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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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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 September 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
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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
--- ---
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The number of shares outstanding of the issuer's common stock is 5,231,165 (as
of November 14, 2003) ( giving effect to issuance of 242,931 shares as a result
of conversion of 60.7309 shares of Series B preferred stock for which the Series
B preferred stock certificates have not yet been surrendered.)
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ORTEC INTERNATIONAL, INC.
INDEX TO QUARTERLY REPORT ON FORM 10-Q
FILED WITH THE SECURITIES AND EXCHANGE COMMISSION
QUARTER ENDED SEPTEMBER 30, 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. 27
Part II
Item 1. Legal Proceedings and Claims. 27
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. 31
Signatures 32
Item 1. FINANCIAL STATEMENTS
ORTEC INTERNATIONAL, INC.
(A DEVELOPMENT STAGE ENTERPRISE)
BALANCE SHEETS
September 30 DECEMBER 31,
2003 2002 *
------------ ------------
(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 887,188 $ 826,227
Accounts receivable 5,374 15,324
Other current assets 33,777 41,904
----------- -----------
Total current assets 926,339 883,455
Property and equipment, at cost:
Laboratory equipment 1,681,083 1,671,075
Office furniture and equipment 1,352,664 1,350,985
Leasehold improvements 1,354,481 1,567,513
----------- -----------
4,388,228 4,589,573
Accumulated depreciation and amortization (3,627,330) (3,207,977)
----------- -----------
Property and equipment - net 760,898 1,381,596
----------- -----------
Other assets:
Patent application costs, net of accumulated
amortization of $332,273 at September 30, 2003 and
$279,037 at December 31, 2002 690,025 682,885
Deferred financing costs, net of accumulated
amortization of $12,396 at September 30, 2003 and
$7,933 at December 31, 2002 47,105 78,207
Security deposit - New Jersey location 16,000 639,000
Other deposits and other assets 23,670 33,223
----------- -----------
Total other assets 776,800 1,433,315
----------- -----------
$ 2,464,037 $ 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
September 30, DECEMBER 31,
2003 2002 *
------------- ------------
(Unaudited)
LIABILITIES AND SHAREHOLDERS' EQUITY/(DEFICIT)
Current liabilities:
Accounts payable and accrued expenses $ 3,498,697 $ 3,773,063
Accrued compensation 487,835 274,253
Accrued professional fees 470,456 365,945
Capital lease obligation - current 162,451 142,620
Loan payable - current 165,296 155,578
Advances payable 130,000
Obligation under Royalty Revenue Agreement 17,319,031 13,959,541
------------ ------------
Total current liabilities 22,233,766 18,671,000
Long-term liabilities:
Loan payable - noncurrent 488,190 613,405
Capital lease obligation - noncurrent 97,317 215,093
------------ ------------
Total Liabilities 22,819,273 19,499,498
------------ ------------
Commitments and contingencies
Shareholders' equity/(deficit):
Common stock, $.001 par value; authorized, 200,000,000 shares, 5,233,165 shares
issued, 5,231,165 shares outstanding, at September 30, 2003 and 2,320,469
shares issued, 2,318,469 shares outstanding, at December 31, 2002 5,233 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; 50 shares issued and outstanding, at
September 30, 2003 and 938 shares issued and outstanding, at December 31,
2002; liquidation preference $500,000 at September 30, 2003 and
$9,382,742 at December 31, 2002 270,859 5,037,087
Redeemable convertible preferred stock - Series C, stated
value $6,000 per share; authorized 2,000 shares;
948 shares issued and outstanding, at September 30, 2003,
liquidation preference $5,690,000 at September 30, 2003 3,667,041
Convertible preferred stock - Series D, stated
value $10,000 per share; authorized 2,000 shares;
483 shares issued and outstanding, at September 30, 2003,
liquidation preference $4,828,850 at September 30, 2003 2,628,602
Additional paid-in capital 71,922,888 61,195,715
Deficit accumulated during the development stage (98,672,214) (81,858,609)
Treasury stock, at cost (2,000 shares at September 30, 2003
and December 31, 2002) (177,645) (177,645)
------------ ------------
(20,355,236) (15,801,132)
------------ ------------
$ 2,464,037 $ 3,698,366
============ ============
Common stock shares and amount adjusted to reflect one for ten reverse stock
split effective 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)
Cumulative from
Three months ended September 30, Nine months ended September 30, March 12, 1991
-------------------------------- ------------------------------- (inception) to
2003 2002 2003 2002 September 30,2003
----------- ----------- ------------ ------------ -----------------
Product revenue $ -- $ 34,825 $ -- $ 243,775 $ 265,665
----------- ----------- ------------ ------------ ------------
Expenses
Research and development 756,845 656,620 1,615,084 2,871,250 22,810,991
Rent 120,115 130,922 456,687 516,191 3,319,338
Consulting 1,396 92,053 (27,735) 436,331 5,689,606
Personnel 928,629 1,211,132 2,949,064 5,381,600 32,339,383
General and Administrative 738,511 508,194 1,884,103 2,359,632 16,668,684
Interest and other expense 1,221,485 1,425,660 3,443,768 5,092,532 11,744,378
Lease termination costs 1,119,166 1,119,166
Loss on extinguishment of debt
and series A preferred stock 1,004,027
Interest income (106) (283) (14,804) (7,603) (2,271,900)
----------- ----------- ------------ ------------ ------------
3,766,875 4,024,298 11,425,333 16,649,933 92,423,673
----------- ----------- ------------ ------------ ------------
Net Loss (3,766,875) (3,989,473) (11,425,333) (16,406,158) (92,158,008)
Preferred stock dividend 140,600 1,119,272 2,245,206
Preferred stock deemed dividends
and discount 90,000 4,269,000 4,269,000
----------- ----------- ------------ ------------ ------------
Net loss applicable to common
Shareholders $(3,997,475) $(3,989,473) $(16,813,605) $(16,406,158) $(98,672,214)
----------- ----------- ------------ ------------ ------------
Net loss per share
Basic and diluted $ (0.76) $ (4.12) $ (4.38) $ (16.93) $ (133.93)
=========== =========== ============ ============ ============
Weighted average shares outstanding
Basic and diluted 5,263,628 969,161 3,842,933 969,161 736,757
=========== =========== ============ ============ ============
Shares outstanding and per share amounts adjusted to reflect one for ten reverse
stock split effective June 24, 2003.
