<PAGE>
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U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB
[ X ] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 1997
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from ________ to _________
COMMISSION FILE NUMBER 0-22247
NUTRITION MEDICAL, INC.
(Exact name of Small Business Issuer as specified in its charter)
MINNESOTA 41-1756256
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification Number)
9850 51ST AVENUE NORTH, SUITE 110, MINNEAPOLIS, MN 55442
(Address of principal executive offices)
(612) 551-9595
(Issuer's telephone number)
Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 12 months (or for
such shorter period that the registrant was required to file such reports),
and (2) has been subject to such filing requirements for the past 90 days.
Yes __X__ No _____
State the number of shares outstanding of each of the issuer's classes
of common equity, as of the last practicable date:
Class Outstanding as of May 12, 1997 Common
----- -------------------------------------
Stock, $.01 par value 5,453,024 shares
Transitional Small Business Disclosure Format (Check one): Yes No X
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<PAGE>
NUTRITION MEDICAL, INC.
INDEX
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements Page No.
--------
Condensed Statements of Operations (Unaudited) For the
Three Months Ended March 31, 1997 and 1996 2
Condensed Balance Sheets (Unaudited) As of
March 31, 1997 and December 31, 1996 3
Condensed Statements of Cash Flows (Unaudited)
For the Three Months Ended March 31, 1997 and 1996 4
Notes to Condensed Financial Statements (Unaudited) 5
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 7
PART II - OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K 11
1
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PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
NUTRITION MEDICAL, INC.
CONDENSED STATEMENTS OF OPERATIONS
(Unaudited)
<TABLE>
<CAPTION>
Three months ended
March 31,
---------
1997 1996
---- ----
<S> <C> <C>
Net sales $ 1,214,000 $ 704,923
Cost of goods sold 899,605 432,979
------------ ----------
Gross profit 314,395 271,944
Operating expenses:
Selling, general and administrative 644,486 312,165
Research and development 117,191 51,719
------------ ----------
761,677 363,884
------------ ----------
Operating loss (447,282) (91,940)
Other income (expense):
Interest income 48,669 10,655
Interest expense (41,408) (1,425)
------------ ----------
7,261 9,230
------------ ----------
Net loss $ (440,021) $ (82,710)
------------ ----------
------------ ----------
Net loss per share $ (.08) $ (.03)
------------ ----------
------------ ----------
Weighted average number of shares
outstanding 5,324,524 3,105,524
------------ ----------
------------ ----------
</TABLE>
See accompanying notes to condensed financial statements
2
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NUTRITION MEDICAL, INC.
CONDENSED BALANCE SHEETS
<TABLE>
<CAPTION>
March 31, December 31,
1997 1996
---- ----
(Unaudited) (Note)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 3,549,524 $ 2,553,955
Short-term investments -- 1,671,596
Accounts receivable (net) 615,090 356,240
Inventories 1,089,505 460,115
Prepaid expenses 156,455 34,039
------------ ------------
Total current assets 5,410,574 5,075,945
Equipment and office furniture (net) 959,680 132,369
Goodwill (net) 3,434,098 --
------------ ------------
Total assets $ 9,804,352 $ 5,208,314
------------ ------------
------------ ------------
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 432,815 $ 269,037
Accrued expenses 290,164 240,041
------------ ------------
Total current liabilities 722,979 509,078
Subordinated note payable (net) 1,615,908 --
Shareholders' equity:
Common stock, $.01 par value, 20,000,000 shares
authorized, 5,448,024 and 4,593,024 issued and
outstanding in 1997 and 1996 54,480 45,930
Additional paid-in capital 10,140,987 6,943,287
Accumulated deficit (2,730,002) (2,289,981)
------------ ------------
Total shareholders' equity 7,465,465 4,699,236
------------ ------------
Total liabilities and shareholders' equity $ 9,804,352 $ 5,208,314
------------ ------------
------------ ------------
</TABLE>
Note: The balance sheet at December 31, 1996 has been derived from the audited
financial statements at that date but does not include all of the information
and footnotes required by generally accepted accounting principles for
complete financial statements.
See accompanying notes to condensed financial statements
3
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NUTRITION MEDICAL, INC.
