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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-KSB/A-1
[ X ] Annual Report under Section 13 or 15(d) of the Securities Exchange Act of
1934 for the fiscal year ended December 31, 1998
[ ] Transition Report under Section 13 or 15(d) of the Securities Exchange Act
of 1934 for the transition period from _____ to ______
Commission file number: 1-31070
DERMA SCIENCES, INC.
(Exact name of Registrant as specified in its charter)
Pennsylvania 23-2328753
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
214 Carnegie Center, Suite 100, Princeton, New Jersey 08540
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(Address of principal executive offices) (Zip code)
Registrant's telephone number: (800) 825-4325
Securities registered under Section 12(b) of the Exchange Act:
Title of each class Name of each exchange on which registered
Common Stock, $.01 par value Boston Stock Exchange
Common Stock, $.01 par value Pacific Stock Exchange
Securities registered under Section 12(g) of the Exchange Act:
Title of Class
Common Stock, $.01 par value
Check whether the Registrant: (1) filed all reports required to be
filed by Sections 13 or 15(d) of the Exchange Act during the past 12 months (or
for such shorter period that the Registrant was required to file such reports),
and (2) has been subject to such filing requirements for past 90 days.
Yes X No
Check if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-B is not contained in this form, and no disclosure will be
contained, to the best of the Registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-KSB
or any amendment to this Form 10-KSB.[ X ]
Issuer's revenues for its most recent fiscal year were $9,208,594.
The aggregate market value of the voting stock held by
non-affiliates, computed by reference to the average bid and asked prices of
such stock as of March 26, 1999, was approximately $5,677,774.
The number of shares outstanding of each of the issuer's classes of
common equity, as of March 26, 1999, was 6,235,789.
Documents Incorporated by Reference: None
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PART I
ITEM 1. DESCRIPTION OF BUSINESS
Overview
Derma Sciences, Inc. ("Derma Sciences") was incorporated under the
laws of Colorado on September 10, 1984. On June 3, 1996 Derma Sciences changed
its state of domicile to Pennsylvania. In September, 1998, pursuant to an
Agreement and Plan of Merger dated as of July 8, 1998, Derma Sciences acquired
Genetic Laboratories Wound Care, Inc. ("Genetic Labs") by means of a tax-free
reorganization whereby Genetic Labs became a wholly-owned subsidiary of Derma
Sciences.
In 1998, Derma Sciences purchased the stock of Sunshine Products,
Inc. ("Sunshine Products") in a cash transaction. As a result of the stock
purchase, Sunshine Products became a wholly-owned subsidiary of Derma Sciences.
Derma Sciences and its subsidiaries Genetic Labs and Sunshine
Products are referred to collectively as the "Company." The Company's executive
offices are located at 214 Carnegie Center, Suite 100, Princeton, New Jersey.
The Company engages in the marketing and sale of three dermatological
products lines: (1) sprays, ointments and dressings for the management of
chronic non-healing skin ulcerations such as pressure, diabetic and venous
ulcers, surgical incisions and burns; (2) wound closure strips, specialty
fasteners and net dressings; and (3) skin care products and disinfectants.
The Company's Markets
Chronic Wound Care
The Company markets chronic wound care and related products primarily
to extended care facilities such as nursing homes, rehabilitation centers,
hospitals and home healthcare agencies. Chronic wounds, unlike acute wounds
which heal within a natural timeframe, may linger for weeks, months or years and
may defy all traditional attempts at treatment.
The most common chronic wounds are: (1) bedsores (decubitus ulcers)
which result from prolonged pressure on the skin impairing the blood supply to
the affected area; (2) venous ulcers which result from poorly functioning veins;
and (3) diabetic leg ulcers. Traditional techniques for the treatment of chronic
wounds have principally involved cleansing and debriding the wound (removing
infected and dead tissue), controlling infection with antibiotics and protecting
the wound. However, the foregoing treatments are passive in nature and do not
stimulate or accelerate wound healing. Many of the Company's chronic wound care
products seek to provide an environment conducive to wound healing by
addressing, in addition to healing factors such as protection and infection
control, additional healing factors such as moisture, pH balance and nutrition.
Wound Closure Strips and Fasteners
The Company markets wound closure strips, nasal tube fasteners and a
variety of catheter fasteners to doctors, clinics, nursing homes and hospitals.
These wound closure strips eliminate the need for sutures on the surface of many
surgical wounds, decrease the incidence of scarring and infection and promote
wound healing. In contrast to the characteristics of surgical tapes, these wound
closure strips yield to the movement of the skin thereby reducing traction
blisters at the wound site. In additional, these wound closure strips provide
excellent adherence, optimum surgical wound security and protection from
irritation and skin shearing.
The Company's nasal tube and catheter fasteners facilitate attachment
of suction tubes, feeding tubes, urinary catheters, gastrostomy tubes, wound
drainage systems, IV's and chest tubes. These fasteners incorporate dynamic
tape-to-skin adhesion which minimizes irritation, blistering and skin shear.
Further, the fasteners' single piece construction permits adoption of rapid and
standardized attachment procedures.
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Personal Skin Care
The Company markets general purpose and specialized skin care
products to nursing homes, hospitals, home healthcare agencies and other
institutions. These products include antibacterial skin cleansers, soaps,
lotions, and moisturizers. The Company's skin care products are designed to
enable customers to implement and maintain successful skin care/hygiene
programs.
The Company's Products
Descriptions of the Company's products and their intended uses are
set forth below:
Wound Prevention and Treatment
ACCU-Cleanse Wound irrigator that provides an even
flow of irrigation solution into and
around the wound.
DermaCol Hydrocolloid dressing sold in various
sizes. Used as a primary or secondary
dressing for the management of moderately
exudating wounds.
DermaFilm Film dressing, sold in various sizes, with
a high moisture vapor transfer rate. Used
as a primary dressing on partial thickness
wounds and secondary dressing on full
thickness wounds with moderate to heavy
exudate.
Dermagran Ointment Topical ointment with a lanolin odor,
packaged in both jars and tubes. Active
ingredient: aluminum hydroxide gel.
Used to manage stage I and II pressure
and venous ulcers, incisions, burns and
other skin irritations.
Dermagran Spray Colorless, odorless liquid, packaged
in translucent plastic bottles with pump
spray nozzles. Active ingredient: zinc
acetate. Used to manage stage I and II
pressure and venous ulcers, incisions,
burns and other skin irritations.
Dermagran Wet Dressing (Saline) Sterile 4" x 8", 12
ply gauze dressing saturated with sterile
solution, packaged in foil envelopes with
peel-down tabs. Used for the management of
pressure sores, venous ulcers, incisions,
burns and skin irritations.
DermaSite Transparent, vapor permeable film dressing
sold in various sizes. Used as a dressing
for partial thickness wounds and as a
fixation device.
DermaStat Calcium alginate dressing, without zinc,
packaged in various sizes. Used for the
management of moderately to heavily
exudating wounds such as pressure ulcers,
venous stasis ulcers and dermal lesions.
Flexinet/Systenet Woven elastic net dressing for wounds
which reduces dressing time, allows for
proper ventilation of the wound site and
holds dressings in place. Packaged in
various sizes.
In Between Perineal spray skin cleanser. Used to
remove dry fecal matter and odor resulting
from incontinence.
MPH Ointment Topical ointment, packaged in
pumps and jars, containing allantoin and
aloe vera gel. Used to provide protective,
long lasting barrier ointment for perineal
care associated with incontinency.
NutraCleanse Saline wound cleanser with moisturizing
and lubricating properties packaged in a
four ounce plastic bottle. Used to cleanse
dermal wounds and contribute to the
maintenance of a mildly acidic wound
environment.
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NutraCol Hydrocolloid dressing with zinc sold in
various sizes. Used as a primary or
secondary dressing for the management of
moderately exudating wounds.
NutraDress Sterile 4" x 8", 12 ply gauze dressing
saturated with sterile solution and trace
amounts of zinc, packaged in foil
envelopes with peel-down tabs. Used for
the management of pressure sores, venous
ulcers, incisions, burns and skin
irritations.
NutraFil Advanced zinc hydrogel formulation
packaged in tubes. Used for the management
of stages II through IV pressure sores,
diabetic ulcers, venous stasis
ulcerations, thermal burns, surgical
incisions and superficial lacerations,
cuts or abrasions.
NutraGauze Advanced zinc hydrogel formulation
impregnated in gauze, available in various
sizes. Used for the management of stages
II through IV pressure sores, diabetic
ulcers, venous stasis ulcerations, thermal
burns, surgical incisions and superficial
lacerations, cuts or abrasions.
NutraShield Perineal Protectant Topical ointment
packaged in tubes. Used to provide
protective, long lasting barrier ointment
for perineal care associated with
incontinency.
NutraStat Calcium alginate dressing, containing
zinc, packaged in various sizes. Used for
the management of moderately to heavily
exudating wounds, such as pressure ulcers,
venous stasis ulcers and dermal lesions.
NutraVue Clear hydrogel packaged in tubes. Used for
the management of all stages of pressure
sores, surgical incisions, thermal burns,
cuts and abrasions and venous stasis
ulcerations.
NutraWash Cleanser packaged in an eight ounce opaque
plastic bottle with a pump spray nozzle.
Used to remove dry fecal matter and odor
resulting from incontinence.
Wound Prevention and Treatment
LC Strip Wound closure strip made of a
flexible material that allows blood and
exudate to escape the wound site. Used for
wounds resulting from minimally invasive
surgery.
Suture Strip Latex-free, water-resistant,
economical wound closure strip. Made of
the same non-woven material as Suture
Strip(R) Plus. Used in various surgical
and wound care procedures.
Suture Strip Plus(R) Latex-free, water-resistant
wound closure strip. Made of a macroporous
non-woven polyamide with skin friendly
adhesive. Used for primary closure and
early suture removal.
Nasal and Catheter Fasteners
NG Strip Tube fastener made of flexible
material designed to maximize adhesion and
minimize irritation, blistering and skin
shear, packaged in various sizes. Used to
secure nasal or feeding tubes to the nose.
Percu-Stay Sterile, self adhesive catheter fastener
for percutaneous drainage catheters. Made
of a combination of a moisture-absorbent
hydrocolloid surrounded by a pressure
sensitive adhesive on a non-woven backing.
Used to secure percutaneous drainage
catheters.
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UC Strip/Cath-Strip Catheter tubing fastener
made of a flexible material designed to
maximize adhesion and minimize irritation,
blistering and skin shear, available in
various packages. Used for securing
urinary and gastrostomy catheter tubing to
the skin.
Personal Skin Care
Antibacterial Soap Antibacterial hand soap with glycerin and
aloe vera. Active Ingredient:
chloroxylenol. Used as a hand soap for
protection against both gram-positive and
gram-negative organisms as well as yeasts
and fungi.
ApriVera Odor reducing, non-alkaline lotion body
and hair cleanser with aloe vera.
Bathe Away Body and hair cleanser containing
glycerin, coconut oil products and
chamomile.
Hydro-Soft Concentrated blend of skin emollients and
gentle skin cleansers for moisturizing and
conditioning the skin. Used in any
whirlpool and hydrotherapy unit.
Mysotrol Clear gel no-rinse hand sanitizer packaged
in squeeze bottles. Used as a hand
sanitizer to provide germicidal and
virucidal protection. Meets OSHA protocol
for a healthcare handwash.
Optima Bath additive or after-bath moisturizer
enhanced with acetylated lanolin alcohol.
Used to lubricate and soften the skin.
Skin Care Lotion Lotion to moisturize and soften the skin.
Swash Body and hair cleanser.
Therabath Lotion type body and hair cleanser.
Three to One Economical concentrated body and hair
cleanser.
Whirlpool/Hardsurface Disinfectant Detergent and disinfectant.
Used to clean and disinfect any whirlpool
or hardsurface. Effective against a broad
range of microorganisms.
Distribution and Sales
Domestic
The Company employs a direct sales force and utilizes drug
wholesalers, specialty dealers and medical - surgical distributors to sell and
distribute its products. The Company's direct sales force consists of an
executive vice president for field operations, three regional vice presidents,
four district managers, two managers for manufacturer's representatives and
twenty-one sales representatives.
Sales managers and representatives receive a base salary together
with incentive compensation based on achievement, tenure and sales in their
territories. Compensation to wholesalers, dealers and distributors is derived
from markups on the Company's products.
The Company implemented the restructuring of its direct sales force
and the hiring of the majority of its sales managers and representatives during
the period November, 1998 through January, 1999. The Company's reorganized sales
force underwent extensive training through the period December, 1998 through
February, 1999 and began full-scale field operations in March, 1999.
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International
The Company's wound care products are distributed and sold
internationally pursuant to various licensing and distribution agreements. The
Company sells products in the following countries: Austria, Belgium, Canada,
Chile, Columbia, Costa Rica, Denmark, Egypt, Finland, France, Germany,
Guatemala, Indonesia, Israel, Italy, Netherlands, New Zealand, Norway, Panama,
Peru, Philippines, Portugal, Puerto Rico, Spain, Sweden, Switzerland, Taiwan,
United Kingdom, Uruguay and Venezuela. Sales generated from foreign countries
are payable in U.S. dollars and are not material.
Competition
The wound and skin care sectors of the pharmaceutical industry are
characterized by rapidly evolving technology and intense competition. Many
suppliers of competing products are considerably larger and have much greater
resources than the Company. In addition, many specialized pharmaceutical
companies have formed collaborations with large, established companies to
support research, development and commercialization of wound and skin care
products which may be competitive with those of the Company. Academic
institutions, government agencies and other public and private research
organizations are also conducting research activities and may commercialize
wound and skin care products on their own or through joint ventures.
The Company's chronic wound care products compete principally with
those of Convatec, Smith & Nephew, Johnson & Johnson and 3M. The Company's
largest competitor in the field of wound closure strips is 3M. However, several
generic products compete with the Company's specialty fasteners, including
hospital and surgical tapes. The Company's personal skin care products compete
with those of Provon, Steris and Sween.
The ultimate ability of the Company to remain competitive depends
upon its ability to acquire, commercialize and market wound and skin care
technologies which are superior to those of its competitors. The existence of
competing products or treatments, or products or treatments that may be
developed in the future by competitors, may adversely affect the marketability
of products sold by the Company. However, the Company believes that the quality
and performance of its products, together with the skill and dedication of its
employees, allow it to successfully compete with larger companies.
Product Sourcing
The Company maintains manufacturing facilities solely for
manufacturing its skin care products. The manufacture of all other products is
outsourced. The principal manufacturers of the Company's products are: Applied
Labs (Dermagran Spray and Nutrawash); Advanced Medical Solutions Ltd., formerly
Innovative Technologies, Inc. (DermaCol, NutraCol, DermaStat, NutraStat,
DermaSite and DermaFilm); Technol, Inc. (NutraFil gauze); Topiderm, Inc.
