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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 September 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 Incorporation or Organization) (I.R.S. Employer Identification Number)
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 _____
-----
Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes_____ No X
-----
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 November 19, 2002
- ---------------------------------------- ------------------------------------
Common Stock, par value $.01 per share 20,146,595 Shares
This Report Includes a Total of 37 Pages
ORTHOVITA, INC. AND SUBSIDIARIES
INDEX
PART I - FINANCIAL
INFORMATION Page
Number
Item 1. Financial Statements
Consolidated Balance Sheets -
September 30, 2002 and December 31, 2001 2
Consolidated Statements of Operations -
Three and nine months ended
September 30, 2002 and 2001 3
Consolidated Statements of Cash Flows -
Nine months ended September 30, 2002
and 2001 4
Notes to Consolidated Financial Statements 5 - 16
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 17 - 32
Item 3. Quantitative and Qualitative Disclosures About
Market Risk 32
Item 4. Controls and Procedures 33
PART II - OTHER
INFORMATION
Item 2. Changes in Securities and Use of Proceeds 33 - 35
Item 4. Submission of Matters to a Vote of Security
Holders 35 - 36
Item 6. Exhibits and Reports on Form 8-K 36 - 37
Signatures 37
1
PART I. FINANCIAL INFORMATION
ITEM I. FINANCIAL STATEMENTS
ORTHOVITA, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
September 30, 2002 December 31, 2001
------------------ -----------------
ASSETS (Unaudited)
CURRENT ASSETS:
Cash and cash equivalents (Notes 2 and 5) $ 16,629,544 $ 12,906,557
Accounts receivable, net 1,466,739 983,467
Inventories (Note 3) 2,629,995 1,606,333
Other current assets 201,353 125,022
------------ ------------
Total current assets 20,927,631 15,621,379
------------ ------------
PROPERTY AND EQUIPMENT, net 5,125,103 5,433,353
------------ ------------
OTHER ASSETS 92,520 158,111
------------ ------------
$ 26,145,254 $ 21,212,843
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Current portion of long-term capital lease obligations $ 576,125 $ 482,420
Accounts payable 493,675 1,010,423
Accrued compensation and related expenses 594,358 624,168
Other accrued expenses 1,710,287 790,765
------------ ------------
Total current liabilities 3,374,445 2,907,776
------------ ------------
LONG-TERM LIABILITIES:
Other long-term liabilities 102,125 62,000
Capital lease obligations (Note 4) 683,321 350,519
Revenue interest obligation (Note 5) 7,167,700 5,222,107
------------ ------------
Total long-term liabilities 7,953,146 5,634,626
------------ ------------
COMMITMENTS AND CONTINGENCIES
SHAREHOLDERS' EQUITY (Notes 5 and 6):
Preferred Stock, $.01 par value, 20,000,000 shares
authorized designated as:
Series A 6% Adjustable Cumulative Convertible Voting
Preferred Stock, $.01 par value, 2,000 shares
authorized, 1,400 shares issued and outstanding 14 ---
Common Stock, $.01 par value, 50,000,000 shares
authorized, 20,064,538 and 20,874,536 shares issued 200,645 208,745
Additional paid-in capital 88,791,451 74,066,082
Accumulated deficit (74,419,930) (61,599,522)
Accumulated other comprehensive income (loss) 245,483 (4,864)
------------ ------------
Total shareholders' equity 14,817,663 12,670,441
------------ ------------
$ 26,145,254 $ 21,212,843
============ ============
The accompanying notes are an integral part of these statements.
2
ORTHOVITA, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
Three Months Ended Nine Months Ended
September 30 September 30
2002 2001 2002 2001
---- ---- ---- ----
(Unaudited)
PRODUCT SALES (Note 7) $ 2,811,727 $ 1,134,253 $ 7,342,629 $ 2,314,262
COST OF SALES 373,593 170,711 1,075,529 443,749
------------ ------------ ------------ ------------
Gross Profit 2,438,134 963,542 6,267,100 1,870,513
------------ ------------ ------------ ------------
OPERATING EXPENSES:
General and administrative 1,344,385 1,176,866 3,823,172 3,222,515
Selling and marketing 2,314,991 1,435,719 6,460,188 3,957,329
Research and development 1,437,132 1,839,339 4,821,947 5,541,898
------------ ------------ ------------ ------------
Total operating expenses 5,096,508 4,451,924 15,105,307 12,721,742
------------ ------------ ------------ ------------
Operating loss (2,658,374) (3,488,382) (8,838,207) (10,851,229)
INTEREST EXPENSE (37,307) (27,654) (63,235) (98,436)
REVENUE INTEREST
EXPENSE (Note 5) (105,948) -- (276,549) --
INTEREST INCOME 42,793 59,588 114,435 228,934
NET GAIN ON SALE OF
PRODUCT LINE (Note 7) -- -- -- 375,000
------------ ------------ ------------ ------------
NET LOSS $ (2,758,836) $ (3,456,448) $ (9,063,556) $(10,345,731)
============ ============ ============ ============
DEEMED DIVIDEND ON
SERIES A 6% ADJUSTABLE
CUMULATIVE CONVERTIBLE
VOTING PREFERRED
STOCK- Beneficial Conversion
Feature (Note 6) 3,604,962 -- 3,604,962 --
DIVIDENDS ON SERIES A 6%
ADJUSTABLE CUMULATIVE
CONVERTIBLE VOTING
PREFERRED STOCK (Note 6) 151,890 -- 151,890 --
------------ ------------ ------------ ------------
NET LOSS APPLICABLE TO
COMMON SHAREHOLDERS $ (6,515,688) $ (3,456,448) $(12,820,408) $(10,345,731)
============ ============ ============ ============
NET LOSS APPLICABLE TO
COMMON SHAREHOLDERS
PER COMMON SHARE, BASIC
AND DILUTED $ (.33) $ (.20) $ (.63) $ (.65)
============ ============ ============ ============
WEIGHTED AVERAGE
NUMBER OF COMMON
SHARES OUTSTANDING,
BASIC AND DILUTED 20,019,701 17,130,884 20,268,428 15,980,190
============ ============ ============ ============
The accompanying notes are an integral part of these statements
3
ORTHOVITA, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Nine Months Ended
September 30
2002 2001
---- ----
(Unaudited)
OPERATING ACTIVITIES:
Net loss $ (9,063,556) $(10,345,731)
Adjustments to reconcile net loss to net cash used in operating activities -
Depreciation and amortization 906,276 1,025,970
Amortization of deferred compensation --- 73,125
Common Stock options and warrants issued for services rendered 260,501 172,042
Common Stock issued for services rendered 69,998 ---
Loss on disposal of property and equipment 4,473 12,692
Net gain on sale of product line --- (375,000)
(Increase) decrease in -
Accounts receivable (483,272) (677,064)
Inventories (1,023,662) (1,052,118)
Other current assets (76,331) (36,860)
Other assets 65,591 (8,366)
Increase (decrease) in -
Accounts payable (516,748) (445,739)
Accrued compensation and related expenses (29,810) (237,239)
Other accrued expenses 680,280 467,665
------------ ------------
Net cash used in operating activities (9,206,260) (11,426,623)
------------ ------------
INVESTING ACTIVITIES:
Proceeds from sale of investments --- 199,866
Decrease in restricted cash --- 375,000
Purchase of property and equipment (477,499) (1,390,056)
------------ ------------
Net cash used in investing activities (477,499) (815,190)
------------ ------------
FINANCING ACTIVITIES:
Proceeds from short term bank borrowings --- 750,000
Proceeds from capital lease financing arrangement 699,723 --
Repayments of capital lease obligations (398,216) (526,853)
Net proceeds from sale of Common Stock and warrants --- 13,396,868
Net proceeds from sale of Preferred Stock and warrants 12,807,197 --
Proceeds from exercise of Common Stock options and warrants and
Common Stock purchased under the Employee Stock Purchase Plan 47,695 74,450
------------ ------------
Net cash provided by financing activities 13,156,399 13,694,465
------------ ------------
EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS 250,347 164,505
------------ ------------
NET INCREASE IN CASH AND CASH EQUIVALENTS 3,722,987 1,617,157
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 12,906,557 3,614,626
------------ ------------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 16,629,544 $ 5,231,783
============ ============
The accompanying notes are an integral part of these statements
4
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 has characteristics resembling those of cancellous bone, which is less
dense, with a lattice-like or spongy structure that is subject to compressive
forces. CORTOSS has characteristics resembling those of cortical bone, which is
dense, structural, tubular in shape and subject to bending, load bearing and
twisting forces. Both cortical and cancellous bones can be damaged from
traumatic injury and degenerative disease, such as osteoporosis, creating a need
for both cortical and cancellous synthetic bone substitutes.
