<PAGE>
U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-KSB
/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended: DECEMBER 31, 1996 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) (Zip Code)
(612) 551-9595
(Issuer's telephone number)
Securities registered under Section 12 (b) of the Exchange Act: NONE
Securities registered under Section 12 (g) of the Exchange Act:
COMMON STOCK, $.01 PAR VALUE
(title of class)
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
--- ---
Check if there is no disclosure of delinquent filers in response to Item 405 of
Regulation S-B is not contained in this form and no disclosure will be
contained, to the best of the registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-KSB
or any amendment to this Form 10-KSB. X
---
State issuer's revenues for its most recent fiscal year: $2,402,267
On March 19, 1997, and based on the average bid and asked prices as of that
date, the aggregate market value of the voting stock held by non-affiliates of
the Issuer was $11,710,951.
The number of shares outstanding of the registrant's common stock, $.01 par
value, as of March 19, 1997 was 5,448,024 shares.
Transitional Small Business Disclosure Format: Yes No X
--- ---
DOCUMENTS INCORPORATED BY REFERENCE
Certain portions of the Registrant's Proxy Statement for the 1997 Annual Meeting
of Shareholders (which will be filed with the Commission before April 30, 1997)
(the "Proxy Statement") are incorporated by reference in Part III.
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PART I
ITEM 1. DESCRIPTION OF BUSINESS.
Nutrition Medical, Inc. (the "Company" or "Registrant") develops and
sells generic critical care nutrition products for the hospital/nursing home
market, as well as private label nutrition products for sale through regional
and national retail chains. The Company's products are manufactured using
ingredients, formulas and processes comparable to those of national brand
products. As of December 31, 1996, the Company marketed six critical care
nutrition products and three private label nutrition products. The Company
intends to expand these product lines and is also currently in the early stages
of developing an infant formula, which is not expected to be available for sale
until late 1997 or early 1998.
RECENT DEVELOPMENT. On January 13, 1997, the Registrant executed and
consummated an Asset Purchase Agreement (the "Agreement") whereby the Company
agreed to acquire certain assets from Elan Pharma, Inc. ("Elan"), a U.S.
subsidiary of 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 (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 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. Total value of the transaction, after taking into
consideration market interest rates on the note payable, is approximately
$4,800,000.
CLINICAL PRODUCTS
CRITICAL CARE NUTRITION FORMULAS. Critical care nutrition formulas
are used by 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. The use of critical
care nutrition formulas often continues at home or in a nursing home after a
patient is discharged from the hospital.
The Company's strategy has been to focus on the development and sale
of a line of generic critical care formulas for patients who are being treated
in intensive care units. Certain of these products contain unique ingredients or
proportions of ingredients to meet the metabolic requirements of specific
patient populations. The Company markets its critical care nutrition products to
hospitals and other health care providers as a less expensive, generic
alternative to the established products offered by major manufacturers. The
Company intends to develop an expanded line of critical care nutrition products
and to establish itself as a major supplier of such products in generic form.
During the past twelve months, the Company has made sales to more than 400
hospitals and other health care providers.
ACQUIRED PRODUCTS. The Acquired Products from Elan, when combined with
the Company's existing critical care nutrition formulas, will provide the
capability to market a full line of both formulas and the pumps and disposable
administration hardware used in formula delivery. The Company believes that the
ability to now offer its customers a broad line of products will enable it to
compete more effectively by offering package pricing and "one-stop" shopping for
its customers. In addition, the Company believes that these products will
provide opportunities in markets where the Company has not traditionally
maintained a presence.
PRIVATE LABEL NUTRITION PRODUCTS
Private label, or "store brand", nutrition products are marketed to
retailers, which sell the products under their own private labels. The Company's
private label product line currently consists of three adult nutrition
supplements, each of which has three flavors. 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. The Company intends to expand its private label
product line to include additional adult nutrition supplements, some of which
are currently under development.
The Company's private label marketing strategy has been to offer
retailers lower-priced products that are equivalent in quality and efficacy to
leading national brands, such as the Ensure-Registered Trademark- family of
products. The Company's customers currently include 14 retail chains that offer
the Company's adult nutrition supplements in approximately 7,000 stores
nationwide.
Nutrition Medical, Inc. was incorporated in Minnesota in July 1993.
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BACKGROUND
CLINICAL PRODUCTS
Critically ill or severely injured patients are often unlikely to
consume adequate nutrients, which can exacerbate a patient's condition, cause
complications and prolong hospital stays. Total enteral nutrition (TEN)
delivers, often via specialized pumps, formulations of protein, carbohydrates,
fat and vitamins via feeding tubes directly into the patient's intestinal tract.
Unless nearly all of the intestinal tract is missing or nonfunctional, most
patients can be fed via this enteral route. One application of TEN is in the
treatment of critical care patients. The largest single category of TEN
nutrition products used in critical care are products that contain unique
protein sources referred to as "elemental". Unlike long-term care formulas that
contain "whole protein", which must be digested before it can be absorbed and
utilized by the patient, elemental formulas contain predigested protein that
offers immediately available nutrition because little or no digestion is
required. All of the Company's critical care nutrition products are elemental
formulas.
The critical care nutrition formula market is currently dominated by a
small number of established manufacturers of national brands, each of which
focuses on particular segments of the market. These manufacturers include Ross
Laboratories, a division of Abbott Laboratories ("Ross Laboratories"), Novartis,
formerly known as Sandoz Corp. ("Novartis"), Nestle Clinical Nutrition, formerly
known as Clintec Nutrition Co. ("Nestle") and McGaw, Inc. ("McGaw"). The Company
believes these manufacturers sell their formulas at substantial profit margins.
Meanwhile, the United States health care system has been under pressure to
control costs. As a result, the medical community and consumers have come to
accept lower priced generic drugs and private label over-the-counter products
and the market for these products has grown rapidly. The Company believes it is
the only company that has addressed the critical care medical nutrition market
with lower cost, generic alternatives to established brands. The Company
generally sells its generic critical care nutrition formulas under its own
label.
The products acquired from Elan in January 1997 will provide the
Company with several whole-protein formulas, as well as the pumps and disposable
hardware (e.g. feeding tubes and containers) used to administer formulas. The
Acquired Products will be marketed under the Company's label and will generally
be priced below competitor's brands.
PRIVATE LABEL NUTRITION PRODUCTS
Adult nutrition supplements are products 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.
Adult nutrition supplements contain vitamins, minerals, protein, fat,
carbohydrates and flavoring. The retail market for adult nutrition beverage
supplements is estimated to be $375 million in 1996, and to grow to $1 billion
by the year 2000. Market growth is expected to occur due in part to an
increasing number of elderly, who are the primary consumers of nutrition
supplements. The market for adult nutrition supplements is currently dominated
by the Ensure-Registered Trademark- family of products produced by Ross
Laboratories.
In recent years, the retail food and drug industry has experienced a
growing demand for private label products from both consumers and retailers.
Today's private label products generally are equivalent to national brands in
formulation and packaging and appeal to value conscious consumers in all income
brackets. Private label products also appeal to retailers. The cost to the
retailer of a private label product is typically lower than that of a nationally
advertised brand name product. The retailer, therefore, can generally price a
private label product below the competing national brand product.
INFANT FORMULA
Infant formulas are products designed to provide balanced nutrition as
a supplement to or substitute for breast milk, or as a supplement to other foods
in the diet of children, generally under the age of one. The infant formula
market was estimated to be $2.5 billion in 1995, and to grow to $4 billion by
the year 2000. Three manufacturers currently control the infant formula market:
Ross Laboratories (maker of Similac-Registered Trademark-); Mead Johnson
Nutritionals ("Mead Johnson"), a division of Bristol-Myers Squibb Co. (maker of
Enfamil-Registered Trademark-); and Nestle S.A. (maker of Good Start-Registered
Trademark-).
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PRODUCTS
CLINICAL PRODUCTS
CRITICAL CARE NUTRITION FORMULAS. The Company currently has six
critical care nutrition products. Each contains elemental protein sources, which
contain predigested protein that offers immediately available nutrition. Three
of these products are for general use in intensive care unit ("ICU")
environments, and three are designed to meet the needs of specific patient
populations. The following chart provides information regarding each of the
Company's critical care nutrition products.
<TABLE>
<CAPTION>
PRODUCT NAME DATE INTRODUCED TREATMENT CATEGORY COMPETING BRANDED PRODUCT MANUFACTURER
- ------------ --------------- ------------------ ------------------------- ------------
<S> <C> <C> <C> <C>
L-Emental May 1994 ICU nutrition Vivonex-Registered Trademark- Novartis
L-Emental Plus January 1995 ICU nutrition Vivonex Plus-Registered Trademark- Novartis
L-Emental Hepatic June 1996 Liver Failure Hepatic Aid II-Registered Trademark- McGaw
L-Emental Pediatric June 1996 Children Vivonex Pediatric-Registered Trademark- Novartis
Pro-Peptide November 1994 ICU nutrition Peptamen-Registered Trademark- Nestle
Pro-Peptide VHN November 1995 Trauma Peptamen VHP-Registered Trademark- Nestle
</TABLE>
The Company generally establishes target prices for its critical care
nutrition products that are approximately 20 percent to 30 percent less than the
selling prices of competing established brand name products. At least one
competitor in the critical care nutrition products market 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 three competitive products.
ACQUIRED PRODUCTS. The products acquired in January 1997 from Elan
will provide the Company with approximately 40 additional stock keeping units
("SKUs") consisting of special formulas, disposable administration hardware and
the related delivery pumps. In addition to the delivery of critical care
formulas, the Acquired Products appeal to the larger long-term care segment of
the clinical nutrition market. The pricing strategy involves special contractual
pricing with distributors and package pricing for large end users. In addition,
the enteral feeding delivery pump is offered as an OEM product to several
medical supply companies which directly compete with the Company.
PRIVATE LABEL NUTRITION PRODUCTS
The Company produces three private label nutrition supplements that
the Company has designed to be equivalent to the family of Ensure-Registered
Trademark- products. The following chart provides information regarding each of
the Company's adult nutrition supplements.
<TABLE>
<CAPTION>
PRODUCT NAME* DATE INTRODUCED COMPETING BRANDED PRODUCT MANUFACTURER
- ------------- --------------- ------------------------- ------------
<S> <C> <C> <C>
Nutrition PLUS October 1995 Ensure Plus-Registered Trademark- Ross Laboratories
Instant Nutrition February 1996 Ensure Powder-Registered Trademark- Ross Laboratories
Nutrition Advanced Formula June 1996 Ensure Advanced Formula-Registered Trademark- Ross Laboratories
</TABLE>
* Each product is available in vanilla, strawberry and chocolate flavors.
The Company's nutrition supplements are generally priced by the
retailer approximately 20 percent to 30 percent less than the list prices of
branded competitors.
INFANT FORMULA
The Company is currently developing an infant formula to be marketed
through one or more retail chains as a lower-cost alternative to the existing
national brands. The Company believes that its infant formula, if successfully
developed, would not be available for sale until late in 1997 or early 1998.
3
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RESEARCH AND DEVELOPMENT
The product development process begins with a determination by the
Company's management that a market opportunity exists with respect to a
particular product. The Company then contracts with an outside laboratory to
analyze the ingredients of the competitor's product and to formulate the
Company's version of the product. Certain members of the Company's scientific
advisory board consult with the contractors during the development process.
