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U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-KSB/A
Amendment No. 1 to Form 10-KSB
(Mark One)
/X/ Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 for the fiscal year ended at December 31, 1997
/ / Transition report under Section 13 or 15(d) of the Securities Exchange Act
of 1934 for the transition period from ________ to ________.
COMMISSION FILE NUMBER 0-9899
MEDICAL GRAPHICS CORPORATION
(Exact name of registrant as specified in its charter)
MINNESOTA 41-1316712
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
350 OAK GROVE PARKWAY
SAINT PAUL, MINNESOTA 55127
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(Address of principal executive offices and Zip Code)
Issuer's telephone number: (651) 484-4874
Securities registered under Section 12(b) of the Exchange Act: NONE
Securities registered under Section 12(g) of the Exchange Act:
COMMON STOCK, PAR VALUE $.05 PER SHARE (Title of Class)
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes X No
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Check if there is no disclosure of delinquent filers in response to Item 405 of
Regulation S-B is contained in this form, and no disclosure will 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
amendment to this Form 10-KSB. / /
State issuer's revenues for its most recent fiscal year: $19,173,000.
The aggregate market value of the common stock held by non-affiliates of the
registrant based on the closing sale price as reported on The NASDAQ SmallCap
Market on March 25, 1998 was $6,934,000.
As of March 26, 1998, 5,028,743 shares of the registrant's Common Stock, $.05
par value, and 444,445 shares of Class A Stock, $. 05 par value were
outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Company's definitive Proxy Statement for the Annual Meeting of
Shareholders, a definitive copy of which will be filed with the SEC within 120
days of December 31, 1997 are incorporated by reference into Items 9, 10, 11 and
12 of Part III.
Transitional Small Business Disclosure Formats (check one): Yes No X
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TABLE OF CONTENTS
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PART I . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
Item 1. Description of Business . . . . . . . . . . . . . . . . . . . . 1
Item 2. Description of Property . . . . . . . . . . . . . . . . . . . . 6
Item 3. Legal Proceedings . . . . . . . . . . . . . . . . . . . . . . . 6
Item 4. Submission of Matters to a Vote of Security Holders . . . . . . 7
PART II. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7
Item 5. Market for Common Equity and Related Stockholder Matters. . . . 7
Item 6. Management's Discussion and Analysis or Plan of Operation . . . 8
Item 7. Restated Financial Statements . . . . . . . . . . . . . . . . .15
Item 8. Changes In and Disagreements With Accountants on
Accounting and Financial Disclosure . . . . . . . . . . . . . .15
PART III . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .15
Item 9. Directors, Executive Officers, Promoters and Control
Persons; Compliance with Section 16(a) of the Exchange Act. . .15
Item 10. Executive Compensation. . . . . . . . . . . . . . . . . . . . .15
Item 11. Security Ownership of Certain Beneficial Owners and
Management. . . . . . . . . . . . . . . . . . . . . . . . . . .15
Item 12. Certain Relationships and Related Transactions. . . . . . . . .16
Item 13. Exhibits and Reports on Form 8-K. . . . . . . . . . . . . . . .16
INDEX TO EXHIBITS. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .16
SIGNATURES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .19
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PART I
Unless the context indicates otherwise, all references to the "Company"
and "Registrant" in this Annual Report on Form 10-KSB relate to Medical
Graphics Corporation.
The following United States registered trademarks appear in this Annual
Report on Form 10-KSB and are owned by the Company: MedGraphics and
CPXEXPRESS. In addition, the following Company trademarks appear in this
Annual Report on Form 10-KSB: PF/Dx, preVent, BREEZE, 1085 Series, CardiO(2),
CPX/D, CPX/MAX/D, PS~Quest and PS~Tracker. CardiO-KEY is a trademark of
ErgometRx Corporation. Pentium is a trademark of Intel Corporation. Windows
is a trademark of Microsoft Corporation.
ITEM 1. DESCRIPTION OF BUSINESS
GENERAL OVERVIEW
Medical Graphics Corporation was incorporated as a Minnesota corporation
in 1977. The Company designs and provides solutions for innovative
non-invasive diagnostic systems for the prevention, early detection and
cost-effective treatment of heart and lung disease and for evaluation of
sleep disorders. Medical Graphics Corporation provides a wide-ranging line of
diagnostic systems featuring patented hardware and software sold under the
MedGraphics trade name.
Medical Graphics Corporation is a leader in providing non-invasive
cardiorespiratory diagnostic systems worldwide. The Company's products
consist of breath analysis technology integrated with a computer and
applications-specific software. More than 3,300 MedGraphics systems have
been sold to customers for use in over 50 countries.
The Company's primary products include pulmonary function, body
plethysmography, cardiopulmonary exercise testing systems and computerized
sleep diagnostic systems along with an information management platform which
converts these products to hospital information systems, physician office and
health management organizations systems. Most of the Company's revenues are
generated from sales into the hospital cardiopulmonary market, sleeping
disorders centers and the office-based physician market. Revenue from
service and supplies accounted for 24.4 percent of total revenues in 1997, up
from 24.0 percent in 1996.
On October 30, 1997 the Company announced that it had retained the
investment banking firm of Goldmsith, Agio, Helms and Company ("Goldsmith
Agio") to explore strategic options for the Company. Goldmsith Agio,
headquartered in Minneapolis with offices in Florida and California, is a
nationally recognized investment banking firm specializing in merger and
acquisition transactions.
PRIMARY PRODUCTS
PULMONARY FUNCTION TESTING SYSTEM. The PF/Dx System is a complete
pulmonary function testing lab which helps health care professionals diagnose
lung diseases and manage treatment of their patients. The PF/Dx System
currently consists of a flow sensor, a patented nitrogen analyzer, a gas
chromatograph, an IBM-compatible computer with Pentium processor, a
full-color monitor, a printer and other peripherals. Applications include
screening asthma patients, assessing pre-operative and post-operative risk of
heart and lung surgery patients, evaluating lung damage from occupational
exposures and documenting outcomes and responses to therapy. The PF/Dx
System's compact design and mobility options attract a wide variety of
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customers, including cardiopulmonary laboratories in hospitals, office-based
clinics, occupational medicine clinics, asthma centers and clinical research
centers. The PF/Dx System utilizes the preVent pneumotach, a patented
mouthpiece/flow device with a snap-in, snap-out design which helps prevent
the transmission of infectious diseases. The preVent pneumotach is attached
by tubing to the PF/Dx System for the measurement of patients' lung function.
The PF/Dx System's unique features also include the Company's proprietary
BreezePF Windows95 software, which is designed to operate in a simple,
easy-to-use manner. Additionally, the product uses a patented "expert system"
to assist physicians in the interpretation of patient test results.
BODY PLETHYSMOGRAPHY SYSTEMS. The Company's 1085 Series offers four
body plethysmography systems for lung function testing. A body
plethysmograph is an enclosed chamber in which the patient sits and performs
diagnostic pulmonary function testing. Body plethysmography is the most
sensitive method for identifying lung diseases, including difficult-to-detect
diseases such as asthma. The systems are comprised of a clear acrylic
chamber, a patented nitrogen analyzer, a gas chromatograph, an IBM-compatible
computer with Pentium processor, a full-color monitor, a printer and other
peripherals. Applications include diagnosing lung diseases and managing
their treatment, assessing surgical risk of lung transplant and lung
reduction surgery candidates and evaluating the impact of neuromuscular
disease on breathing. Included in the 1085 Series systems is the patented
preVent pneumotach for helping to prevent the transmission of infectious
diseases between patient tests. The system's design optimizes patient
comfort with clear-view acrylic enclosures and enables testing of a broad
population including pediatric patients and individuals using wheelchairs.
Additionally, the product uses a patented "expert system" to assist
physicians in the interpretation of patient test results.
CARDIOPULMONARY EXERCISE TESTING SYSTEMS. The Company's cardiopulmonary
exercise systems both measure one's fitness or conditioning level and help
physicians diagnose heart and lung diseases by measuring the gas exchange of
the patient's lungs in conjunction with the electrical activity of their
heart. Should there be a limitation in the heart or lungs or in the level of
conditioning, these systems help detect and quantify the degree of impairment
by measuring the amount of oxygen consumed during exercise.
MedGraphics cardiopulmonary exercise testing systems are sold in four
different models. They include the CardiO(2) System, CPX/D System, CPX/MAX/D
System and CPX EXPRESS System. The systems use a patented breath by breath
methodology, which consists of a patented oxygen analyzer, a carbon dioxide
analyzer, the patented preVent pneumotach, an IBM-compatible computer with
Pentium processor, a full-color monitor, a printer and other peripherals.
The CardiO(2) includes a full 12-lead ECG system while the other systems are
designed to be used in conjunction with stand-alone ECG systems. The systems
are used for differential diagnosis of cardiovascular and pulmonary disease,
screening for early signs of cardiac and pulmonary dysfunction, establishing
exercise prescriptions and training programs and evaluating the efficacy of
prescribed therapy. Medical Graphics Corporation has several patents
relating to data reporting, including two expert systems for evaluating the
information. Test results are displayed in easy-to-interpret graphs and
summary reports. Customers include hospital cardiopulmonary laboratories,
cardiology and pulmonary office-based clinics, cardiac rehabilitation units,
human performance laboratories and health clubs.
CYCLE ERGOMETERS. The Company offers several models of cycle ergometers
providing physicians and patients a tool for more successful outcomes in
clinical rehabilitation and athletic training. A cycle ergometer is a
specially designed stationary exercise bicycle which can operate at a broad
spectrum of resistance levels. The Company has four models of cycle
ergometers that are used in diagnostic, rehabilitation, training and sports
medicine applications. Three of the four models in the CardiO(2) Cycle Series
incorporate patented CardiO-KEY technology, a "data key" capable of storing
exercise protocols and recording exercise session data. The data key is used
to individualize exercise sessions and monitor conditioning progress.
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SLEEP DIAGNOSTICS SYSTEMS. During 1997 the Company obtained
non-exclusive rights to sell computerized polysomnography systems in the
United States. With its new PS~Quest polysomnography system, the Company has
entered the growing sleep diagnostics market. The standard system includes a
workstation computer with Pentium processor, a 17 or 21 inch high resolution
color monitor and a preamplifier. The PS~Quest is designed to meet the needs
of all modern sleep laboratories. Advanced system features include a
flexible 24-channel preamplifier, remote control of all gain and filter
settings from the workstation computer, data sample rates as high as 500 Hz
per channel and fully configurable montages and polygraphs. In addition,
WindowsNT software and local area networking allow customers to monitor more
than one patient on one screen with split time base displays. In December
1997, the Company obtained similar rights to sell PS~Tracker, a portable
version of the PS~Quest.
