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, 2001
[ ] 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 14,
2002 was approximately $162,264,308. 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
14, 2002 was 31,816,531.
ORTHOLOGIC CORP.
FORM 10-K ANNUAL REPORT
YEAR ENDED DECEMBER 31, 2001
TABLE OF CONTENTS
PART I Page
----
Item 1. General Development of Business.................................. 1
Item 2. Properties....................................................... 8
Item 3. Legal Proceedings................................................ 8
Item 4. Submission of Matters to a Vote of Security Holders.............. 10
PART II
Item 5. Market for the Registrant's Common Equity and Related
Stockholder Matters............................................ 11
Item 6. Selected Financial Data.......................................... 12
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations...................................... 13
Item 7A. Quantitative and Qualitative Disclosures About Market Risk....... 24
Item 8. Financial Statements and Supplementary Data...................... 24
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure....................................... 24
PART III
Item 10. Directors and Executive Officers of the Registrant............... 24
Item 11. Executive Compensation........................................... 25
Item 12. Security Ownership of Certain Beneficial Owners and Management... 26
Item 13. Certain Relationships and Related Transactions................... 26
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.. 26
SIGNATURES.................................................................. S-1
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA................................. F-1
PART I
ITEM 1. BUSINESS
GENERAL DEVELOPMENT OF BUSINESS
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, references to the "Company" or "OrthoLogic" refer 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 designed to promote the healing of musculoskeletal
tissue, with particular emphasis on fracture healing and spinal repair.
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.
In July 2001, the Company sold its continuous passive motion ("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 fit in
the Company's long-term strategic plans.
OrthoRehab., Inc. purchased the CPM business for $12.0 million in cash, the
assumption of approximately $2.0 million in liabilities and a potential
additional payment to OrthoLogic of up to $2.5 million in cash, conditioned on
OrthoRehab's ability to collect on certain accounts receivable in the year
following the sale. OrthoLogic is currently in litigation with OrthoRehab, Inc.
regarding this $2.5 million contingent payment. The litigation is described in
greater detail in "Item 3 - Legal Proceedings."
In connection with the sale of the CPM business, OrthoLogic terminated 331
of its 505 employees and sublet approximately half of its principal business
facilities in Phoenix, Arizona to OrthoRehab.
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.
PRODUCTS AND OTHER PRODUCT DEVELOPMENT
OrthoLogic's product line includes bone growth stimulation and fracture
fixation devices. The Company's product line is sold primarily through the
Company's direct sales force supplemented by regional distributors. 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, electromagnetic
bone growth stimulator designed for patients with nonunion fractures. The OL1000
comprises two magnetic field treatment transducers (coils) and a
microprocessor-controlled signal generator that delivers a highly specific, low
energy signal to the injured area. The device is attached by the patient to the
patient's arm, leg or other area where there is a nonunion fracture. The OL1000
then evenly distributes a magnetic field over the patient's injured area. As a
result, specific placement of the device over the nonunion fracture is not
crucial for product efficacy as it is for some of our competitors' products.
The device is worn by the patient for 30 minutes each day. The Company
believes the reduced treatment time leads to increased patient compliance with
treatment protocol. In addition, the micro-controller tracks the patient's daily
treatment compliance.
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The OL1000 is used for the noninvasive treatment of an established nonunion
acquired secondary to trauma, excluding vertebrae and all flat bones. A nonunion
is considered to be established when the fracture site shows no visibly
progressive signs of healing.
The OL1000 SC is a single coil device, which utilizes the same magnetic
field as the OL1000, is available in three sizes and is designed to be more
comfortable for patients with certain types of fractures.
SPINALOGIC(R). SpinaLogic is a portable, noninvasive, electromagnetic 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 device is attached
to the lumbar injury location by a patient and provides localized magnetic field
treatment to the fusion site. Like the OL1000, the SpinaLogic device contains a
micro-controller which tracks the patient's daily treatment compliance, which
can easily be checked by the surgeon upon follow-up visits.
SpinaLogic is approved by the FDA as an adjunct treatment for primary
lumbar spinal fusions. It is designed for single patient use and is programmed
for 270 consecutive, 30minute daily treatments.
FRACTURE FIXATION DEVICES
ORTHOFRAME, ORTHOFRAME/MAYO. The Company began to manufacture and
distribute the OrthoFrame line of external fixation products in 1993. The
OrthoFrame/Mayo product is an external fixation device used in conjunction with
surgical procedures. It is low profile, lightweight, and primarily sold to
hospitals.
DISCONTINUED OR DIVESTED PRODUCTS
CONTINUOUS PASSIVE MOTION. In July 2001 the Company sold its CPM business.
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 Company offered a wide range of lower and upper extremity CPM devices. The
Company's financial results reflect sales of the CPM devices through the third
quarter of 2001.
ANCILLARY ORTHOPEDIC PRODUCTS. Along with the July 2001 sale of the CPM
business, the Company sold its ancillary orthopedic product lines of bracing,
electrotherapy, cryotherapy and dynamic splinting products. The bracing line
included 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. Cryotherapy is used to cool the operative or injured
site in order to prevent pain and swelling. The electrotherapy line consisted of
TENS, NMES, high volt pulsed current, interferential, and biofeedback units.
HYALGAN(R) (SODIUM HYALURONATE). The Company began selling Hyalgan to
orthopedic surgeons in July 1997, under a Co-Promotion Agreement with Sanofi
Synthelabo, Inc. (the "Co-Promotion Agreement"). In October 2000, it was
announced that the Company and Sanofi had mutually agreed to terminate this
agreement. The Company received an up-front cash payment, financial incentives
to complete the transition of the business through December 2000, and continuing
royalties through 2002.
PRODUCTS IN RESEARCH
CHRYSALIN(R). In January 1998, the Company made a minority equity
investment (less than 10%) in a biotech firm, Chrysalis BioTechnology, Inc.
("Chrysalis").
Chrysalin is a 23-amino acid synthetic peptide representing a fragment of
the human thrombin molecule. Thrombin has been shown to be involved in the
healing process for both soft tissue and bone. By mimicking specific attributes
of the thrombin molecule, Chrysalin stimulates the body's natural healing
processes, resulting in accelerated tissue repair.
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During 2001 the Company completed a Phase I/II human clinical trial
utilizing Chrysalin for fresh fracture repair to test the safety and preliminary
efficacy of Chrysalin. The Company is currently seeking approval to begin a
Phase III trial for that indication.
In March 2002, the Company received approval by the FDA to commence a Phase
I/II clinical trial for a spinal fusion indication. The Company anticipates
initiating a trial in the third quarter of 2002. The clinical trial will include
approximately 300 patients and will be performed at 15 to 20 centers in the
United States. The purpose of the study is to evaluate the safety and
preliminary efficacy of Chrysalin in combination with allograft. The patient
enrollment process is expected to take approximately 18 to 24 months with a
nine-month follow-up period. The Company also intends to submit an
Investigational New Drug application ("IND") for a combined Phase I/II human
clinical trial for Chrysalin for articular cartilage repair during 2002.
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.
OrthoLogic does not own the patents to Chrysalin. Chrysalin was developed
by and patented by Chrysalis BioTechnology, Inc., a company in which OrthoLogic
holds a minority equity interest. OrthoLogic, through a series of licensing
agreements, obtained from Chrysalis BioTechnology, Inc., the worldwide rights to
use Chrysalin for all orthopedic indications.
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 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, Inc. ("DePuy AcroMed"), a unit of Johnson and Johnson.
The Company's sales efforts for the OL1000 are through a combination of
direct sales representatives and select regional distributors. Of the Company's
approximately 149 employees at December 31, 2001, approximately 48 are involved
in field sales and marketing. The Company employs a Vice President of Sales, as
well as four Area Vice Presidents, to manage territory sales, along with a Vice
President of Distributor Sales to coordinate with the SpinaLogic distributors.
Through specialized marketing and sales staff, the Company has initiated
and maintained contracts with over 400 third party payors for the OL1000,
SpinaLogic, and for CPM product lines. In addition, the Company is an approved
Medicare and Medicaid provider.
OrthoLogic has not typically experienced seasonality in sales of the OL1000
or SpinaLogic. However, revenues from the Company's former CPM line had proven
to be seasonal. Historically the strongest quarters were the first and fourth
quarters for the CPM business of the calendar year. The Company believed 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. The
Company does not expect this seasonality in revenues to continue since the sale
of the CPM business in July 2001.
3
RESEARCH AND DEVELOPMENT
Individuals within the research and development department have extensive
experience in the areas of biomaterials, bioengineering, animal modeling, and
cellular and molecular biology. Research and development efforts emphasize
product engineering, basic and pre-clinical research, and the design and conduct
of the clinical trials conducted by the Company.
With regard to basic research, the research and development staff conducts
in-house research projects in the areas of bone biology, fracture healing, and
spine fusion, directed toward the clinical applications of the Chrysalin
platform technology. The staff also supports and monitors external research
projects in cartilage repair and biophysical stimulation applications in tissue
engineering. Both the in-house and external research and development projects
provide technical marketing support for the Company's products, explore the
development of new products, and additional therapeutic applications for
existing products.
The Company has a clinical affairs group that is part of research and
development that designs, initiates, and monitors clinical trials. The Company's
clinical affairs and regulatory groups recently completed a Phase I/II
Investigational New Drug trial for Chrysalin for fracture repair and is pursuing
further studies in both articular cartilage repair and spinal fusion.
The Company acquired a minority equity interest in Chrysalis for $750,000
in 1998. As part of the transaction, the Company was awarded a world-wide
exclusive option to license the orthopedic applications of Chrysalin. As part of
the equity investment, OrthoLogic acquired options to license Chrysalin for
orthopedic applications. A 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 fracture repair. As part of
the license agreement, and in conjunction with FDA clearance to begin human
clinical trials for fracture repair, OrthoLogic made a $500,000 milestone
payment to Chrysalis in the fourth quarter of 1999. In 2000, the Company paid
Chrysalis $2 million to extend its license agreement to include all Chrysalin
orthopedic indications worldwide. In July 2001, the Company paid $1.0 million to
Chrysalis to extend its worldwide license for Chrysalin to include the rights
for orthopedic "soft tissue" indications, including cartilage, tendon and
ligament repair. The license agreement calls for the Company to pay certain
other additional milestone payments and royalty fees, based upon the product's
development 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 March 2002, the Company made a $500,000
milestone payment to Chrysalis for receiving clearance from the FDA to begin a
Phase I/II trial for spinal fusion. See "Item 6 - Selected Financial Data and
Item 7 - Management's Discussion and Analysis of Financial Condition and Results
of Operations."
The Company's research and development expenditures totaled $3.9 million,
$4.7 million and $2.9 million the years ended December 31, 2001, 2000 and 1999,
respectively.
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 assembled CPM devices from parts that it manufactured in-house
or purchased from third parties. These parts were assembled, calibrated and
tested at the Company's facilities in Pickering (outside of Toronto), Canada.
The operations in Canada and all the Company's CPM related inventory were sold
to OrthoRehab, Inc. in the July 2001 sale of the CPM business.
The Company purchases components from specialty vendors for the
OrthoFrame/Mayo external fixation product. In-house manufacturing is limited to
inspection of the components and minor assembly tasks. Assembly and packaging of
the OrthoFrame/Mayo is contracted to specialty vendors.
4
A third party produces Chrysalin for the Company in only limited amounts.
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 businesses. In addition to surgical procedures, 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 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 AcroMed).
Many of the Company's competitors have substantially greater resources and
experience in research and development, obtaining regulatory approvals,
manufacturing, 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 the treatment of fractures and spinal fusions, 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.
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 - Risks Related to Our Industry."
PATENTS, LICENSES AND PROPRIETARY RIGHTS
The Company's practice is to require its employees, consultants and
advisors to execute a confidentiality and non-compete 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 65 BioLogic patents and design patents: 29 of
which are United States patents and the remainder are patents held in France,
Switzerland, Germany, Canada, Japan, Spain, United Kingdom, Italy and Australia.
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
5
2016. The BioLogic technology license covers all improvements and applies to the
use of the technology for all medical applications in humans 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.
The Company has been assigned and maintains 19 patents, 8 of which are
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.
ORTHOLOGIC(R), ORTHOFRAME(R), SPINALOGIC(R), TOMORROW'S TECHNOLOGY
TODAY(R), CASELOG(R), ORTHONAIL(TM) are federally registered trademarks of the
Company.