The Company has to date only developed products with respect to which
the Company believed that no patent had been issued, and expects to continue
this development strategy. The Company has not engaged legal counsel to conduct
formal searches for intellectual property rights with respect to its products in
development, instead relying on the industry knowledge of its employees and
consultants. In the future, the Company may engage legal counsel if warranted
under the circumstances.
The Company's critical care nutrition formulas and adult nutrition
supplements are not required to undergo clinical testing or obtain FDA approval.
The Company's proposed infant formula will undergo a clinical study and will be
subject to the infant formula regulations of the FDA, including any additional
requirements that the FDA may impose under recently proposed revisions to these
regulations.
MANUFACTURING AND DISTRIBUTION
All of the Company's products are manufactured on a contract basis by
third parties. These contract manufacturers are subject to FDA regulatory
requirements for food and medical food production, and the Company's products
undergo quality control testing during and after the production process. By
using third party manufacturers, the Company is better able to introduce new
products that require differing manufacturing processes. Nevertheless, reliance
on contract manufacturers involves various risks.
Critical care nutrition products are shipped from the manufacturer to
the Company's distribution warehouse in Minneapolis, Minnesota. Home consumers
of critical care and nutrition products typically acquire the Company's products
through health care providers.
The majority of the enteral feeding products acquired from Elan in
January 1997 are distributed by a third party master distributor with the
balance shipped from the Company's Minneapolis warehouse. The Company expects to
add additional distributors and direct customers as it integrates these products
into its existing customer base and expands marketing efforts.
Private label nutrition products generally are shipped directly from
the contract manufacturers to the Company's retail customers. Any excess product
is stored and subsequently distributed from locations in New York and California
by a private warehouser that the Company has engaged for this purpose.
MARKETING
CLINICAL PRODUCTS
CRITICAL CARE NUTRITION PRODUCTS. The Company employs its own inside
sales personnel to market its critical care nutrition products. These sales
personnel target, via telephone, the dietary and pharmaceutical departments of
hospitals and nursing homes. This approach reduces the Company's selling costs
by eliminating travel expenses and allowing its sales personnel to contact and
service a larger number of potential and actual customers. The Company also uses
direct mail and trade shows to further promote its products. In addition, the
Veteran's Administration and state and county hospitals have annual bids for
clinical nutrition products and the Company actively participates in these bids.
ACQUIRED PRODUCTS. The Company expects to market the Acquired
Products through the master distributor which historically marketed the majority
of the Acquired Products for Elan. The Company believes that this distributor
will also assist in marketing the Company's critical care formulas. Further, the
Company will attempt to utilize its existing inside sales force to target
customers of these products, assisted by the master distributor's sales force.
With the addition of the Acquired Products to its critical care nutrition
products, the Company expects to seek additional distributors or, in certain
concentrated population areas, may hire direct sales people to further penetrate
the desired markets.
4
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It is not uncommon for pump manufacturers to supply enteral feeding
pumps to customers at no charge in return for the opportunity to supply, on an
exclusive basis, the related formulas and administration hardware. This
strategy has been employed by Elan in the marketing of the Acquired Products.
The Company expects some repeat business from the acquired Elan installed pump
base and expects to continue this strategy to attract new customers.
PRIVATE LABEL NUTRITION PRODUCTS
The Company markets its private label nutrition products nationwide to
retail chains through independent brokers working on a commission basis. The
Company makes promotional announcements regarding adult nutrition supplements
through the Company's hospital customers. Customers also have access to a
toll-free phone number that the Company staffs with dietitians. The Company
works directly with retailers to develop product labeling and conducts joint
advertising campaigns with retailers.
COMPETITION
CLINICAL PRODUCTS
CRITICAL CARE NUTRITION FORMULAS. Competition in the critical care
nutrition products market primarily consists of three companies that have
established brands in the specialty markets in which the Company has chosen to
compete. These companies, Novartis, Nestle and McGaw, each market their
specialty products through sales personnel who use traditional in-person sales
calls rather than the telemarketing approach historically employed by the
Company. Although Ross Laboratories is the dominant manufacturer in the United
States adult TEN market (which includes the critical care nutrition market),
Ross Laboratories has focused on whole protein products that do not compete
directly with the Company's critical care elemental protein formulas. 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.
ACQUIRED PRODUCTS. The Acquired Products represented in excess of $3
million in sales for Elan in the 12 months ended December 31, 1996. Competitors
in this market include, like the critical care formulas, Nestle and Novartis.
However, the market leaders are Ross Laboratories and Sherwood Medical, which
combined control approximately 75 percent of the pump and disposables market.
The Company believes that the Acquired Products will enable it to more
effectively compete with these companies by providing a broad line of products
to its customers.
PRIVATE LABEL NUTRITION PRODUCTS
Competition in the private label nutrition supplement market consists
of companies that sell established national brands and companies that sell
private label products. In the adult nutrition supplement market, Ross
Laboratories sells Ensure-Registered Trademark-, which has an approximately 80
percent share of this market. The other established national brands are
Sustacal-Registered Trademark- and Boost-Registered Trademark-, both of which
are Mead Johnson products. The Company believes that retail customers in the
adult nutrition supplement market make purchase decisions based on the price,
taste and quality of the product. Competitors in the private label segment of
this market include established companies that produce private label products
for a wide range of markets, including Perrigo Company and NutraMax Products,
Inc., as well as a number of small private label product producers.
INFANT FORMULA
Three manufacturers currently control the infant formula market: Ross
Laboratories (maker of Similac-Registered Trademark-); Mead Johnson (maker of
Enfamil-Registered Trademark-); and Nestle USA Inc. (maker of Good
Start-Registered Trademark-). The Company is aware of a competitor attempting
to market an already-developed, lower-priced infant formula. At this time,
however, the Company is unable to determine the near-term impact, if any, that
this competitor may have with regard to the Company's infant formula plans. The
Company believes, however, that the marketing strategies and product formulation
of this start-up company will not significantly impact the Company's long-term
goals for its infant formula product family.
5
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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 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. 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 Acquired Products, the Company will be
subject to FDA regulations regarding Class II medical devices. These
regulations involve more stringent tracking, testing and documentation
standards. Failure to comply with FDA 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.
EMPLOYEES
The Company currently has 23 full-time employees, engaged in sales,
marketing, quality control and general corporate and administrative functions.
The Company does not have an agreement with any labor union and the Company
believes its relations with its employees are good.
ITEM 2. DESCRIPTION OF PROPERTY.
The Company's corporate headquarters is currently located at 9850 51st
Avenue North, Minneapolis, Minnesota, 55442, in an office/warehouse complex
consisting of approximately 9,500 square feet. The Company's current lease
expires on November 30, 2001. Monthly rent, which includes the Company's pro
rata share of taxes, utilities and common area charges, is $6,900. In addition,
the Company rents, on an as-needed basis, public warehouse space to store
inventory. The Company considers the facilities adequate and suitable for the
purposes they currently serve. Future growth, however, may necessitate
additional office space.
The Company accrued a $75,000 charge to earnings in 1995 relating to
the termination of its former leased headquarters facility, located in Buffalo,
Minnesota.
ITEM 3. LEGAL PROCEEDINGS.
In August 1995, the Company was named as a defendant in a patent
infringement lawsuit brought by Novartis, formerly Sandoz, in the United States
District Court for the District of Minnesota. The complaint asserts that one of
the Company's products, L-Emental Plus, infringes on two patents held by
Novartis and asks for relief in the form of an injunction that would prevent the
Company from selling the product as well as damages of an unspecified amount.
Both patents were issued subsequent to the Company's introduction of L-Emental
Plus. The Company has responded with a counterclaim seeking a declaration of
invalidity, unenforceability, non-infringement and inventorship of the subject
patents. A court order has stayed the litigation pending a reexamination by the
United States Patent and Trademark Office of both patents. The Company intends
to continue to defend vigorously against the claim. Sales of L-Emental Plus
constituted $298,000, or 35 percent, and $458,000 or 19 percent, of the
Company's net sales in 1995 and 1996, respectively. It is not possible at this
time to predict the outcome of the lawsuit, including whether the Company will
have to cease selling L-Emental Plus, or to estimate the amount or range of
potential loss, if any. To date, no injunction has been issued.
ITEM 4. SUBMISSION OR MATTERS TO A VOTE OF SECURITY HOLDERS.
During the quarter ended December 31, 1996, no matter was submitted to
a vote of security holders.
6
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PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
The Company's common stock has traded on the Nasdaq Small Cap Market
System under the symbol NMED since September 26, 1996. As of March 17, 1997,
there were approximately 773 beneficial owners of the Company's common stock,
including those held in "street name". The quotations shown below represent
interdealer bid prices as reported by the Nasdaq Small Cap Market System,
without markup, markdown or commission and may not represent actual
transactions.
High Low
1996 Bid Bid
- ---------------------------------------------------- --------- ---------
Third Quarter (since the September 26, 1996 initial
public offering) 4 1/4 3 1/2
Fourth Quarter 4 5/8 3 5/8
The Company has never paid or declared any cash dividends on its
Common Stock and does not intend to declare any dividends on its Common Stock in
the foreseeable future. The Company currently intends to retain any earnings
for use in the operation and expansion of its business.
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
CAUTIONARY STATEMENT
This Annual Report on Form 10-KSB 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-KSB 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-KSB.
GENERAL
The Company develops and sells nutrition products marketed as
cost-effective, generic alternatives to equivalent national brand products.
Initial development focused on branded generic formulas for the critical care
nutrition market. These products are sold to hospitals and other health care
facilities to feed critically ill patients who cannot consume adequate nutrients
orally and consequently require specialized feeding via tubes into the
intestinal tract. As of December 31, 1996, 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 quantities. Until the fourth quarter of 1995, all sales were attributable
solely to this product line.
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 to 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 brand adult
nutrition products. The Company's private label nutrition product line
currently consists of three adult nutrition supplements, each of which
7
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is available in three flavors. Adult nutrition supplements are generally
purchased by a relatively small customer base, which typically places relatively
large orders.
RECENT DEVELOPMENT. On January 13, 1997, the Company purchased the
Acquired Products from Elan in exchange for a 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.
RESULTS OF OPERATIONS
TWELVE MONTHS ENDED DECEMBER 31, 1996 AND 1995
NET SALES. Net sales for the twelve months ended December 31, 1996
totaled $2,402,267 compared with $841,241 for the same period in 1995, an
increase of 186 percent. The growth in sales is the result of increases in sales
of products offered in both periods, as well as new products introduced late in
or subsequent to the December 31, 1995 reporting period. Sales of the Company's
critical care nutrition products increased 64 percent, from $745,245 in 1995 to
$1,224,871 in 1996. This growth is attributable to the addition of new
customers and growth in orders from existing customers, combined with a greater
number of products available for sale in the 1996 period. 1996 net sales of the
Company's adult nutrition supplement products, introduced in October, 1995,
totaled $1,179,999, up from $95,996 for the three months that the product was
available in 1995.
The adult nutrition supplement net sales in the quarter ended December
31, 1996 are reduced to reflect a one time credit of $50,000 related to a
product return agreement reached with a major customer. This customer recently
underwent a conversion to a new private label, and simultaneously expanded
distribution of the products to include additional outlets. The new label
program rendered existing short-dated, discontinued label inventory as obsolete,
which the Company agreed to credit. Management believes that the label upgrade,
combined with an increase in the number of stores within this chain offering the
product, will enhance the Company's opportunity for future increased sales from
this customer.
