FORM 10-K
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
----------------------
Annual Report Pursuant
to Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the fiscal year ended
December 31, 1998
Commission file number
0-26694
SPECIALIZED HEALTH PRODUCTS INTERNATIONAL, INC.
(Exact name of registrant as specified in its charter)
Delaware 93-0945003
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation)
585 West 500 South, Bountiful, Utah 84010 (Address of
principal executive offices)
(801) 298-3360
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(g) of the Act:
Title of each class Name of each exchange on which registered
Common Stock, $.02 Par Value None
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. |X| Yes |_| No
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. |X|
The aggregate market value of voting stock held by non-affiliates of
the registrant at April 5, 1999 was $11,308,600. On that date, there were
12,356,440 outstanding shares of the registrant's common stock.
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SPECIALIZED HEALTH PRODUCTS INTERNATIONAL, INC.
TABLE OF CONTENTS TO ANNUAL REPORT
ON FORM 10-K
YEAR ENDED DECEMBER 31, 1998
PART I
Item 1. Business .........................................................3
Item 2. Properties ......................................................15
Item 3. Legal Proceedings ...............................................15
Item 4. Submission of Matters to a Vote of Security Holders .............16
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters .............................................17
Item 6. Selected Financial Data .........................................18
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations .......................................19
Item 8. Financial Statements and Supplementary Data .....................29
Item 9. Changes in and Disagreements on Accounting and Financial
Disclosure ......................................................29
PART III
Item 10. Directors and Executive Officers of the Registrant ..............30
Item 11. Executive Compensation ..........................................32
Item 12. Security Ownership of Certain Beneficial Owners
and Management ..................................................35
Item 13. Certain Relationships and Related Transactions ..................37
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports
on Form 8-K .....................................................38
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PART I
Item 1. Business.
General
The Company is engaged principally in the development of
cost-effective, disposable, proprietary health care products designed to reduce
the incidence of accidental injury in the health care industry, and thus reduce
the spread of disease. The Company has created a portfolio of proprietary health
care products that are in various stages of production, pre-production,
development and research. At present, the Company is focusing its resources and
activities principally on completing development of products under current
licensing and development arrangements, developing new safety medical device
products and identifying marketing partners for the Company's sharps containers
and other new safety medical devices. All of the Company's products are designed
to reduce the risk of acquiring HIV/AIDS, hepatitis B and other blood-borne
diseases through accidental needlesticks.
In May 1997, the Company entered into an agreement (the "License
Agreement") with Becton Dickinson and Company Infusion Therapy Division ("BDIT")
relating to a single application of the Company's ExtreSafe(R) safety needle
technology (the "Technology"). Pursuant to the terms of the License Agreement,
BDIT made payments of $4,000,000 to the Company. Of these total payments,
$3,750,000 was for advanced royalties for sales occurring before the year 2002
and $250,000 was for a product development fee. BDIT is required to pay ongoing
royalties to the Company based on sales of products utilizing the Technology. In
addition, beginning in BDIT's fiscal year 2002, BDIT is required to pay minimum
royalties in order to maintain exclusive rights under the License Agreement.
BDIT has told the Company that BDIT expects to begin selling the product that is
the subject of the License Agreement in the second quarter of 1999. The Company
will not be manufacturing product in connection with the License Agreement.
There is no assurance that the Company will realize revenues under the License
Agreement or that the product will be launched in the second quarter of 1999 as
anticipated.
In December 1997, the Company entered into a Development and License
Agreement (the "JJM Agreement") with Johnson & Johnson Medical, Inc. ("JJM") to
commercialize two applications of the safety needle technology. The JJM
Agreement provides for monthly development payments by JJM, sharing of field
related patent costs, the possibility of payments for initial periods of low
volume manufacturing, an ongoing royalty stream and a JJM investment in molds,
assembly equipment and other capital costs related to commercialization of each
product. The JJM Agreement also provides for an ongoing joint cooperative
program between the Company and JJM which derives future funding directly from
sales of Company created products, the possibility of low volume manufacturing
revenue for the Company and an ongoing royalty stream for additional safety
products which are jointly approved for development. The Company anticipates
that JJM will perform substantially all of the manufacturing under the JJM
Agreement during 1999. The Company and JJM also reached arrangements whereby
they are pursuing development and commercialization of four additional products
under their joint cooperative program. In connection with the JJM Agreement,
Johnson & Johnson Development Corporation purchased $2,000,000 of Company
securities in a private placement that closed in January 1998. In addition, in
1998 the Company recognized $1,028,934 in development fee revenue relating to
the JJM Agreement. The Company anticipates that sales of two products under the
JJM Agreement will begin in 1999. There is no assurance that the Company will
realize revenues under the JJM Agreement or that any of these products will be
launched as anticipated.
The Company has an ongoing program for developing products using its
ExtreSafe(R) medical needle technology and other medical needle technologies.
These technologies allow a contaminated needle to be protected without exposure
of the health care worker to the contaminated needle. Products under development
that incorporate these safety medical needle technologies include phlebotomy
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devices, catheters inserters and several different syringe applications.
Prototypes of the phlebotomy devices, catheters inserters and syringes have been
completed. The Company is developing other medical safety devices.
Company Background
Specialized Health Products, Inc. ("SHP"), a Utah corporation, was
incorporated in November 1993. On July 28, 1995, SHP became a wholly owned
subsidiary of Specialized Health Products International, Inc. ("SHPI" or
"Registrant"), a Delaware corporation, through a merger with a subsidiary of
SHPI (the "Acquisition").
The Registrant was incorporated as a Utah corporation in 1986. The
Company's corporate domicile was changed to the State of Delaware, and its name
was changed to Russco, Inc., effective December 20, 1990, by merger into a then
newly created Delaware corporation. The Company had no operations until the date
of the Acquisition. On that date the Company changed its name to "Specialized
Health Products International, Inc." The persons serving as officers and
directors of SHP immediately prior to the consummation of the Acquisition were
elected to the same offices with SHPI and retained their positions as directors
and officers of SHP. In addition, the outstanding securities of SHP became
outstanding securities of SHPI. Prior to the Acquisition, neither SHP nor any
affiliate of SHP had an interest in Russco, Inc.
Products
Sharps Containers
In January 1994, SHP acquired the Sharp-Trap(R) name and all technology
developed by Sharp-Trap, Inc., a Michigan corporation, relating to a patented
container entry system designed to reduce the risk of accidental needlesticks
and exposure to contaminated needles, blades and instruments when disposing of
such devices. At the time of SHP's purchase of the Sharp-Trap(R) technology,
Sharp-Trap, Inc. was manufacturing sharps container products in two
configurations, a 0.5 quart and a 1.5 quart (the "Sharp-Trap(R)" Containers).
Following additional research and discussions with medical product distributors
and end users, SHP designed an improved line of sharps containers (the Company's
"Safety Cradle(R)" line) which incorporated improvements to the basic container
closure technology to make them safer, higher quality, easier to use and less
costly to manufacture than the Sharp-Trap(R) Containers.
The self-closing Safety Cradle(R) sharps containers allow for the
disposal of sharps in containers that incorporate a self-closing sharps
containment flap and incorporate both a temporary and a permanent locking
mechanism. Especially adapted for alternate site use (alternate sites include
emergency vehicles, in-home and insurance testing), the Company's Safety
Cradle(R) sharps containers provide convenience and safety for home health care
and other portable applications. In addition, each of the Company's sharps
containers is designed to be used as a shipping container for the transport of
medical products. The containers then readily convert at the user's site into
safe and efficient sharps disposal containers. This special design feature
permits the Safety Cradle(R) container to fill a unique market niche. Made of
polypropylene material, the Safety Cradle(R) sharps container's novel, single
injection molded part lid fits three sizes of containers, allowing the Company
to offer products for a broad spectrum of sharps containment applications,
especially alternate site use. Because each Safety Cradle(R) sharps container is
formed from only two molded parts, unit manufacturing costs are low which
enhances the Company's competitive position.
The Safety Cradle(R) can be used for a variety of purposes, including:
Safety Cradle(R) Sharps Container - all three sizes (1.8, 3.4 and 5.3
quart) can be used as Safety Cradle(R) sharps containers for the disposal of
contaminated sharps.
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Transporter - all three sizes are designed to be shipping containers
for new medical devices being sent to customers. Each Safety Cradle(R) sharps
container can then be utilized by the customer for sharps disposal.
Recycler - all three sizes are designed for use by medical product
manufacturers as secured containers, so that discarded sharps may be shipped
back to the manufacturer for recycling or to a sharps disposal facility.
While the Company has entered into several marketing and distribution
arrangements relating to its sharps container products in the past, such
arrangements were not successful and no such arrangements are currently in
effect. The Company is actively seeking to enter into distribution, marketing
and/or licensing arrangements. There can be no assurance that the Company will
be successful in entering into such arrangements, or that if such arrangements
are consummated that they will be on terms that are favorable to the Company.
Safety Lancets
The Company attempted to market and sell its ExtreSafe(R) Lancet Strip.
Because of poor market response, the Company is no longer producing or selling
the ExtreSafe(R) Lancet Strip. Rather, it is developing two single safety lancet
products. Accordingly, certain of the Company's ExtreSafe(R) Lancet Strip
manufacturing assets previously held for sale were written off or reduced to
their estimated realizable value. Those assets that were not written off total
$142,600 and are expected to be used in the Company's future operations.
Products Under Development
Company sponsored research activities resulted in expenses of $909,048
for 1998, compared with $1,191,857 and $1,264,186 for 1997 and 1996,
respectively. Customers sponsored research activities relating to the
development of new products, services or techniques or the improvement of
existing products, services or techniques for which the Company earned revenue
of $1,028,934 in 1998, $250,000 in 1997 and $0 in 1996. The following products
are currently under development.
The Safety Lancets
Lancets are small devices containing needles or blades used to
penetrate the skin, usually a finger, to obtain a few drops of blood for
analysis. Lancets are used by health care workers on patients and by individuals
on themselves, such as by diabetics using insulin. The same safety concerns that
exist with handling needles exist with the handling of lancets, because lancets
become contaminated after coming into contact with blood.
There are a number of lancets on the market today. The most common is a
small "nail" type instrument which is pressed against the finger at which time
the "nail" penetrates the skin by hand pressure. Some lancets penetrate the skin
with a blade, which generally produces better blood flow. The nail type lancet
is often inserted into a spring loaded activation device, about the size of a
large pen. The device is pressed against the patient's finger which is
penetrated when the spring is triggered. After triggering, the activation device
must be emptied and then reloaded with another lancet for use on the next
patient. Activation devices currently marketed by other companies may become
contaminated by blood splattering when the finger is penetrated. To help prevent
contamination, activation devices should be sterilized or disposed of after each
use. However, while intended for use on multiple patients, these activation
devices are not designed or intended to be sterilized, thus increasing the risk
of cross contamination.
The safety lancets are being designed such that they can only be used
one time. A lancet activation device provides for the safe and convenient
triggering of each lancet. After a lancet is used once, the blade automatically
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returns inside its protective housing and the mechanism is disabled so that the
lancet cannot be reused. The used lancet can be appropriately discarded into a
sharps container which provides additional protection. In the opinion of
management, the blade and blade actuation mechanism of the Company's safety
lancets have revolutionary designs. Management also believes that the safety
lancet's design makes it less painful than nail type lancets, although no formal
comparison testing has been conducted. It is also noteworthy that the part of
the lancet in contact with the patient's skin prior to lancing is sterile until
contaminated by the procedure.
Safety Phlebotomy Devices (ExtreSafe(R), FlexLoc(TM) and AutoLoc(TM))
The present method for drawing larger amounts of blood from patients
for blood tests involves insertion of a needle, which is attached to a barrel,
into a blood vessel. Blood is then obtained by way of vacuum pressure, most
often into a small evacuated tube-like container inserted into the barrel. (The
barrel is commonly known as a Vacutainer(R); Vacutainer(R) is not a trademark of
the Company.) After blood is drawn, the needle is manually removed from the
patient. While the health care worker continues attending to the patient, the
Vacutainer(R), barrel and needle are often placed on a tray, bed, table or
otherwise set aside. Afterward, the needle is usually unscrewed from the barrel
and discarded into a sharps container, while the barrel is often used again with
another patient (which increases the risk of cross contamination). Management
believes the Company's ExtreSafe(R) phlebotomy device technologies provide a
safer method. The ExtreSafe(R) devices quickly retract the needle from the
patient directly into a safe housing, minimizing the chance of an inadvertent
stick by a contaminated needle. Retraction is initiated by simply depressing a
designated distortable portion of the housing which has been designed to ensure
that there is no action directed toward or away from the patient which might
affect the depth of needle penetration. Prototypes of the ExtreSafe(R)
phlebotomy device have been completed. The Company's AutoLoc(TM) technology is a
special version of the ExtreSafe(R) technology. In the FlexLoc(TM) technology
the needle is manually sheathed rather than being retracted.
Safety Catheter Inserters
Catheter inserters are devices that insert catheters into veins or
other areas of the body using a catheter insertion needle to allow blood or
other fluids to be removed from or delivered into the patient's body.
Contemporary catheter use has problems similar to those faced in drawing blood.
Inserting a catheter involves a percutaneous (i.e., through the skin)
needlestick followed by threading the catheter over the needle into a patient's
vein or artery. This method can be unsafe in two respects. First, when the
needle is pulled out of the catheter, there is often a discharge of blood which
could contaminate the health care worker. Second, inadvertent needlesticks can
occur when the needle is withdrawn from the catheter because, in most instances,
the needle is temporarily left exposed while the patient is tended to by the
health care worker. Like the ExtreSafe(R) and AutoLoc(TM) safety phlebotomy
device, the Company's catheter inserters quickly retract the contaminated needle
from the patient and enclose it safely in a protective housing. Prototypes of
the catheter inserters have been completed.
Safety Syringes (ExtreSafe(R) and FlexLoc(TM))
Another area where there is significant risk of needlesticks is in
syringe use. Generally, use of a needle for a medical procedure involves
removing a cap over the needle just prior to performing the procedure. In the
past, medical personnel attempted to achieve protection from accidental
needlesticks by replacing the needle cap after performing a procedure, but the
volume of accidental needlesticks related to needle cap replacement resulted in
such practice being prohibited. Medical personnel began using needles and
syringes having sheaths which could be extended over the exposed needle after a
procedure. Also, medical facilities began installing sharps containers in
patients rooms (they had previously been centrally located) and health care
workers began disposing of exposed needles after use in the sharps containers
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found in the patient's room. The ExtreSafe(R) syringe provides an extendible
needle which is retracted into a safe housing in a manner similar to the
retraction of the ExtreSafe(R) phlebotomy devices and catheter inserters
described above. Like phlebotomy, in FlexLoc(TM) devise technology, the needle
is sheathed.
Other Medical Safety Devices
The Company has an ongoing program for developing additional medical
safety devices.
Filmless Digitized Imaging Technology
The procedures for taking a large area x-ray image having generally
acceptable resolution and presenting the x-ray to an attending physician for
interpretation has changed little over the past 40 years. The most common x-ray
image today is taken using film which requires development in a darkroom. The
physician personally handles the x-ray image, which is generally imprinted on a
14" x 17" plastic sheet. For record keeping purposes, hospitals usually retain
x-ray images for at least six years. X-ray storage and retrieval is a costly
problem for many medical facilities. While some filmless x-ray systems have been
introduced recently, none provide the resolution of standard x-rays.
In October 1995, SHP entered into a joint venture with Zerbec, Inc.
("Zerbec"), whereby Quantum Imaging Corporation ("QIC") was organized to
develop, manufacture, distribute and market products and technologies using a
patented, solid state, filmless digitized imaging technology. The filmless
digitized imaging technology involves a method of directly producing an
electrical signal from an image recorded on an x-ray plate. The signal is
instantly digitized and stored on a CD-ROM and the same x-ray plate is then
available for subsequent procedures. The filmless digitized imaging technology
eliminates film as the x-ray image recording medium and enables x-ray images to
be translated to a CD-ROM format to simplify their storage, retrieval and
handling. The Company believes that QIC's filmless digitized imaging technology
can improve the way in which x-ray images are obtained, interpreted and stored,
while also providing clearer images having higher resolutions that are more
easily interpreted than x-ray films. Furthermore, the Company believes that this
technology could be applicable for use in x-ray facilities in mobile medical
emergency units which has not been achieved to date in part because of the
necessity of carrying chemical handling equipment required for film processing.
Pursuant to the terms of the joint venture agreement, Zerbec assigned
patented filmless digitized imaging technology to QIC and will provide ongoing
support for the development and commercialization of the technology. The joint
venture agreement also provides that QIC is to finish the development and
commercialize the filmless digitized imaging technology. A prototype has been
produced to demonstrate image resolution compatible with breast cancer
diagnosis.
In the fourth quarter of 1998, QIC entered into a non-binding letter of
intent for U.S. Healthcare, LC to acquire QIC. While discussions with U.S.
Healthcare are ongoing, the transaction has not been completed and there can be
no assurance that the transaction will be completed or that if completed it will
be on terms that are favorable to the Company. In 1999, Zerbec exercised its
right to acquire two-thirds of SHP's interest in QIC for nominal consideration
under the parties joint venture agreement because certain funding objectives
were not satisfied. As a result of Zerbec exercising its rights, SHP's ownership
was reduced to approximately 17 percent of the outstanding common stock of QIC.
The Company continues to negotiate alternative arrangements with Zerbec.
Company Strategy
The Company's primary objective is to establish itself as a leading
developer of safety medical products. To achieve this objective, the Company's
growth strategy is focused on the following five principal elements.
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o Capturing significant market share of targeted segments of the
sharps container, lancet, phlebotomy device, catheter,
catheter inserter, syringe, and specialty medical needle
markets through marketing, license and/or distribution
arrangements.
o Broadening the Company's existing products lines and
developing new product lines to penetrate related markets.
o Seeking additional market opportunities based on the Company's
existing or new proprietary technologies.
o Entering into marketing, licensing, distribution and
development agreements with large medical product
organizations.
o Arranging for the manufacture of these products by reputable
manufacturers.
Future Market Opportunities
The Company intends to enter additional markets where it believes that
it can gain significant market share based on proprietary technology or by
capitalizing on the sales and distribution channels it establishes. There are a
number of possible future applications for the Company's technology, but there
can be no assurance that the Company will commence development of any such
products or that, if commenced, such development will be successful or
profitable.
Marketing and Sales
The Company employs a limited number of sales and marketing personnel.
The Company is and will seek third parties to market and distribute its products
in the United States and selected foreign countries. The Company may enter into
contracts, licensing agreements or joint ventures with such third parties
whereby the Company would receive a licensing fee or royalty payment based on
the licensee's revenues from licensed products. The Company would likely enter
into such licensing arrangements with several companies based on geographical
regions or product types, but may enter into exclusive arrangements with
individual companies having a major presence in the markets the Company seeks to
penetrate. There can be no assurance that the Company will be able to enter into
contracts, license agreements or joint ventures with third parties in the future
on terms acceptable to the Company or that the License Agreement and JJM
Agreement will be profitable for the Company.
The Company intends to support the marketing of its products by, among
other things, attending trade shows and advertising in industry publications.
The Company intends to distribute samples of its products free of charge to
various health care institutions and professionals in the United States and in
selected foreign countries to introduce and attempt to create a demand for its
products in the marketplace.
Product Agreements
Consistent with this strategy, in May 1997 the Company entered into the
License Agreement with BDIT relating to a single application of the Technology.
Pursuant to the terms of the License Agreement, BDIT made payments of $4,000,000
to the Company. Of these total payments, $3,750,000 was for advanced royalties
for sales occurring before the year 2002 and $250,000 was for a product
development fee. BDIT is required to pay ongoing royalties to the Company based
on sales of products utilizing the Technology. In addition, beginning in BDIT's
fiscal year 2002, BDIT is required to pay minimum royalties in order to maintain
exclusive rights under the License Agreement. BDIT has told the Company that
BDIT expects to begin selling the product that is the subject of the License
Agreement in the second quarter of 1999. The Company will not be manufacturing
product in connection with the License Agreement. There is no assurance that the
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Company will realize revenues under the License Agreement or that the product
will be launched in the second quarter of 1999 as anticipated.
Similarly, in December 1997 the Company entered into the JJM Agreement
with JJM to commercialize two applications of safety needle technology. The JJM
Agreement provides for monthly development payments by JJM, sharing of field
related patent costs, the possibility of payments for initial periods of low
volume manufacturing, an ongoing royalty stream and a JJM investment in molds,
assembly equipment and other capital costs related to commercialization of each
product. The JJM Agreement also provides for an ongoing joint cooperative
program between the Company and JJM which derives future funding directly from
sales of Company created products, the possibility of low volume manufacturing
revenue for the Company and an ongoing royalty stream for additional safety
products which are jointly approved for development. The Company anticipates
that JJM will perform substantially all of the manufacturing under the JJM
Agreement during 1999. The Company and JJM also reached arrangements whereby
they are pursuing development and commercialization of four additional products
under their joint cooperative program. In connection with the JJM Agreement,
Johnson & Johnson Development Corporation purchased $2,000,000 of Company
securities in a private placement that closed in January 1998. In addition, in
1998 the Company recognized $1,028,934 in development fee revenue relating to
the JJM Agreement. The Company anticipates that sales of two products under the
JJM Agreement will begin in 1999. There is no assurance that the Company will
realize revenues under the JJM Agreement or that any of these products will be
launched as anticipated.
