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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K
(Mark One)
[X]Annual report pursuant to section 13 or 15(d) of the Securities Exchange
Act of 1934 [No Fee Required] for the fiscal year ended December 31, 1999
or
[_]Transition report pursuant to section 13 or 15(d) of the Securities
Exchange Act of 1934 [No Fee Required] for the transition period from
to .
Commission file number 0-24517
ORTHOVITA, INC.
(Exact name of registrant as specified in its charter)
Pennsylvania 23-2694857
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
45 Great Valley Parkway 19355
Malvern, Pennsylvania (Zip Code)
(Address of principal executive
offices)
Registrant's telephone number, including area code: (610) 640-1775
Securities registered pursuant to Section 12(b) of the Act:
(Title of class) Name of each exchange on which registered
---------------- -----------------------------------------
None None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $.01 per share
(Title of class)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes [X] No [_]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of registrant's knowledge, in the definitive proxy statement
incorporated by reference in Part III of this annual report on Form 10-K or
any amendment to this annual report on Form 10-K. [_]
As of March 15, 2000, the aggregate market value of the Common Stock held
by non-affiliates of the registrant was $76,000,032. Such aggregate market
value was computed by reference to the closing sale price of the Common Stock
as reported on the European Association of Securities Dealers' Automated
Quotation System on such date. For purposes of making this calculation only,
the registrant has defined affiliates as including all director, executive
officers and beneficial owners of more than ten percent of the registrant's
Common Stock.
As of March 15, 2000, there were 11,478,273 shares of the registrant's
Common Stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE:
As stated in Part III of this annual report on Form 10-K, portions of the
following document are incorporated herein by reference:
Definitive proxy statement to be filed within 120 days after the end of the
fiscal year covered by this annual report on Form 10-K.
Unless the context indicates otherwise, the terms "Orthovita" and "Company"
refer to Orthovita, Inc. and, where appropriate, one or more of its
subsidiaries.
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TABLE OF CONTENTS
PART I
ITEM 1. Business..................................................... 2-15
ITEM 2. Properties................................................... 15
ITEM 3. Legal Proceedings............................................ 15
ITEM 4. Submission of Matters to a Vote of Security Holders.......... 15
PART II
Market for Registrant's Common Equity And Related Shareholder
ITEM 5. Matters...................................................... 15
ITEM 6. Selected Consolidated Financial Data......................... 16
ITEM 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations.................................... 17-29
ITEM 7A. Quantitative and Qualitative Disclosure About Market Risk.... 30
ITEM 8. Financial Statements and Supplemental Data................... 30
Changes In and Disagreements with Accountants and Financial
ITEM 9. Disclosure................................................... 30
PART III
ITEM 10. Directors and Executive Officers of the Registrant........... 30
ITEM 11. Executive Compensation....................................... 30
Security Ownership of Certain Beneficial Owners and
ITEM 12. Management................................................... 31
ITEM 13. Certain Relationships and Related Transactions............... 31
PART IV
Exhibits, Financial Statement Schedules, and Reports on Form
ITEM 14. 8-K.......................................................... 31-32
SIGNATURES
1
PART I
Item 1. Business
In addition to historical facts or statements of current conditions, this
report contains forward-looking statements. Forward-looking statements provide
our current expectations or forecasts of future events. These may include
statements regarding anticipated scientific progress in our research programs,
development of potential products, prospects for regulatory approval,
manufacturing capabilities, market prospects for our products, sales and
earnings projections and other statements regarding matters that are not
historical facts. Some of these forward-looking statements may be identified by
the use of words in the statements such as "anticipated," "estimate," "expect,"
"project," "intend," "plan," "believe," or other words and terms similar in
meaning. Our performance and financial results could differ materially from
those reflected in these forward-looking statements due to general financial,
economic, regulatory and political conditions affecting the biotechnology,
orthopaedic and medical device industries as well as more specific risks
discussed throughout this document. Given these risks and uncertainties, any or
all of these forward-looking statements may prove to be incorrect. Therefore,
you are cautioned not to place too much reliance on any such forward-looking
statements. Furthermore, we do not intend, and are not obligated to update
publicly any forward-looking statements, whether as a result of new
information, future events or otherwise. We claim the protections afforded by
the Private Securities Litigation Reform Act of 1995, as amended, for our
forward-looking statements. The use of the words "Orthovita", the "Company",
"we", "us" or "our" herein refers to Orthovita, Inc., together with its
subsidiaries.
Orthovita is a leading developer of biomaterials and orthobiologics focused
on synthetic bone substitute products for orthopaedic applications primarily in
spine. The spine market represents one of the fast growing markets in
orthopaedics. We are also developing products for use in trauma and joint
replacement applications. We believe that there is a particular application for
our products in patients suffering from osteoporosis. Osteoporosis, whereby
bone becomes less dense and more likely to break, afflicts 10 million Americans
of which more than 80% are women. Our six products under development are based
on two broad technology platforms. Our patented CORTOSSTM biomaterial platform
consists of a bioactive glass and non-resorbable resin, which is used to form
synthetic cortical bone and can be delivered as either an injectable or a
putty. ORTHOCOMP(TM) Injectable, CORTOSS(TM) Injectable, and CORTOSS(TM) Putty
are under development in this platform. Our VITOSSTM orthobiologic platform
consists of a patented small particle resorbable calcium phosphate, which is
used to form osteoconductive synthetic cancellous bone and can be delivered as
an injectable or a scaffold. VITOSS(TM) Injectable and VITOSS(TM) Scaffold are
under development in this bone platform. Additionally, the two materials can be
combined to form our CORTOSSTM Implant products that incorporate the advantages
of each platform.
We are developing the CORTOSS and VITOSS product lines independently and
have retained all of the commercial rights to these products. We have a
worldwide agreement for the joint development and commercialization of
ORTHOCOMP Injectable for use in joint implant procedures, such as hip
replacements, with Howmedica, a subsidiary of Stryker Corp., the market leader
for joint implant cements.
The first product we developed was BIOGRAN(R) for use in the dental market.
In order to better focus on the orthopaedic market in, March 2000 we sold our
BIOGRAN dental grafting product line to Implant Innovations Inc. ("3i"), a
Biomet Company, for $3.9 million. We received proceeds of $3.5 million, with an
additional $400,000 held in an escrow account for one year, and realized a one-
time gain on the transaction of approximately $3.1 million.
Orthovita's Technology
The human skeleton consists of two types of bone: cortical bone (80%) and
cancellous bone (20%). Cortical bone is dense, structural and tubular in shape
and is subject to bending, load bearing and twisting forces. Cancellous bone is
less dense, more vascular and primarily subject to compressive forces. Skeletal
integrity is maintained by an ongoing process of regeneration and remodeling.
Both types of bone can be damaged from traumatic injury and degenerative
disease, such as osteoporosis, creating a need for both cortical and cancellous
synthetic bone substitutes.
2
Synthetic Cortical Bone Substitute Platform
Our synthetic cortical bone substitute platform is based on a nonresorbable,
load bearing, resin composite. We currently have three products under
development derived from this platform: ORTHOCOMP Injectable, CORTOSS
Injectable, and CORTOSS Putty. Products derived this platform are formulated to
allow for controlled setting times, varying viscosities and differing
strengths. Less viscous formulations may be delivered through pre-filled unit
dose cartridges directly into the surgical site or through minimally invasive
surgery, and more viscous formulations can be hand-packed as putty.
Our synthetic cortical bone platform provides the basis for products with
the ability to conform to the precise area of placement, with its fast setting
times, immediate load-bearing strength, and elasticity more closely resembling
that of natural bones. Because of their bioactivity, products derived from this
platform, we believe, will become integrated with the bone at the interface
where the bone is in contact with these products, enhancing the strength of the
bond. CORTOSS Injectable, our most advanced product under this platform,
possesses these unique properties, and unlike polymethylmethacrylate ("PMMA")
bone cement, which requires a relatively lengthy mixing time and short interval
during which the material can be used, has a mix-on-demand delivery system
which should allow the surgeon much greater flexibility. CORTOSS Putty is in an
ealier stage of development. CORTOSS Injectable is covered by two U.S. issued
patents and other U.S. and foreign patent applications are pending.
Synthetic Cancellous Bone Substitute Platform
The synthetic cancellous bone substitute platform, our other core
technology, is based on synthetic resorbable, calcium phosphate. Cancellous
bone has a lattice-like or spongy structure, which allows for nutrient
transport. We currently have two products under development from this platform,
VITOSS Injectable and VITOSS Scaffold. VITOSS Scaffold is a resorbable calcium
phosphate delivered as a preformed scaffold matrix that closely resembles the
porosity of normal cancellous bone and is replaced by bone as it is resorbed.
VITOSS Scaffold incorporates our patented nano-particle technology that enables
it to have thorough interconnected porosity, ultra-high purity and a precise
and controlled chemical composition with excellent reabsorption dynamics. We
believe our VITOSS Scaffold product will allow for both the flow of blood and
nutrients required for bone remodeling and for the seeding of signaling
molecules and growth factors to accelerate the healing process. We believe that
the characteristics of VITOSS make it potentially superior to that of calcium
phosphate based products currently on the market. VITOSS Scaffold may be
especially useful in cases where moderate load bearing, coupled with fixation
hardware, would permit quicker return to functionality in younger patients with
healthy bone physiology. VITOSS Injectable is in an earlier stage of
development. Our VITOSS platform is covered by two U.S. issued patents and
other U.S. and foreign patent applications are pending. In addition to the
products described above, the two materials can be combined to form our CORTOSS
Implant products that incorporate the advantages of each platform.
3
Our Product Pipeline and Related Clinical Applications
The following table reflects the development status as of February 29, 2000
of our most advanced product candidates:
[GRAPH]
As further discussed in Government Regulations below, our product candidates
are subject to extensive regulation as medical devices by the United States
Food and Drug Administration (the "FDA") and European regulatory authorities.
For certain indications, approval (in the U.S. 510(k) clearance) may be granted
if we can establish that the product is "substantially equivalent" to certain
approved medical devices and generally does not require submission of data from
clinical studies. However the authorities may require additional information
including data from clinical studies before a substantial equivalence
determination can be made. Product approval applications for other products or
other indications must be supported by valid scientific evidence that typically
includes clinical trial data, to demonstrate the safety and effectiveness of
the device.
As described below, in December 1999, we filed a 510(k) with the FDA in the
U.S. for the approval of VITOSS Scaffold for use in bone defect repair. We have
also filed the first part of our application for approval in Europe for this
indication and expect to complete our filing in 2000 for this indication. We
also intend to file in 2000 a 510(k) application with the FDA for the use of
CORTOSS Injectable in cranial repair. As permitted by the regulations, these
filings do not include clinical data.
There can be no assurance that our clinical studies will be successful, our
applications will be made within the planned timeframe, that our 510(k)
application will be accepted without clinical data or that we will succeed in
obtaining any of the necessary regulatory approvals.
VITOSS Scaffold
Bone Defect Repair. Cancellous bone can be damaged and compressed due to
traumatic injury such as skiing or motor vehicle accidents. Cancellous bone may
also be removed in connection with surgery such as tumor resection or in
complex orthopaedic procedures leading to bone voids or gaps. We estimate that
100,000 patients suffer damage or removal of cancellous bone each year.
4
Current "Scaffold" products on the market that are used to replace/repair
cancellous bone fall into three categories. Allograft or cadaver derived
products, calcium sulfate materials and coral derived materials consisting of a
hydroxyappitite shell around calcium carbonate. Allograft products may not
always be of uniform quality and consistency, and patients and physicians may
be concerned about the possibility of disease transmission. The calcium sulfate
products are non-porous tablets that resorb rapidly through dissolution
processes only. A successful cancellous replacement must resorb by both
dissolution and by cell mediated process to conduct the creation of new bone.
Coraline scaffold is mined from naturally occurring coral and has significantly
less porosity than VITOSS and is constructed from large blocks of mineral
rather than nano-sized particles.
Injectable, setting calcium phosphate cements are also used to repair
cancellous defects. These materials set to form a dense, brittle mass or block
of mineral. They are also non-porous and thus we believe they do not resorb and
turn over to bone as readily as VITOSS Scaffold.
We believe that replacement or repair of the cancellous bone with VITOSS
Scaffold will promote cancellous bone regrowth and allow patients to return
more quickly to function. Our patented method of producing VITOSS Scaffold
results in a unique porous structure closely resembling the structure of
natural cancellous bone.
In December 1999, we filed a 510(k) with the FDA in the U.S. for the
approval of VITOSS Scaffold for use in bone defect repair and have filed the
first part of our application for CE Mark approval with our notified body in
Europe for this indication.
Spinal Fusions. Many patients affected by severe back pain due to
degeneration of one or more discs are treated with a spinal fusion procedure.
Spinal fusion involves the fusing together of adjoining vertebrae in cases
where the patient has advanced disc degeneration or spinal instability. This
procedure involves surgical incision in the patient's back or abdomen. Fusions
frequently require the removal of the affected disc material and the surgical
attachment of a metal implant or a spinal fusion cage to join the two
surrounding vertebrae. The metal implant or spinal fusion cage is usually
packed with bone grafting material to help promote the union of the two
adjacent vertebrae. Bone grafting material is either autograft material, which
is obtained or harvested from the iliac crest region of the patient's own hip,
or allograft material, which is obtained from a cadaver.
The autograft harvest is an additional procedure that extends surgical time,
adding to costs and increasing blood loss and patient risk of infection or
adverse reaction from the additional time under anesthesia. Of equal concern,
harvesting bone for autograft sometimes causes protracted pain that
necessitates a trip back to the surgeon several months after the fracture
repair procedure. Allograft material may be perceived by some physicians as
less effective than autograft and may not be accepted by all patients.
We estimate that 400,000 spinal fusions are done annually, many of which use
autograft, allograft or synthetic grafting material. As further discussed in
Bone Defect Repair above, we have filed a 510(k) application with the FDA for
the use of VITOSS Scaffold in bone defect repair. We intend to initiate
preclinical studies exploring the use of VITOSS Scaffold soaked with bone
aspirate as a spinal fusion graft material. We believe VITOSS Scaffold has the
potential to replace the use of autologous grafts. The elimination of this
second operating procedure required by autograft may reduce patient pain and
potentially reduce the length of hospitalization. Therefore, VITOSS Scaffold
may be more readily accepted by patients and physicians than allograft
material.
CORTOSS Injectable
Cranial Repair Traumatic head injury or diseases affecting the brain and
eyes can require surgery to repair and treat the affected area. In order to
gain access to the brain, holes are made in the bony cranial structure, which
are required to be sealed or repaired after the surgery is completed. We
estimate that
5
approximately 155,000 procedures requiring repair of the access holes or damage
from traumatic injury are performed worldwide each year. We believe that the
existence of an approved predicate device may allow CORTOSS Injectable to be
approved for use in cranial repair through the 510(k) process without the
necessity of conducting clinical trials. We have completed the preclinical
testing of CORTOSS for use in this indication and are preparing to file a
510(k) application. We believe that CORTOSS Injectable may possess superior
characteristics to the materials approved for use in this procedure today, in
particular its rapid setting and mix on demand delivery.
Long Bone Screw Augmentation. The augmentation of long bone screws is
required in cases where the patient's bone is of insufficient quality to allow
a screw to function. We estimate 1,000,000 of the 2,300,000 long bone fractures
which occur worldwide each year require external support including steel
plates. With plating, the fracture is aligned and the plate is shaped to
conform to the natural shape of the bone. The first screws placed into the
plate serve to compress the fracture, permitting faster healing. The remaining
screws are then placed to stabilize the plate so that the fracture will not
move and healing can occur. The healing of a fracture is directly proportional
to the degree of stabilization. The failure of screws to purchase or hold is
common, especially in osteoporotic bone, although it can occur in non-
osteoporotic patients as well. Screws that do not hold are removed, and either
the screw hole is not used or is filled with a larger screw. The non-use of a
screw hole causes a large weak point to be created, presenting a greater
potential for fracture of the bone and plate through the weak area. The use of
a larger screw often results in a looser placement due to concerns of
stripping. We estimate that approximately 150,000 patients may require the
augmentation of screws with approximately six screws augmented per patient.
We believe the use of CORTOSS Injectable to anchor the screw in a quick and
efficient way will allow the full function of the screw to be restored. There
are no known cement products that have received FDA approval or CE marking that
would be in competition with CORTOSS Injectable for this indication. Clinical
trials for CORTOSS Injectable for this indication are being conducted in
Europe.
Vertebroplasty. We estimate there are 660,000 patients worldwide with
compression of the vertebrae due to fractures caused by osteoporosis or bone
cancer resulting in severe pain and immobility. The traditional treatments,
e.g., bed rest, bracing, narcotics or injections do not address the underlying
fracture. Vertebroplasty is a procedure for repairing the fractured vertebrae.
When used in this procedure, CORTOSS Injectable is injected into the vertebrae,
setting within minutes and becoming load bearing. The procedure can be
performed on an outpatient or short-stay basis.
