UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
----------------------
FORM 10-Q
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
-----------
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended November 30, 1998
TRANSITION REPORT PURSUANT TO SECTION 13 OR
15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
Commission File No. 0-7578
ELECTRO-CATHETER CORPORATION
(Exact name of the Registrant as specified in Charter)
New Jersey 22-1733406
(State of Incorporation) (I.R.S. Employer ID Number)
2100 Felver Court, Rahway, New Jersey 07065
(Address of Principal Executive Offices) (Zip Code)
Registrant's Telephone No. including Area Code: 732-382-5600
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 X No
Indicate the number of shares outstanding of the issuer's common stock, as
of the latest practical date:
As of January 11, 1999, the number of shares outstanding of the
Registrant's common stock was 6,390,389 shares, $.10 par value.
<PAGE>
ELECTRO-CATHETER CORPORATION
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
- -----------------------------
PAGE
Item 1. Financial Statements (Unaudited):
Condensed Comparative Balance Sheets
November 30, 1998 and August 31, 1998 1
Condensed Comparative Statements of Operations -
Three Months Ended November 30, 1998
and November 30, 1997 2
Condensed Comparative Statements of Cash Flows -
Three Months Ended November 30, 1998 and
November 30, 1997 3
Notes to Condensed Financial Statements 4 - 7
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 8 - 13
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K 14
SIGNATURES 14
INDEX TO EXHIBITS 15
<PAGE>
<TABLE>
PART I - FINANCIAL INFORMATION
Item 1. - Financial Statements
ELECTRO-CATHETER CORPORATION
CONDENSED COMPARATIVE BALANCE SHEETS
November 30, 1998 and August 31, 1998
(Unaudited)
<CAPTION>
November 30 August 31
1998 1998
---- ----
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 64,454 168,762
Accounts receivable, net 426,561 723,753
Inventories 1,148,914 1,253,456
Prepaid expenses and other current assets 54,341 68,538
----------- ----------
Total current assets 1,694,270 2,214,509
Property, plant and equipment, net 623,236 653,452
Deferred merger costs 321,180 234,253
Other assets, net 101,933 80,733
---------- ---------
Total assets 2,740,619 3,182,947
========= =========
LIABILITIES AND STOCKHOLDERS' DEFICIENCY
Current liabilities:
Current installments of subordinated debentures
due to The T Partnership, a related party 75,000 -
Current installments of capitalized lease
obligations 77,000 73,279
Accounts payable - trade 575,942 774,200
Accrued expenses 304,786 341,646
Accrued merger costs 257,446 181,319
Accrued interest due to The T Partnership, a related party 361,178 293,764
Accrued litigation expenses 235,134 265,134
--------- ---------
Total current liabilities 1,886,486 1,929,342
Subordinated debentures and promissory note due to
The T Partnership, a related party 2,172,125 2,247,125
Capitalized lease obligations, excluding
current installments 176,863 196,614
--------- ---------
Total liabilities 4,235,474 4,373,081
--------- ---------
Stockholders' deficiency:
Common stock 639,039 639,039
Additional paid-in capital 10,704,803 10,704,803
Accumulated deficit (12,838,697) (12,533,976)
----------- ----------
Total stockholders' deficiency (1,494,855) (1,190,134)
------------ ------------
Total liabilities and stockholders' deficiency $ 2,740,619 3,182,947
========== =========
See accompanying notes to condensed financial statements.
</TABLE>
1
<PAGE>
<TABLE>
ELECTRO-CATHETER CORPORATION
CONDENSED COMPARATIVE STATEMENTS OF OPERATIONS
(Unaudited)
<CAPTION>
Three Months Ended
November 30,
1998 1997
---- ----
<S> <C> <C>
Net revenues, including product sales,
royalty revenue and license fees $ 967,286 1,335,313
Cost of goods sold 701,981 864,846
------- ---------
Gross profit 265,305 470,467
Operating expenses:
Selling, general and administrative 362,069 526,050
Research and development 119,667 163,018
------- -------
Operating loss (216,431) (218,601)
Other expense:
Interest expense (88,290) (72,856)
------- -------
Net loss $ (304,721) (291,457)
========= =========
Basic and diluted net loss per common share $ (0.05) (0.05)
===== =====
Dividends per share None None
Weighted average shares outstanding 6,390,389 6,383,611
========= =========
See accompanying notes to condensed financial statements.
