<PAGE> 1
================================================================================
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
FORM 10-K/A
(AMENDMENT NO. 2)
FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
FOR THE FISCAL YEAR ENDED MARCH 31, 1997
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934
COMMISSION FILE NUMBER: 1-11150
------------------------
UROHEALTH SYSTEMS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
<TABLE>
<S> <C>
DELAWARE 98-0122944
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
</TABLE>
5 CIVIC PLAZA, SUITE 100, NEWPORT BEACH, CALIFORNIA 92660
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)(ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (714) 668-5858
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
TITLE OF EACH CLASS
COMMON STOCK
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
As of June 30, 1997, the aggregate market value of the Common Stock held by
non-affiliates of the Registrant was approximately $108,553,635. The number of
shares outstanding of the Registrant's Common Stock as of June 30, 1997 was
23,809,817.
This Amendment No. 2 is being filed to amend Part IV information.
================================================================================
<PAGE> 2
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
The following consolidated financial statements of the Company are included
herein:
<TABLE>
<CAPTION>
PAGE OR
METHOD
OF FILING
---------
<S> <C> <C>
(a)(1) Consolidated Financial Statements
(1) Report of Independent Auditors -- Ernst & Young LLP................ F-2
(2) Report of Coopers & Lybrand L.L.P. ................................ F-3
(3) Independent Auditors' Reports of KPMG Peat Marwick LLP............. F-4
(4) Consolidated Balance Sheets at March 31, 1996 and 1997............. F-5
(5) Consolidated Statements of Operations for the year ended June 30,
1995, for the nine months ended March 31, 1996 and for the year
ended March 31, 1997............................................... F-6
(6) Consolidated Statements of Common Stockholders' Equity (Deficiency)
for the year ended June 30, 1995, for the nine months ended March
31, 1996, and for the year ended March 31, 1997.................... F-7
(7) Consolidated Statements of Cash Flows for the year ended June 30,
1995, for the nine months ended March 31, 1996 and for the year
ended March 31, 1997............................................... F-8
(8) Notes to Consolidated Financial Statements......................... F-9
(2) Financial Statement Schedules
Report of Independent Auditors.......................................... S-1
Schedule II -- Consolidated Valuation Accounts.......................... S-2
All other financial statement schedules have been omitted because they are
inapplicable or the information required thereby is included in the financial
statements.
(3) Exhibits
Reference is made to the Exhibit Index immediately preceding the
exhibits hereto for the exhibits included herein.
(b) Reports on Form 8-K.
</TABLE>
The following Form 8-K was filed by the Company during the last quarter of the
fiscal year ended March 31, 1997: Form 8-K, dated March 14, 1997 (Commission
file no. 1-11150)
2
<PAGE> 3
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
UROHEALTH SYSTEMS, INC.
Reports of Independent Auditors....................................................... F-2
Consolidated Balance Sheets as of March 31, 1996 and 1997............................. F-5
Consolidated Statements of Operations for the year ended June 30, 1995, for the nine
months ended March 31, 1996 and for the year ended March 31, 1997................... F-6
Consolidated Statements of Common Stockholders' Equity (Deficiency) for the year ended
June 30, 1995, for the nine months ended March 31, 1996 and for the year ended March
31, 1997............................................................................ F-7
Consolidated Statements of Cash Flows for the year ended June 30, 1995, for the nine
months ended March 31, 1996 and for the year ended March 31, 1997................... F-8
Notes to Consolidated Financial Statements............................................ F-9
</TABLE>
F-1
<PAGE> 4
REPORT OF INDEPENDENT AUDITORS
Stockholders and Board of Directors
UROHEALTH Systems, Inc.
We have audited the accompanying consolidated balance sheets of UROHEALTH
Systems, Inc. as of March 31, 1996 and 1997, and the related consolidated
statements of operations, stockholders' equity (deficiency) and cash flows for
the year ended June 30, 1995, the nine months ended March 31, 1996 and the year
ended March 31, 1997. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based upon our audits. We did not audit the financial
statements of Microsurge, Inc., a wholly-owned subsidiary, as of March 31, 1996
and 1997 and for the year ended December 31, 1995, the nine months ended March
31, 1996 and the year ended March 31, 1997 and of Dacomed Corporation, a
wholly-owned subsidiary, for the year ended June 24, 1995, which statements
reflect total assets constituting 16.5% and 3.9% of consolidated total assets as
of March 31, 1996 and 1997, respectively, and net sales constituting 27%, 8%,
and 8% of consolidated net sales for the year ended June 30, 1995, the nine
months ended March 31, 1996 and the year ended March 31, 1997, respectively.
Those statements were audited by other auditors whose reports have been
furnished to us, and our opinion, insofar as it relates to data included in the
consolidated financial statements for such entities, is based solely on the
reports of other auditors.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform our audits to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits and the reports of other auditors provide a
reasonable basis for our opinion.
In our opinion, based upon our audits and the reports of other auditors,
the financial statements referred to above present fairly, in all material
respects, the consolidated financial position of UROHEALTH Systems, Inc. at
March 31, 1996 and 1997, and the consolidated results of its operations and its
cash flows for the year ended June 30, 1995, the nine months ended March 31,
1996 and the year ended March 31, 1997 in conformity with generally accepted
accounting principles.
/s/ ERNST & YOUNG LLP
Orange County, California
July 8, 1997
F-2
<PAGE> 5
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors of
UROHEALTH Systems, Inc.:
We have audited the accompanying balance sheets of Microsurge, Inc. as of
March 31, 1997 and 1996, and the related statements of operations, stockholders'
deficit and cash flows for the year ended March 31, 1997, the nine months ended
March 31, 1996 and the year ended December 31, 1995 (not included separately
herein). 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.
As described in Note 1 to the financial statements, on March 31, 1997,
Microsurge, Inc. was acquired by and became a wholly-owned subsidiary of
UROHEALTH Systems, Inc.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Microsurge, Inc. as of March
31, 1997 and 1996, and the results of its operations and its cash flows for the
year ended March 31, 1997, the nine months ended March 31, 1996, and the year
ended December 31, 1995 in conformity with generally accepted accounting
principles.
/s/ COOPERS & LYBRAND L.L.P.
Boston, Massachusetts
May 9, 1997
F-3
<PAGE> 6
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders
Dacomed Corporation:
We have audited the accompanying consolidated statements of operations,
stockholders' equity, and cash flows of Dacomed Corporation for the fiscal year
ended June 24, 1995 (not included separately herein). These consolidated
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audit.
We conducted our audit 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 audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the results of operations and cash
flows of Dacomed Corporation and subsidiary for the fiscal year ended June 24,
1995, in conformity with generally accepted accounting principles.
/s/ KPMG PEAT MARWICK LLP
Minneapolis, Minnesota
October 10, 1995
F-4
<PAGE> 7
UROHEALTH SYSTEMS, INC.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
UNAUDITED
MARCH 31, PRO FORMA
---------------------- MARCH 31,
1996 1997 1997
-------- --------- -----------
(IN THOUSANDS, EXCEPT SHARE DATA)
<S> <C> <C> <C>
ASSETS (NOTE 5)
Current assets:
Cash and equivalents............................................ $ 3,345 $ 2,591 $ 34,007
Short-term investments.......................................... 243 -- --
Receivables, net of allowance for doubtful accounts of $1,744
and $1,896 in 1996 and 1997, respectively..................... 8,074 17,272 17,272
Income tax receivable........................................... -- 377 377
Advances to officers............................................ -- 114 114
Inventories..................................................... 6,702 20,945 20,945
Distributor inventories......................................... -- 6,307 6,307
Prepaid expenses................................................ 1,715 2,278 2,278
Deferred debt issuance costs.................................... 614 -- --
-------- --------- ---------
Total current assets.............................................. 20,693 49,884 81,300
Restricted cash................................................... 96 48 19,228
Receivables -- long term.......................................... -- 2,722 2,722
Property and equipment, net....................................... 9,084 26,035 26,035
Patents and intangibles, net of accumulated amortization of $2,102
and $2,646 in 1996 and 1997, respectively....................... 2,401 6,285 6,285
Loans to officers................................................. -- 550 550
Deposits and other assets......................................... 688 2,232 2,232
Deferred debt issuance costs...................................... -- 5,986 9,305
Goodwill.......................................................... 393 43,417 43,417
-------- --------- ---------
$ 33,355 $ 137,159 $ 191,074
======== ========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIENCY)
Current liabilities:
Accounts payable and accrued liabilities........................ $ 10,541 $ 20,882 $ 20,882
Compensation and employee benefits.............................. 2,042 3,250 3,250
Restructuring liabilities....................................... 1,345 6,192 6,192
Short-term debt................................................. 9,549 14,518 5,268
Current portion of long-term debt............................... 546 3,328 3,328
-------- --------- ---------
Total current liabilities......................................... 24,023 48,170 38,920
Long-term liabilities:
Long-term debt.................................................. 8,272 98,292 53,292
Senior subordinated notes, net of discount...................... -- -- 108,278
Restructuring liabilities, less current portion................. 823 822 822
Other liabilities............................................... 185 4,149 4,149
Commitments and contingencies (Notes 1, 7 and 15)
Minority interest in consolidated subsidiary...................... 1,073 237 237
Redeemable convertible preferred stock............................ 3,554 -- --
Common stockholders' equity (deficiency):
Preferred stock, $0.001 par value Authorized shares -- 5,000,000
Issued and outstanding shares -- none......................... -- -- --
Common stock, $0.001 par value
Authorized shares -- 50,000,000
Issued and outstanding shares -- 15,230,000 and 23,807,000, at
March 31, 1996 and 1997, respectively....................... 15 24 24
Warrants........................................................ 3,000 5,359 7,080
Additional paid-in capital...................................... 75,975 150,468 150,468
Foreign currency translation adjustment......................... (98) (14) (14)
Deficit......................................................... (83,467) (170,348) (172,182)
-------- --------- ---------
Total common stockholders' equity (deficiency).................... (4,575) (14,511) (14,624)
-------- --------- ---------
$ 33,355 $ 137,159 $ 191,074
======== ========= =========
</TABLE>
See accompanying notes.
