Form 10-K
Annual Report Pursuant to Section 13 or 15 (d) of
the Securities Exchange Act of 1934
For the fiscal year ended July 30, 1996
Commission file number 0-21019
INNOVATIVE MEDICAL SERVICES
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(Exact name of registrant as specified in its charter)
California 84-110928
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1725 Gillespie Way, El Cajon, California 92020
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(Address of principal executive offices) (Zip Code)
Registrant's Telephone Number: (619) 596 8600
Securities registered pursuant to Section 12(b) of the Act:
Common Stock, Class A Warrants
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(Title of Class)
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, Class A Warrants
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(Title of Class)
Indicate by check mark whether the registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities
Exchange Act of 1934 during the preceding 12 months (or for such shorter
period that the registrant was required to file such reports and (2) has
been subject to such filing requirements for the past 90 days.
Yes No X
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Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-B is not contained herein, and will not be
contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form
10-KSB or any amendments to this Form 10-KSB. [ X ]
State issuer's revenues for its most recent fiscal year: $825,695
State the aggregate market value of the voting stock held by non-
affiliates of the registrant: Approximately $4,887,748 as of October 31,
1996
Indicate the number of shares outstanding of each of the issuer's
classes of common stock: 3,220,851 shares of common stock as of October 31,
1996.
Documents incorporated by reference: Exhibits to Form SB-2 Registration
Statement
File #333-00434
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PART I
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ITEM 1. DESCRIPTION OF BUSINESS
Innovative Medical Services (the Company) was incorporated in the
State of California on August 24, 1992 to pursue the immediate business of
manufacturing and marketing of the Fillmaster(R) (or the Product) and
subsequently a broadly based business of delivering advanced technology,
equipment and supplies to the Pharmacy Industry. Over the past three
years, the Company has established the production and design, entered into
contracts with its parts suppliers and or manufacturers, developed its
initial assembly process and initiated its marketing program for the
Product.
In August, 1996 the Company completed its initial public offering
whereby it sold 1,387,000 shares of its common stock at a public offering
price of $4.00 per share and 1,437,500 Class A Warrants at a public
offering price of $0.10 per Class A Warrant.
The Product is an apparatus that provides measured amounts of
"Purified Water" (as defined by the United States Pharmacopoeia, ("USP")
for reconstitution of liquid oral antibiotics and certain other pharmacy
applications. It consists of a six-stage water purification unit, an
electronic water purity testing module, an auxiliary faucet for dispensing
purified water and a calibrated volumetric measuring and dispensing
apparatus for the actual reconstitution. The entire system is closed and
pressurized and, according to the Company's testing, has a fill rate at
least three times that of current methods.
The Company also markets unique and proprietary filter replacements
for the purification unit which require changing at intervals of
approximately 9-12 months or whenever indicated by the purity testing
module. The filter replacements represent a significant continuing source
of future sales and cash flow to the Company.
There are approximately 72,000 pharmacies in the United States and
Canada, with many thousands more world-wide. Water-mixed antibiotic
prescriptions, for which the Fillmaster(R) is primarily used, make up
approximately 12.6% of a pharmacy's total prescriptions and approximately
25% of a pharmacy's gross profit.
Approximately 4,500 units of the Product have been sold to date, and
the Fillmaster(R) is specified as standard equipment for all newly
constructed and remodeled pharmacies at Walgreens, Target, Eckerd and
SavOn/Osco. In addition, Fillmasters(R) have been purchased and are now
being used by such pharmacy chains as Wal-Mart, Thrifty PayLess, Thrift
Drug, Dillon Stores, City Market, Kroger, Smith's Food and Drug, Longs
Drugs, Rite-Aid, Revco, Drug Emporium and Acme Markets. Also included in
the customer base are United States Military Clinics, including Bethesda
Naval Hospital; the Kaiser Foundation for Medical Care; the Mayo Clinic and
several hundred Independent and Hospital Pharmacies.
Gross Sales of the Company have been $179,000 and $459,000 for the
fiscal years ended 1994 and 1995 respectively. In the fiscal year ended July,
31, 1996, the Company's sales were $825,700. In 1994 it began selling the
proprietary replacement filters which represent a long-term, repeat sale
market with profit margins far exceeding those from the original sale of the
Product.
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Principal Product and its Market
The Fillmaster(R) consists of a six-stage water purification unit, a
pharmaceutical water dispenser with precise measuring capabilities, a
purity testing module and anti-contamination controls for use by
pharmacists in mixing liquid prescriptions. The entire system integrates
with the building's tap water system, is closed and pressurized, and
therefore has a fill rate 300% faster than the bottle-and-hose systems
which are the only known competition. The Product utilizes proprietary
filter cartridges which are changed every 9-12 months or when prompted by
the Product's purity test indicator. The Product is packed and shipped by
the Company and installed by the End-User who follows the illustrated
instructions included with the Product using common household tools.
The United States Pharmacopeia (USP) is a comprehensive reference work
which has established the standards for pharmacy practices and supplies in
the United States for over one hundred years. The USP is recognized as the
official standard for pharmacy practice and supply by various federal
statutes, including the Food Drug and Cosmetic Act, and by virtually all
states. The USP requires pharmacists to use "Purified Water" in
reconstituting powdered medications such as antibiotics. "Purified Water"
is defined as "...water obtained by distillation, ion-exchange treatment,
reverse osmosis or other suitable process." Also, ". . .Purified Water
contains no added substances." Previously, the only realistic source of
"Purified Water" conforming to the USP standard was bottled distilled
water. Other forms of bottled water prepared through purification have
minerals and other substances added to them for taste purposes.
Historically, pharmacists have either hand poured water for
reconstitution directly from a bottle into a measuring container and then
into the medicine bottle, or they used a wall-mounted measuring and
gravity-flow dispensing cylinder connected by a system of rubber siphon
tubing and pinch clamps to a water bottle. Both of these methods have
significant drawbacks and possibilities for contamination which the
Fillmaster(R) minimizes. Both old methods have the potential for inaccurate
measurements: the first method because two hands are required and the
latter because the gravity-fed system can produce a variable fill rate due
to variation in siphon pressure. (The siphoning rate decreases as the
bottles empties thus producing a reduced flow of water.) The Fillmaster(R)
uses precision valves which exactly control the water flow.
Also, use of the Fillmaster(R) ensures that pharmacies that water used
in prescriptions will conform to USP standards. Prior methods pose the risk
of accidental use of "spring" or bottled "drinking water" due to label
similarities, simple mistakes in supply purchasing, or the pharmacy staff's
unawareness of the differences in water types. Water that does not qualify
as "Purified Water" contains minerals and other impurities which will
reduce the stability and potency of the prescription medicine. The use of
such water, in essence, is an adulteration of the medication by the
introduction of foreign materials and a violation of the Federal Food Drug
and Cosmetic Act.
Even when using the intended conforming water, these unsealed methods
allow bacteria, mold and other airborne contaminants to enter and grow
within the water supply. In addition, the dispensing tips of the other
methods can accumulate residue from the various prescriptions being mixed
and cause cross-contamination of the medications. Cross-contamination
creates a danger of serious reactions by the patient.
<PAGE>
The hazards of contamination in the Pharmacy's water source are
greatly reduced by the Fillmaster(R). The Product's filtering system
consists of a sediment filter, two multi-stage carbon block filters and a
reverse osmosis membrane. The system produces "Purified Water",
eliminating the problem of incorrect source. The Fillmaster(R) is a closed,
pressurized system; therefore, the airborne contamination problem is
eliminated, and the rate of filling is increased dramatically. Finally,
cross-contamination of medications is easily prevented by the
Fillmaster's(R) cleanable and disposable dispensing tips.
Competition and the proliferation of "third party" reimbursement plans
have combined to reduce pharmacy margins nationwide to dangerously low
levels, mandating efficiency and higher volumes as the only practical means
to continued profitability. In this context, time becomes valuable in the
extreme. Blocking the road to maximum time utilization is recent federal
legislation (OBRA-90) and conforming state mandates requiring pharmacists
to counsel each patient receiving a new prescription. The time spent
filling liquid antibiotics for which the Fillmaster(R) is used is
disproportionately time-consuming and difficult when compared with the time
necessary to fill other prescriptions. In addition, virtually all liquid
antibiotic prescriptions are new prescriptions, and each requires an
additional expenditure of time for patient counseling as required by OBRA-
90.
Extensive testing performed by the Company shows that use of the
Fillmaster(R) saves a pharmacy more than 20 seconds of actual filling time
for each liquid antibiotic prescription. When multiplied by over 6,000
antibiotics per year (on average), the resulting time savings are dramatic.
Coupled with the time savings generated by eliminating water bottle changes
(once for each 28 to 30 prescriptions -- approximately 5 minutes for each
change), the profitability of liquid antibiotics is substantially enhanced,
and pharmacist time for patient counseling and other activities is
multiplied.