VITOSS is a resorbable, beta-tricalcium phosphate scaffold, which is
manufactured using our proprietary VITOMATRIX(TM) calcium phosphate technology.
VITOSS is used as bone void filler in trauma and spinal procedures. CORTOSS is a
high-strength, bioactive 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, bioactive 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 a 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
5
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 allows 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 have completed post-marketing human clinical studies in Europe for
the use of CORTOSS in hip compression screw augmentation. We completed the
enrollment phase of a clinical study in Europe for the use of Cortoss in
vertebral augmentation and submitted the vertebral augmentation study results to
the European regulatory authorities in November 2002. During 2002, we received
approval from the FDA to conduct a pilot clinical study in the U.S. for the use
of CORTOSS in vertebral 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 is manufactured
utilizing our proprietary ORTHOBONE(TM) bioactive composite technology. 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. In August 2002, we completed patient enrollment for the
pilot phase of our human clinical studies in Europe for our RHAKOSS spinal
implants. We have begun an expanded pivotal phase of our human clinical study in
Europe of RHAKOSS for patients undergoing cervical spinal fusion surgery. 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 may seek a
similar arrangement for CORTOSS in Japan.
In August 2002, we entered into a supply agreement with BioMimetic
Pharmaceutical Inc. ("BioMimetic") that allows BioMimetic to use its recombinant
human platelet derived growth factor (rhPDGF) in combination with our
proprietary particulate synthetic scaffold biomaterial. Under the agreement, we
will supply our proprietary calcium phosphate
6
biomaterial manufactured under our VITOMATRIX platform to BioMimetic for its
clinical and commercial use in conjunction with rhPDGF. The agreement provides
that, upon obtaining the requisite regulatory approvals, BioMimetic will market
and sell the combined product, which is currently for investigational use, only
in the dental, periodontal, oral and cranio-maxillofacial bone grafting markets.
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 and IMBIBE in the U.S., and
VITOSS and CORTOSS in Europe. 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 September 30, 2002, we had an accumulated deficit of $74,419,930.
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 $16,629,544 as of September 30, 2002, together
with the net proceeds of approximately $4,650,000 received in October 2002, from
the sale of additional Series A Preferred Stock and warrants (see Note 6), will
be sufficient to meet our currently estimated operating and investing
requirements into 2004. During October 2002, our shareholders approved the sale
of 500 shares of our Series A Preferred Stock which are 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. While we have no immediate plans to do so,
we may seek to obtain additional funds in the future 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.
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
7
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 and provide cash management. 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 nine months ended September 30, 2002 and 2001,
because they were anti-dilutive due to our losses.
Revenue
Revenue from product sales is recognized upon the receipt of a valid order and
shipment to our distributor customers in Europe, Australia and Israel who stock
products for resale. 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, and we have no post-shipment
obligations to our customers. In addition, collection of the customers'
receivable balance must be deemed probable. Both our U.S. hospital customers and
our distributor customers in Europe, Australia and Israel are generally required
to pay on a net 30-day basis and sales discounts are not offered. 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.
Inventory
Inventory is stated at the lower of cost or market value using the first-in,
first-out basis, or FIFO, method.
8
Equity Compensation
We apply Accounting Principal Board Opinion No. 25, "Accounting for Stock Issued
to Employees," ("APB 25") and the related interpretations in accounting for
equity issuances to our employees under our stock option plans rather than the
alternative fair value accounting provided under SFAS 123 (see below). Under APB
No. 25, compensation cost related to stock options is computed based on the
intrinsic value of the stock option at the date of grant, reflected by the
difference between the exercise price and the fair value of our Common Stock.
We apply Standard Financial Accounting Standard No. 123, "Accounting for Stock-
Based Compensation," ("SFAS 123") for equity issuances to non-employees. Under
SFAS No. 123, we recognize compensation costs when services are provided, based
on the value of the stock options and warrants at the date of grant using the
Black-Scholes option pricing model.
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 September 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 5,
covenants under our revenue interest agreement require us to maintain specified
levels of aggregate cash, cash equivalents and short-term investments.
As of September 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 $ 16,629,544 $ --- $ --- $16,629,544
Short-term investments --- --- --- ---
------------- ------------ ------------ -----------
$ 16,629,544 $ --- $ --- $16,629,544
============= ============ ============ ===========
3. INVENTORIES:
Inventories are stated at the lower of cost or market on a first-in, first-out
basis. As of September 30, 2002 and December 31, 2001, inventories consisted of
the following:
September 30, 2002 December 31, 2001
------------------ -----------------
Raw materials ...................................... $ 176,562 $ 108,960
Work-in-process .................................... 1,244,938 752,079
Finished goods ..................................... 1,208,495 745,294
------------------ -----------------
$ 2,629,995 $ 1,606,333
================== =================
9
4. CAPITAL LEASE OBLIGATIONS:
During July 2002, we entered into a new capital lease financing arrangement with
a lending institution. The term of each individual lease is 35 months from each
individual lease's inception. During the third quarter of 2002 we closed on two
individual leases totaling $574,723 with annual interest of approximately
11.38%. In addition, during January 2002, we entered into a $125,000 capital
lease financing arrangement with a different lending institution. The term of
this lease is 60 months with an annual interest rate of 11.45%.