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, the Safe Medical Devices
Acts of 1990 and 1992, and the Food and Drug Administration Modernization Act of
1997, 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
an 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 limited or terminated. 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 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
6
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 for a
combined Phase I/II clinical trial for fracture repair. 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 IND
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 the 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 an 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 - Risks
Related to Our Industry."
Since the July 2001 sale of the CPM business, the Company has no longer
been subject to the review of the Canadian food and drug regulatory agencies.
The Company's Pickering, Canada facility manufactured the Company's CPM devices
that were imported into the United States. Under the Canada Food and Drugs Act,
the CPM devices required Canadian regulatory approval before their introduction
in the market and the manufacturing facility required an establishment license
that was applied for annually and could be denied upon site inspection. As of
July 2001, the Company had obtained these and other electrical safety approvals
required by Canadian law.
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 hospitals, 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 affect the Company's
profitability and cash flows.
7
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 bone growth stimulation products. To date, liability claims
resulting from when the Company sold CPM devices have not had a material adverse
effect on the Company. See "Item 7 - Management's Discussion and Analysis of
Financial Condition and Results of Operations - Risk Related to our Business."
EMPLOYEES
As of December 31, 2001, the Company had 149 employees in its operations,
including 48 in sales and marketing, 19 in research and development clinical and
regulatory affairs, 31 in reimbursement and 51 in manufacturing, finance and
administration. 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. None of the employees are represented by
a union. The Company considers its relationship with its employees to be good.
See "Item 7 - Management's Discussion and Analysis of Financial Condition and
Results of Operations - Risks Related to Our Business."
ITEM 2. PROPERTIES
The Company leases facilities in Tempe, Arizona. This facility is designed
and constructed for industrial purposes and is located in an industrial
district. The Company believes the facility is suitable for the Company's
purposes and is effectively utilized. The Company has a third party sublease
agreement for approximately 50 percent of the building through December 2002
with OrthoRehab, Inc., the company that purchased the CPM business. The table
below sets forth certain information about the Company's facility.
Approx. Lease Principal
Location Square Feet Expires Description Activity
- -------- ----------- ------- ----------- --------
Tempe 80,000(1) 11/07 2-story, in Assembly,
industrial park Administration
- ----------
(1) Approximately half of the facility is subleased to OrthoRehab, Inc.,
through December 2002.
The Company believes that the facility is well maintained and adequate for
use in the foreseeable future.
ITEM 3. LEGAL PROCEEDINGS
SETTLEMENT OF CLASS ACTION SUIT NORMAN COOPER, ET AL. V. ORTHOLOGIC CORP.
ET AL., MARICOPA COUNTY SUPERIOR COURT, ARIZONA, CASE NO. CV 96-10799, AND
RELATED FEDERAL CASES. 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 if 1934 ("Exchange Act") and SEC Rule 10b-5 promulgated
thereunder, and, as to other defendants, Section 20(a) of the Exchange Act.
The cases were originally filed in 1996, alleged generally that information
concerning the May 31, 1996 letter received by the Company from the FDA
regarding the Company's OL1000 Bone Growth Stimulator, and the matters set forth
therein, were material and undisclosed, leading to an artificially inflated
stock price. Plaintiffs further allege 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 in order to make the statement 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 the plaintiffs. All plaintiffs sought
class action status, unspecified compensatory damages, fees and costs. The
8
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 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 Case 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 injunction and or equitable relief. The court
granted the plaintiffs' motion for the class certification on November 24, 1999.
In early October 2000, the parties negotiated a global settlement of this
state court class action and the federal class action described below. In return
for dismissal of both the state and federal class actions, and releases by a
settlement class comprised of all purchasers of OrthoLogic common stock during
the period from January 18 through June 18, 1996, inclusive, the settlement
called for $1 million in cash and 1 million shares of newly-issued OrthoLogic
common stock. The settlement was presented to the Arizona superior court for
approval. The court granted preliminary approval of the settlement and ordered
notice to the settlement class by order dated April 30, 2001. Following notice
to the settlement class and a hearing on whether to give final approval of the
settlement, on August 17, 2001, the superior court gave final approval of the
settlement and signed and filed a judgment of dismissal of the action with
prejudice. We are not aware of any appeal from the judgment or other challenge
to the final approval of the settlement. Pursuant to the terms of the
settlement, the cash portion of the settlement fund has already been paid into
the settlement fund, with the substantial portion of the $1 million paid form
the proceeds of the Company's directors' and officers' liability insurance
policy, and the remaining cash paid by the Company. The Company recorded a $3.6
million charge, including legal expenses, for settlement. Pursuant to the terms
of the settlement and order of the superior court, the Company has issued and
delivered 300,000 shares of common stock to plaintiffs' settlement counsel as
part of the plaintiffs' counsel's fee award. The remaining 700,000 shares remain
to be delivered to the settlement fund pending administration of the claims
process under the settlement. Notices have been sent to stockholders of record
for the relevant time period to calculate the settlement pool each stockholder
is to receive.
Management believes the settlement is in the best interests of the Company
and its shareholders as it frees the Company from the cost and significant
distraction of the ongoing litigation. The settlement does not constitute, and
should not be construed as, an admission that the defendants have any liability
or acted wrongfully in any way with respect to the plaintiffs or any other
person.
UNITED STATES OF AMERICA EX REL. DAVID BARMAK V. SUTTER CORP., UNITED
STATES ORTHOPEDIC CORP., ORTHOLOGIC CORP., ET AL., United States District Court,
Southern District of New York, Civ Action No 95 Civ 7637. The complaint in this
matter was filed in September 1997 under the Qui Tam provisions of the Federal
False Claims Act and primarily relate to events occurring prior to the Company's
acquisition of Sutter Corporation. The allegations relate to the submission of
claims for reimbursement for continuous passive motion exercisers to various
federal health care programs. In June 2001, the U.S. Department of Justice and
the Company entered into a settlement agreement and the government's amended
complaint was dismissed with prejudice. In October 2001, Plaintiff Barmak filed
a second amended complaint, pursuing the claim independent of the U.S.
Department of Justice. The Company filed a motion to dismiss the second amended
complaint on various grounds including that the allegations are barred because
of the earlier settlement. The case has just begun discovery. At the present
stage, it is not possible to evaluate the likelihood of an unfavorable outcome
or the amount or a range of potential loss, if any, which may be experienced by
the Company.
ORTHOREHAB, INC. AND ORTHOMOTION, INC. V. ORTHOLOGIC CORPORATION AND
ORTHOLOGIC CANADA, LTD., Superior Court of the State of Delaware, County of New
Castle, Case No. C.A. No. 01C-11-224 WCC. In November 2001, OrthoRehab, Inc.,
filed a complaint in connection with acquisition of the Company's continuous
passive motion business in July 2001 alleging, among other things, that some of
the assets purchased were over valued and that the Company had breached its
contract. The case is being heard in the Superior Court of the State of
Delaware. The Company has denied the Plaintiffs' allegations and intends to
defend the matter vigorously. The case is currently in discovery. At the present
stage, it is not possible to evaluate the likelihood of an unfavorable outcome
or the amount or a range of potential loss, if any, which may be experienced by
the Company.
9
In addition to the matters disclosed above, the Company is involved in
various other legal proceedings that arise in the ordinary course of business.
In our management's opinion, the ultimate resolution of these other legal
proceedings are not likely to have a material adverse effect on the financial
position of the Company.
The health care industry is subject to numerous laws and regulations of
federal, state, and local governments. Compliance with these laws and
regulations, specifically those relating to the Medicare and Medicaid programs,
can be subject to government review and interpretations, as well as regulatory
actions unknown and unasserted at this time. Recently, federal government
activity has increased with respect to investigations and allegations concerning
possible violations by health care providers of regulations, which could result
in the imposition of significant fines and penalties, as well as significant
repayments of previously billed and collected revenues from patient services.
Management believes that the Company is in substantial compliance with current
laws and regulations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
10
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.
2001 2000
----------------- -----------------
HIGH LOW HIGH LOW
------ ------ ------ ------
First Quarter 4.4375 2.8438 8.3125 2.5625
Second Quarter 4.5000 3.0000 6.1250 3.5625
Third Quarter 4.4600 3.2500 5.2500 2.7500
Fourth Quarter 5.2800 3.2000 3.2188 2.1563
As of March 14, 2002, 31,816,531 shares of the Common Stock of the Company
were outstanding and held by approximately 285 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.
11
ITEM 6. SELECTED FINANCIAL DATA
SELECTED FINANCIAL DATA
The selected financial data for each of the five years in the period ended
December 31, 2001, 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 relative to the CPM business in March 1997 and one in August 1996.
The Company divested the CPM business unit in 2001.
YEARS ENDING DECEMBER 31,
-------------------------------------------------------------
STATEMENTS OF OPERATIONS DATA 2001(3) 2000(2) 1999 1998 1997(1)
- ----------------------------- --------- --------- --------- --------- ---------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Total Revenues $ 62,356 $ 90,080 $ 83,232 $ 75,369 $ 77,049
Total cost of revenues 11,349 18,289 18,504 17,693 18,369
Operating expenses
Selling, general and administrative 46,467 71,580 61,936 72,011 61,484
Research and development 3,889 4,690 2,860 2,920 2,320
Restructuring and other charges (Note 1) -- -- (216) (399) 13,844
CPM divestiture and related charges 14,327 -- -- -- --
Legal settlement -- 4,499 -- -- --
Write-off of goodwill -- 23,348 -- -- --
Net gain from discontinuation
of the co-promotion agreement -- (844) -- -- --
--------- --------- --------- --------- ---------
Total operating expenses 64,683 103,273 64,580 74,532 77,648
--------- --------- --------- --------- ---------
Operating profit (loss) (13,676) (31,482) 148 (16,856) (18,968)
Other income 594 303 148 354 1,466
Income taxes (12) (12) (58) (100) (212)
--------- --------- --------- --------- ---------
NET INCOME (LOSS) (13,094) (31,191) 238 (16,602) (17,714)
Accretion of non-cash preferred stock dividend -- -- (824) (1,236) --
--------- --------- --------- --------- ---------
Net loss applicable to common stockholders $ (13,094) $ (31,191) $ (586) $ (17,838) $ (17,714)
Net loss per common share basic $ (0.42) $ (1.04) $ (0.02) $ (0.71) $ (0.71)
--------- --------- --------- --------- ---------
Net loss per common share diluted $ (0.42) $ (1.04) $ (0.02) $ (0.71) $ (0.71)
--------- --------- --------- --------- ---------
Basic shares outstanding 31,464 29,855 26,078 25,291 25,116
Equivalent shares
--------- --------- --------- --------- ---------
DILUTED SHARES OUTSTANDING 31,464 29,855 26,078 25,291 25,116
--------- --------- --------- --------- ---------
1. Net income was affected in 1997 by a one-time charge for restructuring and
other cost 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 charges is a loss of $0.55 per share.
2. Net income was affected in 2000 by several 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.
3. Net income was affected in 2001 by a loss of $14.3 million associated with
the sale of the Company's CPM business and a $1.0 million charge for the
license extension for Chrysalin.
12
YEARS ENDED DECEMBER 31,
-------------------------------------------------------------
BALANCE SHEET DATA 2001 2000 1999 1998 1997
- ------------------ --------- --------- --------- --------- ---------
(IN THOUSANDS)
Working capital $ 40,039 $ 43,056 $ 40,865 $ 38,817 $ 44,418
Total assets 49,697 65,035 92,203 93,980 103,103
Long term liabilities, less current
maturities 287 88 209 196 1,631
Stockholders' equity 41,896 51,910 73,054 68,225 84,737
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONS AND RESULTS
OF OPERATIONS
OVERVIEW
OrthoLogic began 2001 as a developer, manufacturer and seller of bone
growth stimulation products, fracture fixation devices and continuous passive
motion ("CPM") devices. The Company's principal businesses were the sale of the
OL1000 and SpinaLogic in the bone growth stimulation business and the sale and
rental of the CPM devices in the rehabilitation business.
In July 2001, the Company sold its CPM business to OrthoRehab, Inc. for
$12.0 million in cash, the assumption of approximately $2.0 million in
liabilities and a potential additional payment to OrthoLogic of up to $2.5
million in cash, conditioned on OrthoRehab's ability to collect on certain
accounts receivable in the year following the sale. OrthoLogic is currently in
litigation with OrthoRehab, Inc. regarding this $2.5 million contingent payment.
