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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR FISCAL YEAR ENDED SEPTEMBER 30, 1997
COMMISSION FILE NUMBER: 0-18933
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ROCHESTER MEDICAL CORPORATION
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MINNESOTA 41-1613227
State of Incorporation IRS Employer Identification No.
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ONE ROCHESTER MEDICAL DRIVE
STEWARTVILLE, MINNESOTA 55976
Address of Principal Executive Offices
Telephone Number: 507/533-9600
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
COMMON STOCK WITHOUT PAR VALUE
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Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such
shorter period that the Registrant was required to file such reports), and has
been subject to such filing requirements for the past 90 days. Yes /X/ No / /
Check if no disclosure of delinquent filers pursuant to Item 405 of
Regulation S-B is contained in this form, and no disclosure will be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. /X/
The issuer's revenues for its most recent fiscal year were $7,615,439
The aggregate market value of voting stock held by non-affiliates based upon
the closing NASDAQ sale price on December 23, 1997 was $60,390,000.
Number of shares outstanding on December 23, 1997 was 5,261,500 Common
Shares.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of Registrant's Proxy Statement for its February 4, 1998 Annual
Meeting of Shareholders are incorporated by reference in Part III.
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PART I
ITEM 1. BUSINESS
OVERVIEW
Rochester Medical Corporation (the "Company") was incorporated in Minnesota
in April, 1988. The Company develops, manufactures and markets innovative
urinary continence care products for urinary dysfunction management and urine
drainage management. During the fiscal year ended September 30, 1997, the
Company introduced new products; expanded its sales force; increased its
marketing activities; obtained ISO 9001 and CE Mark quality systems
certification for its current Foley and male external catheter manufacturing
facilities, and expanded those facilities; occupied newly constructed
administrative offices and FEMSOFT-TM- manufacturing facilities; submitted a
510-k notification to the FDA to obtain marketing approval for its Antibacterial
Foley Catheter; commenced clinical testing of the FEMSOFT INSERT; and expanded
administrative infrastructure necessary to support its increasing activities.
In November 1997, the Company completed a public offering of 1,125,000
shares of common stock, resulting in net proceeds to the Company of
approximately $15,800,000.
The Company currently manufactures and markets a broad line of functionally
and technologically enhanced latex-free versions of standard continence care
products, including male external catheters, Foley catheters and intermittent
catheters. The Company is also developing innovative and technologically
advanced products designed to provide clinically and commercially attractive
solutions to continence care needs. The Company is conducting clinical trials
relating to the FEMSOFT INSERT, a soft, liquid-filled, conformable urethral
insert for managing female incontinence. In May 1997, the Company submitted a
510(k) pre-market notification (a "510(k)") to the United States Food and Drug
Administration (the "FDA") for the Antibacterial Foley catheter, which is
designed to reduce the incidence of bacterial catheter-associated urinary tract
infection ("CUTI"). The Company intends to expand the marketing and sales of
ROCHESTER MEDICAL brand products using the Company's dedicated sales force and,
simultaneously, to increase the distribution of private label products through
its existing strategic relationships. The Company believes that its proprietary
manufacturing technologies, including its liquid encapsulation techniques,
automated production processes and synthetic materials know-how, enable the
Company to manufacture products with innovative designs and features on a cost
effective basis.
The Company's urinary dysfunction management products address the two
primary types of chronic urinary dysfunction: urinary incontinence, the
inability to control one's urinary function, leading to involuntary and frequent
urine leakage; and urinary retention, an inability to voluntarily, spontaneously
and completely empty the bladder. The Company markets a broad line of latex-free
catheters for urinary dysfunction management, including male external catheters
for male urinary incontinence and intermittent catheters for male and female
urinary retention. The Company is developing the FEMSOFT INSERT for managing
female stress urinary incontinence, the most common form of urinary
incontinence. In February 1997, the Company commenced a multi-site clinical
trial of the FEMSOFT INSERT, which will involve 120 patients using the device
over a 12 month period. The Company has compiled preliminary clinical trial
results through October 17, 1997. These preliminary clinical trial results cover
58 patients and 4,203 patient uses and indicate that use of the FEMSOFT INSERT
resulted in a significant reduction of incontinence episodes with a 100% rate of
patient satisfaction in patients using the device for more than three months and
a continuing low rate of complications. The Company will be required to file a
pre-market approval application (a "PMA") to obtain FDA approval to market the
FEMSOFT INSERT in the United States.
Urinary dysfunction affects approximately 11 million women and two million
men in the United States. The consequences of urinary dysfunction, including
discomfort, depression, loss of mobility, social withdrawal and embarrassment
about appearance and odor, are significant and often result in a dramatic change
in quality of life. Urinary incontinence has medical consequences as well,
including predisposition to perineal rashes, pressure ulcers, urinary tract
infections and urosepsis. The medical consequences of
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urinary retention include severe infection, kidney failure and death.
Approximately $15 billion is spent annually in the United States for the medical
treatment and management of urinary dysfunction. Of this amount, the Company
estimates that $3 billion is spent on management products, including devices,
catheters and absorbents, and the remainder is spent on institutionalization and
medical treatments, including surgery, pharmaceuticals and behavior therapy. To
date, available medical treatments and
management products have had limited success in continence management. In a
recent survey of incontinent individuals, survey respondents reported an overall
cure rate of less than 3% for all medical treatments, and 62% of respondents
reported they were dissatisfied with their medical treatment for urinary
incontinence.
The Company's urine drainage management products are used by medical
professionals on a temporary basis to monitor and manage urine drainage during
surgery, post-operative recovery and other forms of acute care. For urinary
drainage management, the Company markets a broad line of silicone Foley
catheters. The Company's Foley catheters are latex-free, eliminating the risk of
allergic reactions and reducing the potential for tissue damage, which can be
associated with latex use. These catheters incorporate advanced features, such
as smooth, seamless exteriors, which help to reduce the risk of irritation. The
Company is developing the Antibacterial Foley Catheter, an advanced-design
catheter which provides sustained release of a broad-spectrum antibacterial
agent while the patient is catheterized. Clinical trials have demonstrated that
the Antibacterial Foley catheter provided a six-fold reduction in the incidence
of CUTI during the first five days of catheterization, as compared to other
silicone Foley catheters. CUTI is a leading type of infection in hospitals,
resulting in approximately 900,000 infections annually in the United States.
CUTI develops in approximately 10% to 30% of patients with Foley catheters. The
cost of treating CUTI is estimated at over $600 million annually in the United
States or an average of $680 per case of CUTI.
Through an expanded sales force, the Company intends to promote awareness of
the key advantages of ROCHESTER MEDICAL brand products, including the FEMSOFT
INSERT and the Antibacterial Foley catheter, relative to competitive continence
care products. The sales force will focus on differentiating the Company's
products on the basis of quality, potential improved medical outcomes and cost
effectiveness. The Company intends to increase its penetration of the continence
care market further through distribution relationships with established medical
products companies, which provide the Company with broad access to the hospital,
long-term care, home care and physician markets. The Company supplies male
external catheters and Foley catheters to the ConvaTec division of E.R. Squibb &
Sons, Inc., a subsidiary of Bristol-Myers Squibb Company ("ConvaTec"), pursuant
to a distribution and co-development arrangement. Also, the Company supplies
Hollister, Incorporated ("Hollister") with its requirements of self-adhering,
latex-free male external catheters and is a supplier to Euromedical Industries
Sdn Bhd (a subsidiary of Allegiance Health Care Corporation) ("Allegiance
Euromedical") and Mentor Corporation ("Mentor").
The Company uses custom-designed and custom-built equipment, automated
program control and comprehensive performance testing to maintain product
quality. The Company believes that its manufacturing technology is particularly
well-suited to high unit volume production and that its automated processes
enable cost-effective production through simplification and automation of
traditional catheter manufacturing techniques. The Company intends to use its
proprietary capabilities in molding, shaping and forming liquid encapsulated
devices, as well as its antimicrobial matrix and polymer and adhesive
technologies, to develop other innovative medical devices.
THE CONTINENCE CARE MARKET
URINARY SYSTEM AND CONTINENCE CARE
In a normally functioning urinary system, the kidneys filter waste products
from the circulatory system, creating urine to remove the waste. Urine drains
from the kidneys into the bladder, which serves as a reservoir until emptied
through urination. Urinary continence, or the appropriate storage and release of
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urine, is controlled by the bladder neck and the urinary sphincter, which
surrounds the bladder neck and urethra, acting together as a valve. As the
bladder fills, the bladder is relaxed while the urinary sphincter contracts to
prevent urination. During urination, the urinary sphincter relaxes as the
bladder contracts to evacuate urine through the bladder neck and urethra.
Urinary dysfunction may result from a malfunction of any part of the system.
Urinary continence care involves both the treatment and management of urinary
dysfunction and the temporary management of a normally functioning urinary
system during surgery, post-operative recovery and other forms of acute care.
URINARY DYSFUNCTION
Urinary dysfunction affects approximately 11 million women and two million
men in the United States. Urinary dysfunction can be characterized as either
incontinence or retention. Urinary incontinence is the inability to control
one's urinary function, leading to involuntary and frequent urine leakage from
the bladder. Urinary retention is the inability to voluntarily, spontaneously
and completely empty one's bladder, preventing urine flow even though the
bladder continues to fill.
The consequences of urinary dysfunction, including depression, discomfort
and embarrassment about appearance and odor, are significant and often result in
a dramatic change in quality of life. Urinary dysfunction often results in loss
of self-esteem, an increased dependence on caregivers, a loss of mobility and
social withdrawal and isolation. In addition, urinary dysfunction has been
associated with a number of physical effects, including a predisposition to
perineal rashes, pressure ulcers, urinary tract infections, urosepsis, falls and
fractures. In the elderly, urinary dysfunction is a major cause of
institutionalization into a nursing home.
URINARY INCONTINENCE. Urinary incontinence may result from one or more
conditions: weakened pelvic muscles; pelvic organic prolapse; tumors or other
cancers and cancer treatments; prostate surgery; pelvic trauma; spinal cord
damage; and medications. These diverse conditions cause three primary forms of
urinary incontinence.
- Stress Incontinence is the involuntary loss of urine caused by an increase
in abdominal pressure during common activities, such as laughing,
sneezing, coughing, lifting or even standing up. Among women, stress
incontinence is primarily due to a weakening of the pelvic muscles caused
by pregnancy and childbirth.
- Urge Incontinence is the involuntary loss of urine due to an involuntary
bladder contraction which is associated with a strong, uncontrollable
desire to urinate.
- Overflow Incontinence is the involuntary loss of urine when the amount of
urine produced exceeds the bladder's capacity.
Stress incontinence or mixed stress and urge incontinence represent over 50%
of all cases of urinary incontinence and over 60% of cases among women. While
urinary incontinence is present at all ages, the prevalence of urinary
incontinence increases with age. Urinary incontinence affects more than 50% of
the more than 1.5 million nursing home residents in the United States. Among
persons older than 60 years of age, other than nursing home residents, the
prevalence of urinary incontinence ranges from 15% to 35%, with women having
twice the prevalence of men. In the population between 15 and 64 years of age,
the prevalence of urinary incontinence ranges from 1.5% to 5% of men and from
10% to 30% of women.
URINARY RETENTION. Individuals suffering from urinary retention are unable
to empty their bladders voluntarily. This condition may have serious medical
consequences, including severe infection, kidney failure and death. Urinary
retention is commonly caused by neurogenic bladder, an inability of the bladder
to contract in a normal manner to initiate voiding, and urinary tract
obstruction, a blockage of the bladder neck or urethra which prevents the normal
passage of urine. Neurogenic bladder is often a result of spinal cord injury,
diabetes, Parkinson's Disease, multiple sclerosis and other nervous system
trauma. Urinary
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tract obstructions are primarily due to drug side effects, surgery and
congenital abnormalities. Urinary retention patients often experience a
combination of incontinence and retention.
CURRENT TREATMENTS FOR AND MANAGEMENT OF URINARY DYSFUNCTION
Approximately $15 billion is spent annually in the United States for the
medical treatment and management of urinary dysfunction. Of this amount, the
Company estimates that $3 billion is spent annually on management products and
devices and the remainder is spent on institutionalization and medical
treatments, including surgery, pharmaceuticals and behavior therapies. To date,
available medical treatments and management products have had limited success in
continence management. In a recent survey of incontinent individuals, survey
respondents reported an overall cure rate of less than 3% for all medical
treatments, and 56% of respondents reported that their medical treatments
produced no improvement in, or worsened, their condition. Additionally, 62% of
respondents reported that they were dissatisfied with their medical treatment
for urinary incontinence.
The primary medical treatments for urinary dysfunction management are
discussed below.
BEHAVIORAL THERAPIES. Behavioral therapies for stress incontinence include
bladder training and habit modification, pelvic muscle exercise, biofeedback and
electrical stimulation. All such therapies are used primarily to treat female
stress incontinence. Although these therapies are non-invasive and often result
in some patient improvement, they typically do not provide a complete cure for
urinary incontinence and require significant patient involvement. The success of
many behavioral therapies depends on following rigid voiding schedules and
strenuous exercise programs on a daily basis. Many patients are unable or
unwilling to comply with these schedules and programs over the long term.
SURGERY. Surgery is used primarily to treat stress incontinence and
includes artificial urinary sphincter implantations for patients with intrinsic
sphincter deficiency (the inability of the urinary sphincter to contract
sufficiently to maintain continence) and bladder neck suspension surgery to
stabilize the urethra for patients with hypermobility (a significant
displacement of the urethra during exertion, which accounts for a majority of
stress incontinence cases). These surgeries are expensive, involve risks of
failure and complications, including urinary retention, and are highly invasive,
requiring general anesthesia and several weeks or months for full recovery.
Another surgical treatment, indicated primarily for patients with intrinsic
sphincter deficiency, is the injection of urethral bulking agents into the area
around the urethra to create a mild obstruction. Although less invasive than
other surgeries, urethral bulking agents are relatively expensive, and the
procedure must be repeated periodically due to bioabsorption of the bulking
agents. In addition, surgery to treat urinary retention may be performed to
remove urethral obstructions, although these obstructions often return.
PHARMACEUTICALS. Pharmaceutical treatments primarily manage urge
incontinence by blocking involuntary bladder contractions. Pharmaceutical
treatments provide symptomatic relief rather than curing the underlying
condition and require long-term use. Drug treatments for urinary incontinence
may cause adverse effects, including drowsiness, dryness of the mouth,
dizziness, constipation and urinary retention.
The primary management products for urinary dysfunction are discussed below.
ABSORBENTS. The most prevalent incontinence management products are adult
absorbents, including adult diapers and absorbent pads, either disposable or
reusable. Adult absorbents are used because they provide needed protection and
can be easily self-administered without seeing a physician. Disadvantages of the
adult absorbents include lack of control over urine flow and corresponding
discomfort from wetness, skin irritations and rash; embarrassment about
appearance and odor; perceived social stigma; inconvenience; and significant
compromise of freedom of lifestyle. Retail sales of adult absorbents in the
United States during 1995 were estimated to exceed $2.5 billion.
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FOLEY CATHETERS. Foley catheters, or in-dwelling catheters (as more fully
described below), are used on a limited basis to manage urinary dysfunction. The
United States Department of Health and Human Services ("HHS") has reported that
more than 100,000 residents in nursing homes in the United States have long-term
Foley catheters in place to manage urinary dysfunction. The use of Foley
catheters to manage urinary dysfunction may cause urethral irritation and tissue
erosion due to catheter movement.
The Company believes that over 90% of the Foley catheters sold worldwide are
made of latex. Although latex has certain attractive physical characteristics
and cost advantages, latex contains natural proteins and allergens that may
irritate and damage the surrounding tissue. Latex catheters may be less
comfortable to use than synthetic catheters because crystals of urine salt can
form more easily on the surface of latex catheters. These crystals can make
withdrawal of latex catheters cause painful tissue trauma, and can also result
in the development of permanent strictures (scar tissue) inside the urethra.
Healthcare providers now recognize that latex can also cause allergic reactions
that may be life-threatening for some patients. Concerns about latex allergies
among healthcare workers and the general population have also increased in
recent years. It has been reported that 10% to 15% of healthcare workers are
sensitive to latex healthcare products. As a result, healthcare institutions are
increasingly attempting to limit their workers' exposure to latex.
On September 30, 1997, the FDA issued final rules that require labeling of
latex medical devices to warn of possible allergic reactions. The final rules
require that all medical devices containing natural rubber latex be labeled with
the warning "Caution: This Product Contains Natural Rubber Latex Which May Cause
Allergic Reactions." The FDA will also require the removal of all claims that
latex medical devices are hypoallergenic from the labeling of these devices.
Manufacturers have until September 30, 1998 to comply with the new rules.
MALE EXTERNAL CATHETERS. Male external catheters are disposable devices for
the management of male incontinence. The male external catheter consists of a
condom-like sheath that tapers into a cone and funnel. The sheath is unrolled
upon the penis and adheres by means of an adhesive, either contained as a part
of the wall of the sheath ("self-adhering") or provided by a separate strip of
adhesive tape ("tape-on"). The male external catheter drains through an attached
tube into a leg bag which is periodically emptied. Typically, the male external
catheter is removed and discarded daily. Male external catheters are designed to
be self-administered. These catheters are used primarily in home care settings
and long-term care facilities. Potential drawbacks of male external catheters
are leakage, skin irritation, inconvenience and reduced mobility. The Company
believes that approximately 75% of male external catheters sold worldwide are
made of latex, which results in many of the disadvantages associated with latex
products described above.
URETHRAL INSERTS AND BLADDER NECK SUPPORT PROSTHESES. The bladder neck and
urethra are delicate structures of mucous membranes and muscle that manage the
flow of fluids from the body. The urethra is a narrow, ribbon shaped canal,
which in females gradually twists and curves slightly from the bladder neck to
the exterior opening. As a result of the urethra's structure and sensitive
tissues, any rigid, nonconformable device that is inserted into the urethra has
the potential to distort the urethra's shape, cause muscle erosion and irritate
or damage the urethral tissues and make them more susceptible to infection.
Recently, urethral inserts and bladder neck support prostheses for female stress
incontinence have been introduced to the market. Currently marketed urethral
inserts occlude the female urethra to manage incontinence. Bladder neck support
prostheses manage incontinence by lifting the bladder neck and urethra through
pressure applied from the device in the vaginal cavity.
INTERMITTENT CATHETERIZATION. Intermittent catheterization is the preferred
management modality for patients with urinary retention. Intermittent
catheterization involves the use of a straight catheter inserted through the
urethra into the bladder to achieve voiding. Patients using intermittent
catheterization often must perform this procedure every three to six hours. This
procedure can be uncomfortable, is associated with an increased incidence of
urinary tract infection, and in some patients may result in severe urethral
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irritation. As an adjunct to medical treatments, primarily behavioral therapies,
intermittent catheterization increasingly is being recommended to manage urinary
incontinence.
URINE DRAINAGE MANAGEMENT
During surgery, post-operative recovery and certain other acute care
settings, it is often necessary for medical professionals to monitor the flow of
urine, and manage the urinary functions, of patients with normally functioning
urinary systems. Typically, urine drainage management is accomplished by placing
a Foley catheter in these patients. HHS has reported estimates that as many as
one out of four hospital patients in acute care settings undergoes a short-term
Foley catheterization. The Company believes over 90% of such patients require a
Foley catheter for seven days or less. The Company estimates that sales of Foley
catheters and related accessories in the United States were $240 million in
1995.
The Foley catheter is an in-dwelling catheter that provides continuous
drainage of the bladder. A Foley catheter consists of a tube (the "catheter
tube") with interior conduits ("lumens") and an inflatable balloon portion near
one end. The balloon end of the Foley catheter is inserted through the urethra
into the bladder. A sterile saline solution is injected into the balloon lumen
to inflate the balloon inside the bladder and prevent the catheter from being
withdrawn. Urine drains through eyelets in the tip of the catheter into the
drain lumen, which is connected by tubing to an external collection device, such
as a leg bag. A Foley catheter is inserted primarily by healthcare professionals
and is not designed for self-administration.
The regular use of Foley catheterization for urinary drainage management is
associated with CUTI. CUTI is primarily caused by bacteria that migrate through
the urethra into the bladder along the outside of the catheter. The Company and
other industry sources estimate that 10% to 30% of patients with Foley catheters
develop a CUTI. Hospitals have reported that cases of CUTI account for 40% of
hospital-acquired infections, or approximately 900,000 infections each year.
CUTI prolongs patients' recovery time and increases mortality risk. The direct
cost of treating these infections is estimated at over $600 million annually in
the United States, or an average $680 per case of CUTI, which is substantially
greater than the cost of a Foley catheter. Moreover, increases in the number of
antibiotic-resistant strains of bacteria has raised the level of concern
regarding CUTI. In particular, as a result of these concerns, many physicians
are reluctant to prescribe antibiotics prophylactically to control CUTI.
