strategy is to reach its major target markets through a
combination of direct sales, strategic partnerships, and independent
distributors. The Company's marketing strategy is to raise awareness of its
products through a mix of trade shows, print advertising, and distributor
promotions to support sales in each target market.
The Company markets its products in the United States and internationally.
Revenues attributable to customers in the United States amounted to $27.3
million, $24.8 million and $21.4 million in 2001, 2000 and 1999, respectively.
Revenues attributable to international customers amounted to $5.3 million,
$4.0 million and $2.7 million, in 2001, 2000 and 1999, respectively.
Insurance Risk Assessment
The Company currently markets the OraSure(R) oral fluid collection device
for use in screening life insurance applicants in the United States and
internationally to test for three of the most important underwriting risk
factors: HIV-1, cocaine, and cotinine. The Company sells the devices to
insurance testing laboratories, which in turn provide the devices to insurance
companies, usually in combination with testing services. The Company also
maintains a direct sales force that promotes use of the OraSure(R) device
directly to insurance companies. Insurance companies then make their own
decision regarding which laboratory to use to supply their collection devices
and testing services. The Company's OraSure(R) Western Blot confirmatory test
is distributed through BMX and is used to confirm oral fluid specimens that
test positive for HIV-1.
8
Because insurance companies are in various stages of their adoption of the
OraSure(R) device, there exists a wide range of policy limits where the
product is being applied. Some insurance companies have chosen to extend their
testing to lower policy limits where they did not test at all before, while
others have used OraSure(R) to replace some of their blood and urine-based
testing. The Company's sales force continues to encourage additional insurance
companies to use OraSure(R) and to extend the use of the product by existing
customers. Several companies have expanded use of OraSure(R) to the $1 million
and higher dollar policy amounts. This expansion is attributable to several
factors, including increasing acceptance of the reliability of oral fluid
testing, the high quality of test results, the low cost of oral fluid testing
relative to blood tests, and the ease of use of the OraSure(R) device.
The Company also sells its AUTO-LYTE(R) and MICRO-PLATE assays and reagents
in the insurance testing market directly to laboratories, including LabOne,
Inc., Heritage Labs, Clinical Reference Laboratory, and the laboratory testing
division of Metropolitan Life Insurance Company. AUTO-LYTE(R) assays are used
principally to test urine samples for cotinine and other metabolites and to
perform urine chemistries for risk assessment purposes. MICRO-PLATE assays are
used principally to test oral fluid specimens collected with the OraSure(R)
device for cocaine and cotinine.
Infectious Disease Testing
The Company's sales personnel market products directly to customers in the
public health market primarily for HIV-1 testing. This market consists of a
broad range of clinics and laboratories and includes states, counties, and
other governmental agencies, colleges and universities, correctional
facilities and the military. There are also a number of organizations in the
public health market such as AIDS service organizations and various community-
based organizations set up primarily for the purpose of encouraging and
enabling HIV-1 testing. To better serve this market, the Company has entered
into agreements with LabOne, Inc. and Heritage Labs to provide prepackaged
OraSure(R) test kits, with prepaid laboratory testing and specimen shipping
costs included. The Company has sold the OraSure(R) and OraQuick(R) HIV
devices in the international public health markets.
Substance Abuse Testing
The Company's substance abuse products are marketed into the workplace
testing, forensic toxicology, criminal justice, and drug rehabilitation
markets, through direct sales and distributors. The forensic toxicology market
consists of 250-300 laboratories including federal, state and county crime
laboratories, medical examiner laboratories, and reference laboratories. The
criminal justice market consists of a wide variety of entities in the criminal
justice system that require drug screening, such as pre-trial services, parole
and probation officials, police forces, drug courts, prisons, drug treatment
programs and community/family service programs. The Company has entered into
agreements for the distribution of Intercept(R) collection kits and associated
reagents for drugs-of-abuse testing in the workplace testing market in the
United States and Canada through several laboratory distributors, including
LabOne, Inc., Quest Diagnostics, Clinical Reference Laboratory and NWT, Inc.,
and internationally for workplace and forensic toxicology testing through Bio-
Rad Laboratories, Altrix Plc and other distributors. The Company also
distributes its Q.E.D.(R) saliva alcohol test primarily in the workplace
testing market through various distributors.
Physicians' Offices
The Company sells the Histofreezer(R) product line to distributors that
market to more than 150,000 primary care physicians and podiatrists in the
United States. Major U.S. distributors include Cardinal Healthcare, McKesson
HBOC, Physicians Sales & Service, Bergen Brunswig, and Henry Schein.
Internationally, the Company markets Histofreezer(R) in a number of countries
through a network of distributors.
International Markets
The Company sells a number of its products into international markets
primarily through distributors with knowledge of their local markets.
Principal markets include physicians' offices, insurance risk assessment,
public
9
health, and laboratory testing. The Company assists its distributors in
registering the products and obtaining required regulatory approvals in each
country and provides training and support materials. The Company's
international marketing program includes direct assistance to distributors in
arranging for laboratory services, cooperation from screening test
manufacturers, and performance of Western Blot confirmatory tests when
necessary.
Significant Products and Customers
Several different products have contributed significantly to the Company's
financial performance, accounting for 15% or more of total revenues during the
past three years. The Company's OraSure(R) and Intercept(R) oral fluid
collection devices, Histofreezer(R), and immunoassay tests and reagents
accounted for total revenues of approximately $13.0 million, $6.7 million and
$7.4 million in 2001, $11.2 million, $6.8 million, and $6.7 million in 2000,
and $7.8 million, $5.7 million, and $6.2 million in 1999, respectively. As new
products are developed and commercialized, the Company expects to reduce its
dependence on the products referred to above.
The Company has one customer, LabOne, Inc., that has accounted for 10% or
more of total revenues. LabOne recently acquired Osborne Group, Inc., another
customer of the Company in the insurance testing market. During 2001, the
Company's sales to LabOne, Inc. and Osborne Group, Inc. together accounted for
approximately 29% of the Company's total revenues. As a result of its
acquisition of Osborne, LabOne has achieved certain operating efficiencies and
reduced its overall inventory levels which in turn lowered purchases of the
Company's insurance testing products during the fourth quarter of 2001. While
the Company believes that its relationship with LabOne is good, there can be
no assurance that sales to this customer will not decrease further or that
this customer will not choose to replace the Company's products with those of
competitors. The loss of this customer or a significant decrease of products
purchased by it would have a material adverse effect on the Company.
Supply and Manufacturing
The Company has entered into an agreement with a contractor in the United
States for the assembly and supply of OraSure(R) and Intercept(R) oral fluid
collection devices through December 31, 2002. This agreement will
automatically renew for additional annual periods unless either party provides
timely notice of termination prior to the end of an annual period. The Company
believes that other firms or the Company would be able to manufacture the
OraSure(R) and Intercept(R) devices on terms no less favorable than those set
forth in the agreement with the contractor in the event that this contractor
were to be unable or unwilling to continue manufacturing this product. A
change in manufacturer of these devices would require FDA review and approval
which could require significant time to complete and could disrupt the
Company's ability to manufacture and sell the OraSure(R) and Intercept(R)
devices. The Company expects to transfer manufacturing of its OraSure(R) and
Intercept(R) collection devices to its Bethlehem, Pennsylvania facility during
2003.
In the second quarter of 2001, the Company completed a realignment of its
manufacturing operations, which included the elimination of the manufacturing
of OraQuick(R) in the Beaverton, Oregon facility, the installation of
automated manufacturing equipment for OraQuick(R) in Bethlehem, Pennsylvania,
and the addition of contract manufacturing capacity in Thailand. In connection
with this realignment, the Company entered into a supply agreement for the
manufacture of the OraQuick(R) HIV testing device in Thailand. This agreement
has an initial term of one year, and will automatically renew for additional
annual periods unless either party provides a timely notice of termination
prior to the end of an annual period. The Company believes that other firms
would be able to manufacture the OraQuick(R) test on terms no less favorable
than those set forth in the agreement in the event that the Thailand
contractor would be unable or unwilling to continue manufacturing this
product.
The Company can purchase the HIV antigen required for the OraQuick(R)
product only from a limited number of sources. This antigen is currently
purchased from a contract supplier under a long-term agreement with an initial
term ending in January 2010 and one-year automatic renewal terms thereafter.
If for any reason the supplier should no longer be able to supply the
Company's antigen needs, the Company believes that an
10
alternative supply could be obtained at a competitive cost. However, a change
in the antigen would require FDA approval which could require significant time
to complete and could disrupt the Company's ability to manufacture and sell
the OraQuick(R) device in the United States.
The Company expects to assemble analyzers, test cassettes and collectors
used in the Company's UPlink(TM) drugs of abuse rapid detection system and to
package this product for shipment at the Company's Bethlehem, Pennsylvania
facilities.
The Company's oral fluid Western Blot HIV-1 confirmatory test is
manufactured in the Company's Beaverton, Oregon facility. The HIV antigen
needed to manufacture the Company's Western Blot HIV-1 confirmatory test kits
is available from only a limited number of sources. The Company purchases
antigen and certain other materials for this product from BMX, which is also
the exclusive distributor of the test kits. BMX is required to supply the
Company's requirements for antigen and other materials for the term of its
distribution agreement with the Company, which originally expired on March 31,
2001. OraSure Technologies and BMX are currently negotiating certain
amendments to the agreements, including an extension of their terms. If for
any reason BMX is no longer able to supply the Company's antigen and other
material needs, the Company would be able to obtain alternate supplies at a
competitive cost, although a change in the antigen would require FDA approval
which could require significant time to complete and could disrupt the
Company's ability to manufacture and sell its Western Blot HIV-1 confirmatory
test.
Histofreezer(R) is manufactured in The Netherlands by Koninklijke,
Utermohlen, N.V. ("Utermohlen"), the company from which the Company acquired
the product in 1998. The Company purchases the product pursuant to an
exclusive production agreement between the two companies. The production
agreement provides that Utermohlen shall be the exclusive supplier of the
Histofreezer(R) product until at least December 31, 2006. The Company believes
that additional manufacturers of the Histofreezer(R) product are available on
terms no less favorable than the terms of the production agreement with
Utermohlen in the event that Utermohlen would be unable or unwilling to
continue manufacturing the Histofreezer(R) product.
The Company's AUTO-LYTE(R) and MICRO-PLATE assays are manufactured at its
Bethlehem, Pennsylvania, facility. The Company manufactures the test
components and assembles and packages the tests for distribution. The
Company's tests require the production of highly specific and sensitive
antibodies corresponding to the antigen of interest. Substantially all of the
Company's antibody requirements are provided by contract suppliers. However,
in 1999, the Company began to develop its own in-house monoclonal and
polyclonal antibody capabilities. The Company believes that it maintains
adequate reserves of antibody supplies and believes it has access to
sufficient raw materials for these products.
AUTO-LYTE(R) test kits are manufactured by adding specific antibodies to
chemical solutions which are then packaged as a defined volume of liquid in a
plastic container to be run on laboratory equipment. MICRO-PLATE test kits are
produced by placing purified antibodies into plastic microwells which are sent
to customers in multiples of 96 tests along with a set of reagents necessary
to control the reaction.
The Q.E.D.(R) saliva alcohol test is manufactured, packaged, and shipped
from the Company's Bethlehem, Pennsylvania facility.
Employees
As of December 31, 2001, the Company had 221 full-time employees, including
46 in sales, marketing, and client services; 80 in research and development;
77 in operations, manufacturing, quality control, purchasing and shipping; and
18 in administration and finance. Sixteen of the Company's employees hold
Ph.D. degrees. The Company's employees are not represented by a collective
bargaining agreement.
During 2001, the Company completed a realignment of its manufacturing
operations, pursuant to which employee headcount was reduced in its Beaverton,
Oregon facility by approximately 33%. The reduction was
11
accomplished primarily through layoffs and attrition during the first half of
2001. During the first quarter of 2002, the Company implemented a 10%
reduction in force as a result of lower than anticipated sales levels during
2001 and the elimination of certain development projects.
Competition
The diagnostic industry is a multi-billion dollar international industry and
is intensely competitive. Many of the Company's competitors are substantially
larger and have greater financial, research, manufacturing, and marketing
resources. Important competitive factors for the Company's products include
product quality, price, ease of use, customer service, and reputation.
Industry competition is based upon scientific and technological capability,
proprietary know-how, access to adequate capital, the ability to develop and
market products and processes, the ability to attract and retain qualified
personnel, and the availability of patent protection.
A few large corporations produce a wide variety of diagnostic tests and
other medical devices and equipment, a larger number of mid-size companies
generally compete only in the diagnostic industry, and a significant number of
small companies produce only a few diagnostic products. As a result, the
diagnostic test industry is fragmented and segmented. The future market for
diagnostic tests is expected to be characterized by consolidation, greater
cost consciousness, and tighter reimbursement policies. The purchasers of
diagnostic products are expected to place increased emphasis on lowering
costs, reducing inventory levels, automation, service, and volume discounts.
The increased complexity of the market is expected to force many competitors
to enter into joint ventures or license certain products or technologies.
Competition is expected to intensify as technological advances are made and
become more widely known, and as new products reach the market. Furthermore,
new testing methodologies could be developed in the future that render the
Company's products impractical, uneconomical or obsolete. There can be no
assurance that the Company's competitors will not succeed in developing or
marketing technologies and products that are more effective than those
developed by the Company or that would render its technologies and products
obsolete or otherwise commercially unattractive. In addition, there can be no
assurance that competitors will not succeed in obtaining regulatory approval
for these products, or in introducing or commercializing them before the
Company. Such developments could have a material adverse effect on the
Company's business, financial condition, and results of operations.
Competition in the market for HIV testing is intense and is expected to
increase. The Company believes that the principal competition will come from
existing laboratory-based blood tests, point-of-care whole blood rapid tests,
urine-based assays, or other oral fluid-based tests that may be developed. The
Company's competitors include specialized biotechnology firms as well as
pharmaceutical companies with biotechnology divisions and medical diagnostic
companies.
Several companies market or have announced plans to market oral specimen
collection devices and tests outside the United States. The Company expects
the number of devices competing with its OraSure(R) device to increase as the
benefits of oral specimen-based testing become more widely accepted.
The FDA has approved an HIV-1 screening test for use with a urine sample. In
June 1998, the FDA notified Cambridge Biotech Corp. (acquired by Calypte, Inc.
in December 1998) that it had approved the use of its HIV-1 Western Blot
confirmatory test for use with urine samples. Urine testing will compete in
the same markets as the Company's products. The Company believes that urine
collection can be logistically more difficult, inconvenient, and potentially
embarrassing for the individual being tested, and that privacy and chain-of-
custody issues are further impediments to routine use of urine-based HIV
tests. The Company cannot predict the impact of the availability of urine-
based tests on the HIV testing market or on sales of the Company's products.
Significant competitors in the rapid assay HIV testing market include Abbott
Laboratories, the Ortho Diagnostics division of Johnson & Johnson, Bio-Rad
Laboratories, Trinity Biotech Plc, MedMira Laboratories, Inc. and Chembio
Diagnostic Systems, Inc.
12
In the insurance risk assessment market, the Company's AUTO-LYTE(R)
homogeneous assays for cocaine and cotinine compete with reagents from
Microgenics, Inc. (a subsidiary of Sybron Lab Products). The Company's AUTO-
LYTE(R) homogeneous assays for beta-blockers and thiazide as well as MICRO-
PLATE heterogeneous assays specifically designed for the detection of cocaine,
cotinine, and IgG in oral fluid are the only assays available in the
marketplace. In urine chemistries, the Company's significant competitors
include The Diagnostics Systems Group of Olympus America Inc.
The Company's MICRO-PLATE drugs-of-abuse reagents are targeted to forensic
testing laboratories where sensitivity, automation, and "system solutions" are
important. In the past, these laboratories have typically had to rely on
radioimmunoassay test methods to provide an adequate level of sensitivity.
Radioimmunoassays require radioactive materials, which have a short shelf-life
and disposal problems. The Company's MICRO-PLATE tests meet the laboratories'
sensitivity needs, run on automated equipment, are not radioimmunoassays, and
are offered to the laboratory as a complete system solution of reagents,
instrumentation and software to meet the specific needs of each customer.
Options to buy or rent the instrumentation and software are offered to these
customers.
In the forensic toxicology market, the Company competes with both
homogeneous and heterogeneous tests manufactured by a host of companies.
Significant competitors in the market for these assays include Dade Behring,
Microgenics, Inc., Abbott Laboratories, Roche Diagnostics, and Immunalysis.
The Intercept(R) drug testing system competes with a wide variety of drug
testing products and services. These competitors can be divided into two
groups: 1) rapid tests, and 2) laboratory-based services. Within each product
or service group, drug testing can be further divided into testing matrices
such as urine, hair, sweat and oral fluid. Major competitors in the
laboratory-based urine drug testing market are Quest Diagnostics, LabOne,
Inc., LabCorp., Psychemedics, PharmChem, and Medtox Laboratories. The
Company's UPlink(TM) product will also compete with other on-site, rapid drug
assays. Major competitors in the rapid drug testing market include American
Biomedica, Roche Diagnostics, Biosite Diagnostics, Avitar, Inc., LifePoint,
Inc. and eScreen.
Within the sub-segment of oral fluid drugs-of-abuse testing, Intercept(R)
and UPlink(TM) will compete with Avitar, Inc., which markets a rapid drug test
to the workplace and criminal justice markets, Ansys Technologies, Inc., which
markets saliva alcohol and drug tests, and LifePoint, Inc., which has
announced plans to sell a reader-based saliva test panel that will include
alcohol testing.
Q.E.D.(R) has two direct competitors, Roche Diagnostics and Chematics. These
companies offer semi-quantitative saliva-based alcohol tests and have received
DOT approval. Indirect competitors who offer breath testing equipment include
Intoximeters, Drager, and CMI. Although there are lower priced tests on the
market that use oral fluid or breath as a test medium, these tests are
qualitative tests that are believed to be substantially lower in quality and
scope of benefits than the Company's Q.E.D.(R) test.
The Histofreezer(R) product's delivery system and warmer operating
temperature than liquid nitrogen provide the Company with the opportunity to
target sales to primary care physicians, such as family practitioners,
pediatricians, and podiatrists. The Company does not generally target sales to
dermatologists because they have the volume of patients required to support
the capital costs associated with a liquid nitrogen delivery system. There is
limited competition for convenient cryosurgical products for wart removal in
the primary care physician market. Major competitors for the Histofreezer(R)
product include CryoSurgery, Inc. and Aurium Pharma Inc. In addition, liquid
nitrogen is used by medical professionals to remove warts and other benign
skin lesions. Lastly, patients may purchase various over-the-counter products
to treat warts at home.
Patents and Proprietary Information
The Company seeks patent and other intellectual property rights to protect and
preserve its proprietary technology and its right to capitalize on the results
of its research and development activities. The Company also relies upon trade
secrets, know-how, continuing technological innovations, and licensing
opportunities to provide
13
it with competitive advantages in its selected markets and to accelerate new
product introductions. Respecting the patent and intellectual property rights
of others, the Company regularly searches for third-party patents in its
fields of endeavor to shape its own patent and product commercialization
strategies as effectively as possible and to identify licensing opportunities.
United States patents generally have a maximum term of 20 years from the date
an application is filed.
The Company has ten United States patents and numerous foreign patents for
the OraSure(R) and Intercept(R) collection devices and related technology
relating to oral fluid collection, containers for oral fluids, methods to test
oral fluid, formulations for the manufacture of synthetic oral fluid, and
methods to control the volume of oral fluid collected and dispersed. The
Company has also applied for additional patents, in both the United States and
certain foreign countries, on such products and technology. The Company has
one patent for the OraQuick(R) rapid HIV test in the United States and intends
to apply for other patents for this product. The Company may need to obtain
licenses or other rights under, or enter into distribution or other business
arrangements in connection with, certain HIV-2 and lateral flow patents in
order to market the OraQuick(R) HIV test in the United States and certain
other countries. See the Section entitled, "Risk Factors--Patent Issues
Affecting OraQuick(R)," for a further discussion of these issues.
In April 1995, the Company received exclusive worldwide rights under patents
and know-how owned by SRI International to develop and market products that
involve the use of UPT(TM). The Company also received non-exclusive worldwide
rights under patents and know-how owned by the Sarnoff Corporation (a
subsidiary of SRI International formerly called the David Sarnoff Research
Center) to develop and market products that involve the use of UPT(TM). The
Company has the right to sublicense these rights under the agreements subject
to consent from SRI and Sarnoff.