GROSS PROFIT. The following table sets forth the gross profit, by
product line, for the year ended December 31, 1996 and 1995:
<TABLE>
<CAPTION>
TWELVE MONTHS ENDED DECEMBER 31,
--------------------------------
1996 1995
---- ----
PRODUCT LINE GROSS PROFIT GROSS PROFIT % GROSS PROFIT GROSS PROFIT %
------------ ------------ -------------- ------------ --------------
<S> <C> <C> <C> <C>
Critical Care Nutrition $685,431 56.0 $423,401 56.8
Adult Nutrition Supplements 166,441 14.1 11,449 11.9
------- ---- ------ ----
Total $851,872 35.5 $434,850 51.7
</TABLE>
As illustrated in the table above, the overall decrease in the gross profit
percentage between the two periods is principally related to the introduction,
in October 1995, of the lower gross profit adult nutrition supplement products.
This product line comprised 49 percent of net sales in 1996 compared with 11
percent in 1995. Consequently, the overall gross profit, when expressed as a
percentage of sales, has decreased between the two periods. The slight decrease
in gross profit within the critical care nutrition product line is the result of
product mix changes within the periods. The increase within the adult nutrition
supplements gross profit in 1996 relates to the absence of certain start-up
costs associated with the introduction of the product line in 1995.
The gross profit generated by the sale of adult nutrition supplements
within the quarter ended December 31, 1996 was offset by the inventory write-off
of approximately $37,000 related to the short-dated discontinued label product
return discussed above, along with production and distribution inefficiencies,
totaling approximately $12,000, attributable to a new customer.
SELLING GENERAL AND ADMINISTRATIVE. For the year ended December 31,
1996, selling, general and administrative expenses increased by $186,889, or 15
percent, to $1,429,752 from $1,242,863 in the same period of 1995. The expense
increase relates to the overall staffing and related expenditures required to
support the growth in sales by the Company. Selling, general and administrative
expenses, expressed as a percentage of net sales, were 59.5 percent and 148
percent for the years ended December 31, 1996 and 1995, respectively. The
percentage decrease is the result of economies of scale arising from the
relatively fixed nature of certain of the Company's
8
<PAGE>
selling, general and administrative expenses, which have increased slowly in
comparison to the increase in overall sales, combined with a lower average
support costs related to sales of adult nutrition supplements, which represented
a larger share of the 1996 sales.
RESEARCH AND DEVELOPMENT. Research and development costs increased 53
percent to $260,988 for the year ended December 31, 1996 when compared with the
$170,963 incurred in the comparable 1995 period. The increase is attributable
to higher costs associated with new products under development, particularly
costs related to development of an infant formula product.
YEARS ENDED DECEMBER 31, 1995 AND 1994
NET SALES. Net sales increased by $759,280 to $841,241 in 1995 from
$81,961 in 1994. Net sales in 1994 consisted entirely of critical care nutrition
products. Net sales of critical care nutrition products in 1995 increased by
$663,284 due to increased unit sales resulting from the introduction of new
critical care nutrition products and expansion of the Company's customer base.
The remaining $95,996 of the increase in 1995 net sales is attributable to adult
nutrition supplements, which were introduced in October 1995.
GROSS PROFIT. Gross profit increased by $377,502 to $434,850 in 1995
from $57,348 in 1994. Gross profit as a percentage of net sales decreased to 52
percent in 1995 from 70 percent in 1994. The gross profit percentage in 1994 was
based on a limited sales volume, and was significantly above the level the
Company expects to have on a continuing basis. The decrease in the 1995 gross
profit percentage is also attributable to the introduction of adult nutrition
supplements, which have substantially lower gross profit percentages.
SELLING, GENERAL AND ADMINISTRATIVE. Selling, general and
administrative expenses increased by $509,450 to $1,242,863 in 1995 from
$733,413 in 1994. The increase is principally due to the addition of sales and
administrative personnel. Total personnel costs in 1995 increased by
approximately $400,000. In addition, the Company incurred a $75,000 relocation
charge in connection with the Company's planned move of its operations to
Minneapolis, Minnesota. The charge relates to the write-off of the remaining
costs associated with the Company's lease of its Buffalo, Minnesota facility.
The Company also incurred approximately $144,000 more in legal expenses in 1995
than in 1994 due to the costs associated with two lawsuits against the Company.
RESEARCH AND DEVELOPMENT. Research and development costs increased by
$153,406 to $170,963 in 1995 from $17,557 in 1994. The increase was the result
of increased product development expenditures.
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.
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. As of December 31, 1996, the Company had no interest
bearing debt. In connection with the above described activities and results of
operations, the Company's net cash used by operations for 1996 totaled
$1,087,372. This cash use was offset by the $4.24 million net proceeds of the
initial public offering, $1,671,596 of which was invested in U.S. Treasury bills
with a maturity in excess of six months as of December 31, 1996. Cash and cash
equivalents as of December 31, 1996 totaled $2,553,955.
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
9
<PAGE>
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.
ITEM 7. FINANCIAL STATEMENTS.
The following financial statements are included as a separate section
following the signature page to this Form 10-KSB:
Report of Independent Auditors
Balance Sheets as of December 31, 1996 and 1995
Statements of Operations for the years ended December 31, 1996, 1995
and 1994
Statement of Changes in Shareholders' Equity for the years ended
December 31, 1996, 1995 and 1994
Statements of Cash Flows for the years ended December 31, 1996, 1995
and 1994
Notes to Financial Statements
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
No changes in accountants or disagreements between the Company and its
accountants regarding accounting principles or financial statement disclosures
have occurred within the twenty-four months prior to date of the Issuer's most
recent financial statements.
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
COMPLIANCE WITH SECTION 16 (a) OF THE EXCHANGE ACT.
The information required by Item 9 is incorporated by reference to the
sections entitled "Election of Directors" and "Executive Officers" in the
Company's Proxy Statement for its 1997 Annual Meeting of Shareholders, which
will be filed with the Securities Exchange Commission pursuant to Regulation 14A
of the Securities Exchange Act of 1934, as amended, within 120 days of the end
of the Company's fiscal year ended December 31, 1996.
ITEM 10. EXECUTIVE COMPENSATION.
The information required by Item 10 is incorporated by reference to
the section entitled "Executive Compensation" in the Company's Proxy Statement
for its 1997 Annual Meeting of Shareholders, which will be filed with the
Securities Exchange Commission pursuant to Regulation 14A of the Securities
Exchange Act of 1934, as amended, within 120 days of the end of the Company's
fiscal year ended December 31, 1996.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The information required by Item 11 is incorporated by reference to
the section entitled "Voting Securities and Principal Holders Thereof" in the
Company's Proxy Statement for its 1997 Annual Meeting of Shareholders, which
will be filed with the Securities Exchange Commission pursuant to Regulation 14A
of the Securities Exchange Act of 1934, as amended, within 120 days of the end
of the Company's fiscal year ended December 31, 1996.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information required by Item 12 is incorporated by reference to
the section entitled "Certain Transactions" in the Company's Proxy Statement for
its 1997 Annual Meeting of Shareholders, which will be filed with the Securities
Exchange Commission pursuant to Regulation 14A of the Securities Exchange Act of
1934, as amended, within 120 days of the end of the Company's fiscal year ended
December 31, 1996.
10
<PAGE>
ITEM 13. EXHIBITS LIST AND REPORTS ON FORM 8-K.
A) EXHIBITS
The following exhibits are included with this Annual Report on Form
10-KSB (or incorporated by reference) as required by Item 601 of Regulation S-B:
Exhibit No. Description
- ----------- ------------
1.1* Form of Underwriting Agreement and Warrant
3.1** Restated Articles of Incorporation of the Company, as amended
3.2** Second Restated Bylaws of Nutrition Medical, Inc.
4.1* Specimen Form of the Company's Common Stock Certificate
10.1 1995 Long-Term Incentive and Stock Option Plan, as amended
10.2* 1996 Non-Employee Director Stock Option Plan
10.3* Purchasing Agreement, dated October 15, 1995, by and between the
Company and VHA, Inc.; Trademark License Agreement, dated October
15, 1995, by and between the Company and VHA, Inc.; Memorandum of
Understanding, dated April 17, 1995, between the Company and VHA,
Inc.
10.4 Executive Employment Agreement, dated October 1, 1996, by and
between the Company and William L. Rush
10.5* Employment Agreement, dated November 20, 1995, by and between the
Company and Richard J. Hegstrand
10.6* Employment Agreement, dated September 1, 1994, by and between the
Company and Joseph F. Coffey
10.7* Employment Agreement, dated December 19, 1994, by and between the
Company and Marlin G. Rudebusch
10.8* Office Lease, dated October 15, 1993, by and between the Company
and the 308 Corporation
10.9* Lease Agreement, dated February 22, 1996, by and between the
Company and Caliber Development Corporation
11.1 Statement of Computation of Net Loss Per Share
24 Powers of Attorney (set forth on the Signature Page hereof)
27 Financial Data Schedule (EDGAR only)
99.1 Cautionary Statement
________________
* Incorporated by reference to the exhibit of the same number to the
Registrant's previously filed Form SB-2 Registration Statement
effective September 26, 1996 (Reg. No. 333-9999).
** Incorporated by reference to the exhibit of the same number to the
Registrant's Quarterly Report on Form 10-QSB filed on November 13,
1996 (File No. 333-9999).
B) REPORTS ON FORM 8-K.
The Company did not file any reports on Form 8-K for the quarter ended
December 31, 1996.
11
<PAGE>
SIGNATURES
In accordance with Section 13 or 15 (d) of the Exchange Act, the
Registrant caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.
Nutrition Medical, Inc.
By: /s/ William L. Rush
------------------------
William L. Rush, Chief Executive Officer
Date: March 20, 1997
In accordance with the Exchange Act, this report has been signed below
by the following persons on behalf of the Registrant and in the capacities and
on the dates indicated. Each person whose signature to this report on Form
10-KSB appears below hereby constitutes and appoints William L. Rush and Richard
J. Hegstrand, and each of them, as his true and lawful attorney-in-fact and
agent, with full power of substitution, to sign on his behalf individually and
in the capacity stated below and to perform any acts necessary to be done in
order to file all amendments to this report on Form 10-KSB, and any and all
instruments or documents filed as part of or in connection with this report on
Form 10-KSB or the amendments thereto and each of the undersigned does hereby
ratify and confirm all that said attorney-in-fact and agent, or his substitutes,
shall do or cause to be done by virtue hereof.
<TABLE>
<CAPTION>
<S> <C> <C>
By: /s/ William L. Rush Chairman of the Board, Date: March 20, 1997
---------------------- Chief Executive Officer,
William L. Rush President and Director
(Principal Executive Officer)
By: /s/ Richard J. Hegstrand Chief Financial Officer Date: March 20, 1997
--------------------------- Secretary
Richard J. Hegstrand (Principal Financial Officer)
By: /s/ Kenneth L. Evenstad Director Date: March 20, 1997
--------------------------
Kenneth L. Evenstad
By: /s/ George E. Kline Director Date: March 20, 1997
----------------------
George E. Kline
By: /s/ Lawrence A. Lehmkuhl Director Date: March 20, 1997
---------------------------
Lawrence A. Lehmkuhl
</TABLE>
12
<PAGE>
INDEX TO EXHIBITS
Exhibit No. Description
- ----------- -----------
1.1* Form of Underwriting Agreement and Warrant
3.1** Restated Articles of Incorporation of the Company, as amended
3.2** Second Restated Bylaws of Nutrition Medical, Inc.