The burdensome nature of these medications is compounded by their
natural instability once reconstituted. Post-reconstitution shelf life is
extremely limited and, once reconstituted, the medications require
refrigeration. A pharmacy will generally add water to the medication only
when the patient is physically present. If the patient is delayed or does
not pick up the prescription, the medication often must be discarded. As a
result, the workflow related to these medications is determined not by
efficiency, but by the arrival of the patient. Furthermore, the
efficiencies and time savings generated by use of the Fillmaster(R) have a
dramatic effect on customer satisfaction because of the reduced waiting
time at the pickup window.
Direct and indirect costs associated specifically with bottled water
are reduced or eliminated by use of the Fillmaster(R). Pharmacy storage
space can be reallocated to more profitable items, and the expense of
bottled water purchases of up to $1.25 for each gallon is replaced by one
annual filter replacement currently costing $65. Under optimum usage, the
cost of "Purified Water" is reduced to approximately $.04 per gallon.
Based on the Company's surveys of Fillmaster(R) users, customer
satisfaction levels are extremely high. Users agree unanimously that the
Product is faster, easier to use, cleaner, and that the elimination of the
aggravation and difficulties associated with all other methods of
reconstitution make the Fillmaster(R) well worth the investment in its
acquisition.
The Product carries a suggested list price of $659, and quantity
discounts are available for volume purchase agreements. This price level
was established
<PAGE>
to provide reasonable gross profit margins even after the negotiation of
volume discounts. These margins have been calculated at actual production
levels and are likely to increase through a reduction of costs associated
with higher volumes.
After installation, the filters require replacement approximately
every 9 to 12 months in order to maintain water purity. Since filters
compatible with the Fillmaster(R) system are proprietary and only available
from the Company, Management is confident that future replacement filter
sales will be an ongoing and significant source of income.
Revenues from the replacement filter sales, over a five-year period,
will approach the revenue generated by the original sale of the Product
with much higher profit levels. Thus, Management views the sale of the
Product as occurring in two distinct stages: immediate and deferred. The
acquisition of a new customer, while generating profit during the current
year, produces a deferred income stream with at least twice as much gross
margin and minimal or no sales expense.
The Product is primarily assembled from purchased components. It is
the Company's goal to perform minor manufacturing in the Company's facility
to minimize wages, equipment expense and insurance. No components of the
Product have permanent or unequivocally restricted availability. Most are
items that are common in either design or manufacture, and a change in
suppliers would result in virtually no lost production. There are no plans
to alter production methods.
The purification module is the major component of the Product and is
purchased under an agreement with its manufacturer that is exclusive with
the Company as to Pharmaceutical uses. While Management regards this
particular product as the finest of its kind, suitable alternatives are
available on the open market. This module and its accompanying hardware and
accessories are repackaged and labeled with Fillmaster(R) graphics, the
dispensing apparatus is inserted, and the system is shipped to the
customer.
The dispenser apparatus is assembled mostly from parts that are
standard items stocked by wholesale supply houses or fabricated to Company
specifications from injection-molded plastic and acrylic. The sole
deviation is the Reconstitube(R): an integral part of the dispensing
apparatus and available only from its manufacturer. This product's patent
expired in 1992, and in the unlikely event of supply difficulties, the
Company has a contingency plan that will allow for the fabrication of a
replacement with loss of production limited to 2-4 weeks.
Recently, the Company began offering lease financing through a third
party lender that will open the market to customers whose capital resources
are limited. This program will allow the customer to lease the Product and
a five-year supply of replacement filters for less than current
expenditures for bottled water.
New sales of the Fillmaster(R) continue to rise. More significant,
however, is fact that the number of chain pharmacies testing the product
has doubled in the last year. Company records show that more than 80% of
pharmacies that test the Fillmaster(R) place orders within 6 months. Also
this year, the Company began working to establish long-term agreements with
chain pharmacies to specify installation of the Fillmaster(R) as standard
pharmacy equipment in new and remodeled stores. Naturally, as product sales
increase, the sale of replacement filters will increase.
<PAGE>
As of October 31, 1996, the Company employed seventeen individuals
whose principal responsibilities are product assembly and shipping (four
employees), marketing (four employees), new product development (two
employees) and administration (seven employees).
ITEM 2. PROPERTIES
The Company's business operates in a 10,000 square foot facility
located in a light industrial/office park in El Cajon, California. This
location houses all administrative, executive, sales, assembly, shipping
and manufacturing functions for the Company.
ITEM 3. LEGAL PROCEEDINGS
The Company is a defendant in a lawsuit filed by Durland and Company
of West Palm Beach, Florida in the Circuit Court of Palm Beach County,
Florida which claims approximately $25,000 of fees owed for accounting
services. The Company has moved to quash services of the summons in this
action as the Company has never conducted business in the State of Florida.
The Company believes the law suit is completely without merit and will
vigorously defend the action. The Company believes that any financial
exposure is adequately provided for in its financial statements and that
this matter will not have a material adverse effect on the financial
condition or operating results of the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On April 17, 1996, a Special Meeting of the Shareholders was held in
San Diego, California. At this meeting the Shareholders elected Dennis
Brovarone and Patrick Galuska to the Board of Directors for their first
term. The Shareholders also re-elected Norman Andersen, Michael L. Krall,
Eugene Peiser and Gary Brownell to the Board of Directors. The
Shareholders also approved the Company's Incentive Stock Option Plan. Of
the 1,828,851 shares entitled to vote at this meeting, 754,977 were present
in person or by proxy. Voting for the nominees and in favor of the
Incentive Stock Option Plan was unanimous by those shares represented.
<PAGE>
PART II
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ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
(1) Market Information: The Company's common stock is traded on the
NASDAQ SmallCap Market under the symbol "PURE" and its Class A Warrants are
traded under the symbol "PUREW". The Company's common stock and Class A
Warrants are also traded on the Boston Stock Exchange. The Company's Class
Z Warrants are not listed for trading on any recognized market.
(2) HIGH AND LOW BID PRICES: The following table sets forth high and
low bid prices for the first fiscal quarter for which there has been a
market for the common stock. Such quotations represent inter-dealer prices
without retail mark-ups, mark-downs, or commissions and, accordingly, may
not represent actual transactions.
Quarter Ended High Low
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October 31 (common stock) 7.75 1.81
October 31 (class A warrants) 3.37 .25
(3) Security Holders: As of October 31, 1996, the Company had
approximately 39 holders of record of its common stock, 16 holders of its
Class A Warrants and 18 holders of the Company's Class Z Warrants. This
does not include beneficial owners holding shares or Class A Warrants in
street name.
(4) Dividend Plans: The Company has paid no common stock cash
dividends and has no current plans to do so.
(5) Preferred Stock: There are no shares of preferred stock presently
outstanding.
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion and analysis should be read in conjunction with
the audited and unaudited financial statements of the Company and related
notes included therein.
Overview
Innovative Medical Services is engaged principally in the business of
manufacturing and marketing of the Fillmaster(R), a unique water
purification, measuring and dispensing apparatus used in pharmacies to
reconstitute oral antibiotic suspensions. In addition, the company intends
to develop and market other pharmacy-related efficiency products worldwide.
Results of operations Fiscal 1996 vs. Fiscal 1995
Revenues of $825,700 in fiscal year ending 1996 were 172% of the
$479,000 in revenues reported for fiscal year 1995. This revenue increase
was attributable to increased sales of Fillmaster(R) Purification Systems
and the continued growth of replacement filter sales. Fillmaster(R)
Purification System sales in fiscal 1996 were $761,300, and replacement
filter sales
<PAGE>
were $64,400. In 1995, Fillmaster(R) Purification System sales were
$427,000, and replacement filter sales were $33,000. While occurring in
all markets, more than 80% of the volume increase in Fillmaster(R)
Purification System sales took place in the chain pharmacy marketplace.
The increase in replacement filter sales was expected due to the increased
number of Fillmaster(R) Purification Systems in use.
Gross profits in 1996 were $207,000 vs. $169,000 in 1995. Gross
profit percentages in 1996 (25%) were lower vs. 1995 (37%) because the
Company offered penetration (lower) pricing to a national chain purchaser
of the Product for the initial installation of the systems.
Net loss for fiscal 1996 was $430,048 vs. a net profit of $2,400 for
fiscal 1995. This decrease was due to the decrease in gross profit as
outlined above. In addition, Selling Expenses and General and
Administrative Expenses increased approximately $419,000 from 1995 to 1996
due to costs incurred to position the Company for growth.
