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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 SEPTEMBER 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 19,765,480 (as
of November 14, 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 SEPTEMBER 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. 24
Item 3 Quantitative and Qualitative Disclosures About Market Risk. None
Item 4 Controls and Procedures. 34
Part II
Item 1. Legal Proceedings and Claims. 34
Item 2. Changes in Securities and Use of Proceeds. 34
Item 3. Default Upon Senior Securities. None
Item 4. Submission of Matters to a Vote of Security Holders. None
Item 5. Other Information. 37
Item 6. Exhibits and Reports on Form 8-K. 38
Signatures 39
Item 1. FINANCIAL STATEMENTS
ORTEC INTERNATIONAL, INC.
(A DEVELOPMENT STAGE ENTERPRISE)
BALANCE SHEETS
SEPTEMBER 30, DECEMBER 31,
2002 2001 *
---- ----
(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 357,588 $ 854,025
Accounts receivable 59,700 21,890
Other current assets 28,016 169,516
---------- ----------
Total current assets 445,304 1,045,431
---------- ----------
Property and equipment, at cost:
Laboratory equipment 2,146,558 2,126,771
Office furniture and equipment 1,239,665 982,948
Leasehold improvements 1,567,513 1,367,784
---------- ----------
4,953,736 4,477,503
Accumulated depreciation and
amortization 3,363,525 2,894,782
---------- ----------
Property and equipment - net 1,590,211 1,582,721
---------- ----------
Other assets:
Patent application costs, net of
accumulated amortization of $261,985 at
September 30, 2002 and $213,105 at
December 31, 2001 694,473 619,676
Deferred financing costs, net of accumulated
amortization of $93,249 at September 30, 2002
and $1,983 at December 31, 2001 193,926 57,517
Security deposit - New Jersey location 639,000 598,000
Deposits and other assets 26,170 135,256
---------- ----------
Total other assets 1,553,569 1,410,449
---------- ----------
Total Assets $3,589,084 $4,038,601
========== ==========
* Derived from audited financial statements.
See notes to condensed unaudited financial statements.
1
ORTEC INTERNATIONAL, INC.
(A DEVELOPMENT STAGE ENTERPRISE)
BALANCE SHEETS
SEPTEMBER 30, DECEMBER 31,
2002 2001*
---- ----
(Unaudited)
LIABILITIES AND SHAREHOLDERS' EQUITY/(DEFICIT)
Current liabilities:
Accounts payable and accrued
liabilities $ 4,110,905 $ 2,444,945
Accrued compensation 238,383 223,393
Accrued professional fees 457,082 301,783
Accrued interest 167,011 460,964
12% Convertible debentures due
April 30, 2003 - net 1,884,590
12% Debentures due April 30, 2003 - net 597,000
Long-term liabilities - current 238,434 143,505
------------ ------------
Total current liabilities 7,693,405 3,574,590
------------ ------------
Long-term liabilities - noncurrent 13,490,068 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 September 30, 2002
and December 31, 2001 9,712 9,712
Additional paid-in capital 56,264,236 53,017,615
Deficit accumulated during the
development stage (75,560,812) (59,154,654)
Treasury stock, at cost (20,000 shares at
June 30, 2002 and December 31, 2001) (177,645) (177,645)
------------ ------------
Total shareholders' equity/(deficit) (19,464,509) (6,304,972)
------------ ------------
Total Liabilities and
Shareholders' Equity $ 3,589,084 $ 4,038,601
============ ============
* Derived from audited financial statements.
See notes to condensed unaudited financial statements.
2
ORTEC INTERNATIONAL, INC.
(A DEVELOPMENT STAGE ENTERPRISE)
STATEMENTS OF OPERATIONS
(Unaudited)
Nine months Cumulative from
Quarter ended September 30, ended September 30, March 12, 1991
---------------------------- -------------------------- (inception) to
2002 2001 2002 2001 September 30, 2002
---- ---- ---- ---- ------------------
Product revenue $ 34,825 $ -- $ 243,775 $ -- $ 265,665
------------ ------------ ------------ ------------ ------------
Expenses
Research and development 656,620 977,652 2,871,250 3,306,287 20,919,642
Rent 130,922 147,326 516,191 438,534 2,695,726
Consulting 92,053 565,015 436,331 1,105,578 5,662,846
Personnel 1,211,132 1,774,990 5,381,600 4,775,219 28,330,960
General and administrative 508,194 709,002 2,359,632 1,918,008 14,362,317
Interest and other expense 1,425,660 19,484 5,092,532 60,455 6,112,038
Interest income (283) (19,876) (7,603) (182,885) (2,257,052)
------------ ------------ ------------ ------------ ------------
4,024,298 4,173,593 16,649,933 11,421,196 75,826,477
------------ ------------ ------------ ------------ ------------
Net loss (3,989,473) (4,173,593) (16,406,158) (11,421,196) (75,576,895)
Preferred stock dividend -- -- -- -- --
------------ ------------ ------------ ------------ ------------
Net loss applicable to common
shareholders $ (3,989,473) $ (4,173,593) $(16,406,158) $(11,421,196) $(75,560,812)
============ ============ ============ ============ ============
Net loss per share
Basic and diluted $ (.41) $ (.43) $ (1.69) $ (1.18) $ (15.13)
============ ============ ============ ============ ============
Weighted average shares outstanding
Basic and diluted 9,691,608 9,691,608 9,691,608 9,691,608 4,993,826
============ ============ ============ ============ ============
See notes to condensed unaudited financial statements
3
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.
