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U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2000
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _______________ to _________________
Commission files number: 0-21214
ORTHOLOGIC CORP.
(Exact name of registrant as specified in its charter)
Delaware 86-0585310
(State or other jurisdiction of (IRS employer
incorporation or organization) Identification no.)
1275 West Washington Street, Tempe, Arizona 85281
(Address of principal executive offices)
Issuer's telephone number: (602) 286-5520
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $.0005 per share
(Title of Class)
Rights to purchase 1/100 of a share of Series A Preferred Stock
(Title of Class)
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 report(s)), 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 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 aggregate market value of the voting and non-voting common equity held
by non-affiliates of the registrant, based upon the closing bid price of the
registrant's Common Stock as reported on the NASDAQ National Market on March 23,
2001 was approximately $94,311,003. Shares of Common Stock held by each officer
and director and by each person who owns 10% or more of the outstanding Common
Stock have been excluded in that such persons may be deemed to be affiliates.
This determination of affiliate status is not necessarily conclusive.
The number of outstanding shares of the registrant's Common Stock on March
23, 2001 was 31,437,001.
ORTHOLOGIC CORP.
FORM 10-K ANNUAL REPORT
YEAR ENDED DECEMBER 31, 2000
TABLE OF CONTENTS
PART I..................................................................... 3
Item 1. Business........................................................ 3
Item 2. Properties...................................................... 10
Item 3. Legal Proceedings............................................... 11
Item 4. Submission of Matters to a Vote of Security Holders............. 12
PART II.................................................................... 13
Item 5. Market for the Registrant's Common Equity and Related
Stockholder Matters............................................. 13
Item 6. Selected Financial Data......................................... 13
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations....................................... 14
Item 8. Financial Statements and Supplementary Data..................... 22
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure........................................ 37
PART III................................................................... 37
Item 10. Directors and Executive Officers of the Registrant.............. 37
Executive Officers of the Registrant............................ 37
Item 11. Executive Compensation.......................................... 38
Item 12. Security Ownership of Certain Beneficial Owners and Management.. 38
Item 13. Certain Relationships and Related Transactions.................. 38
PART IV.................................................................... 38
Item 14. Exhibits, Financial Statement Schedules and Reports
on Form 8-K.................................................... 38
SIGNATURES................................................................. S-1
2
PART I
ITEM 1. BUSINESS
GENERAL
The Company was incorporated as a Delaware corporation in July 1987 as
IatroMed, Inc. and changed its name to OrthoLogic Corp. in July 1991. Unless the
context otherwise requires, the "Company" or "OrthoLogic" as used herein refers
to OrthoLogic Corp. and its subsidiaries. The Company's executive offices are
located at 1275 West Washington Street, Tempe, Arizona 85281, and its telephone
number is (602) 286-5520.
OrthoLogic develops, manufactures and markets proprietary, technologically
advanced orthopedic products and packaged services for the orthopedic health
care market including bone growth stimulation devices and continuous passive
motion ("CPM") devices. In 2000, the Company also sold Hyalgan (sodium
hyaluronate), a therapeutic injectable for relief of pain from osteoarthritis of
the knee. The rights to sell this product to the orthopedic market were mutually
terminated in October 2000. OrthoLogic's products are designed to enhance the
healing of diseased, damaged, degenerated or recently repaired musculoskeletal
tissue. The Company's products focus on improving the clinical outcomes and
cost-effectiveness of orthopedic procedures that are characterized by
compromised healing, high-cost, potential for complication and long recuperation
time.
OrthoLogic periodically discusses with third parties the possible
acquisition and sale of technology, product lines and businesses in the
orthopedic health care market and from time to time enters into letters of
intent that provide OrthoLogic with an exclusivity period during which it
considers possible transactions. In January 2001, the Company announced it plans
to divest the CPM business. Management's decision to divest the CPM business was
based on a desire by OrthoLogic to refocus all of its activities in the fracture
healing and spinal repair segments of the orthopedic market. The CPM business,
which is focused in the rehabilitation segment of the orthopedic market, no
longer fits in the Company's long-term strategic plans.
PRODUCTS AND OTHER PRODUCT DEVELOPMENT
OrthoLogic's product line includes bone growth stimulation and fracture
fixation devices and CPM devices and related products. Hyalgan was sold by the
Company through the fourth quarter of 2000. The Company's product line is sold
primarily through the Company's direct sales force. However, the Company uses an
international spine product distributor for the sales and marketing of its bone
growth stimulation device, SPINALOGIC(R).
BONE GROWTH STIMULATION PRODUCTS
OL1000, OL1000 SC. The OL1000 is a U.S. Food and Drug Administration
("FDA") approved portable, noninvasive physician prescribed electro magnetic
field bone growth stimulator designed for patients with a nonunion fracture of
certain long bones. The OL1000 comprises two magnetic field treatment
transducers (coils) and a microprocessor-controlled signal generator that
delivers highly specific, low energy signal.
In the first quarter of 1998, the Company began selling a single-coil model
of the OL1000. The single-coil device, the OL1000 SC, utilizes the same magnetic
field as the OL1000, is available in four sizes and is designed to be more
comfortable for patients with certain types of fractures.
SPINALOGIC(R). SPINALOGIC is a portable, noninvasive electro magnetic field
bone growth stimulator, which enhances the healing process as an adjunct to
spinal fusion surgery. The Company believes that SPINALOGIC offers benefits
similar to those of the OL1000 in that it is relatively easy to use, requires a
small power supply and requires only 30 minutes of treatment per day. The FDA
approved SpinaLogic on December 20, 1999, allowing the Company to begin selling
SPINALOGIC to customers as an adjustment to spinal fusion surgery.
3
CPM DEVICES AND RELATED PRODUCTS
CONTINUOUS PASSIVE MOTION. CPM devices provide controlled, continuous
movement to joints and limbs without requiring the patient to exert muscular
effort and are intended to be applied immediately following orthopedic trauma or
surgery. The products are designed to reduce swelling, increase joint range of
motion, reduce the length of hospital stay and reduce the incidence of
post-trauma and post-surgical complications. The primary use of CPM devices
occurs in the hospital and home environments, but they are also utilized in
skilled nursing facilities, sports medicine and rehabilitation centers. The
Company offers a wide range of lower and upper extremity CPM devices. Lower
extremity CPM is a widely accepted treatment for rehabilitation from knee
surgical procedures such as total knee replacement and anterior cruciate
ligament reconstruction. Consequently, the number of companies competing in this
line of business has increased, resulting in decreased reimbursement rates from
managed care providers. Upper extremity CPM for the shoulder, elbow, wrist and
hand are not yet standard rehabilitation procedures but are continuing to gain
acceptance. No clinical studies have been published supporting the efficiency of
upper extremity CPM. As a result, there is no Medicare reimbursement to date for
this treatment though other payors will reimburse for upper extremity CPM usage.
Currently, the majority of upper extremity CPM reimbursement payments are
workers' compensation related. The Company maintains a fleet of CPM devices that
are placed on consignment in hospitals or rented to patients upon receipt of a
written prescription.
The Company has developed a new elbow CPM device incorporating Progressive
Stretch Relaxation (PSR) technology. The new device should be launched by
mid-2001 and will offer physicians and therapists a new alternative to
conventional CPM and dynamic splinting.
On January 24, 2001, the Company announced its plans to divest of its CPM
business. The decision to divest the CPM business was based on a desire by
OrthoLogic to refocus all of its activities in the fracture healing and spinal
repair segments of the orthopedic market. The CPM business, which is focused in
the rehabilitation segment of the orthopedic market, no longer fits in the
Company's long-term strategic plans. See "Item 1 -- Business -- General."
ANCILLARY ORTHOPEDIC PRODUCTS. The Company also offers a complete line of
bracing, electrotherapy, cryotherapy and dynamic splitting products. The bracing
line includes post-operative, custom and pre-sized functional and osteoarthritis
models. Post-operative braces are used in the early phases of post-surgical
rehabilitation while functional braces are applied as the patient returns to
work or sports activities. The electrotherapy line consists of TENS, NMES, high
volt pulsed current, interferential, and biofeedback units. Cryotherapy is used
to cool the operative or injured site in order to prevent pain and swelling.
HYALGAN(R) (SODIUM HYALURONATE)
The Company began selling Hyalgan to orthopedic surgeons in July 1997,
under a Co-Promotion Agreement with Sanofin Synthelabo, Inc. (the "Co-Promotion
Agreement"). Hyalgan is used for relief of pain from osteoarthritis of the knee
for those patients who have failed to respond adequately to conservative
non-pharmacological therapy and to simple analgesics, such as acetaminophen. In
October 2000, it was announced that the Company and Sanofi had mutually agreed
to terminate this agreement. The Company returned the rights to sell Hyalgan
back to Sanofi in October 2000. The Company received an up-front cash payment,
financial incentives to complete the transition of the business through December
2000, and continuing royalties for the next two years.
FUTURE PRODUCTS
CHRYSALIN. In January 1998, the Company made a minority equity investment
in Chrysalis Biotechnology, Inc. ("Chrysalis"). As an amendment to this
transaction and in exchange for a one-time license fee of $2 million, the
Company acquired a license for worldwide exclusive rights for the orthopedic
applications of Chrysalin, a patented 23-amino acid peptide that has shown
promise in accelerating the healing process of fractured bones. In pre-clinical
animal studies, Chrysalin was shown to double the rate of fracture healing with
a single injection into the fracture gap. In November 1999, the Company received
authorization to proceed with a Phase I / Phase II Investigational New Drug
Application ("INDA"), for human clinical trials for Chrysalin. In January 2000,
the Company began enrolling patients in a double blind Phase I/II INDA clinical
trial. The Company announced that the enrollment was completed in January
2001.The trial consists of a prospective, randomized double blind study of 90
patients in seven clinical centers to study the safety and preliminary
efficiency of Chrysalin on healing fractures. The Company has not yet applied
for FDA approval to market Chrysalin and there is no assurance that the Company
will do so or that it would receive such approval if sought.
4
ORTHOSOUND(TM). The Company holds patents for diagnostic and therapeutic
devices utilizing its nonthermal ultrasound technology "OrthoSound" for use in
medical applications that relate to bone, cartilage, ligament or tendon
diagnostics and healing. The Company is not currently engaged in any clinical
studies using this technology and there can be no assurance that the Company
will do so or that it would receive such approval if sought.
MARKETING AND SALES
OrthoLogic's products have historically been marketed and sold to
orthopedic and podiatric surgeons in private practice, hospitals, and clinics,
as well as to general orthopedic physicians and therapists in sports medicine
and trauma centers. Direct sales and marketing efforts have thus centered on
these groups in these locations.
The launch of SpinaLogic(R) has added a new customer base for the Company:
orthopedic spine surgeons and neurosurgeons who perform spine procedures. This
fact in combination with a desire to quickly penetrate this new market led the
Company in August 2000 to sign an exclusive 10-year sales agreement with DePuy
AcroMed.
The Company's sales efforts are through a combination of direct sales
representatives and select regional distributors, plus DePuy AcroMed for
SpinaLogic. Of the Company's approximately 581 employees at December 31, 2000,
approximately 318 are involved in field sales, service and marketing. The
Company employs a Vice President of Sales as well as eight Area Vice Presidents
to manage territory sales, along with a Vice President of Distributor Sales to
coordinate distributor activities.
Through specialized marketing and sales staff, the Company has initiated
and maintained contracts with over 400 third party payors for the OL1000,
SpinaLogic, and CPM product lines. In addition, the Company is an approved
Medicare and Medicaid provider.
OrthoLogic has not typically experienced any seasonality in sales of the
OL1000, and is not expecting any seasonality in SpinaLogic sales. However,
revenues from the CPM line have proven to be seasonal. Historically the
strongest quarters are the first and fourth quarters of the calendar year. The
Company believes this trend may be due to (i) individuals putting off elective
surgical intervention until later in the year when insurance deductibles have
been met, and (ii) sports-related injuries which tend to increase in fall and
winter months. As noted earlier, the Company intends to divest the CPM business.
See "Item 1 - Business - General."
RESEARCH AND DEVELOPMENT
Individuals within the research and development organization have extensive
experience in the areas of biomaterials, bioengineering, animal modeling, and
cell biology. Research and development efforts emphasize product engineering,
activities related to the clinical trials conducted by the Company and basic
research. With regard to basic research, the research and development staff
conducts in-house research projects in the area of fracture healing. The staff
also supports and monitors external research projects in biophysical stimulation
of growth factors and the potential use of ultrasound technology in diagnostic
and therapeutic applications relating to bone, cartilage, ligament or tendon.
Both the in-house and external research and development projects also provide
technical marketing support for the Company's products and explore the
development of new products and also additional therapeutic applications for
existing products. The Company also has a clinical regulatory group that
initiates and monitors clinical trials. The Company's clinical regulatory group
recently completed enrollment into its double blind human clinical trials on
Chrysalin. The Company announced in January 1998 that it had acquired a minority
equity interest in a biotech firm, Chrysalis Bio Technology, Inc. ("Chrysalis")
for $750,000. As Part of the transaction, the Company was awarded a world-wide
exclusive option to license the orthopedic applications of Chrysalin, a patented
23-amino acid pep-tide that has shown promise in accelerating the healing
process and has completed an extensive pre-clinical safety and efficacy profile
of the product. As part of the equity investment, OrthoLogic acquired options to
license Chrysalin for orthopedic applications. An additional fee of $750,000 for
the initial license was expended in the third quarter of 1998, and the Agreement
was extended to January 1999, when the Company exercised its options to license
the U.S. development, marketing and distribution rights for Chrysalin, for fresh
fracture indications. As part of the license agreement, and in conjunction with
FDA clearance to begin human clinical trials, OrthoLogic made and expensed a
$500,000 milestone payment to Chrysalis in the fourth quarter of 1999.
5
The Company's research and development expenditures totaled $2.9 million,
$2.9 million and $4.7 million in the years ended December 31, 1998, 1999 and
2000, respectively. In 2000, the Company paid Chrysalis a license fee of $2
million to extend its license agreement to include all Chrysalin orthopedic
indications worldwide. See "Item 6 -- Selected Financial Data and Item 7 --
Management's Discussion and Analysis of Financial Condition and Results of
Operations."
MANUFACTURING
The Company assembles the OL1000 and SpinaLogic products from parts
supplied by third parties, performs tests on the components and the assembled
product, and calibrates the assembled product to specifications. The Company
purchases several components including the magnetic field sensor employed in the
OL1000 and SpinaLogic products from a single source. Establishing additional or
replacement suppliers for this component cannot be accomplished quickly. Other
components and materials used in the manufacture and assembly of the OL1000 and
SpinaLogic are available from multiple sources.
The Company assembles CPM devices from parts that it manufactures in-house
or purchases from third parties. These parts are assembled, calibrated and
tested at the Company's facilities in Pickering (outside of Toronto), Canada.
The Company purchases several CPM components, including microprocessors, motors
and custom key panels from single-source suppliers. The Company believes that
its CPM products are not dependent on these components and could be redesigned
to incorporate comparable components. The Company places orders for these
components to meet sales forecasts for up to six months. Other components and
materials used in the manufacture and assembly of CPM products are available
from multiple sources.
A third party produces Chrysalin for the Company. Because Chrysalin is
currently still in the clinical trial phase and not being sold to the public, it
is manufactured by a sole supplier.
COMPETITION
The orthopedic industry is characterized by rapidly evolving technology and
intense competition. The Company has common competitors for its fracture healing
and spine stimulation business. In addition to surgical procedures themselves,
other manufacturers of bone growth stimulators include Electro-Biology, Inc.
(EBI), a subsidiary of Biomet, Inc., OrthoFix International N.V., and Exogen,
Inc. a subsidiary of Smith & Nephew.
New research in osteobiologics, such as the development of growth factors
like bone morphogenic proteins (BMP's) and even the Company's own work with
Chrysalin, may well affect the market potential for bone growth stimulation in
the future.
With respect to the adjunctive treatment of spinal fusion surgery, the
primary competitors are EBI and OrthoFix. With respect to external fixation
devices, the Company's primary competitors are OrthoFix, Stryker, EBI, Smith &
Nephew Richards, Inc., Synthes, Inc. and ACE Orthopedic Manufacturing (a
division of DePuy, Inc.). The Company's primary competitors in the United States
for CPM devices are privately held Thera-Kinetics, Inc., many independent
owners/lessors of CPM devices and suppliers of traditional orthopedic
rehabilitation services including orthopedic immobilization and follow up
physical therapy. The Company also believes that there are several foreign CPM
device manufacturers and providers with whom the Company will compete if it
increases international sales efforts or as those competitors sell in the United
States. As noted above, the Company intends to divest the CPM business. See
"Item 1 -Business - General."
Many of the Company's competitors have substantially greater resources and
experience in research and development, obtaining regulatory approvals,
manufacturing, and marketing and sales of medical devices and services, and
therefore represent significant competition for the Company. The Company is
aware that its competitors are conducting clinical trials for other medical
applications of their respective technologies. In addition, other companies are
developing or may develop a variety of other products and technologies to be
used in CPM devices, the treatment of fractures and spinal fusion's, including
growth factors, bone graft substitutes combined with growth factors, and
nonthermal ultrasound. The Company believes that competition is based on, among
other factors, the safety and efficacy of products in the marketplace, physician
familiarity with the product, ease of patient use, product reliability,
reputation, price, sales and marketing capability and reimbursement.
6
Any product developed by the Company that gains any necessary regulatory
approval would have to compete for market acceptance and market share in an
intensely competitive market. An important factor in such competition may be the
timing of market introduction of competitive products. Accordingly, the relative
speed with which the Company can develop products, complete clinical testing as
well as any necessary regulatory approval processes and supply commercial
quantities of the product to the market will be critical to its competitive
success. There can be no assurance the Company can successfully compete on these
bases. See "Item 7 -- Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Intense Competition" and "-- Rapid
Technological Change."