The Company currently intends to market and sell its other products in
the United States and selected foreign countries through third parties. The
Company's plan for the sales and distribution of its products is to target major
segments of the respective markets for those products, including major hospital
and institutional buying groups, pharmaceutical companies, distributors and
wholesalers, and government and military agencies. The Company intends to market
and distribute its products through one or more companies that have a major
presence in these major segments. The Company may enter into contracts,
licensing agreements and joint ventures with such third parties whereby the
Company would receive a licensing fee and/or royalty payment based on the
licensee's revenues from licensed products. The Company will determine whether
or not it will manufacture products on a case by case basis depending on its
arrangements with marketing and distribution partners, if any. The Company
currently does not have distribution, marketing and/or licensing arrangements in
place with respect to its Safety Cradle(R) sharps container products, safety
lancets products or other products and there can be no assurance that such
arrangements will be completed or if completed that they will be on terms
favorable to the Company.
License and distribution arrangements, such as those discussed above,
create certain risks for the Company, including (i) reliance for sales of
products on other parties, and therefore reliance on the other parties'
marketing ability, marketing plans and credit-worthiness; (ii) if the Company's
products are marketed under other parties' labels, goodwill associated with use
of the products may inure to the benefit of the other parties rather than the
Company; (iii) the Company may have only limited protection from changes in
manufacturing costs and raw materials costs; and (iv) if the Company is reliant
on other parties for all or substantially all of its sales, the Company may be
limited in its ability to negotiate with such other parties upon any renewals of
their agreements. Further, because such arrangements are generally expected to
provide the Company's marketing partners with certain elements of exclusivity
with respect to the products to be marketed by those partners, the Company's
success will be highly dependent on the results obtained by its partners.
The Company is not permitted to sell products based on its safety
medical needle technologies for commercial use in the United States until
regulatory approval is obtained. The Company must also comply with the laws and
regulations of the various foreign countries in which the Company sells its
products. Certain foreign countries may only require that the Company submit
evidence of the FDA's pre-market clearance of the relevant products prior to
selling those products in such countries. However, some foreign countries may
require additional testing and approval. See "--Government Regulation."
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Industry
Market
Health care is one of the largest industries in the world and continues
to grow. There is increasing demand in the health care market for products that
are safer, more efficient and cost-effective. The Company's products target
segments of this market. While traditional, non-safety products in the market
segments which the Company seeks to address compete primarily on the basis of
price, the Company expects to compete generally on the basis of health care
worker safety, ease of use, reduced cost of disposal, patient comfort and
compliance with OSHA regulations, but not on the basis of purchase price.
However, the Company intends to be competitive on price with other safety
devices. The Company believes that when all indirect costs (disposal of needles,
and testing, treatment and workers compensation expense) related to needlestick
injuries are considered, the Company's products will compete effectively both
with "traditional" products and with the safety products of the Company's
competitors.
There can be no assurance, however, that purchasers will be willing to
pay any costs over and above that of traditional non-safety products. This risk
may by reduced by the fact that there appears to be a national movement toward
the passage of legislation requiring the use of safety needle products. In March
1999, Tennessee joined California in passing legislation requiring the use of
safety needles over conventional needle products to protect health care workers
from hazardous needlesticks. Similar legislation is under consideration in 18
other states and nationally. There is no assurance that additional safety needle
legislation will be implemented.
Accidental Needlesticks
Needles for hypodermic syringes, phlebotomy sets, intravenous catheters
and specialty medical needles are used for injecting drugs and other fluids into
the body and for drawing blood and other fluids from the body. Hypodermic
needles are used for the injection of drugs, phlebotomy sets are used for the
drawing of blood and catheters and specialty needles are used for access to
patient vessels. There is an increasing awareness of the potential danger of
infections and illnesses that result from accidental needlesticks and of the
need for safer needle devices to reduce the number of accidental needlesticks
that occur.
Infections contracted as a result of accidental needlesticks are a
major concern to health care institutions, health care workers, sanitation and
environmental services workers and certain regulatory agencies. Accidental
needlesticks may result in the spread of infectious diseases such as hepatitis
B, HIV (which may lead to AIDS), diphtheria, gonorrhea, typhus, herpes, malaria,
rocky mountain spotted fever, syphilis and tuberculosis. According to
International Health Care worker Safety Center at the University of Virginia,
"the average rate of reported sharp-object injuries is 30 injuries per 100
occupied hospital beds per year. The total annual percutaneous and mucocutaneous
exposures to blood or at-risk biological substances in the U.S., based on 1996
Epinet data, was 786,885." Also, "in the two categories of devices that pose the
greatest risk for transmission of bloodborne pathogens, IV catheters and
blood-drawing needles, only 28% and less than 10% of hospitals have switched to
safety technology, respectively."
The majority of health care workers' adverse exposures to blood are
either product related (e.g., needlesticks) or could be prevented by the use of
appropriate products. The Company believes that pressure is increasing from the
government and private sectors for the health care industry to develop medical
devices that will provide a safer working environment for health care and
related workers and patients. The Company's products attempt to address the
demand for medical devices that reduce the risk of accidental exposure to
blood-borne diseases.
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Patents and Proprietary Rights
The Company's policy is to seek patent protection for all developments,
inventions and improvements that are patentable and which have potential value
to the Company and to protect as trade secrets other confidential and
proprietary information. The Company intends to vigorously defend its
intellectual property rights to the extent its resources permit.
The Company owns seven United States patents and has other patent
applications pending (in the United States and in other countries) which are
directly applicable to the Company's Safety Cradle(R) sharps container products.
The Company also owns two United States patents and allowed patent applications
relating to its safety lancet technology, and nine United States patents and
allowed patent applications relating to its safety medical needle technologies.
The Company has additional United States and international patent applications
pending. The patents referred to above begin to expire on April 1, 2006.
QIC owns four United States patents plus granted claims in one other
applications, and has three Canadian patents, relating to its filmless digitized
imaging technology. These patents expire in May 2001, September 2002 and
September 2005.
The future success of the Company may depend upon the strength of its
intellectual property. The Company believes that the scope of its patents/patent
applications is sufficiently broad to prevent competitors from introducing
devices of similar novelty and design to compete with its current products and
that such patents and patent applications are or will be valid and enforceable.
There is no assurance, however, that if such patents are challenged, this belief
will prove correct. In addition, patent applications filed in foreign countries
and patents granted in such countries are subject to laws, rules and procedures
which differ from those in the United States. Patent protection in such
countries may be different from patent protection provided by U.S. laws and may
not be as favorable to the Company. The Company plans to timely file
international patents in all countries in which the Company is seeking market
share.
The Company is not aware of any patent infringement claims against it.
Litigation to enforce patents issued to the Company, to protect proprietary
information owned by the Company, or to defend the Company against alleged
infringement by the Company of the rights of others may occur. Such litigation
would be costly, could divert resources of the Company from other planned
activities, and could have a material adverse effect on the Company's results of
operations and financial condition.
Manufacturing
The Company has designed, paid for the construction of, and owns
various molds and machinery used to manufacture its Safety Cradle(R) sharps
containers. Certain of the Company's ExtreSafe(R) Lancet Strip manufacturing
assets previously held for sale were written off or reduced to their estimated
realizable value. Those assets that were not written off are expected to be used
in the Company's future operations. The Company's other products are in various
stages of development and are not currently being manufactured. The materials
used to produce the Company's products are generally widely available. The
Company does not anticipate difficulty in obtaining such materials. At present,
there are a number of manufacturers that could produce sharps containers, safety
lancets and safety needle products and a number of suppliers could supply the
necessary parts and materials.
Competition
The health care products market is highly competitive. Many of the
Company's competitors have longer operating histories and are substantially
larger, better financed and better situated in the market than the Company.
The leading suppliers in the sharps container market are Baxter
International, Inc., Becton Dickinson and Company, Kendall Healthcare Products
Company and Sage Products, Inc. There are also numerous smaller suppliers. A
11
<PAGE>
variety of sharps disposal products have been introduced into the marketplace.
Some of these disposal containers accommodate only the needle while others
accommodate the needle, syringe and limited surgical instruments. The majority
of the sharps containers on the market, however, allow contaminated instruments
to fall out when the container is inverted. Many of these other products are
unstable if not supported by wall supports or other apparatus. The Company
believes its products are more stable, safer and more effective than
competitively priced products on the market. In addition, to the best of the
Company's knowledge, there are no sharps disposable transporters or
recycler/transporter type products on the market today.
The leading suppliers in the lancet market are Becton Dickinson and
Company, Surgicutt, Inc., Miles, Inc., Diagnostic Corporation, Boehringer
Mannheim, Inc. and Kendall Healthcare Products Company. There are also numerous
smaller suppliers. To the best of the Company's knowledge, there are no safety
lancets on the market today that operate in a manner similar to the Company's
safety lancets.
The leading suppliers of standard needles are Becton Dickinson and
Company, Kendall Healthcare Products Company, B. Braun and Terumo Medical
Corporation of Japan. The leading developers of safety medical needle devices
include Med-Design Company, Bio-Plexus, Inc., Maxxon, Inc., Retractable
Technologies, Inc. and Univec, Inc. The Company believes that its products are
superior to those presently being marketed by its competitors. Applications for
the Company's safety needle technologies may also be found in phlebotomy
devices, percutaneous catheter insertion devices, syringes, and other medical
needle devices.
While traditional, non-safety products in the market segments which the
Company seeks to address compete primarily on the basis of price, the Company
expects to compete on the basis of health care worker safety, ease of use,
reduced cost of disposal, patient comfort and compliance with OSHA regulations,
but not on the basis of price except with respect to comparable safety products.
However, the Company believes that when all indirect costs (disposal of needles,
testing, treatment and workers' compensation expense) related to accidental
needlestick injuries are considered, the Company's products compete effectively
both with "traditional" products and with the safety products of the Company's
competitors. There can be no assurance, however, that purchasers will be willing
to purchase at prices over and above that of traditional non-safety products
unless mandated by applicable law such as those recently passed in California
and Tennessee.
Research and Development/Acquisition of Technology
The Company has devoted a substantial portion of its efforts to
acquiring, designing and developing health care products. Research and
development costs were $909,048, $1,191,857 and $1,264,186 for 1998, 1997 and
1996, respectively. The Company plans to acquire additional technologies that it
determines support its business strategy. In addition, the Company plans to
continue research and development on its current products and possible new
products. There is no assurance that the Company's research and development
activities will prove effective.
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<PAGE>
Government Regulation
The Company and its products are regulated by the FDA, pursuant to
various statutes, including the FD&C Act, as amended and supplemented by the
Medical Device Amendments of 1976 (the "1976 Amendments") and the Safe Medical
Devices Act of 1990. Pursuant to the 1976 Amendments, the FDA classifies medical
devices intended for use with humans into three classes, Class I, Class II and
Class III. The controls applied to the different classifications are those the
FDA believes are necessary to provide reasonable assurance that a device is safe
and effective. Many Class I devices have been exempted from pre-market
notification requirements by the FDA. These products can be adequately regulated
by the same types of controls the FDA has used on devices since the passage of
the FD&C Act in 1938. These "general controls" include provisions related to
labeling, producer registration, defect notification, records and reports and
good manufacturing practices. The good manufacturing practice regulation has
been recently replaced by a more comprehensive Quality System Regulation
("QSR"). QSRs include implementation of quality assurance programs, written
manufacturing specifications and processing procedures, written distribution
procedures and record keeping requirements. Class II devices are products for
which the general controls of Class I devices are deemed not sufficient to
assure the safety and effectiveness of the device and thus require special
controls. Special controls for Class II devices include performance standards,
post-market surveillance, patient registries and the use of FDA guidelines.
Standards may include both design and performance requirements. Class III
devices have the most restrictive controls and require pre-market approval by
the FDA. Generally, Class III devices are limited to life-sustaining,
life-supporting or implantable devices. The FDA has further established three
tiers or levels of scientific review - Tier 1, Tier 2, and Tier 3 within each
class. Submissions for Tier 1 devices receive limited review while submissions
for Tier 2 and 3 devices receive more comprehensive reviews.
Section 510(k) of the FD&C Act requires individuals or companies
manufacturing medical devices intended for use with humans to file a notice with
the FDA at least 90 days before introducing a product not exempted from
notification requirements into the marketplace. The notice (a "510(k)
Notification") must state the class in which the device is classified and the
actions taken to comply with performance standards or pre-market approval which
may be needed if the device is a Class II or Class III device, respectively. If
a company states the device is unclassified, it must explain the basis for that
determination.
In some cases obtaining pre-market approval can take several years.
Product clearance pursuant to a 510(k) Notification can be obtained in much less
time. In general, clearance of a 510(k) Notification for a Class II device may
be obtained if the Company can establish that the new device is "substantially
equivalent" to another device of that Class already on the market. This requires
the new device to have the same intended use as a legally marketed predicate
device and have the same technological characteristics as the predicate device.
If the technological characteristics are different, the new device can still be
found to be "substantially equivalent" if information submitted by the applicant
(including clinical data if requested) supports a finding that the new device is
as safe and effective as a legally marketed device and does not raise questions
of safety or efficacy that are different from the predicate device.
The Company has received a 510(k) Notification from the FDA that its
Sharp-Trap(R) sharps containers are substantially equivalent to legally marketed
predicate devices. The Company's Safety Cradle(R) sharps containers are subject
to the general controls of the FD&C Act and the additional controls applicable
to Class II devices. The Company has received a clearance on a second 510(k)
Notification for its sharps containers which includes all areas of use for the
Safety Cradle(R) sharps container. The Company has received FDA clearance on a
510(k) notification on a phlebotomy device.
OSHA also requires, in part, that sharps containers be closable,
disposable, puncture-resistant, leak proof on the sides and bottom and
appropriately labeled. The Company's Safety Cradle(R) sharps containers are in
compliance with present OSHA regulations. Future regulations, however, may be
imposed which could have a material adverse effect on the Company.
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<PAGE>
The Company's follow-on products (i.e., other products based on its
safety medical needle technologies, intravenous flow gauge and blood collection
device) are still in the development stage. In March 1995, the FDA issued a
draft guidance document on 510(k) Notifications for medical devices with sharps
injury prevention features, a category that would cover most of the Company's
safety medical products. The draft guidance provisionally placed this category
of products into Class II Tier 3 for purposes of 510(k) review, meaning that
such products will be subject to the FDA's most comprehensive and rigorous
review for 510(k) products. The draft guidance also states that in most cases,
FDA will accept, in support of a 510(k) Notification, data from tests involving
simulated use of such a product by health care professionals, although in some
cases the agency might require actual clinical data.
The Company expects its other follow-on products (i.e., intravenous
flow gauge and blood collection device) to be categorized as Class II devices.
The Company also expects that these follow-on products will not require
pre-market approval applications but will be eligible for marketing clearance
through the 510(k) Notification procedure based upon their substantial
equivalence to previously marketed devices.
Although the 510(k) Notification clearance process is ordinarily
simpler and faster than the pre-market approval application process, there can
be no assurance that the Company will obtain 510(k) Notification clearance to
market its products, that the Company's products will be classified as set forth
above, or that, in order to obtain 510(k) Notification clearance, the Company
will not be required to submit additional data or meet additional FDA
requirements which could substantially delay sales and add to the Company's
expenses. Moreover, any 510(k) Notification clearance, if obtained, may be
subject to conditions on the marketing or manufacturing of the related products
which could impede the Company's ability to market or manufacture such products.
In addition to the requirements described above, the FD&C Act requires
that all medical device manufacturers and distributors register with the FDA
annually and provide the FDA with a list of those medical devices which they
distribute commercially. The FD&C Act also requires that all manufacturers of
medical devices comply with labeling requirements and manufacture devices in
accordance with QSRs. QSRs require that companies manufacture their products and
maintain their documents in a prescribed manner with respect to manufacturing,
testing, and quality control. The FDA's Medical Device Reporting regulation
requires that companies provide information to the FDA on death or serious
injuries alleged to have been associated with the use of their products, as well
as product malfunctions that would likely cause or contribute to death or
serious injury if the malfunction were to recur. The FDA further requires that
certain medical devices not cleared with the FDA for marketing in the United
States meet specific requirements before they are exported. The Company is
registered as a manufacturer with the FDA. To date, no incidents have occurred
with Company products that have necessitated submission of a Medical Device
Report to the FDA.
The FDA inspects medical device manufacturers and distributors, and has
broad authority to order recalls of medical devices, to seize noncomplying
medical devices, to enjoin and/or impose civil penalties on manufacturers and
distributors marketing non-complying medical devices, and to criminally
prosecute violators. Noncompliance with FDA regulations could have a material
adverse effect on the Company.
In addition to the laws and regulations enforced by the FDA and OSHA,
the Company is subject to government regulations applicable to all businesses,
including, among others, regulations related to occupational health and safety,
workers' benefits and environmental protection. Moreover, in March 1999
Tennessee joined California in passing legislation requiring the use of safety
needles over conventional needle products. Similar legislation is under
consideration in 18 other states and nationally.
Distribution and sales of the Company's products in countries other
than the United States is subject to regulations in those countries. There can
be no assurance that the Company will be able to obtain the approvals necessary
to market its products outside the United States.
14
<PAGE>
Seasonality of Business
Sales of the Company's products are not anticipated to be subject to
seasonal variations.
Backlog
There is no material backlog of unfilled orders of the Company's
products.
Employees
As of April 5, 1999, the Company employed 21 people, including ten
research and development employees, two sales and marketing employees, seven
accounting and administrative employees and two quality assurance employees. The
Company expects to add additional employees, principally in the areas of
marketing and research and development. The planned increase in personnel is
based primarily on expected increases in product development, production and
sales. The Company's employees are not represented by any labor union, and the
Company believes its relations with its employees are good.
Item 2. Properties.
The Company's principal offices are located at 585 West 500 South,
Bountiful, Utah, under terms of a lease with an unaffiliated lessor which
expires on June 30, 2003, subject to the Company's right to extend the lease
term for an additional three-year term. The offices comprise 17,273 square feet
of space. The Company believes that its current office space will be adequate to
meet the needs of current and expected growth for the foreseeable future. The
Company may, however, require additional manufacturing facilities in the future
depending upon the volume of products sold and the manufacturing arrangements to
which the Company is a party.
The Company owns production molds for the Safety Cradle(R) sharps
containers and certain automated assembly equipment. At present the molds and
automated assembly equipment are not being utilized. The Company anticipates,
however, that it will utilize the molds and equipment in the future.
Item 3. Legal Proceedings.
In April 1997, the Company entered into an agreement with Leerink Swann
& Company ("Leerink"), whereby Leerink agreed to assist the Company in raising
funds in a private placement of equity securities. Sufficient funding was
deposited into escrow to hold an initial closing, but the closing did not occur.
Leerink alleges that the Company refused to close on the placement. The Company
alleges that the closing did not occur because Leerink, as a condition precedent
to closing, made certain pre-closing demands that management believes went far
beyond the terms of the agreement and which demands Company management believes
were not in the best interests of the Company or its stockholders. In August
1997, Leerink filed suit in the United States District Court for the District of
Massachusetts alleging breach of contract, misrepresentation and violation of
M.G.L. c.93A, ss.11. Leerink is seeking compensatory damages exceeding $230,000,
113,251 warrants to purchase 113,251 shares of the Company's Common Stock,
treble damages and reasonable attorneys' fees and costs.
In October 1997, the Company filed a counterclaim alleging breach of
contract and violation of M.G.L. c.93A, ss.11. The Company is seeking in excess
of $60,000 in money damages, treble damages, reasonable attorneys' fees and
costs. The case is scheduled to go to trial in July 1999.
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<PAGE>
Item 4. Submission of Matters to a Vote of Security Holders.
The Company held its annual meeting of stockholders on October 23,
1998, at which meeting certain members of the Company's Board of Directors (the
"Board") were elected. The Company's Board is divided into three classes. One
class of directors is elected at each annual meeting of stockholders for a
three-year term. Each year a different class of directors is elected on a
rotating basis. The term of David A. Robinson expired in 1998, the terms of
David T. Rovee and Robert R. Walker expire in 1999, the terms of David G. Hurley
and Gale H. Thorne expire in 2000 and the term of Melinda S. Mitchell expires in
2001.
David A. Robinson, who is currently a director of the Company, was
nominated by the Board for election to the class whose term expires at the 2001
annual meeting of stockholders. The stockholders then elected David A. Robinson
by a vote of 7,629,598 for and 12,500 withheld authority.
The stockholders also considered a proposal to adopt the Specialized
Health Products International, Inc. 1998 Stock Option Plan. The stockholders
approved the plan by a vote of 7,316,347 in favor, 288,251 against and 37,500
abstained from voting.
[REMAINDER OF PAGE INTENTIONALLY LEFT BLANK]
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<PAGE>
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.
Dividend Policy
To date, the Company has not paid dividends on its common stock. The
payment of dividends, if any, in the future is within the discretion of the
Board and will depend upon the Company's earnings, its capital requirements and
financial condition, and other relevant factors. See "Management's Discussion
and Analysis of Financial Condition and Operating Results." The Board does not
intend to declare any dividends in the foreseeable future, but instead intends
to retain all earnings, if any, for use in the Company's operations.