</TABLE>
2
<PAGE>
<TABLE>
ELECTRO-CATHETER CORPORATION
CONDENSED COMPARATIVE STATEMENTS OF CASH FLOWS
(Unaudited)
<CAPTION>
Three Months Ended
November 30,
1998 1997
---- ----
<S> <C> <C>
Cash flows from operating activities:
Net loss $ (304,721) (291,457)
Reconciliation of net loss to net cash used in operating activities:
Depreciation 30,216 32,508
Amortization 2,083 2,083
Changes in assets and liabilities:
Decrease in accounts receivable, net 297,192 15,050
Decrease (increase) in inventories 104,542 (103,541)
Decrease in prepaid expenses and
other current assets 14,197 85,411
(Increase) decrease in other assets (23,283) 3,354
Increase in deferred merger costs (86,927) -
(Decrease) increase in accounts payable
and accrued expenses (121,577) 90,317
--------- ---------
Net cash used in operating activities $ (88,278) (166,275)
------- -------
Cash flows used in investing activities -
Purchases of property, plant and
equipment - (1,649)
--------- -------
Cash flows (used in) provided by financing activities:
Proceeds from loan and warrants
from The T Partnership, a related party - 100,000
Repayment of capitalized lease obligations (16,030) (14,320)
------ ------
Net cash (used in) provided by
financing activities (16,030) 85,680
------- --------
Net decrease in cash (104,308) (82,244)
Cash at beginning of period 168,762 98,127
------- ------
Cash at end of period $ 64,454 15,883
====== ======
See accompanying notes to condensed financial statements.
</TABLE>
3
<PAGE>
ELECTRO-CATHETER CORPORATION
NOTES TO CONDENSED FINANCIAL STATEMENTS
Note 1 Basis of Presentation
- ------ ---------------------
In the opinion of management, the accompanying unaudited condensed financial
statements contain all adjustments (consisting only of normal recurring
accruals) necessary to present fairly the financial position of Electro-Catheter
Corporation ("Electro") as of November 30, 1998, the results of operations and
cash flows for the three months ended November 30, 1998 and November 30, 1997,
but are not necessarily indicative of the results to be expected for the full
year.
The financial statements have been prepared in accordance with the requirements
of Form 10-Q and consequently do not include disclosures normally made in an
Annual Report on Form 10-K. Accordingly, the financial statements included
herein should be reviewed in conjunction with the financial statements and notes
thereto included in Electro's Annual Report on Form 10-K for the fiscal year
ended August 31, 1998.
Note 2 Liquidity
- ------ ---------
The accompanying financial statements have been prepared on a going concern
basis which contemplates the continuation of operations, realization of assets
and liquidation of liabilities in the ordinary course of business. Electro
incurred net losses of $1,077,317, $1,354,942 and $892,940 for the years ended
August 31, 1998, 1997 and 1996, respectively, and a loss of $304,721 for the
three months ended November 30, 1998. At November 30, 1998, Electro had an
accumulated deficit of $12,838,697. The net losses incurred by Electro have
consumed working capital and weakened its financial position. Electro's ability
to continue in business is dependent upon its success in generating sufficient
cash flow from operations or obtaining additional financing. Electro continues
to re-evaluate its plans and adopt certain cost reduction measures. The
contemplated merger between Electro and Cardiac Control Systems, Inc. ("Cardiac"
or "CCS"), a Delaware corporation located in Palm Coast, Florida, is contingent
upon raising sufficient capital to support each Company's product development
efforts. However, there can be no assurance that the merger will occur or that
Electro will be able to generate the funding required.
