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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
----------
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2003
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
Commission file number 0-27046
ORTEC INTERNATIONAL, INC.
(Exact name of registrant 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
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: Common Stock, $.001 par value
Indicate by check mark whether the Registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K ('SS'229.405 of this chapter) is not contained
herein, and will not be contained, to the best of Registrant's knowledge, in
definitive proxy or information statements incorporated by reference in Part III
of this Form 10-K or any amendment to this Form 10-K.
The number of shares outstanding of the Registrant's common stock is
5,422,665 (as of March 23, 2004) (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 been surrendered.) The
aggregate market value of the voting stock held by nonaffiliates of the
Registrant was $13,620,053 (as of March 23, based upon a closing price of the
Company's Common Stock on the Nasdaq Bulletin Board on such date of $2.53).
DOCUMENTS INCORPORATED BY REFERENCE
None.
ORTEC INTERNATIONAL, INC.
INDEX TO ANNUAL REPORT ON FORM 10-K
FILED WITH THE SECURITIES AND EXCHANGE COMMISSION
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2003
ITEMS IN FORM 10-K
Page
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Facing page
Part I
Item 1. Business................................................................1
Item 2. Properties.............................................................10
Item 3. Legal Proceedings......................................................11
Item 4. Submission of Matters to a Vote of Security Holders....................N/A
Part II
Item 5. Market for the Registrant's Common Equity and Related
Stockholder Matters.................................................11
Item 6. Selected Financial Data................................................13
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations.................................14
Item 7A. Quantitative and Qualitative Disclosures About
Market Risk.........................................................N/A
Item 8. Financial Statements and Supplementary Data............................26
Item 9. Changes in and Disagreements with Accountants
on Accounting and Financial Disclosure..............................N/A
Part III
Item 10. Directors and Executive Officers of the Registrant.....................27
Item 11. Executive Compensation.................................................30
Item 12. Security Ownership of Certain Beneficial Owners
and Management and Related Stockholder Matters......................34
Item 13. Certain Relationships and Related Transactions.........................37
Item 14. Controls and Procedures................................................38
Part IV
Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K........39
Signatures.................................................................................42
PART I
Item 1. BUSINESS
Overview
We are a development stage tissue engineering company that has
developed a proprietary and patented technology that we call "OrCel", which is
used to stimulate the repair and regeneration of human skin. OrCel is a two
layered tissue engineered dressing that consists of human derived skin cells,
both dermal and epidermal, supported within a porous collagen matrix. The
composite matrix is seeded with keratinocytes for epidermal growth and
fibroblasts for dermal growth. When OrCel is applied to the wound site, it
produces a mix of growth factors that stimulates wound closure.
In 2001 the FDA granted our application for the commercial sale of
OrCel for the treatment of donor site wounds. A donor site wound is created in
an area of the patient's body from which the patient's skin was taken to cover a
wound at another part of such patient's body. In 2001 the FDA also granted our
application for the commercial sale of OrCel for use on patients with recessive
dystrophic epidermolysis bullosa undergoing hand reconstruction, as well as to
treat the donor site wounds created during the surgery. Recessive dystrophic
epidermolysis bullosa is a condition in which a newborn infant's skin instantly
blisters and can peel off at the slightest touch and leave painful ulcerations
and permanent scarring resulting in deformity of the hands and feet. From
December 2001 through December 2002, our gross revenues from the sale of OrCel
were $265,665. We discontinued our sales efforts and the manufacture of OrCel
for commercial sale because of our need to use our limited financial resources
for the completion of our clinical trial for the use of OrCel in the treatment
of venous stasis ulcers, which is a larger potential market. Venous stasis
ulcers are open lesions on the legs which result from the poor circulation of
the blood returning from the legs to the heart.
We completed a pivotal clinical trial for the use of OrCel in its
cryopreserved form for the treatment of venous stasis ulcers. The study was
conducted at 19 clinical sites and 136 patients were treated in the trial. One
half of the patients were a control group and were treated with standard of care
currently being used for treatment of venous stasis ulcers. In February 2004, we
completed the filing with the Food and Drug Administration (FDA) of our
application for premarket approval to market OrCel for the treatment of venous
leg ulcers.
We have developed the technology for the cryopreservation of OrCel
without diminishing its effectiveness. Cryopreservation is the freezing of our
product which gives it a minimum shelf life of six months, as opposed to only a
few days when our product is not cryopreserved.
Due to budgetary constraints we are encountering in this difficult
investment climate, we have deferred conducting a pivotal clinical trial for the
use of OrCel in the treatment of diabetic foot ulcers (although the FDA granted
clearance for us to conduct that pivotal trial) until after FDA determination of
whether we may make commercial sales of cryopreserved OrCel to treat
venous stasis ulcers. We completed a pilot clinical trial for the use of OrCel,
in its fresh, not cryopreserved, form in the treatment of diabetic foot ulcers
in the latter part of 2001. People with diabetic foot ulcers also constitute a
large patient population and therefore also a large potential market for OrCel.
Our target patient population for the use of OrCel are persons with
venous stasis and diabetic foot ulcers which we believe are large potential
markets for the use of OrCel. We also believe that OrCel can be used to treat
other medical conditions, such as decubitis ulcers, and for cosmetic surgery.
Decubitis ulcers are pressure sores, commonly known as bed sores. Decubitis
ulcers range from a small wound to a very deep wound extending to and sometimes
through a bone into internal organs.
Our cash on hand as of December 31, 2003, an additional $650,000 in
loans repayable June 30, 2004 which we received in January and a $250,000 loan
payable on demand which we received in March 2004, all from some of the
holders of our convertible preferred stock, will enable us to continue our
operations through approximately March 31, 2004, assuming that we will not incur
unexpected costs. Before March 31, 2004, we will be required to raise additional
funds (through the sale of our securities or debt financing) to complete our
clinical trials, to produce and market OrCel and to pay our accumulated debt.
Our failure to receive additional financing will make it impossible for us to
continue our business.
Ortec was organized in 1991 under the laws of the State of Delaware
for the purpose of acquiring, developing, testing and marketing our skin
replacement product. Our executive offices are located at 3960 Broadway, New
York, New York, and our telephone number is (212) 740-6999. Our website address
is www.ortecinternational.com.
The Product
OrCel is produced from cells derived from infant foreskins obtained
during routine circumcisions. The immature, neonatal cells are highly
reproductive and provide enhanced proliferation and rapid remodeling of the
human skin. We separate the epidermis from the dermis and treat each of these
layers to release individual keratinocyte (epidermal) and fibroblast (dermal)
cells, which are the primary cellular components of human skin. We grow the
fibroblast and keratinocyte cells in culture in large quantities, then freeze
and store them as a cell bank, ready for use. Prior to the use of each cell
line, we conduct extensive testing and screening in accordance with current FDA
guidelines to ensure that the cells are free of presence of bacterial
contaminants, viruses, pathogens, tumorigenicity or other transmittable
diseases. We then apply the dermal fibroblast cells to a proprietary,
cross-linked bovine collagen sponge to form the dermal layer matrix and we grow
the epidermal keratinocyte cells on a separate non-porous layer of collagen. We
then incubate and supply this composite matrix with the proper nutrients to
allow the cells to multiply and for the fibroblasts to permeate inside and
anchor to the porous collagen sponge. The top layers of keratinocyte cells and
bottom layers of fibroblast cells in the collagen matrix, together, constitute
our proprietary OrCel, which we can then deliver to customers in a fresh or
cryopreserved state.
Original Research
Our technology was developed by Dr. Mark Eisenberg, a physician in
Sydney, Australia. Dr. Eisenberg is a director and one of the founders of Ortec.
He has been involved in biochemical and clinical research at the University of
New South Wales in Australia for over twenty five years, focusing primarily on
treating the symptoms of epidermolysis bullosa. In 1987, through his work on
epidermolysis bullosa, Dr. Eisenberg first succeeded in growing epidermal layers
of human skin, which he successfully applied as an allograft on an epidermolysis
bullosa patient. An allograft is a transplant other than with the patient's own
skin. Dr. Eisenberg continued his research which eventually led to the
development of OrCel - a tissue-engineered dressing which consists of both the
dermal and epidermal layers.
The FDA Clearance Process
Pursuant to the Federal Food Drug and Cosmetic Act and regulations
promulgated thereunder, the FDA regulates the manufacture, distribution and
promotion of medical devices in the United States. OrCel is considered by the
FDA to be a medical device and is therefore regulated by the FDA. We must
receive pre-market clearance from the FDA for any commercial sale of our
product. Before receiving such clearance we must provide proof in human clinical
trials of the safety and efficacy of OrCel. Pre-market clearance is a lengthy
and expensive process.
The steps in the FDA clearance process may be summarized as follows:
o The sponsor (such as Ortec) prepares a protocol which sets forth
in detail all aspects of the proposed clinical trial. The
information includes the number of patients to be treated, the
number of sites (hospitals and clinics) at which the patients in
the clinical trial are to be treated, the then current standard
of care with which the patients in the control group (in
comparable medical condition as the patients to be treated with
the medical device which is the subject of the clinical trial)
are to be treated, the treatment frequency and the statistical
plan that will be utilized to analyze the data derived from the
clinical trial.
o The protocol also has to establish the safety of the use of the
medical device to be studied in the trial. Safety can be
established in a number of ways. One is by showing the results of
use of the medical device in treatments in other clinical trials,
in hospital approved treatments elsewhere in the world or by use
in animal clinical trials and/or in an FDA cleared "pilot"
clinical trial in which far fewer patients are treated than in
the definitive "pivotal" clinical trial.
o The sponsor submits the protocol to the FDA.
o The FDA staff give their comments, objections and requirements on
the submitted protocol.
o The sponsor redrafts the protocol and otherwise responds to the
FDA's comments.
o The sponsor recruits hospitals and clinics as sites at which the
patients in the study are to be treated. Such recruitment begins
with or prior to the preparation of the protocol.
o After the FDA clears the protocol the trial sites and the sponsor
recruit the patients to be treated in the study.
o The patients are treated at not more than the number of trial
sites specified in the protocol. One half of the patients are
treated with the medical device being studied and the other half,
the control group, with the then current standard of care for
treatment of the same medical condition.
o The sites follow up each treated patient (for the period and the
number of times provided in the FDA cleared protocol) to
determine the efficacy of the medical device being studied in the
treatment of the medical condition identified in the protocol, as
against the efficacy of the standard of care used in the study.
o The sponsor assists and monitors compliance with the protocol's
requirements in each site's conduct of the study.
o The sponsor collects the clinical data of each patient's
treatment and progress from the sites.
o The data is analyzed by or for the sponsor. The sponsor prepares
a report of the results of the study and submits the report and
the supporting clinical data to the FDA staff reviewers for their
comments and questions.
o After staff review of the submitted data, the sponsor responds to
the FDA's comments and questions.
o After completion of its review the FDA staff may submit a report
of the results of the trial to an advisory medical panel
consisting of experts in the treatment of the medical condition
which the studied medical device is intended to treat.
o The panel submits its advice as to the efficacy and safety of the
device to the FDA official who is the Director of the FDA
Division to which the protocol and the results of the pivotal
trial were originally submitted. If no advisory panel is required
the FDA staff reviewers submit their recommendation directly to
the Division Director.
o The FDA Division Director is the FDA official who determines
whether or not to clear the medical device for commercial sale
for treatment of that medical
condition. The sponsor may appeal a Division Director's negative
determination through appeal levels within the FDA, up to the
Commissioner of the FDA.
o After FDA clearance the sponsor must submit all labeling
information for the medical device to the FDA to make certain
that the claims on the label accurately state the uses for which
the medical device has been cleared.
We have completed the treatment and follow-up of 136 patients in the
pivotal clinical trial of the use of OrCel in its cryo-preserved form for the
treatment of venous stasis ulcers. We have also collected the clinical data of
treatment and patient follow up from all the 19 sites that participated in the
study. In February 2004 we completed the filing of our Premarket Approval (PMA)
application with the Food and Drug Administration (FDA) to market OrCel for the
treatment of venous stasis ulcers. We submitted the Manufacturing and Controls
section of our PMA application in December 2003 and in February 2004 we filed
the final section of our PMA, which included the summary of safety and
effectiveness in the clinical studies and device labeling.
We may not obtain FDA clearance for the commercial sale of the
cryopreserved form of OrCel for the treatment of venous stasis ulcers and later
for diabetic foot ulcers. Among the factors which may contribute to that finding
are a negative assessment of our manufacturing processes, raw materials used in
manufacturing our product, our freezing technique, and OrCel's clinical results.
For example, the clinical results submitted in our PMA application show
statistically significant differentials between OrCel and the standard of care
therapy for both primary clinical endpoints in patients who were shown to have
typical venous ulcers (ulcers resulting from venous insufficiency and extending
into but not through the dermal layer of the skin). In the overall group of
patients which included patients who had venous ulcers complicated by other
factors (including diseases other than venous insufficiency), we achieved
statistically significant differentials for certain secondary endpoints, but did
not achieve statistically significant differentials for the two primary clinical
endpoints.
Although we have completed an FDA cleared pilot clinical trial for the
use of the fresh form of OrCel for the treatment of diabetic foot ulcers, we do
not have the funds available to conduct a pivotal clinical trial for the use of
OrCel in its cryo-preserved form for the treatment of diabetic foot ulcers. We
will not begin the FDA clearance process for a pivotal trial for cryo-preserved
OrCel for the treatment of diabetic foot ulcers until we believe that we can
secure financing for the conduct of that trial.
Although we have already received FDA clearance for the commercial
sale of the fresh version of OrCel for the treatment of donor site wounds and
the treatment of recessive dystrophic epidermolysis bullosa during
reconstructive hand surgery, due to our limited resources we decided to
discontinue the sale of the fresh version of OrCel preferring to sell the
cryo-preserved form of OrCel when cleared to do so by the FDA.
Based on published information we believe that the use of OrCel for
the treatment of patients suffering from venous stasis ulcers, and of patients
suffering from diabetic foot ulcers, each represents a significantly larger
potential market than the use of OrCel for the treatment of donor site wounds.
Published reports and studies indicate that the epidermolysis bullosa patient
population is a small one.
Regulatory Strategies, Product Development and Sales
We employ a team of regulatory and clinical professionals, both full
time employees and consultants, with extensive knowledge in strategic regulatory
and clinical trial planning to support our product development efforts through
every stage of the development and FDA approval process. We also employ persons
with extensive knowledge and experience in the marketing and sale of new FDA
approved products for treatment of many medical conditions, including experience
in securing approval of insurance companies to reimburse their insured patients
for the cost of the use of new medical products used in medical treatments. We
have
secured approval for Medicare payments for the use of OrCel under Medicare's
Outpatient Prospective Payment System (OPPS). This approval covers the use of
OrCel in hospitals, other hospital-owned facilities and for hospital outpatient
treatment. This OPPS approval expires December 31, 2005. However, we will still
need to secure the approval of Medicare designated contractors in different
parts of the country for approval of the different medical conditions for which
Medicare reimbursement of the use of OrCel will be made. We can only secure that
further approval after we have received FDA clearance for use of OrCel for the
treatment of that medical condition. We will also seek to secure approval for
private health insurance providers' reimbursement for the cost of OrCel. We
believe that securing Medicare reimbursement approval for OrCel will be of
significant assistance to us in securing reimbursement approval by private
health insurance companies.
Production and Supply
In October 2003 we entered into an agreement with Cambrex Bio Science
Walkersville, Inc., a subsidiary of Cambrex Corporation, for Cambrex to
manufacture OrCel in its cryo-preserved form in Cambrex's Walkersville, Maryland
facilities. The Cambrex manufacturing facility is required to meet FDA's good
manufacturing processes standards. Cambrex is experienced in the manufacture of
cell-based medical products such as our OrCel.
Our agreement with Cambrex requires us to pay Cambrex $1,200,000 a
year for the use of a Cambrex production facility in Walkersville, Maryland. The
annual payments we will make to Cambrex will increase to $2,100,000 per year if
we require Cambrex to build us a larger production facility to meet our
requirements for the production of OrCel. Such annual payments we are required
to make will increase by a small percentage each year. Such annual payments
include some services and overhead expenses provided and paid for by Cambrex. We
are required to pay a portion of the cost of the construction of that larger
production facility. However, the amount we contribute to the construction of
that larger facility will be repaid to us by credits against a portion of the
future annual payments of $2,100,000 and of certain other payments we are
required to make to Cambrex after the larger facility is in use. We are also
required to pay specified hourly charges for the Cambrex employees engaged in
the production of OrCcel as well as certain other charges. After construction of
the larger production facility we are required to acquire from Cambrex virtually
all of our requirements for OrCel that Cambrex can produce. Prior to our
election to have Cambrex construct the larger production facility for us, either
we or Cambrex may terminate the agreement on six months notice by us and twelve
months notice by Cambrex, except that such termination will not be effective
prior to November 1, 2004. If we elect to have Cambrex construct the larger
production facility for us the agreement will continue for six years after the
larger production facility is constructed. However, even after such construction
we and Cambrex may elect to scale down over the following three years the
portion of our requirements for OrCel that Cambrex will produce for us. We may
elect the scale down period at any time after one year after the larger
production facility is constructed and in operation in which event there are
additional payments we must make to Cambrex. Either Cambrex or we may elect the
scale down period later than three years after that facility is in operation and
neither of us will be required to make any additional payments to the other
because of that election. If after the construction of the larger production
facility, we breach a material term of our agreement with Cambrex, or elect to
terminate the agreement, there are substantial payments we must make to Cambrex.
The raw materials that we use to manufacture OrCel come from a limited
number of key suppliers. We purchase bovine collagen sponges, a key component of
OrCel, from one supplier who produces the sponges to our specifications. We have
no written agreement with that supplier obligating it to supply sponges to us.
While there are other manufacturers from whom we could purchase bovine collagen
sponges, with one of whom we are discussing such supply arrangement, if we are
required to secure another source for bovine collagen sponges we would encounter
delay and expense in manufacturing OrCel. We also rely on a limited number of
outside suppliers to supply other materials that we use in the manufacture and
testing of OrCel. While there are other sources from whom we could purchase such
other materials, as with bovine collagen sponges, if we are required to replace
any or all of our suppliers we would encounter delay and expense in
manufacturing OrCel.
Competition
We are aware of several companies that are actively engaged in the
research and development of products for the repair and regeneration of skin.
There are currently three primary and distinct approaches to the repair and
regeneration of skin: the acellular (no cell) approach, including the use of
cadaver based products; the cell-based unilayered (epidermal or dermal cell)
approach, and the cell based bi-layered (epidermal and dermal cell) approach. A
cell based approach makes use of donor cells. The approach we believe to be the
most advanced and effective is the cell based bi-layered approach, making use of
donor cells. The production of OrCel consists of a top layer of epidermal cells
and a bottom layer of dermal cells in a collagen matrix, that is a bi-layered
approach utilizing donor cells.
There are many products available for treating skin wounds. However,
as already noted, we believe that the use of donor cells on a collagen sponge
matrix is the most effective process for healing skin wounds and in particular
hard to heal skin wounds. Therefore, we consider only products using donor cells
on a collagen sponge matrix would compete with OrCel.
We previously considered Organogenesis, Inc. and Advanced Tissue
Sciences, Inc. to be our principal competitors because each of them was
previously manufacturing and selling an FDA approved product using donor cells
on a collagen sponge matrix, as we do, for the treatment, in the case of
Organogenesis' Apligraf, of both venous stasis and diabetic foot ulcers, and in
the case of Advanced Tissue Sciences' Dermagraft for the treatment of diabetic
foot ulcers. Advanced Tissue Sciences' Dermagraft was manufactured in a
cryopreserved form while Organogenesis' Apligraf was not. However, in 2002 both
Organogenesis and Advanced Tissue Sciences filed for bankruptcy protection and,
at least temporarily, discontinued the sale of their products. We believe that
sales of both Dermagraft and Apligraf have been resumed. We believe that sales
of Apligraf are now being made directly by Organogenesis and that sales of
Dermagraft are being made by Smith & Nephew, a major pharmaceutical company
which, we believe, purchased Advance Tissue Science's interest in Dermagraft.
Smith & Nephew is substantially larger than we are and has significantly greater
resources than we have.
The biomedical field is continually undergoing rapid and significant
technological changes. Other companies may succeed in developing other products
that are more effective than OrCel. If such new products are accepted by the
medical community, or if those products receive FDA approval for treatment of
venous stasis and diabetic foot ulcers before OrCel does, or if other companies
develop products that are more effective than OrCel, any such developments could
impede our ability to continue our operations.
Patents and Proprietary Rights
We have four United States patents, one European patent covering
thirteen countries and nine patents in nine other countries, issued. We also
have one United States and eight international patent applications (filed under
the Patent Cooperation Treaty) pending, for our technology and processes:
o The first of these patents covers the method for the production
of OrCel. It is an epidermal layer of cultured epidermal cells
and a bilayered collagen sponge structure that includes a layer
of highly purified, non-porous collagen on top of a porous
cross-linked collagen sponge containing cultured dermal cells.
This patent expires on February 1, 2011. This is also the
technology covered by the European and other foreign patents
which have been issued to us. These foreign patents also expire
in 2011.
o Another United States patent provides for the extension of the
use of the collagen sponge structure described above which may
contain cells other than epidermal and/or dermal cells, such as
cells for regenerating such organs and tissues as heart muscle,
blood vessels, ligaments, cartilage and nerves. This patent also
expires on February 1, 2011. We have not performed, nor are we
planning to perform in the near future, any clinical trial using
our platform technology for use of donor cells other than
epidermal and dermal cells.
o Another United States patent covers a manufacturing process
which, when implemented, can reduce the cost of producing OrCel.
These new manufacturing processes create an improvement over our
collagen structures described above in that a third layer of
collagen which is hospitable to cell growth is deposited on the
non-porous collagen layer. This patent expires on December 28,
2020.
o Our fourth United States patent covers a process for the
cryo-preservation of OrCel. This patent expires on December 26,
2021.
Despite such patents our success will depend, in part, on our ability to
maintain trade secret protection for our technology.
Our European patent was granted to us by the European Patent Office
and was challenged by Advanced Tissue Sciences in an opposition proceeding after
grant. We successfully defeated
that opposition. Advanced Tissue Sciences has appealed that determination in our
favor and the appeal is currently pending.
The validity and breadth of claims in medical technology patents
involves complex legal and factual questions and, therefore, are highly
uncertain. We do not know if any pending patent applications or any future
patent application will issue as patents, that the scope of any patent
protection obtained will be enough to exclude competitors or that any of our
patents will be held valid if subsequently challenged in court proceedings. We
do not know if others have or will develop similar products, duplicate any of
our products or design around any of our patents issued or that may be issued in
the future. In addition, whether or not patents are issued to us, others may
hold or receive patents which contain claims having a scope that covers aspects
of our products or processes.
