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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
-----------
FORM 10-Q
-----------
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTER ENDED
JUNE 30, 2002
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION
PERIOD FROM _______________ TO ____________________
Commission file number 0-27368
ORTEC INTERNATIONAL, INC.
(Exact name of issuer as specified in its charter)
Delaware 11-3068704
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
3960 Broadway 10032
New York, New York (Zip Code)
(Address of principal
executive offices)
(212) 740-6999
Issuer's telephone number, including area code
----------------
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Securities Exchange Act during the past 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
---- ----
----------------
The number of shares outstanding of the issuer's common stock is 9,691,608 (as
of August 15, 2002)
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ORTEC INTERNATIONAL, INC.
INDEX TO QUARTERLY REPORT ON FORM 10-Q
FILED WITH THE SECURITIES AND EXCHANGE COMMISSION
QUARTER ENDED JUNE 30, 2002
ITEMS IN FORM 10-Q
Page
----
Facing Page
Part I
Item 1. Financial Statements (Unaudited). 1
Item 2. Management's Discussion and Analysis of Financial Condition and Results of
Operation. 20
Item 3 Quantitative and Qualitative Disclosures About Market Risk. 28
Part II
Item 1. Legal Proceedings and Claims. 29
Item 2. Changes in Securities and Use of Proceeds. 30
Item 3. Default Upon Senior Securities. None
Item 4. Submission of Matters to a Vote of Security Holders. None
Item 5. Other Information. 34
Item 6. Exhibits and Reports on Form 8-K. 36
Signatures
Item 1. FINANCIAL STATEMENTS
ORTEC INTERNATIONAL, INC.
(A DEVELOPMENT STAGE ENTERPRISE)
CONDENSED BALANCE SHEETS
JUNE 30, DECEMBER 31,
2002 2001 *
---- ----
(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents $784,262 $854,025
Accounts receivable 94,525 21,890
Other current assets 33,282 169,516
---------- ----------
Total current assets 912,069 1,045,431
---------- ----------
Property and equipment, at cost:
Laboratory equipment 2,138,471 2,126,771
Office furniture and equipment 1,240,868 982,948
Leasehold improvements 1,567,513 1,367,784
---------- ----------
4,946,852 4,477,503
Accumulated depreciation and
amortization 3,196,668 2,894,782
---------- ----------
Property and equipment - net 1,750,184 1,582,721
---------- ----------
Other assets:
Patent application costs, net of
accumulated amortization of $244,986 at
June 30, 2002 and $213,105 at
December 31, 2001 709,122 619,676
Deferred financing costs, net of accumulated
amortization of $38,104 at June 30,2002
and $1,983 at December 31, 2001 209,106 57,517
Security deposit - New Jersey location 639,000 598,000
Deposits and other assets 26,349 135,256
---------- ----------
Total other assets 1,583,577 1,410,449
---------- ----------
Total Assets $4,245,830 $4,038,601
========== ==========
* Derived from audited financial statements.
See notes to condensed unaudited financial statements.
1
ORTEC INTERNATIONAL, INC.
(A DEVELOPMENT STAGE ENTERPRISE)
CONDENSED BALANCE SHEETS
JUNE 30, DECEMBER 31,
2002 2001 *
---- ----
(Unaudited)
LIABILITIES AND SHAREHOLDERS' DEFICIENCY
Current liabilities:
Accounts payable and accrued
liabilities $ 3,929,482 $ 2,444,945
Accrued compensation 111,443 223,393
Accrued professional fees 146,474 301,783
Accrued interest 87,416 460,964
12% Convertible debentures due April 30, 2003--net 667,894 --
Other Loans payable - current 233,048 143,505
------------ ------------
Total current liabilities 5,175,757 3,574,590
------------ ------------
Loans payable and other long term
obligations 12,693,584 6,768,983
------------ ------------
Commitments and contingencies
Redeemable Convertible Preferred Stock 1,870,120 --
------------ ------------
Shareholders' equity/(deficit):
Common stock, $.001 par value;
authorized 35,000,000 shares;
9,711,608 shares issued, 9,691,608
shares outstanding at June 30, 2002
and December 31, 2001 9,712 9,712
Additional paid-in capital 56,245,642 53,017,615
Deficit accumulated during the
development stage (71,571,340) (59,154,654)
Treasury stock, at cost (20,000 shares at
June 30, 2002 and December 31, 2001) (177,645) (177,645)
------------ ------------
Total shareholders' deficiency (15,493,631) (6,304,972)
------------ ------------
Total Liabilities and
Shareholders' Deficiency $ 4,245,830 $ 4,038,601
============ ============
* Derived from audited financial statements.
See notes to condensed unaudited financial statements.
2
ORTEC INTERNATIONAL, INC.
(A DEVELOPMENT STAGE ENTERPRISE)
CONDENSED STATEMENTS OF OPERATIONS
(Unaudited)
Six months Cumulative from
Quarter ended June 30, ended June 30, March 12, 1991
---------------------- -------------- (inception) to
2002 2001 2002 2001 June 30, 2002
---- ---- ---- ---- -------------
Product revenue $ 92,535 $ - $ 208,950 $ - $ 230,840
----------- ------------ ------------ ----------- ------------
Expenses
Research and development 1,060,793 1,073,288 2,214,630 2,328,635 20,263,022
Rent 210,038 147,334 385,269 291,208 2,564,804
Consulting 174,406 405,205 344,278 540,563 5,570,793
Personnel 2,097,025 1,504,077 4,170,468 3,000,229 27,119,828
General and administrative 941,356 652,579 1,851,439 1,209,006 13,854,124
Interest and other expense 2,882,691 20,156 3,666,872 40,971 4,686,378
Interest income (1,227) (49,509) (7,320) (163,009) (2,256,769)
----------- ------------ ------------ ----------- ------------
7,365,082 3,753,130 12,625,636 7,247,603 71,802,180
----------- ------------ ------------ ----------- ------------
Net loss (7,272,547) (3,753,130) (12,416,686) (7,247,603) (71,571,340)
Preferred stock dividend -- -- --
----------- ============ ------------ =========== ------------
Net loss applicable to common
shareholders $(7,272,547) $ 3,753,130 $(12,416,686) $(7,247,603) $(71,571,340)
=========== ============ ============ =========== ============
Net loss per share
Basic and diluted $(.75) $(.39) $(1.28) $(.75) $(14.31)
===== ===== ====== ===== =======
Weighted average shares outstanding
Basic and diluted 9,691,608 9,691,608 9,691,608 9,691,608 5,000,503
=========== ============ ============ =========== ============
See notes to condensed unaudited financial statements.
ORTEC INTERNATIONAL, INC.
(A DEVELOPMENT STAGE ENTERPRISE)
STATEMENT OF SHAREHOLDERS' EQUITY/(DEFICIT)
(Unaudited)
Common Stock Additional Deficit accumulated
Paid-in in the development Treasury
Shares Amount Capital stage Stock Total
------ ------ ------- ----- ----- -----
Issuance of stock:
Founders 1,553,820 $1,554 $ (684) $ 870
First private placement 217,440 217 64,783 65,000
The Director 149,020 149 249,851 250,000
Second private placement 53,020 53 499,947 500,000
Share issuance expenses (21,118) (21,118)
Net loss for the period from
March 12, 1991 (inception) to
December 31, 1991 $ (281,644) (281,644)
--------- ------ ---------- ----------- ---------
Balance - December 31, 1991 1,973,300 1,973 792,779 (281,644) 513,108
Issuance of stock:
Second private placement 49,320 49 465,424 465,473
Stock purchase agreement with
The Director 31,820 32 299,966 299,998
Share issuance expenses (35,477) (35,477)
Net loss for the year ended
December 31, 1992 (785,941) (785,941)
--------- ------ ---------- ----------- ---------
Balance - December 31, 1992 2,054,440 $2,054 $1,522,692 $(1,067,585) $ 457,161
========= ====== ========== =========== =========
See notes to condensed unaudited financial statements.
ORTEC INTERNATIONAL, INC.
(A DEVELOPMENT STAGE ENTERPRISE)
STATEMENT OF SHAREHOLDERS' EQUITY/(DEFICIT)
(Unaudited)
Common Stock Additional Deficit accumulated
Paid-in in the development Treasury
Shares Amount Capital stage Stock Total
------ ------ ------- ----- ----- -----
(brought forward) 2,054,440 $2,054 $1,522,692 $(1,067,585) $ 457,161
Issuance of stock:
Third private placement 132,150 132 1,321,368 1,321,500
Stock purchase agreement with
Home Insurance Company 111,111 111 999,888 999,999
Stock purchase agreement with
The Director 21,220 21 199,979 200,000
Shares issued in exchange
for commissions earned 600 1 5,999 6,000
Share issuance expenses (230,207) (230,207)
Net loss for the year ended
December 31, 1993 (1,445,624) (1,445,624)
--------- ------ ---------- ----------- -----------
Balance - December 31, 1993 2,319,521 2,319 3,819,719 (2,513,209) 1,308,829
Issuance of stock:
Fourth private placement 39,451 40 397,672 397,712
Stock purchase agreement with
Home Insurance Company 50,000 50 499,950 500,000
Share issuance expenses (8,697) (8,697)
Net loss for the year ended
December 31, 1994 (1,675,087) (1,675,087)
--------- ------ ---------- ----------- -----------
Balance - December 31, 1994 2,408,972 $2,409 $4,708,644 $(4,188,296) $ 522,757
========= ====== ========== =========== ===========
See notes to condensed unaudited financial statements.
ORTEC INTERNATIONAL, INC.
(A DEVELOPMENT STAGE ENTERPRISE)
STATEMENT OF SHAREHOLDERS' EQUITY/(DEFICIT)
(Unaudited)
Common Stock Additional Deficit accumulated
Paid-in in the development Treasury
Shares Amount Capital stage Stock Total
------ ------ ------- ----- ----- -----
(brought forward) 2,408,972 $2,409 $4,708,644 $(4,188,296) $ 522,757
Rent forgiveness 40,740 40,740
Net loss for the year ended
December 31, 1995 (1,022,723) (1,022,723)
--------- ------ ----------- ----------- -----------
Balance - December 31, 1995 2,408,972 2,409 4,749,384 (5,211,019) (459,226)
Issuance of stock:
Initial public offering 1,200,000 1,200 5,998,800 6,000,000
Exercise of warrants 33,885 34 33,851 33,885
Fifth private placement 959,106 959 6,219,838 6,220,797
Share issuance expenses (1,580,690) (1,580,690)
Non-cash stock compensation
and interest 152,000 152,000
Net loss for the year ended
December 31, 1996 (2,649,768) (2,649,768)
--------- ------ ----------- ----------- -----------
Balance - December 31, 1996 4,601,963 $4,602 $15,573,183 $(7,860,787) $ 7,716,998
========= ====== =========== =========== ===========
See notes to condensed unaudited financial statements.