4
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.
5
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
6
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.
7
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.
8
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.
9
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 434,523 434,523
Warrants issued with convertible
redeemable preferred stock 559,289 559,289
Warrants issued with debentures 6,000 6,000
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 nine months
ended September 30, 2002 (16,406,158) (16,406,158)
--------- ------ ----------- ------------ --------- ------------
Balance - September 30, 2002 9,711,608 $9,712 $56,264,236 $(75,560,812) $(177,645) $(19,464,509)
========= ====== =========== ============ ========= ============
See notes to condensed unaudited financial statements.
10
ORTEC INTERNATIONAL, INC.
(A DEVELOPMENT STAGE ENTERPRISE)
STATEMENTS OF CASH FLOWS
(Unaudited)
Cumulative from
Nine months ended September 30, March 12, 1991
------------------------------- (inception) to
2002 2001 September 30, 2002
---- ---- ------------------
Cash flows from operating activities:
Net loss $(16,406,158) $(11,421,196) $(75,560,812)
Adjustments to reconcile net loss
to net cash used in operating
activities:
Depreciation and amortization 544,485 535,130 3,662,813
Amortization of deferred
financing costs 91,266 91,266
Unrealized loss on marketable
securities 11,404
Realized loss on marketable
securities 5,250
Non-cash stock compensation 106,260 168,390 3,147,431
Non-cash interest 4,797,023 5,251,798
Purchases of marketable securities (19,075,122)
Sales of marketable securities 19,130,920
Changes in operating assets and
liabilities
Accounts receivable (37,810) (59,700)
Other current assets and
other assets 180,398 25,840 10,884
Accounts payable and accrued
liabilities 1,967,072 235,711 4,971,709
------------ ------------ ------------
Net cash used in operating activities (8,757,464) (10,456,125) (58,412,159)
------------ ------------ ------------
Cash flows from investing activities:
Purchases of property and equipment,
excluding capital leases (234,452) (439,721) (4,624,889)
Payments for patent application (123,676) (37,672) (954,678)
Organization costs (10,238)
Deposits 2,548 (45,595) (728,725)
Purchases of marketable securities (594,986)
Sale of marketable securities 522,532
------------ ------------ ------------
Net cash used in investing activities (355,580) (522,988) (6,390,984)
------------ ------------ ------------
See notes to condensed unaudited financial statements.
11
ORTEC INTERNATIONAL, INC.
(A DEVELOPMENT STAGE ENTERPRISE)
STATEMENTS OF CASH FLOWS
(Unaudited)
Cumulative from
Nine months ended September 30, March 12, 1991
------------------------------- (inception) to
2002 2001 September 30, 2002
---- ---- ------------------
Cash flows from financing activities:
Proceeds from issuance of
notes payable $515,500
Proceeds from issuance of
convertible debentures $3,408,000 3,408,000
Proceeds from issuance of
redeemable preferred stock 1,200,000 1,200,000
Proceeds from issuance of
debentures 600,000 600,000
Proceeds from issuance of
common stock 53,550,522
Financing costs for convertible
debentures and preferred stock (413,980) (413,980)
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 $5,000,000 10,000,000
Repayment of capital lease
obligations (60,988) (168,192)
Repayment of loans payable (106,535) (98,269) (669,208)
Repayment of long term obligation (9,890) (9,890)
Repayment of notes payable (515,500)
---------- ---------- -----------
Net cash provided by (used in)
financing activities 8,616,607 4,901,731 65,160,731
---------- ---------- -----------
Net increase (decrease) in cash
and cash equivalents (496,437) (6,077,382) 357,588
Cash and cash equivalents at
beginning of period 854,025 9,292,478
---------- ---------- -----------
Cash and cash equivalents at
end of period $ 357,588 $3,215,096 $ 357,588
========== ========== ===========
See notes to condensed unaudited financial statements.
12
ORTEC INTERNATIONAL, INC.
(A DEVELOPMENT STAGE ENTERPRISE)
STATEMENTS OF CASH FLOWS
(Unaudited)
Nine months ended September 30, Cumulative from
------------------------------ March 12, 1991
(inception) to
2002 2001 September 30, 2002
---- ---- ------------------
Supplemental disclosure of
cash flow information:
Non-cash financing activities
Capital lease obligations $ 268,644 $ 387,547
Forgiveness of rent payable 40,740
Share issuance
expenses - warrants 255,000
Warrants issued with debentures 434,523 434,523
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 31,043 $60,455 518,584
Cash paid for income taxes 31,589 199,576
See notes to condensed unaudited financial statements.
13
ORTEC INTERNATIONAL, INC.
(a development stage enterprise)
NOTES TO FINANCIAL STATEMENTS (UNAUDITED)
September 30, 2002 and 2001
NOTE 1 - FINANCIAL STATEMENTS
The condensed balance sheet as of September 30, 2002, and the condensed
statements of operations for the three and nine month periods, and the
statements of shareholders' equity and cash flows for the nine month periods
ended September 30, 2002 and 2001, and for the period from March 12, 1991
(inception) to September 30, 2002, have been prepared by the Company and are
unaudited. In the opinion of management, all adjustments (which include only
normal recurring accrual adjustments) necessary to present fairly the financial
position as of September 30, 2002, results of operations for the three and nine
month periods ended September 30, 2002 and 2001, and stockholders equity and
cash flows for the nine month periods ended September 30, 2002 and 2001, have
been made. Certain information and footnote disclosures normally included in the
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 nine month
periods ended September 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
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, as the Company has been focusing its effort and resources
towards its clinical trials for the use of OrCel for the treatment of venous
stasis ulcers.