Vertebroplasty provides almost immediate pain relief in over 90% of
osteoporotic patients. Early relief of pain provided by vertebroplasty results
in patients maintaining better functional capacity. Functional capacity, in
turn, is directly related to the ability to live independently and unassisted.
We are not aware of any known products that have received FDA approval or
European approval for use in this procedure and physicians currently use PMMA
"off-label". We believe that CORTOSS Injectable may have advantages over PMMA
in vertebroplasty including the ability to be seen by the physician when using
imaging equipment in performing the procedure, lower temperature setting time,
higher compression strength and the ability to be mixed on demand.
We have initiated clinical studies of CORTOSS Injectable in vertebroplasty
in Europe and believe these are the only controlled studies in this field. For
the patients accrued to date, the product has been well tolerated and effective
in stabilizing the compressive fracture and in providing significant pain
relief. We will accept additional patients into these clinical studies once we
refine the delivery needles and tubes used to deliver the material to the
vertebrae.
Compression Screw Augmentation We estimate approximately 750,000 hip
fractures occur annually of which an estimated 250,000 patients are repaired
using compression screw augmentation.
6
Many osteoporotic patients, particularly elderly women, suffer a fracture of
the hip whereby the head or the "ball" of the hip ball and socket of the femur
leg bone is separated from the rest of the bone. These fractures are often
treated through the use of compression hip screws, which are placed through the
bone and into the femoral head to stabilize and compress the fracture to permit
healing. The healing of a fracture is directly proportional to the degree of
stabilization. The failure of screws to purchase or hold is common, especially
in osteoporotic bone.
We believe the use of CORTOSS Injectable to anchor the screw in a quick and
efficient way will allow the full function of the screw to be restored. There
are no known products approved for this indication that would be in competition
with CORTOSS Injectable.
Pedicle Screw Augmentation. Many spinal surgeries today have become
possible only because of the availability of instrumentation systems that allow
manipulation and fixation of the individual elements of the spine. These
instrumentation systems are attached to the spine by means of screws placed in
the pedicle region of the vertebrae. In patients with sub optimal bone quality,
such as osteoporotic patients, the purchase or "bite" of these screws may be
insufficient to maintain the integrity of the construction.
There are approximately 280,000 patients in which pedicle screws are placed
each year. We estimate that approximately 35,000 may require the augmentation
of screws due to osteoporosis. There is no approved product for this procedure
and off-label use of PMMA, we believe, is inconvenient.
We believe CORTOSS Injectable has the potential to ensure secure fixation of
the screws, allowing the instrumentation systems to restore maximum fixation
and stabilize the spine. We believe CORTOSS Injectable's mix on demand delivery
system makes its use here convenient and practical.
Iliac Crest Repair. The bone grafting material used to pack the metal
implant and cages used in spinal fusion procedure is often autograft material,
obtained or "harvested" from the iliac crest region of the patient's own hip
through an operating procedure. This procedure leaves an open space in the
iliac crest, which is often painful and slow healing. We estimate that 400,000
spinal fusions are done annually, of which approximately 200,000 procedures use
autograft material and another 100,000 non-spinal fusion related procedures use
harvested material.
We believe that CORTOSS Injectable can be used to repair the bone void left
by the harvest procedure at the time of surgery and may reduce pain and speed
healing time.
CORTOSS Implants
Spine Revision. Spine revision surgery to restore the shape and alignment
of the spine is performed on patients suffering from deformities of the spine
such as scoliosis, which is a deviation in the normal curvature and alignment
of the spine. Spine revision and reconstruction procedures often require the
use of human cadaver bone to provide bone structure for the surgical repair.
Cadaver bone has various drawbacks, such as limited supply, poor and
inconsistent quality, and may not be accepted by all patients and physicians
due to concern over possible disease transmission. We believe there is a market
need for non-cadaver based revision products.
We believe CORTOSS Implants have the potential to address this need. CORTOSS
Implants are made of a combination of a CORTOSS outer shell and a VITOSS
Scaffold inner core that can be made in virtually any size and shape to fit the
clinical need. We believe the VITOSS Scaffold inner core will provide an
interconnected series of calcium phosphate micro pores similar to the porosity
of cancellous bone, and we expect it to be fully resorbable resulting in new
bone formation. We have identified the initial prototype design of the CORTOSS
Implants and have begun formulation development and initial mechanical studies.
7
ORTHOCOMP
Reconstructive Joint Implant Procedures. Many patients, due to either
injury or osteoarthritis, need to have a skeletal joint, such as a hip or knee,
replaced by an artificial one made of metal or other materials. There are
approximately 1.1 million procedures performed with hip and knee prosthesis
worldwide. Although non-cement products are available, we estimate that in
approximately 65% of implant procedures bone cement is used to secure the new
joint to the bone. Currently, PMMA is typically used in this procedure and
Howmedica, producer of the Simplex brand of PMMA cement, has the dominant
market share. We believe that ORTHOCOMP possesses superior mechanical and
bioactive properties, and uses a more efficient delivery system than PMMA.
As further described in Sales and Marketing on June 9, 1998, we entered into
a series of agreements with Howmedica under which we will collaborate with
Howmedica to further develop our ORTHOCOMP products.
We have successfully completed a pilot preclinical study for the use of
ORTHOCOMP Injectable in joint implant procedures and are now moving this
program forward into a full-scale preclinical study. Successful results from
that study will allow our filing an Investigative Device Exemption ("IDE") for
the start of clinical studies.
Research and Development
Our products under development to date have been the result of our internal
research and development activities related more to applied research than that
of basic research discovery. We have also gained access to intellectual
property resulting from certain research carried out at the University of
Pennsylvania through a license and technology transfer agreement (the "Penn
License Agreement"). The Penn License Agreement grants us an exclusive,
worldwide right and license to use and sell products that utilize biomaterials
and certain bioactive glass fiber technology protected by the University of
Pennsylvania's patent rights for use in medical, dental and veterinary fields.
We issued 120,008 shares of our stock to the University of Pennsylvania as
partial consideration for the exclusive license. Additionally, in order to
retain our rights under the Penn License Agreement, we need to pay for the
related patent prosecution costs. We have agreed to pay a royalty of 4% of the
net sales of any products made by us that utilize technology covered by the
Penn License Agreement.
In addition, we may seek to enter into strategic alliances, or license
patented technologies or develop additional technologies to broaden our future
product offerings. We have incurred $5.3 million, $2.8 million and $2.0 million
in research and development expense in 1999, 1998 and 1997, respectively.
Patents and Proprietary Intellectual Property
We intend to file applications as appropriate for patents covering our
technologies, products and processes. As of March 24, 2000, we own or control
six issued U.S. patents, six pending patent applications in the United States
and numerous counterparts of certain of these patents and pending patent
applications in Europe and Japan. There can be no assurance that patents will
be issued from any of the pending patent applications. Since
8
patent applications in the United States are maintained in secrecy until
issued, and since publication of discoveries in the scientific or patent
literature tends to lag behind actual discoveries, we cannot be certain that we
or any of our licensors were the first creator of inventions covered by pending
patent applications or that we or any of our licensors were the first to file
patent applications for such inventions. Further, there can be no assurance
that the claims allowed under any issued patents will be sufficiently broad as
to protect our proprietary position in the technology. In addition, there can
be no assurance that any patents issued to us or any of our licensors will not
be challenged, invalidated or circumvented, or that the rights granted
thereunder will provide commercially useful competitive advantages to us.
On July 23, 1994, U.S. Biomaterials Corporation filed with the U.S. Patent
and Trademark Office a Request for Reexamination of the FBFC U.S. Patent which
provides patent protection in the U.S. for BIOGRAN. This patent has now been
assigned to 3i who purchased the BIOGRAN product line in March 2000. FBFC filed
a response in this proceeding, establishing that the claims of the FBFC Patent
were properly allowed. As a result, a Certificate of Reexamination was issued
by the U.S. Patent and Trademark Office confirming the patentability of all
claims of the FBFC Patent without amendment. However, U.S. Biomaterials
Corporation also instituted a nullification proceeding against the European
counterpart to the FBFC U.S. Patent. The opposition division of the European
Patent Office tentatively decided in FBFC's favor, but the matter is still
proceeding under an appeal. In connection with the BIOGRAN sale to 3i, 3i has
assumed control of this matter and we have agreed to reimburse for the
associated legal costs and to provide them with certain indemnification with
respect to the matter.
Spine Advisory Panel
We have a Spine Advisory Panel of physician experts that provides advise and
guidance to us in our spinal product development programs regarding potential
clinical uses of our products. Certain members of the Spine Advisory Panel have
received options to purchase common stock of the Company, a practice that the
Company may continue in the future.
Manufacturing and Product Supply
Our ability to conduct clinical trials on a timely basis, to obtain
regulatory approvals and to commercialize our products will depend in part upon
our ability to manufacture our products at a competitive price and in
accordance with applicable FDA and other regulatory requirements, including
Quality System Requirements ("QSR") and current Good Manufacturing Practice
("GMP") regulations.
We currently manufacture adequate supplies of product for clinical trials
and other studies. In order to sell our products on a commercial basis, we are
in the process of expanding our facilities and scaling-up our manufacturing
processes. Certain of our key raw materials used in the manufacturing of
CORTOSS Injectable and VITOSS Scaffold are purchased from third party vendors
some of whom are our only source of such raw materials.
Sales and Marketing
We intend to market our products, upon receipt of the necessary regulatory
approvals, through a combination of exclusive third-party strategic alliances
and arrangements with agents and distributors, depending upon the clinical
indications for which the products are intended and the geographic region in
which they are to be sold.
On June 9, 1998, we entered into a series of agreements with Howmedica under
which we will collaborate with Howmedica to further develop our ORTHOCOMP
products. Under these agreements, we granted Howmedica the exclusive worldwide
right to use and sell our ORTHOCOMP products for joint replacement surgery. We
will earn payments if and when various milestones are reached during the
development and approval process for this indication up to an aggregate of
$4,500,000. If the necessary regulatory approvals are
9
received in the United States, the European Union or Japan, Howmedica will be
required to purchase from us a minimum volume of ORTHOCOMP products for each
region in which approval has been obtained for a six-year period. The annual
minimum purchase requirements may be set aside if, during the period from the
third anniversary of Howmedica's first commercial sale of an ORTHOCOMP product
until the fifth anniversary of such sale, Howmedica elects to purchase
exclusive manufacturing rights of ORTHOCOMP from us for a one-time payment of
$7,000,000. In addition, if Howmedica makes this election, they would make
royalty payments to us on future sales during the term of the Development and
License Agreement equal to 10% of Howmedica's net sales of ORTHOCOMP products
in territories with a valid claim of patent, or 5% of net sales in territories
with no such valid claim of patent.
We intend to seek arrangements with distributors and agents for the sale and
distribution of CORTOSS Injectable and VITOSS Scaffold in the U.S. and Europe.
Additionally, we seek to enter into a strategic alliance with an orthopaedic
company in Japan for the distribution, selling and marketing of CORTOSS
Injectable and VITOSS Scaffold.
Competition
Competition in the medical device industry is intense in both the U.S. and
Europe with rapid product development and technological advancement. Our
products could be rendered noncompetitive or obsolete by technological
advancements made by current or potential competitors. There can be no
assurance that we will be able to respond to technological advancements through
the development and introduction of new products. Moreover, many of our
existing and potential competitors have substantially greater financial,
marketing, sales, distribution and technological resources than us. Such
existing and potential competitors may be in the process of seeking FDA or
other regulatory approvals, or patent protection, for their respective
products. They may also enjoy substantial advantages over us in terms of
research and development expertise, experience in conducting clinical trials,
experience in regulatory matters, manufacturing efficiency, name recognition,
sales and marketing expertise or the development of distribution channels.
Since our products compete with procedures that have, over the years, become
standard within the medical community, there can be no assurance that the
procedures underlying our products will be able to replace more established
procedures and products. There can be no assurance that we will be able to
compete successfully against current or future competitors or that competition
will not have a material adverse effect on our business, financial condition
and results of operations.
In the orthopaedic market, we face competition from existing products and
companies, and potential competition from emerging companies developing bone
substitutes. In orthopaedic applications for trauma, we believe our VITOSS
Scaffold matrix will face competition from similar products currently on the
market or that may enter the market in the near future. We believe that VITOSS
Scaffold may have certain superior characteristics such as thorough
interconnected porosity, rapid resorption and replacement by bone. There are no
known products that have received FDA approval or a CE Mark for screw
augmentation and vertebroplasty that would be in competition with CORTOSS
Injectable for these indications; however, we may face off-label use of PMMA.
The reconstruction joint implant market is dominated by the use of PMMA, and
Howmedica, the producer of Simplex cement, has the dominant market share. We
believe that ORTHOCOMP has certain desirable attributes, such as higher
compressive strength, lower exotherm and simple mix-on-demand delivery system.
However, PMMA has been a successful product and orthopaedic surgeons will
likely be conservative in accepting new cements. See "Management's Discussion
and Analysis of Financial Condition and Results of Operations--Dependence on
the Commercial Success of CORTOSS and VITOSS."
Government Regulation
In order to market our products, we must apply for and be granted all
necessary regulatory approvals in Europe, the United States, Japan and other
selected geographic territories. There can be no assurance that we will succeed
in obtaining any of the necessary regulatory approvals described below.
10
Europe
In order to sell our products within the European Economic Area, we are
required to achieve compliance with the requirements of the European Union
Medical Devices Directive (the "MDD") and affix CE marking on our products to
attest such compliance. To achieve this, our products must meet the "essential
requirements" defined under the MDD relating to safety and performance and we
must successfully undergo a verification of our regulatory compliance
("conformity assessment") by an independent notified body. We have selected the
TNO, or the Netherlands Organization for Applied Scientific Research, as our
notified body. The nature of the conformity assessment will depend on the
regulatory class of our products. Under European law, our products are likely
to be in Class III. In the case of Class III products, we must (as a result of
the regulatory structure which we have elected to follow) establish and
maintain a complete quality system for design and manufacture as described in
Annex II of the MDD (this corresponds to a quality system for design in ISO
9001 and EN 46001 standards). The Notified Body must audit this quality system
and determine if it meets the requirements of the MDD. In addition, the
Notified Body must approve the specific design of each device in Class III. As
part of the design approval process, the Notified Body must also verify that
the products comply with the essential requirements of the MDD. In order to
comply with these requirements, we must, among other things, complete a risk
analysis and may be required to present sufficient clinical data. The clinical
data presented by us must provide evidence that the products meet the
performance specifications claimed by us, provide sufficient evidence of
adequate assessment of unwanted side effects and demonstrate that the benefits
to the patient outweigh the risks associated with the device. We will be
subject to continued surveillance by the Notified Body and will be required to
report any serious adverse incidents to the appropriate authorities. We also
will be required to comply with additional national requirements that are
beyond the scope of the MDD.
We are in the process of implementing policies and procedures that are
intended to allow us to receive International Standards Organization
("ISO") 9000 series certification of our processes. ISO 9000 series
certification is one of the quality systems satisfying the CE Mark
certification requirements for all products manufactured in the United States.
United States
The medical devices that we intend to manufacture and market are subject to
extensive regulation by the FDA. Pursuant to the Federal Food, Drug and
Cosmetic Act and the regulations promulgated thereunder, the FDA regulates the
clinical testing, manufacture, labeling, distribution and promotion of medical
devices. Noncompliance with applicable requirements can result in, among other
things, fines, injunctions, civil penalties, recall or seizure of products,
total or partial suspension of production, failure of the government to grant
premarket clearance or premarket approval for devices, withdrawal of marketing
approvals and criminal prosecution.
In the United States, medical devices are classified into one of three
classes (Class I, II or III) on the basis of the controls deemed necessary by
the FDA to reasonably assure their safety and effectiveness. Under FDA
regulations, Class I devices, the least regulated category, are subject to
general controls and Class II devices are subject to general and special
controls. Generally, Class III devices are those that must receive premarket
approval by the FDA to ensure their safety and effectiveness. Our products are
either Class II or Class III devices.
Before a new device can be introduced into the market, the manufacturer must
generally obtain market clearance through either a 510(k) notification or a
premarket approval ("PMA") through a PMA application. A 510(k) clearance will
be granted if the submitted information establishes that the proposed device is
"substantially equivalent" to a legally marketed Class I or II medical device,
or to a Class III medical device for which the FDA has not called for a PMA.
The FDA may determine that a proposed device is not substantially equivalent to
a legally marketed device, or that additional information or data are needed
before a substantial equivalence determination can be made. A request for
additional data may require that clinical studies be performed to establish the
device's "substantial equivalence."
11
Commercial distribution of a device for which a 510(k) notification is
required can begin only after the FDA issues an order finding the device to be
"substantially equivalent" to a predicate device. Pursuant to the Food and Drug
Administration Modernization Act ("FDAMA"), enacted in November 1997, the FDA
must make a determination with respect to a 510(k) submission within 90 days of
its receipt. The FDA may extend this time frame by requesting additional data
or information. Prior to enactment of the new law, it generally has taken from
four to twelve months from the date of submission to obtain a 510(k) clearance,
and in some instances has taken longer. It is not expected that the new law
will shorten this time frame significantly, if at all.
