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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
----------
FORM 10-Q
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(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 FOR THE QUARTER ENDED JUNE 30, 2003
[_] 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 of (I.R.S. Employer
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 [_]
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Indicate by check mark whether the issuer is an accelerated filer (as defined in
Rule 12b-2 of the Exchange Act).
Yes [_] No [X]
----------
The number of shares outstanding of the issuer's common stock is 4,496,499,
after giving effect to a one share for ten shares reverse stock split effective
5 PM EDT on June 24, 2003, (as of August 14, 2003)
ORTEC INTERNATIONAL, INC.
INDEX TO QUARTERLY REPORT ON FORM 10-Q
FILED WITH THE SECURITIES AND EXCHANGE COMMISSION
QUARTER ENDED JUNE 30, 2003
ITEMS IN FORM 10-Q
Facing Page Page
- ----------- ----
Part I
Item 1. Financial Statements (Unaudited). 1
Item 2. Management's Discussion and Analysis of Financial Condition and Results of
Operation. 20
Item 3 Quantitative and Qualitative Disclosures About Market Risk. None
Item 4 Controls and Procedures. 26
Part II
Item 1. Legal Proceedings and Claims. 26
Item 2. Changes in Securities and Use of Proceeds. 27
Item 3. Default Upon Senior Securities. None
Item 4. Submission of Matters to a Vote of Security Holders. None
Item 5. Other Information. None
Item 6. Exhibits and Reports on Form 8-K. 32
Signatures 30
Item 1. FINANCIAL STATEMENTS
ORTEC INTERNATIONAL, INC.
(A DEVELOPMENT STAGE ENTERPRISE)
BALANCE SHEETS
JUNE 30, DECEMBER 31,
2003 2002*
----------- ------------
(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 3,014,614 $ 826,227
Accounts receivable 5,374 15,324
Other current assets 35,869 41,904
----------- -----------
Total current assets 3,055,857 883,455
Property and equipment, at cost:
Laboratory equipment 1,671,700 1,671,075
Office furniture and equipment 1,351,110 1,350,985
Leasehold improvements 1,354,481 1,567,513
----------- -----------
4,377,291 4,589,573
Accumulated depreciation and amortization (3,487,158) (3,207,977)
----------- -----------
Property and equipment - net 890,133 1,381,596
----------- -----------
Other assets:
Patent application costs, net of accumulated
amortization of $314,057 at June 30, 2003 and
$279,037 at December 31, 2002 679,876 682,885
Deferred financing costs, net of accumulated
amortization of $10,908 at June 30, 2003 and
$7,933 at December 31, 2002 48,592 78,207
Security deposit - New Jersey location 16,000 639,000
Other deposits and other assets 23,669 33,223
----------- -----------
Total other assets 768,137 1,433,315
----------- -----------
$ 4,714,127 $ 3,698,366
=========== ===========
* Derived from audited financial statements.
See notes to condensed unaudited financial statements.
1
ORTEC INTERNATIONAL, INC.
(A DEVELOPMENT STAGE ENTERPRISE)
BALANCE SHEETS
JUNE 30, DECEMBER 31,
2003 2002*
------------ ------------
(Unaudited)
LIABILITIES AND SHAREHOLDERS' EQUITY/(DEFICIT)
Current liabilities:
Accounts payable and accrued expenses $ 3,654,832 $ 3,773,063
Accrued compensation 398,178 274,253
Accrued professional fees 355,105 365,945
Capital lease obligation - current 150,706 142,620
Loan payable - current 161,991 155,578
Advances payable 130,000
Other obligations 16,131,440 13,959,541
------------ ------------
Total current liabilities 20,982,252 18,671,000
Long-term liabilities:
Loan payable - noncurrent 530,774 613,405
Capital lease obligation - noncurrent 137,663 215,093
------------ ------------
Total Liabilities 21,650,689 19,499,498
------------ ------------
Commitments and contingencies
Shareholders' equity/(deficit):
Common stock, $.001 par value; authorized, 200,000,000 shares, 5,078,333
shares issued, 5,076,333 shares outstanding, at June 30, 2003 and 2,320,469
shares issued, 2,318,469 shares outstanding, at December 31, 2002 5,078 2,320
Preferred stock, $.001 par value; authorized, 1,000,000 shares,
Redeemable convertible preferred stock - Series B, stated value $10,000 per
share; authorized 1,200 shares; 533 shares issued and outstanding, at June
30, 2003 and 938 shares issued and outstanding, at December 31, 2002;
liquidation preference $5,328,852 at June 30, 2003 and $9,382,742
at December 31, 2002 2,899,461 5,037,087
Redeemable convertible preferred stock - Series C, stated
value $6,000 per share; authorized 2,000 shares;
890 shares issued and outstanding, at June 30, 2003,
liquidation preference $5,340,000 at June 30, 2003 3,466,338
Additional paid-in capital 71,544,945 61,195,715
Deficit accumulated during the development stage (94,674,739) (81,858,609)
Treasury stock, at cost (2,000 shares at June 30, 2003
and December 31, 2002 (177,645) (177,645)
------------ ------------
(16,936,562) (15,801,132)
------------ ------------
$ 4,714,127 $ 3,698,366
============ ============
Common stock shares and amount adjusted to reflect one for ten reverse stock
split declared on June 24, 2003
* Derived from audited financial statements.
See notes to condensed unaudited financial statements.
2
ORTEC INTERNATIONAL, INC.
(A DEVELOPMENT STAGE ENTERPRISE)
STATEMENTS OF OPERATIONS
(Unaudited)
Six months Cumulative from
Three months ended June 30, ended June 30, March 12, 1991
--------------------------- --------------------------- (inception) to
2003 2002 2003 2002 June 30, 2003
----------- ----------- ------------ ------------ ---------------
Product revenue $ -- $ 92,535 $ -- $ 208,950 $ 265,665
----------- ----------- ------------ ------------ ------------
Expenses
Research and development 501,974 1,060,793 858,239 2,214,630 22,054,146
Rent 91,607 210,038 336,572 385,269 3,199,223
Consulting 3,151 174,406 (29,131) 344,278 5,688,210
Personnel 1,049,865 2,097,025 2,020,435 4,170,468 31,410,754
General and administrative 515,570 941,356 1,145,592 1,851,439 15,930,173
Interest and other expense 1,153,732 2,882,691 2,222,283 3,666,872 10,522,893
Lease termination costs (11,077) 1,119,166 1,119,166
Loss on extinguishment of debt
and series A preferred stock 1,004,027
Interest income (29) (1,227) (14,698) (7,320) (2,271,794)
----------- ----------- ------------ ------------ ------------
3,304,793 7,365,082 7,658,458 12,625,636 88,656,798
----------- ----------- ------------ ------------ ------------
Net loss (3,304,793) (7,272,547) (7,658,458) (12,416,686) (88,391,133)
Preferred stock dividends 55,595 978,672 2,104,606
Preferred stock deemed dividends
and discounts 1,120,000 -- 4,179,000 -- 4,179,000
----------- ----------- ------------ ------------ ------------
Net loss applicable to common
shareholders $(4,480,388) $(7,272,547) $(12,816,130) $(12,416,686) $(94,674,739)
=========== =========== ============ ============ ============
Net loss per share
Basic and diluted $ (1.19) $ (7.50) $ (4.09) $ (12.81) $ (146.78)
=========== =========== ============ ============ ============
Weighted average shares outstanding
Basic and diluted 3,777,995 969,161 3,132,558 969,161 644,995
=========== =========== ============ ============ ============
Shares outstanding and per share amounts adjusted to reflect one for ten reverse
stock split declared on June 24, 2003
See notes to condensed unaudited financial statements.
3
Ortecc International, Inc.
(a development stage enterprise)
STATEMENT OF SHAREHOLDERS' EQUITY/(DEFICIT)
(Unaudited)
Common stock Preferred stock
---------------- -------------------
Shares Amount Series B Series C
------- ------ -------- --------
March 12, 1991 (inception) to December 31, 1991
Issuance of stock
Founders 155,382 $155
First private placement ($.03 cash per share) 21,744 22
The Director ($.12 and $.53 cash per share) 14,902 15
Second private placement ($.94 cash per share) 5,302 5
Share issuance expenses
Net loss
------- ----
Balance at December 31, 1991 197,330 197
Issuance of stock
Second private placement ($.94 cash per share) 4,932 5
Stock purchase agreement with the Director
($.94 cash per share) 3,182 3
Share issuance expenses
Net loss
------- ----
Balance at December 31, 1992 205,444 205
Issuance of stock
Third private placement ($1.00 cash per share) 13,215 13
Stock purchase agreement with Home
Insurance Company ($.94 cash per share) 11,111 11
Stock purchase agreement with the Director
($.09 cash per share) 2,122 2
Shares issued in exchange for commission
($1.00 value per share) 60 1
Share issuance expenses
Net loss
------- ----
Balance at December 31, 1993 (carried forward) 231,952 232
Deficit
accumulated
Additional during the Total
paid-in development Treasury shareholders'
capital stage stock equity/(deficit)
---------- ----------- -------- ----------------
March 12, 1991 (inception) to December 31, 1991
Issuance of stock
Founders $ 715 $ 870
First private placement ($.03 cash per share) 64,978 65,000
The Director ($.12 and $.53 cash per share) 249,985 250,000
Second private placement ($.94 cash per share) 499,995 500,000
Share issuance expenses (21,118) (21,118)
Net loss $ (281,644) (281,644)
---------- ----------- -----------
Balance at December 31, 1991 794,555 (281,644) 513,108
Issuance of stock
Second private placement ($.94 cash per share) 465,468 465,473
Stock purchase agreement with the Director
($.94 cash per share) 299,995 299,998
Share issuance expenses (35,477) (35,477)
Net loss (785,941) (785,941)
---------- ----------- -----------
Balance at December 31, 1992 1,524,541 (1,067,585) 457,161
Issuance of stock
Third private placement ($1.00 cash per share) 1,321,487 1,321,500
Stock purchase agreement with Home
Insurance Company ($.94 cash per share) 999,988 999,999
Stock purchase agreement with the Director
($.09 cash per share) 199,998 200,000
Shares issued in exchange for commission
($1.00 value per share) 5,999 6,000
Share issuance expenses (230,207) (230,207)
Net loss (1,445,624) (1,445,624)
---------- ----------- -----------
Balance at December 31, 1993 (carried forward) 3,821,806 (2,513,209) 1,308,829
4
Ortec International, Inc.
