10-Q 1 e-8507.txt QUARTERLY REPORT FOR QTR. ENDED 03/31/2002 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549 FORM 10-Q (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended March 31, 2002 or [ ] 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: 0-21214 ORTHOLOGIC CORP. (Exact name of registrant as specified in its charter) Delaware 86-0585310 (State of other jurisdiction of (IRS Employer incorporation or organization) Identification No.) 1275 W. Washington Street, Tempe, Arizona 85281 (Address of principal executive offices) (Zip Code) (602) 286-5520 (Registrant's telephone number, including area code) (Former name, former address and former fiscal year, if changed since last report) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or 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 [ ] APPLICABLE ONLY TO CORPORATE ISSUERS: Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. 31,917,144 shares of common stock outstanding as of April 30, 2002 ORTHOLOGIC CORP. INDEX Page No. Part I Financial Information Item 1. Financial Statements Condensed Consolidated Balance Sheets March 31, 2002 and December 31, 2001.................................................. 3 Condensed Consolidated Statements of Operations and of Comprehensive Income for the Three months ending March 31, 2002 and 2001............................................ 4 Condensed Consolidated Statements of Cash Flows for the three months ending March 31, 2002 and 2001.............................. 5 Notes to Unaudited Condensed Consolidated Financial Statements............................................... 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations........................ 12 Item 3. Quantitative and Qualitative Disclosures about Market Risk................................................ 16 Part II Other Information Item 1. Legal Proceedings.......................................... 23 Item 6. Exhibits and Reports on Form 8-K........................... 23 2 PART I - FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS OrthoLogic Corp. Condensed Consolidated Balance Sheets (in thousands) March 31, December 31, 2002 2001 --------- --------- (Unaudited) ASSETS Cash and cash equivalents $ 15,162 $ 19,503 Short term investments 16,158 11,008 Accounts receivable, net 10,792 11,361 Inventory, net 2,090 1,762 Prepaids and other current assets 711 688 Deferred income tax 2,631 2,631 --------- --------- Total current assets 47,544 46,953 Furniture and equipment 8,428 8,325 Accumulated depreciation (6,596) (6,423) --------- --------- Furniture and equipment, net 1,832 1,902 Investment in Chrysalis BioTechnology 750 750 Deposits and other assets 130 92 --------- --------- Total assets $ 50,256 $ 49,697 ========= ========= LIABILITIES & STOCKHOLDERS' EQUITY Liabilities Accounts payable $ 1,277 $ 1,031 Accrued liabilities 4,693 5,883 --------- --------- Total current liabilities 5,970 6,914 Deferred rent obligations 303 287 --------- --------- Total liabilities 6,273 7,201 --------- --------- Series B Convertible Preferred Stock 600 600 Stockholders' Equity Common stock 16 16 Additional paid-in capital 135,367 135,326 Common stock to be used for legal settlement 2,969 2,969 Accumulated deficit (94,832) (96,278) Treasury stock (137) (137) --------- --------- Total stockholders' equity 43,383 41,896 --------- --------- Total liabilities and stockholders' equity $ 50,256 $ 49,697 ========= ========= See Notes to Unaudited Condensed Consolidated Financial Statements. 3 OrthoLogic Corp. Condensed Consolidated Statements of Operations and of Comprehensive Income (in thousands, except per share data) Unaudited Three months ending March 31, ------------------- 2002 2001 -------- -------- Revenues $ 9,609 $ 21,682 Cost of Revenues 1,313 4,733 -------- -------- Gross Profit 8,296 16,949 Operating expenses Selling, general and administrative 6,704 16,103 Research and development 920 704 Change in estimated collectability of CPM receivables (600) -- -------- -------- Total operating expenses 7,024 16,807 -------- -------- Operating income 1,272 142 Other income 187 129 -------- -------- Income before income taxes 1,459 271 Provision for income taxes 13 67 -------- -------- Net income $ 1,446 $ 204 ======== ======== BASIC EARNINGS PER SHARE Net income per common share $ 0.04 $ 0.01 -------- -------- Weighted average number of common shares outstanding 32,515 31,140 -------- -------- DILUTED EARNINGS PER SHARE Net income per common and equivalent shares $ 0.04 $ 0.01 -------- -------- Weighted shares outstanding 33,300 31,649 -------- -------- CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME Net income $ 1,446 $ 204 Foreign currency translation adjustment (13) -------- -------- Comprehensive income $ 1,446 $ 191 ======== ======== See Notes to Unaudited Condensed Consolidated Financial Statements. 4 OrthoLogic Corp. Condensed Consolidated Statements of Cash Flows (in thousands) Unaudited Three months ending March 31, ------------------- 2002 2001 -------- -------- OPERATING ACTIVITIES Net income $ 1,446 $ 204 Noncash items: Depreciation and amortization 173 281 Change in operating assets and liabilities: Accounts receivable 569 2,502 Inventory (328) 1,413 Prepaids and other current assets (23) (517) Deposits and other assets (38) 81 Accounts payable 246 (841) Accrued liabilities (1,174) (977) -------- -------- Net cash provided in operating activities 871 2,146 -------- -------- INVESTING ACTIVITIES Expenditures for rental fleet, equipment and furniture (103) (430) (Purchases) sales of short term investments (5,150) 1,333 -------- -------- Net cash (used) provided in investing activities (5,253) 903 -------- -------- FINANCING ACTIVITIES Net proceeds from stock option exercises and other 41 27 -------- -------- Net cash provided by financing activities 41 27 -------- -------- NET INCREASE IN CASH AND CASH EQUIVALENTS (4,341) 3,076 CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 19,503 6,753 -------- -------- CASH AND CASH EQUIVALENTS, END OF PERIOD $ 15,162 $ 9,829 ======== ======== Supplemental schedule of non-cash investing and financing activities: Cash paid during the period for interest $ 23 $ 20 Cash paid during the period for income taxes $ 2 $ -- See Notes to Unaudited Condensed Consolidated Financial Statements. 5 ORTHOLOGIC CORP. NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS 1. FINANCIAL STATEMENT PRESENTATION The Condensed Consolidated Balance Sheet as of March 31, 2002 and the Condensed Consolidated Statements of Operations and Comprehensive Income for the three months ending March 31, 2002 and 2001 and the Condensed Consolidated Statements of Cash Flows for the three months ending March 31, 2002 and 2001 are unaudited. In the opinion of management, the unaudited interim financial statements include all adjustments necessary for the fair presentation of the Company's financial position, results of operations, and cash flows. The results of operations for the interim periods are not indicative of the results to be expected for the complete fiscal year. The Balance Sheet as of December 31, 2001 is derived from the Company's audited financial statements included in the 2001 Annual Report on Form 10-K. These financial statements should be read in conjunction with the financial statements and notes thereto included in the Company's 2001 Annual Report on Form 10-K. Use of estimates. - The preparation of the financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from these estimates. Significant estimates include the allowance for doubtful accounts and sales discounts and adjustments of approximately $3.3 million and $12.7 million at March 31, 2002 and 2001, respectively, which are based primarily on trends in historical collection statistics, consideration of current events, payor mix and other considerations. The Company derives a significant amount of its revenues from third-party payors, including Medicare and certain commercial insurance carriers, health maintenance organizations, and preferred provider organizations. Amounts paid under these plans are generally based on fixed or allowable reimbursement rates. Revenues are recorded at the expected or pre-authorized reimbursement rates when earned and include unbilled receivables of $2.3 million and $7.8 million on March 31, 2002 and 2001, respectively. Some billings are subject to review by such third party payors and may be subject to adjustments. In the opinion of management, adequate allowances have been provided for doubtful accounts and contractual adjustments. However, these estimates are always subject to adjustment, which could be material. Any differences between estimated reimbursement and final determinations are reflected in the period finalized. In January 2001, the Company announced plans to divest its Continuous Passive Motion ("CPM") business to refocus the Company on its core business of fracture healing and spinal repair (See Note 3). 