4.1* Specimen Form of the Company's Common Stock Certificate
10.1 1995 Long-Term Incentive and Stock Option Plan, as amended
10.2* 1996 Non-Employee Director Stock Option Plan
10.3* Purchasing Agreement, dated October 15, 1995, by and between the
Company and VHA, Inc.; Trademark License Agreement, dated October
15, 1995, by and between the Company and VHA, Inc.; Memorandum of
Understanding, dated April 17, 1995, between the Company and VHA,
Inc.
10.4 Executive Employment Agreement, dated October 1, 1996, by and
between the Company and William L. Rush
10.5* Employment Agreement, dated November 20, 1995, by and between the
Company and Richard J. Hegstrand
10.6* Employment Agreement, dated September 1, 1994, by and between the
Company and Joseph F. Coffey
10.7* Employment Agreement, dated December 19, 1994, by and between the
Company and Marlin G. Rudebusch
10.8* Office Lease, dated October 15, 1993, by and between the Company
and the 308 Corporation
10.9* Lease Agreement, dated February 22, 1996, by and between the
Company and Caliber Development Corporation
11.1 Statement of Computation of Net Loss Per Share
24 Powers of Attorney (set forth on the Signature Page hereof)
27 Financial Data Schedule (EDGAR only)
99.1 Cautionary Statement
________________
* Incorporated by reference to the exhibit of the same number to the
Registrant's previously filed Form SB-2 Registration Statement
effective September 26, 1996 (Reg. No. 333-9999).
** Incorporated by reference to the exhibit of the same number to the
Registrant's Quarterly Report on Form 10-QSB filed on November 13,
1996 (File No. 333-9999).
13
<PAGE>
Nutrition Medical, Inc.
Financial Statements
Years ended December 31, 1996, 1995 and 1994
CONTENTS
Report of Independent Auditors . . . . . . . . . . . . . . . . . . . . . . .F-2
Financial Statements
Balance Sheets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .F-3
Statements of Operations . . . . . . . . . . . . . . . . . . . . . . . . . .F-4
Statement of Shareholders' Equity. . . . . . . . . . . . . . . . . . . . . .F-5
Statements of Cash Flows . . . . . . . . . . . . . . . . . . . . . . . . . .F-6
Notes to Financial Statements. . . . . . . . . . . . . . . . . . . . . . . .F-7
F-1
<PAGE>
Report of Independent Auditors
Board of Directors and Shareholders
Nutrition Medical, Inc.
We have audited the balance sheets of Nutrition Medical, Inc. as of December 31,
1996 and 1995 and the related statements of operations, shareholders' equity and
cash flows for each of the three years in the period ended December 31, 1996.
These financial statements are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements based
on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Nutrition Medical, Inc. at
December 31, 1996 and 1995 and the results of its operations and its cash flows
for each of the three years in the period ended December 31, 1996, in conformity
with generally accepted accounting principles.
Ernst & Young LLP
January 22, 1997
F-2
<PAGE>
Nutrition Medical, Inc.
Balance Sheets
<TABLE>
<CAPTION>
DECEMBER 31,
1996 1995
----------------------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $2,553,955 $1,127,247
Short-term investments 1,671,596 -
Accounts receivable, less allowance of $31,000 in 1996
and $-0- in 1995 356,240 121,345
Inventories 460,115 358,104
Prepaid expenses 34,039 5,729
----------------------------
Total current assets 5,075,945 1,612,425
Equipment and office furniture, net 132,369 81,595
----------------------------
Total assets $5,208,314 $1,694,020
----------------------------
----------------------------
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 269,037 $ 313,810
Accrued lease costs 75,000 75,000
Accrued payroll 80,554 65,113
Accrued expenses 84,487 58,399
Notes payable - 100,000
----------------------------
Total current liabilities 509,078 612,322
Shareholders' equity:
Undesignated Preferred Stock, $.01 par value:
Authorized shares - 5,000,000
Issued and outstanding shares - none - -
Common Stock, $.01 par value:
Authorized shares - 20,000,000 shares
Issued and outstanding shares - 4,593,024--1996;
3,105,524--1995 45,930 31,055
Paid-in capital 6,943,287 2,581,612
Accumulated deficit (2,289,981) (1,530,969)
----------------------------
Total shareholders' equity 4,699,236 1,081,698
----------------------------
Total liabilities and shareholders' equity $5,208,314 $1,694,020
----------------------------
----------------------------
</TABLE>
SEE ACCOMPANYING NOTES.
F-3
<PAGE>
Nutrition Medical, Inc.
Statements of Operations
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
1996 1995 1994
--------------------------------------------
<S> <C> <C> <C>
Net sales $2,402,267 $ 841,241 $ 81,961
Cost of goods sold 1,550,396 406,391 24,613
--------------------------------------------
Gross profit 851,871 434,850 57,348
Operating expenses:
Selling, general and administrative 1,429,752 1,242,863 733,413
Research and development 260,988 170,963 17,557
--------------------------------------------
1,690,740 1,413,826 750,970
--------------------------------------------
Operating loss (838,869) (978,976) (693,622)
Other income (expense):
Interest expense (4,075) (5,481) (8,306)
Interest income 83,932 24,834 7,239
--------------------------------------------
79,857 19,353 (1,067)
--------------------------------------------
Net loss $ (759,012) $ (959,623) $(694,689)
--------------------------------------------
--------------------------------------------
Net loss per share $(.18) $(.30) $(.29)
--------------------------------------------
--------------------------------------------
Weighted average number of shares outstanding 4,325,384 3,174,827 2,415,348
--------------------------------------------
--------------------------------------------
</TABLE>
SEE ACCOMPANYING NOTES.
F-4
<PAGE>
Nutrition Medical, Inc.
Statement of Shareholders' Equity
<TABLE>
<CAPTION>
COMMON STOCK
---------------- PAID-IN ACCUMULATED
SHARES AMOUNT CAPITAL DEFICIT TOTAL
---------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Balance at December 31, 1993 738,000 $ 7,380 $ 52,120 $ (35,657) $ 23,843
Issuance of Common Stock at $.08 per share on
January 6, 1994 62,000 620 4,380 - 5,000
Recapitalization resulting from election of
C Corporation status - - (159,000) 159,000 -
Issuance of Common Stock at $1.00 per share from
March 4, 1994 through April 19, 1994 640,000 6,400 633,600 - 640,000
Value of warrants granted for services performed - - 63,000 - 63,000
Value of options granted for services performed - - 20,000 - 20,000
Value of warrants granted in connection with notes
payable - - 5,000 - 5,000
Net loss - - - (694,689) (694,689)
---------------------------------------------------------------
Balance at December 31, 1994 1,440,000 14,400 619,100 (571,346) 62,154
Issuance of Common Stock at $1.35 per share from
February through September 1995, net of offering
costs 1,665,524 16,655 1,957,512 - 1,974,167
Value of warrants granted for services performed - - 5,000 - 5,000
Net loss - - - (959,623) (959,623)
---------------------------------------------------------------
Balance at December 31, 1995 3,105,524 31,055 2,581,612 (1,530,969) 1,081,698
Issuance of Common Stock at $2.50 per share in
June 1996 50,000 500 124,500 - 125,000
Issuance of Common Stock at $3.50 per share in
October 1996, net of offering costs 1,437,500 14,375 4,222,675 - 4,237,050
Value of warrants granted for services performed - - 14,500 - 14,500
Net loss - - - (759,012) (759,012)
---------------------------------------------------------------
Balance at December 31, 1996 4,593,024 $45,930 $6,943,287 $(2,289,981) $4,699,236
---------------------------------------------------------------
---------------------------------------------------------------
</TABLE>
SEE ACCOMPANYING NOTES.
F-5
<PAGE>
Nutrition Medical, Inc.
Statements of Cash Flows
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
1996 1995 1994
--------------------------------------------------
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net loss $ (759,012) $ (959,623) $(694,689)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation 25,600 17,777 6,538
Reserve for bad debts 31,000 - -
Value of options and warrants granted for
services performed 14,500 5,000 88,000
Changes in operating assets and liabilities:
Accounts receivable (265,895) (99,011) (22,334)
Inventories (102,011) (307,695) (50,409)
Prepaid expenses (28,310) (2,779) (2,950)
Accounts payable (44,773) 250,534 65,921
Accrued liabilities 41,529 177,957 20,555
--------------------------------------------------
Net cash used in operating activities (1,087,372) (917,840) (589,368)
INVESTING ACTIVITIES
Purchase of short-term investments (1,671,596) - -
Purchase of equipment and office furniture (76,374) (40,160) (51,111)
--------------------------------------------------
Net cash used in investing activities (1,747,970) (40,160) (51,111)
FINANCING ACTIVITIES
Proceeds from issuance of Common Stock 4,362,050 1,974,167 645,000
Proceeds from issuance of notes payable - 200,000 100,000
Payments on notes payable (100,000) (200,000) -
--------------------------------------------------
Net cash provided by financing activities 4,262,050 1,974,167 745,000
--------------------------------------------------
Increase in cash 1,426,708 1,016,167 104,521
Cash at beginning of year 1,127,247 111,080 6,559
--------------------------------------------------
Cash at end of year $2,553,955 $1,127,247 $ 111,080
--------------------------------------------------
--------------------------------------------------
</TABLE>
SEE ACCOMPANYING NOTES.
F-6
<PAGE>
Nutrition Medical, Inc.
Notes to Financial Statements
December 31, 1996
1. NATURE OF OPERATIONS
Nutrition Medical, Inc. (the "Company") develops and sells branded generic
critical care nutrition products for the hospital/nursing home market, as well
as private label nutrition products for sale through retail chains. The
Company's products are manufactured using ingredients, formulas and processes
comparable to those of national brand products. The Company currently has six
critical care nutrition products and three private label nutrition products. The
Company intends to expand its existing product lines and is also currently
developing an infant formula, which is not expected to be available for sale for
up to one year.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
CASH EQUIVALENTS
The Company considers all highly liquid investments with maturities of three
months or less at the time of purchase to be cash equivalents. Cash equivalents
are available-for-sale, are carried at cost which approximates market and
consist of money market funds.
SHORT-TERM INVESTMENTS
Short-term investments are comprised of U.S. Treasury debt securities and are
classified as available-for-sale. At December 31, 1996, the Company's cost of
short-term investments approximated market value, with no resulting unrealized
gains and losses recognized. Realized gains and losses and declines in value
judged to be other than temporary are included in investment income along with
interest and dividends.
INVENTORIES
Inventories are valued at the lower of cost or market by the first-in, first-out
(FIFO) method.
EQUIPMENT AND OFFICE FURNITURE
Equipment and office furniture are stated at cost. Depreciation is provided
using the straight-line method over the estimated useful lives of the assets
ranging from three to five years.
INCOME TAXES
Income taxes are accounted for under the liability method. Deferred income taxes
are provided for temporary differences between the financial reporting and tax
bases of assets and liabilities.
REVENUE RECOGNITION
The Company recognizes revenue at the time of shipment of the product.
Provisions for estimated returns and allowances are accrued for at the time of
sale.
RESEARCH AND DEVELOPMENT COSTS
All research and development costs are charged to operations as incurred.
F-7
<PAGE>
Nutrition Medical, Inc.
Notes to Financial Statements (continued)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the amounts reported in the financial statements and accompanying notes.
Actual results could differ from those estimates.
