-----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, CeArLmSOWAmR0WVqVNFgmsuMKYr2FH2LleGQCtvXm8OZ/fKSfHrDD10Z8cYx5xim ms7IXSLznXwdes2VWTBoNQ== 0000950117-03-001440.txt : 20030415 0000950117-03-001440.hdr.sgml : 20030415 20030415114056 ACCESSION NUMBER: 0000950117-03-001440 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 20021231 FILED AS OF DATE: 20030415 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: 03649841 BUSINESS ADDRESS: STREET 1: 3960 BROADWAY STREET 2: BLDG 28 CITY: NEW YORK STATE: NY ZIP: 10032 BUSINESS PHONE: 7183264698 10-K 1 a34968.txt ORTEC INTERNATIONAL, INC. SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ---------- FORM 10-K (Mark One) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 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 0-27046 ORTEC INTERNATIONAL, INC. (Exact name of registrant as specified in its charter) 11-3068704 Delaware (I.R.S. Employer (State or other jurisdiction of Identification No.) incorporation or organization) 3960 Broadway New York, New York 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 Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K ('SS'229.405 of this chapter) is not contained herein, and will not 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. The number of shares outstanding of the Registrant's common stock is 26,547,768 (as of 4/7/03). The aggregate market value of the voting stock held by nonaffiliates of the Registrant was approximately $5,107,487 (as of 4/7/03, based upon a closing price of the Company's Common Stock on the Nasdaq Bulletin Board on such date of $0.20). DOCUMENTS INCORPORATED BY REFERENCE None. ORTEC INTERNATIONAL, INC. INDEX TO ANNUAL REPORT ON FORM 10-K FILED WITH THE SECURITIES AND EXCHANGE COMMISSION FOR THE FISCAL YEAR ENDED DECEMBER 31, 2002 ITEMS IN FORM 10-K
Page ---- Facing page Part I Item 1. Business.............................................................1 Item 2. Properties...........................................................6 Item 3. Legal Proceedings....................................................7 Item 4. Submission of Matters to a Vote of Security Holders................N/A Part II Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters...............................................8 Item 6. Selected Financial Data.............................................12 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations..............................14 Item 7A. Quantitative and Qualitative Disclosures About Market Risk.........N/A Item 8. Financial Statements and Supplementary Data.........................24 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure..........................N/A Part III Item 10. Directors and Executive Officers of the Registrant..................25 Item 11. Executive Compensation..............................................28 Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters...................31 Item 13. Certain Relationships and Related Transactions......................35 Item 14. Controls and Procedures.............................................36 Part IV Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K.....38 Signatures.......................................................................40
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. When OrCel is applied to the wound site, it produces a mix of growth factors that stimulates wound closure. In 2001 the FDA granted our application for the commercial sale of OrCel for the treatment of donor site wounds. In 2001 the FDA also granted our application for the commercial sale of OrCel for use on patients with recessive dystrophic epidermolysis bullosa undergoing hand reconstruction, as well as to treat the donor site wounds created during the surgery. From December 2001 through December 2002, our gross revenues from the sale of OrCel were $265,665. We discontinued our sales efforts and the manufacture of OrCel for commercial sale because of our need to use our limited financial resources for the completion of our clinical trial for the use of OrCel in the treatment of venous stasis ulcers, which is a much larger potential market. We are currently conducting a pivotal clinical trial for the use of OrCel in its cryopreserved form for the treatment of venous stasis ulcers. The study is being conducted at 13 clinical sites, and as of March 14, 2003, over 80 patients were enrolled to participate in the trial. We are targeting an enrollment of 102 patients in the trial after which the trial can be considered completed upon our demonstrating that there is a significant positive statistical difference in the treatment of enrolled patients with OrCel as compared with the treatment of other enrolled patients, in a control group, with standard of care. We can then file a pre-market application with the FDA for the FDA's approval of the commercial sale of OrCel for the treatment of venous stasis ulcers. The results of the trial so far are encouraging. 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 only a few days when our product is not cryopreserved. Due to budgetary constraints we are encountering in this difficult investment climate, we have deferred conducting a pivotal clinical trial for the use of OrCel in the treatment of diabetic foot ulcers (although the FDA granted its approval for us to conduct that pivotal trial) until after we have completed our pivotal clinical trial, now in progress, for the use of OrCel in the treatment of venous stasis ulcers. We completed a pilot clinical trial for the use of OrCel in the treatment of diabetic foot ulcers in the latter part of 2001. We reported the favorable results of that pilot clinical trial in our annual report on Form 10-K for the fiscal year ended December 31, 2001. 1 People with diabetic foot ulcers also constitute a large patient population and therefore also a large potential market for OrCel. In December 2001 OrCel was approved by the Centers for Medicare Services for inclusion on the Outpatient Prospective Payment Systems Pass Through List. The inclusion on this list allows prescribers to recover their cost for OrCel from Medicare when utilizing OrCel for treatment of a Medicare patient as a hospital outpatient. Our target patient population for the use of OrCel are persons with venous stasis and diabetic foot ulcers and donor site wounds which we believe are large potential markets for the use of OrCel. We also believe that OrCel can be used to treat other medical conditions, such as decubitis ulcers, and for cosmetic surgery. Our cash on hand at the end of March 2003 will enable us to continue our operations through May, 2003, assuming that we will not incur unexpected costs and that we are able to manage payments, over a period of time, of obligations we have accumulated. Before the end of May, 2003, we will be required to raise additional funds (through the sale of our securities or debt financing) to complete our clinical trials, to produce and market OrCel and to pay our accumulated debt. Our failure to receive additional financing will have a material adverse effect on our operations. 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, successfully market OrCel and can rely on a third party contract manufacturer to produce OrCel in the quantity we need at the cost we now estimate, we believe that we will have the opportunity to reach cash break even in 2005. 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. Our website address is www.ortecinternational.com. The Product OrCel cells are derived from infant foreskins obtained during routine circumcisions. The immature, neonatal cells are highly reproductive and provide enhanced proliferation and 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. 2 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. 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 insurance companies to reimburse their insured patients for the cost of the use of new medical products used in medical treatments. We have already secured approval for Medicare payments for the use of OrCel. Production and Supply We believe that the production capacity at our facility in the Audubon Biomedical Science and Technology Park in New York City is sufficient to supply the amount of OrCel we need for our clinical trials and for limited amounts of commercial sales. If we achieve a significant volume of sales we will need production facilities capable of producing much larger quantities of OrCel. We initially planned to construct our own manufacturing facilities for the production of OrCel for commercial sales. However, due to the difficulty in securing investment capital in this difficult investment climate, and the large amount we would have to invest to construct our own production facilities, our current plans call for the manufacture of OrCel in large quantities by a third party contract manufacturer experienced in production of cell based medical products, whose production facilities are in compliance with the good manufacturing processes and quality system regulations mandated by the FDA. We are now negotiating with such third party contract manufacturers to produce OrCel. Based on our discussions we believe that the production of OrCel by such a third party manufacturer will allow us to produce OrCel at a lower cost, particularly considering the significant investment we would otherwise have to make in creating our own manufacturing facility. Our production facility in the Audubon Biomedical Science and Technology Park was inspected and approved by the FDA in September 2000 for the manufacture of OrCel. We anticipate that even when we use third party production 3 facilities we may still be required to make a financial contribution, over a period of time, to modify those production facilities for our use and, if we are successful in our marketing efforts, to expand those third party manufacturing facilities. 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. 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, which we use. 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. We previously considered Organogenesis, Inc. and Advanced Tissue Sciences, Inc. to be our principal competitors because each of them was previously manufacturing and selling a tissue engineered product approved by the FDA for the treatment, in the case of Organogensis' Apligraf, of both venous stasis and diabetic foot ulcers, and in the case of Advanced Tissue Sciences' Dermagraft for the treatment of diabetic foot ulcers. Advanced Tissue Sciences' Dermagraft was manufactured in a cryopreserved form while Organogenesis' Apligraf was not. However, in 2002 both Organogenesis and Advanced Tissue Sciences filed for bankruptcy protection. Advanced Tissue Sciences had entered into a joint venture agreement with Smith & Nephew, a major pharmaceutical company, for the distribution of Dermagraft. According to publicly available information Smith & Nephew has purchased Advanced Tissue Sciences' half interest in their joint venture. We believe that Smith & Nephew will resume manufacturing and selling Dermagraft, if it has not already done so. Organogenesis had entered into an agreement with Novartis Pharmaceuticals, also a major pharmaceutical company, for Novartis to distribute Organogenesis' Apligraf. As a result of Organogenesis' bankruptcy that distribution agreement was modified to terminate on June 30, 2003. Organogensis announced that it planned to resume manufacturing and selling its Apligraf product and it may have already done so. Smith & Nephew, and any pharmaceutical company that may distribute Apligraf in the future, is substantially larger than we are and has significantly greater financial, marketing and other resources than we have. Such greater financial and other resources will put us at a disadvantage in marketing OrCel despite what we believe are certain advantages OrCel has (such as ease of application and greater mix of growth factors which appear to enable a quicker healing process, and in the case of Organogenesis' Apligraf, the fact that OrCel can be sold in a cryopreserved form and Apligraf cannot). We can give no assurance that we will be able to enter into joint venture or distribution agreements with pharmaceutical or health product distribution companies that are strong financially and in their marketing capabilities, on terms, if at all, that will make our operations profitable. 4 The biomedical field is continually undergoing rapid and significant technological changes. Other companies may succeed in developing other products that are more effective than OrCel. If such new products are accepted by the medical community, or if those products receive FDA approval for treatment of venous stasis and diabetic foot ulcers before OrCel does, or if other companies develop products that are more effective than OrCel, any such developments may have a material adverse effect on our business, results of operations and financial condition. Patents and Proprietary Rights We have four United States patents, one European patent covering thirteen countries and ten international patents in ten other countries, and two United States and four international patent applications (three of which are applications filed under the Patent Cooperation Treaty) pending, for our technology and processes. However, our success will depend, in part, on our ability to maintain trade secret protection for our technology. Our European patent was granted to us by the European Patent Office and was challenged by Advanced Tissue Sciences in an opposition proceeding. We successfully defeated that opposition. Advanced Tissue Sciences has appealed that determination in our favor and the appeal is currently pending. The validity and breadth of claims in medical technology patents involves complex legal and factual questions and, therefore, are highly uncertain. We do not know if any pending patent applications or any future patent application will issue as patents, that the scope of any patent protection obtained will be enough to exclude competitors or that any of our patents will be held valid if subsequently challenged in court proceedings. We do not know if others have or will develop similar products, duplicate any of our products or design around any of our patents issued or that may be issued in the future. In addition, whether or not patents are issued to us, others may hold or receive patents which contain claims having a scope that covers aspects of our products or processes. Several of our competitors, including Organogenesis and Advanced Tissue Sciences, Inc., have been granted patents relating to their particular skin technologies. We successfully defended challenges to our United States and European patents in the respective patent offices where those patents were issued. However, those successful defenses do not preclude future challenges in court. The dismissal of the challenge to our patent in Europe has been appealed. We do not know if any of the other patents issued to us will be challenged, invalidated or circumvented. Patents and patent applications in the United States may be subject to interference proceeding brought by the U.S. Patent and Trademark Office, or to opposition proceedings initiated in a foreign patent office by third parties or to re-examination proceedings in the United States. We might incur significant costs defending such proceedings and we might not be successful. In August 2001 and in 2002 we entered into agreements with Paul Capital Royalty Acquisition Fund, L.P. pursuant to which we agreed to pay to Paul Capital 3 1/3% of the end user sales prices paid for our product in the United States, Canada and Mexico through the period ending in 2011. 5 As security for the performance of our obligations to Paul Capital, we granted Paul Capital a security interest in all of our U.S. patents, patent applications and trademarks. If there are defaults on our part in our performance of our agreements with Paul Capital, including defaults occasioned by events beyond our control (such as our insolvency), and we are unable to pay Paul Capital the large amounts required to be paid by us because of our default, Paul Capital may foreclose its security interest in our U.S. patents, patent applications and trademarks and it is most likely that in such event we will have to discontinue our operations. Employees We presently employ 35 people on a full-time basis, including three executive officers. We also have 5 part time employees. We anticipate hiring additional employees in the areas of quality assurance, manufacturing, marketing and research and development as our needs arise. Item 2. PROPERTIES We occupy an aggregate of approximately 14,000 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 March 1, 2003 we were paying rent of approximately $55,000 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 were to be located in two buildings. 26,000 square feet in an existing building were to be renovated to our specifications. The other 32,000 square feet was to be a building specifically constructed for us. We planned to equip that space primarily for the production and manufacturing of OrCel in large quantities for commercial sale. However, as we noted above, because our financial resources are significantly more limited than we anticipated when we signed the lease, we were able to terminate our obligation for the leasing of the 32,000 square feet building that was to be constructed and we have had discussions with the New Jersey Economic Development Agency to defer or terminate the remainder of our obligation to lease the other 26,000 square feet. We can give no assurance that we will be able to defer or terminate our obligation with respect to the 26,000 square feet portion of that lease or what damages, if any, incurred by the New Jersey Economic Development Agency because of our failure to perform our obligations relating to the 26,000 square feet portion of that lease, we will have to pay. Before we changed our plans and decided not to build production facilities in North Brunswick, we also leased from the same landlord approximately 3,200 square feet in another building in North Brunswick, 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 lease. 6 That lease expires June 30, 2003. We are currently using that space for process development operations and offices. Item 3. LEGAL PROCEEDINGS ClinTrials Networks, LLC (ClinTrials) has claimed that we have breached an agreement with them, which provided for ClinTrials to arrange and manage a portion of the FDA mandated clinical trials for use of our OrCel product for the treatment of venous stasis ulcers, and for other services. During the quarter ended September 30, 2002, ClinTrials commenced an arbitration proceeding against us, claiming that we owe ClinTrials $165,936 and that ClinTrials reserves the right to claim additional amounts from us, based on continuing additional monthly fees ClinTrials claims that it is entitled to receive under its agreement with us. We have denied ClinTrials' claim and have advised ClinTrials that we are not in breach of our agreement. We have filed a counterclaim in the arbitration proceeding for overpayments of $75,000 under the terms of our agreement with ClinTrials. During the quarter ended September 30, 2002, PDI, Inc. commenced an action against us in the Superior Court of New Jersey, Bergen County, claiming that we owe $205,000 to PDI for services that they have performed for us. We are in the process of discussing a settlement of the amount claimed with PDI. In December 2002 Amarex LLC commenced an action against us in the Circuit Court for Montgomery County, Maryland. Amarex provided statistical programming and data management services for us for the data generated in our clinical trials. Although in its complaint Amarex claims we owe it $2,457,875, that amount is the additional amount we would have had to pay Amarex if Amarex had performed all the work needed for all our contemplated clinical trials. We have answered Amarex's complaint denying Amarex's claim. We are negotiating with Amarex to establish the amount of services Amarex performed for us for which it has not already been paid and to arrange for payment of that amount. We have entered into agreements with some of our creditors providing for payment of our obligations to them over extended periods of time. We will have to secure additional financing to meet those payment obligations. 7 PART II Item 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS Market Information Our common stock commenced trading on January 19, 1996 under the symbol "ORTC." The common stock traded on the Nasdaq SmallCap market until August 2002, when it became delisted from the SmallCap market and commenced trading on the National Association of Securities Dealers' Bulletin Board, where it presently trades under the symbol "ORTC.OB." The following table sets forth the high and low sales prices of the common stock as reported by Nasdaq and the Bulletin Board for each full quarterly period within the two most recent fiscal years.