2. CO-PROMOTION AGREEMENT FOR HYALGAN The Company began selling Hyalgan to orthopedic surgeons in July 1997, under a Co-Promotion Agreement with Sanofi Synthelabo, Inc. (the "Co-Promotion Agreement"). In October 2000, the Company and Sanofi mutually agreed to terminate the agreement. The Company received an up-front cash payment to complete the transition of the business and continuing royalties through 2002. 6 Hyalgan royalty revenue in the quarter ended March 31, 2002 was $904,000 as compared to Hyalgan royalty revenue of $716,000 for the same period in 2001. 3. CPM DIVESTITURE AND CHANGE IN ESTIMATED COLLECTABILITY OF CPM RECEIVABLES In January 2001, the Company announced plans to divest its CPM business to refocus the Company on its core business of fracture healing and spinal repair. The sale of the CPM business was completed in July 2001. As part of the divestiture, the Company retained the billed accounts receivable related to the CPM business with a net carrying value of approximately $10.8 million (net of a $5.2 million allowance for doubtful accounts). During the first quarter of 2002, the Company changed its estimate of the collectability of the CPM accounts receivable and now anticipates that it will collect $600,000 more in CPM accounts receivable than was estimated at the time of the divestiture. A summary of the severance and other reserve balances at March 31, 2001 are as follows:
Total Charges Amount Charged Cash Reserves June 30, 2001 Against Assets Paid March 31, 2001 ------------- -------------- ------- -------------- Severance and stay-on bonus $ 3,300 $ -- $(2,668) $ 632 Other exit costs 1,387 (245) (1,066) 76 ------- ------- ------- ------- Total non-recurring charges $ 4,687 $ (245) $(3,734) $ 708
Subsequent to the sale, the Company is no longer in the CPM business. Substantially all costs, expenses and impairment charges related to CPM exit activities were recorded prior to the end of the second quarter of 2001. The revenue and cost of revenue attributable to the CPM business were: 2001 2000 1999 -------- -------- -------- Revenue $ 28,861 $ 60,259 $ 62,862 Cost of revenue 5,811 14,103 15,947 -------- -------- -------- Gross profit $ 23,050 $ 46,156 $ 46,915 4. LICENSING AGREEMENT FOR CHRYSALIN The Company announced in January 1998, that it had acquired a minority equity investment (less than 10%) in a biotech firm, Chrysalis BioTechnology, Inc. ("Chrysalis") for $750,000. As part of the transaction, the Company was awarded a worldwide exclusive option to license the orthopedic applications of Chrysalin, a patented 23-amino acid peptide that has shown promise in accelerating the healing process and has completed a pre-clinical safety and efficacy profile of the product. The Company's agreement with Chrysalis contains provisions for the Company to continue and expand its option to license Chrysalin contingent upon regulatory approvals, successful pre-clinical trials, and certain trials and certain milestone payments to Chrysalis by the Company. As part of the equity investment, OrthoLogic acquired options to license Chrysalin for orthopedic applications. A fee of $750,000 for the initial license was expensed in the third quarter of 1998. In January 1999, the Company exercised its option to license the U. S. development, marketing and 7 distribution rights for Chrysalin, for fresh fracture indications. As part of the license agreement, and in conjunction to FDA clearance to begin human clinical trials for fracture repair, OrthoLogic made a $500,000 milestone payment to Chrysalis in the fourth quarter of 1999. In January 2000, the Company began enrolling patients in the combined Phase I/II clinical trial for Chrysalin. In July 2000, the Company made a $2 million payment to Chrysalis and announced it was expanding its license agreement to include all Chrysalin orthopedic indications worldwide. In July 2001 the Company paid $1.0 million to Chrysalis to extend its worldwide license for Chrysalin to include the rights for orthopedic "soft tissue" indications including cartilage, tendon and ligament repair. The license agreement calls for the Company to pay certain additional milestone payments and royalty fees, based upon products developed and achievement of commercial services. In March 2002, the Company made a $500,000 milestone payment to Chrysalis for receiving clearance from the FDA to begin a Phase I/II trial for spinal fusion. Except for the $750,000 minority equity interest, all payments made to Chrysalis have been expensed as research and development. During 2001 the Company completed a Phase I/II clinical trial utilizing Chrysalin for fresh fracture repair and is currently seeking approval to begin a Phase III trial for that indication. In March 2002, the Company received approval by the FDA to commence a Phase I/II clinical trial for a spinal fusion indication and anticipates initiating a trial in 2002. The Company is currently moving forward with an Investigational New Drug application for Phase I/II human clinical trial for Chrysalin for articular cartilage repair in 2002. There can be no assurance, however, that the clinical trials will result in favorable data or that FDA approvals, if sought, will be obtained. Significant additional costs for the Company will be necessary to complete development of these products. 5. LITIGATION SETTLEMENT OF CLASS ACTION SUIT NORMAN COOPER, ET AL. V. ORTHOLOGIC CORP. ET AL., MARICOPA COUNTY SUPERIOR COURT, ARIZONA, CASE NO. CV 96-10799, AND RELATED FEDERAL CASES. During 1996, certain class actions lawsuits were filed in the United States District Court for the District of Arizona against the Company and certain officers and directors alleging violations of Sections 10(b) of the Securities Exchange Act if 1934 ("Exchange Act") and SEC Rule 10b-5 promulgated thereunder, and, as to other defendants, Section 20(a) of the Exchange Act. The cases were originally filed in 1996, alleged generally that information concerning the May 31, 1996 letter received by the Company from the FDA regarding the Company's OL1000 Bone Growth Stimulator, and the matters set forth therein, were material and undisclosed, leading to an artificially inflated stock price. Plaintiffs further allege that the Company's non-disclosure of the FDA correspondence and of the alleged practices referenced in that correspondence operated as a fraud against plaintiffs, in that the Company allegedly made untrue statements of material facts or omitted to state material facts in order to make the statement not misleading. Plaintiffs further alleged that once the FDA letter became known a material decline in the stock price of the Company occurred, causing damage to the plaintiffs. All plaintiffs sought class action status, unspecified compensatory damages, fees and costs. The actions were consolidated for all purposes in the United States District Court for the District of Arizona. On March 31, 1999, the judge in the consolidated case before the United States District Court granted the Company Motion to Dismiss and entered an order dismissing all claims in the suit against the Company and two