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, 1999
[ ] 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 23,
2000 was approximately $173,609,383. 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
23, 2000 was 29,738,263.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's Annual Report to Stockholders for the fiscal
year ended December 31, 1999 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 19, 2000 are incorporated by reference in Part
III hereof.
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ORTHOLOGIC CORP.
FORM 10-K ANNUAL REPORT
YEAR ENDED DECEMBER 31, 1999
TABLE OF CONTENTS
PART I
Item 1. Business........................................................... 1
Item 2. Properties......................................................... 9
Item 3. Legal Proceedings.................................................. 9
Item 4. Submission of Matters to a Vote of Security Holders................ 11
Executive Officers of the Registrant............................... 11
PART II
Item 5. Market for the Registrant's Common Equity and Related
Stockholder Matters.............................................. 13
Item 6. Selected Financial Data............................................ 13
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations........................................ 13
Item 7A. Quantitative and Qualitative Disclosures About Market Risk......... 18
Item 8. Financial Statements and Supplementary Data........................ 18
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure......................................... 18
PART III
Item 10. Directors and Executive Officers of the Registrant................. 19
Item 11. Executive Compensation............................................. 19
Item 12. Security Ownership of Certain Beneficial Owners and Management..... 19
Item 13. Certain Relationships and Related Transactions..................... 19
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.... 20
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.
However, the Company plans to use regional spine product distributors coupled
with its direct sales force for the sale of its new bone growth stimulation
device, the SPINALOGIC.
BONE GROWTH STIMULATION PRODUCTS
ORTHOLOGIC(R) 1000; OL-1000 SC. The ORTHOLOGIC 1000 is a U.S. Food and Drug
Administration ("FDA") approved, portable, noninvasive physician prescribed
magnetic field bone growth stimulator designed for home treatment of patients
who have 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. 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 July 1997, the Company received a Pre-Market Approval ("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.
SPINALOGIC(R). The SPINALOGIC is a portable, noninvasive magnetic field
bone growth stimulator which enhances 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 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
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 Investigational Device Exemption from
the FDA in August 1992 and commenced clinical trials for the SPINALOGIC 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 as a noninvasive treatment for a failed spinal fusion
surgery. After OrthoLogic submitted several amendments to the PMA Supplement in
response to discussions with the FDA, the U.S. Food and Drug Administration
approved the SPINALOGIC PMA Supplement on December 20, 1999 allowing the Company
to begin selling SPINALOGIC to customers.
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CPM DEVICES AND RELATED PRODUCTS
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. The
Company offers a wide range of lower and upper extremity CPM devices. Lower
extremity CPM is a widely accepted treatment for rehabilitation from knee
surgical procedures such as total knee replacement and anterior cruciate
ligament reconstruction. Consequently the number of companies competing in this
line of business has increased, resulting in decreased reimbursement rates from
managed care providers. Upper extremity CPM for the shoulder, elbow, wrist and
hand are not yet standard rehabilitation procedures but are continuing to gain
acceptance. No clinical studies have been completed supporting the efficiency of
upper extremity CPM. As a result, there is no Medicare reimbursement to date for
this treatment. Currently, the majority of upper extremity CPM reimbursement
payments are workers' compensation related. The Company maintains a fleet of CPM
devices that are rented to patients upon receipt of a written prescription.
ANCILLARY ORTHOPEDIC PRODUCTS. The Company offers a complete line of
bracing, electrotherapy, cryotherapy and dynamic splinting products. The bracing
line includes post-operative, custom and pre-sized functional and osteoarthritis
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 Arctic, 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. On January 24, 2000, the U.S. Food and Drug
Administration approved new labeling for Hyalgan which states Hyalgan can
produce pain relief beyond 26 weeks. The labeling will allow the Company to
utilize published clinical papers exhibiting up to 12 months of pain relief with
a single course of therapy. In addition, the revised label allows the Company to
promote Hyalgan for repeated cycles of treatment.
FUTURE PRODUCTS
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. In November, 1999 the U.S. Food and Drug
Administration approved the Company's Investigational New Drug Application,
authorizing the Company to proceed on human clinical trials for Chrysalin. In
January 2000, the Company began enrolling patients in double blind clinical
trials. Depending on the rate of patient enrollment, the trials could be
completed by the end of 2000. However, there can be no assurance that the trials
will be completed at that time or the nature of the findings. The trial consists
of prospective, randomized double blind studies of 90 patients in three clinical
centers to study the safety and efficiency of Chrysalin on healing fractures.
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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
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, and the Orthopedic Products 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. Additionally, the Company utilizes
physician-to-physician selling via presentations and scientific and clinical
articles published in medical journals. 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. In
marketing the SPINALOGIC, the Company is using a combination of its own direct
sales force and regional spine product distributors. Because the SPINALOGIC'S
PMA was only recently approved by the FDA on December 20, 1999, there is no
assurance that the marketing strategy or the level of sales of the SPINALOGIC
will be successful.
The Company's sales and marketing efforts are primarily conducted directly
through the Company's own sales people with some marketing by outside spine
product distributors for the SPINALOGIC. Of the Company's approximately 521
employees at December 31, 1999, approximately 301 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.
Through the efforts of the Company's specialized direct sales force
servicing third party payors, the Company has contracted with over 513 third
party payors, including various Blue Cross/Blue Shield organizations, Aetna U.S.
Healthcare 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. Effective April 1, 2000, Medicare patients with non- healing
fractures are eligible to be treated with the ORTHOLOGIC 1000 90 days after the
injury. Prior to this change in the Medicare acceptance criteria, patients were
required to wait six months before their non-union fractures were eligible for
the ORTHOLOGIC 1000. Because this change in the acceptance criteria has not yet
become effective, there is no assurance what effect, if any, this change will
have on the demand for the ORTHOLOGIC 1000.
While OrthoLogic has not experienced seasonality of revenues from sales of
the ORTHOLOGIC 1000 and related products, 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 first and fourth quarters 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. There has been no
seasonal impact on sales of Hyalgan.
RESEARCH AND DEVELOPMENT
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
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development of new products and also additional therapeutic applications for
existing products. The Company also has a clinical regulatory group that
initiates and monitors clinical trials. The Company's clinical regulatory group
recently began accepting enrollment into its double blind human clinical trials
on Chrysalin. The Company's research and development expenditures totaled $2.3
million, $2.9 million and $2.9 million in the years ended December 31, 1997,
1998 and 1999, respectively. See "Item 7 -- Management's Discussion and Analysis
of Financial Condition and Results of Operations."
MANUFACTURING
The Company assembles the ORTHOLOGIC 1000 and SPINALOGIC products 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
SPINALOGIC products from a single manufacturer. The ORTHOLOGIC 1000 and
SPINALOGIC 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 or
with its suppliers to meet its sales forecast and provide for any such redesign
work. In addition, the magnetic field sensor employed in the ORTHOLOGIC 1000 and
SPINALOGIC products is 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 SPINALOGIC 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 up to 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.
A third party drug manufacturer produces Chrysalin for the Company. Because
Chrysalin is currently still in the clinical trial phase and not being sold to
the public, it is manufactured by a sole supplier.
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, SpinaLogic 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"), Biolectron
Inc., and Exogen, Inc. With respect to the adjunctive treatment of spinal fusion
surgery, the primary competitors are EBI, OrthoFix and Biolectron Inc. With
respect to external fixation devices, the Company's primary competitors are
OrthoFix, Stryker, 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
therefore represent significant competition for the Company. The Company is
aware that its competitors are conducting clinical trials for other medical
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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 a European patent (Switzerland, Germany, and France), as well as
to a pending patent application in Japan, and holds an exclusive worldwide
license to 27 United States patents, seven Australian patents, five Canadian
patents, two European patents (Germany, France, the United Kingdom, Spain and
Italy) and three Japanese patents. Currently there are also pending patent
application 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 has been assigned eight 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 Europe and Japan.
With respect to CPM technology, the Company currently owns 21 United States
patents, 8 foreign patents and 5 foreign patent applications pending and
applications being distributed in Canada, Europe and Japan. The issued patents
on this technology are due to expire over a period of years beginning in the
year 2002 and extending through 2017. 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.
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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 PERIOLOGIC(TM), OSTEOLOGIC(TM), ORTHONAIL(TM), ORTHOSOUND(TM),
QUICKFIX(TM), CPM 9000AT(TM), LEGASUS CPM(TM), SUTTER CAREPLAN(TM), HOME REHAB
SYSTEM(TM) and DANNIFLEX(TM).
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, as amended, and the Safe Medical
Devices Act of 1990, as amended (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 Investigational Device Exemption
("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.
The European Community requires compliance with newly formed quality control
standards. The Company 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.
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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 are Class I
devices and therefore do not require any Canadian regulatory approvals prior to
their introduction to the market. However, the Company must provide Health
Canada with notice concerning the sale of a device and obtain a license to sell
the devices. Notice for all of the CPM devices currently manufactured by the
Company in Canada has been provided to Health Canada and the Company license was
renewed. Subsequent to such notification, Health 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 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. The Company's Biologic technology-based products require
and have obtained pre-market approval under Canadian law.
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. The CPM devices have, unless otherwise exempt, obtained such
necessary approvals.
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.
As a new drug product, Chrysalin is subject to clinical trial and GMP
reviews, similar to those described for the BioLogic technology-based products.
Under the FDC Act, drug products are required to be tested under Investigational
New Drug ("IND") Phase I, II, and III clinical trials and approved for marketing
under a New Drug Application ("NDA"). To begin human clinical trials the Company
must apply to the FDA for an IND approval. Generally, preclinical laboratory and
animal tests are required to establish a scientific basis for granting of an IND
application. Once an IND application is granted, the clinical trials may
commence and involve rigorous data collection as specified in the IND
protocol(s). Data from earlier phases may need to be reviewed by FDA before
proceeding to later phases. After all phases of clinical trials are completed,
data are compiled and submitted to the FDA in an NDA application. FDA approval
of an NDA application occurs after the applicant has established safety and
efficacy to the satisfaction of the FDA. Approval of an NDA application includes
specific requirements for labeling, manufacturing, and controls. The approval
process may include review by an FDA advisory panel. Among conditions for NDA
approval is the requirement that the prospective manufacturer's quality control
and manufacturing procedures comply with the FDA regulations setting forth Good
Manufacturing Practices. A third party manufactures Chrysalin for the Company.
The manufacturer is required to register with the FDA and is subject to periodic
FDA inspections of manufacturing facilities. Because Chrysalin is currently
manufactured by a sole supplier, if violations of applicable regulation are
noted during FDA inspections, the continued marketing of the product may be
adversely affected.
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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
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 513 third party payors as an
approved provider for its fracture healing and orthopedic rehabilitation
products, including the Department of Veterans Affairs, Aetna U.S. Healthcare
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.
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 Company did not experience any material Year 2000 computer problems on
its primary computer systems. The Company's computer systems functioned properly
into the year 2000. As a result, the Company was able to service its customers,
communicate with its suppliers, and submit billings to third party payers
without disruption. The Company, however, continues to monitor its systems,
suppliers, and customers for any unanticipated issues that have yet to surface.
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EMPLOYEES
As of December 31, 1999, the Company had 521 employees, including 301 in
sales and marketing, 15 in research and development and clinical and regulatory
affairs, approximately 4 in managed care, 100 in reimbursement and 101 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."
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 Assembly,
industrial park Administration
Pickering 28,500 2/02 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 Pickering
facility and all CPM administrative and service functions in Tempe. 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.
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.
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DOROTHY COHEN, ON BEHALF OF HERSELF AND ALL OTHERS SIMILARLY SITUATED V.
ORTHOLOGIC CORP. AND ALLAN M. WEINSTEIN, Cause No. CIV 96-1615 PHX SMM, filed in
the United States District Court for the District of Arizona (Phoenix Division)
on July 9, 1996.
JOSEPH C. BARTON, ON BEHALF OF HIMSELF AND ALL OTHERS SIMILARLY SITUATED V.
ORTHOLOGIC CORP. AND ALLAN M. WEINSTEIN, Cause No. CIV 96-1643 PHX ROS, filed in
the United States District Court for the District of Arizona (Phoenix Division)
on July 12, 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.
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. The
actions were consolidated for all purposes in the United States District Court
for the District of Arizona. On March 31, 1999, the judge in the consolidated
case before the United States District Court granted the Company's Motion to
Dismiss and entered an order dismissing all claims in the suit against the
Company and two individual officers/directors. The judge allowed certain narrow
claims based on insider trading theories to proceed against certain individual
defendants. On December 21, 1999, the District Court granted plaintiffs' motion
for class certification to include purchasers of common stock between June 4
through June 18, 1996, inclusive.
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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 seek
class action status, unspecified compensatory and punitive damages, fees and
costs. Plaintiffs also seek injunctive and/or equitable relief. The Company
filed a Motion to Dismiss the Complaint in Arizona State Court in May 1999. The
Court denied the motion in July 1999 and granted the plaintiffs' motion for the
class certification on November 24, 1999. The Company has appealed the state
court's class certification and the appeal is now pending in the Arizona Supreme
Court.
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. The Company filed a Motion to DismisS
the Complaint which was granted on December 13, 1999. As of March 13, the
Plaintiff had not appealed the dismissal.
The Company continues to deny the substantive allegations in the aforesaid
lawsuits and will continue to defend the action vigorously.
As of December 31, 1999, in addition to other matters disclosed above, the
Company is involved in other various legal proceedings that arose in the
ordinary course of business.
The costs associated with defending the above allegations and 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 proceedings will not
have a material effect on the financial position of the Company.
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 52 Chief Executive Officer, President and Director
Frank P. Magee, D.V.M. 43 Executive Vice President, Research and Development
Terry D. Meier 61 Senior Vice President, Chief Financial Officer
William C. Rieger 50 Vice President, Marketing Worldwide
David K. Floyd 39 Vice President, Sales
Ruben Chairez, Ph.D. 57 Vice President, Medical Regulatory and Clinical
Affairs
MaryAnn G. Miller 42 Vice President, Human Resources
Kevin Lunau 42 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
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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.
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 16 of
the Company's Annual Report to Stockholders for the year ended December 31, 1999
(the "Annual Report") is incorporated herein by reference.
ITEM 6. SELECTED FINANCIAL DATA
The information on pages 16 through 29 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 11 through 15 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, 1999. 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 301
employees. During 1996, the Company shifted its primary focus from sales through
independent orthopedic specialty dealers to an internal sales force. To enhance
market penetration of the recently approved SPINALOGIC product, the Company
plans to supplement the distribution of the product using a combination of its
own direct sales force and regional spine product distributors. 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 academic institutions. There can be no
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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,
1998 and 1999 revenues from CPM devices and Hyalgan reduced the Company's
dependence on revenues from the ORTHOLOGIC 1000. Near the end of 1999 the
Company began human clinical trials of its Chrysalin product and received
approval from the FDA to begin marketing SPINALOGIC. However, the Company
believes that, to sustain long-term growth, it must continue to 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 and SPINALOGIC and the Company's other products will also depend in
significant part upon its widespread acceptance by a significant portion of the
medical community as a safe, efficacious and cost-effective alternative to
invasive procedures. The Company is unable to predict how quickly, if at all,
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, although it has been in use for about 12 years, is
still a relatively 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. As a new
product to the market, SPINALOGIC'S sales and acceptance by the medical
community are unknown. 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.
MANAGEMENT OF GROWTH. The Company's future performance will depend in part
on its ability to manage change in its operations and changes in the healthcare
industry, 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
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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.
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 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 non- competitive. In addition, new
technologies, procedures and medications could be developed that replace or
reduce the value of the Company's products. The Company's success will depend in
part on its ability to respond quickly to medical and technological changes
through the development and introduction of new products. There can be no
assurance that the Company's new product development efforts will result in any
commercially successful products. A failure to develop new products could have a
material adverse effect on the company's business, financial condition and
results of operations. See "Item 1 -- Business -- Research and Development."
15
<PAGE>
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. Chrysalin, as a new drug, is
subject to clinical trial and Good Manufacturing Practices review similar to
those that apply to the BioLogic technology-based products.
The FDA and comparable agencies in many foreign countries and in state and
local governments impose substantial limitations on the introduction of medical
devices through costly and time-consuming laboratory and clinical testing and
other procedures. The process of obtaining FDA and other required regulatory
approvals is lengthy, expensive and uncertain. Moreover, regulatory approvals,
if granted, typically include significant limitations on the indicated uses for
which a product may be marketed. In addition, approved products may be subject
to additional testing and surveillance programs required by regulatory agencies,
and product approvals could be withdrawn and labeling restrictions may be
imposed for failure to comply with regulatory standards or upon the occurrence
of unforeseen problems following initial marketing.
The Company is also required to adhere to applicable requirements for FDA
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
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 SPINALOGIC devices from a single manufacturer,
Phillips N.V. Although there are feasible alternate microprocessors that might
be used immediately, all are produced by Phillips. In addition, there are single
suppliers for other components used in the ORTHOLOGIC 1000 and SPINALOGIC
devices and only two suppliers for the magnetic field sensor employed in them.
Establishment of additional or replacement suppliers for these components cannot
be accomplished quickly. Therefore, the Company maintains sufficient inventories
of such components in an attempt to ensure availability of finished products in
the event of supply shortage or in the event that a redesign is required. The
Company 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 without a material interruption to product
availability. Hyalgan is also manufactured by a single company, Fidia S.p.A.
Fidia has been manufacturing Hyalgan for sale in Europe since 1987. The Company
maintains a supply of certain ORTHOLOGIC 1000 and SPINALOGIC components to meet
sales forecasts for 3 to 12 months. The distributor of Hyalgan maintains a
supply of product to last several months. Chrysalin, which is currently only in
the clinical trial phase, is produced by a third party sale supplier. Any delay
or interruption in supply of components or products could significantly impair
the Company's ability to deliver its products in sufficient quantities, and
therefore, could have a material adverse effect on its business, financial
condition and results of operations.
16
<PAGE>
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
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."
17
<PAGE>
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 11 through 15 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 has exposure to foreign exchange rates through its
manufacturing subsidiary in Canada.
The Company does not use foreign currency exchange forward contracts or
commodity contracts to limit its exposure. The Company is not currently
vulnerable to a material extent to fluctuations in interest rates and commodity
prices.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The information on pages 11 through 29 of the Annual Report is incorporated
herein by reference.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
18
<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 19, 2000 (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, 1999.
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.
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 17 through 29
of the Annual Report:
Balance Sheets - December 31, 1999 and 1998.
Statements of Operations - Each of the three years in the period ended
December 31, 1999.
Statements of Comprehensive Income - Each of the three years in the
period ended December 31, 1999.
Statements of Stockholders' Equity - Each of the three years in the
period ended December 31, 1999.
Statements of Cash Flows - Each of the three years in the period ended
December 31, 1999.
Notes to Financial Statements
19
<PAGE>
2. FINANCIAL STATEMENT SCHEDULES
Valuation and Qualifying Accounts.
Allowance for doubtful accounts
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)
1999 Additions charged to expense (18,800,728)
1999 Deductions to allowance 22,615,832
Balance December 31, 1999 $(15,502,720)
Allowance for inventory reserves
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)
1999 Additions charged to expense (1,422,333)
1999 Deductions to allowance 1,190,929
Balance December 31, 1999 $ (979,802)
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.
20
<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 30, 2000 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 30, 2000
- --------------------------- Officer and Director
Thomas R. Trotter (Principal Executive Officer)
/s/ John M. Holliman III Chairman of the Board of March 30, 2000
- --------------------------- Directors and Director
John M. Holliman III
/s/ Fredric J. Feldman Director March 30, 2000
- ---------------------------
Fredric J. Feldman
/s/ Elwood D. Howse, Jr. Director March 30, 2000
- ---------------------------
Elwood D. Howse, Jr.
/s/ Stuart H. Altman Director March 30, 2000
- ---------------------------
Stuart H. Altman, Ph.D.
/s/ Augustus A. White III Director March 30, 2000
- ---------------------------
Augustus A. White III, M.D.
/s/ Terry D. Meier Senior Vice President and March 30, 2000
- --------------------------- 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, 1999
(FILE NO. 0-21214)
<TABLE>
<CAPTION>
Exhibit Filed
No. Description Incorporated by Reference To: Herewith
- ------- ----------- ----------------------------- --------
<S> <C> <C> <C>
3.1 Amended and Restated Certificate Exhibit 3.1 to the Company's Form
of Incorporation 10-Q for the quarter ended March
31, 1997 ("March 1997 10-Q")
3.2 Certificate of Designation in Exhibit 3.1 to Company's Form
respect of Series A Preferred 10-Q for the quarter ended March
Stock 31, 1997 ("March 1997 10-Q")
3.3 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 Stock Purchase Warrant, dated Exhibit 4.6 to Company's
September 20, 1995, issued to Registration Statement on Form
Registered Consulting Group, Inc. S-1 (No. 33-97438) filed with the
SEC on September 27, 1995 ("1995
S-1")
4.2 Stock Purchase Warrant dated Exhibit 4.7 to the Company's Form
October 15, 1996 issued to 10-K for the year ended December
Registered Consulting Group, Inc. 31, 1996 ("1996 10-K")
4.3 Rights Agreement dated as of Exhibit 4.1 to the Company's
March 4, 1997 between the Company Registration Statement on Form
and Bank of New York, and 8-A filed with the SEC on March
Exhibits A, B and C thereto 6, 1997
4.4 1987 Stock Option Plan of the Exhibit 4.4 to the Company's Form
Company, as amended and approved 10-Q for the quarter ended June
by stockholders (1) 30, 1997 ("June 1997 10-Q")
4.5 1987 Stock Option Plan of the Exhibit 4.5 to the Company's June
Company(1) 1997 10-Q
4.6 Stock Purchase Warrant dated Exhibit 4.10 to the Company's
March 2, 1998 issued to Silicon 1997 10-K
Valley Bank
4.7 Antidilution Agreement dated Exhibit 4.11 to the Company's
March 2, 1998 by and between the 1997 10-K
Company and Silicon Valley Bank
4.8 Amendment to Stock Purchase Exhibit 4.1 to the Company's form
Warrant dated May 12, 1998 issued 10-Q for the quarter ended March
to Silicon Valley Bank 31, 1998
4.9 Form of Warrant Exhibit 4.1 to the Company's Form
8-K filed on July 13, 1998
4.10 Registration Rights Agreement Exhibit 4.2 to the Company's Form
8-K filed on July 13, 1998
10.1 License Agreement dated September Exhibit 10.6 to January 1993 S-1
3, 1987 between the Company and
Life Resonances, Inc.