See notes to condensed unaudited financial statements.
3
Ortec International, Inc.
(a development stage enterprise)
STATEMENT OF SHAREHOLDERS' EQUITY/(DEFICIT)
(Unaudited)
Common Stock Preferred stock
---------------- ------------------------------
Shares Amount Series B Series C Series D
------- ------ -------- -------- --------
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 expense
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 expense
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) 11,112 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) 231,953 232
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 expense (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 expense (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 Series D
------- ------ -------- -------- --------
(brought forward) 231,953 $232
Issuance of stock
Fourth private placement ($1.00 cash per share) 3,946 4
Stock purchase agreement with Home
Insurance Company ($1.00 cash per share) 5,000 5
Share issuance expense
Net loss
------- ----
Balance at December 31, 1994 240,899 241
Rent forgiveness
Net loss
------- ----
Balance at December 31, 1995 240,899 241
Initial public offering 120,000 120
Exercise of warrants 3,389 3
Fifth private placement ($.65 cash per share) 95,911 96
Share issuance costs
Stock options issued for services
Net loss
------- ----
Balance at December 31, 1996 (carried forward) 460,199 460
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 ($1.00 cash per share) 499,995 500,000
Share issuance expense (8,697) (8,697)
Net loss (1,675,087) (1,675,087)
----------- ----------- -----------
Balance at December 31, 1994 4,710,812 (4,188,296) 522,757
Rent forgiveness 40,740 40,740
Net loss (1,022,723) (1,022,723)
----------- ----------- -----------
Balance at December 31, 1995 4,751,552 (5,211,019) (459,226)
Initial public offering 5,999,880 6,000,000
Exercise of warrants 33,882 33,885
Fifth private placement ($.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 Series D
------- ------ -------- -------- --------
(brought forward) 460,199 $460
Exercise of warrants 115,878 116
Share issuance costs
Stock options and warrants issued for services
Net loss
------- ----
Balance at December 31, 1997 576,077 576
Exercise of warrants 22,149 22
Stock options and warrants issued for services
Sixth private placement 20,000 20
Warrants issued in Sixth private placement
Share issuance costs
Purchase of 660 shares of treasury (at cost)
Net loss
------- ----
Balance at December 31, 1998 618,226 618
Exercise of warrants 1,410 1
Stock options and warrants issued for services
Seventh private placement ($.88 cash per share) 38,916 39
Warrants issued in Seventh private placement
Eighth private placement ($.55 cash per share) 163,637 164
Share issuance costs
Purchase of 910 shares of treasury (at cost)
Net loss
------- ----
Balance at December 31, 1999 (carried forward) 822,189 822
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 (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 (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 Series D
--------- ------ ----------- -------- --------
(brought forward) 822,189 $ 822
Exercise of options and warrants 17,554 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 971,167 971
Stock options issued for services
Net loss
--------- ------
Balance at December 31, 2001 971,167 971
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 and exercised with preferred stock 938,275 938 (3,479,043)
Share issuance costs - preferred stock (866,612)
Preferred stock dividends 375,312 375
Net loss
--------- ------ -----------
Balance at December 31, 2002 2,320,477 2,320 5,037,087
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)
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 and exercised 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)
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 Series D
--------- ------ ----------- ----------- ----------
(brought forward) 2,320,477 $2,320 $ 5,037,087
Exercise of options and warrants 398,750 399
Issuance of preferred stock:
series B (200 shares), series C
(948 shares) 2,000,000 $ 5,690,000
Warrants issued with preferred stock (490,567) (1,225,632)
Share issuance costs - preferred stock (393,488) (797,327)
Conversion of series B preferred
stock (605 shares) into common stock 2,421,556 2,422 (3,253,571)
Conversion of series B preferred
stock into series D preferred stock
(483 shares) (2,628,602) $2,628,602
Preferred Stock deemed dividends
and discounts
Preferred stock dividends 92,308 92
Common stock dividend to be distributed on
Series C preferred stock
Adjustment for one for ten reverse stock
split 74
Net loss
--------- ------ ----------- ----------- ----------
Balance at September 30, 2003 5,233,165 $5,233 $ 270,859 $ 3,667,041 $2,628,602
========= ====== =========== =========== ==========
Deficit
accumulated
Additional during the Total
paid-in development Treasury shareholders'
capital stage stock equity/(deficit)
----------- ------------ --------- ----------------
(brought forward) $61,195,715 $(81,858,609) $(177,645) $(15,801,132)
Exercise of options and warrants 12,567 12,966
Issuance of preferred stock:
series B (200 shares), series C
(948 shares) 7,690,000
Warrants issued with preferred stock 1,716,199
Share issuance costs - preferred stock 359,078 (831,737)
Conversion of series B preferred
stock (605 shares) into common stock 3,251,149
Conversion of series B preferred
stock into series D preferred stock
(483 shares)
Preferred Stock deemed dividends
and discounts 4,269,000 (4,269,000)
Preferred stock dividends 922,985 (923,077)
Common stock dividend to be distributed on
Series C preferred stock 196,195 (196,195)
Adjustment for one for ten reverse stock
split
Net loss (11,425,333) (11,425,333)
----------- ------------ --------- ------------
Balance at September 30, 2003 $71,922,888 $(98,672,214) $(177,645) $(20,355,236)
=========== ============ ========= ============
Common stock shares and amounts adjusted to reflect one for ten reverse stock
split effective June 24, 2003
See notes to condensed unaudited financial statements.