The litigation is described in greater detail in "Item 3 - Legal Proceedings."
In connection with the sale of the CPM business, OrthoLogic terminated 331
of its 505 employees and sublet approximately half of its principal business
facilities in Phoenix, Arizona to OrthoRehab.
Revenue is recognized for sales of the OL1000 and SpinaLogic(R) products at
the time 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. Rental
revenue for CPM products was recorded during the period of usage. Revenue on
rehabilitative ancillary products was 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.
Use of estimates. - The preparation of the financial statements in
conformity with accounting principles generally accepted in the United States of
America 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 (approximately $5.9 million and $13.8 million at December 31, 2001 and
2000, 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 certain commercial insurance carriers, health maintenance
organizations, and preferred provider organizations. Amounts paid under these
plans are generally based on fixed or allowable reimbursement rates. 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. As a result
of the decision to divest of the CPM business, and as reflected in the 2000
statement of operations, 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,
ACCOUNTING FOR THE IMPAIRMENT OF LONG-LIVED ASSETS AND FOR LONG-LIVED ASSETS TO
BE DISPOSED. Revenues are recorded at the expected or pre-authorized
reimbursement rates when earned and include unbilled receivables of $1.9 million
and $8.0 million on December 31, 2001 and 2000, respectively. Some billings are
subject to review by such third party payors 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
13
estimated reimbursement and final determinations are reflected in the period
finalized.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The Company's discussion and analysis of the financial conditions and
results of operations are based upon the consolidated financial statements
prepared in conformity with accounting principles generally accepted in the
United States of America. The preparation of these statements 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
revenues and expenses during the reported period. These estimates and
assumptions form the basis for the carrying values of assets and liabilities. On
an on-going basis, the Company evaluates these estimates, including those
related to allowance for doubtful accounts, sales adjustments and discounts,
inventories, investments, restructuring, income taxes, contingencies, and
litigation. Management bases its estimates on historical experience and various
other assumptions and believes its estimates are reasonable about the carrying
values of assets and liabilities that are not evident from other sources. Actual
results may differ from these estimates.
The Company recognizes revenue when the product is placed on the patient,
or if the sale is to a commercial buyer, at the time of shipment. Estimated
reductions to revenues are in the form of sales discounts and adjustments from
certain commercial carriers, health maintenance organizations and preferred
provider organizations. Changes to estimated revenues are recognized in the
period in which the facts that give rise to the change become known. Allowances
for doubtful accounts are maintained to estimate losses resulting from the
inability of its customers and third-party payors inability to make the required
payments. If the financial condition of the third-party payors were to
deteriorate, resulting in an ability to make payments, additional allowances
might be necessary.
The Company writes-down its inventory for inventory shrinkage and
obsolescence equal to the difference between the cost of the inventory and the
estimated market value based upon assumptions about future demand and market
conditions. If conditions used in determining these valuations changed, future
additional inventory write-downs would be necessary.
The Company considers future taxable income and tax planning strategies in
determining the need for valuation allowances. In the event the Company
determined it would be unable to realize deferred tax assets in the future, an
adjustment to the deferred tax asset and charge to income would be necessary in
the period such a determination would be made.
The Company holds a minority interest in a company in the technological
field in which the Company has a strategic focus. The Company is not publicly
traded so it is difficult to determine the value of the investment. Should the
investment be determined to be permanently impaired, a charge to income would be
recorded in the period such a determination would be made.
RESULTS OF OPERATIONS COMPARING YEAR ENDED DECEMBER 31, 2001 TO 2000
REVENUES: OrthoLogic's total revenues decreased 30.7% from $90.1 million in 2000
to $62.4 million in 2001. Revenues from net sales decreased from $41.7 million
during 2000 to $41.5 million in 2001. Net sales are comprised of sales of the
OL1000, SpinaLogic, fracture fixation devices, and, for a portion of 2001,
before the sale of the CPM business, orthopedic rehabilitation equipment and
ancillary products.
Sales recorded for the bone growth stimulation products increased by 49%
from 2000 to 2001. The significant increase in sales is related to the
introduction of SpinaLogic in 2000, a new OL1000 SC product in 2001 and changes
in Medicare guidelines for reimbursement of bone growth stimulators enacted in
2000 that allow doctors to prescribe our bone growth simulators earlier in a
patient's care.
The increase in OL1000 and SpinaLogic sales was offset by the decrease in
total revenue due to the divestiture of the CPM and related ancillary products
in July 2001. Net rentals for CPM equipment declined 54.5% from $39.1 million in
2000 to $17.8 million in 2001, reflecting the fact the Company only had CPM
business related revenues for half of 2001. The revenues attributed to the CPM
business were approximately $28.9 million in 2001 and $60.3 million in 2000. The
cost of revenues attributable to the CPM business were approximately $5.8
million for 2001 and $14.1 million in 2000.
14
Hyalgan(R) royalty revenue was $3.0 million in 2001 compared to Hyalgan
fees and sales of $9.3 million in 2000, reflecting the termination of the
Co-Promotion Agreement with Hyalgan's producer in the fourth quarter of 2000.
Under the 1997 Co-Promotion Agreement with Sanofi Pharmaceuticals Inc.
("Sanofi") OrthoLogic had exclusive rights to market Hyalgan to orthopedic
surgeons in the United States for the treatment of pain in patients with
osteoarthritis of the knee. In the fourth quarter of 2000, the Company and
Sanofi mutually decided to terminate this Co-Promotion Agreement and provided
for certain royalty payments to continue to be made to OrthoLogic through 2002.
GROSS PROFIT: Gross profit decreased from $71.8 million in 2000 to $51.0 million
in 2001, primarily due to the lower total revenues created by the half year of
sales revenue from the CPM business. The fall in revenue was partially offset by
a decrease in the cost of revenues as a percentage of total revenue improved
from 20.3% in 2000 to 18.2% in 2001. This decrease in cost of revenues is
attributed to the divestiture of the CPM business in mid-year, which had a
higher cost of revenues than the bone growth stimulation or fracture fixation
product businesses.
SELLING, GENERAL AND ADMINISTRATIVE ("SG&A") EXPENSES: SG&A expenses decreased
35% from $71.6 million in 2000 to $46.5 million in 2001. The decrease is
partially attributed to the sale of the CPM business and the variable expenses
related to that business such as commissions, bad debt, advertising and support
staff expenses. In addition, in 2000, the Company recorded a charge of
approximately $3.0 million for additional bad debt related to older CPM
receivables as a result of a change in estimated collection rates. SG&A
expenses, as a percentage of total revenues, were 74.5% in 2001 and 79.5% in
2000.
RESEARCH AND DEVELOPMENT EXPENSES: Research and development expenses were $3.9
million in 2001, a decline of $800,000 compared to 2000. This decline is
attributed to the fact research and development expenses in 2000 were unusually
high because of a $2 million payment in 2000 to Chrysalis to expand the
Company's license agreement to include all Chrysalin orthopedic indications
worldwide. In 2001, the Company paid $1.0 million to Chrysalis to extend the
worldwide license to include the rights to orthopedic "soft tissue" indications,
including cartilage, tendon and ligament repair. A significant portion of the
2001 research and development direct expense is attributed to the continuation
of the Chrysalin clinical trials.
CPM DIVESTITURE AND RELATED CHARGES: In July 2001, the Company announced the
sale of its CPM business. The Company recorded a $6.9 million charge to
write-down the CPM assets to their fair value, plus direct costs of selling the
assets. The Company retained all the billed account receivable related to the
CPM business, with a net carrying value of approximately $10.8 million, net of a
$5.2 million allowance for doubtful accounts. The collection staff and
supervisor previously responsible for the collection of these receivables were
part of the employee team hired by the purchaser of the CPM business. Company
management believed that there would be some negative effect to the efficiency
of the collection team and hired contractors to replace the previous collection
personnel. As a result, the Company recognized a charge of $2.8 million in 2001.
In connection with the sale of the CPM business, approximately 331 of the
Company's positions were eliminated. The Company recorded a charge of $3.3
million for the severance and stay-on bonuses that will be paid to individuals
during 2002. The Company also recorded additional charges of approximately $1.4
million for various costs relating to the CPM divestiture.
These various charges are reflected in the $14.3 million "Loss from CPM
Divestiture and related charges" total in the 2001 Statement of Operations.
A summary of the severance and other reserve balances at December 31, 2001
are as follows:
Amount
Charged
Total Against Cash Reserves
Charges Assets Paid at 12/31/01
------- ------- ------- -----------
Severance and stay-on bonus $ 3,300 $ -- $(2,354) $ 946
Other exit costs 1,387 (245) (1,066) 76
------- ------- ------- -------
Total non-recurring charges $ 4,687 $ (245) $(3,420) $ 1,022
15
Cash requirements for the severance charges and exit costs were funded from the
Company's current cash balances.
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.
LEGAL SETTLEMENT: The Company also recognized in 2000 an expense of $3.6 million
as a result of the settlement agreement reached in the class action lawsuit and
expensed $941,000 related to other legal settlements. These expenses in 2000
were partially offset by a gain of $844,000 of the discontinuation of the
co-promotion distribution rights for Hyalgan.
OTHER INCOME. Other income in 2001 and 2000 consisted primarily of interest
income. Other income increased from $303,000 in 2000 to $594,000 as a result of
interest earned on the purchase price from the mid-year sale of the CPM
business.
NET LOSS: The Company had a net loss in 2001 of $13.1 million compared to a net
loss of $31.2 million in 2000. The significant decline in net loss is attributed
to a one-time goodwill write off of $23.3 million in 2000 and legal settlement
expenses discussed above, partially offset by the CPM divestiture in 2001.
RESULTS OF OPERATIONS COMPARING YEAR ENDED DECEMBER 31, 2000 TO 1999
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 affected by the introduction of the OL1000 SC 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 had been to improve
profitability of the business including not accepting un-profitable sales.
Fee revenue from Hyalgan 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 felt the emphasis on the rehabilitation
segment of the orthopedic business no longer fit the Company's long-term
strategic plan. As of December 31, 2000, assets of the CPM business consisted
primarily of accounts receivable, the rental fleet and related inventory, which
had a carrying value at year end of approximately $20.6 million, $7.3 million,
and $6.0 million respectively. The related liabilities had a carrying value of
approximately $4.6 million. The revenues attributable to the CPM business have
been approximately $60.3 million and $62.9 million for 2000 and 1999. The costs
of revenues attributable to the CPM business had been approximately $14.1
million and $15.9 million for 2000 and 1999. 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, ACCOUNTING FOR THE IMPAIRMENT OF LONG-LIVED ASSETS AND FOR
LONG-LIVED ASSETS TO BE DISPOSED. Additional adjustments to the carrying value
of the CPM net assets were based on negotiated terms of the sale. The Company
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.
16
The Company's sales force began to promote Hyalgan in the third quarter of
1997. Fee revenue of $9.3 and $8.3 million was recognized during 2000 and 1999.
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 $3 million in cash in 2000 and $1.0 million
in cash in the first quarter of 2001 to complete a successful transition of the
business back to Sanofi by January 1, 2001, and will receive continuing
royalties through 2002.
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 of
2000 with full implementation by December 31, 2000.
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 as a percentage of
total revenues improved 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.
SELLING, GENERAL AND ADMINISTRATIVE ("SGA") 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 temporarily higher than normal. While the margin
for SpinaLogic is favorable, commissions as a percentage of sales 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. SGA expenses as a percentage of total revenues were 74.4% in 1999 and
79.5% in 2000.
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 in Chrysalin, the Company acquired an option to license
Chrysalin for orthopedic applications. 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.
OTHER INCOME: Other income in 2000 and 1999 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 from operating cash flows.
At December 31, 2001, the Company had cash and cash equivalents of $19.5
million and short term investments of $11.0 million, $12 million of which is
from the cash portion of the purchase price from the sale of the CPM business.
