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U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB
[ X ] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 1997
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from ________ to _________
COMMISSION FILE NUMBER 0-22247
NUTRITION MEDICAL, INC.
(Exact name of Small Business Issuer as specified in its charter)
MINNESOTA 41-1756256
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification Number)
9850 51ST AVENUE NORTH, SUITE 110, MINNEAPOLIS, MN 55442
(Address of principal executive offices)
(612) 551-9595
(Issuer's telephone number)
Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such
shorter period that the registrant was required to file such reports), and (2)
has been subject to such filing requirements for the past 90 days.
Yes X No
----- -----
State the number of shares outstanding of each of the issuer's classes of
common equity, as of the last practicable date:
Class Outstanding as of August 8, 1997
----- --------------------------------
Common Stock, $.01 par value 5,455,024 shares
Transitional Small Business Disclosure Format (Check one): Yes No X
----- -----
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NUTRITION MEDICAL, INC.
INDEX
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements Page No.
--------
Condensed Statements of Operations (Unaudited) For the
Three and Six Months Ended June 30, 1997 and 1996 2
Condensed Balance Sheets (Unaudited) As of
June 30, 1997 and December 31, 1996 3
Condensed Statements of Cash Flows (Unaudited)
For the Six Months Ended June 30, 1997 and 1996 4
Notes to Condensed Financial Statements (Unaudited) 5
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 7
PART II - OTHER INFORMATION
Item 1. Legal Proceedings 13
Item 2. Changes in Securities 13
Item 4. Submission of Matters to a Vote of Security Holders 14
Item 6. Exhibits and Reports on Form 8-K 14
1
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PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
NUTRITION MEDICAL, INC.
CONDENSED STATEMENTS OF OPERATIONS
(Unaudited)
<TABLE>
<CAPTION>
Three months ended Six months ended
June 30, June 30,
-------- --------
1997 1996 1997 1996
---- ---- ---- ----
<S> <C> <C> <C> <C>
Net sales $ 1,329,978 $ 381,126 $ 2,543,978 $1,086,049
Cost of goods sold 1,031,829 249,215 1,931,434 682,194
------------- ---------- ------------ ----------
Gross profit 298,149 131,911 612,544 403,855
Operating expenses:
Selling, general and administrative 635,617 265,514 1,280,103 577,679
Research and development 119,813 44,436 237,004 96,155
------------- ---------- ------------ ----------
755,430 309,950 1,517,107 673,834
------------- ---------- ------------ ----------
Operating loss (457,281) (178,039) (904,563) (269,979)
Other income (expense):
Interest income 38,449 8,813 87,118 19,468
Interest expense (49,737) (1,479) (91,145) (2,904)
------------- ---------- ------------ ----------
(11,288) 7,334 (4,027) 16,564
------------- ---------- ------------ ----------
Net loss $ (468,569) $ (170,705) $ (908,590) $ (253,415)
------------- ---------- ------------ ----------
------------- ---------- ------------ ----------
Net loss per share $ (.08) $ (.05) $ (.17) $ (.06)
------------- ---------- ------------ ----------
------------- ---------- ------------ ----------
Weighted average number of shares
outstanding 5,452,835 3,105,524 5,393,430 4,220,816
------------- ---------- ------------ ----------
------------- ---------- ------------ ----------
</TABLE>
See accompanying notes to condensed financial statements
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NUTRITION MEDICAL, INC.
CONDENSED BALANCE SHEETS
June 30, December 31,
1997 1996
---- ----
(Unaudited) (Note)
ASSETS
Current assets:
Cash and cash equivalents $ 2,778,946 $ 2,553,955
Short-term investments ---- 1,671,596
Accounts receivable (net) 903,730 356,240
Inventories 1,762,243 460,115
Prepaid expenses 318,369 34,039
------------ ------------
Total current assets 5,763,288 5,075,945
Equipment and office furniture (net) 949,217 132,369
Goodwill (net) 3,346,601 --
------------ ------------
Total assets $ 10,059,106 $ 5,208,314
------------ ------------
------------ ------------
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 1,097,477 $ 269,037
Accrued expenses 314,588 240,041
------------ ------------
Total current liabilities 1,412,065 509,078
Subordinated note payable (net) 1,643,145 --
Shareholders' equity:
Common stock, $.01 par value, 20,000,000
shares authorized, 5,455,024 and 4,593,024
issued and outstanding in 1997 and 1996 54,550 45,930
Additional paid-in capital 10,147,917 6,943,287
Accumulated deficit (3,198,571) (2,289,981)
------------ ------------
Total shareholders' equity 7,003,896 4,699,236
------------ ------------
Total liabilities and shareholders'
equity $ 10,059,106 $ 5,208,314
------------ ------------
------------ ------------
Note: The balance sheet at December 31, 1996 has
been derived from the audited financial
statements at that date but does not include all
of the information and footnotes required by
generally accepted accounting principles for
complete financial statements.