10.2 Invention, Confidential Exhibit 10.11 to January 1993 S-1
Information and Non-Competition
Agreement dated January 10, 1989
between the Company and Frank P.
Magee
10.3 Form of Indemnification Exhibit 10.16 to January 1993 S-1
Agreement*
10.4 License Agreement dated December Exhibit 10.22 to January 1993 S-1
2, 1992 between Orthotic Limited
Partnership and Company
10.5 Consulting Agreement dated May 1, Exhibit 10.11 to the Company's
1990 between Augustus A. White September 30, 1994 Form 10-Q
III and the Company(1)
10.6 Employment Agreement by and Exhibit 10.8 to the Company's
between MaryAnn G. Miller and the March 1997 10-Q
Company effective as of December
1, 1996 (1)
10.7 Co-promotion Agreement dated June Exhibit 10.1 to the Company's
23, 1997 by and between the June 1997 10-Q
Company and Sanofi
Pharmaceuticals, Inc.
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
Exhibit Filed
No. Description Incorporated by Reference To: Herewith
- ------- ----------- ----------------------------- --------
<S> <C> <C> <C>
10.8 Single-tenant Lease-net dated Exhibit 10.2 to the Company's
June 12, 1997 by and between the Form 10-Q for the quarter ended
Company and Chamberlain September 30, 1997 ("September
Development, L.L.C. 1997 10-Q")
10.9 Employment Agreement dated Exhibit 10.3 to the Company's
October 20, 1997 by and between September 1997 10-Q
the Company and Thomas R.
Trotter, including Letter of
Incentive Option Grant,
OrthoLogic Corp. 1987 Stock
Option Plan (1)
10.10 Employment Agreement dated Exhibit 10.4 to the Company's
October 17, 1997 by and between September 1997 10-Q
the Company and Frank P. Magee (1)
10.11 Employment Agreement effective as Exhibit 10.40 to the Company's
of December 15, 1997 by and 1997 10-K
between the Company and William
C. Rieger (1)
10.12 Employment Agreement effective as Exhibit 10.42 to the Company's
of March 16, 1998 by and between 1997 10-K
the Company and Terry D. Meier (1)
10.13 Registration Rights Agreement Exhibit 10.45 to the Company's
dated March 2, 1998 by and 1997 10-K
between the Company and Silicon
Valley Bank
10.14 Licensing Agreement with Exhibit 10.1 to the Company's
Chrysalis Biotechnolgoy, Inc. September 1998 10-Q
10.15 1998 Management Bonus Program Exhibit 10.2 to the Company's
September 1998 10-Q
10.16 Securities Purchase Agreement Exhibit 10.1 to the Company's
Form 8-K filed on July 13, 1998
10.17 First Amendatory Agreement to Exhibit 10.1 to the Company's
March 4, 1997 Rights Agreement Form 8-K filed August 24, 1999
10.18 Credit and Security Agreement X
between the Company and Wells
Fargo Business Credit, Inc. dated
February 28, 2000
10.19 Lease Extension and Amendment X
Agreement dated September 29,
1998 between the Company and the
Heritage Corp. for the Pickering
property
11.1 Statement of Computation of Net X
Income (Loss) per Weighted
Average Number of Common Shares
Outstanding
13.1 Portions of 1999 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
23.2 Independent Auditors' Report 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.
CREDIT AND SECURITY AGREEMENT
Dated as of February 28, 2000
ORTHOLOGIC CORP., a Delaware corporation (the "Borrower"), and WELLS FARGO
BUSINESS CREDIT, INC., a Minnesota corporation (the "Lender"), hereby agree as
follows:
ARTICLE I
DEFINITIONS
SECTION 1.1 DEFINITIONS. For all purposes of this Agreement, except as
otherwise expressly provided or unless the context otherwise requires:
(a) the terms defined in this Article have the meanings assigned to
them in this Article, and include the plural as well as the singular; and
(b) all accounting terms not otherwise defined herein have the
meanings assigned to them in accordance with GAAP.
"Accounts" means all of the Borrower's accounts, as such term is
defined in the UCC, including without limitation the aggregate unpaid
obligations of customers and other account debtors to the Borrower arising out
of the sale or lease of goods or rendition of services by the Borrower on an
open account or deferred payment basis.
"Advance" means a Revolving Advance.
"Affiliate" or "Affiliates" means any Person controlled by,
controlling or under common control with the Borrower, including (without
limitation) any Subsidiary of the Borrower. For purposes of this definition,
"control," when used with respect to any specified Person, means the power to
direct the management and policies of such Person, directly or indirectly,
whether through the ownership of voting securities, by contract or otherwise.
"Agreement" means this Credit and Security Agreement, as amended,
supplemented or restated from time to time.
"Allowed Investments" means Borrower's Co-Promotion Agreement with
Sanofi Pharmaceuticals, Inc. and Borrower's Minority Equity Investment with
Chrysalis Biotechnology, Inc.
"Availability" means the positive difference, if any, between (i) the
Borrowing Base, and (ii) the outstanding principal balance of the Revolving
Note.
"Banking Day" means a day other than a Saturday, Sunday or other day
on which banks are generally not open for business in Phoenix, Arizona.
1
<PAGE>
"Borrowing Base" means, at any time the lesser of:
(a) the Maximum Line; or
(b) subject to change from time to time in the Lender's sole
discretion if the nature of the Collateral changes, 75% of Eligible
Accounts.
"Capital Expenditures" for a period means any expenditure of money for
the lease, purchase or other acquisition of any capital asset, or for the lease
of any other asset whether payable currently or in the future.
"Collateral" means all of the Borrower's Equipment, General
Intangibles (except Patents unless and until the occurrence of an Event of
Default), Inventory, Accounts, Receivables, all sums on deposit in any
Collection Account, and any items in any lockbox; together with (i) all
substitutions and replacements for and products of any of the foregoing; (ii)
proceeds of any and all of the foregoing; (iii) in the case of all tangible
goods, all accessions; (iv) all accessories, attachments, parts, equipment and
repairs now or hereafter attached or affixed to or used in connection with any
tangible goods; and (v) all warehouse receipts, bills of lading and other
documents of title now or hereafter covering such goods.
"Collection Account" has the meaning given in Section 4.3.
"Commitment" means the Lender's commitment to make Advances to or for
the Borrower's account pursuant to Article II.
"Credit Facility" means the credit facility being made available to
the Borrower by the Lender pursuant to Article II.
"Debt" of any Person means all items of indebtedness or liability
which in accordance with GAAP would be included in determining total liabilities
as shown on the liabilities side of a balance sheet of that Person as of the
date as of which Debt is to be determined. For purposes of determining a
Person's aggregate Debt at any time, "Debt" shall also include the aggregate
payments required to be made by such Person at any time under any lease that is
considered a capitalized lease under GAAP.
"Debt to Tangible Net Worth Ratio" as of a given date means the ratio
of the Borrower's Debt to the Borrower's Tangible Net Worth.
"Default" means an event that, with giving of notice or passage of
time or both, would constitute an Event of Default.
"Default Period" means any period of time beginning on the first day
of any month during which a Default or Event of Default has occurred and ending
on the date the Lender notifies the Borrower in writing that such Default or
Event of Default has been cured or waived.
"Default Rate" means an annual rate equal to three percent (3%) over
the Floating Rate, which rate shall change when and as the Floating Rate
changes.
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"ERISA" means the Employee Retirement Income Security Act of 1974, as
amended.
"Eligible Accounts" means all unpaid Accounts, net of any credits,
except the following shall not in any event be deemed Eligible Accounts:
(i) That portion of Accounts over 120 days past invoice date;
(ii) That portion of Accounts that is disputed or subject to a
claim of offset or a contra account;
(iii) That portion of Accounts not yet earned by the final
delivery of goods or rendition of services, as applicable, by the Borrower to
the customer;
(iv) Accounts owed by any unit of government (including without
limitation through the Medicare/Medicaid programs), whether foreign or domestic
(provided, however, that there shall be included in Eligible Accounts that
portion of Accounts owed by such units of government for which the Borrower has
provided evidence satisfactory to the Lender that (A) the Lender has a first
priority perfected security interest and (B) such Accounts may be enforced by
the Lender directly against such unit of government under all applicable laws);
(v) Accounts owed by an account debtor located outside the United
States which are not (A) backed by a bank letter of credit naming the Lender as
beneficiary or assigned to the Lender, in the Lender's possession and acceptable
to the Lender in all respects, in its sole discretion, or (B) covered by a
foreign receivables insurance policy acceptable to the Lender in its sole
discretion;
(vi) Accounts owed by an account debtor that is insolvent, the
subject of bankruptcy proceedings or has gone out of business;
(vii) Accounts owed by a Subsidiary, Affiliate, officer or
employee of the Borrower;
(viii) Accounts not subject to a duly perfected security interest
in the Lender's favor or which are subject to any lien, security interest or
claim in favor of any Person other than the Lender including without limitation
any payment or performance bond;
(ix) That portion of Accounts that has been restructured,
extended, amended or modified;
(x) That portion of Accounts that constitutes advertising,
finance charges, service charges or sales or excise taxes; and
(xi) Accounts, or portions thereof, otherwise deemed ineligible
by the Lender in its sole discretion.
"Environmental Laws" has the meaning specified in Section 5.12.
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"Equipment" means all of the Borrower's equipment, as such term is
defined in the UCC, whether now owned or hereafter acquired, including but not
limited to all present and future machinery, vehicles, furniture, fixtures,
manufacturing equipment, shop equipment, office and recordkeeping equipment,
parts, tools, supplies, and including specifically (without limitation) the
goods described in any equipment schedule or list herewith or hereafter
furnished to the Lender by the Borrower.
"Event of Default" has the meaning specified in Section 8.1.
"Existing Lockbox Agreement" has the meaning specified in Section
6.10.
"Floating Rate" means an annual rate equal to the Prime Rate, which
annual rate shall change when and as the Prime Rate changes.
"Funding Date" has the meaning given in Section 2.1.
"GAAP" means generally accepted accounting principles, applied on a
basis consistent with the accounting practices applied in the financial
statements described in Section 5.5, except for any change in accounting
practices to the extent that, due to a promulgation of the Financial Accounting
Standards Board changing or implementing any new accounting standard, the
Borrower either (i) is required to implement such change, or (ii) for future
periods will be required to and for the current period may in accordance with
generally accepted accounting principles implement such change, for its
financial statements to be in conformity with generally accepted accounting
principles (any such change is herein referred to as a "Required GAAP Change"),
provided that (1) the Borrower shall fully disclose in such financial statements
any such Required GAAP Change and the effects of the Required GAAP Change on the
Borrower's income, retained earnings or other accounts, as applicable, and (2)
the Borrower's financial covenants set forth in Sections 6.12 through 6.13, and
7.10 shall be adjusted as necessary to reflect the effects of such Required GAAP
Change.
"General Intangibles" means all of the Borrower's general intangibles,
as such term is defined in the UCC, whether now owned or hereafter acquired,
including (without limitation) all Patents, copyrights, trademarks, trade names,
trade secrets, customer or supplier lists and contracts, manuals, operating
instructions, permits, franchises, the right to use the Borrower's name, and the
goodwill of the Borrower's business.
"Hazardous Substance" has the meaning given in Section 5.12.
"Inventory" means all of the Borrower's inventory, as such term is
defined in the UCC, whether now owned or hereafter acquired, whether consisting
of whole goods, spare parts or components, supplies or materials, whether
acquired, held or furnished for sale, for lease or under service contracts or
for manufacture or processing, and wherever located.
"Loan Documents" means this Agreement, the Note and the Security
Documents.
"Lockbox Agreement" has the meaning specified in Section 6.10.
"Maturity Date" means February 28, 2003.
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"Maximum Line" means on any given day the lesser of (i)
$10,000,000.00, or (ii) an amount equal to 1.25 multiplied by the total cash
(resulting from continuing operations) received by the Borrower during the
immediately preceding 60 days. The Maximum Line may be reduced pursuant to
Section 2.6, in which event "Maximum Line" means the amount to which said amount
is reduced.
"Net Income" means fiscal year-to-date after-tax net income from
continuing operations as determined in accordance with GAAP.
"Net Loss" means fiscal year-to-date after-tax net loss from
continuing operations as determined in accordance with GAAP.
"Note" means the Revolving Note.
"Obligations" means the Note and each and every other debt, liability
and obligation of every type and description which the Borrower may now or at
any time hereafter owe to the Lender, whether such debt, liability or obligation
now exists or is hereafter created or incurred, whether it arises in a
transaction involving the Lender alone or in a transaction involving other
creditors of the Borrower, and whether it is direct or indirect, due or to
become due, absolute or contingent, primary or secondary, liquidated or
unliquidated, or sole, joint, several or joint and several, and including
specifically, but not limited to, all indebtedness of the Borrower arising under
this Agreement, the Note or any other loan or credit agreement or guaranty
between the Borrower and the Lender, whether now in effect or hereafter entered
into.
"Patents" means all present and future patents and patent
applications.
"Permitted Lien" has the meaning given in Section 7.1.
"Person" means any individual, corporation, partnership, joint
venture, limited liability company, association, joint-stock company, trust,
unincorporated organization or government or any agency or political subdivision
thereof.
"Plan" means an employee benefit plan or other plan maintained for the
Borrower's employees and covered by Title IV of ERISA.
"Premises" means all premises where the Borrower conducts its business
and has any rights of possession, including (without limitation) the premises
legally described in Exhibit C attached hereto.
"Prime Rate" means the rate of interest publicly announced from time
to time by Wells Fargo Bank, N.A. as its "prime rate" or, if such bank ceases to
announce a rate so designated, any similar successor rate designated by the
Lender.
"Principal Premises" means Borrower's Premises in Phoenix, Arizona and
Toronto, Ontario, Canada.
"Quick Assets" means, on any date, the Borrower's consolidated,
unrestricted cash, cash equivalents, net billed accounts receivable and
investments with maturities of fewer than 12 months determined according to
GAAP.
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"Quick Ratio" means as of a given date the ratio of Borrower's Quick
Assets divided by Borrower's current liabilities, as determined in accordance
with GAAP.
"Receivables" means each and every right of the Borrower to the
payment of money, whether such right to payment now exists or hereafter arises,
whether such right to payment arises out of a sale, lease or other disposition
of goods or other property, out of a rendering of services, out of a loan, out
of the overpayment of taxes or other liabilities, or otherwise arises under any
contract or agreement, whether such right to payment is created, generated or
earned by the Borrower or by some other person who subsequently transfers such
person's interest to the Borrower, whether such right to payment is or is not
already earned by performance, and howsoever such right to payment may be
evidenced, together with all other rights and interests (including all liens and
security interests) which the Borrower may at any time have by law or agreement
against any account debtor or other obligor obligated to make any such payment
or against any property of such account debtor or other obligor; all including
but not limited to all present and future accounts, contract rights, loans and
obligations receivable, chattel papers, bonds, notes and other debt instruments,
tax refunds and rights to payment in the nature of general intangibles.
"Reportable Event" shall have the meaning assigned to that term in
Title IV of ERISA.
"Revolving Advance" has the meaning given in Section 2.1.
"Revolving Note" means the Borrower's revolving promissory note,
payable to the order of the Lender in substantially the form of Exhibit A
hereto, as the same may hereafter be amended, supplemented or restated from time
to time, and any note or notes issued in substitution therefor, as the same may
hereafter be amended, supplemented or restated from time to time and any note or
notes issued in substitution therefor.
"Security Documents" means this Agreement, the Collection Account
Agreement, the Lockbox Agreement, and any other document delivered to the Lender
from time to time to secure the Obligations, as the same may hereafter be
amended, supplemented or restated from time to time.
"Security Interest" has the meaning given in Section 3.1.
"Subordinated Debt" is debt incurred by Borrower subordinated to
Borrower's debt to Lender (and identified as subordinated by Borrower and
Lender).
"Subsidiary" means any corporation of which more than 50% of the
outstanding shares of capital stock having general voting power under ordinary
circumstances to elect a majority of the board of directors of such corporation,
irrespective of whether or not at the time stock of any other class or classes
shall have or might have voting power by reason of the happening of any
contingency, is at the time directly or indirectly owned by the Borrower, by the
Borrower and one or more other Subsidiaries, or by one or more other
Subsidiaries.
"Tangible Net Worth" means, on any date, the consolidated total assets
of Borrower and its Subsidiaries MINUS, (i) any amounts attributable to (a)
goodwill, (b) intangible items such as unamortized debt discount and expense,
Patents, trade and service marks and names, copyrights and research and
development expenses except prepaid expenses, and (c) reserves not already
deducted from assets, AND (ii) Total Liabilities plus Subordinated Debt.
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"Termination Date" means the earliest of (i) the Maturity Date, (ii)
the date the Borrower terminates the Credit Facility, or (iii) the date the
Lender demands payment of the Obligations after an Event of Default pursuant to
Section 8.2.
"Threshold Amount" means the lesser of (i) $2,000,000.00, or (ii) an
amount equal to the value of 20% of Eligible Accounts as set forth in the most
recent collateral reporting complying with the requirements of Section 6.1
below.
"Threshold Event" means the earlier to occur of (i) Borrower's request
for an Advance which Lender has been informed by Borrower shall cause the
Threshold Amount to be outstanding for thirty days or more, or (ii) the date
when outstanding Revolving Advances shall have exceeded the Threshold Amount for
thirty consecutive days.
"Total Liabilities" is on any day, obligations that should, under
GAAP, be classified as liabilities on Borrower's consolidated balance sheet,
including all indebtedness, and current portion Subordinated Debt allowed to be
paid, but excluding all other Subordinated Debt.
"UCC" means the Uniform Commercial Code as in effect from time to time
in the state designated in Section 9.13 as the state whose laws shall govern
this Agreement, or in any other state whose laws are held to govern this
Agreement or any portion hereof.
"Wells Fargo Bank, N.A." means Wells Fargo Bank, National Association.
SECTION 1.2 CROSS REFERENCES. All references in this Agreement to Articles,
Sections and subsections, shall be to Articles, Sections and subsections of this
Agreement unless otherwise explicitly specified.
ARTICLE II
Amount and Terms of the Credit Facility
SECTION 2.1 REVOLVING ADVANCES. The Lender agrees, on the terms and subject
to the conditions herein set forth, to make advances to the Borrower from time
to time from the date all of the conditions set forth in Section 4.1 are
satisfied (the "Funding Date") to the Termination Date, on the terms and subject
to the conditions herein set forth (the "Revolving Advances"). The Lender shall
have no obligation to make a Revolving Advance if, after giving effect to such
requested Revolving Advance, the sum of the outstanding and unpaid Revolving
Advances would exceed the Borrowing Base. The Borrower's obligation to pay the
Revolving Advances shall be evidenced by the Revolving Note and shall be secured
by the Collateral as provided in Article III. Within the limits set forth in
this Section 2.1, the Borrower may borrow, prepay pursuant to Section 2.6 and
reborrow. The Borrower agrees to comply with the following procedures in
requesting Revolving Advances under this Section 2.1:
(a) The Borrower shall make each request for a Revolving Advance to
the Lender before 11:00 a.m. (Phoenix time) of the day of the requested
Revolving Advance, provided however, that in the event that the requested
Revolving Advance shall cause a Threshold Event, the Borrower shall make such
request for a Revolving Advance to the Lender before 11:00 a.m. (Phoenix time)
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on that date which is thirty (30) days prior to the date of the disbursement of
the requested Revolving Advance. Requests may be made in writing or by
telephone, specifying the date of the requested Revolving Advance and the amount
thereof. Each request shall be by (i) any officer of the Borrower; or (ii) any
person designated as the Borrower's agent by any officer of the Borrower in a
writing delivered to the Lender; or (iii) any person whom the Lender reasonably
believes to be an officer of the Borrower or such a designated agent.
(b) Upon fulfillment of the applicable conditions set forth in Article
IV, the Lender shall disburse the proceeds of the requested Revolving Advance by
crediting the same to the Borrower's demand deposit account maintained with
Wells Fargo Bank, N.A. unless the Lender and the Borrower shall agree in writing
to another manner of disbursement. Upon the Lender's request, the Borrower shall
promptly confirm each telephonic request for an Advance by executing and
delivering an appropriate confirmation certificate to the Lender. The Borrower
shall repay all Advances even if the Lender does not receive such confirmation
and even if the person requesting an Advance was not in fact authorized to do
so. Any request for an Advance, whether written or telephonic, shall be deemed
to be a representation by the Borrower that the conditions set forth in Section
4.2 have been satisfied as of the time of the request.
SECTION 2.2 INTEREST; DEFAULT INTEREST; PARTICIPATIONS; USURY. Interest
accruing on the Note shall be due and payable in arrears on the first day of
each month.
(a) REVOLVING NOTE. Except as set forth in Sections 2.2(b) and 2.2(d),
the outstanding principal balance of the Revolving Note shall bear interest at
the Floating Rate.
(b) DEFAULT INTEREST RATE. At any time during any Default Period,
commencing with the first day of the first month following the Default, in the
Lender's sole discretion and without waiving any of its other rights and
remedies, the principal of the Advances outstanding from time to time shall bear
interest at the Default Rate, effective for any periods designated by the Lender
from time to time during that Default Period.