Note 3 Accounts Receivable
- ------ -------------------
<TABLE>
Accounts receivable comprise the following:
<CAPTION>
November 30, August 31,
1998 1998
---- ----
<S> <C> <C>
Accounts receivable - trade $ 645,760 937,342
Allowance for doubtful accounts (219,199) (213,589)
-------- --------
$ 426,561 723,753
======== =======
</TABLE>
Note 4 Inventories
- ------ -----------
<TABLE>
Inventories consist of the following:
<CAPTION>
November 30, August 31,
1998 1998
---- ----
<S> <C> <C>
Finished goods $ 460,990 398,503
Work-in-process 477,308 611,300
Materials and supplies 210,616 243,653
------- -------
$ 1,148,914 1,253,456
========= =========
</TABLE>
4
<PAGE>
Note 5 Commitments and Contingencies
- ------ -----------------------------
FDA Warning Letter
- ------------------
Electro's products are classified as medical devices under the FDA Act and, as
such, are subject to extensive regulatory compliance requirements. In February
1997, the FDA conducted an inspection and audit of Electro's facilities and
practices, as a result of which the FDA issued a Warning Letter (the "FDA
Warning Letter") regarding non-compliance by Electro with certain regulations
regarding current good manufacturing practices ("cGMP") in the manufacture of
its products. The areas of noncompliance include Electro's methods of
investigation of device complaints, methods of validation of device
sterilization, environmental monitoring procedures, methods of validation of
extrusion processes which are used in the manufacture of certain of Electro's
catheters and other quality assurance and recordkeeping requirements. Electro
has communicated with the FDA its intentions to remedy the non-compliance, has
established a plan to effectuate such remediation and has diligently worked to
take the necessary corrective actions. Electro's actions have included the
establishment of certain validation protocols, revisions of Electro's Quality
System and Quality System Manual, the implementation of a program for
environmental testing, the purchase of equipment for extrusion process
validation and the institution of file and recordkeeping protocols. A subsequent
FDA inspection in September 1997 indicated that while substantial progress had
been made, not all corrective actions had been completed. Electro is continuing
in its efforts to complete such actions and it is Electro's intention to inform
the FDA in early 1999 that it has completed such actions and is ready for
reinspection. There can be no assurance, however, that Electro will be ready for
such reinspection nor that Electro will pass any such reinspection when it
occurs. While Electro is currently under no restrictions by the FDA regarding
the manufacture or sale of its products, Electro is unable to determine
precisely the short-term economic impact of instituting the required corrective
actions and there can be no assurance that the FDA will not take further action,
including seizure of products, injunction and/or civil penalties, if the
necessary corrective actions are not completed on a timely basis. Until all
corrective actions required under the FDA Warning Letter have been taken, the
FDA will not consider new products for approval. However, Electro's insufficient
financing for research and development efforts over the last few years have
limited its ability to produce new products and, consequently, no FDA approvals
are currently sought.
The Proposed Merger
- -------------------
Electro entered into an Agreement and Plan of Reorganization dated as of January
20, 1998, with CCS, to effect a merger of the two companies targeted toward
the development and marketing of advanced specialty electrophysiology products.
The structure of the transaction contemplates the merger of a newly-created,
wholly-owned subsidiary of CCS into and with Electro as a result of which
Electro shall become a wholly-owned subsidiary of CCS and the stockholders of
Electro will become stockholders of Catheter Technology Group, Inc. ("CTG"), a
Delaware corporation and parent holding company of CCS, formed as part of a
restructuring in connection with the merger. By virtue of the merger, each
outstanding share of common stock, $.10 par value, of Electro will be converted
into the right to receive one-fifth of a share of common stock $.10 par value of
CTG. Pursuant to the restructuring, CTG will succeed to all rights and
obligations of CCS and stockholders of CCS will become stockholders of CTG.
Pursuant to the restructuring, it is intended that CCS will undergo a 1 for 5
reverse stock split reducing the number of shares of common stock, $.10 par
value, of CCS outstanding to approximately 529,748 shares. By virtue of the
merger, subsequent to the reverse stock split, each outstanding share of common
stock, $.10 par value, of Electro will be converted into the right to receive
one-fifth of a share of CTG Common Stock, effectively equal to an even exchange
of shares prior to such reverse stock split. Upon consummation of the merger,
CTG plans to issue stock in a public offering. It is expected that the merger
will be accounted for using the purchase method of accounting as a reverse
acquisition with Electro deemed to be the accounting acquiror as its
stockholders will receive the largest portion of the voting rights in CTG.
Accordingly, Electro has deferred costs associated with the merger. If the
merger is not consummated, such costs will be recognized as expense in that
period.
5
<PAGE>
Consummation of the merger is subject to a number of conditions, many of which
have already been met. The remaining conditions are to be satisfied on or before
January 31, 1999 in order for the merger to be consummated. Among conditions
remaining to be satisfied are: (i) the securing of a minimum of $4.0 million in
financing in addition to any existing debt obligations of both Cardiac and
Electro; and (ii) the receipt of all required regulatory approvals by the two
companies. The stockholders of each of Electro and Cardiac approved the merger
at the respective Special Meetings of such Stockholders held on November 16,
1998.
There is no assurance that the remaining conditions will be satisfied in time or
that the merger will be completed at all.
