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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 For the Quarterly Period Ended June 30, 2002 .
-------------------
[_] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 For the Transition Period from _______ to ________.
Commission File Number 0-24517 .
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ORTHOVITA, INC.
--------------------------------------------------------
(Exact Name of Registrant as Specified in its Charter)
Pennsylvania 23-2694857 .
- ---------------------------------------- ---------------------------------------
(State or Other Jurisdiction of (I.R.S. Employer Identification Number)
Incorporation or Organization)
45 Great Valley Parkway, Malvern, PA 19355 .
- ---------------------------------------- ---------------------------------------
(Address of Principal Executive Offices) (Zip Code)
Registrant's Telephone Number, Including Area Code (610) 640-1775 .
----------------------------
Not Applicable .
- --------------------------------------------------------------------------------
Former Name, Former Address and Former Fiscal Year, If Changed Since Last Report
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 such shorter period that the Registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days.
Yes X No ____
-----
Applicable only to corporate issuers:
Indicate the number of shares outstanding of each of the issuer's classes of
Common Stock, as of the latest practicable date.
Class Outstanding as of August 9, 2002
- -------------------------------------- --------------------------------
Common Stock, par value $.01 per share 20,019,622 Shares
This Report Includes a Total of 28 Pages
ORTHOVITA, INC. AND SUBSIDIARIES
INDEX
PART I - FINANCIAL Page
INFORMATION Number
Item 1. Financial Statements
Consolidated Balance Sheets -
June 30, 2002 and December 31, 2001 3
Consolidated Statements of Operations -
Three and six months ended June 30, 2002 and
2001 4
Consolidated Statements of Cash Flows -
Six months ended June 30, 2002 and 2001 5
Notes to Consolidated Financial Statements 6 - 14
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 14 - 25
Item 3. Quantitative and Qualitative Disclosures About
Market Risk 26
PART II - OTHER
INFORMATION
Item 2. Changes in Securities and Use of Proceeds 26
Item 4. Submission of Matters to a Vote of Security
Holders 27
Item 6. Exhibits and Reports on Form 8-K 27
Signatures 28
2
PART I. FINANCIAL INFORMATION
ITEM I. FINANCIAL STATEMENTS
ORTHOVITA, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
June 30, 2002 December 31, 2001
------------- -----------------
(Unaudited)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents (Notes 2 and 4) $ 5,575,011 $ 12,906,557
Accounts receivable, net 1,526,142 983,467
Inventories (Note 3) 2,217,898 1,606,333
Other current assets 182,648 125,022
------------- -------------
Total current assets 9,501,699 15,621,379
------------- -------------
PROPERTY AND EQUIPMENT, net 5,379,556 5,433,353
------------- -------------
OTHER ASSETS 151,760 158,111
------------- -------------
$ 15,033,015 $ 21,212,843
============= =============
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Current portion of long-term capital lease obligations $ 402,149 $ 482,420
Accounts payable 492,524 1,010,423
Accrued compensation and related expenses 525,742 624,168
Other accrued expenses 1,435,675 790,765
------------- -------------
Total current liabilities 2,856,090 2,907,776
------------- -------------
LONG-TERM LIABILITIES:
Other long-term liabilities 88,750 62,000
Capital lease obligations 289,839 350,519
Revenue interest obligation (Note 4) 7,167,700 5,222,107
------------- -------------
Total long-term liabilities 7,546,289 5,634,626
------------- -------------
COMMITMENTS AND CONTINGENCIES
SHAREHOLDERS' EQUITY (Notes 4 and 5):
Preferred Stock, $.01 par value, 20,000,000 shares
authorized, no shares issued and outstanding (Note 5) --- ---
Common Stock, $.01 par value, 50,000,000 shares
authorized, 20,880,504 and 20,874,536 shares issued 208,805 208,745
Additional paid-in capital 74,074,429 74,066,082
Less: Treasury stock, 860,882 shares, at cost (1,945,593) ---
Accumulated deficit (67,904,242) (61,599,522)
Accumulated other comprehensive income (loss) 197,237 (4,864)
------------- -------------
Total shareholders' equity 4,630,636 12,670,441
------------- -------------
$ 15,033,015 $ 21,212,843
============= =============
The accompanying notes are an integral part of these statements.
3
ORTHOVITA, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
Three Months Ended June 30 Six Months Ended June 30
2002 2001 2002 2001
---- ---- ---- ----
(Unaudited)
PRODUCT SALES (Note 6) $ 2,692,513 $ 953,603 $ 4,530,902 $ 1,180,009
COST OF SALES 367,975 253,638 701,936 273,038
------------ ------------ ------------ ------------
Gross Profit 2,324,538 699,965 3,828,966 906,971
------------ ------------ ------------ ------------
OPERATING EXPENSES:
General and administrative 1,265,732 1,136,616 2,478,787 2,045,649
Selling and marketing 2,271,906 1,350,302 4,145,197 2,521,610
Research and development 1,656,075 1,881,165 3,384,815 3,702,559
------------ ------------ ------------ ------------
Total operating expenses 5,193,713 4,368,083 10,008,799 8,269,818
------------ ------------ ------------ ------------
Operating loss (2,869,175) (3,668,118) (6,179,833) (7,362,847)
INTEREST EXPENSE (18,582) (34,221) (25,928) (70,782)
REVENUE INTEREST EXPENSE
(Note 4) (102,863) -- (170,601) --
INTEREST INCOME 29,254 103,853 71,642 169,346
NET GAIN ON SALE OF PRODUCT
LINE (Note 6) -- -- -- 375,000
------------ ------------ ------------ ------------
NET LOSS $ (2,961,366) $ (3,598,486) $ (6,304,720) $ (6,889,283)
============ ============ ============ ============
NET LOSS PER COMMON SHARE,
BASIC AND DILUTED $ (.15) $ (.22) $ (.31) $ (.45)
============ ============ ============ ============
WEIGHTED AVERAGE NUMBER
OF COMMON SHARES
OUTSTANDING, BASIC and
DILUTED 20,012,392 16,633,954 20,392,791 15,404,842
============ ============ ============ ============
The accompanying notes are an integral part of these statements
4
ORTHOVITA, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Six Months Ended
June 30
2002 2001
---- ----
(Unaudited)
OPERATING ACTIVITIES:
Net loss $ (6,304,720) $ (6,889,283)
Adjustments to reconcile net loss to net cash used in operating activities -
Depreciation and amortization 593,973 667,778
Amortization of deferred compensation --- 48,750
Common Stock options and warrants issued for services rendered 98,721 64,792
Loss on disposal of property and equipment 4,473 12,692
Net gain on sale of product line --- (375,000)
------------ ------------
Net cash used in operations (5,607,553) (6,470,271)
(Increase) decrease in -
Accounts receivable (542,675) (597,558)
Inventories (611,565) (729,351)
Other current assets (57,626) (25,223)
Other assets 6,351 (50,026)
Increase (decrease) in -
Accounts payable (517,899) 29,926
Accrued compensation and related expenses (98,426) (379,988)
Other accrued expenses 544,184 96,595
------------ ------------
Net cash used in operating activities (6,885,209) (8,125,896)
------------ ------------
INVESTING ACTIVITIES:
Proceeds from sale of investments --- 199,866
Decrease in restricted cash --- 375,000
Purchase of property and equipment (419,649) (1,052,965)
------------ ------------
Net cash used in investing activities (419,649) (478,099)
------------ ------------
FINANCING ACTIVITIES:
Proceeds from short term bank borrowings --- 750,000
Repayments of capital lease obligations (265,951) (361,257)
Net proceeds from sale of Common Stock and warrants --- 13,396,868
Proceeds from exercise of Common Stock options and warrants and
Common Stock purchased under the Employee Stock Purchase Plan 37,162 58,073
------------ ------------
Net cash (used in) provided by financing activities (228,789) 13,843,684
------------ ------------
EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS 202,101 92,523
------------ ------------
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS (7,331,546) 5,332,212
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 12,906,557 3,614,626
------------ ------------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 5,575,011 $ 8,946,838
============ ============
The accompanying notes are an integral part of these statements.
5
ORTHOVITA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
The Company:
Orthovita, Inc. ("Orthovita" or the "Company") is a Pennsylvania corporation
with proprietary technologies applied to the development of biostructures, which
are synthetic, biologically active, tissue engineering products for restoration
of the human skeleton. Our focus is on developing products for use in spine
surgery and in the repair of osteoporotic fractures. We are also addressing a
broad range of clinical needs in the trauma market. We have developed several
products to date:
. VITOSS(R)Scaffold Synthetic Cancellous Bone Void Filler;
. IMBIBE(TM) Bone Marrow Aspirate Syringe used with VITOSS;
. CORTOSS(TM) Synthetic Cortical Bone Void Filler; and
. ALIQUOT(TM) Microdelivery System used with CORTOSS.
In addition, we are developing RHAKOSS(TM) Synthetic Bone Spinal Implants.