CONDENSED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
Three months ended
March 31,
---------
1997 1996
---- ----
<S> <C> <C>
OPERATING ACTIVITIES
Net loss $ (440,021) $ (82,710)
Adjustments to reconcile net loss to net cash
used in operating activities:
Amortization 96,235 --
Depreciation 31,548 5,500
Changes in operating assets and liabilities:
Accounts receivable (258,850) (28,127)
Inventories (129,390) 50,448
Prepaid expenses (122,416) (23,075)
Accounts payable 163,778 (153,055)
Accrued expenses 50,123 (28,096)
------------ ----------
Net cash used in operating activities (608,993) (259,115)
INVESTING ACTIVITIES
Proceeds from sale of short-term investments 1,671,596 --
Purchase of goodwill (58,174) --
Purchase of equipment and office furniture (8,860) (9,150)
------------ ----------
Net cash provided by (used in) investing activities 1,604,562 (9,150)
FINANCING ACTIVITIES
Net cash provided by financing activities -- --
------------ ----------
Increase (decrease) in cash 995,569 (268,265)
Cash and cash equivalents at beginning of period 2,553,955 1,127,247
------------ ----------
Cash and cash equivalents at end of period $ 3,549,524 $ 858,982
------------ ----------
------------ ----------
</TABLE>
<TABLE>
<S> <C>
SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTMENT AND
FINANCING ACTIVITIES
Acquisition of Elan Pharma, Inc. product line through:
Issuance of note payable $1,593,750
Issuance of common stock 3,206,250
</TABLE>
See accompanying notes to condensed financial statements
4
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NUTRITION MEDICAL, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
1. BASIS OF PRESENTATION
The condensed financial statements as of March 31, 1997 and for the
three months ended March 31, 1997 and 1996 included in this Form 10-QSB have
been prepared by the Company pursuant to the rules and regulations of the
Securities and Exchange Commission. Certain information and footnote
disclosures, normally included in financial statements prepared in accordance
with generally accepted accounting principles, have been condensed or omitted
pursuant to such rules and regulations. These financial statements should be
read in conjunction with the financial statements and related notes thereto
included in the Company's December 31, 1996 Annual Report on Form 10-KSB.
The condensed financial statements presented herein as of March 31, 1997
and for the three months ended March 31, 1997 and 1996 are unaudited, but in
the opinion of management, reflect all adjustments, consisting of normal
recurring adjustments, necessary for a fair presentation of financial
position, results of operations and cash flows for the periods presented.
The results of operations for any interim period are not necessarily
indicative of results for the full year.
2. PRODUCT LINE ACQUISITION
On January 13, 1997, the Company executed an Asset Purchase Agreement
(the "Agreement") whereby the Company acquired certain assets from Elan
Pharma, Inc. ("Elan"), a U.S. subsidiary of Ireland-based Elan Corporation,
plc. The assets purchased pursuant to the Agreement include the inventory
and fixed assets relating to the production of the enteral (tube feeding)
products (the "Acquired Products") of Elan as well as exclusive rights to
manufacture and market the Acquired Products. In exchange for the Acquired
Products and related assets, the Company issued Elan a subordinated
promissory note in the amount of $3,000,000 (due in seven years along with
interest accruing at three percent per annum) and 855,000 shares of the
Company's common stock. The Agreement allows for the forgiveness of up to
100% of the promissory note based upon the Company's future stock performance
and contains provisions which restrict Elan's ability to vote or sell the
shares of Common Stock. Total value of the transaction, after taking into
consideration market interest rates on the note payable, and $58,174 in
acquisition expenses associated with the purchase, was $4,858,174.
5
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NUTRITION MEDICAL, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
2. PRODUCT LINE ACQUISITION (CONTINUED)
Based upon management's estimates of asset values, taking into
consideration market values and condition of the assets as well as the future
cash flows estimated to be generated from the Acquired Products, the
following represents an allocation of the purchase price to the acquired
assets, with the excess of the purchase price over the assets allocated to
goodwill:
Inventory $ 500,000
Manufacturing equipment 500,000
Leased pumps 350,000
Goodwill 3,508,174
----------
$4,858,174
----------
----------
3. NET LOSS PER SHARE
Net loss per share is computed using the weighted average number of
common shares outstanding during the period. Common equivalent shares from
stock options and warrants are excluded from the computation as their effect
is antidilutive. In February 1997, the Financial Accounting Standards Board
(FASB) issued FASB Statement No. 128, "EARNINGS PER SHARE". This Statement
replaces the presentation of primary earnings per share (EPS) with basic EPS
and also requires dual presentation of basic and dilutive EPS for entities
with complex capital structures. This Statement is effective for the fiscal
year ending December 31, 1997. For the quarter ended March 31, 1997, there
is no difference between basic earnings per share under Statement No. 128 and
primary net loss per share as reported.
