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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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, 1998
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
Malvern, Pennsylvania 19355
(Address of principal executive offices) (Zip Code)
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
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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 12, 1999, the aggregate market value of the Common Stock held by
non-affiliates of the registrant was $34,772,256. 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 12, 1999, there were 11,404,828 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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PART I
ITEM 1. BUSINESS
Orthovita, Inc. ("Orthovita" or the "Company") is a biomaterials company
that is incorporated under the laws of the Commonwealth of Pennsylvania and
began operations in 1993. The Company is developing proprietary osteobiologic
bone substitutes and bone cements that it intends to manufacture and market on
a global basis. Orthovita has targeted its products for sale to the trauma,
spine, implant cement, cranio-maxillofacial and dental implant surgery markets.
The Company has developed and is manufacturing through third party vendors
BIOGRAN(R), it's first commercialized product that is a resorbable, granular
biomaterial that biologically transforms to bone and which it is selling and
marketing through Implant Innovations Inc. ("3i"), a leading dental implant
company. The Company has in development ORTHOCOMP(TM) Injectable cement and
ORTHOBONE(TM) Putty, as composite, fast-setting, high strength resins with a
biological interface that bonds to bone; and VITOSS(TM), in development as an
injectable resorbable cement that aids in fracture healing and as a resorbable
calcium phosphate, high porosity scaffold matrix developed through its fine
particle synthesis technology. To date, the Company has only received
regulatory approval for BIOGRAN for use in certain dental surgical
applications. There can be no assurance that the Company will obtain regulatory
approval for any other indications or for any of its other products or that it
will successfully commercialize any of its products. See "Management's
Discussion and Analysis--Certain Risks Associated with Orthovita's Business."
In August 10, 1998, the Company announced the formation of PARTISYN CORP, a
wholly owned subsidiary company, to exploit the industrial and commercial
applications of its fine particle synthesis or nano-structured technology
through licensing and royalty arrangements. The formation of the subsidiary
will allow the Company to continue to maintain its major focus in the
development and commercialization of its core business of biomaterial based
bone substitutes and bone cements.
On June 9, 1998, the Company entered into license and development and supply
agreements with Howmedica Inc., ("Howmedica") a wholly owned subsidiary of
Stryker, Inc., whereby Howmedica has obtained the exclusive worldwide
marketing, sales and distribution rights for ORTHOCOMP in joint implant
procedures.
On April 28, 1998, the Company entered into a global strategic alliance for
the marketing and distribution of BIOGRAN and ORTHOCOMP for the dental implant
surgery market with 3i.
Background
Orthovita has targeted its products for sale to the trauma, spine, implant
cement, oncology, cranio-maxillofacial and dental implant surgery markets,
which the Company estimates have an aggregate market potential of approximately
US$1 billion. The Company believes that these markets will require, and that
its products will address the need for bone substitutes and bone cements that
offer a broader range of performance attributes, better patient outcomes and
lower cost than are currently available. The Company's biomaterials technology
currently encompasses the following product platforms which address differing
patient needs: BIOGRAN, is commercialized as a resorbable, granular biomaterial
that biologically transforms to remodeled cancellous bone in four to six
months; ORTHOCOMP Injectable cements and ORTHOBONE Putty, are in development as
composite, fast-setting, high strength resins with a biological interface that
bonds to bone and are immediately load bearing; and VITOSS, in development as
an injectable resorbable cement that aids in fracture healing and as a scaffold
matrix that is conducive to cell attachment.
Since its inception in 1992, the Company has focused its efforts on
developing and commercializing its products. As a result, the Company has
incurred substantial operating losses since its inception and at December 31,
1998, had an accumulated deficit of approximately US$27 million. These losses
have resulted principally from expenses required to be incurred before the
Company can begin marketing its products, including the development and
patenting of the Company's technologies, preclinical and clinical studies,
preparation of submissions to the FDA and foreign regulatory bodies, and the
development of marketing, manufacturing and distribution capabilities.
1
Prior to April 28, 1998, the Company generally marketed BIOGRAN through
internal direct sales efforts in the U.S. and through local distributors
overseas. On April 28, 1998, the Company signed an agreement with 3i pursuant
to which 3i has obtained the global distribution rights for BIOGRAN and
ORTHOCOMP for the dental implant surgery market. The arrangement provided for
3i to purchase, and for the Company to supply, specified minimum monthly
amounts of BIOGRAN in 1998 for the dental market. For the years 2000 through
2003, inclusively, 3i has minimum purchase requirements of US$2.4 million per
year. The agreement may be terminated if 3i fails to purchase more than
US$600,000 in a given calendar quarter after 1999. For 1999, 3i has no minimum
purchase requirements.
To date, the Company's sale of BIOGRAN to 3i has exceeded the rate of
product resale by 3i to its customers as the sales transition and training
period with 3i has taken longer than expected due to sales force turnover and
management changes within 3i. As a result, additional sales of BIOGRAN in 1999
by the Company to 3i will depend upon 3i's rate of BIOGRAN product resale to
its customers in comparison to the amount of BIOGRAN held by 3i. The Company
reached an understanding with 3i during the fourth quarter of 1998 to defer all
of the fourth quarter 1998 contract purchase minimums until 1999. After 3i has
fulfilled, in 1999, its fourth quarter 1998 contract purchase minimums of
US$800,000 there may be a period in 1999 during which the Company may not have
any BIOGRAN product sales to 3i. Additional 1999 BIOGRAN product sales to 3i
will be dependent upon 3i's ability to successfully market the product.
The global distribution agreement with 3i provides for a sale price from the
Company to 3i in 1998, 1999 and 2000 through 2003 equal to 50%, 45% and 40%,
respectively, of 3i's average sales price to its customers in the previous
quarter. The alliance has allowed the Company to significantly reduce its sales
and marketing expenses in 1998 in comparison to 1997.
On June 9, 1998, the Company entered into a series of agreements with
Howmedica pursuant to which Howmedica obtained exclusive worldwide marketing,
sales and distribution rights for ORTHOCOMP in joint implant procedures. To the
extent that the Company chooses not to, or is unable to enter into similar
strategic alliances for its other products and indications, it would need to
either develop a network of independent sales agents, distributors and dealers
or create its own internal direct sales and marketing capabilities for these
products and indications.
The Company has entered into certain agreements pursuant to which it is
obligated to pay royalties based on net revenues of the Company's VITOSSTM
products that are currently under development. After commercialization, to the
extent that sales of these products increase in future periods, the Company's
license obligations will be expected to increase.
The Company has benefited from the research and development activities
conducted through its agreement with the University of Pennsylvania ("Penn").
This agreement provides for and has broadened the Company's technological base
through patents that have been issued and others that are pending and has
allowed the Company to place greater focus on the commercialization of its
products. The Company's operating results and financial condition could be
adversely affected if it were required to fund all of the research expenses
related to its current and future products.
The Company's Bone Substitutes
The Company's products are designed to solve a wide range of clinical
problems associated with current bone substitutes and provide optimal
attributes for a variety of specific applications.
BIOGRAN
BIOGRAN is commercialized as a bioactive glass granule that, when implanted
in a bone defect site, forms a calcium phosphate shell with an internal chamber
where bone forming cells differentiate and form new bone tissue over a four to
six month period. BIOGRAN is designed for cancellous bone defects that are not
immediately subject to load or for use in conjunction with fixation hardware.
The principal indication is for bone regeneration in preparation for tooth root
implantation. BIOGRAN has the consistency of paste when mixed with blood or
saline. BIOGRAN is available in both pre-formed dampen dishes and pre-filled
syringes.
2
ORTHOCOMP AND ORTHOBONE
ORTHOCOMP Injectable cement and ORTHOBONE Putty are in development as
bioactive, self-setting, bone bonding composite resins that offer ease of use
delivery and are designed to provide rapid restoration of functionality in load
bearing, bone reinforcement, implant stabilization and bone repair
applications. The Company believes the bioactive composite nature of ORTHOCOMP
and ORTHOBONE will allow them to conform to the precise area of placement, and
their setting polymerization will react and lead to immediate load bearing
strength, with elasticity more closely resembling that of natural bone than
metal. Because of their bioactivity, ORTHOCOMP and ORTHOBONE should be
integrated with the bone at the interface, enhancing the strength of the bond
and the overall efficacy of the implant system.
ORTHOCOMP will be formulated to allow for controllable setting times,
various viscosities and differing levels of strength. Less viscous formulations
may be delivered through pre-filled unit dose cartridges directly into the
surgical site or through minimally invasive surgery, and the more viscous
ORTHOBONE formulations may be hand packed as putty. Unlike PMMA, which requires
a relatively lengthy mixing time and a short interval during which the material
can be used, the Company believes ORTHOCOMP's novel mix-on-demand delivery
system will allow the surgeon much greater flexibility with respect to the
commencement of the setting time of the material. ORTHOCOMP and ORTHOBONE are
also easily visualized under radiographic or fluoroscopic imaging. The Company
is not aware of any current competitors for these types of surface bonding,
high load bearing bone substitutes.
In June 1998, the Company submitted a 510(k) application to the United
States Food and Drug Administration (the "FDA") for using ORTHOCOMP as an
augment to screw fixation in fracture repair. The Company subsequently had
discussions with the FDA regarding the regulatory approval pathway for
ORTHOCOMP for this indication. In those discussions, the Company withdrew its
510(k) submission for ORTHOCOMP, and it was agreed with the FDA that the FDA
would first look at the results of clinical studies that the Company previously
planned to start in 1999 in Europe and in the U.S. When the clinical results
become available, the FDA will then determine whether or not the request for
marketing clearance of ORTHOCOMP for this indication should be resubmitted
under a 510(k) or submitted under a PMA application. The Company held
additional discussions with the FDA in January 1999 in preparation for filing
an investigation device exemption (an "IDE") necessary to start the U.S.
clinical trials for ORTHOCOMP for screw augmentation. The Company expects to
start clinical studies in Europe during the middle of 1999 for ORTHOCOMP for
screw augmentation and to file for CE Mark approval in late 1999. The Company
also expects to start a multi-center study for the use of ORTHOCOMP for
vertebroplasty in osteoporotic patients during the middle of 1999. Pre-clinical
studies for the use of ORTHOCOMP have begun in Europe and the United States for
tooth root anchoring. Pre-clinical studies are planned to start during the
second half of 1999 for the use of ORTHOCOMP as a cement for joint implant
replacement. Upon the successful completion of these preclinical studies, the
Company expects to receive its first milestone payment under the Howmedica
Agreements in the first half of 2000.
VITOSS
VITOSS is in development as both an injectable, self-setting, resorbable
calcium phosphate bone cement material that is replaced by bone as it is
resorbed and as a resorbable scaffold matrix that closely resembles the
porosity of trabecular bone. The Company believes VITOSS may allow for the flow
of blood and nutrients required for bone remodeling, as well as the seeding of
signaling molecules and growth factors to accelerate the healing process. The
novel, mixed paste formula, based on the Company's fine particle synthesis
technology, should allow complete interaction of the respective components and
proper placement in the body. The result should be consistent setting in the
body of a fine-grained structure comparable to human bone. It should be
especially useful in moderate load bearing situations that are coupled with
fixation hardware, and should permit quicker return to function in younger
patients with healthy bone physiology. Pre-clinical studies are currently
underway for the use of VITOSS in metaphyseal defects, which include tibial
plateau fractures, and cranio-maxillofacial reconstruction.
3
Clinical Applications
The Company is initially focused on seven clinical indications for use with
a potential global market of approximately seven million annual procedures,
representing approximately US$1.4 billion opportunity. The Company believes the
clinician purchase decision will be based on patient bone health factors, load
bearing requirements at a particular site, and clinician judgment regarding
resorbable products that require fixation and longer healing times versus non-
resorbable products that return patients to their maximum recovery state
rapidly. The following chart sets forth certain information regarding these
seven indications, including the potential annual global procedures, the
applicable product, and whether the product has been commercialized for the
applicable indication and the regulatory timeline.
Potential
Annual
Global
Procedures(/1/)
Indications US$ Product Regulatory Timeline
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(in thousands)
Screw Augmentation...... 2,330 ORTHOCOMP CE Clinicals expected to begin Q2-1999
Vertebroplasty.......... 700 ORTHOCOMP CE Clinicals expected to begin Q2-1999
Joint Implant Cement.... 656 ORTHOCOMP IDE expected to be filed 1H-2000
Metaphyseal Defects..... 100 VITOSS CE Mark expected Q4-1999
Cranio-Maxillofacial VITOSS In pre-clinical studies
Reconstruction......... 155(/2/) ORTHOCOMP
Dental Surgery.......... 2,315 BIOGRAN Commercialized
Tooth Root Implant
Cement................. 830 ORTHOCOMP In pre-clinical studies
Oncology................ 480 ORTHOCOMP In research and development
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(1) Potential annual global procedures are derived from historical data for the
U.S. from various sources, including a 1990 American Dental Association
Survey of Dental Services Rendered, a 1997 Medical Data International
report, a 1992 study in the Journal of Bone Mineral Resources and
information from the Health Care Information Association. This information
was extrapolated globally by doubling the United States figures to produce
worldwide projections.
(2) This estimate includes the projections for Cranio-Maxillofacial
Reconstruction procedures for both ORTHOCOMP and VITOSS.
The following describes each of these seven indications in more detail, of
which, only the use of BIOGRAN for certain dental surgical procedures has yet
received regulatory approval.
Screw Augmentation is required in cases where the patient's bone is of
insufficient quality to allow a plate and screw construct to function. In a
typical plating procedure, 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. Failure of screws to purchase or hold is
common, especially in osteoporotic bone, although it can occur in non-
osteoporotic patients as well.
Currently, 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. An alternative
option currently used by the physicians is to disassemble and reposition the
plate and screw construct; however, this alternative adds cost of surgical time
and provides no assurance of a favorable outcome.
4
The Company believes using ORTHOCOMP to anchor the screw in a quick and
efficient way allows the full function of the screw to be restored, to the
benefit of both the surgeon and the patient. The Company knows of no cement
products that have received FDA approval or CE marking that would be in
competition with ORTHOCOMP for this indication. However the Company may face
off-label use of PMMA or calcium phosphate cements for this indication. The
Company expects to begin clinical trials in Europe and the U.S. during mid-
1999.during mid-1999.