(a development stage enterprise)
STATEMENT OF SHAREHOLDERS' EQUITY/(DEFICIT) (continued)
(Unaudited)
Common stock Preferred stock
---------------- -------------------
Shares Amount Series B Series C
------- ------ -------- --------
(brought forward) 231,952 $232
Issuance of stock
Fourth private placement ($1.00 cash per share) 3,945 4
Stock purchase agreement with Home
Insurance Company ($1.00 cash per share) 5,000 5
Share issuance expenses
Net loss
------- ----
Balance at December 31, 1994 240,897 241
Rent forgiveness
Net loss
------- ----
Balance at December 31, 1995 240,897 241
Initial public offering 120,000 120
Exercise of warrants 3,388 3
Fifth private placement ($.65 cash per share) 95,911 96
Share issuance costs
Stock options issued for services
Net loss
------- ----
Balance at December 31, 1996 (carried forward) 460,196 460
Deficit
accumulated
Additional during the Total
paid-in development Treasury shareholders'
capital stage stock equity/(deficit)
----------- ----------- -------- ----------------
(brought forward) $ 3,821,806 $(2,513,209) $ 1,308,829
Issuance of stock
Fourth private placement ($1.00 cash per share) 397,708 397,712
Stock purchase agreement with Home
Insurance Company ($1.00 cash per share) 499,995 500,000
Share issuance expenses (8,697) (8,697)
Net loss (1,675,087) (1,675,087)
----------- ----------- -----------
Balance at December 31, 1994 4,710,812 (4,188,296) 522,757
Rent forgiveness 40,740 40,740
Net loss (1,022,723) (1,022,723)
----------- ----------- -----------
Balance at December 31, 1995 4,751,552 (5,211,019) (459,226)
Initial public offering 5,999,880 6,000,000
Exercise of warrants 33,882 33,885
Fifth private placement ($.65 cash per share) 6,220,701 6,220,797
Share issuance costs (1,580,690) (1,580,690)
Stock options issued for services 152,000 152,000
Net loss (2,649,768) (2,649,768)
----------- ----------- -----------
Balance at December 31, 1996 (carried forward) 15,577,325 (7,860,787) 7,716,998
5
Ortec International, Inc.
(a development stage enterprise)
STATEMENT OF SHAREHOLDERS' EQUITY/(DEFICIT) (continued)
(Unaudited)
Common stock Preferred stock
---------------- -------------------
Shares Amount Series B Series C
------- ------ -------- --------
(brought forward) 460,196 $460
Exercise of warrants 115,877 116
Share issuance costs
Stock options and warrants issued for services
Net loss
------- ----
Balance at December 31, 1997 576,073 576
Exercise of warrants 22,149 22
Stock options and warrants issued for services
Sixth private placement 20,000 20
Warrants issued in Sixth private placement
Share issuance costs
Purchase of 660 shares of treasury stock (at cost)
Net loss
------- ----
Balance at December 31, 1998 618,222 618
Exercise of warrants 1,410 1
Stock options and warrants issued for services
Seventh private placement ($.88 cash per share) 38,916 39
Warrants issued in Seventh private placement
Eighth private placement ($.55 cash per share) 163,636 164
Share issuance costs
Purchase of 910 shares of treasury stock (at cost)
Net loss
------- ----
Balance at December 31, 1999 (carried forward) 822,184 822
Deficit
accumulated
Additional during the Total
paid-in development Treasury shareholders'
capital stage stock equity/(deficit)
----------- ------------ --------- ----------------
(brought forward) $15,577,325 $ (7,860,787) $ 7,716,998
Exercise of warrants 10,822,675 10,822,791
Share issuance costs (657,508) (657,508)
Stock options and warrants issued for services 660,000 660,000
Net loss (4,825,663) (4,825,663)
----------- ------------ ------------
Balance at December 31, 1997 26,402,492 (12,686,450) 13,716,618
Exercise of warrants 1,281,935 1,281,957
Stock options and warrants issued for services 1,920,111 1,920,111
Sixth private placement 1,788,678 1,788,698
Warrants issued in Sixth private placement 211,302 211,302
Share issuance costs (48,000) (48,000)
Purchase of 660 shares of treasury stock (at cost) $ (67,272) (67,272)
Net loss (8,412,655) (8,412,655)
----------- ------------ --------- ------------
Balance at December 31, 1998 31,556,518 (21,099,105) (67,272) 10,390,759
Exercise of warrants 14,102 14,103
Stock options and warrants issued for services 64,715 64,715
Seventh private placement ($.88 cash per share) 3,168,746 3,168,785
Warrants issued in Seventh private placement 468,291 468,291
Eighth private placement ($.55 cash per share) 8,999,838 9,000,002
Share issuance costs (619,908) (619,908)
Purchase of 910 shares of treasury stock (at cost) (75,518) (75,518)
Net loss (10,040,509) (10,040,509)
----------- ------------ --------- ------------
Balance at December 31, 1999 (carried forward) 43,652,302 (31,139,614) (142,790) 12,370,720
6
Ortec International, Inc.
(a development stage enterprise)
STATEMENT OF SHAREHOLDERS' EQUITY/(DEFICIT) (continued)
(Unaudited)
Common stock Preferred stock
---------------- -------------------
Shares Amount Series B Series C
------- ------ -------- --------
(brought forward) 822,184 $822
Exercise of options and warrants 17,553 17
Stock options and warrants issued for services
Ninth private placement ($1.50 cash per share) 6,667 7
Warrants issued in Ninth private placement
Tenth private placement ($.68 cash per share) 124,757 125
Share issuance costs
Purchase of 430 shares of treasury stock (at cost)
Net loss
------- ----
Balance at December 31, 2000 971,161 971
Stock options issued for services
Net loss
------- ----
Balance at December 31, 2001 971,161 971
Deficit
accumulated
Additional during the Total
paid-in development Treasury shareholders'
capital stage stock equity/(deficit)
----------- ------------ --------- ----------------
(brought forward) $43,652,302 $(31,139,614) $(142,790) $12,370,720
Exercise of options and warrants 327,265 327,282
Stock options and warrants issued for services 56,265 56,265
Ninth private placement ($1.50 cash per share) 999,998 1,000,005
Warrants issued in Ninth private placement 23,000 23,000
Tenth private placement ($.68 cash per share) 8,420,946 8,421,071
Share issuance costs (641,500) (641,500)
Purchase of 430 shares of treasury stock (at cost) (34,855) (34,855)
Net loss (12,129,663) (12,129,663)
----------- ------------ --------- -----------
Balance at December 31, 2000 52,838,276 (43,269,277) (177,645) 9,392,325
Stock options issued for services 188,080 188,080
Net loss (15,885,377) (15,885,377)
----------- ------------ --------- -----------
Balance at December 31, 2001 53,026,356 (59,154,654) (177,645) (6,304,972)
7
Ortec International, Inc.
(a development stage enterprise)
STATEMENT OF SHAREHOLDERS' EQUITY/(DEFICIT) (continued)
(Unaudited)
Common stock Preferred stock
------------------ -------------------------
Shares Amount Series B Series C
--------- ------ ----------- -----------
(brought forward) 971,161 $ 971
Exercise of options and warrants 35,723 36
Stock options and warrants issued for services
Warrants issued with convertible debentures
Warrants issued with convertible redeemable
preferred stock
Convertible debenture conversion benefit
Redeemable convertible preferred stock conversion
benefit
Issuance of series B preferred stock (938 shares) $ 9,382,742
Warrants issued with preferred stock 938,274 938 (3,479,043)
Share issuance costs - preferred stock (866,612)
Preferred stock dividends 375,311 375
Net loss
--------- ------ -----------
Balance at December 31, 2002 2,320,469 2,320 5,037,087
Exercise of options and warrants 244,000 244
Issuance of preferred stock: series B (200 shares)
series C (890 shares) 2,000,000 $ 5,340,000
Warrants issued with preferred stock (490,567) (1,135,276)
Share issuance costs - preferred stock (393,488) (738,386)
Conversion of series B preferred stock into common
stock 2,421,556 2,422 (3,253,571)
Preferred stock deemed dividends and discounts
Preferred stock dividends 92,308 92
Net loss
--------- ------ ----------- -----------
Balance at June 30, 2003 5,078,333 $5,078 $ 2,899,461 $ 3,466,338
========= ====== =========== ===========
Deficit
accumulated
Additional during the Total
paid-in development Treasury shareholders'
capital stage stock equity/(deficit)
----------- ------------ --------- ----------------
(brought forward) $53,026,356 $(59,154,654) $(177,645) $ (6,304,972)
Exercise of options and warrants 321 357
Stock options and warrants issued for services 113,060 113,060
Warrants issued with convertible debentures 440,523 440,523
Warrants issued with convertible redeemable
preferred stock 559,289 559,289
Convertible debenture conversion benefit 1,042,663 1,042,663
Redeemable convertible preferred stock conversion
benefit 1,097,886 1,097,886
Issuance of series B preferred stock (938 shares) 9,382,742
Warrants issued with preferred stock 3,485,443 7,338
Share issuance costs - preferred stock 304,615 (561,997)
Preferred stock dividends 1,125,559 (1,125,934)
Net loss (21,578,021) (21,578,021)
----------- ------------ --------- ------------
Balance at December 31, 2002 61,195,715 (81,858,609) (177,645) (15,801,132)
Exercise of options and warrants 11,175 11,419
Issuance of preferred stock: series B (200 shares)
series C (890 shares) 7,340,000
Warrants issued with preferred stock 1,625,843
Share issuance costs - preferred stock 359,078 (772,796)
Conversion of series B preferred stock into common
stock and series D preferred stock (483 shares) 3,251,149
Redeemable convertible preferred stock
conversion benefit 4,179,000 (4,179,000)
Preferred stock dividends 922,985 (978,672) (55,595)
Net loss (7,658,458) (7,658,458)
----------- ------------ --------- ------------
Balance at June 30, 2003 $71,544,945 $(94,674,739) $(177,645) $(16,936,562)
=========== ============ ========= ============
Common stock shares and amounts adjusted to reflect one for ten reverse stock
split on June 24, 2003
See notes to condensed unaudited financial statements.
8
Ortec International, Inc.
(a development stage enterprise)
STATEMENTS OF CASH FLOWS
(Unaudited)
Cumulative
from
March 12,
1991
Six Months ended June 30, (inception) to
-------------------------- June 30,
2003 2002 2003
----------- ------------ --------------
Cash flows from operating activities
Net loss $(7,658,458) $(12,416,656) $(88,391,133)
Adjustments to reconcile net loss to net cash
used in operating activities
Depreciation and amortization 314,202 333,767 4,147,222
Amortization of deferred financing costs 2,974 36,121 326,199
Unrealized loss on marketable securities 11,404
Realized loss on marketable securities 5,250
Loss on sale of property and equipment 8,364
Cost to terminate lease on New Jersey facility 1,130,243 1,130,243
Non-cash stock compensation 106,260 3,154,231
Non-cash imputed interest 2,172,164 3,531,016 9,484,590
Loss on extinguishment of debt and series A
preferred stock 1,004,027
Purchases of marketable securities (19,075,122)
Sales of marketable securities 19,130,920
Changes in operating assets and liabilities
Accounts receivable 9,950 (72,635) (5,374)
Other current assets and other assets 42,230 246,234 61,361
Accounts payable and accrued liabilities (354,952) 1,268,452 4,086,636
----------- ------------ ------------
Net cash used in operating activities (4,341,647) (6,967,441) (64,921,182)
----------- ------------ ------------
Cash flows from investing activities
Purchases of property and equipment, excluding
capital leases (750) (200,705) (4,454,647)
Proceeds from sale of property and equipment 56,901
Payments for patent applications (32,011) (121,327) (992,153)
Organization costs (10,238)
Deposits (42,093) (731,273)
Purchases of marketable securities (594,986)
Sale of marketable securities 522,532
----------- ------------ ------------
Net cash provided by (used in) investing activities (32,761) (364,125) (6,203,864)
----------- ------------ ------------
9
Ortec International, Inc.