ORTEC INTERNATIONAL, INC.
(A DEVELOPMENT STAGE ENTERPRISE)
STATEMENT OF SHAREHOLDERS' EQUITY/(DEFICIT)
(Unaudited)
Common Stock Additional Deficit accumulated
Paid-in in the development Treasury
Shares Amount Capital stage Stock Total
------ ------ ------- ----- ----- -----
(brought forward) 4,601,963 $4,602 $15,573,183 $ (7,860,787) $ 7,716,998
Exercise of warrants 1,158,771 1,159 10,821,632 10,822,791
Share issuance costs (657,508) (657,508)
Stock options and warrants
issued for services 660,000 660,000
Net loss for the year ended
December 31, 1997 (4,825,663) (4,825,663)
--------- ------ ----------- ------------ -------- -----------
Balance - December 31, 1997 5,760,734 5,761 26,397,307 (12,686,450) 13,716,618
Exercise of warrants 221,486 221 1,281,736 1,281,957
Stock options and warrants
issued for services 1,920,111 1,920,111
Sixth private placement 200,000 200 1,788,498 1,788,698
Warrants issued in Sixth
private placement 211,302 211,302
Share issuance costs (48,000) (48,000)
Purchase of treasury stock
(at cost) $(67,272) (67,272)
Net loss for the year ended
December 31, 1998 (8,412,655) (8,412,655)
--------- ------ ----------- ------------ -------- -----------
Balance - December 31, 1998 6,182,220 $6,182 $31,550,954 $(21,099,105) $(67,272) $10,390,759
========= ====== =========== ============ ======== ===========
See notes to condensed unaudited financial statements.
ORTEC INTERNATIONAL, INC.
(A DEVELOPMENT STAGE ENTERPRISE)
STATEMENT OF SHAREHOLDERS' EQUITY/(DEFICIT)
(Unaudited)
Common Stock Additional Deficit accumulated
Paid-in in the development Treasury
Shares Amount Capital stage Stock Total
------ ------ ------- ----- ----- -----
(brought forward) 6,182,220 $6,182 $31,550,954 $(21,099,105) $ (67,272) $ 10,390,759
Exercise of warrants 14,103 14 14,089 14,103
Stock options issued for
services 64,715 64,715
Seventh private placement 389,156 389 3,168,396 3,168,785
Warrants issued in Seventh
private placement 468,291 468,291
Eighth private placement 1,636,364 1,637 8,998,365 9,000,002
Share issuance costs (619,908) (619,908)
Purchase of treasury stock
(at cost) (75,518) (75,518)
Net loss for the year ended
December 31, 1999 (10,040,509) (10,040,509)
--------- ------ ----------- ------------ --------- ------------
Balance - December 31, 1999 8,221,843 $8,222 $43,644,902 $(31,139,614) $(142,790) $ 12,370,720
========= ====== =========== ============ ========= ============
See notes to condensed unaudited financial statements.
ORTEC INTERNATIONAL, INC.
(A DEVELOPMENT STAGE ENTERPRISE)
STATEMENT OF SHAREHOLDERS' EQUITY/(DEFICIT)
(Unaudited)
Common Stock Additional Deficit accumulated
Paid-in in the development Treasury
Shares Amount Capital stage Stock Total
------ ------ ------- ----- ----- -----
(brought forward) 8,221,843 $8,222 $43,644,902 $(31,139,614) $(142,790) $ 12,370,720
Exercise of options and warrants 175,532 175 327,107 327,282
Stock options and warrants issued
for services 56,265 56,265
Ninth private placement 66,667 67 999,938 1,000,005
Warrants issued in Ninth
private placement 23,000 23,000
Tenth private placement 1,247,566 1,248 8,419,823 8,421,071
Share issuance costs (641,500) (641,500)
Purchase of treasury stock
(at cost) (34,855) (34,855)
Net loss for the year ended
December 31, 2000 (12,129,663) (12,129,663)
--------- ------ ----------- ------------ --------- ------------
Balance - December 31, 2000 9,711,608 9,712 52,829,535 (43,269,277) (177,645) 9,392,325
Stock options issued for services 188,080 188,080
Net loss for the year ended
December 31, 2001 (15,885,377) (15,885,377)
--------- ------ ----------- ------------ --------- ------------
Balance - December 31, 2001 9,711,608 $9,712 $53,017,615 $(59,154,654) $(177,645) $ (6,304,972)
========= ====== =========== ============ ========= ============
See notes to condensed unaudited financial statements.
ORTEC INTERNATIONAL, INC.
(A DEVELOPMENT STAGE ENTERPRISE)
STATEMENT OF SHAREHOLDERS' EQUITY/(DEFICIT)
(Unaudited)
Common Stock Additional Deficit accumulated
Paid-in in the development Treasury
Shares Amount Capital stage Stock Total
------ ------ ------- ----- ----- -----
(brought forward) 9,711,608 $9,712 $53,017,615 $(59,154,654) $(177,645) $ (6,304,972)
Stock options and Warrants
issued for services 106,260 106,260
Warrants issued with convertible debentures 421,929 421,929
Warrants issued with convertible redeemable
preferred stock 559,289 559,289
Convertible Debenture conversion benefit 1,042,663 1,042,663
Redeemable convertible preferred stock
conversion benefit 1,097,886 1,097,886
Net loss for the six months
ended June 30, 2002 (12,416,686) (12,416,686)
--------- ------ ----------- ------------ --------- ------------
Balance - June 30, 2002 9,711,608 $9,712 $56,245,642 $(71,571,340) $(177,645) $(15,493,631)
========= ====== =========== ============ ========= ============
See notes to condensed unaudited financial statements.
10
ORTEC INTERNATIONAL, INC.
(A DEVELOPMENT STAGE ENTERPRISE)
CONDENSED STATEMENTS OF CASH FLOWS
(Unaudited)
Six months ended June 30, Cumulative from
------------------------- March 12, 1991
(inception) to
2002 2001 June 30, 2002
---- ---- ---------------
Cash flows from operating activities:
Net loss $(12,416,656) $(7,247,603) (71,571,340)
Adjustments to reconcile net loss
to net cash used in operating
activities:
Depreciation and amortization 333,767 352,679 3,452,095
Amortization of deferred
financing costs 36,121 -- 36,121
Unrealized loss on marketable
securities 11,404
Realized loss on marketable
securities 5,250
Non-cash stock compensation 106,260 168,390 3,147,454
Non-cash interest 3,531,016 3,985,768
Purchases of marketable securities (19,075,122)
Sales of marketable securities 19,130,920
Changes in operating assets and
liabilities
Accounts receivable (72,635) (94,525)
Other current assets
and other assets 246,234 18,191 76,720
Accounts payable and accrued
liabilities 1,268,482 339,670 4,273,119
------------ ----------- ------------
Net cash used in operating activities (6,967,441) (6,368,673) (56,622,136)
------------ ----------- ------------
Cash flows from investing activities:
Purchases of property and equipment,
excluding capital leases (200,705) (318,683) (4,591,142)
Payments for patent application (121,327) (25,147) (952,329)
Organization costs (10,238)
Deposits (42,093) 2,821 (773,366)
Purchases of marketable securities (594,986)
Sale of marketable securities 522,532
------------ ----------- ------------
Net cash provided by (used in)
investing activities (364,125) (341,009) (6,399,529)
------------ ----------- ------------
See notes to condensed unaudited financial statements.
11
ORTEC INTERNATIONAL, INC.
(A DEVELOPMENT STAGE ENTERPRISE)
CONDENSED STATEMENTS OF CASH FLOWS
(Unaudited)
Six months ended June 30, Cumulative from
------------------------ March 12, 1991
(inception) to
2002 2001 June 30, 2002
---- ---- -------------
Cash flows from financing activities:
Proceeds from issuance of
notes payable -- $515,500
Proceeds from issuance of
convertible debentures 2,583,000 -- 2,583,000
Proceeds from issuance of
redeemable preferred stock 1,200,000 1,200,000
Proceeds from issuance of
common stock 53,550,522
Financing costs for convertible
debentures and preferred stock (400,655) (400,655)
Share issuance expenses (3,605,105)
Purchase of treasury stock (177,645)
Proceeds from issuance of
loans payable 1,446,229
Proceeds from other long-term
Obligations 4,000,000 10,000,000
Repayment of capital lease
obligations (42,806) (150,010)
Repayment of loans payable (70,304) $ (64,849) (632,977)
Repayment of long term obligation (7,432) (7,432)
Repayment of notes payable (515,500)
---------- ----------- -----------
Net cash provided by (used in)
financing activities 7,261,803 (64,849) 63,805,927
---------- ----------- -----------
Net increase (decrease) in cash
and cash equivalents (69,763) (6,774,531) 784,262
Cash and cash equivalents at
beginning of period 854,025 9,292,478
---------- ----------- -----------
Cash and cash equivalents at
end of period $ 784,262 $ 2,517,947 $ 784,262
========== =========== ===========
See notes to condensed unaudited financial statements.
12
ORTEC INTERNATIONAL, INC.
(A DEVELOPMENT STAGE ENTERPRISE)
STATEMENTS OF CASH FLOWS
(Unaudited)
Six months ended June 30, Cumulative from
------------------------- March 12, 1991
(inception) to
2002 2001 June 30, 2002
---- ---- -------------
Supplemental disclosure of
cash flow information:
Non-cash financing activities
Capital lease obligations $268,644 $ - $387,547
Deferred offering costs included
in accounts payable and
accrued liabilities - - -
Financing costs - other
long-term obligations included
in accounts payable and
accrued liabilities - -
Forgiveness of rent payable - - 40,740
Share issuance
expenses - warrants - - 255,000
Warrants issued with
debentures 421,929 - 421,929
Warrants issued with
preferred stock 559,289 - 559,289
Debenture conversion
feature 1,042,663 - 1,042,663
Preferred stock
conversion feature 1,097,886 - 1,097,886
Cash paid for interest 26,876 41,410 514,417
Cash paid for income taxes - 23,508 199,576
See notes to condensed unaudited financial statements.
