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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-KSB
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1996
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from. . . . . . to. . . . . .
Commission file number 0-20532
LIFEQUEST MEDICAL, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 74-2559866
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
9601 MCALLISTER FREEWAY, SUITE 1120
SAN ANTONIO, TEXAS 78216
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (210) 366-2100
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SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
Common Stock, $.001 par value
(TITLE OF CLASS)
INDICATE BY CHECK MARK WHETHER THE REGISTRANT (1) HAS FILED ALL
REPORTS REQUIRED TO BE FILED BY SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934 DURING THE PRECEDING 12 MONTHS (OR FOR SUCH SHORTER PERIOD THAT THE
REGISTRANT WAS REQUIRED TO FILE SUCH REPORTS), AND (2) HAS BEEN SUBJECT TO SUCH
FILING REQUIREMENTS FOR THE PAST 90 DAYS. YES X NO .
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INDICATE BY CHECK MARK IF DISCLOSURE OF DELINQUENT FILERS PURSUANT TO
ITEM 405 OF REGULATION S-B IS NOT CONTAINED HEREIN, AND WILL NOT BE CONTAINED,
TO THE BEST OF REGISTRANT'S KNOWLEDGE, IN DEFINITIVE PROXY OR INFORMATION
STATEMENTS INCORPORATED BY REFERENCE IN PART III OF THIS FORM 10-KSB OR ANY
AMENDMENT TO THIS FORM 10-KSB____
REGISTRANT'S REVENUES FOR FISCAL YEAR ENDED DECEMBER 31, 1996:
$3,850,000
AT MARCH 18, 1997 (BASED UPON THE LAST REPORTED SALES PRICE OF $5.00
PER SHARE), THE AGGREGATE MARKET VALUE OF THE COMMON STOCK, $.001 PAR VALUE, OF
THE REGISTRANT HELD BY NON-AFFILIATES WAS APPROXIMATELY $21.9 MILLION. AT MARCH
18, 1997, THERE WERE OUTSTANDING 5,712,641 SHARES OF COMMON STOCK, $.001 PAR
VALUE, OF THE REGISTRANT.
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DOCUMENTS INCORPORATED BY REFERENCE
<TABLE>
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DOCUMENT FORM 10-KSB PART
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<S> <C>
Definitive Proxy Statement for 1997 Annual Meeting Part III, Items 9, 10, 11 and 12
Transitional Small Business Disclosure Format. YES NO X .
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PART I
ITEM 1. BUSINESS
GENERAL
LifeQuest Medical, Inc. (the "Company") and its subsidiaries,
LifeQuest Endoscopic Technologies, Inc., Klein Medical, Inc., Val-U-Med, Inc.,
and ValQuest Medical, Inc. are engaged in the development, manufacture and
distribution of instruments, equipment and surgical supplies used in minimally
invasive surgery ("MIS").
MIS, a rapidly growing field, involves surgical procedures,
accomplished without a major incision, through strategically placed punctures
in a patient's body. These procedures generally result in reduced patient
discomfort, reduced risks of infection and greatly shortened hospitalization,
thereby decreasing overall costs. MIS products include a wide variety of
reusable and disposable items such as endoscopes, trocars, trocar
sleeves/cannulas, video systems, mechanical and laser-related cutting devices,
stapling systems, electrocautery systems, suction and irrigation systems,
graspers and dissectors, and hand- operated retractors. The products are used
by surgeons in hospitals and outpatient surgery facilities.
In December 1996, the Company acquired Val-U-Med, Inc. ("Val-U-Med"),
and in November 1996 the Company acquired Klein Medical, Inc. ("Klein"). Klein
and Val-U-Med are private companies located in San Antonio, Texas and Atlanta,
Georgia, respectively. Both companies, which are wholly owned subsidiaries of
the Company, distribute instruments, equipment and surgical supplies used in
MIS.
In February 1996, the Company completed the merger of GM Engineering,
Inc., ("GME") a private company, with and into LifeQuest Endoscopic
Technologies, Inc. ("LQET"), a wholly owned subsidiary of the Company. LQET
develops and manufactures MIS products at its facilities located in La Verne,
California.
In May 1994, the Company and Valdor Fiber Optics ("Valdor") of San
Jose, California, formed a corporate venture, ValQuest, which is an 82% owned
subsidiary of the Company. ValQuest's patented Impact Mount(TM) technology is
being used to develop proprietary, autoclavable (heat sterilizable) flexible
fiber optic endoscopes which are expected to have broad applications in the MIS
field.
The Company intends to continue to allocate its resources toward
becoming a significant competitor in the MIS market by utilizing the combined
capabilities of its subsidiaries to expand its geographical distribution
coverage in the U.S. and add relevant new products to its existing line through
internal development, licensing and acquisition.
The Company is also a party to manufacturing agreements with various
companies in the medical instrument industry, under which the Company produces
selected MIS products for private labeling. In the future, the Company intends
to introduce a number of additional MIS products for the domestic and
international MIS markets.
The Company was incorporated on December 23, 1988, as a Delaware
corporation and commenced operations on January 1, 1989. In August 1992, the
Company completed its initial public offering of common stock, $.001 par value
("Common Stock") which is quoted on the NASDAQ SmallCap Market. The Company's
executive offices are located at 9601 McAllister Freeway, Suite 1120, San
Antonio, Texas 78216, and its telephone number is (210) 366-2100.
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RECENT ACQUISITIONS
Klein Medical
In November 1996, the Company completed the merger (the "Klein
Merger") of Klein with and into Klein Medical Acquisition Co., a Nevada
corporation ("KMI") and wholly owned subsidiary of the Company, with KMI as the
surviving corporation. KMI distributes instruments, equipment and surgical
supplies used in MIS. The Klein Merger was consummated under a Plan of Merger
and Acquisition Agreement, among the Company, Klein, KMI and Richard H. Klein,
as sole shareholder of KMI, pursuant to which Richard H. Klein received the
right to receive an aggregate of 600,000 shares of the Company's Common Stock.
Val-U-Med
In December 1996, the Company completed the merger (the "Val-U-Med
Merger") of Val-U-Med with and into Val-U-Med Acquisition Co., a Nevada
corporation ("VMI") and wholly owned subsidiary of the Company, with VMI as the
surviving corporation. VMI distributes instruments, equipment and surgical
supplies used in MIS. The Val-U-Med Merger was consummated under a Plan of
Merger and Acquisition Agreement, among the Company, Val-U-Med, VMI and the
shareholders of VMI (the "VMI Shareholders"), pursuant to which the VMI
Shareholders received the right to receive an aggregate of 1,200,000 shares of
Common Stock and an aggregate of $400,000.
GM Engineering
In February 1996, the Company completed the merger (the "GM Merger")
of GME with and into LQET. Prior to the GM Merger, GME, a private company
located in La Verne, California, was primarily engaged in the development,
manufacture and marketing of surgical and related instruments used in MIS.
Under the terms of the Plan of Merger and Acquisition Agreement dated February
13, 1996, but effective as of January 1, 1996, the principal shareholders of
GME received 350,000 shares of Common Stock, along with the right to exercise
one piggy-back registration following the expiration of 12 months.
The ValQuest Venture
In May 1994, the Company and Valdor formed ValQuest as a corporate
venture between the two companies. In accordance with the terms of the venture
agreement, Valdor transferred to ValQuest the exclusive worldwide rights to
develop, manufacture, and market all medical applications of Valdor's patented
Impact Mount(TM) fiber optic connector technology. The Company paid $100,000 to
Valdor in connection with the transfer of these rights and contributed $400,000
to be used as working capital in exchange for a 55% interest in ValQuest.
Subsequent purchases of stock of ValQuest by the Company have increased the
Company ownership, making ValQuest a 82% owned subsidiary of the Company.
INDUSTRY BACKGROUND
The health care industry continues to undergo change, led primarily by
market forces which are demanding greater efficiencies and reduced costs.
Government proposed health care mandates in the United States have not
occurred, and it is unclear whether, and to what extent, any future government
mandate will affect the domestic health care market. Industry led changes are
expected to continue irrespective of any governmental efforts toward health
care reform. The scope and timing of any further government sponsored proposals
for health care reform are presently unclear.
The primary trend in the industry is toward cost containment. Payors
and managed care organizations have been able to exercise greater influence
through managed treatment and hospitalization patterns, including a shift from
reimbursement on a retrospective basis to prospective limits for patient
treatment. Hospitals have been severely impacted by the resulting cost
restraints and are competing for business and becoming more sophisticated in
management and marketing. The increasing use of managed care, centralized
purchasing decisions, consolidations among hospitals and hospital groups, and
integration of health care providers, are continuing to affect purchasing
patterns in the health care system. Purchasing decisions are often shared by a
coalition of surgeons, nursing staff, and hospital administrators, with
purchasing decisions taking into account whether a product reduces the cost of
treatment and/or attracts additional patients to a hospital. All of these
factors along with competition, have contributed to continuing reductions in
prices for the Company's products and, in the near term, to slower acceptance
of more advanced surgical procedures in which the Company's products are used,
given hospital and surgeon concerns as to the costs of training and
reimbursement by payors. In
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addition, the primary care physician is expected to exercise significant
influence on referrals of patients for surgical procedures under managed care.
The Company could potentially benefit from this focus on cost
containment and on managed care. Minimally invasive surgery decreases operating
room time including anesthesia and patient recovery time and is highly cost
effective. Doctors, patients, employers and payors all value decreased patient
recovery time. This could lead to potential increases in volume as minimally
invasive procedures are selected over alternative techniques. However, an undue
focus on discrete costs or similar limits which fail to consider the overall
value of these advanced procedures could adversely impact the Company. Some
hospitals may also lose per night revenues through reduced post-operative care
requirements as to procedures performed by MIS, which could influence their
analysis of acceptance of newer procedures. The Company is adapting itself to
this environment by promoting the cost effectiveness of its products, by
striving to efficiently produce the highest quality products at the lowest
cost, and by assisting hospitals and payors in achieving meaningful cost
reductions for the health care system while retaining the quality of care
permitted by the Company's products.
Minimally invasive surgery refers to surgical procedures which can be
accomplished without a major incision or other traumatization to the patient,
in some cases without general anesthesia. Endoscopy is one of the most
important minimally invasive surgical techniques. In addition to decreasing
patient trauma or frequently avoiding general anesthesia, endoscopy can
substantially reduce or eliminate postoperative hospitalization, thereby
decreasing overall costs. The Company believes that the current pressures for
medical cost containment could result in greater utilization of cost-effective,
less invasive procedures. There can be no assurance, however, that greater
utilization of such procedures will result.
The availability of innovative medical technologies, patient demand
and the motivation of physicians and payors are among the driving forces behind
the movement toward, and the wide acceptance of, minimally invasive surgical
procedures. The Company believes that these minimally invasive techniques are
desired because they benefit all significant participants in the healthcare
system: the patient experiences less pain and trauma and enjoys a more rapid
recovery; surgeons and hospitals or other surgical centers that adopt these
techniques enhance their practices and reputations; and the healthcare payor
incurs lower overall costs. The Company believes that the growing acceptance of
minimally invasive surgical procedures is changing the standards of practice
over a wide range of surgical specialties and that this trend should create
significant business opportunities for manufacturers of minimally invasive
surgical products.
According to a 1995 market research report by Theta Corporation, the
United States MIS market exceeded $2 billion in 1994 and is forecast to grow at
a 17 to 22 percent rate through 1998. MIS instruments include a wide variety of
reusable and disposable items such as trocars, trocar sleeves/cannulas, video
systems, mechanical and laser-related cutting devices, stapling systems,
electrocautery systems, suction and irrigation systems, graspers and
dissectors, hand-operated retractors and insufflation devices.
PRODUCTS
The Company's wholly-owned subsidiaries, KMI and VMI, distribute a
variety of products used primarily for minimally invasive surgical procedures,
including branded products manufactured and owned by other companies as well as
branded products owned and manufactured by the Company. The list of companies
which utilize KMI and/or VMI to distribute selected products includes the
following: Origin Medsystems, Inc., ConMed Corporation, Sony Medical Products
Division, Fischer Imaging Products, Welch Allyn Imaging, MicroAire Surgical
Instruments, Endo-LTD, Microline, Inc., Innerdyne, Inc. and Urohealth.
The Company distributes disposable instruments, durable (reusable)
instruments and capital equipment. The first two categories include the
following: surgical hand instruments such as scissors, forceps, clip appliers,
tackers, and suction irrigators; surgical entry instrumentation such as
trocars, cannulas and dissection balloons; endoscopes; surgical accessories
such as insufflation tubing, Endofog and electrosurgical pens and pads;
electrosurgical instruments; and pneumatic small bone surgical instruments for
driving wire, drilling, and sawing. Capital equipment includes cameras,
electrosurgical generators, pumps, monitors, printers, telemedicine systems and
breast biopsy systems.
In addition to manufacturing selected products and components for
distribution by KMI and VMI, LQET also operates as an Original Equipment
Manufacturer ("OEM") of MIS products such as trocars, cannulas, etc. for
several U.S. medical device companies.
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BIOMEDICAL AND TECHNICAL SERVICES
The Company employs qualified technicians who provide its customers
with testing, repair and maintenance service for a wide variety of instruments,
endoscopes and capital equipment items such as generators and cameras.
SALES AND MARKETING
The Company began commercial sales of its first MIS access product in
the first quarter of 1996 following the GM Merger, and, therefore, has limited
sales, marketing and distribution experience. In the fourth quarter of 1996,
the Company completed the Klein Merger and Val-U-Med Merger. Both KMI and VMI
specialize in the sales, marketing and distribution of MIS devices and through
these subsidiaries, the Company is marketing its MIS access products as well as
the MIS products of other manufacturers, to hospitals, purchasing groups and
surgeons throughout the United States by demonstrating the economic
efficiencies of the Company's products and by assisting hospital management in
realizing the benefits associated with MIS. In the United States, the Company
markets MIS products primarily through direct representatives who are employed
by the Company or its subsidiaries within selected geographical areas and
independent sales representatives who typically sell other complementary MIS
products to the same customer base. If the need arises, the Company may expand
its sales force, which will require recruiting and training additional
personnel. There can be no assurance that the Company will be able to recruit
and train such additional personnel in a timely fashion. Loss of a significant
number of the Company's current sales personnel or independent sales
representatives, or failure to attract additional personnel, could have a
material adverse effect on the Company's business, financial condition and
results of operations.
BUSINESS STRATEGY
The Company plans to utilize the combined capabilities of KMI, VMI and
LQET to expand its geographical coverage in the U.S. and add significant new
products to its existing line through internal development, licensing and
acquisition. In 1996, the combined distribution coverage of KMI and VMI
included Georgia, Florida, Alabama, North Carolina, South Carolina, Tennessee,
Texas, and New Mexico. Management intends to add a significant number of direct
sales representatives in 1997, particularly in the northeastern, mid-Atlantic,
Great Lakes and midwestern areas of the U.S. and plans to achieve national
distribution coverage in 1998. Additionally, the Company plans to continually
increase the volume of products which LQET manufactures for KMI and VMI. LQET
also is, and will continue to be, a party to manufacturing agreements with
various companies in the medical instrument industry under which the Company
produces selected MIS products for private labeling.