A "not substantially equivalent" determination, or a request for additional
information, could delay or prevent the market introduction of new products for
which we file such notifications. For any of our products that are cleared
through the 510(k) process, modifications or enhancements that could
significantly affect the safety or efficacy of the device or that constitute a
major change to the intended use of the device will require new 510(k)
submissions. The FDA has recently implemented a policy, under which certain
device modifications may be submitted as a "Special 510(k)," which will require
only a 30-day review. Special 510(k)'s will be limited to those device
modifications that do not affect the intended use or alter the fundamental
scientific technology of the device and for which substantial equivalence can
be demonstrated through design controls.
A PMA application must be filed if a proposed device is not substantially
equivalent to a legally marketed Class I or Class II device, or if it is a
Class III device for which FDA has called for PMA applications. A PMA
application must be supported by valid scientific evidence that typically
includes extensive data, including preclinical and clinical trial data, to
demonstrate the safety and effectiveness of the device, as well as extensive
manufacturing information.
An FDA review of a PMA application generally takes one to two years from the
date the PMA application is accepted for filing, but may take significantly
longer. The review time is often significantly extended should the FDA ask for
more information or clarification of information already provided in the
submission. Pursuant to FDAMA, the FDA has established a number of policies and
procedures intended to streamline preparation and review of PMAs. These include
the opportunity for device sponsors to obtain FDA agreement in writing on an
investigational plan, the opportunity to meet with FDA within 100 days of the
PMA's filing to review its status, the ability to rely on compliance with
certain national or international standards to satisfy certain PMA
requirements, and increased use of post market controls to reduce PMA data
requirements. There can be no assurance that we will benefit from any of these
new policies or procedures.
During the PMA review period, an advisory committee, typically a panel of
clinicians, will likely be convened to review and evaluate the application and
provide recommendations to the FDA as to whether the device should be approved.
The FDA is not bound by the recommendations of the advisory panel. Toward the
end of the PMA review process, the FDA generally will conduct an inspection of
the manufacturer's facilities to ensure that they are in compliance with
applicable GMP requirements.
If the FDA's evaluations of both the PMA application and the manufacturing
facilities are favorable, the FDA will either issue an approval letter or an
"approvable letter," which usually contains a number of conditions which must
be met in order to secure final approval of the PMA. When and if those
conditions have been fulfilled to the satisfaction of the FDA, the agency will
issue an approval letter, authorizing commercial marketing of the device for
certain indications. If the FDA's evaluation of the PMA application or
manufacturing facilities is not favorable, the FDA will deny approval of the
PMA application or issue a "not approvable letter." The FDA may also determine
that additional clinical trials are necessary, in which case PMA approval may
be delayed up to several years while additional clinical trials are conducted
and submitted in an amendment to the PMA application. The PMA process can be
expensive, uncertain and lengthy and a number of devices for which other
companies have sought FDA approval have never been approved for marketing.
12
Modifications to a device that is the subject of an approved PMA application
(including modifications to its labeling or manufacturing process) may require
approval by the FDA of PMA supplements or new PMAs. Supplements to a PMA
application often require the submission of the same type of information
required for an initial PMA, except that the supplement is generally limited to
that information needed to support the proposed change from the product covered
by the original PMA application.
If clinical trials of a device are required in connection with either a
510(k) notification or a PMA application and the device presents a "significant
risk," the sponsor of the trial (usually the manufacturer or the distributor of
the device) is required to file an IDE application prior to commencing clinical
trials. The IDE application must be supported by data, typically including the
results of animal and laboratory testing. If the IDE application is reviewed
and approved by the FDA and one or more appropriate Institutional Review Boards
("IRBs"), clinical trials may begin at a specific number of investigational
sites with a specific number of patients, as approved by the FDA. If the device
presents a "non-significant risk" to the patient, a sponsor may begin the
clinical trial after obtaining approval for the study by one or more
appropriate IRBs, but not the FDA. For "significant risk" devices, an IDE
supplement must be submitted to and approved by the FDA before a sponsor or an
investigator may make a change to the investigational plan that may affect its
scientific soundness or the rights, safety or welfare of human subjects. IRB
approval may be required for changes in the investigational plan for both non-
significant risk and significant risk devices.
Any products manufactured or distributed by us pursuant to FDA clearances or
approvals are subject to extensive regulation by the FDA, including record
keeping requirements and reporting of adverse experiences with the use of the
device. Device manufacturers are required to register their establishments and
list their devices with the FDA and certain state agencies, and are subject to
periodic inspections by the FDA and certain state agencies. The FFD&C Act
requires devices to be manufactured in accordance with GMP regulations that
impose certain procedural and documentation requirements upon us with respect
to manufacturing and quality assurance activities. Revisions to the GMP
regulations impose new design control requirements on device manufacturers that
may increase the cost of complying with GMP requirements. Medical devices are
also subject to post market reporting requirements for deaths or serious
injuries when the device may have caused or contributed to the death or serious
injury, and for certain device malfunctions that would be likely to cause or
contribute to a death or serious injury if the malfunction were to recur. If
safety or efficacy problems occur after the product reaches the market, the FDA
may take steps to prevent or limit further marketing of the product.
Labeling and promotion activities are subject to scrutiny by the FDA and, in
certain instances, by the Federal Trade Commission. The FDA actively enforces
regulations prohibiting marketing of products for unapproved or uncleared uses.
Pursuant to the FDAMA, however, limited dissemination of information on
unapproved uses is permitted; provided certain procedures are followed and
certain commitments are made. Our products and we are also subject to a variety
of state laws and regulations in those states or localities where our products
are or will be marketed. Any applicable state or local regulations may hinder
our ability to market our products in those states or localities. Manufacturers
are also subject to numerous federal, state and local laws relating to such
matters as safe working conditions, manufacturing practices, environmental
protection, fire hazard control and disposal of hazardous or potentially
hazardous substances. There can be no assurance that we will not be required to
incur significant costs to comply with such laws and regulations now or in the
future or that such laws or regulations will not have a material adverse effect
upon our ability to do business.
Third-Party Reimbursement
Successful sales of our products in the United States and other markets will
depend on the availability of adequate reimbursement from third-party payers.
In the United States, health care providers, such as hospitals and physicians
that purchase medical devices for treatment of their patients, generally rely
on third-party
13
payers to reimburse all or part of the costs and fees associated with the
procedures performed with these devices. Both public and private insurance
reimbursement plans are central to new product acceptance. For the U.S.
government, coverage and reimbursement decisions for patients eligible to
receive public health care benefits are made by the Health Care Financing
Administration ("HCFA"), which administers the U.S. Medicare and Medicaid
programs. The market for our products could be adversely affected by U.S.
legislation that reduces reimbursements under the cost reimbursement system for
the U.S. Medicare program. In certain circumstances, such as many procedures
involving PMMA cement, HCFA deems such procedures "approvable" and reimburses
the providers for such services. The U.S. Medicare inpatient reimbursement
system is a prospective reimbursement system whereby rates are set in advance,
fixed for a specific fiscal period, constitute full institutional payment for
the designated health service and generally do not vary with hospital treatment
costs. Medicare reimburses outpatient services based on a predetermined fee
schedule.
In addition, an increasing emphasis on managed care in the U.S. has placed,
and will continue to place, greater pressure on medical device pricing. While
we cannot predict the effect such changes may have on our business, the
announcement of such proposals could have a material adverse effect on our
ability to raise capital. In addition, the adoption of such proposals would
have a material adverse effect on our business, financial condition and results
of operations. Failure by hospitals and other users of our products to obtain
coverage or reimbursement from third-party payors or changes in governmental
and private third-party payors' policies toward reimbursement for procedures
employing our products would reduce demand for our products.
Member countries of the EU operate various combinations of centrally
financed health care systems and private health insurance systems. The relative
importance of government and private systems varies from country to country.
The choice of devices is subject to constraints imposed by the availability of
funds within the purchasing institution. Medical devices are most commonly sold
to hospitals or health care facilities at a price set by negotiation between
the buyer and the seller. A contract to purchase products may result from an
individual initiative or as a result of a competitive bidding process. In
either case, the purchaser pays the supplier, and payment terms vary widely
throughout the EU. Failure to obtain favorable negotiated prices with hospitals
or health care facilities could adversely affect sales of our products.
In Japan, at the end of the regulatory approval process, the Ministry of
Health and Welfare ("MHW") makes a determination of the reimbursement level of
the product. The MHW can set the reimbursement level for our products at their
discretion, and we may not be able to obtain regulatory approval in Japan or if
such approval is granted, we may not obtain a favorable per unit reimbursement
level.
Product Liability and Insurance
Our business involves the risk of product liability claims. While we have
not experienced any product liability claims to date, there can be no assurance
that product liability claims will not be asserted against our licensees or us.
Although we maintain product liability insurance in the annual aggregate amount
of up to $3 million, there can be no assurance that this coverage will be
adequate to protect us against future product liability claims. In addition,
product liability insurance is expensive and there can be no assurance that
product liability insurance will be available to us in the future on terms
satisfactory to us, if at all. A successful product liability claim or series
of claims brought against us in excess of our coverage could have a material
adverse effect on our business, financial condition and results of operations.
Employees
As of December 31, 1999, we had 50 full-time employees, consisting of eleven
persons in research and development activities, seventeen persons in
manufacturing, quality and facilities, three persons in clinical, medical and
regulatory affairs, seven persons in sales and marketing, eleven persons in
general and administrative functions, and one employee at our office in
Belgium. We had an average of 42, 33 and 53 employees in 1999, 1998 and 1997,
respectively. The increased number of employees from 1998 to 1999 is attributed
to our continued development of manufacturing, process technology and research
and development.
14
The decline in employment from 1997 to 1998 is a result of our greater reliance
on exclusive third-party strategic alliances, such as our alliance with 3i, and
a reduced reliance on a direct sales force.
Item 2. Properties
Our headquarters are located at the Great Valley Corporate Center, Malvern,
Pennsylvania, which is a suburb of Philadelphia. We conduct all of our
principal activities at two adjacent facilities that total 32,000 square feet,
and which are leased or have renewal options through February 2005. We also
have our international sales and marketing activities based in our
administrative office in Grez Doiceau, Belgium.
Item 3. Legal Proceedings
In May 1996, the University of Florida Research Foundation, Inc., U.S.
Biomaterials Corporation and Block Drug Corporation filed a complaint in the
U.S. District Court for the Northern District of Florida, against us, a
distributor of BIOGRAN, and our former Chairman. This action charged the
defendants with infringement of U.S. Patent No. 4,851,046, said to be assigned
to the University of Florida Research Foundation and said to be exclusively
licensed to U.S. Biomaterials Corporation. In April 1998, the court granted our
summary judgment motion stating that the BIOGRAN product does not infringe this
patent. The complaint also alleges false representation, unfair competition,
false advertising and trade disparagement under U.S. federal and Florida state
law and these complaints were settled with the Plaintiffs in September 1998.
During September 1998, the Plaintiffs filed with the U.S. Court of Appeals for
the Federal Circuit a request for an appeal of the U.S. District Court's
summary judgment with respect to the patent infringement claim. On October 6,
1999 the U.S. Court of Appeals entered an order affirming our motion for
summary judgment and dismissing a complaint for patent infringement. On January
4, 2000, the time period for filing a petition by the plaintiffs with the U.S.
Supreme Court expired; accordingly, this matter is considered to be finalized
in the United States.
Item 4. Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of security holders during the fourth
quarter of fiscal 1999.
PART II
Item 5. Market for Registrant's Common Equity and Related Shareholder Matters
The Common Stock of the Company is quoted on the European Association of
Securities Dealers Automated Quotation ("EASDAQ"). Our ticker symbol is "VITA".
The following table reflects the range of high and low closing prices for the
common stock as reported on the EASDAQ for the stated periods.
High Low
----- -----
First Quarter, 1999.............................................. $7.40 $4.00
Second Quarter, 1999............................................. 6.50 5.00
Third Quarter, 1999.............................................. 6.40 3.85
Fourth Quarter, 1999............................................. 6.25 4.30
As of December 31, 1999 there were 327 holders of record of our common
stock. On March 15, 2000, the last reported sale price of the common stock as
reported on the EASDAQ was $8.62 per share.
We have never declared or paid cash dividends on our capital stock and do
not anticipate paying any cash dividends in the foreseeable future.
15
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The following table presents selected historical consolidated financial data
that have been derived from the consolidated financial statements of Orthovita,
Inc. and subsidiaries as of and for each of the five years in the period ended
December 31, 1999 which have been audited by Arthur Andersen, LLP, independent
public accountants. This data should be read in conjunction with our
consolidated financial statements, including notes thereto, and "Management's
Discussion and Analysis of Financial Condition and Results of Operations,"
included in this document.
Year Ended December 31,
----------------------------------------------------------
1999 1998 1997 1996 1995
----------- ---------- ---------- ---------- ----------
Statement of Operations
Data:
Net revenues(1)......... $ 1,054,120 $2,780,658 $3,311,540 $1,860,326 $ 577,753
Cost of sales........... 324,590 927,792 1,096,848 887,236 695,998
Operating expenses...... 10,755,317 7,897,961 9,998,945 7,162,104 3,066,399
Other (income)
expenses............... (529,193) (344,307) 169,066 250,939 151,406
Extraordinary item--
(gain)................. -- -- (397,402) -- --
Accretion of preferred
stock.................. -- 391,213 536,517 -- --
----------- ---------- ---------- ---------- ----------
Net loss applicable to
common shareholders.... $ 9,496,594 $6,092,001 $8,092,434 $6,439,953 $3,336,050
=========== ========== ========== ========== ==========
Net loss per common
share, basic and
diluted................ $ 0.83 $ 0.73 $ 1.60 $ 1.60 $ 1.04
=========== ========== ========== ========== ==========
Shares used in computing
net loss per common
share, basic and
diluted................ 11,411,896 8,314,679 5,050,397 4,036,150 3,215,000
=========== ========== ========== ========== ==========
As of December 31,
-------------------------------------------------------------
1999 1998 1997 1996 1995
----------- ----------- ----------- ----------- -----------
Balance Sheet Data:
Cash, cash equivalents
and short-term
investments............ $ 8,873,545 $15,355,808 $ 2,257,902 $ 253,465 $ 762,678
Total assets............ 11,321,446 18,888,632 4,862,010 1,546,137 1,508,288
Working capital
(deficit).............. 4,118,730 14,471,102 (1,080,859) (3,140,323) (914,732)
Long-term debt.......... 616,726 737,427 832,991 1,588,539 1,645,374
Redeemable convertible
preferred stock........ -- -- 7,383,090 -- --
Total shareholders'
equity (deficit)....... 5,646,669 15,528,575 (7,712,696) (4,088,685) (2,145,693)
- --------
(1) Net revenues consist solely of sales of our BIOGRAN dental grafting
product. From product launch in 1994 until April 1998, we sold BIOGRAN
directly to our dental customers, and beginning in May 1998, we sold
BIOGRAN through our global distributor Implant Innovations, Inc. ("3i"). On
March 22, 2000, we sold the BIOGRAN dental grafting product line to 3i for
$3.9 million.
16
Item 7: Management's Discussion and Analysis of Financial Condition and Results
of Operations
Forward-Looking Statements
In addition to historical facts or statements of current conditions, this
report contains forward-looking statements. Forward-looking statements provide
our current expectations or forecasts of future events. These may include
statements regarding anticipated scientific progress in our research programs,
development of potential products, prospects for regulatory approval,
manufacturing capabilities, market prospects for our products, sales and
earnings projections and other statements regarding matters that are not
historical facts. Some of these forward-looking statements may be identified by
the use of words in the statements such as "anticipated," "estimate," "expect,"
"project," "intend," "plan," "believe," or other words and terms similar in
meaning. Our performance and financial results could differ materially from
those reflected in these forward-looking statements due to general financial,
economic, regulatory and political conditions affecting the biotechnology,
orthopaedic and medical device industries as well as more specific risks
discussed throughout this document. Given these risks and uncertainties, any or
all of these forward-looking statements may prove to be incorrect. Therefore,
you are cautioned not to place too much reliance on any such forward-looking
statements. Furthermore, we do not intend, and are not obligated to update
publicly any forward-looking statements, whether as a result of new
information, future events or otherwise. We claim the protections afforded by
the Private Securities Litigation Reform Act of 1995, as amended, for our
forward-looking statements.
Certain Risks Related to Our Business
We are dependent on the commercial success of CORTOSS Injectable and VITOSS
Scaffold.
Our success depends on obtaining regulatory approval for and successfully
launching our products. VITOSS Scaffold and CORTOSS Injectable, which are our
products furthest along in development, must be approved and successfully
launched during the next several years. To successfully commercialize our
products, our management team must rapidly execute our manufacturing, sales and
marketing plans. At the same time, our management team must manage anticipated
growth by implementing effective planning and operating processes. To manage
anticipated growth in operations, we may need to increase our manufacturing and
quality assurance staff, expand our manufacturing facility and expand our
marketing and distribution management staff. Our systems, procedures and
controls may not be adequate to support our expected growth in operations. If
we fail to manage our growth effectively, our business could suffer.
