-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, HAd7ddMIjQLvSBIwRejx4CfHAS/z/aVGA3ZrKrBgR9GusJnPG6+e+/rWB+Z1zzdK o33uKdB/IBFkXg0GKvvOVg== 0000950117-02-000863.txt : 20020416 0000950117-02-000863.hdr.sgml : 20020416 ACCESSION NUMBER: 0000950117-02-000863 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 20011231 FILED AS OF DATE: 20020415 FILER: COMPANY DATA: COMPANY CONFORMED NAME: ORTEC INTERNATIONAL INC CENTRAL INDEX KEY: 0000889992 STANDARD INDUSTRIAL CLASSIFICATION: BIOLOGICAL PRODUCTS (NO DIAGNOSTIC SUBSTANCES) [2836] IRS NUMBER: 113068704 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 000-27368 FILM NUMBER: 02611170 BUSINESS ADDRESS: STREET 1: 3960 BROADWAY STREET 2: BLDG 28 CITY: NEW YORK STATE: NY ZIP: 10032 BUSINESS PHONE: 7183264698 10-K 1 a32315.txt ORTEC 10-K - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- U.S. 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 OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 2001 [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ________________ TO _________________ Commission file number 0-27368 ORTEC INTERNATIONAL, INC. (Exact name of issuer as specified in its charter) Delaware 11-3068704 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 3960 Broadway New York, NY 10032 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (212) 740-6999 ---------------- Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Common Stock, $.001 par value Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act during the past 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 --- --- Check if there is no disclosure of delinquent filers in response to Item 405 of Regulation S-K contained in this form, and no disclosure will be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ X ] ---------------- The number of shares outstanding of the Registrant's common stock is 9,691,608 (as of 4/11/02). The aggregate market value of the voting stock held by nonaffiliates of the Registrant was approximately $35,878,542 as of April 11, 2002, based upon a closing price on such date of $4.27 as listed on the Nasdaq SmallCap Market. DOCUMENTS INCORPORATED BY REFERENCE - None - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- ORTEC INTERNATIONAL, INC. INDEX TO ANNUAL REPORT ON FORM 10-K FILED WITH THE SECURITIES AND EXCHANGE COMMISSION YEAR ENDED DECEMBER 31, 2001 ITEMS IN FORM 10-K
Facing Page Page ---- Part I - ------ Item 1. Business ...................................................................................1 Item 2. Properties..................................................................................16 Item 3. Legal Proceedings ..........................................................................17 Item 4. Submission of Matters to a Vote of Security Holders.......................................None Part II - ------- Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters ..................18 Item 6. Selected Financial Data ....................................................................19 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations ......20 Item 7a. Quantitative and Qualitative Disclosures About Market Risk ..............................None Item 8. Financial Statements and Supplementary Data.................................................27 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure ....None Part III - -------- Item 10. Directors and Executive Officers of the Registrant .........................................28 Item 11. Executive Compensation .....................................................................30 Item 12. Security Ownership of Certain Beneficial Owners and Management .............................34 Item 13. Certain Relationships and Related Transactions..............................................36 Part IV Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K ............................38 Signatures ...................................................................................................39 Financial Statements ........................................................................................F-1
PART I Item 1. BUSINESS Overview We are a development stage tissue engineering company that has developed a proprietary and patented technology that we call "OrCel", which is used to stimulate the repair and regeneration of human skin. OrCel is a two layered tissue engineered dressing that consists of human derived skin cells, both dermal and epidermal, supported within a porous collagen matrix. The composite matrix is seeded with keratinocytes for epidermal growth and fibroblasts for dermal growth. This active dressing stimulates the repair, replacement and regeneration of human skin. When OrCel is applied to the wound site, it produces a mix of growth factors that stimulates wound closure. We have achieved a number of milestones toward our goal of the commercial sale of OrCel including: o In August 2001 the FDA granted our application for commercial sale of OrCel for the treatment of donor site wounds. The results of the pivotal clinical trial for the use of OrCel to treat donor site wounds, which we submitted to the FDA, showed that there was a clinically and statistically shorter time to 100% wound closure when OrCel was used compared to the use of a current standard of care in that trial. The median differential in those healing times ranged from four to seven days o In December 2001 we commenced commercial sale of OrCel for the treatment of donor site wounds. These sales have been made to hospitals and other medical treatment facilities. For the 14-week period ended March 9, 2002, we generated gross sales of approximately $105,000. Such sales have been made before we have commenced any marketing efforts to sell OrCel. o In December 2001 our OrCel was approved by the Centers for Medicaid and Medicare Services for inclusion on the Outpatient Prospective Payment Systems Pass Through List. The inclusion on this list allows hospitals to recover their cost for OrCel from Medicare when utilizing OrCel for treatment of a Medicare patient as a hospital outpatient. o In December 2001 we entered into an agreement with PDI to market OrCel to hospitals and other medical treatment facilities. We have not yet started utilizing PDI's marketing staff to generate sales. If on the basis of the results of our clinical trials for the use of OrCel for the treatment of venous and diabetic ulcers, the FDA authorizes us to make commercial sales of OrCel for the treatment of those medical conditions, we expect to enter into other marketing arrangements to market OrCel to the larger medical community for use of OrCel for those two larger patient markets. Such marketing programs might consist of joint ventures with pharmaceutical companies or pharmaceutical sales organizations. At this time we can give no assurance that we will enter into such other marketing arrangements. o We have received encouraging results from the pilot clinical trial of the non frozen version of OrCel for the treatment of venous ulcers. These results show that OrCel is significantly more effective in treating venous ulcer wounds than the standard of care used in the clinical trial. Two months after initiating treatments, the OrCel treated group achieved 100% healing in 47% of the patients treated vs. 26% of the patients in the standard of care group. Six months after treatment the OrCel treated group achieved 100% healing in 71% of the patients treated, compared to 37% of the patients in the standard of care treated group. The results in that trial for the OrCel treated group compared favorably with the reported results of the clinical trials that were conducted by our competitors using their products for healing venous ulcers. o We have received encouraging results from the pilot clinical trial of the non frozen version of OrCel for the treatment of venous ulcers. These results show that OrCel is significantly more effective in treating venous ulcer wounds than the standard of care used in the clinical trial. Two months after initiating treatments, the OrCel treated group achieved 100% healing in 47% of the patients treated vs. 26% of the patients in the standard of care group. Six months after treatment the OrCel treated group achieved 100% healing in 71% of the patients treated, compared to 37% of the patients in the standard of care treated group. The results in that trial for the OrCel treated group compared favorably with the reported results of the clinical trials that were conducted by our competitors using their products for healing venous ulcers. o In October 2001 a preliminary review of the first 13 patients completing treatment of venous ulcers using OrCel in its frozen (cryopreserved) state showed that 9 of the patients (69%) achieved 100% wound closure within three months and that the other 4 patients achieved 90% or higher wound closure in that same three month period. o We have also received encouraging results from the pilot clinical trial of OrCel for the treatment of diabetic foot ulcers. These results show that OrCel is significantly more effective in treating diabetic foot ulcer wounds than the standard of care used in that clinical trial. Twelve weeks after treatment of diabetic ulcers of 6 sq. cm. or less (the largest diabetic ulcers population group) the OrCel treated group achieved 100% healing in 47% (7 of 15 patients) of the patients treated, compared to 23% (3 of 13 patients) of the patients in the standard of care treated group, for a greater than 100% improvement over standard of care. The daily rate of healing for the OrCel treated group was twice as fast as the rate for the standard of care treated group (2.2% /day vs. 1.1% /day). For the entire forty patient group, 35% (7 of 20 patients) of OrCel 2 treated patients achieved 100% healing compared to 20% (4 of 20 patients) in the standard of care treated group, for a 75% improvement over standard of care. This forty patient group included only difficult to heal ulcers in the study since the protocol required a pre-screening period in which all the patients whose ulcers responded readily to standard of care treatment were excluded from the trial. The results in that trial for the OrCel treated group compared favorably with the reported results of the clinical trials that were conducted by our competitors for use of their products for treatment of diabetic ulcers. Based on the results in the pilot trial, in February 2002 the FDA authorized us to commence a pivotal trial for use of OrCel in the treatment of diabetic ulcers. o We have developed the technology for the cryopreservation of OrCel without diminishing its effectiveness. Cryopreservation is the freezing of our product which gives it a minimum shelf life of six months, as opposed to a few days when our product is not cryopreserved. We are using our product in its cryopreserved form in our pivotal clinical trials for the treatment of venous and diabetic ulcers. o On February 21, 2001, the FDA granted our application for commercial sale of OrCel for use on patients with recessive dystrophic epidermolysis bullosa undergoing hand reconstruction, as well as to treat donor site wounds created during that surgery. This is the most severe form of epidermolysis bullosa, a condition in which a newborn's skin constantly blisters and can peel off at the slightest touch and leave painful ulcerations and permanent scarring, resulting in deformity of the hands and feet. The epidermolysis bullosa patient population that OrCel will address is small. o Our manufacturing facilities, which are at the same location as our offices in New York City, have been approved by the FDA for the manufacture of OrCel for commercial sale. However, we will need larger facilities to manufacture sufficient units of OrCel for anticipated sales for treatment of donor site wounds, after our marketing efforts to secure such sales are under way, and for treatment of venous and diabetic ulcers, if and when FDA approval is secured for sales for treatment of those medical conditions. In December 2001 we entered into a ten-year lease with the New Jersey Economic Development Authority for lease of approximately 58,000 square feet of manufacturing and office space located in North Brunswick, New Jersey. The leased premises (Tech Center) will be completed and will be available to us in two phases. The initial space, consisting of approximately 26,000 square feet, is in an existing 3 building and will be renovated to our specifications ("Phase #1"). The additional space, consisting of 32,000 square feet, will be a newly constructed building to be built to our specifications ("Phase 2"). The new building will adjoin the existing building. The landlord will be responsible for the completion of the renovations and construction of the buildings and is contributing up to $1,300,000 for the renovations in the existing building and $3,200,000 for the construction of the new building. Any additional renovation or construction costs will be borne by us. We have not yet estimated the cost of such renovations and new construction. Our FDA trials have resulted in approval of commercial sales of OrCel for treatment of donor site wounds and for patients with recessive epidermolysis bullosa undergoing hand reconstruction. Two other FDA trials we are currently conducting are for the use of OrCel in treating venous leg ulcers and diabetic foot ulcers. The target population for these four conditions is approximately one million people in aggregate, and a sales potential in excess of $1 billion. Each market is described briefly below. See "Forward Looking Statements." Venous Leg Ulcers. Approximately 700,000 Americans are plagued with venous leg ulcers. This type of ulcer is generally found in the lower leg proximate to the ankle and can result from trauma, but is typically associated with chronic venous insufficiency. Chronic venous insufficiency occurs when the venous valves don't close completely and blood is allowed to flow back from the deep venous system through the perforator veins into the superficial venous system. The weight of the backlogged blood pushes on the surrounding tissues of the lower leg and produces swollen, hyperpigmented ankles. Over time the pressure will cause tissue breakdown and an ulcer will form. Roughly 50% of venous leg ulcers are successfully treated with traditional methods, which include compression therapy followed by suggested regular walking and resting with the legs elevated for two hours a day. Diabetic Foot Ulcers. Diabetic foot ulcers will affect about 2 million of the 14 million diabetics in the United States during their lifetime. We estimate that there are between 800,000 and 1,200,000 Americans infected with diabetic foot ulcers each year. The ulcers are open sores that remain after the destruction of surface tissue. There are approximately 67,000 amputations each year from the complications created by these ulcers. Current treatments, which include off-loading of pressure, debridement, maintenance of a moist wound environment, wound cleansing and nutritional support, will cure between 50% and 60% of 4 most diabetic ulcers. Assuming that there are 800,000 persons infected with diabetic foot ulcers each year and that 50% are cured with traditional treatments, the remaining nearly 400,000 patients are candidates for use of OrCel to treat their ulcers. Donor Site Wounds. There are about 1.2 million people treated annually for burns at medical facilities across the United States. A vast majority of the burns, about 96%, cover a relatively small portion of the total body surface area and are treated on an outpatient basis in doctors' offices, hospitals and burn units. Roughly 4%, or 50,000, of the burn cases are severe and, we believe, require autograft transplants, thereby creating donor site wounds. A donor site wound is the result of an autograft, which involves removing a piece of healthy skin from an uninjured part of the body to cover an open wound at another location on the body. We estimate that the typical severe burn case in which autograft transplant procedures are required to be used creates four donor site wounds per patient, or a total of approximately 200,000 donor site wounds created in the United States each year. Due to differing severity of burns, we estimate that OrCel can be used to treat the donor site wounds resulting from autograft transplants in about 43% of the 50,000 (or 21,500) severely burned patients. Epidermolysis Bullosa. Few babies born with severe epidermolysis bullosa survive the first year and those that do are bombarded with constant blistering, which causes scarring that constricts the skin so much that the hands can become disfigured and fingers and toes can fuse together requiring reconstructive surgery. In 1986 a national registry was established to track the number of people with epidermolysis bullosa. OrCel is for use by epidermolysis bullosa patients who have the dystrophic and junctional form of the disease, a population of about 900 according to the national registry's database. Advocacy groups for epidermolysis bullosa patients argue that the registry's estimate is significantly under reported. Although we have received FDA approval for the sale of OrCel for treatment of patients with recessive dystrophic epidermolysis bullosa undergoing hand reconstruction, as well as to treat donor site wounds created during that surgery, our sales efforts will be focused on a small number of regional hospitals with expertise in treating epidermolysis bullosa. Consequently, we do not expect to have significant revenues from the sale of OrCel for the treatment of epidermolysis bullosa. 5 Our immediate focus is to use OrCel to treat these four medical conditions. However, we believe OrCel can also be used to treat additional acute and chronic indications such as pressure ulcers (decubitus), cosmetic surgery and indeterminate burns. We also believe that there is an opportunity to apply our core technologies to repair selected structural tissues such as tendon, ligament, cartilage, bone and blood vessels. While we believe that our bi-layered product will be effective in treating the medical conditions in our target markets, many companies and academic institutions have developed, or are capable of developing, products or other technologies that are or may be competitive with OrCel. We know of only one other company, Organogenesis, Inc., that has developed a bi-layered product, Apligraf, to treat the same wounds as OrCel. Organogenesis has licensed Novartis, Inc. to market Apligraf and Apligraf, having received FDA approval, is currently being sold for the treatment of venous and diabetic ulcers. We believe that OrCel will have certain competitive advantages over other comparable bio-engineered products in that OrCel (i) has demonstrated superior clinical results in recently released clinical data, accelerating healing in comparison to standard of care and other competitive products; (ii) has the capability to be less expensive to produce and easier for the physician to handle and use; and (iii) can be stored and delivered in a cryopreserved form, providing production and distribution efficiencies. As a development stage company we have only recently begun selling OrCel, realizing net revenues of $105,000 in the 14 week period ending March 9, 2002. Such modest sales were achieved without any marketing effort on our part. Except for such limited sales our activities to date have been limited to human clinical trials of OrCel and research and development. From the creation of our company in March 1991 through December 31, 2001, we have spent approximately $18.0 million for human clinical trials and research and development, not including employee salaries. From inception in March 1991 through December 31, 2001, we have sustained a net loss of $59.2 million and expect to continue to incur substantial operating losses until at least 2003. On August 29, 2001, we entered into a Revenue Interests Assignment agreement with Paul Capital Royalty Acquisition Fund, L.P. Under such agreement we received $6,000,000 during 2001 and received an additional $4,000,000 in January 2002. Upon completion of additional milestones, we may be eligible to receive another $5,000,000 from Paul Capital, if requested by us, and may incrementally receive an additional $10,000,000, but only upon mutual agreement by both Paul Capital and us. In consideration for the first $10,000,000 received by us, Paul Capital will receive a minimum 3.33% of the end user sales of our products in the United States, Canada, and Mexico. Such percentage may be further adjusted upward or downward, based on the volume 6 of net receipts from end users of our products in those three countries. We anticipate that the effective cost of the amounts we received from Paul Capital will range from 20% to 35% per annum over the term of the agreement which terminates in December 2011. Beginning on January 1, 2003, Paul Capital will be entitled to receive each year the first proceeds we receive from end user sales of our products in those three countries. Such annual amounts Paul Capital will be able to draw in advance will range from $1.5 million in 2003 to $7.5 million in 2005 and thereafter. The agreement provides for quarterly and annual accountings between Paul Capital and us for those advance payments. In the event of a change in control of Ortec or upon the occurrence of certain other events as defined in the agreement, Paul Capital has the option to put its revenue interest back to us for an amount as provided in the agreement. Ortec also has the option to repurchase Paul Capital's interest upon the occurrence of a change in control of Ortec or a complete divestiture by us of our products, for an amount provided in the agreement. We have granted Paul Capital a security interest in our United States and Canadian patents and trademarks relating to our technology for our OrCel product to secure payments we are required to make to Paul Capital. The agreement terminates on December 31, 2011, unless terminated earlier by either party, as permitted by the terms of the agreement. We have also recently received a $1,300,000 line of credit for equipment lease financing. At our current rate of spending, our cash and cash equivalents on hand at December 31, 2001 (approximately $ .9 million) and the additional $4 million which was due from Paul Capital at December 31, 2001, and was received in January 2002, will enable us to continue our operations through April 30, 2002, assuming that we will not incur unexpected costs. We will be required to raise additional funds (through sale of our securities or debt financing) to complete our clinical trials and to produce and market OrCel. Our failure to receive additional financing will have a material adverse effect on our operations. Also, in order to produce OrCel for treatment of medical conditions with large patient populations, we will have to build larger production facilities, which will require significant additional funding. If we secure the additional funding we need, receive FDA approval for commercial sales of OrCel for treatment of medical conditions with large patient populations and successfully market OrCel, we believe that we will have the opportunity to reach cash break even in 2003. On March 27, 2002, we engaged H.C. Wainwright & Co., Inc., an investment banking firm, to act as our financial advisor in connection with raising capital for the Company through debt and/or equity financing. While we can give no assurance that any equity financing will be secured, Wainwright is assisting us in raising equity financing of $12,000,000, which we believe will enable us to continue our operations for the next 12 months. If received, we will use the above proceeds primarily to complete our clinical trials for use of OrCel in the treatment of venous stasis and diabetic ulcers and to submit the results of those trials to the FDA for approval to market OrCel for treatment of those medical conditions. We expect that the anticipated financing will allow us to do this. Based upon our current schedule for completion of the clinical trials and submission to the FDA, we believe that we can obtain FDA approval for the use of our product in treating both venous stasis and diabetic ulcers patients in 2003. 