F-5
<PAGE> 8
UROHEALTH SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
NINE MONTHS
YEAR ENDED ENDED YEAR ENDED
JUNE 30, MARCH 31, MARCH 31,
1995 1996 1997
---------- ----------- ----------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C>
Net sales............................................... $ 49,250 $ 42,953 $ 90,695
Cost of sales........................................... 18,529 14,964 41,083
-------- -------- --------
Gross profit............................................ 30,721 27,989 49,612
Operating expenses:
Selling, general and administrative................... 41,057 37,056 57,691
Research and development.............................. 5,406 2,777 4,997
Restructuring charges................................. 1,200 5,456 12,000
Write-off of purchased research and development....... 5,312 -- 47,232
Direct acquisition costs.............................. 851 4,232 3,600
Settlement of litigation.............................. 300 -- --
-------- -------- --------
Total operating expenses................................ 54,126 49,521 125,520
-------- -------- --------
Loss from operations.................................... (23,405) (21,532) (75,908)
Other income (expense):
Minority interest consisting of accrued dividends on
preferred stock of subsidiary...................... (78) (55) (25)
Interest income....................................... 394 101 339
Interest expense...................................... (367) (1,059) (8,143)
Other................................................. 5 (48) --
-------- -------- --------
Loss before taxes and extraordinary item................ (23,451) (22,593) (83,737)
Provision (benefit) for income taxes.................... 1,386 431 (227)
-------- -------- --------
Loss before extraordinary item.......................... (24,837) (23,024) (83,510)
Extraordinary item (early extinguishment of debt)....... -- -- (2,973)
-------- -------- --------
Net loss................................................ $(24,837) $ (23,024) $(86,483)
======== ======== ========
Net loss per share:
Loss before extraordinary item........................ $(24,837) $ (23,024) $(83,510)
Dividends and accretion on redeemable convertible
preferred stock.................................... (45) (579) (398)
-------- -------- --------
Loss attributable to common stockholders before
extraordinary item................................. (24,882) (23,603) (83,908)
Extraordinary item.................................... -- -- (2,973)
-------- -------- --------
Net loss attributable to common stockholders.......... $(24,882) $ (23,603) $(86,881)
======== ======== ========
Loss per share before extraordinary item.............. $ (1.70) $ (1.58) $ (4.31)
======== ======== ========
Net loss per share.................................... $ (1.70) $ (1.58) $ (4.47)
======== ======== ========
Weighted average number of shares used to compute net
loss per share........................................ 14,672 14,980 19,453
======== ======== ========
</TABLE>
See accompanying notes.
F-6
<PAGE> 9
UROHEALTH SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF COMMON STOCKHOLDERS' EQUITY (DEFICIENCY)
(IN THOUSANDS)
<TABLE>
<CAPTION>
COMMON STOCK ADDITIONAL FOREIGN
----------------- PAID-IN CURRENCY
SHARES AMOUNT WARRANTS CAPITAL DEFICIT TRANSLATION TOTAL
------ -------- -------- ---------- --------- ----------- --------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at June 30, 1994................. 14,171 $ 46,476 $1,000 $ 20,623 $ (48,562) $ -- $ 19,537
Exercise of options and warrants....... 55 87 -- 15 -- -- 102
Issuance of common stock............... 169 899 -- 95 -- -- 994
Warrants............................... -- -- 402 -- -- -- 402
Issuance of common stock for preferred
stock of subsidiary................. 195 2,720 -- -- -- -- 2,720
Reincorporation in Delaware............ -- (50,168) -- 50,168 -- -- --
Adjustment for pooling of interests.... -- -- -- -- 13,953 -- 13,953
Dividends and accretion on redeemable
convertible preferred stock......... -- -- -- -- (45) -- (45)
Net loss............................... -- -- -- -- (24,837) -- (24,837)
Foreign currency translation........... -- -- -- -- -- 115 115
------ -------- ------ -------- --------- ----- --------
Balance at June 30, 1995................. 14,590 14 1,402 70,901 (59,491) 115 12,941
Adjustments for pooling of interests... -- -- -- -- (373) -- (373)
Exercise of options and warrants....... 170 -- -- 880 -- -- 880
Issuance of equity securities by pooled
company............................. 467 -- -- 4,149 -- -- 4,149
Issuance of common stock for preferred
stock of subsidiary................. 3 1 -- 45 -- -- 46
Dividends and accretion on redeemable
convertible preferred stock......... -- -- -- -- (579) -- (579)
Warrants............................... -- -- 1,598 -- -- -- 1,598
Net loss............................... -- -- -- -- (23,024) -- (23,024)
Foreign currency translation........... -- -- -- -- -- (213) (213)
------ -------- ------ -------- --------- ----- --------
Balance at March 31, 1996................ 15,230 15 3,000 75,975 (83,467) (98) (4,575)
Exercise of options and warrants....... 295 -- -- 1,436 -- -- 1,436
Issuance of common stock for preferred
stock of subsidiary................. 54 -- -- 860 -- -- 860
Issuance of common shares relating to
secondary offering.................. 2,684 3 -- 18,814 -- -- 18,817
Issuance of common shares related to
acquisitions........................ 4,088 4 -- 48,042 -- -- 48,046
Issuance of common shares on conversion
of convertible preferred stock...... 1,056 1 -- 3,656 -- -- 3,657
Issuance of common shares on conversion
of convertible note................. 359 1 -- 1,326 -- -- 1,327
Issuance of common shares under stock
purchase plan....................... 41 -- -- 359 -- -- 359
Warrants............................... -- -- 2,359 -- -- -- 2,359
Dividends and accretion on redeemable
convertible preferred stock......... -- -- -- -- (398) -- (398)
Net loss............................... -- -- -- -- (86,483) -- (86,483)
Foreign currency translation........... -- -- -- -- -- 84 84
------ -------- ------ -------- --------- ----- --------
Balance at March 31, 1997................ 23,807 $ 24 $5,359 $ 150,468 $(170,348) $ (14) $(14,511)
====== ======== ====== ======== ========= ===== ========
</TABLE>
See accompanying notes.
F-7
<PAGE> 10
UROHEALTH SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED NINE MONTHS ENDED YEAR ENDED
JUNE 30, MARCH 31, MARCH 31,
1995 1996 1997
---------- ----------------- ----------
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net loss................................................ $(24,837) $ (23,024) $(86,483)
Noncash items included in net loss:
Extraordinary item.................................... -- -- 2,433
Write-off of purchased research and development....... 5,312 -- 40,982
Depreciation and amortization......................... 3,090 1,715 5,272
Loss on retirement/write-off of assets................ 61 664 347
Deferred income taxes................................. 50 (152) --
Amortization of deferred debt issuance costs.......... -- 637 813
Provision for doubtful accounts....................... 134 1,126 (39)
Accretion and accrued interest on convertible notes... -- 15 445
Accrued dividends on preferred stock of subsidiary.... 78 55 25
Changes in operating assets and liabilities............. 3,252 2,070 (18,801)
-------- -------- --------
Net cash used in operating activities................... (12,860) (16,894) (55,006)
INVESTING ACTIVITIES
Purchases of investments................................ (4,363) (1,502) --
Sale of investments..................................... 10,433 2,282 243
Purchases of property and equipment, net................ (3,645) (3,033) (12,277)
Payments for acquisition of businesses, net of cash
acquired.............................................. -- -- (38,161)
Proceeds from disposal of property and equipment........ 5 788 --
Purchases of technology................................. (605) (333) (1,207)
Decrease in restricted cash............................. -- -- 48
Note receivable from related party...................... (60) -- --
Loans and advances to officers.......................... -- -- (664)
-------- -------- --------
Net cash provided by (used in) investing activities..... 1,765 (1,798) (52,018)
FINANCING ACTIVITIES
Issuance of common shares............................... 748 -- 359
Secondary offering of common stock...................... -- -- 18,817
Exercise of stock options and warrants.................. 16 709 1,436
Issuance of preferred stock by subsidiary............... 3,331 1,831 --
Issuance of equity securities by pooled company......... 4,149 4,149 --
Issuance of warrants.................................... -- 670 --
Proceeds from long-term debt............................ 1,888 7,913 110,184
Revolving lines of credit, net.......................... 256 5,433 1,977
Principal payments on long-term debt.................... (984) (868) (19,888)
Deferred debt issuance costs............................ -- (130) (6,615)
-------- -------- --------
Net cash provided by financing activities............... 9,404 19,707 106,270
-------- -------- --------
Net increase (decrease) in cash and equivalents......... (1,691) 1,015 (754)
Cash and equivalents, beginning of year................. 4,520 2,330 3,345
-------- -------- --------
Cash and equivalents, end of year....................... $ 2,829 $ 3,345 $ 2,591
======== ======== ========
</TABLE>
See accompanying notes.
F-8
<PAGE> 11
UROHEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. DESCRIPTION OF THE COMPANY AND BASIS OF FINANCIAL STATEMENT PRESENTATION
Description of the Company
Urohealth Systems, Inc. ("Urohealth" or the "Company") is engaged in the
manufacture, marketing and distribution of products used by surgeons, urologists
and gynecologists. The Company is focused on developing a broad range of
products specific to these three specialities using a direct sales and
distributor distribution channel.