13
ORTEC INTERNATIONAL, INC.
(a development stage enterprise)
NOTES TO CONDENSED FINANCIAL STATEMENTS (UNAUDITED)
NOTE 1 - FINANCIAL STATEMENTS
The condensed balance sheet as of June 30, 2002, and the condensed
statements of operations for the three and six month periods ended June 30,
2002 and 2001 and the statements of shareholders' equity (deficiency) and
cash flows for the six month periods ended June 30, 2002 and 2001, and for
the period from March 12, 1991 (inception) to June 30, 2002, have been
prepared by the Company and are unaudited. In the opinion of management,
all adjustments (which include normal recurring adjustments) necessary
to present fairly the financial position as of June 30, 2002, results of
operations for the three and six month periods ended June 30, 2002 and
2001, and stockholders equity and cash flows for the six month periods
ended June 30, 2002 and 2001 and for the period from March 12, 1991
(inception) to June 30, 2002, have been made. Certain information and footnote
disclosures normally included in annual financial statements prepared in
accordance with accounting principles generally accepted in the United States of
America have been condensed or omitted. It is suggested that these condensed
financial statements be read in conjunction with the financial statements and
notes thereto in the Company's December 31, 2001 annual report on Form 10-K
filed with the Securities and Exchange Commission. The results of operations for
the three and six month periods ended June 30, 2002, are not necessarily
indicative of the operating results for the full year or for any other
interim period.
NOTE 2 - FORMATION OF THE COMPANY AND BASIS OF PRESENTATION
Formation of the Company
Ortec International, Inc. ("Ortec" or the "Company") was incorporated
in March 1991 as a Delaware corporation to secure and provide funds for the
further development of the technology developed by Dr. Mark Eisenberg of Sydney,
Australia, to replicate in the laboratory, a tissue engineered skin substitute
for use in skin regeneration procedures (the "Technology"). Pursuant to a
license agreement dated September 7, 1991, Dr. Eisenberg had granted Ortec a
license for a term of ten years, with automatic renewals by Ortec for two
additional ten-year periods, to commercially use and exploit the Technology for
the development of products. In April 1998, Dr. Eisenberg assigned his patent
for the Technology to Ortec.
14
Basis of Presentation and liquidity
Ortec is a development stage enterprise, which had no operating revenue
prior to December 2001. During 2001, the Company received Food and Drug
Administration ("FDA") approval for the use of OrCel for treatment of
Epidermolysis Bullosa and donor sites in burn patients. The Company then began
marketing and selling its product for use on patients with these indications.
Revenues to date have not been significant.
On March 27, 2002, the Company engaged H.C. Wainwright & Co., Inc. an
investment banking firm, to act as its financial advisor in connection with
raising capital for the Company through debt and/or equity financing. Wainwright
is assisting the Company in raising financing of approximately $8.5 million. On
May 13, 2002, the Company secured the first $2.3 million of this financing, in
the form of 12% convertible debentures, which are convertible into common shares
at the lesser of $3.36 or the price per share of the equity securities to be
issued in an anticipated forthcoming financing. It is expected that these
debentures will be converted into equity securities upon the final closing of
this financing. As June 30, 2002, $0.6 million has been converted into
redeemable convertible preferred stock. The Company also issued 291,625 stock
purchase warrants as part of this May 13, 2002 financing, which are exercisable
at $4.50 per share for up to 5 years from the date of grant subject to
adjustment under certain conditions. On June 28, 2002, an additional
$1.5 million of financing was secured, which consists of $1.2 million in
redeemable convertible preferred stock and $.3 million in 12% convertible
debentures, which the Company also expects will be converted into equity
securities. The Company also issued 31,250 stock purchase warrants at an
exercise price of $4.50 per share and 623,374 stock purchase warrants,
at an exercise price of $1.875 per common share for a five-year period,
as part of the June 28, 2002 financing. Subsequent to June 30, 2002, the
Company has issued an additional $0.2 million in convertible debentures,
similar to those raised in the May 7, 2002 and June 28, 2002 financings.
The Company anticipates continuing its financing efforts with the
issuance of its Series B Convertible Preferred Stock. The preferred stock is
convertible into common shares at any time at the option of the investor, based
on a fixed conversion rate of $1.67 or commencing after January 1, 2003, based
on a alternative conversion rate equal to 90% of the average of the five lowest
volume weighted average prices for the common stock for the twenty trading days
immediately prior to conversion, subject to a floor price. The alternative
conversion price is cancelable under certain circumstances, as described below.
Conversion is mandatory, upon the occurrence of certain financial events, such
as, beginning six months from the date of issue, if the closing bid price of
common shares exceeds $3.35 for a period of 20 consecutive trading days, or if
within nine months from the date of issue, the Company completes a public
offering, raising a minimum of $8 million. In the event that the Company
receives a licensing fee or a strategic investment of at least $8.0 million,
within six months of closing, the alternative conversion rate is adjusted to the
closing rate of the investment or the fixed rate of $1.67, if lower. Similarly,
if the Company completes a subsequent public or private financing of a least
$5.0 million, within six months of closing, the alternative conversion rate is
adjusted to the closing price or the fixed rate of $l.67 if lower. Dividends
will be paid in common shares at the rate of 12% in the first year after issue
and in either cash or common shares in subsequent years at the election of the
Company, until at such time as the preferred stock is converted to common
shares. Along with the convertible preferred stock, the Company is also issuing
warrants to purchase common shares. The Series A warrants, exercisable at $.001
per share, must be exercised immediately upon closing of the purchase of
15
preferred stock. The Series B-1 warrants are exercisable nine months after
closing at $2.00 per share and the Series B-2 warrants are exercisable at $3.00
per share, twelve months after closing.
The Company anticipates completing the balance of this financing with
H.C. Wainwright in August 2002.
We require substantial funding to continue our research and
development activities, clinical trials, manufacturing, sales, distribution and
administrative activities. We believe that our cash and cash equivalents on hand
at June 30, 2002, (approximately $.8 million) and the anticipated additional new
financing expected in August 2002 of approximately $5.0 million will enable us
to continue our operations until December 2002. In addition, on August 5, 2002,
we executed a letter of intent with a securities brokerage firm, whereby they
agreed to act as the underwriter for the Company on a firm commitment basis and
to complete a $12.0 million follow on public offering.
We continue to explore and, as appropriate, enter into discussions with
other companies regarding the potential for equity investment, collaborative
arrangements, license agreements or other funding programs with us, in exchange
for manufacturing, marketing, distribution or other rights to our products.
However, we can give no assurances that discussions with other companies will
result in any additional investments, collaborative arrangements, agreements or
other funding, or that the necessary additional financing through debt or equity
will be available to us on acceptable terms, if at all. Further, we can give no
assurance that any arrangements resulting from these discussions will
successfully reduce our funding requirements. If additional funding is not
available to us when needed, we may not be able to continue operations.
These financial statements have been prepared assuming that Ortec will
continue as a going concern. Successful future operations depend upon the
successful development and marketing of Ortec's product to be used for the
repair, replacement and regeneration of human skin. Historically Ortec has
funded its operating losses by periodically raising additional sources of
capital. If additional funding is not available to Ortec when needed, Ortec may
not be able to continue operations. No adjustments have been made to the
accompanying financials as a result of this uncertainty.
NOTE 3 - NET LOSS PER SHARE
As of June 30, 2002, an aggregate of 3,740,119 outstanding warrants and
options were excluded from the weighted average share calculations, as the
effect was antidilutive. As of June 30, 2001, an aggregate of 2,764,579
outstanding warrants and options were excluded from the weighted average share
calculations for the same reason.
Additionally, the effects of the conversion of the debentures and
preferred stock were excluded from the weighted average share calculation
as the effect would be antidilutive. An aggregate of 1,322,000 and 1,246,747
shares of common stock would be issuable upon conversion of the debentures and
preferred stock at June 30, 2002, respectively.
NOTE 4 - LONG TERM OBLIGATIONS
On August 29, 2001, the Company entered into a Royalty Revenue Interest
Assignment agreement with Paul Capital Royalty Acquisition Fund L.P. and as part
of this agreement has
16
received $10.0 million. $6.0 million was received in 2001 with the remaining
$4.0 million in January 2002. Such amounts are reflected as long term debt
as of June 30, 2002 and December 31, 2001. On August 6, 2002, the Company
reached an agreement in principle to a non-binding term sheet with Paul Capital.
The term sheet provides that Paul Capital would relinquish 70% of its revenue
interest in exchange for $7.0 million in Series C Secured Participating
Preferred Stock and 500,000 warrants exercisable at a nominal exercise price.
This agreement is contingent upon completion of the current financing with
H.C. Wainwright (Note 2). Beginning in 2003, these securities will accrue
fixed dividends at 12% per annum, payable in preferred stock and will also
earn an additional dividend of .875%, which may be adjusted upward, if certain
level of sales are not achieved by the Company. If the Company does not redeem
the preferred stock and accrued dividends prior to December 31, 2011, the
accrued dividends will be converted into common shares and the face value of
the preferred stock will remain outstanding at an increased dividend rate. The
Company may redeem these securities at any time by payment of the preferred
stock and accrued dividends to date.
The remaining $3.0 million of the original $10.0 million received from
Paul Capital will continue to be treated as Long Term Debt, under the Royalty
Interest Assignment Agreement. The Company may incrementally receive up to an
additional $15.0 million, but only upon the mutual agreement of both the Company
and Paul Capital.
Under the August 29, 2001 agreement, in consideration for the original
$10.0 million, Paul Capital received a minimum of 3-1/3% of end user revenues
from the sale of the Company's products in the United States, Canada and Mexico.
These percentage payments may be further adjusted upward or downward, based on
the volume of net sales to end users of the Company's products in those three
countries. As of June 30, 2002, the Company estimated that its effective cost of
the amounts it received from Paul Capital was 28% per annum, and has accrued
interest accordingly which is reflected as long-term at June 30, 2002. The
non-binding terms of the agreement reached in principle provides that Paul
Capital will receive a minimum of 1.125% on end user revenues up to $100 million
and 0.6% on revenues in excess of $100 million. Under the August 29, 2001
agreement, beginning on January 1, 2003, Paul Capital will be entitled to
receive each year the first proceeds to the Company from end user sales of
its products. Such annual amounts Paul Capital will be able to draw in
advance will range from $1.5 million in 2003 to $7.5 million in 2005 and
thereafter. Based upon the proposed revision to the original contract, prorated
amounts of the advance payments will be due in each year of the agreement. The
agreement provides for quarterly and annual accountings between Paul Capital and
the Company for those advance payments, compared to amounts owed based on actual
sales.
