<PAGE> 1
The SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-QSB MARK ONE:
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarter ended September 30, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
Commission file number 0-12850
DENTAL/MEDICAL DIAGNOSTIC SYSTEMS, INC.
(Exact name of small business issuer as specified in its charter)
Delaware 13-3185553
- ------------------------------- -------------------
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
200 N. Westlake Blvd., Suite 202, Westlake Village, CA 91362
(Address of principal executive offices)
Issuer's telephone number, including area code (805) 381-2700.
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 issuer was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes [X] No [ ]
State the number of shares of registrant's common stock outstanding as of
November 3, 1998: 5,155,694
Transitional Small Business Disclosure Format Yes [ ] No [X]
<PAGE> 2
DENTAL/MEDICAL DIAGNOSTIC SYSTEMS, INC. AND SUBSIDIARIES
TABLE OF CONTENTS
FORM 10-QSB REPORT
September 30, 1998
<TABLE>
<CAPTION>
PART I - FINANCIAL INFORMATION PAGE
<S> <C>
Item 1. Interim Condensed Consolidated Financial Statements (Unaudited)
Condensed Consolidated Balance Sheet-September 30, 1998 3
Condensed Consolidated Statements of Operations 4
Three and Nine Month Periods Ended September 30, 1998 and 1997
Condensed Consolidated Statements of Cash Flows 5
Nine Month Periods Ended September 30, 1998 and 1997
Consolidated Statements of Comprehensive Income 6
Three and Nine Month Periods Ended September 30, 1998 and 1997
Notes to Interim Condensed Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis or Plan of Operation 12
PART II - OTHER INFORMATION
Item 2. Changes in Securities and Use of Proceeds 22
Item 4. Submission of Matters to a Vote of Security-Holders 22
Item 6. Exhibits and Reports on Form 8-K 22
(a) Exhibits 22
(b) Reports on 8-K 22
Signatures 23
</TABLE>
2
<PAGE> 3
PART I - FINANCIAL INFORMATION
ITEM 1 - INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
DENTAL/MEDICAL DIAGNOSTIC SYSTEMS, INC AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEET
(Unaudited)
<TABLE>
<CAPTION>
September 30, 1998
------------------
<S> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 3,687,439
Accounts receivable 3,753,512
Inventories 3,994,170
Prepaid expenses and other 808,237
------------
Total current assets 12,243,358
Property and equipment, net 758,589
Loans receivable from related parties 70,000
Other assets 138,973
------------
Total assets $ 13,210,920
============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Notes Payable $ 3,746,508
Accounts payable 1,479,214
Current portion of capital lease obligation 25,282
Accrued liabilities 850,872
Customer deposits 44,953
------------
Total current liabilities 6,146,829
Notes payable 470,338
Capital lease obligations 25,330
Other long term liabilities 16,072
------------
Total liabilities 6,658,569
------------
Commitments and contingencies
STOCKHOLDERS' EQUITY
Preferred stock, par value $.01 per share;
1,000,000 shares authorized, none issued and --
outstanding
Common stock, par value $.01
per share; 20,000,000 shares authorized:
5,125,194 shares issued and outstanding 51,251
Paid in capital 12,919,037
Cumulative translation adjustment 12,769
Accumulated deficit (6,430,706)
------------
Total stockholders' equity 6,552,351
------------
Total liabilities and stockholders' equity $ 13,210,920
============
</TABLE>
The accompanying notes are an integral part of these interim condensed
consolidated financial statements.
3
<PAGE> 4
DENTAL/MEDICAL DIAGNOSTIC SYSTEMS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE AND NINE MONTH PERIOD ENDED SEPTEMBER 30, 1998 AND 1997
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended Three Months Ended Nine Months Ended Nine Months Ended
September 30,1998 September 30, 1997 September 30, 1998 September 30, 1997
------------------ ------------------ ------------------ ------------------
<S> <C> <C> <C> <C>
Net sales $ 6,157,358 $ 3,505,575 $ 10,886,402 $ 11,688,838
Cost of sales 2,866,104 2,356,863 6,363,099 7,384,583
------------ ------------ ------------ ------------
Gross profit 3,291,254 1,148,712 4,523,303 4,304,255
Selling, general & administrative
expenses 1,845,232 1,359,117 5,709,490 4,056,544
Research & development expenses 197,283 155,387 521,972 228,721
Non-recurring charge -- 256,250 -- 256,250
------------ ------------ ------------ ------------
Operating income (loss) 1,248,739 (622,042) (1,708,159) (237,260)
Interest income (47,103) (90,285) (155,433) (139,250)
Interest expense 551,416 4,655 1,184,705 136,774
Amortization of debt issuance costs 75,000 -- 160,484 76,431
------------ ------------ ------------ ------------
Income (loss) before income taxes and
Extraordinary item 669,426 (536,412) (2,897,915) (311,215)
Provision for income taxes -- (96,837) -- (11,042)
------------ ------------ ------------ ------------
Income (loss) before extraordinary
Item 669,426 (439,575) (2,897,915) (300,173)
Extraordinary loss on early extinguishment
of debt (net of tax benefit of $143,511) -- -- -- (234,149)
------------ ------------ ------------ ------------
Net income (loss) $ 669,426 $ (439,575) $ (2,897,915) $ (534,322)
============ ============ ============ ============
Basic earnings per share
Income (loss) before extraordinary item $ 0.13 $ (0.09) $ (0.57) $ (0.07)
Extraordinary item $ -- $ -- $ -- $ (0.06)
------------ ------------ ------------ ------------
Net loss $ 0.13 $ (0.09) $ (0.57) $ (0.13)
Diluted earnings per share
Income (loss) before extraordinary item $ 0.13 $ (0.09) $ (0.57) $ (0.07)
Extraordinary item $ -- $ -- $ -- $ (0.06)
------------ ------------ ------------ ------------
Net loss $ 0.13 $ (0.09) $ (0.57) $ (0.13)
Weighted average number of shares:
Basic 5,122,072 5,066,653 5,119,061 4,081,152
Diluted 5,210,236 5,066,653 5,119,061 4,081,152
</TABLE>
The accompanying notes are an integral part of these
interim consolidated financial statements.
4
<PAGE> 5
DENTAL/MEDICAL DIAGNOSTIC SYSTEMS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTH PERIODS ENDED SEPTEMBER 30, 1998 AND 1997
(Unaudited)
<TABLE>
<CAPTION>
Nine Months Ended Nine Months Ended
September 30, 1998 September 30, 1997
------------------ ------------------
<S> <C> <C>
Cash flows from operating activities:
Net loss $(2,897,915) $ (534,322)
Adjustments to reconcile net loss to net cash used by
operating activities:
Depreciation and amortization 1,233,813 201,279
Allowances for returns and
doubtful accounts -- (86,428)
Inventory write-downs -- 20,000
Extraordinary item -- 234,149
Other -- (795)
Changes in operating assets and liabilities:
Accounts receivable (1,767,350) (624,782)
Inventories (1,093,235) (995,682)
Income taxes receivable -- (37,522)
Prepaid expenses and other (306,225) (87,980)
Other assets 432,804 23,618
Accounts payable (47,578) 184,954
Accrued liabilities (197,033) 151,943
Income taxes payable 35,696 (25,059)
Customer deposits 1,958 (17,932)
----------- -----------
Net cash used by operating activities (4,605,065) (1,594,559)
----------- -----------
Cash flows from investing activities:
Purchase of property and equipment (398,368) (118,795)
Loan to related party 56,000 (126,000)
----------- -----------
Net cash used in investing activities (342,368) (244,795)
----------- -----------
Cash flows from financing activities:
Decrease in other long term liabilities -- (13,237)
Net proceeds from issuance of common stock -- 8,654,898
Net proceeds from exercise of stock options 27,592 --
Repayment of notes payable -- (1,600,000)
Net proceeds from issuance of
notes payable 4,500,000 --
Debt issuance cost (300,000) --
Long term note payable 471,304 --
Repayments on borrowings from
related parties (48,477) (178,852)
Principal payments on capital
lease obligations (12,602) --
Increase in other long term liabilities 2,749 --
----------- -----------
Net cash provided by financing activities 4,640,566 6,862,809
----------- -----------
Net (decrease) increase in cash and
cash equivalents (306,867) 5,023,455
Effect of exchange rate changes on cash and cash
equivalents 13,244 --
Cash and cash equivalents,
beginning of period 3,981,062 1,058,836
----------- -----------
Cash and cash equivalents,
end of period $ 3,687,439 $ 6,082,291
=========== ===========
Supplemental cash flow information:
Interest paid $ 291,563 $ 92,962
Income taxes paid $ 14,981 $ 48,904
</TABLE>
The accompanying notes are an integral part of these interim condensed
consolidated financial statements
5
<PAGE> 6
DENTAL/MEDICAL DIAGNOSTIC SYSTEMS, INC. AND SUBSIDIARIES
CONDENSED STATEMENTS OF COMPREHENSIVE INCOME
FOR THE THREE AND NINE MONTH PERIOD ENDED SEPTEMBER 30, 1998 AND 1997
(Unaudited)
<TABLE>
<CAPTION>
Three months ended Three months ended Nine months ended Nine months ended
September 30, 1998 September 30, 1997 September 30, 1998 September 30, 1997
------------------ ------------------ ------------------ ------------------
<S> <C> <C> <C> <C>
Net income (loss) $ 669,426 $ (439,575) $ (2,897,916) $ (534,322)
Other comprehensive income:
Foreign currency translation
adjustment 12,073 -- 12,769 --
------------ ------------ ------------ ------------
Comprehensive income (loss) $ 681,499 $ (439,575) $ (2,885,147) $ (534,322)
============ ============ ============ ============
</TABLE>
The accompanying notes are an integral part of these interim consolidated
financial statements.