Basis of Financial Statement Presentation
The accompanying consolidated financial statements include the accounts of
the Company and its subsidiaries, all of which are wholly owned except for
Urohealth, Inc. (California). All significant intercompany accounts and
transactions are eliminated in consolidation.
In 1996, the Company changed its fiscal year to March 31. Fiscal 1996 is a
nine month transition period ended March 31, 1996. During the nine month period
ended March 31, 1995, the Company's unaudited consolidated results of operations
included net sales of $34.5 million; gross profit of $22.0 million; net loss of
$19.3 million; and net loss per share of $1.39.
Financial information for 1995 and 1996 has been restated to reflect the
fiscal 1997 merger with Microsurge, Inc., which has been accounted for as a
pooling of interests. Additionally, certain amounts in the fiscal 1995 and 1996
consolidated financial statements have been reclassified to conform with the
fiscal 1997 presentation.
The minority interest in Urohealth, Inc. (California) at March 31, 1997
consists of 42,000 shares of its Series A preferred stock, which were redeemed
or exchanged for shares of common stock subsequent to March 31, 1997. The
redemption price was $6.41 per share, consisting of the redemption price of
$5.00 per share plus accrued and unpaid dividends and a $.20 per share
redemption premium.
Unaudited Pro Forma Financial Information
The unaudited pro forma balance sheet as of March 31, 1997 gives effect to
a private placement of $110 million of senior subordinated notes, which the
Company completed on April 10, 1997, as if such debt had been issued at March
31, 1997 and a portion of proceeds had been used to retire other outstanding
debt and to establish a restricted cash fund to be used solely for payment of
interest. (See Note 5).
Business Combinations
On March 31, 1997, the Company acquired all of the outstanding voting
securities of Microsurge, Inc. (Microsurge), a designer and manufacturer of
products for use in minimally invasive surgery, in a transaction accounted for
as a pooling of interests. Additionally, during the nine months ended March 31,
1996 the Company acquired four other companies in separate transactions
accounted for as pooling of interests. Dacomed Corporation (Dacomed), a
manufacturer of urological products, and Allstate Medical Products, Inc.
(Allstate), a manufacturer and distributor of disposable urinary incontinence
products, were acquired in July 1995. Osbon Medical Systems, Ltd. (Osbon), a
manufacturer of urological products, and Advanced Surgical, Inc. (Advanced), a
manufacturer and distributor of minimally invasive surgical products, were
acquired in December 1995. The accompanying consolidated financial statements
include the accounts of these entities for all periods presented. The following
number of shares of the Company's common stock were issued in the transactions:
Microsurge -- 2,771,366; Dacomed -- 1,610,367; Allstate -- 190,488; Osbon --
5,000,000; and Advanced -- 937,833.
F-9
<PAGE> 12
UROHEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
1. DESCRIPTION OF THE COMPANY AND BASIS OF FINANCIAL STATEMENT PRESENTATION
(CONTINUED)
The results of operations previously reported by the Company, including
Osbon, Advanced, Dacomed, and Allstate, and those of Microsurge included in the
accompanying consolidated financial statements are summarized below (in
thousands):
<TABLE>
<CAPTION>
NINE MONTHS
YEAR ENDED ENDED YEAR ENDED
JUNE 30, MARCH 31, MARCH 31,
1995 1996 1997
---------- ----------- ----------
<S> <C> <C> <C>
Net sales:
Osbon....................................... $ 25,767 $ 23,653 $
Advanced.................................... 2,231 1,223
Dacomed..................................... 9,300 8,017
Allstate.................................... 2,275 1,798
Urohealth................................... 5,880 4,950 83,679
-------------------------
As previously reported................... 45,453 39,641
Microsurge.................................. 3,797 3,312 7,584
Consolidation adjustment.................... -- -- (568)
-------- -------- --------
Combined................................. $ 49,250 $ 42,953 $ 90,695
======== ======== ========
Net income (loss):
Osbon....................................... $ 2,035 $ 530 $
Advanced.................................... (12,283) (2,408)
Dacomed..................................... (692) (1,310)
Allstate.................................... (42) (623)
Urohealth................................... (7,524) (14,185) (79,146)
-------------------------
As previously reported................... (18,506) (17,996)
Microsurge.................................. (6,331) (5,028) (7,337)
-------- -------- --------
Combined................................. $(24,837) $ (23,024) $(86,483)
======== ======== ========
</TABLE>
Prior to the March 31, 1997 merger, Microsurge prepared its financial
statements on the basis of a December 31 fiscal year end. The consolidated
results of operations for the year ended June 30, 1995, include the results of
operations of Microsurge for the year ended December 31, 1995. The reporting
periods for Microsurge's results of operations have been conformed to those of
the Company for the nine months ended March 31, 1996 and the fiscal year ended
March 31, 1997. Accordingly, net sales of approximately $2,155,000 and net loss
of $3,521,000 were included in the consolidated results of operations for both
the fiscal periods ended June 30, 1995 and March 31, 1996.
Prior to the December 1995 mergers, Osbon prepared its financial statements
on the basis of a September 30 fiscal year and Advanced on the basis of a
December 31 fiscal year. The consolidated results of operations for the year
ended June 30, 1995 includes the results of operations of Osbon for the year
ended September 30, 1995. Accordingly, net sales of approximately $6,809,000 and
net income of $373,000 were included in the consolidated results of operations
for both the fiscal periods ended June 30, 1995 and March 31, 1996. The
consolidated results of operations for the years ended June 30, 1994 and 1995
include the results of operations of Advanced for the year ended December 31,
1994 and for the year ended June 30, 1995, respectively. Accordingly, net sales
of approximately $1,111,000 and net loss of $10,154,000 for Advanced were
included in both the June 30, 1994 and 1995 consolidated results of operations.
Prior to the July 1995 mergers, Dacomed and Allstate prepared their
financial statements on the basis of an October 31 and December 31 fiscal
year-end, respectively. Net sales of approximately $3,500,000 and net
F-10
<PAGE> 13
UROHEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
1. DESCRIPTION OF THE COMPANY AND BASIS OF FINANCIAL STATEMENT PRESENTATION
(CONTINUED)
loss of $315,000 of Dacomed for the period from July 1, 1994 to October 31, 1994
were included in both the June 30, 1994 and 1995 consolidated results of
operations. Net sales of approximately $1,100,000 and net income of $74,000 of
Allstate for the period from July 1, 1994 to December 31, 1994 were included in
both the June 30, 1994 and 1995 consolidated results of operations.
No adjustments were required to be made to the net assets of the combining
enterprises to conform accounting practices and there was no effect on net
income previously reported.
During the year ended March 31, 1997, in transactions accounted for as
purchases, the Company acquired: Richard-Allan Medical Industries, Inc.
(Richard-Allan); X-Cardia Corporation (X-Cardia); The Intermed Group (Intermed);
certain assets from O.R. Concepts, Inc. (O.R. Concepts) and three other
immaterial businesses. Richard-Allan and the O.R. Concepts assets; are engaged
in the development, manufacture and marketing of surgical products and supplies;
X-Cardia is developing cardiac monitoring products; and Intermed develops,
manufactures and markets disposable medical products. The aggregate initial
purchase price for these entities, including direct acquisition costs, was $39.7
million in cash, $3.0 million in debt, and 3,622,000 shares of the Company's
common stock valued at $44.0 million. In allocating the total purchase price for
these acquisitions, it was determined that acquired in-process research and
development costs aggregating $37.0 million related to the Richard-Allan and
X-Cardia acquisitions should be immediately expensed and the balance of the
total purchase price for all of the transactions allocated to the fair value of
the net assets acquired, including $44.6 million which was assigned to goodwill
and relates to all transactions, except X-Cardia, that is being amortized over a
period of 25 years. Independent valuations were obtained in connection with the
Richard-Allan and X-Cardia acquisitions and were used as aids in the allocation
of the purchase price for these entities. The Company agreed to make additional
payments in connection with the X-Cardia acquisition of up to $21 million upon
achievement of clinical and patent approval milestones. There can be no
assurance that the milestones will be achieved. In addition, the Company is
obligated to pay a percentage of sales for a four-year period after commercial
introduction of the first product using the acquired X-Cardia technology.
These entities have been included in the Company's consolidated operating
results from their respective dates of acquisition. Unaudited pro forma
operating results assuming the acquisition of Richard-Allan had taken place as
of July 1, 1995 are as follows:
<TABLE>
<CAPTION>
NINE MONTHS
ENDED YEAR ENDED
MARCH 31, MARCH 31,
1996 1997
----------- ----------
<S> <C> <C>
Net sales........................................... $ 58,658 $ 99,122
Loss before extraordinary item...................... (26,444) (88,045)
Net loss............................................ (26,444) (91,018)
Net loss per share.................................. (1.58) (4.52)
</TABLE>
The unaudited pro forma results including the other business acquisitions
accounted for as purchases do not differ materially from those presented above.
Additionally, during the year ended March 31, 1997, the Company purchased
five in-process research and development projects that did not constitute
businesses, and expensed the aggregate purchase price of $10.2 million as
acquired in-process research and development costs.
Prior year business combinations accounted for as purchases include
Laparomed Corporation, which was acquired by Advanced on July 27, 1994 in
exchange for 236,000 shares of the Advanced common stock and Urohealth of
Kentucky, Inc., which was acquired by the Company on March 17, 1995 in exchange
for 25,000 shares of the Company's common stock and assumption of debt
aggregating $137,000. The pro forma
F-11
<PAGE> 14
UROHEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
1. DESCRIPTION OF THE COMPANY AND BASIS OF FINANCIAL STATEMENT PRESENTATION
(CONTINUED)
effect of these acquisitions is immaterial. The consolidated results of
operations for the fiscal year ended June 30, 1995, included approximately
$1,665,000 of expenses related to the relocation of Laparomed's operations and
employee termination costs.