In the event of a change in control of the Company or upon the
occurrence of certain other events as defined in the agreement, Paul Capital has
the option to put its revenue interest back to the Company for an amount as
provided in the agreement. The Company also has the option to repurchase Paul
Capital's interest upon the occurrence of a change in control of the Company or
a complete divestiture by the Company of its interests in its products, for an
amount as provided in the agreement.
The Company granted Paul Capital a security interest in its United
States and Canadian patents and trademarks relating to its technology for its
product, to secure payments required to be
17
made by the Company to Paul Capital based on sales generated under the Royalty
Revenue Interest Assignment and the Secured Participating Redeemable Preferred
Stock agreements, as described above.
The original agreement and the modification to the agreement reached in
principle terminate on December 31, 2011, unless terminated earlier by either
party, as permitted by the terms of the agreement.
NOTE 5 - ISSUANCE OF DEBENTURES-
On May 13, 2002, the Company issued an aggregate of $2,333,000 in
convertible debentures. An additional $250,000 of convertible debentures were
issued on June 28, 2002. These debentures are payable April 10, 2003, bear
interest at the rate of 12% per annum, increasing to 18% per annum on
October 10, 2002, which is payable at the end of each quarter. The Company has
deferred payment of interest due June 30, 2002, until it completes additional
financing. The debentures and accrued interest were to be converted into Ortec's
equity securities if the Company completed a sale of the Company's equity
securities for a minimum of an additional $5,000,000 by July 12, 2002. Although
the Company only sold $1,200,000 of convertible redeemable preferred stock prior
to July 13, 2002, the Company remains in negotiation with some of the note
holders and other potential investors to secure additional equity financing. The
Company believes that that the note holders will convert their debentures into
the equity securities that the Company intends to issue in such additional
financing on the terms set forth in the debentures as if the Company had
completed such additional financing by July 12, 2002. The debentures provide for
conversion of the debentures into equity securities (if the Company had secured
not less than an additional $5,000,00 in equity financing by July 12, 2002)
issued in such equity financing, by taking 110% of the principal amount of the
debentures and 110% of the unpaid accrued interest, and purchasing so many of
such equity securities determined by dividing such 110% principal and accrued
interest of the note by the purchase price of one equity security in such equity
financing.
The debentures may be converted at the option of the holder of
the debenture, to shares of the Company's common stock at a conversion rate
which is the lower of $3.36 or the price per share of the equity securities in
the proposed equity financing described above. However, the debentures provide
for "price protection" so that the conversion rates at which the debentures are
convertible to the Company's common stock is reduced if the Company sells its
common stock in the future, or the exercise price or conversion rate of any
warrants or options to purchase, or other securities which may be converted
into, the Company's common stock, which the Company may issue in the future, are
sold at a price, or are exercisable or convertible at a price, lower than the
conversion rate of these debentures.
The purchasers of the debentures were also granted five-year warrants
to purchase an aggregate of 322,875 shares of the Company's common stock at an
exercise price of $4.50 per share. Like the debentures, these warrants also
provide "price protection" so that the exercise price is reduced if the Company
sell common stock in the future, or the exercise price or conversion rate of any
warrants or options to purchase, or other securities which may be converted
into, the Company's common stock, which the Company may issue in the future, is
lower than the exercise price of these warrants.
The relative estimated fair value of the warrants of $421,929 was
recorded as additional debt discount and is being amortized over the life of the
convertible debentures. In addition, the estimated fair value of the beneficial
conversion feature of $1,042,663 has been recorded as additional debt discount
and is being amortized over the remaining life of the convertible debentures.
NOTE 6 - AMENDMENT OF CERTIFICATE OF INCORPORATION AND ISSUANCE OF SERIES A
REDEEMABLE CONVERTIBLE PREFERRED STOCK
On June 28, 2002, the Company's board of directors unanimously adopted
an amendment to the Company's certificate of incorporation designating 2,000
shares out of the 1,000,000 shares of preferred stock that the Company is
authorized to issue, as Series A Convertible Preferred Stock, and designating
the relative rights and preferences of the Series A Convertible Preferred Stock.
The stated value, which is also the Liquidation Preference of the Series A
Convertible Preferred Stock, is $10,000 per share. The Company is required to
pay dividends on the Series A Preferred shares, at the rate of 6% per annum of
the $10,000 Liquidation Preference per share, through June 30, 2003; at the
rate of 9% per annum thereafter until June 30, 2004; and thereafter at the rate
of 12% per annum. At the Company's option such dividends may be paid in the
Company's common stock at the "conversion price" for the conversion of such
preferred shares if such shares of common stock have been registered under the
Securities Act of 1933 for sale in the public securities markets. The conversion
price is fixed initially at $1.50 per share of the Company's common stock.
Commencing nine months after the date of issuance of any shares of Series A
Convertible Preferred Stock, the holder may elect to convert its Series A shares
plus interest accrued thereon at an "Alternative Conversion Price" which shall
be the average of the five lowest volume the weighted average prices for the
Company's common stock during the 15 days immediately prior to conversion.
However, at no time is the Alternative Conversion Price to be less than 50% of
the fixed conversion price. The Alternative Conversion Price will be cancelled
if within six months of issuance (i) the Company sell shares of the Company's
common stock in a financing in which aggregate cash proceeds are not less than
$5,000,000 and the price at which each share is sold is not less than $2.00, or
(ii) the Company receive at least $8,000,000 as an up-front payment for a
licensing fee from a third party. There is price protection for the alternative
conversion price only so that the alternative conversion price is reduced if the
Company sells shares of the Company's common stock in the future at, or the
exercise price of any warrants or options to purchase the Company's common stock
which the Company may grant in the future, or the conversion price for the
conversion of other securities (the Company may issue in the future) to the
Company's common stock, is lower than the alternative conversion price for the
Series A Preferred shares. The Company has the right to redeem all or a portion
of the outstanding Series A Convertible Preferred Stock by payment of $15,000
per share plus any accrued and unpaid dividends. The holders of the Series A
Convertible Preferred Stock may compel the Company to redeem their shares upon
the occurrence of certain events, at $12,000 or $15,000 per Series A Preferred
share, plus accrued dividends, depending on the event which triggers the
holders' rights to compel redemption.
18
On June 28, 2002 the Company sold to one institutional investor 187.012
shares of the Company's Series A Convertible Preferred Stock for a cash
investment of $1,200,000 and conversion of $600,000 of the debentures the
Company issued to such investor in May 2002. The Company also granted five year
warrants to such purchaser to purchase an aggregate of 623,374 shares of the
Company's common stock at an exercise price of $1.875 per share. Such warrants
contain the same type of "price protection" provisions as were contained in the
warrants the Company issued with its debentures.
Under EITF 00-19, "Accounting for Derivative Instruments Indexed to and
Potentially Settled in the Company's Own Stock", the beneficial conversion
feature related to the redeemable convertible preferred stock and the warrants
issued in connection with such preferred stock, do not qualify for presentation
as permanent equity or temporary equity because the common shares that must be
delivered upon conversion of the redeemable preferred stock or exercise of the
warrants must be registered shares of the Company's common stock. The Company
does not have sufficient registered shares of common stock as of June 30, 2002,
and has not yet filed a registration statement for such shares. As the preferred
stock has no stated redemption date, the entire amount of the discount has been
reflected as interest expense during the three and six month periods ended June
30, 2002.
The relative estimated fair value of the warrants of $559,289 was
recorded as a discount to the preferred stock and was reflected as interest
expense during the period ended June 30, 2002. In addition, the estimated fair
value of the beneficial conversion feature of $1,097,886 has been recorded as an
additional discount and has been reflected as interest expense during the period
ended June 30, 2002.
The debentures, the Series A Preferred shares and all of the warrants
issued in connection with the debentures and Series A Preferred financings have
"blocking" provisions which prevent the issuance of most of the shares of the
Company's common stock issuable upon conversion of such debentures or Series A
Preferred shares, or upon exercise of such warrants, until the Company secures
shareholder approval for the sale of the debentures, the Series A Preferred
shares and the grant of the warrants. The Company intends to secure such
shareholder approval at the next annual meeting of the Company's shareholders
which the Company intends to schedule for October 2002. If the Company does not
secure such shareholder approval, the Company will suffer monetary penalties.
The Company also are required to qualify all of the shares of the Company's
common stock issuable upon conversion of the debentures and the Series A
Preferred shares, and/or the exercise of the warrants, for sale in the public
securities markets by registering them under the Securities Act of 1933, as
amended, and keeping such registration statement in effect for close to two
years. Although the Company has not filed the Company's proxy statement for the
Company's annual meeting or the registration statement to qualify such shares of
the Company's common stock for sale in the public securities markets within the
time required by the Company's agreements and other documents, the Company
believes that the holders of the debentures, the Series A Preferred shares and
such warrants will participate in the Company's next equity financing and that
therefore they will waive the monetary penalties that may be invoked against the
Company for such delays in filing.
NOTE 7 - LEGAL PROCEEDINGS, CLAIMS AND OTHER CONTINGENCIES
On August 15, 2001, a complaint was filed against the Company and its
directors in the United States District Court for the Southern District of New
York. The complaint claims that the plaintiff purchased the Company's class B
warrants which expired December 31, 2000, claiming that he received assurances
from the Company's chief executive officer that the board would reduce the
strike price of such warrants and/or extend the due date of such warrants, and
that the plaintiff relied on actions taken in the past by the Company to extend
these warrants. The Company's chief executive officer denies giving such
assurances. The Company denies that the plaintiff could rely upon actions taken
in the past as representation that future actions would be taken. On April 25,
2002, the claim was settled by the issuance 36,000 three-year warrants to the
claimant to purchase the Company common stock at $4.50 per share and reflected
$61,560 of expense related to such warrants during such quarter.
The Company has been notified by Columbia University, the landlord of
premises at 3960 Broadway in New York City, where we maintain our principal
offices, laboratory and production facilities, that the Company has been
delinquent in payment of rent. The Company has recently surrendered
approximately 11% of the space occupied by us in that building and will
surrender an additional 11% within the next sixty days, as part of its program
to reduce spending. The Company is now negotiating a pay out of the remainder of
its unpaid obligations to Columbia. The Company's ability to make such payment
is dependent on its ability to secure the additional equity financing, noted
above.