HIGH LOW ----- ----- Fiscal Year Ended December 31, 2001 First Quarter $8.75 $5.81 Second Quarter 6.98 5.75 Third Quarter 7.75 6.00 Fourth Quarter 6.94 4.45 Fiscal Year Ended December 31, 2002 First Quarter $6.99 $4.96 Second Quarter 5.05 1.50 Third Quarter 2.00 0.30 Fourth Quarter 0.54 0.27
8 Security Holders To the best of our knowledge, at March 7, 2003, there were 139 record holders of our common stock. We believe there are more than 1,000 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. Recent Sales of Unregistered Securities In our quarterly report on Form 10-Q for the three month period ended September 30, 2002, in a registration statement we filed with the Securities and Exchange Commission which became effective January 31, 2003, and in our proxy statement for our stockholders meeting held on February 11, 2003, we described a series of private placements arranged by H.C. Wainwright & Co., Inc. in which we received gross proceeds of $8.2 million. At the conclusion of those series of financings we issued, in November and December of 2002, to the investors in those private placements, 938.2742 shares of our Series B convertible preferred stock, 13,135,858 shares of our common stock (including 3,753,116 shares which were dividends payable on our Series B convertible preferred stock, which dividends we can pay in our common stock and which dividends for the first year were paid in advance), and warrants to purchase an additional 10,076,579 shares of our common stock, of which warrants to purchase 5,429,891 shares are exercisable at $1.50 per share, and warrants to purchase 4,691,386 shares are exercisable at $2.00 per share. In November 2002, in addition to cash compensation we also granted to H.C. Wainwright & Co., Inc. for its services in arranging such Series B financing, and to Wainwright's designees, warrants to purchase 1,300,000 shares of our common stock, of which warrants to purchase 800,000 shares were exercisable at $0.001 per share, and of which warrants to purchase 500,000 shares are exercisable at $1.50 per share. The warrants to purchase 800,000 shares at an exercise price of $0.001 per share were exercised in December 2002 and January 2003 and as a result we issued an additional 797,227 shares of our common stock to the holders of those warrants. The 797,227 shares were 2,773 shares less than the 800,000 shares issuable upon exercise of those warrants because of cashless exercise provisions in those warrants which were utilized by all except one of the holders. In February 2003 we received additional gross proceeds of $2 million from five of the investors who had purchased our Series B convertible preferred stock in November and December 2002, and from one new investor. We issued to such six investors 200 shares of our Series B convertible preferred stock, 2,923,077 shares of our common stock (including 923,077 shares of our common stock constituting the first year's dividends on such 200 shares of Series B convertible preferred stock, which dividends were paid in advance) and warrants to purchase an additional 2,000,000 shares of our common stock, of which warrants to purchase 1,000,000 shares are exercisable at $1.50 per share and warrants to purchase the other 1,000,000 shares are exercisable at $2.00 per share. In March 2003, in addition to cash compensation, we also granted to Wainwright for its services in arranging such February 2003 Series B financing, and to one designee of Wainwright's, warrants to purchase an aggregate of 376,923 shares of our common stock, exercisable at $0.001 per share. 9 Each share of the Series B preferred stock is convertible into so many shares of our common stock as determined by dividing the $10,000 liquidation preference amount of one Series B preferred share by the conversion price. There is a fixed conversion price and an alternative conversion price. The fixed conversion price is $1.00 per share. After February 1, 2003, the holders of the Series B preferred stock may elect an alternative conversion price, equal to 90% of the average of the five lowest volume weighted average prices for our common stock during the twenty trading days immediately prior to conversion. At no time will the alternative conversion price be less than $0.25 per share. The certificate of designations of the relative rights and preferences of the Series B convertible preferred stock provides for customary adjustments to the conversion price in the event of stock splits, combinations, dividends, distributions, reclassification and other corporate events. If we issue or sell any additional shares of common stock at a price per share less than $0.50, or without consideration, or options or warrants to purchase, or other securities convertible into, shares of our common stock, in effect giving the holders of those options, warrants or convertible securities the right to purchase our common stock at a price per share less than $0.50, the fixed conversion price will be reduced (except in certain specified events, some of which would also increase the alternative conversion price to $1.00) to a price equal to the consideration per share paid or payable for such additional shares of common stock, and the number of shares of our common stock into which the Series B preferred stock can be converted will be proportionately increased. Each holder of Series B preferred stock is entitled to receive dividends at the rate of 12% of the Series B preferred stock's stated $10,000 per share liquidation preference, payable by us semi-annually and at our option in either cash or shares of our common stock that have been registered pursuant to an effective registration statement. The formula for determining the number of shares of our common stock to be paid as a dividend on each Series B preferred share is the number equal to the quotient of (i) the dividend payment divided by (ii) the conversion price. The relative rights and preferences of our Series B convertible preferred stock are described in greater detail in our prospectus dated January 21, 2003, which can be viewed on the SEC's internet site, http://www.sec.gov. All of the purchasers of our Series B convertible preferred stock represented to us that they were "accredited investors" as such term is defined in the rules promulgated by the Securities and Exchange Commission. The sale of such Series B convertible preferred stock, the issuance of such common stock and the grant of such warrants, in our Series B financings, were all exempt from the registration requirements of the Securities Act of 1933 (the "Act") pursuant to Section 4(2) of the Act and Regulation D promulgated under the Act because such sales did not involve any public offering. 10 During the fourth quarter of 2002 we granted to 12 employees (including four executive officers), two non-employee directors and two consultants, options both under and outside our Employee Stock Option Plan, to purchase an aggregate of 4,400,500 shares of our common stock, at exercise prices ranging from $0.30 to $0.45 per share. The grant of such options was exempt from the registration requirements of the Act pursuant to the provisions of Section 4(2) thereof because such option grants did not involve any public offering and because such option grants did not constitute sales of securities. 11 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 8 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, 1998 1999 2000 2001 2002 2002 ----------- ------------ ------------ ------------ ------------ --------------- Product revenue $ -- $ -- $ -- $ 21,890 $ 243,775 $ 265,665 ----------- ------------ ------------ ------------ ------------ ------------ Expenses Research and development 1,933,877 3,106,908 4,191,317 4,283,038 3,147,515 21,195,907 Rent 252,397 473,010 535,443 589,238 683,116 2,862,651 Consulting 908,495 834,180 838,383 1,413,153 490,826 5,717,341 Personnel 4,060,629 3,742,632 4,763,662 6,605,630 6,440,959 29,390,319 General and administrative 1,725,201 2,152,968 2,297,769 2,671,887 2,781,896 14,784,581 Interest and other expense 104,605 99,522 89,712 536,070 7,281,104 8,300,610 Interest income (572,549) (368,711) (586,623) (191,749) (7,647) (2,257,096) Loss on extinguishment of debt and Series A preferred shares -- -- -- -- 1,004,027 1,004,027 ----------- ------------ ------------ ------------ ------------ ------------ 8,412,655 10,040,509 12,129,663 15,907,267 21,821,796 80,998,340 ----------- ------------ ------------ ------------ ------------ ------------ Net loss (8,412,655) (10,040,509) (12,129,663) (15,885,377) (21,578,021) (80,732,675) Preferred stock dividends -- -- -- -- 1,125,934 1,125,934 ----------- ------------ ------------ ------------ ------------ ------------ Net loss applicable to common shareholders $(8,412,655) $(10,040,509) $(12,129,663) $(15,885,377) $(22,703,955) $(81,858,609) =========== ============ ============ ============ ============ ============ Net loss per share of common stock Basic and diluted $(1.43) $(1.51) $(1.37) $(1.64) $(2.01) $(15.54) Weighted average common stock outstanding Basic and diluted 5,878,971 6,634,874 8,847,295 9,691,608 11,305,956 5,269,187 =========== ============ ============ ============ ============ ============
Balance sheet data 1998 1999 2000 2001 2002 - ------------------ ----------- ----------- ----------- ----------- ------------ Working capital/(deficiency) $ 9,368,901 $11,009,660 $ 7,966,410 $(2,529,159) $(17,787,545) Total assets 12,391,039 15,011,645 11,719,760 4,038,601 3,698,366 Long-term debt, excluding current maturities 1,152,180 1,044,857 912,489 6,768,983 828,498 Shareholders' equity/(deficit) 10,390,759 12,370,720 9,392,325 (6,304,972) (15,801,132)
12 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 May Prove Inaccurate 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 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 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 Annual Report on Form 10-K. 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. 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. 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 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, we 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 we are still a development stage enterprise, in December 2001 we began commercial sales of our product, generating revenues of $22,000 and $244,000 in 2001 and 2002, respectively. During 2002, we engaged a sales force organization to actively pursue the sales of our product, but due to a reduction in anticipated financing, we had to curtail these activities in the second half of the year. From inception to date, we have incurred cumulative net losses of approximately $81.9 million. We expect to continue to incur substantial losses through 2004, due to continued spending on research and development programs, the funding of clinical trials and regulatory activities and the increased costs of manufacturing, marketing and sales, distribution and administrative activities. 13 We are currently conducting a pivotal clinical trial using OrCel in the treatment of venous stasis 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. As of March 14, 2003, we have enrolled over 80 patients to participate in the pivotal clinical trial and we are anticipating a total enrollment of 102 patients to complete the trial. We expect to complete the venous stasis pivotal clinical trials during the second quarter of 2003, with submission of the FDA filing in September 2003. We anticipate obtaining FDA approval early in 2004 for the use of our OrCel product in the treatment of venous stasis ulcers. In June 2002, we received approval from the FDA to initiate a pivotal clinical trial using OrCel in the treatment of diabetic foot ulcers. Diabetic ulcers are open sores that remain after the destruction of surface tissue. We have deferred the implementation of the diabetic foot ulcers pivotal clinical trial and expect to resume this trial in the second half of 2003 dependent on obtaining sufficient additional financing, with FDA approval anticipated by the end of 2004. We are investigating and currently are in discussions with a third party manufacturer for the production of OrCel. If these discussions are successful, we will be able to produce the large quantities of OrCel that will be required upon the anticipated receipt of FDA approval for the sale of our product for use in the treatment of patients with venous stasis ulcers. If we conclude an agreement with the third party manufacturer, we will be able to defer or terminate the costlier plan of constructing our owned manufacturing facility. We are also concurrently in the process of evaluating various sales and marketing collaborative arrangements. 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 through 2004. Critical Accounting Estimates Revenue Recognition. Revenues from sales are recognized upon shipment of product to customers. Research and Development Costs. As we are still engaged in clinical trials of our product and remain a development stage enterprise, the cost of producing product for clinical trials and for sale, is included in Research and Development costs. Additionally, all research and development costs, including consulting and personnel costs, relating to products under development, are expensed as incurred. 14 Long Term Obligations. 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 anticipated under the terms of the agreement. Pursuant to the default provisions under the agreement, interest is accrued at 30% per annum. At such time when the default provisions are no longer applicable, interest will be accrued based upon the expected level of future revenues, which may result in a lower imputed interest rate, with potential material financial impact. Impact of recently issued accounting pronouncements On April 30, 2002, the Financial Accounting Standards Board (the FASB) issued SFAS No.145, "Rescission of FASB Statements No.4, 44 and 64, Amendment of SFAS No.13 and Technical Corrections". SFAS No.145 rescinds Statement No.4, which requires all gains and losses from extinguishments of debt to be aggregated and, if material, classified as an extraordinary item, net the related income tax effect. Upon adoption of SFAS No.145, companies will be required to apply the criteria in APB Opinion No.30, "Reporting the Results of Operations-Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions" in determining the classification of gains and losses resulting from the extinguishment of debt. SFAS No.145 is effective for fiscal years beginning after May 15, 2002. We are currently evaluating the requirements and impact of the statement on our results of operations and financial position. On July 30, 2002, the FASB issued SFAS No.146, "Accounting for Costs Associated with Exit or Disposal Activities". The standard requires companies to recognize costs associated with exit or disposal activities when they are incurred, rather than at a date of a commitment to an exit or disposal plan. Example of costs covered by the standard include lease termination costs and certain employee severance costs that are associated with a restructuring, discontinued operations, plant closing, or other exit or disposal activity. SFAS No.146 is to be applied prospectively to exit and disposal activities initiated after December 31, 2002. We will apply the provisions of this statement prospectively to disposal activities commencing after December 31. 2002. In December 2002, the FASB issued SFAS No.148, "Accounting for Stock Based Compensation - Transition and Disclosure, an amendment of FASB Statement No.123". This statement requires companies to reflect the fair market value of employee stock based compensation in their results of operations as an additional expense or disclose the pro-forma impact of this adjustment to net income and earnings per share, in the notes to the financial statements. The Company has elected to continue to account for its stock-based compensation under the rules of APB Opinion No.25, with footnote disclosure, as required by SFAS No.148. Results of Operations Year Ended December 31, 2002, and December 31, 2001. 