Liquidity Requirements
During the year ended March 31, 1997, the Company relied primarily upon a
net increase in borrowings of $92 million and net proceeds of $19 million from
the sale of its common stock to finance its fiscal 1997 operating cash
requirements of $55 million and cash expenditures aggregating $52 million in
fiscal 1997 in connection with capital improvements and business and technology
acquisitions. In addition, in April 1997 the Company completed a $110 million
offering of its 12 1/2% Senior Subordinated Notes and entered into an amended
and restated $50 million revolving credit facility. As a result, the Company is
highly leveraged with approximately $172 million of debt outstanding at March
31, 1997 after giving effect to issuance of the Senior Subordinated Notes and
the simultaneous repayment of all amounts outstanding under its revolving credit
agreement as well as certain other debt items. While the Company believes it has
adequate sources of liquidity to finance its operations for the next 12 months,
such sources primarily consist of: available cash balances; borrowings under the
April 1997 revolving credit agreement; and funds generated from operations.
However, through June 30, 1997 the Company has continued to experience negative
cash flows from operations, and it will be necessary for the Company to improve
its operating results to generate cash from operations and qualify for
borrowings under the April 1997 revolving credit agreement's financial covenant
requirements. Additionally, the Company's business strategy includes efforts to
expand its business through the acquisition of new products, product lines and
businesses. Therefore, the Company may need to obtain additional capital from
other debt or equity financing transactions. No assurance can be given that
additional financing will be available or that, if available, such financing
will be obtainable on terms favorable to the Company. In such event, the Company
may be required to restructure its operations and/or proceed with its planned
expansion at a slower rate.
2. SIGNIFICANT ACCOUNTING POLICIES
Revenue Recognition
Revenue from sales of manufactured products is generally recognized upon
the dates of shipment to customers. Revenue from sales of certain introductory
products containing return privileges where the amount of future returns cannot
be reasonably estimated is recognized upon acceptance by the customer after date
of shipment. With respect to certain distributor initial stocking orders shipped
during 1997 to new distributors, the Company will recognize revenue on those
orders upon establishment of a sales and payment history by those distributors,
thereby establishing that collection of the sales price is reasonably assured.
The Company grants its distributors limited stock balancing rights whereby
inventory previously purchased may be returned for credit against purchases of
other Company products. It also generally provides the ultimate customers for
its products with a right to return products they find unsatisfactory within 30
days after purchase. Sales revenue and cost of sales reported in the
consolidated statements of operations are net of estimated provisions,
determined based on experience, for costs or losses that may be incurred in
connection with sales returns.
Cash and Equivalents
Cash and equivalents include time deposits, certificates of deposit and
other marketable securities with original maturities of three months or less.
F-12
<PAGE> 15
UROHEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Investments
All investments have been classified as available-for-sale, and are carried
at amortized cost which approximates fair value. At March 31, 1996, investments
consisted of corporate bonds and certificates of deposits which matured not more
than one month after the balance sheet date.
Property and Equipment
Property and equipment are recorded at cost, less accumulated depreciation
and amortization. Maintenance and repairs are charged to expense as incurred,
and renewals and betterments are capitalized. Depreciation and amortization are
provided on the straight line method over the assets estimated useful lives.
Estimated useful lives range from five to seven years for office equipment, five
to ten years for equipment and tooling, ten years for molds and three to five
years for vehicles. For leasehold improvements, the useful life is determined to
be the original term of the lease.
Patents, Intangibles and Goodwill
Intangible assets consisting of patents, trademarks and goodwill are
amortized on a straight-line basis over various periods up to twenty-five years.
Intangible assets are reviewed if the facts and circumstances suggest that they
may be impaired. An intangible asset is deemed to be impaired when the
unamortized balance exceeds the undiscounted estimated future cash flows from
the related assets.
Asset Impairment
Following adoption of Statement of Financial Accounting Standards No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long Lived Assets to
be Disposed Of" by the Company in the first quarter of fiscal 1996, the Company
tests for and records 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 assets' carrying amount.
Asset impairment is recognized on long-lived assets held for sale when the
estimated fair value less costs to sell is less than the assets carrying amount.
As a result of the Company's decision to deemphasize its participation in
incontinence clinics, the Company recorded in the fourth quarter of fiscal 1997
a $347,000 charge relating to the impairment of the goodwill recorded on the
acquisition of Urohealth of Kentucky.
Advertising Expense
Advertising and promotion costs are expensed when incurred. Such costs in
fiscal 1995, 1996 and 1997 were $1,261,000, $895,000 and $1,612,000,
respectively.
Research and Development Expense
Research and development expenses are charged to operations as incurred.
Warranty and Product Liability Costs
Estimated warranty costs, insurance deductible amounts associated with
product liability claims, and an amount for incurred but not reported product
liability incidents are accrued in the period revenue is recognized from the
sale of products. Actual costs are charged against the accrual when paid.
F-13
<PAGE> 16
UROHEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Per Share Information
Net loss per share is based on net loss attributable to common stockholders
and the weighted average number of shares of common stock outstanding during the
periods presented. Common stock equivalents and other potentially dilutive
securities have not been included in the calculation as they are anti-dilutive.
Recent Accounting Pronouncements
In February 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 128, "Earnings per Share" (SFAS 128). SFAS
128 redefines the standards for computing earnings per share and is effective
for the Company on March 31, 1998. The Company has not yet determined the impact
that the adoption of SFAS No. 128 will have on future earnings per share
calculations.
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. Such estimates primarily relate to the collectibility of
accounts receivable, inventory obsolescence and estimates of future cash flows
used to evaluate whether conditions are present that would require asset
impairment charges to be recognized. Actual results could differ from those
estimates.
3. PROPERTY AND EQUIPMENT
Property and equipment consists of the following (in thousands):
<TABLE>
<CAPTION>
MARCH MARCH
31, 31,
1996 1997
-------- --------
<S> <C> <C>
Office equipment........................................ $ 4,574 $10,887
Equipment and tooling................................... 5,504 15,229
Molds................................................... 2,177 1,336
Leasehold improvements.................................. 1,223 2,204
Building................................................ 1,718 6,179
Land.................................................... 247 334
Other................................................... 962 665
------- -------
16,405 36,834
Accumulated depreciation................................ 7,321 10,799
------- -------
$ 9,084 $26,035
======= =======
Equipment recorded under capital leases included
above................................................. $ 1,434 $ 1,475
Accumulated depreciation................................ 639 937
------- -------
$ 795 $ 538
======= =======
</TABLE>
F-14
<PAGE> 17
UROHEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
4. INVENTORIES
Inventories are carried at the lower of cost, determined on the first-in,
first-out basis, or market and consist of the following (in thousands):
<TABLE>
<CAPTION>
MARCH MARCH
31, 31,
1996 1997
-------- --------
<S> <C> <C>
Raw materials and supplies.............................. $ 2,339 $ 8,731
Work in progress........................................ 395 2,942
Finished goods.......................................... 3,968 9,272
------- -------
$ 6,702 $20,945
======= =======
Distributor inventories................................. $ -- $ 6,307
======= =======
</TABLE>
Distributor inventories are comprised of initial stocking orders shipped
during fiscal 1997 to new distributors for which revenue recognition has been
deferred. (See Note 2 -- Revenue Recognition.)
5. DEBT
Short-term debt
Short-term debt consists of the following (dollars in thousands):
<TABLE>
<CAPTION>
MARCH 31, MARCH 31,
1996 1997
--------- ---------
<S> <C> <C>
Line of credit under Credit Agreement, interest at 9.75%....... $ -- $ 9,250
Line of credit under Credit Agreement, repaid in May 1996...... 5,500 --
Convertible subordinated notes at 9.25%, due August 1997....... 2,276 5,268
Line of credit with a bank, repaid in May 1996................. 1,623 --
Line of credit with a bank, repaid October 1996................ 150 --
------ -------
$ 9,549 $14,518
====== =======
</TABLE>
To finance the cash portion of the Richard-Allan acquisition, the Company
obtained a $35.0 million bank credit facility. The facility originally consisted
of a $20.0 million dollar term loan and a $15.0 million revolving line of
credit, which was subsequently increased to $16.5 million in November 1996. A
portion of the proceeds from the public equity offering in November 1996 were
used to reduce the term loan by $6.5 million. The credit facility is secured by
substantially all the assets of the Company has a five-year term and bears
interest at a rate of approximately 9.75% at March 31, 1997. Additionally, the
Company is required to meet certain financial covenants. In March 1997, the
Company's term and revolving credit facility was amended to provide for maximum
borrowings of $55.0 million, consisting of $45.8 million of term loans and $9.2
million of revolving loans. As of March 31, 1997, the Company had outstanding
borrowings of $54.3 million under this facility.
In February 1996, Microsurge entered into a credit agreement with a group
of lenders ("Purchasers") who agreed to purchase a series of convertible
subordinated notes ("the Notes") up to $3,268,180 upon the request of the
Company. In August 1996, the agreement was amended to provide for total advances
of $5,268,180. The Company received advances of $2,334,414 in February and March
1996, $933,766 in June 1996 and $2,000,000 in August 1996. The Notes bear
interest at 9.25% and mature on August 28, 1997. The Company may prepay amounts
outstanding on the Notes without penalty at any time after an Investor Sale (as
defined below) and prior to maturity date. Upon the closing, or series of
closings, in which Microsurge sells capital stock of Microsurge for gross
proceeds of $10,000,000 or more (an "Investor Sale"), the Notes will become
convertible, at the option of the Purchasers, into the same type and class of
stock issued in connection with the Investor Sale. Any outstanding principal
amount of the Notes plus accrued interest may convert at a conversion price
equal to 60% of the price per share paid by the purchasers of capital stock in
F-15
<PAGE> 18
UROHEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
5. DEBT (CONTINUED)
connection with the Investor Sale (the "Investor Sale Price"). The Company has
no plans to undertake any action that would constitute an Investor Sale and
expects to retire the notes for cash at maturity.