(Dermagran Ointment and Nutrashield); and TapeMark Company (LC Strip, Suture
Strip, Suture Strip Plus(R), NG Strip, Percu-Stay, UC Strip/Cath-Strip).
The Company's products utilize readily available components and there
are numerous laboratories and production facilities capable of producing these
products to the standards required by the FDA, the Company and the
pharmaceutical industry. Given the ready availability of other suppliers, the
Company does not believe that the loss of one or more of its suppliers would
adversely affect its operations.
The Company requires that all of its suppliers conform to the
standards set forth in the Good Manufacturing Practice ("GMP") regulations
promulgated by the FDA. See "Government Regulation."
Patents, Proprietary and Non-Proprietary Technology
Under the title "Two-Step Procedure for Indolent Would Healing and
Aqueous Medium and Topical Ointment Used in Connection therewith," the Company's
Dermagran Spray and Dermagran Ointment have received patent protection. Patents
have been obtained in: Australia, Canada, European Community (comprised of:
Austria, Belgium, France, Germany, Italy, Luxembourg, Netherlands, Sweden,
Switzerland and United Kingdom), Ireland, Mexico, Philippines, Spain, and the
United States. These patents begin to expire in the year 2003. Patent
applications relative to these products are pending in various other countries.
The Company also has patents on its Suture Strip, NG Strip,
Cath-Strip and UC Strip products in the United States and United Kingdom. These
patents begin to expire in the year 2005.
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The Company believes that the foregoing patents and patent
applications afford reasonable protection to the Company against the
unauthorized copying of the technology embodied in the subject products.
However, it must be emphasized that: (1) the means whereby the wound care
products may stimulate and accelerate wound healing are unknown, and (2) the
chemical and biological processes bearing upon wound healing are highly complex
and subject to a wide variety of influences and stimuli. As such, it is possible
that others will develop wound healing products equal or superior to those of
the Company without infringing the Company's patents.
Patent law relating to the scope of claims with respect to wound care
pharmaceutical products is still evolving and the Company's patent rights are
subject to this uncertainty. Furthermore, the existence of patent rights does
not provide absolute assurance against infringement of these rights. The
prosecution and defense of patent claims is both costly and time consuming,
regardless of outcome.
An important component of the Company's growth strategy is to
acquire, by purchase or license, both proprietary and non-proprietary wound and
skin care technology. There can be no assurance that the Company will be able to
obtain such technology on acceptable terms, if at all. Future inability to
acquire or license wound care technology could have a material adverse effect on
the Company's business.
Government Regulation
Scope of Regulation
The manufacture, distribution and advertising of the Company and its
products are subject to regulation by numerous federal and state governmental
agencies in the United States and by similar agencies in foreign countries. The
United States Food and Drug Administration ("FDA") is responsible for
enforcement of the Federal Food, Drug and Cosmetic Act, as amended, ("FDC Act")
which regulates drugs and devices manufactured and distributed in interstate
commerce. Many of the Company's products are classified either as drugs or
medical devices pursuant to the FDC Act. The Federal Trade Commission ("FTC")
administers the Federal Trade Commission Act ("FTC Act") which regulates the
advertising of products including drugs and devices. All states have individual
laws which resemble the FDC Act and the FTC Act.
Medical Devices
The following products are registered with the FDA as Class I
"devices" pursuant to the regulations under Section 510(k) of the FDC Act:
Dermagran Wet Dressing (Saline), Dermagran Zinc-Saline Wet Dressing,
NutraCleanse, DermaFilm, DermaSite, NutraCol, DermaCol, NutraFil, NutraVue,
NutraGauze, NutraDress, NutraStat, DermaStat, Suture Strip, NG Strip, Cath-Strip
and UC Strip.
The FDC Act requires that all devices for human use marketed in the
United States prior to May 28, 1976 ("Preamendment Devices") be classified by
the FDA, based on recommendations of expert panels, into one of three regulatory
classes. Class I products are subject only to the general controls which apply
to all devices, irrespective of class. General controls include the registration
of manufacturers, recordkeeping requirements, labeling requirements, and Good
Manufacturing Practice ("GMP") regulations.
Class II devices are those for which general controls are not
sufficient to ensure safety and effectiveness, and for which enough information
exists to develop a standard. These devices are required to meet performance
standards established by the FDA. Performance standards may specify materials,
construction components, ingredients, labeling and other properties of the
device. A standard may also provide for the testing of devices to ensure that
different lots of individual products conform to the requirements.
The most restrictive controls are applied to devices placed in Class
III. Class III devices are required to have FDA approval for safety and
effectiveness before they can be marketed unless the FDA determines that
pre-market approval is not necessary. Pre-market approval necessitates the
compilation of extensive safety and effectiveness data which is extremely
expensive to compile.
Approval of Glass III devices may require several years.
Devices marketed after May 28, 1976 are considered to be one of two
kinds: those that are and those that are not substantially the same as a
Preamendment Device. Those that are substantially equivalent to a Preamendment
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Device are given the same classification as the equivalent Preamendment Device.
New devices which are not substantially equivalent to Preamendment Devices are
automatically placed in Class III thereby requiring pre-market approval.
All manufacturers are required to give the FDA ninety days notice
before they can introduce a device on the market. During the ninety-day period,
the FDA will determine whether the device is or is not substantially equivalent
to a Preamendment Device. If the FDA determines that the device is not
substantially equivalent to a Preamendment Device, it is automatically placed in
Class III and the manufacturer will have to provide the FDA with a Premarket
Approval Application ("PMA") containing evidence that the device is safe and
effective before the device may be commercially distributed to the public.
However, the manufacturer may request that the FDA reclassify the device by
filing a reclassification petition.
All of the devices currently marketed by the Company have been found
by the FDA to be substantially equivalent to a Preamendment Device.
Drugs
Those of the Company's products which are classified as drugs
pursuant to the FDC Act are: Dermagran Spray, Dermagran Ointment, Mysotrol and
Antibacterial Soap. Pursuant to the provisions of the FDC Act, the FDA has been
given extensive authority to regulate the manufacture and distribution of drugs.
"New drugs" are the most highly regulated category of drugs. A drug
is a "new drug" if it is not generally recognized among scientifically qualified
experts as safe and effective for use under the conditions indicated in its
labeling. In addition, a drug is a new drug if it has not been used to a
material extent or for a material time under the indicated conditions. These
conditions do not include use in safety and effectiveness investigations even if
the drug has become generally recognized as safe and effective as a result of
such investigations.
A new drug may not be commercially marketed in the United States
unless it has been approved as safe and effective by the FDA. Such approval is
based on a New Drug Application ("NDA") submitted by the sponsor of the drug
containing acceptable scientific data including the results of tests to evaluate
its safety and substantial evidence of effectiveness for the conditions for
which the drug is to be offered. Drugs that are not "new" are not subject to the
"new drug" procedure, but must comply with all other drug requirements,
including registration, labeling, and GMP regulations.
Prior to the commencement of clinical studies to compile the data
necessary for approval of a NDA, the sponsor must obtain approval of an
Investigational New Drug Application to commence investigations regarding the
safety and effectiveness of drugs.
Over-the-Counter Drugs
Prescription drugs may be dispensed only by or on the prescription of
a licensed practitioner and must be labeled: "Caution: Federal law prohibits
dispensing without prescription." In general, a drug is restricted to the
prescription class if it is not safe for use except under professional
supervision. All drugs having characteristics that do not require prescription
dispensing are considered to be over-the-counter ("OTC") drugs. Those of the
Company's products which are classified as drugs (see above) are further
classified as OTC drugs.
In 1972, the FDA began a comprehensive review of the safety,
efficacy, and labeling of all OTC drugs for the purpose of establishing the
conditions under which such drugs could be generally recognized as safe,
effective, and not misbranded. To facilitate the review, these drug products
were grouped into therapeutic classes, and advisory panels were established to
review each class. The panels completed their review in 1983, and it remains for
the FDA to complete the rulemaking process.
On the basis of the recommendations submitted by the panels, the FDA
issues monographs setting forth the conditions under which OTC drugs in each
class are deemed to be generally recognized as safe, effective, and not
misbranded. Generally, the administrative process includes the publication of a
"Preliminary," "Tentative Final," and "Final Monograph." During the rulemaking
process, products are placed into one of three categories describing whether a
drug is deemed to be generally recognized as safe and effective and not
misbranded (Category I), to be not
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generally recognized as safe and effective or misbranded (Category II), or to
lack sufficient data for categorization (Category III). Products that do not
comply with general OTC regulations or an applicable Final Monograph are subject
to regulatory action. Any OTC drug not in compliance with the content and
labeling requirements of a Final Monograph is subject to regulatory action
unless it is the subject of an approved new drug application. The FDA has issued
a Compliance Policy Guide in which it determined that it would not pursue
regulatory action against OTC drugs prior to the adoption of a final regulation
unless failure to do so presents a potential public health hazard.
Dermagran Spray and Dermagran Ointment are currently being marketed
as over-the-counter skin protectant drug products. Skin protectant products are
the subject of an ongoing FDA rule making procedure which will result in the
issuance of a final regulation specifying those active ingredients which are
permitted in, and designating labeling requirements for, such products.
Preliminary Monographs and Tentative Final Monographs applicable to Dermagran
Spray and Dermagran Ointment have been issued by the FDA in 1978 and 1984,
respectively.
Dermagran Spray and Dermagran Ointment have been formulated and
labeled in accordance with the proposals outlined in the Preliminary Monograph.
The Dermagran Spray and Dermagran Ointment labels carry treatment indications of
"For symptoms of oozing and weeping due to rubbing or friction" and "For the
temporary protection and lubrication of minor skin irritations such as
intertrigo, chafing, galling, rubbing or friction," respectively.
Under the Tentative Final Monograph, products formulated and
identified in the manner of Dermagran Spray and Dermagran Ointment would be
required to carry treatment indications of "Dries the oozing and weeping of
poison ivy, poison oak and poison sumac." Thus, if the proposals outlined in the
Tentative Final Monograph are adopted without modification in a final
regulation, and if no modifications were made to the formulations of Dermagran
Spray and Dermagran Ointment, the treatment indications on the current Spray and
Ointment labels would have to be revised.
It is currently impossible to predict when the FDA will promulgate a
final regulation, what the final regulation will provide or how a final
regulation (monograph) will affect either of these products or their labels.
Pursuant to the FDA's Compliance Policy Guide, discussed above, Dermagran Spray
and Dermagran Ointment may be marketed under their current monographs until one
year following the issuance of a Final Monograph. It is the Company's intention
to manufacture Dermagran Spray and Dermagran Ointment pursuant to the FDA's
Final Monograph relative to "skin protectants" and to make whatever formulation
and labeling changes are necessary to fully comply with the final regulation.
Given the uncertainty with respect to both the timing and provisions of a Final
Monograph relative to Dermagran Spray and Dermagran Ointment, it is not possible
to assess the probable impact of this Final Monograph upon these products'
manufacture, marketing or sale.
Foreign Regulatory Authorities
Whether or not FDA approval has been obtained, approval of medical
drugs and devices by regulatory authorities in foreign countries must be
obtained prior to marketing drugs and devices in such countries. The
requirements governing the conduct of clinical trials and product approval vary
widely from country to country and the time required for approval may be longer
or shorter than that required for FDA approval. Although there are procedures
for unified filings for certain European countries, most countries currently
maintain their own product approval procedures and requirements.
Other Regulatory Requirements
In addition to the regulatory framework for product approvals, the
Company is subject to regulation under state and federal law, including
requirements regarding occupational safety, laboratory practices, environmental
protection and hazardous substance control, and may be subject to other present
and future local, state, federal and foreign regulation.
The Company is also subject to federal, state and foreign laws and
regulations adopted for the protection of the environment and the health and
safety of employees. Management believes that the Company is in compliance with
all such laws, regulations and standards currently in effect and that the cost
of compliance with such laws, regulations and standards will not have a material
adverse effect on the Company.
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Third Party Reimbursement
The Company sells its wound care products to nursing homes,
hospitals, home healthcare agencies and similar institutions. The patients at
these institutions for whose care the Company's products are purchased often are
covered by medical insurance. Accordingly, the Company's customers routinely
seek reimbursement for the cost of the Company's wound care products from third
party payors such as Medicare, Medicaid, health maintenance organizations and
private insurers. The availability of reimbursement from such third party payors
is a significant factor in the Company's sales of wound care products.
Medicaid is a federally funded program administered by the states.
Medicaid insurance is available to individuals who have no Medicare or private
health insurance or to individuals who have exhausted their Medicare benefits.
Included in the Medicaid insurance coverage are in-patient stays in long term
care facilities, hospitalization and drugs.
Medicaid reimbursement of the Company's products is dependent upon
Company paid rebates to state Medicaid agencies. Effective January 1, 1991, the
Omnibus Budget Reconciliation Act of 1990 requires pharmaceutical companies, as
a condition of the eligibility of its products for Medicaid reimbursement, to
enter into a rebate agreement with the federal government. Only drugs of the
pharmaceutical companies having such rebate agreements are covered by state
Medicaid programs. Pharmaceutical companies participating in the Medicaid rebate
program must remit to state Medicaid agencies a formula-based rebate which
varies from quarter to quarter in accordance with the Company's quarterly net
sales and the average manufacturer price of the individual products. Prior to
1998, Medicaid rebates ranged between 3% and 5% of the Company's net sales.
During 1998, Medicaid rebates represented less than 1% of net sales.
Medicare is a federally funded program administered by four private
insurance companies. Medicare insurance generally is available to individuals
who have paid social security taxes and are over the age of 65 years. The
majority of the Company's wound care products, together with Cath-Strip and
Percu-Stay, are eligible for Medicare reimbursement.
Several of the Company's products have been the subject of past
Medicare reimbursement cutbacks. Federal and state governments, as well as
private insurers, will continue their pursuit of programs designed to control or
reduce the cost of health care. These cost cutting measures may include
reductions in reimbursements and/or increases in mandatory rebates for wound
care products. As such, there is uncertainty as to whether, and to what extent,
reimbursements for the Company's products will continue to be available.
Likewise, there is uncertainty as to the future extent of the Company's rebate
obligations.
Product Development
The Company does not conduct in-house product development activities
and relies for the expansion of its product lines upon the purchase or licensing
of products from outside sources.
9
<PAGE>
Employees
The Company maintained 74 full-time employees at December 31, 1998
and 83 full-time employees at March 30, 1999. The Company employs no part-time
employees. The Company considers its employee relations to be satisfactory.
ITEM 2. DESCRIPTION OF PROPERTY
The Company's executive offices are located in Princeton, New Jersey.