The Company also intends to capitalize on its in-house technical
expertise by significantly increasing the size and scope of its service and
repair site. Management believes that these operations are very synergistic
with the Company's distribution business.
COMPETITION
The primary industry in which the Company competes, minimally
invasive surgery, is highly competitive and in the current healthcare
environment, cost containment has become a significant factor in purchasing
decisions by hospitals. The MIS market is dominated by two large,
well-positioned entities that are intensely competitive and frequently offer
substantial discounts as a competitive tactic. The United States Surgical
Corporation ("U.S. Surgical") is primarily engaged in developing, manufacturing
and marketing surgical wound management products, and has historically been the
firm most responsible for providing products that have led to the growth of the
industry. U.S. Surgical supplies a broad line of products to the MIS industry,
including products which facilitate access, assessment and treatment. Ethicon
Endo-Surgery ("Ethicon"), a Johnson & Johnson company, has made a major
investment in the MIS field in recent years and is one of the leading suppliers
of hospital products in the world. Furthermore, U.S. Surgical and Ethicon each
utilize purchasing contracts that link discounts on the purchase of one product
to purchases of other products in their broad product lines. Substantially all
of the hospitals in the United States have purchasing contracts with one or
both of these entities. Accordingly, customers may be dissuaded from purchasing
access products from the Company rather than U.S. Surgical or Ethicon to the
extent it would cause them to lose discounts on products that they regularly
purchase from U.S. Surgical or Ethicon.
The Company believes that the primary competitive factors affecting
its business are the safety and effectiveness of the products offered, ease of
product use, product reliability, price, physician familiarity with the
manufacturer and its products, distribution channels and third party
reimbursement
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policies. For certain of the Company's potential products, an important factor
in competition may be the timing of market introduction of its or its
competitors' products. Accordingly, the relative speed with which the Company
can develop products and complete approval or clearance processes and supply
commercial quantities of the products to the market are important competitive
factors. The Company believes that its competitive success will be based on its
ability to create and maintain scientifically advanced technology, develop
proprietary products, attract and retain scientific personnel, obtain patent or
other protection for its products, obtain required regulatory approvals and
manufacture and successfully market its products.
Many of the Company's competitors and potential competitors have
substantially greater resources, including easy access to capital, research and
development personnel, extensive manufacturing and marketing capabilities,
broad and well established product lines as well as ancillary services, such as
training programs. Some of the Company's competitors have long-term or
preferential supply arrangements with hospitals. Such arrangements may act as a
barrier to market entry. In addition, it is possible that other large
healthcare companies may enter the MIS device market in the future. Competing
companies may succeed in developing products that are more efficacious or less
costly than any that may be developed or distributed by the Company and such
companies also may be more successful than the Company in production and
marketing. Rapid technological development by others may result in the
Company's products becoming obsolete before the Company recovers a significant
portion of the research, development and commercialization expenses incurred
with respect to those products.
The impact of competition will likely have a continuing effect on
sales volumes and on prices charged by the Company. The Company faces a
formidable task in successfully gaining significant revenues within the MIS
market. In order to succeed, management believes that the Company will need to
objectively demonstrate substantial product benefits, and its sales effort must
be able to effectively present such benefits to both clinicians and health care
administrators. The MIS market is dominated by U.S. Surgical and Ethicon. Both
entities introduced new access devices, trocars with added features, during the
past two years. A number of other entities participate in various segments of
the MIS market.
There can be no assurance that the Company will be able to
successfully compete in the MIS market, and failure to do so would have a
material adverse effect on the Company's business, financial condition and
results of operations.
PRODUCTS SUPPLY: DEPENDENCE ON KEY SUPPLIERS
The ability of the Company to obtain particular products or product
lines in the required quantities to fulfill customer orders for MIS devices on
a timely basis is critical to the Company's success. In most cases, the Company
has no guaranteed price or delivery agreements with its MIS device suppliers.
As a result, the Company may experience short-term inventory shortages. In
addition, manufacturers of MIS devices who currently distribute their products
through the Company may decide to distribute, or to substantially increase
their existing distribution through other distributors, their own dealer
networks, or directly to resellers. There can be no assurance that suppliers
will be able to maintain an adequate supply of products to fulfill the
Company's customer orders on a timely basis or that the Company will be able to
obtain particular products or that a product line currently offered by
suppliers will continue to be available. Failure of the Company to obtain
particular products or product lines in the required quantities or to fulfill
customer orders on a timely basis could have a material adverse effect on its
business, financial condition or results of operation.
The Company's ability to achieve increases in net sales or to sustain
current net sales levels depends in part on the ability and willingness of the
Company's suppliers to provide products in the quantities the Company requires.
Although the Company has written distribution agreements with many of its
suppliers, these agreements usually provide for non-exclusive distribution
rights and often include territorial restrictions that limit the geographical
area in which the Company is permitted to distribute the products. The
agreements are also generally short-term, subject to periodic renewal and often
contain provisions permitting termination by either party without cause upon
relatively short notice. The termination of an agreement may have a material
adverse impact on the Company's business, financial condition or result of
operations.
DEPENDENCE UPON INDEPENDENT SHIPPING COMPANIES
The Company relies heavily on arrangements with independent shipping
companies for the delivery of its products. In order to meet customer demand,
products are shipped from suppliers through independent shipping companies.
Currently, United Parcel Service delivers the substantial majority of
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the Company's products to its customers. The termination of the Company's
relationship with United Parcel Service, or the failure of one or more other
independent shipping companies to deliver products from suppliers to the
Company or products from the Company to its customers could have a material
adverse effect on the Company's business, financial condition or results of
operations. For instance, an employee work stoppage or slow-down at one or more
of these independent shipping companies could materially impair the shipping
company's ability to perform the services required by the Company. There can be
no assurance that the services of these independent shipping companies will
continue to be available to the Company on terms as favorable as those
currently available or that these companies will choose or be able to perform
the required shipping services for the Company.
DEPENDENCE ON KEY PERSONNEL
The success of the Company will be largely dependent on the efforts of
a number of key management and technical personnel. The loss of the services of
one or more key employees could have an adverse effect on the Company. The
Company currently maintains key-man life insurance on Herbert H. Spoon,
President and Chief Executive Officer of the Company. The Company believes that
its future success will depend in large part upon its ability to hire and
retain suitable operating, marketing, financial and technical personnel. The
competition for qualified personnel in the medical device industry is intense
and, accordingly, there can be no assurance that the Company will be able to
hire or retain necessary personnel.
PRODUCT DEVELOPMENT AND MANUFACTURING
The Company's success will depend in part on its ability to obtain
patent protection for products and processes, to preserve its trade secrets and
to operate without infringing the proprietary rights of third parties. Although
the Company has obtained certain patents and applied for additional United
States and foreign patents covering certain aspects of its technology, no
assurance can be given that any additional patents will be issued or that the
scope of any patent protection will exclude competitors or provide a
competitive advantage, or that any of the Company's patents will be held valid
if subsequently challenged. The validity and breadth of claims covered in
medical technology patents involves complex legal and factual questions and
therefore may be highly uncertain. The Company also relies upon unpatented
trade secrets, and no assurance can be given that others will not independently
develop or otherwise acquire substantially equivalent trade secrets. In
addition, whether or not the Company's patents are issued, others may hold or
receive patents and contain claims having a scope that covers products
developed by the Company.
There has been substantial litigation regarding patent and other
intellectual property rights in the medical device industry and companies in
the medical device industry have used litigation to gain competitive advantage.
Litigation involving the Company would result in substantial cost and diversion
of management attention from the day-to-day operation of the business, but
could be necessary to enforce patents issued to the Company, to protect trade
secrets and other specialized knowledge unknown to outside parties, to defend
the Company against claimed infringement of the rights of others or to
determine the scope and validity of the proprietary rights of others. An
adverse determination in litigation could subject the Company to significant
liabilities to third parties, could require the Company to seek licenses from
third parties under less favorable terms than might otherwise be possible and
could prevent the Company from manufacturing, selling or using its products,
any of which could have a material adverse effect on the Company's business,
financial condition or results of operations.
Working from an idea, sketch, or rough model, the Company can take a
project through all the steps of product development, engineering, and
industrial design, culminating in an exact working prototype. The Company's
mold design, tooling, assembly, packaging and regulatory staff can develop
necessary plans to transform the prototype into a market ready, versatile,
medical device. The Company utilizes the latest in design hardware and
software, as well as a complete machine shop.
The Company's manufacturing strategy has four primary goals: (i) to
provide its customers with high quality products and services; (ii) to improve
the performance of its products over time through design and manufacturing
innovation; (iii) to continuously improve manufacturing efficiency and lower
costs; and (iv) to improve product quality. The Company's manufacturing
operations include machining of various components, assembly, testing,
inspection and packaging. Most operations are conducted by the Company at its
facility in La Verne, California. Sterilization of certain products is
performed by a subcontractor.
The Company meets the required Food and Drug Administration ("FDA")
manufacturing requirements. These requirements include the need for lot
traceability, clean environment and institution
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of the FDA's Good Manufacturing Practices ("GMP") in assembly and manufacturing
procedures. FDA requirements consists of four functions: documentation, quality
engineering, inspection and regulatory affairs. The Company has personnel
dedicated to maintaining compliance with each of these areas.
The Company utilizes steel, aluminum and other raw materials in its
manufacturing process. All raw materials are sourced from several different
suppliers and the Company has rarely experienced a significant manufacturing
delay as a result of a disruption of its sources for raw materials or other
product components. The Company currently maintains small finished goods
inventories. Most products are produced and shipped in direct response to
customer product requests on a "Just in Time" basis.
During the last two fiscal years, the Company has continued to be
engaged in company sponsored research and development. Expenditures in this
area have declined from $729,000 in fiscal 1995 to $398,000 in fiscal 1996. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
PATENTS, PROPRIETARY INFORMATION AND TRADEMARKS
The Company holds all rights to medical applications of the patented
Impact Mount(TM) technology owned by ValQuest.
The Company's success will depend in part on its ability to obtain
patent protection for products and processes, to preserve its trade secrets and
to operate without infringing the proprietary rights of third parties. While
the Company has obtained exclusive rights to certain patents and to various
applications for additional United States and foreign patents covering certain
aspects of its technology, no assurance can be given that any additional
patents will be issued, that the scope of any patent protection will exclude
competitors or that any of the Company's patents will be held valid if
subsequently challenged. The validity and breadth of claims covered in the
medical technology patents involve complex legal and factual questions and,
therefore, may be highly uncertain. Whether or not the Company's patents are
issued, others may receive patents which contain claims having a scope that
covers products developed by the Company.
There has been substantial litigation regarding patent and other
intellectual property rights in the medical device industry. Litigation, which
would result in substantial cost to and diversion of effort by the Company, may
be necessary to enforce patents issued to the Company, to protect trade secrets
or know-how owned by the Company or to defend the Company against claimed
infringement of the rights of others and to determine the scope and validity of
the proprietary rights of others. Adverse determinations in litigation could
subject the Company to significant liabilities to third parties, could require
the Company to seek licenses from third parties and could prevent the Company
from manufacturing, selling or using its products, any of which could have a
material adverse effect on the Company's business, financial condition or
results of operations.
The Company may decide for business reasons to retain certain
knowledge that it considers proprietary as trade secrets. In that event, or if
patent protection is unattainable, then the Company must rely upon trade
secrets, know-how and continuing technological innovation to maintain its
competitive position. Employees and consultants of the Company who have access
to proprietary information have signed confidentiality agreements with the
Company. There can be no assurance that these agreements will provide
meaningful protection for the Company's trade secrets in the event of
unauthorized use or disclosure of such information. The Company intends to
require any new employees to sign similar confidentiality agreements.
There can be no assurance that others will not independently develop
substantially equivalent proprietary information and techniques, or otherwise
gain access to the Company's trade secrets or disclose such technology, or that
the Company can meaningfully protect its rights to its unpatented trade
secrets.
GOVERNMENT REGULATION
As a manufacturer of medical devices, the Company is subject to
regulation by, among other governmental entities, the FDA and the corresponding
agencies of states and foreign countries in which the Company sells its
products. These regulations govern the introduction of new medical devices, the
observance of certain standards with respect to the manufacture and labeling of
such devices, the maintenance of certain records and the reporting of potential
product defects and other matters. Failure to comply with such regulations may
have a material adverse effect on the Company.
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Manufacturers of medical devices marketed in the United States are
required to adhere to applicable regulations setting forth detailed GMP
requirements, which include testing, control and documentation requirements.
Manufacturers also must comply with Medical Device Reporting ("MDR")
requirements which require that a firm report to the FDA certain adverse events
associated with the Company's devices. The Company is subject to routine
inspection by the FDA and certain state agencies for compliance with GMP
requirements, MDR requirements and other applicable regulations. The FDA is
using its statutory authority more vigorously during inspections of companies
and in other enforcement matters. The FDA has promulgated new GMP regulations
and MDR regulations, both of which will likely increase the cost of compliance
with GMP requirements. The Company also is subject to numerous federal, state
and local laws relating to matters such as safe working conditions,
manufacturing practices, environmental protection, fire hazard control and
disposal of hazardous or potentially hazardous substances. Changes in existing
requirements or adoption of new requirements could have a material adverse
effect on the Company's business, financial condition or results of operations.
Although the Company believes that it is in compliance with all applicable
regulations of the FDA and the State of California, current regulations depend
heavily on administrative interpretation and there can be no assurance that the
Company will not incur significant costs to comply with laws and regulations in
the future or that laws and regulations will not have a material adverse effect
upon the Company's business, financial condition or results of operations. In
addition, the potential effects on the Company of heightened enforcement of
federal and state regulations cannot be predicted.
With the enactment of the Medical Device Amendments in May 1976 to the
Federal Food, Drug and Cosmetic Act (the "FDC Act"), the FDA classified medical
devices in commercial distribution into three classes, Class I, II or III. This
classification is based on the controls necessary to reasonably ensure the
safety and effectiveness of the medical device. Class I devices are those
devices whose safety and effectiveness can reasonably be ensured through
general controls such as adequate labeling, premarket notification and
adherence to GMP regulations. Some Class I devices are further exempted from
some of the general controls. Class II devices are those devices whose safety
and effectiveness can reasonably be ensured through the use of special controls
such as performance standards, post-market surveillance, patient registries and
FDA guidelines. Class III devices are devices which must receive premarket
approval by the FDA pursuant to a Premarket Approval ("PMA") application to
ensure their safety and effectiveness. Generally, Class III devices are limited
to life-sustaining, life-supporting or implantable devices.
Most medical instruments introduced to the United States market are
required by the FDA, as a condition of marketing, to secure either clearance of
a premarket notification pursuant to Section 510(k) of the FDC Act (a "510(k)
Notification") or an approved PMA. Obtaining PMA can take several years. In
contrast, the process of obtaining a 510(k) Notification clearance requires the
submission of substantially less data and generally involves a shorter review
period.