Share Price History
The Company's common stock (the "Common Stock") has been quoted on the
Nasdaq Small-Cap Market since October 1995 under the trading symbol "SHPI." The
following table sets forth the high and low bid information of the Common Stock
for the periods indicated. Note that such over-the-counter market quotations
reflect inter-dealer prices, without retail mark-up, mark-down or commission and
the quotations may not necessarily represent actual transactions in the Common
Stock.
Quarter Ended High Low
1997
March 31.............................. $3.56 $2.75
June 30............................... $3.37 $2.00
September 30.......................... $2.31 $2.00
December 31........................... $2.19 $1.00
1998
March 31.............................. $3.50 $1.63
June 30............................... $2.38 $1.44
September 30.......................... $2.25 $1.19
December 31........................... $1.56 $0.94
Holders of Record
At April 5, 1999, there were 317 holders of record of the Company's
Common Stock. The number of holders of record was calculated by reference to the
Company's stock transfer agent's books.
Issuance of Securities
In 1998, the Company granted to two members of the Company's Board
stock options to acquire 20,000 shares of the Company's common stock. These
stock options were granted in equal quarterly installments at exercise prices of
$1.75, $1.63, $1.25 and $1.25 per share, respectively. In 1998, the Company
granted two employees stock options to acquire a total of 15,000 shares of the
Company's common stock at exercise prices ranging from $1.81 to $2.06 per share.
The exercise prices of the above options were equal to the quoted market prices
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<PAGE>
of the underlying common stock on the date of grant. The options expire five
years from the date of grant. The options were issued pursuant to Section 4(2)
of the Securities Act.
Item 6. Selected Financial Data.
The following data have been derived from the Company's consolidated
financial statements. The information set forth below is not necessarily
indicative of the results of future operations and should be read in conjunction
with the consolidated financial statements and related notes appearing elsewhere
in this Form 10-K: <TABLE> <CAPTION>
Period Ended
---------------------------------------------------------------------------------------
Nov. 19,
Dec. 31, Dec. 31, Dec. 31, Dec. 31, Dec. 31, 1993
1998 1997 1996 1995 1994 (inception)
to Dec. 31,
1998
------------ ------------ ------------ ------------ ------------ -------------
Statement of Operations Data:
<S> <C> <C> <C> <C> <C> <C>
Net product sales and
development fees $ 1,039,136 $ 432,363 $ 74,563 $ 447,844 $ 33,256 $ 2,027,162
Cost of product sales and
development fees 831,194 141,857 70,257 294,171 21,669 1,359,148
------------ ------------ ------------ ------------ ------------ -------------
Gross margin 207,942 290,506 4,306 153,673 11,587 668,014
------------ ------------ ------------ ------------ ------------ -------------
Operating expenses:
Selling, general and
administrative 2,946,722 3,311,222 2,901,434 2,133,021 620,022 11,915,871
Research and development 909,048 1,191,857 1,264,186 804,639 290,950 4,460,680
Write-off of operating assets 754,803 92,557 72,363 255,072 -- 1,174,795
------------ ------------ ------------ ------------ ------------ -------------
Total operating expenses
4,610,573 4,595,636 4,237,983 3,192,732 910,972 17,551,346
------------ ------------ ------------ ------------ ------------ -------------
Operating loss (4,402,631) (4,305,130) (4,233,677) (3,039,059) (899,385) (16,883,332)
Net other income (expense) 205,064 31,127 140,289 119,570 (7,563) 488,487
------------ ------------ ------------ ------------ ------------ -------------
Net loss (4,197,567) (4,274,003) (4,093,388) (2,919,489) (906,948) (16,394,845)
Dividends on preference stock -- -- -- (11,389) (16,780) (28,169)
------------ ----------- ------------ ------------ ------------ -------------
Net loss attributable to common
stockholders $ (4,197,567) $ (4,274,003) $ (4,093,388) $ (2,930,878) $ (923,728) $ (16,423,014)
============ ============ ============ ============ ============ =============
Basic and diluted net loss per
common share(1) $ (.35) $ (.47) $ (.48) $ (.69) $ (.75)
============ ============ ============ ============ ============
Weighted average common shares
outstanding (1) 12,153,264 9,170,541 8,589,952 4,269,131 1,224,074
============ ============ ============ ============ ============
</TABLE>
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<PAGE>
<TABLE>
<CAPTION>
Period Ended
---------------------------------------------------------------------------------------
Nov. 19,
Dec. 31, Dec. 31, Dec. 31, Dec. 31, Dec. 31, 1993
1998 1997 1996 1995 1994 (inception)
to Dec. 31,
1998
------------ ------------ ------------ ------------ ------------ -------------
Balance Sheet Data (at year end):
<S> <C> <C> <C> <C> <C> <C>
Working capital (deficit) $ 2,877,205 $ 609,962 $ 30,754 $ 4,194,568 $ (287,723)
Total assets 4,381,075 3,285,413 1,848,839 5,950,728 656,865
Long-term debt, less current
maturities -- -- -- -- 458,333
Total stockholders' equity
(deficit) 326,540 540,248 1,513,217 5,369,805 (355,878)
</TABLE>
(1) Net loss per common share is based on the weighted average number of common
shares outstanding. Stock options and warrants, and preferred shares prior
to conversion, are not included in the calculation because this inclusion
would be anti-dilutive, thereby reducing the net loss per common share.
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
The following discussion and analysis provides information which
management believes is relevant to an assessment and understanding of the
Company's consolidated results of operations and financial condition. The
discussion should be read in conjunction with the consolidated financial
statements and notes thereto. Wherever in this discussion the term "Company" is
used, it should be understood to refer to SHPI and its wholly owned
subsidiaries, SHP, Specialized Cooperative Corporation and Iontophoretics
Corporation, on a consolidated basis, except where the context clearly indicates
otherwise.
Overview
From its inception, the Company has incurred losses from operations. As
of December 31, 1998, the Company had cumulative net losses applicable to the
common shares totaling $16,423,014. To date, the Company's principal focus has
been the design, development, testing, and evaluation of its Safety Cradle(R)
sharps containers, safety lancets, safety needle technologies, intravenous flow
gauge, blood collection devices, and other safety medical products, and the
design and development of various molds and production processes.
Financial Position
The Company had $2,480,083 in cash and cash equivalents as of December
31, 1998. This represented an increase of $1,038,527 from December 31, 1997.
Working capital as of December 31, 1998, increased to $2,877,205 as compared to
$609,962 at December 31, 1997. These increases were largely due to the
completion of a private placement of securities by the Company that closed in
January 1998, receipt of advanced royalty revenue from BDIT and product
development payments from JJM.
Years Ended December 31, 1998, 1997 and 1996
During the year ended December 31, 1998, the Company had total
operating revenues of $1,039,136, compared with total operating revenues of
$432,363 and $74,563 for the years ended December 31, 1997 and 1996,
respectively. During 1998, $10,202 of the Company's revenues were from product
sales and the remaining revenues were development fee revenues from JJM under
the JJM Agreement. During 1997, BDIT paid the Company $250,000 in development
fees for services provided in 1997 and the Company had $182,363 in product
sales. During 1996, all of the Company's revenues were comprised of product
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<PAGE>
sales. Substantially all of the sales during these periods related to the
Company's sharps containers. As discussed below, the Company will look to
several other products and devices for future sales revenues.
The JJM Agreement provides that the Company and JJM will seek to
commercialize two products using safety medical needle technology. The JJM
Agreement provides for monthly development payments by JJM, sharing of field
related patent costs, the possibility of payments for initial periods of low
volume manufacturing, an ongoing royalty stream and a JJM investment in molds,
assembly equipment and other capital costs related to commercialization of each
product. The JJM Agreement also provides for an ongoing joint cooperative
program between the Company and JJM which derives future funding directly from
sales of Company created products, the possibility of low volume manufacturing
revenue for the Company and an ongoing royalty stream for additional safety
products which are jointly approved for development. The Company anticipates
that JJM will perform substantially all of the manufacturing under the JJM
Agreement during 1999. The Company and JJM also reached arrangements whereby
they are pursuing development and commercialization of four additional products
under their joint cooperative program. In connection with the JJM Agreement,
Johnson & Johnson Development Corporation purchased $2,000,000 of Company
securities in a private placement that closed in January 1998. In addition, in
1998 the Company recognized $1,028,934 in development fee revenue relating to
the JJM Agreement. The Company anticipates that sales of two products under the
JJM Agreement will begin in 1999. The Company had previously believed sales of
product under the JJM Agreement would begin in early 1999. The reason for the
delay primarily related to design changes to meet anticipated market
requirements. There is no assurance that the Company will realize revenues under
the JJM Agreement or that any of these products will be launched as anticipated.
The BDIT License Agreement relates to a single application of the
Company's ExtreSafe(R) safety needle technology (the "Technology"). Pursuant to
the terms of the License Agreement, BDIT made payments of $4,000,000 to the
Company. Of these total payments, $3,750,000 was for advanced royalties for
sales occurring before the year 2002 and $250,000 was for a product development
fee. BDIT is required to pay ongoing royalties to the Company based on sales of
products utilizing the Technology. The Company will not be manufacturing product
in connection with the License Agreement. In addition, beginning in BDIT's
fiscal year 2002, BDIT is required to pay minimum royalties in order to maintain
exclusive rights under the License Agreement. BDIT has told the Company that
BDIT expects to begin selling the product that is the subject of the License
Agreement in the second quarter of 1999. There is no assurance that the Company
will realize revenues under the License Agreement or that the product will be
launched in the second quarter of 1999 as anticipated.
In August 1996, the Company entered into a distribution agreement (the
"BDSDS Distribution Agreement") with Becton Dickinson and Company Sharps
Disposal Systems ("BDSDS") whereby BDSDS was attempting to market and distribute
the Company's Safety Cradle(R) sharps containers. BDSDS began selling the Safety
Cradle(R) sharps containers under the BDSDS Distribution Agreement in the first
quarter of 1997. During 1997, however, BDSDS did not order the minimum required
amount of product under the terms of the BDSDS Distribution Agreement and,
therefore, BDSDS' exclusive distribution rights became nonexclusive. In
addition, on May 26, 1998 the BDSDS Distribution Agreement was terminated and
the Company has since been pursuing various alternatives with respect to the use
and distribution of the Company's Safety Cradle(R) sharps containers.
The Company had previously entered into a distribution agreement with
New Alliance Of Independent Medical Distributors, Inc. (the "New Alliance"),
effective September 1997. The agreement provided for the Company to manufacture
and the New Alliance to market and sell the ExtreSafe(R) Lancet Strip on an
exclusive basis in various markets. Effective March 1, 1998, the agreement was
converted to a nonexclusive agreement with no sales minimums so that the Company
could pursue additional sources of distribution. Thereafter, the Company elected
to abandon the further manufacture and distribution of the ExtreSafe(R) Lancet
Strip. Sales of the ExtreSafe(R) Lancet Strip through December 31, 1998 were
minimal.
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During 1998, the Company's product sales were substantially less than
product sales during 1997 and 1996. The reason for the reduction in sales
primarily related to a reduction in the sale of sharps containers. The Company
does not anticipate that sales of its sharps container product will increase
until it enters into a distribution and/or marketing arrangement. There is no
assurance that such an arrangement will be finalized or that if finalized it
will be on terms favorable to the Company. The Company also anticipates future
revenues under the License Agreement and JJM Agreement. Moreover, the Company
expects that a substantial majority of its future revenues will be derived from
the development and sale of safety needle products.
License and distribution arrangements, such as those discussed above,
create certain risks for the Company, including (i) reliance for sales of
products on other parties, and therefore reliance on the other parties'
marketing ability, marketing plans and credit-worthiness; (ii) if the Company's
products are marketed under other parties' labels, goodwill associated with use
of the products may inure to the benefit of the other parties rather than the
Company; (iii) the Company may have only limited protection from changes in
manufacturing costs and raw materials costs; and (iv) if the Company is reliant
on other parties for all or substantially all of its sales, the Company may be
limited in its ability to negotiate with such other parties upon any renewals of
their agreements. Further, because such arrangements are generally expected to
provide the Company's marketing partners with certain elements of exclusivity
with respect to the products to be marketed by those partners, the Company's
success will be highly dependent on the results obtained by its partners.
Research and development ("R&D") expenses were $909,048 for the year
ended December 31, 1998, compared with $1,191,857 and $1,264,186 for the years
ended December 31, 1997 and 1996, respectively. The Company's efforts during
1998 focused on development of several additional products utilizing the
ExtreSafe(R) and FlexLoc(TM) safety needle technology, the safety single lancet
technology and continued development work on a filmless digitized imaging
technology (which was performed by QIC, but was funded by the Company). The 1998
R&D effort was expanded beyond development of ExtreSafe(R) products to manually
actuated safety sheathing devices. The Company's R&D efforts in 1997 focused on
completing final development of the ExtreSafe(R) Lancet Strip, development
relating to several products utilizing safety medical needle technologies and
development work on the filmless digitized imaging technology. The Company's
efforts in 1996 focused on making certain improvements to the Safety Cradle(R)
sharps container products, development of the ExtreSafe(R) Lancet Strip,
ExtreSafe(R) medical needle technology, intravenous flow gauge and blood
collection device.
Research and development expenses during 1996 through 1998 were limited
because of funding constraints. Funding constraints also set back the
anticipated dates on which the Company's products under development will be
brought to market. It is anticipated that if the Company has adequate funding
during 1999, research and development expenses will increase over 1998 levels.
Reductions in R&D expenditures are not anticipated unless funding constraints
require the Company to make such reductions. Reductions in R&D expenditures
would comprise primarily reductions in R&D staff. Such staff reductions could
have a material adverse effect on product development and on the Company.
Management does not intend to downsize.
Selling, general and administrative expenses were $2,946,722 for the
year ended December 31, 1998, compared to $3,311,222 and $2,901,434 for the
years ended December 31, 1997 and 1996, respectively. The decrease in
expenditures resulted mainly from reductions in professional and consulting
fees.
The Company wrote-off $754,803 in operating assets during 1998. These
assets were comprised primarily of molds, production equipment and other assets
relating to the ExtreSafe(R) Lancet Strip. These assets were written-off in
connection with the Company's decision to abandon the further manufacture and
distribution of the ExtreSafe(R) Lancet Strip.
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Net other income was $205,064 for the year ended December 31, 1998,
compared with net other income of $31,127 and $140,289 for the years ended
December 31, 1997 and 1996, respectively. The increase in net other income is
attributable to interest earned on higher levels of funds on deposit and
short-term interest bearing investments. As funds on deposit and interest
bearing short-term investments have increased, so has the interest income.
Liquidity and Capital Resources
To date, the Company has financed its operations principally through
private placements of equity securities, advanced royalties, development fees
and proceeds from the exercise of common stock options. The Company generated
$16,125,885 and $3,813,159 in net proceeds through financing activities from
inception through December 31, 1998 and in 1998, respectively. The Company used
net cash for operating activities of $2,069,322 during the year ended December
31, 1998. As of December 31, 1998, the Company's liabilities totaled $4,054,535,
which included $3,750,000 in deferred royalty revenues relating to the License
Agreement. The Company had working capital as of December 31, 1998 of
$2,877,205. The Company anticipates setting its subscriptions receivable through
collection or otherwise in the immediate future.
The Company's working capital and other capital requirements for the
foreseeable future will vary based upon a number of factors, including the costs
to complete development and bring the safety medical needle technologies,
intravenous flow gauge, blood collection devices and other products to
commercial viability, and the level of sales of and marketing for the Safety
Cradle(R) sharps containers, safety lancets and other products. At December 31,
1998, the Company had not committed to spend any funds on capital expenditures.
The Company believes that existing funds, development fees from JJM under the
JJM Agreement, license revenues and funds generated from sales of products and
non-core technologies, will be sufficient to support the Company's operations
and planned capital expenditures through at least 1999. See "--Years Ended
December 31, 1998, 1997 and 1996." The Company may, however, raise additional
funds through a subsequent public or private offering if, in the opinion of
management, the Company is in need of additional funding. There is no assurance
that any such offering will be completed or that, if completed, the terms of
such offering will be favorable to the Company.
At April 5, 1999, the Company had 3,609,787 Series D Warrants and
800,000 other warrants (the "SHPI Warrants") outstanding which are exercisable
for the same number of shares of Common Stock of the Company at $2.00 per share.
In the event that the closing price of the Common Stock for any ten consecutive
trading days exceeds $6.00 per share, and subject to the availability of a
current prospectus covering the underlying stock, the Company may redeem the
Warrants. The Series D Warrants expire on the earlier of (a) two years from the
date of effectiveness of a registration statement under the Act covering the
sale of the shares of Common Stock underlying such warrants, which period shall
be extended day-for-day for any time that a prospectus meeting the requirements
of the Act is not available, or (b) the redemption date if such warrants are
redeemed (subject to the right of the holder to exercise the warrants within 20
days of notice of such redemption). The SHPI Warrants expire on December 31,
2002. The exercise of all the Warrants would result in an equity infusion to the
Company of $8,819,574. The Company presently intends to redeem the warrants when
and if the necessary conditions are met, but there can be no assurance that such
conditions will be satisfied. A registration statement covering the resale of
the shares of Common Stock underlying the Series D Warrants and SHPI Warrants
was declared effective on May 8, 1998. As of the date hereof, all of the
warrants are out of the money and there can be no assurance that any warrants
will ever be exercised.
The Company has granted stock options that are currently exercisable
for 1,307,905 shares of Common Stock at exercise prices of between $.39 and
$2.625 per share. The exercise of all of such stock options would result in an
equity infusion to the Company of $2,698,452. Most of the stock options are out
of the money and there can be no assurance that any of the stock options will be
exercised.
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In June 1998, the Company entered into an Option to Purchase Agreement
(the "Option Agreement") with the University of Texas System to purchase certain
patents and related technology, research and development for a total purchase
price of $2,400,000. In accordance with the Option Agreement, a $240,000
non-refundable payment was made in July 1998 with the balance of $2,160,000 to
be paid within 30 days of the exercise of the purchase option. The Company
retained the exclusive right to exercise the option and acquire the patents and
related technology for a period of one year from the date of the execution of
the Option Agreement, or within 14 days of notification of successful completion
of animal toxicity studies. The Company received notice of successful completion
of the toxicity studies in February 1999 and subsequently entered into tow
amendments to the Option Agreement resulting in an extension of the exercise
period to May 1999 in exchange for payments totaling $65,000. The Company
anticipates reimbursement of a portion of these fees from a third party who is
potentially interested in acquiring the technology from the Company upon
exercise of the option.
In connection with this Option Agreement, the Company entered into
consulting agreements with three individuals who were the principal inventors of
the technology. These consulting agreements provide for the individuals to
assist the Company to successfully develop the related technology. The
individuals are to provide a minimum of 50 hours of services annually for which
they will be compensated at a rate of $150 per hour. Each individual also
executed stock option agreements with the subsidiary corporation, Ion to
Phorectics Corporation ("IPC"), which is the entity entering into the Option
Agreement and the individual consulting agreements. The stock option agreements
provide for the individuals to purchase up to 40,000 shares of IPC common stock
at an exercise price of $.01 per share in 10,000 share increments based on
achieving certain milestone events in the future. The Company has recorded
$7,200 of consulting expense in the 1998 consolidated financial statements
related to the granting of these options.
Nasdaq Small-Cap Market Quotation
The Company's common stock is currently traded on the Nasdaq Small-Cap
Market System. In order to continue to qualify its stock for quotation on the
Nasdaq Small-Cap Market, the Company must have, among other things, $2 million
in net tangible assets, a market capitalization of $35 million or annual net
income of $500,000. The Company is also required to have a minimum bid price of
at least $1.
As of December 31, 1998, the Company had net tangible assets of
$313,860 and the Company's bid price has recently been below the $1 minimum. As
a result, the Company does not meet the Nasdaq Small-Cap Market listing
requirements. A hearing was held with Nasdaq on April 1, 1999 to consider
delisting and/or suspension of the Company's Common Stock from the Nasdaq
Small-Cap Market. The panel has not made a decision regarding this matter. The
Company expects that delisting or suspension will occur unless the Company can
bring itself into compliance with the requirements and demonstrate an ability to
maintain compliance with those requirements. The Company is attempting to bring
itself into compliance with all applicable Nasdaq Small-Cap Market listing
requirements. There can be no assurance that the Company will be in compliance
and be able to demonstrate the ability to maintain compliance in the immediate
future or otherwise. In the event of delisting or suspension, trading, if any,
in the Company's securities would be expected to be conducted in the
over-the-counter market in what is commonly referred to as the "Electronic
Bulletin Board." As a result, an investor may find it more difficult to dispose
of, or to obtain accurate quotations as to the price of the Company's
securities. The loss of continued price quotations as provided by the Nasdaq
System could also cause a decline in the price of the Common Stock, a loss of
news coverage of the Company and difficulty in obtaining subsequent financing.
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Inflation
The Company does not expect the impact of inflation on operations to be
significant.