(c) PARTICIPATIONS. If any Person shall acquire a participation in the
Advances under this Agreement, the Borrower shall be obligated to the Lender to
pay the full amount of all interest calculated under Section 2.2(a), along with
all other fees, charges and other amounts due under this Agreement, regardless
if such Person elects to accept interest with respect to its participation at a
lower rate than the Floating Rate, or otherwise elects to accept less than its
pro rata share of such fees, charges and other amounts due under this Agreement.
(d) USURY. In any event no rate change shall be put into effect which
would result in a rate greater than the highest rate permitted by law.
Notwithstanding anything to the contrary contained in any Loan Document, all
agreements which either now are or which shall become agreements between the
Borrower and the Lender are hereby limited so that in no contingency or event
whatsoever shall the total liability for payments in the nature of interest,
additional interest and other charges exceed the applicable limits imposed by
the usury laws of the State of California. If any payments in the nature of
interest, additional interest and other charges made under any Loan Document are
held to be in excess of the applicable limits imposed by the usury laws of the
State of California, it is agreed that any such amount held to be in excess
shall be considered payment of principal hereunder, and the indebtedness
evidenced hereby shall be reduced by such amount so that the total liability for
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payments in the nature of interest, additional interest and other charges shall
not exceed the applicable limits imposed by the usury laws of the State of
California, in compliance with the desires of the Borrower and the Lender. This
provision shall never be superseded or waived and shall control every other
provision of the Loan Documents and all agreements between the Borrower and the
Lender, or their successors and assigns.
(e) SAVINGS CLAUSE. The Borrower agrees that the interest rate
contracted for includes the interest rate set forth herein plus any other
charges or fees set forth herein and costs and expenses incident to this
transaction paid by the Borrower to the extent that the same are deemed interest
under applicable law.
SECTION 2.3 FEES.
(a) ORIGINATION FEE. The Borrower hereby agrees to pay the Lender a
fully earned and non-refundable origination fee of $50,000.00 due and payable
upon the execution of this Agreement.
(b) UNUSED LINE FEE. For the purposes of this Section 2.3(b), "Unused
Amount" means the Maximum Line reduced by outstanding Revolving Advances. The
Borrower agrees to pay to the Lender an unused line fee at the rate of
one-quarter of one percent (0.25%) per annum on the average daily Unused Amount
from the date of this Agreement to and including the Termination Date, due and
payable monthly in arrears on the first day of the month and on the Termination
Date.
(c) COMMITMENT FEE. The Borrower hereby agrees to pay the Lender an
annual commitment fee in the amount of $50,000.00 due and payable commencing on
the first anniversary of the Funding Date, and continuing on each subsequent
anniversary of the Funding Date.
(d) ADMINISTRATION FEE. The Borrower hereby agrees to pay the Lender
an administration fee in the amount of $1,000.00 per month commencing on the
first day of the first calendar month after the initial Revolving Advance and on
the first day of each month thereafter.
(e) AUDIT FEES. The Borrower hereby agrees to pay the Lender, on
demand, audit fees in connection with any audits or inspections conducted by the
Lender of any Collateral or the Borrower's operations or business at the rates
established from time to time by the Lender as its audit fees (which fees are
currently $75.00 per hour per auditor), together with all actual out-of-pocket
costs and expenses incurred in conducting any such audit or inspection;
PROVIDED, HOWEVER, that Lender will not perform such audits until either (i) a
Default, or (ii) the occurrence of the first Threshold Event.
SECTION 2.4 COMPUTATION OF INTEREST AND FEES; WHEN INTEREST DUE AND
PAYABLE. Interest accruing on the outstanding principal balance of the Advances
and fees hereunder outstanding from time to time shall be computed on the basis
of actual number of days elapsed in a year of 360 days. Interest shall be
payable in arrears on the first day of each month and on the Termination Date.
SECTION 2.5 [INTENTIONALLY OMITTED]
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SECTION 2.6 VOLUNTARY PREPAYMENT; TERMINATION OF CREDIT FACILITY BY THE
BORROWER; PERMANENT REDUCTION OF THE MAXIMUM LINE; WAIVER OF REDUCTION AND
TERMINATION FEES. Except as otherwise provided herein, the Borrower may
terminate the Credit Facility or prepay the Advances in whole at any time or
from time to time in part, and, subject to payment and performance of all
Obligations and termination of the Credit Facility, the Lender shall release or
terminate the Security Interest and the Security Documents to which the Borrower
is entitled by law.
(a) TERMINATION BY BORROWER. The Borrower may terminate the Credit
Facility at any time by (i) giving at least 30 days' prior written notice to the
Lender of the Borrower's intention to terminate the Credit Facility; and (ii)
paying the Lender fees in accordance with Subsection (b) if the Borrower
terminates the Credit Facility effective as of any date other than a Maturity
Date.
(b) PERMANENT REDUCTION OF MAXIMUM LINE. The Borrower may at any time
and from time to time, upon at least 30 days' prior written notice to the
Lender, permanently reduce in part or completely the Maximum Line or terminate
the Credit Facility in accordance with the following provisions:
(i) The Borrower may not reduce the Maximum Line to an amount
less than the then-aggregate outstanding balance of the Revolving Advances.
(ii) If a reduction of the Maximum Line occurs at any time other
than the Maturity Date, the Borrower shall pay to the Lender a premium in an
amount equal to one-half of one percent (0.5%) of the reduction.
(iii) Any reduction in the Maximum Line must be in an amount not
less than $1,000,000.00 or an integral multiple thereof.
(iv) If the Borrower reduces the Maximum Line to zero, all
Obligations shall be immediately due and payable.
(c) WAIVER OF REDUCTION FEES. The Borrower will not be required to pay
the fees otherwise due under Subsection (b) if such reduction is requested is
made because of increased cash flow generated from the Borrower's operations or
refinancing by an affiliate of the Lender.
SECTION 2.7 MANDATORY PREPAYMENT. Without notice or demand, if the
outstanding principal balance of the Revolving Advances shall at any time exceed
the Borrowing Base, the Borrower shall immediately prepay the Revolving Advances
to the extent necessary to eliminate such excess. Any payment received by the
Lender under this Section 2.7 or under Section 2.6 may be applied to the
Obligations, in such order and in such amounts as the Lender, in its discretion,
may from time to time determine. For each day or portion thereof that the
Revolving Advances shall exceed the Borrowing Base, the Borrower shall pay to
the Lender an overadvance charge (which charge shall be in addition to and not
in lieu of any other interest, fees, or charges payable by Borrower hereunder)
in the amount of $100.00; provided, however, that if such day occurs during a
Default Period, the overadvance charge for such day shall be $200.00.
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SECTION 2.8 PAYMENT. All payments to the Lender shall be made in
immediately available funds and shall be applied to the Obligations upon receipt
by the Lender. Notwithstanding anything in Section 2.1, the Borrower hereby
authorizes the Lender, in its discretion at any time or from time to time
without the Borrower's request and even if the conditions set forth in Section
4.2 would not be satisfied, to make a Revolving Advance in an amount equal to
the portion of the Obligations from time to time due and payable.
SECTION 2.9 PAYMENT ON NON-BANKING DAYS. Whenever any payment to be made
hereunder shall be stated to be due on a day which is not a Banking Day, such
payment may be made on the next succeeding Banking Day, and such extension of
time shall in such case be included in the computation of interest on the
Advances or the fees hereunder, as the case may be.
SECTION 2.10 USE OF PROCEEDS. The Borrower shall use the proceeds of
Advances for ordinary working capital purposes and to repay all outstanding
indebtedness of the Borrower owed to Silicon Valley Bank.
SECTION 2.11 LIABILITY RECORDS. The Lender may maintain from time to time,
at its discretion, liability records as to the Obligations. All entries made on
any such record shall be presumed correct until the Borrower establishes the
contrary. Upon the Lender's demand, the Borrower will admit and certify in
writing the exact principal balance of the Obligations that the Borrower then
asserts to be outstanding. Any billing statement or accounting rendered by the
Lender shall be conclusive and fully binding on the Borrower unless the Borrower
gives the Lender specific written notice of exception within 30 days after
receipt.
ARTICLE III
SECURITY INTEREST; OCCUPANCY; SETOFF
SECTION 3.1 GRANT OF SECURITY INTEREST. The Borrower hereby pledges,
assigns and grants to the Lender a security interest (collectively referred to
as the "Security Interest") in the Collateral, as security for the payment and
performance of the Obligations.
SECTION 3.2 NOTIFICATION OF ACCOUNT DEBTORS AND OTHER OBLIGORS. The Lender
may at any time (upon a Default or the occurrence of a Threshold Event) notify
any account debtor or other person obligated to pay the amount due that such
right to payment has been assigned or transferred to the Lender for security and
shall be paid directly to the Lender. The Borrower will join in giving such
notice if the Lender so requests. At any time after the Borrower or the Lender
gives such notice to an account debtor or other obligor, the Lender may, but
need not, in the Lender's name or in the Borrower's name, (a) demand, sue for,
collect or receive any money or property at any time payable or receivable on
account of, or securing, any such right to payment, or grant any extension to,
make any compromise or settlement with or otherwise agree to waive, modify,
amend or change the obligations (including collateral obligations) of any such
account debtor or other obligor; and (b) as the Borrower's agent and
attorney-in-fact, notify the United States Postal Service to change the address
for delivery of the Borrower's mail to any address designated by the Lender,
otherwise intercept the Borrower's mail, and receive, open and dispose of the
Borrower's mail, applying all Collateral as permitted under this Agreement and
holding all other mail for the Borrower's account or forwarding such mail to the
Borrower's last known address.
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SECTION 3.3 ASSIGNMENT OF INSURANCE. As additional security for the
payment and performance of the Obligations, the Borrower hereby assigns to the
Lender any and all monies (including, without limitation, proceeds of insurance
and refunds of unearned premiums) due or to become due under, and all other
rights of the Borrower with respect to, any and all policies of insurance now or
at any time hereafter covering the Collateral or any evidence thereof or any
business records or valuable papers pertaining thereto, and the Borrower hereby
directs the issuer of any such policy to pay all such monies directly to the
Lender. At any time, if a Default Period then exists, the Lender may (but need
not), in the Lender's name or in the Borrower's name, execute and deliver proof
of claim, receive all such monies, endorse checks and other instruments
representing payment of such monies, and adjust, litigate, compromise or release
any claim against the issuer of any such policy.
SECTION 3.4 OCCUPANCY.
(a) The Borrower hereby irrevocably grants to the Lender the right to
take possession of the Premises at any time during each Default Period.
(b) The Lender may use the Premises only to hold, process,
manufacture, sell, use, store, liquidate, realize upon or otherwise dispose of
goods that are Collateral and for other purposes that the Lender may in good
faith deem to be related or incidental purposes.
(c) The Lender's right to hold the Premises shall cease and terminate
upon the earlier of (i) payment in full and discharge of all Obligations and
termination of the Commitment, (ii) final sale or disposition of all goods
constituting Collateral and delivery of all such goods to purchasers, or (iii)
the end of the applicable Default Period.
(d) The Lender shall not be obligated to pay or account for any rent
or other compensation for the possession, occupancy or use of any of the
Premises; provided, however, that if the Lender does pay or account for any rent
or other compensation for the possession, occupancy or use of any of the
Premises, the Borrower shall reimburse the Lender promptly for the full amount
thereof. In addition, the Borrower will pay, or reimburse the Lender for, all
taxes, fees, duties, imposts, charges and expenses at any time incurred by or
imposed upon the Lender by reason of the execution, delivery, existence,
recordation, performance or enforcement of this Agreement or the provisions of
this Section 3.4.
SECTION 3.5 LICENSE. The Borrower hereby grants to the Lender a
non-exclusive, worldwide and royalty-free license to use or otherwise exploit
all trademarks, franchises, trade names, copyrights and patents of the Borrower
for the purpose of selling, leasing or otherwise disposing of any or all
Collateral during any Default Period.
SECTION 3.6 FINANCING STATEMENT. A carbon, photographic or other
reproduction of this Agreement or of any financing statements signed by the
Borrower is sufficient as a financing statement and may be filed as a financing
statement in any state to perfect the security interests granted hereby. For
this purpose, the following information is set forth:
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Name and address of Debtor:
OrthoLogic Corp.
1275 West Washington Street
Tempe, AZ 85281
Federal Tax Identification No. 86-0585310
Name and address of Secured Party:
Wells Fargo Business Credit, Inc.
100 West Washington Street, 7th Floor
MAC S4101-076
Phoenix, AZ 85003
Federal Tax Identification No. 41-1237652
SECTION 3.7 SETOFF. The Borrower agrees that the Lender may at any time or
from time to time, at its sole discretion and without demand and without notice
to anyone, setoff any liability owed to the Borrower by the Lender, whether or
not due, against any Obligation, whether or not due. In addition, each other
Person holding a participating interest in any Obligations (so long as Borrower
has been made aware of such participation) shall have the right to appropriate
or setoff any deposit or other liability then owed by such Person to the
Borrower, whether or not due, and apply the same to the payment of said
participating interest, as fully as if such Person had lent directly to the
Borrower the amount of such participating interest.
ARTICLE IV
CONDITIONS OF LENDING
SECTION 4.1 CONDITIONS PRECEDENT TO THE INITIAL REVOLVING ADVANCE. The
Lender's obligation to make the initial Revolving Advance hereunder shall be
subject to the conditions precedent that (i) after giving effect to the initial
Revolving Advance there is not less than $1,500,000.00 in excess Availability,
and (ii) the Lender shall have received all of the following, each in form and
substance satisfactory to the Lender:
(a) This Agreement, properly executed by the Borrower.
(b) The Note, properly executed by the Borrower.
(c) A true and correct copy of any and all leases pursuant to which
the Borrower is leasing the Principal Premises, together with a landlord's
disclaimer and consent with respect to the lease for the principal premises in
Phoenix, Arizona.
(d) A true and correct copy of any and all agreements pursuant to
which the Borrower's property at its Principal Premises is in the possession of
any Person other than the Borrower, together with, (i) an acknowledgment and
waiver of liens from each subcontractor who has possession of the Borrower's
goods from time to time, (ii) UCC financing statements sufficient to protect the
Borrower's and the Lender's interests in such goods, and (iii) UCC searches
showing that no other secured party has filed a financing statement covering
such Person's property other than the Borrower, or if there exists any such
secured party, evidence that each such secured party has received notice from
the Borrower and the Lender sufficient to protect the Borrower's and the
Lender's interests in the Borrower's goods from any claim by such secured party.
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(e) Current searches of appropriate filing offices showing that (i) no
state or federal tax liens have been filed and remain in effect against the
Borrower, (ii) no financing statements or assignments of patents, trademarks or
copyrights have been filed and remain in effect against the Borrower except
those financing statements and assignments of patents, trademarks or copyrights
relating to Permitted Liens or to liens held by Persons who have agreed in
writing that upon receipt of proceeds of the Advances, they will deliver UCC
releases and/or terminations and releases of such assignments of patents,
trademarks or copyrights satisfactory to the Lender, and (iii) the Lender has
duly filed all financing statements necessary to perfect the Security Interest,
to the extent the Security Interest is capable of being perfected by filing.
(f) A certificate of the Borrower's Secretary or Assistant Secretary
certifying as to (i) the resolutions of the Borrower's directors and, if
required, shareholders, authorizing the execution, delivery and performance of
the Loan Documents, (ii) the Borrower's articles of incorporation and bylaws,
and (iii) the signatures of the Borrower's officers or agents authorized to
execute and deliver the Loan Documents and other instruments, agreements and
certificates, including Advance requests, on the Borrower's behalf.
(g) A current certificate issued by the Secretary of State of
Delaware, certifying that the Borrower is in compliance with all applicable
organizational requirements of the State of Delaware.
(h) Evidence that the Borrower is duly licensed or qualified to
transact business in Arizona and Ontario, Canada.
(i) A certificate of an officer of the Borrower confirming, in his
corporate capacity, the representations and warranties set forth in Article V.
(j) An opinion of counsel to the Borrower, addressed to the Lender.
(k) Certificates of the insurance required hereunder, with all hazard
insurance containing a lender's loss payable endorsement in the Lender's favor
and with all liability insurance naming the Lender as an additional insured.
(l) Payment of the fees and commissions due through the date of the
initial Advance under Section 2.3 and expenses incurred by the Lender through
such date and required to be paid by the Borrower under Section 9.6, including
all legal expenses incurred through the date of this Agreement.
(m) Such other documents as the Lender in its sole discretion may
require.
SECTION 4.2 CONDITIONS PRECEDENT TO ALL ADVANCES. The Lender's obligation
to make each Advance shall be subject to the further conditions precedent that
on such date:
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(a) the representations and warranties contained in Article V are
correct on and as of the date of such Advance as though made on and as of such
date, except to the extent that such representations and warranties relate
solely to an earlier date; and
(b) no event has occurred and is continuing, or would result from such
Advance which constitutes a Default or an Event of Default.
SECTION 4.3 CONDITIONS PRECEDENT TO AN ADVANCE CREATING A THRESHOLD EVENT.
The Lender's obligation to make any Advance which shall constitute a Threshold
Event shall be subject to the further conditions precedent that on such date:
(a) The Borrower shall have entered into an agreement with Lender and
Wells Fargo Bank, N.A. or such other bank (including Silicon Valley Bank) as
Borrower and Lender shall agree, establishing a collection account into which
all payments on Receivables shall be deposited (the "Collection Account")
pursuant to terms satisfactory to Lender and Wells Fargo Bank, N.A. or such
other bank.
(b) Borrower shall have directed all account debtors to make all
payments on Receivables to the lockbox established under the Lockbox Agreement
and/or the Existing Lockbox Agreement, as set forth in Section 6.10.
(c) If the Existing Lockbox Agreement shall then still exist, Borrower
shall have obtained either an acknowledgment from the bank maintaining the
Existing Lockbox Agreement that all Receivables deposited into the lockbox
maintained thereunder shall be directed to the Collection Account, or Borrower
shall have cooperated with Lender in submitting a change of address to all of
Borrower's account debtors to direct the payment of all Receivables to the
lockbox established under the Lockbox Agreement.
(d) Lender shall have completed a Collateral examination at the
expense of Borrower, the results of which shall be satisfactory to Lender.
(e) Lender shall have received an acknowledgment and agreement (in
form and substance satisfactory to Lender) from each licensor in favor of the
Lender, together with a true, correct and complete copy of all license
agreements.
ARTICLE V
REPRESENTATIONS AND WARRANTIES
The Borrower represents and warrants to the Lender as follows:
SECTION 5.1 CORPORATE EXISTENCE AND POWER; NAME; CHIEF EXECUTIVE OFFICE;
INVENTORY AND EQUIPMENT LOCATIONS; TAX IDENTIFICATION NUMBER. The Borrower is a
corporation, duly organized, validly existing and in good standing under the
laws of the State of Delaware and is duly licensed or qualified to transact
business in all jurisdictions where the character of the property owned or
leased or the nature of the business transacted by it makes such licensing or
qualification necessary. The Borrower has all requisite power and authority,
corporate or otherwise, to conduct its business, to own its properties and to
execute and deliver, and to perform all of its obligations under, the Loan
Documents. During its existence, the Borrower has done business solely under the
names set forth in Schedule 5.1 hereto. The Borrower's chief executive office
and principal place of business is located at the address set forth in Schedule
5.1 hereto, and all of the Borrower's records relating to its business or the
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Collateral are kept at that location. All Inventory and Equipment is located at
that location or at one of the other locations set forth in Schedule 5.1 hereto.
The Borrower's tax identification number is correctly set forth in Section 3.6
hereto.
SECTION 5.2 AUTHORIZATION OF BORROWING; NO CONFLICT AS TO LAW OR
AGREEMENTS. The execution, delivery and performance by the Borrower of the Loan
Documents and the borrowings from time to time hereunder have been duly
authorized by all necessary corporate action and do not and will not (i) require
any consent or approval of the Borrower's stockholders; (ii) require any
authorization, consent or approval by, or registration, declaration or filing
with, or notice to, any governmental department, commission, board, bureau,
agency or instrumentality, domestic or foreign, or any third party, except such
authorization, consent, approval, registration, declaration, filing or notice as
has been obtained, accomplished or given prior to the date hereof; (iii) violate
any provision of any law, rule or regulation (including, without limitation,
Regulation X of the Board of Governors of the Federal Reserve System) or of any
order, writ, injunction or decree presently in effect having applicability to
the Borrower or of the Borrower's articles of incorporation or bylaws; (iv)
result in a breach of or constitute a default under any indenture or loan or
credit agreement or any other material agreement, lease or instrument to which
the Borrower is a party or by which it or its properties may be bound or
affected; or (v) result in, or require, the creation or imposition of any
mortgage, deed of trust, pledge, lien, security interest or other charge or
encumbrance of any nature (other than the Security Interest) upon or with
respect to any of the properties now owned or hereafter acquired by the
Borrower.
SECTION 5.3 LEGAL AGREEMENTS. This Agreement constitutes and, upon due
execution by the Borrower, the other Loan Documents will constitute the legal,
valid and binding obligations of the Borrower, enforceable against the Borrower
in accordance with their respective terms.
SECTION 5.4 SUBSIDIARIES. Except as set forth in Schedule 5.4, the Borrower
has no Subsidiaries.
SECTION 5.5 FINANCIAL CONDITION; NO ADVERSE CHANGE. The Borrower has
heretofore furnished to the Lender unaudited financial statements of the
Borrower for the fiscal year ended December 31, 1999, and those statements
fairly present the Borrower's financial condition on the dates thereof and the
results of its operations and cash flows for the periods then ended and were
prepared in accordance with generally accepted accounting principles. Since the
date of the most recent financial statements, there has been no material adverse
change in the Borrower's business, properties or condition (financial or
otherwise).