In general, clearance of a 510(k) Notification may be obtained if a
manufacturer or distributor of medical devices can establish that a new device
is "substantially equivalent" to a legally marketed medical device. The 510(k)
Notification and the claim of substantial equivalence may have to be supported
by various types of information indicating that the device is as safe and
effective for its intended use as a legally marketed predicate device. In
addition to requiring clearance for new products, FDA rules typically require a
filing and a waiting period prior to marketing modified versions of existing
products. The Company anticipates that most of its products will be eligible
for the 510(k) Notification procedure. At this time, the FDA typically responds
to a submission of a 510(k) Notification within 180 to 360 days. Market
clearance may take three to 12 months or longer. In the event that the shorter
510(k) Notification procedure is not available, the Company will be required to
file a PMA.
Under the Safe Medical Devices Act of 1990 ("SMDA"), the FDA is
directed to adopt new 510(k) Notification regulations which could potentially
make the approval process for the Company's products more time-consuming,
difficult and expensive. The SMDA includes new provisions relating to post-
market surveillance requirements for certain types of devices and authorizes
the FDA to adopt new controls to be applied to certain devices such as some
currently being developed by the Company, including the promulgation of a
performance standard, requirements for patient registries, distributor and
purchaser reporting and imposition of guidelines.
The process of obtaining necessary government approvals can be
time-consuming and expensive. There can be no assurance that the necessary
approvals will be obtained by the Company or, if they are obtained, that they
will be obtained on a timely basis. Furthermore, the Company or the FDA may
suspend clinical trials at any time upon a determination that the subjects or
patients are being exposed to an unacceptable health risk. The FDA may also
require post-approval testing and surveillance programs to monitor the effects
of the Company's products and the products it distributes as a condition
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<PAGE> 10
of approval. Approvals that have been or may be granted are subject to
continual review and surveillance programs required by regulatory agencies, and
later discovery of previously unknown problems may result in product labeling
restrictions or withdrawal of products from marketing.
International sales of medical devices are subject to the regulatory
agency requirements of each country, and more recently in Europe, the
regulations of the European Economic Community. The regulatory review process
varies from country to country. In addition, international sales of medical
devices not cleared by the FDA for distribution in the United States may be
subject to FDA export requirements, which require the Company to document that
the sale of the device is not in violation of that country's medical device
laws. This documentation is then submitted to the FDA with a request for a
permit for export to that country. The Company intends to apply for regulatory
approval, import approval and export approval for its products for sales in
countries comprising the major foreign market.
The Company is also required to register and list its products with
the FDA as a device manufacturer or distributor. As such, the Company is
subject to inspection on a routine basis for compliance with the FDA's GMP
requirements and other applicable regulations. Further, the Company is required
to comply with various FDA requirements for labeling. The Medical Device
Reporting regulation requires that the Company provide information to the FDA
on death or serious injuries alleged to have been associated with the use of
its product, as well as product malfunctions that would likely cause or
contribute to death or serious injury if the malfunction were to recur. Special
reports and routine annual reports are required to be submitted to the FDA by a
company after a PMA for a device has been approved. These reports assure that
the official FDA file for the PMA is kept current and reflects actual
manufacturing, labeling, marketing, and use practices and experience once the
product is marketed. In addition, the FDA prohibits an approved device from
being promoted for unapproved applications.
In addition to the statutes and regulations enforced by the FDA, the
Company is also subject to regulation under the Occupational Safety and Health
Act, the Environmental Protection Act, the Toxic Substances Control Act, the
Resource Conservation and Recovery Act and other present and potential future
federal, state and local statutes, regulations and ordinances, including those
promulgated by the Environmental Protection Act and the Department of Labor.
Regulations regarding the manufacture and sale of the Company's products are
subject to change. The Company cannot predict what impact, if any, such changes
might have on its business.
THIRD-PARTY REIMBURSEMENT
In the United States, health care providers, such as hospitals and
physicians, that purchase medical devices, such as the Company's products,
generally rely on third-party payors, principally federal Medicare, state
Medicaid and private health insurance plans, to reimburse all or part of the
cost of the procedure in which the medical device is being used. In addition,
certain health care providers are moving toward a managed care system in which
such providers contract to provide comprehensive health care for a fixed cost
per person. Managed care providers are attempting to control the cost of health
care by authorizing fewer elective surgical procedures. The Company is unable
to predict what changes will be made in the reimbursement methods utilized by
third-party health care payors. Furthermore, the Company could be adversely
affected by changes in reimbursement policies of governmental or private health
care payors, particularly to the extent any such changes affect reimbursement
for procedures in which the Company's products are used. Failure by physicians,
hospitals and other users of products sold by the Company to obtain sufficient
reimbursement from health care payors for procedures in which the Company's
products are used or adverse changes in governmental and private third-party
payors' policies toward reimbursement for such procedures would have a material
adverse effect on the Company's business, financial condition or results of
operations.
If the Company obtains the necessary foreign regulatory approvals,
market acceptance of the products sold by the Company in international markets
would be dependent, in part, upon the availability of reimbursement within
prevailing health care payment systems. Reimbursement and health care payment
systems in international markets vary significantly by country, and include
both government- sponsored health care and private insurance. The Company
intends to seek international reimbursement approvals, although there can be no
assurance that any such approvals will be obtained in a timely manner, if at
all, and the effect on market acceptance of the Company's products in the
international markets in which such approvals are sought.
Hospitals, medical clinics and physicians' offices that purchase
medical devices generally rely on third-party payors, such as Medicare,
Medicaid and private health insurance plans, to pay for some or all of the
costs of the screening, diagnostic and therapeutic procedures performed with
these devices.
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<PAGE> 11
Whether a particular procedure qualifies for third-party reimbursement depends
upon such factors as the safety and effectiveness of the procedure; and
reimbursement may be denied if the medical device is experimental or was used
for a non-approved indication. The Company believes that third-party
reimbursement will be available for most procedures using its products.
In April 1983, Congress enacted the Social Security Act Amendments of
1983 which mandated a system of Medicare reimbursement for in-patient hospital
services based primarily upon diagnostic- related groups known as "DRGs." Under
this system, hospitals are generally paid only a fixed amount per patient plus
additional amounts for certain specific hospital costs. The amount payable
under DRGs for a particular patient depends on many factors, including the
principal diagnosis of the patient, but it usually does not depend upon the
hospital's actual current cost of treating the patient. The prospective payment
system and other cost control measures adopted by third-party payors in recent
years, including reductions in Medicare payments for hospital outpatient
services and capital costs, have had and may continue to have significant
effect on the purchasing practices of many providers, generally causing them to
be more selective in the purchase of medical devices.
Third-party payors use a variety of mechanisms to determine
reimbursement fees for surgical procedures. In some cases, reimbursement
amounts are based on the provider's costs associated with the procedure,
including materials costs. In such a situation, the cost of a device used in
the procedure would likely be covered by the reimbursement payment.
While third-party payors generally make their own decisions regarding
which items and services to cover, Medicaid and other third-party payors often
apply standards similar to Medicare's in determining whether to provide
coverage for a particular medical procedure. The Medicare statute prohibits
payment for any items or services that are not reasonable and necessary for the
diagnosis or treatment of illness or injury or to improve the functioning of a
malformed body member, and the Health Care Financing Administration ("HCFA"),
an agency within the Federal Department of Health and Human Services
responsible for administering the Medicare program, has interpreted this
provision to prohibit Medicare coverage of procedures or devices that, among
other things, are determined to be medically unnecessary, inappropriate, not
cost-effective, unsafe, ineffective, experimental or used for non-approved
indication. For medical devices, FDA clearance for marketing is required but is
not determinative of whether those prerequisites for Medicare coverage have
been met. In particular, although the FDA may grant approval to market a
medical device, the HCFA, a state health care agency or a third-party payor
could independently determine not to approve coverage for the use of a
particular medical device.
While a limited number of national coverage decisions are made by
HCFA, in general, the determination of whether a procedure or device satisfies
these standards is made by the Medicare carrier or intermediary which processes
claims for reimbursement within that carrier's or intermediary's jurisdiction.
The unavailability of third-party coverage or the inadequacy of the
reimbursement for medical procedures using the Company's products, including
any future product that the Company may develop or acquire, would adversely
affect the Company's business, financial condition and results of operations.
Moreover, the Company is unable to predict what additional legislation or
regulation, if any, may be enacted or adopted in the future relating to the
Company's business or the health care industry, including third-party coverage
and reimbursement, or what effect any such legislation or regulation may have
on the Company.
PRODUCT LIABILITY AND INSURANCE
The development, manufacture and sale of MIS products by the Company
entails the risk of product liability claims, involving both potential
financial exposure and associated adverse publicity. The Company's current
product liability insurance coverage limits are $1,000,000 in the aggregate,
and there can be no assurance that such coverage limits are adequate to protect
the Company from any liabilities it might incur in connection with the
development, manufacture and sale of its current and potential products. In
addition, the insurance is expensive and may not be available in the future on
acceptable terms, or at all. In addition, if such insurance is available, there
can be no assurance that the limits of coverage of such policies will be
adequate. A successful product liability claim in excess of the Company's
insurance coverage could have a material adverse effect on the Company's
business, financial condition or results of operations.
The Company's business exposes it to potential product liability risks
which are inherent in the design, manufacture and marketing of medical devices.
The Company has not experienced any product
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<PAGE> 12
liability claims to date. The Company currently maintains product liability
insurance coverage in the aggregate annual amount of $1,000,000. The Company
believes that the amount of such coverage is comparable to liability insurance
maintained by other companies in the medical device industry during clinical
development. There can be no assurance that product liability claims will not
exceed such insurance coverage limits, which could have a material adverse
effect on the Company. Product liability claims or products recalls in the
future, regardless of their ultimate outcome, could have a material adverse
effect on the Company's business and reputation and on its ability to attract
and retain customers for its products.
EMPLOYEES
As of March 18, 1997, the Company employed approximately 61 persons.
None of the Company's employees are represented by a union for collective
bargaining purposes. The Company considers its relations with its employees to
be satisfactory.
EXECUTIVE OFFICERS OF THE REGISTRANT
The current executive officers of the Company and their names, ages,
positions and tenure with the Company are as follows:
<TABLE>
<CAPTION>
OFFICER
NAME AGE POSITION SINCE
---- --- -------- -----
<S> <C> <C> <C>
Herbert H. Spoon 53 President and Chief Executive
Officer 1991
Randall K. Boatright 48 Vice President, Chief Financial
Officer and Secretary 1992
David J. Collette, M.D. 43 Vice President of Research and
Development 1993
Richard H. Klein 43 Vice President 1996
K.C. Fadem 38 Vice President 1996
Robert Fadem 35 Vice President 1996
</TABLE>
K.C. Fadem and Robert Fadem are brothers. There are no other family
relationships among the officers listed. In connection with the Klein Merger,
Richard H. Klein was made a vice president. In connection with the Val-U-Med
Merger, K.C. Fadem and Robert Fadem were made vice presidents. There are no
other arrangements or understandings pursuant to which any of the other
officers listed were elected as officers. Officers are elected annually by the
Board of Directors at its first meeting following the Annual Meeting of
Stockholders, each to hold office until the corresponding meeting of the Board
in the next year or until his successor shall have been elected or shall have
been qualified.
ITEM 2. PROPERTIES
The Company currently leases corporate headquarters and distribution
facilities in San Antonio, Texas, under a lease expiring in May 1997. LQET
currently leases manufacturing and office facilities in La Verne, California on
a month-to-month basis for approximately $4,000 per month. The Company has
substantially completed negotiations on a new lease which will house the
corporate headquarters, Klein Medical and LQET in San Antonio, Texas under a
lease expiring in May 2002. Val-U-Med entered into a lease agreement for office
and distribution facilities in February 1997 in Atlanta, Georgia, under a lease
expiring in March 2002. During 1996 the Company paid aggregate rentals of
approximately $145,000.
ITEM 3. LEGAL PROCEEDINGS
Not applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
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<PAGE> 13
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND
RELATED STOCKHOLDER MATTERS
The Common Stock, $.001 par value ("Common Stock"), of the Company
trades on the Nasdaq SmallCap Market under the symbol "LQMD" and commenced
trading in August 1992. The following table presents the range of high and low
sales prices for the Common Stock as reported by the Nasdaq Stock Market for
the periods indicated. The quotations represent prices in the over-the-counter
market between dealers in securities, do not include retail markup, markdown or
commissions and may not necessarily represent actual transactions.
<TABLE>
<CAPTION>
QUARTER ENDED HIGH LOW
- ------------- ---- ---
Fiscal 1996:
<S> <C> <C>
Fourth Quarter 3 3/4 1 7/8
Third Quarter 2 1/2 1 3/8
Second Quarter 3 5/8 2
First Quarter 4 1/8 2 1/4
Fiscal 1995:
Fourth Quarter 3 3/8 2 1/8
Third Quarter 2 3/4 2
Second Quarter 2 3/4 1 7/8
First Quarter 3 1/8 1 3/4
</TABLE>
At March 18, 1997, there were approximately 200 record holders of the
Common Stock and approximately 2,100 beneficial holders of the Common Stock.
The Company has not in the past declared any cash dividends on the
Common Stock, and does not anticipate paying dividends on the Common Stock at
any time in the foreseeable future.
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<PAGE> 14
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Certain statements contained in this Item 6, "Management's Discussion
and Analysis of Financial Condition and Results of Operations," including
statements regarding the anticipated development and expansion of the Company's
business, expenditures, the intent, belief or current expectations of the
Company, its directors or its officers, primarily with respect to the future
operating performance of the Company and other statements contained herein
regarding matters that are not historical facts, are "forward-looking"
statements (as such term is defined in the Private Securities Litigation Reform
Act of 1995). Because such statements include risks and uncertainties, actual
results may differ materially from those expressed or implied by such
forward-looking statements. Factors that could cause actual results to differ
materially from those expressed or implied by such forward-looking statements
include, but are not limited to, those discussed in the Company's Registration
Statement on Form S-3 filed on February 7, 1997, and the Company's annual and
quarterly reports filed with the Securities and Exchange Commission.
OVERVIEW
From inception through December 31, 1995, the Company was a
development stage enterprise whose efforts and resources were devoted primarily
to research and development activities related to its initial products. During
this development stage, the Company received minimal operating revenues and,
thus, was unprofitable. As of December 31, 1996, the Company had an accumulated
deficit of approximately $14,341,000. There can be no assurance that the
Company will be able to achieve or sustain profitability.
The Company's future operating results will depend on many factors,
including the Company's ability to manufacture and market its products on a
cost-effective basis, demand for the Company's products and the level of
competition in the market place.
In December, 1996, Val-U-Med, Inc., a Georgia corporation
("Val-U-Med") was acquired by the Company and merged into Val-U-Med Acquisition
Co., a Nevada corporation ("VMI") and newly-formed, wholly-owned subsidiary of
the Company. Val-U-Med was purchased for an aggregate of 1,200,000 shares of
Common Stock and an aggregate of $400,000. The transaction was accounted for
using the purchase method of accounting. VMI is involved in the distribution
and marketing of minimally invasive surgical products.