ROCHESTER MEDICAL SOLUTIONS
The Company currently manufactures and markets functionally and
technologically enhanced versions of standard continence care products,
including Foley catheters, male external catheters and intermittent catheters.
The Company is also developing innovative and technologically advanced products
designed to provide clinically and commercially attractive solutions to the
limitations of current continence care. The Company's products are designed to
advance the quality of continence care by providing improved medical outcomes on
a cost effective basis. The Company believes that its proprietary manufacturing
technologies, including its liquid encapsulation techniques, automated
production processes and synthetic materials know-how, enable the Company to
manufacture products with innovative designs and features.
The Company believes that its current products and products in development,
including the Antibacterial Foley catheter and FEMSOFT insert, offer some or all
of the following benefits.
- IMPROVED MEDICAL OUTCOMES. The Company's products are designed to improve
the medical outcome of continence care as compared to many current
continence care devices. The Company's Foley catheters are designed to
reduce irritation and damage to the urethra that can lead to infection,
while its male external catheters are intended to reduce the incidence of
tissue damage, in part through the Company's materials technology. The
Company's soft and pliable FEMSOFT insert and advanced-design products are
designed to reduce irritation and tissue erosion in the urethra by
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conforming to the movement of the urethra during normal activities. The
Antibacterial Foley catheter is designed to reduce bacterial CUTI.
- IMPROVED PATIENT SATISFACTION. Each of the Company's products is designed
to improve patient satisfaction and comfort. The Company's silicone male
external catheters are odor-free and have greater gas permeability than
catheters made from other materials. The Company believes these catheters
may reduce skin irritation and increase patient comfort. In addition, the
Company's male external catheters incorporate proprietary adhesive
technologies, which create better adherence to the skin, reduce leakage
and give the wearer greater confidence. The Company's liquid encapsulation
technology enables it to produce soft, pliable devices, such as the
FEMSOFT insert and other advanced design products, that are more
comfortable for the patient to use. In addition, the FEMSOFT insert
requires no collection bags or absorbent pads or liners, which can cause
embarrassment, restrict mobility and compromise lifestyle.
- ELIMINATION OF RISK OF LATEX REACTIONS. The Company manufactures all of
its products from silicone, a non-toxic, biocompatible and hypoallergenic
material, or other non-latex synthetic materials, thereby eliminating the
risk of latex reactions in patients and caregivers. The use of non-latex
materials in the Company's products also protects against the irritation
and discomfort that is sometimes associated with the use of latex-based
products.
- EASE OF USE. The Company's self-administered products are designed to be
easy to use and convenient for the patient. The Company's male external
catheters are transparent, permitting visual skin inspection without
removal of the catheters and aiding proper placement of the catheters. The
FEMSOFT insert is designed to be easily inserted and removed by most women
following proper training. It requires no inflation, deflation, syringes
or valving mechanisms.
- COST EFFECTIVENESS. The Company has designed its products to include
features intended to reduce the incidence of tissue trauma or other
adverse consequences of continence care, which may increase the total cost
of patient treatment. The Company believes that these features position
its products as cost effective alternatives for patients and caregivers.
For example, the Company believes that the Antibacterial Foley catheter
will lower overall patient costs by reducing the incidence of bacterial
CUTI among the relevant patient population.
- QUALITY. The Company seeks to manufacture quality continence care products
using superior materials, program controlled production processes,
comprehensive quality control testing and innovative product designs.
BUSINESS STRATEGY
The Company's objective is to become a leading developer and worldwide
marketer of innovative continence care products of high quality and value. The
Company's strategy is to offer a broad range of continence care products,
including products for urinary dysfunction management and urinary drainage
management. Key elements of the Company's business strategy include:
- FOCUS ON COMMERCIALIZING ANTIBACTERIAL FOLEY CATHETER AND FEMSOFT INSERT.
The Company is focused on manufacturing scale-up and marketing and sales
preparation for introduction of the Antibacterial Foley catheter, if the
Company receives clearance from the FDA. The Company is also focused on
continuing clinical testing of the FEMSOFT insert in preparation for
submitting a PMA to the FDA, and is completing installation of a
production line for the FEMSOFT insert and other liquid encapsulation
products. Once these product development programs are completed, the
Company intends to increase its focus on the development and
commercialization of the Company's other advanced design products.
- AGGRESSIVELY PURSUE SALES GROWTH OF ROCHESTER MEDICAL BRAND PRODUCTS. To
date, the majority of the Company's sales have been made through private
label arrangements. The Company's strategy is to
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place increased emphasis on promotion of Rochester Medical brand products
in order to develop market recognition of the brand. Through an expanded
sales force and related marketing activities, the Company intends to
promote awareness of the key advantages of the Company's Rochester Medical
brand products over competitive continence care products. The sales force
will focus its efforts on the relatively small number of significant
buying groups, dealers, distributors, institutions and home care providers
that control a substantial portion of product purchases in the Company's
target markets. In order to penetrate these purchasers, the Company's
sales force focuses on differentiating the Company's products on the basis
of quality, improved medical outcomes and cost effectiveness. The Company
intends to emphasize the sale of the FEMSOFT insert and Antibacterial
Foley catheter through the Rochester Medical brand. The Company will also
continue to expand its network of international distributors of Rochester
Medical brand products.
- UTILIZE PROPRIETARY TECHNOLOGIES TO EXPAND PRODUCT OFFERINGS. The Company
will continue development of disposable, latex-free continence care
products using its proprietary technologies. The Company will seek to
apply its capabilities in molding, shaping, and forming liquid
encapsulated devices under programmed controls to develop new devices that
are softer and more comfortable for the patient. The Company also intends
to pursue opportunities to develop other continence care products using
its antimicrobial matrix and polymer and adhesives technologies. In the
longer term, the Company intends to explore opportunities for the
development of innovative medical devices for other markets, such as fecal
incontinence, ostomy and gastro-intestinal tubes, which will benefit from
the softer, more conformable devices that can be produced using the
Company's liquid encapsulation technologies.
- LEVERAGE STRENGTHS IN AUTOMATED MANUFACTURING TECHNOLOGY. The Company
seeks to use its proprietary manufacturing processes, materials expertise,
custom designed equipment and technical know-how to simplify and automate
traditional manufacturing techniques for continence care products. In
order to manufacture high quality products at competitive costs, the
Company concurrently designs and develops new products and the processes
and equipment to manufacture them. The Company's manufacturing technology
is well suited to high-unit volume production of disposable devices on a
cost effective basis. The Company believes that controlling the cost of
the device is an important factor in the market for disposable devices.
- CAPITALIZE ON CONVATEC RELATIONSHIP AND OTHER PRIVATE LABEL ARRANGEMENTS.
The Company's growth strategy includes increasing its share of the
continence care market through its relationship with ConvaTec and other
private label arrangements. The Company will continue to work closely with
ConvaTec to increase sales under their strategic alliance and to increase
the Company's access to worldwide markets. In addition, the Company,
subject to the rights of ConvaTec, will continue to distribute its
products under private label arrangements with other established medical
products companies. For a discussion of recent developments in the
Company's relationship with ConvaTec, see "Management's Discussion and
Analysis of Financial Condition and Results of Operations-- Business
Outlook."
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PRODUCTS AND PRODUCTS IN DEVELOPMENT
The Company has the following disposable, latex-free continence care devices
in the market or in development for urinary dysfunction and urine drainage
management:
ROCHESTER MEDICAL PRODUCTS AND PRODUCTS IN DEVELOPMENT
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PRODUCT PRIMARY APPLICATION STATUS
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Urinary Dysfunction:
FEMSOFT insert Management of female incontinence In development/in a multi-site
clinical trial
Male external catheters Management of male incontinence Marketed product line
Personal Catheter Intermittent self-catheterization Marketed product line
for urine retention management
Urine Drainage:
Antibacterial Foley catheter Reduction of the incidence of In development/clinical trial
bacterial CUTI in surgery and completed/510(k) submitted
post-operative recovery urine
drainage management
Foley catheters Surgery and post-operative recovery Marketed product line
urine drainage management
Other Advanced Design Products:
Comfort Sleeve Foley catheter Long-term urine drainage management 510(k) clearance received/not
currently marketed
Female catheter Surgery and post-operative recovery 510(k) clearance received/not
urine drainage management; female currently marketed
incontinence management
Female valved catheter Female incontinence management In development
</TABLE>
URINARY DYSFUNCTION
FEMSOFT INSERT
The FEMSOFT insert is a disposable device currently in clinical trials for
the management of stress incontinence in active women. It is a soft, conformable
urethral insert that assists the female urethra and bladder neck to control the
involuntary loss of urine. The device can be simply inserted, worn and removed
for voiding by most women. It requires no inflation, deflation, syringes or
valving mechanisms..
PRODUCT DESCRIPTION. The FEMSOFT insert consists of a small cylindrical,
liquid-filled silicone membrane, approximately two inches in length. The
membrane has a bulb-shaped portion near the tip and an oval-shaped tab at the
end that remains outside the urethra. The tip of the device is inserted into the
urethra by use of a disposable applicator which resides in a central tube
extending the length of the device. As the device is inserted, the pressure from
the urethra compresses the bulb causing the liquid to move
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toward the external end of the device. When the bulb portion enters the bladder,
the pressure exerted by the urethra causes the liquid to refill the bulb portion
which seats the device in the bladder neck and urethra. The user removes and
discards the disposable applicator, allowing the urethra to resume its natural
curve and shape. The silicone tab of the insert remains outside the urethra
after insertion. When a user needs to void, the tab is pulled to remove the
insert; the device is discarded and another inserted.
The FEMSOFT insert is designed such that incidental pressures on the bladder
caused by normal activity, which are typically the immediate causes of stress
incontinence, improve the seal created by the device in the bladder neck,
thereby helping to prevent leakage. Steady pressure from a contracting bladder,
as during voluntary urination, will compress the bulb and expel the device,
thereby providing further ease of use and minimizing the possibility of harm in
persons who may be unable to otherwise remove the device due to injury or loss
of consciousness.
TARGET MARKET. The Company believes the FEMSOFT insert will provide
significant advantages in the management of female stress incontinence. The
FEMSOFT insert is a minimally invasive device that provides a patient with
effective control of her urinary function and eliminates the need for collection
bags and pads or liners that can cause embarrassment, restrict mobility and
compromise lifestyle. In addition, the soft, liquid-filled silicone membrane of
the FEMSOFT insert has been designed to conform to the irregular shape of the
urethra and follow the movements of the urethra during normal activities,
thereby helping to reduce chafing, abrasion and leakage. The FEMSOFT insert has
also been designed to provide a variable, supportive pressure to the muscles of
the urethra and bladder neck, while reducing tissue erosion and loss of muscle
tone. Although intended principally for the management of female stress
incontinence, the FEMSOFT insert may also be suitable for the management of some
conditions of urge incontinence or mixed stress and urge incontinence.
The FEMSOFT insert will be a prescription device that will require the
patient to visit her physician. Before a patient begins using the FEMSOFT
insert, the physician will fit the patient with the proper size and instruct the
patient on proper application of the FEMSOFT insert. The Company anticipates
manufacturing the device in combinations of three widths to provide a proper
fit.
CLINICAL TRIAL PROGRAM. The FEMSOFT insert requires PMA approval by the FDA
before it may be marketed commercially. A clinical trial of the FEMSOFT insert
is being conducted at eight sites in the United States under an Investigational
Device Exemption ("IDE") application approved by the FDA. The clinical trial
protocol contemplates 120 patients studied over a 12 month period. 110 patients
are currently enrolled in the clinical trial, of which 87 are using the device
and 23 are completing preliminary evaluation protocols necessary to begin using
the device. The Company has compiled preliminary clinical trial results through
October 17, 1997. These preliminary clinical trial results cover 58 patients and
4,203 patient uses and indicate that use of the FEMSOFT INSERT resulted in a
significant reduction of incontinence episodes with a 100% rate of patient
satisfaction in patients using the device for more than three months and a
continuing low rate of complications. In the trial, each patient compared urine
leakage and incontinence episodes during periods of use of the device and
periods of non-use. These results are preliminary and may not necessarily be
indicative of the final results of the clinical trial.
The Company is continuing the multi-site FEMSOFT insert clinical trial to
collect the data necessary to submit a PMA regarding the FEMSOFT insert to the
FDA. The Company intends to submit a PMA based on the data to be derived from
the continuing clinical trial. The timing of this submission will depend on the
progress and results of the clinical trial and the Company's determination that
it has gathered sufficient data for a submission. The process for obtaining FDA
approval is unpredictable and often lengthy and there can be no assurance that
the FDA will grant approval in a timely manner, if at all. Even if regulatory
approval is obtained, there can be no assurance that the FEMSOFT insert will
perform as designed or will be successfully marketed.
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MALE EXTERNAL CATHETERS
The Company manufactures and markets three types of silicone male external
catheters: the Ultraflex, Pop-On and Wide Band catheters. The Ultraflex catheter
has adhesive positioned midway down a standard length catheter sheath. The
Pop-On catheter has a sheath that is shorter than that of a standard male
external catheter and has adhesive applied to the full length of the sheath. It
is designed to accommodate patients who have retracted penises or other physical
impediments to using standard length male external catheters. In addition, the
Company believes the Pop-On catheter may be used as an alternative to standard
length catheters.
The Company's Wide Band self-adhering male external catheter, which is of
standard length, has an adhesive band which extends over the full length of the
sheath, providing approximately 70% more adhesive coverage than other male
external catheters currently marketed. The recently introduced Wide Band
catheter is designed to reduce the adhesive failure and resulting leakage that
may occur with male external catheters due to normal activities, which is a
common complaint among users of male external catheters. In light of this
advantage, the Company intends to focus its male external catheter marketing
efforts on this product.
All of the Company's male external catheters are produced in five sizes for
better patient fit. The Company believes that its silicone male external
catheters have advantages compared both to latex catheters and to other
non-latex catheters. Silicone is a non-toxic, biocompatible and hypoallergenic
material that eliminates the risks of latex-related skin irritation. Silicone
catheters are also odor free and have greater gas permeability than catheters
made from other materials, including latex. Gas permeability reduces skin
irritation and damage from catheter use and thereby increases patient comfort.
Unlike latex male external catheters, the Company's silicone catheters are
transparent, permitting visual skin inspection without removal of the catheters
and aiding proper placement of the catheters. The Company's catheters also have
a kink-proof funnel design to ensure uninterrupted urine flow. The self-adhering
technology of the Company's catheters eases application of the catheters and
provides a strong bond to the skin for greater patient confidence and prolonged
wear. Finally, unlike the processes used by manufacturers of competitive
catheters, the Company's proprietary manufacturing processes enable it to
manufacture its Pop-On catheter with sufficient adhesive strength in a shorter
sheath.
The Company sells silicone male external catheters under the Rochester
Medical brand and to private label customers. The Wide Band male external
catheter is currently sold only under the Rochester Medical brand.
The Company also manufactures and sells male external catheters made from a
proprietary non-latex, non-silicone material to certain private label customers.
These catheters use the same self-adhesive technology as the Company's silicone
male external catheters. Like the silicone male external catheters, the
non-silicone catheters eliminate the risk of latex reactions and latex-related
skin irritations. The non-silicone catheters also are odor free.
PERSONAL CATHETER
The Company's Personal Catheter is a disposable intermittent catheter
manufactured from two different silicones, with a stiff core catheter tube and a
softer outer cover. This construction provides sufficient stiffness for ease of
insertion, while the softer cover is designed to reduce tissue irritation during
insertion. Most competitive intermittent catheters are made from thermoplastics,
which become stiffer when cool and more flexible when warm and which also tend
to deform if bent for any length of time, as when carried in a purse or pocket.
The Personal Catheter is not sensitive to normal temperature variations and does
not deform if bent for storage. The Company produces the Personal Catheter in
three lengths and multiple diameters. The Company introduced the Personal
Catheter in May 1997 and markets it under the Rochester Medical brand.
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URINE DRAINAGE
ANTIBACTERIAL FOLEY CATHETER
The Company's Antibacterial Foley catheter is a silicone Foley catheter that
incorporates all of the advantages of the Company's other marketed Foley
catheters (as described below) and has been designed to reduce the incidence of
bacterial CUTI. The Antibacterial Foley catheter incorporates a broad-spectrum
antibacterial agent, nitrofurazone, into the silicone matrix of the outer and
inner surfaces of the catheter in a formulation that gives sustained release of
the medication into and throughout the urethra and bladder neck while the
patient is catheterized.
Nitrofurazone, which has been used for over 40 years, is effective against
both gram-positive and gram-negative bacteria. Laboratory tests conducted by the
University of Minnesota and funded by the Company have shown the imbedded
nitrofurazone in the Antibacterial Foley catheter to inhibit the growth of most
bacteria known to cause bacterial CUTI, including some common
antibiotic-resistant bacterial strains. Nitrofurazone, an active ingredient of
the catheter, kills bacteria by inhibiting a broad range of bacterial enzymes,
particularly those involved in both the aerobic and anaerobic degradation of
glucose and pyruvate. This inhibition process is different than the mechanisms
of systemic antibiotics that are typically used for the treatment and control of
CUTI.
The Company funded a prospective, randomized, double-blinded clinical trial
of the Antibacterial Foley catheter at the University of Wisconsin which
evaluated 344 patients in acute care, intensive care and surgical settings. This
completed clinical trial demonstrated that use of the Antibacterial Foley
catheter yielded a six-fold reduction in the incidence of bacterial CUTI
compared to use of a silicone, non-medicated Foley catheter in patients who were
catheterized for one to five days, a period that is typical of approximately 90%
of all hospital Foley catheterizations. The Antibacterial Foley catheter was
well-tolerated by the patients using it, and no complications or attributable
side-effects or systemic absorption of nitrofurazone were observed. The clinical
study was designed and carried out by Dennis G. Maki, M.D., Professor of
Medicine and Head of the Section of Infectious Diseases in the Department of
Medicine of the University of Wisconsin Medical School, and Hospital
Epidemiologist.
In May 1997, the Company submitted a 510(k) for the Antibacterial Foley
catheter based upon the University of Wisconsin clinical trial and the
University of Minnesota tests. Unless the Company obtains FDA clearance, the
product cannot be marketed in the United States. There can be no assurance that
the Company will obtain such FDA clearance in a timely manner, if at all. Even
if regulatory clearance is obtained, there can be no assurance that the
Antibacterial Foley catheter catheter will perform as designed or will be
successfully marketed.
The Company believes that the six-fold reduction in the incidence of
bacterial CUTI and the associated improved patient outcomes as indicated in the
Antibacterial Foley catheter clinical trials may provide potentially significant
cost savings to hospitals and other purchasers of urinary catheters and enable
the Company to position the Antibacterial Foley catheter as a premium product in
the market. The Company intends to sell the Antibacterial Foley catheter under
the Rochester Medical brand. The Company may also market the Antibacterial Foley
catheter through ConvaTec depending on the negotiation of mutually satisfactory
pricing terms.
FOLEY CATHETERS
The Company offers Foley catheters in a standard two lumen version and in a
three lumen version for irrigation of the urinary tract. These Foley catheters
are available in all standard adult and pediatric sizes as well as in
specialized pediatric sizes. All of the Company's silicone Foley catheters
eliminate the risk of the allergic reactions and tissue irritation and damage
that is sometimes associated with latex Foley catheters. The Company's Foley
catheters are transparent which enables healthcare professionals to observe
urine flow. The Company's standard Foley catheters also feature solid, rounded
tips for ease of
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insertion and smooth, proportional eyes for ease of insertion and maximum
drainage. Unlike the manufacturing processes used by producers of competing
silicone Foley catheters, in which the balloon portion is formed by hand in a
separate procedure involving gluing and burnishing, the Company's automated
manufacturing processes allow the Company to integrate the balloon into the
structure of the Foley catheter, resulting in a smoother, more uniform exterior
that may help reduce irritation to urinary tissue.
The Company's standard Foley catheters are packaged in single catheter
strips and sold under the Rochester Medical brand and under private label
arrangements. In addition, the Company sells its standard Foley catheters in
bulk under private label arrangements for packaging in kits with tubing,
collection bags and other associated materials. The Company's standard silicone
Foley catheters are priced competitively compared to a substantial majority of
Foley catheters sold in the United States.
OTHER ADVANCED DESIGN PRODUCTS
COMFORT SLEEVE FOLEY CATHETER
The Comfort Sleeve Foley catheter has a flexible, liquid-filled sheath
encasing the urethral section of the catheter tube, and is made from silicone
using the Company's liquid encapsulation technologies. The Company believes that
its Comfort Sleeve Foley catheter can provide improved patient comfort as
compared to other Foley catheters. Its liquid-filled urethral section is softer
and more pliable than other Foley catheters and its design permits the catheter
tube to move and rotate independently of the flexible encasing sheath, lessening
abrasion and irritation to the urethra during use. The Company believes these
features may be particularly beneficial to long-term catheterized patients,
including nursing home residents. The Company also believes that the Comfort
Sleeve Foley catheter can reduce the leakage sometimes associated with other
Foley catheters because the liquid-filled sheath of the Comfort Sleeve Foley
catheter conforms to the shape of the urethra.