On November 22, 1995, the Company entered into a $10.0 million Credit
Agreement consisting initially of a $6.0 million term loan and a $4.0 million
revolving line of credit. The revolving line of credit under the Credit
Agreement was increased to $5.5 million in March 1996 and to $10.5 million in
April 1996. Interest on all borrowings under the Credit Agreement was at the
bank's prime rate plus 4.0% (plus 2.0% in the event of default). The Credit
Agreement was repaid with proceeds from the sale of convertible subordinated
debentures in May 1996. In connection with this repayment, the Company incurred
an extraordinary loss of $2.9 million resulting from the early repayment of this
debt.
In connection with the initial borrowings under the Credit Agreement, the
Company granted a warrant to purchase 366,667 shares of the Company's common
stock at $9.15 per share. The warrant expires on November 22, 2000. In
connection with subsequent increases of amounts available under the line of
credit and significant covenant modifications, the Company granted a warrant to
purchase 350,000 shares of the Company's common stock at $9.15 per share. The
warrant expires on April 12, 2001.
On April 10, 1997, the Company used proceeds from the sale of the Senior
Subordinated Notes (see below) to repay all amounts outstanding under the
Company's term and revolving credit facility. Concurrently with the repayment of
the existing credit facility, the Company entered into an amended and restated
$50 million revolving credit facility with its senior lender. The new credit
facility is secured by substantially all of the Company's assets and contains
the same basic covenants as in the prior facility.
F-16
<PAGE> 19
UROHEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
5. DEBT (CONTINUED)
Long-term debt
Long-term debt consist of the following (dollars in thousands):
<TABLE>
<CAPTION>
MARCH 31, MARCH 31,
1996 1997
--------- ---------
<S> <C> <C>
Convertible subordinated debentures............................ $ -- $ 50,000
Term loan under Credit Agreement, repaid April 10, 1997........ -- 45,000
Term loan under Credit Agreement, repaid May 13, 1996.......... 6,000 --
Bank note, interest at 8.75%, repaid in April 1996............. 326 --
Bank note, interest at 8.75%, repaid in April 1996............. 221 --
Bank note dated December 21, 1992, due in 180 monthly
installments with interest at 8.75% collateralized by a
building..................................................... 175 167
Bank note dated August 15, 1996, interest at 8.25%. Note is
collateralized by a building and matures on August 15, 2006.
The entire balance is due on maturity........................ -- 3,000
Bank note dated August 15, 1996, interest at 6.25%. Note
matures on April 17, 1997. The entire balance is due on
maturity..................................................... -- 3,000
Bank note dated April 29, 1994, due in 36 monthly installments
with interest at 8.75%; collateralized by equipment.......... 41 14
Bank note dated February 11, 1994, repaid May 1996............. 29 --
Various notes payable with interest from 8.5% to 10%, due dates
through August 1, 1997, secured by equipment................. 19 40
Convertible subordinated notes................................. 1,284 --
Capital leases................................................. 723 399
------ --------
8,818 101,620
Less current maturities........................................ 546 3,328
------ --------
$ 8,272 $ 98,292
====== ========
</TABLE>
On May 3, 1996, the Company authorized the issuance of $50.0 million of
8.75% convertible subordinated debentures (the "Debentures") and warrants to
purchase 250,000 shares of the Company's common stock at $12.88 per warrant,
subject to anti-dilution adjustments. The Debentures are convertible at any time
and are subject to certain registration rights. The Debentures mature in May
2006 and interest is payable quarterly in arrears. The warrants expire in five
years. The Debentures are redeemable at the option of the Company after two
years, if the average market price of the Company's common stock is above $22.00
for 60 consecutive days, or after three years without regard to the Company's
common stock price. The redemption price is equal to 105% of the principal
amount decreasing annually to the principal amount in 2004, plus accrued and
unpaid interest. The Debentures are convertible into common stock at $10.90 per
share, subject to further anti-dilution adjustments, are subordinate to all
future senior borrowings and will have voting rights on all matters on an "as
converted" basis. The holders of the Debentures must approve any dividend,
payment or other distribution to stockholders, as well as any redemption of
shares of common stock, options or warrants of the Company or any subsidiary
other than the preferred stock issued by Urohealth (California).
The Company has various capital equipment leases with future minimum lease
payments for years ending March 31, 1998, 1999, 2000, and 2001 of $301,000;
$102,000; $43,000; and $2,000, respectively. Pursuant to a capital lease
agreement entered into during 1993 and as amended in 1994, the Company
maintained $96,000 and $48,000 in restricted cash at March 31, 1996 and 1997.
F-17
<PAGE> 20
UROHEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
5. DEBT (CONTINUED)
Senior Subordinated Notes
On April 10, 1997, the Company completed the sale of $110 million of its
12 1/2% Senior Subordinated Notes due 2004 (the "Notes") raising net proceeds of
approximately $105 million. The Notes bear interest, payable semi-annually, at
12 1/2% per annum, subject to increase if certain obligations are not satisfied,
and mature on April 1, 2004. There are no mandatory redemption or sinking fund
payments required on the Notes. The Company is entitled to redeem the Notes on
or after April 1, 2001 for an amount equal to the principal amount of the Note,
accrued but unpaid interest through the redemption date, the redemption premium
and liquidated damages, if any. In the event of a Change of Control (as defined
in the Indenture), each holder of a Note is entitled to require the Company to
purchase such holder's Notes at 101% of the principal amount of the Notes, plus
accrued but unpaid interest to the date of repurchase and liquidated damages, if
any.
The Notes are general unsecured obligations of the Company subordinated in
right of payment to all existing and future senior indebtedness of the Company.
The Indenture governing the Notes contains certain covenants, including among
other matters limitations on the ability of the Company to: (i) incur additional
indebtedness; (ii) incur certain liens; (iii) engage in certain transactions
with affiliates; (iv) engage in unrelated lines of business; or (v) engage in
mergers, consolidations or similar transactions. The Company used $19.2 million
of the proceeds from the sales of the Notes to purchase government securities
(the "Pledged Securities") which that have been pledged for the benefit of the
holders of the Notes. The scheduled interest and principal payments on the
Pledged Securities is in an amount sufficient to pay when due the first three
scheduled interest payments on the Notes.
The Company is a holding company with no material assets or operations
other than its investments in its subsidiaries. The Notes are guaranteed by all
of the Company's domestic and material foreign subsidiaries. The guarantees are
full, unconditional, and joint and several. All of the guarantor subsidiaries
are wholly-owned by the Company. Assets, equity, income and cash flows of all
other subsidiaries of the Company that have not guaranteed the Notes are less
than two percent of the respective consolidated amounts and are inconsequential,
individually and in the aggregate to the Company. The Company has not included
separate financial information for the guarantors, since the Company believes
that such information is not material to investors.
In connection with the issuance of the Notes, the Company issued with each
$1,000 principal amount of Notes, a warrant entitling the holder to purchase
4.44 shares of Common Stock of the Company (or 9.06 shares, if a certain level
of EBITDA for fiscal 1998 is not achieved) at an exercise price of $9.50 per
share. The warrants are exercisable on or after June 30, 1998 and expire April
1, 2004.
Debt Maturities
The contractual maturities of all debt securities of the Company at March
31, 1997 and on a pro forma basis to reflect the sale of the Notes and the
repayment of the term and revolving credit facility with a portion of the
proceeds after March 31, 1997 are as follows (in thousands):
<TABLE>
<CAPTION>
YEAR ENDING MARCH 31, PRO FORMA
------------------------------------------------------------- ---------
<S> <C> <C>
1998.................................................... $ 17,846 $ 8,596
1999.................................................... 4,612 112
2000.................................................... 5,554 54
2001.................................................... 6,014 14
2002.................................................... 6,513 13
Thereafter.............................................. 75,599 163,099
-------- ---------
Total.............................................. $116,138 $ 171,888
======== ========
</TABLE>
F-18
<PAGE> 21
UROHEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
6. RESTRUCTURING CHARGES
During the year ended June 30, 1995, the Company hired a new senior
management team which adopted and implemented a restructuring plan under which
it has refocused the Company's strategic direction. Under the plan, the Company
terminated or amended certain distribution, consulting and employment
agreements. Accordingly, the consolidated statement of operations reflects a
charge of $1,200,000 to terminate or restructure these agreements under the
plan. The components of the restructuring charges include a provision to
discontinue the distribution of the Adzorbstar(TM) product line of $360,000,
termination agreements which include indemnification costs of former employees
for legal fees associated with an SEC investigation of $250,000, termination of
certain other consulting and distributor agreements of $50,000, and the
amendment and settlement of certain claims under the employment agreement with
the former Chief Executive Officer of $540,000. All significant restructuring
charges were paid in cash during the 1995 calendar year. Through March 31, 1997,
cash payments have reduced the balance of this restructuring accrual to $49,000,
which primarily relates to the settlement of certain claims with the former
Chief Executive Officer.