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 has assisted
the Company in raising financing of approximately $8.7 million. On May 13, 2002,
the Company secured the first $2.3 million of this financing, in the form of 12%
convertible debentures, which is convertible into common shares at the lesser of
$3.36 or the price per share of the equity securities to be issued in a
subsequent financing. On June 28, 2002, $0.6 million of these debentures was
converted into equity securities. The Company also issued 291,000 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. On June 28, 2002,
an additional $1.5 million of financing was secured, which consists of $1.2
million in Series A convertible preferred stock and $.3 million in 12%
convertible debentures. 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. In August and September 2002, the Company raised
an additional $0.8 million in convertible debentures and $0.6 million in notes,
with terms similar to those raised in the May 13, 2002 and June 28, 2002
financings.
Subsequent to September 30, 2002, the Company has raised an additional $0.5
million in notes and on November 13, 2002 closed on its Series B Convertible
Preferred Stock financing, receiving cash of an additional $2.5 million, which
included convertible debentures of $1.6 million. All the financings raised to
date, except for the last mentioned $1.6 million of convertible debentures, has
been converted into, or consisted of purchases of, the Series B Convertible
Preferred Stock upon final closing on November 13, 2002. In addition, the
warrants issued with the Series A convertible preferred stock at September 28,
2002, were exchanged for new warrants issued as part of the Series B Preferred
Stock financing. The $1.6 million convertible debentures received on November
13, 2002, will convert into Series B Convertible Preferred shares if an
anticipated additional investment of at least $1.7 million in Series B
Convertible Preferred Stock is not secured by December 13, 2002. If the
additional investment is received, based on commitments received to date, the
Company anticipates that some of the $1.6 million convertible debentures will be
converted, resulting in additional Series B Preferred investment of
approximately $1.0 million. The Company expects to complete this financing with
H.C. Wainwright before December 31, 2002. Certain of the
15
investors were also given options to purchase, for one year and for amounts
ranging from 100% to 200% of their loans, shares of the Series B Convertible
Preferred Stock at the price paid for such stock by investors on November 13,
2002.
The Series B preferred stock is convertible into common shares at any time at
the option of the investor, based on a fixed conversion rate of $1.00, or
commencing after February 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 of $0.25. The fixed conversion rate may be adjusted
downward if the Company subsequently issues common stock at a purchase price
less than $0.50. In that event, the fixed conversion rate will be adjusted
downward to the price of the new issuance. 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 $2.00 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.
The alternative conversion price is adjustable or cancelable under certain
circumstances, such as, in the event that the Company receives a licensing fee
and/or a strategic investment of at least $5.0 million within six months of
closing, the alternative conversion rate is adjusted to the common share price
of the investment or is cancelled if the share price exceeds the fixed rate of
$1.00. If within six months from date of issue, the Company receives a licensing
fee with an upfront payment of at least $5.0 million, the alternative conversion
rate is adjusted to the quoted closing stock price on the day of the public
announcement or is cancelled if this closing price exceeds $1.00. 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.00, if lower. Dividends
will be paid in advance in common shares at the rate of 12% in the first year
after issue and semiannually in subsequent years, in either cash or common
shares, 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, were exercised immediately upon
closing of the purchase of the Series B Preferred Stock. The B-1 warrants are
exercisable nine months after closing at $1.50 per share and the B-2 warrants
are exercisable at $2.00 per share, twelve months after closing. The B-1 and B-2
warrants are both seven year warrants and are redeemable by the Company at $0.10
per share, twelve months and twenty-four months after issuance, respectively, if
the Company's common shares closes above $3.00 and $4.00, respectively, for 15
consecutive trading days.
We required 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 September 30, 2002, (approximately $0.4 million) and the financing of $3.0
million received in October and November 2002, will enable us to continue our
operations until March 1, 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
16
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. 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 OrCel product. 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 September 30, 2002, an aggregate of 3,923,031 outstanding warrants and
options were excluded from the weighted average share calculations, as the
effect was antidilutive. As of September 30, 2001, an aggregate of 2,233,329
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 2,595,935 and 1,246,747 shares of
common stock would be issuable upon conversion of the debentures and preferred
stock at September 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 received $10.0 million. $6.0 million was received in 2001
with the remaining $4.0 million in January 2002. 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 was contingent upon completion of the current financing with H.C.
17
Wainwright, which has been satisfied with the closing of the Series B Preferred
Stock on November 13, 2002. 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 September 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. 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 made by the Company to Paul Capital based on
sales generated under the Royalty Revenue Interest Assignment.
18
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, and an additional $250,000 on June 28, 2002. During the 3rd quarter
2002, the Company issued $825,000 in convertible debentures and $600,000 in
notes, with terms comparable to those issued in the 2nd quarter. These
debentures are payable April 10, 2003 and bear interest at the rate of 12% per
annum, up to October 10, 2002 and 18% thereafter. The Company deferred the
payment of interest due on June 30 and September 30, 2002, pending the
completion of the Series B Preferred Stock financing. These debentures along
with the accrued interest were convertible into equity securities if the Company
completed the sale of at least $5.0 million in equity securities by July 12,
2002. The debenture holders have agreed to extend this conversion date
requirement, and on November 13, 2002, these debentures and accrued interest
were converted into preferred stock with the closing of the Series B Preferred
Stock financing on November 13, 2002. These were converted at the rate of 110%
of the debentures plus accrued interest into $10,000 par value Series B
Convertible preferred shares.