Under the agreement with SRI, OraSure Technologies is required to make
license, maintenance and royalty payments to SRI. The Company made an initial
license payment to SRI in 1995 and paid research fees in 1995 and 1996 in
connection with development projects in which SRI participated. The Company is
obligated to make annual maintenance payments on each anniversary of the
agreement following the completion of the development period until the first
commercial sale of a product. The Company also must make royalty payments for
a period equal to the longer of ten years from the date of the first
commercial sale of the products or the term during which the manufacture, use,
or sale of a product would infringe licensed patents, but for SRI's license to
the Company. The Company believes that the royalty rates payable by the
Company are comparable to the rates generally payable by other companies under
similar arrangements. The Company's agreement with SRI terminates upon the
expiration of the Company's obligation to pay royalties to SRI.
In 1999, the Company paid $1.5 million to TPM Europe Holding B.V., its
sublicensor, for the termination of an existing license agreement between the
sublicensor and the Company with respect to the sublicense of UPT(TM) patents
owned by Leiden University, The Netherlands, and to secure a direct research,
development, and license arrangement with Leiden University.
The Company has or has licensed rights under nine United States patents and
numerous foreign patents for methods, compositions, and apparatuses relating
to phosphor technologies. Several additional UPT(TM) patent applications
remain pending in the United States and abroad. The Company expects to
continue to expand its UPT(TM) patent portfolio in 2002. Several new patent
applications were also filed by the Company in the U.S. for the design and
methods used in the UPlink(TM) rapid detection platform.
The Company has one U.S. patent relating to the Company's method for
detecting blood in urine specimens and the Company's AUTO-LYTE(R) products.
The Company has three U.S. patents and numerous foreign patents issued for
apparatuses and methods for the topical removal of skin lesions relating to
its Histofreezer(R) device.
14
The Company has five U.S. patents and numerous foreign patents and patent
applications for the analog-to-digital threshold signaling technology used in
the Q.E.D.(R) test. These patents are related to the analog-to-digital
technology color control systems and methods, systems and devices for the
test, and detection of biochemical molecules.
It is the Company's policy to require its employees, consultants, outside
collaborators, and other advisors to execute confidentiality agreements upon
the commencement of employment or consulting relationships with the Company.
These agreements provide that all confidential information developed by or
made known to the individual during the course of the individual's
relationship with the Company, is to be kept confidential and not disclosed to
third parties except in specific circumstances. In the case of employees, the
agreements provide that all inventions conceived by the individual during his
or her tenure at the Company will be the exclusive property of the Company.
The Company owns rights to trademarks and service marks that it believes are
necessary to conduct its business as currently operated. The Company is the
owner in the United States of trademarks, including UPT(TM), UPlink(TM),
OraSure(R), Intercept(R), OraQuick(R), Histofreezer(R), Q.E.D.(R), and AUTO-
LYTE(R). The Company also is the owner of many of these marks and others in
several foreign countries. The Company is not aware of any pending claims of
infringement or other challenges to the Company's rights to use its marks in
the United States or in other countries as currently used by the Company.
Although important, the issuance of a patent or existence of trademark or
trade secret protection does not in itself ensure the Company's success.
Competitors may be able to produce products competing with a patented Company
product without infringing on the Company's patent rights. Issuance of a
patent in one country generally does not prevent manufacture or sale of the
patented product in other countries. The issuance of a patent to the Company
or to a licensor is not conclusive as to validity or as to the enforceable
scope of the patent. The validity or enforceability of a patent can be
challenged by litigation after its issuance, and, if the outcome of such
litigation is adverse to the owner of the patent, the owner's rights could be
diminished or withdrawn. Trade secret protection does not prevent independent
discovery and exploitation of the secret product or technique.
Government Regulation
General
Most of the Company's existing and proposed diagnostic products are
regulated by the FDA, certain state and local agencies, and comparable
regulatory bodies in other countries. This regulation governs almost all
aspects of development, production, and marketing, including product testing,
authorizations to market, labeling, promotion, manufacturing, and
recordkeeping. All of the Company's FDA-regulated products require some form
of action by the FDA before they can be marketed in the United States, and,
after approval or clearance, the Company must continue to comply with other
FDA requirements applicable to marketed products. Both before and after
approval or clearance, failure to comply with the FDA's requirements can lead
to significant penalties.
Domestic Regulation
Most of the Company's diagnostic products are regulated as medical devices.
The Company's Serum Western Blot HIV-1 confirmatory test, which was
discontinued in February 2001, was regulated as a biologic or blood product.
There are two review procedures by which medical devices can receive FDA
clearance or approval. Some products may qualify for clearance under Section
510(k) of the Federal Food, Drug and Cosmetic Act, in which the manufacturer
provides a pre-market notification that it intends to begin marketing the
product, and shows that the product is substantially equivalent to another
legally marketed product (i.e., that it has the same intended use and is as
safe and effective as a legally marketed device and does not raise different
questions of safety and effectiveness). In some cases, the submission must
include data from human clinical studies. Marketing may
15
commence when the FDA issues a clearance letter finding such substantial
equivalence. An applicant must submit a 510(k) application at least 90 days
before marketing of the affected product commences. Although FDA clearance may
be granted within that 90-day period, in some cases as much as a year or more
may be required before clearance is obtained, if at all.
If the medical device does not qualify for the 510(k) procedure (either
because it is not substantially equivalent to a legally marketed device or
because it is required by statute and the FDA's implementing regulations to
have an approved application), the FDA must approve a pre-market approval
application ("PMA") before marketing can begin. PMAs must demonstrate, among
other matters, that the medical device provides a reasonable assurance of
safety and effectiveness. A PMA is typically a complex submission, including
the results of preclinical and clinical studies. Preparing a PMA is a detailed
and time-consuming process. Once a PMA has been submitted, the FDA is required
to review the submission within 180 days. However, the FDA's review may, and
often is, much longer, often requiring one year or more, and may include
requests for additional data.
Biologic products must be the subject of an approved biologics license
application ("BLA") before they can be marketed. The FDA approval process for
a biologic product is similar to the PMA approval process, involving a
demonstration of the product's safety and effectiveness based in part on both
preclinical and clinical studies.
Many of the insurance testing products are used for non-medical purposes and
many of the drugs-of-abuse products sold to state crime labs are for forensic
use. The Company intends initially to sell its UPlink(TM) rapid drug detection
system for law enforcement purposes into the criminal justice market. The FDA
does not currently regulate products used for these purposes.
Every company that manufactures biologic products or medical devices
distributed in the United States must comply with the FDA's Quality System
Regulations ("QSRs"). These regulations govern the manufacturing process,
including design, manufacture, testing, release, packaging, distribution,
documentation, and purchasing. Compliance with QSRs is required before the FDA
will approve an application, and these requirements also apply to marketed
products. Companies are also subject to other post-market and general
requirements, including compliance with restrictions imposed on marketed
products, compliance with promotional standards, recordkeeping, and reporting
of certain adverse reactions. The FDA regularly inspects companies to
determine compliance with QSRs and other post-approval requirements. Failure
to comply with statutory requirements and the FDA's regulations can lead to
substantial penalties, including monetary penalties, injunctions, product
recalls, seizure of products, and criminal prosecution.
Products that include electrical or light emitting equipment must also
comply with the FDA's safety and performance standards applicable to such
equipment. The Company's UPlink(TM) analyzer is a piece of electrical
equipment that uses a laser to read the test results and is, therefore,
subject to these requirements. In addition, there is an industry safety and
performance standard for electrical equipment established by Underwriters
Laboratories, Inc., known as UL3101. Although a voluntary standard, compliance
with UL3101 will support the Company's 510(k) submission for the UPlink(TM)
analyzer. The Company has retained Underwriters Laboratories Inc. to examine
and test the UPlink(TM) analyzer and certify that it meets the FDA
requirements and UL3101.
The Clinical Laboratory Improvement Act of 1988 ("CLIA") prohibits
laboratories from performing in vitro tests for the purpose of providing
information for the diagnosis, prevention or treatment of any disease or
impairment of, or the assessment of, the health of human beings unless there
is in effect for such laboratories a certificate issued by the U.S. Department
of Health and Human Services applicable to the category of examination or
procedure performed. Although a certificate is not required for OraSure
Technologies, the Company considers the applicability of the requirements of
CLIA in the design and development of its products. In addition, the Company
has obtained a waiver of the CLIA requirements for its Q.E.D.(R) alcohol
saliva test and may seek similar waivers for certain of its other products. A
CLIA waiver will remove certain quality control and other requirements that
must be met for certain customers to use the Company's products.
16
In June 2000, the FDA issued observations of deficiencies following an
inspection of OraSure Technologies' manufacturing facility in Beaverton,
Oregon, stating the FDA's view that the Company's Serum Western Blot product
was not manufactured in compliance with the QSRs. The FDA had previously
issued a warning letter in September 1998, and observations of deficiencies in
January 1999 to the Company based on prior inspections of the Oregon facility.
The FDA questioned the Company's compliance with the QSRs in areas such as
process validation, purchasing controls, complaint handling, and equipment
controls at the Oregon facility. The Company has undertaken a substantial
review of its manufacturing and quality systems, and has either already made
changes or has developed plans to make changes, to satisfy the FDA's concerns
with respect to its QSR compliance. This was communicated to the FDA in a
written reply in September 2000.
On October 20, 2000, the FDA sent a letter to the Company regarding the
Serum Western Blot product voicing the agency's concern over the previously
observed deficiencies and stating its intent to revoke the Company's license
to manufacture this product if the problems were not corrected in sufficient
time. The FDA acknowledged the receipt of the Company's written responses and
found that those items which had been completed appeared to be adequate, but
required the Company to submit a comprehensive report on corrective action
plans and the schedule to address the remaining items. The Company submitted
such a report in November 2000, and believes that it either has already
implemented changes or has appropriate plans in place to implement changes
that will adequately address the FDA's concerns.
Production of the Serum Western Blot product line was voluntarily
discontinued by the Company and, in response to this voluntary action by the
Company, the associated biologics license was revoked on October 12, 2001.
However, OraSure Technologies has recognized that the basic changes to the
overall quality system needed to remedy the FDA's observations would also
assist in the quality for all of the Company's product lines, and therefore
has devoted a considerable amount of time and resources to improving quality
procedures throughout the Company. Even with the substantial efforts and the
progress made to date, there is a risk that the FDA will not be satisfied with
the Company's efforts. If the FDA is not satisfied, it could take action
intended to force OraSure Technologies to stop manufacturing its products at
the Oregon facility (which consists solely of the manufacture of Company's
oral fluid Western Blot HIV-1 confirmatory test) until the FDA believes the
Company is in compliance with QSR requirements. Also, although the FDA has
granted the Company permission to obtain certificates needed for export of
products, the FDA could refuse export permission in the future if the agency
determines that the Company's progress toward QSR compliance is not
sufficient.
International
The Company is also subject to regulations in foreign countries governing
products, human clinical trials and marketing, and may need to obtain approval
from international public health agencies, such as the World Health
Organization, in order to sell products in certain countries. Approval
processes vary from country to country, and the length of time required for
approval or to obtain other clearances may in some cases be longer than that
required for U.S. governmental approvals. The extent of potentially adverse
governmental regulation affecting the Company that might arise from future
legislative or administrative action cannot be predicted. The Company will
pursue approval only in those countries that have a significant market
opportunity.
The International Organization for Standardization ("ISO") is a worldwide
federation of national standards bodies from some 130 countries, established
in 1947. The mission of ISO is to promote the development of standardization
and related activities in the world with a view to facilitating the
international exchange of goods and services. ISO certification is evidenced
by the CE mark and indicates that the Company's quality system complies with
standards applicable to activities ranging from initial product design and
development through production and distribution. ISO certification is a
prerequisite to obtaining a CE mark, which is required for distribution of
medical devices in the European common markets.
In the first quarter of 1999, the Company received approval to use the CE
mark for the OraSure(R) and Intercept(R) collection devices. In December 2000,
the Company's Bethlehem facility received final certification for the European
Medical Device Directive (93/42/EEC), ISO 9001, ISO 13485, and EN46001. The
Company has also received authorization to use the CE mark for its
Histofreezer(R) product line.
17
In order to obtain the CE mark for a product containing electrical
equipment, that product would need to meet several international safety and
performance standards (IEC 60825-1; IEC/EN 61010-1, CSA C 22.2, IEC 1010-1, EN
61000). The Company's UPlink(TM) analyzer will need to meet these standards in
order to obtain its CE mark. The Company has retained Underwriter
Laboratories, Inc. and Laird Technologies to examine and test the UPlink(TM)
analyzer and certify that it meets these international standards.
The Company must also submit evidence of marketing approval or clearance by
the FDA to Health Canada's Therapeutic Products Programme prior to commencing
sales in Canada. The Company has completed this process for several of its
current products which require FDA review.
Environmental Regulation
Because of the nature of its current and proposed research, development, and
manufacturing processes, the Company is subject to stringent federal, state,
and local laws, rules, regulations, and policies governing the use,
generation, manufacture, storage, air emission, effluent discharge, and
handling and disposal of materials and wastes. The Company believes that it
has complied with these laws and regulations in all material respects and has
not been required to take any action to correct any noncompliance.
Forward-Looking Statements
This Report contains certain "forward-looking statements," within the
meaning of the Federal securities laws. These may include statements about
expected revenues, earnings, expenses or other financial performance, future
product performance or development, expected regulatory filings and approvals,
planned business transactions, views of future industry or market conditions,
other factors that could affect future operations or financial position, and
statements that include the words "believes," "expects," "anticipates,"
"intends," "plans," "estimates," "may," "will," "should," "could," or similar
expressions. Forward-looking statements are not guarantees of future
performance or results. Known and unknown factors could cause actual
performance or results to be materially different from those expressed or
implied in these statements. Some of these factors are: ability to market
products; impact of competitors, competing products and technology changes;
ability to develop, commercialize and market new products; market acceptance
of oral fluid testing products and up-converting phosphor technology products;
ability to fund research and development and other projects and operations;
ability to obtain and timing of obtaining necessary regulatory approvals;
ability to develop product distribution channels; uncertainty relating to
patent protection and potential patent infringement claims; ability to enter
into international manufacturing agreements; obstacles to international
marketing and manufacturing of products; ability to sell products
internationally; loss or impairment of sources of capital; exposure to product
liability and other types of litigation; changes in international, federal or
state laws and regulations; changes in relationships with strategic partners
and reliance on strategic partners for the performance of critical activities
under collaborative arrangements; changes in accounting practices or
interpretation of accounting requirements; customer consolidations and
inventory practices; equipment failures and ability to obtain needed raw
materials and components; the impact of terrorist attacks and civil unrest;
and general political, business and economic conditions. These and other
factors that could cause the forward-looking statements to be materially
different are described in greater detail in the Section entitled, "Risk
Factors," and elsewhere in this Report. Although forward-looking statements
help to provide complete information about future prospects, they may not be
reliable. The forward-looking statements are made as of the date of this
Report and Orasure Technologies undertakes no duty to update these statements.
Risk Factors
The following is a discussion of certain significant risk factors that could
potentially affect the Company's financial condition, performance and
prospects.
Competing Products
The diagnostic industry is focused on the testing of biological specimens in
a laboratory or at the point-of-care and is highly competitive and rapidly
changing. The Company's principal competitors have considerably
18
greater financial, technical, and marketing resources. As new products enter
the market, the Company's products may become obsolete or a competitor's
products may be more effective or more effectively marketed and sold than the
Company's. If OraSure Technologies fails to maintain and enhance its
competitive position, its customers may decide to use products developed by
competitors which could result in a loss of revenues.
Ability to Develop New Products
In order to remain competitive, the Company must commit substantial
resources each year to research and development. The research and development
process generally takes a significant amount of time from inception to
commercial product launch. This process is conducted in various stages, and
during each stage there is a substantial risk that the Company will not
achieve its goals and will have to abandon a product in which it has invested
substantial amounts.
During 2001, 2000 and 1999, the Company incurred $9.4 million, $10.4 million
and $5.6 million, respectively, in research and development expenses. The
Company expects to continue to incur significant costs in its research and
development activities. Moreover, there can be no assurance that OraSure
Technologies will succeed in its research and development efforts. If the
Company fails to develop commercially successful products, or if competitors
develop more effective products or a greater number of successful new
products, customers may decide to use products developed by the Company's
competitors, which would result in a loss of revenues.
Market Acceptance of Oral Fluid Testing Products
The Company has made significant progress in gaining acceptance of oral
fluid testing for HIV in the insurance and public health markets. The Company
has also made significant progress in gaining acceptance of oral fluid testing
for drugs of abuse in the workplace and criminal justice testing markets.
Other markets, particularly the physician office market, may resist the
adoption of oral fluid testing as a replacement for other testing methods in
use today. In addition, certain state laws prohibit or restrict the use of
oral fluid testing for drugs of abuse in certain markets. There can be no
assurance that the Company will be able to expand the use of its oral fluid
testing products in these or other markets.
Loss or Impairment of Sources of Capital
Although the Company has made significant progress in the past toward
controlling expenses and increasing product revenue, historically the Company
has depended, to a substantial degree, on capital raised through the sale of
equity securities and bank borrowings to fund its operations. The Company's
future liquidity and capital requirements will depend on numerous factors,
including, but not limited to, the costs and timing of the expansion of
manufacturing capacity, the success of product development efforts, the costs
and timing of expansion of sales and marketing activities, the timing of
commercial launch of new products, the extent to which existing and new
products gain market acceptance, competing technological and market
developments, and the scope and timing of strategic acquisitions. If
additional financing is needed, the Company may seek to raise funds through
the sale of equity or other securities or through bank borrowings. There can
be no assurance that financing through the sale of securities, bank borrowings
or otherwise, will be available to the Company on satisfactory terms, if at
all.
Ability of the Company to Develop Product Distribution Channels
The Company has marketed many of its products by collaborating with
laboratories, diagnostic companies and distributors. For example, the
Company's OraSure(R) oral fluid collection device is distributed to the
insurance industry through major insurance testing laboratories. One of these
laboratories, LabOne, Inc., acquired another insurance laboratory customer,
Osborne Group, Inc., in 2001 and these customers together accounted for
approximately 29%, 30%, and 28% of the Company's revenues for the years 2001,
2000, and 1999, respectively. The Company's sales depend to a substantial
degree on its ability to sell products to these customers and develop
19
new product distribution channels, and on the marketing abilities of the
companies with which it collaborates. In addition, some of the Company's
distributors have recently consolidated, and such consolidation has had, and
may continue to have, an adverse impact on the level of orders for the
Company's products. There can be no assurance that such companies will
continue to be able to purchase or distribute the Company's products or
maintain historic order volumes, or that new distribution channels will be
available on satisfactory terms.
Obtaining and Maintaining Regulatory Approvals and Clearances
As described more fully above under "Government Regulation," many of the
Company's proposed and existing products are subject to regulation by the FDA
and other governmental or public health agencies. In particular, the Company
is subject to strict governmental controls on the development, manufacture,
labeling, distribution and marketing of its products. The process of obtaining
required approvals or clearances from governmental or public health agencies
varies according to the nature of, and uses for, the specific product and can
involve lengthy and detailed laboratory testing, human clinical trials,
sampling activities, and other costly, time-consuming procedures. The
submission of an application to a regulatory authority does not guarantee that
it will grant an approval or clearance to market the product. Each authority
may impose its own requirements and delay or refuse to grant approval or
clearance, even though a product has been approved in another country.
The approval or clearance process for a new product can be complex and
lengthy. The time taken to obtain approval or clearance varies depending on
the nature of the application and may result in the passage of a significant
period of time from the date of submission of the application. This time span
increases the costs to develop new products and increases the risk that the
Company will not succeed in introducing or selling them.
Changes in government regulations could also require the Company to undergo
additional trials or procedures, or could make it impractical or impossible
for the Company to market its products for certain uses, in certain markets,
or at all. Other changes in government regulations, such as the adoption of
the FDA's Quality System Regulation, may adversely affect the Company's
financial condition and results of operations by requiring that the Company
incur the expense of changing or implementing new manufacturing and control
procedures.
In addition, the European Union has established a requirement that
diagnostic medical devices used to test biological specimens must receive
regulatory approval known as a CE mark by December 31, 2003. After that date,
export to the European community of products without the CE mark will be
stopped or delayed until the mark is received. This requirement will affect
many of OraSure Technologies' products. OraSure Technologies will not be
permitted to make European sales of its products for which a CE mark is not
obtained by December 31, 2003, which could lead to the termination of
strategic alliances for sales of those products in Europe. While the Company
intends to apply for CE marks for certain of its existing and future products,
and is not aware of any material reason why such approvals will not be
granted, there can be no assurance that any CE marks will be received prior to
the deadline.