Vertebroplasty is the filling or supplementation of up to three vertebrae,
compressed as a result of fracture, with a material that adds rigidity to
failing bone and reduces pain in the compression site. There is currently no
material approved for use in this procedure and this indication presents a
potential new market for ORTHOCOMP. Using ORTHOCOMP, the Company expects the
procedure to be performed on an outpatient or short-stay basis. The vertebra is
perforated through the pedicular arch using a catheter. The material is then
injected into the vertebra, setting within minutes and becoming load bearing.
The procedure would then be repeated through the other arch. Upon completion,
the patient should typically experience immediate pain relief and greater
mobility. The Company knows of no other approved treatment for compressed
vertebrae that remedies the physical impairment and long-term immobility that
in turn leads to morbidity and reduced life expectancy. The primary alternative
method of treatment is the use of pharmaceutical regimens; however, this method
only provides some patients with temporary pain relief. The Company knows of no
cement products that have received FDA approval or CE marking that would be in
competition with ORTHOCOMP for this indication. However the Company may face
off-label use of PMMA or calcium phosphate cements for this indication. The
Company expects to begin clinical studies in Europe and the U.S. in mid-1999.
Joint Implant Cement is used to secure reconstructive products to the bone
by applying a grout made up of a liquid (monomer) mixed with a powder (PMMA).
During the procedure, the patient's joint is exposed and prepared for the
implant. The cement material is then added to bond the implant to the bone.
Currently, PMMA is typically used in this procedure and Howmedica, producer of
Simplex cement, has the dominant market share. Joint implant cement is
currently the prevalent mode of fixation for hip, knee, shoulder and other
replacements, and according to Orthopedic Network News, joint implant cement
implants represent approximately 65% of all implant procedures. The use of
PMMA, however, exposes patients to the monomer of PMMA as well to potentially
bone-damaging high temperatures during the setting of this material. The
Company believes that ORTHOCOMP possesses superior mechanical and bioactive
properties, is more biocompatible and uses a more efficient delivery system
than PMMA. This program is currently in pre-clinical development.
Metaphyseal Defect addresses the loss of cancellous structure including the
tibial plateau. The function of the tibial plateau is to transfer the load
(weight of the body) to the shaft of the tibia (cortical bone). The cancellous
structure transfers load in a similar way to a girder structure in a building.
The plateau needs to continue to function so the patient can return to normal
activities. The Company expects the replacement of the material with VITOSS, a
space filling and load transferring material, to allow the patient to return
more quickly to function. The procedure involves the restoration of the tibial
plateau, allowing the femur to have a congruous surface with which to
interface. The fracture is augmented, if necessary, with orthopaedic hardware
such as screws. The Company may face competition from a new generation of
similar products currently entering the market or expected to enter the market
in the near future. This program is currently in pre-clinical development.
Oncology Defect procedures address the treatment of bone that has
deteriorated in strength due to cancer. Although the patient's life expectancy
has been reduced due to cancer, this procedure allows the patient an improved
quality of life. The surgeon should be able to fill cortical bone defects,
which have been created by tumors, with ORTHOCOMP. This should allow the
patient to return to an increased level of function. The patient's may also be
able to have prophylactic treatment of weakened bone regions reinforced with
ORTHOCOMP. Without this type of procedure, the patients must be bedridden to
protect the bones from failing. This program is currently in pre-clinical
development and is expected to begin clinical trials during 1999.
5
Cranio-Maxillofacial Reconstruction utilizing VITOSS as a resorbable cement
or as a scaffold matrix can possibly offer a promising bone substitute option
for indications including mandibular resections due to trauma or disease,
reconstruction of fractures and cranial defects. The Company expects ORTHOCOMP
to be useful for complicated applications such as plastic reconstruction and
facial augmentation to adjust the height and position, and to shape certain
facial features, especially the chin and cheekbone. It is feasible that both
VITOSS and ORTHOCOMP may be used in the same reconstruction or repair
procedure. Utilizing the Company's biocompatible products could potentially
reduce the recovery time and provide ease of use features for the surgeon. The
Company may face competition from a new generation of similar products
currently entering the market or expected to enter the market in the near
future. This program is currently in pre-clinical development.
Oral Surgery indications include the filling of bone defects, both those
created surgically and those caused by disease. During the course of procedures
ranging from periodontal disease treatment to implant placement, there is often
a need to build bone. BIOGRAN is placed into the site through a surgical
incision in proximity to the bone. The site is then surgically closed, and bone
regeneration ensues over a six-month period. For this indication, BIOGRAN
competes with bone grafting products for filling oral defects, including
autograft bone, allograft bone, xenograft bone and other synthetic bone graft
materials.
Tooth Root Implant Cement is used to anchor prosthetic teeth. Implants are
placed into surgically prepared sites in either the mandible or maxilla to
which prosthetic teeth are later attached. They may be placed singularly,
several teeth in a row or as a full arch. If there is a full and healthy bone
bed, the implants may be placed immediately; otherwise, a bone grafting
procedure is necessary. The current bone grafting procedure requires about six
months for the bone to regenerate. The implant is then placed and is monitored
for stability. The development and placement of the prosthetic usually occurs
after the implant has demonstrated requisite stability and this may add
additional time to the process. As a result, the entire implant procedure can
take well over a year. In comparison, implants anchored with ORTHOCOMP may
allow load bearing within two to four weeks and may possibly serve a broader
patient population, including patients with low bone-regenerative potential. In
tooth root anchoring applications, the Company believes that no alternative
exists at this time that will compete with ORTHOCOMP, other than the current
method of tooth root implantation. This program is currently in pre-clinical
development.
License Agreements
The Company's product development efforts have been dependent in part upon
Dr. Paul Ducheyne and the University of Pennsylvania ("Penn") in Philadelphia,
Pennsylvania, USA. In September 1993, the Company and Penn entered into a
license agreement (the "Penn License Agreement"). The Penn License Agreement
grants the Company an exclusive, worldwide right and license to use and sell
products that utilize technology protected by Penn's patent rights. The Penn
License Agreement allows for use in medical, dental and veterinary fields for
growth of bone cells, fixing human prosthetic devices, coating human prosthetic
devices, including bone growth onto or into modified human prosthetic device
and/or producing human prosthetic devices. The Penn License Agreement has
resulted in substantial cost savings to the Company while allowing the Company
to greatly expand its product development efforts. The Company has agreed to
pay a royalty of 4% of the net sales of products made by the Company that
utilize technology covered by the Penn License Agreement. To date no such sales
have been made. The Company agreed to developing the technologies covered by
the Penn License Agreement within a five year time period from the effective
date of the Agreement. If the Company does not develop the technologies within
the five year time period, the Company will return the rights to the Penn.
Additionally, the Company issued 120,008 shares of Company stock to Penn as
partial consideration for the exclusive license.
The Company's product development efforts have also been dependent upon FBFC
International ("FBFC"), a Belgian company established in the Kingdom of Belgium
with a registered office at B-1000 Brussels Wetstraat 24. In July 1992, the
Company and FBFC entered into a license agreement (the "FBFC License"). Under
the FBFC License, which expires in 2002, FBFC granted the Company an exclusive,
worldwide license to use the technical knowledge and expertise developed or
obtained by FBFC relating to
6
bioactive glass granules. FBFC also provides technical assistance to the
Company under the FBFC License Agreement. On December 23, 1998, the Company and
FBFC entered into a Release and Termination Agreement (the "Release") whereby
as a result of the patent defense costs exceeding the maximum earned royalty,
FBFC agreed to reimburse the Company US$474,580, the payment of which was
received January 1999. The Release specified the Company had satisfied all of
its royalty obligations under the FBFC License and that FBFC will transfer all
of its rights in the intellectual property, including the patents, to the
Company.
The Company has entered into certain agreements pursuant to which it is
obligated to pay royalties based on net revenues of the Company's VITOSS
products. To the extent that sales of these products increase future periods,
the Company's license obligations will be expected to increase.
PARTISYN CORP, a wholly owned subsidiary company, was formed to exploit the
industrial and commercial applications of the Company's fine particle synthesis
or nano-structured technology through licensing and royalty arrangements. The
formation of the subsidiary allows the Company to continue to maintain its
major focus in the development and commercialization of its core business of
biomaterials based bone substitutes and bone cements.
Sales and Marketing
The Company intends to market its products through a combination of
exclusive third-party strategic alliances, arrangements with agents and
distributors and/or through direct sales, depending upon the clinical
indications for which the products are intended.
Prior to April 28, 1998, the Company generally marketed BIOGRAN through
internal direct sales efforts in the U.S. and through local distributors
overseas. On April 28, 1998, the Company signed an agreement with 3i pursuant
to which 3i has obtained the global distribution rights for BIOGRAN and
ORTHOCOMP for the dental implant surgery market. The arrangement provided for
3i to purchase, and for the Company to supply, specified minimum monthly
amounts of BIOGRAN in 1998 for the dental market. For the years 2000 through
2003, inclusively, 3i has minimum purchase requirements of US$2.4 million per
year. The agreement may be terminated if 3i fails to purchase more than
US$600,000 in a given calendar quarter after 1999. For 1999, 3i had no minimum
purchase requirements.
The global distribution agreement with 3i provides for a sale price from the
Company to 3i in 1998, 1999 and 2000 through 2003 equal to 50%, 45% and 40%,
respectively, of 3i's average sales price to its customers in the previous
quarter. The 3i alliance has allowed the Company to decrease its sales and
marketing expenses by US$1.4 million for the year ending December 31, 1998 as
compared to 1997. The savings in sales and marketing expenses were partially
offset by a US$0.4 million decrease in gross profit margin for 1998 in
comparison to 1997.
On June 9, 1998, the Company entered into the Howmedica Agreements whereby
Howmedica has obtained exclusive worldwide marketing, sales and distribution
rights for ORTHOCOMP in joint implant procedures. Under the Howmedica
Agreements, the Company may earn payments of up to an aggregate of US$4,500,000
if various milestones are reached during the anticipated four to five year
development and approval process for this indication. Upon receipt of
regulatory approvals, Howmedica will be required to make annual minimum
purchases of ORTHOCOMP from the Company for a six-year period. Howmedica may
obtain exclusive manufacturing rights from the Company upon a one-time payment
of US$7,000,000 that, in turn, will require Howmedica to pay royalties on
future sales. Howmedica had an option until December 9, 1998 to acquire
worldwide distribution rights for screw augmentation and vertebroplasty,
subject to agreement between the two parties on minimum purchase quantities;
however, Howmedica did not exercise this option. Additionally, Howmedica has
certain rights of first negotiation and refusal for orthopaedic applications of
other Company technologies.
7
Third-Party Reimbursement
Successful sales of the Company's products in the United States and other
markets will depend, in part, on the availability of adequate reimbursement
from third-party payors. 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 payors to reimburse all or part of the
costs and fees associated with the procedures performed with these devices.
HCFA administers the policies and guidelines for coverage and reimbursement of
health care providers treating Medicare and Medicaid patients. In certain
circumstances, such as many procedures involving PMMA cement, HCFA deems such
procedures "approvable" and reimburses the providers for such services. Both
public and private insurance plans are central to new product acceptance. The
United States 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. Both
outpatient and inpatient reimbursement systems could affect the amount of
payment a hospital receives for using the Company's products if they are
approved for coverage.
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. Payment terms can vary widely
throughout the EU.
In Japan, at the end of the regulatory process, the MHW in its discretion
makes a determination of the per unit sales price of the product and the
reimbursement level.
Through the patient informed consent process, the Company receives full
access to the United States clinical trial patient's hospital discharge
financial record and other medical financial information. By comparing the cost
outcomes of treated patients and control patients, the Company expects to
substantiate the claim that the Company's products provide overall reductions
in costs thereby outweighing the incremental added cost of the product.
Research and Development
The Company's development efforts to date have been concentrated on the
development of products derived from research initially carried out at the
Catholic University of Leuven, Belgium and from its own internal research. The
Company has also gained access to intellectual property resulting from research
carried out at the Penn through a license agreement and will be working to
develop and commercialize products resulting from such research. This
intellectual property includes biomaterial substrates for tissue engineering
and carriers for growth factors and drug delivery. The Company believes that
these additional technologies may represent significant potential future market
opportunities that the Company may pursue. In addition, the Company will seek
to enter into strategic alliances, joint ventures, acquisitions, license
patented technologies and develop additional technologies to broaden its future
product offerings. The Company has incurred US$2.8 million, US$2.0 million and
US$1.2 million in research and development expense in 1998, 1997 and 1996,
respectively. See "License Agreements."
Clinical Advisory Board
The Company has a Clinical Advisory Board that currently consists of ten
preeminent clinicians. The Clinical Advisory Board has actively advised the
Company regarding potential clinical uses of its products and members may be
involved in the clinical trials of the Company's products. Certain members of
the Clinical Advisory Board have received options to purchase common stock of
the Company, a practice that the Company may continue in the future. The
Company is currently transitioning to specialized advisory Board panels for
trauma, spine and reconstruction.
8
Competition
Competition in the medical device industry is intense in both the U.S. and
Europe. Rapid product development and technological advancement generally
characterize the medical device industry. The Company's products could be
rendered noncompetitive or obsolete by technological advancements made by the
Company's current or potential competitors. There can be no assurance that the
Company will be able to respond to technological advancements through the
development and introduction of new products. Moreover, many of the Company's
existing and potential competitors have substantially greater financial,
marketing, sales, distribution and technological resources than the Company.
Such existing and potential competitors may be in the process of seeking FDA or
other regulatory approvals, or patent protection, for their respective
products. Such competitors may enjoy substantial advantages over the Company 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 the Company's products compete with procedures that have, over
the years, become standard within the medical community, there can be no
assurance that the procedures underlying the Company's products will be able to
replace more established procedures and products. There can be no assurance
that reimbursement for such procedures by third party payors will be adequate
or that the Company will succeed in obtaining a new reimbursement code for such
procedures. There can be no assurance that the Company will be able to compete
successfully against current or future competitors or that competition will not
have a material adverse effect on the Company's business, financial condition
and results of operations.