We are dependent on the commercial success of CORTOSS Injectable and VITOSS
Scaffold, and in particular:
-- the need to obtain their regulatory approval,
-- the need to develop at-scale manufacturing capability and capacity for
these products,
-- the need to build an effective sales and distribution network,
-- uncertainty of operating in international markets, and
-- the need for the market place to accept VITOSS and CORTOSS.
Each of these factors is described in more detail below.
We need to obtain regulatory approval.
The jurisdictions in which we will seek to market our bone substitutes will
regulate these products as medical devices. In most circumstances, we and our
distributors and agents must obtain various regulatory approvals and otherwise
comply with extensive regulations regarding safety, quality and efficacy
standards. These regulations vary from country to country, and the regulatory
review can be lengthy, expensive and uncertain. We may not ultimately obtain
the necessary regulatory approvals to market our products in any of
17
the targeted markets and any such regulatory approval may include significant
restrictions on the anatomic sites and types of procedures for which our
products can be used. In addition, we may be required to incur significant
costs in obtaining or maintaining our regulatory approvals. The regulatory
requirements in some of the jurisdictions where we currently intend to market
our products are outlined below.
Modification of our products or development of new products may require us
to conduct additional clinical trials for these new or modified products and to
revise our filings with the FDA, which is time consuming and expensive. If we
were not successful in obtaining a license or redesigning our product, our
business could suffer.
United States
Regulation by FDA. Pursuant to the U.S. Federal Food, Drug, and Cosmetic
Act (the "FFD&C Act"), the FDA regulates the clinical testing, manufacturing,
labeling, sale, distribution and promotion of medical devices. Before we may
market our products in the U.S., we generally must obtain from the FDA either
market clearance through a Section 510(k) premarket notification or premarket
approval through PMA application. In December 1999, we filed a 510(k) with the
FDA for VITOSS Scaffold, based on the data from our preclinical studies, and we
intend to file a 510(k) in 2000 with the FDA for CORTOSS Injectable on a
similar basis. There can be no assurance that the FDA will find either of our
applications acceptable or "substantially equivalent." If not, then we will
have to pursue the PMA regulatory path which would require the addition of data
from clinical trials. This would result in a significant delay in the receipt
of regulatory clearance from the FDA. In addition, there can be no assurance
that the data from such clinical trials would support the receipt of regulatory
clearance from the FDA.
European Union and Other International Markets
General. The introduction of our products in markets outside the U.S. will
also be subject to regulatory clearances in those jurisdictions, which may
impose substantial additional costs and burdens. International sales of medical
devices are subject to the regulatory requirements of each country. The
regulatory review process varies from country to country. Many countries also
impose product standards, packaging and labeling requirements and import
restrictions on devices. In addition, each country has our own tariff
regulations, duties and tax requirements. The approval by the foreign
government authorities is unpredictable and uncertain, and the necessary
approvals or clearances may not be granted on a timely basis, if at all. Delays
in receipt of, or failure to receive, such approvals or clearances, or the loss
of any previously received approvals or clearances, could substantially limit
our ability to market our products.
Requirement of CE marking in the EU. To market a product in the European
Union (the "EU"), we must be entitled to affix a CE marking, an international
symbol of adherence to quality assurance standards and compliance with
applicable European medical device directives. A CE marking allows us to market
a product in all of the member states of the EU. We intend to seek to obtain a
CE Mark from our notified body for the use of VITOSS Scaffold in metaphyseal
defects, based on the data from our preclinical studies, and we intend to seek
to obtain a CE Mark from our notified body for the use of CORTOSS Injectable in
screw augmentation and vertebroplasty supported by the data from the ongoing
clinical trials in Europe. There can be no assurance our notified body will
find any of our applications acceptable. We may be required to obtain
additional data from clinical trials for VITOSS Scaffold, which would result in
a significant delay in the receipt of the CE Mark for that product. In
addition, there can be no assurance that the data from any of our clinical
trials would support the receipt of the CE Mark by our notified body.
Requirement of MHW approval in Japan. In Japan, the approval of VITOSS
Scaffold and CORTOSS Injectable are likely to require clinical trials conducted
in Japan. Accordingly, we intend to seek a third party strategic alliance to
conduct such trials, obtain the necessary regulatory approvals and to market
our products in Japan. There can be no assurance that we will be successful in
entering into such an alliance or that, if successful, such third party will
succeed in conducting such clinical trials or in obtaining the necessary
regulatory approvals in Japan.
18
We need to develop at-scale manufacturing capability and capacity and we have
limited manufacturing experience.
We have limited manufacturing capacity and experience. Our future success is
dependent on our ability to manufacture our products in commercial quantities,
in compliance with regulatory requirements and in a cost-effective manner. In
order to do so we need to scale up our manufacturing processes and facilities.
There can be no assurance that we will be successful in scaling-up and
manufacturing our products in a cost-effective manner. The manufacture of our
products is subject to regulation and periodic inspection by various regulatory
bodies for compliance with GMP's, QSR's, ISO 9000 Series standards and
equivalent requirements. There can be no assurance that the regulatory
authorities will not, during the course of an inspection of existing or new
facilities, identify what they consider to be deficiencies in GMP's, QSR's or
other requirements and request, or seek, remedial action. Failure to comply
with such regulations or delay in attaining compliance may adversely affect our
manufacturing activities. We may not be able to obtain necessary regulatory
approvals or clearances to manufacture on a timely basis, if at all.
Our ability to manufacture VITOSS Scaffold and CORTOSS Injectable is
dependent on a limited number of specialty suppliers of certain raw materials.
The failure of a supplier to continue to provide us with these materials at a
price or quality acceptable to us, or at all, would have a material adverse
effect on our ability to manufacture these products. Although we believe that
we maintain good relationships with our suppliers, there can be no guarantee
that such supplies and services will continue to be available with respect to
our current and future commercialized products.
We need to build an effective sales and distribution network.
We currently do not have a distribution channel for our products in either
the U.S. or in Europe. We intend to build a distribution network of independent
distributors and agents in both the U.S. and Europe in order to market CORTOSS
Injectable and VITOSS Scaffold. The following describe the risks associated
with these efforts:
Any failure to build and manage our distributor organization may negatively
affect our potential market share and revenues. There are significant risks
involved in building and managing our distribution network, including the
failure to manage the development and growth of such a network, the failure to
adequately train both our employees and our outside sales agents and
distributors in the use and benefits of our products and the dependence on
outside agencies and distributors, over which we have limited or no control.
The amount and timing of resources that are devoted to the performance of
the contractual responsibilities by our distributors and agents will not be
within our control. There can be no assurance that third parties will perform
their obligations as expected, pay any required fees to us or market any
products under these agreements, or that we will derive any revenue from such
arrangements. Certain agreements may also permit these third parties to pursue
existing or alternative products in preference to our products. There can be no
assurance that our interests will continue to coincide with those of these
third parties or that they will not distribute products that could compete with
our products.
There are uncertainties when operating in international markets.
We intend to operate in international markets and a number of risks are
inherent in international operations. International sales and operations may be
limited or disrupted by the imposition of governmental controls, difficulties
in managing international operations, and fluctuations in foreign currency
exchange rates. The international nature of our business subjects us and our
representatives, agents and distributors to the laws and regulations of the
jurisdictions in which they operate, and in which our products are sold.
In Japan, the approval of VITOSS Scaffold and CORTOSS Injectable are likely
to require clinical trials. Accordingly, we intend to seek a third party
strategic alliance to conduct such trials, obtain the necessary regulatory
approvals and to market our products in Japan. There can be no assurance that
we will be successful in entering into such an alliance or that, if successful,
such third party will succeed in marketing our products in Japan.
19
The market place may not accept any of our products.
Because the markets for our products are new and evolving, we cannot
accurately predict either the future growth rate, if any, or the ultimate size
of these markets. Physicians will not use our products unless they determine,
based on experience, clinical data and recommendations from prominent
physicians and mentors, that our products are safe and effective. In addition,
physicians tend to be slow to change their medical treatment practices because
of perceived liability risks arising from the use of new products and the
uncertainty of third party reimbursement for our products.
We may fail to gain market acceptance for our products, as a result of:
. our dependence on the continued publication of independent pre-clinical
and clinical data to support the use of our products;
. our failure to train a sufficient number of physicians to create demand
for our products;
. the refusal of payors to authorize insurance reimbursement for
procedures using our products.
Physicians and payors may not support the use of our products because there
is only limited preclinical or clinical data to support their effectiveness.
Our products are based on new technologies which have not been previously used
and must compete with more established treatments currently accepted as the
standards of care. Market acceptance of our products will largely depend on our
ability to demonstrate their relative safety, efficacy, cost-effectiveness and
ease of use. We expect our initial product sales to be made to a group of early
adopting physicians. Further sales may require us to convince physicians who
currently favor existing techniques to switch to our products or to new
procedures that would use our products. Many physicians will not purchase our
products until there is sufficient, long-term clinical evidence to convince
them to alter their existing treatment methods. In addition, some payors
require the publication of peer reviewed clinical data before authorizing
payment. We believe that recommendations and endorsements by physicians will be
essential for market acceptance of our products, and we are not certain that
any such recommendations or endorsements can be obtained. There has been no
published clinical data for our products. Thus, continued publication of
positive clinical data and longer-term patient follow-up are necessary for us
to achieve significant sales growth.
Any failure in our physician training efforts could also significantly
reduce adoption rates. It is critical to the success of our sales effort to
train a sufficient number of physicians and to provide them adequate
instruction in the use of our products. We will rely on physicians to spend
their time and money to attend our training sessions. If physicians are not
properly trained they may misuse or ineffectively use our products. This may
result in unsatisfactory patient outcomes, patient injury, negative publicity
or lawsuits against us, any of which could have an adverse effect on our
product sales.
Successful sales of our products in the United States and other markets will
depend on the availability of adequate reimbursement from third-party payers.
In the United States, health care providers, such as hospitals and physicians
that purchase medical devices for treatment of their patients, generally rely
on third-party payers to reimburse all or part of the costs and fees associated
with the procedures performed with these devices. Both public and private
insurance reimbursement plans are central to new product acceptance. For the
U.S. government, coverage and reimbursement decisions for patients eligible to
receive public health care benefits are made by the Health Care Financing
Administration ("HCFA"), which administers the U.S. Medicare and Medicaid
programs. The market for our products could be adversely affected by U.S.
legislation that reduces reimbursements under the cost reimbursement system for
the U.S. Medicare program. In certain circumstances, such as many procedures
involving PMMA cement, HCFA deems such procedures "approvable" and reimburses
the providers for such services. The U.S. Medicare inpatient reimbursement
system is a prospective reimbursement system whereby rates are set in advance,
fixed for a specific fiscal period, constitute full institutional payment for
the designated health service and generally do not vary with hospital treatment
costs. Medicare reimburses outpatient services based on a predetermined fee
schedule.
20
In addition, an increasing emphasis on managed care in the U.S. has placed,
and will continue to place, greater pressure on medical device pricing. While
we cannot predict the effect such changes may have on our business, the
announcement of such proposals could have a material adverse effect on our
ability to raise capital. In addition, the adoption of such proposals would
have a material adverse effect on our business, financial condition and results
of operations. Failure by hospitals and other users of our products to obtain
coverage or reimbursement from third-party payors or changes in governmental
and private third-party payors' policies toward reimbursement for procedures
employing our products would reduce demand for our products.
Member countries of the EU operate various combinations of centrally
financed health care systems and private health insurance systems. The relative
importance of government and private systems varies from country to country.
The choice of devices is subject to constraints imposed by the availability of
funds within the purchasing institution. Medical devices are most commonly sold
to hospitals or health care facilities at a price set by negotiation between
the buyer and the seller. A contract to purchase products may result from an
individual initiative or as a result of a competitive bidding process. In
either case, the purchaser pays the supplier, and payment terms vary widely
throughout the EU. Failure to obtain favorable negotiated prices with hospitals
or health care facilities could adversely affect sales of our products.
In Japan, at the end of the regulatory approval process, the MHW makes a
determination of the reimbursement level of the product. The MHW can set the
reimbursement level for our products at their discretion, and we may not be
able to obtain regulatory approval in Japan or if such approval is granted, we
may not obtain a favorable per unit reimbursement level.
We have a history of operating losses and need to raise additional capital
that may not be available in the future.
We have experienced negative operating cash flows since our inception. We
plan to continue to spend substantial funds for clinical trials in support of
regulatory and reimbursement approvals, research and development, and the
establishment of our commercial scale manufacturing capabilities and in support
of potential product launch. Factors which may cause our future capital
requirements to be greater than anticipated include the extent to which
unforeseen developments arise with our clinical trials, timing of regulatory
approval, research and development or manufacturing activities, market
acceptance of our products, the acquisition and defense of intellectual
property rights or the development of strategic alliances for the marketing of
certain of our products. We believe our existing cash as of December 31, 1999
together with the cash generated from the closing of the BIOGRAN sale will be
sufficient to meet our currently estimated operating and capital requirements
through at least December 31, 2000. We will need to obtain additional funds
through equity or debt financings, strategic alliances with third parties or
from other sources. Any such required financing may not be available on
satisfactory terms, if at all. The sale of additional equity or convertible
debt securities would result in additional dilution to our shareholders. If
additional funds are raised through the issuance of debt securities, these
securities could have certain rights senior to holders of common stock, and
could contain covenants that would restrict our operations. Any additional
financing may not be available in amounts or on terms acceptable to us, if at
all. If adequate financing is not available, we may be required to delay, scale
back or eliminate certain operations.
We have incurred substantial operating losses since our inception and, at
December 31, 1999, had an accumulated deficit of approximately $36.4 million.
These losses have resulted principally from expenses required to be incurred
before we can begin marketing our products, including the development and
patenting of our technologies, preclinical and clinical studies, preparation of
submissions to the FDA and foreign regulatory bodies, and the development of
sales, marketing and manufacturing capabilities. We expect to continue to incur
significant operating losses in the future as we continue our product
development efforts, expand our marketing and sales activities and further
develop our manufacturing capabilities.
We may never become profitable. Our future sales of product from our
synthetic cortical and cancellous bone technology platforms, if any, may not
grow, and we may not be able to achieve or maintain profitability in the
future.
21
Our results of operations may fluctuate significantly in the future as a
result of a number of factors, many of which are outside of our control. These
factors include, but are not limited to, the timing of governmental approvals,
unanticipated events associated with clinical and preclinical trials, the
medical community's acceptance of our products, the success of competitive
products, our ability to enter into strategic alliances with other companies,
expenses associated with development and protection of intellectual property
matters, establishment of commercial scale manufacturing capabilities, and the
timing of expenses related to commercialization of new products. The results
of our operations may fluctuate significantly from quarter to quarter and may
not meet expectations of securities analysts and investors.
Our success depends significantly on our ability to protect our proprietary
rights to the technologies used in our products.
General. Our success will depend in part on our ability to protect our
proprietary technology and we rely on patent protection, as well as a
combination of copyright, trade secret and trademark laws, and nondisclosure
and confidentiality agreements and other contractual restrictions to do so.
However, these legal means afford only limited protection and may not
adequately protect our rights or permit us to gain or keep any competitive
advantage. For example, our patents that have been issued may be challenged,
invalidated or circumvented by third parties. In addition, while we have
received notices of allowance with respect to some patent claims for certain
of our products, our patent applications and the notices of allowance we have
received, may not issue as patents in a form that will be advantageous to us.
Our patents and applications cover particular aspects of our products and
technology. There may be more effective technologies, designs or methods. If
the most effective treatment method is not covered by our products or
applications, it could have an adverse effect on any product sales. If we lose
any key personnel, we may not be able to prevent the unauthorized disclosure
or use of our technical knowledge or other trade secrets by those former
employees. Furthermore, the laws of foreign countries may not protect our
intellectual property rights to the same extent as the laws of the U.S.
Finally, even if our intellectual property rights are adequately protected,
litigation may be necessary to enforce our intellectual property rights, which
could result in substantial costs to us and result in a substantial diversion
of management attention. If our intellectual property is not adequately
protected, our competitors could use the intellectual property that we have
developed to enhance their products and compete more directly with which could
result in a decrease in our market share.
Intellectual Property Rights of Others. We may be sued for violating the
intellectual property rights of others. While we attempt to ensure that our
products do not infringe other parties' patents and proprietary rights, our
products may infringe. Whether a product infringes a patent involves complex
legal and factual issues, the determination of which is, in many cases, not
certain. In addition, because patent applications can take many years to
issue, there may be applications now pending of which we are unaware, which
may later result in issued patents that our products may infringe. There could
also be existing patents that one or more of our products may inadvertently be
infringing of which we are unaware. As the number of competitors in the
markets for minimally invasive treatment of spinal, trauma and joint disorders
grows, the possibility of a patent infringement claim against us increases.