15 Revenues We earned revenues of approximately $244,000 in 2002, and $22,000 in 2001 from commercial shipments of products to customers. Sales to commercial customers began in December 2001, and were curtailed in the second half of 2002. Expenses Expenses increased by approximately $5.9 million in 2002, from approximately $15.9 million in 2001 to $21.8 million in 2002. Interest, which primarily consisted of non-cash charges relating to the preferred stock and debentures financings, accounted for $6.7 million of this increase, while the loss on extinguishment of debt represented $1.0 million of the increase. Other expenses incurred in 2002, decreased by $1.8 million, compared with 2001. Research and Development. These expenses decreased by approximately $1.1 million, from $4.3 million in 2001 to $3.2 million in 2002. Additionally, 2001 costs included a $0.4 million credit to expenses as a result of an insurance recovery for damaged Orcel, which costs were incurred in 2000. All other research and development costs decreased by $1.5 million in 2002, compared with 2001. This decrease in research and development expenses was due to the fact that the costs incurred in 2002 included only one clinical trial, the venous ulcer pivotal trial, whereas in 2001 there were three trials conducted and concluded, the donor site pivotal trial, and the venous and diabetic ulcers pilot trials. We expect to conclude the venous ulcer pivotal trial in 2003. Personnel. Personnel costs decreased by approximately $.2 million from $6.6 million in 2001 to $6.4 million in 2002. Personnel costs initially increased in the first half of 2002 due to the additional personnel required to conduct and manage clinical trial programs, to manufacture the increased quantity of product required by our clinical trial programs and for commercial sales and to initiate our sales and marketing program for our FDA approved products. In July 2002, management implemented a cost reduction plan and deferred the implementation of the diabetic clinical trial, as well as, reduced production of product for commercial sales, which resulted in significant reductions in personnel costs in the second half of 2002. Consulting. These fees decreased by $.9 million from $1.4 million in 2001 to $.5 million in 2002. This was due to the increased costs in 2001 related to the specific requirements for concluding the clinical trials for donor site wounds and FDA submissions, noted above, as well as, the costs of conducting the pilot clinical trials for venous leg stasis and diabetic foot ulcers. In 2002, only the costs of beginning the pivotal clinical trials for venous leg stasis ulcers were incurred. General and Administrative. These expenses increased by $.1 million from $2.7 million in 2001 to $2.8 million in 2002. The increase in 2002 was primarily due to increased marketing expenses incurred early in the year, as we prepared for commercial sales of our product. As noted above, the decision to reduce fresh OrCel production in the third quarter resulted in a curtailment of marketing expense in the second half of the year. In 2002, we also incurred 16 higher expenses, as we continued our intense financing efforts. These increases were partially offset by a reduction of travel expenses in 2002, as we focused on reducing our overall spending. Rent. This expense increased by $.1 million in 2002 compared with 2001, primarily due to the charges incurred for the New Jersey leases in 2002, which expense was not incurred in 2001. Interest Expense. Interest expense increased by $6.7 million, from $.5 million in 2001 to $7.2 million in 2002. This increase was due to the imputed non-cash interest resulting from the convertible debenture and convertible preferred financings, which occurred in 2002. Interest of $3.6 million was recorded as a result of these financings, $.2 million in coupon rate interest on the debentures and $3.4 million recorded as the fair market value of the conversion features and warrants issued with the financings. Additionally, non-cash interest of $3.5 million was accrued in 2002, relating to the Paul Capital Royalty obligation, as compared to $.5 million in 2001. Interest Income. Interest income declined by approximately $.2 million in 2002, compared with 2001, primarily due to the smaller average cash balances outstanding during 2002 compared with 2001. Loss on extinguishment of debt and series A preferred shares. We incurred a loss of $1.0 million due to the conversion of debt into preferred shares in 2002. Year Ended December 31, 2001 and December 31, 2000. Revenues Ortec made its first commercial shipments of products 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. 17 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. 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. As of December 31, 2001, management anticipated that the effective cost of these funds based on the anticipated revenue stream, over the term of this agreement, which terminates in December 2011, may range between 20% to 35% per annum and as such, approximately $455,000 in interest expense had been accrued in 2001. 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. Liquidity and Capital Resources Since inception (March 12, 1991) through December 31, 2002, we have accumulated a deficit of approximately $81.9 million and we expect to continue to incur substantial operating losses through 2004. We have financed our operations primarily through private placements of our common stock, preferred stock and convertible debentures, our initial public offering and the exercise of our publicly traded Class A warrants at the end of 1997. From inception to December 31, 2002, we received cash proceeds from the sale of common equity securities, net of share issuance expenses, of approximately $49.0 million, we received net proceeds from the issuance of debentures and preferred stock of $8.2 million, and we have received a total of $10 million from the sale of a percentage interest in our future revenues from the sale of our product in North America. 18 Subsequent to December 31, 2002, the Company has continued with its convertible preferred stock financing and on February 26, 2003, closed on an additional $2.0 million investment in preferred equity. For the year ended December 31, 2002, we used net cash for operating activities of approximately $10.9 million. Cash used in operating activities resulted primarily from our net loss of $21.6 million, offset by depreciation and amortization of approximately $715,000, approximately $6.9 million of non-cash interest expense, a loss on extinguishment of debt on series A preferred stock of $1.0 million and an increase in accounts payable and accrued expenses of approximately $1.4 million. During the year ended December 31, 2002 we invested approximately $192,000 in property, plant, equipment and patent application costs. In January 2002, we received a $1,300,000 line of credit from GE Capital for equipment lease financing, with which we financed $450,000 of additional purchases of fixed assets. This line of credit was available for eligible manufacturing equipment purchases in 2002. We repaid $246,000 of our loans payable and long-term debt during the year ended December 31, 2002. We received $4.0 million under our agreement with Paul Capital Royalty Acquisition Fund, L.P. and $8.2 million from issuance of our convertible debentures, notes and preferred stock financing through H.C. Wainwright, as noted above. As a result of the aforementioned preferred stock financing, common shares outstanding increased by 13.5 million shares, due to the conversion of warrants granted and the issuance of common stock dividends. In December 2001, we entered into a ten-year lease with New Jersey Economic Development Authority ("NJEDA") to lease approximately 58,000 square feet of manufacturing and office space located in North Brunswick, New Jersey. On August 5, 2002, we reached an agreement with NJEDA to terminate the December 2001 lease and enter into a new lease for approximately 26,000 square feet of manufacturing and office space. The new lease began on August 1, 2002 and terminates on December 31, 2005, with rental payments beginning in January 2003. A security deposit of $623,000, which was paid by us on the original lease, has been applied as a security deposit on the new lease. All construction costs advanced by NJEDA for the renovation of the premises, approximately $420,000, has been included as a construction allowance in the new lease and is reflected in the rent base. Due to the lower level of financing received in 2002 than had originally been planned, the Company is currently engaged in discussions with the NJEDA to defer or terminate the lease entered into in August 2002. In the event that we reach an agreement with the NJEDA to terminate the lease, the security deposit of $623,000 may be partially or wholly utilized as part of the termination settlement. Under the August 29, 2001 agreement, as amended, in consideration for the investment of $10.0 million, Paul Capital received 3-1/3% of end user revenues from the sale of our products in the United States, Canada and Mexico. These percentage payments may be further adjusted upward or downward, based on the volume of net sales to end users of our products in 19 those three countries. As of December 31, 2002, we have provided for the effective cost of the amounts received from Paul Capital at 30% per annum, pursuant to default provisions of the agreement and we have accrued interest accordingly. However, at such time when the default provisions are no longer applicable, interest will be accrued based upon the expected level of future revenues, which may result in a lower imputed interest rate, with potential material financial impact. Under the August 29, 2001 agreement, as amended, beginning on January 1, 2003, Paul Capital will be entitled to receive each year advances from the first proceeds to us from end user sales of our products. The agreement provides for quarterly and annual accountings between Paul Capital and us for those advance payments, compared to amounts owed based on actual sales. Such annual amounts Paul Capital will be able to draw in advance will range from $.6 million in 2003, $1.0 million in 2004 to $7.5 million in 2005 and thereafter. At December 31, 2002, our liabilities exceeded the value of our assets and as such, we were technically in default of the solvency requirement under the Paul Capital agreement. Paul Capital is aware of this breech and based on our discussions regarding this issue, has indicated to us that it presently does not intend to exercise its option to require us to repurchase its revenue interest. Additionally, in February 2003, Paul Capital amended its agreement with us, restating and updating certain provisions of the original agreement. On February 26, 2003, Paul Capital invested an additional $500,000 in our Series B preferred stock, in concurrence with this amendment. 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 all our United States patents and trademarks relating to our technology for our product, to secure payments we are required to make to Paul Capital, based on sales generated under the Royalty Revenue Interest Assignment agreement, as described above. The original agreement and modifications to the agreement terminate on December 31, 2011, unless terminated earlier by either party, as permitted by the terms of the agreement. 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. Wainwright has assisted us in raising financing of approximately $8.2 million in 2002 and has continued its financing efforts on our behalf in 2003. On May 13, 2002, we secured the first $2.3 million of this financing, in the form of 12% convertible debentures, which was convertible into common shares. On June 28, 2002, $0.6 million of these debentures were converted into Series-A convertible preferred stock. We also issued 291,000 warrants to purchase common stock as part of this May 13, 2002 financing. On June 28, 2002, an additional $1.5 million of financing was secured, which consisted of $1.2 million in Series A convertible preferred stock and $.3 million in 12% convertible debentures. We also issued 655,000 stock purchase warrants as part of the June 28, 2002 financing. In the third and 20 fourth quarters of 2002, we raised an additional $3.3 million in convertible debentures and $1.1 million in convertible preferred stock. On November 13 and December 13, 2002, the investors converted all their outstanding convertible debentures and Series-A convertible preferred stock into Series-B convertible preferred stock, thereby acquiring 938.2742 shares of preferred shares, at a stated value of $9,382,742. In addition, these investors were granted Series A warrants, to purchase 9,382,742 shares of the Company's common stock at an exercise price of $.001. These Series-A warrants vested immediately and were exercised immediately, upon grant. The investors were also granted Series B-1 and Series B-2 warrants, which can be used to purchase 5,429,891 and 4,691,386 shares of common stock at an exercise price of $1.50 and $2.00 per share, respectively. The Series B-1 and B-2 warrants are exercisable nine and twelve months, respectively, after issue. The warrants previously granted with the issuance of the convertible debentures and Series-A preferred stock, were exchanged for Series B-1 warrants. In conjunction with this preferred stock financing, the investors were also paid a common stock dividend, whereby they were granted 3,753,116 shares of common stock. The Series B preferred stock is convertible into common shares at any time at the option of the investor, based on a fixed conversion rate of $1.00 or commencing after February 1, 2003, based on an alternative conversion rate equal to 90% of the average of the five lowest volume weighted average prices for the common stock for the twenty trading days immediately prior to conversion, subject to a floor price of $0.25. The fixed conversion rate may be adjusted downward if the Company subsequently issues common stock at a purchase price less than $0.50. In that event, the fixed conversion rate will be adjusted downward to the price of the new issuance. Conversion is mandatory, upon the occurrence of certain financial events, such as, beginning six months from the date of issue, if the closing bid price of common shares exceeds $2.00 for a period of 20 consecutive trading days, or if within nine months from the date of issue, the Company completes a public offering, raising a minimum of $8 million. The alternative conversion price is adjustable or cancelable under certain circumstances, such as, in the event that the Company receives a licensing fee and/or a strategic investment of at least $5.0 million, within six months of closing, the alternative conversion rate is adjusted to the common share price of the investment or is cancelled if the share price exceeds the fixed rate of $1.00. If within six months from date of issue, the Company receives a licensing fee with an upfront payment of at least $5.0 million, the alternative conversion rate is adjusted to the quoted closing stock price on the day of the public announcement or is cancelled if this closing price exceeds $1.00. Similarly, if the Company completes a subsequent public or private financing of a least $5.0 million, within six months of closing, the alternative conversion rate is adjusted to the closing price or the fixed rate of $l.00, if lower. Dividends were paid in advance in common shares at the rate of 12% in the first year after issue and will be paid semiannually in subsequent years, in either cash or common shares, at the election of the Company, until at such time as the preferred stock is converted to common shares. Along with the convertible preferred stock, the Company also issued warrants to purchase common shares, as noted above. The Series B-1 and B-2 warrants are redeemable by the Company at $0.10 per share, twelve months and twenty-four months after issuance, respectively, if the Company's common shares closes above $3.00 and $4.00, respectively, for 15 consecutive trading days. 21 Our capital funding requirements will depend on numerous factors, including the progress and magnitude of our research and development programs, pre-clinical 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 have raised funds in the past through the public or private sale of equity securities and debentures and through the agreement with Paul Capital. 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. We require substantial funding to continue our research and development activities, clinical trials, manufacturing, sales, distribution and administrative activities. We believe that our cash and cash equivalents on hand at December 31, 2002, (approximately $0.8 million) and the financing of $2.0 million received in February 2003, will enable us to continue our operations until May 31, 2003. We are continuing our equity financing efforts with H.C. Wainwright and we expect to raise an additional $5.0 million from investors, some of whom have previously participated in the $10.2 million raised to date. This will enable us to complete our venous clinical pivotal trial, file our PMA with the FDA and execute on our plan to engage the services of a third party manufacturer. Accomplishing these milestones will also enable us to raise an additional $5.0 million in 2003 through other potential collaborative arrangements with companies for sales, marketing and distribution of our product and through other equity investments. Based on these efforts, management believes that the Company will be able to continue its operations for at least the next 12 months. 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. 22 Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Reference is made to the Financial Statements contained in this Form 10-K report, setting forth the financial statements of Ortec International, Inc., together with the report of Grant Thornton LLP, dated March 31, 2003. 23 PART III Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT Directors and Executive Officers Set forth below are the directors and executive officers of Ortec, their respective names and ages, positions with Ortec, principal occupations and business experiences during at least the past five years and the dates of the commencement of each individual's term as a director and/or officer.