individual officers/directors. The judge allowed certain narrow claims based on insider trading theories to proceed against certain individual defendants. On December 21, 1999, the District Court granted plaintiffs' motion 8 for class certification to include purchasers of common stock between June 4 through June 18, 1996, inclusive. On or about June 20, 1996, a lawsuit entitled Norman Cooper, et. al. v. OrthoLogic, Corp., et. al, and Case No. CV 96-10799 was filed in the Superior Court, Maricopa County, Arizona. The plaintiffs allege violations of Arizona Revised Statutes sections 44-1991 (state securities fraud) and 44-1522 (consumer fraud) and common law fraud based upon factual allegations substantially similar to those alleged in the federal court class action complaints. Plaintiffs sought class action status, unspecified compensatory and punitive damages, fees and costs. Plaintiffs also sought injunction and or equitable relief. The court granted the plaintiffs' motion for the class certification on November 24, 1999. In early October 2000, the parties negotiated a global settlement of this state court class action and the federal class action described below. In return for dismissal of both the state and federal class actions, and releases by a settlement class comprised of all purchasers of OrthoLogic common stock during the period from January 18 through June 18, 1996, inclusive, the settlement called for $1 million in cash and 1 million shares of newly-issued OrthoLogic common stock. The settlement was presented to the Arizona superior court for approval. The court granted preliminary approval of the settlement and ordered notice to the settlement class by order dated April 30, 2001. Following notice to the settlement class and a hearing on whether to give final approval of the settlement, on August 17, 2001, the superior court gave final approval of the settlement and signed and filed a judgment of dismissal of the action with prejudice. We are not aware of any appeal from the judgment or other challenge to the final approval of the settlement. Pursuant to the terms of the settlement, the cash portion of the settlement fund has already been paid into the settlement fund, with the substantial portion of the $1 million paid from the proceeds of the Company's directors' and officers' liability insurance policy, and the remaining cash paid by the Company. The Company recorded a $3.6 million charge in 2000, including legal expenses, for settlement. Pursuant to the terms of the settlement and order of the superior court, and the Company has issued and delivered 300,000 shares of common stock to plaintiffs' settlement counsel as part of the plaintiffs' counsel's fee award. The remaining 700,000 shares remain to be delivered to the settlement fund pending administration of the claims process under the settlement. Notices have been sent to stockholders of record for the relevant time period to calculate the settlement pool each stockholder is to receive. Management believes the settlement is in the best interests of the Company and its shareholders as it frees the Company from the cost and significant distraction of the ongoing litigation. The settlement does not constitute, and should not be construed as, an admission that the defendants have any liability or acted wrongfully in any way with respect to the plaintiffs or any other person. UNITED STATES OF AMERICA EX REL. DAVID BARMAK V. SUTTER CORP., UNITED STATES ORTHOPEDIC CORP., ORTHOLOGIC CORP., ET AL., UNITED STATES DISTRICT COURT, SOUTHERN DISTRICT OF NEW YORK, CIV ACTION NO 95 CIV 7637. The complaint in this matter was filed in September 1997 under the Qui Tam provisions of the Federal False Claims Act and primarily relates to events occurring prior to the Company's acquisition of Sutter Corporation. The allegations relate to the submission of claims for reimbursement for continuous passive motion exercisers to various federal health care programs. In June 2001, the U.S. Department of Justice and the Company entered into a settlement agreement and the government's amended complaint was dismissed with prejudice. In October 2001, Plaintiff Barmak filed a second amended complaint, pursuing the claim independent of the U.S. Department of Justice. The Company filed a motion to dismiss the second 9 amended complaint on various grounds including that the allegations are barred because of the earlier settlement. The case has just begun discovery. At the present stage, it is not possible to evaluate the likelihood of an unfavorable outcome or the amount or a range of potential loss, if any, which may be experienced by the Company. ORTHOREHAB, INC. AND ORTHOMOTION, INC. V. ORTHOLOGIC CORPORATION AND ORTHOLOGIC CANADA, LTD., SUPERIOR COURT OF THE STATE OF DELAWARE, COUNTY OF NEW CASTLE, CASE NO. C.A. NO. 01C-11-224 WCC. In November 2001, OrthoRehab, Inc., the company which purchased the assets related to the CPM business of OrthoLogic Corp., filed a complaint in connection with the acquisition of the Company's continuous passive motion business in July 2001 alleging, among other things, that some of the assets purchased were over valued and that the Company had breached its contract. The case is being heard in the Superior Court of the State of Delaware. The Company has denied the Plaintiffs' allegations and intends to defend the matter vigorously. The case is currently in discovery. At the present stage, it is not possible to evaluate the likelihood of an unfavorable outcome or the amount or a range of potential loss, if any, which may be experienced by the Company. The health care industry is subject to numerous laws and regulations of federal, state, and local governments. Compliance with these laws and regulations, specifically those relating to the Medicare and Medicaid programs, can be subject to government review and interpretations, as well as regulatory actions unknown and unasserted at this time. Recently, federal government activity has increased with respect to investigations and allegations concerning possible violations by health care providers of regulations, which could result in the imposition of significant fines and penalties, as well as significant repayments of previously billed and collected revenues from patient services. Management believes that the Company is in substantial compliance with current laws and regulations. As of December 31, 2001, in addition to the matters disclosed above, the Company is involved in various other legal proceedings that arose in the ordinary course of business. The costs associated with defending the above allegations and the potential outcome cannot be determined at this time and accordingly, no estimate for such costs have been included in the accompanying financial statements. In management's opinion, the ultimate resolution of the above legal proceedings will not have a material effect on the Company's financial position, results of operations or cash flows. 6. LINE OF CREDIT The Company has a $4 million revolving line of credit with a lending institution. The Company may borrow up to 75% of eligible account receivable, as defined in the agreement. The interest rate is at prime rate. Interest accruing on any outstanding balance and a monthly administration fee is due in arrears on the first day of each month. The line of credit expires February 28, 2003. There are certain financial covenants and reporting requirements associated with the loan. Included in the financial covenants are (1) tangible net worth of not less than $30 million, (2) a quick ratio of not less than 2.0 to 1.0, (3) a debt to tangible net worth ratio of not less than 0.50 to 1.0, and (4) capital expenditures will not exceed more than $7.0 million during any fiscal year. As of March 31, 2002, the Company has not utilized this line of credit. 10 7. SERIES B CONVERTIBLE PREFERRED STOCK As of March 31, 2002, 14,400 shares of Series B Convertible Preferred Stock had been converted into 5,746,584 Shares of common stock. Subsequent to March 31, 2002, an additional 300 shares of Series B Convertible Preferred Stock was converted to an additional 98,838 Shares of Common Stock. 