The Company leases these offices on a month-to-month basis at a price of $1,600
per month. The Company has a lease for offices located in Wilkes Barre,
Pennsylvania, at a rate of $3,000 per month, that expires June, 2000. The
Company has a month-to-month lease for 8,200 square feet of warehouse space in
Old Forge, Pennsylvania, at a rate of $1,750 per month. The Company has a five
year lease for 9,500 square feet of office and warehouse space in St. Paul,
Minnesota, at a rate of $7,400 per month, which expires in March, 2002. The
Company has a lease for 24,000 square feet of office and warehouse space in St.
Louis, Missouri, at a rate $7,085 per month which expires in August, 1999 and a
month-to-month lease for 2,000 square feet of warehouse space, also in St.
Louis, at a rate of $1,000 per month.
ITEM 3. LEGAL PROCEEDINGS
The Company is not a party to any material litigation.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Company did not submit any matter to a vote of shareholders
during the fourth quarter, 1998.
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED SHAREHOLDER MATTERS
The Common Stock of the Company is traded on Nasdaq under the symbol
"DSCI." The Common Stock is also traded on the Boston and Pacific Stock
Exchanges under the symbol "DMS." The Company's Common Stock commenced trading
on May 13, 1994. The following table sets forth the high and low bid prices for
the Company's Common Stock as reported by Nasdaq:
QUARTER ENDED HIGH LOW
March 31, 1997 2 1/8 1 1/8
June 30, 1997 2 1/16 5/8
September 30, 1997 1 1/4 5/8
December 31, 1997 1 3/4 13/16
March 31, 1998 2 1/8 1
June 30, 1998 2 1/4 1 1/2
September 30, 1998 1 5/8 5/8
December 31, 1998 1 1/8 5/8
The stock prices reflect inter-dealer prices without retail mark-up,
mark-down or commission and may not necessarily represent actual transactions.
There is no public market for the Company's preferred stock.
10
<PAGE>
As of the close of business on March 29, 1999, there were 1,270
holders of record of the Common Stock.
The Company has paid no cash dividends in respect of its Common Stock
and does not intend to pay cash dividends in the near future.
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Introduction
Since its formation in September of 1984, the Company has been
engaged in the development, marketing and sale of topical preparations for the
treatment of chronic, non-healing wounds. In 1998 the Company acquired two
companies, Genetic Laboratories Wound Care, Inc. ("Genetic Labs"), and Sunshine
Products, Inc., ("Sunshine Products"), to become a full-line provider of
advanced wound and skin care products. Genetic Labs specializes in wound
closure, fastener, net dressings and specialty products. Sunshine Products
offers a complete line of skin care products.
Management's Discussion and Analysis of Financial Condition and
Results of Operations should be read in conjunction with the historical
consolidated financial statements and notes of the Company.
In 1998 and 1997, the Company experienced a 40% increase and a 10%
decrease, respectively, in annual revenue. The Company incurred a net loss of
$1,816,029 and $2,302,903 in 1998 and 1997, respectively. The Company's net loss
for 1998 was primarily attributable to: (1) restructure and merger costs
relative to the acquisitions of Genetic Labs and Sunshine Products totaling
$550,000 and $254,827, respectively, and (2) litigation settlement expense of
$819,353 (discussed below). At December 31, 1998 and 1997, the Company's
accumulated deficits were $5,343,088 and $3,527,059, respectively.
Results of Operations
The following table presents selected financial information for the
periods indicated expressed as a percentage of net sales:
1998 1997
--------------- --------------
--------------- --------------
Net sales 100.0% 100.0%
Cost of sales ............................ 23.4 28.5
--------------- --------------
--------------- --------------
Gross profit ............................. 76.6 71.5
Selling, general and administrative:...... 79.5 107.1
Restructuring charges .................... 6.0 0.0
Merger related costs ..................... 2.8 0.0
Litigation settlement 8.9 0.0
Other income and expenses, net (1.1) (1.4)
--------------- --------------
Loss before income taxes............ (19.5) (34.2)
Income taxes ............................ .2 .7
--------------- --------------
Net loss (19.7%) (34.9%)
=============== ==============
Sales Overview
The Company's net sales are comprised of chronic wound care products,
wound closure strips and fasteners, and skin care products. Chronic wound care
sales are primarily derived from Dermagran Ointment, Dermagran Spray and
Dermagran Hydrophilic Wound Dressing. Wound closure strips and fastener sales
are primarily derived from the Suture Strips, Percu Stay, NG Strip, and Net
Dressings. Skin care sales are primarily derived from Aprivera and other body
washes and shampoos, in addition to skin conditioners and moisturizers. Net
sales increased in 1998 compared to 1997 by 40%.
11
<PAGE>
The following table presents sales by product line, expressed in
dollars and as a percentage of total increase in net sales:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
% of Total
Product Line 1998 1997 Variance Variance
------------ ---- ---- -------- --------
<S> <C> <C> <C> <C>
Chronic wound care $5,534,254 $3,584,765 $1,949,489 75%
Wound closure strips
and fasteners 3,172,006 3,016,759 155,247 6%
Skin care 502,334 0 502,334 19%
----------------- ----------------- ----------------- ----------------
Total $9,208,594 $6,601,524 $2,607,070 100%
================= ================= ================ ================
</TABLE>
1998 Compared to 1997
Net Sales and Gross Profit
Net sales increased in 1998 by $2,607,070, or 40%, to $9,208,594 from
$6,601,524 in 1997. Of this increase, 75% is attributable to the chronic wound
care product line. The increase in net sales for this line is composed of a
$1,174,876 net increase in product sales and a refund of Medicaid rebates of
$774,613. The increase in the wound closure strips and fastener net sales is
attributable to a $162,832 increase in the sale of Percu Stay. The increase of
$502,334, or 19% of total net sales, in the skin care product line is due to the
Sunshine Products acquisition on October 31, 1998. No net sales for the skin
care product line are included in the 1997 results or the first ten months of
1998.
Cost of sales expressed as a percentage of net sales decreased from
28% in 1997 to 23% in 1998. This decrease is attributable primarily to a
favorable sales mix. The chronic wound care product line had the largest
increase in sales and also had the lowest cost of sales as a percentage of net
sales. Cost of sales for the chronic wound care line was 13% and 22% for 1998
and 1997, respectively. This decrease in cost of sales is attributable to
increased sales in 1998 of high margin products coupled with the refund of
Medicaid rebates previously discussed. Cost of sales as a percentage of net
sales for the chronic wound care and wound closure strips and fastener lines
remained consistent at 37% and 36% for 1998 and 1997, respectively. Aggregate
cost of sales increased $271,643 to $2,155,835 in 1998 from $1,884,192 in 1997.
The increase in aggregate cost of sales is attributable to the increase in net
sales discussed above.
Gross profit expressed as a percentage of net sales increased from
72% in 1997 to 77% in 1998. Aggregate gross profit increased $2,335,427, or 50%,
to $7,052,759 in 1998 from $4,717,332 in 1997. Both the increase in the gross
profit percentage and the aggregate gross profit are attributable to the
previously discussed increase in net sales and the more favorable sales mix.
Operating Expenses
Operating expenses increased $1,871,585, or 27%, from $6,975,985 in
1997 to $8,847,570 in 1998. Merger and restructuring costs of $254,827 and
$550,000, respectively, in addition to the ABS Litigation settlement of $819,353
(discussed below), combine for $1,624,180, or 87%, of the total increase.
Selling, general and administrative expense for 1998 increased
$253,021, or 4%, to $7,322,335 from $7,069,314 in 1997 and decreased as a
percentage of sales from 107% in 1997 to 80% in 1998. The increase in selling,
general and administrative expense is primarily attributable to 1998 sales of
skin care products in the amount of $252,034 compared to none for 1997.
Additionally, in 1998 there was an increase in professional fees of $418,457
(primarily legal) and a decrease in bad debt expense of $491,131.
12
<PAGE>
Litigation Settlement
On June 8, 1998 the Company and ABS LifeSciences, Inc. ("ABS"), a
subsidiary of Integra Life Sciences, Inc. agreed to a settlement of their
respective claims and counter claims asserted in the civil action ABS
LifeSciences, Inc. v. Derma Sciences, Inc. (the "Action"). The settlement
provides that the Company pay ABS a total of $550,000 and return all unsold
Chronicure inventory. The settlement further provides for the dismissal of all
claims and counter claims asserted in the action. The settlement resulted in a
charge to operations of $819,353 in the quarter ended June 30, 1998.
Net Loss
The Company incurred a net loss in 1998 and 1997 of $1,816,029 and
$2,302,903, or $0.29 and $0.40 per share, respectively.
Liquidity and Capital Resources
At December 31, 1998 and 1997 the Company had working capital of
$3,293,516 and $2,546,730, respectively.
On November 19, 1997, the Company successfully closed on its
$1,800,000 securities offering (exclusive of commissions and related expenses).
On November 24, 1997, $400,000 of such securities were converted directly into
common stock and warrants. The remaining $1,400,000 of the securities were
converted to preferred stock and warrants, effective as of December 31, 1997.
The proceeds of the convertible securities were invested in short term,
investment grade commercial paper having an aggregate market value of $1,808,000
on December 31, 1997.
Further, on July 14, 1998, the Company successfully closed a private
placement of convertible securities ("Class B Securities") in which an aggregate
of $4.0 million was raised (net proceeds were $3,955,000 after related costs).
Terms of the Class B Securities required that upon approval by the Company's
shareholders of at least 3,333,400 additional shares of preferred stock, the
Class B securities automatically convert into Class B Units at the rate of $1.20
per Unit. Each Class B Unit consists of one share of preferred stock convertible
into one share of common stock ("Class B Preferred") and one warrant to purchase
one share of common stock exercisable at $1.35 per share ("Class B Warrants").
The Class B Securities at year-end have been classified as preferred stock.
Class B Warrants issued in connection with this offering totaled 3,333,400.
The Company has a short-term line of credit facility for $1,000,000
of which $300,000 was outstanding at December 31, 1998, at a fluctuating rate
per annum equal to the prime rate minus 1%, (6.75% at December 31, 1998). This
line of credit is secured by cash on deposit with the bank. In 1998 the Company
utilized its line of credit primarily for working capital.
Statements that are not historical facts, including statements about
the Company's confidence and strategies, expectations about new or existing
products, technologies and opportunities, and market demand or acceptance of new
or existing products are forward-looking statements that involve risks and
uncertainties. These uncertainties include, but are not limited to, product
demand and market acceptance risks, impact of competitive products and prices,
product development, commercialization or technological delay or difficulties,
and trade, legal, social and economic risks.
The Nasdaq Stock Market Listing
The Company was notified on February 5, 1999 by The Nasdaq Stock
Market ("Nasdaq") that it was not in compliance with the Nasdaq SmallCap Market
("SmallCap Market") listing requirement relative to maintenance of a minimum bid
price per share of $1.00. The Company has until May 4, 1999 to either satisfy
the minimum bid price listing requirement or submit to Nasdaq its plan for
achieving compliance with this requirement.
Ultimately, the Company's failure to maintain a minimum bid price per
share of $1.00 would result in the Company's common stock being delisted from
the SmallCap Market. Were this to occur, the common stock would trade
exclusively on the Nasdaq Bulletin Board, the Boston Stock Exchange and the
Pacific Exchange. Delisting of the Company's common stock from the SmallCap
Market could make it more difficult for the Company's shareholders to sell their
shares and could also make it more difficult for the Company to secure
additional financing.
13
<PAGE>
The Company is reviewing various alternatives for achieving
compliance with Nasdaq's minimum bid price requirement.
Year 2000 Compatibility
The year 2000 issue is the result of computer programs being written
using two digits rather than four to define the applicable year. In other words,
date sensitive software may recognize a date using"00" as the year 1900 rather
than the year 2000. This could result in system failures or miscalculations
causing disruptions of operations, including, among others, a temporary
inability to process transactions and information or engage in similar normal
business activities.
The Company is working to resolve the potential impact of the year
2000 on the ability of the Company's computerized information systems to
accurately process information that may be date-sensitive. The Company believes
that it does not have significant year 2000 issues to its computerized
information systems and is currently reviewing these systems. This review is
expected to be completed during 1999.
In addition, it is also possible that certain computer systems or
software products of the Company's suppliers and contractors may not be year
2000 compatible. The Company is requesting assurances from all software vendors
from which it has purchased or from which it may purchase software that such
software will correctly process all date information at all times. Furthermore,
the Company is querying its suppliers and contractors as to their progress in
identifying and addressing problems that their computer systems will face in
correct processing date information as the year 2000 approaches. The Company
expects this assessment to be completed during 1999 and currently believes that
costs of addressing this issue will not have a material adverse impact on the
Company's financial position. However, if the Company and third parties upon
which it relies are unable to address this issue in a timely manner, it could
result in a material financial risk to the Company. In order to assure that this
does not occur, the Company plans to devote all resources required to resolve
any significant year 2000 issues in a timely manner.
Through 1998 the Company has expended $25,000 on the year 2000 issue
and intends to spend an additional $20,000 in 1999. To date the Company has not
made any contingency plans to address third-party year 2000 risks. The Company
plans to formulate contingency plans to the extent necessary in 1999.
14
<PAGE>
ITEM 7. FINANCIAL STATEMENTS
Index
Description Page
Report of Independent Auditors............................ 16
Balance Sheets............................................ 17
Statements of Operations.................................. 18
Statements of Cash Flows.................................. 19
Statements of Shareholders' Equity........................ 20
Notes to Financial Statements............................. 21
15
<PAGE>
REPORT OF INDEPENDENT AUDITORS
Board of Directors
Derma Sciences, Inc.
We have audited the accompanying balance sheet of Derma Sciences,
Inc., as of December 31, 1998 and the related statements of operations,
shareholders' equity, and cash flows for the two years then ended. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted
auditing standards. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present
fairly, in all material respects, the financial position of Derma Sciences,
Inc., at December 31, 1998, and the results of its operations and its cash flows
for the two years then ended, in conformity with generally accepted accounting
principles.