(a development stage enterprise)
STATEMENTS OF CASH FLOWS (continued)
(Unaudited)
Cumulative
from
March 12,
1991
Six Months ended June 30, (inception) to
------------------------- June 30,
2003 2002 2003
---------- ---------- --------------
Cash flows from financing activities
Proceeds from issuance of notes payable $ 515,500
Proceeds from issuance of common stock 53,550,522
Proceeds from exercise of warrants $ 11,418 19,112
Share issuance expenses and other financing costs (772,796) $ (400,655) (5,284,472)
Purchase of treasury stock (177,645)
Proceeds from issuance of loans payable 1,446,229
Proceeds from other obligations 4,000,000 10,000,000
Proceeds from issuance of convertible debentures 2,583,000 5,908,000
Proceeds from issuance of redeemable preferred
stock - series A 1,200,000 1,200,000
Proceeds from issuance of preferred stock - series B 2,000,000 3,070,000
Proceeds from issuance of preferred stock - series C 5,340,000 5,340,000
Advances received 130,000 130,000
Repayment of capital lease obligations (69,344) (42,806) (268,276)
Repayment of loan payable (76,218) (70,304) (782,396)
Repayment of other obligations (265) (7,432) (11,414)
Repayment of notes payable (515,500)
---------- ---------- -----------
Net cash provided by financing activities 6,562,795 7,261,803 74,139,660
---------- ---------- -----------
NET INCREASE (DECREASE) IN CASH AND CASH
EQUIVALENTS 2,188,387 (69,763) 3,014,614
Cash and cash equivalents at beginning of period 826,227 854,025 --
---------- ---------- -----------
Cash and cash equivalents at end of period $3,014,614 $ 784,262 $ 3,014,614
========== ========== ===========
10
Ortec International, Inc.
(a development stage enterprise)
STATEMENTS OF CASH FLOWS (continued)
(Unaudited)
Cumulative
From
March 12,
1991
Six Months ended June 30, (inception) to
------------------------- June 30,
2003 2002 2003
---------- ------------ --------------
Supplemental disclosures of cash flow information:
Noncash financing activities
Capital lease obligations $ -- $268,644 $ 568,344
Deferred offering costs included in accrued
professional fees -- -- 314,697
Financing costs - other long-term obligations
included in accrued expenses -- -- 59,500
Forgiveness of rent payable -- -- 40,740
Share issuance expenses - warrants -- -- 255,000
Dividends on series B preferred stock paid in
common shares 923,077 -- 2,049,011
Accretion of discount on preferred stock 4,179,000 4,179,000
Share issuance expenses for series B preferred
stock incurred through issuance of warrants 86,692 -- 391,307
Share issuance expenses for series C preferred
stock incurred through issuance of warrants 272,386 -- 272,386
Cash paid for interest 44,931 26,876 589,789
Cash paid for income taxes 750 -- 200,326
See notes to condensed unaudited financial statements.
11
ORTEC INTERNATIONAL, INC.
(a development stage enterprise)
NOTES TO CONDENSED FINANCIAL STATEMENTS (UNAUDITED)
NOTE 1 - FINANCIAL STATEMENTS
The condensed balance sheet as of June 30, 2003, and the condensed statements of
operations for the three and six month periods ended June 30, 2003 and 2002 and
the statements of shareholders' equity (deficiency) and cash flows for the six
month periods ended June 30, 2003 and 2002, and for the period from March 12,
1991 (inception) to June 30, 2003, have been prepared by the Company and are
unaudited. In the opinion of management, all adjustments (which include normal
recurring accrual adjustments) necessary to present fairly the financial
position as of June 30, 2003, results of operations for the three and six month
periods ended June 30, 2003 and 2002, and stockholders equity and cash flows for
the six month periods ended June 30, 2003 and 2002 and for the period from March
12, 1991 (inception) to June 30, 2003, have been made. Certain information and
footnote disclosures normally included in annual financial statements prepared
in accordance with accounting principles generally accepted in the United States
of America have been condensed or omitted. It is suggested that these condensed
financial statements be read in conjunction with the financial statements and
notes thereto in the Company's December 31, 2002 annual report on Form 10-K
filed with the Securities and Exchange Commission. The results of operations for
the three and six month periods ended June 30, 2003, 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.
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 on patients with recessive dystrophic
epidermolysis bullosa undergoing reconstructive surgery 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 efforts and resources towards its clinical
trial for use of OrCel for the treatment of venous stasis ulcers.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. The Company incurred a net loss of
$3.3 million and $7.7 million during the three and six months ended June 30,
2003, and, as of that date, the Company's current liabilities exceeded its
current assets by $17.9 million, its total liabilities exceeded its total assets
by $16.9 million and the Company has an accumulated deficit in its development
stage of $94.2 million. These factors, among others, raise substantial doubt
about the Company's ability to continue as a going concern.
On March 27, 2002, the Company engaged an investment banking firm to act as its
financial advisor in connection with raising capital for the Company through
debt and/or equity financing. During 2002, using the services of the investment
banking firm the Company raised capital of approximately $8.2 million and in
2003 has raised an additional $2.0 million, $5.3 million, and $.4 million in
February, May, and July, respectively. While the Company can give no assurance
of the total amount of financing that will be secured, the Company is continuing
to use the services of an investment banking firm in raising capital in 2003 and
expects to raise an additional $6.0 million. The
12
funds received to date, as well as the anticipated additional capital will
enable the Company to complete its venous clinical pivotal trial, file its PMA
with the FDA and execute its plan to engage the services of a third party
manufacturer. Accomplishing these milestones could also enable the Company to
raise additional financing through other potential collaborative arrangements
with companies for sales, marketing and distribution of its product and through
other equity investments and to launch sales of its OrCel product in the second
half of 2004. The Company requires substantial funding to continue its research
and development activities, clinical trials, manufacturing, marketing, sales,
distribution, and administrative activities. The Company believes that its cash
and cash equivalents on hand at June 30, 2003, (approximately $3.0 million), as
well as the additional $6.0 million anticipated to be raised in 2003 will enable
it to continue its operations for the next 12 months.
Additionally, the Company continues 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
the Company, in exchange for manufacturing, marketing, distribution or other
rights to our product. However, the Company 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 the
Company on acceptable terms, if at all. If additional funding is not available
when needed, the Company may not be able to continue operations.
These financial statements have been prepared assuming that the Company will
continue as a going concern. Successful future operations depend upon the
successful development and marketing of the Company's product. Historically, the
Company has funded its operating losses by periodically raising additional
capital. If additional funding is not available to the Company when needed, the
Company may not be able to continue operations. No adjustments have been made to
the accompanying financial statements as a result of this uncertainty.
Common Stock Reverse Split
On June 24, 2003, the Company executed a reverse stock split of its common
shares outstanding, whereby every stockholder, warrant and option holder, was
granted one new common share or warrant or option to purchase common shares, for
every ten outstanding common shares (or its equivalent). The par value of the
common shares remained unchanged at $.001 per share, however, the exercise
prices of the warrants and options outstanding were adjusted as a result of this
reverse split. The number of common shares, warrants, and options outstanding
were reduced as a result of this one for ten reverse split to common shares,
warrants, and options outstanding of 5,076,333, 3,024,730, and 1,703,303,
respectively. The conversion rates the Preferred stock outstanding was also
adjusted accordingly, and as of June 30, 2003 would result in the issuance of
9,844,541 shares of common shares, if converted.
As a result of this reverse split, 2,963,648 warrants are exercisable at prices
ranging from $.01 to $6.00 and 61,082 warrants are exercisable at prices in
excess of $6.00. Similarly, 1,508,954 options are exercisable at pries ranging
from $1.80 to $6.00 and 194,348 options are exercisable at prices in excess of
$10.00.
13
Employees Stock Options
As permitted by SFAS 148, the Company continues to account for its employee
stock options under the recognition and measurement principles of APB Opinion
No. 25, "Accounting for Stock Issued to Employees", and related Interpretations.
No stock-based employee compensation cost is reflected in net loss for the
quarter and six months ended June 30, 2003, as all options granted under this
plan had an exercise price equal to the market value of the underlying common
stock on the date of grant. The following table illustrates the effect on net
loss and loss per share for the quarter and six months ended June 30, 2003 and
2002, if the Company had applied the fair value recognition provisions of FASB
Statement No. 123, "Accounting for Stock-Based Compensation".
Quarter Ended Six Months Ended Quarter Ended Six Months Ended
June 30, 2003 June 30, 2003 June 30, 2002 June 30, 2002
------------- ---------------- ------------- ----------------
Net loss, as reported .................................... $(4,480,388) $(12,816,130) $(7,272,547) $(12,416,686)
Deduct: Total stock-based employee compensation expense
determined under fair value based method .............. (1,003,000) (1,186,000) (197,000) (389,000)
Pro forma net loss ....................................... $(5,483,388) $(14,002,130) $(7,469.547) $(12,805,686)
Loss per share:
Basic and Diluted - as reported ....................... $ (1.19) $ (4.09) $ (7.50) $ (12.81)
Basic and Diluted - pro forma ......................... $ (1.45) $ (4.47) $ (7.71) $ (13.21)
Impact of Recently Issued Accounting Standards
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements
No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical
Corrections." This statement eliminates the requirement to report gains and
losses from extinguishment of debt as extraordinary unless they meet the
criteria of APB Opinion 30. SFAS No. 145 also requires sale-leaseback accounting
for certain lease modifications that have economic effects that are similar to
sale-leaseback transactions. The changes related to lease accounting are
effective for transactions occurring after May 15, 2002 and the changes related
to debt extinguishment are effective for fiscal years beginning after May 15,
2002. The impact of adopting the provisions related to lease accounting did not
have a material impact on the Company's financial position or results of
operations. The Company early adopted the provisions related to debt
extinguishments during the year ended December 31, 2002. The adoption did not
have a material impact on the Company's financial position or results of
operations.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities." SFAS No. 146 nullifies Emerging Issues Task
Force Issue No. 94-3 and requires that a liability for a cost associated with
an exit or disposal activity be recognized when the liability is incurred. This
statement also establishes that fair value is the objective for initial
measurement of the liability. SFAS No. 146 is effective for exit or disposal
activities that are initiated after December 31, 2002. The impact of the
adoption of SFAS No. 146 did not have a material impact on the Company's
financial position or results of operations.
