U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1998
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from _______________ to _________________
Commission file number: 0-21214
ORTHOLOGIC CORP.
(Exact name of registrant as specified in its charter)
Delaware 86-0585310
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) identification no.)
1275 West Washington Street, Tempe, Arizona 85281
(Address of principal executive offices)
Issuer's telephone number: (602) 286-5520
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $.0005 per share
(TITLE OF CLASS)
Rights to purchase 1/100 of a share of Series A Preferred Stock
(TITLE OF CLASS)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such report(s)), and (2) has been subject to
such filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of Registrant's knowledge, in 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 aggregate market value of the voting and non-voting common equity
held by non-affiliates of the registrant, based upon the closing bid price of
the registrant's Common Stock as reported on the Nasdaq National Market on March
1, 1999 was approximately $82,742,000. Shares of Common Stock held by each
officer and director and by each person who owns 10% or more of the outstanding
Common Stock have been excluded in that such persons may be deemed to be
affiliates. This determination of affiliate status is not necessarily
conclusive.
The number of outstanding shares of the registrant's Common Stock on
March 25, 1999 was 25,441,590.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's Annual Report to Stockholders for the
fiscal year ended December 31, 1998 are incorporated by reference in Part II
hereof and portions of the Registrant's Proxy Statement for the Annual Meeting
of Stockholders to be held on May 4, 1999 are incorporated by reference in Part
III hereof.
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ORTHOLOGIC CORP.
FORM 10-K ANNUAL REPORT
YEAR ENDED DECEMBER 31, 1998
TABLE OF CONTENTS
PART I
Item 1. Business........................................................... 1
Item 2. Properties......................................................... 10
Item 3. Legal Proceedings.................................................. 10
Item 4. Submission of Matters to a Vote of Security Holders................ 12
Executive Officers of the Registrant............................... 12
PART II
Item 5. Market for the Registrant's Common Equity and Related
Stockholder Matters........................................... 14
Item 6. Selected Financial Data............................................ 14
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations..................................... 14
Item 7A. Quantitative and Qualitative Disclosures About Market Risk..........20
Item 8. Financial Statements and Supplementary Data........................ 20
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure...................................... 20
PART III
Item 10. Directors and Executive Officers of the Registrant................. 21
Item 11. Executive Compensation............................................. 21
Item 12. Security Ownership of Certain Beneficial Owners and Management..... 21
Item 13. Certain Relationships and Related Transactions..................... 21
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.... 21
SIGNATURES...................................................................S-1
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PART I
ITEM 1. BUSINESS
GENERAL
The Company was incorporated as a Delaware corporation in July 1987 as
IatroMed, Inc. and changed its name to OrthoLogic Corp. in July 1991. Unless the
context otherwise requires, the "Company" or "OrthoLogic" as used herein refers
to OrthoLogic Corp. and its subsidiaries. The Company's executive offices are
located at 1275 West Washington Street, Tempe, Arizona 85281, and its telephone
number is (602) 286-5520.
OrthoLogic develops, manufactures and markets proprietary, technologically
advanced orthopedic products and packaged services for the orthopedic health
care market including bone growth stimulation devices, continuous passive motion
("CPM") devices and ancillary orthopedic recovery products and a therapeutic
injectable for relief of pain from osteoarthritis of the knee. OrthoLogic's
products are designed to enhance the healing of diseased, damaged, degenerated
or recently repaired musculoskeletal tissue. The Company's products focus on
improving the clinical outcomes and cost-effectiveness of orthopedic procedures
that are characterized by compromised healing, high-cost, potential for
complication and long recuperation time.
OrthoLogic periodically discusses with third parties the possible
acquisition of technology, product lines and businesses in the orthopedic health
care market and from time to time enters into letters of intent that provide
OrthoLogic with an exclusivity period during which it considers possible
acquisitions.
PRODUCTS AND OTHER PRODUCT DEVELOPMENT
OrthoLogic's product line includes bone growth stimulation and fracture
fixation devices, CPM devices and related products and Hyalgan. The Company's
product line is sold primarily through the Company's direct sales force.
ORTHOLOGIC(R) 1000; OL-1000 SC. The ORTHOLOGIC 1000 is a portable,
noninvasive physician prescribed magnetic field bone growth stimulator designed
for home treatment of patients who have a non-healing fracture. The ORTHOLOGIC
1000 comprises two magnetic field treatment transducers (coils) and a
microprocessor-controlled signal generator that delivers highly specific, low
energy combined static and alternating magnetic fields.
In 1989, the Company received U.S. Food and Drug Administration ("FDA")
clearance of an Investigational Device Exemption ("IDE") to conduct a clinical
trial of the ORTHOLOGIC 1000 for the treatment of patients with a specific
variety of non-healing fracture, called a nonunion fracture, of certain long
bones. A nonunion fracture was defined for the purposes of this study as a
fracture that remains unhealed for at least nine months post-injury. In 1990,
the Company received supplemental IDE clearance to conduct human clinical trials
of the ORTHOLOGIC 1000 on patients with another type of non-healing fracture
called a delayed union fracture. For purposes of this study, a delayed union
fracture was defined as a non-healing fracture five to nine months post-injury.
In March 1994, the FDA granted the Company's PreMarket Approval ("PMA") to
market the ORTHOLOGIC 1000 for treatment of nonunion fractures. During June
1998, the Company received the approval of the FDA to change the ORTHOLOGIC 1000
label to remove references to the nine months post injury time frame. The
revised label states that the ORTHOLOGIC 1000 is safe and effective for use in
treating non-union fractures.
In July 1997, the Company received a PMA supplement from the FDA for a
single-coil model of the ORTHOLOGIC 1000. The single-coil device, the OL-1000
SC, utilizes the same magnetic fields as the ORTHOLOGIC 1000, is available in
four sizes and is designed to be more comfortable for patients with fractures of
some long bones, such as the upper femur or the scaphoid. The Company released
this product during the first quarter of 1998.
CONTINUOUS PASSIVE MOTION. CPM devices provide controlled, continuous
movement to joints and limbs without requiring the patient to exert muscular
effort and are intended to be applied immediately following orthopedic trauma or
surgery. The products are designed to reduce swelling, increase joint range of
motion, reduce the length of hospital stay and reduce the incidence of
post-trauma and post-surgical complication. The primary use of CPM devices
occurs in the hospital and home environments, but they are also utilized in
skilled nursing facilities, sports medicine and rehabilitation centers.
ANCILLARY ORTHOPEDIC PRODUCTS. The Company offers a complete line of
bracing, electrotherapy, cryotherapy and dynamic splinting products. The bracing
line incudes post-operative, custom and pre-sized functional and osteoarthritis
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models. Post-operative braces are used in the early phases of post-surgical
rehabilitation while functional braces are applied as the patient returns to
work or sports activities. The electrotherapy line consists of TENS, NMES, high
volt pulsed current, interferential, and biofeedback units. Cryotherapy is used
to cool the operative or injured site in order to prevent pain and swelling.
OrthoLogic produces its own motorized cryotherapy device, the Blue Artic, which
provides temperature-controlled cold therapy using a reservoir of ice water and
a pump that circulates the water through a pad over the injury/surgical site.
HYALGAN. The Company began marketing Hyalgan to orthopedic surgeons during
July 1997 under a Co-Promotion Agreement with Sanofi Pharmaceuticals, Inc. (the
"Co-Promotion Agreement"). Hyalgan is used for relief of pain from
osteoarthritis of the knee for those patients who have failed to respond
adequately to conservative non-pharmacological therapy and to simple analgesics,
such as acetaminophen. Orthopedic surgeons administer Hyalgan in their offices,
with each patient receiving five injections over a period of four weeks. Hyalgan
is a preparation of highly purified sodium hyaluronate, a chemical found in the
body and present in high amounts in joints and synovial fluid. The body's own
hyaluronate plays a number of key roles in normal joint function, and in
osteoarthritis, the quality and quantity of hyaluronate in the joint fluid and
tissues may be deficient.
CHRYSALIN. In January 1998 the Company made a minority equity investment in
Chrysalis BioTechnology, Inc. As part of the transaction, the Company has been
awarded a world-wide exclusive option to license the orthopedic applications of
Chrysalin, a patented 23-amino acid peptide that has shown promise in
accelerating the healing process of fractured bones. In pre-clinical animal
studies, Chrysalin was shown to double the rate of fracture healing with a
single injection into the fracture gap. The Company conducted pre-clinical
studies during 1998, and, intends to submit an Investigational New Drug
Application ("INDA") to the FDA during 1999. However, there can be no assurance
that the Company will do so or that it would receive such approval if sought.
ORTHOFRAME(R). ORTHOFRAme products are external fixation devices constructed
of non-metallic carbon fiber-epoxy composite material. The ORTHOFRAME offers a
versatile design which can be utilized for immobilization of a wide array of
fracture types, including tibia, femur, ankle, elbow and pelvic fractures. The
ORTHOFRAME/MAYO Wrist Fixator is a specialized device developed in cooperation
with the Orthopedic Department of the Mayo Clinic, Rochester, Minnesota, for the
treatment of complex wrist (Colles) fractures. The Orthopedic Department of the
Mayo Clinic has agreed to provide ongoing clinical input on future design
enhancements for the ORTHOFRAME/MAYO Wrist Fixator. Both products utilize
non-metallic carbon fiber-epoxy materials to reduce device weight and are
radiolucent (I.E., eliminate the blocking of x-rays caused by metallic devices).
The Company believes that the patented fracture alignment mechanism of the
ORTHOFRAME products allows for simpler application, and the radiolucency and
light weight composite materials of the ORTHOFRAME products provide benefits to
both surgeon and patient. ORTHOFRAME products are shipped pre-assembled in
sterile packaging to increase ease-of-use for the surgeon and to reduce handling
and inventory expenses for the hospital.
SPINALOGIC(R) 1000. ThE SPINALOGIC 1000 is a portable, noninvasive magnetic
field bone growth stimulator being developed to enhance the healing process as
either an adjunct to spinal fusion surgery or as treatment for a failed spinal
fusion surgery. The Company believes that the SPINALOGIC 1000 offers benefits
similar to those of the ORTHOLOGIC 1000 in that it is relatively easy to use,
requires a small power supply and requires only 30 minutes of treatment per day.
The SPINALOGIC 1000 consists of one magnetic field treatment transducer and a
microprocessor-controlled signal generator, both of which are positioned near
the spine through use of an adjustable belt which the patient places around the
torso. The Company received approval of an IDE from the FDA in August 1992 and
commenced clinical trials for the SPINALOGIC 1000 as an adjunct to spinal fusion
surgery in February 1993. The Company received approval of an IDE supplement
from the FDA in September of 1995 to conduct a clinical trial of the SPINALOGIC
1000 as a noninvasive treatment for a failed spinal fusion surgery. The Company
commenced this on-going clinical trial in the fourth quarter of 1995. The
Company's application for a PMA Supplement was submitted to the FDA's Center for
Devices and Radiological Health with a filing date of August 20, 1998. This
acceptance indicates that the FDA has made a determination that the PMA
application, as supplemented, is sufficiently complete to permit a substantive
review. At the end of December, 1998 the Company submitted an amendment to the
PMA Supplement in response to requests from the FDA.
ORTHOSOUND(TM). The Company currently is conducting preclinical and a pilot
clinical trial relating to the design, development and testing of diagnostic and
therapeutic devices utilizing its nonthermal ultrasound technology
("ORTHOSOUND") for use in medical applications that relate to bone, cartilage,
ligament or tendon diagnostics and healing. In the area of diagnostics, the
ORTHOSOUND research projects address the potential use of ultrasound for the
assessment of bone strength and fracture risk in osteoporotic patients and the
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assessment of fracture healing. In therapeutic applications, the focus of the
ORTHOSOUND research is on the potential use of ultrasound for the treatment of
at-risk fractures to increase the healing rate and reduce the need for
subsequent surgical procedures. The Company has not yet applied for FDA approval
to market ORTHOSOUND based products, and there can be no assurance that the
Company will do so or that it would receive such approval if sought.
MARKETING AND SALES
The ORTHOLOGIC 1000, OL-1000 SC, the ORTHOFRAME and the ORTHONAIL are
prescribed by orthopedic surgeons and podiatrists practicing in private
practices, hospitals and orthopedic and podiatric treatment centers. The Company
is focusing its marketing and sales efforts on these groups, with particular
emphasis on those clinicians who treat bone healing problems. CPM products are
prescribed by orthopedic surgeons, hospitals, orthopedic trauma centers and
allied health professionals. CPM devices are leased to the patient, typically
for a period of one to three weeks. Orthopedic surgeons purchase Hyalgan from an
exclusive distributor who sells Hyalgan under an agreement with Sanofi
Pharmaceuticals, Inc. The Company's sales force calls on orthopedic surgeons to
provide them with product information relative to Hyalgan. Additionally, the
Company utilizes physician-to-physician selling via presentations and scientific
and clinical articles published in medical journals.
The Company's sales and marketing efforts are primarily conducted directly
through the Company's own sales people. Of the Company's approximately 501
employees at December 31, 1998, approximately 309 are involved in sales and
marketing. The Company employs 9 area vice presidents to manage territory sales,
each of whom has responsibility for the Company's sales and marketing efforts in
a designated geographic area. The Company's sales force services all product
lines.
Through the efforts of the Company's specialized direct sales force
servicing third party payors, the Company has contracted with over 425 third
party payors, including various Blue Cross/Blue Shield organizations, and the
Department of Veteran Affairs. In addition, the Company is an approved Medicare
provider and is also an approved Medicaid provider for a majority of states.
ORTHOFRAME and ORTHOFRAME/MAYO products are sold internationally through
distributors located in European and South American countries. Historically, the
Company's export sales as a percentage of net sales have been less than 1%. See
"Item 1 -- Business -- General."
While OrthoLogic has not experienced seasonality of revenues from sales of
the ORTHOLOGIC 1000 and ORTHOFRAME, revenues from leasing CPM equipment are
seasonal. CPM devices are used most commonly as adjuncts to surgery and
historically the strongest quarter tends to be the fourth quarter of the
calendar year. The Company believes this trend may be because (i) individuals
tend to put off elective surgical intervention until later in the year when
their insurance deductibles have been met, and (ii) sports-related injuries tend
to increase in the fall and winter months. The Company does not believe that
revenues for Hyalgan will be seasonal.
RESEARCH AND DEVELOPMENT
The Company's research and development staff presently includes 15
individuals, of whom 4 hold doctoral (Ph.D. or D.V.M.) degrees. Individuals
within the research and development organization have extensive experience in
the areas of biomaterials, bioengineering, animal modeling and cell biology.
Research and development efforts emphasize product engineering, activities
related to the clinical trials conducted by the Company and basic research. With
regard to basic research, the research and development staff conducts in-house
research projects in the area of fracture healing. The staff also supports and
monitors external research projects in biophysical stimulation of growth factors
and the potential use of ultrasound technology in diagnostic and therapeutic
applications relating to bone, cartilage, ligament or tendon. Both the in-house
and external research and development projects also provide technical marketing
support for the Company's products and explore the development of new products
and also additional therapeutic applications for existing products. Product
engineering activities are primarily related to improvements in the CPM devices.
The Company also has a clinical regulatory group that initiates and monitors
clinical trials. The Company's research and development expenditures totaled
$2.2 million, $2.3 million and $2.9 million in the years ended December 31,
1996, 1997 and 1998, respectively. See "Item 7 -- Management's Discussion and
Analysis of Financial Condition and Results of Operations."
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MANUFACTURING
The Company assembles the ORTHOLOGIC 1000 and OL-1000 SC from parts supplied
by third parties, performs tests on both the components and assembled product
and calibrates the assembled product to specifications. The Company currently
purchases the microprocessors used in the ORTHOLOGIC 1000 and OL-1000 SC from a
sole source supplier. The ORTHOLOGIC 1000 and OL-1000 SC are not dependent on
this microprocessor, and the Company believes that each could be redesigned to
incorporate another microprocessor. At any point in time, the Company maintains
a supply of the microprocessor on hand to meet its sales forecast for at least
one year. In addition, the magnetic field sensor employed in the ORTHOLOGIC 1000
and OL-1000 SC are available from two sources. Establishment of additional or
replacement suppliers for these components cannot be accomplished quickly. Other
components and materials used in the manufacture and assembly of the ORTHOLOGIC
1000 and OL-1000 SC are available from multiple sources.
The Company assembles CPM devices from parts that it manufactures in-house
or purchases from third parties. These parts are assembled, calibrated and
tested at the Company's facilities in Pickering (outside of Toronto), Canada.
The Company purchases several CPM components, including microprocessors, motors
and custom key panels from sole-source suppliers. The Company believes that its
CPM products are not dependent on these components and could be redesigned to
incorporate comparable components. The Company places orders for these
components to meet sales forecast for six months. Other components and materials
used in the manufacture and assembly of CPM products are available from multiple
sources.
Fidia S.p.A., an Italian corporation, manufactures Hyalgan under an
agreement with Sanofi Pharmaceuticals, Inc. Future revenues of the Company could
be adversely affected in the event Fidia S.p.A. experiences disruptions in the
manufacture of Hyalgan.
The Company assembles the ORTHOFRAME product from parts supplied by third
parties. The composite material components of the ORTHOFRAME products are
currently sourced from two vendors. Establishment of additional or replacement
suppliers for these components cannot be accomplished quickly. The Company
maintains a supply of these components on hand to meet its sales forecast for at
least six months. Other components and materials used in the manufacture and
assembly of the ORTHOFRAME products are readily available from multiple sources.
See "Item 7 -- Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Dependence on Key Suppliers."
The Company purchases other orthopedic products fully assembled from
third-party suppliers. These products are available from multiple sources.
COMPETITION
The orthopedic industry is characterized by rapidly evolving technology and
intense competition. With respect to the treatment of bone fractures, the
Company believes that patients with non-healing fractures are primarily treated
with surgery, and this represents the Company's primary competition, although
other manufacturers of noninvasive bone growth stimulators also represent
competition for the ORTHOLOGIC 1000 and OL-1000 SC. The Company's main
competitors for these products are Electro-Biology, Inc. ("EBI"), a subsidiary
of Biomet, Inc., OrthoFix International N.V. ("OrthoFix") and Biolectron Inc.
Exogen, Inc. markets a nonthermal ultrasound device for the acceleration of the
time to a healed fracture for closed, cast immobilized, fresh fractures of the
tibia and distal radius. With respect to the adjunctive treatment of spinal
fusion surgery, the Company expects its primary competitors for its products to
be EBI and OrthoFix. With respect to external fixation devices, the Company's
primary competitors are OrthoFix, Howmedica, Inc. (a subsidiary of Pfizer,
Inc.), EBI, Smith & Nephew Richards, Inc., Synthes, Inc. and ACE Orthopedic
Manufacturing (a division of Depuy, Inc.). The same group of companies and
Applied OsteoSystems, Inc. represent its primary competition in the internal
fixation market. The Company's primary competitors in the United States for CPM
devices are privately held Thera-Kinetics, Inc., many independent owners/lessors
of CPM devices and suppliers of traditional orthopedic rehabilitation services
including orthopedic immobilization and follow up physical therapy. The Company
also believes that there are several foreign CPM device manufacturers and
providers with whom the Company will compete if it increases international sales
efforts or as those competitors sell in the United States. The Company's primary
competitor for Hyalgan is Biomatrix, Inc.
Many of the Company's competitors have substantially greater resources and
experience in research and development, obtaining regulatory approvals,
manufacturing, and marketing and sales of medical devices and services, and
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therefore represent significant competition for the Company. The Company is
aware that its competitors are conducting clinical trials for other medical
applications of their respective technologies. In addition, other companies are
developing or may develop a variety of other products and technologies to be
used in CPM devices, the treatment of fractures and spinal fusions, including
growth factors, bone graft substitutes combined with growth factors, nonthermal
ultrasound and the treatment of pain associated with osteoarthritis of the knee.
The Company believes that competition is based on, among other factors, the
safety and efficacy of products in the marketplace, physician familiarity with
the product, ease of patient use, product reliability, reputation, price, sales
and marketing capability and reimbursement.
Any product developed by the Company that gains any necessary regulatory
approval will have to compete for market acceptance and market share in an
intensely competitive market. An important factor in such competition may be the
timing of market introduction of competitive products. Accordingly, the relative
speed with which the Company can develop products, complete clinical testing as
well as any necessary regulatory approval processes and supply commercial
quantities of the product to the market will be critical to its competitive
success. There can be no assurance the Company can successfully compete on these
bases. See "Item 7 -- Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Intense Competition" and "-- Rapid
Technological Change."