INDUSTRY
Early detection and prevention of heart and lung diseases is becoming
more commonplace as health care reform and cost containment efforts increase.
Physicians and health plan administrators are becoming more motivated to use
non-invasive diagnostic testing to detect early signs of disease and reverse
the disease process by therapeutic treatments, rather than relying on
invasive and expensive procedures to treat disease after it has already
progressed. Thus, the demand for therapeutic and diagnostic products, such
as the Company's, is being affected by trends in the medical profession and
its approach to the treatment of illness as well as third party payment and
reimbursement policies.
COMPETITION
The principal competitive factors in diagnostic markets are quality and
reliability, price performance, software that is flexible, yet easy-to-use,
and technical support. These markets are characterized by intense
competition. Some companies with which the Company competes have greater
financial, human and technological resources than Medical Graphics
Corporation. This competitive marketplace has in some circumstances led to
price discounting to which Medical Graphics Corporation has responded in
kind, and may do so again in the future. Recently, the marketplace has begun
to request an increased focus on management of information obtained in the
laboratory as well as other value added programs. To address this request,
Medical Graphics Corporation established networking and financial services
programs which should allow the Company to compete more effectively.
The medical device industry in which the Company operates is
characterized by relatively rapid technological change. Accordingly, the
Company must continually implement improvements in its core technologies and
products. The Company's success depends on its ability to anticipate changes
in technology and industry standards, to develop and successfully introduce
new and enhanced products on a timely basis and to promote market acceptance
by demonstrating positive outcomes of such products. The Company believes
its principal competitors are SensorMedics Corporation, a subsidiary of
ThermoElectron Corporation, Warren E. Collins Company and Erich Jaeger GmbH &
Co. KG.
MARKETING AND DISTRIBUTION
In the United States, the Company markets its products through a direct
sales force that targets customers located in hospitals, university-based
medical centers and office-based clinics. Each sales person is assigned to
one of two regional managers who report to the Company's Vice President of
Sales. Each salesperson is responsible for a specific geographic area and
sells the Company's complete product line
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within that area. Company salespersons are compensated with a base salary,
expenses and a revenue-based commission.
The Company markets its products outside the United States into over 40
countries through approximately 32 international sales organizations that
operate primarily as distributors who carry a limited inventory of the
Company's products. These organizations sell the Company's products in
specific geographic areas, generally on an exclusive basis. International
sales accounted for 18% and 27% of total sales in 1997 and 1996,
respectively. All of the Company's international sales are made on a United
States dollar-denominated basis.
Conducting business in foreign countries involves certain risks not
ordinarily associated with domestic business including governmental laws or
restrictions that could adversely affect pricing of, and the Company's
ability to, market its products.
The Company believes that demonstration of its products' capabilities to
potential customers is one of the most significant factors in achieving
sales. Consequently, the main thrust of domestic and international
promotional efforts is product demonstrations at conventions and customer
facilities. Other promotional efforts include educational seminars, print
advertisements, direct mail campaigns and a company web site.
RESEARCH AND DEVELOPMENT
Research and development expenses for 1996 reflected the extensive use
of independent software contractors as part of a general transition to the
Windows95 platform. The Company made a restructuring decision to continue
this project in 1997 with in-house software engineers. Pulmonary function
products began shipping with the Company's software based on Windows95 in
December 1997. The remainder of the software product line is scheduled for
conversion during 1998. In addition, the Company is finishing development of
a number of product improvements designed to enhance product reliability and
improve margins. The Company is also developing new products targeted for
new growth markets. The Company believes ongoing research and development
efforts have been and will remain important to its continuing success.
MANUFACTURING
The Company currently manufactures and assembles all major analyzer
components of its systems including a waveform analyzer, gas chromatograph,
nitrogen analyzer and oxygen analyzer. Sheet metal, electrical components
and some measurement devices are purchased from outside vendors and are
tested, assembled and packaged by Company personnel into fully integrated
systems. The Company also acquires general purpose computers, monitors and
printers from a variety of sources and integrates its proprietary transducer
modules into these systems. Although some of the Company's components are
available through only one or a limited number of suppliers, the Company
believes that if it is unable to obtain components from these suppliers, it
would be able to obtain comparable components from other sources without
significant additional expense or interruption of business. Additionally,
the Company has entered into a distribution agreement with an OEM
manufacturer of sleep products.
During 1997, the Company began to convert to a modified form of cellular
manufacturing, a process that should be completed in 1998. Cellular
manufacturing utilizes an employee team to plan and schedule production,
manufacture the product and ensure the achievement of quality standards.
This process facilitates faster throughput of manufactured product and
requires lower inventory support levels. The Company has already benefited
from continually improving manufacturing efficiencies. In addition, the
Company has
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established a manufacturing engineering department to assist in identifying
and achieving further efficiencies associated with the manufacturing process.
Although the Company experienced difficulty in obtaining materials from
suppliers during the first quarter of 1997 as a result of its 1996 liquidity
crisis, the Company negotiated agreements with each of its principal vendors
so that it was able to acquire raw materials from these vendors without
further interruptions. See Item 6, "Management's Discussion and Analysis of
Financial Condition or Plan of Operation - Overview".
GOVERNMENT REGULATION
Products manufactured by Medical Graphics Corporation are "devices" as
defined in the Federal Food, Drug and Cosmetic Act (the "Act") and are
subject to regulatory authority of the Food and Drug Administration ("FDA")
which regulates the manufacture, distribution, related record keeping,
labeling and advertising of such devices. The Medical Device Amendments of
1976 (the "Amendments") amended the Act and substantially increased the
regulatory authority of the FDA over medical devices. Devices manufactured
by the Company must comply with the provisions of this law. Under the
Amendments, the FDA must determine the extent of control necessary to assure
the safety and effectiveness of devices, and must define these control levels
by the promulgation of regulations and standards.
The Company has filed notifications with the FDA of its intent to market
its systems pursuant to Section 510(k) of the Amendments. Under Section
510(k), a medical device can be marketed if the FDA determines that the
device is substantially equivalent to similar devices marketed prior to May
28, 1976. The FDA made such determinations for these systems, and the
Company is marketing the devices under Section 510(k).
The action of the FDA does not, however, constitute approval by the FDA
of the Company's products or pass upon their safety and effectiveness. The
FDA has increased the depth of its inspections for compliance with Good
Manufacturing Practices Regulations covering software documentation, as well
as hardware documentation.
The Company's products are also subject to similar regulation in various
foreign countries. The Company is in the process of implementing ISO 9001, a
certification showing that the Company's procedures and manufacturing
facilities comply with standards for quality assurance and manufacturing
process control. ISO 9001 certification, along with the European Medical
Device Directive ("MDD") certification, evidences compliance with the
requirements that enable a company to affix the CE Mark to its products. The
CE Mark denotes conformity with European standards for safety and allows
certified devices to be placed on the market in all European Union ("EU")
countries. After June 1998, medical devices may not be sold in EU countries
unless they display the CE Mark. The Company expects to meet all of the
requirements for continued use of the CE Mark so that it may continue to
affix the CE to its product after June 1998. There can be no assurance,
however, that the Company will be able to obtain regulatory approvals or
clearances for its products in foreign countries.
The Company must comply with various federal, state and local
environmental laws and regulations. The Company believes that it is currently
in material compliance with such applicable environmental laws and
regulations.
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PATENTS
The Company currently owns 17 United States domestic patents which cover
the basic aspects of the Company's core technologies, including gas pressure,
flow measurement, breath-by-breath assessment of gas exchange and some expert
systems. In addition, the Company has a number of foreign patents with
respect to technologies covered by its United States patents. There can be
no assurance, however, that these patents, or any patents that may be issued
as a result of existing or future application, will offer any degree of
protection from competitors. The Company intends to aggressively enforce its
intellectual property rights and has successfully done so in the past. The
Company also relies on trade secrets and proprietary know-how, which it seeks
to protect, in part, through proprietary information agreements with
employees, consultants and other parties.
EMPLOYEES
As of December 31, 1997, the Company had 140 full-time employees. As
part of its restructuring during the first quarter of 1997, the Company
reduced its work force to 132 employees from a total of 169 full-time
employees as of December 31, 1996. Attrition and selective layoffs have
reduced the workforce to 121 full-time employees as of March 1, 1998. No
employees are represented by labor organizations and there are no collective
bargaining agreements. Management believes that the Company's relations with
its employees are good.
ITEM 2. DESCRIPTION OF PROPERTY
The Company currently leases a 52,250 square foot building for its
office, assembly and warehouse facilities located in St. Paul, Minnesota.
The lease expires June 30, 2002, at which time the Company has an option to
renew the lease for an additional four years. The Company has the option to
purchase the building at the end of each lease expiration period at the
building's fair market value. Annual rental costs will be approximately
$345,000 over the next five years. Rent expense for the years ended December
31, 1997 and 1996 was $348,000 and $340,000, respectively.
ITEM 3. LEGAL PROCEEDINGS
The Company has been named as a defendant in two product liability suits as
follows:
JOHN GEFROH V. TRINITY HOSPITAL AND MEDICAL GRAPHICS CORPORATION, North
Dakota District Court, Northwestern Judicial District, filed in March 1997.
ROGER D. CROWE V. NORTHSHORE REGIONAL MEDICAL CENTER, NME HOSPITALS, INC.,
TENET HEALTHCARE CORPORATION, ASTRAND MANUFACTURING AND MEDICAL GRAPHICS
CORPORATION, 22d Judicial District Court for the Parish of St. Tammany,
State of Louisiana, Case No. JDC No. 95-14240-B, filed in November 1996.
The plaintiffs in both product liability suits are seeking compensatory
damages of an undisclosed amount resulting from injuries in connection with
the use of one of the Company's products. The Company believes the injuries
resulted from the actions of one or more third parties and did not result
from any actions of the Company. The Company carries insurance in an amount
that it believes is adequate to cover any liability it may be found to have
arising from the claims in both of these suits.
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In the fourth quarter of 1996, the Company experienced a liquidity
crisis and was unable to pay a significant number of its vendors when due.