PATENTS, LICENSES AND PROPRIETARY RIGHTS
The Company's practice is to require its employees, consultants and
advisors to execute a confidentiality agreement upon the commencement of an
employment or consulting relationship with the Company. The agreements provide
that all confidential information developed by or made known to an individual
during the course of the employment or consulting relationship will be kept
confidential and not disclosed to third parties except in specified
circumstances. In the case of employees, the agreements provide that all
inventions conceived by the individual relating to the Company's business while
employed by the Company shall be the exclusive property of the Company. There
can be no assurance, however, that these agreements will provide meaningful
protection for the Company's trade secrets in the event of unauthorized use or
disclosure of such information.
It is also the Company's policy to protect its owned and licensed
technology by, among other things, filing patent applications for the
technologies that it considers important to the development of its business. The
Company uses the BIOLOGIC(R) technology in its bone growth stimulation devices
through a worldwide exclusive license granted by a corporation owned by
university professors who discovered the technology. With respect to the
BIOLOGIC technology, the delivery of such technology to the patient and specific
applications of such technology, the Company holds title to or has exclusive
worldwide license of a total of 50 BioLogic patents and design patents: twenty
seven patents are United States patents; the remaining patents are held in
France, Switzerland, Germany, Canada, Japan, Spain, United Kingdom, Italy,
Australia, and Europe. Two of the foreign patents (Canadian) are pending. The
Company's license for the BioLogic technology extends for the life of the
underlying patents, which are due to expire over a period of years beginning in
2006 and extending through 2016. The Biologic technology license covers all
improvements and applies to the use of the technology for all medical
applications in man and animals. The license provides for payment of royalties
by the Company from the net sales revenues of products using the BioLogic
technology. The license agreement can be terminated for breach of any material
provision of the license. See Note 4 of Notes to Financial Statements.
The Company has been assigned and maintains eight United States patents
covering methods for ultrasonic bone assessment and therapy by noninvasively and
quantitatively evaluating the status of bone tissue IN VIVO through measurement
of bone mineral density, strength and fracture risk. Additionally, three
European and two Japanese patent applications are pending for this technology.
With respect to CPM technology, the Company currently owns 34 patents, 23
United States patents and 11 foreign patents. Of these patents, two United
States and five foreign patents are pending. The issued United States patents on
this technology are due to expire over a period of years beginning in the year
2002 and extending through 2017. These patents could expire at an earlier date
if the patents are not maintained by paying certain fees and / or annuities to
the United States Patent and Trademark Office and/or appropriate foreign patent
offices at certain intervals over the life of the patents.
ORTHOLOGIC(R), ORTHOFRAME(R), BIOLOGIC(R), SPINALOGIC(R), TOMORROW'S
TECHNOLOGY TODAY(R), CASELOG(R), LEGASUS SPORT CPM(R), LITELIFT(R),
SPORTLITE(R), SUTTER(R), DANNINGER MEDICAL(R), MOBILIMB(R), WAVEFLEX(R),
TOTALCARE(R), SUGARBOOTS, SYSTEM S(R), ORTHONAIL(TM), LEGASUS CPM(TM), and
DANNIFLEX(TM) are federally registered trademarks of the Company.
7
GOVERNMENT REGULATION
The activities of the Company are regulated by foreign, federal, state and
local governments. Government regulation in the United States and other
countries is a significant factor in the development and marketing of the
Company's products and in the Company's ongoing manufacturing and research and
development activities. The Company and its products are regulated by the FDA
under a number of statutes, including the Medical Device Amendments Act of 1976
to the Federal Food, Drug and Cosmetic Act, as amended, and the Safe Medical
Devices Act of 1990, as amended (collectively, the "FDC Act").
The Company's current BIOLOGIC technology-based products are classified as
Class III Significant Risk Devices, which are subject to the most stringent FDA
review, and are required to be tested under an Investigational Device Exemption
("IDE") clinical trial and approved for marketing under a Pre-Market Approval
("PMA"). To begin human clinical studies the Company must apply to the FDA for
an IDE. Generally, preclinical laboratory and animal tests are required to
establish a scientific basis for granting of an IDE. Once an IDE is granted,
clinical trials can commence, which involve rigorous data collection as
specified in the IDE protocol. After the clinical trial is completed, the data
are compiled and submitted to the FDA in a PMA application. FDA approval of a
PMA application occurs after the applicant has established safety and efficacy
to the satisfaction of the FDA. The FDA approval process may include review by a
FDA advisory panel. Approval of a PMA application includes specific requirements
for labeling of the medical device with regard to appropriate indications for
use. Among the conditions for PMA approval is the requirement that the
prospective manufacturer's quality control and manufacturing procedures comply
with the FDA regulations setting forth Good Manufacturing Practices ("GMP"). The
FDA monitors compliance with these requirements by requiring manufacturers to
register with the FDA, which subjects them to periodic FDA inspections of
manufacturing facilities. In addition, the Company must comply with
post-approval reporting requirements of the FDA. If violations of applicable
regulations are noted during FDA inspections, the continued marketing of any
products manufactured by the Company may be adversely affected. No significant
deficiencies have been noted in FDA inspections of the Company's manufacturing
facilities.
The ORTHOFRAME and ORTHOFRAME/MAYO WRIST FIXATOR are Class II devices. If a
medical device manufacturer can establish that a newly developed device is
"substantially equivalent" to a device that was legally marketed prior to May
28, 1976, the date on which the Medical Device Amendments Act of 1976 was
enacted, the manufacturer may seek marketing clearance from the FDA to market
the device by filing a 510(k) pre-market notification with the agency. The
Company obtained 510(k) pre-market notification clearances from the FDA for
ORTHOFRAME.
The Company's CPM devices are Class I devices in the United States that do
not require 510(k) pre-market notification. However, CPM manufacturers must
comply with GMP regulations. The devices must also meet Underwriters
Laboratories standards for electrical safety. For sales to the European
Community, CPM devices must meet established electromechanical safety and
electromagnetic emissions regulations and must have a CE mark. The European
Community requires compliance with newly formed quality control standards. The
Company currently complies with the new standards.
Manufacturers outside the United States that export devices to the United
States may be subject to FDA inspection. The FDA generally inspects companies
every few years. The frequency of inspection depends upon the Company's status
with respect to regulatory compliance. To date, the Company's foreign operations
have not been the subject of any inspections conducted by the FDA.
Under Canada's Food and Drugs Act and the rules and regulations thereunder
(the "Food and Drugs Act"), the CPM devices sold by the Company are Class II
devices and therefore require Canadian regulatory approval prior to their
introduction to the market. The Company must also obtain an establishment
license. The Company has obtained both approvals for the CPM devices and an
establishment license. The license is renewed annually. Health Canada may
request the Company to provide it with the results of the testing conducted on
the device. If the results of such testing do not substantiate the nature of the
benefits claimed to be obtainable from the use of the device or the performance
characteristics claimed for such device to the satisfaction of Health Canada,
the sale of the device in Canada would be prohibited until appropriate results
had been submitted. The Company has not been asked to provide such testing
results to the Canadian authorities. The Company's Biologic technology-based
products require and have obtained pre-market approval under Canadian law.
8
CPM devices must comply with the applicable provincial regulations
regarding the sale of electrical products by receiving the prior approval of
either the Canadian Standards Association ("CSA") or the provincial
hydro-electric authority, unless the device is otherwise exempt from such
requirement. The CPM devices have, unless otherwise exempt obtained such
necessary approvals. As noted above, the Company intends to divest the CPM
business. See "Item 1 - Business - General."
The FDC Act regulates the labeling of medical devices to indicate the uses
for which they are approved, both in connection with PMA approval and
thereafter, including any sponsored promotional activities or marketing
materials distributed by or on behalf of the manufacturer or seller. A
determination by the FDA that a manufacturer or seller is engaged in marketing
of a product for other than its approved use may result in administrative, civil
or criminal actions against the manufacturer or seller.
Regulations governing human clinical studies outside the United States vary
widely from country to country. Historically, some countries have permitted
human studies earlier in the product development cycle than the United States.
This disparity in regulation of medical devices may result in more rapid product
approvals in certain foreign countries than the United States, while approvals
in countries such as Japan may require longer periods than in the United States.
In addition, although certain of the Company's products have undergone clinical
trials in the United States and Canada, such products have not undergone
clinical studies in any other foreign country and the Company does not currently
have any arrangements to begin any such foreign studies.
As a potential new drug product, Chrysalin would be subject to clinical
trial and GMP review similar to those described for the BioLogic
technology-based products. Under the FDC Act, drug products are required to be
tested under Investigational New Drug ("IND") Phase I, II, and III clinical
trials and approved for marketing under a New Drug Application ("NDA"). To begin
human clinical trials the Company applied to the FDA for an IND approval.
Generally, preclinical laboratory and animal tests are required to establish a
scientific basis for granting of an IND application. Once the Company received
authorization to begin clinical trials, the process of collecting data as
specified in the INDA protocol(s) began. Once an IND application was granted,
the clinical trial commenced and involved rigorous data collection as specified
in the IND protocol(s). Data from earlier phases may need to be reviewed by FDA
before proceeding to later phases. After all phases of clinical trials are
completed, data will be compiled and submitted to the FDA in an NDA application.
FDA approval of an NDA application occurs after the applicant has established
safety and efficacy to the satisfaction of the FDA. Approval of an NDA
application includes specific requirements for labeling, manufacturing, and
controls. The approval process may include review by a FDA advisory panel. Among
conditions for NDA approval is the requirement that the prospective
manufacturer's quality control and manufacturing procedures comply with the FDA
regulations setting forth Good Manufacturing Practices.
The process of obtaining necessary government approvals is time consuming
and expensive. There can be no assurance that the necessary approvals for new
products or applications will be obtained by the Company or, if they are
obtained, that they will be obtained on a timely basis. Furthermore, the Company
must suspend clinical trials upon a determination that the subjects or patients
are being exposed to an unreasonable health risk. The FDA may also require
post-approval testing and surveillance programs to monitor the effects of the
Company's products. In addition to regulations enforced by the FDA, the Company
is also subject to regulations under the Occupational Safety and Health Act, the
Environmental Protection Act, the Toxic Substances Control Act, the Resource
Conservation and Recovery Act and other present and potential future federal,
state and local regulations. The ability of the Company to operate profitably
will depend in part upon the Company obtaining and maintaining all necessary
certificates, permits, approvals and clearances from the United States and
foreign and other regulatory authorities and operating in compliance with
applicable regulations. Failure to comply with regulatory requirements could
have a material adverse effect on the Company's business, financial condition
and results of operations. Regulations regarding the manufacture and sale of the
Company's current products or other products that may be developed or acquired
by the Company are subject to change. The Company cannot predict what impact, if
any, such changes might have on its business. See "Item 7 -- Management's
Discussion and Analysis of Financial Condition and Results of Operations --
Government Regulation."
9
THIRD PARTY PAYMENT
Most medical procedures are reimbursed by a variety of third party payors,
including Medicare and private insurers. The Company is an approved Medicare
provider and is also an approved Medicaid provider for a majority of states. The
Company contracts with over 400 third party payors as an approved provider for
its fracture healing and orthopedic rehabilitation products, including the
Department of Veterans Affairs, Aetna, U.S. Healthcare and various Blue
Cross/Blue Shield organizations. Because the process of obtaining reimbursement
for products through third-party payors is longer than through direct invoicing
of patients, the Company must maintain sufficient working capital to support
operations during the collection cycle. In addition, third party payors as an
industry have undergone consolidation, and that trend appears to be continuing.
The concentration of such economic power may result in third party payors
obtaining additional leverage and thus could negatively affecting the Company's
profitability and cash flows.
PRODUCT LIABILITY INSURANCE
The business of the Company entails the risk of product liability claims.
The Company maintains a product liability and general liability insurance policy
and an umbrella excess liability policy. There can be no assurance that
liability claims will not exceed the coverage limit of such policies or that
such insurance will continue to be available on commercially reasonable terms or
at all. Consequently, product liability claims could have a material adverse
effect on the business, financial condition and results of operations of the
Company. The Company has not experienced any product liability claims to date
resulting from its Fracture Healing Products. To date, liability claims
resulting from the Company's CPM Products have not had a material adverse effect
on business. See "Item 7 -- Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Risk of Product Liability Claims."
EMPLOYEES
As of December 31, 2000, the Company had 537 employees in its United
State's operations, including 318 in sales and marketing, 16 in research and
development and clinical and regulatory affairs, approximately five in managed
care, 91 in reimbursement and 107 in manufacturing, finance and administration.
The managed care staff is charged with changing the practice patterns of the
orthopedic community through the influence of third party payors on treatment
regimes. The Company believes that the success of its business will depend, in
part, on its ability to identify, attract and retain qualified personnel. In the
future, the Company may need to add additional skilled personnel or retain
consultants in such areas as research and development, manufacturing and
marketing and sales. The Company considers its relationship with its employees
to be good. There are 44 employees in the Company's Canadian facilities
consisting of 35 in manufacturing, finance and administration, five in marketing
and sales, and four in research and development. See "Item 7 -- Management's
Discussion and Analysis of Financial Condition and Results of Operations --
Dependence on Key Personnel.
ITEM 2. PROPERTIES
The Company leases facilities in Tempe, Arizona and Pickering, Ontario,
Canada. These facilities are designed and constructed for industrial purposes
and are located in industrial districts. The Company believes each facility is
suitable for the Company's purposes and is effectively utilized. The table below
sets forth certain information about the Company's principal facilities.
Approx.
Location Square Feet Lease Expires Description Principal Activity
- -------- ----------- ------------- ----------- ------------------
2-story, in Assembly,
Tempe 80,000 11/07 industrial park Administration
1-story, in
Pickering 28,500 2/02 industrial park CPM assembly
The Company believes that each facility is well maintained and adequate for
use in the foreseeable future. In 1997, the Company consolidated all CPM
manufacturing in its Pickering facility and all CPM administrative and service
functions in Tempe. As noted above, the Company intends to divest the CPM
business. See Item 1 - Business - General. The Company ceased operations at
facilities in San Diego, California in connection with the consolidation.
10
In addition to the principal facilities, the Company has approximately 66
sales and service offices that it leases at various locations in the United
States.
ITEM 3. LEGAL PROCEEDINGS
On June 24, 1996, and on several days thereafter, lawsuits were filed in
the United States District Court for the District of Arizona against the Company
and certain officers and directors alleging violations of Sections 10(b) of the
Securities Exchange Act of 1934 ("Exchange Act") and SEC Rule 10b-5 promulgated
thereunder, and, as to other defendants, Section 20(a) of the Exchange Act.
These lawsuits are:
Mark Silveria v. Allan M. Weinstein, Allen R. Dunaway, David E. Derminio
and OrthoLogic Corporation, Cause No. CIV 96-1563 PHX EHC, filed in the United
States District Court for the District of Arizona (Phoenix Division) on July 1,
1996.
Derric C. Chan and Anna Chan as attorney in fact for Moon-Yung Chow, on
behalf of themselves and all others similarly situated v. OrthoLogic
Corporation, Allan M. Weinstein, Frank P. Magee and David E. Derminio, Cause No.
CIV 96-1514 PHX RCB, filed in the United States District Court for the District
of Arizona (Phoenix Division) on June 21, 1996.
Jeffrey M. Boren and Charles E. Peterson, Jr., on behalf of themselves and
all others similarly situated v. Allan M. Weinstein and OrthoLogic Corp., Cause
No. CIV 96-1520 PHX RCB, filed in the United States District Court for the
District of Arizona on June 24, 1996.
Dorothy Cohen, on behalf of herself and all others similarly situated v.
OrthoLogic Corp. and Allan M. Weinstein, Cause No. CIV 96-1615 PHX SMM, filed in
the United States District Court for the District of Arizona (Phoenix Division)
on July 9, 1996.
Joseph C. Barton, on behalf of himself and all others similarly situated v.
OrthoLogic Corp. and Allan M. Weinstein, Cause No. CIV 96-1643 PHX ROS, filed in
the United States District Court for the District of Arizona (Phoenix Division)
on July 12, 1996.
Jeffrey Draker, on behalf of himself and all others similarly situated v.
Allan M. Weinstein and OrthoLogic Corp., Cause No. CIV 96-1667 PHX RCB, filed in
the United States District Court for the District of Arizona (Phoenix Division)
on July 16, 1996.
Edward and Eleanor Katz v. OrthoLogic Corp. and Allan M. Weinstein, Cause
No. CIV 96-1668 PHX RGS, filed in the United States District Court for the
District of Arizona (Phoenix Division) on July 17, 1996.
Mark J. Rutkin, Paul A. Wallace, Malcolm E. Brathwaite, Elaine K. Davies
and David G. Davies, Larry E. Carder and Carl Hust, on behalf of themselves and
all others similarly situated v. Allan M. Weinstein, Allen R. Dunaway, David E.
Derminio and OrthoLogic Corp., Cause No. CIV 96-1678 PHX EHC, filed in the
United States District Court for the District of Arizona (Phoenix Division), on
July 17, 1996.
Frank J. DeFelice, on behalf of himself and all others similarly situated
v. OrthoLogic Corp. and Allan M. Weinstein, Cause No. CIV 96-1713 PHX EHC, filed
in the United States District Court for the District of Arizona (Phoenix
Division), on July 23, 1996.
Scott Longacre, Joseph E. Sheedy, Trustee, Rickie Trainor, W. Preston
Battle, III, Taylor D. Shepherd, Dianna Lynn Shepherd, Gordon H. Hogan, Trustee,
and Dallas Warehouse Corp., Inc., on behalf of themselves and all others
similarly situated v. Allan M. Weinstein, Allen R. Dunaway, David E. Derminio,
Frank P. Magee and OrthoLogic Corp., Cause No. CIV 96-1891 PHX PGR, filed in the
United States District Court for the District of Arizona (Phoenix Division) on
August 16, 1996.