At the present time, the Company has received FDA clearance or approval for
the OraSure(R) and Intercept(R) oral fluid collection devices, the
Histofreezer(R) portable cryosurgical system, the Q.E.D.(R) saliva alcohol
test, the OraSure(R) oral fluid Western Blot confirmatory test for HIV-1, and
various other tests. The Company has also received CE mark approval for the
OraSure(R), Intercept(R) and Histofreezer(R) products. The Company has
submitted to the FDA an application for pre-market approval of its OraQuick(R)
rapid HIV-1 test using whole blood and expects to file an application for oral
fluid applications in 2002. The Company has also submitted an application to
the FDA for 510(k) clearance of the UPlink(TM) drugs of abuse rapid detection
system, has resubmitted additional data requested by the FDA for the
UPlink(TM) analyzer and opiates assay, and is in the process of gathering
additional data requested by the FDA for the full NIDA-5 drug panel for that
product. See the Sections entitled "Products" and "Government Regulation" for
a further discussion of regulatory approvals and clearances obtained for the
Company's products.
20
Regulatory Compliance
The Company can manufacture and sell many of its products, both in the
United States and in some cases abroad, only if it complies with regulations
of government agencies such as the FDA. The Company has implemented a quality
system that is intended to comply with applicable regulations. The FDA has
issued warning letters with respect to the Serum Western Blot product, stating
that the Company is not in compliance with the FDA's regulations. The Company
has responded to each of these letters and voluntarily discontinued this
product. Although the Company believes that it has satisfactorily addressed
the points raised by the FDA, the FDA could force the Company to stop
manufacturing products at its Oregon facility if the FDA concludes that the
Company remains out of compliance with applicable regulations. In addition,
until the FDA agrees that the Company has resolved all points raised in the
letters, the Company may not be able to obtain regulatory clearance
certificates needed in certain foreign countries. The FDA could also require
the Company to recall products if it fails to comply with applicable
regulations, which could force the Company to stop manufacturing such
products. See the Section entitled "Government Regulation" for a further
discussion of regulatory compliance matters.
History of Losses and Projected Profitability
The Company has not achieved full-year profitability. The Company incurred
net losses of approximately $3.7 million, $12.7 million and $4.2 million in
2001, 2000 and 1999, respectively, and as of December 31, 2001, the Company
had an accumulated deficit of approximately $126.1 million.
The Company's limited combined operating history makes it difficult to
forecast future operating results. In order to achieve sustainable
profitability, the Company's revenues will have to continue to grow at a
significant rate. The Company's ability to achieve revenue growth will be
dependent upon a number of factors including, without limitation, creating
market acceptance for and selling increasing volumes of the OraSure(R)
collection device, the Intercept(R) and UPlink(TM) drugs-of-abuse products,
and the OraQuick(R) rapid HIV-1 test, achieving growth in international
markets with the Company's OraQuick(R) rapid HIV-1 test and other products,
obtaining timely FDA approval or clearance for the OraQuick(R) rapid HIV-1
test and UPlink(TM) drugs-of-abuse rapid detection system, and commercially
developing, and obtaining regulatory approval and creating market acceptance
for, UPT(TM) and other products in a time frame consistent with the Company's
objectives. The Company has not yet fully achieved these objectives. In the
event that the Company cannot create a significant commercial market for its
OraQuick(R) test, the Intercept(R) and UPlink(TM) products, or its other
products, or to the extent other events described in this Section occur, the
Company's revenue, and consequently profitability, could be lower than
estimated. Even if the Company achieves profitability, there is no assurance
that such profitability can be sustained in the future.
Stock Price Volatility
Because the Company's stock price may be volatile, the stock price could
experience substantial declines. The market price of the Company's common
stock has historically experienced and might continue to experience volatility
in the future in response to a number of factors, including quarter-to-quarter
variations in operating results, analysts' reports, the relative low trading
value for the Company's stock, market conditions in the industry, regulatory
developments affecting the Company's products, changes in governmental
regulations, and changes in general conditions in the economy or in the
financial or stock markets.
The market has also recently experienced significant decreases in value.
This recent market decline has affected the market prices of securities issued
by many companies, often for reasons unrelated to their operating performance,
and may adversely affect the price of the Company's common stock.
Ability to Market New Products
OraSure Technologies' future success will depend, in part, on the market
acceptance, and the timing of such acceptance, of new products such as the
Intercept(R) drug testing service, the OraQuick(R) rapid HIV-1 test, products
21
currently under final development such as the UPlink(TM) drugs of abuse rapid
detection system and other products using up-converting phosphor technology,
and other new products or technologies that may be developed or acquired and
introduced in the future. To achieve market acceptance, OraSure Technologies
must make substantial marketing efforts and spend significant funds to inform
potential customers and the public of the perceived benefits of these
products. The Company currently has limited evidence on which to evaluate the
market reaction to products that may be developed, and there can be no
assurance that any products will meet with market acceptance and fill the
market need that is perceived to exist.
Reliance on Patents and Other Proprietary Rights
The diagnostics industry places considerable importance on obtaining patent,
trademark, and trade secret protection, as well as other intellectual property
rights, for new technologies, products and processes. The Company's success
depends, in part, on its ability to develop and maintain a strong intellectual
property portfolio or obtain licensing to patents and other technology for
products and technologies both in the United States and in other countries.
As appropriate, the Company intends to file patent applications and obtain
patent protection for its proprietary technology. These patent applications
and patents will cover, as applicable, compositions of matter for the
Company's products, methods of making those products, methods of using those
products, and apparatus relating to the use or manufacture of those products.
The Company will also rely on trade secrets, know-how, and continuing
technological advancements to protect its proprietary technology. The Company
has entered, and will continue to enter, into confidentiality agreements with
its employees, consultants, advisors and collaborators. However, these parties
may not honor these agreements and the Company may not be able to successfully
protect its rights to unpatented trade secrets and know-how. Others may
independently develop substantially equivalent proprietary information and
techniques or otherwise gain access to the Company's trade secrets and know-
how.
Many of the Company's employees, including scientific and management
personnel, were previously employed by competing companies. Although the
Company encourages and expects all of its employees to abide by any
confidentiality agreement with a prior employer, competing companies may
allege trade secret violations and similar claims against OraSure
Technologies.
The Company may incur substantial costs and be required to expend
substantial resources in asserting or protecting its intellectual property
rights, or in defending suits against it related to intellectual property
rights. Disputes regarding intellectual property rights could substantially
delay product development or commercialization activities. Disputes regarding
intellectual property rights might include state, federal or foreign court
litigation as well as patent interference, patent reexamination, patent
reissue, or trademark opposition proceedings in the United States Patent and
Trademark Office. Opposition or revocation proceedings could be instituted in
a foreign patent office. An adverse decision in any proceeding regarding
intellectual property rights could result in the loss of the Company's rights
to a patent, an invention, or trademark.
To facilitate development and commercialization of a proprietary technology
base, the Company may need to obtain licenses to patents or other proprietary
rights from other parties. Obtaining and maintaining such licenses may require
the payment by the Company of substantial costs. In addition, if the Company
is unable to obtain these types of licenses, the Company's product development
and commercialization efforts may be delayed or precluded.
Patent Issues Affecting OraQuick(R)
There are several factors that will affect the specific countries in which
the Company will be able to sell its OraQuick(R) rapid HIV test and therefore
the overall sales potential of the test. One factor is whether the Company can
arrange a sublicense or distribution agreement related to patents for
detection of the HIV-2 virus. HIV-2 is a type of the HIV virus estimated to
represent a small fraction of the known HIV cases worldwide. Nevertheless,
HIV-2 is considered to be an important component in the testing regimen for
HIV in many markets. HIV-2
22
patents are in force in most of the countries of North America and Western
Europe, as well as in Japan, Korea, South Africa, and Australia. Access to a
license for one or more HIV-2 patents may be necessary to sell HIV-2 tests in
countries where such patents are in force, or to manufacture in countries
where such patents are in force and then sell into non-patent markets. Since
HIV-2 patents are in force in the United States, the Company may be restricted
from manufacturing an OraQuick(R) rapid HIV-2 test in the United States and
selling into other countries, even if there were no HIV-2 patents in those
other countries.
The importance of HIV-2 differs by country, and can be affected by both
regulatory requirements and by competitive pressures. In most countries, any
product used to screen the blood supply will be required to detect HIV-2,
although the OraQuick(R) rapid HIV test has not been intended for that market
purpose. In other markets, including the United States, a test that can detect
only the more prevalent HIV-1 type is considered sufficient by the FDA, except
in testing related to blood supply. Because the competitive situation in each
country will be affected by the availability of other testing products as well
as the country's regulatory environment, the Company may be at a competitive
disadvantage in some markets without an HIV-2 product even if HIV-2 detection
is not required by regulations. In particular, the Company may be limited in
its ability to sell a product that does not include an HIV-2 test, or a
competitor's product that includes an HIV-2 test may be preferred and have a
competitive advantage over an HIV-1 only test sold by the Company.
The Company has obtained licenses to HIV-1 patents held by the manufacturer
of the HIV-1 antigen used in the OraQuick(R) device and by the National
Institutes of Health. The Company is not aware of any other HIV-1 patents
which would need to be licensed in order to manufacture and sell the
OraQuick(R) rapid HIV-1 test.
Another factor that may affect the specific countries in which the Company
will be able to sell an OraQuick(R) rapid HIV-1 or HIV-2 test, and therefore
the overall sales potential, concerns whether the Company can arrange a
sublicense or distribution agreement related to any patents which claim
lateral flow assay methods and devices covering the OraQuick(R) rapid HIV
tests or their use. OraQuick(R) is a lateral flow assay device that tests for
specific antibodies or other substances. The term "lateral flow" generally
refers to a test strip through which a sample flows and which provides a test
result on a portion of the strip downstream from where the sample is applied.
There are numerous patents in the United States and other countries which
claim lateral flow assay methods and devices. Some of these patents may
broadly cover the technology used in the OraQuick(R) assay and are in force in
the United States and other countries. The Company may not be able to make the
OraQuick(R) test in the United States and sell it in countries where there is
no patent on the device. The Company has obtained or intends to obtain
licenses under several lateral flow patents, which it believes should be
sufficient to permit the manufacturing and sale of the OraQuick(R) device as
currently contemplated.
In the event that it is determined that a license is required and it is not
possible to negotiate a license agreement under a necessary patent, the
Company may be able to modify the OraQuick(R) rapid HIV test such that a
license would not be necessary. However, this alternative could delay
introduction of the OraQuick(R) rapid HIV test into the United States and
other markets.
Loss of Key Personnel
The Company's success will depend to a large extent upon the contributions
of its executive officers, management, and sales, marketing, and scientific
staff. The Company may not be able to attract or retain qualified employees in
the future due to the intense competition for qualified personnel among
medical products businesses. If the Company is not able to attract and retain
the necessary personnel to accomplish its business objectives, the Company may
experience constraints that will adversely affect its ability to effectively
sell and market its products, to meet the demands of its strategic partners in
a timely fashion, or to support internal research and development programs. In
particular, product development programs depend on the ability to attract and
retain highly skilled scientists, including molecular biologists, biochemists
and engineers, and sales and marketing efforts depend on the ability to
attract and retain skilled and experienced sales and marketing
representatives. Recruiting qualified personnel can be an intensely
competitive and time-consuming process. Although OraSure Technologies believes
it will be successful in attracting and retaining qualified personnel,
competition for experienced scientists and other personnel from numerous
companies and academic and other research institutions may limit its ability
to do so on acceptable terms.
23
All of the Company's employees, other than a few senior officers who have
employment agreements, are at-will employees, which means that either the
employee or OraSure Technologies may terminate their employment at any time.
If the Company experiences difficulty in recruiting and retaining qualified
personnel, it may need to provide higher compensation to such personnel than
currently anticipated or the Company may incur additional expenses for the
recruitment of qualified personnel.
The Company's business strategies will require additional expertise in
specific industries and areas applicable to the development efforts related to
up-converting phosphor technologies. These activities will require the
addition of new personnel, including management, and the development of
additional expertise by existing management personnel. The inability to
acquire these services or to develop this expertise could impair the
development, if any, of products related to these technologies.
International Marketing and Manufacturing
The Company intends to increase international sales of its products. The
Company's international revenues accounted for approximately $5.3 million or
16% of total revenues for 2001, approximately $4 million or 14% of total
revenues for 2000, and approximately $2.7 million or 11% of total revenues for
1999.
A number of factors can slow or prevent international sales, or
substantially increase the cost of international sales, including those set
forth below:
. Regulatory requirements (including compliance with applicable customs
regulations) may slow, limit, or prevent the offering of products in
foreign jurisdictions;
. Cultural and political differences may make it difficult to effectively
market, sell and gain acceptance of products in foreign jurisdictions;
. Inexperience in international markets may slow or limit the Company's
ability to sell products in foreign countries;
. Exchange rates, currency fluctuations, tariffs and other barriers,
extended payment terms and dependence on and difficulties in managing
international distributors or representatives may affect the Company's
revenues even when product sales occur;
. The creditworthiness of foreign entities may be less certain and foreign
accounts receivable collection may be more difficult;
. Economic conditions and the absence of available funding sources may
slow or limit the Company's ability to sell its products in foreign
countries;
. International markets often have long sales cycles, especially sales to
foreign governments, quasi-governmental agencies and international
public health agencies, thereby delaying or limiting the Company's
ability to sell its products; and
. The Company may be at a disadvantage if competitors in foreign countries
sell competing products at prices at or below such competitors' or the
Company's cost.
The Company has entered into a contract for the manufacture and supply of
the OraQuick(R) HIV device in Thailand. However, the Company does not have
significant direct experience with the use of international manufacturers.
Factors such as economic and political conditions and foreign regulatory
requirements may slow or prevent the manufacture of the Company's products in
countries other than the United States. Interruption of the supply of the
Company's products could reduce revenues or cause the Company to incur
significant additional expenses in finding an alternative source of supply.
Product Liability Exposure
The Company may be held liable if any of its products, or any product which
is made with the use or incorporation of any of the technologies belonging to
the Company, causes injury of any type or is found otherwise unsuitable during
product testing, manufacturing, marketing, sale or usage. Although the Company
has
24
obtained product liability insurance, this insurance may not fully cover
potential liabilities. As the Company brings new products to market, the
Company may need to increase its product liability coverage. Inability to
obtain sufficient insurance coverage at an acceptable cost or otherwise to
protect against potential product liability claims could affect the Company's
decision to commercialize products developed by the Company or its strategic
partners.
Ability to Fully Commercialize UPT(TM)
The Company's up-converting phosphor technology is new and, except for the
UPlink(TM) rapid detection system, is in the early stage of development.
Commercial development of UPT(TM) for certain other applications may not be
successful. Successful products require significant development and
investment, including testing, to demonstrate their cost-effectiveness or
other benefits prior to commercialization. In addition, regulatory approval
must be obtained before most products based upon UPT(TM) may be sold.
Additional development efforts on these products will be required before any
regulatory authority will review them. Regulatory authorities may not approve
these products for commercial sale. Accordingly, because of these
uncertainties, products based upon UPT(TM) may not be commercialized. The
failure to develop UPT(TM) products with commercial potential would negatively
affect OraSure Technologies' future revenues.
Dependence on Strategic Partners
Although the Company intends to pursue some product opportunities
independently, opportunities that require a significant level of investment
for development and commercialization or a distribution network beyond the
Company's existing sales force may necessitate involving one or more strategic
partners. In particular, the Company's strategy for development and
commercialization of UPT(TM) and certain other products, such as the
OraQuick(R) rapid HIV test, may entail entering into additional arrangements
with distributors or other corporate partners, universities, research
laboratory licensees, and others. OraSure Technologies may be required to
transfer material rights to such strategic partners, licensees, and others.
While the Company expects that its current and future partners, licensees, and
others have and will have an economic motivation to succeed in performing
their contractual responsibilities, the amount and timing of resources to be
devoted to these activities will be controlled by others. Consequently, there
can be no assurance that any revenues or profits will be derived from such
arrangements.
Dependence on Third Party Licenses and Rights
The Company has licensed the worldwide rights to up-converting phosphor
compositions, methods, and apparatuses for use in diagnostic applications,
which are the subject of numerous United States and patents and several
pending United States applications. Corresponding patents and patent
applications have been granted, issued or filed in numerous foreign countries,
including, for example, European countries, Japan, and Canada. OraSure
Technologies cooperates with the licensor to prosecute such patent
applications and protect such patent rights. If the licensors do not meet
their obligations under the license agreements or do not reasonably consent to
sublicenses by the Company, or if the license agreement is terminated, the
Company could lose the opportunity to develop UPT(TM).
Recent Economic Downturn and Terrorist Attacks
Since the September 11, 2001 terrorist attacks, the United States economy
has experienced a decline. Changes in economic conditions could adversely
affect the Company's business. For example, in a difficult economic
environment, customers may be unwilling or unable to invest in new diagnostic
products, may elect to reduce the amount of their purchases or may perform
less drug testing because of declining employment levels. A weakening business
climate could also cause longer sales cycles and slower growth, and could
expose the Company to increased business or credit risk in dealing with
customers adversely affected by economic conditions.
25
The terrorist attacks and subsequent governmental responses to these attacks
could cause further economic instability or lead to further acts of terrorism
in the United States and elsewhere. These actions could adversely affect
economic conditions outside the United States and reduce demand for our
products internationally. Terrorist attacks could also cause regulatory
agencies, such as the FDA or agencies that perform similar functions outside
the United States, to focus their resources on vaccines or other products
intended to address the threat of biological or chemical warfare. This
diversion of resources could delay the Company's ability to obtain regulatory
approvals required to manufacture, market or sell its products in the United
States and other countries.
Restructuring of Operations
The Company may from time to time restructure and consolidate various
aspects of its operations in order to achieve cost savings and other
efficiencies. For example, during 2001 the Company completed a restructuring
of its manufacturing operations which included the transfer of OraQuick(R)
manufacturing from the Beaverton, Oregon facility to Bethlehem, Pennsylvania.
In addition, the Company plans to close the Oregon facility during 2003 and
transfer all remaining manufacturing operations, which are solely related to
the Western Blot HIV-1 confirmatory test, and research and development
activities to Pennsylvania. The transfer of operations may result in the loss
of scientific or other personnel and thereby delay the transfer or disrupt the
continuation of operations thereafter. The Company will also be required to
obtain FDA approval to transfer certain operations to another location, which
could delay the transfer or disrupt continued operations. Any delay or
disruption of operations, and in particular manufacturing operations, could
result in increased costs or could prevent the Company from selling certain
products and thereby result in a loss of revenue.
The previous discussion of the Company's business should be read in
conjunction with the Financial Statements and accompanying notes included in
Item 14 of this Annual Report on Form 10-K.
ITEM 2. Properties.
On April 30, 1999, the Company signed a five-year lease to rent 25,845
square feet of space at the John M. Cook Technology Center in Bethlehem,
Pennsylvania, which the Company uses as its main corporate, sales and
marketing, and research and development offices. Annual rent for the first
five years of this lease is approximately $270,000. The lease also includes a
five-year renewal option and a ten-year purchase option.
The Company owns a 33,500 square foot building in Bethlehem, Pennsylvania
which is used for manufacturing, engineering, information systems and
accounting activities. The Company rents additional warehouse space on an as-
needed basis. The Company leases space for a sales office in Reeuwijk, The
Netherlands.
The Company leases approximately 30,500 square feet of office,
manufacturing, and laboratory space in Beaverton, Oregon, under a lease that
expires on January 31, 2005. The Company has base lease obligations under the
lease, which escalate during the term of the lease and average approximately
$375,000 per year. The Company also leases 2,265 square feet of warehouse
space in Oregon to store inventory and equipment under a lease expiring
September 30, 2002. The Company expects to consolidate the research and
development and manufacturing operations currently performed in Oregon with
the Company's Bethlehem operation during 2003.
The Company has executed a lease for an approximate 48,000 square foot
manufacturing, research and development and office facility to be constructed
on property adjacent to its existing corporate headquarters in Bethlehem,
Pennsylvania. Construction of the facility is expected to be completed during
the summer of 2002. The lease has an initial term of 10 years and base rental
rate starting at $480,000 and increasing to $528,000 per year over the initial
term. The lease also has a five-year renewal option and a ten-year purchase
option.
The Company believes that its existing and proposed facilities are adequate
for its requirements.
26
ITEM 3. Legal Proceedings.
The Company is from time to time involved in legal proceedings arising in
the ordinary course of business. In the Company's opinion, based on the advice
of counsel, these proceedings are not expected to have a material adverse
effect on the Company's financial position or results of operations.
ITEM 4. Submission of Matters to a Vote of Security Holders.
No matters were submitted to a vote of security holders during the fourth
quarter of the year ended December 31, 2001.
27
PART II
ITEM 5. Market for Registrant's Common Equity and Related Stockholder Matters.
The Company's Common Stock is listed for trading on the National Market tier
of The Nasdaq Stock Market ("NASDAQ") under the symbol OSUR. High and low
sales prices reported by NASDAQ during the periods indicated are shown below.
Prices for quarters ending prior to the September 29, 2000 Merger with Epitope
and STC, represent the high and low sales prices reported by NASDAQ for the
common stock of the Company's predecessor, Epitope, which traded under the
symbol EPTO.