ClinTrials Networks, LLC has claimed that the Company has breached its
agreement with them, which provided for ClinTrials to arrange and manage the FDA
mandated clinical trials for use of our OrCel product for the treatment of
venous stasis ulcers, and for other services. ClinTrials claims that as a result
of such a breach the Company owes an unspecified amount, in excess of $100,000.
The Company has advised ClinTrials that it is not in breach of its contract and
that in any event, under the terms of the contract, ClinTrials is not entitled
to recovery of any damages from the Company.
The Company has reached an agreement with the New Jersey Economic
Development Administration to terminate the current lease of approximately
58,000 square feet and to enter into a new lease for approximately 26,000 square
feet of production and office space in North Brunswick, New Jersey.
By letter dated June 27, 2002, the staff of the Nasdaq Stock Market,
Inc., advised the Company that it had not met Nasdaq's requirements for
continued listing of its common stock on the Nasdaq SmallCap market. On July 1,
2002 the Company appealed that determination and requested an oral hearing
before a Nasdaq Listing Qualification Panel. At that hearing, which was held on
August 8, 2002, the Company asked the panel to defer delisting the Company's
common stock for up to six months in order to give the Company time to complete
a plan, which it presented to the panel, to raise sufficient capital to provide
for the Company's cash needs for the next twelve months and to enable the
Company to meet Nasdaq's requirements for continued listing of its common stock
on the Nasdaq SmallCap market. The Company's common stock will continue to be
listed pending the panel's determination of our request. The debentures, the
Series A Preferred Shares and the warrants issued in connection with such
financings provide for monetary penalties against the Company if its common
stock is deleted from Nasdaq and is not listed for trading on the Bulletin
Board.
NOTE 8- EQUIPMENT FINANCING-
In January 2002, the Company secured a $1,300,000 lease line of credit
to be used for the acquisition of additional manufacturing, laboratory and other
equipment required to expand its manufacturing capacity. During the six months
ended June 30, 2002, the Company purchased $268,644 of equipment under this
financing which was accounted for as a sales-leaseback.
19
NOTE 9 - STOCK OPTIONS AND WARRANTS
The following represents stock option and warrant activity during the
six months ended June 30, 2002:
Stock Options Warrants Total
------------- -------- -----
Balance at December 31, 2002 2,033,306 395,412 2,428,718
Granted 194,150 1,336,331 1,510,481
Exercised - - -
Expired or cancelled (121,250) (77,830) (199,080)
--------------------------------------------
Balance at June 30, 2002 2,106,206 1,633,913 3,740,119
============================================
During the three and six months ended June 30, 2002, there were 35,000
options and 36,000 issued to non-employees for services, which resulted in an
aggregate expense of $106,260. The Company accounts for equity instruments
issued to non-employees in accordance with the provisions of SFAS No. 123 and
Emerging Issues Task Force ("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." All transactions in which goods or
services are the consideration received for the issuance of equity instruments
are accounted for based on the fair value of the consideration received or the
fair value of the equity instrument issued, whichever is more reliably
measurable.
The Company is required to grant to the placement agent who arranged for
the sale of the debentures and the Series A Preferred shares, 5 year warrants to
purchase a percentage of the shares of the Company's common stock issuable upon
conversion of the debentures and the Series A Preferred shares. The terms of the
warrants the Company are to grant to the placement agent, including the exact
number of shares of the Company's common stock the placement agent may purchase,
and other warrants the Company will grant to the placement on the completion of
the proposed additional financing discussed above, are being negotiated by the
Company and the placement agent. As the Company is unable to estimate the amount
of warrants or the price of such warrants, no compensation expense has been
recognized for such warrants during the three and six months ended June 30,
2002.
The Company is also required to grant 3 year warrants to purchase
300,000 shares of the Company's common stock at exercise prices of $3.50 per
share for 100,000 shares, at $5.50 per share for the second 100,000 shares and
at $7.50 per share for the third 100,000 shares, to one entity in exchange for
financial consulting services rendered by that entity. The warrants vest as to
each 100,000 share tranche on June 1, 2002, on December 1, 2002 and on June 1,
2003. The Company has the right to cancel such financial consulting services
agreement on 30 days' notice. If the Company cancel the agreement, all warrants
which did not vest prior to the date of termination of the agreement are
cancelled. The Company has not yet issued such warrants, but has accrued an
aggregate of $143,083 of expense (which is reflected in accrued expenses)
related to such warrants as of June 30, 2002.
NOTE 10 - ADOPTION OF RECENTLY ISSUED ACCOUNTING STANDARD AND IMPACT OF RECENTLY
ISSUED PRONOUNCEMENTS
Effective January 1, 2002, the Company adopted Statement of Financial
Accounting Standards ("SFAS") No. 142 Goodwill and Other Intangible Assets.
Under SFAS No. 142, goodwill and indefinite lived intangible assets are no
longer amortized but will be reviewed at least annually for impairment.
Separable intangible assets that are not deemed to have an indefinite life will
continue to be amortized over their useful lives.
The Company's intangible assets subject to amortization primarily
consists of patent application costs totaling $832,781 as of January 1, 2002.
As of January 1, 2002, there were no intangible assets with indefinite useful
lives. The Company continues to amortize these costs over their estimated
useful lives. Adoption of this accounting standard did not have a material
effect on financial position or results of operations. The Company adopted the
provisions of SFAS No. 144 effective January 1, 2002. The adoption of SFAS
No. 144 had no effect on the financial position or results of operations of the
Company.
On April 30, 2002 the FASB issued Statement of Financial Accounting
Standard No. 145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment of
SFAS No. 13, and Technical Corrections" ("SFAS No. 145"). SFAS No. 145 rescinds
Statement No. 4, which required all gains and losses from extinguishments of
debt to be aggregated and, if material, classified as an extraordinary item, net
the related income tax effect. Upon adoption of SFAS No. 145, companies will be
required to apply the criteria in APB Opinion No. 30, "Reporting the Results of
Operations-Reporting the Effects of Disposal of a Segment of a Business, and
Extraordinary, Unusual and Infrequently Occurring Events and Transactions" in
determining the classification of gains and losses resulting from the
extinguishment of debt. SFAS No. 145 is effective for fiscal years beginning
after May 15, 2002. The Company is currently evaluating the requirements and
impact of this statement on its consolidated results of operations and financial
position.
On July 30, 2002, the FASB issued Statement of Financial Accounting
Standard No. 146, "Accounting for Costs Associated with Exit or Disposal
Activities" ("SFAS No. 146"). The standard requires companies to recognize costs
associated with exit or disposal activities when they are incurred rather than
at the date of a commitment to an exit or disposal plan. Examples of costs
covered by the standard include lease termination costs and certain employee
severance costs that are associated with a restructuring, discontinued
operation, plant closing, or other exit or disposal activity. SFAS No. 146 is to
be applied prospectively to exit or disposal activities initiated after
December 31, 2002. The Company iscurrently evaluating the requirements and
impact of this statement on its consolidated results of operations and financial
position.
NOTE 11 - SUBSEQUENT EVENTS-
Issuance of debentures-
In August 2002, the Company issued an aggregate of $175,000 in
convertible debentures with comparable terms as those that were issued on
May 13, 2002. An aggregate of 21,875 warrants were issued in connection with
such financing with the same terms as those that were issued on May 13, 2002.
Letter of Intent-
As more fully discussed in Note 2, the Company signed a non-binding
letter of intent with Paul Capital on August 6, 2002 in order to convert a
portion of the outstanding obligations to Paul Capital to Series C Preferred
Stock.
Item 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Forward Looking Information May Prove Inaccurate
20
This Quarterly Report on Form 10-Q contains certain forward looking
statements and information relating to Ortec, that are based on the beliefs of
management, as well as assumptions made by and information currently available
to us. When used in this document, the words "anticipate," "believe,"
"estimate," and "expect" and similar expressions, as they relate to Ortec, are
intended to identify forward looking statements. Such statements reflect our
current views with respect to future events and are subject to certain risks,
uncertainties and assumptions, including those described in this discussion and
elsewhere in this Quarterly Report on Form 10-Q. Should one or more of these
risks or uncertainties materialize, or should underlying assumptions prove
incorrect, actual results may vary materially from those described herein as
anticipated, believed, estimated or expected. We do not intend to update these
forward-looking statements.
The following discussion should be read in conjunction with our
financial statements and notes thereto. This discussion may be deemed to include
forward-looking statements.
General
Since Ortec's inception we have been principally engaged in the
research and development of our tissue engineered skin regeneration product, for
use in the treatment of chronic and acute wounds, such as venous and diabetic
skin ulcers, and autograft donor site wounds for burn victims. We call our
product OrCel'TM' and in June 2001 we filed a trademark application for such
name with the United States Patent and Trademark Office.
In February 2001 Ortec received FDA approval to make commercial sales
of OrCel for use on patients with recessive dystrophic epidermolysis bullosa,
followed by FDA approval in September 2001 for use of the product in the
treatment of donor site wounds in burn patients. With these approvals, though we
are still a development stage enterprise, in December 2001 we began commercial
sales of our product.
From inception to date, we have incurred cumulative net losses of
approximately $71.6 million. We expect to continue to incur substantial losses
until at least 2003, due to continued spending on research and development
programs, the funding of clinical trials and regulatory activities and the
increased personnel costs of manufacturing, marketing and sales, distribution
and administrative activities.
We are currently conducting pivotal clinical trials of OrCel in the
treatment of venous stasis ulcers. Venous stasis ulcers are open lesions on the
legs, which result from the poor circulation of blood returning from the legs to
the heart. We expect to complete the venous stasis pivotal clinical trials
by the end of 2002, with submission of the FDA filing by the first quarter of
2003. We anticipate obtaining FDA approval in 2003 for the use of our OrCel
product in the treatment of venous stasis ulcers. Diabetic ulcers are open sores
that remain after the destruction of surface tissue. We have deferred the
implementation of the diabetic ulcers pivotal clinical trials and expect to
resume these trials in 2003 dependent on obtaining additional financing.
We anticipate that future revenues and results of operations may
continue to fluctuate significantly depending on, among other factors, the
timing and outcome of applications for
21
additional regulatory approvals, our ability to successfully manufacture, market
and distribute OrCel and/or the establishment of collaborative arrangements for
the manufacturing, marketing and distribution of our product. We anticipate that
our operating activities will result in substantial net losses until at least
2003.