6
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
CAUTIONARY STATEMENT
This Quarterly Report on form 10-QSB contains forward-looking statements
within the meaning of Section 27A of the Securities Act of 1933, as amended,
and Section 21E of the Securities Exchange Act of 1934, as amended. When
used in this Form 10-QSB and in future filings by the Company with the
Securities and Exchange Commission, in the Company's press releases and in
oral statements made with the approval of an authorized executive officer,
the words or phrases "believes", "anticipates", "intends", "will likely
result", "estimates", "projects" or similar expressions are intended to
identify such forward -looking statements, but are not the exclusive means of
identifying such statements. These forward-looking statements involve risks
and uncertainties that may cause the Company's actual results to differ
materially from the results discussed in the forward-looking statements. The
Company wishes to caution readers not to place undue reliance on any such
forward-looking statements, which speak only as of the date made. The
Company undertakes no obligation to revise any forward-looking statements in
order to reflect events or circumstances after the date of such statements.
Readers are urged to carefully review and consider the various disclosures
made by the Company in this report and in the Company's other reports filed
with the Securities and Exchange Commission that attempt to advise interested
parties of the risks and factors that may affect the Company's business.
Such forward-looking statements are qualified in their entirety by the
cautions and risk factors set forth under the "Cautionary Statement" filed as
exhibit 99.1 to this Form 10-QSB.
GENERAL
The Company develops and sells nutrition products marketed as
cost-effective, generic alternatives to equivalent national branded products.
Products to date have focused on clinical products for the healthcare
industry and adult nutrition supplements generally sold to large retailers
under private label arrangements. In addition, the Company is currently
developing an infant formula.
CLINICAL PRODUCTS
The Company's initial product development efforts centered on branded
generic products for the critical care nutrition market. These products are
sold to hospitals and other health care providers to feed critically ill
patients who cannot consume adequate nutrients orally and consequently
require specialized feeding via tubes into the intestinal tract. As of March
31, 1997, the Company had developed six such products. Critical care
nutrition products are generally purchased by a relatively large customer
base which typically places orders in relatively small order quantities.
On January 13, 1997, the Company expanded its clinical products line by
acquiring the inventory and fixed assets associated with the production of
the enteral (tube feeding) products of Elan Pharma, Inc. as well as the
exclusive rights to manufacture and market approximately 40
7
<PAGE>
enteral products consisting of special formulas, disposable administration
hardware and the related delivery pumps.
RETAIL PRODUCTS-PRIVATE LABEL NUTRITION PRODUCTS
In October 1995, the Company introduced an adult nutrition supplement
product line. Adult nutrition supplements are designed to provide balanced
nutrition in beverage form as a supplement or substitute for solid food for
healthy individuals as well as those recovering from or affected by illness.
These products are marketed to retail chains and are generally packaged using
the retailer's proprietary store brand label. Such private label products
allow the retailer to offer quality, low cost alternatives to national
branded adult nutrition products. The Company's private label nutrition
product line currently consists of three adult nutrition supplements, each of
which is available in three flavors. Adult nutrition supplements are
generally purchased by a relatively small customer base which typically
places relatively large orders.
RESULTS OF OPERATIONS
THREE MONTHS ENDED MARCH 31, 1997 AND 1996
NET SALES. The Company's net sales for the three months ended March 31,
1997 totaled $1,214,000, representing an increase of $509,076, or 72%, over
net sales of $704,925 in the corresponding 1996 period. Sales of the
Company's clinical products, which in the 1996 period totaled $276,934,
increased 175% to $760,784 in the three months ended March 31, 1997. 84 % of
the increase in clinical product sales is attributable to sales of the
products acquired from Elan Pharma, Inc. in January 1997. Sales of the
Company's retail products totaled $453,217 (14 customers) in the three months
ended March 31, 1997, an increase of $25,227 over the corresponding 1996
period, in which 77% of total retail sales consisted an initial stocking
order to one customer.
The prices of the Company's products remained relatively stable within
and between the two reporting periods. In response to the Company's strategy
of marketing its critical care nutrition products as less expensive
alternatives to established brands, a competitor of the Company has lowered
its prices to select customers of its branded products, offsetting part or
all of the price advantage of the Company's three competing products.
Although the Company continues to experience overall sales growth of these
products, management believes that these selective price reductions resulted
in lost sales and slowed the rate of sales growth of the Company's three
competing products, and that this competitor will continue to use this form
of selective price competition. Management further believes that the impact
on total sales of this competitor's price reductions may be lessened as the
Company introduces additional non-competing products.