In orthopaedic and the dental surgery markets, the Company faces competition
from existing products and companies, and potential competition from emerging
companies developing bone substitutes and osteobiologics. In the dental surgery
market, BIOGRAN competes with bone grafting products for filling oral defects,
including autograft bone (bone from another part of the patient's body),
allograft bone (bone derived from cadavers), xenograft bone (bone derived from
bovines), and other synthetic bone graft materials. In orthopaedic applications
for trauma and for cranio-maxillofacial reconstruction, the Company's VITOSS
resorbable bone cements will face competition from a new generation of similar
products currently entering the market or expected to enter the market in the
near future. The Company is not aware of any cement products that have received
FDA approval or CE marking for screw augmentation or vertebroplasty that would
be in competition with ORTHOCOMP for these indications. However, the Company
may face off-label use of PMMA or calcium phosphate cements for these
indications. In tooth root anchoring applications, the Company believes that no
alternative exists at this time that will compete with ORTHOCOMP, other than
the current method of tooth root implantation. The joint implant cement market
is dominated by the use of PMMA, and Howmedica, the producer of Simplex cement,
has the dominant market share.
Government Regulation
Consistent with its intent to market its products internationally, the
Company systematically applies for all necessary regulatory approvals for its
products in defined applications in Europe, the United States and other
selected geographic territories.
Products that have premarket approval or clearance from the FDA do not
require FDA export approval. However, some countries require manufacturers to
provide an FDA certificate for products for export ("CPE"). This process
requires the device manufacturer to submit a request for certification to the
FDA that the product has been granted premarket approval or clearance in the
United States and that the manufacturing facilities appeared to be in
compliance with GMPs at the time of the last GMP inspection. The FDA will
refuse to issue a CPE if significant outstanding GMP violations exist.
The introduction of the Company's products in international markets will
also subject the Company to international regulatory clearances that may impose
additional substantial 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 its own tariff
regulations, duties and tax requirements.
9
Europe
In order to continue selling its products within the European Economic Area
following June 14, 1998, the Company is required to achieve compliance with the
requirements of the European Union Medical Devices Directive (the "MDD") and
affix CE marking on its products to attest such compliance. To achieve this,
the Company's products must meet the "essential requirements" defined under the
MDD relating to safety and performance. Furthermore, the Company must
successfully undergo a verification of its regulatory compliance ("conformity
assessment") by TNO, or the Netherlands Organization for Applied Scientific
Research, the Dutch Notified Body selected by the Company. The nature of this
assessment will depend on the regulatory class of the Company's products. Under
European law, the Company's products are likely to be in Class III. In the case
of Class III products, the Company must (as a result of the regulatory
structure which the Company has 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, the Company must, among other things, complete a risk analysis
and present sufficient clinical data. The clinical data presented by the
Company must provide evidence that the products meet the performance
specifications claimed by the Company, 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. The Company will be
subject to continued surveillance by the Notified Body and will be required to
report any serious adverse incidents to the appropriate authorities. The
Company also will be required to comply with additional national requirements
that are beyond the scope of the MDD.
The Company is in the process of implementing policies and procedures that
are intended to allow the Company to receive ISO 9000 series certification of
its 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 to be manufactured and marketed by the Company are
subject to extensive regulation by the FDA. Pursuant to the FFD&C 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 which must receive premarket
approval by the FDA to ensure their safety and effectiveness. Other than
BIOGRAN, which is not classified, the Company's 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 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."
10
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. There can be no
assurance that the Company will obtain 510(k) clearance for its products on a
timely basis.
A "not substantially equivalent" determination, or a request for additional
information, could delay the market introduction of new products that fall into
this category and could have a material adverse effect on the Company's
business, financial condition and results of operations. For any of the
Company's 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. There can
be no assurance that the Company will be able to utilize the new "Special
510(k)" option for any modifications made to the Company's 510(k)-cleared
devices.
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 postmarket controls to reduce PMA data
requirements. There can be no assurance that the Company 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.
11
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 then 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 ("IRB's"), 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 IRB's, 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 the Company 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
the Company with respect to manufacturing and quality assurance activities.
Revisions to the GMP regulations, effective June 1, 1998, will impose new
design control requirements on device manufacturers that likely will increase
the cost of complying with GMP requirements. Medical devices are also subject
to postmarket reporting requirements for deaths or serious injuries when the
device may have caused or contributed to the death or serious injury. Medical
devices are also subject to postmarket reporting requirements 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. The Company and its products are also subject to
a variety of state laws and regulations in those states or localities where its
products are or will be marketed. Any applicable state or local regulations may
hinder the Company's ability to market its 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
the Company 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 the Company's ability to do business.
Product Liability and Insurance
The Company's business involves the risk of product liability claims. While
the Company has not experienced any product liability claims to date, there can
be no assurance that product liability claims will not be asserted against the
Company or its licensees. Although the Company maintains product liability
insurance in the annual aggregate amount of up to US$10.0 million, there can be
no assurance that this coverage will be
12
adequate to protect the Company 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 the Company in
the future on terms satisfactory to the Company, if at all. A successful
product liability claim or series of claims brought against the Company in
excess of its coverage could have a material adverse effect on the Company's
business, financial condition and results of operation.
Litigation
In July 1992, the Company obtained a license from FBFC International ("FBFC"
or the "FBFC License") that allowed the Company to manufacture and sell its
BIOGRAN product. In May 1996, the University of Florida Research Foundation,
Inc., U.S. Biomaterials Corporation and Block Drug Corporation (the
"Plaintiffs") filed a complaint in the U.S. District Court for the Northern
District of Florida against the Company, a distributor of the Company's BIOGRAN
product and the Company's Chairman (the "BIOGRAN Matter"). 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. This action also
included complaints alleging false representation, unfair competition, false
advertising and trade disparagement under Federal and Florida state laws. In
April 1998, the court granted the Company's summary judgment motion stating
that the Company's BIOGRAN product does not infringe this patent. The
complaints alleging false representation, unfair competition, false advertising
and trade disparagement were settled with the Plaintiffs in September 1998.
During September 1998, the Plaintiffs requested an appeal to the Court's
summary judgment with respect to the patent infringement claim. In response,
the Company filed a counterclaim alleging inequitable conduct. For the years
ended December 31, 1997 and 1996, the Company recorded approximately US$1.7
million and US$759,000 of expenses related to its defense of the BIOGRAN,
respectively. The Company recorded an offset to expense of US$900,000 during
1998 related to the BIOGRAN Matter. As of December 31, 1998, the Company has
accrued US$472,492 for the estimated future cost of defending this litigation.
In accordance with the FBFC License, FBFC agreed to indemnify the Company
for all reasonable damages and costs incurred by the Company arising out of or
resulting from this action, for an amount not to exceed the maximum aggregate
royalty payments associated with this technology. Since 1996, the Company has
recorded patent litigation legal fees in excess of US$1.5 million and, based
upon the royalty of 12% of net sales, approximately US$1,024,000 was be owed to
FBFC. On December 23, 1998, the Company and FBFC entered into a Release and
Termination Agreement (the "Release") whereby, FBFC agreed to reimburse the
Company US$474,580 for patent defense costs that exceeded the maximum earned
royalty. This payment was received in January 1999. The Release specified the
Company had satisfied all of its royalty obligations under the FBFC License,
and that FBFC will transfer all of its rights in the intellectual property,
including the patents, to the Company.
From time-to-time, the Company may be involved in litigation relating to
claims arising out of its business. Other than the BIOGRAN Matter, there are no
claims or actions that are currently pending or anticipated against the
Company.
Employees
As of December 31, 1998, the Company had a total of 31 full-time employees
primarily employed at the Company's headquarters in Malvern, Pennsylvania, USA.
The Company believes that it has been highly successful in attracting and
retaining experienced personnel, however, competition for such personnel is
strong. None of the Company's employees are covered by collective bargaining
agreements. Management considers its relations with its employees to be good.
13
ITEM 2. PROPERTIES
The Company's administrative and research facilities currently occupy
approximately 18,500 square feet of space in two facilities in Malvern,
Pennsylvania, USA at an annual payment of approximately US$143,000. These
facilities are leased through July 2001, with an option to renew for an
additional five-year term. The Company is adding capacity of approximately
7,000 square feet at a third facility nearby to support development efforts.
ITEM 3. LEGAL PROCEEDINGS
In July 1992, the Company obtained a license from FBFC that allowed the
Company to manufacture and sell its BIOGRAN product. In May 1996, the
University of Florida Research Foundation, Inc., U.S. Biomaterials Corporation
and Block Drug Corporation (the "Plaintiffs") filed a complaint in the U.S.
District Court for the Northern District of Florida against the Company, a
distributor of the Company's BIOGRAN product and the Company's Chairman (the
"BIOGRAN Matter"). 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. This action also included complaints alleging false
representation, unfair competition, false advertising and trade disparagement
under Federal and Florida state laws. In April 1998, the court granted the
Company's summary judgment motion stating that the Company's BIOGRAN product
does not infringe this patent. The complaints alleging false representation,
unfair competition, false advertising and trade disparagement were settled with
the Plaintiffs in September 1998. During September 1998, the Plaintiffs
requested an appeal to the Court's summary judgment with respect to the patent
infringement claim. In response, the Company filed a counterclaim alleging
inequitable conduct. For the years ended December 31, 1997 and 1996, the
Company recorded approximately US$1.7 million and US$759,000 of expenses
related to its defense of the BIOGRAN Matter, respectively. During 1998, the
Company recorded an offset to expense of US$900,000 related to the BIOGRAN
Matter. As of December 31, 1998, the Company has a reserve of US$472,492 for
the estimated future cost of defending this litigation.
In accordance with the license obtained from FBFC, FBFC agreed to indemnify
the Company for all reasonable damages and costs incurred by the Company
arising out of or resulting from this action, for an amount not to exceed the
maximum aggregate royalty payments associated with this technology. Since 1996,
the Company has recorded patent litigation legal fees in excess of US$1.5
million and, based upon the royalty of 12% of net sales, approximately
US$1,024,000 was be owed to FBFC. On December 23, 1998, the Company and FBFC
entered into a Release and Termination Agreement (the "Release") whereby, FBFC
agreed to reimburse the Company US$474,580 for patent defense costs that
exceeded the maximum earned royalty. This payment was received in January 1999.
The Release specified the Company had satisfied all of its royalty obligations
under the FBFC License, and that FBFC will transfer all of its rights in the
intellectual property, including the patents, to the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to the vote of security holders during the fourth
quarter of fiscal 1998.
14
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS
The Common Stock of Orthovita, Inc. is quoted on the European Association of
Securities Dealers Automated Quotation ("EASDAQ") under the ticker symbol
"VITA." The following table sets forth the range of high and low sale prices
for the common stock as reported on the EASDAQ for the periods indicated below.
High Low
-------- --------
Initial Public Offering (June 25, 1998) through June 30,
1998................................................... US$10.88 US$10.00
Third Quarter, 1998..................................... 11.38 9.50
Fourth Quarter, 1998.................................... 9.50 4.38
As of December 31, 1998 there were 225 holders of record of the common
stock. On March 23, 1999, the last reported sale price of the common stock as
reported on the EASDAQ was US$ 5.25 per share.
The Company has never declared or paid cash dividends on its capital stock
and does not anticipate paying any cash dividends in the foreseeable future.
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The following selected consolidated financial data have been derived from
the consolidated financial statements of Orthovita, Inc. and Subsidiaries as of
and for each of the four years in the period ended December 31, 1998 which have
been audited by Arthur Andersen LLP, independent public accountants. These data
should be read in conjunction with the Company's consolidated financial
statements, including notes thereto, and "Management's Discussion and Analysis
of Financial Condition and Results of Operations" included herein.
Year Ended December 31,
-------------------------------------
1998 1997 1996
------------ ----------- ----------
Statement of Operations Data:
Net revenues........................... $ 2,780,658 $ 3,311,540 $1,860,326
Cost of sales.......................... 927,792 1,096,848 887,236
Operating expenses..................... 7,897,961 9,998,945 7,162,104
Other (income) expenses................ (344,307) 169,066 250,939
Extraordinary item--(gain)............. -- (397,402) --
Accretion of preferred stock........... 391,213 536,517 --
------------ ----------- ----------
Net loss applicable to common
shareholders.......................... $ 6,092,001 $ 8,092,434 $6,439,953
============ =========== ==========
Net loss per common share.............. $ 0.73 $ 1.60 $ 1.60
============ =========== ==========
Shares used in computing net loss per
common share 8,314,679 5,050,397 4,036,150
============ =========== ==========
As of December 31,
-------------------------------------
1998 1997 1996
------------ ----------- ----------
Balance Sheet Data:
Cash, cash equivalents and short-term
investments........................... $ 15,355,808 $ 2,257,902 $ 253,465
Total assets........................... 18,888,632 4,862,010 1,546,137
Working capital (deficit).............. 14,471,102 (1,080,859) (3,140,323)
Long-term debt......................... 737,427 832,991 1,588,539
Redeemable convertible preferred
stock................................. -- 7,383,090 --
Total shareholders' equity (deficit)... 15,528,575 (7,712,696) (4,088,685)
15
ITEM 7: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion should be read in conjunction with the Consolidated
Financial Statements and Notes to the Consolidated Financial Statements on
pages F-1 to F-15 of this Form 10-K
Overview
Orthovita is a biomaterials company that was incorporated under the laws of
the Commonwealth of Pennsylvania and began operations in 1993. The Company is
developing proprietary osteobiologic bone substitutes and bone cements that it
intends to manufacture and market on a global basis. Orthovita has targeted its
products for sale to the trauma, spine, implant cement, cranio-maxillofacial
and dental implant surgery markets. The Company has developed and is
manufacturing through third party vendors BIOGRAN(R) it's first commercialized
product that is a resorbable, granular biomaterial that biologically transforms
to bone and which it is selling and marketing through Implant Innovations Inc.
("3i"), a leading dental implant company. The Company has in development
ORTHOCOMP(TM) injectable cement and ORTHOBONE(TM) Putty, as composite, fast-
setting, high strength resins with a biological interface that bonds to bone;
and VITOSS(TM), in development as an injectable resorbable cement that aids in
fracture healing and as a scaffold matrix that is conducive to cell attachment.
To date, the Company has only received regulatory approval for BIOGRAN for use
in certain dental surgical applications. There can be no assurance that the
Company will obtain regulatory approval for any other indications or for any of
its other products or that it will successfully commercialize any of its
products.