/s/ ERNST & YOUNG LLP
Philadelphia, Pennsylvania
February 25, 1999
16
<PAGE>
DERMA SCIENCES, INC
CONSOLIDATED BALANCE SHEETS
==============================================================================
December 31,
ASSETS 1998 1997
- -------------------------------------------------------------------------------
Current Assets
Cash and cash equivalents $ 2,338,552 $ 2,514,560
Accounts receivable, net of allowances of
$140,000 in 1998 and $59,000 in 1997 1,378,219 903,869
Inventories 1,645,556 1,309,511
Current portion of officers' notes receivable 19,330 19,330
Prepaid expenses and other current assets 216,461 274,989
- -------------------------------------------------------------------------------
Total current assets 5,598,118 5,022,259
Property and equipment, net 409,938 262,332
Other Assets
Officers' notes receivable 76,034 90,979
Goodwill and other intangibles, net 1,674,426 416,666
Other 13,055 60,762
- -------------------------------------------------------------------------------
TOTAL ASSETS $ 7,771,571 $ 5,852,998
===============================================================================
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities
Bank line of credit $ 300,000 $ 549,633
Accounts payable 1,034,415 1,023,364
Accrued expenses and other
current liabilities 970,187 902,532
- -------------------------------------------------------------------------------
Total current liabilities 2,304,602 2,475,529
- -------------------------------------------------------------------------------
SHAREHOLDERS' EQUITY
Common stock $.01 par value,
15,000,000 shares authorized;
issued and outstanding: 6,235,789
shares in 1998; 6,249,298 in 1997 62,357 62,493
Convertible preferred stock $.01 par
value; 11,750,000 shares authorized;
issued and outstanding: 5,070,900
shares in 1998; 1,750,000 in 1997 50,709 17,500
Additional paid-in capital 10,696,991 6,824,535
Accumulated deficit (5,343,088) (3,527,059)
- -------------------------------------------------------------------------------
Total Shareholders' Equity 5,466,969 3,377,469
- -------------------------------------------------------------------------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 7,771,571 $ 5,852,998
===============================================================================
See notes to consolidated financial statements
17
<PAGE>
DERMA SCIENCES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
==============================================================================
Year Ended December 31,
1998 1997
- -------------------------------------------------------------------------------
NET SALES $ 9,208,594 $ 6,601,524
Cost of sales 2,155,835 1,884,192
- -------------------------------------------------------------------------------
GROSS PROFIT 7,052,759 4,717,332
- -------------------------------------------------------------------------------
Selling, general and administrative 7,322,335 7,069,314
Restructuring charges 550,000 --
Merger related costs 254,827 --
Litigation settlement 819,353 --
Other income and expense, net ( 98,945) ( 93,329)
- -------------------------------------------------------------------------------
8,847,570 6,975,985
- -------------------------------------------------------------------------------
Net loss before income taxes $(1,794,811) $(2,258,653)
Provision for income taxes 21,218 44,250
- -------------------------------------------------------------------------------
NET LOSS $(1,816,029) $(2,302,903)
==============================================================================
Loss per common share basic and diluted $( 0.29) $( 0.37)
==============================================================================
Shares used in computing loss per common share 6,253,181 6,249,671
==============================================================================
See notes to consolidated financial statements
18
<PAGE>
DERMA SCIENCES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
================================================================================
Year Ended December 31,
1998 1997
- --------------------------------------------------------------------------------
OPERATING ACTIVITIES
Net loss $(1,816,029) $(2,302,903)
Adjustments to reconcile net loss to
net cash used in operating activities
Depreciation and amortization 300,634 207,258
Medicaid rebate adjustments ( 475,866) -
Provision for bad debts 21,233 558,530
Changes in operating assets and
liabilities, net of effects
of purchased business
Accounts receivable ( 260,477) 251,150
Inventories ( 200,434) 141,279
Prepaid expenses and other current
assets 63,152 8,294
Other assets 50,002 ( 7,337)
Accounts payable ( 235,683) 193,398
Accrued expenses and other
current liabilities 359,950 34,474
- --------------------------------------------------------------------------------
Net cash used in operating activities (2,193,518) ( 915,857)
- --------------------------------------------------------------------------------
INVESTING ACTIVITIES
Decrease in short-term investments - 1,887,171
Purchases of property and equipment, net ( 124,505) ( 149,970)
Increase in patents and trademarks ( 3,826) ( 47,855)
Acquisition of business, net of
cash acquired (1,525,000) -
Net cash (used in) provided by investing
Activities (1,653,331) 1,689,346
FINANCING ACTIVITIES
Net change in bank line of credit ( 249,633) ( 250,367)
Principal payments on long term debt - ( 5,547)
Proceeds from issuance of convertible
securities, net of issuance costs 3,955,000 1,571,211
Purchase (and retirement) of treasury stock ( 39,633) -
Proceeds from issuance of common stock 9,514 391
Collection of officers' notes receivable ( 4,407) 172,230
- --------------------------------------------------------------------------------
Net cash provided by financing activities 3,670,841 1,487,918
- --------------------------------------------------------------------------------
NET (DECREASE) INCREASE IN CASH AND
CASH EQUIVALENTS ( 176,008) 2,261,407
Cash and cash equivalents
Beginning of year 2,514,560 253,153
- --------------------------------------------------------------------------------
End of year $ 2,338,552 $ 2,514,560
================================================================================
See notes to consolidated financial statements.
19
<PAGE>
DERMA SCIENCES, INC.
<TABLE>
<CAPTION>
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
============================================================================================================
Convertible Additional Accumu- Total
Preferred Common Paid-In lated Shareholders'
Stock Stock Capital Deficit Equity
- ------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
BALANCE, DECEMBER 31, 1996 $ -- $57,602 $ 5,298,526 $(1,224,156) $ 4,131,972
Tender of common shares by
officers for payment of
notes receivable -- ( 116) ( 23,086) -- ( 23,202)
Issuance of 2,250,000 convertible
securities on $1,800,000 private
placement, net of fees 22,500 -- 1,548,711 -- 1,571,211
Conversion of convertible
securities into 500,000 common
shares in November 1997 (5,000) 5,000 -- -- --
Other -- 7 384 -- 391
Net loss -- -- -- (2,302,903) (2,302,903)
- ------------------------------------------------------------------------------------------------------------
BALANCE, DECEMBER 31, 1997 17,500 62,493 6,824,535 (3,527,059) 3,377,469
Tender of common shares by
officers for payment of
notes receivable -- ( 97) ( 19,255) -- ( 19,352)
Issuance of convertible
securities on $4,000,000
private placement, net of fees 33,334 -- 3,921,666 -- 3,955,000
Conversion of convertible shares ( 125) 125 -- -- --
Purchase and retirement of
Treasury stock, at cost -- ( 370) ( 39,263) -- ( 39,633)
Other -- 206 9,308 -- 9,514
Net loss -- -- -- (1,816,029) (1,816,029)
- ------------------------------------------------------------------------------------------------------------
BALANCE, DECEMBER 31, 1998 $ 50,709 $62,357 $10,696,991 $(5,343,088) $ 5,466,969
============================================================================================================
</TABLE>
See notes to consolidated financial statements.
20
<PAGE>
DERMA SCIENCES, INC.
Notes to Consolidated Financial Statements
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Derma Sciences, Inc., and Subsidiaries (the "Company") is a full line
provider of advanced wound and skin care products. The Company markets its
products principally through independent distributors servicing the long-term
care, home health and acute care markets in the United States and select
international markets.
On September 9, 1998, the Company acquired Genetic Laboratories Wound
Care, Inc. ("Genetic Labs"), in a business combination accounted for as a
pooling of interests. Genetic Labs markets proprietary wound care products;
primarily wound closure strips, specialty fasteners and net dressings. Sales are
made primarily to medical supply distributors throughout the United States and
in foreign countries, mainly Europe, utilizing independent sales
representatives.
On October 29, 1998, the Company acquired all of the issued and
outstanding stock of Sunshine Products, Inc. ("Sunshine Products"), in a
business combination accounted for as a purchase. Sunshine Products is a
manufacturer of general purpose and specialized skincare products for hospitals,
nursing homes and other institutional facilities.
BASIS OF PRESENTATION
Certain amounts in the prior years' financial statements have been
reclassified to conform to the current year presentation.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION - The consolidated financial statements
include the accounts of Derma Sciences, Inc., and its wholly owned subsidiaries,
Genetic Laboratories Wound Care, Inc. and Sunshine Products, Inc. All
significant intercompany accounts and transactions have been eliminated upon
consolidation.
USE OF ESTIMATES - In conformity with generally accepted accounting
principles, the preparation of our financial statements requires our management
to make estimates and assumptions that affect the amounts reported in our
financial statements and accompanying notes. Although these estimates are based
on our knowledge of current events and actions we may undertake in the future,
actual results may ultimately differ from these estimates.
CASH AND CASH EQUIVALENTS - The Company considers cash and cash
equivalents as amounts on hand, on deposit in financial institutions and highly
liquid investments purchased with an original maturity of three months or less.
NET LOSS PER SHARE - Net loss per common share is calculated based
upon the weighted average number of shares of common stock, on an as if
converted basis, outstanding during each period. No exercise of stock options,
stock purchase warrants or the conversion of preferred stock was included
because the exercise of all these securities would be anti-dilutive.
INVENTORIES - Inventories consist primarily of raw materials,
supplies and finished goods valued at the lower of cost or market. Cost is
determined on the basis of the first-in, first-out method.
21
<PAGE>
DERMA SCIENCES, INC.
Notes to Consolidated Financial Statements
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
PROPERTY AND EQUIPMENT - Property and equipment are stated at cost
and are depreciated principally by the straight-line method over the estimated
useful lives of the assets ranging from five to fifteen years.
GOODWILL AND OTHER INTANGIBLE ASSETS - Goodwill and other intangible
assets are stated on the basis of cost and are amortized, principally on a
straight-line basis, over the estimated future periods to be benefited not
exceeding 40 years. Goodwill on the Sunshine Products acquisition is being
amortized over 12 years.
CASH FLOW INFORMATION - Interest paid during 1998 and 1997 amounted
to $54,638 and $66,369, respectively. Income taxes paid during 1998 and 1997
amounted to $20,000 and $23,000, respectively.
Non-cash transactions in 1998 included receipts of 9,676 shares of
common stock in repayment of officers' note receivable.
STOCK BASED COMPENSATION - The Company grants stock options for a
fixed number of shares to employees with an exercise price equal to the fair
value of the shares at the date of grant. The Company accounts for stock option
grants in accordance with APB Option No. 25, "Accounting for Stock Issued to
Employees", and, accordingly recognizes no compensation expense for the stock
option grants.
INCOME TAXES - The Company accounts for income taxes under the
liability method. Under this method, deferred tax assets and liabilities are
determined based on differences between financial reporting and tax bases of
assets and liabilities and are measured using the enacted tax rates and laws
that will be in effect when the differences are expected to reverse.
REVENUE RECOGNITION - The Company operates in one segment and its
products are primarily sold to independent distributors. Sales are recorded when
product is shipped and title passes to our customers.
ADVERTISING COSTS - Advertising costs are generally expensed in the
year incurred.
2. ACQUISITIONS
On September 9, 1998, the Company acquired Genetic Labs, in a
business combination accounted for as a pooling of interests. Genetic Labs
markets proprietary wound care products; primarily wound closure strips,
specialty fasteners and net dressings. Sales are made primarily to medical
supply distributors throughout the United States and in foreign countries,
mainly Europe, utilizing independent sales representatives. Sales generated from
foreign countries are payable in U.S. dollars and are not material. Genetic Labs
became a wholly owned subsidiary of the Company through the exchange of
1,690,791 shares of the Company's common stock for all the outstanding stock of
Genetic Labs. The accompanying financial statements for the years ended December
31, 1998 and 1997 are based on the assumption that the companies were combined
for the full periods, and financial statements of prior periods have been
restated to give effect to the combination.
22
<PAGE>
DERMA SCIENCES, INC.
Notes to Consolidated Financial Statements
2. ACQUISITIONS (CONTINUED)
There were no intercompany transactions or adjustments required to
the net assets or retained earnings of the combined companies due to the
business combination. Summarized results of operations of the separate companies
for the period from January 1 to August 31, 1998 (the date of acquisition is
September 9, 1998), are as follows:
Company Genetic Labs Total
Net sales $ 3,585,853 $ 2,048,992 $ 5,634,845
--------- --------- ---------
Net income (loss) $( 831,845) $ 61,762 $( 770,083)
--------- ----------- ---------
The following is a reconciliation of the amounts of net sales and net
income (loss) previously reported for 1997 with restated amounts:
Year Ended
December 31, 1997
Net sales
As previously reported - Company $ 4,010,148
Reclassification (425,383)
Genetic Labs 3,016,759
---------
As restated $ 6,601,524
=========
Net income (loss)
As previously reported - Company $(2,416,244)
Genetic Labs 113,341
---------
As restated $(2,302,903)
=========
In 1998, the Company acquired all of the issued and outstanding stock
of Sunshine Products in a business combination accounted for as a purchase.
Sunshine Products is a manufacturer of general purpose and specialized skincare
products for hospitals, nursing homes and other institutional facilities.
23
<PAGE>
DERMA SCIENCES, INC.
Notes to Consolidated Financial Statements
2. ACQUISITIONS (CONTINUED)
The results of operations of Sunshine Products are included in the
accompanying financial statements since the date of acquisition. The following
summarized pro forma (unaudited) information assumes the Sunshine Products
acquisition had occurred on January 1, 1997.
1998 1997
---- ----
Net Sales $ 11,564,647 $ 9,312,874
Net Income $ (1,712,942) $(2,223,970)
Earnings Per Share:
Basic and Diluted $ (.27) $ (.39)
The purchase price was allocated as follows:
Accounts receivable $ 235,106
Inventory 135,610
Fixed assets 133,331
Intangible assets 1,447,000
Liabilities (426,047)
-------------
Total $ 1,525,000
Intangible assets of approximately $1,447,000 are classified as
goodwill and are being amortized using the straight-line method over twelve
years.
3. RESTRUCTURING CHARGES
Beginning in September 1998, the board of directors of the Company
approved a plan to integrate the acquired companies and consolidate its
corporate and operating facilities, including support services. Restructuring
charges represent certain non-recurring cost and expenses associated therewith,
including but not limited to moving expenses, severance pay, lease penalty
payments and professional fees. The restructuring is expected to be completed
within nine months.
4. INVENTORIES
Inventories comprise the following:
December 31,
------------
1998 1997
---- ----
Finished goods $1,446,816 $1,231,908
Raw materials 31,972 --
Supplies 166,768 77,603
---------- ----------
$1,645,556 $1,309,511
========== ==========
24
<PAGE>
DERMA SCIENCES, INC.
Notes to Consolidated Financial Statements
5. PROPERTY AND EQUIPMENT
Property and equipment comprise the following:
December 31,
------------
1998 1997
---- ----
Furniture and equipment $ 867,745 $ 620,248
Leasehold improvements 14,543 14,543
------- -------
882,288 634,791
Less: Accumulated depreciation 472,350 372,459
------- -------
$ 409,938 $ 262,332
======= =======
6. GOODWILL AND OTHER INTANGIBLES
Goodwill and other intangibles comprise the following:
December 31,
------------
1998 1997
---- ----
Goodwill $ 1,497,365 $ 50,731
Patents and trademarks 454,469 450,643
Contract rights 350,000 350,000
--------- -------
2,301,834 851,374
Less: accumulated amortization 627,408 434,708
--------- -------
$ 1,674,426 $ 416,666
========= =======
7. CONCENTRATION OF CREDIT RISK
The Company sells almost all of its products to medical supply
companies, pharmacies and healthcare providers. At December 31, 1998 and 1997,
primarily all of the Company's accounts receivable are from companies in the
healthcare industry. Credit is extended based on an evaluation of the customer's
financial condition and collateral is not required.