Jeffrey D. Bailey, Milton Berg, Bryan Boatwright, Charles R. Campbell, Mark
and Cathy Daniel, Tom Drotar, Rudy Gonnella, David Gross, Janet Gustafson, Willa
P. Koretz, Dr. Richard Lewis, John Maynard, Margaret Milosh, Michelle Milosh,
Theresa L. Onn, Ward B. Perry, William Schillings, Darwin and Merle Sen, Nestor
Serrano and Larry E. and Gloria M. Swanson v. Allan M. Weinstein, Allen R.
Dunaway, David E. Derminio and OrthoLogic Corporation, Cause No. CIV 96-1910 PHX
PGR, filed in the United States District Court for the District of Arizona
(Phoenix Division) on August 19, 1996.
Nancy Z. Kyser and Mark L. Nichols, on behalf of themselves and all others
similarly situated v. OrthoLogic Corporation, Allan M. Weinstein, Frank P. Magee
and David E. Derminio, Cause No. CIV 96-1937 PHX ROS, filed in the United States
District Court for the District of Arizona (Phoenix Division) on August 22,
1996.
11
Plaintiffs in these actions allege generally that information concerning
the May 31, 1996 letter received by the Company from the FDA regarding the
Company's OrthoLogic 1000 Bone Growth Stimulator, and the matters set forth
therein, were material and undisclosed, leading to an artificially inflated
stock price. Plaintiffs further alleged that the Company's non-disclosure of the
FDA correspondence and of the alleged practices referenced in that
correspondence operated as a fraud against plaintiffs, in that the Company
allegedly made untrue statements of material facts or omitted to state material
facts necessary in order to make the statements not misleading. Plaintiffs
further alleged that once the FDA letter became known a material decline in the
stock price of the Company occurred, causing damage to plaintiffs. All
plaintiffs sought class action status, unspecified compensatory damages, fees
and costs. Plaintiffs also sought extraordinary, equitable and/or injunctive
relief as permitted by law. The actions were consolidated for all purposes in
the United States District Court for the District of Arizona. On March 31, 1999,
the judge in the consolidated case before the United States District Court
granted the Company's Motion to Dismiss and entered an order dismissing all
claims in the suit against the Company and two individual officers/directors.
The judge allowed certain narrow claims based on insider trading theories to
proceed against certain individual defendants. On December 21, 1999, the
District Court granted plaintiffs' motion for class certification to include
purchasers of common stock between June 4 through June 18, 1996, inclusive.
On or about June 20, 1996, a lawsuit entitled Norman Cooper, et al. v.
OrthoLogic Corp., et al., and Cause No. CV 96-10799, was filed in the Superior
Court, Maricopa County, Arizona. The plaintiffs allege violations of Arizona
Revised Statutes Sections 44-1991 (state securities fraud) and 44-1522 (consumer
fraud) and common law fraud based upon factual allegations substantially similar
to those alleged in the federal court class action complaints. Plaintiffs sought
class action status, unspecified compensatory and punitive damages, fees and
costs. Plaintiffs also sought injunctive and/or equitable relief. The Company
filed a Motion to Dismiss the Complaint in Arizona State Court in May 1999. The
Court denied the motion in July 1999, and granted the plaintiffs' motion for the
class certification on November 24, 1999.
In October 2000, the Company announced that it had entered into a
Memorandum of Understanding regarding settlement of the remaining class action
claims and the Norman Cooper lawsuit. The settlement consists of $1 million in
cash and one million shares of newly issued OrthoLogic Common Stock valued at
$2,969,000. A significant portion (approximately $800,000) of the cash payment
was funded from its directors' and officers' liability insurance policy. The
Company recorded a $3.6 million charge, including legal expenses, for settlement
of the litigation. The settlement is subject to approval by the lead plaintiffs
and defendants; the preparation, execution and filing of the formal Stipulation
of Settlement; notice to settlement class members; and final approval of the
settlement by the courts at hearing. Management believes the settlement is in
the best interest of the Company and its shareholders as it frees the Company
from the cost and significant distraction of ongoing litigation. The agreement
to the Memorandum of Understanding does not constitute, and should not be
construed as, an admission that the defendants have any liability to or acted
wrongfully in any way with respect to the plaintiffs or any other person.
As of December 31, 2000, in addition to other matters disclosed above, the
Company is involved in other various legal proceedings that arose in the
ordinary course of business. In management's opinion, the ultimate resolution of
these proceedings will not have a material effect on the financial position,
results of operations and liquidity of the Company.
In the fourth quarter of 2000, the Company expensed $941,000 related to
other legal settlements.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
12
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS
MARKET INFORMATION. The Company's Common Stock commenced trading on the
NASDAQ National Market on January 28, 1993 under the symbol "OLGC." The bid
price information included herein is derived from the NASDAQ Monthly Statistical
Report, represents quotations by dealers, may not reflect applicable markups,
markdowns or commissions and does not necessarily represent actual transactions.
2000 1999
High Low High Low
---- --- ---- ---
First Quarter $ 8 5/16 2 9/16 $ 4 3/16 2 3/4
Second Quarter 6 1/8 3 9/16 3 7/8 2 5/16
Third Quarter 5 1/4 2 3/4 3 1/8 2 1/4
Fourth Quarter 3 7/32 2 5/32 3 1/16 2 1/4
As of March 23, 2001, 31,437,001 shares of the Common Stock of the Company
were outstanding and held by approximately 288 stockholders of record.
DIVIDENDS The Company has never paid a cash dividend on its Common Stock.
The Board of Directors currently anticipates that all the Company's earnings, if
any, will be retained for use in its business and does not intend to pay any
cash dividends on its Common Stock in the foreseeable future.
ITEM 6. SELECTED FINANCIAL DATA
SELECTED FINANCIAL DATA
The selected financial data for each of the five years in the period ended
December 31, 2000, are derived from audited financial statements of the Company.
The selected financial data should be read in conjunction with the Financial
Statements and related Notes thereto and other financial information appearing
elsewhere herein and the discussion in "Management's Discussion and Analysis of
Financial Condition and Results of Operations." The Company completed two
acquisitions in March 1997 and one in August 1996.
YEARS ENDING DECEMBER 31,
-------------------------------------------------------------
STATEMENTS OF OPERATIONS DATA: 2000 (2) 1999 1998 1997 (1) 1996
--------- --------- --------- --------- ---------
Total revenues $ 90,080 $ 83,232 $ 75,369 $ 77,049 $ 41,884
Total cost of revenues 18,289 18,504 17,693 18,369 8,299
Operating expenses:
Selling, general, and administrative 71,580 61,936 72,011 61,484 31,901
Research and development 4,690 2,860 2,920 2,320 2,169
Restructuring and other charges [Note 1] -- (216) (399) 13,844 --
Legal settlements 4,499 -- -- -- --
Write-off of Goodwill 23,348 -- -- -- --
Net gain from Discontinuation of
co-promotion agreement (844) -- -- -- --
--------- --------- --------- --------- ---------
Total operating expenses 103,273 64,580 74,532 77,648 34,070
--------- --------- --------- --------- ---------
Operating profit (loss) (31,482) 148 (16,856) (18,968) (485)
Other income 303 148 354 1,466 3,023
Income Taxes (12) (58) (100) (212) --
--------- --------- --------- --------- ---------
NET INCOME (LOSS) (31,191) 238 (16,602) (17,714) 2,538
Accretion of non-cash preferred stock dividend -- (824) (1,236) -- --
--------- --------- --------- --------- ---------
Net loss applicable to common stockholders $ (31,191) $ (586) $ (17,838) $ (17,714) $ 2,538
========= ========= ========= ========= =========
Net loss per common share
Basic $ (1.04) $ (0.02) $ (0.71) $ (0.71) $ 0.11
========= ========= ========= ========= =========
Net loss per common share
Diluted $ (1.04) $ (0.02) $ (0.71) $ (0.71) $ 0.11
========= ========= ========= ========= =========
Basic shares outstanding 29,855 26,078 25,291 25,116 23,275
Equivalent shares -- -- -- -- 869
--------- --------- --------- --------- ---------
DILUTED SHARES OUTSTANDING 29,855 26,078 25,291 25,116 24,144
========= ========= ========= ========= =========
13
1. Net income was affected in 1997 by a one-time charge for restructuring and
other costs, applicable to the impairment of dealer intangibles acquired in
the transition to a direct sales force and expenses related to severance,
facility closing and related costs. The effect on earnings per share from
the restructuring and other changes is a loss of .55 cents per share.
2. Net income was affected in 2000 by several additional charges consisting of
$3.6 million for the class action legal settlement; $27.3 million related
to the CPM business comprised of the write-off of impaired Goodwill,
adjustments to accounts receivable, and expenses related to other legal
settlements; $2 million to obtain additional Chrysalin rights; and a net
gain of $844,000 on the discontinuation of the Co-Promotion Agreement for
Hyalgan.
Years Ended December 31,
----------------------------------------------------
2000 1999 1998 1997 1996
-------- -------- -------- -------- --------
BALANCE SHEET DATA:
(In Thousands)
Working capital $ 43,056 $ 40,865 $ 38,817 $ 44,418 $ 74,985
Total assets 65,035 92,203 93,980 103,103 113,026
Long-term debt, less current maturities 88 209 196 1,631 280
Stockholders' equity 51,910 73,054 68,225 84,737 101,927
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
RESULTS OF OPERATIONS YEARS ENDED
DECEMBER 31, 1998, 1999 AND 2000
REVENUES OrthoLogic's total revenues increased 8.2% from $83.2 million in
1999 to $90.1 million in 2000. Revenues from net sales increased by 28% to $41.7
million during 2000 from $32.6 million in 1999. Net sales are comprised of sales
of the OL1000, SpinaLogic, fracture fixation devices, orthopedic rehabilitation
equipment and ancillary products. The growth in net sales is primarily
attributed to sales of the SpinaLogic product, which was introduced in 2000.
Sales recorded for the OL1000 product increased 10.7% from 1999 to 2000. OL1000
sales were positively effected by the introduction of the Single Coil size
2-unit and residual benefits from the changes in Medicare guidelines for
reimbursement of bone growth stimulators enacted in 2000. Net rentals for CPM
equipment declined by $3.3 million in 2000, or 4.1% under 1999 rental revenue.
The Company emphasis on CPM sales has been to improve profitability of the
business including not accepting un-profitable sales. Fee revenue from
Hyalgan(R) increased from 1999 to 2000 by $1.0 million.
In January 2001, the Company announced plans to divest its CPM business to
refocus the Company on its core business of fracture healing and spinal repair.
After careful consideration, the Board feels the emphasis on the rehabilitation
segment of the orthopedic business no longer fits the Company's long-term
strategic plan. As of December 31, 2000, assets of the CPM business consist
primarily of accounts receivable, the rental fleet and related inventory which
have a carrying value at year end of approximately $20.6 million, $7.3 million,
and $6.0 million respectively. The related liabilities have a carrying value of
approximately $4.6 million. The Company anticipates a sale of the CPM assets
will be completed within a twelve-month period. The revenues attributable to the
CPM business have been approximately $60.3 million, $62.9 million, and $53.8
million for 2000, 1999, and 1998 respectively. The costs of revenues
attributable to the CPM business have been approximately $14.1 million, $15.9
million and $13.9 million for 2000, 1999 and 1998 respectively. Most operating
expenses are not directly allocated between the Company's various lines of
business. As a result of the decision to divest this business, the Company wrote
off the remaining $23.3 million of Goodwill related to the CPM business. The
goodwill was assessed to be impaired to accordance with Statement of Financial
Standards No. 121. Additional adjustments to the carrying value of the CPM net
assets may be necessary in the future based on negotiated terms of any sale that
might occur. The Company has retained an investment-banking firm to assist in
evaluating the fair value of the business and the divestiture options.
The Company entered into an exclusive Co-Promotion Agreement (the
"Agreement") with Sanofi Pharmaceuticals Inc. ("Sanofi") at a cost of $4 million
on June 23, 1997, for purpose of marketing Hyalgan, a hyaluronic acid sodium
salt, to orthopedic surgeons in the United States for the treatment of pain in
patients with osteoarthritis of the knee.
14
The Company's sales force began to promote Hyalgan in the third quarter of
1997. Fee revenue of $9.3, $8.3 and $8.7 million was recognized during 2000,
1999 and 1998, respectively. In the fourth quarter of 2000, the Company and
Sanofi mutually agreed to terminate this Agreement. The Company has returned the
rights to sell Hyalgan back to Sanofi. The Company received $4 million to
complete a successful transition of the business back to Sanofi by January 1,
2001, and will receive continuing royalties for the next two years.
The Company signed an exclusive worldwide sales agreement for a 10-year
period, beginning August 18, 2000 with DePuy AcroMed, Inc. ("DePuy"), a unit of
Johnson and Johnson whereby DePuy will assume sales responsibility for
SpinaLogic, the Company's device used as an adjunctive treatment after lumbar
spinal fusion surgeries. This sales transition began in the third quarter with
full implementation by December 31, 2000.
OrthoLogic's total revenues increased 10% from $75.4 million in 1998 to
$83.2 million in 1999. Net sales increased by 10% to $32.6 million during 1999.
The growth in net sales is primarily attributed to an increased demand for
orthopedic rehabilitation products. Sales recorded for the OL1000 products were
relatively constant over the two-year period. The Company recorded its first
sale of SpinaLogic units after receiving FDA approval in late December 1999. Net
rentals for CPM equipment increases by $5.2 million in 1999 or 14% over 1998
rental revenue. Fee revenue from Hyalgan(R) decreased from 1998 to 1999 by
$444,000 or 5%.
GROSS PROFIT Gross profit increased 10.9% from $64.7 million in 1999 to
$71.8 million in 2000. The overall improvement in the margin is primarily
attributable to SpinaLogic's first year of sales. The cost of revenues decreased
from 22.2% in 1999 to 20.3% in 2000. This improvement is primarily attributable
to the increased sales of SpinaLogic, which has a more favorable margin compared
to other products. Overall, gross profit increased by 12% in 1999 from 1998.
That margin increase was attributable to a 14% growth in net rentals in 1999.
SELLING, GENERAL AND ADMINISTRATIVE ("SG&A") EXPENSES: SGA expenses
increased 15.6% from $61.9 million in 1999 to $71.6 million in 2000. This
increase is partially attributable to the growth in expenses directly related to
increased sales. Sales commission, royalty payments, bad debt reserves and
advertising expenses increased due to the growth of revenues cited above.
Because of the transition of SpinaLogic to DePuy AcroMed, expenses related to
sales of that product were temporally higher than normal. While the margin for
SpinaLogic is favorable, commissions as a percentage of net revenue, are higher.
In addition, in the fourth quarter of 2000, the Company recorded a charge of
approximately $3.0 million for additional bad debt related to older CPM
receivables. This charge was a result of a change in the estimated collection
rates. See Note 3 of the financial statements. SGA expenses were 74.4% of
revenues in 1999 and 79.5% of revenues in 2000.
SGA expenses decreased 14% from $72.0 million during 1998, to $61.9 million
during 1999. A significant portion of the decrease in cost is directly related
to an increase in bad debt expense of approximately $9.3 million during the
first quarter of 1998. Given the increase in variable costs associated with the
revenues, such as commissions and bad debt reserve, the fixed SG&A costs
decreased from 1998 to 1999. Excluding the additional bad debt expense in 1998,
SG&A expenses would have been 83.2% of total revenues, compared to 74.4% in
1999. See Note 3 of the financial statements.
RESEARCH AND DEVELOPMENT EXPENSES Research and development expenses
increased by $1.8 million in 2000 compared to 1999. The increase is attributable
to a payment of $2 million in 2000 to Chrysalis, which expanded the Company's
license agreement to include all Chrysalin orthopedic indications worldwide. In
January 1998, when OrthoLogic acquired an equity stake in Chrysalis for $750,000
as part of the equity investment, the Company acquired an option to license
Chrysalin for orthopedic applications. An additional fee of $750,000 for the
initial license was expensed in 1998. In 1999, the Company expensed an
additional milestone payment to Chrysalis for $500,000 to initiate the start of
the human clinical trials.
RESTRUCTURING AND OTHER CHARGES Included in other operating expenses for
2000 is a one-time write-off of impaired goodwill as a result of the decision to
divest the CPM business. This expense totaled $23.3 million. The Company also
recognized an expense of $3.6 million as a result of the settlement agreement
reached in the class action lawsuit. These expenses were partially offset by a
gain of $844,000 on the discontinuation of the co- promotion distribution rights
for Hyalgan. In the fourth quarter of 2000, the Company expensed $941,000
related to legal settlements.
15
During the third quarter of 1997, the Company restructured its sales,
marketing and managed care groups. As a result of the restructuring and a second
consecutive quarter of declining sales of the OL1000 in the third quarter of
1997, the Company determined that certain dealer intangibles acquired in the
transition to a direct sales force had been impaired. The Company recorded a
restructuring charge of $13.8 million in the third quarter of 1997, composed of
a $10.0 million write-off of its dealer intangibles and $3.8 million in
severance, facility closing and related costs. During 1999 and 1998, $216,000
and $399,000 of the 1997 restructuring charge was reversed.
OTHER INCOME (EXPENSE) Net other income in 2000, 1999, and 1998 consisted
primarily of interest income.
LIQUIDITY AND CAPITAL RESOURCES
The Company has financed its operations through the public and private
sales of equity securities and product revenues.
At December 31, 2000, the Company had cash and cash equivalents of $6.8
million and short term investments of $2.5 million. Working capital increased
5.6% from $40.8 million at December 31, 1999, to $43.1 million at December 31,
2000.