Name Age Position - ---- --- -------- Steven Katz, Ph.D. 58 Chairman of the Board of Directors Mark Eisenberg, M.D. 65 Senior Vice President, Research and Development, and Director Ron Lipstein 47 Chief Executive and Chief Financial Officer, Vice Chairman of the Board of Directors, Secretary and Treasurer Costantin Papastephanou, Ph.D. 57 President Steve Lilien, Ph.D. 55 Director Allen I. Schiff, Ph.D. 57 Director Gregory B. Brown, M.D. 49 Director
Directors 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. 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 "Certain Relationships and Related Transactions - 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. 24 Ron Lipstein, one of our founders, has been the Secretary, Treasurer, Chief Financial Officer and a director of Ortec since 1991. Mr. Lipstein was elected Vice Chairman of our Board of Directors in January 2001 and as our Chief Executive Officer in March 2003. He has been employed by us since 1991. Mr. Lipstein is a certified public accountant. 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 fifteen 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. Allen I. Schiff has been a director of Ortec since June 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. Gregory B. Brown has been a director of our Company since March 2003. Since January 2003 Dr. Brown has been a partner at Paul Capital Investors and serves as the director selected by Paul Capital Royalty Acquisition Fund, L.P., an affiliate of Paul Capital Investors. Pursuant to our agreement with Paul Capital Royalty Acquisition Fund, L.P., we are required to elect a person designated by Paul Capital Royalty Acquisition Fund, L.P. as a director of Ortec. From 1997 to 2002 Dr. Brown served as a managing director of Adams, Harness & Hill, an investment banking firm, and from April 2001 to December 2002 as head of its Healthcare and co-head of investment banking. Prior to 1997 Dr. Brown was a thoracic and vascular surgeon. He received a B.A. degree from Yale University, an M.D. from Upstate Medical School and an M.B.A. from Harvard Business School. All directors hold office until the next annual meeting of stockholders and the election and qualification of their successors. Drs. Steven Lilien, Allen I. Schiff and Gregory B. Brown are non-employee directors. For Dr. Steven Lilien's services in 2002 as a director and as chairman of our audit committee, we granted Dr. Lilien 7 year options to purchase 48,500 shares of common stock. For his services in 2002 as a director and as a member of our audit committee, we paid Dr. Schiff an aggregate of $3,000 and granted Dr. Schiff 7 year options to purchase an aggregate of 20,000 shares of common stock. Such options were granted under our Employee Stock Option Plan and are exercisable at prices ranging from $0.30 to $0.60 per share. Dr. Gregory B. Brown was not a director in 2002. 25 Executive Officers Officers are elected annually by the Board of Directors and serve at the discretion of the Board of Directors. Two of our executive officers, Steven Katz and Ron Lipstein, are also members of our Board of Directors. Information with regard to such persons is set forth above under the heading "Directors." The remaining executive officer is Costantin Papastephanou, our President. Costantin Papastephanou was employed by us in February 2001 as our president. Prior to joining Ortec 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. The Committees The Board of Directors has an Audit Committee, a Compensation Committee and a Stock Option Committee. The Board of Directors does not have a Nominating Committee and the usual functions of such committee are performed by the entire Board of Directors. Audit Committee. The functions of the Audit Committee include recommendations to the Board of Directors with respect to the engagement of our independent certified public accountants and the review of the scope and effect of the audit engagement. The current members of the Audit Committee are Drs. Lilien and Schiff. Compensation Committee. The function of the Compensation Committee is to make recommendations to the Board of Directors with respect to the compensation of our executive officers, including salary, bonus and other incentives. The current members of the Compensation Committee are Messrs. Katz, Eisenberg and Lilien. Stock Option Committee. The Stock Option Committee determines the employees, (other than our executive officers), consultants and advisors, to whom options should be granted under our Stock Option Plan and the number of options to be granted to each such employee, consultant and advisor. The current members of the Stock Option Committee are Messrs. Katz and Lipstein. The Board of Directors determines any other persons (our executive officers and directors) to whom options should be granted and the number of options to be granted to each such person. 26 Attendance at Meetings During 2002, the Board of Directors, Audit Committee, Compensation Committee and Stock Option Committee each met or acted without a meeting pursuant to unanimous written consent 7 times, 6 times, 1 time and 16 times, respectively. In 2002 all of the directors attended all of the meetings of the Board of Directors except for Dr. Lilien who attended six of the seven meetings. Dr. Lilien attended all six meetings and Dr. Schiff attended three meetings of the Audit Committee. Messrs. Katz, Eisenberg and Lilien all attended the one meeting of the Compensation Committee and Messrs. Katz and Lipstein attended all meetings of the Stock Option Committee. Section 16(a) Beneficial Ownership Reporting Compliance To the best of our knowledge, during 2002 the following individuals who were executive officers and/or directors of Ortec did not file a Form 4 report in time: Steven Katz, Mark Eisenberg and Costantin Papastephanou, once each, and Ron Lipstein, Alain Klapholz, William Schaeffer, Steven Lilien and Allen Schiff, twice each. To the best of our knowledge, all other Forms 3, 4 and 5 required to be filed during 2002 were done so on a timely basis. Item 11. EXECUTIVE COMPENSATION The following table sets forth the compensation paid by us for our fiscal years ended December 31, 2002, 2001 and 2000 to (i) our Chief Executive Officer; (ii) our other executive officers; and (iii) up to two additional individuals for whom disclosure would have been provided under the above clause (ii) but for the fact that the individuals were not serving as executive officers at the end of the last completed fiscal year (the "Named Officers"). 27 SUMMARY COMPENSATION TABLE
--------------------------------------------- ------------ Long Term Annual Compensation Compensation --------------------------------------------- ------------ - ------------------------------------------------------------------------------------------------- Securities Name and Other Annual Underlying Principal Position Year Salary($) Bonus($) Compensation($) Options/SARs - ------------------------------------------------------------------------------------------------- Steven Katz 2002 225,058 150,850 2,100,825 Chairman 2001 236,392 92,000 200,000 2000 209,807 94,605 9,000* 129,278 - ------------------------------------------------------------------------------------------------ Ron Lipstein 2002 201,115 150,850 2,100,825 CEO, Vice Chairman, Secretary, Treasurer and CFO 2001 214,447 86,000 185,000 2000 179,712 78,105 9,000* 118,128 - ------------------------------------------------------------------------------------------------ Costantin Papastephanou 2002 205,784 115,000 President 2001 181,625 60,000 - ------------------------------------------------------------------------------------------------ Alain Klapholz 2002 162,884 100,000 Former Vice President and former Director (1) 2001 170,604 20,000 60,000 2000 159,808 30,000 23,300 - ------------------------------------------------------------------------------------------------ William Schaeffer 2002 181,733 34,220 Former Chief Operating Officer (1) 2001 188,688 10,000 2000 167,308 17,000 - ------------------------------------------------------------------------------------------------
- ---------- * In lieu of health insurance. (1) Mr. Klapholz resigned as our Vice President and as a member of our Board of Directors in March 2003, and Mr. Schaeffer resigned as our Chief Operating Officer on February 14, 2003. Board Compensation Drs. Steven Lilien and Allen I. Schiff were our only non-employee directors in 2002. For Dr. Steven Lilien's services in 2002 as a director and as chairman of our audit committee, we granted Dr. Lilien 7 year options to purchase 48,500 shares of common stock. For his services in 2002 as a director and as a member of our audit committee, we paid Dr. Schiff an aggregate of $3,000 and granted Dr. Schiff 7 year options to purchase an aggregate of 20,000 shares of common stock. Such options were granted under our Employee Stock Option Plan and are exercisable at prices ranging from $0.30 to $0.60 per share. Option Grants in Last Fiscal Year The following table sets forth certain information regarding options granted during the fiscal year ended December 31, 2002 by us to the Named Officers: 28
- ---------------------------------------------------------------------------------------------------------- Potential Realizable Value at Assumed Annual Rates of Stock Price Appreciation for Individual Grants Option Term - ---------------------------------------------------------------------------------------------------------- (a) (b) (c) (d) (e) (f) (g) - ---------------------------------------------------------------------------------------------------------- Number of % of Total Securities Options/SARs Underlying Granted to Exercise or Options/SARs Employees in Base Price Expiration Name Granted Fiscal Year (1) ($/Share) Date 5% ($) 10% ($) - ---------------------------------------------------------------------------------------------------------- Steven Katz 2,100,000 43.4 $0.35 11/11/09 $294,000 $693,000 825 * 5.95 1/3/09 1,997 4,653 - ---------------------------------------------------------------------------------------------------------- Ron Lipstein 2,100,000 43.4 0.35 11/11/09 294,000 693,000 825 * 5.95 1/3/09 1,997 4,653 - ---------------------------------------------------------------------------------------------------------- Costantin Papastephanou 25,000 0.5 0.30 11/7/09 3,000 7,000 50,000 1.0 1.00 7/15/04 20,500 47,500 40,000 0.8 6.05 1/15/09 98,400 229,600 - ---------------------------------------------------------------------------------------------------------- Alain Klapholz 50,000 1.0 0.30 11/7/09 3,000 7,000 50,000 1.0 0.60 8/13/09 12,000 28,500 - ---------------------------------------------------------------------------------------------------------- William D. Schaeffer(2) 10,000 0.2 0.30 11/7/09 3,000 7,000 15,431 0.3 0.31 12/5/05 823 1,743 8,789 0.2 1.00 7/15/04 879 1,846 - ----------------------------------------------------------------------------------------------------------
- ---------- * Less than one percent (1) Options to purchase a total of 4,831,609 shares of common stock were granted to our employees, including the Named Officers, during the fiscal year ended December 31, 2002. The following table sets forth certain information regarding options exercised and exercisable during the fiscal year ended December 31, 2002 and the value of the options held as of December 31, 2002 by the Named Officers. None of the Named Officers exercised any options during the fiscal year ended December 31, 2002. 29 Aggregated Option Exercises In Last Fiscal Year and Fiscal Year-End Option Value
Number of Securities Value of Unexercised Underlying Unexercised In-the-Money Options Options At Fiscal Year-End at Fiscal Year-End (1)($) (#) --------------------------- --------------------------- Name Exercisable Unexercisable Exercisable Unexercisable - ---- ----------- ------------- ----------- ------------- Steven Katz 2,710,853 0 $273,000 0 Ron Lipstein 2,658,953 0 273,000 0 Costantin Papastephanou 15,000 160,000 0 $4,500 Alain Klapholz 262,300 0 9,000 0 William D. Schaeffer 48,313 59,657 0 4,423
(1) The product of (x) the difference between $0.48 (the closing price of our Common Stock at December 31, 2002, as reported by Nasdaq) and the exercise price of the unexercised options, multiplied by (y) the number of unexercised options. Compensation Committee Interlock and Insider Participation None of our 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 our 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. Item 12. SECURITY OWNERSHIP OF BENEFICIAL OWNERS AND MANAGEMENT The following table sets forth information, as of March 21, 2003, based upon information obtained from the persons named below, regarding beneficial ownership of our common stock by (i) each person who is known by us to own beneficially more than 5% of the outstanding shares of our common stock, (ii) each of our directors, (iii) each of the Named Officers, and (iv) all of our executive officers and directors as a group. 30
Amount and Percentage of Name and Address Nature of Beneficial Outstanding of Beneficial Owner Ownership** Shares Owned** - ------------------------------------------------------------------------------ Steven Katz* 2,902,915(1) 9.92 - ------------------------------------------------------------------------------ Mark Eisenberg* 598,500(2) 2.25 - ------------------------------------------------------------------------------ Ron Lipstein* 2,881,224(3) 9.86 - ------------------------------------------------------------------------------ Alain Klapholz* 548,906(4) 2.05 - ------------------------------------------------------------------------------ Costantin Papastephanou* 154,250(5) *** - ------------------------------------------------------------------------------ William D. Schaeffer 2,500 *** 1 Saucon Valley Court Skillman, NJ 08558 - ------------------------------------------------------------------------------ Steven Lilien 55,525(6) *** 19 Larchmont Street Ardsley, NY 10502 - ------------------------------------------------------------------------------ Allen I. Schiff 27,500(7) *** Fordham University Graduate School of Business 113 West 60th Street New York, NY 10023 - ------------------------------------------------------------------------------ Gregory B. Brown 0 140 E. 45th Street, 44th Floor New York, NY 10017 - ------------------------------------------------------------------------------ Pequot Capital Management, Inc. 9,573,645(9)(10) 29.75 5000 Nyala Farm Road Westport, CT 06880 - ------------------------------------------------------------------------------ DMG Advisors LLC 9,523,994(9)(10) 28.35 53 Forest Avenue, Suite 202 Old Greenwich, CT 06870 - ------------------------------------------------------------------------------ Sargon Capital International Fund Ltd. 9,315,524(9)(10) 28.87 6 Louis Drive Montville, NJ 07045 - ------------------------------------------------------------------------------ SDS Merchant Fund L.P. 13,884,087(9)(10) 37.73 53 Forest Avenue, Suite 201 Old Greenwich, CT 06870 - ------------------------------------------------------------------------------ Stonestreet Limited Partnership 7,960,480(10) 23.07 c/o Canaccord Capital Corp. 32 Bay Street, Suite 1250 Toronto, ON M5H4A6 - ------------------------------------------------------------------------------ Paradigm Group 1,483,693(9)(10) 5.37 3000 Dundee Road, Suite 105 Northbrook, IL 60062 - ------------------------------------------------------------------------------ All officers and directors as a group 7,171,320(1-8) 22.32 (eight person) - ------------------------------------------------------------------------------
* The address of these persons is at Ortec'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 31 shares which such person or entity has the right to acquire within 60 days after March 21, 2003. 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 2,710,853 shares issuable to Dr. Katz upon his exercise of outstanding options and warrants. 2. Includes 2,500 shares issuable to Dr. Eisenberg upon his exercise of outstanding options. 3. Includes 33,600 shares owned by Mr. Lipstein's minor children. Mr. Lipstein disclaims any beneficial interest in such 33,600 shares. Also includes 2,658,953 shares issuable to Mr. Lipstein upon his exercise of outstanding options and warrants. 4. Includes 24,000 shares owned by Mr. Klapholz' minor children. Mr. Klapholz disclaims any beneficial interest in such shares. Also includes 262,300 shares issuable to Mr. Klapholz upon his exercise of outstanding options. 5. Includes 152,500 shares issuable to Mr. Papastephanou upon his exercise of outstanding options. 6. Includes 55,125 shares issuable to Dr. Lilien on his exercise of outstanding options. 7. All 27,500 shares are issuable to Dr. Schiff on his exercise of outstanding options. 8. Does not include 30,769 shares of common stock and 50 shares of Series B convertible preferred stock which are convertible into shares of common stock, held by Paul Capital Royalty Acquisition Fund, L.P. Dr. Brown was selected by Paul Capital Royalty Acquisition Fund, L.P. to serve as a director of Ortec pursuant to Ortec's agreement giving Paul Capital Royalty Acquisition Fund, L.P. the right to name one director. 9. Shares held by investment funds. These have sole or shared investment and/or voting power for these shares. 10. Includes the following number of shares of Series B convertible preferred stock and assuming the conversion of such preferred shares into the following number of shares of our common stock, which is determined by dividing the liquidation preference amount of $10,000 per share by an assumed conversion price of $0.25. 32
Number of Shares of Shares of Common Series B Convertible Stock Assuming Preferred Stock Conversion -------------------- ---------------- Pequot Capital Management Fund, Inc. 140.8146 5,632,584 DMG Advisors LLC 176.1422 7,045,688 Sargon Capital International Fund Ltd. 171.9399 6,877,596 SDS Merchant Fund L.P. 256.2010 10,248,040 Stonestreet Limited Partnership 199.0120 7,960,480 Paradigm Group 27.4758 1,099,032
Equity Compensation Plan Information The table below sets forth the following information as of the fiscal year ended December 31, 2002 for (i) all compensation plans previously approved by our stockholders and (ii) all compensation plans not previously approved by our stockholders, if any: (a) the number of securities to be issued upon the exercise of outstanding options, warrants and rights; (b) the weighted-average exercise price of such outstanding options, warrants and rights; and (c) other than securities to be issued upon the exercise of such outstanding options, warrants and rights, the number of securities remaining available for future issuance under the plans. 33
(c) Number of Securities Remaining (a) (b) Available for Future Number of Securities to Weighted-Average Issuance Under Equity be Issued Upon Exercise Exercise Price of Compensation Plans of Outstanding Options, Outstanding Options, (excluding securities Plan Category(1) Warrants and Rights Warrants and Rights reflected in column (a)) - ---------------- ----------------------- -------------------- ------------------------ Equity Compensation 2,872,117 $5.73 127,883 Plans Approved by Securityholders Equity Compensation 3,874,832 $0.56 0 Plans Not Approved by Securityholders --------- ------- Total 6,746,949 127,883
(1) The only equity compensation plan approved by our stockholders is our Third Amended and Restated 1996 Stock Option Plan. The equity compensation plans that have not been approved by our stockholders consists of stock options outside of that Stock Option Plan granted to our executive officers to purchase 3,800,000 shares of our common stock at an exercise price of $0.35 per share, and warrants issued for services and to a lender whose loan is secured by our equipment. Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Termination of Employment Agreements We have entered into agreements with Messrs. Katz, Lipstein and Alain Klapholz that provide for payments to them in the event that their employment is terminated by us, including "constructive termination" as defined in those agreements. We will pay to such terminated individuals in the event it is Dr. Katz or Mr. Lipstein an amount equal to 2.99 times, and in the event it is Mr. Klapholz 1.99 times, the average annual compensation paid by us to such person in the five tax years prior to termination of his employment. The agreements with Messrs. Katz, Lipstein and Klapholz also provide that in the event of such termination of employment, the expiration dates of all options and warrants which have been granted to such persons and which expire less than three years after such termination of employment, will be extended so that such options and warrants expire three years after such termination of employment. The agreements further provide that in the event of the death or disability of Messrs. Katz, Lipstein or Klapholz, or the voluntary termination of Messrs. Katz' or Lipstein's employment, and in certain events the voluntary termination of Mr. Klapholz' employment, we will pay to such executive an amount equal to the compensation received by such executive from us in the previous 12 months. 34 The Internal Revenue Code provides that in the event that payments to an executive officer resulting from a change of control of a company exceeds three times the average annual compensation paid by us to such executive officer in the five year period 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. Such agreements are commonly referred to as "golden parachutes." The agreements with Messrs. Katz, Lipstein and Klapholz provide that we will pay such excise tax payable by such executive officer, as well as income taxes payable by such executive officer as a result of our payment of such excise tax. One of our directors, Dr. Gregory Brown, was selected by Paul Capital Royalty Acquisition Fund, L.P. as provided by an amendment in February 2003 of an agreement between us and Paul Capital. In August 2001 and in 2002 we originally entered into agreements with Paul Capital pursuant to which we agreed to pay to Paul Capital 3 1/3% of the end user sales prices paid for our product in the United States, Canada and Mexico through the period ending in 2011. As security for the performance of our obligations to Paul Capital, we granted Paul Capital a security interest in all of our U.S. patents, patent applications and trademarks. If there are defaults on our part in our performance of our agreements with Paul Capital, including defaults occasioned by events beyond our control (such as our insolvency), and we are unable to pay Paul Capital the large amounts required to be paid by us because of our default, Paul Capital may foreclose its security interest in our U.S. patents, patent applications and trademarks and it is most likely that in such event we will have to discontinue our operations. In February 2003, Paul Capital purchased 50 shares of our Series B convertible preferred stock, 30,769 shares of our common stock and warrants to purchase an aggregate of 500,000 shares of our common stock, at exercise prices of $1.50 per share for 250,000 shares and at $2.00 per share for the other 250,000 shares. The February 2003 amendments to our agreements with Paul Capital provided, among other things, for (a) the election of one director designated by Paul Capital, (b) the right of one observer (other than such director) selected by Paul Capital to attend and observe all meetings of Ortec's Board of Directors and (c) that after June 30, 2003 Ortec has to use its best efforts to have independent directors who are acceptable to both Ortec and Paul Capital, including the director designated by Paul Capital, as a majority of Ortec's Board of Directors. Item 14. CONTROLS AND PROCEDURES (a) Evaluation of disclosure controls and procedures. Our Principal Executive Officer and Principal Financial Officer, after evaluating the effectiveness of our disclosure controls and procedures (as defined in Exchange Act Rules 13a-14(c) and 15-d-14(c) as of a date within 90 days of the filing date of the Annual Report (the "Evaluation Date") have concluded that as of the Evaluation Date, our disclosure controls and procedures were adequate and effective to ensure that material information relating to us would be made known to us and them by others within those entities, particularly during the period in which this Annual Report was being prepared. (b) Changes in internal controls. 35 There were no significant changes in our internal controls or in other factors that could significantly affect our internal controls and procedures subsequent to the Evaluation Date, nor any significant deficiencies or material weaknesses in such internal controls and procedures requiring corrective actions. As a result, no corrective actions were taken. 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, 2002, 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, or other securities convertible into 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. 36 PART IV Item 15. 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. On December 12, 2002, we filed a Current Report on Form 8-K reporting our entering into the Termination of Employment Agreements with Messrs. Katz, Lipstein and Klapholz, as described above under the heading "Certain Relationships and Related Transactions - Termination of Employment Agreements." Other than the foregoing, we did not file any report on Form 8-K in the fourth quarter of 2002. 37 (c) Exhibits.