Several of our competitors, including Organogenesis and Advanced
Tissue Sciences, Inc., have been granted patents relating to their particular
skin technologies which also utilize donor cells on a collagen sponge matrix. To
that extent they may be considered similar to our OrCel technology.
We successfully defended challenges by Organogenesis to our United
States patent and by Advanced Tissue Sciences to our European patent in the
respective patent offices where those patents were issued. However, those
successful defenses do not preclude future challenges in court. The dismissal of
the challenge to our patent in Europe has been appealed. We do not know if any
of the other patents issued to us will be challenged, invalidated or
circumvented. Patents and patent applications in the United States may be
subject to interference proceeding brought by the U.S. Patent and Trademark
Office, or to opposition proceedings initiated in a foreign patent office by
third parties or to re-examination proceedings in the United States. We might
incur significant costs defending such proceedings and we might not be
successful.
Paul Capital Agreements
In August 2001 and in 2002 we entered into agreements with Paul
Capital Royalty Acquisition Fund, L.P. pursuant to which we agreed in
consideration of Paul Capital paying us $10,000,000, to pay to Paul Capital 3
1/3% of the end user sales prices paid for our OrCel product in the United
States, Canada and Mexico through the period ending in 2011. Such percentage
interest in our revenues in those three countries may be adjusted upward or
downward based on the volume of sales to end users of OrCel in those three
countries. As security for the performance of our obligations to Paul Capital,
we have granted Paul Capital a security interest in all of our U.S. patents,
patent applications and trademarks. Our agreement with Paul Capital provides
that in certain events Paul Capital may, at its option, compel us to repurchase
the interest in our revenues that we sold to Paul Capital for a price equal to
the $10,000,000 Paul Capital paid us plus an amount that would yield Paul
Capital a 30% per annum internal rate of return on its $10,000,000 investment.
Among the events that would entitle Paul Capital to compel us to repurchase its
interest in our revenues at that price is if we are insolvent or if we are
unable to pay our debts as they become due. Our agreement with Paul Capital
provides that in determining such insolvency any amount we owe to Paul Capital
is excluded in
calculating our net worth (or negative net worth). As defined in our agreement
with Paul Capital we are currently insolvent. In addition, although we are
currently trying to manage our debt we are not paying our debts as they become
due. Although Paul Capital has had the right for well over a year to compel us
to repurchase its interest in our revenues at the price provided in our
agreement, Paul Capital has so far not exercised that right. If Paul Capital
does exercise its right to compel us to repurchase its interest in our revenues
we would be unable to pay the purchase price and Paul Capital could foreclose
its security interest in our U.S. patents, patent applications and trademarks
and in such event we will have to discontinue our business operations.
In February 2003, Paul Capital purchased 50 shares of our Series B
convertible preferred stock, and in connection therewith we issued to Paul
Capital 73,077 shares of our common stock and granted Paul Capital warrants to
purchase an aggregate of 50,000 shares of our common stock, at exercise prices
of $15.00 per share for 25,000 shares and at $20.00 per share for the other
25,000 shares. The February 2003 amendments to our agreements with Paul Capital
provided, among other things, for (a) the election of one director designated by
Paul Capital, (b) the right of one observer (other than such director) selected
by Paul Capital to attend and observe all meetings of Ortec's Board of Directors
and (c) for us to use our best efforts to have independent directors who are
acceptable to both Ortec and Paul Capital, including the director designated by
Paul Capital, as a majority of Ortec's Board of Directors.
Employees
We presently employ 39 people on a full-time basis, including three
executive officers. We also have 2 part time employees.
Item 2. PROPERTIES
We occupy an aggregate of approximately 14,800 sq. ft. of space in
Columbia University's Audubon Biomedical Science and Technology Park in New York
City, for laboratory and office space. We use our laboratories for assay
development, wound healing research, biomaterial development, bioprocess
development, histology, quality assurance testing and for two clean rooms where
we produce OrCel. 11,800 sq. ft. are occupied pursuant to a lease which expires
December 31, 2005 and 3,000 sq. ft. are occupied on a month to month basis. Rent
for the entire 14,800 sq. ft. is $33,332 per month.
In connection with our leases in the Audubon Biomedical Science and
Technology Park, Columbia University made loans to us for improvements to our
leased space as well as for construction and set up costs for the laboratory in
that space. We are repaying such loans in monthly installment aggregating annual
payments of $212,503 for each of 2004 and 2005, $161,988 in 2006, $91,265 in
2007 and $30,422 in 2008. We are current in repaying these loans. However we owe
Columbia University approximately $588,000 in past due rent, including rent for
space we no longer occupy. Pursuant to an agreement we have entered into with
Columbia we will pay this obligation in monthly installments of $25,400 each
beginning February 2004.
We also rent approximately 800 sq. ft. of space in North Brunswick,
New Jersey pursuant to a lease which expires June 30, 2004, at a rent of $2,300
per month. We owe the landlord of that space $5,400 for past due rent for that
and other space we previously occupied in that building. By agreement with the
landlord we are repaying that obligation at the rate of $1,250 per month.
Item 3 LEGAL PROCEEDINGS
In our quarterly report on Form 10-QA for the three months ended
September 30, 2002, we reported that ClinTrials Networks, LLC 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. We paid this award in the fourth quarter of 2003.
In December 2002 Amarex LLC commenced an action against us in the
Circuit Court for Montgomery County, Maryland. Amarex provided statistical
programming and data management services for us for the data generated in our
clinical trials. We have settled that litigation by agreeing to pay Amarex
$613,060, of which we have paid $25,000. We are required to pay $50,000 on April
10, 2004, and $60,000 each month thereafter until the obligation is paid in
full.
Previously, the Company has successfully defended challenges to its
United States and European patents. The dismissal of the European challenge
has been appealed. The ultimate outcome of this matter cannot be presently
determined.
PART II
Item 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
Reverse Stock Split
We effected, as of 5 PM EDT on June 24, 2003, a reverse split of our
common stock of one new share for each ten shares previously outstanding. All
references we make in this Item 5 of Part II of this Form 10-K, to the number of
shares of our common stock, the market prices of our common stock, the
conversion prices of securities convertible into our common stock and the
exercise prices of our outstanding warrants, are after giving effect to such one
new share for ten old shares reverse split.
Market Information
Our common stock commenced trading on January 19, 1996 under the
symbol "ORTC." The common stock traded on the Nasdaq SmallCap market until
August 2002, when it became delisted from the SmallCap market and commenced
trading on the National Association of
Securities Dealers' Bulletin Board, where it presently trades under the symbol
"ORTN.OB." The following table sets forth the high and low sales prices of our
common stock as reported by Nasdaq and the Bulletin Board for each full
quarterly period within the two most recent fiscal years, giving effect, as
noted above, to the one share for ten share reverse split of our common stock we
effected June 24, 2003.
HIGH LOW
---------------
Fiscal Year Ended December 31, 2002
First Quarter $69.90 $49.60
Second Quarter 50.50 20.00
Third Quarter 20.00 3.00
Fourth Quarter 5.40 2.70
Fiscal Year Ended December 31, 2003
First Quarter 5.00 1.50
Second Quarter 2.70 1.70
Third Quarter 2.25 1.25
Fourth Quarter 2.55 1.45
Security Holders
To the best of our knowledge, at March 23, 2004, there were 141 record
holders of our common stock. We believe there are more than 1,000 beneficial
owners of our common stock whose shares are held in "street name."
Dividends
We have not paid and have no current plans to pay dividends on our
common stock.
Item 6. Selected Financial Data
The following selected financial data are derived from the Company's financial
statements and should be read in conjunction with, and are qualified in their
entirety by, the financial statements and related notes included in Item 8 and
Management's Discussion and Analysis included elsewhere in this Annual Report.
Statement of operations data
Years Ended December 31, 1999 2000 2001
------------ ------------ ------------
Product Revenue $ -- $ -- $ 21,890
Expenses
Production and laboratory costs 3,106,908 4,191,317 4,283,038
Rent 473,010 535,443 589,238
Consulting 834,180 838,383 1,413,153
Personnel 3,742,632 4,763,662 6,605,630
General and administrative 2,152,968 2,297,769 2,671,887
Interest and other expense 99,522 89,712 536,070
Lease termination costs -- -- --
Loss on extinguishments of debt and
series A preferred stock -- -- --
Interest income (368,711) (586,623) (191,749)
------------ ------------ ------------
10,040,509 12,129,663 15,907,267
------------ ------------ ------------
Net loss (10,040,509) (12,129,663) (15,885,377)
Preferred stock dividends -- -- --
Preferred stock deemed dividends
and discount -- -- --
------------ ------------ ------------
Net loss applicable to common stock $(10,040,509) $(12,129,663) $(15,885,377)
============ ============ ============
Basic and diluted $ (15.13) $ (13.71) $ (16.39)
Weighted average common stock outstanding
Basic and diluted 663,487 884,730 969,161
============ ============ ============
Balance sheet data
Working capital (deficiency) $ 11,009,660 $ 7,966,410 $ (2,529,159)
Total assets 15,011,645 11,719,760 4,038,601
Long-term debt, excluding current maturities 1,044,857 912,489 6,768,983
Shareholders' equity/(deficit) 12,370,720 9,392,325 (6,304,972)
Cumulative
March 12, 1991
(inception) to
Statement of operations data December 31,
Years Ended December 31, 2002 2003 2003
- -------------------------------------------- ------------ ------------ --------------
Product Revenue $ 243,775 $ -- $ 265,665
Expenses
Production and laboratory costs 3,147,515 2,956,217 24,152,124
Rent 683,116 627,861 3,490,512
Consulting 490,826 (27,735) 5,689,606
Personnel 6,440,959 3,938,116 33,328,435
General and administrative 2,781,896 2,586,476 17,371,057
Interest and other expense 7,281,104 4,735,292 13,035,902
Lease termination costs -- 1,119,166 1,119,166
Loss on extinguishments of debt and
series A preferred stock 1,004,027 -- 1,004,027
Interest income (7,647) (14,889) (2,271,985)
------------ ------------ -------------
21,821,796 15,920,504 96,902,844
------------ ------------ -------------
Net loss (21,578,021) (15,920,504) (96,653,179)
Preferred stock dividends 1,125,934 1,259,627 2,385,561
Preferred stock deemed dividends
and discount -- 4,269,000 4,269,000
------------ ------------ -------------
Net loss applicable to common stock $(22,703,955) $(21,449,131) $(103,307,740)
============ ============ =============
Basic and diluted $ (20.08) $ (5.11) $ (125.23)
Weighted average common stock outstanding
Basic and diluted 1,130,596 4,198,107 824,943
============ ============ =============
Balance sheet data
Working capital (deficiency) $(17,787,545) $(25,581,740)
Total assets 3,698,366 2,582,623
Long-term debt, excluding current maturities 828,498 485,795
Shareholders' equity/(deficit) (15,801,132) (24,697,407)
Item 7. 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
This report on Form 10-K contains certain forward looking statements
and information relating to Ortec, that are based on the beliefs of management,
as well as assumptions made by management, utilizing currently available
information. 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 Form 10-K report. Should one or more of these risks or
uncertainties materialize, or should underlying assumptions prove to be
incorrect, actual results may vary materially and adversely 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
in order to focus our efforts and resources towards completing the clinical
trials for the use of OrCel for the treatment of venous stasis ulcers. As a
result of this curtailment, there have been no commercial sales of our product
in the current year ended December 31, 2003.
In 2003, we completed a pivotal clinical trial for the use of OrCel in its
cryopreserved form for 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. The study was conducted at 19
clinical sites and 136 patients were treated in the trial. One half of the
patients were a control group and were treated with standard of care currently
being used for treatment of venous stasis ulcers. In December 2003, we initiated
the filing of the Premarket Approval (PMA) application with the Food and Drug
Administration (FDA) to market OrCel for the
treatment of venous leg ulcers. We submitted the Manufacturing and Controls
(CMC) section, the first of two modules of the application. The final section of
the PMA, which included a summary of safety and effectiveness in the clinical
studies and device labeling, was filed with the FDA in February 2004.
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 until
after FDA determination of whether we may make commercial sales of cryopreserved
OrCel to treat venous stasis ulcers.
From inception to date, we have incurred cumulative net losses of approximately
$103 million. We expect to continue to incur substantial losses and may have to
discontinue operations, unless we are able to secure FDA clearance for the sale
of OrCel in its cyropreserved form to treat venous leg ulcers, and later
diabetic foot ulcers, gain market acceptance for OrCel, and execute our
production plans with our third party manufacturer.
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 until we obtain FDA clearance to sell OrCel and we successfully market
OrCel for the treatment of venous leg ulcers.
Critical Accounting Estimates
Revenue Recognition. Product revenue is recognized upon shipment of OrCel when
title and risk of loss pass to the customer, which occurs when the product is
received by the end user hospital. Royalties from licensees will be based on
third-party sales of licensed products and will be recorded in accordance with
contract terms when third-party results are reliably measurable and
collectibility is reasonable assured. Fees paid to Ortec upon entering a license
agreement are recognized when earned as defined by the terms of the agreement.
Research and Development Costs. As we are still engaged in clinical trials of
our product and remain a development stage enterprise, the cost of producing
product for clinical trials and for sale, is included in Research and
Development costs. Additionally, all research and development costs, which
comprise of Product Production and laboratory costs, Rent, Consulting, Personnel
and Depreciation and Amortization expenses, are expensed as incurred.
Obligation under Revenue Interest Assignment. We account for our Revenue
Interest Assignment Agreement with Paul Capital in a manner similar to that of
debt. Currently, our liabilities exceed the value of our assets and as such, we
are technically in default of the solvency requirement under this agreement.
Pursuant to the default provisions, which entitles Paul Capital to compel us to
repurchase its interest in our revenues at a price equal to hundred thirty (130)
percent of $10,000,000, the purchase price paid to Ortec by Paul Capital,
interest on such debt has been accrued at an amount which would yield a 30%
internal rate of return to Paul Capital. At such time when the default
provisions are no longer applicable and a reasonable estimate of future
revenues can be determined, the effective interest rate imputed on the
obligation will be determined using the interest method and payments to Paul
Capital will be recorded as a reduction of the Company's obligation under the
revenue interest assignment. This may result in an imputed interest rate, which
is significantly below 30% and could have a potential material financial impact.
However, no assurances can be given that such lower rate could be achieved.
Additionally, we had no revenues in 2003 as we suspended sales of OrCel in 2002
to focus on completing a clinical trial for venous leg ulcers and submitting the
results to the Food and Drug Administration (FDA). We hope to obtain FDA
approval to sell OrCel for the treatment of venous leg ulcers in the second half
of 2004; however approval cannot be assured. In addition, if approval is
obtained from the FDA, the timing of such event may not be in line with our
expectations. For these reasons, we may not be able to make a reasonable
estimate of future revenues and payments that may become due to Paul Capital
under this financing agreement in 2004, if we are no longer in technical default
of this agreement, and as such may not be able to determine an effective
interest rate to apply to the debt. Therefore, given these uncertainties, once
we are no longer in technical default, we will charge revenue interest expense
as revenues subject to the revenue interest obligation are recognized. When we
are able to make a reasonable estimate of our related revenue interest
obligation, interest expense will be charged based upon the interest method.
Impact of Recently Issued Accounting Standards
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 adoption of SFAS No. 150
did not have a material impact on the Company's financial position and results
of operations.
Results of Operations
Year Ended December 31, 2003 and December 31, 2002.
Revenues
We earned revenues of approximately $244,000 in 2002 from commercial shipments
of products to customers. As previously discussed, our sales activities were
curtailed in the second half of 2002, resulting in no product sales for the year
ended December 31, 2003.
Expenses
Expenses decreased by approximately $5.9 million from approximately $21.8
million in 2002 to approximately $15.9 million in 2003.
Production and laboratory costs. These expenses decreased by $0.2 million from
$3.1 million in 2002 to $2.9 million in 2003. The decrease in production and
laboratory costs was due to the fact that during 2003 costs were incurred
primarily for the venous ulcer pivotal clinical trial, whereas in 2002 costs
were incurred for 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 Production and laboratory
costs. This decrease in production and laboratory costs was partly offset by
suite fees incurred in 2003 in connection with our cell therapy manufacturing
arrangement with Cambrex, our third party manufacturer, and a settlement charge
pursuant to an agreement with Dr. Eisenberg.
Consulting. These fees decreased by $.5 million compared with the twelve months
ended December 31, 2003. Lower consulting expenses 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 period included costs
incurred as a result of product and process improvement projects, as well as for
the clinical trials.
Personnel. Personnel costs decreased by approximately $2.5 million to $3.9
million in 2003, compared with $6.4 million in 2002 due to lower headcount and a
reduction in executive salary. The reduction in expense in 2003 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.
General and Administrative. These expenses decreased by $0.2 million from $2.8
million in 2002 to $2.5 million in 2003 due principally to reduced marketing and
recruitment expenses incurred in 2003 compared with 2002, in which period we
were preparing for commercial sales of our product. This decrease was partly
offset by higher legal fees in 2003 relating to financing activities and lawsuit
settlements.
Rent and Lease Termination Costs. Rent expense decreased by $55,000 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 $2.5 million in 2003 compared
with 2002. The 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 December 31,
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.
Year Ended December 31, 2002, and December 31, 2001.
Revenues
We earned revenues of approximately $244,000 in 2002, and $22,000 in 2001 from
commercial shipments of products to customers. Sales to commercial customers
began in December 2001, and were curtailed in the second half of 2002.
Expenses
Expenses increased by approximately $5.9 million in 2002, from approximately
$15.9 million in 2001 to $21.8 million in 2002. Interest, which primarily
consisted of non-cash charges relating to the preferred stock and debentures
financings, accounted for $6.7 million of this increase, while the loss on
extinguishment of debt represented $1.0 million of the increase. Other expenses
incurred in 2002, decreased by $1.8 million, compared with 2001.
Production and laboratory costs. These expenses decreased by approximately $1.1
million, from $4.3 million in 2001 to $3.2 million in 2002. Additionally, 2001
costs included a $0.4 million credit to expenses as a result of an insurance
recovery for damaged OrCel, which costs were incurred in 2000. All other
research and development costs decreased by $1.5 million in 2002, compared with
2001. This decrease in research and development expenses was due to the fact
that the costs incurred in 2002 included only one clinical trial, the venous
ulcer pivotal trial, whereas in 2001 there were three trials conducted and
concluded, the donor site pivotal trial, and the venous and diabetic ulcers
pilot trials. We concluded the venous ulcer pivotal trial in 2003.
Personnel. Personnel costs decreased by approximately $.2 million from $6.6
million in 2001 to $6.4 million in 2002. Personnel costs initially increased in
the first half of 2002 due to the additional personnel required to conduct and
manage clinical trial programs, to manufacture the increased quantity of product
required by our clinical trial programs and for the commercial sales and to
initiate our sales and marketing program for our FDA approved products. In July
2002, management implemented a cost reduction plan and deferred the
implementation of the diabetic clinical trial, as well as reduced production of
product for commercial sales, which resulted in significant reductions in
personnel costs in the second half of 2002. As a result of our cost reduction
plan, 34 employees were terminated and the Company paid $40,000 in termination
benefits in July 2002. No other costs were incurred as a result of these
terminations.
Consulting. These fees decreased by $.9 million from $1.4 million in 2001 to $.5
million in 2002. This was due to the increased costs in 2001 related to the
specific requirements for concluding the clinical trials for donor site wounds
and FDA submissions, noted above, as well as, the costs of conducting the pilot
clinical trials for venous leg stasis and diabetic foot ulcers. In 2002, only
the costs of beginning the pivotal clinical trials for venous leg stasis ulcers
were incurred.
General and Administrative. These expenses increased by $.1 million from $2.7
million in 2001 to $2.8 million in 2002. The increase in 2002 was primarily due
to increased marketing expenses incurred early in the year, as we prepared for
commercial sales of our product. As noted above, the decision to reduce fresh
OrCel production in the third quarter resulted in a curtailment of marketing
expense in the second half of the year. In 2002, we also incurred higher
expenses, as we continued our intense financing efforts. These increases were
partially offset by a reduction of travel expenses in 2002, as we focused on
reducing our overall spending.
Rent. This expense increased by $.1 million in 2002 compared with 2001,
primarily due to the charges incurred for the New Jersey leases in 2002, which
expense was not incurred in 2001.
Interest Expense. Interest expense increased by $6.7 million, from $.5 million
in 2001 to $7.2 million in 2002. This increase was due to the imputed non-cash
interest resulting from the convertible debenture and convertible preferred
financings, which occurred in 2002. Interest of $3.6 million was recorded as a
result of these financings, $.2 million in coupon rate interest on the
debentures and $3.4 million recorded as the fair market value of the conversion
features and warrants issued with the financings. Additionally, non-cash
interest of $3.5 million was accrued in 2002, relating to the Paul Capital
Royalty obligation, as compared to $.5 million in 2001.
Interest Income. Interest income declined by approximately $.2 million in 2002,
compared with 2001, primarily due to the smaller average cash balances
outstanding during 2002 compared with 2001.
Loss on extinguishment of debt and series A preferred shares. We incurred a loss
of $1.0 million due to the conversion of debt into preferred shares in 2002.
Liquidity and Capital Resources
Since inception (March 12, 1991) through December 31, 2003, we have accumulated
a deficit of approximately $103 million and we expect to continue to incur
substantial operating losses until we obtain FDA approval to sell our product,
OrCel, for the treatment of venous leg ulcers and successfully market OrCel to
the medical community. We have financed our operations primarily through private
placements of our common stock, preferred stock, promissory notes payable 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 December
31, 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, promissory notes and preferred stock
of $13.7 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 year ended December 31, 2003, we used net cash for operating activities
of approximately $9.3 million. Cash used in operating activities resulted
primarily from our net loss of $15.9 million, offset by depreciation and
amortization of approximately $.6 million, approximately $4.6 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 twelve-month period.
In 2003, we received gross proceeds of $7.7 million from the issuance of
preferred stock, $3.1 million from the issuance of promissory notes, 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, Ortec 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. This reverse stock split is retroactively
reflected in the accompanying financial statements and all reference to shares
are to the new shares with per share amounts appropriately adjusted.