Subsequent to December 31, 1996, the Company negotiated agreements with
vendors, who were owed $3,541,000, for payment of the outstanding balances in
equal monthly installments for up to 36 months. While a few vendors
initially refused to accept the proposed terms and in some cases commenced
litigation, the Company ultimately reached agreement with all vendors
regarding payment of the outstanding balances. See Item 6, "Management's
Discussion & Analysis -Liquidity and Capital Resources."
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not Applicable.
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
MARKET INFORMATION
The Company's common stock trades on The NASDAQ SmallCap Market System
under the symbol MGCC. The following table shows the range of high and low
bid prices for the Company's common stock for the fiscal quarters indicated,
as reported by NASDAQ in its "Monthly Statistical Report" for the NASDAQ
SmallCap Market from August 20, 1997 through December 31, 1997 and on the
NASDAQ National Market from January 1, 1996 through August 19, 1997. The
quotations represent prices in The NASDAQ Stock Market between dealers in
securities, and do not include retail mark-up, mark-down or commission, and
may not represent actual transactions. Prices have been adjusted to reflect
the Company's 3 for 2 stock dividend.
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1997
First Quarter $2.50 $1.11
Second Quarter 1.94 1.17
Third Quarter 2.61 1.67
Fourth Quarter 2.39 1.67
1996
First Quarter $5.67 $3.08
Second Quarter 6.09 4.25
Third Quarter 5.58 3.67
Fourth Quarter 4.17 2.67
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APPROXIMATE NUMBER OF HOLDERS OF COMMON EQUITY
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Approximate Number of
Holders
Title of Class (as of March 26, 1998)
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Common Stock, par value of $.05 1,900
Class A Stock, par value of $.05 1
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DIVIDENDS
The Company has not paid any cash dividends on its common stock, and the
Board of Directors intends to retain earnings, if any, for the foreseeable
future for use in expansion of the Company's business. Under the terms of the
Company's credit agreement, the Company is prohibited from paying cash
dividends unless it is in compliance with certain covenants.
RECENT SALES OF UNREGISTERED SECURITIES
In November 1997, the Company entered into agreements to sell to four
private, accredited investors up to 1,090,908 shares of common stock at a price
of $2.75 per share. These investors purchased 545,454 shares for $1,500,000
on November 12, 1997. Subsequent to December 31, 1997, these investors
purchased 363,636 shares for $1,000,000 on January 30, 1998 and 181,818
shares for $500,000 on February 10, 1998. The Company believes that the sales
were exempt pursuant to Section 4(2) of the Securities Act of 1933, as
amended, and Regulation D, promulgated thereunder.
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION OR PLAN OF
OPERATION
FORWARD-LOOKING STATEMENTS
Statements included in this Annual Report on Form 10-KSB that are not
historical or current facts are "forward-looking statements" made pursuant to
the safe harbor provisions of the Private Securities Litigation Reform Act of
1995 and are subject to certain risks and uncertainties that could cause
actual results to differ materially. Various forward-looking statements have
been made in this Annual Report on Form 10-KSB and may also be made in the
Company's other reports filed under the Securities Exchange Act of 1934, in
its press releases and in other documents. In addition, from time to time,
the Company through its management may make oral forward-looking statements.
Forward-looking statements are subject to risks and uncertainties,
including those identified below, which could cause actual results to differ
materially from such statements. The words "anticipate", "believe",
"expect", "intend", "optimistic", "will" or similar expressions are intended
to identify forward-looking statements. Readers are cautioned not to place
undue reliance on these forward-looking statements, which speak only as of
the date on which they are made. The Company undertakes no obligation to
update publicly or revise any forward-looking statements.
Important factors that could cause actual results to differ materially
from the Company's forward-looking statements, as well as affect the
Company's ability to achieve its financial and other goals, include, but are
not limited to, the following:
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TECHNOLOGICAL CHANGE AND NEW PRODUCT DEVELOPMENT. The markets for the
Company's products are characterized by rapidly changing technology. The
Company's future success will continue to depend upon its ability to enhance
its current products and to develop and introduce new products that keep pace
with technological developments and evolving industry standards, respond to
changes in customer requirements and achieve market acceptance. Any failure
by the Company to anticipate or respond adequately to technological
developments and customer requirements, or any significant delays in product
development or introduction, could have a material adverse effect on the
Company's business, results of operations, financial condition and liquidity.
In addition, there can be no assurance the new products and services or
product and service enhancements, if any, developed by the Company will
achieve market acceptance.
CYCLICAL CAPITAL SPENDING BY CUSTOMERS. A significant portion of the
Company's revenues are derived from sales to various segments of the health
care industry, such as the hospital cardiopulmonary market, sleeping
disorders centers and office-based physician market. The markets for these
segments, and for the health care industry in general, can be cyclical,
resulting in varying amounts of capital spending. Any significant downturn
in capital spending in these markets, or in any other market served by the
Company's products, could have a material adverse effect on the Company's
business and results of operations.
PROPRIETARY TECHNOLOGY. The Company relies heavily on its pulmonary
function, body plethysmography and cardiopulmonary exercise testing systems,
along with proprietary software technology. Although the Company in the past
has been issued patents, or obtained licenses to patents on certain
technology and currently has patents pending on new technologies, it also
relies on protecting its proprietary information as trade secrets. There can
be no assurance that the steps taken by the Company will be adequate to
prevent misappropriation of its technology by third parties or will be
adequate under the laws of some foreign countries, which may not protect the
Company's proprietary rights to the same extent as do laws of the United
States. In addition, the possibility exists that others may "reverse
engineer" the Company's products in order to determine their method of
operation and then introduce competing products.
QUARTERLY FLUCTUATIONS IN OPERATING RESULTS. The Company has
experienced quarterly fluctuations in operating results and anticipates that
these fluctuations will continue. These fluctuations have been caused by
various factors, including the order flow of its customers, and the timing of
product shipments and marketing. Future operating results may fluctuate as a
result of these and other factors, including the Company's ability to
continue to develop innovative products, the announcement or introduction of
new products by the Company's competitors, the Company's product and customer
mix, the level of competition and overall trends in the economy.
DEPENDENCE ON OUTSIDE CONTRACTORS AND SUPPLIERS. The Company currently
contracts with third parties for a portion of its components and assembly
needs. Although the Company endeavors to inspect and internally test most
components prior to final assembly and has established a vendor audit
process, reliance on outside vendors reduces its control over quality and
delivery schedules. The failure by one or more of these vendors to deliver
quality components in a timely manner could have a material adverse effect on
the Company's results of operations. In addition, a number of the components
integral to the functioning of the Company's products are available from only
a single supplier or from a limited number of suppliers. Any interruption in
or termination of supply of these components, or a material change in the
purchase terms, including pricing, of any of these components, or a reduction
in their quality or reliability, could have a material adverse effect on the
Company's business or results of operations.
INTERNATIONAL REVENUE. In the years ended December 31, 1997, 1996 and
1995, sales of the Company's products to customers outside North America
accounted for approximately 18.4%, 26.7% and 27.6%, respectively, of the
Company's net revenue. The Company anticipates that international revenue
will
9
<PAGE>
continue to account for a significant portion of its net revenue. The
Company's operating results are subject to the risks inherent in
international sales, including various regulatory requirements, political and
economic changes and disruptions, transportation delays and difficulties in
staffing and managing foreign sales operations and distributor relationships.
In addition, fluctuations in exchange rates may render the Company's
products less price competitive relative to local product offerings. There
can be no assurance that these factors will not have a material adverse
effect on the Company's future international revenue and, consequently, on
the Company's operating results.
COMPETITION. The Company competes with other vendors of pulmonary
function, body plethysmography, cardiopulmonary exercise testing systems and
computerized sleep diagnostic systems, some of which may have greater
financial and other resources than the Company. There can be no assurance
that the Company will be able to compete successfully in the future or that
the Company will not be required to incur significant costs in connection
with its engineering research, development, marketing and customer service
efforts to remain competitive. Competitive pressures may result in price
erosion or other factors which will adversely affect the Company's financial
performance.
DEPENDENCE ON KEY PERSONNEL. The Company's success depends in large
part upon the continued services of many of its highly skilled personnel
involved in management, research and product development, sales and
marketing, and upon its ability to attract and retain additional highly
qualified employees. The loss of services of these key personnel could have
a material adverse effect on the Company. The Company does not have
key-person life insurance on any of its employees.
OVERVIEW
During 1996, the Company aggressively expanded its sales, marketing, and
research and development activities and management personnel. This
expansion, in part, resulted in the Company reaching its borrowing base limit
on its credit line, entering into a forbearance agreement with its lender and
becoming unable to pay vendors' accounts payable when due, all of which
occurred during the fourth quarter of 1996. These events restricted the
Company's ability to produce products in the fourth quarter of 1996 and
required management and the Board of Directors to devote a significant amount
of time to restructuring the Company during the first quarter of 1997.
Subsequent to December 31, 1996, the Company retained Manchester
Business Services, Inc., to design and implement a cost reduction plan.
Under the plan, the Company obtained a new line of credit, received
$1,500,000 of cash from the issuance of common stock, entered into agreements
with vendors which provided for payment of approximately $3,500,000 of
accounts payable in equal monthly installments for up to 36 months and
reduced its work force by approximately 25%. The Company obtained an
additional $1,500,000 of cash from the issuance of common stock on November
12, 1997 and $1,000,000 and $500,000 from the issuance of common stock in
January and February 1998, respectively. All issuances of common stock were
recorded net of related issuance costs.
During 1997, the Company withstood the initial challenge of its
liquidity crisis and the ensuing disruptions associated with cost reduction
activities and numerous personnel changes to generate total revenue of
$19,173,000, only 5.5% lower than 1996. In addition, the Company improved
gross margins to 37.6% in 1997 from 29.4% in 1996 while also reducing total
operating expenses by 23.2% to $11,987,000 in 1997 from $15,617,000 in 1996.
10
<PAGE>
The following discussion should be read in conjunction with the
Company's restated consolidated financial statements as of and for the years
ended December 31, 1997 and 1996 included in Item 7 of this Form 10-KSB/A.