Prior to April 28, 1998, the Company generally marketed BIOGRAN through
internal direct sales efforts in the U.S. and through local distributors
overseas. On April 28, 1998, the Company signed an agreement with 3i pursuant
to which 3i has obtained the global distribution rights for BIOGRAN and
ORTHOCOMP for the dental implant surgery market. The arrangement provided for
3i to purchase, and for the Company to supply, specified minimum monthly
amounts of BIOGRAN in 1998 for the dental market. For the years 2000 through
2003, inclusively, 3i has minimum purchase requirements of US$2.4 million per
year. The agreement may be terminated if 3i fails to purchase more than
US$600,000 in a given calendar quarter after 1999. For 1999, 3i has no minimum
purchase requirements.
Results of Operations
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 US$2.8
million, compared to US$3.3 million for the year ended December 31, 1997. This
decrease was a result of the 3i agreement which dictates that the Company's
selling price per unit is 50% of 3i's average selling price per unit to their
customers. The Company actually shipped 19% more BIOGRAN units in 1998 in
comparison to 1997. The global distribution agreement with 3i provides for a
sales price from the Company to 3i in 1998 equal to 50% of 3i's average sales
price to its customers in the previous quarter. The 3i alliance has allowed the
Company to decrease its sales and marketing expenses by US$1.4 million for the
year ending December 31, 1998 as compared to 1997. The savings in sales and
marketing expenses offset were partially offset by a US$0.4 million decrease in
gross profit margin.
Gross Profit. The Company's gross profit for the year ended December 31,
1998 was US$1.9 million, or 67% of net revenues, compared to US$2.2 million, or
67% of net revenues, for the prior year. The Company realized significant
BIOGRAN manufacturing cost reductions in 1998 when the Company consolidated its
BIOGRAN manufacturing operation into the U.S. The manufacturing cost reductions
enabled the Company to maintain its gross profit margins percentage on its
BIOGRAN net product revenues in 1998 as compared to 1997 as the Company reduced
in its average selling price per unit to 50% of 3i's average selling price per
unit to their customers.
16
Operating Expenses. The Company's operating expenses for the year ended
December 31, 1998 were US$7.9 million compared to US$10.0 million for the prior
year. This decrease in operating expenses consisted primarily of decreases in
general and administrative expenses of US$1.5 million and decreases in selling
and marketing expenses of US$1.4 million offset by an increase in research and
development of US$778,000. The Company attributes the decreases in general and
administrative expenses to lower expenses relating to patent litigation
expenses associated with the BIOGRAN Matter and reimbursement of those expenses
from FBFC and the Company's insurance company related to the BIOGRAN 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 Matter. Decreases in selling and marketing expenses are a result of
the reduction in the dental direct sales force in connection with the
transition to 3i. The Company attributes its increases in research and
development expenses to expenses incurred in its preclinical activities in
preparation for regulatory filings.
Other Income (Expenses). The Company's other income (expenses), include
interest expense, interest income and currency translation losses. The Company
recorded US$344,000 of other income for the year ended December 31, 1998
compared to US$169,000 of other expense for the year ended December 31, 1997.
In 1998 the Company realized net interest income as a result the investment of
the initial public offering in June 1998. In 1997, the Company recorded a
currency translation loss of US$202,527 from the impact of exchange rate
changes on intercompany balances.
Extraordinary Gain. In 1997, the Company recorded an extraordinary gain of
US$397,000 when it was relieved of certain debt owing to the Flemish government
upon the Company's election not to pursue the commercialization of one of the
dental products licensed from FBFC. See Note 6 to Notes to Financial
Statements.
Net Loss. As a result of the foregoing factors, the Company's net loss for
the year ended December 31, 1998 was US$6.1 million compared to a net loss of
US$8.1 million for the prior year.
Comparison of the Year Ended December 31, 1997 to the Year Ended December 31,
1996
Net Revenues. Net revenues for the year ended December 31, 1997 were US$3.3
million, compared to US$1.9 million for the year ended December 31, 1996,
representing an increase of 78%. The Company attributes this increase to
greater market penetration of BIOGRAN that resulted from the Company's
increased marketing efforts.
Gross Profit. The Company's gross profit for the year ended December 31,
1997 was US$2.2 million, or 67% of net revenues, compared to US$1.0 million, or
52% of net revenues, for the prior year. The Company attributes this
improvement in its gross profit margin to its consolidation of its
manufacturing of BIOGRAN in the U.S., which consolidation was completed in the
fourth quarter of 1997.
Operating Expenses. The Company's operating expenses for the year ended
December 31, 1997 were US$10.0 million compared to US$7.2 million for the prior
year. This increase in operating expenses consisted primarily of increases in
general and administrative expenses of US$1.7 million and in research and
development of US$808,000. The Company attributes the increases in general and
administrative expenses to ongoing growth in staffing and facilities necessary
to support the growth of its business, US$1.0 million in additional fees and
expenses relating to the BIOGRAN Matter, and US$350,000 relating to the closing
of the Company's European manufacturing facility. The Company attributes its
increases in research and development expenses to expenses incurred in its
preclinical activities in preparation for regulatory filings.
Other Expenses. The Company's other expenses, which includes interest
expense, interest income and currency translation losses, were US$169,000 for
the year ended December 31, 1997 compared to US$251,000 for the year ended
December 31, 1996. In 1997 the Company realized net interest income as a result
the
17
investment of the net proceeds realized from the April 1997 Financing. The
Company recorded a currency translation loss of US$203,000 in 1997 from the
impact of exchange rate changes on intercompany receivables.
Extraordinary Gain. In 1997, the Company recorded an extraordinary gain of
US$397,000 when it was relieved of certain debt owing to the Flemish government
upon the Company's election not to pursue the commercialization of one of the
dental products licensed from FBFC. See Note 6 to Notes to Financial
Statements.
Net Loss. As a result of the foregoing factors, the Company's net loss for
the year ended December 31, 1997 was US$7.6 million compared to a net loss of
US$6.4 million for the prior year.
Liquidity and Capital Resources
The Company has experienced negative operating cash flows since its
inception. The Company plans 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. The Company believes that existing cash, together with the cash
generated from the sale of current products, will be sufficient to meet the
Company's currently estimated operating and capital requirements at least
through the end of 2000. The Company's 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
the Company's products gain market acceptance, the acquisition and defense of
intellectual property rights, the development of strategic alliances for the
marketing of certain of its products, and competitive developments. In
addition, although the Company has no present commitments or understandings, it
may seek to expand its operations and product line via acquisitions or joint
ventures and any such acquisition or joint venture may increase the Company's
capital requirements. Should the Company's cash not be sufficient to meet the
Company's currently estimated requirements, the Company will need to obtain
additional funds through equity or debt financings, strategic alliances with
third parties or from other sources. This activity may result in substantial
dilution to the holders of common stock and in significant financial and
operational restrictions. Any such required financing may not be available on
satisfactory terms, if at all.
As a result of the Company's initial public offering during June 1998, cash,
cash equivalents and short-term investments increased 580% from December 31,
1997 to 1998. As a percentage of total assets, cash, cash equivalents and
short-term investments increased from 46% at December 31,1997 to 81% at
December 31, 1998. As of December 31, 1998 and 1997 cash, cash equivalents and
investments consisted of the following:
Gross Gross
Unrealized Unrealized Fair Market
Original Cost Gains Losses Value
-------------- ---------- ---------- -------------
December 31, 1998:
Cash and cash
equivalents............. US$ 842,064 -- -- US$ 842,064
Short-term investments... 14,414,394 US$106,882 US$(7,532) 14,513,744
-------------- ---------- --------- -------------
US$ 15,256,458 US$106,882 US$(7,532) US$15,355,808
============== ========== ========= =============
Percentage of total
assets.................. 81.3%
=============
December 31, 1997:
Cash and cash
equivalents............. US$ 2,257,902 -- -- US$ 2,257,902
============== ========== ========= =============
Percentage of total
assets.................. 46.4%
=============
The Company invests its 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 (deficit).
18
The following is a summary of selected cash flow information:
Year Ended December 31,
--------------------------------------------
1998 1997 1996
-------------- ------------- -------------
Net cash used in operating
activities..................... US$ (6,335,509) US$(7,588,532) US$(4,968,612)
Net cash used in investing
activities..................... (14,525,341) (413,939) (345,877)
Net cash provided by financing
activities..................... 19,407,435 10,008,992 4,821,127
Effect or exchange rate on
cash........................... 37,577 (2,084) (15,851)
-------------- ------------- -------------
Net change in cash.............. US$ (1,415,838) US$ 2,004,437 US$ (509,213)
============== ============= =============
Net Cash Used for Operating Activities
The principal source of the Company's current operating cash inflows is from
the sale of BIOGRAN. Cash outflows were primarily used for the
commercialization of BIOGRAN and for development and pre-clinical activities in
preparation for regulatory filings of ORTHOCOMP and VITOSS. Funds have been
used for the further selling, marketing and distribution of BIOGRAN and the
expansion of the Company from a development-stage company.
Net Cash Used for Investing Activities
The Company has invested US$111,000, US$414,000 and US$346,000 for the years
ended December 31, 1998, 1997 and 1996, respectively in the purchase of
property and equipment for the expansion of its product development
capabilities. During the year ended December 31, 1998, the Company invested
US$14,414,000 in short-term marketable securities.
Net Cash Provided By Financing Activities
A summary of net cash provided by financing activities is as follows:
Year Ended December 31,
------------------------------------------
1998 1997 1996
------------- ------------- ------------
Proceeds from sale of common stock
and warrants..................... US$20,187,838 US$ 2,255,694 US$4,446,817
Proceeds from sale of convertible
preferred stock.................. -- 7,609,204 --
Proceeds from exercise of common
stock options and warrants....... 640,633 -- --
Proceeds (repayments) of debt..... (487,507) 163,197 370,700
Repayments of capital lease
obligations...................... (241,529) (51,103) (6,390)
Proceeds (repayments) of short-
term bank borrowings............. (692,000) 32,000 10,000
------------- ------------- ------------
Net cash provided by financing
activities....................... US$19,407,435 US$10,008,992 US$4,821,127
============= ============= ============
In September 1997, the Company obtained a US$1.2 million capital lease
financing arrangement. The term of each individual lease under this arrangement
is 42 months, with payments based upon a monthly lease factor of US$29.31 per
US$1,000 of acquisition cost and imputed interest of approximately 14.85%.
These leases are secured by the underlying capital assets.
Commitments and Contingencies
The Company leases office space and equipment under non-cancelable operating
leases. For the years ended December 31, 1998, 1997 and 1996, lease expense was
US$213,000, US$164,000 and US$150,000, respectively. Future minimum rent
payments through the expiration of these leases are US$217,000 in 1999,
US$206,000 in 2000, US$102,000 in 2001.
19
Readiness for the Year 2000
The Year 2000 issue results from the writing of computer programs using two
digits rather than four digits to define the applicable year. In other words,
date-sensitive software may recognize a date using "00" as the year 1900 rather
than the year 2000. This could result in system failures or miscalculations
causing disruptions of operations, including, among others, a temporary
inability to process transactions or engage in other normal business
activities.
Set forth below is a description of the Company's current state of readiness
and other information related to Year 2000 issues that may affect the Company.
Will Orthovita Be Ready?
Information Technology Systems. The core information technology systems
utilized by the Company appear to be Year 2000 compliant. These information
technology systems support the Company's major business functions, including
accounting and financial reporting and internal and external electronic mail.
The Company uses the Great Plains/Horizon system for, accounting and financial
reporting, purchasing and manufacturing functions. This system's software
programs currently utilize a four-digit year that properly recognizes the Year
2000. In addition, the Company's software to handle both internal and external
electronic mail uses a four-digit year. The Company's third party payroll
processor has certified to the Company that it is Year 2000 compliant.
Non-Information Technology Systems Non-information technology systems
include embedded technology such as microcontrollers. The Company's non-
technology systems include HVAC systems, fax machines and certain process
development equipment. Based on its initial assessment of these systems at its
facilities, the Company has determined that the systems are not date sensitive
and therefore do not raise Year 2000 issues. However, the Company is continuing
to examine all in-house equipment in greater detail to confirm compliance or
identify areas of potential non-compliance.
Material Third Party Relationships The Company has made inquiries of its
principal suppliers and service providers to determine its vulnerability if
these third parties fail to identify and remediate their own Year 2000 issues,
if any. The Company believes that third party service providers and suppliers
whose Year 2000 issues could have a material impact on the Company include its
telecommunications providers and key supply chain vendors.
The Company has defined its principal vendors, suppliers and service
providers and has made inquiries regarding Year 2000 compliance. The Company
mailed written letters to approximately 110 vendors, suppliers and service
providers and no negative response has been received to-date. The Company will
continue to monitor existing and new vendors, suppliers and service providers
to determine if alternative vendors, suppliers or service providers will need
to be established.
How Much Will It Cost to Address Year 2000 Issues?
To date, the Company has not incurred any remediation costs associated with
Year 2000 issues and future costs are uncertain and difficult to estimate. The
Company is in the process of determining future costs related to Year 2000
issue. All remediation costs will be expensed as incurred.
What are the Possible Consequences of Year 2000 Issues Confronting the
Company?
In the event that key suppliers, vendors or service providers are not
compliant, the Company would be required to migrate its services to compliant
vendors. This would require additional time and resources, resulting in
additional operating expenses through a transition period and could possibly
impact the Company's ability to manufacture its products for clinical supply or
for commercial sale and could possible result in the delay of certain clinical
studies. In addition, if the Company determines that key in-house equipment is
not compliant, programming costs would be necessary to upgrade or replace the
equipment.
20
What is the Company's Contingency Plans?
Given the Company has not determined that a contingency plan with respect to
non-compliant in-house systems or third party suppliers, vendors or service
providers is necessary, no such plan has been established. If in the future the
Company determines a contingency plan is required, it will formulate such
contingency plan.
Forward-Looking Statements
The statements in the Company's Year 2000 disclosure contain forward-looking
statements and should be read in conjunction with the Company's disclosure
under "Management's Discussion and Analysis of Financial Condition and Results
of Operations--Certain Risks Related to Orthovita's Business."