11 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. The following is management's discussion of significant factors that affected the Company's interim financial condition and results of operations. This should be read in conjunction with Management's Discussion and Analysis of Financial Condition and Results of Operations included in the Company's Annual Report on Form 10-K for the year ending December 31, 2001. OVERVIEW OrthoLogic Corp. ("OrthoLogic" or the "Company") develops, manufactures and markets proprietary, technologically advanced orthopedic products designed to promote the healing of musculoskeletal tissue, with particular emphasis on fracture healing and spinal repair. OrthoLogic's products are designed to enhance the healing of diseased, damaged, degenerated or recently repaired musculoskeletal tissue. The Company's products focus on improving the clinical outcomes and cost-effectiveness of orthopedic procedures that are characterized by compromised healing, high-cost, potential for complication and long recuperation time. In July 2001, the Company sold its Continuous Passive Motion ("CPM") business. The Company's decision to divest the CPM business was based on its desire to refocus all of its activities in the fracture healing and spinal repair segments of the orthopedic market. The CPM business, which is focused in the rehabilitation segment of the orthopedic market, no longer fit in the Company's long-term strategic plans. OrthoRehab., Inc. purchased the CPM business for $12.0 million in cash, the assumption of approximately $2.0 million in liabilities and a potential additional payment to OrthoLogic of up to $2.5 million in cash, conditioned on OrthoRehab's ability to collect on certain accounts receivable in the year following the sale. OrthoLogic is currently in litigation with OrthoRehab, Inc. regarding this $2.5 million contingent payment. The litigation is described in greater detail in Note 5. Use of estimates. - The preparation of the financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from these estimates. Significant estimates include the allowance for doubtful accounts and sales discounts and adjustments of approximately $3.3 million and $12.7 million at March 31, 2002 and 2001, respectively, which are based primarily on trends in historical collection statistics, consideration of current events, payor mix and other considerations. The Company derives a significant amount of its revenues from third-party payors, including Medicare and certain commercial insurance carriers, health maintenance organizations, and preferred provider organizations. Amounts paid under these plans are generally based on fixed or allowable reimbursement rates. Revenues are recorded at the expected or pre-authorized reimbursement rates when earned and include unbilled receivables of $2.3 million and $7.8 million on March 31, 2002 and 2001, respectively. Some billings are subject to review by such third party payors and may be subject to adjustments. In the opinion of management, adequate allowances have been provided for doubtful accounts and contractual adjustments. However, these estimates are always subject to adjustment, which could be material. Any 12 differences between estimated reimbursement and final determinations are reflected in the period finalized. In January 2001, the Company announced plans to divest its CPM business to refocus the Company on its core business of fracture healing and spinal repair. As a result of the decision to divest of the CPM business, and as reflected in the 2000 statement of operations, the Company wrote off the remaining $23.3 million of goodwill related to the CPM business. The goodwill was assessed to be impaired in accordance with Statement of Financial Accounting Standards, No. 121, ACCOUNTING FOR THE IMPAIRMENT OF LONG-LIVED ASSETS AND FOR LONG-LIVED ASSETS TO BE DISPOSED. CRITICAL ACCOUNTING POLICIES AND ESTIMATES The Company's discussion and analysis of the financial conditions and results of operations are based upon the Unaudited Condensed Consolidated Financial Statements prepared in conformity with accounting principles generally accepted in the United States of America. The preparation of these statements necessarily requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reported period. These estimates and assumptions form the basis for the carrying values of assets and liabilities. On an on-going basis, the Company evaluates these estimates, including those related to allowance for doubtful accounts, sales adjustments and discounts, inventories, investments, restructuring, income taxes, contingencies, and litigation. Management bases its estimates on historical experience and various other assumptions and believes its estimates are reasonable under the circumstances, the results of which form the basis for making judgments. Actual results may differ from these estimates. The Company recognizes revenue when the product is placed on the patient, or if the sale is to a commercial buyer, at the time of shipment. Estimated reductions to revenues are in the form of sales discounts and adjustments from certain commercial carriers, health maintenance organizations and preferred provider organizations. Changes to estimated revenues are recognized in the period in which the facts that give rise to the changes become known. Allowances for doubtful accounts are maintained for estimated losses resulting from the inability of its customers and third-party payors inability to make the required payments. If the financial condition of the third-party payors were to deteriorate, resulting in an ability to make payments, additional allowances might be necessary. The Company writes-down its inventory for inventory shrinkage and obsolescence equal to the difference between the cost of the inventory and the estimated market value based upon assumptions about future demand and market conditions. If conditions used in determining these valuations changed, future additional inventory write-downs would be necessary. The Company considers future taxable income and tax planning strategies in determining the need for valuation allowances. In the event the Company determines it is unable to realize deferred tax assets in the future, an adjustment to the deferred tax asset and charge to income would be necessary in the period such a determination is made. The Company holds a minority interest in a company in the technological field in which the Company has a strategic focus. The Company is not publicly traded so it is difficult to determine the value of the investment. Should the 13 investment be determined to be permanently impaired, a charge to income would be recorded in the period such a determination is made. RESULTS OF OPERATIONS COMPARING THREE MONTH PERIOD ENDING MARCH 31, 2002 TO 2001 REVENUES: The Company's total revenues decreased 55.8% from $21.7 million in 2001 to $9.6 million in the first quarter of 2002. Revenues for the first quarter of 2001 included sales of $14.1 million from the divested CPM business. Sales recorded for our bone growth stimulation products, the OL1000 and SpinaLogic, increased by 25.9% from the first quarter of 2001 to 2002. The significant increase in bone growth stimulation sales is related to the growth in market share for both the OL1000 and SpinaLogic. Hyalgan royalty revenue was $904,000 in the three month period ended March 31, 2002 compared to Hyalgan fees and sales of $716,000 in 2001. The royalty agreement for Hyalgan will terminate at the end of fiscal year 2002. We anticipate receiving additional royalties of $1.3 million during the remainder of the year. GROSS PROFIT: Gross profit decreased from $16.9 million in 2001 to $8.3 million in 2002. Gross profit, as a percent of revenue, was 86.3% for the quarter ending March 31, 2002. Gross profit for the same period in 2001 was 78.2%. The majority of the profit