Year 2000
The Company uses computer networks, personal based development and
measurement equipment, and personal microprocessors that have the potential for
operational problems if they lack the ability to handle the transition to the
Year 2000. The Company has been aggressively proactive in pursuing solutions for
the Year 2000 problem. The Company has acquired new accounting software that the
vendor has represented is Year 2000 compliant and has initiated communications
with its suppliers, dealers, distributors and other third parties in order to
assess and reduce the risk that the Company's operations could be adversely
affected by the failure of these third parties to adequately address the Year
2000 issue.
The Company's principal computer systems (including the embedded
microprocessor systems) have been purchased since December 31, 1996 and the
vendors supplying such systems have generally represented that such systems are
Year 2000 compliant. The software utilized by the Company is generally standard
"off the shelf" software, typically available from a number of vendors. The
Company is verifying with its software vendors that the services and products
provided are, or will be, Year 2000 compliant. Subject to such verification, the
Company believes that its computer systems and software is Year 2000 compliant
in all material respects. The Company estimates that the cost to redevelop,
replace or repair its technology that is not Year 2000 compliant will not be
material. The Company is not using any independent verification or validation
procedures. There can be no assurance, however, that its systems programs are or
will be Year 2000 compliant and that the failure of those systems would not have
a material adverse impact on the Company's business and operations.
In connection with its business activities, the Company interacts with
suppliers, customers, and financial service organizations who use computer
systems. The Company is verifying with those parties their state of Year 2000
readiness. Based on its assessment activity to date, the Company believes that a
majority of the suppliers, customers and financial service organizations with
whom it interacts are making acceptable progress toward Year 2000 readiness. The
Company currently believes that the most reasonable likely worst case scenario
is that there will be some localized disruptions of supplier, customer and/or
financial services that will affect the Company and its suppliers, and
distribution channels for a short time rather than systemic or long-term
problems affecting its business operations as a whole. In view of the foregoing,
the Company does not currently anticipate that it will experience a significant
disruption to its business as a result of the Year 2000 issue. However, there is
still uncertainty about the broader scope of the Year 2000 issue as it may
affect the Company and third parties that are critical to the Company's
operations. For example, lack of readiness by electrical and water utilities,
financial institutions, government agencies or other providers of general
infrastructure could pose significant impediments to the Company's ability to
carry on its normal operations in the area or areas so affected. The Company is
currently evaluating what contingency plans, if any, to make in the event the
Company or parties with whom the Company does business experience Year 2000
problems.
The statements made herein about the costs expected to be associated
with the Year 2000 compliance and the results that the Company expects to
achieve, constitute forward-looking information. As noted above, there are many
uncertainties involved in the Year 2000 issue, including the extent to which the
Company will be able to successfully and adequately provide for contingencies
that may arise, as well as the broader scope of the Year 2000 issue as it may
affect third parties that are not controlled by the Company. Accordingly, the
costs and results of the Company's Year 2000 program and the extent of any
impact on the Company's operations could vary materially from those stated
herein.
Forward-Looking Statements
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When used in this Form 10-K, in filings by the Company with the SEC, in
the Company's press releases or other public or stockholder communications, or
in oral statements made with the approval of an authorized executive officer of
the Company, the words or phrases "would be," "will allow," "intends to," "will
likely result," "are expected to," "will continue," "is anticipated,"
"estimate," "project," or similar expressions are intended to identify
"forward-looking statements" within the meaning of the Private Securities
Litigation Reform Act of 1995. Forward-looking statements specifically include,
but are not limited to, the dates disclosed herein upon which sales of or
royalty payments from the Company's various products are anticipated to
commence.
The Company cautions readers not to place undue reliance on any
forward-looking statements, which speak only as of the date made, are based on
certain assumptions and expectations which may or may not be valid or actually
occur, and which involve various risks and uncertainties, including but not
limited to risk of product demand, market acceptance, economic conditions,
competitive products and pricing, difficulties in product development,
commercialization, and technology, changes in the regulation of safety health
care products, the level of marketing, development and distribution efforts of
the Company's partners and other risks. Furthermore, manufacturing delays may
result from additional mold redesigns or delays may result from the failure to
timely obtain FDA approval to sell future products. In addition, sales and other
revenues may not commence as anticipated due to delays or otherwise. If and when
product sales commence, sales may not reach the levels anticipated. As a result,
the Company's actual results for future periods could differ materially from
those anticipated or projected.
Unless otherwise required by applicable law, the Company does not
undertake, and specifically disclaims any obligation, to update any
forward-looking statements to reflect occurrences, developments, unanticipated
events or circumstances after the date of such statement.
Other Factors
The Company is subject to certain other risk factors due to its
development stage status, the industry in which it competes and the nature of
its operations. These risk factors include the following.
History of Losses/Profitability Uncertain. The Company is in the
development stage and has reported losses each year since 1993. At December 31,
1998, it had an accumulated deficit of $16,423,014. The Company's products are
in various stages of production, pre-production, development and research. The
Company has made only limited sales of its sharps container products, the only
product it was selling as of December 31, 1998. The Company does not have
marketing or distribution agreements in place for this product. There is no
assurance that the Company's products will be commercially viable and no
assurance can be given that the Company will become profitable. In addition,
prospects for the Company's profitability will be affected by expenses,
operational difficulties and other factors frequently encountered in the
development of a business enterprise in a competitive environment, many of which
factors may be unforeseen and beyond the Company's control.
Need for Additional Funds. Due to the development stage status of the
Company and the uncertainty of future profits, the Report of Independent Public
Accountants relating to the Company's 1998 audited financial statements,
attached hereto, contains a "going concern" explanatory paragraph. See
Consolidated Financial Statements and related Notes. The Company believes that
its existing funds, development fee revenues, license fees and funds generated
from sales of products and non-core technologies (such as QIC) will be
sufficient to support the Company's operations and planned capital expenditures
through at least December 31, 1999. The level of the Company's future need for
capital will depend on a number of factors, including the rate at which demand
for products expands, the level of sales and marketing activities for the
Company's products, and the level of expenditures needed to develop and
commercialize safety medical needle technologies, intravenous flow gauge, blood
collection devices, and the imaging technology. Moreover, the Company's business
plans may change or unforeseen events may occur which affect the amount of
additional funds required by the Company. If additional funds are not obtained
if and when required, the lack thereof could have a material adverse effect on
the Company. Further, there
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is no assurance that the terms on which any funds obtained by the Company will
be favorable to stockholders of the Company at that time.
Manufacturing Strategy/Dependence on Single Manufacturers. The Company
intends to subcontract the manufacture of certain of its products. This strategy
could result in various problems that could have a materially adverse effect on
the Company. Further, the Company may not be able to arrange for the manufacture
of its products through other companies which could delay sales and result in
increased expenses if the Company establishes its own manufacturing capability.
This could have a material adverse effect on the Company. The Company's Safety
Cradle(R) sharps containers is its only product currently available for sale and
it is produced by a single manufacturer. If the Company's manufacturer fails to
perform its obligations in a timely and satisfactory manner, or if there is a
change in the Company's manufacturer, it could have a material adverse effect on
the Company. There can be no assurance that the Company would be successful in
replacing its current manufacturer on terms favorable to the Company. Also,
there can be no assurance that the Company will be successful in finding
additional manufacturers to manufacture future products on favorable terms.
Negative Pricing Pressures on the Company's Safety Products. Prices for
the Company's safety products may be higher than for competing conventional
products which are not designed to provide the safety protection afforded by the
Company's products. The Company's prices, however, are expected to be
competitive with those of competing safety products. Continuing pressure from
third-party payors to reduce costs in the health care industry as well as
increasing competition from safety products made by other companies, could
adversely affect the Company's selling prices. Reductions in selling prices
could adversely affect operating margins if the Company cannot achieve
corresponding reductions in manufacturing costs.
Rapidly Changing Technology. The Company is in various stages of
production, pre-production, development and research with respect to its Safety
Cradle(R) sharps containers, safety lancets, medical safety needle technologies,
intravenous flow gauge, blood collection devices, filmless digitized imaging
technology and other products. There is no assurance that development of
superior products by competitors or changes in technology will not eliminate the
need for the Company's products. The introduction of competing products using
different technology could adversely affect the Company's attempts to develop
and market its products.
Potential Lack of Market Acceptance. The use of safety medical
products, including the Company's products, is relatively new. The Company's
products may not be accepted by the market and their acceptance will depend in
large part on (i) the Company's ability (directly or through its marketing
partners) to demonstrate the operational advantages, safety, efficacy, and
cost-effectiveness of its products in comparison with competing products and
(ii) its ability to distribute its products through major medical products
companies. There can be no assurance that the Company's products will achieve
market acceptance or that major medical products companies will sell the
Company's products.
Dependence on Continued Research and Development. The safety medical
needle technologies, intravenous flow gauge, safety lancets and imaging
technology are still in various stages of development. The Company is also
exploring additional applications for all of its products. The continued
development of its products and development of additional applications and new
products is important to the long-term success of the Company. There can be no
assurance that such applications or products will be developed or, if developed,
that they will be successful.
Dependence on Patents and Proprietary Rights. The Company's future
success depends in part on its ability to protect its intellectual property and
maintain the proprietary nature of its technology through a combination of
patents and other intellectual property arrangements. There can be no assurance
that the protection provided by patents, if issued, will be broad enough to
prevent competitors from introducing similar products or that such patents, if
challenged, will be upheld by the courts of any jurisdiction. Patent
infringement litigation, either to enforce the Company's patents or defend the
Company from infringement suits, would be expensive and, if it occurs, could
divert Company resources from other planned uses. Any adverse outcome in such
litigation could have a material adverse effect on the Company. Patent
applications filed in foreign countries and patents in such countries are
subject to laws and procedures that differ from those in the United States.
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Patent protection in such countries may be different from patent protection
under U.S. laws and may not be as favorable to the Company. Certain portions of
the Company's international patent prosecution efforts are funded by third
parties. The failure of the funding parties to pay for the international patent
prosecution costs would materially effect the Company's ability to prosecute
these patents. The Company also attempts to protect its proprietary information
through the use of confidentiality agreements and by limiting access to its
facilities. There can be no assurance that the Company's program of patents,
confidentiality agreements and restricted access to its facilities will be
sufficient to protect the Company's proprietary technology.
Ability to Manage Expanding Operations. The Company intends to pursue a
strategy of rapid growth although there can be no assurance that any growth will
be achieved. The Company plans to significantly expand its product lines and to
devote substantial resources to support operations, research and development,
marketing and administrative functions. There can be no assurance that the
Company will obtain sufficient manufacturing capacity on favorable terms,
arrange for the marketing and distribution of its products, attract qualified
personnel or effectively manage expanded operations. The failure to properly
manage growth could have a material adverse effect on the Company.
Competition/Potential Inability to Compete. The Company is engaged in a
highly competitive business and will compete directly with firms that have
longer operating histories, more experience, substantially greater financial
resources, greater size, more substantial research and development and marketing
organizations, established distribution channels and that are better situated in
the market than the Company. The Company's competitors and potential competitors
include Baxter International, Inc., Becton Dickinson and Company, Johnson &
Johnson, Sage Products, Inc., Surgicutt, Inc., Miles, Inc., B. Braun, Diagnostic
Corporation, Boehringer Mannheim, Inc., Kendall Healthcare Products Company,
Terumo Medical Corporation, Med-Design Company, Bio-Plexus, Inc., Maxon, Inc.
and Retractable Technologies, Inc. and Univec, Inc. See "Business Competition."
Such competitors may use their economic strength to influence the market to
continue to buy their existing products. These competitors may also be potential
strategic partners with respect to various products as are, for example, BDIT
and JJM. The Company does not have an established customer base and is likely to
encounter a high degree of competition in developing a customer base. One or
more of these competitors could use their resources to improve their current
products or develop new products that may compete more effectively with the
Company's products. New competitors may emerge and may develop products which
compete with the Company's products. However, new laws passed in California and
Tennessee and under consideration in 18 other states are creating a new business
climate in which the Company is uniquely qualified to compete. No assurance can
be given that the Company will be successful in competing in this industry.
Product Liability. The sale of medical devices entails an inherent risk
of liability in the event of product failure or claim of harm caused by product
operation. There can be no assurance that the Company will not be subject to
such claims, that any claim will be successfully defended or, if the Company is
found liable, that the claim will not exceed the limits of the Company's
insurance. The Company's current insurance coverage is in the amount of $1
million per occurrence and $2 million in aggregate. The Company also has an
umbrella policy in the amount of $5 million. In certain cases the Company has
indemnification arrangements in place with its strategic partners who will be
selling Company developed products under the partner's label. There is no
assurance that the Company will maintain product liability insurance on
acceptable terms in the future or that such insurance will be available. Product
liability claims could have a material adverse effect on the Company.
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Uncertainty in the Health Care Industry. The health care industry is
subject to changing political, economic and regulatory influences that may
affect the procurement practices and operations of health care facilities.
During the past several years, the health care industry has been subject to
increased government regulation of reimbursement rates and capital expenditures.
Among other things, third-party payors are increasingly attempting to contain
health care costs by limiting both coverage and reimbursement levels for health
care products and procedures. Because prices of the Company's products may
exceed the price of conventional products, the cost control policies of
third-party payors, including government agencies, may adversely affect use of
the Company's products. The Company believes that the costs associated with
accidental needlesticks, however, exceed the procurement costs of safety
products such as those of the Company.
There are numerous proposals to reform the U.S. health care system and
the health care systems of various states including the safety initiatives that
were passed in California and Tennessee and which are under consideration in
eighteen other states and on a national level. Many of these proposals seek to
increase government involvement in health care, lower reimbursement rates,
contain costs and otherwise change the operating environment for the Company's
prospective customers. Health care providers may react to these proposals and
the uncertainty surrounding such proposals by curtailing or deferring
investments in new technology and new products, including those of the Company.
The Company cannot predict what impact, if any, such proposals or health care
reforms might have on the Company's financial condition and results of
operations.
Management/Dependence on Key Personnel/Board. The success of the
Company depends upon the skills, experience and efforts of its management and
other key personnel. Should the services of one or more members of its present
management or other key personnel become unavailable to the Company for any
reason, the business of the Company could be adversely affected. There is no
assurance that the Company will be able to retain existing employees or attract
new employees of the caliber needed to achieve the Company's objectives. The
Company has noncompetition agreements in place with its key personnel. The Board
currently consists of six members, two of whom are employed by the Company.
Market Volatility. Market prices of securities of medical technology
companies are highly volatile from time to time. The trading price of the
Company's securities may be significantly affected by factors such as the
announcement of new product or technical innovations by the Company or its
competitors, proposed changes in the regulatory environment, or by other factors
that may or may not relate directly to the Company. Sales of substantial amounts
of Common Stock (including stock which may be issued upon exercise of warrants
or stock options), or the perception that such sales may occur, could adversely
affect the trading price of the Common Stock.
No Assurance of Dividends. The Company has never paid dividends on its
Common Stock. The payment of dividends, if any, on the Common Stock in the
future is at the discretion of the Board and will depend upon the Company's
earnings, if any, capital requirements, financial condition and other relevant
factors. The Board does not intend to declare any dividends on the Common Stock
in the foreseeable future.
Limitations on Director Liability. The Company's Certificate of
Incorporation provides, as permitted by Delaware law, that a director of the
Company shall not be personally liable to the Company or its stockholders for
monetary damages for any action or failure to take any action, with certain
exceptions. These provisions may discourage stockholders from bringing suit
against a director for breach of duty and may reduce the likelihood of
derivative litigation brought by stockholders on behalf of the Company against a
director. In addition, the Company has agreed and its Certificate of
Incorporation and Bylaws provide, for mandatory indemnification of directors and
officers to the fullest extent permitted by Delaware law and it has entered into
contracts with its directors and officers providing for such indemnification.
Anti-Takeover Provisions of Certificate and Bylaws. The Certificate of
Incorporation of the Company provides for the division of the Board into three
classes substantially equal in number. At each annual meeting of stockholders
one class of directors is to be elected for a three-year term. Amendments to
this provision must be approved by a two-thirds vote of all the outstanding
stock entitled to vote; the number of directors may be changed by a majority of
the entire Board or by a two-thirds vote of the outstanding stock entitled to
vote. Meetings of stockholders may be called only by the Board, the Chief
Executive Officer or the President of the Company, and stockholder action may
not be taken by written consent. These provisions could have the effect of (i)
discouraging attempts at non-negotiated takeovers of the Company which may
provide for stockholders to receive a premium price for their stock or (ii)
delaying or preventing a change of control of the Company which some
stockholders may believe is in their interest.
Effect of the Issuance of Preferred Stock. The Company has an
authorized class of preferred stock, shares of which may be issued with the
approval of its Board on such terms and with such rights, preferences and
designations as the Board may determine. Issuance of additional series of
preferred stock, depending upon the rights, preferences and designations
thereof, may have the effect of delaying, deterring or preventing a change in
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control of the Company. In addition, certain "anti-takeover" provisions of the
Delaware General Corporation Law, among other things, may restrict the ability
of stockholders to effect a merger or business combination or obtain control of
the Company and may be considered disadvantageous by some stockholders.
Management of the Company presently does not intend to issue any shares of
preferred stock. Preferred stock may, however, be issued at some future date
which stock might have substantially more than one vote per share or other
provisions designed to deter a change in control of the Company. The issuance of
such stock to a limited group of management stockholders may vest in such
persons absolute voting control of the Company, including, among other things,
the ability to elect all of the directors, control certain matters submitted to
a vote of stockholders and prevent any change in management despite their
performance. Also, preferred stock may have the right to vote upon certain
matters as a separate class.
Current Litigation. In April 1997, the Company entered into an
agreement with Leerink Swann & Company ("Leerink"), whereby Leerink agreed to
assist the Company in raising funds in a private placement of equity securities.
Sufficient funding was deposited into escrow to hold an initial closing, but the
closing did not occur. Leerink alleges that the Company refused to close on the
placement. The Company alleges that the closing did not occur because Leerink,
as a condition precedent to closing, made certain pre-closing demands that went
far beyond the terms of the agreement and which demands Company management
believes were not in the best interests of the Company or its stockholders. In
August 1997, Leerink filed suit in the United States District Court for the
District of Massachusetts alleging breach of contract, misrepresentation and
violation of M.G.L. c.93A, ss.11. Leerink is seeking compensatory damages
exceeding $230,000, 113,251 warrants to purchase 113,251 shares of the Company's
Common Stock, treble damages and reasonable attorneys' fees and costs. In
October 1997, the Company filed a counterclaim alleging breach of contract and
violation of M.G.L. c.93A, ss.11. The Company is seeking in excess of $60,000 in
money damages, treble damages, reasonable attorneys' fees and costs.
The Company believes that Leerink's claims are without merit and that
the Company will ultimately prevail. This matter has been scheduled for trial in
July 1999. The litigation is subject to all of the risks and uncertainties of
litigation and the outcome cannot presently be predicted. Specifically, there is
no assurance that the Company will be successful in this lawsuit or that the
lawsuit will be resolved on acceptable terms, and the Company may incur
significant costs in asserting its claims and defenses.
Item 8. Financial Statements and Supplementary Data.
See index to financial statements and financial statement schedules
included herein as Item 14.
Item 9. Changes in and Disagreements on Accounting and Financial Disclosure.
None.
29
<PAGE>
PART III
Item 10. Directors and Executive Officers of the Registrant.
Set forth below is certain information concerning each of the directors
and executive officers of the Company as of April 5, 1999.
With the
Name Age Position Company Since
David A. Robinson (1) 55 President, Chairman of the Board, 1993
Chief Executive Officer and Director
Dr. Gale H. Thorne(1) 66 Vice President - Product Development 1994
and Director
Charles D. Roe 48 Vice President - Finance and Investor 1997
Relations, Chief Financial Officer,
Secretary and Treasurer
David G. Hurley(2)(3) 63 Director 1999
Malinda S. Mitchell 54 Director 1999
David T. Rovee(2)(3) 59 Director 1998
Robert R. Walker(2)(3) 68 Director 1994
- ---------------
(1) Member of Executive Committee.
(2) Member of Audit Committee.
(3) Member of Compensation Committee.
David A. Robinson. Mr. Robinson is President, Chief Executive Officer
and Chairman of the Board of the Company. He has been a director and officer of
the Company since November 1993 and his term expires in 2001. From November 1992
to November 1993, Mr. Robinson was President of EPC Products, Inc., a
distribution company based in Bountiful, Utah. From 1981 to 1992, Mr. Robinson
was President of Royce Photo/Graphics Supply, Inc., a distributor of
photographic and graphic arts equipment and supplies based in Glendale,
California. He holds a Masters degree in Business Administration and a Masters
degree in Management Science from the University of Southern California.
Dr. Gale H. Thorne. Dr. Thorne is Vice President - Product Development,
for the Company. He has been a director since January 1995 and his term expires
in 2000. Dr. Thorne has held his present position as Vice President - Product
Development, since October 1994. From 1993 to 1994, Dr. Thorne was Vice
President - Engineering, of Eneco, Inc., a Utah company. During Dr. Thorne's
tenure at Eneco, Inc., the company was engaged primarily in the business of
prosecuting patent applications relating to cold-fusion technology. From 1989 to
1993, Dr. Thorne was employed as a patent consultant and patent agent with
Foster & Foster, a Salt Lake City intellectual property law firm. Dr. Thorne
holds thirty patents and has published numerous technical publications. He has
been a technical consultant and a member of the Board of the Small Business
Innovation Program of the State of Utah. Dr. Thorne manages all the patent and
product development work for the Company and is a patent agent. He holds a Ph.D.
