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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
(MARK ONE)
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/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
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FOR THE FISCAL YEAR ENDED MARCH 31, 2000
COMMISSION FILE NO. 0-20970
VISION-SCIENCES, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
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DELAWARE 13-3430173
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NUMBER)
9 STRATHMORE ROAD 01760
NATICK, MASSACHUSETTS (ZIP CODE)
(ADDRESS OF PRINCIPAL EXECUTIVE
OFFICES)
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REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (508) 650-9971
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SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
COMMON STOCK, PAR VALUE $.01
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Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No / /
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. ______
Aggregate market value of Common Stock held by non-affiliates of the
Registrant as of May 26, 2000 based upon the last sale price of the Common Stock
on the Nasdaq SmallCap
Market as reported by Nasdaq: $13,042,915
Number of shares outstanding of the Registrant's Common Stock as of May 26,
2000 20,933,413
Documents incorporated by reference: Portions of the Proxy Statement for the
2000 Annual Meeting of Stockholders are incorporated by reference into Part III
of this Form 10-K.
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PART I
ITEM 1. BUSINESS
This Annual Report on Form 10-K contains forward-looking statements,
including statements about new product introductions, expectations as to future
sales of the products of Vision-Sciences, Inc. (the "Company"), the availability
of supplies, the sufficiency of the Company's capital resources to meet
anticipated capital requirements, the Company's intentions to continue selling
through its indirect sales force and the Company's expectations as to future
expenditures, including research and development expenditures. For this purpose,
any statements contained herein that are not statements of historical fact may
be deemed to be forward-looking statements. Without limiting the foregoing, the
words "believes", "anticipates", "plans", "expects", and similar expressions are
intended to identify forward-looking statements. These forward-looking
statements involve risks and uncertainties, and the Company's actual results may
differ significantly from the results discussed in the forward-looking
statements. Factors that might cause such a difference include, but are not
limited to the availability of capital resources, the availability of
third-party reimbursement, government regulation, commercialization and
technological difficulties, general economic conditions and other risks detailed
below. See "Certain Factors That May Affect the Company's Future Operating
Results."
The Company develops, manufactures and markets products for endoscopy which
have infection control and economic advantages over conventional flexible
endoscopes. The Company has developed, and is marketing, proprietary flexible
endoscope systems designed to eliminate the risk of cross-contamination to
patients and health-care professionals and that also provide quick changeover
between patients by eliminating the difficult task of cleaning the endoscopes.
The risk of cross-contamination results from the reuse of conventional flexible
endoscopes. The Company's systems consist of two main components--a proprietary
sterile disposable sheath, known as an EndoSheath-Registered Trademark- System
("EndoSheath") and a reusable flexible endoscope incorporating the Company's
proprietary design. The EndoSheath is designed to cover all surfaces of the
endoscope that come in contact with the patient and contains the air, water,
suction and accessory channels that are a part of conventional flexible
endoscopes, thus providing a contamination-free instrument and substantially
reducing the burdensome cleaning required of conventional flexible endoscopes.
The Company has developed a family of disposable EndoSheath/reusable flexible
endoscope systems for gastrointestinal ("GI") endoscopy and began commercial
shipments of its first such system, a fiberoptic sigmoidoscope, in April 1993.
The Company also manufactures and sells disposable EndoSheaths for use with
certain conventional nasopharyngo-laryngoscopes ("ENT endoscopes") currently
sold by the Company and other manufacturers. In December 1992 the Company began
commercial shipments of its first such EndoSheath, for use with one of its ENT
endoscopes. In January 1993 the Company received clearance from the U.S. Food
and Drug Administration (the "FDA") to market four additional disposable
EndoSheaths for use with certain other ENT endoscopes. In February 1994 the
Company received clearance from the FDA to market its black and white CCD video
sigmoidoscope and EndoSheath system. In February 1995 the Company received
clearance from the FDA to market its 130 cm length fiberoptic colonoscope and
EndoSheath system and its fiberoptic gastroscope and EndoSheath system. In
December 1995 the Company received clearance from the FDA to market its
fiberoptic ENT scope. In December 1996 the Company received clearance from the
FDA to market its fiberoptic bronchoscope and EndoSheath system. In
January 1997 the Company received clearance from the FDA to market its color
video sigmoidoscope. In April 1999 the Company received clearance from the FDA
to market its Slide-On-TM- EndoSheath for use with not only the Company's ENT
endoscope, but also for ENT endoscopes of other companies.
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ENDOSCOPY
BACKGROUND
Endoscopy is a minimally invasive technique that is being used with
increased frequency in a growing number of medical applications. Endoscopes are
used for a variety of screening and diagnostic procedures and are also used
therapeutically as an alternative to more traditional surgical procedures.
Endoscopic therapeutic procedures, unlike more traditional "open" surgical
procedures, can be performed without a major incision, in most cases without
general anesthesia, and are, therefore, safer and less expensive than
traditional surgical procedures. In addition, endoscopic procedures are
typically performed on an outpatient basis and generally involve less recovery
time and patient discomfort than traditional surgery. The patient benefits and
cost savings associated with endoscopy have caused many governmental
reimbursement programs and private health insurance plans to encourage the use
of endoscopic procedures in a number of medical applications.
Flexible endoscopes are tubular instruments that enter the body through a
natural orifice and enable physicians to view the interior of a body organ or
cavity remotely and perform various screening, diagnostic, and therapeutic
procedures. Flexible endoscopes generally utilize fiberoptic bundles or video
camera technology for image production. The physician can steer the distal
portion of a flexible endoscope with control knobs on the endoscope's operator
body. By maneuvering the tip of the endoscope, the physician can access body
regions through lengthy and twisted passageways (such as the colon) and perform
a variety of procedures. Most flexible endoscopes contain a series of channels
running the length of the endoscope for delivery of air, water, suction and
accessory devices, such as biopsy forceps and cutting instruments.
Rigid endoscopes generally utilize a stainless steel tube encasing a series
of high resolution lenses to transmit the optical image. Most rigid endoscopes
do not contain the channels that are characteristic of flexible endoscopes.
Rigid endoscopes are currently utilized for diagnostic and surgical procedures
such as arthroscopy, laparoscopy, and urological and gynecological procedures.
While rigid endoscopes for other medical applications, such as bronchoscopes,
sigmoidoscopes, and nasopharyngo-laryngoscopes are still marketed, they have
largely been supplanted by flexible endoscopes, which offer improved patient
comfort and better handling capabilities. The Company does not currently plan to
manufacture endoscopes for the rigid endoscope market.
APPLICATIONS
Flexible endoscopes are widely used in hospitals, clinics and physicians'
offices, primarily on an outpatient basis. The Company's flexible endoscopes are
designed primarily for screening, diagnostic and therapeutic procedures in
fields such as gastroenterology, surgery, primary care, otolaryngology
(ear-nose-throat medicine, or "ENT") and pulmonary medicine. The Company
estimates, based on various industry sources, that approximately 20 million
flexible endoscopic procedures in these fields were performed in the United
States in 1995.
GASTROINTESTINAL ENDOSCOPY. The Company estimates that based on industry
sources, over 12 million flexible endoscopic procedures involving the screening,
diagnosis or treatment of the colon, esophagus, stomach and duodenum were
performed in the United States in 1995. Continued growth in such procedures is
expected to result from an increase in sigmoidoscopies performed for the purpose
of detecting cancer of the descending colon, as well as the increased medical
needs associated with an aging population. The American Cancer Society has
recommended that every adult over the age of 50 (currently approximately
65 million Americans) receive a screening sigmoidoscopy every three to five
years.
The most common flexible endoscopes used in gastrointestinal endoscopy are
as follows:
- SIGMOIDOSCOPES are used for viewing the sigmoid colon and descending colon
for screening and diagnostic purposes, such as screening for colon cancer.
An estimated 4.7 million procedures were
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performed in the United States in 1995 by gastroenterologists, family
practitioners, and general and colon-rectal surgeons in hospitals,
clinics, and physicians' offices primarily on an outpatient basis.
- COLONOSCOPES are used for viewing the complete colon for screening,
diagnostic and therapeutic purposes, such as removing polyps. Colonoscopy
is often performed following sigmoidoscopy. An estimated 3.6 million
procedures were performed in the United States in 1995, primarily by
gastroenterologists and colon-rectal surgeons in hospitals and clinics.
- GASTROSCOPES are used for viewing the esophagus and the stomach for
diagnostic and therapeutic purposes, such as detecting and cauterizing
ulcers. An estimated 4.2 million procedures were performed in the United
States in 1995 by gastroenterologists in hospitals and clinics.
- DUODENOSCOPES are used for viewing and intubating the biliary and
pancreatic ducts from the duodenum for diagnostic and therapeutic
purposes, such as detecting gallstones. An estimated 400,000 procedures
were performed in the United States in 1995 by gastroenterologists in a
hospital setting.
ENT ENDOSCOPES. These endoscopes are used for viewing the ears, nose,
throat and larynx for diagnostic purposes, such as testing for throat cancer.
The Company estimates that based on industry sources, approximately 4 million
such procedures were performed in the United States in 1995, generally by
otolaryngologists and allergists in hospitals, clinics, and physicians' offices.
PULMONARY ENDOSCOPES. A bronchoscope and an intubation endoscope are
flexible endoscopes used for viewing the trachea, bronchi and lungs for
diagnostic and therapeutic purposes, generally by pulmonary specialists and
anesthesiologists in a clinic or hospital setting. The Company estimates that
based on industry sources, approximately 1 million procedures using flexible
bronchoscopes were performed in the United States in 1995. Because pneumonia is
common in persons infected with the HIV virus, and because bronchoscopy is often
used to make this diagnosis, there has been increased usage of bronchoscopes for
this purpose, as well as greater recognition of the need to perform
bronchoscopies in a contamination-free manner to protect both the HIV positive
patients (who have weakened immune systems) and subsequent patients on whom the
bronchoscope is used.
PROBLEMS WITH CONVENTIONAL FLEXIBLE ENDOSCOPES
While endoscopy represents a significant advance in the field of clinical
medicine, conventional flexible endoscopes present a number of health risks and
problems to both patients and medical personnel. Conventional flexible
endoscopes are intended for repeated use in hundreds of procedures and, with
each use, come in contact with some combination of the patient's blood, tissue,
mucus, saliva and stool. Therefore, a conventional flexible endoscope must be
meticulously manually cleaned and disinfected after each procedure. However, the
design of conventional flexible endoscopes makes it difficult to attain
high-level disinfection after cleaning. As a result, the repeated use of
conventional flexible endoscopes and the difficulty in thoroughly cleaning and
disinfecting them after each use create the following problems:
- Patients, and to a lesser degree the physicians using the flexible
endoscopes and the nurse assistants cleaning them, are exposed to the risk
of infection from contaminated endoscopes that results from their repeated
use.
- The nurses or other medical personnel who clean the endoscope face health
risks from exposure to toxic disinfecting agents used in the cleaning
process.
- The proper cleaning of a flexible endoscope is relatively expensive,
time-consuming and arduous.
- The repeated cleaning of a flexible endoscope subjects it to wear and
tear, reduces its useful life, and impairs the quality of its optics; in
addition, improper cleaning can cause blocked channels, which require
expensive endoscope repairs.
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- The time needed to clean a flexible endoscope after each use results in a
period of "down time" during which the endoscope cannot be used and may
require users to buy and maintain multiple endoscopes.
DIFFICULTY OF PROPER CLEANING. The problems associated with cleaning
conventional flexible endoscopes can be better understood by examining the
cleaning procedures they require. The cleaning of endoscopes is generally the
responsibility of the nurse or endoscopic assistant. The Society of
Gastroenterology Nurses and Associates, Inc., in 1990 published Recommended
Guidelines for Infection Control in Gastrointestinal Endoscopy Settings (the
"SGNA Guidelines"). Although cleaning procedures for endoscopes vary widely, the
following is a summary of the principal steps in the cleaning procedures that
are called for by the SGNA Guidelines.
- Inspection--Endoscopes should be tested for leaks and inspected for
damage. Even small leaks can lead to costly fiberoptic or video component
damage or contamination of the endoscope.
- Cleaning--After gross cleaning to remove patient material, endoscopes
should be thoroughly rinsed, the detachable parts should be removed and
cleaned and exteriors should be sponge-cleaned. All internal channels that
are accessible should be scrubbed with brushes, while unreachable air and
water channels should be rinsed clear of residual patient organic matter,
as the presence of such matter diminishes the effectiveness of the
disinfecting agents used. The endoscope should then be washed in a
detergent and enzyme solution, with such cleaning agents drawn through
internal channels. The endoscope should then be rinsed, with excess water
removed, since residual water can dilute disinfectants.
- Disinfection--Endoscopes should be disinfected using recommended chemical
agents or an automated cleaner. Disinfectants must also be drawn through
internal channels during this process. Although certain sterilization
methods are available for flexible endoscopes, conventional heat
sterilization will destroy flexible endoscopes.
- Rinsing--To ensure that patients are not exposed to toxic disinfectants,
endoscopes should be thoroughly rinsed using either tap water or sterile
water, followed by a final rinse in an alcohol solution.
- Drying--Endoscopes and channels should be dried using forced air, flushed
with an alcohol solution and dried again, prior to storage.
- Storage--Endoscopes should be hung vertically in well-ventilated cabinets
to prevent recontamination or damage between uses.
Proper cleaning of conventional flexible endoscopes, even when done in
compliance with the SGNA Guidelines, is difficult to achieve for a number of
reasons. Firstly, the design of conventional flexible endoscopes, which includes
channels, joints and crevices, makes it difficult to reach and clean all parts
of the endoscope. As the SGNA Guidelines state, an endoscope's "complex and
fragile structure presents problems in cleaning/disinfecting/sterilizing".
Secondly, the Company believes the most important step in the cleaning process
is the manual removal of organic material, and therefore, the opportunity for
human error is always present, even if optimal cleaning procedures are followed.
Finally, there are questions concerning the efficiency of some disinfecting
agents used in the endoscope cleaning process. For example, in 1991 the FDA
recommended that the medical profession cease the use of Sporicidin, a
widely-used endoscope disinfectant, based upon the FDA's conclusion that this
disinfectant does not work. The FDA has also required that the manufacturers of
chemical glutaraldehyde-based disinfectants change the recommended soak time on
their instructions for use from 20 minutes to 45 minutes, and increased the
temperature from 20 degrees Celsius to 25 degrees Celsius. This longer soak time
means slower turnaround on conventional scopes, and the increased temperature of
the glutaraldehyde is hazardous due to increased caustic vapors released during
heating.
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HEALTH RISKS. Because flexible endoscopes are difficult to clean properly,
sterilization (the complete elimination of microbial life) is virtually
impossible to achieve. Therefore, "high-level disinfection" (the elimination of
all microbial life other than the most highly resistant spores) is the standard
for flexible endoscope cleaning currently recommended by the Centers for Disease
Control. However, studies indicate that high-level disinfection is often not
attained and that cross-contamination remains a risk to patients and medical
personnel.
An FDA-sponsored study published in The American Journal of Medicine in
March 1992, reported that 23.9% of the gastrointestinal endoscopes tested
produced 100,000 or more bacterial colonies AFTER all cleaning and disinfection
procedures had been completed, and the endoscopes were deemed ready for use on
the next patient. This study concluded that "actual disinfection/sterilization
procedures for endoscopes are not always optimal, and high-level disinfection of
gastrointestinal endoscopes is not always achieved." Numerous infectious agents,
including tuberculosis and salmonella, have been reported in the medical
literature as having been transmitted through the use of contaminated
endoscopes. Concern about the risk of endoscopic cross-contamination has also
been heightened by the increasing prevalence of the HIV and hepatitis viruses.
The cleaning procedures required for endoscopes also subject medical
personnel to health risks (such as severe eye, nose and throat irritation,
nausea, headaches, asthma and skin rashes) from exposure to toxic disinfecting
agents. The Occupational Safety and Health Administration has classified
glutaraldehyde, a key ingredient in many endoscope disinfecting agents, as a
highly toxic material and requires hospitals, clinics, and physicians' offices
to reduce the level of emissions to 0.2 parts per million wherever
glutaraldehyde is used. In addition, toxic disinfectants must be disposed of in
compliance with applicable environmental laws.
OTHER PROBLEMS. In addition to the health problems posed by the use and
cleaning of conventional flexible endoscopes, the required cleaning of these
products is relatively expensive, time-consuming and arduous. The Company
estimates, based upon its own experience, that the cleaning and disinfection
procedure required following each use of a flexible endoscope, if done in
compliance with the FDA recommendations, would take 60 minutes. The repeated
cleaning in harsh chemical disinfectants also subjects a flexible endoscope to
wear and tear, reducing its useful life and impairing the quality of its optics.
Moreover, the failure to clean all organic materials from a flexible endoscope's
channels is a common cause of blocked channels, which require expensive
endoscope repairs as well as a back-up inventory of endoscopes. In addition, the
need to properly clean a flexible endoscope after each use requires that each
doctor performing endoscopies must either have access to a number of endoscopes
or be forced to wait an estimated 60 minutes between each endoscopic procedure
(assuming the endoscope is cleaned in compliance with FDA Guidelines).
COMPANY STRATEGY
The Company's primary business strategy is to develop, manufacture and
market products for endoscopy which have infection-control and economic
advantages over conventional flexible endoscopes. To implement this strategy,
the Company has developed, and is marketing and selling, proprietary flexible
endoscope systems which consist of two main components--a proprietary sterile
disposable sheath, known as an EndoSheath, and a reusable flexible endoscope
incorporating the Company's proprietary design. In particular, the Company has
developed, and is marketing and selling, a family of disposable EndoSheath/
reusable flexible endoscope systems for gastrointestinal endoscopy and pulmonary
endoscopy. The Company has also developed, and is marketing and selling, ENT
EndoSheaths for use with certain conventional flexible ENT endoscopes currently
sold by the Company and by other manufacturers.
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The Company believes that its EndoSheath technology offers the following
advantages over conventional reusable flexible endoscopes:
- It represents the only known effective technology designed to eliminate
the risk of cross-contamination from prior use of a flexible endoscope.
- It is designed to substantially reduce the health risks to nurses and
other medical personnel resulting from exposure to toxic disinfecting
agents used in the cleaning process.
- It significantly reduces the time and effort involved in the cleaning and
disinfection of conventional flexible endoscopes by hospital staff.
- It will reduce endoscope wear and tear resulting from repeated cleaning
and reduces endoscope repair costs, as the air, water, suction and
accessory channels that are the source of a majority of repairs have been
made part of the disposable EndoSheath.
- It reduces endoscope "down time" since there is little delay before an
endoscope is ready for use in the next procedure, and thereby allows
hospitals and clinics to stock a smaller number of flexible endoscopes.
- It increases the number of patients physicians can examine in a given
period of time due to the reduced delay in endoscope processing between
procedures.
During the fiscal years ended March 31, 1999 and 2000, the Company has also
pursued a strategy of exploring diversification toward the development of
improved endoscopes and related imaging devices. Included in these exploratory
areas have been the following:
- The use of advanced CMOS sensors in video endoscopes, in order to reduce
their cost and size over traditional CCD sensored video endoscopes.
- The use of 3-Dimensional visualization enhancements to improve the
perception of endoscopic images for both medical and industrial markets.
These areas of exploration have been undertaken through an agreement with
Imagineering, Ltd. and through an investment in 3DV Systems Ltd., two Israeli
corporations. The goal of these investigations has been to analyze opportunities
to further leverage the Company's core competencies in its current markets,
while at the same time analyzing new technologies the Company may develop or
acquire to enhance its offerings.
PRODUCTS AND PRODUCT DEVELOPMENT PROGRAMS
The Company's primary products include proprietary flexible endoscopes,
EndoSheaths and related products for a variety of medical applications. In
addition, the Company currently manufactures and sells borescopes
(endoscope-like devices for industrial applications), and related products.
ENDOSHEATH/ENDOSCOPE SYSTEMS
The Company has developed a family of proprietary flexible endoscope systems
for gastrointestinal and pulmonary applications consisting of two main
components--proprietary sterile disposable sheaths, known as EndoSheaths and
reusable flexible endoscopes incorporating the Company's propriety design. The
EndoSheaths and endoscopes included in this system are functional only when used
together.
Conventional flexible endoscopes generally include fiberoptic bundles or
video cameras for image production, a series of channels for delivery of air,
water, suction, and accessory devices and an operator body containing user
control knobs. The Company's proprietary design separates these features between
the disposable EndoSheath and the reusable endoscope. The Company's proprietary
flexible endoscopes include the lighting, imaging and operator control features
necessary to perform the intended medical
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procedures. The endoscopes also include microswitches instead of valves, and
control knobs that may be removed for sterilization. The EndoSheaths, which are
designed to cover all surfaces of the endoscope that come in contact with the
patient, contain the air, water, suction and accessory channels that are a part
of conventional flexible endoscopes, thus eliminating the need to clean these
channels. The Company believes, based upon its own quality assurance testing of
this product and physicians who have purchased and are using the system, that
this product functions clinically in essentially the same manner as conventional
flexible endoscopes, requiring no retraining of personnel or changes in
procedural techniques.
Installation of the EndoSheath onto the reusable endoscope can be performed
in a matter of minutes and is accomplished by inflating the sterile EndoSheath
with air, allowing the endoscope to be easily inserted into the EndoSheath.
After an endoscopic procedure, the disposable EndoSheath is then re-inflated,
and the flexible endoscope is removed from the EndoSheath. The EndoSheath and
packaging are then discarded, and the reusable endoscope is ready for use with a
new EndoSheath in the next procedure. This process takes 4 to 5 minutes, as
compared to the 60 minutes estimated for the proper cleaning of a conventional
flexible endoscope.
Due to the fact that the Company believes that sigmoidoscopy is one of the
most frequently performed endoscopic procedures, a fiberoptic sigmoidoscope was
the Company's first disposable EndoSheath/reusable flexible endoscope system.
The Company received FDA clearance of its 510(k) Pre-market Notification for
this product in October 1992 and began commercial shipments of this product in
April 1993. The Company also received FDA clearance of its 510(k) Pre-market
Notification for its black and white CCD video sigmoidoscope and EndoSheath
system in February 1994, its 130 cm length fiberoptic colonoscope and EndoSheath
system in February 1995, its fiberoptic gastroscope and EndoSheath system in
February 1995, and its fiberoptic ENT scope in December 1995. In December 1996
the Company received clearance from the FDA to market its fiberoptic
bronchoscope and EndoSheath system. In January 1997 the Company received
clearance from the FDA to market its color video sigmoidoscope.