In July 1998, the Company completed a private equity placement with two
investors, an affiliate of Credit Suisse First Boston Corp. and Capital Ventures
International. Under the terms of the Purchase Agreement, OrthoLogic sold 15,000
shares of Series B Convertible Preferred Stock for $15 million (less $1 million
of operating costs). The Series B Convertible Preferred Stock is convertible
into shares of Common Stock and will automatically convert, to the extent not
previously converted, into Common Stock four years following the date of
issuance. Each share of Series B Convertible Preferred Stock is convertible into
Common Stock at a per share price equal to the lesser of the average of the 10
lowest closing bids during the 30 days prior to conversion, or $3.0353. In the
event of certain Mandatory Redemption Events, each holder of Series B Preferred
Shares will have the right to require the Company to redeem those shares for
cash at the Mandatory Redemption Price. Mandatory Redemption Events include, but
are not limited to: the failure of the Company to timely deliver Common Shares,
or Warrants; the Company's failure to satisfy registration requirements
applicable to such securities; the failure of the Company's stockholders to
approve the transactions contemplated by the Securities Purchase Agreement
related to the issuance of the Series B Preferred Shares; the failure by the
company to maintain the listing of its Common Stock on NASDAQ or another
national securities exchanges; and certain transactions involving the sale of
assets or business combinations involving the Company. In the event of only
liquidation dissolution or winding up the Company, holders of the Series B
Shares are entitled to receive, prior and in preference to any distribution of
any assets of the Company to the holders of Common Stock, the Stated Value for
each Series B Preferred Shares outstanding at that time. The Purchases Agreement
contains strict convents that protect against hedging and short-selling of
OrthoLogic Common Stock while the purchaser holds shared of the Series B
Convertible Preferred Stock.
In connection with the private placement of the Series B Convertible
Preferred Stock, OrthoLogic issued to the purchasers warrants to purchase 40
shares of Common Stock for each share of Series B Convertible Preferred Stock,
exercisable at $5.50. These warrants expire in 2008. The warrants were valued at
$1,093,980. Additional costs of the private placement were approximately
$966,000. Both the value of the warrants and the cost of the equity offering
were recognized over the 10-month conversion period as an "accretion of non-cash
Preferred Stock dividends." The Company filed a registration statement covering
the underlying Common Stock.
Net proceeds of $14 million from the private placement were used to fund
new product opportunities, including SpinaLogic, Chrysalin and Hyalgan(R), as
well as to complete the re-engineering of the Company's key business processes.
The Company anticipates that its cash and short term investments, cash from
operations on hand and the funds available from its $10 million line of credit
[see note 10 of the accompanying Consolidated Financial Statements] will be
sufficient to meet the Company's presently projected cash and working capital
requirements for the next 12 months. There can be no assurance, however, that
this will prove to be the case. The timing and amounts of cash used will depend
on many factors, including the Company's ability to continue to increase
revenues, reduce and control its expenditures, become profitable and collect
amounts due from third party payors. Additional funds may be required if the
Company is not successful in any of these areas. The Company's ability to
continue funding its planned operations beyond the next 12 months is dependent
upon its ability to generate sufficient cash flow to meet its obligations on a
timely basis, or to obtain additional funds through equity or debt financing, or
from other sources of financing, as may be required.
16
Net cash provided by operations during 2000 was $1.5 million compared to
$4.7 million in 1999. This decrease was primarily attributed to (1) net losses
of $31.2 million (which include a goodwill write-off of $23.3 million, Common
Stock issued for legal settlement of $3.0 million and license payment to
Chrysalin for $2.0 million), and (2) an increase in inventory of $700,000 and
depreciation/amortization of $5.3 million. The balance in accounts receivable
declined by $320,000 in 2000 compared to December 31, 1999.
Depreciation/amortization expense decreased in 2000, to $5.3 million from $6.8
million in 1999, due to the fact that 2000 does not contain a full year of
amortization of goodwill and other intangibles due to the write-off referenced
above. Net cash provided by operations during 1999 was $4.7 million, compared to
cash used by operations of $10 million in 1998. This improvement in operating
cash flows was primarily a result of (1) net income of $237,901, and (2) a
decrease in inventories of $2.7 million and depreciation/amortization of $6.8
million, partially offset by an increase in accounts receivable of $3.4 million
in 1999. The 1998 amount was primarily due to (1) a net loss of $16.6 million,
(2) a decrease in accrued and other current liabilities of $4.5 million, and (3)
an increase in inventories of $1.4 million, which was offset by a decrease in
accounts receivable of $5.7 million and depreciation/amortization of $6.5
million.
In June 1998, the FASB issued SFAS No. 133, Accounting for Derivative
Instruments and Hedging Activities. SFAS No. 133 requires that enterprises
recognize all derivatives as either assets or liabilities in the statement of
financial position and measure those instruments at fair value. The statement is
effective in the first quarter of 2001. The adoption of SFAS No. 133 will not
have a material effect on the Company's financial position or results of
operation because the Company currently has no derivative instruments or hedging
activities.
As discussed in greater detail in Note 11 to the Consolidated Financial
Statement, the Company has been named as a defendant in certain lawsuits and
product liability claims. Management believes that the allegations are without
merit and will vigorously defend them. Anticipated costs related to the
potential outcome of these actions have been accrued. No costs related to the
potential outcome of other actions have been accrued. "See Item 3 -Legal
Proceedings."
RISKS
The Company may from time to time make written or oral forward-looking
statements, including statements contained in the Company's filings with the
Securities and Exchange Commission and its reports to stockholders. This Report
contains forward-looking statements made pursuant to the "safe harbor"
provisions of the Private Securities Litigation Reform Act of 1995. In
connection with these "safe harbor" provisions, the Company identifies important
factors that could cause actual results to differ materially from those
contained in any forward-looking statements made by or on behalf of the Company.
Any such forward-looking statement is qualified by reference to the following
cautionary statements.
DIVESTITURE OF THE CPM DIVISION The Company announced its decision to
refocus its core business in the fracture healing and spinal repair segment of
the orthopedic market. The CPM business, which is focused in the rehabilitation
segment of the orthopedic market, no longer fits in the Company's long-term
strategic plans. Future market price of the Common Stock of the Company could be
greatly influenced by the successful completion of the transition plan.
LIMITED HISTORY OF PROFITABILITY; QUARTERLY FLUCTUATIONS IN OPERATING
RESULTS The Company was founded in 1987 and only began generating revenues from
the sale of its primary product in 1994. The Company has experienced significant
operating losses since its inception and had an accumulated deficit of
approximately $83 million at December 31, 2000. There can be no assurance that
the Company will ever generate sufficient revenues to attain operating
profitability or retain net profitability on an on-going annual basis. In
addition, the Company may experience fluctuations in revenues and operating
results based on such factors as demand for the Company's products, the timing,
cost and acceptance of product introductions and enhancements made by the
Company or others, levels of third party payment, alternative treatments that
currently exist or may be introduced in the future, completion of acquisitions
and divestitures, changes in practice patterns, competitive conditions,
regulatory announcements and changes affecting the Company's products in the
industry and general economic conditions. The development and commercialization
by the Company of additional products will require substantial product
development and regulatory, clinical and other expenditures. See "Item 1 --
Business -- Competition."
17
DEPENDENCE ON METHODS TO DISTRIBUTE PRODUCT Substantial portions of the
Company's sales are generated through the Company's internal sales force of
approximately 318 employees for all products except SpinaLogic. To enhance
market penetration of SPINALOGIC, the Company distributes this product through
an exclusive sales distribution agreement with DePuy AcroMed, Inc. If the
Company becomes dissatisfied with the SpinaLogic distribution, the Company may
increase expenses to terminate the distribution agreement and train its internal
sales staff to include SpinaLogic sales. The delay associated with such an event
may have an adverse effect on the Company's sales of SpinaLogic, its newest
product on the market. See "Item 1 -- Business -- Marketing and Sales."
POTENTIAL ADVERSE OUTCOME OF LITIGATION IN October 2000, the Company
announced that it had entered into a memorandum of understanding regarding
settlement of several law suits in 1996. See "Item 3 - Legal Proceeding's." The
settlement is still subject to review by the members of the class and the judge
who will conduct a fairness hearing before the settlement is accepted.
Objections by either party could result in a nullification of the current
memorandum of Understanding, which could result in new settlement terms that are
not as favorable to the Company.
DEPENDENCE ON KEY PERSONNEL The success of the Company is dependent in
large part on the ability of the Company to attract and retain its key
management, operating, technical, marketing and sales personnel as well as
clinical investigators who are not employees of the Company. Such individuals
are in high demand, and the identification, attraction and retention of such
personnel could be lengthy, difficult and costly. The Company competes for its
employees and clinical investigators with other companies in the orthopedic
industry and research and academic institutions. There can be no assurance that
the Company will be able to attract and retain the qualified personnel necessary
for the expansion of its business. A loss of the services of one or more members
of the senior management group, or the Company's inability to hire additional
personnel as necessary, could have an adverse effect on the Company's business,
financial condition and results of operations. See "Item 1 -- Business --
Employees."
HISTORICAL DEPENDENCE ON PRIMARY PRODUCT; FUTURE PRODUCTS The Company
believes that, to sustain long-term growth, it must continue to develop and
introduce additional products and expand approved indications for its remaining
products. The development and commercialization by the Company of additional
products will require substantial product development, regulatory, clinical and
other expenditures. There can be no assurance that the Company's technologies
will allow it to develop new products or expand indications for existing
products in the future or that the Company will be able to manufacture or market
such products successfully. Any failure by the Company to develop new products
or expand indications could have a material adverse effect on the Company's
business, financial condition and results of operations. See "Item 1 -- Business
- -- Products" and "Item 1 -- Business -- Competition."
UNCERTAINTY OF MARKET ACCEPTANCE The Company believes that the demand for
bone growth stimulators is still developing and the Company's success will
depend in part upon the growth of this demand. There can be no assurance that
this demand will develop. The long-term commercial success of the OL1000 and
SPINALOGIC and the Company's other products will also depend in significant part
upon its widespread acceptance by a significant portion of the medical community
as a safe, efficacious and cost-effective alternative to invasive procedures.
The Company is unable to predict how quickly, if at all, members of the
orthopedic medical community may accept its products. The widespread acceptance
of the Company's primary products represents a significant change in practice
patterns for the orthopedic medical community and in reimbursement policy for
third party payors. Historically, some orthopedic medical professionals have
indicated hesitancy in prescribing bone growth stimulator products such as those
manufactured by the Company. The use of CPM is more widely accepted, however the
Company must continue to prove that the products are safe, efficacious, and cost
effective in order to maintain and grow its market share. As the newest product
to the market, SPINALOGIC'S sales and acceptance by the medical community is not
certain. Failure of the Company's products to achieve widespread market
acceptance by the orthopedic medical community and third party payors would have
a material adverse effect on the Company's business, financial condition and
results of operations. See "Item 1 -- Business -- Third Party Payment."
MANAGEMENT OF GROWTH The Company's future performance will depend in part
on its ability to manage change in its operations and changes in the healthcare
industry, including integration of acquired businesses. In addition, the
Company's ability to manage its growth effectively will require it to continue
to improve its manufacturing, operational and financial control systems and
infrastructure and management information systems, and to attract, train,
motivate, manage and retain key employees. If the Company's management were to
become unable to manage growth effectively, the Company's business, financial
condition, and results of operations could be adversely affected.
18
LIMITATIONS ON THIRD PARTY PAYMENT; UNCERTAIN EFFECTS OF MANAGED CARE The
Company's ability to commercialize its products successfully in the United
States and in other countries will depend in part on the extent to which
acceptance of payment for such products and related treatment will continue to
be available from government health administration authorities, private health
insurers and other payors. Cost control measures adopted by third party payors
in recent years have had and may continue to have a significant effect on the
purchasing and practice patterns of many health care providers, generally
causing them to be more selective in the purchase of medical products. In
addition, payors are increasingly challenging the prices and clinical efficacy
of medical products and services. Payors may deny reimbursement if they
determine that the product used in a procedure was experimental, was used for a
non-approved indication or was unnecessary, inappropriate, not cost-effective,
unsafe, or ineffective. The Company's products are reimbursed by most payors,
however there are generally specific product usage requirements or documentation
requirements in order for the Company to receive reimbursement. In certain
circumstances, the Company is successful in appealing reimbursement coverage for
those applications, which do not comply with the payor requirements. Significant
uncertainty exists as to the reimbursement status of newly approved health care
products, and there can be no assurance that adequate third party coverage will
continue to be available to the Company at current levels. See "Item 1 -
Business - Third Party Payment."
UNCERTAINTY AND POTENTIAL NEGATIVE EFFECTS OF HEALTHCARE REFORM The health
care industry is undergoing fundamental changes resulting from political,
economic and regulatory influences. In the United States, comprehensive programs
have been proposed that seek to (i) increase access to health care for the
uninsured, (ii) control the escalation of health care expenditures within the
economy and (iii) use health care reimbursement policies to help control the
federal deficit. The Company anticipates that Congress and state legislatures
will continue to review and assess alternative health care delivery systems and
methods of payment, and public debate of these issues will likely continue. Due
to uncertainties regarding the outcome of reform initiatives and their enactment
and implementation, the Company cannot predict which, if any, of such reform
proposals will be adopted and when they might be adopted. Other countries also
are considering health care reform. The Company's plans for increased
international sales are largely dependent upon other countries' adoption of
managed care systems and their acceptance of the potential benefits of the
Company's products and the belief that managed care plans will have a positive
effect on sales. For the reasons identified in this and in the preceding
paragraph, however, those assumptions may be incorrect. Significant changes in
health care systems are likely to have a substantial impact over time on the
manner in which the Company conducts its business and could have a material
adverse effect on the Company's business, financial condition and results of
operations and ability to market its products as currently contemplated.
INTENSE COMPETITION The orthopedic industry is characterized by intense
competition. Currently, there are three major competitors other than the Company
selling bone growth stimulation products approved by the FDA for the treatment
of nonunion fractures, one large domestic and several foreign manufacturers of
CPM devices, and two competitors selling bone growth stimulation products for
use with spinal fusion patients. The Company also competes with many independent
owners/lessors of CPM devices in addition to the providers of traditional
orthopedic immobilization products and rehabilitation services. The Company
estimates that one of its competitors has a dominant share of the market for
bone growth stimulation products for non-healing fractures in the United States,
and another has a dominant share of the market for use of their device as an
adjunct to spinal fusion surgery. In addition, several large, well-established
companies sell fracture fixation devices similar in function to those sold by
the Company. Many participants in the medical technology industry, including the
Company's competitors, have substantially greater capital resources, research
and development staffs and facilities than the Company. Such participants have
developed or are developing products that may be competitive with the products
that have been or are being developed or researched by the Company. Other
companies are developing a variety of other products and technologies to be used
in CPM devices, the treatment of fractures and spinal fusion's, including growth
factors, bone graft substitutes combined with growth factors, and nonthermal
ultrasound. Many of the Company's competitors have substantially greater
experience than the Company in conducting research and development, obtaining
regulatory approvals, manufacturing and marketing and selling medical devices.
Any failure by the Company to develop products that compete favorably in the
marketplace would have a material adverse effect on the Company's business,
financial condition and results of operations. See "Item 1 -- Business --
Research and Development" and "Item 1 -- Business -- Competition."
RAPID TECHNOLOGICAL CHANGE The medical device industry is characterized by
rapid and significant technological change. There can be no assurance that the
Company's competitors will not succeed in developing or marketing products or
technologies that are more effective or less costly, or both, and which render
the Company's products obsolete or non-competitive. In addition, new
technologies, procedures and medications could be developed that replace or
reduce the value of the Company's products. The Company's success will depend in
19
part on its ability to respond quickly to medical and technological changes
through the development and introduction of new products. There can be no
assurance that the Company's new product development efforts will result in any
commercially successful products. A failure to develop new products could have a
material adverse effect on the Company's business, financial condition and
results of operations. See "Item 1 -- Business -- Research and Development."
GOVERNMENT REGULATION The Company's current and future products and
manufacturing activities are and will be regulated under the FDC Act. The
Company's current BIOLOGIC technology-based products are classified as Class III
Significant Risk Devices, which are subject to the most stringent level of FDA
review for medical devices and are required to be tested under IDE clinical
trials and approved for marketing under a PMA. The Company's fracture fixation
devices are Class II devices that are marketed pursuant to 510(k) clearance from
the FDA. Chrysalin, as a new drug, is subject to clinical trial and Good
Manufacturing Practices review similar to those that apply to the BioLogic
technology-based products.
The FDA and comparable agencies in many foreign countries and in state and
local governments impose substantial limitations on the introduction of medical
devices through costly and time-consuming laboratory and clinical testing and
other procedures. The process of obtaining FDA and other required regulatory
approvals is lengthy, expensive and uncertain. Moreover, regulatory approvals,
if granted, typically include significant limitations on the indicated uses for
which a product may be marketed. In addition, approved products may be subject
to additional testing and surveillance programs required by regulatory agencies,
and product approvals could be withdrawn and labeling restrictions may be
imposed for failure to comply with regulatory standards or upon the occurrence
of unforeseen problems following initial marketing.
The Company is also required to adhere to applicable requirements for FDA
GMP, to engage in extensive record keeping and reporting and to make available
its manufacturing facilities for periodic inspections by governmental agencies,
including the FDA and comparable agencies in other countries. Failure to comply
with these and other applicable regulatory requirements could result in, among
other things, significant fines, suspension of approvals, seizures or recalls of
products, or operating restrictions and criminal prosecutions. From time to
time, the Company receives letters from the FDA regarding regulatory compliance.
The Company has responded to all such letters and believes all outstanding
issues raised in such letters have been resolved. See "Item 1 -- Business --
Government Regulation."
Changes in existing regulations or interpretations of existing regulations
or adoption of new or additional restrictive regulations could prevent the
Company from obtaining, or affect the timing of, future regulatory approvals. If
the Company experiences a delay in receiving or fails to obtain any governmental
approval for any of its current or future products or fails to comply with any
regulatory requirements, the Company's business, financial condition and results
of operations could be materially adversely affected. See "Item 1 -- Business --
Products" and "Item 1 -- Business -- Government Regulation."