Cautionary Statement Concerning Forward-Looking Statements
This Form 10-K contains forward-looking statements including the information
concerning possible or assumed future results of operations of our company that
appear in this Form 10-K and those preceded by, followed by or that include the
words "anticipates," "believes," "estimates," "expects," "hopes," "intends" or
similar expressions. For those statements, we claim the protection of the safe
harbor for forward-looking statements contained in the Private Securities
Litigation Reform Act of 1995. You should understand that the following
important factors, in addition to those discussed elsewhere in this document
particularly in Item 1, Business and Item 7, Management's Discussion and
Analysis of Financial Condition and Results of Operations, could adversely
affect the future results of Orthovita and could cause those results to differ
materially from those expressed in our forward-looking statements:
.the ability to obtain regulatory approvals to market our products;
.restrictions on the anatomic sites and types of procedures for which our
products may be used;
.the ability to enroll sufficient numbers of patents to complete clinical
studies;
.the market acceptance of our products;
.the ability to market, sell and distribute our products;
.the expectation of continuing losses;
.the safety and effect of our products for use in any new indications;
.third-party reimbursements;
.the preservation of trade secrets, and the ability to obtain and
maintain patent protection and operation without infringing the
proprietary rights of others;
.the ability to manufacture our products in commercial quantities, in a
cost-effective manner and in compliance with regulatory requirements;
.the possible effects of changes in government regulation;
.reliance on suppliers;
.the dependence on key personnel; and
.the exposure to Year 2000 issues.
Actual future results may differ materially from those expressed in our
forward-looking statements set forth in this Form 10-K for a number of reasons,
including our inability to:
.obtain additional financing;
.protect our proprietary rights;
21
.maintain relationships with our the University of Pennsylvania, FBFC
International, Howmedica, Inc., Implant Innovations, Inc and other
important business partners;
.compete effectively with other companies;
.manage effectively our growth; and
.avoid Year 2000 issues.
22
OTHER MATTERS--RISK FACTORS
You should carefully consider the following factors and other information in
this Form 10-K.
Keep these risk factors in mind when you read "forward-looking" statements
elsewhere in this document. These are statements that relate to future events
and time periods or our expectations. Generally, the words "anticipates,"
"believes," "estimates," "expects," "hopes," "intends" and similar expressions
identify forward-looking statements. Forward-looking statements involve risks
and uncertainties, and future events and circumstances could differ
significantly from those anticipated.
We have a history of losses and expect future losses that could decrease the
value of your shares.
We are a developmental company and since we were founded, we have a history
of losses and have had a negative cash flow. As of December 31, 1998, we
experienced cumulative net losses of about $27.0 million, with net loss of
about $6.1 million and $8.1 million for each of the years ended December 31,
1998 and December 31, 1997, respectively. We expect to continue to incur
significant operating losses in the future as we continue to:
.expand our product development efforts;
.expand our marketing and sales activities; and
.develop our manufacturing capabilities.
We can offer no assurance that we will ever be profitable.
Fluctuations in our quarterly operating results may result in a failure to meet
analysts' and investors' expectations, causing our share price to decline or
fluctuate widely.
We expect that our quarterly operating results will fluctuate significantly.
This may be caused by:
.the timing of governmental approvals;
.unanticipated events associated with clinical and preclinical trials;
.restrictions on the anatomic sites and types of procedures for which our
products may be used;
.the medical community's acceptance of our products;
.the success of competitive products;
.our ability to enter into business relationships with third parties;
.our ability to market our product and access the distribution channels;
.expenses associated with development and protection of intellectual
property matters;
.the departure of key personnel;
.unexpected problems with key suppliers;
.establishment of commercial scale manufacturing capabilities; and
.the timing of expense related to the commercialization of new products.
Therefore, we believe that comparing our quarterly results will not be
informative and is not an indication of future performance.
We are subject to government regulation that may be costly to comply with and
may interfere with our ability to conduct business.
We may be required to incur significant costs and burdens to comply with all
government regulation to which we are subject. We intend to apply for all
necessary regulatory approvals for our products in Europe, the United States
and other selected geographic territories in order to market our products. As
the review process
23
varies from country to country, we must comply with the regulatory clearances
in each country that may impose additional costs and burdens on our business.
These regulations include:
.product standards and approvals, including in the United States, FDA
approval;
.packaging and labeling requirements;
.promotional restrictions;
.U.S. federal, state and local laws where our products are marketed or
manufactured;
.country or local regulations where our products are marketed or
manufactured;
.environmental laws;
.import restrictions;
.tariff regulations; and
.duties and tax requirements.
We may need additional funds that, if available, could substantially increase
our interest expense or dilute your shareholdings. If these additional funds
are unavailable, we will be materially adversely affected.
We may need additional funding which may not be available. Since our
inception, we have experienced negative operating cash flows. We expect this to
continue as we plan to continue to spend substantial funds for clinical trials,
research and development and the establishment of commercial scale
manufacturing capabilities. We may need to raise additional funding to provide
sufficient cash reserves that may not be available. If we issue equity
securities in connection with a financing, your shareholdings will be diluted.
If we do need to raise additional funds through a debt financing, we will incur
interest charges and will likely become subject to restrictions on our
operations and finances. These funds may not be available on satisfactory
terms, if at all. If adequate financing is not available, we may be required to
delay, scale back or eliminate certain operations.
If our products are not accepted, we will be materially adversely affected.
Our products are based on new technology, that we expect will to be used in
certain new emerging procedures such as vertebroplasty, and may not be accepted
by the market. If our products are not accepted, we will be materially
adversely affected. Our products compete with more established treatments and
procedures currently accepted as the standards of care. Market acceptance of
our products will depend on:
.the receipt and timing of regulatory approvals;
.physician awareness;
.marketing and sales efforts of us and our third-parties; and
.the availability of adequate third-party reimbursement.
Our business will suffer if our products are not accepted in the market in
preference to other competing products or therapies.
We rely on licenses with third parties.
These licenses provide us with rights to exploit patent rights that are used
to make products. These licenses have provided us with substantial cost
savings. Our ability to develop and market our products will be materially
adversely affected by any negative developments in relation to these patents.
The failure to demonstrate safety and effectiveness in clinical trials could
hinder us from obtaining regulatory approval.
Our product candidates, ORTHOCOMP Injectable cement, ORTHOBONE Putty, VITOSS
Scaffold and VITOSS Injectable cement, that are in pre-clinical studies or
research and development, may not receive timely
24
regulatory approval, if at all. These products may not be successful based on a
number of factors including:
.failure to demonstrate safety and effectiveness for use in any new
indication;
.failure to obtain regulatory approval to market our products for new
indications;
.the ability to manufacture our products in commercial quantities, in a
cost-effective manner and in compliance with regulatory requirements;
.lack of market acceptance; and
.unavailability of third-party reimbursement.
Our products may not be considered cost-effective by third party payors and
that may materially adversely affect our ability to sell our products on a
profitable basis.
We will be negatively affected if we can not successfully sell our products
to third party payors. Hospitals or practicing physicians, surgeons and
dentists generally purchase our products and bill various third-party payors
such as:
.governmental programs;
.managed care organizations;
.other private health insurers; and
.other governmental health insurers.
Since some of the procedures that will require the use of our product will
be new, an existing reimbursement code may not be available or suitable to
provide reimbursement at an adequate level, if at all. These third-party payors
may deny reimbursement or reimburse at a low price if they conclude that our
product is not cost effective or that the product is being used for an
unapproved indication. The third-party payors may make this decision based on
clinical, economic and other data. Also, these third-party payors are
pressuring medical suppliers to lower their prices that would negatively affect
our ability to sell our products on a profitable basis.
We many not be able to protect our proprietary rights and may infringe on the
proprietary rights of others, both of which would have a material adverse
effect on our business.
Our efforts to establish and protect our proprietary rights may be
inadequate to prevent misappropriation or infringement of our proprietary
property in the United States, the European Union and other jurisdictions.
Further, our business will be affected if we can not operate without infringing
the proprietary rights of other parties.
As we expend a substantial amount of time and expense on developing and
commercializing new medical devices, it is important for us to obtain and
maintain trade secrets and patent protections in connection with these new
medical devices. We also try to protect our trade secrets and proprietary know-
how, in part, by confidentiality agreements with our corporate partners,
collaborators, employees and consultants. As of December 31, 1998, we owned or
controlled 19 U.S. patents and 14 pending U.S. patent applications, 2 issued
patents and 11 pending patent applications in Europe, 11 patent applications in
Japan and 1issued patent in Taiwan. We intend to continue to cooperate with our
licensors and Penn, in obtaining patent protection for intellectual property
exclusively licensed to us.
In July 1992, the Company obtained a license from FBFC (the "FBFC License")
that allowed the Company to manufacture and sell its BIOGRAN product. In May
1996, the University of Florida Research Foundation, Inc., U.S. Biomaterials
Corporation and Block Drug Corporation (the "Plaintiffs") filed a complaint in
the U.S. District Court for the Northern District of Florida against the
Company, a distributor of the Company's BIOGRAN product and the Company's
Chairman (the "BIOGRAN Matter"). This action charged the defendants with
infringement of U.S. Patent No. 4,851,046, said to be assigned to the
University of
25
Florida Research Foundation and said to be exclusively licensed to U.S.
Biomaterials Corporation. This action also included complaints alleging false
representation, unfair competition, false advertising and trade disparagement
under Federal and Florida state laws. In April 1998, the court granted the
Company's summary judgment motion stating that the Company's BIOGRAN product
does not infringe this patent. The complaints alleging false representation,
unfair competition, false advertising and trade disparagement were settled with
the Plaintiffs in September 1998. During September 1998, the Plaintiffs
requested an appeal to the Court's summary judgment with respect to the patent
infringement claim. In response, the Company filed a counterclaim alleging
inequitable conduct. For the years ended December 31, 1997 and 1996, the
Company recorded approximately US$1.7 million and US$759,000 of expenses
related to its defense of the BIOGRAN, respectively. The Company recorded an
offset to expenses of US$900,000 in 1998 related to the BIOGRAN Matter. As of
December 31, 1998, the Company has accrued US$472,492 for the estimated future
cost of defending this litigation. There can be no assurance that the BIOGRAN
Matter will be resolved on a basis that is favorable to us in the near future,
if at all.
In accordance with the FBFC License, FBFC agreed to indemnify the Company
for all reasonable damages and costs incurred by the Company arising out of or
resulting from this action, for an amount not to exceed the maximum aggregate
royalty payments associated with this technology. Since 1996, the Company has
recorded patent litigation legal fees in excess of US$1.5 million and, based
upon the royalty of 12% of net sales, approximately US$1,024,000 was be owed to
FBFC. On December 23, 1998, the Company and FBFC entered into a Release and
Termination Agreement (the "Release") whereby, FBFC agreed to reimburse the
Company US$474,580 for patent defense costs that exceeded the maximum earned
royalty. This payment was received in January 1999. The Release specified the
Company had satisfied all of its royalty obligations under the FBFC License,
and that FBFC will transfer all of its rights in the intellectual property,
including the patents, to the Company.
Our future success depends on our ability to manufacture our products.
Our success is dependent on our ability to manufacture our products for
which we have limited manufacturing capacity and experience. We are subject to
regulation and periodic inspection of our manufacturing process. Our
manufacturing activities could fail to comply with these regulations and our
manufacturing activities would be materially adversely affected. If we do
obtain the necessary regulatory approvals, it may not be on a timely basis. We
cannot assure that we will be able to manufacture our products in commercial
quantities, in a cost-effective manner and in compliance with regulatory
requirements.
If we are unable to maintain our relationship with our supplies, our ability to
distribute our products will be impeded.
We are dependent on a limited number of suppliers. Our ability to distribute
our products will be impeded if we are unable to maintain our relationship with
our suppliers. We are unable to manufacture our products without the specialty
products and services we receive from our suppliers. Therefore, our business is
dependent on our ability to maintain our relationship with these suppliers or
to establish new relationships with companies who provide similar products and
services. We cannot assure that we will maintain our relationship with these
suppliers or find replacement suppliers capable of providing products and
services on satisfactory terms.
We may face technological changes that could render our products noncompetitive
or obsolete.
New developments medical device, medical products and pharmaceutical
companies could render our products noncompetitive or obsolete by technological
advances. Our business is characterized by extensive research efforts and rapid
technological progress. We may not be able to respond to technological advances
through the development and introduction of new products. In addition,
unforeseen problems may develop with our technologies or applications. We may
not successfully address technological challenges that we encounter in our
research and development programs and may not ultimately develop commercially
feasible products.
26
We must establish our own orthobiologics marketing and sales capabilities or
gain access to existing orthopaedic distribution channels for our products in
order for us to successfully sell our products.
The orthopedic distribution channels are well established but may not be
well suited to the marketing, sales and distribution of our products. We expect
we will need to build our own direct sales and marketing abilities in
orthobiologics in certain territories such as the U.S. and Europe in order for
us to successfully sell our products for certain indications such as
vertebroplasty. We cannot assure that we will be successful in these efforts
or, in the alternative, be able to gain access to the established orthopedic
distribution channels. These efforts may require the considerable expenditure
of funds that will adversely effect operating results.
We compete with other biotechnology and medical device companies who may be
more successful that we are in developing and marketing products.
Competition in our business is intense in both the United States and Europe.
We will be materially adversely affected if we cannot compete successfully. Our
competitors have substantially greater financial, marketing, sales,
distribution and technological resources than we do. These current and future
competitors may be in the process of seeking FDA or other regulatory approvals
or patent protection for their products. They also may have 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
.development of distribution channels.
As our products compete with procedures that have over the years become
standard within the medical community, the procedures that underlie our
products may not be able to replace more established procedures and products.
In orthopaedic and the dental surgery markets, we face competition from
existing products and companies and potential competition from companies
developing bone substitutes and osteobiologics. In the dental surgery market,
our product, BIOGRAN competes with bone grafting products for filling oral
defects which includes:
.autograft bone, which is bone from another part of the patent's body;
.allograft bone, which is bone derived from cadavers;
.xenograft bone, which is bone derived from bovines; and
.other synthetic bone graft materials.
In orthopaedic applications for trauma and for cranio-maxillofacial
reconstruction, our VITOSS resorbable bone cements will face competition from a
new generation of similar products currently entering the market or expected to
enter the market in the near future. We do not know of any cement product that
has received regulatory approval for screw augmentation or vertebroplasty that
would be in competition with ORTHOCOMP for these indications. We may, however,
face competition from the off-label use of other products for these
indications. In tooth root anchoring applications, we believe that no
alternative exists at this time to compete with ORTHOCOMP, other than the
current method of tooth root implantation.
27
Our business success is dependent on our personnel and our ability to
effectively manage our growth.