SECTION 5.6 LITIGATION. Except as disclosed on Schedule 5.6, there are no
actions, suits or proceedings pending or, to the Borrower's knowledge,
threatened against or affecting the Borrower or any of its Affiliates or the
properties of the Borrower or any of its Affiliates before any court or
governmental department, commission, board, bureau, agency or instrumentality,
domestic or foreign, which, if determined adversely to the Borrower or any of
its Affiliates, would have a material adverse effect on the financial condition,
properties or operations of the Borrower or any of its Affiliates.
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SECTION 5.7 REGULATION U. The Borrower is not engaged in the business of
extending credit for the purpose of purchasing or carrying margin stock (within
the meaning of Regulation U of the Board of Governors of the Federal Reserve
System), and no part of the proceeds of any Advance will be used to purchase or
carry any margin stock or to extend credit to others for the purpose of
purchasing or carrying any margin stock.
SECTION 5.8 TAXES. The Borrower and its Affiliates have paid or caused to
be paid to the proper authorities when due all federal, state and local taxes
required to be withheld by each of them. The Borrower and its Affiliates have
filed all federal, state and local tax returns which to the knowledge of the
officers of the Borrower or any Affiliate, as the case may be, are required to
be filed, and the Borrower and its Affiliates have paid or caused to be paid to
the respective taxing authorities all taxes as shown on said returns or on any
assessment received by any of them to the extent such taxes have become due.
SECTION 5.9 TITLES AND LIENS. The Borrower has good and absolute title to
all Collateral described in the collateral reports provided to the Lender and
all other Collateral, properties and assets reflected in the latest financial
statements referred to in Section 5.5 and all proceeds thereof, free and clear
of all mortgages, security interests, liens and encumbrances, except for
Permitted Liens. No financing statement naming the Borrower as debtor is on file
in any office except to perfect only Permitted Liens.
SECTION 5.10 PLANS. Except as disclosed to the Lender in writing prior to
the date hereof, neither the Borrower nor any of its Affiliates maintains or has
maintained any Plan. Neither the Borrower nor any Affiliate has received any
notice or has any knowledge to the effect that it is not in full compliance with
any of the requirements of ERISA. No Reportable Event or other fact or
circumstance which may have an adverse effect on the Plan's tax qualified status
exists in connection with any Plan. Neither the Borrower nor any of its
Affiliates has:
(a) Any accumulated funding deficiency within the meaning of ERISA; or
(b) Any liability or knows of any fact or circumstances which could
result in any liability to the Pension Benefit Guaranty Corporation, the
Internal Revenue Service, the Department of Labor or any participant in
connection with any Plan (other than accrued benefits which or which may become
payable to participants or beneficiaries of any such Plan).
SECTION 5.11 DEFAULT. The Borrower is in compliance with all provisions of
all agreements, instruments, decrees and orders to which it is a party or by
which it or its property is bound or affected, the breach or default of which
could have a material adverse effect on the Borrower's financial condition,
properties or operations.
SECTION 5.12 ENVIRONMENTAL MATTERS.
(a) DEFINITIONS. As used in this Agreement, the following terms shall
have the following meanings:
(i) "Environmental Law" means any federal, state, local or other
governmental statute, regulation, law or ordinance dealing with the protection
of human health and the environment.
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(ii) "Hazardous Substances" means pollutants, contaminants,
hazardous substances, hazardous wastes, petroleum and fractions thereof, and all
other chemicals, wastes, substances and materials listed in, regulated by or
identified in any Environmental Law.
(b) To the Borrower's best knowledge, there are not present in, on or
under the Premises any Hazardous Substances in such form or quantity as to
create any liability or obligation for either the Borrower or the Lender under
common law of any jurisdiction or under any Environmental Law, and to the best
of Borrower's knowledge no Hazardous Substances have been stored, buried,
spilled, leaked, discharged, emitted or released in, on or under the Premises
during Borrower's occupancy of the Premises in such a way as to create any such
liability.
(c) To the Borrower's best knowledge, the Borrower has not disposed of
Hazardous Substances in such a manner as to create any liability under any
Environmental Law.
(d) There are not and there never have been, during Borrower's
occupancy of the Premises to the best of Borrower's knowledge, any requests,
claims, notices, investigations, demands, administrative proceedings, hearings
or litigation, relating in any way to the Premises or the Borrower, alleging
liability under, violation of, or noncompliance with any Environmental Law or
any license, permit or other authorization issued pursuant thereto. To the
Borrower's best knowledge, no such matter is threatened or impending.
(e) To the Borrower's best knowledge, the Borrower's businesses are
and have in the past always been conducted in accordance with all Environmental
Laws and all licenses, permits and other authorizations required pursuant to any
Environmental Law and necessary for the lawful and efficient operation of such
businesses are in the Borrower's possession and are in full force and effect. No
permit required under any Environmental Law is scheduled to expire within 12
months and there is no threat that any such permit will be withdrawn,
terminated, limited or materially changed.
(f) To the Borrower's best knowledge, the Premises are not and never
have been, during Borrower's occupancy of the Premises, listed on the National
Priorities List, the Comprehensive Environmental Response, Compensation and
Liability Information System or any similar federal, state or local list,
schedule, log, inventory or database.
(g) The Borrower has delivered to Lender all environmental
assessments, audits, reports, permits, licenses and other documents describing
or relating in any way to the Premises or Borrower's businesses.
SECTION 5.13 SUBMISSIONS TO LENDER. All financial and other information
provided to the Lender by or on behalf of the Borrower in connection with the
Borrower's request for the credit facilities contemplated hereby is true and
correct in all material respects and, as to projections, valuations or proforma
financial statements, present a good faith opinion as to such projections,
valuations and proforma condition and results.
SECTION 5.14 FINANCING STATEMENTS. The Borrower has provided to the Lender
signed financing statements sufficient when filed to perfect the Security
Interest and the other security interests created by the Security Documents.
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When such financing statements are filed in the offices noted therein, the
Lender will have a valid and perfected security interest in all Collateral and
all other collateral described in the Security Documents which is capable of
being perfected by filing financing statements. None of the Collateral or other
collateral covered by the Security Documents is or will become a fixture on real
estate, unless a sufficient fixture filing is in effect with respect thereto.
SECTION 5.15 RIGHTS TO PAYMENT. Each right to payment and each instrument,
document, chattel paper and other agreement constituting or evidencing
Collateral or other collateral covered by the Security Documents is (or, in the
case of all future Collateral or such other collateral, will be when arising or
issued) the valid, genuine and legally enforceable obligation, subject to no
defense, setoff or counterclaim, of the account debtor or other obligor named
therein or in the Borrower's records pertaining thereto as being obligated to
pay such obligation.
SECTION 5.16 FINANCIAL SOLVENCY. Both before and after giving effect to the
transactions contemplated in the Loan Documents, none of the Borrower or its
Affiliates:
(a) was or will be insolvent, as that term is used and defined in
Section 101(32) of the United States Bankruptcy Code and Section 2 of the
Uniform Fraudulent Transfer Act;
(b) has unreasonably small capital or is engaged or about to engage in
a business or a transaction for which any remaining assets of the Borrower or
such Affiliate are unreasonably small;
(c) by executing, delivering or performing its obligations under the
Loan Documents or other documents to which it is a party or by taking any action
with respect thereto, intends to, nor believes that it will, incur debts beyond
its ability to pay them as they mature;
(d) by executing, delivering or performing its obligations under the
Loan Documents or other documents to which it is a party or by taking any action
with respect thereto, intends to hinder, delay or defraud either its present or
future creditors; and
(e) at this time contemplates filing a petition in bankruptcy or for
an arrangement or reorganization or similar proceeding under any law any
jurisdiction, nor, to the best knowledge of the Borrower, is the subject of any
actual, pending or threatened bankruptcy, insolvency or similar proceedings
under any law of any jurisdiction.
ARTICLE VI
BORROWER'S AFFIRMATIVE COVENANTS
So long as the Obligations shall remain unpaid, or the Credit Facility
shall remain outstanding, the Borrower will comply with the following
requirements, unless the Lender shall otherwise consent in writing:
SECTION 6.1 REPORTING REQUIREMENTS. The Borrower will deliver, or cause to
be delivered, to the Lender each of the following, which shall be in form and
detail acceptable to the Lender (provided that in the case of matters due on a
date certain pursuant to the terms of this Section 6.1, it shall not be a
Default so long as the reporting requirement shall be satisfied by Borrower
within 10 days after such due date):
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(a) as soon as available, and in any event within 90 days after the
end of each fiscal year of the Borrower, the Borrower's audited financial
statements with the unqualified opinion of independent certified public
accountants selected by the Borrower and acceptable to the Lender, which annual
financial statements shall include the Borrower's balance sheet as of the end of
such fiscal year and the related statements of the Borrower's income, retained
earnings and cash flows for the fiscal year then ended, prepared, if the Lender
so requests, on a consolidating and consolidated basis to include any
Affiliates, all in reasonable detail and prepared in accordance with GAAP,
together with (i) copies of all management letters prepared by such accountants;
(ii) a report signed by such accountants stating that in making the
investigations necessary for said opinion they obtained no knowledge, except as
specifically stated, of any Default or Event of Default hereunder and all
relevant facts in reasonable detail to evidence, and the computations as to,
whether or not the Borrower is in compliance with the requirements set forth in
Sections 6.12 through 6.14, and 7.10; and (iii) a certificate of the Borrower's
chief financial officer stating that such financial statements have been
prepared in accordance with GAAP and whether or not such officer has knowledge
of the occurrence of any Default or Event of Default hereunder and, if so,
stating in reasonable detail the facts with respect thereto;
(b) as soon as available and in any event within 20 days after the end
of each month, an unaudited/internal balance sheet and statements of income and
retained earnings of the Borrower as at the end of and for such month and for
the year to date period then ended, prepared, if the Lender so requests, on a
consolidating and consolidated basis to include any Affiliates, in reasonable
detail and stating in comparative form the figures for the corresponding date
and periods in the previous year, all prepared in accordance with GAAP, subject
to year-end audit adjustments; and accompanied by a certificate of the
Borrower's chief financial officer, substantially in the form of Exhibit B
hereto stating (i) that such financial statements have been prepared in
accordance with GAAP, subject to year-end audit adjustments, (ii) whether or not
such officer has knowledge of the occurrence of any Default or Event of Default
hereunder not theretofore reported and remedied and, if so, stating in
reasonable detail the facts with respect thereto, and (iii) all relevant facts
in reasonable detail to evidence, and the computations as to, whether or not the
Borrower is in compliance with the requirements set forth in Sections 6.12
through 6.14, and 7.10;
(c) within 20 days after the end of each month or more frequently if
the Lender so requires, agings of the Borrower's accounts receivable and its
accounts payable, an inventory certification report, and a calculation of the
Borrower's Accounts, Eligible Accounts, and Inventory as at the end of such
month or shorter time period;
(d) at least 30 days before the beginning of each fiscal year of the
Borrower, the projected balance sheets and income statements for each month of
such year, each in reasonable detail, representing the Borrower's good faith
projections and certified by the Borrower's chief financial officer as being the
most accurate projections available and identical to the projections used by the
Borrower for internal planning purposes, together with such supporting schedules
and information as the Lender may in its discretion require;
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(e) immediately after the commencement thereof, notice in writing of
all litigation and of all proceedings before any governmental or regulatory
agency affecting the Borrower of the type described in Section 5.12 or which
seek a monetary recovery against the Borrower in excess of $500,000.00;
(f) as promptly as practicable (but in any event not later than five
business days) after an officer of the Borrower obtains knowledge of the
occurrence of any event which constitutes a Default or Event of Default
hereunder, notice of such occurrence, together with a detailed statement by a
responsible officer of the Borrower of the steps being taken by the Borrower to
cure the effect of such Default or Event of Default;
(g) as soon as possible and in any event within 30 days after the
Borrower knows or has reason to know that any Reportable Event with respect to
any Plan has occurred, the statement of the Borrower's chief financial officer
setting forth details as to such Reportable Event and the action which the
Borrower proposes to take with respect thereto, together with a copy of the
notice of such Reportable Event to the Pension Benefit Guaranty Corporation;
(h) as soon as possible, and in any event within 20 days after the
Borrower fails to make any quarterly contribution required with respect to any
Plan under Section 412(m) of the Internal Revenue Code of 1986, as amended, the
statement of the Borrower's chief financial officer setting forth details as to
such failure and the action which the Borrower proposes to take with respect
thereto, together with a copy of any notice of such failure required to be
provided to the Pension Benefit Guaranty Corporation;
(i) on and after the earlier to occur of (i) a Threshold Event, or
(ii) a Default, promptly upon knowledge thereof, notice of (i) any dispute or
claim by the Borrower's customers which exceeds $25,000.00; (ii) credit memos;
(iii) any goods returned to or recovered by the Borrower; and (iv) any change in
the persons constituting the Borrower's officers and directors;
(j) promptly upon knowledge thereof, notice of any loss of or material
damage to the Collateral or other collateral covered by the Security Documents
or of any substantial adverse change in the Collateral or such other collateral
or the prospect of payment thereof;
(k) promptly upon their distribution, copies of all financial
statements, reports and proxy statements which the Borrower shall have sent to
its stockholders;
(l) promptly after the sending or filing thereof, copies of all
regular and periodic reports which the Borrower shall file with the Securities
and Exchange Commission or any national securities exchange;
(m) promptly upon knowledge thereof, notice of the Borrower's
violation of any law, rule or regulation, the non-compliance with which could
materially and adversely affect the Borrower's business or its financial
condition; and
(n) within 20 days after the end of each month until such time as a
Threshold Event shall occur and then thereafter from time to time with such
frequency as shall be required by Lender, with reasonable promptness, any and
all receivables schedules, collection reports, deposit records, equipment
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schedules, copies of invoices to account debtors, shipment documents and
delivery receipts for goods sold, and such other material, reports, records or
information as the Lender may request.
SECTION 6.2 BOOKS AND RECORDS; INSPECTION AND EXAMINATION. The Borrower
will keep accurate books of record and account for itself pertaining to the
Collateral and pertaining to the Borrower's business and financial condition and
such other matters as the Lender may from time to time request in which true and
complete entries will be made in accordance with GAAP and, upon the Lender's
request, will permit any officer, employee, attorney or accountant for the
Lender to audit, review, make extracts from or copy any and all corporate and
financial books and records of the Borrower at all times during ordinary
business hours, to send and discuss with account debtors and other obligors
requests for verification of amounts owed to the Borrower, and to discuss the
Borrower's affairs with any of its directors, officers, employees or agents. The
Borrower will permit the Lender, or its employees, accountants, attorneys or
agents, to examine and inspect any Collateral, other collateral covered by the
Security Documents or any other property of the Borrower at any time during
ordinary business hours.
SECTION 6.3 ACCOUNT VERIFICATION. The Lender may at any time and from time
to time send or require the Borrower to send requests for verification of
accounts or notices of assignment to account debtors and other obligors. The
Lender may also at any time and from time to time telephone account debtors and
other obligors to verify accounts.
SECTION 6.4 COMPLIANCE WITH LAWS.
(a) The Borrower will (i) comply with the requirements of applicable
laws and regulations, the non-compliance with which would materially and
adversely affect its business or its financial condition and (ii) use and keep
the Collateral, and require that others use and keep the Collateral, only for
lawful purposes, without violation of any federal, state or local law, statute
or ordinance.
(b) Without limiting the foregoing undertakings, the Borrower
specifically agrees that it will comply with all applicable Environmental Laws
and obtain and comply with all permits, licenses and similar approvals required
by any Environmental Laws, and will not generate, use, transport, treat, store
or dispose of any Hazardous Substances in such a manner as to create any
liability or obligation under the common law of any jurisdiction or any
Environmental Law.
SECTION 6.5 PAYMENT OF TAXES AND OTHER CLAIMS. The Borrower will pay or
discharge, when due, (a) all taxes, assessments and governmental charges levied
or imposed upon it or upon its income or profits, upon any properties belonging
to it (including, without limitation, the Collateral) or upon or against the
creation, perfection or continuance of the Security Interest, prior to the date
on which penalties attach thereto, (b) all federal, state and local taxes
required to be withheld by it, and (c) all lawful claims for labor, materials
and supplies which, if unpaid, might by law become a lien or charge upon any
properties of the Borrower; provided, that the Borrower shall not be required to
pay any such tax, assessment, charge or claim whose amount, applicability or
validity is being contested in good faith by appropriate proceedings and for
which proper reserves have been made.
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SECTION 6.6 MAINTENANCE OF PROPERTIES.
(a) The Borrower will keep and maintain the Collateral, the other
collateral covered by the Security Documents and all of its other properties
necessary or useful in its business in good condition, repair and working order
(normal wear and tear excepted) and will from time to time replace or repair any
worn, defective or broken parts; provided, however, that nothing in this Section
6.6 shall prevent the Borrower from discontinuing the operation and maintenance
of any of its properties if such discontinuance is, in the Lender's judgment,
desirable in the conduct of the Borrower's business and not disadvantageous in
any material respect to the Lender.
(b) The Borrower will defend the Collateral against all claims or
demands of all persons (other than the Lender and Permitted Liens) claiming the
Collateral or any interest therein.
(c) The Borrower will keep all Collateral and other collateral covered
by the Security Documents free and clear of all security interests, liens and
encumbrances except Permitted Liens. SECTION 6.7 INSURANCE. The Borrower will
obtain and at all times maintain insurance with insurers believed by the
Borrower to be responsible and reputable, in such amounts and against such risks
as may from time to time be required by the Lender, but in all events in such
amounts and against such risks as is usually carried by companies engaged in
similar business and owning similar properties in the same general areas in
which the Borrower operates. Without limiting the generality of the foregoing,
the Borrower will at all times maintain business interruption insurance
including coverage for force majeure and keep all tangible Collateral insured
against risks of fire (including so-called extended coverage), theft, collision
(for Collateral consisting of motor vehicles) and such other risks and in such
amounts as the Lender may reasonably request, with any loss payable to the
Lender to the extent of its interest, and all policies of such insurance shall
contain a lender's loss payable endorsement for the Lender's benefit acceptable
to the Lender. All policies of liability insurance required hereunder shall name
the Lender as an additional insured.
SECTION 6.8 PRESERVATION OF EXISTENCE. The Borrower will preserve and
maintain its existence and all of its rights, privileges and franchises
necessary or desirable in the normal conduct of its business and shall conduct
its business in an orderly, efficient and regular manner.
SECTION 6.9 DELIVERY OF INSTRUMENTS, ETC. Upon request by the Lender, the
Borrower will promptly deliver to the Lender in pledge all instruments,
documents and chattel papers constituting Collateral, duly endorsed or assigned
by the Borrower.
SECTION 6.10 LOCKBOX AGREEMENTS AND COLLECTION ACCOUNT.
(a) As of the date of this Agreement, the Borrower maintains a lockbox
under the "Existing Lockbox Agreement" with Silicon Valley Bank. At such time as
a Threshold Event may occur, Borrower shall irrevocably and permanently ensure
that all Receivables deposited in the lockbox under the Existing Lockbox
Agreement shall be deposited directly to the Collection Account.
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(b) After the date of this Agreement, but in any event not later than
the earlier to occur of, (i) a Threshold Event, or (ii) 18 months from the date
of this Agreement, Borrower shall have entered into the Lockbox Agreement with
Lender, Wells Fargo Bank, N.A. and Regulus West, LLC pursuant to an agreement
with terms and conditions satisfactory to Lender (the "Lockbox Agreement"). As
each account debtor's contract is renewed, Borrower shall direct that all
Receivables thereafter be directed to the lockbox established under the Lockbox
Agreement. The following provisions shall apply to the Lockbox Agreement:
(i) The Lockbox Agreement will require all payments on
Receivables to be deposited in the Collection Account so long as any Revolving
Advance remains outstanding after the occurrence of a Threshold Event. If the
Borrower receives any payments on Receivables after the occurrence of a
Threshold Event and while any Revolving Advance is outstanding, the Borrower
shall deposit such payments into the Collection Account. Until so deposited, the
Borrower shall hold all such payments in trust for and as the property of the
Lender and shall not commingle such payments with any of its other funds or
property.
(ii) Amounts deposited in the Collection Account shall not bear
interest and shall not be subject to withdrawal by the Borrower, except after
full payment and discharge of all Obligations.
(iii) All deposits in the Collection Account shall constitute
proceeds of Collateral and shall not constitute payment of the Obligations. The
Lender from time to time at its discretion may, apply deposited funds in the
Collection Account to the payment of the Obligations, in any order or manner of
application satisfactory to the Lender, by transferring such funds to the
Lender's general account.
(iv) All items deposited in the Collection Account shall be
subject to final payment. If any such item is returned uncollected, the Borrower
will immediately pay the Lender, or, for items deposited in the Collection
Account, the bank maintaining such account, the amount of that item, or such
bank at its discretion may charge any uncollected item to the Borrower's
commercial account or other account. The Borrower shall be liable as an endorser
on all items deposited in the Collection Account, whether or not in fact
endorsed by the Borrower.
(c) Until the earlier to occur of (i) a Default, or (ii) a Threshold
Event, Borrower may have monies deposited in any lockbox deposited to its
operating account rather than to the Collection Account.