Exhibit No. Description - ----------- ----------- 3.1 Restated Certificate of Incorporation (1) 3.2 Amendment to Restated Certificate of Incorporation (2) 3.3 Amendment to Certificate of Incorporation adopted June 28, 2002, being a Certificate of Designation of the Relative Rights and Preferences of the Series A Convertible Preferred Stock (3) 3.4 Amendment to Certificate of Incorporation filed on August 26, 2002, being an Amended Certificate of Designation of the Relative Rights and Preferences of the Series B Convertible Preferred Stock (4) 3.5 By-Laws (5) 23. Consent of Grant Thornton LLP (2) 99.1 Certificate of Principal Executive Officer (2) 99.2 Certification of Principal Financial Officer (2)
- ---------- (1) Filed as an Exhibit to our Form 10-Q filed for the quarter ended September 30, 2001, and incorporated herein by reference. (2) Filed herewith. (3) Filed as an Exhibit to our Form 10-Q for the quarter ended June 30, 2002. (4) Filed as an Exhibit to our Form 10-QA for the quarter ended September 30, 2002. (5) Filed as an Exhibit to our Registration Statement on Form SB-2 (File No. 33-96090), or Amendment 1 thereto, and incorporated herein by reference. 38 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. Dated: April 14, 2003 Ortec International, Inc. By: /s/ Steven Katz ---------------------- Steven Katz, Ph.D. Chairman Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
Signature Title Date - --------- ----- ---- /s/ Steven Katz Chairman (Principal Executive Officer) April 14 2003 - -------------------- Steven Katz /s/ Dr. Mark Eisenberg Senior Vice President, Research and April 14 2003 - --------------------- Development and Director Dr. Mark Eisenberg /s/ Ron Lipstein Vice Chairman, Chief Executive and April 14, 2003 - -------------------- Financial Officer, Secretary, Treasurer Ron Lipstein and Director (Principal Financial and Accounting Officer) /s/ Steven Lilien Director April 14, 2003 - -------------------- Steven Lilien /s/ Allen I. Schiff Director April 14, 2003 - -------------------- Allen I. Schiff /s/ Gregory B. Brown Director April 14, 2003 - -------------------- Gregory B. Brown
39 CERTIFICATIONS I, Steven Katz, certify that: 1. I have reviewed this annual report on Form 10-K of Ortec International, Inc.; 2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and c) presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officer and I have indicated in this annual report whether there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: April 14, 2003 /s/ Steven Katz ---------------------------------------- STEVEN KATZ Chairman and Principal Executive Officer I, Ron Lipstein, certify that: 1. I have reviewed this annual report on Form 10-K of Ortec International, Inc.; 2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and c) presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officer and I have indicated in this annual report whether there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: April 14, 2003 /s/ Ron Lipstein --------------------------- RON LIPSTEIN Principal Financial Officer 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, 2002 and 2001 F-3 Statements of Operations for the years ended December 31, 2002, 2001 and 2000, and for the cumulative period from March 12, 1991 (inception) to December 31, 2002 F-5 Statement of Shareholders' Equity/(Deficit) for the cumulative period from March 12, 1991 (inception) to December 31, 2002 F-6 Statements of Cash Flows for the years ended December 31, 2002, 2001 and 2000, and for the cumulative period from March 12, 1991 (inception) to December 31, 2002 F-11 Notes to Financial Statements F-14 - F-42
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, 2002 and 2001, and the related statements of operations, shareholders' equity/(deficit) and cash flows for each of the three years in the period ended December 31, 2002, and for the period from March 12, 1991 (inception) to December 31, 2002. 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, 2002 and 2001, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2002, and for the period from March 12, 1991 (inception) to December 31, 2002, 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 1, the Company incurred a net loss of $21,578,021 during the year ended December 31, 2002, and, as of that date, the Company's current liabilities exceeded its current assets by $17,787,545, its total liabilities exceeded its total assets by $15,801,132, and the Company has a deficit accumulated in its development stage of $81,858,609. These factors, among others, as discussed in Note 1 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 1. The financial statements do not include any adjustments that might result from the outcome of this uncertainty. GRANT THORNTON LLP New York, New York March 31, 2003 F-2 Ortec International, Inc. (a development stage enterprise) BALANCE SHEETS December 31,
ASSETS 2002 2001 ----------- ----------- CURRENT ASSETS Cash and cash equivalents $ 826,227 $ 854,025 Accounts receivable 15,324 21,890 Due from New Jersey Economic Development Authority 82,433 Other current assets 41,904 87,083 ----------- ----------- Total current assets 883,455 1,045,431 PROPERTY AND EQUIPMENT, AT COST Laboratory equipment 1,671,075 2,126,771 Office furniture and equipment 1,350,985 982,948 Leasehold improvements 1,567,513 1,367,784 ----------- ----------- 4,589,573 4,477,503 Less accumulated depreciation and amortization (3,207,977) (2,894,782) ----------- ----------- 1,381,596 1,582,721 OTHER ASSETS Patent application costs, net of accumulated amortization of $279,037 in 2002 and $213,105 in 2001 682,885 619,676 Deferred financing costs, net of accumulated amortization of $7,933 in 2002 and $1,983 in 2001 78,207 57,517 Security deposit - New Jersey location 639,000 598,000 Other deposits and other assets 33,223 135,256 ----------- ---------- $ 3,698,366 $ 4,038,601 =========== ===========
F-3 Ortec International, Inc. (a development stage enterprise) BALANCE SHEETS (continued) December 31,
LIABILITIES AND SHAREHOLDERS' EQUITY/(DEFICIT) 2002 2001 ------------ ------------ CURRENT LIABILITIES Accounts payable and accrued expenses $ 3,773,063 $ 2,451,133 Accrued compensation 274,253 223,393 Accrued professional fees 365,945 301,783 Capital lease obligation - current 142,620 Loan payable - current 155,578 143,505 Other obligations 13,959,541 454,776 ------------ ------------ Total current liabilities 18,671,000 3,574,590 LONG-TERM LIABILITIES Loan payable - noncurrent 613,405 768,983 Capital lease obligation - noncurrent 215,093 Other long-term obligations 6,000,000 COMMITMENTS AND CONTINGENCIES SHAREHOLDERS' EQUITY/(DEFICIT) Common stock, $.001 par value; authorized, 35,000,000 shares; 23,204,693 shares issued, 23,184,693 shares outstanding, at December 31, 2002 and 9,711,608 shares issued, 9,691,608 outstanding, at December 31, 2001 23,205 9,712 Redeemable Convertible Preferred stock - Series B stated value $10,000 per share; authorized 1,000,000 shares; 938 shares issued and outstanding, at December 31, 2002, liquidation preference at December 31, 2002 is $9,382,942 5,037,087 Additional paid-in capital 61,174,830 53,017,615 Deficit accumulated during the development stage (81,858,609) (59,154,654) Treasury stock, at cost (20,000 shares at December 31, 2002 and 2001) (177,645) (177,645) ------------ ------------ (15,801,132) (6,304,972) ------------ ------------ $ 3,698,366 $ 4,038,601 ============ ============
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, 2002 2001 2000 2002 ------------ ------------ ------------ -------------- Product revenue $ 243,775 $ 21,890 $ -- $ 265,665 ------------ ------------ ------------ ------------ Expenses Research and development 3,147,515 4,283,038 4,191,317 21,195,907 Rent 683,116 589,238 535,443 2,862,651 Consulting 490,826 1,413,153 838,383 5,717,341 Personnel 6,440,959 6,605,630 4,763,662 29,390,319 General and administrative 2,781,896 2,671,887 2,297,769 14,784,581 Interest and other expense 7,281,104 536,070 89,712 8,300,610 Interest income (7,647) (191,749) (586,623) (2,257,096) Loss on extinguishment of debt and series A preferred shares 1,004,027 -- -- 1,004,027 ------------ ------------ ------------ ------------ 21,821,796 15,907,267 12,129,663 80,998,340 ------------ ------------ ------------ ------------ Net loss (21,578,021) (15,885,377) (12,129,663) (80,732,675) Preferred stock dividends 1,125,934 -- -- 1,125,934 ------------ ------------ ------------ ------------ Net loss applicable to common shareholders $(22,703,955) $(15,885,377) $(12,129,663) $(81,858,609) ============ ============ ============ ============ Net loss per share Basic and diluted $(2.01) $(1.64) $(1.37) $(15.54) ====== ====== ====== ======= Weighted average shares outstanding Basic and diluted 11,305,956 9,691,608 8,847,295 5,269,187 ============ ============ ============ ============
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 ------------------ Preferred paid-in development Treasury shareholders' Shares Amount stock 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 ------------------ Preferred paid-in development Treasury shareholders' Shares Amount stock 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 Preferred stock 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 Preferred stock 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)
F-9 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 Preferred stock capital stage stock equity/(deficit) --------- ------ --------------- ----------- ------------- --------- ---------------- (brought forward) 9,711,608 $ 9,712 $53,017,615 $(59,154,654) $(177,645) $ (6,304,972) Exercise of options and warrants 357,227 357 357 Stock options and warrants issued for services 113,060 113,060 Warrants issued with convertible debentures 440,523 440,523 Warrants issued with convertible redeemable preferred stock 559,289 559,289 Convertible debenture conversion benefit 1,042,663 1,042,663 Redeemable convertible preferred stock conversion benefit 1,097,886 1,097,886 Issuance of 938 shares of preferred stock $ 9,382,742 9,382,742 Warrants issued and exercised with preferred stock 9,382,742 9,383 (3,479,043) 3,476,998 7,338 Share issuance costs - preferred stock (866,612) 304,615 (561,997) Preferred stock dividends 3,753,116 3,753 1,122,181 (1,125,934) -- Net loss (21,578,021) (21,578,021) ---------- ------- ----------- ----------- ------------ ---------- ------------- Balance at December 31, 2002 23,204,693 $23,205 $ 5,037,087 $61,174,830 $(81,858,609) $(177,645) $(15,801,132) ========== ======= =========== =========== ============ ========== =============
The accompanying notes are an integral part of this statement. F-10 Ortec International, Inc. (a development stage enterprise) STATEMENTS OF CASH FLOWS
Cumulative from March 12, 1991 Year ended December 31, (inception) to ------------------------------------------ December 31, 2002 2001 2000 2002 ------------ ------------ ------------ -------------- Cash flows from operating activities Net loss $(21,578,021) $(15,885,377) $(12,129,663) $(80,732,675) Adjustments to reconcile net loss to net cash used in operating activities Depreciation and amortization 714,692 725,567 708,928 3,833,020 Amortization of deferred financing costs 323,225 323,225 Unrealized loss on marketable securities 11,404 Realized loss on marketable securities 5,250 Loss on sale of property and equipment 8,364 8,364 Non-cash stock compensation 113,060 188,080 56,265 3,154,231 Non-cash imputed interest 6,857,650 454,775 7,312,425 Loss on extinguishment of debt & Series A preferred stock 1,004,027 -- 1,004,027 Purchases of marketable securities (19,075,122) Sales of marketable securities 19,130,920 Changes in operating assets and liabilities Accounts receivable 6,566 (21,890) (15,324) Other current assets and other assets 188,645 (80,638) (87,177) 19,131 Accounts payable and accrued liabilities 1,436,952 1,634,233 (186,243) 4,441,589 ------------ ------------ ------------ ------------ Net cash used in operating activities (10,924,840) (12,985,250) (11,637,890) (60,579,535) ------------ ------------ ------------ ------------ Cash flows from investing activities Purchases of property and equipment, excluding capital leases (63,460) (518,456) (551,630) (4,453,897) Proceeds from sale of property and equipment 56,901 56,901 Payments for patent applications (129,140) (99,453) (90,363) (960,142) Organization costs (10,238) Deposits (702,924) 578 (731,273) Purchases of marketable securities (594,986) Sale of marketable securities 522,532 ------------ ------------ ------------ ------------ Net cash used in investing activities (135,699) (1,320,833) (641,415) (6,171,103) ------------ ------------ ------------ ------------
F-11 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, 2002 2001 2000 2002 ----------- ----------- ----------- --------------- Cash flows from financing activities Proceeds from issuance of notes payable $ 515,500 Proceeds from issuance of common stock $ 9,748,358 53,550,522 Proceeds from exercise of warrants $ 7,694 7,694 Share issuance expenses and other financing costs (906,571) (618,500) (4,511,676) Purchase of treasury stock (34,855) (177,645) Proceeds from issuance of loans payable 1,446,229 Proceeds from other obligations 4,000,000 6,000,000 10,000,000 Proceeds from issuance of convertible debentures 5,908,000 5,908,000 Proceeds from issuance of redeemable preferred stock - series A 1,200,000 1,200,000 Proceeds from issuance of preferred stock - series B 1,070,000 1,070,000 Repayment of capital lease obligations (91,728) (5,151) (198,932) Repayment of loan payable (143,505) (132,370) (122,096) (706,178) Repayment of other obligations (11,149) (11,149) Repayment of notes payable (515,500) ----------- ----------- ----------- ----------- Net cash provided by financing activities 11,032,741 5,867,630 8,967,756 67,576,865 ----------- ----------- ----------- ----------- NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (27,798) (8,438,453) (3,311,549) 826,227 Cash and cash equivalents at beginning of period 854,025 9,292,478 12,604,027 -- ----------- ----------- ----------- ----------- Cash and cash equivalents at end of period $ 826,227 $ 854,025 $ 9,292,478 $ 826,227 =========== =========== =========== ===========
F-12 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, 2002 2001 2000 2002 -------- ------- ------- -------------- Supplemental disclosures of cash flow information: Noncash financing activities Capital lease obligations $449,441 $ -- $ -- $568,344 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 -- -- 23,000 255,000 Dividends on series B preferred stock paid in common shares 1,125,934 -- -- 1,125,934 Share issuance expenses for series B preferred stock incurred through issuance of warrants 304,615 -- -- 304,615 Cash paid for interest 57,317 80,205 90,565 544,858 Cash paid for income taxes -- 44,528 41,286 199,576
The accompanying notes are an integral part of these statements. F-13 ORTEC INTERNATIONAL, INC. (a development stage enterprise) NOTES TO FINANCIAL STATEMENTS December 31, 2002, 2001 and 2000, and for the period from March 12, 1991 (Inception) through December 31, 2002 NOTE 1 - 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, a tissue engineered skin substitute for use in skin regeneration procedures (the "Technology"). Pursuant to a license agreement dated September 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. The Skin Group, Ltd. (the "Skin Group") also was formed as a Delaware corporation in March 1991, to raise funds for the 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 Ortec is a development stage enterprise, which had no operating revenue prior to December 2001. During 2001, the Company received Food and Drug Administration ("FDA") approval for the use of OrCel for treatment of patients with recessive dystrophic epidermolysis bullosa and donor sites in burn patients. The Company then began marketing and selling its product for use on patients with these indications. Revenues to date have not been significant, as the Company has been focusing its effort and resources towards its clinical trial for the use of OrCel for the treatment of venous stasis ulcers. The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. The Company incurred a net loss of $21,578,021 during the year ended December 31, 2002, and, as of that date, the Company's current liabilities exceeded its F-14 current assets by $17,787,545, its total liabilities exceeded its total assets by $15,801,132 and the Company has a deficit accumulated in its development stage of $81,858,609. 