8
ORTEC INTERNATIONAL, INC.
(A DEVELOPMENT STAGE ENTERPRISE)
STATEMENT OF CASH FLOWS
(Unaudited)
Cumulative
from
March 12, 1991
Nine Months ended September 30, (inception) to
------------------------------- September 30,
2003 2002 2003
------------ ------------ --------------
Cash flow from operating activities
Net loss $(11,425,333) $(16,406,158) $(92,158,008)
Adjustments to reconcile net loss to net cash
used in operating activities
Depreciation and amortization 472,589 544,485 4,305,609
Amortization of deferred financing costs 4,462 91,266 327,687
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 3,359,755 4,797,023 10,672,181
Loss on extinguishment of debt and series A
preferred stock 1,004,027
Purchase of marketable securities (19,075,122)
Sale of marketable securities 19,130,920
Change in operating assets and liabilities
Accounts receivable 9,950 (37,810) (5,374)
Other current assets and other assets 44,320 180,398 63,451
Accounts payable (250,484) 1,967,072 4,191,104
------------ ------------ ------------
Net cash used in operating activities (6,654,498) (8,757,464) (67,234,033)
------------ ------------ ------------
Cash flows from investing activities
Purchase of property and equipment, excluding capital leases (11,687) (234,452) (4,465,584)
Proceeds from sale of property and equipment 56,901
Payments for patent applications (60,376) (123,676) (1,020,518)
Organization costs (10,238)
Deposits 2,548 (731,273)
Purchase of marketable securities (594,986)
Sale of marketable securities 522,532
------------ ------------ ------------
Net cash used in investing activities (72,063) (355,580) (6,243,166)
------------ ------------ ------------
9
Ortec International, Inc.
(a development stage enterprise)
STATEMENT OF CASH FLOWS
(Unaudited)
Cumulative
from
March 12, 1991
Nine Months ended September 30, (inception) to
------------------------------- September 30,
2003 2002 2003
---------- ---------- --------------
Cash flow 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 $ 12,966 20,660
Share issuance of expenses and other financing costs (831,737) $ (413,980) (5,343,413)
Purchase of treasury stock (177,645)
Proceeds from issuance of loan payable 1,446,229
Proceeds from other obligations 4,000,000 10,000,000
Proceeds from issuance of convertible debentures 4,008,000 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 5,690,000 5,690,000
Advances received 130,000 130,000
Repayment of capital lease obligations (97,945) (60,988) (296,877)
Repayment of loan payable (115,497) (106,535) (821,675)
Repayment of other obligation (265) (9,890) (11,414)
Repayment of notes payable (515,500)
---------- ---------- -----------
Net cash provided by (used in) financing activities 6,787,522 8,616,607 74,364,387
---------- ---------- -----------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 60,961 (496,437) 887,188
Cash and cash equivalents at beginning of period 826,227 854,025 --
---------- ---------- -----------
Cash and cash equivalents at end of period $ 887,188 $ 357,588 $ 887,188
========== ========== ===========
10
Ortec International, Inc.