There is a substantial amount of litigation over patent and other intellectual
property rights in the medical device industry generally and in the spinal
market segments particularly. Infringement and other intellectual property
claims, whether with or without merit, can be expensive and time-consuming to
litigate and divert management attention from our core business. Our products
may be covered by U.S. patents held by our competitors. We have made a careful
analysis in consultation with our experts and, based on such analysis, we
believe that either such patents or claims are invalid or if valid we do not
infringe. If the holder of patents brought an infringement action against us,
the cost of litigating the claim could be substantial. In addition, if the
relevant patent claims were upheld as valid and enforceable and our products
were found to infringe the patent, we could be prevented from selling the
relevant product unless we could obtain a license from the owner of the patent
or were able to redesign our product to avoid infringement. A license may not
be available or if available may be on terms unacceptable to us, or we may not
be successful in any attempt to redesign our products to avoid any
infringement.
22
In addition, to determine the priority of inventions, we may have to
participate in interference proceedings declared by the U.S. Patent and
Trademark Office or in opposition, nullity or other proceedings before foreign
agencies with respect to any of our existing patents or patent applications or
any future patents or applications, which could result in substantial cost to
us. Further, we may have to participate at substantial cost in International
Trade Commission proceedings to abate importation of goods that would compete
unfairly with our products.
Company Patents. We intend to file applications as appropriate for patents
covering our technologies, products and processes. As of March 24, 2000, we own
or control six issued U.S. patents, six pending patent applications in the
United States and numerous counterparts of certain of these patents and pending
patent applications in Europe and Japan. There can be no assurance that patents
will issue from any of the pending patent applications. Since patent
applications in the United States are maintained in secrecy until issued, and
since publication of discoveries in the scientific or patent literature tends
to lag behind actual discoveries, we cannot be certain that we or any of our
licensors were the first creator of inventions covered by pending patent
applications or that we or any of our licensors were the first to file patent
applications for such inventions. Further, there can be no assurance that the
claims allowed under any issued patents will be sufficiently broad as to
protect our proprietary position in the technology. In addition, there can be
no assurance that any patents issued to us or any of our licensors will not be
challenged, invalidated or circumvented, or that the rights granted thereunder
will provide commercially useful competitive advantages to us.
Ownership of Patents. Certain of the patents and patent applications in our
patent portfolio are not owned by us, but are licensed from third parties under
license agreements which give us exclusive rights for the commercial
exploitation of the patents, subject to certain provisions of the license
agreements. Failure to comply with these provisions could result in the loss of
our rights under these agreements.
Enforceability of Patents. Under Title 35 of the United States Code as
amended by the General Agreement on Tariffs and Trade implementing the Uruguay
Round Agreement Act of 1994, ("GATT"), patents that issue from patent
applications filed on or prior to June 8, 1995, will enjoy a 17-year period of
enforceability as measured from the date of patent issue or a 20-year period of
enforceability as measured from the earliest effective date of filing,
whichever is longer. Patents that issue from applications filed on or after
June 8, 1995, will enjoy a 20-year period of enforceability as measured from
the date the patent application was filed or the first claimed priority date,
whichever is earlier. Patents that issue from applications filed on or after
June 8, 1995, may be extended under the term extension provisions of GATT for a
period up to five years to compensate for any period of enforceability lost due
to interference proceedings, government secrecy orders or appeals to the Board
of Patent Appeals or the Federal Circuit. Under the Drug Price Competition and
Patent Term Restoration Act of 1984, including amendments implemented under
GATT (the "Patent Term Restoration Act"), the period of enforceability of a
first or basic product patent or use patent may be extended for up to five
years to compensate the patent holder for the time required for FDA regulatory
review of the product. This law also establishes a period of time following FDA
approval of certain applications during which the FDA may not accept or approve
applications for similar or identical products from other sponsors. Any
extension under the Patent Term Restoration Act and any extension under GATT
are cumulative. There can be no assurance that we will be able to take
advantage of such patent term extensions or marketing exclusivity provisions of
these laws, either as now constituted or as they may be changed by any future
legislation, or that such extensions will adequately restore the time lost to
the FDA approval process. Furthermore, the possibility of shorter terms of
patent protection, combined with the lengthy FDA review process and possibility
of extensive delays in such process, could effectively further reduce the term
during which a marketed product could be protected by patents.
23
Trade Secrets and Know-how. We also rely on trade secrets and proprietary
know-how that we seek to protect, in part, by confidentiality agreements with
our corporate partners, collaborators, employees and consultants. There can be
no assurance that these agreements will not be breached, that we would have
adequate remedies for any breach, or that our trade secrets will not otherwise
become known or be independently discovered by competitors.
FBFC Patent Challenge. On July 23, 1994, U.S. Biomaterials Corporation filed
with the U.S. Patent and Trademark Office a Request for Reexamination of the
FBFC U.S. Patent which provides patent protection in the U.S. for BIOGRAN. This
patent has now been assigned to 3i who purchased the BIOGRAN product line in
March 2000. FBFC filed a response in this proceeding, establishing that the
claims of the FBFC Patent were properly allowed. As a result, a Certificate of
Reexamination was issued by the U.S. Patent and Trademark Office confirming the
patentability of all claims of the FBFC Patent without amendment. However, U.S.
Biomaterials Corporation also instituted a nullification proceeding against the
European counterpart to the FBFC U.S. Patent. The opposition division of the
European Patent Office tentatively decided in FBFC's favor, but the matter is
still proceeding under an appeal. In connection with the BIOGRAN sale to 3i, 3i
has assumed control of this matter and we have agreed to reimburse for the
associated legal costs and to provide them with certain indemnification with
respect to the matter.
The orthopaedic market is highly competitive.
Extensive research efforts and rapid technological change characterize the
market for bone substitutes and cements in the orthopaedic market. We
anticipate that we will face intense competition from medical device, medical
products and pharmaceutical companies. Our products could be rendered
noncompetitive or obsolete by technological advances made by our current or
potential competitors. There can be no assurance that we will be able to
respond to technological advances through the development and introduction of
new products. Moreover, many of our existing and potential competitors have
substantially greater financial, marketing, sales, distribution, manufacturing
and technological resources than us. Such existing and potential competitors
may be in the process of seeking FDA or other regulatory approvals, or patent
protection, for their respective products or they may have such approvals. They
may also enjoy substantial advantages over us in terms of research and
development expertise, experience in conducting clinical trials, experience in
regulatory matters, manufacturing efficiency, name recognition, sales and
marketing expertise or the development of distribution channels. The attributes
of our products may cause some changes in surgical techniques that have become
standard within the medical community, and there may be resistance to change.
In addition, such competitors may obtain regulatory approval and introduce or
commercialize competing products in advance of our products.
We may be sued in a product liability action.
We manufacture medical devices that are used on patients in surgery, and we
may be subject to a product liability lawsuit. In particular, the market for
spine products has a history of product liability litigation. Any product
liability claim brought against us, with or without merit, could result in the
increase of our product liability insurance rates or the inability to secure
coverage in the future. In addition, we would have to pay any amount awarded by
a court in excess of policy limits. Although we maintain product liability
insurance in the annual aggregate amount of up to $3 million, our insurance
policies have various exclusions. Thus, we may be subject to a product
liability claim for which we have no insurance coverage, in which case we may
have to pay the entire amount of any award. Even in the absence of a claim, our
insurance rates may rise in the future to a point where we decide not to carry
this insurance. Finally, even a meritless or unsuccessful product liability
claim would be time-consuming and expensive to defend and could result in the
diversion of management's attention from our core business.
Our business could suffer if we cannot attract and retain the services of key
employees.
We depend substantially upon the continued service and performance of our
existing executive officers. We rely on our key personnel in formulating and
implementing our product research, development and
24
commercialization strategies. Our success will depend in large part on our
ability to attract and retain highly skilled employees. We compete for such
personnel with other companies, academic institutions, government entities and
other organizations. We may not be successful in hiring or retaining qualified
personnel. If one or more of our key employees resigns, it could harm our
business. If we lose any key personnel, we may not be able to prevent the
unauthorized disclosure or use of our technical knowledge or other trade
secrets by those former employees. Other than employment agreements with David
S. Joseph, our Chairman and Chief Executive Officer, Bruce A. Peacock, our
President and Chief Operating Officer and Dr. Erik M. Erbe, our Vice President,
Research and Development, we have not entered into any employment agreements
with any of our executive officers.
Other risks.
We may issue preferred stock as an anti-takeover provision.
Certain provisions of Pennsylvania law could make it more difficult for a
third party to acquire us, or could discourage a third party from attempting to
acquire us. These provisions could limit the price that certain investors might
be willing to pay in the future for shares of our common stock. In addition,
our Board of Directors may issue shares of preferred stock without your
approval on such terms and conditions, and the preferred stock may have its
rights, privileges and preferences determined by the Board of Directors at that
time. The rights of the holders of any preferred stock that may be issued in
the future may adversely affect your rights as a holder of common stock. We
have no current plans to issue any shares of preferred stock.
Our executive officers and directors own a large percentage of our voting
stock and could exert significant influence over matters requiring shareholder
approval.
Our executive officers and directors own approximately 23.4% of our
outstanding common stock. In addition, one of our directors controls an
additional 6.9% of our outstanding common stock through the fund he manages.
Accordingly, these shareholders may, as a practical matter, be able to exert
significant influence over matters requiring approval by our shareholders,
including the election of directors and the approval of mergers or other
business combinations. This concentration could have the effect of delaying or
preventing a change in control. Our certificate of incorporation, our bylaws
and Pennsylvania law contains provisions that could discourage a takeover.
Provisions of our certificate of incorporation, bylaws and Delaware law may
discourage, delay or prevent a merger or acquisition that a shareholder may
consider favorable.
We have not and do not intend to pay any dividends.
We have never declared nor paid dividends on our capital stock. We currently
intend to retain any future earnings for funding growth and, therefore, do not
intend to pay any cash dividends in the foreseeable future.
Our stock price is highly volatile.
Our stock price, like that of many early stage medical technology companies,
may be volatile. In general, equity markets, including EASDAQ, have from time
to time experienced significant price and volume fluctuations that are
unrelated to the operating performance of particular companies or existing
economic conditions. These broad market fluctuations may adversely affect the
market price of our common stock. Factors such as fluctuations in our results,
under performance in relation to analysts' estimates, changes in stock market
analyst recommendations regarding our stock, announcements of technological
innovations or new products by us or our competitors, FDA and international
regulatory actions, actions with respect to reimbursement matters, developments
with respect to patents or proprietary rights, public concern as to the safety
of products developed by us or by others, changes in health care policy in the
United States and internationally, business conditions affecting other medical
device companies or the medical device industry generally, and general market
conditions may cause the market price of our common stock to be highly volatile
or to be significantly adversely effected.
25
If our future quarterly operating results are below the expectations of
securities analysts or investors, the price of our common stock would likely
decline. Stock price fluctuations may be exaggerated if the trading volume of
our common stock is low.
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 our
initial public offering. Cash, cash equivalents and short-investments decreased
42% from December 31, 1998 to 1999 due to the use of the proceeds for operating
spending. As of December 31, 1999 and 1998 cash, cash equivalents and
investments consisted of the following:
Gross Unrealized
Unrealized Gross Fair Market
Original Cost Gains Losses Value
------------- ---------- ---------- -----------
December 31, 1999:
Cash and cash equivalents..... $ 2,487,343 $ -- $ -- $ 2,487,343
Short-term investments........ 6,446,469 -- (60,267) 6,386,202
----------- -------- -------- -----------
$ 8,933,812 $ -- $(60,267) $ 8,873,545
=========== ======== ======== ===========
Percentage of total assets.... 78.4%
===========
December 31, 1998:
Cash and cash equivalents..... $ 842,064 $ -- $ -- $ 842,064
Short-term investments........ 14,414,394 106,882 (7,532) 14,513,744
----------- -------- -------- -----------
$15,256,458 $106,882 $ (7,532) $15,355,808
=========== ======== ======== ===========
Percentage of total assets.... 81.3%
===========
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:
Year Ended December 31,
--------------------------------------
1999 1998 1997
----------- ------------ -----------
Net cash used in operating
activities........................... $(7,460,787) $ (6,335,509) $(7,588,532)
Net cash provided by (used in)
investing activities................. 7,614,061 (14,525,341) (413,939)
Net cash provided by financing
activities........................... 1,472,122 19,407,435 10,008,992
Changes in comprehensive income....... 19,883 37,577 (2,084)
----------- ------------ -----------
Net change in cash and cash
equivalents.......................... $ 1,645,279 $ (1,415,838) $ 2,004,437
=========== ============ ===========
Net Cash Used in Operating Activities
Operating Cash Inflows--
The principal source of our current operating cash inflows has been derived
from sales of BIOGRAN product and interest income on short-term investments.
Additionally in January 1999, we received a one-time reimbursement of patent
defense costs of $474,580 under the Release and Termination Agreement with
FBFC.
Operating Cash Outflows--
Our cash outflows were primarily used for development and pre-clinical
activities in preparation for regulatory filings of potential products. In
addition, funds have been used for the leasing and fit-up of expanded
facilities and the hiring and training of additional employees.
26
Operating Cash Flow Requirements Outlook--
On March 22, 2000, we sold our BIOGRAN dental grafting product line to
Implant Innovations, Inc. ("3i") for $3.9 million. We continued to supply
BIOGRAN under the terms of our global distribution agreement with 3i prior to
the closing and have associated net product revenue. After the closing of the
sale agreement, we will have no product revenues derived from the sale of
BIOGRAN.
We expect operating cash outflows to continue to be driven by the expansion
of our product development efforts. During the second quarter of 1999, we were
cleared to begin clinical trials in Europe for the use of CORTOSS Injectable in
spinal fractures due to osteoporosis and for our use in screw augmentation
procedures. We also intend to seek clearance to begin clinical studies in the
U.S. We expect our cash requirements to increase significantly due to efforts
associated with the clinical trials as well as due to pre-commercial launch
activities in the U.S. and Europe. We expect our cash flow from operating
activities to continue to be negative until such time, if any, as regulatory
clearances for our products are obtained and revenue received from product
sales exceeds funding of operating costs. The timing of such events is
dependent upon a number of variables outside of our control.
Net Cash Provided By Investing Activities
We have invested $354,000, $111,000 and $414,000 for the years ended
December 31, 1999, 1998 and 1997, respectively in the purchase of property and
equipment for the expansion of our product development capabilities. In
addition during the twelve months ended December 31, 1999 and 1998, $8.0
million was provided by the net sale of investment quality marketable
securities and $14.4 million was used in the net purchase of investment quality
marketable securities, respectively.
Investing Cash Outlook--
In order to provide funds for operations, we expect to continue to sell
marketable securities. We expect that our use of cash for the purchase of
property and equipment for 2000 may increase in comparison to that of prior
periods as we scale-up manufacturing capacity for CORTOSS Injectable and VITOSS
Scaffold. We have approximately $882,000 remaining on an existing capital lease
line for use in funding the equipment necessary for the expansion of our
development and manufacturing facilities. The timing of such expansion is
dependent upon a number of variables outside of our control and include the
timing of regulatory clearances for marketing of our future products, the rate
of market acceptance and growth of product sales, and the lead times required
to bring additional manufacturing capacity on line.
Net Cash Provided By Financing Activities
In December 1999, we borrowed $2.0 million on a line of credit with our Bank
that was repaid in January 2000.
During the year ended 1999, stock options and warrants to purchase 106,072
shares of common stock were exercised resulting in proceeds of $352,380. In
addition during 1999, 2,732 shares of common stock were issued under our
Employee Stock Purchase Plan raising $11,831.
Our board of directors has approved a program to repurchase up to $1,000,000
worth of our common stock in open market transactions. The program is subject
to specific market conditions and other factors, on the EASDAQ exchange or in
negotiated transactions. Repurchases are made from time to time depending upon
the market price of our common stock and other circumstances. We do not expect
to make significant repurchases in 2000. During 1999, we repurchased 72,000
shares of common stock at an aggregate cost of $349,640, or approximately $4.86
per share.
27
Financing Requirements Outlook
We expect to continue to use cash and investments to fund operating and
investing activities. We plan to continue to spend substantial funds for
clinical trials in support of regulatory and reimbursement approvals, research
and development and establishment of commercial scale manufacturing
capabilities. We believe existing cash, together with the cash generated from
the closing of the BIOGRAN asset sale agreement with 3i will be sufficient to
meet our currently estimated operating and capital requirements through at
least December 31, 2000. Our future capital requirements will depend upon
numerous factors, including the extent to which unforeseen clinical,
regulatory, manufacturing or sales and marketing difficulties arise or to which
our products gain market acceptance, the acquisition and defense of
intellectual property rights, the development of strategic alliances for the
marketing of certain of our products, and other competitive developments. In
addition, although we have no present commitments or understandings, we may
seek to expand our operations and product line via acquisitions or joint
ventures and any such acquisitions or joint ventures may increase our capital
requirements. We will need to obtain additional funds through equity or debt
financings, strategic alliances with third parties or from other sources. This
activity will result in substantial dilution to the holders of common stock or
significant financial or operational restrictions. Any such required financing
may not be available on satisfactory terms, if at all.
Results of Operations
This section should be read in conjunction with the more detailed discussion
under "Liquidity and Capital Resources." And as described therein, we expect to
continue to incur significant operating losses in the future as we continue our
product development efforts, expand our marketing and sales activities and
further develop our manufacturing capabilities.