Although the Company has received 510(k) marketing clearance from the FDA to
market the Comfort Sleeve Foley catheter, the Company has not commenced
marketing. Prior to introducing the Comfort Sleeve Foley catheter, the Company
intends to conduct clinical preference testing with several leading physicians
and medical institutions in order to determine appropriate usage protocols and
patient preferences. The Company has not yet scheduled clinical preference
testing for the Comfort Sleeve Foley catheter.
FEMALE CATHETER
The female catheter is a disposable self-retaining urinary catheter designed
to continuously empty the bladder. The female catheter can be self-administered
to manage all forms of female incontinence. The female catheter can also be used
by medical professionals for urine drainage management during surgery and
post-operative recovery. The female catheter has been designed to be easy and
convenient for the patient to use. It consists of a silicone lumen surrounded by
a soft, liquid-filled silicone sleeve. To position the female catheter, the user
inserts a catheter through the urethra into the bladder. The user compresses a
self-contained liquid-filled reservoir to move the liquid through the catheter
sleeve to inflate an expandable portion of the catheter positioned inside the
bladder. A soft shroud covers the reservoir to prevent the liquid from flowing
back to the reservoir and to maintain inflation of the catheter. The female
catheter is then attached to any standard collection device. To deflate and
remove the female catheter, the shroud is easily pulled off the sleeve to allow
the liquid to flow back into the reservoir. The female catheter may be inserted
once daily, and the Company believes a majority of urinary incontinence
sufferers can safely position the catheter and inflate it after appropriate
training. Beyond its applications for urinary incontinence, the female catheter
may function as a more comfortable, less expensive replacement for some uses of
standard Foley catheters by women. The Company has received FDA 510(k) marketing
clearance for the female catheter but has not commenced marketing. Before
commercial introduction of
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this catheter, the Company intends to conduct clinical preference tests with
several leading physicians and medical institutions to determine appropriate
usage protocols and patient preferences. The Company has not yet scheduled
clinical testing of the female catheter. In addition, while the Company
currently can produce limited quantities of the female catheter for testing and
other purposes, the Company must complete the installation and testing of its
new automated production facility before beginning production of commercial
quantities of the female catheter.
FEMALE VALVED CATHETER
The Company is developing a female valved catheter that will use the same
construction and be administered in the same manner as the female catheter. The
female valved catheter is intended for use as a daily disposable device for
controlled periodic urine drainage throughout the day without removal. This
catheter would provide users with increased convenience because the device would
not require an exterior collection bag. The Company believes that the female
valved catheter may also be used throughout the day as an alternative in some
circumstances to intermittent catheterization. The female valved catheter
requires further research and development and will require significant clinical
testing before marketing clearance may be applied for and received from the FDA.
The Company has not yet scheduled such clinical testing for this catheter. There
can be no assurance that the female valved catheter may be successfully
developed or that clinical tests of the female valved catheter will support the
safety and efficacy of the catheter or that the FDA will approve the marketing
of the catheter in a timely manner, if at all.
TECHNOLOGY
The Company uses proprietary, automated manufacturing technologies and
processes to manufacture continence care devices cost effectively. The
production of the Company's products also depends on its materials expertise and
know-how in the formulation of silicone and advanced polymer products. The
Company's proprietary liquid encapsulation technology enables it to manufacture
innovative products, such as its FEMSOFT insert and Comfort Sleeve Foley and
female catheters, that have soft, conformable, liquid-filled reservoirs, which
cannot be manufactured using conventional technologies. Using this liquid
encapsulation technology, the Company can mold and form liquid encapsulated
devices in a variety of shapes and sizes in an automated process. The Company's
manufacturing technologies and materials know-how also allow the Company to
incorporate a sustained release antibacterial agent into its products. The
Company believes that its manufacturing technology is particularly well-suited
to high unit volume production and that its automated processes enable
cost-effective production. The Company further believes that its manufacturing
and materials expertise, particularly its proprietary liquid encapsulation
technology is applicable to a variety of medical applications. The Company plans
to consider, commensurate with its resources, future research and development
activities to investigate opportunities provided by the Company's technology and
know-how.
The Company believes that its proprietary manufacturing processes, materials
expertise, custom designed equipment and technical know-how allow it to simplify
and further automate traditional catheter manufacturing techniques to reduce the
Company's manufacturing costs. In order to manufacture high quality products at
competitive costs, the Company concurrently designs and develops new products
and the processes and equipment to manufacture them.
MARKETING AND SALES
To date, the majority of the Company's revenues have been derived from sales
of its products under private label arrangements with medical products
companies, and such arrangements, including the arrangement with ConvaTec, are
likely to account for a significant portion of the Company's revenues in the
foreseeable future. However, the Company has begun to focus its marketing
efforts on gaining increased market recognition and sales of Rochester Medical
brand products. In particular, assuming it
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receives FDA approval, the Company intends to focus on marketing and selling its
Antibacterial Foley catheter and the FEMSOFT insert under the Rochester Medical
brand.
SALES AND MARKETING OF ROCHESTER MEDICAL BRAND PRODUCTS. The Company
directly sells Rochester Medical brand products in the domestic market,
primarily to key accounts consisting of significant buying groups, dealers,
distributors, institutions and home care providers. The Company believes that
purchasing power in the healthcare market is being centralized in these large
purchasers of healthcare products, and that there is an opportunity to market
effectively to a large portion of the domestic continence care market with a
limited, focused sales organization by marketing to these significant
purchasers. The Company's sales force focuses on differentiating the Company's
products on the basis of quality, the potential for improved medical outcomes
and cost effectiveness.
The Company's North American sales organization currently consists of a
director of sales, five regional managers and one sales representative. The
Company is in the process of recruiting sales representatives for each of the
regions. This direct domestic sales force is supported by a small, centralized
customer service and telesales staff. For international sales of Rochester
Medical brand products, the Company has developed and continues to build a
network of independent distributors. The Company currently has arrangements
covering 38 countries.
The Company believes that the introduction and marketing of the FEMSOFT
insert, if FDA marketing approval is received, will differ significantly from
that of its other products. The Company currently anticipates that this strategy
will require significant physician and clinician education efforts and
substantial consumer oriented media advertising. The educational efforts
directed to clinicians may include personal visits and demonstrations; the
preparation and presentation of instructions for the prescription, sizing and
use of the FEMSOFT insert and for follow-on procedures for patient care and
monitoring; and the preparation of written, audio and video materials for
clinicians to use for patient education purposes.
CONVATEC AND OTHER PRIVATE LABEL ARRANGEMENTS. The Company sells certain of
its current products, including male external and Foley catheters, under private
label arrangements to established medical products companies that provide the
Company with commercial distribution of its products, a large sales force and
broad access to the hospital, long-term care, home care and physician markets.
Under the ConvaTec Agreement, and under a separate agreement predating the
ConvaTec Agreement, the Company supplies male external and Foley catheters to
ConvaTec, a division of a subsidiary of Bristol-Myers Squibb Company. ConvaTec
is a leading global manufacturer and marketer of ostomy and modern wound care
products and a comprehensive provider of skin care, infection control,
contamination control and incontinence care products. ConvaTec has an extensive
sales organization in the United States and approximately 70 other countries.
ConvaTec resells the Company's products under its own brands. The Company is the
exclusive supplier of Hollister's requirements of self-adhering non-latex male
external catheters which Hollister resells under its own brand. The Company
currently supplies Allegiance Euromedical with silicone Foley catheters. The
Company supplies Mentor with silicone male external catheters, which Mentor
resells under its own brand.
MANUFACTURING
The Company designs and builds custom equipment to implement its
manufacturing technologies and processes. The Company's manufacturing facilities
are located in Stewartville, Minnesota. The Company produces its Foley catheters
on one production line and its male external catheters on a second line. The
Company has expanded its current manufacturing facility and is currently
completing the installation of additional manufacturing equipment for its male
external and Foley catheter products. The Company has also constructed a new
manufacturing facility to house its liquid encapsulation manufacturing
operations. The Company is currently in the process of installing the
manufacturing line for this facility.
The Company maintains a comprehensive quality assurance and quality control
program, which includes documentation of all material specifications, operating
procedures, equipment maintenance and
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quality control test methods. To control the quality of its finished product,
the Company uses ongoing statistical process control systems during the
manufacturing process and comprehensive performance testing of finished goods.
Each Foley catheter's balloon function is tested, and each male external
catheter is visually inspected. The Company has recently obtained ISO 9001
certification and quality system certification for the CE mark for its Foley
catheter and male external catheter production lines. The Company will be
required to obtain additional ISO 9001 and CE mark certifications for the new
liquid encapsulation manufacturing line through a separate qualification
process.
The Company's manufacturing facility has been designed to accommodate the
specialized requirements for the manufacture of medical devices, including the
FDA's regulations concerning Quality System Regulation for current good
manufacturing practices ("GMP").
In connection with the PMA for the FEMSOFT insert, the Company will be
required to establish that its new liquid encapsulation manufacturing facility
complies with GMP. In 1995, the FDA conducted a routine inspection of the
Company's existing manufacturing facility, in which the Company's facility,
documentation and quality control systems were evaluated and no substantial
matters of non-compliance with GMP were raised with the Company. In 1996, the
Minnesota Pollution Control Agency awarded the Company public recognition for
its environmental compliance program and procedures.
SOURCES OF SUPPLY
The Company obtains certain raw materials and components for a number of its
products from single suppliers. The Company depends on Dow Corning and GE for
raw materials used in the manufacture of its silicone male external Foley and
intermittent catheters. The loss of either of these suppliers, or a material
interruption of deliveries from either one, could have a material adverse effect
on the Company. Although the Company considers its relationship with Dow Corning
to be satisfactory, Dow Corning is currently in bankruptcy proceedings and there
can be no assurance that Dow Corning will continue to manufacture silicone or to
supply silicone to medical device manufacturers, such as the Company. The
Company believes that most, if not all, of the silicone it currently purchases
from Dow Corning or GE could be replaced by silicone from other suppliers, and
the Company has located and evaluated other potential suppliers. In the event
that the Company had to replace Dow Corning or GE, however, the Company would be
required to repeat biocompatibility testing of its products using the silicone
from the new supplier, which may result in disruption of the Company's
production of catheters, and might be required to obtain additional regulatory
clearances.
The Company is dependent on Shell for raw materials for the polymer used in
manufacturing the Company's non-silicone male external catheters. During 1994, a
disruption in Shell's production of these materials caused the Company to
curtail production of these catheters during the fourth quarter of fiscal 1994.
Although the Company adjusted to the disruption by reformulating this product,
the future loss of raw materials from this supplier could have a material
adverse effect on the Company. In the event that the Company had to replace
Shell, however, the Company would be required to repeat biocompatibility testing
of its products using the materials from the new supplier, which may result in
disruption of the Company's production of non-silicone male external catheters,
and might be required to obtain additional regulatory clearances.
To date, the Company has fulfilled its requirements for nitrofurazone, which
is used in its Antibacterial Foley catheter, through a single distributor.
Although the Company is aware of other distributors who are able to supply
nitrofurazone, the Company does not currently have arrangements for alternative
supplies. In the event that the Company had to replace its supplier, the Company
would be required to repeat biocompatibility testing of its products using the
materials from the new supplier, which may disrupt the timing of the Company's
introduction of its Antibacterial Foley catheter, and might also require
additional regulatory clearances. There can be no assurance that alternative
sources will be available on reasonable terms, if at all.
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The Company believes there are adequate alternative sources of supply
available for the Company's other raw material requirements. In order to
minimize the possibilities of disruption in the production of its products, the
Company has begun to conduct routine sourcing and testing of raw materials,
including silicone and other polymers, in order to provide alternate sources of
raw materials in the event of supply shortages from its current suppliers.
RESEARCH AND DEVELOPMENT
The Company believes that its ability to add new products to its existing
continence care product line is important to the Company's future success.
Accordingly, the Company is engaged in ongoing research and development to
introduce new products which provide additional features and functionality.
The Company's principal research and development efforts are currently
directed toward bringing the Antibacterial Foley catheter through the 510(k)
process, as well as on completing clinical trials of the FEMSOFT insert. The
Company is also focused on installing and testing standard and customized
components for its automated liquid encapsulation line in its new manufacturing
facility and on installing and testing equipment for the expansion of its
current male external and Foley catheter manufacturing operations. In the
future, the Company also intends to perform clinical studies for its other
advanced design catheter products that have obtained FDA clearance and other
products in development.
Research and development expense for fiscal years 1995, 1996 and 1997, was
$358,000, $1,182,000 and $1,452,000, respectively.
COMPETITION
The continence management market is highly competitive. The Company believes
that the primary competitive factors include price, product quality, technical
capability, breadth of product line and distribution capabilities. The Company's
ability to compete is affected by its product development and innovation
capabilities, its ability to obtain regulatory clearances, its ability to
protect the proprietary technology of its products and manufacturing processes,
its marketing capabilities, its ability to attract and retain skilled employees,
and, for products sold in managed care environments, its ability to maintain
current distribution relationships and establish new distribution relationships.
The Company believes that it will be important for the Company to differentiate
its products in order to attract large customers, such as healthcare buying
groups, distributors, dealers, institutions and home care organizations.
The Company's products compete with a number of alternative products and
treatments for continence management. The Company's ability to compete with
these alternative methods for urinary continence management depends on the
relative market acceptance of alternative products and therapies and the
technological advances in these alternative products and therapies. Any
development of a broad-based and effective cure for a significant form of
incontinence could have a material adverse effect on sales of incontinence
management devices such as the Company's products.
The Company competes directly for sales of continence management devices
under the Company's own brand with larger, multi-product medical device
manufacturers and distributors such as ConvaTec, C.R. Bard, Inc., Allegiance
Euromedical, Kendall Healthcare Products Company, Sherwood Medical Company,
Hollister and Mentor. In order to compete in the developing managed care
environment in the United States, the Company also supplies various male
external and Foley catheters to certain of these competitors (ConvaTec,
Allegiance, Mentor and Hollister) who market such devices under their own brands
as a part of their broader product lines. UroMed recently introduced female
incontinence devices for the daily management of female incontinence that will
likely compete with the FEMSOFT insert and certain other of the Company's
products. Many of the competitive alternative products to the Company's
catheters are distributed by larger competitors including Johnson & Johnson
Personal Products Company, Kimberly-Clark Corporation and Proctor & Gamble
Company (for adult diapers and absorbent pads), and C.R. Bard, Inc. (for
injectable materials). Many of the Company's competitors, potential competitors
and
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providers of alternative therapies have significantly greater financial,
manufacturing, marketing, distribution and technical resources and experience
than the Company. It is possible that other large healthcare and consumer
products companies may enter this market in the future. Furthermore, academic
institutions, governmental agencies and other public and private research
organizations will continue to conduct research, seek patent protection and
establish arrangements for commercializing products in this market. Such
products may compete directly with any products which may be offered by the
Company.
PATENTS AND PROPRIETARY RIGHTS
The Company's success may depend in part on its ability to obtain patent
protection for its products and manufacturing processes, to preserve its trade
secrets and to operate without infringing the proprietary rights of third
parties. The Company may seek patents on certain features of its products and
technology based on the Company's analysis of various business considerations,
such as the cost of obtaining a patent, the likely scope of patent protection
and the benefits of patent protection relative to relying on trade secret
protection. The Company also relies upon trade secrets, know-how and continuing
technological innovations to develop and maintain its competitive position.
The Company owns 14 United States patents and a number of foreign patents
that generally relate to certain of the Company's catheters and devices and
certain of the Company's production processes. In addition, the Company owns a
number of pending United States and foreign patent applications. The Company may
file additional patent applications for certain of the Company's current and
proposed products and processes in the future.
There can be no assurance that the Company's patents will be of sufficient
scope or strength to provide meaningful protection of the Company's products and
technologies. The coverage sought in a patent application can be denied or
significantly reduced before the patent is issued. In addition, there can be no
assurance that the Company's patents will not be challenged, invalidated or
circumvented or that the rights granted thereunder will provide proprietary
protection or commercial advantage to the Company.
Should attempts be made to challenge, invalidate or circumvent the Company's
patents in the United States Patent and Trademark Office and/or courts of
competent jurisdiction, including administrative boards or tribunals, the
Company may have to participate in legal or quasi-legal proceedings therein, to
maintain, defend or enforce its rights in these patents. Any legal proceedings
to maintain, defend or enforce the Company's patent rights can be lengthy and
costly, with no guarantee of success. There also can be no assurance that the
Company will file additional patent applications or that additional patents will
issue from the Company's pending patent applications.
A claim by third parties that the Company's current products or products
under development allegedly infringe their patent rights could have a material
adverse effect on the Company. The Company is aware that others, including
UroMed, a manufacturer of a urethral insert, have obtained or are pursuing
patent protection for various aspects of the design, production and
manufacturing of continence care products. The medical device industry is
characterized by frequent and substantial intellectual property litigation,
particularly with respect to newly developed technology. The Company has
received an opinion from patent counsel to the effect that the FEMSOFT insert as
configured, as of the date of the opinion, does not infringe a United States
patent held by UroMed. The opinion only represents the reasoned professional
judgment of the Company's patent counsel and is not binding on any court or
third party. This opinion of patent counsel would not preclude an action for
patent infringement by UroMed, and UroMed could choose to bring an action
alleging infringement of the UroMed patent at any time in the future.
Intellectual property litigation is complex and expensive, and the outcome of
such litigation is difficult to predict. Any future litigation, regardless of
outcome, could result in substantial expense to the Company and significant
diversion of the efforts of the Company's technical and management personnel. An
adverse determination in any such proceeding could subject the Company to
significant liabilities to third parties, require disputed rights to be licensed
from such parties, if licenses to such rights could be obtained, and/or require
the Company to cease using such technology. There can be no assurance that if
such licenses were
18
<PAGE>
obtainable, they would be obtainable at costs reasonable to the Company. If
forced to cease using such technology, there can be no assurance that the
Company would be able to develop or obtain alternate technology. Additionally,
if third party patents containing claims affecting the Company's technology are
issued and such claims are determined to be valid, there can be no assurance
that the Company would be able to obtain licenses to such patents at costs
reasonable to the Company, if at all, or be able to develop or obtain alternate
technology. Accordingly, an adverse determination in a judicial or
administrative proceeding or failure to obtain necessary licenses could prevent
the Company from manufacturing, using or selling certain of its products, which
could have a material adverse effect on the Company's business, financial
condition and results of operations.
There also can be no assurance that any third party does not currently have,
has not applied for, or might not in the future apply for, additional patents in
the United States which, if ultimately granted, might be infringed by any of the
Company's products as currently configured or any other product of the Company
and provide the basis for an infringement action against the Company.
The Company also relies on proprietary manufacturing processes and
techniques, materials expertise and trade secrets applicable to the manufacture
of its products. The Company seeks to maintain the confidentiality of this
proprietary information. There can be no assurance, however, that these measures
will provide the Company with adequate protection of its proprietary information
or with adequate remedies in the event of unauthorized use or disclosure. In
addition, there can be no assurance that the Company's competitors will not
independently develop or otherwise gain access to processes, techniques or trade
secrets that are similar or superior to the Company's. Finally, as with patent
rights, legal action to enforce trade secret rights can be lengthy and costly,
with no guarantee of success.
GOVERNMENT REGULATION
The manufacture and sale of the Company's products are subject to regulation
by numerous governmental authorities, principally the FDA and corresponding
foreign agencies. In the United States, the medical devices manufactured and
sold by the Company are subject to laws and regulations administered by the FDA,
including regulations concerning the prerequisites to commercial marketing, the
conduct of clinical investigations, compliance with GMP and labeling.
A manufacturer may seek from the FDA market authorization to distribute a
new medical device by filing a 510(k) to establish that the device is
"substantially equivalent" to medical devices legally marketed in the United
States prior to the Medical Device Amendments of 1976. A manufacturer may also
seek market authorization for a new medical device through the more rigorous PMA
process, which requires the FDA to determine that the device is safe and
effective for the purposes intended.
All of the Company's currently marketed products have received FDA marketing
authorization pursuant to 510(k)s filed by the Company. The Company has
submitted a 510(k) for the Antibacterial Foley catheter based upon the clinical
data derived from the University of Wisconsin clinical trial and the University
of Minnesota study. Following this submission, the Company has received and
responded to communications from the FDA requesting additional information and
providing comments on the Company's submission. The Company is currently waiting
for an action by the FDA. The FDA may require further information, such as
additional test data, before making a determination regarding substantial
equivalence. The FDA may also determine that the proposed device is not
substantially equivalent and require the Company to file a PMA application for
this device. There can be no assurance that the Company will receive FDA
authorization to market the Antibacterial Foley catheter or that market
introduction of the Antibacterial Foley catheter will not be delayed.