Net cash provided by operations during 2001 was $9.9 million compared to
$1.5 million in 2000. This increase was primarily attributed to (1) a decline in
net losses from $31.2 million in 2000 to $13.1 million in 2001 and (2) a
decrease in accounts receivable by $10.7 million, offset by a decrease in
accrued and other current liabilities by $4.8 million primarily as a result of
17
the CPM divestiture. The net cash provided by operations during 2000 of $1.5
million was primarily due to (1) net losses of $31.2 million (offset by a
non-cash charge which include a goodwill write-off of $23.3 million, Common
Stock issued for legal settlement of $3.0 million and license payment to
Chrysalis for $2.0 million), and (2) an increase in inventory of $700,000.
The Company also has available a $4 million line of credit with a lending
institution. The Company may borrow up to 75% of the eligible accounts
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 $30 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. As of December 31, 2001, the Company is in compliance with all the
financial covenants.
The Company does not expect significant capital investments in 2002 and
anticipates that its cash and short term investments, cash from operations on
hand and the funds available from its $4 million line of credit will be
sufficient to meet the Company's presently projected cash and working capital
requirements for the next 12 months. 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.
In October 2001, the Financial Accounting Standards Board issued SFAS No.
144, ACCOUNTING FOR IMPAIRMENT OR DISPOSAL OF LONG-LIVED ASSETS. SFAS No. 144
addresses financial accounting and reporting for the impairment or disposal of
long-lived assets. This statement also extends the reporting requirements to
report separately, as discontinued operations, components of an entity that have
either been disposed of or are classified as held-for-sale. We adopted the
provisions of SFAS No. 144 effective January 1, 2002. The adoption of this
statement did not have any impact on the Company's financial condition or
results from operations.
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. No costs related to the potential outcome of other
actions have been accrued. See "Item 3 -Legal Proceedings."
The following table sets forth all known commitments as of December 31,
2001 and the year in which these commitments become due, or are expected to be
settled (in thousands):
ACCOUNTS PAYABLE
OPERATING AND ACCRUED
YEAR LEASES LIABILITIES TOTAL
---- ------- ---------------- -------
2002 $ 1,078 $ 6,914 $ 7,992
2003 $ 1,078 - $ 1,078
2004 $ 1,078 - $ 1,078
2005 $ 1,078 - $ 1,078
2006 $ 1,078 - $ 1,078
Thereafter $ 989 - $ 989
------- ------- -------
Total $ 6,379 $ 6,914 $13,293
======= ======= =======
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
18
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.
RISKS RELATED TO OUR INDUSTRY
THE COMPANY IS IN A HIGHLY REGULATED FIELD AND WE MUST OBTAIN GOVERNMENT
APPROVAL BEFORE SELLING ANY NEW PRODUCTS.
The Federal Drug Administration 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's current and future products and manufacturing activities are
and will be regulated under the Medical Devices Amendment Act of 1976 to the
Federal Food, Drug and Cosmetics Act, as amended, the Safe Medical Devices acts
of 1990 and 1992, and the Food and Drug Administration Modernization Act of
1997, as amended, (collectively the "FDC Act"). The Company's current BioLogic
technology-based products and fracture fixation devices are marketed for their
current uses with clearance from the FDA. Before the Company is able to market
these products for any other use, it would have to seek the approval of the FDA,
which may require lengthy and costly testing and review by the FDA. In addition,
the FDA may, if it believes the Company's products have problems unforeseen at
the time of the initial approval, require additional testing to retain FDA
approval.
Chrysalin, as a new drug, is subject to the most stringent level of FDA
review. The Company is currently seeking approval by the FDA to conduct human
testing on Chrysalin. Even if the testing is approved and the results of the
tests are favorable, there can be no guarantee that the FDA will grant approval
of Chrysalin for the indicated uses or if it will do so in a timely manner. In
addition, changes in existing regulations or interpretations of existing
regulations or adoption of new or additional restrictive regulations could
prevent or delay obtaining regulatory approvals.
THE COMPANY MUST ADHERE TO CURRENT AND EVOLVING REGULATORY COMPLIANCE STANDARDS
IN ORDER TO MAINTAIN THE APPROVAL TO SELL ITS PRODUCTS.
The Company is also required to adhere to applicable requirements for FDA Good
Manufacturing Practices, 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.
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.
ANY LIMITATIONS ON THIRD PARTY PAYMENT REIMBURSEMENT FOR THE COMPANY'S PRODUCTS
AND RELATED SERVICES WOULD ADVERSELY AFFECT THE BUSINESS AND RESULTS OF
OPERATIONS.
The Company's ability to sell products successfully in the United States
and in other countries will depend in part on the extent to which government
health administration authorities, private health insurers and other payors
continue to reimburse insureds for the cost of products and related treatment.
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
19
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 and recent
governmental regulations have favorably made our products available to patients
earlier in their medical treatment, 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.
THE COMPANY OPERATES IN AN INTENSELY COMPETITIVE FIELD IN WHICH MANY OF ITS
COMPETITORS ARE BIGGER OR BETTER KNOWN.
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, and two competitors selling bone growth stimulation products for use
with spinal fusion patients. 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 the treatment of fractures and spinal fusions, 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."
TECHNOLOGY IN THE MEDICAL DEVICE INDUSTRY CHANGES RAPIDLY. IF THE COMPANY IS NOT
ABLE TO KEEP UP WITH TECHNOLOGICAL ADVANCES BY ITS COMPETITORS, THE BUSINESS
WILL BE HARMED.
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 part on its ability to respond
quickly to medical and technological changes through the development and
introduction of new products. Because of the lengthy testing period required to
develop new products and the costly FDA approval process, there can be no
assurance that the Company's new product development efforts will result in any
commercially successful products or will do so in a timely manner. 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."
THE INDUSTRY FACES A HIGH 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 bone growth stimulation
products. Over the years, the Company has had limited product liability claims
associated with the former CPM products, all of which have been or are being
managed by the Company's insurance carrier.
The Company maintains a product liability and general liability insurance
policy with coverage of an annual aggregate maximum of $2.0 million per
20
occurrence. The 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.
Based on the history of claims, the Company believes the levels of
insurance coverage are adequate, however, 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."
LEGISLATIVE REFORM OF THE HEALTHCARE INDUSTRY COULD HAVE A NEGATIVE EFFECT ON
THE COMPANY'S BUSINESS.
In response to complaints from patients against insurance companies and
recent and continued expectations of rises in the cost of health care insurance
coverage, the health care industry is being reviewed and investigated by public
and private groups to (i) increase access to health care for the uninsured and
underinsured people, (ii) control the escalation of health care expenditures
within the economy and (iii) use health care reimbursement policies to help
control federal expenditures. Although this has been an ongoing public debate
for a number of years that has not resulted in substantial federal or state
legislation fundamentally changing the health care industry business model, the
Company expects public debate of these issues continue. The Company cannot
predict which, if any, of current reform proposals will be adopted and when they
might be adopted and what effect such reform would have on patient's ability to
seek reimbursement for use of our product and the costs associated with
regulatory and health care program compliance.
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 and
future products as currently contemplated.
INCREASED INVESTIGATION OF HEALTH CARE PROVIDERS.
The health care industry is subject to numerous laws and regulations of
federal, state, and local governments. Compliance with these laws and
regulations, specifically those relating to the Medicare and Medicaid programs,
can be subject to government review and interpretations, as well as regulatory
actions unknown and unasserted at this time. Recently, federal government
activity has increased with respect to investigations and allegations concerning
possible violations by health care providers of regulations, which could result
in the imposition of significant fines and penalties, as well as significant
repayments of previously billed and collected revenues from patient services.
Management believes that the Company is in substantial compliance with current
laws and regulations.
RISKS RELATED TO OUR BUSINESS
THE DIVESTITURE OF THE CPM DIVISION HAS CAUSED SOME DISTRACTIONS FOR THE
COMPANY'S MANAGEMENT.
In July 2001, the Company sold its CPM business and began focusing on its
core business in the fracture healing and spinal repair segment of the
orthopedic market. In connection with the sale, the Company is obligated to
assist the buyer in certain transition functions for the first year following
the sale. Consequently, the Company's management has had to devote some time
assuring the smooth transition of the CPM business. In addition, in November
2001, the buyers of the CPM business filed a suit against the Company, claiming,
among other things, that the company did not fulfill the post closing
obligations and that the value of some purchased assets were overestimated. This
suit also challenges whether the Company will receive the contingent $2.5
million payment in the year following the closing. Management has also had to
manage this litigation. These issues related to the sale of the CPM business
could distract management's focus on the transition back to the core bone growth
stimulation business.
FOLLOWING THE SALE OF THE CPM BUSINESS, THE COMPANY HAS BECOME HIGHLY DEPENDENT
ON THE SALES OF TWO PRIMARY PRODUCTS AND HAVE INVESTED HEAVILY IN A FUTURE
PRODUCT WHICH MAY NOT BE AVAILABLE FOR SALE FOR SOME TIME.
Following the sale of the CPM business, the Company's business focused on
the sales of two primary products, the OL1000 and SpinaLogic. The Company
believes that, to sustain long-term growth, it must continue to develop and
21
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 review, and
clinical testing all of which may be expensive and lengthy. There can be no
assurance that the Company will 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."
IF THE MEDICAL COMMUNITY DOES NOT ACCEPT THE COMPANY'S PRODUCTS AS ALTERNATIVES
TO CURRENT PRODUCTS AND PROCEDURES, SALES WILL NOT GROW AND BUSINESS WILL BE
ADVERSELY AFFECTED.
The long-term commercial success of the OL1000 and SpinaLogic and the
Company's other products will depend in significant part upon their 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. As the newest product to the market, SpinaLogic's sales and acceptance
by the medical community is not certain. Failure of the Company and its
distributors to create widespread market acceptance by the orthopedic medical
community and third party payors of our products would have a material adverse
effect on the Company's business, financial condition and results of operations.
See "Item 1 - Business - Third Party Payment."
THE COMPANY'S ABILITY TO COMPETE COULD BE JEOPARDIZED IF IT IS UNABLE TO OBTAIN
AND PROTECT ITS INTELLECTUAL PROPERTY OR RETAIN LICENSES FOR INTELLECTUAL
PROPERTY.
In this industry, a company's success depends in 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 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. The Company licenses the technology in the BioLogic and
OrthoFrame technologies for which it pays a royalty.
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."
In addition the licenses for the technology used by the Company in the
BioLogic and OrthoFrame products may be terminated by the licensor 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.
22
SALES FOR ONE OF THE COMPANY'S PRIMARY PRODUCTS DEPENDS ON THE SUCCESS OF A
DISTRIBUTOR WHICH HAS BEEN GIVEN EXCLUSIVE DISTRIBUTION RIGHTS.
Substantial portions of the Company's sales related to the OL1000 and
affiliated products are generated through the Company's internal sales force of
approximately 38 employees. The Company distributes SpinaLogic through an
exclusive sales distribution agreement with DePuy AcroMed. If DePuy AcroMed does
not generate sales sufficient to meet the agreed upon annual minimum sales, and
if the Company becomes dissatisfied with SpinaLogic distribution, the Company
may terminate the distribution agreement and train its internal sales staff to
include SpinaLogic sales. The delay associated with termination of DePuy AcroMed
and building and training a new sales force would have an adverse effect on the
Company's sales of SpinaLogic. See "Item 1 - Business - Marketing and Sales."
THE COMPANY'S RELIANCE ON A PRIMARY SUPPLIER COULD RESULT IN DISRUPTION OF
OPERATIONS.
The Company purchases the microprocessor used in the OL1000 and SpinaLogic
devices from a single manufacturer. Although there are feasible alternate
microprocessors that might be used immediately, all are produced by one single
supplier. 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 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.
IF THE COMPANY IS NOT ABLE TO RETAIN AND COMPETE FOR KEY MANAGEMENT AND
TECHNICAL EMPLOYEES, ITS LONG-TERM BUSINESS WILL BE ADVERSELY AFFECTED.
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."
THE RESULTS OF OPERATIONS ARE AFFECTED BY A NUMBER OF CONDITIONS WHICH ARE
OUTSIDE THE COMPANY'S CONTROL.
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 $96 million at December 31, 2001. 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."
23
THE COMPANY'S STOCK PRICE IS VOLATILE AND FLUCTUATES DUE TO A VARIETY OF
FACTORS.
The stock price has varied significantly in the past and may vary in the
future due to a number of factors including:
* fluctuations in the Company's operating results;
* developments in litigation to which the Company or a competitor 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 of the
Company or competitors;
* 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.
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 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
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, 2001.