Comparison of the Year Ended December 31, 1999 to the Year Ended December 31,
1998
Net Revenues. Net revenues for the year ended December 31, 1999 were $1.1
million, compared to $2.8 million for the year ended December 31, 1998. Product
revenues for 1999 reflect sales to 3i at a transfer price equal to 50% of 3i's
sales price to its retail customers. For the same period in 1998, revenues
reflect our direct sales to customers through April plus the contract minimum
sales to 3i for the period May through September 1998. Under the global
distribution agreement we entered into with 3i, such sales to 3i in 1998
exceeded the rate of product re-sale by 3i to its customers and resulted in
product inventory at 3i. In 1999, 3i fulfilled the balance of its 1998 minimum
BIOGRAN purchase commitments that were deferred to 1999 and purchased an
additional $250,000 of BIOGRAN. 3i had no contracted purchase minimums during
1999.
Gross Profit. Our gross profit for the year ended December 31, 1999 was
$730,000, or 69% of net revenues, compared to $1.9 million, or 67% of net
revenues, for 1998.
Operating Expenses. Operating expenses for the year ended December 31, 1999
were $10.8 million compared to $7.9 million for the prior year. The increase in
general and administrative expenses year-over-year is primarily a result of an
increase in the number of employees during 1999 and a one-time $900,000
reimbursement during 1998 of patent litigation fees which was netted against
our expenses. Selling and marketing expenses decreased year-over-year as a
result of the elimination of the direct dental sales force when we entered into
our global distribution arrangement for BIOGRAN with 3i. The increase from 1998
to 1999 in research and development expenses is attributable to the expanded
development of our product pipelines and pre-clinical and clinical activities
of CORTOSS Injectable for vertebroplasty and screw augmentation in Europe.
Other Income (Expense). Other income (expense), includes interest expense,
interest income and, for 1998, currency translation losses. We recorded
$529,000 of other net income for the year ended December 31, 1999 compared to
$344,000 of other net income for the year ended December 31, 1998. The increase
in net income between 1998 and 1999 is attributed to higher average cash
balances from our June 1998 initial public offering.
28
Net Loss. As a result of the foregoing factors, our net loss for the year
ended December 31, 1999 was $9.5 million compared to a net loss of $6.1 million
for 1998.
Comparison of the Year Ended December 31, 1998 to the Year Ended December 31,
1997
Net Revenues. Net revenues for the year ended December 31, 1998 were $2.8
million compared to $3.3 million for the year ended December 31, 1997. This
decrease was a result of our 3i agreement reached in 1998 that sets our selling
price per unit at 50% of 3i's average selling price per unit to their
customers. In 1997, we sold BIOGRAN directly to customers. We actually shipped
19% more BIOGRAN units in 1998 in comparison to 1997.
Gross Profit. Gross profit for the year ended December 31, 1998 was $1.9
million, or 67% of net revenues, compared to $2.2 million, or 67% of net
revenues, for the prior year. We realized significant BIOGRAN manufacturing
cost reductions in 1998 when we consolidated our BIOGRAN manufacturing
operation into the U.S. The manufacturing cost reductions enabled us to
maintain our gross profit margins percentage on BIOGRAN net product revenues in
1998 as compared to 1997 even as we reduced our average selling price per unit
to 50% of 3i's average selling price per unit to their customers.
Operating Expenses. Operating expenses for the year ended December 31, 1998
were $7.9 million compared to $10.0 million for the prior year. While our
arrangement with 3i has lowered our revenues, this alliance has allowed us to
decrease our sales and marketing expenses by $1.4 million for the year ending
December 31, 1998 as compared to 1997. Additionally there were decreases in
general and administrative expenses of $1.5 million and partially offset by an
increase in research and development of $778,000. We attribute the decreases in
general and administrative expenses to lower expenses relating to patent
litigation expenses associated with the BIOGRAN patent matter and reimbursement
of those expenses from FBFC. In addition, we received reimbursement from our
insurance company related to the BIOGRAN patent matter. In 1998, the Company
recorded $900,000 as an offset to general and administrative expense relating
to insurance proceeds and reimbursement from FBFC related to the BIOGRAN patent
matter. Increases in research and development expenses are attributed to
expenses incurred in preclinical activities in preparation for regulatory
filings.
Other Income (Expense). Other income (expense), include interest expense,
interest income and currency translation losses. We recorded $344,000 of other
income for the year ended December 31, 1998 compared to $169,000 of other
expense for the year ended December 31, 1997. In 1998, we realized net interest
income as a result of the investment of the initial public offering in June
1998. In 1997, the Company recorded a currency translation loss of $203,000
from the impact of exchange rate changes on intercompany balances.
Extraordinary Gain. In 1997, we recorded an extraordinary gain of $397,000
when we were relieved of certain debt owing to the Flemish government upon our
election not to pursue the commercialization of one of the dental products
licensed from FBFC.
Net Loss. As a result of the foregoing factors, our net loss for the year
ended December 31, 1998 was $6.1 million compared to a net loss of $8.1 million
for the prior year.
Commitments and Contingencies
We lease office space and equipment under non-cancelable operating leases.
For the years ended December 31, 1999, 1998 and 1997, lease expense was
$305,000, $213,000 and $164,000, respectively. As of December 31, 1999, future
minimum rent payments through the expiration of these leases are $321,000 in
2000, $166,000 in 2001, $19,000 in 2002 and $12,000 in 2003.
Subsequent Events
On March 22, 2000, we completed the sale of our BIOGRAN dental grafting
product line to 3i, a Biomet Company, for $3.9 million. 3i has been our
worldwide distributor for BIOGRAN since April 1998.
29
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Foreign Currency Risk
The functional currency for our Belgian branch is the Belgian franc.
Accordingly, 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. The Belgian manufacturing facility was closed during
December 1997 and subsequently the amount of expense incurred during 1999 and
1998 in Belgium has been minor. A significant fluctuation in the exchange rate
between the Belgian Franc and the U.S. Dollar would not have a significant
effect on our results of operations. Since entering the global distribution
agreement with 3i on April 28, 1998, all product revenue was a result of
domestic sales to 3i and therefore there is no significant foreign currency
gain or loss for the years ended December 31, 1999 and 1998.
Market Risk
We are 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.
As of December 31, 1999 and 1998, our investments consisted primarily of
commercial paper, United States government agency bonds and high credit quality
corporate bonds. We estimate that if the average yield of our investment
portfolio decreased by 100 basis points, interest income for the year ended
December 31, 1999 would have decreased by approximately $185,000 during the
year. This estimate assumes that the decrease occurred on the last day of each
month during the years and reduced the yield of each investment instrument by
100 basis points. The impact on the Company's future interest income and future
changes in investment yields will depend on the gross amount of the Company's
investments and various external economic factors. See Item 7--"Management's
Discussion and Analysis of Financial Condition and Results of Operations--
Liquidity and Capital Resources".
Item 8. Financial Statements Supplemental Data
The consolidated financial statements of the Company and its subsidiaries
and supplementary data required by this item are attached to this annual
statement on Form 10-K beginning on page F-1.
Item 9. Change in and Disagreements with Accountants on Accounting and
Financial Disclosures
None.
PART III
Item 10. Directors and Executive Officers of the Registrant
The information concerning directors and compliance with Section 16(a) of
the Securities Exchange Act of 1934 called for by Item 10 of Form 10-K will be
set forth under the captions "Nominees for the Board of Directors" and "Section
16(a) Beneficial Ownership Reporting and Compliance" in our definitive proxy
statement, to be filed within 120 days after the end of the fiscal year covered
by this annual report on Form 10-K, and is incorporated herein by reference.
Item 11. Executive Compensation
See Item 12.
30
Item 12. Security Ownership of Certain Beneficial Owners and Management
The information called for by Items 11 and 12 of Form 10-K will be set forth
under the captions "Executive Compensation: Report of the Compensation
Committee," "Summary Compensation Table," and "Holders of 5% or more and
Directors and Officers' Ownership of Orthovita, Inc. Stock," respectively, in
our definitive proxy statement, to be filed within 120 days after the end of
the fiscal year covered by this annual report on Form 10-K, and is incorporated
herein by reference.
Item 13. Certain Relationships and Related Transactions
None.
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.
(a) 1. Financial Statements Financial Statements beginning on page F-2 are
filed as part of this annual report on Form 10-K.
2. Financial Statement Schedules Financial Statement Schedules beginning
on page F-2 are filed as part of this annual report on Form 10-K.
3. Exhibits. (see (c) below).
(b) Reports on Form 8-K.
The Company did not file a report on Form 8-K during the quarter ended
December 31, 1999.
(c) Exhibits
The following is a list of exhibits filed as part of this annual report on
Form 10-K. Where so indicated, exhibits which were previously filed are
incorporated by reference. For exhibits incorporated by reference, the location
of the exhibit in the previous filing is indicated in parentheses.
3.1 Amended and Restated Articles of Incorporation of the Company **
3.2 Amended and Restated Bylaws of the Company **
10.18 Master Equipment Lease Agreement dated as of July 11, 1997 between the
Company and Finova Technology Finance, Inc. *
10.25 Amendment to the Master Equipment Lease Agreement dated as of April 15,
1999 between the Company and Finova Technology Finance, Inc. +
10.26 Amended and Restated 1997 Equity Compensation Plan ***
10.27 Second Amendment to Line of Credit, Term Loan and Security Agreement and
Second Amended and Restated Line of Credit Note +
10.28 Asset Sale Agreement dated as of February 10, 2000 between the Company
and Implant Innovations, Inc.+
23.1 Consent of Arthur Andersen LLP +
24.1 Power of Attorney (included in the signature page).
27.1 Financial Data Schedule.+
- --------
+ Filed herewith.
* Filed as an Exhibit to the Company's Registration Statement on Form S-1
(333-51689) on May 1, 1998 and incorporated herein by reference.
** Filed as an Exhibit to the Company's Registration Statement on Form S-1/A
(335-51689) on June 15, 1998 and incorporated herein by reference.
31
*** Filed as an Exhibit to the Company's Registration Statement on Form S-8
(333-90981) on November 15, 1999 and incorporated herein by reference.
Copies of the exhibits are available to shareholders (upon payment of a $.20
per page fee to cover the Company's expenses in furnishing the exhibits) from
Investor Relations Manager, Orthovita, Inc., 45 Great Valley Parkway, Malvern,
Pennsylvania, 19355.
32
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized.
Orthovita, Inc.
Date: March 28, 2000
/s/ David S. Joseph
By: _________________________________
David S. Joseph
Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
Each person in so signing also makes, constitutes and appoints David S.
Joseph Chairman and Chief Executive Officer of Orthovita, Inc. and subsidiaries
and Joseph M. Paiva, Vice President and Chief Financial Officer of Orthovita,
Inc. and subsidiaries, and each of them acting alone, as his true and lawful
attorneys-in-fact, in his name, place and stead, to execute and cause to be
filed with the Securities and Exchange Commission any or all amendments to this
report.
Signature Capacity Date
--------- -------- ----
/s/ David S. Joseph Chairman, Chief Executive March 28, 2000
______________________________________ Officer (principal
David S. Joseph executive officer)
/s/ Joseph M. Paiva Vice President and Chief March 28, 2000
______________________________________ Financial Officer
Joseph M. Paiva (principal financial
officer and accounting)
/s/ Paul Ducheyne, Ph.D. Director March 28, 2000
______________________________________
Paul Ducheyne, Ph.D.
/s/ Lew Bennett Director March 28, 2000
______________________________________
Lew Bennett
/s/ James M. Garvey Director March 28, 2000
______________________________________
James M. Garvey
/s/ Richard M. Horowitz Director March 28, 2000
______________________________________
Richard M. Horowitz
/s/ Bruce A. Peacock Director March 28, 2000
______________________________________
Bruce A. Peacock
/s/ Jos B. Peeters, Ph.D. Director March 28, 2000
______________________________________
Jos B. Peeters, Ph.D.
/s/ Howard Salasin, Ph.D. Director March 28, 2000
______________________________________
Howard Salasin, Ph.D.
33
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Orthovita, Inc.:
We have audited the accompanying consolidated balance sheets of Orthovita,
Inc. (a Pennsylvania corporation) and subsidiaries as of December 31, 1999 and
1998, and the related consolidated statements of operations, shareholders'
equity and cash flows for each of the three years in the period ended December
31, 1999. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test
basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Orthovita, Inc. and
subsidiaries as of December 31, 1999 and 1998, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1999, in conformity with accounting principles generally accepted
in the United States.
/s/ Arthur Andersen LLP
Philadelphia, Pennsylvania,
January 21, 2000
(except with respect to the matter discussed in Note 16,
as to which the date is March 22, 2000)
F-1
ORTHOVITA, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31
1999 1998
------------ ------------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents (Note 3)............... $ 2,487,343 $ 842,064
Short-term investments (Note 3).................. 6,386,202 14,513,744
Other receivables (Note 6)....................... -- 635,188
Inventories (Note 4)............................. 147,270 329,251
Other current assets............................. 155,966 773,485
------------ ------------
Total current assets........................... 9,176,781 17,093,732
------------ ------------
PROPERTY AND EQUIPMENT, net (Note 5)............... 2,041,524 1,709,506
------------ ------------
OTHER ASSETS....................................... 103,141 85,394
------------ ------------
$ 11,321,446 $ 18,888,632
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Short-term bank borrowings (Note 7).............. $ 2,000,000 $ --
Note payable (Note 6)............................ 137,702 287,412
Current portion of long-term liabilities......... -- 175,058
Current portion of long-term capital lease
obligations (Note 8)............................ 530,126 362,239
Accounts payable................................. 1,327,825 381,144
Accrued patent defense cost (Note 15)............ 69,515 472,492
Accrued compensation and related expenses........ 605,507 342,453
Other accrued expenses........................... 387,376 601,832
------------ ------------
Total current liabilities...................... 5,058,051 2,622,630
------------ ------------
LONG-TERM LIABILITIES:
Capital lease obligations (Note 8)............... 616,726 608,562
Other liabilities................................ -- 128,865
------------ ------------
Total long-term liabilities.................... 616,726 737,427
------------ ------------
COMMITMENTS AND CONTINGENCIES (Note 14)
SHAREHOLDERS' EQUITY (Note 10):
Common stock, $.01 par value, 15,000,000 shares
authorized, 11,331,632 and 11,372,700 shares
issued and outstanding as of December 31, 1999
and December 31, 1998, respectively............. 113,316 113,727
Additional paid-in capital....................... 42,002,795 42,289,024
Accumulated deficit.............................. (36,473,754) (26,977,160)
Accumulated other comprehensive income........... 4,312 102,984
------------ ------------
Total shareholders' equity..................... 5,646,669 15,528,575
------------ ------------
$ 11,321,446 $ 18,888,632
============ ============
The accompanying notes are an integral part of these statements.
F-2
ORTHOVITA, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
Year Ended December 31
--------------------------------------
1999 1998 1997
------------ ----------- -----------
NET REVENUES (Note 11)................ $ 1,054,120 $ 2,780,658 $ 3,311,540
COST OF SALES......................... 324,590 927,792 1,096,848
------------ ----------- -----------
Gross profit...................... 729,530 1,852,866 2,214,692
------------ ----------- -----------
OPERATING EXPENSES:
General and administrative............ 3,674,515 2,253,836 3,762,906
Selling and marketing................. 1,807,212 2,879,804 4,249,533
Research and development (Note 12).... 5,273,590 2,764,321 1,986,506
------------ ----------- -----------
Total operating expenses.......... 10,755,317 7,897,961 9,998,945
------------ ----------- -----------
Operating loss.................... (10,025,787) (6,045,095) (7,784,253)
INTEREST EXPENSE...................... (110,601) (174,898) (148,156)
INTEREST INCOME....................... 639,794 511,882 181,617
FOREIGN CURRENCY TRANSACTION GAIN
(LOSS)............................... -- 7,323 (202,527)
------------ ----------- -----------
Loss before extraordinary item.... (9,496,594) (5,700,788) (7,953,319)
EXTRAORDINARY ITEM--GAIN ON EARLY
EXTINGUISHMENT OF DEBT (Note 6)....... -- -- 397,402
NET LOSS.............................. (9,496,594) (5,700,788) (7,555,917)
------------ ----------- -----------
ACCRETION OF REDEMPTION PREMIUM ON
PREFERRED STOCK...................... -- (391,213) (536,517)
------------ ----------- -----------
NET LOSS APPLICABLE TO COMMON
SHAREHOLDERS......................... $ (9,496,594) $(6,092,001) $(8,092,434)
============ =========== ===========
NET LOSS PER COMMON SHARE, BASIC AND
DILUTED:
Before extraordinary item......... $ (.83) $ (.73) $ (1.68)
Extraordinary item................ -- -- 0.08
------------ ----------- -----------
NET LOSS PER COMMON SHARE, BASIC AND
DILUTED.............................. $ (.83) $ (.73) $ (1.60)
============ =========== ===========
WEIGHTED AVERAGE NUMBER OF COMMON
SHARES OUTSTANDING, BASIC AND
DILUTED.............................. 11,411,896 8,314,679 5,050,397
============ =========== ===========
The accompanying notes are an integral part of these statements.