International Sales
- -------------------
Beginning in June 1998, international sales were adversely affected in Europe
(approximately 21% and 17% of total revenues for the fiscal years 1996 and 1997,
respectively) as Electro was not able to obtain the CE Mark on its products on a
timely basis in order to continue to sell into this market. Several months ago,
Electro and CCS submitted an application requesting CE Mark certification for
CCS to sell Electro's steerable line of catheters, as manufacturer, with Electro
acting as vendor to CCS in such regard. The CE Mark certification was granted on
October 26, 1998, issued in the name of CCS. Upon completion of the merger, the
CE Mark will belong to CTG. CCS and Electro intend to have product with the CE
Mark available for shipment in early 1999. Applications for the CE Mark for many
additional products of Electro have been submitted recently. However, there can
be no assurance that the CE Mark for the additional products will be obtained,
that the merger between CCS and Electro will be consummated or that the pre-June
1998 sales levels will be recaptured.
Note 6 Reclassifications
- ------ -----------------
Certain reclassifications have been made to conform to the fiscal year 1999
presentation.
Note 7 Earnings Per Share
- ------ ------------------
Basic loss per share is based on net loss for the relevant period, divided by
the weighted average number of common shares outstanding during the period.
Diluted loss per share is based on net loss for the relevant period, divided by
the weighted average number of common shares outstanding during the period.
Common share equivalents, such as outstanding stock options, are not included in
the calculation since the effect would be antidilutive.
Note 8 Comprehensive Income
- ------ --------------------
On June 7, 1997, the FASB issued SFAS No. 130 "Reporting Comprehensive Income".
SFAS No. 130 establishes standards for reporting and display of comprehensive
income and its components (revenues, expenses, gains, and losses) in a full set
of general purpose financial statements. SFAS No. 130 requires that all items
that are required to be recognized under accounting standards as components of
6
<PAGE>
comprehensive income be reported in a financial statement that is displayed with
the same prominence as other financial statements. SFAS No. 130 is effective for
fiscal years beginning after December 15, 1997. Reclassification of financial
statements for earlier periods provided for comparative purposes is required.
Electro adopted SFAS No. 130 for the quarter ended November 30, 1998.
Comprehensive income for the three month periods ended November 30, 1998 and
1997 were the same as net losses of $304,721 and $291,457, respectively.
7
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
- -----------------------------------------------------------
AND RESULTS OF OPERATIONS
-------------------------
Results of Operations
- ---------------------
General. The following is management's discussion and analysis of certain
significant factors which have affected the financial condition and results of
operations of Electro-Catheter Corporation ("Electro") during the periods
included in the accompanying financial statements.
Statements contained in and preceding management's discussion and analysis
include various forward-looking information that is based on data currently
available to management and management's beliefs and assumptions. When used in
this report, the words "anticipates," "estimates," "believes," "plans," and
similar expressions are intended to identify forward-looking statements, but are
not the exclusive means of identifying such statements. Such statements are
subject to risks and uncertainties, and Electro's actual results may vary
materially from those anticipated, estimated or projected due to a number of
factors, including, without limitation, the competitive environment for
Electro's products and services, and other factors set forth in reports and
other documents filed by Electro with the Securities and Exchange Commission
from time to time.
Proposed Merger. Electro entered into an Agreement and Plan of Reorganization
dated as of January 20, 1998, with Cardiac Control Systems, Inc. ("Cardiac" or
"CCS"), to effect a merger of the two companies targeted toward the development
and marketing of advanced specialty electrophysiology products. The structure of
the transaction contemplates the merger of a newly-created, wholly-owned
subsidiary of CCS into and with Electro as a result of which Electro shall
become a wholly-owned subsidiary of CCS and the stockholders of Electro will
become stockholders of Catheter Technology Group, Inc. ("CTG"), a Delaware
corporation and parent holding company of CCS, formed as part of a restructuring
in connection with the merger. By virtue of the merger, each outstanding share
of common stock, $.10 par value, of Electro will be converted into the right to
receive one-fifth of a share of common stock $.10 par value of CTG. Pursuant to
the restructuring, CTG will succeed to all rights and obligations of CCS and
will become the successor issuer of CCS such that stockholders of CCS will
become stockholders of CTG. Pursuant to the restructuring, it is intended that
CCS will undergo a 1 for 5 reverse stock split reducing the number of shares of
common stock, $.10 par value, of CCS outstanding to approximately 529,748
shares. By virtue of the merger, subsequent to the reverse stock split, each
outstanding share of common stock, $.10 par value, of Electro will be converted
into the right to receive one-fifth of a share of CTG Common Stock, effectively
equal to an even exchange of shares prior to such reverse stock split. Upon
consummation of the merger, CTG plans to issue stock in a public offering. It is
expected that the merger will be accounted for using the purchase method of
accounting as a reverse acquisition with Electro deemed to be the accounting
acquiror as its stockholders will receive the largest portion of the voting
rights in CTG. Accordingly, Electro has deferred costs associated with the
merger. If the merger is not consummated, such costs will be recognized as
expense in that period.