(a development stage enterprise)
STATEMENT OF CASH FLOWS
(Unaudited)
Cumulative
from
March 12, 1991
Nine Months ended September 30, (inception) to
------------------------------- September 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 cost - other long term obligations included in
accrued expense 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
Warrants issued with debentures 440,523
Warrants issued with preferred stock 559,289
Debenture conversion feature 1,042,663
Preferred stock conversion feature 1,097,886
Conversion of debt to preferred stock 670,120
Cash paid for interest 65,244 31,043 610,102
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 September 30, 2003, and the condensed
statements of operations for the three and nine month periods ended September
30, 2003 and 2002, and for the period from March 12, 1991 (inception) to
September 30, 2003, and the statements of shareholders' equity (deficiency) and
cash flows for the nine month periods ended September 30, 2003 and 2002, and for
the period from March 12, 1991 (inception) to September 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 September 30, 2003, results of
operations for the three and nine month periods ended September 30, 2003 and
2002, and for the period from March 12, 1991 (inception) to September 30, 2003,
and stockholders' equity and cash flows for the nine month periods ended
September 30, 2003 and 2002 and for the period from March 12, 1991 (inception)
to September 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 nine month periods ended September 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
$3.8 million and $11.4 million during the three and nine months ended September
30, 2003, and, as of that date, the Company's current liabilities exceeded its
current assets by $21.3 million, its total liabilities exceeded its total assets
by $20.4 million and the Company has an accumulated deficit in its development
stage of $98.7 million. These factors, among others, raise substantial doubt
about the Company's ability to continue as a going concern.
12
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
needs to raise an additional $2.0 million by the end of the year. The funds
received to date, as well as $2.0 million of additional capital through 2003, if
secured, will enable the Company to file with the FDA for pre-market approval
for the commercial sales of OrCel in its cryo-preserved form for the treatment
of venous ulcers and begin the transfer of technology to its third party
manufacturer. Accomplishing these milestones might 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. The Company needs to secure approximately $12.0
million of financing in 2004 to fund working capital and general corporate
expenses as well as production costs associated with the launch of its OrCel
product in the second half of 2004 for treatment of venous stasis ulcers. 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 September 30, 2003, (approximately $0.9 million), as well
as the additional $2.0 million and $12.0 million needed to be raised in 2003 and
2004, respectively, will enable it to continue its operations for the next 15
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 effected 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 as
of September 30, 2003 were reduced as a result of this one for ten reverse split
to common shares, warrants, and options outstanding of 5,231,165, 3,012,673, and
1,676,974, respectively. The conversion rates of the Preferred stock outstanding
was also adjusted accordingly, and as of September 30, 2003 would result in the
issuance of 10,207,704 shares of common shares, if converted.
As a result of this reverse split, 2,951,590 warrants are exercisable at prices
ranging from $.01 to $6.00 and 61,083 warrants are exercisable at prices in
excess of $6.00. Similarly, 1,490,594 options are exercisable at prices ranging
from $1.80 to $6.00 and 186,380 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 nine months ended September 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 nine months ended September 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 Nine Months Ended Quarter Ended Nine Months Ended
Sept. 30, 2003 Sept. 30, 2003 Sept. 30, 2002 Sept. 30, 2002
- ------------------------------------------------------------------------------------------------------------------
Net loss applicable to common shareholders,
as reported $(3,997,475) $(16,813,605) $(3,989,473) $(16,406,158)
- ------------------------------------------------------------------------------------------------------------------
Deduct: Total stock-based employee
compensation expense determined under
fair value based method (89,000) (1,275,000) (234,000) (623,000)
- ------------------------------------------------------------------------------------------------------------------
Pro forma net loss applicable to common
shareholders $(4,086,475) $(18,088,605) $(4,223,473) $(17,029,158)
- ------------------------------------------------------------------------------------------------------------------
Loss per share:
- ------------------------------------------------------------------------------------------------------------------
Basic and Diluted-as reported $ (0.76) $ (4.38) $ (4.12) $ (16.93)
- ------------------------------------------------------------------------------------------------------------------
Basic and Diluted-pro forma $ (0.78) $ (4.71) $ (4.36) $ (17.57)
- ------------------------------------------------------------------------------------------------------------------
Impact of Recently Issued Accounting Standards
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.
14
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 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 ending after December 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 have 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 in the
first interim period beginning after June 15, 2003. The effect of the adoption
of SFAS No. 150 did not have a material impact on the Company's financial
position and results of operations.
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 September 30, 2003, an
aggregate of 4,657,185 outstanding warrants and options were excluded from the
diluted weighted average share calculations, as the effect was antidilutive. An
aggregate of 200,000 shares of common stock, if converted at the conversion
price of $2.50 per share would be issuable upon the conversion of Series B
preferred stock, 2,844,999 common shares, if converted at the conversion price
of $2.00 per share, would be issuable upon the conversion of Series C
preferred stock, and 1,931,540
15
common shares if converted at the conversion price of $2.50 per share, would be
issuable upon conversion of Series D preferred stock outstanding at
September 30, 2003. These were also excluded from the calculation of diluted net
loss per share at September 30, 2003, as the effect would be antidilutive. As of
September 30, 2002, an aggregate of 402,303 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 nine
months ended September 30, 2003, includes warrants to purchase 32,460 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 7).
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
September 30, 2003, there have been no advance payments made to Paul Capital, as
the Company is not engaged in sales activity.
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, June 30, 2003 and September 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. Additionally, in order to facilitate the Company's ability to
raise future financing, in October 2003 Paul Capital agreed, under certain
circumstances, to provide the Company with a forbearance agreement, whereby,
Paul Capital relinquished its right to require the company to repurchase its
revenue interest as a result of this technical breach of contract. In order
for this forbearance agreement to be effected, the Company must obtain funds
from a qualified financing arrangement and cannot be insolvent, as defined
in the agreement.