ENT ENDOSHEATHS AND ENDOSCOPES
The Company has developed EndoSheaths for use with its own ENT endoscope and
with ENT endoscopes manufactured by other companies. ENT endoscopes do not
contain air, water, suction, or accessory channels and, therefore, do not
require the Company's proprietary flexible endoscope design in order to be used
with an EndoSheath. In addition, because ENT endoscopes do not contain channels,
the EndoSheath covers the distal end of the endoscope thus making these
EndoSheaths a simpler and less expensive product. The Company received FDA
clearance of its 510(k) Pre-market Notification for its first ENT EndoSheath in
October 1992 and began commercial shipments of this product in December 1992. In
January 1993, the Company received FDA clearance of its 510(k) Pre-market
Notification covering four additional disposable EndoSheaths for use with the
Company's other ENT endoscope, two ENT endoscopes sold by Pentax Precision
Instrument Corporation ("Pentax"), and an ENT endoscope sold by Olympus Optical
Co., Ltd. ("Olympus"). The Company began shipping its EndoSheath for use with an
endoscope sold by Olympus in March 1993 and began shipments of the three other
EndoSheaths during fiscal 1994. In December 1995 the Company received clearance
from the FDA to market its own fiberoptic ENT scope, and in April 1999 the
Company received clearance from the FDA to market its Slide-On ENT EndoSheath
barrier for use with the Company's ENT endoscope and with the endoscopes of
other manufacturers. The Slide-On sheath does not require the use of a pump to
inflate the EndoSheath during installation onto an endoscope. Rather, the
Slide-On sheath is made of proprietary materials that allow the provider to
slide the EndoSheath onto the insertion tube of an ENT endoscope. The Slide-On
sheath has a proximal connector that attaches to the strain relief of any ENT
endoscope, allowing a snug fit. After the procedure is completed, the provider
slides the EndoSheath off the endoscope and disposes of it.
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INDUSTRIAL PRODUCTS
Under the Machida name, the Company designs, manufactures and markets
flexible borescopes, which are similar in design to endoscopes and are used for
inspection and quality-control functions in industrial applications, such as the
inspection of aircraft engines and nuclear power plants. Through Machida, the
Company was the first to offer a flexible borescope with a grinding attachment
that allows users to "blend", or smooth small cracks, in small turbine blades of
jet engines without disassembling the engine, which would involve significant
expense and delay. The Company also offers a variety of ancillary products for
use with flexible endoscopes and borescopes, such as light sources, cameras,
adapters, accessories and imaging systems. Sales of these non-medical and
ancillary products were approximately $3.7 million, or 52%, of the Company's net
sales in fiscal 2000. The Company expects that net sales of these products over
the next several years will remain relatively constant and will constitute a
decreasing percentage of the Company's total business.
SALES AND MARKETING
The customers for the Company's disposable EndoSheaths, flexible endoscopes
and related products are Gastroenterologists, Colon and Rectal Surgeons,
Otolaryngologists, Pulmonologists, Primary Care Physicians, and high-volume
users in hospitals, medical clinics, and physicians' offices. In January 2000,
the Company hired a new Vice President of Sales and Marketing, Alan Jacobson,
who has over 20 years experience in selling products to the ENT and other
medical markets. As of May 31, 2000, the Company had four sales and marketing
employees, and utilized 27 independent sales representatives in the United
States and 18 independent distributors in Europe, Australia, Japan and South
America. The Company intends to expand this indirect sales force over the next
year.
Although the Company has no specific plans or commitments in this regard,
the Company may also license to one or more third parties rights to manufacture
and sell reusable flexible endoscopes incorporating the Company's proprietary
design features, while retaining the rights to manufacture and sell the
EndoSheaths used with these endoscopes.
The Company sold its ENT endoscopes, disposable ENT EndoSheaths, and related
ancillary ENT products through an exclusive five-year distribution agreement,
which commenced in March 1994, with the ENT Division of Smith & Nephew, Inc.
("Smith & Nephew"). In March 1998 the Company and Smith & Nephew replaced this
agreement with a new agreement that expired in March 1999. That agreement
included a firm, non-cancelable purchase order for the supply of 200,000 ENT
EndoSheaths during fiscal year 1999. The Company fulfilled that order during
fiscal 1999. Effective April 1999, the Company began selling its own ENT
endoscopes and ENT EndoSheaths through its own channel of independent sales
representatives and international distributors.
By selling through its own sales representative and distributor channel the
Company has improved its market presence and has increased the sales of ENT
sheaths. In the fiscal year ended March 31, 2000, sales of ENT sheaths increased
11% to $1,634,000. Sales of ENT sheaths in the first quarter of fiscal 2000 were
adversely affected by excess inventory present at Smith & Nephew during the
Company's first fiscal quarter. During the second through the fourth fiscal
quarters the Company experienced sales increases of 34% for ENT sheaths,
compared to the same period in fiscal 1999. This sales increase was due
primarily to the higher price the Company was able to realize by selling ENT
sheaths directly to the end user. Unit shipments for the second through fourth
quarters were within 10% of unit shipments during the same period in fiscal
1999. The Company believes sales through this channel will continue to grow in
fiscal year 2001 due to improvements in the size and quality of the sales
representative channel, more effective sales promotion expenditures and
continued interest in the Company's Slide-On EndoSheath. The Company incurred
higher costs for commissions and sales promotion in fiscal 2000, compared to
fiscal 1999, and expects these costs will increase in fiscal 2001.
The Company's borescopes are sold both directly by its Machida subsidiary
and through independent sales representatives.
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Sales to unaffiliated customers outside of the United States were
approximately $619,000, $606,000 and $1,239,000 for the fiscal years ended
March 31, 1998, 1999 and 2000, respectively. In the fiscal year ended March 31,
2000, sales to foreign customers accounted for approximately 18% of the
Company's annual net sales of its medical segment and 17% of net annual sales of
its industrial division. The company experienced increased sales of its medical
products to foreign customers in fiscal 2000, especially in Europe and
Australia. This increase is due to increased demand for the Company's ENT and
gastrointestinal products in the United Kingdom and to selling to an increased
number of international distributors in other countries. The Company expects to
sell its medical segment products outside of the United States in fiscal 2001 in
approximately the same proportion as in fiscal 2000. The Company currently sells
certain models of its borescopes and repair services outside of the United
States.
For the fiscal years ended March 31, 1998 and 1999 Smith & Nephew accounted
for 35% of net sales, respectively. During the fiscal year ended March 31, 2000,
no customer accounted for more than 10% of sales.
MANUFACTURING AND SUPPLIERS
The Company produces its EndoSheaths at its Natick, Massachusetts facility
using molded and extruded components purchased from independent vendors, some of
which are manufactured to the Company's specifications. Most purchased
components are available from multiple sources. With the exception of its supply
agreement with Asahi Optical Co., Ltd. ("Asahi"), discussed below, the Company
has no agreements with any of its vendors or suppliers and purchases its
required components and supplies on a purchase-order basis. The Company
contracts with third parties for the sterilization of EndoSheaths.
The Company assembles its flexible endoscopes for the medical segment at its
Orangeburg, New York facility using purchased components and subassemblies, as
well as certain proprietary components produced by the Company. Most purchased
components and subassemblies are available from more than one supplier. However,
certain critical components, such as image bundles for all endoscopes
manufactured for the medical markets and operator control bodies for
sigmoidoscopes are currently being purchased solely from Asahi, which is the
parent company of a competitor of the Company. These components are being
purchased pursuant to a supply agreement, which expires in March 2001, subject
to earlier termination by mutual consent or upon breach or bankruptcy, and which
may be extended with the consent of both parties. The Company believes that
while substitute components, which are currently produced by sources other than
Asahi, would be available, such substitute components may be more expensive and
of a lower quality and may require a redesign of the Company's endoscope and
additional regulatory clearances. Moreover, such substitute components may not
be immediately available in quantities needed by the Company. The Company's
inability to obtain a sufficient quantity of such critical components on
favorable terms could materially adversely affect the Company's business. To
date, the Company has encountered no significant difficulties or delays in
obtaining a sufficient quantity of such critical components or subassemblies for
the Company's ENT endoscopes or for its proprietary flexible endoscopes designed
for use with its EndoSheaths. However, there can be no assurance that no
difficulties or delays will be experienced in the future as the Company
increases its manufacturing operations.
The Company had entered into a manufacturing agreement, due to expire in
February 2001, with Applied Fiberoptics of Sturbridge, Massachusetts, to supply
a fiberoptic ENT scope. During the fiscal year ended March 31, 1999, the Company
and Applied Fiberoptics amended the terms of the agreement to allow for each
party to design, manufacture and sell its own ENT endoscope. During the fiscal
year ended March 31, 2000, the Company did not purchase any fiberoptic ENT
scopes from Applied Fiberoptics.
The Company's borescopes are assembled using components and sub-assemblies
purchased from independent vendors. While most components and sub-assemblies are
currently available from more than one supplier, certain critical components are
currently purchased only from Asahi and Machida Endoscope Company, Ltd., an
unaffiliated Japanese company. The failure of the Company to obtain a sufficient
quantity of such components on favorable terms could materially adversely affect
the Company's business.
10
<PAGE>
The Company's light sources, camera, adapters, accessories and imaging
systems for non-medical applications are generally purchased by the Company from
a variety of vendors.
The Company has negotiated the worldwide, royalty-free exclusive right from
a third party to use polymer technology for manufacturing optically clear
windows to be included in its EndoSheaths for use with ENT endoscopes. The
Company has also negotiated a license to include the same technology in its
EndoSheaths for use with intubation endoscopes and bronchoscopes.
COMPETITION
The Company believes that the primary competitive factors in the medical
market for flexible endoscopes and endosheaths are the safety and effectiveness
(including optical quality) of the products offered, ease of product use,
product reliability, price, physician familiarity with the manufacturer and its
products and third-party reimbursement policies. In its industrial markets, the
Company believes that product effectiveness, ease of product use, product
reliability and price are the principal competitive factors. The Company's
ability to compete in its markets is affected by its product development and
innovation capabilities, its ability to obtain required regulatory clearances,
its ability to protect the proprietary technology included in its products, its
manufacturing and marketing skills and its ability to attract and retain skilled
employees.
The flexible endoscopes and related products currently sold and under
development by the Company face competition primarily from medical products
companies such as Olympus and Pentax, a subsidiary of Asahi. In addition, any
company that is able to significantly redesign conventional flexible endoscopes
to simplify the cleaning process, or significantly improve the current methods
of cleaning flexible endoscopes, would provide competition for the Company's
products. The principal competitors for the Company's non-medical products are
Olympus and Welch Allyn, Inc.
Many of the Company's competitors and potential competitors have greater
financial resources, research and development personnel, and manufacturing and
marketing capabilities than the Company. In addition, it is possible that other
large health care companies may enter the flexible endoscope market in the
future.
PATENTS AND PROPRIETARY RIGHTS
The Company's success depends in part on its ability to maintain patent
protection for its products, to preserve its trade secrets and to operate
without infringing the proprietary rights of third parties. The Company's
strategy regarding the protection of its proprietary rights and innovations is
to seek patents on those portions of its technology that it believes are
patentable, and to protect as trade secrets other confidential and proprietary
information.
The Company and its subsidiaries currently hold 21 U.S. patents and have 6
patent applications pending. In addition, the Company has 17 foreign patents and
has 2 patent applications pending. All of these patents relate to its disposable
EndoSheaths and reusable flexible endoscopes. These issued patents will expire
on various dates in the years 2004 through 2017. In addition, the Company has 2
patent applications pending in the U.S. and 1 foreign application for CMOS image
sensor design patents. There can be no assurance that the Company's pending
patent applications will result in patents being issued or that competitors of
the Company will not circumvent, or challenge the validity of, any patents
issued to the Company. In addition, in the event that another party infringes
the Company's patent rights, the enforcement of such rights is at the option of
the Company and can be a lengthy and costly process, with no guarantee of
success.
Some of the technology used in, and that may be important to, the Company's
products is not covered by any patent or patent application of the Company. The
Company seeks to maintain the confidentiality of its proprietary technology by
requiring all employees who work with proprietary information to sign
confidentiality agreements and by limiting access by parties outside the Company
to such confidential information. However, there can be no assurance that these
measures will prevent the unauthorized
11
<PAGE>
disclosure or use of this information, or that others will not be able to
independently develop such information. Moreover, as is the case with the
Company's patent rights, the enforcement by the Company of its trade secret
rights can be lengthy and costly, with no guarantee of success.
To date, no claims have been brought against the Company alleging that its
technology or products infringe intellectual property rights of others. However,
there can be no assurance that such claims will not be brought against the
Company in the future or that any such claims will not be successful.
GOVERNMENT REGULATION
The medical products currently marketed and under development by the Company
are regulated as medical devices by the FDA under the federal Food, Drug and
Cosmetic Act (the "FDC Act") and require regulatory clearance prior to
commercialization in the United States. Under the FDC Act, the FDA regulates
clinical testing, manufacturing, labeling, distribution and promotion of medical
devices in the United States. Various states and other countries in which the
Company's products may be sold in the future may impose additional regulatory
requirements.
Following the enactment of the Medical Device Amendments to the FDC Act in
May 1976, the FDA classified medical devices in commercial distribution into one
of three classes, Class I, II, or III. This classification is based on the
controls necessary to reasonably ensure the safety and effectiveness of the
medical device. Class I devices are those devices whose safety and effectiveness
can reasonably be ensured through general controls, such as adequate labeling,
pre-market notification, and adherence to the FDA's Quality System Regulations
("QSR"). Some Class I devices are further exempted from some of the general
controls. Class II devices are those devices whose safety and effectiveness can
reasonably be ensured through the use of special controls, such as performance
standards, post-market surveillance, patient registries and FDA guidelines.
Class III devices are devices that must receive pre-market approval by the FDA
to ensure their safety and effectiveness. Generally, Class III devices are
limited to life-sustaining, life-supporting or implantable devices.
If a manufacturer or distributor of medical devices can establish that a new
device is "substantially equivalent" to a legally marketed Class I or Class II
medical device or to a Class III medical device for which the FDA has not
required pre-market approval, the manufacturer or distributor may seek FDA
marketing clearance for the device by filing a 510(k) Pre-market Notification.
The 510(k) Pre-market Notification and the claim of substantial equivalence may
have to be supported by various types of information indicating that the device
is as safe and effective for its intended use as a legally marketed predicate
device.
Following submission of the 510(k) Pre-market Notification, the manufacturer
or distributor may not place the device into commercial distribution until an
order is issued by the FDA. By regulation, the FDA has no specific time limit by
which it must respond to a 510(k) Pre-market Notification. At this time, the FDA
typically responds to the submission of a 510(k) Pre-market Notification within
approximately 90 days. The FDA may declare that the device is "substantially
equivalent" to another legally marketed device and allow the proposed device to
be marketed in the United States. The FDA may, however, determine that the
proposed device is not substantially equivalent, or may require further
information, such as additional test data, before the FDA is able to make a
determination regarding substantial equivalence. Such determination or request
for additional information could delay the Company's market introduction of its
products and could have a material adverse effect on the Company.
If a manufacturer or distributor cannot establish to the FDA's satisfaction
that a new device is substantially equivalent, the manufacturer or distributor
will have to seek pre-market approval ("PMA") or reclassification of the new
device. A PMA application would have to be submitted and be supported by
extensive data, including pre-clinical and clinical trial data, to demonstrate
the safety and efficacy of the device. Upon receipt, the FDA will conduct a
preliminary review of the PMA application to determine whether the submission is
sufficiently complete to permit a substantive review. If sufficiently complete,
the submission is declared fileable by the FDA. By regulation, the FDA has
180 days to review a PMA
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<PAGE>
application once it is determined to be fileable. While the FDA has responded to
PMA applications within the allotted time period, PMA reviews more often occur
over a significantly protracted time period and generally take approximately two
years or more from the date of filing to complete. A number of devices for which
FDA marketing clearance has been sought have never been cleared for marketing.
If human clinical trials of a proposed device are required and the device
presents "significant risk", the manufacturer or distributor of the device will
have to file an investigational device exemption ("IDE") application with the
FDA prior to commencing human clinical trials. The IDE application must be
supported by data, typically including the results of animal and mechanical
testing. If the IDE application is approved, human clinical trials may begin at
the specific number of investigational sites and could include the number of
patients approved by the FDA.
Flexible endoscopes, EndoSheaths, and accessory products have been
classified by the FDA as Class II devices, and a Section 510(k) Pre-market
Notification must be submitted to and cleared by the FDA before such devices can
be sold. The Company has received FDA clearance of its 510(k) Pre-market
Notifications for the following products as of the dates noted. The Company
expects that it will be required to obtain 510(k) clearance for each additional
disposable EndoSheath/reusable flexible endoscope system that it develops in the
future.
<TABLE>
<CAPTION>
DATE OF CLEARANCE PRODUCT
----------------- -------
<S> <C>
October 1992 EndoSheath/reusable fiberoptic sigmoidoscope system
October 1992 EndoSheath for use with the Company's flexible ENT endoscope
January 1993 Four models of EndoSheaths for use with certain other ENT
endoscopes
February 1994 EndoSheath/reusable black and white CCD video sigmoidoscope
system
February 1995 EndoSheath/reusable fiberoptic 130 cm length colonoscope
system
February 1995 EndoSheath/reusable fiberoptic gastroscope system
December 1995 Fiberoptic ENT scope
July 1996 EndoSheath for use with the Company's reusable fiberoptic
ENT endoscope
August 1996 Vacuum ENT EndoSheath barrier
November 1996 EndoSheath barrier for use with the Company's fiberoptic
sigmoidoscope
December 1996 EndoSheath barrier for use with the Company's fiber/video
sigmoidoscopes
December 1996 EndoSheath barrier/reusable fiberoptic bronchoscope system
January 1997 EndoSheath barrier/reusable color video sigmoidoscope system
April 1999 Slide-On EndoSheath for use with the Company's fiberoptic
ENT endoscope
April 1999 Four models of Slide-On EndoSheaths for use with certain
other ENT endoscopes
</TABLE>
Effective July 1998, the Company's Natick, Massachusetts facility was
certified as having established and is maintaining a quality system that meets
the requirements of ISO 9001 and EN 46001. In addition, both the Natick and
Orangeburg, New York facilities received their EC certificate, indicating they
maintain a quality system that conforms to the essential requirements of the
Council Directive 93/42/EEC, applying this system at every stage from design to
final controls. In June 1999 the Company's Natick facility successfully
completed its first surveillance audit, receiving the recommendation of
continued validity of its ISO 9001 certificate. The Natick and Orangeburg
facilities are registered with the FDA as medical device manufacturers. As a
result, these facilities are subject to the FDA's QSR's, which regulate their
design, manufacturing, testing, quality control and documentation procedures.
The Company is also required to comply with the FDA's labeling requirements, as
well as its information reporting regulations. The export of medical devices is
also subject to regulation in certain instances. The Company's compliance with
these various regulatory requirements will be monitored through periodic
inspections by the FDA and audits by independent authorities to maintain its ISO
9001 status.
The process of obtaining required regulatory clearances can be lengthy and
expensive, and compliance with ISO 9001 and the FDA's QSR's and regulatory
requirements can be burdensome. Moreover, there can be no assurance that the
required regulatory clearances will be obtained, and those obtained may include
13
<PAGE>
significant limitations on the uses of the product in question. In addition,
changes in existing regulations or the adoption of new regulations could make
regulatory compliance by the Company more difficult in the future. The failure
to obtain the required regulatory clearances or to comply with applicable
regulations may result in fines, delays or suspensions of clearances, seizures,
or recalls of products, operating restrictions and criminal prosecutions, and
could have a material adverse effect on the Company.
THIRD-PARTY REIMBURSEMENT
Hospitals, medical clinics and physicians' offices that purchase medical
devices such as the Company's EndoSheaths and flexible endoscopes generally rely
on third-party payors, such as Medicare, Medicaid, and private health insurance
plans to pay for some or all of the costs of the screening, diagnostic and
therapeutic procedures performed with these devices. Whether a particular
procedure qualifies for third-party reimbursement depends upon such factors as
the safety and effectiveness of the procedure, and reimbursement may be denied
if the medical device used is experimental or was used for a non-approved
indication. The Company believes, based upon its knowledge of third-party
reimbursement practices, advice from consultants in this area and seven years of
selling experience, that third-party reimbursement is available for most
procedures that utilize its disposable Slide-On ENT sheath and its EndoSheath/
reusable flexible endoscope systems.
Third-party payors use a variety of mechanisms to determine reimbursement
amounts for procedures such as endoscopies. In some cases, reimbursement amounts
are based upon the provider's costs associated with the procedure, including
materials costs. In such a situation, the cost of the EndoSheath used in the
procedure would likely be covered by the reimbursement payment. In other cases,
payment is based upon amounts determined by the Health Care Finance
Administration (HCFA), a governmental agency under the Department of Health and
Human Services. As part of its responsibilities, HCFA assigns relative value
units ("RVUs") to over 10,000 physician services. An RVU for a specific
procedure is comprised of values for work, practice expense and malpractice
insurance, and when multiplied by a Conversion Factor, represents a dollar value
for a specific procedure. Historically, the practice expense component of an RVU
was calculated using a charge-based system. Section 121 of the Social Security
Act Amendments of 1994 required HCFA to replace the charge-based practice
expense RVUs with new resource-based ones. The Balanced Budget Act of 1997
requires a four-year transition from the charge-based system to the resource-
based system beginning January 1, 1999. During calendar 2000, the practice
expense component of the RVUs is comprised of 50% of the charge-based system,
and 50% of the resource-based system. In 2002 the practice expense component of
the RVUs will be based 100% upon the resource-based system.
Under the charge-based system, HCFA had a policy of reducing the practice
expense RVUs for certain services by 50% when those services were performed in a
facility setting. Under the resource-based system, this policy will not be
applicable, as HCFA has developed practice expense RVUs specific to facility and
non-facility settings. Generally, under the resource-based system, the facility
practice expense RVUs will be used for services performed in inpatient or
outpatient hospital settings, emergency rooms, skilled nursing facilities or
ambulatory surgical centers. The non-facility practice expense RVUs will be used
for services performed in all other settings. Based upon a review of calendar
year 2000 RVUs for flexible sigmoidoscopies, the Company believes health care
providers will receive payments totaling 60% to 75% more per procedure for
performing them in non-facility settings in 2000, 2001 and 2002, compared to
performing these services in facility settings. The increase in the RVUs for
practice expense is based upon extensive reviews by HCFA of actual practice
expense data from the Clinical Practice Expert Panel and the American Medical
Association's Socioeconomic Monitoring System.