6
<PAGE> 7
DENTAL/MEDICAL DIAGNOSTIC SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
September 30, 1998
1. General
The accompanying unaudited interim condensed consolidated financial
statements include the accounts of Dental/Medical Diagnostic Systems, Inc.
and Subsidiaries (the "Company"). All significant intercompany accounts and
transactions have been eliminated in the consolidated financial statements.
The interim consolidated financial statements have been prepared in
accordance with generally accepted accounting principles for interim
financial information and with instructions to Form 10-QSB and Item 10 of
Regulation S-B. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments
(consisting of normal recurring accruals) considered necessary for a fair
representation have been included. Operating results for the nine-month
period ended September 30, 1998 are not necessarily indicative of the
results that may be expected for the year ending December 31, 1998. For
further information, refer to the consolidated financial statements and
footnotes thereto included in the Company's annual report on Form 10-KSB
for the period ended December 31, 1997.
2. Summary of Significant Accounting Policies
Concentration of Credit Risk and Major Customers
Financial instruments that potentially subject the Company to significant
concentrations of credit risk consist principally of trade accounts
receivable. Also, at various times throughout the year, cash balances are
maintained in excess of Federally insured limits.
For the nine-month period ended September 30, 1998 and 1997, international
customers accounted for 34% and 26% of sales, respectively. At September
30, 1998 and 1997 international customers accounted for approximately 59%
and 70% of trade accounts receivable, respectively.
The Company performs ongoing credit evaluations of its customers' financial
condition and generally does not require collateral. Estimated credit
losses and returns have been provided for in the financial statements.
The majority of the Company's current customers consist of dental
professionals. Certain of the dental professionals lease the Company's
products through third party leasing companies. Under the terms of the
sales, the leasing companies have no recourse against the Company.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities at
the date of the financial statements and the reported amounts of revenues
and expenses during the reporting period. The significant estimates made in
the preparation of the consolidated financial statements relate to the
assessment of the carrying value of accounts receivable, inventories and
warranty provisions. Actual results could differ from those estimates.
Risks and Uncertainties
The Company buys certain key components from one supplier or from a limited
number of suppliers. Although there are a limited number of suppliers of
the key components, management believes that other suppliers could provide
similar components on comparable terms. Changes in key suppliers could
cause delays in manufacturing and distribution of products and a possible
loss in sales, which could adversely affect operating results.
The Company has derived substantially all of its revenues from the sales of
a two product family. The Company believes that the inability to attract
new customers, the loss of one or more of its major customers, a
significant reduction in business from
7
<PAGE> 8
such customers, or the uncollectibility of amounts due from any of its
larger customers, could have a material adverse affect on the Company.
Revenue Recognition
The Company recognizes revenue from the sales of systems and supplies at
the time of shipment net of an allowance for estimated sales returns. The
Company generally provides warranties on its systems for one year. A
provision for estimated future costs relating to warranty is recorded when
systems are shipped.
Cash and Cash Equivalents
For purposes of the statement of cash flows, the Company considers all
highly liquid investments purchased with an original maturity of three
months or less to be cash equivalents.
Income Taxes
The Company accounts for income taxes under the liability method. Under
this method, deferred tax assets and liabilities are determined based on
the differences between the financial statement and tax bases of assets and
liabilities, using enacted tax rates in effect for the year in which the
differences are expected to reverse. Valuation allowances are established
when necessary to reduce deferred tax assets to the amount expected to be
realized. Income tax expense is the tax currently payable for the period
and the change during the period in deferred tax assets and liabilities.
Computation of Earnings Per Share
The Company adopted Statement of Financial Accounting Standards (SFAS) No.
128; "Earnings Per Share" for the year ended December 31, 1997, and has
reported earnings per common share for all periods presented in accordance
with the new standard. Net income (loss) per common share is computed by
dividing net income (loss) by the weighted average number of shares of
common stock outstanding during the period. Net income (loss) per common
share assuming dilution is computed by dividing net income (loss) by the
weighted average number of shares of common stock outstanding plus the
number of additional common shares that would have been outstanding if all
dilutive potential common shares had been issued. Potential common shares
related to stock options and stock warrants are excluded from the
computation when their effect is antidilutive.
The following is a reconciliation of the numerator and denominator of the
basic and diluted earnings per share (EPS) computations for income before
extraordinary item for the three and nine month periods ended September 30,
1998 and 1997:
8
<PAGE> 9
<TABLE>
<CAPTION>
Three months Three months Nine months Nine months
ended ended ended ended
September 30, September 30, September 30, September 30,
1998 1997 1998 1997
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Numerator:
Basic and diluted income available to common
stockholders:
Income (loss) before extraordinary item $ 669,426 $ (439,575) $ (2,897,915) $ (300,173)
Income (loss) after extraordinary item $ 669,426 $ (439,575) $ (2,897,915) $ (534,322)
Denominator:
Basic weighted average shares 5,122,072 5,066,653 5,119,061 4,081,152
Effect of dilutive securities:
Stock options and warrants 88,164 -- -- --
------------- ------------- ------------- -------------
Diluted weighted average shares 5,210,236 5,066,653 5,119,061 4,081,152
</TABLE>
Common shares related to stock options and stock warrants that are
antidilutive amounted to approximately 4,906,500 for the nine month period
ended September 30, 1998.
Recently Issued Accounting Standards
In June 1997, the FASB issued SFAS No. 131, Disclosures about Segments of
an Enterprise and Related Information. This statement will change the way
public companies report information about segments of their business in
their annual financial statements and requires them to report selected
segment information in their quarterly reports issued to shareholders. It
also requires entity-wide disclosures about the products and services an
entity provides, the material countries in which it holds assets and
reports revenues, and its major customers. The Statement is effective for
fiscal years beginning after December 15, 1997. Management has not yet
determined the effect, if any, of SFAS No. 131 on the consolidated
financial statements.
Comprehensive Income
In January 1998, the Company adopted the provisions of Statement of
Financial Accounting Standards No. 130, "Reporting Comprehensive Income"
("SFAS 130"). SFAS 130 establishes standards for reporting and displaying
comprehensive income and its components (revenues, expenses, gains and
losses) in financial statements. SFAS 130 requires that all items that are
required to be recognized under accounting standards as components of
comprehensive income be reported in a financial statement that is displayed
with the same prominence as other financial statements.
No tax effect has been allocated to the foreign currency translation
adjustment for the periods presented.
The following is a reconciliation of accumulated other comprehensive income
balance for the nine months ended September 30, 1998.
<TABLE>
<CAPTION>
September 30, 1998
------------------
<S> <C>
Beginning balance $ 696
Current period change 12,073
---------
Ending balance $ 12,769
========
</TABLE>
9
<PAGE> 10
3. Related Party Transactions
From December 1995 through February 1996, Robert H. Gurevitch, Chairman of
the Board and Chief Executive Officer of the Company, and Boston Marketing
Company, Ltd. ("Boston Marketing"), an affiliate of Hiroki Umezaki, a
former Director of the Company, loaned the Company an aggregate of
$377,015. The Promissory Notes evidencing such loans bear interest at 6%
per annum and were originally payable within six months. On February 26,
1996, the Company repaid $50,000 to each of Mr. Gurevitch and Boston
Marketing. In November 1996, Mr. Gurevitch and Boston Marketing each agreed
to extend the term of their respective notes. On May 23, 1997, Boston
Marketing was paid the remaining principal balance of $150,000 of its loan
plus the accrued interest of $3,526. Mr. Gurevitch was paid $25,000 on July
10, 1997 and $26,850 on October 22, 1997; $5,000 on October 30, 1997;
$13,787 on November 1, 1997; $3,447 on December 1, 1997; $3,447 on January
1, 1998; $5,319 on February 1, 1998; $12,806 on February 19, 1998; $3,447
on April 1, 1998; $1,341 on May 1, 1998; $3,512 on May 18, 1998; $3,976 on
June 3, 1998; $81 on June 17, 1998; and the balance was paid during the
third quarter of 1998.
On May 27, 1997, the Company loaned Dewey Perrigo, Vice President of Sales
of the Company, and Andrea Niemiec-Perrigo, an employee of the Company,
$126,000 for the purpose of buying a home. The Promissory Notes evidencing
such loans bear interest at prime plus .25% (presently 8.75%), and are due
and payable on May 27, 1999. On August 19, 1998, a principal payment of
$56,000 and an interest payment of $6,152 was made leaving a loan balance
of $70,000.