5. 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"). The
business purpose of the transaction was to raise working capital. Our obligation
under this arrangement is to use the proceeds realized from this financing for
working capital, including the funding of clinical development and marketing
programs relating to our VITOSS, CORTOSS and RHAKOSS products. Regulatory
authorities or competing products and technologies and other factors may prevent
us from ever effectively marketing one or more of these three products.
10
In this financing, we sold Paul Royalty a revenue interest and 2,582,645 shares
of our Common Stock. The value of these shares at the time the transaction
closed was $1.85 per share, or $4,777,893 in the aggregate. 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 in accordance with Emerging Issues
Task Force ("EITF") Issues No. 88-18.
On March 22, 2002, an amendment was made to this agreement with Paul Royalty,
which provided for Paul Royalty to surrender to us 860,882 shares of Common
Stock that it had originally purchased in the October 2001 financing, in
exchange for our surrender of the right to receive credits against the revenue
interest obligation. Under the original structure, the credits equaled the first
$5,000,000 of any proceeds realized by Paul Royalty or its affiliates from the
resale of the 2,582,645 shares plus one-third of any appreciation realized by
Paul Royalty from the original $5,000,000 purchase price of the shares. The
amendment also provided for a reduction in the amount required to repurchase
Paul Royalty's revenue interest, if a repurchase event were to occur (see below
for description of a repurchase event). 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. Since this represents a
non-monetary transaction, we utilized the fair value of the Common Stock
surrendered to us on March 22, 2002, or $1,945,593, to determine the fair value
of the non-monetary consideration in accordance with APB 29.
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 September 30, 2002, we were in compliance with all financial covenants.
However, if we fail to maintain such balances and financial covenants, Paul
Royalty can demand that we repurchase its revenue interest. In addition to the
financial covenants
11
described above, the occurrence of certain events, including those set forth
below, triggers Paul Royalty's right to require 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. 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. We were in compliance with all financial covenants and no repurchase
events or foreclosures have occurred as of September 30, 2002. As of September
30, 2002, if the repurchase event had been triggered and Paul Royalty exercised
its right to require us to repurchase its revenue interest, we would have owed
Paul Royalty $10,638,836. The repurchase amount was calculated by applying a 45%
rate of return to the original $10,000,000 purchase price from October 2001 to
September 30, 2002, and then reducing that amount by both $3,333,333 (see above)
and the actual revenue interest payments made during the specified period.
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 September 30, 2002, we do not expect to fall out of compliance in the
foreseeable future with the covenants and terms of the revenue interest
obligation.
Paul Royalty bears the risk of revenue interest paid to it being significantly
less than the current revenue interest liability, as well as the reward of the
revenue interest paid to it being significantly more than the current revenue
interest liability. Therefore, we are under no obligation to make any other
payments to Paul Royalty in the scenario where no repurchase right is triggered
and no significant revenue interest payments are paid. Conversely, we will be
obligated to continue to make revenue interest payments in the scenario where
sales are sufficiently high to result in amounts due under the revenue interest
agreement being in excess of the current revenue interest liability. Absent an
event where a repurchase right is triggered, we are not aware of any other
scenarios that would obligate us to make payments due under the agreement. The
products that are subject to the revenue interest have only recently been
approved and marketed or are still under development. For these reasons, as of
September 30, 2002 and for the forseeable future, we cannot make a reasonable
estimate of future revenues and payments that may become due to Paul Royalty
under the revenue interest agreement, or the impact of this agreement on our
results of operations, liquidity and financial position. Future sales from
VITOSS in the U.S. and VITOSS and CORTOSS in Europe, our approved products, are
difficult to estimate. RHAKOSS is under development with human clinical trials
initiated in Europe in April 2002. We have initiated, or plan to initiate, human
clinical trials for CORTOSS and RHAKOSS in the U.S. There is no assurance that
the data from these clinical trials will result in obtaining the necessary
approval to sell CORTOSS in the U.S. or RHAKOSS in either the U.S. or Europe.
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.
6. SHAREHOLDERS' EQUITY:
Preferred Stock and Warrants
In July 2002, we sold 1,400 shares of Series A 6% Adjustable Cumulative
Convertible Voting Preferred Stock ("Series A Preferred Stock") at $10,000 per
share that 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 cash
12
proceeds of $12,807,197. Additionally, in July 2002, we issued to the designees
of the placement agent for the transaction, five-year warrants to purchase an
aggregate 820,633 shares of our Common Stock at $1.706 per share. In connection
with this transaction, after obtaining the required shareholder approval in
October 2002, we sold on the same terms and conditions as in the July 2002
closing, an additional 500 shares of Series A Preferred Stock convertible into
2,930,832 shares of our Common Stock together with warrants to purchase
2,198,125 shares of Common Stock at $1.612 per share, for net cash proceeds of
approximately $4,650,000. In connection with the October 2002 sale, we issued to
the placement agent's designees additional five-year warrants to purchase
293,083 shares of our Common stock at $1.706 per share.
For each Series A Preferred Stock closing, the respective proceeds were
allocated to the Series A Preferred Stock and the warrants based on the relative
fair values of each instrument. The fair value of the warrants issued, in both
July and in October 2002, were determined based on an independent third party
valuation.
Accordingly, approximately $8,565,000 of the July 2002 proceeds was allocated to
the Series A Preferred Stock and $3,504,000 of the proceeds was allocated to the
warrants. In addition, in accordance with EITF Issue No. 00-27, "Application of
Issue No. 98-5 to Certain Convertible Instruments," the issuance costs were not
offset against the proceeds received in the issuance in calculating the
intrinsic value of the conversion option but were considered in the calculation
of the amount shown on the consolidated balance sheets. After considering the
allocation of the proceeds based on the relative fair values, it was determined
that the Series A Preferred Stock has a beneficial conversion feature ("BCF") in
accordance with EITF Issue No. 98-5, "Accounting for Convertible Securities with
Beneficial Conversion Features or Contingently Adjustable Conversion Ratios" and
EITF Issue No. 00-27. Accordingly, a BCF adjustment of $3,604,962 was recorded,
with respect to the Series A Preferred Stock at the July 2002 closing. The value
of the BCF was recorded in a manner similar to a deemed dividend, and since the
Series A Preferred Stock has no maturity date and is convertible at the date of
issuance, the BCF was fully amortized through retained earnings during the third
quarter of 2002. We will record a similar adjustment during the fourth quarter
of 2002 of approximately $4,376,000 for the BCF with respect to the Series A
Preferred Stock sold at the October 2002 closing.