RESTATEMENT OF PREVIOUSLY REPORTED FINANCIAL STATEMENTS
Subsequent to the issuance of the Company's 1997 financial statements,
the Company's management determined that inventory write-downs recorded in
1996 were overstated and that certain restructuring charges recorded in 1996
and 1997 were misclassified and/or recorded in the wrong period. As a result,
the financial statements for 1996 and 1997 have been restated to increase
inventory at December 31, 1997 and 1996, to reduce the German office closing
reserve at December 31, 1996, to properly classify charges previously
recorded as restructuring charges in 1996 and 1997, and to record charges
related to the German office closing in 1997 which had previously been
reported in 1996 (see note 13 to the consolidated financial statements). The
effects of these restatements of the Company's financial statements as of and
for the years ended December 31, 1997 and 1996 are as follows:
Selected financial data:
<TABLE>
<CAPTION>
1997 1996
---------------------------- ----------------------------
As As
Previously As Previously As
Reported Restated Reported Restated
------------ ------------ ------------- ------------
<S> <C> <C> <C> <C>
For the year ended December 31:
Total cost of goods sold $ 12,144 $ 11,969 $ 14,640 $ 14,330
General and administrative 1,802 2,228 4,369 4,469
Non-recurring charges 0 1,610 0 200
Restructuring 1,711 0 700 0
Net loss (4,962) (5,112) (9,071) (8,361)
Net loss per share
(basic and diluted) (1.11) (1.15) (2.37) (2.19)
At December 31:
Inventories 4,240 4,800 6,633 7,193
German office closing reserve 700 550
Retained deficit (12,769) (12,209) (7,807) (7,097)
</TABLE>
11
<PAGE>
RESULTS OF OPERATIONS
Management's discussion and analysis of financial condition and results
of operations have been revised to reflect the impact of the restatement of
the financial statements discussed above.
REVENUE. Total revenue decreased 5.5% to $19,173,000 in 1997 from
$20,289,000 in 1996. Domestic revenue increased 9.6% over 1996 to partially
offset a 34.8% decline in revenue from international sources while revenue
from service and supplies was relatively flat.
The increase in domestic revenue reflected a late September introduction
of the Company's new diagnostics system for sleep disorders and the business
strategy of refocusing its efforts on domestic core products. The Company
has a non-exclusive agreement to sell sleep diagnostic systems in the United
States and in December 1997 acquired similar rights to sell a companion
portable version. International revenue for 1997 was depressed by closing of
the Company's German office at the end of 1996 as part of its cost reduction
plan. In addition, continued strength of the dollar has negatively affected
European revenue.
GROSS MARGIN. The gross margin percentage increased to 37.6% of revenue
in 1997 from 29.4% in 1996. This margin increase was achieved through
improved manufacturing efficiencies and better control over technical service
costs. In addition, 1996 gross margins were negatively impacted by
significant charges recorded to record inventory at the lower of cost or
market.
The Company's manufacturing process was revised during 1997 to a
modified version of cellular manufacturing under which major systems are
produced in one continuous process over a shorter period of time rather than
producing several subassemblies requiring longer throughput times. These
process revisions not only reduce manufacturing costs but also require
significantly lower levels of inventory. Technical service costs were also
reduced by repairing more systems on site in lieu of returning them to a
central location. In addition, the Company made several engineering
revisions to its system's material components that have improved their
reliability and consequently reduced the incidence of service. In addition,
the amount of inventory write-downs affecting gross margin was only $100,000
in 1997 compared to $1,100,000 in 1996. Moreover, the warranty reserve was
increased in 1996 to reflect the cost of offering a more competitive
five-year warranty program on certain of the Company's products. The Company
discontinued this five-year warranty program for systems sold after March 31,
1997.
SELLING. Selling and marketing expenses decreased 23.3% to $6,282,000
in 1997 from $8,186,000 in 1996. Selling expenses as a percent of revenue
decreased to 32.8% in 1997 compared to 40.3% in 1996. The closing of the
Company's German office and sale of its asthma business unit reduced expenses
by $788,000 and $207,000, respectively, in 1997. Selling expenses also
decreased with improved management of customer incentives, seminar expenses
and costs of demonstrating Company products. In addition, management reduced
the cost of attending trade shows by being more selective and improving
management of related expenses.
GENERAL AND ADMINISTRATIVE. General and administrative expenses
decreased 50.1% to $2,228,000 in 1997 from $4,469,000 in 1996. As a percent
of revenue, general and administrative expenses decreased to 11.6% in 1997
compared to 22.0% in 1996. These decreases were principally due to a lower
allowance for uncollectible accounts receivable established in 1997 and lower
executive compensation and recruiting expenses associated with former senior
management personnel. In addition, management's efforts to control expenses
resulted in reductions for most expense categories.
12
<PAGE>
RESEARCH AND DEVELOPMENT. Research and development expenses decreased
32.4% to $1,867,000 in 1997 from $2,762,000 in 1996 and as a percentage of
revenue decreased to 9.7% in 1997 from 13.6% in 1996. During 1996 the
Company incurred significant expenses associated with the use of independent
contractors to convert product software to a Windows95 environment. The
Company not only reduced its dependence on independent contractors but also
reduced its personnel costs in 1997. The Company, in December 1997,
successfully released its new Windows95 based BreezePF software which is used
on the majority of its products. In addition, the Company made significant
strides in redesigning several products to improve serviceability and reduce
associated manufacturing expenses. The Company expects to benefit from these
efforts in 1998.
NON-RECURRING EXPENSES. Non-recurring expenses of $1,610,000 incurred
during the year ended December 31, 1997 included severance, legal, accounting
and consulting expenses associated with operational and personnel changes
implemented in the first quarter of 1997.
OTHER INCOME. The Company recognized income of $1,438,000 in 1996 in
connection with the settlement of a lawsuit with SensorMedics Corporation.
NET INTEREST EXPENSE. The Company incurred net interest expense of
$329,000 in 1997 compared to $189,000 in 1996, which resulted from increased
interest payments related to higher rates of interest and levels of
borrowings under the Company's working capital line of credit used to finance
losses from operations and working capital requirements.
INCOME TAX BENEFIT. The Company recognized no income tax benefit for
1997 compared to $48,000 recognized in 1996. Effective tax rates for income
tax benefits are less than the statutory rates because the Company does not
have sufficient taxable income in prior years to carry back recent losses and
because the Company has increased its deferred income tax valuation allowance
due to uncertainty regarding the realization of future income tax benefits.
NEW ACCOUNTING STANDARDS
In June 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards (SFAS) No. 130, "Reporting Comprehensive
Income", which will be effective for the Company beginning January 1, 1998.
SFAS No. 130 requires the disclosure of comprehensive income and its
components in the general-purpose financial statements. The adoption by the
Company of SFAS No. 130 is not expected to have a material effect on results
of operations or financial position.
In June 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards (SFAS) No. 131, "Disclosures about Segments
of an Enterprise and Related Information", which will be effective for the
Company beginning January 1, 1998. SFAS No. 131 redefines how operating
segments are determined and requires disclosures of certain financial and
descriptive information about a Company's operating segments. Although the
Company has not completed its analysis of operating segments on which it will
report, the adoption by the Company of SFAS No. 131 is not expected to have a
material effect on results of operations or financial position.
INFLATION
The Company believes that inflation did not have a significant impact on
the Company's operations in 1997 or 1996.
13
<PAGE>
YEAR 2000
The Company has assessed the impact of the transition to the year 2000
on its software applications. Management does not believe that any material
issues exist with internally developed software and has received confirmation
from vendors of certain purchased software that current releases or upgrades,
if installed, are year 2000 compliant. The Company plans to install current
releases or upgrades at a cost approximating $30,000. Failure to implement
such releases or upgrades, or the failure of software vendors to have
eliminated the issues as represented, could materially and adversely affect
the Company.
LIQUIDITY AND CAPITAL RESOURCES
As of December 31, 1997, the Company had cash of $387,000 and working
capital of $918,000. The Company financed part of its $5,112,000 net loss
with a $2,393,000 decrease in inventory and a $924,000 decrease in accounts
receivable. Cash provided from financing activities was generated through the
issuance of common stock in private sales to investors for net proceeds of
$2,935,000. The cash provided from financing activities was used to reduce
net borrowings under the Company's line of credit by $1,146,000 and for
investing in capital expenditures of $215,000 and software production costs
of $417,000.
As of December 31, 1996, the Company had cash of $545,000 and working
capital of $3,173,000. The Company used $288,000 of cash in operating
activities, primarily as a result of its net loss of $8,361,000, which was
partially offset by a decrease in accounts receivable of $4,368,000 and an
increase in accounts payable of $1,873,000. The Company used $1,229,000 in
investing activities for capital expenditures of $884,000 and software
production costs of $345,000. The Company generated $2,031,000 from
financing activities, primarily as a result of an increase of $1,725,000 in
borrowings under its line of credit.
At December 31, 1997, the Company had a working capital line of credit
with a bank that provides for total borrowings, based on available
collateral, of up to $4,100,000, at the discretion of the lender, and expires
March 31, 2000. Total borrowings outstanding under the credit agreement are
secured by the Company's accounts receivable and inventories. The credit
agreement contains certain restrictive covenants as well as limitations on
capital expenditures and payment of dividends. The credit line allows the
Company to borrow up to 75% of eligible domestic accounts receivable, 40% of
eligible domestic inventory (not to exceed $1,500,000), and 90% of eligible
foreign accounts receivable.
During 1997, the Company entered into financing arrangements with
certain vendors which provide for payment of outstanding balances in equal
monthly installments for up to 36 months. The balances which will be paid
after December 31, 1998, have been classified as long-term accounts payable
financed with vendors. The amounts due under the agreements are $748,000 and
$59,000 for 1999 and 2000, respectively.
In November 1997, the Company entered into agreements to sell to private
investors up to 1,090,908 shares of common stock at a price of $2.75 per
share. These investors purchased 545,454 shares for $1,500,000 on November
12, 1997. Subsequent to December 31, 1997, these investors purchased 363,636
additional shares for $1,000,000 on January 30, 1998 and 181,818 additional
shares for $500,000 on February 10, 1998.
The Company has no material commitments for 1998 capital expenditures.
The Company believes that its revenues from operations and the $1,500,000 of
proceeds received from the sale of common stock in January and February 1998,
together with cash and borrowings under its credit facility will be adequate
to satisfy its liquidity and capital resource needs through 1998.