See accompanying notes to condensed financial statements
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NUTRITION MEDICAL, INC.
CONDENSED STATEMENTS OF CASH FLOWS
(UNAUDITED)
Six months ended
June 30,
--------
1997 1996
---- ----
OPERATING ACTIVITIES
Net loss $ (908,590) $ (253,415)
Adjustments to reconcile net loss to net cash
used in operating activities:
Amortization 210,968 --
Depreciation 122,673 11,359
Value of options and warrants granted
for services performed -- 14,500
Changes in operating assets and liabilities:
Accounts receivable (547,490) (78,544)
Inventories (802,128) 82,479
Prepaid expenses (284,330) (32,121)
Accounts payable 828,440 (82,032)
Accrued expenses 74,547 (15,293)
----------- -----------
Net cash used in operating activities (1,305,910) (353,067)
INVESTING ACTIVITIES
Proceeds from sale of short-term investments 1,671,596 --
Purchase of goodwill (58,174) --
Purchase of equipment and office furniture (89,521) (9,148)
----------- -----------
Net cash provided by (used in) investing activities 1,523,901 (9,148)
FINANCING ACTIVITIES
Proceeds from issuance of common stock 7,000 125,000
----------- -----------
Net cash provided by financing activities 7,000 125,000
----------- -----------
Increase (decrease) in cash 224,991 (237,215)
Cash and cash equivalents at beginning of period 2,553,955 1,127,247
----------- -----------
Cash and cash equivalents at end of period $ 2,778,946 $ 890,032
----------- -----------
----------- -----------
SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTMENT AND
FINANCING ACTIVITIES
Acquisition of Elan Pharma, Inc. product
line through:
Issuance of note payable $ 1,593,750
Issuance of common stock 3,206,250
See accompanying notes to condensed financial statements
4
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NUTRITION MEDICAL, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
1. BASIS OF PRESENTATION
The condensed financial statements as of June 30, 1997 and for the three
and six-month periods ended June 30, 1997 and 1996 included in this Form 10-QSB
have been prepared by the Company pursuant to the rules and regulations of the
Securities and Exchange Commission. Certain information and footnote
disclosures, normally included in financial statements prepared in accordance
with generally accepted accounting principles, have been condensed or omitted
pursuant to such rules and regulations. These financial statements should be
read in conjunction with the financial statements and related notes thereto
included in the Company's December 31, 1996 Annual Report on Form 10-KSB.
The condensed financial statements presented herein as of June 30, 1997 and
for the three and six-month periods ended June 30, 1997 and 1996 are unaudited,
but in the opinion of management, reflect all adjustments, consisting of normal
recurring adjustments, necessary for a fair presentation of financial position,
results of operations and cash flows for the periods presented. The results of
operations for any interim period are not necessarily indicative of results for
the full year.
2. PRODUCT LINE ACQUISITION
On January 13, 1997, the Company executed an Asset Purchase Agreement (the
"Agreement") whereby the Company acquired certain assets from Elan Pharma, Inc.
("Elan"), a U.S. subsidiary of Ireland-based Elan Corporation, plc. The assets
purchased pursuant to the Agreement include the inventory and fixed assets
relating to the production of the enteral (tube feeding) products (the "Acquired
Products") of Elan as well as exclusive rights to manufacture and market the
Acquired Products. In exchange for the Acquired Products and related assets, the
Company issued Elan a subordinated promissory note in the amount of $3,000,000
(due in seven years along with interest accruing at three percent per annum) and
855,000 shares of the Company's common stock. The Agreement allows for the
forgiveness of up to 100% of the promissory note based upon the Company's future
stock performance and contains provisions which restrict Elan's ability to vote
or sell the shares of Common Stock. Total value of the transaction, after
taking into consideration market interest rates on the note payable, and $58,174
in acquisition expenses associated with the purchase, was $4,858,174.
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NUTRITION MEDICAL, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
2. PRODUCT LINE ACQUISITION (CONTINUED)
Based upon management's estimates of asset values, taking into
consideration market values and condition of the assets as well as the future
cash flows estimated to be generated from the Acquired Products, the following
represents an allocation of the purchase price to the acquired assets, with the
excess of the purchase price over the assets allocated to goodwill:
Inventory $ 500,000
Manufacturing equipment 500,000
Leased pumps 350,000
Goodwill 3,508,174
----------
$4,858,174
----------
----------
3. NET LOSS PER SHARE
Net loss per share is computed using the weighted average number of common
shares outstanding during the period. Common equivalent shares from stock
options and warrants are excluded from the computation as their effect is
antidilutive. In February 1997, the Financial Accounting Standards Board (FASB)
issued FASB Statement No. 128, "EARNINGS PER SHARE". This Statement replaces
the presentation of primary earnings per share (EPS) with basic EPS and also
requires dual presentation of basic and dilutive EPS for entities with complex
capital structures. This Statement is effective for the fiscal year ending
December 31, 1997. For the quarter ended June 30, 1997, there is no difference
between basic earnings per share under Statement No. 128 and primary net loss
per share as reported.