DEPENDENCE ON KEY SUPPLIERS The Company purchases the microprocessor used
in the OL1000 and SPINALOGIC devices from a single manufacturer, Phillips NV.
Although there are feasible alternate microprocessors that might be used
immediately, all are produced by Phillips. In addition, there are single
suppliers for other components used in the OL1000 and SPINALOGIC devices and
only two suppliers for the magnetic field sensor employed in them. Establishment
of additional or replacement suppliers for these components cannot be
accomplished quickly. Therefore, the Company maintains sufficient inventories of
such components in an attempt to ensure availability of finished products in the
event of supply shortage or in the event that a redesign is required. The
Company purchases several CPM components, including microprocessors, motors and
custom key panels from sole-source suppliers. The Company believes that its CPM
products are not dependent on these components and could be redesigned to
incorporate comparable components without a material interruption to product
availability. The Company maintains a supply of certain OL1000 and SPINALOGIC
components to meet sales forecasts for 3 to 12 months. Chrysalin, which is
currently only in the clinical trial phase, is produced by a third party sole
supplier. Any delay or interruption in supply of components or products could
significantly impair the Company's ability to deliver its products in sufficient
quantities, and therefore, could have a material adverse effect on its business,
financial condition and results of operations.
DEPENDENCE ON PATENTS, LICENSES AND PROPRIETARY RIGHTS The Company's
success will depend in significant part on its ability to obtain and maintain
patent protection for products and processes, to preserve its trade secrets and
proprietary know-how and to operate without infringing the proprietary rights of
third parties. While the Company holds title to numerous United States and
foreign patents and patent applications, as well as licenses to numerous United
States and foreign patents, no assurance can be given that any additional
20
patents will be issued or that the scope of any patent protection will exclude
competitors, or that any of the patents held by or licensed to the Company will
be held valid if subsequently challenged See "Item 1 -- Business -- Patents,
Licenses and Proprietary Rights." The validity and breadth of claims covered in
medical technology patents involves complex legal and factual questions and
therefore may be highly uncertain. In addition, although the Company holds or
licenses patents of its technologies, others may hold or receive patents, which
contain claims having a scope that covers products developed by the Company.
There can be no assurance that licensing rights to the patents of others, if
required for the Company's products, will be available at all or at a cost
acceptable to the Company.
The Company's licenses covering the BIOLOGIC and ORTHOFRAME technologies
provide for payment by the Company of royalties. Each license may be terminated
if the Company breaches any material provision of such license. The termination
of any license would have a material adverse effect on the Company's business,
financial condition and results of operations.
The Company also relies on un-patented trade secrets and know-how. The
Company generally requires its employees, consultants, advisors and
investigators to enter into confidentiality agreements which include, among
other things, an agreement to assign to the Company all inventions that were
developed by the employee while employed by the Company that are related to its
business. There can be no assurance, however, that these agreements will protect
the Company's proprietary information or that others will not gain access to, or
independently develop similar trade secrets or know-how.
There has been substantial litigation regarding patent and other
intellectual property rights in the orthopedic industry. Litigation, which could
result in substantial cost to and diversion of effort by the Company, may be
necessary to enforce patents issued or licensed to the Company, to protect trade
secrets or know-how owned by the Company, or to defend the Company against
claimed infringement of the rights of others and to determine the scope and
validity of the proprietary rights of others. There can be no assurance that the
results of such litigation would be favorable to the Company. In addition,
competitors may employ litigation to gain a competitive advantage. Adverse
determinations in litigation could subject the Company to significant
liabilities, and could require the Company to seek licenses from third parties
or prevent the Company from manufacturing, selling or using its products, any of
which determinations could have a material adverse effect on the Company's
business, financial condition and results of operations. See "Item 1 -- Business
- -- Patents, Licenses and Proprietary Rights."
RISK OF PRODUCT LIABILITY CLAIMS The Company faces an inherent business
risk of exposure to product liability claims in the event that the use of its
technology or products is alleged to have resulted in adverse effects. To date,
no product liability claims have been asserted against the Company for its
fracture healing and only limited claims for its CPM products. The Company
maintains a product liability and general liability insurance policy with
coverage of an annual aggregate maximum of $2.0 million per occurrence. The
Company's product liability and general liability policy is provided on an
occurrence basis. The policy is subject to annual renewal. In addition, the
Company maintains an umbrella excess liability policy, which covers product and
general liability with coverage of an additional annual aggregate maximum of
$25.0 million. There can be no assurance that liability claims will not exceed
the coverage limits of such policies or that such insurance will continue to be
available on commercially reasonable terms or at all. If the Company does not or
cannot maintain sufficient liability insurance, its ability to market its
products may be significantly impaired. In addition, product liability claims
could have a material adverse effect on the business, financial condition and
results of operations of the Company. See "Item 1 -- Business -- Product
Liability Insurance."
POSSIBLE VOLATILITY OF STOCK PRICE Factors such as fluctuations in the
Company's operating results, developments in litigation to which the Company is
subject, announcements and timing of potential acquisitions, divestitures,
conversion of preferred stock, announcements of technological innovations or new
products by the Company or its competitors, FDA and international regulatory
actions, actions with respect to reimbursement matters, developments with
respect to patents or proprietary rights, public concern as to the safety of
products developed by the Company or others, changes in health care policy in
the United States and internationally, changes in stock market analyst
recommendations regarding the Company, other medical device companies or the
medical device industry generally and general market conditions may have a
significant effect on the market price of the Common Stock. In addition, the
stock market has from time to time experienced significant price and volume
fluctuations that are unrelated to the operating performance of particular
companies. These broad market fluctuations may adversely affect the market price
of the Company's Common Stock.
Developments in any of these areas, which are more fully described
elsewhere in "Item 1 -- Business," "Item 3 -- Legal Proceedings," and "Item 7 --
Management's Discussion and Analysis of Financial Condition and Results of
21
Operations" could cause the Company's results to differ materially from results
that have been or may be projected by or on behalf of the Company.
The Company cautions that the foregoing list of important factors is not
exclusive. The Company does not undertake to update any forward-looking
statement that may be made from time to time by or on behalf of the Company.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company has no debt and no derivative instruments at December 31, 2000.
The Company has exposure to foreign exchange rates through its
manufacturing subsidiary in Canada.
The Company does not use foreign currency exchange forward contracts or
commodity contracts to limit its exposure. The Company is not currently
vulnerable to a material extent to fluctuations in interest rates and commodity
prices.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Consolidated balance sheets, as of December 31, 2000 and 1999, and
consolidated statements of operations, stockholders' equity and cash flows for
each of the years in the period ended December 31, 2000 together with the
related notes and the report of Deloitte & Touche LLP, independent auditors, are
set forth on the following pages. Other required financial information is set
forth herein, as more fully described in Item 14 hereof.
Independent Auditors' Report
BOARD OF DIRECTORS AND STOCKHOLDERS
OrthoLogic Corp., Tempe, Arizona
We have audited the accompanying consolidated balance sheets of OrthoLogic Corp.
and subsidiaries (the "Company") as of December 31, 2000 and 1999, and the
related consolidated statements of operations, comprehensive income (loss),
stockholders' equity, and cash flows for each of the three years in the period
ended December 31, 2000. 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, such consolidated financial statements present fairly, in all
material respects, the financial position of the Company at December 31, 2000
and 1999, and the results of its operations and its cash flows for each of the
three years in the period ended December 31, 2000 in conformity with accounting
principles generally accepted in the United States of America.
/s/ Deloitte & Touche LLP
Deloitte & Touche LLP
Phoenix, Arizona
January 31, 2001
22
CONSOLIDATED BALANCE SHEETS
December 31,
----------------------------------
2000 1999
------------- -------------
ASSETS
Current assets:
Cash and cash equivalents $ 6,752,973 $ 6,023,263
Short-term investments [Note 5] 2,492,379 250,000
Accounts receivable, less allowance for
doubtful accounts of $13,801,791 and $15,502,720 [Note 3] 29,951,195 30,428,564
Inventories, net [Note 6] 10,006,665 9,306,455
Prepaids and other current assets 1,018,992 986,753
Deferred income taxes [Note 8] 2,630,659 2,630,659
------------- -------------
Total current assets 52,852,863 49,625,694
------------- -------------
Rental fleet, equipment & furniture, net [Note 7] 11,094,065 13,061,771
Deposits and other assets 338,068 766,586
Goodwill, net of accumulated amortization of $4,645,793 in 1999 [Note 1] -- 24,643,822
Investment in Chrysalis BioTechnology and other assets, net [Note 14] 750,000 4,105,574
------------- -------------
TOTAL ASSETS $ 65,034,996 $ 92,203,447
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 3,029,956 $ 2,568,805
Accrued compensation 3,044,599 2,852,631
Deferred credits 358,016 138,813
Accrued royalties [Note 4] 267,618 37,040
Accrued restructuring expenses [Note 2] -- 150,086
Sales and property taxes payable 1,259,579 1,908,904
Other accrued expenses 1,836,989 1,104,475
------------- -------------
Total current liabilities 9,796,757 8,760,754
------------- -------------
Deferred rent and capital leases 87,966 209,138
------------- -------------
Total liabilities 9,884,723 8,969,892
------------- -------------
Commitments and contingencies [Notes 4, 10, 11, 13 and 14]
Series B Convertible Preferred Stock, $1,000 par value; 3,240 and 10,180
shares issued and outstanding; liquidation preference, $3,240,000 and
$10,180,000 [Note 9] 3,240,000 10,180,000
STOCKHOLDERS' EQUITY [NOTE 9]
Common Stock, $.0005 par value; 50,000,000 shares authorized;
and 30,349,941 and 27,637,593shares issued and outstanding 15,174 13,818
Additional paid in capital 132,331,739 125,206,621
Common stock to be used for legal settlement 2,968,750
Deficit (83,182,628) (51,992,079)
Comprehensive loss (222,762) (174,805)
------------- -------------
Total stockholders' equity 51,910,273 73,053,555
------------- -------------
TOTAL LIABILTIES AND STOCKHOLDERS' EQUITY $ 65,034,996 $ 92,203,447
============= =============
See notes to consolidated financial statements
23
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDING DECEMBER 31,
---------------------------------------------------
2000 1999 1998
------------- ------------- -------------
REVENUES
Net sales $ 41,699,626 $ 32,578,511 $ 29,491,932
Net rentals 39,069,630 42,356,168 37,138,960
Fee revenue from co-promotion agreement [Note 13] 9,310,648 8,296,844 8,737,325
------------- ------------- -------------
Total revenues 90,079,904 83,231,523 75,368,217
------------- ------------- -------------
COST OF REVENUES
Cost of good sold 10,392,292 11,303,309 10,591,924
Cost of rentals 7,897,143 7,200,549 7,100,706
------------- ------------- -------------
Total cost of revenues 18,289,435 18,503,858 17,692,630
------------- ------------- -------------
GROSS PROFIT 71,790,469 64,727,665 57,675,587
OPERATING EXPENSES
Selling, general and administrative [Note 3] 71,580,178 61,936,094 72,010,982
Research and development [Note 14] 4,689,588 2,860,159 2,919,857
Restructuring and other charges [Note 2] (216,211) (398,943)
Legal Settlements [Note 11] 4,498,847
Write-off of goodwill [Note 1] 23,348,074
Net gain from discontinuation of co-promotion
of agreement [Note 13] (844,424)
------------- ------------- -------------
Total operating expenses 103,272,263 64,580,042 74,531,896
OPERATING PROFIT (LOSS) (31,481,794) 147,623 (16,856,309)
OTHER INCOME (EXPENSE)
Interest and other income 450,792 225,445 454,719
Interest expense (147,372) (77,281) (101,100)
------------- ------------- -------------
Total other income 303,420 148,164 353,619
------------- ------------- -------------
INCOME (LOSS) BEFORE INCOME TAXES (31,178,374) 295,787 (16,502,690)
Provision for income taxes [Note 8] (12,175) (57,886) (99,804)
------------- ------------- -------------
NET INCOME (LOSS) (31,190,549) 237,901 (16,602,494)
Accretion of non-cash preferred stock dividend (823,991) (1,235,988)
------------- ------------- -------------
Net loss applicable to common stockholders $ (31,190,549) $ (586,090) $ (17,838,482)
============= ============= =============
Net loss per common share-basic $ (1.04) $ (0.02) $ (0.71)
============= ============= =============
Net loss per common share-diluted $ (1.04) $ (0.02) $ (0.71)
============= ============= =============
Basic and diluted shares outstanding 29,855,397 26,078,058 25,290,784
============= ============= =============
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
YEAR ENDING DECEMBER 31,
--------------------------------------------------
2000 1999 1998
------------ ------------ ------------
Net loass applicable to common shareholders $(31,190,549) $ (586,090) $(17,838,482)
Foreign translation adjustment (47,957) (134,088) (18,136)
Comprehensive loss applicable to common stockholders $(31,238,506) $ (720,178) $(17,856,618)
============ ============ ============
See notes to consolidated financial statements
24
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
PAID IN COMPREHENSIVE
SHARES AMOUNT CAPITAL INCOME DEFICIT TOTAL
------ ------ ------- ------ ------- -----
Balance, January 1, 1998 25,255,190 $12,626 $119,413,210 $ (22,581) $(34,665,794) $ 84,737,461
Exercise of common stock options at
prices ranging from $.50 to $4.55
per share 47,000 23 158,754 -- -- 158,777
Stock option compensation -- -- 25,622 -- -- 25,622
Series B Preferred Convertible Stock -- -- 1,093,980 -- 1,093,980
Accretion of non-cash Preferred Stock -- -- (1,093,980) -- (142,008) (1,235,988)
Other -- -- 61,250 -- 4,307 65,557
Foreign translation adjustment (18,136) (18,136)
Net Loss -- -- -- -- (16,602,494) (16,602,494)
---------- ------- ------------ --------- ------------ ------------
Balance December 31, 1998 25,302,190 12,649 119,658,836 (40,717) (51,405,989) 68,224,779
Accretion of non-cash Preferred Stock (823,991) (823,991)
Exercise of common stock options
at prices ranging from $2.03 to
$2.88 per share 282,400 142 728,812 728,954
Conversion of Series B Preferred Stock 2,053,003 1,027 4,818,973 4,820,000
Foreign translation adjustment (134,088) (134,088)
Net Income 237,901 237,901
---------- ------- ------------ --------- ------------ ------------
Balance December 31, 1999 27,637,593 13,818 125,206,621 (174,805) (51,992,079) 73,053,555
Exercise of common stock options at
prices ranging from $2.03 to
$6.563 per share 91,637 46 186,428 186,474
Conversion of Series B Preferred Stock 2,620,711 1,310 6,938,690 6,940,000
Common Stock to be used for legal
settlement [Note 11] 2,968,750 2,968,750
Foreign translation adjustment (47,957) (47,957)
Net loss (31,190,549) (31,190,549)
---------- ------- ------------ --------- ------------ ------------
Balance December 31, 2000 30,349,941 $15,174 $135,300,489 $(222,762) $(83,182,628) $ 51,910,273
========== ======= ============ ========= ============ ============
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
25
CONSOLIDATED STATEMENTS OF CASH FLOW
Years Ended December 31,
-----------------------------------------------
2000 1999 1998
------------ ----------- ------------
OPERATING ACTIVITIES
Net income (loss) $(31,190,549) $ 237,901 $(16,602,494)
Adjustments to reconcile net income (loss)
to net cash used in operating activities:
Depreciation and amortization 5,325,110 6,758,663 6,473,000
Restructuring and other charges -- (216,211) (399,000)
Common stock issued for legal settlement 2,968,750 -- --
Write-off of Goodwill 23,348,074 -- --
Change in operating assets and liabilities:
Accounts receivable 319,569 (3,415,663) 5,682,834
Inventories (700,210) 2,653,616 (1,411,898)
Prepaids and other current assets (32,239) (175,153) 280,065
Deposits and other assets 428,518 (421,671) 186,870
Accounts payable 461,151 (469,879) 242,628
Accrued and other current liabilities 574,852 (263,944) (4,466,299)
------------ ----------- ------------
Net cash provided (used) in operating activities 1,503,026 4,687,659 (10,014,294)
------------ ----------- ------------
INVESTING ACTIVITIES
Expenditures for rental fleet, equipment and furniture (1,861,658) (4,958,701) (5,423,652)
Officer note receivable 157,800 (157,800) --
Investments in Chrysalin -- -- (750,000)
(Purchase) sale of short-term investments (2,242,379) 5,802,469 (1,484,943)
Sale of Hyalgan rights back to Sanofi - discontinuation
of co-promotion agreement 3,155,576
------------ ----------- ------------
Net cash (used) provided in investing activities (790,661) 685,968 (7,658,595)
FINANCING ACTIVITIES
Payments under long-term debt and capital lease obligations (121,172) (159,197) (157,984)
Payments on loan payable -- (500,000) (500,000)
Payments under co-promotion agreement -- (1,000,000) (2,000,000)
Net proceeds from stock options exercised and other 138,517 594,867 227,490
Net proceeds from issuance of convertible preferred stock and warrants -- -- 14,034,000
------------ ----------- ------------
Net cash (used in) provided by financing activities 17,345 (1,064,330) 11,603,506
------------ ----------- ------------
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS 729,710 4,309,297 (6,069,383)
------------ ----------- ------------
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 6,023,263 1,713,966 7,783,349
------------ ----------- ------------
CASH AND CASH EQUIVALENTS, END OF YEAR $ 6,752,973 $ 6,023,263 $ 1,713,966
============ =========== ============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Conversion of series B preferred stock for common stock $ 6,940,000 $ 4,820,000 --
Accretion of non-cash preferred stock dividend $ -- $ 823,992 $ 1,235,988
Purchase of property and equipment with capital leases -- -- $ 493,289
Purchase price adjustment related to preacquisition contingencies $ -- $ 175,653 $ 1,816,362
Cash paid during the year for interest $ 91,467 $ 50,510 $ 101,100
Cash paid during the year for income taxes $ 12,175 $ 3,295 $ 350,000
See notes to consolidated financial statements.