14
<PAGE>
ITEM 7. RESTATED FINANCIAL STATEMENTS
The following restated consolidated financial statements of the Company are
included herein:
Independent Auditors' Report
Consolidated Balance Sheets-December 31, 1997 and 1996
Consolidated Statements of Operations-Years ended December 31, 1997 and
1996
Consolidated Statements of Shareholders' Equity-Years ended December 31,
1997 and 1996
Consolidated Statements of Cash Flows-Years ended December 31, 1997 and
1996
Notes to Consolidated Financial Statements-Years ended December 31, 1997
and 1996
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
On January 24, 1997, the Company filed a Report on Form 8-K reporting
that it had dismissed Ernst & Young LLP as its principal independent auditor
and on March 4, 1997 filed a Report on Form 8-K indicating that it had
engaged Deloitte & Touche LLP as its independent auditors for the year ended
December 31, 1996. The Reports on Form 8-K also indicated that there were no
disagreements between the Company and Ernst & Young LLP on any matter with
respect to accounting policies or practices.
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT
The information contained under the headings "Election of Directors",
"Executive Officers of the Company", and "Section 16(a) Beneficial Ownership
Reporting Compliance" in the Company's definitive proxy statement for its
Annual Meeting of Shareholders, a definitive copy of which will be filed
within 120 days of December 31, 1997, is hereby incorporated by reference.
ITEM 10. EXECUTIVE COMPENSATION
The information contained under the heading "Executive Compensation" in
the Company's definitive proxy statement for its 1998 Annual Meeting of
Shareholders, is hereby incorporated by reference.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information contained under the heading "Security Ownership of
Certain Beneficial Owners and Management" in the Company's definitive proxy
statement for its 1998 Annual Meeting of Shareholders, is hereby incorporated
by reference.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information contained under the heading "Certain Transactions" in the
Company's definitive proxy statement for its 1998 Annual Meeting of
Shareholders, is hereby incorporated by reference.
15
<PAGE>
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
Exhibit Number Description Exhibit Method of Filing
- -------------- ----------- -------------------------------------
<S> <C> <C>
3.1 Restated Articles of Incorporation, Exhibit 3(a) to Report on Form 10-KSB
as amended for the year ended December 31, 1991,
file no. 0-9899
3.2 Amended bylaws Exhibit 3(b) to Report on Form 10-KSB
for the year ended December 31, 1992,
file no. 0-9899
4.1 Certificate of Rights and Preferences Exhibit 4.1 to Report on Form 10-KSB
of Class A Stock of the Company for the year ended December 31, 1996,
file no. 0-9899
10.1 Seventh Amendment to Lease for Exhibit 10(b) to Report on Form 10-KSB
350 Oak Grove Parkway, St. Paul, for the year ended December 31, 1994,
Minnesota file no. 0-9899
10.2 Credit Agreement dated March 31, 1997 Exhibit 10.2 to Report on Form 10-KSB
between the Company and Norwest Bank for the year ended December 31, 1996,
Minnesota, N.A. file no. 0-9899
10.2.1 Letter Amendment dated Filed electronically herewith
November 12, 1997
10.3 Credit and Security Agreement dated Exhibit 10.3 to Report on Form 10-KSB
March 31, 1997 between the Company for the year ended December 31, 1996,
and Norwest Business Credit, Inc. file no. 0-9899
10.3.1 Letter Amendment dated April 14, 1997 Exhibit 10.3.1 to Report on Form 10-KSB
for the year ended December 31, 1996,
file no. 0-9899
10.3.2 Letter Amendment dated Filed electronically herewith
November 12, 1997
10.4 Warrant between the Company Exhibit 10.4 to Report on Form 10-KSB
and Norwest Business Credit, Inc. for the year ended December 31, 1996,
dated March 27, 1997 file no. 0-9899
10.5* 1987 Stock Option Plan Exhibit 10(d) to Report on Form 10-KSB
for the year ended December, 31,
1992, file no. 0-9899
16
<PAGE>
10.6 Sub-license Agreement between the Exhibit 10(e) to Report on Form 10-KSB
Company and ErgometRx for the year ended December 31, 1992,
Corporation (formally Scientific file no. 0-9899
Exercise Prescriptions
Incorporated), dated February 11, 1993
10.7 Warrant Agreement between Exhibit 4.1 to Report on Form S-8
the Company and Catherine A. filed on May 16, 1997,
Anderson dated March 25, 1997 file no. 333-27251
10.8* Non-Employee Director Exhibit 4.1 to Report on Form S-8
Compensation Plan filed on December 8, 1997,
file no. 333-41725
10.9* Stock Option Agreement between Exhibit 10(h) to Report on Form 10-KSB
the Company and Donald C. for the year ended December 31, 1993,
Wegmiller file no. 0-9899
10.10 Registration Rights Agreement between Exhibit 10.11 to Report on Form 10-KSB
the Company and FAMCO II LLC for the year ended December 31, 1996,
file no. 0-9899
10.11 Registration Rights Agreement between Exhibit 4 to Schedule 13D/A filed on
the Company and FAMCO II LLC, November 21, 1997 with respect to FAMCO
Special Situations Fund III, L.P., II LLC and Family Financial Strategies, Inc.
Special Situations Private Equity Fund
L.P.(4), Special Situations Cayman Fund
L.P.(4)
10.12 Eighth Amendment to Lease for Filed electronically herewith
350 Oak Grove Parkway, St. Paul,
Minnesota.
21.1 The Company has one wholly owned subsidiary,
Medical Graphics Corporation GmbH, located in
Germany.
23.1 Independent Auditors' Consent of Filed electronically herewith
Deloitte & Touche LLP
27.1 Financial Data Schedule Filed electronically herewith
</TABLE>
- -----------------------------
*Indicates compensatory contract or arrangement.
(b) REPORTS ON FORM 8-K
No reports on Form 8-K were filed during the three months ended December
31, 1997. During the quarter ended March 31, 1998 the Company filed a Report
on Form 8-K reporting that it had completed the second tranche of a private
equity investment with the issuance of 545,454 shares of common stock for
gross
17
<PAGE>
proceeds of $1,500,000. See Part II, Item 6, "Liquidity and Capital
Resources". In addition, the Company submitted an unaudited pro forma balance
sheet and income statement as of and for the year ended December 31, 1997,
respectively. The unaudited balance sheet illustrates the Company's
compliance with new quantitative maintenance requirements for continued
listing on the NASDAQ SmallCap Market, which were effective February 23, 1998.
18
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the
registrant has duly caused this Amendment No. 1 to Form 10-KSB to be signed
on its behalf by the undersigned, thereunto duly authorized, in the City of
Saint Paul, State of Minnesota, on the 15th day of April, 1999.
MEDICAL GRAPHICS CORPORATION
By
-----------------------------------------
Richard E. Jahnke, President and
Chief Executive Officer
POWER OF ATTORNEY
The undersigned officers and directors of Medical Graphics Corporation
hereby constitute and appoint Richard E. Jahnke and Mark W. Sheffert, or
either of them, with power to act one without the other, our true and lawful
attorney-in-fact and agent, with full power of substitution and
resubstitution, for us and in our stead, in any and all capacities to sign
any and all amendments (including post-effective amendments) to this
Registration Statement and all documents relating thereto, and to file the
same, with all exhibits thereto, and other documents in connection therewith,
with the Securities and Exchange Commission, granting unto said
attorney-in-fact and agent, full power and authority to do and perform each
and every act and thing necessary or advisable to be done in and about the
premises, as fully to all intents and purposes as he or she might or could do
in person, hereby ratifying and confirming all that said attorney-in-fact and
agent, or his or her substitutes, may lawfully do or cause to be done by
virtue hereof.
Pursuant to the requirements of the Securities Act of 1933, as amended,
this Amendment No. 1 to Form 10-KSB has been signed below by the following
persons in the capacities indicated on April 15, 1999.
Signature
--------------------------------------
Richard E. Jahnke, President,
Chief Executive Officer
(Principal Executive Officer) and Director
--------------------------------------
Dale H. Johnson, Chief Financial
Officer (Principal Financial Officer)
--------------------------------------
Mark W. Sheffert, Chairman
--------------------------------------
Anthony J. Adducci, Director
19
<PAGE>
MEDICAL GRAPHICS CORPORATION
RESTATED CONSOLIDATED FINANCIAL STATEMENTS FOR
THE YEARS ENDED DECEMBER 31, 1997 AND 1996
AND INDEPENDENT AUDITORS' REPORT
<PAGE>
INDEPENDENT AUDITORS' REPORT
Shareholders and Board of Directors
Medical Graphics Corporation
We have audited the accompanying consolidated balance sheets of Medical Graphics
Corporation and Subsidiary (the Company) as of December 31, 1997 and 1996 and
the related consolidated statements of operations, shareholders' equity, and
cash flows for the years then ended. These consolidated financial statements are
the responsibility of the Company's management. Our responsibility is to express
an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the consolidated financial statements are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the consolidated financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements present fairly, in all
material respects, the financial position of Medical Graphics Corporation and
Subsidiary at December 31, 1997 and 1996 and the results of their operations and
of their cash flows for the years then ended, in conformity with generally
accepted accounting principles.
As discussed in Note 13, the accompanying 1996 and 1997 financial statements
have been restated.
February 13, 1998 (April 14, 1999 as to Note 13)
Minneapolis, Minnesota
<PAGE>
MEDICAL GRAPHICS CORPORATION
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1997 AND 1996 (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
1997 1996
(AS (AS
RESTATED RESTATED
SEE SEE
NOTE 13) NOTE 13)
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash $ 387 $ 545
Accounts receivable, less allowance for doubtful accounts of $164 and $496, respectively 3,890 4,814
Inventories (Notes 1 and 2) 4,800 7,193
Prepaid expenses and other current assets 272 193
-------- ---------
Total current assets 9,349 12,745
EQUIPMENT AND FIXTURES (Notes 1 and 3) 4,072 3,857
Less accumulated depreciation 3,110 2,531
-------- ---------
Equipment and fixtures, net 962 1,326
SOFTWARE PRODUCTION COSTS, less accumulated amortization of $855
and $568, respectively (Note 1) 602 472
OTHER ASSETS 13 20
-------- ---------
$ 10,926 $ 14,563
-------- ---------
-------- ---------
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 2,261 $ 921
Accounts payable financed with vendors - current (Note 1) 1,145 1,742
Note payable (Note 7) 2,254 3,400
Employee compensation 786 978
Deferred service contract revenue 896 988
Warranty reserve 414 563
German office closing reserve (Note 4) 179 550
Other liabilities and accrued expenses 496 430
-------- ---------
Total current liabilities 8,431 9,572
LONG-TERM ACCOUNTS PAYABLE FINANCED WITH VENDORS (Note 1) 807 1,736
COMMITMENTS AND CONTINGENCIES (Notes 6 and 11)
SHAREHOLDERS' EQUITY (Notes 1, 8, 9, and 12):
Class A stock, par value $.05 per share; 500 shares authorized, liquidation
preference of $3.38 per share, 444 issued and outstanding 22
Common stock, par value $.05 per share; authorized 9,500 shares; issued
and outstanding 4,453 and 3,839, respectively 223 192
Additional paid-in capital 13,652 10,160
Retained deficit (12,209) (7,097)
-------- ---------
Total shareholders' equity 1,688 3,255
-------- ---------
$ 10,926 $ 14,563
-------- ---------
-------- ---------
</TABLE>
See notes to consolidated financial statements.