In December 1995, the Company implemented a restructuring plan to
consolidate redundant facilities and reduce personnel resulting from the mergers
with Dacomed Corporation, Osbon Medical Systems, Ltd. and Advanced Surgical,
Inc. Under the plan the Company has eliminated approximately 70 manufacturing,
engineering and administrative personnel and closed all operations at two
acquired facilities. The estimated cost associated with each component of this
restructuring plan and the cash and non-cash charges incurred through March 31,
1997 are summarized in the table below. Non-cash charges consist of the
write-down of existing assets to their estimated net realizable value.
Reclassifications during the period relate to decreases in severance amounts
payable to officers of acquired companies, offset by increases in estimates for
facility closure costs including loss on sale of discontinued product lines and
closure costs related to international operations of acquired companies. The
remaining restructuring accrual at March 31, 1997 relates primarily to facility
lease obligations, which are expected to be paid in cash.
<TABLE>
<CAPTION>
BEGINNING BALANCE AT
RESTRUCTURING NON-CASH CASH RECLASSI- MARCH 31,
ACCRUAL CHARGES CHARGES FICATIONS 1997
------------- -------- ------- --------- ----------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Personnel reduction costs............. $ 2,620 $ -- $1,822 $ (730) $ 68
Facility reduction costs.............. 2,836 1,199 1,822 730 545
------ ------ ------ ----- ----
$ 5,456 $1,199 $3,644 $ -- $ 613
====== ====== ====== ===== ====
</TABLE>
In September 1996, the Company established a restructuring plan to
eliminate redundant manufacturing facilities resulting from the Richard-Allan,
Intermed and O.R. Concepts acquisitions and their consolidation with some of the
existing manufacturing locations. This restructuring is expected to be completed
within one year except for redundant facility, lease costs and payments under
certain severance agreements that may continue over their terms. The Company has
provided a restructuring charge of $4.0 million, of which all are cash
expenditures. This restructuring includes severance costs for approximately 18
employees, certain facility closures and elimination of other redundant selling
and administrative costs.
<TABLE>
<CAPTION>
BEGINNING BALANCE AT
RESTRUCTURING NON-CASH CASH MARCH 31,
ACCRUAL CHARGES CHARGES 1997
------------- -------- ------- ----------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Personnel reduction costs................... $ 2,412 $ -- $ 990 $1,422
Facility reduction costs.................... 1,588 -- 263 1,325
------ ------ ------ ------
$ 4,000 $ -- $1,253 $2,747
====== ====== ====== ======
</TABLE>
In March 1997, the Company implemented a restructuring plan to consolidate
redundant facilities and reduce personnel resulting from the mergers with Osbon
and Microsurge. The plan provides for the elimination of approximately 90
personnel and the closure of all operations at Osbon except for customer
service, sales and a limited accounting support staff, and the closure of all
Microsurge facilities. The estimated
F-19
<PAGE> 22
UROHEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
6. RESTRUCTURING CHARGES (CONTINUED)
cost associated with each component of this restructuring plan and the cash and
non-cash charges incurred through March 31, 1997 are summarized in the table
below. Non-cash charges consist of the write-down of existing assets to their
estimated net realizable value.
<TABLE>
<CAPTION>
BEGINNING BALANCE AT
RESTRUCTURING NON-CASH CASH MARCH 31,
ACCRUAL CHARGES CHARGES 1997
------------- -------- ------- ----------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Personnel reduction costs...................... $ 7,067 $ -- $3,879 $3,188
Facility reduction costs....................... 933 473 43 417
------ ------ ------ ------
$ 8,000 $ 473 $3,922 $3,605
====== ====== ====== ======
</TABLE>
Although subject to future adjustment, management of the Company believes
that restructuring liabilities as of March 31, 1997 are adequate to complete the
actions contemplated by the restructuring plans.
7. COMMITMENTS AND CONTINGENCIES
Dacomed is a defendant in approximately five lawsuits seeking damages
against Dacomed in products liability and related theories. Dacomed has also
been notified of certain other products liability claims that may become the
subject of lawsuits in the future. Dacomed is being defended in such lawsuits by
law firms selected by Dacomed's products liability insurer(s). In addition, the
Company is involved from time to time in various claims and legal actions in the
ordinary course of business. No provision for any liability that may result from
the ultimate resolution of such matters has been included in the accompanying
consolidated financial statements.
The Company has various operating lease agreements for office and
production facilities. Minimum future lease payments for years ending March 31,
1998, 1999, 2000, 2001, 2002 and thereafter are $1,200,000, $1,210,000,
$705,000, $439,000, $210,000 and $368,000 respectively. In addition, the Company
is required to pay maintenance and property taxes attributable to the
facilities. Rent expense under all operating leases was approximately
$1,408,000, $859,000, and $1,237,000 in 1995, 1996 and 1997, respectively.
The Company has employment agreements with 9 officers providing for annual
aggregate salaries of approximately $2.2 million per annum.
The Company has various product licensing arrangements which require the
payment of certain of the licensor's patent costs and royalties on sales of
products which incorporate the licensed technology.
8. CAPITAL STOCK
Each outstanding share of the Company's common stock carries a stock
purchase right. Under certain circumstances, each right may be exercised to
purchase one-hundredth of a share of the Company's Series B Preferred Stock for
$200. Under certain circumstances, following the acquisition of 20% or more of
the Company's outstanding common stock by an acquiring person, as defined in the
Preferred Share Purchase Rights Plan, each right (other than rights held by an
acquiring person) may be exercised to purchase common stock of the Company or a
successor company with a market value of twice the $200 exercise price. The
rights, which are redeemable by the Company at $.01 per right, expire June 30,
2003.
At March 31, 1997, the Company had reserved 12,313,142 shares of authorized
common stock, subject to increase under anti-dilution provisions, pursuant to
outstanding stock options and warrants and for conversion of debt and the
preferred stock of Urohealth (California).
F-20
<PAGE> 23
UROHEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
8. CAPITAL STOCK (CONTINUED)
Subsequent to March 31, 1997, the Board of Directors approved an increase
in the number of common shares authorized to be issued from 50 million shares to
100 million shares, which increase is subject to stockholder approval.
9. STOCK OPTIONS AND WARRANTS
The Company has outstanding, under various stock option plans, options
granted to current and former employees, management personnel and directors for
up to 5,123,376 shares of the Company's common stock. Additionally, in
connection with the acquisitions of Dacomed, Advanced, X-Cardia and Microsurge,
the Company assumed the obligations of those corporations to their employees and
consultants with respect to 129,449 stock options granted under the respective
plans and currently outstanding. Options granted generally have five to ten-year
terms and generally vest and become exercisable over periods of one to five
years.
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 for under FASB
Statement No. 123, "Accounting for Stock-Based Compensation," requires use of
option valuation models that were not developed for use in valuing employee
stock options. Under APB 25, because 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.
Pro forma information regarding net income and earnings per share is
required by Statement 123, which also requires that the information be
determined as if the Company has accounted for its employee stock options
granted subsequent to June 30, 1995 under the fair value method of that
Statement. The fair value for these options was estimated at the date of grant
using a Black-Scholes option pricing model with the following weighted average
assumptions for fiscal 1996 and 1997, respectively: risk-free interest rates of
5.6% and 6.6%; no dividend yield; volatility factors of the expected market
price of the Company's common stock of 63% and 57%; and a weighted-average
expected life of the option of 6 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 including the expected stock price
volatility. 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 options' vesting period. The Company's
pro forma information follows (in thousands except for earnings per share
information):
<TABLE>
<CAPTION>
1996 1997
-------- --------
<S> <C> <C>
Pro forma net loss..................................... $(24,554) $(93,325)
Pro forma net loss per share........................... $ (1.68) $ (4.82)
</TABLE>
Because Statement 123 is applicable only to options granted subsequent to
June 30, 1995, its pro forma effect will not be fully reflected until fiscal
2000.
F-21
<PAGE> 24
UROHEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
9. STOCK OPTIONS AND WARRANTS (CONTINUED)
A summary of the Company's stock option activity, and related information
for the years ended June 30, 1995, March 31, 1996 and March 31, 1997 follows:
<TABLE>
<CAPTION>
1995 1996 1997
------------------------ ------------------------ ------------------------
WEIGHTED- WEIGHTED- WEIGHTED-
OPTIONS AVERAGE OPTIONS AVERAGE OPTIONS AVERAGE
(000) EXERCISE PRICE (000) EXERCISE PRICE (000) EXERCISE PRICE
------- -------------- ------- -------------- ------- --------------
<S> <C> <C> <C> <C> <C> <C>
Outstanding -- beginning of year... 464 $14.87 1,532 $10.23 4,017 $10.66
Granted............................ 1,143 9.43 2,684 8.51 1,758 7.63
Assumed in acquisitions............ -- -- -- -- 52 2.22
Exercised.......................... (31) 9.43 (160) 5.20 (327) 5.20
Forfeited.......................... (44) 9.01 (39) 9.62 (246) 8.61
------- ------- ------- ------- ------- -------
Outstanding end of year............ 1,532 $10.23 4,017 $10.66 5,254 $ 9.97
Exercisable at end of year......... -- -- 975 $ 9.14 2,557 $ 9.74
Weighted-average fair value of
options granted during year...... $ 5.35 $ 7.74
</TABLE>
Exercise prices for options outstanding as of March 31, 1997 ranged from
$1.86 to $54.50. The weighted average remaining contractual life of those
options is 7.09 years.
Additionally, at March 31, 1997, the Company has non-employee stock options
and warrants for 2,458,986 shares of common stock outstanding with exercise
prices ranging from $3.81 to $58.48 per share, of which options and warrants for
2,449,186 are currently exercisable. These options and warrants were assigned
values at issuance generally using a Black-Scholes option pricing model and
expire at various dates through May 2005. The outstanding non-employee options
and warrants are exercisable for the following per share prices: less than $5
per share -- 0; $5 to $10 per share -- 2,034,167; $10 to $20 per
share -- 408,909; and the remainder have exercise prices in excess of $20 per
share. In March 1997 approximately 1,321,991 warrants issued in connection with
various securities offerings expired unexercised.