4. Inventories
Inventories consisted of the following:
<TABLE>
<CAPTION>
SEPTEMBER 30, 1998
------------------
<S> <C>
Raw materials $1,758,331
Work in progress 645,843
Finished goods 1,589,996
----------
Total $3,994,170
==========
</TABLE>
5. Capital Transactions
On March 2, 1998, the Company entered into an agreement with accredited
investors and institutional purchasers for the private placement (the "Debt
Placement") of its 12% Senior Subordinated Notes due 1999 (the "Notes") and
450,000 warrants (the "1998 Warrants"). The Debt Placement was consummated
on March 19, 1998. The 1998 Warrants are (i) exercisable commencing on May
15, 1998, and for five years thereafter for the purchase of one share of
Common Stock per Warrant; and (ii) at an exercise price of $5.812 per
share. The Notes (i) bear interest payable semi-annually at a rate of 12%
per annum; (ii) mature on the first anniversary of the date of issuance;
and (iii) may be repaid by the Company prior to maturity at one hundred and
two (102%) percent of the amount of the unpaid principal plus interest due
as of the date of repayment. As a result of the warrant issuance, the
Senior Subordinated Notes were discounted by $1,620,225, which will be
amortized over the term of the Notes. If the Notes are unpaid at maturity,
each Note holder has the option to convert the outstanding principal and
interest then due on such Note into Common Stock of the Company (the
"Conversion Shares") at a conversion price equal to eighty (80%) percent of
the average of the five lowest closing bid prices for the twenty
consecutive trading days prior to the date of conversion. The unpaid
principal and interest then due on the Notes is convertible into a maximum
aggregate amount of 500,000 shares of Common Stock. Depending on the stock
price at the time of conversion, more than 500,000 shares of common stock
may be required to permit conversion of one hundred (100%) percent of the
unpaid principal and interest then due on the Notes into Common Stock. The
Company's stockholders approved issuance of a sufficient number of shares
of Common Stock to permit conversion upon default of one hundred (100%)
percent of the unpaid principal and interest then due on all of the
outstanding Notes to Common Stock at the annual stockholders meeting on
July 21, 1998. On September 16, 1998, accrued interest of $270,000 was paid
to the Note holders in accordance with the Debt Placement agreement.
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<PAGE> 11
6. Income Taxes
Due to the cumulative loss position of the Company, a full valuation
allowance has been provided against the deferred tax asset, as realization
is not reasonably assured at this time.
7. Other
The Company had obtained distribution rights under an agreement with Ion
Laser Technology, Inc. ("ILT") for a composite curing and whitening device
under development by ILT. That device, which was similar in many respects
to the Apollo 95E, was intended to be marketed by the Company as the Apollo
9500 in the United States and Canada. On May 4, 1998, ILT announced that it
would not be able to perform its obligations under ILT's agreement with the
Company. According to the terms of the agreement, ILT repaid the Company
approximately $500,000 in inventory advances and prepaid license fees.
On June 2, 1998, the Company filed for 510(k) notification on the Apollo
95E, with the Food and Drug Administration. The Company received 510(k)
notification on August 20, 1998 and began shipping the Apollo 95E into the
United States and Canadian markets on August 24, 1998. The Apollo 95E is a
tooth whitening and curing device that will significantly whiten discolored
teeth in less than one hour, as well as, cure restorative composite
material in one to three seconds.
The Apollo 95E was developed by the Company.
8. Foreign Operations and Export Sales
The Company markets its products worldwide from its operations in the
United States and United Kingdom. Sales from the United States are
primarily to domestic customers. The majority of revenues from the United
Kingdom are to customers in Europe. Selected financial data by primary
geographic area for the three and nine month periods ended September 30,
1998 and 1997 are as follows:
<TABLE>
<CAPTION>
Three months ended Three months ended Nine months ended Nine months ended
September 30, 1998 September 30, 1997 September 30, 1998 September 30, 1997
------------------ ------------------ ------------------ ------------------
<S> <C> <C> <C> <C>
Sales to unaffiliated customers:
United States $ 4,569,100 $ 3,505,575 $ 7,890,606 $ 11,688,838
United Kingdom 1,588,258 -- 2,995,796 --
------------ ------------ ------------ ------------
$ 6,157,358 $ 3,505,575 $ 10,886,402 $ 11,688,838
Operating profit (loss)
United States $ 620,300 $ (622,042) $ (2,402,505) $ (237,260)
United Kingdom 628,439 -- 694,346 --
------------ ------------ ------------ ------------
$ 1,248,739 $ (622,042) $ (1,708,159) $ (237,260)
Identifiable Assets
United States $ 10,333,625 $ 11,437,456 $ 10,333,625 $ 11,437,456
United Kingdom 2,877,295 _ 2,877,295 --
------------ ------------ ------------ ------------
$ 13,210,920 $ 11,437,456 $ 13,210,920 $ 11,437,456
Export Sales
United States $ 507,202 $ 900,868 $ 633,642 $ 3,086,206
</TABLE>
11
<PAGE> 12
Item 2. - Management's Discussion and Analysis or Plan of Operation
Introduction
This discussion summarizes the significant factors affecting the consolidated
operating results, financial condition and liquidity/cash flows of the Company
for the three-month and nine-month periods ended September 30, 1998 and 1997.
Except for the historical information contained herein, the matters discussed in
this Management's Discussion and Analysis are forward looking statements that
involve risks and uncertainties and are based upon judgments concerning various
factors that are beyond the Company's control. Actual results could differ
materially from those projected in the forward looking statements as a result
of, among other factors, the factors set forth under the caption "Cautionary
Statements and Risk Factors" below.
Dental Medical Diagnostic Systems, Inc. ("Company") designs, develops,
manufactures and sells high technology dental equipment. The Company was
organized in New York in 1981 under the name Edudata Corporation and
reincorporated in Delaware in 1983. The Company was initially organized to
provide education in the use of personal computers, to market software programs
developed by others, and to provide a broad range of advisory services to
businesses in conjunction with both computer and non-computer related management
issues. From 1988 to early 1996, the Company's operations were limited to
exploring opportunities to acquire or to become an operating business.
The Company's primary product emphasis for approximately the past two years has
been on the manufacture and sale of an intraoral camera system known as the
"TeliCam II System," an updated version of the intraoral camera system, the
"TeliCam Elite," and a multi-operatory intraoral camera system known as the
InTELInet, for use in connection with the TeliCam II System. However, in the
last nine months the Company's primary product emphasis has begun to shift
toward a teeth whitening and curing device known as the Apollo 95E which the
Company now markets both domestically and internationally. The Company had
originally obtained distribution rights under an agreement with Ion Laser
Technology, Inc. ("ILT") for a composite curing and whitening device under
development by ILT. That device, which was similar in many respects to the
Apollo 95E, was intended to be marketed by the Company as the Apollo 9500 in the
United States and Canada, while the Apollo 95E would be marketed solely in
international markets. On May 4, 1998, ILT announced that it would not be able
to perform its obligations under ILT's agreement with the Company. The Company
then filed for 510(k) notification on June 2, 1998 and received 510(k)
notification for the Apollo 95E on August 20, 1998. On August 24, 1998, the
Company began shipping Apollo 95E units into the United States and Canada.
The TeliCam II and Elite Systems display close-up color video images of dental
patients' teeth and gums. These TeliCam images assist dentists in displaying
dental health and hygiene problems to patients and, as a result of such display,
promote patient acceptance of treatment plans. The TeliCam II System offers
dentists the ability to capture and display multiple video images without an
expensive external capture device such as a video cassette recorder or color
printer, thereby providing a low-cost alternative to the more expensive
traditional intraoral dental camera systems. The Company commenced shipments of
a predecessor of the TeliCam II System known as the "TeliCam I System" to
customers in February 1996, shipped TeliCam II Systems commencing in the second
quarter of 1997 and shipped Elite Systems in the second quarter of 1998. The
Company believes that the market for intraoral cameras such as the TeliCam II
and Elite system is a market which has matured. TeliCam System II and Elite
Systems sales have recently been below levels of prior comparable periods, a
trend which the Company expects to continue.
The Company introduced a curing and whitening device, the Apollo 95E, to
international markets in the first quarter of 1998 and to U.S. and Canadian
markets in the third quarter of 1998. The Apollo 95E was developed by S.E.D.
Gerant ("S.E.D."), a developer and manufacturer of medical and dental devices
organized under the laws of France which was acquired by the Company in 1997.
The Company believes that the Apollo 95E produces faster results than products
currently available in the market place. This product is designed to cure
composite material in three seconds or less, and to produce teeth whitening in a
dental operatory in less than one hour. In the third quarter the Apollo 95E has
received a strong response from the domestic marketplace and the Company
anticipates an increase in production for the fourth quarter and for calendar
year 1999. See "Cautionary Statements and Risk Factors -- Substantial Dependence
on Third Parties -- Suppliers."