In November 2002, the FASB issued FASB Interpretation No. 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others." FIN No. 45 requires that upon
issuance of a guarantee, a guarantor must recognize a liability for the fair
value of an obligation assumed under a guarantee. FIN No. 45 also requires
additional disclosures by a guarantor in its interim and annual financial
statements about the obligations associated with guarantees issued. The
recognition provisions of FIN No. 45 are effective for any guarantees issued or
modified after December 31, 2002. The disclosure requirements are effective for
financial statements of interim or annual periods ending after December 15,
2002. The adoption of FIN No. 45 did not have a material impact on the Company's
financial position or results of operations.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation--Transition and Disclosure, an amendment of FASB Statement
No. 123." SFAS No. 148 amends SFAS No. 123, "Accounting for Stock-Based
Compensation," to provide alternative methods of transition for an entity that
voluntarily changes to the fair value-based method of accounting for
stock-based employee compensation. It also amends the disclosure provisions of
that Statement to require prominent disclosure about the effects on reported net
income of an entity's accounting policy decisions with respect to stock-based
employee compensation. The Company has chosen to continue to account for
stock-based compensation using the intrinsic value
14
method prescribed in APB Opinion No. 25 and related interpretations as provided
for under SFAS No. 148. Accordingly, compensation expense is only recognized
when the market value of the Company's stock at the date of the grant exceeds
the amount an employee must pay to acquire the stock. The adoption of SFAS
No. 148 did not have a material impact on the Company's financial position or
results of operations.
In January 2003, the FASB issued FASB Interpretation No. 46
"Consolidation of Variable Interest Entities." In general, a variable interest
entity is a corporation, partnership, trust, or any other legal structure used
for business purposes that either (a) does not have equity investors with voting
rights or (b) has equity investors that do not provide sufficient financial
resources for the entity to support its activities. A variable interest entity
often holds financial assets, including loans or receivables, real estate or
other property. A variable interest entity may be essentially passive or it may
engage in activities on behalf of another company. Until now, a company
generally has included another entity in its consolidated financial statements
only if it controlled the entity through voting interests. FIN No. 46 changes
that by requiring a variable interest entity to be consolidated by a company if
that company is subject to a majority of the risk of loss from the variable
interest entity's activities or entitled to receive a majority of the entity's
residual returns or both. FIN No. 46's consolidation requirements apply
immediately to variable interest entities created or acquired after January 31,
2003. The consolidation requirements apply to older entities in the first fiscal
year or interim period beginning after June 15, 2003. Certain of the disclosure
requirements apply to all financial statements issued after January 31, 2003,
regardless of when the variable interest entity was established. The Company has
adopted FIN No. 46 effective January 31, 2003. The adoption of FIN No. 46 did
not had a material impact on the Company's financial position or results of
operations.
In April 2003, the FASB issued Statement of Financial Accounting
Standards No. 149 ("SFAS No. 149"), "Amendment of Statement 133 on Derivative
Instruments and Hedging Activities," which amends and clarifies financial
accounting and reporting for derivative instruments, including certain
derivative instruments embedded in other contracts and for hedging activities
under SFAS No. 133. SFAS No. 149 is effective for contracts entered into or
modified after June 30, 2003 except for the provisions that were cleared by the
FASB in prior pronouncements. The Company does not expect the adoption of SFAS
No. 149 to have a material impact on its financial position and results of
operations.
In May 2003, the FASB issued Statement of Financial Accounting
Standards No. 150 ("SFAS No. 150"), "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity." This statement
establishes standards for how an issuer classifies and measures in its statement
of financial position certain financial instruments with characteristics of both
liabilities and equity. In accordance with the standard, financial instruments
that embody obligations for the issuer are required to be classified as
liabilities. This Statement shall be effective for financial instruments entered
into or modified after May 31, 2003, and otherwise shall be effective for the
year ended December 31, 2003. The Company is currently evaluating the effect of
the adoption of SFAS No. 150 on its financial position and results of
operations.
15
NOTE 3- NET LOSS PER SHARE
On June 24, 2003, the Company effected a one for ten reverse stock split of its'
common shares outstanding. Loss per share for all periods presented have been
adjusted as a result of this reverse stock split. As of June 30, 2003, an
aggregate of 4,728,032 outstanding warrants and options were excluded from the
diluted weighted average share calculations, as the effect was antidilutive. An
aggregate of 166,667 shares of common stock, if converted at $3.00 per share and
1,931,541 common shares if converted at $2.50 would be issuable upon the
conversion of Series B preferred stock, and 2,670,000 common shares, if
converted at $2.00 per share, would be issuable upon the conversion of Series C
preferred stock outstanding at June 30, 2003. These were also excluded from the
calculation of diluted net loss per share at June 30, 2003. As of June 30, 2002,
an aggregate of 374,013 outstanding warrants and options were excluded from the
diluted weighted average share calculations, as the effect would be
antidilutive. Basic and diluted loss per share, for the six months ended June
30, 2003, includes warrants to purchase 187,212 shares of common stock,
exercisable at $.01 per share reflected as outstanding from the date of grant.
NOTE 4 - OTHER OBLIGATIONS
On August 29, 2001, the Company entered into a Royalty Revenue Interest
Assignment agreement with Paul Capital Royalty Acquisition Fund L.P. ("Paul
Capital"), which terminates on August 29, 2011. Under such agreement the Company
was eligible to receive $10,000,000 during 2001. The Company received $6,000,000
during 2001 and the remaining $4,000,000 in January 2002. In February 2003, Paul
Capital and the Company signed an amendment to the agreement, restating and
updating certain provisions of the original agreement, including removing
additional funding requirements by Paul Capital. On February 26, 2003, Paul
Capital invested an additional $500,000 in Series B preferred stock, in
concurrence with this amendment, which is included in the overall Series B
convertible preferred financing (Note 8).
In consideration for the $10,000,000 million, Paul Capital will receive a
minimum of 3.33% of end user sales of the Company's products in the United
States, Canada and Mexico. Such percentage 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. Beginning January 1, 2003, Paul Capital is
entitled to receive each year advances from the first proceeds to the Company
from end user sales of its products in North America. The agreement provides for
quarterly and annual accountings between Paul Capital and the Company for those
advance payments. Such annual amounts that Paul Capital is able to draw in
advance range from $600,000 in 2003 to $7,500,000 in 2005 and thereafter. As of
June 30, 2003, there have been no advance payments made to Paul Capital, as the
Company is not engaged in sales
16
activity. The Company is in the process of negotiating an amendment to the
agreement with Paul Capital, relating to these advance payments.
The amounts received from Paul Capital have been classified as debt. Pursuant to
the default provisions under the agreement, interest has been accrued at 30% per
annum. At such time when the default provisions are no longer applicable,
interest will be accrued based upon the expected level of future revenues, which
may result in a lower imputed interest rate, with potential material lower
interest expense.
As defined in the agreement, in the event of a change in control of the Company
or upon the occurrence of certain other events, including insolvency, Paul
Capital has the option to put its revenue interest back to the Company for an
amount of cash flows which will generate a 30% internal rate of return to Paul
Capital. 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 interest in its products, for an amount of
cash flows, which will generate a 35% internal rate of return to Paul Capital.
At December 31, 2002, March 31, 2003, and June 30, 2003, the Company's
liabilities exceeded the value of its assets and as such, the Company was
technically in default of the solvency requirement under the Paul Capital
agreement. Paul Capital is aware of this breach and in discussions with
management regarding this issue, has indicated to the Company that it presently
does not intend to exercise its option to require the Company to repurchase its
revenue interest.
The Company granted Paul Capital a security interest in its United States and
Canadian patents and trademarks relating to its technology for its OrCel
product, to secure payments required to be made by the Company to Paul Capital
under this agreement.
Ortec has executed a letter of intent with a third party manufacturer for the
production of OrCel and is in the process of negotiating the terms of a final
contract. These negotiations encompass the lease of production space as well as
production personnel needed for the manufacture of OrCel product. Upon
completion of these negotiations, the Company expect to have the capacity to
produce the large quantities of OrCel that may be required upon the anticipated
receipt of FDA approval for the sale of product for use in the treatment of
patients with venous stasis ulcers.
NOTE 5 - LEGAL PROCEEDINGS, CLAIMS AND OTHER CONTINGENCIES
ClinTrials Networks, LLC (ClinTrials) has claimed that the Company has breached
its agreement with them, which provided for ClinTrials to arrange and manage a
portion of the FDA mandated clinical trial for use of our OrCel product for the
treatment of venous stasis ulcers, and for other services. In October 2002,
ClinTrials commenced an arbitration proceeding against the Company, claiming
that the Company owes ClinTrials $165,936 and that ClinTrials reserves the right
to claim additional amounts from the Company, 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. In March 2003, the Company
filed a counterclaim for overpayment of $75,000 under the terms of the contract,
and as such, the Company has not provided for any additional amounts due under
this contract. Arbitration hearings between Ortec and ClinTrials took place in
July 2003, and during this hearing ClinTrials increased its claim to
approximately $400,000, plus reimbursement of legal fees. Ortec is now awaiting
the arbitrator's decision regarding resolution of this matter. The outcome of
this litigation cannot be determined at the present time.
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 $196,762, plus interest, to PDI for services that they
have performed. The Company reached an agreement with PDI and in May 2003 paid
$150,000 in settlement of the amount claimed.
On August 5, 2002, the Company entered into an agreement with the New Jersey
Economic Development Administration (NJEDA) to lease approximately 26,000 square
feet of production and office space, modifying an original lease for
approximately 58,000 square feet. Monthly payments under such lease were
scheduled to begin on January 1, 2003. On June 9, 2003 the Company and NJEDA
executed an agreement to terminate this lease. Based
17
on the terms of this settlement, a termination cost of $978,000 was agreed upon.
This termination costs was settled by applying the $623,000 security deposit,
plus accrued interest thereon, with the balance of $340,000 paid on June 11,
2003.
NOTE 6 - STOCK OPTIONS AND WARRANTS
The following represents stock option and warrant activity during the six months
ended June 30, 2003:
Stock Options Warrants Total
------------- --------- ---------
Balance at December 31, 2002 ...... 287,212 1,117,211 1,404,423
Granted ........................... 160,761 2,189,212 2,349,973
Exercised ......................... -- (244,000) (244,000)
Expired or cancelled .............. (19,072) -- (19,072)
------- --------- ---------
Balance at June 30, 2003 .......... 428,901 3,062,423 3,491,324
======= ========= =========
Additionally, as of June 30, 2003, there were 1,274,000 stock options
outstanding that were granted outside of the plan. All options and warrants
activity and outstanding balances have been adjusted for the one for ten reverse
split executed on June 24, 2003.
The Company accounts for its employee stock options under the recognition and
measurement principles of APB Opinion No. 25, "Accounting for Stock Issued to
Employees", and related Interpretations. No stock-based employee compensation
cost is reflected in net loss for the quarter and six months ended June 30,
2003, as all options granted under this plan had an exercise price equal to the
market value of the underlying common stock on the date of grant.