VITOSS is a resorbable, beta-tricalcium phosphate scaffold used as bone void
filler in trauma and spinal procedures. CORTOSS is a high-strength,
bone-bonding, self-setting composite used in the augmentation of screws that may
have applications in a variety of orthopaedic procedures and in vertebral
augmentation. RHAKOSS is under development as a high-strength, bone-bonding
preformed composite. RHAKOSS is being designed to address the needs of the
vertebral interbody fusion and spinal reconstruction markets.
We received regulatory clearance for VITOSS in the U.S. from the United States
Food and Drug Administration ("FDA") in December 2000 and the CE Mark in the
European Union from our Notified Body in July 2000. The CE Mark permits us to
sell VITOSS in all of the countries of the European Union, as well as in other
countries such as Switzerland and Israel that have adopted the European Union's
regulatory standards. These regulatory approvals allow us to market VITOSS for
use as cancellous bone void filler for bony voids or gaps of the skeletal
system, including the extremities, spine and pelvis. We also received regulatory
approval in March 2001 to sell VITOSS for this use in Australia. We launched
VITOSS in Europe in October 2000 and in the United States in February 2001. In
April 2001, we entered into an agreement with Japan Medical Dynamic Marketing,
Inc. ("MDM"), an orthopaedic company, under which MDM will initiate clinical
studies necessary to apply for regulatory approval to market VITOSS in Japan.
These clinical studies in Japan have not yet been initiated.
In September 2001, we received regulatory clearance in the United States from
the FDA to market IMBIBE for use as a bone marrow aspiration syringe. IMBIBE
provides spine and trauma surgeons with a simple method for harvesting a
patient's own bone marrow, mixing it with VITOSS and delivering the mixture to
the bone graft site.
We received the CE Mark for CORTOSS in October 2001 in the European Union and
regulatory approval in March 2001 in Australia, which allow us to sell CORTOSS
in these territories, as well as in other countries, such as Switzerland and
Israel, that have adopted the European Union's regulatory standards, for use in
screw augmentation procedures. Screw augmentation is a procedure for the
fixation of bone screws used in patients with weak bone caused by
6
osteoporosis. We initiated a limited launch of CORTOSS in Europe in December
2001. In addition, we are conducting post-marketing human clinical studies in
Europe for the use of CORTOSS in hip compression screw augmentation. We have
completed the enrollment phase of a clinical study in Europe for the use of
Cortoss in vertebral augmentation. We expect to submit vertebral augmentation
study results to the European regulatory authorities by the end of 2002. During
2001, we received conditional approval from the FDA to conduct a pilot clinical
study in the U.S. for the use of CORTOSS for vertebral augmentation. In
addition, during 2002, we received approval from the FDA to conduct a pivotal
clinical study in the U.S. for the use of CORTOSS in long bone screw
augmentation. There can be no assurance that the data from any such clinical
trials will support clearance or approval from the FDA or European authorities
to market this product for any of these uses.
Our ALIQUOT Microdelivery System facilitates the effective delivery of our
CORTOSS product directly to the surgical site. A two-part system of catheter and
dispenser is designed to assure effective delivery of CORTOSS in screw
augmentation procedures.
RHAKOSS is under development and is designed to mimic the strength and
flexibility characteristics of bone, as well as its radiopacity, which means its
degree of transparency to x-rays and other radiation. RHAKOSS can be
manufactured into any size or shape to optimize anatomic fit. RHAKOSS is being
designed to address the needs of the vertebral interbody fusion and spinal
reconstruction markets. We initiated human clinical studies for our RHAKOSS
spinal implants during April 2002 in Europe. There can be no assurance that the
data from such clinical trials will result in obtaining the CE Mark necessary to
sell RHAKOSS in the European Union.
We have assembled a network of independent stocking distributors in Europe,
Australia and Israel and commissioned sales agencies in the U.S. in order to
market VITOSS, and we are utilizing this network for CORTOSS in Europe,
Australia and Israel. If MDM is successful in obtaining clearance to market
VITOSS, it will distribute, sell and market VITOSS in Japan. We plan to seek a
similar arrangement for CORTOSS in Japan.
We incorporated in Pennsylvania in 1992 and began operations in 1993. Our
principal offices are located at 45 Great Valley Parkway, Malvern, Pennsylvania
19355.
Our operations are subject to certain risks including, but not limited to, the
need to successfully commercialize both VITOSS in the U.S., Europe, Australia
and Israel, and CORTOSS in Europe, Australia and Israel. We also need to
successfully develop, obtain regulatory approval for, and commercialize CORTOSS
in the U.S. and RHAKOSS in the U.S. and Europe. We have incurred losses each
year since our inception in 1993, and we expect to continue to incur losses for
at least the next couple of years. As of June 30, 2002, we had an accumulated
deficit of $67,904,242. Our products under development may never be
commercialized or, if commercialized, may never generate substantial revenue. We
do not expect sales to generate cash flow in excess of operating expenses for at
least the next couple of years, if at all. We expect to continue to use cash,
cash equivalents and short-term investments to fund operating and investing
activities. We believe that our existing cash of $5,575,011 as of June 30, 2002,
together with the net proceeds received in July 2002 from the sale of Preferred
Stock and warrants of approximately $12,900,000 (see Note 5), received will be
sufficient to meet our currently estimated operating and investing requirements
through 2003. We intend to seek shareholder approval during the third quarter of
2002 for the sale of 500 shares of our Preferred Stock convertible into
2,930,832 shares of our Common Stock and warrants to purchase 2,198,125 shares
of Common Stock at $1.612 per share. If our shareholders approve this sale, and
the sale of these securities is completed, we expect to receive approximately
$4,600,000 in net proceeds. We may seek to obtain additional funds through
subsequent equity or debt financings, or strategic alliances with third parties
7
either alone or in combination with equity. These financings could result in
substantial dilution to the holders of our Common Stock and Preferred Stock or
require debt service and/or royalty payment arrangements. Any such required
financing may not be available in amounts or on terms acceptable to us.
Basis of Presentation
Our consolidated interim financial statements are unaudited and, in our opinion,
include all adjustments (consisting only of normal and recurring adjustments)
necessary for a fair presentation of results for these interim periods. The
preparation of financial statements requires that we make assumptions and
estimates that affect the reported amounts of assets and liabilities, the
disclosure of contingent assets and liabilities at the date of the interim
financial statements, and the reported amounts of revenues and expenses during
the reporting periods. Actual results could differ from those estimates. The
consolidated interim financial statements do not include all of the information
and footnote disclosures normally included in financial statements prepared in
accordance with accounting principles generally accepted in the United States,
and should be read in conjunction with the consolidated financial statements and
notes thereto included in our Annual Report on Form 10-K for the year ended
December 31, 2001, filed with the Securities and Exchange Commission, which
includes financial statements as of December 31, 2001 and 2000, and for the
years ended December 31, 2001, 2000 and 1999. The results of our operations for
any interim period are not necessarily indicative of the results of our
operations for any other interim period or for a full year.
Basis of Consolidation
The consolidated financial statements include the accounts of Orthovita, Inc.,
our European branch operations, and our wholly-owned subsidiaries including Vita
Licensing, Inc. and Vita Special Purpose Corp., which were established to hold
all intellectual property. We have eliminated all intercompany balances in
consolidation.
Net Loss Per Common Share
We have presented net loss per common share pursuant to Statement of Financial
Accounting Standards ("SFAS") No. 128, "Earnings per Share." Basic net loss per
share excludes potentially dilutive securities and is computed by dividing net
loss applicable to common shareholders by the weighted average number of shares
of Common Stock outstanding for the period. Diluted net loss per common share
data is generally computed assuming the conversion or exercise of all dilutive
securities such as Common Stock options and warrants; however, Common Stock
options and warrants were excluded from our computation of diluted net loss per
common share for the three and six months ended June 30, 2002 and 2001, because
they were anti-dilutive due to our losses.
Revenue Recognition
Revenue from product sales is recognized upon the receipt of a valid order and
shipment to our distributor customers in Europe, Australia and Israel. In the
U.S., product sales revenue is recognized upon the receipt of a valid order and
shipment of the product to the end user hospital. We do not allow product
returns or exchanges. In addition, collection of the customers' receivable
balance must be deemed probable. We maintain an accounts receivable allowance
for an estimated amount of losses that may result from customers' failure to pay
for product purchased. If the financial condition of our customers was to
deteriorate, resulting in an impairment of their ability to make payments,
additional allowances may be required.
8
Inventory
Inventory is stated at the lower of cost or market value using the first-in,
first-out basis, or FIFO, method.
Recent Accounting Pronouncements
The Financial Accounting Standards Board's ("FASB") Statement of Financial
Accounting Standards ("SFAS") No. 145, "Rescission of FASB Statements No. 4, 44,
and 64, Amendment of FASB Statement No. 13, and Technical Corrections." SFAS No.