The convertible debentures did offer the holder the option of converting into
the Company's common shares at the rate of $3.36 or the price per share of the
equity securities in the Series B Preferred Stock financing, described above.
The debenture holders were also granted five-year warrants to purchase an
aggregate of 501,002 shares of the Company's common stock at an exercise price
of $4.50 per share. These warrants provide for "price protection", so that the
exercise price is reduced if the Company sells common stock in the future at a
lower price, 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 these warrants of $434,523 was recorded as
debt discount, as well as the estimated fair value of the conversion feature of
$1,042,663. Both of these values are being amortized over the remaining life of
the convertible debentures.
NOTE 6 - AMENDMENT OF CERTIFICATE OF INCORPORATION AND ISSUANCE OF REDEEMABLE
CONVERTIBLE PREFERRED STOCK
On June 25, 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
19
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 dividends 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.
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.
On November 7, 2002, the Company's board of directors adopted an amendment to
the Company's certificate of incorporation designating 2,000 shares out of the
1,000,000 shares of preferred stock, as Series B Convertible Preferred Stock at
a stated value of $10,000 per share. Dividends on the Series B Preferred shares
is payable at the rate of 12% per annum, in cash or shares of common stock, at
the option of the Company, except that in the first year, dividends are payable,
in advance, in shares of common stock.
On November 13, 2002, all outstanding shares of Series A Convertible Preferred
stock, as well as, all outstanding convertible debentures and notes, were
converted to shares of Series B Convertible Preferred stock. Additionally, the
Company received $0.9 million in new investments in Series B Convertible
Preferred stock and $1.6 million in convertible debentures, which may convert
into Series B Convertible Preferred stock, if an anticipated additional
investment of at least $1.7 million is not secured by December 13, 2002.
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 September 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
20
the three and nine-month periods ended September 30, 2002.
The relative estimated fair value of the warrants of $797,919 was recorded as a
discount to the preferred stock and was reflected as interest expense in the
nine months ended September 30, 2002. Additionally, in the nine months ended
September 30, 2002, the estimated fair value of the beneficial conversion
feature of $859,256 has been recorded as an additional discount and reflected as
interest expense.
NOTE 7 - LEGAL PROCEEDINGS, CLAIMS AND OTHER CONTINGENCIES
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 we have been delinquent in payment of
rent. The Company has reduced the amount of the space leased from Columbia
University, as part of our program to reduce spending. The Company is now
negotiating a pay out of the remainder of our unpaid obligations to Columbia.
The Company's ability to make such payment is dependent on our ability to secure
the additional equity financing, noted above.
ClinTrials Networks, LLC (ClinTrials) 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. During the quarter ended September
30, 2002, ClinTrials commenced an arbitration proceeding against the Company,
claiming that we owe them $165,936 and that they reserve the right to claim
additional amounts from us, based on continuing additional monthly fees
ClinTrials claims that it is entitled to receive under their agreement with us.
The Company has denied ClinTrials' claim and has advised ClinTrials that it is
not in breach of its contract. The Company has reserved its right to file a
counterclaim for overpayment under the terms of the contract.
During the quarter ended September 30, 2002, PDI, Inc. commenced an action
against the Company in the Superior Court of New Jersey, Bergen County, claiming
that the Company owes $205,000 to PDI for services that they have performed for
us. Though we have not yet filed an answer to the Court in that proceeding, we
are in the process of discussing a settlement of the amount claimed with PDI.
On August 5, 2002, the Company 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
21
on the Nasdaq SmallCap market. On July 1, 2002, the Company appealed that
determination and requested an oral hearing before the 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 its plan to raise
sufficient capital to provide for the Company's cash needs for the next twelve
months and enable the Company to meet Nasdaq's requirements for continued
listing of its common stock on the Nasdaq SmallCap market. Nasdaq denied the
Company's request and the Company's stock was moved to the National Association
of Securities Dealers' Bulletin Board and as such still meets the listing
requirements of the Company's debentures and preferred stock holders.
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 nine months
ended September 30, 2002, the Company financed $268,644 of equipment purchases
under this financing, which was accounted for as a sales-leaseback. In October
2002, the Company financed an additional $180,797 in equipment purchases in this
manner.
NOTE 9 - STOCK OPTIONS AND WARRANTS
The following represents stock option and warrant activity during the nine
months ended September 30, 2002:
Stock Options Warrants Total
------------- -------- -----
Balance at December 31, 2001 2,033,306 395,412 2,428,718
Granted 554,609 1,468,626 2,023,235
Exercised - - -
Expired or cancelled (251,092) (177,830) (428,922)
--------- --------- ---------
Balance at September 30, 2002 2,336,823 1,686,208 4,023,031
========= ========= =========
During the three and nine months ended September 30, 2002, there were no options
and 56,000 options, respectively, 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
22
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.
Pursuant to the Company's agreement with the placement agent who arranged for
the sale of the debentures, the Series A Preferred stock and the Series B
Preferred shares, the Company granted to the placement agent 800,000 warrants at
an exercise price of $.001 per share and 500,000 warrants at an exercise price
of $1.50 per share. The 800,000 warrants expire 5 days after the effective date
of a registration statement to be filed by the Company qualifying the common
stock issuable upon exercise of all those warrants for sale in the public
securities markets.