7 Ortec was organized in 1991 under the laws of the State of Delaware for the purpose of acquiring, developing, testing and marketing our skin replacement product. Our executive offices are located at 3960 Broadway, New York, New York, and our telephone number is (212) 740-6999. The Product Background Human skin is composed of cells and matrix proteins that are tough yet flexible and protect the body against abrasion, water loss, and infection. For cells to function normally within tissues, the cells must interact with the proteins that surround them. When certain tissues become damaged, normal healthy cells attempt to repair the deficient site by moving into the damaged area, dividing, and depositing new matrix proteins that very often result in scars. Scars do not function like normal tissue since the area is surrounded by excessive amounts of matrix proteins. In the case of burns, wounds and other skin diseases, where the human body cannot repair the tissue by spontaneous healing, there are several medical treatments that are available, but no treatment that provides completely satisfactory results. For chronic wounds like epidermolysis bullosa and diabetic ulcers, the conventional approach is cleaning, disinfecting the site, and then treating with moist dressings; while for venous stasis ulcers the conventional treatment after cleaning and disinfecting is compression therapy. Another approach is grafting the wound site with the patient's own healthy tissue, which is called an autograft transplant. Physicians have for years been using skin transplanted from one site of a patient's body onto a wound site that no longer has the capacity to heal spontaneously. This approach creates a second wound site where the healthy tissue is harvested and is of limited use when patients are left with a minimal amount of healthy tissue for grafting. Physicians have sought to replace autograft transplants with substitute synthetic or natural materials which would eliminate the medically undesirable problems that accompany autograft transplants, such as the creation of additional wound sites, possible infection and scarring. Another approach that has been developed in recent years is the replication of human skin in a laboratory setting in order to create an artificial skin that can be transplanted onto diseased or injured patients. Major problems encountered by scientists include the rejection of the artificial skin by the patient's immune system and significant contraction of the transplant after healing, causing cosmetically undesirable scarring. 8 OrCel Our OrCel is a device consisting of two layers of immature human-derived skin cells (dermal and epidermal) supported in a permeable bi-layered collagen matrix. When applied to an area needing skin regeneration, OrCel stimulates the body's healthy cells to rapidly regenerate and remodel the human skin. OrCel is not a skin transplant or an artificial skin, but rather a tissue engineered dressing which, we believe, provides an optimal environment for the production and delivery of a multitude of growth factors which appear to promote migration of the patient's own healthy cells into the wound site resulting in accelerated skin regeneration and wound healing. Rejection of OrCel is mitigated because in approximately two weeks the entire OrCel dressing is absorbed by the body and the cells from our product are no longer present. We believe that OrCel's bi-layered structure and porous collagen matrix are key differentiating product features which provide a superior structure for cell migration and tissue regeneration. We believe that the immature cells in OrCel produce an optimal mixture of growth factors that stimulate the patient's own natural healing process. The open collagen structure also allows the patients own dermal and epidermal cells to proliferate and migrate into the wound site, as well as to allow the return of blood vessels to the wound site. The OrCel dressing is absorbed by the body in approximately 7-14 days and is replaced by the patient's own skin. Benefits There are currently three primary and distinct approaches to the repair and regeneration of skin: the acellular (no cell) approach, the cell-based unilayered approach, and the cell based bi-layered approach. The acellular approach uses a non-living material, particularly cadaver skin, collagen, silicone, or an ointment to treat the wound. The cell-based approaches employ living cells in order to closely replicate human skin cells and stimulate wound repair and tissue regeneration. The unilayered approach, although a cell-based approach, utilizes either living epidermal or dermal cells, but not both. The approach we believe to be the most advanced is the bi-layered, dermal and epidermal, approach. The only bi-layered product other than OrCel that is available for sale is Apligraf, a product developed by Organogenesis, Inc. We believe OrCel induces faster wound healing and reduces pain and complications generally associated with open wounds. We also believe that autograft donor sites treated with OrCel tend to be ready for recropping earlier than sites treated with the current standard of care. 9 We believe that OrCel is easier to use than the existing available bi-layered technology because the composition and packaging of our product allows the surgeon or other physician to easily remove OrCel from its packaging and simply drape it over the wound. Our product can generally be applied to a wound in less than one minute. We further believe our product constitutes a cost effective alternative to conventional standards of wound care. The conventional treatment for wounds such as venous and diabetic ulcers, burns and autograft donor sites can be expensive and require multiple doctor visits and potentially lengthy hospitalization. Because of the more rapid healing process we expect from treating these wounds with OrCel, the length of hospital stays and the number of follow up visits to doctors may be reduced substantially. In addition, our ability to cryopreserve our product allows for a longer shelf life for storage of our product, which we believe will make it more appealing to the end user - the physician or hospital. See " Forward Looking Statements." Regulatory Process and Clinical Trials Regulatory Framework. We are subject to extensive government regulation. Products for human treatment are subject to rigorous pre-clinical and clinical testing procedures as a condition for approval by the FDA and by similar authorities in foreign countries for commercial sale. The FDA regulates the manufacture, distribution and promotion of medical devices in the United States, pursuant to the Federal Food, Drug and Cosmetic Act and regulations promulgated thereunder. OrCel is subject to these regulations and is currently classified as a medical device. We must obtain pre-market approval by the FDA prior to commercial sale of OrCel. Pre-market approval requires proof of safety and efficacy through human clinical trials. Pre-market approval is a lengthy and expensive process. Although we have secured pre market approval from the FDA for commercial sales of OrCel for the treatment of donor site wounds and for use on patients with recessive dystrophic epidermolysis bullosa undergoing reconstructive hand surgery and to treat donor site wounds created during that surgery, we can give no assurance that we will obtain pre-market approval for sale of OrCel for the treatment of medical conditions with larger patient populations. To obtain pre-market approval, we must submit an application to the FDA, supported by extensive data, including human clinical trial data, and documentation to prove the safety and efficacy of the device. Applicable regulations provide that the FDA has 180 days to review an application for pre-market approval during which time an advisory committee usually evaluates the application and makes recommendations to the FDA. While the FDA has 10 responded to applications for pre-market approval within that time period, as it did in approving OrCel for treatment of donor site wounds, reviews usually occur over a significantly protracted period of twelve to twenty-four months. Many devices are never cleared for marketing. If human clinical trials of a proposed device are required and the device presents a possible or unknown risk, the manufacturer or distributor of the device has to file an application for an investigative device exemption with the FDA prior to commencing such trials. The application for an investigative device exemption must be supported by data, including the results of animal and other testing. If the application for an investigative device exemption is approved, human clinical trials may begin. The human clinical trials for medical devices may consist of two stages: the first is a feasibility study/pilot trial, in which a small group of patients is tested in order to collect preliminary safety and effectiveness data; the second, a pivotal trial, requires testing of a larger patient population to determine a fuller understanding of safety and to confirm efficacy of the device for the targeted medical conditions. We have developed rigorous internal standards for testing and compiling data necessary for FDA filings. We conducted feasibility studies for all the medical conditions we propose to treat with OrCel prior to filing applications with the FDA for pivotal trials. We assume that this process has allowed us to submit more precise protocols to the FDA, clearly defining the clinical objectives we wish to support in the pivotal trial phase. We engage in an ongoing dialogue with the FDA in an effort to manage the approval process both effectively and efficiently. At the present time we - have received FDA approvals for commercial sales of OrCel for treatment of donor site wounds and for use on patients with recessive dystrophic epidermolysis bullosa undergoing hand reconstructive surgery and to treat donor site wounds created during that surgery, and - are conducting two pivotal clinical trials for use of OrCel in its cryopreserved form for the treatment of venous ulcers and diabetic ulcers. Description of the Production Process OrCel cells are derived from infant foreskins obtained during routine circumcisions. The immature, neonatal cells are highly reproductive and provide enhanced proliferation and 11 rapid remodeling of the human skin. We separate the epidermis from the dermis and treat each of these layers to release individual keratinocyte (epidermal) and fibroblast (dermal) cells, which are the primary cellular components of human skin. We grow the fibroblast and keratinocyte cells in culture in large quantities, then freeze and store them as a cell bank, ready for use. Prior to the use of each cell line, we conduct extensive testing and screening in accordance with current FDA guidelines to ensure that the cells are free of presence of bacterial contaminants, viruses, pathogens, tumorigenicity or other transmittable diseases. We then apply the dermal fibroblast cells to a proprietary, cross-linked bovine collagen sponge to form the dermal layer matrix and we grow the epidermal keratinocyte cells on a separate non-porous layer of collagen. We then incubate and supply this composite matrix with the proper nutrients to allow the cells to multiply and for the fibroblasts to permeate inside and anchor to the porous collagen sponge. The top layers of keratinocyte cells and bottom layers of fibroblast cells in the collagen matrix, together, constitute our proprietary OrCel, which we can then deliver to customers in a "fresh" or cryopreserved state. Original Research Our technology was developed by Dr. Mark Eisenberg, a physician in Sydney, Australia. Dr. Eisenberg is an officer and director and one of the founders of Ortec. He has been involved in biochemical and clinical research at the University of New South Wales in Australia for over twenty five years, focusing primarily on treating the symptoms of epidermolysis bullosa. In 1987, through his work on epidermolysis bullosa, Dr. Eisenberg first succeeded in growing epidermal layers of human skin, which he successfully applied as an allograft on an epidermolysis bullosa patient. An allograft is a transplant other than with the patient's own skin. Dr. Eisenberg continued his research which eventually led to the development of OrCel - a tissue-engineered dressing which consists of both the dermal and epidermal layers. The current research for our proprietary technology is performed at our laboratory in New York City and in our laboratory in Sydney, Australia. Regulatory Strategies, Product Development and Sales We employ a team of regulatory and clinical professionals, both full time employees and consultants, with extensive knowledge in strategic regulatory and clinical trial planning to support our product development efforts through every stage of the development and FDA approval process. We also employ persons with extensive knowledge and experience in the marketing and sale of new FDA approved products for treatment of many medical conditions, including experience in securing approval of third party payors (insurance companies, Medicare, Medicaid) for use of new medical products. 12 Production and Supply We believe that production capacity at our facility in the Audubon Biomedical Science and Technology Park in New York City should be sufficient to meet demands for OrCel for treatment of donor site wounds and in hand reconstruction surgery for patients with recessive dystrophic epidermolysis bullosa. We will need larger production facilities to achieve significant sales of OrCel for treatment of larger patient populations, such as patients with venous and diabetic ulcers. In December 2001 we entered into a ten-year lease with the New Jersey Economic Development Agency to lease approximately 58,000 square feet of manufacturing and office space, located in North Brunswick, New Jersey. The terms of that lease transaction is described in Part I, Item 1 - "Business-Overview" in this annual report and in Item 2 - "Properties." Such facilities will have to be FDA validated and approved. Any manufacturing, whether by us or by a third party manufacturer, for any future commercial scale production of OrCel will also have to be in compliance with the good manufacturing processes and quality system regulations mandated by the FDA. Our production facility in the Audubon Biomedical Science and Technology Park was inspected and approved by the FDA in September 2000 for the manufacturing of OrCel for commercial sale. We expect to move into our new facilities in North Brunswick, New Jersey in 2003. Competition We are aware of several companies that are actively engaged in the research and development of products for the repair and regeneration of skin. As we noted previously, there are currently three primary and distinct approaches to the repair and regeneration of skin: the acellular (no cell) approach, including the use of cadaver based products; the cell- based unilayered (epidermal or dermal cell) approach, and the cell based bi-layered (epidermal and dermal cell) approach. The approach we believe to be the most advanced and effective is the bi-layered approach. There is also a procedure which cultures the patient's own epidermal cells to create an epidermis like layer. That procedure takes a number of weeks to create that epidermal layer. Genzyme Biosurgery is currently selling such a product for treatment of severely burned patients only, pursuant to an FDA humanitarian device exemption. 13 We consider our primary competitors to be Organogenesis, Inc. and Advanced Tissue Sciences, Inc. The FDA approved Organogenesis' Apligraf, which employs the bi-layered approach, for treatment of venous ulcers in May 1998 and for the treatment of diabetic ulcers in June 2000, and Organogenesis is selling Apligraf through a joint venture with Novartis Pharmaceuticals Corporation. Advanced Tissue, through a joint venture agreement with Smith & Nephew PLC, markets Transcyte, a unilayer, non-absorbable biosynthetic matrix, seeded with dermal fibroblast cells, which acts as a temporary wound covering for severe burns and as a covering for partial thickness burns. Advanced Tissue's Dermagraft product for the treatment of diabetic foot ulcers was rejected by the FDA in June 1998 and additional trials were mandated by the FDA to prove efficacy. In August 2000 Advanced Tissue submitted the results of their additional trials to the FDA and received approval for commercial sale of their product in October 2001. We believe that the following are the greater benefits derived by users of OrCel. o OrCel can be cryopreserved so that it can be stored by the hospital or clinic instead of awaiting shipment. o OrCel uses a porous collagen matrix and undifferentiated epidermal and dermal cells, resulting in a vigorous growth factor production which appears to enable a quicker healing process. o OrCel is "user friendly". The physician opens a cassette, peels off the protective mesh and immediately lays the Composite Cultured Skin on the wound. The process should take as little as one minute. We believe that many of our competitors may have greater financial and other resources than we do and most of them have conducted and continue to conduct human clinical trials, some of which are at more advanced stages than our human clinical trials. Although we are not aware of any biologically active skin repair product that has received pre-market approval from the FDA except as discussed above, there may be other companies having greater financial resources than we do who may develop other skin regeneration or wound healing technologies that may be more effective than OrCel, or that may make OrCel obsolete. 14 Patents and Proprietary Rights We have two U.S. patents for the technology for OrCel, both of which expire in 2011. We have also been granted corresponding patents in Europe (for most of the countries in Europe) and in Australia and New Zealand, Ireland, Israel, Japan, Thailand and South Africa. We are prosecuting patent claims in Canada, The Russian Federation, Brazil and China. In December 2000 and January 2001, we filed four additional patent applications with the United States Patent Office directed to further aspects of our OrCel technology. The patent applications focus on our cryopreservation, cell and manufacturing processes, and a cardiovascular application of our technology. One of our competitors filed an opposition with the European Patent Office challenging the validity of our European patent. The opposition in Europe was rejected in February 2002 and our patent was held novel and inventive. The expiration date of our European patent is March 24, 2011. Our patents might be successfully challenged in court proceedings, invalidated or rendered unenforceable. Our success will depend, in part, on our ability to maintain patent protection for our technology, both in the United States and other countries. Our patents may be infringed, invalidated or circumvented by others. Others may also develop technologies or processes that are the same or substantially as effective as ours, thereby by-passing the benefits of our patent protection. Therefore, our United States and foreign patents may not provide us with any commercial benefits. Nor can we give any assurance that our currently pending patent applications will be granted. Several of our competitors, including Organogenesis, Inc., Advanced Tissue Sciences, Inc., Genzyme Biosurgery Repair Inc., Integra Life Sciences and LifeCell Corporation, have been granted patents relating to their particular artificial skin technologies. See "Competition". Employees We presently employ 95 people on a full-time basis, including five executive officers. Including our executive officers, we employ 92 persons in New York City and 3 people at our laboratory in Sydney, Australia. We also have part time employees, 4 in New York and 2, including Dr. Eisenberg, in Australia. We anticipate hiring additional employees in the areas of quality assurance, manufacturing, marketing and research and development as our needs arise. 15 Item 2. PROPERTIES We occupy an aggregate of 17,287 sq. ft. of space in Columbia University's Audubon Biomedical Science and Technology Park in New York City, pursuant to four separate lease agreements, for laboratory and office space. We use our laboratories for assay development, wound healing research, biomaterial development, bioprocess development, histology, quality assurance testing and for two clean rooms where we produce OrCel. As of December 31, 2001 we were paying an aggregate of $47,615 rent per month for use of all our space at the Audubon facility. In December 2001 we entered into a ten-year lease with the New Jersey Economic Development Agency to lease approximately 58,000 square feet of manufacturing and office space located in North Brunswick, New Jersey. The leased premises (Tech Center) will be completed and will be available to us in two phases. The initial space, consisting of approximately 26,000 square feet, is in an existing building, which will be renovated to our specifications ("Phase #1") and the additional space, consisting of 32,000 square feet, will be a newly constructed building built to our specifications ("Phase #2"). The new building ("Phase #2") will adjoin the existing building ("Phase #1"). The landlord will be responsible for the completion of the renovations and construction of the buildings and is contributing up to $1,300,000 for the renovations in the existing building and $3,200,000 for the construction of the new building. Any additional renovation or construction costs will be borne by us. We have not estimated the cost of such renovations and new construction. We expect to move into these new facilities in 2003. The initial base rent for Phase #1, starting 9 months after the lease Commencement Date, is $14.00 per square foot for the next 15 months, increasing to $25.00 and $26.00 per square foot during the third and fourth years, respectively, and to a base rent of $29.00 per square foot in the fifth year to the balance of the initial term of the lease. The initial base rent for Phase #2, commencing upon substantial completion of the construction of the building, is $23.00 per square foot during the first year after completion, increasing annually at the rate of $1.00 per square foot during the second and third years, to a base rent of $26.00 per square foot in the fourth year to the balance of the initial term of the lease. We will also be responsible for additional rent for operating expenses. 16 Due to timing of our anticipated move to the Tech Center premises in North Brunswick, we also leased, as of March 1, 2002, from the same landlord, approximately 3,200 square feet in an adjoining building, for a 16 month term, at an initial base rent of $30.00 per square foot during the first year, increasing to $31.50 per square foot during the last four months of the term. We also lease approximately 5,000 square feet of space at 147-155 Queen Street, Beaconsfield, Sydney, Australia, on a month to month basis, where we operate a research laboratory to conduct our research and development activities in Australia. We pay rent in Australian dollars, which at the current rate of exchange amounts to approximately US$24,900 per year. We rent this space from Dr. Mark Eisenberg's father's estate on terms that we believe are not less favorable to us than for rental of similar space in Sydney, Australia, from non-related third parties. ITEM 3. LEGAL PROCEEDINGS The summons and the complaint in the legal proceeding instituted by Dov Shellef against us and six of our then directors and one of our executive officers who was not a director, were served on us and those individual defendants in December 2001. The complaint's allegations and the court in which that legal proceeding was instituted, are described in our 10-Q report for the quarter ended September 30, 2001. 17 PART II Item 5. MARKET FOR THE COMPANY'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS Market Information Our common stock is listed on the NASDAQ SmallCap Market under the symbol "ORTC". The following table sets forth the high and low sales prices of our common stock as reported by NASDAQ for each full quarterly period from January 1, 2000 through December 31, 2001.