We are highly dependent on the performance of our executive officers and key
employees. Some of these officers and employees have not entered into
employment agreements with us. There is intense competition for qualified
personnel. Therefore, we may not be able to attract and retain the qualified
personnel necessary for the development of our business. The loss of the
services of existing personnel, as well as the failure to recruit additional
key technical, scientific and personnel in a timely manner, would be
detrimental to our business. Furthermore, we may incur substantial expenses in
connection with hiring and retaining employees.
We must manage our operations effectively while responding to constant
changes in both technology and the markets where we compete if we are to grow
in the future. Our results will suffer if we cannot manage growth effectively.
We may be subject to product liability and may not have adequate insurance.
We could suffer a material adverse effect if any product liability claim or
litigation is brought against us. While we maintain product liability
insurance, our insurance may not cover the claim or litigation or may not be
adequate. Whether or not successful, any claim or litigation brought against us
could divert management's attention and time and result in significant
expenditures.
Our computer systems and those of our key suppliers and service providers may
not be Year 2000 compliant and may cause system failures and disruptions of
operations.
The Year 2000 issue could result in system failures or miscalculations
causing disruptions of operation, including, among others, a temporary
inability to process transactions, send invoices or engage in similar normal
business activities which may materially adversely affect us. To date, we have
experienced very few problems related to Year 2000 problems and we do not
believe that we have material exposure to the Year 2000 issue with respect to
our information systems as these systems correctly define the Year 2000.
We are currently conducting an analysis to determine the extent to which the
systems of third parties raise Year 2000 issues that may affect us. The failure
of a major supplier, that is subject to the Year 2000 issue, to convert its
systems on a timely basis or to effect a conversion that is incompatible with
our systems could have a material adverse effect on us, which is not currently
quantifiable.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Foreign Currency Risk
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 (Deficit). The Company closed its Belgian manufacturing
facility during December 1997 and subsequently the amount of expense incurred
during 1998 in Belgium has been minor. A significant fluctuation in the
exchange rate between the Belgian Franc and the US Dollar would not have a
significant effect on the Company's 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 year ended December 31, 1998.
Market Risk
The Company is exposed to market risk through changes in market interest
rates that could affect the value of its 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.
28
As of December 31, 1998, the Company's investments consisted primarily of
commercial paper, United States government agency bonds and high credit quality
corporate bonds. The Company estimates that had the average yield of the
Company's investments decreased by 100 basis points, interest income for the
year ended December 31, 1998 would have decreased by less than $90,000. This
estimate assumes that the decrease occurred on the last day of each month
during 1998 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 "Election of Directors" and "Section 16(a)
Beneficial Ownership Reporting Compliance" in the Company's 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.
The required information as to executive officers is set forth in Part I
hereof and incorporated herein by reference. The executive officers and
directors of the Company and their ages as of December 31, 1998 are as follows:
ITEM 11. EXECUTIVE COMPENSATION
See Item 12.
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" and "Security Ownership of Certain
Beneficial Owners and Management," respectively, in the Company's 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.
29
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, 1998.
30
(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.**
10.1 Class C Convertible Preferred Stock and Warrant Purchase Agreement
dated as of April 11, 1997.*
10.2 Class A Holder Agreement dated as of April 11, 1997.*
10.3 Note and Warrant Holder Agreement dated as of April 11, 1997.*
10.4 Registration Rights Agreement dated as of April 11, 1997.*
10.5 License Agreement dated as of September 1, 1993 between the Company and
the Trustees of the University of Pennsylvania.*
10.6 Amendment A to the License Agreement between Orthovita, Inc. and the
Trustees of the University of Pennsylvania dated February 27, 1997.*
10.7 Employment Agreement dated as of December 31, 1996 between the Company
and David S. Joseph.*
10.8 Employment Agreement dated as of July 1, 1997 between the Company and
Dr. Erik Erbe.*
10.9 Form of Warrant dated as of April 11, 1997 issued by the Company.*
10.10 Form of Warrant dated as of April 11, 1997 issued by the Company.*
10.11 Form of Warrant dated as of April 11, 1997 issued by the Company.*
10.12 Form of Warrant dated as of April 11, 1997 issued by the Company.*
10.13 Form of Warrant dated as of April 11, 1997 issued by the Company.*
10.14 Amended and Restated 1993 Stock Option Plan.**
10.15 Amended and Restated 1997 Equity Compensation Plan.**
10.16 Line of Credit, Term Loan and Security Agreement dated as of September
19, 1997 between the Company and Progress Bank.*
10.17 First Amendment to Line of Credit, Term Loan and Security Agreement
dated August 31, 1998 between the Company and Progress Bank.+
10.18 Master Equipment Lease Agreement dated as of July 11, 1997 between the
Company and Finova Technology Finance, Inc.*
10.19 Amended and Restated Employee Stock Purchase Plan.**
10.20@ Global Distribution Agreement dated as of April 29, 1998 between the
Company and Implant Innovations, Inc.**
10.21@ License and Development Agreement dated as of June 9, 1998 between the
Company and Howmedica, Inc.**
10.22@ Supply Agreement dated as of June 9, 1998 between the Company and
Howmedica, Inc.**
10.23 Stock Purchase Agreement dated as of June 9, 1998 between the Company
and Howmedica, Inc.**
10.24 Biomedical Materials Agreement dated as of July 29, 1992 between the
Company and FBFC, International.**
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.
@ Confidential Treatment Requested.
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.
31
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 30, 1999 /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 Joseph M.
Paiva, Vice President and Chief Financial Officer of Orthovita, Inc., 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 Date Capacity
--------- ---- --------
/s/ Paul Ducheyne, Ph.D. March 30, 1999
____________________________ Chairman of the Board and Chief
Paul Ducheyne, Ph.D. Science and Technology Officer
/s/ David S. Joseph March 30, 1999
____________________________ President, Chief Executive Officer
David S. Joseph (principal executive officer)
/s/ Joseph M. Paiva March 30, 1999 Vice President and Chief Financial
____________________________ Officer (principal financial officer
Joseph M. Paiva and accounting)
/s/ Lew Bennett March 30, 1999 Director
____________________________
Lew Bennett
/s/ James M. Garvey March 30, 1999 Director
____________________________
James M. Garvey
/s/ Richard M. Horowitz March 30, 1999 Director
____________________________
Richard M. Horowitz
/s/ Jos B. Peeters, Ph.D. March 30, 1999 Director
____________________________
Jos B. Peeters, Ph.D.
/s/ Howard Salasin, Ph.D. March 30, 1999 Director
____________________________
Howard Salasin, Ph.D.
32
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, 1998 and
1997, and the related consolidated statements of operations, redeemable
convertible preferred stock and shareholders' equity (deficit) and cash flows
for each of the three years in the period ended December 31, 1998. 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 U.S. generally accepted auditing
standards. 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, 1998 and 1997, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1998, in conformity with generally accepted accounting principles.
/s/ Arthur Andersen LLP
Philadelphia, Pa.,
January 29, 1999
F-1
ORTHOVITA, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31
---------------------------
1998 1997
------------- ------------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents....................... $ 842,064 $ 2,257,902
Restricted cash................................. -- 200,000
Short-term investments.......................... 14,513,744 --
Trade accounts receivable net of allowance of
$90,726 and $100,078........................... 8,468 469,363
Other receivables............................... 635,188 --
Inventories..................................... 329,251 248,707
Other current assets............................ 765,017 101,794
------------- ------------
Total current assets........................... 17,093,732 3,277,766
------------- ------------
PROPERTY AND EQUIPMENT, net....................... 1,709,506 1,584,244
------------- ------------
OTHER ASSETS...................................... 85,394 --
------------- ------------
$ 18,888,632 $ 4,862,010
============= ============
LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)
CURRENT LIABILITIES:
Short-term bank borrowings...................... $ -- $ 692,000
Current portion of long-term debt............... 287,412 478,952
Current portion of long-term liabilities........ 175,058 --
Current portion of long-term capital lease
obligations.................................... 362,239 212,033
Accounts payable................................ 381,144 668,446
Accrued patent defense cost..................... 472,492 1,003,236
Accrued compensation and related expenses....... 342,453 412,926
Other accrued expenses.......................... 601,832 891,032
------------- ------------
Total current liabilities...................... 2,622,630 4,358,625
------------- ------------
LONG-TERM LIABILITIES:
Capital lease obligations....................... 608,562 557,991
Other liabilities............................... 128,865 --
Debt............................................ -- 275,000
------------- ------------
Total long-term liabilities.................... 737,427 832,991
------------- ------------
COMMITMENTS AND CONTINGENCIES (Notes 14 and 15)
REDEEMABLE CLASS C CONVERTIBLE PREFERRED STOCK, no
shares issued and outstanding at December 31,
1998 and 1,882,353 shares issued and outstanding
at December 31, 1997 ............................ -- 7,383,090
------------- ------------
SHAREHOLDERS' EQUITY (DEFICIT):
Class A Convertible Preferred stock, $.01 par
value, no shares issued and outstanding at
December 31, 1998 and 606,060 shares issued and
outstanding at December 31, 1997 .............. -- 6,061
Class B Convertible Preferred stock, $.01 par
value, no shares issued and outstanding at
December 31, 1998 and 1,038,005 shares issued
and outstanding at December 31, 1997 .......... -- 10,380
Common stock, $.01 par value, 15,000,000 shares
authorized, 11,372,700 and 5,186,222 shares
issued and outstanding as of December 31, 1998
and December 31, 1997, respectively............ 113,727 51,862
Additional paid-in capital...................... 42,289,024 13,138,103
Accumulated deficit............................. (26,977,160) (20,885,159)
Accumulated other comprehensive income.......... 102,984 (33,943)
------------- ------------
Total shareholders' equity (deficit)........... 15,528,575 (7,712,696)
------------- ------------
$ 18,888,632 $ 4,862,010
============= ============
The accompanying notes are an integral part of these statements.
F-2
ORTHOVITA, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
Year Ended December 31
-------------------------------------
1998 1997 1996
----------- ----------- -----------
NET REVENUES........................... $ 2,780,658 $ 3,311,540 $ 1,860,326
COST OF SALES.......................... 927,792 1,096,848 887,236
----------- ----------- -----------
Gross profit ...................... 1,852,866 2,214,692 973,090
----------- ----------- -----------
OPERATING EXPENSES:
General and administrative............. 2,253,836 3,762,906 2,069,289
Selling and marketing.................. 2,879,804 4,249,533 3,914,485
Research and development............... 2,764,321 1,986,506 1,178,330
----------- ----------- -----------
Total operating expenses........... 7,897,961 9,998,945 7,162,104
----------- ----------- -----------
Operating loss..................... (6,045,095) (7,784,253) (6,189,014)
INTEREST EXPENSE....................... (174,898) (148,156) (273,036)
INTEREST INCOME........................ 511,882 181,617 22,097
FOREIGN CURRENCY TRANSACTION GAIN
(LOSS)................................ 7,323 (202,527) --
----------- ----------- -----------
Loss before extraordinary item..... (5,700,788) (7,953,319) (6,439,953)
EXTRAORDINARY ITEM--GAIN ON EARLY
EXTINGUISHMENT OF DEBT................ -- 397,402 --
----------- ----------- -----------
NET LOSS............................... (5,700,788) (7,555,917) (6,439,953)
----------- ----------- -----------
ACCRETION OF REDEMPTION PREMIUM ON
PREFERRED STOCK....................... (391,213) (536,517) --
----------- ----------- -----------
NET LOSS APPLICABLE TO COMMON
SHAREHOLDERS.......................... $(6,092,001) $(8,092,434) $(6,439,953)
=========== =========== ===========
NET LOSS PER COMMON SHARE:
Before extraordinary item............ $ (.73) $ (1.68) $ (1.60)
Extraordinary item................... -- 0.08 --
----------- ----------- -----------
NET LOSS PER COMMON SHARE.............. $ (.73) $ (1.60) $ (1.60)
=========== =========== ===========
WEIGHTED AVERAGE NUMBER OF COMMON
SHARES OUTSTANDING.................... 8,314,679 5,050,397 4,036,150
=========== =========== ===========
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 (DEFICIT)
Redeemable
Class C
Convertible
Preferred
Stock
-----------
BALANCE, DECEMBER
31, 1995........... $ --
Sale of 243,075
shares of common
stock and 48,615
Class A Common
stock purchase
warrants, net of
offering costs of
$22,714........... --
Sale of 828,357
shares of common
stock, net of
offering costs of
$84,055........... --
Comprehensive
income:
Net loss......... --
Other
comprehensive
income:
Currency
translation
adjustment...... --
Comprehensive
income..........
-----------
BALANCE, DECEMBER
31, 1996........... --
Sale of 533,685
shares of common
stock, net of
offering costs of
$12,467........... --
Issuance of
585,936 shares of
Class B
Convertible
Preferred stock... --
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
Issuance of common
stock and common
stock options for
services.......... --
Accretion of
redemption premium
and dividends on
Class C
Convertible
Preferred stock... 536,517
Comprehensive
income:
Net loss......... --
Other
comprehensive
income:
Currency
translation
adjustment...... --
Comprehensive
income..........
-----------
BALANCE, DECEMBER
31, 1997........... 7,383,090
Sale of 370,392
shares of common
stock............. --
Sale of 1,800,000
shares of common
stock, net of
offering costs of
$889,103 --
Conversion of
preferred stock to
common stock...... (7,774,303)
Exercise of common
stock options and
warrants to
purchase common
stock --
Issuance of common
sock and common
stock options for
services.......... --
Accretion of
redemption premium
and dividends on
Class C
Convertible
Preferred stock... 391,213
Comprehensive
income:
Net loss......... --
Other
comprehensive
income:
Unrealized gain
on short-term
investments.....