2
<PAGE>
MEDICAL GRAPHICS CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 1997 AND 1996
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
1997 1996
(AS RESTATED (AS RESTATED
SEE NOTE 13) SEE NOTE 13)
<S> <C> <C>
REVENUES:
Equipment sales $ 14,492 $ 15,422
Service and supplies revenue 4,681 4,867
----------- -----------
Total revenues 19,173 20,289
COST OF GOODS SOLD:
Cost of equipment sales 9,460 11,042
Cost of service and supplies revenues 2,509 3,288
----------- -----------
Total cost of goods sold 11,969 14,330
----------- -----------
GROSS MARGIN 7,204 5,959
OPERATING EXPENSES:
Selling and marketing 6,282 8,186
General and administrative 2,228 4,469
Research and development 1,867 2,762
Non-recurring charges (Note 4) 1,610 200
----------- -----------
Total operating expenses 11,987 15,617
----------- -----------
LOSS FROM OPERATIONS (4,783) (9,658)
OTHER (EXPENSE) INCOME:
SensorMedics settlement, net of settlement costs (Note 11) 1,438
Interest expense (329) (189)
----------- -----------
Total other (expense) income, net (329) 1,249
----------- -----------
LOSS BEFORE INCOME TAX BENEFIT (5,112) (8,409)
INCOME TAX BENEFIT (Note 5) 48
----------- -----------
NET LOSS $ (5,112) $ (8,361)
----------- -----------
----------- -----------
BASIC AND DILUTIVE NET LOSS PER SHARE OF COMMON
STOCK (Note 1) $ (1.15) $ (2.19)
----------- -----------
----------- -----------
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING 4,449 3,818
----------- -----------
----------- -----------
</TABLE>
See notes to consolidated financial statements.
3
<PAGE>
MEDICAL GRAPHICS CORPORATION
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (IN THOUSANDS)
(AS RESTATED - SEE NOTE 13)
<TABLE>
<CAPTION>
CLASS A STOCK COMMON STOCK ADDITIONAL RETAINED
---------------- ----------------- PAID-IN EARNINGS
SHARES AMOUNT SHARES AMOUNT CAPITAL (DEFICIT) TOTAL
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE AT DECEMBER 31, 1995 3,745 $ 185 $ 9,858 $ 1,264 $ 11,310
Net loss (8,361) (8,361)
Common stock issued upon exercise of
stock options 67 3 228 231
Common stock issued under Employee
Stock Purchase Plan 27 1 74 75
------- ------- -------- --------- ---------
BALANCE AT DECEMBER 31, 1996 3,839 192 10,160 (7,097) 3,255
Net loss (5,112) (5,112)
Class A stock issued in a private sale,
net of issuance costs 444 $ 22 1,434 1,456
Common stock issued to chairman of Board
of Direcotors 46 2 100 102
Common stock issued in a private sale,
net of issuance costs 545 28 1,384 1,412
Common stock issued under Employee
Stock Purchase Plan 24 1 66 67
Warrants issued in conjunction with
development and implementation
the cost reduction plan (Note 4) 508 508
----- ------- ------- ------- -------- --------- ---------
BALANCE AT DECEMBER 31, 1997 444 $ 22 4,453 $ 223 $ 13,652 $ (12,209) $ 1,688
----- ------- ------- ------- -------- --------- ---------
----- ------- ------- ------- -------- --------- ---------
</TABLE>
See notes to consolidated financial statements.
4
<PAGE>
MEDICAL GRAPHICS CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1997 AND 1996 (IN THOUSANDS)
<TABLE>
<CAPTION>
1997 1996
(AS RESTATED (AS RESTATED
SEE NOTE 13) SEE NOTE 13)
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (5,112) $ (8,361)
Adjustments to reconcile net loss to net cash used
in operating activities:
Depreciation 579 765
Amortization, principally software production costs 287 276
Common stock and warrants issued in conjunction with the
development and implementation of a cost reduction plan (Note 4) 610
Changes in operating assets and liabilities:
Accounts receivable 924 4,368
Inventory 2,393 (1,033)
Prepaid expenses and other assets (72) (12)
Refundable income taxes 443
Accounts payable (186) 1,873
Employee compensation, other liabilities, and accrued expenses (126) 688
Warranty reserve (149) 323
Germany office closing reserve (371) 550
Deferred service contract revenue (92) (168)
---------- --------
Net cash used in operating activities (1,315) (288)
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures (215) (884)
Software production costs (417) (345)
---------- --------
Net cash used in investing activities (632) (1,229)
CASH FLOWS FROM FINANCING ACTIVITIES:
Net (payments) borrowings under line of credit agreement (1,146) 1,725
Proceeds from stock options exercised 231
Net proceeds from sale of Class A stock and common stock 2,935 75
--------- --------
Net cash provided by financing activities 1,789 2,031
--------- --------
(DECREASE) INCREASE IN CASH (158) 514
CASH AT BEGINNING OF YEAR 545 31
--------- --------
CASH AT END OF YEAR $ 387 $ 545
---------- --------
---------- --------
</TABLE>
See notes to consolidated financial statements.
5
<PAGE>
MEDICAL GRAPHICS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1997 AND 1996 (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
1. DESCRIPTION OF BUSINESS, LIQUIDITY, AND SIGNIFICANT ACCOUNTING POLICIES
BUSINESS - Medical Graphics Corporation (the Company) designs and produces
innovative noninvasive diagnostic systems for the prevention, early
detection, and cost-effective treatment of heart and lung disease. In
addition, the Company purchases noninvasive sleep diagnostic systems from a
third party.
LIQUIDITY - The Company's working capital requirements for 1997 were met
principally through amounts borrowed on the Company's line of credit (see
Note 7), the issuance of Class A stock and common stock under private sales
to investors (see Note 8) and credit arranged with the Company's vendors.
This vendor credit consisted of the Company entering into financing
arrangements with certain vendors which provided for payment of outstanding
balances in equal monthly installments for up to 36 months. The remaining
amounts due under these vendor agreements are payable in the amount of
$1,145, $748, and $59, in 1998, 1999, and 2000, respectively. The balances
outstanding at December 31, 1997 which will be paid after December 31, 1998
have been classified as long-term accounts payable financed with vendors.
In addition, the Company insured net losses of $5,112 and $8,361 for the
years ended December 31, 1997 and 1996, respectively. Management plans to
generate profitable operations include increasing revenues, improving gross
margins, and controlling expenses. There can be no assurance the Company
will be able to generate profitable operations in the future.
CONSOLIDATION - The financial statements include the accounts of the
Company and its wholly owned subsidiaries, Medical Graphics Corporation,
GmbH (MGCG). All intercompany transactions have been eliminated. The
operations of MGCG were terminated early in 1997 in accordance with an exit
plan adopted in the fourth quarter of 1996.(see Note 4).
INVENTORIES - Inventories are valued at the lower of cost or market
determined by the first-in, first-out method.
EQUIPMENT AND FIXTURES - Equipment and fixtures are stated at cost. The
Company provides for depreciation using straight-line and accelerated
methods at rates designed to amortize the cost of equipment and fixtures
over their estimated useful lives.
SOFTWARE PRODUCTION COSTS - Software production costs are capitalized once
technological feasibility has been established and all research and
development activities for other components of the product are completed.
Capitalized software production costs are amortized over three years using
the straight-line method.
REVENUE RECOGNITION - Sales are recorded by the Company when products are
shipped or services are provided to the customer.
6
<PAGE>
DEFERRED SERVICE CONTRACTS - Amounts billed to customers under service
contracts are deferred and recognized in income over the term of the
agreement, and costs are recognized as incurred.
INCOME TAXES - Income taxes are recorded under the liability method.
Deferred income taxes are recorded to reflect the tax consequences in
future years of differences between the basis of assets and liabilities for
income tax and for financial reporting purposes using enacted tax rates in
effect during the year in which the differences are expected to reverse.
Deferred tax asset valuation allowances are recorded to reduce deferred tax
assets to the amount expected to be realized.
BASIC AND DILUTIVE NET LOSS PER SHARE - In 1997, the Company adopted
Statement of Financial Accounting Standards (SFAS) No. 128, EARNINGS PER
SHARE. Basic net loss per share of common stock is computed by dividing
net loss by the weighted average number of common shares outstanding
during each year. Common equivalent shares from stock options and
warrants to purchase 1,343 and 915 shares of common stock at a range of
$1.92 to $10.00 and $3.00 to $10.00 were outstanding during 1997 and
1996, respectively, but are excluded from the computation of dilutive
net loss per share as their effect is antidilutive. Therefore, basic and
dilutive net loss per share amounts are equal for each of the periods
presented. Net loss per share amounts presented for 1996 have been
restated for the adoption of SFAS No. 128.
SALES AND SEGMENT INFORMATION - The Company manufactures and sells its
products to customers primarily in the medical field and operates in only
one business segment. The Company grants its customers credit in connection
with sales of its products. It performs periodic credit evaluations of its
customers' financial condition and generally does not require collateral.
The Company requires irrevocable letters of credit on sales to certain
foreign customers. Receivables generally are due within 30 days for
domestic customers. Credit losses relating to customers have consistently
been within management's expectations. Export sales to foreign countries
primarily in Europe and the Pacific Rim accounted for 18% and 27% of total
sales in 1997 and 1996, respectively.
USE OF ESTIMATES - The preparation of the consolidated financial statements
in conformity with generally accepted accounting principles requires
management to make estimates and assumptions that affect the amounts
reported in the financial statements and accompanying notes. Actual results
could differ from the estimates.