PATENTS, LICENSES AND PROPRIETARY RIGHTS
The Company's practice is to require its employees, consultants and advisors
to execute a confidentiality agreement upon the commencement of an employment or
consulting relationship with the Company. The agreements provide that all
confidential information developed by or made known to an individual during the
course of the employment or consulting relationship will be kept confidential
and not disclosed to third parties except in specified circumstances. In the
case of employees, the agreements provide that all inventions conceived by the
individual relating to the Company's business while employed by the Company
shall be the exclusive property of the Company. There can be no assurance,
however, that these agreements will provide meaningful protection for the
Company's trade secrets in the event of unauthorized use or disclosure of such
information.
It is also the Company's policy to protect its owned and licensed technology
by, among other things, filing patent applications for the technologies that it
considers important to the development of its business. The Company uses the
BIOLOGIC(R) technology in its bone growth stimulation devices through a
worldwide exclusive license granted by a corporation owned by university
professors who discovered the technology. With respect to the BIOLOGIC
technology, the delivery of such technology to the patient and specific
applications of such technology, the Company holds title to five United States
patents and to patents issued in Australia and Europe (Switzerland, Germany,
France, and the United Kingdom), as well as to a pending international
application and pending patent applications in the United States and Japan, and
holds an exclusive worldwide license to 27 United States patents, eight
Australian patents, five Canadian patents, two European patents (Germany,
France, the United Kingdom, Spain and Italy) and two Japanese patents. Currently
there is one pending patent application in Japan and multiple pending patent
applications in Canada and Germany. The Company's license for the BIOLOGIC
technology extends for the life of the underlying patents (which are due to
expire over a period of years beginning in 2006 and extending through 2016) and
covers all improvements and applies to the use of the technology for all medical
applications in man and animals. The license provides for payment of royalties
by the Company from the net sales revenues of products using the BIOLOGIC
technology. The license agreement can be terminated for breach of any material
provision of the license. See Note 6 of Notes to Consolidated Financial
Statements.
The Company holds an exclusive worldwide license to four United States
patents covering ORTHOFRAME products. The license, which extends for the life of
the underlying patents (the earliest of which issued in 1986) and covers all
improvements, provides for payment of royalties by the Company from the sales
revenues of ORTHOFRAME products. The license provides for minimum royalties of
$100,000 per calendar year. The license agreement can be terminated for breach
of any material provision of the license and, at the Company's option, upon 60
days' notice to the licensor. See Note 6 of Notes to Consolidated Financial
Statements.
The Company has been assigned four United States patents covering methods
for ultrasonic bone assessment by noninvasively and quantitatively evaluating
the status of bone tissue IN VIVO through measurement of bone mineral density,
strength and fracture risk. Additionally, patent applications are pending for
this technology in the United States, Canada, Japan, and Europe as well as two
pending international applications.
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With respect to CPM technology, the Company currently owns 17 United States
patents, one pending United States patent application, two Canadian patents,
three Canadian patent applications, two Japanese patents, and a European patent.
The issued United States patents on this technology are due to expire over a
period of years beginning in the year 2001 and extending through 2016. These
patents could expire at an earlier date if the patents are not maintained by
paying certain fees and/or annuities to the United States Patent and Trademark
Office and/or appropriate foreign patent offices at certain intervals over the
life of the patents. The pending United States patents, if issued, would begin
to expire over a period of time beginning around 2015, and could expire at an
earlier date, if not maintained as noted in the previous sentence.
ORTHOLOGIC(R), ORTHOLOGIC & DESIGN(R), ORTHOFRAME(R), BIOLOGIC(R),
SPINALOGIC(R), TOMORROW'S TECHNOLOGY TODAY(R), TALON(R), CASELOG(R),
ORTHOSONIC(R), LEGASUS SPORT CPM(R), LITELIFT(R), SPORTLITE(R), SUTTER(R),
DANNINGER MEDICAL(R), MOBILIMB(R), WAVEFLEX(R), AND TOTALCARE(R) are federally
registered trademarks of the Company. Additionally, the Company claims trademark
rights in PERIOLOGICTM, OSTEOLOGICTM, ORTHONAILTM, ORTHOSOUNDTM, QUICKFIXTM, CPM
9000ATTM, LEGASUS CPMTM, SUTTER CAREPLANTM, HOME REHAB SYSTEMTM and DANNIFLEXTM.
The Company has become aware of an assertion in Germany against one of its
CPM patents. The Company does not believe that it will have a material effect on
the Company. The Company is not aware of any other claims that have been
asserted against the Company for infringement of proprietary rights of third
parties. There can be no assurance, however, that third parties will not assert
infringement claims against the Company in the future.
GOVERNMENT REGULATION
The activities of the Company are regulated by foreign, federal, state and
local governments. Government regulation in the United States and other
countries is a significant factor in the development and marketing of the
Company's products and in the Company's ongoing manufacturing and research and
development activities. The Company and its products are regulated by the FDA
under a number of statutes, including the Medical Device Amendments Act of 1976
to the Federal Food, Drug and Cosmetic Act and the Safe Medical Devices Act of
1990 (collectively, the "FDC Act").
The Company's current BIOLOGIC technology-based products are classified as
Class III Significant Risk Devices, which are subject to the most stringent FDA
review, and are required to be tested under an IDE clinical trial and approved
for marketing under a PMA. To begin human clinical studies the Company must
apply to the FDA for an IDE. Generally, preclinical laboratory and animal tests
are required to establish a scientific basis for granting of an IDE. Once an IDE
is granted, clinical trials can commence which involve rigorous data collection
as specified in the IDE protocol. After the clinical trial is completed, the
data are compiled and submitted to the FDA in a PMA application. FDA approval of
a PMA application occurs after the applicant has established safety and efficacy
to the satisfaction of the FDA. The FDA approval process may include review by
an FDA advisory panel. Approval of a PMA application includes specific
requirements for labeling of the medical device with regard to appropriate
indications for use. Among the conditions for PMA approval is the requirement
that the prospective manufacturer's quality control and manufacturing procedures
comply with the FDA regulations setting forth Good Manufacturing Practices
("GMP"). The FDA monitors compliance with these requirements by requiring
manufacturers to register with the FDA, which subjects them to periodic FDA
inspections of manufacturing facilities. In addition, the Company must comply
with post-approval reporting requirements of the FDA. If violations of
applicable regulations are noted during FDA inspections, the continued marketing
of any products manufactured by the Company may be adversely affected. No
significant deficiencies have been noted in FDA inspections of the Company's
manufacturing facilities.
The ORTHOFRAME and ORTHOFRAME/MAYO WRIST FIXATOR are Class II devices. If a
medical device manufacturer can establish that a newly developed device is
"substantially equivalent" to a device that was legally marketed prior to May
28, 1976, the date on which the Medical Device Amendments Act of 1976 was
enacted, the manufacturer may seek marketing clearance from the FDA to market
the device by filing a 510(k) pre-market notification with the agency. The
Company obtained 510(k) pre-market notification clearances from the FDA for the
ORTHOFRAME and ORTHONAIL products.
The Company's CPM devices are Class I devices which do not require 510(k)
pre-market notification. However, CPM manufacturers must comply with GMP
regulations. The devices must also meet Underwriters Laboratories standards for
electrical safety. For sales to the European Community, CPM devices must meet
established electromechanical safety and electromagnetic emissions regulations.
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The Company also expects that the European Community will soon require
compliance with quality control standards. The Company believes that it
currently complies with the new standards.
Manufacturers outside the United States that export devices to the United
States may be subject to FDA inspection. The FDA generally inspects companies
every few years. The frequency of inspection depends upon the Company's status
with respect to regulatory compliance. To date, the Company's foreign operations
have not been the subject of any inspections conducted by the FDA.
Under Canada's Food and Drugs Act and the rules and regulations thereunder
(the "Food and Drugs Act"), the CPM devices sold by the Company do not require
any Canadian regulatory approvals prior to their introduction to the market.
However, the Company must provide Health and Welfare Canada with notice
concerning the sale of a device. Notice for all of the CPM devices currently
manufactured by the Company in Canada has been provided to Health and Welfare
Canada. Subsequent to such notification, Health and Welfare Canada may request
the Company to provide it with the results of the testing conducted on the
device. If the results of such testing do not substantiate the nature of the
benefits claimed to be obtainable from the use of the device or the performance
characteristics claimed for such device to the satisfaction of Health and
Welfare Canada, the sale of the device in Canada would be prohibited until
appropriate results had been submitted. The Company has not been asked to
provide such testing results to the Canadian authorities.
CPM devices must comply with the applicable provincial regulations regarding
the sale of electrical products by receiving the prior approval of either the
Canadian Standards Association ("CSA") or the provincial hydro-electric
authority, unless the device is otherwise exempt from such requirement. To date,
the Company believes that its CPM devices have, unless otherwise exempt,
obtained such necessary approvals prior to introduction to the market.
The FDC Act regulates the labeling of medical devices to indicate the uses
for which they are approved, both in connection with PMA approval and
thereafter, including any sponsored promotional activities or marketing
materials distributed by or on behalf of the manufacturer or seller. A
determination by the FDA that a manufacturer or seller is engaged in marketing
of a product for other than its approved use may result in administrative, civil
or criminal actions against the manufacturer or seller.
Regulations governing human clinical studies outside the United States vary
widely from country to country. Historically, some countries have permitted
human studies earlier in the product development cycle than the United States.
This disparity in regulation of medical devices may result in more rapid product
approvals in certain foreign countries than the United States, while approvals
in countries such as Japan may require longer periods than in the United States.
In addition, although certain of the Company's products have undergone clinical
trials in the United States and Canada, such products have not undergone
clinical studies in any other foreign country and the Company does not currently
have any arrangements to begin any such foreign studies.
Hyalgan is considered a Class III Significant Risk Device and is subject to
the same clinical trial and GMP reviews as described for the BIOLOGIC
technology-based products. The product is manufactured by Fidia S.p.A. in Italy
and is imported into the United States. As a result, each shipment of the
product into the United States is subject to inspections, including by the
United States Department of Agriculture. The import of Hyalgan could be delayed
or denied for numerous reasons, and, if this occurs, it could have a material
adverse affect on sales of the product. To the Company's knowledge, no
significant deficiencies have been noted in the FDA inspections of Fidia
S.p.A.'s manufacturing facility.
The process of obtaining necessary government approvals is time-consuming
and expensive. There can be no assurance that the necessary approvals for new
products or applications will be obtained by the Company or, if they are
obtained, that they will be obtained on a timely basis. Furthermore, the Company
or the FDA must suspend clinical trials upon a determination that the subjects
or patients are being exposed to an unreasonable health risk. The FDA may also
require post-approval testing and surveillance programs to monitor the effects
of the Company's products. In addition to regulations enforced by the FDA, the
Company is also subject to regulations under the Occupational Safety and Health
Act, the Environmental Protection Act, the Toxic Substances Control Act, the
Resource Conservation and Recovery Act and other present and potential future
federal, state and local regulations. The ability of the Company to operate
profitably will depend in part upon the Company obtaining and maintaining all
necessary certificates, permits, approvals and clearances from the United States
and foreign and other regulatory authorities and operating in compliance with
applicable regulations. Failure to comply with regulatory requirements could
have a material adverse effect on the Company's business, financial condition
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and results of operations. Regulations regarding the manufacture and sale of the
Company's current products or other products that may be developed or acquired
by the Company are subject to change. The Company cannot predict what impact, if
any, such changes might have on its business. See "Item 7 -- Management's
Discussion and Analysis of Financial Condition and Results of Operations --
Government Regulation" and "-- Condition of Acquired Facilities."
THIRD PARTY PAYMENT
Most medical procedures are reimbursed by a variety of third party payors,
including Medicare and private insurers. The Company's strategy for obtaining
reimbursement authorization for its products is to establish their safety,
efficacy and cost effectiveness as compared to other treatments. The Company is
an approved Medicare provider and is also an approved Medicaid provider for a
majority of states. The Company contracts with over 425 third party payors as an
approved provider for its fracture healing and orthopedic rehabilitation
products, including the Department of Veterans Affairs and various Blue
Cross/Blue Shield organizations. Because the process of obtaining reimbursement
for products through third-party payors is longer than through direct invoicing
of patients, the Company must maintain sufficient working capital to support
operations during the collection cycle. In addition, third party payors as an
industry have undergone consolidation, and that trend appears to be continuing.
The concentration of such economic power may result in third party payors
obtaining additional leverage and thus negatively affecting the Company's
profitability and cash flows.
As part of the Company's efforts to establish its primary products as
treatments of choice among third party payors, the Company has entered into two
consulting agreements with practicing physicians. These physicians were retained
by the Company to increase product acceptance, respond to inquiries from other
clinicians regarding the Company's products or to assist the Company in seeking
third party payor endorsement of practice pattern changes. Significant
uncertainty exists as to the reimbursement status of newly approved health care
products, and there can be no assurance that adequate third party coverage will
continue to be available for the Company's products at current levels. See "Item
7 -- Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Limitations on Third Party Payment; Uncertain Effects of Managed
Care."
PRODUCT LIABILITY INSURANCE
The business of the Company entails the risk of product liability claims.
The Company maintains a product liability and general liability insurance policy
and an umbrella excess liability policy. There can be no assurance that
liability claims will not exceed the coverage limit of such policies or that
such insurance will continue to be available on commercially reasonable terms or
at all. Consequently, product liability claims could have a material adverse
effect on the business, financial condition and results of operations of the
Company. The Company has not experienced any product liability claims to date
resulting from its Fracture Healing Products. To date, liability claims
resulting from the Company's CPM Products have not had a material adverse effect
on business. Additionally, the agreements by which the Company acquired its CPM
businesses generally require the seller to retain liability for claims arising
before the acquisition. See "Item 7 -- Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Risk of Product Liability
Claims."
YEAR 2000 COMPLIANCE
The inability of computers, software and other equipment utilizing
microprocessors to recognize and properly process data fields containing a 2
digit year is commonly referred to as the Year 2000 Compliance issue. As the
Year 2000 approaches, such systems may be unable to accurately process certain
data-based information.
STATE OF READINESS: The Company has implemented a Year 2000 Corporate
Compliance Plan for coordinating and evaluating compliance activities in all
business activities. The Company's Plan includes a series of initiatives to
ensure that all the Company's computer equipment and software will function
properly in the next millennium. "Computer equipment (or hardware) and software"
includes systems generally thought of as IT dependent, as well as systems not
obviously IT dependent, such as manufacturing equipment, telecopier machines,
and security systems.
The Company began the implementation of this plan in fiscal year 1998. All
internal IT systems and non-IT systems were inventoried during the assessment
phase of the plan. The first execution of the plan occurred in June 1998 when
the Company converted all internal processing systems for accounting,
manufacturing, third party billing, inventory and other operational processes to
the Year 2000 compliant software. In addition, in the ordinary course of
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business, as the Company periodically replaces computer equipment and software,
it will acquire only Year 2000 compliant products. The Company presently
believes that its software replacements and planned modifications of certain
existing computer equipment and software will be completed on a timely basis so
as to avoid any of the potential Year 2000 related disruptions or malfunctions
of its computer equipment and software.
The Company has completed its compliance review of virtually all of its
products and has not learned of any products that it manufactures that will
cease functioning or experience an interruption in operations as a result of the
transition to the Year 2000.
COSTS: The Company has used both internal and external resources to
reprogram or replace, test and implement its IT and non-IT systems for Year 2000
modifications. The Company does not separately track the internal costs incurred
to date on the Year 2000 compliance. Such costs are principally payroll and
related costs for internal IT personnel. The costs to date have been less than
$100,000. Future costs related to Year 2000 compliance are anticipated to be
less than $100,000 for fiscal year 1999. External costs have been incurred for
the normal system upgrades and software conversions related to other operational
requirements.
RISKS: The Company believes it has an effective Plan in place to anticipate
and resolve any potential Year 2000 issues in a timely manner. In the event,
however, that the Company does not properly identify Year 2000 issues or that
compliance testing is not conducted on a timely basis, there can be no assurance
that Year 2000 issues will not materially and adversely affect the Company's
results of operations or relationships with third parties. In addition,
disruptions in the economy generally resulting from Year 2000 issues also could
materially and adversely affect the Company. The amount of potential liability
and lost revenue that would be reasonably likely to result from the failure by
the Company and certain key parties to achieve Year 2000 compliance on a timely
basis cannot be reasonably estimated at this time.
The Company currently believes that the most likely worst case scenario
with respect to the Year 2000 issue is the failure of third party insurance
payors to become compliant, which could result in the temporary interruption of
the payments received for services and products purchased. This could interrupt
cash payments received by the Company, which in turn would have a negative
impact on the Company.
CONTINGENCY PLAN: A contingency plan has not yet been developed for dealing
with the most likely worst case scenarios. As part of its continuous assessment
process, the Company is developing contingency plans as necessary. These plans
could include, but are not limited to, use of alterative suppliers and vendors,
substitutes for banking institutions, and the development of alternative
payments solutions in dealing with third party payors. The Company currently
plans to complete such contingency planning by October 1999.
These plans are based on management's best estimates, which were derived
utilizing numerous assumptions of future events including the continued
availability of certain resources, third party modification plans and other
factors. However, there can be no guarantee that these estimates will be
achieved and actual results could differ from those plans.
EMPLOYEES
As of December 31, 1998, the Company had 501 employees, including 309 in
sales and marketing, 15 in research and development and clinical and regulatory
affairs, approximately 4 in managed care, 83 in reimbursement and 90 in
manufacturing, finance and administration. The managed care staff is charged
with changing the practice patterns of the orthopedic community through the
influence of third party payors on treatment regimes. The Company believes that
the success of its business will depend, in part, on its ability to identify,
attract and retain qualified personnel. In the future, the Company will need to
add additional skilled personnel or retain consultants in such areas as research
and development, manufacturing and marketing and sales. The Company considers
its relationship with its employees to be good. See "Item 7 -- Management's
Discussion and Analysis of Financial Condition and Results of Operations --
Dependence on Key Personnel; Recent Management Changes."
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ITEM 2. PROPERTIES
The Company leases facilities in Tempe, Arizona and Pickering, Ontario,
Canada. These facilities are designed and constructed for industrial purposes
and are located in industrial districts. Each facility is suitable for the
Company's purposes and is effectively utilized. The table below sets forth
certain information about the Company's principal facilities.
Approx.
Location Square Feet Lease Expires Description Principal Activity
- - -------- ----------- ------------- ----------- ------------------
Tempe 80,000 11/07 2-story, in industrial Assembly,
park Administration
Pickering 28,500 2/99 1-story, in CPM assembly
industrial park
The Company believes that each facility is well maintained.
In 1997, the Company consolidated all CPM manufacturing in its Toronto
facility and all CPM administrative and service functions in Phoenix. The
Company has ceased operations at facilities in San Diego, California in
connection with the consolidation. See "Item 7 -- Management's Discussion and
Analysis of Financial Condition Results of Operations -- Condition of Acquired
Facilities."
ITEM 3. LEGAL PROCEEDINGS
On June 24, 1996, and on several days thereafter, lawsuits were filed in the
United States District Court for the District of Arizona against the Company and
certain officers and directors alleging violations of Sections 10(b) of the
Securities Exchange Act of 1934 ("Exchange Act") and SEC Rule 10b-5 promulgated
thereunder, and, as to other defendants, Section 20(a) of the Exchange Act. See
"Item 7 -- Management's Discussion and Analysis of Financial Condition Results
of Operations -- Potential Adverse Outcome of Litigation." These lawsuits are:
Mark Silveria v. Allan M. Weinstein, Allen R. Dunaway, David E. Derminio and
OrthoLogic Corporation, Cause No. CIV 96-1563 PHX EHC, filed in the United
States District Court for the District of Arizona (Phoenix Division) on July 1,
1996.
Derric C. Chan and Anna Chan as attorney in fact for Moon-Yung Chow, on
behalf of themselves and all others similarly situated v. OrthoLogic
Corporation, Allan M. Weinstein, Frank P. Magee and David E. Derminio, Cause No.
CIV 96-1514 PHX RCB, filed in the United States District Court for the District
of Arizona (Phoenix Division) on June 21, 1996.
Jeffrey M. Boren and Charles E. Peterson, Jr., on behalf of themselves and
all others similarly situated v. Allan M. Weinstein and OrthoLogic Corp., Cause
No. CIV 96-1520 PHX RCB, filed in the United States District Court for the
District of Arizona on June 24, 1996.
Jeffrey Draker, on behalf of himself and all others similarly situated v.
Allan M. Weinstein and OrthoLogic Corp., Cause No. CIV 96-1667 PHX RCB, filed in
the United States District Court for the District of Arizona (Phoenix Division)
on July 16, 1996.
Edward and Eleanor Katz v. OrthoLogic Corp. and Allan M. Weinstein, Cause
No. CIV 96-1668 PHX RGS, filed in the United States District Court for the
District of Arizona (Phoenix Division) on July 17, 1996.