The Company believes that, based upon the new resource-based practice
expense RVU, the number of flexible sigmoidoscopies performed in non-facility
settings will increase. This increase will be due primarily to the increased
differential in payments that providers will receive for performing these
procedures. As these procedures move to non-facility settings, providers will
have to contend with the cost and effort required for cleaning endoscopes. The
Company believes its disposable EndoSheath/reusable flexible endoscope systems,
which eliminate the time and cost of cleaning endoscopes, will provide a
14
<PAGE>
positive economic alternative to the use of conventional equipment. This
economic alternative is based upon the provider not having to purchase multiple
endoscopes, expensive sterilizing equipment and supplies and not having to spend
valuable provider time cleaning endoscopes. In addition, the Company believes
that the increase in the population of people over 50 years old will increase
the potential number of procedures that providers will be performing. There are
approximately 65 million people in the United States between 50 and 79 years
old. The American Cancer Society recommends people over the age of 50 receive
flexible sigmoidoscopies every three to five years as part of a program for the
early detection of colorectal cancer. The Company believes its disposable
EndoSheath system combined with the resource-based system for setting values for
physician services together represent a sound economic method to screen for
colorectal cancer.
There can be no assurance that third-party reimbursement will continue to be
available for procedures performed with the Company's products or that the cost
of the Company's EndoSheaths would be covered by such reimbursement in the
future. In addition, reimbursement standards and rates may change. The Company
believes that the failure of users of the Company's products to obtain adequate
reimbursement from third-party payors has had a materially adverse effect on the
Company.
PRODUCT LIABILITY AND INSURANCE
The nature of the Company's products exposes the Company to significant
product liability risks. The Company maintains product liability insurance with
coverage limits of $2,000,000 per year. The Company believes that this level of
coverage is adequate, given its past sales levels and its anticipated sales
levels for the fiscal year ending March 31, 2001. The Company will re-evaluate
the adequacy of this coverage when and if its sales level substantially
increase. No product liability claims have been brought against the Company to
date. However, there can be no assurance that product liability insurance will
continue to be available to the Company on acceptable terms, or that product
liability claims in excess of the Company's insurance coverage, if any, will not
be successfully asserted against the Company in the future.
RESEARCH AND DEVELOPMENT
The Company believes that its future success depends in part upon its
ability to develop new products and enhance its existing products. In the past
the Company has devoted significant funds and efforts to research and
development. In order to lower expenses in the year ended March 31, 1999, the
Company reduced its efforts in the development of new products. In the year
ended March 31, 2000, the Company incurred higher costs for research and
development compared to fiscal 1999, due primarily to the costs associated with
the activities of Imagineering, Ltd. and Vision-Sciences, Ltd. and their
development of patents for CMOS image sensors.
The Company's research and development expenses in fiscal years 1998, 1999,
and 2000 were $763,000, $209,000 and $684,000, respectively. The increase in
research and development expenses for fiscal 2000 was due primarily to the cost
associated with the grant of a non-qualified stock option to a non-employee who
delivered the innovations covering CMOS sensors. The fair value of that option
was calculated using the Black-Scholes option-pricing model, and amounted to
$421,911 being recorded as an expense. The Company will calculate the fair value
of the option granted to the non-employee on a quarterly basis during fiscal
2001 and beyond, until the option is exercised or lapses. The Company's research
and development efforts in fiscal 1998 focused on image-guided surgical
applications using third-party surgical navigation technology combined with
EndoSheath technology and refinement and cost reduction of existing products.
During fiscal 1999, the research and development efforts focused on the
development of a new ENT scope and the Company's Slide-On ENT EndoSheath. During
fiscal 2000, the research and development efforts focused on continued
improvement in the Slide-On ENT EndoSheath, and in completing innovations
related to CMOS sensors. The efforts in the CMOS area were undertaken primarily
through the Company's relationship with Imagineering, Ltd., an Israeli
corporation with whom the Company has an agreement, and were managed by the
Company's corporate segment and its subsidiary, Vision-Sciences, Ltd. in Israel.
These efforts have resulted in the Company's filing for two
15
<PAGE>
patents in the U.S. and for one foreign patent in fiscal 2000. In fiscal 2001
the Company expects to concentrate primarily on continuing enhancements of, and
additions to, the fiberoptic sigmoidoscope, the fiberoptic ENT endoscope, its
Slide-On EndoSheath systems and to pursue patent applications covering the CMOS
image sensors.
EMPLOYEES
As of April 30, 2000, the Company had 71 employees. No Company employees are
represented by a labor union. The Company believes that its employee relations
are good. The Company's success depends in large part upon its ability to
attract and retain highly qualified scientific, management, sales and marketing
personnel.
ITEM 2.__PROPERTIES
The Company's principal executive offices, manufacturing, sales and medical
research and development facilities currently occupy approximately 20,000 square
feet of space in Natick, Massachusetts under a lease that expires in
November 2003. The operations of the Company's Machida subsidiary are located in
Orangeburg, New York under a lease for approximately 25,000 square feet which
expires in August 2000. As part of its plans to reduce expenses in fiscal 1999,
the Company consolidated its operations in Natick into one facility. As part of
that consolidation, the Company paid $105,000 in March 1999 to its landlord as a
lease termination fee. In March 2000, the landlord for the building leased in
Orangeburg sold its interest to an independent third party, who plans to
continue leasing the building to Machida on the same lease terms as the prior
landlord until September 2000. At that time, Machida plans to reduce its space
to 10,000 square feet, resulting in lower costs for rent, maintenance and taxes
for the second half of fiscal 2001.
The Company's currently occupied Natick facilities and the Orangeburg
facility are registered with the FDA as medical device manufacturing facilities
and are, therefore, subject to the FDA's QSRs regarding manufacturing, testing,
quality control and documentation procedures. The Company believes that the
physical characteristics and layouts of these facilities are adequate to
manufacture its products in compliance with applicable FDA regulations. In
addition, the Company's Natick facilities are registered as meeting the
requirements of ISO 9001 and EN 46001. The Natick facility is registered as
meeting the requirements of Council Directive 93/42/EEC, allowing the Company to
sell its medical products in Europe.
ITEM 3.__LEGAL PROCEEDINGS
As of March 31, 2000, there were no material legal proceedings to which the
Company or any of its subsidiaries is a party, or to which any of their
properties is subject.
ITEM 4.__SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of the Company's security holders during
the last quarter of the fiscal year ended March 31, 2000.
EXECUTIVE OFFICERS OF THE COMPANY
Katsumi Oneda, age 62, a co-founder of the Company, has been President,
Chief Executive Officer, and Chairman of the Board of Directors of the Company
since October 1993. He served as Vice-Chairman of the Board of Directors of the
Company from May 1992 to October 1993, as Honorary Chairman of the Board of
Directors from October 1991 to October 1993, and as Chairman of the Board of
Directors from September 1990 to October 1991. From 1979 to December 1990, he
was President and Chief Executive Officer of Pentax Precision Instrument
Corporation. Mr. Oneda is a director of several private companies. He has been a
director of the Company since 1987.
Lewis C. Pell, age 57, a co-founder of the Company, has been Vice-Chairman
of the Board of Directors of the Company since May 1992. Mr. Pell has served as
a director of Heart Technology, Inc., a
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<PAGE>
publicly-held medical device company. Mr. Pell is a founder or co-founder of a
number of other privately-held medical device companies, including
Biosense, Inc., Influence, Inc., Flexiclave, Inc., iSight, Inc., Vitality
Biotechnologies, Inc. Mr. Pell was co-founder and a director of Versaflex
Delivery Systems, Inc. and INStent, Inc., which were sold in 1988 and 1996,
respectively, to Medtronic, Inc. In 1983, Mr. Pell co-founded American
Endoscopy, Inc. and served as a director until it was sold in 1986 to C.R.
Bard, Inc. In September 1979, he co-founded Pentax Precision Instrument
Corporation and served as Executive Vice President and director until
December 1990, when it was sold to Asahi Optical Company. Mr. Pell is a director
of several private companies.
Gerald B. Lichtenberger, Ph.D., age 55, has served as Vice President,
Business Development since December 1998. From January 1997 to December 1998 he
served as Executive Vice President, Chief Operating Officer and Secretary of the
Company. Prior to joining the Company, Dr. Lichtenberger served since 1990 as
President and a Director of iSight, Inc., a developer and manufacturer of
digital video cameras and components. Dr. Lichtenberger was Vice President of
Strategic Planning and Vice President of Operations of Pentax Precision
Instrument Corporation from 1986 until 1990, and was President, Chief Executive
Officer and Chairman of the Board of Directors of Systems of the Future, Inc.
from 1979 until 1986.
James A. Tracy, age 51, joined the Company in July 1997 and was elected Vice
President Finance in August 1997. From 1994 to 1996 Mr. Tracy was the Vice
President Finance at ORS Environmental Systems, a manufacturer of environmental
equipment and sensor instrumentation. From 1990 to 1994 he was Vice President
Finance at Sigma Designs, Inc., a publisher of CAD software. Mr. Tracy received
a CPA certificate in 1975.
Isao Fujimoto, age 52, has served as Vice President Manufacturing and
Engineering of the industrial segment since January 1995. Mr. Fujimoto joined
the Company in 1975, and served in a variety of roles in the manufacturing and
engineering departments from that date to January 1995.
Mark S. Landman, age 46, has served as Vice President Operations of the
medical segment since July 1999. From May 1998 to July 1999, Mr. Landman served
as the General Manager of the medical segment. From November 1995 to May 1998,
Mr. Landman served as the Director of Material Control of the medical segment.
From March 1995 to November 1995, Mr. Landman served as the Director of
Manufacturing Engineering of the medical segment. Mr. Landman joined the Company
in January 1991, and served in a variety of roles in product development and
project management from that date to March 1995.
Alan M. Jacobson, age 51, joined the Company in January 2000 as Vice
President Sales and Marketing of the medical segment. From December 1996 to
December 1999, Mr. Jacobson was an Area Manager at XOMED, Inc., specializing in
the sales of capital equipment and disposable products to healthcare providers
in the ENT, Plastic Surgery and Neurosurgery markets. From April 1993 to
December 1996, Mr. Jacobson was a Marketing Consultant and Manufacturers
Representative for ASK Medical Resources, Inc., an independent sales
representative company specializing in distribution channels and the management
of sales networks for a variety of medical device companies.
Officers are elected on an annual basis and serve at the discretion of the
Board of Directors.
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<PAGE>
PART II
ITEM 5.__MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER
MATTERS
From December 15, 1992 to October 29, 1997, the Company's Common Stock was
quoted on the Nasdaq National Market, and since October 30, 1997, the Company's
Common Stock has been traded on the Nasdaq SmallCap Market under the symbol
VSCI. The following table sets forth the high and low sale prices for the Common
Stock on the Nasdaq National Market, or the Nasdaq SmallCap Market, as the case
may be, as reported by Nasdaq during the periods indicated.
<TABLE>
<CAPTION>
FISCAL YEAR ENDED
MARCH 31, 1999 HIGH LOW
----------------- ---- ---
<S> <C> <C>
1st Quarter................................................. 2 7/8 7/16
2nd Quarter................................................. 2 1 1/32
3rd Quarter................................................. 1 7/16 3/4
4th Quarter................................................. 3 29/32
</TABLE>
<TABLE>
<CAPTION>
FISCAL YEAR ENDED
MARCH 31, 2000 HIGH LOW
----------------- ---- ---
<S> <C> <C>
1st Quarter................................................. 2 1 1/16
2nd Quarter................................................. 2 3/16 1 5/16
3rd Quarter................................................. 1 5/8 15/16
4th Quarter................................................. 3 7/8 1 5/32
</TABLE>
Such over-the-counter market quotations reflect inter-dealer prices without
retail mark-up, mark-down, or commission and may not necessarily represent
actual transactions.
As of May 28, 2000, there were 20,933,413 outstanding shares of Common Stock
held by 256 stockholders of record, in addition to which there were
approximately 1750 beneficial stockholders.
The Company has never paid cash dividends on its Common Stock, and the
Company does not expect to pay any cash dividends on its Common Stock in the
foreseeable future. In accordance with a demand line-of-credit agreement that
the Company has with a bank, the Company is prevented from paying cash dividends
on its Common Stock.
ITEM 6.__SELECTED FINANCIAL DATA
The following table summarizes certain selected financial data and should be
read in conjunction with the financial statements and related notes on
Appendix A to this report.
<TABLE>
<CAPTION>
YEAR ENDED MARCH 31,
----------------------------------------------------
1996 1997 1998 1999 2000
-------- -------- -------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Net sales....................................... $ 6,222 $ 8,330 $ 7,998 $ 7,476 $ 7,055
Gross profit (loss)............................. (978) 736 1,419 1,274 2,262
Net loss from operations........................ (9,736) (6,453) (2,902) (1,965) (1,561)
Net loss per share.............................. (.84) (.46) (.17) (.12) (.24)
BALANCE SHEET DATA:
Cash, cash equivalents and marketable
securities.................................... 5,866 2,681 2,891 3,195 1,581
Total assets.................................... 11,076 6,850 6,172 7,882 4,908
Total liabilities............................... 2,579 2,461 2,355 2,433 1,993
Stockholders' equity............................ 8,497 4,389 3,817 5,450 2,914
</TABLE>
18
<PAGE>
ITEM 7.__MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
BACKGROUND
Vision-Sciences, Inc. develops, manufactures and markets unique flexible
endoscope products utilizing disposable sheaths which provide the users quick,
efficient product turnover while ensuring the patient a contaminant-free
product.
RESULTS OF OPERATIONS
FISCAL YEARS ENDED MARCH 31, 2000 AND 1999
Net sales for the fiscal year ended March 31, 2000 were $7,055,000, a
decrease of $421,000, or 6%, compared to the prior fiscal year. The decrease in
net sales was primarily due to medical sales decreasing by $522,000 while
industrial sales increased by $101,000. The decrease in medical sales was due
primarily to lower sales of endoscopes to the ENT market, offset by an increase
of 11% in the sales of our proprietary ENT EndoSheath, and a 4% increase in
sales of GI EndoSheaths. During fiscal 2000, the Company changed its sales
channel for ENT products from selling through a master distributor to selling
directly to end users through its own network of independent sales
representatives. This change required time to select and train the sales reps,
and to educate the user community of the Company's presence. The Company
believes this shift has been successful, as evidenced by a 39% increase in the
sales of ENT EndoSheaths in its fiscal 2000 fourth quarter, compared to the
fourth quarter of fiscal 1999. This increase was due primarily to the higher
selling prices the Company was able to obtain by selling direct, while the unit
volume was approximately the same as the comparable quarter in fiscal 1999. The
Company is committed to this selling channel, and expects in fiscal 2001 to
realize higher unit and dollar sales of ENT EndoSheaths.
The increase in sales of industrial products was due primarily to higher
demand from the defense and aircraft maintenance markets for the repair of
borescopes.
Gross profit for fiscal 2000 increased by $988,000, and was 32% of sales,
compared to 17% of sales for fiscal 1999. The gross profit of the medical
segment increased by $682,000 and the gross profit of the industrial segment
increased by $306,000. The increase in gross profit was due primarily to the
higher prices obtained by selling the ENT EndoSheaths directly to end users, to
higher volumes of industrial sales and to better utilization of factory overhead
expenses by both the medical and industrial segments. In addition, although the
Company sold fewer ENT endoscopes in fiscal 2000 compared to fiscal 1999, the
gross profit from the ones sold was higher due to the higher prices received by
selling direct to users, and to the lower costs derived by manufacturing it in
the Company's facilities. In fiscal 1999 the Company purchased ENT scopes for
resale and sold them to the master distributor. The new strategy resulted in a
higher average selling price per scope and higher gross profit dollars for the
ENT endoscopes that were sold.
The Company expects unit and dollar sales for both ENT EndoSheaths and
endoscopes to continue to improve in fiscal 2001 due primarily to improvements
in the size and quality of the sales representative channel, to more effective
product promotion and to continued interest in the Slide-On EndoSheath. In
addition to the domestic sales channel, the Company has established a network of
international distributors that accounted for approximately 28% of the unit
sales of ENT EndoSheaths in fiscal 2000. As unit volumes increase, at comparable
average selling prices per unit, the Company believes it will derive higher
gross profit percentages due to higher utilization of factory overhead.
Selling, general and administrative expenses for fiscal 2000 increased by
$110,000, or 4%, to $3,139,000, compared to $3,029,000 in fiscal 1999. These
costs were 44% of sales in fiscal 2000, compared to 43% of sales in fiscal 1999.
Expenses for selling and marketing increased by $141,000, or 11%, compared to
fiscal 1999. These costs increased due to higher expenses for commissions for
medical sales and higher
19
<PAGE>
payroll costs, offset partially by lower costs for public relations.
Administrative expenses declined by $31,000 due primarily to lower costs related
to investor relations.
Research and development expenses increased by $475,000, and were 10% of
sales, compared to 3% of sales in fiscal 1999. The higher expenses for research
and development were due to compensation to an Imagineering Ltd. consultant
working on the CMOS sensors. During fiscal 2000 the Imagineering Ltd. consultant
delivered the innovations per the contractual obligation and the Company granted
an option for 1,000,000 shares of the Company's common stock with a fair market
value of $422,000 as compensation for work performed. The Company is now
applying for patents for these innovations, and expects to complete the patent
applications during fiscal 2001. The Company expects this activity may result in
higher expenses for research and development in fiscal 2001. As the Company has
limited resources for this development, it will assess progress periodically to
determine that sufficient resources are available to continue these activities.
In addition, the Company will recalculate the fair value of the option granted
in fiscal 2000 on a quarterly basis until the option is exercised or lapses.
Depending upon the volatility of the price of the Company's stock as traded on
the Nasdaq SmallCap market, some or no incremental cost will be incurred for the
fair value of that option for the periods on which the Company will report. The
cost associated with the option was recorded as a research and development
expense and as an increase to additional paid in capital in the equity section
of the consolidated balance sheet.
The loss from operations declined by 21% in fiscal 2000 to $1,561,000, after
declining 32% in fiscal 1999 to $1,965,000. This improvement was due primarily
to the success of the strategy of selling ENT EndoSheaths and endoscopes
directly to users, and by controlling selling and administrative expenses. If
the Company had not incurred the expense related to the option, the operating
loss would have improved by 42%, compared to fiscal 1999. During fiscal 2001, if
the Company reaches its sales targets and continues to control expenses, it may
be able to achieve an operating income during the second half of the fiscal
year, net of any required charges for revaluing the option granted to the
non-employee.
Interest income, net declined by $73,000 in fiscal 2000 compared to fiscal
1999, due primarily to lower balances of cash equivalents and marketable
securities during fiscal 2000.
Equity in losses of 3DV Systems Ltd. increased to $3,331,000 from $367,000
in fiscal 1999. This increase was due primarily to recording 100% of the losses
of this entity during the first nine months of fiscal 2000. During this period,
the Company was deemed to have effective control over the operations of 3DV, and
had a commitment to finance their working capital needs for calendar years 1999
and 2000. In December 1999, 3DV raised $4.5 million of new capital, of which the
Company contributed $1.5 million. After this recapitalization the Company owns
approximately 29% of the outstanding shares of 3DV. The terms of that
recapitalization eliminated the responsibility to fund the working capital needs
of 3DV, and eliminated the Company's option to purchase the remaining
outstanding shares not owned by the Company. Therefore, as the Company did not
have effective control over the operations of 3DV as of December 23, 1999, it
recognized only its portion of the losses of 3DV from that date to March 31,
2000.
The loss per share for the year ended March 31, 2000 was $.24 per share,
compared to $.12 per share in fiscal 1999. Excluding the charges for equity in
the losses of 3DV and compensation for the option granted to a non-employee, the
net loss would have been $.05 per share, compared to a loss per share of $.10
per share in fiscal 1999, adjusted for equity in the losses of 3DV.
FISCAL YEARS ENDED MARCH 31, 1999 AND 1998
Net sales for the fiscal year ended March 31, 1999 were $7,476,000, a
decrease of $522,000, or 7%, compared to the prior fiscal year. The decrease in
net sales was primarily attributable to medical sales decreasing $489,000, or
11%, and industrial sales decreasing $33,000, or 1%, compared to the prior
fiscal year ended March 31, 1998.
20
<PAGE>
The decrease in medical sales resulted primarily from a decline in the sales
of scopes of $418,000, or 28%, partially offset by an increase in the sales of
the Company's proprietary EndoSheath product of $48,000, or 2%. In addition,
sales of $138,000 of certain medical devices in fiscal 1998 did not recur in
fiscal 1999. The decrease in sales of scopes was due primarily to the Company's
decision to begin selling its own proprietary ENT-2000 scope and cease selling a
similar scope the Company had previously purchased from a supplier. The Company
made this decision as part of its strategy to improve its penetration of the
market for ENT scopes and sheaths. The other part of the strategy was to sell
ENT sheaths directly to users utilizing a sales representative network
established by the Company, as compared to selling ENT scopes and sheaths
through a master distributor. This transition period began in the fourth quarter
of fiscal 1999.
Sales of industrial products in fiscal year 1999 were consistent with sales
in fiscal year 1998. Within this segment reduced demand for repair services was
offset by increased demand from industrial customers for new borescopes.
Gross profit for the fiscal year ended March 31, 1999 decreased $146,000,
and was 17% of sales, compared to 18% of sales in the prior fiscal year. Gross
profit on medical sales increased by $171,000, due primarily to a more
profitable mix of sales oriented toward sheaths. Also, the benefits of the
Company's reduction of overhead expenses in April 1998 was offset by the
non-recurring sales of certain medical devices that occurred in fiscal 1998.
Gross profit on industrial sales decreased by $317,000, due primarily to the
mix of sales preventing the same utilization of material inventory as this
segment experienced in fiscal 1998.
Selling, general, and administrative expenses for the fiscal year ended
March 31, 1999 decreased $530,000 or 15%, to $3,029,000, compared to the prior
fiscal year and represented 41% of net sales versus 45% in the prior fiscal
year. The decrease resulted primarily from sales and marketing expenses
decreasing $293,000, or 19%, versus the prior fiscal year, primarily due to
reduced expenses for payrolls and product promotion. General and administrative
expenses decreased by $237,000, or 12%, compared to the prior fiscal year,
primarily due to lower expenses for payrolls. In addition, the Company utilized
reserves, established in prior years, of approximately $335,000 to record
certain non-recurring expenses incurred in the year ended March 31, 1999.
Research and development expenses for the fiscal year ended March 31, 1999
decreased $553,000, or 73%, versus the prior fiscal year and represented 3% of
net sales in the current year versus 10% of net sales in the prior fiscal year.
These lower expenses were due primarily to reduced headcount and lower spending
for new products.
Interest income, net, for the fiscal year ended March 31, 1999 increased
$36,000 or 24%, to $183,000, compared to the prior fiscal year due to higher
levels of cash equivalents and marketable securities.
Equity in losses of 3DV was $367,000 in fiscal 1999. The Company accounted
for its investment in 3DV using the equity method of accounting, absorbing 100%
of the losses of that entity. From August 1998 through March 1999, the Company
recognized $1,693,000 of losses incurred by 3DV. These losses were partially
offset by $1,332,000 of development fees received from Asahi to fund the
development costs of 3DV. Under the agreements signed in August 1998, the
Company was required to fund the working capital need of 3DV.