IMPAIRMENT OF LONG-LIVED ASSETS - The Company records losses on long-lived
assets used in operations when indicators of impairment are present and the
undiscounted cash flows estimated to be generated by those assets are less
than the carrying amount. To the extent long-lived assets are considered
impaired, such assets are adjusted to their estimated fair values with fair
value determined by the present value of discounted future cash flows or,
to the extent such long-lived assets are held for sale, the estimated sale
proceeds less costs of disposal.
RECLASSIFICATIONS - Certain reclassifications have been made to the 1996
financial statements to conform to the classifications used in 1997. These
reclassifications had no effect on previously reported net loss or
shareholders' equity.
7
<PAGE>
2. INVENTORIES
At December 31, the Company's inventories consisted of the following
components:
<TABLE>
<CAPTION>
1997 1996
<S> <C> <C>
Purchased components and work-in-process $ 3,164 $ 3,755
Finished goods 1,636 3,438
-------- ---------
$ 4,800 $ 7,193
-------- ---------
-------- ---------
</TABLE>
3. EQUIPMENT AND FIXTURES
At December 31, the Company's equipment and fixtures consisted of the
following:
<TABLE>
<CAPTION>
1997 1996
<S> <C> <C>
Building improvements $ 733 $ 722
Computer equipment 1,491 1,387
Manufacturing equipment 933 928
Furniture and fixtures 915 820
-------- ---------
Total equipment and fixtures, at cost 4,072 3,857
Less accumulated depreciation 3,110 2,531
-------- ---------
$ 962 $ 1,326
-------- ---------
-------- ---------
</TABLE>
4. NON-RECURRING CHARGES
During December 1996, the Board of Directors approved closing the
Company's sales and marketing subsidiary in Germany and authorized
implementation of a restructuring plan. The Company recorded a $550
charge to operations in the fourth quarter of 1996 related to expected
exit costs of the German office. Of this total, $250,000 was recorded in
cost of goods sold and $100,000 was recorded in general and
administrative expenses, and the remainder as a non-recurring charge.
During 1997, the Company recorded an additional $150,000 charge for
employee severance costs relating to the subsidiary in Germany and
implemented certain cost reduction strategies that included the
termination of certain additional employees and the sale of a product
line. Non-recurring charges during 1997 of $1,610, substantially all of
which were paid during 1997, included employee severance, legal,
consulting, and accounting expenses.
In connection with the 1997 cost reduction efforts , the Company granted,
in 1997, the former chairman of the Company a warrant to purchase 195
shares of common stock at a price of $2.67 per share in exchange for
certain consulting services to the Company. The warrant expires on March
31, 2000. The Company also issued 45 shares of common stock and granted a
warrant to purchase 225 shares of common stock at a price of $2.25 per
share to an individual for services provided in connection with developing
and implementing the cost reduction strategies. This individual also was
elected the Chairman of the Board of Directors. The warrant expires on
March 31, 2002. Non-recurring charges relating for 1997 include $557
relating to the issuance of stock and warrants.
8
<PAGE>
5. INCOME TAXES
Significant components of the income tax benefit are as follows:
<TABLE>
<CAPTION>
1997 1996
<S> <C> <C>
Current:
Federal $ - $ (28)
State (20)
Deferred - -
-------- ----------
Income tax benefit $ - $ (48)
-------- ----------
-------- ----------
</TABLE>
Significant components of the Company's deferred tax assets and liabilities
at December 31 are as follows:
<TABLE>
<CAPTION>
1997 1996
<S> <C> <C>
Allowance for bad debts $ 58 $ 176
Inventory reserve 69 243
Warranty reserve 147 200
Restructuring reserve 63 185
Vacation accrual 48 77
Deferred service contract revenue 60 35
Valuation allowance (445) (916)
--------- ----------
Total current - -
Inventory capitalization 3 (14)
Capitalized software and patents (214) (154)
Net operating loss and tax credit carryforwards 3,806 2,153
Valuation allowance (3,595) (1,985)
--------- ----------
Total noncurrent - -
--------- ----------
Net deferred tax assets $ - $ -
--------- ----------
--------- ----------
</TABLE>
Reconciliations of the Company's expected income tax benefits computed at
the U.S. federal statutory tax rate to the income tax benefits recorded are
as follows:
<TABLE>
<CAPTION>
1997 1996
<S> <C> <C>
Income tax benefit at statutory rate $ (1,789) $ (2,926)
Foreign tax loss 172
Increase of deferred tax asset valuation allowance 1,139 2,615
Utilization of net operating loss carryforward related
to IRS audit adjustments for 1994 and 1993 613
Other 37 91
-------- ---------
$ - $ (48)
-------- ---------
-------- ---------
</TABLE>
9
<PAGE>
As of December 31, 1997, the Company has federal net operating loss
carryforwards of $10,714 that expire from 2002 through 2012. The Company's
income tax returns through December 31, 1995 have been examined by the
Internal Revenue Service. Total income taxes paid were $24 and $26 in 1997
and 1996, respectively.
6. LEASES
The Company leases office and manufacturing facilities, automobiles, and
various office accessories. The building lease expires in 2002, at which
time the Company has an option to renew the lease for an additional four
years. The Company has the option to purchase the building at the end of
each lease expiration period at the building's fair market value.
Future minimum lease payments under noncancelable operating leases with
remaining terms of one year or more consisted of the following at December
31, 1997:
<TABLE>
<CAPTION>
<S> <C>
Year ending December 31:
1998 $ 420
1999 381
2000 357
2001 351
2002 172
---------
$ 1,681
</TABLE>
Rent expense for the years ended December 31, 1997 and 1996 was $490 and
$494, respectively.
7. NOTE PAYABLE TO BANK
In March 1997, the Company obtained a new credit agreement with Norwest
Business Credit Inc. (Norwest) that provides for total borrowings, based on
available collateral as defined, of up to $4,100, at the discretion of
Norwest, and expires March 31, 2000. Total borrowings outstanding under the
credit agreement are secured by the Company's accounts receivable and
inventories. The credit agreement contains certain restrictive covenants,
including maintenance of minimum net worth (as defined), earnings
requirements, and debt service requirements as well as limitations on
capital expenditures and payment of dividends. The credit line allows the
Company to borrow up to 75% of eligible domestic accounts receivable, 40%
of eligible domestic inventory (not to exceed $1,500), and 90% of eligible
foreign accounts receivable.
Borrowings under the line of credit bear interest at the Norwest "base"
rate plus 4.0% (12.5% at December 31, 1997). The "base" rate is equal to
the interest rate publicly announced by Norwest Bank Minnesota, National
Association from time to time as its "base" rate. The line of credit
contains a minimum monthly interest charge of $15. In addition, the Company
granted to Norwest a three-year warrant to purchase 93.75 shares of the
Company's common stock at an exercise price of $2.25 per share. The value
of this warrant ($73,000) is being amortized to interest expense over the
term of the line of credit. The warrant contains anti-dilution
provisions.
10
<PAGE>
The Company had outstanding borrowings of $2,254 and $3,400 at December 31,
1997 and 1996, respectively. Total cash paid for interest was $329 and $167
for the years ended December 31, 1997 and 1996, respectively. In June and
November 1997, the Company amended its line of credit agreement. As of
December 31, 1997, the Company was in compliance with all financial
covenants pursuant to the amended line of credit agreement.
8. CAPITAL STOCK
In March 1997, the Company's Board of Directors authorized 500 shares of
a new class of participating convertible stock (Class A stock). The
Class A stock contains anti-dilution provisions. The Class A stock has
voting rights and a liquidation preference of $3.38 per share over the
common stock. Each share is convertible to one share of common stock.
The Company issued 444 shares of the new class of stock at $3.38 per
share, for net proceeds of $1,456.
In October 1997, the Company's Board of Directors authorized the issuance
of additional common stock in a private sale to investors. On November 10,
1997 the Company agreed to sell up to 1,091 shares of the Company's common
stock at a price of $2.75 per share. The investors purchased 545 shares for
$1,500 (less costs of issuance of $88) on November 10, 1997 and 545 shares
for $1,500 (less costs of issuance of $31) in 1998 (see Note 12).
9. STOCK OPTION PLANS, EMPLOYEE STOCK PURCHASE PLAN, AND 401(k) PLAN
The Company has an Employee Incentive Stock Option Plan under which a total
of 1,350 shares have been reserved for issuance, with 483 shares remaining
reserved and unissued at December 31, 1997. Options are generally issued at
prices not less than the fair market value at the date of grant and become
exercisable over a one- to five-year period. Also, under the Option Plan,
nonqualified options have been issued to certain nonemployees. These
options become exercisable over a one- to five-year period following the
date of grant.
The Company also has a Nonemployee Director Compensation Plan, which
provides for the granting of nonqualified options for up to 375 shares of
common stock to nonemployee members of the Board of Directors as well as
the Chairman of the Board. Under the plan, an option to purchase 15 shares
of Common Stock will be granted automatically when an eligible director is
first elected to the Board of Directors of the Company. An option to
purchase 2.25 shares (4.5 shares for the Chairman of the Board) will be
granted automatically following each Board Meeting personally attended by
each director, not to exceed 13.5 shares (27 shares for the Chairman of the
Board) per director annually. An option to purchase .75 shares will be
granted automatically following each Board Committee Meeting personally
attended by each director, not to exceed 2.25 shares per director annually.
The option exercise price per share will equal the fair market value of the
common stock on the date of grant. All options granted under the plan
become exercisable one year after the date of grant.
11
<PAGE>
A summary of option activity is as follows:
<TABLE>
<CAPTION>
Employee Weighted Weighted
Incentive Average Nonqualified Average
Stock Options Exercise Stock Options Exercise
Outstanding Price Outstanding Price
<S> <C> <C> <C> <C>
Balance at December 31, 1995 332 $ 4.41 347 $ 5.03
Granted 143 3.91 247 3.68
Exercised (67) 3.00
Canceled or expired (84) 5.67 (3) 2.00
----- -------
Balance at December 31, 1996 324 4.09 591 4.48
Granted 400 2.46 312 2.43
Canceled or expired (246) 4.19 (554) 4.45
----- -------
Balance at December 31, 1997 478 $ 2.68 349 $ 2.69
----- ------- ------- -------
----- ------- ------- -------
Exercisable at December 31, 1996 124 $ 4.47 315 $ 5.14
----- ------- ------- -------
----- ------- ------- -------
Exercisable at December 31, 1997 124 $ 3.17 214 $ 2.71
----- ------- ------- -------
----- ------- ------- -------
</TABLE>
The Company's Employee Stock Purchase Plan (the ESP Plan), a qualified plan
pursuant to Internal Revenue Code Section 423, became effective in May
1993. The ESP Plan gives eligible employees an opportunity to purchase the
Company's common stock, through payroll deductions not exceeding 15% of
eligible compensation, at a per share price of 85% of the lesser of the
fair value on the first day or the last day of each six-month purchase
period. The six-month purchase periods begin on July 1 and January 1 of
each year. Participating employees may purchase a maximum of 7.5 shares
during each purchase period and no more than $25 of fair value of stock in
each calendar year. A total of 300 shares have been authorized for issuance
under the ESP Plan. Shares issued under the ESP Plan in 1997 and 1996 were
24 and 27 shares, respectively. The ESP Plan will terminate on January 1,
2003, unless extended by the Board of Directors.