Liquidity and Capital Resources
The Company's current asset to liabilities ratio fell from 1.73 in
fiscal year 1995 to 0.29 in fiscal year 1996. The majority of this
decrease was the addition of the $375,000 bridge loan to current
liabilities and the accrual of officer compensation. Historically,
expansion has been financed by the sale of common stock. Equity financing
activities have provided cash in the amounts of $172,000, $45,000 and
$66,000 for fiscal years 1994, 1995 and 1996, respectively. Debt financing
has been in the amounts of $9,000, $21,000 and $25,000 for the same
periods. Cash flows provided (used) from operations were $(327,000) in
1996 and $26,000 in 1995. Cash flows used in investing activities were,
respectively, $101,000 and $8,000 for the purchase of machinery and
equipment. Cash flows from investing activities were $402,000 in 1996 and
23,000 in 1995.
The Company has operated on a just-in-time assembly and manufacturing
basis and therefore has kept inventory to low levels. Parts and components
have been, for the most part, brought into the factory for assembly and
shipment only after a firm customer order has been received. As a result,
the time period during which cash resources must be utilized for inventory
has been compressed as much as possible. Also, aggressive receivables
management combined with the quality of the customer base has resulted in
a very favorable position with regards to receivables aging.
Nonetheless, the extremely vigorous growth of the Company has created
an ongoing dilemma related to cash. The very expansion that has made
revenue projections appear so positive has at the same time hindered the
Company's ability to expand sales at an even faster rate. The need to
finance ever-increasing part and component inventories, even for a short
period of time, has served to divert cash resources from critical sales,
marketing and new product development areas that could enhance future
revenues to an even greater extent. Sales and marketing decisions have
often been driven by the lack of available cash resources, frequently to
the exclusion of valuable opportunities.
During the past months, the Company has focused on establishing a
strong foundation for realistic, sustainable growth. The Company has
recruited key marketing, sales, customer service and financial
professionals who have outstanding industry experience and credibility, and
who have the ability to
<PAGE>
spur the Company to achieve sales results. In addition, the Company moved
into a larger facility that houses both production and administration. The
new facility provides for improvement of current operations, increased
production capacity and advances in the areas of research and development.
Such corporate growth would not have been possible without the efforts of
Michael L. Krall, the Company's President, during the weeks leading to
NASDAQ approval of the Initial Public Offering. To compensate Mr. Krall for
his outstanding work during that time, the Board of Directors awarded Mr.
Krall a bonus of 257,500.
To generate capital for further expansion and to alleviate the cash
issues described above, the company has issued $5,810,000 in marketable
equity securities subsequent to the balance sheet date.
Management intends that the proceeds of the offering will provide liquidity
for:
Sales and Marketing expansion: (a) expand the sales force, (b) recruit a
director of marketing, (c) elevated public exposure through increased
public relations efforts, (d) increased trade show participation, (e)
advertising in trade journals and via targeted direct response advertising,
(f) increased face-to-face sales calls with corporate customers and, (g)
development of new marketing materials.
Inventory increase: (a) support the increased sales activity expected, (b)
to reduce the cost of goods through volume purchasing.
Receivables Financing: (a) support the increased sales activity expected,
(b) eliminate early-payment discounts given to customers.
New Product Development: (a) further development of advanced concepts for
the existing product line, (b) further develop and bring to market new
products currently in various stages of development, (c) identify new
products for future development.
Lease Financing: (a) provide alternative financing to its customers where
few options exist (b) provide the ability to finance the purchase of the
Company's products internally, (c) establish an additional source of profit
and cash flow.
Facilities Expansion: (a) provide adequate production facilities for the
anticipated increased Fillmaster(R) product sales, (b) production
facilities for new products (c) office and administrative space for
increased staff requirements.
Patent, Trademark and Legal Expense: (a) provide patent and trademark
protection for existing and anticipated products.
Manufacturing/Computer Equipment: (a) provide production and assembly
equipment to improve production efficiency (b) provide additional computer
equipment for increased productivity by administrative and executive staff.
Working Capital: (a) provide liquidity for general business
contingencies.
Management believes that the offering of its securities will provide
sufficient liquidity to meet the requirements described above for the
balance of fiscal 1996 and 1997.
Future Outlook
<PAGE>
The key to long term profitability of the Fillmaster(R) product line
and, ultimately the company, is to establish a substantial number of
Fillmaster(R) units installed and in use. Since each unit requires a
replacement of its filters at least once a year, each new system installed
becomes a source of steady future income that potentially exceeds the
income from the initial sale of the Product. In addition, each pharmacy
using the Fillmaster(R) will be an easily-approachable candidate for any
new pharmacy tools developed by the Company in the future.
These multiple reasons for establishing a solid base of users have
caused the Company's sales efforts to focus primarily on the chain pharmacy
market. When combined with the short-term efficiencies inherent in
multiple-unit sales and the expanding nature of the market, chain
pharmacies were the most attractive of the options. This strategy has been
successful, as the Company continues to build an ever-increasing sales
revenue base with sales and marketing expenditures a fraction of those
necessary to reach independent and hospital pharmacies.
At the beginning of fiscal year 1994, the Company's chain pharmacy
customer base consisted of scattered individual locations in three chains.
By the end of fiscal year 1996, the Fillmaster(R) product was installed at
more than 4,500 total locations representing 6% of the total domestic
market, with approximately 3,500 of these locations being in more than 20
regional and national chains ranging in size from 30 to 2600 stores. These
customers include the nation's largest drug store chain, Walgreens, and
Wal-Mart, the world's largest retailer. The 3,500 locations represent
approximately 11% of a total chain pharmacy market that is expanding at the
rate of approximately 10% per year.
The Company's chain customer base continues to expand at the rate of
approximately one chain per month and is expected to continue at that pace
for the foreseeable future. Acquisition of a new chain customer generally
results in staged product acquisition after initial testing, typically
beginning with higher-volume pharmacies. Complete saturation of each
customer's locations generally takes place over an extended period. Thus,
gaining a new chain customer bodes well for sales of new Fillmaster(R)
Purification Systems over the intermediate term and for continuing
replacement filter sales over the long term. Currently, the 3,500 chain
drug store locations in which the Product is installed are less than 20% of
the available locations in the chains represented
The logical, ultimate and final development in the chain sales cycle
will be when the Product becomes specified as standard equipment for all
new and remodeled pharmacies, making new orders automatic as construction
occurs. As of July 31, 1996, Walgreens, Eckerd, Target and Sav-On/Osco,
have designated the Fillmaster(R) as standard equipment for their new and
remodeled pharmacies. Sales revenues for new Fillmaster(R) units from
these customers' new openings and remodeling programs are projected at
approximately $600,000 per year (1300 units) for each of the next five
years with virtually no additional sales effort or expense. Each
succeeding year, these installations will generate an equal incremental
increase in the number of replacement filter sets sold.
The Company expects that additional chains will make the same
specification during the balance of fiscal 1996, 97 and 98, expanding the
ongoing base of recurring orders.
<PAGE>
In the upcoming year, the introduction of leasing is anticipated to
have a positive effect on sales revenues, with more dramatic results
expected in ensuing years. Through leasing, which is currently being
offered through a third-party lender, new chain customers whose capital
resources are limited will be able to acquire the Product with no effect on
the balance sheet, and a net monthly decrease in expenses associated with
water in the pharmacy.
As resources allow, marketing expenditures will increase significantly
to focus on the costlier-and more difficult-to-reach independent pharmacy
market. This market, although shrinking somewhat due to inroads made by
the chains, is still relatively stable in size. Representing more than
30,000 locations, the independent pharmacy market has remained virtually
untapped. Currently, the Company's penetration is less than 3%.
Near-term sales efforts in the independent pharmacy market will focus
primarily on offering price concessions based upon quantity sales to the
members of independent buying cooperatives and quasi-chains created by
wholesale drug distributors. By accessing large numbers of pharmacies
through their cooperatives and wholesalers, the Company retains the
economies of scale associated with chain sales but generates higher margins
through higher negotiated pricing and direct sales to the customer.
Wholesale distributors have exited the durable goods markets and are
not in a position to be able to stock and distribute the Product on any
reasonable basis; however, at the same time, they do offer centralized
access to large numbers of independent pharmacy customers. By utilizing
their customer structures but not their distribution systems, the Company
will retain margins that would otherwise be paid to the distributor.
Recently, the Company formed an alliance with McKesson Drug Company to
promote the Fillmaster(R) Purification System to its Value-Rite quasi-chain
group of independent pharmacies at a price that is discounted, but not to
wholesale or chain pricing levels. McKesson is distributing product
information in its regular mailings to this group, with the Product being
sold and distributed directly to the customer by the Company.
Longer-term marketing efforts in the independent pharmacy market will
concentrate on non-affiliated independent community pharmacies. Leasing is
expected to be an especially powerful tool in the independent pharmacy
market once the Company has generated the capital necessary to be able to
finance a leasing program internally. Capital expenditures are difficult
for the independent community pharmacy because of limited cash resources,
so access to this market has been problematical. The higher sales and
marketing expenses associated with this market segment require the Company
to retain the full $659 list price in order to maintain profit margins.