Mark J. Rutkin, Paul A. Wallace, Malcolm E. Brathwaite, Elaine K. Davies and
David G. Davies, Larry E. Carder and Carl Hust, on behalf of themselves and all
others similarly situated v. Allan M. Weinstein, Allen R. Dunaway, David E.
Derminio and OrthoLogic Corp., Cause No. CIV 96-1678 PHX EHC, filed in the
United States District Court for the District of Arizona (Phoenix Division), on
July 17, 1996.
Frank J. DeFelice, on behalf of himself and all others similarly situated v.
OrthoLogic Corp. and Allan M. Weinstein, Cause No. CIV 96-1713 PHX EHC, filed in
the United States District Court for the District of Arizona (Phoenix Division),
on July 23, 1996.
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Scott Longacre, Joseph E. Sheedy, Trustee, Rickie Trainor, W. Preston
Battle, III, Taylor D. Shepherd, Dianna Lynn Shepherd, Gordon H. Hogan, Trustee,
and Dallas Warehouse Corp., Inc., on behalf of themselves and all others
similarly situated v. Allan M. Weinstein, Allen R. Dunaway, David E. Derminio,
Frank P. Magee and OrthoLogic Corp., Cause No. CIV 96-1891 PHX PGR, filed in the
United States District Court for the District of Arizona (Phoenix Division) on
August 16, 1996.
Jeffrey D. Bailey, Milton Berg, Bryan Boatwright, Charles R. Campbell, Mark
and Cathy Daniel, Tom Drotar, Rudy Gonnella, David Gross, Janet Gustafson, Willa
P. Koretz, Dr. Richard Lewis, John Maynard, Margaret Milosh, Michelle Milosh,
Theresa L. Onn, Ward B. Perry, William Schillings, Darwin and Merle Sen, Nestor
Serrano and Larry E. and Gloria M. Swanson v. Allan M. Weinstein, Allen R.
Dunaway, David E. Derminio and OrthoLogic Corporation, Cause No. CIV 96-1910 PHX
PGR, filed in the United States District Court for the District of Arizona
(Phoenix Division) on August 19, 1996.
Nancy Z. Kyser and Mark L. Nichols, on behalf of themselves and all others
similarly situated v. OrthoLogic Corporation, Allan M. Weinstein, Frank P. Magee
and David E. Derminio, Cause No. CIV 96-1937 PHX ROS, filed in the United States
District Court for the District of Arizona (Phoenix Division) on August 22,
1996.
Plaintiffs in these actions allege generally that information concerning the
May 31, 1996 letter received by the Company from the FDA regarding the Company's
OrthoLogic 1000 Bone Growth Stimulator, and the matters set forth therein, was
material and undisclosed, leading to an artificially inflated stock price.
Plaintiffs further allege that the Company's non-disclosure of the FDA
correspondence and of the alleged practices referenced in that correspondence
operated as a fraud against plaintiffs, in that the Company allegedly made
untrue statements of material facts or omitted to state material facts necessary
in order to make the statements not misleading. Plaintiffs further allege that
once the FDA letter became known, a material decline in the stock price of the
Company occurred, causing damage to plaintiffs. All plaintiffs seek class action
status, unspecified compensatory damages, fees and costs. Plaintiffs also seek
extraordinary, equitable and/or injunctive relief as permitted by law. Pursuant
to court orders dated December 17, 1996 and January 19, 1997, the preceding
actions were consolidated for all purposes before Judge Broomfield in Arizona
federal district court, and lead plaintiffs and counsel were appointed.
Thereafter, the Company and its officers and directors moved to dismiss the
consolidated amended complaint for failure to state a claim. On February 5,
1998, Judge Broomfield dismissed the consolidated amended complaint in its
entirety against the Company and its officers and directors, giving plaintiffs
leave to amend all claims to cure all deficiencies. Plaintiffs have filed an
amended complaint, and the cases are pending.
On or about June 20, 1996, a lawsuit entitled Norman Cooper, et al. v.
OrthoLogic Corp., et al., Cause No. CV 96- 10799, was filed in the Superior
Court, Maricopa County, Arizona. The plaintiffs allege violations of Arizona
Revised Statutes Sections 44-1991 (state securities fraud) and 44-1522 (consumer
fraud) and common law fraud based upon factual allegations substantially similar
to those alleged in the federal court class action complaints. Plaintiffs also
seek class action status, unspecified compensatory and punitive damages, fees
and costs. Plaintiffs also seek injunctive and/or equitable relief. By agreement
of the parties, that action has been stayed while the federal actions proceed.
On or about July 16, 1996, Jacob B. Rapoport filed a Shareholder Derivative
Complaint for Breach of Fiduciary Duty and Misappropriation of Confidential
Corporation Information (based on similar factual issues underlying the above
lawsuits) in the Superior Court of the State of Arizona, Maricopa County, No. CV
96-12406 against Allan M. Weinstein, John M. Holliman, Augustus A. White,
Fredric J. Feldman, Elwood D. Howse, George A. Oram, Frank P. Magee and David E.
Derminio, Defendants and OrthoLogic Corp., Nominal Defendant. On October 29,
1996 the defendants removed the case to the United States District Court for the
District of Arizona (Phoenix Division) No. CIV 96-2451 PHX RCB on grounds of
diversity pursuant to 28 U.S.C. ss. 1332. Defendants filed a motion to dismiss
the complaint. By agreement of the parties, the case had been stayed pending a
decision on defendants' motion to dismiss the consolidated amended class action
complaint. The case continues to be stayed pending plaintiffs' amendment of
their consolidated amended class action complaint in compliance with the Court's
Order of Dismissal.
The Company continues to deny the substantive allegations in the aforesaid
lawsuits and will continue to defend the action vigorously.
In February 1997, the Company received a letter from the California
Department of Industrial Relations Division of Occupational Safety and Health
regarding an informal complaint involving certain physical problems with one of
the facilities leased by Sutter prior to its acquisition by the Company. The
Company responded to the letter in March 1997
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and believes that it has addressed the issues raised in that letter. See "Item 2
- - -- Properties" and "Item 7 -- Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Condition of Acquired Facilities."
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
EXECUTIVE OFFICERS OF THE REGISTRANT
The following table sets forth information regarding the executive officers
of the Company:
Name Age Title
- - ---- --- -----
Thomas R. Trotter 51 Chief Executive Officer, President and Director
Frank P. Magee, D.V.M. 42 Executive Vice President, Research and Development
Terry D. Meier 60 Senior Vice President, Chief Financial Officer
William C. Rieger 49 Vice President, Marketing Worldwide
David K. Floyd 38 Vice President, Sales
Ruben Chairez, Ph.D. 56 Vice President, Medical Regulatory and Clinical
Affairs
MaryAnn G. Miller 41 Vice President, Human Resources
Kevin Lunau 41 Vice President, Manufacturing
Thomas R. Trotter joined the Company as President and Chief Executive
Officer and a Director in October 1997. From 1988 to October 1997, Mr. Trotter
held various positions at Mallinckrodt, Inc. in St. Louis, Missouri, most
recently as President of the Critical Care Division and a member of the
Corporate Management Committee. From 1984 to 1988, he was President and Chief
Executive Officer of Diamond Sensor Systems, a medical device company in Ann
Arbor, Michigan. From 1976 to 1984, he held various senior management positions
at Shiley, Inc. (a division of Pfizer, Inc.) in Irvine, California.
Frank P. Magee, D.V.M. joined the Company as a Vice President in November
1989 and became Executive Vice President, Research and Development in 1991. Mr.
Magee served as President between August 1997 and October 1997. From 1984 to
1989, Dr. Magee was head of Experimental Surgery at Harrington Arthritis
Research Center, a not-for-profit independent research and development
organization.
Terry D. Meier joined the Company in March 1998 as Senior Vice President and
on April 1, 1998, began serving as its Chief Financial Officer. From 1974 to
1997, Mr. Meier held several positions at Mallinckrodt, Inc., a healthcare and
specialty chemicals company. Most recently, he served as their Vice President
and Corporate Controller and from 1989 to 1996, as the Senior Vice President and
Chief Financial Officer.
William C. Rieger joined the Company in January 1998 as Vice President,
Marketing and Sales. From 1994 to 1997, Mr. Rieger held the position of Vice
President of Sales and Marketing at Hollister Inc., a privately held
manufacturer of medical products. From 1985-1994, he held several positions as
Vice President at Miles Inc. Diagnostic Division, a manufacturer of diagnostic
products.
David K. Floyd joined the Company in May 1998 as Vice President, Sales. From
September 1994 through April 1998, Mr. Floyd was associated with Sulzer
Orthopedics, most recently as Vice President of Sales with responsibility for
sales activity in North America and South America. From May 1987 through August
1994. Mr. Floyd held positions in sales and marketing with Zimmer Inc., a
Bristol-Myers Squibb Company and a manufacturer of medical devices.
Ruben Chairez, Ph.D., joined the Company in May 1998 as Vice President,
Medical Regulatory and Clinical Affairs. From November, 1993 through April 1998,
Dr. Chairez served as Vice President, Regulatory Affairs/Quality Assurance of
SenDx Medical, Inc., a manufacturer of blood gas analyzer systems. From July
1990 to November 1993, Mr. Chairez was the Director of Regulatory Affairs with
Glen - Probe Incorporated, an in retro diagnostic device manufacturer.
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MaryAnn G. Miller joined the Company as Vice President of Human Resources in
October 1996. From November 1995 to June 1996, Ms. Miller was Human Resources
Director for Southwestco Wireless, Inc. doing business as CellularOne, a
subsidiary of Bell Atlantic Nynex Mobile, a provider of wireless
telecommunications services in the Southwest. From October 1992 to July 1995,
Ms. Miller was a human resources officer with Firstar Corporation, a
Wisconsin-based bank holding company. She was previously First Vice President
and Regional Human Resources Director of Firstar from January 1994 to July 1995.
Kevin Lunau joined the Company as Vice President of Manufacturing on March
17, 1999. From 1991 to 1999, Mr. Lunau held management positions at Orthologic
Canada (previously Toronto Medical Corp.), a subsidiary of OrthoLogic. Most
recently, he served as Orthologic Canada's Executive Vice President and General
Manager.
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PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
The information under the heading "Stockholder Information" on page 18 of
the Company's Annual Report to Stockholders for the year ended December 31, 1998
(the "Annual Report") is incorporated herein by reference.
ITEM 6. SELECTED FINANCIAL DATA
The information on pages 17 and 31 of the Annual Report under the heading
"Selected Financial Data" is incorporated herein by reference.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The information on pages 13 through 16 of the Annual Report under the
heading "Management's Discussion and Analysis of Financial Condition and Results
of Operations" is incorporated herein by reference.
The Company may from time to time make written or oral forward-looking
statements, including statements contained in the Company's filings with the
Securities and Exchange Commission and its reports to stockholders. This Report
contains forward-looking statements made pursuant to the "safe harbor"
provisions of the Private Securities Litigation Reform Act of 1995. In
connection with these "safe harbor" provisions, the Company identifies important
factors that could cause actual results to differ materially from those
contained in any forward-looking statements made by or on behalf of the Company.
Any such forward-looking statement is qualified by reference to the following
cautionary statements.
LIMITED HISTORY OF PROFITABILITY; QUARTERLY FLUCTUATIONS IN OPERATING
RESULTS. The Company was founded in 1987 and only began generating revenues from
the sale of its primary product in 1994. The Company has experienced significant
operating losses since its inception and had an accumulated deficit of
approximately $51.4 million at December 31, 1998. There can be no assurance that
the Company will ever generate sufficient revenues to attain operating
profitability or retain net profitability on an on-going annual basis. In
addition, the Company may experience fluctuations in revenues and operating
results based on such factors as demand for the Company's products, the timing,
cost and acceptance of product introductions and enhancements made by the
Company or others, levels of third party payment, alternative treatments which
currently exist or may be introduced in the future, completion of acquisitions,
changes in practice patterns, competitive conditions, regulatory announcements
and changes affecting the Company's products in the industry and general
economic conditions. The development and commercialization by the Company of
additional products will require substantial product development and regulatory,
clinical and other expenditures. See "Item 1 -- Business -- Competition."
POTENTIAL ADVERSE OUTCOME OF LITIGATION. The Company is a defendant in a
number of investor lawsuits relating generally to correspondence received by the
Company from the FDA in mid-1996 regarding the promotion and configuration of
the ORTHOLOGIC 1000. See "Item 1 -- Business -- Governmental Regulation" and
"Item 3 -- Legal Proceedings." The Company intends to defend these lawsuits
vigorously. However, an adverse litigation outcome could have a material adverse
effect on the Company's business, financial condition and results of operations.
DEPENDENCE ON SALES FORCE. A substantial portion of the Company's sales are
generated through the Company's internal sales force of approximately 282
employees. During 1996, the Company shifted its primary focus from sales through
independent orthopedic specialty dealers to an internal sales force. In January
1998 the sales management was restructured so that territories are determined
based only on geography and not on geography and devices. As a result, certain
members of sales management were now responsible during 1998 for devices not
previously within their area of responsibility. There can be no assurance that
these individuals will be able to manage their new responsibilities
successfully. See "Item 1 -- Business -- Marketing and Sales."
DEPENDENCE ON KEY PERSONNEL; RECENT MANAGEMENT CHANGES. The success of the
Company is dependent in large part on the ability of the Company to attract and
retain its key management, operating, technical, marketing and sales personnel
as well as clinical investigators who are not employees of the Company. Such
individuals are in high demand, and the identification, attraction and retention
of such personnel could be lengthy, difficult and costly. The Company competes
for its employees and clinical investigators with other companies in the
orthopedic industry and research and
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academic institutions. There can be no assurance that the Company will be able
to attract and retain the qualified personnel necessary for the expansion of its
business. A loss of the services of one or more members of the senior management
group, or the Company's inability to hire additional personnel as necessary,
could have an adverse effect on the Company's business, financial condition and
results of operations. See "Item 1 -- Business -- Employees."
HISTORICAL DEPENDENCE ON PRIMARY PRODUCT; FUTURE PRODUCTS. During 1997 and
1998 revenues from CPM devices and Hyalgan reduced the Company's dependence on
revenues from the ORTHOLOGIC 1000. However, the Company believes that, to
sustain long-term growth, it must develop and introduce additional products and
expand approved indications for its existing products. The development and
commercialization by the Company of additional products will require substantial
product development, regulatory, clinical and other expenditures. There can be
no assurance that the Company's technologies will allow it to develop new
products or expand indications for existing products in the future or that the
Company will be able to manufacture or market such products successfully. Any
failure by the Company to develop new products or expand indications could have
a material adverse effect on the Company's business, financial condition and
results of operations. See "Item 1 -- Business -- Products" and "Item 1 --
Business -- Competition."
UNCERTAINTY OF MARKET ACCEPTANCE. The Company believes that the demand for
bone growth stimulators is still developing and the Company's success will
depend in part upon the growth of this demand. There can be no assurance that
this demand will develop. The long-term commercial success of the ORTHOLOGIC
1000 will also depend in significant part upon its widespread acceptance by a
significant portion of the medical community as a safe, efficacious and
cost-effective alternative to invasive procedures. The Company is unable to
predict how quickly, if at all, its products may be accepted by members of the
orthopedic medical community. The widespread acceptance of the Company's primary
products represents a significant change in practice patterns for the
orthopaedic medical community and in reimbursement policy for third party
payors. Historically, some orthopedic medical professionals have indicated
hesitancy in prescribing bone growth stimulator products such as those
manufactured by the Company. The use of CPM is more widely accepted, however the
Company must continue to prove that the products are safe, efficacious and
cost-effective in order to maintain and grow its market share. Hyalgan is a new
therapeutic treatment for relief of pain from osteoarthritis of the knee. The
long-term commercial success of the product will depend upon its widespread
acceptance by a significant portion of the medical community and third party
payors as a safe, efficacious and cost-effective alternative to other treatment
options such as simple analgesics. Failure of the Company's products to achieve
widespread market acceptance by the orthopedic medical community and third party
payors would have a material adverse effect on the Company's business, financial
condition and results of operations. See "Item 1 -- Business -- Third Party
Payment."
INTEGRATION OF ACQUISITIONS. The Company acquired three businesses in 1996
and 1997. In the first quarter of 1997, the Company commenced the consolidation
of the recent acquisitions. The administrative operations, manufacturing and
servicing operations were consolidated by the end of 1997. The sales force
management was consolidated in early 1998 and computer hardware and software
systems were consolidated during 1998. Successful integration of such
acquisitions is critical to the future financial performance of the combined
Company.
CONDITION OF ACQUIRED FACILITIES. The Company has determined that the
facilities acquired in the acquisition of Sutter Corporation ("Sutter") had
several physical problems, primarily resulting from excessive moisture and water
leaks. Two Sutter employees have filed related worker's compensation claims, and
these two claims are being processed by Sutter's worker's compensation carrier.
In addition, the lack of maintenance has allegedly caused some structural
problems at one facility, and employee complaints based upon these problems have
led to two informal complaints by the California Department of Industrial
Relations and Division of Occupational Safety and Health. Sutter has responded
to both complaints and continues to work with its landlord to correct the
problems. In addition, Sutter has notified the prior owners of Sutter of the
problems because the prior owners may be the responsible party under the
acquisition agreement for any required remedies. Sutter has vacated the
leasehold premises of both Sutter facilities. Sutter vacated a manufacturing
facility in conjunction with a negotiated lease termination. Sutter also vacated
a mixed use facility and notified that landlord of its termination of the lease
due to acts and omissions of the landlord. That landlord claims that rent
remains unpaid but has not yet responded to Sutter's claim that the lease has
been terminated. Damages, claims and future discoveries regarding the
maintenance of the facilities by prior occupants could have a material adverse
effect on the Company's business, financial condition and results of operations.
See "Item 3 -- Legal Proceedings" and "Item 2 -- Properties."
15
<PAGE>
MANAGEMENT OF GROWTH. The Company experienced a period of rapid growth
during 1996 and 1997. This growth has placed, and could continue to place, a
significant strain on the Company's financial, management and other resources.
The Company's future performance will depend in part on its ability to manage
change in its operations, including integration of acquired businesses. In
addition, the Company's ability to manage its growth effectively will require it
to continue to improve its manufacturing, operational and financial control
systems and infrastructure and management information systems, and to attract,
train, motivate, manage and retain key employees. If the Company's management
were to become unable to manage growth effectively, the Company's business,
financial condition, and results of operations could be adversely affected.
LIMITATIONS ON THIRD PARTY PAYMENT; UNCERTAIN EFFECTS OF MANAGED CARE. The
Company's ability to commercialize its products successfully in the United
States and in other countries will depend in part on the extent to which
acceptance of payment for such products and related treatment will continue to
be available from government health administration authorities, private health
insurers and other payors. Cost control measures adopted by third party payors
in recent years have had and may continue to have a significant effect on the
purchasing and practice patterns of many health care providers, generally
causing them to be more selective in the purchase of medical products. In
addition, payors are increasingly challenging the prices and clinical efficacy
of medical products and services. Payors may deny reimbursement if they
determine that the product used in a procedure was experimental, was used for a
nonapproved indication or was unnecessary, inappropriate, not cost-effective,
unsafe, or ineffective. The Company's products are reimbursed by most payors,
however there are generally specific product usage requirements or documentation
requirements in order for the Company to receive reimbursement. In certain
circumstances the Company is successful in appealing reimbursement coverage for
those applications which are not in compliance with the payor requirements.
Medicare has very strict guidelines for reimbursement, and until the second
quarter 1997, the Company had some success in appealing claims for applications
of the ORTHOLOGIC 1000 which were outside the coverage guidelines. During the
second quarter of 1997 the Company determined that Medicare would no longer
reimburse for such cases, and the Company wrote off all Medicare receivables
which did not meet Medicare's guidelines. Significant uncertainty exists as to
the reimbursement status of newly approved health care products, and there can
be no assurance that adequate third party coverage will continue to be available
to the Company at current levels. See "Item 1 - Business Third Party Payment."
UNCERTAINTY AND POTENTIAL NEGATIVE EFFECTS OF HEALTH CARE REFORM. The health
care industry is undergoing fundamental changes resulting from political,
economic and regulatory influences. In the United States, comprehensive programs
have been proposed that seek to (i) increase access to health care for the
uninsured, (ii) control the escalation of health care expenditures within the
economy and (iii) use health care reimbursement policies to help control the
federal deficit. The Company anticipates that Congress and state legislatures
will continue to review and assess alternative health care delivery systems and
methods of payment, and public debate of these issues will likely continue. Due
to uncertainties regarding the outcome of reform initiatives and their enactment
and implementation, the Company cannot predict which, if any, of such reform
proposals will be adopted and when they might be adopted. Other countries also
are considering health care reform. The Company's plans for increased
international sales are largely dependent upon other countries' adoption of
managed care systems and their acceptance of the potential benefits of the
Company's products and the belief that managed care plans will have a positive
effect on sales. For the reasons identified in this and in the preceding
paragraph, however, those assumptions may be incorrect. Significant changes in
health care systems are likely to have a substantial impact over time on the
manner in which the Company conducts its business and could have a material
adverse effect on the Company's business, financial condition and results of
operations and ability to market its products as currently contemplated.