The Company also plans to begin marketing the chemical composite (Apollo Cure)
and whitening materials (Apollo Secret) to be used in connection with the Apollo
95E in the fourth quarter 1998. The Company is currently in the process of
having the products manufactured for initial shipment to dentists. The Company
has the exclusive worldwide distribution rights for Apollo Secret whitening
agents and composite curing materials, and plans to begin shipping to dentist in
the fourth quarter of 1998. The benefits of Apollo Secret Power Whitening
include a unique desensitizing formulation that substantially reduces patient
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discomfort, allows the procedure to be performed by a dental assistant or
hygienist, generally in less that 40 minutes, and has the ability to whiten the
patient's teeth up to ten shades lighter. Apollo Secret is the subject of a
pending patent application by its developer. This product eliminates many of the
common problems associated with other tooth whitening agents by combining a 35%
Hydrogen Peroxide solution with a patent applied for formula which reduces
burning or discomfort to the gums and causes no surface damage to the teeth,
enamel or pulp. No assurance can be given that the tooth whitening formula will
be successfully introduced or that the Company will be able to commercially
exploit it
The Company has entered into an agreement with Suni Imaging Microsystems, Inc.
("Suni") to develop digital x-ray technology for incorporation into systems for
the dental market. The Company has obtained exclusive rights to market products
to the dental market incorporating certain digital x-ray technology developed by
Suni. Suni will retain the rights to developed microchip technology underlying
the x-ray system it develops for the Company. Digital x-ray systems, including
those currently on the market, reduce radiation exposure compared to
conventional x-ray systems and allow dentists to view x-ray images in real-time
without the time-consuming process of film development and eliminate the need to
use and dispose of chemicals required to develop conventional x-ray film. This
technology, if successfully developed for the Company by Suni, would provide an
improved image quality digital x-ray system at a price expected to be lower than
competitive systems. This technology also is designed to allow database storage
and recall of images for comparison purposes. The development of the technology
will be done by Suni and funded by the Company. No assurance can be given that
digital x-ray technology will be successfully developed, or if the technology is
developed, that the Company will be able to commercially exploit it.
Additionally, the Company believes that any products it may develop
incorporating the digital x-ray technology will require FDA notification prior
to marketing, and as a consequence, the timing of the domestic introduction of
such product is uncertain. A group of professional dental experts consulting
with the Company recently reviewed the digital x-ray images produced by the
Company's prototype sensors and they announced that, in their opinion, the
images exhibited a high level of clarity for a digital x-ray. The Company plans
to launch this product internationally commencing in the near term. Marketing
this device domestically will begin if, and when, FDA approval pursuant to a
510(k) filing is granted. See "Cautionary Statements and Risk Factors --
Substantial Dependence on Third Parties -- Suppliers."
In November 1996, the Company introduced its InTELInet Video Monitoring System
("InTELInet") which generally includes two TeliCam systems, a printer, a
video-cassette monitor, cabling and installation. InTELInet creates a
video-electronic information link between the different operatories of the
dental office. InTELInet is different from most other intra-office networking
systems known to the Company in that it enables simultaneous use of two or more
intraoral cameras, which allows dentists and their staffs to conduct more than
one patient examination at a time using two or more intraoral cameras
simultaneously. InTELInet is thus designed to be a cost-effective solution to
the problems generally associated with standard networking of various intraoral
cameras in multiple operatories within a single dental practice. The Company
emphasizes the savings to dental practices and the ease of use of the InTELInet
in its marketing campaigns. The InTELInet is being marketed by the Company only
in the United States due to the general absence of multiple operatory practices
outside of the United States. The InTELInet facilitates simple network expansion
and is only compatible with intraoral dental cameras marketed by the Company.
While there can be no assurance that digital x-ray technology will be developed,
the Company has designed the InTELInet system to be compatible with the digital
x-ray technology the Company is currently developing with Suni Imaging
Microsystems, Inc.
On February 2, 1998 the Company formed "DMDS, Ltd." a wholly owned subsidiary
created under the laws of the United Kingdom. DMDS, Ltd. holds the assets
acquired from S.E.D. In addition, the Company currently plans to market certain
of its new products internationally through DMDS, Ltd.
On March 2, 1998, the Company entered into an agreement with accredited
investors and institutional purchasers for the private placement (the "Debt
Placement") of its 12% Senior Subordinated Notes due 1999 (the "Notes") and
450,000 warrants (the "1998 Warrants"). The Debt Placement was consummated on
March 19, 1998. The 1998 Warrants are (i) exercisable commencing on May 15,
1998, and for five years thereafter for the purchase of one share of Common
Stock per Warrant; and (ii) at an exercise price of $5.812 per share. The Notes
(i) bear interest payable semi-annually at a rate of 12% per annum; (ii) mature
on the first anniversary of the date of issuance; and (iii) may be repaid by the
Company prior to maturity at one hundred and two (102%) percent of the amount of
the unpaid principal plus interest due as of the date of repayment. As a result
of the warrant issuance, the Senior Subordinated Notes were discounted by
$1,620,225, which will be amortized over the term of the Notes. If the Notes are
unpaid at maturity, each Note holder has the option to convert the outstanding
principal and interest then due on such Note into Common Stock of the Company
(the "Conversion Shares") at a conversion price equal to eighty (80%) percent of
the average of the five lowest closing bid prices for the twenty consecutive
trading days prior to the date of conversion. The unpaid principal and interest
then due on the Notes is convertible into a maximum aggregate amount of 500,000
shares of Common Stock. Depending on the stock price at the time of conversion,
more than 500,000 shares of common stock may be required to permit conversion of
one hundred (100%) percent of the unpaid principal and interest then due on the
Notes into Common Stock. The Company has
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presented a proposal to its stockholders at the annual meeting of stockholders
to approve issuance of a sufficient number of shares of Common Stock to permit
conversion upon default of one hundred (100%) percent of the unpaid principal
and interest then due on all of the outstanding Notes to Common Stock. This
proposal was approved at the meeting held on July 21, 1998. On September 16,
1998, accrued interest of $270,000 was paid to the Note holders in accordance
with the Debt Placement agreement.
Results of Operations
For the three-month periods ended September 30, 1998 and 1997, net sales totaled
$6,157,358 and $3,505,575, respectively. For the nine-month periods ended
September 30, 1998 and 1997, net sales totaled $10,886,402 and $11,688,838,
respectively. The Company had operating income of $669,426 for the quarter ended
September 30, 1998 and an operating loss of $439,575 for the quarter ended
September 30, 1997.
Net sales for the three-month period ended September 30, 1998 were $6,157,358
compared to $3,505,575 for the three-month period ended September 30, 1997, or
an increase of approximately 76%. Net sales for the nine-month period ended
September 30, 1998 were $10,886,402 compared to $11,688,838 for the nine-month
period ended September 30, 1997, or a decrease of approximately 7%. Sales are
comprised primarily of TeliCam Systems and the Apollo 95E. The decrease in sales
for the nine months ended September 30, 1998 was primarily due to reduced
TeliCam sales both domestically and internationally resulting from weaker demand
and increased competition as the market for intraoral cameras matured. The
Company expects the decline in TeliCam sales to continue into the future.
Partially offsetting the reduced TeliCam volume was the introduction of the
Apollo 95E, a tooth whitening and curing device, in Europe in the first quarter
of 1998 and domestically in the third quarter of 1998. Net sales internationally
of the Apollo 95E for the three months ended March 31, 1998 were $298,150, for
the three months ended June 30, 1998 were $1,104,867, and $1,757,180 for the
three months ended September 30, 1998. Domestic net sales of the Apollo 95E for
the quarter ended September 30, 1998 totaled $2,720,668. No assurance can be
given that Apollo 95E sales will ultimately offset the reduced TeliCam sales in
the future. See - "Cautionary Statements and Risk Factors Importance of New
Product Development to Growth".
Cost of sales for the three month period ended September 30, 1998 were
$2,866,104 or 47% of sales as compared to $2,356,863 or 67% of sales for the
three months ended September 30, 1997. Cost of sales for the nine month period
ended September 30, 1998 were $6,363,099 or 58% of sales as compared to
$7,384,583 or 63% of sales for the nine months ended September 30, 1997. Cost of
sales decreased as a percentage of sales primarily due to the favorable margins
on the Apollo 95E. The Company expects margins on the sale of the TeliCams will
be reduced in the next quarter as inventory of the TeliCam systems will be sold
at a discount.
Selling, general and administrative expenses totaled $1,845,232 and $1,359,117
for the three-months ended September 30, 1998 and 1997, respectively. Selling,
general and administrative expenses totaled $5,709,490 and $4,056,544 for the
nine-months ended September 30, 1998 and 1997, respectively. The increase in
expense is primarily due to increased advertising, salary and wages, and legal
and accounting expenses. These increases were primarily due to preparation for
the curing and whitening product introductions. These expenses are expected to
continue to increase as sales volume increases and as new products are
introduced. The Company expects that significant expenses will be incurred in
connection with the introduction and increasing market penetration of the Apollo
95E.