The Company utilized the Black-Scholes option-pricing model to quantify the
expense of options and warrants granted to non-employees and the pro forma
effect on net loss and net loss per share of the fair value of the options and
warrants granted to employees during the quarter and six months ended June 30,
2003. The Company issued 1,751,521 and 2,189,212 warrants to non-employees
during the three and six-month periods ended June 30 2003, which were all issued
in conjunction with the preferred stock financing. The fair market value of
these warrants was recorded as equity financing costs. 2,500 options were
granted to non-employees during the quarter and six-month period, with $3,000 of
expense recorded. During the quarter and six month ended June 30, 2003, 131,761
and 158,261 options, respectively, were granted to employees within the plan and
894,400 options were issued to employees outside the plan.
NOTE 7- PREFERRED STOCK ISSUANCES
In February 2003, Ortec received gross proceeds of $2.0 million from the sale of
the Company's Series B convertible preferred stock. The Company issued to such
investors 200 shares of Series B convertible preferred stock, 2,923,077 shares
of common stock (including 923,077 shares of common stock constituting the first
year's dividends on such 200 shares of Series B convertible preferred stock,
which dividends were paid in advance and 2,000,000 shares of common stock, which
were issued upon exercise of Series A warrants, exercised at $.001 per share)
and warrants to purchase an additional 2,000,000 shares of common stock, of
which warrants to purchase 1,000,000 shares are exercisable at $1.50 per share
and warrants to purchase the other 1,000,000 shares are exercisable at $2.00 per
share. In May and June 2003, in conjunction with the conversion of the Preferred
B and the reverse stock split, these B-1 and B-2 warrants were amended and
restated as 100,000 shares each at $4.00 and $5.00, respectively. Paul Capital
did not convert its Preferred Series B on May 23, 2003 and, accordingly, the
exercise price of their B-1 and B-2 Warrants were not amended. In March 2003, in
addition to cash compensation, Ortec also granted warrants to purchase an
aggregate of 376,923 shares of common stock, exercisable at $0.001 per share
(37,692 shares at $.01 per share, post split) to employees of the investment
banking firm for their services in arranging such February 2003 Series B
financing.
18
On May 23, 2003, 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 C Convertible Preferred Stock
at a stated value of $6,000 per share. Dividends on the Series C Preferred
shares is payable at the rate of 10% per annum, in cash or shares of common
stock, at the option of the Company. The Series C preferred stock is convertible
into common shares at any time at the option of the investor, based on a
conversion rate of $2.00. Six months after issue, mandatory conversion can occur
if the closing bid price of the Company's common stock exceeds $6.00 for a
period of 10 consecutive trading days. The conversion rate may be adjusted
downward if the Company subsequently issues common stock at a purchase price
less than the conversion rate $2.00. In that event, the conversion rate will be
adjusted downward according to the formula contained in the Certificate of
Designation of the Relative Rights and Preferences of the Series C preferred
stock, which is the amendment to the Company's certificate of incorporation
relating to the Series C Preferred shares.
The Series C preferred stock has redemption provisions, where upon occurrence of
certain events, the holders can require the Company to redeem the shares.
In May 2003, Ortec received gross proceeds of $5.3 million from the sale of 890
shares of convertible preferred Series C stock, issuing warrants to purchase
16,020,000 shares of common stock at $.36 per share (1,602,000 shares at $3.60
post split). These Series C preferred stock are convertible into 2,670,000
shares of common stock at $2.00 per share, post split. In addition, the
investors, other than Paul Capital, agreed to convert their Series B Preferred
shares into common shares or their equivalent. As a result, 605.389 shares of
preferred Series B stock were converted into 24, 215,560 shares of common stock
at $.25 per share (2,421,556 at $2.50 post split) and 482.8852 shares of
preferred Series B stock are pending conversion into Preferred Series D stock
(common stock equivalent 1,931,540 shares post split). The Company is currently
in the process of finalizing the issuance of the Series D convertible preferred
stock, which is non-redeemable, with a stated value of $10,000 per share and
authorized at 2,000 shares. Once issued, the liquidation value of these shares
will be $4,828,852.
In conjunction with these conversions, all Series B-1 and B-2 warrants held by
these investors, were amended to reflect the revised exercise price of $4.00 and
$5.00, respectively, post split. Paul Capital did not exercise its options to
convert its 50 shares of Preferred Series B into common stock or its equivalent
and as such, its B-1 and B-2 warrants were not amended and remained at its
original exercise price of $1.50 and $2.00 ($15.00 and $20.00, post split),
respectively. As a result of the change in the B-1 and B-2 warrants valuation at
May 23, 2003, the Company recognized a deemed dividend to investors of $519,000.
As part of the May 2003 financing, employees of the investment-banking firm were
granted 1,495,200 shares at an exercise price of $.001 (149,520 share at $.01,
post split) as part of their compensation. During the quarter, the Company
recorded $269,000 in Preferred Series C share issuance costs related to the
warrants issued to the investment-banking firm.
Based on the relative fair market value of the Preferred stock at the date of
issuance and the estimated fair market value of the warrants, using the
Black-Scholes option pricing model, during the quarter ended June 30, 2003, the
Company assigned values to the Series C Preferred stock and its related C
warrants of $4,204,724 and $1,l35,276, respectively. Similarly, upon conversion,
the Company will assign values to the Series D Preferred stock, allocating
values previously assigned to the Series B Preferred stock.
During the quarter, the Company incurred $466,000 of financing fees relating to
the Series C preferred stock issued in the quarter, which was paid in cash, in
addition to the fees paid by issuance of warrants.
Additionally, since the effective conversion price of the preferred Series C
stock on the date of issuance was lower than the market value of the common
shares on that date, the Company recognized $601,000 of additional discounts on
the preferred issuances in the quarter ended June 30, 2003. This conversion
feature was charged to retained earnings as accretion of discount during the
quarter.
NOTE 8 - ADVANCES FROM THIRD PARTIES
During the quarter ended March 31, 2003, the Company received non-interest
bearing advances of $130,000 from certain investors. This amount remains
outstanding as of June 30, 2003.
NOTE 9 - SUBSEQUENT EVENTS
In July 2003, the Company sold 58.33 shares of Preferred C stock and received an
additional $350,000 in financing from new investors. In relation to this
financing, the Company issued 105,000 C warrants at an exercise price of $3.60.
These 58.33 Preferred Series C shares are convertible into 174,999 shares of
common stock.
19
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
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
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.
General
Since our inception we have been principally engaged in the research and
development of our tissue engineered skin regeneration product, for use in the
treatment of chronic and acute wounds, such as venous and diabetic skin ulcers,
and autograft donor site wounds for burn victims. We call our product OrCel'r'
and in June 2001 we filed a trademark application for such name with the United
States Patent and Trademark Office.
In February 2001 we received FDA approval to make commercial sales of OrCel for
use in reconstructive surgery 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. During 2002, we engaged a sales force
organization to actively pursue sales of our product, but due to a reduction in
anticipated financing, we curtailed these activities in the second half of 2002.
As a result of this curtailment, there have been no sales of our product in the
current quarter and six-month period ended June 30, 2003.
From inception to date, we have incurred cumulative net losses of approximately
$94.2 million. We expect to continue to incur substantial losses through 2005,
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 a pivotal clinical trial using 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. As of July 7, 2003, we have completed our enrollment at 134 patients
to participate in the pivotal clinical trial. We expect to complete the venous
stasis pivotal clinical trials patient treatment phase and analysis of data
during the third quarter of 2003, with submission of the FDA filing in November
2003. We anticipate obtaining FDA approval in the second quarter 2004 for the
use of our OrCel product in the treatment of venous stasis ulcers.
In June 2002, we received approval from the FDA to initiate a pivotal clinical
trial using OrCel in the treatment of diabetic foot ulcers. Diabetic ulcers are
open sores that remain after the destruction of surface tissue. We have deferred
the implementation of the diabetic foot ulcers pivotal clinical trial and expect
to resume this trial in the second quarter of 2004 dependent on obtaining
sufficient additional financing, with submission to and approval from the FDA
anticipated in 2005.
We are in negotiations with and we have received a letter of intent from a third
party manufacturer for the production of OrCel. If these negotiations are
successful, we will have the capacity to produce the large quantities of
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OrCel that will be required upon the anticipated receipt of FDA approval for the
sale of our product for use in the treatment of patients with venous stasis
ulcers. Concluding an agreement with the third party manufacturer will allow us
to avoid the costlier plan of constructing our owned manufacturing facility. We
are also concurrently in the process of evaluating various sales and marketing
collaborative arrangements.
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 through 2005.
Critical Accounting Estimates
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. All research and development costs, including consulting and
personnel costs, are expensed as incurred.
Other 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 anticipated under the terms of the agreement. Pursuant to the
default provisions under the agreement, interest is accrued at 30% per annum. At
such time when the default provisions are no longer applicable, interest will be
accrued based upon the expected level of future revenues, which may result in a
lower imputed interest rate, with potential material lower interest expense.
Impact of Recently Issued Accounting Standards
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements
No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical
Corrections." This statement eliminates the requirement to report gains and
losses from extinguishment of debt as extraordinary unless they meet the
criteria of APB Opinion 30. SFAS No. 145 also requires sale-leaseback accounting
for certain lease modifications that have economic effects that are similar to
sale-leaseback transactions. The changes related to lease accounting are
effective for transactions occurring after May 15, 2002 and the changes related
to debt extinguishment are effective for fiscal years beginning after May 15,
2002. The impact of adopting the provisions related to lease accounting did not
have a material impact on the Company's financial position or results of
operations. The Company early adopted the provisions related to debt
extinguishments during the year ended December 31, 2002. The adoption did not
have a material impact on the Company's financial position or results of
operations.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities." SFAS No. 146 nullifies Emerging Issues Task
Force Issue No. 94-3 and requires that a liability for a cost associated with
an exit or disposal activity be recognized when the liability is incurred. This
statement also establishes that fair value is the objective for initial
measurement of the liability. SFAS No. 146 is effective for exit or disposal
activities that are initiated after December 31, 2002. The impact of the
adoption of SFAS No. 146 did not have a material impact on the Company's
financial position or results of operations.
In November 2002, the FASB issued FASB Interpretation No. 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others." FIN No. 45 requires that upon
issuance of a guarantee, a guarantor must recognize a liability for the fair
value of an obligation assumed under a guarantee. FIN No. 45 also requires
additional disclosures by a guarantor in its interim and annual financial
statements about the obligations associated with guarantees issued. The
recognition provisions of FIN No. 45 are effective for any guarantees issued or
modified after December 31, 2002. The disclosure requirements are effective for
financial statements of interim or annual periods ending after December 15,
2002. The adoption of FIN No. 45 did not have a material impact on the Company's
financial position or results of operations.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation--Transition and Disclosure, an amendment of FASB Statement
No. 123." SFAS No. 148 amends SFAS No. 123, "Accounting for Stock-Based
Compensation," to provide alternative methods of transition for an entity that
voluntarily changes to the fair value-based method of accounting for
stock-based employee compensation. It also amends the disclosure provisions of
that Statement to require prominent disclosure about the effects on reported net
income of an entity's accounting policy decisions with respect to stock-based
employee compensation. The Company has chosen to continue to account for
stock-based compensation using the intrinsic value
21
method prescribed in APB Opinion No. 25 and related interpretations as provided
for under SFAS No. 148. Accordingly, compensation expense is only recognized
when the market value of the Company's stock at the date of the grant exceeds
the amount an employee must pay to acquire the stock. The adoption of SFAS
No. 148 did not have a material impact on the Company's financial position or
results of operations.