6
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
CAUTIONARY STATEMENT
This Quarterly Report on form 10-QSB contains forward-looking statements
within the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended. When used in
this Form 10-QSB and in future filings by the Company with the Securities and
Exchange Commission, in the Company's press releases and in oral statements made
with the approval of an authorized executive officer, the words or phrases
"believes", "anticipates", "intends", "will likely result", "estimates",
"projects" or similar expressions are intended to identify such forward -looking
statements, but are not the exclusive means of identifying such statements.
These forward-looking statements involve risks and uncertainties that may cause
the Company's actual results to differ materially from the results discussed in
the forward-looking statements. The Company wishes to caution readers not to
place undue reliance on any such forward-looking statements, which speak only as
of the date made. The Company undertakes no obligation to revise any forward-
looking statements in order to reflect events or circumstances after the date of
such statements. Readers are urged to carefully review and consider the various
disclosures made by the Company in this report and in the Company's other
reports filed with the Securities and Exchange Commission that attempt to advise
interested parties of the risks and factors that may affect the Company's
business. Such forward-looking statements are qualified in their entirety by
the cautions and risk factors set forth under the "Cautionary Statement" filed
as exhibit 99.1 to this Form 10-QSB.
GENERAL
The Company develops and sells nutrition products marketed primarily as
cost-effective, generic alternatives to equivalent national branded products.
Products to date have focused on clinical products for the healthcare industry
and adult nutrition supplements generally sold to large retailers under private
label arrangements. In addition, the Company is currently developing an infant
formula.
CLINICAL PRODUCTS
The Company's initial product development efforts centered on branded
generic products for the critical care and disease specific nutrition market.
These products are sold to hospitals and other health care providers to feed
critically ill or disabled patients who cannot consume adequate nutrients orally
and consequently require specialized feeding via tubes into the intestinal
tract. As of June 30, 1997, the Company had developed eight such products.
Critical care and disease specific nutrition products are generally purchased by
a relatively large customer base which typically places orders in relatively
small order quantities.
On January 13, 1997, the Company expanded its clinical products line by
acquiring the inventory and fixed assets associated with the production of the
enteral (tube feeding) products of Elan Pharma, Inc. as well as the exclusive
rights to manufacture and market approximately 40
7
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enteral products consisting of special formulas, disposable administration
hardware and the related delivery pumps.
During the quarter ended June 30, 1997, the Company added two formulas to
its clinical product line. In May 1997, the Company launched, Pro-Peptide-TM-
For Kids, a critical care formula designed specifically for gastrointestinally-
impaired children between the ages of one and ten. This product will be
marketed primarily to hospitals, particularly those with active pediatric
programs. In June 1997, the Company introduced Gluco-Pro-TM-, a disease
specific formula for people with hyperglycemia and diabetes. This formula will
also be marketed to hospitals, but, unlike many of the Company's critical care
products, it also has many applications in long-term care and home-care
environments. As with other new products, the Company expects that customer
trial and acceptance will vary.
RETAIL PRODUCTS-PRIVATE LABEL NUTRITION PRODUCTS
In October 1995, the Company introduced an adult nutrition supplement
product line. Adult nutrition supplements are designed to provide balanced
nutrition in beverage form as a supplement or substitute for solid food for
healthy individuals as well as those recovering from or affected by illness.
These products are marketed to retail chains and are generally packaged using
the retailer's proprietary store brand label. Such private label products allow
the retailer to offer quality, low cost alternatives to national branded adult
nutrition products. The Company's private label nutrition product line
currently consists of three adult nutrition supplements, each of which is
available in three flavors. "Light" versions of these products are currently
under development. Adult nutrition supplements are generally purchased by a
relatively small customer base which typically places relatively large orders.
RESULTS OF OPERATIONS
THREE MONTHS ENDED JUNE 30, 1997 AND 1996
NET SALES. The Company's net sales for the three months ended June 30,
1997 totaled $1,329,978, representing an increase of $948,852, or 249%, over
net sales of $381,126 in the corresponding 1996 period. Sales of the
Company's clinical products, which in the 1996 period totaled $268,589,
increased 154% to $683,626 in the three months ended June 30, 1997. Of this
increase, a substantial portion is attributable to sales of the products
acquired from Elan Pharma, Inc. in January 1997, with the balance associated
with increased sales to existing customers, newly converted customers and
sales of new products. Sales of the Company's retail products totaled
$646,352 in the three months ended June 30, 1997, an increase of $533,815,
or 474% over the corresponding 1996 period sales of $112,537. The 1997 period
sales increase is principally the result of a larger customer base and
increased order levels within this customer base.