In 1996, the Company adopted Statement of Financial Accounting Standards
(SFAS) No. 123, ACCOUNTING FOR STOCK-BASED COMPENSATION. The Company has
elected to continue following the accounting guidance of Accounting
Principles Board Opinion No. 25, ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES,
for measurement and recognition of stock-based transactions with employees.
No compensation cost has been recognized for options issued under the stock
option plans, because the exercise price of all options granted was at
least equal to the fair value of the common stock on the date of the grant.
Had compensation costs for the stock options issued to certain directors
and employees and common stock issued under the ESP Plan been determined at
the grant date, based on the fair value provisions of SFAS No. 123, the
Company's 1997 and 1996 pro forma net loss would have been $5,535 and
$8,593, respectively, and basic and dilutive net loss per share would have
been $1.24 and $2.25, respectively.
12
<PAGE>
The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option-pricing model with the following weighted average
assumptions: dividend yield of 0%; a risk-free interest rate of 6.5% and
6.1% in 1997 and 1996, respectively; an expected life of 7 and 10 years in
1997 and 1996, respectively; and expected volatility of 54% and 44% in 1997
and 1996, respectively. The weighted average fair value of options issued
in 1997 and 1996 was $1.66 and $2.51, respectively.
Substantially all employees of the Company may participate in a defined
contribution plan established under the provisions of Section 401(k) of the
Internal Revenue Code. The plan generally provides for a contribution by
the employee of up to 15% of their gross earnings with a 25% matching
contribution by the Company on the first 6% of gross earnings. The Company
expensed contributions to the plan of approximately $12 and $62 in 1997 and
1996, respectively.
10. RELATED-PARTY TRANSACTIONS
An officer and former director of the Company who resigned in October 1997
is the president of ErgometRx Corporation and is the husband of an
officer/Chairman of the Board of Directors who resigned in March 1997.
ErgometRx Corporation possesses certain proprietary information and
prototype hardware relating to an exercise bike used for stress testing and
physical exercise. The Company has obtained an exclusive license to
manufacture and sell products utilizing this proprietary information in
certain markets under a five-year royalty agreement. Under this agreement,
the Company paid royalties of $0 and $40 in 1997 and 1996, respectively.
During 1996, the Company advanced ErgometRx Corporation approximately $165
in cash and products, which was fully reserved for at December 31, 1996.
An officer/Chairman of the Board of Directors of the Company who resigned
in March 1997 is also the president of e-med.OnCall, Inc. During 1996, the
Chairman began a transition from the Company to e-med.OnCall, Inc. As part
of this transition, the Company transferred equipment with a net book value
of approximately $75 to a new office for the Chairman and paid certain
administrative expenses in the amount of approximately $60 with respect to
that office. This office also serves as the office for e-med.OnCall, Inc.
All such amounts were recorded as administrative expense during 1996.
The current Chairman of the Board of Directors is the president of
Manchester Companies. As part of the cost reduction plan in 1997, the Board
of Directors engaged Manchester Companies to provide investment banking and
management consulting services to the Company. During 1997, $265 was paid
to Manchester Companies for those services. In addition, the Company was
paid $10 for administrative services that were provided to Manchester
Companies.
11. LITIGATION
During 1995, the Company was awarded a judgment of $4.35 million, related
to a patent infringement suit against a competitor. The judgment was to be
paid over an eight-year period. The Company received $975 after associated
legal costs during 1995. The Company recorded the gain as cash was received
due to uncertainty regarding the ultimate collectibility of the judgment.
During 1996, the competitor was acquired by a third party and pursuant to
the terms of the settlement agreement, the Company received the net present
value of the remaining payments. The Company received $1,438 after paying
associated legal costs in 1996.
13
<PAGE>
The Company is a defendant in various claims and litigation which are
incidental to its business. Management is of the opinion that certain of
these matters are covered by insurance and that ultimate settlement of
these matters will not have a material impact on its consolidated financial
statements.
12. SUBSEQUENT EVENTS
In November 1997, the Company entered into agreements with investors for
the issuance of up to 1,091 shares of the Company's common stock at a
price of $2.75 per share. These investors purchased 545 shares on
November 10, 1997 (see Note 8). Under the terms of the agreement, each
investor had the right to purchase and the Company had the right to
require the investor to purchase such additional shares at a purchase
price of $2.75 per share, subject to certain conditions, on or before
February 23, 1998. These investors purchased 363 shares for $1,000 on
January 30, 1998 and 182 shares for $500 on February 10, 1998. The
following unaudited pro forma shareholders' equity as of December 31,
1997 gives effect to the 1998 issuances of common stock:
<TABLE>
<CAPTION>
Unaudited
Pro Forma
Amount
<S> <C>
Class A stock $ 22
Common stock 249
Additional paid-in capital 15,095
Retained deficit (12,769)
-----------
Pro forma shareholders' equity $ 2,597
-----------
-----------
</TABLE>
14
<PAGE>
13. RESTATEMENT
Subsequent to the issuance of the Company's 1997 financial statements, the
Company's management determined that inventory write-downs recorded in 1996
were overstated and that certain restructuring charges recorded in 1996 and
1997 were misclassified and/or recorded in the wrong period. As a result,
the financial statements for 1997 and 1996 have been restated to increase
inventory at December 31, 1997 and 1996, to reduce the German office
closing reserve at December 31, 1996, to properly classify charges
previously recorded as restructuring charges in 1997 and 1996, and to
record charges related to the German office closing in 1997 which had
previously been reported in 1996. The effects of these restatements of the
Company's financial statements as of and for the years ended December 31,
1997 and 1996 are as follows:
<TABLE>
<CAPTION>
1997 1996
---------------------------- ----------------------------
As As
Previously As Previously As
Reported Restated Reported Restated
------------ ------------ ------------- ------------
<S> <C> <C> <C> <C>
For the year ended December 31:
Total cost of goods sold $ 12,144 $ 11,969 $ 14,640 $ 14,330
General and administrative 1,802 2,228 4,369 4,469
Non-recurring charges 0 1,610 0 200
Restructuring 1,711 0 700 0
Net loss (4,962) (5,112) (9,071) (8,361)
Net loss per share
(basic and diluted) (1.11) (1.15) (2.37) (2.19)
At December 31:
Inventories 4,240 4,800 6,633 7,193
German office closing reserve 700 550
Retained deficit (12,769) (12,209) (7,807) (7,097)
</TABLE>
In June 1998, the Company distributed a three-for-two stock split effected
in the form of a stock dividend. All share and per share data has been
adjusted to reflect this stock split.
<PAGE>
EXHIBIT 21.1
SUBSIDIARIES OF THE COMPANY
<TABLE>
<CAPTION>
Jurisdiction or
Name of Direct Subsidiaries Organization
------------
<S> <C>
Medical Graphics Corporation GmbH Germany
Name of Indirect Subsidiaries
None
</TABLE>
20
<PAGE>
EXHIBIT 23.1
INDEPENDENT AUDITORS' CONSENT OF
DELOITTE & TOUCHE LLP
We consent to the incorporation by reference in Registration Statements No.
33-15765, No. 33-47993, No. 33-64430, No. 33-64432, No. 33-80596, No.
33-80386, No. 33-14295, No. 33-27251, No. 33-32465, No. 33-32469, No.
33-41725, and No. 33-52759 of Medical Graphics Corporation on Form S-8 and in
Registration Statements No. 33-32467 and No. 33-41721 of Medical Graphics
Corporation on Form S-3 of our report dated February 13, 1998 (April 14, 1999
as to Note 13) appearing in this Amendment No. 1 to the Annual Report on Form
10-KSB of Medical Graphics Corporation for the year ended December 31, 1997
on Form 10-KSB/A.
April 14, 1999
/s/ Deloitte & Touche LLP
Minneapolis, Minnesota
21
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE RESTATED
CONSOLIDATED FINANCIAL STATEMENTS AS OF AND FOR THE YEAR ENDED DECEMBER 31,
1997, AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH RESTATED FINANCIAL
STATEMENTS.
</LEGEND>
<RESTATED>
<MULTIPLIER> 1,000
<S> <C> <C>
<PERIOD-TYPE> YEAR YEAR
<FISCAL-YEAR-END> DEC-31-1997 DEC-31-1996
<PERIOD-START> JAN-01-1997 JAN-01-1996
<PERIOD-END> DEC-31-1997 DEC-31-1996
<CASH> 387 545
<SECURITIES> 0 0
<RECEIVABLES> 4,054 5,310
<ALLOWANCES> (164) (496)
<INVENTORY> 4,800 7,193
<CURRENT-ASSETS> 9,349 12,745
<PP&E> 4,072 3,857
<DEPRECIATION> (3,110) (2,531)
<TOTAL-ASSETS> 10,926 14,563
<CURRENT-LIABILITIES> 8,431 9,572
<BONDS> 0 0
0 0
0 0
<COMMON> 171 128
<OTHER-SE> 1,517 3,127
<TOTAL-LIABILITY-AND-EQUITY> 10,926 14,563
<SALES> 19,173 20,289
<TOTAL-REVENUES> 19,173 20,289
<CGS> 11,969 14,330
<TOTAL-COSTS> 23,956 29,947
<OTHER-EXPENSES> 0 0
<LOSS-PROVISION> 145 0
<INTEREST-EXPENSE> 329 189
<INCOME-PRETAX> (5,112) (8,409)
<INCOME-TAX> 0 48
<INCOME-CONTINUING> (5,112) (8,361)
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> (5,112) (8,361)
<EPS-PRIMARY> (1.72) (3.29)
<EPS-DILUTED> (1.72) (3.29)
</TABLE>