26
NOTES TO FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION OrthoLogic Corp. (the "Company" or "OrthoLogic") was
incorporated on July 30, 1987 (date of inception) and commenced operations in
September 1987. On August 30, 1996, OrthoLogic acquired all of the outstanding
capital stock of Sutter Corporation ("Sutter"), which became a wholly owned
subsidiary of OrthoLogic. On March 9, 1997, and March 12, 1997, the Company
acquired certain assets and assumed certain liabilities of Toronto Medical Corp.
("Toronto") and Danninger Medical Technology, Inc. ("DMTI "). Concurrent with
the acquisition of Toronto, the Company formed a wholly owned Canadian
subsidiary, now known as OrthoLogic Canada Ltd.
DESCRIPTION OF THE BUSINESS OrthoLogic develops, manufactures and markets
proprietary, technologically advanced orthopedic products and packaged services
for the orthopedic health care market including bone growth stimulation devices
and continuous passive motion ("CPM") devices. On January 24, 2001, the Company
announced its plans to divest of its CPM business. The decision to divest the
CPM business was based on a desire by OrthoLogic to refocus all of its
activities in the fracture healing and spinal repair segments of the orthopedic
market. The CPM business, which is focused in the rehabilitation segment of the
orthopedic market, no longer fits in the Company's long-term strategic Plan. The
Company also distributed Hyalgan (sodium hyaluronate), a therapeutic injectable
for relief of pain from osteoarthritis of the knee under the terms of the
Co-Promotion Agreement. The Co-Promotion Agreement was terminated and the rights
to distribute this product mutually terminated in October 2000.
OrthoLogic's products are designed to enhance the healing of diseased,
damaged, degenerated or recently repaired musculoskeletal tissue. The Company's
products focus on improving the clinical outcomes and cost-effectiveness of
orthopedic procedures that are characterized by compromised healing, high-cost,
potential for complication and long recuperation time. On January 14, 1999, the
Company exercised its option to license the United States development,
marketing, and distribution rights for the fresh fracture indications for
Chrysalin, a new tissue repair synthetic peptide. In 2000, the Company exercised
its options to license Chrysalin worldwide for Orthopedic applications and began
enrolling patients in the combined Phase I/II clinical trials for Chrysalin.
During the years ended December 31, 2000, 1999, and 1998, the Company
reported net income (losses) of $(31.2) million, $.2 million and $(16.6) million
respectively. The Company anticipates that its cash and short-term investments
on hand, cash from operations and the funds available from the revolving line of
credit (Note 10) will be sufficient to meet the Company's presently projected
cash and working capital requirements for the next 12 months. There can be no
assurance, however, that this will prove to be the case. The timing and amounts
of cash used will depend on many factors, including the Company's ability to
continue to increase revenues, reduce and control expenditures, become
profitable and collect amounts billed to Medicare and private insurers. Because
of the process of obtaining reimbursement from third party payors, the Company
must maintain sufficient working capital to support operations during the
collection cycle. Additional funds may be required if the Company is not
successful in any of these areas. The Company's ability to continue funding its
planned operations beyond the next 12 months is dependent on its ability to
generate sufficient cash flow to meet its obligations on a timely basis, or to
obtain additional funds through equity or debt financing, as may be required.
In January 2001, the Company announced plans to divest its CPM business to
refocus the Company on its core business of fracture healing and spinal repair.
After careful consideration, the Board feels the emphasis on the rehabilitation
segment of the orthopedic business no longer fits the Company's long-term
strategic plan. As of December 31, 2000, assets of the CPM business consist
primarily of accounts receivable, the rental fleet and related inventory which
have a carrying value at year end of approximately $20.6 million, $7.3 million,
and $6.0 million, respectively. The related liabilities have a carrying value of
approximately $4.6 million. The Company anticipates a sale of the CPM assets
will be completed within a twelve-month period. The revenues attributable to the
CPM business have been approximately $60.3 million, $62.9 million, and $53.8
million for 2000, 1999, and 1998 respectively. The costs of revenues
attributable to the CPM business have been approximately $14.1 million, $15.9
million and $13.9 million for 2000, 1999 and 1998 respectively. Most operating
expenses are not directly allocated between the Company's various lines of
business. As a result of the decision to divest this business, the Company wrote
off the remaining $23.3 million of Goodwill related to the CPM business. The
goodwill was assessed to be impaired in accordance with Statement of Financial
Accounting Standards No. 121. Additional adjustment to the carrying value if the
CPM net assets may be necessary in the future based on negotiated terms of any
sale that might occur. The Company has retained an investment-banking firm to
assist in evaluating the fair value of the business and the divestiture options.
27
PRINCIPLES OF CONSOLIDATION The consolidated financial statements include
the accounts of OrthoLogic and its subsidiaries. All intercompany accounts and
transactions have been eliminated. The Company prepares its consolidated
financial statements in accordance with accounting principles generally accepted
in the United States of America. The following briefly describes the significant
accounting policies used in the preparation of the financial statements of the
Company:
A. INVENTORIES are stated at the lower of cost (first in, first out method)
or market.
B. RENTAL FLEET, EQUIPMENT AND FURNITURE ARE stated at cost or, in the case
of leased assets under capital leases, at the present value of future lease
payments at inception of the lease. Depreciation is calculated on a
straight-line basis over the estimated useful lives of the various assets, which
range from three to seven years. Leasehold improvements and leased assets under
capital leases are amortized over the life of the asset or the period of the
respective lease using the straight-line method, whichever is the shortest.
C. REVENUE is recognized for sales of the OL1000 and SpinaLogic products at
the time authorization is received and the product is placed on the patient. If
the sale of either product is to a commercial buyer, revenue is recognized at
the time of shipment. The OrthoFrame(R) and the OrthoFrame/Mayo are typically
held on consignment at hospitals and revenue is recognized at the point a
purchase order is received from the hospital. Rental revenue for CPM products is
recorded during the period of usage. Revenue on rehabilitative ancillary
products is generally recognized at the time of shipment. Fee revenue for
Hyalgan was based upon the number of units sold at the wholesale acquisition
cost less amounts for distribution costs, discounts, rebates, returns, product
transfer price, an overhead factor and a royalty factor.
D. RESEARCH AND DEVELOPMENT represent both costs incurred internally for
research and development activities, as well as costs incurred by the Company to
fund the activities of the various research groups with which the Company has
contracted. All research and development costs are expensed when incurred.
E. CASH AND CASH EQUIVALENTS consist of cash on hand and cash deposited
with financial institutions, including money market accounts, and commercial
paper purchased with an original maturity of three month or less.
F. INCOME (LOSS) PER COMMON SHARES is computed on the weighed average
number of common or common and equivalent shares outstanding during each year.
Basic EPS is computed as net income (loss) applicable to common stockholders
divided by the weighted average number of common shares outstanding for the
period. Diluted EPS reflects the potential dilution that could occur from common
shares issuable through stock options, warrants, and other convertible
securities when the effect would be dilutive.
G. INTANGIBLE ASSETS. Goodwill from the acquisition of Sutter, Toronto and
DMTI was capitalized and amortized on a straight-line basis over 15-20 years.
The intangible relating to the product distribution rights for Hyalgan acquired
in the Co-Promotion Agreement was being amortized over 15 years.
H. IMPAIRMENT OF LONG-LIVED ASSETS. In accordance with Statement of
Financial Accounting Standards ("SFAS") No. 121, the Company reviews the
carrying values of its long-lived assets and identifiable intangibles for
possible impairment whenever events or changes in circumstances indicate that
the carrying amount of assets to be held and used may not be recoverable. We
evaluate the recoverability of property and equipment and intangibles held for
sale by comparing the carrying amount of the asset or group of assets against
the estimated undiscounted future net cash flows expected to result from the use
of the asset or group of assets and their eventual disposition. Goodwill from
acquisitions related to a group of assets being evaluated for impairment is
included in the evaluation. If the undiscounted estimated cash flows are less
than the carrying value of the asset or group of assets being reviewed, an
impairment loss would be recorded. The loss would be measured based on the
estimated fair value of assets. The estimated fair value would be based on the
best information available under the circumstances, including prices for similar
assets and the results of valuation techniques, including the present value of
expected future cash flows using a discount rate commensurate with the risks
involved. For assets to be disposed, the Company reports long-lived assets at
the lower of the carrying amount or fair value less cost to sell.
28
I. STOCK BASED COMPENSATION. The Company accounts for its stock based
compensation plan based on accounting Principles Board ("APB") Opinion No. 25.
In October 1995, the Financial Accounting Standards Board issued SFAS No. 123,
Accounting for Stock-Based Compensation. The Company has determined that it will
not change to the fair value method and will continue to use APB Opinion No. 25
for measurement and recognition of employee stock based transactions (Note 9).
J. USE OF ESTIMATES The preparation of the financial statements in
conformity with generally accepted accounting principles necessarily requires
management 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 and the reported amounts of revenue and
expenses during the reporting period. Actual results could differ from these
estimates. Significant estimates include the allowance for doubtful accounts
($13,801,791 and $15,502,720 at December 31, 2000 and 1999, respectively) and
sales discounts and adjustments which are based primarily on trends in
historical collection statistics, consideration of current events, payor mix and
other considerations. The Company derives a significant amount of its revenues
in the United States from third-party payors, including Medicare and private
insurers. Amounts paid under these plans are generally based on fixed or
allowable reimbursement rates. Revenues are recorded at the expected or
pre-authorized reimbursement rates when earned and include unbilled receivables
of $8.0 million and $6.3 million on December, 31, 2000 and 1999, respectively.
Some billings are subject to review by such third party payers and may be
subject to adjustments. In the opinion of management, adequate allowances have
been provided for doubtful accounts and contractual adjustments. However, these
estimates are always subject to adjustment which could be material. Any
differences between estimated reimbursement and final determinations are
reflected in the period finalized.
K. NEW ACCOUNTING PRONOUNCEMENT. In June 1998, the FASB issued SFAS No.
133, Accounting for Derivative Instruments and Hedging Activities. SFAS No. 133
requires that enterprises recognize all derivatives as either assets or
liabilities in the statement of financial position and measure those instruments
at fair value. The statement is effective in the first quarter of 2001. The
adoption of SFAS No. 133 will not have a material effect on the Company's
financial position or results of operation because the Company currently has no
derivative instruments or hedging activities.
2. RESTRUCTURING AND OTHER CHARGES
During the third quarter of 1997, the Company restructured its sales,
marketing and managed care groups. As a result of the restructuring and a second
consecutive quarter of declining sales of the OL1000 bone growth stimulator, the
Company determined that certain dealer intangibles acquired in the transition to
a direct sales force in 1996 had been impaired. The Company recorded a
restructuring charge of $13.8 million in the third quarter of 1997, composed of
a $10.0 million write-off its dealer intangibles, $2.3 million in severance,
$1.2 million in facility closing and $300,000 of related costs. There was a
reversal of 1997 restructuring expenses of $216,000 during 1999 and $399,000
during 1998. The $150,086 balance of restructuring reserves remaining at
December 31, 1999 related to severance, which was paid during 2000.
3. BAD DEBT EXPENSES
During the fourth quarter of 2000, the Company recorded a charge of
approximately $3.0 million of additional bad debt expense related to the older
receivables of the CPM business.
During the first quarter of 1998, the Company recorded a charge of
approximately $9.3 million for additional bad debt expense. The charge was a
result of a management decision during the first quarter of 1998 to focus
proportionately more resources on collection of current sales and on
re-engineering the overall process of billing and collections. Management
determined it was no longer considered to be cost effective to expend
significant resources on the collection of the older receivables as had been
done in the past.
4. LICENSE AGREEMENTS
The Company has committed to pay royalties on the sale of products or
components of products developed under certain product developing and licensing
agreements. The royalty percentages vary but generally range from 0.5% to 7% of
the sales amount for licensed products. The royalty percentage under the
different agreements decrease when either a certain sales dollar amount is
reached or royalty amount is paid. Royalty expense under these agreements
totaled $681,921, $126,179, and $258,456 in 2000, 1999, and 1998 respectively.
This increase in royalty expenses during 2000 is attributable to the
introduction of SpinaLogic in 2000.
29
5. INVESTMENTS AND FAIR VALUE DISCLOSURES
At December 31, 2000, marketable securities were composed of municipal
bonds, were managed as part of the Company's cash management program, and were
classified as held-to-maturity securities. All such securities were purchased
with original maturities of less than one year. Such classification requires
these securities to be reported at amortized cost.
A summary of the fair market value and unrealized gains and losses on these
securities is as follows:
December 31,
--------------------------
2000 1999
----------- -----------
Amortized cost $ 2,492,379 $ 250,000
Gross unrealized gains -- --
Gross unrealized losses (27,055) --
----------- -----------
Fair value $ 2,465,324 $ 250,000
=========== ===========
SFAS No. 107, Disclosures about Fair Value of Financial Instruments,
requires that the Company disclose estimated fair values for its financial
instruments. Fair value estimates are made at a specific point in time and are
based on relevant market information and information about financial
instruments; they are subject in nature and involve uncertainties, matters of
judgements, and therefore, cannot be determined with precision. These estimates
do not reflect any premium or discount that could result from offering for sale
at one time the Company's entire holdings of a particular instrument. Since the
fair market value is estimated at December 31, 2000, the amounts that will
actually be realized or paid in settlement of the instruments could be
significantly different.
For the Company's cash and cash equivalents, the carrying amount is assumed
to be the fair market value because of the liquidity of these instruments. The
carrying amount is assumed to be the fair value for account receivable, accounts
payable and other accrued expenses because of the short maturity of the
portfolios. Management believes the terms of the Company's Preferred Stock
approximates the terms in the marketplace under which they could be replaced.
Therefore, management believes the fair value approximates the carrying value of
these financial instruments
6. INVENTORIES
Inventories consisted of the following:
December 31,
----------------------------
2000 1999
------------ ------------
Raw materials $ 6,877,516 $ 7,083,159
Work-in-process 471,844 92,584
Finished goods 3,903,127 3,110,514
------------ ------------
11,252,487 10,286,257
Less allowance for obsolescene (1,245,822) (979,802)
------------ ------------
Total $ 10,006,665 $ 9,306,455
============ ============
30
7. RENTAL FLEET, EQUIPMENT AND FURNITURE
Rental fleet, equipment and furniture consisted of the following:
December 31,
----------------------------
2000 1999
------------ ------------
Rental fleet $ 18,727,713 $ 17,827,501
Machinery and equipment 2,223,770 2,243,657
Computer equipment 5,627,684 4,760,501
Furniture and fixtures 1,522,844 1,495,054
Leasehold and improvements 788,966 744,896
------------ ------------
28,890,977 27,071,609
Less accumulated depreciation and amortization (17,796,912) (14,009,838)
------------ ------------
Total $ 11,094,065 $ 13,061,771
============ ============
8. INCOME TAXES
At December 31, 2000, the Company has accumulated approximately $41 million
in net operating loss carryforwards and approximately $750,000 of general
business credit carryforwards expiring from 2002 through 2020 for federal income
tax purposes. Stock issuances, as discussed in Note 9, may cause a change in
ownership under the provisions of Internal Revenue Code Section 382;
accordingly, the utilization of the Company's net operating loss carry forwards
may be subject to annual limitations. Management has evaluated the available
evidence about future taxable income and other possible sources of realization
of deferred tax assets. The valuation allowance reduces deferred tax assets to
an amount that management believes will more likely than not be realized. The
components of deferred income taxes at December 31 are as follows:
December 31,
------------------------------
2000 1999
------------ ------------
Allowance for bad debts $ 5,521,000 $ 6,201,000
Other accruals and reserves 956,659 886,659
Valuation allowance (3,847,000) (4,457,000)
------------ ------------
Total current 2,630,659 2,630,659
------------ ------------
Net operating loss and general business
credit carryforwards 17,332,000 14,064,000
Difference in basis of fixed assets (1,756,000) (1,517,000)
Nondeductible accruals and reserves 159,000 159,000
Difference in basis of intangibles 9,203,000 4,011,000
Valuation allowance (24,938,000) (16,717,000)
------------ ------------
Total non current -- --
------------ ------------
Total deferred income taxes $ 2,630,659 $ 2,630,659
============ ============
The provision for income taxes are as follows (in thousands):
Years Ended December 31,
-----------------------------------
2000 1999 1998
-------- -------- --------
Current $ 12,175 $ 45,636 $146,327
Deferred 12,250 (46,523)
-------- -------- --------
Income Tax Provisions $ 12,175 $ 57,886 $ 99,804
======== ======== ========
31
A reconciliation of the difference between the provision (benefit) for income
taxes and income taxes at the statutory U.S. federal income tax rate is as
follows for the years ending December 31:
Years Ended December 31,
------------------------------------------------
2000 1999 1998
------------ ------------ ------------
Income taxes (benefit) at statutory rate $(10,912,000) $ 80,000 $ (5,611,000)
State income taxes (benefit) (1,559,000) 28,000 (990,000)
Change in valuation allowance 7,611,000 (471,000) 6,403,000
Other, primarily non-deductible goodwill 4,872,175 420,886 297,804
------------ ------------ ------------
Net Provision $ 12,175 $ 57,886 $ 99,804
============ ============ ============
9. STOCKHOLDERS' EQUITY AND SERIES B CONVERTIBLE PREFERRED STOCK
The number of common shares reserved for issuance under the 1987 Option
Plan is 4,160,000 shares. This plan expired during October 1997. In May 1997,
the Stockholders adopted a new Stock Option Plan (the "1997 Option Plan") which
replaced the 1987 Option Plan. The 1997 Option Plan reserved for issuance
1,040,000 shares of Common Stock and was amended in 1998 to increase the number
of shares of Common Stock by 275,000 shares. Two types of options may be granted
under the 1997 Option Plan: options intended to qualify as incentive stock
options under Section 422 of the Internal Revenue Code ("Code") and other
options not specifically authorized or qualified for favorable income tax
treatment by the Code. All eligible employees may receive more than one type of
option. Any director or consultant who is not an employee of the Company shall
be eligible to receive only nonqualified stock options under the 1997 Option
Plan. Included in the stock options granted are 100,100 granted in 2000 to an
employee exclusive of the 1987 and 1997 stock option plans.