The prices of the Company's products remained relatively stable within
and between the two reporting periods. In response to the Company's strategy
of marketing its critical care nutrition products as less expensive
alternatives to established brands, one competitor of the Company, in late
1996, lowered its prices to select customers of its branded products,
offsetting part or all of the price advantage of the Company's three
competing products. Although the Company
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continues to experience overall sales growth of these products, management
believes that these selective price reductions resulted in lost sales and
slowed the rate of sales growth of the Company's three competing products,
and that this competitor will continue to use this form of selective price
competition. Management further believes that the current impact of this
competitor's price reductions on total sales has been reduced due to the
Company's introduction of additional non-competing products in 1997.
GROSS PROFIT. The Company's gross profit increased 126% to $298,149 for
the three months ended June 30, 1997, compared with $131,911 in the same period
in 1996. The following table sets forth the gross profit and gross profit
percentage, by product line, for the three months ended June 30, 1997 and 1996:
Three months ended June 30,
---------------------------
1997 1996
------------------------ -------------------------
Product Line Gross profit % of Sales Gross Profit % of Sales
------------ ------------------------ -------------------------
Clinical Products $205,230 30.0% $143,010 53.2%
Retail Products 92,919 14.4% (11,099) (9.9)%
------------------------ -------------------------
Total $298,149 22.4% $131,911 34.6%
The decrease in overall gross profit, as a percentage of sales, is related to
product mix differences between the two periods and increased indirect
production and distribution overhead costs. The gross profit generated by the
Company's clinical products decreased as a percentage of clinical sales,
principally as a result of the introduction in the 1997 period of the lower
gross margin products acquired from Elan. These products generated a lower than
expected gross profit in the second quarter of 1997 due to higher than
anticipated freight costs and an increase in fixed costs as a percentage of
sales . Management expects that while increased sales of these acquired
products will continue to generate an increase in the clinical product gross
profit contribution, the overall gross profit, as a percentage of sales, may
decline, particularly if sales of the lower gross profit acquired products
increase as a proportion of total clinical product sales. The retail gross
profit, as a percentage of sales, of 14.4% for the three months ended June 30,
1997 is consistent with overall historical performance levels. The negative
gross profit generated in the 1996 period was the result of low sales volume
generated during that period which was unable to cover the related product line
fixed costs.
SELLING, GENERAL AND ADMINISTRATIVE. Selling, general and
administrative expenses in the three months ended June 30, 1997, increased by
$370,103, or 139% to $635,617, compared with the same period in 1996. The
increase is related to higher costs resulting from the continued development
of the Company's sales and administration infrastructure, including costs
associated with marketing the infant formula product line currently under
development, and approximately $117,000 in depreciation and goodwill
amortization charges related to the Elan Pharma, Inc. product line. These
increases were offset by a $145,000 insurance reimbursement received in the
current period for legal fees incurred by the Company in two previously
settled lawsuits.
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RESEARCH AND DEVELOPMENT. Research and development costs increased 169% to
$119,813 for the three months ended June 30, 1997, compared with $44,436 in the
corresponding 1996 period. The increase is attributable to higher costs
associated with the Company's development of several infant formula products.
SIX MONTHS ENDED JUNE 30, 1997 AND 1996
NET SALES. Net sales for the six months ended June 30, 1997 totaled
$2,543,978, compared to $1,086,049 for the same period in 1996, an increase
of $1,457,929, or 134%. Sales of the Company's clinical products increased
$898,943, or 165%, from $545,521 in the six months ended June 30, 1996 to
$1,444,464 in corresponding 1997 period. A substantial portion of the
increase is attributable to sales of the products acquired from Elan Pharma,
Inc. in January 1997, with the balance attributable to an increased customer
base and new products. Sales of the Company's retail products increased
$558,986, or 103%, to $1,099,514 in the six months ended June 30, 1997
compared to sales of $540,528 in the corresponding 1996 period. The 1997
period sales increase is principally the result of a larger customer base and
increased order levels within this customer base.
GROSS PROFIT. The Company's gross profit increased 52% to $612,544 for the
six months ended June 30, 1997, compared with $403,855 in the same period in
1996. The following table sets forth the gross profit and gross profit
percentage, by product line, for the six months ended June 30, 1997 and 1996:
Six months ended June 30,
-------------------------
1997 1996
------------------------ ------------------------
Product Line Gross profit % of Sales Gross Profit % of Sales
------------ ------------------------ ------------------------
Clinical Products $472,264 32.7% $306,896 56.3%
Retail Products 140,280 12.8% 96,959 17.9%
------------------------ ------------------------
Total $612,544 24.1% $403,855 37.2%
The decrease in overall gross profit, as a percentage of sales, is related to
product mix differences between the two periods as well as certain indirect
production and distribution overhead costs. As a result of combining the lower
gross margin products acquired from Elan Pharma Inc. in January 1997 with the
Company's previous clinical product offerings, the gross profit, as a percentage
of sales has declined. The gross profit, as a percentage of sales, on products
offered in both periods remained relatively consistent between the periods
presented. Management expects that while increased sales of the Elan acquired
products will continue to generate an increase in the clinical product gross
profit contribution, the overall gross profit, as a percentage of sales, will
decline, particularly if sales of the lower gross profit acquired products
increase as a proportion of total clinical product sales. The decrease in gross
profit as a percentage of retail product sales in the 1997 period is
attributable to a $40,000 write-off of dated product in the first quarter of
1997 and a gross profit percentage in the 1996 period that exceeded historical
levels.