Year ended December 31
-----------------------------
2001 2000
-------------- --------------
High Low High Low
------- ------ ------- ------
First Quarter.................................. $10.000 $5.875 $18.188 $5.563
Second Quarter................................. 12.640 6.688 14.375 7.000
Third Quarter.................................. 15.000 7.260 15.938 9.938
Fourth Quarter................................. 12.880 8.890 13.500 5.563
On March 22, 2002, there were 787 holders of record and, based on mailings
for the 2001 Annual Meeting of Stockholders, approximately 9,500 holders in
street name of the Common Stock, and the closing price of the Common Stock was
$6.48 per share. The Company has never paid any cash dividends, and the Board
of Directors does not anticipate paying cash dividends in the foreseeable
future. The Company intends to retain any future earnings to provide funds for
the operation and expansion of its business.
ITEM 6. Selected Financial Data.
The following table sets forth selected financial data of the Company. See
Note 1 to the Company's Financial Statements for a discussion of the Merger
with Epitope and STC and change in the fiscal year end of Epitope. The data
below for the year ended September 30, 1997 includes discontinued operations
of two of Epitope's former subsidiaries, Agritope, Inc. and Andrew and
Williamson Sales, Co. The charge for discontinued operations during this
period includes the operating losses of these subsidiaries through their
disposition dates and final losses on disposal incurred by Epitope. This
information should be read in conjunction with the Financial Statements and
notes thereto included in Item 14 and the information set forth in Item 7,
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
28
Selected Financial Data
(In thousands, except per share data)
Year ended Three months ended Year ended
December 31, December 31, September 30,
-------------------- -------------------- ------------------------------
2001 2000 1999 1998 1999 1998 1997
--------- --------- --------- --------- --------- --------- --------
Operating Results:
Revenues................ $ 32,573 $ 28,788 $ 6,822 $ 5,138 $ 24,046 $ 20,444 $ 17,282
Costs and expenses...... 36,906 42,917 7,105 5,857 28,138 22,721 23,295
Other income (expense),
net.................... 634 1,407 (138) (159) (91) (98) 782
Loss from continuing
operations before
income taxes........... (3,699) (12,722) (421) (878) (4,183) (2,374) (5,231)
Loss from continuing
operations............. (3,728) (12,747) (471) (878) (4,233) (2,374) (5,231)
Discontinued
operations............. -- -- -- -- -- -- (18,359)
Net loss................ (3,728) (12,747) (471) (878) (4,233) (2,374) (23,590)
Per Share of Common
Stock:
Loss from continuing
operations............. $ (0.10) $ (0.36) $ (0.02) $ (0.03) $ (0.14) $ (0.09) $ (0.20)
Loss from discontinued
operations............. -- -- -- -- -- -- (0.70)
Basic and diluted net
loss................... (0.10) (0.36) (0.02) (0.03) (0.14) (0.09) (0.90)
Shares used in per share
calculations:.......... 36,868 35,002 30,887 26,246 30,597 26,180 26,055
Financial position:
Working capital......... $ 19,764 $ 21,440 $ 16,314 $ 8,255 $ 16,773 $ 8,725 $ 12,470
Total assets............ 37,285 37,736 29,626 20,075 30,251 20,783 25,978
Long-term debt.......... 3,586 4,644 5,820 6,001 5,820 6,001 4,026
Accumulated deficit..... (126,092) (122,365) (109,618) (105,603) (109,104) (104,903) (96,837)
Stockholders' equity.... 26,541 26,172 18,238 10,264 18,592 10,701 17,873
29
ITEM 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations.
Statements below regarding future events or performance are "forward-looking
statements" within the meaning of the Private Securities Litigation Reform Act
of 1995. The Company's actual results could be quite different from those
expressed or implied by the forward-looking statements. Factors that could
affect results are discussed more fully under the Sections entitled "Forward-
Looking Statements" and "Risk Factors" in Item 1 and elsewhere in this Annual
Report on Form 10-K. Although forward-looking statements help to provide
complete information about the Company, readers should keep in mind that
forward-looking statements may not be reliable. Readers are cautioned not to
place undue reliance on the forward-looking statements.
On September 29, 2000, STC Technologies, Inc. ("STC"), a privately held
company, and Epitope, Inc. ("Epitope"), a public company whose stock was
traded on the Nasdaq Stock Market, were merged into the Company (the
"Merger"). The Merger was structured as an all stock transaction and was
accounted for as a "pooling of interests."
Epitope previously reported its financial results on the basis of a fiscal
year ending September 30, while STC previously reported its financial results
on a calendar year basis. Immediately prior to the Merger, Epitope adopted a
calendar year for financial reporting purposes. As a result, the Financial
Data for 2001 and 2000 reflect results for the calendar years ended December
31, 2001 and 2000, respectively. Since Epitope did not adopt a calendar year
reporting period until 2000, the Financial Data for 1999 reflects the results
of Epitope for the twelve-months ended September 30, 1999 and the results of
STC for the twelve months ended December 31, 1999. See Note 1 to the Company's
Financial Statements for a discussion of the Merger and the change in fiscal
year end.
In selecting the presentation of results for 1999, the Company determined
that it was not necessary to restate the Epitope 1999 results on a calendar
year basis. To do so would have required the addition of Epitope's results for
the three months ended December 31, 1999 and the elimination of Epitope's
results for the three months ended December 31, 1998. A comparison of the
results for these three-month periods demonstrated that there were no events,
transactions or economic changes that caused the Epitope results for these
periods to be materially different. Accordingly, a restatement of the Epitope
results would not have materially affected the comparison of STC results for
the twelve months ended December 31, 1999 and Epitope results for the twelve
months ended September 30, 1999.
Certain reclassifications have been made to prior period market segment
revenues to conform to the current year presentation. The following discussion
should be read in conjunction with the financial statements contained herein
and the notes thereto, along with the Section entitled, "Critical Accounting
Policies and Estimates" set forth below.
Results of Operations--2001 Compared to 2000
Total revenues increased 13% to approximately $32.6 million in 2001 from
approximately $28.8 million in 2000. Excluding revenues of approximately $1.6
million in 2000 from the Serum Western Blot confirmatory test, which was
discontinued in January 2001, total revenues would have increased
approximately 20%.
30
The table below shows the amount of the Company's total revenues (in
thousands, except %) generated in each of its principal markets and by
licensing and product development activities.
Percentage of
Percentage Total
Dollars Change Revenues (%)
----------------- Inc. ---------------
2001 2000 (Dec.) 2001 2000
-------- -------- ---------- ------ ------
Market revenues
Insurance risk assessment...... $ 11,713 $ 14,693 (20)% 36% 51%
Infectious disease testing..... 5,754 3,453 67 18 12
Substance abuse testing........ 6,955 3,172 119 21 11
Physicians' office therapies... 6,674 6,777 (2) 20 24
-------- -------- ------ ------
31,096 28,095 11 95 98
Licensing and product
development.................... 1,477 693 113 5 2
-------- -------- ------ ------
Total revenues.................. $ 32,573 $ 28,788 13% 100% 100%
======== ======== ====== ======
Sales to the insurance risk assessment market declined by 20% to
approximately $11.7 million in 2001 from approximately $14.7 million in 2000,
as a result of the discontinuation of the Company's Serum Western Blot
confirmatory test, improved efficiencies by end users in the use of OraSure(R)
collection devices and by insurance testing laboratories in the use of
immunoassay tests, inventory consolidations which resulted from the merger of
the Company's two largest insurance laboratory customers, LabOne, Inc. and
Osborne Group, Inc., and lower sales of urine assays. Partially offsetting
this decline was an increase in sales of oral fluid assays resulting from
increased penetration of the insurance risk assessment market.
Sales to the infectious disease testing market increased 67% to
approximately $5.8 million in 2001 from approximately $3.5 million in 2000, as
a result of continued penetration of the Company's OraSure(R) laboratory-based
HIV-1 test and shipments of the OraQuick(R) rapid HIV test into sub-Saharan
Africa.
Sales to the substance abuse testing market increased 119% to approximately
$7.0 million in 2001 from approximately $3.2 million in 2000, as a result of
the substantial market penetration of the Intercept(R) drug testing service
into the workplace and criminal justice markets and increased forensic
toxicology sales. Of the $7.0 million in substance abuse testing revenues,
approximately $1.7 million resulted from the sale of equipment manufactured by
third party vendors.
Sales to the physicians' office therapies market, which consisted solely of
the Histofreezer(R) portable cryosurgical system, declined 2% to approximately
$6.7 million in 2001 from approximately $6.8 million in 2000, as a result of
inventory consolidation by distributors in the United States and lower
international sales. Despite this small decline in revenues, Histofreezer(R)
sales in the United States improved steadily throughout 2001 on a quarter-to-
quarter basis.
As a percentage of total revenues, international revenues increased to
approximately 16% in 2001 from approximately 14% in 2000, with Histofreezer(R)
accounting for approximately 39% of 2001 international revenues. LabOne, Inc.,
the Company's largest customer, and Osborne Group, Inc., which was acquired by
LabOne, Inc. in 2001, together accounted for approximately 29% and 30% of
total revenues in 2001 and 2000, respectively.
Licensing and product development revenues increased 113% to approximately
$1.5 million in 2001 from approximately $0.7 million in 2000, reflecting a
different mix of development work performed in 2001. During 2001, licensing
and product development revenues were primarily from the continued development
of the UPlink(TM) drugs-of-abuse rapid detection system under an agreement
with Drager, development of infectious disease applications for UPlink(TM)
under an agreement with Meridian Bioscience, and the second phase of a grant
from the National Institutes of Health ("NIH") for the development of an oral
fluid syphilis test. During
31
2000, licensing and product development revenues consisted primarily of income
from a collaboration with LabOne, Inc. related to the Intercept(R) drug
testing service, development work with Drager on the UPlink(TM) drugs-of-abuse
rapid detection system, and the first phase of the NIH grant. Under its
agreements with Drager and Meridian Bioscience, the Company expects to receive
additional development revenues if it meets certain milestones in 2002.
The first phase of the NIH grant was for development of a laboratory-based
oral fluid syphilis test using the OraSure(R) collection device. During 2001,
the Company requested and the NIH approved a change for the second phase of
that grant to apply to the development of a rapid test for syphilis using the
OraQuick(R) platform. During the first quarter of 2002, the Company reassessed
this project and the potential marketability of the resulting product, and
elected to terminate development of the syphilis test. As a result, the
Company does not expect to receive further funding under the NIH grant.
The Company's gross margin increased to approximately 62% in 2001 from 61%
in 2000. This increase was primarily the result of lower material costs and
productivity gains, negotiated contract savings, cost savings as a result of
restructuring the Company's manufacturing operations, and higher licensing and
product development revenues, partially offset by incremental costs and
manufacturing inefficiencies associated with the initial production of
UPlink(TM) analyzers and commencement of OraQuick(R) manufacturing.
Additionally, during the fourth quarter of 2001, the gross margin was
negatively affected by the recording of an inventory reserve of approximately
$0.6 million related to OraQuick(R) HIV tests manufactured for sale to the
Company's African distributor. Because of the failure by the Company's African
distributor to meet its contractually-required minimum purchase commitments,
the Company reevaluated its international distribution strategy for
OraQuick(R) and terminated its agreement with this distributor in February
2002. The reserve was required because of concerns about the remaining shelf
life of the inventory in relation to the Company's ability to rapidly
establish a new distribution channel to sell OraQuick(R) in Africa. During
2000, the Company wrote off approximately $0.5 million for expired OraSure(R)
collection device inventory and $0.6 million for Serum Western Blot
confirmatory test inventory that was obsolete, expired, or rendered unsaleable
as a result of the discontinuation of that product.
Research and development expenses declined 10% to approximately $9.4 million
in 2001 from approximately $10.4 million in 2000. Research and development
efforts in 2001 were focused upon the continued development of the UPlink(TM)
analyzer, test cassette and collector, the development of certain UPlink(TM)
drugs of abuse and infectious disease assays, DNA feasibility studies, and
clinical trials for the OraQuick(R) rapid HIV-1 test. The investments into
these projects were offset by reduced expenditures related to development of
the OraQuick(R) device and lower personnel and consulting expenses at the
Company's Beaverton, Oregon facility.
Sales and marketing expenses increased 14% to approximately $7.9 million in
2001 from approximately $6.9 million in 2000. This increase was primarily the
result of additional costs associated with increased staffing levels and
related expenses, and the expansion of the Company's customer service
functions.
General and administrative expenses remained flat at approximately $6.9
million in both 2001 and 2000. Higher professional fees associated with
certain partnering activities in 2001 were offset by cost savings from the
elimination of duplicative overhead structures as a result of the Merger.
During the first quarter of 2002, the Company will record a charge of
approximately $0.6 million relating to severance payments, including
approximately $480,000 for Robert D. Thompson, the Company's former Chief
Executive Officer, who resigned on January 31, 2002, and approximately
$100,000 in severance payments in connection with a 10% workforce reduction
implemented during that period.
Merger-related expenses were approximately $7.6 million in 2000. These costs
included fees for investment bankers, attorneys and accountants, filing fees,
proxy solicitation expenses, employee severance, and integration costs. There
were no such costs in 2001.
32
Restructuring-related expenses were $450,000 as a result of the
manufacturing restructuring in the first quarter of 2001. These costs included
expenses for employee severance and travel and transport resulting from
relocating and consolidating manufacturing operations, and were paid by June
30, 2001. There were no such costs in 2000.
Interest expense decreased by 18% to $403,000 in 2001 from $490,000 in 2000
as a result of loan principal repayments.
Interest income decreased by 29% to approximately $0.9 million in 2001 from
approximately $1.3 million in 2000 as a result of lower cash and cash
equivalents available for investment and lower interest rates.
Gain on the sale of securities was $100,000 in 2001 as a result of the sale
of LabOne, Inc. common stock the Company received as part of a distribution
arrangement with LabOne, entered into in 1999 for the Company's Intercept(R)
drug testing service. In 2000, the Company recorded a gain on the sale of
securities of $600,000, as a result of the sale of Andrew & Williamson Sales
Company ("A&W") preferred stock the Company had received as part of a
settlement with A&W in 1997.
During 2001 and 2000, provisions for foreign income taxes were recorded.
Results of Operations--2000 Compared to 1999
Total revenue increased 20% to approximately $28.8 million in 2000 from
approximately $24.0 million in 1999. The table below shows the amount (in
thousands) and percentage of the Company's total revenue contributed by each
of its principal markets and by licensing and product development activities.
Percentage of
Percentage Total
Dollars Change Revenues (%)
--------------- Inc. ---------------
2000 1999 (Dec.) 2000 1999
------- ------- ---------- ------ ------
Market sales
Insurance risk assessment........ $14,693 $12,364 19% 51% 51%
Infectious disease testing....... 3,453 2,549 35 12 11
Substance abuse testing.......... 3,172 2,491 27 11 10
Physicians' office therapies..... 6,777 5,744 18 24 24
------- ------- ------ ------
28,095 23,148 21 98 96
Licensing and product
development...................... 693 898 (23) 2 4
------- ------- ------ ------
Total revenues.................... $28,788 $24,046 20% 100% 100%
======= ======= ====== ======
Sales to the insurance risk assessment market increased by 19% to
approximately $14.7 million in 2000 from approximately $12.4 million in 1999,
as a result of increased market acceptance of the OraSure(R) oral fluid
collection device and higher sales of the associated immunoassay tests.
Sales to the infectious disease testing market increased 35% to
approximately $3.5 million in 2000 from approximately $2.5 million in 1999, as
a result of increased penetration of the Company's higher priced public health
HIV-1 kit.
Sales to the substance abuse testing market increased 27% to approximately
$3.2 million in 2000 from approximately $2.5 million in 1999, as a result of
the market introduction of the Intercept(R) drug testing service and increased
Q.E.D.(R) and forensic toxicology sales.
Sales to the physicians' office therapies market, which consisted solely of
the Histofreezer(R) portable cryosurgical system, increased 18% to
approximately $6.8 million in 2000 from approximately $5.7 million in 1999, as
a result of price and volume increases both domestically and internationally.
33
As a percentage of total revenues, international revenues increased to
approximately 14% in 2000 from 12% in 1999, as a result of increased
international sales of the Histofreezer(R) product and the OraSure(R)
collection devices. LabOne, Inc. and Osborne Group Inc., which was acquired by
LabOne, Inc. in 2001, together accounted for approximately 30% and 28% of the
total revenues in 2000 and 1999, respectively.
Licensing and product development revenue decreased 23% to $0.7 million in
2000 from $0.9 million in 1999, reflecting a different mix of development work
performed in 2000. During 2000, licensing and product development revenue
primarily consisted of income from a collaboration with LabOne, Inc. related
to the Intercept(R) drug testing service, development work with Drager on the
UPlink(TM) drugs-of-abuse rapid detection system, and receipt of the first
phase of the NIH grant for the development of an oral fluid syphilis test.
During 1999, the Company received licensing and product development revenue in
connection with a research agreement to collaborate on the development of
analytes for point-of-care testing, a business and technology assessment of
UPT(TM) for food pathogen applications, and the Company's collaboration with
LabOne for the Intercept(R) drug testing service.
The Company's gross margin declined slightly to 61% in 2000 from 62% in
1999. The decline was the result of the Company's write off of approximately
$0.5 million of expired OraSure(R) collection device inventory and $0.6
million of obsolete, expired, or unsaleable Serum Western Blot inventory, and
manufacturing inefficiencies related to the start up of the OraQuick(R)
product line. Partially offsetting these factors in 2000 were favorable
changes in product mix and greater revenues compared to the Company's fixed
costs.
Research and development expenses increased 86% to approximately $10.4
million in 2000 from approximately $5.6 million in 1999. Research and
development efforts in 2000 were focused on development of the OraQuick(R)
rapid HIV test, development of the UPlink(TM) analyzer, test cassette and
collector for drugs-of-abuse applications, DNA feasibility studies, and
regulatory compliance. In addition, the Company also performed research and
development activities with respect to additional Intercept(R) products, new
antibody development, and improvements to existing products.
Sales and marketing expenses increased approximately 22% to approximately
$6.9 million from approximately $5.7 million in 1999. This increase was
primarily the result of costs associated with cultivating foreign markets for
the OraQuick(R) rapid HIV test, which was launched in July 2000, launching the
Intercept(R) drug testing service in the United States in February 2000, and
expanded sales activities for the Company's other product lines.
General and administrative expenses increased 10% to approximately $6.9
million in 2000 from approximately $6.2 million in 1999. This increase was the
result of increased staffing levels and operating expenses associated with a
facility expansion in Bethlehem, Pennsylvania.
In 1999, the Company recorded a $1.5 million charge for acquired in-process
technology from TPM Europe Holding B.V., its sublicensor, relating to the
termination of an existing license agreement between the sublicensor and the
Company with respect to the sublicense of UPT(TM) patents owned by Leiden
University, The Netherlands, and securing a direct research, development, and
license arrangement with Leiden University. The Company accounted for the
purchase price of the technology as acquired in-process technology expense,
because at the date of the transaction, the technology rights acquired by the
Company had not progressed to a stage where the technology, or any alternative
future use of the technology, had met technological feasibility. Furthermore,
there existed a significant amount of uncertainty as to the Company's ability
to complete the development of this technology and achieve market acceptance
of any related commercial products within a reasonable timeframe. There were
no such expenses in 2000.
Merger-related expenses were approximately $7.6 million in 2000. These costs
included fees for investment bankers, attorneys and accountants, filing fees,
proxy solicitation expenses, employee severance, and integration costs. There
were no such expenses in 1999.
34
Interest expense decreased to $490,000 in 2000 from $545,000 in 1999, as a
result of loan principal repayments and the refinancing of certain debt.
Interest income increased to approximately $1.3 million in 2000 from
approximately $0.6 million in 1999, as a result of higher cash and cash
equivalents available for investment generated by the exercise of stock
options and warrants.
Gain on the sale of securities was $600,000 in 2000 as a result of a gain on
the sale of A&W preferred stock the Company had received as a part of a
settlement with A&W in 1997. There was no similar item in 1999.
During 2000 and 1999, provisions for foreign income taxes were recorded.
Results of Operations--Three Months Ended December 31, 1999 Compared to 1998
Total revenues increased 33% to approximately $6.8 million for the three
months ended December 31, 1999 from approximately $5.1 million for the
comparable period in 1998. This increase resulted from increased sales across
all market segments, including a $400,000 increase in sales to the infectious
disease market, a $300,000 increase in sales to the substance abuse testing
market, and increased licensing and product development revenue.
The Company's gross margin increased to approximately 63% for the three
months ended December 31, 1999 from approximately 59% in 1998. This increase
was primarily the result of a more favorable product mix and higher product
sales and licensing and product development revenue.