Consummation of the merger is subject to a number of conditions, many of which
have already been met. The remaining conditions are to be satisfied on or before
January 31, 1999 in order for the merger to be consummated. Among conditions
remaining to be satisfied are: (i) the securing of a minimum of $4.0 million in
financing in addition to any existing debt obligations of both Cardiac and
8
<PAGE>
Electro; and (ii) the receipt of all required regulatory approvals by the two
companies. The stockholders of each of Electro and Cardiac approved the merger
at the respective Special Meetings of such Stockholders held on November 16,
1998.
There is no assurance that the remaining conditions will be satisfied in time or
that the merger will be completed at all.
Overview. Electro's insufficient financing for research and development efforts
over the last few years has limited its ability to produce new products and,
consequently, has adversely affected product sales. Additionally, international
sales have been adversely affected in Europe recently as Electro was not able to
obtain the CE Mark on its products on a timely basis in order to continue to
sell into this market. While this situation has been addressed in part by
issuance of certification to CCS to market Electro's steerable line of
catheters, as manufacturer, there can be no assurance that pre-June 1998 sales
levels will be recaptured. Domestic sales were also affected as sales
representatives that left Electro were not replaced as a result of the financial
condition of Electro. This decline in sales was partially offset by instituting
certain cost reduction measures.
Revenues. Net revenues declined $368,027 (27.6%) for the three months ended
November 30, 1998 as compared to the three months ended November 30, 1997.
Product sales declined $273,318 (22.2%), sales to an OEM customer declined
$51,185 and licensing and royalty revenues decreased $43,524 as compared to the
same period last year.
Direct domestic sales decreased $138,418 (15.9%) for the three months ended
November 30, 1998 as compared to the same period in the prior year. The decline
was primarily attributed to lower electrophysiology sales as Electro has not
introduced any new products and also to Electro not having an approved
electrophysiology ablation catheter. Sales of Electro's Pacewedge catheter also
declined as a result of lower demand. A decline in demand for Electro's older
products in pacing and monitoring, backorders, as well as the impact of not
replacing sales representatives who have left Electro have also adversely
affected sales. International revenues decreased $134,900 (37.6%) for the three
months ended November 30, 1998 as compared to the three months ended November
30, 1997. The decline in international revenues is attributed to Electro not
obtaining the CE Mark on its products on a timely basis in order to continue to
sell into Europe and the lack of new products for the electrophysiology market
that Electro has targeted. Certain of Electro's European distributors have
terminated their relationship with Electro in order to represent competitors.
Several months ago, Electro and CCS submitted an application requesting CE Mark
certification for CCS to sell Electro's steerable line of catheters, as
manufacturer, with Electro acting as vendor to CCS in such regard. The CE Mark
certification was granted on October 26, 1998, issued in the name of CCS. Upon
completion of the merger, the CE Mark will belong to CTG. CCS and Electro intend
to have product with the CE Mark available for shipment in early 1999.
Applications for the CE Mark for many additional products of Electro have been
submitted recently. However, there can be no assurance that the CE Mark for the
additional products will be obtained, that the merger between CCS and Electro
will be consummated or that the pre-June 1998 sales levels will be recaptured.
Gross Profit. Gross profit dollars decreased $205,162 (43.6%) for the three
months ended November 30, 1998 as compared to the three months ended November
30, 1997. This decrease is primarily attributed to decreased production levels,
for the most part related to the lower sales volume. The gross profit percentage
for the three months ended November 30, 1998 was 27.4% as compared to 35.2% for
the three months ended November 30, 1997. The lower volume continues to
negatively impact gross profit.
9
<PAGE>
Selling, General and Administrative. Selling, general and administrative
expenses decreased $163,981 (31.2%) for the three months ended November 30, 1998
as compared to the same period in the prior year. This decrease reflects lower
domestic and international selling expenses primarily attributed to the loss of
field sales personnel that have not been replaced and the slowdown in
international activities. In addition, the prior year includes legal expenses
associated with the aforementioned merger with CCS which were subsequently
reclassified and recorded as a deferred charge in the second quarter of the
prior fiscal year.
Research and Development. Research and development expenses decreased $43,351
(26.6%) for the three months ended November 30, 1998 as compared to the same
period in the prior year. This decrease reflects the lower level of R & D
efforts, primarily attributed to a decrease in personnel.
Other Expense. Interest expense increased for the three months ended November
30, 1998 as compared to the same period in the prior year as a result of the
increased borrowings from The T Partnership and interest on capitalized lease
obligations.