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The 1997 retail product gross profit, excluding the aforementioned write-off,
was within the historical product line gross profit range.
SELLING, GENERAL AND ADMINISTRATIVE. Selling, general and administrative
expenses in the six months ended June 30, 1997 totaled $1,280,103, an increase
of $702,424, or 122%, over the $577,679 expensed in the corresponding 1996
period. The increase is related to higher costs resulting from the continued
development of the Company's sales and administration infrastructure in support
of new products and approximately $216,000 in depreciation and goodwill
amortization charges related to the Elan Pharma, Inc. product acquisition.
RESEARCH AND DEVELOPMENT. Research and development costs increased
$140,849, or 146%, to $237,004 for the six months ended June 30, 1997, compared
with $96,155 in the corresponding 1996 period. The increase is attributable to
higher costs associated with the Company's development of several infant formula
products.
LIQUIDITY AND CAPITAL RESOURCES
Since inception, the Company has incurred net losses and negative cash
flows from operations. On September 26, 1996, the Company's initial public
offering was declared effective by the Securities and Exchange Commission. The
Company sold pursuant to this registration statement, in a transaction that
closed on October 1, 1996, 1,437,500 shares of the Company's Common Stock at
$3.50 per share, including an overallotment of 197,500 shares. Net proceeds to
the Company, after deducting all offering costs, totaled $4.24 million. Unused
funds are invested in U.S. Treasury bills with maturities ranging from one to
six months.
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 received approximately $2,800,000 in net proceeds.
The Company also obtained loans from the City of Buffalo, Minnesota totaling
$100,000. These loans were repaid in July 1996 when the Company relocated to
Minneapolis, Minnesota.
On January 13, 1997, the Company executed an Asset Purchase Agreement
whereby the Company acquired certain assets from Elan Pharma, Inc. ("Elan"), a
U.S. subsidiary of the Ireland-based Elan Corporation, plc. The agreement
provides for the sale to the Company of the inventory and fixed assets relating
to the production of the enteral (tube feeding) products of Elan as well as
exclusive rights to manufacture the products. In exchange for the product rights
and related assets, the Company issued the seller 855,000 shares of common stock
and a subordinated promissory note in the amount of $3,000,000. The note, along
with all interest, which accrues at 3% per annum, is due in seven years.
In connection with the above described activities and results of
operations, the Company's net cash used by operations in the six months ended
June 30, 1997 totaled $1,305,910. Cash and cash equivalents as of June 30, 1997
totaled $2,778,946. The Company utilizes several contract manufacturers to
produce its products. Two of these contractors have scheduled production line
shutdowns in the third quarter of 1997. As a result of these shutdowns and
several large customer shipments which required delivery dates just subsequent
to June 30,
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1997, the Company increased its inventory levels as of June 30, 1997 of products
affected by these events. Management believes that this temporary impact on
inventory levels has resulted in inventory levels that, as of June 30, 1997,
were approximately $500,000 above desired levels.
The Company expects that the existing cash balances will be sufficient to
fund operations of the Company through 1997. However, the Company's future
liquidity and capital requirements will depend on numerous factors including
competition, the extent to which the Company's products gain market acceptance
and the costs and timing of expansion of sales, marketing and product
development activities. There can be no assurance that the Company will not be
required to raise additional capital before the end of 1997 or any time
thereafter, or that such capital will be available on acceptable terms, or at
all. The Company's strategy for 1997 includes pursuing the establishment of a
bank line of credit to secure additional operating funds, should they be needed.
There can be no assurance that such a credit line, if needed, can be secured on
terms acceptable to the Company.