In August 2001 we entered into a Revenue Interests Assignment agreement with
Paul Capital Royalty Acquisition Fund, L.P. pursuant to which we agreed in
consideration of Paul Capital paying us $10,000,000, to pay to Paul Capital 3
1/3% of the end user sales prices paid for our OrCel product in the United
States, Canada and Mexico through the period ending in 2011. Such percentage
interest in our revenues in those three countries may be adjusted upward or
downward based on the volume of sales to end users of OrCel in those three
countries. In accordance with the terms of the Revenue Interest Agreement,
beginning on January 1, 2003 we are required to make advances payments on the
revenue interest obligation as follows: the first $0.6 million of annual net
sales for the year ended December 31,2003; the first $1.0 million of annual net
sales for the year ended December 31, 2004 and the first $7.5 million of annual
net sales for each subsequent calendar year thereafter through the year ending
December 31, 2011. The Company did not pay Paul Capital $0.6 million in 2003 as
we discontinued the commercial sale of OrCel in the second half of 2002 due to
budgetary constraints resulting from a difficult investment climate. We will not
resume sales unless we obtain FDA approval for the use of OrCel in the treatment
of venous stasis ulcers, which is not expected to occur before the second half
of 2004.
As security for the performance of our obligations to Paul Capital, we have
granted Paul Capital a security interest in all of our U.S. patents, patent
applications and trademarks.
Our agreement with Paul Capital provides that in certain events Paul Capital
may, at its option, compel us to repurchase the interest in our revenues that we
sold to Paul Capital for a price equal to the $10,000,000 Paul Capital paid us
plus an amount that would yield Paul Capital a 30% internal rate of return on
their investment. That repurchase price would have been approximately
$18,553,856 as of December 31, 2003. Among the events that would entitle Paul
Capital to compel us to repurchase its interest in our revenues at that price is
if we are insolvent or if we are unable to pay our debts as they become due. Our
agreement with Paul Capital provides that in determining such insolvency any
amount we owe to Paul Capital is excluded in calculating our net worth (or
negative net worth). As defined in our agreement with Paul Capital we are
currently insolvent. In addition, although we are currently trying to manage our
debt we are not
paying our debts as they become due. Although Paul Capital has had the right for
well over a year to compel us to repurchase its interest in our revenues at the
price provided in our agreement, Paul Capital has so far not exercised that
right. If Paul Capital does exercise its right to compel us to repurchase its
interest in our revenues we would be unable to pay the purchase price and Paul
Capital could foreclose its security interest in our U.S. patents, patent
applications and trademarks and in such event we will have to discontinue our
business operations.
In addition to the requirement that the Company remain solvent, as described
above, the occurrence of certain events, including those set forth below,
triggers Paul Capital's right to require us to repurchase its revenue interest:
o a change of control of our company;
o the transfer of all or substantially all of our consolidated assets;
o the transfer of all or any part of our respective interests in our
products other than pursuant to any distribution agreements, license
agreements and future agreements; and
o a judicial decision that has a material adverse effect on our
business, operations, assets or financial condition as defined by the
agreement.
If a repurchase event occurred and Paul Capital required us to repurchase their
interest in our revenues, the Company may not have sufficient cash funds to pay
Paul Capital. As such, the investor could foreclose on certain assets that are
essential to our operations. The exact amount of the repurchase price is
dependent upon certain factors, including when the repurchase event occurs. At
December 31, 2003, since the Company was technically in default of the solvency
requirement under the Revenue Interest Assignment agreement, we provided for an
amount that approximated what we would have owed Paul Capital had they exercised
their repurchase option. To date, Paul Capital has not exercised this option and
has not indicated to us that they intend to compel us to repurchase its revenue
interest. Once the Company is no longer insolvent and therefore no longer in
technical breach of the agreement, Paul Capital bears the risk of revenue
interest paid to it being significantly less than the revenue interest
liability, as well as the reward of revenue interest paid to it being
significantly greater than the interest liability.
In February 2003, Paul Capital amended its agreement with us, restating and
updating certain provisions of the original agreement. 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.
In January 2002, we secured a $1.3 million lease line of credit with GE Capital
which enabled us to finance our fixed assets needs, such as laboratory and
laboratory support equipment, computer hardware and office furniture. In January
2002 and October 2002, we drew $268,000 and $181,000, respectively. Each
equipment purchase has a fixed lease term of 36 months. For equipment acquired
in 2002, the Company is obligated to make future rental payments during the
years ending December 31, 2004 and 2005 of $160,000 and $43,000, respectively.
This line of credit expired in 2002.
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 200,000 Series A warrants at $.001 per share, which were
immediately converted into 200,000 common shares, 100,000 Series B-1 and 100,000
Series B-2 warrants exercisable at $15.00 per share and $20.00 per share,
respectively. Concurrent with the Series B conversion and giving effect to the
reverse stock split, the exercise prices of these warrants were reduced to $4.00
and $5.00, respectively. Dividends on our Series B preferred stock sold in such
financing were paid in common shares at the rate of 12% per annum, resulting in
the issue of 92,307 shares of common stock. 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 $ 2.00 per share.
Dividends will be paid in cash, or common shares at our option, at the rate of
10% per annum. An accrued dividend of $336,550 at December 31, 2003 has been
provided for within 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 $6.00 per share for a period of 10 consecutive trading days. Additionally,
each investor was issued 1,800 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. 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 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 $2.50 per share. As a result
of this conversion, 605.389 shares of Series B preferred stocks were converted
into 2,421,556 shares of common stock 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 1,931,540 shares of common stock. 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 $15.00 and $20.00, respectively, to $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 $10.00 and $12.50, respectively,
for 10 consecutive trading days.
In October 2003, we entered into a cell therapy manufacturing agreement with
Cambrex Bio Science Walkerville, Inc., a subsidiary of Cambrex Corporation, for
the commercial manufacture
of Ortec's tissue engineered product, OrCel. It is expected that Cambrex will
begin production of OrCel in the first half of 2004 and this inventory may be
used for sale in the second half of 2004 if we receive FDA clearance to market
OrCel for use on patients in the treatment of venous leg ulcers. Pursuant to the
terms of this agreement, we are required to pay Cambrex $100,000 per month for
the use of a production suite in their facility located in Walkersville,
Maryland while we are in Phase I of the production plan, as defined by the
agreement. During Phase I only, we may terminate this agreement by giving 6
months advance notice of the effective date of such termination, however no such
termination will be effective prior to the date 12 months after the commencement
date for Phase I. At any time during Phase I, we can elect to initiate Phase II
of the agreement by written notice to Cambrex. The annual payments we will make
to Cambrex will increase to $2,100,000 per year if we require Cambrex to build
us a larger production facility to meet our requirements for the production of
OrCel. Such annual payments we are required to make will increase by a small
percentage each year. Such annual payments include some services and overhead
expenses provided and paid for by Cambrex. We are required to pay a portion of
the cost of construction of that larger production facility. However, the amount
we contribute to the construction of that larger facility will be repaid to us
by credits against a portion of the future annual payments of $2,100,000 and of
certain other payments we are required to make to Cambrex after the larger
facility is in use. We are also required to pay specified hourly charges for the
Cambrex employees engaged in the production of OrCel as well as certain other
charges. After construction of the larger production facility we are required to
acquire from Cambrex virtually all of our requirements for OrCel that Cambrex
can produce. Prior to our election to have Cambrex construct the larger
production facility for us, either we or Cambrex may terminate the agreement on
six months notice by us and 12 months notice by Cambrex, except that such
termination will not be effective prior to November 1, 2004. If we elect to have
Cambrex construct the larger production facility for us the agreement will
continue for 6 years after the larger production facility is constructed.
However, even after such construction we and Cambrex may elect to scale down
over the following three years the portion of our requirements for OrCel that
Cambrex will produce for us. We may elect the scale down period at any time
after one year after the larger production facility is constructed and in
operation in which event there are additional payments we must make to Cambrex.
Either Cambrex or we may elect the scale down period later than 3 years after
that facility is in operation and neither of us will be required to make any
additional payments to the other because of that election. If after the
construction of the larger production facility, we breach a material term of our
agreement with Cambrex, or elect to terminate the agreement, there are
substantial payments we must make to Cambrex.
In October, November, and December 2003, and January 2004, we received loans
payable in June 30, 2004, aggregating $3,790,000. These notes accrue interest at
8% per annum. In February 2004 we received a $250,000 loan which is payable on
demand. We will need to raise capital in 2004 to repay these commitments.
As of December 31, 2003, payment of approximately $2,500,000 of the
approximately $2,900,000 we owed to our trade creditors was past due. While we
have arranged for payment of some our obligations over a period of time, and
have to make some payments of past due obligations to our current and ongoing
suppliers, our ability to make payments we have agreed to pay and to insure
continued receipt of needed supplies, and to continue reducing our past due
obligations, will depend on our ability to secure needed financing. Raising
additional capital can be dependent on numerous factors, such as our ability to
obtain regulatory approval for the commercial sale of OrCel to treat venous
stasis ulcers, and, later diabetic foot ulcers as well as the general investment
climate.
A summary of our contractual obligation requirements as of December 31, 2003 is
as follows:
Payments due by period
Less than 1-3 3-5
Total 1 year years years
----------- ----------- ---------- -------
Loan Payable $ 708,684 $ 212,503 $ 465,759 $30,422
Promissory Notes Payable
(including interest) 3,283,800 3,283,800
Capital Lease Obligation 208,362 165,207 43,155
Operating Leases 738,000 361,000 377,000
Other Obligations:
Settlement with Dr. Eisenberg (1) 398,574 398,574
Cell Therapy Manufacturing
Agreement (Cambrex) (1) 1,000,000 1,000,000
Obligation under Revenue
Interest Assignment (2) 18,553,856 18,553,856
------------------------------------------------
$25,330,076 $24,106,740 $1,192,914 $30,422
================================================
(1) See Note 12 to the financial statements for settlement terms relating to the
agreement with Dr. Eisenberg and our contractual obligation under our Cell
Therapy Manufacturing Agreement with Cambrex.
(2) See Note 8 to the financial statements for repayment terms.
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, the issuance of promissory
notes to lenders all but a few of whom were investors in our Series C
Convertible Preferred Stock, and through the agreement with Paul Capital. We
will need to raise additional funds in the future through collaborative
arrangements with a pharmaceutical sales company and through the sale of our
securities to the public and through private placements, debt financing or
short-term loans. 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 2004. Our capital funding requirements depend on
numerous factors, including:
o the progress and magnitude of our research and development programs;
o the time involved in obtaining regulatory approvals for the commercial
sale of our OrCel product in its cryopreserved form to treat venous
stasis ulcers, and later diabetic foot ulcers;
o the costs involved in filing and maintaining patent claims;
o technological advances;
o competitive and market conditions;
o our ability to establish and maintain collaborative arrangements;
o the successful implementation of an agreement we have entered into
with Cambrex Bio Science Walkersville, Inc. for manufacturing of our
OrCel product in its cryopreserved form; and
o the cost and effectiveness of commercialization activities and
arrangements.
We are currently in the process of completing a registration statement to be
filed with the Securities and Exchange Commission to register shares of our
common stock and warrants. Once our registration statement become effective, we
hope to receive net proceeds, after payment of placement fees and other expenses
we incur in connection with the filing, of approximately $11 million through the
sale of 6,000,000 shares of our common stock together with the issuance of
warrants to purchase an additional 3,000,000 shares of our common stock. We
estimate this financing we hope to raise in 2004, will enable us to execute our
production plan with our third party manufacturer and prepare for sales in 2004,
pay a portion of our past due obligations, repay a portion of our short-term
promissory note borrowings, initiate the pivotal clinical trial for the use of
OrCel in its cryopreserved form for the treatment of diabetic foot ulcers, and
provide for our general and corporate working capital requirements for 2004. We
believe that our cash and cash equivalents on hand at December 31, 2003,
(approximately $1.2 million) and the $650,000 we have already raised in 2004, as
well as the additional $11.0 million we hope to raise in 2004 may enable us to
continue our operations for the next 12 months. However, we can give no
assurance that additional investment or other funds can be secured.
Additionally, we are also likely to continue to encounter difficulties which are
common to development stage companies, including unanticipated costs relating to
development, delays in the testing of products, regulatory approval and
compliance and competition.
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 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 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Reference is made to the Financial Statements contained in this Form
10-K report, setting forth the financial statements of Ortec International,
Inc., together with the report of Grant Thornton LLP, dated March 12, 2004.
PART III
Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Directors and Executive Officers
Set forth below are the directors and executive officers of Ortec,
their respective names and ages, positions with Ortec, principal occupations and
business experiences during at least the past five years and the dates of the
commencement of each individual's term as a director and/or officer.
Name Age Position
- ---- --- --------
Steven Katz, Ph.D. 59 Chairman of the Board of Directors
Ron Lipstein 48 Chief Executive and Chief Financial Officer,
Vice Chairman of the Board of Directors,
Secretary and Treasurer
Mark Eisenberg, M.D. 66 Director
Costantin Papastephanou, Ph.D. 58 President
Steve Lilien, Ph.D. 56 Director
Allen I. Schiff, Ph.D. 57 Director
Gregory B. Brown, M.D. 50 Director
Directors
Steven Katz, one of our founders, has been a director since our
inception in 1991 and was elected Chairman of our Board of Directors in
September 1994. He has been employed by us since 1991. Dr. Katz has also been a
professor of Economics and Finance at Bernard M. Baruch College in New York City
since 1972. He has a Ph.D. in Finance and Statistics as well as an MBA and an MS
in Operations Research, both from New York University.
Ron Lipstein, one of our founders, has been the Secretary, Treasurer,
Chief Financial Officer and a director of Ortec since 1991. Mr. Lipstein was
elected Vice Chairman of our Board of Directors in January 2001 and as our Chief
Executive Officer in March 2003. He has been employed by us since 1991. Mr.
Lipstein is a certified public accountant.
Mark Eisenberg, one of our founders, has been a director since 1991.
Dr. Eisenberg was formerly our senior vice president and a consultant to us. See
"Certain Relationships and Related Transactions". He has been a physician in
private practice in Sydney, Australia since 1967. He is a member and co-founder
of the dystrophic epidermolysis bullosa clinic at the Prince of Wales Hospital
for children in Sydney, Australia. He has done extensive research on
epidermolysis bullosa disease.
Steven Lilien has been a director of Ortec since February 1998. He has
been chairman of the accounting department of Bernard M. Baruch College in New
York City for the past sixteen years and is currently the Weinstein Professor of
Accounting there. He is a certified public accountant and has a Ph.D. in
accounting and finance and an MS, both from New York University.
Allen I. Schiff has been a director of Ortec since June 2001. He has
been Director of the Field Study Program at Fordham University Graduate School
of Business since 1992. That program performs consulting projects for businesses
and charitable institutions including a number of major well-known business and
charitable entities. From 1985 through 1989 he was chairman of both the
undergraduate and the graduate accounting departments at Fordham University. He
has a Ph.D. in finance and economics and an MS in accounting, both from New York
University. He is a director and chairman of the audit committee of Data
Software and Systems, Inc., a publicly held company whose shares are listed on
Nasdaq and whose principal business is the development of compatible software
for use by utilities.
Gregory B. Brown has been a director of Ortec since March 2003. Since
January 2003 Dr. Brown has been a partner at Paul Capital Partners and serves as
the director selected by Paul Capital Royalty Acquisition Fund, L.P., an
affiliate of Paul Capital Partners. Pursuant to our agreement with Paul Capital
Royalty Acquisition Fund, L.P., we are required to elect a person designated by
Paul Capital Royalty Acquisition Fund, L.P. as a director of Ortec. From 1997 to
2002 Dr. Brown served as a managing director of Adams, Harness & Hill, an
investment banking firm, and from April 2001 to December 2002 as head of its
Healthcare and co-head of investment banking. Prior to 1997 Dr. Brown was a
thoracic and vascular surgeon. He received a B.A. degree from Yale University,
an M.D. from Upstate Medical School and an M.B.A. from Harvard Business School.
All directors hold office until the next annual meeting of
stockholders and the election and qualification of their successors. Drs. Mark
Eisenberg, Steven Lilien, Allen I. Schiff and Gregory B. Brown are non-employee
directors.
Executive Officers
Officers are elected annually by the Board of Directors and serve at
the discretion of the Board of Directors. Two of our executive officers, Steven
Katz and Ron Lipstein, are also members of our Board of Directors. Information
with regard to such persons is set forth above under the heading "Directors."
The other executive officer is Costantin Papastephanou, our president.
Costantin Papastephanou was employed by us in February 2001 as our
president. Prior to joining Ortec he was employed by Bristol Myers-Squibb for 30
years, the last 14 of which he was with Bristol Myers' Convatec, a multinational
ostomy and wound care management division. His last position at Convatec was as
president of the global chronic care division, where he was responsible for that
division's sales and marketing, clinical trials, research and
development, manufacturing, quality assurance and regulatory affairs. He holds a
Ph.D. in Biochemistry from University of Miami as well as a Master of Science in
Microbial Biochemistry from University of London.
The Committees
The Board of Directors has an Audit Committee, a Compensation
Committee and a Stock Option Committee. The Board of Directors does not have a
Nominating Committee and the usual functions of such committee are performed by
the entire Board of Directors.
Audit Committee. The functions of the Audit Committee include
recommendations to the Board of Directors with respect to the engagement of our
independent certified public accountants and the review of the scope, cost and
effect of the audit engagement. The current members of the Audit Committee are
Drs. Lilien and Schiff. Dr. Lilien serves as chairman of the Audit Committee.
Both Drs. Lilien and Schiff are independent directors and both are audit
committee financial experts in that each has:
o An understanding of generally accepted accounting principles and
financial statements;
o The ability to assess the general application of such principles in
connection with the accounting for estimates, accruals and reserves;
o Experience preparing, auditing, analyzing or evaluating financial
statements that present a breadth and level of complexity of
accounting issues that are generally comparable to the breadth and
complexity of issues that can reasonably be expected to be raised by
Ortec's financial statements, or experience actively supervising one
or more persons engaged in such activities;
o An understanding of internal controls and procedures for financial
reporting; and
o An understanding of audit committee functions.
As we noted above Dr. Lilien is a certified public accountant, has a Ph.D.
in accounting and finance and is chairman of the accounting department of
Bernard M. Baruch College in New York City. Dr. Schiff has an M.S. in accounting
and a Ph.D. in finance and economics and from 1985 through 1989 he was, and
again currently he is, chairman of both the graduate and undergraduate
accounting departments at Fordham University.
Compensation Committee. The function of the Compensation Committee
is to make recommendations to the Board of Directors with respect to the
compensation of our executive officers, including salary, bonus and other
incentives. The current members of the Compensation Committee are Messrs. Katz,
Eisenberg and Lilien.
Stock Option Committee. The Stock Option Committee determines the
employees (other than our executive officers), consultants and advisors, to whom
options should be granted under our Stock Option Plan and the number of options
to be granted to each such employee, consultant and advisor. The current members
of the Stock Option Committee are Messrs. Katz and Lipstein. The Board of
Directors determines any other persons (our executive officers and directors) to
whom options should be granted and the number of options to be granted to each
such person.
Attendance at Meetings
During 2003, the Board of Directors, Audit Committee, Compensation
Committee and Stock Option Committee each met or acted without a meeting
pursuant to unanimous written consent nine times, five times, one time and five
times, respectively. In 2003 all of the directors attended all of the meetings
of, or consented to actions by, the Board of Directors except for Dr. Eisenberg
who missed two meetings. Dr. Lilien attended all five meetings and Dr. Schiff
attended three meetings of the Audit Committee. Drs. Katz, Schiff and Lilien all
attended the one meeting of the Compensation Committee and Messrs. Katz and
Lipstein attended all meetings of the Stock Option Committee.
Section 16(a) Beneficial Ownership Reporting Compliance
To the best of our knowledge, during 2003 the following individuals
who were executive officers and/or directors of Ortec did not file a Form 3 or 4
report in time: Steven Katz, five times, Ron Lipstein, three times, Costantin
Papastephanou, twice and Mark Eisenberg and Gregory Brown, once each.
Code of Ethics
Ortec's directors have adopted a code of ethics requiring its
employees, including its executive officers and its directors, to act honestly
and with integrity with respect to Ortec and Ortec's business dealings and to
provide full and fair disclosure about the Company that is required to, or will,
be reported to the public. The code of ethics requires Ortec's employees to
disclose to Ortec's Board of Directors any material transaction or relationship
on the part of any Ortec employee or director that could reasonably be deemed
dishonest or that reasonably could be expected to give rise to an actual or
apparent conflict of interest. We have filed a copy of our code of ethics with
the Securities and Exchange Commission.
Item 11. EXECUTIVE COMPENSATION
The following table sets forth the compensation paid by us for our
fiscal years ended December 31, 2003, 2002 and 2001 to (i) our Chief Executive
Officer; (ii) our other executive officers; and (iii) two additional individuals
for whom disclosure would have been provided but for the fact that the
individuals were not serving as executive officers at the end of the last
completed fiscal year (the "Named Officers"). The number of shares of our common
stock issuable upon the exercise of options, the exercise prices and the
potential realizable values as of December 31, 2003 of those options granted in
2003, are the number of shares, exercise prices and realizable values after
giving effect to the one share for ten shares reverse split of our common stock
effective June 24, 2003.
SUMMARY COMPENSATION TABLE
---------------------------------------------------------------
Long Term
Annual Compensation Compensation
---------------------------------------------------------------
Securities
Name and Other Annual Underlying
Principal Position Year Salary($) Bonus($) Compensation($)(2) Options/SARs
---------------------------------------------------------------
Ron Lipstein 2003 224,366 118,300(1) 476,431
Chief Executive Officer, 2002 201,115 150,850 210,082
Vice Chairman, 2001 214,447 86,000 18,500
Secretary,
Treasurer and Chief
Financial Officer
- ------------------------------------------------------------------------------------------
Steven Katz 2003 158,558 118,300(1) 476,431
Chairman 2002 225,058 150,850 210,082
2001 236,392 92,000 20,000
- ------------------------------------------------------------------------------------------
Costantin Papastephanou 2003 207,493 57,500
President 2002 205,784 19,000
2001 181,625 6,000
- ------------------------------------------------------------------------------------------
Melvin Silberklang 2003 172,735 10,000 7,500
Vice President, Chief 2002 132,051 2,998
Scientific Officer 2001 125,429 1,000
- ------------------------------------------------------------------------------------------
Alain Klapholz 2003 168,492 5,000
Vice President for 2002 162,884 10,000
Operations and Planning 2001 170,604 20,000 6,000
- ------------------------------------------------------------------------------------------
(1) Mr. Lipstein and Dr. Katz have each deferred payment of $108,300 of these
amounts.
(2) Does not include allocation of 1,725,000 shares of common stock that we may
issue to the Named Officers as follows: 1,000,000 shares to Mr. Lipstein,
340,000 shares to Dr. Katz, 220,000 shares to Mr. Papastephanou, 100,000
shares to Mr. Silberklang and 65,000 shares to Mr. Klapholz, because the
issuance of such shares is contingent on Ortec achieving certain
milestones, none of which have been achieved.
Board Compensation
Drs. Mark Eisenberg, Steven Lilien, Allen I. Schiff and Gregory B.