145 eliminated the requirement that gains and losses from the extinguishment of
debt be aggregated and, if material, classified as an extraordinary item, net of
the related income tax effect. However, an entity is not prohibited from
classifying such gains and losses as extraordinary items, so long as they meet
the criteria outlined in Accounting Principles Board Opinion No. 30, Reporting
the Results of Operations - Reporting the Effects of Disposal of a Segment of a
Business, and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions. SFAS No. 145 also eliminated the inconsistency between the
accounting for sale-leaseback transactions and certain lease modifications that
have economic effects that are similar to sale-leaseback transactions. This
statement is effective for financial statements issued for fiscal years
beginning after May 15, 2002. FAS 145 does not have any impact on us.
The FASB's SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal
Activities" addresses significant issues regarding the recognition, measurement,
and reporting of costs associated with exit and disposal activities, including
restructuring activities. SFAS No. 146 also addresses recognition of certain
costs related to terminating a contract that is not a capital lease, costs to
consolidate facilities or relocate employees, and termination benefits provided
to employees that are involuntarily terminated under the terms of a one-time
benefit arrangement that is not an ongoing benefit arrangement or an individual
deferred-compensation contract. SFAS No. 146 is effective for exit or disposal
activities that are initiated after December 31, 2002. We did not have any exit
and disposal activities, including restructuring activities, during 2002.
2. CASH AND CASH EQUIVALENTS:
We invest excess cash in highly liquid investment-grade marketable securities
including corporate commercial paper and U.S. government agency bonds. For
financial reporting purposes, we consider all highly liquid investment
instruments purchased with an original maturity of three months or less to be
cash equivalents. As of June 30, 2002 and December 31, 2001, we invested all
excess cash in cash equivalents and short-term investments; however, if
long-term investments are held, such investments are considered
available-for-sale and, accordingly, unrealized gains and losses are included in
a separate component of shareholders' equity. As further discussed in Note 4,
covenants under our revenue interest agreement require us to maintain specified
levels of aggregate cash, cash equivalents and short-term investments.
9
As of June 30, 2002, cash and cash equivalents consisted of the following:
Gross Gross
Unrealized Unrealized Fair Market
Original Cost Gains Losses Value
------------- ----- ------ -----
Cash and cash equivalents $ 5,575,011 $ --- $ --- $ 5,575,011
Short-term investments --- --- --- ---
------------- ---------- ---------- ------------
$ 5,575,011 $ --- $ --- $ 5,575,011
============= ========== ========== ============
3. INVENTORIES:
Inventories are stated at the lower of cost or market on a first-in, first-out
basis. As of June 30, 2002 and December 31, 2001, inventories consisted of the
following:
June 30, 2002 December 31, 2001
------------- -----------------
Raw materials ................... $ 261,669 $ 108,960
Work-in-process ................. 1,000,429 752,079
Finished goods .................. 955,800 745,294
----------- -----------
$ 2,217,898 $ 1,606,333
=========== ===========
4. REVENUE INTEREST OBLIGATION:
During October 2001, we completed a $10,000,000 product development and equity
financing with Paul Capital Royalty Acquisition Fund, L.P. ("Paul Royalty"). We
are using the proceeds realized from this financing for clinical development,
marketing programs and working capital relating to our VITOSS, CORTOSS and
RHAKOSS products. In this financing, we sold Paul Royalty a revenue interest and
2,582,645 shares of our Common Stock, for aggregate gross proceeds of
$10,000,000.
The net proceeds of the financing were first allocated to the fair value of the
Common Stock on the date of the transaction, and the $5,222,107 remainder of the
net proceeds was allocated to the revenue interest obligation. Given that the
products subject to the revenue interest have only recently been approved and
marketed or are still under development, we, as of June 30, 2002, and for the
forseeable future, cannot make a reasonable estimate of their future sales
levels and the related revenue interest obligation. Future sales from VITOSS and
CORTOSS, our approved products, are difficult to estimate. RHAKOSS is under
development with human clinical trials initiated in Europe in April 2002. There
is no assurance that the data from these clinical trials will result in
obtaining the necessary approval to sell RHAKOSS. Even if such approval is
obtained, future revenue levels, if any, are difficult to estimate. Accordingly,
given these uncertainties in 2002 and for the foreseeable future, we will charge
revenue interest expense as revenues subject to the revenue interest obligation
are recognized. We will continue to monitor our product sales levels. Once we
are able to make a reasonable estimate of our related revenue interest
obligation, interest expense will be charged based upon the interest method and
the obligation will be reduced as principal payments are made.
On March 22, 2002, the agreement with Paul Royalty was modified whereby Paul
Royalty exchanged 860,882 shares of our Common Stock for the elimination of
certain potential credits allowable to us against our revenue interest
obligation, as well as a reduction in the amount required to repurchase Paul
Royalty's revenue interest if a repurchase event described below were to occur.
This modification was accounted for as a treasury stock transaction with a
decrease to shareholders' equity and an increase to the revenue interest
obligation based upon
10
the fair market value of the Common Stock on the date of the modification to the
transaction of $2.26 per share, or $1,945,593.
The revenue interest provides for Paul Royalty to receive 3.5% on the first
$100,000,000 of annual sales plus 1.75% of annual sales in excess of
$100,000,000 of our VITOSS, CORTOSS and RHAKOSS products in North America and
Europe through 2016, subject to certain adjustments. Our obligation to pay the
revenue interest is secured by our licenses, patents and trademarks relating to
our VITOSS, CORTOSS and RHAKOSS products in North America and Europe and the 12%
royalty interest we pay to Vita Licensing, Inc., our wholly-owned subsidiary, on
the sales of our products (collectively, the "Pledged Assets"). We are also
required to maintain:
-cash and cash equivalent balances equal to or greater than the product of
(i) 1.5 and (ii) total operating losses, net of non-cash charges, for the
preceding fiscal quarter; and
-total shareholders' equity of at least $8,664,374; provided, however, that
under the provisions of the agreement with Paul Royalty, when calculating
shareholders' equity for the purposes of the financial covenants, the
revenue interest obligation is included in shareholders' equity.
As of June 30, 2002 and December 31 2001, we were in compliance with all
financial covenants. However, if we fail to maintain such balances and
shareholders' equity, Paul Royalty can demand that we repurchase its revenue
interest for $9,619,784 (see below).
In addition to the financial covenants described above, Paul Royalty has the
right to cause us to repurchase its revenue interest upon the occurrence of
certain events, including:
-a judicial decision that has a material adverse effect on our business,
operations, assets or financial condition;
-the acceleration of our obligations or the exercise of default remedies by
a secured lender under certain debt instruments;
-a voluntary or involuntary bankruptcy that involves us or our wholly-owned
subsidiary, Vita Special Purpose Corp.;
-our insolvency;
-a change in control of our company;
-the breach of a representation, warranty or certification made by us in
the agreements with Paul Royalty that, individually or in the aggregate,
would reasonably be expected to have a material adverse effect on our
business, operations, assets or financial condition, and such breach is not
cured within 30 days after notice thereof from Paul Royalty.
We may not have sufficient cash funds to repurchase the revenue interest upon a
repurchase event. The exact amount of the repurchase price is dependent upon
certain factors, including when the repurchase event occurs. The repurchase
price targets an internal rate of return for Paul Royalty's $10,000,000
investment ranging up to 45% net of revenue interest amounts paid by us to Paul
Royalty during the term of the revenue sharing agreement. The March 22, 2002
amendment to our agreement with Paul Royalty reduced by $3,333,333 the amount
that would be due to Paul Royalty should any such repurchase event described
above occur in the future, and result in Paul Royalty requiring us to repurchase
its revenue interest. If we were unable to repurchase the revenue interest upon
a repurchase event, Paul Royalty could foreclose on the Pledged Assets, and we
could be forced into bankruptcy. Paul Royalty could also foreclose on the
Pledged Assets if we are insolvent or involved in a voluntary or involuntary
bankruptcy. No repurchase events or foreclosures have occurred as of June 30,
2002. As of June 30, 2002, if the repurchase event had been triggered and Paul
Royalty exercised their right to require us to repurchase their revenue
interest, we would have owed Paul Royalty $9,619,784.
If we know that we will not be in compliance with our covenants under the Paul
Royalty agreement, we will be required to adjust the revenue interest obligation
to equal the amount required to repurchase Paul Royalty's revenue interest. As
of June 30, 2002, we believe that we will remain in compliance for the
foreseeable future, with all covenants and terms of the revenue interest
obligation.