Leasing allows the customer to acquire a Fillmaster(R) unit for a monthly
payment equal to or less than its existing monthly bottled water
expenditures. Third-party lease financing is not currently available for
fewer than four Fillmaster(R) units due to minimums imposed by the lenders.
Reduction of the cash outlay necessary to acquire a Fillmaster(R) unit
from $659 to an affordable monthly payment will allow the Company to
penetrate this market to a much greater degree. The Company has calculated
that the profits generated from internal leasing of Fillmaster(R)
Filtration Systems and replacement filters will be more than double that
generated by straight sales or third-party leasing for an equal number of
units.
<PAGE>
ITEM 7. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
See Item 13 of this Report.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE: None
<PAGE>
PART III
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ITEM 9. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The executive officers and directors of the Company and their ages are
as follows:
Name Age Position
- ---- --- --------
Michael L. Krall 44 President, CEO, Director
Norman Andersen 77 Chairman of the Board, Director
Gary Brownell, CPA 47 Chief Financial Officer, Director
Dennis Atchley, Esq. 44 Secretary
Eugene Peiser, PD 65 Director
Patrick Galuska 37 Director
Dennis Brovarone 40 Director
The Directors serve until their successors are elected by the
shareholders. Vacancies on the Board of Directors may be filled by
appointment of the majority of the continuing directors. The executive
officers serve at the discretion of the Board of Directors.
DENNIS B. ATCHLEY Mr. Atchley, 44, is a civil litigation attorney with
the law firm of Epsten & Grinnell since January 1995. He was a sole
practitioner from 1985 to 1995, was formerly a partner in the firm of
Winters ad Atchley and served as an associate attorney with several larger
law firms. He became an officer of Innovative Medical Services in 1992.
Mr. Atchley graduated from Loyola University of Los Angeles in 1973 with a
Bachelor of Arts degree in political science. He received his Juris
Doctorate in 1976 from California Western University School of Law. Mr.
Atchley is a member of the American Bar Association and the American
Arbitration Association. Mr. Atchley resides in San Diego with his wife and
two children.
GARY W. BROWNELL Mr. Brownell, 47, is a Certified Public Accountant in
a private partnership practice. He is the partner in charge of taxes and
municipal audits for his firm. Mr. Brownell graduated from San Diego State
University in 1973 with a Bachelor of Science degree in accounting. He
received his Certified Public Accountant designation in 1983. Mr. Brownell
has been a partner in Brownell and Duffy since 1985.
MICHAEL L. KRALL Mr. Krall, 44, is the President and CEO of Innovative
Medical Services, a position he has held since 1993. He is responsible for
the strategic planning, product development, and day-to-day operations of
IMS. Previously, Mr. Krall was the President and CEO of Bettis-Krall
Construction, Inc. a successful building-development company of custom
homes and commercial property in San Diego County, California. He has also
held numerous positions in general management in the hospitality industry.
Mr. Krall attended Pepperdine University (economics, statistics mechanical
engineering). He previously served 4 years in the United States Marine
Corps and was elected, by general election, to a 4 year term on the Valle
de Oro Planning Board. Mr. Krall lives in El Cajon, California with his
wife, Connie and two children.
<PAGE>
NORMAN L. ANDERSEN Mr. Andersen, 77, currently retired, was from 1974
until September of 1994, Chairman of the Board of Cord North American
Moving and Storage, Inc., in Earth City, MO, a suburb of St. Louis. Prior
to serving solely as Chairman of the Board from 1987 until this year, he
also served as its Chief Executive Officer. Cord North American is a
holding company for several moving and storage concerns in the St. Louis
area. Mr. Andersen served for many years and in several capacities in the
Al Bahr Shrine. He is widowed and lives in Fairview Heights, IL.
EUGENE S. PEISER, DOCTOR OF PHARMACY Dr. Peiser, 65, has been an
independent consultant to FDA regulated industries since 1974 and a Member
of the Board of Innovative Medical Services since 1994. He graduated from
the University of Tennessee College of Pharmacy with a Bachelor of Science
in Pharmacy in 1951 and has received his Doctorate of Pharmacy. Dr.
Peiser's consultancy advises on a wide variety of subjects, including
compliance with the Prescription Drug Marketing Act and other government
compliance matters, employee training and drug repackaging. Dr. Peiser
furnishes expert witness services and has provides approved Pharmaceutical
Continuing Education to several thousand attendees at his seminars. Dr.
Peiser is a Founding Director of the Association of Drug Repackagers; is
appointed as a Registered Arbitrator by the American Registry of
Arbitrators; serves as a member of the Surgeon General's Speakers Bureau;
and is President of the Southwest Chapter of the Association of Military
Surgeons. Dr. Peiser lives and works in Palm Harbor, FL.
PATRICK GALUSKA Mr. Galuska, 37, is a Petroleum Engineer and has been
with Meridian Oil Inc., since 1982. He is responsible for the financial
viability of numerous properties located in the Rocky Mountains and has
also been involved in many property acquisitions and contract negotiations.
He is a Registered Professional Engineer and is a member of the Society of
Petroleum Engineers. Mr. Galuska graduated from the University of Wyoming
in 1982 with a Bachelor of Science degree in Petroleum Engineering. He
received his Masters in Business Administration, specializing in Finance
from the University of Denver in 1992. Mr. Galuska resides in Denver,
Colorado with his wife.
DENNIS BROVARONE Mr. Brovarone, 40 has been practicing corporate and
securities law since 1986 and as a solo practitioner since 1990. He was
elect to the Company's Board of Directors in April, 1996. Prior to 1990,
Mr. Brovarone served as in-house counsel to R.B. Marich, Inc., a Denver,
Colorado based brokerage firm. Mr. Brovarone also serves as President
(chairman) of the Board of Directors of The Community Involved Charter
School, a three year old K-12 public school located in Lakewood, Colorado,
operating under an independent charter and serving approximately 350
students in an individualized, experiential learning environment. Mr.
Brovarone lives and works in Denver, Colorado.
Compensation of Directors
Directors are entitled to receive $300 plus reimbursement for all out-
of-pocket expenses incurred for attendance at Board of Directors meetings.
Mr. Anderson receives a salary of $2,000 for services as Chairman of the
Board and of the Board's Compensation and Budget Committees.
ITEM 11. EXECUTIVE COMPENSATION
Summary Compensation Table
The following table shows for the past three fiscal years ending July
31, the compensation awarded or paid by the Company to its Chief Executive
Officer and its executive officers during such years:
<PAGE>
Restricted
Name & Position Total Annual Cash Compensation Stock or
(Year ended 7/31) ($ Amt.) Options Granted
Michael L. Krall 1994 30,000 0
1995 45,000 0
1996 96,000 31,250 shares (1)
1996 257,500(2)
Dennis Atchley 1994 0 21,978 shares
1995 0 0
1996 0
Gary Brownell 1994 0 18,315 shares
1995 0 14,000 shares
1996 0 0
Dennis Brovarone 1996 36,000 13,334 shares
(1) Five year Options exerciseable after April, 1997 at $3.20 per share.
See EMPLOYMENT CONTRACTS below.
(2) A bonus awarded in September, 1996 by the Board of Directors
No other executive officer earned more than $100,000 during the current
fiscal year.
Employment Agreements
In April, 1996, the Board of Directors approved a five year employment
agreement for Michael Krall, its President. Mr. Krall is to receive a
salary of $108,000 per year, an amount equal to 3% of the Company's net
income before taxes if any plus other benefits. In addition, the Board of
Directors awarded Mr. Krall compensation in the amount of $30,000, $45,000
and $60,000 for the fiscal years ended July 31, 1994, 1995 and the eight
month period ended March 31, 1996. Mr. Krall has contributed these amounts
back to the Company as additional paid in capital for shares previously
issued to Mr. Krall. Mr. Krall was also awarded five year options to
acquire 31,250 common shares at $3.20 per share which are first
exerciseable in April, 1997. In September, 1996, the Board of Directors
awarded Mr. Krall a bonus of $257,500 as compensation for his extraordinary
work in the weeks preceding the Initial Public Offering.
Mr. Brovarone serves as securities counsel for the Company and
receives $3,000 per month plus expenses.
Mr. Atchley serves as Secretary for the Company and beginning
September, 1996, receives $1,000 per month.
Incentive Stock Option Plan
On April 17, 1996, the Shareholders approved the Company's 1995
Incentive Stock Option Plan (the Plan). The purpose of the Plan is to
advance the business and development of the Company and its shareholders by
affording to the key employees of the Company the opportunity to acquire a
propriety interest in the Company by the grant of Options to acquire shares
of the Company's common stock. The Options granted are "Incentive Stock
Options" within the meaning of Section 422 of the Internal Revenue Code of
1986, as
<PAGE>
amended, for certain key employees. The Plan is administered by an
Administrative Committee whom shall serve a one year term. Subject to
anti-dilution provisions, the Plan may issue Options to acquire up to
1,000,000 shares to Key Employees. The maximum number of shares subject to
Options granted to any one Key Employee shall not exceed 100,000 shares.