2001 High Low - ---- First Quarter 8.75 5.81 Second Quarter 6.98 5.75 Third Quarter 7.75 6.00 Fourth Quarter 6.94 4.45 2000 High Low - ---- First Quarter 17.00 7.00 Second Quarter 11.13 6.00 Third Quarter 11.00 7.00 Fourth Quarter 11.15 5.50
Security Holders To the best of our knowledge at March 11, 2002, there were 121 record holders of our common stock. We believe that as of such date there were an additional 1,889 beneficial owners of our common stock, whose shares are held in "street name." Dividends We have not paid, and have no current plans to pay, dividends on our common stock. 18 Recent Sales of Unregistered Securities During the fourth quarter of 2001 we granted to 17 employees, directors and consultants options under our Employee Stock Option Plan to purchase an aggregate of 426,000 shares of our common stock, at exercise prices ranging from $4.70 to $6.10 per share. The grant of such options was exempt from the registration requirements of the Act pursuant to the provisions of Section 4(2) of the Act because such option grants did not involve any public offering and because such option grants did not constitute sales of securities. Item 6. Selected Financial Data The following selected financial data are derived from the Company's financial statements and should be read in conjunction with, and are qualified in their entirety by, the financial statements and related notes included in Item 7 and Management's Discussion and Analysis included elsewhere in this Annual Report:
Cumulative from March 12, 1991 Statement of operations data (inception) to - ---------------------------- December 31, Years Ended December 31, 1997 1998 1999 2000 2001 2001 ---------- ---------- ------------ ----------- ----------- ------------ Product revenue $ - $ - $ - $ - $ 21,890 $ 21,890 ---------- ---------- ------------ ----------- ----------- ------------ Expenses Research and development 1,178,836 1,933,877 3,106,908 4,191,317 4,283,038 18,048,392 Rent 166,498 252,397 473,010 535,443 589,238 2,179,535 Consulting 474,908 908,495 834,180 838,383 1,413,153 5,226,515 Personnel 1,901,409 4,060,629 3,742,632 4,763,662 6,605,630 22,949,360 General and administrative 1,320,488 1,725,201 2,152,968 2,297,769 2,671,887 12,002,685 Interest and other expense 75,126 104,605 99,522 89,712 536,070 1,019,506 Interest income (291,602) (572,549) (368,711) (586,623) (191,749) (2,249,449) ---------- ---------- ------------ ----------- ----------- ------------ 4,825,663 8,412,655 10,040,509 12,129,663 15,907,267 59,176,544 ---------- ---------- ---------- ---------- ---------- ----------- Net loss $(4,825,663) $(8,412,655) $(10,040,509) $(12,129,663) $(15,885,377) $(59,154,654) ========== ========== =========== =========== =========== =========== Net loss per share of common stock Basic and diluted $(1.01) $(1.43) $(1.51) $(1.37) $(1.64) $(12.67) Weighted average common stock outstanding Basic and diluted 4,782,239 5,878,971 6,634,874 8,847,295 9,691,608 4,668,594 ========= ========= ========= ========= ========= ========= Balance sheet data - ------------------ Working capital (deficiency) $12,982,711 $ 9,368,901 $ 11,009,660 $ 7,966,410 $ (2,529,159) Total assets 14,998,414 12,391,039 15,011,645 11,719,760 4,038,601 Long-term debt, excluding current maturities 722,704 1,152,180 1,044,857 912,489 6,768,983 Shareholders' equity/(deficit) 13,716,618 10,390,759 12,370,720 9,392,325 (6,304,972)
19 Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion should be read in conjunction with our financial statements and notes thereto. This discussion may be deemed to include forward looking statements. Forward Looking Information This Report on Form 10-K contains certain forward looking statements and information relating to Ortec, that are based on the beliefs of management, as well as assumptions made by management, utilizing currently available information. When used in this document, the words "anticipate," "believe," "estimate," and "expect" and similar expressions, as they relate to Ortec, are intended to identify forward looking statements. Such statements reflect our current views with respect to future events and are subject to certain risks, uncertainties and assumptions, including those described in this discussion and elsewhere in this Form 10-K Report. Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove to be incorrect, actual results may vary materially and adversely from those described herein as anticipated, believed, estimated or expected. We do not intend to update these forward looking statements. The following discussion should be read in conjunction with our financial statements and notes thereto. General Since Ortec's inception we have been principally engaged in the research and development of our tissue engineered skin regeneration product, for use in the treatment of chronic and acute wounds, such as venous and diabetic skin ulcers, and autograft donor site wounds for 20 burn victims. We call our product OrCel'TM' and in June 2001 we filed a trademark application for such name with the United States Patent and Trademark Office. In February 2001 Ortec received FDA approval to make commercial sales of OrCel for use on patients with recessive dystrophic epidermolysis bullosa, followed by FDA approval in September 2001 for use of the product in the treatment of donor site wounds in burn patients. With these approvals, though Ortec is still a development stage enterprise, in December 2001 we began our first commercial shipment of product, realizing sales revenues of approximately $22,000. From inception to date, we have incurred cumulative net losses of approximately $59.2 million. We expect to continue to incur substantial losses until at least 2003, due to continued spending on research and development programs, the funding of clinical trials and regulatory activities and the increased personnel costs of manufacturing, marketing and sales, distribution and administrative activities. We are currently conducting pivotal clinical trials of OrCel in the treatment of venous stasis and diabetic foot ulcers. Venous stasis ulcers are open lesions on the legs, which result from the poor circulation of blood returning from the legs to the heart. Diabetic ulcers are open sores that remain after the destruction of surface tissue. Ortec expects to complete the venous stasis clinical trials by the end of 2002, with submission of the FDA filing by the first quarter of 2003. We expect to complete the diabetic ulcers pivotal clinical trials early in 2003, with submission to the FDA anticipated by the end of the second quarter 2003. We anticipate obtaining FDA approval in 2003 for the use of our OrCel product in the treatment of both these medical conditions. We anticipate that future revenues and results of operations may continue to fluctuate significantly depending on, among other factors, the timing and outcome of applications for additional regulatory approvals, our ability to successfully manufacture, market and distribute OrCel and/or the establishment of collaborative arrangements for the manufacturing, marketing and distribution of our product. We anticipate that our operating activities will result in substantial net losses until at least 2003. Critical Accounting Policies Revenue Recognition. Revenues from sales are recognized upon shipment of product to customers. In December 2001 Ortec made its first commercial sales of product to customers. 21 We account for our Revenue Interest Assignment Agreement in a manner similar to that of debt and provide for interest to reflect the estimated cost of the funds received. Interest is imputed at 30% per annum, which is the minimum return under the agreement. Interest may range from 20% to 35% per annum depending on our sales and the ultimate term of the Agreement. Results of Operations Year Ended December 31, 2001, and December 31, 2000. Revenues Ortec made its first commercial shipments of OrCel to customers in December 2001, earning revenues from operations of approximately $22,000. Expenses Expenses increased by approximately $3.4 million in 2001 from approximately $12.7 million in 2000 to approximately $16.1 million in 2001. Personnel. Personnel costs increased by approximately $1.8 million to $6.6 million in 2001, compared with $4.8 million in 2000. This increased expense resulted from the additional personnel required to conduct and manage the clinical trial programs, to manufacture the product required by our clinical trial programs and other research and development activities, to prepare for manufacturing scale-up and marketing and an increase in corporate and administrative expenses. During 2001, we conducted two pilot clinical trials, concluded a pivotal clinical trial and the relevant FDA submissions. Based on these trials and submissions, Ortec was granted two FDA approvals in 2001. Consulting. These fees increased by $.6 million from $.8 million in 2000 to $1.4 million in 2001, primarily due to costs incurred in conducting the clinical trials and FDA submissions, noted above, the development of a new cryopreserved product and in hiring a marketing consultant. Research and Development. These expenses increased by approximately $.1 million to $4.3 million in 2001, compared with $4.2 million in 2000. The increase in research and development expenses was primarily due to the costs of conducting the venous and diabetic ulcers clinical trials, as well as research work performed in the areas of cryopreservation and production cost reduction. 22 General and Administrative. These expenses increased by $.4 million from $2.3 million in 2000 to $2.7 million in 2001, due to increased marketing and legal expenses incurred, as Ortec prepares for commercial sales of its product and continues its financing activities. During 2001, the Company worked on and entered into several significant agreements, including the Paul Capital Revenue Interest Assignment agreement, the GE Capital Asset Financing agreement and the Technology Center of New Jersey Lease agreement. We also investigated and evaluated several potential corporate investment partners. Interest Expense. Ortec incurred increased interest expense of $.4 million in 2001, compared with the expense incurred in 2000. On August 29, 2001, Ortec entered into a Royalty Revenue Interest Assignment agreement with Paul Capital and as part of this agreement, was entitled to receive $10.0 million in 2001. $6.0 million of this amount was received in 2001 and the remaining $4.0 million was received in January 2002. Upon the achievement of certain milestones, Ortec may be entitled to receive another $5.0 million and may incrementally receive an additional $10.0 million, but only upon the mutual agreement of both the Company and Paul Capital. Management anticipates that the effective cost of these funds based on the anticipated revenue stream, over the term of this agreement, which terminates in December 2011, will range between 20% to 35% per annum and as such, approximately $455,000 in interest expense has been accrued in 2001. We have provided for interest at 30% per annum which represents the minimum return to Paul Capital assuming that we do not early terminate the agreement. Interest Income. Interest income declined by approximately $395,000 from $587,000 in 2000 to approximately $192,000 in 2001, primarily due to the smaller average cash balances outstanding during 2001 compared with 2000. Year Ended December 31, 2000, and December 31, 1999. Revenues There were no revenues from commercial sales in 2000 and 1999. Expenses Research and Development. Expenses for the year ended December 31, 2000 increased to $4.2 million from $3.1 million for the year ended December 31, 1999, which amounts do not include consulting expenses, a significant portion of which was paid for research and development projects. Such consulting expenses for research and development amounted to approximately $838,000 in 2000 and $834,000 in 1999. The increase in research and development expenses relate primarily to the costs associated with the increased clinical trial activity, cryopreservation research and for enhancement and other applications of Orcel. 23 General and Administrative. This expense amounted to $2.3 million for the year ended December 31, 2000 and $2.2 million for 1999. Personnel. Personnel expenses for the year ended December 31, 2000 increased to $4.8 million from $3.7 million for the year ended December 31, 1999. This increase resulted from the larger number of persons employed because of increased research and product development, to conduct our clinical trials, to prepare for manufacturing scale-up in anticipation of marketing our product, and for additional administrative personnel required as a result of such increased staffing levels. Rent. This expense increased to $535,000 in 2000 from $473,000 for the year ended December 31, 1999. This resulted from the increased space occupied at Columbia University's Audubon Biomedical Science and Technology Park in New York City for additional research and development laboratories and to accommodate the increased staffing in 2000. Interest Income. Interest income increased by approximately $218,000 from approximately $369,000 in 1999 to approximately $587,000 in 2000, because of larger cash and cash equivalent balances in 2000 that resulted from sales of common stock. Liquidity and Capital Resources Since inception (March 12, 1991) through December 31, 2001, Ortec has accumulated a deficit of approximately $59.2 million and we expect to continue to incur substantial operating losses until at least 2003. We have financed our operations primarily through private placements of our common stock, our initial public offering and the exercise of our publicly traded Class A warrants at the end of 1997. From inception to December 31, 2001, we received cash proceeds from the sale of equity securities, net of share issuance expenses, of approximately $49.9 million, and in 2001, we received $6 million from the sale of a percentage interest in our future revenues from the sale of our product in North America. For the year ended December 31, 2001, we used net cash for operating activities of approximately $13.0 million. Cash used in operating activities resulted primarily from our net loss of $15.9 million, offset by non cash depreciation and amortization of approximately $737,000, approximately $188,000 of non cash stock compensation and an increase in accounts payable and accrued expenses of approximately $2.1 million. 24 In 2001 we invested approximately $620,000 in property, plant, equipment and patent application costs and made deposits and advances of $105,000 toward certain agreements. Additionally, we paid down $132,000 on our loans payable during 2001. We did not receive any cash from the sale of our common stock, but we did receive $6.0 million under our agreement with Paul Capital Royalty Acquisition Fund, L.P. In December 2001 we entered into a ten-year lease with New Jersey Economic Development Authority to lease approximately 58,000 square feet of manufacturing and office space located in North Brunswick, New Jersey. The leased premises will be completed and will be available to us in two phases. The initial space, consisting of approximately 26,000 square feet, is in an existing building, which will be renovated to our specifications. The additional space, adjoining the existing building and consisting of 32,000 square feet, will be constructed to our specifications. The landlord is responsible for the completion of the renovations and construction of the building and is contributing up to $1,300,000 for the renovations and $3,200,000 for the construction of the new building. Any additional renovation or construction costs will be borne by us. We expect to move to the new facility and to be fully operational at that site in 2003. We believe that the move into the existing building will provide us with the anticipated manufacturing capacity required through 2004, sufficient to generate sales revenues in excess of $50.0 million. Accordingly, we believe that initially no additional manufacturing build-out costs will be necessary in the building to be constructed. That second move into the newly constructed building will allow us to consolidate our manufacturing, marketing and sales, research and administrative operations in one location, facilitate future growth and afford us the ability to increase our manufacturing capacity at such time as the manufacturing capacity in the existing building is fully utilized. On August 29, 2001, we entered into a Revenue Interests Assignment Agreement with Paul Capital. During 2001, Ortec was eligible to receive $10.0 million under this agreement. We received $6.0 million in 2001 and the remaining $4.0 million balance in January 2002. Upon completion of additional milestones, we may be eligible to receive another $5.0 million. In addition, we may incrementally receive another $10.0 million, but only upon mutual agreement by both Ortec and Paul Capital. In consideration for the first $10.0 million received by us, Paul Capital will receive a minimum of 3 1/3% of end user revenues from the sale of our products in the United States, Canada and Mexico, which percentage will be proportionately increased by the additional amounts paid by Paul Capital to us under the August 29, 2001 agreement. These percentage payments may be further adjusted upward or downward, based on the volume of net sales to 25 end users of our products in those three countries. We anticipate that our effective cost for the amounts we receive from Paul Capital will range between 20% to 35% per annum. Beginning on January 1, 2003, Paul Capital will be entitled to receive each year the first proceeds to us from end user sales of our products in those three countries. Such annual amounts Paul Capital will be able to draw in advance will range from $1.5 million in 2003 to $7.5 million in 2005 and thereafter. The agreement provides for quarterly and annual accountings between Paul Capital and us for those advance payments. In the event of a change in control of Ortec or upon the occurrence of certain other events as defined in the agreement, Paul Capital has the option to put its revenue interest back to us for an amount as provided in the agreement. Ortec also has the option to repurchase Paul Capital's interest upon the occurrence of a change in control of Ortec or a complete divestiture by us of our products, for an amount provided in the agreement. We have granted Paul Capital a security interest in our United States and Canadian patents and trademarks relating to our technology for our product, to secure payments we are required to make to Paul Capital. The agreement terminates on December 31, 2011, unless terminated earlier by either party, as permitted by the terms of the agreement. In January 2002 we received a $1,300,000 line of credit from GE Capital for equipment lease financing. These proceeds will be utilized in financing manufacturing equipment purchases in 2002. Our capital funding requirements will depend on numerous factors, including the progress and magnitude of our research and development programs, preclinical testing and clinical trials, the time involved in obtaining regulatory approvals for commercial sale of our product to treat venous stasis and diabetic foot ulcers, the cost involved in filing and maintaining patent claims, technological advances, competitive and market conditions, our ability to establish and maintain collaborative arrangements, our cost of manufacturing scale up and the cost and effectiveness of commercialization activities and arrangements. We require substantial funding to continue our research and development activities, clinical trials, manufacturing scale up, marketing, sales, distribution, and administrative activities. Our cash and cash equivalents on hand at December 31, 2001, (approximately $.9 million), and the additional $4.0 million which was due from Paul Capital and was received in January 2002, will enable us to continue our operations until April 30, 2002. 26 We have raised funds in the past through the public or private sale of securities and through the agreement with Paul Capital. Even after the remaining $4.0 million received from Paul Capital in January 2002, we will need to raise additional funds in the future through public or private financings, collaborative arrangements or from other sources. The success of such efforts will depend in large part upon continuing developments in our clinical trials and upon market conditions. On March 27, 2002, we engaged H.C. Wainwright & Co., Inc., an investment banking firm, to act as our financial advisor in connection with raising capital for the Company through debt and/or equity financing. While we can give no assurance that any equity financing will be secured, Wainwright is assisting us in raising equity financing of $12,000,000, which we believe will enable us to continue our operations for the next 12 months. If received, we will use the above proceeds primarily to complete our clinical trials for use of OrCel in the treatment of venous stasis and diabetic ulcers and to submit the results of those trials to the FDA for approval to market OrCel for treatment of those medical conditions. We expect that the anticipated financing will allow us to do this. Based upon our current schedule for completion of the clinical trials and submission to the FDA, we believe that we can obtain FDA approval for the use of our product in treating both venous stasis and diabetic ulcers patients in 2003. We continue to explore and, as appropriate, enter into discussions with other companies regarding the potential for equity investment, collaborative arrangements, license agreements or other funding programs with us, in exchange for manufacturing, marketing, distribution or other rights to our product. However, we can give no assurance that discussions with other companies will result in any additional investments, collaborative arrangements, agreements or other funding, or that the necessary additional financing through debt or equity financing will be available to us on acceptable terms, if at all. Further, we can give no assurance that any arrangements resulting from these discussions will successfully reduce our funding requirements. If additional funding is not available to us when needed, we may not be able to continue operations. Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Reference is made to the Financial Statements referred to in the accompanying Index, setting forth the financial statements of the Company, together with the report of Grant Thornton LLP, dated February 22, 2002, except for Note A as to which the date is April 15, 2002. 27 PART III Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT. Directors and Executive Officers Our directors and executive officers are as follows:
Name Age Position - ---- --- -------- Steven Katz, Ph.D. 57 Chairman of the Board of Directors and Chief Executive Officer Dr. Mark Eisenberg 64 Senior Vice President, Research and Development, and Director Ron Lipstein 46 Vice Chairman of the Board of Directors, Secretary, Treasurer and Chief Financial Officer Alain M. Klapholz 45 Vice President, Operations, and Director Costa Papastephanou, Ph.D. 56 President William Schaeffer 54 Chief Operating Officer Steven Lilien, Ph.D. 54 Director Allen I. Schiff, Ph.D. 56 Director
Steven Katz, one of our founders, has been a director since our inception in 1991 and was elected Chairman of our Board of Directors in September 1994. He has been employed by us since 1991. Dr. Katz has also been a professor of Economics and Finance at Bernard M. Baruch College in New York City since 1972. He has a Ph.D. in Finance and Statistics as well as an MBA and an MS in Operations Research, both from New York University. 28 Dr. Mark Eisenberg, one of our founders, has been a director and Senior Vice President since 1991. Dr. Eisenberg has also been a consultant to us since 1991. See "Eisenberg Consulting Agreement". He has been a physician in private practice in Sydney, Australia since 1967. He is a member and co-founder of the dystrophic epidermolysis bullosa clinic at the Prince of Wales Hospital for children in Sydney, Australia. He has done extensive research on epidermolysis bullosa disease. Ron Lipstein, one of our founders, has been our Secretary, Treasurer, Chief Financial Officer and a director since 1991. In January 2001 Mr. Lipstein was elected Vice Chairman of our Board of Directors. He has been employed by us since 1991. Mr. Lipstein is a certified public accountant. Alain M. Klapholz, one of our founders, has been our Vice President and a director since 1991. He has been employed by us since 1991. He has an MBA from New York University. Costa Papastephanou was employed by us in February 2001 as our president. Prior to joining us, he was employed by Bristol Myers-Squibb for 30 years, the last 14 of which he was with Bristol Myers' Convatec, a multinational ostomy and wound care management division. His last position at Convatec was as President of the global chronic care division, where he was responsible for that division's sales and marketing, clinical trials, research and development, manufacturing, quality assurance and regulatory affairs. He holds a Ph.D. in Biochemistry from University of Miami as well as a Master of Science in Microbial Biochemistry from University of London. William Schaeffer, has been our Chief Operating Officer since May 1998. Prior to joining us, Mr. Schaeffer was employed by Johnson & Johnson for more than 25 years. His last position was Vice President, Quality Assurance Worldwide for Johnson & Johnson's Cordis, Inc., where he was also a member of its Management Board. Mr. Schaeffer has also held senior management positions at Johnson & Johnson's Ethicon, Inc., Johnson & Johnson Cardiovascular and Ortho Diagnostics, Inc. His responsibilities have included process development, manufacturing and quality assurance for a broad range of medical devices developed, produced and distributed by Johnson & Johnson. Steven Lilien has been a director of Ortec since February 1998. He has been chairman of the accounting department of Bernard M. Baruch College in New York City for the past fourteen years and is currently the Weinstein Professor of Accounting there. He is a certified public accountant and has a Ph.D. in accounting and finance and an MS, both from New York University. 29 Allen I. Schiff was elected a director of Ortec on June 11, 2001. He has been Director of the Field Study Program at Fordham University Graduate School of Business since 1992. That program performs consulting projects for businesses and charitable institutions including a number of major well known business and charitable entities. From 1985 through 1989 he was chairman of both the undergraduate and the graduate accounting departments at Fordham University. He has a Ph.D. in business administration and an MS in accounting, both from New York University. He is a director and chairman of the audit committee of Data Software and Systems, Inc., a publicly held company whose shares are listed on NASDAQ and whose principal business is the development of compatible software for use by utilities. All directors hold office until the next annual meeting of stockholders and the election and qualification of their successors. Our non-employee directors were compensated for their services and attendance at meetings in 2001 through the grant of options pursuant to our Employee Stock Option Plan and payment of $5,000 to Dr. Steven Lilien for his services as chairman of our audit committee and $2,500 to Dr. Allen Schiff for his services in the last three months of 2001 as a director and a member of our audit committee. Officers are elected annually by the Board of Directors and serve at the discretion of the Board of Directors. Eisenberg Consulting Agreement Pursuant to a consulting agreement dated June 7, 1991, as amended on September 1, 1992, with Dr. Eisenberg, we have retained the services of Dr. Eisenberg as a consultant until June 6, 2005. Under such consulting agreement, Dr. Eisenberg is required to devote 20 hours per week to Ortec. We pay Dr. Eisenberg an annual fee at the rate of $73,000. Dr. Eisenberg's fee is subject to annual increases based on certain formulas. Dr. Eisenberg has agreed not to compete with us until one year after termination of his consulting agreement. Item 11. EXECUTIVE COMPENSATION Compensation of Executive Officers The following table sets forth the compensation paid by us for our fiscal years ended December 31, 2001, 2000 and 1999 to our Chief Executive Officer and to each of our other executive officers (collectively, the "Named Officers"). 30 SUMMARY COMPENSATION TABLE
Long Term Annual Compensation Compensation ------------------- ------------ Securities Name and Other Annual Underlying Principal Position Year Salary($) Bonus($) Compensation($) Options/SARs ------------------ ---- --------- -------- --------------- ------------ Steven Katz ........................... 2001 236,392 92,000 200,000 Chief Executive 2000 209,807 94,605 9,000* 129,278 Officer and Chairman 1999 200,000 35,000 9,000* 50,000 Ron Lipstein ......................... 2001 214,447 86,000 185,000 Vice Chairman, Secretary, 2000 179,712 78,105 9,000* 118,128 Treasurer and CFO 1999 165,000 50,000 9,000* 35,000 Costa Papastephanou................ 2001 181,625 60,000 President Alain Klapholz ....................... 2001 170,604 20,000 60,000 Vice President 2000 159,808 30,000 23,300 and Director 1999 150,000 15,000 10,000 William Schaeffer ................... 2001 188,688 10,000 Chief Operating Officer 2000 167,308 17,000 1999 157,871 30,000 20,000
- ---------------------- * In lieu of health insurance. Board Compensation Drs. Steven Lilien and Allen I. Schiff are our only non-employee directors. For Dr. Steven Lilien's services in 2001 as a director and as chairman of our audit committee, in November 2001 we granted Dr. Lilien 7 year options to purchase 15,000 shares of our common stock. For his services in 2001 as a director and as a member of our audit committee, in June and November 2001 we paid Dr. Schiff an aggregate of $2,500 and we granted Dr. Schiff 7 year options to purchase an aggregate of 15,000 shares of our Common Stock. Such options were granted under our Employee Stock Option Plan and different options are exercisable at $4.75, $6.30 and $8.75 per share each. 31 Option Grants in Last Fiscal Year The following table sets forth certain information regarding options granted during the fiscal year ended December 31, 2001 by us to the Named Officers:
Potential Realizable Value at Assumed Annual Rates of Stock Price Appreciation for Individual Grants Option Term ----------------- ----------- (a) (b) (c) (d) (e) (f) (g) Number of % of Total Securities Options/SARs Underlying Granted to Exercise or Options/SARs Employees in Base Price Expiration Name Granted Fiscal Year (1) ($/Share) Date 5% ($) 10% ($) ---- ------- --------------- --------- ---- ------ ------- Steven Katz 50,000 7.9 8.75 2/12/08 178,106 415,064 150,000 23.8 4.75 11/1/08 290,059 675,961 Ron Lipstein 45,000 7.1 8.75 2/12/08 160,296 373,557 140,000 22.2 4.75 11/1/08 270,722 630,877 Costa Papastephanou(2) 10,000 1.6 7.063 2/5/08 28,753 67,008 30,000 4.8 6.30 6/12/08 76,942 179,308 20,000 3.2 4.75 11/1/08 38,675 90,128 Alain Klapholz 10,000 1.6 8.75 2/12/08 35,621 83,013 50,000 7.9 4.75 11/1/08 96,686 225,320 William D. Schaeffer (2) 10,000 1.6 4.75 11/1/08 19,337 45,064
- ---------------------- (1) Options to purchase a total of 630,500 shares of common stock were granted to our employees, including the Named Officers, during the fiscal year ended December 31, 2001. (2) The options granted to Messrs. Papastephanou and Mr. Schaeffer vest as follows: 25% one year after the date of grant, an additional 25% two years after, an additional 25% three years after and the remaining 25% four years after the date of grant. 32 Aggregated Options Exercised in Last Fiscal Year and Fiscal Year End Option Value The following table sets forth certain information regarding options (which include warrants) exercisable during 2001 and the value of the options held as of December 31, 2001 by the Named Officers. None of the Named Officers exercised any options in 2001 nor did Messrs. Katz, Lipstein or Klapholz hold any options which were not exercisable at December 31, 2001. At December 31, 2001, Mr. Papastephanou and Mr. Schaeffer respectively held 60,000 and 35,874 options which were not yet exercisable.
Value of Unexercised Number of Unexercised Options at In-the-Money Options Name Fiscal Year End at Fiscal Year End (1) - --------- --------------- ---------------------- Steven Katz 625,028 $158,820 Ron Lipstein 633,128* 148,100 Costa Papastephanou 60,000 (not exercisable) 21,000 Alain Klapholz 202,300 52,940 William D. Schaeffer 34,876 2,625 William D. Schaeffer 35,874 (not exercisable) 7,875
- ------------------- * Includes warrants to purchase 15,000 shares held by Mr. Lipstein's minor children. (1) The closing price of our common stock on December 31, 2001, as listed on the Nasdaq SmallCap Market, was less than the exercise price of options held by these five Named Officers to purchase an aggregate of 1,164,006 shares. Compensation Committee Interlock and Insider Participation None of Ortec's executive officers serves as a member of the compensation committee or on the board of directors of another entity, one of whose executive officers serves on Ortec's Board of Directors. The Compensation Committee of our Board of Directors determines compensation policies applicable to our five executive officers. Messrs. Steven Katz, Mark Eisenberg and Steven Lilien are the members of the Compensation Committee. Mr. Katz is an executive officer of Ortec. Although Dr. Mark Eisenberg is not an executive officer of Ortec, he is employed by Ortec on a part time basis devoting his time to research in our facility in Australia. The compensation paid to Dr. Eisenberg is determined by an agreement between Dr. Eisenberg and Ortec entered into on June 7, 1991 and amended on September 1, 1992. 33 Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The following table sets forth certain information regarding beneficial ownership of our common stock as of February 28, 2002 by (i) each person (or group of affiliated persons) who we know owns beneficially more than 5% of the outstanding shares of our common stock, (ii) each of our executive officers and directors, and (iii) all of our executive officers and directors as a group. Except as indicated in the footnotes to this table, the persons named in this table have sole voting and investment power with respect to all shares of common stock shown as beneficially owned by them.
Amount and Percentage of Name and Address Nature of Outstanding of Beneficial Owner Beneficial Ownership Shares Owned** - ------------------- -------------------- -------------- Steven Katz* 747,915(1) 7.2 Mark Eisenberg* 596,000 6.1 Ron Lipstein* 876,024(2) 8.5 Alain Klapholz* 491,806(3) 5.0 Costa Papastephanou* 4,250(4) *** William D. Schaeffer* 40,114(5) *** Steven Lilien 35,900(6) *** 19 Larchmont Street Ardsley, NY 10502 Allen I. Schiff 15,000(7) *** Fordham University Graduate School of Business 113 West 60th Street New York, NY 10023 George Soros 1,153,906(8) 11.9% 888 Seventh Avenue, 33rd Floor New York, NY 10106 Franklin Resources, Inc. 688,866(9)(10) 7.1% One Franklin Parkway San Mateo, CA 94403-1906 Pequot Capital Management, Inc. 2,069,064(9)(10) 21.3% 5000 Nyala Farm Road Westport, CT 06880 All officers and directors as a group 2,807,009(1-7) 25.0% (eight persons)
34 * The address of these persons is at the Company's offices 3960 Broadway, New York, NY 10032. ** The number of shares of common stock beneficially owned by each person or entity is determined under rules promulgated by the Securities and Exchange Commission. Under such rules, beneficial ownership includes any shares as to which the person or entity has sole or shared voting power or investment power. Included among the shares owned by such person are any shares which such person or entity has the right to acquire within 60 days after February 28, 2002. Unless otherwise indicated, each person or entity referred to above has sole voting and investment power with respect to the shares listed. The inclusion herein of any shares deemed beneficially owned does not constitute an admission of beneficial ownership of such shares. *** Less than 1%, based upon information available to us. (1) Does not include shares owned by Dr. Katz's children, their spouses and his grandchildren. Dr. Katz disclaims any beneficial interest in such shares. Includes 625,853 shares issuable to Dr. Katz upon his exercise of outstanding options and warrants. (2) Includes 33,600 shares owned by Mr. Lipstein's minor children. Mr. Lipstein disclaims any beneficial interest in such 33,600 shares. Also includes 618,953 shares issuable to Mr. Lipstein and 15,000 to his minor children upon his and their exercise of outstanding options and warrants. (3) Includes 26,900 shares owned by Mr. Klapholz' minor children. Mr. Klapholz disclaims any beneficial interest in such 26,900 shares. Also includes 202,300 shares issuable to Mr. Klapholz upon his exercise of outstanding options. (4) Includes 2,500 shares issuable to Mr. Papastephanou upon his exercise of outstanding options. (5) Includes 37,514 shares issuable to Mr. Schaeffer on his exercise of outstanding options. (6) Includes 35,500 shares issuable to Dr. Lilien on his exercise of outstanding options. (7) All 15,000 shares are issuable to Dr. Schiff on his exercise of outstanding options. (8) As reported by Mr. Soros on a Form 13GA filed by him with the Securities and Exchange Commission which recites that this number includes 722,238 shares held for the account of Quasar International Partners C.V. ("Quasar") and 431,572 shares held for the account of Lupa Family Partners ("Lupa"). Soros Fund Management LLC serves as principal investment manager of Quasar (a Netherlands Antilles limited partnership) and, as such, and Mr. George Soros as Chairman of Soros Fund 35 Management LLC, may be deemed to have investment discretion over and the power to direct the voting and disposition of the shares held for the account of Quasar. Lupa is a New York limited partnership. In his capacity as a general partner of Lupa, Mr. Soros may be deemed to have voting and dispositive power with respect to shares held for the account of Lupa. (9) As reported on Forms 13G filed by such persons with the Securities and Exchange Commission. (10) Shares held by investment funds. These have sole or shared investment and/or voting power for these shares. Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Consulting Agreement See "Eisenberg Consulting Agreement" for a description of our consulting agreement with Dr. Mark Eisenberg. Change of Control Agreements Our Board of Directors has authorized agreements with four of our executive officers in the event of a "change of control" of Ortec. In the agreements with Messrs. Katz, Lipstein and Klapholz "change of control" of Ortec will be defined as a change in the ownership or effective control of Ortec or in the ownership of a substantial portion of Ortec's assets, but in any event if Messrs. Katz, Lipstein and Klapholz and Dr. Mark Eisenberg no longer constitute a majority of our Board of Directors. The payments to be made to such three executive officers in the event of a change of control range from 2 to 2.99 times the compensation paid by us to such executive in the twelve-month period prior to the change of control. The change of control agreements with Messrs. Katz, Lipstein and Klapholz will provide that in the event that such change of control occurs, the expiration dates of all options and warrants which have been granted to such executive officers and which expire less than three years after such change of control, will be extended so that such options and warrants expire three years after such change of control, and that at Messrs. Katz, Lipstein or Klapholz' election, we will lend such executive officer upon his exercise of any of his warrants or options, interest free and repayable after three years, the funds needed by such executive officer to pay the exercise price. We believe that such payments to most, if not all, of these three executive officers will, if they are made, constitute "golden parachute" payments under the Internal Revenue Code and to the extent the change of control payments made to an individual executive officer exceeds the average annual compensation paid by us to such executive officer in the five year period 36 prior to such change of control (a) such excess will not be able to be deducted by us in calculating our income for income tax purposes and (b) a special excise tax equal to 20% of such excess will have to be paid by the executive officer receiving such excess payments. The change of control agreements will provide that we will pay such excise tax payable by such executive officer. The change of control agreement with Mr. Schaeffer will provide that all his options will vest immediately upon a change of control of Ortec. The agreement with Mr. Schaeffer will define "change of control" as a merger or consolidation of Ortec with another company or the sale by us of all or substantially all of our assets. FORWARD LOOKING STATEMENTS This Annual Report includes statements that are "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, including statements regarding our expectations, hopes, beliefs, intentions or strategies regarding the future, that are based on the beliefs of our management, as well as assumptions made by and information currently available to us. When used in this document, the words "anticipate," "believe," "estimate," and "expect" and similar expressions, as they relate to us are intended to identify such forward-looking statements. Such statements reflect the current views of our management with respect to future events and are subject to certain risks, uncertainties and assumptions, including those described in this annual report. Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may vary materially from those described herein as anticipated, believed, estimated or expected. We do not intend to update these forward-looking statements. AVAILABILITY OF FORM 10-K We will provide a copy of our annual report on Form 10-K for the year ended December 31, 2001, filed with the Securities and Exchange Commission, including our financial statements and the financial statement schedules, to any of our stockholders and to any person holding our warrants or options to purchase shares of our common stock, upon written request and without charge. Such written request should be directed to Mr. Ron Lipstein, Secretary, at Ortec International, Inc., 3960 Broadway, New York, NY 10032. 37 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a) Financial Statements and Financial Statement Schedules. (i) Financial Statements: See Index to Financial Statements. (ii) Financial Statement Schedules All financial statement schedules have been omitted since either (i) the schedule or condition requiring a schedule is not applicable or (ii) the information required by such schedule is contained in the Financial Statements and Notes thereto or in Management's Discussion and Analysis of Financial Condition and Results of Operation. (b) Reports on Form 8-K. We did not file any report on Form 8-K in the fourth quarter of 2001. (c) Exhibits.