SECTION 6.11 PERFORMANCE BY THE LENDER. If the Borrower at any time fails
to perform or observe any of the foregoing covenants contained in this Article
VI or elsewhere herein, and if such failure shall continue for a period of ten
calendar days after the Lender gives the Borrower written notice thereof (or in
the case of the agreements contained in Sections 6.5, 6.7 and 6.10, immediately
upon the occurrence of such failure, without notice or lapse of time), the
Lender may, but need not, perform or observe such covenant on behalf and in the
name, place and stead of the Borrower (or, at the Lender's option, in the
Lender's name) and may, but need not, take any and all other actions which the
Lender may reasonably deem necessary to cure or correct such failure (including,
without limitation, the payment of taxes, the satisfaction of security
interests, liens or encumbrances, the performance of obligations owed to account
debtors or other obligors, the procurement and maintenance of insurance, the
execution of assignments, security agreements and financing statements, and the
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endorsement of instruments); and the Borrower shall thereupon pay to the Lender
on demand the amount of all monies expended and all costs and expenses
(including reasonable attorneys' fees and legal expenses) incurred by the Lender
in connection with or as a result of the performance or observance of such
agreements or the taking of such action by the Lender, together with interest
thereon from the date expended or incurred at the Floating Rate. To facilitate
the Lender's performance or observance of such covenants of the Borrower, the
Borrower hereby irrevocably appoints the Lender, or the Lender's delegate,
acting alone, as the Borrower's attorney in fact (which appointment is coupled
with an interest) with the right (but not the duty) from time to time to create,
prepare, complete, execute, deliver, endorse or file in the name and on behalf
of the Borrower any and all instruments, documents, assignments, security
agreements, financing statements, applications for insurance and other
agreements and writings required to be obtained, executed, delivered or endorsed
by the Borrower under this Section 6.12.
SECTION 6.12 TANGIBLE NET WORTH. The Borrower covenants that as of the date
of this Agreement, the Borrower has a Tangible Net Worth of not less than
$43,000,000.00. The Borrower covenants that commencing with the month ending
January 31, 2000 and continuing each month thereafter, the Borrower's Tangible
Net Worth as of the last day of each month shall be not less than
$43,000,000.00.
SECTION 6.13 QUICK RATIO. The Borrower covenants that commencing with the
month ending January 31, 2000 and continuing each month thereafter, the Borrower
will maintain during each month a Quick Ratio of not less than 2.0 to 1.0 as
determined at the end of each month.
SECTION 6.14 DEBT TO TANGIBLE NET WORTH. The Borrower covenants that
commencing with the month ending January 31, 2000 and continuing each month
thereafter, the Borrower will maintain during each month a Debt to Tangible Net
Worth Ratio of not less than 0.50 to 1.00 as determined at the end of each
month.
ARTICLE VII
NEGATIVE COVENANTS
So long as the Obligations shall remain unpaid, or the Credit Facility
shall remain outstanding, the Borrower agrees that, without the Lender's prior
written consent:
SECTION 7.1 LIENS. The Borrower will not create, incur or suffer to exist
any mortgage, deed of trust, pledge, lien, security interest, assignment or
transfer upon or of any of its assets (including, without limitation, the
Patents), now owned or hereafter acquired, to secure any indebtedness;
EXCLUDING, HOWEVER, from the operation of the foregoing, the following
(collectively, "Permitted Liens"):
(a) in the case of any of the Borrower's property which is not
Collateral or other collateral described in the Security Documents, covenants,
restrictions, rights, easements and minor irregularities in title which do not
materially interfere with the Borrower's business or operations as presently
conducted;
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(b) mortgages, deeds of trust, pledges, liens, security interests,
capital leases and assignments listed in Schedule 7.1 hereto, securing
indebtedness for borrowed money permitted under Section 7.2;
(c) the Security Interest and liens and security interests created by
the Security Documents; and
(d) purchase money security interests relating to the acquisition of
machinery and equipment of the Borrower not exceeding the cost or fair market
value thereof and so long as no Default Period is then in existence and none
would exist immediately after such acquisition.
SECTION 7.2 INDEBTEDNESS. The Borrower will not incur, create, assume or
permit to exist any indebtedness or liability on account of deposits or advances
or any indebtedness for borrowed money or letters of credit issued on the
Borrower's behalf, or any other indebtedness or liability evidenced by notes,
bonds, debentures or similar obligations, except:
(a) indebtedness arising hereunder;
(b) indebtedness of the Borrower in existence on the date hereof and
listed in Schedule 7.2 hereto; and
(c) indebtedness relating to liens permitted in accordance with
Section 7.1.
SECTION 7.3 GUARANTIES. The Borrower will not assume, guarantee, endorse or
otherwise become directly or contingently liable in connection with any
obligations of any other Person, except:
(a) the endorsement of negotiable instruments by the Borrower for
deposit or collection or similar transactions in the ordinary course of
business; and
(b) guaranties, endorsements and other direct or contingent
liabilities in connection with the obligations of other Persons, in existence on
the date hereof and listed in Schedule 7.2 hereto.
SECTION 7.4 INVESTMENTS AND SUBSIDIARIES.
(a) The Borrower will not purchase or hold beneficially any stock or
other securities or evidences of indebtedness of, make or permit to exist any
loans or advances to, or make any investment or acquire any interest whatsoever
in, any other Person, including specifically but without limitation any
partnership or joint venture, except:
(i) investments in direct obligations of the United States of
America or any agency or instrumentality thereof whose obligations constitute
full faith and credit obligations of the United States of America having a
maturity of one year or less, commercial paper issued by U.S. corporations rated
"A-1" or "A-2" by Standard & Poors Corporation or "P-1" or "P-2" by Moody's
Investors Service or certificates of deposit or bankers' acceptances having a
maturity of one year or less issued by members of the Federal Reserve System
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having deposits in excess of $100,000,000.00 (which certificates of deposit or
bankers' acceptances are fully insured by the Federal Deposit Insurance
Corporation); and
(ii) travel advances or loans to the Borrower's officers and
employees; and
(iii) advances in the form of progress payments, prepaid rent not
exceeding three (3) months or security deposits; and
(iv) the Allowed Investments;
(b) The Borrower will not create or permit to exist any Subsidiary
other than the Subsidiary shown on Schedule 5.4.
SECTION 7.5 DIVIDENDS. The Borrower will not declare or pay any dividends
(other than dividends payable solely in stock of the Borrower) on any class of
its common stock or make any payment on account of the purchase, redemption or
other retirement of any shares of such stock or make any distribution in respect
thereof, either directly or indirectly (provided that, except during a Default
Period, Borrower may pay dividends on its common shares, or redeem or retire
shares of such stock, so long as all such dividends or payments for redemption
or retirement in any fiscal year of Borrower shall not exceed, in the aggregate,
the lesser of (i) 10% of Borrower's total assets, or (ii) 10% of Borrower's
total sales for such period.
SECTION 7.6 SALE OR TRANSFER OF ASSETS; SUSPENSION OF BUSINESS OPERATIONS.
The Borrower will not sell, lease, assign, transfer or otherwise dispose of (i)
the stock of any Subsidiary, (ii) all or a substantial part of its assets, or
(iii) any Collateral or any interest therein (whether in one transaction or in a
series of transactions) to any other Person other than the sale of Inventory in
the ordinary course of business and will not liquidate, dissolve or suspend
business operations. The Borrower will not in any manner transfer any property
without prior or present receipt of full and adequate consideration.
SECTION 7.7 CONSOLIDATION AND MERGER; ASSET ACQUISITIONS. The Borrower will
not consolidate with or merge into any Person, or permit any other Person to
merge into it, or acquire (in a transaction analogous in purpose or effect to a
consolidation or merger) all or substantially all the assets of any other
Person.
SECTION 7.8 SALE AND LEASEBACK. The Borrower will not enter into any
arrangement, directly or indirectly, with any other Person whereby the Borrower
shall sell or transfer any real or personal property, whether now owned or
hereafter acquired, and then or thereafter rent or lease as lessee such property
or any part thereof or any other property which the Borrower intends to use for
substantially the same purpose or purposes as the property being sold or
transferred.
SECTION 7.9 RESTRICTIONS ON NATURE OF BUSINESS. The Borrower will not
engage in any line of business materially different from that presently engaged
in by the Borrower and will not purchase, lease or otherwise acquire assets not
related to its business.
SECTION 7.10 CAPITAL EXPENDITURES. The Borrower will not incur or contract
to incur Capital Expenditures of more than (i) $4,000,000.00 in the aggregate
during any fiscal year applicable to Borrower's rental fleet, or (ii) more than
$3,000,000.00 in the aggregate during any fiscal year which are not applicable
to Borrower's rental fleet.
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SECTION 7.11 ACCOUNTING. The Borrower will not adopt any material change in
accounting principles other than as required by GAAP. The Borrower will not
adopt, permit or consent to any change in its fiscal year.
SECTION 7.12 DISCOUNTS, ETC. The Borrower will not, after notice from the
Lender, grant any discount, credit or allowance to any customer of the Borrower
outside the ordinary course of Borrower's business or accept any return of goods
sold, or at any time (whether before or after notice from the Lender) modify,
amend, subordinate, cancel or terminate the obligation of any account debtor or
other obligor of the Borrower.
SECTION 7.13 DEFINED BENEFIT PENSION PLANS. The Borrower will not adopt,
create, assume or become a party to any defined benefit pension plan, unless
disclosed to the Lender pursuant to Section 5.10.
SECTION 7.14 OTHER DEFAULTS. The Borrower will not permit any breach or
default (beyond any applicable notice and cure period) or event of default to
occur under any note, loan agreement, indenture, lease, mortgage, contract for
deed, security agreement or other contractual obligation binding upon the
Borrower.
SECTION 7.15 PLACE OF BUSINESS; NAME. The Borrower will not transfer its
chief executive office or principal place of business, or move, relocate, close
or sell any business location. The Borrower will not permit any tangible
Collateral or any records pertaining to the Collateral to be located in any
state or area in which, in the event of such location, a financing statement
covering such Collateral would be required to be, but has not in fact been,
filed in order to perfect the Security Interest. The Borrower will not change
its name.
SECTION 7.16 ORGANIZATIONAL DOCUMENTS; S CORPORATION STATUS. The Borrower
will not amend its certificate of incorporation, articles of incorporation or
bylaws in any material manner or in any manner adverse to the interests of
Lender hereunder. The Borrower will not become an S Corporation.
ARTICLE VIII
EVENTS OF DEFAULT, RIGHTS AND REMEDIES
SECTION 8.1 EVENTS OF DEFAULT. "Event of Default", wherever used herein,
means any one of the following events:
(a) Default in the payment of the Obligations when they become due and
payable;
(b) Default in the payment of any fees, commissions, costs or expenses
required to be paid by the Borrower under this Agreement;
(c) Default in the performance, or breach, of any covenant or
agreement of the Borrower contained in this Agreement;
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(d) The Borrower shall be or become insolvent, or admit in writing its
inability to pay its debts as they mature, or make an assignment for the benefit
of creditors; or the Borrower shall apply for or consent to the appointment of
any receiver, trustee, or similar officer for it or for all or any substantial
part of its property; or such receiver, trustee or similar officer shall be
appointed without the application or consent of the Borrower (and in the case of
such appointment without the consent of Borrower, such appointment order shall
not be vacated or reversed within 60 days after such appointment); or the
Borrower shall institute (by petition, application, answer, consent or
otherwise) any bankruptcy, insolvency, reorganization, arrangement, readjustment
of debt, dissolution, liquidation or similar proceeding relating to it under the
laws of any jurisdiction; or any such proceeding shall be instituted (by
petition, application or otherwise) against the Borrower (provided, however,
that in the case of such proceeding being instituted against the Borrower
without the Borrower's consent, such proceeding shall not have been dismissed
within 60 days after the filing thereof); or any judgment, writ, warrant of
attachment or execution or similar process shall be issued or levied against a
substantial part of the property of the Borrower;
(e) A petition shall be filed by or against the Borrower under the
United States Bankruptcy Code naming the Borrower as debtor (provided, however,
that in the event of an involuntary filing Borrower shall fail to have the same
dismissed within 60 days after the filing thereof);
(f) Any representation or warranty made by the Borrower in this
Agreement, or by the Borrower (or any of its officers) in any agreement,
certificate, instrument or financial statement or other statement contemplated
by or made or delivered pursuant to or in connection with this Agreement or any
such guaranty shall prove to have been incorrect in any material respect when
deemed to be effective;
(g) The rendering against the Borrower of a final judgment, decree or
order for the payment of money in excess of $250,000.00 and the continuance of
such judgment, decree or order unsatisfied and in effect for any period of 30
consecutive days without a stay of execution;
(h) A default under any bond, debenture, note or other evidence of
indebtedness of the Borrower owed to any Person other than the Lender, or under
any indenture or other instrument under which any such evidence of indebtedness
has been issued or by which it is governed, or under any lease of any of the
Principal Premises, and the expiration of the applicable period of grace, if
any, specified in such evidence of indebtedness, indenture, other instrument or
lease;
(i) Any Reportable Event, which the Lender determines in good faith
might constitute grounds for the termination of any Plan or for the appointment
by the appropriate United States District Court of a trustee to administer any
Plan, shall have occurred and be continuing 30 days after written notice to such
effect shall have been given to the Borrower by the Lender; or a trustee shall
have been appointed by an appropriate United States District Court to administer
any Plan; or the Pension Benefit Guaranty Corporation shall have instituted
proceedings to terminate any Plan or to appoint a trustee to administer any
Plan; or the Borrower shall have filed for a distress termination of any Plan
under Title IV of ERISA; or the Borrower shall have failed to make any quarterly
contribution required with respect to any Plan under Section 412(m) of the
Internal Revenue Code of 1986, as amended, which the Lender determines in good
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faith may by itself, or in combination with any such failures that the Lender
may determine are likely to occur in the future, result in the imposition of a
lien on the Borrower's assets in favor of the Plan;
(j) An event of default shall occur under any Security Document or
under any other security agreement, mortgage, deed of trust, assignment or other
instrument or agreement securing any obligations of the Borrower hereunder or
under any note evidencing any obligations of the Borrower hereunder;
(k) The Borrower shall liquidate, dissolve, terminate or suspend its
business operations or otherwise fail to operate its business in the ordinary
course, or sell all or substantially all of its assets, without the Lender's
prior written consent;
(l) The Borrower shall fail to pay, withhold, collect or remit any tax
or tax deficiency in excess of $150,000.00 when assessed or due (other than any
tax deficiency which is being contested in good faith and by proper proceedings
and for which it shall have set aside on its books adequate reserves therefor)
or notice of any state or federal tax liens shall be filed or issued;
(m) Default in the payment of any amount owed by the Borrower to the
Lender other than any indebtedness arising hereunder;
(n) Any breach, default or event of default by or attributable to any
Affiliate under any agreement between such Affiliate and the Lender.
SECTION 8.2 RIGHTS AND REMEDIES. During any Default Period, the Lender may
exercise any or all of the following rights and remedies:
(a) the Lender may, by notice to the Borrower, declare the Commitment
to be terminated, whereupon the same shall forthwith terminate;
(b) the Lender may, by notice to the Borrower, declare the Obligations
to be forthwith due and payable, whereupon all Obligations shall become and be
forthwith due and payable, without presentment, notice of dishonor, protest or
further notice of any kind, all of which the Borrower hereby expressly waives;
(c) the Lender may, without notice to the Borrower and without further
action, apply any and all money owing by the Lender to the Borrower to the
payment of the Obligations;
(d) the Lender may exercise and enforce any and all rights and
remedies available upon default to a secured party under the UCC, including,
without limitation, the right to take possession of Collateral, or any evidence
thereof, proceeding without judicial process or by judicial process (without a
prior hearing or notice thereof, which the Borrower hereby expressly waives) and
the right to sell, lease or otherwise dispose of any or all of the Collateral,
and, in connection therewith, the Borrower will on demand assemble the
Collateral and make it available to the Lender at a place to be designated by
the Lender which is reasonably convenient to both parties;
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(e) the Lender may exercise and enforce its rights and remedies under
the Loan Documents; and
(f) the Lender may exercise any other rights and remedies available to
it by law or agreement.
Notwithstanding the foregoing, upon the occurrence of an Event of Default
described in subsections (d) or (e) of Section 8.1, the Obligations shall be
immediately due and payable automatically without presentment, demand, protest
or notice of any kind.
SECTION 8.3 INTELLECTUAL PROPERTY. In addition to the rights and remedies
set forth in Section 8.2 above, upon the occurrence of an Event of Default, the
Borrower shall, upon the request of Lender, immediately execute and deliver to
Lender a Patent and Trademark Security Agreement, in form and substance
satisfactory to the Lender, covering all of the Borrower's Patents, and
trademarks, and creating a first and prior lien thereon in favor of Lender.
SECTION 8.4 CERTAIN NOTICES. If notice to the Borrower of any intended
disposition of Collateral or any other intended action is required by law in a
particular instance, such notice shall be deemed commercially reasonable if
given (in the manner specified in Section 9.3) at least ten calendar days before
the date of intended disposition or other action.
ARTICLE IX
MISCELLANEOUS
SECTION 9.1 NO WAIVER; CUMULATIVE REMEDIES. No failure or delay by the
Lender in exercising any right, power or remedy under the Loan Documents shall
operate as a waiver thereof; nor shall any single or partial exercise of any
such right, power or remedy preclude any other or further exercise thereof or
the exercise of any other right, power or remedy under the Loan Documents. The
remedies provided in the Loan Documents are cumulative and not exclusive of any
remedies provided by law.
SECTION 9.2 AMENDMENTS, ETC. No amendment, modification, termination or
waiver of any provision of any Loan Document or consent to any departure by the
Borrower therefrom or any release of a Security Interest shall be effective
unless the same shall be in writing and signed by the Lender, and then such
waiver or consent shall be effective only in the specific instance and for the
specific purpose for which given. No notice to or demand on the Borrower in any
case shall entitle the Borrower to any other or further notice or demand in
similar or other circumstances.
SECTION 9.3 ADDRESSES FOR NOTICES, ETC. Except as otherwise expressly
provided herein, all notices, requests, demands and other communications
provided for under the Loan Documents shall be in writing and shall be (a)
personally delivered, (b) sent by first class United States mail, (c) sent by
overnight courier of national reputation, or (d) transmitted by telecopy, in
each case addressed or telecopied to the party to whom notice is being given at
its address or telecopier number as set forth below:
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If to the Borrower:
OrthoLogic Corp.
1275 West Washington Street
Tempe, AZ 85281
Telecopier: 602/937-5520
Attention: Terry D. Meier
With a copy to (provided such copy shall not be required to effect official
notice to Borrower):
Quarles & Brady LLP
One East Camelback, Suite 400
Phoenix, AZ 85012-1659
Telecopier: 602/230-5598
Attention: P. Robert Moya
If to the Lender:
Wells Fargo Business Credit, Inc.
100 West Washington Street, 7th Floor
MAC S4101-076
Phoenix, AZ 85003
Telecopier: 602/378-6215
Attention: Sanat Amladi
or, as to each party, at such other address or telecopier number as may
hereafter be designated by such party in a written notice to the other party
complying as to delivery with the terms of this Section. All such notices,
requests, demands and other communications shall be deemed to have been given on
(a) the date received if personally delivered, (b) when deposited in the mail if
delivered by mail, (c) the date sent if sent by overnight courier, or (d) the
date of transmission if delivered by telecopy, except that notices or requests
to the Lender pursuant to any of the provisions of Article II shall not be
effective until received by the Lender.
SECTION 9.4 FURTHER DOCUMENTS. The Borrower will from time to time execute
and deliver or endorse any and all instruments, documents, conveyances,
assignments, security agreements, financing statements and other agreements and
writings that the Lender may reasonably request in order to secure, protect,
perfect or enforce the Security Interest or the Lender's rights under the Loan
Documents (but any failure to request or assure that the Borrower executes,
delivers or endorses any such item shall not affect or impair the validity,
sufficiency or enforceability of the Loan Documents and the Security Interest,
regardless of whether any such item was or was not executed, delivered or
endorsed in a similar context or on a prior occasion).
SECTION 9.5 COLLATERAL. This Agreement does not contemplate a sale of
accounts, contract rights or chattel paper, and, as provided by law, the
Borrower is entitled to any surplus and shall remain liable for any deficiency.
The Lender's duty of care with respect to Collateral in its possession (as
imposed by law) shall be deemed fulfilled if it exercises reasonable care in
physically keeping such Collateral, or in the case of Collateral in the custody
or possession of a bailee or other third person, exercises reasonable care in
the selection of the bailee or other third person, and the Lender need not
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otherwise preserve, protect, insure or care for any Collateral. The Lender shall
not be obligated to preserve any rights the Borrower may have against prior
parties, to realize on the Collateral at all or in any particular manner or
order or to apply any cash proceeds of the Collateral in any particular order of
application.
SECTION 9.6 COSTS AND EXPENSES. The Borrower agrees to pay on demand all
costs and expenses, including (without limitation) attorneys' fees, incurred by
the Lender in connection with the Obligations, this Agreement, the Loan
Documents, and any other document or agreement related hereto or thereto, and
the transactions contemplated hereby, including without limitation all such
costs, expenses and fees incurred in connection with the negotiation,
preparation, execution, amendment, administration, performance, collection and
enforcement of the Obligations and all such documents and agreements and the
creation, perfection, protection, satisfaction, foreclosure or enforcement of
the Security Interest.
SECTION 9.7 INDEMNITY. In addition to the payment of expenses pursuant to
Section 9.6, the Borrower agrees to indemnify, defend and hold harmless the
Lender, and any of its participants, parent corporations, subsidiary
corporations, affiliated corporations, successor corporations, and all present
and future officers, directors, employees, attorneys and agents of the foregoing
(the "Indemnitees") from and against any of the following (collectively,
"Indemnified Liabilities"):
(a) any and all transfer taxes, documentary taxes, assessments or
charges made by any governmental authority by reason of the execution and
delivery of the Loan Documents or the making of the Advances;
(b) any claims, loss or damage to which any Indemnitee may be
subjected if any representation or warranty contained in Section 5.12 proves to
be incorrect in any respect or as a result of any violation of the covenant
contained in Section 6.4(b); and
(c) any and all other liabilities, losses, damages, penalties,
judgments, suits, claims, costs and expenses of any kind or nature whatsoever
(including, without limitation, the reasonable fees and disbursements of
counsel) in connection with the foregoing and any other investigative,
administrative or judicial proceedings, whether or not such Indemnitee shall be
designated a party thereto, which may be imposed on, incurred by or asserted
against any such Indemnitee, in any manner related to or arising out of or in
connection with the making of the Advances and the Loan Documents or the use or
intended use of the proceeds of the Advances except to the extent the same arise
out of the gross negligence or willful misconduct of Indemnitees.