Brown were all non-employee directors in 2003. For Dr. Steven Lilien's services
in 2003 as a director and as
chairman of our audit committee, we paid Dr. Lilien $5,167 and for his services
in 2003 as a director and as a member of our audit committee, we paid Dr. Schiff
$20,667. We paid no compensation to either Dr. Eisenberg or Dr. Brown for their
services as directors.
Option Grants in Last Fiscal Year
The following table sets forth certain information regarding options
granted during the fiscal year ended December 31, 2003 by us to the Named
Officers:
Potential Realizable
Value at
Assumed Annual
Rates of Stock Price
Appreciation for
Individual Grants Option Term
- ---------------------------------------------------------------------------------------------------------
(a) (b) (c) (d) (e) (f) (g)
- ---------------------------------------------------------------------------------------------------------
Number of % of Total Exercise
Securities Options/SARs or
Underlying Granted to Base
Options/SARs Employees in Price Expiration
Name Granted Fiscal Year (1) ($/Share) Date 5% ($) 10% ($)
- ---------------------------------------------------------------------------------------------------------
Steven Katz 230,000 16.0 1.80 5/23/10 347,300 639,400
138,000 9.6 3.60 5/23/10 0 135,240
37,000 2.6 2.10 6/2/10 44,770 91,760
49,231 3.4 2.00 4/7/10 64,493 120,016
22,200 1.5 3.60 6/2/10 0 21,756
- ---------------------------------------------------------------------------------------------------------
Ron Lipstein 230,000 16.0 1.80 5/23/10 347,300 639,400
138,000 9.6 3.60 5/23/10 0 135,240
37,000 2.6 2.10 6/2/10 44,770 91,760
49,231 3.4 2.00 4/7/10 64,493 120,016
22,200 1.5 3.60 6/2/10 0 21,756
- ---------------------------------------------------------------------------------------------------------
Costantin Papastephanou 50,000 3.5 1.80 5/23/10 75,500 139,000
7,500 0.5 4.10 2/6/10 0 3,600
- ---------------------------------------------------------------------------------------------------------
Alain Klapholz 5,000 0.3 1.80 5/23/07 5,300 8,200
- ---------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------
Melvin Silberklang 2,500 0.2 1.80 5/23/07 2,650 4,100
2,500 0.2 3.00 2/28/10 775 3,950
2,500 0.2 4.10 2/6/10 0 1,200
- ------------------------------------------------------------------------------------------------------------
* Less than one percent
(1) Options to purchase a total of 1,432,761 shares of common stock were
granted to our employees, including the Named Officers, during the fiscal
year ended December 31, 2003.
The following table sets forth certain information regarding options
exercised and exercisable during the fiscal year ended December 31, 2003 and the
value of the options held as of December 31, 2003 by the Named Officers. None of
the Named Officers exercised any options during the fiscal year ended December
31, 2003.
Aggregated Option Exercises In Last Fiscal Year
and Fiscal Year-End Option Value
Number of Securities
Underlying Unexercised Value of Unexercised
Options At Fiscal In-the-Money Options
Year-End (#) at Fiscal Year-End (1)($)
--------------------------- ---------------------------
Name Exercisable Unexercisable Exercisable Unexercisable
- ---- ----------- ------------- ----------- -------------
Steven Katz 724,441 0 $152,981 $ 0
Ron Lipstein 720,326 0 152,981 0
Costantin Papastephanou 14,625 60,375 0 27,500
Alain Klapholz 19,230 5,000 0 2,750
Mel Silberklang 6,919 5,963 1,375 1,375
(1) The product of (x) the difference between $2.35 (the closing price of our
common stock at December 31, 2003, as reported on the over the counter
Bulletin Board) and the exercise price of the unexercised options,
multiplied by (y) the number of unexercised options.
Compensation Committee Interlock and Insider Participation
None of our executive officers serves as a member of the compensation
committee or on the board of directors of another entity, one of whose executive
officers serves on our Board of Directors.
The Compensation Committee of our Board of Directors determines
compensation policies applicable to our three executive officers. Messrs. Steven
Katz, Steven Lilien and Allen Schiff are the members of the Compensation
Committee. Mr. Katz is an executive officer of Ortec.
Item 12. SECURITY OWNERSHIP OF BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth information, as of December 15, 2003,
based upon information obtained from the persons named below, regarding
beneficial ownership of our common stock by (i) each person who is known by us
to own beneficially more than 5% of the outstanding shares of our common stock,
(ii) each of our directors, (iii) each of the Named Officers, and (iv) all of
our executive officers and directors as a group.
Amount and Percentage of
Name and Address Nature of Beneficial Outstanding
of Beneficial Owner Ownership** Shares Owned**
- ------------------------------------------------------------------------------
Steven Katz* 742,258(1) 12.1
- ------------------------------------------------------------------------------
Mark Eisenberg* 60,600(2) 1.1
- ------------------------------------------------------------------------------
Ron Lipstein* 741,354(3) 12.1
- ------------------------------------------------------------------------------
Costantin Papastephanou* 75,175(4) 1.4
- ------------------------------------------------------------------------------
Steven Lilien 7,640(5) ***
19 Larchmont Street
Ardsley, NY 10502
- ------------------------------------------------------------------------------
Allen I. Schiff 3,500(6) ***
Fordham University
Graduate School of Business
113 West 60th Street
New York, NY 10023
- ------------------------------------------------------------------------------
Gregory B. Brown 0(7) 0
140 E. 45th Street, 44th Floor
New York, NY 10017
- ------------------------------------------------------------------------------
Pequot Capital Management, Inc. 957,364(8) 17.7
5000 Nyala Farm Road
Westport, CT 06880
- ------------------------------------------------------------------------------
DMG Advisors LLC 445,114(8) 8.2
53 Forest Avenue, Suite 202
Old Greenwich, CT 06870
- ------------------------------------------------------------------------------
Sargon Capital International Fund Ltd. 448,045(8) 8.3
6 Louis Drive
Montville, NJ 07045
- ------------------------------------------------------------------------------
SDS Merchant Fund L.P. 445,591(8) 8.2
53 Forest Avenue, Suite 201
Old Greenwich, CT 06870
- ------------------------------------------------------------------------------
Stonestreet Limited Partnership 796,048(9) 14.7
c/o Canaccord Capital Corp.
32 Bay Street, Suite 1250
Toronto, ON M5H4A6
- ------------------------------------------------------------------------------
Jason Adelman 307,479(10) 5.7
Burnham Hill Holdings, LLC
900 Park Avenue
New York, NY 10021
- ------------------------------------------------------------------------------
All officers and directors as a group 1,630,527(1-7) 23.4
(eight person)
- ------------------------------------------------------------------------------
Notes on the following page.
* The address of these persons is at Ortec's offices, 3960 Broadway, New
York, NY 10032.
** The number of shares of common stock beneficially owned by each person or
entity is determined under rules promulgated by the Securities and Exchange
Commission. Under such rules, beneficial ownership includes any shares as
to which the person or entity has sole or shared voting power or investment
power. Included among the shares owned by such person are any shares which
such person or entity has the right to acquire within 60 days after March
21, 2003. Unless otherwise indicated, each person or entity referred to
above has sole voting and investment power with respect to the shares
listed. The inclusion herein of any shares deemed beneficially owned does
not constitute an admission of beneficial ownership of such shares.
*** Less than 1%, based upon information available to us.
1. Does not include shares owned by Dr. Katz's children, their spouses and his
grandchildren. Dr. Katz disclaims any beneficial interest in such shares.
Includes 724,241 shares issuable to Dr. Katz upon his exercise of
outstanding options.
2. Includes 1,000 shares issuable to Dr. Eisenberg upon his exercise of
outstanding options.
3. Includes 3,360 shares owned by Mr. Lipstein's minor children. Mr. Lipstein
disclaims any beneficial interest in such 3,360 shares. Also includes
720,126 shares issuable to Mr. Lipstein upon his exercise of outstanding
options.
4. Includes 75,000 shares issuable to Mr. Papastephanou upon his exercise of
outstanding options.
5. Includes 7,600 shares issuable to Dr. Lilien on his exercise of outstanding
options.
6. All 3,500 shares are issuable to Dr. Schiff on his exercise of outstanding
options.
7. Does not include 73,077 shares of common stock, 50 shares of Series B
convertible preferred stock which are convertible into approximately
200,000 shares of common stock, and warrants to purchase 50,000 shares of
common stock, all owned by Paul Capital Royalty Acquisition Fund, L.P. Dr.
Brown was selected by Paul Capital to serve as a director of Ortec pursuant
to Ortec's agreement giving Paul Capital the right to name one director.
8. Shares held by investment funds. The following persons have sole investment
and voting power for these shares.
Pequot Capital Management, Inc. -
DMG Advisors LLC - Tom McCauley
Sargon Capital International Fund, Inc. - Margaret Chu
SDS Merchant Fund L.P. - Steve Derby
9. The individuals at Stonestreet Limited Partnership who have shared
investment and voting power for the shares of Ortec common stock owned by
Stonestreet are Michael Finkelstein and Elizabeth Leonard.
10. Includes 150,000 shares owned by Burnham Hill Holdings, LLC.
Equity Compensation Plan Information
The table below sets forth the following information as of the fiscal
year ended December 31, 2003 for (i) all compensation plans previously approved
by our stockholders and (ii) all compensation plans not previously approved by
our stockholders, if any:
(a) the number of securities to be issued upon the exercise of
outstanding options, warrants and rights;
(b) the weighted-average exercise price of such outstanding options,
warrants and rights; and
(c) other than securities to be issued upon the exercise of such
outstanding options, warrants and rights, the number of
securities remaining available for future issuance under the
plans.
(c)
Number of
(a) Securities Remaining
Number of Securities (b) Available for Future
to be Issued Upon Weighted-Average Issuance Under Equity
Exercise of Exercise Price of Compensation Plans
Outstanding Options, Outstanding Options, (excluding securities
Plan Category(1) Warrants and Rights Warrants and Rights reflected in column(a))
- ------------------- -------------------- -------------------- -----------------------
Equity Compensation
Plans Approved by
Securityholders 348,919 $3.62 94,051
Equity Compensation
Plans Not Approved
by Securityholders 1,274,400 $2.78 0
--------- ------
Total 1,622,599 94,051
(1) The only equity compensation plan approved by our stockholders is our Third
Amended and Restated 1996 Stock Option Plan. The equity compensation plans
that have not been approved by our stockholders consists of stock options
outside of that Stock Option Plan granted to our executive officers to
purchase 1,274,400 shares of our common stock and warrants issued for
services and to a lender whose loan is secured by our equipment.
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Termination of Employment Agreements
We have entered into agreements with Messrs. Katz, Lipstein and Alain
Klapholz that provide for payments to them in the event that their employment is
terminated by us, including "constructive termination" as defined in those
agreements. We will pay to such terminated individuals in the event it is Dr.
Katz or Mr. Lipstein an amount equal to 2.99 times, and in the event it is Mr.
Klapholz 1.99 times, the average annual compensation paid by us to such person
in the five tax years prior to termination of his employment. The agreements
with Messrs. Katz, Lipstein and Klapholz also provide that in the event of such
termination of employment, the expiration dates of all options and warrants
which have been granted to such persons and which expire less than three years
after such termination of employment, will be extended so that such options and
warrants expire three years after such termination of employment. The agreements
further provide that in the event of the death or disability of Messrs. Katz,
Lipstein or Klapholz, or the voluntary termination of Messrs. Katz' or
Lipstein's employment, and in certain events the voluntary termination of Mr.
Klapholz' employment, we will pay to such executive an amount equal to the
compensation received by such executive from us in the previous 12 months.
The Internal Revenue Code provides that in the event that payments to
an executive officer resulting from a change of control of a company exceeds
three times the average annual compensation paid by us to such executive officer
in the five year period prior to such change of control (a) such excess will not
be able to be deducted by us in calculating our income for income tax purposes
and (b) a special excise tax equal to 20% of such excess will have to be paid by
the executive officer receiving such excess payments. Such agreements are
commonly referred to as "golden parachutes." The agreements with Messrs. Katz,
Lipstein and Klapholz provide that we will pay such excise tax payable by such
executive officer, as well as income taxes payable by such executive officer as
a result of our payment of such excise tax.
One of our directors, Dr. Gregory Brown, was selected by Paul Capital
Royalty Acquisition Fund, L.P. as provided by an amendment in February 2003 of
an agreement between us and Paul Capital. See Part I, Item 1, "Business - Paul
Capital Agreements."
We owe Dr. Mark Eisenberg, one of our directors who is also one of our
founders, an aggregate of $398,574. Of such amount $304,478 was for consulting
services Dr. Eisenberg had provided to us under an agreement we had with him,
$65,215 was for payments Dr. Eisenberg
made in our behalf for the laboratory we maintained in Australia (including
salaries and obligations to suppliers) and $28,881 for rent we owe him for the
space occupied by our laboratory. We no longer operate a laboratory in
Australia. We have reached an agreement in principal with Dr. Eisenberg to grant
him options to purchase 100,000 shares of our common stock at an exercise price
of $2.00 per share as payment in full of the $398,574 we owe him. We have not
yet submitted that agreement to our board of directors for their approval.
Item 14. CONTROLS AND PROCEDURES
(a) Evaluation of disclosure controls and procedures.
Our Principal Executive Officer and Principal Financial Officer, after
evaluating the effectiveness of our 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 this Annual Report on Form 10-K (the "Evaluation
Date") have concluded that as of the Evaluation Date, our disclosure controls
and procedures were adequate and effective to ensure that material information
relating to us and our consolidated subsidiaries would be made known to us and
them by others within those entities, particularly during the period in which
this Annual Report was being prepared.
(b) Changes in internal controls.
There were no significant changes in our internal controls or in other
factors that could significantly affect our disclosure controls and procedures
subsequent to the Evaluation Date, nor any significant deficiencies or material
weaknesses in such disclosure controls and procedures requiring corrective
actions. As a result, no corrective actions were taken.
FORWARD LOOKING STATEMENTS
This Annual Report on Form 10-K includes statements that are
"forward-looking statements" within the meaning of Section 27A of the Securities
Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934,
as amended, including statements regarding our expectations, hopes, beliefs,
intentions or strategies regarding the future, that are based on the beliefs of
our 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 us are
intended to identify such forward-looking statements. Such statements reflect
the current views of our management with respect to future events and are
subject to certain risks, uncertainties and assumptions, including those
described in this annual report. 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.
AVAILABILITY OF FORM 10-K
We will provide a copy of our annual report on Form 10-K for the year
ended December 31, 2003, as filed with the Securities and Exchange Commission,
including our financial statements and the financial statement schedules, to any
of our stockholders and to any person holding our warrants or options to
purchase shares of our common stock, or other securities convertible into our
common stock, upon written request and without charge. Such written request
should be directed to Mr. Ron Lipstein, Secretary, at Ortec International, Inc.,
3960 Broadway, New York, NY 10032.
PART IV
Item 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) Financial Statements and Financial Statement Schedules.
(i) Financial Statements:
See Index to Financial Statements.
(ii) Financial Statement Schedules
All financial statement schedules have been omitted since either
(i) the schedule or condition requiring a schedule is not applicable or (ii) the
information required by such schedule is contained in the Financial Statements
and Notes thereto or in Management's Discussion and Analysis of Financial
Condition and Results of Operation.
(b) Reports on Form 8-K.
We did not file any report on Form 8-K in the fourth quarter of
2003.
(c) Exhibits.
Exhibit No. Description
- ----------- -----------
3.1 Restated Certificate of Incorporation (1)
3.2 Amendment to Restated Certificate 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 (4)
3.5 Amendment to Certificate of Incorporation filed on May 23, 2003,
being the Certificate of Designation of the Relative Rights and
Preferences of the Series C convertible preferred stock (5)
3.6 Amendment to Certificate of Incorporation filed on June 10, 2003 (8)
3.7 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)
3.8 By-Laws (7)
14 Code of Ethics (8)
10.1 Agreement with Cambrex BioScience of Walkersville, Inc.; redacted
(9)
10.2 Agreement with Paul Capital Royalty Acquisition Fund L.P.;
redacted (10)
10.3 Termination of Employment Agreements between the Registrant and
Steven Katz, Ron Lipstein and Alain Klapholz (11)
10.4 Lease with Audubon Biomedical Science and Technology Park (9)
23. Consent of Grant Thornton LLP (8)
31.1 Certifications (Principal Executive Officer) (8)
31.2 Certifications (Principal Financial Officer) (8)
32.1 Certification of Principal Executive Officer (8)
32.2 Certification of Principal Financial Officer (8)
- ----------
(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 with our Annual Report on 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-QA for the quarter ended September 30,
2002, and incorporated herein by reference.
(5) Filed as an Exhibit to our Form 10-Q for the quarter ended June 30, 2003,
and incorporated herein by reference.
(6) Filed as an Exhibit to our Form 10-Q for the quarter ended September 30,
2003, and incorporated herein by reference.
(7) 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.
(8) Filed herewith.
(9) Filed as an Exhibit to our Registration Statement No. 333-109027, or an
amendment thereto, and incorporated herein by reference. Certain portions
of Exhibit 10.1 marked by asterisks were omitted pursuant to a confidential
treatment request and filed separately with the Securities and Exchange
Commission.
(10) Filed as an Exhibit to Amendment No. 1 to our Annual Report on Form 10-K
for the year ended December 31, 2002, and incorporated herein by reference.
Certain portions marked by asterisks were omitted pursuant to a
confidential treatment request and filed separately with the Securities and
Exchange Commission.
(11) Filed as an Exhibit to our Form 8-K filed on December 12, 2002, and
incorporated herein by reference.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this report to be signed on its
behalf by the undersigned thereunto duly authorized.
Dated: March 30, 2004
Ortec International, Inc.
By: /s/ Steven Katz
---------------------
Steven Katz, Ph.D.
Chairman
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
Signature Title Date
--------- ----- ----
/s/ Steven Katz Chairman (Principal Executive Officer) March 30, 2004
- --------------------
Steven Katz
/s/ Ron Lipstein Vice Chairman, Chief Executive and March 30, 2004
- -------------------- Chief Financial Officer, Secretary,
Ron Lipstein Treasurer and Director (Principal
Financial and Accounting Officer)
/s/ Mark Eisenberg Director March 30, 2004
- --------------------
Mark Eisenberg
/s/ Steven Lilien Director March 30, 2004
- --------------------
Steven Lilien
/s/ Allen I. Schiff Director March 30, 2004
- -------------------
Allen I. Schiff
/s/ Gregory B. Brown Director March 30, 2004
- --------------------
Gregory B. Brown
Ortec International, Inc.
(a development stage enterprise)
INDEX TO FINANCIAL STATEMENTS
Page
----
Report of Independent Certified Public Accountants F-2
Financial Statements
Balance Sheets as of December 31, 2003 and 2002 F-3
Statements of Operations for the years ended December 31, 2003, 2002 and
2001, and for the cumulative period from
March 12, 1991 (inception) to December 31, 2003 F-5
Statement of Shareholders' Equity/(Deficit) for the cumulative
period from March 12, 1991 (inception) to December 31, 2003 F-6
Statement of Cash Flows for the years ended December 31, 2003, 2002 and
2001, and for the cumulative period from
March 12, 1991 (inception) to December 31, 2003 F-11
Notes to Financial Statements F-14 - F-52
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
Directors and Stockholders
Ortec International, Inc.
We have audited the accompanying balance sheets of Ortec International, Inc. (a
development stage enterprise) (the "Company") as of December 31, 2003 and 2002,
and the related statements of operations, shareholders' equity/(deficit) and
cash flows for each of the three years in the period ended December 31, 2003,
and for the period from March 12, 1991 (inception) to December 31, 2003. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Ortec International, Inc. at
December 31, 2003 and 2002, and the results of its operations and its cash flows
for each of the three years in the period ended December 31, 2003, and for the
period from March 12, 1991 (inception) to December 31, 2003, in conformity with
accounting principles generally accepted in the United States of America.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note A, the Company
incurred a net loss applicable to common shareholders of $21,449,131 during
the year ended December 31, 2003, and, as of that date, the Company's current
liabilities exceeded its current assets by $25,360,740, its total liabilities
exceeded its total assets by $24,476,407, and the Company has a deficit
accumulated in its development stage of $103,307,740. These factors, among
others, as discussed in Note A to the financial statements, raise substantial
doubt about the Company's ability to continue as a going concern. Management's
plans in regard to these matters are also described in Note A. The financial
statements do not include any adjustments that might result from the outcome
of this uncertainty.
GRANT THORNTON LLP
New York, New York
March 12, 2004, except for Note 14 as to which the date is March 23, 2004
F-2
Ortec International, Inc.
(a development stage enterprise)
BALANCE SHEETS
December 31,
2003 2002
----------- -----------
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 1,328,387 $ 826,227
Accounts receivable, net of allowance for doubtful accounts
of $ 5,374 at December 31, 2003 15,324
Other current assets 33,756 41,904
----------- -----------
Total current assets 1,362,143 883,455
PROPERTY AND EQUIPMENT, AT COST
Laboratory equipment 1,670,656 1,671,075
Office furniture and equipment 1,313,954 1,350,985
Leasehold improvements 1,354,481 1,567,513
----------- -----------
4,339,091 4,589,573
Less accumulated deprecation and amortization (3,749,251) (3,207,977)
----------- -----------
589,840 1,381,596
OTHER ASSETS
Patent application costs, net of accumulated
amortization of $352,998 in 2003 and $279,037
in 2002 620,513 682,885
Deferred financing costs, net of accumulated
amortization of $13,883 in 2003 and $7,933 in 2002 45,617 78,207
Security deposit - New Jersey location 16,000 639,000
Other deposits and other assets 98,158 33,223
----------- -----------
$ 2,732,271 $ 3,698,366
=========== ===========
F-3
Ortec International, Inc.