The exercise price for Options shall be set by the Administrative Committee
but shall not be for less than the fair market value of the shares on the
date the Option is granted. The period in which Options can be exercised
shall be set by the Administrative Committee not to exceed five years from
the date of Grant. The Plan may be terminated, modified or amended by the
Board of directors upon the recommendation of the Administrative Committee.
The issuance of options pursuant to this Plan is not expected to be a
taxable event for recipient until such time that the recipient elects to
exercise the option whereupon the recipient is expected to recognize income
to the extent the market price of the shares exceeds the exercise price of
the option on the date of exercise. All Key Employees of the Company and
its subsidiaries are eligible to participate in the Incentive Stock
Options. A Key Employee is defined in the Plan as a Company employee who
in the judgment of the Administrative Committee has the ability to
positively affect the profitability and economic well-being of the Company.
Part time employees, independent contractors, consultants and advisors
performing bona fide services to the Company shall be considered employees
for purposes of participation in the Plan.
On April 17, 1996, the Company's Board of Directors approved a
Directors and Officers Stock Option Plan. The purpose of the Plan is to
advance the business and development of the Company and its shareholders by
affording to the Directors and Officers of the Company who are ineligible
to participate in the above Incentive Stock Option Plan, the opportunity to
acquire a propriety interest in the Company by the grant of Options to
acquire shares of the Company's common stock. The Plan is administered by
the entire Board of Directors. The Plan became effective on April 17, 1996
by the Board of Directors, was not subject to Shareholder approval and
shall terminate on April 17, 2006. Subject to anti-dilution provisions,
the Plan may issue Options to acquire up to 1,000,000 shares to Directors
and Officers. The maximum number of shares subject to Options granted to
any one Director or Officer shall not exceed 100,000 shares. The exercise
price for Options shall be set by the Board of Directors but shall not be
for less than eighty-five (85%) of the fair market value per share on the
date of grant. The period in which Options can be exercised shall be set
by the Board of Directors not to exceed five years from the date of Grant.
The Plan may be terminated, modified or amended by the Board of Directors.
As of the date of this Prospectus, Michael L. Krall the Company's
president has been awarded options to purchase up to 31,250 shares at $3.20
per share.
<PAGE>
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth the stock ownership of each person
known by the Company to be the beneficial owner of five percent or more of
the Company's Common Stock, all Directors individually and all Directors
and Officers of the Company as a group.
Name and Address Common Stock Percentage
of Beneficial Owner Ownership(1) of Class
- ------------------- --------- --------
Norman Anderson 51,334 1.59%
1725 Gillespie Way
El Cajon, CA 92020
Dennis Atchley 22,000 0.68%
1725 Gillespie Way
El Cajon, CA 92020
Gary Brownell 32,334 1.00%
1725 Gillespie Way
El Cajon, CA 92020
Michael L. Krall(2) 618,307 19.20%
1725 Gillespie Way
El Cajon, CA 92020
Thomas E. Smith(3) 618,307 19.20%
9408 Lightwood Cove
Austin, TX 78748
Eugene Peiser 6,334 0.20%
1725 Gillespie Way
El Cajon, CA 92020
Patrick Galuska 33,334 1.03%
8137 S. Downing St.
Littleton, CO 80122
Dennis Brovarone 13,334 0.41%
11249 W. 103rd Dr.
Westminster, CO 80021
Officers and Directors
as a group (7 Persons) 776,977 24.12%
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
In December, 1995, Dennis Brovarone was issued 20,000 (pre-split)
shares of common stock in consideration of services rendered to the Company
with respect to corporate financing plans and federal securities law
compliance.
Since inception, the Company has periodically made loans to Mr. Krall
and Thomas E. Smith, (Jr.) which accrued interest at the rate of 7% per
annum. These debt balances were also periodically reduced by Mr. Krall and
Thomas E. Smith,(Jr.) by cash payments to the Company. These loans were
made by the Company to insure Mr. Krall and Mr. Smith's availability to the
Company and the proceeds were used by Mr. Krall and Mr. Smith for personal
expenses unrelated
<PAGE>
to the Company. While the Company does not make loans to unrelated
parties, it believes that the terms of these loans were favorable to the
Company.
As of July 31, 1994, Thomas E. Smith, (Jr.)'s balance was $21,449.23
and the Company received a Promissory Note in the principal amount of
$21,449.23 from Thomas E. Smith, (Jr.). The Note accrued interest at the
rate of 7% per annum was payable in one installment on or before September
30, 1995. In November, 1994, Thomas E. Smith, (Jr.) partially repaid his
balance by contribution of $29,000 of proceeds from the sale of 29,000 of
Thomas E. Smith, (Jr.)'s shares of the Company's common stock. As of July
31, 1995, Thomas E. Smith, (Jr.)'s balance owed was $9,128.199 and Thomas
E. Smith, (Jr.) issued a new Promissory Note dated July 31, 1995 in the
principal amount of $9,128.19 which accrues interest at the rate of 7% per
annum and is payable on or before September 30, 1996. As of July 31,
1996, the balance owed on this note is $9,128.
As of July 31, 1994, Mr. Krall had a debt balance of $0.00 and had
contributed an additional $16,620.40 to the Company. On July 31, 1994, the
Company issued Mr. Krall a Promissory Note in the principal amount of
$16,620.40. The Note accrued interest at the rate of 7% per annum was
payable on or before September 30, 1995. In November, 1994, Mr. Krall
contributed $29,000 of proceeds from the sale of 29,000 of Mr. Krall's
shares of the Company's common stock. As of July 31, 1995 and as a result
of additional borrowing by Mr. Krall, Mr. Krall's balance owed was
$15,857.71 and Mr. Krall issued a new Promissory Note dated July 31, 1995
in the principal amount of $15,857.71 which accrues interest at the rate of
7% per annum and is payable on or before September 30, 1996. As of July
31, 1996, the balance owed on this note is $76,387.
On January 1, 1994, the Company issued a Promissory Note with a
principal amount of $30,000 to Thomas E. Smith, Sr., a Director of the
Company. The Note accrued interest at the rate of 9.873% per annum. The
Note was repaid by the conversion of $5,000 into 5,000 shares of common
stock in November, 1994 and the issuance on January 1, 1995, of another
Promissory Note for the remaining principal amount of $25,000. This Note
accrues interest at the rate of 11.848% per annum and is payable in monthly
interest with the principal due on or before January 1, 1997. The Company
is current in its payments on this Note.
<PAGE>
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K
A. Exhibits
(3)(i) Articles of Incorporation (Incorporated by reference from Form
SB-2 Registration SEC File # 333-00434 effective August 8, 1996)
(3)(ii) By-Laws of Corporation (Incorporated by reference from Form
SB-2 Registration SEC File # 333-00434 effective August 8, 1996)
(27) Financial Data Schedule
B. Reports on Form 8-K: None
<PAGE>
INNOVATIVE MEDICAL SERVICES
FINANCIAL STATEMENTS AND SUPPLEMENTARY INFORMATION
For the Years Ended July 31, 1996 and July 31, 1995
<PAGE>
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANT
To the Board of Directors and Stockholders
Innovative Medical Services
El Cajon, California
I have audited the balance sheets of Innovative Medical Services as of July
31, 1996 and July 31, 1995, and the related statements of income,
accumulated deficit, and cash flows for the years then ended. These
financial statements are the responsibility of the Company's management. My
responsibility is to express an opinion on these financial statements based
on my audit.
I conducted the audit in accordance with generally accepted auditing
standards. Those standards require that I 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. I believe that my audits provide
a reasonable basis for my opinion.
In my opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Innovative Medical
Services as at July 31, 1996 and July 31, 1995, and the results of its
operations and its cash flows for the years then ended in conformity with
generally accepted accounting principles.