Based upon a financial consulting services agreement, the Company was obligated
to grant 3 year warrants to purchase 300,000 shares of the Company's common
stock at exercise prices of $3.50 for the first 100,000 shares, $5.50 for the
second 100,000 shares and $7.50 for the third 100,000 shares. These warrants
vest as to each 100,000 share tranche on June 1, 2002, December 1, 2002 and on
June 1, 2003. This agreement was terminated, and as such, the warrants
associated with tranche 2 and 3, which vest on December 1, 2002 and June 1,
2003, have been cancelled. During the 2nd quarter, the Company had accrued
$143,083 in expense related to these warrants. $16,083 of this accrual was
reversed in the 3rd quarter as a result of this cancellation.
NOTE 10 - 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 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 operation. 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 31, 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 Statements
No.4, which required all gains and losses from extinguishments of debt to be
aggregated and, if material, classified as an extraordinary item, net of the
related income tax effect. Upon adoption of SFAS No.145,
23
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 extinguishments 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 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
N0.146"). 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
results of operations and financial position.
Item 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIALCONDITION AND RESULTS OF OPERATIONS
Forward Looking Information May Prove Inaccurate
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
24
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
$75.6 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 first
quarter of 2003, with submission of the FDA filing in the second quarter. 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 sufficient 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 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. 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. Additionally, all research and development costs, including
consulting and personnel costs, relating to products under development, are
expensed as incurred.
25
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
SFAS No.145, "Rescission of FASB Statements No.4, 44 and 64, Amendment of SFAS
No.13 and Technical Corrections". SFAS No.145 rescinds Statement No.4, which
requires 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 the statement on
its results of operations and financial position.
On July 30, 2002, the FASB issued SFAS No.146, "Accounting for Costs Associated
with Exit or Disposal Activities". The standard requires companies to recognize
costs associated with exit or disposal activities when they are incurred, rather
than at a date of a commitment to an exit or disposal plan. Example of costs
covered by the standard include lease termination costs and certain employee
severance costs that are associated with a restructuring, discontinued
operations, plant closing, or other exit or disposal activity. SFAS No.146 is to
be applied prospectively to exit and disposal activities initiated after
December 31, 2002. The Company is currently evaluating the requirements and
impact of this statement on its results of operations and financial position.
26
Results of Operations
Three and Nine Months Ended September 30, 2002, and September 30, 2001.
Revenues
We earned revenues of approximately $35,000 in the 2002 quarter, and $244,000
for the nine months ended September 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 nine
months ended September 30, 2001.
Expenses
Expenses decreased by approximately $.1 million in the quarter from
approximately $4.2 million in 2001 to approximately $4.1 million in 2002 and
increased by $5.0 million in the nine-month period from approximately $11.4
million in 2001 to approximately $16.7 million in 2002.
Personnel. Personnel costs decreased by approximately $.6 million in the quarter
from $1.8 million in 2001 to $1.2 million in 2002, and increased by $0.6 million
in the nine-month period from $4.8 million in 2001 to $5.4 million in 2002. The
increased expense in the nine-month period 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 and for commercial sales, 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. In July 2002, management
decided to defer the implementation of the diabetic clinical trial, as well as
to reduce production of product for commercial sales. This decision resulted in
a significant reduction in personnel costs in the 2002 third quarter compared
with the comparable period in 2001. These changes in personnel levels also
resulted in comparable changes in the amount of space leased, resulting in a
decrease in rent expense in the quarter and an increase in rent expense in the
nine-month period.
Consulting. These fees decreased by $.5 million in the quarter and $.7 million
in the nine months ended September 30, 2002 compared with the nine months ended
September 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 $.3 million
in the
27
quarter and $.4 million in the nine months ended September 30, 2002 compared
with the quarter and nine months ended September 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. Additionally, management's decision to reduce production of
fresh product for commercial sales has resulted in decreased costs in the
current periods. This decrease was partially offset by the higher costs incurred
in 2002 relevant to producing cryo OrCel for the larger venous stasis clinical
trial.
General and Administrative. These expenses decreased by $.2 million in the
quarter and increased by $.5 million in the nine months ended September 30,
2002, compared with the similar periods in 2001. The increase in the nine-month
period was primarily due to increased marketing, recruitment, insurance and
other expenses incurred, as Ortec prepared for commercial sales of its product
and continues its financing activities. As noted above, the decision to reduce
fresh OrCel production in the current quarter has resulted in decreased
marketing and recruitment expenses in the 2002 quarter.
Interest Expense. Interest expense increased by $1.4 million in the quarter and
by $5.0 million in the nine months ended September 30, 2002, compared with the
expense incurred in the quarter and nine months ended September 30, 2001, due to
the imputed interest accrued on the Paul Capital agreement, and interest accrued
on convertible debentures issued in May 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 $2.3 million
in interest expense has been accrued in the nine months ended September 30,
2002. Interest expense of $0.2 million was accrued as a result of the issuance
of convertible debentures and notes in the 2nd and 3rd quarters. Additionally,
interest of $2.4 million was recorded due to the beneficial conversion feature
and warrants issued on the convertible preferred stock.
Interest Income. Interest income declined by approximately $20,000 in the
quarter and $175,000 in the nine months ended September 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 September 30, 2002, Ortec has
accumulated a deficit of approximately $75.6 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 at the end of 1997. From inception to
September 30, 2002, we received cash proceeds from the sale of equity
securities,
28
net of share issuance expenses, of approximately $51.2 million, we received net
proceeds from the issuance of debentures of $4.0 million and we have 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, which contingency was
fulfilled with the closing of the Series B Preferred Stock financing on November
13, 2002. 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.