The Company currently has manufacturing arrangements in place with
contract manufacturers with respect to all of its products. The Company believes
that the raw materials used in manufacturing its products are available in
adequate quantities from multiple sources.
Although the Company typically has a manufacturing agreement with a
single source for each product, multiple sources are generally available. The
Company has never experienced a material interruption of supply from any of its
manufacturers. However, in those instances in which it has only a single source
of supply, any material delay or cessation of production by the Company's
contract manufacturers could have a material adverse impact on the Company's
results of operations. The Company does not believe that the level of
manufacturing over-capacity in the industry is likely to change significantly in
the near future and, accordingly, does not believe that its reliance upon
contract manufacturers will have a material adverse effect on the Company's
operations.
25
<PAGE>
DERMA SCIENCES, INC.
Notes to Consolidated Financial Statements
8. ACCRUED EXPENSES
Accrued expenses comprise the following:
December 31,
------------
1998 1997
---- ----
Salary, wages and severance $ 46,889 $ 321,687
Professional fees 205,045 101,200
Restructuring charges 463,183 -
Other 125,554 297,461
Rebates payable 125,068 163,787
------- -------
$ 965,739 $ 884,135
======= =======
9. BANK LINE OF CREDIT
The Company has a $1,000,000 bank line of credit facility, with
$300,000 and $549,633 outstanding at December 31, 1998 and 1997, respectively,
which amounts approximate fair value. The maturity date of the line is October
31, 1999. The line of credit agreement requires monthly interest payments at
prime minus 1%, or 6.75% at December 31, 1998. The line of credit is secured by
cash deposited with the bank of $1,000,000.
10. OPERATING LEASES
The Company has operating lease agreements for its facilities and
equipment expiring in various years through 2002. Expense under these agreements
amounted to $231,660 and $135,658 in 1998 and 1997, respectively. Minimum future
rental payments under non-cancelable operating leases as of December 31, 1998
are:
Year Ending
December 31,
1999 $ 319,536
2000 192,790
2001 167,222
2002 30,888
-------
Total minimum future rental payments $ 710,436
=======
26
<PAGE>
DERMA SCIENCES, INC.
Notes to Consolidated Financial Statements
11. INCOME TAXES
Significant components of the Company's deferred tax assets and liabilities
are as follows:
December 31,
------------
1998 1997
---- ----
Deferred tax liabilities:
Prepaid insurance $( 10,842) $( 9,233)
Patent amortization ( 76,856) ( 82,748)
--------- ----------
Total deferred tax liabilities ( 87,698) ( 91,981)
--------- ----------
Deferred tax assets:
Net operating loss carryforwards 1,863,403 1,332,878
Depreciation 31,219 26,760
Amortization of intangibles 108,656 55,513
Foreign tax, research and
development credits 24,559 24,559
Allowance for bad debts 32,881 20,297
Other 65,333 70,610
--------- ---------
2,126,051 1,530,617
Valuation allowance (2,038,353) (1,438,636)
--------- ---------
Total deferred tax assets 87,698 91,981
--------- ---------
Net deferred tax assets $ - $ -
========== =========
The majority of the current year valuation allowance relates to net
operating loss carryforwards for which realization is not assured.
Significant components of the provision for income taxes are as
follows:
December 31,
------------
1998 1997
---- ----
Current:
Federal $ 19,000 $ 40,000
State 2,218 4,250
------ ------
Total current $ 21,218 $ 44,250
====== ======
Deferred:
Federal $ - $ -
State - -
----------- --------
Total deferred $ - $ -
=========== ========
27
<PAGE>
DERMA SCIENCES, INC.
Notes to Consolidated Financial Statements
11. INCOME TAXES (CONTINUED)
The reconciliation of income tax attributable to continuing
operations computed at the U.S. federal statutory tax rates to income tax
expense (benefit) is:
December 31,
------------
1998 1997
---- ----
Tax benefit at U.S. statutory rates $(610,236) $(767,942)
State income taxes, net of
federal benefit ( 63,327) (146,580)
Increase in valuation allowance 599,717 949,260
Nondeductible expenses 14,950 11,686
Tax on unconsolidated subsidiary
(pre acquisition) 21,218 44,250
Effect of graduated rates 11,750 11,750
Other 47,146 ( 57,174)
------- -------
$ 21,218 $ 44,250
======= =======
At December 31, 1998, the Company has net operating loss
carryforwards of approximately $4,780,000 for federal tax purposes that begin to
expire in years 2011 through 2018. For state tax purposes, the Company has net
operating loss carryforwards of $3,750,000 that expire in years 2004 through
2008. During 1998 the Company had a change in control as defined by the Internal
Revenue Code Section 382. Consequently, certain limitations may apply to limit
the timing and amount of such net operating loss carryforwards.
12. SHAREHOLDERS' EQUITY
FIRST CONVERTIBLE SECURITIES OFFERING
On November 19, 1997, the Company successfully closed a private
placement of Convertible Securities ("Class A Securities") in which an aggregate
of $1.8 million was raised (net proceeds were $1,571,211 after related costs).
Terms of the Class A Securities required that upon approval by the Company's
shareholders of a new class of preferred stock, the Class A Securities
automatically convert into Class A Units at the rate of $0.80 per Unit. Each
Class A Unit consists of one share of preferred stock convertible into one share
of common stock ("Class A Preferred") and one warrant to purchase one share of
common stock exercisable at $0.90 per share ("Class A Warrants"). As the Class A
Securities were not payable in cash, the unconverted Class A Securities at
December 31, 1997 were classified as preferred stock. Class A Warrants issued in
connection with this offering totaled 2,250,000.
CONVERSION TO COMMON STOCK
On November 24, 1997, investors owning $490,000 of Class A Securities
converted their Class A Securities directly into 500,000 shares of common stock
and 500,000 Class A Warrants pursuant to the terms of the instruments governing
the Class A Securities.
28
<PAGE>
DERMA SCIENCES, INC.
Notes to Consolidated Financial Statements
12. SHAREHOLDERS' EQUITY (CONTINUED)
SECOND CONVERTIBLE SECURITIES OFFERING
Further, on July 14, 1998, the Company successfully closed a private
placement of convertible securities ("Class B Securities") in which an aggregate
of $4.0 million was raised (net proceeds were $3,955,000 after related costs).
Terms of the Class B Securities required that upon approval by the Company's
shareholders of at least 3,333,400 additional shares of preferred stock, the
Class B Securities automatically convert into Class B Units at the rate of $1.20
per Unit. Each Class B Unit consists of one share of preferred stock convertible
into one share of common stock ("Class B Preferred") and one warrant to purchase
one share of common stock exercisable at $1.35 per share ("Class B Warrants").
PREFERRED STOCK
The Company's shareholders, at a special meeting of shareholders held
on January 7, 1998, authorized creation of 1,750,000 shares of preferred stock.
The Company's directors then designated all 1,750,000 shares of preferred stock
as Series A Convertible Preferred Stock ("Class A Preferred") with the above and
below described rights and preferences. Upon authorization of the Class A
Preferred, the $1,400,000 of outstanding Class A Securities were automatically
converted into 1,750,000 Class A Units (effective as of December 31, 1997). The
Class A Preferred bears no dividend and there are no conversion price reset or
anti-dilution provisions. It has a liquidation preference of $0.80 per share, or
$1,400,000, at December 31, 1997.
The Company's shareholders, at a special meeting of shareholders held
on September 9, 1998, authorized creation of an additional 10,000,000 shares of
preferred stock. The Company's directors then designated 3,333,400 shares of the
10,000,000 shares of newly authorized preferred stock as Series B Convertible
Preferred Stock ("Class B Preferred") with the above and below designated rights
and preferences. Upon authorization of the Class B Preferred, the $4,000,000 of
the outstanding Class B Securities were automatically converted into 3,333,400
Class B Units. The Class B Preferred bears no dividend and there are no
conversion price reset or anti-dilution provisions. It has a liquidation
preference of $1.20 per share, or $4,000,000, at December 31, 1998.
During 1998, 12,500 shares of Class A Preferred were converted into
12,500 shares of common stock.
STOCK PURCHASE WARRANTS
At December 31, 1998, the Company had 5,723,400 warrants outstanding
to purchase the Company's common stock, all of which are currently exercisable
at prices ranging from $.90 to $6.25 and expiring 1997 through 2004.
13. STOCK OPTIONS
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 stock options. 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 stock options. Under APB 25,
compensation expense is recognized if the exercise price of the Company's stock
options is less than the market price of the underlying stock on the date of
grant.
29
<PAGE>
DERMA SCIENCES, INC.
Notes to Consolidated Financial Statements
13. STOCK OPTIONS (CONTINUED)
The Company has a stock option plan under which options to purchase a
maximum of 1,500,000 shares of common stock may be issued. The plan permits the
granting of both incentive stock options and nonqualified stock options to
employees and directors of the Company, excluding members of the Compensation
Committee, and certain outside consultants and advisors to the Company. The
option exercise price may not be less than 100% (110% for owners of more than
10% of common stock of the Company on the date of grant) of the fair market
value of the stock on the date of the grant of the option. The duration of each
option may not exceed 10 years from the date of grant (five years for owners of
more than 10% of the common stock of the Company). No options granted under the
plan have been exercised.
In addition to the options granted under the stock option plan,
options to purchase 380,273 and 856,000 shares of common stock were granted to
officers and directors in 1998 and 1997 respectively, with exercise prices
ranging from $.80 to $1.125 per share. No options have been exercised.
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 stock options granted
subsequent to December 31, 1994 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 1998 and 1997: risk-free interest rate of 6.0% and 6.25%,
respectively; dividend yield of 0%; a volatility factor of the expected market
price of the Company's common stock of 0.885 and 0.830, respectively; and a
weighted average life of the option of 4 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. The Company's stock options have characteristics significantly
different from those of traded options.
Further, changes in the subjective input assumptions related to the
options can materially affect the fair value estimate. Therefore, in
management's opinion the existing models do not necessarily provide a reliable
single measure of the fair value of the Company's stock options.
For purposes of pro forma disclosures, the estimated fair value of
traded options is amortized to expense over the options' vesting period. The
Company's pro forma information follows:
1998 1997
---- ----
Pro forma net loss $(2,369,376) $(2,715,882)
Pro forma loss per common share ( .38) ( .43)
30
<PAGE>
DERMA SCIENCES, INC.
Notes to Consolidated Financial Statements
13. STOCK OPTIONS (CONTINUED)
A summary of the Company's stock option activity and related
information for the years ended December 31, follows:
<TABLE>
<CAPTION>
1998 1997
---- ----
Weighted- Weighted-
Average Average
Exercise Exercise
Options Price Options Price
--------- -------- ---------- -------
<S> <C> <C> <C> <C>
Outstanding - beginning of year 1,338,055 $ 1.44 587,180 $ 1.91
Granted 760,773 1.12 906,000 1.12
Exercised - - - -
Forfeited ( - ) - ( 155,125) 2.46
--------- ----- --------- ----
Outstanding - end of year 2,098,828 $ 1.32 1,338,055 $ 1.44
========= ==== ========= ====
Exercisable at end of year 1,770,328 841,888
========= =========
</TABLE>
Exercise prices for options outstanding under the stock option plan,
non-statutory option agreements and employment agreements at December 31, 1998
ranged from $.36 to $3.60. The weighted average fair value of opinions issued
was $.87 in 1998.
14. RELATED PARTY TRANSACTIONS
The Company leased office space from a shareholder of the Company
under an operating lease which was terminated January 31, 1998. Rent expense
under this lease was $3,600 and $43,200 for the years ended December 1998 and
1997.
In 1994, the Company entered into a five-year consulting agreement
with a director and shareholder. The agreement provides that this individual
will provide consulting services to the Company in return for annual
compensation of $70,000, to be adjusted from time to time by the Company's
President and Chief Executive Officer. In 1998 and 1997, such compensation was
$99,000.
In 1997, the Company entered into a consulting arrangement with a
firm with which the Company's Chief Financial Officer is affiliated to provide
financial and accounting services. Total expenses for these services amounted to
$75,000 and $85,000 in 1998 and 1997 respectively.
15. OFFICERS' NOTES RECEIVABLE
Various officers of the Company received draws against incentive
compensation during 1994 totaling approximately $296,165. The Compensation
Committee of the Board of Directors subsequently determined that no incentive
compensation was payable relative to 1994. Accordingly, the officers executed
promissory notes requiring repayment of the incentive compensation over a period
of ten (10) years with interest of 8.01% per annum. The Board of Directors has
determined that the officers may tender either common stock of the Company or
cash in payment of the promissory notes.
During 1997, the Compensation Committee approved forgiveness of one
officer's promissory note in the amount of $74,248 as part of the officer's
severance package. Repayments of other officers' notes receivable during 1998
and 1997 totaled $20,000 and $134,031, respectively inclusive of principal and
interest.
31
<PAGE>
DERMA SCIENCES, INC.
Notes to Consolidated Financial Statements
16. MEDICAID REBATES
During 1998 the Company negotiated and received $475,000 related to
Medicaid rebate adjustments. Such adjustments are reflected in the accompanying
statement of operations.
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE
WITH SECTION 16(A) OF THE EXCHANGE ACT
Directors and Executive Officers
The directors and executive officers of the Company are:
<TABLE>
<CAPTION>
NAME AGE POSITION HELD WITH THE COMPANY
<S> <C> <C>
Edward J. Quilty (2)(3)......... 48 Chairman of the Board
Richard S. Mink ................ 46 Vice President and Chief Operating Officer
Charles F. Caudell, III ........ 46 Executive Vice President for Field Operations
Stephen T. Wills, CPA .......... 42 Vice President and Chief Financial Officer
John T. Borthwick .............. 45 Director of Business Development and Director
Laurence F. Lane (1)(3)......... 53 Director
Srini Conjeevaram (1)(2)........ 40 Director
Timothy J. Patrick (2)(3)....... 40 Director
Arthur A. Beisang ............. 67 Director
- ---------------
</TABLE>
(1) Member of the Audit Committee.
(2) Member of the Compensation Committee.
(3) Member of the Nominating Committee.