Exhibit No. Description - ---------- ----------- 3.1 Agreement of Merger of the Skin Group, Ltd. and the Company dated July 9, 1992 (1) 3.2 Original Certificate of Incorporation (1) 3.3 By-Laws (1) 4.1 Form of Certificate evidencing shares of Common Stock (1) 10.1 Agreement for Consulting Services dated as of June 7, 1991 by and between the Company and Dr. Mark Eisenberg (1) 23 Consent of Grant Thornton LLP (2)
- ----------- (1) Filed as an Exhibit to the Company's Registration Statement on Form SB-2 (File No. 33-96090), or Amendment 1 thereto, and incorporated herein by reference. (2) Filed herewith 38 SIGNATURES In accordance with Section 13 or 15(d) of the Exchange Act, the registrant has caused this report to be signed on its behalf by the undersigned, thereto duly authorized. Registrant: ORTEC INTERNATIONAL, INC. By: /s/ Steven Katz --------------- Steven Katz, Ph.D. Chairman and Chief Executive Officer Dated: April 12, 2002 In accordance with the Exchange Act, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Signature Title Date - --------- ----- ---- /s/ Steven Katz Chairman, Chief Executive April 12, 2002 - ------------------------- Officer and Director (Principal Steven Katz, Ph.D. Executive Officer) - ------------------------------- Senior Vice President, Research Dr. Mark Eisenberg and Development and Director /s/ Ron Lipstein Vice Chairman, Chief Financial April 12, 2002 - ------------------------- Officer, Secretary, Ron Lipstein Treasurer and Director (Principal Financial and Accounting Officer) /s/ Alain M. Klapholz Vice President, Operations April 12, 2002 - ---------------------- and Director Alain M. Klapholz
39
Signature Title Date - --------- ----- ---- /s/ Steven Lilien Director April 12, 2002 - ------------------------ Steven Lilien /s/ Allen I. Schiff Director April 12, 2002 - ------------------------ Allen I. Schiff
Exhibit Index.
Exhibit No. Description - ---------- ----------- 3.1 Agreement of Merger of the Skin Group, Ltd. and the Company dated July 9, 1992 (1) 3.2 Original Certificate of Incorporation (1) 3.3 By-Laws (1) 4.1 Form of Certificate evidencing shares of Common Stock (1) 10.1 Agreement for Consulting Services dated as of June 7, 1991 by and between the Company and Dr. Mark Eisenberg (1) 23 Consent of Grant Thornton LLP (2)
- --------------- (1) Filed as an Exhibit to the Company's Registration Statement on Form SB-2 (File No. 33-96090), or Amendment 1 thereto, and incorporated herein by reference. (2) Filed herewith. 40 Ortec International, Inc. (a development stage enterprise) INDEX TO FINANCIAL STATEMENTS
Page ---- Report of Independent Certified Public Accountants F-2 Financial Statements Balance Sheets as of December 31, 2001 and 2000 F-3 Statements of Operations for the years ended December 31, 2001, 2000 and 1999, and for the cumulative period from March 12, 1991 (inception) to December 31, 2001 F-5 Statement of Shareholders' Equity/(Deficit) for the cumulative period from March 12, 1991 (inception) to December 31, 2001 F-6 Statements of Cash Flows for the years ended December 31, 2001, 2000 and 1999, and for the cumulative period from March 12, 1991 (inception) to December 31, 2001 F-10 Notes to Financial Statements F-12 - F-40
F-1 REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS Board of Directors and Stockholders Ortec International, Inc. We have audited the accompanying balance sheets of Ortec International, Inc. (a development stage enterprise) (the "Company") as of December 31, 2001 and 2000, and the related statements of operations, shareholders' equity/(deficit) and cash flows for each of the three years in the period ended December 31, 2001, and for the period from March 12, 1991 (inception) to December 31, 2001. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Ortec International, Inc. at December 31, 2001 and 2000, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2001, and for the period from March 12, 1991 (inception) to December 31, 2001, in conformity with accounting principles generally accepted in the United States of America. The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note A, the Company incurred a net loss of $15,885,337 during the year ended December 31, 2001, and, as of that date, the Company's current liabilities exceeded its current assets by $2,529,159 and its total liabilities exceeded its total assets by $6,304,972. These factors, among others, as discussed in Note A to the financial statements, raise substantial doubt about the Company's ability to continue as a going concern. Management's plans in regard to these matters are also described in Note A. The financial statements do not include any adjustments that might result from the outcome of this uncertainty. GRANT THORNTON LLP New York, New York February 22, 2002, except for Note A as to which the date is April 15, 2002 F-2 Ortec International, Inc. (a development stage enterprise) BALANCE SHEETS December 31,
ASSETS 2001 2000 ------------ ------------ CURRENT ASSETS Cash and cash equivalents $ 854,025 $ 9,292,478 Accounts receivable 21,890 Due from New Jersey Economic Development Authority 82,433 Other current assets 87,083 88,878 ---------- ----------- Total current assets 1,045,431 9,381,356 PROPERTY AND EQUIPMENT, AT COST Laboratory equipment 2,126,771 1,768,872 Office furniture and equipment 982,948 857,031 Leasehold improvements 1,367,784 1,333,144 ---------- ---------- 4,477,503 3,959,047 Less accumulated depreciation and amortization (2,894,782) (2,223,064) ----------- ---------- 1,582,721 1,735,983 OTHER ASSETS Patent application costs, net of accumulated amortization of $213,105 in 2001 and $159,460 in 2000 619,676 572,089 Deferred financing costs, net of accumulated amortization of $1,983 in 2001 57,517 Security deposit - New Jersey location 598,000 Other deposits and other assets 135,256 30,332 ----------- ----------- $ 4,038,601 $11,719,760 =========== ===========
F-3 Ortec International, Inc. (a development stage enterprise) BALANCE SHEETS (continued) December 31,
LIABILITIES AND SHAREHOLDERS' EQUITY/(DEFICIT) 2001 2000 ----------- ------------ CURRENT LIABILITIES Accounts payable and accrued expenses $ 2,444,945 $ 872,760 Accrued compensation 223,393 226,208 Accrued professional fees 301,783 176,528 Accrued interest 460,964 7,081 Loan payable - current 143,505 132,369 ------------ ------------ Total current liabilities 3,574,590 1,414,946 LONG-TERM LIABILITIES Loan payable - noncurrent 768,983 912,489 Other long-term obligations 6,000,000 COMMITMENTS AND CONTINGENCIES SHAREHOLDERS' EQUITY/(DEFICIT) Common stock, $.001 par value; authorized, 35,000,000 shares; 9,711,608 shares issued, 9,691,608 shares outstanding, at December 31, 2001 and 2000 9,712 9,712 Additional paid-in capital 53,017,615 52,829,535 Deficit accumulated during the development Stage (59,154,654) (43,269,277) Treasury stock, at cost (20,000 shares at December 31, 2001 and 2000) (177,645) (177,645) ------------ ------------ (6,304,972) 9,392,325 ------------ ------------ $ 4,038,601 $ 11,719,760 ============ ============
The accompanying notes are an integral part of these statements. F-4 Ortec International, Inc. (a development stage enterprise) STATEMENTS OF OPERATIONS
Cumulative from March 12, 1991 Year ended December 31, (inception) to ------------------------------------------------------- December 31, 2001 2000 1999 2001 ------------ ------------ ------------ ------------ Product revenue $ 21,890 $ - $ - $ 21,890 ------------ ------------ ------------ ------------ Expenses Research and development 4,283,038 4,191,317 3,106,908 18,048,392 Rent 589,238 535,443 473,010 2,179,535 Consulting 1,413,153 838,383 834,180 5,226,515 Personnel 6,605,630 4,763,662 3,742,632 22,949,360 General and administrative 2,671,887 2,297,769 2,152,968 12,002,685 Interest and other expense 536,070 89,712 99,522 1,019,506 Interest income (191,749) (586,623) (368,711) (2,249,449) ------------ ------------ ------------ ------------ 15,907,267 12,129,663 10,040,509 59,176,544 ---------- ------------ ------------ ------------ Net loss $(15,885,377) $(12,129,663) $(10,040,509) $(59,154,654) ============ ============ ============ ============ Net loss per share Basic and diluted $(1.64) $(1.37) $(1.51) $(12.67) ===== ===== ===== ====== Weighted average shares outstanding Basic and diluted 9,691,608 8,847,295 6,634,874 4,668,594 ========= ========= ========= =========
The accompanying notes are an integral part of these statements. F-5 Ortec International, Inc. (a development stage enterprise) STATEMENT OF SHAREHOLDERS' EQUITY/(DEFICIT)
Deficit accumulated Common stock Additional during the Total ----------------- paid-in development Treasury shareholders' Shares Amount capital stage stock equity/(deficit) ------ ------ ----------- ----------- -------- ---------------- March 12, 1991 (inception) to December 31, 1991 Issuance of stock Founders 1,553,820 $1,554 $ (684) $ 870 First private placement ($.30 cash per share) 217,440 217 64,783 65,000 The Director ($1.15 and $5.30 cash per share) 149,020 149 249,851 250,000 Second private placement ($9.425 cash per share) 53,020 53 499,947 500,000 Share issuance expenses (21,118) (21,118) Net loss $ (281,644) (281,644) --------- ------ ----------- ----------- ------------ Balance at December 31, 1991 1,973,300 1,973 792,779 (281,644) 513,108 Issuance of stock Second private placement ($9.425 cash per share) 49,320 49 465,424 465,473 Stock purchase agreement with the Director ($9.425 cash per share) 31,820 32 299,966 299,998 Share issuance expenses (35,477) (35,477) Net loss (785,941) (785,941) --------- ------ ----------- ----------- ------------ Balance at December 31, 1992 2,054,440 2,054 1,522,692 (1,067,585) 457,161 Issuance of stock Third private placement ($10.00 cash per share) 132,150 132 1,321,368 1,321,500 Stock purchase agreement with Home Insurance Company ($9.00 cash per share) 111,111 111 999,888 999,999 Stock purchase agreement with the Director ($9.425 cash per share) 21,220 21 199,979 200,000 Shares issued in exchange for commission ($10.00 value per share) 600 1 5,999 6,000 Share issuance expenses (230,207) (230,207) Net loss (1,445,624) (1,445,624) --------- ------ ----------- ----------- ------------ Balance at December 31, 1993 (carried forward) 2,319,521 2,319 3,819,719 (2,513,209) 1,308,829
F-6 Ortec International, Inc. (a development stage enterprise) STATEMENT OF SHAREHOLDERS' EQUITY/(DEFICIT) (continued)
Deficit accumulated Common stock Additional during the Total ----------------- paid-in development Treasury shareholders' Shares Amount capital stage stock equity/(deficit) ------ ------ ----------- ----------- -------- ---------------- (brought forward) 2,319,521 $2,319 $ 3,819,719 $(2,513,209) $ 1,308,829 Issuance of stock Fourth private placement ($10.00 cash per share) 39,451 40 397,672 397,712 Stock purchase agreement with Home Insurance Company ($10.00 cash per share) 50,000 50 499,950 500,000 Share issuance expenses (8,697) (8,697) Net loss (1,675,087) (1,675,087) --------- ------ ----------- ----------- ------------ Balance at December 31, 1994 2,408,972 2,409 4,708,644 (4,188,296) 522,757 Rent forgiveness 40,740 40,740 Net loss (1,022,723) (1,022,723) --------- ------ ----------- ----------- ------------ Balance at December 31, 1995 2,408,972 2,409 4,749,384 (5,211,019) (459,226) Initial public offering 1,200,000 1,200 5,998,800 6,000,000 Exercise of warrants 33,885 34 33,851 33,885 Fifth private placement ($6.49 cash per share) 959,106 959 6,219,838 6,220,797 Share issuance costs (1,580,690) (1,580,690) Stock options issued for services 152,000 152,000 Net loss (2,649,768) (2,649,768) --------- ------ ----------- ----------- ------------ Balance at December 31, 1996 (carried forward) 4,601,963 4,602 15,573,183 (7,860,787) 7,716,998
F-7 Ortec International, Inc. (a development stage enterprise) STATEMENT OF SHAREHOLDERS' EQUITY/(DEFICIT) (continued)
Deficit accumulated Common stock Additional during the Total ----------------- paid-in development Treasury shareholders' Shares Amount capital stage stock equity/(deficit) ------ ------ ----------- ------------ -------- ---------------- (brought forward) 4,601,963 $4,602 $15,573,183 $ (7,860,787) $ 7,716,998 Exercise of warrants 1,158,771 1,159 10,821,632 10,822,791 Share issuance costs (657,508) (657,508) Stock options and warrants issued for services 660,000 660,000 Net loss (4,825,663) (4,825,663) --------- ------ ----------- ------------ ------------ Balance at December 31, 1997 5,760,734 5,761 26,397,307 (12,686,450) 13,716,618 Exercise of warrants 221,486 221 1,281,736 1,281,957 Stock options and warrants issued for services 1,920,111 1,920,111 Sixth private placement 200,000 200 1,788,498 1,788,698 Warrants issued in Sixth private placement 211,302 211,302 Share issuance costs (48,000) (48,000) Purchase of 6,600 shares of treasury stock (at cost) $(67,272) (67,272) Net loss (8,412,655) (8,412,655) --------- ------ ----------- ------------ -------- ------------ Balance at December 31, 1998 6,182,220 6,182 31,550,954 (21,099,105) (67,272) 10,390,759 Exercise of warrants 14,103 14 14,089 14,103 Stock options and warrants issued for services 64,715 64,715 Seventh private placement ($8.75 cash per share) 389,156 389 3,168,396 3,168,785 Warrants issued in Seventh private placement 468,291 468,291 Eighth private placement ($5.50 cash per share) 1,636,364 1,637 8,998,365 9,000,002 Share issuance costs (619,908) (619,908) Purchase of 9,100 shares of treasury stock (at cost) (75,518) (75,518) Net loss (10,040,509) (10,040,509) --------- ------ ----------- ------------ -------- ------------ Balance at December 31, 1999 (carried forward) 8,221,843 8,222 43,644,902 (31,139,614) (142,790) 12,370,720
F-8 Ortec International, Inc. (a development stage enterprise) STATEMENT OF SHAREHOLDERS' EQUITY/(DEFICIT) (continued)
Deficit accumulated Common stock Additional during the Total ----------------- paid-in development Treasury shareholders' Shares Amount capital stage stock equity/(deficit) ------ ------ ----------- ----------- -------- ---------------- (brought forward) 8,221,843 $8,222 $43,644,902 $(31,139,614)$(142,790) $ 12,370,720 Exercise of options and warrants 175,532 175 327,107 327,282 Stock options and warrants issued for services 56,265 56,265 Ninth private placement ($15.00 cash per share) 66,667 67 999,938 1,000,005 Warrants issued in Ninth private placement 23,000 23,000 Tenth private placement ($6.75 cash per share) 1,247,566 1,248 8,419,823 8,421,071 Share issuance costs (641,500) (641,500) Purchase of 4,300 shares of treasury stock (at cost) (34,855) (34,855) Net loss (12,129,663) (12,129,663) --------- ------ ----------- ------------ --------- ------------ Balance at December 31, 2000 9,711,608 9,712 52,829,535 (43,269,277) (177,645) 9,392,325 Stock options issued for services 188,080 188,080 Net loss (15,885,377) (15,885,377) --------- ------ ----------- ------------ --------- ------------ Balance at December 31, 2001 9,711,608 $9,712 $53,017,615 $(59,154,654)$(177,645) $ (6,304,972) ========= ====== =========== ============ ========= ============
The accompanying notes are an integral part of this statement. F-9 Ortec International, Inc. (a development stage enterprise) STATEMENTS OF CASH FLOWS
Cumulative from March 12, 1991 Year ended December 31, (inception) to ---------------------------------------------------- December 31, 2001 2000 1999 2001 ----------- ----------- ------------ --------- Cash flows from operating activities Net loss $(15,885,377) $(12,129,663) $(10,040,509) $(59,154,654) Adjustments to reconcile net loss to net cash used in operating activities Depreciation and amortization 725,567 708,928 597,528 3,118,328 Unrealized loss on marketable securities 11,404 Realized loss on marketable securities 5,250 Non-cash stock compensation and imputed interest 642,855 56,265 64,715 3,495,946 Purchases of marketable securities (6,298) (19,075,122) Sales of marketable securities 771,956 19,130,920 (Increase) decrease in assets Accounts receivable (21,890) (21,890) Other current assets (80,638) (87,177) (37) (169,514) Increase (decrease) in liabilities Accounts payable and accrued liabilities 1,634,233 (186,243) 762,650 3,004,637 ------------ ------------ ------------ ------------ Net cash used in operating activities (12,985,250) (11,637,890) (7,849,995) (49,654,695) ------------ ------------ ------------ ------------ Cash flows from investing activities Purchases of property and equipment, excluding capital leases (518,456) (551,630) (705,277) (4,390,437) Payments for patent applications (99,453) (90,363) (124,917) (831,002) Organization costs (10,238) Deposits (702,924) 578 787 (731,273) Purchases of marketable securities (594,986) Sale of marketable securities 522,532 ------------ ------------ ------------ ------------ Net cash used in investing activities (1,320,833) (641,415) (829,407) (6,035,404) ------------ ------------ ------------ ------------
F-10 Ortec International, Inc. (a development stage enterprise) STATEMENTS OF CASH FLOWS (continued)
Cumulative from March 12, 1991 Year ended December 31, (inception) to ---------------------------------------------------- December 31, 2001 2000 1999 2001 ----------- ----------- ----------- ------------ Cash flows from financing activities Proceeds from issuance of notes payable $ 515,500 Proceeds from issuance of common stock $ 9,748,358 $12,419,181 53,550,522 Share issuance expenses (618,500) (387,908) (3,605,105) Purchase of treasury stock (34,855) (75,518) (177,645) Proceeds from issuance of loans payable 20,379 1,446,229 Proceeds from other long-term obligations $6,000,000 6,000,000 Repayment of capital lease obligations (5,151) (30,706) (107,204) Repayment of loan payable (132,370) (122,096) (111,678) (562,673) Repayment of notes payable (515,500) ----------- ----------- ----------- ------------ Net cash provided by financing activities 5,867,630 8,967,756 11,833,750 56,544,124 ----------- ----------- ----------- ------------ NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (8,438,453) (3,311,549) 3,154,348 854,025 Cash and cash equivalents at beginning of period 9,292,478 12,604,027 9,449,679 - ----------- ----------- ----------- ------------ Cash and cash equivalents at end of period $ 854,025 $ 9,292,478 $12,604,027 $ 854,025 =========== =========== =========== ============ Supplemental disclosures of cash flow information: Noncash financing activities Capital lease obligations $ - $ - $ - $ 118,903 Deferred offering costs included in accrued professional fees - - 314,697 Financing costs - other long-term obligations included in accrued expenses 59,500 - - 59,500 Forgiveness of rent payable - - - 40,740 Share issuance expenses - warrants - 23,000 232,000 255,000 Cash paid for interest 80,205 90,565 100,418 487,541 Cash paid for income taxes 44,528 41,286 53,671 199,576