F-3
ORTHOVITA, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF REDEEMABLE CONVERTIBLE PREFERRED STOCK AND
SHAREHOLDERS' EQUITY
Shareholders' Equity
----------------------------------------------------------------------------------------
Redeemable
Class C Additional Accumulated
Convertible Convertible Common Paid-in Accumulated Comprehensive Comprehensive
Preferred Stock Preferred Stock Stock Capital Deficit Income Income Total
--------------- --------------- ------- ---------- ------------ ------------- ------------- -----------
BALANCE, DECEMBER 31,
1996................. $ -- $10,582 $46,108 $8,679,209 $(12,792,725) $(31,859) $ -- $(4,088,685)
Sale of 533,685
shares of common
stock, net of
offering costs of
$12,467............. -- -- 5,337 2,250,357 -- -- -- 2,255,694
Issuance of 585,936
shares of Class B
Convertible
Preferred stock..... -- 5,859 -- 1,019,531 -- -- -- 1,025,390
Sale of 1,882,353
shares of Class C
Convertible
Preferred stock and
common stock
warrants, net of
offering costs of
$1,153,427.......... 6,846,573 -- -- 762,631 -- -- -- 762,631
Issuance of common
stock and common
stock options for
services............ -- -- 417 426,375 -- -- -- 426,792
Accretion of
redemption premium
and dividends on
Class C Convertible
Preferred stock..... 536,517 -- -- -- (536,517) -- -- (536,517)
Comprehensive
income:
Net loss.......... -- -- -- -- (7,555,917) -- (7,555,917) (7,555,917)
Other
comprehensive
income:
Currency
translation
adjustment...... -- -- -- -- -- (2,084) (2,084) (2,084)
-----------
Comprehensive
income.......... $(7,558,001)
---------- ------- ------- ---------- ------------ -------- =========== -----------
BALANCE, DECEMBER 31,
1997................. 7,383,090 16,441 51,862 13,138,103 (20,885,159) (33,943) -- (7,712,696)
Sale of 370,392
shares of common
stock............... -- -- 3,704 3,496,296 -- -- -- 3,500,000
Sale of 1,800,000
shares of common
stock, net of
offering costs of
89,103.............. -- -- 18,000 16,669,838 -- -- -- 16,687,838
Conversion of
preferred stock to
common stock........ (7,774,303) (16,441) 35,264 7,755,480 -- -- -- 7,774,303
Accretion of
redemption premium
and dividends on
Class C Convertible
Preferred stock..... 391,213 -- -- -- (391,213) -- -- (391,213)
Exercise of common
stock options and
warrants to
purchase common
stock............... -- -- 4,897 1,163,760 -- -- -- 1,168,657
Issuance of common
stock options for
services............ -- -- -- 65,547 -- -- -- 65,547
Comprehensive
income:
Net loss........... -- -- -- -- (5,700,788) -- $(5,700,788) (5,700,788)
Other
comprehensive
income:
Unrealized gain on
short-term
investments, net... -- -- -- -- -- 99,350 99,350 99,350
Currency
translation
adjustment...... -- -- -- -- -- 37,577 37,577 37,577
-----------
Comprehensive
income.......... -- -- -- -- -- -- $(5,563,861) --
---------- ------- ------- ---------- ------------ -------- =========== -----------
F-4
Shareholders'
Redeemable Equity
Class C Additional Accumulated
Convertible Convertible Common Paid-in Accumulated Comprehensive Comprehensive
Preferred Stock Preferred Stock Stock Capital Deficit Income Income
--------------- --------------- -------- ----------- ------------ ------------- -------------
BALANCE, DECEMBER 31,
1998................. -- -- 113,727 42,289,024 (26,977,160) 102,984 --
Exercise of common
stock options and
warrants to
purchase common
stock and common
stock purchased
under the Employee
Stock Purchase
Plan................ -- -- 1,088 363,123 -- -- --
Issuance of common
stock options and
warrants for
services............ -- -- -- 185,664 -- -- --
Repurchase of
common shares....... -- -- (720) (348,920) -- -- --
Receipt of common
shares in repayment
of loan ............ -- -- (779) (486,096) -- -- --
Comprehensive
income:
Net loss........... -- -- -- -- (9,496,594) -- $(9,496,594)
Other
comprehensive
income:
Unrealized loss on
short-term
investments, net.. -- -- -- -- -- (60,267) (60,267)
Currency
translation
adjustment...... -- -- -- -- -- (38,405) (38,405)
-----------
Comprehensive
income............ -- -- -- -- -- -- $(9,595,266)
===========
BALANCE, DECEMBER 31,
1999................. $-- $-- $113,316 $42,002,795 $(36,473,754) $ 4,312
==== ==== ======== =========== ============ =======
Total
-----------
BALANCE, DECEMBER 31,
1998................. 15,528,575
Exercise of common
stock options and
warrants to
purchase common
stock and common
stock purchased
under the Employee
Stock Purchase
Plan................ 364,211
Issuance of common
stock options and
warrants for
services............ 185,664
Repurchase of
common shares....... (349,640)
Receipt of common
shares in repayment
of loan ............ (486,875)
Comprehensive
income:
Net loss........... (9,496,594)
Other
comprehensive
income:
Unrealized loss on
short-term
investments, net.. (60,267)
Currency
translation
adjustment...... (38,405)
Comprehensive
income............ --
BALANCE, DECEMBER 31,
1999................. $5,646,669
===========
The accompanying notes are an integral part of these statements.
F-5
ORTHOVITA, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended December 31
---------------------------------------
1999 1998 1997
------------ ------------ -----------
OPERATING ACTIVITIES:
Net loss............................ $ (9,496,594) $ (5,700,788) $(7,555,917)
Adjustments to reconcile net loss to
net cash used in operating
activities--
Extraordinary gain................ -- -- (397,402)
Depreciation and amortization..... 631,696 427,991 217,432
Imputed interest.................. -- 20,967 42,569
Services provided for common stock
and common stock options......... 185,664 65,546 426,792
(Increase) decrease in--
Restricted cash................. -- 200,000 (200,000)
Other receivables............... 744,959 (703,809) --
Inventories..................... 181,981 (80,544) 84,080
Other current assets............ 20,873 394,318 (251,449)
Other assets.................... (17,747) (85,394) 49,008
Increase (decrease) in--
Accounts payable................ 946,681 (287,302) (256,502)
Accrued patent defense costs.... (402,977) (530,744) 253,236
Other liabilities............... (128,865) 303,923 --
Other accrued expenses.......... (126,460) (359,673) (379)
------------ ------------ -----------
Net cash used in operating
activities................... (7,460,789) (6,335,509) (7,588,532)
------------ ------------ -----------
INVESTING ACTIVITIES:
Purchase of investments............. (10,346,255) (15,892,669) --
Proceeds from sale of investments... 18,314,180 1,478,275 --
Purchase of property and equipment.. (353,862) (110,947) (413,939)
------------ ------------ -----------
Net cash provided by (used in)
investing activities......... 7,614,063 (14,525,341) (413,939)
------------ ------------ -----------
FINANCING ACTIVITIES:
Proceeds (repayments) of short-term
bank borrowings.................... 2,000,000 (692,000) 32,000
Proceeds (repayments) of debt....... (108,649) (487,507) 514,322
Repayments of subordinated debt..... -- -- (351,125)
Repayments of capital lease
obligations........................ (433,800) (241,529) (51,103)
Proceeds from exercise of common
stock options and warrants......... 364,211 640,633 --
Repurchase of common stock.......... (349,640) -- --
Proceeds from sale of Redeemable
Class C Convertible Preferred
stock.............................. -- -- 7,609,204
Proceeds from sale of common stock
and warrants....................... -- 20,187,838 2,255,694
------------ ------------ -----------
Net cash provided by financing
activities................... 1,472,122 19,407,435 10,008,992
------------ ------------ -----------
EFFECT OF EXCHANGE RATE CHANGES ON
CASH AND CASH EQUIVALENTS............ 19,883 37,577 (2,084)
------------ ------------ -----------
NET INCREASE (DECREASE) IN CASH AND
CASH EQUIVALENTS..................... 1,645,279 (1,415,838) 2,004,437
CASH AND CASH EQUIVALENTS, BEGINNING
OF YEAR.............................. 842,064 2,257,902 253,465
------------ ------------ -----------
CASH AND CASH EQUIVALENTS, END OF
YEAR................................. $ 2,487,343 $ 842,064 $ 2,257,902
============ ============ ===========
The accompanying notes are an integral part of these statements.
F-6
ORTHOVITA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. The Company:
Orthovita, Inc. (the "Company"), a Pennsylvania corporation, began
operations in November 1993. We seek to develop, manufacture and market
orthopaedic products including synthetic bone substitutes based on novel
materials and technologies.
Our operations are subject to certain risks including but not limited to the
successful development and commercialization of our products in development and
our need for additional capital. We have incurred losses since out inception in
1993 and expect to continue to incur losses for at least the next several
years. Our products under development may never be commercialized or if
commercialized, may never generate substantial revenue. On March 22, 2000, we
completed the sale of our BIOGRAN(R) dental grafting product line to Implant
Innovations, Inc. ("3i") for $3.9 million. BIOGRAN has generated all of our net
revenue (see Notes 11 and 16).
Although we believe our existing cash, and short-term investments together
with the cash generated from the BIOGRAN sale will be sufficient to meet our
currently estimated operating and cash requirements for at least the next
twelve months, we will need to raise additional funds. If adequate financing is
not available, we may be required to delay, scale back or eliminate certain
operations.
2. Summary of Significant Accounting Policies:
Preparation of Financial Statements
Our financial statements have been prepared using United States generally
accepted accounting principles. This preparation 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 financial statements, and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.
Reclassifications
We have reclassified certain amounts in prior years' financial statements to
conform to the presentation for the current year.
Basis of Consolidation
The consolidated financial statements include the accounts of Orthovita,
Inc., its Belgian branch operations, and its wholly owned subsidiaries. We have
eliminated all material intercompany balances in consolidation.
Net Loss Per Share
We have presented net loss per common share pursuant to Statement of
Financial Accounting Standards ("SFAS") No. 128, "Earnings per Share." Basic
loss per share excludes potentially dilutive securities and was computed by
dividing net loss applicable to common shareholders by the weighted average
number of shares of common stock outstanding for the period. Diluted per share
data is computed assuming the conversion or exercise of all dilutive securities
such as preferred stock, options and warrants. Convertible preferred stock,
common stock options and warrants outstanding have not been included in the
calculation of diluted earnings per share as the impact is anti-dilutive for
all periods presented due to the Company's losses.
Revenue Recognition
Revenue on product sales is recognized at the time of shipment. Revenues are
presented net of returns. The Company records the cost for product returns as
incurred.
F-7
ORTHOVITA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Research and Development Costs
Research and development costs are charged to expense as incurred.
Foreign Currency Translation
The functional currency for the Company's Belgian branch is the Belgian
franc. Accordingly, 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.
Supplemental Cash Flow Information
In 1999, we issued options and warrants for the purchase of 41,100 shares of
common stock with various exercise prices to certain vendors in payment of
services valued at $185,664. During 1998, we issued options and warrants for
the purchase of 24,000 shares of common stock with various exercise prices to
certain vendors in payment of services valued at $65,547.
In 1999, we received 77,900 common shares of our stock in repayment of a
loan valued at $486,875. The balance of the loan was repaid in full with cash.
At December 31, 1998 the loan was included in Other Current Assets.
In 1999, 1998 and 1997, we incurred capital lease obligations of $609,851,
$442,306 and $797,068, respectively. In 1999, 1998 and 1997, cash paid for
interest was $110,601, $174,898 and $148,156, respectively. The Company paid no
income taxes in 1999, 1998 and 1997.
3. Cash, Cash Equivalents and Investments:
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, the Company considers all highly
liquid investment instruments purchased with an original maturity of three
months or less to be cash equivalents. All investments are considered
available-for-sale and, accordingly, unrealized gains and losses are included
in a separate component of shareholders' equity.
As of December 31, 1999 and 1998, cash and cash equivalents and investments
at cost and fair market value consisted of the following:
Gross Gross Fair
Original Unrealized Unrealized Market
Cost Gains Losses Value
----------- ---------- ---------- -----------
December 31, 1999:
Cash and cash equivalents... $ 2,487,343 $ -- $ -- $ 2,487,343
Short-term investments...... 6,446,469 -- (60,267) 6,386,202
----------- -------- -------- -----------
$ 8,933,812 $ -- $(60,267) $ 8,873,545
=========== ======== ======== ===========
December 31, 1998:
Cash and cash equivalents... $ 842,064 $ -- $ -- $ 842,064
Short-term investments...... 14,414,394 106,882 (7,532) 14,513,744
----------- -------- -------- -----------
$15,256,458 $106,882 $ (7,532) $15,355,808
=========== ======== ======== ===========
F-8
ORTHOVITA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
As further discussed in Note 7, we are required to maintain an minimum level
of aggregate cash, cash equivalents and investments.
4. Inventories:
Inventories are stated at the lower of cost or market on a first-in, first-
out basis. As of December 31, 1999 and 1998, inventories consisted of the
following:
December 31
-----------------
1999 1998
-------- --------
Raw materials and work-in-process....................... $134,356 $280,927
Finished goods.......................................... 12,914 48,324
-------- --------
$147,270 $329,251
======== ========
5. Property, Equipment and Depreciation:
Property and equipment, including assets held under capitalized lease
obligations, are recorded at cost. Depreciation is calculated on a straight-
line basis over the estimated useful lives of assets, primarily three to five
years except for leasehold improvements where, if shorter, the remaining term
of the facility lease is used.
Expenditures for major renewals and improvements to property and equipment
are capitalized and expenditures for maintenance and repairs are charged to
operations as incurred.
Property and equipment consisted of the following:
December 31
-----------------------
1999 1998
----------- ----------
Machinery and equipment........................... $ 1,853,969 $1,456,375
Furniture, marketing, and office equipment........ 891,330 478,228
Leasehold improvements............................ 716,619 563,602
----------- ----------
3,461,918 2,498,205
Less--Accumulated depreciation.................... (1,420,394) (788,699)
----------- ----------
$ 2,041,524 $1,709,506
=========== ==========
In the years ended December 31, 1999 and 1998, certain property and
equipment was acquired under capitalized lease obligations. Total capital
assets under lease are $1,922,621 and $1,316,941 with related accumulated
depreciation of $634,715 and $297,387 at December 31, 1999 and 1998,
respectively.
6. FBFC International Technology License:
In July 1992, we obtained a license from FBFC International, a Belgian
company, (the "FBFC License") to certain patents covering BIOGRAN. We had
agreed to pay FBFC a maximum aggregate royalty of $3,000,000, allocated evenly
between each of two dental products. We also agreed to pay FBFC a running
royalty, and receive credit against the related maximum, of 12% on BIOGRAN net
sales.
Also, as part of the license agreement, we assumed the payback provisions
contained in a loan agreement between FBFC and the Flemish government for a
noninterest-bearing loan payable in Belgian Francs. We discounted the loan
using a market rate of interest and recorded a liability and an expense for
acquired
F-9
ORTHOVITA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
technology. Imputed interest expense is recognized on the loan based on the
loan repayment schedule. Payments on this loan are to be made annually through
December 2003. These payments are in addition to the payment of royalties and
are due to the Flemish government. Repayments under the loan and the payment of
certain other fees, as defined, reduce the amount of the maximum royalty on a
dollar for dollar basis. During 1996, we decided not to commercialize one of
the dental products licensed from FBFC and petitioned the Flemish government to
exempt us from the debt assumed when the technology was licensed. In 1997, the
Flemish government granted us an exemption of reimbursement of approximately
$426,000 of long-term debt ($397,402, net of unamortized debt discount). We
recorded an extraordinary gain of $397,402 in 1997 due to the extinguishment of
this debt. By virtue of our decision not to commercialize this product, the
maximum aggregate royalty payment to be made by us was reduced from $3,000,000
to $1,500,000. We closed certain facilities in Belgium during 1997, and based
on the terms of the debt, this closure gives the Flemish government the right
to call the debt. Although the Flemish government has not exercised this right,
we have classified the liability of $137,702 and $287,412, at December 31, 1999
and 1998, respectively, as a current liability. As further discussed under Note
15, in connection with certain patent litigation, FBFC agreed to reimburse
patent defense costs of $474,580, which was classified as Other Receivables at
December 31, 1998.
7. Bank Borrowings:
We have a one-year $2 million line of credit arrangement with our commercial
bank that expires at the end of 2000. The line of credit requires us to
maintain a minimum aggregate level of cash and investments of $4 million,
minimum working capital of $4 million and other specific financial covenants.
Interest on the line of credit is payable at the prime rate plus 1.0% and the
weighted average interest rate was 9.5% for the year ended December 31, 1999.
As of December 31, 1999, $2 million was outstanding under the line, which was
repaid in January 2000.