INTENSE COMPETITION. The orthopedic industry is characterized by intense
competition. Currently, there are three major competitors other than the Company
selling electromagnetic bone growth stimulation products approved by the FDA for
the treatment of nonunion fractures, one large domestic and several foreign
manufacturers of CPM devices and one competitor selling a therapeutic injectable
for treatment of osteoarthritis of the knee. The Company also competes with many
independent owners/lessors of CPM devices in addition to the providers of
traditional orthopedic immobilization products and rehabilitation services. The
Company estimates that one of its competitors has a dominant share of the market
for electromagnetic bone growth stimulation products for non-healing fractures
in the United States, and another has a dominant share of the market for use of
their device as an adjunct to spinal fusion surgery. In addition, there are
several large, well-established companies that sell fracture fixation devices
similar in function to those sold by the Company. Many participants in the
medical technology industry, including the Company's competitors, have
substantially greater capital resources, research and development staffs and
facilities than the Company. Such participants have developed or are developing
products that may be competitive with the products that have been or are
16
<PAGE>
being developed or researched by the Company. Other companies are developing a
variety of other products and technologies to be used in CPM devices, the
treatment of fractures and spinal fusions, including growth factors, bone graft
substitutes combined with growth factors, and nonthermal ultrasound. One company
has received FDA approval for a nonthermal ultrasound device to treat nonsevere
fresh fractures of the lower leg and lower forearm. There can be no assurance
that products marketed by these or other companies will not be sold for use in
treating non-healing fractures or spinal fusions, even in the absence of
regulatory approval to do so. Any such sales could have a material adverse
effect on the Company. Many of the Company's competitors have substantially
greater experience than the Company in conducting research and development,
obtaining regulatory approvals, manufacturing and marketing and selling medical
devices. Any failure by the Company to develop products that compete favorably
in the marketplace would have a material adverse effect on the Company's
business, financial condition and results of operations. See "Item 1 -- Business
- - -- Research and Development" and "Item 1 -- Business -- Competition."
RAPID TECHNOLOGICAL CHANGE. The medical device industry is characterized by
rapid and significant technological change. There can be no assurance that the
Company's competitors will not succeed in developing or marketing products or
technologies that are more effective or less costly, or both, and which render
the Company's products obsolete or noncompetitive. In addition, new
technologies, procedures and medications could be developed that replace or
reduce the value of the Company's products. The Company's success will depend in
part on its ability to respond quickly to medical and technological changes
through the development and introduction of new products. There can be no
assurance that the Company's new product development efforts will result in any
commercially successful products. A failure to develop new products could have a
material adverse effect on the company's business, financial condition and
results of operations. See "Item 1 -- Business -- Research and Development."
GOVERNMENT REGULATION. The Company's current and future products and
manufacturing activities are and will be regulated under the Medical Device
Amendments Act of 1976 to the Food, Drug and Cosmetic Act and the 1990 Safe
Medical Devices Act. The Company's current BIOLOGIC technology-based products
and Hyalgan are classified as Class III Significant Risk Devices, which are
subject to the most stringent level of FDA review for medical devices and are
required to be tested under IDE clinical trials and approved for marketing under
a PMA. The Company's fracture fixation devices are Class II devices that are
marketed pursuant to 510(k) clearance from the FDA.
The Company received approval of an IDE for the SPINALOGIC 1000 for use as
an adjunct to spinal fusion surgery in August 1992 and commenced clinical trials
for this product in February 1993. The Company is in the process of evaluating
the results of the clinical trial for use of the SPINALOGIC 1000 as an adjunct
to spinal fusion surgery. In September 1995, the Company received an approval of
an IDE supplement for the SPINALOGIC 1000 for treatment of failed spinal
fusions. The Company commenced this study in the fourth quarter of 1995. The
Company submitted a PMA (pre-market approval) Supplement to the FDA for
SPINALOGIC 1000 on August 20, 1998, starting the FDA's 180 day review period.
The supplement was based on the original PMA approved for the ORTHOLOGIC 1000.
However, on December 30, 1998 the Company submitted an amendment to the
SpinaLogic PMA Supplement, providing more analysis of the clinical data. The
Company believes the submission of the amendment may restart the 180 day review
period. There can be no assurance that the Company will receive regulatory
approval of the SPINALOGIC 1000 or any other products. Any significant delay in
receiving or failure to receive regulatory approval of the Company's products
could have a material adverse effect on the Company's business, financial
condition and results of operations. See "Item 1 -- Business -- Products" and
"Item 1 -- Business -- Government Regulation."
The FDA and comparable agencies in many foreign countries and in state and
local governments impose substantial limitations on the introduction of medical
devices through costly and time-consuming laboratory and clinical testing and
other procedures. The process of obtaining FDA and other required regulatory
approvals is lengthy, expensive and uncertain. Moreover, regulatory approvals,
if granted, typically include significant limitations on the indicated uses for
which a product may be marketed. In addition, approved products may be subject
to additional testing and surveillance programs required by regulatory agencies,
and product approvals could be withdrawn and labeling restrictions may be
imposed for failure to comply with regulatory standards or upon the occurrence
of unforeseen problems following initial marketing.
The Company is also required to adhere to applicable requirements for FDA
Good Manufacturing Practices, to engage in extensive record keeping and
reporting and to make available its manufacturing facilities for periodic
inspections by governmental agencies, including the FDA and comparable agencies
in other countries. Failure to comply with these and other applicable regulatory
requirements could result in, among other things, significant fines, suspension
of approvals, seizures or recalls of products, or operating restrictions and
17
<PAGE>
criminal prosecutions. From time to time, the Company receives letters from the
FDA regarding regulatory compliance. The Company has responded to all such
letters and believes all outstanding issues raised in such letters have been
resolved. See "Item 1 -- Business -- Government Regulation."
Changes in existing regulations or interpretations of existing regulations
or adoption of new or additional restrictive regulations could prevent the
Company from obtaining, or affect the timing of, future regulatory approvals. If
the Company experiences a delay in receiving or fails to obtain any governmental
approval for any of its current or future products or fails to comply with any
regulatory requirements, the Company's business, financial condition and results
of operations could be materially adversely affected. See "Item 1 -- Business --
Products" and "Item 1 -- Business -- Government Regulation."
DEPENDENCE ON KEY SUPPLIERS. The Company purchases the microprocessor used
in the ORTHOLOGIC 1000 and OL- 1000 SC from a sole source supplier, Phillips
N.V. In addition, there are two suppliers for another component used in the
ORTHOLOGIC 1000 and OL-1000 SC and two suppliers for the composite material
components of the ORTHOFRAME products. Establishment of additional or
replacement suppliers for the components cannot be accomplished quickly. In
addition, Hyalgan is manufactured by a single company, Fidia S.p.A. Fidia has
been manufacturing Hyalgan for sale in Europe since 1987. The Company purchases
several CPM components, including microprocessors, motors and custom key panels
from sole-source suppliers. The Company believes that its CPM products are not
dependent on these components and could be redesigned to incorporate comparable
components. While the Company maintains a supply of certain ORTHOLOGIC 1000 and
OL-1000 SC components to meet sales forecasts for one year and ORTHOFRAME
components to meet sales forecasts for three months and the distributor of
Hyalgan maintains a supply of product to last several months, any delay or
interruption in supply of these components or products could significantly
impair the Company's ability to deliver its products in sufficient quantities,
and therefore, could have a material adverse effect on its business, financial
condition and results of operations. See "Item 1 -- Business -- Manufacturing."
DEPENDENCE ON PATENTS, LICENSES AND PROPRIETARY RIGHTS. The Company's
success will depend in significant part on its ability to obtain and maintain
patent protection for products and processes, to preserve its trade secrets and
proprietary know-how and to operate without infringing the proprietary rights of
third parties. While the Company holds title to numerous United States and
foreign patents and patent applications, as well as licenses to numerous United
States and foreign patents (see "Item 1 -- Business -- Patents, Licenses and
Proprietary Rights"), no assurance can be given that any additional patents will
be issued or that the scope of any patent protection will exclude competitors or
that any of the patents held by or licensed to the Company will be held valid if
subsequently challenged. The validity and breadth of claims covered in medical
technology patents involves complex legal and factual questions and therefore
may be highly uncertain. In addition, although the Company holds or licenses
patents for certain of its technologies, others may hold or receive patents
which contain claims having a scope that covers products developed by the
Company. There can be no assurance that licensing rights to the patents of
others, if required for the Company's products, will be available at all or at a
cost acceptable to the Company.
The Company's licenses covering the BIOLOGIC and ORTHOFRAME technologies
provide for payment by the Company of royalties. A Co-Promotion Agreement with
Sanofi provides the Company with exclusive marketing rights for Hyalgan to
orthopedic surgeons in the United States. The Company is paid a fee which is
based upon the number of units sold at the wholesale acquisition cost less
amounts for distribution costs, discounts, rebates, returns, product transfer
price, overhead factor and a royalty factor. Each license may be terminated if
the Company breaches any material provision of such license. The termination of
any license would have a material adverse effect on the Company's business,
financial condition and results of operations. See Note 15 of Notes to
Consolidated Financial Statements.
The Company also relies on unpatented trade secrets and know-how. The
Company generally requires its employees, consultants, advisors and
investigators to enter into confidentiality agreements which include, among
other things, an agreement to assign to the Company all inventions that were
developed by the employee while employed by the Company that are related to its
business. There can be no assurance, however, that these agreements will protect
the Company's proprietary information or that others will not gain access to, or
independently develop similar trade secrets or know-how.
There has been substantial litigation regarding patent and other
intellectual property rights in the orthopedic industry. Litigation, which could
result in substantial cost to, and diversion of effort by the Company may be
necessary to enforce patents issued or licensed to the Company, to protect trade
18
<PAGE>
secrets or know-how owned by the Company or to defend the Company against
claimed infringement of the rights of others and to determine the scope and
validity of the proprietary rights of others. There can be no assurance that the
results of such litigation would be favorable to the Company. In addition,
competitors may employ litigation to gain a competitive advantage. Adverse
determinations in litigation could subject the Company to significant
liabilities, and could require the Company to seek licenses from third parties
or prevent the Company from manufacturing, selling or using its products, any of
which determinations could have a material adverse effect on the Company's
business, financial condition and results of operations. See "Item 1 -- Business
- - -- Patents, Licenses and Proprietary Rights."
RISK OF PRODUCT LIABILITY CLAIMS. The Company faces an inherent business
risk of exposure to product liability claims in the event that the use of its
technology or products is alleged to have resulted in adverse effects. To date,
no product liability claims have been asserted against the Company for its
fracture healing and Hyalgan products and only limited claims for its CPM
products. The Company maintains a product liability and general liability
insurance policy with coverage of an annual aggregate maximum of $2.0 million
per occurrence. The Company's product liability and general liability policy is
provided on an occurrence basis. The policy is subject to annual renewal. In
addition, the Company maintains an umbrella excess liability policy which covers
product and general liability with coverage of an additional annual aggregate
maximum of $25.0 million. There can be no assurance that liability claims will
not exceed the coverage limits of such policies or that such insurance will
continue to be available on commercially reasonable terms or at all. If the
Company does not or cannot maintain sufficient liability insurance, its ability
to market its products may be significantly impaired. In addition, product
liability claims could have a material adverse effect on the business, financial
condition and results of operations of the Company. See "Item 1 -- Business --
Product Liability Insurance."
POSSIBLE VOLATILITY OF STOCK PRICE. Factors such as fluctuations in the
Company's operating results, developments in litigation to which the Company is
subject, announcements and timing of potential acquisitions, conversion of
preferred stock, announcements of technological innovations or new products by
the Company or its competitors, FDA and international regulatory actions,
actions with respect to reimbursement matters, developments with respect to
patents or proprietary rights, public concern as to the safety of products
developed by the Company or others, changes in health care policy in the United
States and internationally, changes in stock market analyst recommendations
regarding the Company, other medical device companies or the medical device
industry generally and general market conditions may have a significant effect
on the market price of the Common Stock. In addition, the stock market has from
time to time experienced significant price and volume fluctuations that are
unrelated to the operating performance of particular companies. These broad
market fluctuations may adversely affect the market price of the Company's
Common Stock.
Developments in any of these areas, which are more fully described elsewhere
in "Item 1 -- Business," "Item 3 -- Legal Proceedings," and "Item 7 --
Management's Discussion and Analysis of Financial Condition and Results of
Operations" on pages 13 through 16 of the Company's Annual Report to
stockholders, each of which is incorporated into this section by reference,
could cause the Company's results to differ materially from results that have
been or may be projected by or on behalf of the Company.
The Company cautions that the foregoing list of important factors is not
exclusive. The Company does not undertake to update any forward-looking
statement that may be made from time to time by or on behalf of the Company.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is not currently vulnerable to a material extent to fluctuations
in interest rates, commodity prices, or foreign currency exchange rates.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The information on pages 17 through 31 of the Annual Report is incorporated
herein by reference.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
19
<PAGE>
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information in response to this Item is incorporated by reference to (i) the
biographical information relating to the Company's directors under the caption
"Election of Directors" and the information relating to Section 16 compliance
under the caption, "Section 16(a) Beneficial Ownership Reporting Compliance" in
the Company's definitive Proxy Statement for its Annual Meeting of Stockholders
to be held May 15, 1999 (the "Proxy Statement"), and (ii) the information under
the caption "Executive Officers of the Registrant" in Part I hereof. The Company
anticipates filing the Proxy Statement within 120 days after December 31, 1998.
ITEM 11. EXECUTIVE COMPENSATION
The information under the heading "Executive Compensation" and "Compensation
of Directors" in the Proxy Statement is incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information under the heading "Voting Securities and Principal Holders
Thereof - Security Ownership of Certain Beneficial Owners and Management" in the
Proxy Statement is incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information under the heading "Certain Transactions" in the Proxy
Statement is incorporated herein by reference.
20
<PAGE>
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) The following documents are filed as part of this report:
1. Financial Statements
The following financial statements of OrthoLogic Corp. and Independent
Auditors' Report are incorporated by reference from pages 19 through
31 of the Annual Report:
Balance Sheets - December 31, 1998 and 1997.
Statements of Operations - Each of the three years in the period
ended December 31, 1998.
Statements of Comprehensive Income - Each of the three years in the
period ended December 31, 1998.
Statements of Stockholders' Equity - Each of the three years in the
period ended December 31, 1998.
Statements of Cash Flows - Each of the three years in the period
ended December 31, 1998.
Notes to Financial Statements
2. Financial Statement Schedules
Valuation and Qualifying Accounts.
Allowance for doubtful accounts
Balance December 31, 1995 $ (1,480,000)
1996 Additions charged to expense (10,151,117)
1996 Deductions to allowance 3,036,117
Balance December 31, 1996 (8,595,000)
1997 Additions charged to expense (11,246,229)
1997 Deductions to allowance 8,470,705
Balance December 31, 1997 (11,370,524)
1998 Additions charged to expense (19,529,547)
1998 Deductions to allowance 11,582,247
Balance December 31, 1998 $(19,317,824)
Allowance for inventory reserves
Balance December 31, 1995 $ 0
1996 Additions charged to expense (260,602)
1996 Deductions to allowance
Balance December 31, 1996 (260,602)
1997 Additions charged to expense (944,313)
1997 Deductions to allowance 843,277
Balance December 31, 1997 (361,638)
1998 Additions charged to expense (1,239,181)
1998 Deductions to allowance 852,421
Balance December 31, 1998 $ (748,398)
21
<PAGE>
3. Exhibits and Management Contracts, and Compensatory Plans and
Arrangements
All management contracts and compensatory plans and arrangements are
identified by footnote after the Exhibit Descriptions on the attached
Exhibit Index.
(b) Reports on Form 8-K.
None.
(c) Exhibits
See the Exhibit Index immediately following the signature page of this
report, which Index is incorporated herein by reference.
(d) Financial Statements and Schedules
See Item 14(a)(1) and (2) above.
22
<PAGE>
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.
ORTHOLOGIC CORP.
Date: March 31, 1999 By /s/ Thomas R. Trotter
-------------------------------------
Thomas R. Trotter
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
Signature Title Date
- - --------- ----- ----
/s/ Thomas R. Trotter President, Chief Executive March 31, 1999
- - --------------------------- Officer and Director
Thomas R. Trotter (Principal Executive Officer)
/s/ John M. Holliman III Chairman of the Board of March 31, 1999
- - --------------------------- Directors and Director
John M. Holliman III
/s/ Fredric J. Feldman Director March 31, 1999
- - ---------------------------
Fredric J. Feldman
/s/ Elwood D. Howse, Jr. Director March 31, 1999
- - ---------------------------
Elwood D. Howse, Jr.
/s/ Stuart H. Altman Director March 31, 1999
- - ---------------------------
Stuart H. Altman, Ph.D.
/s/ Augustus A. White III Director March 31, 1999
- - ---------------------------
Augustus A. White III, M.D.
/s/ Terry D. Meier Senior Vice President and March 31, 1999
- - --------------------------- Chief Financial Officer
Terry D. Meier (Principal Financial and
Accounting Officer)
S-1
<PAGE>
ORTHOLOGIC CORP.
EXHIBIT INDEX TO REPORT ON FORM 10-K
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998
(FILE NO. 0-21214)
<TABLE>
<CAPTION>
Exhibit Filed
No. Description Incorporated by Reference To: Herewith
--- ----------- ----------------------------- --------
<S> <C> <C> <C>
2.1 Stock Purchase Agreement dated August Exhibit 2.1 to the Company's Current
30, 1996 by and among the Company, Report on Form 8-K filed on
Sutter Corporation and Smith September 13, 1996
Laboratories, Inc.
2.2 Purchase and Sale Agreement dated as of Exhibit 2.1 to the Company's Current
December 30, 1996 by and among the Report on Form 8-K filed on March 18,
Company and Toronto Medical Corp., an 1997 ("March 18, 1997 8-K")
Ontario corporation
2.3 Amendment to Purchase and Sale Exhibit 2.2 to March 18, 1997 8-K
Agreement dated as of January 13, 1997
by and among the Company and Toronto
Medical Corp., an Ontario corporation
2.4 Second Amendment to Purchase and Exhibit 2.3 to March 18, 1997 8-K
Sale Agreement dated as of March 1,
1997 by and among the Company and
Toronto Medical Corp., an Ontario
corporation
2.5 Assignment of Purchase and Sale Exhibit 2.4 to March 1997 8-K
Agreement dated as of March 1, 1997 by
and among the Company, Toronto
Medical Orthopaedics Ltd., a Canada
corporation and Toronto Medical Corp.,
an Ontario corporation
2.6 Asset Purchase Agreement dated March Exhibit 2.1 to the Company's Current
12, 1997 by and among the Company, Report on Form 8-K filed on March 27,
Danninger Medical Technology, Inc., a 1997
Delaware corporation, and Danninger
Health care, Inc., an Ohio corporation
3.1 Composite Certificate of Incorporation Exhibit 3.1 to Company's Form 10-Q
of the Company, as amended, including for the quarter ended March 31, 1997
Certificate of Designation in respect of ("March 1997 10-Q")
Series A Preferred Stock
3.2 Bylaws of the Company Exhibit 3.4 to Company's Amendment
No. 2 to Registration Statement on
Form S-1 (No. 33-47569) filed with the
SEC on January 25, 1993 ("January
1993 S-1")
4.1 Articles 5, 9 and 11 of the Certificate of Exhibit 3.1 to March 1997 10-Q
Incorporation of the Company
4.2 Articles II and III.2(c)(ii) of Bylaws of Exhibit 3.4 to January 1993 S-1
the Company
4.3 Specimen Common Stock Certificate Exhibit 4.1 to January 1993 S-1
4.4 Stock Purchase Warrant, dated August Exhibit 4.6 to the Company's Form 10-
18, 1993, issued to CyberLogic, Inc. K for the fiscal year ended December
31, 1994 ("1994 10-K")
4.5 Stock Purchase Warrant, dated Exhibit 4.6 to Company's Registration
September 20, 1995, issued to Statement on Form S-1 (No. 33-97438)
Registered Consulting Group, Inc. filed with the SEC on September 27,
1995 ("1995 S-1")
4.6 Stock Purchase Warrant, dated October Exhibit 4.7 to the Company's Annual
15, 1996, issued to Registered Report on Form 10-K for the year
Consulting Group, Inc. ended December 31, 1996 ("1996
10-K")
4.7 Rights Agreement dated as of March 4, Exhibit 4.1 to the Company's
1997 between the Company and Bank of Registration Statement on Form 8-A
New York, and Exhibits A, B and C filed with the SEC on March 6, 1997
thereto
4.8 1987 Stock Option Plan of the Company, Exhibit 4.4 to the Company's Form
as amended and approved by 10-Q for the quarter ended June 30,
stockholders (1) 1997 ("June 1997 10-Q")
4.9 1997 Stock Option Plan of the Company(1) Exhibit 4.5 to the Company's June
1997 10-Q
4.10 Stock Purchase Warrant dated March Exhibit 4.10 to the Company's 1997 10-K
2, 1998 issued to Silicon Valley Bank
</TABLE>
EX-1
<PAGE>
<TABLE>
<CAPTION>
Exhibit Filed
No. Description Incorporated by Reference To: Herewith
--- ----------- ----------------------------- --------
<S> <C> <C> <C>
4.11 Antidilution Agreement dated March 2, Exhibit 4.11 to the Company's 1997 10-K
1998 by and between the Company and
Silicon Valley Bank
4.12 Amendment to Stock Purchase Warrant Exhibit 4.1 to the Company's form 10-Q
dated May 12, 1998 issued to Silicon for the quarter ended September 30, 1998
Valley Bank ("September 1998 10-Q")
4.13 Form of Warrant Exhibit 4.1 to the Company's Form 8-K filed
on July 13, 1998
4.14 Registration Rights Agreement Exhibit 4.2 to the Company's Form 8-K filed
on July 13, 1998
5.1 Form of Opinion Letter of Quarles & Brady Exhibit 5.1 to the Company's S-3 filed on
August 24, 1998.