Upon the occurrence of each of the following events, each holder of Series A
Preferred Stock can require us to redeem each share of Series A 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 Series A 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
Series A 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 Series A Preferred
Stock Purchase Agreement that is reasonably likely to have a material adverse
effect on Orthovita.
13
As all of the redemption features are within our control, the Series A Preferred
Stock is classified within shareholders' equity on the consolidated balance
sheets. Dividends on the Series A Preferred Stock accrue and are cumulative from
the date of issuance of the Series A Preferred Stock, 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
limitations as set forth in the Statement of Designations of the Series A
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 Series A
Preferred Stock will be 6% per year on the $10,000 stated value of the Series A
Preferred Stock. Commencing after 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 year.
Given the substantial value associated with the warrants and the related BCF,
the total dividend attributed to holders of the Series A Preferred Stock during
the third quarter of 2002 consisted of the BCF of $3,604,962 and the stated
preferred dividend of 6% totaling $151,890. The Company considers the quarterly
reporting period in which the BCF was recognized to be appropriately excludable
from the period of dividend attribution described in Staff Accounting Bulletin
No. 68, "Increasing Rate Preferred Stock" ("SAB 68"), since this reporting
period already includes a disproportionate dividend attribution. The Company
will commence recognition of the implied discount addressed in SAB 68 in the
quarterly reporting period following recognition of the BCF. For this purpose,
the Company will seek to engage an independent appraiser to assist it in
determining the implicit market rate for dividends on the Series A Preferred
Stock. It is expected that this appraisal will indicate that the market rate for
the Series A Preferred Stock exclusive of the increasing scheduled cash dividend
entitlement, will be between the initial and ultimate rates of 6% and 14%,
respectively. Similar dividend accounting treatment will occur for the Series A
Preferred Stock sold at the October 2002 closing. Similar dividend accounting
treatment will occur for the Series A Preferred Stock sold at the October 2002
closing.
In addition, in the event that the Series A 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 Series A Preferred Stock, we will pay an additional dividend equal to the
difference between (x) $2,000 per share of Series A 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.
During the third quarter of 2002, we declared dividends of $151,890 on the 1,400
shares of Series A Preferred Stock outstanding as of September 30, 2002. We paid
these dividends in-kind during October 2002 by issuing an aggregate 57,057
shares of our Common Stock.
Treasury Stock
As previously discussed above, we sold Paul Royalty a revenue interest and
2,582,645 shares of our Common Stock. 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.
On March 22, 2002, an amendment was made to this agreement with Paul Royalty,
which provided for Paul Royalty to surrender to us 860,882 shares of Common
Stock that it had originally purchased in the October 2001 financing, in
exchange for our surrender of the right to receive credits against the revenue
interest obligation. Under the original structure, the credits equaled the first
$5,000,000 of any proceeds realized by
14
Paul Royalty or its affiliates from the resale of the 2,582,645 shares plus
one-third of any appreciation realized by Paul Royalty from the original
$5,000,000 purchase price of the shares. The amendment also provided for a
reduction in the amount required to repurchase Paul Royalty's revenue interest,
if a repurchase event 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 the fair market value of
the Common Stock on the date of the modification. Since this represents a
non-monetary transaction, we utilized the fair value of the common stock
surrendered to us on March 22, 2002, or $1,945,593, to determine the fair value
of the non-monetary consideration in accordance with APB 29. These shares were
retired during September 2002.
Common Stock
During the nine months ended September 30, 2002, we issued 37,838 shares of
Common Stock valued at $69,998 to our non-employee directors in consideration of
their services.
Common Stock Options
There were no stock option exercises during the third quarter of 2002. During
the nine months ended September 30, 2002, stock options to purchase 10,000
shares of Common Stock were exercised for proceeds of $17,000. Additionally,
during the three and nine months ended September 30, 2002, we issued stock
options for the purchase of 48,050 shares and 103,850 shares of Common Stock
with various exercise prices to certain vendors in consideration for services
valued at $76,900 and $168,221, respectively.
Employee Stock Purchase Plan
During the three and nine months ended September 30, 2002, 7,081 shares and
19,299 shares of Common Stock were purchased by the Employee Stock Purchase Plan
for proceeds of $10,533 and $30,695, respectively.
Common Stock Purchase Warrants
During the three and nine months ended September 30, 2002, warrants to purchase
5,000 shares and 552,010 shares of our Common Stock expired unexercised,
respectively, at an exercise price of $4.25 per share.
During the nine months ended September 30, 2002, pursuant to a clinical
assessment agreement, we issued warrants to purchase an aggregate 110,000 shares
of our Common Stock. These warrants have an exercise price of $1.75 per share
and an exercise period of five years and were valued at $92,280 using the
Black-Scholes model. 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.
As of September 30, 2002, pursuant to an investment banking agreement with
SmallCaps Online Group LLC, as partial payment for financial advisory services
rendered, we are obligated to issue warrants to purchase an aggregate 92,000
shares of
15
our Common Stock. These warrants have an exercise price of $4.625 per share and
an exercise period of four years. We have recorded the value of these warrants
or $138,000 as consulting expense. The issuance of these securities is 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.
7. 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 nine months ended September 30, 2002 and 2001,
product sales of VITOSS and CORTOSS by geographic market were as follows:
For the three months ended For the nine months ended
September 30, September 30, September 30, September 30,
PRODUCT SALES: 2002 2001 2002 2001
---- ---- ---- ----
United States $ 2,670,964 $ 1,013,538 $ 6,873,618 $ 1,828,116
Outside the United States 140,763 120,715 469,011 486,146
----------- ----------- ----------- -----------
Total product sales $ 2,811,727 $ 1,134,253 $ 7,342,629 $ 2,314,262
=========== =========== =========== ===========
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 nine months ended September 30,
2001.
16
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, 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 has characteristics resembling those of cancellous bone, which is less
dense, with a lattice-like or spongy structure that is subject to compressive
forces. CORTOSS has characteristics resembling those of cortical bone, which is
dense, structural, tubular
17
in shape and subject to bending, load bearing and twisting forces. Both cortical
and cancellous bones can be damaged from traumatic injury and degenerative
disease, such as osteoporosis, creating a need for both cortical and cancellous
synthetic bone substitutes.
VITOSS is a resorbable, beta-tricalcium phosphate scaffold, which is
manufactured using our proprietary VITOMATRIX(TM) calcium phosphate technology.
VITOSS is used as bone void filler in trauma and spinal procedures. CORTOSS is a
high-strength, bioactive 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, bioactive 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 a 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 have completed post-marketing human clinical studies in Europe for
the use of CORTOSS in hip compression screw augmentation. We completed the
enrollment phase of a clinical study in Europe for the use of Cortoss in
vertebral augmentation and submitted the vertebral augmentation study results to
the European regulatory authorities in November 2002. During 2002, we received
approval from the FDA to conduct a pilot clinical study in the U.S. for the use
of CORTOSS in vertebral 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.