The Company granted Paul Capital a security interest in its United States and
Canadian patents and trademarks relating to its technology for its OrCel
product, to secure payments required to be made by the Company to Paul Capital
under this agreement.
Ortec has entered into a contract with Cambrex Bio. Science Walkerville, Inc, a
third party manfacturer, for the
16
production of Ortec's OrCel product in October (see Note 9). The contract
provides for the lease of production space as well as providing production
personnel needed for the manufacture of OrCel. The Company expects to have the
capacity to produce the large quantities of OrCel that may be required in the
event of the receipt of FDA approval for the sale of OrCel for use in the
treatment of patients with venous stasis ulcers.
NOTE 5 - LEGAL PROCEEDINGS, CLAIMS AND OTHER CONTINGENCIES
ClinTrials Networks, LLC (ClinTrials) filed an arbitration claim against the
Company for breach of an agreement 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. ClinTrials
claimed that the Company owed ClinTrials $165,936 and during the arbitration
hearings Clin Trials increased its claim to approximately $400,000, plus
reimbursement of legal fees. In September 2003, the arbitrator awarded
ClinTrials $93,263 in full settlement of its claim plus interest of 6% per annum
from January 1, 2002 until the award is fully paid. Additionally, the Company
was ordered to pay $61,497 for claimant's attorney's fees and costs, and $1,438
for arbitration fees. These amounts have been accrued as of September 30, 2003.
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 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 nine
months ended September 30, 2003:
Stock Options Warrants Total
------------- ---------- ---------
Balance at December 31, 2002 667,212 1,117,211 1,784,423
Granted 1,055,261 2,294,212 3,349,473
Exercised -- (398,750) (398,750)
Expired or cancelled (45,499) -- (45,499)
--------- --------- ---------
Balance at September 30, 2003 1,676,974 3,012,673 4,689,647
========= ========= =========
Of the 1,676,974 stock options outstanding as of September 30, 2003, 1,274,400
represent stock options that were granted outside the plan. All options and
warrants activity and outstanding balances have been adjusted for the one for
ten reverse split effected 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 nine months ended September
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.
17
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 nine months ended September
30, 2003. The Company issued 105,000 and 2,294,212 warrants to non-employees
during the three and nine-month periods ended September 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 nine-month period, with $3,000 of expense
recorded. There were no stock options granted to employees during the quarter
ended September 30, 2003. For the nine months ended September 30, 2003, 159,261
options 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 (the B-1 warrants) shares were
exercisable at $1.50 per share and warrants to purchase the other 1,000,000 (the
B-2 warrants) shares were exercisable at $2.00 per share. In May and June 2003,
in conjunction with the conversion of the Series B preferred stock 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 50 shares of Series B preferred stock on May 23, 2003 and,
accordingly, the exercise price of their B-1 and B-2 Warrants were not amended
and are now exercisable at $15.00 and $20.00, respectively. 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.
In May and July 2003, Ortec received gross proceeds of $5.7 million from the
sale of 948 shares of Series C convertible preferred stock, issuing warrants to
purchase 1,707,000 shares at $3.60 per share, post split. These Series C
preferred stock has a stated value of $6,000 per share and are convertible
into 2,844,999 shares of common stock at $2.00 per share, post split. Dividends
will be paid in cash or common shares at the option of the Company, at the rate
of 10% per annum. An accrued dividend of $196,195 at September 30, 2003 has
been provided for within stockholders' equity/(deficit) as the Company's
current intent is to issue common shares in payment of the dividend. 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 Series B preferred stock were converted into 24,215,560
shares of common stock at $.25 per share (2,421,556 at $2.50 post split) and
482.885 shares of Series B preferred stock were converted into an equal
number of shares of Series D preferred stock (common stock equivalent
1,931,540 shares post split). The Series D convertible preferred stock
is non-redeemable and has a stated value of $10,000 per share. The
liquidation value of these shares is $4,828,850. Ortec is authorized
to issue up to 2,000 shares of Series D preferred stock.
In conjunction with these conversions, all Series B-1 and B-2 warrants were
amended to reflect the revised exercise price of $4.00 and $5.00, respectively,
post split. Paul Capital did not exercise its right to convert its 50 shares of
Series B preferred stock 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 Series C financing, employees of the investment-banking
firm were granted warrants to purchase 1,495,200 shares at an exercise price of
$.001 (149,520 shares at $.01, post split) as part of their compensation.
Accordingly, the Company recorded $269,000 in Series C preferred share
issuance costs related to the warrants.
Based on the relative fair market value of the preferred stock at the dates of
issuance and the estimated fair market
18
value of the warrants, using the Black-Scholes option pricing model, at
September 30, 2003, the Company assigned values to the Series C preferred stock
and its related C warrants of $4,464,368 and $1,225,632, respectively.
Similarly, the Company assigned values to the Series D Preferred stock, based on
values previously assigned to the Series B Preferred stock.
During the quarter, the Company incurred $39,000 of financing fees relating to
the Series C preferred stock issued in the quarter, which was paid in cash.