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, commodity
prices, or foreign exchange rates.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Consolidated balance sheets, as of December 31, 2001 and 2000, and
consolidated statements of operations, stockholders' equity and cash flows for
each of the years in the period ended December 31, 2001, together with the
related notes and the report of Deloitte & Touche LLP, independent auditors, are
set forth on the "F" pages following this report. Other required financial
information is set forth herein, as more fully described in Part IV, Item 14
hereof.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
24
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 54 Chief Executive Officer, President and Director
Sherry A. Sturman 37 Vice President of Finance and Administration, Chief Financial Officer
Ruben Chairez, Ph.D. 59 Vice President of Medical Regulatory and Compliance
Jeff Culhane 35 Vice President of Manufacturing and Product Development
Shane P. Kelly 32 Vice President of Sales
Donna L. Lucchesi 38 Vice President of Marketing
James T. Ryaby, Ph.D. 43 Vice President of Research and Clinical Affairs
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.
Sherry A. Sturman joined the company as Director of Finance in October 1997
and began serving as the Vice President of Administration, and Chief Financial
Officer in June 2001. From 1994 to 1997, Ms. Sturman was employed as the Chief
Financial Officer for ComCare, a large managed care company based in Phoenix.
She has over fifteen years of financial management experience in both healthcare
and public companies. She is a Certified Public Accountant, with a Masters in
Business Administration.
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.
Jeff Culhane joined the company as Vice President, Product Development &
Engineering in June 1998. From May 1993 to June 1998, Mr. Culhane held
Industrial Design and Manager of Product Development positions at OrthoLogic
Canada (previously Toronto Medical Corp.). His related product development
experience includes bone growth stimulators, continuous passive motion devices
and cryotherapy.
Shane P. Kelly joined the Company in 1991 as a Field Sales and Service
Representative. Since then, he has held numerous positions within the company in
the area of sales, managed care and operations. He was named Vice President of
Sales in 2000. Mr. Kelly received an undergraduate degree in business from
Tulane University and a Master's Degree in International Management from
Thunderbird, the American Graduate School of International Management.
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 of Health Care Systems Marketing. She holds a Master's Degree in
Business Administration from Washington University.
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.
25
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 17, 2002 (the "Proxy Statement"). The Company
anticipates filing the Proxy Statement within 120 days after December 31, 2001.
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 in addendum F.
Independent Auditors' Report
Consolidated Balance Sheets - December 31, 2001 and 2000.
Consolidated Statements of Operations - Each of the three years
in the period ended December 31, 2001.
Consolidated Statements of Comprehensive Income - Each of the
three years in the period ended December 31, 2001.
Consolidated Statements of Stockholders' Equity - Each of the
three years in the period ended December 31, 2001.
Consolidated Statements of Cash Flows - Each of the three years
in the period ended December 31, 2001.
Notes to Consolidated Financial Statements
2. Financial Statement Schedules
Independent Auditors Consent and Report on Schedule.
Valuation and Qualifying Accounts
26
Financial Statement Schedules
Independent Auditors Consent and Report on Schedule.
Balance Balance
at beginning Charged to at end
Valuation and Qualifying Accounts of period Expenses Write-offs of period
----------- ----------- ----------- -----------
Allowance for doubtful accounts,
sales discounts and sales adjustments:
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)
Balance December 31, 2000 (13,801,791)
2001 Additions charged to expense (6,770,362)
2001 Deductions to allowance 14,671,489
Balance December 31, 2001 (5,900,664)
Allowance for inventory shrinkage
and obsolescence:
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)
Balance December 31, 2000 (1,245,822)
2001 Additions charged to expense (2,286,868)
2001 Deductions to allowance 2,810,923
Balance December 31, 2001 (721,767)
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.
27
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 28, 2002 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 March 28, 2002
- ----------------------------- Officer and Director
Thomas R. Trotter (Principal Executive Officer)
/s/ John M. Holliman III Chairman of the Board of March 28, 2002
- ----------------------------- Directors and Director
John M. Holliman III
/s/ Fredric J. Feldman Director March 28, 2002
- -----------------------------
Fredric J. Feldman
/s/ Elwood D. Howse, Jr. Director March 28, 2002
- -----------------------------
Elwood D. Howse, Jr.
/s/ Stuart H. Altman Director March 28, 2002
- -----------------------------
Stuart H. Altman, Ph.D.
/s/ Augustus A. White III Director March 28, 2002
- -----------------------------
Augustus A. White III, M.D.
Vice President of Finance March 28, 2002
/s/ Sherry Sturman and Administration and
- ----------------------------- Chief Financial Officer
Sherry Sturman (Principal Financial and
Accounting Officer)
S-1
ORTHOLOGIC CORP.
EXHIBIT INDEX TO REPORT ON FORM 10-K
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2001
(FILE NO. 0-21214)
EXHIBIT FILED
NO. DESCRIPTION INCORPORATED BY REFERENCE TO: HEREWITH
--- ----------- ----------------------------- --------
3.1 Amended and Restated Certificate Exhibit 3.1 to the Company's Form
of Incorporation 10-Q for the quarter ended March
31, 1997 ("March 1997 10-Q")
3.2 Amended and Restated Certificate Exhibit 3.2 to the Company's Form
of Incorporation dated May 9, 2000 10-Q for the quarter ended March
31, 2000
3.3 Certificate of Designation in Exhibit 3.1 to Company's Form 10-Q
respect of Series A Preferred for the quarter ended March 31,
Stock 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 Rights Agreement dated as of March Exhibit 4.1 to the Company's
4, 1997, between the Company and Registration Statement on Form 8-A
Bank of New York, and Exhibits A, filed with the SEC on March 6, 1997
B and C thereto
4.2 1987 Stock Option Plan of the Exhibit 4.4 to the Company's Form
Company, as amended and approved 10-Q for the quarter ended June 30,
by stockholders (1) 1997 ("June 1997 10-Q")
4.3 1987 Stock Option Plan of the Exhibit 4.5 to the Company's June
Company (1) 1997 10-Q
4.4 Stock Purchase Warrant dated March Exhibit 4.10 to the Company's
2, 1998, issued to Silicon Valley 1997 10-K
Bank
4.5 Antidilution Agreement dated March Exhibit 4.11 to the Company's
2, 1998, by and between the 1997 10-K
Company and Silicon Valley Bank
4.6 Amendment to Stock Purchase Exhibit 4.1 to the Company's form
Warrant dated May 12, 1998, issued 10-Q for the quarter ended March
to Silicon Valley Bank 31, 1998
4.7 Form of Warrant Exhibit 4.1 to the Company's Form
8-K filed on July 13, 1998
4.8 Registration Rights Agreement Exhibit 4.2 to the Company's Form
8-K filed on July 13, 1998
4.9 1987 Stock Option Plan of the Exhibit 4.5 to the Company's June
Company (1) 1997 10-Q
10.1 License Agreement dated September Exhibit 10.6 to January 1993 S-1
3, 1987, between the Company and
Life Resonance's, Inc.
10.2 Form of Indemnification Agreement* Exhibit 10.16 to January 1993 S-1
10.3 License Agreement dated December Exhibit 10.22 to January 1993 S-1
2, 1992, between Orthotic Limited
Partnership and Company
10.4 Co-promotion Agreement dated June Exhibit 10.1 to the Company's
23, 1997, by and between the June 1997 10-Q
Company and Sanofi
Pharmaceuticals, Inc.
10.5 Single-tenant Lease-net dated June Exhibit 10.2 to the Company's
12, 1997, by and between the Form 10-Q for the quarter ended
Company and Chamberlain September 30, 1997 ("September
Development, L.L.C. 1997 10-Q")
10.6 Employment Agreement dated October Exhibit 10.3 to the Company's
20, 1997, by and between the September 1997 10-Q
Company and Thomas R. Trotter,
including Letter of Incentive
Option Grant, OrthoLogic Corp.
1987 Stock Option Plan (1)
10.7 Employment Agreement effective as Exhibit 10.40 to the Company's
of December 15, 1997, by and 1997 10-K
between the Company and William C.
Rieger (1)
E-1
EXHIBIT FILED
NO. DESCRIPTION INCORPORATED BY REFERENCE TO: HEREWITH
--- ----------- ----------------------------- --------
10.8 Registration Rights Agreement Exhibit 10.45 to the Company's
dated March 2, 1998, by and 1997 10-K
between the Company and Silicon
Valley Bank
10.9 Licensing Agreement with Chrysalis Exhibit 10.1 to the Company's
BioTechnology, Inc. September 1998 10-Q
10.10 1998 Management Bonus Program Exhibit 10.2 to the Company's
September 1998 10-Q
10.11 Securities Purchase Agreement Exhibit 10.1 to the Company's
Form 8-K filed on July 13, 1998
10.12 First Amendatory Agreement to Exhibit 10.1 to the Company's
March 4, 1997, Rights Agreement Form 8-K filed August 24, 1999
10.13 Credit and Security Agreement Exhibit 10.18 to the Company's
between the Company and Wells 1999 form 10/KA
Fargo Business Credit, Inc. dated
February 28, 2000
10.14 Lease Extension and Amendment Exhibit 10.19 to the Company's
Agreement dated September 29, 1998 1999 form 10/KA
between the Company and the
Heritage Corp. for the Pickering
property
10.15 Termination of Co-Promotion Exhibit 10.2 to the Company's
Agreement/ Hyalgan between the form 10Q for the quarter ended
Company and Sanofi September 30, 2000
Pharmaceuticals, Inc. (2)
10.16 Amendment of Marketing and Exhibit 10.1 to the Company's
Distribution Agreement Effective form 10Q for the quarter ended
July 12, 2000. (2) June 30, 2000.
10.17 Employment Agreement effective Exhibit 10.22 to the Company's
December 4, 2000 between the form 10Q for the quarter ended
Company and Shane Kelly. (1) March 31, 2001.
10.18 Employment Agreement effective Exhibit 10.23 to the Company's
January 2, 2001 between the form 10Q for the quarter ended
Company and Donna Lucchesi. (1) March 31, 2001.
10.19 Asset Purchase Agreement effective Exhibit 10.1 to the Company's
May 8, 2001 between the Company, form 8-K filed July 26, 2001.
OrthoLogic Canada, Ltd. and
OrthoRehab Inc. (2)
10.20 First Amendment to the May 8, 2001 Exhibit 10.2 to the Company's
Asset Purchase Agreement. (2) form 8-K filed July 26, 2001.
10.21 Employment Agreement effective X
June 1, 2001 between the Company
and James Ryaby. (1)
10.22 Employment Agreement effective X
May 1, 2001 between the Company
and Sherry Sturman. (1)
10.23 Employment Agreement effective X
July 9, 2001 between the Company
and Jeff Culhane. (1)
10.24 Employment Agreement effective X
May 1, 1998 between the Company
and Ruben Chairez. (1)
21.1 Subsidiaries of Registrant X
23.1 Independent Auditor's Consent and
Report on Schedule X
99.1 Audit Committee Charter Exhibit 99.1 to the Company's
form 10-K filed April 2, 2001.
- ----------
(1) Management contract or compensatory plan or arrangement
(2) Filed under confidential treatment request with the Securities and Exchange
Commission.
* 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.
E-2
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 (as of December 31, 2001 and 2000, 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, 2001.
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 OrthoLogic Corp. and subsidiaries
at December 31, 2001 and 2000, and the results of their operations and their
cash flows for each of the three years in the period ended December 31, 2001 in
conformity with accounting principles generally accepted in the United States of
America.
Deloitte & Touche LLP
Phoenix, Arizona
February 19, 2002
F-1
ORTHOLOGIC CORP.