(a development stage enterprise)
BALANCE SHEETS (continued)
December 31,
2003 2002
------------- ------------
LIABILITIES AND SHAREHOLDERS' EQUITY/(DEFICIT)
CURRENT LIABILITIES
Accounts payable and accrued expenses $ 3,601,044 $ 3,773,063
Accrued compensation 695,298 274,253
Accrued professional fees 554,080 365,945
Capital lease obligation - current 150,937 142,620
Loan payable - current 168,668 155,578
Advances payable 130,000
Promissory notes - current, net 2,869,000
Obligation under revenue interest assignment 18,553,856 13,959,541
------------- ------------
Total current liabilities 26,722,883 18,671,000
LONG-TERM LIABILITIES
Loan payable - noncurrent 444,737 613,405
Capital lease obligation - noncurrent 41,058 215,093
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 December 31, 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, none issued
Redeemable convertible preferred stock - Series B, stated value $10,000 per
share; authorized 1,200 shares; 50 shares issued and outstanding, at
December 31, 2003 and 938 shares issued and outstanding, at December 31,
2002; liquidation preference $500,000 at December 31, 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
December 31, 2003 liquidation preference $5,690,000 at December 31, 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 December 31, 2003, liquidation preference $4,828,850
at December 31, 2003 2,628,602
Additional paid-in capital 72,437,243 61,195,715
Deficit accumulated during the development stage (103,307,740) (81,858,609)
Treasury stock, at cost (2,000 shares at December 31, 2003 and
December 31, 2002) (177,645) (177,645)
------------- ------------
Total Shareholders' Equity/(Deficit) (24,476,407) (15,801,132)
------------- ------------
$ 2,732,271 $ 3,698,366
============= ============
Common stock shares and amount have been adjusted to reflect one for ten
reverse stock split effective June 24, 2003
The accompanying notes are an integral part of these statements.
F-4
Ortec International , Inc
(a development stage enterprise)
STATEMENTS OF OPERATIONS
Cumulative
From
March 12,
1991
Year ended December 31, (inception) to
------------------------------------------ December 31,
2003 2002 2001 2003
------------ ------------ ------------ --------------
Operating Revenue $ -- $ 243,775 $ 21,890 $ 265,665
------------ ------------ ------------ -------------
Expenses
Product and laboratory costs 2,956,217 3,147,515 4,283,038 24,152,124
Rent 627,861 683,116 589,238 3,490,512
Consulting (27,735) 490,826 1,413,153 5,689,606
Personnel 3,938,116 6,440,959 6,605,630 33,328,435
General and administrative 2,586,476 2,781,896 2,671,887 17,371,057
Interest and other expense 4,735,292 7,281,104 536,070 13,035,902
Interest income (14,889) (7,647) (191,749) (2,271,985)
Lease termination costs 1,119,166 1,119,166
Loss on extinguishments of debt
and series A preferred shares 1,004,027 1,004,027
------------ ------------ ------------ -------------
15,920,504 21,821,796 15,907,267 96,902,844
------------ ------------ ------------ -------------
Net loss (15,920,504) (21,578,021) (15,885,377) (96,653,179)
Preferred stock dividend 1,259,627 1,125,934 2,385,561
Preferred stock deemed dividends
and discounts 4,269,000 4,269,000
------------ ------------ ------------ -------------
Net loss applicable to common
shareholders $(21,449,131) $(22,703,955) $(15,885,377) $(103,307,740)
============ ============ ============ =============
Net loss per share
Basic and diluted $ (5.11) $ (20.08) $ (16.39) $ (125.23)
============ ============ ============ =============
Weighted average shares
outstanding
Basic and diluted 4,198,107 1,130,596 969,161 824,943
============ ============ ============ =============
Weighted average shares and per share amounts have been adjusted to reflect
one for ten reverse stock split effective June 24, 2003.
The accompanying notes are an integral part of these statements.
F-5
Ortec International Inc.
(a development stage enterprise)
STATEMENT OF SHAREHOLDERS' EQUITY/(DEFICIT)
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 ($3.00 cash per share) 21,744 22
The Director ($11.50 and $53.00 cash per share) 14,902 15
Second private placement ($94.25 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 ($94.25 cash per share) 4,932 5
Stock purchase agreement with the Director
($94.25 cash per share) 3,182 3
Share issuance expense
Net loss
Balance at December 31, 1991 205,444 205
Issuance of stock
Third private placement ($100.00 cash per share) 13,215 13
Stock purchase agreement with Home
Insurance Company ($90.00 cash per share) 11,112 11
Stock purchase agreement with the Director
($94.25 cash per share) 2,122 2
Shares issued in exchange for commission
($100.00 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 ($3.00 cash per share) 64,978 65,000
The Director ($11.50 and $53.00 cash per share) 249,985 250,000
Second private placement ($94.25 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 ($94.25 cash per share) 465,468 465,473
Stock purchase agreement with the Director
($94.25 cash per share) 299,995 299,998
Share issuance expense (35,477) (35,477)
Net loss (785,941) (785,941)
Balance at December 31, 1991 1,524,541 (1,067,585) 457,161
Issuance of stock
Third private placement ($100.00 cash per share) 1,321,487 1,321,500
Stock purchase agreement with Home
Insurance Company ($90.00 cash per share) 999,988 999,999
Stock purchase agreement with the Director
($94.25 cash per share) 199,998 200,000
Shares issued in exchange for commission
($100.00 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
F-6
Ortec International Inc.
(a development stage enterprise)
STATEMENT OF SHAREHOLDERS' EQUITY/(DEFICIT)
Common Stock Preferred Stock
---------------- ------------------------------
Shares Amount Series B Series C Series D
------- ------ -------- -------- --------
(brought forward) 231,953 $232
Issuance of stock
Fourth private placement ($100.00 cash per share) 3,946 4
Stock purchase agreement with Home
Insurance Company ($100.00 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 ($64.90 cash per share) 95,911 96
Share issuance expenses
Stock options issued for services
Net loss
Balance at December 31, 1996 460,199 460
Exercise of warrants 115,878 116
Share issuance expenses
Stock options and warrants issued for services
Net loss
Balance at December 31, 1997 (carried forward) 576,077 576
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 ($100.00 cash per share) 397,708 397,712
Stock purchase agreement with Home
Insurance Company ($100.00 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 ($64.90 cash per share) 6,220,701 6,220,797
Share issuance expenses (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 15,577,325 (7,869,787) 7,716,998
Exercise of warrants 10,822,675 10,822,791
Share issuance expenses (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 (carried forward) 26,402,492 (12,686,450) 13,716,618
F-7
Ortec International Inc.
(a development stage enterprise)
STATEMENT OF SHAREHOLDERS' EQUITY/(DEFICIT)
Common Stock Preferred Stock
---------------- ------------------------------
Shares Amount Series B Series C Series D
------- ------ -------- -------- --------
(brought forward) 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 expenses
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 ($87.50 cash per share) 38,916 39
Warrants issued in Seventh private placement
Eighth private placement ($55.00 cash per share) 163,637 164
Share issuance expenses
Purchase of 910 shares of treasury (at cost)
Net loss
Balance at December 31, 1999 822,189 822
Exercise of options and warrants 17,554 17
Stock options and warrants issued for services
Ninth private placement ($150.00 cash per share) 6,667 7
Warrants issued in Ninth private placement
Tenth private placement ($67.50 cash per share) 124,757 125
Share issuance expenses
Purchase of 430 shares of treasury stock (at cost)
Net loss
Balance at December 31, 2000 (carried forward) 971,167 971
Deficit
accumulated
Additional during the Total
paid-in development Treasury shareholders'
capital stage stock equity/(deficit)
----------- ------------ --------- ----------------
(brought forward) $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 expenses (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 ($87.50 cash per share) 3,168,746 3,168,785
Warrants issued in Seventh private placement 468,291 468,291
Eighth private placement ($55.00 cash per share) 8,999,838 9,000,002
Share issuance expenses (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 43,652,302 (31,139,614) 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 ($150.00 cash per share) 999,998 1,000,005
Warrants issued in Ninth private placement 23,000 23,000
Tenth private placement ($67.50 cash per share) 8,420,946 8,421,071
Share issuance expenses (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 (carried forward) 52,838,276 (43,269,277) (177,645) 9,392,325
F-8
Ortec International Inc.
(a development stage enterprise)
STATEMENT OF SHAREHOLDERS' EQUITY/(DEFICIT)
Common Stock Preferred Stock
------------------ --------------------------------
Shares Amount Series B Series C Series D
--------- ------ ---------- -------- --------
(brought forward) 971,167 $ 971
Stock options and warrants issued for services
Net loss
Balance at December 31, 2001 971,167 971
Exercise of options and warrants 35,720 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)
($10,000 cash per share) $ 9,382,742
Warrants issued and exercised with preferred stock 938,275 938 (3,479,043)
Shares issuance costs - preferred stock (866,612)
Preferred stock dividends 375,312 375
Net loss
Balance at December 31, 2002 (carried forward) 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) $52,838,276 $(43,269,277) $(177,645) $ 9,392,325
Stock options and warrants 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)
($10,000 cash per share) 9,382,742
Warrants issued and exercised with preferred stock 3,485,443 7,338
Shares 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 (carried forward) 61,195,715 (81,858,609) (177,645) (15,801,132)
F-9
Ortec International Inc.
(a development stage enterprise)
STATEMENT OF SHAREHOLDERS' EQUITY/(DEFICIT)
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)
Warrants issued for services
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 December 31, 2003 5,233,165 $5,233 $ 270,859 $ 3,667,041 $2,628,602
========= ====== =========== =========== ==========
Deficit
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
Warrants issued for services 87,000 87,000
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 336,550 (336,550)
Common Stock to be issued in connection with
promissory notes 287,000 287,000
Adjustment for one for ten reverse stock split
Net loss (15,920,504) (15,920,504)
Balance at December 31, 2003 $72,437,243 $(103,307,740) $(177,645) $(24,476,407)
=========== ============= ========= ============
Common stock shares and amounts have been adjusted to reflect one for ten
reverse stock split effective June 24, 2003.
The accompanying notes are an integral part of this statement.
F-10
Ortec International, Inc.
(a development stage enterprise)
STATEMENT OF CASH FLOWS
Cumulative
From
March 12,
1991
Year ended December 31, (inception) to
------------------------------------------ December 31,
2003 2002 2001 2003
------------ ------------ ------------ --------------
Cash flows from operating activities
Net loss $(15,920,504) $(21,578,021) $(15,885,377) $(96,653,179)
Adjustments to reconcile net loss to net cash
used in operating activities
Depreciation and amortization 629,712 714,692 725,567 4,462,732
Allowance for doubtful accounts 5,374 5,374
Amortization of deferred financing costs and
loan discount 21,949 323,225 345,174
Unrealized loss on marketable securities 11,404
Realized loss on marketable securities 5,250
(Gain)/Loss on sale of property and
equipment (40,204) 8,364 (31,840)
Cost to terminate lease on New Jersey facility 836,032 836,032
Non-cash stock compensation 87,000 113,060 188,080 3,241,231
Non-cash imputed interest 4,594,580 6,857,650 454,775 11,907,006
Loss on extinguishments of debt & Series A
preferred stock 1,004,027 1,004,027
Purchase of marketable securities (19,075,122)
Sales of marketable securities 19,130,920
Change in operating assets and liabilities
Accounts receivable 9,950 6,566 (21,890) (5,374)
Other current assets and other assets 44,854 188,645 (80,638) 63,985
Accounts payable and accrued liabilities 437,161 1,436,952 1,634,233 4,878,749
------------ ------------ ------------ ------------
Net cash used in operating activities (9,294,096) (10,924,840) (12,985,250) (69,873,631)
------------ ------------ ------------ ------------
Cash flow from investing activities
Purchases of property and equipment,
excluding capital leases (11,823) (63,460) (518,456) (4,465,720)
Proceeds from sale of property and equipment 75,000 56,901 131,901
Payments for patent applications (11,589) (129,140) (99,453) (971,731)
Organization costs (10,238)
Deposits (75,000) (702,924) (806,273)
Purchases of marketable securities (594,986)
Sale of marketable securities 522,532
------------ ------------ ------------ ------------
Net cash used in investing activities (23,412) (135,699) (1,320,833) (6,194,515)
------------ ------------ ------------ ------------
F-11
Ortec International, Inc.
(a development stage enterprise)
STATEMENT OF CASH FLOWS (continued)
Cumulative
From
March 12,
1991
Year ended December 31, (inception) to
December 31,
2003 2002 2001 2003
---------- ----------- ----------- --------------
Cash flows from financing activities
Proceeds from issuance of notes payable $3,140,000 $ 3,655,500
Proceeds from issuance of common stock 53,550,522
Proceeds from exercise of warrants 12,966 $ 7,694 20,660
Share issuance expenses and other financing costs (831,737) (906,571) (5,343,413)
Purchase of treasury stock (177,645)
Proceeds from issuance of loan payable 1,446,229
Proceeds from obligation under Revenue
Interest Assignment 4,000,000 $ 6,000,000 10,000,000
Proceeds from issuance of convertible debentures 5,908,000 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 1,070,000 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 (165,718) (91,728) (364,650)
Repayment of loan payable (155,578) (143,505) (132,370) (861,756)
Repayment of obligation under Revenue
Interest Assignment (265) (11,149) (11,414)
Repayment of notes payable (515,500)
---------- ----------- ----------- -----------
Net cash provided by financing activities 9,819,668 11,032,741 5,867,630 77,396,533
---------- ----------- ----------- -----------
NET INCREASE/(DECREASE) IN CASH AND
CASH EQUIVALENTS 502,160 (27,798) (8,438,453) 1,328,387
Cash and cash equivalents and beginning of period 826,227 854,025 9,292,478
---------- ----------- ----------- -----------
Cash and cash equivalents and end of period $1,328,387 $ 826,227 $ 854,025 $ 1,328,387
========== =========== =========== ===========
F-12
Ortec International, Inc.
(a development stage enterprise)
STATEMENT OF CASH FLOWS (continued)
Cumulative
From
March 12,
1991
Year ended December 31, (inception) to
December 31,
2003 2002 2001 2003
---------- ---------- ------- --------------
Supplemental disclosures of cash flow information:
Non-cash financing and investing activities
Capital lease obligations $ 449,441 $ 568,344
Deferred offering costs included in accrued
professional fees 314,697
Financings costs - other long-term obligations $59,500 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 1,125,934 2,049,011
Accretion of discount on preferred stock 4,269,000 4,269,000
Share issuance expenses for series B preferred
Stock incurred through issuance of warrants 86,692 304,615 391,307
Share issuance expenses for series C preferred
Stock incurred through issuance of warrants 272,386 272,386
Share issuance of Series D preferred stock in
exchange from Series B preferred stock 2,628,602 2,628,602
Equipment transferred to
Combrex in satisfaction of deposit 75,000 75,000
Discount on promissory notes 287,000 287,000
Cash paid for interest 104,023 57,317 80,205 648,881
Cash paid for income taxes 1,000 -- 44,528 200,576
The accompanying notes are an integral part of these statements
F-13
ORTEC INTERNATIONAL, INC.
(a development stage enterprise)
NOTES TO FINANCIAL STATEMENTS
December 31, 2003, 2002 and 2001,
and for the period from March 12, 1991 (Inception) through December 31, 2003
NOTE 1 - 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.
The Skin Group, Ltd. (the "Skin Group") also was formed as a Delaware
corporation in March 1991, to raise funds for the development of the Technology.
On July 27, 1992, the Skin Group was merged with and into Ortec. Owners of Skin
Group shares were given .83672 of an Ortec share for each Skin Group share. The
merger was accounted for as if it were a pooling of interests and, accordingly,
the accompanying financial statements include the accounts of the Skin Group for
all periods presented.
Basis of Presentation
Ortec is a development stage enterprise, which had no operating revenue prior to
December 2001. During 2001, the Company received Food and Drug Administration
("FDA") approval for the use of OrCel for treatment of patients with recessive
dystrophic epidermolysis bullosa and donor sites in burn patients. The Company
then began marketing and selling its product for use on patients with these
indications. Revenues to date have not been significant, as the Company has been
focusing its effort and resources towards its clinical trial for the 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
applicable to common shareholders of $21.4 million during the year ended
December 31, 2003, and, as of that date, the Company's current liabilities
exceeded its current assets by $ 25.4 million, its total liabilities exceeded
its total assets by $ 24.4 million and the Company has a deficit accumulated
in its development stage of $103.3 million. These factors, among others, raise
substantial doubt about the Company's ability to continue as a going concern.
F-14
On March 27, 2002, the Company engaged H.C. Wainwright & Co., Inc. an investment
banking firm, to act as its financial advisor in connection with raising capital
for the Company through debt and/or equity financing. During 2002, using the
services of the investment banking firm the Company raised approximately $8.2
million, and in 2003 has raised an additional $2.0 million and $5.7 million
through the issuances of Series B preferred stock and Series C preferred stock.
respectively. Additionally, in the fourth quarter of 2003 we received loans due
to mature on June 30, 2004 aggregating $3.14 million. All but a few of the
lenders were among purchasers of our Series C Convertible Preferred Stock.
During January 2004, the Company has raised an additional $650,000 in loans that
are due to mature on June 30, 2004. The Company also received an advance of
$250,000 in February 2004 for which repayment terms have not been determined.
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 marketing, distribution or other rights to our products. However, we can
give no assurances that discussions with other companies will result in any
additional investments, collaborative arrangements, agreements or other funding,
or that the necessary additional financing through debt or equity will be
available to us on acceptable terms, if at all.
We require substantial funding to continue our research and development
activities, clinical trials, manufacturing, sales, distribution and
administrative activities. We are currently in the process of completing a
registration statement to be filed with the Security and Exchange Commission to
register shares of our common stock and warrants. Once our registration
statement becomes effective, we hope to receive net proceeds, after payment of
placement fees and other expenses we incur in connection with the filing, of
approximately $11.0 million through the sale of 6,000,000 shares of our common
stock together with the issuance of warrants to purchase an additional 3,000,000
shares of our common stock. We estimate that this financing, will enable us to
execute our production plan with our third party manufacturer and prepare for
sales in 2004, pay a portion of our past due obligations, repay a portion of our
short-term promissory note borrowings, initiate the pivotal clinical trial for
the use of OrCel in its cryo-preserved form for the treatment of diabetic foot
ulcers, and provide for our general and corporate working capital requirements
for 2004. We believe that our cash and cash equivalents on hand at December 31,
2003, (approximately $1.3 million) and the financing of $650,000 and $250,000
received in January and February 2004, respectively, as well as the additional
$11.0 million we hope to raise in 2004 may enable us to continue our operations
for the next 12 months. Additionally, we are continuing our equity financing
efforts with an investment banking firm and we are currently exploring other
potential collaborative arrangements with companies for sales and marketing and
distribution of our product.
These financial statements have been prepared assuming that Ortec will continue
as a going concern. Successful future operations depend upon the successful
development and marketing of Ortec's OrCel product. Historically Ortec has
funded its operating losses by periodically raising additional
F-15
sources of capital. If additional funding is not available to Ortec when needed,
Ortec may not be able to continue operations. No adjustments have been made to
the accompanying financials as a result of this uncertainty.
Initial Public Offering
On January 19, 1996, the Company completed an initial public offering ("IPO") of
120,000 units. Each unit consisted of one share of the Company's common stock,
one class A warrant to purchase one share of common stock at $100.00, of which
108,378 were exercised and the balance, which was not exercised, expired on
December 31, 1998, and one class B warrant to purchase one share of common stock
at $150.00, of which 1,140 were exercised and the balance which was not
exercised, expired on December 31, 2000.
The IPO raised gross proceeds of approximately $6,000,000, of which $800,000,
$537,500 and approximately $315,000 were used to pay underwriting commissions,
notes payable and deferred offering costs, respectively, thereby providing the
Company with net proceeds of approximately $4,347,500.
Common Stock Reserve Split
On June 24, 2003, the Company affected 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 all warrants and options outstanding were adjusted as a result of this
reverse split. The number of common shares, warrants, and options outstanding as
of December 31, 2003 were reduced as a result of this one for ten reverse split
to common shares, warrants, and options outstanding of 5,231,165, 3,085,173, and
1,622,599 respectively. The conversion rates of the Preferred stock outstanding
was also adjusted accordingly, and as of December 31, 2003 would result in the
issuance of 4,976,539 shares of common stock, if converted.
As a result of this reverse split, 3,026,590 warrants are exercisable at prices
ranging from $.01 to $6.00 and 58,583 warrants are exercisable at prices ranging
from $6.01 to $120.00. Similarly, 1,490,594 options are exercisable at prices
ranging from $1.80 to $6.00 and 132,005 options are exercisable at prices
ranging from $10.00 to $127.50. See Note 12.
F-16
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Revenue Recognition
Product revenue is recognized upon shipment of OrCel when title and risk of loss
pass to the customer, which occurs when the product is received by the end user
customer. Royalties from licensees will be based on third-party sales of
licensed products and will be recorded in accordance with contract terms when
third-party results are reliably measurable and collectibility is reasonable
assured. Fees paid to Ortec upon entering a license agreement are recognized
when earned as defined by the terms of the agreement.
Research and Development Costs
The Company is in the business of research and development and therefore, all
research and development costs, including payments relating to products under
development, research, consulting agreements and personnel costs, are expensed
when incurred, and for 2001 and 2002, include the costs of production related to
sales, as such costs are not readily separable. Research and Development costs
aggregated $7,474,067, $10,134,740 and $12,409,954 for the years ending 2003,
2002 and 2001, respectively. Research and Development costs are comprised of
Product Production and laboratory costs, rent, consulting, personnel, and
depreciation and amortization expenses.
Depreciation and Amortization
Property and equipment are carried at cost, less any grants received for
construction. In 1996, the Company received a $400,000 grant toward the
construction of its new laboratory and office facilities and it received an
additional grant of $130,000 in 1998. (see Note 12).
Office furniture and equipment and laboratory equipment are depreciated on the
straight-line basis over the estimated lives of the assets (5 years). Leasehold
improvements are amortized over the shorter of the term of the related lease or
the life of the asset. Depreciation and amortization expense for the years ended
December 31, 2003, 2002 and 2001, was approximately $556,000, $649,000 and
$672,000, respectively.
Patent Application Costs
Patent application costs relate to the Company's U.S. patent application and
application fees in foreign jurisdictions and consist of legal and other direct
fees. The recoverability of the patent application costs is dependent upon,
among other matters, obtaining further FDA approvals for the use of the
underlying technology.
F-17
Effective January 1, 2002, the Company adopted Statement of Financial Accounting
Standards ("SFAS") No. 142 Goodwill and Other Intangible Assets. Under SFAS No.
142, goodwill and indefinite lived intangible assets are no longer amortized but
will be reviewed at least annually for impairment. Separable intangible assets
that are not deemed to have an indefinite life will continue to be amortized
over their useful lives.
The Company's intangible assets subject to amortization primarily consists of
patent application costs totaling $832,781 as of January 1, 2002. As of January
1, 2002, there were no intangible assets with indefinite useful lives. The
Company continues to amortize these costs over their estimated useful lives.
Adoption of this accounting standard did not have a material effect on financial
position or results of operation. The Company adopted the provisions of SFAS
No.144 effective January 1, 2002. Foreign Currency Translation
The Company conducted some of its research and development at its laboratory in
Sidney, Australia. However, because all Australian expenditures were funded from
the United States, the Company has determined that the functional currency of
its Australian office is the U.S. dollar. Accordingly, current assets and
current liabilities are remeasured into the functional currency using current
exchange rates and non-current assets and liabilities are remeasured using
historical exchange rates. Expense accounts are measured using the average rate
in effect for the year. Gains and losses arising from the remeasurement of
foreign currency are included in the results of operations for all periods
presented. As of December 31, 2002, the Company terminated all of its research
and development activities at its laboratory in Sidney.