Liquidity and Capital Resources
- -------------------------------
At November 30, 1998, Electro had negative working capital of $192,216 as
compared to positive working capital of $285,167 at August 31, 1998. Net cash
used in operating activities was $88,278 for the three months ended November 30,
1998 as compared to $166,275 used in operating activities for the same period in
the prior fiscal year. This decrease in cash required for operations is
primarily attributed to the decrease in accounts receivable and inventories,
offset partially by a decrease in accounts payable and accrued expenses and an
increase in deferred merger costs. Electro was able to satisfy its cash
requirements with cost saving measures, especially in the sales and marketing
area where sales personnel have not been replaced, cash on hand, collection of
accounts receivable and extension of its accounts payable.
Electro's ability to continue with its plans is contingent upon its ability to
obtain sufficient cash flow from operations or to obtain additional financing.
Electro has had difficulty in paying its obligations and, as a result has
delayed certain payments to vendors and others providing services to Electro,
such as attorneys. Electro continues to evaluate its plans and adopt certain
cost-saving measures, where appropriate. The contemplated merger is contingent
upon both companies raising sufficient capital to support their product
development efforts. Electro's management and Board of Directors believe that
this merger can offer advantages to the combined companies by, among other
benefits, providing economies of scale and elimination of redundancies. However,
there can be no assurance that the merger will occur or that Electro will be
able to generate the funding required. Further, there can be no assurance that
the combined company, upon consummation of the merger, will be able to achieve
positive operating results in the future.
The rate of interest on the debt to The T Partnership is 12% per annum on any
outstanding balance and is payable monthly. As of November 30, 1998, Electro
owed The T Partnership $361,178 for monthly interest payments dating back to
July 1997. Electro has sent the required interest payments to The T Partnership.
The T Partnership has chosen not to tender such checks for payment. Therefore,
Electro has considered the interest payments unpaid at November 30, 1998 and has
reflected the amount as a liability in the accompanying balance sheet. Interest
payments under this agreement continue to be required to be made monthly;
however, The T Partnership has agreed that the failure to make such monthly
payments will not constitute an event of default, as defined in the agreement,
and has agreed not to request acceleration of payment for the prior interest
payments or, further, for any fiscal year 1999 interest payments. Monthly
principal payments of $25,000 scheduled to begin on September 1, 1996 have,
pursuant to several waivers, with the latest received in January 1999, been
deferred to December 1, 1999. The loan is secured by Electro's property,
10
<PAGE>
building, accounts receivable, inventories and machinery and equipment. Electro
is to prepay the outstanding balance in the event it is merged into or
consolidated with another corporation or it sells all or substantially all of
its assets, unless The T Partnership and Electro agree otherwise. The Merger
Agreement contemplates that the total indebtedness outstanding and due to The T
Partnership plus interest accrued thereon (totaling approximately $2.6 million
at November 30, 1998) shall be redeemed at the merger effective time by: (a) the
issuance by the Surviving Subsidiary to The T Partnership of an aggregate of
1,000 shares of Series A Preferred Stock of the Surviving Subsidiary, which
shares shall have a liquidation value equal to, and shall be issued in
redemption of, $1.0 million of the indebtedness and shall be convertible into
shares of the new combined company's common stock; (b) the delivery to The T
Partnership of the new combined company's 9% conditional promissory note in the
amount of $1.0 million pursuant to which the new combined company is obligated
to pay only those amounts which are due but not paid to the holders of the
Series A Preferred Stock, or in the event of certain other non-monetary
defaults; and (c) the delivery to The T Partnership of a secured promissory note
made by the new combined company in an amount not to exceed $1.3 million (which
amount shall be the approximate remaining amount of Electro's secured
indebtedness to The T Partnership exclusive of the amount redeemed under (a)
above), bearing interest at the rate of 12% per annum payable quarterly, the
principal amount of which shall be due and payable three years from the date of
execution of such note (the terms of the security for the note have yet to be
agreed upon). As a result of the issuance of Series A Preferred Stock, The T
Partnership shall be entitled to receive dividends. In addition, pursuant to the
terms of the Merger Agreement, The T Partnership shall be entitled to
reimbursement for cash advances provided to Electro in the amount of $200,000,
or any greater amount as may be agreed to by Electro and Cardiac, in writing,
which may have been extended by The T Partnership between May 1, 1998 and the
completion of the merger for the purpose of operating capital, plus interest
accrued on such amount.
Under the provisions of the agreement with The T Partnership, Electro is
obligated to comply with certain covenants, to be tested on a monthly basis.