The Company has yet to apply for and receive FDA marketing authorization for
certain of its devices. The Company has received approval of an IDE application
to conduct multi-site clinical studies of its FEMSOFT insert, which commenced in
early 1997. Upon receipt of the clinical data to be derived from that study, the
Company plans to submit the FEMSOFT insert for FDA marketing authorization
through the PMA application process. A PMA application must be supported by
extensive data, including preclinical and
19
<PAGE>
clinical trial data, as well as extensive literature to prove the safety and
effectiveness of the device. Following receipt of a PMA application, if the FDA
determines that the application is sufficiently complete to permit a substantive
review the FDA will "file" the application. The FDA has 180 days to review a PMA
application, although the review of such an application more often occurs over a
protracted time period, and generally takes approximately two years or more from
the date of filing to complete.
The PMA application approval process can be expensive, uncertain and
lengthy. A number of devices for which pre-market approval has been sought have
never been approved for marketing. The review time is often significantly
extended by the FDA, which may require more information or clarification of
information already provided in the filing. During the review period, an
advisory committee likely will be convened to review and evaluate the
application and provide recommendations to the FDA as to whether the device
should be approved. In addition, the FDA will inspect the manufacturing facility
to ensure compliance with the FDA's GMP requirements prior to approval of an
application. If granted, the approval of the PMA application may include
significant limitations on the indicated uses for which a product may be
marketed.
The Company intends to pursue the PMA process for the female valved
catheter, personnel and budgetary constraints permitting. Other products that
the Company may consider for development, if and when developed, will require
marketing authorization by the FDA.
The Company is also required to register with the FDA as a medical device
manufacturer. As such, the Company's manufacturing facilities are inspected on a
routine basis for compliance with GMP. These regulations require that the
Company manufacture its products and maintain its documents in a prescribed
manner with respect to manufacturing, testing and quality control activities.
The Company underwent its latest GMP inspection by the FDA in July 1995, and no
substantial matters of non-compliance were reported to the Company. In
connection with the PMA for the FEMSOFT insert, if any, the Company will be
required to establish that its new liquid encapsulation manufacturing facility
complies with GMP. As a medical device manufacturer, the Company is further
required to comply with FDA requirements regarding the reporting of adverse
events associated with the use of its medical devices, as well as product
malfunctions that would likely cause or contribute to death or serious injury if
the malfunction were to recur. FDA regulations also govern product labeling and
prohibit a manufacturer from marketing an approved device for unapproved
applications. If the FDA believes that a manufacturer is not in compliance with
the law, it can institute enforcement proceedings to detain or seize products,
issue a recall, enjoin future violations and assess civil and criminal penalties
against the manufacturer, its officers and employees.
The Company may become subject to future legislation and regulations
concerning the manufacture and marketing of medical devices. Such future
legislation and regulations could increase the cost and time necessary to begin
marketing new products and could affect the Company in other respects not
currently foreseeable. The Company cannot predict the effect of possible future
legislation and regulations.
Sales of medical devices outside the United States are subject to foreign
regulatory requirements that vary widely from country to country. These laws and
regulations range from simple product registration requirements in some
countries to complex clearance and production controls in others. As a result,
the processes and time periods required to obtain foreign marketing approval may
be longer or shorter than those necessary to obtain FDA approval. These
differences may affect the efficiency and timeliness of international market
introduction of the Company's products. For countries in the European Union
("EU"), in January 1995, CE Mark certification procedures became available for
medical devices, the successful completion of which would allow certified
devices to be placed on the market in all EU countries. After June 1998, medical
devices may not be sold in EU countries unless they display the CE Mark. In
order to obtain and maintain the CE mark, the Company must comply with the EU
Medical Device Directive ("KU Directive") and pass an initial and annual
facilities audit inspections by an EU inspection agency. The EU Directive
requires compliance with ISO 9001 and other specified standards. The Company has
recently obtained ISO 9001 certification and quality system certification for
the CE
20
<PAGE>
mark for its currently marketed products. In order to maintain certification, if
granted, the Company will be required to pass annual facilities audit
inspections conducted by EU inspectors. The certification is site specific, and
the Company will undergo a similar certification process for its new FEMSOFT
manufacturing facility. There can be no assurance, however, that the Company
will be able to maintain regulatory approvals or clearances, including CE mark
certification, for its products in foreign countries.
In addition, international sales of medical devices manufactured in the
United States that have not been approved by the FDA for marketing in the United
States are subject to FDA export requirements. These require that the Company
obtain documentation from the medical device regulatory authority of the
destination country stating that sale of the medical device is not in violation
of that country's medical device laws, and, under some circumstances, may
require the Company to apply to the FDA for permission to export a device to
that country.
Under certain of the Company's international distribution agreements, the
other parties have agreed to bear the burdens and costs of obtaining applicable
export and international regulatory approvals. The Company has agreed to
cooperate where necessary in obtaining such approval.
THIRD PARTY REIMBURSEMENT
In the United States, healthcare providers that purchase medical devices
generally rely on third party payors, such as Medicare, Medicaid, private health
insurance plans and managed care organizations, to reimburse all or a portion of
the cost of the devices. The Medicare program is funded and administered by the
federal government, while the Medicaid program is jointly funded by the federal
government and the states, which administer the program under general federal
oversight. The Company believes its currently marketed products are generally
eligible for coverage under these third party reimbursement programs, and that
its Antibacterial Foley catheter, will also be eligible for third party
reimbursement. The Company is currently unable to assess eligibility of the
FEMSOFT insert for reimbursement. As a result, the competitive position of
certain of the Company's products may be partially dependent upon the extent of
reimbursement for its products.
The federal government and certain state governments are currently
considering a number of proposals to reform the Medicare and Medicaid health
care reimbursement system. The Company is unable to evaluate what legislation
may be drafted and whether or when any such legislation will be enacted and
implemented. Certain of the proposals, if adopted, could have an adverse effect
on the Company's business, financial condition and results of operations.
PRIVATE LABEL DISTRIBUTION AGREEMENTS
CONVATEC. On August 11, 1995, the Company entered into the ConvaTec
Agreement, which grants ConvaTec, subject to obligations and limitations imposed
by certain of the Company's other distribution agreements, worldwide rights to
market the Company's products that, as of the date of the Agreement, were
currently produced or in development ("Products in Development") under
ConvaTec's brand. At the same time, the Company retains worldwide rights to
market its products under the Rochester Medical brand.
The ConvaTec Agreement provides that ConvaTec will purchase all of its
requirements of certain of the Company's products from the Company. However, the
ConvaTec Agreement does not include any minimum purchase requirements or require
that ConvaTec market any or all of the Company's products. The Company will
provide all manufacturing and packaging of the Company's products for ConvaTec.
The ConvaTec Agreement provides, however, in the event that the Company is
unable to supply ConvaTec's requirements for products for any reason other than
a shortage of raw materials and the Company is unable to find a suitable
replacement in a commercially reasonable time, ConvaTec will be deemed to have a
license to the Company's technologies for purposes of manufacturing products for
ConvaTec. The Company currently supplies ConvaTec with silicone male external
catheters and Foley catheters. As the Company's Products in Development become
available for commercial sale in the future, the ConvaTec
21
<PAGE>
Agreement calls for the Company and ConvaTec to negotiate in good-faith on
packaging, quality control specifications and pricing for each of those
products. To maintain its marketing rights to those Products in Development,
ConvaTec is obligated to make good faith efforts to market such additional
products within 18 months following the Company's first commercial sale of any
such products. In addition, the Company and ConvaTec may agree to work
cooperatively to develop additional incontinence and urology products. The
Company is obligated to offer ConvaTec a right of first refusal to market all
products developed after the date of the ConvaTec Agreement ("Future Products").
In addition, prior to entering into a distribution agreement for any Future
Product with a third party, the Company must offer ConvaTec a final opportunity
to market such product on terms no less favorable to ConvaTec than those offered
to the third party.
The Company and ConvaTec are currently in discussions regarding the status
of the FEMSOFT insert under the ConvaTec Agreement. The Company's position is
that the FEMSOFT insert is a Future Product that is subject only to ConvaTec's
rights of first refusal and last offer. ConvaTec has expressed its view that the
FEMSOFT insert is a Product in Development and therefore subject to ConvaTec's
exclusive rights to be the private label distributor of the FEMSOFT insert. If
the Company and ConvaTec are unable to reach agreement, these issues will be
resolved by arbitration under the terms of the ConvaTec Agreement.
The ConvaTec Agreement has an initial term expiring August 31, 2000.
ConvaTec may, at its option, renew the ConvaTec Agreement for an additional
five-year term, and may thereafter renew the ConvaTec Agreement for up to five
additional one-year renewal periods through August 31, 2010. Either party may
terminate the ConvaTec Agreement only upon the other party's material breach of
the ConvaTec Agreement, bankruptcy or insolvency, or inability to perform under
the ConvaTec Agreement for a period of more than six months. The ConvaTec
Agreement may not be terminated in the event that a third party acquires the
Company. The Company has agreed to indemnify ConvaTec against certain
liabilities, including any patent infringement claims by third parties.
Under a separate agreement, the Company supplies ConvaTec with tape-on
non-silicone male external catheters. This agreement has an initial term
expiring September 1999 and is subject to automatic annual renewals cancelable
on six months notice by either party. The agreement may be terminated at any
time, upon six months written notice given by ConvaTec without cause, or by the
Company if ConvaTec fails to make certain agreed minimum purchases.
Sales of products to ConvaTec represented 12% of the Company's revenues in
fiscal 1996 and 24% of revenues in fiscal 1997. For a discussion of recent
developments in the Company's relationship with ConvaTec, see "Management's
Discussion and Analysis of Financial Condition and Results of
Operations--Business Outlook."
HOLLISTER. The Company is the exclusive supplier of Hollister's
requirements of self-adhering non-latex male external catheters which Hollister
resells under its own brand. As a part of its agreement with Hollister, the
Company has agreed to restrict its ability to sell self-adhering non-silicone
male external catheters on a private label basis to other manufacturers and
distributors for distribution outside of the United States and Canada. The
parties recently agreed to a four-year extension of the original agreement
beginning May 1, 1998 and expiring April 30, 2002. During that period, Hollister
is subject to a minimum purchase requirement of four million non-silicone
catheters at the rate of at least one million catheters per year. Sales of
products to Hollister represented 12% of the Company's revenues in fiscal 1996
and 10% of revenues in fiscal 1997.
ALLEGIANCE EUROMEDICAL. Under a two-year agreement which expired on
November 30, 1996, the Company was the exclusive supplier to Allegiance
Euromedical of Allegiance Euromedical's requirements of silicone Foley
catheters, and Allegiance Euromedical was the exclusive distributor of the
Company's standard silicone Foley catheters in Japan, Canada, Western Europe and
the Balkans (subject to grandfather rights for the Company's pre-existing
foreign distributors). Allegiance Euromedical was also a non-exclusive
distributor of silicone Foley catheters for all other territories. Recently, the
parties amended and
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<PAGE>
restated their original agreement to eliminate and phase out Allegiance
Euromedical's exclusive distribution rights and eliminate Allegiance Euromedical
's minimum purchase obligations. Allegiance Euromedical is now a worldwide
distributor of the Company's silicone Foley catheters. The amended and restated
agreement expires November 30, 1999. Sales of products to Allegiance Euromedical
represented 19% of the Company's revenues in fiscal 1996 and 4% of revenues in
fiscal 1997.
MENTOR. The Company sells silicone male external catheters to Mentor
pursuant to a Male External Catheter License, Sales and Distribution Agreement,
as modified in September 1995 (the "MEC Agreement"). Additionally, the Company
granted to Mentor a non-exclusive, paid-up, royalty free license to make, use
and sell silicone male external catheters that the Company currently sells to
Mentor. The Company also granted Mentor a non-exclusive, paid-up, royalty free
license to use for any purpose all technical know-how and/or trade secrets
disclosed by the Company to Mentor pursuant to or in connection with the MEC
Agreement which relate to the manufacture of silicone male external catheters.
In connection with such licenses, upon Mentor's request, the Company is required
to assist, consult, and cooperate with Mentor in the assembly, design,
engineering, manufacturing, inspection, and servicing of the catheters and
components thereof, as well as assist in the selection of the necessary and
proper plant layout, machinery, tools, equipment, and production flow for the
economical manufacture of the catheters and their components by Mentor. Mentor
must reimburse the Company for any costs incurred in providing such cooperation
and assistance.
The license to manufacture, use and sell silicone male external catheters
may be assigned only in connection with Mentor's sale or disposition of its
external catheter product line, or in connection with the merger, consolidation,
or similar corporate reorganization of Mentor or the sale of all or
substantially all of its assets. Mentor may sublicense the license to use
technical know-how and/or trade secrets only for purposes other than the
manufacture of the catheter to persons who agree to maintain the confidentiality
of the Company's know-how and trade secrets.
Sales of products to Mentor represented 29% of the Company's revenues in
fiscal 1996 and 30% of revenues in fiscal 1997. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations--Risk
Factors--Dependence on Distribution Relationships."
EMPLOYEES
As of September 30, 1997, the Company employed 117 full-time employees, of
whom 87 were in manufacturing, and the remainder in marketing and sales,
research and development and administration. The Company is not a party to any
collective bargaining agreement and believes its employee relations are good.
ITEM 2. PROPERTIES
The Company recently constructed a 52,000 square foot manufacturing and
office facility on an approximately 28 acre site owned by the Company and
located in the Stewartville Industrial Park adjacent to the Company's present
manufacturing facilities. This new facility will house the Company's automated
liquid encapsulation production capacity for its FEMSOFT insert and other
advanced design products, and will also house the Company's administrative
offices. The Company currently occupies the office portion of the new facility
and is completing installation of the manufacturing line.
The Company's male external and Foley catheter manufacturing facility
consists of a 30,000 square foot manufacturing and office building, including
10,000 square feet for expanded male external and Foley catheter production
capacity that was recently completed, located on a 3.5 acre site owned by the
Company in the Stewartville Industrial Park, Stewartville, Minnesota. The
facility currently provides approximately 28,000 square feet of manufacturing
and research and laboratory space and 2,000 square feet of office space.
A part of the Company's properties is subject to certain financing
arrangements. See Note 8 of Notes to Financial Statements.
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<PAGE>
ITEM 3. LEGAL PROCEEDINGS
The Company is not involved in any material legal proceedings.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth
quarter ended September 30, 1997.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Common Stock is quoted on the Nasdaq National Market under the symbol
ROCM. The following table sets forth, for the periods indicated, the range of
high and low last sale prices for the Common Stock as reported by the Nasdaq
National Market.
<TABLE>
<CAPTION>
HIGH LOW
--------- ---------
<S> <C> <C>
Fiscal Year Ended September 30, 1996
First Quarter............................................................ $ 18.00 $ 12.88
Second Quarter........................................................... 15.25 14.00
Third Quarter............................................................ 22.25 15.25
Fourth Quarter........................................................... 18.50 15.75
Fiscal Year Ended September 30, 1997
First Quarter............................................................ $ 19.13 $ 15.25
Second Quarter........................................................... 21.00 16.00
Third Quarter............................................................ 16.25 12.25
Fourth Quarter........................................................... 18.00 12.75
</TABLE>
As of December 15, 1997, the Company had 111 shareholders of record. Such
number of record holders does not reflect shareholders who beneficially own
Common Stock in nominee or street name.
The Company has paid no cash dividends on its Common Stock, and it does not
intend to pay cash dividends on its Common Stock in the future.
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<PAGE>
ITEM 6. SELECTED FINANCIAL DATA
The following selected financial data of the Company as of September 30,
1996 and 1997 and for the three fiscal years ended September 30, 1995, 1996 and
1997 are derived from, and are qualified by reference to, the financial
statements of the Company audited by Ernst & Young LLP, independent auditors,
included elsewhere in this Form 10-K. The following selected financial data as
of September 30, 1993, 1994 and 1995 and for the fiscal years ended September
30, 1993 and 1994 are derived from audited financial statements not included
herein. The information set forth below should be read in conjunction with
"Management's Discussion and Analysis of Financial Condition and Results of
Operations," the Financial Statements and Notes thereto and other financial
information included elsewhere in this Form 10-K.
<TABLE>
<CAPTION>
FISCAL YEARS ENDED SEPTEMBER 30,
-----------------------------------------------------
<S> <C> <C> <C> <C> <C>
1993 1994 1995 1996 1997
--------- --------- --------- --------- ---------
<CAPTION>
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C> <C>
Statements of Operations Data:
Net sales.................................................. $ 1,393 $ 2,189 $ 3,131 $ 5,540 $ 7,615
Cost of sales.............................................. 1,254 1,716 2,448 3,788 4,869
--------- --------- --------- --------- ---------
Gross profit............................................. 139 473 683 1,752 2,746
--------- --------- --------- --------- ---------
Operating expenses:
Marketing and selling.................................... 259 574 858 1,351 2,210
Research and development................................. 268 210 358 1,182 1,451
General and administrative............................... 338 692 766 1,112 1,499
--------- --------- --------- --------- ---------
Total operating expenses............................... 865 1,476 1,982 3,645 5,160
--------- --------- --------- --------- ---------
Loss from operations..................................... (726) (1,003) (1,299) (1,893) (2,414)
Interest income.......................................... 126 78 56 818 657
Interest expense......................................... (35) (39) (68) (285) (342)
--------- --------- --------- --------- ---------
Net loss................................................. $ (635) $ (964) $ (1,311) $ (1,360) $ (2,099)
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
Net loss per common share................................ $ (.24) $ (.36) $ (.49) $ (.35) $ (.51)
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
Weighted average number of common shares outstanding..... 2,660 2,660 2,682 3,867 4,132
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
</TABLE>
<TABLE>
<CAPTION>
AS OF SEPTEMBER 30,
-----------------------------------------------------
<S> <C> <C> <C> <C> <C>
1993 1994 1995 1996 1997
--------- --------- --------- --------- ---------
Balance Sheet Data:
Cash, cash equivalents and marketable securities.......... $ 2,840 $ 1,370 $ 2,905 $ 17,408 $ 4,639
Working capital........................................... 3,669 2,822 4,348 18,861 7,081
Total assets.............................................. 6,428 5,631 7,163 23,888 18,613
Long-term debt............................................ 411 395 3,036 3,321 --
Accumulated deficit....................................... (1,783) (2,747) (4,058) (5,418) (7,516)
Total shareholders' equity................................ 5,744 4,815 3,672 19,231 17,181
</TABLE>
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<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
GENERAL
The Company designs, develops, manufactures and markets uninary continence
care products for urinary dysfunction management and urine drainage management.
Through fiscal 1992, the Company was a development stage company, engaged
primarily in the development of its products and manufacturing operations and
systems. In fiscal 1992, the Company began commercial sales under a private
label arrangement. In fiscal 1993, the Company also began marketing products
under the ROCHESTER MEDICAL brand.
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, certain items
from the statements of operations of the Company expressed as a percentage of
net sales:
<TABLE>
<CAPTION>
FISCAL YEARS ENDED SEPTEMBER
30,
-------------------------------
<S> <C> <C> <C>
1995 1996 1997
--------- --------- ---------
Net sales:
Private label........................................................ 79% 82% 78%
Rochester Medical brand.............................................. 21 18 22
--- --- ---
Total net sales........................................................ 100% 100% 100%
Cost of sales.......................................................... 78 68 64
--- --- ---
Gross margin........................................................... 22 32 36
Operating expenses:
Marketing and selling................................................ 27 25 29
Research and development............................................. 11 21 19
General and administrative........................................... 25 20 20
--- --- ---
Total operating expenses............................................... 63 66 68
Loss from operations................................................... (41) (34) (32)
Interest income (expense), net......................................... (1) 9 4
--- --- ---
Net loss............................................................... (42)% (25)% (28)%
--- --- ---
--- --- ---
</TABLE>
FISCAL YEAR ENDED SEPTEMBER 30, 1997 COMPARED TO FISCAL YEAR ENDED SEPTEMBER 30,
1996
NET SALES. Net sales increased 37% to $7.6 million in fiscal 1997, from
$5.5 million in the prior fiscal year. The increase was primarily due to growth
in sales of Rochester Medical brand products and increased sales to ConvaTec.
Sales of Rochester Medical brand products increased 68% to $1.7 million in
fiscal 1997 from $1.0 million in fiscal 1996, while sales to ConvaTec increased
188% to $1.9 million in fiscal 1997 from $643,000 in fiscal 1996. Other private
label sales increased 5% to $4.1 million in fiscal 1997 from $3.9 million in
fiscal 1996. Sales to ConvaTec, Hollister, Allegiance Euromedical and Mentor
accounted, respectively, for 24%, 10%, 4% and 30% of fiscal 1997 net sales
compared, respectively, to 12%, 12%, 19%, and 29% of fiscal 1996 net sales.