18
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 is manufactured
utilizing our ORTHOBONE(TM) proprietary bioactive composite technology. 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. In August 2002, we completed patient enrollment for the
pilot phase of our human clinical studies in Europe for our RHAKOSS spinal
implants. We have begun an expanded pivotal phase of our human clinical study in
Europe of RHAKOSS for patients undergoing cervical spinal fusion surgery. 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 may seek a
similar arrangement for CORTOSS in Japan.
Approximately 95% of our revenues for the nine months ended September 30, 2002
were realized from product sales of VITOSS in the United States. The bone graft
market in which VITOSS competes is highly competitive and dynamic. We estimate
that VITOSS has no more than a 4% share of the estimated $300 million total bone
graft market opportunity.
VITOSS competes in the bone graft market opportunity against the following three
classes of bone graft, defined by the source of supply: (a) autograft, which is
bone the surgeon harvests from the patient at the time of surgery for
re-implantation in the same patient; (b) allograft, which is bone harvested from
cadavers under organ donor programs, processed to remove the risk of disease
transmission, and sold for re-implantation in other patients; and (c) synthetic
materials created or processed and sold for implantation in patients. VITOSS is
categorized in the synthetic segment of the bone graft market. The autograft,
allograft, and synthetic segments command approximately 50%, 40%, and 10%,
respectively, of the bone graft market opportunity.
Autograft is generally considered to be the "gold standard" against which other
treatment solutions are compared. However, we believe the market continues to
move away from the use of autograft, which can be painful and lengthen recovery
time, and towards the greater use of allograft and synthetic materials. During a
surgical procedure, a surgeon typically uses a combination of bone graft
materials from more than one of the three classes of materials described above.
As a result, we believe that VITOSS competes for market share in all three
segments of the bone graft market opportunity.
During 2002, the bone graft market has seen the introduction of synthetic
recombinant signaling growth factors, also known as bone morphogenic proteins
("BMPs"), into the synthetic segment of the marketplace. BMPs are growth factors
believed to significantly accelerate the healing mechanism of bone. We believe
the healing mechanism of bone
19
is dependent upon the presence of all three of the following components: (i)
signaling molecules, either provided by the patient or commercially provided
such as with BMPs, (ii) the patient's own stem cells or osteoprogenitor cells,
and (iii) a bone graft material, either provided by the patient or commercially
provided such as with VITOSS.
We expect that the introduction of BMPs will greatly expand the overall bone
graft market and in particular the synthetic segment of the bone graft market.
However, it is too early to determine whether the market will place greater
emphasis on the signaling molecule component over the other two components to
the healing mechanism of bone. We believe mitigating factors to the broad use of
BMPs include concern over excess bone growth in unwanted areas and their current
high cost in comparison to commercial bone graft materials and to VITOSS in
particular.
In August 2002, we entered into a supply agreement with BioMimetic
Pharmaceutical Inc. ("BioMimetic") that allows BioMimetic to use its recombinant
human platelet derived growth factor (rhPDGF) in combination with our
proprietary VITOMATRIX particulate synthetic scaffold biomaterial. Under the
agreement, we will supply our proprietary calcium phosphate biomaterial
manufactured under our VITOMATRIX platform to BioMimetic for its clinical and
commercial use in conjunction with rhPDGF. The agreement provides that, upon
obtaining the requisite regulatory approvals, BioMimetic will market and sell
the combined product, which is currently for investigational use, only in the
dental, periodontal, oral and cranio-maxillofacial bone grafting markets.
Our operations are subject to certain risks including, but not limited to, the
need to successfully commercialize both VITOSS and IMBIBE in the U.S., and
VITOSS and CORTOSS in Europe. 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 September 30, 2002, we had an accumulated deficit of $74,419,930.
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 $16,629,544 as of September 30, 2002, together
with the net proceeds of approximately $4,650,000 received in October 2002 from
the sale of additional Series A Preferred Stock and warrants (see Note 6 to the
Financial Statements contained in this Quarterly Report on Form 10-Q), will be
sufficient to meet our currently estimated operating and investing requirements
into 2004. During October 2002, our shareholders approved the sale of 500 shares
of our Series A Preferred Stock which are 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. While we have no immediate plans to do so, we may seek to
obtain additional funds in the future 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.
20
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.
If CORTOSS and VITOSS are not commercially successful, our operating results
will be impaired.
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. For these reasons, we are dependent upon VITOSS and
CORTOSS in their respective markets to generate sufficient revenues.
If we are unable to increase sales of our approved products, our operating
results will be affected adversely.
If we are unable to operate an effective sales and distribution network, our
ability to generate sales and become profitable will be impaired.
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. We also intend to distribute VITOSS through a third
party strategic alliance in Japan if it is 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 manufactured by other orthopaedic companies
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. Similarly, our
independent agencies may be unable or unwilling to carry or effectively sell
VITOSS should any of these other orthopaedic companies introduce new products
based upon technologies that could compete with VITOSS. Additionally, our
sales could be adversely affected if one or more of our successful
21
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.
The "off-label" use of our products may harm the reputation of our products.
The medical devices that we manufacture and market, or intend to market, are
subject to extensive regulation by the U.S. Food and Drug Administration, the
European Union Medical Devices Directive and other worldwide regulatory
agencies. In order to market our products, we must apply for, receive and
maintain all necessary regulatory approvals in each applicable jurisdiction
for specified uses of the products. In addition, we market and sell our
products for only their approved indication(s) or use(s); however, we cannot
control a surgeon's "off-label" use of our product. If an adverse event
should occur while using our product "off-label", the reputation of our
product or products could be adversely affected.
If we do not successfully train a sufficient number of surgeons, demand for our
products could be adversely affected.
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
stock. In July 2002 we raised $12,807,197 in net cash proceeds from the sale
of 1,400 shares of our Series A Preferred Stock and warrants to purchase
6,154,747 shares of our Common Stock at $1.612 per share. In October 2002, we
raised approximately $4,650,000 in net cash proceeds from the sale of an
additional 500 shares of our Series A Preferred Stock which are 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. 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 $16,629,544 as of September
30, 2002, together with the net proceeds of approximately $4,650,000 received
in October 2002 from the sale of additional Series A Preferred Stock and
warrants (see Note 6 to the Financial Statements contained in this Quarterly
Report on Form 10-Q), will be sufficient to meet our currently estimated
operating and investing requirements into 2004. While we have no immediate
plans to do so, we
22
may seek to obtain additional funds in the future 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. Factors that
may cause our future capital requirements to be greater than anticipated
include:
-unforeseen developments during our pre-clinical and clinical trials;
-delays in the 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.
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 adequate financing is not available, we may be
required to delay, scale back or eliminate certain operations. In the worst
case, our long-term viability would be threatened.
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.
The difficulties of operating in international markets may harm sales of our
products.