Information Relative to Directors and Executive Officers
EDWARD J. QUILTY has served as Chairman of the Board since May, 1996
and as a director of the Company since March, 1996. Mr. Quilty has been the
Chairman of the Board of Palatin Technologies, Inc., a biopharmaceutical company
specializing in peptide drug design for diagnostic and therapeutic agents, since
November, 1995. From July, 1994 through November, 1995, he was President and
Chief Executive Officer of MedChem Products, Inc., a publicly traded developer
and manufacturer of specialty medical products which was acquired by C. R. Bard
in November, 1995. From March, 1992 through July, 1994 Mr. Quilty served as
President and Chief Executive Officer of Life Medical Sciences, Inc., a
developer and manufacturer of specialty medical products including wound healing
agents. The assets of Life Medical Sciences were purchased by MedChem Products,
Inc. Mr. Quilty has over 25 years of experience in the healthcare industry
primarily in strategic planning, management and sales and marketing. Mr. Quilty
is a member of the Healthcare Manufacturing Marketing Council. He earned a
Bachelor of Science degree from Southwest Missouri State University,
Springfield, Missouri in 1972 and a Master of Business Administration degree
from Ohio University, Athens, Ohio in 1987.
RICHARD S. MINK has served as Vice President and Chief Operating
Officer of the Company since November, 1997 having previously serves as its Vice
President for Marketing since April, 1997. Prior to joining the Company, Mr.
Mink was Senior Vice President/General Manager, Marketing Information Services
Division of Bio Imaging Technologies, Inc., a medical image data and information
management company, from November, 1996 to April, 1997. He was a self-employed
marketing consultant from May, 1995 to October, 1996, Executive Vice President
for Sales and Marketing for MedChem, Inc. from August, 1994 to May, 1995, Vice
President for Sales and Marketing for Life Medical Sciences from July, 1993 to
August, 1994, and had risen to the position of Director of Marketing for Becton
32
<PAGE>
Dickinson Company during his tenure there from August, 1977 to July, 1993.
During May, 1996 through April, 1997, Mr. Mink was a member of the New Jersey
Technology Council Healthcare Advisory Board. He earned a Bachelor of Science
degree in Biology/Chemistry and a Master of Business Administration degree from
Rutgers University, Newark, New Jersey in 1975 and 1977, respectively.
CHARLES F. CAUDELL, III has served as the Company as Executive Vice
President for Field Operations since November, 1997 having previously served as
Vice President for Sales since April, 1997. Prior to joining the Company, Mr.
Caudell was Division Director of CalgonVestal, a former Merck & Co. wound care
subsidiary, and later Division Director of ConvaTec upon the purchase of this
company by Bristol Myers-Squibb, from January, 1984 to April, 1997. Mr. Caudell
earned a Bachelor of Arts degree in Communications from Wake Forest University,
Winston-Salem, North Carolina in 1974 and a Master of Business Administration
from Ohio University, Athens, Ohio in 1993.
STEPHEN T. WILLS, CPA, MST has served as Chief Financial Officer of
the Company since July, 1997 and Vice President since November, 1997. Mr. Wills
also serves as President and Chief Operating Officer of Golomb, Wills & Company,
PC, a public accounting firm, and as Vice President and Chief Financial Officer
of Palatin Technologies, Inc., a publicly traded biopharmaceutical company. Mr.
Wills is a member of the American Institute of Certified Public Accountants, New
Jersey Society of Certified Public Accountants and Pennsylvania Institute of
Certified Public Accountants. He earned a Bachelor of Science degree in
Accounting from West Chester University, West Chester, Pennsylvania in 1979 and
a Master of Science in Taxation from Temple University, Philadelphia,
Pennsylvania in 1994.
JOHN T. BORTHWICK has served as Director of Business Development of
the Company since November, 1997 and served as President and Chief Executive
Officer of the Company from February, 1991 to November, 1997 and February, 1991
to May, 1997, respectively. He has served as a director of the Company since
November, 1984 and served as Vice Chairman of the Board from September, 1994 to
June, 1995. Previously, he was Vice President for Marketing and National Sales
Manager of the Company from 1984 through 1990. Mr. Borthwick serves on the board
of directors of Plansoft Corporation, a developmental stage employee benefit
plan administration software company. During 1988 and 1989, Mr. Borthwick also
served as President of Wound Management Services, a Medicare billing service
specializing in wound care. In 1993, Mr. Borthwick served as a member of the
board of directors of the National Association for the Support of Long Term
Care, an organization which represents the legislative and regulatory interests
of the long term care industry. Mr. Borthwick earned a Bachelor of Arts in
Biology from Temple University in 1975.
LAURENCE F. LANE has served as a director of the Company since June,
1995. Mr. Lane has been the Senior Vice President of Regulatory Affairs of
NovaCare, Inc., a publicly traded medical rehabilitation corporation, since
November, 1986. He has over twenty years of government relations and policy
experience. Mr. Lane has served as the Director for Special Programs of the
American Health Care Association, Director for Policy Development of the
American Association of Homes for the Aging and legislative representative of
the American Association of Retired Persons. He managed the 1980 White House
Mini-Conference on Long Term Care and served as a credentialed resource person
for the 1981 White House Conference on Aging. Mr. Lane is a member of the
following organizations: National Association for the Support of Long Term Care,
International Subacute Healthcare Association, National Association for
Rehabilitation Agencies, National Health Lawyers Association, and Healthcare
Financial Management Association. He earned Bachelor of Arts and Master of Arts
degrees from the School of Public and International Affairs of George Washington
University, Washington, D.C. Mr. Lane has pursued doctoral studies at the
Washington Public Affairs Center, University of Southern California and received
a Gerontology certificate from Andrus Gerontology Center, University of Southern
California in 1974.
SRINI CONJEEVARAM has served as director of the Company since May,
1998. Mr. Conjeevaram has been the General Partner and Chief Financial Officer
of Galen Associates, a healthcare venture capital firm, since January, 1991.
Prior to his affiliation with Galen Associates, he was an Associate in Corporate
Finance at Smith Barney from July, 1989 to December, 1990 and a Senior Project
Engineer for General Motors Corporation from April, 1982 to July, 1987. Mr.
Conjeevaram serves as a director of Halsey Drug Company, Inc., a publicly traded
company. He earned a Bachelor of Science degree in Mechanical Engineering from
Madras University, Madras, India, a Master of Science degree in Mechanical
Engineering from Stanford University, Stanford, California and a Master of
Business Administration in Finance from Indiana University, Bloomington,
Indiana.
33
<PAGE>
TIMOTHY J. PATRICK has served as director of the Company since
February, 1998. Mr. Patrick has been the President and Chief Executive Officer
of Proxima Therapeutics, Inc., a medical device company developing proprietary
site-specific delivery systems for the treatment of solid tumors, since April,
1996. He previously served as President of Gesco International, a subsidiary of
MedChem Products that manufactured and marketed PICC vascular access catheters,
from July, 1994 to January, 1996. Mr. Patrick served McGaw, Inc. for 13 years in
various sales executive positions the last of which was President of Central
Admixture Pharmacy Services, a business unit of McGaw, Inc. that provided
patient-specific intravenous solution products to hospitals and home care
companies. Mr. Patrick earned a Bachelor of Arts degree in Biology from Miami
University, Oxford, Ohio in 1981.
ARTHUR A. BEISANG has served as a director of the Company since
September, 1999. Mr. Beisang has also served as Chief Executive Officer and as
Chairman of the board of directors of the Company's Genetic Labs subsidiary
since May, 1992 and January, 1988, respectively. He served as President of
Genetic Labs from January, 1988 to May, 1992. Mr. Beisang has done post-graduate
work at Wayne State University and the University of Minnesota and is a member
of the American Association of Tissue Banks.
Compliance with Section 16(a) of the Exchange Act
Section 16(a) of the Securities Exchange Act of 1934 (the "Exchange
Act") requires the Company's directors and executive officers, and persons who
own more than ten percent of a registered class of the Company's equity
securities, to file with the Securities and Exchange Commission (the
"Commission") initial reports of ownership and reports of changes in ownership
of common stock and other equity securities of the Company. Officers, directors
and greater than ten percent shareholders are required by Commission regulation
to furnish the Company with copies of all Section 16(a) forms they file.
To the Company's knowledge, based solely on a review of the copies of
such reports furnished to the Company, all reports under Section 16(a) required
to be filed by its officers, directors and greater than ten-percent beneficial
owners were timely filed.
ITEM 10. EXECUTIVE COMPENSATION
COMPENSATION OF EXECUTIVE OFFICERS
Summary Compensation Table
The following table shows all compensation paid by the Company to its
Chairman, Chief Financial Officer and each of the Company's executive officers
whose compensation exceeded $100,000 for their services in all capacities during
the years 1996, 1997 and 1998:
<TABLE>
<CAPTION>
ANNUAL COMPENSATION
------------------- ALL OTHER
NAME AND PRINCIPAL POSITION YEAR SALARY BONUS OPTIONS (#) COMPENSATION
---- ------ ----- ----------- ------------
<S> <C> <C> <C> <C> <C>
Edward J. Quilty 1998 $150,000 $25,000 380,273(1) --
Chairman 1997 $149,986 -- 300,000(2) --
1996 $ 59,615 -- 150,000 --
Richard S. Mink 1998 $157,875 $ 6,000 -- --
Vice President and 1997 $100,961 $25,000(3) 200,000 --
Chief Operating Officer
Charles F. Caudell, III 1998 $157,875 $ 6,000 -- --
Executive Vice President for 1997 $100,961 -- 200,000 --
Field Operations
Stephen T. Wills, CPA, MST 1998 $100,000 (4) -- -- --
Vice President and 1997 $ 85,000 (5) -- 75,000 --
Chief Financial Officer
34
<PAGE>
John T. Borthwick (6) 1998 $180,000 -- -- $ 9,962 (7)
Manager - Manufacturing Representatives 1997 $180,000 -- 50,000 $ 9,962 (7)
1996 $180,000 -- -- $10,861 (7)(8)
</TABLE>
- ---------------------
(1) Options issued pursuant to the anti-dilution provisions of Mr.
Quilty's employment agreement, See Option Grants Table below.
(2) Includes 150,000 options originally granted in 1996 and repriced by
the Executive Committee of the Board of Directors on April 8, 1997.
(3) Sign-on bonus.
(4) Does not include payments of $75,500 made to an affiliate of Mr.
Wills, Golomb, Wills & Company, PC. See Certain Transactions below.
(5) Represents compensation earned during the period July through
December, 1997.
(6) John T. Borthwick resigned as Chief Executive Officer and President
in May, 1997 and November, 1997, respectively. Mr. Borthwick is no
longer an executive officer.
(7) The Company enrolled John T. Borthwick in a split-dollar life
insurance program on July 1, 1993. The monthly premiums are $830.18
for $500,000 coverage.
(8) Matching contributions made pursuant to the Company's 401(k) plan.
Option Grants Table
The following table sets forth information regarding grants of stock
options to the following named executive officer made for the year ended
December 31, 1998:
<TABLE>
<CAPTION>
PERCENT OF TOTAL EXERCISE
OPTIONS OPTIONS GRANTED TO PRICE
NAME GRANTED (#) EMPLOYEES IN 1998 ($/SHARE) EXPIRATION DATE
---- ----------- ------------------ --------- ---------------
<S> <C> <C> <C> <C>
Edward J. Quilty 380,273 (1) 50.0% $1.185 May 22, 2007
</TABLE>
- -------------------
(1) Options issued pursuant to the anti-dilution provisions of Mr.
Quilty's employment agreement. See Employment Arrangements below.
Aggregate Year End Option Value Table
The following table sets forth information regarding the aggregate
number and value of options to purchase Common Stock held by the named executive
officers as of December 31, 1998. No options have been exercised:
<TABLE>
<CAPTION>
NUMBER OF SHARES VALUE OF UNEXERCISED
UNDERLYING UNEXERCISED IN-THE-MONEY OPTIONS
OPTIONS AT DECEMBER 31, 1998 (#) AT DECEMBER 31, 1998 ($)(1)
---------------------------------- --------------------------------
NAME EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
----------- ------------- ----------- -------------
<S> <C> <C> <C> <C>
Edward J. Quilty ......................... 650,273 30,000 0 0
Richard S. Mink .......................... 132,500 67,500 0 0
Charles F. Caudell, III .................. 132,500 67,000 0 0
Stephen T. Wills, CPA..................... 66,665 8,335 0 0
John T. Borthwick ........................ 100,000 50,000 0 0
</TABLE>
- -------------------
(1) Determined based on the fair market value for the Company's Common
Stock at December 31, 1998 of $0.75 per share.
35
<PAGE>
COMPENSATION OF DIRECTORS
Outside directors are entitled to an annual retainer of $12,000. Each
outside director may elect, with respect to any calendar year, to receive his or
her retainer in options to purchase Common Stock of the Company. Upon such
election, each electing director will receive options to purchase that number of
shares of Common Stock of the Company determined by dividing $24,000 by the
Common Stock's fair market value. For a given calendar year, the Common Stock's
fair market value is the lowest average between the Common Stock's bid and asked
prices quoted on the Nasdaq SmallCap Market during the period from December 1
through December 15 of the immediately preceding calendar year.
All directors are reimbursed for expenses incurred in connection with
each board and committee meeting attended. Inside directors receive no
compensation for their services as directors.
The following table sets forth information with respect to the
non-qualified stock options owned by directors of the Company in 1998:
<TABLE>
<CAPTION>
OPTIONS EXERCISABLE OPTIONS AT EXERCISE PRICE
NAME GRANTED (#) DECEMBER 31, 1998 (#) ($/SHARE) EXPIRATION DATE
---- ----------- --------------------- --------- ---------------
<S> <C> <C> <C> <C>
Laurence F. Lane 10,000(1) 8,000 $1.125 November 21, 2006
10,000(2) 10,000 $1.125 April 7, 2007
</TABLE>
- ------------------------
(1) These options began vesting at a rate of 20% per year on November 21,
1995 and were repriced on April 8, 1997.
(2) These options were granted on April 8, 1997.
EMPLOYMENT ARRANGEMENTS
Edward J. Quilty
The Company entered into an employment agreement on August 1, 1996,
and amended on May 2, 1997, (the "Agreement") with Edward J. Quilty, its
Chairman of the Board. The term of the Agreement begins on May 21, 1996 and
expires on May 21, 1999. The Agreement provides that Mr. Quilty will receive
base salary of $150,000 per year, together with such additional incentive
compensation as may be awarded upon the recommendation of the Compensation
Committee of the Board of Directors; provided, however, additional incentive
compensation, if any, shall be predicated upon the extent to which the Company
attains its earnings goals and the extent of Mr.
Quilty's contributions thereto.
As additional compensation, the Agreement grants Mr. Quilty 150,000
non-qualified stock options, exercisable at a price of $1.125 per share, all of
which are currently exercisable. If the Company sells additional Common Stock
during the term of the Agreement in a transaction, or related series of
transactions, the result of which is to increase the number of shares of Common
Stock outstanding by 40%, then Mr. Quilty will be granted such additional stock
options, exercisable at $1.125 per share, as may be necessary to enable him to
purchase the same percentage of outstanding Common Stock as he maintained prior
to such sale or issuance.