Operating expenses increased 23% to approximately $4.6 million for the three
months ended December 31, 1999 from approximately $3.8 million in 1998,
primarily as a result of a general increase in overall sales and marketing
expenses, including additional costs associated with preparation for the
Company's national launch of the Intercept(R) drug testing service in February
2000.
Other expenses decreased to approximately $138,000 for the three months
ended December 31, 1999 from approximately $159,000 in 1998, primarily as a
result of lower interest expense and increased interest income, partially
offset by higher foreign currency losses.
During the three months ended December 31, 1999, a provision for foreign
income taxes of $50,000 was recorded.
Liquidity and Capital Resources
General. The Company's cash, cash equivalents, and short-term investments
position was approximately $15.2 million at December 31, 2001, a decrease of
approximately $4.9 million from the Company's position at December 31, 2000.
This decrease was principally attributable to the Company's net loss of $3.7
million, increased accounts receivable and inventory levels, capital
investment into new manufacturing facilities and equipment, and loan principal
repayments, partially offset by proceeds from the exercise of stock options.
At December 31, 2001, the Company's working capital was approximately $19.8
million.
The Company recorded lower than anticipated product sales in 2001 and
expects its revenues for the first two quarters of 2002 to be roughly
comparable to revenue levels recorded for the same periods in 2001. In
addition, the Company hired personnel during 2001 to support a sales level
higher than that now anticipated through mid-2002. Consequently, in the first
quarter of 2002, the Company terminated certain development projects and
implemented an approximate 10% reduction in its workforce.
Net cash used in operating activities was approximately $5.3 million in
2001, a decrease of approximately $4.8 million from 2000. The $5.3 million of
cash used in operating activities resulted primarily from the Company's net
loss of $3.7 million, the build up of higher inventory levels of OraQuick(R)
raw materials and
35
electronic components for UPlink(TM) readers in anticipation of sales growth,
and an increase in accounts receivable levels.
Net cash used in investing activities during 2001 was $66,000. The Company
purchased approximately $2.8 million of property and equipment and funded this
through net proceeds of approximately $2.1 million of short-term investments
and $637,500 the Company received upon the sale of LabOne, Inc. common stock.
Capital expenditures are anticipated to increase during 2002 as a result of
additional commitments the Company has made for the purchase and installation
of manufacturing equipment for UPlink(TM), and additional tenant fit out costs
expected in connection with its existing facilities and a new facility the
Company has leased in Bethlehem, Pennsylvania.
Net cash provided by financing activities was approximately $2.7 million,
reflecting the proceeds received from the exercise of stock options of
approximately $3.9 million, offset by approximately $1.1 million of loan
principal repayments.
At December 31, 2001, the Company had a $1.0 million working capital line of
credit in place that accrues interest at LIBOR plus 235 basis points and a
$3.0 million equipment line of credit that accrues interest at a rate fixed at
prime at the time of draw down. There were no borrowings under these lines of
credit outstanding at December 31, 2001. The credit facilities require, among
other items, the maintenance of minimum financial ratios and a first lien
position on the Company's accounts receivable and the financed equipment. The
Company's lines of credit expire on April 30, 2002 and are expected to be
extended and/or replaced with other credit or bank facilities, although there
can be no assurance of renewal or extension.
The Company believes that it has sufficient cash, cash equivalents, and
short-term investments for the foreseeable future. The Company's future
liquidity and capital requirements will depend on numerous factors, including,
but not limited to, the costs and timing of the expansion of manufacturing
capacity, the success of product development efforts, the timing of receipt of
regulatory approvals, the costs and timing of expansion of sales and marketing
activities, the timing of commercial launch of new products, the extent to
which existing and new products gain market acceptance, competing
technological and market developments, and the scope and timing of strategic
acquisitions. If additional financing is needed, the Company may seek to raise
funds through the sale of equity or other securities, bank borrowings or
otherwise. There can be no assurance that financing through the sale of
securities, bank borrowings or otherwise will be available to the Company on
satisfactory terms, if at all.
36
Contractual Obligations and Commercial Commitments. The following sets forth
the Company's approximate aggregate obligations at December 31, 2001 for
future payments under contracts and other contingent commitments, for the
years 2002 and beyond:
Payments due by December 31,
-------------------------------------------------------
Contractual Obligations Total 2002 2003 2004 2005 Thereafter
- ----------------------- ----------- ---------- ---------- ---------- -------- ----------
Long-term debt(1)....... $ 4,644,030 $1,057,572 $2,236,923(2) $ 247,842 $ 92,421 $1,009,272
Operating leases(3)..... 7,012,252 934,225 1,131,534 1,142,514 579,979 3,224,000
Employment
contracts(4)........... 3,287,469 2,090,305 1,197,164 -- -- --
Capital
expenditures(5)........ 644,995 644,995 -- -- -- --
Minimum commitments
under contracts(6)..... 2,100,000 300,000 225,000 225,000 225,000 1,125,000
----------- ---------- ---------- ---------- -------- ----------
Total contractual
obligations............ $17,688,746 $5,027,097 $4,790,621 $1,615,356 $897,400 $5,358,272
=========== ========== ========== ========== ======== ==========
- --------
(1) Represents principal repayments required under notes payable to the
Company's lenders. See Note 8 to the financial statements included
herein.
(2) $1,903,211 of the $2,236,923 represents a note payable which is subject
to a call option in December 2003. If the note is not called in December
2003, payments of $577,542, $643,829 and $681,840 would be due in 2003,
2004, and 2005, respectively.
(3) Represents payments required under the Company's operating leases. See
Notes 11 and 12 to the financial statements included herein.
(4) Represents salary, retention bonus or severance payments payable under
the terms of employment agreements executed by the Company. See Note 11
to the financial statements included herein.
(5) Represents payments required by non-cancelable purchase orders related to
capital expenditures. See Note 11 to the financial statements included
herein.
(6) Represents payments required pursuant to certain research, licensing and
royalty agreements executed by the Company. See Note 11 to the financial
statements included herein.
Critical Accounting Policies and Estimates
Management's Discussion and Analysis of Financial Condition and Results of
Operations discusses the Company's financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States. The preparation of these financial statements requires
management to make estimates and assumptions that affect the reported amounts
of assets and liabilities, the 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. On an on-going basis, management
evaluates its judgments and estimates, including those related to bad debts,
inventories, investments, intangible assets, income taxes, revenue
recognition, restructuring costs, contingencies, and litigation. Management
bases its judgments and estimates on historical experience and on various
other factors that are believed to be reasonable under the circumstances, the
results of which form the basis for making judgments about the carrying value
of assets and liabilities that are not readily apparent from other sources.
Actual results may differ from these estimates under different assumptions or
conditions.
The Company's significant accounting policies are described in Note 2 to the
financial statements included in Item 14 of this Report. Management considers
the following policies to be most critical in understanding the more complex
judgments that are involved in preparing the Company's financial statements
and the uncertainties that could impact its results of operations, financial
condition, and cash flows.
Revenue Recognition. The Company follows U.S. Securities and Exchange
Commission Staff Accounting Bulletin No. 101, "Revenue Recognition in
Financial Statements" ("SAB 101"). This bulletin draws on existing accounting
rules and provides specific guidance on revenue recognition of up-front non-
refundable licensing and development fees. The Company licenses certain
products or technology to outside third parties, in return for which the
Company receives up-front licensing fees, some of which can be significant. In
accordance with SAB 101, the Company is required to defer immediate
recognition of these fees as revenue, and instead ratably recognize this
revenue over the related license period.
37
The Company also enters into research and development contracts with
corporate, government or private entities. These contracts generally provide
for payments to the Company upon achievement of certain research or
development milestones. Product development revenues from these contracts are
recognized only if the specified milestone is achieved and accepted by the
customer and payment from the customer is probable. Any amounts received prior
to the performance of product development efforts are recorded as deferred
revenues. Recognition of revenue under these contracts can be sporadic, as it
is the result of achieving specific research and development milestones.
Furthermore, revenue from future milestone payments will not be recognized if
the underlying research and development milestone is not achieved.
The Company recognizes product revenues when products are shipped. The
Company does not grant price protection or product return rights to its
customers, except for warranty returns. Where a product fails to comply with
its limited warranty, the Company can either replace the product or provide
the customer with a refund of the purchase price or credit against future
purchases. Historically, returns arising from warranty issues have been
infrequent and immaterial. Accordingly, the Company expenses warranty returns
as incurred. While such returns have been immaterial in the past, management
cannot guarantee that the Company will continue to experience the same rate of
warranty claims as it has in the past. Any significant increase in product
warranty claims could have a material adverse impact on the Company's
operating results for the period in which such claims occur.
Allowance for Uncollectible Accounts Receivable. Accounts receivable are
reduced by an estimated allowance for amounts that may become uncollectible in
the future. On an ongoing basis, management performs credit evaluations of the
Company's customers and adjusts credit limits based upon the customer's
payment history and creditworthiness, as determined by a review of their
current credit information. The Company continuously monitors collections and
payments from its customers. Based upon the Company's historical experience
and any specific customer collection issues that are identified, management
uses its judgment to establish and evaluate the adequacy of the Company's
allowance for estimated credit losses. While such credit losses have been
within the Company's expectations and the allowance provided, the Company
cannot guarantee that it will continue to experience the same credit loss
rates as it has in the past. Furthermore, some of the Company's accounts
receivable have resulted from sales to distributors located in foreign
countries in South Africa and South America. Also, at December 31, 2001,
approximately $1.3 million or 21.4% of the Company's accounts receivable were
due from one major customer. Any significant changes in the liquidity or
financial position of this customer, or the economies of these foreign
nations, could have a material adverse impact on the collectibility of the
Company's accounts receivable and its future operating results.
Inventories. The Company's inventories are valued at the lower of cost or
market, determined on a first-in, first-out basis, and include the cost of raw
materials, labor and overhead. The majority of the Company's inventories are
subject to expiration dating. The Company continually evaluates the carrying
value of its inventories and when, in the opinion of management, factors
indicate that impairment has occurred, either a reserve is established against
the inventories' carrying value or the inventories are completely written off.
Management bases these decisions on the level of inventories on hand in
relation to the Company's estimated forecast of product demand, production
requirements over the next twelve months and the expiration dates of raw
materials and finished goods. Although the Company makes every effort to
ensure the accuracy of its forecasts of future product demand, any significant
unanticipated changes in demand could have a significant impact on the
carrying value of the Company's inventories and its reported operating
results.
Income Taxes. The Company has a history of losses, which has generated a
sizeable federal tax net operating loss ("NOL") carryforward of approximately
$69.1 million as of December 31, 2001. Generally accepted accounting
principles require the Company to record a valuation allowance against the
deferred tax asset associated with this NOL carryforward if it is more likely
than not that the Company will not be able to utilize the NOL carryforward to
offset future taxes. Due to the size of the NOL carryforward in relation to
the Company's history of unprofitable operations, the Company has not
recognized any of this net deferred tax asset.
It is possible that the Company could be profitable in the future at levels
which would cause management to conclude that it is more likely than not that
the Company will realize all or a portion of the NOL carryforward.
38
Upon reaching such a conclusion, the Company would immediately record the
estimated net realizable value of the deferred tax asset at that time and
would then begin to provide for income taxes at a rate equal to the Company's
combined federal and state effective rates, which management believes would
approximate 40%. Subsequent revisions to the estimated net realizable value of
the deferred tax asset could cause the Company's provision for income taxes to
vary significantly from period to period.
Certain Relationships and Related Transactions
The Company has entered into a Commercial Lease (the "Lease") with Tech III
Partners, LLC ("Tech Partners"), which provides for the construction of a
48,000 square foot facility on land adjacent to the Company's Bethlehem,
Pennsylvania headquarters, and the lease of that facility to the Company. Tech
Partners is owned and controlled by Michael J. Gausling, the Company's
President and Chief Executive Officer, and Dr. R. Sam Niedbala, the Company's
Executive Vice President and Chief Science Officer. The facility is expected
to house manufacturing, research and development, and administrative
operations required to support the expected growth of the Company's business.
Construction of the facility is expected to be completed during the summer of
2002.
The Lease has an initial 10-year term commencing after completion of
construction and a base rent starting at $480,000 and increasing to $528,000
per year over that term. The base rental rate may be increased after the fifth
year of the initial term in order to reflect changes in the interest rate on
debt incurred by Tech Partners to finance construction of the leased
facilities. The Company has not guaranteed any debt incurred by Tech Partners.
The Lease also provides the Company with options to renew the Lease for an
additional five years at a rental rate of $600,000 per year, and to purchase
the facility at any time during the initial ten-year term at a fair value.
Prior to deciding to enter into the Lease, the Company's Board of Directors
retained Imperial Realty Appraisal LLC, an independent commercial real estate
appraisal firm, to evaluate the proposed base rental rate under the Lease.
Imperial Realty issued an opinion indicating that the annual base rent set
forth in the Lease is below the market rental rate the Company could otherwise
expect to pay to lease a comparable commercial property in the same general
geographic market. The terms of the Lease are otherwise substantially similar
to the commercial lease entered into by the Company with a third party for its
existing Bethlehem, Pennsylvania headquarters.
On January 31, 2002, the employment agreement with Robert D. Thompson, the
Company's former Chief Executive Officer, was terminated, and Mr. Thompson
resigned from the Company. The Company and Mr. Thompson have entered into a
severance agreement pursuant to which Mr. Thompson will receive approximately
$480,000. The severance agreement provides that a $75,000 interest-free loan
previously made to Mr. Thompson in connection with his relocation from
Portland, Oregon, will be repaid by application of an amount equal to his net
bi-weekly salary commencing on or after April 17, 2002.
Recent Accounting Pronouncements
In June 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 141, "Business
Combinations" ("SFAS No. 141"), which requires that all business combinations
initiated after June 30, 2001 be accounted for under the purchase method and
addresses the initial recognition and measurement of goodwill and other
intangible assets acquired in a business combination. Business combinations
accounted for under the pooling of interests method prior to June 30, 2001
will not be affected. The adoption of SFAS No. 141 will not have any impact on
the Company's financial position or results of operations.
In June 2001, the FASB issued SAFS No. 142, "Goodwill and Other Intangible
Assets" ("SFAS No. 142"). SFAS No. 142 addresses the initial recognition and
measurement of intangible assets acquired in a business combination and the
accounting for goodwill and other intangible assets subsequent to their
acquisition. SFAS No. 142 provides that intangible assets with finite useful
lives be amortized and that goodwill and intangible assets with indefinite
lives not be amortized, but rather be tested at least annually for impairment.
The adoption of SFAS No. 142 will not have any impact on the Company's
financial position or results of operations.
39
In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment
or Disposal of Long-Lived Assets" ("SFAS No. 144"). SFAS No. 144 addresses the
financial accounting and reporting for the impairment or disposal of long-
lived assets and replaces SFAS No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed of." SFAS No. 144
provides updated guidance concerning the recognition and measurement of an
impairment loss for certain types of long-lived assets and modifies the
accounting and reporting of discontinued operations. The adoption of SFAS No.
144 will not have any impact on the Company's financial position or results of
operations.
ITEM 7A. Quantitative and Qualitative Disclosures About Market Risk.
The Company does not hold any amounts of derivative financial instruments or
derivative commodity instruments, and accordingly has no material market risk
to report under this Item.
The Company's holdings of financial instruments are comprised of U.S.
corporate debt, certificates of deposit, government securities, and commercial
paper. All such instruments are classified as securities available for sale.
The Company's debt security portfolio represents funds held temporarily
pending use in its business and operations. The Company seeks reasonable
assuredness of the safety of principal and market liquidity by investing in
rated fixed income securities while at the same time seeking to achieve a
favorable rate of return. Market risk exposure consists principally of
exposure to changes in interest rates. If changes in interest rates would
affect the investments adversely, the Company could decide to hold the
security to maturity or sell the security. The Company's holdings are also
exposed to the risks of changes in the credit quality of issuers. The Company
typically invests in the shorter end of the maturity spectrum.
The Company does not currently have any foreign currency exchange contracts
or purchase currency options to hedge local currency cash flows. The Company
has operations in The Netherlands which are subject to foreign currency
fluctuations. As currency rates change, translation of income statements of
these operations from Euros to U.S. dollars affects year-to-year comparability
of operating results. The Company's operations in The Netherlands represented
approximately $2.0 million or 1% of the Company's revenues for the year ended
December 31, 2001. Management does not expect the risk of foreign currency
fluctuations to be material.
ITEM 8. Financial Statements and Supplementary Data.
Information with respect to this Item is contained in the Company's
Financial Statements included in Item 14 of this Annual Report on Form 10-K.
ITEM 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure.
None.
40
PART III
The Company has omitted from Part III the information that will appear in
the Company's Definitive Proxy Statement for its 2002 Annual Meeting of
Stockholders (the "Proxy Statement"), which will be filed within 120 days
after the end of the Company's fiscal year pursuant to Regulation 14A.
ITEM 10. Directors and Executive Officers of the Registrant.
The information required by this item is incorporated by reference to the
information under the captions "Election of Directors," "Executive Officers,"
and "Section 16(a) Beneficial Ownership Reporting Compliance" in the Proxy
Statement.
ITEM 11. Executive Compensation.
The information required by this item is incorporated by reference to the
information under the caption "Executive Compensation" in the Proxy Statement.
ITEM 12. Security Ownership of Certain Beneficial Owners and Management.
The information required by this item with respect to the securities
ownership of certain beneficial owners and management is incorporated by
reference to the information under the caption "Principal Stockholders" in the
Proxy Statement.
ITEM 13. Certain Relationships and Related Transactions.
The information required by this item is incorporated by reference to the
information under the captions "Certain Relationships and Related
Transactions" and "Employment Agreements" in the Proxy Statement.
PART IV
ITEM 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.
(a)(1) and (a)(2). For a list of the Financial Statements filed herewith,
see the Index to Financial Statements following the signature page to this
Report. No schedules are included with the Financial Statements because the
required information is inapplicable or is presented in the Financial
Statements or related notes thereto.
(a)(3) Exhibits. See Index to Exhibits following the Financial Statements in
this Report.
(b) Reports on Form 8-K.
1. Current Report on Form 8-K dated October 24, 2001, attaching a press
release that announced third quarter 2001 financial results and disclosed
certain "Frequently Asked Questions" and answers to those questions.
41
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this Report to be signed
on its behalf by the undersigned, thereunto duly authorized, on March 28,
2002.
Orasure Technologies, Inc.
/s/ Michael J. Gausling
By: _________________________________
Michael J. Gausling
President and Chief Executive
Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed on March 28, 2002, by the following persons on behalf
of the Registrant and in the capacities indicated.
Signature Title
--------- -----
/s/ Michael J. Gausling President, Chief Executive Officer and
___________________________________________ Director (Principal Executive Officer)
Michael J. Gausling
/s/ Ronald H. Spair Executive Vice President and Chief
___________________________________________ Financial Officer (Principal Financial
Ronald H. Spair Officer)
/s/ Mark L. Kuna Controller
___________________________________________ (Principal Accounting Officer)
Mark L. Kuna
/s/ *Michael G. Bolton Director
___________________________________________
Michael G. Bolton
/s/ *William W. Crouse Director
___________________________________________
William W. Crouse
/s/ *Carter H. Eckert Director
___________________________________________
Carter H. Eckert
/s/ *Frank G. Hausmann Director
___________________________________________
Frank G. Hausmann
/s/ *Gregory B. Lawless Director
___________________________________________
Gregory B. Lawless
/s/ *Roger L. Pringle Director
___________________________________________
Roger L. Pringle
/s/ *Ronald H. Spair
*By: ______________________________________
Ronald H. Spair
(Attorney-in-Fact)
42
INDEX TO FINANCIAL STATEMENTS
Page
----
Report of Arthur Andersen LLP--Independent Public Accountants.............. F-2
Report of PricewaterhouseCoopers LLP--Independent Accountants.............. F-3
Balance Sheets............................................................. F-4
Statements of Operations................................................... F-5
Statements of Stockholders' Equity......................................... F-6
Statements of Cash Flows................................................... F-7
Notes to Financial Statements.............................................. F-8
F-1
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To OraSure Technologies, Inc.:
We have audited the accompanying balance sheets of OraSure Technologies,
Inc. (a Delaware corporation) as of December 31, 2001 and 2000, and the
related statements of operations, stockholders' equity and cash flows for the
years ended December 31, 2001 and 2000, the three months ended December 31,
1999, and the year ended September 30, 1999. 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 did
not audit the financial statements of Epitope, Inc., a company acquired during
2000 in a transaction accounted for as a pooling of interests, as discussed in
Note 1. Such statements are included in the financial statements of OraSure
Technologies, Inc. and reflect total revenues of 39 percent and 42 percent for
the three months ended December 31, 1999 and year ended September 30, 1999,
respectively, of the related totals. Those statements were audited by other
auditors whose report has been furnished to us, and our opinion, insofar as it
relates to amounts included for Epitope, Inc., is based solely upon the report
of the other auditors.