Other income decreased by $167,000 due primarily to the expiration of
royalty agreements.
LIQUIDITY AND CAPITAL RESOURCES
In the fiscal year ended March 31, 2000 the amount of cash used in the
Company's operations was $1,609,000. In the fiscal year ended March 31, 1999 the
Company generated $472,000 of cash from operations. Cash used in operations
during fiscal year 2000 was primarily devoted to manufacturing, marketing and
research and development. In fiscal year 1999 cash generated from operations was
derived
21
<PAGE>
from the payment by Asahi Optical Co., Ltd. for deferred development cost,
working capital management and depreciation expense. These inflows were offset
by costs for manufacturing, marketing, product development and payments to
support the contractual obligations of the Company to Imagineering and support
of Vision-Sciences, Ltd., the Company's Israeli subsidiary.
Accounts receivable declined $10,000 in the year ended March 31, 2000. The
composition of our accounts receivable has changed significantly during fiscal
2000 due to the change in our sales strategy. During fiscal 2000 we added
approximately 500 customers for our ENT products, compared to having one master
distributor as of March 31, 1999. These customers comprise hospitals, large and
small clinics and individual doctor's offices. Many of these customers have
experienced delays in their cash flow due to the general slowness of payments in
the health care industry. To be conservative, we have increased our allowance
for doubtful accounts to reflect the risks associated with the health care
industry. We plan to monitor our receivables and as we gain more experience with
our direct customers, we plan to adjust the allowance for doubtful accounts
appropriately.
The Company's inventories increased from $634,000 at March 31, 1999 to
$1,278,000 at March 31, 2000. The increase was primarily due to higher levels of
finished sigmoidoscope sheaths and finished ENT sheaths. During the third
quarter of fiscal 2000 we increased the production of both the sigmoidoscope and
ENT sheaths. This increase was due partly to preparation for any Year 2000
problems that our customers might have encountered, and partly in expectation of
higher sales due to preliminary changes to the transitional RVU rates for
flexible sigmoidoscopies published by HCFA in November 1999. These rates were
reduced subsequently, resulting in less of a differential for performing
flexible sigmoidoscopies in non-facility settings. In addition, neither our
customers nor we experienced any Year 2000 type of event that might have
required an emergency shipment of sheaths. Also, the higher quantity of ENT
sheaths on hand at March 31, 2000 reflects the change from selling to one master
distributor to selling directly to the end users. In anticipation that our first
fiscal quarter would be a transition quarter, we had a minimal level of ENT
sheaths on hand at March 31, 1999. At March 31, 2000 we had sufficient quantity
to ship approximately 1.7 months of sales. During fiscal 2001 we plan to monitor
these levels of finished goods, and expect to establish quantities of
inventories appropriate to our sales levels.
The Company currently plans to spend no more than $250,000 on capital
purchases in fiscal year 2001. These capital expenditures are expected to relate
primarily to manufacturing equipment, tooling, molds and, to a lesser extent,
computer equipment and software, leasehold improvements, demonstration
equipment, and furniture and fixtures. The Company has no material commitments
for capital expenditures. The Company anticipates a negative cash flow during at
least the first two quarters of fiscal 2001.
At March 31, 2000 the Company's principal sources of liquidity included
$1.6 million in cash and cash equivalents. In addition, the Company has a demand
bank line of credit under which the Company may borrow up to $250,000 in cash,
net of any outstanding letters of credit. At March 31, 2000, the Company had
acceptances payable totaling $33,000 maturing in April and May 2000. The Company
has pledged $250,000 to secure the bank line of credit. The line is subject to
renewal in February 2002.
The Company has incurred losses since its inception, and losses are expected
to continue during the fiscal year ending March 31, 2001. The Company has funded
the losses principally with the proceeds from public and private equity
financings. The Company has reduced its operating losses significantly in the
years ended March 31, 2000 and 1999, compared to the year ended March 31, 1998,
and the Company believes that, if it meets its projections for sales and
controls operating expenses, it may generate an operating income during the
second half of fiscal 2001. There can be no assurance that the Company's
strategy will result in an operating income during fiscal 2001, and the
management of the Company will continue to seek equity capital during fiscal
2001. However, there can be no assurance that capital will be available on terms
acceptable to the Company, if at all.
22
<PAGE>
CERTAIN FACTORS THAT MAY AFFECT THE COMPANY'S FUTURE OPERATING RESULTS
Factors that may affect the Company's future operating results include,
without limitation, the following:
The Company has incurred substantial losses since its inception, and there
can be no assurance that the Company will achieve a profitable level of
operations in the future. The Company anticipates a negative cash flow during at
least the first two quarters of fiscal 2001, due primarily to the requirement to
fund working capital and marketing expenses in the continued drive to penetrate
the ENT marketplace. The fulfillment of this commitment may require the Company
to obtain additional financing. There can be no assurance that such financing
will be available on terms acceptable to the Company, if at all. Therefore,
there is substantial doubt concerning the Company's ability to continue as a
going concern.
There can be no assurance that third-party reimbursement will be available
for procedures performed with the Company's products or that the cost of the
Company's EndoSheaths would be covered by such reimbursement in the future. In
addition, reimbursement standards and rates may change. The Company believes
that the failure of users of the Company's products to obtain adequate
reimbursement from third-party payors has had and is expected to continue to
have a materially adverse effect on the Company.
The Company's products and its manufacturing practices are subject to
regulation by the FDA and by other state and foreign regulatory agencies. The
process of obtaining required regulatory clearances can be lengthy and
expensive, and compliance with the FDA's QSR requirements can be burdensome.
Moreover, there can be no assurance that the required regulatory clearances will
be obtained, and those obtained may include significant limitations on the uses
of the product in question. In addition, changes in existing regulations or the
adoption of new regulations could make regulatory compliance by the Company more
difficult in the future. The failure to obtain the required regulatory
clearances or to comply with applicable regulations may result in fines, delays
or suspensions of clearances, seizures, or recalls of products, operating
restrictions and criminal prosecutions, and could have a material adverse effect
on the Company.
Certain critical components of the Company's products, such as image
bundles, are currently being purchased solely from Asahi Optical Co., Ltd.,
which is the parent company of a competitor of the Company. These components are
being purchased pursuant to a supply agreement, which expires in March 2001,
subject to earlier termination by mutual consent or upon breach or bankruptcy
and which may be extended with the consent of both parties. The Company believes
that while substitute components, which are currently produced by sources other
than Asahi, would be available, such substitute components may be more expensive
and of a lower quality and may require a redesign of the Company's endoscope and
additional regulatory clearances. Moreover, such substitute components may not
be immediately available in quantities needed by the Company. The Company's
inability to obtain a sufficient quantity of such critical components on
favorable terms could materially adversely affect the Company's business. In
addition, the Company's borescopes are assembled using components and
sub-assemblies purchased from independent vendors. While most components and
sub-assemblies are currently available from more than one supplier, certain
critical components are currently purchased only from Asahi and Machida
Endoscope Company, Ltd. The failure of the Company to obtain a sufficient
quantity of such components on favorable terms could materially adversely affect
the Company's business.
The Company's ability to compete in its markets is affected by its product
development and innovation capabilities, its ability to obtain required
regulatory clearances, its ability to protect the proprietary technology
included in its products, its manufacturing and marketing skills and its ability
to attract and retain skilled employees. The flexible endoscopes and related
products currently sold and under development by the Company face competition
primarily from medical products companies such as Olympus and Pentax, a
subsidiary of Asahi. In addition, any company that is able to significantly
redesign conventional flexible endoscopes to simplify the cleaning process, or
significantly improve the current methods of cleaning flexible endoscopes, would
provide competition for the Company's products. The principal competitors for
the Company's non-medical products are Olympus and Welch Allyn, Inc. Many
23
<PAGE>
of the Company's competitors and potential competitors have greater financial
resources, research and development personnel, and manufacturing and marketing
capabilities than the Company. In addition, it is possible that other large
health care companies may enter the flexible endoscope market in the future.
The Company's success depends in part on its ability to maintain patent
protection for its products, to preserve its trade secrets and to operate
without infringing the proprietary rights of third parties. There can be no
assurance that the Company's pending patent applications will result in patents
being issued or that competitors of the Company will not circumvent, or
challenge the validity of, any patents issued to the Company. There can be no
assurance that measures taken by the Company to protect its proprietary
information will prevent the unauthorized disclosure or use of this information,
or that others will not be able to independently develop such information. In
addition, in the event that another party infringes the Company's patent rights
or other proprietary rights, the enforcement of such rights is at the option of
the Company and can be a lengthy and costly process, with no guarantee of
success. Moreover, there can be no assurance that claims alleging infringement
by the Company of other's proprietary rights will not be brought against the
Company in the future or that any such claims will not be successful.
The nature of the Company's products exposes the Company to significant
product liability risks. The Company maintains product liability insurance with
coverage limits of $2,000,000 per year. The Company believes that this level of
coverage is adequate, given its past sales levels and its anticipated sales
levels for the fiscal year ending March 31, 2001. The Company will reevaluate
the adequacy of this coverage when and if its sales levels substantially
increase. No product liability claims have been brought against the Company to
date. However, there can be no assurance that product liability insurance will
continue to be available to the Company on acceptable terms, or that product
liability claims in excess of the Company's insurance coverage, if any, will not
be successfully asserted against the Company in the future.
ITEM 7A.__ QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company, in the normal course of business, is subject to the risks
associated with fluctuations in interest rates and changes in foreign currency
exchange rates.
INTEREST AND MARKET RISK
The Company maintains a portfolio of marketable, primarily fixed income,
available-for-sale securities of various issuers, types and maturities. The
Company has not used derivative financial instruments in its investment
portfolio. The Company attempts to limit its exposure to interest rate and
credit risk by placing its investments with high-quality financial institutions
and has established investment guidelines relative to diversification and
maturities designed to maintain safety and liquidity.
Investments in both fixed rate and floating rate interest earning
instruments carry a degree of interest rate risk. Fixed rate securities may have
their fair market value adversely impacted due to a rise in interest rates,
while floating rate securities may produce less income than expected if interest
rates decline. Due in part to these factors, the Company's future investment
income may fall short of expectations due to changes in interest rates or the
Company may suffer losses in principal if forced to sell securities which have
seen a decline in market value due to changes in interest rates.
FOREIGN CURRENCY EXCHANGE
The Company faces exposure, due to purchases of raw materials from Japanese
suppliers, to adverse movements in the value of the Japanese Yen. This exposure
may change over time, and could have a materially adverse effect on the
Company's financial results. The Company may attempt to limit this exposure by
purchasing forward contracts, as required. Most of the Company's liabilities are
settled within 90 days of receipt of materials. At March 31, 2000 the Company's
liabilities relating to Japanese Yen were approximately $69,000.
24
<PAGE>
ITEM 8.__FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The information required by this Item is attached as Appendix A.
ITEM 9.__CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
25
<PAGE>
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this Item is contained in (1) the table
appearing under the heading "Election of Directors" in the Company's Proxy
Statement for its 2000 Annual Meeting of Stockholders (the "2000 Proxy
Statement"), which table is incorporated herein by reference, and (2) Part I
hereof under the caption "Executive Officers of the Company."
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item appears under the headings "Election
of Directors--Director Compensation; Executive Compensation; and Agreements with
Senior Executives" in the 2000 Proxy Statement, which sections are incorporated
herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this Item appears under the heading "Stock
Ownership of Certain Beneficial Owners and Managers" in the 2000 Proxy
Statement, which section is incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this Item appears under the heading "Certain
Relationships and Related Transactions" in the 2000 Proxy Statement, which
section is incorporated herein by reference.
26
<PAGE>
PART IV
ITEM 14.__EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) Index to Consolidated Financial Statements.
1. FINANCIAL STATEMENTS. The following financial statements and schedule
of Vision-Sciences, Inc. are included as Appendix A of this Report:
Consolidated Balance Sheets--March 31, 1999 and 2000.
Consolidated Statements of Operations--For the years ended March 31,
1998, 1999 and 2000.
Consolidated Statements of Stockholders' Equity--For the years ended
March 31, 1998, 1999 and 2000.
Consolidated Statements of Cash Flows--For the years ended March 31,
1998, 1999 and 2000.
Notes to Consolidated Financial Statements.
2. FINANCIAL STATEMENTS. The following financial statements and schedule
of 3DV Systems Ltd. are included as Appendix B of this Report:
Consolidated Balance Sheets--December 31, 1998 and 1999.
Consolidated Statements of Operations--For the years ended
December 31, 1998, 1999 and from inception.
Consolidated Statements of Stockholders' Equity--For the years ended
December 31, 1998, 1999 and from inception.
Consolidated Statements of Cash Flows--For the years ended
December 31, 1998, 1999 and from inception.
Notes to Consolidated Financial Statements.
3. FINANCIAL STATEMENT SCHEDULES. The following consolidated financial
statement schedule is included on page S-1.
Schedule II--Valuation and Qualifying Accounts
All other schedules for which provision is made in the applicable
accounting regulations of the Securities and Exchange Commission are
not required under the related instructions or are not applicable
and, therefore, have been omitted.
4. EXHIBITS. The exhibits which are filed with this report or which are
incorporated herein by reference are set forth in the Exhibit Index
on page E-1.
(b) Reports on Form 8-K.
Not applicable.
27
<PAGE>
SIGNATURES
Pursuant to the requirements of Sections 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.
<TABLE>
<S> <C> <C>
VISION-SCIENCES, INC.
By: /s/ KATSUMI ONEDA
-----------------------------------------
Katsumi Oneda
PRESIDENT, CHIEF EXECUTIVE OFFICER AND
CHAIRMAN OF THE BOARD OF DIRECTORS
</TABLE>
Date: June 9, 2000
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the date indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<C> <S> <C>
President, Chief Executive
/s/ KATSUMI ONEDA Officer and Chairman of the
------------------------------------------- Board of Directors June 9, 2000
Katsumi Oneda (Principal Executive
Officer)
/s/ GERALD B. LICHTENBERGER
------------------------------------------- Vice President, Business June 6, 2000
Gerald B. Lichtenberger Development and Secretary
Vice President Finance,
/s/ JAMES A. TRACY Chief Financial and
------------------------------------------- Accounting Officer June 2, 2000
James A. Tracy (Principal Financial and
Accounting Officer)
/s/ KENNETH ANSTEY
------------------------------------------- Director June 2, 2000
Kenneth Anstey
/s/ LEWIS C. PELL
------------------------------------------- Director June 27, 2000
Lewis C. Pell
/s/ FRED E. SILVERSTEIN
------------------------------------------- Director June 7, 2000
Fred E. Silverstein
</TABLE>
<PAGE>
APPENDIX A
VISION-SCIENCES, INC. AND SUBSIDIARIES
CONSOLIDATED FINANCIAL STATEMENTS
AS OF MARCH 31, 1999 AND 2000
TOGETHER WITH AUDITORS' REPORT
<PAGE>
VISION-SCIENCES, INC. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
--------
<S> <C>
Report of Independent Public Accountants.................... F-1
Consolidated Balance Sheets................................. F-2
Consolidated Statements of Operations....................... F-3
Consolidated Statements of Stockholders' Equity............. F-4
Consolidated Statements of Cash Flows....................... F-5
Notes to Consolidated Financial Statements.................. F-6
Schedule II--Valuation and Qualifying Accounts.............. S-1
</TABLE>
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Shareholders and Board of Directors of Vision-Sciences, Inc.:
We have audited the accompanying consolidated balance sheets of
Vision-Sciences, Inc. (a Delaware corporation) and subsidiaries as of March 31,
1999 and 2000, and the related consolidated statements of operations,
stockholders' equity and cash flows for each of the three years in the period
ended March 31, 2000. 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 auditing standards generally
accepted in the United States. 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.
We did not audit the financial statements of 3DV Systems Ltd., the
investment which is reflected in the accompanying financial statements using the
equity method of accounting. The investment in 3DV Systems Ltd. represents
5 percent of total assets and the equity in its net loss represents 70 percent
of net loss. The statements of 3DV Systems Ltd. were audited by other auditors
whose report has been furnished to us and our opinion, insofar as it relates to
the amounts included for 3DV Systems Ltd., is based on the report of the other
auditors.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Vision-Sciences, Inc. and
subsidiaries as of March 31, 1999 and 2000, and the results of their operations
and their cash flows for each of the three years in the period ended March 31,
2000, in conformity with accounting principles generally accepted in the United
States.
The accompanying consolidated financial statements have been prepared
assuming that the Company will continue as a going concern. The Company has
incurred substantial losses for the years ended March 31, 1998, 1999 and 2000,
and losses are expected to continue at least through 2001. The Company may be
required to obtain additional funding or alternative means of financial support
in order to continue to operate as a going concern. Given these factors, there
is substantial doubt concerning the Company's ability to continue as a going
concern. Management's plans in regard to these matters are discussed in Note 1.
The accompanying consolidated financial statements do not include any
adjustments that might result from the outcome of this uncertainty.
Our audits were made for the purpose of forming an opinion on the basic
financial statements taken as a whole. The schedule listed in the index to
consolidated financial statements is presented for purposes of complying with
the Securities and Exchange Commission's rules and is not a part of the basic
financial statements. This schedule has been subjected to the auditing
procedures applied in the audits of the basic financial statements and, in our
opinion, fairly states, in all material respects, the financial data required to
be set forth therein in relation to the basic financial statements taken as a
whole.
/s/ Arthur Andersen LLP
Boston, Massachusetts
May 12, 2000
F-1
<PAGE>
VISION-SCIENCES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS--MARCH 31, 1999 AND 2000
<TABLE>
<CAPTION>
1999 2000
------------ ------------
<S> <C> <C>
ASSETS
Current Assets:
Cash and cash equivalents................................. $ 2,224,863 $ 1,581,381
Marketable securities..................................... 970,608 --
Accounts receivable, net of allowance for doubtful
accounts of $130,000
and $156,000 in 1999 and 2000, respectively............. 1,089,371 1,079,590
Inventories............................................... 633,571 1,278,084
Prepaid expenses and deposits............................. 98,692 76,743
------------ ------------
Total current assets................................ 5,017,105 4,015,798
------------ ------------
Property and Equipment, at Cost:
Machinery and equipment................................... 2,741,919 2,870,944
Furniture and fixtures.................................... 199,070 202,067
Motor vehicles............................................ 23,956 20,949
Leasehold improvements.................................... 279,642 313,154
------------ ------------
3,244,587 3,407,114
Less--Accumulated depreciation and amortization........... 2,561,713 2,846,318
------------ ------------
682,874 560,796
------------ ------------
Equity Investment in 3DV Systems Ltd........................ 2,053,900 222,553
Other Assets, net of accumulated amortization of $22,000 in
1999 and 2000............................................... 128,457 108,783
------------ ------------
Total assets........................................ $ 7,882,336 $ 4,907,930
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Acceptances payable to a bank............................. $ 32,333 $ 32,512
Accounts payable.......................................... 452,378 374,684
Accrued expenses.......................................... 1,601,977 1,586,248
------------ ------------
Total current liabilities........................... 2,086,688 1,993,444
------------ ------------
Deferred Development Fee (Note 3)........................... 345,821 --
------------ ------------
Commitments (Note 6)
Stockholders' Equity:.......................................
Preferred stock, $.01 par value--
Authorized--5,000,000 shares
Issued and outstanding--none -- --
Common stock, $.01 par value--
Authorized--25,000,000 shares
Issued and outstanding--19,212,021 shares and 20,901,128
shares
at March 31, 1999 and 2000, respectively................ 192,119 209,010
Additional paid-in capital................................ 51,830,808 54,054,458
Accumulated deficit....................................... (46,573,100) (51,348,982)
------------ ------------
Total stockholders' equity.......................... 5,449,827 2,914,486
------------ ------------
Total liabilities and stockholders' equity.......... $ 7,882,336 $ 4,907,930
============ ============
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL
STATEMENTS.
F-2
<PAGE>
VISION-SCIENCES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED MARCH 31, 1998, 1999 AND 2000
<TABLE>
<CAPTION>
1998 1999 2000
----------- ----------- -----------
<S> <C> <C> <C>
Net Sales.............................................. $ 7,997,838 $ 7,475,921 $ 7,054,595
Cost of Sales.......................................... 6,578,721 6,202,330 4,792,542
----------- ----------- -----------
Gross profit..................................... 1,419,117 1,273,591 2,262,053
Selling, General and Administrative Expenses........... 3,558,688 3,028,911 3,138,999
Research and Development Expenses...................... 762,558 209,460 684,208
----------- ----------- -----------
Loss from operations............................. (2,902,129) (1,964,780) (1,561,154)
Interest Income, net................................... 147,287 182,899 109,581
Equity in Losses of 3DV Systems Ltd.................... -- (367,242) (3,331,347)
Other Income........................................... 176,874 9,927 5,132
----------- ----------- -----------
Net loss......................................... $(2,577,968) $(2,139,196) $(4,777,788)
=========== =========== ===========
Basic and Diluted Net Loss per Common Share............ $ (.17) $ (.12) $ (.24)
=========== =========== ===========
Shares Used in Computing Basic and Diluted Net Loss per
Common Share......................................... 15,224,000 18,224,448 19,954,842
=========== =========== ===========
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL
STATEMENTS.
F-3
<PAGE>
VISION-SCIENCES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED MARCH 31, 1998, 1999 AND 2000
<TABLE>
<CAPTION>
COMMON STOCK
---------------------- ADDITIONAL TOTAL TOTAL
NUMBER $.01 PAID-IN ACCUMULATED STOCKHOLDERS' COMPREHENSIVE
OF SHARES PAR VALUE CAPITAL DEFICIT EQUITY INCOME (LOSS)
---------- --------- ----------- ------------ ------------- --------------
<S> <C> <C> <C> <C> <C> <C>
Balance, March 31, 1997.......... 14,696,909 $146,968 $46,098,212 $(41,855,936) $4,389,244
Sale of common stock........... 1,941,748 19,417 1,980,583 2,000,000
Exercise of stock options...... 4,414 45 5,197 5,242
Net loss....................... -- -- -- (2,577,968) (2,577,968) $(2,577,968)
---------- -------- ----------- ------------ ---------- -----------
Total Comprehensive Income
(Loss)......................... (2,577,968)
Balance, March 31, 1998.......... 16,643,071 166,430 48,083,992 (44,433,904) 3,816,518
Sale of common stock, net...... 2,000,000 20,000 2,923,727 2,943,727
Issuance of common stock in
connection with investment in
3DV Systems Ltd.............. 500,000 5,000 741,900 746,900
Exercise of stock options...... 68,950 689 81,189 81,878
Net loss....................... -- -- -- (2,139,196) (2,139,196) (2,139,196)
---------- -------- ----------- ------------ ---------- -----------
Total Comprehensive Income
(Loss)......................... (2,139,196)
Balance, March 31, 1999.......... 19,212,021 192,119 51,830,808 (46,573,100) 5,449,827
Sale of common stock, net...... 1,443,088 14,431 1,485,569 1,500,000
Exercise of stock options...... 246,019 2,460 139,258 141,718
Stock option grants to non-
employees.................... -- -- 598,823 598,823
Currency translation
adjustment................... -- -- 1,906 1,906 1,906
Net loss....................... -- -- -- (4,777,788) (4,777,788) (4,777,788)
---------- -------- ----------- ------------ ---------- -----------
Total Comprehensive Income
(Loss)......................... $(4,775,882)
===========
Balance, March 31, 2000.......... 20,901,128 $209,010 $54,054,458 $(51,348,982) $2,914,486
========== ======== =========== ============ ==========
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL
STATEMENTS.