If any investigative, judicial or administrative proceeding arising from any of
the foregoing is brought against any Indemnitee, upon such Indemnitee's request,
the Borrower, or counsel designated by the Borrower and satisfactory to the
Indemnitee, will resist and defend such action, suit or proceeding to the extent
and in the manner directed by the Indemnitee, at the Borrower's sole costs and
expense. Each Indemnitee will use its best efforts to cooperate in the defense
of any such action, suit or proceeding. If the foregoing undertaking to
indemnify, defend and hold harmless may be held to be unenforceable because it
violates any law or public policy, the Borrower shall nevertheless make the
maximum contribution to the payment and satisfaction of each of the Indemnified
Liabilities which is permissible under applicable law. The Borrower's obligation
under this Section 9.7 shall survive the termination of this Agreement and the
discharge of the Borrower's other obligations hereunder.
33
<PAGE>
SECTION 9.8 PARTICIPANTS. The Lender and its participants, if any, are not
partners or joint venturers, and the Lender shall not have any liability or
responsibility for any obligation, act or omission of any of its participants.
All rights and powers specifically conferred upon the Lender may be transferred
or delegated to any of the Lender's participants, successors or assigns.
SECTION 9.9 EXECUTION IN COUNTERPARTS. This Agreement and other Loan
Documents may be executed in any number of counterparts, each of which when so
executed and delivered shall be deemed to be an original and all of which
counterparts, taken together, shall constitute but one and the same instrument.
SECTION 9.10 BINDING EFFECT; ASSIGNMENT; COMPLETE AGREEMENT; EXCHANGING
INFORMATION. The Loan Documents shall be binding upon and inure to the benefit
of the Borrower and the Lender and their respective successors and assigns,
except that the Borrower shall not have the right to assign its rights
thereunder or any interest therein without the Lender's prior written consent.
This Agreement, together with the Loan Documents, comprises the complete and
integrated agreement of the parties on the subject matter hereof and supersedes
all prior agreements, written or oral, on the subject matter hereof. Without
limiting the Lender's right to share information regarding the Borrower and its
Affiliates with the Lender's participants, accountants, lawyers and other
advisors, the Lender, Wells Fargo Bank, N.A. or Norwest Corporation, and all
direct and indirect subsidiaries of Wells Fargo Bank, N.A. or Norwest
Corporation, may exchange any and all information they may have in their
possession regarding the Borrower and its Affiliates, and the Borrower waives
any right of confidentiality it may have with respect to such exchange of such
information.
SECTION 9.11 SEVERABILITY OF PROVISIONS. Any provision of this Agreement
which is prohibited or unenforceable shall be ineffective to the extent of such
prohibition or unenforceability without invalidating the remaining provisions
hereof.
SECTION 9.12 HEADINGS. Article and Section headings in this Agreement are
included herein for convenience of reference only and shall not constitute a
part of this Agreement for any other purpose.
SECTION 9.13 GOVERNING LAW; JURISDICTION; VENUE; WAIVER OF JURY TRIAL. The
Loan Documents shall be governed by and construed in accordance with the
substantive laws (other than conflict laws) of the State of California. The
parties hereto hereby (i) consents to the personal jurisdiction of the state and
federal courts located in the State of California in connection with any
controversy related to this Agreement; (ii) waives any argument that venue in
any such forum is not convenient, (iii) agrees that any litigation initiated by
the Lender or the Borrower in connection with this Agreement or the other Loan
Documents shall be venued in either the Superior Court of Los Angeles County, or
the Central District Court of California; and (iv) agrees that a final judgment
in any such suit, action or proceeding shall be conclusive and may be enforced
in other jurisdictions by suit on the judgment or in any other manner provided
by law. THE PARTIES WAIVE ANY RIGHT TO TRIAL BY JURY IN ANY ACTION OR PROCEEDING
BASED ON OR PERTAINING TO THIS AGREEMENT.
34
<PAGE>
IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be
executed by their respective officers thereunto duly authorized as of the date
first above written.
ORTHOLOGIC CORP., a Delaware corporation
By
-------------------------------------
Its
---------------------------------
WELLS FARGO BUSINESS CREDIT, INC.
By
-------------------------------------
Its
---------------------------------
35
<PAGE>
Table of Exhibits and Schedules
Exhibit A Form of Revolving Note
Exhibit B Compliance Certificate
Exhibit C Premises
Schedule 5.1 Trade Names, Chief Executive Office, Principal
Place of Business, and Locations of Collateral
Schedule 5.4 Subsidiary
Schedule 5.6 Pending Litigation
Schedule 7.1 Permitted Liens
Schedule 7.2 Permitted Indebtedness and Guaranties
36
<PAGE>
Exhibit A to Credit and Security Agreement
REVOLVING NOTE
$10,000,000.00 ____________, _________
_____________, 2000
For value received, the undersigned, OrthoLogic Corp., a Delaware
corporation (the "Borrower"), hereby promises to pay on the Termination Date
under the Credit Agreement (defined below), to the order of Wells Fargo Business
Credit, Inc., a Minnesota corporation (the "Lender"), at its main office in
Phoenix, Arizona, or at any other place designated at any time by the holder
hereof, in lawful money of the United States of America and in immediately
available funds, the principal sum of TEN MILLION DOLLARS ($10,000,000.00) or,
if less, the aggregate unpaid principal amount of all Revolving Advances made by
the Lender to the Borrower under the Credit Agreement (defined below) together
with interest on the principal amount hereunder remaining unpaid from time to
time, computed on the basis of the actual number of days elapsed and a 360-day
year, from the date hereof until this Note is fully paid at the rate from time
to time in effect under the Credit and Security Agreement of even date herewith
(as the same may hereafter be amended, supplemented or restated from time to
time, the "Credit Agreement") by and between the Lender and the Borrower. The
principal hereof and interest accruing thereon shall be due and payable as
provided in the Credit Agreement. This Note may be prepaid only in accordance
with the Credit Agreement.
This Note is issued pursuant, and is subject, to the Credit Agreement,
which provides, among other things, for acceleration hereof. This Note is the
Revolving Note referred to in the Credit Agreement. This Note is secured, among
other things, pursuant to the Credit Agreement and the Security Documents as
therein defined, and may now or hereafter be secured by one or more other
security agreements, mortgages, deeds of trust, assignments or other instruments
or agreements.
The Borrower hereby agrees to pay all costs of collection, including
attorneys' fees and legal expenses in the event this Note is not paid when due,
whether or not legal proceedings are commenced.
Presentment or other demand for payment, notice of dishonor and protest are
expressly waived.
ORTHOLOGIC CORP., a Delaware corporation
By
-------------------------------------
Its
---------------------------------
EXHIBIT A
<PAGE>
Exhibit B to Credit and Security Agreement
COMPLIANCE CERTIFICATE
To: _________________________________
Wells Fargo Business Credit, Inc.
Date: _________________, _____
Subject: OrthoLogic Corp.
Financial Statements
In accordance with our Credit and Security Agreement dated as of
_____________, 2000 (the "Credit Agreement"), attached are the financial
statements of OrthoLogic Corp., a Delaware corporation (the "Borrower") as of
and for ________________, 2000 (the "Reporting Date") and the year-to-date
period then ended (the "Current Financials"). All terms used in this certificate
have the meanings given in the Credit Agreement.
I certify that the Current Financials have been prepared in accordance
with GAAP, subject to year-end audit adjustments, and fairly present the
Borrower's financial condition and the results of its operations as of the date
thereof.
EVENTS OF DEFAULT. (Check one):
[ ] The undersigned does not have knowledge of the occurrence of a
Default or Event of Default under the Credit Agreement.
[ ] The undersigned has knowledge of the occurrence of a Default or
Event of Default under the Credit Agreement and attached hereto
is a statement of the facts with respect to thereto.
I hereby certify to the Lender as follows:
[ ] The Reporting Date does not mark the end of one of the Borrower's
fiscal quarters, hence I am completing only paragraph __ below.
[ ] The Reporting Date marks the end of one of the Borrower's fiscal
quarters, hence I am completing all paragraphs below except
paragraph __.
[ ] The Reporting Date marks the end of the Borrower's fiscal year,
hence I am completing all paragraphs below.
[TO COME]
EXHIBIT B
<PAGE>
Exhibit C to Credit and Security Agreement
PREMISES
The Premises referred to in the Credit and Security Agreement are legally
described as follows:
(See attached 3 pages)
EXHIBIT C
<PAGE>
Schedule 5.1 to Credit and Security Agreement
Trade Names, Chief Executive Office, Principal Place of Business, and Locations
of Collateral
TRADE NAMES:
Iatromed Inc., a Delaware corporation, which changed its name to OrthoLogic
Corp. on June 28, 1991.
CHIEF EXECUTIVE OFFICE/PRINCIPAL PLACE OF BUSINESS:
1275 West Washington Street
Tempe, AZ 85281
OTHER INVENTORY AND EQUIPMENT LOCATIONS:
Most of the collateral is located at the principal place of business, however,
the Company keeps some equipment at the various sales peoples' sites throughout
the country.
SCHEDULE 5.1
<PAGE>
Schedule 5.4 to Credit and Security Agreement
SUBSIDIARY
OrthoLogic Canada (previously Toronto Medical Corp.)
SCHEDULE 5.4
<PAGE>
Schedule 5.6 to Credit and Security Agreement
Pending Litigation
Case Number: Name: Location:
- ------------ ----- ---------
96 CV 01514 Chan v. OrthoLogic Corp. Arizona Dist. Ct.
96 CV 01520 Boren v. Weinstein Arizona Dist. Ct.
96 CV 01563 Silveira v. Weinstein Arizona Dist. Ct.
96 CV 01615 Cohen v. OrthoLogic Corp. Arizona Dist. Ct.
96 CV 01643 Barton v. Weinstein Arizona Dist. Ct.
96 CV 01667 Draker v. Weinstein Arizona Dist. Ct.
96 CV 01678 Rutkin v. Weinstein Arizona Dist. Ct.
96 CV 01713 DeFelice v. OrthoLogic Corp. Arizona Dist. Ct.
96 CV 01891 Longacre v. Weinstein Arizona Dist. Ct.
96 CV 01910 Bailey v. Weinstein Arizona Dist. Ct.
96 CV 01937 Kyser v. OrthoLogic Corp. Arizona Dist. Ct.
96 CV 02451 Rapport v. Weinstein Arizona Dist. Ct.
98 CV 00621 OrthoLogic Corp. v. Freeman Arizona Dist. Ct.
96 CV 01668 Katz, et al. v. OrthoLogic Corp. Arizona Dist. Ct.
TJ97-01248 OrthoLogic Corp./Clemente Ranch HOA Maricopa County Sup. Ct.
CV96-10799 Cooper v. Weinstein Maricopa County Sup. Ct.
CV99-12910 Elizabeth Worley v. Samaritan Health Maricopa County Sup. Ct.
System/OrthoLogic Corp.
SCHEDULE 5.6
<PAGE>
Schedule 7.1 to Credit and Security Agreement
Permitted Liens
Creditor: Collateral:
- --------- -----------
CAPITAL LIENS:
Norstan Financial Services, Inc. Telephone Equipment
Associates Leasing, Inc. Equipment
The CIT Group Computer Equipment
The CIT Group Computer Software
Pitney Bowes Credit Equipment
The CIT Group Equipment
The CIT Group Equipment
T&W Funding Company II, LLC Flooring Equipment
CURRENT CREDIT FACILITY:
Silicon Valley Bank
SCHEDULE 7.1
<PAGE>
Schedule 7.2 to Credit and Security Agreement
Permitted Indebtedness and Guaranties
Creditor: Collateral:
- --------- -----------
CAPITAL LIENS:
Norstan Financial Services, Inc. Telephone Equipment
Associates Leasing, Inc. Equipment
The CIT Group Computer Equipment
The CIT Group Computer Software
Pitney Bowes Credit Equipment
The CIT Group Equipment
The CIT Group Equipment
T&W Funding Company II, LLC Flooring Equipment
CURRENT CREDIT FACILITY:
Silicon Valley Bank
SCHEDULE 7.2
EXHIBIT 10.19
LEASE EXTENSION AND AMENDMENT AGREEMENT
THIS AGREEMENT made the 29th day of September, 1998.
BETWEEN:
TMC (HERITAGE) CORP.
(the "Landlord")
OF THE FIRST PART
- and -
ORTHOLOGIC CANADA LTD.
(the "Tenant")
OF THE SECOND PART
- and -
ORTHOLOGIC CORP.
(the "Idemnifier")
OF THE THIRD PART
WHEREAS by an indenture of lease made the 1st day of March, 1997 (the
"Lease") between Toronto Medical Corp. (the "Prior Landlord") and the Tenant
(then known as Toronto Medical Orthpaedics Ltd.) the Prior Landlord leased to
the Tenant the Premises (as defined in the Lease) upon and subject to the terms
and conditions contained in the Lease.
AND WHEREAS subsequent to the execution of the Lease by the Prior Landlord,
the Prior Landlord changed its corporate name to Saringer Investments Ltd.;
AND WHEREAS subsequent to the execution of the Lease by the Tenant, the
Tenant changed its corporate name to Orthologic Canada Ltd.;
AND WHEREAS on November 14, 1997 the Prior Landlord assigned its interest
in the Lease to the Landlord, notice of which was provided to the Tenant;
AND WHEREAS section 9.1 of the Lease granted the Tenant the right to renew
the Term of the Lease for a further five (5) year term (the "First Renewal
Term");
AND WHEREAS the Landlord and the Tenant have agreed that;
1 the First Renewal Term shall be reduced to a three (3) year term, and
2 the Base Rent for the First Renewal Term shall be the same Base Rent paid
by the Tenant under the Lease for the Term.
-2-
<PAGE>
AND WHEREAS pursuant to an Indemnity Agreement dated March 1, 1997 (the
"Indemnity"), the Indemnifier agreed that throughout the Term of the Lease and
any extension or renewal the Indemnifier will:
1 promptly pay all Base Rent, Additional Rent and any other amount payable by
the Tenant under the Lease, whether to the Landlord or anyone else; and
2 promptly perform each and every obligation of the Tenant under the Lease,
pursuant to the terms and conditions contained in the Indemnity.
NOW THEREFORE THIS AGREEMENT WITNESSETH that in consideration of the
premises and the terms and conditions hereinafter set forth, other good and
valuable consideration and the sum of Two Dollars ($2.00) now paid by each
party to the other (the receipt and sufficiency of which is hereby
acknowledged), the parties agree as follows:
1 The parties hereby acknowledge, confirm and agree that the foregoing
recitals are true in substance and in fact.
2 Where used herein, all capitalized terms and expressions have the same
meaning as they have in the Lease, unless a contrary expression is
expressed herein.
3 Subject to paragraph 6 hereof, the Landlord and the Tenant agree, subject
to the terms of the Lease as amended hereby, to renew the Lease for the
First Renewal Term. The First Renewal Term shall be for a term of three (3)
years from March 1, 1999 until February 28, 2002, and section 9.1 of the
Lease shall be amended accordingly by deleting the word "five (5)"
appearing in the tenth line of the first paragraph and replacing it with
the word "three (3)".
4 The Base Rent for the First Renewal Term shall be the same Base Rent that
was paid by the Tenant during the Term, being the annual sum of One Hundred
and Forty Two Thousand Two Hundred and Eighty Five Dollars ($142,285.00) of
lawful money of Canada, such amount payable in twelve (12) equal monthly
installments of Eleven Thousand Eight Hundred and Fifty Seven Dollars
($11,857.00) in advance on the first day of each and every month during the
First Renewal Term commencing March 1, 1999.
-3-
<PAGE>
5 Pursuant to section 12.2(a) of the Lease, the Landlord's address for the
service shall be amended to read as follows:
"TMC" Heritage Corp.
65 Proctor Avenue
Thornhill, Ontario
L3T 1M6
Attention: Mr. JP. Scheidegger
Facsimile: (905) 882-6678
With a copy to:
Koskie Minsky
Barristers and Solicitors
Suite 900, Box 52
20 Queen Street West
Toronto, Ontorio
MSH 3R3
Attention: Mr. George P. Dzuro
Facsimile: (416) 977-3316
6 The renewal of the Lease for the First Renewal Term is subject to and
conditional upon compliance by the Tenant with the provisions of section
9.1 of the Lease and, in particular, that: the Tenant has not been in
default under the terms of the Lease on more than two (2) occasions in any
consecutive twelve (12) month period occurring prior to the commencement
date of the First Renewal Term; or the Tenant is not in default under the
terms of the Lease on the last day of the Term.
If the foregoing condition has not been performed at or prior to the
commencement date of the First Renewal Term, the Landlord may, by written
notice to the Tenant, terminate all of its obligations with respect to the
First Renewal Term and the Landlord shall be released from all of its
obligations under the Lease, as amended hereby, with respect to the First
Renewal Term. The foregoing condition may be waived be by the Landlord by
notice in writing, without prejudice to any of the Landlord's rights to
renew the Lease for the First Renewal Term and pursue any and all other
legal remedies the Landlord may have, under the Lease or otherwise, with
respect to any default by the Tenant under the terms of the Lease.
The Indemnifier acknowledges, confirms and agrees that the Indemnity shall
continue in full force and effect in favour of the Landlord pursuant to its
terms and conditions with respect to the Lease and the obligations of the
Tenant thereunder, as amended and renewed pursuant to this agreement.
-4-
<PAGE>
2 Save and except as provided for herein, the parties hereto acknowledge and
agree that all of The terms and conditions of the Lease shall continue in
full force and effect, save and except as amended hereby.
3 This agreement shall ensure to the benefit of and be binding upon the
parties hereto and their respective successors and assigns.
4 This agreement may be executed in several counterparts each of which so
executed shall be deemed to be an original and such counterparts together
shall constitute one and the same agreement. This agreement may be executed
by one or more of the parties hereto by way of telecopying device and such
execution shall be accepted as though signatures thereof were signed
originals and in the event of such method of execution each party agrees to
provide the other parties with copies of this agreement bearing original
signatures within a reasonable time after execution.
IN WITNESS WHEREOF the parties hereto have duly executed this agreement on
the date first above written.
TMC (HERITAGE) CORP.
Per:
-----------------------------------
(Authorized Signing Officer)
ORTHOLOGIC CANADA LTD.
Per:
-----------------------------------
(Authorized Signing Officer)
OTHOLOGIC CORP.
Per:
-----------------------------------
(Authorized Signing Officer)
-5-
OrthoLogic, Corp.
Statement of Computation of Net Loss per Weighted Average
Number of Common Shares Outstanding
(in thousands, except per share amounts)
Years Ended December 31,
--------------------------------
1999 1998 1997
-------- -------- --------
Net loss $ (586) $(17,838) $(17,714)
======== ======== ========
Common shares outstanding at end of period 27,638 25,302 25,255
Adjustment to reflect weighted average
for shares issued during the period (1,560) (11) (139)
-------- -------- --------
Weighted average number of
common shares outstanding 26,078 25,291 25,116
======== ======== ========
Net loss per weighted average number
of common shares outstanding (0.02) (0.71) (0.71)
======== ======== ========
ORTHOLOGIC MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
GENERAL
The goal of OrthoLogic Corp. ("the Company") is to become the worldwide leader
in fracture healing and orthopedic rehabilitation. OrthoLogic develops,
manufactures, and distributes products that support physicians and hospitals
improve the quality of life for their patients. OrthoLogic is committed to
providing technologically advanced, superior products to customers at affordable
costs.
OrthoLogic was founded in July 1987. Through August 1996, the Company was
engaged primarily in the commercialization of the Company's proprietary
BioLogicTM 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. The Company completed two additional CPM related
acquisitions in March 1997. These acquisitions allowed the Company to develop,
manufacture and market orthopedic rehabilitation products and services. During
the first 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 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.
MARKET OVERVIEW
Sales in the orthopedic market are in excess of $10 billion with an average
annual growth rate for the last five years of 6.8%. The average annual growth
rate for the next five years is projected to be 8%. The key driver for most of
this growth rate is the age segment of the population between 45 and 64. This
age segment favorably impacts the demand for fracture healing, spine and
osteoarthitis products.
OrthoLogic competes in three segments of the orthopedic market; fracture
healing, rehabilitation and injectable products. The fracture healing product
line consists of electronic bone growth stimulators for long bones and a new
device, SpinaLogic. The recently FDA approved SpinaLogic provides stimulation
for the lumbar lower portion of the spine. The fracture healing market for the
long bone has been growing at an average annual rate of 8% over the last five
years. The market growth for spine stimulation has been growing at an average
annual rate of 12%. The rehabilitation product line consists of continuous
passive motion devices for both the lower and upper extremities and the
ancillary products such as braces and cryotherapy equipment. The rehabilitation
market has been growing at a rate of 5.4% for the past five years. The
injectable product line consists of the Hyalgan(R) brand of hyaluronic acid for
pain relief of the osteoarthritis of the knee. The orthopedic market for
injectable hyaluronic acid was established in 1997. Retail sales for this
product during 1999 were approximately $140 million.
PRODUCT OVERVIEW
BONE GROWTH STIMULATION
OrthoLogic competes in the market for long bone stimulation with the OL-1000,
OL-1000 Single Coil and custom curve coil products.