30
<PAGE>
in Biophysics from the University of Utah. He is a past president of Thorne,
Smith, Astill, Inc., an engineering director for Becton, Dickinson and Company
Immunochemistry Division and a vice president and division manager for Varian
and Diasonics Ultrasound.
Charles D. Roe. Mr. Roe is Chief Financial Officer, Vice President
Finance and Investor Relations, Secretary and Treasurer of the Company. He was
appointed to his position as Chief Financial Officer and Vice-President in
November 1997, he was appointed as Secretary and Treasurer in December 1997 and
he has been with the Company since October 1997. Mr. Roe is a certified public
accountant licensed in the State of Utah and has principally been engaged in the
practice of public accounting since 1976, including four years with Arthur
Andersen LLP. From June 1995 through October 1997, Mr. Roe worked in association
with Jones, Jensen & Co., a certified public accounting firm which is a member
of the McGladrey Network of accounting firms, specializing in audits of public
companies. Mr. Roe was employed by Wellshire Services, Inc. from June 1993 to
June 1995 providing various services to numerous public and private companies in
the United States and Europe. From 1987 to October 1997, Mr. Roe has owned and
operated a public accounting practice focusing on financial audits, individual
and corporate income tax consultation and preparation and other advisory
services. Since 1987, Mr. Roe has served on the board of directors and as
secretary of Covington Capital Corporation, a privately owned financing
business. From June 1995 through November 1996, Mr. Roe was employed by that
company providing management services to various companies financed by Covington
Capital Corporation. Mr. Roe graduated from the University of Utah with a
Bachelor of Arts degree in Accounting.
David G. Hurley. Mr. Hurley has been a director of the Company since
February 1999 and his term expires in 2000. He has spent the last 33 years in
the management consulting and financial advisory business. For 25 years at
Arthur D. Little, Inc., Mr. Hurley was involved in corporate development
consulting with large and mid-sized firms throughout North America. Since 1991,
Mr. Hurley has been self employed and working principally as a management
consultant and financial advisor. He has a Bachelors degree in Economics,
Masters degree in Business Administration and has completed the Advanced
Management Program at Harvard Graduate School of Business.
Malinda S. Mitchell. Ms. Mitchell has been a director of the Company
since February 1999 and her term expires in 2001. Since November 1998, she has
been the Senior Vice President and Chief Operating Officer of UCSF Stanford
Health Care. From 1975 to 1997 she held a number of additional positions at
Stanford Hospital and Clinics, a predecessor of UCSF Stanford Health Care,
including, Interim President and Chief Executive Officer, Vice President and
Chief Operating Officer and Associate Hospital Director and Director of Nursing.
Ms. Mitchell has a Bachelors degree in Nursing from the University of Illinois
with a Masters of Nursing degree from Indiana University and a Masters degree in
Management from Stanford University.
Dr. David T. Rovee. Dr. Rovee has been a director of the Company since
April 1998 and his term expires in 1999. He is currently President and Chief
Operating Officer of Organogenesis, Inc., a publicly traded biotechnology
company. Dr. Rovee has been employed full time with Organogenesis, Inc. since
1991. Prior to his employment with Organogenesis, Inc., Dr. Rovee was employed
for a twenty-five year period by Johnson & Johnson in various capacities
including Vice President and Director of Research and Development for Johnson &
Johnson Patient Care, Inc. Dr. Rovee has a Bachelors degree in Biology from
Memphis State University, a Masters degree in Zoology from Louisiana State
University and a Ph.D. in Development Biology from Brown University.
Robert R. Walker. Mr. Walker is a director of the Company and has been
since March 1994 and his term expires in 1999. He is currently self-employed as
a consultant in the health care industry primarily in the area of start-up
medical device companies. From 1976 to 1992, Mr. Walker was employed by IHC
Affiliated Services Division of Intermountain Health Care, a regional hospital
company, from which he retired as President of IHC Affiliated Services. He is
also a former Chairman of the Board of AmeriNet, Inc., which is a national group
purchasing organization for hospitals, clinics, detox/drug centers, emergency,
nursing homes, private laboratories, psychiatric centers, rehabilitation
31
<PAGE>
facilities, surgical centers and institutions such as schools and prisons. Mr.
Walker is a member of the American Hospital Association and the Hospital
Financial Management Association. He holds a Bachelor of Science degree in
Business Administration.
Executive officers of the Company are elected by the Board on an annual
basis and serve at the discretion of the Board.
Section 16(a) Beneficial Ownership Reporting Compliance
Section 16(a) of the Securities Exchange Act of 1934 requires the
Company's executive officers, directors and persons who beneficially own more
than 10% of the Company's Common Stock to file initial reports of ownership and
reports of changes in ownership with the Securities and Exchange Commission
("SEC"). Such persons are required by SEC regulations to furnish the Company
with copies of all Section 16(a) forms filed by such persons.
Based solely on the Company's review of such forms furnished to the
Company and representations from certain reporting persons, the Company believes
that all filing requirements applicable to the Company's executive officers,
directors and more than 10% stockholders were complied with during 1998.
Item 11. Executive Compensation.
The tables below set forth certain information concerning compensation
paid by the Company to its Chief Executive Officer and all other executive
officers with annual compensation in excess of $100,000 (determined for the year
ended December 31, 1998) (the "Named Executive Officers"). The tables include
information related to stock options granted to the Named Executive Officers.
Summary Compensation Table. The following table provides certain
information regarding compensation paid by the Company to the Named Executive
Officers.
<TABLE>
<CAPTION>
SUMMARY COMPENSATION TABLE
Annual Compensation Long-Term Compensation Awards
Restricted Stock All Other
Name and Other Annual Stock Options/ LTIP Compensation
Principal Position Year Salary($) Bonus ($) Compensation($)(1) Awards ($) SAR(#) Payouts($) ($)(2)
------------------ ---- ------- --------- ------------------ ---------- ------ ---------- ------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
David A. Robinson, 1996 240,000 --- 8,000 --- --- --- 2,777
President, CEO, Chairman 1997 240,000 --- 4,750 --- --- --- 4,150
of the Board and Director 1998 240,000 1,000 10,000 --- --- --- 10,428
Dr. Gale H. Thorne, VP 1996 150,000 --- 4,640 --- --- 72
40,000(3)
Product Development and 1997 150,000 --- 4,750 --- --- --- 429
Director 1998 150,000 1,000 6,925 --- --- --- 6,925
Charles D. Roe, VP 1997 20,833 --- --- --- 50,000(3) --- ---
Finance and Investor 1998 100,000 1,000 5,050 --- --- --- 226
Relations and CFO
Bradley C. Robinson (4), 1996 160,000 --- 5,333 --- --- --- 898
Former Officer and 1997 160,000 --- 4,750 --- --- --- 1,952
Director 1998 120,006 --- 59,130 (5) --- --- --- 1,115
- ---------------
</TABLE>
(1) Except as otherwise noted, these amounts represent payments by the Company
into its 401(k) retirement plan for the benefit of the Named Executive
Officer.
32
<PAGE>
(2) These amounts represent the amounts paid by the Company for term life
insurance on the lives of the Named Executive Officer with insurance
proceeds payable to the beneficiary designated by the Named Executive
Officer. These insurance policies have no cash surrender values.
(3) Options issued pursuant to the NQSOP.
(4) Mr. Bradley C. Robinson was a director and Vice-President of Business
Development prior to his resignation from the Company in September 1998.
(5) Of said amount $5,333 represents payments by the Company into its 401(k)
retirement plan and the balance represents the payment of accrued vacation
pay.
Compensation of Directors
No cash fees or other consideration were paid to employee directors of
the Company by the Company for service on the Board during 1998. During 1998,
the Company compensated non-employee directors at a rate of $10,000 per year
payable in equal quarterly installments along with options to purchase 10,000
shares of the Company's common stock that were granted in equal quarterly
installments at an exercise price equal to the market price of the underlying
common stock on the date of grant. The Company expects that the 1999
compensation for non-employee directors will be the same as the 1998
compensation with the exception that options to purchase 16,000 shares of the
Company's common stock will be granted in equal quarterly installments at an
exercise price equal to the fair market value of the underlying common stock on
the date of grant, but in no event shall the exercise price be less than $2.00
per share. The Company has made no other agreements regarding compensation of
non-employee directors. All directors are entitled to reimbursement for
reasonable expenses incurred in the performance of their duties as Board
members.
Employment and Indemnity Agreements
The Company has entered into employment agreements with Mr. David A.
Robinson and Dr. Gale H. Thorne (collectively, the "Senior Executives"). These
employment agreements, which have been amended from time to time, provide that
(i) Mr. David A. Robinson receive a salary of $240,000 per year and Dr. Gale H.
Thorne receive a salary of $165,000 per year beginning January 1, 1999; (ii) the
Senior Executives' employment agreements are for terms of three years, expiring
on January 1, 2002; (iii) the Senior Executives are entitled to a reasonable car
allowance, vacation pay and health insurance; (iv) if the employment of a Senior
Executive is terminated by reason of disability or other than for cause, the
salary of such Senior Executive will continue for the full term of the
agreement; (v) if a Senior Executive is terminated for cause, the salary of such
Senior Executive ceases as of the date of termination; (vi) the Company will
provide each Senior Executive with up to $1,000,000 of term life insurance while
the Senior Executive is employed by the Company; and (vii) the Senior Executives
shall keep all proprietary information relating to the business of the Company
confidential both during and after the term of the agreements. With one
exception, the Company does not have employment agreements with any of its other
officers or employees. As of December 31, 1998, the Company had accrued vacation
pay of $68,508 and $17,957 owing to Mr. Robinson and Dr. Thorne, respectively.
The Company has entered into indemnity agreements (the "Indemnity
Agreements") with each of its executive officers and directors pursuant to which
the Company has agreed to indemnify the officers and directors to the fullest
extent permitted by law for any event or occurrence related to the service of
the indemnitee as an officer or director of the Company that takes place prior
to or after the execution of the Indemnity Agreement. The Indemnity Agreements
obligate the Company to reimburse or advance expenses relating to any proceeding
arising out of an indemnifiable event. Under the Indemnity Agreements, the
officers and directors of the Company are presumed to have met the relevant
standards of conduct required by Delaware law for indemnification. Should the
Indemnity Agreements be held to be unenforceable, indemnification of these
officers and directors may be provided by the Company in certain cases at its
discretion.
33
<PAGE>
401(k) Retirement Plan
Effective in 1996, the Company adopted a 401(k) retirement plan whereby
the Company contributes five percent of payroll compensation to the plan and
matches employee contributions to the plan on a dollar for dollar basis up to
the maximum contribution allowed by applicable tax law. The Named Executive
Officers have invested all of the funds in their 401(k) accounts in common stock
of the Company.
Indemnification for Securities Act Liabilities
Delaware law authorizes, and the Company's Bylaws and Indemnity
Agreements provide for, indemnification of the Company's directors and officers
against claims, liabilities, amounts paid in settlement and expenses in a
variety of circumstances. Indemnification for liabilities arising under the Act
may be permitted for directors, officers and controlling persons of the Company
pursuant to the foregoing or otherwise. However, the Company has been advised
that, in the opinion of the Securities and Exchange Commission, such
indemnification is against public policy as expressed in the Act and is,
therefore, unenforceable.
Stock Options and Warrants
During 1994, the Board of SHP approved the SHP NQSOP. Options granted
under the SHP NQSOP were required to have exercise prices not less than the fair
market value of the underlying stock at the date of grant as determined by SHP's
Board of Directors. The number of shares, terms and exercise period of options
granted under the SHP NQSOP were determined by the SHP Board of Directors on an
option-by-option basis. On the date of the Acquisition, all options issued under
the SHP NQSOP became obligations of the Company and the SHP NQSOP was
terminated. As of April 5, 1999, options to acquire an aggregate of 18,000
shares of Common Stock were outstanding in connection with the SHP NQSOP.
Options issued under the SHP NQSOP expire in September 2000 and are exercisable
at $.39 per share.
On September 1, 1995, the Company adopted the NQSOP and has reserved
1,500,000 shares of Common Stock for the possible exercise of options under the
plan. The exercise price of options granted under the NQSOP must be not less
than the fair market value of the underlying stock at the date of grant as
determined by the Board. Options granted under the NQSOP expire five years from
the date of grant. As of April 5, 1999, options to acquire an aggregate of
1,475,500 shares of Common Stock at exercise prices ranging from $1.25 to $2.625
per share had been granted and are presently outstanding (not including options
granted under the SHP NQSOP).
On October 22, 1998, the Company's stockholders approved the adoption
of the Specialized Health Products International, Inc. 1998 Stock Option Plan
(the "Option Plan"). The Option Plan will permit the Company to grant
"non-qualified stock options" and "incentive stock options" to acquire the
Company's Common Stock. The total number of shares authorized for the Option
Plan may be allocated by the Board between the non-qualified stock options and
the incentive stock options from time to time, subject to certain requirements
of the Internal Revenue Code of 1986, as amended. The option exercise price per
share under the Option Plan may not be less than the fair market value of a
share of Common Stock on the date on which the option is granted and in no event
can the exercise price be less than $2.00 per share. A total of 2,000,000 shares
are allocated to the Option Plan, but the Option Plan also restricts the total
number of shares of Common Stock that the Company can grant option to acquire
under all of its stock option plans to 2,000,000 shares. As of April 5, 1999,
options to acquire an aggregate of 206,000 shares of Common Stock at an exercise
price of $2.00 per share had been granted and are presently outstanding (not
including options granted under the SHP NQSOP and the NQSOP). Non of the options
granted under the Option Plan were granted to executive officers of the Company.
34
<PAGE>
Possible Delisting of Securities from Nasdaq System.
The Company's common stock is currently traded on the Nasdaq Small-Cap
Market System. In order to continue to qualify its stock for quotation on the
Nasdaq Small-Cap Market, the Company must have, among other things, $2 million
in net tangible assets, a market capitalization of $35 million or annual net
income of $500,000. The Company is also required to have a minimum bid price of
at least $1 per share.
As of December 31, 1998, the Company had net tangible assets of
$313,860 and the Company's bid price has recently been below the $1 minimum
price per share. As a result, the Company does not meet the Nasdaq Small-Cap
Market listing requirements. A hearing was held with Nasdaq on April 1, 1999 to
consider delisting or suspension of the Company's Common Stock from the Nasdaq
Small-Cap Market. The panel has not made a decision regarding this matter. The
Company expects that such delisting will occur unless the Company can bring
itself into compliance with the requirements and demonstrate an ability to
maintain compliance with such requirements. The Company is attempting to bring
itself into compliance with all applicable Nasdaq Small-Cap Market listing
requirements. There can be no assurance that the Company will be in compliance
and be able to demonstrate the ability to maintain compliance in the immediate
future or otherwise. In the event of delisting or suspension, trading, if any,
in the Company's securities would be expected to be conducted in the
over-the-counter market in what is commonly referred to as the "Electronic
Bulletin Board." As a result, an investor may find it more difficult to dispose
of, or to obtain accurate quotations as to the price of the Company's
securities. The loss of continued price quotations as provided by the Nasdaq
System could also cause a decline in the price of the Common Stock, a loss of
news coverage of the Company and difficulty in obtaining subsequent financing.
Compensation Committee Interlocks and Insider Participation
No executive officers of the Company serve on the Compensation
Committee (or in a like capacity) for the Company or any other entity.
Item 12. Security Ownership of Certain Beneficial Owners and Management.
The following table sets forth certain information with respect to the
beneficial ownership of the Common Stock of the Company as of April 5, 1999,
for: (i) each person who is known by the Company to beneficially own more than 5
percent of the Company's Common Stock, (ii) each of the Company's directors,
(iii) each of the Company's Named Executive Officers (defined below), and (iv)
all directors and executive officers as a group. As of April 5, 1999, the
Company had 12,356,440 shares of Common Stock outstanding.
Shares
Name and Address Beneficially Percentage
of Beneficial Owner(1) Owned(2) of Total(2) Position
- ---------------------- -------- ----------- --------
David A. Robinson(3) 609,799 4.9% President, CEO, Chairman
of the Board and
Director
Dr. Gale H. Thorne(4) 379,124 3.0% Vice President - Product
Development and Director
Charles D. Roe(5) 8,226 * Chief Financial Officer,
VP Finance and Investor
Relations
David G. Hurley(6) -- * Director
Malinda S. Mitchell(6) -- * Director
Dr. David T. Rovee(7) 11,000 * Director
Robert R. Walker(8) 123,000 * Director
Executive Officers and 1,131,149 8.9%
Directors as a Group (seven
persons)
35
<PAGE>
Shares
Name and Address Beneficially Percentage
of Beneficial Owner(1) Owned(2) of Total(2) Position
- ---------------------- -------- ----------- --------
Johnson & Johnson Development 2,000,000 15.0%
Corporation(9)
One Johnson & Johnson Plaza,
New Brunswick, NJ 08933
Asdale Ltd (10) 1,500,000 11.4%
44 Lowndes Street
London, England
* Less than 1%.
- --------------
(1) Except where otherwise indicated, the address of the beneficial owner is
deemed to be the same address as the Company.
(2) Beneficial ownership is determined in accordance with SEC rules and
generally includes holding voting and investment power with respect to the
securities. Shares of Common Stock subject to options or warrants currently
exercisable, or exercisable within 60 days, are deemed outstanding for
computing the percentage of the total number of shares beneficially owned
by the designated person, but are not deemed outstanding for computing the
percentage for any other person.
(3) Includes 367,719 shares and stock options to purchase 212,500 shares. Also
includes 29,580 shares purchased through the Company's 401(k) plan.
(4) Includes 18,000 shares, stock options to purchase 115,000 shares and
warrants to purchase 200,000 shares. Also includes 25,000 shares that Dr.
Thorne is deemed to beneficially own through a trust and 21,124 shares
purchased through the Company's 401(k) plan. See "Certain Relationships and
Related Transactions."
(5) Includes 8,226 shares purchased through the Company's 401(k) plan. Does not
include stock options to acquire 50,000 shares, 25,000 of which vest in
October 1999 and 25,000 of which vest in October 2000.
(6) Does not include stock options to purchase 4,000 shares for each director
that vest in December 1999.
(7) Includes 1,000 shares and stock options to purchase 10,000 shares. Does not
include stock options to purchase 4,000 shares that vest in December 1999.
(8) Includes stock options to purchase 60,000 shares. Also includes 63,000
shares that Mr. Walker is deemed to beneficially own through a trust. Does
not include stock options to acquire 4,000 shares that vest in December
1999.
(9) Includes 1,000,000 shares and 1,000,000 Series D Warrants. (10) Includes
750,000 shares and 750,000 Series D Warrants.
The Company is not aware of any arrangements, the operation of which
may, at a subsequent date, result in a change in control of the Company.
Item 13. Certain Relationships and Related Transactions.
Dr. Gale H. Thorne, a director and officer of the Company, was entitled
to a royalty of two and one-half percent on the Company's gross revenues
received from the sale of products utilizing the ExtreSafe(R) medical needle
36
<PAGE>
technology, blood collection device and intravenous flow gauge technologies
(collectively, the "Thorne Products"). These royalties were agreed to in 1994 in
exchange for Dr. Thorne's assignment to the Company of intellectual property
rights he owned prior to his involvement with the Company, which intellectual
property rights relate to the Thorne Products. In addition, the Company was
required under the agreement to pay Dr. Thorne minimum royalty payments of not
less than $435,000 over a six-year period beginning in 1998. Minimum royalty
payments in 1998 and 1999 totaled in the aggregate $195,000. As a condition of
the private placement that closed in January 1998, Dr. Thorne released the
Company from all royalty obligations relating to Thorne Products in exchange for
the issuance of 750,000 SHPI Warrants to Dr. Thorne and his assigns.
The law firm of Blackburn & Stoll, LC provides legal services to the
Company. Eric L. Robinson, a member of that firm, is the nephew of David A.
Robinson.
In January 1997, David A. Robinson, a director and officer of the
Company exercised options to purchase 87,500 shares of the Company's common
stock in order to provide needed working capital for the Company. Mr. Robinson
obtained the funds to exercise the options by margining shares of the Company's
stock that he owned and all of the proceeds from the margin transaction went to
the Company. In August 1997, his margin was called and Mr. Robinson borrowed
$182,577 from the Company to pay the margin call. In December 1997, Mr. Robinson
repaid in full the $182,577 principal amount plus interest thereon at eight
percent per annum.
In December 1997, the Company entered into a development and license
agreement with JJM to commercialize two applications of medical safety needle
technology. The JJM Agreement provides for monthly development payments by J&J,
sharing of field related patent costs, payments for initial periods of low
volume manufacturing, an ongoing royalty stream and a J&J investment in molds,
assembly equipment and other capital costs related to commercialization of each
product. The JJM Agreement also provides for an ongoing joint cooperative
program between the Company and JJM which derives future funding directly from
sales of Company created products, low volume manufacturing revenue for the
Company and an ongoing royalty stream for additional safety products which are
jointly approved for development. In connection with the JJM Agreement, Johnson
& Johnson Development Corporation purchased $2,000,000 of Company securities in
a private placement that closed in January 1998.