In November, 1996, Klein Medical, Inc., a Texas corporation ("Klein")
was acquired by the Company and merged into Klein Medical Acquisition Co., a
Nevada corporation ("KMI") and newly-formed, wholly-owned subsidiary of the
Company. Klein was purchased for an aggregate of 600,000 shares of Common
Stock. The transaction was accounted for using the pooling-of-interests
accounting method, therefore, the assets, liabilities, and operations of KMI
are included in the consolidated financial statements for all periods reported
herein. KMI is involved in the distribution and marketing of minimally invasive
surgical products.
In February, 1996, the Company completed the merger of GM Engineering,
Inc., a California corporation, ("GME"), with and into LifeQuest Endoscopic
Technologies, Inc., ("LQET") a Nevada corporation and newly formed wholly owned
subsidiary of the Company. GME was purchased for 350,000 shares of Common
Stock. The transaction was recorded using the pooling of interests method of
accounting, therefore, the assets, liabilities, and operations of GME are
included in the consolidated financial statements for all period reported
herein. LQET develops, manufactures, and markets surgical and related
instruments used in minimally invasive surgery.
In May, 1994, the Company and Valdor Fiber Optics ("Valdor") of San
Jose, California, formed a corporate joint venture called ValQuest Medical,
Inc. ("ValQuest"). In accordance with the terms of the joint venture agreement,
Valdor transferred to ValQuest the exclusive worldwide rights to develop,
manufacture, and market all present and future medical applications of Valdor's
patented fiber optic connector technology. The Company paid $100,000 to Valdor
in consideration for the transfer of these rights to ValQuest. Valdor
contributed such rights, which had an initial value of $327,273 in the
consolidated financial statements, to ValQuest in exchange for a 45 percent
interest in ValQuest. The Company contributed $400,000 to be used as working
capital in exchange for a 55 percent interest in ValQuest. Currently,
subsequent purchases of stock have increased the Company's ownership interest
in ValQuest to 82 percent.
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<PAGE> 15
LIQUIDITY AND CAPITAL RESOURCES
At December 31, 1996, the Company had current assets of $5,190,000 and
current liabilities of $2,255,000 resulting in working capital of $2,935,000.
This compares to a working capital position of $4,926,000 at December 31, 1995.
The increase at December 31, 1996 in accounts receivable, inventories and
accounts payable reflect the acquisition of Val-U-Med and new product lines at
Klein. The overall decline in working capital is primarily due to increased
merger and acquisition activities and the geographical expansion of the
Company's sales force.
Capital expenditures were $195,000 during 1996 and $81,000 in 1995.
The expenditures in 1996 were primarily for upgrading the LQET manufacturing
facilities. The Company anticipates a slight increase in the 1997 level of
capital expenditures as the Company's geographical expansion continues.
During the year ended December 31, 1996, the Company borrowed $750,000
from a commercial bank pledging a like amount of short-term investments as
collateral. The loan proceeds were used to replace more expensive debt, mainly
capital equipment leases, acquired with the acquisition of GME.
Based upon the current level of operations, the Company believes that
cash flow from operations plus the Company's cash from the realization of its
current assets will be adequate to meet its anticipated requirements for
working capital and capital expenditures. However, there can be no assurance
that the available cash will prove to be sufficient to satisfy these demands.
RESULTS OF OPERATIONS
Net loss for the year ended December 31, 1996 was $1,978,000, a
decrease of 13 percent from the $2,278,000 net loss for the year ended December
31, 1995. The decline was primarily due to a reduction in expenses and an
increase in gross profit margins as detailed hereinafter.
Net sales were relatively flat in 1996 as compared with 1995:
$3,639,000 and $3,686,000 respectively. A decline in sales to OEM customers was
offset by an increase in the volume of revenue generated by our distribution
activity.
Gross profit from sales was $882,000 in 1996 versus $760,000 in 1995.
The corresponding gross profit margins were 24 percent in 1996 and 21 percent
in 1995. The improvement in margins is primarily due to the upgrading of
facilities and increased employee training which both contribute to better
efficiencies. The Company believes the gross profit margins will continue to
improve as an increase in sales will provide advantageous economies of scale.
Furthermore, in the interest of improving efficiencies and to properly plan for
sales growth, the Company is combining its corporate offices, San Antonio
warehouse and distribution center, repair and service center, and manufacturing
facility in one new San Antonio location. The existing LQET facilities in Los
Angeles County and the existing Klein Medical facilities in San Antonio will be
closed and all business activities moved to the new San Antonio location. It is
contemplated the move will be completed by June 1, 1997 and the estimated
relocation costs of $75,000 were recorded in 1996.
Also in planning for sales growth and improving efficiencies,
Val-U-Med and the Atlanta distribution center moved to a new larger facility in
February 1997.
Research and development expenses decreased 45 percent from year to
year. This decline is due to the Company's decision to severely curtail
research activity and to concentrate its resources on sales growth through
geographical and product line expansion. Therefore, these expenses should
continue to decline in 1997.
Selling, general and administrative expenses, which consist primarily
of sales commissions, salaries and other costs necessary to support the
Company's infrastructure, decreased 13 percent to $2,259,000 in 1996 from
$2,607,000 in 1995. This comparative decline is a result of management's
continuing efforts to reduce expenses and improve efficiencies.
The minority interest in net loss of consolidated subsidiary of
$21,000 in 1996 reflects the minority ownership share of the ValQuest net loss.
This interest in ValQuest net loss is down 85 percent from 1995 which reflects
the smaller loss from ValQuest.
Investment income represents interest earned on the Company's short
term investments. Investment income declined from $347,000 in 1995 to $209,000
in 1996 as the level of short term investments declined from year to year.
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<PAGE> 16
Merger and acquisition costs of $254,000 in 1996 include legal,
accounting and testing expenses incurred during the acquisitions of GME, Klein
and Val-U-Med.
In March 1995, the FASB issued Statement No. 121, Accounting for the
Impairment of Long- Lived Assets and for Long-Lived Assets to Be Disposed Of,
which requires impairment losses to be recorded on long-lived assets used in
operations when indicators of impairment are present and the undiscounted cash
flows estimated to be generated by those assets are less than the assets'
carrying amount. Statement 121 also addresses the accounting for long-lived
assets that are expected to be disposed of. Management does not believe, based
on current circumstances, Statement 121 will have a material effect on the
carrying amount of the Company's long-lived assets.
As of December 31, 1996, the Company had net operating loss
carryforwards of approximately $13,083,000 for federal income tax purposes
which are available to reduce future taxable income and will expire in 2006
through 2011 if not utilized. For federal income tax purposes the Company
deferred for future amortization certain acquisition and research and
development costs in the amount of $2,453,000. Such costs, which have been
expensed for financial reporting purposes, will be amortized for tax purposes
over future years when commercial operations commence. The Company received IRS
approval of its request for a change of tax accounting method to expense
research and development costs for expenditures incurred in 1992 and future
years. The Company also has Research and development credit carryforwards
available to offset future income taxes and expire in 2005 through 2010.
The Company's ability to use its NOL carryforwards to offset future
taxable income is subject to restrictions enacted in the United States Internal
Revenue Code of 1986, as amended (the "Code"). These restrictions provide for
limitations on the Company's utilization of its NOL carryforwards following
certain ownership changes described in the Code. As a result of ownership
changes, the Company's existing NOL carryforwards are subject to the
limitation. Of the $13,083,000 of NOL carryforwards, $553,000 is subject to
limitation. Approximately $40,000 of the $553,000 can be utilized annually.
ITEM 7. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements and supplementary data described in Item
13(a) herein are attached hereto.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE
None.
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<PAGE> 17
PART III
ITEM 9. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information required under this Item will be contained in the
Company's Proxy Statement for 1997 Annual Meeting, which is incorporated herein
by reference.
See also "Executive Officers of the Registrant" under Part I, Item 1,
herein.
ITEM 10. EXECUTIVE COMPENSATION
Information required under this Item will be contained in the
Company's Proxy Statement for 1997 Annual Meeting, which is incorporated herein
by reference.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL
OWNERS AND MANAGEMENT
Information required under this Item will be contained in the
Company's Proxy Statement for 1997 Annual Meeting, which is incorporated herein
by reference.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information required under this Item will be contained in the
Company's Proxy Statement for 1997 Annual Meeting, which is incorporated herein
by reference.
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<PAGE> 18
PART IV
ITEM 13. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
AND REPORTS ON FORM 8-K
(a) 1. FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
Report of Independent Public Accountants............................................................. F-1
Balance Sheets at December 31, 1995 and 1996......................................................... F-2
Statements of Operations for the years ended December 31, 1995 and 1996.............................. F-4
Statements of Stockholders' Equity for the years ended December 31, 1995 and 1996.................... F-5
Statements of Cash Flows for the years ended December 31, 1995 and 1996.............................. F-6
Notes to Financial Statements........................................................................ F-8
</TABLE>
2. EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NUMBER IDENTIFICATION OF EXHIBIT PAGE NUMBER
- ------ ------------------------- -----------
<S> <C> <C>
2.1 Plan of Merger and Acquisition Agreement dated February 13,
1996, but effective as of January 1, 1996, among LifeQuest
Medical, Inc., LifeQuest Endoscopic Technologies, Inc., GM
Engineering, Inc., Gregory M. Miles and Susan G. Miles
(incorporated by reference herein to Exhibit 2.1 to the
Company's Current Report on Form 8-K filed February 27, 1996).
2.2 Stock Escrow and Pledge Agreement dated February 13, 1996,
among Gregory M. Miles and Susan G. Miles (as pledgors) and
LifeQuest Medical, Inc. and LifeQuest Endoscopic Technologies,
Inc. (as pledgees) and Texas Commerce Bank National Association
(as escrow agent) (incorporated by reference herein to Exhibit
2.2 to the Company's Current Report on Form 8-K filed February
27, 1996).
2.3 Plan of Merger and Acquisition Agreement dated November 27,
1996, among LifeQuest Medical, Inc., Klein Medical Acquisition
Co., Klein Medical, Inc. and Richard H. Klein (incorporated by
reference herein to Exhibit 2.1 to the Company's Current Report
on Form 8-K filed December 12, 1996).
2.4 Plan of Merger and Acquisition Agreement dated December 27,
1996, among LifeQuest Medical, Inc., Val-U-Med Acquisition Co.,
Val-U-Med, Inc. and the Stockholders of Val-U-Med, Inc.
(incorporated by reference herein to Exhibit 2.1 to the
Company's Current Report on Form 8-K filed January 10, 1997).
3.1 Certificate of Incorporation of the Registrant (incorporated by
reference herein to Exhibit 3.1 to the Company's Registration
Statement on Form S-1 filed on August 19,1992, Registration No.
33-49196).
3.2 Bylaws of the Registrant (incorporated by reference herein to
Exhibit 3.2 to the Company's Registration Statement on Form S-1
filed on August 19, 1992, Registration No. 33-49196).
10.1 1989 Stock Option Plan of LifeQuest Medical, Inc. (incorporated
by reference herein to Exhibit 4.4 to the Company's
Registration Statement on Form S-8 filed on October 12, 1993,
Registration No. 33-70174).
</TABLE>
-17-
<PAGE> 19
<TABLE>
<CAPTION>
EXHIBIT
NUMBER IDENTIFICATION OF EXHIBIT PAGE NUMBER
- ------ ------------------------- -----------
<S> <C> <C>
10.2 Amended and Restated Employment Contract dated November 1,
1989, between LifeQuest Medical, Inc. and Larry J. Miller, M.D.
(incorporated by reference herein to Exhibit 10.7 to the
Company's Registration Statement on Form S-1 filed on August
19, 1992, Registration No. 33-49196).
10.3 Employment Agreement dated February 15, 1992, between
LifeQuest Medical, Inc. and Herbert H. Spoon (incorporated by
reference herein to Exhibit 10.8 to the Company's Registration
Statement on Form S-1 filed on August 19, 1992, Registration No.
33-49196).
10.7 Incentive Stock Option Agreement dated January 15, 1990,
between LifeQuest Medical, Inc. and Herbert H. Spoon
(incorporated herein to Exhibit 10.12 to the Company's
Registration Statement on Form S-1 filed on August 19, 1992,
Registration No. 33-49196).
10.8 Consulting Agreement dated January 9, 1990, between LifeQuest
Medical, Inc. and John G. Kuhn, Pharm.D. (incorporated herein
to Exhibit 10.13 to the Company's Registration Statement on
Form S-1 filed on August 19, 1992, Registration No. 33-49196).
10.9 Consulting Agreement dated January 9, 1990, between LifeQuest
Medical, Inc. and Daniel D. Von Hoff, M.D. (incorporated herein
to Exhibit 10.14 to the Company's Registration Statement on
Form S-1 filed on August 19, 1992, Registration No. 33-49196).
10.10 Patent License Agreement dated January 1, 1989, between
LifeQuest Medical, Inc. and The Board of Regents of the
University of Texas System, as amended by instrument dated
November 1, 1989 (incorporated herein to Exhibit 10.15 to the
Company's Registration Statement on Form S-1 filed on August
19, 1992, Registration No. 33-49196).
10.11 License Agreement dated June 26, 1992, between LifeQuest
Medical, Inc. and George C. Kramer, Ph.D. (incorporated herein
to Exhibit 10.22 to the Company's Registration Statement on
Form S-1 filed on August 19, 1992, Registration No. 33-49196).
10.12 Consulting Agreement dated June 26, 1992, between LifeQuest
Medical, Inc. and George C. Kramer, Ph.D. (incorporated herein
to Exhibit 10.23 to the Company's Registration Statement on
Form S-1 filed on August 19, 1992, Registration No. 33-49196).
10.13 Non-Qualified Stock Option Agreement dated June 26, 1992,
between LifeQuest Medical, Inc. and George C. Kramer, Ph.D.
(incorporated herein to Exhibit 10.23 to the Company's
Registration Statement on Form S-1 filed on August 19, 1992,
Registration No. 33-49196).
10.14 Non-Qualified Stock Option Agreement dated June 26, 1992,
between LifeQuest Medical, Inc. and George C. Kramer, Ph.D.
(incorporated herein to Exhibit 10.24 to the Company's
Registration Statement on Form S-1 filed on August 19, 1992,
Registration No. 33-49196).
10.15 Incentive Stock Option Agreement dated October 17, 1994,
between LifeQuest Medical, Inc. and Herbert H. Spoon
(incorporated herein by reference to Exhibit 10.15 to the
Company's Annual Report on Form 10-K for the fiscal year ended
December 31, 1994).
</TABLE>
-18-
<PAGE> 20
<TABLE>
<CAPTION>
EXHIBIT
NUMBER IDENTIFICATION OF EXHIBIT PAGE NUMBER
- ------ ------------------------- -----------
<S> <C> <C>
10.16 Incentive Stock Option Agreement dated October 17, 1994,
between LifeQuest Medical, Inc. and Randall K. Boatright
(incorporated herein by reference to Exhibit 10.16 to the
Company's Annual Report on Form 10-K for the fiscal year ended
December 31, 1994).