Currency
translation
adjustment...... --
Comprehensive
income.......... --
-----------
BALANCE, DECEMBER
31, 1998........... $ --
===========
Shareholders' Equity (Deficit)
---------------------------------------------------------------------------------------------------
Class A Class B Accumulated
Convertible Convertible Additional Other
Preferred Preferred Common Paid-in Accumulated Comprehensive Comprehensive
Stock Stock Stock Capital Deficit income Income Total
----------- ----------- -------- ----------- ------------- ------------- ------------- ------------
BALANCE, DECEMBER
31, 1995........... $ 6,061 $ 4,521 $ 35,394 $ 4,243,106 $ (6,352,772) $(82,003) $(2,145,693)
Sale of 243,075
shares of common
stock and 48,615
Class A Common
stock purchase
warrants, net of
offering costs of
$22,714........... -- -- 2,431 1,007,924 -- -- 1,010,355
Sale of 828,357
shares of common
stock, net of
offering costs of
$84,055........... -- -- 8,283 3,428,179 -- -- 3,436,462
Comprehensive
income:
Net loss......... -- -- -- -- (6,439,953) $(6,439,953) (6,439,953)
Other
comprehensive
income:
Currency
translation
adjustment...... -- -- -- -- -- 50,144 50,144 50,144
-------------
Comprehensive
income.......... $(6,389,809)
----------- ----------- -------- ----------- ------------- ------------- ============= ------------
BALANCE, DECEMBER
31, 1996........... 6,061 4,521 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........ -- -- -- 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)
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........... 6,061 10,380 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
$889,103 -- -- 18,000 16,669,838 -- -- 16,687,838
Conversion of
preferred stock to
common stock...... (6,061) (10,380) 35,264 7,755,480 -- -- 7,774,303
Exercise of common
stock options and
warrants to
purchase common
stock -- -- 4,897 1,163,760 -- -- 1,168,657
Issuance of common
sock and common
stock options for
services.......... -- -- -- 65,547 -- -- 65,547
Accretion of
redemption premium
and dividends on
Class C
Convertible
Preferred stock... -- -- -- -- (391,213) -- (391,213)
Comprehensive
income:
Net loss......... -- -- -- -- (5,700,788) -- $(5,700,788) (5,700,788)
Other
comprehensive
income:
Unrealized gain
on short-term
investments..... 99,350 99,350 99,350
Currency
translation
adjustment...... -- -- -- -- -- 37,577 37,577 37,577
-------------
Comprehensive
income.......... -- -- -- -- -- -- $(5,563,861)
----------- ----------- -------- ----------- ------------- ------------- ============= ------------
BALANCE, DECEMBER
31, 1998........... $ -- $ -- $113,727 $42,289,024 $(26,977,160) $102,984 $15,528,575
=========== =========== ======== =========== ============= ============= ============
The accompanying notes are an integral part of these statements.
F-4
ORTHOVITA, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended December 31
--------------------------------------
1998 1997 1996
------------ ----------- -----------
OPERATING ACTIVITIES:
Net loss............................. $ (5,700,788) $(7,555,917) $(6,439,953)
Adjustments to reconcile net loss to
net cash used in operating
activities--
Extraordinary gain................. -- (397,402) --
Depreciation and amortization...... 427,991 217,432 115,362
Imputed interest................... 20,967 42,569 46,642
Services provided for common stock
and common stock options.......... 65,546 426,792 --
(Increase) decrease in--
Restricted cash.................. 200,000 (200,000) --
Accounts receivable.............. 460,895 (212,264) (150,434)
Notes and other receivables...... (703,809) -- --
Inventories...................... (80,544) 84,080 (167,115)
Other current assets............. (66,577) (39,185) (21,052)
Other assets..................... (85,394) 49,008 (14,418)
Increase (decrease) in--
Accounts payable................. (287,302) (256,502) 108,810
Accrued patent defense costs..... (530,744) 253,236 750,000
Accrued compensation and related
expenses........................ (70,473) (35,028) 193,971
Other liabilities................ 303,923 -- --
Other accrued expenses........... (289,200) 34,649 609,575
------------ ----------- -----------
Net cash used in operating
activities.................... (6,335,509) (7,588,532) (4,968,612)
------------ ----------- -----------
INVESTING ACTIVITIES:
Purchase of investments.............. (15,892,669) -- --
Proceeds from sale of investments.... 1,478,275 -- --
Purchase of property and equipment... (110,947) (413,939) (345,877)
------------ ----------- -----------
Net cash used in investing
activities.................... (14,525,341) (413,939) (345,877)
------------ ----------- -----------
FINANCING ACTIVITIES:
Proceeds (repayments) of short-term
bank borrowings..................... (692,000) 32,000 10,000
Proceeds (repayments) of debt........ (487,507) 514,322 370,700
Repayments of subordinated debt...... -- (351,125) --
Repayments of capital lease
obligations......................... (241,529) (51,103) (6,390)
Proceeds from exercise of common
stock options and warrants.......... 640,633 -- --
Proceeds from sale of Class C
Convertible Preferred stock......... -- 7,609,204 --
Proceeds from sale of common stock
and warrants........................ 20,187,838 2,255,694 4,446,817
------------ ----------- -----------
Net cash provided by financing
activities.................... 19,407,435 10,008,992 4,821,127
------------ ----------- -----------
EFFECT OF EXCHANGE RATE CHANGES ON CASH
AND CASH EQUIVALENTS.................. 37,577 (2,084) (15,851)
------------ ----------- -----------
NET INCREASE (DECREASE) IN CASH AND
CASH EQUIVALENTS...................... (1,415,838) 2,004,437 (509,213)
CASH AND CASH EQUIVALENTS, BEGINNING OF
YEAR.................................. 2,257,902 253,465 762,678
------------ ----------- -----------
CASH AND CASH EQUIVALENTS, END OF
YEAR.................................. $ 842,064 $ 2,257,902 $ 253,465
============ =========== ===========
F-5
ORTHOVITA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. The Company:
Orthovita, Inc. (the "Company") is a Pennsylvania corporation which began
operations in November 1993. The Company develops, manufactures and markets
bone substitutes including BIOGRAN(R), its first commercialized product that is
a resorbable, granular biomaterial that biologically transforms to bone; and in
development, Orthocomp(TM) Injectable cement and Orthobone(TM) Putty, as
composite, fast-setting, high strength resins with a biological interface that
bonds to bone; and Vitoss(TM), in development as an injectable resorbable
cement that aids in fracture healing and as a scaffold matrix that is conducive
to cell attachment.
The Company's future results of operations involve a number of risks and
uncertainties. Factors that could affect the Company's future operating results
and cause actual results to vary materially from expectations include, but are
not limited to, limited clinical trials, the uncertainty related to regulatory
approvals, uncertainty of market acceptance, uncertainty related to third-party
reimbursement, dependence on patents, trade secrets and proprietary rights,
limited manufacturing experience, dependence on suppliers, competition, capital
availability, uncertainty of technological change, dependence on key personnel
and advisors, and product liability and the availability of adequate insurance.
2. Summary of Significant Accounting Policies:
Preparation of Financial Statements
The financial statements of the Company have been prepared using United
States generally accepted accounting principles. This preparation requires
management to make estimates and assumptions that affect the reported amounts
of assets and liabilities and disclosure of contingent assets and liabilities
at the date of the financial statements and the reported amounts of revenues
and expenses during the reporting period. Actual results could differ from
those estimates.
Basis of Consolidation
The consolidated financial statements include the accounts of Orthovita,
Inc., its Belgian branch operations, and its wholly owned subsidiaries. All
material intercompany balances have been eliminated in consolidation.
Net Loss Per Common Share
The Company has presented net loss per common share pursuant to Statement of
Financial Accounting Standards ("SFAS") No. 128, "Earnings per Share."
Basic loss per share was computed by dividing net loss applicable to common
shareholders by the weighted average number of shares of common stock
outstanding. Diluted loss per share has not been presented since the impact on
loss per share is anti-dilutive due to the Company's losses. Diluted loss per
share is computed using the treasury stock method which assumes that the
Company would use any proceeds it would receive from the exercise of options
and warrants to repurchase shares at fair market value.
Revenue Recognition
Revenue from product sales is recognized at the time of shipment. Revenues
are presented net of sales discounts and returns. The Company records the cost
for product returns as incurred.
Research and Development Costs
Research and development costs are charged to expense as incurred.
F-6
ORTHOVITA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
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 (Deficit).
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 1998, the Company issued options and warrants for the purchase of 24,000
shares of common stock at various prices to certain vendors in payment of
services valued at $65,547. During 1997, the Company issued options for the
purchase of 30,000 shares of common stock at $4.25 per share to certain vendors
in payment of consulting services valued at $38,546. Also during 1997, the
Company issued shares of common stock valued at $177,246 to the University of
Pennsylvania (Note 7).
In 1998, 1997 and 1996, the Company incurred capital lease obligations of
$442,306, $797,068, and $20,051, respectively. In 1998, 1997 and 1996, cash
paid for interest was $174,898, $148,156, and $63,018, respectively. The
Company paid no income taxes in 1998, 1997 and 1996.
3. Cash, Cash Equivalents and Investments:
The Company invests its 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 (deficit).
Restricted cash at December 31, 1997 represents funds maintained in a bank
escrow account as collateral for the Company's bank term loan and line of
credit (Notes 8 and 9).
As of December 31, 1997, the Company had no short-term investments and cost
equaled fair market value for all cash and cash equivalents. As of December 31,
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, 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-7
ORTHOVITA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
4. Inventories:
Inventories are stated at the lower of cost or market on a first-in, first-
out basis. As of December 31, 1998 and 1997, inventories consisted of the
following:
December 31
-----------------
1998 1997
-------- --------
Raw materials and work-in-process...................... $280,927 $ 8,801
Finished goods......................................... 48,324 239,906
-------- --------
$329,251 $248,707
======== ========
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. 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
----------------------
1998 1997
---------- ----------
Machinery and equipment........................... $1,456,375 $ 920,624
Furniture, marketing, and office equipment........ 478,228 436,279
Leasehold improvements............................ 563,602 588,049
---------- ----------
2,498,205 1,944,952
Less--Accumulated depreciation.................... (788,699) (360,708)
---------- ----------
$1,709,506 $1,584,244
========== ==========
In the years ended December 31, 1998 and 1997, certain property and
equipment was acquired under capitalized lease obligations. These assets total
$1,316,941 and $825,931 with related accumulated depreciation of $297,387 and
$81,528 at December 31, 1998 and 1997, respectively.
6 . FBFC International Technology License:
In July 1992, the Company obtained a license from FBFC International, a
Belgian company, (the "FBFC License") that allowed the Company to manufacture
and sell its BIOGRAN product. The Company had agreed to pay FBFC a maximum
aggregate royalty of $3,000,000, allocated evenly between each of two dental
products. The Company paid FBFC a running royalty, and received credit against
the maximum, of 12% on BIOGRAN net sales of FBFC-licensed products in the
dental market.
Also, as part of the license agreement, the Company assumed the payback
provisions contained in a loan agreement between FBFC and the Flemish
government for a noninterest-bearing loan payable in Belgian Francs. In 1993,
the Company discounted the loan using a market rate of interest and recorded a
liability and an expense for acquired 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.
F-8
ORTHOVITA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
During 1996, the Company decided not to commercialize one of the dental
products licensed from FBFC and petitioned the Flemish government to exempt the
Company from the debt assumed when the technology was licensed. In 1997, the
Flemish government granted the Company an exemption of reimbursement of
approximately $426,000 of long-term debt ($397,402, net of unamortized debt
discount). The Company recorded an extraordinary gain of $397,402 in 1997 due
to the extinguishment of this debt. By virtue of the Company's decision not to
commercialize this product, the maximum aggregate royalty payments to be made
by the Company were reduced from $3,000,000 to $1,500,000. The Company 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, the Company has classified
the entire outstanding balance of $287,412 and $378,952, at December 31, 1998
and 1997, respectively, as a current liability.
On May 1, 1996, a complaint was filed against the Company alleging the
technology the Company licensed from FBFC infringed a patent held by another
company. In accordance with the FBFC license, FBFC agreed to indemnify the
Company for all reasonable damages and costs incurred by the Company arising
out of or resulting from this action, for an amount not to exceed the maximum
aggregate royalty payments associated with this technology. From 1996 to
December 23, 1998, the Company charged to expense more than $1,500,000 of
patent litigation legal fees and at December 23, 1998 approximately $1,024,000
was owed to FBFC based upon the royalty of 12% on Biogran net sales.
On December 23, 1998, the Company and FBFC entered into a Release and
Termination Agreement (the "Release") whereby, as a result of the patent
defense costs exceeding the maximum earned royalty, FBFC agreed to reimburse
the Company $474,580 which was included in Other Receivables at December 31,
1998 and collected in January 1999. In 1998, the Company recorded this amount
as an offset to general and administrative expenses. The Release specified the
Company had satisfied all of its royalty obligations under the FBFC License,
and that FBFC will transfer all of its rights in the intellectual property,
including the patents, to the Company.
7. University of Pennsylvania Technology License:
The Company has exclusively licensed on a worldwide basis, from the
University of Pennsylvania ("Penn"), certain intellectual property including
patents relating to materials and techniques for improving orthopedic implants,
bone grafting, and controlled drug release technologies. In consideration for
the above and for certain expenses Penn incurred related to the intellectual
property, the Company issued 41,705 shares in 1997 of common stock to Penn with
a fair market value of $177,246. 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.
8. Bank Borrowings:
The Company had a $750,000 line of credit arrangement with a bank which
expired on June 30, 1997. The Company established a new $1 million line of
credit arrangement with another bank in September 1997 and entered into a
$400,000 term loan with the bank, (collectively the "Credit Facility"). The
Credit Facility requires the Company to maintain certain financial covenants
related to specified levels of cash, accounts receivable, and inventory and to
maintain a restricted cash balance based on certain financial factors. Interest
on the line of credit is payable at the prime rate plus 1.5% and the weighted
average interest rate was 10% for the years ended December 31, 1998 and 1997.
As of December 31, 1998, there was no outstanding balance under the line, and
as of December 31, 1997, $692,000 was outstanding.
F-9
ORTHOVITA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
In connection with the Term Loan, the Company issued to the bank a warrant
to purchase 5,000 shares of common stock at an exercise price of $4.25 per
share. Based on the term and exercise price of the warrants, the Black-Scholes
model determined a minimal value for the warrants. As of December 31, 1997, the
outstanding principal balance on the Term Loan was $375,000, and the weighted
average interest rate on the Term Loan was 9.50% for the year ended December
31, 1998 and 1997. The Term Loan was repaid in full on August 31, 1998.
9. Long-Term Debt:
In 1997, the Company secured a $1,200,000 capital asset 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, the Company secured an additional $1,500,000 capital
financing arrangement with the same lending institution. The term of each
individual lease is 42 months and interest is approximately 9.4%. The leases
are secured by the underlying capital assets.