GROSS PROFIT. The Company's gross profit increased 15% to $314,395 for
the three months ended March 31, 1997, compared with $271,944 in the same
period in 1996. The following table sets forth the gross profit and gross
profit percentage, by product line, for the three months ended March 31, 1997
and 1996:
8
<PAGE>
<TABLE>
<CAPTION>
Three months ended March 31,
----------------------------
1997 1996
-------------------------- --------------------------
Product Line Gross profit % of Sales Gross Profit % of Sales
------------ -------------------------- --------------------------
<S> <C> <C> <C> <C>
Clinical Products $264,821 34.8% $163,887 59.2%
Retail Products 49,575 10.9 108,057 25.2%
-------------------------- --------------------------
Total $314,395 25.9% $271,944 38.6%
</TABLE>
The decrease in overall gross profit, as a percentage of sales, is related to
product mix differences between the two periods and increased indirect
production and distribution overhead costs. The gross profit generated by
the Company's clinical products decreased as a percentage of clinical sales,
principally as a result of the introduction in the 1997 period of the
products acquired from Elan, which generally contribute relatively lower
margins when compared to the critical care products sold in previous periods.
Management expects that while increased sales of these acquired products
will continue to generate an increase in the clinical product gross profit
contribution, the overall gross profit, as a percentage of sales, will
decline, particularly if sales of the lower gross profit acquired products
increase as a proportion of total clinical product sales. The decrease in
gross profit as a percentage of retail product sales is attributable to a
$40,000 write-off of dated product and a gross profit percentage in the 1996
period that exceeded historical levels. The 1997 retail product gross profit,
excluding the aforementioned write-off, was within the historical product
line gross profit range.
SELLING, GENERAL AND ADMINISTRATIVE. Selling, general and
administrative expenses in the three months ended March 31, 1997, increased
by $332,321, or 106%, compared with the same period in 1996. The increase is
related to higher costs resulting from the continued development of the
Company's sales and administration infrastructure and approximately $100,000
in depreciation and goodwill amortization charges related to the Elan Pharma,
Inc. product acquisition.
RESEARCH AND DEVELOPMENT. Research and development costs increased 128%
to $117,191 for the three months ended March 31, 1997, compared with $51,719
in the corresponding 1996 period. The increase is attributable to higher
costs associated with the Company's development of several infant formula
products.
LIQUIDITY AND CAPITAL RESOURCES
Since inception, the Company has incurred net losses and negative cash
flows from operations. On September 26, 1996, the Company's initial public
offering was declared effective by the Securities and Exchange Commission.
The Company sold pursuant to this registration statement, in a transaction
that closed on October 1, 1996, 1,437,500 shares of the Company's Common
Stock at $3.50 per share, including an overallotment of 197,500 shares. Net
proceeds to the Company, after deducting all offering costs, totaled $4.24
million. Unused funds are invested in U.S. Treasury bills with maturities
ranging from one to six months.
9
<PAGE>
Prior to the initial public offering, the Company's principal source of
cash and working capital had been from the private placement of Common Stock,
through which the Company has received approximately $2,800,000 in net
proceeds. The Company also obtained loans from the City of Buffalo, Minnesota
totaling $100,000. These loans were repaid in July 1996 when the Company
relocated to Minneapolis, Minnesota.
On January 13, 1997, the Company executed an Asset Purchase Agreement
whereby the Company acquired certain assets from Elan Pharma, Inc. ("Elan"),
a U.S. subsidiary of the Ireland-based Elan Corporation, plc. The agreement
provides for the sale to the Company of the inventory and fixed assets
relating to the production of the enteral (tube feeding) products of Elan as
well as exclusive rights to manufacture the products. In exchange for the
product rights and related assets, the Company issued the seller 855,000
shares of common stock and a subordinated promissory note in the amount of
$3,000,000. The note, along with all interest, which accrues at 3% per
annum, is due in seven years.
In connection with the above described activities and results of
operations, the Company's net cash used by operations in the three months
ended March 31, 1997 totaled $608,993. Cash and cash equivalents as of March
31, 1997 totaled $3,549,524.
The Company expects that the existing cash balances will be sufficient
to fund operations of the Company through 1997. However, the Company's future
liquidity and capital requirements will depend on numerous factors including
competition, the extent to which the Company's products gain market
acceptance and the costs and timing of expansion of sales, marketing and
product development activities. There can be no assurance that the Company
will not be required to raise additional capital before the end of 1997 or
any time thereafter, or that such capital will be available on acceptable
terms, or at all. The Company's strategy for 1997 includes pursuing the
establishment of a bank line of credit to secure additional operating funds,
should they be needed. There can be no assurance that such a credit line, if
needed, can be secured on terms acceptable to the Company.
10
<PAGE>
PART II - OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a) The following exhibits are included with this quarterly report on Form
10-QSB as required by Item 601 of Regulation S-B.