GROSS MARGIN. The Company's gross margin as a percentage of net sales was
36% in fiscal 1997 compared to 32% for fiscal 1996. Fiscal 1997 gross margin
benefited from manufacturing efficiencies associated with higher production
volumes. The Company expects gross margin to be reduced in future periods by
depreciation and other expenses associated with the expansion and scale-up of
the Company's
26
<PAGE>
manufacturing facilities. The Company expects to experience reduced gross margin
until such time, if ever, as the Company is able to increase utilization of the
expanded and scaled-up manufacturing facilities.
MARKETING AND SELLING. Marketing and selling expense increased 64% to $2.2
million in fiscal 1997 from $1.4 million in fiscal 1996. The increased expense
reflects expansion of the Company's domestic direct sales organization and
increased product promotion spending, in particular increased marketing and
selling activities for Rochester Medical brand products.
RESEARCH AND DEVELOPMENT. Research and development expense increased 23% to
$1.5 million in fiscal 1997 from $1.2 million in fiscal 1996, due to incremental
costs associated with clinical studies for new products, in particular the
FEMSOFT insert.
GENERAL AND ADMINISTRATIVE. General and administrative expense increased
35% to $1.5 million in fiscal 1997 from $1.1 million in fiscal 1996, due to
requirements for business and administrative infrastructure development to
support current and anticipated growth.
INTEREST INCOME (EXPENSE), NET. Interest income decreased to $657,000 for
fiscal 1997 from $818,000 for fiscal 1996, as a result of earnings on lower
levels of cash available for investment. Interest expense in fiscal 1997 and
fiscal 1996 related to the convertible note to ConvaTec (the "ConvaTec Debt")
that the Company repaid on September 30, 1997.
FISCAL YEAR ENDED SEPTEMBER 30, 1996 COMPARED TO FISCAL YEAR ENDED SEPTEMBER 30,
1995
NET SALES. Net sales increased 77% to $5.5 million in fiscal 1996 from $3.1
million in fiscal 1995, due to increased sales in both private label and
Rochester Medical brand product lines. Private label sales increased 83% due to
stronger order volumes from Mentor and Allegiance Euromedical, as well as growth
from initial sales under the ConvaTec strategic alliance. A portion of 1996
sales volumes to Mentor represented inventory replenishment. Sales to ConvaTec,
Hollister, Allegiance Euromedical and Mentor accounted, respectively, for 12%,
12%, 19% and 29% of fiscal 1996 net sales compared, respectively, to 5%, 25%,
19% and 14% of fiscal 1995 net sales.
GROSS MARGIN. The Company's gross margin as a percentage of net sales
improved to 32% in fiscal 1996, compared to 22% for fiscal 1995, due primarily
to efficiencies gained through increasing production volumes and labor
productivity. Additionally, certain nonrecurring costs were incurred in fiscal
1995 for product reformulation and litigation settlement.
MARKETING AND SELLING. Marketing and selling expenses increased 57% to $1.4
million in fiscal 1996 from $858,000 in fiscal 1995. The increased expense
levels reflect overall increases in marketing and selling activities for
Rochester Medical brand products, including the addition of a Vice President of
International Sales, recruiting and employee relocation costs, commissions on
incremental Rochester Medical brand sales and other marketing and sales
activities to establish and expand the Rochester Medical brand. These activities
include customer service and support, direct marketing, attendance at trade
shows, product samples and other promotional programs.
RESEARCH AND DEVELOPMENT. Research and development expenses increased 230%
to $1.2 million in fiscal 1996 from $358,000 in fiscal 1995, due to expanded
clinical testing activities, the addition of a Director of Clinical and
Regulatory Affairs position, and funding requirements for new product
development. During fiscal 1996, the Company completed a major clinical study
for the Antibacterial Foley catheter and initiated a major clinical study for
the FEMSOFT insert.
GENERAL AND ADMINISTRATIVE. General and administrative expenses increased
45% to $1.1 million in fiscal 1996 from $766,000 in fiscal 1995, due to the
addition of a Chief Financial Officer, project costs for implementation of new
business systems, and the CE mark/ISO certification process, and additional
administrative personnel and professional fees associated with general business
development.
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INTEREST INCOME (EXPENSE), NET. Interest income increased to $818,000 in
fiscal 1996 from $56,000 in fiscal 1995, due to the increase in the average
balance of marketable securities purchased with the proceeds from the Company's
public offering in November 1995. Interest expense increased to $285,000 in
fiscal 1996 from $68,000 in fiscal 1995, due to interest on the ConvaTec Debt
for an entire year.
LIQUIDITY AND CAPITAL RESOURCES
The Company has financed its operations primarily through public offerings
and private placements of its equity securities, and has raised approximately
$24.7 million in net proceeds from its inception through September 30, 1997. In
August 1995, the Company received $3.0 million of proceeds from the issuance of
the ConvaTec Debt. The Company repaid the ConvaTec Debt, including accrued
interest, for $3.7 million on September 30, 1997. The Company had an accumulated
deficit of approximately $7.5 million through September 30, 1997. In November
1997, the Company completed a public offering of 1,125,000 shares of common
stock, resulting in net proceeds to the Company of approximately $15,800,000.
The Company's cash and marketable securities at September 30, 1997 were $4.6
million compared to $17.4 million at September 30, 1996, a net decrease of $12.8
million. The Company used $2.5 million of cash to fund operating activities
during fiscal 1997 and approximately $900,000 to fund operating activities
during fiscal 1996.
Cash of $6.9 million was used for capital expenditures during fiscal 1997,
relating to expansion of the existing production facility and construction of
the Company's new production and administrative facility. At September 30, 1997,
the Company had commitments for approximately $2.0 million of capital
expenditures, primarily relating to new production facilities.
Trade accounts receivable at September 30, 1997 increased 30% to $2.0
million as compared to $1.5 million at September 30, 1996, reflecting increased
sales and as a result of the timing of product orders and shipments during the
fourth quarter of fiscal 1997. Inventories increased 39% to $1.7 million as
compared to $1.2 million at September 30, 1996, reflecting the Company's
decision to increase inventory to improve the Company's capability to fill
customer orders. Changes in other asset and liability balances relate primarily
to timing of expense recognition, including an increase of $351,000 of accrued
clinical project costs.
The Company intends to expend substantial funds for product research and
development, expansion of sales and marketing activities, expansion of
manufacturing capacity, product education efforts, advertising and other working
capital and general corporate purposes. Although the Company believes that its
existing resources and anticipated cash flows from operations, will be
sufficient to satisfy its capital needs for approximately the next two years,
there can be no assurance that the Company will not require additional financing
before that time. The Company's actual liquidity and capital requirements will
depend upon numerous factors, including the timing of regulatory approvals, if
any, for the Antibacterial Foley catheter and FEMSOFT insert; the costs and
timing of expansion of sales and marketing activities; the amount of revenues
from sales of the Company's existing and new products; changes in, termination
of, and the success of, existing and new distribution arrangements; the cost of
maintaining, enforcing and defending patents and other intellectual property
rights; competing technological and market developments; developments related to
regulatory and third party reimbursement matters; the cost and progress of the
Company's research and development efforts; and other factors. In the event that
additional financing is needed, the Company may seek to raise additional funds
through public or private financing, collaborative relationships or other
arrangements. Any additional equity financing may be dilutive to shareholders,
and debt financing, if available, may involve significant restrictive covenants.
Collaborative arrangements, if necessary to raise additional funds, may require
the Company to relinquish its rights to certain of its technologies, products or
marketing territories. Failure to raise capital when needed could have a
material adverse effect on the Company's business, financial condition and
results of operations. There can be no assurance that such financing, if
required, will be available on terms satisfactory to the Company, if at all.
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IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS
In June 1997, the Financial Accounting Standards Board ("FASB") issued FASB
Statement No. 130 "Reporting Comprehensive Income," which establishes standards
for the reporting and display of comprehensive income and its components in the
financial statements. The FASB also issued FASB Statement No. 131, "Disclosures
about Segments of an Enterprise and Related Information," which significantly
changes the way segment information is reported in annual financial statements
and also requires selected segment information in interim financial reports to
shareholders. Both statements are effective for fiscal years beginning after
December 15, 1997 and, based on current circumstances, the Company does not
believe the effect of adoption will be material to the financial statements.
BUSINESS OUTLOOK
The following discussion, as well as certain information presented elsewhere
in this Form 10-K, including statements made in the sections captioned
"Business," "Management's Discussion and Analysis of Financial Condition and
Results of Operations" and "Risk Factors," and elsewhere in this Form 10-K
constitute "forward-looking statements" within the meaning of the Private
Securities Litigation Reform Act of 1995. Such forward-looking statements may be
identified by the use of terminology such as "may," "will," "expect,"
"anticipate," "intend," "designed," "estimate," "should" or "continue" or the
negatives thereof or other variations thereon or comparable terminology. Such
forward-looking statements involve known or unknown risks, uncertainties and
other factors which may cause the actual results, performance or achievements of
the Company, or industry results, to be materially different from any future
results, performance or achievements expressed or implied by such
forward-looking statements. Such factors include, among other things, the
following: the lack and uncertainty of regulatory approval for the Company's
products in development, primarily the Antibacterial Foley catheter and FEMSOFT
insert; the uncertainty of market acceptance of the Antibacterial Foley catheter
and FEMSOFT insert; the risks associated with the Company's expanded reliance on
sales of Rochester Medical brand products and the Company's limited sales and
marketing experience with Rochester Medical brand product sales; the Company's
history of losses and uncertainty of profitability; the Company's dependence on
a small number of private label distributors for the majority of its sales; the
Company's dependence on limited or single sources of supply for critical raw
materials; uncertainties associated with beginning production on the Company's
new liquid encapsulation manufacturing line and expanded Foley catheter and male
external catheter manufacturing lines; the Company's highly competitive industry
and risks that advances in alternative treatments or products could make the
Company's products obsolete; changes in, or failure to comply with, government
regulations; the uncertainty of third party reimbursement for certain of the
Company's products; the Company's dependence on and the uncertainty of patent
and proprietary technology protection; possible product liability litigation;
potential fluctuations in the Company's quarterly results; the Company's
dependence on key employees; general economic and business conditions; and other
factors referenced in this Form 10-K.
Order volumes by ConvaTec during the first fiscal quarter of 1998 are
expected to be lower as compared with order volumes during the first quarter of
fiscal 1997. In December, ConvaTec announced a reorganization of senior
management related to a restucturing of its business. ConvaTec has advised the
Company that it remains committed to the continence care market, and that the
lower recent order volumes were related to efforts to manage inventory stock
levels and the timing of its product introductions in overseas markets. The
Company and ConvaTec are currently in discussions regarding their strategic
relationship, including future sales trends and distribution activities for the
Company's products.
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RISK FACTORS
PRODUCT DEVELOPMENT RISKS; LACK OF REGULATORY APPROVAL
The Company believes that its ability to increase revenues and to achieve
profitability and positive cash flow will depend, in part, upon its ability to
complete the development of, receive regulatory approval for, and successfully
market its products in development, particularly the Antibacterial Foley
catheter and FEMSOFT insert. The production and marketing of the Company's
products in development, including the Antibacterial Foley catheter and FEMSOFT
insert, and certain of the Company's ongoing research and development activities
are subject to regulation by numerous government authorities in the United
States and other countries. Neither the Antibacterial Foley catheter nor the
FEMSOFT insert has been authorized for commercial distribution in the United
States or any foreign country. Both products will require FDA authorization
before the Company may begin marketing them in the United States as well as
similar authorization from appropriate regulatory bodies in foreign
jurisdictions prior to commercialization in such jurisdictions. The process of
obtaining FDA and other domestic and foreign regulatory authorization is
unpredictable and often lengthy, and there can be no assurance that the FDA or
any other regulatory body will grant authorization for either the Antibacterial
Foley catheter or the FEMSOFT insert or any other product in a timely manner, if
at all. In May 1997, the Company submitted a 510(k) for the Antibacterial Foley
catheter to the FDA. There can be no assurance that the FDA will authorize
marketing of the Antibacterial Foley catheter, or that the FDA will not make
requests for additional information or clinical data that could result in a
significant delay in bringing the product to market. The Company intends to
submit a PMA for the FEMSOFT insert based on data to be derived from an ongoing
multi-site clinical trial. The clinical data obtained from this clinical trial
to date is preliminary. There can be no assurance that such trials when
completed will yield data that support the safety and efficacy of the FEMSOFT
insert or that such clinical trials, or continued development efforts, will not
identify significant technical, manufacturing, design or other obstacles that
could delay submitting a PMA. As a result, there can be no assurance that the
Company will submit a PMA with respect to the FEMSOFT insert in a timely manner,
if at all. If the FEMSOFT insert is not determined by the FDA to be safe and
effective, or if the Company otherwise fails to obtain FDA approval of either
the FEMSOFT insert or the Antibacterial Foley catheter, or if the Company
experiences a significant delay or unforeseen expenditure in the course of
attempting to obtain such approvals, scaling-up manufacturing, or marketing such
products, if approved, the Company could be materially adversely affected.
UNCERTAINTY OF MARKET ACCEPTANCE OF NEW PRODUCTS
Much of the Company's ability to increase revenues and to achieve
profitability and positive cash flow will depend on the successful introduction
of its products in development, including the Antibacterial Foley catheter and
the FEMSOFT insert, which have not yet been commercially introduced and
represent new methods for urinary continence care. There can be no assurance
that these products will gain any significant degree of market acceptance among
physicians, healthcare payors and patients, even if regulatory and reimbursement
approvals are obtained. The Company believes that recommendations by physicians
and clinicians will be essential for the market acceptance of these products and
there can be no assurance that any such recommendations will be obtained. Broad
market acceptance of the Company's products in development, primarily the
FEMSOFT insert, may require the training of numerous physicians and clinicians,
and the time required to complete such training could result in a delay or
dampening of such market acceptance. Moreover, health care payors' approval of
reimbursement for the Company's products in development will be an important
factor in establishing market acceptance. Patient acceptance of these products
will depend on many factors, including physician recommendations, the degree,
rate and severity of potential complications, the cost and benefits compared to
competing products or alternative medical treatments, lifestyle implications,
available reimbursement and other considerations. In addition, the Company has
not yet determined pricing for these products, and the Company's pricing
policies could adversely impact market acceptance of these products as compared
to competing products and alternative
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treatments. Any of the foregoing factors, or other factors, could limit or
detract from market acceptance of these products. Insufficient market acceptance
of these products could have a material adverse effect on the Company's
business, financial condition and results of operations.
LIMITED REVENUES; HISTORY OF LOSSES AND ANTICIPATED FUTURE LOSSES
The Company has generated only limited revenues to date and has experienced
net losses since its inception. Net losses for the fiscal years ended September
30, 1995, 1996 and 1997 were $1.3 million, $1.4 million and $2.1 million,
respectively. The Company had an accumulated deficit of approximately $7.5
million at September 30, 1997. The Company's ability to increase revenues and
achieve profitability and positive cash flow will depend in part upon the
Company's ability to complete development of, and successfully introduce, new
products, particularly the Antibacterial Foley catheter and FEMSOFT insert, of
which there can be no assurance. The Company expects to incur substantial
product development, clinical research and other expenses in connection with
obtaining regulatory approval for, and commercialization of, the Antibacterial
Foley catheter, and with the clinical testing, development and commercialization
of the FEMSOFT insert, as well as for other new products and products in
development. In addition, the Company anticipates increased operating expenses
as it expands its sales and marketing organization. The Company will also
experience additional manufacturing expenses in connection with the ongoing
expansion and scale-up of capacity at its manufacturing facilities. A
substantial portion of the expenses associated with the expansion and scale-up
of the Company's manufacturing facilities are fixed in nature (i.e.
depreciation) and will reduce the Company's operating margin until such time, if
ever, as the Company is able to increase utilization of such expanded capacity.
As a result, the Company expects to incur substantial operating losses for the
foreseeable future and there can be no assurance that the Company will ever
generate substantial revenues or achieve or sustain profitability.
HIGHLY COMPETITIVE MARKETS; ALTERNATIVE TREATMENTS; TECHNOLOGICAL ADVANCEMENTS
The medical products market in general is, and the markets for urinary
continence care products in particular are, highly competitive. The Company's
ability to compete in the urinary continence care market depends primarily on
price, product quality and features, technical capability, breadth of product
line and distribution capabilities. Many of the Company's competitors have
greater name recognition than the Company and offer well known and established
products, some of which are less expensive than the Company's products. As a
result, even if the Company can demonstrate that its products provide greater
ease of use, lifestyle improvement or beneficial effects on medical outcomes
over the course of treatment, the Company may not be successful in capturing a
significant share of the market. In addition, many of the Company's competitors
offer broader product lines than the Company, which may be a competitive
advantage in obtaining contracts with healthcare purchasing groups. The Company
relies to a large extent on distribution relationships that include the
Company's products, both those sold under private label arrangements and those
marketed under the Rochester Medical brand, as part of broader product
offerings. There can be no assurance, however, that the Company will be able to
maintain such relationships or that they will be successful in inducing
significant purchasers to buy the Company's products. Additionally, many of the
Company's competitors have substantially more marketing and sales experience
than the Company and substantially greater resources to devote to such efforts.
Finally, other factors within and outside the Company's control will also affect
its ability to compete, including its product development and innovation
capabilities, its ability to obtain required regulatory clearances, its ability
to protect the proprietary technology included in its products and manufacturing
processes, its manufacturing and marketing capabilities and its ability to
attract and retain skilled employees. There can be no assurance that the Company
will be able to compete against such competitors or against potential
competitors, or that competition in the Company's markets will not result in
pricing pressures that would adversely affect the Company's unit prices and
sales levels any of which could have a material adverse effect on the Company's
business, financial condition and results of operations.
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In addition to the Company's products, urinary continence care can be
managed with a variety of alternative medical treatments and management products
or techniques, including adult diapers and absorbent pads, surgery, behavior
therapy, pelvic muscle exercise, implantable devices, injectable materials and
other medical devices. Moreover, manufacturers of products similar to the
Company's are engaged in research to develop more advanced versions of current
products. Many of the companies that are engaged in such development work have
substantially greater capital resources than the Company and greater expertise
than the Company in research, development and regulatory matters. There can be
no assurance that the Company's products will be able to compete with existing
or future alternative products, techniques or therapies, or that advancements in
existing products, techniques or therapies will not render the Company's
products obsolete. Finally, the Company's urinary dysfunction products are
management options, not a permanent cure. The development of a cure for urinary
dysfunction would have a material adverse effect on the Company's business,
financial condition, and results of operations.
DEPENDENCE ON DISTRIBUTION ARRANGEMENTS
A significant portion of the Company's net sales to date have depended on
the Company's ability to provide products that meet the requirements of
ConvaTec, Mentor and the other medical product companies with which the Company
has private label or distribution arrangements, and on the sales and marketing
efforts of such entities. These arrangements are likely to continue to be a
significant portion of the Company's revenues in the future. Private label
arrangements with medical products companies accounted for approximately 79%,
82% and 78% of the Company's net sales for fiscal years 1995, 1996 and 1997,
respectively. The Company will also continue to establish distribution
arrangements with third parties for Rochester Medical brand products. There can
be no assurance that the Company's private label purchasers and other
distributors will be able to successfully market and sell the Company's
products, that they will devote sufficient resources to support the marketing of
any of the Company's products, or that they will market any of the Company's
products at prices which will permit such products to develop, achieve, or
sustain market acceptance. The failure of the Company's private label purchasers
or other distributors to effectively market the Company's products could have a
material adverse effect on the Company's business, financial condition and
results of operations. Moreover, in addition to the restrictions and obligations
described below, the private label agreements impose certain obligations upon
the Company relating to, among others, delivery of commercial quantities of its
products, delivery of products in accordance with specifications, the
maintenance of product liability insurance and certain indemnification
obligations. The failure or inability of the Company to comply with the terms of
these agreements could permit the Company's private label purchasers and other
distributors to terminate their respective agreements. In addition, there can be
no assurance that any of these private label purchasers or other distributors
will perform its obligations under its respective agreement with the Company.
Any such termination or abandonment could have a material adverse effect on the
ability of the Company to market and sell its products.
The Company's distribution and co-development agreement with ConvaTec (the
"ConvaTec Agreement") grants ConvaTec, subject to obligations and limitations
imposed by certain of the Company's other distribution agreements, exclusive
private label rights to market, under ConvaTec brands, the Company's products
that, as of the date of the ConvaTec Agreement, were currently produced or in
development. The ConvaTec Agreement limits the Company's ability to distribute
such products through third parties other than under the Rochester Medical
brand. Although ConvaTec's rights are exclusive for certain products on a
private label basis, ConvaTec is not subject to any minimum purchase
requirements. Prior to the distribution of any products, the Company and
ConvaTec must negotiate in good faith on packaging, quality control
specifications and pricing for each of those products. The ConvaTec Agreement
also grants ConvaTec rights of first and last refusal with respect to marketing
future products, developed after the date of the ConvaTec Agreement. Currently,
the Company and ConvaTec are in discussions regarding the status of the FEMSOFT
insert under the ConvaTec Agreement. The Company's position is that the FEMSOFT
insert is subject only to ConvaTec's rights of first and last refusal, while
ConvaTec has expressed its view that
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ConvaTec has exclusive rights to be the private label distributor of the device,
subject to agreement on transfer prices. If the Company and ConvaTec are unable
to reach agreement, these issues may be resolved by arbitration. There can be no
assurance as to the outcome of any such arbitration. The Company is currently in
the process of assessing the status of its strategic relationship with ConvaTec.