In January 2003, the FASB issued FASB Interpretation No. 46
"Consolidation of Variable Interest Entities." In general, a variable interest
entity is a corporation, partnership, trust, or any other legal structure used
for business purposes that either (a) does not have equity investors with voting
rights or (b) has equity investors that do not provide sufficient financial
resources for the entity to support its activities. A variable interest entity
often holds financial assets, including loans or receivables, real estate or
other property. A variable interest entity may be essentially passive or it may
engage in activities on behalf of another company. Until now, a company
generally has included another entity in its consolidated financial statements
only if it controlled the entity through voting interests. FIN No. 46 changes
that by requiring a variable interest entity to be consolidated by a company if
that company is subject to a majority of the risk of loss from the variable
interest entity's activities or entitled to receive a majority of the entity's
residual returns or both. FIN No. 46's consolidation requirements apply
immediately to variable interest entities created or acquired after January 31,
2003. The consolidation requirements apply to older entities in the first fiscal
year or interim period beginning after June 15, 2003. Certain of the disclosure
requirements apply to all financial statements issued after January 31, 2003,
regardless of when the variable interest entity was established. The Company has
adopted FIN No. 46 effective January 31, 2003. The adoption of FIN No. 46 did
not had a material impact on the Company's financial position or results of
operations.
In April 2003, the FASB issued Statement of Financial Accounting
Standards No. 149 ("SFAS No. 149"), "Amendment of Statement 133 on Derivative
Instruments and Hedging Activities," which amends and clarifies financial
accounting and reporting for derivative instruments, including certain
derivative instruments embedded in other contracts and for hedging activities
under SFAS No. 133. SFAS No. 149 is effective for contracts entered into or
modified after June 30, 2003 except for the provisions that were cleared by the
FASB in prior pronouncements. The Company does not expect the adoption of SFAS
No. 149 to have a material impact on its financial position and results of
operations.
In May 2003, the FASB issued Statement of Financial Accounting
Standards No. 150 ("SFAS No. 150"), "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity." This statement
establishes standards for how an issuer classifies and measures in its statement
of financial position certain financial instruments with characteristics of both
liabilities and equity. In accordance with the standard, financial instruments
that embody obligations for the issuer are required to be classified as
liabilities. This Statement shall be effective for financial instruments entered
into or modified after May 31, 2003, and otherwise shall be effective for the
year ended December 31, 2003. The Company is currently evaluating the effect of
the adoption of SFAS No. 150 on its financial position and results of
operations.
Results of Operations
Three and Six Months Ended June 30, 2003, and June 30, 2002.
Revenues
We earned revenues of approximately $93,000 and $209,000 from commercial
shipments of products to customers in the quarter and six months ended June 30,
2002. As previously discussed, our sales activities were curtailed in the second
half of 2002, resulting in no revenues generated in the quarter and six months
ended June 30, 2003.
Expenses
Expenses decreased by approximately $4.1 million from approximately $7.4 million
in the 2002 quarter to approximately $3.3 million in the 2003 quarter, and by
$4.9 million from approximately $12.6 million to $7.7 million in comparable
six-month periods.
Personnel. Personnel costs decreased by approximately $1.1 million to $1.0
million in the 2003 quarter, compared with $2.1 million in the 2002 quarter and
decreased by $2.2 million from $4.2 million to $2.0 million in the six months
ended June 30, 2003 compared to the 2002 six-month period. These reductions in
expense in the 2003 quarter and six-month period resulted from management's
decision in June 2002 to curtail manufacturing of product for sale and focus
completely on conducting the pivotal venous stasis clinical trial. The headcount
and personnel costs were higher in the 2002 periods as we had increased staffing
to manage two clinical trials, manufacture the increased quantity of product
required by our clinical trial programs and for commercial sales, initiate our
sales and marketing program for our FDA approved product, and for additional
administrative personnel required as a result of such increased staffing levels.
Consulting. These fees decreased by $.2 million in the quarter and by $.4
million in the six months ended June 30, 2003, compared with the quarter and six
months ended June 30, 2002. During the current quarter and six months, we did
not incur any consulting expenses, as we have been focused on completing the
venous stasis clinical trial, and as such have utilized primarily existing
personnel. The 2002 periods included costs incurred as a result of
22
product and process improvement projects.
Research and Development. These expenses decreased by approximately $.6 million
to $.5 million in the 2003 quarter, compared with $1.1 million in the 2002
quarter and decreased by $1.4 million to $.9 million from $2.2 million in the
comparable six-month periods. These decreases in research and development
expenses were due to the fact that during the 2003 quarter and six month period,
costs were incurred primarily for the venous ulcer pivotal clinical trial,
whereas in 2002 costs were incurred for concluding the donor site pivotal
clinical trial, an EB post approval study, as well as concluding the venous and
diabetic ulcers pilot trials and beginning the venous pivotal trial. In 2002
there were also significant costs incurred to manufacture product for sale,
which is included in Research and Development expenses.
General and Administrative. These expenses decreased by $.4 million from $.9
million in the 2002 quarter to $.4 million in the 2003 quarter, and by $.7
million from $1.8 million to $1.1 million in the comparable six month periods,
due to reduced marketing, recruitment and other expenses incurred in 2003
compared with 2002, during which period we were preparing for commercial sales
of our product.
Rent and Lease Termination Costs. Rent expense decreased by $118,000 and $49,000
in the 2003 quarter and six month period compared with the 2002 periods, due to
reductions in space leased at all office locations. During the current quarter,
the Company and NJEDA executed an agreement to terminate the lease of the New
Jersey premises, and in accordance with terms of this settlement, we recorded
termination expenses of $1.1 as of June 30, 2003. These costs included $.9
million in lease settlement costs paid to the NJEDA, and the write-off of $.2
million of other leasehold costs incurred directly by us.
Interest Expense. Interest expense decreased by $1.7 million in the quarter and
$1.4 million in the six months ended June 30, 2003, compared with the expense
incurred in the quarter and six months ended June 30, 2002, primarily due to
$2.2 million in interest recorded on convertible debt, which was converted in
2002. The 2003 and 2002 periods included the non-cash imputed interest accrued
on the Paul Capital agreement. Although interest was accrued at 30% per annum
for both periods, at June 30, 2003, interest was accrued on a higher level of
debt outstanding. Due to the default provisions under the agreement, interest
has been accrued at 30% per annum in 2003, which provision may be adjusted in
the future if the default provisions are not longer applicable and interest will
then be accrued based on the expected level of future revenues.
Liquidity and Capital Resources
Since inception (March 12, 1991) through June 30, 2003, we have accumulated a
deficit of approximately $94.2 million and we expect to continue to incur
substantial operating losses through 2005. 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 June 30,
2003, we received cash proceeds from the sale of equity securities, net of share
issuance expenses, of approximately $53.6 million, we received net cash proceeds
from the issuance of debentures and preferred stock of $10.2 million, and we
have received a total of $10.0 million from the sale of a percentage interest in
our future revenues from the sale of our product in North America.
For the six months ended June 30, 2003, we used net cash for operating
activities of approximately $4.3 million. Cash used in operating activities
resulted primarily from our net loss of $7.7 million, offset by depreciation and
amortization of approximately $.3 million, approximately $2.2 million of
non-cash interest expense and approximately $1.1 million in costs for lease
termination costs, relating to the NJEDA lease, of which approximately $.3
million was a cash payment in the six-month period.
In the six months ended June 30, 2003, we received gross proceeds of $7.3
million from the issuance of preferred stock financing, advances of $.1 million
against future financings and incurred $.7 million in financing costs. As a
result of such preferred stock financing, common shares outstanding increased by
27.6 million shares prior to reverse split on June 24, 2003 (adjusted to 2.8
million shares after such reverse split), due to the conversion of preferred
debt, the exercise of warrants and the issuance of common stock for dividends
payable on preferred stock.
23
On June 24, 2003, the Company executed a reverse split of its common shares,
warrants, and options outstanding, whereby every stockholder, warrant holder,
and option holder was granted one new common share, warrant, or option for every
ten common shares, warrants, or options outstanding prior to June 24, 2003. The
par value of the common shares remained unchanged at $.001 per share, however,
the exercise prices of the warrants and options outstanding were adjusted as a
result of this reverse split.
On August 5, 2002, the Company entered into an agreement with the New Jersey
Economic Development Administration (NJEDA) to lease approximately 26,000 square
feet of production and office space, modifying an original lease for
approximately 58,000 square feet. Due to the lower level of financing received
in 2002 than had originally been planned, the Company and NJEDA agreed to
terminate this lease. Based on the terms of this settlement, we have expensed
the $637,000 security deposit plus accrued interest thereon, which had been paid
to NJEDA in 2002, and have paid an additional settlement liability of $340,000.
This settlement has released Ortec from its monthly lease obligation of
approximately $35,000 over a three-year period, terminating on December 31,
2005, as well as its estimated obligation of approximately $7.0 million to
complete the construction of these facilities.
In March 2003, Ortec began discussions with Cambrex, a third party manufacturer,
concerning the commercial contract production of our OrCel product. The parties
have executed a term sheet and are in the process of drafting an agreement to
engage Cambrex as Ortec's contract manufacturer. We expect this agreement to be
completed in the third quarter and the transfer of technology from Ortec to
Cambrex to begin in the fourth quarter of 2003. It is expected that Cambrex will
begin production of OrCel in the first quarter of 2004 in anticipation of the
PMA approval in the second quarter of 2004 for sale of OrCel for use on patients
in the treatment of venous leg ulcers, and the launch of sales immediately
thereafter.
Under the August 29, 2001 agreement, as amended, in consideration for the
investment of $10.0 million, Paul Capital received 3-1/3% of end user revenues
from the sale of our 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 our products in those three countries. As of
June 30, 2003, we have provided for the effective cost of the amounts received
from Paul Capital at 30% per annum, pursuant to default provisions of the
agreement and we have accrued interest accordingly. However, at such time when
the default provisions are no longer applicable, interest will be accrued based
upon the expected level of future revenues, which may result in a lower imputed
interest rate, with potential material lower interest expense. Under the August
29, 2001 agreement, as amended, beginning on January 1, 2003, Paul Capital is
entitled to receive each year advances from the first proceeds to us from end
user sales of our products. The agreement provides for quarterly and annual
accountings between Paul Capital and us for those advance payments, compared to
amounts owed based on actual sales. Such annual amounts Paul Capital is able to
draw in advance will range from $.6 million in 2003, $1.0 million in 2004 to
$7.5 million in 2005 and thereafter. During the six months ended June 30, 2003,
there have been no sales to customers, therefore, no advance payments have been
made to Paul Capital. We are currently in discussions with Paul Capital to amend
the amount of advance payments required under the agreement.