Research and development expenses totaled $197,283 and $155,387 for the
three-month periods ended September 30, 1998 and 1997, respectively. Research
and development expenses totaled $521,972 and $228,721 for the nine-month
periods ended September 30, 1998 and 1997, respectively. The increase is
primarily the result of continued expenditures on the development of the digital
x-ray technology. See "Cautionary Statements and Risk Factors - Importance of
New Product Development to Growth.", and "Cautionary Statements and Risk Factors
- - Expansion through Undetermined Acquisitions and Joint-Ventures.". Increased
expenditures on research and development are expected to continue into future
periods, particularly in connection with the Company's digital x-ray product and
in connection with the investigation and/or development of additional product
lines.
Amortization of debt issuance cost totaled $75,000 for the three month period
ended September 30, 1998. There was no amortization of debt issuance costs for
the three months ending September 30, 1997. Amortization of debt issuance cost
totaled $160,484 and $76,431 for the nine-month periods ended September 30, 1998
and 1997, respectively. The amortization in the first nine months of 1998 is a
result of the costs associated with the $4.5 million Debt Placement on March 19,
1998 and in the first nine months of 1997, was a result of the Bridge Notes
issued in November 1996. This cost will continue into future periods.
Interest income totaled $47,103 and $90,285 for the three-month periods ended
September 30, 1998 and 1997, respectively. Interest income totaled $155,433 and
$139,250 for the nine-month periods ended September 30, 1998 and 1997,
respectively.
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This is primarily the result of investing the net proceeds of the Private
Placement and Offering in a short-term management account through Comerica
Securities.
Interest expense totaled $551,416 and $4,655, respectively for the three-month
periods ended September 30, 1998 and 1997. Interest expense totaled $1,184,705
and $136,774, respectively for the nine-month periods ended September 30, 1998
and 1997. Interest expense consists of interest paid on capital lease
obligations, interest accrued and amortization of debt discount on the $4.5
million Debt Placement, interest accrued on the Comerica capital expenditure
line, and notes payable to related parties. The increase year-to-date is
primarily due to the amortization of debt discount and accrued interest on the
$4.5 million Debt Placement. This expense will also continue into future
periods.
Capital Resources and Liquidity
For the nine-month period ended September 30, 1998, the Company used net cash of
$4,605,065 in operations. Accounts receivable increased by $1,767,350 to
$3,753,512 at September 30, 1998 as the Company commenced shipments of the
Apollo 95E into the U.S. and Canadian markets along with continued international
sales. See "Cautionary Statements and Risk Factors - Fluctuations in Quarterly
Results". Accounts payable and accrued liabilities totaling $2,334,210 at
September 30, 1998 decreased from $ 2,539,585 at the prior year-end period
primarily due to the reduction in purchases associated with the TeliCam product
line, the high profit margins associated with the Apollo 95E, and the timing of
payments. Inventory levels increased $1,093,235 primarily due to the
introduction of the Apollo 95E in the United States and Europe.
Capital expenditures totaled $398,368 for the nine month period ended September
30, 1998 and was primarily due to the new computer network system hardware and
software that is currently being implemented as part of a standard upgrade. Cash
and cash equivalents on hand at the end of the period were $3,687,439. The Debt
Placement of the Company in March 1998 provided approximately $4,200,000 in cash
to the Company after expenses.
On July 14, 1998, the Company finalized a credit agreement with Comerica Bank
("Comerica") extending up to a $1,000,000 line of credit to the Company, secured
by a first priority security interest in the Company's assets and by an
assignment of the Company's rights under the Boston Marketing Distribution
Agreement. The credit facility bears interest at the rate of prime plus .25% per
annum (8.5% at September 30, 1998). All borrowings under the facility are
subject to a formula based, generally, on accounts receivable and inventory. The
Company intends to use the credit facility, when needed, for working capital and
general corporate purposes. No amounts were outstanding at September 30, 1998.
On December 10, 1997, the Company finalized a second agreement with Comerica
Bank ("Comerica") extending up to a $500,000 line of credit to the Company for
capital expenditures, secured by a first priority interest in the Company's
assets. The credit facility bears interest at a rate of prime plus .5% per annum
(8.75% at September 30, 1998). The line expires on December 10, 1998. The
principal balance will amortize over a thirty-six--(36) month period. Borrowings
are at 80% of the capital expenditure. At September 30, 1998, $343,890 was
outstanding.
At present, the expenditures for continued research and development for products
incorporating digital x-ray technology and the minimum purchase obligations of
the Company under its agreement with Boston Marketing are the only significant
future commitment and will be financed by cash from continuing operations and
the remaining proceeds of the $4.5 million Debt Placement. Based on its current
operating plan, the Company anticipates that unless a substantial portion of the
Company's outstanding redeemable warrants are exercised before the maturity of
the Private Placement Debt, further capital may be required during the next
twelve months to satisfy the Company's expected increased working capital and
research and development requirements for the new products. Exercise of the
Company's redeemable warrants is only likely if the market price of the
Company's common stock is in excess of the exercise of the redeemable warrants
and, consequently, there can be no assurance that a significant portion of the
Company's outstanding redeemable warrants will be exercised. However, the market
price of the Company's common stock is currently in excess of the exercise price
of the redeemable warrants. If this continues to be the case, some of the
Company's requirements for additional capital may be satisfied by the exercise
of the redeemable warrants. In addition, the $4,500,000 in Notes payable are due
March 19, 1999. If the Notes are unpaid at maturity each Note holder has the
option to convert the outstanding principal and interest then due on such Note
into Common Stock of the Company at a conversion price equal to eighty (80%)
percent of the average of the five lowest closing bid prices for the twenty
consecutive trading days prior to the date of conversion. If this were to occur,
the Company would recognize a charge in its Statement of Operations for the
amount of the discount in the conversion price from the current market value of
the Common Stock.
Also, the Company is currently considering the possibility of tapping into its
credit facility with Comerica as a means of obtaining additional capital to meet
its needs. The Company is also currently exploring other alternatives to fulfill
its financing
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<PAGE> 16
requirements. No assurance can be given that additional financing will be
available when needed or that, if available, it will be on terms favorable to
the Company or its stockholders. If needed funds are not available, the Company
may be required to curtail its operations, which could have a material adverse
effect on the Company's business, operating results and financial condition.
There can be no assurance that the Company's working capital requirements during
this period will not exceed its available resources or that these funds will be
sufficient to meet the Company's longer-term cash requirements for operations.
Fluctuations in Quarterly Results
The Company's business is subject to certain quarterly influences. Net sales and
operating profit are generally higher in the fourth quarter due to the
purchasing patterns of dentists in the United States and are generally lower in
the first quarter due primarily to the effect upon demand of increased purchases
in the prior quarter. It is also expected that the Company's business will
experience lower sales in the summer months as a consequence of holiday
vacations and a lesser number of trade shows.
Quarterly results may be adversely affected in the future by a variety of other
factors, including the possible costs of obtaining capital, as well as the
release of new products and promotions taking place within the quarter. The
Company plans to continue to fund research and development and to increase
working capital requirements for the new products. To the extent that such
expenses precede or are not subsequently followed by increased revenues, the
Company's business, operating results and financial condition will be adversely
affected.
Year 2000 Issue
The Year 2000 readiness issue, which is common to most businesses, arises from
the inability of information systems, and other time and date sensitive products
and systems, to properly recognize and process date-sensitive information or
system failures. Assessments of the potential cost and effects of Year 2000
issues vary significantly among businesses, and it is extremely difficult to
predict the actual impact. Recognizing this uncertainty, management is
continuing to actively analyze, assess and plan for various Year 2000 issues
across its businesses.
The Year 2000 issue has an impact on both information technology ("IT") systems
and non-IT systems, such as its manufacturing systems and physical facilities
including, but not limited to, security systems and utilities. Although
management believes that a majority of the Company's IT systems are Year 2000
ready, such systems still have to be tested for Year 2000 readiness. The Company
is replacing or upgrading those systems that are identified as non-Year 2000
compliant. Certain IT systems previously identified as non-Year 2000 compliant
are being upgraded or replaced which should be complete by June 30, 1999. Non-IT
system issues are more difficult to identify and resolve. The Company is
actively identifying non-IT Year 2000 issues concerning its products and
services, as well as its physical facility locations. As non-IT areas are
identified, management formulates the necessary actions to ensure minimal
disruption to its business processes. Although management believes that its
efforts will be successful and the costs will be immaterial (i.e., less than
$25,000) to its consolidated financial position and results of operations, it
also recognizes that any failure or delay could cause a potential impact.
The Company has initiated efforts to ensure Year 2000 readiness of its products
and services. The Company has migrated to a Year 2000 compliant Network
Operating System, and its key financial, manufacturing and other in-house
systems are already materially compliant.
The Year 2000 readiness of its customers varies. The Company is not
investigating whether or not its customers are evaluating and/or preparing their
own systems. These efforts by customers to address Year 2000 issues may affect
the demand for certain products and services; however, the impact to the revenue
of any change in revenue patterns is highly uncertain.