F-4
<PAGE>
VISION-SCIENCES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED MARCH 31, 1998, 1999 AND 2000
<TABLE>
<CAPTION>
1998 1999 2000
----------- ----------- -----------
<S> <C> <C> <C>
Cash Flows from Operating Activities:
Net loss............................................. $(2,577,968) $(2,139,196) $(4,777,788)
Adjustments to reconcile net loss to net cash
provided by (used in) operating activities--
Depreciation and amortization...................... 491,191 413,588 290,946
Equity in losses of 3DV Systems Ltd................ -- 1,693,000 3,331,347
Loss on disposal of property and equipment......... 75,172 12,809 --
Amortization of deferred credit.................... (36,558) -- --
Stock option grants to non-employees............... -- -- 598,823
Changes in assets and liabilities--
Accounts receivable.............................. 410,122 349,914 9,781
Inventories...................................... 25,236 47,535 (644,513)
Prepaid expenses and deposits.................... 63,299 (11,970) 21,949
Accounts payable................................. 25,999 (72,763) (77,694)
Accrued expenses................................. (100,863) (166,840) (15,729)
Deferred development fee......................... -- 345,821 (345,821)
----------- ----------- -----------
Net cash (used in) provided by operating
activities....................................... (1,624,370) 471,898 (1,608,699)
----------- ----------- -----------
Cash Flows from Investing Activities:
(Increase) decrease in marketable securities......... (993,146) 22,538 970,608
Purchase of property and equipment................... (192,413) (225,617) (162,527)
Investment in equity of 3DV Systems Ltd.............. -- (3,000,000) (1,500,000)
Decrease in other assets............................. 15,189 52,584 13,333
----------- ----------- -----------
Net cash used in investing activities.............. (1,170,370) (3,150,495) (678,586)
----------- ----------- -----------
Cash Flows from Financing Activities:
Currency translation adjustment...................... -- -- 1,906
Proceeds from (payments of) acceptances payable to a
bank, net.......................................... 6,132 (20,050) 179
Proceeds from the sale of common stock, net.......... 2,000,000 2,943,727 1,500,000
Proceeds from exercise of stock options.............. 5,242 81,878 141,718
----------- ----------- -----------
Net cash provided by financing activities.......... 2,011,374 3,005,555 1,643,803
----------- ----------- -----------
Net (Decrease) Increase in Cash and Cash Equivalents... (783,366) 326,958 (643,482)
Cash and Cash Equivalents, beginning of year........... 2,681,271 1,897,905 2,224,863
----------- ----------- -----------
Cash and Cash Equivalents, end of year................. $ 1,897,905 $ 2,224,863 $ 1,581,381
=========== =========== ===========
Supplemental Disclosure of Non-Cash Investing and
Financing Activities:
Issuance of common stock in connection with equity
investment in 3DV Systems Ltd...................... $ -- $ 746,900 $ --
=========== =========== ===========
Supplemental Disclosure of Cash Flow Information:
Cash paid during the year for interest............... $ 399 $ -- $ --
=========== =========== ===========
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL
STATEMENTS.
F-5
<PAGE>
VISION-SCIENCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2000
(1) OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES
The consolidated financial statements include the accounts of
Vision-Sciences, Inc. (the "Company"), a Delaware corporation, and its
wholly-owned subsidiary, Vision-Sciences Ltd. ("VSL"), a corporation organized
under the laws of Israel.
The Company was organized in 1987 to manufacture and assemble optical
products. The Company's products and accessories, which provide minimally
invasive access to areas not readily visible to the human eye, are used within
two industry segments, medical and industrial. Segment information is presented
in Note 8.
The Company expects to derive a substantial portion of its future revenues
from its disposable EndoSheath/reusable endoscope systems. The Company has
invested substantial funds in this product's development. The Company has
incurred losses for the years ended March 31, 1998, 1999 and 2000. The Company's
auditor's report dated May 12, 2000 includes a reference to the substantial
doubt of the Company's ability to continue as a going concern. Management
believes the Company may require additional financial support for the fiscal
year 2001. Management is pursuing additional sources of capital; however, there
can be no assurance that additional funding will be available, or available on
reasonable terms. The Company is also subject to other risks, including, but not
limited to, the successful marketing of its products, United States Food and
Drug Administration (FDA) clearance and regulation, and dependence on key
personnel.
The accompanying consolidated financial statements reflect the application
of certain accounting policies as described below and elsewhere in the notes to
consolidated financial statements. The preparation of the accompanying
consolidated financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities, disclosure of contingent
assets and liabilities at the date of the financial statements and the reported
amounts of revenues and expenses during the reporting period. Actual results in
the future could differ from those estimates.
(A) PRINCIPLES OF CONSOLIDATION
The accompanying consolidated financial statements reflect the accounts of
the Company and its wholly owned subsidiaries. All significant intercompany
accounts and transactions have been eliminated in consolidation.
(B) BASIC AND DILUTED NET LOSS PER COMMON SHARE
The Company calculates earnings per share according to Statement of
Financial Accounting Standards (SFAS) No. 128, EARNINGS PER SHARE. Basic net
loss per share is calculated by dividing the net loss by the weighted average
number of common shares outstanding. For the years ended March 31, 1998, 1999
and 2000 diluted net loss per common share is the same as basic net loss per
common share as the inclusion of other shares of stock issuable pursuant to
stock options, totaling 1,647,422, 1,381,297 and 2,578,047, respectively, would
be antidilutive.
F-6
<PAGE>
VISION-SCIENCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 2000
(1) OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
(C) DEPRECIATION AND AMORTIZATION
The Company provides for depreciation and amortization using the
straight-line method in amounts that allocate the cost of the assets over their
estimated useful lives, as follows:
<TABLE>
<CAPTION>
ESTIMATED
ASSET CLASSIFICATION USEFUL LIFE
-------------------- -----------
<S> <C>
Motor vehicles.............................................. 3 Years
Machinery and equipment..................................... 3-5 Years
Furniture and fixtures...................................... 5 Years
</TABLE>
Leasehold improvements are amortized over the shorter of their estimated
useful lives or the lives of the leases.
(D) REVENUE RECOGNITION
The Company recognizes revenue upon product shipment.
(E) INVENTORIES
Inventories are stated at the lower of cost or market using the first-in,
first-out (FIFO) method.
The components of inventories are as follows:
<TABLE>
<CAPTION>
MARCH 31,
---------------------
1999 2000
-------- ----------
<S> <C> <C>
Raw materials......................................... $169,653 $ 176,620
Work-in-process....................................... 186,806 215,626
Finished goods........................................ 277,112 885,838
-------- ----------
$633,571 $1,278,084
======== ==========
</TABLE>
Work-in-process and finished goods inventories consist of materials, labor
and manufacturing overhead.
(F) OTHER ASSETS
Other assets consist of deposits and patent costs. Patent costs are
amortized on a straight-line basis over 17 years. The Company follows the
provisions of SFAS No. 121, ACCOUNTING FOR THE IMPAIRMENT OF LONG-LIVED ASSETS
AND FOR LONG-LIVED ASSETS TO BE DISPOSED OF. SFAS No. 121 requires that
long-lived assets be reviewed for impairment by comparing the fair value of the
assets with their carrying amount. Any write-downs are to be treated as
permanent reductions in the carrying value of the assets. The Company believes
that the carrying values of these assets are fully realizable as of March 31,
2000.
(G) FOREIGN CURRENCY TRANSACTIONS
The Company charges foreign currency exchange gains or losses in connection
with its purchases of products from vendors in Japan to operations in accordance
with SFAS No. 52, FOREIGN CURRENCY
F-7
<PAGE>
VISION-SCIENCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 2000
(1) OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
TRANSLATION. For each of the three years in the period ended March 31, 2000
these amounts were not material.
(H) CASH AND CASH EQUIVALENTS
The Company classifies investments with original maturities of three months
or less, consisting of U.S. Government issues and commercial paper, as cash
equivalents. Cash equivalents are stated at amortized cost, which approximates
market value.
(I) MARKETABLE SECURITIES
Marketable securities consist of marketable financial instruments with
original maturities greater than 90 days. The Company has established guidelines
relative to concentration, maturities and credit ratings that are designed to
maintain safety and liquidity.
The Company has classified its investments in marketable securities as
available-for-sale securities, in accordance with SFAS No. 115. Marketable
securities are recorded at market value, which approximates amortized cost.
As of March 31, 1999, the Company's marketable securities consisted of
commmercial paper and corporate notes with a weighted average maturity of
176 days.
(J) RESEARCH AND DEVELOPMENT EXPENSES
Research and development expenses are charged to operations as incurred.
(K) CONCENTRATION OF CREDIT RISK
SFAS No. 105, DISCLOSURE OF INFORMATION ABOUT FINANCIAL INSTRUMENTS WITH
OFF-BALANCE-SHEET RISK AND FINANCIAL INSTRUMENTS WITH CONCENTRATION OF CREDIT
RISK, requires disclosure of any significant off-balance-sheet and credit risk
concentrations. Financial instruments that potentially subject the Company to
concentration of credit risk are principally cash, marketable securities and
accounts receivable. The Company places its cash in federally insured
institutions and invests in marketable securities in highly rated investment
vehicles. Concentration of credit risk with respect to accounts receivable
relates to certain domestic and international customers to whom the Company
makes substantial sales (see Note 7). To reduce risk, the Company routinely
assesses the financial strength of its customers and obtains letters of credit
or advance payments for most of its international sales; as a consequence, the
Company believes that its accounts receivable credit risk exposure is limited.
The Company maintains an allowance for potential credit losses, but historically
has not experienced any significant credit losses related to any individual
customer or group of customers in any particular industry or geographic area.
(L) FAIR VALUE OF FINANCIAL INSTRUMENTS
SFAS No. 107, DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS requires
disclosure of an estimate of the fair value of certain financial instruments.
The Company's financial instruments consist of cash equivalents, accounts
receivable and acceptances payable. The estimated fair value of these financial
F-8
<PAGE>
VISION-SCIENCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 2000
(1) OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
instruments approximates their carrying value at March 31, 1999 and 2000. The
estimated fair values have been determined through information obtained from
market sources and management estimates.
(M) COMPREHENSIVE INCOME
SFAS No. 130, REPORTING COMPREHENSIVE INCOME requires companies to classify
items of other comprehensive income by their nature in a financial statement and
display the accumulated balance of other comprehensive income separately from
retained earnings and additional paid-in capital in the equity section of the
balance sheet.
(2) DEBT
The Company has a demand line-of-credit agreement with a bank in support of
general working capital needs and the issuance of commercial and standby letters
of credit. Borrowings under the agreement bear interest at the bank's prime rate
(9.00% at March 31, 2000) and are secured by the Company's cash and marketable
securities held by the bank. The Company may borrow up to $250,000 (net of any
letters of credit) under the line of credit, which is subject to renewal by the
bank on February 15, 2002. Under this agreement, the Company is also subject to
certain covenants, including the prohibition of paying cash dividends on its
common stock. At March 31, 2000, the Company had acceptances payable aggregating
$32,512, maturing in April and May 2000.
(3) INCOME TAXES
The Company accounts for income taxes under the liability method in
accordance with SFAS No. 109, ACCOUNTING FOR INCOME TAXES. Under SFAS No. 109,
deferred tax assets or liabilities are computed based on the differences between
the financial statement and income tax bases of assets and liabilities as
measured by the enacted tax rates.
The components of the net deferred tax asset recognized in the accompanying
consolidated balance sheets with the approximate income tax effect of each type
of temporary difference are as follows:
<TABLE>
<CAPTION>
MARCH 31,
-------------------------
1999 2000
----------- -----------
<S> <C> <C>
Net operating loss carryforwards................... $17,009,000 $18,933,000
Nondeductible reserves............................. 1,004,000 764,000
Research and development credit carryforwards...... 437,000 581,000
Other temporary differences........................ 314,000 431,000
Depreciation....................................... (80,000) (117,000)
----------- -----------
$18,684,000 $20,592,000
Less--Valuation allowance.......................... 18,684,000 20,592,000
----------- -----------
Net deferred tax asset........................ $ -- $ --
=========== ===========
</TABLE>
F-9
<PAGE>
VISION-SCIENCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 2000
(3) INCOME TAXES (CONTINUED)
The Company has recorded a valuation allowance equal to its net deferred tax
asset due to the uncertainty of realizing the benefit of this asset.
At March 31, 2000, the Company had operating loss carryforwards available to
offset future federal taxable income of approximately $47,753,000. These
operating loss carryforwards expire at various dates through 2020 and are
subject to review and possible adjustment by the Internal Revenue Service.
The Internal Revenue Code limits the amount of net operating loss
carryforwards that companies may use in any one year in the event of certain
cumulative changes in ownership over a three-year period.
(4) 3DV SYSTEMS LTD., IMAGINEERING LTD. AND VISION-SCIENCES LTD.
On August 20, 1998, pursuant to an Investment Agreement dated August 6, 1998
between Vision-Sciences, Inc., (the "Company") and 3DV Systems Ltd., a
privately-held Israeli company ("3DV"), (the "Agreement") the Company purchased
338,099 shares of common stock of 3DV (the "Shares"), for a purchase price of
$3 million in cash. The Company funded the purchase price from proceeds received
from Asahi Optical Co., Ltd., (Asahi Kogaku Kogyo Kabushiki Kaisha), a Japanese
corporation ("Asahi"), pursuant to the License Agreement between the Company and
Asahi described below. The Shares were previously unissued shares of common
stock of 3DV and, after the closing of the transaction, represented 25% of the
fully diluted share capital of 3DV. Prior to the investment by the Company, 3DV
was a wholly-owned subsidiary of RDC Rafael Development Corporation Ltd.
("RDC"), an Israeli company.
Pursuant to the Agreement, the Company also issued 500,000 shares of its
common stock, $.01 par value per share (the "Common Stock"), to RDC in exchange
for certain rights. These rights included an option to purchase all of the
remaining shares of capital stock of 3DV owned by RDC, which then represented
62.85% of the fully-diluted share capital of 3DV, at the then fair market value
of such shares. This option was to be exercisable by the Company during the
period May 15, 2000 to November 14, 2000. The value of the shares issued was
$746,900, and was recorded as a component of the Company's investment in 3DV.
In addition, RDC had the right to require the Company to purchase up to the
remaining 75% of the fully-diluted share capital of 3DV, including 12.15% that
would have been owned by employees of 3DV, at the then fair market value of such
shares. Two of the Company's directors, Mr. Katsumi Oneda and Mr. Lewis C. Pell,
have been appointed to the Board of Directors of 3DV.
The terms of the Agreement were determined on the basis of arms'-length
negotiations. Prior to the execution of the Agreement, neither the Company nor
any of its affiliates had any material relationship with either 3DV or RDC.
In connection with these transactions with 3DV and RDC, the Company also
entered into a License and Manufacturing Agreement (the "L&M Agreement") with
3DV, dated August 6, 1998, pursuant to which the Company obtained exclusive,
worldwide, perpetual and royalty-free rights to commercially exploit products in
certain fields of use that incorporate, or use, component parts embodying
technology developed by 3DV. The L&M Agreement allows the Company to sublicense
certain of these rights to approved assigns. Asahi, which manufactures and
markets a wide variety of cameras, medical endoscopes and industrial imaging
systems worldwide under the brand name Pentax, is the sole approved assign under
F-10
<PAGE>
VISION-SCIENCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 2000
(4) 3DV SYSTEMS LTD., IMAGINEERING LTD. AND VISION-SCIENCES LTD. (CONTINUED)
the L&M Agreement, and the Company has sublicensed certain of its rights under
the L&M Agreement to Asahi pursuant to the License Agreement described below.
On August 6, 1998, the Company executed a Memorandum of Understanding (the
"MOU") with Imagineering, Ltd., ("Imagineering") pursuant to which the Company
acquired exclusive rights to research performed in association with certain
innovations (the "Innovations") that are designed to improve the performance of
CMOS-based Image Sensors. The MOU grants the Company exclusive rights to any
resulting patent applications and patent rights that result from such research.
A consultant to Imagineering performed the research, and delivered the final
Innovation on January 28, 2000. On that date, as part of the terms of the MOU,
the Company granted the consultant a fully-vested nonstatutory stock option for
1,000,000 shares of the Company's Common Stock, at a price of $1.63 per share,
equal to the closing price of the Company's common stock as traded on Nasdaq
SmallCap on January 28, 2000. The fair value of the option was calculated using
the Black-Scholes option-pricing model resulting in $421,911 being recorded as a
research and development expense. In addition, the Company funded the cost of
the research by Imagineering for a period of one year. The terms of the MOU were
determined on the basis of arms'-length negotiations. Prior to the execution of
the MOU, neither the Company nor any of its affiliates had any material
relationship with Imagineering.
The Company also executed a License Agreement (the "License") with Asahi,
dated August 6, 1998, pursuant to which the Company granted Asahi exclusive
rights, as an approved assign under the L&M Agreement, to certain technology in
certain fields and to acquire from the Company and 3DV certain products having
application in those fields. Notwithstanding the License, the Company has
reserved the right to use the technology licensed to Asahi in products bearing
the Company's own trademarks within certain fields of use. In addition, the
License grants Asahi a worldwide, perpetual, royalty-free license to patentable
and non-patentable technology relating to the utilization or application of
CMOS-based Image Sensors, as researched or developed by the Company, pursuant to
the MOU with Imagineering. Pursuant to the License, on August 17, 1998, Asahi
paid the Company $5 million in cash in exchange for the rights described above
and the issuance by the Company to Asahi of 2,000,000 shares of Common Stock.
The terms of the License were determined on the basis of arms'-length
negotiations. Prior to the execution of the License, neither the Company nor any
of its affiliates had any material relationship with Asahi.
The Company recorded the value of the common stock at $1.4938 per share, the
average closing price of the Company's shares on Nasdaq for the ten trading days
ended August 20, 1998. The difference between the market value of the Company's
common stock and the gross proceeds was recorded as a deferred development fee,
representing a prepayment of $2,012,400 by Asahi for future development costs to
be incurred by 3DV and Imagineering and funded by the Company. The Company
incurred fees of approximately $67,000, $44,000 of which was applied to
additional paid-in capital, and $23,000 of which was applied to the deferred
development fee.
In the event that the Company fails to comply with the terms of the License,
it may be required to repurchase the stock issued to Asahi. Management believes
that all events that would require repurchase are within the control of the
Company. Therefore, the stock purchased by Asahi has been classified as an
element of stockholders' equity.
The deferred development fee was initially comprised of $657,000 of expected
development costs to be incurred by Imagineering and funded by the Company, and
$1,332,000 of expected development costs to
F-11
<PAGE>
VISION-SCIENCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 2000
(4) 3DV SYSTEMS LTD., IMAGINEERING LTD. AND VISION-SCIENCES LTD. (CONTINUED)
be incurred by 3DV and funded by the Company's investment in 3DV. The amount
applicable to Imagineering is based upon the MOU, and other costs that the
Company expected to incur during the CMOS development. Any costs related to
Imagineering that exceeded the estimate were recorded by the Company as charges
in its statement of operations. Any losses incurred by 3DV in excess of
$1,332,000 were recorded in the statement of operations of the Company.
In the fiscal years ended March 31, 1999 and 2000, the Company recorded an
expense relating to payments made of $311,000 and $346,000, respectively, to
fund Imagineering and Vision-Sciences, Ltd. The Company offset these expenses
with $311,000 and $346,000 of the development fees received from Asahi. In
addition, in the fiscal year ended March 31, 2000 the Company incurred costs of
$70,000 to fund the operations of Vision-Sciences, Ltd.
In May and August 1999, the Company loaned a total of $1,000,000 to 3DV. The
loans were non-interest bearing Convertible Capital Notes (the "Notes"), issued
pursuant to the Agreement. The issuance of the Notes was part of the Company's
commitment to finance the working capital needs of 3DV for calendar years 1999
and 2000. The Notes were convertible into common stock of 3DV according to
provisions of the Agreement. The Company initially recorded the Notes as part of
its investment in 3DV.
In November 1999, 3DV completed a Share Subscription Agreement (the "SSA"),
among the Company, Mr. Jeff Braun, Discount Investment Corporation ("DIC"), PEC
Israel Economic Corporation ("PEC") and Elron Electronic Industries Ltd.
("Elron"). The purpose of the SSA was to raise $4.5 million of new equity
capital for 3DV. The Company's portion of the SSA was $1.5 million. That
investment is comprised of the Company's Notes, and an additional $500,000 in
cash invested on December 23, 1999.
Upon the closing of the SSA, the Company's Notes converted into common stock
of 3DV which, with the current common stock of 3DV held by the Company and the
new common stock issued to the Company and the other investors, resulted in the
Company owning approximately 29% of the outstanding shares of 3DV.
As part of the SSA in November 1999, the Company and 3DV executed an
Amendment to the Agreement signed on August 6, 1998. Upon completion of
investments totaling $3 million or more, which occurred with the Company's
investment of $500,000 on December 23, 1999, the Amendment deleted Sections 3
and 4 of the Agreement. The deletion of these sections eliminated the Company's
option to purchase the remaining outstanding shares of 3DV under certain
conditions, and exempted the Company from guaranteeing the working capital
requirements of 3DV.
The Company accounts for its investment in 3DV using the equity method of
accounting. Due to the Company's commitment to finance the working capital needs
of 3DV, the Company absorbed 100% of the losses of 3DV up through December 23,
1999. Subsequent to December 23, 1999, the Company continued to account for its
investment in 3DV using the equity method of accounting. However, after
December 23, 1999 the Company has included only its proportional share of 3DV's
losses, not 100% of 3DV's losses. In the fiscal years ended March 31, 1999 and
2000, the Company recognized other expense of $367,000 and $3,331,000,
respectively, as its portion of the losses of 3DV.