Steven Holland
Certified Public Accountant
San Diego, California
October 25, 1996
<PAGE>
INNOVATIVE MEDICAL SERVICES
BALANCE SHEETS
July 31
----------------------
1996 1995
---------- ----------
ASSETS
Current Assets
Cash $ 21,706 $ 47,180
Accounts receivable, net of allowance for
doubtful accounts of $ 9,000 in 1996
and $ 500 in 1995 81,963 174,785
Notes receivable (Note 2) 24,986 24,986
Due from employees 1,390 4,024
Due from shareholders and officers (Note 3) 76,887 20,000
Inventories 55,660 23,110
Prepaid Expenses 7,868 0
---------- ----------
Total current assets 270,460 294,085
---------- ----------
Property, Plant and Equipment
Property, plant and equipment (Note 4) 163,406 91,498
---------- ----------
Total property, plant and equipment 163,406 91,498
---------- ----------
Noncurrent Assets
Deposits 5,649 0
Organizational costs, net (Note 1) 1,032 2,064
Deferred public offering costs (Note 1) 376,695 37,630
---------- ----------
Total noncurrent assets 383,376 39,694
---------- ----------
Total assets $ 817,242 $ 425,277
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities
Accounts payable $ 233,111 $ 164,938
Accrued liabilities 307,092 4,604
Notes Payable (Note 5) 402,154 0
---------- ----------
Total current liabilities 942,357 169,542
---------- ----------
Long-Term Debt (Note 5) 2,978 25,000
---------- ----------
Stockholders' Equity
Class A common stock, no par value;
authorized 20,000,000 shares, issued
and outstanding 1,833,851 shares at
July 31, 1996 and 1,791,851 shares at
July 31, 1995 (Note 8) 663,181 591,961
Accumulated deficit (791,274) (361,226)
---------- ----------
Total stockholders' equity (128,093) 230,735
---------- ----------
Total liabilities and stockholders' equity $ 817,242 $ 425,277
========== ==========
The accompanying notes are an integral part of the financial statements.
<PAGE>
INNOVATIVE MEDICAL SERVICES
STATEMENTS OF INCOME
For the Years Ended
July 31
----------------------
1996 1995
---------- ----------
Net sales $ 825,695 $ 459,330
Cost of sales 618,274 290,609
---------- ----------
Gross profit 207,421 168,721
---------- ----------
Selling expenses 93,940 33,375
General and administrative expenses 556,489 137,651
---------- ----------
Total operating costs 650,429 171,026
---------- ----------
Operating income (loss) ( 443,008) ( 2,305)
---------- ----------
Other income and (expense):
Interest income 1,803 3,266
Miscellaneous income and (expense) 11,957 2,281
---------- ----------
Total other income and (expense) 13,760 5,547
---------- ----------
Income (loss) before income taxes ( 429,248) 3,242
Federal and state income taxes (Note 1) 800 800
---------- ----------
Net income (loss) $( 430,048) $ 2,442
========== ==========
Net (loss) per common share $ ( 0.14) $ 0.00
========== ==========
The accompanying notes are an integral part of the financial statements.
<PAGE>
INNOVATIVE MEDICAL SERVICES
STATEMENTS OF ACCUMULATED DEFICIT
For the Years Ended
July 31
----------------------
1996 1995
---------- ----------
Balance, beginning of year $ (361,226) $ (363,668)
Net income (loss) (430,048) 2,442
---------- ----------
Balance, end of year $ (791,274) $ (361,226)
========== ==========
The accompanying notes are an integral part of the financial statements.
<PAGE>
INNOVATIVE MEDICAL SERVICES
STATEMENTS OF CASH FLOWS
For the Years Ended
July 31
----------------------
1996 1995
---------- ----------
Cash flows from operating activities
Net income (loss) $( 430,048) $ 2,442
Adjustments to reconcile net income
to net cash provided by operating
activities:
Depreciation 29,054 16,395
Amortization 1,032 1,032
Officers wages contributed to capital 44,000 45,000
Stock issued for services 5,000 0
Changes in assets and liabilities:
(Increase) decrease in accounts
receivable 92,822 ( 130,879)
(Increase) in due from officers and
shareholders ( 56,887) ( 3,537)
(Increase) decrease in due from
employees 2,634 ( 2,634)
(Increase) in prepaid expense ( 7,868) 0
(Increase) in inventory ( 32,550) ( 17,228)
(Increase) in deferred public
offering costs ( 339,065) ( 5,250)
(Increase) in deposits ( 5,649) 0
Increase in accounts payable 68,173 120,522
Increase (decrease) in accrued
liabilities 302,488 ( 178)
---------- ----------
Net cash provided (used) by
operating activities ( 326,864) 25,685
---------- ----------
Cash flows from investing activities
Purchase of property, plant and equipment ( 100,962) ( 8,224)
---------- ----------
Net cash (used) in investing
activities ( 100,962) ( 8,224)
---------- ----------
Cash flows from financing activities
Increase (decrease) in notes payable 380,132 ( 21,620)
Proceeds from sale of common stock 22,220 44,790
---------- ----------
Net cash provided by
financing activities 402,352 23,170
---------- ----------
Net increase (decrease) in cash ( 25,474) 40,631
Cash, at beginning of year 47,180 6,549
---------- ----------
Cash, at end of year $ 21,706 $ 47,180
========== ==========
The accompanying notes are an integral part of the financial statements.
<PAGE>
INNOVATIVE MEDICAL SERVICES
NOTES TO FINANCIAL STATEMENTS
SEE ACCOUNTANTS' REPORT
NOTE 1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Organization and Business Activity
Innovative Medical Services was incorporated in San Diego, California
on August 24, 1992. The Company was organized with the purpose of
manufacturing, marketing, and sales of the Fillmaster, a unique and
proprietary pharmaceutical water purification and dispensing product.
The Company is fully operational, with more than 4,500 customers in all
fifty states, Puerto Rico, The United Kingdom, Australia, Canada, and
Europe. The Company intends to expand research and development efforts
in order to further develop its product line to include an additional
11 proprietary pharmacy-related efficiency tools.
Revenue Recognition
The company recognizes revenues when products are delivered.
Research and Development
Research and development costs are charged to operations when incurred
and are included in operating expenses. The total amount charged to
Research and Development in the year ended July 31, 1996 was $6,483.
Depreciation Method
The cost of property, plant and equipment is depreciated on a straight
line basis over the estimated useful lives of the related assets. The
useful lives of property, plant, and equipment for purposes computing
depreciation are:
Computers and equipment 7.0 years
Furniture and fixtures 10.0 years
Property held under capital lease 10.0 years
Leasehold improvements are being depreciated over the life of the lease
which is equal to 29 or 149 months depending on the actual lease.
Depreciation is computed on the Modified Accelerated Cost Recovery
System for tax purposes.
Amortization
The cost of organizational expenses are being amortized on a straight
line basis over their remaining lives of five (5) years. Amortization
expense charged to general and administrative expense for the years
ended July 31, 1996 and July 31, 1995 was $ 1,032 and $ 1,032,
respectively.
Inventory Cost Method
Inventories are stated at the lower of cost determined by the Average
Cost method and net realizable value.
<PAGE>
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Common Stock Public Offering
The Board of Directors authorized the Company to sell up to 1,250,000
shares of the Company s common stock and 1,250,000 Class A warrants in
a public offering pursuant to a Registration Statement on Form SB-2
under the Securities Act of 1933. The board of directors also
authorized obtaining a bridge loan of up to $ 375,000 to facilitate the
public offering (Note 11).
On April 17, 1996, the Company entered into an agreement with Monitor
Investment Group, Inc. of New York, whereby Monitor agreed to structure
a Bridge Financing and act as the sole placement agent on a best effort
basis (Note 5) and act as an underwriter on a firm-commitment basis for
1,250,000 shares of the Company's common stock and 1,250,000 Class A
warrants. Monitor Investment Group, Inc. completed the Bridge Financing
placement. Subsequently, Monitor Investment Group, Inc. and the
Company agreed that Meyers Pollock Robbins, Inc. would replace Monitor
as the lead underwriter for the offering. The Class A warrants will be
exerciseable commencing one year after the effective date of the
offering and entitles each holder to purchase one share of common stock
at $5.25 per common share during the four year period commencing one
year from the effective date of the offering. The Class A Warrants are
redeemable by the Company for $.05 per warrant, at the Company's
option, commencing one year after the effective date of the offering
provided the closing bid price for the Company's common shares shall
have averaged in excess of $9.00 per share for thirty consecutive
business days ending within five days of the date of a notice of
redemption.
The principal terms of the agreement with the Representative are as
follows:
a) Underwriter's discount and commission shall be ten percent of the
aggregate public offering, and
b) The non-accountable expense allowance will be three percent of the
total amount raised, and
c) The Company shall be responsible for and shall bear all expenses
incurred in connection with the bridge financing and the public
offering, and
d) The Company will grant the Representative an option to purchase
all or part of an additional number of securities (the "Over-
Allotment Option") as will be equal to not more than fifteen
percent of the total number of securities initially offered for
a period of thirty days from the closing date of the public
offering in order to cover over-allotments, if any.
Deferred Public Offering Cost
The company has incurred $ 376,695 of costs as of July 31, 1996
related to an initial public offering. These costs have been deferred,
pending completion of the offering, at which time such costs will be
reclassified to shareholders' equity.
Net Loss Per Common Share
Pursuant to the requirements of the Securities and Exchange Commission
(SEC), common stock issued by the Company during the twelve months
immediately preceding an initial public offering, plus the number of
common equivalent shares which became issuable during the same period
pursuant to the grant of stock options and Bridge Financing (Note 11)
have been included in the calculation of the shares used in computing
net loss per common share as if these shares were outstanding for all
periods presented using the treasury stock method.