10.1 License Agreement dated September 3, Exhibit 10.6 to January 1993 S-1
1987 between the Company and Life
Resonances, Inc.
10.2 Invention, Confidential Information and Exhibit 10.7 to January 1993 S-1
Non-Competition Agreement dated
September 18, 1987 between the
Company and Weinstein
10.3 Fifth Amendment to Lease, dated Exhibit 10.10 to the Company's
September 14, 1993 between the September 30, 1994 10-Q
Company and Cook Inlet Region,
Incorporated
10.4 Invention, Confidential Information and Exhibit 10.11 to January 1993 S-1
Non-Competition Agreement dated
January 10, 1989 between the Company
and Frank P. Magee
10.5 Addendum to Lease between the Exhibit 10.8.1 to the Registration
Company and Cook Inlet Region, Inc. Statement on Form S-3 (No. 333-3082)
commencing April 1, 1996 filed with the SEC on April 2, 1996
("April 1996 S-3")
10.6 1995 Officer Bonus Plan(1) Exhibit 10.10 to the Company's Annual
Report on Form 10-K for the year
ended December 31, 1995 ("1995 10-
K")
10.9 Form of Indemnification Agreement* Exhibit 10.16 to January 1993 S-1
10.10 License Agreement dated December 2, Exhibit 10.22 to January 1993 S-1
1992 between Orthotic Limited
Partnership and Company
10.11 Consulting Agreement dated May 1, Exhibit 10.11 to the Company's
1990 between Augustus A. White III and September 30, 1994 Form 10-Q
the Company(1)
10.12 Loan Modification Agreement dated Exhibit 10.22 to 1995 S-1
March 23, 1995 between Company and
Silicon Valley Bank
10.13 Renewal of Employment Agreement of Exhibit 10.23 to 1994 10-K
Frank P. Magee dated March 28,
1995(1)
10.14 [Intentionally omitted]
10.15 Amendment to Employment Agreement Exhibit 10.25 to 1995 10-K
between the Company and Allen R.
Dunaway dated February 14, 1996(1)
10.16 Underwriting Agreement between the Exhibit 1.1 to 1995 S-1
Company and Volpe, Welty & Co. and
Dain Bosworth, Inc., as Representatives
of the Underwriters
10.17 Underwriting Agreement between the Exhibit 1.1 to April 1996 S-3
Company and Volpe, Welty & Company
Hambrecht & Quist and Dain Bosworth,
Inc., as Representatives of the
Underwriters
10.18 Maturity Modification Letter dated Exhibit 10.21 to April 1996 S-3
March 29, 1996, by Silicon Valley Bank
</TABLE>
EX-2
<PAGE>
<TABLE>
<CAPTION>
Exhibit Filed
No. Description Incorporated by Reference To: Herewith
--- ----------- ----------------------------- --------
<S> <C> <C> <C>
10.19 Lease made March 1997 between Exhibit 10.34 to the Company's 1996
Toronto Medical Corp. and Toronto 10-K
Medical Orthopaedics Ltd.
10.20 Lease dated September 4, 1991 by and Exhibit 10.35 to the Company's
between Greystone Realty Corporation Annual Report on Form 10-K/A
and Sutter Corporation (Amendment No. 1) for the year ended
December 31, 1996 ("1996 10-K/A")
10.21 Lease dated February 10, 1988 between Exhibit 10.36 to 1996 10-K/A
MIC Four Points and Sutter Biomedical,
Inc.
10.22 First Addendum to Lease dated February Exhibit 10.37 to 1996 10-K/A
15, 1988 by and between MIC Four
Points and Sutter Biomedical, Inc.
10.23 October 7, 1988 Second Addendum to Exhibit 10.38 to 1996 10-K/A
Lease dated February 10, 1988
between MIC Four Points and
Sutter Biomedical, Inc.
10.24 Severance Agreement dated February Exhibit 10.39 to the Company's 1996
18, 1997 by and between George A. 10-K
Oram, Jr. and the Company (1)
10.25 Promissory Note dated November 15, Exhibit 10.40 to the Company's 1996
1996 made by George A. Oram, Jr. in 10-K
favor of the Company (1)
10.26 [Intentionally Omitted.]
10.27 Employment Agreement by and between Exhibit 10.4 to the Company's March
Allan M. Weinstein and the Company 1997 10-Q
effective as of December 1, 1996 (1)
10.28 Employment Agreement by and between Exhibit 10.5 to the Company's March
Frank P. Magee and the Company 1997 10-Q
effective as of December 1, 1996 (1)
10.29 [intentionally omitted]
10.30 Employment Agreement by and between Exhibit 10.7 to the Company's March
James B. Koeneman and the Company 1997 10-Q
effective as of December 1, 1996 (1)
10.31 Employment Agreement by and between Exhibit 10.8 to the Company's March
MaryAnn G. Miller and the Company 1997 10-Q
effective as of December 1, 1996 (1)
10.32 Employment Agreement by and between Exhibit 10.9 to the Company's March
Nicholas A. Skaff and the Company 1997 10-Q
effective as of December 1, 1996 (1)
10.33 Co-promotion Agreement dated June 23, Exhibit 10.1 to the Company's June
1997 by and between the Company and 1997 10-Q
Sanofi Pharmaceuticals, Inc.
10.34 Single-tenant Lease-net dated June 12, Exhibit 10.2 to the Company's Form
1997 by and between the Company and 10-Q for the quarter ended
Chamberlain Development, L.L.C. September 30, 1997 ("September 1997
10-Q")
10.35 Employment Agreement dated October Exhibit 10.3 to the Company's
20, 1997 by and between the Company September 1997 10-Q
and Thomas R. Trotter, including Letter
of Incentive Option Grant, OrthoLogic
Corp. 1987 Stock Option Plan (1)
10.36 Employment Agreement dated October Exhibit 10.4 to the Company's
17, 1997 by and between the Company September 1997 10-Q
and Frank P. Magee (1)
10.37 Employment Agreement dated Exhibit 10.5 to the Company's
October 17, 1997 by and between the September 1997 10-Q
Company and Allan M. Weinstein (1)
10.38 Severance Agreement dated May 21, Exhibit 10.6 to the Company's
1997 by and between the Company and September 1997 10-Q
David E. Derminio (1)
10.39 Severance Agreement dated September Exhibit 10.7 to the Company's
19, 1997 by and between the Company September 1997 10-Q
and Nicholas A. Skaff (1)
</TABLE>
EX-3
<PAGE>
<TABLE>
<CAPTION>
Exhibit Filed
No. Description Incorporated by Reference To: Herewith
--- ----------- ----------------------------- --------
<S> <C> <C> <C>
10.40 Employment Agreement effective as of Exhibit 10.7 to the Company's September
December 15, 1997 by and between the 1997 10-Q
Company and William C. Rieger (1)
10.41 Transitional Employment Agreement Exhibit 10.40 to the Company's 1997
dated February 2, 1998 by and between 10-K
the Company and Allen R. Dunaway (1)
10.42 Employment Agreement effective as of Exhibit 10.42 to the Company's 1997
March 16, 1998 by and between the 10-K
Company and Terry D. Meier (1)
10.43 Revised and Restated Employment Exhibit 10.43 to the Company's 1997
Agreement effective as of March 16, 10-K
1998 by and between the Company and
Allan M. Weinstein(1)
10.44 Loan and Security Agreement dated Exhibit 10.44 to the Company's 1997
March 2, 1998 by and between the 10-K
Company and Silicon Valley Bank
10.45 Registration Rights Agreement dated Exhibit 10.45 to the Company's 1997
March 2, 1998 by and between the 10-K
Company and Silicon Valley Bank
10.46 Licensing Agreement with Chrysalis Exhibit 10.1 to the Company's September
Biotechnolgoy, Inc. 1998 10-Q
10.47 1998 Management Bonus Program Exhibit 10.2 to the Company's September
1998 10-Q
10.48 Loan Modification Agreement dated Exhibit 10.3 to the Company's September
May 12, 1998 by and between the 1998 10-Q
Company and Silicon Valley Bank
10.49 Securities Purchase Agreement Exhibit 10.1 to the Company's Form 8-K
filed on July 13, 1998
11.1 Statement of Computation of Net Income X
(Loss) per Weighted Average Number of
Common Shares Outstanding
13.1 Portions of 1998 Annual Report to X
Stockholders
21.1 Subsidiaries of Registrant Exhibit 21.1 to the Company's 1997 10-K
23.1 Consent of Deloitte & Touche LLP X
27 Financial Data Schedule X
</TABLE>
- - ----------
(1) Management contract or compensatory plan or arrangement
* The Company has entered into a separate indemnification agreement with each
of its current direct and executive officers that differ only in party
names and dates. Pursuant to the instructions accompanying Item 601 of
Regulation S-K, the Company has filed the form of such indemnification
agreement.
EX-4
EXHIBIT 13.1
PORTIONS OF THE 1998 ANNUAL REPORT TO STOCKHOLDERS
SPECIAL NOTES REGARDING FORWARD-LOOKING STATEMENTS
This Annual Report contains forward-looking statements within the meaning of the
Private Securities Litigation Reform Act of 1995, including projections of
results of operations and financial condition, statements of future economic
performance, and general or specific statements of future expectations and
beliefs. The matters covered by such forward-looking statements are subject to
known and unknown risks, uncertainties and other factors which may cause the
actual results, performance or achievements of the Company to differ materially
from those contemplated or implied by such forward-looking statements. Important
factors which may cause actual results to differ include, but are not limited
to, the following matters, which are discussed in more detail in the Company's
Form 10-K for the 1998 fiscal year:
The Company's lack of experience with respect to newly acquired technologies and
products may reduce the Company's ability to exploit the opportunities offered
by the acquisitions discussed in this report. Potential difficulties in
integrating the operations of newly acquired businesses may impact negatively on
the Company's ability to realize benefits from the acquisitions. As discussed
herein, the Company intends to pursue sales in international markets. The
Company, however, has had little experience in such markets. Expanded efforts at
pursuing new markets necessarily involves expenditures to develop such markets
and there can be no assurance that the results of those efforts will be
profitable. There can be no assurance that the Company's estimates of the market
opportunity are accurate, or that changes in that market will not cause the
nature and extent of that market to deviate materially from the Company's
expectations. To the extent that the Company presently enjoys perceived
technological advantages over competitors, technological innovation by present
or future competitors may erode the Company's position in the market. To sustain
long-term growth, the Company must develop and introduce new products and expand
applications of existing products; however, there can be no assurance that the
Company will be able to do so or that the market will accept any such new
products or applications. The Company operates in a highly regulated environment
and cannot predict the actions of regulatory authorities. The action or
non-action of regulatory authorities may impede the development and introduction
of new products and new applications for existing products, and may have
temporary or permanent effects on the Company's marketing of its existing or
planned products. There can be no assurance that the influence of managed care
will continue to grow either in the United States or abroad, or that any such
growth will result in greater acceptance or sales of the Company's products. In
particular, there can be no assurance that existing or future decision makers
and third party payors within the medical community will be receptive to the use
of the Company's products or replace or supplement existing or future
treatments. Moreover, the transition to managed care and the increasing
consolidation underway in the managed care industry may concentrate economic
power among buyers of the Company's products, which concentration could
foreseeably adversely affect the price third party payors are willing to pay,
and thus adversely affect the Company's margins. Although the Company believes
that existing litigation initiated against the Company is without merit and the
Company intends to defend such litigation vigorously, an adverse outcome of such
litigation could have a material adverse effect on the on the Company's
business, financial condition and results of operation.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
GENERAL
OrthoLogic (the "Company") was founded in July 1987. Through August 1996, the
Company was engaged primarily in the commercialization of the Company's
proprietary BioLogic(TM) technology in order to develop products that stimulate
the healing of bone fractures and spinal fusions. The Company expanded its
product base to include continuous passive motion ("CPM") products on August 30,
1996 by acquiring Sutter Corporation ("Sutter"). In March 1997, the Company
acquired certain assets and assumed certain liabilities of Toronto Medical Corp.
("Toronto") and Danninger Medical Technology, Inc. ("DMTI"). These acquisitions
allowed the Company to develop, manufacture and market orthopedic rehabilitation
products and services. During the first
1
<PAGE>
quarter of 1998, the Company completed the integration of all the CPM
administrative and service related operations from these acquisitions into one
Phoenix based headquarters.
OrthoLogic develops, manufactures and markets proprietary products and services
for the orthopedic health care market. The Company's product lines includes bone
growth stimulation devices, CPM devices and ancillary orthopedic recovery
products, and Hyalgan, a therapeutic injectable. All the Company's products
focus on improving the clinical outcomes and cost-effectiveness of orthopedic
procedures.
OrthoLogic periodically discusses with third parties the possible acquisition of
technology, product lines, and businesses in the orthopedic health care market.
It has previously entered into letters of intent that provides the Company with
an exclusivity period during which it considers possible acquisitions.
BONE GROWTH STIMULATION AND FRACTURE FIXATION DEVICES
The Company's bone growth stimulation products consist of the OrthoLogic 1000
and the OL-1000 SC (single coil) portable, which are noninvasive physician
prescribed magnetic field bone growth stimulators designed for home treatment of
patients with a non-healing fracture, called a nonunion fracture, of certain
long bones.
In March 1994, the FDA granted the Company Pre-Market Approval (PMA) to market
the OrthoLogic 1000 for treatment of nonunion fractures. Initially, a nonunion
fracture was defined as a fracture that remains unhealed for at least nine
months post injury. During June 1998, the Company received the approval of the
FDA to change the OrthoLogic 1000 label to remove reference to the nine-month
post injury time frame. The revised label states that the OrthoLogic 1000 is
safe and effective to use in treating nonunion fractures.
The SpinaLogic 1000 is a portable, noninvasive magnetic field bone growth
stimulator being developed to enhance the healing process as either an adjunct
to spinal fusion surgery or as a treatment for failed spinal fusion surgery. The
Company's application for a PMA supplement was accepted by the FDA's Center for
Devices and Radiological Health with a filing date of August 20, 1998. This
acceptance indicates that the FDA has made a determination that the PMA
application is sufficiently complete to permit a substantive review. At the end
of December 1998, the Company submitted an amendment to the PMA supplement in
response to requests from the FDA.
In July 1997, the Company received a PMA supplement from the FDA for a single
coil model of the OrthoLogic 1000. The single coil device, the OL-1000 SC,
utilizes the same combined magnetic fields as the OrthoLogic 1000. The Company
released this product during the first quarter of 1998. The OrthoFrame(R) and
the OrthoFrame/Mayo products are external fixation devices used in conjunction
with surgical procedures.
The OrthoLogic 1000 and the OL-1000 SC are sold to patients upon receipt of a
written prescription. The Company submits a bill to the patient's insurance
carrier for reimbursement. The Company recognizes revenue at the time the
product is placed on the patient. The OrthoFrame(R) and the OrthoFrame/Mayo
products are sold to hospitals. The revenue is recognized on these products at
the point a purchase order is received and the bill is sent to the hospital.
CONTINUOUS PASSIVE MOTION
CPM devices provide controlled, continuous movement to joints and limbs without
requiring the patient to exert muscular effort and are intended to be applied
immediately following the orthopedic trauma or surgery. The products are
designed to reduce swelling, increase joint range of motion, reduce the length
of hospital stay and reduce the incidence of post-trauma and post surgical
complication. The Company offers a complete line of ancillary orthopedic
products, including bracing, electrotherapy, cryotherapy and dynamic splinting
products. The Company maintains a fleet of CPM devices that are rented to
patients upon receipt of a written prescription. The Company recognizes rental
revenue daily during the period of usage. Revenue on ancillary products is
recognized at the time of billing. A bill is sent to the patient's insurance
carrier for reimbursement.
2
<PAGE>
HYALGAN
The Company began marketing Hyalgan to orthopedic surgeons during July 1997
under a Co-Promotion Agreement (the "Co-Promotion Agreement") with Sanofi
Pharmaceuticals, Inc. Hyalgan is used for relief of pain from osteoarthritis of
the knee for those patients who have failed to respond adequately to simple
analgesics. The Company recognizes fee revenue when the product is shipped from
the distributor to the orthopedic surgeon under a purchase order. The fee
revenue is based upon the number of units sold at the wholesale acquisition cost
less amounts for distribution costs, discounts, rebates, returns, product
transfer price, overhead factor and a royalty factor.
OTHER
The Company reported a net loss of $16.6 million during 1998 with an accumulated
deficit as of December 31, 1998, of $51.4 million.
As of December 31, 1998, the Company had approximately $28.4 million in net
operating loss carryforwards for federal tax purposes. The Company's ability to
utilize its net operating loss carryforwards may be subject to annual
limitations in future years pursuant to the "change in ownership rules" under
Section 382 of the Internal Revenue Code of 1986, as amended, and are dependent
on the Company's future profitability.
Future operating results will depend on numerous factors including, but not
limited to, demand for the Company's products, the timing, cost and acceptance
of product introductions and enhancements made by the Company or others, level
of third party payment, alternate treatments which currently exist or may be
introduced in the future, practice patterns, competitive conditions in the
industry, general economic conditions and other factors influencing the
orthopedic market in the United States or other countries in which the Company
operates or expands. In addition, efforts to reform the health care systems and
contain health care expenditures in the United States could adversely affect the
Company's revenues and results of operations. Furthermore, the Company's
products are subject to regulation by the FDA, and FDA regulations may adversely
affect the marketing and sales of the Company's products. The Company cannot
determine the effect such trends and regulations will have on its operations, if
any.
RESULTS OF OPERATIONS YEARS ENDED DECEMBER 31, 1996, 1997 AND 1998
Revenues. The Company's revenues increased 84% from $41.9 million in 1996 to
$77.0 million in 1997. The increase of revenues is attributed to a full year of
revenues from the acquisition of Sutter, the addition of DMTI and Toronto
product lines in March 1997 and fee income for Hyalgan which started in July
1997. Sales of OrthoLogic 1000 declined in 1997 compared to 1996. Revenues
decreased 2% from $77.0 million in 1997 to $75.4 million in 1998. The decrease
in revenues is primarily attributable to lower sales of the OrthoLogic 1000. The
fee income for Hyalgan represented a full twelve months of revenue.
Gross Profit. Gross profit increased 75% from $33.6 million in 1996 to $58.7
million in 1997. The gross profit percentage declined from 80.2% in 1996 to
76.2% in 1997 primarily as a result of the CPM operations which have a lower
gross profit percentage than the company's fracture healing products. Gross
profit decreased to $57.7 million in 1998, a decrease of 1.7%. Gross profit as a
percent of sales increased to 76.5% in 1998. The gross profit improvement is due
primarily to the sale of Hyalgan.
Selling, General and Administrative ("SG&A") Expenses. SG&A expenses increased
93% from $31.9 million in 1996 to $61.5 million in 1997 and increased 17% to $72
million in 1998. The increase from 1996 to 1997 is primarily due to a full year
of fixed costs and variable costs associated with the 1996 acquisition of Sutter
and the acquisition of the CPM business of Toronto and DMTI in the first quarter
of 1997. The increase from 1997 to 1998 is primarily due to an increase in bad
debt expense of approximately $9.3 million during the first quarter
3
<PAGE>
of 1998. The increase was a result of management's decision to focus resources
on the collection of current sales and on re-engineering the overall process of
billing and collections.