A recent reorganization of senior management and bussiness restructuring at
ConvaTec, coupled with diminished order volumes during the first fiscal quarter
of 1998, have prompted the assessment process. The Company is presently unable
to ascertain the impact of this reorgainzation on the Company's strategic
relationship with ConvaTec or the effect on future sales to ConvaTec.
The Company is also party to a private label agreement with Mentor pursuant
to which the Company grants Mentor a non-exclusive, paid-up, royalty free
license to make, use and sell the silicone external catheters that Mentor now
purchases from the Company. As a result, there can be no assurance that Mentor
will not begin to manufacture the silicone external catheter itself and
discontinue its purchase and marketing of the Company's product Such
discontinuation could have a material adverse effect on the Company's business,
financial condition and results of operations. Mentor has recently introduced a
new non-silicone, non-latex male external catheter which it manufacturers
itself. The Company cannot now estimate the impact, if any, of this new device
on Mentor's future pruchase of silicone male external catheters from the
Company.
In addition, sales of the Company's products under its private label
arrangements compete with sales of the Company's Rochester Medical brand
products. Such competition might have an adverse effect on the Company's ability
to establish its Rochester Medical brand or on the Company's margins.
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RISKS ASSOCIATED WITH MARKETING AND SALES OF ROCHESTER MEDICAL BRAND PRODUCTS
To date, the Company has depended to a significant extent on marketing its
continence care products under private label arrangements and has conducted
relatively limited domestic selling and marketing activities for its Rochester
Medical brand. A key element of the Company's business strategy is to pursue
sales growth of its Rochester Medical brand products, and to develop market
recognition for the brand to support the future market introduction of the
Antibacterial Foley catheter and FEMSOFT insert, as well as other products in
development. The Company is engaged in refining market strategies for its
current Rochester Medical brand products and in developing market strategies for
its planned Rochester Medical brand products. The Company also has established a
small domestic marketing and sales organization to implement its plans. One of
the challenges facing the Company in this respect is the need to structure its
marketing efforts to address the changing nature of the domestic healthcare
market. In particular, healthcare purchasing is becoming increasingly
centralized, which may put the Company at a disadvantage compared to companies
with a wider array of products. In addition, many purchasers of urine drainage
catheters prefer to purchase such catheters packaged in a tray, which is a
single container including a catheter and related accessories, such as
collection bags. The Company does not currently offer its urine drainage
catheters in trays, which can be a competitive disadvantage with potential
customers who prefer such packaging. Although the Company may address this
disadvantage in the future by offering its own catheter trays, the Company does
not currently have any supply arrangements for tray components. There can be no
assurance that the Company will succeed in marketing its products under the
Rochester Medical brand, developing an effective marketing and sales force, or
adapting its marketing efforts to changes in the domestic healthcare market.
Moreover, the FEMSOFT insert, if approved by the FDA and introduced
commercially, may require the Company to undertake extensive educational efforts
directed to physicians and clinicians and significant media advertising directed
to consumers. The Company has no previous experience with such educational
efforts or consumer oriented media advertising, and there can be no assurance
that the Company will be successful in such activities.
The Company has entered into collaborative arrangements with a number of
distributors providing for the marketing and sale of certain of the Company's
products in various international markets. In general, pursuant to these
agreements, the Company is required to provide quantities of its products for
sale by its distributors, and the Company's distributors are required to use
their best efforts to market and sell the Company's products in their respective
markets. Any termination or abandonment by one or more of the Company's
distributors could have a material adverse impact on the ability of the Company
to market and sell its products. Furthermore, failure by the Company's
distributors to effectively market the Company's products in their respective
markets could have a material adverse effect on the Company.
POSSIBLE NEED FOR ADDITIONAL CAPITAL
The Company intends to expend substantial funds for product research and
development, expansion of sales and marketing activities, expansion of
manufacturing capacity, product education efforts, advertising and other working
capital and general corporate purposes. Although the Company its existing
resources and anticipated cash flows from operations will be sufficient to
satisfy its capital needs for approximately the next two years, there can be no
assurance that the Company will not require additional financing before that
time. The Company's actual liquidity and capital requirements will depend on
numerous factors, including the timing of regulatory approvals, if any, for the
Antibacterial Foley catheter and FEMSOFT insert; the costs and timing of
expansion of sales and marketing activities; the amount of revenues from sales
of the Company's existing and new products; changes in, termination of, and the
success of, existing and new distribution arrangements; the cost of maintaining,
enforcing and defending patents and other intellectual property rights;
competing technological and market developments; developments relating to
regulatory and third party reimbursement matters; the cost and progress of the
Company's research and development efforts; and other factors. In the event that
additional financing is needed, the Company may seek to raise additional funds
through public or private financing, collaborate
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relationships or other arrangements. Any additional equity financing may be
dilutive to shareholders, and debt financing, if available, may involve
significant restrictive covenants. Collaborative arrangements, if necessary to
raise additional funds, may require the Company to relinquish its rights to
certain of its technologies, products or marketing territories. Failure to raise
capital when needed could have a material adverse effect on the Company's
business, financial condition and results of operations. There can be no
assurance that such financing, if required, will be available on terms
satisfactory to the Company, if at all.
DEPENDENCE ON SINGLE OR LIMITED SOURCES OF SUPPLY
The Company is dependent upon Dow Corning Corporation ("Dow Corning") and
General Electric Corporation ("GE") for raw materials used in the manufacture of
certain of its silicone products. Dow Corning is currently in bankruptcy
proceedings and there can be no assurance that Dow Corning will continue to
manufacture silicone or to supply silicone to medical device manufacturers,
including the Company. The Company is also dependent on Shell Chemical Company
("Shell") for the primary raw materials for the polymer used in manufacturing
certain of the Company's male external catheters. To date, the Company has
fulfilled its requirements for nitrofurazone, which is used in the Antibacterial
Foley catheter, through a single distributor. Although the Company is aware of
other distributors who are able to supply nitrofurazone, the Company does not
currently have arrangements for alternative supplies. If the Company were to
lose its current suppliers of any of these materials, it would be required to
identify a new supplier for that material, repeat biocompatibility testing of
its products using the raw materials from the new supplier and might be required
to seek additional regulatory clearance. The loss of any such supplier or any
significant decrease or interruption in supply could interrupt the manufacture
of the Company's products and have a material adverse effect on the Company's
business, financial condition and results of operations. Moreover, the
significance of product liability litigation to suppliers of raw materials used
in the manufacture of medical devices has caused such suppliers to carefully
evaluate the use of those raw materials in certain medical devices. There can be
no assurance that the Company's suppliers might not in the future change their
policies regarding raw materials usage, or that such a change, if it occurred,
might not adversely affect production of the Company's then-current products or
its product development activities.
UNCERTAINTIES ASSOCIATED WITH NEW AND EXPANDED MANUFACTURING FACILITIES
The Company is completing installation of the equipment and components
necessary to equip a recently-constructed additional manufacturing facility.
This new facility, which will be devoted primarily to the manufacture of the
FEMSOFT insert, if approved, and certain other liquid encapsulation devices,
will consist, when completed, of approximately 52,000 square feet of office,
storage, manufacturing, chemical handling and clean room manufacturing space.
The Company has also recently expanded its current manufacturing facility to
increase production capacity for male external and Foley catheters, and is in
the process of installing equipment and components there. The Company has not
validated or obtained regulatory approval for either the new facility or the
expansion to the existing facility. The Company may encounter delays and
technical difficulties, along with associated cost over-runs, while installing
and testing, obtaining regulatory approval for, and beginning commercial
production on the new production lines, any of which could have a material
adverse effect on the Company. Additionally, there can be no assurance that the
new facilities will enable the Company to produce the quantities of products
required for commercialization in the United States and abroad. The inability to
produce products in such quantities or to utilize such new capacity fully, if,
for example, the FEMSOFT insert is not successfully developed, authorized by the
FDA and marketed, could have a material adverse effect on the Company.
EFFECTS OF GOVERNMENT REGULATION
The Company's products, product development activities and manufacturing
processes are subject to extensive regulation by the FDA and by comparable
agencies in foreign countries. In the United States, the
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<PAGE>
FDA regulates the introduction of medical devices as well as manufacturing,
labeling and record keeping procedures for such products. The process of
obtaining marketing clearance for new medical products from the FDA can be
costly and time consuming, and there can be no assurance that such clearance
will be granted for the Company's future products on a timely basis, if at all,
or that FDA review will not involve delays that would adversely affect the
Company's ability to commercialize additional products or to expand permitted
uses of existing products. Even if regulatory clearance to market a product is
obtained from the FDA, this clearance may entail limitations on the indicated
uses of the product. Marketing clearance can also be withdrawn by the FDA due to
failure to comply with regulatory standards or the occurrence of unforeseen
problems following initial clearance. The Company may be required to make
further filings with the FDA under certain circumstances, such as the addition
of product claims or product reformulation. The FDA could also limit or prevent
the manufacture or distribution of the Company's products and has the power to
require the recall of such products. FDA regulations depend heavily on
administrative interpretation, and there can be no assurance that future
interpretation made by the FDA or other regulatory bodies, which may have
retroactive effect, will not adversely affect the Company. The FDA and various
state agencies inspect the Company and its facilities from time to time to
determine whether the Company is in compliance with regulations relating to
medical device manufacturing companies, including regulations concerning
manufacturing, testing, quality control and product labeling practices. A
determination that the Company is in material violation of such regulations
could lead to the imposition of civil penalties, including fines, product
recalls, product seizures, or, in extreme cases, criminal sanctions.
A portion of the Company's revenues are dependent upon sales of its products
outside the United States. Foreign regulatory bodies have established varying
regulations governing product standards, packaging requirements, labeling
requirements, import restrictions, tariff regulations, duties and tax
requirements. The Company relies on its third-party foreign distributors to
comply with certain foreign regulatory requirements. The inability or failure of
the Company or such foreign distributors to comply with varying foreign
regulations or the imposition of new regulations could restrict the sale of the
Company's products internationally and thereby adversely affect the Company's
business, financial condition and results of operations.
DEPENDENCE ON THIRD PARTY REIMBURSEMENT
The Company's products are purchased by hospitals and other users, which
bill various third party payors, such as government health programs, private
health insurance plans, managed care organizations and other similar programs,
for the health care products and services provided to their patients. Payors may
deny reimbursement if they determine that a product used in a procedure was not
used in accordance with established payor protocols regarding cost-efficient
treatment methods, was used for an unapproved indication or was not otherwise
covered. Third party payors are increasingly challenging the prices charged for
medical products and services and, in some instances, have pressured medical
suppliers to lower their prices. The Company is unable to predict what changes
will be made in the reimbursement methods used by third party health care
payors. There can be no assurance that treatments utilizing the Company's
products will be considered cost effective by third party payors, that
reimbursement for such treatments will be available or, if available, that payor
reimbursement levels will not adversely affect the Company's ability to sell its
products on a profitable basis. Moreover, Medicare, Medicaid and private third
party payors may limit reimbursement for disposable devices such as those
manufactured by the Company by implementing fee schedules or by allowing
reimbursement for only a fixed number of devices per month. In addition,
healthcare costs have risen significantly over the past decade, and there have
been and may continue to be proposals by legislators, regulators and third party
payors to curb these costs. The Company is currently unable to assess the
eligibility of the FEMSOFT insert for reimbursement. Failure by users of the
Company's products to obtain reimbursement from third party payors, changes in
third party payors' policies towards reimbursement for the Company's products or
legislative action limiting reimbursement for certain procedures or products
could have a material adverse effect on the Company's business, financial
condition and results of operations.
36
<PAGE>
DEPENDENCE ON PATENTS AND PROPRIETARY RIGHTS
The Company's success may depend in part on its ability to obtain patent
protection for its products and manufacturing processes, to preserve its trade
secrets, and to operate without infringing the proprietary rights of third
parties. The validity and breadth of claims covered in medical technology
patents involve complex legal and factual questions and, therefore, may be
highly uncertain. No assurance can be given that the scope of any patent
protection under the Company's current patents, or under any patent the Company
might obtain in the future, will exclude competitors or provide competitive
advantages to the Company; that any of the Company's patents will be held valid
if subsequently challenged; or that others will not claim rights in or ownership
of the patents and other proprietary rights held by the Company. The Company is
aware that others, including UroMed Corporation ("UroMed"), a manufacturer of a
urethral insert, have obtained or are pursuing patent protection for various
aspects of the design, production and manufacturing of continence care products.
There can be no assurance that the Company's technology, current or future
products or activities will not be deemed to infringe upon the rights of others,
including but not limited to UroMed. Furthermore, there can be no assurance that
others have not developed or will not develop similar products or manufacturing
processes, duplicate any of the Company's products or manufacturing processes,
or design around the Company's patents. The Company also relies upon unpatented
trade secrets to protect its proprietary technology, and no assurance can be
given that others will not independently develop or otherwise acquire
substantially equivalent technology or otherwise gain access to the Company's
proprietary technology or disclose such technology or that the Company can
ultimately protect meaningful rights to such unpatented proprietary technology.
The medical device industry is characterized by frequent and substantial
intellectual property litigation, particularly with respect to newly developed
technology. Litigation may be necessary to enforce patents issued to the
Company, to protect trade secrets or know-how owned by the Company, or to
determine the ownership, scope or validity of the proprietary rights of the
Company and others. The Company has received an opinion from patent counsel to
the effect that the FEMSOFT insert as configured, as of the date of the opinion,
does not infringe a United States patent held by UroMed. The opinion only
represents the reasoned professional judgment of the Company's patent counsel
and is not binding on any court or third party. This opinion of patent counsel
would not preclude an action for patent infringement by UroMed, and UroMed could
choose to bring an action alleging infringement of the UroMed patent at any time
in the future. Intellectual property litigation is complex and expensive, and
the outcome of such litigation is difficult to predict. Any such litigation,
regardless of outcome, could result in substantial expense to the Company and
significant diversion of the efforts of the Company's technical and management
personnel. As a result, a claim by a third party that the Company's current
products or products in development allegedly infringe its patent rights could
have a material adverse effect on the Company. Moreover, an adverse
determination in any such proceeding could subject the Company to significant
liabilities to third parties, require disputed rights to be licensed from such
parties, if licenses to such rights could be obtained, and/or require the
Company to cease using such technology. If third party patents containing claims
affecting the Company's technology were issued and such claims were determined
to be valid, there can be no assurance that the Company would be able to obtain
licenses to such patents at costs reasonable to the Company, if at all, or be
able to develop or obtain alternate technology. Accordingly, an adverse
determination in a judicial or administrative proceeding or failure to obtain
necessary licenses could prevent the Company from manufacturing, using or
selling certain of its products, which could have a material adverse effect on
the Company's business, financial condition and results of operations.
POSSIBILITY OF PRODUCT LIABILITY LITIGATION; POSSIBLE INADEQUACY OF INSURANCE
The medical products industry is subject to substantial product liability
litigation, and the Company faces an inherent business risk of exposure to
product liability claims in the event that the use of its products is alleged to
have resulted in adverse effects to a patient. Although the Company has not
experienced any product liability claims to date, any such claims could have a
material adverse effect on
37
<PAGE>
the Company, including on market acceptance of its products. The Company
maintains general insurance policies that include coverage for product liability
claims. The policies are limited to an aggregate maximum of $6 million per
product liability claim, with an annual aggregate limit of $6 million under the
policies. The Company may require increased product liability coverage as new
products are developed and commercialized. There can be no assurance that
liability claims will not exceed the coverage limits of the Company's policies
or that adequate insurance will continue to be available on commercially
reasonable terms, if at all. A product liability claim or other claim with
respect to uninsured liabilities or in excess of insured liabilities could have
a material adverse effect on the Company's business, financial condition and
results of operations.
DEPENDENCE ON KEY PERSONNEL
The Company is dependent upon Anthony J. Conway, the Company's Chief
Executive Officer and President, and upon Philip J. Conway and Richard D. Fryar,
Vice Presidents of the Company, who together perform the substantial majority of
the Company's research and development efforts as well as perform various
management functions. Additionally, the Company is dependent on the services of
Brian J. Wierzbinski, the Company's Chief Financial Officer, as well as on the
services of certain of the Company's marketing and sales personnel. The Company
also depends on its ability to attract and retain additional highly qualified
management and technical personnel. Additionally, the Company's future success
depends on its ability to attract and retain skilled and unskilled production
personnel in accordance with future sales volumes. The Company faces intense
competition for qualified personnel in all of the aforementioned areas, and
there can be no assurance that the Company will be able to attract and retain
such personnel. The loss of the services of one or more of the current
management group or the inability to hire additional personnel as needed could
impair the Company's ability to commercialize and manufacture its products or to
develop new products and could have a material adverse effect on the Company's
business, financial condition and results of operations.
FLUCTUATIONS IN QUARTERLY FINANCIAL PERFORMANCE
The Company may experience significant fluctuations in revenues and results
of operations on a quarter to quarter basis in the future. Quarterly operating
results may fluctuate due to numerous factors, including the timing of
regulatory approvals, if any, of the Antibacterial Foley catheter and FEMSOFT
insert, the timing and level of market acceptance, if any, of the Antibacterial
Foley catheter and FEMSOFT insert, the timing and level of expenditures
associated with new product development activities, the timing and level of
expenditures associated with expansion of sales and marketing activities and
overall operations, the Company's ability to cost-effectively expand
manufacturing capacity and maintain consistently acceptable yields in the
manufacture of continence care products, the success of the activities conducted
under private label arrangements including ConvaTec, changes in demand for the
Company's products based on changes in third party reimbursement, competition,
changes in government regulation and other factors, the timing of significant
orders from and shipments to customers, and general economic conditions. These
factors are difficult to forecast, and these or other factors could have a
material adverse effect on the Company's business, financial condition and
results of operations. Fluctuations in quarterly demand for products and order
cancellations may adversely affect the continuity of the Company's manufacturing
operations, increase uncertainty in operational planning, disrupt cash flow from
operations and contribute to the volatility of the Company's stock price. The
Company's expenses are based in part on the Company's expectations as to future
revenue levels and to a large extent are fixed in the short-term. If actual
revenues do not meet expectations, the Company's business, financial condition
and results of operations could be materially adversely affected.
38
<PAGE>
POTENTIAL VOLATILITY OF STOCK PRICE
In recent years, the stock markets have experienced price and volume
fluctuations that have particularly affected medical technology companies,
resulting in changes in the market prices of the stocks of many companies which
may not have been directly related to the operating performance of those
companies. Factors such as variations in the Company's financial performance,
changes in stock market analysts' recommendations regarding the Company,
announcements of technological innovations by the Company, its competitors or
providers of alternative products, therapies or results of clinical trials or
other regulatory or reimbursement developments relating to the Company could
cause the market price of the Common Stock to fluctuate substantially. Broad
market fluctuations, or other factors affecting the market prices of the stocks
of medical technology companies generally, may adversely affect the market price
of the Common Stock.
39
<PAGE>
ITEM 8. FINANCIAL STATEMENTS
ROCHESTER MEDICAL CORPORATION
FINANCIAL STATEMENTS
YEARS ENDED SEPTEMBER 30, 1997, 1996 AND 1995
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Report of Independent Auditors............................................ 41
Audited Financial Statements
Balance Sheets............................................................ 42
Statements of Operations.................................................. 43
Statement of Shareholders' Equity......................................... 44
Statements of Cash Flows.................................................. 45
Notes to Financial Statements............................................. 46
</TABLE>
40
<PAGE>
REPORT OF INDEPENDENT AUDITORS
Shareholders
Rochester Medical Corporation
We have audited the accompanying balance sheets of Rochester Medical
Corporation as of September 30, 1996 and 1997, and the related statements of
operations, shareholders' equity and cash flows for each of the three years in
the period ended September 30, 1997. 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 Rochester Medical
Corporation at September 30, 1996 and 1997, and the results of its operations
and its cash flows for each of the three years in the period ended September 30,
1997, in conformity with generally accepted accounting principles.