For the nine months ended September 30, 2002, we used net cash for operating
activities of approximately $8.8 million. Cash used in operating activities
resulted primarily from our net loss of $16.4 million, offset by depreciation
and amortization of approximately $636,000, approximately $4.8 million of
non-cash interest expense and an increase in accounts payable and accrued
expenses of approximately $2.0 million.
In the nine months ended September 30, 2002 we invested approximately $358,000
in property, plant, equipment and patent application costs. In 2001, we
received a $1,300,000 line of credit from GE Capital for equipment lease
financing, and in January 2002 we financed $268,000 of purchases of fixed
assets. These proceeds are available to be utilized in financing manufacturing
equipment purchases in 2002, and in October 2002, we financed an additional
$180,797 in equipment purchases.
We repaid $177,000 of our loans payable and long-term debt during the nine
months ended September 30, 2002. We did not sell our common stock, however we
did receive $4.0 million under our agreement with Paul Capital Royalty
Acquisition Fund, L.P. and $5.2 million in our convertible debentures, notes 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. On August
5, 2002, we reached an agreement with NJEDA to terminate the December 2001 lease
and enter into a new lease for approximately 26,000 square feet of manufacturing
and office space. The new lease began on August 1, 2002 and will 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, has
29
been applied as a security deposit on the new lease. All construction costs
advanced by 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, 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 September 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 was
contingent upon completion of the current financing with H.C. Wainwright, which
contingency has been satisfied by the closing of the Series B Preferred Stock
financing on November 13, 2002. 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.
30
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.
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 has assisted
the Company in raising financing of approximately $8.7 million. On May 13, 2002,
the Company secured the first $2.3 million of this financing, in the form of 12%
convertible debentures, which is 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. On June 28, 2002, $0.6 million of these
debentures was converted into equity securities. The Company also issued
291,000 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. On
June 28, 2002, an additional $1.5 million of financing was secured, which
consists of $1.2 million in Series A convertible preferred stock and $.3 million
in 12% convertible debentures. 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. In August and September 2002,
the Company raised an additional $0.8 million in convertible debentures and $0.6
million in notes, with terms similar to those raised in the May 13, 2002 and
June 28, 2002 financings.
Subsequent to September 30, 2002, the Company has raised an additional $0.5
million in notes and on November 13, 2002 closed on its Series B Preferred Stock
financing, receiving cash of an additional $2.5 million. Except for $1.6 million
of funds from the November 13, 2002 closing, all the financings raised to date,
beginning with the May 13, 2002 financing, including accrued interest thereon,
have been converted into or invested in the Series B Convertible Preferred Stock
upon final closing on November 13, 2002. In addition, the warrants issued with
the Series A convertible preferred stock at September 28, 2002, were exchanged
for new warrants issued as part of the Series B Preferred Stock financing.
Included in the November 13, 2002 closing are $1.6 million of convertible
debentures, which bear interest at 12 1/2 %. In the event that prior to December
13, 2002, we receive an additional $1.7 million Series B Preferred Stock
investment from another investor, these debenture-holders have the option of
seeking repayment on their debentures or converting them into Series B
convertible preferred stock at the rate of 125% of principal plus accrued
interest thereon. If we do not receive such $1.7 million Series B Preferred
stock investment from another investor by December 13, 2002, such $1.6 million
of convertible debentures will automatically convert into Series B Preferred
Stock and warrants at the rate of 125% of the $1.6 million principal amount plus
accrued interest. Based on commitments received to date, the Company expects to
raise an additional $1.0 million from the sale of Series B preferred stock and
complete this financing with H.C. Wainwright before December 31, 2002.
The Series B preferred stock is convertible into common shares at any time at
the option of the
31
investor, based on a fixed conversion rate of $1.00 or commencing after February
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 of
$0.25. The fixed conversion rate may be adjusted downward if the Company
subsequently issues common stock at a purchase price less than $0.50. In that
event, the fixed conversion rate will be adjusted downward to the price of the
new issuance. 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 $2.00 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. The alternative conversion
price is adjustable or cancelable under certain circumstances, such as, in the
event that the Company receives a licensing fee and/or a strategic investment of
at least $5.0 million, within six months of closing, the alternative conversion
rate is adjusted to the common share price of the investment or is cancelled if
the share price exceeds the fixed rate of $1.00. If within six months from date
of issue, the Company receives a licensing fee with an up front payment of at
least $5.0 million, the alternative conversion rate is adjusted to the quoted
closing stock price on the day of the public announcement or is cancelled if
this closing price exceeds $1.00. 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.00, if lower. Dividends will be paid in advance in
common shares at the rate of 12% in the first year after issue and semiannually
in subsequent years, in either cash or common shares, 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 $1.50 per share and the Series B-2 warrants are exercisable at $2.00
per share, twelve months after closing. The Series B-1 and B-2 warrants are also
redeemable by the Company at $0.10 per share, twelve months and twenty-four
months after issuance, respectively, if the Company's common shares closes above
$3.00 and $4.00, respectively, for 15 consecutive trading days.
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 and debentures 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
32
sources. The success of such efforts will depend in large part upon continuing
developments in our clinical trials and upon market conditions.
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 September 30, 2002, (approximately $.4 million) and the additional financing
received subsequent to September 2002 of approximately $4.4 million, as well as
additional funds anticipated from the sale of additional Series B Preferred
Stock before December 31, 2002, will enable us to continue our operations until
March 1, 2003. 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
in the 1st quarter of 2003. We believe that the additional anticipated
financing to be realized from these efforts will enable us to continue our
operations for the next 12 months.
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.