37
<PAGE>
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.
(a) The following documents are filed as part of this report:
(1) Financial Statements
Listed on page F-1.
(2) Financial Statement Schedules
None required.
(b) Reports on Form 8-K
None.
(c) Exhibits
Listed on page 40 hereof.
38
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
SPECIALIZED HEALTH PRODUCTS
INTERNATIONAL, INC.
(Registrant)
Date: April 14, 1999 By /s/ David A. Robinson
----------------------
David A. Robinson
President, Chief Executive Officer
and Director
Pursuant to the requirements of the Securities and Exchange Act of
1934, this report has been signed below by the following persons on behalf of
the registrant and in the capacities and on the dates indicated.
Signature Title Date
/s/ David A. Robinson President, Chief Executive April 14, 1999
- --------------------- Officer and Director (Principal
David A. Robinson Executive Officer)
/s/ Charles D. Roe Vice President, Chief Financial April 14, 1999
- ---------------------- Officer, Secretary and
Charles D. Roe Treasurer (Principal Financial
and Accounting Officer)
/s/ Gale H. Thorne Director and Vice President April 14, 1999
- ----------------------
Gale H. Thorne
/s/ David G. Hurley Director April 14, 1999
- ----------------------
David G. Hurley
/s/ Malinda S. Mitchell Director April 14, 1999
- -----------------------
Malinda S. Mitchell
/s/ Robert R. Walker Director April 14, 1999
- -----------------------
Robert R. Walker
39
<PAGE>
EXHIBIT INDEX
EXHIBIT NO. DESCRIPTION OF EXHIBIT
3(i).1 Restated Certificate of Incorporation of the Company.
(Incorporated by reference to Exhibit 3(i).1 of the
Company's current report on Form 8-K, dated July 28,
1995)
3(i).2 Certificate of Amendment of Certificate of Incorporation
of the Company. (Incorporated by reference to Exhibit
3(i).2 of the Company's Form 10-K, dated December 31,
1996).
3(i).3 Articles of Incorporation of Specialized Health
Products, Inc. ("SHP") (Incorporated by reference to
Exhibit 3(i).2 of the Company's Form 10-K, dated
December 31, 1995)
3(i).4 Articles of Amendment of SHP (Incorporated by reference
to Exhibit 3(i).3 of the Company's Form 10-K, dated
December 31, 1995)
3(ii).1 Second Amended and Restated Bylaws of the Company
(Incorporated by reference to Exhibit 3(ii).1 of the
Company's Annual Report on Form 10-K, dated December 31,
1997)..
3(ii).2 Bylaws of SHP (Incorporated by reference to Exhibit
3(ii).2 of the Company's Form 10-K, dated December 31,
1995)
4.1 Form of Series D Warrant Certificate (Incorporated by
reference to Exhibit 4.3 of the Company's Form 10-K,
dated December 31, 1997)
4.2 Form of SHPI Warrant Certificate (Incorporated by
reference to Exhibit 4.4 of the Company's Form 10-K,
dated December 31, 1997)
10.1 Form of Employment Agreement with Executive Officers
(Incorporated by reference to Exhibit 10.3 of the
Company's Form 10-K, dated December 31, 1995)
10.2 Form of Indemnity Agreement with Executive Officers and
Directors (Incorporated by reference to Exhibit 10.4 of
the Company's Form 10-K, dated December 31, 1995)
10.3 Form of Confidentiality Agreement (Incorporated by
reference to Exhibit 10.5 of the Company's Form 10-K,
dated December 31, 1995)
10.4 Joint Venture Agreement between SHP and Zerbec, Inc.,
dated October 30, 1995 (Incorporated by reference to
Exhibit 10.6 of the Company's Form 10-K, dated December
31, 1995)
10.5 Distribution Agreement between SHP and Becton, Dickinson
and Company (Incorporated by reference to Exhibit 10.1
of the Company's Current Report on Form 8-K, dated
August 26, 1996)
10.6 License Agreement between SHP and Becton, Dickinson and
Company (Incorporated by reference to Exhibit 10.1 of
the Company's Current Report on Form 8-K, dated June 4,
1997)
10.7 Distribution and License Agreement between SHP and
Johnson and Johnson Medical, Inc. (Incorporated by
reference to Exhibit 10.1 of the Company's Current
Report on Form 8-K, dated December 22, 1997)
21.1 Schedule of subsidiaries.
23.1 Consent of Arthur Andersen LLP, Independent Public\
Accountants
27.1 Financial Data Schedule
40
<PAGE>
SPECIALIZED HEALTH PRODUCTS international, INC. AND SUBSIDIARIES
(A Company in the Development Stage)
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
Report of Independent Public Accountants F - 2
Consolidated Balance Sheets as of December 31, 1998 and 1997 F - 3
Consolidated Statements of Operations for the Years Ended
December 31, 1998, 1997 and 1996 and for the Period
from Inception to December 31, 1998 F - 5
Consolidated Statements of Stockholders' Equity (Deficit)
for the Years Ended December 31, 1998, 1997 and 1996 and
for the Period from Inception to December 31, 1998 F - 6
Consolidated Statements of Cash Flows for the Years Ended
December 31, 1998, 1997 and 1996 and for the Period
from Inception to December 31, 1998 F - 11
Notes to Consolidated Financial Statements F - 13
F-1
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Specialized Health Products International, Inc.:
We have audited the accompanying consolidated balance sheets of Specialized
Health Products International, Inc. (a Delaware corporation in the development
stage) and subsidiaries as of December 31, 1998 and 1997, and the related
consolidated statements of operations, stockholders' equity (deficit) and cash
flows for each of the three years in the period ended December 31, 1998 and the
related statements of operations, stockholders' equity (deficit) and cash flows
for the period from inception (November 19, 1993) to December 31, 1998. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits. We did not audit the consolidated financial statements of
Specialized Health Products International, Inc. and subsidiaries for the period
from inception to December 31, 1995. Such statements are included in the
cumulative inception to December 31, 1998 totals of the statements of
operations, stockholders' equity (deficit) and cash flows and reflect total
revenues and net loss of 23 percent and 24 percent, respectively, of the related
cumulative totals. Those statements were audited by other auditors whose reports
have been furnished to us and our opinion, insofar as it relates to amounts for
cumulative totals, is based solely upon the reports of the other auditors.
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 financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits and the reports of other auditors provide a
reasonable basis for our opinion.
In our opinion, based on our audits and the reports of other auditors, the
financial statements referred to above present fairly, in all material respects,
the consolidated financial position of Specialized Health Products
International, Inc. and subsidiaries as of December 31, 1998 and 1997, and the
results of their operations and their cash flows for each of the three years in
the period ended December 31, 1998 and for the period from inception to December
31, 1998, in conformity with generally accepted accounting principles.
The accompanying consolidated financial statements have been prepared assuming
that the Company will continue as a going concern. As discussed in Note 1 to the
consolidated financial statements, the Company has experienced recurring net
losses of $4,197,567, $4,274,003, and $4,093,388 and negative cash flows from
operating activities of $2,069,322, $1,389,016, and $3,558,778 during the years
ended December 31, 1998, 1997 and 1996, respectively. As of December 31, 1998,
the Company had an accumulated deficit of $16,423,014. These matters raise
substantial doubt about the Company's ability to continue as a going concern.
Management's plans in regard to these matters are also described in Note 1. The
accompanying consolidated financial statements do not include any adjustments
relating to the recoverability and classification of asset carrying amounts or
the amount and classification of liabilities that might result should the
Company be unable to continue as a going concern.
ARTHUR ANDERSEN LLP
Salt Lake City, Utah
April 14, 1999
F-2
<PAGE>
<TABLE>
<CAPTION>
SPECIALIZED HEALTH PRODUCTS international, INC. AND SUBSIDIARIES
(A Company in the Development Stage)
CONSOLIDATED BALANCE SHEETS
ASSETS December 31,
-----------------------------------------
1998 1997
-----------------------------------------
CURRENT ASSETS:
<S> <C> <C>
Cash and cash equivalents $ 2,480,083 $ 1,441,556
Accounts receivable 494,484 34,328
Unbilled receivables on contracts 142,414 -
Inventories 2,520 72,352
Prepaid expenses and other 37,431 56,891
Amounts due from related parties 24,808 -
-----------------------------------------
Total current assets 3,181,740 1,605,127
-----------------------------------------
PROPERTY AND EQUIPMENT, at cost:
Manufacturing molds 474,633 812,994
Office furnishings and fixtures 531,215 352,925
Assembly and manufacturing equipment 339,356 46,138
Leasehold improvements 132,326 -
Construction-in-progress 152,599 546,372
-----------------------------------------
1,630,129 1,758,429
Less accumulated depreciation and amortization (442,331) (308,000)
-----------------------------------------
Net property and equipment 1,187,798 1,450,429
-----------------------------------------
OTHER ASSETS 11,537 229,857
-----------------------------------------
$ 4,381,075 $ 3,285,413
=========================================
</TABLE>
The accompanying notes to consolidated financial statements
are an integral part of these consolidated balance sheets.
F-3
<PAGE>
<TABLE>
<CAPTION>
SPECIALIZED HEALTH PRODUCTS international, INC. AND SUBSIDIARIES
(A Company in the Development Stage)
CONSOLIDATED BALANCE SHEETS (Continued)
LIABILITIES AND STOCKHOLDERS' EQUITY December 31,
----------------------------------------
1998 1997
----------------------------------------
CURRENT LIABILITIES:
<S> <C> <C>
Accounts payable $ 17,238 $ 469,948
Accrued liabilities 287,297 398,022
Amounts due to related parties - 127,195
----------------------------------------
Total current liabilities 304,535 995,165
----------------------------------------
DEFERRED ROYALTY REVENUES 3,750,000 1,750,000
----------------------------------------
COMMITMENTS AND CONTINGENCIES (Notes 1,3,4,5 and 6)
STOCKHOLDERS' EQUITY:
Preferred stock, $.001 par value; 5,000,000 shares authorized, no shares
outstanding - -
Common stock, $.02 par value; 50,000,000 shares authorized, 12,356,440 and
10,129,842 shares outstanding, respectively 247,129 202,597
Common stock subscriptions receivable (200,200) (209,200)
Additional paid-in capital 14,788,373 12,113,346
Series C warrants to purchase common stock - 310,994
Series D warrants to purchase common stock 1,954,452 388,158
Deficit accumulated during the development stage (16,423,014) (12,225,447)
Deferred consulting expense (40,200) (40,200)
----------------------------------------
Total stockholders' equity 326,540 540,248
----------------------------------------
$ 4,381,075 $ 3,285,413
========================================
</TABLE>
The accompanying notes to consolidated financial statements
are an integral part of these consolidated balance sheets.
F-4
<PAGE>
<TABLE>
<CAPTION>
SPECIALIZED HEALTH PRODUCTS INTERNATIONAL, INC. AND SUBSIDIARIES
(A Company in the Development Stage)
CONSOLIDATED STATEMENTS OF OPERATIONS
Period from
Year Ended December 31, Inception to
------------------------------------------------------------ December 31,
1998 1997 1996 1998
-------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
NET PRODUCT SALES $ 10,202 $ 182,363 $ 74,563 $ 748,228
COST OF PRODUCT SALES 8,048 141,857 70,257 536,002
-------------------------------------------------------------------------------
Gross margin on product sales 2,154 40,506 4,306 212,226
-------------------------------------------------------------------------------
DEVELOPMENT FEES 1,028,934 250,000 - 1,278,934
COST OF DEVELOPMENT FEES 823,146 - - 823,146
-------------------------------------------------------------------------------
Gross margin on development fees 205,788 250,000 - 455,788
-------------------------------------------------------------------------------
OPERATING EXPENSES:
Selling, general and administrative 2,946,722 3,311,222 2,901,434 11,915,871
Research and development 909,048 1,191,857 1,264,186 4,460,680
Write-off of operating assets 754,803 92,557 72,363 1,174,795
-------------------------------------------------------------------------------
Total operating expenses 4,610,573 4,595,636 4,237,983 17,551,346
-------------------------------------------------------------------------------
LOSS FROM OPERATIONS (4,402,631) (4,305,130) (4,233,677) (16,883,332)
-------------------------------------------------------------------------------
OTHER INCOME (EXPENSE):
Interest income 199,287 18,236 108,701 461,889
Interest expense - - - (23,658)
Other income, net 5,777 12,891 31,588 50,256
-------------------------------------------------------------------------------
Net other income 205,064 31,127 140,289 488,487
-------------------------------------------------------------------------------
NET LOSS (4,197,567) (4,274,003) (4,093,388) (16,394,845)
LESS PREFERENCE STOCK DIVIDENDS
- - - (28,169)
-------------------------------------------------------------------------------
NET LOSS APPLICABLE TO COMMON SHARES $ (4,197,567) $ (4,274,003) $ (4,093,388) $ (16,423,014)
===============================================================================
BASIC AND DILUTED NET LOSS PER COMMON SHARE $ (.35) $ (.47) $ (.48)
============================================================
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING 12,153,264 9,170,541 8,589,952
============================================================
</TABLE>
The accompanying notes to consolidated financial statements
are an integral part of these consolidated balance sheets.
F-5
<PAGE>
<TABLE>
<CAPTION>
SPECIALIZED HEALTH PRODUCTS international, INC. AND SUBSIDIARIES
(A Company in the Development Stage)
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
Deficit
Common Addi- Accumulated
Preferred Stock Common Stock Stock Sub- tional During the Deferred
----------------------------------------- scriptions Paid-in Series C Series D Development Consulting
Shares Amount Shares Amount Receivable Capital Warrants Warrants Stage Expense
------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Issuance of
common stock for
cash at inception - $ - 1,170,000 $ 1,300 $ - $ - $ - $ - $ - $ -
Net loss - - - - - - - - (3,450) -
-------------------------------------------------------- -------- --------- --------- ------------ ----------
BALANCE as of
December 31, 1993
- - 1,170,000 1,300 - - - - (3,450) -
Issuance of
preferred stock
for cash 1,440,000 560,000 - - - - - - - -
Issuance of common
stock for services
and stock
subscriptions
receivable - - 193,500 208,500 (198,500) - - - - -
Unpaid dividends
on preference
stock - - - - - - - - (16,780) -
Net loss - - - - - - - - (906,948) -
-------------------------------------------------------- -------- --------- --------- ------------ ----------
BALANCE as of
December 31, 1994
1,440,000 560,000 1,363,500 209,800 (198,500) - - - (927,178) -
Issuance of
preferred stock
for cash 362,403 604,001 - - - - - - - -
</TABLE>
The accompanying notes to consolidated financial statements
are an integral part of these consolidated balance sheets.
F-6
<PAGE>
<TABLE>
<CAPTION>
SPECIALIZED HEALTH PRODUCTS international, INC. AND SUBSIDIARIES
(A Company in the Development Stage)
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT) (Continued)
Deficit
Common Addi- Accumulated Deferred
Preferred Stock Common Stock Stock Sub- tional During the Consult-
---------------------------------------------- scriptions Paid-in Series C Series D Development ing
Shares Amount Shares Amount Receivable Capital Warrants Warrants Stage Expense
------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Issuance of common
stock for
stock subscriptions
receivable - $ - 70,000 $ 1,400 $(140,000) $ 138,600 $- $ - $ - $ -
Reduction in stock
subscriptions
receivable
(cash and services) - - - - 288,500 - - - - -
Unpaid dividends on
preference stock - - - - - - - - (11,389) -
Exchange of debt for
common stock - - 396,500 386,000 - 99,000 - - - -
Issuance of common
shares to
stockholders under
antidilution
provisions - - 90,000 180,000 - (180,000) - - - -
Business combination (1,802,403) (1,164,001) 2,102,403 (696,752) - 1,860,753 - - - -
Issuance of
common stock for
cash, net of expenses - - 4,256,250 85,125 - 7,193,935 - - - -
</TABLE>
The accompanying notes to consolidated financial statements
are an integral part of these consolidated balance sheets.
F-7
<PAGE>
<TABLE>
<CAPTION>
SPECIALIZED HEALTH PRODUCTS international, INC. AND SUBSIDIARIES
(A Company in the Development Stage)
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT) (Continued)
Deficit
Common Addi- Accumulated
Preferred Stock Common Stock Stock Sub- tional During the Deferred
----------------------------------------- scriptions Paid-in Series C Series D Development Consulting
Shares Amount Shares Amount Receivable Capital Warrants Warrants Stage Expense
------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Exercise of
stock options
for common stock
subscriptions
receivable - $ - 288,000 $ 5,760 $(209,500) $ 203,740 $- $- $ - $ -
Net loss - - - - - - - - (2,919,489) -
-------------------------------------------------------------------------------------------------------------
BALANCE as of
December 31, 1995 - - 8,566,653 171,333 (259,500) 9,316,028 - - (3,858,056) -
Cash received
for stock
subscriptions
receivable - - - - 50,300 - - - - -
Exercise of
common stock
options - - 45,000 900 - 16,650 - - - -
Exercise of
common stock
warrants - - 45,000 900 - 74,250 - - - -
Grant of stock
options for
consulting
services - - - - - 134,000 - - - (40,200)
Net loss - - - - - - - - (4,093,388) -
-------------------------------------------------------------------------------------------------------------
BALANCE as of
December 31, 1996 - - 8,656,653 173,133 (209,200) 9,540,928 - - (7,951,444) (40,200)
The accompanying notes to consolidated financial statements
are an integral part of these consolidated balance sheets.
F-8
<PAGE>
SPECIALIZED HEALTH PRODUCTS international, INC. AND SUBSIDIARIES
(A Company in the Development Stage)
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT) (Continued)
Deficit
Common Addi- Accumulated
Preferred Stock Common Stock Stock Sub- tional During the Deferred
----------------------------------------- scriptions Paid-in Series C Series D Development Consulting
Shares Amount Shares Amount Receivable Capital Warrants Warrants Stage Expense
------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Exercise of
common stock
options - $ - 110,000 $ 2,200 $ - $ 181,575 $ - $ - $ - $ -
Issuance of
common stock and
common stock
warrants for
cash, net
of expenses - - 1,263,189 25,264 - 2,180,343 310,994 388,158 - -
Issuance of
common stock
for services - - 100,000 2,000 - 210,500 - - - -
Net loss - - - - - - - - (4,274,003) -
--------------------------------------------------------------------------------------------------------------
BALANCE as of
December 31, 1997 - - 10,129,842 202,597 (209,200) 12,113,346 310,994 388,158 (12,225,447) (40,200)
Exercise of
common stock
warrants - - 85,000 1,700 - 168,300 - - - -
Issuance of
common stock and
conversion of
Series C
warrants to
Series D
warrants - - 256,598 5,132 - (5,132)(310,994) 310,994 - -
</TABLE>
The accompanying notes to consolidated financial statements
are an integral part of these consolidated balance sheets.
F-9
<PAGE>
<TABLE>
<CAPTION>
SPECIALIZED HEALTH PRODUCTS international, INC. AND SUBSIDIARIES
(A Company in the Development Stage)
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT) (Continued)
Deficit
Common Addi- Accumulated
Preferred Stock Common Stock Stock Sub- tional During the Deferred
----------------------------------------- scriptions Paid-in Series C Series D Development Consulting
Shares Amount Shares Amount Receivable Capital Warrants Warrants Stage Expense
------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Issuance of
common stock and
common stock
warrants for
cash, net
of expenses - $ - 1,860,000 $ 37,200 $ - $ 2,518,159 $- $1,078,800 $ - $ -
Issuance of
common stock
warrants for
service - - - - - - - 163,500 - -
Cash received
for stock
subscriptions
receivable - - - - 9,000 - - - - -
Issuance of
common stock
options for
services - - - - - 7,200 - - - -
Issuance of
common stock
for services - - 25,000 500 - (13,500) - 13,000 - -
Net loss - - - - - - - - (4,197,567) -
--------------------------------------------------------------------------------------------------------------
BALANCE as of
December 31, 1998 - $ - 12,356,440 $247,129 $(200,200) $14,788,373 $- $1,954,452 $(16,423,014) $(40,200)
==============================================================================================================
</TABLE>
The accompanying notes to consolidated financial statements
are an integral part of these consolidated balance sheets.