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PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
In August 1995, the Company was named as a defendant in a patent
infringement lawsuit brought by Novartis, formerly Sandoz Nurtrition, in the
United States District Court for the District of Minnesota. The complaint
asserts that one of the Company's products, L-Emental-TM- 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 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 the reexamination by the United States patent
and Trademark Office of both patents. On August 13, 1997 the Company received
notification that the United States Patent and Trademark Office will reissue
the two patents under review. The Company expects that the litigation which
was stayed pending this determination will resume and intends to continue to
defend vigorously against the claim. Sales of L-Elemental Plus constituted
$298,000, or 35% and $458,000 or 19 percent, of the Company's net sales in
1995 and 1996, respectively and $203,000 or 8 percent of sales in the six
months ended June 30, 1997. 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 2. CHANGES IN SECURITIES
c) Options exercised within the period from April 1, 1997 to June
30, 1997:
Date: Number of Shares Exercised:
April 4, 1997 1,000
April 9, 1997 1,000
April 15, 1997 1,000
April 22, 1997 1,000
April 30, 1997 1,000
May 28, 1997 1,000
June 5, 1997 1,000
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ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The annual meeting of Shareholders of the Company was held on May 8, 1997
at which time (i) four nominees were elected to the Board of Directors for one-
year terms and (ii) the appointment of Ernst & Young LLP as the independent
auditors of the Company was, approved. Proxies for the Company were solicited
pursuant to Section 14(a) of the Securities Exchange Act of 1934, as amended,
and there was no solicitation in opposition to management's solicitations. All
nominees for directors as listed in the proxy statement were elected. The
voting results were as follows:
Election of Directors:
For Withhold Authority
--------- ------------------
William L. Rush 3,690,161 3,000
George E. Kline 3,690,161 3,000
Kenneth L. Evenstad 3,690,161 3,000
Lawrence A. Lehmkuhl 3,690,161 3,000
Approval of Independent Auditors:
For Against Abstain Broker Non-Vote
--- ------- ------- ---------------
Ernst & Young LLP 3,690,161 0 3,000 0
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a) The following exhibits are included with this quarterly report on
Form 10-QSB as required by Item 601 of Regulation S-B.
Exhibit
Number Description
------- -----------
11 Calculation of loss per share
27 Financial data schedule
99.1 Cautionary Statement
b) Reports on Form 8-K.
There were no reports on Form 8-K filed during the quarter ended
June 30, 1997.
14
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SIGNATURE
In accordance with the requirements of the Securities Exchange Act of 1934,
the registrant caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.
NUTRITION MEDICAL, INC.
Dated: August 11, 1997 By:/s/ Richard J. Hegstrand
--------------------------
Richard J. Hegstrand
Chief Financial Officer
15
<PAGE>
EXHIBIT INDEX
Exhibit
Number Description
------- -----------
11 Calculation of loss per share
27 Financial data schedule
99.1 Cautionary Statement
16
<PAGE>
EXHIBIT 11
COMPUTATION OF LOSS PER SHARE
<TABLE>
<CAPTION>
Three months ended Six months ended
June 30, June 30,
-------- --------
1997 1996 1997 1996
---- ---- ---- ----
<S> <C> <C> <C> <C>
PRIMARY AND FULLY DILUTED:
Average shares outstanding 5,452,835 3,105,524 5,393,430 3,105,797
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 1,115,019
Dilutive stock equivalents --- --- --- ---
---------- ---------- ---------- ----------
Total 5,452,835 3,105,524 5,393,430 4,220,816
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
Net loss $ (468,569) $ (170,705) $ (908,590) $ (253,415)
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
Net loss per share $ (.08) $ (.05) $ ( .17) $ (.06)
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
BALANCE SHEETS OF NUTRITION MEDICAL, INC. AS OF JUNE 30, 1997 AND 1996,
AND THE RELATED STATEMENTS OF OPERATIONS FOR THE THREE AND SIX MONTHS
ENDED MARCH 31, 1997 AND 1996, AND IS QUALIFIED IN ITS ENTIRETY BY
REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> JUN-30-1997
<CASH> 2,778,946
<SECURITIES> 0
<RECEIVABLES> 936,927
<ALLOWANCES> 33,197
<INVENTORY> 1,762,243
<CURRENT-ASSETS> 5,763,288
<PP&E> 1,122,402
<DEPRECIATION> 173,185
<TOTAL-ASSETS> 10,059,106
<CURRENT-LIABILITIES> 1,412,065
<BONDS> 1,643,145
0
0
<COMMON> 10,202,467
<OTHER-SE> (3,198,571)
<TOTAL-LIABILITY-AND-EQUITY> 10,059,106
<SALES> 2,543,978
<TOTAL-REVENUES> 2,543,978
<CGS> 1,931,434
<TOTAL-COSTS> 1,931,434
<OTHER-EXPENSES> 1,517,107
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 91,145
<INCOME-PRETAX> (908,590)
<INCOME-TAX> 0
<INCOME-CONTINUING> (908,590)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (908,590)
<EPS-PRIMARY> (.17)
<EPS-DILUTED> (.17)
</TABLE>
<PAGE>
EXHIBIT 99.1
CAUTIONARY STATEMENT
Nutrition Medical, Inc. (the "Company"), or persons acting on behalf of the
Company, or outside reviewers retained by the Company making statements on
behalf of the Company, or underwriters, from time to time may make, in writing
or orally, "forward-looking statements" as defined under the Private Securities
Litigation Reform Act of 1996 (the "Act"). This Cautionary Statement is for the
purpose of qualifying for the "safe harbor" provisions of the Act and is
intended to be a readily available written document that contains factors, any
one of which may cause actual results to differ from those which might be
projected, forecast, estimated or budgeted by in such forward-looking statement.