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 and the
report of other auditors provide a reasonable basis for our opinion.
In our opinion, based on our audits and the report of other auditors, the
financial statements referred to above present fairly, in all material
respects, the financial position of OraSure Technologies, Inc. as of
December 31, 2001 and 2000, and the results of its operations and its cash
flows for the years ended December 31, 2001 and 2000, the three months ended
December 31, 1999, and the year ended September 30, 1999, in conformity with
accounting principles generally accepted in the United States.
ARTHUR ANDERSEN LLP
Philadelphia, Pennsylvania,
January 31, 2002 (except for
the facility lease discussed
in Note 12, as to which the
date is March 21, 2002)
F-2
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholders of
OraSure Technologies, Inc.
In our opinion, the consolidated statements of operations, of changes in
shareholders' equity and of cash flows of Epitope, Inc. (the Company) (not
presented herein) present fairly, in all material respects, the Company's
results of operations and cash flows for the three months ended December 31,
1999 and for the year ended September 30, 1999, in conformity with accounting
principles generally accepted in the United States of America. 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 of these statements in accordance with
auditing standards generally accepted in the United States of America, which
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, assessing the accounting principles
used and significant estimates made by management and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion. We have not audited the consolidated
financial statements of the Company for any period subsequent to December 31,
1999.
PricewaterhouseCoopers LLP
Portland, Oregon
January 15, 2001
F-3
ORASURE TECHNOLOGIES, INC.
BALANCE SHEETS
December 31,
----------------------------
2001 2000
------------- -------------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents....................... $ 2,426,346 $ 5,095,639
Short-term investments.......................... 12,764,903 14,956,779
Accounts receivable, net of allowance for
doubtful accounts of $209,492 and $114,685..... 6,057,927 5,276,772
Notes receivable from officer................... 75,000 175,649
Inventories..................................... 4,444,772 1,495,604
Prepaid expenses and other...................... 1,038,511 1,113,691
------------- -------------
Total current assets........................... 26,807,459 28,114,134
PROPERTY AND EQUIPMENT, net...................... 7,800,137 6,738,034
PATENTS AND PRODUCT RIGHTS, net.................. 2,042,533 2,402,386
OTHER ASSETS..................................... 634,546 481,618
------------- -------------
$ 37,284,675 $ 37,736,172
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Current portion of long-term debt............... $ 1,057,572 $ 1,125,138
Accounts payable................................ 2,874,061 2,120,534
Accrued expenses................................ 3,111,886 3,428,862
------------- -------------
Total current liabilities...................... 7,043,519 6,674,534
------------- -------------
LONG-TERM DEBT................................... 3,586,458 4,644,098
------------- -------------
OTHER LIABILITIES................................ 114,025 245,464
------------- -------------
COMMITMENTS AND CONTINGENCIES (Note 11)
STOCKHOLDERS' EQUITY:
Preferred stock, par value $.000001; 25,000,000
shares authorized, none issued................. -- --
Common stock, par value $.000001; 120,000,000
shares authorized, 37,403,269 and 36,434,004
shares issued and outstanding.................. 37 36
Additional paid-in capital...................... 152,758,591 148,767,789
Accumulated other comprehensive loss............ (125,664) (231,247)
Accumulated deficit............................. (126,092,291) (122,364,502)
------------- -------------
Total stockholders' equity..................... 26,540,673 26,172,076
------------- -------------
$ 37,284,675 $ 37,736,172
============= =============
The accompanying notes are an integral part of these statements.
F-4
ORASURE TECHNOLOGIES, INC.
STATEMENTS OF OPERATIONS
For the For the year
For the year ended three ended
December 31, months ended September
--------------------------- December 31, 30,
2001 2000 1999 1999
------------ ------------- ------------ ------------ --- ---
REVENUES:
Product................ $ 31,095,850 $ 28,095,408 $ 6,460,501 $ 23,147,808
Licensing and product
development........... 1,477,494 692,808 361,153 898,213
------------ ------------- ----------- ------------
32,573,344 28,788,216 6,821,654 24,046,021
COST OF PRODUCTS SOLD... 12,333,695 11,102,096 2,491,760 9,125,995
------------ ------------- ----------- ------------
Gross profit.......... 20,239,649 17,686,120 4,329,894 14,920,026
------------ ------------- ----------- ------------
OPERATING EXPENSES:
Research and
development........... 9,389,313 10,399,120 1,412,288 5,590,807
Sales and marketing.... 7,880,496 6,932,068 1,682,030 5,696,673
General and
administrative........ 6,852,326 6,876,516 1,518,488 6,224,408
Acquired in-process
technology............ -- -- -- 1,500,000
Merger--related........ -- 7,607,158 -- --
Restructuring--
related............... 450,000 -- -- --
------------ ------------- ----------- ------------
24,572,135 31,814,862 4,612,806 19,011,888
------------ ------------- ----------- ------------
Operating loss........ (4,332,486) (14,128,742) (282,912) (4,091,862)
INTEREST EXPENSE........ (402,686) (490,415) (135,357) (544,643)
INTEREST INCOME......... 933,050 1,315,666 183,855 594,928
FOREIGN CURRENCY GAIN
(LOSS)................. 3,122 (18,696) (186,873) (141,687)
GAIN ON SALE OF
SECURITIES............. 100,000 600,000 -- --
------------ ------------- ----------- ------------
Loss before income
taxes................ (3,699,000) (12,722,187) (421,287) (4,183,264)
INCOME TAXES............ 28,789 24,363 50,000 50,000
------------ ------------- ----------- ------------
NET LOSS................ $ (3,727,789) $ (12,746,550) $ (471,287) $ (4,233,264)
============ ============= =========== ============
BASIC AND DILUTED NET
LOSS PER SHARE......... $ (0.10) $ (0.36) $ (0.02) $ (0.14)
============ ============= =========== ============
WEIGHTED AVERAGE NUMBER
OF SHARES OUTSTANDING.. 36,868,101 35,002,283 30,887,007 30,596,882
============ ============= =========== ============
The accompanying notes are an integral part of these statements.
F-5
ORASURE TECHNOLOGIES, INC.
STATEMENTS OF STOCKHOLDERS' EQUITY
Accumulated
Common Stock Additional Other
----------------- Paid-in Comprehensive Accumulated
Shares Amount Capital Income (Loss) Deficit Total
---------- ------ ------------ ------------- ------------- ------------
Balance at September 30,
1998................... 26,228,340 $ 26 $115,589,348 $ 15,042 $(104,902,963) $ 10,701,453
Sale of common stock,
net of expenses........ 5,720,003 6 8,851,345 -- -- 8,851,351
Common stock issued upon
exercise of options.... 632,580 1 3,028,575 -- -- 3,028,576
Common stock issued as
compensation........... 6,233 -- 29,996 -- -- 29,996
Common stock issued
under Employee Stock
Purchase Plan and
Savings Plan........... 28,965 -- 135,172 -- -- 135,172
Compensation expense for
stock option grants.... -- -- 321,006 -- -- 321,006
------------
Comprehensive loss:
Net loss............... -- -- -- -- (4,233,264) (4,233,264)
Currency translation
adjustment............ -- -- -- (74,260) -- (74,260)
Net unrealized loss on
marketable
securities............ -- -- -- (200,000) -- (200,000)
------------
Total comprehensive
loss.................. (4,507,524)
---------- ---- ------------ --------- ------------- ------------
Balance at September 30,
1999................... 32,616,121 33 127,955,442 (259,218) (109,136,227) 18,560,030
Common stock issued upon
exercise of options.... 12,846 -- 58,250 -- -- 58,250
Common stock issued
under Employee Stock
Purchase Plan and
Savings Plan........... 3,944 -- 21,689 -- -- 21,689
Compensation expense for
stock option grants.... -- -- 87,200 -- -- 87,200
------------
Comprehensive loss:
Net loss............... -- -- -- -- (471,287) (471,287)
Currency translation
adjustment............ -- -- -- (38,298) -- (38,298)
Net unrealized loss on
marketable
securities............ -- -- -- (131,250) -- (131,250)
Adjustment for change
in year-end........... -- -- (7,092) 169,548 (10,438) 152,018
------------
Total comprehensive
loss.................. (488,817)
---------- ---- ------------ --------- ------------- ------------
Balance at December 31,
1999................... 32,632,911 33 128,115,489 (259,218) (109,617,952) 18,238,352
Common stock issued upon
exercise of options.... 1,319,624 1 5,720,997 -- -- 5,720,998
Common stock issued upon
exercise of warrants... 2,405,907 2 13,865,364 -- -- 13,865,366
Common stock issued
under Employee Stock
Purchase Plan and
Savings Plan........... 75,562 -- 273,254 -- -- 273,254
Compensation expense for
stock option grants.... -- -- 792,685 -- -- 792,685
------------
Comprehensive loss:
Net loss............... -- -- -- -- (12,746,550) (12,746,550)
Currency translation
adjustment............ -- -- -- (61,140) -- (61,140)
Net unrealized gain on
marketable
securities............ -- -- -- 89,111 -- 89,111
------------
Total comprehensive
loss.................. (12,718,579)
---------- ---- ------------ --------- ------------- ------------
Balance at December 31,
2000................... 36,434,004 36 148,767,789 (231,247) (122,364,502) 26,172,076
Common stock issued upon
exercise of options.... 968,729 1 3,851,805 -- -- 3,851,806
Common stock issued
under Employee Stock
Purchase Plan and
Savings Plan........... 536 -- 2,123 -- -- 2,123
Compensation expense for
stock option grants.... -- -- 136,874 -- -- 136,874
------------
Comprehensive loss:
Net loss............... -- -- -- -- (3,727,789) (3,727,789)
Currency translation
adjustment............ -- -- -- (75,670) -- (75,670)
Net unrealized gain on
marketable
securities............ -- -- -- 181,253 -- 181,253
------------
Total comprehensive
loss.................. (3,622,206)
---------- ---- ------------ --------- ------------- ------------
Balance at December 31,
2001................... 37,403,269 $ 37 $152,758,591 $(125,664) $(126,092,291) $ 26,540,673
========== ==== ============ ========= ============= ============
The accompanying notes are an integral part of these statements.
F-6
ORASURE TECHNOLOGIES, INC.
STATEMENTS OF CASH FLOWS
For the year ended For the three For the
December 31, months ended year ended
-------------------------- December 31, September
2001 2000 1999 30, 1999
------------ ------------ ------------- ------------
OPERATING ACTIVITIES:
Net loss............... $ (3,727,789) $(12,746,550) $ (471,287) $ (4,233,264)
Adjustments to
reconcile net loss to
net cash provided by
(used in) operating
activities:
Stock based
compensation
expense.............. 136,874 792,685 87,200 321,006
Common stock issued as
compensation for
services............. -- 62,409 -- 105,471
Amortization of
deferred revenue..... (179,167) (143,334) (40,313) (107,500)
Acquired in-process
technology........... -- -- -- 1,500,000
Depreciation and
amortization......... 2,175,055 2,243,001 448,654 1,855,479
Gain on sale of
securities and
disposition of
investment in
affiliated company... (116,853) (600,000) -- --
(Gain) loss on
disposition of
property and
equipment............ 173,975 10,844 42,245 (36,952)
Provision for reserve
for excess and
obsolete
inventories.......... 600,000 1,141,351 -- --
Deferred income
taxes................ -- -- 91,497 --
Changes in assets and
liabilities--
Accounts receivable.. (1,118,408) (1,853,514) (261,924) (985,070)
Inventories.......... (3,549,168) (231,516) 237,956 (300,882)
Prepaid expenses and
other............... 175,829 (153,631) (76,981) 31,817
Accounts payable..... 443,050 308,789 (199,275) 47,904
Accrued expenses and
other............... (269,248) 1,125,020 482,312 843,381
------------ ------------ ----------- ------------
Net cash provided by
(used in) operating
activities......... (5,255,850) (10,044,446) 340,084 (958,610)
------------ ------------ ----------- ------------
INVESTING ACTIVITIES:
Purchases of property
and equipment......... (2,763,639) (3,071,565) (626,036) (1,701,520)
Proceeds from the sale
of property and
equipment............. 33,231 -- 78,250 98,250
Purchase of patents and
product rights........ -- (619,589) (18,024) (1,627,377)
Purchase of short-term
investments........... (21,297,303) (24,869,468) (1,250,261) (37,624,613)
Proceeds from sale of
short-term
investments........... 23,420,432 22,339,595 2,016,757 29,383,614
Proceeds from sale of
securities............ 637,500 600,000 -- --
Proceeds from
disposition of
investment in
affiliated company.... 106,102 -- -- --
Investment in
affiliated companies.. -- (20,404) (32,181) (17,435)
(Increase) decrease in
other assets.......... (202,819) 50,000 -- 195,273
------------ ------------ ----------- ------------
Net cash provided by
(used in) investing
activities......... (66,496) (5,591,431) 168,505 (11,293,808)
------------ ------------ ----------- ------------
FINANCING ACTIVITIES:
Proceeds from term
debt.................. -- -- -- 2,219,433
Repayment of term
debt.................. (1,125,206) (1,054,194) (250,374) (1,872,475)
Net proceeds from
issuance of common
stock................. 3,853,929 19,797,206 79,939 11,939,624
------------ ------------ ----------- ------------
Net cash provided by
(used in) financing
activities......... 2,728,723 18,743,012 (170,435) 12,286,582
------------ ------------ ----------- ------------
EFFECT OF FOREIGN
EXCHANGE RATE CHANGES
ON CASH................ (75,670) (61,140) (38,298) (74,260)
------------ ------------ ----------- ------------
NET INCREASE (DECREASE)
IN CASH AND CASH
EQUIVALENTS............ (2,669,293) 3,045,995 299,856 (40,096)
CASH AND CASH
EQUIVALENTS, BEGINNING
OF PERIOD.............. 5,095,639 2,049,644 1,749,788 2,370,469
------------ ------------ ----------- ------------
CASH AND CASH
EQUIVALENTS, END OF
PERIOD................. $ 2,426,346 $ 5,095,639 $ 2,049,644 $ 2,330,373
============ ============ =========== ============
The accompanying notes are an integral part of these statements.
F-7
ORASURE TECHNOLOGIES, INC.
NOTES TO THE FINANCIAL STATEMENTS
1. BACKGROUND:
The Company
OraSure Technologies, Inc. (the "Company") develops, manufactures and
markets oral specimen collection devices using its proprietary oral fluid
technologies, proprietary diagnostic products including in vitro diagnostic
tests, and other medical devices. These products are sold in the United States
and certain foreign countries to government agencies, clinical laboratories,
physician offices, hospitals, commercial and industrial entities and various
distributors.
Merger
On September 29, 2000, STC Technologies, Inc. ("STC") and Epitope, Inc.
("Epitope") were merged (the "Merger") into the Company, a newly formed
subsidiary of Epitope incorporated under Delaware law solely for the purposes
of combining the two companies and changing the state of incorporation of
Epitope from Oregon to Delaware. The companies were merged pursuant to an
Agreement and Plan of Merger, dated May 6, 2000, by and among Epitope, the
Company and STC, which was subsequently approved by both companies'
stockholders on September 29, 2000. The Merger was accounted for as a pooling
of interests and, accordingly, all prior period financial statements of
Epitope have been restated to include the results of operations, financial
position and cash flows of STC. Information concerning common stock, employee
stock plans and per share data has been restated on an equivalent share basis.
The financial statements as of September 30, 1999 and for the year then ended
include Epitope's previous September 30 fiscal year amounts and STC's December
31, 1999 calendar year amounts.
Change in year-end
On September 29, 2000, the Board of Directors of Epitope approved a change
in the fiscal year-end of Epitope from September 30 to December 31, effective
with the calendar year beginning January 1, 2000. A three-month transition
period from October 1, 1999 through December 31, 1999 (the "Transition
Period") preceded the start of the 2000 fiscal year. References to "1999" mean
the year ended September 30, 1999 and include Epitope's previous September 30
fiscal year amounts and STC's December 31, 1999 calendar year amounts.
References to "2001" and "2000" mean the combined results of the two companies
for the years ended December 31, 2001 and 2000, respectively. As a result of
the Merger, financial statements for the Transition Period include amounts for
Epitope and STC for the three months ended December 31, 1999. Accordingly,
STC's results of operations for the three months ended December 31, 1999 are
included in both the financial statements for 1999 and for the Transition
Period. Included in the statement of stockholders' equity is a $152,018
adjustment for the change in fiscal year-end, which represents STC's results
of operations for the three months ended December 31, 1999 that is included in
both 1999 and the Transition Period.
F-8
A reconciliation of revenues, operating income (loss) and net income (loss)
of Epitope and STC for the periods prior to the combination is as follows:
Three months
ended Year ended
December 31, September
1999 30, 1999
------------ -----------
Revenues:
Epitope......................................... $2,669,026 $10,031,020
STC............................................. 4,152,628 14,015,001
---------- -----------
Combined....................................... $6,821,654 $24,046,021
========== ===========
Operating income (loss):
Epitope......................................... $ (549,488) $(3,515,544)
STC............................................. 266,576 (576,318)
---------- -----------
Combined....................................... $ (282,912) $(4,091,862)
========== ===========
Net income (loss):
Epitope......................................... $ (481,725) $(3,237,644)
STC............................................. 10,438 (995,620)
---------- -----------
Combined....................................... $ (471,287) $(4,233,264)
========== ===========
There were no material adjustments required to conform the accounting
policies of the two companies. Certain amounts of Epitope have been
reclassified to conform to the current presentation. The amounts depicted
above for both companies have been adjusted to reflect the elimination of
intercompany transactions between Epitope and STC.
In connection with the Merger, during the year ended December 31, 2000, the
Company recorded Merger-related expenses of $7.6 million, which were comprised
of the following:
Cash costs:
Transaction costs............................................. $5,273,748
Employee costs................................................ 1,079,607
Other integration costs....................................... 608,393
----------
Subtotal..................................................... 6,961,748
Stock-based compensation....................................... 645,410
----------
Total Merger-related expenses.................................. $7,607,158
==========
Transaction costs include investment banking, legal, accounting, printing
and other direct costs of the Merger. Employee costs represent severance
benefits paid to terminated employees whose responsibilities were deemed
redundant as a result of the Merger, as well as certain relocation expenses.
Other integration costs include financial system conversion costs and
integration-related travel expenses. Stock-based compensation represents the
amount of unamortized deferred compensation on certain nonqualified options
granted by Epitope in prior years, which were immediately accelerated upon the
closing of the Merger under terms of the grants. Of the $7.6 million Merger-
related expenses incurred, $690,750 was accrued at December 31, 2000 and paid
in 2001.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
Use of Estimates
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management to make
estimates and assumptions that affect the reported amounts of
F-9
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.
Cash and Cash Equivalents
The Company considers all highly liquid investments purchased with an
original maturity of ninety days or less to be cash equivalents. As of
December 31, 2001 and 2000, cash equivalents consisted of certificates of
deposit, commercial paper and U.S. government and agency obligations.
Short-term Investments
The Company considers all short-term investments as available-for-sale
securities, in accordance with Statement of Financial Accounting Standards
("SFAS") No. 115, "Accounting for Certain Investments in Debt and Equity
Securities." These securities are comprised of certificates of deposits, U.S.
government and agency obligations and corporate bonds with original maturities
greater than ninety days and less than one year. Available-for-sale securities
are carried at fair value, based upon quoted market prices with unrealized
gains and losses reported in stockholders' equity as a component of
accumulated other comprehensive income (loss).
The following is a summary of available-for-sale securities at December 31,
2001 and 2000:
Gross Gross
Amortized Unrealized Unrealized
Cost Gains Losses Fair Value
----------- ---------- ---------- -----------
December 31, 2001
Certificates of deposit........ $ 2,398,963 $ 709 $ -- $ 2,399,672
Government and agency bonds.... 5,027,637 70,200 -- 5,097,837
Corporate bonds................ 5,267,939 37,109 (37,654) 5,267,394
----------- -------- -------- -----------
Total current available-for-sale
securities..................... $12,694,539 $108,018 $(37,654) $12,764,903
=========== ======== ======== ===========
December 31, 2000
Certificates of deposit........ $ 2,864,038 $ -- $ -- $ 2,864,038
Government and agency bonds.... 6,587,463 49,785 -- 6,637,248
Corporate bonds................ 5,366,167 89,326 -- 5,455,493
----------- -------- -------- -----------
Total current available-for-sale
securities..................... $14,817,668 $139,111 $ -- $14,956,779
=========== ======== ======== ===========
In addition, at December 31, 2000, certain available-for-sale marketable
securities with a carrying value of $287,500, including an unrealized loss of
$250,000, were classified as other assets due to the Company's intent to hold
these securities for greater than one year. In 2001, the Company recorded a
gain of $100,000 upon the sale of these securities.