margin improvement is the result of the change in the product mix to higher margins since the divestiture of the lower margin CPM business products. SELLING, GENERAL AND ADMINISTRATIVE ("SG&A") EXPENSES: SG&A expenses decreased 58.4% from $16.1 million in the three month period ended March 31, 2001 to $6.7 million in the same period in 2002. The decrease is mainly attributable to the sale of the CPM business and the variable expenses related to that business. SG&A expenses, as a percentage of total revenues, were 69.8% in the three month period ended March 31, 2002 and 74.3% in the same period in 2001. RESEARCH AND DEVELOPMENT EXPENSES: Research and development expenses were $920,000 in the three month period ended March 31, 2002, compared to $704,000 for the same period in 2001. This increase is due to $500,000 milestone payment in March 2002 to Chrysalis BioTechnology, Inc. for initiating the Investigative New Drug ("IND") application for a combined Phase I/II human clinical trial of Chrysalin for spinal fusion. Research and development expenses in the first quarter of 2001 reflect the clinical costs of the Phase I/II human clinical trials for fracture repair. CPM DIVESTITURE AND CHANGE IN ESTIMATED COLLECTABILITY OF CPM RECEIVABLES: In the second quarter of 2001, the Company recorded a $6.9 million charge to write down the CPM assets to their fair value, plus the direct costs of selling the assets. The Company retained all the billed accounts receivable related to the CPM business, with a net carrying value of approximately $10.8 million (net of a $5.2 million allowance for doubtful accounts.) The collection staff and supervisor previously responsible for the collection of these receivables were part of the employee team hired by the purchaser of the CPM business. Company management believed that there would be some negative affects on collections, so an additional charge of $2.8 million was recognized in the second quarter of 2001. During the first quarter of 2002, the Company changed its estimate of the 14 collectability of the CPM Accounts Receivable and now anticipates that it will collect $600,000 more in CPM accounts receivable than was estimated at the time of the divestiture. A summary of the severance and other reserve balances at March 31, 2001 are as follows:
Total Charges Amount Charged Cash Reserves June 30, 2001 Against Assets Paid March 31, 2001 ------------- -------------- ------- -------------- Severance and stay-on bonus $ 3,300 $ -- $(2,668) $ 632 Other exit costs 1,387 (245) (1,066) 76 ------- ------- ------- ------- Total non-recurring charges $ 4,687 $ (245) $(3,734) $ 708
OTHER INCOME. Other income in the three month periods ending 2002 and 2001 consisted primarily of interest income and increased from $129,000 in the period ended March 31, 2000 to $187,000 for the same period in 2002. The increase is a result of interest earned on the Company's higher cash balances. NET PROFIT: The Company had a net profit in the period ending March 31, 2002 of $1.4 million compared to a net profit of $204,000 in the same period in 2001. LIQUIDITY AND CAPITAL RESOURCES On March 31, 2002 the Company had cash and equivalents of $15.2 million compared to $19.5 million as of December 31, 2001. The Company had $16.2 million of short-term investments as of March 31, 2002 compared to $11.0 million at December 31, 2001. The total of both cash and cash equivalents and short term investments increased to $31.3 million at March 31, 2002 compared to $30.5 million as of December 31, 2001. In addition, the Company has an available $4.0 million accounts receivable revolving line of credit with a bank. The Company may borrow up to 75% of the eligible accounts receivable, as defined in the agreement. The interest rate is at the prime rate. Interest accruing on the outstanding balance and a monthly administration fee is due in arrears on the first day of each month. The line of credit expires February 28, 2003. There are certain financial covenants and reporting requirements associated with the loan. Included in the financial covenants are (1) tangible net worth of not less than $30 million, (2) a quick ratio of not less than 2.0 to 1.0, (3) a debt to tangible net worth ratio of not less than 0.50 to 1.0, and (4) capital expenditures will not exceed more than $7.0 million dollars during any fiscal year. The Company has not utilized this line of credit. As of March 31, 2002, the Company was in compliance with all the financial covenants. Net cash provided by operations during the three month period ended March 31, 2002 was $871,000 compared to $2.1 million in 2001. This decrease was primarily attributed to (1) a smaller decrease in accounts receivable by $1.9 million (comparing the period ended March 31, 2002 to the same period in 2001) and an increase in inventory of $328,000 (in the period ended March 31, 2002) partially offset by (2) an increase in net income of $1.2 million in the period ended March 31, 2002 as compared to the same period in 2001. 15 The Company does not expect significant capital investments in 2002 and anticipates that its cash and short term investments on hand, cash from operations and the funds available from its $4.0 million line of credit will be sufficient to meet the Company's presently projected cash and working capital requirements for the next 12 months. The timing and amounts of cash used will depend on many factors, including the Company's ability to continue to increase revenues, reduce and control its expenditures, continue profitability and collect amounts due from third party payors. Additional funds may be required if the Company is not successful in any of these areas. The Company's ability to continue funding its planned operations beyond the next 12 months is dependent upon its ability to generate sufficient cash flow to meet its obligations on a timely basis, or to obtain additional funds through equity or debt financing, or from other sources of financing, as may be required. In August 2001, the Company announced that it authorized a repurchase of up to 1 million shares of the Company's outstanding shares over the next 12 months. The repurchased shares will be held as treasury shares and used in part to reduce the dilution from the Company stock option plans. As of March 31, 2002, the Company had repurchased 41,800 shares at a cost, net of fees, for $137,300 or an average price of $3.28 per share. The following table sets forth all known commitments as of March 31, 2002 and the year in which these commitments become due, or are expected to be settled (in thousands): ACCOUNTS PAYABLE YEAR OPERATING LEASES AND ACCRUED LIABILITIES TOTAL ---- ---------------- ----------------------- ----- 2002 $ 809 $ 5,970 $ 6,779 2003 $ 1,078 -- $ 1,078 2004 $ 1,078 -- $ 1,078 2005 $ 1,078 -- $ 1,078 2006 $ 1,078 -- $ 1,078 Thereafter $ 989 -- $ 989 ------- ------- ------- Total $ 6,110 $ 5,970 $12,080 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK The Company has no debt and no derivative instruments at March 31, 2002. The Company's Canadian operations were sold as part of the CPM sale, and the Company has no exposure to foreign exchange rates at March 31, 2002. SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS The Company may from time to time make written or oral forward-looking statements, including statements contained in the Company's filings with the Securities and Exchange Commission and its reports to stockholders. This Report contains forward-looking statements made pursuant to the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995. In connection with these "safe harbor" provisions, the Company identifies important 16 factors that could cause actual results to differ materially from those contained in any forward-looking statements made by or on behalf of the Company. Any such forward-looking statement is qualified by reference to the following cautionary statements. DIVESTITURE OF THE CPM DIVISION. In 2000 the Company announced its decision to refocus its core business