The Company has also initiated efforts to assess the Year 2000 readiness of its
key suppliers and business partners. The Company's direction of this effort is
to ensure the adequacy of resources and supplies to minimize any potential
business interruptions. Management plans to complete this part of its Year 2000
readiness plan in the early part of calendar 1999.
The Year 2000 issue presents a number of other risks and uncertainties that
could impact the Company, such as public utilities failures, potential claims
against it for damages arising from products and services that are not Year 2000
compliant, and the response ability of certain government commissions of the
various jurisdictions where the Company conducts business. While the Company
continues to believe the Year 2000 issues described above will not materially
affect its consolidated financial position or results of operations, it remains
uncertain as to what extent, if any, the Company may be impacted.
CAUTIONARY STATEMENTS AND RISK FACTORS
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Several of the matters discussed in this document contain forward looking
statements that involve risks and uncertainties. Factors associated with the
forward looking statements, which could cause actual results to differ
materially from those projected or forecast in the statements, appear below. In
addition to other information contained in this document, readers should
carefully consider the following cautionary statements and risks factors:
Limited Operating History; History of Losses and Accumulated Deficit. While
the Company has been in existence since 1981, its operations between 1988 and
its acquisition of DMD and BDI in March 1996, were limited to the exploration of
acquisition opportunities. Dental/Medical Diagnostic Systems, the division of
the Company which designs and markets the Company's TeliCam Systems and Apollo
95E have only been in operation since October 1995. For the period from
inception (October 23, 1995) to March 2, 1996, the Company incurred a net loss
of $1,625,213, and for the ten-month period ended December 31, 1996, the Company
had net income of $137,151. For the twelve months ended December 31, 1997 the
Company had a net loss after extraordinary item of $2,044,729, for the nine
months ended September 30, 1998 the Company had a net loss of $2,897,915. At
September 30, 1998, the Company's accumulated deficit was $6,430,706. The
ability of the Company to obtain and sustain profitability will depend, in part,
upon the successful marketing of existing products and the successful and timely
introduction of new products. There can be no assurance that the Company will be
able to generate and sustain net sales or profitability in the future.
Dependence Upon Two Products. The TeliCam Systems, together with related
products such as the InTELInet system, and the Apollo 95E have been the
company's primary products and during the last nine months have accounted for a
substantial portion of the Company's revenue. See "-- Importance of New Product
Development to Growth." The Company believes that the market for intraoral
cameras, such as the TeliCam systems, is a market that has matured. TeliCam
Systems sales have recently been below levels of prior comparable periods, a
trend which the Company expects to continue. If the Company is unable to
successfully develop and introduce additional products and product lines, or
continue to increase market penetration of its Apollo 95E now being sold both
domestically and internationally, it is likely that the Company's business
operations would be substantially and adversely impacted.
Importance of New Product Development to Growth. The Company's ability to
develop and successfully introduce new products, particularly obtaining 510(k)
notification for a line of tooth whitening chemicals and composites, and the
digital x-ray technology under development for the Company by Suni, will be a
significant factor in the Company's ability to grow and remain competitive. See
"Cautionary Statements and Risk Factors -- Substantial Dependence on Third
Parties -- Suppliers." Development of new product lines is risk intensive as
evidenced by ILT's recent announcement that it will be unable to perform its
obligations under its agreement with the Company to develop and supply the
Apollo 9500 to the Company. New product development often requires long-term
forecasting of market trends, the development and implementation of new designs,
compliance with extensive governmental regulatory requirements and a substantial
capital commitment. There are a number of manufacturing and design risks
inherent in engineering high cost custom built prototypes upon which development
and contracting decisions are often made, into commercial products able to be
manufactured in large quantities at acceptable cost. Also, the medical and
dental device industry is characterized by rapid technological change. As
technological changes occur in the marketplace, the Company may have to modify
its products in order to keep pace with these changes and developments. The
introduction of products embodying new technologies, or the emergence of new
industry standards, may render existing products, or products under development,
obsolete or unmarketable. Any failure by the Company to anticipate or respond in
a cost-effective and timely manner to government requirements, market trends or
customer requirements, or any significant delays in product development or
introduction, could have a material adverse effect on the Company's business,
operating results and financial condition.
Need For Additional Financing. Based on its current operating plan, the
Company anticipates that unless a substantial portion of the outstanding
warrants of the Company are exercised by the respective holders thereof, in
addition to the credit facility and the remaining proceeds of the Debt
Placement, further capital will be required during the next twelve months to
satisfy the Company's expected increased working capital and research and
development requirements for its planned new products. The Company is currently
exploring alternatives to fulfill these requirements. No assurance can be given
that additional financing will be available when needed or that, if available,
it will be on terms favorable to the Company or its stockholders. If needed
funds are not available, the Company may be required to curtail its operations,
which could have a material adverse effect on the Company's business, operating
results and financial condition. If additional funds are raised through the
issuance of equity securities, additional dilution to stockholders may occur. In
addition, if sufficient funds to repay the Notes are not available, the Notes
may be converted to shares of Common Stock and additional dilution to
stockholders may occur.
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Expansion through Undetermined Acquisitions and Joint Ventures. The Company
intends to expand its product lines and domestic and international markets, in
part, through acquisitions. The Company's ability to expand successfully through
acquisitions will depend upon the availability of suitable acquisition
candidates at prices acceptable to the Company, the Company's ability to
consummate such transactions and the availability of financing on terms
acceptable to the Company. There can be no assurance that the Company will be
successful in completing acquisitions. Such transactions involve numerous risks,
including possible adverse short-term effects on the Company's operating results
or the market price of the Common Stock. These acquisitions and joint ventures
may not be subject to approval or review by the Company's stockholders. The
Company does not expect that it will obtain an appraisal by any independent
appraisers with respect to any such acquisition. Certain of the Company's future
acquisitions may also give rise to an obligation by the Company to make
contingent payments or to satisfy certain repurchase obligations, which payments
could have an adverse financial effect on the Company. In addition, integrating
acquired businesses may result in a loss of customers or product lines of the
acquired businesses and also requires significant management attention and may
place significant demands on the Company's operations, information systems and
financial resources. The failure effectively to integrate acquired businesses
with the Company's operations could adversely affect the Company. In addition,
the Company competes for acquisition opportunities with companies which have
significantly greater financial and management resources than those of the
Company. There can be no assurance that suitable acquisition opportunities will
be identified, that any such transactions can be consummated, or that, if
acquired, such new businesses can be integrated successfully and profitably into
the Company's operations. Moreover, there can be no assurance that the Company's
historic rate of growth will continue, that the Company will continue to
successfully expand, or that growth or expansion will result in profitability.
The Company also intends to expand its product lines and domestic and
international markets through joint ventures. The Company's ability to expand
successfully through joint ventures will depend upon the availability of
suitable joint venture candidates whose terms are acceptable to the Company, the
Company's ability to consummate such transactions and the availability of
financing on terms acceptable to the Company. There can be no assurance that the
Company will be successful in completing joint ventures. Such transactions
involve numerous risks, including possible adverse short-term effects on the
Company's operating results or the market price of the Common Stock. The failure
effectively to integrate joint ventures with the Company's operations could
adversely affect the Company. In addition, the Company competes for expansion
opportunities with companies which have significantly greater financial and
management resources than those of the Company. There can be no assurance that
suitable investment opportunities will be identified, that any such transactions
can be consummated, or that such new businesses can be integrated successfully
and profitably into the Company's operations. Moreover, there can be no
assurance that the Company's historic rate of growth will continue, that the
Company will continue to successfully expand, or that growth or expansion will
result in profitability.
Substantial Dependence on Third Parties: The Company substantially depends upon
third parties for several critical elements of its business including the
development and licensing for distribution of its products.
Suppliers. With the exception of the TeliCam System's CCD processor unit,
the Company believes that there are multiple sources from which it may purchase
the components of the TeliCam System. The Company anticipates that it will
obtain certain of the components of the TeliCam System from a single source or a
limited number of sources of supply. Although the Company believes it will be
able to negotiate satisfactory supply arrangements and relationships, the
failure to do so may have a material adverse effect on the Company. Furthermore,
there can be no assurance that suppliers will dedicate sufficient production
capacity to satisfy the Company's requirements within scheduled delivery times
or at all. Failure or delay by the Company's suppliers in fulfilling its
anticipated needs may adversely affect the Company's ability to market the
TeliCam System. Pursuant to the Boston Marketing Distribution Agreement, the
Company has the exclusive right to market Teli Units to the dental market.
Boston Marketing is a licensed distributor of the Teli Units under a separate
agreement with their manufacturer. The agreement between Boston Marketing and
the Teli Units manufacturer obligates Boston Marketing to meet minimum purchase
obligations. If Boston Marketing fails to meet these obligations, Boston
Marketing will be terminated as a licensed distributor. In the event of such
termination, the Company, as a sublicensee subdistributor of Boston Marketing,
may lose its right to purchase the Teli Units. Moreover, in the event the
Company is unable to meet its minimum annual purchase obligations under the
Boston Marketing Distribution Agreement, and, as a consequence, such agreement
terminates, the Company may be required to find an alternative source for the
primary component of its TeliCam System. The Company believes that, in the event
the Company loses its right to sell the Teli Units, replacement components could
be developed by and obtained from third parties, but that this may take more
than six months. The potential delay associated with locating an alternative
source of supply would have a significant adverse effect on the Company's
operating results and financial condition. In addition, there is no guarantee
that an intraoral dental camera system utilizing the replacement components will
be accepted by the dental marketplace. The Company has an oral agreement with
S.E.D. to manufacture its Apollo 95E product for sale internationally. Dr.