10. SETTLEMENT OF LITIGATION
Class action litigation which has been settled, was filed against the
Company and its former management in November 1992, in the United States
District Court in Los Angeles, California alleging federal securities law
claims. The Company negotiated a settlement that was approved by the court in
March, 1995. Under the terms of the settlement, the Company issued to the
stockholder class 260,163 warrants to purchase Common Stock identical to the
Company's then outstanding publicly traded warrants at an exercise price of
$15.00 per share. The warrants expired on March 20, 1997. The Company's
insurance carrier made a cash payment to the stockholder class in the amount of
$2.4 million. The settlement included a release of class claims.
The Securities and Exchange Commission (the "Commission") also instituted
an investigation relating to the above matters. The Commission approved a
settlement under which the Company neither admits nor denies the findings of the
Commission and under which the Company is the subject of a cease and desist
order. There were no monetary sanctions sought against the Company as a part of
the settlement.
The Company required Advanced as part of the merger agreement to resolve a
class action complaint filed in the United States District Court for the
Southern District of New York which names Advanced as one of the defendants in
the class action lawsuit titled "In re Blech Securities Litigation." In
September 1995, Advanced and the plaintiffs in the litigation, through their
attorneys, reached an agreement in principle for the settlement of the class
action with respect to Advanced, the terms of which are set forth in a
Stipulation of
F-22
<PAGE> 25
UROHEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
10. SETTLEMENT OF LITIGATION (CONTINUED)
Settlement between such parties (the "Stipulation of Settlement"). Pursuant to
the terms of the Stipulation of Settlement, Advanced paid $300,000 in settlement
of such lawsuit.
11. INCOME TAXES
Deferred income taxes reflect the net effects of temporary differences
between the carrying amount of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components of
the Company's deferred tax assets and liabilities are as follows:
<TABLE>
<CAPTION>
MARCH 31, MARCH 31,
1996 1997
--------- ---------
(IN THOUSANDS)
<S> <C> <C>
Deferred tax assets:
Federal, state and foreign net operating loss
carryovers........................................ $ 25,838 $ 35,826
Restructuring and merger costs....................... 2,875 1,305
Tax credit carryovers................................ 1,394 1,656
Accrued compensation................................. -- 2,179
Inventory reserve.................................... 805 1,754
Allowance for doubtful accounts...................... 645 1,134
Other................................................ 788 1,475
Valuation allowance.................................. (31,115) (43,698)
-------- --------
Total deferred tax assets, net............... 1,230 1,631
Deferred tax liabilities:
Book basis of fixed assets in excess of tax basis.... 270 78
State taxes.......................................... 960 1,553
-------- --------
Total deferred tax liabilities............... 1,230 1,631
-------- --------
Total........................................ $ -- $ --
======== ========
</TABLE>
The Company increased its valuation allowance during the period ended March
31, 1997 by $12,583,000 due to uncertainties as to the ultimate realization of
the Company's deferred tax assets. Certain reductions in the valuation allowance
totaling approximately $1,078,000 will be credited to additional paid-in
capital.
The components of the provision (benefit) for income taxes are as follows:
<TABLE>
<CAPTION>
JUNE 30, MARCH 31, MARCH 31,
1995 1996 1997
-------- --------- ---------
(IN THOUSANDS)
<S> <C> <C> <C>
Current:
Federal..................................... $1,199 $ 420 $(262)
Foreign..................................... -- 14 --
State....................................... 137 149 35
------ ----- -----
Total current....................... 1,336 583 (227)
Deferred:
Federal..................................... 42 (128) --
Foreign..................................... -- -- --
State....................................... 8 (24)
------ ----- -----
Total deferred...................... 50 (152) --
------ ----- -----
Provision for income taxes.................... $1,386 $ 431 $(227)
====== ===== =====
</TABLE>
F-23
<PAGE> 26
UROHEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
11. INCOME TAXES (CONTINUED)
The provision for income taxes at the Company's effective tax rate differed
from the provision for income taxes at the statutory rate as follows:
<TABLE>
<CAPTION>
JUNE 30, MARCH 31, MARCH 31,
1995 1996 1997
-------- --------- ---------
(IN THOUSANDS)
<S> <C> <C> <C>
Tax benefit at the expected statutory rate... $ (7,713) $(7,662) $ (29,339)
Increases (decreases) in taxes resulting
from:
Non-deductible goodwill.................... 286 -- 16,150
Valuation allowance........................ 8,639 6,917 10,839
Reverse foreign net operating loss not
previously benefited.................... -- 1,994 --
State income taxes, net.................... 137 69 593
Other...................................... 37 188 1,530
Establishment of deferred tax assets not
previously benefited.................... -- (1,075) --
------- ------- --------
Provision for income taxes................. $ 1,386 $ 431 $ (227)
======= ======= ========
</TABLE>
The utilization of net operating loss carryovers (NOL's) of the Company is
limited by change in ownership rules under section 382 of the Internal Revenue
Code of 1986. Accordingly, the annual utilization of the Company's NOL's is
limited to a prescribed annual amount equal to 5.75% multiplied by the fair
market value of the Company as of December 29, 1995. The issuance of stock at
March 31, 1997 in connection with the Company's merger with Microsurge caused an
ownership change which may further limit the Company's annual utilization of a
portion of its NOL's. However, the Company does not believe this limitation will
exceed the previous limitation resulting from the December 29, 1995 change in
ownership. Additionally, certain losses and credits of each individual
subsidiary which arose prior to its merger with the Company can only be used
against that subsidiary's future taxable income.
At March 31, 1997, the Company had NOL's for U.S. federal and state income
tax purposes of approximately $92,000,000 and $68,000,000, respectively, and
general business credit carryovers of approximately $1,000,000 and $650,000,
respectively. These NOL's and general business credits are available to offset
future taxable income, if any, through the year 2012 and are subject to
limitations as well as separate return limitations for the subsidiaries
Urohealth (California), Advanced, Laparomed and Microsurge, as described below.
Urohealth (California) has a June 30 tax year end. At March 31, 1997,
Urohealth (California) had federal and state NOL's of approximately $30,000,000
and $20,000,000, respectively, and general business credit carryovers of
approximately $200,000 and $250,000, respectively, reflecting the tax return
filings through June 30, 1996.
Advanced had a December 31 tax year end prior to its merger with the
Company. As of December 29, 1995, Advanced has federal and state NOL's of
approximately $25,000,000 and $21,000,000, respectively and research and
experimental credit carryovers of approximately $600,000. Advanced's
wholly-owned subsidiary, Laparomed, has federal and state NOL's (of
approximately $7,000,000 and $3,000,000, respectively) and research and
experimental credits (of approximately $172,000) included in the amounts above.
There is a strong likelihood that a portion of these attributes will expire
before utilization.
Microsurge had a December 31 tax year end prior to its merger with the
Company on March 31, 1997. As of March 31, 1997, Microsurge has federal and
state NOL's of approximately $23,000,000 and $16,000,000, respectively and
general business credit carryovers of approximately $200,000 and $174,000,
respectively.
F-24
<PAGE> 27
UROHEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
11. INCOME TAXES (CONTINUED)
During 1992, in conjunction with Microsurge's Series C redeemable preferred
stock offering, a change in ownership under Section 382 of the Internal Revenue
Code of 1986 occurred. As a result of this change in ownership, the use of
approximately $1,638,000 of the Microsurge NOL carryforward is limited to
approximately $187,000 per year beginning in 1992. On March 31, 1997 a
subsequent change in ownership occurred as a result of the acquisition of
Microsurge by the Company. Further limitations will be placed on remaining NOL's
equal to 5.50% multiplied by the fair market value of the Company as of March
31, 1997.
On July 24, 1995, the Company redomesticated from Canada to the United
States. As of this date, the Company had loss carryovers for Canadian income tax
purposes of approximately $15,000,000, of which $4,000,000 would expire in
various years through 2003 and $11,000,000 would carryforward indefinitely.
These losses will not be carried forward due to the redomestication. Any
potential Canadian tax liability arising from the redomestication will be offset
against the Company's Canadian loss carryovers. Accordingly, no provision for
any such potential liability has been included in the accompanying consolidated
financial statements.
12. RELATED PARTY TRANSACTIONS
Corporations related through common ownership by a former director provide
advertising, publishing management and computer services to the Company. Such
services totaled $1,977,000, $1,359,000 and $2,710,000 for the fiscal periods
ended June 30, 1995 and March 31, 1996 and 1997, respectively. At March 31, 1996
and 1997, amounts owed to these related corporations totaled $53,000 and $0,
respectively. In the opinion of management, these services are in all cases
competitively priced and of comparable value to services that would have been
received from a third party.
The Company leases certain of its office facilities from a party related to
a former director; rental expense under the lease is $17,500 per month and the
lease expires in 2003.
A member of the board of directors is affiliated with the holder of $25
million of the 8.75% convertible debentures described in Note 5. Interest
expense for the $25 million of debentures aggregated $1.9 for the year ended
March 31, 1997.
An officer of the Company is a member of the board of directors of a
customer to which the Company made net sales aggregating approximately $5.8
million in the year ended March 31, 1997. These sales were made under terms that
provide for payment over 15-36 month periods. At March 31, 1997 accounts
receivable aggregating approximately $4.3 million are due from this customer.
Subsequent to March 31, 1997, the Company advanced its Chairman and Chief
Executive Officer $1.5 million pursuant to an unsecured loan accruing interest
at 6.02%, and maturing on November 25, 1999.