CONSOLIDATED BALANCE SHEETS
December 31,
------------------------------
2001 2000
------------- -------------
ASSETS
Current assets:
Cash and cash equivalents $ 19,502,751 $ 6,752,973
Short-term investments [Note 4] 11,008,444 2,492,379
Accounts receivable less allowance for doubtful
accounts, sales discounts and sales adjustments
of $5,900,664 and $13,801,791 11,361,861 29,951,195
Inventories, net [Note 5] 1,762,063 10,006,665
Prepaids and other current assets 687,555 1,018,992
Deferred income taxes [Note 7] 2,630,659 2,630,659
------------- -------------
Total current assets 46,953,333 52,852,863
------------- -------------
Rental fleet, equipment & furniture, net [Note 6] 1,901,928 11,094,065
Deposits and other assets 91,752 338,068
Investment in Chrysalis BioTechnology [Note 13] 750,000 750,000
------------- -------------
TOTAL ASSETS $ 49,697,013 $ 65,034,996
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 1,030,957 $ 3,029,956
Accrued compensation 2,415,470 3,044,599
Deferred credits 382,812 358,016
Accrued royalties [Note 3] 163,523 267,618
Sales and property taxes payable 359,793 1,259,579
Accrued CPM divestiture costs [Note 2] 1,021,994
Other accrued expenses 1,539,364 1,836,989
------------- -------------
Total current liabilities 6,913,913 9,796,757
------------- -------------
Deferred rent and capital lease obligation 287,131 87,966
------------- -------------
Total liabilities 7,201,044 9,884,723
------------- -------------
Commitments and contingencies [Notes 3,9,10,12 and 13]
Series B Convertible Preferred Stock, $1,000 per
value; 600 and 3,240 shares issued and outstanding;
liquidation preference, $600,000 and $3,240,000 [Note 8] 600,000 3,240,000
STOCKHOLDERS' EQUITY [NOTE 8]
Common stock, $.0005 par value;
50,000,000 shares authorized; and 31,805,418 and
30,349,941 shares issued and outstanding 15,920 15,174
Additional paid-in capital 135,326,024 132,331,739
Common stock to be used for legal settlement 2,968,600 2,968,750
Deficit (96,277,275) (83,182,628)
Treasury stock at cost, 41,800 shares at December 31, 2001 (137,300) --
Comprehensive loss -- (222,762)
------------- -------------
Total stockholders' equity 41,895,969 51,910,273
------------- -------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 49,697,013 $ 65,034,996
============= =============
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
F-2
ORTHOLOGIC CORP.
CONSOLIDATED STATEMENTS OF OPERATIONS
Years Ending December 31,
------------- ------------- -------------
2001 2000 1999
------------- ------------- -------------
REVENUES
Net sales $ 41,507,670 $ 41,699,626 $ 32,578,511
Net rental 17,830,606 39,069,630 42,356,168
Royalties and fee revenue from co-promotion
agreement [Note 12] 3,017,516 9,310,648 8,296,844
------------- ------------- -------------
62,355,792 90,079,904 83,231,523
------------- ------------- -------------
COST OF REVENUES
Cost of goods sold 7,758,654 10,392,292 11,303,309
Costs of rentals 3,590,297 7,897,143 7,200,549
------------- ------------- -------------
Total cost of revenues 11,348,951 18,289,435 18,503,858
------------- ------------- -------------
GROSS PROFIT 51,006,841 71,790,469 64,727,665
OPERATING EXPENSES
Selling general and administrative 46,467,358 71,580,178 61,936,094
Research and development [Note 13] 3,888,838 4,689,588 2,860,159
Reversal of restructuring charges (216,211)
CPM divestiture and related charges [Note 2] 14,327,315
Legal settlement [Note 10] 4,498,847
Write-off of goodwill [Note 1] 23,348,074
Net gain from discontinuation of co-promotion
agreement [Note 12] (844,424)
------------- ------------- -------------
Total operating expenses 64,683,511 103,272,263 64,580,042
------------- ------------- -------------
OPERATING INCOME (LOSS) (13,676,670) (31,481,794) 147,623
OTHER INCOME (EXPENSE)
Interest and other income 682,319 450,792 225,445
Interest expense (88,296) (147,372) (77,281)
------------- ------------- -------------
Total other income 594,023 303,420 148,164
------------- ------------- -------------
INCOME (LOSS) BEFORE INCOME TAXES (13,082,647) (31,178,374) 295,787
Provision for income taxes [Note 7] (12,000) (12,175) (57,886)
------------- ------------- -------------
NET INCOME (LOSS) (13,094,647) (31,190,549) 237,901
Accretion of non-cash preferred stock dividend (823,991)
------------- ------------- -------------
Net loss applicable to common stockholders $ (13,094,647) $ (31,190,549) $ (586,090)
============= ============= =============
Net loss per common share - basic $ (0.42) $ (1.04) $ (0.02)
============= ============= =============
Net loss per common share - diluted $ (0.42) $ (1.04) $ (0.02)
============= ============= =============
Basic and diluted shares outstanding 31,463,502 29,855,397 26,078,058
============= ============= =============
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
Years Ending December 31,
-----------------------------------------------
2001 2000 1999
------------- ------------- -------------
Net loss applicable to common stockholders $ (13,094,647) $ (31,190,549) $ (586,090)
Foreign translation adjustment 222,762 (47,957) (134,088)
------------- ------------- -------------
Comprehensive loss applicable to common stockholders $ (12,871,885) $ (31,238,506) $ (720,178)
============= ============= =============
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
F-3
ORTHOLOGIC CORP.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
ACCUMULATED
PAID IN COMPREHENSIVE ACCUMULATED TREASURY
SHARES AMOUNT CAPITAL LOSS DEFICIT STOCK TOTAL
---------- ------- ------------ --------- ------------ -------- ------------
Balance January 1, 1999 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 Preferred Stock 2,620,711 1,310 6,938,690 6,940,000
Common stock to be used for legal
settlement [Note 10] 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
Exercise of common stock options
at prices ranging from $1.84 to
$4.9375 per share 124,407 61 354,820 354,881
Conversion of Preferred Stock 1,072,870 535 2,639,465 2,640,000
Common stock issued in connection
with legal settlement (Note 10) 300,000 150 (150) --
Foreign translation adjustment 222,762 222,762
Treasury stock repurchases (Note 8) (41,800) (137,300) (137,300)
Net loss (13,094,647) (13,094,647)
---------- ------- ------------ --------- ------------ -------- ------------
Balance December 31, 2001 31,805,418 $15,920 $138,294,624 $ 0 $(96,277,275) (137,300) $ 41,895,969
========== ======= ============ ========= ============ ======== ============
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
F-4
ORTHOLOGIC CORP.
CONSOLIDATED STATEMENTS OF CASH FLOW
Years Ending December 31,
--------------------------------------------
2001 2000 1999
------------ ------------ ------------
OPERATING ACTIVITIES
Net income (loss) $(13,094,647) $(31,190,549) $ 237,901
Adjustments to reconcile net income (loss) to
net cash provided from operating activities:
Depreciation and amortization 970,428 5,325,111 6,758,663
Reversal of restructuring charges -- -- (216,211)
Common stock issued for legal settlement -- 2,968,750 --
Write-off of Goodwill -- 23,348,073 --
Loss from CPM divestiture and related charges 14,327,315 -- --
Elimination of foreign currency adjustment 222,762 -- --
Change in operating assets and liabilities:
Accounts receivable 10,728,353 319,569 (3,415,663)
Inventories 1,962,616 (700,210) 2,653,616
Prepaids and other current assets (79,039) (32,239) (175,153)
Deposits and other assets 246,316 428,518 (421,671)
Accounts payable (587,380) 461,151 (469,879)
Accrued and other current liabilities (4,841,732) 574,852 (263,944)
------------ ------------ ------------
Net cash provided in operating activities 9,854,992 1,503,026 4,687,659
------------ ------------ ------------
INVESTING ACTIVITIES
Expenditures for rental fleet, equipment and
furniture (806,730) (1,861,658) (4,958,701)
Proceeds from sale of CPM assets 12,000,000 -- --
Officer note receivable -- 157,800 (157,800)
(Purchase) sale of short term investments (8,516,065) (2,242,379) 5,802,469
Sale of Hyalgan rights back to Sanofi -
discontinuation of
co-promotion agreement -- 3,155,576 --
------------ ------------ ------------
Net cash (used) provided in investing activities 2,677,205 (790,661) 685,968
------------ ------------ ------------
FINANCING ACTIVITIES
Payments under long-term debt and capital lease obligations -- (121,172) (159,197)
Payments on loan payable -- -- (500,000)
Payments under co-promotion agreement -- -- (1,000,000)
Treasury stock purchases (137,300) -- --
Net proceeds from stock options exercised and other 354,881 138,517 594,867
------------ ------------ ------------
Net cash (used in) provided by financing activities 217,581 17,345 (1,064,330)
NET INCREASE IN CASH AND CASH EQUIVALENTS 12,749,778 729,710 4,309,297
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 6,752,973 6,023,263 1,713,966
------------ ------------ ------------
CASH AND CASH EQUIVALENTS, END OF YEAR $ 19,502,751 $ 6,752,973 $ 6,023,263
------------ ------------ ------------
SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING AND
FINANCING ACTIVITIES:
Conversion of series B preferred stock for common stock $ 2,640,000 $ 6,940,000 $ 4,820,000
Accretion of non-cash preferred stock dividend -- -- $ 823,991
Purchase price adjustment related to preacquisition contingencies -- -- $ 175,653
Cash paid during the year for interest $ 88,296 $ 91,467 $ 50,510
Cash paid during the year for income taxes $ (27,193) $ 12,175 $ 3,295
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
F-5
ORTHOLOGIC CORP.
NOTES TO FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2001, 2000 and 1999
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION OrthoLogic Corp. (the "Company" or "OrthoLogic") was
incorporated on July 30, 1987 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, known as
OrthoLogic Canada Ltd. Each of the acquisitions were related to the Company's
continuous passive motion ("CPM") business. On July 11, 2001, the Company sold
all its CPM business.
DESCRIPTION OF THE BUSINESS OrthoLogic develops, manufactures and markets
proprietary, technologically advanced orthopedic products designed to promote
the healing of musculoskeletal tissue, with particular emphasis on fracture
healing and spinal repair. On January 24, 2001, the Company announced its plans
to divest 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 was
focused on the rehabilitation segment of the orthopedic market, no longer fit in
the Company's long-term strategic plan. The CPM business was sold in July 2001.
The Company also distributed HYALGAN(R) (sodium hyaluronate), a therapeutic
injectable for relief of pain from osteoarthritis of the knee under the terms of
an exclusive Co-Promotion Agreement with Sanofi Synthelabs, Inc. ("Sanofi"). The
rights to distribute this product began in 1997 and were mutually terminated in
October 2000. The Company will continue to receive royalties from Sanofi through
2002.
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. In 1999, the Company
exercised its option to license the United States development, marketing, and
distribution rights for the fresh fracture indications for Chrysalin(TM), a new
tissue repair synthetic peptide. In 2000, the Company exercised its options to
license Chrysalin(TM), worldwide for all orthopedic applications.
During the years ended December 31, 2001, 2000, and 1999, the Company
reported net income (losses) of $(13.1) million, $(31.2) million and $.2
million, respectively. The Company anticipates that its cash and short-term
investments on hand, cash provided 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.
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. The
rental fleet was sold in the sale of the CPM business in 2001.
F-6
C. REVENUE is recognized for sales of the OL1000 and SpinaLogic(R) products
at the time 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. Rental
revenue for CPM products was recorded during the period of usage. Revenue on
rehabilitative ancillary products was 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. Royalty revenue for Hyalgan is based on the sales reported to the
Company.
D. RESEARCH AND DEVELOPMENT represents both costs incurred internally for
research and development activities, as well as costs incurred by the Company to
fund the research activities 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 months or less.
F. LOSS PER COMMON SHARE is computed on the weighted average number of
common or common and equivalent shares outstanding during each year. Basic
earnings per share is computed as net income (loss) applicable to common
stockholders divided by the weighted average number of common shares outstanding
during the period. Diluted earnings per share 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 balance of the Goodwill was determined to be impaired and written off in
2000. The intangible relating to the product distribution rights for Hyalgan
acquired in the Co-Promotion Agreement was being amortized over 15 years. The
balance of the intangible assets was written off in 2000 when the Co-Promotion
Agreement was terminated.
H. IMPAIRMENT OF LONG-LIVED ASSETS. In accordance with Statement of
Financial Accounting Standards ("SFAS") No. 121, ACCOUNTING FOR THE IMPAIRMENT
OF LONG-LIVED ASSETS AND FOR LONG-LIVED ASSETS TO BE DISPOSED, 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. The Company evaluates the recoverability of long-lived assets and
intangibles to be held and used 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 to write
down the carrying value of the asset or group of assets to their estimated fair
value. 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.