At March 31 and June 30, 2003, our liabilities exceeded the value of our assets
and as such, we were technically in default of the solvency requirement under
the Paul Capital agreement. Paul Capital is aware of this breach and based on
our discussions regarding this issue, has indicated to us that it presently does
not intend to exercise its option to require us to repurchase its revenue
interest. Additionally, in February 2003, Paul Capital amended its agreement
with us, restating and updating certain provisions of the original agreement. On
February 26, 2003, Paul Capital invested an additional $500,000 in our Series B
preferred stock, in concurrence with this amendment.
As defined in the agreement, in the event of a change in control of Ortec or
upon the occurrence of certain other events, 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 all our United States
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.
24
The original agreement and modifications to the agreement terminate on December
31, 2011, unless terminated earlier by either party, as permitted by the terms
of the agreement.
On March 27, 2002, we engaged an investment-banking firm to act as our financial
advisor in connection with raising capital for us through debt and/or equity
financing. Using these services we have raised financing of approximately $8.2
million in 2002 and continuing in 2003, we have raised an additional $2.0
million in Series B convertible preferred stock in February 2003 and $5.3
million in Preferred Series C in May 2003. As part of the February financing, we
issued 2,000,000 Series A warrants at $.001 per share, which were immediately
converted into common shares (post split 200,000 common shares), 1,000,000
Series B-1 (post split 100,000) and 1,000,000 Series B-2 (post split 100,000)
warrants exercisable at $1.50 per share and $2.00 per share, (post split $15.00
and $20.00), respectively. Concurrent with the Series B conversion and reverse
stock split, these warrants were revalued at $.40 and $.50, (post split $4.00
and $5.00), respectively. Dividends on our Series B preferred stock sold in such
financing were paid in common shares at the rate of 12% per annum, resulting in
the issue of 923,077 shares of common stock (post split 92,307 shares). The
investors of the Series B Preferred stock issued in February 2003, along with
all previous issues in 2002, agreed to convert their Series B preferred into
common shares and Series D Preferred shares (common stock equivalent) on May 23,
2003. The Company is in the process of finalizing the conversion of the Series B
preferred stock into the Series D preferred stock. Only the shares of Series B
Preferred Stock owned by Paul Capital were not converted.
On May 23, 2003, we closed on Series C preferred equity financing of $5.3
million from investors, some of whom have previously participated in the $10.2
million raised through 2002 and 2003 prior to that date. This financing of
Series C is convertible preferred stock at a stated value of $6,000 per share,
convertible into common shares at a rate of $.20 per share ($2.00 post split).
Dividends will be paid in cash or common shares at the option of the Company, at
the rate of 10% per annum. Beginning 180 days from issue, the Series C
convertible preferred stock shall automatically convert, if the common stock of
the Company trades at a price equal to or greater than $.60 ($6.00 post split)
per share for a period of 10 consecutive trading days. Additionally, each
investor was issued 18,000 (1,800 post split) five-year warrants for each Series
C convertible preferred share purchased. The Series C warrants have an exercise
price of $3.60 per common share, post split. Beginning twenty-four months after
the Closing, the Company may redeem the Series C warrants for $.01 per warrant
if its common stock closes above $10.80 per share (post split) for 10
consecutive trading days.
Concurrently with the closing of this Series C convertible preferred financing,
on May 23, 2003 a majority in interest of the holders of our Series B
Convertible Preferred stock agreed to convert their preferred shares into common
shares or its equivalent, at the conversion rate of $.25 ($2.50 post split) per
share. As a result of this conversion, 605.389 Series B Preferred converted into
24,215,560 shares of common stock (post split 2,421,556 common shares) and
482.8852 Series B Preferred are pending conversion into a similar amount of
Series D Preferred, which are equivalent to 19,315,408 shares of common stock
(post split 1,931,540 common shares). Only the 50 shares of Series B preferred
stock owned by Paul Capital were not converted. Additionally, as a result of the
conversion, the exercise price of the B-1and B-2 warrants relating to the
converted Series B preferred stock, were adjusted from $1.50 and $2.00 (post
split $15.00 and $20.00), respectively to $.40 and $.50 (post split $4.00 and
$5.00), respectively. Beginning twelve months after issue, the B-1 and B-2
Warrants are redeemable for $.01 per share if our common stock closes above
$1.00 and $1.25 (post split $10.00 and $12.50), respectively, for 10 consecutive
trading days. In July 2003, we closed on an additional $350,000 of Series C
Preferred investment.
Our capital funding requirements will depend on numerous factors, including the
progress and magnitude of our research and development programs, pre-clinical
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 require substantial funding to continue our research and development
activities, clinical trials, manufacturing, sales, distribution and
administrative activities. 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 sources.
We can give no assurance of the total amount of financing that will be secured,
we are continuing to use the services of an
25
investment banking firm in raising capital in 2003. The success of such efforts
will depend in large part upon continuing developments in our clinical trials
and upon market conditions.
We estimate that the equity financing raised to date from investors as well as
the additional equity financing anticipated in 2003, will enable us to complete
our venous clinical pivotal trial, file our application for pre-market approval
with the FDA and execute our plan to engage the services of a third party
manufacturer and prepare for sales in 2004. Accomplishing these milestones would
enable us to raise additional funding through other potential collaborative
arrangements with companies for sales, marketing and distribution of its product
and through other equity investments. We believe that our cash and cash
equivalents on hand at June 30, 2003, (approximately $3.0 million), the
additional $.4 million received in July 2003, as well as the additional $6.0
million we hope to raise subsequently in 2003, will enable us to continue our
operations for the next 12 months. We can give no assurance that additional
investment or other funds can be secured.
We continue to explore and, as appropriate, enter into discussions with other
companies regarding the potential for equity investment, collaborative
arrangements, license agreements or other funding programs with us, in exchange
for manufacturing, marketing, distribution or other rights to our product.
However, we can give no assurance that discussions with other companies will
result in any additional investments, collaborative arrangements, agreements or
other funding, or that the necessary additional financing through debt or equity
financing will be available to us on acceptable terms, if at all. Further, we
can give no assurance that any arrangements resulting from these discussions
will successfully reduce our funding requirements. If additional funding is not
available to us when needed, we may not be able to continue operations.
Item 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
In our quarterly report on Form 10-QA for the three months ended September 30,
2002, we reported that ClinTrials Networks, LLC (ClinTrials) had commenced an
arbitration proceeding against us claiming we owe ClinTrials $165,936, and that
PDI, Inc. (PDI) commenced an action against us claiming that we owe PDI
$205,000. In our annual report on Form 10-K for the year ended December 31,
2002, and our quarterly report on Form 10-Q for the three month period ended
March 31, 2003, we reported the current status of those two proceedings against
us.
The arbitration between ClinTrials and us took place in July 2003. At the
hearing ClinTrials increased its claim against us to close to $400,000 plus
reimbursement of its legal fees. We are awaiting the arbitrator's decision.
In the second quarter of 2003 we paid PDI $150,000 in full settlement of its
claim against us.
26
Item 2. CHANGES IN SECURITIES
(a) In our report on Form 8-K filed on June 20, 2003, we reported the 1 for
10 reverse split of our outstanding common stock, which became effective at 5 PM
EDT on June 24, 2003. Unless otherwise indicated, all references to the number
of shares of our common stock in this report are after giving effect to such
reverse stock split.
(c) Recent Sales of Unregistered Securities
In the second quarter ended June 30, 2003, we sold 890 shares of our newly
created Series C convertible preferred stock for $6,000 per share. Such 890
shares of our Series C preferred stock are convertible into an aggregate of
2,670,000 shares of our common stock. We granted to the purchasers of such 890
Series C preferred shares warrants to purchase an aggregate of an additional
1,602,000 shares of our common stock at an exercise price of $3.60 per share. We
also granted to the designees of the placement agent who arranged such Series C
financing warrants to purchase an aggregate of 149,520 shares of our common
stock at an exercise price of $0.01 per share.
On July 29, 2003 we sold an additional 58.333 shares of our Series C convertible
preferred stock for $6,000 per share and granted the purchasers warrants to
purchase 105,000 shares of our common stock at an exercise price of $3.60 per
share. Such 58.333 shares of our Series C preferred stock are convertible into
174,999 shares of our common stock.
The relative rights and preferences of our Series C convertible preferred stock
are described below.
All of the purchasers of our Series C convertible preferred stock represented to
us that they were "accredited investors" as such term is defined in the rules
promulgated by the Securities and Exchange Commission. The sale of such Series C
convertible preferred stock and the grant of such warrants in our Series C
financings, were all exempt from the registration requirements of the Securities
Act of 1933 (the "Act") pursuant to Section 4(2) of the Act and Regulation D
promulgated under the Act because such sales did not involve any public offering
During the second quarter of 2003 we granted to 36 employees (including 3
executive officers) and one non-employee options, both under and outside our
Employee Stock Option Plan, to purchase an aggregate of 1,028,661shares of our
common stock, at exercise prices ranging from $1.80 to $3.60 per share. The
grant of such options was exempt from the registration requirements of the Act
pursuant to the provisions of Section 4(2) thereof because such option grants
did not involve any public offering and because such option grants did not
constitute sales of securities.
Series C Convertible Preferred Stock
Designation and Rank
We are authorized to issue 2000 shares of Series C preferred stock, par value
$0.001 per share. The Series C preferred stock ranks senior to our common stock
and to all other classes and series of our equity securities that by their terms
do not rank senior to the Series C preferred stock. The Series C preferred stock
is subordinate to, and ranks junior to, all of our indebtedness. The Series C
preferred stock has a stated value of $6,000 per share. There are 948.333 shares
of Series C preferred stock outstanding.
Dividends
Each holder of Series C preferred stock is entitled to receive dividends at the
rate of 10% per annum of the Series C preferred stock's stated liquidation
preference amount of $6,000 per share (the "Series C Liquidation Preference
Amount"), payable by us at our option in either cash or shares of our common
stock. The formula for determining the number of shares of our common stock to
be paid as a dividend on each Series C preferred share is the number equal to
the quotient of (i) the dividend payment divided by (ii) the Conversion Price
(defined below).
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Dividends on the Series C preferred stock are cumulative and accrue and are
payable upon the conversion of the Series C preferred stock, at our option, in
either cash or shares of our common stock. Dividends paid on the Series C
preferred stock are paid prior and in preference to any declaration or
distribution on any outstanding share of common stock or any other equity
securities of ours which rank junior to the Series C preferred stock.
As long as any shares of Series C preferred stock are outstanding, we will not
declare, pay or set apart for payment any dividend or make any distribution on
any junior stock (other than dividends or distributions payable in additional
shares of junior stock), unless at the time of such dividend or distribution
that we will have paid all accrued and unpaid dividends on the outstanding
shares of Series C preferred stock.