STOCK-BASED COMPENSATION
The Company has adopted the disclosure-only provisions of Statement of Financial
Accounting Standards No. 123, "Accounting for Stock-Based Compensation," but
applies Accounting Principles Board Opinion No. 25 ("APB 25") and related
interpretations in accounting for its plans. Under APB 25, when the exercise
price of employee stock options equals the market price of the underlying stock
on the date of grant, no compensation expense is recognized.
IMPAIRMENT OF LONG-LIVED ASSETS
The Company will record impairment losses on long-lived assets used in
operations when indicators of impairment are present and the undiscounted cash
flows estimated to be generated by those assets are less than the assets'
carrying amount.
NET LOSS PER SHARE
Net loss per share is computed using the weighted average number of shares of
common stock and common stock equivalents, if dilutive, outstanding during the
periods presented. For periods prior to September 30, 1996, the loss per share
amounts give effect to the application of Securities and Exchange Commission
Staff Accounting Bulletin No. 83 ("SAB No. 83"). Pursuant to SAB No. 83, all
common shares issued and stock options and warrants granted by the Company at a
price less than the initial public offering price during the 12 months preceding
the offering date have been included in the calculation (using the treasury
stock method) of common and common equivalent shares outstanding as if they were
outstanding for all periods prior to the initial public offering date.
3. INVENTORIES
Inventories consist of the following:
DECEMBER 31,
1996 1995
-----------------------------
Raw materials $ 72,403 $ 95,078
Work in progress - 89,848
Finished goods 387,712 173,178
-----------------------------
$460,115 $358,104
-----------------------------
-----------------------------
F-8
<PAGE>
Nutrition Medical, Inc.
Notes to Financial Statements (continued)
4. EQUIPMENT AND OFFICE FURNITURE
Equipment and office furniture consist of the following:
DECEMBER 31,
1996 1995
-----------------------------
Equipment and office furniture:
Computer equipment $ 70,415 $ 48,401
Office furniture 101,074 54,221
Equipment 11,392 3,885
-----------------------------
182,881 106,507
Less accumulated depreciation 50,512 24,912
-----------------------------
$132,369 $ 81,595
-----------------------------
-----------------------------
5. NOTES PAYABLE
Notes payable consist of the following:
DECEMBER 31,
1996 1995
-----------------------------
Notes payable--Housing and Redevelopment
Authority ("HRA") of Buffalo, Minnesota;
interest rates of 6.25% and 5.05%; interest
paid quarterly; due October 11, 1999 and
December 1, 1998 $ - $100,000
-----------------------------
$ - $100,000
-----------------------------
-----------------------------
In connection with the above notes, the Company granted warrants to purchase
30,000 shares of Common Stock at a weighted average exercise price of $1.25 per
share. The warrants were granted in January 1994 and October 1994, expire five
years from the grant date and were deemed to have a value of $5,000, which was
expensed in 1994.
In accordance with the terms of the notes, the Company repaid the HRA notes and
all accrued interest in 1996 upon relocating outside the Buffalo, Minnesota area
in October 1996.
On June 6, 1995, the Company issued a $200,000, 90-day non-interest bearing note
to an entity that is a shareholder of the Company and whose general partner is a
member of the Board of Directors. As consideration for the note and consulting
services provided, the Company granted a warrant to purchase 20,000 shares of
Common Stock at $1.35 per share. The warrants were assigned a value of $5,000,
which was expensed in 1995. On September 6, 1995 the Company repaid the loan.
6. LEASES
The Company entered into an agreement, commencing October 6, 1996, to lease an
office and warehouse facility in Minneapolis, Minnesota. The lease terminates on
November 30, 2001, and requires the Company to pay its proportionate share of
real estate taxes and operating expenses. The agreement allows for a five year
renewal and a termination option after three years in the event the landlord is
unable to provide additional space for the Company.
F-9
<PAGE>
Nutritional Medical, Inc.
Notes to Financial Statements (continued)
6. LEASES (CONTINUED)
The Company's former leased office facility, located in Buffalo, Minnesota, was
vacated upon the signing of aforementioned lease. In December 1995, the Company
approved a relocation plan, and established a reserve of approximately $75,000
related to the post-occupancy rent and operating expenses through the December
1998 lease expiration.
Future minimum lease rental payments required under leases in excess of one year
as of December 31, 1996 are as follows:
1997 $ 93,912
1998 103,065
1999 69,545
2000 69,360
2001 69,664
-------------
$401,546
-------------
-------------
Total rent expense under operating leases for the years ended December 31, 1996,
1995 and 1994 was $48,989, $33,270 and $23,980, respectively.
7. INCOME TAXES
Prior to March 14, 1994, the Company operated as an S Corporation, whereby
taxable income or loss is passed through to the shareholders. The Subchapter S
election was terminated on March 14, 1994 and, as a result, the Company became
subject to federal and state income taxes. Also, as of that date, the Company's
accumulated deficit of $159,000 was reclassified to additional paid-in capital.
As of December 31, 1996, the Company had a net tax operating loss carryforward
for tax purposes of approximately $2,090,000. This carryforward is available to
offset future taxable income through 2011 subject to limitations under Section
382 of the Internal Revenue Code due to changes in the equity ownership of the
Company.
Significant components of deferred tax assets and liabilities are as follows:
DECEMBER 31,
1996 1995
-----------------------------
Deferred tax assets:
Net operating loss carryforwards $836,000 $587,000
Inventory reserve 14,000 -
Accounts receivable allowance 12,000 -
Other accrued expenses 11,000 -
-----------------------------
873,000 587,000
Deferred tax liabilities:
Depreciation (12,000) -
-----------------------------
(12,000) -
-----------------------------
Net deferred income tax assets 861,000 587,000
Valuation allowance (861,000) (587,000)
-----------------------------
Net deferred income taxes $ - $ -
-----------------------------
-----------------------------
F-10
<PAGE>
Nutrition Medical, Inc.
Notes to Financial Statements (continued)
8. CAPITAL STOCK
STOCK AUTHORIZATION
In July 1996, the Company increased the authorized shares of capital stock to
25,000,000, including 20,000,000 shares of common stock and 5,000,000 shares of
undesignated preferred stock.
INITIAL PUBLIC OFFERING
In October 1996, the Company sold 1,437,500 shares of Common Stock in an initial
public offering from which the Company received net proceeds of $4,237,000. In
connection with the initial public offering, the Company sold to the
underwriter, for a nominal price, a five-year warrant to purchase up to 125,000
shares of Common Stock exercisable at $4.20 per share.
9. STOCK OPTIONS AND WARRANTS
The Company has two stock option plans that include both incentive stock options
and non-qualified stock options to be granted (the "Plans") to directors,
officers, employees, consultants and others. As of December 31, 1996, the
maximum number of shares of common stock reserved under the Plans is 900,000
shares. The Board of Directors establishes the terms and conditions of all stock
option grants, subject to the Plans and applicable provisions of the Internal
Revenue Code.
The following table summarizes activity under the Plans:
<TABLE>
<CAPTION>
WEIGHTED
AVAILABLE PLAN OPTIONS OUTSTANDING EXERCISE PRICE
SHARES ------------------------------------- AVERAGE
FOR GRANT INCENTIVE NON-QUALIFIED PER SHARE
-------------------------------------------------------------------
<S> <C> <C> <C> <C>
Balance at December 31, 1993 - - - $ -
Establishment of stock option plan 500,000 - - -
Granted (127,500) 65,000 62,500 1.12
---------------------------------------------------
Balance at December 31, 1994 372,500 65,000 62,500 1.12
Granted (265,000) 44,000 221,000 1.20
Canceled 15,000 - (15,000) 1.00
---------------------------------------------------
Balance at December 31, 1995 122,500 109,000 268,500 1.18
Additional shares reserved 400,000 - - -
Granted (295,750) 166,000 129,750 2.99
Canceled 19,500 (14,500) (5,000) 1.40
---------------------------------------------------
Balance at December 31, 1996 246,250 260,500 393,250 $1.97
---------------------------------------------------
---------------------------------------------------
</TABLE>
F-11
<PAGE>
Nutrition Medical Inc.
Notes to Financial Statements (continued)
9. STOCK OPTIONS AND WARRANTS (CONTINUED)
The following table summarizes information about the stock options outstanding
at December 31, 1996:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------------------------------ -----------------------------------
WEIGHTED WEIGHTED WEIGHTED
RANGE OF NUMBER AVERAGE REMAINING AVERAGE NUMBER AVERAGE
EXERCISE PRICES OUTSTANDING CONTRACTUAL LIFE EXERCISE PRICE EXERCISABLE EXERCISE PRICE
- ------------------------------------------------------------------------- -----------------------------------
<S> <C> <C> <C> <C> <C>
$1.00 - $2.50 502,750 6 years $1.51 296,200 $1.18
3.50 - 3.94 151,000 10 years 3.53 5,000 3.50
--------------- ---------------
$1.00 - $3.94 653,750 7 years $1.97 301,200 $1.22
--------------- ---------------
--------------- ---------------
</TABLE>
Options outstanding under the plan expire at various dates during the period
from November 1998 through December 2006. The number of options exercisable as
of December 31, 1996, 1995 and 1994 were 301,200, 154,500 and -0-, respectively,
and are exercisable at $1.22 and $1.10 per share, respectively. The weighted
average fair value of options granted during the years ended December 31, 1996
and 1995 was $1.06 and $.52 per share, respectively.
In connection with the issuance of Common Stock at $1.35 per share from February
through September 1995, the Company granted warrants to purchase a total of
152,107 shares of Common Stock. The warrants are exercisable at $1.35 per share
and expire at various dates through September 2000.
The Company has elected to following Accounting Principles Board Opinion No. 25,
ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES ("APB 25") and related Interpretations
in accounting for its employee stock options because, as discussed below, the
alternative fair value accounting provided for under FASB Statement No. 123,
ACCOUNTING FOR STOCK-BASED COMPENSATION ("Statement 123"), requires use of
option valuation models that were not developed for use in valuing employee
stock options.
Pro forma information regarding net loss and loss per share is required by
Statement 123, and has been determined as if the Company had accounted for its
employee stock options under the fair value method of Statement 123. The fair
value for these options was estimated at the date of grant using the
Black-Scholes option pricing model with the following weighted-average
assumptions for 1996 and 1995: risk-free interest rate of 6.0%, and 5.3%,
respectively; and dividend yield of 0%; volatility factor of the expected market
price of the Company's Common Stock of .33 and a weighted-average expected life
of the option of 4 years for both years.
The Black-Scholes option valuation model was developed for use in estimating the
fair value of traded options which have no vesting restrictions and are fully
transferable. In addition, option valuation models require the input of highly
subjective assumptions. Because the Company's employee stock options have
characteristics significantly different from those of traded options, and
because change in the subjective input assumptions can materially affect the
fair value estimate, in management's opinion, the existing models do not
necessarily provide a reliable single measure of the fair value of its employee
stock options.
F-12
<PAGE>
Nutriton Medical, Inc.
Notes to Financial Statements (continued)
9. STOCK OPTIONS AND WARRANTS (CONTINUED)
For purposes of pro forma disclosures, the estimated fair value of the options
is amortized to expense over the options' vesting period. The Company's pro
forma information is as follows:
1996 1995
-----------------------------
Pro forma net loss $(822,565) $(967,258)
Pro forma net loss per common share $(.19) $(.30)
The pro forma effect on net loss of 1996 and 1995 is not representative of the
pro forma effect on net loss in future years because it does not take into
consideration pro forma compensation expense related to grants made prior to
1995.