F-12
<PAGE>
VISION-SCIENCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 2000
(5) STOCKHOLDERS' EQUITY
(A) SALE OF STOCK
During fiscal 2000, two of the Company's stockholders/executives invested
$1,500,000 in the Company's common stock at prices per share equal to 80% of the
average closing price of the stock on the Nasdaq SmallCap Market during the
five-day trading period preceding the purchase. The proceeds of the common stock
sales were received directly by the Company in exchange for newly issued shares
of common stock.
(B) STOCK OPTION PLANS
The Company has a stock option plan (the "1990 Plan") under which it may
grant key employees and consultants incentive and nonstatutory stock options at
the fair value of the stock on the date of grant. Options become exercisable at
varying dates ranging up to five years from the date of grant. The Board of
Directors has authorized the issuance of options for the purchase of up to
4,375,000 shares of common stock under the 1990 Plan, of which 1,218,622 shares
remain available for future grant.
A summary of the 1990 Plan activity is as follows:
<TABLE>
<CAPTION>
WEIGHTED
NUMBER EXERCISE AVERAGE
OF SHARES PRICE RANGE OPTION PRICE
--------- ----------- -------------
<S> <C> <C> <C>
Outstanding, March 31, 1997............ 1,502,822 $1.19-$7.50 $3.41
Granted.............................. 843,525 1.13-1.25 1.18
Exercised............................ (4,414) 1.19 1.19
Canceled............................. (734,511) 1.19-7.25 3.85
--------- ----------- -----
Outstanding, March 31, 1998............ 1,607,422 $1.13-$7.50 $2.04
Granted.............................. 80,000 1.00-1.75 1.43
Exercised............................ (68,950) 1.19 1.19
Canceled............................. (297,175) 1.19-1.25 1.19
--------- ----------- -----
Outstanding, March 31, 1999............ 1,321,297 $1.00-$7.50 $2.24
Granted.............................. 1,673,019 .01-1.63 1.48
Exercised............................ (246,019) .01-1.25 .58
Canceled............................. (230,250) 1.00-1.63 1.45
--------- ----------- -----
Outstanding March 31, 2000............. 2,518,047 $1.13-$7.50 $1.97
========= =========== =====
Exercisable, March 31, 2000............ 2,023,047 $1.13-$7.50 $2.08
========= =========== =====
</TABLE>
F-13
<PAGE>
VISION-SCIENCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 2000
(5) STOCKHOLDERS' EQUITY (CONTINUED)
The following table summarizes information about stock options outstanding
and exercisable at March 31, 2000:
<TABLE>
<CAPTION>
OUTSTANDING EXERCISABLE
----------------------------------- --------------------
WEIGHTED
AVERAGE WEIGHTED WEIGHTED
REMAINING AVERAGE AVERAGE
RANGE OF NUMBER OF CONTRACTUAL EXERCISE NUMBER EXERCISE
EXERCISE PRICES SHARES LIFE (YEARS) PRICE OF SHARES PRICE
--------------- --------- ------------ -------- --------- --------
<S> <C> <C> <C> <C> <C>
$1.13-1.25................................. 802,300 6.19 $1.20 742,300 $1.20
1.50-1.88................................. 1,455,000 9.63 1.60 1,022,500 1.63
3.00-4.00................................. 46,897 4.21 3.33 44,397 3.35
5.44-7.50................................. 213,850 3.92 7.07 213,850 7.07
--------- ---------
2,518,047 7.94 $1.97 2,023,047 $2.08
========= =========
</TABLE>
In October 1995, the Financial Accounting Standards Board (FASB) issued SFAS
No. 123, ACCOUNTING FOR STOCK-BASED COMPENSATION, which requires the measurement
of the fair value of stock-based compensation to be included in the statement of
operations or disclosed in the notes to the financial statements. The Company
has determined that it will continue to account for stock-based compensation for
employees under APB Opinion No. 25 and elects the disclosure-only alternative
under SFAS No. 123 for stock-based compensation awarded in the years ended
March 31, 1998, 1999 and 2000 using the Black-Scholes option pricing model
prescribed by SFAS No. 123. The underlying assumptions used are as follows:
<TABLE>
<CAPTION>
MARCH 31,
--------------------------------------------------------
1998 1999 2000
-------- ------------------- -------------------
<S> <C> <C> <C>
Risk-free interest rate............ 6.57% 4.45%-5.46% 5.68%-6.58%
Expected dividend yield............ -- -- --
Expected lives..................... 5 years 5 years 5 years
Expected volatility................ 64% 68% 89%
Weighted average value of grants
per share........................ $ .72 $ .87 $ 1.127
Weighted average remaining
contractual life of options
outstanding (years).............. 7.79 6.94 7.94
</TABLE>
Had compensation cost for the Company's stock option plans been determined
consistent with SFAS No. 123, pro forma net loss and net loss per share would
have been:
<TABLE>
<CAPTION>
MARCH 31,
---------------------------------------
1998 1999 2000
----------- ----------- -----------
<S> <C> <C> <C>
Net loss--As reported.................. $(2,578,000) $(2,139,000) $(4,778,000)
Pro forma..................... (2,815,000) (2,501,000) (4,888,000)
Net loss per share--As reported........ $ (.17) $ (.12) $ (.24)
Pro forma............. (.18) (.14) (.25)
</TABLE>
F-14
<PAGE>
VISION-SCIENCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 2000
(5) STOCKHOLDERS' EQUITY (CONTINUED)
Because the method prescribed by SFAS No. 123 has not been applied to
options granted prior to March 31, 1995, the resulting pro forma compensation
cost may not be representative of that to be expected in future years.
Under the 1990 Plan, there remain 3,736,669 shares of common stock reserved
for the exercise of stock options.
On August 16, 1993, the Company adopted another stock option plan (the "1993
Plan") under which it may grant up to 200,000 nonstatutory stock options to
nonemployee directors of the Company at the fair value of the stock on the date
of grant. Options become exercisable over a four-year period from the date of
grant. The Company has reserved 200,000 shares of common stock for the exercise
of stock options under the 1993 Plan. As of March 31, 2000, 140,000 shares were
available for future grant under the 1993 Plan.
A summary of the 1993 Plan activity is as follows:
<TABLE>
<CAPTION>
NUMBER EXERCISE WEIGHTED AVERAGE
OF SHARES PRICE RANGE OPTION PRICE
--------- ------------------- ----------------
<S> <C> <C> <C>
Outstanding March 31, 1997............................ 80,000 $ 5.50-$11.63 $10.09
Granted............................................. 20,000 1.50 1.50
Canceled............................................ (60,000) 5.50-11.63 9.58
------- ------------------- ------
Outstanding March 31, 1998............................ 40,000 $ 1.50-$11.63 $ 6.56
Granted............................................. 20,000 1.63 1.63
------- ------------------- ------
Outstanding March 31, 1999 and 2000................... 60,000 $ 1.50-$11.63 $ 4.92
======= =================== ======
Exercisable March 31, 2000............................ 40,000 $ 1.50-$11.63 $ 6.59
======= =================== ======
</TABLE>
The following table summarizes information about stock options outstanding
and exercisable at March 31, 2000:
<TABLE>
<CAPTION>
OUTSTANDING EXERCISABLE
------------------------ -----------
WEIGHTED
AVERAGE
REMAINING
NUMBER CONTRACTUAL NUMBER
EXERCISE PRICE OF SHARES LIFE (YEARS) OF SHARES
-------------- --------- ------------ -----------
<S> <C> <C> <C>
$ 1.50...................................................... 20,000 7.38 12,000
1.63...................................................... 20,000 8.38 8,000
11.63...................................................... 20,000 3.38 20,000
------ ------
60,000 6.38 40,000
====== ======
</TABLE>
(C) STOCK COMPENSATION AGREEMENT
During the year ended March 31, 1999, the Company entered into an agreement
with a consulting firm to provide services that will be paid in non-qualified
options to purchase common stock of the
F-15
<PAGE>
VISION-SCIENCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 2000
(5) STOCKHOLDERS' EQUITY (CONTINUED)
Company. The maximum value, as defined in the contract, of services to be
rendered is $200,000. The contract was renewed on January 1, 2000, and the
Company and consultant intend for the contract to remain in effect until the
maximum value of services is reached. The number of shares of common stock to be
issued will be based upon the total amount earned during the contract period
divided by the lowest closing bid price of the Company's common stock during
calendar 1999. During the years ended March 31, 1999 and 2000, the consulting
firm performed services that entitled the firm to receive options for 93,126 and
34,893 shares of common stock, respectively, valued at approximately $128,000
and $49,000, respectively. The value of the options granted was calculated using
the Black-Scholes option-pricing model. All options were granted to the
consulting firm during the year ended March 31, 2000, and were vested 100% upon
grant. The value of the options was recorded as an expense and is included as
part of selling, general and administrative expenses in the consolidated
statements of operations in the year in which the services were performed.
(6) COMMITMENTS AND RELATED PARTY TRANSACTIONS
The Company conducts a portion of its operations in certain facilities
leased from a partnership owned in part by certain stockholders/executive
officers. Rental expense charged to operations for these facilities was
approximately $186,000, $198,000 and $197,000 for the years ended March 31,
1998, 1999 and 2000, respectively. In addition, the Company leased other
facilities from nonrelated parties under various agreements that expire through
November 2003. Rental expense charged to operations under leases from nonrelated
parties was approximately $283,000, $163,000 and $147,000 for the years ended
March 31, 1998, 1999 and 2000, respectively. Future minimum lease commitments
under all operating leases are approximately as follows:
<TABLE>
<CAPTION>
YEAR ENDING MARCH 31,
---------------------
<S> <C>
2001........................................................ $ 265,000
2002........................................................ 222,000
2003........................................................ 233,000
2004........................................................ 184,000
2005 and thereafter......................................... 105,000
----------
$1,009,000
==========
</TABLE>
(7) 401(K) PLAN
The Company has a 401(k) plan (the Plan) whereby employees may contribute a
certain percentage of their annual compensation, up to a defined maximum. The
Company may, but is not obligated to, contribute up to a certain percentage of
each employee's contribution. During the years ended March 31, 1998, 1999 and
2000, the Company recorded expense of approximately $31,000, $23,000 and
$25,000, respectively, relating to the Plan.
F-16
<PAGE>
VISION-SCIENCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 2000
(8) SEGMENT INFORMATION
The Company has adopted SFAS No. 131, DISCLOSURES ABOUT SEGMENTS OF AN
ENTERPRISE AND RELATED INFORMATION. This statement established standards for
reporting information about operating segments and related disclosures about
products and services, geographic areas and major customers.
The Company has determined it has three reportable segments--Medical,
Industrial and Corporate. The medical segment designs, manufactures and sells
endosheaths and sells endoscopes to users in the health care industry. The
industrial segment designs, manufactures and sells borescopes to a variety of
users, primarily in the aircraft maintenance industry. In addition, the
industrial segment manufactures and repairs endoscopes for the medical segment.
The corporate segment consists of certain administrative expenses beneficial to
the company as a whole and the management oversight of the Company's investments
in 3DV, Vision-Sciences, Ltd. and its contractual relations with Imagineering.
The accounting policies of the segments are described in the summary of
significant accounting policies. The Company evaluates segment performance based
upon operating income. Identifiable assets are those used directly in the
operations of each segment. Corporate assets include cash, marketable securities
and the investment in 3DV. The carrying value of the investment in 3DV at
March 31, 2000 is $222,553. Data regarding management's view of the Company's
segments is provided in the following tables.
F-17
<PAGE>
VISION-SCIENCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 2000
(8) SEGMENT INFORMATION (CONTINUED)
<TABLE>
<CAPTION>
FISCAL YEAR ENDED MARCH 31, MEDICAL INDUSTRIAL CORPORATE ADJUSTMENTS TOTAL
--------------------------- ----------- ---------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C>
1998
Sales to external customers..... $ 4,369,845 $3,627,993 $ -- $ -- $ 7,997,838
Intersegment sales.............. -- 437,667 -- (437,667) --
Interest income, net............ -- -- 147,287 -- 147,287
Operating (loss) income......... (2,561,707) 369,590 (710,012) -- (2,902,129)
Depreciation and amortization... 442,933 48,258 -- -- 491,191
Other significant non-cash
items:........................ -- -- -- -- --
Total assets.................... 3,274,683 1,088,445 2,891,051 (1,082,362) 6,171,817
Expenditures for fixed assets... 192,413 -- -- -- 192,413
1999
Sales to external customers..... $ 3,880,493 $3,595,428 $ -- $ -- $ 7,475,921
Intersegment sales.............. -- 277,069 -- (277,069) --
Interest income, net............ -- -- 182,899 -- 182,899
Operating (loss) income......... (1,341,415) 12,681 (636,046) -- (1,964,780)
Depreciation and amortization... 367,704 45,884 -- -- 413,588
Other significant non-cash
items:
Equity in losses of
3DV Systems Ltd............... -- -- (367,242) -- (367,242)
Total assets.................... 2,551,927 987,387 5,249,371 (906,349) 7,882,336
Expenditures for fixed assets... 159,854 65,763 -- -- 225,617
2000
Sales to external customers..... $ 3,358,271 $3,696,324 $ -- $ -- $ 7,054,595
Intersegment sales.............. -- 558,626 -- (558,626) --
Interest income, net............ -- -- 109,581 -- 109,581
Operating (loss) income......... (845,362) 330,178 (1,060,591) 14,621 (1,561,154)
Depreciation and amortization... 265,590 14,576 10,780 -- 290,946
Other significant non-cash
items:
Equity in losses of
3DV Systems Ltd............... -- -- (3,331,347) -- (3,331,347)
Total assets.................... 2,759,068 1,162,088 1,831,675 (844,901) 4,907,930
Expenditures for fixed assets... 150,913 7,050 4,564 -- 162,527
</TABLE>
F-18
<PAGE>
VISION-SCIENCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
MARCH 31, 2000
(8) SEGMENT INFORMATION (CONTINUED)
The following table identifies sales by geographic region. Sales are
attributable to geographic regions based upon the location of customers.
<TABLE>
<CAPTION>
FISCAL YEARS ENDED MARCH 31,
------------------------------------
GEOGRAPHIC REGION 1998 1999 2000
----------------- ---------- ---------- ----------
<S> <C> <C> <C>
Asia and Australia....................... $ 148,244 $ 119,698 $ 274,250
Canada................................... 99,021 139,866 96,933
Europe................................... 125,391 96,516 514,368
Middle East and Africa................... 68,853 40,697 96,590
South America............................ 177,791 209,542 256,439
United States............................ 7,378,538 6,869,602 5,816,015
---------- ---------- ----------
Total.................................... $7,997,838 $7,475,921 $7,054,595
========== ========== ==========
</TABLE>
For the fiscal years ended March 31, 1998, and 1999, one customer accounted
for 35% of net sales. For the fiscal year ended March 31, 2000 no customer
accounted for 10% or more of consolidated sales.
(9) ACCRUED EXPENSES
Accrued expenses consist of the following:
<TABLE>
<CAPTION>
MARCH 31,
-----------------------
1999 2000
---------- ----------
<S> <C> <C>
Accrued payroll and related expenses................. $1,030,231 $1,056,074
Accrued other........................................ 571,746 530,174
---------- ----------
$1,601,977 $1,586,248
========== ==========
</TABLE>
F-19
<PAGE>
SCHEDULE II
VISION-SCIENCES, INC. AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS
FOR THE YEARS ENDED MARCH 31, 1998, 1999 AND 2000
<TABLE>
<CAPTION>
BALANCE, CHARGED TO BALANCE,
BEGINNING COSTS AND END OF
DESCRIPTION OF YEAR EXPENSES WRITE-OFFS YEAR
----------- --------- ---------- ---------- --------
<S> <C> <C> <C> <C>
Deducted from Assets Accounts:
Allowance for doubtful accounts--
Year ended March 31, 1998....................... $127,000 $17,000 $27,000 $117,000
Year ended March 31, 1999....................... 117,000 17,000 4,000 130,000
Year ended March 31, 2000....................... 130,000 41,000 15,000 156,000
</TABLE>
S-1
<PAGE>
APPENDIX B
3DV SYSTEMS LTD.
(A COMPANY IN THE DEVELOPMENT STAGE)
FINANCIAL STATEMENTS
DECEMBER 31, 1999
IN U.S. DOLLARS
<PAGE>
3DV SYSTEMS LTD.
(A COMPANY IN THE DEVELOPMENT STAGE)
FINANCIAL STATEMENTS
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
--------
<S> <C>
Auditors' Report............................................ 2
Balance Sheets.............................................. 3
Statements of Operations.................................... 4
Statements of Shareholders' Equity, (Deficit)............... 5
Statements of Cash Flows.................................... 6-7
Notes to the Financial Statements........................... 8-24
</TABLE>
<PAGE>
Tirat HaCarmel, February 28, 2000
AUDITORS' REPORT TO THE SHAREHOLDERS OF 3DV SYSTEM LTD.
We have audited the accompanying balance sheets of 3DV Systems Ltd. ("the
Company") as of December 31, 1999 and 1998, and the related statements of
operations, shareholders' equity (deficit) and cash flows for the years then
ended. These financial statements are the responsibility of the Company's Board
of Directors and of its 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 in Israel, including those prescribed by the Auditors Regulations
(manner of auditors performance), 1973. Such standards are substantially
identical to generally accepted auditing standards in the United States. Those
standards require that we plan and perform the audit to obtain reasonable
assurances that 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 the Board of
Directors and by management, as well as evaluating the overall financial
statements 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 the Company as of
December 31, 1999 and 1998, the results of its operations, changes in
shareholders' equity (deficit) and cash flows for the years then ended, in
conformity with generally accepted accounting principles in the United States
(U.S. GAAP). As applicable to these financial statements, Israeli GAAP differs
in certain respects from U.S. GAAP as described in Note 21, which includes only
the differences that effect directly the results of operations.
Without qualifying our opinion, we would like to draw attention to Notes
2(b) and 2(d) of the financial statements and to the fact that the Company is in
the development stage, whereby its principal activities in the reported periods
are the development of products in the field of 3D laser camera. The Company has
not yet generated any revenues and it depends on the Company Management's
ability to provide additional financial support.
/s/ Somekh Chaikin
-------------------------------
Certified Public Accountants (Isr.)
2
<PAGE>
3DV SYSTEMS LTD.
(A COMPANY IN THE DEVELOPMENT STAGE)
BALANCE SHEETS AS OF DECEMBER 31,
<TABLE>
<CAPTION>
NOTE 1999 1998
-------- --------------- ---------------
U.S.$ THOUSANDS U.S.$ THOUSANDS
<S> <C> <C> <C>
CURRENT ASSETS
Cash and cash equivalents.................................. 3 2,791 1,725
Accounts receivable........................................ 4 153 109
----- -----
2,944 1,834
----- -----
Cars leasing deposits...................................... 5 3 7
----- -----
Amount funded for employees' rights upon retirement........ 11 119 61
----- -----
Option..................................................... 6 -- --
----- -----
Fixed assets, net.......................................... 7 552 292
----- -----
3,618 2,194
===== =====
CURRENT LIABILITIES
Current maturities of liabilities for capital lease........ 10 31 --
Accounts payable:.......................................... 8
Trade.................................................... 373 347
Other.................................................... 307 128
Related parties.......................................... 23 3
----- -----
734 478
----- -----
LONG-TERM LIABILITIES
Loans from Parent Company.................................. 9 2,143 2,109
Liabilities for capital lease.............................. 10 142 --
Employees' rights upon retirement.......................... 11 124 63
----- -----
2,409 2,172
----- -----
Commitments................................................ 19 -- --
----- -----
Shareholders' equity, (deficit)............................ 12 475 (456)
----- -----
3,618 2,194
===== =====
</TABLE>
The accompanying notes are an integral part of the financial statements.
President & CEO
---------------------------------
Director
---------------------------------
Date: February , 2000
3
<PAGE>
3DV SYSTEMS LTD.
(A COMPANY IN THE DEVELOPMENT STAGE)
STATEMENTS OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31,
<TABLE>
<CAPTION>
NOTE 1999 1998 * CUMULATIVE
-------- --------------- --------------- ---------------
U.S.$ THOUSANDS U.S.$ THOUSANDS U.S.$ THOUSANDS
<S> <C> <C> <C> <C>
Research and development costs, net.......... 13 2,755 2,118 6,217
Marketing expenses........................... 14 752 51 803
General and administrative expenses.......... 15 374 240 945
----- ----- -----
OPERATING LOSS............................... 3,881 2,409 7,965
Financing income, net........................ 16 (20) (39) (61)
----- ----- -----
Loss before income taxes..................... 3,861 2,370 7,904
Income taxes................................. 17 -- -- --
----- ----- -----
NET LOSS..................................... 3,861 2,370 7,904
===== ===== =====
</TABLE>
* Cumulative amounts from the Company's inception.
The accompanying notes are an integral part of the financial statements.
4
<PAGE>
3DV SYSTEMS LTD.
(A COMPANY IN THE DEVELOPMENT STAGE)
STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY, (DEFICIT)
<TABLE>
<CAPTION>
TOTAL
EMPLOYEES' SHAREHOLDERS'
SHARE SHARE CAPITAL STOCK ACCUMULATED EQUITY,
CAPITAL PREMIUM RESERVE OPTIONS LOSS (DEFICIT)
-------- -------- -------- ---------- ----------- -------------
U.S.$ THOUSANDS
<S> <C> <C> <C> <C> <C> <C>
BALANCE AS OF JANUARY 1, 1998............. 3 -- 5 117 (1,673) (1,548)
Shares issued............................. -- 2,927 -- -- -- 2,927
Linkage differences on loans received from
Parent Company.......................... -- -- 167 -- -- 167
Employees' stock options.................. -- -- -- 368 -- 368
Net loss for the year..................... -- -- -- -- (2,370) (2,370)
-------- ----- --- --- ------ ------
BALANCE AS OF DECEMBER 31, 1998........... 3 2,927 172 485 (4,043) (456)
Shares issued............................. 1 4,621 -- -- -- 4,622
Linkage differences on loans received from
Parent Company.......................... -- -- (34) -- -- (34)
Employees' stock options.................. -- -- -- 204 -- 204
Net loss for the year..................... -- -- -- -- (3,861) (3,861)
-------- ----- --- --- ------ ------
BALANCE AS OF DECEMBER 31, 1999........... 4 7,548 138 689 (7,904) 475
======== ===== === === ====== ======
Cumulative amounts from the Company's
inception
Shares issued............................. 4 7,548 -- -- -- 7,552
Linkage differences on loans received from
Parent Company.......................... -- -- 138 -- -- 138
Employees' stock options.................. -- -- -- 689 -- 689
Deficit accumulated during development
stage................................... -- -- -- -- (7,904) (7,904)
-------- ----- --- --- ------ ------
BALANCE AS OF DECEMBER 31, 1999........... 4 7,548 138 689 (7,904) 475
======== ===== === === ====== ======
</TABLE>
The accompanying notes are an integral part of the financial statements.