33
Item 4. Controls and Procedures
1. Evaluation of disclosure controls and procedures.
The Company's chief executive officer and its chief financial officer,
after evaluating the effectiveness of the Company's disclosure controls and
procedures (as defined in Exchange Act Rules 13a-14(c) and 15-d-14(c) as of a
date within 90 days of the filing date of the quarterly report (the "Evaluation
Date") have concluded that as of the Evaluation Date, the Company's disclosure
controls and procedures were adequate and effective to ensure that material
information relating to the Company and its consolidated subsidiaries would be
made known to them by others within those entities, particularly during the
period in which this quarterly report was being prepared.
2. Changes in internal controls.
There were no significant changes in the Company's internal controls or
in other factors that could significantly affect the Company's disclosure
controls and procedures subsequent to the Evaluation Date, nor any significant
deficiencies or material weaknesses in such disclosure controls and procedures
requiring corrective actions. As a result, no corrective actions were taken.
PART II
Item 1. Legal Proceedings and Claims
1. In the quarter ended September 30, 2002, ClinTrials Networks, Inc.
commenced an arbitration proceeding against us claiming that we owe ClinTrials
$165,936. ClinTrials reserved the right to claim additional amounts from us
based on additional monthly fees ClinTrials claims it is entitled to receive
under ClinTrials' agreement with us. We have denied ClinTrials' claim and have
reserved our right to file a counterclaim for overpayment.
2. In that same quarter, PDI, Inc. commenced an action against us in
the Superior Court of New Jersey, Bergen County, claiming that we owe PDI
$205,000 for services PDI performed for us. We have not yet filed an answer in
that proceeding, but we are in the process of discussing a settlement of the
amount claimed with PDI.
Item 2. Changes in Securities
(c) Recent Sales of Unregistered Securities
34
1. During the three month period ended September 30, 2002, we continued
the bridge loan financing described in our report on Form 10-Q for the
three-month period ended June 30, 2002. In August and September 2002, we
borrowed $1,425,000 from nine institutional investors. We borrowed an additional
$490,000 in October 2002 as part of that same bridge loan financing. We issued
notes to those investors for such loans. On November 13, 2002, notes previously
issued by us in the bridge loan financing ($4,498,000 in aggregate), interest
accrued thereon and shares of our Series A Convertible Preferred Stock were all
converted to our Series B Convertible Preferred Stock. Such conversions resulted
in our issuance of 631.562 shares of our Series B Convertible Preferred Stock, A
warrants which were immediately exercised for 6,315,623 shares of our common
stock, seven year B-1 warrants for the purchase of 3,696,316 shares of our
common stock and seven year B-2 warrants for the purchase of 3,157,816 shares of
our common stock. At such time warrants which were granted with the Series A
Convertible Preferred Stock were exchanged for warrants which were issued as
part of the Series B Convertible Preferred Stock financing.
As part of the November 13, 2002 financing, we also sold 88
shares of our Series B Convertible Preferred Stock for an aggregate of $880,000,
and issued warrants to purchase shares of our common stock, which included A
warrants to purchase an aggregate of 880,000 shares of our common stock at an
exercise price of $0.001 per share, which were exercised immediately, and
440,000 B-1 warrants and 440,000 B-2 warrants. All B-1 and B-2 warrants are not
exercisable until 9 and 12 months, respectively, after such November 13, 2002
date of issuance, are exercisable at prices of $1.50 and $2.00 per share,
respectively, and expire in seven years.
In addition, on November 13, 2002, as part of our Series B
Convertible Preferred Stock financing we borrowed $1,600,000 from 5
institutional investors. We issued notes for such loans which bear interest at
the rate of 12 1/2% per annum. In the event that prior to December 13, 2002, a
different investor purchases at least $1,750,000 of our Series B Convertible
Preferred Stock on the same terms as the investors who purchased such Series B
Convertible Preferred Stock on November 13, 2002, at the option of each note
holder the note plus accrued interest will be repaid or 125% of the amount of
note plus accrued interest will be converted into our Series B Convertible
Preferred Stock, on the same terms that the investors in the November 13, 2002
Series B Convertible Preferred Stock financing purchased such Series B
Convertible Preferred Stock. If such different investor does not, prior to
December 13, 2002, invest at least $1,750,000 in Series B Convertible Preferred
Stock, then 125% of the amount of the note plus accrued interest, will
automatically be converted into our Series B Convertible Preferred Stock on the
same terms as purchased by the November 13, 2002 investors.
Certain of the investors were also given the option for a period
of one year to purchase for amounts ranging from 100% to 200% of their loans,
shares of our Series B Convertible Preferred Stock at the price we sold such
shares on November 13, 2002.
35
The stated value, which is also the Liquidation Preference of
the Series B Convertible Preferred Stock, is $10,000 per share. We are required
to pay dividends on each of the Series B Preferred shares, out of our assets
legally available therefore, at the rate of 12% per annum of the $10,000
Liquidation Preference price. Except for the first year, at our option, such
dividends may be paid in cash or common stock at the "conversion price". We paid
the dividends for the first year in advance at the November 13, 2002 closing, in
our common stock.
The fixed conversion price at which the holders of our Series B
Convertible Preferred shares may convert their Series B Convertible Preferred
shares into our common stock, is $1.00 per share for our common stock.