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 Capital Royalty Acquisition Fund, L.P. ("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 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
23
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 September 30, 2002, 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. In
addition to the financial covenants described above, the occurrence of
certain events, including those set forth below, triggers Paul Royalty's
right to require 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. 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 September 30, 2002.
As of September 30, 2002, if the repurchase event had been triggered and
Paul Royalty exercised its right to require us to repurchase its revenue
interest, we would have owed Paul Royalty $10,638,836.
24
Our results of operations may fluctuate due to factors out of our control which
could cause volatility in our stock price.
Our business will be damaged if we are unable to protect our proprietary rights
to VITOSS, CORTOSS, or our other products, and we may be subject to intellectual
property infringement claims by others.
If we cannot keep up with technological changes and marketing initiatives of
competitors, sales of our products may be harmed.
We may acquire technologies or companies in the future, and these acquisitions
could result in dilution to our shareholders and disruption of our business.
Our prior use of Arthur Andersen LLP as our independent public accountants could
impact our ability to access the capital markets.
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 shareholder
approval, including takeover attempts.
We do not intend to pay any cash dividends to our common shareholders.
Our stock price may be volatile.
25
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.
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 and Series A Preferred Stock. Cash and cash equivalents were
$16,629,544 at September 30, 2002, and $12,906,557 at December 31, 2001,
representing 63.6% and 60.8% of our total assets, respectively. In July 2002, we
raised $12,807,197 in net cash proceeds from the sale of 1,400 shares of our
Series A Preferred Stock and warrants to purchase 6,154,747 shares of our Common
Stock. The sale of an additional 500 shares of Series A Preferred Stock and
warrants to purchase 2,198,125 shares of Common Stock took place in October
2002. Net cash proceeds from the October 2002 financing were approximately
$4,650,000.
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 nine months
ended September 30, 2002 and 2001:
Nine Months Ended September 30,
2002 2001
---- ----
Net loss $ (9,063,556) $(10,345,731)
Adjustments for non-cash operating items 1,241,248 908,829
------------ ------------
Net cash operating loss (7,822,308) (9,436,902)
Net change in assets and liabilities (1,383,952) (1,989,721)
------------ ------------
Net cash used in operating activities $ (9,206,260) $(11,426,623)
============ ============
Net cash used in investing activities $ (477,499) $ (815,190)
============ ============
Net cash provided by financing activities $ 13,156,399 $ 13,694,465
============ ============
Net cash used in operating activities
Operating Cash Inflows -
Operating cash inflows for the first nine months of 2002 and 2001 have been
primarily derived from VITOSS and IMBIBE product sales in the U.S. and VITOSS
and CORTOSS product sales in Europe. We have also received cash inflows from
interest income on cash equivalents and short-term investments.
26
Operating Cash Outflows -
Our operating cash outflows for 2002 have continued to be primarily used for the
production of inventory, increases in sales and marketing staffing, and payment
of sales commissions. In addition, operating cash outflows have been utilized
for RHAKOSS process development, and pre-clinical and clinical activities in
preparation for regulatory filings of our products in development.
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, or due to changes in our distribution network.
Additionally, seasonal slowdowns during the summer months are not unusual. 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.
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, fund receivables and in support of marketing and sales activities for
VITOSS and IMBIBE in the United States and with VITOSS and CORTOSS in Europe. We
also expect an increased use of cash in operating activities associated with
research and development, including U.S. clinical trials for CORTOSS and
RHAKOSS, and manufacturing process development and pre-launch marketing
activities in support of our other products under development. 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.
27
Net cash used in investing activities
We have invested $477,499 and $1,390,056 for the nine months ended September 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.
Investing Cash Outlook -
While we anticipate capital spending for improvements to manufacturing processes
at our facilities, we expect the rate of such spending to be lower in comparison
to 2001. We anticipate new capital spending may be required in support of VITOSS
product line extensions and our other products under development.
Net cash provided by financing activities
During the nine months ended September 30, 2002 and 2001, we received $47,695
and $74,450, respectively, from stock option exercises and purchases of Common
Stock under our Employee Stock Purchase Plan. In addition, $398,216 and $526,853
were used to repay capital lease obligations during the first nine months of
2002 and 2001, respectively. During the nine months ended September 2002, we
entered into new capital lease financing arrangements with two lending
institutions. For the nine months ended September 30, 2002, we received proceeds
of $699,723 from capital lease borrowings.
In July 2002, we sold 1,400 shares of Series A 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 $12,807,197.
During the nine months ended September 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
In connection with the July 2002 Series A Preferred Stock transaction, after
obtaining the required shareholder approval in October 2002, we sold, on the
same terms and conditions as the July 2002 closing, an additional 500 shares of
Series A Preferred Stock which are 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, for net cash proceeds of approximately $4,650,000.
28
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 $16,629,544 as of September 30,
2002, together with the net proceeds of approximately $4,650,000 received in
October 2002 from the sale of Series A Preferred Stock and warrants (see above
and Note 6 to the Financial Statements contained in this Quarterly Report on
Form 10-Q), will be sufficient to meet our currently estimated operating and
investing requirements into 2004. While we have no immediate plans to do so, we
may seek to obtain additional funds in the future 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 Series A Preferred Stock will accrue and be cumulative from the
date of issuance of the Series A Preferred Stock, 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 limitations
as set forth in the Statement of Designations of the Series A 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 Series A Preferred Stock will be 6%
per year on the $10,000 stated value of the Series A Preferred Stock. Commencing
after 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 year. In addition, in the event that the Series A 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 Series A 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. (See Note 6 to the
consolidated financial statements for further discussion of accounting
treatment).
During the third quarter of 2002, we declared dividends of $151,890 on the 1,400
shares of Series A Preferred Stock outstanding as of September 30, 2002. We paid
these dividends in-kind during October 2002 by issuing an aggregate 57,057
shares of our Common Stock.