10. CONTINGENCY
In August 1995, the Company was named as a defendant in a patent infringement
lawsuit brought by Novartis, formerly Sandoz Nutrition Company. The complaint
asserts that one of the Company's products, L-Emental Plus, infringes on two
patents held by Novartis and asks for relief in the form of an injunction that
would prevent the Company from selling the product as well as damages of an
unspecified amount. Both patents were issued subsequent to the Company's
introduction of L-Emental Plus. The Company has responded with a counterclaim
seeking a declaration of invalidity, unenforceability, non-infringement and
inventorship of the subject patents. A court order has stayed the litigation
pending a reexamination of both patents by the United States Patent and
Trademark Office. The Company intends to continue to defend vigorously against
the claim. It is not possible at this time to predict the outcome, including
whether the Company will have to cease selling L-Emental Plus, or to estimate
the amount or range of potential loss, if any. Accordingly, no loss provision
has been made in the financial statements for any liability that may result from
the outcome of this uncertainty.
11. MAJOR CUSTOMER
The Company's net sales to one customer constituted approximately 11.6% of the
total net sales for the year ended December 31, 1996.
12. ACQUISITION
On January 13, 1997, the Company acquired the inventory and fixed assets
relating to the production of the enteral (tube feeding) products of Elan
Pharma, Inc. as well as exclusive rights to manufacture and market the products.
The products consist of a line of tube feeding formulas, disposable
administration hardware (feeding tubes, administration sets, containers) and
pumps used by hospitals, nursing homes and home healthcare providers to feed
patients unable to consume adequate nutrition orally. In exchange, the Company
issued a $3,000,000 note payable due in seven years together with interest
accruing at 3% per annum and 855,000 shares of the Company's Common Stock. Total
value of the transaction, after taking into consideration market interest rates
on the note payable, is approximately $4,800,000.
F-13
<PAGE>
Exhibit 10.1
AMENDMENTS TO 1995 LONG-TERM INCENTIVE AND STOCK OPTION PLAN
August 19, 1996
1. The shareholders of Nutrition Medical, Inc. (the "Company") adopted the
following amendment to the Company's 1995 Long-Term Incentive and Stock Option
Plan (the "Plan") at a special meeting held on August 19, 1996:
The amendment adopted had the effect of replacing in its entirety Section 2 of
the Plan with the following text:
Section 2. STOCK SUBJECT TO PLAN. Subject to the provisions of
Section 16 hereof, the stock to be subject to options or other awards under
the Plan shall be the Company's authorized common shares, par value $.01
per share (the "Common Shares"). Such Common Shares may be either
authorized but unissued shares, or issued shares which have been reacquired
by the Company. Subject to adjustment as provided in Section 16 hereof,
the maximum number of shares on which options may be exercised or other
awards issued under this Plan shall be 800,000 shares. If an option or
award under the Plan expires, or for any reason is terminated or
unexercised with respect to any shares, such shares shall again be
available for options or awards thereafter granted during the term of the
Plan.
2 The board of directors of Nutrition Medical, Inc. (the "Company") adopted
the following amendment to the Company's 1995 Long-Term Incentive and Stock
Option Plan (the "Plan") at a meeting held on September 24, 1996:
The amendment adopted had the effect of replacing in its entirety Section 5 of
the Plan with the following text:
Section 5. PRICE. The option price for all Incentive Stock Options
granted under the Plan shall be determined by the Committee but shall not
be less than 100% of the fair market value of the Common Shares at the date
of grant of such option. The option price for options granted under the
Plan that do not qualify as Incentive Stock Options shall also be
determined by the Committee but shall not be less than 85% of the fair
market value of the Common Shares at the date of grant of such option and,
if applicable, the price for all awards shall be determined by the
Committee. For purposes of the preceding sentence and for all other
valuation purposes under the Plan, the fair market value of the Common
Shares shall be as reasonably determined by the Committee. If on the date
of grant of any option or award hereunder the Common Shares are not traded
on an established securities market, the Committee shall make a good faith
attempt to satisfy the requirements of this Section 5 and in connection
therewith shall take such action as it deems necessary or advisable.
<PAGE>
Exhibit 10.4
NUTRITION MEDICAL, INC.
EXECUTIVE EMPLOYMENT AGREEMENT
THIS AGREEMENT ("Agreement") by and between NUTRITION MEDICAL, INC. (the
"Company"), a Minnesota corporation with its principal offices at 308 12th
Avenue South, Buffalo, MN 55313, and William L. Rush ("Executive"), a Minnesota
resident, whose residence address is 11730 50th Place North, Plymouth, MN
55442, is effective October 1, 1996, and amends and restates in its entirety the
Executive Employment Agreement dated September 18, 1996 by and between the
Company and Executive.
RECITALS
A. Executive possesses certain skills, talents, contacts, judgment and
knowledge of the medical nutrition industry.
B. The Company desires to offer employment to Executive, and Executive
desires to accept such employment, subject to the terms and conditions herein.
NOW, THEREFORE, in consideration of the foregoing premises and the parties'
mutual covenants and undertakings contained in this Agreement, the Company and
Executive hereby agree as follows:
ARTICLE 1.0 DEFINITIONS
Capitalized terms used in this Agreement shall have their defined meaning
throughout the Agreement. The following terms shall have the meanings set forth
below, unless the context clearly requires otherwise.
1.1 BOARD. "Board" shall mean the Board of Directors of the Company.
1.2 CONFIDENTIAL INFORMATION. "Confidential Information" shall mean
information that is proprietary to the Company or its members or others and that
is entrusted to the Company, whether or not trade secrets. Confidential
Information includes, but is not limited to, information relating to designs,
software (in source and object code), technology strategies, business plans and
to the business as conducted or anticipated to be conducted by the Company or
its members, and to past or current or anticipated products or services of the
Company or its members. Confidential Information also includes, without
limitation, information concerning research, development, purchasing,
accounting, marketing, selling and services. All information that Executive has
a reasonable basis to consider confidential is Confidential Information, whether
or not originated by Executive and without regard to the manner in which
Executive obtains access to this and any other proprietary information.
1.3 DISABILITY. "Disability" shall mean the unwillingness or inability of
Executive to perform Executive's duties on a full-time basis under this
Agreement because of continuous incapacity due to physical or mental illness,
bodily injury or disease for a period of three (3) months or more.
1.4 EFFECTIVE DATE. "Effective Date" shall mean October 1, 1996.
1.5 INVENTIONS. "Inventions" shall mean ideas, improvements and
discoveries, whether or not such are patentable or copyrightable, and whether or
not in writing or reduced to practice.
1.6 WORKS OF AUTHORSHIP. "Works of Authorship" shall mean any writings,
drawings, diagrams, charts, tables, databases, software (in object or source
code and recorded on any medium), and any other works of authorship, whether or
not such are copyrightable.
<PAGE>
ARTICLE 2.0 EMPLOYMENT AND DUTIES
2.1 EMPLOYMENT. Upon the terms and conditions set forth herein and his
appointment by the Board, the Company hereby employs Executive, and Executive
accepts such employment, as President and Chief Executive Officer of the
Company, commencing as of the effective date of this Agreement, at the Company's
principal place of business. Termination of this Agreement by either party or
by mutual agreement of the parties under Article 4.0 below shall terminate
Executive's employment by the Company.
ARTICLE 3.0 COMPENSATION, BENEFIT AND EXPENSES
3.1 BASE SALARY. Subject to Section 4.9 below, the Company shall pay
Executive an initial Base Salary at a monthly rate of Seven Thousand Nine
Hundred Sixteen Dollars ($7,416) from the Effective Date to December 31, 1996
and at such other Base Salary set under Section 3.2 below for any later period
of the Term. Such Base Salary shall be paid in U.S. Dollars at the end of each
month of employment, or otherwise in accordance with the Company's regular
payroll practices, and will be subject to any applicable income tax, Social
Security or other withholding.
3.2 ADJUSTMENTS TO INITIAL BASE SALARY. Unless this Agreement has been
terminated in accordance with Article 4.0 below, the Board shall provide an
annual year-end performance review to Executive. Following such review, the
Board may, in its sole discretion, adjust Executive's Base Salary accordingly;
provided that the Board may not lower the Executive's Base Salary without the
consent of Executive.
3.3 INCENTIVE COMPENSATION. The Company shall make Executive eligible for
management incentive compensation ("Incentive Compensation"), in addition to the
Base Salary then applicable. Payment of Incentive Compensation will be subject
to Executive's achieving certain objectives set annually by Executive and the
Board.
3.4 EQUITY PARTICIPATION. The Company shall grant, as of the Effective
Date, to Executive an option (the "Option") to purchase 100,000 shares of common
stock, $.01 par value, of the Company (the "Common Stock"), subject to the terms
and conditions of the Company's 1995 Long-Term Incentive and Stock Option Plan
(the "Plan"). The exercise price of the Option will equal to $3.50. The Option
will vest as to 50% of the shares as of April 1, 1998, and as to the remaining
50% of the shares as of October 1, 1999. The Option will not qualify as an
Incentive Stock Option, as defined in the Plan. If at any time Executive's
employment with the Company is terminated pursuant to Section 4.2 or Section 4.5
of this Agreement, the option on all unvested shares will be canceled
immediately. If at any time Executive's employment with the Company is
terminated pursuant to Section 4.3 or Section 4.4 of this Agreement, all options
shall immediately vest and all unexercised options may be exercised in full as
of the date of such termination. The option with respect to vested shares that
has not been exercised by Executive will be canceled if not exercised by
Executive within two years after the date of termination pursuant to Article 4.0
of this Agreement. If at any time during the period of Executive's employment
by the Company a Change in Control (as defined in the agreement covering the
option) occurs, all options shall immediately vest and all unexercised options
may be exercised in full as of the date of the Change in Control.
3.5 BUSINESS EXPENSES. During the Term, the Company shall bear all
ordinary and necessary business expenses incurred by Executive in performing
Executive's duties as an executive officer of the Company, including, without
limitation, all reasonable travel and living expenses while away from home on
business for the Company, provided that Executive accounts promptly and fully
for such expenses in the manner reasonably prescribed by the Board.
-2-
<PAGE>
3.6 HEALTH, DEATH, DISABILITY AND RETIREMENT BENEFITS. Executive shall
also be entitled to participate in the health and group life insurance benefit
plans of the Company to the extent that his position, title, tenure, salary,
age, health, and other qualifications make him eligible to participate. During
the Term, and provided that the Executive is insurable at a rate no more than a
standard rate, the Company will maintain a permanent life insurance policy on
Executive with a death benefit in the amount of One Million Dollars ($1,000,000)
and will enter into a split dollar/collateral assignment agreement (the cost of
the preparation of which the Company will bear) with the Executive in accordance
with the following provisions: (a) the "P.S. 58" (term insurance cost) portion
of premiums on the policy will be paid by the Executive and the remainder will
be paid by the Company, (b) the Company will pay the Executive as compensation
an amount equal to the premium paid by the Executive plus the amount necessary
to pay all federal and state taxes on such additional compensation to Executive,
(c) the Executive will own the policy, (d) any loan or loans that Executive may
take against the policy in the aggegrate will be limited to the excess of the
cash surrender value of the policy over the aggregate premiums paid by the
Company on the policy, and (e) Executive will designate the beneficiary of the
policy; provided, however, that (i) in the event the Executive dies, the Company
will receive as reimbursement, from the proceeds or the cash surrender value of
the policy, an amount equal to the aggregate amount of premiums the Company has
paid on the policy, and (ii) in the event that the policy is terminated or
canceled for any other reason, the Company will receive as reimbursement an
amount equal to the lesser of (A) the aggregate amount of premiums the Company
has paid on the policy and (B) the cash surrender value of the policy.