/s/ Ernst & Young LLP
41
<PAGE>
ROCHESTER MEDICAL CORPORATION
BALANCE SHEETS
<TABLE>
<CAPTION>
SEPTEMBER 30,
----------------------------
<S> <C> <C>
1996 1997
------------- -------------
ASSETS
Current assets:
Cash and cash equivalents........................................................ $ 8,394,607 $ 1,191,428
Marketable securities............................................................ 9,013,522 3,447,461
Accounts receivable, less allowance for doubtful accounts ($50,000-- 1996;
$62,000--1997)................................................................. 1,513,577 1,967,194
Inventories...................................................................... 1,191,283 1,653,733
Prepaid expenses and other current assets........................................ 84,194 253,785
------------- -------------
Total current assets............................................................... 20,197,183 8,513,601
Property, plant and equipment:
Land............................................................................. 60,001 161,001
Building......................................................................... 755,074 2,277,825
Construction in progress......................................................... 1,145,866 5,409,591
Equipment and fixtures........................................................... 2,783,641 3,776,997
------------- -------------
4,744,582 11,625,414
Less accumulated depreciation.................................................... (1,432,257) (1,855,980)
------------- -------------
Total property, plant and equipment................................................ 3,312,325 9,769,434
Patents, less accumulated amortization ($313,937--1996; $428,736--1997)............ 378,232 330,338
------------- -------------
Total assets....................................................................... $ 23,887,740 $ 18,613,373
------------- -------------
------------- -------------
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable................................................................. $ 957,951 $ 457,565
Accrued compensation............................................................. 74,499 382,744
Accrued clinical costs........................................................... 59,545 410,450
Accrued expenses................................................................. 243,769 181,641
------------- -------------
Total current liabilities.......................................................... 1,335,764 1,432,400
Long-term debt..................................................................... 3,320,625 --
Shareholders' equity:
Common Stock, no par value:
Authorized shares--20,000,000
Issued and outstanding shares--4,127,500--1996; 4,133,500--1997.............. 24,648,913 24,697,199
Accumulated deficit.............................................................. (5,417,562) (7,516,226)
------------- -------------
Total shareholders' equity......................................................... 19,231,351 17,180,973
------------- -------------
Total liabilities and shareholders' equity......................................... $ 23,887,740 $ 18,613,373
------------- -------------
------------- -------------
</TABLE>
See accompanying notes.
42
<PAGE>
ROCHESTER MEDICAL CORPORATION
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
FISCAL YEARS ENDED SEPTEMBER 30,
-------------------------------------------
<S> <C> <C> <C>
1995 1996 1997
------------- ------------- -------------
Net sales............................................................ $ 3,130,746 $ 5,540,408 $ 7,615,439
Cost of sales........................................................ 2,447,353 3,788,584 4,869,646
------------- ------------- -------------
Gross profit......................................................... 683,393 1,751,824 2,745,793
------------- ------------- -------------
Operating expenses:
Marketing and selling.............................................. 858,458 1,351,443 2,209,747
Research and development........................................... 358,004 1,181,569 1,450,883
General and administrative......................................... 765,546 1,111,905 1,499,696
------------- ------------- -------------
Total operating expenses............................................. 1,982,008 3,644,917 5,160,326
------------- ------------- -------------
Loss from operations................................................. (1,298,615) (1,893,093) (2,414,533)
Other income (expense):
Interest income.................................................... 55,836 818,387 657,622
Interest expense................................................... (68,238) (285,166) (341,753)
------------- ------------- -------------
Net loss............................................................. $ (1,311,017) $ (1,359,872) $ (2,098,664)
------------- ------------- -------------
------------- ------------- -------------
Net loss per common share............................................ $ (.49) $ (.35) $ (.51)
------------- ------------- -------------
------------- ------------- -------------
Weighted average number of common shares outstanding................. 2,681,510 3,866,764 4,131,600
------------- ------------- -------------
------------- ------------- -------------
</TABLE>
See accompanying notes.
43
<PAGE>
ROCHESTER MEDICAL CORPORATION
STATEMENT OF SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
COMMON STOCK
-------------------------
<S> <C> <C> <C> <C>
ACCUMULATED
DEFICIT
SHARES AMOUNT (DEDUCTION) TOTAL
---------- ------------- ------------------ -------------
Balance September 30, 1994........................ 2,664,000 $ 7,561,518 $ (2,746,673) $ 4,814,845
Exercise of common stock warrants............... 60,000 168,000 -- 168,000
Net loss for the year -- -- (1,311,017) (1,311,017)
---------- ------------- ------------------ -------------
Balance September 30, 1995........................ 2,724,000 7,729,518 (4,057,690) 3,671,828
Common stock issued in public offering.......... 1,323,500 16,199,395 -- 16,199,395
Exercise of common stock warrants............... 80,000 720,000 -- 720,000
Net loss for the year........................... -- -- (1,359,872) (1,359,872)
---------- ------------- ------------------ -------------
Balance at September 30, 1996..................... 4,127,500 24,648,913 (5,417,562) 19,231,351
Exercise of common stock options................ 6,000 48,286 -- 48,286
Net loss for the year........................... -- -- (2,098,664) (2,098,664)
---------- ------------- ------------------ -------------
Balance at September 30, 1997..................... 4,133,500 $ 24,697,199 $ (7,516,226) $ 17,180,973
---------- ------------- ------------------ -------------
---------- ------------- ------------------ -------------
</TABLE>
See accompanying notes.
44
<PAGE>
ROCHESTER MEDICAL CORPORATION
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
FISCAL YEARS ENDED SEPTEMBER 30,
---------------------------------------------
<S> <C> <C> <C>
1995 1996 1997
------------- -------------- --------------
Operating activities
Net loss.......................................................... $ (1,311,017) $ (1,359,872) $ (2,098,664)
Adjustments to reconcile net loss to net cash used in operating
activities:
Depreciation and amortization................................... 345,466 477,682 538,523
Changes in operating assets and liabilities:
Accounts receivable........................................... (33,734) (761,353) (453,617)
Inventories................................................... 201,892 (425,139) (462,450)
Other current assets.......................................... (193,110) 295,272 (169,591)
Accounts payable.............................................. 52,584 753,622 (500,386)
Other current liabilities..................................... 2,424 126,474 597,022
------------- -------------- --------------
Net cash used in operating activities............................. (935,495) (893,314) (2,549,163)
------------- -------------- --------------
Investing activities
Capital expenditures.............................................. (224,256) (1,725,841) (6,880,833)
Patents........................................................... (93,249) (82,452) (66,905)
Purchase of marketable securities................................. (1,888,217) (17,220,523) (18,388,824)
Sales and maturities of marketable securities..................... 1,553,815 9,815,605 23,954,885
------------- -------------- --------------
Net cash used in investing activities............................. (651,907) (9,213,211) (1,381,677)
------------- -------------- --------------
Financing activities
Proceeds from note payable........................................ 3,000,000 -- --
Interest expense added to note payable............................ 35,625 285,000 341,826
Proceeds from sale of common stock................................ -- 16,199,395 48,286
Payments on long-term debt........................................ (415,665) -- (3,662,451)
Exercise of common stock warrants................................. 168,000 720,000 --
------------- -------------- --------------
Net cash provided by (used in) financing activities............... 2,787,960 17,204,395 (3,272,339)
------------- -------------- --------------
Increase (decrease) in cash and cash equivalents.................. 1,200,558 7,097,870 (7,203,179)
------------- -------------- --------------
Cash and cash equivalents at beginning of period.................. 96,179 1,296,737 8,394,607
------------- -------------- --------------
Cash and cash equivalents at end of period........................ $ 1,296,737 $ 8,394,607 $ 1,191,428
------------- -------------- --------------
------------- -------------- --------------
</TABLE>
See accompanying notes.
45
<PAGE>
ROCHESTER MEDICAL CORPORATION
NOTES TO FINANCIAL STATEMENTS
SEPTEMBER 30, 1997
1. BUSINESS ACTIVITY
Rochester Medical Corporation (the "Company") develops, manufactures and
markets innovative urinary continence care products for urinary dysfunction
management and urine drainage management. The Company currently manufactures and
markets a broad line of functionally and technologically enhanced latex-free
versions of standard continence care products, including male external
catheters, Foley catheters and intermittent catheters. The Company is also
developing innovative and technologically advanced products designed to provide
clinically and commercially attractive solutions to continence care needs.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
CASH EQUIVALENTS
The Company considers all highly liquid investments with a remaining
maturity of three months or less when purchased to be cash equivalents.
MARKETABLE SECURITIES
Marketable securities are classified as available for sale and consist of
U.S. Treasury Bills and certificates of deposit. At September 30, 1996 and 1997,
the market value of marketable securities approximates cost.
MANUFACTURING AND SALES
The Company manufactures and sells its products to a full range of companies
in the medical industry on a worldwide basis. There is a concentration of sales
to larger medical wholesalers and distributors. The Company performs periodic
credit evaluations of its customers' financial condition. The Company requires
irrevocable letters of credit on sales to certain foreign customers. Receivables
generally are due within 30 days. Credit losses relating to customers
consistently have been within management expectations.
INVENTORIES
Inventories, consisting of material, labor and manufacturing overhead, are
stated at the lower of cost or market. Cost is determined by the first-in,
first-out (FIFO) method.
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost less accumulated depreciation.
Depreciation is based on estimated useful lives of 4-35 years computed using the
straight-line method.
PATENTS
Capitalized costs include costs incurred in connection with making patent
applications for the Company's products and are amortized on a straight-line
basis over eight years. The Company periodically reviews its patents for
impairment of value. Any adjustment from the analysis is charged to operations.
46
<PAGE>
ROCHESTER MEDICAL CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 1997
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
RESEARCH AND DEVELOPMENT COSTS
Research and development costs are charged to operations as incurred.
Research and development costs include clinical testing costs, certain salary
and related expenses, other labor costs, materials and an allocation of certain
overhead expenses.
INCOME TAXES
Income taxes are accounted for under the liability method.
STOCK-BASED COMPENSATION
The Company follows Accounting Principles Board Opinion No. 25, "Accounting
for Stock Issued to Employees" ("APB 25"), and related interpretations in
accounting for its stock options. Under APB 25, when the exercise price of stock
options equals the market price of the underlying stock on the date of grant, no
compensation expense is recognized.
The Company has adopted the disclosure-only provisions of Statement of
Financial Accounting Standards No 123, Accounting for Stock-Based Compensation.
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 amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.
IMPAIRMENT OF LONG-LIVED ASSETS
The Company will record impairment losses on long-lived assets used in
operations when indicators of impairment are present and the undiscounted cash
flows estimated to be generated by those assets are less than the assets'
carrying amount.
NET LOSS PER SHARE
Net loss per share is computed using the weighted average number of common
shares outstanding during the period. Common equivalent shares from stock
options and convertible debt are excluded from the computation as their effect
is antidilutive. In February 1997, the Financial Accounting Standards Board
(FASB) issued FASB Statement No. 128, "Earnings Per Share." This statement
replaces the presentation of primary earnings per share (EPS) with basic EPS and
also requires dual presentation of basic and diluted EPS for entities with
complex capital structures. This statement is effective for financial statements
for periods ending after December 15, 1997. For the year ended September 30,
1997, there is no difference between the basic loss per share under Statement
No. 128 and net loss per share as reported.
RECLASSIFICATIONS
Certain reclassifications have been made to the 1996 financial statements to
conform to the 1997 presentation.
47
<PAGE>
ROCHESTER MEDICAL CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 1997
3. ADVERTISING COSTS
The Company incurred advertising expenses of $104,000, $151,000, and
$185,000 for the years ended September 30, 1995, 1996 and 1997, respectively.
All advertising costs are charged to operations as incurred.
4. INVENTORIES
Inventories are summarized as follows:
<TABLE>
<CAPTION>
SEPTEMBER 30,
--------------------------
<S> <C> <C>
1996 1997
------------ ------------
Raw materials..................................................... $ 878,885 $ 1,019,021
Work-in-process................................................... 264,729 504,120
Finished goods.................................................... 147,669 222,592
Reserve for inventory obsolescence................................ (100,000) (92,000)
------------ ------------
$ 1,191,283 $ 1,653,733
------------ ------------
------------ ------------
</TABLE>
5. SHAREHOLDERS' EQUITY
STOCK OPTIONS
In January 1992, shareholders approved the 1991 Stock Option Plan (the Plan)
in which 700,000 shares have been authorized for issuance under the Plan. Under
terms of the Plan, the Board of Directors may grant employee incentive stock
options equal to fair market value of the Company's Common Stock or employee
non-qualified options at a price which cannot be less than 85% of the fair
market value. Automatic non-employee director options are also covered under the
Plan, under which 1,000 shares are granted at fair market value to non-employee
directors on the date of each of the Company's Annual Meetings.
In September 1995, the Board of Directors approved the 1995 Non-Statutory
Stock Option Plan, which authorized the issuance of up to 50,000 shares of
Common Stock. In September 1995, Medical Advisory Board members were granted
options to purchase 12,000 shares of the Company's Common Stock at an exercise
price of $15.75 per share.
48
<PAGE>
ROCHESTER MEDICAL CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 1997
5. SHAREHOLDERS' EQUITY (CONTINUED)
Option activity is summarized as follows:
<TABLE>
<CAPTION>
SHARES RESERVED OPTIONS WEIGHTED AVERAGE EXERCISE
FOR GRANT OUTSTANDING PRICE PER SHARE
--------------- ----------- -------------------------
<S> <C> <C> <C>
Balance as of September 30, 1994......................... 93,000 207,000 $ 8.02
Options granted........................................ (9,500) 9,500 15.50
Approval of non-statutory stock options................ 50,000 -- --
--------------- -----------
Balance as of September 30, 1995......................... 133,500 216,500 8.35
Options granted........................................ (253,000) 253,000 14.32
Increase in authorized shares.......................... 400,000 -- --
--------------- -----------
Balance as of September 30, 1996......................... 280,500 469,500 11.57
Options granted........................................ (79,000) 79,000 17.26
Options exercised...................................... -- (6,000) 11.42
Options canceled....................................... 7,500 (7,500) 15.70
--------------- -----------
Balance as of September 30, 1997......................... 209,000 535,000 $ 12.35
--------------- -----------
--------------- -----------
</TABLE>
The weighted average fair value of options granted in 1996 and 1997 was
$5.66 and $6.62 per share, respectively. The exercise price of options
outstanding at September 30, 1997 ranged from $6.75 to $20.00 per share as
summarized in the following table:
<TABLE>
<CAPTION>
WEIGHTED
AVERAGE
NUMBER REMAINING NUMBER WEIGHTED AVERAGE
OUTSTANDING AT CONTRACTUAL EXERCISABLE EXERCISE PRICE PER
RANGE OF EXERCISE PRICES 9/30/97 LIFE AT 9/30/97 SHARE
- ----------------------------------------- -------------- --------------- ------------- -----------------------
<S> <C> <C> <C> <C>
$6.75 - $10.75........................... 202,000 1.3 years 109,250 $ 7.93
11.00 - 15.50............................ 222,000 3.6 years 75,500 13.76
15.75 - 20.00............................ 111,000 4.3 years 8,000 17.41
535,000 3.4 years 192,750 $ 10.60
</TABLE>
The number of stock options exercisable at September 30, 1996 and 1997 was
32,750 and 105,625 at a weighted average exercise price of $8.69 and $9.75 per
share, respectively.
The Company has elected to follow Accounting Principles Board Opinion No.
25, Accounting for Stock Issued to Employees ("APB 25") and related
interpretations in accounting for its employee stock options because, as
discussed below, the alternative fair value accounting provided under FASB
Statement No. 123,
Accounting for Stock-Based Compensation ("Statement 123"), requires use of
option valuation models that were not developed for use in valuing employee
stock options. Under APB 25, when the exercise price of the Company's employee
stock options equals the market price of the underlying stock on the date of
grant, no compensation expense is recognized.
49
<PAGE>
ROCHESTER MEDICAL CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 1997
5. SHAREHOLDERS' EQUITY (CONTINUED)
Pro forma information regarding net loss and loss per share is required by
Statement 123, and has been determined as if the Company had accounted for its
employee stock options under the fair value method of Statement 123. The fair
value of these options was estimated at the date of grant using the
Black-Scholes option pricing model with the following weighted average
assumptions: risk-free interest rate of 5.51%; volatility factor of the expected
market price of the Company's common stock of .34 and a weighted average
expected life of the option of five years.
The Black-Scholes option valuation model was developed for use in estimating
the fair value of traded options which have no vesting restrictions and are
fully transferable. In addition, option valuation models require the input of
highly subjective assumptions. Because the Company's employee stock options have
characteristics significantly different from those of traded options, and
because changes in the subjective input assumptions can materially affect the
fair value estimate, in management's opinion, the existing models do not
necessarily provide a reliable single measure of the fair value of its employee
stock options.
For purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the option's vesting period. The Company's
pro forma information is as follows:
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30,
----------------------------
1996 1997
------------- -------------
<S> <C> <C>
Pro forma net loss.............................................. $ (1,516,751) $ (2,441,970)
Pro forma net loss per common share............................. $ (.39) $ (.59)
</TABLE>
These pro forma amounts may not be indicative of future years' amounts since
the statement provides for a phase in of option values beginning with those
granted in fiscal 1996.
WARRANTS
In connection with the November 1995 public offering, the Company sold to
the underwriters for a nominal purchase price five year warrants to purchase
75,000 shares of Common Stock at $14.85 per share. The warrants can be exercised
any time through November 2000.
50
<PAGE>
ROCHESTER MEDICAL CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 1997
6. INCOME TAXES
Deferred income taxes are due to temporary differences between the carrying
values of certain assets and liabilities for financial reporting and income tax
purposes. Significant components of deferred income taxes are as follows:
<TABLE>
<CAPTION>
SEPTEMBER 30,
----------------------------
1996 1997
------------- -------------
<S> <C> <C>
Deferred assets:
Net operating loss............................................ $ 2,123,000 $ 2,710,000
Allowance for uncollectible accounts.......................... 17,000 21,000
Inventory reserves............................................ 34,000 31,000
Accrued expenses.............................................. 4,000 17,000
------------- -------------
Subtotal........................................................ 2,178,000 2,779,000
Deferred liability:
Depreciation and amortization................................. 315,000 318,000
------------- -------------
Net deferred income tax assets.................................. 1,863,000 2,461,000
Valuation allowance............................................. (1,863,000) (2,461,000)
------------- -------------
Net deferred income taxes....................................... $ -- $ --
------------- -------------
------------- -------------
</TABLE>
The Company will be subject to federal income taxes when operations become
profitable. The Company's tax operating loss carryforwards of approximately
$7,970,000 can be carried forward to offset future taxable income, limited due
to changes in ownership under the net operating loss limitation rules, and
expire in years 2003 through 2012.
7. LONG-TERM DEBT
Long-term debt consisted of a $3,000,000 convertible loan and accrued
interest with ConvaTec (see Note 12). The loan was unsecured and was due August
11, 2000. Interest on the loan was payable at a rate of 9.75% at maturity
together with the principal amount. On September 30, 1997, the Company repaid
the note and accrued interest in its entirety.
8. COMMITMENTS
MINNESOTA TECHNOLOGIES INCORPORATED
On September 30, 1992, Minnesota Technologies Incorporated ("MTI"), a
Minnesota non-profit development organization, provided the Company a grant of
$100,000 for the purpose of developing the automated production of Foley
catheters. Under the terms of the MTI grant, the Company has agreed to repay MTI
the amount of the grant together with 8% simple interest at the rate of 2.5% of
gross sales of Foley catheters. The Company has further agreed to convey to MTI
all rights in any intellectual property, including the manufacturing equipment
and any patents issued with respect thereto, upon occurrence of any of the
following events:
1. The Company dissolves, becomes inoperative, or abandons the intellectual
property relating to the automated production of Foley catheters; or
51
<PAGE>
ROCHESTER MEDICAL CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 1997
8. COMMITMENTS (CONTINUED)
2. More than 25% of its manufacturing or production facilities relating to
Foley catheters are located outside the State of Minnesota before August
17, 1999.
The grant was accounted for as a reduction in the cost of the equipment.
Royalties earned by MTI are charged to operations as royalty expense. Royalty
expense totaled $33,000 in 1995, $53,000 in 1996 and $23,000 in 1997. The
Company has repaid the grant and accrued interest as of September 30, 1997.
CITY OF STEWARTVILLE
On September 28, 1995, the Company and the City of Stewartville, Minnesota
("City") entered into a Contract for Private Development ("City Agreement") and
agreed to enter into an Assessment Agreement and Assessment Certification
("Assessment Agreement") relating to the development of the Company's proposed
manufacturing facility. In connection therewith, the Company also agreed to use
its best efforts to create 55 new full-time jobs in the City by December 31,
1998, and to pay real estate taxes without contest in accordance with the
Assessment Agreement. Under the City Agreement, the City sold to the Company a
20 acre parcel of land for $60,000, and installed roads, utilities and certain
public improvements benefiting the land. The Company has constructed a new
52,000 square foot facility. On December 23, 1996, the Company purchased an
additional 8.38 acre parcel of land from the City for $100,000 to be used for
future expansion of manufacturing facilities.
At September 30, 1997, the Company had commitments of approximately
$2,000,000 for capital expenditures, primarily related to new production
facilities.
9. LEASES
Rent expense from operating leases for the years ended September 30, 1995,
1996, and 1997 was $57,000, $60,000, and $69,000, respectively.