Additionally, since the effective conversion price of the Series C preferred
stock on the date of issuance was lower than the market value of the common
shares on that date, the Company recognized $691,000 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 September 30, 2003.
NOTE 9 - SUBSEQUENT EVENTS
In October 2003, the Company raised additional funds of $0.6 million.
In October 2003, the Company entered into an agreement with Teva Medical, Ltd.,
a wholly owned subsidiary of Teva Pharmaceutical Industries Ltd. (Teva), under
which Teva Medical obtained a license to promote and sell Ortec's tissue
engineered wound healing product, OrCel, in Israel for the treatment of chronic
wounds and other dermatological applications.
The Company finalized the contract manufacturing agreement with Cambrex Bio
Science Walkersville, Inc., a subsidiary of Cambrex Corporation, for the
commercial manufacture of Ortec's tissue engineered product, OrCel, at the end
of October 2003. Under the terms of the six-year agreement, Cambrex will provide
Ortec with requisite manufacturing services and personnel for the commercial
production of OrCel in accordance with Food and Drug Administration (FDA)
requirements. Cambrex's current capacity at its Walkersville, Maryland facility
is expected to meet Ortec's commercial manufacturing requirements for the first
twelve months following the market launch of OrCel. The contract also specifies
that Cambrex will invest in additional capacity to meet the market demand for
OrCel.
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 nine-month period ended September 30, 2003.
From inception to date, we have incurred cumulative net losses of approximately
$98.7 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 have completed the enrollment and treatment of patients in an FDA clinical
trial for the use of OrCel in the treatment of venous stasis ulcers. Venous
stasis ulcers are open lesions on the legs, which result from the poor
circulation of blood returning from the legs to the heart. We expect to file an
application with the FDA for pre-market approval for the commercial sales of
OrCel in its cyro-preserved form for the treatment of venous stasis ulcers by
the end of November 2003. We hope to obtain 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 hope
to resume this trial in the second quarter of 2004 dependent on obtaining
sufficient additional financing.
20
In October 2003, we entered into a contract manufacturing agreement for the
production of OrCel with Cambrex Bio Science Walkerville, Inc, a subsidiary of
Cambrex Corporation. Cambrex's current capacity is expected to meet our
commercial manufacturing requirements for the first twelve months following the
market launch of OrCel if and when we receive FDA approval for the sale of our
product for use in the treatment of patients with venous stasis ulcers. This
agreement 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 for the distribution of
our product in the United States.
In October 2003 we entered into an agreement with Teva Medical, Ltd., a wholly
owned subsidiary of Teva Pharmaceutical Industries Ltd, under which Teva Medical
obtained a license to promote and sell our tissue engineered wound healing
product, OrCel, in Israel for the treatment of chronic wounds and other
dermatological applications.
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 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 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.
21
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 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 ending after December 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 have 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 in the
first interim period beginning after June 15, 2003.
22
The effect of the adoption of SFAS No. 150 did not have a material impact on
the Company's financial position and results of operations.
Results of Operations
Three and Nine Months Ended September 30, 2003, and September 30, 2002.
Revenues
We earned revenues of approximately $35,000 and $244,000 from commercial
shipments of products to customers in the quarter and nine months ended
September 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 nine months ended September 30, 2003.
Expenses
Expenses decreased by approximately $0.2 million from approximately $4.0 million
in the 2002 quarter to approximately $3.8 million in the 2003 quarter, and by
$5.2 million from approximately $16.6 million to $11.4 million in comparable
nine-month periods.
Personnel. Personnel costs decreased by approximately $0.3 million to $0.9
million in the 2003 quarter, compared with $1.2 million in the 2002 quarter due
to lower headcount and a reduction in executive salary and decreased by $2.5
million from $5.4 million to $2.9 million in the nine months ended September 30,
2003 compared to the 2002 nine-month period. The reduction in expense in the
2003 nine-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 $.1 million in the quarter and by $.5
million in the nine months ended September 30, 2003, compared with the quarter
and nine months ended September 30, 2002. Lower consulting expenses in the
current quarter and nine months ended September 30, 2003 are due to the fact
that the company has 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 product and process improvement projects,
as well as for the clinical trials.
Research and Development. These expenses at $0.8 million in 2003 quarter were in
line with 2002 quarter and decreased by $1.3million to $1.6 million from $2.9
million in the comparable nine-month periods. The decrease in research and
development expense was due to the fact that during the 2003 nine 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 increased by $0.2 million from $.5
million in the 2002 quarter to $0.7 million in the 2003 quarter due principally
to higher legal fees relating to the ClinTrials litigation. These expenses
decreased by $.5 million, from $2.4 million to $1.9 million in the comparable
nine 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, partly offset by higher legal fees in 2003.
23
Rent and Lease Termination Costs. Rent expense decreased by $11,000 and $60,000
in the 2003 quarter and nine month period compared with the 2002 periods, due to
reductions in space leased at all office locations. During the 2nd quarter of
2003, 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 $0.2 million in the quarter and
$1.6 million in the nine months ended September 30, 2003, compared with the
expense incurred in the quarter and nine months ended September 30, 2002. The
nine month period decrease is 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 September
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 September 30, 2003, we have accumulated
a deficit of approximately $98.7 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 September
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 $10.5 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 nine months ended September 30, 2003, we used net cash for operating
activities of approximately $6.7 million. Cash used in operating activities
resulted primarily from our net loss of $11.4 million, offset by depreciation
and amortization of approximately $.5 million, approximately $3.4 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 nine-month period.