5. SHAREHOLDERS' EQUITY:
Preferred Stock and Warrants - Subsequent Event
In July 2002, we sold 1,400 shares of Series A 6% Adjustable Cumulative
Convertible Voting Preferred Stock at $10,000 per share which are convertible
into 8,206,331 shares of our Common Stock, together with five-year warrants to
purchase 6,154,747 shares of Common Stock at $1.612 per share, for net proceeds
of approximately $12,900,000. In July 2002, we also issued to the placement
agent for the transaction and its designee, five-year warrants to purchase an
aggregate 820,633 shares of our Common Stock at $1.706 per share. In connection
with this transaction, we have agreed to sell an additional 500 shares of Series
A 6% Adjustable Cumulative Convertible Voting Preferred Stock convertible into
2,930,832 shares of our Common Stock and warrants to purchase 2,198,125 shares
of Common Stock at $1.612 per share if we obtain shareholder approval to do so.
If our shareholders approve this sale, and we sell these additional securities,
we expect to receive approximately $4,600,000 in net proceeds and to issue to
the placement agent additional five-year warrants to purchase 293,083 shares of
our Common stock at $1.706 per share.
The proceeds wil be allocated to the Series A Preferred Stock and the warrants
based on the relative fair values of each instrument. The fair value of the July
2002 warrants issued will be determined based on the Black-Scholes option
pricing model using a life of five years, a volatility of 50% and a risk-free
interest rate of 3.00%. Accordingly, approximately $9,400,000 of the proceeds
will be allocated to the Series A Preferred Stock and $3,500,000 of the proceeds
will be allocated to the warrants. After considering the allocation of the
proceeds based on the relative fair values, it was determined that the Series A
Preferred Stock will have a beneficial conversion feature ("BCF") in accordance
with Emerging Issues Task Force ("EITF") Issue No. 98-5, "Accounting for
Convertible Securities with Beneficial Conversion Features or Contingently
Adjustable Conversion Ratios and EITF Issue No. 00-27, "Application of Issue No.
98-5 to Certain Convertible Instruments." We will record the BCF related to the
July 2002 closing of approximately $3,300,000 as a discount to the Series A
Preferred Stock during the third quarter of 2002. The value of the BCF will be
recorded in a manner similar to a deemed dividend over the period from the date
of issuance to the earliest known date of conversion. As the Preferred Stock is
convertible at the date of issuance, this discount will be fully amortized
through retained earnings at the date of issuance. We will allocate the proceeds
from the second closing, if our shareholders approve this sale, in the manner as
discussed above. At the time of the second closing, if approved, an additional
BCF will be recorded.
Upon the occurrence of each of the following events, each holder of Preferred
Stock can require us to redeem each share of Preferred Stock held by such holder
for cash in an amount equal to (i) $11,000 plus (ii) any accrued and unpaid
dividend payments:
.. our failure or refusal to convert any shares of the Preferred Stock in
accordance with the terms thereof, or our material breach of any other term
or provision of the terms of the Preferred Stock;
11
.. any breach of any warranty or representation made by us as of the date of the
Preferred Stock Purchase Agreement that is reasonably likely to have a
material adverse effect on Orthovita; or
.. any breach by us of any covenant or other provision of the Preferred Stock
Purchase Agreement that is reasonably likely to have a material adverse
effect on Orthovita.
Dividends on the Preferred Stock will accrue and be cumulative from July 2002,
whether or not such dividends are earned or declared by the Board of Directors,
and will be payable at our option either in cash or in kind (subject to certain
share issuance caps as set forth in the Statement of Designations of the
Preferred Stock) on March 31, June 30, September 30 and December 31 of each
year. The dividend rate (the "Dividend Rate") on each share of Preferred Stock
will be 6% per year on the $10,000 stated value of the Preferred Stock.
Commencing June 30, 2004, the Dividend Rate will increase each quarter by an
additional two percentage points per annum, up to a maximum Dividend Rate of 14%
per share per year. In addition, in the event that the Preferred Stock becomes
subject to mandatory conversion due to the achievement of certain revenue
targets by us prior to July 1, 2005, as more fully described in the Statement of
Designations of the Preferred Stock, we will pay an additional dividend equal to
the difference between (x) $2,000 per share of Preferred Stock to be converted
and (y) the sum of all dividends that have been paid and all accrued but unpaid
dividends with respect to each such share.
Treasury Stock
On March 22, 2002, the agreement with Paul Royalty was modified whereby it
exchanged 860,882 shares of our Common Stock for elimination of certain
potential credits allowable to us against our revenue interest obligation, as
well as a reduction in the amount required to repurchase Paul Royalty's revenue
interest if a repurchase event were to occur (see Note 4). This modification was
accounted for as a treasury stock transaction with a decrease to shareholders'
equity and an increase to the revenue interest obligation based upon the fair
market value of the Common Stock on the date of the modification to the
transaction of $2.26 per share, or $1,945,593.
Stock Options
During the six months ended June 30, 2002, stock options to purchase 10,000
shares of Common Stock were exercised for proceeds of $17,000. There were no
stock option exercises during the second quarter of 2002. Additionally, during
the three and six months ended June 30, 2002, we issued stock options for the
purchase of 20,000 shares and 55,800 shares of Common Stock with various
exercise prices to certain vendors in consideration for services valued at
$27,934 and $70,787, respectively.
Employee Stock Purchase Plan
During the three and six months ended June 30, 2002, 4,907 shares and 7,311
shares of Common Stock were purchased by the Employee Stock Purchase Plan for
proceeds of $10,219 and $9,943, respectively.
Common Stock Purchase Warrants
During April 2002, warrants to purchase 547,010 shares of Common Stock at an
exercise price of $4.25 per share expired unexercised.
12
Pursuant to an investment banking agreement with SCO Securities LLC, as partial
payment for financial advisory services rendered, we issued warrants to purchase
an aggregate 76,000 shares of our Common Stock. These warrants have an exercise
price of $4.625 per share and an exercise period of four years. The issuance of
these securities was exempt from registration pursuant to Section 4(2) of the
Securities Act of 1933 and Rule 506 of Regulation D as an issuer transaction not
involving a public offering.
6. PRODUCT SALES AND NET GAIN ON SALE OF PRODUCT LINE:
We initiated sales of VITOSS in Europe and the United States in October 2000 and
February 2001, respectively. CORTOSS sales were initiated in Europe during
December 2001. For the three and six months ended June 30, 2002 and 2001,
product sales of VITOSS and CORTOSS by geographic market were as follows:
For the three months ended For the six months ended
PRODUCT SALES: June 30, 2002 June 30, 2001 June 30, 2002 June 30, 2001
------------- ------------- ------------- -------------
United States $ 2,536,876 $ 715,777 $ 4,202,654 $ 820,587
Outside the United States 155,637 237,826 328,248 359,422
----------- ----------- ----------- -----------
Total product sales $ 2,692,513 $ 953,603 $ 4,530,902 $ 1,180,009
=========== =========== =========== ===========
In March 2000, we sold our BIOGRAN(TM) dental grafting product line for
$3,900,000 and received proceeds of $3,500,000 with an additional $400,000 held
in a restricted cash escrow account until March 2001. We realized a net gain on
the transaction of approximately $375,000 for six months ended June 30, 2001.
13
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Forward-Looking Statements
The use of the words "Orthovita," the "Company," "we," "us" or "our" herein
refers to Orthovita, Inc. together with its subsidiaries. In addition to
historical facts or statements of current conditions, this report contains
forward-looking statements that address, among other things, the generation of
revenues through sales of our approved products, the offer and sale of shares of
our Preferred Stock and warrants to purchase shares of our Common Stock that is
subject to shareholder approval, anticipated uses of proceeds from the sale of
our securities, sufficiency of available resources to fund operations, and the
timing of regulatory approvals for our products under development. When used in
this Form 10-Q, the words "may," "will," "expect," "anticipate," "intend,"
"plan," "believe," "seek," "estimate" and similar expressions are generally
intended to identify forward-looking statements, but are not the exclusive
expressions of forward-looking statements. Forward-looking statements are based
on current expectations of future events that involve risks and uncertainties;
therefore, readers are cautioned not to place undue reliance on these
forward-looking statements, which speak only as of the date made. Furthermore,
we undertake no obligation to publicly update any forward-looking statements. We
claim the protections afforded by the Private Securities Litigation Reform Act
of 1995, as amended, for our forward-looking statements. There are important
facts that could cause actual events or results to differ materially from those
expressed or implied by forward-looking statements including, without limitation
risk factors that are addressed in greater detail in the "Management's
Discussion and Analysis of Financial Condition and Results of Operations -
Certain Risks Related to Our Business" section of our Annual Report on Form 10-K
for the year ended December 31, 2001, which was filed with the U.S. Securities
and Exchange Commission.
In addition, our performance and financial results could differ materially from
those reflected in the forward-looking statements due to general financial,
economic, regulatory and political conditions affecting the biotechnology,
orthopaedic and medical device industries, as well as the more specific risks
discussed in this report.