10. RELATED PARTY TRANSACTIONS
The Company's corporate legal counsel is the brother-in-law of the CEO and
President, the Vice President of Operations and of a member of the board of
directors of the Company. During the years ended September 30, 1995, 1996, and
1997, the Company incurred legal fees and expenses of approximately $124,000,
$83,000, and $90,000, respectively, to such counsel for services rendered in
connection with litigation and for general legal services. Management believes
the fees paid for the services rendered to the Company were on terms at least as
favorable to the Company as could have been obtained from an unrelated party.
The chairman and chief executive officer of Mentor Corporation is the
brother of the CEO and President, the Vice President of Operations, and a member
of the board of directors of the Company (see Note 11).
The Company entered into an agreement with Halcon, Inc. to purchase office
furniture valued at $402,000. A payment of $86,000 was made in fiscal 1996 and
$316,000 was paid in fiscal 1997. The chief executive officer of Halcon, Inc. is
a director of the Company and the brother of the CEO and President and the Vice
President of Operations of the Company. Management believes that the terms of
the agreement are at least as favorable to the Company as could have been
obtained from an unrelated party.
52
<PAGE>
ROCHESTER MEDICAL CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 1997
11. MENTOR AGREEMENT AND RELATED LITIGATION
In April 1991, the Company entered into an exclusive license, sales and
distribution agreement ("MEC Agreement") for external catheters with Mentor
Corporation (Mentor) for which the Company received a non-refundable license fee
of $500,000. The agreement granted Mentor sales exclusivity for silicone
external catheters in North and South America, Africa, Australia, and Western
Europe and a patent license permitting Mentor to manufacture the catheter
itself.
On September 11, 1995, the Company and Mentor entered into a settlement
agreement to conclude all pending litigation among Mentor, the Company and
certain of the Company's officers. As part of the settlement agreement, the
Company waived certain monetary claims against Mentor, which resulted in a
write-off of approximately $115,000 of accounts receivable from Mentor in the
fourth quarter of fiscal 1995. The Company previously wrote off $100,000 of
Mentor accounts receivable in the third quarter of fiscal 1995. The settlement
agreement also provided that Mentor purchase all of the Company's inventory of
silicone male external catheters held for sale to Mentor at an agreed upon
transfer price. This sale resulted in approximately $160,000 of net sales to
Mentor during the fourth quarter of fiscal 1995. As part of the settlement
agreement, Mentor's sales exclusivity was terminated.
12. CONVATEC AGREEMENT
On August 11, 1995, the Company entered into a Distribution and
Co-Development Agreement (the "Distribution Agreement") with ConvaTec, a
division of E.R. Squibb & Sons, Inc., a wholly-owned subsidiary of Bristol-Myers
Squibb Company ("ConvaTec"), for the purpose of marketing and distributing the
Company's incontinence and urological devices. Under the Distribution Agreement,
the Company has granted ConvaTec, subject to obligations and limitations imposed
by the Company's other distribution agreements, worldwide rights to market the
Company's current products and products in development. The Company is obligated
to offer ConvaTec rights of first and last refusal to market all products
developed after the date of the Distribution Agreement. Under the Distribution
Agreement, the Company retains worldwide marketing rights to its products under
the Rochester Medical brand.
The Distribution Agreement has a five year term expiring August 31, 2000.
ConvaTec may, at its option, renew the Distribution Agreement for an additional
five year term, and thereafter, renew the Distribution Agreement for up to five
additional one year renewal periods. A party may terminate the Distribution
Agreement only upon the other party's material breach of the Distribution
Agreement, bankruptcy or insolvency, or an inability to perform under the
Distribution Agreement for a period of more than six months. The Distribution
Agreement may not be terminated in the event that a third party acquires the
Company. The Company has agreed to indemnify ConvaTec against certain
liabilities, including any patent infringement claims by third parties.
53
<PAGE>
ROCHESTER MEDICAL CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 1997
13. SIGNIFICANT CUSTOMERS
Significant customers, measured as a percentage of sales, are summarized as
follows:
<TABLE>
<CAPTION>
SEPTEMBER 30,
-------------------------------------
1995 1996 1997
----- ----- -----
<S> <C> <C> <C>
Significant customers:
Allegiance Euromedical................................................. 19% 19% 4%
ConvaTec............................................................... 5% 12% 24%
Hollister.............................................................. 25% 12% 10%
Mentor................................................................. 14% 29% 30%
-- -- --
Total.................................................................... 63% 72% 68%
-- -- --
-- -- --
</TABLE>
14. SUBSEQUENT EVENT
In November 1997, the Company completed a public offering of 1,125,000
shares of common stock, resulting in net proceeds to the Company of
approximately $15,800,000.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
54
<PAGE>
PART III
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS
Incorporated herein by reference to portions of the Proxy Statement for
Annual Meeting of Shareholders to be filed with the Securities and Exchange
Commission within 120 days of the close of the fiscal year ended September 30,
1997.
ITEM 10A. EXECUTIVE OFFICERS OF THE COMPANY
The executive officers and directors of the Company are as follows:
<TABLE>
<CAPTION>
NAME AGE POSITION
- ---------------------------------------------------- --- ------------------------------------------------------
<S> <C> <C>
Anthony J. Conway................................... 53 Chairman of the Board, Chief Executive
Officer,President and Secretary
Philip J. Conway.................................... 41 Vice President, Operations and Director
Richard D. Fryar.................................... 50 Vice President, Research and Development and Director
Alfred T. Mannino................................... 48 Senior Vice President
Martyn R. Sholtis................................... 38 Vice President, Sales and Marketing
Brian J. Wierzbinski................................ 39 Chief Financial Officer and Treasurer
Darnell L. Boehm(1)(2).............................. 49 Director
Peter R. Conway..................................... 43 Director
Roger W. Schnobrich(1)(2)........................... 67 Director
</TABLE>
- ------------------------
(1) Member of the Compensation Committee of the Board of Directors.
(2) Member of the Audit Committee of the Board of Directors.
Anthony J. Conway, a founder of the Company, has served as Chairman of the
Board, Chief Executive Officer, President and Secretary of the Company since May
1988. In addition to his duties as Chief Executive Officer, Mr. Anthony Conway
actively contributes to the Company's research and development and design
activities. From 1979 to March 1988, he was President, Secretary and Treasurer
of Arcon Corporation ("Arcon"), a company that he co-founded in 1979 to develop,
manufacture and sell latex-based male external catheters and related medical
devices. Prior to founding Arcon, Mr. Anthony Conway worked for twelve years for
International Business Machines Corporation ("IBM") in various research and
development capacities. Mr. Anthony Conway is one of the named inventors on
numerous patent applications that have been assigned to the Company, of which to
date 14 have resulted in issued United States patents.
Philip J. Conway, a founder of the Company, has served as Vice President,
Operations and as a director of the Company since May 1988. Mr. Philip Conway is
responsible for overseeing plant design and operation, and is also active in the
Company's research and development and design activities. From 1979 to March
1988, Mr. Philip Conway served as Plant and Production Manager of Arcon, a
company that he co-founded. Prior to joining Arcon, Mr. Philip Conway was
employed in a production supervisory capacity by AFC Corp., a manufacturer and
fabricator of fiberglass plastics and other composite materials. He is one of
the named inventors on numerous patent applications that have been assigned to
the Company, of which to date 14 have resulted in issued United States patents.
Richard D. Fryar, a founder of the Company, has served as Vice President,
Research and Development and as a director of the Company since May 1988. Mr.
Fryar is responsible for overseeing the Company's research and development and
regulatory affairs activities. From 1984 to March 1988, Mr. Fryar was employed
by Arcon, a company that he co-founded, in research and development capacities.
From 1969 to 1984, he was employed by IBM in various research and development
capacities. He is one of
55
<PAGE>
the named inventors on numerous patent applications that have been assigned to
the Company, of which to date 14 have resulted in issued United States patents.
Alfred T. Mannino has served as the Company's Senior Vice President since
August 1996, and served as its Executive Vice President from November 1994 to
August 1996. Mr. Mannino is generally responsible for marketing the Company's
products. From 1991 to 1994, he served as Vice President of Sales and Marketing
of Dacomed Corporation, a company that produces and sells incontinence and
impotence devices and diagnostic equipment. Mr. Mannino has over 26 years of
experience in sales and marketing management of incontinence related products.
Martyn R. Sholtis has served as Vice President, Sales and Marketing of the
Company since April 1992. Mr. Sholtis' responsibilities include the sales and
marketing of Rochester Medical brand products in international markets and the
management of the Company's private label relationships, including its alliance
with ConvaTec. From 1985 to April 1992, Mr. Sholtis was employed by Sherwood
Medical Company, a company that manufactures and sells Foley catheters and a
variety of other urologic and hospital-based medical products, most recently as
Regional Sales Manager for the Nursing Care Division, with responsibility for
twelve states in the midwest region.
Brian J. Wierzbinski has served as the Company's Chief Financial Officer
since February 1996, with principal responsibility for management of the
Company's financial and administrative affairs. From 1986 until joining the
Company in 1996, Mr. Wierzbinski was employed in various financial and financial
management capacities by Ecolab Inc., most recently as Asia Pacific Vice
President, planning and control. Prior to joining Ecolab Inc., Mr. Wierzbinski
was employed for six years in various audit and audit management capacities by
KPMG Peat Marwick. Mr. Wierzbinski is a certified public accountant.
Darnell L. Boehm has served as a director of the Company since October 1995.
Since 1986, Mr. Boehm has served as a Director and the Chief Financial Officer
and Secretary of Aetrium, Inc., a manufacturer of electromechanical equipment
for handling and testing semiconductor devices. From October 1988 to March 1993,
Mr. Boehm served as the Acting President of Genesis Labs, Inc., a manufacturer
of medical diagnostic products. He is also the principal of Darnell L. Boehm &
Associates, a management consulting firm.
Peter R. Conway has served as a director of the Company since May 1988. He
has been a director and the Chairman and Chief Executive Officer of Halcon
Corporation, a manufacturer of quality office furniture, of which he was a
co-founder, since 1978. From 1979 to 1985, Mr. Peter Conway served as a director
of Arcon.
Roger W. Schnobrich has served as a director of the Company since October
1995. Mr. Schnobrich has been a partner with the law firm of Hinshaw &
Culbertson since 1997. Prior to joining Hinshaw & Culbertson, Mr. Schnobrich was
a partner in the law firm of Popham, Haik, Schnobrich and Kaufman Ltd. for more
than five years. Mr. Schnobrich serves as a director of Developed Technology
Resource Inc., a company that invests in business, technology and infrastructure
in the former Soviet Union.
Messrs. Anthony J. Conway, Philip J. Conway and Peter R. Conway are
brothers.
The Compensation Committee of the Board of Directors has power and authority
to recommend compensation for the Company's executive officers. The Audit
Committee has oversight over the process of auditing the Company's internally
prepared financial statements, and is charged with reviewing any potential
conflicts of interest. Mr. Anthony J. Conway serves ex officio as a member of
each committee.
ITEM 10B. COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT
Incorporated herein by reference to portions of the Proxy Statement for
Annual Meeting of Shareholders to be filed with the Securities and Exchange
Commission within 120 days of the close of the fiscal year ended September 30,
1997.
56
<PAGE>
ITEM 11. EXECUTIVE COMPENSATION
Incorporated herein by reference to portions of the Proxy Statement for
Annual Meeting of Shareholders to be filed with the Securities and Exchange
Commission within 120 days of the close of the fiscal year ended September 30,
1997.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Incorporated herein by reference to portions of the Proxy Statement for
Annual Meeting of Shareholders to be filed with the Securities and Exchange
Commission within 120 days of the close of the fiscal year ended September 30,
1997.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Incorporated herein by reference to portions of the Proxy Statement for
Annual Meeting of Shareholders to be filed with the Securities and Exchange
Commission within 120 days of the close of the fiscal year ended September 30,
1997.
ITEM 14. EXHIBITS AND REPORTS ON FORM 8-K
(a)(1) The following financial statements are filed herewith in Item 7.
(i) Balance Sheets as of September 30, 1997, 1996 and 1995.
(ii) Statements of Operations for the years ended September 30, 1997,
1996 and 1995.
(iii) Statement of Shareholders' Equity for the years ended September 30,
1996 and 1995.
(iv) Statements of Cash Flows for the years ended September 30, 1997,
1996 and 1995.
(v) Notes to financial statements at September 30, 1997.
(a)(2) The following exhibits are submitted herewith:
3.1 Articles of Incorporation of the Company, as amended. (Incorporated
by reference to Exhibit 4.1 of Registrant's Registration Statement on Form
S-2, Registration Number 33-97788).
3.2 Restated Bylaws of the Company. (Incorporated by reference to
Exhibit 3.2 of Registrant's Registration Statement on Form S-18,
Registration Number 33-36362-C).
3.3 Amendment to Restated Bylaws of the Company. (Incorporated by
reference to Exhibit 4.3 of Registrant's Registration Statement on Form S-2,
Registration Number 33-97788).
4.1 Specimen of Common Stock Certificate. (Incorporated by reference to
Exhibit 4.4 of Registrant's Annual Report on Form 10-KSB for fiscal year
ended September 30, 1995.
4.2 The Company's 1991 Stock Option Plan as amended (Incorporated by
reference to Exhibit 4.5 of Registrant's Registration Statement on Form S-8,
Registration Number 333-10261.
10.1 Agreement, contractual (non-state employee) dated September 27,
1989, between the Company and the Greater Minnesota Corporation.
(Incorporated by reference to Exhibit 10.2 of Registrant's Registration
Statement on Form S-18, Registration Number 33-36362-C).
10.2 Contract for Private Development dated October 11, 1989 between
the Company and the City of Stewartville, Minnesota. (Incorporated by
reference to Exhibit 10.3 of Registrant's Registration Statement on Form
S-18, Registration Number 33-36362-C).
10.3 Indenture dated October 19, 1989 between the Company and the City
of Stewartville, Minnesota. (Incorporated by reference to Exhibit 10.4 of
Registrant's Registration Statement on Form S-18, Registration Number
33-36362-C).
57
<PAGE>
10.4 Employment Agreement, dated August 31, 1990 between the Company
and Anthony J.
Conway. (Incorporated by reference to Exhibit 10.13 of Registrant's
Registration Statement on Form S-18, Registration Number 33-36362-C).
10.5 Employment Agreement, dated August 31, 1990 between the Company
and Philip J. Conway. (Incorporated by reference to Exhibit 10.14 of
Registrant's Registration Statement on Form S-18, Registration Number
33-36362-C).
10.6 Employment Agreement, dated August 31, 1990 between the Company
and Richard D. Fryar. (Incorporated by reference to Exhibit 10.15 of
Registrant's Registration Statement on Form S-18, Registration Number
33-36362-C).
10.7 Employment Agreement dated April 21, 1991 between the Registrant
and Martyn R. Sholtis. (Incorporated by reference to Exhibit 10.19 to
Registrant's Annual Report on Form 10-KSB for the fiscal year ended
September 30, 1992).
10.8 Employment Agreement Addendum dated June 13, 1994 between the
Registrant and Martyn R. Sholtis. (Incorporated by reference to Exhibit
10.15 to Registrant's Annual Report on Form 10-KSB for the fiscal year ended
September 30, 1994).
10.9 Employment Agreement dated September 29, 1994 between the
Registrant and Alfred T. Mannino. (Incorporated by reference to Exhibit
10.16 to Registrant's Annual Report on Form 10-KSB for the fiscal year ended
September 30, 1994).
10.10 Employment Agreement dated February 1, 1996 between the
Registrant and Brian J. Wierzbinski. (Incorporated by reference to Exhibit
10.10 to Registrant's Annual Report on Form 10-KSB for the fiscal year ended
September 30, 1996).
10.11 Male External Catheter License, Sales and Distribution Agreement
dated April 24, 1991, between the Company and Mentor Corporation.
(Incorporated by reference to Exhibit 10.7 of Registrants Registration
Statement on Form S-1, Registration Number 33-40934).
10.12 Amended UF Catheter Exclusive OEM/Private Label Agreement dated
March 18, 1994, between the Company and Hollister Incorporated.
(Incorporated by reference to Exhibit (a)(i) of Registrant's Quarterly
Report on Form 10-QSB for the quarter ended March 31, 1994).
10.13 First Amendment to Amended UF Catheter Exclusive OEM/Private
Label Agreement dated May 7, 1997, between the Company and Hollister
Incorporated. (Incorporated by reference to Exhibit 10.13 of Registrant's
Quarterly Report on Form 10-Q for the quarter ended June 30, 1997).
10.14 Amended and Restated Supply and Distribution Agreement dated
April March 19, 1997, between the Company and Euromedical Industries Sdn Bhd
(a subsidiary of Allegiance Health Care Corporation). (Incorporated by
reference to Exhibit 10.12 of Registrant's Quarterly Report on Form 10-Q for
the quarter ended March 31, 1997).
10.15 Convertible Senior Secured Loan Agreement, dated as of August 11,
1995, by and between E. R. Squibb & Sons, Inc. (through its ConvaTec
division) and the Registrant. (Incorporated by reference to Exhibit 4.11 of
Registrant's Quarterly Report on Form 10-QSB for the quarter ended June 30,
1995).
10.16 Distribution and Co-Development Agreement, dated as of August 11,
1995, between the Registrant and E. R. Squibb & Sons, Inc. (through its
ConvaTec division). (Incorporated by reference to Exhibit 10.23 of
Registrant's Quarterly Report on Form 10-QSB for the quarter ended June 30,
1995).
23 Consent of Ernst & Young LLP.*
27 Financial Data Schedule.*
- ------------------------
* Filed herewith.
(b) Registrant filed no Report on Form 8-K during its fourth fiscal quarter.
58
<PAGE>
SIGNATURES
Pursuant to the requirements of the Exchange Act, the registrant has caused
this report to be signed on its behalf by the undersigned, thereunto duly
authorized on this 29th day of December, 1997.
<TABLE>
<S> <C> <C>
ROCHESTER MEDICAL CORPORATION
By: /s/ ANTHONY J. CONWAY
-----------------------------------------
Anthony J. Conway
PRESIDENT
</TABLE>
Pursuant to the requirements of the Exchange Act, this Report has been
signed below by the following persons in the capacities and on the dates
indicated.
<TABLE>
<S> <C>
/s/ ANTHONY J. CONWAY
--------------------------
Anthony J. Conway
Chairman of the Board, Dated December 29, 1997
President and Director
(Principal Executive
Officer)
/s/ BRIAN J. WIERZBINSKI
--------------------------
Brian J. Wierzbinski
Chief Financial Officer Dated December 29, 1997
and Treasurer
(Principal Financial
Officer)
/s/ DARNELL L. BOEHM
--------------------------
Darnell L. Boehm, a Dated December 29, 1997
Director
/s/ PETER R. CONWAY
--------------------------
Peter R. Conway, a Dated December 29, 1997
Director
/s/ PHILIP J. CONWAY
--------------------------
Philip J. Conway, a Dated December 29, 1997
Director
/s/ RICHARD D. FRYAR
--------------------------
Richard D. Fryar, a Dated December 29, 1997
Director
/s/ ROGER W. SCHNOBRICH
--------------------------
Roger W. Schnobrich, a Dated December 29, 1997
Director
</TABLE>
59
<PAGE>
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT PAGE
- ----------- -----
<S> <C> <C>
23 Consent of Ernst & Young LLP......................................................................
27 Financial Data Schedule...........................................................................
</TABLE>
<PAGE>
EXHIBIT 23
CONSENT OF ERNST & YOUNG LLP
We consent to the incorporation by reference in the Registration Statement
(Form S-8 No. 333-10261) pertaining to the 1991 Stock Option Plan of Rochester
Medical Corporation, of our report dated October 15, 1997, except for Note 14,
as to which the date is November 5, 1997, with respect to the financial
statements of Rochester Medical Corporation included in this Annual Report (Form
10-K) for the year ended September 30, 1997.
ERNST & YOUNG LLP
Minneapolis, Minnesota
December 23, 1997
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> SEP-30-1997
<PERIOD-START> JUL-01-1997
<PERIOD-END> SEP-30-1997
<CASH> 1,191,428
<SECURITIES> 3,447,461
<RECEIVABLES> 2,029,194
<ALLOWANCES> 62,000
<INVENTORY> 1,653,733
<CURRENT-ASSETS> 8,513,601
<PP&E> 11,625,414
<DEPRECIATION> 1,855,980
<TOTAL-ASSETS> 18,613,373
<CURRENT-LIABILITIES> 1,432,400
<BONDS> 0
0
0
<COMMON> 24,697,199
<OTHER-SE> 0
<TOTAL-LIABILITY-AND-EQUITY> 18,613,373
<SALES> 7,615,439
<TOTAL-REVENUES> 7,615,439
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<OTHER-EXPENSES> 0
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<INTEREST-EXPENSE> 341,753
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<INCOME-TAX> 0
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<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (2,098,664)
<EPS-PRIMARY> (0.51)
<EPS-DILUTED> (0.51)
</TABLE>