Exhibit
Number Description
------- -----------
11 Calculation of loss per share
27 Financial data schedule
99.1 Cautionary Statement
b) Reports on Form 8-K.
On January 23, 1997, the Company filed a Current Report on Form 8-K
pursuant to the requirements of Form 8-K, Item 2 with regard to the
Asset Purchase Agreement executed on January 13, 1997 with Elan
Pharma, Inc.
On March 31, 1997, the Company filed a Current Report on Form 8K/A
regarding additional information with regard to the aforementioned
acquisition. This Current Report included financial statements of
the business acquired and proforma financial information.
11
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SIGNATURE
In accordance with the requirements of the Securities Exchange Act of
1934, the registrant caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
NUTRITION MEDICAL, INC.
Dated: May 12, 1997 By: /s/ Richard J. Hegstrand
---------------------------
Chief Financial Officer
12
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EXHIBIT INDEX
Exhibit
Number Description
------ -----------
11 Calculation of loss per share
27 Financial data schedule
99.1 Cautionary Statement
13
<PAGE>
EXHIBIT 11
COMPUTATION OF LOSS PER SHARE
<TABLE>
<CAPTION>
Three months ended
March 31,
---------
1997 1996
---- ----
<S> <C> <C>
PRIMARY AND FULLY DILUTED:
Average shares outstanding 5,324,524 3,105,524
Dilutive stock equivalents -- --
----------- ----------
Total 5,324,524 3,105,524
----------- ----------
----------- ----------
Net loss $ (440,021) $ (82,710)
----------- ----------
----------- ----------
Net loss per share $ (.08) $ (.03)
----------- ----------
----------- ----------
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE BALANCE
SHEETS OF NUTRTITION MEDICAL, INC. AS OF MARCH 31, 1997 AND 1996, AND THE
RELATED STATEMENTS OF OPERATIONS FOR THE THREE MONTHS ENDED MARCH 31, 1997 AND
1996, AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL
STATEMENTS.
</LEGEND>
<S> <C> <C>
<PERIOD-TYPE> 3-MOS 3-MOS
<FISCAL-YEAR-END> DEC-31-1997 DEC-31-1996
<PERIOD-START> JAN-01-1997 JAN-01-1997
<PERIOD-END> MAR-31-1997 MAR-31-1996
<CASH> 3,549,524 858,982
<SECURITIES> 0 0
<RECEIVABLES> 648,287 149,472
<ALLOWANCES> 33,197 0
<INVENTORY> 1,089,505 307,656
<CURRENT-ASSETS> 5,410,574 1,344,914
<PP&E> 1,066,765 115,657
<DEPRECIATION> 107,085 30,412
<TOTAL-ASSETS> 9,804,352 1,430,159
<CURRENT-LIABILITIES> 722,979 431,170
<BONDS> 1,615,908 0
0 0
0 0
<COMMON> 10,195,467 2,612,667
<OTHER-SE> (2,730,002) (1,613,678)
<TOTAL-LIABILITY-AND-EQUITY> 9,804,352 1,430,159
<SALES> 1,214,000 704,923
<TOTAL-REVENUES> 1,214,000 704,923
<CGS> 899,605 432,979
<TOTAL-COSTS> 899,605 432,979
<OTHER-EXPENSES> 761,677 363,884
<LOSS-PROVISION> 0 0
<INTEREST-EXPENSE> 41,408 1,425
<INCOME-PRETAX> (447,282) (82,710)
<INCOME-TAX> 0 0
<INCOME-CONTINUING> (447,282) (82,710)
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> (447,282) (82,710)
<EPS-PRIMARY> (.08) (.03)
<EPS-DILUTED> (.08) (.03)
</TABLE>
<PAGE>
EXHIBIT 99.1
CAUTIONARY STATEMENT
Nutrition Medical, Inc. (the "Company"), or persons acting on behalf of
the Company, or outside reviewers retained by the Company making statements
on behalf of the Company, or underwriters, from time to time may make, in
writing or orally, "forward-looking statements" as defined under the Private
Securities Litigation Reform Act of 1996 (the "Act"). This Cautionary
Statement is for the purpose of qualifying for the "safe harbor" provisions
of the Act and is intended to be a readily available written document that
contains factors, any one of which may cause actual results to differ from
those which might be projected, forecast, estimated or budgeted by in such
forward-looking statement. The factors set forth below are in addition to any
other cautionary statements, written or oral, which may be made or referred
to in connection with any such forward-looking statement.