Duret, president of S.E.D. oversees manufacturing of the Apollo 95E for the
Company, and renders consulting services for the Company. If S.E.D. were unable
to meet the Company's requirements, the Company would have to obtain an
alternative manufacturing arrangement. The Company believes
18
<PAGE> 19
that such manufacturing capability could be developed by the Company or obtained
from third parties, but that developing or obtaining alternative capacities may
take up to four months. The potential delay associated with either developing or
locating an alternative source of supply could have a significant adverse effect
on the Company's operating results and financial condition.
The Company is dependent upon third party developers and suppliers for the
development and manufacture of tooth whitening chemicals and composites, such as
Apollo Secret and Apollo Cure, for sale with the Apollo 95E. Although tooth
whitening chemicals and composites usable with the Apollo 95E are commercially
available, failure by the Company to develop and successfully market a
proprietary line of tooth whitening and composite chemicals would have an
adverse effect on the companies earnings and revenues because of higher cost of
goods associated with and lesser functionality of commercially available
products.
Suni. Under the Company's licensing and development arrangements with Suni
for the development of digital x-ray technology for the dental market, the
Company has obtained exclusive marketing rights to products incorporating
certain digital x-ray technology developed by Suni. The Company has paid
significant advances to, and is dependent upon Suni to successfully develop the
digital x-ray technology and to commercialize the digital x-ray technology.
There can be no assurance that Suni will be successful in this endeavor. If Suni
should not develop a digital x-ray product acceptable to the Company or the
marketplace, this would have a material adverse effect on the Company's
operating results and financial condition. The agreement with Suni provides that
the Company is obligated to make minimum royalty payments if products
incorporating the developed technology are introduced to the market in order to
maintain exclusivity. There can be no assurance that the Company will be able to
meet the royalty payments required to maintain exclusivity. Suni would then be
able to license the developed technology to the Company's competitors, or grant
an exclusive license to a competitor, which could have a material adverse effect
on the Company's operating results and financial condition.
Fluctuations in Quarterly Results. The Company's business is subject to
certain quarterly influences. Management's prior experience in the industry
would indicate that net sales and operating profits are generally higher in the
fourth quarter due to the purchasing patterns of dentists and are generally
lower in the first quarter due primarily to increased purchases in the prior
quarter and during the summer months due to a reduced volume of trade shows and
increased unavailability of dentists due to summer vacations. The Company plans
to increase expenses to fund greater levels of research and development and to
fund investments in joint ventures and acquisitions. To the extent that such
expenses precede or are not subsequently followed by increased revenues, the
Company's business, quarterly operating results and financial condition will be
adversely affected. Quarterly results may also be adversely affected by a
variety of other factors, including the timing of acquisitions and their related
costs, as well as the release of new products and promotions taking place within
the quarter. Other factors that may influence the Company's quarterly operating
results include the timing of introduction or enhancement of products by the
Company or its competitors, market acceptance of the TeliCam Elite, the
InTELInet System, the Apollo 95E and other new products, development and
promotional expenses relating to the introduction of new products or
enhancements of existing products, reviews in the industry press concerning the
products of the Company or its competitors, changes or anticipated changes in
pricing by the Company or its competitors, mix of distribution channels through
which products are sold, mix of products sold, product returns, the timing of
orders from major distributors, order cancellations, delays in shipment and
general economic conditions. Due to all of the foregoing factors, it is also
likely that in some future periods the Company's operating results may be below
the expectations of analysts and investors. In such event, the price of the
Company's Common Stock would likely be materially adversely affected.
Extensive Government Regulation. The Company's products and its
manufacturing practices are subject to regulation by the United States Food and
Drug Administration ("FDA") pursuant to the Federal Food, Drug and Cosmetic Act
("FDC Act"), and by other state and foreign regulatory agencies. Under the FDC
Act, medical and dental devices, including those under development by the
Company must receive FDA clearance or notification before they may be sold, or
be exempted from the need to obtain such clearance or notification. FDA
regulations also require the Company to adhere to certain "Good Manufacturing
Practices" ("GMP") regulations, which include validation testing, quality
control and documentation procedures. The Company's compliance with applicable
regulatory requirements is subject to periodic inspections by the FDA.
The Company will need to file for 510(k) notification for any new products that
are developed in the future using digital x-ray technology. The process of
obtaining required regulatory clearances or notifications can be time-consuming
and expensive, and compliance with the FDA's GMP regulations and other
regulatory requirements can be burdensome. Moreover, there can be no assurance
that the required regulatory notifications will be obtained, and those obtained
may include significant limitations on the uses of the product in question. In
addition, changes in existing regulations or the adoption of new regulations
could make regulatory compliance by the Company more difficult in the future.
Although the Company believes that its products and procedures are currently in
material compliance with all relevant FDA requirements, the failure to obtain
the required regulatory clearances or to comply with applicable regulations
could result in fines, delays or suspensions of clearances, seizures or recalls
of products, operating restrictions and criminal prosecutions, and would have a
material adverse effect on the Company.
19
<PAGE> 20
Competition. The manufacture and distribution of medical and dental devices
is intensely competitive. The Company competes with numerous other companies,
including several major manufacturers and distributors. With respect to the
intraoral camera market, the Company has at least twelve major competitors. The
Apollo 95E presently has two major competitors. Some of the Company's
competitors have greater financial and other resources than the Company.
Consequently, such entities may begin to develop, manufacture, market and
distribute systems which are substantially similar or superior to the Company's
products.
Rapid Expansion of the Company's Business. From inception (October 23, 1995)
through September 30, 1998, the Company has experienced rapid and substantial
growth in revenues and geographic scope of operations. Any future growth may
place a significant strain on management and on the Company's financial
resources and information processing systems. The failure to recruit additional
staff and key personnel, to have sufficient financial resources, to maintain or
upgrade these financial reporting systems, or to respond effectively to
difficulties encountered during expansion could have a material adverse effect
on the Company's business, operating results and financial condition.
Reliance on International Sales and Distributors and General Risks of
International Operations. For the nine-month period ended September 30, 1998,
international sales have accounted for approximately 34% of the Company's net
sales, and the Company expects that international sales may increase as a
percentage of sales in the future. Consequently, the Company is subject to the
risks of conducting business internationally, including unexpected changes in,
or impositions of, legislative or regulatory requirements; fluctuations in the
US dollar which could materially adversely affect US dollar revenues; tariffs
and other barriers and restrictions; potentially adverse taxes; and the burdens
of complying with a variety of international laws and communications standards.
The Company's international sales involve potentially longer payment cycles and
the Company may experience greater difficulty collecting accounts receivable.
The Company currently depends on third party distributors for substantially all
of its international sales. At September 30, 1998, the Company's international
receivables accounted for 59% of the Company's accounts receivable, and
international sales were approximately $2,095,460 or 34%, of the Company's total
sales for the nine-month period ended September 30, 1998. Certain of the
Company's third party distributors may also act as resellers for competitors of
the Company and could devote greater effort and resources to marketing
competitive products. The loss of, or other significant reduction in sales to,
certain of these third party distributors could have a material adverse effect
on the Company's business and results of operations. The Company is also subject
to general geopolitical risks, such as political and economic instability and
changes in diplomatic and trade relationships, in connection with its
international operations. There can be no assurance that these risks of
conducting business internationally will not have a material adverse effect on
the Company's business. Further, any failure by the Company to predict or plan
for changes in the international arena could have a material adverse effect on
the Company's business, operating results and financial condition.
Dependence on Key Personnel. The Company's future performance will depend
significantly upon its Chairman of the Board and Chief Executive Officer, Robert
H. Gurevitch, and upon certain other key employees of the Company. The loss of
service of one or more of these persons could have a material adverse effect on
the Company's business and operations. The Company has entered into Employment
Agreements with Robert H. Gurevitch and Dewey Perrigo, the Company's Vice
President of Sales, pursuant to which they each have agreed to render services
to the Company until October 1, 1999. The Company has obtained "key person" life
insurance on Mr. Gurevitch in the amount of $2,000,000, of which the Company is
the sole beneficiary, but there can be no assurance that the proceeds of such
insurance will be sufficient to offset the loss to the Company in the event of
his death. The Company does not maintain any insurance on the lives of its other
senior management. In addition, the Company's success will be dependent upon its
ability to recruit and retain qualified personnel. Any failure by the Company to
retain and attract key personnel could have a material adverse effect on the
Company's business, operating results, and financial condition.