Bone growth stimulation devices are noninvasive physician prescribed magnetic
field bone growth stimulators designed for home treatment of patients with a
non-union fracture. Market growth for fractures of the long bone is dependent on
manufactures' continuing to demonstrate the economic and patient benefits of
using bone growth stimulation prior to moving forward with more expensive
surgical alternatives. During November 1999, a Decision Memorandum issued by the
Health Care Financing Administration (HCFA) changed the acceptance criteria for
Medicare patients who qualify for treatment with a bone growth stimulator. The
new criteria broaden the potential patient population by removing the six-month
period required to determine the existence of a non-union fracture. Due to
HCFA's Y2K policy, the new guideline was not formally implemented until April 1,
2000. Over the past few years, both the United States Food and Drug
Administration (FDA) and HCFA have changed both the definitions of a non-union
fracture and the reimbursement guidelines for using a bone growth stimulator.
The new HCFA reimbursement guidelines have defined a non-union fracture as being
established when at least 90 days have passed and healing has ceased. This new
definition allows for non-unions to be treated with the Company's OL-1000
product as soon as 90 days post-injury. The OrthoFrame(R) and the
OrthoFrame/Mayo(R) products are external fixation devices used in conjunction
with surgical procedures.
The FDA approved SpinaLogic in December of 1999. SpinaLogic is a technologically
advanced medical device that can be used as an adjunct to spinal fusion surgery
to improve the probability of a successful fusion. SpinaLogic is a non-invasive
externally worn device, that delivers a unique, patented magnetic signal to the
surgical site and requires only a 30-minute daily treatment cycle. There are
currently only two other approved noninvasive spine bone growth stimulators on
the market. The Company began commercial distribution of SpinaLogic during the
last few business days of December. To enhance market penetration, the Company
plans to supplement the distribution of the product using a combination of its
own direct sales force and regional spine product distributors. Full
distribution in the United States will occur in early fiscal year 2000, with
distribution for Europe planned for late third quarter.
<PAGE>
ORTHOLOGIC MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The main call point for fracture healing product sales is the physician office.
Orthopedic surgeons, spine surgeons, neurosurgeons and podiatrists prescribe
bone growth stimulators. They are placed on patients in the physician's office
or the home. Strong relationships with the physician, reimbursement coverage,
product efficacy and prompt customer service are the most important factors in
the sale process.
Fracture healing products are placed on 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(R) products are sold
to hospitals. The revenue is recognized on these products at the point a
purchase order is received and the product is sent to the hospital.
REHABILITATION PRODUCTS
CPM devices provide controlled, continuous movement to joints and limbs without
requiring the patient to exert muscular effort and is 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, reduce the incidence of post-trauma, and post surgical
complication. OrthoLogic competes in the rehabilitation market with a complete
line of lower and upper extremity CPM devices and ancillary products such as
knee braces, splints and cryotherapy products. Lower extremity CPM is an
accepted treatment modality for knee surgical procedures such as total knee
replacement (TKR) and anterior cruciate ligament reconstruction (ACL). Due to
the wide acceptance of lower extremity CPM and the number of companies competing
for this business, managed care companies have been decreasing their
reimbursement rates. Upper extremity CPM for the shoulder, elbow, wrist and hand
are continuing to gain acceptance in the rehabilitation market. No outcomes
based on clinical studies have been completed supporting the efficacy of upper
extremity CPM. As a result, there is no Medicare reimbursement to date for this
treatment. The majority of the reimbursement payments for upper extremity are
Worker's Compensation related. This segment of the market is expected to
experience some growth as upper extremity CPM becomes accepted as a standard
treatment modality. Cryotherapy is used to cool the operative or injured site in
order to prevent pain and swelling. The Company produces its own cryotherapy
device, the Blue Arctic.
The main call points for the rehabilitation market are hospitals, orthopedic
surgeons, plastic surgeons, physical therapists and hand therapists.
Rehabilitation products are sold and rented to hospital customers and rented
directly to patients in the home. The length of use in the hospital rental
business continues to decline because of shorter hospital stays. Historically,
rehabilitation product sales were based on strong customer relationships and a
high level of customer service. Due to cost cutting initiatives by managed care
companies, price has become a major factor with the orthopedic surgeon having
less impact on the choice of rehabilitation providers.
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 when the
patient receives the product. A bill is sent to the patient's insurance carrier
for reimbursement.
HYALGAN(R)
The Company began marketing Hyalgan(R) to orthopedic surgeons during July 1997
under a Co-Promotion Agreement (the "Co-Promotion Agreement") with Sanofi
Pharmaceuticals, Inc. Hyalgan(R) is used for relief of pain from osteoarthritis
of the knee for those patients who have failed to respond adequately to simple
analgesics.
In January 2000, the FDA approved new labeling for Hyalgan(R). The labeling
states that Hyalgan(R) can produce pain relief beyond 26 weeks. This labeling
will allow the Company to use published clinical papers exhibiting up to 12
months of pain relief with a single course of therapy. In addition, the revised
label allows the Company to promote Hyalgan(R) for repeated cycles of treatment.
Short-term market growth for Hyalgan(R) is dependent on orthopedic surgeons
using hyaluronic acid early in the continuum of care as a replacement for
non-steroidal anti-inflammatory drugs (NSAIDs) and steroidals. Longer-term
market growth will depend in part on expanded applications for Hyalgan(R) use
beyond osteoarthritis of the knee.
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.
CHRYSALIN
In January 1998, the Company acquired a minority interest in a biotech firm,
Chrysalis Bio Technology, Inc., for $750,000. Chrysalin is a synthetically
manufactured peptide that has shown potential in preclinical animal studies to
accelerate fracture healing. Chrysalin represents a portion of the
receptor-binding domain of the human thrombin molecule, which is actively
involved in the healing process for both soft tissue and bone. By mimicking
specific attributes of the thrombin molecule, Chrysalin stimulates the body's
natural healing processes, resulting in accelerated tissue repair. On January
12, 2000, the Company began enrolling patients in an FDA authorized combined
<PAGE>
ORTHOLOGIC MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Phase I/II clinical trial for Chrysalin. The trial consists of a prospective,
randomized double-blind study of 90 patients in three to five clinical centers
to evaluate the safety and preliminary efficacy of Chrysalin. Patients will
receive one injection of Chrysalin or placebo (saline solution) at the time the
fracture is set and will be monitored weekly to evaluate healing. Depending on
the rate of patient enrollment, the trial could be completed by the end of
fiscal year 2000.
OTHER
The Company reported a net loss attributable to common shareholders of $586,000
during 1999 with an accumulated deficit as of December 31, 1999 of $52.0
million. As of December 31, 1999, the Company had approximately $33.6 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 is 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, 1997, 1998 AND 1999
REVENUES. OrthoLogic's total revenues increased 10% from $75.4 million in 1998
to $83.2 million in 1999. OrthoLogic's revenues consist of net sales of the bone
growth stimulator for long bone and spine, fracture fixation devices, orthopedic
rehabilitation equipment and ancillary products, net rentals of CPM equipment
and fee revenues from the co-promotion agreement. The Company recognizes fee
revenue for the distribution of Hyalgan(R). Net sales increased by 10% to $32.6
million during 1999. The growth in net sales is primarily attributed to an
increased demand for orthopedic rehabilitation products. Sales recorded for the
OL1000 product were relatively constant over the two-year period. The Company
recorded its first sale of SpinaLogic units after receiving FDA approval in late
December 1999. Net rentals for CPM equipment increased by $5.2 million in 1999
or 14% over 1998 rental revenue. Fee revenue from Hyalgan(R) decreased from 1998
to 1999 by $440,000 or 5%.
Total revenues decreased 2% from $77.0 million in 1997 to $75.4 million in 1998.
The decrease in net sales of 18% or $6.6 million is primarily attributable to
the Company restructuring its sales force, marketing and managed care
operations. Prior to 1998, the primary source of sales for the OL-1000 product
was through distributor sales teams. As a result of the change in the sales
structure, sales of the OL-1000 fell during 1998. Net rentals of CPM equipment
stayed fairly constant between 1997 and 1998. Fee revenue was recorded for
Hyalgan(R) over twelve months of 1998, after launching the distribution of the
product during 1997.
GROSS PROFIT. Gross profit increased 12% from $57.7 million in 1998 to $64.7
million in 1999. The gross profit on net sales was 65% in 1999 compared to 64%
in 1998. The overall improvement in the margin is attributable to 14% growth in
net rentals. The cost of rentals as a percent of net rentals decreased from 19%
in 1998 to 17% in 1999. For future margins, the recent launch of SpinaLogic in
late 1999 is anticipated to allow the Company economies of scale in the current
manufacturing process by adding the production of an additional product in
future periods. Overall, gross profit decreased by 2% in 1998 from 1997. The
decrease in gross profit is reflective of the overall decrease in total revenues
during 1998. The cost of goods sold increased as a percent of net sales to 36%
in 1998 from 28% in 1997. The increase in cost of goods sold is due to the
change in the mix of the products sold. The decrease in the net sales of OL-1000
was partially offset by increased sales of CPM equipment and ancillary products
for rehabilitation, which have lower margins.
SELLING, GENERAL AND ADMINISTRATIVE ("SG&A") EXPENSES. SG&A expenses decreased
from $72.0 million during 1998 to $61.9 million during 1999, a 14% decrease. A
significant portion of the decrease in cost is directly related to bad debt of
approximately $9.3 million recorded during the first quarter 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. The increased sales recorded in 1999 have related variable
costs associated with the increased revenues, such as commissions and bad debt
reserve. Despite the increase in variable costs associated with the higher
revenues, SG&A costs decreased from 1998 to 1999. Excluding the first quarter
<PAGE>
ORTHOLOGIC MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
increase in bad debt expense in 1998, SG&A expenses would have been 83% of total
revenues, compared to 74% in 1999. SG&A costs during 1997 were 80% of sales.
RESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses decreased
slightly in 1999 from 1998. R&D costs were increased in the third quarter of
1998, when the Company paid an additional fee of $750,000 for the initial
license of Chrysalin.
As part of the transaction, OrthoLogic was awarded various options to license
orthopedic applications of Chrysalin. In January of 1999, OrthoLogic exercised
the option to acquire the rights to Chrysalin for fracture indications for the
U.S. market. As part of the license agreement, and in conjunction to FDA
clearance to begin human clinical trials, OrthoLogic made a $500,000 milestone
payment to Chrysalis Biotechnology in the fourth quarter of 1999.
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.
During 1999 and 1998, $216,000 and $399,000 of the 1997 restructuring charge was
reversed.
NET INCOME (LOSS). Net income in 1999 of $238,000 consists of an operating
profit of $148,000 and other income. 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.
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 equity 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 (before costs).
The Series B Convertible Preferred Stock is convertible into shares of Common
Stock 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 $3.0353. 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 of the Company's stockholders to approve the
transactions contemplated by the Securities Purchase Agreement related 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 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 Shares outstanding at that time. The Purchase Agreement contains
strict covenants that protect against hedging and short-selling of OrthoLogic
Common Stock while the purchaser holds 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. These warrants expire in 2008. The warrants were 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 equity offering were 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 were used to fund new product opportunities,
including SpinaLogic, Chrysalin and Hyalgan(R), as well as to complete the
re-engineering of the Company's key business processes.
At the close of business on December 31, 1999, 4,820 shares of Series B
Convertible Preferred Stock had been converted into 2,053,003 shares of Common
Stock.
From the inception of the Company through December 31, 1999, equity financing
has resulted in net proceeds of $134.4 million. At December 31, 1999, the
<PAGE>
ORTHOLOGIC MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Company had cash and cash equivalents of $6.0 million and short term investments
of $250,000. Working capital increased 5% from $38.8 million at December 31,
1998 to $40.9 million at December 31, 1999.
Through December 31, 1999, the Company had 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 70% of the 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 December 3, 2000 and the revolving term loan on
November 30, 2000. 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 0.65% for the accounts
receivable line of credit, and prime plus 1.05% 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.
On February 28, 2000, the Company obtained a new $10 million accounts receivable
revolving line of credit with a different bank. The Company may borrow up to 75%
of the eligible accounts receivable. The interest rate is at prime for the
revolving line of credit. Interest accruing on the note and a monthly
administration fee is due in arrears on the first day of each month. The
revolving note matures February 28, 2003. There are certain financial covenants
and reporting requirements associated with the loan. Included in the financial
covenants are (1) tangible net worth of not less than $43 million, (2) a quick
ratio of not less than 2.0 to 1.0, (3) a debt to tangible net worth ration of
not less than 0.50 to 1.0, and (4) capital expenditures will not exceed more
than $7.0 million dollars during any fiscal year.
The Company anticipates that its cash on hand and the funds available from the
line of credit 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 payers. 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 dependant 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 provided by operations during 1999 was $4.7 million. This improvement
in operating cash flow was primarily a result of (1) net income of $237,901, (2)
a decrease in inventories of $2.7 million and depreciation/amortization of $6.8
million, partially offset by an increase in accounts receivable of $3.4 million.
Net cash used in operations during 1998 was $10 million, an increase of 108%
over the cash used in operations of $4.8 million in 1997. 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. 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.
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.
MARKET RISKS
The Company has exposure to foreign exchange rates through its manufacturing
subsidiary in Canada.
The Company does not use foreign currency exchange forward contracts or
commodity contracts to limit its exposure. The Company is not currently
vulnerable to a material extent to fluctuations in interest rates and commodity
prices.
YEAR 2000 COMPLIANCE
The Company did not experience any material Year 2000 computer problems on its
primary computer systems. The Company's computer systems functioned properly
into the year 2000. As a result, the Company was able to service its customers,
communicate with its suppliers, and submit billings to third party payers
without disruption. The Company, however, continues to monitor its systems,
suppliers, and customers for any unanticipated issues that have yet to surface.
<PAGE>
ORTHOLOGIC SELECTED FINANCIAL DATA
The selected financial data for each of the five years in the period ended
December 31, 1999 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, the Company completed two acquisitions in March 1997 and one in August
1996.
<TABLE>
<CAPTION>
Years Ending December 31,
------------------------------------------------------------
(in thousands) 1999 1998 1997 1996 1995
-------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
STATEMENTS OF OPERATIONS DATA:
Total revenues $ 83,232 $ 75,369 $ 77,049 $ 41,884 $ 14,678
Total cost of revenues 18,504 17,693 18,369 8,299 3,065
Operating expenses:
Selling, general, and administrative 61,936 72,011 61,484 31,901 11,304
Research and development 2,860 2,920 2,320 2,169 2,132
Restructuring and other charges [Note 1] (216) (399) 13,844 -- --
-------- -------- -------- -------- --------
Total operating expenses 64,580 74,532 77,648 34,070 13,436
-------- -------- -------- -------- --------
Operating profit (loss) 148 (16,856) (18,968) (485) (1,823)
Other income 148 354 1,466 3,023 471
Income Taxes (58) (100) (212) -- --
-------- -------- -------- -------- --------
Net income (loss) 238 (16,602) (17,714) 2,538 (1,352)
Accretion of non-cash preferred stock dividend (824) (1,236) -- -- --
-------- -------- -------- -------- --------
Net income (loss) applicable to common stockholders $ (586) $(17,838) $(17,714) $ 2,538 $ (1,352)
======== ======== ======== ======== ========
Net income (loss) per common share
Basic [Note 1] $ (0.02) $ (0.71) $ (0.71) $ 0.11 $ (0.09)
======== ======== ======== ======== ========
Net income (loss) per common share
Diluted [Note 1] $ (0.02) $ (0.71) $ (0.71) $ 0.11 $ (0.09)
======== ======== ======== ======== ========
Basic shares outstanding 26,078 25,291 25,116 23,275 15,549
Equivalent shares and stock options -- -- 869 --
Diluted shares outstanding 26,078 25,291 25,116 24,114 15,549
======== ======== ======== ======== ========
</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.
<TABLE>
<CAPTION>
Years Ended December 31,
-------------------------------------------------------------
(in thousands) 1999 1998 1997 1996 1995
-------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Working capital $ 40,865 $ 38,817 $ 44,418 $ 74,985 $ 23,518
Total assets 92,203 93,980 103,103 113,026 27,490
Long-term debt, less current maturities 209 196 1,631 280 --
Stockholders' equity 73,054 68,225 84,737 101,927 24,437
</TABLE>
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.
1999 1998
-------------------- ------------------
High Low High Low
------- ------ ------- ------
First Quarter $4 3/16 $2 3/4 $7 9/16 $5 1/2
Second Quarter 3 7/8 2 5/16 7 1/2 4 3/4
Third Quarter 3 1/8 2 1/4 5 2 1/2
Fourth Quarter 3 1/16 2 1/4 4 3/8 2 15/16
As of January 31, 2000, there were 29,126,456 shares outstanding of the Common
Stock of the Company held by approximately 275 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.
<PAGE>
ORTHOLOGIC CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
December 31,
-------------------------------
1999 1998
------------- -------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 6,023,263 $ 1,713,966
Short-term investments [Note 7] 250,000 6,052,469
Accounts receivable, less allowance for
doubtful accounts of $15,502,720 and
$19,317,823 [Note 12] 30,428,564 27,030,755
Inventories, net [Note 8] 9,306,455 11,960,071
Prepaids and other current assets 986,753 799,350
Deferred income taxes [Note 10] 2,630,659 2,642,909
------------- -------------
Total current assets 49,625,694 50,199,520
------------- -------------
Rental fleet, equipment & furniture, net [Note 9 and 12] 13,061,771 12,867,391
Deposits and other assets 766,586 344,915
Goodwill, net of accumulated amortization
of $4,645,793 and $2,918,116 [Note 2] 24,643,822 26,195,846
Other Intangibles, net [Notes 3,15, and 16] 4,105,574 4,372,238
------------- -------------
Total assets $ 92,203,447 $ 93,979,910
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 2,568,805 $ 3,038,684
Loan payable -- 500,000
Accrued compensation 2,852,631 1,458,849
Deferred credits 138,813 1,542,393
Accrued royalties [Note 6] 37,040 166,457
Accrued restructuring expenses [Note 3] 150,086 762,151
Obligations under co-promotion agreement [Note 15] -- 1,000,000
Sales and property taxes payable 1,908,904 1,185,190
Accrued expenses 1,104,475 1,729,207
------------- -------------
Total current liabilities 8,760,754 11,382,931
Deferred rent and capital leases 209,138 196,192
------------- -------------
Total liabilities 8,969,892 11,579,123
------------- -------------
Commitments and contingencies [Notes 6,12,13,14,15 and 16]
Series B Convertible Preferred Stock,
$1,000 par value; 10,180 and 15,000 shares issued and outstanding;
liquidation preference, $10,180,000 and $15,000,000 [Note 11] 10,180,000 14,176,008
------------- -------------
STOCKHOLDERS' EQUITY [NOTE 11]
Common Stock, $.0005 par value; 50,000,000 shares authorized;
and 27,637,593 and 25,302,190 shares issued and outstanding 13,818 12,649
Additional paid in capital 125,206,621 119,658,836
Deficit (51,992,079) (51,405,989)
Comprehensive income (loss) (174,805) (40,717)
------------- -------------
Total stockholders' equity 73,053,555 68,224,779
------------- -------------
Total liabilities and stockholders' equity $ 92,203,447 $ 93,979,910
============= =============
</TABLE>
See notes to consolidated financial statements
<PAGE>
ORTHOLOGIC CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
Years Ending December 31,
------------------------------------------------
1999 1998 1997
------------ ------------ ------------
<S> <C> <C> <C>
REVENUES
Net sales $ 32,578,511 $ 29,491,932 $ 36,043,169
Net rentals 42,356,168 37,138,960 37,362,446
Fee revenue from co-promotion agreement [Note 15] 8,296,844 8,737,325 3,643,618
------------ ------------ ------------
Total revenues 83,231,523 75,368,217 77,049,233
------------ ------------ ------------
COST OF REVENUES
Cost of goods sold 11,303,309 10,591,924 10,224,397
Cost of rentals 7,200,549 7,100,706 8,144,806
------------ ------------ ------------
Total cost of revenues 18,503,858 17,692,630 18,369,203
------------ ------------ ------------
Gross Profit 64,727,665 57,675,587 58,680,030
OPERATING EXPENSES
Selling, general and administrative 61,936,094 72,010,982 61,484,418
Research and development 2,860,159 2,919,857 2,319,640
Restructuring and other charges [Note 3] (216,211) (398,943) 13,843,591
------------ ------------ ------------
Total operating expenses 64,580,042 74,531,896 77,647,649
------------ ------------ ------------
Operating Profit (Loss) 147,623 (16,856,309) (18,967,619)
OTHER INCOME (EXPENSE)
Grant/other revenue 1,306 103,861 147,263
Interest income 224,139 350,858 1,384,133
Interest expense (77,281) (101,100) (65,884)
------------ ------------ ------------
Total other income 148,164 353,619 1,465,512
------------ ------------ ------------
Income (Loss) Before Income Taxes 295,787 (16,502,690) (17,502,107)
Provision for income taxes [Note 8] (57,886) (99,804) (211,560)
------------ ------------ ------------
Net Income (Loss) 237,901 (16,602,494) (17,713,667)
Accretion on non-cash preferred stock dividend (823,991) (1,235,988) --
------------ ------------ ------------
Net loss applicable to common stockholder $ (586,090) $(17,838,482) $(17,713,667)
============ ============ ============
Net loss per common share-basic $ (0.02) $ (0.71) $ (0.71)
============ ============ ============
Net loss per common share-diluted $ (0.02) $ (0.71) $ (0.71)
============ ============ ============
Basic and diluted shares outstanding 26,078,058 25,290,784 25,116,164
============ ============ ============
OrthoLogic Consolidated Statements of Comprehensive Income (Loss)
Years Ending December 31,
------------------------------------------------
1999 1998 1997
------------ ------------ ------------
Net loss applicable to common stockholders $ (586,091) $(17,838,482) $(17,713,667)
Foreign translation adjustment (134,088) (18,136) (22,581)
------------ ------------ ------------
Comprehensive loss applicable to common stockholders $ (720,179) $(17,856,618) $(17,736,248)
============ ============ ============
</TABLE>
See notes to consolidated financial statements
<PAGE>
ORTHOLOGIC CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
Paid in Comprehensive
Shares Amount Capital Income Deficit Total
------ ------ ------- ------ ------- -----
<S> <C> <C> <C> <C> <C> <C>
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 stock 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
Series B Preferred
Convertible Stock -- -- 1,093,980 -- 1,093,980
Accretion of Non-cash
Preferred Stock -- -- (1,093,980) -- (142,008) (1,235,988)
Other -- -- 61,250 -- 4,307 65,557
Foreign translation adjustment -- -- -- (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
Accretion of non-cash
preferred stock dividend 00 00 00 00 (823,991) (823,991)
Exercise of common options
at prices ranging from
$2.03 to $2.88 per share 282,400 142 728,812 00 00 728,954
Conversion of Preferred Stock 2,053,003 1,027 4,818,973 00 00 4,820,000
Foreign translation adjustment (134,088) (134,088)
Net Income 00 00 00 00 237,901 237,901
---------- --------- ------------ -------- ------------ -------------
Balance December 31, 1999 27,637,593 $ 13,818 $125,206,621 $(174,805) $(51,992,079) $73,053,555
========== ========= ============ ========= ============ ===========
</TABLE>
See notes to consolidated financial statements
<PAGE>
ORTHOLOGIC CONSOLIDATED STATEMENTS OF CASH FLOW
<TABLE>
<CAPTION>
Years Ending December 31,
----------------------------------------------
1999 1998 1997
------------ ------------ ------------
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net income (loss) $ 237,901 $(16,602,494) $(17,713,667)
Adjustments to reconcile net income (loss)
to net cash used in operating activities:
Depreciation and amortization 6,758,663 6,473,000 5,510,251
Restructuring and other charges (216,211) (399,000) 13,843,591
Other -- -- (438,504)
Change in operating assets and liabilities,
excluding acquisitions:
Accounts receivable (3,415,663) 5,682,834 (2,759,187)
Inventories 2,653,616 (1,411,898) (1,494,096)
Prepaids and other current assets (175,153) 280,065 (23,215)
Deposits and other assets (421,671) 186,870 (438,447)
Accounts payable (469,879) 242,628 (871,546)
Accrued and other current liabilities (263,944) (4,466,299) (437,934)
------------ ------------ ------------
Net cash provided (used) in operating activities 4,687,659 (10,014,294) (4,822,754)
------------ ------------ ------------
INVESTING ACTIVITIES
Expenditures for rental fleet, equipment and furniture (4,958,701) (5,423,652) (5,128,159)
Intangibles from dealer transactions -- -- (704,966)
Officer note receivable, net (157,800) -- 200,000
Acquisitions, net of cash acquired -- -- (24,886,134)
Investments in Chrysalin -- (750,000)
(Purchase) sale of short-term investments 5,802,469 (1,484,943) 30,738,463
------------ ------------ ------------
Net cash (used) provided in investing activities 685,968 (7,658,595) 219,204
------------ ------------ ------------
FINANCING ACTIVITIES
Payments under long-term debt and capital lease obligations (159,197) (157,984) (233,756)
Payments on loan payable (500,000) (500,000) (420,084)
Payments under co-promotion agreement (1,000,000) (2,000,000) (1,000,000)
Net proceeds from stock options exercised and other 594,867 227,490 546,886
Net proceeds from issuance of
convertible preferred stock and warrants -- 14,034,000 --
------------ ------------ ------------
Net cash (used in) provided by financing activities (1,064,330) 11,603,506 (1,106,954)
------------ ------------ ------------
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS 4,309,297 (6,069,383) (5,710,504)
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 1,713,966 7,783,349 13,493,853
------------ ------------ ------------
CASH AND CASH EQUIVALENTS, END OF YEAR $ 6,023,263 $ 1,713,966 $ 7,783,349
============ ============ ============
Supplemental schedule of non-cash investing
and financing activities:
Stock option compensation -- $ 25,622 $ 84,577
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Acquisition of intangible asset through obligation
for product distribution rights [Note 15] -- -- $ 4,000,000
Conversion of series B preferred stock for common stock $ 4,820,000 -- --
Accretion of non-cash preferred stock dividend $ 823,992 $ 1,235,988 --
Purchase of property and equiupment with capital leases -- $ 493,289 --
Purchase price adjustment related to preacquisition contingencies $ 175,653 $ 1,816,362 --
Cash paid during the year for interest $ 50,510 $ 101,100 $ 65,844
Cash paid during the year for income taxes $ 3,295 $ 350,000 $ 400,000
</TABLE>
See notes to consolidated financial statements.