The accompanying notes are an integral part of these statements. F-11 Ortec International, Inc. (a development stage enterprise) NOTES TO FINANCIAL STATEMENTS December 31, 2001 and 2000 NOTE A - FORMATION OF THE COMPANY AND BASIS OF PRESENTATION Formation of the Company Ortec International, Inc. ("Ortec" or the "Company") was incorporated in March 1991 as a Delaware corporation to secure and provide funds for the further development of the technology developed by Dr. Mark Eisenberg of Sydney, Australia, to replicate in the laboratory, composite cultured skin ("OrCel"), for use in skin transplant procedures (the "Technology"). Pursuant to a license agreement dated June 7, 1991, Dr. Eisenberg had granted Ortec a license for a term of ten years, with automatic renewals by Ortec for two additional ten-year periods, to commercially use and exploit the Technology for the development of products. In April 1998, Dr. Eisenberg assigned his patent for the Technology to Ortec for no consideration. The Skin Group, Ltd. (the "Skin Group") also was formed as a Delaware corporation, in March 1991, to raise funds for development of the Technology. On July 27, 1992, the Skin Group was merged with and into Ortec. Owners of Skin Group shares were given .83672 of an Ortec share for each Skin Group share. The merger was accounted for as if it were a pooling of interests and, accordingly, the accompanying financial statements include the accounts of the Skin Group for all periods presented. Basis of Presentation The Company is a development stage enterprise which prior to 2001 had no operating revenue. In February and September 2001, respectively, the Company received Food and Drug Administration ("FDA") approvals for the use of OrCel for treatment of Epidermolysis Bullosa and donor sites in burn patients. Following these approvals, in December 2001 the Company shipped its first product and realized approximately $22,000 in revenues. The Company is also pursuing FDA approvals for venous and diabetic skin ulcers. Successful future operations depend upon gaining FDA approvals for these indications, as well as the successful development and marketing of OrCel. The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. The Company incurred a net loss of $15,885,337 during the year ended December 31, 2001, and, as of that date, the Company's current liabilities exceeded its current assets by $2,529,159 and its total liabilities exceeded its total assets by $6,304,972. These factors, among others, raise substantial doubt about the Company's ability to continue as a going concern. On March 27, 2002, the Company engaged H.C. Wainwright & Co., Inc. ("Wainwright"), an investment banking firm, to act as its financial advisor and assist it in obtaining financing. F-12 Ortec International, Inc. (a development stage enterprise) NOTES TO FINANCIAL STATEMENTS (continued) December 31, 2001 and 2000 NOTE A (continued) While the Company can give no assurance that any equity financing will be secured, Wainwright and the Company are proceeding to try to secure $12,000,000 in equity financing. If the Company receives the $12,000,000 it believes that it will be able to continue its operations for the next twelve months. The Company's primary focus, and the anticipated use of the above proceeds, is completion of the venous stasis and diabetic skin ulcers clinical trials, with submission of the relevant Pre-Market Approval ("PMA") filings to the FDA. The Company expects that the anticipated financing will allow it to do this. Based upon the Company's current schedule for completion of the clinical trials and PMA submission to the FDA, the Company believes that it can obtain FDA approval for the use of its product in treating both venous stasis and diabetic skin ulcer patients in 2003. The Company's continuation as a going concern is dependent upon its ability to obtain the additional financing. No assurance can be given that the Company will be successful in these efforts. The financial statements do not include any adjustments that might result from the outcome of this uncertainty. Initial Public Offering On January 19, 1996, the Company completed an initial public offering ("IPO") of 1,200,000 units. Each unit consisted of one share of the Company's common stock, one Class A warrant to purchase one share of common stock at $10, of which 1,083,780 were exercised and the balance was not exercised and has expired as of December 31, 1998, and one Class B warrant to purchase one share of common stock at $15, of which 11,400 were exercised and the balance was not exercised and has expired as of December 31, 2000. F-13 Ortec International, Inc. (a development stage enterprise) NOTES TO FINANCIAL STATEMENTS (continued) December 31, 2001 and 2000 NOTE A (continued) The IPO raised gross proceeds of approximately $6,000,000, of which $800,000, $537,500 and approximately $315,000 were used to pay underwriting commissions, notes payable and deferred offering costs, respectively, thereby providing the Company with net proceeds of approximately $4,347,500. NOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES 1. Revenue Recognition Product revenue is recognized upon delivery of OrCel to our customers. 2. Research and Development Costs The Company is in the business of research and development and therefore, all research and development costs, including payments related to products under development and research consulting agreements and personnel costs, are expensed when incurred and for 2001 include costs of production related to sales as such costs are not readily separable. 3. Depreciation and Amortization Property and equipment are carried at cost, less any grants received for construction. In 1996, the Company received a $400,000 grant toward the construction of its new laboratory and office facilities and it received an additional grant of $130,000 in 1998. (see Note J). Office furniture and equipment and laboratory equipment are depreciated on the straight-line basis over the estimated lives of the assets (5 years). Leasehold improvements are amortized over the shorter of the term of the related lease or life of the asset. Depreciation and amortization expense for the years ended December 31, 2001, 2000 and 1999, was approximately $672,000, $657,000 and $554,000, respectively. 4. Patent Application Costs Patent application costs relate to the Company's U.S. patent application and application fees in foreign jurisdictions and consist of legal fees and other direct fees. The recoverability of the patent application costs is dependent upon, among other matters, obtaining further FDA approvals for use on the underlying technology. F-14 Ortec International, Inc. (a development stage enterprise) NOTES TO FINANCIAL STATEMENTS (continued) December 31, 2001 and 2000 NOTE B (continued) 5. Foreign Currency Translation The Company conducts some of its research and development at its laboratory in Sydney, Australia. However, because all Australian expenditures are funded from the United States, the Company has determined that the functional currency of its Australian office is the U.S. dollar. Accordingly, current assets and current liabilities are remeasured into the functional currency using current exchange rates and non-current assets and liabilities are remeasured using historical exchange rates. Expense accounts are remeasured using the average rate in effect for the year. Gains and losses arising from the remeasurement of foreign currency are included in the results of operations for all periods presented. 6. Use of Estimates In preparing financial statements in conformity with accounting principles generally accepted in the United States of America, management is required 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, as well as the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. 7. Income Taxes Deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates in effect for the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. 8. Cash and Cash Equivalents For purposes of the statement of cash flows, the Company considers all highly liquid debt instruments purchased with original maturities of three months or less to be cash equivalents. Cash equivalents consist principally of money market funds. The fair value of cash and cash equivalents approximates the recorded amount because of the short-term maturity of such instruments. Cash and cash equivalents includes approximately $2,000 and $25,000, at December 31, 2001 and 2000, respectively of bank balances denominated in Australian dollars. F-15 Ortec International, Inc. (a development stage enterprise) NOTES TO FINANCIAL STATEMENTS (continued) December 31, 2001 and 2000 NOTE B (continued) 9. Net Loss Per Share Net loss per common share is based on the weighted-average number of common shares outstanding during the periods. Basic net loss per share is computed by dividing the net loss by the weighted-average common shares outstanding for the period. Diluted net loss per share reflects the weighted-average common shares outstanding plus the potential dilutive effect of securities or contracts which are convertible to common shares, such as options, warrants, and convertible preferred stock. Options and warrants to purchase shares of common stock were not included in the computation of diluted net loss per share in each of the years presented because to do so would have been antidilutive for the periods presented. (See Notes H and I.) The amount of options and warrants excluded are as follows:
Years ended December 31, 2001 2000 1999 ---- ---- ---- Warrants 395,412 609,773 764,091 ======= ======= ======= Stock options 2,033,306 1,524,106 1,122,500 ========= ========= =========
10. Impairment of Long-Lived Assets The Company reviews long-lived assets, which consist of fixed assets and patent application costs, for possible impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. The Company has determined that no provision is necessary for the impairment of long-lived assets at December 31, 2001. F-16 Ortec International, Inc. (a development stage enterprise) NOTES TO FINANCIAL STATEMENTS (continued) December 31, 2001 and 2000 NOTE C - CONCENTRATION OF CREDIT RISK The Company maintains cash and money market accounts at four financial institutions located in New York City. Cash accounts are insured by the FDIC up to $100,000. Uninsured balances aggregate to approximately $723,000 and $8,681,000 at December 31, 2001 and 2000, respectively. The Company has not experienced any losses in such accounts and believes it is not exposed to any significant credit risk. NOTE D - PATENTS Patent application costs are stated at cost less amortization computed by the straight-line method principally over 14 years. The Company's U.S. patent was issued in 1994 and expires in 2011. There can be no assurance that any patent will provide commercial benefits to the Company. The Company has granted a security interest in its United States and Canadian patents and trademarks relating to OrCel to collateralize payments it will be required to make to satisfy its other long-term obligation. (see Note G). NOTE E - CAPITAL LEASE OBLIGATION The Company had entered into several capital lease agreements with terms of two to three years at effective interest rates ranging from 12.22% to 15.48%. The agreements ended during the year ended December 31, 2000. As of December 31, 2001 and 2000, the Company has recorded $118,903 in equipment purchased under capital leases and $118,903 in accumulated amortization, respectively. In January 2002, the Company secured a $1,300,000 lease line of credit to be used for the acquisition of additional manufacturing, laboratory and other equipment required to expand its manufacturing capacity. F-17 Ortec International, Inc. (a development stage enterprise) NOTES TO FINANCIAL STATEMENTS (continued) December 31, 2001 and 2000 NOTE F - LOAN PAYABLE During 1996, the Company obtained a loan from the landlord of its laboratory for the construction of, and equipment for, the leased facility. During 1997, the Company modified the terms of the loan as a result of increased build-out costs incurred in the construction of the facility. An adjustment has been made in 1997 to record additional interest and principal. The adjusted loan payments are due in monthly installments of $10,103, including interest at an effective rate of 7.98%, through July 2006. During 1998, the Company obtained an additional loan from the landlord for improvements to the leased facility. During 1999, the Company modified the terms of the additional loan as a result of increased build-out costs incurred. The adjusted loan payments are due in monthly installments of $7,605, including interest at an effective rate of 8.6%, through March 2008. Minimum payments to be made under the terms of the loans are as follows:
Year ending December 31, 2002 $ 212,503 2003 212,503 2004 212,503 2005 212,503 2006 161,988 2007 and thereafter 121,688 --------- 1,133,688 Less amount representing interest 221,200 --------- Net present value of future loan payments $ 912,488 ========= Current portion $ 143,505 Noncurrent portion 768,983 ---------- $ 912,488 =========
F-18 Ortec International, Inc. (a development stage enterprise) NOTES TO FINANCIAL STATEMENTS (continued) December 31, 2001 and 2000 NOTE G - OTHER LONG-TERM OBLIGATIONS On August 29, 2001, the Company entered into a Revenue Interests Assignment agreement with Paul Capital Royalty Acquisition Fund L.P. ("Paul Capital"). Under such agreement the Company was eligible to receive $10,000,000 during 2001. The Company received $6,000,000 during 2001 and the remaining $4,000,000 in January 2002. Upon completion of additional milestones, the Company may be eligible to receive another $5,000,000. In addition, the Company may incrementally receive another $10,000,000, but only upon mutual agreement by both the Company and Paul Capital. In consideration for the first $10,000,000, Paul Capital will receive a minimum of 3.33% of end user sales of the Company's products in the United States, Canada and Mexico, which percentage will be proportionately increased by any additional amounts paid to the Company by Paul Capital. Such percentage may be further adjusted upward or downward, based on the volume of net sales to end users of the Company's products in those three countries. The Company anticipates that its effective cost of the amounts it receives from Paul Capital will range from 20% to 35% per annum over the term of the agreement which terminates in December 2011. Beginning on January 1, 2003, Paul Capital will be entitled to receive each year the first proceeds to the Company from end user sales of its products in those three countries. Such annual amounts that Paul Capital will be able to draw in advance will range from $1,500,000 in 2003 to $7,500,000 in 2005 and thereafter. The agreement provides for quarterly and annual accountings between Paul Capital and the Company for those advance payments. The amounts received from Paul Capital have been classified as a long-term liability similar to debt, and interest has been imputed at a rate of 30% per annum to reflect the estimated cost of such funds. In the event of a change in control of the Company or upon the occurrence of certain other events as defined in the agreement, Paul Capital has the option to put its revenue interest back to the Company for an amount as provided in the agreement. The Company also has the option to repurchase Paul Capital's interest upon the occurrence of a change in control of the Company or a complete divestiture by the Company of its interests in its products, for an amount provided in the agreement. The Company granted Paul Capital a security interest in its United States and Canadian patents and trademarks relating to its technology for its OrCel product, to secure payments required to be made by the Company to Paul Capital under this agreement. F-19 Ortec International, Inc. (a development stage enterprise) NOTES TO FINANCIAL STATEMENTS (continued) December 31, 2001 and 2000 NOTE H - EQUITY TRANSACTIONS Each share of the Company's common stock is entitled to one vote. In January 1993, Ortec effected a stock split and granted twenty new shares of common stock of $.001 par value for each outstanding share of common stock. This stock split is retroactively reflected in the accompanying financial statements and all references to shares are to the new shares with per share amounts appropriately adjusted. Pursuant to an agreement between Dr. Eisenberg and the other founders (the "Other Founders"), a business relationship was formed by the founders for the manufacture and sale of products derived from the Technology (the "Business Agreement"). Under the terms of the Business Agreement, Dr. Eisenberg, who was the owner of all the capital stock of Ortec (600,000 shares) agreed to license the Technology to Ortec and sell 70% of Ortec's shares for a purchase price of $1,000,000 to the Skin Group. Dr. Eisenberg was paid $85,000 in connection with this agreement as reimbursement for his expenses ($35,000 during the period from inception (March 12, 1991) to December 31, 1991 and $50,000 during the year ended December 31, 1992). The "Other Founders" initially owned all of the stock of the Skin Group (953,820 shares). In March 1991, the Skin Group issued, in a private placement, 217,440 shares for $65,000. In June and October 1991, the Skin Group issued 130,160 and 18,860 shares, to a then director of the Company (the "Director") for $150,000 and $100,000, respectively. Commencing in November 1991, the Skin Group issued 79,480 shares under a second private placement for $750,006 (including 26,460 shares during the year ended December 31, 1992). On July 27, 1992, the Skin Group was merged with and into Ortec. Also under the second private placement 22,860 shares of Ortec were issued for $215,467. In addition, the Director was granted warrants to purchase 7,360 shares of Ortec at $9.425 per share. Pursuant to a stock purchase agreement entered into with the Director in June 1992, 53,040 shares of Ortec were sold to the Director for a total purchase price of $499,998. In addition, the Director was granted warrants to purchase 79,570 shares at an exercise price of $9.425 per share, such warrants were exercised on December 29, 1998. The purchase price was payable in installments and shares and warrants were issued in installments pro rata with the payment of the purchase price. During the years ended December 31, 1993 and 1992, the Director paid $200,000 and $299,998, respectively, and was issued 21,220 and 31,820 shares, respectively. F-20 Ortec International, Inc. (a development stage enterprise) NOTES TO FINANCIAL STATEMENTS (continued) December 31, 2001 and 2000 NOTE H (continued) Further, in connection with the Director's purchase of the 53,040 shares, in 1993, the Other Founders granted to the Director options to purchase from them an aggregate of 74,000 Ortec shares, at a price of $5 per share. In 1993, the Director exercised such option in part, and purchased 49,000 shares from the Other Founders at the option price of $5 per share. The remaining balance of such options expired April 15, 1994. Pursuant to a third private placement that commenced in January 13, 1993, and concluded on March 31, 1993, Ortec sold an aggregate of 109,650 shares at $10 per share ($1,096,500). Subsequent to such offering, in 1993, the Company sold an additional 22,500 shares at $10 per share ($225,000). In connection with such purchases, all purchasers received certain registration rights. Pursuant to a Stock Purchase Agreement dated July 19, 1993, by and between Ortec and the Home Insurance Company ("Home Insurance"), the Company sold to Home Insurance 111,111 shares of common stock for an aggregate purchase price of $999,999, or $9 per share. In connection with such purchase, Home Insurance received certain registration rights. In addition, in 1993, the Company