Non-compliance by Electro shall allow The T Partnership to declare an Event of
Default and accelerate repayment of indebtedness. As of November 30, 1998,
Electro was not in compliance with certain covenants. However, in January 1999,
The T Partnership agreed not to exercise its right to accelerate the repayment
of indebtedness through December 1, 1999 as a result of non-compliance with the
aforementioned covenants and agreed to defer the principal and interest payments
due through November 30, 1999.
Operating Trends and Uncertainties
- ----------------------------------
Sales. The ability of Electro to attain profitable operations is dependent upon
expansion of sales volume, both domestically and internationally, and continued
development of new and advanced products. Many countries in which Electro
markets its products regulate the manufacture, marketing and use of medical
devices. Electro intends to pursue product approval or registration procedures
in countries where it is marketing its products. The international registration
process and approval process is normally accomplished in coordination with its
international distributors. In order for Electro to continue to sell its
products in the nations of the EEC, it was required to obtain the CE Mark
certification from the International Organization of Standardization ("ISO").
Since Electro has not yet obtained the CE Mark certification and is now unable
to sell certain of its products in the nations of the EEC (which accounted for
approximately 14%, 17% and 21% of total revenues for fiscal years 1998, 1997 and
1996, respectively), international sales have been adversely affected in Europe.
Several months ago, Electro and Cardiac submitted an application requesting CE
Mark certification for Cardiac to sell Electro's steerable line of catheters, as
manufacturer, with Electro acting as vendor to Cardiac in such regard. CE Mark
certification was granted on October 26, 1998, and issued in the name of
Cardiac. Cardiac and Electro anticipate having product with CE Mark
11
<PAGE>
certification available for shipment in early 1999. Electro and Cardiac have
also recently submitted applications for CE Mark certification for many of
Electro's additional products. However, there can be no assurances that CE Mark
certification for the additional products will be obtained or that the pre-June
1998 sales levels will be recaptured.
FDA Warning Letter. Electro's products are classified as medical devices under
the FDA Act and, as such, are subject to extensive regulatory compliance
requirements. In February 1997, the FDA conducted an inspection and audit of
Electro's facilities and practices as a result of which the FDA issued the FDA
Warning Letter regarding non-compliance by Electro with certain regulations
regarding cGMP in the manufacture of its products. The areas of non-compliance
include Electro's methods of investigation of device complaints, methods of
validation of device sterilization, environmental monitoring procedures, methods
of validation of extrusion processes which are used in the manufacture of
certain of Electro's catheters and other quality assurance and recordkeeping
requirements. Electro has communicated with the FDA its intentions to remedy the
non-compliance, has established a plan and timetable to effectuate such
remediation and has diligently worked to take the necessary corrective actions.
Electro's actions have included the establishment of certain validation
protocols, revisions of Electro's Quality System and Quality System Manual, the
implementation of a program for environmental testing, the purchase of equipment
for extrusion process validation and the institution of file and recordkeeping
protocols. A subsequent FDA inspection in September 1997 indicated that while
substantial progress had been made, not all corrective actions had been
completed. Electro is continuing in its efforts to complete such actions and it
is Electro's intention to inform the FDA in early 1999 that it has completed
such actions and is ready for reinspection. There can be no assurance, however,
that Electro will be ready for such reinspection nor that it will pass any such
reinspection when it occurs. While Electro is currently under no restrictions by
the FDA regarding the manufacture or sale of its products, it is unable to
determine precisely the short-term economic impact of instituting the required
corrective actions and there can be no assurance that the FDA will not take
further action, including seizure of products, injunction and/or civil
penalties, if the necessary corrective actions are not completed on a timely
basis. Until all corrective actions required under the FDA Warning Letter have
been taken, the FDA will not consider new products for approval. However,
Electro's insufficient financing for research and development efforts over the
last few years have limited its ability to produce new products and,
consequently, no FDA approvals are currently sought.
Year 2000 Issue. Many currently installed computer systems use a two-digit
suffix to identify year references with an assumed prefix of "19". This limits
those systems to recognizing dates between 1900 and 1999. As a result, in a
little less than a year, computer systems and/or software used by many companies
in a very wide variety of applications will experience operating difficulties
unless they are modified or upgraded to adequately process information
involving, related to or dependent upon the century change. If not corrected,
systems and/or applications could fail or create erroneous results at or in
connection with applications after December 31, 1999. Significant uncertainty
exists concerning the scope and magnitude of problems associated with the
century change.
Electro has established a project team to address Year 2000 risks. Electro is
currently assessing the impact of Year 2000 on its computer systems and
financial applications although a plan has not been implemented. Electro is also
assessing the potential overall impact of the impending century change on its
business, results of operations and financial position.