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. an investment banking firm, to act as its financial advisor in connection with raising capital for the Company through debt and/or equity financing. During 2002, Wainwright assisted the Company in raising financing of approximately $8.2 million. During 2003, the Company has raised an additional $2.0 million in Preferred Series B financing, as of February 26, 2003. The Company requires substantial funding to continue its research and development activities, clinical trials, manufacturing, sales, distribution and administrative activities. The Company believes that its cash and cash equivalents on hand at December 31, 2002, (approximately $0.8 million) and the financing of $2.0 million received in February 2003, will enable it to continue its operations until May 31, 2003. The Company is continuing its equity financing efforts with H.C. Wainwright and expects to raise an additional $5.0 million from investors, some of whom have previously participated in the $10.2 million raised through February 26, 2003. This will enable the Company to complete its venous clinical pivotal trial, file its PMA with the FDA and execute its plan to engage the services of a third party manufacturer. Accomplishing these milestones will also enable the Company to raise an additional $5.0 million in 2003 through other potential collaborative arrangements with companies for sales, marketing and distribution of its product and through other equity investments. Based on these efforts, management believes that the Company will be able to continue its operations for at least the next 12 months. Additionally, the Company continues 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 the Company, in exchange for manufacturing, marketing, distribution or other rights to its products. However, the Company can give no assurances 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 will be available to the Company on acceptable terms, if at all. If additional funding is not available when needed, the Company may not be able to continue operations. These financial statements have been prepared assuming that the Company will continue as a going concern. Successful future operations depend upon the successful development and marketing of the Company's OrCel product. Historically the Company has funded its operating losses by periodically raising additional sources of capital. If additional funding is not available to the Company when needed, the Company may not be able to continue operations. No adjustments have been made to the accompanying financials as a result 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, which was not exercised, expired on 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 which was not exercised, expired on December 31, 2000. F-15 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 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Revenue Recognition Product revenue is recognized upon shipment of OrCel to our customers. Research and Development Costs The Company is in the business of research and development and therefore, all research and development costs, including payments relating to products under development, research, consulting agreements and personnel costs, are expensed when incurred, and for 2001 and 2002, include the costs of production related to sales, as such costs are not readily separable. 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. 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 the life of the asset. Depreciation and amortization expense for the years ended December 31, 2002, 2001 and 2000, was approximately $649,000, $672,000 and $657,000, respectively. Intangible Assets and Impairment of Long - Lived Assets The Company's intangible assets consist of patent application costs. Patent application costs relate to the Company's U.S. patent applications and application fees in foreign jurisdictions and consist of legal and other direct fees. The recoverability of the patent application costs is dependent upon, among other matters, obtaining further FDA approvals for the use of the underlying technology. 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 provisions are necessary for the impairment of long-lived assets at December 31, 2002 and 2001. F-16 Effective January 1, 2002, the Company adopted Statement of Financial Accounting Standards ("SFAS") No. 142 Goodwill and Other Intangible Assets. Under SFAS No. 142, goodwill and indefinite lived intangible assets are no longer amortized but will be reviewed at least annually for impairment. Separable intangible assets that are not deemed to have an indefinite life will continue to be amortized over their useful lives. As of January 1, 2002, the Company does not have any goodwill or intangible assets with indefinite useful lives. The Company continues to amortize its patent application costs over their estimated useful lives. Additionally, the Company adopted SFAS No. 144 "Accounting for the Impairment or Disposal of Long-Lived Assets" on January 1, 2002. Adoption of SFAS No.142 and SFAS No.144 did not have a material effect on financial position or results of operation. Foreign Currency Translation The Company had conducted some of its research and development at its laboratory in Sydney, Australia. However, because all Australian expenditures were 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 measured 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. As of December 31, 2002, the Company terminated all of its research and development activities at its laboratory in Sydney. 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 effect 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. 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 and for the tax effects of net operating loss carryforwards. 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. The Company records a valuation allowance against its deferred tax assets when there is doubt about the realizability of such assets. F-17 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. Cash and cash equivalents includes approximately $15,000 and $2,000 at December 31, 2002 and 2001, respectively, of bank balances denominated in Australian dollars. 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 8 and 9.) The amount of options and warrants excluded are as follows:
Years ended December 31, 2002 2001 2000 ---------- --------- --------- Warrants 11,172,109 395,412 609,773 ---------- --------- --------- Stock Options - in plan 2,872,117 2,033,306 1,524,106 ---------- --------- --------- Stock Options - outside of plan 3,800,000 ----------
Additionally, the effects of conversion of the preferred stock were excluded from the computation of diluted net loss per share as the effect would be antidilutive. An aggregate of 9,382,742 shares of common stock would be issuable upon conversion of the preferred stock outstanding at December 31, 2002. Basic loss per share for the year ended December 31, 2002 includes the 800,000 warrants exercisable at $.001 per share granted to Wainwright as outstanding from the date of grant. Employee Stock Option Plan The Company accounts for its employee stock options under the recognition and measurement principles of APB Opinion No. 25, Accounting for Stock Issued to Employees, and related Interpretations. No stock-based employee compensation cost is reflected in net income for the years ended December 31, 2002, 2001 and 2000, as all options granted under these plans had an exercise price equal to the market value of the underlying common stock on the date of grant. The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of FASB Statement No.123, "Accounting for Stock-Based Compensation". F-18
Year ended December 31, ------------------------------------------ 2002 2001 2000 ------------ ------------ ------------ Net loss, as reported ($22,703,955) ($15,885,377) ($12,129,663) Deduct: Total stock-based employee compensation expense determined under fair value based method (1,965,592) (2,893,720) (1,818,469) ------------ ------------ ------------ Pro forma net loss ($24,669,547) ($18,779,097) ($13,948,132) ------------ ------------ ------------ Loss per share: Basic and Diluted - as reported ($2.01) ($1.64) ($1.37) Basic and Diluted - pro forma ($2.18) ($1.94) ($1.58)
NOTE 3 - CONCENTRATION OF CREDIT RISK The Company maintains cash and money market accounts at four financial institutions located in New York City and one in Australia. Cash accounts are insured by the FDIC for amounts up to $100,000. Uninsured balances aggregate to approximately $628,000 and $725,000 at December 31, 2002 and 2001, respectively. The Company has not experienced any losses in such accounts and believes it is not exposed to any significant credit risk. NOTE 4 - PATENTS Patent application costs are stated at cost less amortization computed by the straight-line method over the useful life of the patent, approximately 8 years remaining at December 31, 2002. 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 determined that no provision for impairment is necessary at December 31, 2002. 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 obligation (see Note 7). NOTE 5 - CAPITAL LEASE OBLIGATIONS Prior to 2002, 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. F-19 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. During 2002, the Company has drawn $449,000 against this line of credit for the acquisition of eligible fixed assets. As of December 31, 2002 and 2001, the Company has recorded $541,000 and $119,000 in equipment purchased under capital leases and $209,000 and $119,000 in accumulated amortization, respectively. See Note 11 for commitments under capital leases. NOTE 6 - 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 was 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 these loans are as follows:
Year ending December 31, 2003 212,503 2004 212,503 2005 212,503 2006 161,988 2007 and thereafter 121,688 -------- 921,185 Less amount representing interest 152,202 -------- Net present value of future loan payments $768,983 ======== Current portion $155,578 Non-current portion 613,405 -------- $768,983 ========
NOTE 7 - OTHER OBLIGATIONS On August 29, 2001, the Company entered into a Revenue Interests Assignment agreement with Paul Capital Royalty Acquisition Fund L.P. ("Paul Capital"), which terminates on August 29, 2011. 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. In February 2003, Paul Capital and the Company signed an amendment to the agreement, restating and updating certain provisions of the original agreement, including removing additional funding requirements by Paul Capital. On February 26, 2003, Paul Capital invested an additional $500,000 in Series B preferred stock, in concurrence with this amendment. F-20 In consideration for the $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. 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. Beginning on January 1, 2003, Paul Capital will be entitled to receive each year advances from the first proceeds to the Company from end user sales of its products in North America. The agreement provides for quarterly and annual accountings between Paul Capital and the Company for those advance payments. Such annual amounts that Paul Capital will be able to draw in advance will range from $600,000 in 2003 to $7,500,000 in 2005 and thereafter. The amounts received from Paul Capital have been classified as debt. Pursuant to the default provisions under the agreement, interest has been accrued at 30% per annum. At such time when the default provisions are no longer applicable, interest will be accrued based upon the expected level of future revenues, which may result in a lower imputed interest rate, with potential material financial impact. In the event of a change in control of the Company or upon the occurrence of certain other events, including insolvency, as defined in the agreement, Paul Capital has the option to put its revenue interest back to the Company for an amount of cash flows which will generate a 30% internal rate of return to Paul Capital. 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 of cash flows which will generate a 35% internal rate of return to Paul Capital. At December 31, 2002, the Company's liabilities exceeded the value of its assets and as such, the Company was technically in default of the solvency requirement under the Paul Capital agreement. Paul Capital is aware of this breech and in discussions with management regarding this issue, has indicated to the Company that it does not intend to exercise its option to require the Company to repurchase its revenue interest. 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. NOTE 8 - 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. F-21 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. 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. F-22 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. 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. F-23 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 $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 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. F-24 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 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. F-25 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. During 2002, the Company completed a private placement with several investors, in which the Company raised cash proceeds of $8.2 million through the issuance of debentures and preferred stock, which were ultimately converted into Series B redeemable convertible preferred shares, which were issued with warrants to purchase common shares and common stock dividends paid in advance. (See Note 9) In February 2003, the Company, with shareholder approval, increased the authorized amount of its common stock to 200,000,000 shares. The following table summarizes warrant activity during the period from March 12, 1991 (inception) through December 31, 2002 (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) ----------
F-26 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 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 Granted $.001 - $6.2475 22,210,148 Exercised $.001 (9,739,969) Expired $.001 - $14.50 (1,693,482) ---------- Balance, December 31, 2002 $.001 - $15.00 11,172,109 ==========
The following table summarizes warrant data as of December 31, 2002:
Weighted Average Weighted Weighted Remaining Average average Range of Number contractual Exercise Number exercise exercise prices outstanding life price exercisable price --------------- ----------- ----------- -------- ----------- -------- $.001 440,000 .08 years $ .001 440,000 $ .001 $1.50 to $2.00 10,621,277 6.87 years $ 1.72 -- -- $4.50 to $6.25 44,250 1.01 years $ 4.83 44,250 $ 4.83 $7.70 to $10.50 38,915 1.23 years $10.50 38,915 $10.50 $14.00 to $15.00 27,667 1.01 years $14.10 27,667 $14.10
F-27 NOTE 9- AMENDMENT OF THE COMPANY'S CERTIFICATE OF INCORPORATION AND ISSUANCES OF 12% CONVERTIBLE DEBENTURES, SERIES A PREFERRED STOCK AND SERIES B PREFERRED STOCK Amendment of Certificate of Incorporation- On June 25, 2002, the Company's board of directors unanimously adopted an amendment to the Company's certificate of incorporation designating 2,000 shares out of the 1,000,000 shares of preferred stock that the Company is authorized to issue, as Series A Convertible Preferred Stock, and designating the relative rights and preferences of the Series A Convertible Preferred Stock. The stated value, which is also the Liquidation Preference of the Series A Convertible Preferred Stock, is $10,000 per share. The Company is required to pay dividends on the Series A Preferred shares, at the rate of 6% per annum of the $10,000 Liquidation Preference per share, through June 30, 2003; at the rate of 9% per annum thereafter until June 30, 2004; and thereafter at the rate of 12% per annum. At the Company's option such dividends may be paid in the Company's common stock at the "conversion price" for the conversion of such dividends if such shares of common stock have been registered under the Securities Act of 1933 for sale in the public securities markets. The conversion price is fixed initially at $1.50 per share of the Company's common stock. On November 7, 2002, the Company's board of directors adopted an amendment to the Company's certificate of incorporation designating 2,000 shares out of the 1,000,000 shares of preferred stock, as Series B Convertible Preferred Stock at a stated value of $10,000 per share. Dividends on the Series B Preferred shares is payable at the rate of 12% per annum, in cash or shares of common stock, at the option of the Company, except that in the first year, dividends are payable, in advance, in shares of common stock. The Series B preferred stock is convertible into common shares at any time at the option of the investor, based on a fixed conversion rate of $1.00, or commencing after February 1, 2003, based on an alternative conversion rate equal to 90% of the average of the five lowest volume weighted average prices for the common stock for the twenty trading days immediately prior to conversion, subject to a floor price of $0.25. The fixed conversion rate may be adjusted downward if the Company subsequently issues common stock at a purchase price less than $0.50. In that event, the fixed conversion rate will be adjusted downward to the price of the new issuance. Conversion is mandatory upon the occurrence of certain financial events, such as, beginning six months from the date of issue, if the closing bid price of common shares exceeds $2.00 for a period of 20 consecutive trading days, or if within nine months from the date of issue, the Company completes a public offering, raising a minimum of $8 million. The alternative conversion price is adjustable or cancelable under certain circumstances, such as, in the event that the Company receives a licensing fee and/or a strategic investment of at least $5.0 million within six months of closing, the alternative conversion rate is adjusted to the common share price of the investment or is cancelled if the share price exceeds the fixed rate F-28 of $1.00. If within six months from date of issue, the Company receives a licensing fee with an upfront payment of at least $5.0 million, the alternative conversion rate is adjusted to the quoted closing stock price on the day of the public announcement or is cancelled if this closing price exceeds $1.00. Similarly, if the Company completes a subsequent public or private financing of a least $5.0 million within six months of closing, the alternative conversion rate is adjusted to the closing price or the fixed rate of $l.00, if lower. The preferred stock has redemption provisions, where upon occurrence of certain events, the holders can require the Company to redeem the