U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-K/A
Amendment No. 1
[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.
<PAGE>
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.
<PAGE>
ORTHOLOGIC CORP.
FORM 10-K/A ANNUAL REPORT
YEAR ENDED DECEMBER 31, 1999
TABLE OF CONTENTS
PART I
Item 1. Business........................................................... 1
PART II
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations ....................................... 9
PART IV
SIGNATURES.................................................................. 15
<PAGE>
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 an adjunct to
lumbar 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.
<PAGE>
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.
2
<PAGE>
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
3
<PAGE>
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
4
<PAGE>
aware that its competitors are conducting clinical trials for other medical
applications of their respective technologies. In addition, other companies are
developing or may develop a variety of other products and technologies to be
used in CPM devices, the treatment of fractures and spinal fusions, including
growth factors, bone graft substitutes combined with growth factors, nonthermal
ultrasound and the treatment of pain associated with osteoarthritis of the knee.
The Company believes that competition is based on, among other factors, the
safety and efficacy of products in the marketplace, physician familiarity with
the product, ease of patient use, product reliability, reputation, price, sales
and marketing capability and reimbursement.
Any product developed by the Company that gains any necessary regulatory
approval will have to compete for market acceptance and market share in an
intensely competitive market. An important factor in such competition may be the
timing of market introduction of competitive products. Accordingly, the relative
speed with which the Company can develop products, complete clinical testing as
well as any necessary regulatory approval processes and supply commercial
quantities of the product to the market will be critical to its competitive
success. There can be no assurance the Company can successfully compete on these
bases. See "Item 7 -- Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Intense Competition" and "-- Rapid
Technological Change."
PATENTS, LICENSES AND PROPRIETARY RIGHTS
The Company's practice is to require its employees, consultants and
advisors to execute a confidentiality agreement upon the commencement of an
employment or consulting relationship with the Company. The agreements provide
that all confidential information developed by or made known to an individual
during the course of the employment or consulting relationship will be kept
confidential and not disclosed to third parties except in specified
circumstances. In the case of employees, the agreements provide that all
inventions conceived by the individual relating to the Company's business while
employed by the Company shall be the exclusive property of the Company. There
can be no assurance, however, that these agreements will provide meaningful
protection for the Company's trade secrets in the event of unauthorized use or
disclosure of such information.
It is also the Company's policy to protect its owned and licensed
technology by, among other things, filing patent applications for the
technologies that it considers important to the development of its business. The
Company uses the BIOLOGIC(R) technology in its bone growth stimulation devices
through a worldwide exclusive license granted by a corporation owned by
university professors who discovered the technology. With respect to the
BIOLOGIC technology, the delivery of such technology to the patient and specific
applications of such technology, the Company holds title to five United States
patents and to 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 patents and 5 foreign patent
applications pending and applications being distributed in Canda, Europe and
Japan. The issued United States 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.
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),
5
<PAGE>
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.
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
6
<PAGE>
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.
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
7
<PAGE>
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.
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."
8
<PAGE>
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 $52 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
9
<PAGE>
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
10
<PAGE>
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."
11
<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.
12
<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."
13
<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.
14
<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: April 24, 2000 By /s/ Thomas R. Trotter
----------------------------
Thomas R. Trotter
President and Chief Executive Officer
15
<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 of Exhibit 3.1 to the Company's Form 10-Q
Incorporation for the quarter ended March 31, 1997
("March 1997 10-Q")
3.2 Certificate of Designation in respect of Exhibit 3.1 to Company's Form 10-Q
Series A Preferred Stock for the quarter ended March 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 September 20, Exhibit 4.6 to Company's Registration
1995, issued to Registered Consulting Statement on Form S-1 (No. 33-97438)
Group, Inc. filed with the SEC on September 27, 1995
("1995 S-1")
4.2 Stock Purchase Warrant dated October 15, Exhibit 4.7 to the Company's Form 10-K
1996 issued to Registered Consulting for the year ended December 31, 1996
Group, Inc. ("1996 10-K")
4.3 Rights Agreement dated as of March 4, 1997 Exhibit 4.1 to the Company's Registration
between the Company and Bank of New York, Statement on Form 8-A filed with the SEC
and Exhibits A, B and C thereto on March 6, 1997
4.4 1987 Stock Option Plan of the Company, as Exhibit 4.4 to the Company's Form 10-Q
amended and approved by stockholders (1) for the quarter ended June 30, 1997
("June 1997 10-Q")
4.5 1987 Stock Option Plan of the Company(1) Exhibit 4.5 to the Company's June 1997
10-Q
4.6 Stock Purchase Warrant dated March 2, 1998 Exhibit 4.10 to the Company's 1997 10-K
issued to Silicon Valley Bank
4.7 Antidilution Agreement dated March 2, 1998 Exhibit 4.11 to the Company's 1997 10-K
by and between the Company and Silicon
Valley Bank
4.8 Amendment to Stock Purchase Warrant dated Exhibit 4.1 to the Company's form 10-Q
May 12, 1998 issued to Silicon Valley Bank for the quarter ended March 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 3, 1987 Exhibit 10.6 to January 1993 S-1
between the Company and Life Resonances,
Inc.