Research and Development Expenses. Research and development expenses increased
from $2.2 million in 1996 to $2.3 million in 1997. Research and development
expenses increased to $2.9 million in 1998. The increase in 1998 is primarily
due to the $750,000 initial license fee cost for Chrysalin.
Restructuring and Other Charges. During the third quarter of 1997, the Company
restructured its sales, marketing and managed care groups. As a result of their
restructuring and a second consecutive quarter of declining sales of the
OrthoLogic 1000 in the third quarter of 1997, the Company determined that
certain dealer intangibles acquired in the transition to a direct sales force
had been impaired. The Company recorded a restructuring charge of $13.8 million
in the third quarter, composed of a $10.0 million write-off of its dealer
intangibles and $3.8 million in severance, facility closing and related costs.
In the first quarter of 1998, $399,000 of the restructuring reserves were
reversed.
Net Income (Loss). Net loss during 1998 consists of an operating loss of $16.9
million offset by other income of $354,000. Net loss during 1997 is composed of
an operating loss of $19 million offset by other income of $1.5 million,
consisting primarily of interest income of $1.4 million. Net income during 1996
is composed of an operating loss of $485,000 offset by other income of $3.0
million, consisting predominantly of interest income of $2.8 million.
LIQUIDITY AND CAPITAL RESOURCES
The Company has financed its operations through the public and private sales of
equity securities and product revenues. In July 1998, the Company completed a
private placement with two investors, an affiliate of Credit Suisse First Boston
Corp. and Capital Ventures International. Under the terms of the Purchase
Agreement, the Company sold 15,000 shares of Series B convertible Preferred
Stock for $15 million (prior to costs). The Series B Convertible Preferred Stock
is convertible into shares of Common Stock 300 days after issuance and will
automatically convert, to the extent not previously converted, into Common Stock
four years following the date of issuance. Each share of Series B Convertible
Preferred Stock is convertible into Common Stock at a per share price equal to
the lesser of the average of the 10 lowest closing bids during the 30 days prior
to conversion, or 103% of the average of the closing bids for the 10 days prior
to the 300th day following the issuance. The Series B Convertible Preferred
Stock is convertible into Common Stock prior to the 300th day after issuance
upon the occurrence of certain events (in which case the conversion price will
be the average of the 10 lowest closing bids during the 30 days prior to
conversion). In the event of certain Mandatory Redemption Events, each holder of
Series B Preferred Shares will have the right to require the Company to redeem
those shares for cash at the Mandatory Redemption Price. Mandatory Redemption
Events include, but are not limited to: the failure of the Company to timely
deliver Common Shares as required under the terms of the Series B Preferred
Shares or Warrants; the Company's failure to satisfy registration requirements
applicable to such securities; the failure by the Company's stockholders to
approve the transactions contemplated by the Securities Purchase Agreement
relating to the issuance of the Series B Preferred Shares; the failure by the
Company to maintain the listing of its Common Stock on Nasdaq or another
national securities exchange; and certain transactions involving the sale of
assets or business combinations involving the Company. In the event of any
liquidation, dissolution or winding up of the Company, holders of the Series B
Preferred Shares are entitled to receive, prior and in preference to any
distribution of any assets of the Company to the holders of Common Stock, the
Stated Value for each Series B Preferred Share outstanding at that time. The
Purchase Agreement contains strict covenants that protect against hedging and
short-selling of the Company's Common Stock while the purchasers hold shares of
the Series B Convertible Preferred Stock.
In connection with the private placement of the Series B Convertible Preferred
Stock, OrthoLogic issued to the purchasers warrants to purchase 40 shares of
Common Stock for each share of Series B Convertible Preferred Stock, exercisable
at $5.50. The warrants are valued at $1,093,980. Additional costs of the private
placement were approximately $966,000. Both the value of the warrants and the
cost of the private placement will be
4
<PAGE>
recognized over the 10 month conversion period as an "accretion of non-cash
Preferred Stock Dividends" at the amount of $617,994 per quarter.
From the inception of the Company through December 31, 1998, equity financing
has resulted in net proceeds of $134.4 million. At December 31, 1998, the
Company had cash and cash equivalents of $1.7 million and short term investments
of $6.1 million. Working capital decreased 13% from $44.4 million at December
31, 1997 to $38.8 million at December 31, 1998. The decrease of $5.6 million is
primarily the result of a decrease in accounts receivable and cash.
The Company has secured a $7.5 million accounts receivable revolving line of
credit and a $2.5 million revolving term loan from a bank. The maximum amount
that may be borrowed under this agreement is $10 million. The Company may borrow
up to 80% of eligible accounts receivable under the accounts receivable
revolving line of credit and 50% of the net book value of CPM rental fleet under
the revolving term loan. The accounts receivable revolving line of credit
matures May 1, 2000, and the revolving term loan on November 30, 1999. Interest
is payable monthly on the accounts receivable revolving line of credit and
amortized principal and interest are due monthly on the revolving term loan. The
interest rate is prime plus 1.05% for the accounts receivable line of credit,
and prime plus .65% for the revolving term loan. There are certain financial
covenants and reporting requirements associated with the loans. In connection
with these loans the Company issued a warrant to purchase 10,000 shares of
Common Stock at a price equal to the average fair market value for five days
prior to the closing of the loans. The Company anticipates that its cash and
short-term investments on hand, cash from operations, and the funds available
from the line of credit and revolving term loan will be sufficient to meet the
Company's presently projected cash and working capital requirements for the next
12 months. There can be no assurance, however, that this will prove to be the
case. The timing and amounts of cash used will depend on many factors, including
the Company's ability to continue to increase revenues, reduce and control its
expenditures, become profitable and collect amounts due from third party payors.
Additional funds may be required if the Company is not successful in any of
these areas. The Company's ability to continue funding its planned operations
beyond the next 12 months is dependent upon its ability to generate sufficient
cash flow to meet its obligations on a timely basis, or to obtain additional
funds through equity or debt financing, or from other sources of financing, as
may be required.
Net cash used by operations decreased 30.2% from $6.9 million in 1996 to $4.8
million in 1997. The 1997 amount was primarily due to (1) a net loss of $17.7
million, (2) an increase in accounts receivable of $2.8 million, and (3) an
increase in inventories of $1.5 million, which was offset by a non-cash
restructuring charge of $13.8 million and depreciation/amortization of $5.5
million. Net cash used in operations during 1998 rose to $10 million, an
increase of 108% over the $4.8 million. The 1998 amount was primarily due to (1)
a net loss of $16.6 million, (2) a decrease in accrued and other current
liabilities of $4.5 million, and (3) an increase in inventories of $1.4 million,
which was offset by a decrease in accounts receivable of $5.7 million and
depreciation/amortization of $6.5 million.
As discussed in greater detail in Note 13 to the Consolidated Financial
Statements the Company has been named as a defendant in certain lawsuits.
Management believes that the allegations are without merit and will vigorously
defend them. No costs related to the potential outcome of these actions have
been accrued.
Under the terms of the Hyalgan Co-Promotion Agreement (Note 15), the Company is
obligated to pay a total of $4 million during the first eighteen months of the
agreement payable at $1 million every six months. The first $1 million was paid
in 1997. During the first and third quarters of 1998, the Company paid $2.0
million under the Co-Promotion Agreement. The final payment of $1.0 million is
payable during the first quarter of 1999.
YEAR 2000 COMPLIANCE
The inability of computers, software and other equipment utilizing
microprocessors to recognize and properly process data fields containing a 2
digit year is commonly referred to as the Year 2000 Compliance issue. As the
Year 2000 approaches, such systems may be unable to accurately process certain
date-based information.
5
<PAGE>
State of Readiness. The Company has implemented a Year 2000 Corporate Compliance
Plan for coordinating and evaluating compliance actions in all business
activities. The Company's Plan includes a series of initiatives to ensure that
all the Company's computer equipment and software will function properly in the
next millennium. "Computer equipment (or hardware) and software" includes
systems generally thought of as IT dependent, as well as systems not obviously
IT dependent, such as manufacturing equipment, telecopier machines, and security
systems.
The Company began the implementation of this plan in fiscal year 1998. All
internal IT systems and non-IT systems were inventoried during the assessment
phase of the plan. The first execution of the plan occurred in June 1998 when
the Company converted all internal processing systems for accounting,
manufacturing, third party billing, inventory and other operational processes to
Year 2000 compliant software. In addition, in the ordinary course of business,
as the Company periodically replaces computer equipment and software, it will
acquire only Year 2000 compliant products. The Company presently believes that
its software replacements and planned modifications of certain existing computer
equipment and software will be completed on a timely basis so as to avoid any of
the potential Year 2000 related disruptions or malfunctions of its computer
equipment and software.
The Company has completed its compliance review of virtually all of its products
and has not learned of any products that it manufactures that will cease
functioning or experience an interruption in operations as a result of the
transition to the Year 2000.
Costs. The Company has used both internal and external resources to reprogram or
replace, test and implement its IT and non-IT systems for Year 2000
modifications. The Company does not separately track the internal costs incurred
to date on the Year 2000 compliance. Such costs are principally payroll and
related costs for internal IT personnel. The costs to date have been less than
$100,000. Future costs related to Year 2000 compliance is anticipated to be less
than $100,000 for fiscal year 1999. External costs have been incurred for the
system upgrades and software conversions related to other operational
requirements.
Risks. The Company believes it has an effective Plan in place to anticipate and
resolve any potential Year 2000 issues in a timely manner. In the event,
however, that the Company does not properly identify Year 2000 issues or that
compliance testing is not conducted on a timely basis, there can be no assurance
that Year 2000 issues will not materially and adversely affect the Company's
results of operations or relationships with third parties. In addition,
disruptions in the economy generally resulting from Year 2000 issues also could
materially and adversely affect the Company. The amount of potential liability
and lost revenue that would be reasonably likely to result from the failure by
the Company and certain key parties to achieve Year 2000 compliance on a timely
basis cannot be reasonably estimated at this time.
The Company currently believes that the most likely worst case scenario with
respect to the Year 2000 issue is the failure of third party insurance payors to
become compliant, which could result in the temporary interruption of the
payments received for services and products sold. This could interrupt cash
payments received by the Company, which in turn would have a negative impact on
the Company.
Contingency Plan. A contingency plan has not yet been developed for dealing with
the most likely worst case scenarios. As part of its continuous assessment
process, the Company is developing contingency plans as necessary. These plans
could include, but are not limited to, use of alternative suppliers and vendors,
substitutes for banking institutions, and the development of alternative
payments solutions in dealing with third party payors. The Company currently
plans to complete such contingency planning by October 1999.
These plans are based on management's best estimates, which were derived
utilizing numerous assumptions of future events including the continued
availability of certain resources, third party modification plans and other
factors. However, there can be no guarantee that these estimates will be
achieved and actual results could differ from those plans.
6
<PAGE>
MARKET RISKS
The Company is not currently vulnerable to a material extent to fluctuations in
interest rates, commodity prices, or foreign currency exchange rates.
7
<PAGE>
SELECTED FINANCIAL DATA
The selected financial data for each of the five years in the period ended
December 31, 1998 are derived from audited financial statements of the Company.
The selected financial data should be read in conjunction with the Financial
Statements and related Notes thereto and other financial information appearing
elsewhere herein and the discussion in "Management's Discussion and Analysis of
Financial Condition and Results of Operations." As discussed in Note 2 of the
notes to the Company's financial statements, the Company completed two
acquisitions in March 1997 and one in August 1996.
<TABLE>
<CAPTION>
Years Ending December 31,
Statements of Operations Data: 1998 1997 1996 1995 1994
(in thousands, except per share data) ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Total revenues $ 75,369 $ 77,049 $ 41,884 $ 14,678 $ 4,953
Total cost of revenues 17,693 18,369 8,299 3,065 1,314
Operating expenses:
Selling, general, and administrative 72,011 61,484 31,901 11,304 5,611
Research and development 2,920 2,320 2,169 2,132 2,787
Restructuring and other charges [Note 1] (399) 13,844 -- -- --
-------- -------- -------- -------- --------
Total operating expenses 74,532 77,648 34,070 13,436 8,398
-------- -------- -------- -------- --------
Operating loss (16,856) (18,968) (485) (1,823) (4,760)
Other income/expense 354 1,466 3,023 471 288
Income taxes (100) (212) -- -- --
-------- -------- -------- -------- --------
Net income (loss) $(16,602) $(17,714) $ 2,538 $ (1,352) $ (4,472)
Accretion of non-cash preferred
stock dividend $ (1,236) -- -- -- --
-------- -------- -------- -------- --------
Net income (loss) applicable to
common stockholders $(17,838) $(17,714) $ 2,538 $ (1,352) $ (4,472)
======== ======== ======== ======== ========
Net income (loss) per common
share Basic [Note 1] $ (0.71) $ (0.71) $ 0.11 $ (0.09) $ (0.33)
======== ======== ======== ======== ========
Net income (loss) per common
share Diluted [Note 1] $ (0.71) $ (0.71) $ 0.11 $ (0.09) $ (0.33)
======== ======== ======== ======== ========
Weighted Average-- Basic shares outstanding 25,291 25,116 23,275 15,549 13,791
Weighted Average-- Equivalent shares and stock
options -- -- 869 -- --
-------- -------- -------- -------- --------
Diluted shares outstanding 25,291 25,116 24,144 15,549 13,791
======== ======== ======== ======== ========
</TABLE>
1. Net income was affected in 1997 by a one-time charge for restructuring and
other costs, applicable to the impairment of dealer intangibles acquired in the
transition to a direct sales force and expenses related to severance, facility
closing and related costs. The effect on earnings per share from the
restructuring and other changes is a loss of .55 cents per share.
8
<PAGE>
BALANCE SHEET DATA
December 31
--------------------------------------------------
Balance Sheet Data: 1998 1997 1996 1995 1994
(in thousands) ---- ---- ---- ---- ----
Working capital $38,817 $ 44,418 $ 74,985 $23,518 $4,968
Total assets 93,980 103,103 113,026 27,490 7,576
Long-term obligations,
less current maturities 196 1,631 280 -- --
Stockholders' equity 68,225 84,737 101,927 24,437 6,052
STOCKHOLDER INFORMATION
Market Information. The Company's Common Stock commenced trading on the Nasdaq
National Market on January 28, 1993 under the symbol "OLGC." The bid price
information [adjusted for a 2-for-1 stock split effected as a stock dividend in
June 1996] included herein is derived from the Nasdaq Monthly Statistical
Report, represents quotations by dealers, may not reflect applicable markups,
markdowns or commissions and does not necessarily represent actual transactions.
1998 1997
----------------- -----------------
High Low High Low
---- --- ---- ---
First Quarter 7 9/16 5 1/2 7 4 1/2
Second Quarter 7 1/2 4 3/4 6 9/16 4 1/4
Third Quarter 5 2 1/2 7 4 9/16
Fourth Quarter 4 3/8 2 15/16 6 3/16 4 5/8
As of January 29, 1999, there were 25,304,590 shares outstanding of the Common
Stock of the Company held by approximately 306 stockholders of record.
Dividends. The Company has never paid a cash dividend on its Common Stock. The
Board of Directors currently anticipates that all the Company's earnings, if
any, will be retained for use in its business and does not intend to pay any
cash dividends on its Common Stock in the foreseeable future.
9
<PAGE>
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
December 31
1998 1997
---- ----
<S> <C> <C>
Assets
Current assets:
Cash and cash equivalents $ 1,713,966 $ 7,783,349
Short-term investments [Note 7] 6,052,469 4,568,526
Accounts receivable, less allowance for doubtful
accounts of $19,317,823 and $11,370,524 27,030,755 34,530,294
Inventories, net [Note 8] 11,960,071 10,548,173
Prepaids and other current assets 799,350 1,126,075
Deferred income taxes [Note 10] 2,642,909 2,596,386
Total current assets 50,199,520 61,152,803
Furniture, rental fleet & equipment, net [Note 9] 12,867,391 11,459,035
Deposits and other assets 344,915 593,239
Goodwill, net of accumulated amortization of
$2,918,116 and $1,207,707 [Note 2] 26,195,846 26,008,805
Intangibles, net [Notes 3, 15, and 16] 4,372,238 3,888,889
Total assets $ 93,979,910 $ 103,102,771
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable $ 3,038,684 $ 2,896,056
Loan payable 500,000 500,000
Accrued compensation 1,458,849 3,844,359
Deferred credits 1,542,393 1,683,321
Accrued royalties [Note 6] 166,457 447,380
Accrued restructuring and other charges [Note 3] 762,151 2,408,476
Obligations under co-promotion agreement [Note 15] 1,000,000 2,000,000
Accrued expenses 2,914,397 2,955,010
Total current liabilities 11,382,931 16,734,602
Deferred rent and capital leases 196,192 130,708
Loan payable-- long term -- 500,000
Obligations under co-promotion agreement [Note 15] -- 1,000,000
Total liabilities 11,579,123 18,365,310
Commitments and contingencies [Notes 6,12,13,15 and 16]
Series B Convertible Preferred Stock, $1,000 par value;
15,000 shares issued and outstanding; liquidation
preference, $15,000,000 [Note 11] 14,176,008 --
Stockholders' Equity [Note 11]
Common Stock, $.0005 par value; 40,000,000 shares authorized;
25,302,190 and 25,255,190 shares issued and outstanding 12,649 12,626
Additional paid in capital 119,658,836 119,413,210
Deficit (51,405,989) (34,665,794)
Comprehensive income (loss) (40,717) (22,581)
Total stockholders' equity 68,224,779 84,737,461
Total liabilities and stockholders' equity $ 93,979,910 $ 103,102,771
</TABLE>
See notes to consolidated financial statements.
10
<PAGE>
CONSOLIDATED STATEMENTS OF OPERATIONS AND OF COMPREHENSIVE INCOME
<TABLE>
<CAPTION>
Years Ending December 31,
-------------------------------------------
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Revenues
Net sales $ 29,491,932 $ 36,043,169 $ 31,031,451
Net rentals 37,138,960 37,362,446 10,852,788
Fee revenue from co-promotion agreement [Note 15] 8,737,325 3,643,618 --
------------ ------------ ------------
Total revenues 75,368,217 77,049,233 41,884,239
------------ ------------ ------------
Cost of Revenues
Cost of goods sold 10,591,924 10,224,397 5,714,510
Cost of rentals 7,100,706 8,144,806 2,584,530
------------ ------------ ------------
Total cost of revenues 17,692,630 18,369,203 8,299,040
------------ ------------ ------------
Gross profit 57,675,587 58,680,030 33,585,199
Operating Expenses
Selling, general and administrative 72,010,982 61,484,418 31,900,966
Research and development 2,919,857 2,319,640 2,169,090
Restructuring and other charges [Note 3] (398,943) 13,843,591 --
------------ ------------ ------------
Total operating expenses 74,531,896 77,647,649 34,070,056
------------ ------------ ------------
Operating loss (16,856,309) (18,967,619) (484,857)
Other Income (Expense)
Grant/other revenue 103,861 147,263 182,658
Interest income 350,858 1,384,133 2,840,588
Interest expense (101,100) (65,884) --
------------ ------------ ------------
Total other income 353,619 1,465,512 3,023,246
------------ ------------ ------------
Income (loss) before taxes (16,502,690) (17,502,107) 2,538,389
Provision for income taxes [Note 10] (99,804) (211,560) --
------------ ------------ ------------
Net income (loss) (16,602,494) (17,713,667) 2,538,389
Accretion of non-cash preferred stock dividend [Note 11] (1,235,988) -- --
------------ ------------ ------------
Net income (loss) applicable to common stockholders $(17,838,482) $(17,713,667) $ 2,538,389
============ ============ ============
Net income (loss) per common share-- basic $ (0.71) $ (0.71) $ 0.11
============ ============ ============
Net income (loss) per common share-- diluted $ (0.71) $ (0.71) $ 0.11
============ ============ ============
Weighted average-- Basic shares outstanding 25,290,784 25,116,164 23,274,763
Equivalent shares and stock options -- -- 869,000
------------ ------------ ------------
Weighted average-- Diluted shares outstanding 25,290,784 25,116,164 24,143,763
============ ============ ============
CONSOLIDATED STATEMENTS OF COMPREHENSIVE-INCOME
Net income (loss) applicable to common stockholders $(17,838,482) $(17,713,667) $ 2,538,389
Foreign translation adjustment (18,136) (22,581) --
------------ ------------ ------------
Comprehensive income (loss) applicable to
common stockholders $(17,856,618) $(17,736,248) $ 2,538,389
============ ============ ============
</TABLE>
See notes to consolidated financial statements.