5
<PAGE>
3DV SYSTEMS LTD.
(A COMPANY IN THE DEVELOPMENT STAGE)
STATEMENTS OF CASH FLOWS FOR THE YEAR ENDED DECEMBER 31
<TABLE>
<CAPTION>
1999 1998 * CUMULATIVE
--------------- --------------- ---------------
U.S.$ THOUSANDS U.S.$ THOUSANDS U.S.$ THOUSANDS
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss........................................... (3,861) (2,370) (7,904)
ADJUSTMENTS REQUIRED TO RECONCILE
NET LOSS TO NET CASH USED IN OPERATING ACTIVITIES:
Severance pay, net................................. 3 2 5
Depreciation....................................... 122 60 214
Capital loss....................................... 5 -- 5
Employees' stock options........................... 204 368 689
Marketing services against issuance of shares (See
a)............................................... 180 -- 180
CHANGES IN OPERATING ASSETS AND LIABILITIES:
Decrease (increase) in accounts receivable......... (44) 7 (153)
Increase in accounts payable....................... 204 314 672
Increase (decrease) in related parties............. 20 (68) 23
------ ------ ------
NET CASH USED IN OPERATING ACTIVITIES.............. (3,167) (1,687) (6,269)
------ ------ ------
CASH FLOWS USED IN INVESTING ACTIVITIES:
Payments for purchase of fixed assets (See b)...... (215) (211) (599)
Proceeds from sale of fixed assets................. 5 -- 5
Cars leasing deposits.............................. 4 3 (3)
------ ------ ------
NET CASH USED IN INVESTING ACTIVITIES.............. (206) (208) (597)
------ ------ ------
CASH FLOW FROM FINANCING ACTIVITIES:
Loans received from Parent Company................. -- 565 2,281
Repayment of long-term loans to leasing company.... (4) -- (4)
Shares issued...................................... 4,442 2,927 7,372
------ ------ ------
NET CASH PROVIDED BY FINANCING ACTIVITIES.......... 4,438 3,492 9,649
------ ------ ------
EFFECT OF EXCHANGE RATE CHANGES ON CASH............ 1 (3) 8
------ ------ ------
INCREASE IN CASH AND CASH EQUIVALENTS.............. 1,066 1,594 2,791
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR..... 1,725 131 --
------ ------ ------
CASH AND CASH EQUIVALENTS AT END OF YEAR........... 2,791 1,725 2,791
====== ====== ======
</TABLE>
* Cumulative amounts from the Company's inception.
TRANSACTION NOT INVOLVING CASH FLOWS
(a) Marketing services were rendered against issuance of the Company's share
capital.
(b) Capital lease obligations of U.S.$ 177 were incurred in 1999, when the
Company entered into leases for new motor vehicles. See Note 10.
The accompanying notes are an integral part of the financial statements.
6
<PAGE>
3DV SYSTEMS LTD.
(A COMPANY IN THE DEVELOPMENT STAGE)
NOTES TO THE FINANCIAL STATEMENTS
NOTE 1--GENERAL
A) 3DV Systems Ltd. (hereinafter--"the Company") was incorporated on June 16,
1996, as an Israeli Company and commenced operations in July 1996.
The Company is in the development stage, whereby its principal activities in
the reported period are the development of products in the field of 3D laser
camera. The Company has not yet generated any revenues.
B) The Company is a subsidiary of R.D.C. Rafael Development Corporation Ltd.
(hereinafter--"the Parent Company"). See also Note 12.
NOTE 2--BASIS OF PRESENTATION
A) The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of expenses during the reporting
periods. Actual results could differ from those estimates.
B) The Company is in the development stage and its ability to continue
operations in the foreseeable future depends on the Company Management's
ability to provide additional financial support.
C) Reporting currency
(1) The accompanying financial statements are presented in U.S. dollars in
conformity with accounting principles generally accepted in the United
States.
The Company's sales markets are expected to be substantially outside of
Israel in non-Israeli currencies, mainly in U.S. dollars or linked
thereto as well as the Company expenses in U.S. dollar are expected to
grow significantly. Therefore, the Company's functional currency is the
U.S. dollar.
The Company's transactions denominated in currencies other than the U.S.
dollar are remeasured into U.S. dollars and recorded based on the
exchange rate at the time of the transaction. Monetary balances in
currencies other than the U.S. dollar are translated into dollars using
period-end exchange rates. Gains and losses from the aforementioned
re-measurements and translations are recorded in the statement of
operations.
(2) Details of the exchange rate and the C.P.I. in Israel are given as
follows:
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31, CHANGES % CHANGES %
1999 1998 1999 1998
------------ ------------ --------- ---------
<S> <C> <C> <C> <C>
Consumer Price Index
*--points..................... 106.6 105.2 1.33 8.62
U.S. Dollar 1 = NIS............. 4.153 4.16 (0.17) 17.65
</TABLE>
* Average basis 1998 = 100
D) The high technology industry in which the Company is involved is highly
competitive and is characterized by the risks of rapidly changing
technologies. Penetration into world market requires investment of
considerable resources and continuous development efforts. The Company's
future success is dependent upon several factors including the technological
quality and price/performance of its
7
<PAGE>
3DV SYSTEMS LTD.
(A COMPANY IN THE DEVELOPMENT STAGE)
NOTES TO THE FINANCIAL STATEMENTS (CONTINUED)
NOTE 2--BASIS OF PRESENTATION (CONTINUED)
products relative to those of its competitors. There can be no assurance
that the Company will be able to maintain the high technological quality of
its product or to continue to develop or market its new products
effectively.
The Company employs 5 key employees who own major intellectual property.
Management is of the opinion that if several of the above employees leave,
then the Company will be vulnerable to the risk of a severe impact on the
Company's know-how in the near term.
E) SIGNIFICANT ACCOUNTING POLICIES:
(1) FIXED ASSETS
Fixed assets are stated at depreciated cost. The Company provides for
depreciation which is computed by the straight-line method over the
estimated useful life of the assets as follows:
<TABLE>
<S> <C>
Computers.............................................. 3-4 years
Instruments and laboratory equipment................... 7-15 years
Motor vehicles......................................... 7 years
Office furniture and equipment......................... 17 years
</TABLE>
(2) RESEARCH AND DEVELOPMENT COSTS
Research and development costs, net of participation from the Office of
the Chief Scientist of Israeli government are charged to the statement of
operations as incurred. Government participation is recorded on an
accrual basis.
(3) DEFERRED TAXES
The Company accounted for deferred taxes under the liability method. As
described in FAS 109 when it is not more likely than not that deferred
tax assets will be realized, the Company provides for valuation allowance
against deferred tax assets resulted from operating loss carried-forward
and from timing differences between the recognition of expenses in the
financial statements and for tax purposes.
(4) STOCK BASED COMPENSATION
As allowed by Statement of Financial Accounting Standards No.123
("SFAS 123"), the Company measures compensation cost of stock issued to
employees under Accounting Principles Board Opinion No.25 ("APB 25"),
(See Note 12b).
(5) DISCLOSURES REGARDING FAIR VALUE OF FINANCIAL INSTRUMENTS
The financial instruments of the Company consist mainly of cash, accounts
receivable, fund of employees' rights upon retirement and accounts
payable and accruals.
Due to the nature of such financial instruments, their fair value does
not materially differ from their carrying amount.
8
<PAGE>
3DV SYSTEMS LTD.
(A COMPANY IN THE DEVELOPMENT STAGE)
NOTES TO THE FINANCIAL STATEMENTS (CONTINUED)
NOTE 2--BASIS OF PRESENTATION (CONTINUED)
(6) DISCLOSURE OF CUMULATIVE AMOUNTS FROM THE COMPANY INCEPTION
Under FAS 7, the Company provides cumulative amounts, from the Company's
inception till December 31, 1999, in the statements of operations, cash
flows and shareholders' equity.
(7) PREPARATIONS OF THE COMPUTER SYSTEMS FOR YEAR 2000
The costs required to prepare and convert the existing programs of the
Company, to be able to differentiate between years belonging to the
20(th) century and years belonging to the 21(st) century (year 2000
compliance), were recorded as current expense when incurred.
NOTE 3--CASH AND CASH EQUIVALENTS
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31,
1999 1998
--------------- ---------------
U.S.$ THOUSANDS U.S.$ THOUSANDS
<S> <C> <C>
Foreign currency (U.S.$).................................... 2,280 1,425
Israeli currency............................................ 511 300
----- -----
2,791 1,725
===== =====
</TABLE>
Cash equivalents in Israeli currency include bank deposits, bearing an
annual interest rate of 9-10.6% unlinked and which the date of maturity at the
time of the deposit was not in excess of three months. Cash equivalents in
foreign currency include bank deposit, bearing an annual interest rate of
5.22%-6.18% and which the date of maturity at the time of the deposit was not in
excess of three months.
The carrying amount of cash equivalents approximates market value.
NOTE 4--ACCOUNTS RECEIVABLE *
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31,
1999 1998
--------------- ---------------
U.S.$ THOUSANDS U.S.$ THOUSANDS
<S> <C> <C>
Due from the Chief Scientist (See Note 13, 19(c))........... -- 1
Government institutions..................................... 76 70
Advance to supplier......................................... -- 3
Prepaid expenses............................................ 76 27
Employees................................................... 1 1
Related parties............................................. -- 7
--- ---
153 109
=== ===
</TABLE>
* See Note 2e(5), 20
NOTE 5--CARS LEASING DEPOSITS
During 1996 and 1998, the Company signed operating lease contracts with
Albar Ltd. (related party) for the rental of vehicles for a period of three
years. The rental payments are linked to the Israeli
9
<PAGE>
3DV SYSTEMS LTD.
(A COMPANY IN THE DEVELOPMENT STAGE)
NOTES TO THE FINANCIAL STATEMENTS (CONTINUED)
NOTE 5--CARS LEASING DEPOSITS (CONTINUED)
Consumer Price Index. The Company has deposited amounts representing rental
payment for three months in respect of this contracts. The deposit is linked to
the Israeli Consumer Price Index, and bears no interest.
NOTE 6--OPTION
On December 22, 1998, the Company signed an option agreement ("the
agreement") with the Parent Company. According to the Agreement, the Parent
Company granted the Company an option to purchase from the Parent Company up to
75,000 shares of VSI, par value U.S.$ 0.01 per share for the purchase price of
U.S.$ 0.9 per share. The option may be exercised by the Company as of
October 6, 1999 and for a period of six years thereafter, at any time, either in
whole or in part, from time to time. The Company shall pay the price for the
option shares purchased in cash. Any dividends received by the Parent Company
during the term of the option on any option shares prior to their delivery to
the Company shall be held by the Parent Company in trust for the Company and
shall be remitted to the Company upon the exercise of the option in respect of
those option shares on which such dividends were received.
As described in Note 19h, the above 75,000 of VSI's shares which the Company
will receive upon exercising the option, will be used to finance the special
rewards to the company's employees.
NOTE 7--FIXED ASSETS, NET
<TABLE>
<CAPTION>
INSTRUMENTS
& OFFICE
LABORATORY FURNITURE AND
COMPUTERS EQUIPMENT *MOTOR VEHICLES EQUIPMENT TOTAL
--------- ----------- --------------- ------------- --------
U.S.$ THOUSANDS
<S> <C> <C> <C> <C> <C>
Cost
BALANCE AT BEGINNING OF YEAR........... 222 95 17 51 385
Additions.............................. 181 13 177 21 392
Disposals.............................. -- -- (17) -- (17)
--- --- --- -- ---
BALANCE AT END OF YEAR................. 403 108 177 72 760
--- --- --- -- ---
Accumulated depreciation
BALANCE AT BEGINNING OF YEAR........... 69 9 6 9 93
Depreciation for the year.............. 97 15 5 5 122
Reversal for disposals................. -- -- (7) -- (7)
--- --- --- -- ---
BALANCE AT END OF YEAR................. 166 24 4 14 208
--- --- --- -- ---
Depreciated cost at December 31,
1999................................. 237 84 173 58 552
=== === === == ===
Depreciated cost at December 31,
1998................................. 153 86 11 42 292
=== === === == ===
</TABLE>
* See Note 10a.
10
<PAGE>
3DV SYSTEMS LTD.
(A COMPANY IN THE DEVELOPMENT STAGE)
NOTES TO THE FINANCIAL STATEMENTS (CONTINUED)
NOTE 8--ACCOUNTS PAYABLE *
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31,
1999 1998
--------------- ---------------
U.S.$ THOUSANDS U.S.$ THOUSANDS
<S> <C> <C>
TRADE
Open accounts............................................. 273 200
Checks payable............................................ 100 147
--- ---
373 347
=== ===
OTHER
Institutions.............................................. 143 52
Liabilities to employees.................................. 65 55
Accrued expenses.......................................... 99 21
--- ---
307 128
=== ===
RELATED PARTIES (SEE NOTE 17B).............................. 23 3
=== ===
</TABLE>
* See Note 2e(5), 20
NOTE 9--LONG-TERM LOANS FROM PARENT COMPANY
Since its incorporation the Company received loans of U.S.$ 2,281 thousand
from Parent Company, in order to finance its operational activities. These loans
are linked to the Israeli Consumer Price Index, bear no interest and their
maturity date has not yet been determined. Management's opinion is that these
loans would not be repayable in the current year. These loans do not bear real
market interest and therefore, linkage differences on these loans are credited
to a capital reserve in shareholders' equity.
NOTE 10--LIABILITIES FOR CAPITAL LEASE
A) Liabilities due to a leasing company were recorded against the purchase of
eight cars. The liabilities are to be repaid in five years, linked to the
U.S. dollar and bearing interest of 7.6% p.a. As security for the
liabilities, the Company registered liens on all the cars in favor of the
leasing company.
B) The aggregate maturities of these loans at December 31, 1999, are as
follows:
<TABLE>
<CAPTION>
U.S.$ THOUSANDS
---------------
<S> <C>
2000--current maturities.................................... 31
---
2001........................................................ 33
2002........................................................ 36
2003........................................................ 38
2004........................................................ 35
---
142
---
173
===
</TABLE>
11
<PAGE>
3DV SYSTEMS LTD.
(A COMPANY IN THE DEVELOPMENT STAGE)
NOTES TO THE FINANCIAL STATEMENTS (CONTINUED)
NOTE 11--EMPLOYEES' RIGHTS UPON RETIREMENT
The Company is required to make severance payments to dismissed employees.
The Company covers its obligations for severance pay by making payments of
premiums to insurance companies. The amounts accumulated at the insurance
companies are not under the control of the management of the Company.
NOTE 12--SHARE CAPITAL
A) SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
AUTHORIZED ISSUED AND PAID FOR
NUMBER OF SHARES NUMBER OF SHARES
---------------- -------------------
<S> <C> <C>
Ordinary Shares of NIS (0.01) each.......................... 5,170,000 1,498,807
========= =========
Ordinary Shares A of NIS (0.01) each........................ 900,000 29,310
========= =========
</TABLE>
(1) The rights of the Ordinary Shares A are the same as the Ordinary Shares
except for rights to participate or to vote in shareholders meetings. The
Ordinary Shares A shall be converted into Ordinary Shares, on a
one-to-one basis and without any payment, automatically upon the
registration of any of the Company's shares for trade in any stock
market, in Israel or abroad.
(2) In August 1998, the Company, the Parent Company and Vision
Sciences Inc. ("VSI") a Delaware corporation signed an Investment
Agreement ("the Agreement"). According to this Agreement, the Company
issued 338,099 Ordinary Shares, par value NIS 0.01 per share which
represent 25% of the fully diluted share capital of the Company in
consideration for U.S.$ 3 million in cash.
VSI was required to advance funds needed to finance the operations of the
Company in fiscal years 1999 and 2000. Accordingly, the Company issued to
VSI non-interest bearing, redeemable capital notes convertible into
ordinary shares of the Company. VSI's obligation to finance the
operations of the Company was terminated in November 1999. (See also
paragraph 4 below).
(3) In December 1998, the Company issued to VSI 16,068 Ordinary Shares of
the Company, par value 0.01 per share in consideration of their par
value. The issuance was executed due to the increase in the number of
ordinary A shares that are subject to employee stock option plan (See
Note 12(b)).
(4) On May 29, 1999 and August 26, 1999, the Company issued convertible
capital notes of U.S.$ 500 thousand each to VSI. The notes were unsecured
and linked to the US dollar and bear no interest.
According to a Share Subscription Agreement (the "Agreement") which was
signed in November 1999, the capital notes of U.S.$ 1,000 thousand
mentioned above were converted into 65,474 Ordinary Shares constituting
3.67% of the Company's equity on a fully diluted basis.
In addition, the Company issued to VSI, Discount Investment
Corporation Ltd., PEC Israel Economic Corporation and Elron Electronic
Industries Ltd. 32,738 Ordinary Shares each, in consideration of U.S.$
500 thousand each, constituting 1.83% of the Company's equity on a fully
diluted basis each.
12
<PAGE>
3DV SYSTEMS LTD.
(A COMPANY IN THE DEVELOPMENT STAGE)
NOTES TO THE FINANCIAL STATEMENTS (CONTINUED)
NOTE 12--SHARE CAPITAL (CONTINUED)
Furthermore, the Company issued to a foreign investor 98,213 Ordinary
Shares constituting 5.5% of the Company's equity on a fully diluted basis
in consideration of U.S.$ 1,500 thousand.
All the above considerations based on a purchase price of U.S.$ 15.273
per share.
(5) According to the Agreement mentioned in paragraph (4) above, the foreign
investor has the option to make an additional investment in the Ordinary
Share capital of the Company in the amount of up to U.S.$ 750 thousand at
the share price. The option will be effective until the earlier between
two years from the closing date between the Company and the investor and
the initial offering of any securities of the Company to the public.
(6) In the third quarter of 1999, the Company received film planning and
producing services which are worth U.S.$ 180 thousand from a supplier. In
consideration, the Company issued to the supplier 14,310 Ordinary Shares
A of NIS 0.01 each constituting 1% of the Company's equity on a fully
diluted basis. The price per share of this issuance was U.S.$ 12.58.
B) EMPLOYEE STOCK OPTION PLANThe Board of Directors of the Company, at its
meeting in August 1997, approved the resolution to adopt the Company's
employee stock option plan ("ESOP"), providing for the allotment without
consideration of options to employees of the Company, whose eligibility will
be determined from time to time by the Company's Board Compensation
Committee, for the purchase of up to 135,000 Ordinary Shares A of the
Company of par value NIS 0.01 each. Each option will entitle the holder to
purchase one Ordinary Share A of par value NIS 0.01 each at an exercise
price of NIS 0.01 per option. The options vest over a period of two to four
years and are exercisable for a period of eight years from the date of
grant.
The options will be allotted to a trustee who will hold them in trust on
behalf of the employees, in accordance with Section 102 of the Income Tax
Ordinance in Israel and related regulations.
In December 1999, the Board of Directors of the Company resolved to increase
the number of Ordinary Shares A of the Company that are reserved under the ESOP,
up to 269,629.
Based on the above resolutions, the options allotments are as follows:
<TABLE>
<CAPTION>
1999 1998
NUMBER OF OPTIONS NUMBER OF OPTIONS
----------------- -----------------
<S> <C> <C>
Total options under the ESOP................. 269,629 197,500
------- -------
Options as of January 1...................... 131,936 60,000
Options granted during the year.............. *71,322 71,936
Options expired.............................. (5,084) --
------- -------
Options as of December 31.................... 198,174 131,936
------- -------
BALANCE AT END OF YEAR....................... 71,455 65,564
======= =======
</TABLE>
The fair value of the outstanding options (based on the minimal value
pricing model) as of December 31, 1999 is U.S.$ 808 thousand.
* Including 56,988 options with an exercise price of U.S.$ 8.47.
13
<PAGE>
3DV SYSTEMS LTD.
(A COMPANY IN THE DEVELOPMENT STAGE)
NOTES TO THE FINANCIAL STATEMENTS (CONTINUED)
NOTE 12--SHARE CAPITAL (CONTINUED)
In order to estimate the compensation cost of the above options, management
of the Company evaluated the fair value of the Company's Ordinary Shares A based
upon the price per Ordinary Share in a private placement which took place on
August 25, 1998 (See Note 12(a)(2)). Management's assumption is that the fair
value of the Company's Ordinary Shares A grew at a fixed rate commencing the
Company inception until the above private placement date. Accordingly, the
Company evaluated the fair value of Ordinary Shares A, issued prior to the
private placement, by the straight-line method over the period commencing the
inception of the Company (at such time the Company's price per share is assumed
to the U.S.$ 0 (nil)) through the private placement date, in order to compute a
discount from the private placement price, for such Ordinary Shares A.
Compensation cost related to options issued after August 25, 1998 was
calculated based on the last known share price.
The Company did not take into account a discount due to the fact that the
Company's Ordinary Shares A do not have the right to vote as mentioned in
Note 12(a)(1) above because the Stock Option Plan provides that upon initial
public offering, Ordinary Shares A will automatically be converted into Ordinary
Shares. The Company applied APB 25 and recorded in 1999 compensation cost of
U.S.$ 204 thousand (U.S.$ 368 thousand in 1998) due to the above options equal
to the intrinsic value of the above options using the fair value of Ordinary
Shares A as described above.
Had compensation expense for stock options granted under the Company's Stock
Option Plan been determined based on the fair value at the date of grant,
consistent with the method of Financial Accounting Standards Board Statement
No. 123 "Accounting for Stock-Based Compensation" ("FAS 123"), the Company's net
income would have changed to the pro forma amounts indicated below:
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31, 1999
-----------------
U.S.$ THOUSANDS
<S> <C>
Net loss as presented--in thousands......................... 3,861
Additional expenses due to options granted to employees..... 63
-----
Pro forma net income--in thousands.......................... 3,924
=====
</TABLE>
The fair value of each option granted is estimated on the date of grant,
using the minimal value option pricing model using the following weighted
average assumptions:
1. Dividend yield of zero percent.
2. Risk-free interest rate of 6% which represents risk free interest rates
to dollar-liked financial instruments as published by the Israeli Stock
Exchange.
3. Expected lives of 8 years as of the date of grant.
14
<PAGE>
3DV SYSTEMS LTD.