Critical Accounting Policies
Revenue Recognition. Revenues from sales are recognized upon shipment of product
to customers.
Research and Development Costs. We are a development stage enterprise and as
such, all research and development costs, including consulting and personnel
costs, relating to products under development, are expensed as incurred.
Research and Development Costs. As we are still engaged in clinical trials of
our product and remain a development stage enterprise, the cost of producing
product for clinical trials and for sale, is included in Research and
Development costs.
Long Term Obligations. We account for our Revenue Interest Assignment Agreement
in a manner similar to that of debt and provide for interest to reflect the
estimated cost of the funds received. Interest is imputed at approximately 28%
per annum, which is the estimated return under the agreement. Interest may range
from 20-30% per annum depending on our sales and the ultimate terms of the
agreement.
Adoption of Recently Issued Accounting Standard. Effective January 1, 2002, the
Company adopted Statement of Financial Accounting Standards ("SFAS") No. 142
Goodwill and Other Intangible Assets. Under SFAS No. 142, goodwill and
indefinite lived intangible assets are no longer amortized but will be reviewed
at least annually for impairment. Separable intangible assets that are not
deemed to have an indefinite life will continue to be amortized over their
useful lives. The Company's intangible assts subject to amortization consists
primarily of patent application costs. There are no intangible assets with
indefinite useful lives.
The Company adopted the provisions of SFAS No. 144 effective January 1,
2002. The adoption of SFAS No. 144 had no effect on the financial position or
results of operations of the Company.
Impact of recently issued accounting pronouncements:
On April 30, 2002 the Financial Accounting Standards Board (the FASB)
issued Statement of Financial Accounting Standard No. 145, "Rescission of FASB
Statements No. 4, 44, and 64, Amendment of SFAS No. 13, and Technical
Corrections" ("SFAS No. 145"). SFAS No. 145 rescinds Statement No. 4, which
required all gains and losses from extinguishments of debt to be aggregated and,
if material, classified as an extraordinary item, net the related income tax
effect. Upon adoption of SFAS No. 145, companies will be required to apply the
criteria in APB Opinion No. 30, "Reporting the Results of Operations-Reporting
the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual
and Infrequently Occurring Events and Transactions" in determining the
classification of gains and losses resulting from the extinguishment of debt.
SFAS No. 145 is effective for fiscal years beginning after May 15, 2002. The
Company is currently evaluating the requirements and impact of this statement on
its consolidated results of operations and financial position.
On July 30, 2002, the FASB issued Statement of Financial Accounting
Standard No. 146, "Accounting for Costs Associated with Exit or Disposal
Activities" ("SFAS No. 146"). The standard requires companies to recognize costs
associated with exit or disposal activities when they are incurred rather than
at the date of a commitment to an exit or disposal plan. Examples of costs
covered by the standard include lease termination costs and certain employee
severance costs that are associated with a restructuring, discontinued
operation, plant closing, or other exit or disposal activity. SFAS No. 146 is to
be applied prospectively to exit or disposal activities initiated after
December 31, 2002. The Company is currently evaluating the requirements and
impact of this statement on its consolidated results of operations and financial
position.
Results of Operations
Three and Six Months Ended June 30, 2002, and June 30, 2001.
Revenues
We earned revenues of approximately $93,000 in the 2002 quarter, and
$209,000 for the six months ended June 30, 2002 from commercial shipments of
products to customers. Since sales to commercial customers only began in
December 2001, there was no comparable revenue generated in the quarter and six
months ended June 30, 2001.
Expenses
22
Expenses increased by approximately $1.7 million in the quarter from
approximately $3.8 million in 2001 to approximately $5.5 million in 2002 and by
$3.6 million in the six month period from approximately $7.2 million in 2001 to
approximately $10.8 million in 2002.
Personnel. Personnel costs increased by approximately $1.2 million in
the quarter from $3.0 million in 2001 to $4.2 million in 2002, and $0.6 million
in the six month period from $1.5 million in 2001 to $2.1 million in 2002. This
increased expense resulted from the additional personnel required to conduct and
manage larger clinical trial programs, to manufacture the increased quantity of
product required by our clinical trial programs to initiate our sales and
marketing program for our FDA approved products and for additional
administrative personnel required as a result of such increased staffing levels.
This personnel increase resulted in increased rent expense as additional space
was needed to accommodate the increased staffing levels.
Consulting. These fees decreased by $231,000 in the quarter and
$196,000 in the six months ended June 30, 2002 compared with the six months
ended June 30, 2001. This was due to the increased costs in 2001 related to the
specific requirements for concluding the clinical trials for donor site wounds
and FDA submissions, noted above, as well as the costs of conducting the pilot
clinical trials for venous leg stasis and diabetic foot ulcers. In 2002, only
the costs of beginning the pivotal clinical trials for venous leg stasis ulcers
were incurred.
Research and Development. These expenses decreased by approximately
$12,000 in the quarter and $114,000 in the six months ended June 30, 2002
compared with the quarter and six months ended June 30, 2001. The decrease in
research and development expenses was due to the fact that higher costs were
incurred in 2001 for conducting the donor site pivotal clinical trials, as well
as the venous and diabetic ulcers pilot trials, which were concluded in 2001,
compared with the costs incurred in 2002 relevant to only the venous stasis
pivotal trials. This decrease was partially offset by the higher costs incurred
in 2002 relevant to producing cryo OrCel for the larger venous stasis clinical
trial, as well as fresh OrCel for sales to customers.
General and Administrative. These expenses increased by $289,000 in the
quarter and $642,000 in the six months ended June 30, 2002, compared with the
similar period in 2001, due to increased marketing, recruitment, insurance and
other expenses incurred, as Ortec prepares for commercial sales of its product
and continues its financing activities.
Interest Expense. Interest expense increased by $2.8 million in the
quarter and by $3.6 million in the six months ended June 30, 2002, compared with
the expense incurred in the quarter and six months ended June 30, 2001, due to
the imputed interest accrued on the Paul Capital agreement, and interest accrued
on convertible debentures issued on May 13, 2002. Based on the original $10
million received from Paul Capital and the anticipated revenue stream over the
term of this agreement, management anticipates that the effective cost of these
funds will range between 20% to 35% per annum and, as such, approximately $1.4
million in interest expense has been accrued in the six months ended June 30,
2002. Interest expense of $0.3 million was accrued as a result of the issuance
of convertible debentures on May 13, 2002. Additionally, interest of $1.9
million was recorded due to the beneficial conversion feature and warrants on
the convertible preferred stock.
23
Interest Income. Interest income declined by approximately $48,000 in
the quarter and $156,000 in the six months ended June 30, 2002 compared with the
similar periods in 2001, primarily due to the smaller average cash balances
outstanding during 2002 compared with 2001.
Liquidity and Capital Resources
Since inception (March 12, 1991) through June 30, 2002, we have
accumulated a deficit of approximately $71.6 million and we expect to continue
to incur substantial operating losses until at least 2003. We have financed our
operations primarily through private placements of our common stock, preferred
stock and convertible debentures, our initial public offering and the exercise
of our publicly traded Class A warrants. From inception to June 30, 2002, we
received cash proceeds from the sale of equity securities, net of share issuance
expenses, of approximately $51.5 million, we received proceeds from the issuance
of convertible debentures of $2.6 million proceeds from issuance of convertible
redeemable preferred stock of $1.2 million, and received a total of $10 million
from the sale of a percentage interest in our future revenues from the sale of
our product in North America.
On August 6, 2002, the Company reached an agreement in principle to a
non-binding term sheet with Paul Capital. The term sheet provides that Paul
Capital would relinquish 70% of its revenue interest in exchange for $7.0
million in Series C Secured Participating Preferred Stock and 500,000 warrants
exercisable at a nominal exercise price. This agreement is contingent upon
completion of the current financing with H.C. Wainwright. The remaining $3.0
million of the original $10.0 million received from Paul Capital will continue
to be treated as Long Term Debt, under the Royalty Interest Assignment
Agreement. The Company may
24
incrementally receive up to an additional $15.0 million, but only upon the
mutual agreement of both the Company and Paul Capital.
For the six months ended June 30, 2002, we used net cash for operating
activities of approximately $7.0 million. Cash used in operating activities
resulted primarily from our net loss of $12.4 million, offset by depreciation
and amortization of approximately $334,000, approximately $3.5 million of
non-cash interest expense and an increase in accounts payable and accrued
expenses of approximately $1.3 million.
In the six months ended June 30, 2002 we invested approximately
$322,000 in property, plant, equipment and patent application costs. In
January 2002, we received a $1,300,000 line of credit from GE Capital for
equipment lease financing on which we financed $268,000 of additional purchases
of fixed assets. These proceeds are available to be utilized in financing
manufacturing equipment purchases in 2002.
In January 2002, we secured a $1,300,000 lease line of credit to be
used for the acquisition of additional manufacturing, laboratory and other
equipment required to expand our manufacturing capacity. During the six months
ended June 30, 2002, we purchased $268,644 of equipment under this financing.
We repaid $119,000 on our loans payable and long-term debt during the
six months ended June 30, 2002. We did not sell our common stock, but we did
receive $4.0 million under our agreement with Paul Capital Royalty Acquisition
Fund, L.P. and $3.8 million in our Convertible Debentures and Preferred Stock
financing through H.C. Wainwright, as noted above.
In December 2001, we entered into a ten-year lease with New Jersey
Economic Development Authority ("NJEDA") to lease approximately 58,000 square
feet of manufacturing and office space located in North Brunswick, New Jersey.
We have reached an agreement with NJEDA to terminate the current lease and enter
into a new lease for approximately 26,000 square feet of manufacturing and
office space. The new lease will begin on August 1, 2002 and terminate on
December 31, 2005, with a 7-year renewal option beyond the initial term. Rent
will begin at $14 per square foot on January 1, 2003, the expected occupancy
date of these premises, and will incrementally increase to $16 per square foot
in 2005. A security deposit of $639,000, which was paid by us on the original
lease, will be applied as a security deposit on the new lease. All construction
costs advanced to NJEDA for the renovation of the premises, approximately
$420,000, will be included as a construction allowance in the new lease and is
reflected in the rent base, noted above.