Commencing February 1, 2003, the holder may elect to convert its Series B
Preferred shares plus accrued dividends at an "Alternative Conversion Price"
which shall be 90% of the average of the five lowest volume weighted average
prices for our common stock during the 20 days immediately prior to conversion,
but not less than $0.25 per share of common stock nor more than the fixed
conversion price. The Alternative Conversion Price will be cancelled prior to
May 13, 2003 if (i) we sell shares of our common stock in a financing in which
aggregate cash proceeds to us are not less than $5,000,000 and the price at
which each share of common stock is sold is not less than $1.00, (ii) we receive
at least $5,000,000 as an up-front payment for a licensing fee from a third
party, or (iii) in certain other events. There is price protection for the fixed
conversion price in certain events. The fixed conversion price might be reduced
if we sell shares of our common stock in the future at a price that is lower,
or the exercise price of any warrants or options to purchase our common stock
which we may grant in the future is lower or the conversion price for the
conversion of other securities (we may issue in the future) to our common
stock, is lower than the then fixed conversion price for the Series B
Preferred shares or lower than a specified figure. Such price protection will
not apply in an underwritten public offering where we receive gross proceeds
of at least $5,000,000 and if our common stock in such public offering is sold
for not less than $1.00 per share. The holders of the Series B Convertible
Preferred Stock may compel us to redeem their shares upon the occurrence of
certain events, at $12,000 or $15,000 per Series B Preferred share, plus
accrued dividends, depending on the event which triggers the holders' rights
to compel redemption.
2. On August 7, 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 1,200 shares out of
the 1,000,000 shares of preferred stock we are authorized to issue, as Series B
Convertible Preferred Stock, and designating the relative rights and preferences
of the Series B Convertible Preferred Stock, as discussed above.
We intend to secure stockholder approval for an amendment to our
certificate of incorporation to increase the number of shares of our common
stock we will be authorized to issue from 35,000,000 to 200,000,000, to be able
to issue all the shares of common stock we may have to issue if all of the
Series B Convertible Preferred Stock are converted to shares of
36
our common stock, if the warrants we have granted in these transactions are
exercised and for any future financing. We intend to secure such shareholder
approval at the next annual meeting of our shareholders, which we intend to
schedule for January 2003. We also are required to qualify all of the shares of
our common stock issuable upon conversion of the Series B Convertible Preferred
Stock, and issuable upon the exercise of the warrants we granted in this series
of financings, 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. If we do not secure shareholder
approval to increase the number of shares of our common stock we are authorized
to issue, so that we can issue all the shares of our common stock we may
ultimately be required to issue as a result of these transactions, we will
suffer monetary penalties.
3. Pursuant to our agreement with the placement agent who arranged for
the financings which resulted in the issuance of our Series B Convertible
Preferred Stock, we granted to such placement agent warrants to purchase 800,000
shares of our common stock at a price of $0.001 per share, expiring at the later
of January 31, 2003, or 5 days after the effective date of a registration
statement qualifying the sale of such 800,000 shares in the public securities
markets. We also granted the placement agent seven year warrants to purchase
500,000 shares of our common stock at a price of $1.50 per share.
4. The sale of all such notes and preferred shares and the grant of
all such warrants, as described in this Item 1of 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 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.
5. During the third quarter of 2002 we granted to 39 full-time
employees, including two of our executive officers, and to three of our
directors, options under our Employee Stock Option Plan, expiring for periods
ranging from 2 to 7 years after the date of grant, to purchase an aggregate of
360,459 shares of our common stock, at exercise prices ranging from $0.31 to
$1.00 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
During the third quarter our common stock was delisted from trading on
the Nasdaq SmallCap market. Our common stock is currently being traded on the
National Association of Securities Dealers' Bulletin Board.
37
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)
3.5 Amendment to Certificate of Incorporation filed on August 26,
2002, being an Amended Certificate of Designation of the Relative
Rights and Preferences of the Series B Convertible Preferred
Stock (4)
99.1 Certification of Principal Executive Officer (4)
99.2 Certification of Principal Financial Officer (4)
- ---------------------
(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 as an Exhibit to our Form 10-Q for the quarter ended June 30, 2002.
(4) Filed herewith.
(b) Reports on Form 8-K
We did not file any reports on Form 8-K in the third quarter of 2002.
38
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: November 18, 2002 By: /s/ Steven Katz
------------------------------------
Steven Katz, PhD
Chairman and Chief Executive Officer
(Principal Executive Officer)
Date: November 18, 2002 By: /s/ Ron Lipstein
------------------------------------
Ron Lipstein
Chief Financial Officer
(Principal Financial Officer)
39
CERTIFICATIONS
I, Steven Katz, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Ortec International,
Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated subsidiaries,
is made known to us by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the effectiveness of
the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
the registrant's board of directors:
a) all significant deficiencies in the design or operation of internal controls
which could adversely affect the registrant's ability to record, process,
summarize and report financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls; and
40
6. The registrant's other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: November 18, 2002
By: /s/ Steven Katz
--------------------------------------------
STEVEN KATZ
Chairman and Chief Executive Officer
41
I, Ron Lipstein, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Ortec International,
Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
(a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated subsidiaries,
is made known to us by others within those entities, particularly during the
period in which this quarterly report is being prepared;
(b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
(c) presented in this quarterly report our conclusions about the effectiveness
of the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
the registrant's board of directors:
(a) all significant deficiencies in the design or operation of internal controls
which could adversely affect the registrant's ability to record, process,
summarize and report financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
(b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls; and
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6. The registrant's other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: November 18, 2002
By: /s/ Ron Lipstein
-------------------
RON LIPSTEIN
Chief Financial Officer
43
STATEMENT OF DIFFERENCES
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The trademark symbol shall be expressed as............................. 'TM'