<PAGE>
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Net Loss Per Common Share (continued)
Following is a reconciliation of the weighted average number of shares
actually outstanding with the number of shares used in the computations
of loss per common share:
July 31,1996 July 31, 1995
------------ -------------
Weighted average number of shares
actually outstanding 1,821,792 1,782,009
Stock options issued to officer (Note 8) 31,250 31,250
Bridge financing warrants 1,187,500 1,187,500
---------- ----------
3,040,542 3,000,759
========== ==========
The number of shares that would be issued from the exercise of the
warrants has been reduced by the number of shares that could have been
purchased from the proceeds at the average market price of $ 9.00 per
share for Class A warrants and $ 15.00 per share for Class Z warrants,
which represents the redemption prices.
Income Taxes
At July 31, 1996, the Company has financial, federal, and California
tax net operating loss carryforwards of approximately $ 791,000, $
617,000, and $ 433,000, respectively. The difference between the
financial reporting and the federal tax loss carryforward is primarily
due to the capitalization of research and development expenses and
start-up expenses for tax purposes with an amortization over five (5)
years, but for financial reporting purposes these expenses are charged
to operations as incurred. The difference between federal and
California tax loss carryforwards is primarily due to the fifty
percent limitation on California loss carryforwards. The tax loss
carryforwards will begin expiring in fiscal year ended July 31, 2009,
unless previously utilized. Under the Tax Reform Act of 1986, the use
of the Company's net operating loss carryforwards may be limited if
the public offering contemplated results in a cumulative change in
ownership of more than 50%.
The Company adopted Financial Accounting Standards Board Statement No.
109, Accounting for Income Taxes, beginning in fiscal year ended July
31, 1993. The adoption had no impact on 1993 results. In accordance
with this new standard, the Company has recorded total deferred tax
assets of $ 158,000 and a related valuation reserve of $ 158,000 as
of July 31, 1996. Realization of these deferred tax assets, which
relate to operating loss carryforwards and timing differences from the
amortization of research and development expenses and start-up
expenses, is dependent on future earnings. The timing and amount of
future earnings are uncertain and therefore, the valuation reserve has
been established.
NOTE 2. NOTES RECEIVABLE
At July 31, 1996, notes receivable in the amount of $ 15,858
represents amounts due from an officer and $ 9,128 represents amounts
due from a shareholder. All notes receivable are due and payable
within one year.
NOTE 3. DUE FROM SHAREHOLDERS AND OFFICERS
At July 31, 1996, due from shareholder is $ 500 and due from officers
and shareholders is $ 76,387.
<PAGE>
NOTE 4. PROPERTY, PLANT AND EQUIPMENT
The following is a summary of property, plant, and equipment - at
cost, less accumulated depreciation:
July 31, 1996 July 31, 1995
------------- -------------
Computers and equipment $ 132,715 $ 91,582
Furniture and fixtures 47,993 20,336
Property held under capital lease 7,511 0
Leasehold improvements 41,751 17,090
---------- ----------
229,970 129,008
Less: accumulated depreciation 66,564 37,510
---------- ----------
Total $ 163,406 $ 91,498
========== ==========
Depreciation expense charged to general and administrative expense for
the years ended July 31, 1996 and 1995 was $ 29,054 and $ 16,395,
respectively.
NOTE 5. DEBT
The details relating to debt are as follows:
July 31, 1996 July 31, 1995
------------- -------------
Notes payable to a stockholder with
interest at 12% interest payable in
monthly installments of $ 247 and
principal all due and payable on
January 1, 1997 $ 25,000 $ 25,000
Obligation under capital lease 5,132 0
Bridge financing ( Note 11) 375,000 0
---------- ----------
Total notes payable 405,132 25,000
Less: Current maturities of notes payable
included in current liabilities 402,154 0
---------- ----------
Total long term debt $ 2,978 $ 25,000
========== ==========
NOTE 6. CAPITAL LEASE
The company is the lessee of a display booth under a capital lease
expiring in August of 1998. The asset and liability under the capital
lease is recorded at the lower of the present values of the minimum
lease payments or the fair market value of the asset. The asset is
amortized over the estimated useful life of ten years. Depreciation of
the asset under capital lease charged to expense in the year ended July
31, 1996 was $ 474. The monthly lease payment which began in September
1995 is $ 262.
<PAGE>
NOTE 6. CAPITAL LEASE (CONTINUED)
Minimum future lease payments under the capital lease as of July 31,
1996 for each of the next five years and in the aggregate are:
Year ended July 31
------------------
1997 $ 3,144
1998 3,144
1999 262
--------
Total minimum lease payments $ 6,550
Less the amount representing interest 1,418
--------
Present value of net minimum lease payment $ 5,132
--------
The interest rate on the capital lease is approximately 23.6%.
NOTE 7. COMMITMENTS
The company leases office and warehouse facilities under an operating
lease expiring on December 31, 1996. The rental expense recorded in
general and administrative expenses for the years ended July 31, 1996
and July 31, 1995 was $ 23,279 and $ 13,631, respectively.
On May 14, 1996, the Company entered into a new operating lease
agreement for sixty-five months commencing on July 1, 1996. The rent
payment portion of the lease will be for sixty-three months which
allows for an initial building improvement period of two months. The
monthly rental for the 7,000 square foot facility will be $ .61 per
square foot plus $ .08 per square foot for maintenance of common
areas. There is also a fixed yearly increase of 4%. The company has
also signed an amendment to the lease to allow for an option to lease
the building for an additional five years. The company has budgeted
approximately $ 250,000 for leasehold improvements in the new
building.
<PAGE>
NOTE 8. CAPITAL STOCK
The following schedule summarizes the change in capital stock:
Common Common
Stock Shares Stock $
------------ ------------
Balance, July 31, 1994 2,568,750 $ 482,171
Reverse stock split ( 856,233) 0
Sale of stock 76,000 59,790
Stock issued for debt 3,334 5,000
Contribution of officers wages 0 45,000
Balance, July 31, 1995 1,791,851 $ 591,961
Sale of stock 37,000 22,220
Stock issued for services 5,000 5,000
Contribution of officers wages 0 44,000
Balance, July 31, 1996 1,833,851 $ 663,181
On May 4, 1994, the Shareholders voted to increase authorized common
stock from 100,000 to 5,000,000 shares. On November 22, 1993, the
Board of Directors authorized a stock split for shareholders of record
of September 30, 1993, thereby increasing the number of issued and
outstanding shares to 2,117,520.
On April 17, 1996, the Board of Directors approved a 2 for 3 reverse
stock split of the common stock of the founding shareholders of the
corporation, thus reducing the outstanding shares. Also, the board
authorized the issuance of two classes of shares, to be designated
respectively as Common shares and Preferred shares . The total
number of authorized common shares of the corporation was increased
from 5,000,000 shares to 20,000,000 shares, with no par value. The
total number of authorized preferred shares of the corporation was
increased from 1,000,000 shares to 5,000,000 shares, with no par
value. All references in the accompanying financial statements to the
number of common shares and per-share amounts have been restated to
reflect the stock splits.
<PAGE>
NOTE 9. RELATED PARTY TRANSACTIONS
On April 1, 1996, the Company entered into an employment agreement
with the President and Chief Executive Officer. The term of the
agreement is for five years with an automatic renewal of another five
years. The following are the major provisions of the agreement:
1. Compensation -
a. Salary of $108,000 per year, and
b. Additional compensation equal to 3% of the net income
before taxes earned by the corporation during each full
fiscal year, and
c. A monthly amount of not more than $500 per month for a
auto lease, and
d. A five year option to purchase as many shares of the
corporation's common stock as equals one hundred
thousand dollars at 80% of the initial public offering
price of the Company's common stock, approximately
31,250 shares at $3.20 per share, which are exercisable
in April, 1997.
2. Compensation for past services -
In consideration of services which have been rendered during
the fiscal years ended July 31, 1994 and July 31, 1995 and
the eight months period ended March 31, 1996, the
corporation granted the following compensation for past
services rendered:
a. $30,000 for fiscal year ended July 31, 1994, and
b. $45,000 for fiscal year ended July 31, 1995, and
c. $60,000 for the eight months ended March 31, 1996.
The President (Mr. Krall) waived the payment of $119,000 of the
compensation for past services and contributed this amount as an
additional payment for the common stock he presently owns.
In order to reward the efforts of Director Krall for his outstanding
performance in the weeks leading to NASDAQ approval of the initial
public offering, the Compensation Committee recommended and the Board
of Directors authorized a bonus to Mr. Krall in the amount of $
257,500. The bonus of $ 257,500 has been accrued at July 31, 1996.