11
<PAGE>
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
Additional
Paid in Comprehensive
Shares Amount Capital Income Deficit Total
------ ------ ------- ------ ------- -----
<S> <C> <C> <C> <C> <C> <C>
Balance, January 1, 1996 9,625,864 4,813 43,887,804 -- (19,456,005) 24,436,612
Sale of common stock 2,530,000 1,265 73,949,643 -- -- 73,950,908
Exercise of common options at
prices ranging from $.325 to
$14.625 per share 324,318 162 852,051 -- -- 852,213
Exercise of common stock warrant 10,241 5 (5) -- -- --
Stock option compensation -- -- 64,307 -- -- 64,307
Two for one stock split [Note 11] 12,490,423 6,245 (6,245) -- -- --
Exercise of common options at
prices ranging from $1.844 to
$7.313 per share 41,500 20 84,485 -- -- 84,505
Net income -- -- -- -- 2,538,389 2,538,389
---------- ------- ----------- -------- ------------ ------------
Balance, December 31, 1996 25,022,346 12,510 118,832,040 -- (16,917,616) 101,926,934
Exercise of common stock options at
prices ranging from $.16 to $4.78
per share 232,844 116 496,593 -- -- 496,709
Stock option compensation -- -- 84,577 -- -- 84,577
Other -- -- -- (22,581) (34,511) (57,092)
Net loss -- -- -- -- (17,713,667) (17,713,667)
---------- ------- ----------- -------- ------------ ------------
Balance, December 31, 1997 25,255,190 12,626 119,413,210 (22,581) (34,665,794) 84,737,461
Exercise of common options at
prices ranging from $.50 to $4.55
per share 47,000 23 158,754 -- -- 158,777
Stock option compensation -- -- 25,622 -- -- 25,622
Issuance of warrants in connection
with preferred stock -- -- 1,093,980 -- 1,093,980
Accretion of non-cash preferred
stock dividend -- -- (1,093,980) -- (142,008) (1,235,988)
Other warrants issued and other -- -- 61,250 -- 4,307 65,557
Foreign exchange -- -- -- (18,136) -- (18,136)
Net loss -- -- -- -- (16,602,494) (16,602,494)
---------- ------- ----------- -------- ------------ ------------
Balance, December 31, 1998 25,302,190 12,649 119,658,836 (40,717) (51,405,989) 68,224,779
========== ======= =========== ======== ============ ============
</TABLE>
See notes to consolidated financial statements.
12
<PAGE>
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Years Ending December 31,
---------------------------------------
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Operating Activities
Net income (loss) (16,602,494) (17,713,667) 2,538,389
Adjustments to reconcile net income (loss)
to net cash used in operating activities:
Depreciation and amortization 6,473,000 5,510,251 1,926,056
Restructuring and other charges (399,000) 13,843,591 --
Other -- (438,504) --
Change in operating assets and liabilities,
excluding effects of business acquisitions:
Accounts receivable 5,682,834 (2,759,187) (9,062,119)
Inventories (1,411,898) (1,494,096) (3,171,448)
Prepaids and other current assets 280,065 (23,215) (819,623)
Deposits and other assets 186,870 (438,447) 4,636
Accounts payable 242,628 (871,546) (708,136)
Accrued and other current liabilities (4,466,299) (437,934) 2,377,410
----------- ----------- ---------
Net cash used in operating activities (10,014,294) (4,822,754) (6,914,835)
----------- ----------- ---------
Investing Activities
Expenditures for furniture and equipment, net (5,423,652) (5,128,159) (1,389,309)
Intangibles from dealer transactions -- (704,966) (10,752,116)
Officer note receivable, net -- 200,000 (75,000)
Acquisitions, net of cash acquired -- (24,886,134) (24,907,442)
Investments in Chrysalin (750,000) --
(Purchase) sale of short-term investments (1,484,943) 30,738,463 (26,157,629)
----------- ----------- ---------
Net cash (used) provided in investing activities (7,658,595) 219,204 (63,281,496)
----------- ----------- ---------
Financing Activities
Payments under long-term debt and capital
lease obligations (157,984) (233,756) (27,956)
Payments on loan payable (500,000) (420,084) --
Payments under co-promotion agreement (2,000,000) (1,000,000) --
Net proceeds from stock options exercised and other 227,490 546,886 700,700
Net proceeds from issuance of convertible preferred
stock and warrants 14,034,000 --
Net proceeds from issuance of common stock -- -- 74,186,926
----------- ----------- ---------
Net cash (used in) provided by financing activities 11,603,506 (1,106,954) 74,859,670
----------- ----------- ---------
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS (6,069,383) (5,710,504) 4,663,339
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 7,783,349 13,493,853 8,830,514
----------- ----------- ---------
CASH AND CASH EQUIVALENTS, END OF YEAR 1,713,966 7,783,349 13,493,853
=========== =========== =========
Supplemental schedule of non-cash investing and
financing activities:
Stock option compensation 25,622 84,577 64,307
Supplemental Disclosure of Cash Flow Information
Acquisition of intangible asset through obligation
for product distribution rights [Note 15] 4,000,000
Accretion of non-cash preferred stock dividend 1,235,988
Purchase of property and equipment with capital leases 493,289 -- --
Purchase price adjustment related to preacquisition
contingencies 1,816,362 -- --
Cash paid during the year for interest 101,100 65,844 --
Cash paid during the year for income taxes 350,000 400,000 --
</TABLE>
See notes to consolidated financial statements.
13
<PAGE>
NOTES TO FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION. OrthoLogic Corp. ("the Company") was incorporated on July 30, 1987
(date of inception) and commenced operations in September 1987. On August 30,
1996 OrthoLogic Corp. acquired all of the outstanding capital stock of Sutter
Corporation ("Sutter") which became a wholly-owned subsidiary of the Company. On
March 9, 1997 and March 12, 1997, the Company acquired certain assets and
assumed certain liabilities of Toronto Medical Corp. ("Toronto") and Danninger
Medical Technology, Inc. ("DMTI "). Concurrent with the acquisition of Toronto
the Company formed a wholly-owned Canadian subsidiary, now known as OrthoLogic
Canada Ltd.
DESCRIPTION OF THE BUSINESS. OrthoLogic develops, manufactures and markets
proprietary, technologically advanced orthopedic products and packaged services
for the orthopedic health care market including bone growth stimulation,
continuous passive motion ("CPM") devices and ancillary orthopedic recovery
products primarily in the United States. OrthoLogic's products are designed to
enhance the healing of diseased, damaged, degenerated or recently repaired
muscular skeletal tissue. The Company's products focus on improving the clinical
outcomes and cost-effectiveness of orthopedic procedures that are characterized
by compromised healing, high-cost, potential for complication and long
recuperation time. In June 1997, the Company further extended its product line
by entering into a co-promotion agreement (the "Co-Promotion Agreement") with
Sanofi Pharmaceuticals, Inc. of New York (Note 15). The Co-Promotion Agreement
allows the Company to market Hyalgan (sodium hyaluronate) to orthopedic surgeons
in the United States for the relief of pain from osteoarthritis of the knee. The
Company commenced marketing of Hyalgan in July 1997. On January 14, 1999 the
Company exercised its option to license the United States development,
marketing, and distribution rights for the fresh fracture indications for
Chrysalin, a new tissue repair synthetic peptide. The Company will pursue
commercialization of Chrysalin, initially seeking Food and Drug Administration
(FDA) approval for the human clinical trials for the fracture healing
indication. The Company projects that Chrysalin could receive all the necessary
FDA approvals and be introduced in the market during 2003. There can be no
assurance, however, that the clinical trials will result in favorable data or
that FDA approvals if sought will be obtained.
During the year ended December 31, 1998 and 1997 the Company incurred losses of
$16.6 million and $17.7 million, respectively. In addition, the Company used
cash in operating activities of $10.0 million and $4.8 million for the years
ended December 31, 1998 and 1997, respectively. The Company anticipates that its
cash and short-term investments on hand, cash from operations and the funds
available from the line of credit and revolving term loan (Note 12) will be
sufficient to meet the Company's presently projected cash and working capital
requirements for the next 12 months. There can be no assurance, however, that
this will prove to be the case. The timing and amounts of cash used will depend
on many factors, including the Company's ability to continue to increase
revenues, reduce and control its expenditures, become profitable and collect
amounts due from third party payors. Additional funds may be required if the
Company is not successful in any of these areas. The Company's ability to
continue funding its planned operations beyond the next 12 months is dependent
on its ability to generate sufficient cash flow to meet its obligations on a
timely basis, or to obtain additional funds through equity or debt financing, or
from other sources of financing, as may be required.
PRINCIPLES OF CONSOLIDATION. The consolidated financial statements include the
accounts of OrthoLogic Corp. since its inception, Sutter since its acquisition
on August 30, 1996 and the operations of Toronto and DMTI since their
acquisition in March 1997. All material intercompany accounts and transactions
have been eliminated.
14
<PAGE>
The following briefly describes the significant accounting policies used in the
preparation of the financial statement of the Company:
A. INVENTORIES are stated at the lower of cost (first in, first out
method) or market.
B. FURNITURE, RENTAL FLEET, AND EQUIPMENT are stated at cost or, in the
case of leased assets under capital leases, at the present value of
future lease payments at inception of the lease. Depreciation is
calculated on a straight-line basis over the estimated useful lives of
the various assets, which range from three to seven years. Leasehold
improvements and leased assets under capital leases are amortized over
the life of the asset or the period of the respective lease using the
straight-line method, whichever is the shortest.
C. REVENUE recognition for the OrthoLogic 1000 and the OL-1000 SC is at
the time the product is placed on the patient. The OrthoFrame(R) and
the OrthoFrame/Mayo are typically held on consignment at hospitals and
revenue is recognized at the point a purchase order is received from
the hospital. Rental revenue for CPM products is recorded daily during
the period of usage. Revenue on CPM ancillary products is generally
recognized at the time of shipment. Fee revenue for Hylagan is based
upon the number of units sold at the wholesale acquisition cost less
amounts for distribution costs, discounts, rebates, returns, product
transfer price, overhead factor and a royalty factor. Grant revenue is
recorded as earned in accordance with the terms of the grant contracts.
D. RESEARCH AND DEVELOPMENT represent both costs incurred internally for
research and development activities, as well as costs incurred by the
Company to fund the activities of the various research groups which the
Company has contracted. All research and development costs are expensed
when incurred.
E. CASH AND CASH EQUIVALENTS consist of cash on hand and cash deposited
with financial institutions, including money market accounts, and
commercial paper purchased with an original maturity of three months or
less.
F. INCOME (LOSS) PER COMMON SHARES is computed on the weighted average
number of common or common and common equivalent shares outstanding
during each year. Basic EPS is computed as net income (loss) applicable
to common stockholders divided by the weighted average number of common
shares outstanding for the period. Diluted EPS reflects the potential
dilution that could occur from common shares issuable through stock
options, warrants, and other convertible securities when the effect
would be dilutive. The Board of Directors approved a 2-for-1 stock
split in the form of a 100% common share dividend which was paid on
June 25, 1996. The accompanying Financial Statements have been restated
to give effect of the split.
G. CERTAIN RECLASSIFICATIONS have been made to the 1997 and 1996 financial
statements to conform to the 1998 presentation.
H. INTANGIBLE ASSETS. Goodwill from the acquisition of Sutter, Toronto and
DMTI is capitalized and amortized on a straight-line basis over the
estimated useful life of the related asset (15-20 years). The
intangible relating to the product distribution rights for Hyalgan
acquired in the co-promotion agreement is being amortized over 15
years.
I. LONG-LIVED ASSETS. In accordance with Statement of Financial Accounting
Standards ("SFAS") No. 121, the Company reviews the carrying values of
its long lived assets and identifiable intangibles for possible
impairment whenever events or changes in circumstances indicate that
the carrying amount of assets to be held and used may not be
recoverable.
J. STOCK BASED COMPENSATION. The Company accounts for its stock based
compensation plan based on accounting Principles Board ("APB") Opinion
No. 25. In October 1995, the Financial Accounting Standards Board
issued SFAS No. 123, Accounting for Stock-Based Compensation. The
Company has
15
<PAGE>
determined that it will not change to the fair value method and will
continue to use APB Opinion No. 25 for measurement and recognition of
any expense related to employee stock based transactions (Note 11).
K. USE OF ESTIMATES. The preparation of the financial statements in
conformity with generally accepted accounting principles necessarily
requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities and disclosure of contingent
assets and liabilities at the date of the financial statements and the
reported amounts of revenue and expenses during the reporting period.
Significant estimates include the allowance for doubtful accounts
($19,317,823 and $11,370,524 at December 31, 1998 and 1997,
respectively), which is based primarily on trends in historical
collection statistics, consideration of current events, payer mix and
other considerations. The Company derives a significant amount of its
revenues in the United States from third-party health insurance plans,
including Medicare. Amounts paid under these plans are generally based
on fixed or allowable reimbursement rates. Revenues are recorded at the
expected or preauthorized reimbursement rates when billed. Some
billings are subject to review by such third party payors and may be
subject to adjustments. In the opinion of management, adequate
allowances have been provided for doubtful accounts and contractual
adjustments. Any differences between estimated reimbursement and final
determinations are reflected in the year finalized.
L. NEW ACCOUNTING PRONOUNCEMENTS. In June 1998, the FASB issued SFAS No.
133, Accounting for Derivative Instruments and Hedging Activities. SFAS
No. 133 requires that an enterprise recognize all derivatives as either
assets or liabilities in the statement of financial position and
measure those instruments at fair value. The statement is effective for
the Company's fiscal year ending December 31, 2000. The Company has not
completed evaluating the impact of implementing the provisions of SFAS
No. 133. The FASB issued SFAS No. 131 on "Disclosures about Segments of
an Enterprise and Related Information" effective in 1998. The Company
evaluated SFAS No. 131 and determined that the Company operates in only
one segment.
2. ACQUISITIONS
On August 30, 1996, the Company acquired all of the outstanding capital stock of
Sutter for $24.5 million in cash and assumption of $11.7 million of liabilities.
The acquisition was accounted for as a purchase, resulting in goodwill of $13.2
million which is being amortized over 15 years.
On March 3, 1997 and March 12, 1997, the Company acquired certain assets and
assumed certain liabilities of Toronto and DMTI. After paying certain of the
assumed liabilities, the net cash outlay was approximately $7.5 million for
Toronto and $10.7 million for DMTI. In March 1998, the Company recorded an
increase of approximately $1.8 million to goodwill representing the settlement
of a preacquisition contingency and representations and warranties relating to
the 1997 acquisitions. Both acquisitions were accounted for as purchases under
the purchase method of accounting, which resulted in goodwill of $5.5 million
for Toronto and $10.6 million for DMTI. The goodwill is being amortized over 20
years. The Company has substantially completed its integration of operations
related to these acquisitions. The following unaudited pro forma summary
combines the consolidated results of operations of the Company as if the
acquisitions of Toronto and DMTI had occurred January 1, 1997 after giving
effect to certain adjustments including amortization of goodwill, interest
income and income taxes. This pro forma summary is not necessarily indicative of
the results of operations that would have occurred if OrthoLogic, Toronto, and
DMTI had been combined for all of 1997.
Year Ending December 31, 1997
-------------------------------------
(in thousands, except per share data)
Net revenues $ 80,332
Income (loss) from continuing operations (17,725)
Net income (loss) per common share $ (.71)
16
<PAGE>
3. RESTRUCTURING AND OTHER CHARGES
During the third quarter of 1997, the Company restructured its sales, marketing
and managed care groups. As a result of their restructuring and a second
consecutive quarter of declining sales of the OrthoLogic 1000 bone growth
stimulator, the Company determined that certain dealer intangibles acquired in
the transition to a direct sales force in 1996 have been impaired. The Company
recorded a restructuring charge of $13.8 million in the third quarter, composed
of a $10.0 million write-off of its dealer intangibles, $2.3 million in
severance, $1.2 million in facility closing and $300,000 of related costs. There
was a reversal of 1997 restructuring expenses of $399,000 during the first
quarter of 1998.
The remaining balance of the restructuring reserve of $762,000 on December 31,
1998 primarily relates to severance.
4. SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
During the first quarter of 1998, the Company recorded a charge of approximately
$9.3 million for additional bad debt expense. The charge was a result of a
management decision during the first quarter of 1998 to focus proportionately
more resources on collection of current sales and on re-engineering the overall
process of billing and collections. Management determined it was no longer
considered to be cost effective to expend significant resources on the
collection of the older receivables as had been done in the past.
5. LEGAL SETTLEMENT
The Company settled a false claims matter with the U.S. Department of Justice in
a case that was filed in December 1996 under qui tam provisions of the Federal
False Claims Act. The allegations included the submission of claims for
reimbursement for a small number of custom medical devices to various federal
care programs including Medicare, TRICARE (formerly known as CHAMPUS) and
various state Medicaid programs.
OrthoLogic denies any wrongdoing or liability with respect to the allegations in
this matter. Nevertheless, in an effort to avoid the expense, burden and
uncertainty of litigation in this case as well as the potential distraction this
case could have on the Company's management, the Company agreed to settle this
matter. Under the terms of the definitive settlement agreement, OrthoLogic paid
and expensed in 1998 $1.0 million to the U.S. Department of Justice, on behalf
of several federal health care programs including Medicare, TRICARE, and various
state Medicaid programs. In return, the U.S. Department of Justice released the
Company's officers, employees, and directors from any causes of actions for
civil damages or civil penalties for the various allegations being settled in
this matter. The original complaint was dismissed with prejudice.
6. RESEARCH, PRODUCT DEVELOPMENT AND LICENSE AGREEMENTS
The Company has committed to pay royalties on the sale of products or components
of products developed under certain product development and licensing
agreements. The royalty percentages vary but generally range from 7% to 0.5 % of
the sales amount for licensed products. The royalty percentage under the
different agreements decrease when either a certain sales dollar amount is
reached or royalty amount is paid. Royalty expense under these agreements
totaled $258,456, $360,110 and $621,597 in 1998, 1997 and 1996, respectively.
17
<PAGE>
7. INVESTMENTS
The Company has implemented SFAS No. 115 "Accounting for Certain Investments in
Debt and Equity Securities." At December 31, 1998, short term investments were
composed of corporate debt securities and direct obligations of the United
States Government and its agencies and were managed as part of the Company's
cash management program and were classified as held-to-maturity securities. All
such securities were purchased with original maturities less than one year. Such
classification requires these securities to be reported at amortized cost. A
summary of the fair market value and unrealized gains and losses on these
securities is as follows:
Years Ending December 31,
-------------------------
1998 1997
---- ----
Amortized cost $6,052,469 $4,568,526
Gross unrealized gains 665 11,250
Gross unrealized losses (17,205) (73,947)
---------- ----------
Fair value $6,035,929 $4,505,829
========== ==========
8. INVENTORIES
Inventories consisted of the following:
December 31
--------------------------
1998 1997
---- ----
Raw materials $8,484,773 $5,812,861
Work-in-process 122,371 3,463,197
Finished goods 4,101,325 1,633,753
----------- -----------
12,708,469 10,909,811
Less allowance for obsolescence (748,398) (361,638)
----------- -----------
Total $11,960,071 $10,548,173
============ ===========
9. FURNITURE, RENTAL FLEET AND EQUIPMENT
Furniture, rental fleet and equipment consisted of the following:
December 31
--------------------------
1998 1997
---- ----
Rental fleet 14,373,674 10,843,842
Machinery and equipment 2,383,562 2,007,544
Computer equipment 3,708,812 2,574,896
Furniture and fixtures 767,661 780,039
Leasehold and improvements 727,996 186,431
----------- -----------
21,961,705 16,392,752
Less accumulated depreciation and
amortization (9,094,314) (4,933,717)
----------- -----------
Total $12,867,391 $11,459,035
=========== ===========
18
<PAGE>
10. INCOME TAXES
At December 31,1998, the Company has approximately $28.4 million in net
operating loss carryforwards expiring from 2002 through 2017 for federal income
tax purposes. Stock issuances, as discussed in Note 11, may cause a change in
ownership under the provisions of Internal Revenue Code Section 382;
accordingly, the utilization of the Company's net operating loss carryforwards
may be subject to annual limitations.