10.17 Incentive Stock Option Agreement dated October 17, 1994,
between LifeQuest Medical, Inc. and Ruben G. Zamorano
(incorporated herein by reference to Exhibit 10.17 to the
Company's Annual Report on Form 10-K for the fiscal year ended
December 31, 1994).
10.18 Incentive Stock Option Agreement dated October 17, 1994,
between LifeQuest Medical, Inc. and David J. Collette, M.D.
(incorporated herein by reference to Exhibit 10.18 to the
Company's Annual Report on Form 10-K for the fiscal year ended
December 31, 1994).
10.19 1994 Non-Employee Director Stock Option Plan (incorporated
herein by reference to Exhibit 10.19 to the Company's Annual
Report on Form 10-K for the fiscal year ended December 31,
1994).
10.20 Non-Qualified Stock Option Agreement dated October 17, 1994,
between LifeQuest Medical, Inc. and John L. Cassis
(incorporated herein by reference to Exhibit 10.20 to the
Company's Annual Report on Form 10-K on Form 10-K for the
fiscal year ended December 31, 1994).
10.21 Non-Qualified Stock Option Agreement dated October 17, 1994,
between LifeQuest Medical, Inc. and Robert B. Johnson
(incorporated herein by reference to Exhibit 10.21 to the
Company's Annual Report on Form 10-K for the fiscal year ended
December 31, 1994).
10.22 Non-Qualified Stock Option Agreement dated March 2, 1995,
between LifeQuest Medical, Inc. and Jeffrey H. Berg, Ph.D.
(incorporated herein by reference to Exhibit 10.22 to the
Company's Annual Report on Form 10-K for the fiscal year ended
December 31, 1994).
10.23 ValQuest Medical, Inc. 1994 Stock Option Plan (incorporated
herein by reference to Exhibit 10.23 to the Company's Annual
Report on Form 10-K for the fiscal year ended December 31,
1994).
10.24 Incentive Stock Option Agreement dated August 19, 1994, between
ValQuest Medical, Inc. and Herbert H. Spoon (incorporated herein
by reference to Exhibit 10.24 to the Company's Annual Report on
Form 10-K for the fiscal year ended December 31, 1994).
10.25 Incentive Stock Option Agreement dated August 19, 1994, between
ValQuest Medical, Inc. and Randall K. Boatright (incorporated
herein by reference to Exhibit 10.25 to the Company's Annual
Report on Form 10-K for the fiscal year ended December 31,
1994).
10.26 Incentive Stock Option Agreement dated August 19, 1994, between
ValQuest Medical, Inc. and David J. Collette, M.D.
(incorporated herein by reference to Exhibit 10.26 to the
Company's Annual Report on Form 10-K for the fiscal year ended
December 31, 1994).
</TABLE>
-19-
<PAGE> 21
<TABLE>
<CAPTION>
EXHIBIT
NUMBER IDENTIFICATION OF EXHIBIT PAGE NUMBER
- ------ ------------------------- -----------
<S> <C> <C>
10.27 Incentive Stock Option Agreement dated August 19, 1994, between
ValQuest Medical, Inc. and Ruben G. Zamorano (incorporated
herein by reference to Exhibit 10.27 to the Company's Annual
Report on Form 10-K for the fiscal year ended December 31,
1994).
10.28 Non-Incentive Stock Option Agreement dated August 19, 1994,
between ValQuest Medical, Inc. and John L. Cassis (incorporated
herein by reference to Exhibit 10.28 to the Company's Annual
Report on Form 10-K for the fiscal year ended December 31,
1994).
10.29 Non-Incentive Stock Option Agreement dated August 19, 1994,
between ValQuest Medical, Inc. and Robert B. Johnson
(incorporated herein by reference to Exhibit 10.29 to the
Company's Annual Report on Form 10-K for the fiscal year ended
December 31, 1994).
10.30 Assignment and License Agreement dated May 11, 1994, between
ValQuest Medical, Inc. and Fibotech, Inc. d/b/a Valdor Fiber
Optics (incorporated herein by reference to Exhibit 10.30 to
the Company's Annual Report on Form 10-K for the fiscal year
ended December 31, 1994).
10.31 Employment Agreement dated February 13, 1996, between
LifeQuest Endoscopic Technologies, Inc. and Gregory M. Miles
(incorporated by reference herein to Exhibit 10.1 to the
Company's Current Report on Form 8-K filed February 27, 1996).
10.32 Non-Competition Agreement dated February 13, 1996, between
LifeQuest Medical, Inc. and Gregory M. Miles (incorporated by
reference herein to Exhibit 10.2 to the Company's Current
Report on Form 8-K filed February 27, 1996).
10.33 Non-Qualified Stock Option Agreement dated February 13, 1996,
between LifeQuest Medical, Inc. and Gregory M. Miles
(incorporated by reference herein to Exhibit 10.3 to the
Company's Current Report on Form 8-K filed February 27, 1996).
10.34 Employment Agreement dated November 27, 1996, between Klein
Medical Acquisition Co. and Richard H. Klein (incorporated by
reference herein to Exhibit 10.1 to the Company's Current
Report on Form 8-K filed December 12, 1996).
10.35 Non-Qualified Stock Option Agreement dated November 27, 1996,
between LifeQuest Medical, Inc. and Richard H. Klein
(incorporated by reference herein to Exhibit 10.2 to the
Company's Current Report on Form 8-K filed December 12, 1996).
10.36 Employment Agreement dated December 27, 1996, between Val-U-
Med Acquisition Co. and K.C. Fadem (incorporated by reference
herein to Exhibit 10.1 to the Company's Current Report on Form
8-K filed January 10, 1997).
10.37 Non-Qualified Stock Option Agreement dated December 27, 1996,
between LifeQuest Medical, Inc. and K.C. Fadem (incorporated by
reference herein to Exhibit 10.2 to the Company's Current Report
on Form 8-K filed January 10, 1997).
10.38 Employment Agreement dated December 27, 1996, between Val-U-
Med Acquisition Co. and Robert Fadem (incorporated by reference
herein to Exhibit 10.3 to the Company's Current Report on Form
8-K filed January 10, 1997).
</TABLE>
-20-
<PAGE> 22
<TABLE>
<CAPTION>
EXHIBIT
NUMBER IDENTIFICATION OF EXHIBIT PAGE NUMBER
- ------ ------------------------- -----------
<S> <C> <C>
10.39 Non-Qualified Stock Option Agreement dated December 27, 1996,
between LifeQuest Medical, Inc. and Robert Fadem (incorporated
by reference herein to Exhibit 10.4 to the Company's Current
Report on Form 8-K filed January 10, 1997).
22 Subsidiaries
<CAPTION>
Name Under Which
Name State of Incorporation Doing Business
---- ---------------------- --------------
<S> <C> <C>
LifeQuest Endoscopic LifeQuest Endoscopic
Technologies, Inc. Nevada Technologies, Inc.
ValQuest Medical, Inc. Nevada ValQuest Medical, Inc.
Klein Medical
Acquisition Company Nevada Klein Medical, Inc.
Val-U-Med Acquisition
Company Nevada Val-U-Med, Inc.
23 * Consent of Arthur Andersen LLP
27 * Financial Data Schedule
</TABLE>
- ---------------------------
* Filed herewith
(b) REPORTS ON FORM 8-K
(1) Form 8-K dated November 27, 1996 and filed December 12, 1996
described the merger of Klein Medical, Inc., a Texas
corporation, with and into Klein Medical Acquisition Co., a
Nevada corporation and newly formed, wholly owned subsidiary
of LifeQuest Medical, Inc.
(2) Form 8-K dated December 27, 1996 and filed January 10, 1997
described the merger of Val-U-Med, Inc., a Georgia
corporation, with and into Val-U-Med Acquisition Co., a Nevada
corporation and newly formed, wholly owned subsidiary of
LifeQuest Medical, Inc.
(3) Form 8-K/A Amendment No. 1, was filed February 7, 1997, which
provided the financial statements, pro forma financial
information and exhibits pertaining to the previously
announced merger of Klein Medical, Inc., a Texas corporation
with and into Klein Medical, Inc., a Nevada corporation and
newly formed, wholly owned subsidiary of LifeQuest Medical,
Inc.
(4) Form 8-K/A, Amendment No. 1, was filed March 12, 1997 which
provided the financial statements, pro forma financial
information and exhibits pertaining to the previously
announced merger of Val-U-Med, Inc., a Georgia corporation
with and into Val-U-Med, Inc., a Nevada corporation and newly
formed, wholly owned subsidiary of LifeQuest Medical, Inc.
-21-
<PAGE> 23
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.
LIFEQUEST MEDICAL, INC.
March 25, 1997 By /s/ Herbert H. Spoon
---------------------------------------
Herbert H. Spoon
President and Chief Executive Officer
Pursuant to the requirements of the Securities 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.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<S> <C> <C>
/s/ Herbert H. Spoon President, Chief Executive March 25, 1997
- ------------------------- Officer and Director
Herbert H. Spoon (Principal Executive Officer)
/s/ Randall K. Boatright Vice President, Chief Financial March 25, 1997
- ------------------------- Officer and Director (Principal
Randall K. Boatright Financial and Accounting
Officer)
/s/ Robert B. Johnson Director March 25, 1997
- -------------------------
Robert B. Johnson
/s/ K.C. Fadem Director March 25, 1997
- -------------------------
K.C. Fadem
/s/ Jeffrey H. Berg, Ph.D. Director March 25, 1997
- -------------------------
Jeffrey H. Berg, Ph.D.
/s/ Richard H. Klein Director March 25, 1997
- -------------------------
Richard H. Klein
/s/ Robert L. Evans Director March 25, 1997
- -------------------------
Robert L. Evans
/s/ David J. Collette, M.D. Director March 25, 1997
- -------------------------
David J. Collette, M.D.
</TABLE>
-22-
<PAGE> 24
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors and Stockholders of LifeQuest Medical, Inc.:
We have audited the accompanying consolidated balance sheets of
LifeQuest Medical, Inc. (a Delaware corporation) and subsidiaries as of
December 31, 1995 and 1996, and the related consolidated statements of
operations, stockholders' equity and cash flows for the years then ended. 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 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 provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present
fairly, in all material respects, the financial position of LifeQuest Medical,
Inc., and subsidiaries as of December 31, 1995 and 1996, and the results of
their operations and their cash flows for the years then ended in conformity
with generally accepted accounting principles.
/S/ ARTHUR ANDERSEN LLP
San Antonio, Texas
March 7, 1997
F-1
<PAGE> 25
LIFEQUEST MEDICAL, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
ASSETS December 31,
--------------------------
1995 1996
----------- -----------
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 326,065 $ 292,539
Short-term investments 4,817,221 2,464,743
Accounts receivable (net of allowance for doubtful accounts
of $ 6,984 in 1995 and 1996) 374,114 749,744
Accounts receivable from related parties 6,776 11,845
Interest receivable 95,655 60,381
Inventories 284,958 1,517,959
Prepaid and other assets 58,850 92,315
----------- -----------
Total current assets 5,963,639 5,189,526
----------- -----------
Property and equipment:
Equipment held under capital lease 521,867 --
Leasehold improvements 65,229 71,252
Machinery and equipment 118,514 757,318
Furniture and equipment 217,066 313,059
Less: Accumulated depreciation (606,932) (736,910)
----------- -----------
315,744 404,719
----------- -----------
Intangible assets:
Licensed technology rights 427,273 427,273
Goodwill -- 2,677,337
----------- -----------
Total assets $ 6,706,656 $ 8,698,855
=========== ===========
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
F-2
<PAGE> 26
LIFEQUEST MEDICAL, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
LIABILITIES AND STOCKHOLDERS' EQUITY December 31,
-----------------------------
1995 1996
------------ -------------
<S> <C> <C>
Current liabilities:
Accounts payable $ 778,533 1,248,698
Accrued expenses 58,147 994,930
Current portion of long-term debt and capital lease obligations 173,697 11,577
Due to stockholder 27,599 --
------------ ------------
Total current liabilities 1,037,976 2,255,205
Long-term debt and capital lease obligations 244,234 694,379
------------ ------------
Total liabilities 1,282,210 2,949,584
------------ ------------
Minority interest 141,364 120,380
------------ ------------
Commitments and contingencies (Notes 6, 9, 10 and 15)
Stockholders' equity:
Common Stock, $.001 par value; 10,000,000 shares
authorized; 4,354,835 and 5,667,455 shares issued and
outstanding in 1995 and 1996, respectively 4,354 5,667
Additional paid-in capital 17,640,856 19,963,735
Accumulated deficit (12,362,128) (14,340,511)
Total stockholders' equity 5,283,082 5,628,891
------------ ------------
Total liabilities and stockholders' equity $ 6,706,656 $ 8,698,855
============ ============
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
F-3
<PAGE> 27
LIFEQUEST MEDICAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
Year Ended December 31,
--------------------------
1995 1996
----------- -----------
<S> <C> <C>
Revenues:
Net sales $ 3,686,178 $ 3,639,070
----------- -----------
Costs and expenses:
Cost of sales 2,926,480 2,756,581
Research and development 729,000 398,438
Selling, general & administrative 2,607,369 2,258,679
Depreciation and amortization 161,463 129,978
----------- -----------
6,424,312 5,543,676
----------- -----------
Loss from operations (2,738,134) (1,904,606)
Other income (expense):
Investment income 347,143 209,153
Interest expense (50,029) (52,440)
Merger and acquisition costs -- (254,082)
Other -- 2,608
----------- -----------
Net loss before minority interest
and extraordinary item (2,441,020) (1,999,367)
Minority interest in net loss of consolidated subsidiary 138,751 20,984
----------- -----------
Net loss before extraordinary item (2,302,269) (1,978,383)
Extraordinary item:
Gain on extinguishment of debt 24,686 --
Net loss $(2,277,583) $(1,978,383)
=========== ===========
Net loss per share of common stock before extraordinary item $ (.53) $ (.45)
=========== ===========
Net loss per share of common stock $ (.52) $ (.45)
=========== ===========
Weighted average shares used in
computing net loss per share
of common stock 4,354,835 4,418,779
=========== ===========
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
F-4
<PAGE> 28
LIFEQUEST MEDICAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
Common Stock
--------------------------
Shares $.001 Additional
Issued and Par Paid-In Accumulated
Outstanding Value Capital Deficit Total
--------------- ---------- ----------------- ---------- ----------
<S> <C> <C> <C> <C> <C>
Balances, December 31, 1994 4,354,835 $4,354 $17,600,318 $(10,084,545) $7,520,127
Contribution from stockholder - - 19,688 - 19,688
Issuance of stock options - - 20,850 - 20,850
Net loss - - - (2,277,583) (2,277,583)
--------------- ---------- ----------------- ------------ ----------
Balances, December 31, 1995 4,354,835 4,354 17,640,856 (12,362,128) 5,283,082
Contribution from stockholder - - 17,500 - 17,500
Exercise of stock options 38,370 39 13,401 - 13,440
Issuance of stock, Klein acquisition 17,250 17 30,635 - 30,652
Issuance of stock, Val-U-Med acquisition 1,257,000 1,257 2,261,343 - 2,262,600
Net loss - - - (1,978,383) (1,978,383)
--------------- ---------- ----------------- ------------ ----------
Balances, December 31, 1996 5,667,455 $5,667 $19,963,735 $(14,340,511) $5,628,891
========= ====== =========== ============ =========
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
F-5
<PAGE> 29
LIFEQUEST MEDICAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Year Ended December 31,
--------------------------
1995 1996
----------- -----------
<S> <C> <C>
Cash flows from operating activities:
Net loss $(2,277,583) $(1,978,383)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization 161,463 129,978
Issuance of stock options, First-Med acquisition 20,850 --
Issuance of stock, finder's fee, KMI acquisition -- 30,652
Issuance of stock, marketing agreement expense 19,688 17,500
Gain on extinguishment of debt (24,686) --
(Gain) loss on disposal of fixed assets (1,332) 3,198
Minority interest in net loss of consolidated subsidiary (138,751) (20,984)
Changes in operating assets and liabilities
Decrease in accounts receivable, net 175,885 54,617
(Increase) decrease in interest receivable (27,237) 35,274
Decrease (increase) in inventories 53,145 (788,259)
Decrease (increase) in prepaid and other assets 128,966 (25,117)
Decrease (increase) in accounts receivable from related parties 11,126 (5,069)
Increase in accounts payable 234,659 207,931
(Decrease) increase in accrued expenses (48,371) 273,513
----------- -----------
Net cash used in operating activities (1,712,178) (2,065,149)
----------- -----------
Cash flows from investing activities:
Additions to property and equipment (81,322) (194,721)
Proceeds from disposition of property and equipment 9,018 --
Cash paid in connection with Val-U-Med acquisition -- (400,000)
Purchases of investments -- (2,464,743)
Sale of investments 1,398,701 4,817,221
----------- -----------
Net cash provided by investing activities 1,326,397 1,757,757
----------- -----------
Cash flows from financing activities:
Additional capital contributed by minority interest 27,965 --
Funds advanced by stockholder 30,249 --
Proceeds from issuance of notes payable 39,622 750,000
Proceeds from exercise of stock options -- 13,440
Payments on advances from stockholder -- (27,599)
Payments on long-term debt and capital lease obligations (123,009) (461,975)
----------- -----------
Net cash (used in) provided by financing activities (25,173) 273,866
----------- -----------
Net decrease in cash and cash equivalents (410,954) (33,526)
Cash and cash equivalents, beginning of year 737,019 326,065
----------- -----------
Cash and cash equivalents, end of year $ 326,065 $ 292,539
=========== ===========
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
F-6
<PAGE> 30
LIFEQUEST MEDICAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Year Ended December 31,
---------------- ----------
1995 1996
---------------- ----------
<S> <C> <C>
Supplemental Disclosures of Cash Flow Information:
Cash paid during the year for:
Interest $ 50,029 $ 52,440
Income taxes -- --
Supplemental Disclosures of noncash investing and financing activities:
Assets acquired in connection with Val-U-Med acquisition $ -- $3,588,104
================ ==========
Liabilities assumed in connection with the Val-U-Med
acquisition $ -- $ 925,504
================ ==========
1,257,000 shares of common stock issued in connection with the
Val-U-Med acquisition $ -- $2,262,600
================ ==========
</TABLE>
LifeQuest issued 950,000 shares of common stock in connection with the mergers
of G.M. Engineering, Inc. and Klein Medical, Inc. discussed in Note 6.