I. STOCK BASED COMPENSATION. The Company accounts for its stock based
compensation plan based on accounting Principles Board ("APB") Opinion No. 25,
ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES. In October 1995, the Financial
Accounting Standards Board issued SFAS No. 123, ACCOUNTING FOR STOCK BASED
COMPENSATION, which encourages entities to recognize expense over the vesting
period the fair value of all stock based awards on the date of grant.
Alternatively, SFAS No. 123 allows entities to continue to apply the provisions
of APB No. 25, and provide pro forma earnings per share disclosures for employee
stock option grants as if the fair value based method as defined in SFAS No. 123
has been applied. The Company applied the recognition provisions of APB No. 25
and provides the pro forma disclosure provisions of SFAS 123 (See Note 8).
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
(approximately $5.9 million and $13.8 million at December 31, 2001 and 2000,
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
F-7
and certain commercial insurance carriers, health maintenance organizations, and
preferred provider organizations. Amounts paid under these plans are generally
based on fixed or allowable reimbursement rates. The Company's products are
reimbursed by most third-party payors. However, the payors generally have
special medical necessity, and documentation requirements for the Company to
receive reimbursement. Revenues are recorded at the expected or pre-authorized
reimbursement rates when earned and include unbilled receivables of $1.9 million
and $8.0 million on December 31, 2001 and 2000, respectively. Some billings are
subject to review by third party payors 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 October 2001, the Financial Accounting
Standards Board issued SFAS No. 144, ACCOUNTING FOR IMPAIRMENT OR DISPOSAL OF
LONG-LIVED ASSETS. SFAS No. 144 addresses financial accounting and reporting for
the impairment or disposal of long-lived assets. This statement also extends the
reporting requirements to report separately, as discontinued operations,
components of an entity that have either been disposed of or are classified as
held-for-sale. We adopted the provisions of SFAS No. 144 effective January 1,
2002. The adoption of this statement did not have any impact on the Company's
financial condition or results from operations.
2. CPM DIVESTITURE AND RELATED CHARGES
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.
As a result of the decision to divest of the CPM business, and as reflected in
the 2000 statement of operations, 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, ACCOUNTING FOR THE IMPAIRMENT OF LONG-LIVED ASSETS AND FOR LONG-LIVED
ASSETS TO BE DISPOSED.
In July 2001, the Company announced the sale of its CPM business. In early
July 2001, the Company received $12.0 million in cash, with the purchaser
assuming approximately $2.0 million in liabilities in connection with the sale
of certain CPM related assets that had been recorded in the Company's financial
statements at a carrying value of approximately $20.7 million during the second
quarter of 2001. The Company recorded a $6.9 million charge to write down the
CPM assets to their fair value, plus the direct costs of selling the assets
which is included in the "Loss from CPM divestiture and related charges" total
in the accompanying 2001 Statement of Operations. The Company may receive up to
an additional $2.5 million of cash, if certain objectives are achieved by the
purchaser of the CPM business. Because there is no reasonable basis for
estimating the degree of certainty that these objectives will be reached, the
additional contingent consideration has not and will not be recorded in the
accompanying financial statements until the cash is actually received by the
Company.
The Company retained all the billed accounts receivable related to the CPM
business, with a net carrying value of approximately $10.8 million (net of a
$5.2 million allowance for doubtful accounts). The collection staff and
supervisor previously responsible for the collection of these receivables are
part of the employee team hired by the purchaser of the CPM business. Company
management believed that there may be some negative effect to the efficiency of
the collection team as the Company has hired contractors to replace the previous
collection personnel. As a result during the second quarter of 2001, a charge of
$2.8 million was recognized in 2001 and is included in the "CPM Divestiture and
Related Charges" total in the accompanying 2001 Statement of Operations. Actual
collection results could differ materially from these estimates. Any difference
between estimated reimbursement and final determinations will be reflected in
the period finalized.
In connection with the sale of the CPM business, in the second quarter of
2001, the Company notified approximately 331 of the Company's 505 employees that
their positions were being eliminated. The accompanying Statement of Operations
includes a charge of approximately $3.3 million included in "Loss from CPM
divestiture and related charges" for severance and stay-on bonuses that will be
paid to individuals during the next year. The Company also recorded additional
exit charges of approximately $1.4 million for various costs relating to the CPM
divestiture. These other costs are included in the "Loss from CPM divestiture
and related charges".
F-8
A summary of the severance and other reserve balances at December 31, 2001
are as follows:
Total Amount Charged Cash Reserves
Charges Against Assets Paid December 31, 2001
--------- -------------- --------- -----------------
Severance and stay-on bonus $ 3,300 $ -- $ (2,354) $ 946
Other exit costs 1,387 (245) (1,066) 76
--------- --------- --------- ---------
Total non-recurring charges $ 4,687 $ (245) $ (3,420) $ 1,022
========= ========= ========= =========
Subsequent to the sale, the Company is no longer in the CPM business.
Substantially all costs, expenses and impairment charges related to CPM exit
activities were recorded prior to the end of the second quarter, 2001. The
revenue and cost of revenue attributable to the CPM business were:
2001 2000 1999
------- ------- -------
Revenue $28,861 $60,259 $62,862
Cost of revenue 5,811 14,103 15,947
------- ------- -------
Gross profit $23,050 $46,156 $46,915
======= ======= =======
Most operating expenses were not directly allocated between the Company's
various lines of business. Cash requirements for the revenues and exit costs
were funded from the Company's current cash balances.
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.
3. LICENSE AGREEMENTS
The Company has committed to pay royalties on the sale of products or
components of products developed under certain product development 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 $106,000, $382,000, and $126,000 in 2001, 2000, and 1999 respectively.
4. INVESTMENTS AND FAIR VALUE DISCLOSURES
At December 31, 2001, marketable securities consisted of municipal and
corporate bonds 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,
----------------------------------
2001 2000
------------ ------------
Amortized costs $ 11,008,444 $ 2,492,379
Gross unrealized gains -- --
Gross unrealized losses (88,709) (27,055)
------------ ------------
Fair value $ 10,919,735 $ 2,465,324
============ ============
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 subjective in nature and involve uncertainties, matters of
F-9
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, 2001, 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 accounts receivable,
accounts payable and other accrued expenses because of the short maturity of the
portfolios. Management believes the terms of these financial instruments
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
5. INVENTORIES
Inventories consisted of the following:
December 31,
-----------------------------
2001 2000
------------ ------------
Raw materials $ 828,541 $ 6,877,516
Work in progress 410,569 471,844
Finished goods 1,244,720 3,903,127
------------ ------------
2,483,830 11,252,487
Less allowance for shrinkage and obsolescence (721,767) (1,245,822)
------------ ------------
Total $ 1,762,063 $ 10,006,665
============ ============
6. RENTAL FLEET, EQUIPMENT AND FURNITURE
Rental fleet, equipment and furniture consisted of the following:
December 31,
----------------------------
2001 2000
------------ ------------
Rental fleet $ -- $ 18,727,713
Machinery and equipment 2,095,908 2,223,770
Computer equipment 4,513,159 5,627,684
Furniture and fixtures 994,016 1,522,844
Leasehold and improvements 721,638 788,966
------------ ------------
8,324,721 28,890,977
Less accumulated depreciation and amortization (6,422,793) (17,796,912)
------------ ------------
Total $ 1,901,928 $ 11,094,065
============ ============
The rental fleet was sold in the sale of the CPM business in July 2001.
7. INCOME TAXES
At December 31, 2001, the Company has accumulated approximately $63 million
in net operating loss carryforwards and approximately $758,000 of general
business and alternative minimum tax credit carryforwards expiring from 2006
through 2021 for federal income tax purposes. State net operating loss
carryforwards are similar in amounts, but expire from 2002 through 2021 for
state income tax purposes. Stock issuances 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 carryforwards 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:
F-10
December 31,
----------------------------
2001 2000
------------ ------------
Allowance for bad debts $ 2,272,000 $ 5,521,000
Other accruals and reserves 1,397,000 956,659
Valuation allowance (1,038,000) (3,847,000)
------------ ------------
Total current 2,631,000 2,630,659
------------ ------------
Net operating loss and general
business credit carryforwards 25,081,000 17,332,000
Deferred revenue 963,000 --
Difference in basis of fixed assets (369,000) (1,756,000)
Nondeductible accruals and reserves 159,000 159,000
Difference in basis of intangibles 7,839,000 9,203,000
Valuation allowance (33,673,000) (24,938,000)
------------ ------------
Total non current -- --
------------ ------------
Total deferred income taxes $ 2,631,000 $ 2,630,659
============ ============
Years Ended December 31
The provision for income taxes --------------------------------------------
are as follows (in thousands): 2001 2000 1999
- ------------------------------ ------------ ------------ ------------
Current $ 12,000 $ 12,175 $ 45,636
Deferred -- -- 12,250
------------ ------------ ------------
Income Tax Provisions $ 12,000 $ 12,175 $ 57,886
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 year ending December 31:
Years Ended December 31,
--------------------------------------------
2001 2000 1999
------------ ------------ ------------
Income taxes (benefit)
at statutory rate $ (4,578,000) $(10,912,000) $ 80,000
State income taxes (benefit) (589,000) (1,559,000) 28,000
Change in valuation allowance 5,926,000 7,611,000 (471,000)
Other (747,000) 4,872,175 420,886
------------ ------------ ------------
Net Provision $ 12,000 $ 12,175 $ 57,886
============ ============ ============
There is an examination ongoing with the Canadian taxing authority. Management
does not currently expect the outcome of this examination will have a material
impact on the Company's financial position or results of operations.
F-11
8. 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 reserved for issuance 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.
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, 2001, 2000,
and 1999, and changes during the years then ended is:
2001 2000 1999
--------------------------- --------------------------- ---------------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
SHARES EXERCISE PRICE SHARES EXERCISE PRICE SHARES EXERCISE PRICE
---------- -------------- ---------- -------------- ---------- --------------
Fixed options outstanding
at the beginning of year 3,625,846 $ 4.85 3,488,913 $ 5.24 3,384,825 $ 5.66
Granted 1,348,850 3.40 762,400 3.33 688,850 3.12
Exercised (124,407) 2.87 (125,990) 2.37 (282,400) 2.58
Forfeited (978,589) 5.27 (499,477) 5.92 (302,362) 7.83
---------- ---------- ----------
Outstanding at end of year 3,871,700 $ 4.30 3,625,846 $ 4.85 3,488,913 $ 5.24
========== ====== ========== ====== ========== ======
Options exercisable at year-end 2,711,137 $ 4.62 2,734,347 $ 5.09 2,357,717 $ 5.51
========== ========== ==========
F-12
The following table summarizes information about fixed stock options
outstanding at December 31, 2001:
OUTSTANDING EXERCISABLE
---------------- -------------------------------
NUMBER WEIGHTED WEIGHTED NUMBER WEIGHTED
RANGE OF OUTSTANDING AVERAGE REMAINING AVERAGE EXERCISABLE AVERAGE
EXERCISE PRICES AS OF 12/31/01 CONTRACTUAL LIFE EXERCISE PRICE AS OF 12/31/01 EXERCISE PRICE
- -------------------- -------------- ---------------- -------------- -------------- --------------
$ 1.8100 $ 2.5310 454,500 5.63 $ 2.2951 436,270 $ 2.2926
$ 2.6250 $ 3.0160 461,250 8.90 $ 2.8457 208,979 $ 2.9067
$ 3.0630 $ 3.1880 454,400 9.07 $ 3.1634 163,105 $ 3.1868
$ 3.2500 $ 3.5310 527,100 7.25 $ 3.3327 481,229 $ 3.3300
$ 3.5800 $ 3.9300 557,850 9.35 $ 3.7697 213,955 $ 3.7969
$ 4.0000 $ 5.1250 401,850 7.29 $ 4.7920 218,266 $ 4.8569
$ 5.2500 $ 5.6250 673,500 5.86 $ 5.5267 653,083 $ 5.5276
$ 5.8125 $10.6250 244,950 4.44 $ 6.7912 239,950 $ 6.7868
$12.7500 $12.7500 300 4.50 $12.7500 300 $12.7500
$17.3800 $17.3800 96,000 4.34 $17.3800 96,000 $17.3800
- -------- -------- --------- ----- -------- --------- --------
$ 1.8100 $17.3800 3,871,700 7.28 $ 4.2969 2,711,137 $ 4.6155
======== ======== ========= ===== ======== ========= ========
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, 2001, 2000, and 1999, would have been reduced to the pro forma
amount indicated below, followed by the model assumptions used.