Supplemental Cash Flow Information
For 2001, 2000, the Transition Period and 1999, the Company paid interest of
$402,686, $490,410, $135,357 and $565,025, respectively.
For 2001, 2000, the Transition Period and 1999, the Company recorded
provisions for bad debts of $100,000, $0, $0 and $8,851, respectively. The
Company had deductions of $5,193, $4,269, $0 and $0 against the allowance for
doubtful accounts in 2001, 2000, the Transition Period and 1999, respectively.
During 2001, the Company exchanged $337,253 of accounts receivable for an
investment in a nonaffiliated entity.
F-10
Inventories
Inventories are stated at the lower of cost or market determined on a first-
in, first-out basis, and include the cost of raw materials, labor and
overhead. The majority of the Company's inventories are subject to expiration
dating. The Company continually evaluates quantities on hand and the carrying
value of its inventories to determine the need for reserves for excess and
obsolete inventories, based primarily on the estimated forecast of product
sales. When factors indicate that impairment has occurred, either a reserve is
established against the inventories' carrying value or the inventories are
completely written off, as in the case of lapsing expiration dates. The
Company currently buys its entire Histofreezer(R) product line from a foreign
vendor, with such purchases payable in Euros. Changes in the exchange rate of
the Euro could impact the Company's product cost.
Property and Equipment
Property and equipment are stated at cost. Additions or improvements are
capitalized, while repairs and maintenance are charged to expense.
Depreciation and amortization are provided using the straight-line method over
the estimated useful lives of the related assets or the lease term, whichever
is shorter. Buildings are depreciated over 20 years, while computer equipment,
machinery and equipment, and furniture and fixtures are depreciated over three
to ten years. Leasehold improvements are generally amortized over the shorter
of the estimated useful lives or the terms of the related leases. When assets
are sold or otherwise disposed of, the related property amounts are relieved
from the accounts, and any gain or loss is recorded in the statement of
operations.
Patents and Product Rights
Patents and product rights consist of costs associated with the acquisition
of patents and product distribution rights and direct costs associated with
patent submissions. Patents and product rights are amortized using the
straight-line method over estimated useful lives of five to ten years.
Amortization expense for 2001, 2000, the Transition Period and 1999 was
$359,853, $816,111, $123,366 and $482,106, respectively.
Revenue Recognition
The Company recognizes product revenues when products are shipped. The
Company does not grant price protection or product return rights to its
customers, except for warranty returns. Historically, returns arising from
warranty issues have been infrequent and immaterial. Accordingly, the Company
expenses warranty returns as incurred.
The Company follows U.S. Securities and Exchange Commission Staff Accounting
Bulletin No. 101 "Revenue Recognition in Financial Statements" ("SAB 101").
The bulletin draws on existing accounting rules and provides specific guidance
on revenue recognition of up-front non-refundable licensing and development
fees. In accordance with SAB 101, up-front licensing fees are deferred and
recognized ratably over the related license period. Product development
revenues are recognized over the period in which the related product
development efforts are performed. Amounts received prior to the performance
of product development efforts are recorded as deferred revenues. Grant
revenue is recognized as the related work is performed and costs are incurred.
In accordance with Emerging Issues Task Force ("EITF") Issue No. 00-10,
"Accounting for Shipping and Handling Fees and Costs," the Company records
shipping and handling charges billed to customers as revenue.
Significant Customer Concentration
In 2001, 2000 and 1999, one customer accounted for approximately 29 percent,
30 percent and 28 percent of total revenues, respectively. The same customer
accounted for approximately 21 percent and 24 percent of accounts receivable
as of December 31, 2001 and 2000, respectively.
F-11
Research and Development
Research and development costs are charged to expense as incurred.
Income Taxes
The Company follows SFAS No. 109, "Accounting for Income Taxes" ("SFAS No.
109"), pursuant to which the liability method is used in accounting for income
taxes. Under this method, deferred tax assets and liabilities are determined
based on differences between the financial reporting and tax bases of assets
and liabilities and are measured using enacted tax rates that are expected to
be in effect when the differences reverse.
Foreign Currency Translation
Pursuant to SFAS No. 52, "Foreign Currency Translation," the assets and
liabilities of the Company's foreign operations are translated from Euros into
U.S. dollars at current exchange rates as of the balance sheet date, and
revenues and expenses are translated at average exchange rates for the period.
Resulting translation adjustments are reflected as a separate component of
stockholders' equity.
Stock-Based Compensation
The Company accounts for stock-based compensation to employees and directors
using the intrinsic value method in accordance with APB Opinion No. 25,
"Accounting for Stock Issued to Employees" and related interpretations. The
Company accounts for stock-based compensation to nonemployees using the fair
value method in accordance with SFAS No. 123, "Accounting for Stock-Based
Compensation" ("SFAS No. 123") and EITF Issue No. 96-18, "Accounting for
Equity Instruments That Are Issued to Other Than Employees for Acquiring or in
Conjunction with Selling, Goods or Services" ("EITF No. 96-18").
Net Loss Per Common Share
The Company has presented basic and diluted net loss per share pursuant to
SFAS No. 128, "Earnings per Share" ("SFAS 128"). In accordance with SFAS 128,
basic and diluted net loss per share has been computed using the weighted-
average number of shares of common stock outstanding during the period.
Diluted loss per share is generally computed assuming the conversion or
exercise of all dilutive securities such as common stock options and warrants;
however, outstanding common stock options and warrants to purchase 3,915,233,
4,677,357, 6,907,212 and 7,002,673 shares were excluded from the computation
of diluted net loss per common share for 2001, 2000, the Transition Period and
1999, respectively, because they were anti-dilutive due to the Company's
losses.
Impairment of Long-Lived Assets
In accordance with SFAS No. 144, "Accounting for the Impairment or Disposal
of Long-Lived Assets" ("SFAS No. 144"), if indicators of impairment exist, the
Company assesses the recoverability of the affected long-lived assets, which
include property and equipment and patents and product rights, by determining
whether the carrying value of such assets can be recovered through the sum of
the undiscounted future operating cash flows and eventual disposition of the
asset. If impairment is indicated, the Company measures the amount of such
impairment by comparing the carrying value of the assets to the fair value of
these assets, generally determined based on the present value of the expected
future cash flows associated with the use of the asset. Management believes
the future cash flows to be received from the long-lived assets will exceed
the assets' carrying value, and accordingly the Company has not recognized any
impairment losses through December 31, 2001.
F-12
Other Comprehensive Income (Loss)
The Company follows SFAS No. 130, "Reporting Comprehensive Income." This
statement requires the classification of items of other comprehensive income
(loss) by their nature and disclosure of the accumulated balance of other
comprehensive income (loss), separately from retained earnings and additional
paid-in capital, in the equity section of the balance sheet.
Restructuring-related Expenses
In February, 2001, the Company announced plans to restructure certain of its
manufacturing operations. As a result of this restructuring, the Company
incurred an infrequent charge of $450,000 for restructuring costs, primarily
comprised of expenses for employee severance, travel and transport resulting
from relocating and consolidating manufacturing operations. All restructuring-
related expenses were paid by June 30, 2001.
Recent Accounting Pronouncements
In June 2001, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 141, "Business Combinations" ("SFAS No. 141"), which requires that all
business combinations initiated after June 30, 2001 be accounted for under the
purchase method and addresses the initial recognition and measurement of
goodwill and other intangible assets acquired in a business combination.
Business combinations accounted for under the pooling of interests method
prior to June 30, 2001 will not be changed. The adoption of SFAS No. 141 by
the Company will not have any impact on the Company's financial position or
results of operations.
In June 2001, the FASB issued SAFS No. 142, "Goodwill and Other Intangible
Assets" ("SFAS No. 142"). SFAS No. 142 addresses the initial recognition and
measurement of intangible assets acquired in a business combination and the
accounting for goodwill and other intangible assets subsequent to their
acquisition. SFAS No. 142 provides that intangible assets with finite useful
lives be amortized, and that goodwill and intangible assets with indefinite
lives not be amortized, but rather be tested at least annually for impairment.
The adoption of SFAS No. 142 will not have any impact on the Company's
financial position or results of operations.
In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement
Obligations" ("SFAS No. 143"). SFAS No. 143 addresses financial accounting and
reporting for obligations associated with the retirement of long-lived assets
and the associated asset retirement costs. SFAS No. 143 requires the fair
value of a liability associated with an asset retirement be recognized in the
period in which it is incurred, with the associated retirement costs
capitalized as part of the carrying amount of the long-lived asset and
subsequently depreciated over its useful life. The adoption of SFAS No. 143
will not have any impact on the Company's financial position or results of
operations.
Gain on Sale of Securities
In December 2001, the Company recognized a gain of $100,000 on the sale of
50,000 shares of LabOne, Inc. common stock received in connection with a
distribution agreement entered into by the Company and LabOne, Inc. in April
1999. The Company's original investment associated with these shares was
$537,500. The Company no longer holds any common shares or warrants of LabOne,
Inc.
In December 1996, a subsidiary of the Company completed a merger with Andrew
and Williamson Sales, Co. ("A&W"), which was rescinded on May 27, 1997. The
Company received A&W preferred stock in the recission, which had been carried
at zero value due to the circumstances surrounding A&W's financial condition
at the time the stock was received in 1997. In 2000, the Company sold the A&W
preferred stock for $600,000.
F-13
Reclassifications
Certain amounts from prior periods have been reclassified to conform to the
current year presentations.
3. INVENTORIES:
December 31,
-------------------------
2001 2000
------------ -----------
Raw materials................................. $ 2,918,825 $ 473,575
Work in process............................... 644,397 348,819
Finished goods................................ 881,550 673,210
------------ -----------
$ 4,444,772 $ 1,495,604
============ ===========
4. PROPERTY AND EQUIPMENT:
December 31,
-------------------------
2001 2000
------------ -----------
Building and leasehold improvements........... $ 5,464,353 $ 4,599,859
Machinery and equipment....................... 9,935,897 7,848,905
Computer equipment............................ 2,131,606 2,134,411
Furniture and fixtures........................ 1,205,750 1,096,176
Construction in progress...................... 698,675 942,937
------------ -----------
19,436,281 16,622,288
Less--Accumulated depreciation and
amortization................................. (11,636,144) (9,884,254)
------------ -----------
$ 7,800,137 $ 6,738,034
============ ===========
Depreciation expense was $1,815,202, $1,426,890, $325,288 and $1,373,373 for
2001, 2000, the Transition Period and 1999, respectively.
5. PATENTS AND PRODUCT RIGHTS:
In June 1998, the Company acquired the patents and exclusive worldwide
distribution rights to its Histofreezer(R) product. The purchase price of
$2,548,690, including transaction costs, has been recorded as patents and
product rights and is being amortized using the straight-line method over an
estimated useful life of ten years. In connection with this acquisition, the
Company also entered into a product purchase agreement with the manufacturer
of the Histofreezer(R) product, with an initial term extending through
December 31, 2006.
6. ACCRUED EXPENSES:
December 31,
-------------------------
2001 2000
------------ -----------
Payroll and related benefits.................. $ 1,728,651 $ 1,331,545
Professional fees............................. 271,112 372,211
Deferred revenue.............................. 401,060 741,295
Other......................................... 711,063 983,811
------------ -----------
$ 3,111,886 $ 3,428,862
============ ===========
7. CREDIT FACILITIES:
The Company has a $1,000,000 revolving line of credit with a bank which
bears interest at LIBOR plus 235 basis points. Borrowings under this line are
collateralized by the Company's accounts receivable. The line expires on April
30, 2002. There were no borrowings against the line at December 31, 2001 or
2000.
F-14
The Company also has a $3,000,000 equipment facility with a bank, with
interest fixed at the bank's prime rate on the date of commencement.
Borrowings under this line are collateralized by the equipment financed. There
were no outstanding borrowings under this facility as of December 31, 2001 or
2000. The unused portion of the equipment facility expires on April 30, 2002.
These credit facilities require, among other items, the maintenance of
certain financial covenants.
8. LONG-TERM DEBT:
December 31,
------------------------
2001 2000
----------- -----------
Note payable to bank, interest at 8%, monthly
installments of principal and interest of $59,219
through December 2003, at which point the remaining
principal is subject to a call option by the lender
or payable in monthly installments of principal and
interest based on the prime rate plus 1% through
December 2005, secured by certain property and
equipment, inventory and intangible assets......... $ 2,435,902 $ 2,927,226
Note payable to bank, interest at 8%, monthly
installments of principal and interest of $8,181
through December 2003, with remaining monthly
installments of principal and interest based on the
prime rate plus 1% through December 2018, subject
to call options by the lender every five years
commencing March 31, 2010, secured by the Company's
building........................................... 904,238 928,021
Note payable to Pennsylvania Industrial Development
Authority, interest at 2%, monthly installments of
principal and interest of $4,895 through March
2010, secured by a second lien on the Company's
building........................................... 442,285 491,518
Note payable to bank, interest at 7.8%, monthly
installments of principal and interest of $23,146
through July 2004, secured by certain property and
equipment, inventory and intangible assets......... 647,779 864,937
Note payable to bank, interest at 7.75%, monthly
installments of principal and interest of $31,271
through July 2002, secured by certain property and
equipment, inventory and intangible assets......... 213,826 557,534
----------- -----------
4,644,030 5,769,236
Less--Current portion............................... (1,057,572) (1,125,138)
----------- -----------
$ 3,586,458 $ 4,644,098
=========== ===========
Long-term debt maturities as of December 31, 2001 are as follows:
2002............................................................ $1,057,572
2003............................................................ 2,236,923
2004............................................................ 247,842
2005............................................................ 92,421
2006............................................................ 95,800
Thereafter...................................................... 913,472
----------
$4,644,030
==========
These notes payable require, among other items, the maintenance of certain
financial covenants.
F-15
9. INCOME TAXES:
At December 31, 2001, the Company had net operating loss carryforwards for
federal income tax purposes of approximately $69.1 million that have begun to
expire and will continue to expire through 2021. The Tax Reform Act of 1986
contains provisions that may limit the annual amount of net operating loss
carryforwards available to be used in any given year in the event of
significant changes in ownership. In connection with the Merger, a change in
ownership occurred. Management believes the annual limitation will not have a
material effect on the Company's ability to utilize its loss carryforwards.
Given the Company's losses in recent years, management believes a valuation
allowance is needed as of December 31, 2001.
The tax effect of temporary differences as established in accordance with
SFAS No. 109 that give rise to deferred income taxes are as follows:
December 31
--------------------------
2001 2000
------------ ------------
Deferred tax asset:
Net operating loss carryforwards............. $ 26,949,000 $ 24,901,000
Stock based compensation..................... 2,643,000 2,253,000
Accruals and reserves currently not
deductible.................................. 1,696,000 1,384,000
Patent costs................................. 445,000 491,000
Research and development credit
carryforwards............................... 1,850,000 1,677,000
Valuation allowance on deferred tax assets... (33,583,000) (30,706,000)
------------ ------------
$ -- $ --
============ ============
10. STOCKHOLDERS' EQUITY:
Stock Options
As a result of the Merger, the Epitope, Inc. 2000 Stock Award Plan was
adopted by the Company and renamed the OraSure Technologies, Inc. 2000 Stock
Award Plan (the "2000 Plan"). The 2000 Plan permits stock-based awards to
employees, outside directors and consultants or other third-party advisors.
Awards which may be granted under the 2000 Plan include qualified incentive
stock options, nonqualified stock options, stock appreciation rights,
restricted awards, performance awards and other stock-based awards.
Under the terms of the 2000 Plan, qualified incentive stock options for
shares of common stock may be granted to eligible employees, including
officers of the Company. To date, options have generally been granted with
ten-year exercise periods and an exercise price not less than the fair market
value on date of grant. Options generally vest over four years, with one
quarter of the options vesting one year after grant with the remainder vesting
on a monthly basis over the next three years.
The 2000 Plan also provides that nonqualified options may be granted at a
price not less than 75 percent of the fair market value of a share of common
stock on the date of grant. The option term and vesting schedule of such
awards may either be unlimited or have a specified period in which to vest and
be exercised. For the discounted nonqualified options issued, the Company
amortizes, on a straight-line basis over the vesting period of the options,
the difference between the exercise price and the fair market value of a share
of stock on the date of grant.
The Company applies APB Opinion No. 25 and the related interpretations in
accounting for stock options granted to employees. Accordingly, compensation
expense is recognized for the intrinsic value (the difference between the
exercise price and the fair value of the Company's common stock) on the date
of grant. Compensation, if any, is deferred and charged to expense over the
respective vesting period. In 2000, the Company issued an executive an option
to purchase 375,000 shares of common stock for $4.59 per share. The fair
market value of the Company's common stock at the date of issuance was $6.13.
The Company recorded
F-16
deferred compensation of $577,500 on the date of grant to be amortized over
the vesting period of three years. However, the options immediately vested
upon the closing of the Merger in accordance with change in control rights
contained in the stock option grant. As a result, the Company recorded
$577,500 of compensation expense in 2000 related to the options. The Company
recorded an additional $215,185 of compensation expense in 2000 due to the
amortization of deferred compensation related to other stock options due to
the change in control rights provided under the applicable stock option
grants.
Under SFAS No. 123, compensation expense related to stock options granted to
employees and directors is computed based on the fair value of the stock
option at the date of grant using an option valuation methodology, typically
the Black-Scholes pricing model. Pursuant to the disclosure requirements of
SFAS No. 123, had compensation expense for the Company's common stock option
plan been determined based upon the fair value of the options at the date of
grant, the Company's net loss for 2001, 2000 and 1999 would have increased as
follows:
Year ended
December 31, Year ended
--------------------------- September
2001 2000 30, 1999
------------ ------------- ------------
Net loss:
As reported....................... $ (3,727,789) $ (12,746,550) $ (4,233,264)
============ ============= ============
Pro forma......................... $ (6,640,938) $ (17,611,122) $ (6,553,202)
============ ============= ============
Basic and diluted net loss per
share:
As reported....................... $ (0.10) $ (0.36) $ (0.14)
============ ============= ============
Pro forma......................... $ (0.18) $ (0.50) $ (0.21)
============ ============= ============
The weighted average fair value of the options granted during 2001, 2000
and, 1999, is estimated at $7.10, $4.96 and $2.44 per share, respectively,
using the Black-Scholes option pricing model with the following assumptions:
dividend yield of zero; volatility of 65 percent, 64 percent and 55 percent,
respectively; weighted average risk-free interest rate of 4.86 percent, 6.13
percent and 5.31 percent, respectively; and an expected life of 7.0, 7.0 and
4.3 years, respectively.
The Company accounts for stock-based compensation to non-employees using the
fair value method, in accordance with SFAS No. 123 and EITF No. 96-18. In
2001, the Company recorded compensation expense related to options to purchase
19,000 shares of the Company's common stock granted to members of a non-
employee advisory board and an outside consultant. Compensation expense of
$136,874 was computed based on the estimated fair value of the stock options
at the date of grant, using the Black-Scholes option pricing model.
F-17
Information with respect to the options granted under the 2000 Plan and
predecessor plans is as follows:
Price per
Shares Share
---------- -----------
Balance, September 30, 1998......................... 3,958,199 $1.29-18.17
Granted............................................ 1,331,869 0.80- 6.84
Exercised.......................................... (632,580) 3.54- 6.31
Canceled........................................... (242,122) 0.80-18.17
---------- -----------
Balance, September 30, 1999......................... 4,415,366 0.80- 3.97
Granted............................................ 584,143 0.80- 3.97
Exercised.......................................... (17,846) 3.22- 5.04
Canceled........................................... (184,228) 0.80-18.17
Adjustment for change in year end.................. (427,530) 0.80- 2.83
---------- -----------
Balance, December 31, 1999.......................... 4,369,905 0.80-18.17
Granted............................................ 1,596,142 4.59-15.03
Exercised.......................................... (1,319,624) 0.80- 6.00
Canceled........................................... (139,066) 0.80-18.17
---------- -----------
Balance, December 31, 2000.......................... 4,507,357 0.80-15.03
Granted............................................ 357,000 7.88-12.95
Exercised.......................................... (968,729) 0.80- 9.47
Canceled........................................... (150,395) 0.80-14.81
---------- -----------
Balance, December 31, 2001.......................... 3,745,233 $0.80-15.03
========== ===========
At December 31, 2001, 1,272,909 shares were available for future grants
under the 2000 Plan. The following table summarizes information about stock
options outstanding at December 31, 2001:
Options outstanding Options exercisable
-----------------------------------------------------------------------------
Weighted
average Weighted Weighted
remaining average average
Number life, in exercise Number exercise
Range of exercise prices outstanding years price exercisable price
------------------------ ----------- --------- -------- ----------- --------
$ 0.80.................. 490,703 7.39 $ 0.80 226,658 $ 0.80
$ 2.83-$4.17............ 539,176 12.34 3.70 539,176 3.70
$ 4.22-$4.59............ 397,800 11.23 4.56 397,800 4.56
$ 4.72-$4.97............ 153,194 6.98 4.79 153,194 4.79
$ 5.04.................. 541,123 12.67 5.04 541,123 5.04
$ 5.50-$6.84............ 177,851 7.06 6.49 177,851 6.49
$ 7.09.................. 927,176 8.95 7.09 275,151 7.09
$ 7.30-$10.71........... 398,460 9.36 9.89 84,818 9.47
$10.92-$14.84........... 117,750 9.01 12.69 27,750 12.87
$15.03.................. 2,000 8.52 15.03 2,000 15.03
--------- ---------
3,745,233 9.89 $ 5.57 2,425,521 $ 4.84
========= =========
Employee Stock Purchase Plan
In 1993, Epitope's stockholders approved the adoption of the 1993 Employee
Stock Purchase Plan ("1993 ESPP"). The 1993 ESPP, as subsequently amended by
Epitope's stockholders, covered a maximum of 500,000 shares of common stock
for subscription over established offering periods. As a result of the Merger,
the 1993 ESPP was adopted and renamed by the Company. The Compensation
Committee of the Board of directors
F-18
determines the number of offering periods, the number of shares offered, and
the length of each period, provided that no more than three offering periods
may be set during each fiscal year of the Company. The purchase price for
stock purchased under the 1993 ESPP for each subscription period is the lesser
of 85 percent of the fair market value of a share of common stock at the
commencement of the subscription period and the fair market value at the close
of the subscription period. An employee may also elect to withdraw at any time
during the subscription period and receive the amounts paid plus interest at
the rate of 6 percent.