Management has evaluated the available evidence about future taxable income and
other possible sources of realization of deferred tax assets. The valuation
allowance reduces deferred tax assets to an amount that management believes will
more likely than not be realized. The components of deferred income taxes at
December 31 are as follows:
1998 1997
---- ----
Allowance for bad debts $ 7,779,000 $ 4,560,000
Other accruals and reserves 1,263,909 672,386
Valuation allowance (6,400,000) (2,636,000)
------------ ------------
Total current 2,642,909 2,596,386
------------ ------------
Net operating loss carryforwards 12,207,000 6,971,000
Difference in basis of fixed assets (1,100,000) (978,000)
Nondeductible accruals and reserves 159,000 340,000
Amortization of intangibles and other 90,000 2,075,000
Difference in basis of dealer intangible 3,889,000 4,198,000
Valuation allowance (15,245,000) (12,606,000)
------------ ------------
Total noncurrent -- --
------------ ------------
Total deferred income taxes $ 2,642,909 $ 2,596,386
The provision for income taxes are as follows:
1998 1997
---- ----
Current $ 146,327 $ 407,000
Deferred (46,523) (195,440)
------------ ------------
Income Tax Provisions $ 99,804 $ 211,560
============ ============
A reconciliation of the difference between the provision for income taxes and
income taxes at the statutory U.S. federal income tax rate is as follows for the
years ended December 31:
1998 1997 1996
---- ---- ----
Income taxes at statutory rate $(5,611,000) $(5,950,000) $ 863,000
Net operating losses used -- -- (930,000)
State income taxes (990,000) (1,024,000) 200,000
Change in valuation allowance 6,403,000 6,558,000 --
Other 297,804 627,560 (133,000)
----------- ----------- -----------
Net provision $ 99,804 $ 211,560 $ 0
=========== =========== ===========
19
<PAGE>
11. STOCKHOLDERS' EQUITY AND SERIES B CONVERTIBLE PREFERRED STOCK
In October 1987, the stockholders adopted a Stock Option Plan (the "1987 Option
Plan") which was amended in September 1996, and approved by shareholders in May
1997, to increase the number of common shares reserved for issuance under the
1987 Option Plan to 4,160,000 shares. This plan expired during October 1997. In
May 1997, the Stockholders adopted a new Stock Option Plan (the "1997 Option
Plan") which replaced the 1987 Option Plan. The 1997 Option Plan reserved for
issuance 1,040,000 shares of common stock and was amended in 1998 to increase
the number of shares of common stock by 275,000 shares. Two types of options may
be granted under the 1997 Option Plan: options intended to qualify as incentive
stock options under Section 422 of the Internal Revenue Code ("Code") and other
options not specifically authorized or qualified for favorable income tax
treatment by the Code. All eligible employees may receive more than one type of
option. Any director or consultant who is not an employee of the Company shall
be eligible to receive only nonqualified stock options under the 1997 Option
Plan.
In October 1989, the Board of Directors (the "Board") approved that in the event
of a takeover or merger of the company in which 100% of the equity of the
company is purchased, 75% of all unvested employee options will vest, with the
balance vesting equally over the ensuing 12 months, or according to the
individual's vesting schedule, whichever is earlier. If an employee or holder of
stock options is terminated as a result of or subsequent to the acquisition,
100% of that individual's stock option will vest immediately upon employment
termination. These provisions are also included in the 1997 Option Plan.
Options are granted at prices which are equal to the current fair value of the
Company's common stock at the date of grant. The vesting period is generally
related to length of employment and all vested options lapse upon termination of
employment if not exercised within a 90-day period (or one year after death or
disability or the date of termination if terminated for cause).
A summary of the status of the Option Plans as of December 31, 1998, 1997 and
1996, and changes during the years then ended is:
<TABLE>
<CAPTION>
1998 1997 1996
------------------- ------------------- ---------------------
Weighted- Weighted- Weighted-
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
------ ----- ------ ----- ------ -----
<S> <C> <C> <C> <C> <C> <C>
Fixed options outstanding
at beginning of year 2,535,450 $6.07 2,509,644 $7.31 2,356,034 $ 3.33
Granted 1,024,000 4.79 1,132,150 5.54 903,746 13.15
Exercised (47,000) 3.92 (232,844) 2.37 (690,136) 1.60
Forfeited (127,625) 7.48 (873,500) 9.59 (60,000) 6.23
Outstanding at end of year 3,384,825 5.66 2,535,450 6.07 2,509,644 7.31
Options exercisable at year-end 1,744,357 1,072,975 613,737
Weighted-average fair value price of
options granted during the year $2.26 $3.02 $ 7.50
</TABLE>
20
<PAGE>
The following table summarizes information about fixed stock options outstanding
at December 31, 1998:
<TABLE>
<CAPTION>
Outstanding Exercisable
Number Weighted- Weighted- Number Weighted-
Range of Outstanding Average Remaining Average Exercisable Average
Exercise Prices as of 12/31/98 Contractual Life Exercise Price as of 12/31/98 Exercise Price
- - --------------- -------------- ---------------- -------------- -------------- --------------
<S> <C> <C> <C> <C> <C>
$1.8100-2.4400 351,800 5.11 $ 2.0551 348,049 $ 2.0554
2.5000-3.2500 406,600 6.92 2.8192 234,934 2.7315
3.3440-5.0000 375,000 9.03 4.7423 155,000 4.9810
5.0630-5.4380 436,250 8.90 5.3680 229,838 5.3348
5.5000-5.5310 352,900 9.33 5.5018 7,000 5.5000
5.5630-5.5630 100,000 9.01 5.5630 0 0.0000
5.6250-5.6250 381,000 8.76 5.6250 112,833 5.6250
5.8125-6.5625 177,575 8.68 6.2934 54,794 6.3118
6.7800-6.7800 470,000 6.95 6.7800 362,292 6.7800
7.3100-17.3800 333,700 7.48 12.7001 239,617 13.4350
- - --------------- --------- -------- -------- --------- --------
$1.8100 -17.3800 3,384,825 7.89 $ 5.6643 1,744,357 $ 5.7614
================ ========= ======== ======== ========= ========
</TABLE>
The Company applies APB Opinion No. 25 and related interpretations in accounting
for its Option Plans. Had compensation costs been computed based on the fair
value of awards on the date of grant, utilizing the Black-Scholes option-pricing
model, consistent with the method stipulated by SFAS No. 123, the Company's net
earnings and earnings per share for the years ended December 31, 1998, 1997 and
1996 would have been reduced to the pro forma amounts indicated below, followed
by the model assumptions used:
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Net income (loss) attributable to
common stockholders;
As reported (in thousands) $(17,838) $(17,714) $ 2,538
Pro forma (in thousands) $(20,351) $(20,371) $ 679
Basic and Diluted Net income (loss) per-share:
As reported $ (0.71) $ (0.71) $ 0.11
Pro forma $ (0.80) $ (0.81) $ 0.03
Black-scholes model assumptions:
Risk free interest rate 6.00% 6.00% 6.00%
Expected volatility 0.4 0.6 0.6
Expected term 5 Years 5 Years 5 Years
Dividend yield 0% 0% 0%
</TABLE>
In July 1998, the Company completed a private placement with two investors, an
affiliate of Credit Suisse First Boston Corp. and Capital Ventures
International. Under the terms of the Purchase Agreement, OrthoLogic sold 15,000
shares of Series B Convertible Preferred Stock for $15 million (prior to costs).
The Series B Convertible Preferred Stock is convertible into shares of Common
Stock 300 days after issuance and will automatically convert, to the extent not
previously converted, into Common Stock four years following the date of
issuance. Each share of Series B Convertible Preferred Stock is convertible into
Common Stock at a per share price equal to the lesser of the average of the 10
lowest closing bids during the 30 days prior to conversion, or 103% of the
average of the closing bids for the 10 days prior to the 300th day following the
issuance. The Series B Convertible Preferred Stock is convertible into Common
Stock prior to the 300th day after issuance upon the occurrence of certain
events (in which case the conversion price will be the average of the 10 lowest
closing bids during the 30 days prior to conversion). In the event of certain
Mandatory Redemption Events, each holder of Series B Preferred Shares will have
the right to require the Company to redeem those shares for cash at the
Mandatory Redemption Price. Mandatory Redemption Events include, but are not
limited to: the failure of the
21
<PAGE>
Company to timely deliver Common Shares as required under the terms of the
Series B Preferred Shares or Warrants; the Company's failure to satisfy
registration requirements applicable to such securities; the failure by the
Company's stockholders to approve the transactions contemplated by the
Securities Purchase Agreement relating to the issuance of the Series B Preferred
Shares; the failure by the Company to maintain the listing of its Common Stock
on Nasdaq or another national securities exchange; and certain transactions
involving the sale of assets or business combinations involving the Company. In
the event of any liquidation, dissolution or winding up of the Company, holders
of the Series B Preferred Shares are entitled to receive, prior and in
preference to any distribution of any assets of the Company to the holders of
Common Stock, the Stated Value for each Series B Preferred Share outstanding at
that time. The Purchase Agreement contains strict covenants that protect against
hedging and short-selling of OrthoLogic Common Stock while the purchasers hold
shares of the Series B Convertible Preferred Stock.
In connection with the private placement of the Series B Convertible Preferred
Stock, OrthoLogic issued to the purchasers warrants to purchase 40 shares of
Common Stock for each share of Series B Convertible Preferred Stock, exercisable
at $5.50 per share. These warrants expire in 2008. The warrants are valued at
$1,093,980. Additional costs of the private placement were approximately
$966,000. Both the value of the warrants and the cost of the private placement
will be recognized over the 10 month conversion period as an "accretion of
non-cash Preferred Stock Dividends" for the amount of $617,994 per quarter. The
Company filed a registration statement covering the underlying Common Stock.
Proceeds from the private placement will be used to fund new product
opportunities, including SpinaLogic, Chrysalin and Hyalgan, as well as to
complete the re-engineering of the Company's key business processes.
At the closing of the Company's IPO on January 28, 1993 all convertible Series D
Preferred Stock, totaling 4,173,002 shares, was converted into an equal amount
of common stock. At December 31, 1998, there were 2,000,000 shares of preferred
stock authorized.
In 1993, the Company issued a warrant to purchase 20,000 shares of common stock,
at an exercise price of $1.813 per share, to another company for an ownership
interest of that company.
In 1996, the Company issued a warrant to purchase 5,000 shares of common stock,
at an exercise price of $2.41 per share, to a consultant as partial payment for
services.
On April 30, 1996, the Company issued 5,060,000 shares of common stock upon
closing of a public offering of its common stock. Gross proceeds to the Company
were $78.4 million. The net proceeds to the Company after deducting costs of the
offering were approximately $74.0 million. The common stock was sold at $15.50
per share.
During the first quarter of 1996 the Company amended its Certificate of
Incorporation to authorize 40,000,000 shares of common stock, $.0005 par value.
In addition, the Board of Directors approved a 2-for-1 stock split in the form
of a 100% common share dividend which was paid on June 25, 1996. The
accompanying financial statements and footnotes have been restated to give
effect to the split.
12. COMMITMENTS
The Company is obligated under non-cancelable operating lease agreements for its
office, manufacturing and research facilities. Rent expense for the years ended
December 31, 1998, 1997 and 1996 was $1,716,000, $594,000 and $482,000,
respectively.
Future lease payments for fiscal years 1999, 2000, 2001, 2002 and beyond 2002
are $1,781,000, $1,198,000, $985,000, $963,000 and $5,537,000, respectively.
22
<PAGE>
The Company has secured a $7.5 million accounts receivable revolving line of
credit and a $2.5 million revolving term loan from a bank. The maximum amount
that may be borrowed under this agreement is $10 million. The Company may borrow
up to 80% of eligible accounts receivable under the accounts receivable
revolving line of credit and 50% of the net book value of CPM rental fleet under
the revolving term loan. The accounts receivable revolving line of credit
matures May 1, 2000, and the revolving term loan on November 31, 1999. Interest
is payable monthly on the accounts receivable revolving line of credit and
amortized principal and interest are due monthly on the revolving term loan. The
interest rate is prime plus 1.05% for the accounts receivable line of credit,
and prime plus .65% for the revolving term loan. There are certain financial
covenants and reporting requirements associated with the loans. In connection
with these loans the Company issued a warrant to purchase 10,000 shares of
Common Stock at a price of $6.13. These warrants expire in 2003.
13. LITIGATION
During 1996 certain lawsuits were filed in the United States District Court for
the District of Arizona against the Company and certain officers and directors
alleging violations of Section 10(b) of the Securities Exchange Act of 1934 and
SEC Rule 10b-6 promulgated thereunder.
Plaintiffs in these actions allege that correspondence received by the Company
from the U.S. Food and Drug Administration (the "FDA") pertaining principally to
the promotion of the Company's OrthoLogic 1000 Bone Growth Stimulator was
material and undisclosed, leading to an artificially inflated stock price.
Plaintiffs further allege practices referenced in that correspondence operated
as a fraud against plaintiffs. Plaintiffs further allege that once the FDA
letter became known, a material decline in the stock price of the Company
occurred, causing damage to the plaintiffs.
All plaintiffs seek class action status, unspecified compensatory damages, fees,
and costs. Plaintiffs also seek extraordinary, equitable and/or injunctive
relief as permitted by law. The actions were consolidated for all purposes in
the United States District Court for the District of Arizona and lead plaintiffs
and counsel were appointed. The Company and its officers and directors moved to
dismiss the consolidated amended complaint for failure to state a claim. The
Court dismissed the consolidated amended complaint in its entirety against the
Company and its officers and directors but gave plaintiffs leave to amend all
claims to cure all deficiencies. Plaintiffs have filed an amended complaint, and
the cases are pending. If any claim deficiencies are not cured, that claim will
be dismissed with prejudice as against the Company and its officers and
directors.
In addition, the Company has been served with a substantially similar action
filed in Arizona state court alleging state law causes of action grounded in the
same set of facts. By agreement between the parties this action has been stayed
while the federal actions proceed.
In addition to the foregoing, a shareholder derivative complaint alleging, among
other things, breach of fiduciary duty in connection with the conduct alleged in
the aforesaid federal and state court class actions have also been filed in
Arizona state court. That action is stayed pending action on plaintiffs' amended
complaint.
Management believes that the allegations are without merit and will vigorously
defend them.
At December 31, 1998, in addition to the matters disclosed above, the Company is
involved in various other legal proceedings that arose in the ordinary course of
business.
The costs associated with defending the above allegations and the potential
outcome cannot be determined at this time and accordingly, no estimate for such
costs have been included in the accompanying Financial Statements. In
management's opinion, the ultimate resolution of the above legal proceedings
will not have a material effect on the financial position, results of
operations, or cash flow of the Company.
23
<PAGE>
14. 401(k) PLAN
The Company adopted a 401(k) plan (the "Plan") for its employees on July 1,
1993. The Company may make matching contributions to the Plan on behalf of all
Plan participants, the amount of which is determined by the Board of Directors.
The Company did not make any matching contributions to the Plan in 1998, 1997,
and 1996.
15. CO-PROMOTION AGREEMENT
The Company entered into an exclusive co-promotion agreement (the "Agreement")
with Sanofi Pharmaceuticals Inc. ("Sanofi") at a cost of $4 million on June 23,
1997 for purpose of marketing Hyalgan, a hyaluronic acid sodium salt, to
orthopedic surgeons in the United States for the treatment of pain in patients
with osteoarthtitis of the knee. During 1997 and 1998 the Company paid $3.0
million of this amount. At December 31, 1998 the Company has recorded the
remaining $1.0 million as a liability in its financial statements. The initial
term of the agreement ends on December 31, 2002. Upon the expiration of the
initial term, Sanofi may terminate the agreement, extend the agreement for up to
ten additional one year periods, or enter into a revised agreement with the
Company. Management believes it is mutually beneficial for both parties to
extend the agreement beyond the initial period. Upon termination of the
agreement, Sanofi must pay the Company the amount equal to 50% of the gross
compensation paid to the Company, pursuant to the Agreement, for the immediately
preceding year.
The Company's sales force began to promote Hyalgan in the third quarter of 1997.
Fee revenue of $8.7 and $3.6 million was recognized during 1998 and 1997,
respectively.
16. LICENSING AGREEMENT
The Company announced in January 1998 that it had acquired a minority equity
interest in a biotech firm, Chrysalis Bio Technology, Inc. for $750,000. As part
of the transaction, the Company was awarded a nine-month world-wide exclusive
option to license the orthopedic applications of Chysalin, a patented 23-amino
acid peptide that has shown promise in accelerating the healing process and has
completed an extensive pre-clinical safety and efficacy profile of the product.
In pre-clinical animal studies, Chrysalin was also shown to double the rate of
fracture healing with a single injection into the fresh fracture gap. The
Company's agreement with Chrysalis contains provisions for the Company to
continue and expand its option to license Chrysalin contingent upon regulatory
approvals, successful pre-clinical trials, and certain milestone payments to
Chrysalis by the Company. An additional $750,000 for the initial license was
expensed in the third quarter. The agreement was extended to January 1999 to
complete the evaluation of the Technology (Note 17). The Company will pursue
commercialization of Chrysalis, initially seeking Food and Drug Administration
(FDA) approval for the human clinical trials for the fracture-healing
indication. The Company projects that Chrysalis could receive all the necessary
FDA approvals and be introduced in the market during 2003. There can be no
assurance, however, that the clinical trials will result in favorable data or
that FDA approvals, if sought, will be obtained. Significant additional costs
will be necessary to complete development of this product.
17.SUBSEQUENT EVENTS
In January 1999, the Company exercised its option to license the U.S.
development, marketing and distribution rights for Chrysalin, for fresh fracture
indications. As part of the equity investment (Note 16), OrthoLogic acquired
options to license Chrysalin for orthopedic applications.
On February 9, 1999, the Company loaned $157,800 to an Officer of the Company.
The note plus accrued interest is payable on June 15, 1999.
Subsequent to the year-end, the Company settled a lawsuit related to the
acquisition of DMTI and received approximately $100,000 of the amounts escrowed
at the time of the acquisition.
24
<PAGE>
Independent Auditors' Report
BOARD OF DIRECTORS AND STOCKHOLDERS
OrthoLogic Corp., Phoenix, Arizona
We have audited the accompanying consolidated balance sheets of OrthoLogic Corp.
and subsidiaries (the "Company") as of December 31, 1998 and 1997, and the
related consolidated statements of operations, comprehensive income,
stockholders' equity, and cash flows for each of the three years in the period
ended December 31, 1998. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of the Company at December 31, 1998
and 1997, and the results of its operations and its cash flows for each of the
three years in the period ended December 31, 1998 in conformity with generally
accepted accounting principles.
Deloitte & Touche LLP
Phoenix, Arizona
February 9, 1999
ORTHOLOGIC CORP.
STATEMENT OF COMPUTATION OF NET INCOME (LOSS) PER WEIGHTED AVERAGE
NUMBER OF COMMON SHARES OUTSTANDING*
(In thousands, except per share amounts)
<TABLE>
<CAPTION>
Years Ended December 31,
------------------------
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Net income (loss) ............................... ($17,838) ($17,714) $ 2,538
======== ======= =======
Common shares outstanding at end of period....... 25,302 25,255 25,022
Adjustment to reflect weighted average for
shares issued during the period.................. (11) (139) (878)
-------- -------- -------
Weighted average number of common shares
outstanding...................................... 25,291 25,116 24,144
======== ======= =======
Net income (loss) per weighted average number
of common shares outstanding..................... ($.71) ($.71) $.11
======== ======= =======
</TABLE>
* Adjusted to reflect the Company's 2-for-1 stock split effected in the form of
a 100% stock dividend in June 1996.
EXHIBIT 23.1
INDEPENDENT AUDITORS' CONSENT
We consent to the incorporation by reference in Registration Statements No.
33-79010, No. 333-1268, No. 333-09785, No. 333-35507 and No. 333-35505 of
OrthoLogic Corp. on Form S-8 and Registration Statements No. 33-82050, No.
333-1558 and No. 333-62321 of OrthoLogic Corp. on Form S-3 of our reports dated
February 9, 1999, appearing in and incorporated by reference in the Annual
Report on
Form 10-K of OrthoLogic Corp. for the year dated December 31, 1998.
DELOITTE & TOUCHE LLP
Phoenix, Arizona
March 26, 1999
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
FINANCIAL STATEMENTS IN ORTHOLOGIC CORP.'S REPORT ON FORM 10-K FOR THE YEAR
ENDED DECEMBER 31, 1998 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1
<CURRENCY> U.S. DOLLAR
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<EXCHANGE-RATE> 1
<CASH> 1713966
<SECURITIES> 6052469
<RECEIVABLES> 46348578
<ALLOWANCES> 19317823
<INVENTORY> 11960071
<CURRENT-ASSETS> 50199520
<PP&E> 21961705
<DEPRECIATION> 9094314
<TOTAL-ASSETS> 93979910
<CURRENT-LIABILITIES> 11382931
<BONDS> 0
0
14176008
<COMMON> 12649
<OTHER-SE> 68212130
<TOTAL-LIABILITY-AND-EQUITY> 93979910
<SALES> 66630892
<TOTAL-REVENUES> 75368217
<CGS> 17692630
<TOTAL-COSTS> 74531896
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 101100
<INCOME-PRETAX> (16502690)
<INCOME-TAX> 99804
<INCOME-CONTINUING> 0
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (17838482)
<EPS-PRIMARY> (0.71)
<EPS-DILUTED> (0.71)
</TABLE>