29
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 nine months ended September 30, 2002 and 2001, are as
follows:
- -----------------------------------------------------------------------------------------------------------
Three Months Ended % Increase
September 30, (Decrease)
2002 2001 2002 vs. 2001
---- ---- -------------
Product Sales $ 2,811,727 $ 1,134,253 148%
------------ -------------
Gross Profit 2,438,134 963,542 153
------------ -------------
General and Administrative Expenses 1,344,385 1,176,866 14
Selling and Marketing Expenses 2,314,991 1,435,719 61
Research and Development Expenses 1,437,132 1,839,339 (22)
------------ -------------
Total Operating Expenses 5,096,508 4,451,924 14
------------ -------------
Other (Expense) Income (100,462) 31,934 (415)
------------ -------------
Net loss from operations (2,758,836) (3,456,448) (20)
------------ -------------
Deemed dividend on Series A Preferred
Stock-Beneficial Conversion Feature ("BCF" 3,604,962 --- 100
Dividends on Series A Preferred Stock 151,890 --- 100
------------ -------------
Net loss applicable to common shareholders $ (6,515,688) $ (3,456,448) 89
============ =============
- ------------------------------------------------------------------------------------------------------------
Nine Months Ended % Increase
September 30, (Decrease)
2002 2001 2002 vs. 2001
---- ---- -------------
Product Sales $ 7,342,629 $ 2,314,262 217%
------------ -------------
Gross Profit 6,267,100 1,870,513 235
------------ -------------
General and Administrative Expenses 3,823,172 3,222,515 19
Selling and Marketing Expenses 6,460,188 3,957,329 63
Research and Development Expenses 4,821,947 5,541,898 (13)
------------ -------------
Total Operating Expenses 15,105,307 12,721,742 19
------------ -------------
Other (Expense) Income (225,349) 130,498 (273)
Net gain on sale of product line --- 375,000 (100)
------------ -------------
Net loss from operations (9,063,556) (10,345,731) (12)
------------ -------------
Deemed dividend on Series A Preferred
Stock-Beneficial Conversion Feature 3,604,962 --- 100
Dividends on Series A Preferred Stock 151,890 --- 100
------------ -------------
Net loss applicable to common shareholders $(12,820,408) $ (10,345,731) 24
============ =============
- -----------------------------------------------------------------------------------------------------------
30
Product Sales. Product sales for the three and nine months ended September 30,
2002, were $2,811,727 and $7,342,629, respectively, compared to $1,134,253 and
$2,314,262 for the same periods in 2001, respectively. For the three and nine
months ended September 30, 2002, 95% and 94% of total product sales were
realized in the United States, respectively, compared to 89% and 79% 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 VITOSS and CORTOSS sales in Europe. During May 2002, we
instituted a price increase for VITOSS in the U.S. Product sales during the
first nine 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 nine months ended September 30,
2002, was $2,438,134, or 87% of product sales, and $6,267,100, or 85% of product
sales, respectively. Our gross profit for the three and nine months ended
September 30, 2001, was $963,542, or 85% of product sales, and $1,870,513, or
81% 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 nine months ended
September 30, 2002, were $5,096,508 and $15,105,307, respectively, compared to
$4,451,924 and $12,721,742 for the same periods in 2001, respectively. General &
administrative expenses for the three months ended September 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 nine months ended September 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 nine-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 headcount additions in
support of U.S. product sales. Research and development expenses decreased for
the three and nine months ended September 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 $100,462 and $225,349
of net other expense for the three and nine months ended September 30, 2002,
respectively, compared to $31,934 and $130,498 of net other income for the three
and nine months ended September 30, 2001, respectively. The decrease in net
other income between 2002 and 2001, for both the three and nine month periods,
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.
31
Net gain on sale of product line. In March 2000, $400,000 of the proceeds from
the sale of our BIOGRAN dental grafting product line to Implant Innovations Inc.
was placed in an escrow account. During March 2001, we realized a gain when
$375,000 of the proceeds were released from the escrow account.
Net loss from operations. As a result of the foregoing factors, our net loss
from operations for the three and nine months ended September 30, 2002, was
$2,758,836 and $9,063,556, respectively, compared to a net loss of $3,456,448
and $10,345,731 for the three and nine months ended September 30, 2001,
respectively.
Deemed dividend-BCF and dividends on Series A preferred stock. A charge for the
value of the beneficial conversion feature ("BCF") of $3,604,962 was recorded
with respect to the 1,400 shares of Series A Preferred Stock that we sold in
July 2002. The value of the BCF was recorded in a manner similar to a deemed
dividend and was fully amortized through retained earnings during the third
quarter of 2002 as the Series A Preferred Stock has no maturity date and is
convertible at the date of issuance. We will record a similar adjustment during
the fourth quarter of 2002 of approximately $4,376,000 for the BCF relating to
the 500 shares of Series A Preferred Stock that we sold in October 2002. During
the third quarter of 2002, we declared dividends of $151,890 on the 1,400 shares
of Series A Preferred Stock outstanding as of September 30, 2002. We paid these
dividends in-kind during October 2002 by issuing an aggregate 57,057 shares of
our Common Stock. (See Note 6 to the consolidated financial statements).
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
September 30, 2002 and December 31, 2001.
32
ITEM 4. CONTROLS AND PROCEDURES
Orthovita's management, including the Chief Executive Officer and Chief
Financial Officer, have conducted an evaluation of the effectiveness of
disclosure controls and procedures pursuant to Exchange Act Rule 13a-14 within
90 days of the filing date of this quarterly report. Based on that evaluation,
the Chief Executive Officer and Chief Financial Officer concluded that the
disclosure controls and procedures are effective in ensuring that all material
information required to be filed in this quarterly report has been made known to
them in a timely fashion. There have been no significant changes in internal
controls, or in factors that could significantly affect internal controls,
subsequent to the date the Chief Executive Officer and Chief Financial Officer
completed their evaluation.
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 "Series A Preferred Stock"). There are 2,000 shares of Preferred Stock
authorized, of which 1,900 shares are issued and outstanding. The Statement of
Designations, Rights and Preferences of the Series A 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. In addition, see Note 6
to the Financial Statements contained in this Quarterly Report on Form 10-Q for
further explanation of the rights and preferences of the Series A Preferred
Stock.
(c) (i) On July 26, 2002, we sold 1,400 shares of Series A Preferred Stock at
$10,000 per share that 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, subject to adjustments, for an aggregate purchase
price of $14,000,000, to the following investors:
===========================================================================
Shares of
Shares of Common Stock
Preferred Acquirable under
Name of Investor Stock Warrants
---------------------------------------------------------------------------
7 30,774
OrbiMed Associates LLC
---------------------------------------------------------------------------
PW Juniper Crossover Fund LLC 158 694,607
---------------------------------------------------------------------------
Caduceus Private Investment L.P. 335 1,472,743
---------------------------------------------------------------------------
SDS Merchant Fund, L.P. 350 1,538,687
---------------------------------------------------------------------------
DMG Legacy Fund LLC 27 118,699
---------------------------------------------------------------------------
33
============================================================================
Shares of
Shares of Common Stock
Preferred Acquirable under
Name of Investor Stock Warrants
----------------------------------------------------------------------------
DMG Legacy Institutional Fund LLC 150 659,437
----------------------------------------------------------------------------
DMG Legacy International Fund Ltd. 173 760,551
----------------------------------------------------------------------------
ProMed Partners, L.P. 44 193,435
----------------------------------------------------------------------------
ProMed Offshore Fund, Ltd. 6 26,377
----------------------------------------------------------------------------
Xmark Fund, L.P. 13 57,151
----------------------------------------------------------------------------
Xmark Fund, Ltd. 37 162,661
----------------------------------------------------------------------------
SCO Capital Partners LLC 65 285,756
----------------------------------------------------------------------------
Paul Scharfer 35 153,869
----------------------------------------------------------------------------
Totals 1,400 6,154,747
============================================================================
In connection with this transaction, we paid placement agent fees
consisting of (a) $980,000 in cash and (b) five-year warrants to purchase an
aggregate 820,633 shares of our Common Stock at $1.706 per share. The placement
agent warrants were issued to the designees of the placement agent, SmallCaps
Online Group LLC. The securities were issued to accredited investors in a
private placement transaction 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. See Note 6 to the Financial
Statements contained in this Quarterly Report on Form 10-Q for further
explanation of the terms of conversion of the Series A Preferred Stock.