Overview
Orthovita, Inc. ("Orthovita" or the "Company") is a Pennsylvania corporation
with proprietary technologies applied to the development of biostructures, which
are synthetic, biologically active, tissue engineering products for restoration
of the human skeleton. Our focus is on developing products for use in spine
surgery and in the repair of osteoporotic fractures. We are also addressing a
broad range of clinical needs in the trauma market. We have developed several
products to date:
. VITOSS(R) Scaffold Synthetic Cancellous Bone Void Filler;
. IMBIBE(TM) Bone Marrow Aspirate Syringe used with VITOSS;
. CORTOSS(TM) Synthetic Cortical Bone Void Filler; and
. ALIQUOT(TM) Microdelivery System used with CORTOSS.
In addition, we are developing RHAKOSS(TM) Synthetic Bone Spinal Implants.
VITOSS is a resorbable, beta-tricalcium phosphate scaffold used as bone void
filler in trauma and spinal procedures. CORTOSS is a high-strength,
bone-bonding, self-setting composite used in the augmentation of screws that may
have applications in a variety of orthopaedic procedures and in vertebral
augmentation. RHAKOSS is under development as a high-strength,
14
bone-bonding preformed composite. RHAKOSS is being designed to address the needs
of the vertebral interbody fusion and spinal reconstruction markets.
We received regulatory clearance for VITOSS in the U.S. from the United States
Food and Drug Administration ("FDA") in December 2000 and the CE Mark in the
European Union from our Notified Body in July 2000. The CE Mark permits us to
sell VITOSS in all of the countries of the European Union, as well as in other
countries such as Switzerland and Israel that have adopted the European Union's
regulatory standards. These regulatory approvals allow us to market VITOSS for
use as cancellous bone void filler for bony voids or gaps of the skeletal
system, including the extremities, spine and pelvis. We also received regulatory
approval in March 2001 to sell VITOSS for this use in Australia. We launched
VITOSS in Europe in October 2000 and in the United States in February 2001. In
April 2001, we entered into an agreement with Japan Medical Dynamic Marketing,
Inc. ("MDM"), an orthopaedic company, under which MDM will initiate clinical
studies necessary to apply for regulatory approval to market VITOSS in Japan.
These clinical studies in Japan have not yet been initiated.
In September 2001, we received regulatory clearance in the United States from
the FDA to market IMBIBE for use as a bone marrow aspiration syringe. IMBIBE
provides spine and trauma surgeons with a simple method for harvesting a
patient's own bone marrow, mixing it with VITOSS and delivering the mixture to
the bone graft site.
We received the CE Mark for CORTOSS in October 2001 in the European Union and
regulatory approval in March 2001 in Australia, which allow us to sell CORTOSS
in these territories, as well as in other countries, such as Switzerland and
Israel, that have adopted the European Union's regulatory standards, for use in
screw augmentation procedures. Screw augmentation is a procedure for the
fixation of bone screws used in patients with weak bone caused by osteoporosis.
We initiated a limited launch of CORTOSS in Europe in December 2001. In
addition, we are conducting post-marketing human clinical studies in Europe for
the use of CORTOSS in hip compression screw augmentation. We have completed the
enrollment phase of a clinical study in Europe for the use of Cortoss in
vertebral augmentation. We expect to submit vertebral augmentation study results
to the European regulatory authorities by the end of 2002. During 2001, we
received conditional approval from the FDA to conduct a pilot clinical study in
the U.S. for the use of CORTOSS for vertebral augmentation. In addition, during
2002, we received approval from the FDA to conduct a pivotal clinical study in
the U.S. for the use of CORTOSS in long bone screw augmentation. There can be no
assurance that the data from any such clinical trials will support clearance or
approval from the FDA or European authorities to market this product for any of
these uses.
Our ALIQUOT Microdelivery System facilitates the effective delivery of our
CORTOSS product directly to the surgical site. A two-part system of catheter and
dispenser is designed to assure effective delivery of CORTOSS in screw
augmentation procedures.
RHAKOSS is under development and is designed to mimic the strength and
flexibility characteristics of bone, as well as its radiopacity, which means its
degree of transparency to x-rays and other radiation. RHAKOSS can be
manufactured into any size or shape to optimize anatomic fit. RHAKOSS is being
designed to address the needs of the vertebral interbody fusion and spinal
reconstruction markets. We initiated human clinical studies for our RHAKOSS
spinal implants during April 2002 in Europe. There can be no assurance that the
data from such clinical trials will result in obtaining the CE Mark necessary to
sell RHAKOSS in the European Union.
We have assembled a network of independent stocking distributors in Europe,
Australia and Israel and commissioned sales agencies in the U.S. in order to
market VITOSS, and we are
15
utilizing this network for CORTOSS in Europe, Australia and Israel. If MDM is
successful in obtaining clearance to market VITOSS, it will distribute, sell and
market VITOSS in Japan. We plan to seek a similar arrangement for CORTOSS in
Japan.
We incorporated in Pennsylvania in 1992 and began operations in 1993. Our
principal offices are located at 45 Great Valley Parkway, Malvern, Pennsylvania
19355.
Our operations are subject to certain risks including but not limited to, the
need to successfully commercialize both VITOSS in the U.S., Europe, Australia
and Israel, and CORTOSS in Europe, Australia, and Israel. We also need to
successfully develop, obtain regulatory approval for, and commercialize CORTOSS
in the U.S. and RHAKOSS in the U.S. and Europe. We have incurred losses each
year since our inception in 1993, and we expect to continue to incur losses for
at least the next couple of years. As of June 30, 2002, we had an accumulated
deficit of $67,904,242. Our products under development may never be
commercialized or, if commercialized, may never generate substantial revenue. We
do not expect sales to generate cash flow in excess of operating expenses for at
least the next couple of years, if at all. We expect to continue to use cash,
cash equivalents and short-term investments to fund operating and investing
activities. We believe that our existing cash of $5,575,011 as of June 30, 2002,
together with the net proceeds received in July 2002 from the sale of Preferred
Stock and warrants of approximately $12,900,000 (see Note 5), will be sufficient
to meet our currently estimated operating and investing requirements through
2003. We intend to seek shareholder approval during the third quarter of 2002
for the sale of 500 shares of our Preferred Stock convertible into 2,930,832
shares of our Common Stock and warrants to purchase 2,198,125 shares of Common
Stock at $1.612 per share. If our shareholders approve this sale, and the sale
of these securities is completed, we expect to receive approximately $4,600,000
in net proceeds. We may seek to obtain additional funds through subsequent
equity or debt financings, or strategic alliances with third parties either
alone or in combination with equity. These financings could result in
substantial dilution to the holders of our Common Stock and Preferred Stock or
require debt service and/or royalty payment arrangements. Any such required
financing may not be available in amounts or on terms acceptable to us.
Certain Risks Related to Our Business
Additional specific risks to which our performance and financial results are
subject, are set forth below. Certain of these risk factors are set forth in
more detail in our Annual Report on Form 10-K for the year ended December 31,
2001.
We are dependent on the commercial success of CORTOSS and VITOSS.
We are highly dependent on successfully selling our products for which we
have received regulatory approval. We expect approvals for our products under
development, if obtained at all, to take several years. To date, we have
received regulatory approval to market VITOSS and CORTOSS for specified uses
in the European Union, Australia and countries adhering to the regulatory
standards of the European Union. We have also received regulatory clearance
to market VITOSS in the United States. Certain factors that could affect
sales of VITOSS and CORTOSS include the following:
We may be unable to increase sales of our approved products.
We may not be able to operate an effective sales and distribution network.
We have assembled a network of independent stocking distributors in Europe,
Australia and Israel and commissioned sales agencies in the U.S. in order to
market VITOSS, and we are
16
utilizing this network for CORTOSS in Europe, Australia and Israel. We also
intend to distribute VITOSS and CORTOSS through a third party strategic
alliance in Japan if they are approved there. Any failure to maintain and
manage our distribution network will impair our ability to generate sales and
become profitable.
We are dependent upon these distributors and agencies for the sale of our
products. There can be no assurance that the distributors and agencies will
perform their obligations in their respective territories as expected, or
that we will continue to derive any revenue from these arrangements. We
cannot assure that our interests will continue to coincide with those of our
distributors and agencies. In addition, we cannot assure that they will not
develop, independently or with alternative companies, other products that
could compete with our products.
The independent U.S. agencies selling VITOSS generally sell products from
other orthopaedic companies. A single agency may sell to end user hospitals
VITOSS, as well as hardware consisting of metal plates, screws and titanium
spinal cages. Should any of these other orthopaedic companies add a bone
graft material to their product line, our independent agencies could decide
to eliminate VITOSS and terminate their arrangement with us. Our sales could
be adversely affected if, for any reason, one or more of our successful
agencies lost their hardware product line provided by any of these other
orthopaedic companies. Additionally, our sales could be adversely affected if
one or more of our successful agencies eliminated VITOSS from their product
line and terminated their agency arrangements with us.
In addition, our ability to penetrate the markets that we intend to serve is
highly dependent upon the quality and breadth of the other product lines
which our distribution network carries, the components of which may change
from time to time, and over which we have little or no control. The complete
product line represented by the distributors and agencies, including our
products, is an important factor in the distributors' or agencies' ability to
penetrate the market.