The following matters, among others, may have a material adverse effect
on the business, financial condition, liquidity, results of operations or
prospects, financial or otherwise, of the Company:
LACK OF OPERATING PROFITS; LIMITED OPERATING HISTORY
The Company, which was incorporated in July 1993, is subject to all of
the risks inherent in the establishment of a new business. The likelihood of
the success of the Company must be considered in light of the difficulties,
expenses and delays frequently encountered in connection with the development
and marketing of new products and the competitive environment in which the
Company is operating.
Although the Company began generating revenues from product sales in May
1994, the Company has accumulated substantial losses to date. No assurance
can be given that the Company will be able to achieve profitability. Further,
there can be no assurance that the Company will be able to successfully
develop or market additional products or that the Company will have
sufficient funds available to successfully market its current products or any
new products that it may develop in the future.
PRODUCT ACCEPTANCE AND PRICING
The Company's products are designed to be substantially equivalent to
existing branded competitive products. Although the Company believes that the
quality and efficacy of its products is comparable to branded competitive
products, no independent comparison between the Company's products and
competitive products has been completed and there can be no assurance that
the efficacy or quality of the Company's products is or will be comparable to
branded competitive products.
<PAGE>
Furthermore, the Company's name and its products are relatively unknown
to large segments of the Company's target markets, and there can be no
assurance that the Company's marketing efforts will achieve sufficient name
recognition of the Company and its products to significantly enhance
revenues.
The principal advantage of the Company's products is, and is expected to
be, lower price. The Company is aware of one competitor in the critical care
nutrition products market that has lowered prices to various customers of its
branded products to levels that offset all or part of the price advantage of
the Company's competitive products. The Company believes that these selective
price reductions resulted in indeterminable lost sales of the Company's
competing products, and that this competitor has begun to use this form of
price competition more frequently. This competitor may decide to consistently
lower its prices to the Company's level, and other competitors may adopt the
same strategy. The market for the clinical nutrition products acquired from
Elan Pharma, Inc. in January 1997 is expected to be extremely price
competitive and often involves the need to offer package pricing of products.
The Company has also encountered price competition from other suppliers of
adult nutrition supplements. Because the Company's marketing strategy is
focused on the price advantage of its products, if a competitor selling
competitive products reduces or eliminates the price advantage of the
Company's products, there can be no assurance that the Company can compete
successfully with such a competitor or operate profitably under such
conditions.
DEVELOPMENT OF NEW PRODUCTS
The Company intends to continue to develop new products, which will
require both the timely identification of market opportunities and the
identification of, and the negotiation of contracts with, suitable technical
consultants. There can be no assurance that an adequate market opportunity
will exist for the potential products the Company selects for development or
that such products will be successfully developed or marketed.
DEPENDENCE ON CONTRACT MANUFACTURERS
The Company engages contract manufacturers to produce its products
according to the Company's specifications. The Company relies on these
manufacturers to comply with all applicable government regulations and
manufacturing guidelines. There can be no assurance that contract
manufacturers will consistently supply adequate quantities of the Company's
products on a timely basis, that such manufacturers will consistently comply
with government regulations or that the quality of such products will be
consistently maintained. In the event of a sale of a defective product, the
Company would be exposed to product liability claims and could lose customer
confidence. In addition, minimum quantity order requirements imposed by
manufacturers may result in excess inventory levels, requiring additional
working capital and increasing exposure to losses from inventory
obsolescence. Although the Company believes it could find alternative
manufacturers for its products, any interruption in supply of any of the
Company's products could adversely affect the Company's ability to market its
products and, therefore, the Company's business, financial condition and
results of operations.
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DEPENDENCE ON RETAIL DISTRIBUTION OF PRODUCTS
The Company's private label nutrition products are sold only through
retail chains. The Company's strategy includes the development of additional
products, including an infant formula that is currently under development by
the Company. There can be no assurance that the Company will be able to enter
into arrangements with retailers to market its infant formula or any other
private label products or that any such arrangements will result in
successful product commercialization. The Company's future profitability will
depend in large part upon the Company's ability to develop products that meet
the needs of these potential retail customers and upon the marketing efforts
of such retailers. Although the Company believes that its current and
prospective retail customers have an economic motivation to market vigorously
the Company's products, the amount and timing of resources to be devoted to
marketing by such retailers is not within the control of the Company. In
addition, successful commercialization might result in a substantial portion
of the Company's revenues being generated by one or a few retailers. Such
retailers could make material marketing and other commercialization decisions
that would adversely affect the Company's future revenues, financial
condition and results of operations.