Limited Proprietary Protection. The Company's success and ability to compete
is dependent in part upon its proprietary technology. The Company's proprietary
technology is not protected by any patents, with the exception of the Apollo 95E
which has a patent pending. Consequently, the Company relies primarily on
trademark, trade secret and copyright laws to protect its technology. Also, the
Company has implemented a policy that most senior and technical employees and
third-party developers sign nondisclosure agreements. However, there can be no
assurance that such precautions will provide meaningful protection from
competition or that competitors will not be able to develop similar or superior
technology independently. Also, the Company has no license agreements with the
end users of its products, so it may be possible for unauthorized third parties
to copy the Company's products or to reverse engineer or otherwise obtain and
use information that the Company regards as proprietary. If litigation is
necessary in the future, to enforce the Company's intellectual property rights,
to protect the Company's trade secrets or to determine the validity and scope of
the proprietary rights of others, such litigation could result in substantial
costs and diversion of resources and could have a material adverse effect on the
Company's business, operating results and financial condition. Ultimately, the
Company may be unable, for financial or other reasons, to enforce its rights
under intellectual property laws. In
20
<PAGE> 21
addition, the laws of certain countries in which the Company's products are or
may be distributed may not protect the Company's products and intellectual
property rights to the same extent as the laws of the United States.
The Company believes that its products do not infringe upon any valid existing
proprietary rights of third parties. Although the Company has received no
communication from third parties alleging the infringement of proprietary rights
of such parties, there can be no assurance that third parties will not assert
infringement claims in the future. Any such third party claims, whether or not
meritorious, could result in costly litigation or require the Company to enter
into royalty or licensing agreements. There can be no assurance that the Company
would prevail in any such litigation or that any such licenses would be
available on acceptable terms, if at all. If the Company were found to have
infringed upon the proprietary rights of third parties, it could be required to
pay damages, cease sales of the infringing products and redesign or discontinue
such products, any of which alternatives, individually or collectively could
have a material adverse effect on the Company's business, operating results and
financial condition.
Conflict of Interests. Robert Gurevitch, Chairman of the Company, has loaned
money to the Company ("Loan Obligations") and has guaranteed the performance by
the Company under its leases for its Irvine (Technology Drive) and Westlake,
California premises. The Company believes that all of these transactions were on
terms no less favorable than were available from unaffiliated third parties. The
Company intends to attempt to relieve Mr. Gurevitch from his obligations under
each of these guarantees and it is possible that, in order to achieve the
release of Mr. Gurevitch from these guarantees, the Company will be required to
post collateral or provide other concessions to the recipients of the
guarantees. The Company has, in the past, entered into transactions with
affiliates and there can be no assurance that the Company will not enter into
transactions with affiliated parties in the future.
Limitation of Liability and Indemnification. The Company's Amended and
Restated Certificate of Incorporation limits, to the maximum extent permitted by
the Delaware General Corporation Law ("Delaware Law"), the personal liability of
directors for monetary damages for breach of their fiduciary duties as a
director, and provides that the Company shall indemnify its officers and
directors and may indemnify its employees and other agents to the fullest extent
permitted by law. The Company has entered into indemnification agreements with
its directors and executive officers which may require the Company, among other
things, to indemnify such directors or executive officers against liabilities
that arise by reason of their status or service as directors or officers (other
than liabilities arising from willful misconduct of a culpable nature) and to
advance their expenses incurred as a result of any proceeding against them as to
which they could be indemnified. The Company has purchased director's and
officer's liability insurance in the amount of $5.0 million. Section 145 of the
Delaware Law provides that a corporation may indemnify a director, officer,
employee or agent made, or threatened to be, a party to an action by reason of
the fact that he was a director, officer, employee or agent of the corporation
or was serving at the request of the corporation against expenses actually and
reasonably incurred in connection with such action if he acted in good faith and
in a manner he reasonably believed to be in or not opposed to the best interests
of the corporation, and, with respect to any criminal action or proceeding, if
he had no reasonable cause to believe his conduct was unlawful. Delaware Law
does not permit a corporation to eliminate a director's duty of care, and the
provisions of the Company's Amended and Restated Certificate of Incorporation
have no effect on the availability of equitable remedies, such as injunction or
rescission, for a director's breach of the duty of care.
Anti-Takeover Provisions. The Company has an authorized class of 1,000,000
shares of preferred stock, which may be issued by the Board of Directors on such
terms, and with such rights, preferences and designations as the Board of
Directors may determine. Issuance of such preferred stock, depending upon the
rights, preferences and designations thereof, may have the effect of delaying,
deterring or preventing a change in control of the Company. In addition, certain
"anti-takeover" provisions of the Delaware Law, among other things, restrict the
ability of stockholders to effect a merger or business combination or obtain
control of the Company, and may be considered disadvantageous by a stockholder.
Product Liability. Although the Company has not experienced any product
liability claims to date, the sale and support of products by the Company may
entail the risk of such claims, and there can be no assurance that the Company
will not be subject to such claims in the future. A successful product liability
claim or claim arising as a result of use of the Company's products brought
against the Company, or negative publicity attendant to any such claim, could
have a material adverse effect upon the Company's business, operating results
and financial condition. The Company maintains product liability insurance with
coverage limits of $10,000,000 per occurrence and $11,000,000 per year. While
the Company believes that it maintains adequate insurance coverage, there can be
no assurance that the amount of insurance will be adequate to satisfy claims
made against the Company in the future, or that the Company will be able to
obtain insurance in the future at satisfactory rates or in adequate amounts.
PART II - OTHER INFORMATION
21
<PAGE> 22
Item 1. Legal Proceedings.
None.
Item 2. Changes in Securities and Use of Proceeds.
None.
Item 3. Defaults in Senior Securities.
None.
Item 4. Submission of Matters to a Vote of Security-Holders.
The Annual Meeting of Stockholders for Dental/Medical Diagnostic Systems, Inc.
took place on Tuesday, July 21, 1998.
The Company's three directors, namely, Robert Gurevitch (Chairman of the Board),
Marvin Kleinberg and Jack Preston were re-elected and will continue to act in
their same capacities in the ensuing year. Actual votes cast at the meeting were
as follows: 2,983,187 votes for and 15,850 votes withheld.
The issuance of the sufficient number of shares of the Company's Common Stock,
to permit conversion of one hundred (100%) percent of the $4,500,000 aggregate
principal amount of the Notes, and accrued interest, into shares of the Common
Stock upon default in payment of the Notes was approved by the stockholders at
the Annual Meeting. Actual votes cast at the meeting were as follows: 2,937,869
votes for and 55,168 votes withheld.
Also approved at the Annual Meeting was the increase of the maximum number of
shares of Common Stock that may be issued pursuant to awards granted under the
Company's 1997 Stock Incentive Plan. Actual votes cast at the meeting were as
follows:
2,786,373 votes for and 209,655 votes withheld.
No other matters were voted on by the stockholders at the meeting.
Item 5. Other Information
None.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
3.1 Registrant's Certificate of Incorporation*
3.2 Registrant's Bylaws*
27.1 Financial Data Schedule
--------------------------------
* Incorporated by reference to Registrant's Registration Statement on
Form SB-2 filed on April 7, 1997.
(b) Reports on Form 8-K
Current Report on Form 8-K filed August 20, 1998 reporting under Item 5
that the Company had received 510(K) notification for the Apollo 95E tooth
whitening and composite curing system.
22
<PAGE> 23
Signatures
In accordance with the requirements of the Exchange Act, the Registrant caused
this report to be signed on behalf by the undersigned, thereto duly authorized.
Dental/Medical Diagnostic Systems, Inc.
Dated November 12, 1998 By: /s/ Stephen F. Ross
----------------------------------
Stephen F. Ross
Vice President and Chief Financial
Officer
23
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE INTERIM
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS OF DENTAL/MEDICAL DIAGNOSTIC
SYSTEMS, INC. AS OF AND FOR THE NINE MONTH PERIOD ENDED SEPTEMBER 30, 1998
INCLUDED IN THIS REPORT ON FORM 10-QSB AND IS QUALIFIED IN ITS ENTIRETY BY
REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> SEP-30-1998
<CASH> 3,687,439
<SECURITIES> 0
<RECEIVABLES> 3,753,512
<ALLOWANCES> 20,975
<INVENTORY> 3,994,170
<CURRENT-ASSETS> 12,243,358
<PP&E> 1,148,370
<DEPRECIATION> 389,781
<TOTAL-ASSETS> 13,210,920
<CURRENT-LIABILITIES> 6,146,829
<BONDS> 0
0
0
<COMMON> 51,251
<OTHER-SE> 6,501,100
<TOTAL-LIABILITY-AND-EQUITY> 13,210,920
<SALES> 10,886,402
<TOTAL-REVENUES> 10,886,402
<CGS> 6,363,099
<TOTAL-COSTS> 6,231,462
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 1,183,124
<INCOME-PRETAX> (2,897,915)
<INCOME-TAX> 0
<INCOME-CONTINUING> (2,897,915)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (2,897,915)
<EPS-PRIMARY> (.57)
<EPS-DILUTED> (.57)
</TABLE>