In the nine months ended September 30, 2003, we received gross proceeds of $7.7
million from the issuance of preferred stock, advances of $.1 million against
future financings and incurred $.8 million in financing costs. As a result of
such preferred stock financing, common shares outstanding increased by 2.9
million shares , due to the conversion of preferred stock, the exercise of
warrants and the issuance of common stock for dividends payable on preferred
stock.
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.
24
In March 2003, Ortec began discussions with Cambrex, a third party manufacturer,
concerning the commercial contract production of our OrCel product. In October
2003, the agreement between the parties was finalized and the Company has begun
the transfer of technology to Cambrex. It is expected that Cambrex will begin
production of OrCel in the first quarter of 2004 and this inventory may be used
for sale in the second half of 2004 if we receive the PMA approval
in the second quarter of 2004 for sale of OrCel for use on patients in the
treatment of venous leg ulcers.
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
September 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 nine months ended
September 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, June 20, and September 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 also invested an
additional $500,000 in our Series B preferred stock.
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.
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 in 2003 we have raised an additional $2.0 million from the
sale of Series B convertible preferred stock in February 2003 and $5.7 million
from the sale of Series C convertible preferred stock in May and July 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, the exercise prices of these
warrants were reduced to $.40 and $.50 (post split $4.00 and $5.00),
respectively.
25
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 in the Series B
preferred stock issued in February 2003, along with all previous issues in 2002,
agreed to convert their Series B preferred shares into common shares and Series
D preferred shares (common stock equivalent) on May 23, 2003. The Company
finalized the conversion of the Series B preferred stock into the Series D
preferred stock on August 29, 2003. Only the 50 shares of Series B preferred
stock owned by Paul Capital were not converted.
On May 23, 2003 and July 29, 2003 we closed on Series C preferred stock equity
financing of $5.7 million from investors, some of whom have previously
participated in the $10.2 million raised through 2002 and 2003 prior to that
date. The Series C convertible preferred stock has a stated value of $6,000 per
share and is 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. An accrued dividend of $196,195 at
September 30, 2003 has been provided for within the stockholders' equity/
(deficit) as the Company's current intent is to issue common shares in payment
of these dividends. 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 stock
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 shares of Series B preferred
stocks were converted into 24,215,560 shares of common stock (post split
2,421,556 common shares) and shares of 482.885 Series B preferred stock were
converted into a similar number amount of shares of Series D preferred stock,
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.
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 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 we hope to raise in 2003 and 2004, will enable
us to file our application for pre-market approval with the FDA for the
commercial sales of OrCel in its cyro-preserved form for the treatment of venous
stasis ulcers, execute our production plan with our third party manufacturer and
prepare for sales in 2004. Accomplishing these milestones should enable us to
raise additional funding through other potential collaborative arrangements with
a pharmaceutical sales company and through the sale of our securities to the
public and through private placements,
26
debt financing or short-term loans. We believe that our cash and cash
equivalents on hand at September 30, 2003, (approximately $0.9 million), as well
as the additional $2.0 and $12.0 million we hope to raise in 2003 and 2004,
respectively, will enable us to continue our operations for the next 15 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 internal 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. 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. In September 2003, the arbitrator awarded
ClinTrials $93,263 in full settlement of its claim plus interest of 6% per annum
from January 1, 2002 until the award is fully paid. We were also ordered to pay
$61,497 for ClinTrials' attorney's fees and costs, and $1,438 for arbitration
fees.
Item 2. CHANGES IN SECURITIES
(c) Recent Sales of Unregistered Securities
As we reported in our quarterly report on Form 10-Q for the three months ended
June 30, 2003, 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
27
58.333 shares of our Series C preferred stock are convertible into 174,999
shares of our common stock. We sold the other 890 shares of our Series C
convertible preferred stock in the second quarter ended June 30, 2003, which we
also reported on our Form 10-Q for that three month period. In that Form 10-Q we
also described the relative rights and preferences of our Series C convertible
preferred stock.
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.
In August 2003, 482.885 shares of our Series B preferred stock were converted
into an equal number of shares of our newly created Series D convertible
preferred stock. Such 482.885 shares of our Series D preferred stock are
convertible into an aggregate of 1,931,540 shares of our common stock.
Series D Convertible Preferred Stock
Designation and Rank
On August 19, 2003, in connection with our board of director's authority to
issue "blank check" preferred stock, we filed an amendment to our certificate of
incorporation in which amendment we designated the relative rights and
preferences of our Series D preferred stock pursuant to which our board of
directors authorized the issuance of 2,000 shares of Series D preferred stock,
par value $0.001 per share. The Series D preferred stock ranks prior to the
Common Stock for purposes of liquidation preference and to all other classes and
series of equity securities of the Company that by their terms do not rank
senior to the Series D preferred stock, except that the Series D preferred stock
shall be subordinate to and rank junior to all other classes of preferred stock
of the Company outstanding as of August 19,2003 (the Series B and Series C
preferred stock) or thereafter created unless any series of preferred stock
hereafter created by its terms ranks junior to the Series D preferred stock. The
Series D preferred stock shall be subordinate to and rank junior to all
indebtedness of the Company now or hereafter outstanding. The Series D preferred
stock has a stated value of $10,000 per share.