In addition, in the event of the sale of substantially all of the
stock or assets of the Company, or upon the merger or consolidation of the
Company in which the Company is not the surviving entity, the Company shall pay
Mr. Quilty a severance payment equal to the greater of his salary for the
remaining term of the Agreement or $125,000. Mr. Quilty may not disclose any
confidential information of the Company during or after the term of the
Agreement, and may not compete with the Company during the term of the Agreement
and for a period of one year thereafter.
The Company and Mr. Quilty are currently engaged in negotiations with
a view to executing a new employment agreement providing for Mr. Quilty's
continued service as Chairman and his assumption of the roles of President and
Chief Executive Officer.
Richard S. Mink
The Company entered into a two-year employment agreement on April 14,
1997, (the "Agreement") with Richard S. Mink, its Vice President and Chief
Operating Officer. The Agreement provides that Mr. Mink receive the
36
<PAGE>
following: (1) base salary of $150,000 per year, together with a $25,000 sign-on
bonus; (2) incentive compensation as may be awarded upon the recommendation of
the Office of the Chief Executive and approved by the Board of Directors;
provided, however, incentive compensation, if any, shall be predicated upon the
extent to which the Company attains its earnings goals and the extent of Mr.
Mink's contributions thereto; and (3) 118,000 incentive and 32,000 non-qualified
stock options, exercisable at $1.125, which options become exercisable to the
extent of 50%, 75% and 100% upon completion of six, eighteen and twenty-four
months of employment, respectively. These options become 100% exercisable if Mr.
Mink becomes disabled, the Agreement is terminated by the Company other than
"for cause," the Agreement is terminated by Mr. Mink for the Company's breach,
upon the sale of substantially all of the stock or assets of the Company, or
upon the merger or consolidation of the Company in which the Company is not the
surviving entity.
Upon the sale of substantially all of the stock or assets of the
Company, or upon the merger or consolidation of the Company in which the Company
is not the surviving entity, the Company shall pay Mr. Mink a severance payment
equal to the greater of his salary for the remaining term of the Agreement or
$150,000. Mr. Mink may not disclose any confidential information of the Company
during or after the term of the agreement, and may not compete with the Company
during the term of the Agreement and for a period of one year thereafter.
The Company and Mr. Mink are currently engaged in negotiations with a
view to executing a new employment agreement providing for Mr. Mink's continued
service.
Charles F. Caudell, III
The Company entered into a two-year employment agreement on April 21,
1997, (the "Agreement") with Charles F. Caudell, III, its Executive Vice
President for Field Operations. The Agreement provides that Mr. Caudell receive
the following: (1) base salary of $150,000 per year; (2) incentive compensation
as may be awarded upon the recommendation of the Office of the Chief Executive
and approved by the Board of Directors; provided, however, incentive
compensation, if any, shall be predicated upon the extent to which the Company
attains its earnings goals and the extent of Mr. Caudell's contributions
thereto; and (3) 118,000 incentive and 32,000 non-qualified stock options,
exercisable at $1.125, which options become exercisable to the extent of 50%,
75% and 100% upon completion of six, eighteen and twenty-four months of
employment, respectively. These options become 100% exercisable if Mr. Caudell
becomes disabled, the Agreement is terminated by the Company other than "for
cause," the Agreement is terminated by Mr. Caudell for the Company's breach,
upon the sale of substantially all of the stock or assets of the Company, or
upon the merger or consolidation of the Company in which the Company is not the
surviving entity.
Upon the sale of substantially all of the stock or assets of the
Company, or upon the merger or consolidation of the Company in which the Company
is not the surviving entity, the Company shall pay Mr. Caudell a severance
payment equal to the greater of his salary for the remaining term of the
Agreement or $150,000. Mr. Caudell may not disclose any confidential information
of the Company during or after the term of the agreement, and may not compete
with the Company during the term of the Agreement and for a period of one year
thereafter.
The Company and Mr. Caudell are currently engaged in negotiations
with a view to executing a new employment agreement
providing for Mr. Caudell's continued service.
Stephen T. Wills, CPA, MST
The Company entered into an employment agreement on February 1, 1999
(the "Agreement") with Stephen T. Wills, CPA, MST, its Vice President and Chief
Financial Officer. The Agreement carries an indefinite term which can be
canceled by either party upon thirty days notice. The Agreement provides that
Mr. Wills receive the following: (1) base salary of $102,000 per year, together
with incentive compensation as may be awarded upon the recommendation of the
Chairman and approved by the Board of Directors; and (2) 100,000 non-qualified
stock options, exercisable at $1.20, which options became exercisable in 25,000
increments commencing on February 1, 1999 and on each anniversary thereof
through February 1, 2002. These options become 100% exercisable upon a change in
ownership of in excess of 75% of the Company or the sale by the Company of
substantially all of its assets. Upon termination of the Agreement by the
Company without cause, the Company will pay Mr. Wills a severance payment equal
to his salary for one year and will extend the period to exercise the options
granted under the Agreement to the earlier of five years or December 14, 2008.
37
<PAGE>
John T. Borthwick
The Company entered into a five-year employment agreement on December
29, 1995, as amended on March 5, 1997, (the "Agreement") with John T. Borthwick,
its Director of Business Development and former President and Chief Executive
Officer. The Agreement provides that Mr. Borthwick will receive base
compensation of $180,000 during the calendar years 1996, 1997 and 1998 and base
compensation for the calendar years 1999 and 2000 to be determined by the Board
of Directors upon the recommendation of the Compensation Committee, together
with such incentive and/or bonus compensation as may be awarded upon the
recommendation of the Compensation Committee; provided, however, incentive
and/or bonus compensation, if any, will be predicated upon the extent to which
the Company attains its earnings goals and the extent of Mr. Borthwick's
contributions thereto. As additional compensation, the Agreement grants Mr.
Borthwick 100,000 non-qualified stock options, exercisable at a price of $2.31
per share, of which 80,000 were vested as of January 1, 1999 and the remaining
20,000 vest on January 1, 2000.
If the Company sells additional Common Stock during the term of the
Agreement in a transaction, or related series of transactions, the result of
which is to increase the number of shares of Common Stock outstanding by 40%,
the Agreement provides that Mr. Borthwick will then be granted such additional
stock options, exercisable at $2.31 per share, as may be necessary to enable him
to purchase the same percentage of outstanding Common Stock as he maintained
prior to such sale or issuance. In addition, in the event of a sale of
substantially all of the stock or assets of the Company, or a merger or
consolidation of the Company in which the Company is not the surviving entity,
or upon the written agreement of the Company to effect such sale, merger or
consolidation, Mr. Borthwick will have the option of completing the remaining
term of his employment under the Agreement or receiving severance compensation
equal to his base compensation earned during the twelve-month period
immediately preceding such sale, merger or consolidation. Further, in the event
of such sale, merger or consolidation: (1) the stock options granted pursuant to
the Agreement will become exercisable in their entirety and will remain
exercisable for a period of not less than thirty (30) days; and (2) the
promissory note between Mr. Borthwick and the Company dated January 17, 1995 in
the original principal amount of $99,530.34 will be forgiven.
The Agreement further provides that Mr. Borthwick will receive a
severance payment of 100% of his base compensation earned during the
twelve-month period immediately preceding the expiration of the Agreement if the
Company does not renew or extend the term of the Agreement upon expiration
thereof. The Agreement also provides that Mr. Borthwick will receive: (i) a
vehicle for use primarily (but not exclusively) in the conduct of Company
business, (ii) split-dollar life insurance in the face amount of $500,000, and
(iii) disability income insurance providing for payments of 50% of compensation.
Mr. Borthwick may not disclose any confidential information of the Company
during or after the term of the Agreement, and may not compete with the Company
during the term of the Agreement and for a period of one year thereafter.
STOCK OPTION PLAN
The Company adopted the Stock Option Plan, (the "Plan") in July 1991,
and amended the Plan in January, 1994, November 21, 1995 and July 14, 1998. The
number of shares of common stock reserved for issuance pursuant to the Plan is
1,500,000 shares. The Plan authorizes the Company to grant two types of equity
incentives: (i) options intended to qualify as "incentive stock options"
("ISOs") as defined in Section 422 of the Internal Revenue Code of 1986, as
amended, and (ii) non-qualified stock options ("NQSOs"). The Plan authorizes
options to be granted to directors, officers, key employees and consultants of
the Company, except that ISOs may be granted only to employees. The Plan is
administered by a committee of disinterested directors designated by the Board
of Directors (the "Compensation Committee"). Subject to the provisions of the
Plan, the Compensation Committee determines who is eligible to receive stock
options, together with the nature, amount, timing, exercise price, vesting
schedule and all other terms and conditions of the options to be granted.
Under the Plan, ISOs and NQSOs may have a term of up to ten years.
Stock options are not assignable or transferable except by will or the laws of
descent and distribution. Stock options granted under the Plan which have lapsed
or terminated revert to the status of "unissued" and become available for
reissuance.
At December 31, 1998, options to purchase 381,000 shares of the
Company's common stock at prices ranging from $0.80 to $1.125 per share had been
granted under the Plan.
38
<PAGE>
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth certain information regarding the
current beneficial ownership of shares of the Company's Common Stock on March
26, 1999 by: (i) each person known by the Company to own beneficially more than
5% of the outstanding shares of Common Stock, (ii) each director of the Company,
(iii) each officer of the Company, and (iv) all directors and officers of the
Company as a group:
<PAGE>
<TABLE>
<CAPTION>
NUMBER OF SHARES PERCENT
NAME AND ADDRESS OF BENEFICIAL OWNER (1) BENEFICIALLY OWNED (14) BENEFICIALLY OWNED (14)
---------------------------------------- ---------------------- -----------------------
<S> <C> <C>
Srini Conjeevaram (2).............................................. 5,166,670 45.31%
Hambrecht & Quist California (3)................................... 2,241,668 26.44%
Redwood Asset Management (4)....................................... 1,198,334 16.37%
Edward J. Quilty (5)............................................... 1,144,107 15.96%
Mary G. Clark, RN ................................................. 775,474 12.44%
Aries Funds (6).................................................... 750,000 10.70%
John T. Borthwick (7).............................................. 369,414 5.82%
Charles F. Caudell, III (8) ....................................... 312,668 4.82%
Richard S. Mink (9) ............................................... 284,168 4.38%
Stephen T. Wills, CPA (10)......................................... 279,168 4.31%
Arthur A. Beisang (11)............................................. 237,678 3.81%
Laurence F. Lane (12).............................................. 26,000 (*)
Timothy J. Patrick ................................................ 0 (*)
All directors and officers as a group (9 persons) (13) ............ 7,819,871 75.21%
</TABLE>
- -------------------------
(1) Except as otherwise noted, the address of each of the persons listed is:
214 Carnegie Center, Suite 100, Princeton, New Jersey 08540.
(2) Srini Conjeevaram is a general partner of the Galen III Partnerships. The
Galen III Partnerships can be reached at: 610 Fifth Avenue, Fifth Floor,
New York, New York 10020. Includes shares owned by Galen Partners III,
L.P., Galen Partners International III, L.P. and Galen Employee Fund III,
L.P. Ownership consists of: 625,000 shares of Class A Convertible
Preferred Stock ("Class A Preferred"); 375,000 warrants to purchase
Common Stock exercisable at $0.90 per share ("Class A Warrants");
2,083,335 shares of Class B Convertible Preferred Stock ("Class B
Preferred"); and 2,083,335 warrants to purchase Common Stock exercisable
at $1.35 per share ("Class B Warrants").
(3) Hambrecht & Quist California can be reached at: One Bush Street, San
Francisco, California 94104. Ownership consists of: 612,500 shares of
Class A Preferred; 612,500 Class A Warrants; 508,334 shares of Class B
Preferred; and 508,334 Class B Warrants.
(4) Redwood Asset Management can be reached at: Ovre Ullorn Terrasse 32, 0358
Oslo, Norway. Ownership consists of: 115,000 shares of Common Stock;
250,000 Class A Warrants; 416,667 Class B Preferred; and 416,667 Class B
Warrants.
(5) Ownership consists of: 210,500 shares of Common Stock; 190,000 Class A
Warrants; 41,667 shares of Class B Preferred; 41,667 Class B Warrants;
exercisable options to purchase 650,273 shares of Common Stock; and
options to purchase 10,000 shares of Common Stock which will become
exercisable within 60 days of March 26, 1999.
(6) The Aries Funds can be reached at: Paramount Capital, Inc., The Aries
Fund, 787 Seventh Avenue, 48th Floor, New York, New York 10019. Includes
shares owned by The Aries Fund, A Cayman Islands Trust and Aries Domestic
Fund, L.P. Ownership consists of:
375,000 shares of Class A Preferred; and 375,000 Class A Warrants.
(7) Ownership consists of: 259,414 shares of Common Stock; exercisable
options to purchase 100,000 shares of Common Stock; and options to
purchase 10,000 shares of Common Stock will become exercisable within 60
days of March 26, 1999.
(8) Ownership consists of: 59,750 shares of Common Stock; 31,250 Class A
Warrants; 20,834 shares of Class B Preferred; 20,834 Class B Warrants;
exercisable options to purchase 132,500 shares of Common Stock; and
options to purchase 47,500 shares of Common Stock will become exercisable
within 60 days of March 26, 1999.
39
<PAGE>
(9) Ownership consists of: 31,250 shares of Common Stock; 31,250 Class A
Warrants; 20,834 shares of Class B Preferred; 20,834 Class B Warrants;
exercisable options to purchase 132,500 shares of Common Stock; and
options to purchase 47,500 shares of Common Stock will become exercisable
within 60 days of March 26, 1999.
(10) Ownership consists of 38,750 shares of Common Stock; 38,750 Class A
Warrants; 20,834 shares of Class B Preferred; 20,834 Class B Warrants;
and exercisable options to purchase 160,000 shares of Common Stock. No
additional options to purchase Common Stock will become exercisable
within 60 days of March 26, 1999.
(11) Ownership consists of: 237,678 shares of Common Stock.
(12) Ownership consists of: 8,000 shares of Common Stock; and exercisable
options to purchase 18,000 shares of Common Stock. No additional shares
subject to options will become exercisable within 60 days of March 26,
1999.
(13) Ownership consists of: an aggregate of 3,657,845 shares of Common Stock,
Class A Preferred and Class B Preferred; and options currently
exercisable and exercisable within 60 days of March 26, 1999 to purchase
4,162,026 shares of Common Stock.
(14) The number of shares beneficially owned and the percent beneficially
owned by each entity or individual assume the exercise of all exercisable
options (including those that would be exercisable within 60 days of
March 26, 1999) and the exercise of all warrants owned by such entity or
individual.