shares. The redemption price is payable, at the option of the Company, in cash or in common stock. If the Company does not have sufficient authorized shares to effect the redemption payment in common stock, the Company may pay the remainder of the redemption in non-redeemable preferred stock with a dividend rate of 18%. Issuance of 12% Convertible Debentures, Series A Preferred Stock and Series B Preferred Stock: On March 27, 2002, the Company engaged H.C. Wainwright, an investment-banking firm, to act as its advisor and to assist with raising capital for the Company in the form of either debt or equity financing. On May 13, 2002, the Company sold $2,333,000 of 12% convertible debentures, which were convertible into common shares at the lesser of $3.36 or the price per share of the equity securities to be issued in a subsequent financing. These debentures, bear interest at the rate of 12% per annum, up to October 10, 2002 and 18% thereafter and are due on April 10, 2003. The Company also issued 291,625 stock purchase warrants as part of this May 13, 2002 financing, exercisable at $4.50 per share for up to 5 years from the date of grant. The warrants had price protection features whereby the price of the warrants can be reduced to the prices at which common stock or common stock equivalents are thereafter sold by Ortec. On June 28, 2002, $600,000 of these debentures sold on May 13, 2002 were converted into Series A Preferred Stock at 110% of face value plus accrued interest. Additionally, on June 28, 2002, the Company issued an additional $250,000 of 12% convertible debentures and $1,200,000 in Series A convertible preferred stock. The total face value of the preferred stock issued was $1,870,120 which consisted of the $1,200,000 of cash proceeds received, the $600,000 face value of converted debentures and the $70,120 of additional conversion face value and accrued interest. Additionally, the Series A preferred stock was convertible into common shares at a rate of $1.50 per share. The Series A preferred stock had provisions whereby redemption was out of the control of the Company, therefore, the preferred stock was classified in a manner similar to debt. On June 28, 2002, the Company also issued 654,624 stock purchase warrants, at an exercise price of $1.875 per common share for a five-year period. Of the 654,624, an aggregate of 31,250 warrants were issued with the debentures, with the remainder issued with the preferred stock. The warrants also had similar price protection features, whereby the price of the warrants can be reduced to the prices at which common stock or common stock equivalents are thereafter sold by the Company. F-29 The relative estimated fair value of the warrants issued in connection with the debentures of $422,000 was recorded as debt discount, as well as the estimated fair value of the beneficial conversion features of $1,042,663. Both of these values were being amortized over the remaining life of the convertible debentures, or through April 10, 2003. The relative estimated fair value of the warrants issued in connection with the Series A Preferred stock of $559,289 was recorded as a discount to the preferred stock and was accreted to interest expense, on the date of issuance. Additionally, the estimated fair value of the beneficial conversion feature of $1,097,886 has been recorded as an additional discount and accreted to interest expense. The Series A preferred stock has no redemption date, and therefore the charge to interest expense was reflected immediately as the conversion privilege was excercisable immediately. During the 3rd quarter of 2002, the Company issued $1,425,000 in convertible debentures, with terms comparable to those issued in the 2nd quarter. Additionally, 178,127 warrants were issued with similar terms to warrants issued on May 13, 2002. Additional debt discount of $18,523 related to the warrants was recorded in the third quarter, which was being amortized over the remaining useful life of the convertible debentures. In October and November 2002, the Company issued an additional $1,900,000 in convertible debentures and 237,501 warrants, with terms comparable to those issued on May 13, 2002. Upon conversion of all outstanding debentures into Series B preferred stock as discussed below, the remaining unamortized debt discounts relating to warrants and beneficial conversion features were charged to interest expense. These debentures along with the accrued interest were convertible into equity securities if the Company completed the sale of at least $5,000,000 in equity securities by July 12, 2002, which date was extended through November 13, 2002. On November 13, 2002, all outstanding debentures and accrued interest were converted into preferred stock with the closing of the Series B Preferred Stock financing. These were converted at the rate of 110% of the debentures plus accrued interest into $10,000 par value Series B Convertible preferred shares. In November and December 2002, the Company issued 938.2742 shares of Series B convertible preferred stock to several investors in a private placement, which was funded by an aggregate of $8,178,000 of financing received, which included $1,070,000 of new Series B preferred stock and the conversion of the aforementioned convertible debentures and convertible Series A preferred stock. The Company recorded a loss on extinguishment of debentures and preferred shares of $1,004,027, principally due to the additional buying power granted to the investors. The convertible debentures and convertible Series A preferred were converted at 110% of face value, plus accrued interest. In addition, these investors were granted Series A warrants, to purchase 9,382,742 shares of the Company's common stock at an exercise price of $.001. These Series A warrants vested immediately and were exercised immediately, upon grant. The investors were also granted Series B-1 and Series B-2 warrants, which can be used to purchase 5,429,891 and 4,691,386 shares of common stock at an exercise price of $1.50 and $2.00 per share, respectively. These B-1 are exercisable beginning August 13, 2003 and expire seven years from the date of grant and the B-2 warrants are exercisable beginning November 13, 2003 and expire 7 years from date of grant. The Company assigned values to the preferred stock and the Series A, Series B-1 and Series B-2 warrants issued to the investors of $5,903,699, $2,245,206, $694,447 and $539,390, based upon the relative fair market F-30 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. The warrants issued with the second quarter and third quarter financings were exchanged for B-1 warrants, issued in the fourth quarter and are included in the number of warrants issued in the prior paragraph. Dividends on the Series B preferred stock were paid in advance in November and December in common shares at the rate of 12% upon issue of the preferred shares and will be paid semiannually in subsequent years, in either cash or common shares, at the election of the Company, until at such time as the preferred stock is converted to common shares. In conjunction with this preferred stock financing the investors were paid a common stock dividend, whereby the investors were granted 3,753,116 shares of common stock, of which 2,934,888 shares were issued in November 2002 and 818,228 shares in January 2003. In addition, certain of the investors were given options to purchase, for one year and for amounts ranging from 100% to 200% of their investments, shares of the Series B Convertible Preferred stock at the price paid for such stock by investors on November 13, 2002. H.C. Wainwright & Company, Inc. ("Wainwright") acted as placement agent in this private placement. For its services as placement agent, the Company paid Wainwright $601,490 and granted Wainwright and its agents warrants to purchase 800,000 and 500,000 shares of common stock, at an exercise price of $.001 and $1.50, vesting immediately upon issue and November 13, 2003, respectively. These warrants will expire on January 31, 2003 and seven years from issue, respectively. In December 2002, the Company issued 357,227 shares of common stock relative to the $.001 warrants granted to Wainwright. The fair market value assigned to the Wainwright warrants was $280,000 and $24,615 for the $.001 warrants and the $1.50 warrants, respectively. Other share issuance costs, including non-cash costs, amounted to $155,997. Issuance costs for the Series B Preferred Stock are reflected as a reduction of the proceeds of the preferred stock. An additional 440,000 of warrants with an exercise price of $.001 were exercised in January 2003. An aggregate of 797,227 shares were issued pursuant to these warrants, which were substantially exercised using cashless exercise provisions in such warrants. Under EITF 00-19, "Accounting for Derivative Instruments Indexed to and Potentially Settled in the Company's Own Stock", as of December 31, 2002, the Series B Preferred stock is reflected as equity. NOTE 10 - 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, non-employee 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. F-31 In February 2003, the stockholders and Board of Directors ratified and approved an amended and restated Stock Option Plan, increasing the maximum number of shares of the Company's common stock for which stock options may be granted from 3,000,000 to 4,500,000 shares. As of December 31, 2002, 120,133 options were available for grant under the plan. The following table summarizes the stock option activity through December 31, 2002:
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 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 Granted 1,155,109 1.29 Forfeited, expired (316,298) 7.68 ---------
Balance, December 31, 2002 2,872,117 $ 5.73 =========
F-32 The following data has been provided for exercisable options:
December 31, ------------------------------------ 2002 2001 2000 ---------- ---------- ---------- Number of options 2,235,544 1,686,707 1,237,706 Weighted average exercise price $6.57 $8.93 $12.02 Weighted remaining contractual life 4.26 years 4.71 years 3.95 years
The exercise price for all stock options awarded within the plan are determined in accordance with the provisions of the Stock Option plan, as approved by the shareholders and Board of Directors of the Company. The weighted average fair value at the date of grant for options granted during the years ended December 31, 2002, 2001 and 2000 was $1.29, $3.83 and $4.37, respectively. The following table summarizes option data as of December 31, 2002:
Weighted Average Weighted Weighted Remaining average average Range of Number Contractual exercise Number exercise exercise prices outstanding life Price exercisable Price - --------------- ----------- ----------- -------- ----------- -------- $.30 to $.60 763,353 6.36 years $ 0.36 548,500 $ 0.38 $1.00 to $3.53 216,258 1.92 years $ 1.51 35,000 $ 3.53 $4.50 to $7.50 1,006,000 4.90 years $ 5.72 778,425 $ 5.64 $8.00 to $10.44 332,006 4.69 years 9.49 319,119 9.47 $10.50 to $14.25 540,500 0.89 years 12.30 540,500 12.30 $14.25 to $21.38 14,000 0.37 years 21.06 14,000 21.06 --------- --------- 2,872,117 4.26 years $ 5.73 2,235,544 $ 6.57 ========= ---------- ====== ========= ------
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 non-employees 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, 2002, 2001 and 2000. The following weighted average assumptions were made in estimating fair value. F-33
Year ended December 31, --------------------------- 2002 2001 2000 ------- ------- ------- Risk-free interest rate 3.5 % 4.6 % 4.5 % Expected option life 7 years 7 years 7 years Expected volatility 120.2 % 65.8 % 65 %
During the year ended December 31, 2002, the Company issued 3,800,000 options to senior executives, which were not included in the Plan. The exercise price of these options was $0.35, the market price on the date of grant. These options are vested immediately and expire seven years from date of issue. In addition, the Company recognized approximately $113,000, $188,000 and $56,000 in consulting expenses in 2002, 2001 and 2000, respectively, for options and warrants granted to independent consultants and investment bankers for services rendered to the Company. NOTE 11 - 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 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, 2002 and for the cumulative period since inception, no bonuses have been earned by Dr. Eisenberg. For each of the years ended December 31, 2002, 2001 and 2000, Dr. Eisenberg earned approximately $73,000 for consulting services and approximately $834,000 for the period from inception to December 31, 2002, which is included in research and development expense. Included in accrued compensation at December 31, 2002 and 2001 are $109,822 and $36,826, respectively, representing unpaid consulting fees to Dr. Eisenberg. F-34 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. During the quarter ended September 30, 2002, PDI commenced legal action against the Company, claiming that the Company owes them $205,000 for services that they have performed for the Company. The Company is in the process of discussing a settlement of the amount claimed with PDI. The Company has provided for estimated amounts due 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 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. This agreement was terminated as of December 31, 2000. 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 non-related third parties. The Company terminated this agreement effective December 31, 2002. F-35 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. During 2002, the Company terminated three of its leases, reducing the amount of space under lease and extended the term on its primary lease to June 2004. The Company utilizes its laboratory facilities to produce OrCel. On December 31, 2002, the Company amended the lease agreement with Columbia University, extending the lease term to June 2004, as mentioned above. With this amendment, the Company also obtained a waiver of its default for non - payment of past due rent and loan amounts, with an agreed payment plan of these past due amounts in 2003. Total rent expense for the years ended December 31, 2002, 2001 and 2000 was approximately $683,000, $589,000 and $535,000, respectively. 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. These premises would become available to the Company in two phases. The initial space, consisting of approximately 26,000 square feet, is in an existing building, which was to be renovated to the Company's specifications. The second phase, approximately 32,000 square feet, would be newly constructed and adjoining the initial space. On August 5, 2002, the Company reached an agreement with the New Jersey Economic Development Administration to terminate the December 2001 lease and to enter into a new lease covering only the initial space of approximately 26,000 square feet of production and office space. Due to the lower level of financing in 2002 than had originally been planned, the Company is currently engaged in discussions with the NJEDA to defer or terminate the lease entered into in August 2002. We can give no assurance that we will be able to defer or terminate this obligation or what damages, if any, incurred by NJEDA because of our failure to perform our obligations under this lease, we may have to pay. F-36 The minimum rental payments on non-cancelable leases with terms exceeding one year at December 31, 2002 are as follows:
Year ending December 31, Operating Leases Capital Leases - ------------------------ ---------------- -------------- 2003 820,000 175,156 2004 543,000 175,156 2005 416,000 58,717 2006 -- 2007 -- Thereafter -- ========= ======= Total 1,779,000 409,029 ========= Less: Amounts representing interest 51,316 ======= Principal Payments 357,713 ======= Current portion 142,620 Long-term portion 215,093 ======= 357,713 =======