NOTE 10. STOCK OPTION PLANS
On April 17, 1996, the Board of Directors and the shareholders
approved a stock option plan for the key employees of the Company and
non-employee Directors of the Company. Under the plan the number of
shares of stock which may be issued and sold shall not exceed
1,000,000 shares, with 900,000 shares reserved for issuance to key
employees pursuant to their Incentive Stock Options and 100,000 shares
reserved for issuance to non-employee Directors pursuant to their non-
statutory options. The per share option shall be determined by
committee, but the per share exercise price shall not be less than the
fair market value of the stock on the date the option is granted. No
person shall receive options, first exercisable during any single
calendar year for stock, the fair market value of which exceeds
$100,000.
On April 17, 1996, the Board of Directors approved a stock option plan
for the executive officers and Directors of the Company. Under the
plan the maximum number of shares of stock which may be issued and
sold shall not exceed 1,000,000 shares ,with the maximum number of
shares for which an option may be granted to any one Director or
officer shall be 100,000. The per share option price for the stock
subject to each option shall be $1.00 per share or such other price as
the Board of Directors may determine.
Also, on April 17, 1996, the Board of Directors approved the issuance
of 2,500 shares to each of two retiring board members for past
services.
<PAGE>
NOTE 11. BRIDGE FINANCING
In May 1996, the Company offered in a private placement 15 Bridge Loan
Units each originally consisting of one $25,000 secured promissory
note, 50,000 common shares, 50,000 Class A Bridge Warrants to acquire
one common share at $5.25 and 50,000 Class Z Warrants to acquire one
common share at $10.00 per share. On August 1, 1996 the Company
renegotiated the terms of the Bridge Financing with the investors
therein in order to address concerns of The Nasdaq SmallCap Market as
to the potential return to these investors. As a result, the Bridge
Financing investors agreed to the cancellation of the 50,000 common
shares per the Bridge Loan Unit (750,000 common shares in total) and
an increase of 100,000 Class A Warrants per Bridge Loan Unit
(1,500,000 additional Class A Warrants in total). As a result, the
Bridge Financing investors have been issued a total 2,250,000 Class A
warrants and 750,000 Class Z Warrants. In addition, the Bridge
Financing investors have each agreed to an irrevocable and complete
restriction on the transfer of each investor s Class A Warrants for a
six month period from August 8, 1996. The promissory notes bear
interest at the rate of (5%) five percent and are due and payable on
the earlier of the closing of the public offering or October 26, 1996.
The Bridge Loan promissory notes are secured by substantially all of
the assets of the Company and a personal guaranty granted by Michael
Krall, the Company's president. The Class A and Class Z Warrants
cannot be exercised for one year and two years, respectively, and both
expire in August 2001. The Company will receive the exercise price of
the Bridge Loan Unit warrants, but will not receive any proceeds from
any sale of the Bridge Loan Unit warrants or the shares underlying the
warrants. The net proceeds to the Company from the issuance of the
promissory notes was $ 292,150, after payment of $ 82,850 for public
offering costs.
The Bridge Financing and the public offering may be deemed integrated
together and as a result, the Bridge Financing may have been in
violation of the registration requirements of Section 5 of the
Securities Act of 1933. This results in a contingent liability for the
purchase price of the securities sold in violation of section 5 in the
amount of $ 375,000 as well as other damages and litigation cost. The
Company is already contractually bound to repay the entire
consideration given for the Bridge Financing Units. No assurance can
be given that this contingent liability will not have a material
adverse effect upon the company or its operations. On August 16, 1996,
after the closing of the initial public offering, all Bridge loans
were repaid with interest.
NOTE 12. SUBSEQUENT EVENTS
Initial public offering
On August 13, 1996, the Company completed a public offering of its
common stock and Class A warrants. A registration statement covering
that offer was filed with the SEC on August 8, 1996. The IPO price to
the public was $ 4.00 per share of the common stock and $ .10 per
share on the warrants. The total proceeds from the IPO was $ 5,125,000
(1,250,000 shares of common and 1,250,000 Class A warrants). The net
proceeds after deducting the underwriters fees and other costs was $
4,525,625. On September 13, 1996, the overallottment shares were sold
as per the underwriters agreement and the Company received $ 476,760
( 137,000 shares of common at $ 4.00 per share and 137,000 Class A
warrants at $ .10 per warrant less underwriters fees and costs).
Directors and officers stock option plan
On September 20, 1996, the Board of Directors approved subject to
underwriters approval an offer to all Directors and Executive
Officers, the option of purchasing up to 50,000 shares of the
corporations stock at $ 4.00 per share. The option would be for a
period of five years with the underlying shares registered with the
SEC on form S-8.
<PAGE>
Auditor's Report
on Supplementary Information
Our audits of the basic financial statements were made primarily to
form an opinion on such financial statements taken as a whole. The
supplementary information contained in the following pages is presented for
the purpose of additional analysis and, although not required for a fair
presentation of financial position, results of operations, and cash flows,
was subjected to the audit procedures applied in the examinations of the
basic financial statements. In our opinion, the supplementary information
is fairly presented in all material respects in relation to the basic
financial statements taken as a whole.
Steven Holland
Certified Public Accountant
San Diego, Ca.
October 25, 1996
<PAGE>
INNOVATIVE MEDICAL SERVICES
SUPPLEMENTARY INFORMATION
For the Years Ended
July 31
----------------------
1996 1995
---------- ----------
Schedule of Cost of Sales
Material purchases $ 503,721 $ 250,148
Production labor 73,151 18,783
Freight 41,138 21,214
Supplies and miscellaneous 264 464
---------- ----------
Total cost of sales $ 618,274 $ 290,609
========== ==========
Schedule of Selling Expenses
Advertising and promotion $ 0 $ 15,886
Brochures and catalogs 4,146 80
Demo and evaluation systems 2,185 467
Marketing expenses 11,516 3,448
Sales wages 46,184 10,577
Travel and entertainment 12,435 2,877
Trade shows 17,474 40
---------- ----------
Total selling expenses $ 93,940 $ 33,375
========== ==========
<PAGE>
Innovative Medical Services
Supplementary Information
For the Years Ended
July 31
----------------------
1996 1995
---------- ----------
Schedule of General and Administrative Expenses
Auto expenses $ 15,698 $ 11,046
Amortization 1,032 1,032
Bad debt expense 8,500 0
Bank charges 720 225
Computer expenses 12,652 4,445
Contributions 205 0
Credit card fees 165 78
Depreciation 29,054 16,395
Dues and subscriptions 2,711 32
Equipment rental 337 0
Insurance 7,833 5,334
Interest expense 9,163 3,061
Legal and professional 8,000 2,503
License and permits 743 52
Miscellaneous 1,551 556
Office supplies and expense 15,213 9,098
Office wages and payroll taxes 38,017 11,928
Officers wages 353,500 45,000
Postage 1,089 1,030
Rent expense 23,279 13,631
Repairs and maintenance 4,360 262
Research and development expenses 6,483 0
Security 210 211
Taxes: business and sales 4,192 0
Telephone expense 8,152 9,687
Utilities 3,630 2,045
---------- ----------
Total general and administrative expenses $ 556,489 $ 137,651
========== ==========
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the
Securities Exchange Act of 1934, the registrant has duly caused this
report to be signed on its behalf by the undersigned, thereunto duly
authorized.
INNOVATIVE MEDICAL SERVICES
/s/ NORMAN ANDERSON
----------------------------
Norman Anderson, Chairman
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report is signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
NAME TITLE DATE
/s/ MICHAEL L. KRALL Chief Executive Officer October 31, 1996
- -------------------------- Director and President ----------------
Michael L. Krall
/s/ EUGENE PEISER Director October 31, 1996
- -------------------------- ----------------
Eugene Peiser
/s/ PATRICK GALUSAK Director October 31, 1996
- -------------------------- ----------------
Patrick Galuska
/s/ DENNIS BROVARONE Director October 31, 1996
- -------------------------- ----------------
Dennis Brovarone
/s/ GARY BROWNELL Chief Financial Officer October 31, 1996
- -------------------------- Director ----------------
Gary Brownell
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<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> JUL-31-1996
<PERIOD-START> AUG-01-1995
<PERIOD-END> JUL-31-1996
<CASH> 21,706
<SECURITIES> 0
<RECEIVABLES> 90,963
<ALLOWANCES> (9,000)
<INVENTORY> 55,660
<CURRENT-ASSETS> 270,460
<PP&E> 229,970
<DEPRECIATION> (66,564)
<TOTAL-ASSETS> 817,242
<CURRENT-LIABILITIES> 942,357
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0
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<COMMON> 663,181
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<TOTAL-LIABILITY-AND-EQUITY> 817,242
<SALES> 825,695
<TOTAL-REVENUES> 825,695
<CGS> 618,274
<TOTAL-COSTS> 650,429
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<INTEREST-EXPENSE> 9,163
<INCOME-PRETAX> (429,248)
<INCOME-TAX> 800
<INCOME-CONTINUING> (430,048)
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<NET-INCOME> (430,048)
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