In October 1989, the Board of Directors (the "Board") approved that in the
event of a takeover or merger of the Company in which 100% of the equity of the
Company is purchased, 75% of all unvested employee options will vest, with the
balance vesting equally over the ensuing 12 months, or according to the
individual's vesting schedule, whichever is earlier. If an employee or holder of
stock options is terminated as a result of or subsequent to the acquisition,
100% of that individual's stock option will vest immediately upon employment
termination. These provisions are also included in the 1997 Option Plan.
Options are granted at prices that are equal to the current fair value of
the Company's Common Stock at the date of grant. The vesting period is generally
related to length of employment and all incentive stock options lapse upon
termination of employment if not exercised within a 90-day period (or one year
after death or disability or the date of termination if terminated for cause).
A summary of the status of the Option Plans as of December 31, 2000, 1999,
and 1998, and changes during the years then ended is:
2000 1999 1998
---------------------- ---------------------- ----------------------
WEIGHTED- WEIGHTED- WEIGHTED-
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
SHARES PRICE SHARES PRICE SHARES PRICE
------ ----- ------ ----- ------ -----
Fixed options outstanding
at beginning of year 3,488,913 $ 5.24 3,384,825 $ 5.66 2,535,450 $ 6.07
Granted 762,400 3.33 688,850 3.12 1,024,000 4.79
Exercised (125,990) 2.37 (282,400) 2.58 (47,000) 3.92
Forfeited (499,477) 5.92 (302,362) 7.83 (127,625) 7.48
---------- ---------- ----------
Outstanding at end of year 3,625,846 4.85 3,488,913 5.24 3,384,825 5.66
========== ====== ========== ====== ========== ======
Options exercisable at year-end 2,734,347 2,357,717 1,744,357
========== ========== ==========
32
The following table summarizes information about fixed stock options outstanding
at December 31, 2000:
OUTSTANDING EXERCISABLE
-------------------------------------------------------- ----------------------------------
NUMBER WEIGHTED- WEIGHTED- NUMBER WEIGHTED-
RANGE OF OUTSTANDING AVERAGE REMAINING AVERAGE EXERCISABLE AVERAGE
EXERCISE PRICES AS OF 12/31/00 CONTRACTUAL LIFE EXERCISED PRICE AS OF 12/31/00 EXERCISED PRICE
- --------------- -------------- ---------------- --------------- -------------- ---------------
$1.8100 - $ 2.5000 433,008 6.40 $ 2.2623 348,530 $ 2.2256
$2.5310 - $ 3.1880 348,600 9.33 $ 2.7529 238,101 $ 2.7577
$3.2500 - $ 3.2500 405,000 7.77 $ 3.2500 315,521 $ 3.2500
$3.3440 - $ 3.6250 406,013 8.63 $ 3.5566 235,049 $ 3.5387
$4.0000 - $ 5.0000 382,700 7.91 $ 4.7349 174,950 $ 4.9037
$5.0630 - $ 5.5000 641,400 7.11 $ 5.4289 538,977 $ 5.4216
$5.5310 - $ 5.5630 120,000 7.01 $ 5.5577 95,000 $ 5.5563
$5.6250 - $ 5.6250 381,000 6.76 $ 5.6250 303,333 $ 5.6250
$5.8125 - $ 9.5000 410,725 5.59 $ 7.5058 387,486 $ 7.5566
$9.6250 - $17.3800 97,400 5.34 $17.2792 97,400 $17.2792
- ------------------ ---------- ----- -------- ---------- --------
$1.8100 - $17.3800 3,625,846 7.31 $ 4.8456 2,734,347 $ 5.0888
================== ========== ===== ======== ========== ========
The Company applies APB Opinion No. 25 and related interpretations in
accounting for its Option Plans. Accordingly, no compensation cost has been
recognized for its Option Plans. Had compensation cost been computed based on
the fair value of awards on the date of grant, as determined using the
Black-Scholes option-pricing model, consistent with the method stipulated by
SFAS No. 123, the Company's net loss and loss per share for the years ended
December 31, 2000, 1999, and 1998, would have been reduced to the pro forma
amount indicated below, followed by the model assumptions used.
2000 1999 1998
--------- --------- ----------
Estimated weighted-average fair value of
options granted during the year 2.13 1.61 2.26
Net income (loss) attributable to common stockholders:
As reported (in thousands) $(31,191) $ (586) $(17,838)
Pro forma (in thousands) $(32,814) $ (2,525) $(20,351)
Basic and Diluted Net income (loss) per-share:
As reported $ (1.04) $ (0.02) $ (0.71)
Pro forma $ (1.07) $ (0.10) $ (0.80)
Black-Scholes model assumptions:
Risk free interest rate 6.00% 6.00% 6.00%
Expected volatility 70% 60% 40%
Expected term 5 Years 5 Years 5 Years
Dividend yield 0% 0% 0%
In July 1998, the Company completed a private equity placement with two
investors, an affiliate of Credit Suisse First Boston Corp. and Capital Ventures
International. Under the terms of the Purchase Agreement, OrthoLogic sold 15,000
shares of Series B Convertible Preferred Stock for $15 million (before costs).
The Series B Convertible Preferred Stock is convertible into shares of Common
Stock and will automatically convert, to the extent not previously converted,
into Common Stock four years following the date of issuance. Each share of
Series B Convertible Preferred Stock is convertible into Common Stock at a per
share price equal to the lesser of the average of the 10 lowest closing bids
during the 30 days prior to conversion or $3.0353. In the event of certain
Mandatory Redemption Events, each holder of Series B Preferred Shares will have
the right to require the Company to redeem those shares for cash at the
Mandatory Redemption Price, as defined. Mandatory Redemption Events include, but
are not limited to: the failure of the Company to timely deliver common stock as
required under the terms of the Series B Preferred Shares, or Warrants; the
Company's failure to satisfy registration requirements applicable to such
securities; the failure by the Company to maintain the listing of its Common
Stock on NASDAQ or another national securities exchange; and certain
transactions involving the sale of assets or business combinations involving the
Company. In the event of any liquidation, dissolution or winding up of the
Company, holders of the Series B Shares are entitled to receive, prior and in
preference to any distribution of any assets of the Company to the holders of
Common Stock, the Stated Value for each Series B Preferred Shares outstanding at
that time. The Purchase Agreement contains strict covenants that protect against
hedging and short-selling of OrthoLogic Common Stock while the purchaser holds
shares of the Series B Convertible Preferred Stock.
33
In connection with the private placement of the Series B Convertible
Preferred Stock, OrthoLogic issued to the purchasers warrants to purchase 40
shares of Common Stock for each share of Series B Convertible Preferred Stock,
exercisable at $5.50. These warrants expire in 2008. The warrants were valued at
$1,093,980. Additional costs of the private placement were approximately
$966,000. Both the value of the warrants and the cost of the equity offering
were recognized over the 10-month conversion period as an "accretion of non-cash
Preferred Stock dividends." The Company filed a registration statement covering
the underlying Common Stock.
Proceeds from the private placement were used to fund new product
opportunities, including SpinaLogic, Chrysalin and Hyalgan, as well as to
complete the re-engineering of the Company's key business processes.
At the close of business on December 31, 2000, 11,760 shares of Series B
Convertible Preferred Stock had been converted into 4,673,714 shares of Common
Stock.
At December 31, 2000, there were 2,000,000 shares of Preferred Stock
authorized.
10. COMMITMENTS
The Company is obligated under non-cancelable operating lease agreements
for its office, manufacturing and research facilities. Rent expense for the
years ended December 31, 2000, 1999, and 1998, was approximately $1,767,000,
$1,998,000 and $1,716,000 respectively.
Future lease payments for 2001, 2002, 2003, 2004, 2005, and beyond 2005 are
approximately $1,033,000 $1,173,000, $1,173,000, $1,094,000, $1,078,000, and
$2,067,000, respectively.
The Company signed an exclusive worldwide sales agreement for a 10-year
period, beginning August 18, 2000 with DePuy AcroMed, Inc. ("DePuy"), a unit of
Johnson and Johnson whereby DePuy will assume sales responsibility for
SpinaLogic, the Company's device used as an adjunctive treatment after lumbar
spinal fusion surgeries. This sales transition began in the third quarter with
full implementation by December 31, 2000.
On February 28, 2000, the Company obtained a $10 million accounts
receivable revolving line of credit with a lending institution. The Company may
borrow up to 75% of the eligible account receivable, as defined in the
agreement. The interest rate is at the prime rate. Interest accruing on the
outstanding balance and a monthly administration fee is due in arrears on the
first day of each month. The line of credit expires February 28, 2003. There are
certain financial covenants and reporting requirements associated with the loan.
Included in the financial covenants are (1) tangible net worth of not less than
$43 million, (2) a quick ratio of not less than 2.0 to 1.0, (3) a debt to
tangible net worth ratio of not less than 0.50 to 1.0, and (4) capital
expenditures will not exceed more than $7.0 million dollars during any fiscal
year. The Company has not utilized this line of credit.
11. LITIGATION
In 1998, the Company settled a false claims matter with the U.S. Department
of Justice in a case that was filed in December 1996 under qui tam provisions of
the Federal False Claims Act. The allegations included the submission of claims
for reimbursement for a small number of custom medical devices to various
federal care programs including Medicare, TRICARE (formerly known as CHAMPUS)
and various state Medicaid programs.
OrthoLogic denies any wrongdoing or liability with respect to the
allegations in this matter. Nevertheless, in an effort to avoid the expense,
burden and uncertainty of litigation in this case as well as the potential
distraction this case could have on the Company's management, the Company agreed
to settle this matter. Under the terms of the definitive settlement agreement,
OrthoLogic paid to the U.S. Department of Justice, on behalf of several federal
health care programs, including Medicare, TRICARE, and various state Medicaid
programs, the amount of $1,000,000. In return, the U.S. Department of Justice
released the Company's officers, employees, and directors from any causes of
actions for civil damages or civil penalties for the various allegations being
settled in this matter. The original complaint was dismissed with prejudice.
During 1996, certain class actions lawsuits were filed in the United States
District Court for the District of Arizona against the Company and certain
officers and directors alleging violations of Sections 10(b) of the Securities
Exchange Act of 1934 ("Exchange Act") and SEC Rule 10b-5 promulgated thereunder,
and, as to other defendants, Section 20(a) of the Exchange Act.
34
Plaintiffs in these actions allege generally that information concerning
the May 31, 1996 letter received by the Company from the FDA regarding the
Company's OrthoLogic 1000 Bone Growth Stimulator, and the matters set forth
therein, were material and undisclosed, leading to an artificially inflated
stock price. Plaintiffs further alleged that the Company's non-disclosure of the
FDA correspondence and of the alleged practices referenced in that
correspondence operated as a fraud against plaintiffs, in that the Company
allegedly made untrue statements of material facts or omitted to state material
facts necessary in order to make the statements not misleading. Plaintiffs
further alleged that once the FDA letter became known a material decline in the
stock price of the Company occurred, causing damage to plaintiffs. All
plaintiffs sought class action status, unspecified compensatory damages, fees
and costs. Plaintiffs also sought extraordinary, equitable and/or injunctive
relief as permitted by law. The actions were consolidated for all purposes in
the United States District Court for the District of Arizona. On March 31, 1999,
the judge in the consolidated case before the United States District Court
granted the Company's Motion to Dismiss and entered an order dismissing all
claims in the suit against the Company and two individual officers/directors.
The judge allowed certain narrow claims based on insider trading theories to
proceed against certain individual defendants. On December 21, 1999, the
District Court granted plaintiffs' motion for class certification to include
purchasers of common stock between June 4 through June 18, 1996, inclusive.
On or about June 20, 1996, a lawsuit entitled Norman Cooper, et al. v.
OrthoLogic Corp., et al., and Cause No. CV 96-10799 was filed in the Superior
Court, Maricopa County, and Arizona. The plaintiffs allege violations of Arizona
Revised Statutes Sections 44-1991 (state securities fraud) and 44-1522 (consumer
fraud) and common law fraud based upon factual allegations substantially similar
to those alleged in the federal court class action complaints. Plaintiffs sought
class action status, unspecified compensatory and punitive damages, fees and
costs. Plaintiffs also sought injunctive and/or equitable relief. The Company
filed a Motion to Dismiss the Complaint in Arizona State Court in May 1999. The
Court denied the motion in July 1999, and granted the plaintiffs' motion for the
class certification on November 24, 1999.
In October 2000, the Company announced that it had entered into a
Memorandum of Understanding regarding settlement of the remaining class action
claims and Norman Cooper lawsuits. The settlement consists of $1 million in cash
and one million shares of newly issued OrthoLogic Common Stock valued at
$2,969,000. A significant portion (approximately $800,000) of the cash payment
was funded from its directors' and officers' liability insurance policy. The
Company recorded a $3.6 million charge, including legal expenses, for settlement
of the litigation. The settlement is subject to approval by the lead plaintiffs
and defendants; the preparation, execution and filing of the formal Stipulation
of Settlement; notice to settlement class members; and final approval of the
settlement by the courts at hearing. Management believes the settlement is in
the best interest of the Company and its shareholders as it frees the Company
from the cost and significant distraction of ongoing litigation. The agreement
to the Memorandum of Understanding does not constitute, and should not be
construed as, an admission that the defendants have any liability to or acted
wrongfully in any way with respect to the plaintiffs or any other person.
In the fourth quarter of 2000, the Company expensed $941,000 related to
other legal settlements.
As of December 31, 2000, in addition to other matters disclosed above, the
Company is involved in other various legal proceedings and product liability
claims that arose in the ordinary course of business. The costs associated with
defending these other matters cannot be determined at this time and accordingly,
no estimate of such costs have been included in there financial statements. In
management's opinion, the ultimate resolution of these proceedings will not have
a material effect on the financial position, results of operation, and liquidity
of the Company.
12. 401(k) PLAN
The Company adopted a 401(k) plan (the "Plan") for its employees on July 1,
1993. The Company may make matching contributions to the Plan on behalf of all
Plan participants, the amount of which is determined by the Board of Directors.
The Company did not make any matching contributions to the Plan in 1998. The
Company matched approximately $195,000 and $98,000 in 2000, and 1999
respectively.
13. CO-PROMOTION AGREEMENT
The Company entered into an exclusive Co-Promotion Agreement (the
"Agreement") with Sanofi Pharmaceuticals Inc. ("Sanofi") at a cost of $4 million
on June 23, 1997, for purpose of marketing Hyalgan, a hyaluronic acid sodium
salt, to orthopedic surgeons in the United States for the treatment of pain in
patients with osteoarthritis of the knee.
35
The Company's sales force began to promote Hyalgan in the third quarter of
1997. Fee revenue of $9.3, $8.3 and $8.7 million was recognized during 2000,
1999, and 1998, respectively. In the fourth quarter of 2000, the Company and
Sanofi mutually agreed to terminate this Agreement. The Company has returned the
rights to sell Hyalgan back to Sanofi. The Company received $4 million for the
return of the rights and to complete a successful transition of the business
back to Sanofi by January 1, 2001, and will receive continuing royalties for the
next two years. At the time of the sale, the carrying value of the related
intangible was $3,155,576. The net gain of $844,424 reimbursed the Company for
transition costs incurred by the Company.
14. LICENSING AGREEMENT
The Company announced in January 1998, that it had acquired a minority
equity interest in a biotech firm, Chrysalis Bio Technology, Inc. ("Chrysalis")
for $750,000. As part of the transaction, the Company was awarded a world-wide
exclusive option to license the orthopedic applications of Chrysalin, a patented
23-amino acid peptide that has shown promise in accelerating the healing process
and has completed an extensive pre-clinical safety and efficacy profile of the
product. In pre-clinical animal studies, Chrysalin was also shown to double the
rate of fracture healing with a single injection into the fresh fracture gap.
The Company's agreement with Chrysalis contains provisions for the Company to
continue and expand its option to license Chrysalin contingent upon regulatory
approvals, successful pre-clinical trials, and certain trials and certain
milestone payments to Chrysalis by the Company. As part of the equity
investment, OrthoLogic acquired options to license Chrysalin for orthopedic
applications. An additional fee of $750,000 for the initial license was expensed
in the third quarter of 1998 and the Agreement was extended to January 1999. In
January 1999, the Company exercised its option to license the U. S. development,
marketing and distribution rights for Chrysalin, for fresh fracture indications.
As part of the license agreement, and in conjunction to FDA clearance to begin
human clinical trials, OrthoLogic made and expensed a $500,000 milestone payment
to Chrysalis Biotechnology in the fourth quarter of 1999. In January 2000, the
Company began enrolling patients in the combined Phase I/II clinical trial for
Chrysalin. In July 2000, the Company made and expensed a $2 million payment to
Chrysalis and announced it was expanding its license agreement to include all
Chrysalin orthopedic indications worldwide. In addition, the agreement calls for
the Company to pay certain milestone payments and royalty fees, based upon
products developed and achievement of commercial services. Except for the
$750,000 minority equity interest, all payments made to Chrysalis have been
expensed as Research and Development expenses.
In January 2001, the Company announced that it had completed the enrollment
in its combined Phase I/II Investigation New Drug Application (INDA) clinical
trial for Chrysalin. Data permitting, the Company expects to submit an
application for a Phase III clinical trial to the FDA during the second half of
2001. There can be no assurance, however, that the clinical trials will result
in favorable data or that FDA approvals, if sought, will be obtained.