We may not train a sufficient number of surgeons to create demand for our
products.
If healthcare providers cannot obtain third-party reimbursement for procedures
using our products, or if such reimbursement is inadequate, we may never become
profitable.
If we are unable to raise additional capital in the future, our product
development will be limited and our long term viability may be threatened; if we
raise additional capital, your percentage ownership as a shareholder of
Orthovita will decrease and constraints could be placed on the operation of our
business.
We have experienced negative operating cash flows since our inception and
have funded our operations primarily from proceeds received from sales of our
Common Stock. In July 2002 we raised approximately $12,900,000 in net
proceeds from the sale of 1,400 shares of our Preferred stock and warrants to
purchase 6,154,747 shares of our Common Stock. We do not expect sales to
generate cash flow in excess of operating expenses for at least the next
couple of years, if at all. We expect to continue to use cash, cash
equivalents and short-term investments to fund operating and investing
activities. We believe that our existing cash of $5,575,011 as of June 30,
2002, together with the net proceeds realized in July 2002 from the sale of
Preferred Stock and warrants (see Note 5), will be sufficient to meet our
currently estimated operating and investing requirements through 2003. We
intend to seek shareholder approval during the third quarter of 2002 for the
sale of 500 shares of our Preferred Stock convertible into 2,930,832 shares
of our Common Stock and warrants to
17
purchase 2,198,125 shares of our Common Stock at $1.612 per share. If our
shareholders approve this sale, and the sale of these securities is
completed, we expect to realize approximately $4,600,000 in net proceeds. We
may seek to obtain additional funds through subsequent equity or debt
financings, or strategic alliances with third parties either alone or in
combination with equity. These financings could result in substantial
dilution to the holders of our Common Stock or require debt service and/or
royalty payment arrangements. Any such required financing may not be
available in amounts or on terms acceptable to us. Factors that may cause our
future capital requirements to be greater than anticipated include:
-unforeseen developments during our pre-clinical and clinical trials;
-timing of receipt of required regulatory approvals;
-unanticipated expenditures in research and development or manufacturing
activities;
-delayed market acceptance of our products;
-unanticipated expenditures in the acquisition and defense of intellectual
property rights; or
-the failure to develop strategic alliances for the marketing of some of
our products.
If adequate financing is not available, we may be required to delay, scale
back or eliminate certain operations. In addition, although we have no
present commitments or understandings to do so, we may seek to expand our
operations and product line via acquisitions or joint ventures. Any such
acquisitions or joint ventures may increase our capital requirements.
If we fail to obtain and maintain the regulatory approvals necessary to sell our
products, sales could be delayed or never realized.
If we do not manage commercial scale manufacturing capability and capacity for
our products, our product sales may suffer.
It may be difficult to operate in international markets.
If losses continue in the long term, it could limit our growth and slow our
generation of revenues.
If we fail to meet our obligations under a revenue sharing agreement, we may be
required to repurchase from an investor its right to receive revenues on certain
of our product sales, and the investor could foreclose on certain assets that
are essential to our operations.
During October 2001, we completed a $10,000,000 product development and
equity financing with Paul Royalty. In this financing, we sold Paul Royalty a
revenue interest and shares of our Common Stock.
The revenue interest provides for Paul Royalty to receive 3.5% on the first
$100,000,000 of annual sales plus 1.75% of annual sales in excess of
$100,000,000 of certain of our products, including VITOSS, CORTOSS and
RHAKOSS, in North America and Europe through 2016, subject to certain
adjustments. This royalty percentage can increase if we fail to meet
contractually specified levels of annual net sales of products for which Paul
Royalty is entitled to receive its revenue interest. Our obligation to pay
the revenue interest is secured by our licenses, patents and trademarks
relating to certain of our products, including VITOSS, CORTOSS and RHAKOSS,
in North America and Europe, and the 12% royalty interest we pay to Vita
Licensing, Inc., our wholly-owned subsidiary, on the sales of our products
(collectively, the "Pledged Assets"). We are also required to maintain:
18
-cash and cash equivalent balances equal to or greater than the product of
(i) 1.5 and (ii) total operating losses, net of non-cash charges, for the
preceding fiscal quarter; and
-total shareholders' equity of at least $8,664,374; provided, however, that
under the provisions of the agreement with Paul Royalty when calculating
shareholders' equity for the purposes of the financial covenants, the revenue
interest obligation is included in shareholders' equity.
As of June 30, 2002 and December 31, 2001, we were in compliance with all
financial covenants. However, if we fail to maintain such balances and
shareholders' equity, Paul Royalty can demand that we repurchase its revenue
interest for $9,619,784 (see below).
In addition to the failure to comply with the financial covenants described
above, the occurrence of certain events, including those set forth below,
triggers Paul Royalty's right to cause us to repurchase its revenue interest:
- a judicial decision that has a material adverse effect on our business,
operations, assets or financial condition;
- the acceleration of our obligations or the exercise of default remedies by
a secured lender under certain debt instruments;
- a voluntary or involuntary bankruptcy that involves us or our wholly-owned
subsidiary, Vita Special Purpose Corp.;
- our insolvency;
- a change in control of our company;
- the breach of a representation, warranty or certification made by us in the
agreements with Paul Royalty that, individually or in the aggregate, would
reasonably be expected to have a material adverse effect on our business,
operations, assets or financial condition, and such breach is not cured
within 30 days after notice thereof from Paul Royalty.
We may not have sufficient cash funds to repurchase the revenue interest upon
a repurchase event. The exact amount of the repurchase price is dependent
upon certain factors, including when the repurchase event occurs. The
repurchase price targets an internal rate of return for Paul Royalty's
$10,000,000 investment ranging up to 45% net of revenue interest amounts paid
by us to Paul Royalty during the term of the revenue sharing agreement. The
March 22, 2002 amendment to our agreement with Paul Royalty reduced by
$3,333,333 the amount that would be due to Paul Royalty should any such
repurchase event described above occur in the future, and result in Paul
Royalty requiring us to repurchase its revenue interest. If we were unable to
repurchase the revenue interest upon a repurchase event, Paul Royalty could
foreclose on the Pledged Assets, and we could be forced into bankruptcy. Paul
Royalty could also foreclose on the Pledged Assets if we are insolvent or are
involved in a voluntary or involuntary bankruptcy. No repurchase events or
foreclosures have occurred as of June 30, 2002. As of June 30, 2002, if the
repurchase event had been triggered and Paul Royalty exercised their right to
require us to repurchase their revenue interest, we would have owed Paul
Royalty $9,619,784.
We may be required to redeem shares of Preferred Stock upon the occurrence of
certain events.
During July 2002, we completed a private placement of 1,400 shares of our
Preferred Stock. In connection with the private placement, we agreed to sell
an additional 500 shares of our Preferred Stock, subject to approval by our
shareholders. We intend to seek shareholder approval for the sale of the
additional 500 shares of Preferred Stock during the third quarter of 2002.
19
Upon the occurrence of each of the following events, each holder of Preferred
Stock can require us to redeem each share of Preferred Stock held by such
holder for cash in an amount equal to (i) $11,000 plus (ii) any accrued and
unpaid dividend payments:
. our failure or refusal to convert any shares of the Preferred Stock in
accordance with the terms thereof, or our material breach of any other term
or provision of the terms of the Preferred Stock;
. any breach of any warranty or representation made by us as of the date of
the Preferred Stock Purchase Agreement that is reasonably likely to have a
material adverse effect on Orthovita; or
. any breach by us of any covenant or other provision of the Preferred Stock
Purchase Agreement that is reasonably likely to have a material adverse
effect on Orthovita.
We may not have sufficient cash funds to redeem the Preferred Stock upon a
redemption event. If we were unable to redeem the Preferred Stock upon a
redemption event, we could be forced into bankruptcy.
Our results of operations may fluctuate due to factors out of our control.
The results of our operations may fluctuate significantly from quarter to
quarter and may not meet expectations of securities analysts and investors. This
may cause our stock price to be volatile.
Our business will be damaged if we are unable to protect our proprietary rights
to the technologies used in our products, and we may be subject to intellectual
property infringement claims by others.
We may lack the financial resources needed to respond to technological changes
and other actions by competitors, obtain regulatory approvals for our products
and efficiently market our products.
We may acquire technologies or companies in the future, and these acquisitions
could result in dilution to our shareholders and disruption of our business.
Provisions of Pennsylvania law or our Articles of Incorporation may deter a
third party from seeking to obtain control of us or may affect your rights as a
shareholder.
Our executive officers and directors own a large percentage of our voting stock
and could exert significant influence over matters requiring stockholder
approval, including takeover attempts.
We do not intend to pay any cash dividends to our Common Stock shareholders.
Our stock price may be volatile.
If our shares are delisted from the Nasdaq National Market, it may be difficult
to sell your investment in our company.