Under the August 29, 2001 agreement with Paul Capital, in
consideration for the original $10.0 million, Paul Capital received a minimum of
3-1/3% of end user revenues from the sale of the Company's products in the
United States, Canada and Mexico. These percentage payments may be further
adjusted upward or downward, based on the volume of net sales to end users of
the Company's products in those three countries. As of June 30, 2002, the
Company estimated that its effective cost of the amounts it received from
Paul Capital was 28% per annum, and has accrued interest accordingly. On
August 6, 2002, the Company reached an agreement in principle to a non-binding
term sheet with Paul Capital. The term sheet provides that Paul Capital would
relinquish 70% of its revenue interest in exchange for $7.0 million in Series
C Secured Participating Preferred Stock and 500,000 warrants exercisable at a
nominal exercise price. This agreement is contingent upon
25
completion of the current financing with H.C. Wainwright. The non-binding terms
of the agreement in principle provides that Paul Capital will receive a minimum
of 1.125% on end user revenues up to $100 million and 0.6% on revenues in
excess of $100 million. Under the August 29, 2001 agreement, beginning on
January 1, 2003, Paul Capital will be entitled to receive each year the first
proceeds to the Company from end user sales of its products. Such annual amounts
Paul Capital will be able to draw in advance will range from $1.5 million in
2003 to $7.5 million in 2005 and thereafter. Based upon the proposed revision to
the original contract, prorated amounts of the advance payments will be due in
each year of the agreement. The agreement provides for quarterly and annual
accountings between Paul Capital and the Company for those advance payments,
compared to amounts owed based on actual sales.
The remaining $3.0 million of the original $10.0 million received will
continue to be treated as Long Term Debt, under the revised Royalty Interest
Assignment Agreement. We may incrementally receive another $15 million, but only
upon mutual agreement by both Ortec and Paul Capital.
In the event of a change in control of Ortec or upon the occurrence of
certain other events as defined in the agreement, Paul Capital has the option to
put its revenue interest back to us for an amount as provided in the agreement.
Ortec also has the option to repurchase Paul Capital's interest upon the
occurrence of a change in control of Ortec or a complete divestiture by us of
our products, for an amount provided in the agreement.
We have granted Paul Capital a security interest in our United States
and Canadian patents and trademarks relating to our technology for our product,
to secure payments we are required to make to Paul Capital, based on sales
generated under the Royalty Revenue Interest Assignment agreement, as described
above.
The original agreement and the modification to the agreement reached in
principle terminate on December 31, 2011, unless terminated earlier by either
party, as permitted by the terms of the agreement.
26
On March 27, 2002, we engaged H.C, Wainwright & Co. Inc., an investment
banking firm, to act as our financial advisor in connection with raising capital
for the Company through debt and/or equity financing. While we can give no
assurance of the total amount of financing that will be secured, Wainwright is
assisting us in raising financing of approximately $8.5 million. On May 13,
2002, the Company secured the first $2.3 million of this financing, in the form
of 12% convertible debentures, which are convertible into common shares at the
lesser of $3.36 or the price per share of the equity securities to be issued in
an anticipated forthcoming financing. The debentures are due on April 30, 2003.
It is expected that these debentures will be converted into equity securities
upon the final closing of this financing. As of June 28, 2002, $0.6 million
has been converted into redeemable convertible preferred stock. The Company also
issued 291,000 stock purchase warrants as part of this May 7, 2002 financing,
which are exercisable at $4.50 per share for up to 5 years from the date of
grant. On June 28, 2002, an additional $1.5 million of financing was secured,
which consists of $1.2 million in convertible preferred stock and $.3 million in
12% convertible debentures, which the Company also expects will be converted
into equity securities. The Company also issued 655,000 stock purchase warrants,
at an exercise price of $1.875 per common share for a five-year period, as part
of the June 28, 2002 financing. Subsequent to June 30, 2002, the Company has
raised an additional $0.2 million in convertible debentures, similar to those
raised in the May 7, 2002 and June 28, 2002 financings.
The Company anticipates continuing its financing efforts with the
issuance of its Series B Convertible Preferred Stock. The preferred stock is
convertible into common shares at any time at the option of the investor, based
on a fixed conversion rate of $1.67 or commencing after January 1, 2003, based
on a alternative conversion rate equal to 90% of the average of the five lowest
volume weighted average prices for the common stock for the twenty trading days
immediately prior to conversion, subject to a floor price. The alternative
conversion price is cancelable under certain circumstances, as described below.
Conversion is mandatory, upon the occurrence of certain financial events, such
as, beginning six months from the date of issue, if the closing bid price of
common shares exceeds $3.35 for a period of 20 consecutive trading days, or if
within nine months from the date of issue, the Company completes a public
offering, raising a minimum of $8 million. In the event that the Company
receives a licensing fee or a strategic investment of at least $8.0 million,
within six months of closing, the alternative conversion rate is adjusted to the
closing rate of the investment or the fixed rate of $1.67, if lower. Similarly,
if the Company completes a subsequent public or private financing of a least
$5.0 million, within six months of closing, the alternative conversion rate is
adjusted to the closing price or the fixed rate of $l.67 if lower. Dividends
will be paid in common shares at the rate of 12% in the first year after issue
and in either cash or common shares in subsequent years at the election of the
Company, until at such time as the preferred stock is converted to common
shares. Along with the convertible preferred stock, the Company is also issuing
warrants to purchase common shares. The Series A warrants, exercisable at $.001
per share, must be exercised immediately upon closing of the purchase of
preferred stock. The Series B-1 warrants are exercisable nine months after
closing at $2.00 per share and the Series B-2 warrants are exercisable at $3.00
per share, twelve months after closing.
The Company anticipates completing the balance of this financing with
H.C. Wainwright in August 2002.
Our capital funding requirements will depend on numerous factors,
including the progress and magnitude of our research and development programs,
preclinical testing and clinical trials, the time involved in obtaining
regulatory approvals for commercial sale of our product to treat venous stasis
and diabetic foot ulcers, the cost involved in filing and maintaining patent
claims, technological advances, competitive and market conditions, our ability
to establish and maintain collaborative arrangements, our cost of manufacturing
scale up and the cost and effectiveness of commercialization activities and
arrangements.
We have raised funds in the past through the public or private sale of
equity securities, debentures and preferred stocks and through the agreement
with Paul Capital. We will need to raise additional funds in the future through
public or private financings, collaborative arrangements or from other sources.
The success of such efforts will depend in large part upon continuing
developments in our clinical trials and upon market conditions.
27
We require substantial funding to continue our research and
development activities, clinical trials, manufacturing, sales, distribution and
administrative activities. We believe that our cash and cash equivalents on hand
at June 30, 2002, (approximately $.8 million) and the anticipated additional
financing expected in August 2002 of approximately $5.0 million will enable us
to continue our operations until December 2002. On August 5, 2002, we signed a
letter of intent with a securities brokerage firm, and expect to complete a
$12.0 million follow on public offering before December 31, 2002. We believe
that this additional anticipated financing will enable us to continue our
operations through the end of 2003.
We continue to explore and, as appropriate, enter into discussions with
other companies regarding the potential for equity investment, collaborative
arrangements, license agreements or other funding programs with us, in exchange
for manufacturing, marketing, distribution or other rights to our product.
However, we can give no assurance that discussions with other companies will
result in any additional investments, collaborative arrangements, agreements or
other funding, or that the necessary additional financing through debt or equity
financing will be available to us on acceptable terms, if at all. Further, we
can give no assurance that any arrangements resulting from these discussions
will successfully reduce our funding requirements. If additional funding is not
available to us when needed, we may not be able to continue operations.
Item 3- Quantitative and Qualitative Disclosures about Market Risk
See Note 6 to the financial statements for information regarding the
conversion of the Company's convertible notes and redeemable convertible
preferred stock.
28
PART II
Item 1. Legal Proceedings and Claims
1. The litigation instituted against Ortec, five of its directors, one
former director and one officer who is not a director, by Dov Shellef in the
United States District Court for the Southern District of New York, was settled
in April 2002. In full satisfaction of Mr. Shellef's claims, we issued a three
year warrant to Mr. Shellef entitling him to purchase 36,000 shares of Ortec's
common stock at an exercise price of $4.50 per share.
2. We have been notified by Columbia University, the landlord of
premises 3960 Broadway in New York City, where we maintain our principal
offices, laboratory and production facilities, that we have been delinquent in
payment of rent. We have recently surrendered approximately 11% of the space
occupied by us in that building, and we intend to surrender an additional 11% by
the middle of October 2002, as part of our program to reduce spending. We are
negotiating a pay out of the remainder of our unpaid obligations to Columbia.
Our ability to make such payments is dependent on our ability to secure
additional equity financing.
3. ClinTrials Networks, LLC has claimed that we have breached our
agreement with ClinTrials which provided for ClinTrials to arrange and manage
the FDA mandated clinical trials for use of our OrCel product for the treatment
of venous stassis ulcers, and for other services. ClinTrials claims that as a
result of such a breach we owe it an unspecified amount, but in excess of
$100,000. We have advised ClinTrials that we are not in breach of our contract
with it and that in any event ClinTrials is not, under the terms of its contract
with us, entitled to recover any damages from us.
4. We have reached an agreement with the New Jersey Economic
Development Administration to terminate our lease for approximately 58,000 sq.
ft. of production and office space in North Brunswick, New Jersey. We have
entered into a new lease with the New Jersey Economic Development Administration
for approximately 26,000 sq. ft. of office and laboratory
29
space and future production facilities in one of those same buildings in North
Brunswick, New Jersey.
Item 2. Changes in Securities
(c) Recent Sales of Unregistered Securities
1. In May, June and August 2002, we borrowed from 20 accredited
investors an aggregate of $2,758,000. More than 80% of such loans were made to
us by institutional investors. We issued notes to those investors for such
loans. The notes are payable April 10, 2003, bear interest at the rate of 12%
per annum, increasing to 18% per annum on October 10, 2002, payable at the end
of each quarter. Payment of interest due June 30, 2002 has been deferred pending
completion of an additional $5,000,000 in equity financing which we are now
trying to secure. The notes and accrued interest were to be converted into
Ortec's equity securities if we completed a sale of our equity securities for a
minimum of an additional $5,000,000 by July 12, 2002. Although we only sold
$1,200,000 of our equity securities prior to July 13, 2002, we are still in
negotiation with some of the note holders and other potential investors to
secure additional equity financing. We believe that the note holders will
convert their notes into the equity securities we issue in such additional
financing on the terms set forth in the notes as if we had completed such
additional equity financing by July 12, 2002. The notes provide for conversion
of the notes into our equity securities (if we had secured not less than an
additional $5,000,00 in equity financing by July 12, 2002) issued in such equity
financing, by taking 110% of the principal amount of the notes and 110% of the
unpaid accrued interest, and purchasing so many of such equity securities
determined by dividing such 110% principal and accrued interest of the note by
the purchase price of one equity security in such equity financing.