Executive shall also be entitled to participate in disability programs and
simplified employee pension plans of the Company to the extent the Company
establishes these plans and to the extent that his position, title, tenure,
salary, age, health, and other qualifications make him eligible to participate;
provided that during the Term the Company will pay the premiums on and otherwise
maintain a disability insurance policy for the benefit of Executive with terms
subject to Executive's reasonable approval, which approval will not be
unreasonably withheld. The Company does not guarantee the adoption or
continuance of any particular employee benefit plan or program during the term
of this Agreement, and the Employee's participation in any such plan or program
shall be subject to the provisions, rules, and regulations applicable thereto.
ARTICLE 4.0 TERM; TERMINATION
4.1 TERM. Executive's employment under this Agreement shall commence upon
the Effective Date and shall continue for three (3) years from such date ("the
Term") unless earlier terminated under this Article 4.0. This Agreement may be
thereafter extended beyond the Term upon the mutual written agreement of the
parties on an annual basis, provided, such agreement is reached at least sixty
(60) days prior to the end of the Term or the then-current year extension
thereof.
4.2 TERMINATION BY THE COMPANY FOR GOOD CAUSE. Notwithstanding Section
4.1 above, the Company may terminate this Agreement for Good Cause. For
purposes of this Agreement, "Good Cause" shall mean:
(a) repeated violations by Executive of any of his duties or repeated
failures or omissions to carry out lawful and reasonable orders of the
Company's Board under Section 2.2 above which, in the reasonable
judgment of the Board, are willful and deliberate and which are not
cured within 30 days after Executive's receipt of written notice
thereof from the Company;
(b) any act or acts of (i) personal dishonesty by Executive and intended
to result in substantial personal enrichment of Executive at the
expense of the Company; (ii) any willful and deliberate misconduct
that is materially and demonstrably injurious to the
-3-
<PAGE>
Company; or (iii) any criminal indictment, presentment or conviction
for a felony, whether or not the Company is the victim of such
offense.
4.3 TERMINATION BY THE COMPANY WITHOUT GOOD CAUSE. Notwithstanding
Section 4.1 above, the Company may terminate this Agreement without Good Cause,
subject to Section 4.8.
4.4 TERMINATION BY EXECUTIVE FOR GOOD REASON. Notwithstanding Section
4.1 above, Executive may terminate this Agreement for Good Reason. For purposes
of this Agreement, "Good Reason" shall mean termination of employment based on
any one or more of the following:
(a) any material and adverse change in Executive's duties,
responsibilities or authority as the Company's President and Chief
Executive Officer (except in connection with the termination of
Executive's employment in accordance with Sections 4.2, 4.3, 4.6 or
4.7 hereof);
(b) Any unreasonable reduction by the Company below the then-applicable
Base Salary and/or Incentive Compensation; or
(c) Any other material breach of this Agreement by the Company which is
not cured within thirty (30) days after written notice thereof from
Executive.
4.5 TERMINATION BY EXECUTIVE WITHOUT GOOD REASON. Notwithstanding
Section 4.1 above, Executive may terminate this Agreement at any time, subject
to Section 4.8.
4.6 TERMINATION IN THE EVENT OF EXECUTIVE'S DEATH OR DISABILITY.
Notwithstanding Section 4.1 above, Executive's employment under this Agreement
shall terminate in the event of Executive's death or Disability.
4.7 TERMINATION BY MUTUAL AGREEMENT. Notwithstanding Section 4.1 above,
the parties may terminate this Agreement at any time and upon any other terms or
conditions by mutual written agreement.
4.8 TERMINATION NOTICE; TERMINATION DATE. This Section 4.8 shall apply to
any early termination of Executive's employment hereunder pursuant to Article
4.0.
(a) A "Termination Notice" hereunder shall mean a written notice which
indicates the specific termination provision herein and which, other
than in the case of a termination pursuant to Sections 4.3, 4.5, or
4.7 or by Executive's death, states in reasonable detail the
circumstances claimed to provide the basis for such termination.
(b) A "Termination Date" hereunder shall mean:
(i) if due to Executive's death, the last day of the month first
following the month of Executive's death;
(ii) if due to Disability, termination by the Company for Good
Cause or termination by the Executive for Good Reason, thirty
(30) calendar days after the Termination Notice is given;
(iii) if due to termination by the Company without Good Cause or by
Executive without Good Reason, ninety (90) days after the
Termination Notice is given; or
-4-
<PAGE>
(iv) if by mutual agreement of the parties, the date specified in
such agreement.
(c) Notwithstanding Section 4.8(b) above, if within thirty (30) days after
receipt of a Termination Notice, the recipient notifies the
terminating party that a dispute exists concerning the termination or
its basis, then the Termination Date shall be the date on which such
dispute is finally resolved, whether by the parties' mutual written
agreement or by final and binding arbitration under Article 7.0 below.
Until the dispute is so resolved, the Company shall continue to pay
Executive all his compensation and benefits under Article 3.0
immediately prior to the Termination Notice, subject to Executive's
express written undertaking to repay to the Company all such sums paid
after the nominal Termination Date in the event of an adverse ruling
in such arbitration.
4.9 COMPENSATION UPON EARLY TERMINATION. As Executive's sole and
exclusive compensation for Executive's early termination, the Company shall pay
Executive as follows:
(a) If due to his Disability or death, within ten (10) days after the
Termination Date, the Company shall pay any amounts due to
Executive for Base Salary though the Termination Date together
with any other unpaid and pro rata amounts of accrued Incentive
Compensation, vacation pay, sick leave and/or business expense
reimbursements;
(b) If due to termination by the Company for Good Cause or by
Executive without Good Reason, within ten (10) days after the
Termination Date, the Company shall pay Executive any amounts due
to Executive for Base Salary through the Termination Date
together with any other unpaid and pro rata amounts of accrued
vacation pay, sick leave, and/or business expense reimbursements,
but the Company shall have no duty to pay any Incentive
Compensation which would otherwise be due and owing to Executive
pursuant to Article 3.0 hereof.
(c) If by the mutual agreement of the parties under Section 4.7
above, the Company shall provide Executive with the payments and
benefits when and as specified in such agreement.
(d) If due to a termination by the Company without Good Cause,
termination by Executive for Good Reason, or any other material
and uncured breach of this Agreement by the Company, the Company
shall:
(i) continue to pay all amounts due to Executive for Base
Salary in accordance with Section 3.1 or Section 3.2
above, as may be the case, at the monthly rate in effect
thereunder immediately prior to the Termination Date for
twelve (12) months after the end of the month of such
Termination Date;
(ii) continue to pay all amounts due to Executive for the
maximum amount of Incentive Compensation in accordance
with Section 3.3 above, computed on the Base Salary as
provided in Section 4.9(d)(i) above, in the same manner as
if Executive had remained continuously employed for the
relevant period set forth in Section 4.9(d)(i) above and
had achieved all the goals and objectives for such
Incentive Compensation during such period;
-5-
<PAGE>
(iii) pay any other unpaid and pro rata amounts of accrued
vacation pay, sick leave, and/or business expense
reimbursements; and
(iv) continue to pay all premiums due for and to keep in full
force and effect Executive's benefit arrangements in
accordance with Section 3.6 above in the same manner as if
Executive had remained continuously employed throughout
the relevant period set forth in Section 4.9(d)(i) above.
(e) The Company shall have no duty or obligation to employ Executive
following any such early termination by the Company for any
reason whatsoever, with or without Good Cause, and Executive
shall have no duty or obligation whatsoever to find other
employment during the remainder of the Term with respect to which
compensation or benefits are required to be paid by the Company
under Section 4.9(d) above. However, if and to the extent that
Executive does have other earned income of any kind during such
period, he shall promptly and fully disclose to the Company in
writing the nature and amount of any such earned income for
purposes of mitigation and reduction of the Company's obligations
hereunder, and Executive shall be liable to repay any such
amounts paid by the Company which should have been so mitigated
and reduced but for Executive's failure to make such a
disclosure.
4.10 SURVIVAL. The provisions of Article 4.0 (relating to termination
rights and the provision of compensation and benefits beyond the termination of
this Agreement), the provisions of Article 5.0 (relating to Confidential
Information and intellectual property rights of the Company), the provisions of
Article 6.0 (relating to non-competition and non-solicitation), the provisions
of Article 7.0 (relating to dispute resolution) and the provisions of Article
8.0 (relating to miscellaneous terms and conditions) shall survive termination
of this Agreement for any reason.
ARTICLE 5.0 CONFIDENTIAL INFORMATION; INTELLECTUAL PROPERTY
5.1 PROHIBITIONS AGAINST UNAUTHORIZED USE. During and subsequent to
Executive's employment under this Agreement, Executive shall not use or
disclose, other than in connection with Executive's employment with the Company,
any Confidential Information to any person not employed by the Company or not
authorized by the Company to receive such Confidential Information, without the
prior written consent of the Company. Executive shall use reasonable and
prudent care to safeguard and protect and prevent the unauthorized use and
disclosure of Confidential Information.
5.2 EXCLUSIONS. The obligations under Section 5.1 above shall not apply
to any information that:
(a) is now or becomes generally available to the public through no fault
of Executive;
(b) was already known to Executive, as shown by Executive's books and
records, prior to disclosure of same by the Company;
(c) is or was independently developed or acquired by Executive without any
use of or reliance on Confidential Information;
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<PAGE>
(d) is or was provided to Executive by a third party not under any
obligation of confidentiality to the Company; or
(e) is required to be disclosed by law, provided, however, Executive shall
render reasonable cooperation, at Company's expense, to lawfully
prevent or minimize any such public disclosure of Confidential
Information through protective orders or other similar measures.
5.3 OWNERSHIP AND RETURN OF COMPANY PROPERTY. All Confidential
Information or other Company property in Executive's possession, custody or
control, including without limitation, all documents, reports, manuals, business
plans, minutes, memoranda, computer software, computer databases, computer
print-outs, member or customer lists, credit cards, keys, identification,
products, access cards, and all other tangible or intangible property relating
in any way to the business of the Company are the exclusive property of the
Company, even if Executive authored, created or assisted in authoring or
creating such property. Executive shall return to the Company all such
Confidential Information or other property immediately upon termination of
employment for any reason whatsoever or at such earlier time as the Company may
reasonably request.
5.4 DISCLOSURE AND ASSIGNMENT OF INVENTIONS AND OTHER WORKS. Executive
shall promptly disclose to the Company in writing all Inventions and Works of
Authorship which are conceived, made, discovered, written or created by
Executive alone or jointly with another person, group or entity, whether during
the normal hours of his employment at the Company or on Executive's own time,
during the term of this Agreement and for twelve (12) months after termination
of this Agreement. Executive hereby assigns all rights to all such Inventions
and Works of Authorship to the Company. Executive shall give the Company all
the assistance it reasonably requires for the Company to perfect, protect, and
use its rights to such Inventions and Works of Authorship. Executive shall sign
all such documents, take all such actions and supply all such information that
the Company considers necessary or desirable to transfer or record the transfer
of Executive's entire right, title and interest in such Inventions and Works of
Authorship and to enable the Company to obtain exclusive patent, copyright, or
other legal protection for Inventions and Works of Authorship anywhere in the
world, provided, the Company shall bear all reasonable expenses of Executive in
such rendering cooperation.