If we are sued in a product liability action, we could be forced to pay
substantial damages, and the attention of our management team may be diverted
from operating our business.
Our business could suffer if we cannot attract and retain the services of key
employees.
20
Liquidity and Capital Resources
We have experienced negative operating cash flows since our inception, and we
have funded our operations primarily from the proceeds received from the sale of
our Common Stock. Cash and cash equivalents were $5,575,011 at June 30, 2002,
and $12,906,557 at December 31, 2001, representing 37.1% and 60.8% of our total
assets, respectively. In July 2002 we raised approximately $12,900,000 in net
proceeds from the sale of 1,400 shares of our Preferred Stock and warrants to
purchase 6,154,747 shares of our Common Stock. We invest excess cash in highly
liquid investment-grade marketable securities including corporate commercial
paper and U.S. government agency bonds.
The following is a summary of selected cash flow information for the six months
ended June 30, 2002 and 2001:
Six Months Ended June 30,
2002 2001
---- ----
Net loss $ (6,304,720) $ (6,889,283)
Adjustments for non-cash operating items 697,167 419,012
------------ ------------
Net cash operating loss (5,607,553) (6,470,271)
Net change in assets and liabilities (1,277,656) (1,655,625)
------------ ------------
Net cash used in operating activities (6,885,209) (8,125,896)
============ ============
Net cash used in investing activities (419,649) (478,099)
============ ============
Net cash (used in) provided by financing activities (228,789) 13,843,684
============ ============
Net cash used in operating activities
Operating Cash Inflows -
Operating cash inflows for the first half of 2002 have been derived from VITOSS
and CORTOSS product sales. We have also received cash inflows from interest
income on cash equivalents and short-term investments.
With respect to the first half of 2001, operating cash inflows have been derived
from VITOSS product sales, and we received cash inflows from interest income on
short-term investments.
Operating Cash Outflows -
Our operating cash outflows for 2002 have continued to be primarily used for
RHAKOSS process development, and pre-clinical and clinical activities in
preparation for regulatory filings of our products in development. In addition,
funds have been used for the production of inventory, increase in sales and
marketing staffing, development of marketing materials related to the
commercialization of VITOSS and CORTOSS products, and payment of sales
commissions.
21
Operating Cash Flow Requirements Outlook -
We do not expect sales to generate cash flow in excess of operating expenses for
at least the next couple of years, if at all. We expect to continue to use cash,
cash equivalents and short-term investments to fund operating activities. We
began selling VITOSS in Europe in the fourth quarter of 2000, and in the United
States late in the first quarter of 2001. During the third quarter of 2001, we
received a 510(k) FDA regulatory clearance to market the IMBIBE Bone Marrow
Aspirate Syringe in the United States. Late in the fourth quarter of 2001, we
began selling CORTOSS in Europe for the fixation of bone screws under a CE Mark.
Future cash flow levels from VITOSS, CORTOSS and IMBIBE product sales are
difficult to predict at this stage of the products' launches. None of our
product sales to date may be indicative of future sales levels. VITOSS and
CORTOSS sales levels in Europe may fluctuate due to the timing of any
distributor stocking orders and may experience seasonal slowdowns during the
summer months. Sales of VITOSS and IMBIBE in the U.S. may fluctuate due to the
timing of orders from hospitals and may fluctuate due to changes in our
distribution network and sales management.
Any future cash flows from CORTOSS are dependent upon the successful controlled
launch of the product in Europe during 2002. Beginning in December 2001, we
initiated a controlled launch of CORTOSS in selected European countries. CORTOSS
was sold to up to three teaching institutions in each of the selected European
countries. Our plan is to utilize these teaching institutions in each country as
centers for the training of surgeons from other institutions within their
respective countries. We expect to have CORTOSS generally available in Europe
during the second half of 2002.
There may be future quarterly fluctuations in spending. We expect that our sales
commission expense may increase at a higher rate than any increase in VITOSS and
IMBIBE product sales in the United States as we make enhancements to our sales
commission program. In addition, we expect increases in the use of cash to build
inventory and fund receivables. We also expect to continue to use cash in
operating activities associated with research and development, including
clinical trials for CORTOSS and RHAKOSS, manufacturing process development, and
pre-launch marketing activities in support of our other products under
development as well as the associated marketing and sales activities with VITOSS
and IMBIBE in the United States, and with VITOSS and CORTOSS in Europe,
Australia and Israel.
Finally, we have entered into and may enter into additional financing
arrangements where we pay revenue sharing amounts on the sales of certain
products. These arrangements can increase expenses related to the sale of our
products.
Net cash used in investing activities
We have invested $419,649 and $1,052,965 for the six months ended June 30, 2002
and 2001, respectively, primarily for the purchase of leasehold improvements,
manufacturing equipment and research and development equipment in order to
further expand our product development and manufacturing capabilities.
During March 2001, we received $375,000 from the escrow account that had been
established in connection with the March 2000 sale of our BIOGRAN dental
grafting product line to Implant Innovations, Inc. Of the original escrow amount
of $400,000, $25,000 continues to be held in escrow for costs related to certain
patent litigation.
22
Investing Cash Outlook -
We anticipate capital spending for improvements to manufacturing processes at
our facilities. Accordingly, we expect the rate at which we invest funds in 2002
related to improvements to our leased office and manufacturing facilities to be
relatively stable compared to 2001. We anticipate new capital spending will be
required in support of the RHAKOSS program.
Net cash provided by financing activities
During the first six months of 2002 and 2001, we received $37,162 and $58,073,
respectively, from stock option exercises and purchases of Common Stock under
our Employee Stock Purchase Plan. In addition, $265,951 and $361,257 were used
to repay capital lease obligations during the first six months of 2002 and 2001,
respectively. During the six months ended June 30, 2001, we borrowed $750,000 on
a line of credit with our bank, and we paid the line in full during July 2001.
Additionally, in the first half of 2001, we sold 3,678,118 shares of our Common
Stock in private equity financings, raising aggregate net proceeds of
approximately $13,396,868.
Financing Requirements Outlook
The extent and timing of proceeds from future stock option and warrant
exercises, if any, are primarily dependent upon our Common Stock's market price,
as well as the exercise prices and expiration dates of the stock options and
warrants.
We do not expect sales to generate cash flow in excess of operating expenses for
at least the next couple of years, if at all. We expect to continue to use cash,
cash equivalents and short-term investments to fund operating and investing
activities. We believe that our existing cash of $5,575,011 as of June 30, 2002,
together with the net proceeds received in July 2002 from the sale of Preferred
Stock and warrants of approximately $12,900,000 (see Note 5), will be sufficient
to meet our currently estimated operating and investing requirements through
2003. We intend to seek shareholder approval during the third quarter of 2002
for the sale of 500 shares of our Preferred Stock convertible into 2,930,832
shares of our Common Stock and warrants to purchase 2,198,125 shares of Common
Stock at $1.612 per share. If our shareholders approve this sale, and the sale
of these securities is completed, we expect to receive approximately $4,600,000
in net proceeds. We may seek to obtain additional funds through subsequent
equity or debt financings, or strategic alliances with third parties either
alone or in combination with equity. These financings could result in
substantial dilution to the holders of our Common Stock and Preferred Stock or
require debt service and/or royalty payment arrangements. Any such required
financing may not be available in amounts or on terms acceptable to us.
Dividends on the Preferred Stock will accrue and be cumulative from July 2002,
whether or not such dividends are earned or declared by the Board of Directors,
and will be payable at our option either in cash or in kind (subject to certain
share issuance caps as set forth in the Statement of Designations of the
Preferred Stock) on March 31, June 30, September 30 and December 31 of each
year. The dividend rate (the "Dividend Rate") on each share of Preferred Stock
will be 6% per year on the $10,000 stated value of the Preferred Stock.
Commencing June 30, 2004, the Dividend Rate will increase each quarter by an
additional two percentage points per annum, up to a maximum Dividend Rate of 14%
per share per year. In addition, in the event that the Preferred Stock becomes
subject to mandatory conversion due to the achievement of certain revenue
targets by us prior to July 1, 2005, as more fully described in the Statement of
Designations of the Preferred Stock, we will pay an additional dividend equal to
the difference between (x) $2,000 per share of Preferred Stock to be converted
and (y) the
23
sum of all dividends that have been paid and all accrued but unpaid dividends
with respect to each such share.