(*) Less than one percent
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
During 1998, the Company employed the accounting firm of Golomb, Wills &
Company, PC for various tax and financial planning services. Stephen T. Wills,
CPA, MST, Vice President and Chief Financial Officer of the Company, is a
principal of Golomb, Wills & Company, PC. Payments to Golomb, Wills & Company,
PC during 1998 totaled $75,500.
The Company has a five-year consulting agreement with its founder and
former President and director, Mary G. Clark. In 1998 compensation under this
agreement was $99,000.
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
<TABLE>
<CAPTION>
Exhibit
Number Description Page
- ------ ----------- ----
<S> <C> <C>
3.1 Articles of Incorporation effective June 3, 1996 (previously filed as --
Exhibit B to the Company's Proxy Statement filed on April 23, 1996
and incorporated herein by reference).
3.2 Amendment to the Articles of Incorporation effective February 10, --
1998 (previously filed as Exhibit A to the Company's Proxy Statement
filed on December 22, 1997 and incorporated herein by reference).
3.3 Amendment to the Articles of Incorporation effective October 20, 1998 --
(previously filed as Exhibit A to the Company's Proxy Statement filed
on August 14, 1998 and incorporated herein by reference).
3.4 Bylaws effective May 14, 1997 (previously filed as Exhibit 3.1 to the --
Company's Form 10-QSB filed on August 15, 1997 and incorporated
herein by reference).
10.01 Agreement and Plan of Merger dated as of July 7, 1998 by and among --
Derma Sciences, Inc., Derma Merging Corporation and Genetic
Laboratories Wound Care, Inc. (previously filed as Appendix A to the
Company's Form S-4 Registration Statement filed on July 17, 1998 and
incorporated herein by reference).
10.02 Stock Purchase Agreement with annexes dated October 29, 1998 by and --
among Derma Sciences, Inc., the John G. Vogel, Jr. Revocable Trust
U/A dated August 23, 1995, Martha A. Crimmins, the Gordon E. Cory
Revocable Trust U/A dated August 24, 1995, John G. Vogel, Jr., Gordon
E. Cory and Sunshine Products, Inc. (previously filed as Exhibit 2.1
to the Company's Form 8-K filed on November 13, 1998 and incorporated
by reference).
40
<PAGE>
10.03* Employment Agreement, dated August 1, 1996, between the Company and --
Edward J. Quilty (previously filed as Exhibit 10.41 to the Company's
Form 10-KSB filed on March 24, 1997 ["1996 Form 10-KSB"] and
incorporated herein by reference).
10.04* Employment Agreement - Amendment and Restatement, dated May 2, 1997, --
between the Company and Edward J. Quilty (previously filed as Exhibit
10.04 to the Company's Form 8-K filed on May 6, 1997 and incorporated
herein by reference).
10.05* Senior Management Stock Option Agreement, dated April 30, 1997, --
between the Company and Edward J. Quilty (previously filed as Exhibit
10.05 to the Company's Form 8-K filed on May 6, 1997 and incorporated
herein by reference).
10.06* Employment Agreement, dated April 14, 1997 between the Company and --
Richard S. Mink (previously filed as Exhibit 10.01 to the Company's
Form 8-K filed on May 6, 1997 and incorporated herein by reference).
10.07* Employment Agreement, dated April 21, 1997 between the Company and --
Charles F. Caudell, III (previously filed as Exhibit 10.02 to the
Company's Form 8-K filed on May 6, 1997 and incorporated herein by
reference).
10.08* Senior Management Stock Option Agreement, dated April 14, 1997, --
between the Company and Richard S. Mink (previously filed as Exhibit
10.10 to the Company's Form 8-K filed on May 6, 1997 and incorporated
herein by reference).
10.09* Senior Management Stock Option Agreement, dated April 21, 1997, --
between the Company and Charles F. Caudell, III (previously filed as
Exhibit 10.08 to the Company's Form 8-K filed on May 6, 1997 and
incorporated herein by reference).
10.10* Stock Option Agreement, dated July 23, 1997, between the Company and --
Stephen T. Wills, CPA, MST (previously filed as Exhibit 10.01 to the
Company's Form 10-QSB filed on August 15, 1997).
10.11* Employment Agreement, dated December 29, 1995, between the Company --
and John T. Borthwick (previously filed as Exhibit 10.37 to the
Company's Form 10-KSB filed on March 29, 1996 ["1995 Form 10-KSB"]
and incorporated herein by reference).
10.12* Addendum to Employment Agreement, dated March 5, 1997, between the --
Company and John T. Borthwick (previously filed as Exhibit 10.38 to
the Company's 1996 Form 10-KSB and incorporated herein by reference).
10.13* Senior Management Stock Option Agreement, dated April 30, 1997, --
between the Company and John T. Borthwick (previously filed as
Exhibit 10.06 to the Company's Form 8-K filed on May 6, 1997 and
incorporated herein by reference).
10.14* Employment Agreement, dated December 29, 1995, between the Company --
and Robert P. DiGiovine (previously filed as Exhibit 10.41 to the
Company's 1995 Form 10-KSB and incorporated herein by reference).
10.15* Employment Agreement - Amendment and Restatement, dated April 30, --
1997, between the Company and Robert P. DiGiovine (previously filed
as Exhibit 10.03 to the Company's Form 8-K filed on May 6, 1997 and
incorporated herein by reference).
10.16* Senior Management Stock Option Agreement, dated April 30, 1997, --
between the Company and Robert P. DiGiovine (previously filed as
Exhibit 10.09 to the Company's Form 8-K filed on May 6, 1997 and
incorporated herein by reference).
10.17* Promissory Note, dated January 17, 1995, between the Company and John --
T. Borthwick (previously filed as Exhibit 10.73 to the Company's Form
10-KSB filed on March 30, 1995 ["1994 Form 10-KSB"] and incorporated
herein by reference).
10.18* Stock Option Agreement, dated November 21, 1995, between the Company --
and Laurence F. Lane (previously filed as Exhibit 10.51 to the
Company's 1995 Form 10-KSB and incorporated herein by reference).
10.30* Employment Agreement, dated May 1, 1998, between the Company and --
Arthur A. Beisang (previously filed as Exhibit 10.30 to the Company's
Form 10-KSB filed on March 31, 1999) ["1998 Form 10-KSB"] and
incorporated herein by reference).
10.31* Employment Agreement, dated May 1, 1998, between the Company and --
Robert A. Ersek (previously filed as Exhibit 10.31 to the Company's
1998 Form 10-KSB and incorporated herein by reference).
10.32* Employment Agreement, dated May 1, 1998, between the Company and H. --
James Thompson (previously filed as Exhibit 10.32 to the Company's
1998 Form 10-KSB and incorporated herein by reference).
41
<PAGE>
10.33 Stock Option Agreement dated October 29, 1998 by and between Derma --
Sciences, Inc. and John G. Vogel, Jr. (previously filed as Exhibit
10.01 to the Company's Form 8-K filed on November 13, 1998 and
incorporated by reference).
10.34 Stock Option Agreement dated October 29, 1998 by and between Derma --
Sciences, Inc. and Martha A. Crimmins (previously filed as Exhibit
10.02 to the Company's Form 8-K filed on November 13, 1998 and
incorporated by reference).
10.35 Stock Option Agreement dated October 29, 1998 by and between Derma --
Sciences, Inc. and Gordon E. Cory (previously filed as Exhibit 10.03
to the Company's Form 8-K filed on November 13, 1998 and incorporated
by reference).
10.36 Settlement Agreement dated June 8, 1998 between Registrant and ABS --
LifeSciences, Inc. (previously filed as Exhibit 10 to the Company's
Form 8-K filed on June 10, 1998 and incorporated by reference).
10.37 Lease Agreement, dated December 16, 1991, between KK Three --
Corporation and Genetic Laboratories Wound Care, Inc. (previously
filed as Exhibit 10.37 to the Company's 1998 Form 10-KSB and
incorporated herein by reference).
10.38 Lease Agreement, dated January 5, 1994, between James S. Reid, --
Frances S. Reid and Joan R. Milburn and Sunshine Products, Inc.
(previously filed as Exhibit 10.38 to the Company's 1998 Form 10-KSB
and incorporated herein by reference).
10.39 Lease Agreement, dated July 1, 1997, between the Company and Cross --
Creek Pointe (previously filed as Exhibit 10.44 to the Company's Form
10-KSB filed on March 31, 1998 ["1997 Form 10-KSB"] and incorporated
by reference).
10.40 Lease Agreement, dated September 1, 1993, between the Company and --
Mariotti Building Products (previously filed as Exhibit 10.51 to the
Company's Registration Statement filed on Form SB-2, No. 33-52246-NY,
declared effective on May 13, 1994 ["Registration Statement"] and
incorporated herein by reference).
10.41 Distribution Agreement, dated April 8, 1995, between the Company and --
Inter-Health, Inc. (previously filed as Exhibit 10.02 to the
Company's Form 10-QSB filed on June 30, 1995 and incorporated herein
by reference).
10.42 Distribution Agreement, dated January 29, 1996, between the Company --
and Manta Medical (previously filed as Exhibit 10.36 to the Company's
1995 Form 10-KSB and incorporated herein by reference).
10.43 Generic Products Agreement, dated September 29, 1997, between the --
Company and Innovative Technologies Ltd. (previously filed as Exhibit
10.01 to the Company's Form 10-QSB filed on November 10, 1997 and
incorporated herein by reference).
10.44 Private Label Agreement, dated September 29, 1997, between the --
Company and Innovative Technologies Ltd. (previously filed as Exhibit
10.02 to the Company's Form 10-QSB filed on November 10, 1997 and
incorporated herein by reference).
10.45 Asset Purchase Agreement, dated June 21, 1996, between the Company --
and Morgan Paris, Inc. (previously filed as Exhibit 10.01 to the
Company's Form 8-K filed on June 27, 1996 and incorporated herein by
reference).
10.46 Settlement Agreement and Mutual Release, dated June 21, 1996, between --
the Company and Morgan Paris, Inc. (previously filed as Exhibit 10.02
to the Company's Form 8-K filed on June 27, 1996 and incorporated
herein by reference).
10.47 Agreement and Release, dated May 29, 1997, between the Company and --
Gary L. Borthwick (previously filed as Exhibit 10 to the Company's
Form 8-K filed on July 1, 1997 and incorporated herein by reference).
10.48 Consulting Agreement, dated March 14, 1994, between the Company and --
Mary G. Clark (previously filed as Exhibit 10.80 to the Company's
Registration Statement and incorporated herein by reference).
10.49 Agreement and Release, dated December 23, 1996, between the Company --
and Donald F. McHale (previously filed as Exhibit 10.01 to the
Company's Form 8-K filed on January 6, 1997).
10.50 Manufacturers Agreement, dated August 25, 1992, between the Company --
and TapeMark Company (previously filed as Exhibit 10.50 to the
Company's 1998 Form 10-KSB and incorporated herein by reference).
42
<PAGE>
10.60* Stock Option Plan, dated July 18, 1991 (previously filed as Exhibit --
10.01 to the Company's Registration Statement and incorporated herein
by reference).
10.61* Stock Option Plan Amendment, dated January 14, 1994 (previously filed --
as Exhibit 10.02 to the Company's Registration Statement and
incorporated herein by reference).
10.62* Stock Option Plan Amendment, dated November 21, 1995 (previously --
filed as Exhibit 10.03 to the Company's 1995 Form 10-KSB and
incorporated herein by reference).
10.63* Stock Option Plan Amendment, dated July 14, 1998 (previously filed as --
Appendix C to the Company's Registration Statement on Form S-4 filed
July 17, 1998 and incorporated herein by reference).
10.64* The Company's 401(k) Plan, dated June 30, 1995 (previously filed as --
Exhibit 10.56 to the Company's 1995 Form 10-KSB and incorporated
herein by reference).
21 Information relative to subsidiaries (previously filed as Exhibit 21 to --
the Company's 1998 Form 10-KSB and incorporated herein by reference).
23.1 Consent of Ernst & Young LLP --
23.2 Consent of Ernst & Young LLP --
23.2 Consent of Ernst & Young LLP --
27 Financial Data Schedule (previously filed as Exhibit 27 to the --
Company's 1998 Form 10-KSB and incorporated herein by reference).
* Management contract or compensatory plan.
</TABLE>
(b) Reports on Form 8-K
A current report on Form 8-K was filed on November 13, 1998, and
amended on January 11 and February 11, 1999 relative to the Company's
acquisition of Sunshine Products, Inc.
43
<PAGE>
SIGNATURES
In accordance with Section 13 or 15(d) of the Securities Exchange Act
of 1934, the Registrant has duly caused this report to be signed on its behalf
by the undersigned, thereunto duly authorized.
DERMA SCIENCES, INC.
May 3, 1999 By: /s/ Edward J. Quilty
-----------------------
Edward J. Quilty
Chairman
44
Exhibit 23.1
Consent of Independent Auditors
We consent to the reference to our firm under the caption "Experts" in the
Registration Statement (Form S-3 No. 333-45983) and related Prospectus of Derma
Sciences, Inc. for the registration of 3,750,000 shares of its common stock and
to the incorporation by reference therein of our report dated February 18, 1998,
with respect to the financial statements of Derma Sciences, Inc. included in its
Annual Report (Form 10-KSB) for the year ended December 31, 1997, filed with the
Securities and Exchange Commission.
/s/ ERNST & YOUNG LLP
Philadelphia, Pennsylvania
March 31, 1999
Exhibit 23.2
Consent of Independent Auditors
We consent to the reference to our firm under the caption "Experts" in the
Registration Statement (Form S-3 No. 333-45983) and related Prospectus of Derma
Sciences, Inc. for the registration of 3,750,000 shares of its common stock and
to the incorporation by reference therein of our report dated February 25, 1999,
with respect to the financial statements of Derma Sciences, Inc. included in its
Annual Report (Form 10-KSB) for the year ended December 31, 1997, filed with the
Securities and Exchange Commission.
/s/ ERNST & YOUNG LLP
Philadelphia, Pennsylvania
March 31, 1999
Exhibit 23.3
Consent of Independent Auditors
We consent to the reference to our firm under the caption "Experts" in the
Registration Statement (Form S-3 No. 333-72107) and related Prospectus of Derma
Sciences, Inc. for the registration of 6,375,012 shares of its common stock and
to the incorporation by reference therein of our report dated February 25, 1999,
with respect to the financial statements of Derma Sciences, Inc. included in its
Annual Report (Form 10-KSB) for the year ended December 31, 1998, filed with the
Securities and Exchange Commission.
/s/ ERNST & YOUNG LLP
Philadelphia, Pennsylvania
March 31, 1999