5.5 EXCLUSIONS. Notwithstanding Section 5.4 above, the following shall
not be deemed Inventions or Works of Authorship assigned to the Company by
Executive hereunder: Any invention or work of authorship for which no
equipment, supplies, facility or Confidential Information of the Company was
used and which was developed entirely on Executive's own time, and which (a)
does not relate (i) directly to the business of the Company or (ii) to the
Company's actual or demonstrably anticipated research or development, or (b)
which does not result from any work performed by Executive for the Company.
ARTICLE 6.0 NON-COMPETITION AND NON-SOLICITATION COVENANTS
6.1 NON-COMPETITION COVENANT. Subject to Section 6.2 and 6.3 below,
during the term of this Agreement and for a period of twelve (12) months
following termination of employment for any reason, Executive shall not directly
or indirectly, alone or as a partner, officer, director, shareholder or employee
of any other firm or entity, engage in any activity anywhere in the United
States in direct competition with the Company. For purposes hereof,
"shareholder" shall not include beneficial ownership of less than five percent
(5%) of the combined voting power of all issued and outstanding
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<PAGE>
voting securities of a publicly held corporation whose stock is traded on a
major stock exchange or quoted on the Nasdaq National Market or SmallCap Market.
6.2 EARLY TERMINATION WITHOUT GOOD CAUSE OR WITH GOOD REASON.
Notwithstanding Section 6.1 above, if Executive's employment terminates under
circumstances which entitle him to receive compensation and benefits payments
pursuant to Section 4.9(d) above and if the Company fails to provide Executive
with any such compensation or benefits due him pursuant to said Section 4.9(d)
and does not remedy such failure within ten (10) days after receipt of notice
thereof from Executive, the covenant set forth in Section 6.1 above shall
thereafter cease to apply to Executive for the remainder of the period to which
such covenant would otherwise apply, notwithstanding any subsequent remedy of
such failure by the Company.
6.3 COMPANY'S OPTION TO REVISE. At its sole option, the Company may, by
written notice to Executive, within thirty (30) days after the effective date of
the termination of Executive's employment, waive or limit the line of business,
time period and/or geographic area in which Executive is prohibited from
engaging in competitive activity under Section 6.1 above.
6.4 COVENANT NOT TO SOLICIT. Executive hereby acknowledges that the
Company's employees, consultants and other contractors constitute vital and
valuable aspects of its business and missions on a world-wide basis. In
recognition of that fact, for a period of twelve (12) months following the
termination of this Agreement for any reason whatsoever, Executive shall not
solicit, or assist anyone else in the solicitation of, any of the Company's
then-current employees, consultants or other contractors to terminate their
respective relationships with the Company and to become employees, consultants
or contractors by any enterprise with which the Executive may then be
associated, affiliated or connected.
ARTICLE 7.0 DISPUTE RESOLUTION
7.1 DISPUTE RESOLUTION. Except as provided in Section 7.2 below, the
Company and Executive shall each use its best efforts to resolve any dispute
between them promptly and amicably and without resort to any legal process if
feasible within thirty (30) days of receipt of a written notice by one party to
the other party of the existence of such dispute. Except as provided in Section
7.2 below, no further action may be taken under this Article 7 unless and until
one or more members of the Board and Executive have met in good faith to discuss
and settle such dispute. The foregoing requirement in this Section 7.1 shall be
without prejudice to either party's rights, if applicable, to terminate this
Agreement under Article 4.0 above.
7.2 LITIGATION RIGHTS RESERVED. If any dispute arises with regard to the
unauthorized use or infringement of Confidential Information by Executive or
with regard to Executive's breach or threatened breach of his non-competition or
non-solicitation covenants, the Company may seek any available remedy at law or
in equity from a court of competent jurisdiction.
7.3 PROCEDURE FOR ARBITRATION. Except as provided in Section 7.2 above,
any dispute, claim or controversy arising out of or in connection with this
Agreement which has not been settled through negotiation within a period of
thirty (30) days after the date on which either party shall first have notified
the other party in writing of the existence of a dispute shall be settled by
final and binding arbitration under the then applicable Commercial Arbitration
Rules of the American Arbitration Association ("AAA"). Any such arbitration
shall be conducted by one (1) neutral arbitrator appointed by mutual agreement
of the parties or, failing such agreement, in accordance with said Rules. Such
arbitrator shall be an experienced business attorney with a background in
employment law. Any such
-8-
<PAGE>
arbitration shall be conducted in Minneapolis, Minnesota. An arbitral award
may be enforced in any court of competent jurisdiction. Notwithstanding any
contrary provision in the AAA Rules, the following additional procedures and
rules shall apply to any such arbitration:
(a) Each party shall have the right to request from the arbitrator, and
the arbitrator shall order upon good cause shown, reasonable and
limited prehearing discovery, including (i) exchange of witness lists,
(ii) depositions under oath of named witnesses at a mutually
convenient location, (iii) written interrogatories, and (iv) document
requests.
(b) Upon conclusion of the pre-hearing discovery, the arbitrator shall
promptly hold a hearing upon the evidence to be adduced by the parties
and shall promptly render a written opinion and award.
(c) The arbitrator shall adhere strictly to the sole and exclusive
remedies set forth in Article 4.0 above and may not award or assess
punitive damages against either party.
(d) Each party shall bear its own costs and expenses of the arbitration
and one-half (1/2) of the fees and costs of the arbitrator, subject to
the power of the arbitrator, in his or her sole discretion, to award
all such reasonable costs, expenses and fees to the prevailing party.
ARTICLE 8.0 GENERAL PROVISIONS
8.1 SUCCESSORS AND ASSIGNS. This Agreement constitutes a personal service
agreement on the part of Executive and his duties hereunder may not be assigned
or delegated to any other person without the prior written consent of the
Company, but all rights of Executive hereunder shall inure to the benefit of and
be enforceable by Executive's personal or legal representatives, executors,
administrators, successors, heirs, distributees, devisees and legatees. If
Executive should die while any amounts would still be payable to Executive
hereunder if Executive had continued to live, all such amounts, unless otherwise
provided herein, shall be paid in accordance with the terms of this Agreement to
Executive's devisee, legatee, or other designee or, if there be no such
designee, to Executive's estate.
8.2 NOTICES. All notices, requests and demands required or permitted
hereunder shall be in writing and be personally or courier delivered or mailed
postage prepaid, registered or certified U.S. mail to the other party at its
address set forth on the last page of this Agreement. Either party may, by
notice hereunder, designate a changed address. Any notice hereunder shall be
deemed effectively given and received: (a) if personally or courier delivered,
upon delivery; or (b) if mailed, on the third (3rd) day after deposit in the
mail.
8.3 CAPTIONS. The various headings or captions in this Agreement are for
convenience only and shall not affect the meaning or interpretation of this
Agreement.
8.4 GOVERNING LAW; CHOICE OF FORUM. The validity, interpretation,
construction, performance, enforcement and remedies of or relating to this
Agreement, and the rights and obligations of the parties hereunder, shall be
governed by the substantive laws of the State of Minnesota (without regard to
the conflict of laws rules or statutes of any jurisdiction), and, expressly
subject to the dispute resolution mechanism in Article 7.0 above, any and every
other legal proceeding arising out of or in connection with this Agreement shall
be brought in the appropriate courts of the State of Texas, each of the parties
hereby consenting to the exclusive jurisdiction of said courts for this purpose.
-9-
<PAGE>
8.5 CONSTRUCTION. Wherever possible, each provision of this Agreement
shall be interpreted in such manner as to be effective and valid under
applicable law, but if any provision of this Agreement shall be prohibited by or
invalid under applicable law, such provision shall be ineffective only to the
extent of such prohibition or invalidity without invalidating the remainder of
such provision or the remaining provisions of this Agreement.
8.6 WAIVERS. No failure on the part of either party to exercise, and no
delay in exercising, any right or remedy hereunder shall operate as a waiver
thereof; nor shall any single or partial exercise of any right or remedy
hereunder preclude any other or further exercise thereof or the exercise of any
other right or remedy granted hereby or by any related document or by law.
8.7 MODIFICATION. This Agreement may not be modified or amended except by
written instrument signed by Executive and another officer of the Company who is
not the Executive and who is authorized to do so by the Board.
8.8 ENTIRE AGREEMENT, This Agreement constitutes the entire agreement and
understanding between the parties hereto in reference to all the matters herein
agreed upon. This Agreement replaces in full all prior employment offers,
discussions, requests, agreements or understandings of the parties hereto, and
any and all such prior offers, discussions, requests, agreements or
understandings are hereby rescinded by mutual agreement.
IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be duly
executed and delivered as of the day and year first above written in Buffalo,
Minnesota.
EXECUTIVE NUTRITION MEDICAL, INC.
By:_________________________ By:__________________________
William L. Rush Richard J. Hegstrand
Chief Financial Officer
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<PAGE>
EXHIBIT 11.1
NUTRITION MEDICAL, INC.
STATEMENT OF COMPUTATION
OF NET LOSS PER SHARE
Years ended December 31,
------------------------
1996 1995
---------- ------
Primary and Fully Diluted:
Average shares outstanding . . . . . . . . . . . 3,489,120 2,059,808
SAB No. 83- for stock issued and
options or warrants granted
at exercise prices less than the
initial public offering price
during the 12 months preceding
the initial public offering using
the treasury method . . . . . . . . . . . . 836,264 1,115,019
Total. . . . . . . . . . . . . . . . . . . . . . 4,325,384 3,174,827
========= =========
Net loss . . . . . . . . . . . . . . . . . . . . $(759,012) $(959,623)
======== ========
Net loss per share . . . . . . . . . . . . . . . $(.18) $(.30)
==== ====
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE BALANCE
SHEET OF NUTRITION MEDICAL, INC. AS OF DECEMBER 31, 1996 AND THE RELATED
STATEMENT OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 1996, AND IS QUALIFIED
IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> DEC-31-1996
<CASH> 2,553,955
<SECURITIES> 1,671,596
<RECEIVABLES> 356,271
<ALLOWANCES> 31
<INVENTORY> 460,115
<CURRENT-ASSETS> 34,039
<PP&E> 182,881
<DEPRECIATION> 50,512
<TOTAL-ASSETS> 5,208,314
<CURRENT-LIABILITIES> 509,078
<BONDS> 0
0
0
<COMMON> 6,989,217
<OTHER-SE> (2,289,981)
<TOTAL-LIABILITY-AND-EQUITY> 5,208,314
<SALES> 2,402,267
<TOTAL-REVENUES> 2,402,267
<CGS> 1,550,396
<TOTAL-COSTS> 1,690,740
<OTHER-EXPENSES> (83,932)
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 4,075
<INCOME-PRETAX> (759,012)
<INCOME-TAX> 0
<INCOME-CONTINUING> (759,012)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (759,012)
<EPS-PRIMARY> (.18)
<EPS-DILUTED> (.18)
</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.
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.
1
<PAGE>
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.
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.
2
<PAGE>
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 purchasers in
this offering, and debt financing, if available, may 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.
3
<PAGE>
COMPETITION
Competition in the clinical care 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.
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 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.
4
<PAGE>
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 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.
5