Government Regulation The Company is 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 prior to commercial sale. Presently, the Company is continuing its clinical trials for the use of its product in the treatment of patients with venous leg ulcers and 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. NOTE 12 - LEGAL PROCEEDINGS The Company has been notified by Columbia University, the landlord of premises at 3960 Broadway in New York City, where we maintain our principal offices, laboratory and production facilities, that we have been delinquent in payment of rent. The Company has reduced the amount of the space leased from Columbia University, as part of our program to reduce spending. The Company has negotiated a pay out of the remainder of our unpaid obligations to Columbia. The Company's ability to make such payment is dependent on our ability to continue to secure additional equity financing. ClinTrials Networks, LLC (ClinTrials) has claimed that the Company has breached its agreement with them, which provided for ClinTrials to arrange and manage the FDA mandated clinical trials for use of our OrCel product for the treatment of venous stasis ulcers, and for other services. In October 2002, ClinTrials commenced an arbitration proceeding against the Company, claiming that the Company owes ClinTrials $165,936 and that ClinTrials reserves the right to claim additional amounts from the Company, based on continuing additional monthly fees ClinTrials claims that it is entitled to receive under their agreement with us. The Company has denied ClinTrials' claim and has advised ClinTrials that it is not in breach of its contract. In March 2003 the Company filed a counterclaim for overpayment of $75,000 under the terms of the contract, and as such, the Company has not provided for any additional amounts due under this contract. F-37 During the quarter ended September 30, 2002, PDI, Inc. commenced an action against the Company in the Superior Court of New Jersey, Bergen County, claiming that the Company owes $205,000 to PDI for services that they have performed for us. The Company is in the process of discussing a settlement of the amount claimed with PDI. The Company has provided for estimated amounts owed to PDI. In December 2002 Amarex LLC commenced an action against the Company in the Circuit Court for Montgomery County, Maryland. Amarex provided statistical programming and data management services for the Company for the data generated in the Company's clinical trials. Although in its complaint Amarex claims the Company owes it $2,457,875, that amount is the additional amount the Company would have had to pay Amarex if Amarex had performed all the work needed for all of the Company's contemplated clinical trials. The Company has answered Amarex's complaint denying Amarex's claim. The Company is negotiating with Amarex to establish the amount of services Amarex performed for the Company for which it has not already been paid and to arrange for payment of that amount. The Company has provided for estimated amounts due to Amarex. On August 5, 2002, the Company reached an agreement with the New Jersey Economic Development Administration to terminate the current lease of approximately 58,000 square feet and to enter into a new lease for approximately 26,000 square feet of production and office space in North Brunswick, New Jersey. The Company is currently in discussion with the NJEDA to defer or terminate this lease for 26,000 square feet. The Company is unable to estimate what amount may be payable to NJEDA to defer or terminate this agreement and accordingly, no amounts have been provided for in the accompanying financial statements. By letter dated June 27, 2002, the staff of the Nasdaq Stock Market, Inc., advised the Company that it had not met Nasdaq's requirements for continued listing of its common stock on the Nasdaq SmallCap market. On July 1, 2002, the Company appealed that determination and requested an oral hearing before the Nasdaq Listing Qualification Panel. At that hearing, which was held on August 8, 2002, the Company asked the panel to defer delisting the Company's common stock for up to six months, in order to give the Company time to complete its plan to raise sufficient capital to provide for the Company's cash needs for the next twelve months and enable the Company to meet Nasdaq's requirements for continued listing of its common stock on the Nasdaq SmallCap market. Nasdaq denied the Company's request and the Company's stock was moved to the Nasdaq Buletin Board and as such, still meets the listing requirements of the Company's preferred stock holders. NOTE 13 - 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 8). 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 8). F-38 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 and Termination of Employment Agreements 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. On December 5, 2002, these agreements, relating to three of the executive officers, were modified by the Company's Board of Directors. As modified, each of the three executive officers will receive certain benefits and compensation in the event of the individual's death, disability, retirement or if terminated without cause, as defined in the agreement. NOTE 14 - 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, 2002, the Company had net operating loss carry-forwards of approximately $17,877,000 for Federal and New York State income tax purposes expiring through 2022. 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 $30,873,000 and $23,294,000 at December 31, 2002 and 2001, respectively, has been recognized to offset entirely the Company's deferred tax assets, which arose primarily from the Company's operating loss carry-forwards and the deferral of start-up expenses for tax purposes and accrued interest, as the realization of such deferred tax assets is uncertain. Components of the Company's deferred tax asset are as follows:
December 31, --------------------------- 2002 2001 ------------ ------------ Net operating loss carry-forwards $ 7,508,000 $ 6,179,000 Deferral of start-up costs 21,029,000 16,757,000 Interest 1,825,000 -- Other 511,000 358,000 ------------ ------------
30,873,000 23,294,000 Valuation allowance (30,873,000) (23,294,000) ------------ ------------ Net deferred tax asset $ -- $ -- ============ ============
F-39 The following reconciles the income taxes computed at the Federal Statutory rate to the amounts recorded in the Company's statement of operations:
Year ended December 31, Cumulative from --------------------------------------- March 12, 1991 (inception) 2002 2001 2000 to December 31, 2002 ----------- ----------- ----------- -------------------------- Income tax benefit at the Statutory rate $(7,337,000) $(5,401,000) $(4,124,000) $(27,450,000) State and local income taxes, net of Federal benefit (1,443,000) (1,270,000) (961,000) (4,624,000) Permanent differences 1,201,000 -- -- 1,201,000 Effect of valuation allowance 7,579,000 6,671,000 5,085,000 30,873,000 ----------- ----------- ----------- ------------ Total $ -- $ -- $ -- $ -- =========== =========== =========== ============
The Company's net operating loss tax carry-forwards 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 December 31, 2022 3,164,000 ----------- $17,877,000 ===========
The Company's ability to utilize its net operating losses may be limited by changes in control, as defined in the Internal Revenue Code. NOTE 15 - OPERATIONS IN OTHER GEOGRAPHIC AREAS Long-lived assets, which consists of fixed assets and patents, are located as follows as of December 31, 2002 and 2001
2002 2001 ---------- ---------- United States $2,064,481 $2,139,341 Australia -- 63,056 ---------- ---------- $2,064,481 $2,202,397 ========== ==========
F-40 NOTE 16 - 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, loans 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. Loans 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 loans payable, capital lease obligations and other long-term obligations approximate the fair value. NOTE 17 - IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS On April 31, 2002, the FASB issued Statement of Financial Accounting Standard No.145, "Rescission of FASB Statements No.4, 44 and 64, Amendment of SFAS No.13, and Technical Corrections" ("SFAS no.145"). SFAS No.145 rescinds Statements No.4, which required all gains and losses from extinguishments of debt to be aggregated and, if material, classified as an extraordinary item, net of the related income tax effect. Upon adoption of SFAS No.145, companies will be required to apply the criteria in APB Opinion No.30, "Reporting the Results of Operations-Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions" in determining the classification of gains and losses resulting from the extinguishments of debt. SFAS No.145 is effective for fiscal years beginning after May 15, 2002. The Company is currently evaluating the requirements and impact of this statement on its results of operations and financial position. On July 30, 2002, the FASB issued Statement of Financial Accounting Standard No.146, "Accounting for Costs Associated with Exit or Disposal Activities" (SFAS N0.146"). The standard requires companies to recognize costs associated with exit or disposal activities when they are incurred rather than at the date of a commitment to an exit or disposal plan. Examples of costs covered by the standard include lease termination costs covered by the standard include lease termination costs and certain employee severance costs that are associated with a restructuring, discontinued operation, plant closing, or other exit or disposal activity. SFAS No.146 is to be applied prospectively to exit or disposal activities initiated after December 31, 2002. This statement will be applied prospectively to disposal activities initiated after December 31, 2002. F-41 Stock-Based Employee Compensation In December 2002, the FASB issued Statement 148 (SFAS 148), Accounting for Stock-Based Compensation -- Transition and Disclosure: an amendment of FASB Statement 123 (SFAS 123), to provide alternative transition methods for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, SFAS 148 amends the disclosure requirements of SFAS 123 to require prominent disclosures in annual financial statements about the method of accounting for stock-based employee compensation and the pro forma effect on reported results of applying the fair value based method for entities that use the intrinsic value method of accounting. The pro forma effect disclosures are also required to be prominently disclosed in interim period financial statements. This statement is effective for financial statements for fiscal years ending after December 15, 2002 and is effective for financial reports containing condensed financial statements for interim periods beginning after December 15, 2002, with earlier application permitted. The Company does not plan a change to the fair value based method of accounting for stock-based employee compensation and has included the disclosure requirements of SFAS 148 in the accompanying financial statements. NOTE 18 - QUARTERLY FINANCIAL DATA (UNAUDITED) Summarized quarterly financial for the years ended December 31, 2002 and 2001, is as follows: Quarter Ended
March 30th, June 30, September 30, December 31, ------------------------ ------------------------ ------------------------ ------------------------ 2002 2001 2002 2001 2002 2001 2002 2001 - ---------------------------------------------------------------------------------------------------------------------------- Revenues $ 116,415 $ -- $ 92,535 $ -- $ 34,825 $ -- $ -- $ 21,890 - ---------------------------------------------------------------------------------------------------------------------------- Net loss $(5,144,138) $(3,494,473) $(7,272,547) $(3,753,130) $(3,989,473) $(4,173,593) $(6,297,797) $(4,464,181) - ---------------------------------------------------------------------------------------------------------------------------- Net loss per share Basic and diluted $(.53) $(.36) $(.75) $(.39) $(.41) $(.43) $(.39) $(.46) - ----------------------------------------------------------------------------------------------------------------------------
NOTE 19 - SUBSEQUENT EVENTS Issuance of Series B Convertible Preferred Stock In February 2003, the Company received additional gross proceeds of $2 million from five investors, who had purchased the Company's Series B convertible preferred stock in November and December 2002, and from one new investor. The Company issued to the six investors 200 shares of the Company's convertible preferred stock, 2,923,077 shares of the Company's common stock, of which 923,077 common shares constituted the first year dividends on the 200 shares of Series B convertible preferred stock, which dividends were paid in advance. The investors were also granted warrants to purchase an additional 2,000,000 shares of common stock, of which warrants to purchase 1,000,000 shares are exercisable at $1.50 per share and warrants to purchase the other 1,000,000 shares are exercisable at $2.00 per shares. In March 2003, in addition to cash compensation, the Company also granted to H.C. Wainwright, and to one of its designees, for their services in arranging the aforementioned financing, warrants to purchase an aggregate of 376,923 shares of the Company's common stock, exercisable at $.001 per share. F-42 STATEMENT OF DIFFERENCES The trademark symbol shall be expressed as.................. 'TM' The section symbol shall be expressed as.................... 'SS' EX-3 3 ex3-2.txt EXHIBIT 3.2 Exhibit 3.2 CERTIFICATE OF AMENDMENT OF CERTIFICATE OF INCORPORATION OF ORTEC INTERNATIONAL, INC. It is hereby certified that: 1. The name of the Corporation (hereinafter called the "Corporation") is Ortec International, Inc. 2. The certificate of incorporation of the Corporation as previously amended and restated is hereby amended by striking out Article FOURTH thereof and by substituting in lieu of said Article the following new Article FOURTH and by adding a new Article ELEVENTH. FOURTH: 1. Authorized Capital Stock. The total number of shares of capital stock that the Corporation is authorized to issue is 201,000,000, consisting of 200,000,000 shares of common stock, par value $.001 per share ("Common Stock"), and 1,000,000 shares of preferred stock, par value $.001 per share ("Preferred Stock"). 2. Preferred Stock. The Board of Directors of the Corporation is hereby authorized to provide for the issuance of shares of Preferred Stock in one or more series, to increase or decrease the number of shares of Preferred Stock designated for any such series, and to fix the designation, relative powers, preferences, and rights and qualifications, limitations, or restrictions of all shares of such series. The authority of the Board of Directors with respect to each such series will include, without limiting the generality or effect of the foregoing, the determination of any or all of the following: (a) the voting powers, if any, and whether such voting powers are full or limited in such series; (b) the redemption provisions, if any, applicable to such series, including the redemption price or prices to be paid; (c) whether dividends, if any, will be cumulative or noncumulative, the dividend rate, if any, of such series, and the dates and preferences of dividends, if any, on such series; (d) the rights of such series upon the voluntary or involuntary dissolution of, or upon any distribution of the assets of, the Corporation; (e) the provisions, if any, pursuant to which the shares of such series are convertible into, or exchangeable for, shares of any other class or classes or of any other series of the same or any other class or classes of stock, or any other security, of the Corporation or any other corporation or other entity, and the price or prices or the rates of exchange applicable thereto; (f) the right, if any, to subscribe for or to purchase any securities of the Corporation or any other corporation or other entity; and (g) the provisions, if any, of a sinking fund applicable to such series; all as may be determined from time to time by the Board of Directors and stated in the resolution or resolutions providing for the issuance of such Preferred Stock (collectively, a "Preferred Stock Designation"). 3. Common Stock. Except as may otherwise be provided in a Preferred Stock Designation, the holders of Common Stock will be entitled to one vote on each matter submitted to a vote at a meeting of stockholders for each share of Common Stock held of record by such holder as of the record date for such meeting. ELEVENTH: The Board of Directors of the Corporation is hereby authorized in its discretion at any time prior to December 31, 2003, to amend the certificate of incorporation of the Corporation to effect a reverse stock split of the Corporation's outstanding shares of common stock at a ratio within the range from one share for each two shares outstanding to one share for each ten shares outstanding, without further approval or authorization of its stockholders. 3. The amendment of the certificate of incorporation herein certified has been duly adopted in accordance with the provisions of Section 242 of the General Corporation Law of the State of Delaware. Signed on February 11, 2003 /s/ Ron Lipstein --------------------------------- Name: Ron Lipstein Title: Secretary EX-23 4 ex23.txt EXHIBIT 23 EXHIBIT 23 CONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS We have issued our report dated March 31, 2003, accompanying the financial statements included in the Annual Report of Ortec International, Inc. on Form 10-K for the year ended December 31, 2002. We hereby consent to the incorporation by reference of said report in the Registration Statements of Ortec International Inc. on Form S-2 (File No. 333-102409, effective January 23, 2003) 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 March 31, 2003 EX-99 5 ex99-1.txt EXHIBIT 99.1 EXHIBIT 99.1 CERTIFICATION OF PRINCIPAL EXECUTIVE OFFICER Pursuant to 18 U.S.C. Section 1350, the undersigned officer of Ortec International, Inc. ("Ortec"), hereby certifies that Ortec's Annual Report on Form 10-K for the fiscal year ended December 31, 2002 (the "Annual Report") fully complies with the requirements of Section 13(a) or 15(d), as applicable, of the Securities Exchange Act of 1934 and that the information contained in the Annual Report fairly presents, in all material respects, the financial condition and results of operations of Ortec. Dated: April 14, 2003 /s/ Steven Katz - ---------------------------------------- Steven Katz Chairman and Principal Executive Officer EX-99 6 ex99-2.txt EXHIBIT 99.2 EXHIBIT 99.2 CERTIFICATION OF PRINCIPAL FINANCIAL OFFICER Pursuant to 18 U.S.C. Section 1350, the undersigned officer of Ortec International, Inc. ("Ortec"), hereby certifies that Ortec's Annual Report on Form 10-K for the fiscal year ended December 31, 2002 (the "Annual Report") fully complies with the requirements of Section 13(a) or 15(d), as applicable, of the Securities Exchange Act of 1934 and that the information contained in the Annual Report fairly presents, in all material respects, the financial condition and results of operations of Ortec. Dated: April 14, 2003 /s/ Ron Lipstein - --------------------------- Ron Lipstein Chief Financial Officer Principal Financial Officer -----END PRIVACY-ENHANCED MESSAGE-----