In the event of our dissolution, liquidation or winding up, all accrued and
unpaid dividends on the Series C preferred stock shall be payable on the day
immediately preceding the date of payment of the liquidation preference amount
to the holders of Series C preferred stock. In the event of (i) a mandatory
redemption of the Series C preferred stock, (ii) a redemption upon the
occurrence of a Major Transaction (as defined below) or (iii) a redemption upon
the occurrence of a Series C Triggering Event (as defined below), all accrued
and unpaid dividends on the Series C preferred stock shall be payable on the day
immediately preceding the date of such redemption. In the event of a voluntary
conversion of the Series C preferred stock, all accrued and unpaid dividends on
the Series C preferred stock being converted shall be payable on the day
immediately preceding the voluntary conversion.
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"Major Transaction" means:
o the consolidation, merger or other business combination of Ortec with or
into another person (other than (A) pursuant to a merger effected solely
for the purpose of changing the jurisdiction of our incorporation or (B) a
consolidation, merger or other business combination in which holders of our
voting power immediately prior to the transaction continue after the
transaction to hold, directly or indirectly, the voting power of the
surviving entity or entities necessary to elect a majority of the members
of the board of directors of such entity or entities);
o the sale or transfer of more than 50% of the our assets other than
inventory in the ordinary course of business; or
o acquisition by a third party of more than 50% of the outstanding shares of
our Common Stock.
"Series C Triggering Event" means:
o if any shares of Series C preferred stock are outstanding, the
effectiveness of the registration statement (we are required to file
qualifying for public sale all shares of our common stock issuable upon
conversion of the shares of Series C preferred stock and upon exercise of
the warrants we granted to the purchasers of the Series B preferred stock)
lapses for any reason or is unavailable to the holders of the Series C
preferred stock for sale of such shares of our common stock, and such lapse
or unavailability continues for a period of ten consecutive trading days
and such shares of our common stock cannot be sold in the public securities
market pursuant to Rule 144(k), provided that the cause of such lapse or
unavailability is not due to factors solely within the control of such
holder of Series C preferred stock;
o the suspension from listing or the failure of the Common Stock to be listed
on the OTC Bulletin Board, Nasdaq SmallCap Market, The New York Stock
Exchange, Inc. or The American Stock Exchange, Inc., for a period of five
(5) consecutive days;
o Our notice to any holder of Series C preferred stock of our inability to
comply or our intention not to comply with proper requests for conversion
of any Series C preferred stock;
o our failure to comply with a conversion notice within ten business days
after the receipt by us of the conversion notice and the Series C preferred
stock certificates; or
o we breach any representation, warranty, covenant or other term or condition
of the Series C preferred stock purchase agreement, the Series C preferred
stock Certificate of Designation or any other agreement, document,
certificate or other instrument delivered in connection with the sale of
the Series C preferred stock, except to the extent that such breach would
not have a material adverse effect and except, in the case of a breach of a
covenant which is curable, only if such breach continues for a period of a
least ten days.
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Voting Rights
Except as described below and otherwise required by Delaware law, the Series C
preferred stock has no voting rights.
As long as any shares of the Series C preferred stock remain outstanding, we
will not, without the affirmative vote or consent of the holders of at least 75%
of the shares of the Series C preferred stock outstanding at the time, voting
separately as a class:
o change to our certificate of incorporation or the certificate of
designation of the relative rights and preferences of the Series C
preferred stock, which would amend, alter, change or repeal any of the
powers, designations, preferences and rights of the Series C preferred
stock;
o issue any additional shares of Series C preferred stock.
Liquidation Preference
In the event of our liquidation, dissolution or winding up, the holders of
shares of the Series C preferred stock then outstanding shall be entitled to
receive, out of our assets, a liquidation preference amount equal to $6,000 per
share of the Series C preferred stock plus any accrued and unpaid dividends
before any payment shall be made or any assets distributed to the holders of our
common stock or any other junior stock. If our assets are not sufficient to pay
in full such Series C liquidation preference amount (plus any accrued and unpaid
dividends) to the holders of the Series C preferred stock and any series of
preferred stock or any other class of stock on a parity, as to rights on
liquidation, dissolution or winding up, with the Series C preferred stock, then
all of our assets available to pay such liquidation preference amounts will be
distributed among the holders of the Series C preferred stock and the other
classes of stock on a parity with the Series C preferred stock, if any, ratably
in accordance with the respective amounts that would be payable on such shares
if all amounts payable thereon were paid in full. After payment of the full
Series C liquidation preference amount (plus any accrued and unpaid dividends),
the holders of shares of Series C preferred stock will not be entitled to any
further participation as such in any distribution of our assets.
Conversion
Voluntary Conversion
Each holder of Series C preferred stock may, at such holder's option, subject to
certain limitations described below, elect to convert all or any portion of
the shares of Series C preferred stock held by such holder into a number of
fully paid and non-assessable shares of our common stock equal to the quotient
of (i) the Series C Liquidation Preference Amount divided by (ii) the Series C
Conversion Price (as defined below).
Mandatory Conversion
Upon the occurrence of a Mandatory Conversion Date, each share of Series C
preferred stock outstanding on the Mandatory Conversion Date shall automatically
convert into a number of fully paid and non-assessable shares of our common
stock equal to the quotient of (i) the Series C liquidation preference amount
divided by (ii) the applicable conversion price in effect on the Mandatory
Conversion Date. However, the mandatory conversion can only occur if the closing
bid price of our common stock exceeds $6.00 for a period of ten consecutive
trading days before the Mandatory Conversion Date.
"Mandatory Conversion Date" means the date, which is not earlier than six months
after the effective date of the registration statement (above referred to).
Provided, however, that on the Mandatory Conversion Date, such registration
statement must be effective or the shares of our common stock into which the
Series C preferred stock can be converted may be offered for sale to the public
pursuant to Rule 144(k) under the Securities Act.
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Series C Conversion Price
The Series C Conversion Price is equal to $2.00 per share, subject to certain
adjustments described below, and at no time will the Series C Conversion Price
exceed $2.00 per share.
The certificate of designation for the Series C preferred stock sets forth
customary adjustments to the Series C Conversion price in the event of stock
splits, combinations, dividends, distributions, reclassifications and other
corporate events. If we issue or sell any additional shares of common stock at a
price per share less than $2.00, or without consideration, the Series C
Conversion Price will be reduced to a price determined by multiplying the
Series C Conversion Price by a fraction:
(i) the numerator of which shall be equal to the sum of (A) the number of
shares of common stock outstanding immediately prior to the issuance
of the additional shares of common stock plus (B) the number of shares
of common stock which the aggregate consideration paid for the
additional shares would purchase at a price equal to the Series C
Conversion Price, and
(ii) the denominator of which shall be equal to the number of shares of
common stock outstanding immediately after the issuance of the
additional shares.
Conversion Restrictions
At no time may a holder of shares of Series C preferred stock convert such
shares if the number of shares of our common stock to be issued pursuant to such
conversion would exceed, when aggregated with all other shares of our common
stock owned by such holder at such time, the number of shares of our common
stock which would result in the holder Beneficially Owning more than 4.99% or
9.99%of all of our common stock outstanding at such time. However, this
restriction may be waived by such holder if we are provided with a sixty-one day
written notice by such holder that such holder desires to waive this
restriction. This restriction will not be applicable during the sixty-one days
immediately preceding the Mandatory Series C Conversion Date.
Redemption
Redemption by holders of Series C preferred stock
Upon the occurrence of a Major Transaction or a Series C Triggering Event, each
holder of Series C preferred stock will have the right, at such holder's option,
to require us to redeem all or a portion of such holder's shares of Series C
preferred stock at a price per share equal to 100% of the liquidation preference
amount if paid in cash, or 120% of the liquidation preference amount in the case
of a Major Transaction and 150% in the case of a Series C Triggering Event if
paid in shares of our common stock, plus any accrued but unpaid dividends and
liquidated damages (the "Major Transaction Series C Redemption Price"). We will
have the right to decide whether to pay the Major Transaction Series C
Redemption Price in cash or shares of our common stock. If we elect to pay the
Major Transaction Series C Redemption Price in shares of our common stock, the
price per share will be based upon the Series C Conversion Price then in effect
on the day preceding the date of delivery of written notice by the holder of our
Series C preferred stock of its election to have us redeem its Series C
preferred stock.
Ortec's Redemption Option
We may redeem all or a portion of the Series C preferred stock outstanding upon
five days prior written notice at a price per share equal to 150% of the
liquidation preference amount plus any accrued but unpaid dividends and
liquidated damages. If a holder of Series C preferred stock has, prior to our
redemption notice, delivered a conversion notice to us or delivers a conversion
notice to us within twenty-four hours of such holder's receipt of our redemption
notice, up to 50% of the shares of Series C preferred stock designated to be
redeemed may be converted by such holder. If during the period between delivery
of our redemption notice and the redemption date a holder would become entitled
to deliver a notice of redemption at the option of the holder because of a Major
Transaction, then the right of such holder shall take precedence over our
previously delivered redemption notice.
There are no restrictions on the repurchase or redemption of the shares of
Series C preferred stock because of any arrearage in the payment of dividends.
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Item 6. Exhibits and Reports on Form 8-K
(a) Exhibit No. Description
----------- -----------
3.1 Restated Certificate of Incorporation (1)
3.2 Amendment to Restated Certification of Incorporation (2)
3.3 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)
3.4 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 (2)
3.5 Amendment to Certificate of Incorporation filed on May 23, 2003, being the
Certificate of Designation of the Relative Rights and Preferences of the Series C
convertible preferred stock (5)
3.6 By-Laws (4)
31.1 Certifications (Principal Executive Officer) (5)
31.2 Certifications (Principal Financial Officer) (5)
99.1 Certification of Principal Executive Officer (5)
99.2 Certification of Principal Financial Officer (5)
- ---------------------
(1) Filed as an Exhibit to our Form 10-Q filed for the quarter ended September
30, 2001, and incorporated herein by reference.
(2) Filed as an Exhibit to our Form 10-K for the year ended December 31, 2002
and incorporated herein by reference.
(3) Filed as an Exhibit to our Form 10-Q for the quarter ended June 30, 2002.
(4) 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.
(5) Filed herewith.
(b) Reports on Form 8-K
We filed one report on Form 8-K in the second quarter of 2003.
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SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the registrant has
caused this report to be signed on its behalf by the undersigned, thereto duly
authorized.
Registrant:
ORTEC INTERNATIONAL, INC.
Date: August 14, 2003 By: /s/ Steven Katz
---------------------------------------
Steven Katz, PhD
Chairman
(Principal Executive Officer)
Date: August 14, 2003 By: /s/ Ron Lipstein
---------------------------------------
Ron Lipstein
Chief Financial Officer
(Principal Executive Officer)
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STATEMENT OF DIFFERENCES
The registered trademark symbol shall be expressed as.................... 'r'