Results of Operations
This section should be read in conjunction with the more detailed discussion
under "Liquidity and Capital Resources." A summary of net product sales and
expenses for the three and six months ended June 30, 2002 and 2001, are as
follows:
Three Months Ended % Increase
June 30, (Decrease)
2002 2001 2002 vs. 2001
---- ---- -------------
Product Sales $ 2,692,513 $ 953,603 182%
----------- -----------
Gross Profit 2,324,538 699,965 232
----------- -----------
General and Administrative Expenses 1,265,732 1,136,616 11
Selling and Marketing Expenses 2,271,906 1,350,302 68
Research and Development Expenses 1,656,075 1,881,165 (12)
----------- -----------
Total Operating Expenses 5,193,713 4,368,083 19
----------- -----------
Other (Expense) Income (92,191) 69,632 (232)
----------- -----------
Net loss from operations (2,961,366) (3,598,486) (18)
----------- -----------
Net gain on sale of product line --- --- ---
----------- -----------
Net Loss $(2,961,366) $(3,598,486) (18)
=========== ===========
Six Months Ended % Increase
June 30, (Decrease)
2002 2001 2002 vs. 2001
---- ---- -------------
Product Sales $ 4,530,902 $ 1,180,009 284%
----------- -----------
Gross Profit 3,828,966 906,971 322
----------- -----------
General and Administrative Expenses 2,478,787 2,045,649 21
Selling and Marketing Expenses 4,145,197 2,521,610 64
Research and Development Expenses 3,384,815 3,702,559 (9)
----------- -----------
Total Operating Expenses 10,008,799 8,269,818 21
----------- -----------
Other (Expense) Income (124,887) 98,564 (227)
----------- -----------
Net loss from operations (6,304,720) (7,264,283) (13)
----------- -----------
Net gain on sale of product line --- 375,000 (100)
----------- -----------
Net Loss $(6,304,720) $(6,889,283) (8)
=========== ===========
Product Sales. Product sales for the three and six months ended June 30, 2002,
were $2,692,513 and $4,530,902, respectively, compared to $953,603 and
$1,180,009 for the same periods in 2001, respectively. For the three and six
months ended June 30, 2002, 94% and 93%
24
of total product sales were realized in the United States, respectively,
compared to 75% and 70% for the same periods in 2001. In future periods, we
anticipate a majority of product sales will continue to be realized from within
the U.S. in comparison to outside of the U.S.
Product sales to-date during 2002 consisted primarily of VITOSS and IMBIBE sales
in the U.S. and Europe and CORTOSS sales in Europe. During May 2002, we
instituted a price increase for VITOSS in the U.S. Product sales during the
first six months of 2001 consisted primarily of sales of VITOSS in the U.S. and
Europe. VITOSS was launched in Europe during October 2000 and in the U.S. during
February 2001. We initiated a limited launch of CORTOSS in Europe during
December 2001.
Gross Profit. Our gross profit for the three and six months ended June 30, 2002,
were $2,324,538, or 86% of product sales, and $3,828,966, or 85% of product
sales, respectively. Our gross profit for the three and six months ended June
30, 2001, was $699,965, or 73% of product sales, and $906,971, or 77% of product
sales, respectively. The gross profit as a percentage of revenues is expected to
vary depending upon the proportion of sales derived from stocking distributors
outside of the U.S., where margins are lower, in comparison to sales derived
from commissioned sales agents in the U.S., where margins are higher, as well as
from any changes in our average selling price.
Operating Expenses. Operating expenses for the three and six months ended June
30, 2002, were $5,193,713 and $10,008,799, respectively, compared to $4,368,083
and $8,269,818 for the same periods in 2001, respectively. General &
administrative expenses for the three months ended June 30, 2002, were higher
than the same period in 2001 principally due to increased spending for property
and casualty insurance. In addition, General & administrative expenses for the
six months ended June 30, 2002 were higher than the same period in 2001 due to
increased spending for personnel-related expenses and insurance. Selling and
marketing expenses for same three and six-month periods increased from 2001 to
2002 as a result of commission expense paid to the independent sales agencies in
the U.S. on higher VITOSS product sales and enhancements made to the independent
sales agencies' commission plans and other spending related to the support of
product sales. Research and development expenses decreased for the three and six
months ended June 30, 2002, as compared to the same periods in 2001, primarily
as a result of the completion of process development activities related to the
commercial scale manufacturing of CORTOSS.
Other (expense) income. Net other (expense) income includes interest income,
interest expense and revenue interest expense. We recorded $92,191 and $124,887
of net other expense for the three and six months ended June 30, 2002,
respectively, compared to $69,632 and $98,564 of net other income for the three
and six months ended June 30, 2001, respectively. The decrease in net other
income between 2002 and 2001 is attributed to lower average interest rates
earned on invested cash and revenue interest expense incurred in 2002 as a
result of the arrangement with Paul Royalty.
Net gain on sale of product line. In March 2000, we sold our BIOGRAN dental
grafting product line to Implant Innovations Inc. for $3,900,000. We received
proceeds of $3,500,000, with an additional $400,000 that was held in an escrow
account. During March 2001, an additional gain of $375,000 was realized when
these proceeds from the escrow account were released.
Net Loss. As a result of the foregoing factors, our net loss for the three and
six months ended June 30, 2002, was $2,961,366 and $6,304,720, respectively,
compared to a net loss of $3,598,486 and $6,889,283 for the three and six months
ended June 30, 2001, respectively.
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Foreign Currency Risk
The functional currency for our European branch operation is the Euro.
Accordingly, in accordance with SFAS No. 52 "Foreign Currency Translation," all
assets and liabilities related to this operation are translated at the current
exchange rates at the end of each period. The resulting translation adjustments
are accumulated in a separate component of shareholders' equity. Revenues and
expenses are translated at average exchange rates in effect during the period
with foreign currency transaction gains and losses, if any, included in results
of operations.
Market Risk
We may be exposed to market risk through changes in market interest rates that
could affect the value of our short-term investments. Interest rate changes
would result in unrealized gains or losses in the market value of the short-term
investments due to differences between the market interest rates and rates at
the inception of the short-term investment. We held no investments as of June
30, 2002 and December 31, 2001.
PART II. OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
(a) Not applicable.
(b) In July 2002, the Company designated a new series of preferred stock called
"Series A 6% Adjustable Cumulative Convertible Voting Preferred Stock" (the
"Preferred Stock"). There are 2,000 shares of Preferred Stock authorized, of
which 1,400 shares are issued and outstanding. The Company has agreed to sell an
additional 500 shares of Preferred Stock, which sale is contingent upon approval
by the Company's shareholders. The Statement of Designations, Rights and
Preferences of the Preferred Stock was previously filed as an Exhibit to a Form
8-K dated July 19, 2002 and filed with the SEC on July 23, 2002, as amended on
July 31, 2002.
(c) Pursuant to an investment banking agreement with SCO Securities LLC, as
partial payment for financial advisory services rendered, we issued warrants to
purchase an aggregate 76,000 shares of our Common Stock. These warrants have an
exercise price of $4.625 per share and an exercise period of four years. The
issuance of these securities was exempt from registration pursuant to Section
4(2) of the Securities Act of 1933 and Rule 506 of Regulation D as an issuer
transaction not involving a public offering.
26
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On May 24, 2002, we held our 2002 Annual Meeting of Shareholders. At the Annual
Meeting, the following matters were submitted to a vote of our shareholders:
1. The following seven individuals were nominated and elected to serve as the
directors of the Company:
David S. Joseph FOR: 12,677,161
WITHHOLD AUTHORITY: 520,925
Paul Ducheyne, Ph.D.: FOR: 13,189,466
WITHHOLD AUTHORITY: 8,620
Randal R. Betz, M.D. FOR: 13,188,966
WITHHOLD AUTHORITY: 9,120
Morris Cheston, Jr. FOR: 13,189,466
WITHHOLD AUTHORITY: 8,620
James M. Garvey FOR: 13,183,466
WITHHOLD AUTHORITY: 14,620
Robert M. Levande FOR: 13,183,966
WITHHOLD AUTHORITY: 14,120
Jos B. Peeters FOR: 13,176,866
WITHHOLD AUTHORITY: 21,220
2. The Company proposed that its shareholders adopt an amendment to the
Company's 1997 Equity Compensation Plan to increase the number of shares of the
Company's Common Stock available for issuance pursuant to grants thereunder from
2,850,000 to 3,850,000. The holders of 13,188,066 shares of Common Stock voted
in favor of adoption of the amendment, the holders of 100 shares of Common Stock
voted against the amendment, and the holders of 9,920 shares of Common Stock
abstained with respect to the adoption of the amendment. Accordingly, the
proposal regarding adoption of the amendment to the 1997 Equity Compensation
Plan was approved.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
Exhibit 99.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
Exhibit 99.2 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
(b) Reports on Form 8-K.
A Form 8-K was filed on June 13, 2002, under Item 5, reporting that the Company
appointed Antony Koblish as President and Chief Executive Officer, and that the
Company had entered into new employment agreements with executive officers.
27
SIGNATURES
Pursuant to the requirements 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.
ORTHOVITA, INC.
(Registrant)
August 13, 2002 By: /s/ Antony Koblish
-------------------
Antony Koblish
President and Chief Executive Officer
(Principal executive officer)
August 13, 2002 By: /s/ Joseph M. Paiva
--------------------
Joseph M. Paiva
Chief Financial Officer
(Principal financial and accounting officer)
28