(A COMPANY IN THE DEVELOPMENT STAGE)
NOTES TO THE FINANCIAL STATEMENTS
NOTE 13--RESEARCH AND DEVELOPMENT COSTS, NET
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------------
1999 1998 * CUMULATIVE
--------------- --------------- ---------------
U.S.$ THOUSANDS U.S.$ THOUSANDS U.S.$ THOUSANDS
<S> <C> <C> <C>
Salaries and related expenses (1).................. 1,385 1,081 3,168
Patent registration expenses....................... 108 148 358
Materials.......................................... 282 356 947
Subcontractors..................................... 620 209 922
Vehicle expenses................................... 108 87 267
Communications..................................... 11 9 34
Overseas travel.................................... 6 22 121
Depreciation....................................... 112 53 190
Rent and maintenance............................... 64 43 142
Professional publication........................... 7 76 92
Other.............................................. 51 35 92
----- ----- -----
2,754 2,119 6,333
Less: grants received from the Chief Scientist..... 1 (1) (116)
----- ----- -----
2,755 2,118 6,217
===== ===== =====
(1) Include compensation expenses in respect of
options granted (See Note 12(b))................ 204 368 689
===== ===== =====
</TABLE>
* Cumulative amounts from the Company's inception.
NOTE 14--MARKETING EXPENSES
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------------
1999 1998 * CUMULATIVE
--------------- --------------- ---------------
U.S.$ THOUSANDS U.S.$ THOUSANDS U.S.$ THOUSANDS
<S> <C> <C> <C>
Participation in exhibitions....................... 383 -- 383
Overseas travel.................................... 145 25 170
Advertisement...................................... 181 24 205
Others............................................. 43 2 45
--- -------- ---
752 51 803
=== ======== ===
</TABLE>
* Cumulative amounts from the Company's inception.
15
<PAGE>
3DV SYSTEMS LTD.
(A COMPANY IN THE DEVELOPMENT STAGE)
NOTES TO THE FINANCIAL STATEMENTS (CONTINUED)
NOTE 15--GENERAL AND ADMINISTRATIVE EXPENSES
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------------
1999 1998 * CUMULATIVE
--------------- --------------- ---------------
U.S.$ THOUSANDS U.S.$ THOUSANDS U.S.$ THOUSANDS
<S> <C> <C> <C>
Salaries and related expenses...................... 139 110 433
Accounting services by Parent Company.............. 25 16 52
Legal and accounting............................... 20 29 81
Consulting......................................... 5 5 15
Insurance.......................................... 1 -- 2
Office expenses.................................... 11 8 35
Maintenance........................................ 14 5 37
Communications..................................... 18 11 42
Overseas travel.................................... -- 7 14
Entertainment...................................... 32 8 47
Vehicle expenses................................... 20 11 45
Tax of benefits.................................... 14 6 27
Depreciation....................................... 10 7 26
Transporting....................................... 34 15 54
Advertisement...................................... 13 -- 13
Other.............................................. 18 2 22
--- --- ---
374 240 945
=== === ===
</TABLE>
* Cumulative amounts from the Company's inception.
NOTE 16--FINANCING INCOME, NET
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------------
1999 1998 * CUMULATIVE
--------------- --------------- ---------------
U.S.$ THOUSANDS U.S.$ THOUSANDS U.S.$ THOUSANDS
<S> <C> <C> <C>
Interest income and linkage difference relating to
monetary items................................... (34) (44) (85)
Bank charges....................................... 14 5 24
--- --- ---
(20) (39) (61)
=== === ===
</TABLE>
* Cumulative amounts from the Company's inception.
NOTE 17--INCOME TAXES
A) The Israel tax is computed on the basis of the Company's results in nominal
NIS determined for statutory purposes.
The Company is assessed for tax purposes under the Income Tax Law
(Inflationary Adjustments 1985), the purpose of which is to prevent taxation
on inflationary profits.
16
<PAGE>
3DV SYSTEMS LTD.
(A COMPANY IN THE DEVELOPMENT STAGE)
NOTES TO THE FINANCIAL STATEMENTS (CONTINUED)
NOTE 17--INCOME TAXES (CONTINUED)
Pursuant to the Law of Encouragement of Capital Investment, the Company was
awarded "Approved Enterprise" status in the government alternative benefits
track. The program is for investments in the development of infrastructure,
and for investments in locally produced and imported equipment.
The main benefits to which the Company will be entitled, if it implements
all the terms of the approved program, are the exemption from tax on income
deriving from the Approved Enterprise, and reduced tax rates on dividends
originating from this income. The income deriving from the Approved
Enterprise will be exempt from tax for a ten year period, commencing on the
date that taxable income is first generated by the Approved Enterprise
(limited to the earlier of a maximum period of 12 years from commencing
operations or 14 years from the date the approval letter was received).
Dividend distribution originating from the income of the Approved Enterprise
will be subject to tax at the rate of 15%, provided that the dividend is
distributed during the period stipulated in the Law.
In the event of a dividend distribution (including withdrawals and charges
that are deemed to be dividends) out of the income originating from the
Approved Enterprise, and on which the Company received a tax exemption,
income from which the dividend is distributed will be subject to corporate
taxes at the rate varying from 10%-25% depending on the percentage of
foreign investment holding in the Company as defined by the Law.
Should the Company derive income from sources other than the Approved
Enterprise during the relevant period of benefits, such income will be
taxable at regular corporate tax rates (in the year 1997 and
thereafter--36%).
Tax benefits under the Law for the Encouragement of Industry (Taxes), 1969:
The Company is an "industrial company", as defined by this law and, as such,
is entitled to certain tax benefits, mainly accelerated depreciation of
machinery and equipment, as prescribed by regulations published under the
Inflationary Adjustments Law, the right to claim public issuance expenses
and amortization of patents and other intangible property rights as a
deduction for tax purposes.
B) As of the balance sheet date the Company accumulated losses for tax purposes
are approximately U.S.$ 7 million. These losses are linked to the Israeli
Consumer Price Index and may be utilized against future taxable income.
C) Deferred income taxes are provided primarily for operating loss for tax
purposes and for all the differences between the tax and the accounting
basis of assets and liabilities bases on the tax rate that is expected to be
in effect at the time the deferred income taxes will be realized.
Realization of the deferred tax assets is dependent on generating sufficient
taxable income in the period that the deferred tax assets are realized.
Based on all available information, Management believes that all of the
deferred tax assets are not realizable. Under FAS 109, a valuation allowance
was established in respect of all of the deferred tax assets because it is
not more likely than not that such assets will be realized in the
foreseeable future.
17
<PAGE>
3DV SYSTEMS LTD.
(A COMPANY IN THE DEVELOPMENT STAGE)
NOTES TO THE FINANCIAL STATEMENTS (CONTINUED)
NOTE 17--INCOME TAXES (CONTINUED)
D) The components of deferred tax assets and liabilities are as follows:
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31,
1999 1998
--------------- ---------------
U.S.$ THOUSANDS U.S.$ THOUSANDS
<S> <C> <C>
Deferred tax assets:
Employees' rights...................................... 25 9
Employee stock options................................. 248 175
Non deductible research and development costs.......... 86 97
Know-how for tax purposes only (1)..................... 41 48
Loss for tax purposes.................................. 2,505 1,048
------ ------
2,905 1,377
Valuation allowance (1)................................ (2,905) (1,377)
------ ------
-- --
====== ======
Statutory tax rate..................................... 36% 36%
====== ======
</TABLE>
------------------------
(1) Know-how purchased from principal shareholder have deferent value for tax
and accounting purposes.
E) Reconciliation of theoretical tax expense to the actual tax expense:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------------
1999 1998
--------------- ---------------
U.S.$ THOUSANDS U.S.$ THOUSANDS
<S> <C> <C>
Loss before income taxes as reported in the statements
of operations......................................... (3,861) (2,370)
====== ======
Statutory tax on the above amount (36%)................ (1,390) (853)
INCREASE IN TAXES RESULTING FROM PERMANENT DIFFERENCES:
Non-deductible operating expenses...................... 16 7
Linkage differences on loans received from Parent
Company............................................... (12) 60
Others................................................. (79) 23
------ ------
(1,465) (763)
TIMING DIFFERENCES IN RESPECT OF WHICH VALUATION
ALLOWANCE WERE RECORDED AGAINST DEFERRED TAX ASSET:
Non-deductible expenses in respect of employees'
liabilities........................................... 89 137
Non-deductible research and development expenses....... 86 97
Depreciation of know-how for tax purpose only.......... (7) (7)
Research and Development expenses which were recorded
in the books of last year and are tax deductible in
current year.......................................... (90) (20)
Loss for tax purposes carried forward from last year... (1,094) (492)
Loss for tax purposes in the current year.............. 2,481 1,048
------ ------
-- --
====== ======
</TABLE>
18
<PAGE>
3DV SYSTEMS LTD.
(A COMPANY IN THE DEVELOPMENT STAGE)
NOTES TO THE FINANCIAL STATEMENTS (CONTINUED)
NOTE 17--INCOME TAXES (CONTINUED)
F) Composition of taxes on income included in the statements of operations:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------------
1999 1998
--------------- ---------------
U.S.$ THOUSANDS U.S.$ THOUSANDS
<S> <C> <C>
Deferred tax........................................... 1,528 711
Valuation allowance.................................... (1,528) (711)
------ ----
-- --
====== ====
</TABLE>
NOTE 18--RELATED PARTIES TRANSACTIONS AND BALANCES
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------------
1999 1998
--------------- ---------------
U.S.$ THOUSANDS U.S.$ THOUSANDS
<S> <C> <C>
A) TRANSACTIONS:
Parent Company--mainly accounting services and rental.... 124 101
--- ---
Rafael--a subcontractor.................................. 32 18
--- ---
Vsoft Ltd.--general services............................. 8 10
--- ---
Leasing from Albar Ltd................................... 24 32
--- ---
Deposit to Albar Ltd..................................... (4) (3)
--- ---
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31,
1999 1998
--------------- ---------------
U.S.$ THOUSANDS U.S.$ THOUSANDS
<S> <C> <C>
B) BALANCE OF AMOUNTS DUE TO:
Accounts payable--Current accounts:
Parent Company........................................... 21 2
----- -----
Rafael................................................... -- 1
----- -----
Vsoft Ltd................................................ 2 --
----- -----
Long-term liabilities:
Loans from Parent Company................................ 2,143 2,109
----- -----
</TABLE>
NOTE 19--COMMITMENTS
A) In the fourth quarter of 1999, the Company signed leasing contracts with a
leasing company (See Note 10). The Company guaranteed its commitments in
respect of these contracts. As of December 31, 1999, the guarantees totaled
U.S.$ 146 thousand.
B) The Company sub-leases its premises from Parent Company. Minimum future
rental payment for a year, due under the Company and the Parent Company's
lease agreement is U.S.$ 44 thousand. The rental payment is linked to the
Consumer Price Index and updated by 1% each year.
19
<PAGE>
3DV SYSTEMS LTD.
(A COMPANY IN THE DEVELOPMENT STAGE)
NOTES TO THE FINANCIAL STATEMENTS (CONTINUED)
NOTE 19--COMMITMENTS (CONTINUED)
C) The Company is committed to pay royalties to the Government of Israel in
respect of sales of product, the research and development of which were made
with the participation of the Chief Scientist. The amount of royalty payment
is computed on the portion of sales proceeds from such products at rates
varying from 3% to 5%. Under certain circumstances, the commitment is
limited to the amount of the participation received, U.S.$ 116 thousand.
D) In August 1998, the Company signed a License and Manufacturing Agreement
("L&M Agreement") with VSI granting VSI exclusive, perpetual, royalty free
and worldwide rights under the six initial patents as described in the L&M
Agreement, to commercially exploit products in certain fields of use that
incorporate, or use, component parts embodying technology developed by the
Company. VSI shall have the right to sublicense certain of these rights to
other assignees which shall be subject to the prior written approval of the
Company. Pursuant to the L&M Agreement the Company expect to derive more
revenues by selling its components to VSI or Approved Assign.
E) In August 1998, the Company signed a Collaboration agreement ("Collaboration
agreement") with ASAHI Optical Co. Ltd. ("AOC") a Japanese corporation. AOC
which is an Approved Assign under the L&M Agreement has licensed certain
proprietary technology rights of the Company. The Collaboration agreement
set forth the principles under which AOC and the Company shall cooperate
with each other and negotiate in good faith the term of any collaborative
research and joint development of 3D cameras or 3D imaging modules or
devices, which Collaboration Agreement shall set forth the proposed scope of
work for such collaboration, the costs and expenses of the project to be
born by the parties and, subject to certain conditions, the rights of the
parties in and to any intellectual property rights, including any patents or
patent applications, arising out of any such collaboration ("Developed
Technologies"). The Company shall have a non-exclusive, worldwide, perpetual
license to the Developed Technologies for use and incorporation in any
product commercialized by the Company or components resulting from the
Developed Technologies, provided that AOC shall be entitled to receive from
the Company a royalty in the such case equal to 3% of the gross revenues
derived by the Company from the sale of such 3DV component. The Company
shall not be entitled to use the Developed Technologies or otherwise grant a
license of the Developed Technologies in connection with any other
collaborative research and joint development arrangement between the Company
and any non-affiliate of the Company without the prior written consent of
AOC.
F) The Company agreed to pay to key employees a special lump sum bonus, in the
event that the Company shall sell its rights in all or a major portion of
its technology. The lump sum bonus will be calculated based upon the
percentage of the employees shareholding in the Company.
G) The Company gave bank guarantees in the total amount of U.S.$ 69 thousand
due to camera and supporting equipment which were sent abroad as "carnet de
passage" for chamber of commerce.
H. The Board of Directors of the Company at its meeting on December 22, 1998
adopted the Company's Stock Appreciation Plan (the "plan"). The plan shall
provide key employees of the Company with special rewards corresponding to
the fair market value of a specified number of VSI shares. In order to
finance payment of the awards granted under the plan the Company has entered
into an Option Agreement with the Parent Company under which the Parent
Company granted the Company the option to purchase 75,000 share of common
stock of VSI, which shares shall be sold by the Company (See Note 6).
20
<PAGE>
3DV SYSTEMS LTD.
(A COMPANY IN THE DEVELOPMENT STAGE)
NOTES TO THE FINANCIAL STATEMENTS (CONTINUED)
NOTE 19--COMMITMENTS (CONTINUED)
A participant in the plan (an employee of the Company who is awarded
according to the plan) may exercise the right to receive payment of any portion
of the units awarded to his/her credit, at any time and from time to time as
from October 6, 1999 and until October 5, 2005 (the "Exercise Period") by
delivering to the Company a written notice, stating the number of whole units
payment of which is requested. The right to receive payments is limited within
the exercise period only and shall subsequently expire. Any income which may
accrue to the participant as a result of the plan will not be regarded as part
of his salary for the purpose of any pension, severance pay, saving or other
benefits applicable to employee-employer relations.
As of December 31, 1999, the Board of Directors did not grant options under
these plans.
NOTE 20--CONCENTRATION OF CURRENCY RISK--MONETARY BALANCES IN NON-U.S. DOLLAR
CURRENCIES
<TABLE>
<CAPTION>
DECEMBER 31, 1999 DECEMBER 31, 1998
ISRAELI CURRENCY * ISRAELI CURRENCY *
-------------------- --------------------
UNLINKED LINKED ** UNLINKED LINKED **
-------- --------- -------- ---------
U.S.$ THOUSANDS U.S.$ THOUSANDS
<S> <C> <C> <C> <C>
ASSETS:
Current assets:
Cash and cash equivalents............................ 511 -- 300 --
Accounts receivable.................................. 153 -- 106 --
Cars leasing deposits................................ -- 3 -- 7
--- ----- --- -----
664 3 406 7
=== ===== === =====
LIABILITIES:
Current liabilities:
Accounts payable..................................... 623 -- 374 --
Non-current liabilities:
Long-term loans from Parent Company.................. -- 2,143 -- 2,109
--- ----- --- -----
623 2,143 374 2,109
=== ===== === =====
</TABLE>
* Does not include balances in U.S. dollars or linked thereto.
** To the Israeli CPI.
21
<PAGE>
3DV SYSTEMS LTD.
(A COMPANY IN THE DEVELOPMENT STAGE)
NOTES TO THE FINANCIAL STATEMENTS (CONTINUED)
NOTE 21--ADJUSTMENT TO ISRAELI GAAP
At the request of the shareholders, the Company presents only the
differences that effect directly the results of operations. This Note does not
include required differences in the whole presentation. The effect of the
differences between U.S. GAAP and Israeli GAAP on the financial statements items
are as follows:
(1) On statements of operations
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------------
1999 1998
--------------- ---------------
U.S.$ THOUSANDS U.S.$ THOUSANDS
<S> <C> <C>
Net loss as reported............................ 3,861 2,370
Compensation expenses in respect of options
granted....................................... 204 368
----- -----
Net loss according to Israeli GAAP.............. 3,657 2,002
===== =====
</TABLE>
(2) On balance sheet items
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1999 YEAR ENDED DECEMBER 31, 1998
----------------------------------- -----------------------------------
AS AS
PER PER
ISRAELI ISRAELI
AS REPORTED ADJUSTMENT GAAP AS REPORTED ADJUSTMENT GAAP
----------- ---------- -------- ----------- ---------- --------
U.S.$ THOUSANDS
<S> <C> <C> <C> <C> <C> <C>
Amount funded for employees' rights upon
retirement............................... 119 (119) -- 61 (61) --
Employees' rights upon retirement.......... (124) 119 (5) (63) 61 (2)
Accumulated loss........................... 7,904 (689) 7,215 4,043 (485) 3,558
Employees' stock options................... (689) 689 -- (485) 485 --
----- ---- ----- ----- ---- -----
7,210 -- 7,210 3,556 -- 3,556
===== ==== ===== ===== ==== =====
</TABLE>
22
<PAGE>
VISION-SCIENCES, INC.
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT DESCRIPTION OF EXHIBIT PAGE
------- ---------------------- --------
<C> <S> <C>
3.1.(1) Restated Certificate of Incorporation of the Company, as
amended to date
3.2.(2) By-laws, as amended to date
*10.1.(4) 1990 Stock Option Plan, as amended
*10.2.(4) 1993 Director Option Plan
10.3.(2) Registration Rights Agreement dated as of February 28, 1992
among the Registrant and the persons listed therein
*10.4.(2) Vision-Sciences, Inc. 401(k) Plan, as amended
10.5.(2) Supply Agreement between Machida Incorporated and Steve
Onody dated August 29, 1991
10.6.(2) Purchase Agreement between Vascu-Care, Inc. and Steve Onody
dated August 29, 1991
10.7.(2) Lease between Machida Incorporated and J&J Associates dated
September 1, 1990
10.8.(7) Renewal to Lease between Machida Incorporated and J&J
Associates dated September 1, 1995
10.9.(2) Non-Exclusive License Agreement among Opielab, Inc., O.S.
Limited Partnership and Asahi Optical Co., Ltd. dated
September 28, 1988
10.10.(3) License Agreement between Vision-Sciences, Inc. and Advanced
Polymers, Inc. dated June 10, 1993
10.11.(2) Distributorship Agreement dated January 1, 1991 between
Storz Instrument Company and Machida Incorporated, as
amended
*10.12.(2) Form of Vision-Sciences, Inc. Invention, Non-Disclosure and
Non-Competition Agreement for employees
10.13.(2) Supply Agreement between the Company and Asahi Optical Co.,
Ltd. dated March 16, 1992
10.14.(2) Consulting Agreement between Vision-Sciences, Inc. and
Richard Rothstein dated November 1, 1991
10.15.(2) Agreement, Assumption and Release dated as of September 1,
1992 among Stephen Onody, Vascu-Care, Inc., Machida
Incorporated and Summit Technologies, Inc.
10.16.(5) Amendment to License Agreement between Vision-Sciences, Inc.
and Advanced Polymers, Inc. dated April 5, 1994
10.17.(7) Amendment to License Agreement between Vision-Sciences, Inc.
and Advanced Polymers, Inc. dated April 5, 1995
10.18.(7) Amendment to License Agreement between Vision-Sciences, Inc.
and Advanced Polymers, Inc. dated February 14, 1996
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT DESCRIPTION OF EXHIBIT PAGE
------- ---------------------- --------
<C> <S> <C>
10.19.(6) Commercial Loan Agreement (including Security Agreement and
Promissory Note) between Vision-Sciences, Inc. and The First
National Bank of Boston dated January 24, 1995
10.20.(7) Extension to Commercial Loan Agreement between
Vision-Sciences, Inc. and The First National Bank of Boston
dated November 16, 1995
10.21.(7) Lease between Paul D. McKeon, Trustee of 14 Burr Street
Realty Trust and Vision-Sciences, Inc. dated April 23, 1993
**10.22.(8) Investment Agreement dated as of August 6, 1998 between
Vision-Sciences, Inc., 3DV Systems Ltd. and RDC Rafael
Development Corporation Ltd.
**10.23.(8) License and Manufacturing Agreement dated as of August 6,
1998 between Vision-Sciences, Inc. and 3DV Systems Ltd.
**10.24.(8) Memorandum of Understanding dated August 6, 1998 between
Vision-Sciences, Inc. and Imagineering, Ltd.
**10.25.(8) License Agreement dated as of August 6, 1998 between
Vision-Sciences, Inc. and Asahi Optical Co., Ltd
*10.26. 2000 Stock Incentive Plan
10.27. Agreement of Lease between 30 Ramland Road LLC and
Vision-Sciences, Inc. dated as of March 23, 2000
*10.28. Letter Agreement between the Company and Alan Jacobson dated
December 20, 1999.
*10.29.(9) Letter Agreement between the Company and James A. Tracy
dated July 18, 1997.
*10.30.(9) Memorandum of Understanding between the Company and Gerald
B. Lichtenberger dated December 5, 1998.
21.1.(1) Subsidiaries of the Company
23.1. Consent of Arthur Andersen LLP
23.2. Consent of Somekh Chaikin
27.1. Financial Data Schedule
</TABLE>
------------------------
* Management contract or compensatory plan or arrangement filed as an exhibit
to this Form pursuant to Items 14(a) and 14(c) of Form 10-K.
** Confidential treatment granted as to certain portions, which portions have
been deleted and filed separately with the Securities and Exchange
Commission.
(1) Incorporated by reference from the Annual Report on Form 10-K for the fiscal
year ended March 31, 1993.
(2) Incorporated by reference from the Registration Statement on Form S-1 (File
No. 33-53490).
(3) Incorporated by reference to the Quarterly Report on Form 10-Q for the
quarter ended June 30, 1993.
(4) Incorporated by reference from the Annual Report on Form 10-K for the fiscal
year ended March 31, 1994.
(5) Incorporated by reference from the Quarterly Report on Form 10-Q/A for the
quarter ended June 30, 1994.
(6) Incorporated by reference from the Annual Report on Form 10-K for the fiscal
year ended March 31, 1995.
<PAGE>
(7) Incorporated by reference from the Annual Report on Form 10-K for the fiscal
year ended March 31, 1996.
(8) Incorporated by reference from the Current Report on Form 8-K dated
August 20, 1998.
(9) Incorporated by reference from the Quarterly Report on Form 10-Q for the
quarter ended June 30, 1999.