Dividends
In the event we declare a cash dividend on our common stock we will be
required to pay a dividend on each share of our Series D preferred stock in an
amount equal to the cash dividend paid on one share of our common stock
multiplied by the number of shares of our common stock into which such one share
of our Series D preferred stock can be converted.
Voting Rights
Except as described below and otherwise required by Delaware law, the
Series D preferred stock has no voting rights.
As long as any shares of the Series D 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 D preferred stock outstanding at the time,
voting separately as a class:
o amend, alter or repeal the provisions of the Series D preferred stock
so as to adversely affect any right, preference, privilege or voting
power of the Series D preferred stock;
o effect any distribution with respect to junior stock except that we
may effect a distribution on our common stock if we make a like kind
distribution on each share of our Series D preferred stock
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outstanding in an amount equal to the distribution on one share of our
common stock multiplied by the number of shares of our common stock
into which one share of our Series D preferred stock can be converted
at such time.
Liquidation Preference
In the event of our liquidation, dissolution or winding up, the holders of
shares of the Series D preferred stock then outstanding shall be entitled to
receive, out of our assets, a Series D Liquidation Preference Amount equal to
$10,000 per share of the Series D preferred stock before any payment shall be
made or any assets distributed to the holders of our common stock or any other
junior stock. However, no Series D Liquidation Preference Amount shall be paid
on any Series D preferred stock unless we have first finished paying all
liquidation preference amounts on all other classes of our outstanding preferred
stock which do not by their terms rank junior to the Series D preferred stock.
If our assets can pay some of, but are not sufficient to pay in full, the Series
D Liquidation Preference Amount to the holders of the Series D preferred stock,
then all of our assets available to pay any portion of the Series D Liquidation
Preference Amount will be distributed among the holders of the Series D
preferred stock ratably on a per share basis. After payment of the full Series D
Liquidation Preference Amount, the holders of shares of Series D 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 D 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 D preferred stock held by such holder into a
number of fully paid and nonassessable shares of our common stock equal to the
quotient of (i) the Series D Liquidation Preference Amount divided by (ii) the
Series D Conversion Price (as defined below).
Conversion Restrictions
At no time may a holder of shares of Series D preferred stock convert
shares of the Series D preferred stock if the number of shares of 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 common stock which would result in such holder Beneficially Owning
in excess of 9.99% of all of our common stock outstanding at such time;
provided, however, that upon a holder of Series D preferred stock providing us
with sixty-one days notice that such holder would like to waive this provision
with regard to any or all shares of common stock issuable upon conversion of his
Series D preferred stock, this provision shall be of no force or effect with
regard to those shares of Series D preferred stock designated in such notice.
Mandatory Conversion
Upon our written request a holder of Series D preferred stock shall advise
us in writing as to the number of shares of our common stock that are
Beneficially Owned by such holder. If the shares of our common stock
Beneficially Owned by such holder amount to less than 9.99% of the shares of our
common stock outstanding at such time, we may, at our option, compel such holder
to convert such portion of the Series D preferred stock owned by him into so
many shares of our common stock so that the total number of shares of our common
stock Beneficially Owned by such holder after such conversion shall equal 9.99%,
but not more, of the shares of our common stock outstanding after such
conversion.
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Series D Conversion Price
The Series D preferred stock is subject to a fixed conversion price equal
to $2.50 per share, subject to customary adjustments to the Series D Conversion
Price in the event of stock splits, combinations, dividends, distributions,
reclassifications and other corporate events.
Reservation of Shares of Common Stock
As long as any shares of Series D preferred stock are outstanding, we are
required to reserve and keep available out of our authorized and unissued common
stock, solely for the purpose of effecting the conversion of the Series D
preferred stock, 100% of such number of shares of common stock that will be
sufficient to effect the conversion of all of the Series D preferred stock then
outstanding.
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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 (4)
3.6 Amendment to Certificate of Incorporation filed on August 19, 2003, being the
Certificate of Designation of the Relative Rights and Preferences of the Series D
convertible preferred stock. (6)
3.7 By-Laws (5)
31.1 Certification (Principal Executive Officer) (6)
31.2 Certifications (Principal Financial Officer (6)
32.1 Certification of Principal Executive Officer (6)
32.2 Certification of Principal Financial Officer (6)
- ----------
(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
and incorporated herein by reference.
(4) Filed as an Exhibit to our Form 10-Q for the quarter ended June 30, 2003.
(5) 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.
(6) Filed herewith.
(b) Reports on Form 8-K
We filed no reports on Form 8-K in the third 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: November 14, 2003 By: /s/ Steven Katz
----------------------------------
Steven Katz, PhD
Chairman
(Principal Executive Officer)
Date: November 14, 2003 By: /s/ Ron Lipstein
----------------------------------
Ron Lipstein
Chief Executive Officer
(Principal Executive Officer)
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