F-25
<PAGE> 28
UROHEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
13. SUPPLEMENTAL CASH FLOW INFORMATION
<TABLE>
<CAPTION>
JUNE 30, MARCH 31, MARCH 31,
1995 1996 1997
-------- --------- ---------
(IN THOUSANDS)
<S> <C> <C> <C>
Changes in operating assets and liabilities:
Receivables.................................................. $ (1,800) $(1,853) $ (8,019)
Income tax receivable........................................ -- -- (377)
Inventories.................................................. (809) (963) (12,342)
Distributor inventories...................................... -- -- (6,307)
Prepaid expenses............................................. (261) (1,044) (447)
Deposits and other assets.................................... 1,162 -- (1,333)
Accounts payable and accrued liabilities..................... 3,510 3,014 272
Compensation and employee benefits........................... 343 729 1,205
Restructuring liabilities.................................... 486 2,005 5,319
Other liabilities............................................ 76 -- 3,116
Other........................................................ 545 182 112
------- ------- --------
$ 3,252 $ 2,070 $ (18,801)
======= ======= ========
NONCASH INVESTING AND FINANCING ACTIVITIES
Equipment acquired under capital leases........................ $ 160 $ -- $ 41
======= ======= ========
Preferred stock of subsidiary exchanged for common shares of
the Company.................................................. $ 2,720 $ 45 $ 860
======= ======= ========
Equity issued in acquisitions of businesses.................... $ 6,990 -- $ 48,046
======= ======= ========
Warrants issued in early extinguishment of debt................ $ -- $ $ 1,794
======= ======= ========
Warrants issued in connection with financings.................. $ -- $ 1,520 $ 501
======= ======= ========
Issuance of common stock on debt and preferred stock
conversions.................................................. $ -- $ -- $ 4,984
======= ======= ========
SUPPLEMENTAL CASH FLOW INFORMATION
Cash paid for interest......................................... $ 259 $ 950 $ 7,529
======= ======= ========
Cash paid for taxes, net of refunds............................ $ 1,262 $ 1,010 $ 18
======= ======= ========
</TABLE>
14. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
Set forth below is summary operating results on a quarterly basis for
fiscal 1997. These results for the first three quarters have been restated to
reflect the delayed recognition of revenue from distributor initial stocking
orders and introductory products and manufacturing variance adjustments. The
information presented in the first table below excludes the results of
operations of Microsurge, which was acquired on March 31, 1997 in a transaction
accounted for as a pooling-of-interests, while the information in the second
table includes Microsurge.
<TABLE>
<CAPTION>
QUARTERS
---------------------------------------------
FISCAL 1997 -- WITHOUT MICROSURGE FIRST SECOND THIRD FOURTH
------------------------------------------ ------- -------- ------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Net sales............................... $16,027 $ 20,064 $26,995 $ 20,593
Gross profit............................ 10,778 13,106 16,207 6,953
Income (loss) from operations........... 1,329 (27,694) 2,270 (45,277)
Net income (loss)....................... (2,572) (28,986) 119 (47,707)
Income (loss) per share................. (0.22) (1.88) .01 (2.39)
</TABLE>
F-26
<PAGE> 29
UROHEALTH SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
14. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED) (CONTINUED)
The results of operations for the first three quarters of fiscal 1997 were
restated primarily to reflect the delayed recognition of revenues relating to
distributor initial stocking orders ($2,465,000 in Q3), the delayed recognition
of revenue relating to the shipment of introductory products ($661,000 in Q1,
$855,000 in Q2 and $55,000 in Q3), reductions of overhead capitalized in
inventory ($143,000 in Q1, $349,000 in Q2 and $978,000 in Q3) and increased
sales return allowances ($53,000 in Q1, $53,000 in Q2 and $115,000 in Q3).
<TABLE>
<CAPTION>
QUARTERS
---------------------------------------------
FISCAL 1997 -- INCLUDING MICROSURGE FIRST SECOND THIRD FOURTH
------------------------------------------ ------- -------- ------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Net sales............................... $17,318 $ 21,581 $28,891 $ 22,905
Gross profit............................ 11,198 13,575 16,898 7,941
Loss from operations.................... (287) (29,168) (57) (46,396)
Net loss................................ (4,263) (30,555) (2,452) (49,213)
Loss per share.......................... (0.29) (1.68) (0.11) (2.17)
</TABLE>
The operating results for the fourth quarter of fiscal 1997 include the
writeoff of acquired in-process research and development of $21,732,000, costs
of restructuring certain operations of $8,000,000, costs associated with the
Microsurge merger of $3,600,000, the writeoff of $1,916,000 in discontinued
product inventory, $197,000 in cost associated with the abandoned Relax project,
and $347,000 relating to the impairment of goodwill on the Company's Urohealth
of Kentucky subsidiary.
15. SUBSEQUENT EVENTS
Pending Acquisition
On April 19, 1997, the Company entered into a definitive agreement pursuant
to which the Company would acquire Imagyn Medical, Inc. ("Imagyn") in a
stock-for-stock merger (the "Merger"). The Merger is expected to be accounted
for as a pooling of interests and each share of Imagyn common stock will be
exchanged for 1.0358 shares (subsequently increased to 1.4 shares) of Common
Stock of the Company. The consummation of the Merger is subject to approval by
the Company's and Imagyn's stockholders, and other customary closing conditions.
No assurances can be given that the Merger will be successfully consummated.
Securities Litigation
In July 1997, several complaints were filed against the Company, certain of
its officers and directors and, in certain complaints, the lead underwriters of
the Company's November 1996 public offering requesting certification of a class
action, alleging various violations of Federal securities laws and seeking
unspecified compensatory damages. The suits were filed in the United States
District Court for the Central District of California. All of the suits are
based on substantially the same facts and have been brought on behalf of
purchasers of Common Stock of the Company during various periods between July
18, 1996 and July 1, 1997. No proceedings have taken place in any of the suits,
and no provision for any liability that may result from the ultimate resolution
of this matter has been included in the accompanying consolidated financial
statements.
F-27
<PAGE> 30
REPORT OF INDEPENDENT AUDITORS
We have audited the consolidated financial statements of Urohealth Systems,
Inc. as of March 31, 1996 and 1997, and for the year ended June 30, 1995, the
nine months ended March 31, 1996 and the year ended March 31, 1997, and have
issued our report thereon dated July 8, 1997 (included elsewhere in this
report). Our audits also included the financial statement schedule listed in
Item 14(a)(2) of this Annual Report on Form 10-K. This schedule is the
responsibility of the Company's management. Our responsibility is to express an
opinion based on our audits. We did not audit the financial statements of
Microsurge, Inc., a wholly-owned subsidiary, as of March 31, 1996 and 1997, and
for the year ended December 31, 1995, the nine months ended March 31, 1996 and
the year ended March 31, 1997 and of Dacomed Corporation, a wholly owned
subsidiary, for the year ended June 24, 1995, which statements reflect total
assets constituting 16.5% and 3.9% of consolidated total assets as of March 31,
1996 and 1997, respectively, and net sales constituting 27% and 8% and 8% of
consolidated net sales for the year ended June 30, 1995, the nine months ended
March 31, 1996 and the year ended March 31, 1997, respectively. Those statements
were audited by other auditors whose reports have been furnished to us, and our
opinion, insofar as it relates to data included in the consolidated financial
statements for such entities, is based solely on the reports of other auditors.
In our opinion, based on our audits and the reports of other auditors, the
financial statement schedule referred to above, when considered in relation to
the basic financial statements taken as a whole, presents fairly in all material
respects the information set forth therein.
/s/ ERNST & YOUNG LLP
Orange County, California
July 8, 1997
S-1
<PAGE> 31
UROHEALTH SYSTEMS, INC.
SCHEDULE II
CONSOLIDATED VALUATION ACCOUNTS
<TABLE>
<CAPTION>
BALANCE AT
BEGINNING BALANCE AT
DESCRIPTION OF PERIOD ADDITIONS ACQUISITION WRITE OFFS END OF PERIOD
- -------------------------------------------- ---------- --------- ---------- ---------- -------------
<S> <C> <C> <C> <C> <C>
Year ended March 31, 1997:
Allowance for doubtful accounts........ $1,744 $ 82 $232 $ (162) $ 1,896
Reserve for inventory obsolescence..... 1,665 157 451 (679) 1,594
------ ------ ---- ----- ------
Total............................. $3,409 $ 239 $683 $ (841) $ 3,490
====== ====== ==== ===== ======
Nine month period ended March 31, 1996:
Allowance for doubtful accounts........ $ 618 $ 1,126 $ -- $ -- $ 1,744
Reserve for inventory obsolescence..... 391 1,320 -- (46) 1,665
------ ------ ---- ----- ------
Total............................. $1,009 $ 2,446 $ -- $ (46) $ 3,409
====== ====== ==== ===== ======
Year ended June 30, 1995:
Allowance for doubtful accounts........ $ 506 $ 134 $ -- $ (22) $ 618
Reserve for inventory obsolescence..... -- 422 -- (31) 391
------ ------ ---- ----- ------
Total............................. $ 506 $ 556 $ -- $ (53) $ 1,009
====== ====== ==== ===== ======
</TABLE>
S-2
<PAGE> 32
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this Amendment No. 2 on
Form 10-K/A to be signed on its behalf by the undersigned, thereunto duly
authorized in the City of Newport Beach, State of California on August 29, 1997.
UROHEALTH SYSTEMS, INC.
By: /s/ CHARLES A. LAVERTY
------------------------------------
Charles A. Laverty
Chairman and Chief Executive Officer