in the fracture healing and spinal repair segment of the orthopedic market. The CPM business, which was focused in the rehabilitation segment of the orthopedic market, no longer fit in the Company's long-term strategic plans. The sale was finalized in July 2001. Future market price of the Common Stock of the Company could be greatly influenced by the success of the transition back to the core bone stimulation business. LIMITED HISTORY OF PROFITABILITY; QUARTERLY FLUCTUATIONS IN OPERATING RESULTS. The Company was founded in 1987 and only began generating revenues from the sale of its primary product in 1994. The Company has experienced significant operating losses since its inception and had an accumulated deficit of approximately $96 million at December 31, 2001. There can be no assurance that the Company will ever generate sufficient revenues to attain operating profitability or retain net profitability on an on-going annual basis. In addition, the Company may experience fluctuations in revenues and operating results based on such factors as demand for the Company's products, the timing, cost and acceptance of product introductions and enhancements made by the Company or others, levels of third party payment, alternative treatments that currently exist or may be introduced in the future, completion of acquisitions and divestitures, changes in practice patterns, competitive conditions, regulatory announcements and changes affecting the Company's products in the industry and general economic conditions. The development and commercialization by the Company of additional products will require substantial product development and regulatory, clinical and other expenditures. DEPENDENCE ON METHODS TO DISTRIBUTE PRODUCT. Substantial portions of the Company's sales are generated through the Company's internal sales force of approximately 38 employees for the OL1000. To enhance market penetration of SPINALOGIC, the Company distributes this product through an exclusive sales distribution agreement with DePuy AcroMed. If DePuy Acromed does not generate sales sufficient to meet the agreed upon annual minimum sales, and if the Company becomes dissatisfied with the SpinaLogic distribution, the Company may terminate the distribution agreement and train its internal sales staff to include SpinaLogic sales. The delay associated with such an event may have an adverse effect on the Company's sales of SpinaLogic, its newest product on the market. POTENTIAL ADVERSE OUTCOME OF LITIGATION. In October 2000, the Company announced that it had entered into a Memorandum of Understanding regarding settlement of several law suits filed in 1996. See "ITEM 3 - LEGAL PROCEEDING'S." The settlement is still subject to review by the members of the class and the judge who will conduct a fairness hearing before the settlement is accepted. Objections by either party could result in a nullification of the current Memorandum of Understanding, which could result in new settlement terms that are not as favorable to the Company. DEPENDENCE ON KEY PERSONNEL. The success of the Company is dependent in large part on the ability of the Company to attract and retain its key management, operating, technical, marketing and sales personnel as well as clinical investigators who are not employees of the Company. Such individuals are in high demand, and the identification, attraction and retention of such personnel could be lengthy, difficult and costly. The Company competes for its employees and clinical investigators with other companies in the orthopedic industry and research and academic institutions. There can be no assurance that the Company 17 will be able to attract and retain the qualified personnel necessary for the expansion of its business. A loss of the services of one or more members of the senior management group, or the Company's inability to hire additional personnel as necessary, could have an adverse effect on the Company's business, financial condition and results of operations. HISTORICAL DEPENDENCE ON PRIMARY PRODUCT: FUTURE PRODUCTS. The Company believes that, to sustain long-term growth, it must continue to develop and introduce additional products and expand approved indications for its remaining products. The development and commercialization by the Company of additional products will require substantial product development, regulatory, clinical and other expenditures. There can be no assurance that the Company's technologies will allow it to develop new products or expand indications for existing products in the future or that the Company will be able to manufacture or market such products successfully. Any failure by the Company to develop new products or expand indications could have a material adverse effect on the Company's business, financial condition and results of operations. UNCERTAINTY OF MARKET ACCEPTANCE. The Company believes that the demand for bone growth stimulators is still developing and the Company's success will depend in part upon the growth of this demand. There can be no assurance that this demand will develop. The long-term commercial success of the OL1000 and SpinaLogic and the Company's other products will also depend in significant part upon its widespread acceptance by a significant portion of the medical community as a safe, efficacious and cost-effective alternative to invasive procedures. The Company is unable to predict how quickly, if at all, members of the orthopedic medical community may accept its products. The widespread acceptance of the Company's primary products represents a significant change in practice patterns for the orthopedic medical community and in reimbursement policy for third party payors. Historically, some orthopedic medical professionals have indicated hesitancy in prescribing bone growth stimulator products such as those manufactured by the Company. As the newest product to the market, SpinaLogic's sales and acceptance by the medical community is not certain. Failure of the Company's products to achieve widespread market acceptance by the orthopedic medical community and third party payors would have a material adverse effect on the Company's business, financial condition and results of operations. MANAGEMENT OF GROWTH. The Company's future performance will depend in part on its ability to manage change in its operations and changes in the healthcare industry. In addition, the Company's ability to manage its growth effectively will require it to continue to improve its manufacturing, operational and financial control systems and infrastructure, and management information systems, and to attract, train, motivate, manage and retain key employees. If the Company's management were to become unable to manage growth effectively, the Company's business, financial condition, and results of operations could be adversely affected. LIMITATIONS ON THIRD PARTY PAYMENT; UNCERTAIN EFFECTS OF MANAGED CARE. The Company's ability to commercialize its products successfully in the United States and in other countries will depend in part on the extent to which acceptance of payment for such products and related treatment will continue to be available from government health administration authorities, private health insurers and other payors. Cost control measures adopted by third party payors in recent years have had and may continue to have a significant effect on the purchasing and practice patterns of many health care providers, generally causing them to be more selective in the purchase of medical products. In addition, payors are increasingly challenging the prices and clinical efficacy of medical products and services. Payors may deny reimbursement if they 18 determine that the product used in a procedure was experimental, was used for a non-approved indication or was unnecessary, inappropriate, not cost-effective, unsafe, or ineffective. The Company's products are reimbursed by most payors, however there are generally specific product usage requirements or documentation requirements in order for the