The notes may be converted at the holders' options to shares of our
common stock at a conversion rate which is the lower of $3.36 or the price per
share of the equity securities in the proposed equity financing described above.
However, the notes provide for "price protection" so
30
that the conversion rates at which the notes are convertible to our common stock
is reduced if we sell our common stock in the future, or the exercise price or
conversion rate of any warrants or options to purchase, or other securities
which may be converted into, our common stock, which we may issue in the future,
are sold at a price, or are exercisable or convertible at a price, lower than
the conversion rate of these notes.
The 20 purchasers of the notes were also granted five-year warrants to
purchase an aggregate of 344,750 shares of our common stock at an exercise price
of $4.50 per share. Like the notes, these warrants also provide "price
protection" so that the exercise price is reduced if we sell common stock in the
future, or the exercise price or conversion rate of any warrants or options to
purchase, or other securities which may be converted into, our common stock,
which we may issue in the future, is lower than the exercise price of these
warrants.
2. On June 28, 2002, pursuant to the authority granted our directors by
our certificate of incorporation, our board of directors unanimously adopted an
amendment to our certificate of incorporation designating 2,000 shares out of
the 1,000,000 shares of preferred stock we are authorized to issue, as Series A
Convertible Preferred Stock, and designating the relative rights and preferences
of the Series A Convertible Preferred Stock. The stated value, which is also the
Liquidation Preference of the Series A Convertible Preferred Stock, is $10,000
per share. We are required to pay dividends on the Series A Preferred shares,
out of our assets legally available therefore, at the rate of 6% per annum of
the $10,000 Liquidation Preference per share, through June 30, 2003; at the rate
of 9% per annum thereafter until June 30, 2004; and thereafter at the rate of
12% per annum. At our option such dividends may be paid in our common stock at
the "conversion price" for the conversion of such preferred shares if such
shares of common stock have been registered under the Securities Act of 1933 for
sale in the public securities markets. The conversion price is fixed initially
at $1.50 per share of our common stock. Commencing nine months after the date of
issuance of any shares of Series A Convertible Preferred Stock, the holder may
elect to convert its Series A shares plus interest accrued thereon at an
"Alternative Conversion Price" which shall be the average of the five lowest
volume weighted average prices for our common stock during the 15 days
immediately prior to conversion. However, at no time is the
31
Alternative Conversion Price to be less than 50% of the fixed conversion price.
The Alternative Conversion Price will be cancelled if within six months of
issuance (i) we sell shares of our common stock in a financing in which
aggregate cash proceeds are not less than $5,000,000 and the price at which each
share is sold is not less than $2.00, or (ii) we receive at least $8,000,000 as
an up-front payment for a licensing fee from a third party. There is price
protection for the alternative conversion price only so that the alternative
conversion price is reduced if we sell shares of our common stock in the future
at, or the exercise price of any warrants or options to purchase our common
stock which we may grant in the future, or the conversion price for the
conversion of other securities (we may issue in the future) to our common stock,
is lower than the alternative conversion price for the Series A Preferred
shares. We have the right to redeem all or a portion of the outstanding Series A
Convertible Preferred Stock by payment of $15,000 per share plus any accrued and
unpaid dividends. The holders of the Series A Convertible Preferred Stock may
compel us to redeem their shares upon the occurrence of certain events, at
$12,000 or $15,000 per Series A Preferred share, plus accrued dividends,
depending on the event which triggers the holders' rights to compel redemption.
On June 28, 2000 we sold to one institutional investor 187.012 shares
of our New Series A Convertible Preferred Stock for a cash investment of
$1,200,000 and cancellation of $600,000 of the notes we issued to such investor
in May 2002. We also granted five year warrants to such purchaser to purchase an
aggregate of 623,374 shares of our common stock at an exercise price of $1.875
per share. Such warrants contain the same type of "price protection" provisions
as were contained in the warrants we issued to the 20 accredited investors who
acquired our notes described in paragraph 1 above.
3. The notes, the Series A Preferred shares and all of the warrants
described in paragraphs numbered 1 and 2 of this Item 2 of Part II, have
"blocking" provisions which prevent the issuance of most of the shares of our
common stock issuable upon conversion of such notes or Series A Preferred
shares, or upon exercise of such warrants, until we secure shareholder approval
for the sale of the notes, the Series A Preferred shares and the grant of the
warrants. We intend to secure such shareholder approval at the next annual
meeting of our shareholders which we intend to schedule for October 2002. If we
do not secure such shareholder approval, we will suffer
32
monetary penalties. We also are required to qualify all of the shares of our
common stock issuable upon conversion of the notes and the Series A Preferred
shares, and/or the exercise of the warrants, for sale in the public securities
markets by registering them under the Securities Act of 1933, as amended, and
keeping such registration statement in effect for close to two years. Although
we have not filed our proxy statement for our annual meeting or the registration
statement to qualify such shares of our common stock for sale in the public
securities markets within the time required by our agreements and other
documents, we believe that the holders of the notes, the Series A Preferred
shares and such warrants will participate in our next equity financing and that
therefore they will waive the monetary penalties that may be invoked against us
for such delays in filing.
4. We are required to grant to the placement agent who arranged for the
sale of the notes and the Series A Preferred shares, 5 year warrants to purchase
a percentage of the shares of our common stock issuable upon conversion of the
notes and the Series A Preferred shares. The terms of the warrants we are to
grant to the placement agent, including the exact number of shares of our common
stock the placement agent may purchase, and other warrants we will grant to the
placement on the completion of the proposed additional financing discussed
above, are being negotiated by us and the placement agent.
5. We are also required to grant 3 year warrants to one entity for
financial consulting services rendered by that entity to us, to purchase 300,000
shares of our common stock at exercise prices of $3.50 per share for 100,000
shares, at $5.50 per share for the second 100,000 shares and at $7.50 per share
for the third 100,000 shares. The warrants vest as to each 100,000 share tranche
on June 1, 2002, on December 1, 2002 and on June 1, 2003. We have the right to
cancel such financial consulting services agreement on 30 days' notice. If we
cancel the agreement, all warrants which did not vest prior to the date of
termination of the agreement are cancelled. We have not yet issued such
warrants.
6. As noted in paragraph numbered 1 of Item 1 of this Part II, we have
granted to Mr. Dov Shellef a three year warrant to purchase 36,000 shares of our
common stock at an exercise
33
price of $4.50 per share, in full satisfaction of all claims he has against us
or our directors, a former director and a non-director officer, whom he named
as defendants in the litigation he instituted against us.
7. The sale of all such notes and Series A Preferred shares, and the
grant of all such warrants, as described in paragraphs numbered 1 through 6,
both inclusive, of this Item 2 of Part II, were exempt from the registration
requirements of the Securities Act of 1933, as amended, pursuant to the
provisions of Section 4(2) of the Act, as not involving any public offering, and
with respect to the sale of the notes and the Series A Preferred shares, and the
warrants granted as part of such sales, pursuant to Regulation D promulgated by
the Securities and Exchange Commission under the Act, since all the purchasers
represented that they were "accredited investors", as such term is defined in
Regulation D.
8. During the second quarter of 2002 we granted to 15 full-time
employees and to one consultant options under our Employee Stock Option Plan,
expiring in the case of our employees 7 years after the date of grant, and in
the case of the consultant 3 years after the date of grant, to purchase an
aggregate of 60,500 shares of our common stock, at exercise prices ranging from
$1.90 to $5.00 per share. Such grants were in consideration for services
rendered to Ortec. The grant of such options was exempt from the registration
requirements of the Securities Act of 1933, as amended, pursuant to the
provisions of Section 4(2) of the Act, as not involving any public offering.
Item 5. Other Information
By letter dated June 27, 2002, the staff of the Nasdaq Stock Market,
Inc., advised us that we had not met Nasdaq's requirements for continued listing
of our common stock on the Nasdaq SmallCap market. On July 1, 2002 we appealed
that determination and requested an oral hearing before a Nasdaq Listing
Qualification Panel. At that hearing, which was held on August 8, 2002, we asked
the panel to defer delisting our common stock for up to six months in order to
give
34
us time to complete a plan, which we presented to the panel, to raise sufficient
capital to provide for our cash needs for the next twelve months and to enable
us to meet Nasdaq's requirements for continued listing of our common stock on
the Nasdaq SmallCap market. Our common stock will continue to be listed pending
the panel's determination of our request. The notes, the Series A Preferred
Shares and the warrants described in paragraphs numbered 1 and 2 of Item 2 of
Part II, provide for monetary penalties against us if our common stock is
deleted from Nasdaq and is not listed for trading on the Bulletin Board.
35
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibit No. Description
----------- -----------
3.2 Restated Certificate of Incorporation (2)
3.3 By-Laws (1)
3.4 Amendment to Certificate of Incorporation adopted
June 28, 2002, being a Certificate of Designation of
the Relative Rights and Preferences of the Series A
Convertible Preferred Stock (3)
99.1 Certification of Principal Executive Officer (3)
99.2 Certification of Principal Financial Officer (3)
- ---------------------
(1) Filed as an Exhibit to our Registration Statement on Form SB-2 (file No.
33-96090), or Amendment 1 thereto, and incorporated herein by reference.
(2) Filed as an Exhibit to our Form 10-Q filed for the quarter ended September
30, 2001, and incorporated herein by reference.
(3) Filed herewith.
(b) Reports on Form 8-K
We did not file any reports on Form 8-K in the second quarter of 2002.
36
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the
registrant has caused this report to be signed on its behalf by the undersigned,
thereto duly authorized.
Registrant:
ORTEC INTERNATIONAL, INC.
Date: August 19, 2002 By: /s/ Steven Katz
------------------------------------
Steven Katz, PhD
Chairman and Chief Executive Officer
(Principal Executive Officer)
Date: August 19, 2002 By: /s/ Ron Lipstein
------------------------------------
Ron Lipstein
Chief Financial Officer
(Principal Financial Officer)
37
STATEMENT OF DIFFERENCES
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The trademark symbol shall be expressed as............................. 'TM'