(ii) On October 18, 2002, we sold, on the same terms and conditions as in
the July 2002 closing, an additional 500 shares of Series A Preferred Stock
convertible into 2,930,832 shares of our Common Stock, together with warrants to
purchase 2,198,125 shares of Common Stock at $1.612 per share, subject to
adjustments, for an aggregate purchase price of $5,000,000, to the following
investors:
34
============================================================================
Shares of
Shares of Common Stock
Preferred Acquirable under
Name of Investor Stock Warrants
----------------------------------------------------------------------------
OrbiMed Associates LLC 7 30,774
----------------------------------------------------------------------------
PW Juniper Crossover Fund LLC 158 694,608
----------------------------------------------------------------------------
Caduceus Private Investment L.P. 335 1,472,743
----------------------------------------------------------------------------
Totals 500 2,198,125
----------------------------------------------------------------------------
In connection with this transaction, we paid placement agent fees
consisting of (a) $350,000 in cash and (b) five-year warrants to purchase an
aggregate 293,083 shares of our Common Stock at $1.706 per share. The placement
agent warrants were issued to the designees of the placement agent, SmallCaps
Online Group LLC. The securities were issued to accredited investors in a
private placement transaction 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. See Note 6 to the Financial
Statements contained in this Quarterly Report on Form 10-Q for further
explanation of the terms of conversion of the Series A Preferred Stock.
(iii) Pursuant to an investment banking agreement with SmallCaps Online
Group LLC, as partial payment for financial advisory services rendered during
the third quarter of 2002, we are obligated to issue to SmallCaps Online Group
LLC or its designees warrants to purchase an aggregate 92,000 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 is 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.
(iv) On July 1, 2002, we issued to The Musculoskeletal Research
Foundation, Inc. and one of its principal investigators warrants to purchase an
aggregate 110,000 shares of our Common Stock in consideration for agreeing to
perform services under a clinical assessment agreement. These warrants have an
exercise price of $1.75 per share, subject to adjustment, and an exercise period
of five 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.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On October 11, 2002, we held a Special Meeting of Shareholders. Under applicable
Nasdaq Marketplace Rules, votes of our preferred shareholders did not count
towards the voting requirements necessary to approve the matters submitted to a
vote of our
35
shareholders at the Special Meeting of Shareholders. At the Special Meeting of
Shareholders, the following matters were submitted to a vote of our
shareholders:
1. The issuance and sale of up to 500 shares of Orthovita's Series A 6%
Adjustable Cumulative Convertible Voting Preferred Stock (the "Series A
Preferred Stock"), and warrants to purchase an aggregate of up to 2,198,125
shares of Orthovita's Common Stock (the "Common Stock"), in connection with the
second closing of a private financing (the "Financing"). The holders of
12,210,802 shares of Common Stock voted in favor of this matter, the holders of
71,699 shares of Common Stock voted against this matter, and the holders of
20,370 shares of Common Stock abstained with respect to this matter.
Accordingly, this matter was approved.
2. The adoption of an amendment to Orthovita's Bylaws providing for the rights
of holders of the Series A Preferred Stock to nominate one member to the Board
of Directors, and to approve the nomination of up to two additional independent
directors who are not affiliated with the holders of the Series A Preferred
Stock. The holders of 12,242,352 shares of Common Stock voted in favor of this
matter, the holders of 52,200 shares of Common Stock voted against this matter,
and the holders of 8,319 shares of Common Stock abstained with respect to this
matter. Accordingly, this matter was approved.
3. The issuance of shares of Common Stock as payment of dividends on all
outstanding shares of the Series A Preferred Stock (the "Dividend Shares"), with
the price at which the Dividend Shares are issued based on the market price of
the Common Stock as of the record date for the dividend payment. The holders of
12,196,455 shares of Common Stock voted in favor of this matter, the holders of
102,146 shares of Common Stock voted against this matter, and the holders of
4,270 shares of Common Stock abstained with respect to this matter. Accordingly,
this matter was approved.
4. The issuance in full of shares of Common Stock that may become issuable upon
the conversion of the Series A Preferred Stock and upon the exercise of the
warrants sold in the Financing in the event that the anti-dilution provisions of
the Series A Preferred Stock and warrants are triggered by a future issuance by
Orthovita of Common Stock or other securities effectively equivalent to Common
Stock at prices below $1.706 per share with respect to the anti-dilution
protection of the Series A Preferred Stock and at prices below $1.612 per share
with respect to the anti-dilution protection of the warrants. The holders of
12,190,981 shares of Common Stock voted in favor of this matter, the holders of
106,946 shares of Common Stock voted against this matter, and the holders of
4,944 shares of Common Stock abstained with respect to this matter. Accordingly,
this matter was approved.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
Exhibit 3.1 Bylaw Amendment Effective as of October 18, 2002
Exhibit 99.1 Certifications Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
36
Exhibit 99.2 Certifications 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.
On July 17, 2002, the Company filed a Form 8-K under Item 4, reporting that the
Company dismissed Arthur Andersen LLP and appointed KPMG LLP as the Company's
principal independent public accountants.
On July 23, 2002, the Company filed a Form 8-K under Item 5, reporting that the
Company entered into an agreement to sell preferred stock and warrants to
purchase Common Stock, and filed an amendment to the Form 8-K on July 31, 2002.
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)
November 19, 2002 By: /s/ Antony Koblish
-------------------
Antony Koblish
President and Chief Executive Officer
(Principal executive officer)
November 19, 2002 By: /s/ Joseph M. Paiva
--------------------
Joseph M. Paiva
Chief Financial Officer
(Principal financial and accounting officer)
37
ORTHOVITA, INC.
CERTIFICATIONS PURSUANT TO
SECTION 302 OF
THE SARBANES-OXLEY ACT OF 2002
I, Antony Koblish, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Orthovita, Inc.;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant
and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent function):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data
and have identified for the registrant's auditors any material
weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in
this quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent
evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
/s/ Antony Koblish
Antony Koblish
President and Chief Executive Officer
November 19, 2002
ORTHOVITA, INC.
CERTIFICATIONS PURSUANT TO
SECTION 302 OF
THE SARBANES-OXLEY ACT OF 2002
I, Joseph M. Paiva, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Orthovita, Inc.;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant
and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in
this quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent
evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
/s/ Joseph M. Paiva
Joseph M. Paiva
Chief Financial Officer
November 19, 2002