POSSIBLE FLUCTUATIONS IN OPERATING RESULTS
The Company believes that its future operating results may be subject to
substantial quarterly fluctuations because its retail customers and a large
OEM pump customer may order large quantities at irregular intervals. In
addition, the gross profit as a percentage of sales on the Company's private
label nutrition products is substantially less than the gross profit
percentage on the Company's critical care and clinical nutrition products,
and therefore the Company's overall gross profit percentage could vary widely
based on the product mix in a given period. To the extent that quarterly
revenues and operating results fluctuate substantially, the market price of
the Company's common stock may be affected.
CUSTOMER CONCENTRATION
Although the Company's experience with its customer base is limited,
retail customers often place a large initial stocking order that can increase
the relative importance of a particular customer in a particular period. In
addition, the Company may incur similar concentration issues with large
distributors and OEM customers for its clinical nutrition products, including
the products acquired from Elan. There can be no assurance that such retail
orders will continue or that its future orders will not significantly
decline.
FUTURE CAPITAL REQUIREMENTS; NO ASSURANCE FUTURE CAPITAL WILL BE AVAILABLE
Although the Company's existing cash balances are expected to be
sufficient to fund the Company's operations through 1997, under certain
circumstances the Company may require substantial additional funds before the
end of 1997 to meet its working capital requirements in connection with the
introduction of new products, including its proposed infant formula. In order
to meet this possible need, and to meet possible needs after 1997, the
Company may be required to raise additional funds through public or private
financings, including equity financings. Any additional equity financings may
be dilutive to existing shareholders, and debt financing, if available, may
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involve restrictive covenants. Adequate funds for the Company's operations,
regardless of the source, may not be available when needed or on terms
attractive to the Company. Insufficient funds may require the Company to
delay, scale back or eliminate the introduction of new products, including
its proposed infant formula, and the failure to obtain funding when needed
could have a material adverse effect on the Company's business, financial
condition and results of operations.
KEY PERSONNEL
The Company is particularly dependent on the services of its President,
Mr. William Rush. If the services of Mr. Rush were to become unavailable to
the Company for any reason, there can be no assurance that the Company could
adequately replace him. The loss of Mr. Rush's services could have a material
adverse effect on the Company. The Company has an employment agreement with
Mr. Rush that expires September 30, 1999. The Company currently maintains a
life insurance policy with a face value of $1 million on Mr. Rush.
ADDITION OF MANAGEMENT PERSONNEL AND STAFF
In order to pursue its growth objectives, the Company intends to
increase the number of its employees, including management personnel and
sales and marketing staff. There can be no assurance that the Company will be
able to hire, train and retain sufficient personnel with the necessary
experience and abilities to achieve the Company's growth objectives, or that
they will perform at a level commensurate with the Company's expectations.
LITIGATION INVOLVING COMPETITORS
It is not uncommon for companies in the generic and private label
industry to be the subject of claims and lawsuits brought by brand name
competitors alleging that the generic or private label products have
formulas, labelings or packagings similar to competing brand name products.
The Company recently resolved two lawsuits in which competitors alleged
patent infringement and false advertising by the Company, and the Company is
currently subject to another suit alleging patent infringement. Since the
Company's business strategy is to develop and market products that are
equivalent to competitors' branded products, similar claims may be made by
competitors in the future. Competitors may also respond to the Company's
strategy by more aggressively seeking patents on their products to limit the
Company's future product development efforts.
If similar allegations are made against the Company in the future, some
of the Company's current and future products may need to be reformulated or
repackaged in order for the Company to continue to market products that are
comparable to competitors' patented products. While the Company believes that
reformulation of its products is generally possible, the Company may be
unable to effectively reformulate certain of its products, and there can be
no assurance that a reformulated product would be deemed by customers to be
essentially equivalent to the patented product. Moreover, there can be no
assurance that any future lawsuits could be satisfactorily settled by
reformulating, relabeling or repackaging a product, that such litigation will
not require the commitment of substantial management time and legal fees, or
that such litigation would not have a material adverse effect on the
Company's future revenues, financial condition and results of operations.
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COMPETITION
Competition in the clinical nutrition products market consists of
established companies that sell branded products which have achieved a high
level of customer awareness. Although the Company believes it is the only
company currently offering low cost, generic alternatives to the established
brands, other companies may enter this market.
Competition in the private label nutrition market consists of companies
that sell established national brands and companies that sell private label
products. Competitors that sell private label products include established
companies that produce private label products for a wide range of markets and
a number of small producers of private label products. Nearly all of the
Company's competitors and potential competitors have substantially greater
financial resources, more extensive business experience and more personnel
than the Company. The Company's ability to compete will depend on the
timeliness of the development of its products and its ability to market its
products effectively.
The Company is currently developing, for sale to regional and national
retail and grocery chains, a lower-priced infant formula designed to be
equivalent in nutritional profile and efficacy to the leading national brand.