The accompanying notes are an integral part of these
consolidated financial statements.
F-7
<PAGE> 31
LIFEQUEST MEDICAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - ORGANIZATION AND DESCRIPTION OF LIFEQUEST
LifeQuest Medical, Inc., a Delaware corporation ("LifeQuest" or the
"Company"), was incorporated on December 23, 1988 and commenced operations on
January 1, 1989. LifeQuest is engaged in the development, commercialization,
and distribution of proprietary and non-proprietary medical devices. In 1994,
LifeQuest and Valdor Fiber Optics formed ValQuest Medical, Inc., a Nevada
corporation ("ValQuest"), a corporate joint venture (see Note 5). ValQuest
currently operates as an 82% (approximately 63% as of December 31, 1995) owned
subsidiary of LifeQuest. In February 1996, LifeQuest completed the merger of GM
Engineering, Inc., a California corporation ("GME") with and into LifeQuest
Endoscopic Technologies, Inc., a Nevada corporation ("LQET") (see Note 6) and
wholly owned subsidiary of LifeQuest. In November 1996, LifeQuest completed the
merger of Klein Medical, Inc., a Texas corporation ("Klein") with and into
Klein Medical Acquisition Corp., a Nevada corporation ("KMI") (see Note 6) and
wholly owned subsidiary of LifeQuest. The LQET and KMI mergers were accounted
for as poolings of interest. The consolidated financial statements for 1995
were restated to include the accounts of LifeQuest, ValQuest, LQET, and KMI. In
December 1996, LifeQuest completed the merger of Val-U-Med, Inc., a Georgia
corporation ("Val-U-Med") with and into Val-U-Med Acquisition Corp., a Nevada
corporation ("VMI") (see Note 6) and wholly owned subsidiary of LifeQuest. The
VMI merger was accounted for as a purchase transaction. The consolidated
financial statements for 1996 include the accounts of LifeQuest, ValQuest,
LQET, and KMI. The accounts of VMI have been included since acquisition date.
All significant intercompany accounts and transactions have been eliminated in
consolidation.
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Revenue Recognition
Operating revenues are recognized upon the shipment of products to the
customer.
Inventory
Inventory consists of raw materials, work-in-process, and finished
goods which are stated at the lower of cost (determined on a first-in,
first-out basis) or market.
Research and Development
Research and development costs are expensed as incurred.
Fixed Assets and Depreciation
Fixed assets are recorded at cost less accumulated depreciation.
Depreciation is provided utilizing the straight-line method over the estimated
useful lives of the respective assets (3 - 5 years).
Additions and improvements that extend the useful life of the asset are
capitalized. Repairs and maintenance are charged to expense as incurred. Upon
sales or retirement of property and equipment, the related cost and accumulated
depreciation are eliminated from the accounts and the resulting gain or loss is
recorded.
Licensed Technology Rights
Licensed technology rights will be amortized upon the commencement of
ValQuest's planned principle operations. The carrying value of the licensed
technology is periodically reviewed by the Company with impairments being
recognized when the expected future operating cash flows derived from such
licensed technology rights is less than their carrying value.
Net Loss Per Share
Net loss per share has been computed using the weighted average number
of shares of common stock outstanding during the year. Stock options are
excluded from the computation as their effect is antidilutive.
F-8
<PAGE> 32
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities 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 may differ from those estimates.
Statements of Cash Flows
The Company considers all highly liquid investments with original
maturities of three months or less to be cash equivalents. See Note 8 for
investments not considered cash equivalents.
Impact of Recently Issued Accounting Standards
In March 1995, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of,"
which requires impairment losses to be recorded on long-lived assets used in
operations when indicators of impairment are present and the undiscounted cash
flows estimated to be generated by those assets are less than the assets'
carrying amount. SFAS 121 also addresses the accounting for long-lived assets
that are expected to be disposed of. The Company adopted SFAS 121 in the first
quarter of 1996. The adoption of SFAS No. 121 did not have a material effect on
the Company's financial position or results of operations.
In October 1995, SFAS No. 123, "Accounting for Stock Based
Compensation" ("SFAS 123"), was issued. SFAS 123 defines a fair value based
method of accounting for employee stock options or similar equity instruments
and encourages all entities to adopt that method of accounting for all of their
employee stock compensation plans. Under the fair value based method,
compensation cost is measured at the grant date based on the value of the award
and is recognized over the service period of the award, which is usually the
vesting period. However, SFAS 123 also allows entities to continue to measure
compensation costs for employee stock compensation plans using the intrinsic
value method of accounting prescribed by APB Opinion No. 25, "Accounting for
Stock Issued to Employees" ("APB 25"). The Company has adopted SFAS 123
effective January 1, 1996, and has elected to remain with the accounting
prescribed by APB 25. The Company has made the required disclosures prescribed
by SFAS 123
The FASB issued SFAS No. 125, "Accounting for Transfers and Servicing
of Financial Assets and Extinguishments of Liabilities," ("SFAS 125") in June
1996. This statement will require the Company to classify its financial assets
pledged as collateral separately in the financial statements. This statement is
effective for fiscal years beginning after December 31, 1996, and is to be
applied prospectively. Earlier or retroactive application is not permitted. The
FASB issued SFAS No. 127, "Deferral of the Effective Date of Certain Provisions
of FASB Statement 125" ("SFAS 127"). SFAS 127 moves forward some, but not all,
of the provisions of SFAS 125 to December 31, 1997. The Company believes the
adoption of this statement will not have a material impact on the financial
condition or results of operation of the Company.
In February 1997, SFAS No. 128, "Earnings per Share" ("SFAS 128"), was
issued. SFAS 128 specifies the computation, presentation and disclosure
requirements for earnings per share (EPS) for entities with publicly held
common stock or potential common stock. SFAS 128 is effective for fiscal years
ending after December 15, 1997, including interim periods. Earlier application
is not permitted. SFAS 128 requires restatement of all prior periods for which
EPS data is presented.
F-9
<PAGE> 33
NOTE 3 - CONCENTRATION OF RISK:
Credit Risk
The Company's accounts receivable are from various hospitals, clinics
and practicing surgeons. Based on the Company's evaluation of the
collectibility of these accounts receivable, $77,984 and $16,672 of
uncollectible accounts were written off in 1995 and 1996, respectively. The
Company's management believes that the remainder of the receivables outstanding
are collectible. The Company's accounts receivable are generally not
collateralized.
Customer
The Company had 1 customer which accounted for 23 percent of
consolidated sales for the year ended December 31, 1996.
Supplier
The Company had 2 suppliers which accounted for 27 percent and 25
percent of purchases for the year ended December 31, 1995, and 14 percent and
12 percent for the year ended December 31, 1996.
NOTE 4 - INVENTORIES
Inventories at December 31 are summarized as follows:
<TABLE>
<CAPTION>
1995 1996
---------- ----------
<S> <C> <C>
Raw materials $ 59,711 $ 66,979
Work-in-process -- 128,774
Finished goods 225,247 1,322,206
---------- ----------
$ 284,958 $1,517,959
========== ==========
</TABLE>
NOTE 5 - VALQUEST JOINT VENTURE
In May 1994, LifeQuest and Valdor Fiber Optics ("Valdor") of San Jose,
California, formed ValQuest, a corporate joint venture. In accordance with the
terms of the joint venture agreement, Valdor transferred to ValQuest the
exclusive worldwide rights to develop, manufacture, and market all present and
future medical applications of Valdor's patented fiber optic connector
technology. LifeQuest paid $100,000 to Valdor in consideration for the transfer
of these rights to ValQuest. Valdor contributed such rights, which had an
initial value of $327,273 in the consolidated financial statements, to ValQuest
in exchange for a 45% interest in ValQuest. LifeQuest contributed $400,000 to
be used as working capital in exchange for a 55% interest in ValQuest. At
December 31, 1996, purchases of additional stock have increased LifeQuest's
ownership interest in ValQuest to 82%.
NOTE 6 - ACQUISITIONS
The following describes acquisitions by the Company during the year ended
December 31, 1996:
G.M. Engineering, Inc.
In February 1996, GME was merged with and into LQET, a subsidiary of
LifeQuest. The merger was accomplished through exchanging all of the
outstanding common stock of GME for 350,000 shares of LifeQuest restricted
common stock. The transaction was recorded using the pooling-of-interest method
of accounting.
Klein Medical, Inc.
In November 1996, Klein was merged with and into KMI, a subsidiary of
LifeQuest. The merger was accomplished through exchanging all of the
outstanding common stock of Klein for 600,000 shares of LifeQuest restricted
common stock. The transaction was recorded using the pooling-of-interest method
of accounting.
F-10
<PAGE> 34
The KMI merger agreement also provides a compensation agreement with
the former stockholder of Klein to act as chief executive officer and president
of the surviving corporation, KMI, through December 31, 1999. The agreement
provides for base compensation of $125,000 per year, additional performance
based compensation and participation in all employee benefits provided by
LifeQuest. LifeQuest issued 17,250 shares of LifeQuest restricted common stock
to a third-party for a finder's fee associated with the transaction. In
addition, LifeQuest and the former stockholder have entered into a nonqualified
stock option agreement pursuant to which LifeQuest has granted to the former
stockholder nonqualified stock options to buy up to 60,000 shares of LifeQuest
common stock.
Val-U-Med, Inc.
In December 1996, Val-U-Med was merged with and into VMI, a subsidiary
of LifeQuest. The merger was accomplished through exchanging all of the
outstanding stock of Val-U-Med for 1,200,000 shares of LifeQuest restricted
common stock and $400,000. In addition, LifeQuest gave 57,000 shares of
LifeQuest restricted common stock to a third party for a finder's fee
associated with the transaction. The transaction was recorded using the
purchase method of accounting effective December 27, 1996.
LifeQuest recorded the assets and liabilities of Val-U-Med at fair
value as of the purchase date. The excess of the purchase price over net assets
acquired of $2,677,337 was recorded as goodwill and will be amortized over 10
years.
The following table reflects unaudited pro forma combined results of operations
of the Company and Val-U-Med on the basis that the acquisition had taken place
at the beginning of the fiscal year for each of the periods presented:
<TABLE>
<CAPTION>
1995 1996
----------- -----------
<S> <C> <C>
Revenues $ 6,733,486 $ 8,236,548
Net loss (2,552,522) (2,375,694)
Net loss per common share $ (.45) $ (.42)
</TABLE>
The unaudited pro forma combined results of operations are not
necessarily indicative of the actual results that would have occurred had the
acquisition been consummated at the beginning of 1995 or at the beginning of
1996 nor does such information purport to project the results of operations for
any future period.
The VMI merger agreement also provides a compensation agreement with
the former president of Val-U-Med to act as president and chief operating
officer of the surviving corporation, VMI, and as vice president of LifeQuest
through December 31, 1999. Furthermore the agreement provides a compensation
agreement with the former vice president of sales of Val-U-Med to act as vice
president of sales of the surviving corporation, VMI, through December 31,
1999. The agreements provide for base compensations of $100,000 each per year,
additional performance based compensation and participation in all employee
benefits provided by LifeQuest. In addition, LifeQuest and the president and
vice president of sales of VMI have entered into a nonqualified stock option
agreement pursuant to which LifeQuest has granted to the president and vice
president of sales of VMI nonqualified stock options to receive up to 60,000
shares each of LifeQuest common stock.