Significant additional costs for the Company will be necessary to complete
development of this product.
15. RELATED PARTY TRANSACTIONS
At December 31, 1999, the Company had an outstanding note receivable from
an officer of the Company for $157,800. The loan was increased by $81,200 in
January 2000. The principal and interest of both loans were paid in full in
2000.
16. CONDENSED CONSOLIDATED QUARTERLY RESULTS (UNAUDITED)
First Quarter Second Quarter Third Quarter Fourth Quarter
-------------------- -------------------- --------------------- ---------------------
2000 1999 2000 1999 2000 1999 2000 1999
-------- -------- -------- -------- -------- -------- -------- --------
(000 omitted, except for per share data)
Net sales $ 22,490 $ 21,068 $ 22,540 $ 20,728 $ 21,011 $ 20,258 $ 24,039 $ 21,177
Gross profit 17,682 16,350 18,245 16,119 16,709 15,586 19,154 16,672
Operating income (loss) 700 92 509 (214) (6,431) 24 (26,260) 246
Net income (loss) 694 (133) 549 (168) (6,207) 52 (26,227) 221
Accretion of non cash
preferred stock dividend -- (618) -- (206) -- -- -- --
Net income (loss) applicable
to Common Stockholders 694 (485) 549 (374) (6,207) 52 (26,227) 221
Net income (loss) per share
Basic 0.02 (0.02) 0.02 (0.01) (0.21) -- (0.87) 0.01
Diluted 0.02 (0.02) 0.02 (0.01) (0.21) -- (0.87) 0.01
36
In the third quarter of 2000, the Company expensed $3.6 million regarding
settlement of the class action lawsuits and expensed a $2 million payment to
expand its license agreement to include all Chrysalin orthopedic indications
worldwide.
In the fourth quarter of 2000, the Company expensed $27.3 million related
to the CPM business comprised of the write-off of impaired Goodwill, adjustments
to accounts receivable, expenses related to other legal settlements and a net
gain of $844,000 on the discontinuation of the Co-Promotion Agreement for
Hyalgan.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
EXECUTIVE OFFICERS OF THE REGISTRANT
The following table sets forth information regarding the executive officers
of the Company:
NAME AGE TITLE
- ---- --- -----
Thomas R. Trotter 53 Chief Executive Officer, President and Director
Terry D. Meier 62 Senior Vice President, Chief Financial Officer
William C. Rieger 51 Vice President of Business Development
Shane Kelly 31 Vice President of Sales
Ruben Chairez, Ph.D. 58 Vice President of Medical Regulatory and
Compliance
MaryAnn G. Miller 43 Vice President of Corporate Services
Kevin Lunau 43 Vice President of Manufacturing
Donna L. Lucchesi 37 Vice President of Marketing
James T. Ryaby 42 Vice President of Research
Thomas R. Trotter joined the Company as President and Chief Executive
Officer and a Director in October 1997. From 1988 to October 1997, Mr. Trotter
held various positions at Mallinckrodt, Inc. in St. Louis, Missouri, most
recently as President of the Critical Care Division and a member of the
Corporate Management Committee. From 1984 to 1988, he was President and Chief
Executive Officer of Diamond Sensor Systems, a medical device company in Ann
Arbor, Michigan. From 1976 to 1984, he held various senior management positions
at Shiley, Inc. (a division of Pfizer, Inc.) in Irvine, California.
Terry D. Meier joined the Company in March 1998 as Senior Vice President
and on April 1, 1998, began serving as its Chief Financial Officer. From 1974 to
1997, Mr. Meier held several positions at Mallinckrodt, Inc., a healthcare and
specialty chemicals company. Most recently at Mallinchrodt, he served as its
Vice President and Corporate Controller from 1989 to 1996, as the Senior Vice
President and Chief Financial Officer.
William C. Rieger joined the Company in January 1998 as Vice President,
Marketing and Sales. From 1994 to 1997, Mr. Rieger held the position of Vice
President of Sales and Marketing at Hollister Inc., a privately held
manufacturer of medical products. From 1985-1994, he held several positions as
Vice President at Miles Inc. Diagnostic Division, a manufacturer of diagnostic
products. Mr. Reiger was named Vice President of Business Development in 2000.
Shane Kelly joined the Company in 1991 as a Field Sales and Service
Representative. He has held numerous positions within the company including
National Accounts Manager, Director of National Accounts, Director of Corporate
and Payor Relations, Director of Managed Care, Area Vice President, and National
Sales Manager. He was named Vice President of Sales in 2000.
Ruben Chairez, Ph.D., joined the Company in May 1998 as Vice President,
Medical Regulatory and Compliance. From November 1993 through April 1998, Dr.
Chairez served as Vice President, Regulatory Affairs/Quality Assurance of SenDx
Medical, Inc., a manufacturer of blood gas analyzer systems. From July 1990 to
November 1993, Dr. Chairez was the Director of Regulatory Affairs with GlenProbe
Incorporated, an in vitro diagnostic device manufacturer.
MaryAnn G. Miller joined the Company as Vice President of Human Resources
in October 1996. From 1978 to 1987, Ms Miller held various positions with
Allstate Insurance Company in operations, management, and human resources. From
November 1995 to June 1996, Ms. Miller was Human Resources Director for
Southwestco Wireless, Inc., a provider of wireless telecommunications services
37
in the Southwest. From October 1992 to July 1995, Ms. Miller was a human
resources officer with Firstar Corporation, a Wisconsin-based bank holding
company. Ms. Miller was named Vice President of Corporate Services in 2001.
Kevin Lunau joined the Company as Vice President of Manufacturing on March
17, 1999. From 1991 to 1999, Mr. Lunau held management positions at OrthoLogic
Canada (previously Toronto Medical Corp.), a subsidiary of OrthoLogic. Most
recently, he served as OrthoLogic Canada's Executive Vice President and General
Manager.
Donna L. Lucchesi joined the Company in August 1998 as Director of
Marketing - Injectable Products. She was promoted to Director of Marketing in
February 2000 and moved into her current position as Vice President of Marketing
in January 2001. From 1990 to 1998, Ms. Lucchesi held a variety of marketing
positions at Mallinckrodt, Inc. in St. Louis, Missouri, most recently as
Director - Health Care Systems Marketing.
James T. Ryaby, Ph.D. joined the company as Director of Research in 1991
and became Vice President of Research in 1997. Prior to joining OrthoLogic, he
was a research scientist at Mt. Sinai School of Medicine in New York, where he
received his Ph.D. degree in cellular biology. His current research interests
are applications of cytokines, growth factors, and electromagnetic fields in
musculoskeletal tissue repair. Dr. Ryaby also serves as Adjunct Professor of
Bioengineering at Arizona State University.
Information in response to this Item is also incorporated by reference to
(i) the biographical information relating to the Company's directors under the
caption "Election of Directors" and the information relating to Section 16
compliance under the caption, "Section 16(a) Beneficial Ownership Reporting
Compliance" in the Company's definitive Proxy Statement for its Annual Meeting
of Stockholders to be held May 18, 2001 (the "Proxy Statement"). The Company
anticipates filing the Proxy Statement within 120 days after December 31, 2000.
ITEM 11. EXECUTIVE COMPENSATION
The information under the heading "Executive Compensation" and
"Compensation of Directors" in the Proxy Statement is incorporated herein by
reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information under the heading "Voting Securities and Principal Holders
Thereof - Security Ownership of Certain Beneficial Owners and Management" in the
Proxy Statement is incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information under the heading "Certain Transactions" in the Proxy
Statement is incorporated herein by reference.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) The following documents are filed as part of this report:
1. Financial Statements
The following financial statements of OrthoLogic Corp. and Independent
Auditors' Report are listed above.
Independent Auditors' Report
Balance Sheets - December 31, 2000 and 1999.
Statements of Operations - Each of the three years in the period ended
December 31, 2000.
Statements of Comprehensive Income - Each of the three years in the period
ended December 31, 2000.
Statements of Stockholders' Equity - Each of the three years in the period
ended December 31, 2000.
Statements of Cash Flows - Each of the three years in the period ended
December 31, 2000.
38
Notes to Financial Statements
2. Financial Statement Schedules
Independent Auditors Consent and Report on Schedule.
Valuation and Qualifying Accounts
Balance at Charged to Deductions to Balance at end
beginning of period Expenses Allowance of period
------------------- -------- --------- ---------
Allowance for doubtful accounts:
Balance December 31, 1997 $(11,370,524)
1998 Additions charged to expense $(19,529,547)
1998 Deductions to allowance $ 11,582,247
Balance December 31, 1998 $(19,317,824)
Balance December 31, 1998 (19,317,824)
1999 Additions charged to expense (18,800,728)
1999 Deductions to allowance 22,615,832
Balance December 31, 1999 (15,502,720)
Balance December 31, 1999 (15,502,720)
2000 Additions charged to expense (16,348,442)
2000 Deductions to allowance 18,049,371
Balance December 31, 2000 (13,801,791)
Allowance for inventory reserve:
Balance December 31, 1997 $ (361,638)
1998 Additions charged to expense $ (1,239,181)
1998 Deductions to allowance $ 852,421
Balance December 31, 1998 $ (748,398)
Balance December 31, 1998 (748,398)
1999 Additions charged to expense (1,422,333)
1999 Deductions to allowance 1,190,929
Balance December 31, 1999 (979,802)
Balance December 31, 1999 (979,802)
2000 Additions charged to expense (3,329,720)
2000 Deductions to allowance 3,063,700
Balance December 31, 2000 (1,245,822)
3. All management contracts and compensatory plans and arrangements are
identified by footnote after the Exhibit Descriptions on the attached Exhibit
Index.
(b) Reports on Form 8-K.
None.
(c) Exhibits
See the Exhibit Index immediately following the signature page of this
report, which Index is incorporated herein by reference.
(d) Financial Statements and Schedules - See Item 14(a)(1) above.
39
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.
ORTHOLOGIC CORP.
Date: March 30, 2001 By /s/ Thomas R. Trotter
----------------------------------------
Thomas R. Trotter
President and Chief Executive Officer
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/ Thomas R. Trotter President, Chief Executive Officer and March 30, 2001
- --------------------------- Director (Principal Executive Officer)
Thomas R. Trotter
/s/ John M. Holliman III Chairman of the Board of Directors March 30, 2001
- --------------------------- and Director
John M. Holliman III
/s/ Fredric J. Feldman Director March 30, 2001
- ---------------------------
Fredric J. Feldman
/s/ Elwood D. Howse, Jr. Director March 30, 2001
- ---------------------------
Elwood D. Howse, Jr.
/s/ Stuart H. Altman Director March 30, 2001
- ---------------------------
Stuart H. Altman, Ph.D.
/s/ Augustus A. White III Director March 30, 2001
- ---------------------------
Augustus A. White III, M.D.
/s/ Terry D. Meier Senior Vice President and Chief Financial March 30, 2001
- --------------------------- Officer (Principal Financial and Accounting
Terry D. Meier Officer)
S-1
ORTHOLOGIC CORP.
EXHIBIT INDEX TO REPORT ON FORM 10-K
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2000
(FILE NO. 0-21214)
EXHIBIT FILED
NO. DESCRIPTION INCORPORATED BY REFERENCE TO: HEREWITH
- ------- ----------- ----------------------------- --------
3.1 Amended and Restated Certificate of Exhibit 3.1 to the Company's Form 10-Q
Incorporation for the quarter ended March 31, 1997
("March 1997 10-Q")
3.2 Amended and Restated Certificate of Exhibit 3.2 to the Company's Form 10-Q
Incorporation dated May 9, 2000 for the quarter ended March 31, 2000
3.3 Certificate of Designation in respect of Exhibit 3.1 to Company's Form 10-Q for
Series A Preferred Stock the quarter ended March 31, 1997
("March 1997 10-Q")
3.4 Bylaws of the Company Exhibit 3.4 to Company's Amendment No. 2
to Registration Statement on Form S-1
(No. 33-47569) filed with the SEC on
January 25, 1993 ("January 1993 S-1")
4.1 Stock Purchase Warrant, dated September Exhibit 4.6 to Company's Registration
20, 1995, issued to Registered Consulting Statement on Form S-1 (No. 33-97438)
Group, Inc. filed with the SEC on September 27, 1995
("1995 S-1")
4.2 Stock Purchase Warrant dated October 15, Exhibit 4.7 to the Company's Form 10-K
1996, issued to Registered Consulting for the year ended December 31, 1996
Group, Inc. ("1996 10-K")
4.3 Rights Agreement dated as of March 4, Exhibit 4.1 to the Company's Registration
1997, between the Company and Bank of New Statement on Form 8-A filed with the SEC
York, and Exhibits A, B and C thereto on March 6, 1997
4.4 1987 Stock Option Plan of the Company, as Exhibit 4.4 to the Company's Form 10-Q
amended and approved by stockholders (1) for the quarter ended June 30, 1997
("June 1997 10-Q")
4.5 1987 Stock Option Plan of the Company(1) Exhibit 4.5 to the Company's June 1997 10-Q
4.6 Stock Purchase Warrant dated March 2, Exhibit 4.10 to the Company's 1997 10-K
1998, issued to Silicon Valley Bank
4.7 Antidilution Agreement dated March 2, Exhibit 4.11 to the Company's 1997 10-K
1998, by and between the Company and
Silicon Valley Bank
4.8 Amendment to Stock Purchase Warrant dated Exhibit 4.1 to the Company's form 10-Q
May 12, 1998, issued to Silicon Valley for the quarter ended March 31, 1998
Bank
4.9 Form of Warrant Exhibit 4.1 to the Company's Form 8-K filed
on July 13, 1998
4.10 Registration Rights Agreement Exhibit 4.2 to the Company's Form 8-K
filed on July 13, 1998
10.1 License Agreement dated September 3, 1987, Exhibit 10.6 to January 1993 S-1
between the Company and Life Resonance's,
Inc.
10.2 Invention, Confidential Information and Exhibit 10.11 to January 1993 S-1
Non-Competition Agreement dated January
10, 1989, between the Company and Frank P.
Magee
10.3 Form of Indemnification Agreement* Exhibit 10.16 to January 1993 S-1
10.4 License Agreement dated December 2, 1992, Exhibit 10.22 to January 1993 S-1
between Orthotic Limited Partnership and
Company
10.5 Consulting Agreement dated May 1, 1990, Exhibit 10.11 to the Company's September
between Augustus A. White III and the 30, 1994 Form 10-Q
Company(1)
10.6 Employment Agreement by and between Exhibit 10.8 to the Company's March 1997 10-Q
MaryAnn G. Miller and the Company
effective as of December 1, 1996 (1)
10.7 Co-promotion Agreement dated June 23, Exhibit 10.1 to the Company's June 1997 10-Q
1997, by and between the Company and
Sanofi Pharmaceuticals, Inc.
EXHIBIT FILED
NO. DESCRIPTION INCORPORATED BY REFERENCE TO: HEREWITH
- ------- ----------- ----------------------------- --------
10.8 Single-tenant Lease-net dated June 12, Exhibit 10.2 to the Company's Form 10-Q
1997, by and between the Company and for the quarter ended September 30, 1997
Chamberlain Development, L.L.C. ("September 1997 10-Q")
10.9 Employment Agreement dated October 20, Exhibit 10.3 to the Company's
1997, by and between the Company and September 1997 10-Q
Thomas R. Trotter, including Letter of
Incentive Option Grant, OrthoLogic Corp.
1987 Stock Option Plan (1)
10.10 Employment Agreement dated October 17, Exhibit 10.4 to the Company's
1997, by and between the Company and Frank September 1997 10-Q
P. Magee (1)
10.11 Employment Agreement effective as of Exhibit 10.40 to the Company's 1997 10-K
December 15, 1997, by and between the
Company and William C. Rieger (1)
10.12 Employment Agreement effective as of March Exhibit 10.42 to the Company's 1997 10-K
16, 1998, by and between the Company and
Terry D. Meier (1)
10.13 Registration Rights Agreement dated March Exhibit 10.45 to the Company's 1997 10-K
2, 1998, by and between the Company and
Silicon Valley Bank
10.14 Licensing Agreement with Chrysalis Exhibit 10.1 to the Company's September 1998 10-Q
Biotechnolgoy, Inc.
10.15 1998 Management Bonus Program Exhibit 10.2 to the Company's September 1998 10-Q
10.16 Securities Purchase Agreement Exhibit 10.1 to the Company's Form 8-K
filed on July 13, 1998
10.17 First Amendatory Agreement to March 4, Exhibit 10.1 to the Company's Form 8-K
1997, Rights Agreement filed August 24, 1999
10.18 Credit and Security Agreement between the Exhibit 10.18 to the Company's 1999 Form 10/KA
Company and Wells Fargo Business Credit,
Inc. dated February 28, 2000
10.19 Lease Extension and Amendment Agreement Exhibit 10.19 to the Company's' 1999 Form 10/KA
dated September 29, 1998 between the
Company and the Heritage Corp. for the
Pickering property
10.20 Termination of Co-Promotion Agreement/ Exhibit 10.2 to the Company's Form 10-Q X
Hyalgan between the Company and Sanofi for the quarter ended September 30, 2000
Pharmaceuticals, Inc. in redacted form pursuant to a
confidentiality request and filed
herewith without redactions.
10.21 Amendment of Marketing and Distribution Exhibit 10.1 to the Company's Form 10-Q
Agreement Effective July 12, 2000. for the quarter ended June 30, 2000.
21.1 Subsidiaries of Registrant Exhibit 21.1 to the Company's 1997 10-K
23.1 Independent Auditors' Consent and Report
on Schedule. X
99.1 Audit Committee Charter X
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(1) Management contract or compensatory plan or arrangement
* The Company has entered into a separate indemnification agreement with each
of its current direct and executive officers that differ only in party
names and dates. Pursuant to the instructions accompanying Item 601 of
Regulation S-K, the Company has filed the form of such indemnification
agreement.