issued 600 shares to an individual as compensation for commissions in connection with the sale of the Company's shares. Such commissions are included in share issuance expenses. The stock issued was valued at $10 per share. In August 1993, the Director entered into a stock option agreement with Dr. Eisenberg and the Other Founders, pursuant to which he received the right to purchase an aggregate of 100,000 shares owned by such persons in various amounts and at various times, at a purchase price of $10 per share. As of December 31, 1993, the Director had exercised options and purchased 5,000 shares under such agreement at $10 per share. The remaining balance of such options has expired. Pursuant to a fourth private placement consummated in July 1994, Ortec sold an aggregate of 39,451 shares at between $10 and $10.25 per share for aggregate proceeds of $397,712. Pursuant to a Stock Purchase Agreement dated July 22, 1994, between Ortec and Home Insurance, the Company sold to Home Insurance 50,000 shares of common stock for an aggregate purchase price of $500,000, or $10 per share. In connection with such purchase, Home Insurance received certain registration rights and warrants to purchase 10,000 shares of common stock at $12 per share, which expired on July 21, 1997. F-21 Ortec International, Inc. (a development stage enterprise) NOTES TO FINANCIAL STATEMENTS (continued) December 31, 2001 and 2000 NOTE H (continued) On January 19, 1996, the Company completed an initial public offering ("IPO") of 1,200,000 units for aggregate proceeds of $6,000,000. Each unit consisted of one share of the Company's common stock, one Class A warrant to purchase one share of common stock at $10 and one Class B warrant to purchase one share of common stock at $15. As of December 31, 1998, 1,083,780 Class A warrants were exercised and the balance expired unexercised. The Class B warrants were originally set to expire in January 1999. The Company extended the expiration date to March 31, 2000. The Class B warrants are subject to redemption by the Company at $.01 per warrant. The Company received gross proceeds of approximately $1,282,000 and $10,823,000 and net proceeds of approximately $1,262,000 and $10,165,000 as a result of the exercise of warrants in 1998 and 1997, respectively. In November 1996, the Company completed a private placement of its securities from which it received gross proceeds of $6,220,797 and net proceeds of approximately $5,733,000 (after deducting approximately $487,000 in placement fees and other expenses of such private placement). The Company sold 959,106 shares of common stock in such private placement at average prices of $6.49 per share. In addition, the Company granted five-year warrants to placement agents to purchase such number of shares equal to 10% of the number of shares of common stock sold by such placement agents, exercisable at prices equal to 120% of the prices paid for such shares. Pursuant to the purchasers' request, the Company registered all 959,106 shares. During 1992 and 1993, the Company issued warrants to purchase 6,660 shares at $9.425 per share, and during 1995 the Company issued warrants to purchase 2,000 shares at $10 per share to members of the Scientific Advisory Board of the Company. During 1996 and 1997, the Company issued warrants to purchase 242,101 shares at $6 to $12 per share to the Director and certain others. These warrants expired at various dates through November 2001. On January 20, 1996, the Company granted "lock-up warrants" entitling shareholders to purchase an aggregate of 389,045 shares of the Company's common stock at a price of $1.00 per share. All unexercised warrants expired on January 18, 2000. At different times during 1996, seven persons exercised such warrants and purchased 33,885 shares of common stock at the $1.00 per share exercise price. The issuance of such lock-up warrants was in consideration for such shareholders signing lock-up agreements agreeing not to sell or transfer shares of the Company's common stock purchased at prices of $9.00 or more per share until January 20, 1997. At different times during the third quarter of 1997, eight persons exercised such warrants and purchased an aggregate of 21,210 shares of common stock at the F-22 Ortec International, Inc. (a development stage enterprise) NOTES TO FINANCIAL STATEMENTS (continued) December 31, 2001 and 2000 NOTE H (continued) $1.00 per share exercise price. During 1998, nine persons exercised such warrants and purchased an aggregate of 96,077 shares of common stock at the $1.00 per share exercise price. During 1999, five persons exercised such warrants and purchased an aggregate of 14,103 shares of common stock at the $1.00 per share exercise price. There were no underwriting discounts or commissions given or paid in connection with any of the foregoing warrant exercises. During the third quarter of 1997, the Company granted to one person and its seven designees four-year warrants to purchase an aggregate of 37,500 shares of common stock, at an exercise price of $12.00 per share. Such warrants are not exercisable until July 18, 1998 and were granted in consideration for consulting services rendered to the Company. During the fourth quarter of 1997, the Company granted to one person and its six designees four-year warrants to purchase an aggregate of 37,500 shares of common stock, at an exercise price of $12.00 per share. Such warrants are not exercisable until July 18, 1998 and were granted in consideration for consulting services rendered to the Company. During 1998, warrants for 18,700 shares, mentioned in the two previous paragraphs, were exercised utilizing the cashless exercise option of the warrant agreement. The Company issued 6,204 shares under this exercise. During the third quarter of 1997, the Company granted to one person a one-year warrant to purchase an aggregate of 625 shares of common stock, at an exercise price of $12.00 per share. Such warrants were granted in consideration for consulting services rendered to the Company. The warrant was exercised during 1998. The Company recorded consulting expense of approximately $64,000 as a result of these grants during the year ended December 31, 1998. During the fourth quarter of 1997, the Company granted five-year warrants to its three executive officers to purchase an aggregate of 240,000 shares of common stock, at an exercise price of $12.00 per share. Such warrants were granted in consideration for services rendered to the Company. The exercise of such warrants is contingent upon the occurrence of certain events, which were considered probable at December 31, 1997. As of December 31, 1998, five of the six events have occurred so that 185,000 of F-23 Ortec International, Inc. (a development stage enterprise) NOTES TO FINANCIAL STATEMENTS (continued) December 31, 2001 and 2000 NOTE H (continued) those warrants are now vested. As a result, the Company recorded compensation expense of approximately $80,000 in December 1997 and $1,185,000 for the year ended December 31, 1998. The balance of the warrants became vested upon the exercise of warrants owned by a director in December 1998 in accordance with the terms of certain compensation provisions as approved by the Company's Board of Directors. In consideration for services rendered by him as a director of the Company in the five-year period from 1992 to 1996 for which he never received compensation, the Company extended by one year to December 31, 1998 the expiration date of warrants owned by a director to purchase an aggregate of 86,930 shares, exercisable at $9.425 per share. As a result, the Company recorded compensation expense of approximately $420,000, during the fourth quarter of 1997. All of these warrants were exercised on December 29, 1998. During the fourth quarter of 1998, the Company granted five-year options to its three executive officers to purchase an aggregate of 520,750 shares of common stock, at exercise prices ranging from $12.13 to $12.44 per share. The exercise of such options was contingent upon the occurrence of certain events. All of these options became vested upon the exercise of warrants owned by a director in December 1998 in accordance with the terms of certain compensation provisions as approved by the Company's Board of Directors. As a result, the Company recorded compensation expense of approximately $495,000 in December 1998. In December 1998, the Company completed a private placement of its securities from which it received proceeds of $2,000,000. In addition, the Company granted three-year warrants to the Purchaser to purchase 50,000 shares at $12 per share. The Company sold 200,000 shares of common stock in such private placement. The Company assigned value to the common stock and warrants issued of $1,788,698 and $211,302 based upon the relative fair market value of the stock at the date of issuance and the estimated fair value of the warrants using the Black-Scholes option pricing model. In March 1999, the Company completed a private placement of 389,156 shares of its common stock to twenty investors from which it received proceeds of approximately $3,405,000. In addition, each investor also received a three-year warrant to purchase 20% of the number of shares of the Company's common stock such investor purchased in such private placement. The prices at which such warrants are F-24 Ortec International, Inc. (a development stage enterprise) NOTES TO FINANCIAL STATEMENTS (continued) December 31, 2001 and 2000 NOTE H (continued) exerciseable are $12.50 per share for one half, and $14.50 per share for the other half, of the number of shares issuable upon exercise of such warrants. The Company assigned value to the common stock and warrants issued to the investors of $3,168,785 and $236,291 based upon the relative fair market value of the stock at the date of issuance and the estimated fair market value of the warrants using the Black-Scholes option pricing model. Oscar Gruss & Son, Incorporated ("Gruss") acted as placement agent in such private placement. For its services as placement agent, the Company paid Gruss $272,406 and granted Gruss a five-year warrant to purchase an aggregate of 38,915 shares of the Company's common stock at an exercise price of $10.50 per share. The value assigned to the Gruss warrants was $232,000. Other share issuance costs amounted to $106,002. In December 1999, the Company completed a private placement of 1,636,364 shares of its common stock to two institutional funds from which it received proceeds of approximately $9,000,000. Share issuance costs amounted to approximately $9,500. In March 2000, the Company completed a private placement of 66,667 shares of its common stock to one fund from which it received proceeds of approximately $1,000,000. In addition, the Company paid a placement agent who introduced the Company to the fund a fee of approximately $43,400 and granted such placement agent a five year warrant to purchase 2,667 shares of the Company's common stock at an exercise price of $15.00 per share. The value assigned to the warrant was $23,000, which was reflected as share issuance costs. Other share issuance costs amounted to $3,200. In September 2000, the Company completed a private placement of 1,247,566 shares of its common stock to ten investors from which it received approximately $8,421,000. In addition, the Company paid the placement agent who introduced the Company to the investors a fee of approximately $525,400. Other share issuance costs amounted to approximately $46,500. In April 2001, the Company issued options to purchase 60,000 shares of the Company's common stock, at $6.95 per share, to certain professionals. The estimated fair value of $188,080 of such options has been recorded as an expense in the accompanying financial statements. In September 2001, the Company, with shareholder approval, increased the authorized amount of its common stock to 35,000,000 shares and authorized the issuance of up to 1,000,000 shares of preferred stock. F-25 Ortec International, Inc. (a development stage enterprise) NOTES TO FINANCIAL STATEMENTS (continued) December 31, 2001 and 2000 NOTE H (continued) The following table summarizes warrant activity during the period from March 12, 1991 (inception) through December 31, 2001 (excluding the Class A and B warrants which were issued during the IPO):
Price range Shares ----------- ------ March 12, 1991 (inception) to December 31, 1991 Granted $ 9.425 7,360 --------- Balance, December 31, 1991 9.425 7,360 Granted 9.425 55,080 -------- Balance, December 31, 1992 9.425 62,440 Granted 9.425 - 12.00 48,230 -------- Balance, December 31, 1993 9.425 - 12.00 110,670 Granted 12.00 10,000 -------- Balance, December 31, 1994 9.425 - 12.00 120,670 Granted 10.00 4,000 Expired 9.425 (2,680) --------- Balance, December 31, 1995 9.425 - 12.00 121,990 Granted 1.00 - 10.00 511,606 Exercised 1.00 (33,885) Expired 12.00 (2,450) --------- Balance, December 31, 1996 1.00 - 12.00 597,261 Granted 12.00 - 14.25 330,625 Expired 12.00 (10,000) -------- Balance, December 31, 1997 1.00 - 14.25 917,886 Granted 12.00 - 14.00 75,000 Exercised 1.00 - 12.00 (205,852) Expired 12.00 (108,425) -------- Balance, December 31, 1998 (carried forward) 1.00 - 14.25 678,609
F-26 Ortec International, Inc. (a development stage enterprise) NOTES TO FINANCIAL STATEMENTS (continued) December 31, 2001 and 2000 NOTE H (continued)
Price range Shares ----------- ------ Balance, December 31, 1998 (brought forward) $ 1.00 - 14.25 678,609 Granted 12.50 - 14.50 116,745 Exercised 1.00 (14,103) Expired 6.00 - 9.425 (17,160) -------- Balance, December 31, 1999 1.00 - 14.25 764,091 Granted 15.00 2,667 Exercised 12.00 (2,000) Expired 1.00 - 10.00 (154,985) -------- Balance, December 31, 2000 7.70 - 15.00 609,773 Expired 7.70 - 12.00 (214,361) -------- Balance, December 31, 2001 $ 7.70 - 15.00 395,412 ========
The following table summarizes warrant data as of December 31, 2001:
Weighted average Weighted Weighted remaining Average average Range of Number contractual Exercise Number exercise exercise prices outstanding life price exercisable price --------------- ------------ ----------- --------- ------------ ------- $7.70 to $10.50 38,915 2.24 years $10.50 38,915 $10.50 $12.00 to $12.50 278,918 0.67 years $12.07 278,918 $12.07 $14.00 to $15.00 77,579 0.96 years $14.32 77,579 $14.32
F-27 Ortec International, Inc. (a development stage enterprise) NOTES TO FINANCIAL STATEMENTS (continued) December 31, 2001 and 2000 NOTE I - STOCK OPTIONS AND WARRANTS In April 1996, the Board of Directors and stockholders approved the adoption of a stock option plan (the "Plan"). The Plan provides for the grant of options to purchase up to 350,000 shares of the Company's common stock. These options may be granted to employees, officers of the Company, nonemployee directors of the Company and consultants to the Company. The Plan provides for granting of options to purchase the Company's common stock at not less than the fair value of such shares on the date of the grant. The options generally vest ratably over a four year period and expire after seven years. In August 1998, the stockholders and Board of Directors ratified and approved an amended and restated 1996 Stock Option Plan increasing the maximum number of shares of the Company's common stock for which stock options may be granted from 350,000 to 1,550,000 shares. In August 2000, the stockholders and Board of Directors ratified and approved the second amendment to the Company's Amended and Restated 1996 Stock Option Plan increasing the number of shares of the Company's common stock for which options have been or could be granted under the Plan from 1,550,000 to 3,000,000 shares. The following table summarizes the stock option activity through December 31, 2001:
Weighted average Number exercise price ------ -------------- Granted - adoption of stock option plan 156,000 $ 7.08 --------- Balance, December 31, 1996 156,000 7.08 Granted 123,000 11.94 Forfeited, expired (3,000) 6.63 --------- Balance, December 31, 1997 276,000 9.25 Granted 689,750 12.10 Exercised (6,750) 7.42 Forfeited, expired (14,500) 11.19 --------- Balance, December 31, 1998 944,500 11.17 Granted 399,000 10.87 Forfeited, expired (221,000) 14.93 --------- Balance, December 31, 1999 (carried forward) 1,122,500 10.33
F-28 Ortec International, Inc. (a development stage enterprise) NOTES TO FINANCIAL STATEMENTS (continued) December 31, 2001 and 2000 NOTE I (continued) Balance, December 31, 1999 (brought forward) 1,122,500 $10.33 Granted 449,956 7.96 Exercised (3,500) 7.00 Forfeited, expired (44,850) 8.27 --------- Balance, December 31, 2000 1,524,106 $12.30 Granted 756,500 5.93 Forfeited, expired (247,300) 7.41 --------- Balance, December 31, 2001 2,033,306 $ 8.54 =========
The following data has been provided for exercisable options:
December 31, ------------ 2001 2000 1999 ---- ---- ---- Number of options 1,686,707 1,237,706 974,950 Weighted average exercise price $8.93 $12.02 $10.74 Weighted remaining contractual life 4.71 years 3.95 years 4.18 years
The exercise price for all stock options awarded has been determined by the Board of Directors of the Company. The weighted average fair value at the date of grant for options granted during the year ended December 31, 2001 and 2000 was $3.83 and $4.37, respectively. F-29 Ortec International, Inc. (a development stage enterprise) NOTES TO FINANCIAL STATEMENTS (continued) December 31, 2001 and 2000 NOTE I (continued) The following table summarizes option data as of December 31, 2001:
Weighted Average Weighted Weighted Remaining average average Range of Number Contractual exercise Number exercise exercise prices outstanding life Price exercisable price --------------- ------------ ----------- --------- ------------ ------- $4.50 to $7.50 1,025,400 5.62 years $ 5.79 723,263 $ 5.61 $8.00 to $10.44 408,906 4.95 years 9.47 366,444 9.44 $10.50 to $14.25 584,000 2.61 years 12.43 582,500 12.43 $14.25 to $21.38 15,000 1.40 years 20.73 14,500 21.45 --------- --------- 2,033,306 $ 8.54 1,686,707 $ 8.93 ========= ====== ========= ======
In October 1995, the Financial Accounting Standards No. 123 ("SFAS No. 123"), "Accounting for Stock-Based Compensation," established financial accounting and reporting standards for stock-based employee compensation plans. The financial accounting standards of SFAS No. 123 permit companies to either continue accounting for stock-based compensation under existing rules or adopt SFAS No. 123 and reflect the fair value of stock options and other forms of stock-based compensation in the results of operations as additional expense. The disclosure requirements of SFAS No. 123 require companies which elect not to record the fair value in the statement of operations to provide pro forma disclosures of net income and earnings per share in the notes to the financial statements as if the fair value of stock-based compensation had been recorded. The Company follows Accounting Principles Board Opinion No. 25 and its related interpretations in accounting for its stock-based compensation plans. The Company recognized approximately $1,696,000 of compensation expense for options and warrants issued to officers and directors of the Company in 1998. Such options and warrants were accounted for as variable option grants. Such options and warrants had vested prematurely in December 1998, upon the exercise of warrants owned by a director of the Company, in accordance with the terms of certain compensation provisions provided for and approved by the Company's Board of Directors. The Company utilized the Black-Scholes option-pricing model to quantify the expense of options and warrants granted to nonemployees and the pro forma effects on net loss and net loss per share of the fair value of the options and warrants granted to employees during the years ended December 31, 2001, 2000 and 1999. The following assumptions were made in estimating fair value. F-30 Ortec International, Inc. (a development stage enterprise) NOTES TO FINANCIAL STATEMENTS (continued) December 31, 2001 and 2000 NOTE I (continued)