The factors set forth below are in addition to any other cautionary statements,
written or oral, which may be made or referred to in connection with any such
forward-looking statement.
The following matters, among others, may have a material adverse effect on
the business, financial condition, liquidity, results of operations or
prospects, financial or otherwise, of the Company:
LACK OF OPERATING PROFITS; LIMITED OPERATING HISTORY
The Company, which was incorporated in July 1993, is subject to all of the
risks inherent in the establishment of a new business. The likelihood of the
success of the Company must be considered in light of the difficulties, expenses
and delays frequently encountered in connection with the development and
marketing of new products and the competitive environment in which the Company
is operating.
Although the Company began generating revenues from product sales in
May 1994, the Company has accumulated substantial losses to date. No assurance
can be given that the Company will be able to achieve profitability. Further,
there can be no assurance that the Company will be able to successfully develop
or market additional products or that the Company will have sufficient funds
available to successfully market its current products or any new products that
it may develop in the future.
PRODUCT ACCEPTANCE AND PRICING
The Company's products are designed to be substantially equivalent to
existing branded competitive products. Although the Company believes that the
quality and efficacy of its products is comparable to branded competitive
products, no independent comparison between the Company's products and
competitive products has been completed and there can be no assurance that the
efficacy or quality of the Company's products is or will be comparable to
branded competitive products.
<PAGE>
Furthermore, the Company's name and its products are relatively unknown to
large segments of the Company's target markets, and there can be no assurance
that the Company's marketing efforts will achieve sufficient name recognition of
the Company and its products to significantly enhance revenues.
The principal advantage of the Company's products is, and is expected to
be, lower price. The Company is aware of one competitor in the critical care
nutrition products market that has historically 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 have resulted in indeterminable lost
sales of the Company's competing products, and other competitors may adopt
the same strategy. The market for the clinical nutrition products acquired
from Elan Pharma, Inc. in January 1997 is expected to be extremely price
competitive and often involves the need to offer package pricing of products.
The Company has also encountered price competition from other suppliers of
adult nutrition supplements. Because the Company's marketing strategy is
focused on the price advantage of its products, if a competitor selling
competitive products reduces or eliminates the price advantage of the
Company's products, there can be no assurance that the Company can compete
successfully with such a competitor or operate profitably under such
conditions.
DEVELOPMENT OF NEW PRODUCTS
The Company intends to continue to develop new products, which will require
both the timely identification of market opportunities and the identification
of, and the negotiation of contracts with, suitable technical consultants. There
can be no assurance that an adequate market opportunity will exist for the
potential products the Company selects for development or that such products
will be successfully developed or marketed.
DEPENDENCE ON CONTRACT MANUFACTURERS
The Company engages contract manufacturers to produce its products
according to the Company's specifications. The Company relies on these
manufacturers to comply with all applicable government regulations and
manufacturing guidelines. There can be no assurance that contract manufacturers
will consistently supply adequate quantities of the Company's products on a
timely basis, that such manufacturers will consistently comply with government
regulations or that the quality of such products will be consistently
maintained. In the event of a sale of a defective product, the Company would be
exposed to product liability claims and could lose customer confidence. In
addition, minimum quantity order requirements imposed by manufacturers may
result in excess inventory levels, requiring additional working capital and
increasing exposure to losses from inventory obsolescence. Although the Company
believes it could find alternative manufacturers for its products, any
interruption in supply of any of the Company's products could adversely affect
the Company's ability to market its products and, therefore, the Company's
business, financial condition and results of operations.
<PAGE>
DEPENDENCE ON RETAIL DISTRIBUTION OF PRODUCTS
The Company's private label nutrition products are sold only through retail
chains. The Company's strategy includes the development of additional products,
including an infant formula that is currently under development by the Company.
There can be no assurance that the Company will be able to enter into
arrangements with retailers to market its infant formula or any other private
label products or that any such arrangements will result in successful product
commercialization. The Company's future profitability will depend in large part
upon the Company's ability to develop products that meet the needs of these
potential retail customers and upon the marketing efforts of such retailers.
Although the Company believes that its current and prospective retail customers
have an economic motivation to market vigorously the Company's products, the
amount and timing of resources to be devoted to marketing by such retailers is
not within the control of the Company. In addition, successful commercialization
might result in a substantial portion of the Company's revenues being generated
by one or a few retailers. Such retailers could make material marketing and
other commercialization decisions that would adversely affect the Company's
future revenues, financial condition and results of operations.
POSSIBLE FLUCTUATIONS IN OPERATING RESULTS
The Company believes that its future operating results may be subject to
substantial quarterly fluctuations because its retail customers and a large OEM
pump customer may order large quantities at irregular intervals. In addition,
the gross profit as a percentage of sales on the Company's private label
nutrition products is substantially less than the gross profit percentage on the
Company's critical care and clinical nutrition products, and therefore the
Company's overall gross profit percentage could vary widely based on the product
mix in a given period. To the extent that quarterly revenues and operating
results fluctuate substantially, the market price of the Company's common stock
may be affected.