December 31
----------------------
1998 1997
---------- ----------
Payable for acquired technology net of
unamortized discount of $20,967 in 1997 (see
Note 6)....................................... $ 287,412 $ 378,952
Term loan to a bank (Note 8)................... -- 375,000
Capital lease obligations...................... 970,801 770,024
---------- ----------
1,258,213 1,523,976
Less-- current portion......................... (649,651) (690,985)
---------- ----------
$ 608,562 $ 832,991
========== ==========
Long-term debt maturities as of December 31, 1998 are as follows:
1999........................................................... $ 649,651
2000........................................................... 393,466
2001........................................................... 206,965
2002........................................................... 8,131
----------
$1,258,213
==========
10. Profit Sharing Plan:
The Company has a Section 401(k) plan for all qualified employees, as
defined. Company contributions were $65,860 and $29,301 for the years ended
December 31, 1998 and 1997, respectively.
11. Redeemable Convertible Preferred Stock and Shareholder's Equity (Defict):
As of December 31, 1997, the Company had 5,000,000 authorized shares of $.01
par value preferred stock of which 606,060, 1,038,005 and 1,882,353 were
designated issued and outstanding as Class A Convertible Preferred stock
("Class A Preferred"), Class B Convertible Preferred stock ("Class B
Preferred") and Redeemable Class C Convertible Preferred stock ("Class C
Preferred"), respectively.
On June 25, 1998, in connection with the Company's Initial Public Offering
(the "Offering"), the Company exercised its right to cause the conversion into
common stock of all, but not less than all, the Class A Preferred and Class B
Preferred then issued. The holders of the Class C Preferred agreed to convert
their shares into common stock upon the consummation of the Offering.
F-10
ORTHOVITA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Common Stock
On June 25, 1998, the Company completed the Offering of its common shares on
the Brussels-based EASDAQ stock exchange. The issue 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, the Company
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.
On June 9, 1998, the Company entered into a series of agreements with
Howmedica, Inc. (the "Howmedica Agreements") pursuant to which Howmedica
obtained exclusive worldwide marketing, sales and distribution rights for
ORTHOCOMP in joint implant procedures. In connection with the Howmedica
Agreements, the Company sold 370,392 shares of common stock to Howmedica, Inc.,
for $3.5 million. Under the Howmedica Agreements, the Company may earn payments
of up to an aggregate of $4,500,000 if various milestones are reached during
the anticipated four to five-year development and approval process for this
indication. Upon receipt of regulatory approvals, Howmedica will be required to
make annual minimum purchases of ORTHOCOMP from the Company for a six-year
period. Howmedica may obtain exclusive manufacturing rights from the Company
upon a one-time payment of $7,000,000 and will be required to pay royalties on
future sales. Howmedica had an option until December 9, 1998 to acquire
worldwide distribution rights for screw augmentation and vertebroplasty,
subject to agreement between the two parties on minimum purchase quantities;
however, Howmedica did not exercise this option. Additionally, Howmedica has
certain rights of first negotiation and refusal for orthopaedic applications of
other Company technologies.
In 1997, the Company sold 533,685 shares of common stock for $4.25 per
share, raising net proceeds of $2,255,694.
Stock Options
The Company has stock option plans that provide for both incentive and
nonqualified stock options to be granted to key employees, consultants and
advisors. Options must have exercise prices equal to or greater than the fair
market value of the common stock on the date of grant. The options remain
exercisable for a maximum period of ten years. As of December 31, 1998, there
were 290,206 options available for grant under the plans and 694,994
exercisable options outstanding with a weighted average exercise price of $3.30
per share. For these outstanding options, the weighted average exercise price
per share is $3.68 with a weighted average remaining contractual life of
approximately eight and one-half years. Summary stock option information is as
follows:
Number Price Range Aggregate
--------- ----------- ----------
Outstanding, December 31, 1995......... 445,744 $ 1.00-4.25 $ 832,512
Granted.............................. 240,900 2.75-4.25 881,425
Canceled............................. (50,500) 1.00-4.25 (55,250)
--------- ----------- ----------
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
========= =========== ==========
F-11
ORTHOVITA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
In 1997, the exercise period for vested options to purchase 66,000 shares of
common stock held by three former employees were extended beyond the normal 90
days following termination of employment. For accounting purposes, this created
a new measurement date for the options, and therefore, the Company charged to
expense $211,000 related to the differences between the exercise prices of
these options and the fair value of the Company's common stock at the dates the
extensions were granted. Such amount is included in issuances of common stock
options for services on the Statement of Redeemable Convertible Preferred Stock
and Shareholders' Equity (Deficit). During 1998, the Company issued to an
employee 500 stock options with an exercise price lower than the stock market
value on the date of issuance. A charge of $3,438 was recorded to compensation
expense.
The Company applies Accounting Principal Board Opinion No. 25, "Accounting
for Stock Issued to Employees," (APB 25) and the related interpretations in
accounting for its 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, which represents the difference between the exercise
price and the fair value of the Company's 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 option 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. The disclosure requirement of SFAS No.
123, "Accounting for Stock-Based Compensation," has been applied by the
Company. Had compensation cost for the Company's common stock option plan been
determined under SFAS No. 123, the Company's net loss and net loss per common
share would have been adjusted to the following pro forma amounts:
Year Ended December 31
----------------------------------
1998 1997 1996
---------- ---------- ----------
Net loss applicable to common
shareholders:
As reported...................... $6,092,001 $8,092,434 $6,439,953
Pro forma........................ 6,677,576 8,499,187 6,519,456
Net loss per common share:
As reported...................... (.73) (1.60) (1.60)
Pro forma........................ (.80) (1.69) (1.62)
The weighted average fair value of the options granted during 1998 is
estimated as $2.64 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 5%, and an expected
life of six years. The weighted average fair value of the options granted
during 1997 and 1996 is estimated as $1.46 and $1.14 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 zero, risk-free
interest rate at 7.0% and 6.12% during 1997 and 1996, 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, the Company established an Employee Stock Purchase
Plan (the "ESPP") to provide eligible employees an opportunity to purchase
common stock of the Company. 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.
No shares were purchased under the ESPP during 1998.
F-12
ORTHOVITA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
12. Net Product Revenue:
In September 1998, the Company issued a voluntary product notice for certain
lot numbers of BIOGRAN packaged in glass syringes. As of December 31, 1998,
substantially all recalled product had been replaced.
Prior to April 28, 1998, the Company generally marketed BIOGRAN through
internal direct sales efforts in the U.S. On April 28, 1998, the Company signed
an agreement with Implant Innovations Inc. ("3i") pursuant to which 3i obtained
the global distribution rights for BIOGRAN and ORTHOCOMP for the dental implant
surgery market. The arrangement provides for 3i to purchase, and for the
Company to supply, specified minimum monthly amounts of BIOGRAN in 1998 for the
dental market. For the years 2000 through 2003, inclusively, 3i also has
minimum purchase requirements of $2.4 million per year. The agreement may be
terminated if 3i fails to purchase more than $600,000 in a given calendar
quarter after 1999.
For 1999, 3i had no minimum purchase requirements; however, the Company
reached an understanding with 3i to defer all of the fourth quarter 1998
contract purchase minimums until 1999. After 3i has fulfilled, in 1999, its
fourth quarter 1998 contract purchase minimums of $800,000 there may be a
period in 1999 during which the Company may not have any BIOGRAN product sales
to 3i. Additional 1999 BIOGRAN product sales to 3i will be dependent upon 3i's
ability to successfully market the product. The global distribution agreement
with 3i provides for a sales price from the Company to 3i equal to 50% of 3i's
average sales price to its customers in the previous quarter.
In 1998, 3i accounted for 50.0% of the Company's product revenue. No
customer accounted for more than 10% of the Company's product revenue in 1997
or 1996.
13. Income Taxes:
The Company accounts 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 Company's
financial statements or tax returns.
The components of income taxes are as follows:
Year Ended December 31
-------------------------------------
1998 1997 1996
----------- ----------- -----------
Current............................... $ -- $ -- $ --
Deferred.............................. (2,015,603) (2,428,881) (2,198,880)
----------- ----------- -----------
(2,015,603) (2,428,881) (2,198,880)
Valuation allowance................... 2,015,603 2,428,881 2,198,880
----------- ----------- -----------
$ -- $ -- $ --
=========== =========== ===========
The difference between the Company's federal statutory income tax rate and
its effective income tax rate is primarily due to state income taxes and the
valuation allowance.
F-13
ORTHOVITA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Components of the Company's deferred tax asset as of December 31, 1998 and
1997 are as follows:
December 31
------------------------
1998 1997
----------- -----------
Deferred tax assets:
Net operating loss carryforwards............... $ 6,418,700 $ 4,404,854
Accrued expenses not currently deductible...... 179,087 582,078
Research, patent and organizational costs
capitalized for tax purposes.................. 2,232,784 1,892,226
----------- -----------
8,830,571 6,879,158
Valuation allowance.............................. (8,830,571) (6,879,158)
----------- -----------
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 the Company's
deferred tax assets since the realization of the deferred tax asset is not
assured given the Company's history of operating losses. The Company's 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 the Company's federal tax returns. These tax assets are amortized over
periods generally ranging from 5 to 20 years for federal tax purposes.
As of December 31, 1998, the Company had approximately $18,614,000 of
federal net operating loss carryforwards, which begin to expire in 2008. The
Company's annual utilization of its 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 the Company's common stock and common stock equivalents.
The Company believes, however, that such limitation may not have a material
impact on the ultimate utilization of its 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............................. 4,641,992
2012............................. 4,574,052
2013............................. 5,923,077
-----------
$18,613,823
===========
F-14
ORTHOVITA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
14. Commitments and Contingencies:
The Company leases office space and equipment under noncancelable operating
leases. For the years ended December 31, 1998, 1997 and 1996, lease expense was
$212,948, $164,384, $149,926, respectively. At December 31, 1998, future
minimum rental payments under operating leases are as follows:
1999................................ $216,562
2000................................ 205,938
2001................................ 101,966
2002................................ --
--------
$524,466
========
At December 1998, the Company has reserved $303,923 for its commitment under
an employment and severance agreement.
15. Litigation:
In July 1992, the Company obtained a license from FBFC (the "FBFC License")
that allowed the Company to manufacture and sell its BIOGRAN product. In May
1996, the University of Florida Research Foundation, Inc., U.S. Biomaterials
Corporation and Block Drug Corporation (the "Plaintiffs") filed a complaint in
the U.S. District Court for the Northern District of Florida against the
Company, a distributor of the Company's BIOGRAN product and the Company's
Chairman (the "BIOGRAN Matter"). 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. This action also included complaints alleging
false representation, unfair competition, false advertising and trade
disparagement under Federal and Florida state laws. In April 1998, the court
granted the Company's summary judgment motion stating that the Company's
BIOGRAN product does not infringe this patent. The complaints alleging false
representation, unfair competition, false advertising and trade disparagement
were settled with the Plaintiffs in September 1998. During September 1998, the
Plaintiffs requested an appeal to the Court's summary judgment with respect to
the patent infringement claim. In response, the Company filed a counterclaim
alleging inequitable conduct. For the years ended December 31, 1997 and 1996,
the Company recorded approximately $1.7 million and $759,000 of expenses
related to its defense of the BIOGRAN Matter, respectively. 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 Matter. As of December 31, 1998, the Company has a reserve of $472,492
for the estimated future cost of defending this litigation.
In accordance with the FBFC License, FBFC agreed to indemnify the Company
for all reasonable damages and costs incurred by the Company arising out of or
resulting from this action, for an amount not to exceed the maximum aggregate
royalty payments associated with this technology. Since 1996, the Company has
recorded patent litigation legal fees in excess of $1.5 million and, based upon
the royalty of 12% of net sales, approximately $1,024,000 was due to FBFC. On
December 23, 1998, the Company and FBFC entered into a Release and Termination
Agreement (the "Release") whereby, FBFC agreed to reimburse the Company
$474,580 for patent defense costs that exceeded the maximum earned royalty.
This payment was received in January 1999. The Release specified the Company
had satisfied all of its royalty obligations under the FBFC License, and that
FBFC will transfer all of its rights in the intellectual property, including
the patents, to the Company.
F-15
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.**
Class C Convertible Preferred Stock and Warrant Purchase Agreement
10.1 dated as of April 11, 1997.*
10.2 Class A Holder Agreement dated as of April 11, 1997.*
10.3 Note and Warrant Holder Agreement dated as of April 11, 1997.*
10.4 Registration Rights Agreement dated as of April 11, 1997.*
10.5 License Agreement dated as of September 1, 1993 between the Company
and the Trustees of the University of Pennsylvania.*
10.6 Amendment A to the License Agreement between Orthovita, Inc. and the
Trustees of the University of Pennsylvania dated February 27, 1997.*
10.7 Employment Agreement dated as of December 31, 1996 between the Company
and David S. Joseph.*
Employment Agreement dated as of July 1, 1997 between the Company and
10.8 Dr. Erik Erbe.*
10.9 Form of Warrant dated as of April 11, 1997 issued by the Company.*
10.10 Form of Warrant dated as of April 11, 1997 issued by the Company.*
10.11 Form of Warrant dated as of April 11, 1997 issued by the Company.*
10.12 Form of Warrant dated as of April 11, 1997 issued by the Company.*
10.13 Form of Warrant dated as of April 11, 1997 issued by the Company.*
10.14 Amended and Restated 1993 Stock Option Plan.**
10.15 Amended and Restated 1997 Equity Compensation Plan.**
10.16 Line of Credit, Term Loan and Security Agreement dated as of September
19, 1997 between the Company and Progress Bank.*
10.17 First Amendment to Line of Credit, Term Loan and Security Agreement
dated August 31, 1998 between the Company and Progress Bank.+
10.18 Master Equipment Lease Agreement dated as of July 11, 1997 between the
Company and Finova Technology Finance, Inc.*
10.19 Amended and Restated Employee Stock Purchase Plan.**
10.20@ Global Distribution Agreement dated as of April 29, 1998 between the
Company and Implant Innovations, Inc.**
10.21@ License and Development Agreement dated as of June 9, 1998 between the
Company and Howmedica, Inc.**
10.22@ Supply Agreement dated as of June 9, 1998 between the Company and
Howmedica, Inc.**
10.23 Stock Purchase Agreement dated as of June 9, 1998 between the Company
and Howmedica, Inc.**
10.24 Biomedical Materials Agreement dated as of July 29, 1992 between the
Company and FBFC, International.**
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.
@ Confidential Treatment Requested.
1