Use of Estimates
In preparing financial statements in conformity with accounting principles
generally accepted in the United States of America, management is required to
make estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements, as well as the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.
Income Taxes
Deferred tax assets and liabilities are recognized for the estimated future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases. Deferred tax assets and liabilities are measured using enacted tax rates
in effect for the years in which those temporary differences are expected to be
recovered or settled. The effect on deferred tax assets and liabilities of a
change in tax rates is recognized in income in the period that includes the
enactment date. A valuation allowance is provided for as it is more likely
than not that deferred tax assets will not be realized.
F-18
Cash and Cash Equivalents
For purposes of the statement of cash flows, the Company considers all highly
liquid debt instruments purchased with original maturities of three months or
less to be cash equivalents. Cash equivalents consist principally of money
market funds. The fair value of cash and cash equivalents approximates the
recorded amount because of the short-term maturity of such instruments. Cash and
cash equivalents includes approximately $15,000 at December 31, 2002, of bank
balances denominated in Australian dollars.
Net Loss Per Share
Net loss per common share is based on the weighted-average number of common
shares outstanding during the periods.
Basic net loss per share is computed by dividing the net loss by the
weighted-average common shares outstanding for the period. Diluted net loss per
share reflects the weighted-average common shares outstanding plus the potential
dilutive effect of securities or contracts which are convertible to common
shares, such as options, warrants and convertible preferred stock.
Options and warrants to purchase shares of common stock were not included in the
computation of diluted net loss per share in each of the years presented because
to do so would have been antidilutive for the periods presented. (see Notes 10
and 12.)
The amount of options and warrants excluded are as follows:
Years ended December 31,
-------------------------------
2003 2002 2001
--------- --------- -------
Warrants 3,085,173 1,117,211 39,541
========= ========= =======
Stock Options - in plan 348,199 287,212 203,331
========= ========= =======
Stock Options - outside of plan 1,274,400 380,000
========= =========
All options and warrants activity and outstanding balances have been adjusted
for the one for ten reverse stock split effective June 24, 2003.
Additionally, the effects of conversion of the preferred stock were excluded
from the weighted average share calculation as the effect would be antidilutive.
An aggregate of 4,976,539 shares of common stock would be issuable upon
conversion of the preferred stock outstanding at December 31, 2003.
F-19
Employee Stock Option Plan
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 income, as all options granted under these plans 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 income and
earnings per share if the Company had applied the fair value recognition
provisions of FASB Statement No.123, "Accounting for Stock-Based Compensation".
Year ended December 31,
------------------------------------------
2003 2002 2001
Net loss, as reported $(21,383,131) $(22,703,955) $(15,885,377)
Deduct: Total stock-based employee
compensation expense determined under
fair value based method (1,723,343) (1,965,592) (2,893,720)
------------ ------------ ------------
Pro forma net loss $(23,106,474) $(24,669,547) $(18,779,097)
============ ============ ============
Loss per share:
Basic and Diluted - as reported $ (5.09) $ (2.01) $ (1.64)
Basic and Diluted - pro forma $ (5.50) $ (2.18) $ (1.94)
Impairment of Long - Lived Assets
The Company reviews long-lived assets, which consist of fixed assets and patent
application costs, for possible impairment whenever events or changes in
circumstances indicate that the carrying amount of an asset may not be
recoverable. The Company has determined, based on estimated future cash flows,
that no provision is necessary for the impairment of long-lived assets at
December 31, 2003.
NOTE 3 - CONCENTRATION OF CREDIT RISK
The Company maintains cash and money market accounts at four financial
institutions located in New York City. Cash accounts are insured by the FDIC for
amounts up to $100,000. Uninsured balances aggregate to approximately $1,228,000
and $628,000 at December 31, 2003 and 2002, respectively.
The Company has not experienced any losses in such accounts and believes it is
not exposed to any significant credit risk.
F-20
NOTE 4 - PATENTS
Patent application costs are stated at cost less amortization computed by the
straight-line method over the useful life of the patent. As of December 31,
2003, patents, net of accumulated amortization were as follows:
Expiration Historical Accumulated
Patents subject to Amortization Date Cost Amortization Net
---------- ---------- ------------ --------
Composite Culture Skin (CCS) 2/1/2011 $873,856 $350,543 $523,313
Manufacturing of Bi-layered
Collagen Sponge 12/28/2020 33,037 1,838 31,199
Cryopreservation Process 12/26/2021 66,618 617 66,001
-------- -------- --------
$973,511 $352,998 $620,513
======== ======== ========
The Company' U.S. patent for CCS was issued in 1994. During 2002 and 2003 the
Company was issued two patents by the United States Patent Office. The first
patent covers unique manufacturing processes for our tissue-engineered product,
OrCel. These processes specifically relate to the manufacturing of Ortec's
bi-layered collagen sponge structure and when implemented, can reduce the
current manufacturing costs of OrCel. This patent was issued on December 31,
2002. The second patent covers the freezing process for OrCel. This process,
referred to as Cryopreservation, gives our product a minimum shelf life of six
months, as opposed to only a few days when our product is not cryopreserved.
This second patent was issued on October 28, 2003.
There can be no assurance that any patent will provide commercial benefits to
the Company. The Company has determined that no provision for impairment is
necessary at December 31, 2003.
The Company has granted a security interest in its United States and Canadian
patents and trademarks relating to OrCel to collateralize payments it will be
required to make to satisfy its obligation under a Revenue Interest Assignment
Agreement. (see Note 9).
NOTE 5 - CAPITAL LEASE OBLIGATION
In January 2002, the Company secured a $1,300,000 lease line of credit to be
used for the acquisition of additional manufacturing, laboratory and other
equipment required to expand its manufacturing capacity. During 2002, the
Company has drawn $449,000 against this line of credit for the acquisition of
eligible fixed assets. This line of credit expired during 2002.
F-21
As of December 31, 2003, 2002 and 2001, the Company has recorded $ 503,000,
$541,000 and $119,000 in equipment purchased under capital leases and $335,000,
$209,000 and $119,000 in accumulated amortization, respectively. (see note 13).
NOTE 6 - LOAN PAYABLE
During 1996, the Company obtained a loan from the landlord of its laboratory for
the construction of, and equipment for, the leased facility. During 1997, the
Company modified the terms of the loan as a result of increased build-out costs
incurred in the construction of the facility. An adjustment was made in 1997 to
record additional interest and principal. The adjusted loan payments are due in
monthly installments of $10,103, including interest at an effective rate of
7.98%, through July 2006. During 1998, the Company obtained an additional loan
from the landlord for improvements to the leased facility. During 1999, the
Company modified the terms of the additional loan as a result of increased
build-out costs incurred. The adjusted loan payments are due in monthly
installments of $7,605, including interest at an effective rate of 8.6%, through
March 2008.
Minimum payments to be made under the terms of these loans are as follows:
Year ending December 31,
2004 $212,503
2005 212,503
2006 161,990
2007 91,266
2008 30,422
--------
708,684
Less amount representing interest 95,279
--------
Net present value of future loan payments $613,405
========
Current portion $168,668
Non-current portion 444,737
--------
$613,405
========
F-22
NOTE 7 - ADVANCES FROM THIRD PARTIES
During the quarter ended March 31st, 2003, the Company received non-interest
bearing advances of $130,000 from certain investors. This amount remains
outstanding and, to date, its repayment terms have not been determined.
NOTE 8 - PROMISSORY NOTES PAYABLE - CURRENT
The Company received loans in October, November and December 2003 that are
payable June 30, 2004, aggregating $3,140,000. These notes accrue interest at a
rate of 8% per annum. If the Company receives $5 million of gross proceeds from
a qualified financing, as defined in the notes, the Company may elect to,
without penalty, prepay the notes and any accrued interest in cash or in the
Company's stock. All but a few of the lenders were among purchasers of our
Series C Convertible Preferred Stock. The Company incurred $14,400 of financing
fees relating to the promissory notes issued in the fourth quarter, which was
paid in cash.
In addition, the Company agreed to issue 157,000 shares of its common stock to
its placement agent in connection with the above promissory notes.
NOTE 9 - OBLIGATION UNDER REVENUE INTEREST ASSIGNMENTS
On August 29, 2001, the Company entered into a Revenue Interests 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.
In consideration for the $10,000,000, 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 on January 1, 2003, Paul Capital will be entitled to
receive each year the first proceeds to the Company from end user sales of its
products 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 will be able to draw in advance will range
from $600,000 in 2003 to $7,500,000 in 2005 and thereafter. The Company did not
pay Paul Capital any advances in 2003 as there were no sales during the year as
we discontinued the commercial sale of OrCel in the second half of 2002 due to
budgetary constraints resulting from a difficult investment climate. The amounts
received from Paul Capital have been classified as debt. Pursuant to the default
provisions under the agreement which entitles Paul Capital to compel us to
repurchase its interest in our revenues at a price equal to an amount which
would yield a 30% internal rate of return to Paul Capital. At such time when the
default provisions are no longer applicable, the effective
F-23
interest rate imputed on the obligation will be determined using the interest
method and payments to Paul Capital will be recorded as a reduction of the
Company's obligation under the revenue interest assignment. This may result in
an imputed interest rate, which is significantly below 30% and could have a
potential material financial impact. However, no assurances can be given that
such lower rate could be achieved.
In the event of a change in control of the Company or upon the occurrence of
certain other events, including insolvency, as defined in the agreement, 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 interests in its products, for an amount of
cash flows that will generate a 35% internal rate of return to Paul Capital.
At December 31, 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. Although Paul Capital has had the right for
well over a year to compel us to repurchase its interest in our revenues at the
price provided in our agreement, Paul Capital has so far not exercised that
right. At December 31, 2003, since the Company was technically in default of the
solvency requirement under the Revenue Interest Assignment agreement, we
provided for an amount that approximated what we would have owed Paul Capital
had they exercised their repurchase option. To date, Paul Capital has not
exercised this option and has not indicated to us that they intend to compel us
to repurchase its revenue interest. Once the Company is no longer insolvent and
therefore no longer in technical breach of the agreement, Paul Capital bears the
risk of revenue interest paid to it being significantly less than the revenue
interest liability, as well as the reward of revenue interest paid to it being
significantly greater than the interest liability.
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.
NOTE 10 - EQUITY TRANSACTIONS
Each share of the Company's common stock is entitled to one vote.
On June 24, 2003, Ortec affected a one for ten reverse stock split for each
outstanding share of common stock. This reverse stock split is retroactively
reflected in the accompanying financial statements and all references to shares
are to the new shares with per share amounts appropriately adjusted.
F-24
Pursuant to an agreement between Dr. Eisenberg and the other founders (the
"Other Founders"), a business relationship was formed by the founders for the
manufacture and sale of products derived from the Technology (the "Business
Agreement"). Under the terms of the Business Agreement, Dr. Eisenberg, who was
the owner of all the capital stock of Ortec (60,000 shares) agreed to license
the Technology to Ortec and sell 70% of Ortec's shares for a purchase price of
$1,000,000 to the Skin Group. Dr. Eisenberg was paid $85,000 in connection with
this agreement as reimbursement for his expenses ($35,000 during the period from
inception (March 12, 1991) to December 31, 1991 and $50,000 during the year
ended December 31, 1992).
The "Other Founders" initially owned all of the stock of the Skin Group (95,382
shares). In March 1991, the Skin Group issued, in a private placement, 21,744
shares for $65,000. In June and October 1991, the Skin Group issued 13,016 and
1,886 shares, to a then director of the Company (the "Director") for $150,000
and $100,000, respectively. Commencing in November 1991, the Skin Group issued
7,948 shares under a second private placement for $750,006 (including 2,646
shares during the year ended December 31, 1992). On July 27, 1992, the Skin
Group was merged with and into Ortec.
Also under the second private placement 2,286 shares of Ortec were issued for
$215,467. In addition, the Director was granted warrants to purchase 736 shares
of Ortec at $94.25 per share.
Pursuant to a stock purchase agreement entered into with the Director in June
1992, 5,304 shares of Ortec were sold to the Director for a total purchase price
of $499,998. In addition, the Director was granted warrants to purchase 7,957
shares at an exercise price of $94.25 per share; such warrants were exercised on
December 29, 1998. The purchase price was payable in installments and shares and
warrants were issued in installments pro rata with the payment of the purchase
price. During the years ended December 31, 1993 and 1992, the Director paid
$200,000 and $299,998, respectively, and was issued 2,122 and 3,182 shares,
respectively.
Further, in connection with the Director's purchase of the 5,304 shares, in
1993, the Other Founders granted to the Director options to purchase from them
an aggregate of 7,400 Ortec shares, at a price of $50.00 per share. In 1993, the
Director exercised such option in part, and purchased 4,900 shares from the
Other Founders at the option price of $50.00 per share. The remaining balance of
such options expired April 15, 1994.
Pursuant to a third private placement that commenced in January 13, 1993, and
concluded on March 31, 1993, Ortec sold an aggregate of 10,965 shares at $100.00
per share ($1,096,500). Subsequent to such offering, in 1993, the Company sold
an additional 2,250 shares at $100.00 per share ($225,000). In connection with
such purchases, all purchasers received certain registration rights.
Pursuant to a Stock Purchase Agreement dated July 19, 1993, by and between Ortec
and the Home Insurance Company ("Home Insurance"), the Company sold to Home
Insurance 11,112 shares of
F-25
common stock for an aggregate purchase price of $999,999, or $90.00 per share.
In connection with such purchase, Home Insurance received certain registration
rights.
In addition, in 1993, the Company issued 60 shares to an individual as
compensation for commissions in connection with the sale of the Company's
shares. Such commissions are included in share issuance expenses. The stock
issued was valued at $100.00 per share.
In August 1993, the Director entered into a stock option agreement with Dr.
Eisenberg and the Other Founders, pursuant to which he received the right to
purchase an aggregate of 10,000 shares owned by such persons in various amounts
and at various times, at a purchase price of $100.00 per share. As of December
31, 1993, the Director had exercised options and purchased 500 shares under such
agreement at $100.00 per share. The remaining balance of such options has
expired.
Pursuant to a fourth private placement consummated in July 1994, Ortec sold an
aggregate of 3,946 shares at between $100.00 and $125.00 per share for aggregate
proceeds of $397,712.
Pursuant to a Stock Purchase Agreement dated July 22, 1994, between Ortec and
Home Insurance, the Company sold to Home Insurance 5,000 shares of common stock
for an aggregate purchase price of $500,000, or $100.00 per share. In connection
with such purchase, Home Insurance received certain registration rights and
warrants to purchase 1,000 shares of common stock at $120.00 per share, which
expired on July 21, 1997.
On January 19, 1996, the Company completed an initial public offering ("IPO") of
120,000 units for aggregate proceeds of $6,000,000. Each unit consisted of one
share of the Company's common stock, one Class A warrant to purchase one share
of common stock at $100.00 and one Class B warrant to purchase one share of
common stock at $150.00. As of December 31, 1998, 108,378 Class A warrants were
exercised and the balance expired unexercised. The Class B warrants were
originally set to expire in January 1999. The Company extended the expiration
date to March 31, 2000. The Class B warrants are subject to redemption by the
Company at $.10 per warrant. The Company received gross proceeds of
approximately $1,282,000 and $10,823,000 and net proceeds of approximately
$1,262,000 and $10,165,000 as a result of the exercise of warrants in 1998 and
1997, respectively.
In November 1996, the Company completed a private placement of its securities
from which it received gross proceeds of $6,220,797 and net proceeds of
approximately $5,733,000 (after deducting approximately $487,000 in placement
fees and other expenses of such private placement). The Company sold 95,911
shares of common stock in such private placement at average prices of $64.90 per
share. In addition, the Company granted five-year warrants to placement agents
to purchase such number of shares equal to 10% of the number of shares of common
stock sold by such placement agents, exercisable at prices equal to 120% of the
prices paid for such shares. Pursuant to the purchasers' request, the Company
registered all 95,911 shares.
F-26
During 1992 and 1993, the Company issued warrants to purchase 666 shares at
$94.25 per share, and during 1995 the Company issued warrants to purchase 2,000
shares at $100 per share to members of the Scientific Advisory Board of the
Company. During 1996 and 1997, the Company issued warrants to purchase 24,210
shares at $60.00 to $120.00 per share to the Director and certain others. These
warrants expired at various dates through November 2001.
On January 20, 1996, the Company granted "lock-up warrants" entitling
shareholders to purchase an aggregate of 38,905 shares of the Company's common
stock at a price of $10.00 per share. All unexercised warrants expired on
January 18, 2000. At different times during 1996, seven persons exercised such
warrants and purchased 3,389 shares of common stock at the $10.00 per share
exercise price. The issuance of such lock-up warrants was in consideration for
such shareholders signing lock-up agreements agreeing not to sell or transfer
shares of the Company's common stock purchased at prices of $90.00 or more per
share until January 20, 1997. At different times during the third quarter of
1997, eight persons exercised such warrants and purchased an aggregate of 2,121
shares of common stock at the $10.00 per share exercise price. During 1998, nine
persons exercised such warrants and purchased an aggregate of 9,608 shares of
common stock at the $10.00 per share exercise price. During 1999, five persons
exercised such warrants and purchased an aggregate of 1,410 shares of common
stock at the $10.00 per share exercise price. There were no underwriting
discounts or commissions given or paid in connection with any of the foregoing
warrant exercises.
During the third quarter of 1997, the Company granted to one person and its
seven designees four-year warrants to purchase an aggregate of 3,750 shares of
common stock, at an exercise price of $120.00 per share. Such warrants are not
exercisable until July 18, 1998 and were granted in consideration for consulting
services rendered to the Company.
During the fourth quarter of 1997, the Company granted to one person and its six
designees four-year warrants to purchase an aggregate of 3,750 shares of common
stock, at an exercise price of $120.00 per share. Such warrants are not
exercisable until July 18, 1998 and were granted in consideration for consulting
services rendered to the Company.
During 1998, warrants for 1,870 shares, mentioned in the two previous
paragraphs, were exercised utilizing the cashless exercise option of the warrant
agreement. The Company issued 620 shares under this exercise.
During the third quarter of 1997, the Company granted to one person a one-year
warrant to purchase an aggregate of 63 shares of common stock, at an exercise
price of $120.00 per share. Such warrants were granted in consideration for
consulting services rendered to the Company. The warrant was exercised during
1998.
The Company recorded consulting expense of approximately $64,000 as a result of
these grants during the year ended December 31, 1998.
F-27
During the fourth quarter of 1997, the Company granted five-year warrants to its
three executive officers to purchase an aggregate of 24,000 shares of common
stock, at an exercise price of $120.00 per share. Such warrants were granted in
consideration for services rendered to the Company. The exercise of such
warrants is contingent upon the occurrence of certain events, which were
considered probable at December 31, 1997. As of December 31, 1998, five of the
six events have occurred so that 18,500 of those warrants are now vested. As a
result, the Company recorded compensation expense of approximately $80,000 in
December 1997 and $1,185,000 for the year ended December 31, 1998. The balance
of the warrants became vested upon the exercise of warrants owned by a director
in December 1998 in accordance with the terms of certain compensation provisions
as approved by the Company's Board of Directors.
In consideration for services rendered by him as a director of the Company in
the five-year period from 1992 to 1996 for which he never received compensation,
the Company extended by one year to December 31, 1998 the expiration date of
warrants owned by a director to purchase an aggregate of 8,693 shares,
exercisable at $94.25 per share. As a result, the Company recorded compensation
expense of approximately $420,000, during the fourth quarter of 1997. All of
these warrants were exercised on December 29, 1998.
During the fourth quarter of 1998, the Company granted five-year options to its
three executive officers to purchase an aggregate of 52,075 shares of common
stock, at exercise prices ranging from $121.30 to $124.40 per share. The
exercise of such options was contingent upon the occurrence of certain events.
All of these options became vested upon the exercise of warrants owned by a
director in December 1998 in accordance with the terms of certain compensation
provisions as approved by the Company's Board of Directors. As a result, the
Company recorded compensation expense of approximately $495,000 in December
1998.
In December 1998, the Company completed a private placement of its securities
from which it received proceeds of $2,000,000. In addition, the Company granted
three-year warrants to the Purchaser to purchase 5,000 shares at $120.00 per
share. The Company sold 20,000 shares of common stock in such private placement.
The Company assigned value to the common stock and warrants issued of $1,788,698
and $211,302 based upon the relative fair market value of the stock at the date
of issuance and the estimated fair value of the warrants using the Black-Scholes
option pricing model.
In March 1999, the Company completed a private placement of 38,916 shares of its
common stock to twenty investors from which it received proceeds of
approximately $3,405,000. In addition, each investor also received a three-year
warrant to purchase 20% of the number of shares of the Company's common stock
such investor purchased in such private placement. The prices at which such
warrants are exercisable are $125.00 per share for one half, and $145.00 per
share for the other half, of the number of shares issuable upon exercise of such
warrants. The Company assigned value to the common stock and warrants issued to
the investors of $3,168,785 and $236,291 based upon the relative fair market
value of the stock at the date of issuance and the estimated fair market value
of the warrants using the Black-Scholes option pricing model. Oscar Gruss & Son,
Incorporated ("Gruss") acted as placement agent in such private placement. For
its services as placement agent,
F-28
the Company paid Gruss $272,406 and granted Gruss a five-year warrant to
purchase an aggregate of 3,892 shares of the Company's common stock at an
exercise price of $105.00 per share. The value assigned to the Gruss warrants
was $232,000. Other share issuance costs amounted to $106,002.
In December 1999, the Company completed a private placement of 163,637 shares of
its common stock to two institutional funds from which it received proceeds of
approximately $9,000,000. Share issuance costs amounted to approximately $9,500.
In March 2000, the Company completed a private placement of 6,667 shares of its
common stock to one fund from which it received proceeds of approximately
$1,000,000. In addition, the Company paid a placement agent who introduced the
Company to the fund a fee of approximately $43,400 and granted such placement
agent a five year warrant to purchase 267 shares of the Company's common stock
at an exercise price of $150.00 per share. The value assigned to the warrant was
$23,000, which was reflected as share issuance costs. Other share issuance costs
amounted to $3,200.
In September 2000, the Company completed a private placement of 124,757 shares
of its common stock to ten investors from which it received approximately
$8,421,000. In addition, the Company paid the placement agent who introduced the
Company to the investors a fee of approximately $525,400. Other share issuance
costs amounted to approximately $46,500.
In April 2001, the Company issued options to purchase 6,000 shares of the
Company's common stock, at $69.50 per share, to certain professionals. The
estimated fair value of $188,080 of such options has been recorded as an expense
in the accompanying financial statements.