As of December 31, 2001 and 2000, 8,804 and 9,832 shares of common stock,
respectively, were subscribed for through one offering. These shares may be
purchased over 24 months at an initial subscription price of $3.96. During the
years ended December 31, 2001 and 2000, 536 and 70,253 shares, respectively,
were issued at prices ranging from $2.74 to $4.78 per share under the 1993
ESPP.
Common Stock Warrants
As of December 31, 2001, the following warrants to purchase shares of common
stock were outstanding:
Exercise
Date of Issuance Shares Price Expiration Date
---------------- ------- -------- ---------------
July 15, 1992.......................... 50,000 $16.44 July 15, 2002
September 30, 1998..................... 120,000 $ 6.13 September 30, 2008
-------
170,000
=======
11. COMMITMENTS AND CONTINGENCIES:
Phosphor Agreements
In April 1995, the Company entered into several research, licensing and
royalty agreements (collectively the "Phosphor Agreements"), related to
development and commercialization of the Company's up-converting phosphor
technology ("UPT(TM)"). Under the terms of the Phosphor Agreements, as
amended, the Company is obligated to make an annual license payment of $50,000
and an annual minimum royalty payment of $100,000 for usage of patented
technology licensed to the Company. Upon the first commercial sale of a
UPT(TM)-based product or service, the Company is then obligated to pay
royalties based upon a percentage of the net sales of UPT(TM)-based products,
research and development fees and sublicensing revenues, for a period equal to
the longer of ten years from the date of the first commercial sale of a
UPT(TM)-based product or service (which occurred in 2001) or the remaining
life of the patents underlying the licensed technology, which expire through
2017. Royalties from the commercial sale of products or services can be
credited against the Company's minimum royalty obligation of $100,000 per
year.
In July 1999, the Company paid approximately $1,500,000 to acquire certain
rights (the "Rights") related to UPT(TM). The Company accounted for the
purchase price of the Rights as acquired in-process technology expense,
because at the date of the transaction, the Rights acquired by the Company had
not progressed to a stage where the technology, or any alternative future use
of the technology, had met technological feasibility. Furthermore, there
existed a significant amount of uncertainty as to the Company's ability to
complete the development of this technology and achieve market acceptance of
any related commercial products within a reasonable timeframe. In connection
with this acquisition of this in-process technology, the Company is required
to pay sponsored research funds of $125,000 in 2002 and $50,000 per year
thereafter, as well as royalties of $25,000 per year, until the Rights expire
in 2008. During 2001, the Company finalized development of its first
commercial product utilizing this technology.
F-19
Leases
The Company leases office, manufacturing, warehouse and laboratory
facilities under operating lease agreements. Future payments required under
these leases are as follows:
2002............................................................ $ 654,225
2003............................................................ 651,534
2004............................................................ 662,514
2005............................................................ 99,979
2006 and thereafter............................................. --
----------
$2,068,252
==========
Rent expense for 2001, 2000 and 1999 was $805,878, $716,748 and $461,105,
respectively.
Capital Expenditures
As of December 31, 2001, the Company had outstanding non-cancelable purchase
commitments of $644,995 related to capital expenditures.
Employment Agreements
Under terms of employment agreements with certain executive officers and
other employees, extending through 2003, the Company is required to pay each
individual a base salary and for some individuals, a retention bonus, for
continuing employment with the Company. The agreements require payments of
$2,090,305 and $1,197,164, in 2002 and 2003, respectively, which include the
severance payments discussed below.
On January 31, 2002, the Company terminated an employment agreement with an
executive officer. During the first quarter of 2002, the Company will record
$480,063 in severance expenses, of which, $269,010 and $211,053 is payable in
2002 and 2003, respectively. These expenses include continued salary and
benefit premium payments to this officer, related employment taxes, and the
value of certain computer equipment transferred to this individual. As of
January 31, 2002, the Company held a $75,000 note receivable from this
officer, which he has agreed to repay in bi-weekly principal installments of
approximately $7,000, commencing in April 2002 (See Note 12).
Litigation
From time-to-time, the Company is involved in certain legal actions arising
in the ordinary course of business. In management's opinion, based upon the
advice of counsel, the outcome of such actions are not expected to have a
material adverse effect on the Company's future financial position or results
of operations.
12. RELATED-PARTY TRANSACTIONS:
Officer Notes
In March and October 2000, the Company issued notes receivable to an officer
of the Company ("Officer Notes") for $75,000 and $100,649, respectively, for
relocation purposes. The Officer Notes do not bear interest if they are repaid
on or before the earlier of the tenth day following the close of sale on the
officer's previous residences or the due date of the Officer Notes, as
extended. In May 2001, this officer repaid the Officer Note having an
outstanding balance of $100,649. In January 2002, this same officer resigned
from the Company and as part of his severance agreement, agreed to repay the
remaining $75,000 balance in bi-weekly principal installments of approximately
$7,000, commencing in April 2002. (See Note 11).
Facility Lease
Effective March 1, 2002, the Company signed a 10-year operating lease with
Tech III Partners, LLC, an entity owned and controlled by two of the Company's
executive officers. Under the terms of this lease, the
F-20
Company will lease a 48,000 square foot facility currently being constructed
on land adjacent to the Company's headquarters, at a base rent of $480,000 per
year, increasing to $528,000 per year, during the initial 10-year term. The
lease also provides for certain renewal and purchase options.
13. RETIREMENT PLANS:
As a result of the Merger, during 2000 and a portion of 2001, the Company
maintained two distinct retirement plans covering substantially all of its
employees. Both plans permitted voluntary employee contributions to be
excluded from the employees' current taxable income under the provisions of
Internal Revenue Code Section 401(k) and the regulations thereunder. During
the prior periods reported, generally all employees of Epitope were eligible
to participate in a profit sharing and deferred savings plan. The plan
provided for a Company matching contribution (either in cash, Company stock,
or a combination of both) equal to 50 percent of an employee's contribution,
not to exceed 2.5 percent of an employee's compensation. The Company
contributed 5,309, 2,691 and 12,693 shares valued at $62,409, $17,492 and
$75,475 during 2000, the Transition Period, and 1999, respectively, to this
plan. During the prior periods reported, generally all employees of STC were
eligible to participate in a profit sharing plan. The plan provided for the
Company, subject to the Board of Directors' discretion, to match employee
contributions up to $3,000 or 8% of a participant's salary, whichever is less.
Company contributions to the plan were $75,789, $122,903, $19,247, and
$113,708 for 2001, 2000, the Transition Period, and 1999, respectively.
On May 1, 2001, the Company merged the two aforementioned plans into the
OraSure Technologies, Inc. 401(k) Plan (the "New Plan"). The New Plan permits
voluntary employee contributions to be excluded from an employer's current
taxable income under provisions of Internal Revenue Code Section 401(k) and
the regulations thereunder. The New Plan also provides for the Company to
match employee contributions up to the lesser of $4,000 or 10% of the
employee's salary. Contributions to the New Plan were $239,402 in 2001.
14. GEOGRAPHIC INFORMATION:
Under the disclosure requirements of SFAS No. 131, "Segment Disclosures and
Related Information," the Company operates within one segment, medical devices
and products. The Company's products are sold principally in the United States
and Europe. Operating income and identifiable assets are not applicable since
all of the Company's revenues outside the United States are export sales.
The following table represents total revenues by geographic area (amount in
thousands):
For the year
ended For the three For the year
December 31, months ended ended
--------------- December 31, September 30,
2001 2000 1999 1999
------- ------- ------------- -------------
United States.................... $27,321 $24,763 $5,912 $21,382
Europe........................... 3,510 2,507 659 1,816
Other regions.................... 1,742 1,518 251 848
------- ------- ------ -------
$32,573 $28,788 $6,822 $24,046
======= ======= ====== =======
15. QUARTERLY DATA (Unaudited):
The following tables summarize the quarterly results of operations for each
of the quarters in 2001 and 2000, as well as the Transition Period and the
comparable three-month period ended December 31, 1998. These quarterly results
are unaudited, but in the opinion of management, have been prepared on the
same basis as the Company's audited financial information and include all
adjustments (consisting only of normal recurring adjustments) necessary for a
fair presentation of the information set forth herein (all amounts in
thousands, except per share amounts).
F-21
2001 Results
-----------------------------------------------------------
Three months ended
---------------------------------------------- Year ended
March 31, June 30, September 30, December 31, December 31,
2001 2001 2001 2001 2001
--------- -------- ------------- ------------ ------------ ---
Revenues................ $ 7,404 $ 8,508 $ 8,598 $ 8,063 $ 32,573
Costs and expenses...... 8,636 9,105 8,609 10,556 36,906
------- ------- ------- ------- --------
Operating loss......... (1,232) (597) (11) (2,493) (4,333)
Other income, net....... 251 159 26 198 634
------- ------- ------- ------- --------
Income (loss) before
income taxes.......... (981) (438) 15 (2,295) (3,699)
Income taxes............ 16 6 (1) 8 29
------- ------- ------- ------- --------
Net income (loss)....... $ (997) $ (444) $ 16 $(2,303) $ (3,728)
======= ======= ======= ======= ========
Basic and diluted net
loss per share......... $ (0.03) $ (0.01) $ 0.00 $ (0.06) $ (0.10)
======= ======= ======= ======= ========
Weighted average number
of shares outstanding.. 36,457 36,702 39,009 37,246 36,868
======= ======= ======= ======= ========
2000 Results
-----------------------------------------------------------
Three months ended
---------------------------------------------- Year ended
March 31, June 30, September 30, December 31, December 31,
2000 2000 2000 2000 2000
--------- -------- ------------- ------------ ------------
Revenues................ $ 6,619 $ 7,161 $ 7,222 $ 7,786 $ 28,788
Costs and expenses...... 7,512 8,313 15,435 11,657 42,917
------- ------- ------- ------- --------
Operating loss......... (893) (1,152) (8,213) (3,871) (14,129)
Other income, net....... 115 771 302 219 1,407
------- ------- ------- ------- --------
Loss before income
taxes................. (778) (381) (7,911) (3,652) (12,722)
Income taxes............ 56 (44) 13 -- 25
------- ------- ------- ------- --------
Net loss................ $ (834) $ (337) $(7,924) $(3,652) $(12,747)
======= ======= ======= ======= ========
Basic and diluted net
loss per share......... $ (0.03) $ (0.01) $ (0.22) $ (0.10) $ (0.36)
======= ======= ======= ======= ========
Weighted average number
of shares outstanding.. 33,442 34,818 35,370 36,361 35,002
======= ======= ======= ======= ========
Three months ended
December 31,
------------------
1999 1998
--------- --------
Revenues................ $ 6,822 $ 5,138
Costs and expenses...... 7,105 5,857
------- -------
Operating loss......... (283) (719)
Other expense........... (138) (159)
------- -------
Loss before income
taxes................. (421) (878)
Income taxes............ 50 --
------- -------
Net loss................ $ (471) $ (878)
======= =======
Basic and diluted net
loss per share......... $ (0.02) $ (0.03)
======= =======
Weighted average number
of shares outstanding.. 30,887 26,246
======= =======
F-22
INDEX TO EXHIBITS
Exhibit
Number Exhibit
------- -------
2.1 Agreement and Plan of Merger, dated as of May 6, 2000, by and among
Epitope, Inc., the Company and STC Technologies, Inc., including the
Epitope Stockholders Agreement and the STC Stockholders Agreement
attached as Exhibits A and B thereto and the other exhibits attached
thereto, is incorporated by reference to Exhibit 2 to the Current
Report on Form 8-K of Epitope, Inc. dated May 9, 2000.
3.1 Certificate of Incorporation of OraSure Technologies is incorporated
by reference to Exhibit 3.1 to the Company's Registration Statement on
Form S-4 (No. 333-39210).
3.1.1 Certificate of Amendment to Certificate of Incorporation dated May 23,
2000 is incorporated by reference to Exhibit 3.1.1 to the Company's
Registration Statement on Form S-4 (No. 333-39210).
3.1.2 Certificate of Designation of Series A Preferred Stock of OraSure
Technologies (filed as Exhibit A to the Rights Agreement referred to
in Exhibit 4.2).
3.2 Amended and Restated Bylaws of OraSure Technologies, effective as of
September 27, 2001, are incorporated by reference to Exhibit 3 to the
Company's Quarterly Report on Form 10-Q for the quarter ended
September 30, 2001.
4.1 Specimen certificate representing shares of OraSure Technologies
$.000001 par value Common Stock is incorporated by reference to
Exhibit 4.1 to the Company's Registration Statement on Form S-4
(No. 333-39210).
4.2 Rights Agreement, dated as of May 6, 2000, between OraSure
Technologies and ChaseMellon Shareholder Service, L.L.C. (now called
Mellon Investor Services LLC), as Rights Agent, is incorporated by
reference to Exhibit 4.2 to the Company's Registration Statement on
Form S-4 (No. 333-39210).
4.3 Stockholders' Agreement among STC Technologies, Inc., HealthCare
Ventures V, L.P., RHO Management Trust II, Hudson Trust and
Pennsylvania Early Stage Partners, L.P., dated March 30, 1999, is
incorporated by reference to Exhibit 4.3 to the Company's Registration
Statement on Form S-4 (No. 333-39210).
4.4 Amendment to Stockholders' Agreement filed is Exhibit 4.3 is
incorporated by reference to Exhibit 4.4 to the Company's Registration
Statement on Form S-4 (No. 333-39210).
4.5 Second Amendment to Stockholders' Agreement filed as Exhibit 4.3 is
incorporated by reference to Exhibit 4 to the Company's Quarterly
Report on Form 10-Q for the quarter ended June 30, 2001.
10.1 Form of Indemnification Agreement (and list of parties to such
agreement) is incorporated by reference to Exhibit 10.1 to the
Company's Registration Statement on Form S-4 (No. 333-39210).*
10.2 Separation Agreement and Release dated as of February 14, 2002 between
OraSure Technologies and Robert D. Thompson.*
10.3 Employment Agreement dated as of September 29, 2000 between OraSure
Technologies and Robert D. Thompson is incorporated by reference to
Exhibit 10.3 to the Company's Annual Report on Form 10-K for the year
ended December 31, 2000.*
10.4 Employment Agreement dated as of September 29, 2000 between OraSure
Technologies and Michael J. Gausling is incorporated by reference to
Exhibit 10.4 to the Company's Annual Report on Form 10-K for the year
ended December 31, 2000.*
10.5 Employment Agreement dated as of November 1, 2001 between OraSure
Technologies and Ronald H. Spair is incorporated be reference to
Exhibit 10 to the Company's Quarterly Report on Form 10-Q for the
quarter ended September 30, 2001.*
Exhibit
Number Exhibit
------- -------
10.6 Employment Agreement dated as of September 29, 2000 between OraSure
Technologies and William Hinchey is incorporated by reference to
Exhibit 10.5 to the Company's Annual Report on Form 10-K for the year
ended December 31, 2000.*
10.7 Employment Agreement dated as of September 29, 2000 between OraSure
Technologies and Dr. R. Sam Niedbala is incorporated by reference to
Exhibit 10.6 to the Company's Annual Report on Form 10-K for the year
ended December 31, 2000.*
10.8 Employment Agreement dated as of September 29, 2000 between OraSure
Technologies and William D. Block is incorporated by reference to
Exhibit 10.7 to the Company's Annual Report on Form 10-K for the year
ended December 31, 2000.*
10.9 Employment Agreement dated as of September 29, 2000 between OraSure
Technologies and J. Richard George is incorporated by reference to
Exhibit 10.8 to the Company's Annual Report on Form 10-K for the year
ended December 31, 2000.*
10.10 Employment Agreement dated as of September 29, 2000 between OraSure
Technologies and P. Michael Formica.*
10.11 Description of Non-Employee Director Compensation Policy is
incorporated by reference to Exhibit 10 to the Company's Quarterly
Report on Form 10-Q for the quarter ended March 31, 2001.*
10.12 Incentive Stock Option Plan of Epitope, Inc. as amended, is
incorporated by reference to Exhibit 10.2 to the Epitope, Inc. Annual
Report on Form 10-K for 1994.*
10.13 Amended and Restated Epitope, Inc. 1991 Stock Award Plan is
incorporated by reference to Exhibit 10.2 to the Epitope, Inc. Annual
Report on Form 10-K for 1997.*
10.14 OraSure Technologies, Inc. Employee Incentive and Non-Qualified Stock
Option Plan, as amended and restated effective September 29, 2000, is
incorporated by reference to Exhibit 10.12 to the Company's Annual
Report on Form 10-K for the year ended December 31, 2000.*
10.15 OraSure Technologies, Inc. 2000 Stock Award Plan, as amended effective
as of September 29, 2000, is incorporated by reference to Exhibit
10.13 to the Company's Annual Report on Form 10-K for the year ended
December 31, 2000.*
10.16 Nonqualified Stock Option Agreement For Discounted Non-Plan Option
between Epitope, Inc. and Robert D. Thompson is incorporated by
reference to Exhibit 10.14 to the Company's Annual Report on Form 10-K
for the year ended December 31, 2000.*
10.17 Production Agreement with Koninklinjke Utermohlen, N.V. dated June 9,
1998 is incorporated by reference to Exhibit 10.8 to the Company's
Registration Statement on Form S-4 (No. 333-39210).
10.18 Amendment No. 1 to Production Agreement, dated as of December 11,
2001, between the Company and Koninklijke Utermohlen N.V.
10.19 Research and License Agreement with SRI International and David
Sarnoff Research Center dated April 26, 1995 is incorporated by
reference to Exhibit 10.9 to the Company's Registration Statement on
Form S-4 (No. 333-39210).
10.20 First Amendment to Research and License Agreement among SRI
International and David Sarnoff Research Center and the Company dated
September 1, 1995 is incorporated by reference to Exhibit 10.10 of the
Company's Registration Statement on Form S-4 (No. 333-39210).
10.21 Third Amendment to Research and License Agreement dated August 30,
2000 among SRI International, Sarnoff Corporation (formerly David
Sarnoff Research Center) and the Company is incorporated by reference
to Exhibit 10.19 to the Company's Annual Report on Form 10-K for the
year ended December 31, 2000.
Exhibit
Number Exhibit
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10.22 Commercial Lease between Northampton County New Jobs Corp., as
Landlord, and STC Technologies, Inc., as Tenant, dated April 30, 1999,
is incorporated by reference to Exhibit 10.11 to the Company's
Registration Statement on Form S-4 (No 333-39210).
10.23 Lease dated October 25, 1999 between PS Business Parks, L.P., a
California Limited Partnership, and Epitope, Inc., is incorporated by
reference to Exhibit 10.6 to the Epitope, Inc. Annual Report on
Form 10-K for 1999.
10.24 Commercial Lease between Tech III Partners, LLC and OraSure
Technologies, dated March 1, 2002.
23.1 Consent of Arthur Andersen LLP.
23.2 Consent of PricewaterhouseCoopers LLP.
24 Powers of Attorney.
99 Letter dated March 28, 2002 from OraSure Technologies to the
Securities and Exchange Commission concerning certain representations
from Arthur Andersen LLP.
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* Management contract or compensatory plan or arrangement.