8. Capital Lease Obligations:
Capital lease obligations consisted of the following:
December 31
----------------------
1999 1998
---------- ----------
Capital lease obligations......................... $1,308,690 $1,163,043
Less--amount representing interest................ (161,838) (192,242)
---------- ----------
Present value of minimum lease payments........... 1,146,852 970,801
Less--current portion of minimum lease payments... (530,126) (362,239)
---------- ----------
$ 616,726 $ 608,562
========== ==========
Capital lease obligation maturities as of December 31, 1999 are as follows:
2000............................................................ $ 614,097
2001............................................................ 440,627
2002............................................................ 223,529
2003............................................................ 30,437
----------
$1,308,690
==========
F-10
ORTHOVITA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
In 1997, we secured a $1,200,000 capital asset lease financing arrangement
with a lending institution. The term of each individual lease is 42 months and
interest is approximately 10.85%. The leases are secured by the underlying
capital assets. Prior to the expiration of the financing arrangement in
December 1998, we secured an additional $1,500,000 capital lease financing
arrangement with the same lending institution. Consistent with the first
arrangement, each individual lease's term is 42 months and the leases are
secured by the underlying capital assets. Interest is approximately 9.4%.
9. Profit Sharing Plan:
The Company has a Section 401(k) plan for all qualified employees, as
defined. Company contributions are discretionary and determined annually and
were $67,541 and $65,860 for the years ended December 31, 1999 and 1998,
respectively.
10. Shareholders' Equity:
On June 25, 1998, in connection with our Initial Public Offering (the
"Offering"), all convertible preferred stock then outstanding was converted to
common shares.
Common Stock
On June 25, 1998, we completed the Offering of our common shares on the
Brussels-based EASDAQ stock exchange. The offering raised net proceeds of
approximately $13.8 million from the sale of 1.5 million shares of common stock
at $10.50 per share. In July 1998, in connection with the Offering, we sold
300,000 additional shares of common stock at $10.50 per share as the
underwriters exercised their over-allotment option, raising net proceeds of
approximately $2.9 million.
In June 1998, in connection with a series of agreements that we entered into
with Howmedica, Inc., we sold 370,392 shares of common stock to Howmedica,
Inc., for $3.5 million (See Note 12).
F-11
ORTHOVITA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Stock Options
We have stock option plans that provide for both incentive and nonqualified
stock options to be granted to key employees, consultants and advisors. Options
are granted with exercise prices equal to or greater than the fair market value
of the common stock on the date of grant. Generally incentive stock options
become exercisable in equal installments over a four-year period and
nonqualified stock options are issued fully vested. The options remain
exercisable for a maximum period of ten years. As of December 31, 1999, there
were 84,306 options available for grant under the plans and 779,555 exercisable
options outstanding with a weighted average exercise price of $3.38 per share.
For all outstanding options, the weighted average exercise price per share is
$4.42 with a weighted average remaining contractual life of approximately eight
and one-half years. Summary stock option information is as follows:
Exercise Aggregate
Number Price Range Exercise Price
--------- ----------- --------------
Outstanding, December 31, 1996......... 636,144 $1.00- 4.25 $1,658,687
Granted.............................. 460,000 4.25 1,955,000
Canceled............................. (17,000) 3.50- 4.25 (64,000)
--------- ----------- ----------
Outstanding, December 31, 1997......... 1,079,144 1.00- 4.25 3,549,687
Granted.............................. 232,050 4.25-11.63 1,130,423
Exercised............................ (227,000) 1.00- 4.25 (651,500)
Canceled............................. (101,400) 1.00- 4.25 (404,950)
--------- ----------- ----------
Outstanding, December 31, 1998......... 982,794 1.00-11.63 3,623,660
Granted.............................. 739,850 4.35- 6.60 3,869,778
Exercised............................ (101,472) 2.75- 4.25 (332,830)
Canceled............................. (33,950) 4.25- 4.75 (147,888)
--------- ----------- ----------
Outstanding, December 31, 1999......... 1,587,222 $1.00-11.63 $7,012,720
========= =========== ==========
We apply Accounting Principal Board Opinion No. 25, "Accounting for Stock
Issued to Employees," (APB 25) and the related interpretations in accounting
for our stock option plans. Under APB 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. Under SFAS No. 123, "Accounting for Stock-Based
Compensation," compensation cost related to stock options is computed based on
the value of the stock options at the date of grant using an option valuation
methodology, typically the Black-Scholes model. SFAS No. 123 can be applied
either by recording the Black-Scholes model value of the options or by
continuing to record the APB 25 value and by disclosing SFAS No. 123
information on a pro forma basis. We have applied the proforma disclosure
requirement of SFAS No. 123, "Accounting for Stock-Based Compensation". Had
compensation cost for our common stock option plan been determined under SFAS
No. 123, our net loss and net loss per common share would have been adjusted as
follows:
Year Ended December 31
-----------------------------------
1999 1998 1997
----------- ---------- ----------
Net loss applicable to common
shareholders:
As reported......................... $ 9,496,594 $6,092,001 $8,092,434
Pro forma........................... 11,508,328 6,677,576 8,499,187
Net loss per common share, basic and
diluted:
As reported......................... $ (.83) $ (.73) $ (1.60)
Pro forma........................... (1.01) (.80) (1.68)
F-12
ORTHOVITA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The weighted average fair value of the options granted during 1999 is
estimated as $2.87 per share on the date of grant, using the Black-Scholes
option pricing model with the following assumptions: dividend yield of zero,
volatility of 50%, risk-free interest rate of approximately 6.4%, and an
expected life of six years. The weighted average fair value of the options
granted during 1998 and 1997 is estimated as $2.64 and $1.46 per share,
respectively, on the date of grant using the Black-Scholes option pricing model
with the following assumptions: dividend yield of zero, volatility of 50%,
risk-free interest rate at 5.0% and 7.0% during 1998 and 1997, respectively,
and an expected life of six years. The resulting pro forma compensation charge
presented may not be representative of that to be expected in the future years
to the extent that additional stock options are granted and the fair value of
the common stock increases or decreases.
Employee Stock Purchase Plan
During November 1998, an Employee Stock Purchase Plan (the "ESPP") was
established to provide eligible employees an opportunity to purchase our common
stock. Under the terms of the ESPP, eligible employees may have up to 10% of
eligible compensation deducted from their pay to purchase common stock. The per
share purchase price is 85% of the last trading price of common stock on the
EASDAQ Exchange on the last day of each calendar quarter. The amount that may
be offered pursuant to the ESPP is 300,000 common shares. There were 2,732
shares purchased under the ESPP during 1999. No shares were purchased under the
ESPP during 1998.
Common Stock Purchase Warrants
In connection with the issuance of our $2.0 million line of credit
arrangement, in November 1999, we issued to our lender warrants to purchase
10,000 shares of our common stock at $6.00 per share. The warrants remain
exercisable for five years from date of issue and were valued at $30,825 on
date of issuance.
In addition, we have issued warrants in connection with other equity
transactions and, as of December 31, 1999, we had 781,255 common stock purchase
warrants outstanding with an average exercise price of $4.13 per share. The
warrants have an average remaining life of approximately 2 years.
11. Net Revenues:
On April 29, 1998, we entered into a Global Distribution Agreement with 3i,
whereby 3i obtained the exclusive worldwide marketing, sales and distribution
rights for BIOGRAN for dental surgical applications. The arrangement provides
for 3i to pay us 50% of their BIOGRAN average selling price through December
31, 1998 and 45% for the year 1999. On March 22, 2000, we sold our BIOGRAN
dental grafting product line to 3i for $3.9 million. In 1999 and 1998, 3i
accounted for 100% and 58%, respectively, of our net revenue (See Note 16).
12. Research and Development:
In June 1998, we entered into a series of agreements with Howmedica, Inc.
(the "Howmedica Agreements"), under which we granted Howmedica the exclusive
worldwide marketing, sales and distribution rights for the use of our ORTHOCOMP
Injectable in joint implant procedures. In connection with the Howmedica
Agreements, we may earn payments of up to an aggregate of $4,500,000 if various
milestones are reached during the development and approval process for this
indication. If regulatory approvals are received, Howmedica will be required to
make annual minimum purchases of ORTHOCOMP Injectable from us for a six-year
period. The annual minimum purchase requirement may be set aside if, during the
period from the third anniversary of Howmedica's first commercial sale of
ORTHOCOMP until the fifth anniversary of such sale, Howmedica elects to obtain
exclusive manufacturing rights from us by making a one-time payment of
$7,000,000 and by making royalty payments to us on future sales during the term
of the agreement equal to
F-13
ORTHOVITA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
10% of Howmedica's net sales in territories with a valid claim of patent or 5%
of net sales in territories with no such valid claim of patent. Additionally,
except for our VITOSS synthetic cancellous bone technology platform, Howmedica
has certain rights of first negotiation and refusal for orthopaedic
applications of our other technologies.
We have exclusively licensed on a worldwide basis, from the University of
Pennsylvania ("Penn"), certain intellectual property including patents relating
to materials and techniques for improving orthopaedic implants, bone grafting,
and controlled drug release technologies. In consideration for the above and
for certain expenses Penn incurred related to the intellectual property, we
issued 41,705 shares of common stock to Penn during 1997. Penn is also entitled
to a royalty on net sales, as defined, of products based on the Penn-licensed
technologies. No royalties have been incurred since inception.
13. Income Taxes:
We account for income taxes in accordance with SFAS No. 109, "Accounting for
Income Taxes." SFAS No. 109 is an asset and liability approach that requires
the recognition of deferred tax assets and liabilities for the expected tax
consequences of events that have been recognized in the financial statements or
tax returns.
The components of income taxes are as follows:
Year Ended December 31
-------------------------------------
1999 1998 1997
----------- ----------- -----------
Current............................. $ -- $ -- $ --
Deferred............................ (2,116,201) (2,015,603) (2,428,881)
----------- ----------- -----------
(2,116,201) (2,015,603) (2,428,881)
Valuation allowance................. 2,116,201 2,015,603 2,428,881
----------- ----------- -----------
$ -- $ -- $ --
=========== =========== ===========
The difference between our federal statutory income tax rate and our
effective income tax rate is primarily due to state income taxes and the
valuation allowance.
Components of our deferred tax asset as of December 31, 1999 and 1998 are as
follows:
December 31
-------------------------
1999 1998
------------ -----------
Deferred tax assets:
Net operating loss carryforwards............ $ 8,121,626 $ 6,418,700
Accrued expenses not currently deductible... 294,217 179,087
Research, patent and organizational costs
capitalized for tax purposes............... 3,638,336 2,232,784
------------ -----------
12,054,179 8,830,571
Valuation allowance........................... (12,054,179) (8,830,571)
------------ -----------
Net deferred tax asset........................ $ -- $ --
============ ===========
SFAS No. 109 requires that deferred tax assets and liabilities be recorded
without consideration as to their realizability. The portion of any deferred
tax asset for which it is more likely than not that a tax benefit will not be
realized must then be offset by recording a valuation allowance against the
asset. A valuation allowance has been established against all of our deferred
tax assets since the realization of the deferred tax asset is not
F-14
ORTHOVITA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
assured given our history of operating losses. The deferred tax asset includes
the cumulative temporary difference related to certain research, patent and
organizational costs, which have been charged to expense in the accompanying
Statements of Operations but have been recorded as assets for federal tax
return purposes. These tax assets are amortized over periods generally ranging
from 5 to 20 years for federal tax purposes.
As of December 31, 1999, we had approximately $23,622,000 of federal net
operating loss carryforwards, which begin to expire in 2008. Our annual
utilization of net operating loss carryforwards will be limited pursuant to the
Tax Reform Act of 1986, since a cumulative change in ownership over a three-
year period of more than 50% occurred as a result of the cumulative issuance of
our common stock and common stock equivalents. We believe, however, that such
limitation may not have a material impact on the ultimate utilization of our
carryforwards.
The federal net operating loss carryforwards are scheduled to expire
approximately as follows:
2008............................. $ 7,729
2009............................. 490,568
2010............................. 2,976,405
2011............................. 4,342,295
2012............................. 5,450,361
2013............................. 4,219,188
2014............................. 6,135,884
-----------
$23,622,430
===========
14. Commitments and Contingencies:
We lease office space and equipment under noncancelable operating leases.
For the years ended December 31, 1999, 1998 and 1997, lease expense was
$304,732, $212,948, $164,384, respectively. At December 31, 1999, future
minimum rental payments under operating leases are as follows:
2000................................ $321,039
2001................................ 165,911
2002................................ 18,636
2003................................ 12,489
--------
$518,075
========
At December 31, 1999, we reserved $171,169 for our commitment under an
employment severance agreement.
15. Litigation and Proceedings:
In May 1996, the University of Florida Research Foundation, Inc., U.S.
Biomaterials Corporation and Block Drug Corporation filed a complaint in the
U.S. District Court for the Northern District of Florida, against us, a
distributor of our BIOGRAN product, and our former Chairman. This action
charged the defendants with infringement of U.S. Patent No. 4,851,046, said to
be assigned to the University of Florida Research Foundation and said to be
exclusively licensed to U.S. Biomaterials Corporation. In April 1998, the court
granted our summary judgment motion stating that our BIOGRAN product does not
infringe this patent. The complaint also alleges false representation, unfair
competition, false advertising and trade disparagement under U.S. federal and
Florida state law and these complaints were settled with the Plaintiffs in
September 1998.
F-15
ORTHOVITA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
During September 1998, the Plaintiffs filed with the U.S. Court of Appeals for
the Federal Circuit a request for an appeal of the U.S. District Court's
summary judgment with respect to the patent infringement claim. On October 6,
1999 the U.S. Court of Appeals entered an order affirming our motion for
summary judgment and dismissing a complaint for patent infringement. On January
4, 2000, the time period for filing a petition by the plaintiffs with the U.S.
Supreme Court expired, accordingly, this matter is considered to be finalized
in the United States.
On July 23, 1994, U.S. Biomaterials Corporation filed with the U.S. Patent
and Trademark Office a Request for Reexamination of the FBFC U.S. Patent which
provides patent protection in the U.S. for BIOGRAN. This patent has now been
assigned to 3i who purchased the BIOGRAN product line in March 2000. FBFC filed
a response in this proceeding, establishing that the claims of the FBFC Patent
were properly allowed. As a result, a Certificate of Reexamination was issued
by the U.S. Patent and Trademark Office confirming the patentability of all
claims of the FBFC Patent without amendment. However, U.S. Biomaterials
Corporation also instituted a nullification proceeding against the European
counterpart to the FBFC U.S. Patent. The opposition division of the European
Patent Office tentatively decided in FBFC's favor, but the matter is still
proceeding under an appeal. In connection with the BIOGRAN sale to 3i, 3i has
assumed control of this matter and we have agreed to reimburse for the
associated legal costs and to provide them with certain indemnification with
respect to the matter. Net of insurance recoveries and other reimbursements, we
have incurred approximately $1.0 million in legal defense expenses related to
this matter. At December 31, 1999, we reduced our reserve to $69,500 to cover
future legal fees related to this matter in Europe.
16. Subsequent Events:
On March 22, 2000, we completed the sale of our BIOGRAN dental grafting
product line to 3i, a Biomet Company, for $3.9 million. 3i has been our
worldwide distributor for BIOGRAN since April 1998. Upon the closing of the
sale, we expect to receive $3.5 million in cash, with an additional $400,000 to
be held in an escrow account for one year, and to realize a one-time gain on
the transaction of approximately $3.1 million. In connection with this
transaction, we have agreed to indemnify 3i for any product liability that may
arise from BIOGRAN product manufactured by us prior to the closing of this
transaction, any liability that may arise from the European Patent Office
nullification proceeding, if any, and certain other liabilities. If no
liabilities arise within one year from the close of this sale for which we have
agreed to indemnify 3i, then the $400,000 escrow will be released to us.
F-16
EXHIBIT INDEX
Exhibit
Number Description
------- -----------
3.1 Amended and Restated Articles of Incorporation of the Company**
3.2 Amended and Restated Bylaws of the Company**
10.18 Master Equipment Lease Agreement dated as of July 11, 1997 between the
Company and Finova Technology Finance, Inc.*
10.25 Amendment to the Master Equipment Lease Agreement dated as of April
15, 1999 between the Company and Finova Technology Finance, Inc.+
10.26 Amended and Restated 1997 Equity Compensation Plan***
10.27 Second Amendment to Line of Credit, Term Loan and Security Agreement
and Second Amended and Restated Line of Credit Note+
10.28 Asset Sale Agreement dated as of February 10, 2000 between the Company
and Implant Innovations, Inc.+
23.1 Consent of Arthur Andersen LLP+
24.1 Power of Attorney (included in the signature page)
27.1 Financial Data Schedule+
- --------
+ Filed herewith.
* Filed as an Exhibit to the Company's Registration Statement on Form S-1
(333-51689) on May 1, 1998 and incorporated herein by reference.
** Filed as an Exhibit to the Company's Registration Statement on Form S-1/A
(335-51689) on June 15, 1998 and incorporated herein by reference.
*** Filed as an Exhibit to the Company's Registration Statement on Form S-8
(333-90981) on November 15, 1999 and incorporated herein by reference.