In September 2001, the Company, with shareholder approval, increased the
authorized amount of its common stock to 35,000,000 shares and authorized the
issuance of up to 1,000,000 shares of preferred stock.
During 2002, the Company completed a private placement with several investors,
in which the Company raised cash proceeds of $8.2 million, issued convertible
preferred shares, issued warrants to purchase common shares and granted common
stock as dividends. (See Note No.11)
In February 2003, the Company, with shareholder approval, increased the
authorized amount of its common stock to 200,000,000 shares.
F-29
In February 2003, the Company 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, 292,308
shares of common stock (including 92,308 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 200,000 shares of common stock,
which were issued upon exercise of Series A warrants, exercised at $.10 per
share) and warrants to purchase an additional 200,000 shares of common stock, of
which warrants to purchase 100,000 (the B-1 warrants) shares were exercisable at
$15.00 per share and warrants to purchase the other 100,000 (the B-2 warrants)
shares were exercisable at $20.00 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 exercisable 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 its 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 37,692 shares of common stock, exercisable at $0.01 per share 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. This Series C preferred stock has
a stated value of $6,000 per share and is convertible into 2,844,999 shares of
common stock at $2.00 per share. 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 $336,550 at December 31, 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 2,421,556 shares of common stock and 482.885 shares of Series B
preferred stock were converted into an equal number of shares of Series D
preferred stock (with a common stock equivalent of 1,931,540 shares). 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.
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 $15.00
and $20.00, 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.
F-30
As part of the May 2003 Series C financing, employees of the investment-banking
firm were granted warrants to purchase 149,520 shares at an exercise price of
$.01 as part of their compensation. Accordingly, the Company recorded $269,000
in Series C preferred share issuance costs related to the warrants issued.
Based on the relative fair market value of the preferred stock at the dates of
issuance and the estimated fair market value of the warrants, using the
Black-Scholes option pricing model, at December 31, 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.
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.
During the year, the Company granted 75,000 warrants at an exercise price of
$2.00 to a vendor in consideration for consulting services. As a result, the
Company recorded expense of $87,000.
During 2003 an allocation of 1,800,000 restricted shares of common stock were
granted to officers and certain employees. The issuance of these shares is
contingent on the Company achieving certain milestones and if issued will
contain certain vesting and payout provisions.
F-31
The following table summarizes warrant activity during the period from March 12,
1991 (inception) through December 31, 2003 (excluding the Class A and B warrants
which were issued during the IPO):
Price range Shares
--------------- ---------
March 12, 1991 (inception) to December 31, 1991
Granted $94.25 736
---------
Balance, December 31, 1991 94.25 736
Granted 94.25 5,508
---------
Balance, December 31, 1992 94.25 6,244
Granted 94.25-120.00 4,823
---------
Balance, December 31, 1993 94.25-120.00 11,067
Granted 120.00 1,000
---------
Balance, December 31, 1994 94.25-120.00 12,067
Granted 100.00 400
Expired 94.25 (268)
---------
Balance, December 31, 1995 94.25-120.00 12,199
Granted 10.00-100.00 51,161
Exercised 100.00 (3,389)
Expired 120.00 (245)
---------
Balance, December 31, 1996 10.00-120.00 59,726
Granted 120.00-142.50 33,063
Expired 120.00 (1,000)
---------
Balance, December 31, 1997 10.00-142.50 91,789
Granted 120.00-140.00 7,500
Exercised 10.00-120.00 (20,585)
Expired 120.00 (10,843)
---------
Balance, December 31, 1998 10.00-142.50 67,861
Granted 125.00-145.00 11,674
Exercised 10.00 (1,410)
Expired 60.00-94.25 (1,716)
---------
Balance, December 31, 1999 10.00-142.50 76,409
Granted 150.00 267
Exercised 120.00 (200)
Expired 10.00-100.00 (15,499)
---------
Balance, December 31, 2000 77.00-150.00 60,977
Expired 77.00-120.00 (21,436)
---------
F-32
Balance, December 31, 2001 77.00-150.00 39,541
Granted .01- 62.48 2,221,015
Exercised .01 (973,997)
Expired .01-145.00 (169,348)
---------
Balance, December 31, 2002 $.01-$150.00 1,117,211
Granted $.01-$15.00 2,369,212
Exercised $.01- $4.00 (398,750)
Expired $140.00 (2,500)
Balance, December 31, 2003 3,085,173
=========
The following table summarizes warrant data as of December 31, 2003:
Weighted
Average Weighted
Remaining Average
Range of Number contractual Exercise Number
exercise prices outstanding life Price exercisable
- ------------------ ----------- ----------- -------- -----------
$.01 32,462 9.3 years $ .01 32,462
$2.00 to $5.00 2,994,128 5.0 years $ 4 .00 2,994,128
$15.00 to $20.00 50,000 9.2 years $ 17.86 50,000
$45.00 to $100.00 4,425 1.2 years $ 49.75 4,425
$105.00 to $120.00 4,158 0.3 years $106.09 4,158
NOTE 11 - AMENDMENT OF THE COMPANY'S CERTIFICATE OF INCORPORATION AND ISSUANCES
OF 12% CONVERTIBLE DEBENTURES, SERIES A PREFERRED STOCK, SERIES B PREFERRED
STOCK, SERIES C PREFERRED STOCK AND SERIES D PREFERRED STOCK
Amendment of Certificate of Incorporation:
On June 25, 2002, the Company's board of directors unanimously adopted an
amendment to the Company's certificate of incorporation designating 2,000 shares
out of the 1,000,000 shares of preferred stock that the Company is authorized to
issue, as Series A Convertible Preferred Stock, and designating the relative
rights and preferences of the Series A Convertible Preferred Stock. The stated
value, which is also the Liquidation Preference of the Series A Convertible
Preferred Stock, is $10,000 per share. The Company is required to pay dividends
on the Series A Preferred shares, at the rate of 6% per annum of the $10,000
Liquidation Preference per share, through June 30, 2003; at the rate of 9% per
annum thereafter until June 30, 2004; and thereafter at the rate of 12% per
annum. At the Company's option such
F-33
dividends may be paid in the Company's common stock at the "conversion price"
for the conversion of such dividends if such shares of common stock have been
registered under the Securities Act of 1933 for sale in the public securities
markets. The conversion price is fixed initially at $15.00 per share of the
Company's common stock. There are no shares of Series A convertible preferred
stock outstanding.
On November 7, 2002, the Company's board of directors adopted an amendment to
the Company's certificate of incorporation designating 2,000 shares out of the
1,000,000 shares of preferred stock, as Series B Convertible Preferred Stock at
a stated value of $10,000 per share. Dividends on the Series B Preferred shares
is payable at the rate of 12% per annum, in cash or shares of common stock, at
the option of the Company, except that in the first year, dividends are payable,
in advance, in shares of common stock.
The Series B preferred stock is convertible into common shares at any time at
the option of the investor, based on a fixed conversion rate of not less than
$3.00, or commencing after February 1, 2003, based on an alternative conversion
rate equal to 90% of the average of the five lowest volume weighted average
prices for the common stock for the twenty trading days immediately prior to
conversion, subject to a floor price of $2.50.
The preferred stock has redemption provisions, where upon occurrences of certain
events, the holders can require the Company to redeem the shares. Such
provisions include:
o the consolidation, merger or other business combination of the Company
with or into another Person, except for a migratory merger effected
solely for the purpose of changing jurisdiction of incorporation, or
if the holders of the Company's voting power have the ability after
the transaction is completed to elect a majority of members of the
board of directors of the surviving entity or entities;
o the sale or transfer of more than 20% of the Company's assets other
than inventory in the ordinary course of business; or
o consummation of a purchase, tender or exchange offer made to the
holders of more than 30% of the outstanding shares of Common Stock.
The redemption price is payable, at the option of the Company, in cash or in
common stock. If the Company does not have sufficient authorized shares to
effect the redemption payment in common stock, the Company may pay the remainder
of the redemption in non-redeemable preferred stock with a dividend rate of 18%.
On May 23, 2003, the Company's board of directors adopted an amendment to the
Company's certificate of incorporation designating 2,000 shares out of the
1,000,000 shares of preferred stock, as Series C Convertible Preferred Stock at
a stated value of $6,000 per share. Dividends on the Series C Preferred shares
is payable at the rate of 10% per annum, in cash or shares of common stock, at
the option of the Company.
The Series C preferred stock is convertible into common shares at any time at
the option of the investor, based on a maximum fixed conversion rate of $2.00
per share. The conversion rate may be reduced (using a formula provided in the
Certificate of Designation for the Series C
F-34
Preferred Stock) if the Company sells shares of its common stock for less than
$2.00 per share.
On August 19, 2003, the Company's board of directors adopted an amendment to the
Company's certificate of incorporation designating 2,000 shares out of the
1,000,000 shares of preferred stock, as Series D Convertible Preferred Stock at
a stated value of $10,000 per shares. 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.
Each holder of Series D Preferred Stock may, at such holder's option, subject to
certain limitations, 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 of
$2.50 per share. The conversion price is subject to customary adjustments to the
Series D Conversion Price in the event of stock splits, combinations, dividends,
distributions, reclassifications and other corporate events.
Issuance of 12% Convertible Debentures, Series A Preferred Stock, Series B
Preferred Stock, Series C Preferred Stock and Series D Preferred Stock:
In March 2002, the Company engaged an investment-banking firm to act as its
advisor and to assist with raising capital for the Company in the form of either
debt or equity financing.
On May 13, 2002, the Company issued $2,333,000 of 12% convertible debentures,
which were convertible into common shares at the lesser of $3.36 or the price
per share of the equity securities to be issued in a subsequent financing. These
debentures, payable April 10, 2003, bear interest at the rate of 12% per annum,
up to October 10, 2002 and 18% thereafter. The Company also issued 291,000 stock
purchase warrants as part of this May 13, 2002 financing, exercisable at $4.50
per share for up to 5 years from the date of grant. The warrants had price
protection features whereby the price of the warrants can be reduced to the
prices at which common stock or common stock equivalents are thereafter sold by
Ortec.
On June 28, 2002, $600,000 of these debentures sold on May 13, 2002 were
converted into Series A Preferred Stock at 110% of face value. Additionally, on
June 28, 2002, the Company issued an additional $250,000 of 12% convertible
debentures and $1,200,000 in Series A convertible preferred stock. The total
face value of the preferred stock issued was $1,870,000 which consisted of the
$1,200,000 of cash proceeds received, the $600,000 face value of converted
debentures and the $70,000 of additional conversion face value. Additionally,
the Series A preferred stock was convertible into common shares at a rate of
$1.50 per share. The Series A preferred stock had provisions whereby redemption
was out of the control of the Company; therefore, the preferred stock was
classified as temporary equity.
F-35
On June 28, 2002, the Company also issued 654,624 stock purchase warrants, at an
exercise price of $1.875 per common share for a five-year period. Of the
654,624, an aggregate of 31,250 warrants were issued with the debentures, with
the remainder issued with the preferred stock. The warrants also had similar
price protection features, whereby the price of the warrants can be reduced to
the prices at which common stock or common stock equivalents are thereafter sold
by the Company.
During the 3rd quarter 2002, the Company issued $1,425,000 in convertible
debentures, with terms comparable to those issued in the 2nd quarter.
Additionally, 178,127 warrants were issued with similar terms to warrants issued
on May 13, 2002.
In October and November 2002, prior to the preferred stock financing, the
Company issued an additional $1,900,000 in convertible debentures and 237,503
warrants, with terms comparable to those issued earlier in 2002.
The Company deferred the payment of interest due on June 30 and September 30,
2002, pending the completion of the Series B Preferred Stock financing. These
debentures along with the accrued interest were convertible into equity
securities if the Company completed the sale of at least $5,000,000 in equity
securities by July 12, 2002, which date was extended through November 13, 2002.
On November 13, 2002, these debentures and accrued interest were converted into
preferred stock with the closing of the Series B Preferred Stock financing.
These were converted at the rate of 110% of the debentures plus accrued interest
into $10,000 par value Series B Convertible preferred shares.
The relative estimated fair value of the warrants issued in connection with the
debentures of $440,523 was recorded as debt discount, as well as the estimated
fair value of the beneficial conversion features of $1,042,663. Both of these
values were being amortized over the remaining life of the convertible
debentures, or through April 10, 2003. Upon conversion, the remaining
unamortized beneficial conversion features were charged to interest expense.
The relative estimated fair value of the warrants issued in connection with the
Series A Preferred stock of $797,919 was recorded as a discount to the preferred
stock and was reflected as interest expense, on the date of issuance.
Additionally, the estimated fair value of the beneficial conversion feature of
$859,256 has been recorded as an additional discount and reflected as interest
expense. The Series A preferred stock has no redemption date, and therefore the
charge to interest expense was reflected immediately as the conversion privilege
was excercisable immediately.
In November and December 2002, the Company issued 938.2742 shares of Series B
convertible preferred stock to several investors in a private placement, which
was funded by an aggregate of $8,178,000 of financing received, which included
$1,070,000 of new Series B preferred stock and the conversion of the
aforementioned convertible debentures and convertible Series A preferred stock.
The Company recorded a loss on extinguishment of debentures and preferred shares
of $1,004,027, principally due to the additional buying power
F-36
granted to the investors resulting from the difference between the present value
of the original debt and the revised present value. The convertible debentures
and convertible Series A preferred were converted at 110% of face value, plus
accrued interest. In addition, these investors were granted Series A warrants,
to purchase 938,275 shares of the Company's common stock at an exercise price of
$.01. These Series A warrants vested immediately and were exercised immediately,
upon grant. The investors were also granted Series B-1 and Series B-2 warrants,
which can be used to purchase 5,429,891 and 4,691,386 shares of common stock at
an exercise price of $15.00 and $20.00 per share, respectively. These B-1
warrants are exercisable beginning August 13, 2003 and expire seven years from
the date of grant and the B-2 warrants are exercisable beginning November 13,
2003 and expire 7 years from date of grant. The Company assigned values to the
preferred stock and the Series A, Series B-1 and Series B-2 warrants issued to
the investors of $5,903,699, $2,245,206, $694,447 and $539,390, based upon the
relative fair market value of the stock at the date of issuance and the
estimated fair market value of the warrants, using the Black-Scholes option
pricing model.
The warrants issued with the second quarter and third quarter financings in 2002
were exchanged for B-1 warrants, issued in the fourth quarter of 2002.
Dividends on the Series B preferred stock were paid in advance in common shares
at the rate of 12% upon issue of the preferred shares and will be paid
semiannually in subsequent years, in either cash or common shares, at the
election of the Company, until at such time as the preferred stock is converted
to common shares. In conjunction with this preferred stock financing the
investors were paid a common stock dividend, whereby the investors were granted
375,312 shares of common stock, of which 293,489 shares were issued in November
2002 and 81,823 shares in January 2003.
In addition, certain of the investors were given options to purchase, for one
year and for amounts ranging from 100% to 200% of their investments, shares of
the Series B Convertible Preferred stock at the price paid for such stock by
investors on November 13, 2002.
H.C. Wainwright & Company, Inc. ("Wainwright") acted as placement agent in this
private placement. For its services as placement agent, the Company paid
Wainwright $601,490 and granted Wainwright and its agents warrants to purchase
800,000 and 500,000 shares of common stock, at an exercise price of $.01 and
$15.00, vesting immediately upon issue and August 13, 2003, respectively. These
warrants expired on January 31, 2003 and will expire seven years from issue,
respectively. In December 2002, the Company issued 35,273 shares of common stock
relative to the $.01 warrants granted to Wainwright. The fair market value
assigned to the Wainwright warrants was $280,000 and $24,615 for the $.01
warrants and the $15.00 warrants, respectively. Other share issuance costs
amounted to $155,997. Issuance costs for the Series B Preferred Stock are
reflected as a reduction of the proceeds of the preferred stock.
In February 2003, the Company issued 200 shares of Series B convertible
preferred to several investors in a private placement, which was funded by an
aggregate of $2.0 million of
F-37
financing received. In connection with the issuance of Series B convertible
preferred stock, the Company also issued 292,308 shares of common stock
(including 92,308 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 200,000 shares of common stock, which were issued upon
exercise of Series A warrants, exercised at $.01 per share) and warrants to
purchase an additional 200,000 shares of common stock, of which warrants to
purchase 100,000 (the B-1 warrants) shares were exercisable at $15.00 per share
and warrants to purchase the other 100,000 (the B-2 warrants) shares were
exercisable at $20.00 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 and
exercisable 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.
H.C. Wainwright & Company, Inc. acted as placement agent in this private
placement and in addition to cash compensation, Ortec granted warrants to
purchase an aggregate of 37,692 shares of common stock, exercisable at $0.01 per
share to employees of the placement agent firm.
In May and July 2003, the Company issued 948 shares of Series C convertible
preferred stock and warrants to purchase 1,707,000 common shares at $3.60 per
share to several investors in a private placement, which was funded by an
aggregate of $5.7 million of financing received. As part of the May 2003 Series
C financing, employees of the investment-banking firm were granted warrants to
purchase 149,520 shares at an exercise price of $.01 as part of their
compensation. The Company incurred $39,000 of financing fees related to the
Series C preferred stock that was issued in July 2003, which was paid in cash.
In August 2003, holders of 483 shares of Series B convertible preferred stock
converted their shares into an equal number of shares of Series D convertible
preferred stock.
In December 2003 the Company agreed to compensate its current placement agent
four percent of the gross proceeds received from the exercise of outstanding
Series B and C Warrants anytime through December 13, 2006 other than through
a contractual forced exercise occurring prior to December 13, 2006 in which case
the compensation will be two percent.
NOTE 12 - STOCK OPTIONS AND WARRANTS
On June 24, 2003, Ortec affected a one for ten reverse stock split for each
outstanding share of common stock. This reverse stock split is retroactively
reflected in the accompanying financial statements and all references to shares
are to the new shares with per share amounts appropriately adjusted.
In April 1996, the Board of Directors and stockholders approved the adoption of
a stock option plan (the "Plan"). The Plan provides for the grant of options to
purchase up to 35,000 shares of the Company's common stock. These options may be
granted to employees, officers of the Company, non-employee directors of the
Company and consultants to the Company. The Plan provides for granting of
options to purchase the Company's common stock at not less than the fair value
of such shares on the date of the grant. The options generally vest ratably over
a four-year period and expire after seven years.
F-38
In August 1998, the stockholders and Board of Directors ratified and approved an
amended and restated 1996 Stock Option Plan increasing the maximum number of
shares of the Company's common stock for which stock options may be granted from
35,000 to 155,000 shares. In August 2000, the stockholders and
Board of Directors ratified and approved the second amendment to the Company's
Amended and Restated 1996 Stock Option Plan increasing the number of shares of
the Company's common stock for which options have been or could be granted under
the Plan from 155,000 to 300,000 shares.
In February 2003, the stockholders and Board of Directors ratified and approved
an amended and restated Stock Option Plan, increasing the maximum number of
shares of the Company's common stock for which stock options may be granted from
300,000 to 450,000 shares. As of December 31, 2003, 94,051 options were
available for grant under the plan.The following table summarizes the stock
option activity through December 31, 2003:
Weighted average
Number exercise price
------- ----------------
Granted - adoption of stock option plan 15,600 $ 70.80
-------
Balance, December 31, 1996 15,600 70.80
Granted 12,300 119.40
Forfeited, expired (300) 66.30
-------
Balance, December 31, 1997 27,600 92.50
Granted 68,975 121.00
Exercised (675) 74.20
Forfeited, expired (1,450) 111.90
-------
Balance, December 31, 1998 94,450 111.70
Granted 39,900 108.70
Forfeited, expired (22,100) 149.30
-------
Balance, December 31, 1999 112,250 103.30
Granted 44,996 79.60
Exercised (350) 70.00
Forfeited, expired (4,485) 82.70
-------
Balance, December 31, 2000 152,411 123.00
Granted 75,650 59.30
Forfeited, expired (24,730) 74.10
-------
F-39
Balance, December 31, 2001 203,331 85.40
Granted 115,511 12.90
Forfeited, expired (31,630) 76.80
-------
Balance, December 31, 2002 287,212 $ 57.30
Granted 160,861 2.20
Forfeited, expired (99,874) 84.02
-------
Balance, December 31, 2003 348,199 $ 24.16
=======
The following data has been provided for exercisable options:
Years ended December 31,
2003 2002 2001
---------- ---------- ----------
Number of options 250,508 223,554 168,671
Weighted average exercise price $ 29.98 $ 65.70 $ 89.30
Weighted remaining contractual life 4.79 years 4.26 years 4.71 years
The exercise price for all stock options awarded has been determined by the
Board of Directors of the Company.
The weighted average fair value at the date of grant for options granted during
the year ended December 31, 2003, 2002 and 2001 was $1.64, $12.90 and $38.30,
respectively.
The following table summarizes option data as of December 31, 2003:
Weighted
Average Weighted Weighted
Remaining Average Average
Range of Number Contractual Exercise Number Exercise
exercise prices outstanding life Price Exercisable Price
- ------------------ ----------- ----------- -------- ----------- --------
$1.80 to $6.00 216,194 5.91 years $ 2.63 130,144 $ 2.87
$10.00 to $35.30 17,730 .86 years $ 15.63 17,318 $ 15.28
$47.00 to $68.00 81,445 4.24 years $ 55.70 71,514 $ 55.12
$70.00 to $99.38 20,255 3.93 years $ 87.35 18,957 $ 88.10
$100.00 to $127.50 12,575 3.74 years $100.22 12,575 $100.22
------- -------
348,199 5.07 years $ 24.16 250,508 $ 29.98
======= ---------- ======= -------
The Company recognized approximately $1,696,000 of compensation expense for
options and warrants issued to officers and directors of the Company in 1998.
Such options and warrants were accounted for as
F-40
variable option grants. Such options and warrants had vested prematurely in
December 1998, upon the exercise of warrants owned by a director of the Company,
in accordance with the terms of certain compensation provisions provided for and
approved by the Company's Board of Directors.
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
effects on net loss and net loss per share of the fair value of the options and
warrants granted to employees during the years ended December 31, 2003, 2002 and
2001. The following weighted average assumptions were made in estimating fair
value.
Year ended December 31,
---------------------------
2003 2002 2001
------- ------- -------
Risk-free interest rate 3.3% 3.5% 4.6%
Expected option life 5 years 7 years 7 years
Expected volatility 84.9% 120.2% 65.8%
During the years ended December 31, 2003 and December 31 2002, the Company
issued 894,400 and 380,000 options, respectively, to senior executives, which
were not included in the Plan. These options vested immediately. The following
table provides the exercise price for options issued to senior management.