10.2 Invention, Confidential Information and Exhibit 10.11 to January 1993 S-1
Non-Competition Agreement dated January
10, 1989 between the Company and
Frank P. Magee
10.3 Form of Indemnification Agreement* Exhibit 10.16 to January 1993 S-1
10.4 License Agreement dated December 2, 1992 Exhibit 10.22 to January 1993 S-1
between Orthotic Limited Partnership and
Company
10.5 Consulting Agreement dated May 1, 1990 Exhibit 10.11 to the Company's September
between Augustus A. White III and the 30, 1994 Form 10-Q
Company(1)
10.6 Employment Agreement by and between Exhibit 10.8 to the Company's March 1997
MaryAnn G. Miller and the Company 10-Q
effective as of December 1, 1996 (1)
10.7 Co-promotion Agreement dated June 23, 1997 Exhibit 10.1 to the Company's June 1997
by and between the Company and Sanofi 10-Q
Pharmaceuticals, Inc.
</TABLE>
EX-1
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT FILED
NO. DESCRIPTION INCORPORATED BY REFERENCE TO: HEREWITH
--- ----------- ----------------------------- --------
<S> <C> <C> <C>
10.8 Single-tenant Lease-net dated June 12, 1997 Exhibit 10.2 to the Company's Form 10-Q
by and between the Company and Chamberlain for the quarter ended September 30, 1997
Development, L.L.C. ("September 1997 10-Q")
10.9 Employment Agreement dated October 20, 1997 Exhibit 10.3 to the Company's
by and between the Company and Thomas R. September 1997 10-Q
Trotter, including Letter of Incentive
Option Grant, OrthoLogic Corp. 1987 Stock
Option Plan (1)
10.10 Employment Agreement dated October 17, 1997 Exhibit 10.4 to the Company's
by and between the Company and Frank P. September 1997 10-Q
Magee (1)
10.11 Employment Agreement effective as of Exhibit 10.40 to the Company's 1997 10-K
December 15, 1997 by and between the
Company and William C. Rieger (1)
10.12 Employment Agreement effective as of March Exhibit 10.42 to the Company's 1997 10-K
16, 1998 by and between the Company and
Terry D. Meier (1)
10.13 Registration Rights Agreement dated Exhibit 10.45 to the Company's 1997 10-K
March 2, 1998 by and between the Company
and Silicon Valley Bank
10.14 Licensing Agreement with Chrysalis Exhibit 10.1 to the Company's September
Biotechnolgoy, Inc. 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 March 4, 1997 Exhibit 10.1 to the Company's Form 8-K
Rights Agreement filed August 24, 1999
10.18 Credit and Security Agreement between the Exhibit 10.18 to the Company's Form 10-K
Company and Wells Fargo Business Credit, filed for year ended December 31, 1999
Inc. dated February 28, 2000 ("1999 10-K")
10.19 Lease Extension and Amendment Agreement Exhibit 10.19 to the Company's 1999 10-K
dated September 29, 1998 between the
Company and the Heritage Corp. for the
Pickering property
11.1 Statement of Computation of Net Income Exhibit 11.1 to the Company's 1999 10-K
(Loss) per Weighted Average Number of
Common Shares Outstanding
13.1 Portions of 1999 Annual Report to Exhibit 13.1 to the Company's 1999 10-K
Stockholders
21.1 Subsidiaries of Registrant Exhibit 21.1 to the Company's 1997 10-K
23.1 Consent of Deloitte & Touche LLP Exhibit 23.1 to the Company's 1999 10-K
23.2 Independent Auditors' Report Exhibit 23.2 to the Company's 1999 10-K
23.3 Independent Auditors' Report *
27 Financial Data Schedule Exhibit 27 to the Company's 1999 10-K
</TABLE>
- ----------
(1) Management contract or compensatory plan or arrangement
* The Company has entered into a separate indemnification agreement with each
of its current direct and executive officers that differ only in party
names and dates. Pursuant to the instructions accompanying Item 601 of
Regulation S-K, the Company has filed the form of such indemnification
agreement.
EX-2
BOARD OF DIRECTORS AND SHAREHOLDERS
ORTHOLOGIC CORP., PHOENIX, ARIZONA
We have audited the accompanying consolidated balance sheets of OrthoLogic
Corp. and subsidiaries (the "Company") as of December 31, 1999 and 1998, and the
related consolidated statements of operations, comprehensive income (loss),
stockholders' equity, and cash flows for each of the three years in the period
ended December 31, 1999. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in
all material respects, the financial position of the Company at December 31,
1999 and 1998, and the results of its operations and its cash flows for each of
the three years in the period ended December 31, 1999 in conformity with
accounting principles generally accepted in the United States of America.
/s/ Deloitte & Touche LLP
Phoenix, Arizona
January 26, 2000 (except for the
last paragraph of Note 12, as to
which the date is February 28, 2000)