The Company is aware of a competitor attempting to market an already existing
lower-priced infant formula, which Management believes is not equivalent to
the national brand. While the Company believes that successful development
of a national brand equivalent will give it a competitive advantage over this
competitor, it is unable to determine the impact, if any, that this
competitor may have with regard to product acceptance by the targeted
customers.
If a larger company with significant financial resources were to compete
directly with the Company in particular market segments, there can be no
assurance that the Company will be able to compete successfully with such a
competitor or operate profitably.
PRODUCT LIABILITY AND INSURANCE RISKS
The Company's business involves exposure to potential product liability
risks that are inherent in the production, manufacture and distribution of
food and medical device products. The Company maintains a general insurance
policy that includes coverage for product liability claims up to an aggregate
amount of $5 million. There can be no assurance, however, that the Company
will be able to maintain such insurance on acceptable terms, that the Company
will be able to secure increased coverage as the commercialization of its
products increases or that any insurance will provide adequate protection
against potential liabilities.
GOVERNMENT REGULATION
The Company's products and potential products are or will be subject to
government regulation. The Company's current products are regulated as food
and medical food by the Food and
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Drug Administration (the "FDA") and are subject to labeling requirements,
current good manufacturing practice ("CGMP") regulations and certain other
regulations designed to ensure the safety of the products. The Company's
proposed infant formula will undergo an adequate and well controlled clinical
study, in accordance with good clinical practice, to determine whether the
formula supports normal physical growth in infants when fed as the sole
source of nutrition. There can be no assurance that the Company's proposed
infant formula, if developed, would successfully complete this trial.
Additionally, the FDA has recently proposed significant revisions to its
infant formula regulations to establish requirements for quality factors and
CGMP, and to amend its quality control procedure, notification, and records
and report requirements for infant formulas. These regulations, if adopted,
may delay, and increase the cost of, the Company's introduction of an infant
formula product.
Claims made by the Company in labeling and advertising its products are
subject to regulation by the FDA, the Federal Trade Commission and various
state agencies under their general authority to prevent false, misleading and
deceptive trade practices. With the addition of the products acquired from
Elan, the Company will be subject to FDA regulations regarding Class 2
medical devices. These regulations involve more stringent tracking, testing
and documentation standards. Failure to comply with such requirements can
result in adverse regulatory action, including injunctions, civil or criminal
penalties, product recalls or the relabeling, reformulation or possible
termination of certain products.
The Company's current and potential products may become subject to
further regulation in the future. The burden of such regulation could add
materially to the costs and risks of the Company's development and marketing
efforts. There can be no assurance that the Company could obtain the required
approvals or comply with new regulations if the Company's products are
subject to additional governmental regulation in the future. Failure to
obtain necessary approvals or otherwise comply with government regulations
could have a material adverse effect on the Company's future revenues,
financial condition and results of operations.
CONTROL BY PRINCIPAL SHAREHOLDERS
Directors, officers and principal shareholders of the Company own
beneficially approximately 41% of the outstanding Common Stock. As a result,
such shareholders may have the ability to effectively control the election of
the Company's entire Board of Directors and the affairs of the Company,
including all fundamental corporate transactions such as mergers,
consolidations and the sale of substantially all of the Company's assets.
TRADEMARKS
The Company has not registered its existing trademarks, but instead
relies on its common law trademark rights. The lack of such registration may
impair the ability of the Company to prosecute successfully an infringement
action against other users of these trademarks. There can be no assurance
that the Company's marks do not or will not violate the proprietary rights of
others, that the Company's proprietary rights in the marks would be upheld if
challenged, or that the Company would not be prevented from using its marks,
any of which could have an adverse effect on the Company. In
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addition, there can be no assurance that the Company will have the financial
resources necessary to enforce or defend its trademarks.
UNDESIGNATED STOCK
The Company's authorized capital consists of 25,000,000 shares of
capital stock, of which 20,000,000 shares are designated as Common Stock and
5,000,000 are preferred shares undesignated as to series. The Company has no
outstanding shares of preferred stock, and there are no current plans to
designate or issue any shares of preferred stock. Nevertheless, the Company's
Board of Directors has the power to issue any or all of these shares of
unissued stock, including the authority to establish the rights and
preferences of the unissued shares, without shareholder approval.
Furthermore, as a Minnesota corporation, the Company is subject to certain
"anti-takeover" provisions of the Minnesota Business Corporation Act. These
provisions and the power to issue additional shares and to establish separate
classes or series of common or preferred stock may, in certain circumstances,
deter or discourage take-over attempts and other changes in control of the
Company not approved by the Board.