F-11
<PAGE> 35
NOTE 7 - FEDERAL INCOME TAXES
As of December 31, 1996, the Company had net operating loss (NOL)
carryforwards of approximately $13,083,000 for federal income tax purposes
which are available to reduce future taxable income and will expire in 2006
through 2011 if not utilized. For federal income tax purposes, the Company
deferred for future amortization certain acquisition and research and
development costs in the amount of $2,453,000. Such costs, which have been
expensed for financial reporting purposes, will be amortized for tax purposes
over future years when commercial operations commence. The Company received IRS
approval of its request for a change of tax accounting method to expense
research and development costs for expenditures incurred in 1992 and future
years. The Company also has Research and development credit carryforwards
available to offset future income taxes and expire in 2005 through 2010.
The principal components of deferred taxes at December 31, 1995, and 1996, are
as follows:
<TABLE>
<CAPTION>
1995 1996
----------- -----------
Temporary differences:
<S> <C> <C>
Capitalized research and development and acquisition costs $ 734,766 $ 734,766
Depreciation 25,008 44,768
Accrual to cash adjustments -- 19,600
Reserves not deductible for tax -- 94,400
Other 34,279 34,279
----------- -----------
Total temporary differences 794,053 927,813
Research and development credit carryforwards 551,656 551,656
Federal tax losses not currently utilizable 3,073,893 4,724,891
----------- -----------
Net deferred tax assets 4,419,602 6,204,360
Deferred tax valuation reserve (4,419,602) (6,204,360)
----------- -----------
Net deferred tax assets $ -- $ --
=========== ===========
</TABLE>
As the Company has not generated significant operating revenues since
its inception, nor is there any assurance of future revenues, a 100% valuation
reserve in 1995 and 1996 has been established to recognize its deferred tax
assets only to the extent of its deferred tax credits. The Company will
continue to evaluate the necessity for such valuation reserve in the future.
The Company's ability to use its NOL carryforwards to offset future
taxable income is subject to restrictions enacted in the United States Internal
Revenue Code of 1986, as amended (the "Code"). These restrictions provide for
limitations on the Company's utilization of its NOL carryforwards following
certain ownership changes described in the Code. As a result of ownership
changes, the Company's existing NOL carryforwards are subject to the
limitation. Of the $13,083,000 of NOL carryforwards, $553,000 is subject to
limitation. Approximately $40,000 of the $553,000 can be utilized annually.
F-12
<PAGE> 36
NOTE 8 - SHORT-TERM INVESTMENTS
Short-term investments consist solely of debt securities issued by the
United States Treasury. In May 1993, the FASB issued SFAS No. 115, "Accounting
for Certain Investments in Debt and Equity Securities," effective for fiscal
years beginning after December 15, 1993. Under the new rules, debt securities
that the Company has both the positive intent and ability to hold to maturity
are carried at amortized cost. Debt securities that the Company does not have
the positive intent and ability to hold to maturity and all marketable equity
securities are classified as available-for-sale or trading and carried at fair
value. Unrealized holding gains and losses on securities classified as
available-for-sale are reported as a separate component of stockholders'
equity. Unrealized holding gains and losses on securities classified as trading
are reported in earnings. The Company intends to hold these securities to
maturity and believes it has the ability to do so. Therefore, these securities
are reported at amortized cost. A portion of the investments is pledged as
collateral (see Note 10). The following table summarizes short-term investments
held by the Company at December 31, 1995, and 1996:
<TABLE>
<CAPTION>
Gross Gross
Amortized Fair Market Unrealized Unrealized
Cost Value Holding Gains Holding Losses
--------- ----------- ------------- --------------
<S> <C> <C> <C> <C>
December 31, 1995:
Debt securities issued by the
U.S. Treasury $ 4,817,221 $ 4,913,915 $ 96,694 $ -
December 31, 1996:
Debt securities issued by the
U.S. Treasury $ 2,464,743 $ 2,522,776 $ 58,033 $ -
</TABLE>
NOTE 9 - LEASE OBLIGATIONS
The Company leases office space under non-cancelable operating leases.
Rentals are subject to escalation for increases in property taxes, insurance
and various other expenses. Future minimum rental payments of the Company under
existing and pending operating lease agreements at December 31, 1996, are as
follows (see Note 16):
<TABLE>
<S> <C>
1997 $ 223,103
1998 198,054
1999 206,969
2000 210,999
2001 210,135
Thereafter 55,480
-----------
$ 1,104,740
===========
</TABLE>
Rent expense totaled approximately $201,000 and $145,000 for the years ended
December 31, 1995, and 1996, respectively.
F-13
<PAGE> 37
NOTE 10 - CURRENT AND LONG-TERM DEBT AND CAPITAL LEASE OBLIGATIONS
The Company had the following current and long-term debt and capital
lease obligations at December 31:
<TABLE>
<CAPTION>
1995 1996
-------- --------
<S> <C> <C>
Secured note payable for a vehicle loan, bearing interest at 6.9 percent, $ 725 $ --
principal and interest due monthly
Secured note payable for a vehicle loan, bearing interest at 8.75 percent, 16,919 11,879
principal and interest due monthly with a maturity date of February 9,
2000
Unsecured note payable to an unrelated individual, bearing interest at 10 29,495 --
percent, principal and interest due March 1996
Unsecured note payable under a $20,000 revolving line of credit with a 15,394 --
bank, bearing interest at a bank's prime rate plus 3.16 percent (11.66
percent at December 31, 1995), interest payable monthly, principal
due on demand or, if no demand is made, in November 1996
Settlement and release agreement with a leasing company entered into in 7,309 --
November 1994
Unsecured note payable to an unrelated individual, bearing interest at 10 12,500 --
percent, principal and interest due March 1996
Note payable to a financial institution, secured by short-term -- 682,500
investments, bearing interest at 6.41 percent, interest due monthly with
a maturity date of January 23, 1998
Unsecured note, bearing interest at a bank's prime rate plus 3.09 (11.34 -- 11,577
percent at December 31, 1996), interest payable monthly, principal
due on demand or, if no demand is made, in monthly installments of
$1,458 through August 1997
Capital lease obligations 335,589 --
-------- --------
Total long-term debt and capital lease obligations 417,931 705,956
Less - Current portion 173,697 11,577
-------- --------
Long-term debt and capital lease obligations $244,234 $694,379
======== ========
</TABLE>
The carrying amount of the debt approximates the fair value of the
debt. This determination is based on management's estimate of the fair value at
which such instruments could be sold or obtained in a third-party transaction.
F-14
<PAGE> 38
NOTE 11 - STOCK OPTIONS
In October 1995, SFAS No. 123, "Accounting for Stock Based
Compensation" ("SFAS 123"), was issued. SFAS 123 defines a fair value based
method of accounting for employee stock options or similar equity instruments
and encourages all entities to adopt that method of accounting for all of their
employee stock compensation plans. Under the fair value based method,
compensation cost is measured at the grant date based on the value of the award
and is recognized over the service period of the award, which is usually the
vesting period. However, SFAS 123 also allows entities to continue to measure
compensation costs for employee stock compensation plans using the intrinsic
value method of accounting prescribed by APB Opinion No. 25, "Accounting for
Stock Issued to Employees" ("APB 25"). The Company has adopted SFAS 123
effective January 1, 1996, and has elected to remain with the accounting
prescribed by APB 25. The Company has made the required disclosures prescribed
by SFAS 123
In December 1989, the Company adopted a stock option plan (the "1989
Plan"). Under the 1989 Plan, the Company may grant incentive and non-statutory
stock options to employees, directors and consultants of the Company. The
maximum number of shares available for grant under the 1989 Plan, as amended in
1993, is 685,000. Unexercised options expire ten years from the date of grant.
In August 1994, ValQuest adopted the 1994 Stock Option Plan (the "1994
Plan"). Under the 1994 Plan, ValQuest may grant incentive and non-statutory
stock options to employees, directors and consultants of ValQuest. The maximum
number of shares of ValQuest common stock available for grant under the 1994
Plan is 250,000. Stock options under the 1989 Plan and the 1994 Plan become
exercisable pursuant to the individual written agreements between the Company
and ValQuest, respectively, and the participants. Unexercised options expire
ten years from the date of grant for the 1994 Plan.
In May 1995, the Company adopted the 1995 Non-Employee Director Stock
Option Plan ("NEDSOP"). Under NEDSOP, the Company may grant stock options to
non-employee directors of the Company. The maximum number of shares available
for grant under NEDSOP is 400,000. The NEDSOP options vest in 25 percent
increments on each succeeding anniversary of the grant date, with unexercised
options expiring on the tenth anniversary of the date they vest. Under all
three stock option plans the option exercise price must be equal to at least
the stock's market price on the date of grant.
Pursuant to certain agreements entered into in May 1990, the Company
in January 1993 granted three consultants non-qualified stock options to
purchase in the aggregate up to 21,141 shares of Common Stock at an exercise
price of $.001 per share. The options, which expire in May 1997, were granted
outside any option plan and vested in 1994. Options to purchase 7,047 shares
have been exercised to date and 12,332 options are currently exercisable. Prior
to December 31, 1996, the Company has recognized approximately $236,000 (none
in the current year) as research and development expense representing the
difference between the exercise price and the fair market value of options
which became exercisable.
In 1996, the Company granted four employee directors non-qualified
options to purchase in the aggregate up to 380,000 shares of Common Stock at an
exercise price equal to the stock's market price on the date of grant. The
options were granted outside any option plan and vest over three years based on
continued employment and achievement of certain performance goals in 1997, 1998
and 1999. Options for 15,000 shares are currently exercisable. There are
options for 120,000 that expire on July 31, 2000, options for 200,000 shares
that expire on February 1, 2006, and the remaining options expire on December
31, 2006.
Had compensation cost for these plans been determined consistent with
SFAS 123, the Company's net loss and net loss per share (EPS) would have been
reduced to the following pro forma amounts at December 31:
<TABLE>
<CAPTION>
1995 1996
------------- -------------
<S> <C> <C> <C>
Net Loss: As Reported $ (2,277,583) $ (1,978,383)
Pro Forma (2,456,973) (2,138,758)
EPS: As Reported $ (.52) $ (.45)
Pro Forma (.56) (.48)
</TABLE>
Because the SFAS 123 method of accounting has not been applied to
options granted prior to January 1, 1995, the resulting pro forma compensation
cost may not be representative of that to be expected in future years.
F-15
<PAGE> 39
A summary of the status of the Company's stock options at December 31,
1995, and 1996, and changes during the years then ended is presented in the
table and narrative below:
<TABLE>
<CAPTION>
1995 1996
------------------- -----------------
Weighted Weighted
Average Average
Exercise Exercise
Shares Price Per Shares Price Per
(000) Share (000) Share
----- ----- ----- -----
<S> <C> <C> <C> <C>
Outstanding at beginning of year 459 $1.12 577 $1.34
Granted 129 2.35 440 2.67
Exercised -- -- (39) .35
Forfeited (11) 4.00 (24) 3.05
--- ----- ----- -----
Outstanding at end of year 577 1.34 954 1.95
Options exercisable at end of year 396 .97 436 .83
Weighted Average fair value of options granted $2.16 $2.51
</TABLE>
The following table summarizes the information about options
outstanding at December 31, 1996:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
--------------------------------------- -----------------------------
Weighted
Average
Weighted Exercise Weighted
Average Price Per Number Average
Remaining Share Exercisable at Exercise
Number Contractual at December December 31, Price Per
Exercise Prices Per Share Outstanding Life 31, 1996 1996 Share
------------------------- ----------- ------------------- ----------------- ---------------- ----------
<S> <C> <C> <C> <C> <C>
$.001 12,332 0.42 years $.001 12,332 $.001
.35 235,907 4.39 years .35 179,523 .35
.75 84,000 7.67 years .75 84,000 .75
2.00 28,000 9.69 years 2.00 26,000 2.00
2.25 75,000 8.42 years 2.25 75,000 2.25
2.50 270,420 9.03 years 2.50 24,745 2.50
3.00 180,000 9.72 years 3.00 - 3.00
4.00 68,580 7.33 years 4.00 34,290 4.00
------- ------
954,239 7.63 years $1.95 435,890 $.83
</TABLE>
The fair value of each option grant is estimated on the date of grant
using the Black Scholes option pricing model for a stock that does not pay
dividends with the following weighted-average assumptions used for grants in
1995 and 1996, respectively: risk-free interest rates of 6.8 and 6.0 percent;
expected lives of 10 years and expected volatility of 103.4 and 111.3 percent.
F-16
<PAGE> 40
NOTE 12 - RELATED-PARTY TRANSACTIONS
The Company made payments to certain stockholders for consulting fees
of approximately $24,000 and $12,000 for the two years ended December 31, 1995,
and 1996, respectively.
At December 31, 1995, the Company owed a stockholder $27,599 in a note
payable bearing interest at a bank's prime rate plus 3.09 percent (11.59
percent at December 31, 1995), interest payable monthly, principal due on
demand, or if no demand is made, in monthly installments of $1,458 through
August 1997. During 1996 this liability was repaid.
NOTE 13 - MARKETING AGREEMENT
In April 1995, GME entered into an agreement, as amended, whereby a
marketing consultant would provide marketing, distribution and sales consulting
services to GME over the three-year term of the agreement. As compensation for
entering into this contract, a stockholder gave to the consultant shares equal
to 3.75 percent of the outstanding shares of GME stock, which had an estimated
fair market value of $17,500. This stock was subsequently exchanged for the
Company's common stock. The consultant also earned commissions based on sales
levels as defined in the agreement. The Company accounted for this transaction
as a contribution of capital and recognized the related expense in 1995.
During 1995 and 1996, the Company expensed approximately $40,000 and $35,000,
respectively, related to this agreement. The agreement was terminated June 30,
1996.
NOTE 14 - EXTRAORDINARY ITEM
In January 1995, LQET entered into a settlement agreement with a bank
for debts owed to the bank, pursuant to which the bank agreed to forgive debt
of $24,686. This gain on extinguishment has been reflected as an extraordinary
item on the accompanying statement of operations.
NOTE 15 - CONTINGENCY REGARDING SALES TAX
The Company has accrued $311,000 and $574,000 as of December 31, 1995
and 1996, respectively, related to sales tax payable. The Company is currently
in the process of obtaining the necessary documentation to achieve exemption
from sales tax related to sales made to certain of its customers. However, as
there can be no assurance that the management of the Company will ultimately be
successful in obtaining such documentation, management has established accruals
for the potential sales tax liability.
NOTE 16 - SUBSEQUENT EVENTS
Effective January 1, 1997, KMI entered into a settlement agreement
with a supplier which accounted for 14 percent of consolidated purchases for
the year ended December 31, 1996. The settlement agreement called for the
termination of the distribution agreement dated October 6, 1994, between KMI
and the supplier. Specifically, KMI and any affiliated companies are prohibited
from selling, marketing or otherwise distributing certain of the suppliers'
products or competing products within the territory covered by the original
distribution agreement for a specified period of time. The supplier will pay to
KMI an amount, as specified in the confidentiality agreement, during 1997.
Management does not believe this will significantly impact the financial
position or results of operations.