F-10
<PAGE>
<TABLE>
<CAPTION>
SPECIALIZED HEALTH PRODUCTS international, INC. AND SUBSIDIARIES
(A Company in the Development Stage)
CONSOLIDATED STATEMENTS OF CASH FLOWS
Increase (Decrease) in Cash and Cash Equivalents
Period from
Year Ended December 31, Inception to
------------------------------------------------------- December 31,
1998 1997 1996 1998
----------------------------------------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES:
<S> <C> <C> <C> <C>
Net loss $ (4,197,567) $ (4,274,003) $ (4,093,388) $ (16,394,845)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation and amortization 430,315 220,276 203,523 957,973
Common stock issued for services - 212,500 - 231,000
Noncash consulting expense 23,700 147,000 93,800 264,500
Loss on disposition of assets 754,803 92,557 72,363 1,176,086
Changes in operating assets and liabilities:
Accounts receivable (460,156) (33,169) 349,559 (494,484)
Unbilled receivables on contracts (142,414) - - (142,414)
Inventories 69,832 (56,642) 612 (2,520)
Prepaid expenses and other 19,460 39,922 (62,796) (37,431)
Amounts due from related parties (24,808) - 122,850 (24,808)
Other assets 1,143 - - 1,143
Accounts payable (452,710) 369,262 (33,763) 25,038
Accrued liabilities 36,275 89,238 (284,690) 279,497
Amounts due to related parties (127,195) 54,043 73,152 -
Deferred royalty revenues 2,000,000 1,750,000 - 3,750,000
----------------------------------------------------------------------------
Net cash used in operating activities (2,069,322) (1,389,016) (3,558,778) (10,411,265)
----------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment (709,827) (510,656) (580,468) (2,882,908)
Purchase of patents and technology - - (2,644) (356,146)
Proceeds from the sale of assets 4,517 - - 4,517
----------------------------------------------------------------------------
Net cash used in investing activities (705,310) (510,656) (583,112) (3,234,537)
----------------------------------------------------------------------------
</TABLE>
The accompanying notes to consolidated financial statements
are an integral part of these consolidated balance sheets.
F-11
<PAGE>
<TABLE>
<CAPTION>
SPECIALIZED HEALTH PRODUCTS international, INC. AND SUBSIDIARIES
(A Company in the Development Stage)
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
Increase (Decrease) in Cash and Cash Equivalents
Period from
Year Ended December 31, Inception to
----------------------------------------------------- December 31,
1998 1997 1996 1998
-------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
<S> <C> <C> <C> <C>
Proceeds from issuance of common stock $ 2,725,359 $ 2,389,382 $ 92,700 $ 12,487,801
Proceeds from issuance of common stock warrants 1,078,800 699,152 - 1,777,952
Proceeds from stock subscriptions 9,000 - 50,300 339,300
Proceeds from issuance of preferred stock - - - 1,164,001
Proceeds from issuance of redeemable preference stock - - - 240,000
Payments on redeemable preference stock and dividends - - - (268,169)
Net repayments on stockholder loans - - - 385,000
-------------------------------------------------------------------------
Net cash provided by financing activities 3,813,159 3,088,534 143,000 16,125,885
-------------------------------------------------------------------------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
1,038,527 1,188,862 (3,998,890) 2,480,083
CASH AND CASH EQUIVALENTS AT BEGINNING OF THE PERIOD
1,441,556 252,694 4,251,584 -
-------------------------------------------------------------------------
CASH AND CASH EQUIVALENTS AT END OF THE PERIOD
$ 2,480,083 $ 1,441,556 $ 252,694 $ 2,480,083
=========================================================================
</TABLE>
SUPPLEMENTAL DISCLOSURES OF NONCASH INVESTING AND
FINANCING ACTIVITIES:
For the period from inception to December 31, 1998, the Company recorded
in-kind dividends on the redeemable preferred stock of $28,169.
For the period from inception to December 31, 1998, the Company issued common
stock for subscriptions receivable of $548,000.
For the period from inception to December 31, 1998, the Company converted
certain stockholder loans and amounts due to stockholders to common stock
totaling $485,000.
F-12
<PAGE>
SPECIALIZED HEALTH PRODUCTS INTERNATIONAL, INC. AND SUBSIDIARIES
(A Company in the Development Stage)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) NATURE OF OPERATIONS AND BUSINESS COMBINATION
Nature of Operations
Specialized Health Products International, Inc. together with its wholly owned
subsidiaries, Specialized Health Products, Inc. ("SHP"), Specialized Cooperative
Corporation ("SCC") and Iontophoretics Corporation ("IPC") (collectively, the
"Company") is a development stage company which is primarily engaged in
developing cost-effective, disposable, proprietary healthcare products designed
to limit or prevent the risk of accidental needle sticks which may cause the
spread of blood-borne diseases such as HIV/AIDS and hepatitis B. The Company's
activities since inception have focused on research and development of products,
obtaining financing, recruiting personnel and identifying and contracting with
manufacturers, distributors and strategic partners. The Company has a portfolio
of proprietary, safety healthcare products that are in various stages of
production, pre-production, development and research. The Company principally
intends to use third parties to manufacture, market and distribute its products
worldwide.
Development Stage Presentation
The Company is in the development stage and from its inception has incurred
losses. During the years ended December 31, 1998, 1997 and 1996, the Company
experienced net losses of $4,197,567, $4,274,003, and $4,093,388, respectively,
and negative cash flows from operating activities of $2,069,322, $1,389,016, and
$3,558,778, respectively. As of December 31, 1998, the Company had an
accumulated deficit of $16,423,014. These matters raise substantial doubt about
the Company's ability to continue as a going concern. The Company's continued
existence is dependent upon several factors including the Company's success in
raising sufficient funding, bringing its products to commercialization, reducing
costs and entering into favorable contracts with third-party manufacturers,
distributors and strategic partners.
The Company believes that existing cash, funds from potential technology sales,
proceeds from sale of its interest in Quantum Imaging Corporation (see Note 4)
and funds from potential development and licensing agreements (see Note 3), will
be sufficient to support the Company's operations at least through December 31,
1999. The Company's operating plan also includes raising additional funds
through issuing common stock upon the potential exercise of outstanding warrants
and/or proceeds from potential new strategic partner relationships in order for
commercialization of its products under development to not be further delayed.
Management has negotiated agreements with third parties to assist in the
development, financing, manufacturing and distribution of its products under
development or near commercialization. Nonetheless, the Company's inability to
obtain additional funding, as required, could severely impair its business
operations and there can be no assurance that the Company's operating plan will
be successful.
The Company is subject to certain other risk factors due to its development
stage status, the industry in which it competes and the nature of its
operations. Many of these factors may be unforeseen and beyond the Company's
control. These risk factors include:
a) The Company has experienced limited sales of its Safety Cradle(R) sharps
container products, the Company's only currently commercialized product.
There is no assurance that other products will be commercially viable and
no assurance can be given that the Company will have sufficient sales or a
sufficient customer base to become profitable. The business prospects of
the Company will be affected by expenses, operational issues and
uncertainties frequently encountered in the development of a business
enterprise in a competitive environment.
F-13
<PAGE>
b) The Company's need for capital during the next year or more will vary based
upon a number of factors, including the rate at which demand for products
expands, the level of sales and marketing activities for the Safety
Cradle(R) sharps container product and the level of effort needed to
develop and commercialize other products utilizing the Company's medical
needle and other technologies. If additional funds are not successfully
raised, the lack of liquidity will likely have a material adverse effect on
the Company.
c) The Company's safety medical products may not be accepted by the market.
Market acceptance of the Company's products will depend in large part upon
the Company's ability to demonstrate the operational advantages, safety,
efficacy, and cost-effectiveness of its products compared to competing
products and its ability to distribute through major medical distributors
and strategic partners.
d) Regulation is a significant factor in the development and marketing of the
Company's products and in the Company's ongoing manufacturing and research
and development activities. The Company and its products are regulated, in
part, by the Federal Food, Drug, and Cosmetic Act which is administered by
the United States Food and Drug Administration. The process of obtaining
required regulatory clearances or approvals for products can be
time-consuming and expensive.
e) The Company anticipates that it will be dependent on third party contracts
for the distribution of its products, none of which have been successful to
date.
f) The Company operates in a very competitive market and there is no assurance
that development of superior competing products and changes in technology
will not eliminate the need for the Company's products. The introduction of
competing products could adversely affect the Company's attempts to develop
and market its products successfully.
g) The Company's future success depends in part on its ability to protect its
intellectual property and maintain the proprietary nature of its technology
through a combination of patents and other intellectual property
arrangements. There can be no assurance that the protection provided by
patents will be broad enough to prevent competitors from introducing
similar products or that such patents, if challenged, will be upheld by the
courts of any jurisdiction.
h) The sale of medical devices entails an inherent risk of liability in the
event of product failure or claim of harm caused by product operation. The
Company currently maintains product liability insurance; however, there is
no assurance that the Company will be able to maintain adequate product
liability insurance with acceptable terms in the future.
Business Combination
SHP was organized in November 1993. In July 1995, SHP entered into a business
combination with Russco, Inc. wherein it became a wholly owned subsidiary of
Russco and Russco's name was changed to Specialized Health Products
International, Inc. ("SHPI"). Russco was organized in February 1986. Russco had
no significant operations and minimal capital with which to conduct its
business.
F-14
<PAGE>
At the closing of the business combination, Russco's 300,000 shares of common
stock remained outstanding as common stock of the Company and Russco issued
3,602,403 shares of its common stock for all of the issued and outstanding
shares of SHP's common stock and preferred stock. The business combination was
treated as a reverse merger for accounting purposes. SHP was determined to be
the acquiring company even though Russco issued its common shares to acquire SHP
because the stockholders of SHP received the significant majority of the
outstanding common stock of the Company. In addition, management of SHP became
the management of the Company. Because Russco had limited operations, the
business combination was accounted for as a purchase transaction with the net
assets of Russco (which were insignificant) being recorded at their estimated
fair value at the date of closing and operating results of Russco prior to the
business combination not being included with the historical operating results of
SHP.
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of SHPI
and its wholly owned subsidiaries. All material intercompany balances and
transactions have been eliminated in consolidation.
Pervasiveness of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
effect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
Cash and Cash Equivalents
Cash and cash equivalents are comprised of checking and money market accounts at
a bank. As of December 31, 1998 and 1997, the Company had demand deposits at a
bank in excess of the $100,000 limit for insurance by the Federal Deposit
Insurance Corporation. Also included in cash and cash equivalents at December
31, 1998 are investments in commercial paper having maturity dates from January
4, 1999 to March 4, 1999 with interest rates ranging from 5.50 percent to 5.53
percent. The Company intends to hold these investments until maturity. All of
the Company's cash equivalents have an original maturity of three months or
less.
Inventories
Inventories are stated at the lower of cost or market value. Cost is determined
using the first-in, first-out method.
Inventory consisted of the following at December 31, 1998 and 1997:
1998 1997
------------------ -----------------
Raw materials $ 2,520 $ 19,973
Work-in-process - 4,555
Finished goods - 47,824
------------------ -----------------
$ 2,520 $ 72,352
================== =================
F-15
<PAGE>
Property and Equipment
Property and equipment are stated at cost and consist primarily of manufacturing
molds and equipment, office furniture and fixtures and construction-in-progress.
Manufacturing molds and equipment are depreciated using the straight-line method
over seven years or the units-of-production method, whichever is greater. All
other property and equipment are depreciated using the straight-line method
based on the estimated useful lives of the related assets which are five years.
Maintenance and repairs are charged to expense as incurred and costs of
improvements and betterments are capitalized. Upon disposal or sale, the related
asset costs and accumulated depreciation are removed from the accounts and
resulting gains or losses are reflected in current operations.
Costs incurred in connection with the fabrication and construction of
manufacturing molds and equipment are capitalized as construction-in-progress.
No depreciation is recognized on these assets until they are placed in service.
Other Assets
Other assets consist primarily of purchased technology rights and patents, and
related patent costs such as outside legal fees. These costs are being amortized
on a straight-line basis over seven years. Accumulated amortization totaled
approximately $431,000 and $221,000 at December 31, 1998 and 1997, respectively.
Management evaluates the recoverability of these costs on a periodic basis,
based on sales of the product related to the technology, existing or expected
sales contracts, revenue trends and projected cash flows.
Long-Lived Assets
The Company accounts for impairment of long-lived assets in accordance with
Statement of Financial Accounting Standards No. 121, "Accounting for Impairment
of Long-Lived Assets and for Long-Lived Assets to be Disposed Of" ("SFAS No.
121"). SFAS No. 121 requires that long-lived assets be reviewed for impairment
when events or changes in circumstances indicate that the book value of an asset
may not be recoverable. The Company evaluates, at each balance sheet date,
whether events and circumstances have occurred that indicate possible
impairment. In accordance with SFAS No. 121, the Company uses an estimate of
future undiscounted net cash flows of the related asset or group of assets over
the remaining life in measuring whether the assets are recoverable.
During 1998, the Company elected, for various reasons, to abandon the further
manufacture and distribution of the ExtreSafe(R) Lancet Strips. As a result, the
Company wrote off $49,853 of inventory, $7,380 of patent costs, net of
accumulated amortization, and $739,924 of fixed assets, net of accumulated
depreciation, related to the discontinued product that cannot be utilized by the
Company for other purposes.
Also during 1998, the Company adjusted the estimated useful lives of certain
patents in order to properly reflect the fair market value of the patents at
December 31, 1998. As a result of the adjustment, an additional $144,169 of
amortization expense was recognized during 1998.
Revenue Recognition
Sales are recognized when product is shipped to the customer. Development fees
are recognized in the period that the related services are performed. Deferred
royalty revenues will be recognized as revenues when the related products are
sold.
Research and Development Costs
Research and development costs are expensed as incurred.
F-16
<PAGE>
Income Taxes
The Company recognizes a liability or asset for the deferred tax consequences of
temporary differences between the tax basis of assets and liabilities and their
reported amounts in the consolidated financial statements that will result in
taxable or deductible amounts in future years when the reported amounts of the
assets and liabilities are recovered or settled.
Fair Value of Financial Instruments
The book values of the Company's financial instruments approximates their fair
values. The estimated fair values have been determined using appropriate market
information and valuation methodologies.
Recent Accounting Pronouncements
During 1998, the Company adopted Statements of Financial Accounting Standards
("SFAS") No. 130, "Reporting Comprehensive Income," ("SFAS No. 130") and No.
131, "Disclosures about Segments of an Enterprise and Related Information"
("SFAS No. 131"). SFAS No. 130 requires an "all-inclusive" approach which
specifies that all revenues, expenses, gains and losses recognized during the
period be reported in income regardless of whether they are considered to be
results of operations of the period. SFAS No. 131 establishes new standards for
public companies to report information about their operating segments, products
and services, geographic areas and major customers. These statements did not
have an impact on the Company's consolidated financial statements for the year
ended December 31, 1998. As the Company generated no amounts within the
definitional requirements of comprehensive income and the Company has only one
operating segment.
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivatives Instruments and Hedging Activities." This statement
establishes accounting and reporting standards requiring that every derivative
instrument be recorded on the balance sheet as either an asset or liability
measured at fair value. The statement also requires that changes in the
derivative's fair value be recognized currently in earnings unless specific
hedge accounting criteria are met. This statement is effective for fiscal years
beginning after June 15, 1999, and is not expected to have a material impact on
the Company's consolidated financial statements.
Basic and Diluted Net Loss Per Common Share
As a result of the Company incurring net losses for all periods presented, both
basic and diluted net loss per common share are based on the weighted average
number of common shares outstanding. Stock options and warrants prior to
conversion are not included in the calculation of diluted net loss per common
share because their inclusion would be antidilutive, thereby reducing the net
loss per common share. The Company has common stock options and warrants
outstanding at December 31, 1998 that, if exercised, would result in the
issuance of an additional 5,903,287 shares of common stock.
Reclassifications
Certain reclassifications have been made in the prior years' consolidated
financial statements to conform to the current year presentation.
F-17
<PAGE>
(3) DISTRIBUTION AND LICENSE AGREEMENTS
Becton Dickinson and Company
In August 1996, the Company entered into an exclusive distribution agreement
with Becton Dickinson and Company Sharps Disposal Systems Division relating to
the Company's Safety Cradle(R) sharps container products. The agreement granted
Becton Dickinson an exclusive worldwide right to market and distribute the
Company's sharps containers products for an initial term of three years. The
first sales pursuant to the agreement occurred in the first quarter of 1997;
however, as a result of Becton Dickinson's failure to meet minimum purchase
requirements set forth in the agreement, the Company terminated the agreement
during 1998. Sales of the Safety Cradle(R) sharps containers through December
31, 1998 have been minimal.
In May 1997, the Company entered into an exclusive license agreement with Becton
Dickinson and Company Infusion Therapy Division relating to a single application
of the Company's ExtreSafe(R) safety needle withdrawal technology. Pursuant to
the terms of the agreement, Becton Dickinson paid $1,750,000 to the Company in
June 1997, $250,000 in September 1997 and $2,000,000 in April 1998. Of these
total payments, $3,750,000 represents prepaid royalties and $250,000 represents
a one-time product development fee. Becton Dickinson is also required to pay
ongoing royalties to the Company based on sales of products utilizing the
technology. In addition, beginning in Becton Dickinson's fiscal year 2002, it is
required to pay minimum royalties in order to maintain exclusive rights under
the agreement.
Johnson & Johnson Medical, Inc.
In December 1997, the Company entered into an agreement with Johnson & Johnson
Medical, Inc. to commercialize two applications of the Company's safety needle
technologies in one restricted field-of-application of the technology. The
agreement provides for monthly development payments by Johnson & Johnson,
sharing of field related patent costs, payments for initial periods of low
volume manufacturing, an ongoing royalty stream and a Johnson & Johnson
investment in molds, assembly equipment and other capital costs related to
commercialization of each product.
The agreement also provides for an ongoing joint cooperative program between
Johnson & Johnson and the Company which derives future funding directly from
sales of Company created products, low volume manufacturing revenue for the
Company and an ongoing royalty stream for additional safety products which are
jointly approved for development. During 1998, the Company and Johnson & Johnson
reached arrangements whereby they are pursuing development and commercialization
of four additional products under their joint cooperative program.
Alliance Medical
The Company entered into a distribution agreement with New Alliance of
Independent Medical Distributors, Inc., dba Alliance Medical, effective
September 1997. The agreement provided for the Company to manufacture and
Alliance Medical to market and sell the ExtreSafe(R) Lancet Strip on an
exclusive basis in various markets. Effective March 1, 1998, the agreement was
converted to a non-exclusive agreement with no sales minimums so that the
Company could pursue additional sources of distribution. Thereafter, the Company
elected to abandon the further manufacture and distribution of the ExtreSafe(R)
Lancet Strip (see Note 2). Sales of the ExtreSafe(R) Lancet Strips through
December 31, 1998 were minimal.
F-18
<PAGE>
(4) INVESTMENT IN QUANTUM IMAGING CORPORATION
In October 1995, the Company entered into a joint venture agreement with Zerbec,
Inc. ("Zerbec"). Under the terms of the agreement, the Company and Zerbec formed
Quantum Imaging Corporation ("QIC"), a Utah corporation, to develop,
manufacture, distribute and market products and technologies using a patented
solid state filmless digitized imaging system. For a 50 percent interest in QIC
(before considering potential dilution as a result of not meeting funding
requirements), the Company was obligated to pay QIC $15,000 a month, which in
turn was paid to Zerbec to perform research and development on QIC's behalf
through March 31, 1997. The Company was also obligated to pay the general and
administrative expenses of QIC up to $15,000 per month through March 31, 1997.
Subsequent to March 31, 1997, the Company continued to pay certain research and
development and general and administrative expenses. The Company provided
funding to QIC of approximately $469,300, $244,800 and $435,200 during 1998,
1997 and 1996, respectively, all of which the Company expensed and QIC used to
fund research and development and to cover administrative expenses. The Company
accounts for its investment using the equity method. Assets and liabilities of
QIC were insignificant as of December 31, 1998 and 1997.
In the fourth quarter of 1998, QIC entered into a non-binding letter of intent
for U.S. Healthcare, LC to acquire QIC. Although discussions with U.S.
Healthcare are ongoing, the transaction has not been completed and there can be
no assurance that the transaction will be completed or that if completed it will
be on terms that are favorable to the Company. Subsequent to December 31, 1998,
Zerbec exercised its option to acquire two thirds of the Company's interest in
QIC for nominal consideration. As a result of Zerbec exercising its rights, the
Company's ownership was reduced to approximately 17 percent of the outstanding
common stock of QIC. The Company continues to negotiate alternative arrangements
with Zerbec.
(5) TECHNOLOGY OPTION TO PURCHASE AGREEMENTS
In June 1998, the Company entered into an Option to Purchase Agreement (the
"Option Agreement") with the University of Texas System to purchase certain
patents and related technology, research and development for a total purchase
price of $2,400,000. In accordance with the Option Agreement, a $240,000
non-refundable payment was made in July 1998 with the balance of $2,160,000 to
be paid within 30 days of the exercise of the purchase option. The Company
retained the exclusive right to exercise the option and acquire the patents and
related technology for a period of one year from the date of the execution of
the Option Agreement, or within 14 days of notification of successful completion
of an animal toxicity study. The Company received notice of successful
completion of the toxicity studies in February 1999 and subsequently entered
into two amendments to the Option Agreement resulting in an extension of the
exercise period to May 1999 in exchange for payments totaling $65,000. The
Company anticipates reimbursement of a portion of these fees from a third party
who is potentially interested in acquiring the technology from the Company upon
exercise of the option.
In connection with this Option Agreement, the Company entered into consulting
agreements with three individuals who were the principal inventors of the
technology. These consulting agreements provide for the individuals to assist
the Company to successfully develop the related technology. The individuals are
to provide a minimum of 50 hours of services annually for which they will be
compensated at a rate of $150 per hour. Each individual also executed stock
option agreements with the subsidiary corporation, IPC, which is the entity
entering into the Option Agreement and the individual consulting agreements. The
stock option agreements provide for the individuals to purchase up to 40,000
shares of IPC common stock at an exercise price of $.01 per share in 10,000
share increments based on achieving certain milestone events in the future. The
Company has recorded $7,200 of consulting expense in the accompanying
consolidated financial statements related to the granting of these options.