Electro has reviewed its information and operational systems and manufacturing
processes in order to identify those products, services or systems that are not
Year 2000 compliant. As a result of its initial assessment, Electro has
12
<PAGE>
determined that it will be required to modify or replace certain information and
operational systems so they will be Year 2000 compliant. These modifications and
replacements are being, and will continue to be, made in conjunction with
Electro's overall systems initiatives. The total cost of these Year 2000
compliance activities is not anticipated to be material to Electro's financial
position or its results of operations. Electro expects to complete its Year 2000
project during 1999. Based on available information, Electro does not believe
any material exposure to significant business interruption exist as a result of
Year 2000 compliance issues. Accordingly, Electro has not adopted any formal
contingency plan in the event its Year 2000 project is not completed in a timely
manner. These costs and the timing in which Electro plans to complete its Year
2000 modification and testing processes are based on management's best
estimates. However, there can be no assurance that Electro will timely identify
and remediate all significant Year 2000 problems, that remedial efforts will not
involve significant time and expense, or that such problems will not have a
material adverse effect on Electro's business, results of operations or
financial position.
Electro also faces risk to the extent that suppliers of products, services and
systems purchased by it and others with whom Electro transacts business on a
worldwide basis do not comply with Year 2000 requirements. Electro will initiate
written communications with significant suppliers and customers to determine the
extent to which it is vulnerable to these third parties' failure to remediate
their own Year 2000 issues. In the event any such third parties cannot provide
Electro with products, services or systems that meet the Year 2000 requirements
on a timely basis, or in the event Year 2000 issues prevent such third parties
from timely delivery of products or services required by Electro, its results
of operations could be materially adversely affected. To the extent Year 2000
issues cause significant delays in, or cancellation of, decisions to purchase
Electro's products or services, its business, results of operations and
financial position could be materially adversely affected. Due to the general
uncertainty, both internally and externally, inherent in the Year 2000 problem
resulting, in part, from the uncertainty of its Year 2000 readiness of third
parties, suppliers and customers, Electro is unable to accurately predict at
this time whether the consequences of Year 2000 failures will have a material
impact on Electro's results of operations, liquidity or financial condition.
The discussion of Electro's efforts, and management's expectations, relating to
Year 2000 compliance are forward-looking statements. Electro's ability to
achieve Year 2000 compliance and the level of incremental costs associated
therewith, could be adversely impacted by, among other things, the availability
and cost of programming and testing resources, vendors' ability to modify
proprietary software, and unanticipated problems identified in the ongoing
compliance review.
13
<PAGE>
Part II. Other Information
- --------------------------
Item 6. Exhibits and Reports on Form 8-K
(a) The exhibits filed or incorporated by reference as part
of this Quarterly Report on Form 10-Q are listed in the
attached Index of Exhibits.
(b) Electro did not file any Current Reports on Form 8-K
during the period reviewed by this Quarterly Report on
Form 10-Q.
Signatures
- ----------
Pursuant to the requirements 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.
ELECTRO-CATHETER CORPORATION
/s/Ervin Schoenblum
-------------------
Date January 14, 1999 Ervin Schoenblum
---------------- Acting President and
Chief Operating Officer
/s/Joseph P. Macaluso
---------------------
Date January 14, 1999 Joseph P. Macaluso
---------------- Chief Financial Officer
14
<PAGE>
INDEX TO EXHIBITS
27 - Financial data schedule which is submitted electronically to the
Securities and Exchange Commission for information only and is not
filed.
15
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> AUG-31-1998
<PERIOD-START> SEP-01-1998
<PERIOD-END> NOV-30-1998
<CASH> 64
<SECURITIES> 0
<RECEIVABLES> 646
<ALLOWANCES> (219)
<INVENTORY> 1,149
<CURRENT-ASSETS> 1,694
<PP&E> 5,262
<DEPRECIATION> (4,639)
<TOTAL-ASSETS> 2,741
<CURRENT-LIABILITIES> 1,886
<BONDS> 0
0
0
<COMMON> 639
<OTHER-SE> (2,134)
<TOTAL-LIABILITY-AND-EQUITY> 2,741
<SALES> 957
<TOTAL-REVENUES> 967
<CGS> 702
<TOTAL-COSTS> 1,184
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> (88)
<INCOME-PRETAX> (305)
<INCOME-TAX> 0
<INCOME-CONTINUING> (305)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (305)
<EPS-PRIMARY> (.05)
<EPS-DILUTED> (.05)
</TABLE>