Company to receive reimbursement. In certain circumstances, the Company is successful in appealing reimbursement coverage for those applications, which do not comply with the payor requirements. Significant uncertainty exists as to the reimbursement status of newly approved health care products, and there can be no assurance that adequate third party coverage will continue to be available to the Company at current levels. UNCERTAINTY AND POTENTIAL NEGATIVE EFFECTS OF HEALTHCARE REFORM. The health care industry is undergoing fundamental changes resulting from political, economic and regulatory influences. In the United States, comprehensive programs have been proposed that seek to (i) increase access to health care for the uninsured, (ii) control the escalation of health care expenditures within the economy and (iii) use health care reimbursement policies to help control federal expenditures. The Company anticipates that Congress and state legislatures will continue to review and assess alternative health care delivery systems and methods of payment, and public debate of these issues will likely continue. Due to uncertainties regarding the outcome of reform initiatives and their enactment and implementation, the Company cannot predict which, if any, of such reform proposals will be adopted and when they might be adopted. Other countries also are considering health care reform. The Company's plans for increased international sales are largely dependent upon other countries' adoption of managed care systems and their acceptance of the potential benefits of the Company's products and the belief that managed care plans will have a positive effect on sales. For the reasons identified in this and in the preceding paragraph, however, those assumptions may be incorrect. Significant changes in health care systems are likely to have a substantial impact over time on the manner in which the Company conducts its business and could have a material adverse effect on the Company's business, financial condition and results of operations and ability to market its products as currently contemplated. INTENSE COMPETITION. The orthopedic industry is characterized by intense competition. Currently, there are three major competitors other than the Company selling bone growth stimulation products approved by the FDA for the treatment of nonunion fractures, and two competitors selling bone growth stimulation products for use with spinal fusion patients. The Company estimates that one of its competitors has a dominant share of the market for bone growth stimulation products for non-healing fractures in the United States, and another has a dominant share of the market for use of their device as an adjunct to spinal fusion surgery. In addition, several large, well-established companies sell fracture fixation devices similar in function to those sold by the Company. Many participants in the medical technology industry, including the Company's competitors, have substantially greater capital resources, research and development staffs and facilities than the Company. Such participants have developed or are developing products that may be competitive with the products that have been or are being developed or researched by the Company. Other companies are developing a variety of other products and technologies to be used in the treatment of fractures and spinal fusion's, including growth factors, bone graft substitutes combined with growth factors, and nonthermal ultrasound. Many of the Company's competitors have substantially greater experience than the Company in conducting research and development, obtaining regulatory approvals, manufacturing, and marketing and selling medical devices. Any failure by the Company to develop products that compete favorably in the marketplace would have a material adverse effect on the Company's business, financial condition and results of operations. 19 RAPID TECHNOLOGICAL CHANGE. The medical device industry is characterized by rapid and significant technological change. There can be no assurance that the Company's competitors will not succeed in developing or marketing products or technologies that are more effective or less costly, or both, and which render the Company's products obsolete or non-competitive. In addition, new technologies, procedures and medications could be developed that replace or reduce the value of the Company's products. The Company's success will depend in part on its ability to respond quickly to medical and technological changes through the development and introduction of new products. There can be no assurance that the Company's new product development efforts will result in any commercially successful products. A failure to develop new products could have a material adverse effect on the Company's business, financial condition, and results of operations. GOVERNMENT REGULATION. The Company's current and future products and manufacturing activities are and will be regulated under the FDC Act. The Company's current BioLogic technology-based products are classified as Class III Significant Risk Devices, which are subject to the most stringent level of FDA review for medical devices and are required to be tested under IDE clinical trials and approved for marketing under a PMA. The Company's fracture fixation devices are Class II devices that are marketed pursuant to 510(k) clearance from the FDA. Chrysalin, as a new drug, is subject to clinical trial and Good Manufacturing Practices review similar to those that apply to the BioLogic technology-based products. The FDA and comparable agencies in many foreign countries and in state and local governments impose substantial limitations on the introduction of medical devices through costly and time-consuming laboratory and clinical testing and other procedures. The process of obtaining FDA and other required regulatory approvals is lengthy, expensive and uncertain. Moreover, regulatory approvals, if granted, typically include significant limitations on the indicated uses for which a product may be marketed. In addition, approved products may be subject to additional testing and surveillance programs required by regulatory agencies, and product approvals could be withdrawn and labeling restrictions may be imposed for failure to comply with regulatory standards or upon the occurrence of unforeseen problems following initial marketing. The Company is also required to adhere to applicable requirements for FDA GMP, to engage in extensive record keeping and reporting and to make available its manufacturing facilities for periodic inspections by governmental agencies, including the FDA and comparable agencies in other countries. Failure to comply with these and other applicable regulatory requirements could result in, among other things, significant fines, suspension of approvals, seizures or recalls of products, or operating restrictions and criminal prosecutions. From time to time, the Company receives letters from the FDA regarding regulatory compliance. The Company has responded to all such letters and believes all outstanding issues raised in such letters have been resolved Changes in existing regulations or interpretations of existing regulations or adoption of new or additional restrictive regulations could prevent the Company from obtaining, or affect the timing of, future regulatory approvals. If the Company experiences a delay in receiving or fails to obtain any governmental approval for any of its current or future products or fails to comply with any regulatory requirements, the Company's business, financial condition and results of operations could be materially adversely affected. DEPENDENCE ON KEY SUPPLIERS. The Company purchases the microprocessor used in the OL1000 and SpinaLogic devices from a single manufacturer. Although there are feasible alternate microprocessors that might be used immediately, all are produced by one single supplier. In addition, there are single suppliers for other components used in the OL1000 and SpinaLogic devices