F-19
<PAGE>
(6) COMMITMENTS AND CONTINGENCIES
Lease Obligations
The Company leases office space, equipment, and vehicles under noncancelable
operating leases. The following summarizes future minimum lease payments under
operating leases at December 31, 1998:
Year Ending December 31,
1999 $ 305,736
2000 285,425
2001 276,963
2002 276,368
2003 69,092
-----------------
$ 1,213,584
=================
Rental expense for the years ended December 31, 1998, 1997 and 1996 totaled
approximately $204,000, $80,300 and $72,000, respectively.
Royalty Agreements
In connection with acquiring technology rights and patents, the Company entered
into various royalty agreements. Generally, the agreements required royalties to
be paid based on various percentages of revenues generated from the related
technologies or patents. In order to maintain certain licenses, the Company was
obligated to pay minimum royalties, of which the Company paid $20,000 during
1998. As the Company has not generated any revenue from licensed technology
rights and patents at December 31, 1998, no additional royalties were accrued or
paid.
The Company elected to abandon the further manufacture and distribution of the
product utilizing the technology encompassed by one of these royalty agreements.
As a result, the royalty agreement was terminated by the Company and related
technology rights and patents were forfeited during 1998. All inventory, patents
and fixed assets used in the manufacture of the discontinued product, which
cannot be utilized by the Company for other purposes, were written off in the
current year (see Note 2).
In January 1998, the Company issued warrants to purchase 750,000 common shares
with an exercise price of $2.00 per share to a director and officer of the
Company and his assigns in consideration of the Company's release from its
obligations under certain royalty agreements (see Note 11). As a result of these
events, the Company has no further obligations under royalty agreements as of
December 31, 1998.
Employment Agreements
The Company has entered into employment agreements with three of its key
employees. The agreements are each for a term of three years and provide for an
annual aggregate base salary of $486,000 to be reviewed annually by the Board of
Directors and adjusted as deemed appropriate. Upon termination of employment
without cause, salary and certain benefits will continue to be paid through the
expiration of the applicable agreement. The agreements have customary provisions
for other benefits and include noncompetition clauses.
In December 1998, one of the agreements was amended to allow for two cash
payments totaling $107,500 in exchange for outstanding common stock warrants
held by the employee. The exchange may be elected by the employee if the fair
market value of the Company's common stock does not reach specified amounts by
January 31, 1999 and January 31, 2000. Additionally, the January 31, 2000
exchange may be accelerated, at the employee's option, should the Company's
F-20
<PAGE>
consolidated cash position fall below a specified level during the period June
30, 1999 through January 31, 2000. On January 31, 1999, the Company paid $50,000
to the employee upon exercise of the first option (see Note 13).
Litigation
In April 1997, the Company entered into an agreement with Leerink Swann &
Company, whereby Leerink agreed to assist the Company in raising funds in a
private placement of equity securities. Sufficient funding was deposited into
escrow to hold an initial closing, but the closing did not occur. Leerink
alleges that the Company refused to close on the placement. The Company alleges
that the closing did not occur because Leerink, as a condition precedent to
closing, made certain pre-closing demands that went far beyond the terms of the
agreement and which demands Company management believes were not in the best
interest of the Company. In August 1997, Leerink filed suit in the United States
District Court for the District of Massachusetts alleging breach of contract.
Leerink is seeking compensatory damages, warrants to purchase shares of the
Company's common stock, treble damages and reasonable attorneys' fees and costs.
In October 1997, the Company filed a counterclaim also alleging breach of
contract. The Company is seeking money damages, treble damages, reasonable
attorneys' fees and costs. This matter has been scheduled for trial in July
1999. The Company believes that Leerink's claims are without merit and that the
Company will ultimately prevail. The litigation is subject to all of the risks
and uncertainties of litigation and thus there is no assurance that the Company
will be successful in this lawsuit or that the lawsuit will be resolved on
acceptable terms, and the Company may incur significant costs in asserting its
claims and defenses. As of December 31, 1998, management, after consultation
with legal counsel, believes that the potential liability to the Company under
such action will not materially affect the Company's consolidated financial
position or results of operations.
(7) STOCK OPTIONS
During 1994, the Board of Directors of SHP approved a nonqualified stock option
plan for its officers, directors and employees, and authorized 396,000 shares of
common stock for issuance. During 1994, options to acquire 396,000 common shares
were granted at prices ranging from $.39 to $1.11 per share. The exercise prices
of the options were equivalent to the estimated fair market value of the
underlying stock as determined by SHP's Board of Directors at the dates of
grant. No options were exercised or lapsed during 1994. On the date of the
business combination, as discussed in Note 1, all of the options issued under
the plan became outstanding obligations of the Company. On September 1, 1995,
options to acquire 288,000 shares were exercised, primarily by directors and
officers of the Company, from which the Company received $209,500 in
non-interest bearing common stock subscriptions receivable. All common stock
subscriptions receivable are due upon demand. During 1996, options to acquire
45,000 shares were exercised at $.39 per share and 22,500 options were canceled.
The remaining 40,500 options became exercisable during 1997, of which 22,500
were exercised at $.39 per share. As of December 31, 1998, 18,000 options are
exercisable at $.39 per share.
Effective September 1995, the Company's Board of Directors approved the adoption
of the Specialized Health Products International, Inc. Stock Option Plan. The
plan is a nonqualified stock option plan and is administered by the Board of
Directors. The plan provided for the issuance of 1,500,000 shares of common
stock to officers, directors, other key employees and consultants. The exercise
prices of the options granted under this plan were not less than 100 percent of
the fair market value of the underlying common stock on the date of grant. The
options are exercisable for the period as defined by the Board of Directors at
the date granted; however, no stock option will be exercisable more than five
years from the date of grant.
Effective August 1998, adoption of the Specialized Health Products
International, Inc. 1998 Stock Option Plan was approved by the Company's Board
of Directors. The plan is a nonqualified stock option plan and is administered
by the Board of Directors. The plan provides for the issuance of up to 2,000,000
shares of common stock to directors, officers, employees and consultants. The
exercise prices of the options granted will not be less than the greater of
$2.00 per share of common stock or the fair market value (or 110 percent of such
fair market value when the optionee is a ten percent stockholder) of the
F-21
<PAGE>
underlying common stock on the date of grant. The options are exercisable for a
period not to exceed ten years (or five years when the optionee is a ten percent
shareholder) from the date of grant.
As permitted by SFAS No. 123, the Company applies APB Opinion No. 25 ("APB No.
25") and related interpretations in accounting for certain aspects of its
stock-based compensation plans. Accordingly, no compensation cost has been
recognized for stock options granted to officers, directors and other key
employees as options were granted at the intrinsic fair market value. The
Company recognized $23,700, $147,000, and $93,800 of consulting expense during
1998, 1997, and 1996, respectively, related to certain options and warrants
granted to nonemployee consultants in accordance with SFAS No. 123.
Had compensation cost been determined based on the fair value at the grant date
for awards under its plans consistent with the method prescribed by SFAS No.
123, the Company's net loss and basic and diluted net loss per common share
would have been increased to the pro forma amounts presented below:
1998 1997 1996
------------ ------------ --------------
Net loss: As reported $(4,197,567) $(4,274,003) $(4,093,388)
Pro forma (4,769,148) (4,445,885) (4,130,140)
Basic and diluted
net loss per
common share: As reported (.35) (.47) (.48)
Pro forma (.39) (.48) (.48)
Because the SFAS No. 123 method of accounting has not been applied to options
and certain warrants granted prior to January 1, 1995, the resulting pro forma
compensation cost may not be representative of that to be expected in future
years.
A summary of the status of the Company's option plans as of December 31, 1998,
1997 and 1996, and changes during the years ended on those dates is presented
below:
<TABLE>
<CAPTION>
1998 1997 1996
------------------------------- -------------------------------- --------------------------------
Wtd. Avg. Wtd. Avg. Wtd. Avg.
Exercise Exercise Exercise
Shares Prices Shares Prices Shares Prices
--------------- --------------- ---------------- --------------- --------------- ----------------
<S> <C> <C> <C> <C> <C> <C>
Outstanding at beginning of
year 1,481,500 $2.11 1,531,500 $2.10 1,279,810 $1.95
Granted 35,000 1.65 60,000 2.16 319,190 2.63
Exercised - (110,000) .88 (45,000) .39
Forfeited (23,000) 1.55 - (22,500) .39
--------------- ---------------- ---------------
Outstanding at
end of year 1,493,500 2.11 1,481,500 2.11 1,531,500 2.10
=============== ================ ===============
Exercisable at
end of year 1,307,905 2.06 1,217,405 2.06 1,187,000 2.04
=============== ================ ===============
Weighted average fair value
of options granted $ .74 $ 1.00 $ 1.24
=============== ================ ===============
</TABLE>
F-22
<PAGE>
<TABLE>
<CAPTION>
The following table summarizes information about the stock options outstanding
at December 31, 1998:
Options Outstanding Options Exercisable
Number Wtd. Avg. Number
Outstanding Remaining Wtd. Avg. Exercisable Wtd. Avg.
Range of At December Contractual Exercise at December Exercise
Exercise Prices 31, 1998 Life Price 31, 1998 Price
------------------------ ------------------ ----------------- -------------- -------------------- -----------------
<S> <C> <C> <C> <C> <C> <C>
$ 0.3900 18,000 0.57 years $ 0.3900 18,000 $ 0.3900
1.2500 10,000 4.85 1.2500 10,000 1.2500
1.6250 5,000 4.60 1.6250 5,000 1.6250
1.7500 5,000 4.44 1.7500 5,000 1.7500
1.8125 10,000 4.38 1.8125 - -
2.0000 1,074,310 1.67 2.0000 1,074,310 2.0000
2.0625 55,000 3.93 2.0625 - -
2.6250 316,190 2.82 2.6250 195,595 2.6250
================== ====================
$.39 to 2.625 1,493,500 $ 2.1070 1,307,905 $ 2.0630
================== ====================
</TABLE>
The fair value of each option granted is estimated on the date of grant using
the Black-Scholes option pricing model with the following weighted-average
assumptions used for grants in 1998, 1997, and 1996: risk-free interest rate of
6.0 percent, 6.0 percent, and 5.95 percent, respectively; expected lives of 2.4
years, 3 years, and 2.3 years, respectively; expected dividend yields of zero
percent in all years; expected volatility of 68 percent in all years.
In calculating the pro forma net loss and pro forma basic and diluted net loss
per share, the Company has also included the effect of 800,000 common stock
warrants issued to a director and officer (see Notes 6 and 11) and an employee
of the Company during 1998. The issuance of the warrants were accounted for in
accordance with APB No. 25. For disclosure purposes under SFAS No. 123, the fair
value of each warrant granted was estimated on the date of grant using the
Black-Scholes option pricing model with the following weighted-average
assumptions used: risk-free interest rate of 6.0 percent; expected lives of 2
years; expected dividend yield of zero; expected volatility of 68 percent.
(8) RECENT CAPITAL TRANSACTIONS
In March 1997, the Company closed a private placement offering wherein the
Company raised $1,539,570, net of expenses, through offering Units to certain
accredited investors at $45 per Unit. Each Unit consisted of 15 shares of the
Company's common stock and Series C warrants to purchase five shares of the
Company's common stock at a price of $3.00 per share. The Company allocated
$1,228,576 of the total net proceeds to the common stock issued and $310,994 to
the Series C warrants issued.
During 1997, the Company issued 100,000 shares of its common stock to a
nonaffiliated stockholder of the Company for consulting and other services
provided. The Company recorded consulting expense of $212,500, which was equal
to the fair market value of the stock on the date of issue.
In January 1998, the Company completed a private placement offering in which it
sold 2,610,000 units at $2.00 per unit for total consideration of approximately
$4,948,500, net of expenses. Each unit consists of one share of the Company's
common stock and one Series D warrant to purchase one share of common stock at a
price of $2.00. Of the total net proceeds, approximately $1,365,200 was received
in December 1997 and approximately $3,583,300 was received in January 1998. The
Company allocated approximately $1,350,800 of the total proceeds to the Series D
warrants based on their relative fair values. Of the total units, 750,000 were
sold in December 1997 and 1,860,000 were sold in January 1998.
F-23
<PAGE>
Pursuant to requirements of the private placement offering in January 1998, the
Company provided accredited investors in the Company's March 1997 private
placement offering with the opportunity to exchange the securities purchased in
the March 1997 placement for a number of units the investor could have purchased
in the January 1998 placement had the investment been made under the January
1998 placement terms rather than the March 1997 terms. In February 1998, all of
the March 1997 accredited investors elected to convert to the January 1998
placement terms in reliance on the registration exemption found in Rule 506 of
Regulation D and Sections 3(9) and 4(2) of the Securities Act. As a result of
the conversion, all outstanding Series C warrants were canceled and the Company
issued 256,598 additional shares of common stock and 769,787 additional Series D
warrants.
The Series D warrants are exercisable for a period of two years from the
effective date of a registration statement covering the resale of the shares of
common stock underlying the Series D warrants by the holder, which period shall
be extended day-for-day for any time that a prospectus meeting the requirements
of the Securities Act of 1933 is not available. The Company may accelerate the
expiration of the Series D warrants in the event that the average market price
of the Company's common stock exceeds $6.00 per share for ten consecutive
trading days. In the event the Company accelerates the expiration of the Series
D warrants, the holders of the Series D warrants would be permitted to exercise
the Series D warrants during a period of not less than 20 days following notice
of such event.
In March 1998, the Company issued 25,000 shares of common stock and 25,000
Series D warrants to an unaffiliated financial advisor in connection with the
January Private Placement. The fair market value of these shares and options
were offset against the gross private placement proceeds as offering costs.
In July 1998, certain Series B warrants were exercised resulting in the issuance
of 85,000 shares of common stock with proceeds to the Company of $170,000. The
remaining outstanding Series A and B warrants have expired.
(9) INCOME TAXES
The Company recognized no income tax expense in 1998, 1997 and 1996 due to net
operating losses. The Company did not record the expected tax benefit related to
the net operating losses and other deferred tax assets as management established
a valuation allowance against the entire amount of those assets. Significant
components of the Company's deferred income tax assets and deferred income tax
liabilities as of December 31, 1998 and 1997, are comprised of the following:
1998 1997
----------------------------------
Deferred income tax assets:
Net operating loss carryforwards $ 4,015,349 $ 3,638,806
Deferred royalty revenue 1,398,750 652,750
Non cash compensation expense 63,671 54,831
Accrued vacation 32,251 48,870
Loss on disposition of assets 267,780 38,268
Patent costs 212,956 121,186
Other 44,847 9,882
----------------------------------
Total gross deferred income tax assets 6,035,604 4,564,593
Less valuation allowance (5,701,271) (4,329,105)
----------------------------------
Net deferred income tax assets 334,333 235,488
Deferred income tax liability -
Property and equipment (334,333) (235,488)
----------------------------------
Net deferred income tax liability $ - $ -
==================================
F-24
<PAGE>
The net change in the total valuation allowance for the years ended December 31,
1998 and 1997, was an increase of $1,372,166 and $1,534,223, respectively.
At December 31, 1998, the Company had total tax net operating losses of
approximately $10,765,000 that can be carried forward to reduce federal income
taxes. If not utilized, the tax net operating loss carryforwards begin to expire
in 2009. As defined in Section 382 of the Internal Revenue Code, the Company has
undergone a greater than 50 percent ownership change. Consequently, a certain
amount of the Company's tax net operating loss carryforwards available to offset
future taxable income in any one year may be limited. The maximum amount of
carryforwards available in a given year is limited to the product of the
Company's value on the date of ownership change and the federal long-term
tax-exempt rate, plus any limited carryforwards not utilized in prior years.
(10) EMPLOYEE BENEFIT PLAN
Effective January 1, 1996, the Company adopted the Specialized Health Products
401(k) Plan. Employees who are 21 years of age are eligible for participation in
the plan and may elect to make contributions to the plan. The Company matches
100 percent of such contributions up to five percent of the individual
participant's compensation. The Company's combined contribution to the plan was
approximately $66,900, $52,100 and $37,100 for the years ended December 31,
1998, 1997 and 1996, respectively.
(11) RELATED-PARTY TRANSACTIONS
In 1995, the Company entered into an agreement with a former director, the
president and a vice president of the Company, whereby these individuals had the
opportunity to receive up to an aggregate of 2,000,000 additional shares of
common stock based upon pre-tax consolidated income over a certain period of
time. The Company did not reach the levels specified in the agreement for any
period. As such, the earn-out shares did not vest and the agreement expired
effective December 31, 1998.
During 1998, 1997 and 1996, the Company advanced approximately $28,700, $7,600
and $121,800, respectively, to a former director and stockholder of the Company.
The advances were non-interest bearing and were repaid in full during 1998. In
addition, the Company paid to an entity, owned in part by this same former
director and stockholder, approximately $100,300 and $203,100 (including
reimbursement of costs) during 1997 and 1996, respectively, for consulting and
professional services rendered on behalf of the Company.
The Company had entered into certain license agreements with a director and
officer of the Company as a result of the acquisition of certain technology
rights and patents. Under the terms of the agreements, the Company was obligated
to pay minimum royalty payments totaling $435,000 over six years. In January
1998, the Company issued 750,000 common stock warrants as consideration for a
release from its obligations under these royalty agreements (see Note 6). Each
warrant is redeemable for one share of the Company's common stock at a price of
$2.00 per share. The warrants are currently exercisable and expire on December
31, 2002.
During 1997, the Company made a loan of approximately $182,500 to one of its
directors and officers. The loan bore interest at eight percent and was repaid
in full prior to December 31, 1997.
In December 1997, the Company borrowed $45,000 from one of its directors and
officers to assist in the cash flow needs of the Company. The loan bore interest
at 10 percent and was repaid in full in January 1998.
In January 1998, 1,000,000 shares of the Company's common stock and 1,000,000
Series D common stock warrants were issued to Johnson & Johnson Development
Corporation in conjunction with the private placement offering closed on January
20, 1998. Johnson & Johnson owns 8.3 percent of the Company.
F-25
<PAGE>
During 1998, the Company paid certain consulting and other expenses of
approximately $10,000 on behalf of QIC. The resulting receivable, which has been
included in "amounts due from related parties" in the accompanying consolidated
balance sheet, will be repaid upon completion of the proposed sale of QIC (see
Note 4).
As of December 31, 1998, the Company was due approximately $9,000 from a former
officer and director of the Company for a non-interest bearing advance made
during the year. The balance was repaid in full in January 1999.
During 1998, the Company advanced approximately $3,700 to an employee and $1,700
to a director and officer of the Company. The advances are non-interest bearing,
are repayable during 1999, and have been included in "amounts due from related
parties" as of December 31, 1998 in the accompanying 1998 consolidated balance
sheet.
In January and February 1999, the Company entered into consulting agreements
with a former director and officer of the Company and relatives of a director
and officer of the Company. Under the agreements, the Company will pay
approximately $22,700 per month for consulting services rendered in connection
with financing and development activities.
(12) SUBSEQUENT EVENTS
In January 1999, the Company granted to various employees options to acquire
190,000 shares of the Company's common stock at an exercise price of $2.00 per
share. The options vest over a three-year period and are exercisable for a
period of ten years from the date of grant.
In February 1999, the Company granted to non-employee directors options to
acquire a total of 16,000 shares of the Company's common stock at an exercise
price of $2.00 per share. The options vest on December 31, 1999 and are
exercisable for a period of ten years from the date of grant.
In February 1999, the Company paid $50,000 to an employee in exchange for
cancellation of 25,000 common stock warrants held by the employee. The exchange
was made pursuant to exercise of the employee's option as provided for in the
employment agreement (see Note 6).
F-26
SCHEDULE OF SUBSIDIARIES
Name of Subsidiary State of Incorporation
Specialized Health Products, Inc. Utah
Specialized Cooperative Corporation Utah
Iontophoretics Corporation Utah
Quantum Imaging Corporation Utah
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the incorporation by
reference of our report included in this Form 10-K, into Specialized Health
Products International, Inc.'s previously filed Registration Statement on Form
S-3 File No. 333-50481.
ARTHUR ANDERSEN LLP
Salt Lake City, Utah
April 14, 1999
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM FINANCIAL
STATEMENTS FOR THE YEAR ENDED DECEMBER 31, 1998 AND IS QUALIFIED IN ITS ENTIRETY
BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> DEC-31-1998
<CASH> 2,480,083
<SECURITIES> 0
<RECEIVABLES> 494,484
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<INVENTORY> 2,520
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<PP&E> 1,630,129
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<OTHER-SE> 79,411
<TOTAL-LIABILITY-AND-EQUITY> 4,381,075
<SALES> 10,202
<TOTAL-REVENUES> 1,039,136
<CGS> 8,048
<TOTAL-COSTS> 831,194
<OTHER-EXPENSES> 205,064
<LOSS-PROVISION> 0
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<INCOME-PRETAX> (4,197,567)
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<NET-INCOME> (4,197,567)
<EPS-PRIMARY> (.35)
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