<PAGE>
OrthoLogic Notes to Consolidated Financial Statements
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Organization. OrthoLogic Corp. 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 OrthoLogic
(collectively the "Company" or "OrthoLogic"). 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,
orthopedic rehabilitation products and injectable products primarily in the
United States. OrthoLogic's products are designed to enhance the healing of
diseased, damaged, degenerated or recently repaired musculo 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. 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. On January 12,
2000, the Company began enrolling patients in the combined Phase I/II clinical
trials for Chrysalin.
During the year ended December 31, 1999 and 1998, the Company reported net
income of $237,901 and a loss of $16.6 million, respectively. In addition, the
Company provided cash from operating activities of $4.7 million and used cash of
$10.0 million for the years ending December 31, 1999 and 1998, respectively. The
Company anticipates that its cash and short-term investments on hand, cash from
operations and the funds available from the revolving line of credit (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 expenditures, maintain profitability and collect
amounts due from third party payers. 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 and 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, Toronto, and DMTI, since their acquisition in March 1997.
All material intercompany accounts and transactions have been eliminated. 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. RENTAL FLEET, EQUIPMENT AND FURNITURE 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 is recognized for sales of the Orthologic 1000 and SpinaLogic
products at the time the product is placed on the patient. If the sale of either
product is to a commercial buyer, revenue is recognized at the time of shipment.
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 rehabilitative ancillary products is generally
recognized at the time of shipment. Fee revenue for Hylagan(R) 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.
<PAGE>
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.
G. CERTAIN RECLASSIFICATIONS have been made to the 1998 and 1997 financial
statements to conform to the 1999 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 assets (15-20 years). The intangible relating to the product
distribution rights for Hyalgan(R) acquired in the co-promotion agreement is
being amortized over 15 years. The investment in Chrysalis continues to be
carried at cost.
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 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 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 ($15,502,720 and $19,317,823 at December 31, 1999 and 1998,
respectively), which is based primarily on trends in historical collection
statistics, consideration of events, payer mix and other considerations. In
addition, 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 payers 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 PRONOUNCEMENT. In June 1998, the FASB issued SFAS No. 133,
Accounting for Derivative Instruments and Hedging Activities. SFAS No. 133
requires that an enterprise recognizes all derivatives as either assets or
liabilities in the statement of financial position and measure those instruments
at fair value. The statement is effective, as ammended, in the first quarter of
2001. The Company has not completed evaluating the impact of implementing the
provisions of SFAS No. 133.
2. ACQUISITIONS
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 . 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 OrthoLogic, Toronto
and DMTI as if the acquisitions 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, Sutter, Toronto,
and DMTI had been combined for all of 1997.
Year Ending December 31,
------------------------
(in thousands, except per share data) 1997
----
Net revenues $ 80,332
Income (loss) from continuing Operations (17,725)
Net income (loss) per common share $ (.71)
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
<PAGE>
the transition to a direct sales force in 1996 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 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 $216,000 during 1999 and $399,000
during 1998. The remaining $150,000 balance of the restructuring reserve on
December 31, 1999 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 has 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 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
to the U.S. Department of Justice, on behalf of several federal health care
programs including Medicare, TRICARE, and various state Medicaid programs, the
amount of $1,000,000. 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 developing 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 $126,179,
$258,456 and $360,110 in 1999, 1998 and 1997 respectively.
7. INVESTMENTS
The Company has implemented SFAS No. 115 "Accounting for Certain Investments in
Debt and Equity Securities." At December 31, 1999, marketable securities were
composed of municipal bonds 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,
-----------------------------
1999 1998
------------ ------------
Amortized cost $ 250,000 $ 6,052,469
Gross unrealized gains - 665
Gross unrealized losses - (17,205)
------------ ------------
Fair value $ 250,000 $ 6,035,929
============ ============
8. INVENTORIES
Inventories consisted of the following:
Years Ending December 31,
-----------------------------
1999 1998
------------ ------------
Raw materials $ 7,083,159 $ 8,484,773
Work-in-process 92,584 122,371
Finished goods 3,110,514 4,101,325
------------ ------------
10,286,257 12,708,469
Less allowance for obsolescene (979,802) (748,398)
------------ ------------
Total $ 9,306,455 $ 11,960,071
============ ============
9. RENTAL FLEET, EQUIPMENT AND FURNITURE
Rental fleet, equipment and furniture consisted of the following:
Years Ending December 31,
-----------------------------
1999 1998
------------ ------------
Rental fleet $ 17,827,501 $ 14,373,674
Machinery and equipment 2,243,657 2,383,562
Computer equipment 4,760,501 3,708,812
Furniture and fixtures 1,495,054 767,661
Leasehold and improvements 744,896 727,996
------------ ------------
27,071,609 21,961,705
Less accumulated depreciation
and amortization (14,009,838) (9,094,314)
------------ ------------
Total $ 13,061,771 $ 12,867,391
============ ============
10. INCOME TAXES
At December 31,1999, the Company has accumulated approximately $33.6 million in
net operating loss carryforwards expiring from 2002 through 2017 for federal
<PAGE>
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:
1999 1998
------------ ------------
Allowance for bad debts $ 6,201,000 $ 7,779,000
Other accruals and reserves 886,659 1,263,909
Valuation allowance (4,457,000) (6,400,000)
------------ ------------
Total current 2,630,659 2,642,909
------------ ------------
Net operating loss carryforwards 14,064,000 12,207,000
Difference in basis of fixed assets (1,517,000) (1,100,000)
Nondeductible accruals
and reserves 159,000 159,000
Amortization of intangibles
and other 430,000 90,000
Difference in basis
of dealer intangible 3,581,000 3,889,000
Valuation allowance (16,717,000) (15,245,000)
------------ ------------
Total noncurrent -- --
------------ ------------
Total deferred income taxes $ 2,630,659 $ 2,642,909
============ ============
The provision for income taxes are as follows:
1999 1998 1997
--------- --------- ---------
Current $ 45,636 $ 146,327 $ 407,000
Deferred $ 12,250 $ (46,523) $(195,440)
--------- --------- ---------
Income Tax
Provision $ 57,886 $ 99,804 $ 211,560
========= ========= =========
A reconciliation of the difference between the provision (benefit) for income
taxes and income taxes at the statutory U.S. federal income tax rate is as
follows for the years ending December 31:
1999 1998 1997
----------- ----------- -----------
Income taxes
at statutory rate $ 80,000 $(5,611,000) $(5,950,000)
State income taxes 28,000 (990,000) (1,024,000)
Change in valuation
allowance (471,000) 6,403,000 6,558,000
Other 420,886 297,804 627,560
----------- ----------- -----------
Net Provision $ 57,886 $ 99,804 $ 211,560
=========== =========== ===========
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. Included in the stock granted in 1999 are 300,000 options granted to an
employee exclusive of the 1987 and 1997 stock 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).
<PAGE>
A summary of the status of the Option Plans as of December 31, 1999, 1998 and
1997, and changes during the years then ended is:
<TABLE>
<CAPTION>
1999 1998 1997
--------------------- ---------------------- ---------------------
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 3,384,825 $5.66 2,535,450 $6.07 2,509,644 $7.31
Granted 688,850 3.12 1,024,000 4.79 1,132,150 5.54
Exercised (282,400) 2.58 (47,000) 3.92 (232,844) 2.37
Forfeited (302,362) 7.83 (127,625) 7.48 (873,500) 9.59
--------- --------- ---------
Outstanding at end of year 3,488,913 5.24 3,384,825 5.66 2,535,450 6.07
========= ==== ========= ==== ========= ====
Options exercisble at year-end 2,357,717 1,744,357 1,072,975
========= ========= =========
</TABLE>
The following table summarizes information about fixed stock options outstanding
at December 31, 1999:
<TABLE>
<CAPTION>
Outstanding Exercisable
--------------------------------------------------- --------------------------------
Number Weighted- Weighted- Number Weighted-
Range of Outstanding Average Remaining Average Exercisable Average
Exercise Prices as of 12/31/99 Contractual Life Exercised Price as of 12/31/99 Exercised Price
--------------- -------------- ---------------- --------------- -------------- ---------------
<S> <C> <C> <C> <C> <C> <C>
$1.8100 - $ 2.5000 397,863 4.18 $2.1569 300,054 $2.0451
$2.5310 - $ 3.0000 172,100 9.47 $2.6195 128,434 $2.5318
$3.2500 - $ 3.2500 405,000 8.77 $3.2500 243,333 $3.2500
$3.3440 - $ 5.0000 469,250 8.29 $4.4152 238,250 $4.7848
$5.0630 - $ 5.4380 419,750 7.91 $5.3677 313,875 $5.3543
$5.5000 - $ 5.5310 351,400 8.33 $5.5018 168,002 $5.5037
$5.5630 - $ 5.5630 100,000 8.01 $5.5630 50,000 $5.5630
$5.6250 - $ 5.6250 381,000 7.76 $5.6250 208,083 $5.6250
$5.8125 - $ 6.5625 114,850 7.49 $6.2769 66,236 $6.2780
$6.7800 - $17.3800 677,700 4.69 $8.8305 641,450 $8.8097
- -------------------- --------- ---- ------- --------- -------
$1.8100 - $17.3800 3,488,913 7.10 $5.2418 2,357,717 $5.5097
==================== ========= ==== ======= ========= =======
</TABLE>
The Company applies APB Opinion No. 25 and related interpretations in accounting
for its Option Plans. Accordingly, no compensation cost has been recognized for
its Option Plans. Had compensation cost been computed based on the fair value of
awards on the date of grant, utilization 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, 1999, 1998 and
1997 would have been reduced to the pro forma amounts indicated below, followed
by the model assumptions used:
<TABLE>
<CAPTION>
1999 1998 1997
-------- -------- --------
<S> <C> <C> <C>
Estimated weighted-average fair value of
options granted during the year $ 1.61 $ 2.26 $ 3.02
Net income (loss) attributable to common
stockholders:
As reported (in thousands) $ (586) $(17,838) $(17,714)
Pro forma (in thousands) $(2,525) $(20,351) $(20,371)
Basic and Diluted Net income (loss) per-share:
As reported $ (0.02) $ (0.71) $ (0.71)
Pro forma $ (0.10) $ (0.80) $ (0.81)
Black- scholes model assumptions:
Risk free interest rate 6.00% 6.00% 6.00%
Expected volatility 0.6 0.4 0.6
Expected term 5 Years 5 Years
5 Years
Dividend yield 0% 0% 0%
</TABLE>
<PAGE>
In July 1998, the Company completed a private equity 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 (before costs).
The Series B Convertible Preferred Stock is convertible into shares of Common
Stock 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 $3.0353. 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 of the Company's stockholders to approve the
transactions contemplated by the Securities Purchase Agreement related 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 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 States Value for each Series
B Preferred Shares outstanding at that time. The Purchase Agreement contains
strict covenants that protect against hedging and short-selling of OrthoLogic
Common Stock while the purchaser holds 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. These warrants expire in 2008. The warrants were 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 equity offering were 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 were used to fund new product opportunities,
including SpinaLogic, Chrysalin and Hyalgan(R), as well as to complete the
re-engineering of the Company's key business processes.
At the close of business on December 31, 1999, 4,820 shares of Series B
Convertible Preferred Stock had been converted into 2,053,003 shares of Common
Stock.
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.
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, 1999, 1998 and 1997 was $1,998,000, $1,716,000, and $594,000
respectively.
Future lease payments for fiscal years 2000,2001,2002, 2003, 2004 and beyond
2004 are $1,819,000, $1,135,000, $1,011,000, $1,130,000, $1,130,000 and
$3,486,000 respectively.
Through December 31, 1999, the Company had 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 70% of the 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 December 3, 2000 and the revolving term loan on
November 30, 2000. 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 .65% for the accounts
receivable line of credit, and prime plus 1.05% 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.
On February 28, 2000, the Company attained a new $10 million accounts receivable
revolving line of credit with a different lending institution. The Company may
borrow up to 75% of the eligible accounts receivable. The interest rate is at
prime for the revolving note. Interest accruing on the note and a monthly
administration fee is due in arrears on the first day of each month. The
revolving note matures February 28, 2003. There are certain financial covenants
<PAGE>
and reporting requirements associated with the loan. Included in the financial
covenants are (1) tangible net worth of not less than $43 million, (2) a quick
ratio of not less than 2.0 to 1.0, (3) a debt to tangible net worth ration of
not less than 0.50 to 1.0, and (4) capital expenditures will not exceed more
than $7.0 million dollars during any fiscal year.
13. LITIGATION
During 1996, certain class action 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 the 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.
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. On March 31, 1999, the judge in the consolidated case before the
United States District Court granted the Company's Motion to Dismiss and entered
an order dismissing all claims in the suit against the Company and two
individual officers/directors. The judge allowed certain narrow claims based on
insider trading theories to proceed against certain individual defendants. On
December 21, 1999, the District Court granted plaintiffs' motion for class
certification to include purchasers of common stock between June 4 through June
18, 1996, inclusive. Discovery is proceeding in the case.
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. The Company filed a Motion to Dismiss the Complaint in
Arizona State Court in May 1999. The Court denied the motion in July 1999 and
granted the plaintiffs' motion for the class certification on November 24, 1999.
The Company has appealed the state court's class certification and the appeal is
now pending in the Arizona Supreme Court.
In addition, a shareholder derivative complaint, alleging, among other things,
breach of fiduciary duty in connection with the conduct alleged in the federal
and state court class actions have also been filed in Arizona state court. The
Company filed a Motion to Dismiss the Complaint which was granted on December
13, 1999.
Management believes that the allegations in the remaining federal and state
cases are without merit and will vigorously defend them.
As of December, 31, 1999, in addition to other matters disclosed above, the
Company is involved in other various legal proceedings that arose in the
ordinary course of business.
The costs associated with defending the above allegations and 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 proceedings will not have a
material effect on the financial position of the Company
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 and
1997. The Company matched $97,980 in 1999, which represented a 10% match of 1999
employee contributions to the plan.
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(R), a hyaluronic acid sodium salt, to
orthopedic surgeons in the United States for the treatment of pain in patients
with osteoarthtitis of the knee. 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 an additional one-year period, or enter
into a revised agreement with the Company. Upon termination of the agreement,
Sanofi must pay the Company an amount equal to 50% of the gross compensation
paid to the Company for the immediately preceding year, provided the Company met
all contractual obligations pursuant to the agreement.
The Company's sales force began to promote Hyalgan(R) in the third quarter of
1997. Fee revenue of $8.3, $8.7 and $3.6 million was recognized during 1999,
1998 and 1997, respectively.
<PAGE>
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 Chrysalin, a patented 23-amino
acid pep-tide 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 preclinical trials, and certain trials and certain
milestone payments to Chrysalis by the Company. As part of the equity
investment, OrthoLogic acquired options to license Chrysalin for orthopedic
applications. An additional fee of $750,000 for the initial license was expensed
in the third quarter of 1998 and the Agreement was extended to January 1999. 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 license agreement, and in conjunction to FDA clearance to begin
human clinical trials, OrthoLogic made a $500,000 milestone payment to Chrysalis
Biotechnology in the fourth quarter of 1999. In January 2000, the Company began
enrolling patients in the combined Phase I/II clinical trial for Chrysalin. The
Company has elected not to exercise its option to license worldwide (excluding
US) development, marketing and distribution rights for Chrysalin for fracture
and orthopedic applications that expired on June 30, 1999.
The Company projects that Chrysalis could receive all the necessary FDA
approvals and be introduced in the market during 2004 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. RELATED PARTIES
In the second quarter of 1999, the Company extended the maturity date on a loan
of $157,800 to an officer of the Company to February 15, 2000. On January 27,
2000, the loan was extended to a maturity date of February 29, 2000. An
additional loan of $81,200 was entered into with the same officer on January 27,
2000, with a maturity date of February 29, 2000. The principal and interest of
both loans were paid in full subsequent to year end.
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
January 26, 2000, except for the last paragraph of Note 12, as to which the date
is February 28, 2000, appearing in and incorporated by reference in the Annual
Report on Form 10-K of OrthoLogic Corp. for the year ended December 31, 1999.
/s/ DELOITTE & TOUCHE LLP
Phoenix, Arizona
March 28, 2000
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders of
OrthoLogic Corporation
Tempe, Arizona
We have audited the consolidated financial statements of OrthoLogic Corporation
as of December 31, 1999 and 1998, and for each of the three years in the period
ended December 31, 1999, and have issued our report thereon dated January 26,
2000, except for the last paragraph of Note 12 as to which the date is February
28, 2000; such consolidated financial statements and report are included in your
1999 Annual Report to Stockholders and are incorporated herein by reference. Our
audits also included the financial statement schedule of OrthoLogic Corporation,
listed in Item 14. This financial statement schedule is the responsibility of
the Corporation's management. Our responsibility is to express an opinion based
on our audits. In our opinion, such financial statement schedule, when
considered in relation to the basic financial statements taken as a whole,
presents fairly in all material respects the information set forth therein.
DELOITTE & TOUCHE LLP
Phoenix, Arizona
January 26, 2000
<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, 1999 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
FINANCIAL STATEMENTS.
</LEGEND>
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