2001 2000 1999
-------- -------- --------
Estimated weighted-average fair value of options
granted during the year $ 2.00 $ 2.13 $ 1.61
Net loss attributable to common stockholders:
As reported (in thousands) $(13,095) $(31,191) $ (586)
Pro forma (in thousands) $(15,020) $(32,814) $ (2,525)
Basic and Diluted Net loss per share:
As reported $ (0.42) $ (1.04) $ (0.02)
Pro forma $ (0.48) $ (1.10) $ (0.10)
Black Scholes model assumptions:
Risk free interest rate 6.00% 6.00% 6.00%
Expected volatility 60% 70% 60%
Expected term 5 Years 5 Years 5 Years
Dividend yield 0% 0% 0%
F-13
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 covenants that protect against
hedging and short-selling of OrthoLogic Common Stock while the purchaser holds
shares 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.
Proceeds from the private placement were used to fund new product
opportunities, including SpinaLogic and Chrysalin, as well as to complete the
re-engineering of the Company's key business processes.
In August 2001, the Company announced that it authorized a repurchase of up
to 1 million shares of the Company's outstanding shares over the next 12 months.
The repurchased shares will be held as treasury shares and used in part to
reduce the dilution from the Company stock option plans. As of December 31,
2001, the Company had repurchased 41,800 shares at a cost, net of fees, for
$137,300 or an average price of $3.28 per share.
At the close of business on December 31, 2001, 14,400 shares of Series B
Convertible Preferred Stock had been converted into 5,746,584 shares of Common
Stock.
At December 31, 2001, there were 2,000,000 shares of Preferred Stock
authorized and there were 600,000 Warrants outstanding.
9. 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, 2001, 2000, and 1999, was approximately $1,541,631,
$1,767,000 and $1,998,000 respectively. Rent expense in 2001 was offset by
$290,000 for rent received from the buyer of the CPM business under a sublease
agreement. The sublease agreement currently extends through December 2002 and
the Company receives approximately $50,000 per month under the sublease
agreement.
Future lease payments for 2002, 2003, 2004, 2005, 2006, and beyond 2006 are
approximately $1,078,000 $1,078,000, $1,078,000, $1,078,000, $1,078,000, and
$989,000, respectively.
The Company signed an exclusive worldwide sales agreement for a 10-year
period, beginning August 18, 2000, with DePuy AcroMed, a unit of Johnson and
Johnson, whereby DePuy AcroMed will assume sales responsibility for SpinaLogic,
the Company's device used as an adjunctive treatment after lumbar spinal fusion
surgeries, in return for a commission to be paid to the company. This sales
transition began with full implementation in 2000.
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On February 28, 2000, the Company obtained a $10 million accounts
receivable revolving line of credit with a lending institution. At the Company's
request, the revolving line of credit was reduced to $4 million on September 24,
2001. The Company may borrow up to 75% of the eligible accounts 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 line of credit. Included in the financial covenants are (1)
tangible net worth of not less than $30 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. As of
December 31, 2001, the Company is in compliance with all the financial
covenants.
10. LITIGATION
SETTLEMENT OF CLASS ACTION SUIT NORMAN COOPER, ET AL. V. ORTHOLOGIC CORP.
ET AL., MARICOPA COUNTY SUPERIOR COURT, ARIZONA, CASE NO. CV 96-10799, AND
RELATED FEDERAL CASES. 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 if 1934 ("Exchange Act") and SEC Rule 10b-5 promulgated
thereunder, and, as to other defendants, Section 20(a) of the Exchange Act.
The cases were originally filed in 1996, alleged generally that information
concerning the May 31, 1996 letter received by the Company from the FDA
regarding the Company's OL1000 Bone Growth Stimulator, and the matters set forth
therein, were material and undisclosed, leading to an artificially inflated
stock price. Plaintiffs further allege 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 in order to make the statement 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 the plaintiffs. All plaintiffs sought
class action status, unspecified compensatory damages, fees and costs. 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 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 Case 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 injunction and or equitable relief. The court
granted the plaintiffs' motion for the class certification on November 24, 1999.
In early October 2000, the parties negotiated a global settlement of this
state court class action and the federal class action described below. In return
for dismissal of both the state and federal class actions, and releases by a
settlement class comprised of all purchasers of OrthoLogic common stock during
the period from January 18 through June 18, 1996, inclusive, the settlement
called for $1 million in cash and 1 million shares of newly-issued OrthoLogic
common stock. The settlement was presented to the Arizona superior court for
approval. The court granted preliminary approval of the settlement and ordered
notice to the settlement class by order dated April 30, 2001. Following notice
to the settlement class and a hearing on whether to give final approval of the
settlement, on August 17, 2001, the superior court gave final approval of the
settlement and signed and filed a judgment of dismissal of the action with
prejudice. We are not aware of any appeal from the judgment or other challenge
to the final approval of the settlement. Pursuant to the terms of the
settlement, the cash portion of the settlement fund has already been paid into
the settlement fund, with the substantial portion of the $1 million paid form
the proceeds of the Company's directors' and officers' liability insurance
policy, and the remaining cash paid by the Company. The Company recorded a $3.6
million charge, including legal expenses, for settlement Pursuant to the terms
of the settlement and order of the superior court, the Company has issued and
delivered 300,000 shares of common stock to plaintiffs' settlement counsel as
part of the plaintiffs' counsel's fee award. The remaining 700,000 shares remain
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to be delivered to the settlement fund pending administration of the claims
process under the settlement. Notices have been sent to stockholders of record
for the relevant time period to calculate the settlement pool each stockholder
is to receive.
Management believes the settlement is in the best interests of the Company
and its shareholders as it frees the Company from the cost and significant
distraction of the ongoing litigation. The settlement does not constitute, and
should not be construed as, an admission that the defendants have any liability
or acted wrongfully in any way with respect to the plaintiffs or any other
person.
The health care industry is subject to numerous laws and regulations of
federal, state, and local governments. Compliance with these laws and
regulations, specifically those relating to the Medicare and Medicaid programs,
can be subject to government review and interpretations, as well as regulatory
actions unknown and unasserted at this time. Recently, federal government
activity has increased with respect to investigations and allegations concerning
possible violations by health care providers of regulations, which could result
in the imposition of significant fines and penalties, as well as significant
repayments of previously billed and collected revenues from patient services.
Management believes that the Company is in substantial compliance with current
laws and regulations.
UNITED STATES OF AMERICA EX REL. DAVID BARMAK V. SUTTER CORP., UNITED
STATES ORTHOPEDIC CORP., ORTHOLOGIC CORP., ET AL., United States District Court,
Southern District of New York, Civ Action No 95 Civ 7637. The complaint in this
matter was filed in September 1997 under the Qui Tam provisions of the Federal
False Claims Act and primarily relates to events occurring prior to the
Company's acquisition of Sutter Corporation. The allegations relate to the
submission of claims for reimbursement for continuous passive motion exercisers
to various federal health care programs. In June 2001, the U.S. Department of
Justice and the Company entered into a settlement agreement and the government's
amended complaint was dismissed with prejudice. In October 2001, Plaintiff
Barmak filed a second amended complaint, pursuing the claim independent of the
U.S. Department of Justice. The Company filed a motion to dismiss the second
amended complaint on various grounds including that the allegations are barred
because of the earlier settlement. The case has just begun discovery. At the
present stage, it is not possible to evaluate the likelihood of an unfavorable
outcome or the amount or a range of potential loss, if any, which may be
experienced by the Company.
ORTHOREHAB, INC. AND ORTHOMOTION, INC. V. ORTHOLOGIC CORPORATION AND
ORTHOLOGIC CANADA, LTD., Superior Court of the State of Delaware, County of New
Castle, Case No. C.A. No. 01C-11-224 WCC. In November 2001, OrthoRehab, Inc.,
the company which purchased the assets related to the CPM business of OrthoLogic
Corp., filed a complaint in connection with the acquisition of the Company's
continuous passive motion business in July 2001 alleging, among other things,
that some of the assets purchased were over valued and that the Company had
breached its contract. The case is being heard in the Superior Court of the
State of Delaware. The Company has denied the Plaintiffs' allegations and
intends to defend the matter vigorously. The case is currently in discovery. At
the present stage, it is not possible to evaluate the likelihood of an
unfavorable outcome or the amount or a range of potential loss, if any, which
may be experienced by the Company.
As of December 31, 2001, in addition to the matters disclosed above, the
Company is involved in various other legal proceedings that arose in the
ordinary course of business. The costs associated with defending the above
allegations and the potential outcome cannot be determined at this time and
accordingly, no estimate for such costs have been included in the accompanying
financial statements. In management's opinion, the ultimate resolution of the
above legal proceedings will not have a material effect on the Company's
financial position, results of operations or cash flows.
11. 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 matched approximately $144,000, $195,000 and $98,000 in 2001, 2000,
and 1999 respectively.
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12. CO-PROMOTION AGREEMENT - HYALGAN
The Company entered into an exclusive Co-Promotion 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.
The Company's sales force began to promote Hyalgan in 1997. Fee revenue of
$9.3 and $8.3 was recognized during 2000 and 1999, respectively. In 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 through 2000. Royalty revenue of $3 million was recognized during
2001.
13. CHRYSALIS LICENSING AGREEMENT
The Company announced in January 1998, that it had acquired a minority
equity investment (less than 10%) in a biotech firm, Chrysalis BioTechnology,
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 a pre-clinical safety and
efficacy profile of the product. 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. A fee of $750,000 for the initial license
was expensed in the third quarter of 1998. 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 for fracture repair, OrthoLogic made a $500,000 milestone
payment to Chrysalis 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 a $2 million payment to Chrysalis and
announced it was expanding its license agreement to include all Chrysalin
orthopedic indications worldwide. In July 2001 the Company paid $1.0 million to
Chrysalis to extend its worldwide license for Chrysalin to include the rights
for orthopedic "soft tissue" indications including cartilage, tendon and
ligament repair. The license agreement calls for the Company to pay certain
additional milestone payments and royalty fees, based upon products developed
and achievement of commercial services. In March 2002, the Company made a
$500,000 milestone payment to Chrysalis for receiving clearance for the FDA to
begin a Phase I/II trial for spinal fusion. Except for the $750,000 minority
equity interest, all payments made to Chrysalis have been expensed as research
and development expenses.
During 2001 the Company completed a Phase I/II clinical trial utilizing
Chrysalin for fresh fracture repair and is currently seeking approval to begin a
Phase III trial for that indication. In March 2002, the Company received
approval by the FDA to commence a Phase I/II clinical trial for a spinal fusion
indication and anticipates initiating a trial in 2002. The Company is currently
moving forward with an Investigational New Drug application for Phase I/II human
clinical trial for Chrysalin for articular cartilage repair in 2002. 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 these products.
14. RELATED PARTY TRANSACTIONS
At December 31, 1999, the Company had an outstanding note receivable from
an officer of the Company for approximately $158,000. The loan was increased by
approximately $81,000 in January 2000. The principal and interest of both loans
were paid in full in 2000.
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15. CONDENSED CONSOLIDATED QUARTERLY RESULTS (UNAUDITED)
First Quarter Second Quarter Third Quarter Fourth Quarter
----------------- ----------------- ----------------- -----------------
2001 2000 2001 2000 2001 2000 2001 2000
------- ------- ------- ------- ------- ------- ------- -------
(000 omitted, except for per share data)
Net revenues 21,682 22,490 22,094 22,540 9,553 21,011 9,027 24,039
Gross profit 16,949 17,682 18,195 18,245 8,299 16,709 7,564 19,154
Operating income (loss) 142 700 (15,176) 509 383 (6,431) 843 (26,260)
Net income (loss) 204 694 (14,986) 549 606 (6,207) 1,081 (26,227)
Net income (loss) per share:
Basic 0.01 0.02 (0.48) 0.02 0.02 (0.21) 0.03 (0.87)
Diluted 0.01 0.02 (0.48) 0.02 0.02 (0.21) 0.03 (0.87)
In the third quarter of 2000, the Company expensed $3.6 million for
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.
In the second quarter of 2001, the Company expensed $14.3 million related
to the divestiture of the CPM business and $1.0 million to extend its worldwide
license for Chrysalin to include the rights for orthopedic "soft tissue"
indications including cartilage, tendon, and ligament repair.
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