Year ended December 31, ----------------------- 2001 2000 1999 ---- ---- ---- Risk-free interest rate 4.6% 4.5% 5% Expected option life 7 years 7 years 3 years Expected volatility 65.8% 65% 65%
Had compensation cost been determined under SFAS No. 123 for the years ended December 31, 2001, 2000 and 1999, net loss and loss per share would have been increased as follows:
Year ended December 31, ----------------------- 2001 2000 1999 ---- ---- ---- Net loss As reported $(15,885,377) $(12,129,663) $(10,040,509) Pro forma $(18,779,097) $(13,948,132) $(11,149,970) Net loss per share (basic and diluted) As reported $(1.64) $(1.37) $(1.51) Pro forma $(1.94) $(1.58) $(1.68)
In addition, the Company recognized approximately $188,000, $56,000 and $65,000 in consulting expenses in 2001, 2000 and 1999, respectively, for options and warrants granted to independent consultants and investment bankers for services rendered to the Company. NOTE J - COMMITMENTS AND CONTINGENCIES Agreement With Dr. Eisenberg Pursuant to an amended agreement, the Company has engaged the services of Dr. Eisenberg as a consultant through August 31, 2005. The consulting agreement may be renewed for an additional two years unless terminated by either party prior to such renewal period. Under the agreement, Dr. Eisenberg is obligated to devote twenty hours per week to Company business and is entitled to an annual compensation for such services with annual increases, as defined. In addition, Dr. Eisenberg is paid $58 per hour for services in excess of twenty hours per week. The agreement also provides for a bonus in the event the Company files for the registration of any patent. The bonus, which shall be determined by the F-31 Ortec International, Inc. (a development stage enterprise) NOTES TO FINANCIAL STATEMENTS (continued) December 31, 2001 and 2000 NOTE J (continued) Board of Directors of the Company, shall not be less than $30,000 per patent registration, but may not aggregate more than $60,000 during any twelve-month period. As of December 31, 1999 and for the cumulative period since inception, no bonuses have been earned by Dr. Eisenberg. For each of the years ended December 31, 2001, 2000 and 1999, Dr. Eisenberg earned approximately $73,000 for consulting services and approximately $761,000 for the period from inception to December31, 2001, which is included in research and development expense. Included in accrued compensation at December 31, 2001 and 2000 are $36,826 and $21,411, respectively, representing unpaid consulting fees to Dr. Eisenberg. Sales Force In December 2001, the Company entered into an agreement with PDI, Inc. ("PDI"), a pharmaceutical and medical device and diagnostics sales and marketing company to provide a dedicated sales force to the Company to target the donor site burn market. The agreement provides for a monthly fee based on the number of sales representatives engaged plus commissions based upon sales of OrCel. In the event that the agreement is terminated by the Company before February 2003, an early termination charge of up to $150,000 will be payable to PDI. Supply Agreements In October 1991, the Company entered into an agreement with Cornell University Medical College ("Cornell"), a medical institution in New York City, for Cornell to produce and supply the Company, on an exclusive basis and using Dr. Eisenberg's technology, all of the cultured skin equivalent necessary for the Company's use in human clinical tests in the United States. Fees earned by Cornell amounted to approximately $1,145,000 for the period from inception to December 31, 1996. The Cornell arrangement was terminated as of December 31, 1996. Research Agreement In January 1997, the Company entered into an agreement with the New Jersey Center for Biomaterials and Medical Devices (the "New Jersey Center"), whereby the Company and the New Jersey Center will collaborate on research focusing on the development of collagen-based biomaterials for soft tissue repair, specifically targeting the development of a second generation collagen matrix to be used for the production of OrCel. The New Jersey Center is a cooperative research initiative sponsored by the University of Medicine and Dentistry of New Jersey, Rutgers University and the New Jersey Institute of Technology, and receives financial support from the New Jersey Commission of Science and Technology. The Company contributed $40,000 of the $100,000 cost of such research in 1998, $45,000 in 1999 and the final $15,000 in 2000. F-32 Ortec International, Inc. (a development stage enterprise) NOTES TO FINANCIAL STATEMENTS (continued) December 31, 2001 and 2000 NOTE J (continued) Occupancy Arrangements The Company leases approximately 5,000 square feet of space in Sydney, Australia, on a month-to-month basis, in which the Company operates a research laboratory to conduct its research and development activities in Australia and to produce OrCel used in the operations conducted in Australia. The Company pays rent in Australian dollars, which at the current rate of exchange, amounts to approximately US $25,000 per year. This space is rented from Dr. Mark Eisenberg's father on terms that the Company believes are not less favorable to it than for rental of similar space in Sydney, Australia, from nonrelated third parties. During the year ended December 31, 1995, Dr. Eisenberg's father waived the rights to $40,740 of unpaid rent which was accounted for as additional paid-in capital. In March 1996, the Company entered into a five-year lease with Columbia University for the Company's laboratory and offices in Columbia's new Audubon Biomedical Science and Technology Park in New York City. Construction of the laboratory and office facility was completed in July 1996 and became fully operational in November 1996. In 1996, the Company also granted Columbia a warrant which expired in March 2001 to purchase 5,000 shares of common stock at an exercise price of $10 per share. In addition, Columbia had agreed to provide the Company with a grant of $400,000 and a ten-year self-amortizing loan with interest at the rate charged by Columbia's bank for up to an additional $600,000, to build and equip the Company's laboratory. During 1998, the Company received the $600,000 loan and an additional grant of $130,000 and entered into two leases with Columbia for additional space in the building. During 2000, the Company extended the two leases for another year and entered into a new lease for additional space in the building. During 2001, the Company extended two of its leases, one for an additional two years and the other for one year and entered into a new lease for additional space in the building. The Company utilizes its laboratory facilities to produce OrCel. Total rent expense for the years ended December 31, 2001, 2000 and 1999 was approximately $589,000, $535,000 and $473,000, respectively. F-33 Ortec International, Inc. (a development stage enterprise) NOTES TO FINANCIAL STATEMENTS (continued) December 31, 2001 and 2000 NOTE J (continued) In December 2001, the Company entered into a ten year lease with the New Jersey Economic Development Authority ("NJEDA") to lease approximately 58,000 square feet of manufacturing and office space, located in North Brunswick, New Jersey. The leased premises will be completed and will be available to the Company in two phases. The initial space, consisting of approximately 26,000 square feet, is an existing building, which will be renovated to the Company's specifications. The additional space, adjoining the existing building and consisting of approximately 32,000 square feet, will be constructed to the Company's specifications. The landlord is responsible for the completion of the renovations and construction of the building and is contributing up to $1,300,000 for the renovations to the existing building and $3,200,000 for the construction of the new building. Any additional renovation or construction costs will be borne by the Company. The Company expects to initiate transition to the new facility during 2002 and to be fully operational at that site during 2003. The Company has also been approved for Business Employment Incentive Grants by the NJEDA, with an anticipated potential value of approximately $1,500,000 over the ten year grant period. The minimum rental payments on noncancelable operating leases with terms exceeding one year at December 31, 2001 are as follows: Year ending December 31, 2002 $ 424,000 2003 611,000 2004 1,110,000 2005 1,476,000 2006 1,586,000 Thereafter 8,410,000
Government Regulation The Company is subject to extensive government regulation. Products for human treatment are subject to rigorous preclinical and clinical testing procedures as a condition for approval by the FDA and by similar authorities in foreign countries prior to commercial sale. Presently, the Company is continuing to submit the results of its human clinical trials to the FDA; however, it is not possible for the Company to determine whether the results achieved from the human clinical trials will be sufficient to obtain FDA approval. F-34 Ortec International, Inc. (a development stage enterprise) NOTES TO FINANCIAL STATEMENTS (continued) December 31, 2001 and 2000 NOTE J (continued) Legal Proceedings On August 15, 2001, a complaint was filed against the Company and its directors in the United States District Court for the Southern District of New York. The complaint claims that the plaintiff purchased the Company's class B warrants, which expired on December 31, 2000 claiming that he received assurances from the Company's chief executive officer that the board would reduce the strike price of such warrants and/or extend the due date of such warrants and that the plaintiff relied on actions taken in the past by the Company to extend these warrants. The Company's chief executive officer denies giving such assurances. The Company denies that the plaintiff could rely upon actions taken in the past as representation that future actions would be taken. NOTE K - RELATED PARTY TRANSACTIONS Prior to December 31, 1998, the "Other Founders" were paid fees for services rendered of approximately $980,000 in the aggregate, for the period from inception to December 31, 1998. In addition, in 1996, $140,000 was paid to a director as cash compensation for services as placement agent in connection with the November 1996 private placement. Also, the director received 30,500 warrants (see Note G). In December 1997, the Company extended the expiration date on warrants to the director to purchase 86,930 shares, exercisable at $9.425 per share, resulting in compensation expense of approximately $420,000 (see Note G). The Company paid approximately $35,000 and $25,000 for the years ended December 31, 1997 and 1996, respectively, as fees for accounting services, to a stockholder (approximately $100,000 for the period from inception to December 31, 1997). Also during the year ended December 31, 1996, the Company repaid loans of approximately $247,000 from the net proceeds of the "IPO" to officers. Prior to June 1996, the Company's executive offices were located in office space leased by a company owned by an officer, founder and director of the Company on a rent-free basis. Change of Control In December 1998, the Company's Board of Directors authorized agreements between the Company and its four executive officers which state that in the event of a "change of control" certain "special compensation arrangements" will occur. A "change of control" is defined as a change in the ownership or effective control of the Company or in the ownership of a substantial portion of the assets of the F-35 Ortec International, Inc. (a development stage enterprise) NOTES TO FINANCIAL STATEMENTS (continued) December 31, 2001 and 2000 NOTE K (continued) Company, but in any event if certain members of the Company's Board of Directors no longer constitute a majority of the Board of Directors. In the event that such change of control occurs, the agreements will provide three of its officers additional compensation, interest-free loans to exercise their stock options and warrants, and extensions of the expiration dates of all of their then outstanding options and warrants. In addition, for all four of the officers, in the event of a change of control, all unvested options and warrants will vest immediately upon such change of control. NOTE L - INCOME TAXES The Company has deferred start-up costs for income tax purposes and intends to elect to amortize such costs over a period of 60 months, under Section 195(b) of the Internal Revenue Code, when the Company commences operations. At December 31, 2001, the Company had net operating loss carryforwards of approximately $14,713,000 for Federal and New York State income tax purposes expiring through 2021. Due to the merger of skin group with and into Ortec in July 1992, the net operating losses and other built-in deductions existing at that time were subject to annual limitations pursuant to Internal Revenue Code Section 382. The Company's ability to utilize net operating losses and other built-in deductions generated after that date may be limited in the future due to additional issuances of the Company's common stock or other changes in control, as defined in the Internal Revenue Code and related regulations. For financial statement purposes, a valuation allowance of approximately $23,294,000 and $16,623,000 at December 31, 2001 and 2000, respectively, has been recognized to offset entirely the deferred tax assets related to the Company's operating loss carryforwards and other temporary differences related to the deferral of start-up expenses for tax purposes, as the realization of such deferred tax assets is uncertain. F-36 Ortec International, Inc. (a development stage enterprise) NOTES TO FINANCIAL STATEMENTS (continued) December 31, 2001 and 2000 NOTE L (continued) Components of the Company's deferred tax asset are as follows:
December 31, ----------------------------------- 2001 2000 ----------- ----------- Net operating loss carryforwards $ 6,179,000 $ 4,494,000 Deferral of start-up costs 16,757,000 12,129,000 Other 358,000 ----------- ----------- 23,294,000 16,623,000 Valuation allowance (23,294,000) (16,623,000) ----------- ----------- Net deferred tax asset $ - $ - =========== ===========
The following reconciles the income taxes computed at the Federal Statutory rate to the amounts recorded in the Company's statement of operations:
Cumulative from March 12, 1991 (inception) Year ended December 31, to December 31, 2001 ----------------------- ----------------------- 2001 2000 1999 ---- ---- ---- Income tax benefit at the Statutory rate $(5,401,000) $(4,124,000) $(3,414,000) $(20,113,000) State and local income taxes, net of Federal benefit (1,270,000) (961,000) (795,000) (3,181,000) Effect of valuation allowance 6,671,000 5,085,000 4,209,000 23,294,000 ----------- ----------- ----------- ------------ Total $ - $ - $ - $ - =========== =========== =========== ============
F-37 Ortec International, Inc. (a development stage enterprise) NOTES TO FINANCIAL STATEMENTS (continued) December 31, 2001 and 2000 NOTE L (continued) The Company's net operating loss tax carryforwards expire as follows: December 31, 2006 $ 76,000 December 31, 2007 233,000 December 31, 2008 511,000 December 31, 2009 597,000 December 31, 2010 440,000 December 31, 2011 677,000 December 31, 2012 839,000 December 31, 2018 1,189,000 December 31, 2019 2,602,000 December 31, 2020 3,535,000 December 31, 2021 4,014,000 ---------- $14,713,000 ===========
NOTE M - OPERATIONS IN OTHER GEOGRAPHIC AREAS Long-lived assets which consists of fixed assets and patents are as follows as of December 31, 2001 and 2000
2001 2000 ---- ---- United States $2,139,341 $2,246,423 Australia 63,056 61,649 --------- --------- $2,202,397 $2,308,072 ========= =========
F-38 Ortec International, Inc. (a development stage enterprise) NOTES TO FINANCIAL STATEMENTS (continued) December 31, 2001 and 2000 NOTE N - FAIR VALUE OF FINANCIAL INSTRUMENTS Statement of Financial Accounting Standards No. 107 ("SFAS No. 107"), "Fair Value of Financial Instruments," requires disclosure of the estimated fair value of an entity's financial instrument assets and liabilities. For the Company, financial instruments consist principally of cash and cash equivalents, loan payable and other long-term obligations. The following methods and assumptions were used to estimate the fair value of each class of financial instrument for which it is practicable to estimate that value. Cash and Cash Equivalents The carrying value reasonably approximates fair value because of the short maturity of those instruments. Loan Payable and Other Long-term Obligations Based on borrowing rates currently available to the Company for bank loans and other financings with similar terms and maturities, the carrying value of the Company's loan payable and other long-term obligations approximates the fair value. F-39 Ortec International, Inc. (a development stage enterprise) NOTES TO FINANCIAL STATEMENTS (continued) December 31, 2001 and 2000 NOTE O - QUARTERLY FINANCIAL DATA (UNAUDITED) Summarized quarterly financial for the years ended December 31, 2001 and 2000, is as follows:
Quarter Ended March 31, June 30, September 30, --------- -------- ------------- 2001 2000 2001 2000 2001 2000 ---- ---- ---- ---- ---- ---- Revenues $ - $ - $ - $ - $ - $ - Net loss $(3,494,473) $(2,650,531) $(3,753,130) $(2,811,949) $(4,173,593) $(3,408,097) Net loss per share Basic and diluted $(.36) $(.32) $(.39) $(.33) $(.43) $(.38) Quarter Ended December 31, ------------ 2001 2000 ---- ---- Revenues $ 21,890 $ - Net loss $(4,464,181) $(3,259,086) Net loss per share Basic and diluted $(.46) $(.34)
F-40 STATEMENT OF DIFFERENCES The trademark symbol shall be expressed as..................................'TM' EX-23 3 ex23.txt EXHIBIT 23 Exhibit 23 CONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS We have issued our report dated February 22, 2002,except for Note A as to which the date is April 15, 2002, accompanying the financial statements included in the Annual Report of Ortec International, Inc. on Form 10-K for the year ended December 31, 2001. We hereby consent to the incorporation by reference of said report in the Registration Statements of Ortec International Inc. on Forms S-3 (File No. 333-42850 effective August 23, 2000, File No. 333-46352, effective September 29, 2000, File No. 333-52019, effective May 7, 1998 and File No. 333-80979, effective October 14, 1999) and on Forms S-8 (File No. 333-47671, effective March 10, 1998 and File No. 333-80799, effective June 16, 1999). GRANT THORNTON LLP New York, New York April 15, 2002 -----END PRIVACY-ENHANCED MESSAGE-----