CUSTOMER CONCENTRATION
Although the Company's experience with its customer base is limited, retail
customers often place a large initial stocking order that can increase the
relative importance of a particular customer in a particular period. In
addition, the Company may incur similar concentration issues with large
distributors and OEM customers for its clinical nutrition products, including
the products acquired from Elan. There can be no assurance that such retail
orders will continue or that its future orders will not significantly decline.
FUTURE CAPITAL REQUIREMENTS; NO ASSURANCE FUTURE CAPITAL WILL BE AVAILABLE
Although the Company's existing cash balances are expected to be sufficient
to fund the Company's operations through 1997, under certain circumstances the
Company may require substantial additional funds before the end of 1997 to meet
its working capital requirements in connection with the introduction of new
products, including its proposed infant formula. In order to meet this possible
need, and to meet possible needs after 1997, the Company may be required to
raise additional funds through public or private financings, including equity
financings. Any additional equity financings may be dilutive to existing
shareholders, and debt financing, if available, may
<PAGE>
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.
<PAGE>
COMPETITION
Competition in the clinical nutrition products market consists of
established companies that sell branded products which have achieved a high
level of customer awareness. Although the Company believes it is the only
company currently offering low cost, generic alternatives to the established
brands, other companies may enter this market.
Competition in the private label nutrition market consists of companies
that sell established national brands and companies that sell private label
products. Competitors that sell private label products include established
companies that produce private label products for a wide range of markets and a
number of small producers of private label products. Nearly all of the Company's
competitors and potential competitors have substantially greater financial
resources, more extensive business experience and more personnel than the
Company. The Company's ability to compete will depend on the timeliness of the
development of its products and its ability to market its products effectively.
The Company is currently developing, for sale to regional and national
retail and grocery chains, a lower-priced infant formula designed to be
equivalent in nutritional profile and efficacy to the leading national brand.
The Company is aware of a competitor marketing an already existing lower-priced
infant formula, which Management believes is not equivalent to the national
brand. The Company believes that this competitor has been selected as a
supplier and commenced shipments of their product to several retail and grocery
chains. The Company believes that while a national brand equivalent, once
developed, will give it a competitive advantage over this competitor, continued
success in the marketplace by this competitor before the Company introduces its
version, may negatively impact the Company's overall long-term success with this
product.
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
<PAGE>
manufacturing practice ("CGMP") regulations and certain other regulations
designed to ensure the safety of the products. The Company's proposed infant
formula will undergo an adequate and well controlled clinical study, in
accordance with good clinical practice, to determine whether the formula
supports normal physical growth in infants when fed as the sole source of
nutrition. There can be no assurance that the Company's proposed infant formula,
if developed, would successfully complete this trial.
Additionally, the FDA has recently proposed significant revisions to its
infant formula regulations to establish requirements for quality factors and
CGMP, and to amend its quality control procedure, notification, and records and
report requirements for infant formulas. These regulations, if adopted, may
delay, and increase the cost of, the Company's introduction of an infant formula
product.
Claims made by the Company in labeling and advertising its products are
subject to regulation by the FDA, the Federal Trade Commission and various state
agencies under their general authority to prevent false, misleading and
deceptive trade practices. With the addition of the products acquired from Elan,
the Company will be subject to FDA regulations regarding Class 2 medical
devices. These regulations involve more stringent tracking, testing and
documentation standards. Failure to comply with such requirements can result in
adverse regulatory action, including injunctions, civil or criminal penalties,
product recalls or the relabeling, reformulation or possible termination of
certain products.
The Company's current and potential products may become subject to further
regulation in the future. The burden of such regulation could add materially to
the costs and risks of the Company's development and marketing efforts. There
can be no assurance that the Company could obtain the required approvals or
comply with new regulations if the Company's products are subject to additional
governmental regulation in the future. Failure to obtain necessary approvals or
otherwise comply with government regulations could have a material adverse
effect on the Company's future revenues, financial condition and results of
operations.
CONTROL BY PRINCIPAL SHAREHOLDERS
Directors, officers and principal shareholders of the Company own
beneficially approximately 41% of the outstanding Common Stock. As a result,
such shareholders may have the ability to effectively control the election of
the Company's entire Board of Directors and the affairs of the Company,
including all fundamental corporate transactions such as mergers, consolidations
and the sale of substantially all of the Company's assets.
TRADEMARKS
The Company has not registered its existing trademarks, but instead relies
on its common law trademark rights. The lack of such registration may impair the
ability of the Company to prosecute successfully an infringement action against
other users of these trademarks. There can be no assurance that the Company's
marks do not or will not violate the proprietary rights of others, that the
Company's proprietary rights in the marks would be upheld if challenged, or that
the Company would not be prevented from using its marks, any of which could have
an adverse effect on the Company. In
<PAGE>
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.