and only two suppliers for the magnetic field sensor employed in them. Establishment of 20 additional or replacement suppliers for these components cannot be accomplished quickly. Therefore, the Company maintains sufficient inventories of such components in an attempt to ensure availability of finished products in the event of supply shortage or in the event that a redesign is required. The Company maintains a supply of certain OL1000 and SpinaLogic components to meet sales forecasts for 3 to 12 months. Chrysalin, which is currently only in the clinical trial phase, is produced by a third party sole supplier. Any delay or interruption in supply of components or products could significantly impair the Company's ability to deliver its products in sufficient quantities, and therefore, could have a material adverse effect on its business, financial condition and results of operations. DEPENDENCE ON PATENTS, LICENSES AND PROPRIETARY RIGHTS. The Company's success will depend in significant part on its ability to obtain and maintain patent protection for products and processes, to preserve its trade secrets and proprietary know-how and to operate without infringing the proprietary rights of third parties. While the Company holds title to numerous United States and foreign patents and patent applications, as well as licenses to numerous United States and foreign patents, no assurance can be given that any additional patents will be issued or that the scope of any patent protection will exclude competitors, or that any of the patents held by or licensed to the Company will be held valid if subsequently challenged. The validity and breadth of claims covered in medical technology patents involves complex legal and factual questions and therefore may be highly uncertain. In addition, although the Company holds or licenses patents of its technologies, others may hold or receive patents, which contain claims having a scope that covers products developed by the Company. There can be no assurance that licensing rights to the patents of others, if required for the Company's products, will be available at all or at a cost acceptable to the Company. The Company's licenses covering the BioLogic and OrthoFrame technologies provide for payment by the Company of royalties. Each license may be terminated if the Company breaches any material provision of such license. The termination of any license would have a material adverse effect on the Company's business, financial condition and results of operations. The Company also relies on un-patented trade secrets and know-how. The Company generally requires its employees, consultants, advisors and investigators to enter into confidentiality agreements which include, among other things, an agreement to assign to the Company all inventions that were developed by the employee while employed by the Company that are related to its business. There can be no assurance, however, that these agreements will protect the Company's proprietary information or that others will not gain access to, or independently develop similar trade secrets or know-how. There has been substantial litigation regarding patent and other intellectual property rights in the orthopedic industry. Litigation, which could result in substantial cost to and diversion of effort by the Company, may be necessary to enforce patents issued or licensed to the Company, to protect trade secrets or know-how owned by the Company, or to defend the Company against claimed infringement of the rights of others and to determine the scope and validity of the proprietary rights of others. There can be no assurance that the results of such litigation would be favorable to the Company. In addition, competitors may employ litigation to gain a competitive advantage. Adverse determinations in litigation could subject the Company to significant liabilities, and could require the Company to seek licenses from third parties or prevent the Company from manufacturing, selling or using its products, any of which determinations could have a material adverse effect on the Company's business, financial condition and results of operations. 21 RISK OF PRODUCT LIABILITY CLAIMS. The Company faces an inherent business risk of exposure to product liability claims in the event that the use of its technology or products is alleged to have resulted in adverse effects. To date, no product liability claims have been asserted against the Company for its bone growth stimulation products and only limited claims for its former CPM products. The Company maintains a product liability and general liability insurance policy with coverage of an annual aggregate maximum of $2.0 million per occurrence. The Company's product liability and general liability policy is provided on an occurrence basis. The policy is subject to annual renewal. In addition, the Company maintains an umbrella excess liability policy, which covers product and general liability with coverage of an additional annual aggregate maximum of $25.0 million. There can be no assurance that liability claims will not exceed the coverage limits of such policies or that such insurance will continue to be available on commercially reasonable terms or at all. If the Company does not or cannot maintain sufficient liability insurance, its ability to market its products may be significantly impaired. In addition, product liability claims could have a material adverse effect on the business, financial condition and results of operations of the Company. POSSIBLE VOLATILITY OF STOCK PRICE. Factors such as fluctuations in the Company's operating results, developments in litigation to which the Company is subject, announcements and timing of potential acquisitions, divestitures, conversion of preferred stock, announcements of technological innovations or new products by the Company or its competitors, FDA and international regulatory actions, actions with respect to reimbursement matters, developments with respect to patents or proprietary rights, public concern as to the safety of products developed by the Company or others, changes in health care policy in the United States and internationally, changes in stock market analyst recommendations regarding the Company, other medical device companies or the medical device industry generally and general market conditions may have a significant effect on the market price of the Common Stock. In addition, the stock market has from time to time experienced significant price and volume fluctuations that are unrelated to the operating performance of particular companies. These broad market fluctuations may adversely affect the market price of the Company's Common Stock. The Company cautions that the foregoing list of important factors is not exclusive. The Company does not undertake to update any forward-looking statement that may be made from time to time by or on behalf of the Company. 22 PART II - OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS See "Note 5 - Litigation" of the Notes to the Condensed Consolidated Financial Statements above. ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS None. ITEM 3. DEFAULTS UPON SENIOR SECURITIES None. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. ITEM 5. OTHER INFORMATION None. ITEM 6. EXHIBITS AND REPORTS (a) Exhibit Index None. (b) Reports on Form 8-K None. 23 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. ORTHOLOGIC CORP. ---------------- (Registrant)
Signature Title Date --------- ----- ---- /s/ Thomas R. Trotter President and Chief Executive Officer May 10, 2002 ------------------------ (Principal Executive Officer) Thomas R. Trotter /s/ Sherry A. Sturman Vice-President and Chief Financial Officer May 10, 2002 ------------------------ (Principal Financial and Accounting Officer) Sherry A. Sturman
24 OrthoLogic Corp. Exhibit Index to Quarterly Report on Form 10-Q For the Quarterly Period Ended March 31, 2002 Incorporated by Filed Exhibit No Description Reference to: Herewith ---------- ----------- ------------- -------- None