Number Exercise Remaining
Outstanding Price Contractual Life
- ----------- -------- ----------------
380,000 $3.50 5.88 years
40,000 $2.00 6.27 years
460,000 $1.80 6.15 years
276,000 $3.60 6.39 years
74,000 $2.10 6.42 years
44,400 $3.60 6.42 years
1,274,400
In addition, the Company recognized approximately $87,000, $113,000 and $188,000
in consulting expenses in 2003, 2002 and 2001, respectively, for options and
warrants granted to independent consultants and investment bankers for services
rendered to the Company.
F-41
NOTE 13 - COMMITMENTS AND CONTINGENCIES
Agreement With Dr. Eisenberg
Pursuant to an amended agreement, the Company had engaged the services of Dr.
Eisenberg as a consultant through August 31, 2005. Under the agreement, Dr.
Eisenberg was obligated to devote twenty hours per week to Company business and
is entitled to an annual compensation for such services with annual increases,
as defined. In addition, Dr. Eisenberg was paid $58 per hour for services in
excess of twenty hours per week. The agreement also provides for a bonus in the
event the Company files for the registration of any patent. The bonus, which
shall be determined by the Board of Directors of the Company, shall not be less
than $30,000 per patent registration, but may not aggregate more than $60,000
during any twelve-month period. As of December 31, 1999 and for the cumulative
period since inception, no bonuses have been earned by Dr. Eisenberg. During
2003, the Company terminated its agreement with Dr. Eisenberg and discontinued
research activities in Australia. In accordance with the settlement agreement,
the Company recorded consulting expense of $194,656 for the remainder of
consulting fees due under the consulting agreement with Dr. Eisenberg.
Additionally, the Company recorded approximately $29,000 in rent expense that
had been paid by Dr. Eisenberg on behalf of Ortec. The total amount due Dr.
Eisenberg under the settlement agreement aggregated $398,575 which represents
unpaid consulting fees and advances made by Dr. Eisenberg on behalf of Ortec.
The Company expects to settle the balance due Dr. Eisenberg in 2004 by issuing
100,000 options to purchase Ortec's common stock at an exercise price of $2.00
per share. These options will be due to expire in 5 years from date of
issuance. For each of the period ended December 31, 2003, 2002 and 2001,
production and laboratory costs include compensation due to Dr. Eisenberg of
$195,000, $73,000 and $73,000, respectively, and approximately $1,029,000 for
the period from inception to December 31, 2003. Included in accrued compensation
at December 31, 2003, 2002 and 2001 are $304,478, $109,822 and $36,826,
respectively, representing unpaid consulting fees to Dr. Eisenberg.
Sales Force
In December 2001, the Company entered into an agreement with PDI, Inc. ("PDI"),
a pharmaceutical and medical device and diagnostics sales and marketing company
to provide a dedicated sales force to the Company to target the donor site burn
market. The agreement provides for a monthly fee based on the number of sales
representatives engaged plus commissions based upon sales of OrCel.
During the quarter ended September 30, 2002, PDI commenced legal action against
the Company, claiming that we owe them $205,000 for services that they have
performed for us. The Company reached an agreement with PDI and in May 2003 paid
$150,000 in settlement of the amount claimed.
F-42
Supply Agreements
In October 1991, the Company entered into an agreement with Cornell University
Medical College ("Cornell"), a medical institution in New York City, for Cornell
to produce and supply the Company, on an exclusive basis and using Dr.
Eisenberg's technology, all of the cultured skin equivalent necessary for the
Company's use in human clinical tests in the United States. Fees earned by
Cornell amounted to approximately $1,145,000 for the period from inception to
December 31, 1996. The Cornell arrangement was terminated as of December 31,
1996.
Occupancy Arrangements
The Company leased approximately 5,000 square feet of space in Sydney,
Australia, on a month-to-month basis, in which the Company operated a research
laboratory to conduct its research and development activities in Australia and
to produce OrCel used in the operations conducted in Australia. The Company paid
rent in Australian dollars, which at the current rate of exchange, amounts to
approximately US $25,000 per year. This space was rented from Dr. Mark
Eisenberg's father on terms that the Company believes are not less favorable to
it than for rental of similar space in Sydney, Australia, from non-related third
parties. The Company terminated this agreement effective December 31, 2002.
During the year ended December 31, 1995, Dr. Eisenberg's father waived the
rights to $40,740 of unpaid rent which was accounted for as additional paid-in
capital.
In March 1996, the Company entered into a five-year lease with Columbia
University for the Company's laboratory and offices in Columbia's new Audubon
Biomedical Science and Technology Park in New York City. Construction of the
laboratory and office facility was completed in July 1996 and became fully
operational in November 1996. In 1996, the Company also granted Columbia a
warrant, which expired in March 2001, to purchase 5,000 shares of common stock
at an exercise price of $10 per share. In addition, Columbia had agreed to
provide the Company with a grant of $400,000 and a ten-year self-amortizing loan
with interest at the rate charged by Columbia's bank for up to an additional
$600,000, to build and equip the Company's laboratory. During 1998, the Company
received the $600,000 loan and an additional grant of $130,000 and entered into
two leases with Columbia for additional space in the building. During 2000, the
Company extended the two leases for another year and entered into a new lease
for additional space in the building. During 2001, the Company extended two of
its leases, one for an additional two years and the other for one year and
entered into a new lease for additional space in the building. During 2002, the
Company terminated three of its leases, reducing the amount of space under lease
and extended the term on its primary lease to June 2004. During 2003, the
Company extended its primary lease to December 31, 2005. The Company utilizes
its laboratory facilities to produce OrCel.
On December 18, 2003, the Company amended the lease agreement with Columbia
University, extending the lease term to December 2005, as mentioned above. With
this amendment, the Company agreed to pay Columbia $25,588 a month for past due
rent commencing on February 1, 2004 and ending on December 31, 2005.
F-43
Total rent expense for the years ended December 31, 2003, 2002 and 2001 was
approximately $432,000, $683,000 and $589,000, respectively.
In December 2001, the Company entered into a ten-year lease with the New Jersey
Economic Development Authority ("NJEDA") to lease approximately 58,000 square
feet of manufacturing and office space, located in North Brunswick, New Jersey.
These premises would become available to the Company in two phases. The initial
space, consisting of approximately 26,000 square feet, is in an existing
building, which was to be renovated to the Company's specifications. The second
phase, approximately 32,000 square feet, would be newly constructed and
adjoining the initial space.
On August 5, 2002, the Company reached an agreement with the New Jersey Economic
Development Administration to terminate the December 2001 lease and to enter
into a new lease covering only the initial space of approximately 26,000 square
feet of production and office space. 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. We
continue to rent approximately 800 sq. ft. of space in North Brunswick, New
Jersey pursuant to a lease which expires June 30, 2004, at a rent of $2,300 per
month.
The minimum rental payments on non-cancelable operating and capital leases with
terms exceeding one year at December 31, 2003 are as follows:
Year ending December 31, Operating Leases Capital Leases
2004 361,000 165,207
2005 377,000 43,155
2006 --
2007 --
2008
Thereafter --
------- -------
Total 738,000 208,362
-------
Less: Amounts representing interest 16,367
-------
Principal Payments 191,995
=======
Current portion 150,937
Long-term portion 41,058
-------
191,995
=======
F-44
Cell Therapy Manufacturing Agreement
In October 2003 the Company entered into an agreement with Cambrex Bio Science
Walkersville, Inc., a subsidiary of Cambrex Corporation, for Cambrex to
manufacture OrCel in its cryo-preserved form in Camrbrex's Walkerville, Maryland
facilities. The Cambrex manufacturing facility is required to meet FDA's good
manufacturing processes standards.
Our agreement with Cambrex requires us to pay Cambrex $100,000 per month for the
use of a production suite in their facility located in Walkersville, Maryland
while the Company is in Phase I of the production plan, as defined by the
agreement. During Phase I only, the Company may terminate this agreement by
giving 6 months advance notice of the effective date of such termination,
however no such termination will be effective prior to the date 12 months after
the commencement date for Phase I. At any time during Phase I, the Company can
elect to initiate Phase II of the agreement by written notice to Cambrex. The
annual payments the Company will make to Cambrex will increase to $2,100,000 per
year if the Company requires Cambrex to build us a larger production facility to
meet the Company's requirements for the production of OrCel. Such annual
payments the Company is required to make will increase by a small percentage
each year. Such annual payments include some services and overhead expenses
provided and paid for by Cambrex. The Company is required to pay a portion of
the cost of construction of that larger production facility. However, the amount
the Company contributes to the construction of that larger facility will be
repaid to us by credits against a portion of the future annual payments of
$2,100,000 and of certain other payments the Company is required to make to
Cambrex after the larger facility is in use. The Company is also required to pay
specified hourly charges for the Cambrex employees engaged in the production of
OrCel as well as certain other charges. After construction of the larger
production facility the Company is required to acquire from Cambrex virtually
all of our requirements for OrCel that Cambrex can produce. Prior to our
election to have Cambrex construct the larger production facility for us, either
the Company or Cambrex may terminate the agreement on six months notice by us
and 12 months notice by Cambrex, except that such termination will not be
effective prior to November 1, 2004. If the Company elects to have Cambrex
construct the larger production facility for us the agreement will continue for
6 years after the larger production facility is constructed. However, even after
such construction the Company and Cambrex may elect to scale down over the
following three years the portion of our requirements for OrCel that Cambrex
will produce for us. The Company may elect the scale down period at any time
after one year after the larger production facility is constructed and in
operation in which event there are additional payments the Company must make to
Cambrex. Either Cambrex or the Company may elect the scale down period later
than 3 years after that facility is in operation and neither of us will be
required to make any additional payments to the other because of that election.
If after the construction of the larger production facility, the Company
breaches a material term of our agreement with Cambrex, or elect to terminate
the agreement, there are substantial payments the Company must make to Cambrex.
F-45
Government Regulation
The Company is subject to extensive government regulation. Products for human
treatment are subject to rigorous preclinical and clinical testing procedures as
a condition for approval by the FDA and by similar authorities in foreign
countries prior to commercial sale. Presently, the Company is continuing its
clinical trials for the use of its product in the treatment of patients with
venous leg ulcers and to submit the results of its human clinical trials to the
FDA; however, it is not possible for the Company to determine whether the
results achieved from the human clinical trials will be sufficient to obtain FDA
approval. If the Company is unable to obtain FDA approval, the Company may no
longer be able to continue its operations.
NOTE 14 - LEGAL PROCEEDINGS
The Company has been notified by Columbia University, the landlord of premises
at 3960 Broadway in New York City, where we maintain our principal offices,
laboratory and production facilities, that we have been delinquent in payment of
rent. The Company has reduced the amount of the space leased from Columbia
University, as part of our program to reduce spending. The Company has
negotiated a pay out of the remainder of our unpaid obligations to Columbia. The
Company's ability to make such payment is dependent on our ability to continue
to secure additional equity financing.
In December 2002 Amarex LLC commenced an action against us in the Circuit Court
for Montgomery County, Maryland. Amarex provided statistical programming and
data management services for us for the data generated in our clinical trials.
In 2004 the Company settled this litigation by agreeing to pay Amarex $673,060,
of which we have paid $25,000. The Company is required to pay $50,000 on April
10, 2004, and $60,000 each month thereafter until the obligation is paid in
full. In the event the Company is in default of its payment obligation the
Company will be required to pay an additional $100,000.
Previously, the Company successfully defended challenges to its United States
and European patents. The dismissal of the European challenge has been appealed.
The ultimate outcome of this matter can not be presently determined.
ClinTrials Networks, LLC (ClinTrials) has claimed that the Company has breached
its agreement with them, which provided for ClinTrials to arrange and manage the
FDA mandated clinical trials for use of our OrCel product for the treatment of
venous stasis ulcers, and for other services. In October 2002, ClinTrials
commenced an arbitration proceeding against the Company, claiming that the
Company owes ClinTrials $165,936 and during the arbitration hearings ClinTrials
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. We have
paid this award in the fourth quarter of 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 $205,000 to PDI for services that they have performed for
us. In the second quarter of 2003 we paid PDI $150,000 in full settlement of its
claim against us.
F-46
On August 5, 2002, the Company entered into an agreement with the New Jersey
Economic Development Administration 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.
By letter dated June 27, 2002, the staff of the Nasdaq Stock Market, Inc.
advised the Company that it had not met Nasdaq's requirements for continued
listing of its common stock on the Nasdaq SmallCap market. On July 1, 2002, the
Company appealed that determination and requested an oral hearing before the
Nasdaq Listing Qualification Panel. At that hearing, which was held on August 8,
2002, the Company asked the panel to defer delisting the Company's common stock
for up to six months, in order to give the Company time to complete its plan to
raise sufficient capital to provide for the Company's cash needs for the next
twelve months and enable the Company to meet Nasdaq's requirements for continued
listing of its common stock on the Nasdaq SmallCap market. Nasdaq denied the
Company's request and the Company's stock was moved to the Nasdaq Bulletin Board
and as such, still meets the listing requirements of the Company's debentures
and preferred stock holders.
NOTE 15 - RELATED PARTY TRANSACTIONS
Prior to December 31, 1998, the "Other Founders" were paid fees for services
rendered of approximately $980,000 in the aggregate, for the period from
inception to December 31, 1998. In addition, in 1996, $140,000 was paid to a
director as cash compensation for services as placement agent in connection with
the November 1996 private placement. Also, the director received 3,050 warrants
(see Note 9).
In December 1997, the Company extended the expiration date on warrants to the
director to purchase 870 shares, exercisable at $94.25 per share, resulting in
compensation expense of approximately $420,000 (see Note 10).
The Company paid approximately $35,000 and $25,000 for the years ended December
31, 1997 and 1996, respectively, as fees for accounting services, to a
stockholder (approximately $100,000 for the period from inception to December
31, 1997). Also during the year ended December 31, 1996, the Company repaid
loans of approximately $247,000 from the net proceeds of the "IPO" to officers.
Prior to June 1996, the Company's executive offices were located in office space
leased by a company owned by an officer, founder and director of the Company on
a rent-free basis.
F-47
Change of Control
In December 1998, the Company's Board of Directors authorized agreements between
the Company and three executive officers, which state that in the event of a
"change of control" certain "special compensation arrangements" will occur. A
"change of control" is defined as a change in the ownership or effective control
of the Company or in the ownership of a substantial portion of the assets of the
Company, but in any event if certain members of the Company's Board of Directors
no longer constitute a majority of the Board of Directors. In the event that
such change of control occurs, the agreements will provide three of its officers
additional compensation, interest-free loans to exercise their stock options and
warrants, and extensions of the expiration dates of all of their then
outstanding options and warrants. In addition, for all of the officers, in the
event of a change of control, all unvested options and warrants will vest
immediately upon such change of control.
NOTE 16- INCOME TAXES
The Company has deferred start-up costs for income tax purposes and intends to
elect to amortize such costs over a period of 60 months, under Section 195(b) of
the Internal Revenue Code, when the Company commences operations.
At December 31, 2003, the Company had net operating loss carry-forwards of
approximately $20,915,000 for Federal and New York State income tax purposes
expiring through 2023. Due to the merger of Skin Group with and into Ortec in
July 1992, the net operating losses and other built-in deductions existing at
that time were subject to annual limitations pursuant to Internal Revenue Code
Section 382. The Company's ability to utilize net operating losses and other
built-in deductions generated after that date may be limited in the future due
to additional issuances of the Company's common stock or other changes in
control, as defined in the Internal Revenue Code and related regulations.
For financial statement purposes, a valuation allowance of approximately
$37,588,000 and $30,873,000 at December 31, 2003 and 2002, respectively, has
been recognized to offset entirely the Company's deferred tax assets, which
arose primarily from the Company's operating loss carry-forwards and the
deferral of start-up expenses for tax purposes, as the realization of such
deferred tax assets is uncertain.
Components of the Company's deferred tax asset are as follows:
December 31,
---------------------------
2003 2002
------------ ------------
Net operating loss carry-forwards $ 8,846,000 $ 7,508,000
Deferral of start-up costs 24,415,000 21,029,000
Interest 3,755,000 1,825,000
Other 572,000 511,000
------------ ------------
37,588,000 30,873,000
Valuation allowance (37,588,000) (30,873,000)
------------ ------------
Net deferred tax asset $ -- $ --
============ ============
The following reconciles the income taxes computed at the Federal Statutory rate
to the amounts recorded in the Company's statement of operations:
F-48
Year ended December 31, Cumulative from
--------------------------------------- March 12, 1991 (inception)
2003 2002 2001 to December 31, 2003
----------- ----------- ----------- --------------------------
Income tax benefit at the
Federal Statutory rate $(5,390,000) $(7,337,000) $(5,401,000) $(32,840,000)
State and local income
taxes, net of Federal
benefit (1,279,000) (1,443,000) (1,270,000) (5,903,000)
Permanent difference (46,000) 1,201,000 1,155,000
Effect of valuation
allowance 6,715,000 7,579,000 6,671,000 37,588,000
----------- ----------- ----------- ------------
Total $ -- $ -- $ -- $ --
=========== =========== =========== ============
The Company's net operating loss tax carry-forwards expire as follows:
December 31, 2006 $ 76,000
December 31, 2007 233,000
December 31, 2008 511,000
December 31, 2009 597,000
December 31, 2010 440,000
December 31, 2011 677,000
December 31, 2012 839,000
December 31, 2018 1,189,000
December 31, 2019 2,602,000
December 31, 2020 3,535,000
December 31, 2021 4,014,000
December 31, 2022 3,164,000
December 31, 2023 3,038,000
-----------
$20,915,000
===========
F-49
NOTE 17 - OPERATIONS IN OTHER GEOGRAPHIC AREAS
Long-lived assets, which consists of fixed assets and patents, are as follows as
of December 31, 2003, 2002 and 2001:
2003 2002 2001
---------- ---------- ----------
United States $1,210,353 $2,064,481 $2,139,341
Australia -- -- 63,056
---------- ---------- ----------
$1,210,353 $2,064,481 $2,202,397
========== ========== ==========
NOTE 18 - FAIR VALUE OF FINANCIAL INSTRUMENTS
Statement of Financial Accounting Standards No. 107 ("SFAS No. 107"), "Fair
Value of Financial Instruments," requires disclosure of the estimated fair value
of an entity's financial instrument assets and liabilities. For the Company,
financial instruments consist principally of cash and cash equivalents, loans
payable and other long-term obligations.
The following methods and assumptions were used to estimate the fair value of
each class of financial instrument for which it is practicable to estimate that
value.
Cash and Cash Equivalents
The carrying value reasonably approximates fair value because of the short
maturity of those instruments.
Loans Payable and Other Long-term Obligations
Based on borrowing rates currently available to the Company for bank loans and
other financings with similar terms and maturities, the carrying value of the
Company's loans payable, capital lease obligations and other long-term
obligations approximate the fair value.
NOTE 19 - ADOPTION OF RECENTLY ISSUED ACCOUNTING STANDARD
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
F-50
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 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 adoption of SFAS No. 150
did not have a material impact on the Company's financial position and results
of operations.
F-51
NOTE 20 - QUARTERLY RESULTS (UNAUDITED)
Summarized quarterly financial for the years ended December 31, 2003 and 2002,
is as follows:
Quarter Ended
March 31, June 30,
------------------------- -------------------------
2003 2002 2003 2002
----------- ----------- ----------- -----------
Revenues -- $ 116,415 -- $ 92,535
Net loss applicable
to Common
Shareholders $(8,335,742) $(5,144,138) $(4,480,388) $(7,272,547)
Net loss per share
Basic and diluted $ (3.35) $ (5.31) $ (1.19) $ (7.50)
Quarter Ended
September 30, December 31,
------------------------- -------------------------
2003 2002 2003 2002
----------- ----------- ----------- -----------
Revenues -- $ 34,825 $ -- $ 21,890
Net loss
applicable to common
shareholders $(3,997,475) $(3,989,473) $(4,635,526) $(6,297,797)
Net loss per share
Basic and diluted $ (0.76) $ (4.12) $ (1.10) $ (3.90)
F-52
Exhibits
Exhibit No. Description
- ----------- -----------
3.1 Restated Certificate of Incorporation (1)
3.2 Amendment to Restated Certificate 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 (4)
3.5 Amendment to Certificate of Incorporation filed on May 23, 2003,
being the Certificate of Designation of the Relative Rights and
Preferences of the Series C convertible preferred stock (5)
3.6 Amendment to Certificate of Incorporation filed on June 10, 2003 (8)
3.7 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)
3.8 By-Laws (7)
14 Code of Ethics (8)
10.1 Agreement with Cambrex BioScience of Walkersville, Inc.;
redacted (9)
10.2 Agreement with Paul Capital Royalty Acquisition Fund L.P.;
redacted (10)
10.3 Termination of Employment Agreements between the Registrant and
Steven Katz, Ron Lipstein and Alain Klapholz (11)
10.4 Lease with Audubon Biomedical Science and Technology Park (9)
23. Consent of Grant Thornton LLP (8)
31.1 Certifications (Principal Executive Officer) (8)
31.2 Certifications (Principal Financial Officer) (8)
32.1 Certification of Principal Executive Officer (8)
32.2 Certification of Principal Financial Officer (8)
- ----------
(1) Filed as an Exhibit to our Form 10-Q filed for the quarter ended
September 30, 2001, and incorporated herein by reference.
(12) Filed with our Annual Report on Form 10-K for the year ended December 31,
2002, and incorporated herein by reference.
(13) Filed as an Exhibit to our Form 10-Q for the quarter ended June 30, 2002,
and incorporated herein by reference.
(14) Filed as an Exhibit to our Form 10-QA for the quarter ended September 30,
2002, and incorporated herein by reference.
(15) Filed as an Exhibit to our Form 10-Q for the quarter ended June 30, 2003,
and incorporated herein by reference.
(16) Filed as an Exhibit to our Form 10-Q for the quarter ended September 30,
2003, and incorporated herein by reference.
(17) 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.
(18) Filed herewith.
(19) Filed as an Exhibit to our Registration Statement No. 333-109027, or an
amendment thereto, and incorporated herein by reference. Certain portions
of Exhibit 10.1 marked by asterisks were omitted pursuant to a
confidential treatment request and filed separately with the Securities
and Exchange Commission.
(20) Filed as an Exhibit to Amendment No. 1 to our Annual Report on Form 10-K
for the year ended December 31, 2002, and incorporated herein by
reference. Certain portions marked by asterisks were omitted pursuant to
a confidential treatment request and filed separately with the Securities
and Exchange Commission.
Filed as an Exhibit to our Form 8-K filed on December 12, 2002, and incorporated
herein by reference.
STATEMENT OF DIFFERENCES
The registered trademark symbol shall be expressed as................. 'r'
The section symbol shall be expressed as.............................. 'SS'