In January 1997, VMI entered into a lease agreement for new office space.
LifeQuest is currently negotiating a lease for a new facility, of which
LifeQuest has agreed to the rent expense and lease terms. The lease terms are
from March 1997 through May 2002. The estimated payments under these operating
leases have been included in the future minimum lease payments in Note 9.
F-17
<PAGE> 41
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NUMBER IDENTIFICATION OF EXHIBIT PAGE NUMBER
- ------ ------------------------- -----------
<S> <C> <C>
2.1 Plan of Merger and Acquisition Agreement dated February 13,
1996, but effective as of January 1, 1996, among LifeQuest
Medical, Inc., LifeQuest Endoscopic Technologies, Inc., GM
Engineering, Inc., Gregory M. Miles and Susan G. Miles
(incorporated by reference herein to Exhibit 2.1 to the
Company's Current Report on Form 8-K filed February 27, 1996).
2.2 Stock Escrow and Pledge Agreement dated February 13, 1996,
among Gregory M. Miles and Susan G. Miles (as pledgors) and
LifeQuest Medical, Inc. and LifeQuest Endoscopic Technologies,
Inc. (as pledgees) and Texas Commerce Bank National Association
(as escrow agent) (incorporated by reference herein to Exhibit
2.2 to the Company's Current Report on Form 8-K filed February
27, 1996).
2.3 Plan of Merger and Acquisition Agreement dated November 27,
1996, among LifeQuest Medical, Inc., Klein Medical Acquisition
Co., Klein Medical, Inc. and Richard H. Klein (incorporated by
reference herein to Exhibit 2.1 to the Company's Current Report
on Form 8-K filed December 12, 1996).
2.4 Plan of Merger and Acquisition Agreement dated December 27,
1996, among LifeQuest Medical, Inc., Val-U-Med Acquisition Co.,
Val-U-Med, Inc. and the Stockholders of Val-U-Med, Inc.
(incorporated by reference herein to Exhibit 2.1 to the
Company's Current Report on Form 8-K filed January 10, 1997).
3.1 Certificate of Incorporation of the Registrant (incorporated by
reference herein to Exhibit 3.1 to the Company's Registration
Statement on Form S-1 filed on August 19,1992, Registration No.
33-49196).
3.2 Bylaws of the Registrant (incorporated by reference herein to
Exhibit 3.2 to the Company's Registration Statement on Form S-1
filed on August 19, 1992, Registration No. 33-49196).
10.1 1989 Stock Option Plan of LifeQuest Medical, Inc. (incorporated
by reference herein to Exhibit 4.4 to the Company's
Registration Statement on Form S-8 filed on October 12, 1993,
Registration No. 33-70174).
</TABLE>
<PAGE> 42
<TABLE>
<CAPTION>
EXHIBIT
NUMBER IDENTIFICATION OF EXHIBIT PAGE NUMBER
- ------ ------------------------- -----------
<S> <C> <C>
10.2 Amended and Restated Employment Contract dated November 1,
1989, between LifeQuest Medical, Inc. and Larry J. Miller, M.D.
(incorporated by reference herein to Exhibit 10.7 to the
Company's Registration Statement on Form S-1 filed on August
19, 1992, Registration No. 33-49196).
10.3 Employment Agreement dated February 15, 1992, between
LifeQuest Medical, Inc. and Herbert H. Spoon (incorporated by
reference herein to Exhibit 10.8 to the Company's Registration
Statement on Form S-1 filed on August 19, 1992, Registration No.
33-49196).
10.7 Incentive Stock Option Agreement dated January 15, 1990,
between LifeQuest Medical, Inc. and Herbert H. Spoon
(incorporated herein to Exhibit 10.12 to the Company's
Registration Statement on Form S-1 filed on August 19, 1992,
Registration No. 33-49196).
10.8 Consulting Agreement dated January 9, 1990, between LifeQuest
Medical, Inc. and John G. Kuhn, Pharm.D. (incorporated herein
to Exhibit 10.13 to the Company's Registration Statement on
Form S-1 filed on August 19, 1992, Registration No. 33-49196).
10.9 Consulting Agreement dated January 9, 1990, between LifeQuest
Medical, Inc. and Daniel D. Von Hoff, M.D. (incorporated herein
to Exhibit 10.14 to the Company's Registration Statement on
Form S-1 filed on August 19, 1992, Registration No. 33-49196).
10.10 Patent License Agreement dated January 1, 1989, between
LifeQuest Medical, Inc. and The Board of Regents of the
University of Texas System, as amended by instrument dated
November 1, 1989 (incorporated herein to Exhibit 10.15 to the
Company's Registration Statement on Form S-1 filed on August
19, 1992, Registration No. 33-49196).
10.11 License Agreement dated June 26, 1992, between LifeQuest
Medical, Inc. and George C. Kramer, Ph.D. (incorporated herein
to Exhibit 10.22 to the Company's Registration Statement on
Form S-1 filed on August 19, 1992, Registration No. 33-49196).
10.12 Consulting Agreement dated June 26, 1992, between LifeQuest
Medical, Inc. and George C. Kramer, Ph.D. (incorporated herein
to Exhibit 10.23 to the Company's Registration Statement on
Form S-1 filed on August 19, 1992, Registration No. 33-49196).
10.13 Non-Qualified Stock Option Agreement dated June 26, 1992,
between LifeQuest Medical, Inc. and George C. Kramer, Ph.D.
(incorporated herein to Exhibit 10.23 to the Company's
Registration Statement on Form S-1 filed on August 19, 1992,
Registration No. 33-49196).
10.14 Non-Qualified Stock Option Agreement dated June 26, 1992,
between LifeQuest Medical, Inc. and George C. Kramer, Ph.D.
(incorporated herein to Exhibit 10.24 to the Company's
Registration Statement on Form S-1 filed on August 19, 1992,
Registration No. 33-49196).
10.15 Incentive Stock Option Agreement dated October 17, 1994,
between LifeQuest Medical, Inc. and Herbert H. Spoon
(incorporated herein by reference to Exhibit 10.15 to the
Company's Annual Report on Form 10-K for the fiscal year ended
December 31, 1994).
</TABLE>
<PAGE> 43
<TABLE>
<CAPTION>
EXHIBIT
NUMBER IDENTIFICATION OF EXHIBIT PAGE NUMBER
- ------ ------------------------- -----------
<S> <C> <C>
10.16 Incentive Stock Option Agreement dated October 17, 1994,
between LifeQuest Medical, Inc. and Randall K. Boatright
(incorporated herein by reference to Exhibit 10.16 to the
Company's Annual Report on Form 10-K for the fiscal year ended
December 31, 1994).
10.17 Incentive Stock Option Agreement dated October 17, 1994,
between LifeQuest Medical, Inc. and Ruben G. Zamorano
(incorporated herein by reference to Exhibit 10.17 to the
Company's Annual Report on Form 10-K for the fiscal year ended
December 31, 1994).
10.18 Incentive Stock Option Agreement dated October 17, 1994,
between LifeQuest Medical, Inc. and David J. Collette, M.D.
(incorporated herein by reference to Exhibit 10.18 to the
Company's Annual Report on Form 10-K for the fiscal year ended
December 31, 1994).
10.19 1994 Non-Employee Director Stock Option Plan (incorporated
herein by reference to Exhibit 10.19 to the Company's Annual
Report on Form 10-K for the fiscal year ended December 31,
1994).
10.20 Non-Qualified Stock Option Agreement dated October 17, 1994,
between LifeQuest Medical, Inc. and John L. Cassis
(incorporated herein by reference to Exhibit 10.20 to the
Company's Annual Report on Form 10-K on Form 10-K for the
fiscal year ended December 31, 1994).
10.21 Non-Qualified Stock Option Agreement dated October 17, 1994,
between LifeQuest Medical, Inc. and Robert B. Johnson
(incorporated herein by reference to Exhibit 10.21 to the
Company's Annual Report on Form 10-K for the fiscal year ended
December 31, 1994).
10.22 Non-Qualified Stock Option Agreement dated March 2, 1995,
between LifeQuest Medical, Inc. and Jeffrey H. Berg, Ph.D.
(incorporated herein by reference to Exhibit 10.22 to the
Company's Annual Report on Form 10-K for the fiscal year ended
December 31, 1994).
10.23 ValQuest Medical, Inc. 1994 Stock Option Plan (incorporated
herein by reference to Exhibit 10.23 to the Company's Annual
Report on Form 10-K for the fiscal year ended December 31,
1994).
10.24 Incentive Stock Option Agreement dated August 19, 1994, between
ValQuest Medical, Inc. and Herbert H. Spoon (incorporated herein
by reference to Exhibit 10.24 to the Company's Annual Report on
Form 10-K for the fiscal year ended December 31, 1994).
10.25 Incentive Stock Option Agreement dated August 19, 1994, between
ValQuest Medical, Inc. and Randall K. Boatright (incorporated
herein by reference to Exhibit 10.25 to the Company's Annual
Report on Form 10-K for the fiscal year ended December 31,
1994).
10.26 Incentive Stock Option Agreement dated August 19, 1994, between
ValQuest Medical, Inc. and David J. Collette, M.D.
(incorporated herein by reference to Exhibit 10.26 to the
Company's Annual Report on Form 10-K for the fiscal year ended
December 31, 1994).
</TABLE>
<PAGE> 44
<TABLE>
<CAPTION>
EXHIBIT
NUMBER IDENTIFICATION OF EXHIBIT PAGE NUMBER
- ------ ------------------------- -----------
<S> <C> <C>
10.27 Incentive Stock Option Agreement dated August 19, 1994, between
ValQuest Medical, Inc. and Ruben G. Zamorano (incorporated
herein by reference to Exhibit 10.27 to the Company's Annual
Report on Form 10-K for the fiscal year ended December 31,
1994).
10.28 Non-Incentive Stock Option Agreement dated August 19, 1994,
between ValQuest Medical, Inc. and John L. Cassis (incorporated
herein by reference to Exhibit 10.28 to the Company's Annual
Report on Form 10-K for the fiscal year ended December 31,
1994).
10.29 Non-Incentive Stock Option Agreement dated August 19, 1994,
between ValQuest Medical, Inc. and Robert B. Johnson
(incorporated herein by reference to Exhibit 10.29 to the
Company's Annual Report on Form 10-K for the fiscal year ended
December 31, 1994).
10.30 Assignment and License Agreement dated May 11, 1994, between
ValQuest Medical, Inc. and Fibotech, Inc. d/b/a Valdor Fiber
Optics (incorporated herein by reference to Exhibit 10.30 to
the Company's Annual Report on Form 10-K for the fiscal year
ended December 31, 1994).
10.31 Employment Agreement dated February 13, 1996, between
LifeQuest Endoscopic Technologies, Inc. and Gregory M. Miles
(incorporated by reference herein to Exhibit 10.1 to the
Company's Current Report on Form 8-K filed February 27, 1996).
10.32 Non-Competition Agreement dated February 13, 1996, between
LifeQuest Medical, Inc. and Gregory M. Miles (incorporated by
reference herein to Exhibit 10.2 to the Company's Current
Report on Form 8-K filed February 27, 1996).
10.33 Non-Qualified Stock Option Agreement dated February 13, 1996,
between LifeQuest Medical, Inc. and Gregory M. Miles
(incorporated by reference herein to Exhibit 10.3 to the
Company's Current Report on Form 8-K filed February 27, 1996).
10.34 Employment Agreement dated November 27, 1996, between Klein
Medical Acquisition Co. and Richard H. Klein (incorporated by
reference herein to Exhibit 10.1 to the Company's Current
Report on Form 8-K filed December 12, 1996).
10.35 Non-Qualified Stock Option Agreement dated November 27, 1996,
between LifeQuest Medical, Inc. and Richard H. Klein
(incorporated by reference herein to Exhibit 10.2 to the
Company's Current Report on Form 8-K filed December 12, 1996).
10.36 Employment Agreement dated December 27, 1996, between Val-U-
Med Acquisition Co. and K.C. Fadem (incorporated by reference
herein to Exhibit 10.1 to the Company's Current Report on Form
8-K filed January 10, 1997).
10.37 Non-Qualified Stock Option Agreement dated December 27, 1996,
between LifeQuest Medical, Inc. and K.C. Fadem (incorporated by
reference herein to Exhibit 10.2 to the Company's Current Report
on Form 8-K filed January 10, 1997).
10.38 Employment Agreement dated December 27, 1996, between Val-U-
Med Acquisition Co. and Robert Fadem (incorporated by reference
herein to Exhibit 10.3 to the Company's Current Report on Form
8-K filed January 10, 1997).
</TABLE>
<PAGE> 45
<TABLE>
<CAPTION>
EXHIBIT
NUMBER IDENTIFICATION OF EXHIBIT PAGE NUMBER
- ------ ------------------------- -----------
<S> <C> <C>
10.39 Non-Qualified Stock Option Agreement dated December 27, 1996,
between LifeQuest Medical, Inc. and Robert Fadem (incorporated
by reference herein to Exhibit 10.4 to the Company's Current
Report on Form 8-K filed January 10, 1997).
22 Subsidiaries
<CAPTION>
Name Under Which
Name State of Incorporation Doing Business
---- ---------------------- --------------
<S> <C> <C>
LifeQuest Endoscopic LifeQuest Endoscopic
Technologies, Inc. Nevada Technologies, Inc.
ValQuest Medical, Inc. Nevada ValQuest Medical, Inc.
Klein Medical
Acquisition Company Nevada Klein Medical, Inc.
Val-U-Med Acquisition
Company Nevada Val-U-Med, Inc.
23 * Consent of Arthur Andersen LLP
27 * Financial Data Schedule
</TABLE>
- ---------------------------
* Filed herewith
<PAGE> 1
EXHIBIT 23
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the incorporation of
our reports included in this Form 10-KSB, into the Company's previously filed
Registration Statement on Form S-3 (SEC File No. 333-21361).
/s/ ARTHUR ANDERSEN LLP
San Antonio, Texas
March 7, 1997
F-19
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> DEC-31-1996
<CASH> 292,539
<SECURITIES> 2,464,743
<RECEIVABLES> 756,728
<ALLOWANCES> 6,984
<INVENTORY> 1,517,959
<CURRENT-ASSETS> 5,189,526
<PP&E> 1,141,629
<DEPRECIATION> 736,910
<TOTAL-ASSETS> 8,698,855
<CURRENT-LIABILITIES> 2,255,205
<BONDS> 694,379
0
0
<COMMON> 5,667
<OTHER-SE> 5,623,224
<TOTAL-LIABILITY-AND-EQUITY> 8,698,855
<SALES> 3,639,070
<TOTAL-REVENUES> 3,850,831
<CGS> 2,756,581
<TOTAL-COSTS> 5,543,676
<OTHER-EXPENSES> 254,082
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 52,440
<INCOME-PRETAX> (1,978,383)
<INCOME-TAX> 0
<INCOME-CONTINUING> (1,978,383)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (1,978,383)
<EPS-PRIMARY> (.45)
<EPS-DILUTED> (.45)
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