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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-KSB/A
ANNUAL REPORT
(Mark One)
[x] ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 (Fee required)
For the fiscal year ended December 31, 1996
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 (No fee required)
For the transition period from ____________ to _________
Commission file number 1-12954
US MEDICAL PRODUCTS, INC.
(Name of small business issuer in its charter)
TEXAS 74-2599718
(State of incorporation) (IRS Employer Identification No.)
12201 TECHNOLOGY BOULEVARD, SUITE 100, AUSTIN, TEXAS 78727
(Address of principal executive offices) (Zip Code)
Issuer's telephone number: (512) 257-8787
Securities registered pursuant to Section 12(b) of the Exchange Act:
Title of each class Name of each exchange on which listed
Common Stock Boston
Warrants Boston
Securities registered pursuant to Section 12(g) of the Exchange Act: None
Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act 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
Check if there is no disclosure of delinquent filers in response to Item 405
of Regulation S-B contained in this form, and no disclosure will be
contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form
10-KSB or any amendment to this Form 10-KSB. [ ]
The issuer's revenues for the fiscal year ended December 31, 1996, were
$4,149,660.
The aggregate market value of voting stock held as of March 21, 1996, was
approximately $3,899,418.
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PART I
US Medical Products, Inc., a Texas corporation (the "Company"), has
entered into merger negotiations with Metrax Medical, Inc., a Delaware
corporation ("Metrax Medical"), which owns 80% of the Company's Common Stock.
Metrax Medical is a privately held company that owns 100% of Metrax GmbH, a
German based medical products company that develops, manufactures and
internationally distributes professional medical products and consumer
wellness products. Upon consummation of the merger, the Company anticipates
that Metrax Medical will be merged with and into the Company, with the
Company remaining as the surviving entity to continue the operations of
Metrax Medical. The Company also intends to change its name to Metrax
International, Inc. The Company also is currently negotiating to sell
substantially all of its existing assets to Hayes Medical, Inc., a California
corporation ("Hayes Medical").
ITEM 1. DESCRIPTION OF BUSINESS
GENERAL
The Company was formed in March 1991, to develop, manufacture and market
medical and surgical products at prices lower than those of competing
products. Its products are joint reconstructive devices, namely the
Consensus-Registered Trademark- Knee, Hip and Bipolar Systems (the "Consensus
Products"), consisting of prostheses that replace all or a part of the
patient's diseased or fractured joint, together with the specialized surgical
instruments used to implant these devices. The Consensus Products are
designed to be substantially equivalent to other highly featured joint
replacement systems on the market. However, both the implant devices and
surgical instruments comprising the Consensus Products incorporate certain
distinctive features designed to accommodate the preferences of orthopedic
surgeons.
The Company's Consensus Products are designed to be substantially
similar in overall design to devices currently marketed in the United States.
Therefore, the Company is required only to obtain a finding of substantial
equivalence from the FDA under 510(k) regulations. Typically, surgical
instruments do not require submission to the FDA prior to domestic marketing;
however, the Company has filed 510(k) submissions with respect to certain
aspects of its instruments.
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PRODUCT BACKGROUND
Joint prostheses replace joint structures damaged by disease or trauma.
Prostheses for hips and knees, and to a lesser extent, shoulders, elbows,
wrists and fingers, provide mobility and pain relief, primarily to patients
suffering from degenerative or rheumatoid arthritis or, in some cases, from
fractures. The procedure has become most common in the treatment of
conditions of the hip and knee and involves the implantation of devices into
the joint to replace degenerated articular surfaces.
Significant advances have been made in the past two decades in the
technology and techniques of joint replacement. Total hip endoprostheses
and total knee implant prostheses are typically comprised of metallic,
ceramic and high density polyethylene components. For example, in a hip
replacement, the femoral head and neck are replaced by metal parts and the
hip socket or acetabulum is replaced by a plastic cup typically strengthened
by a metal backing. These various implant components are affixed to
adjoining bones either by a chemical bone cement or by biological attachment
to the implant. The product life of an implant within the body varies with
several factors, but generally averages 7 to 12 years, although recent
improvements in product and surgical techniques have yielded anticipated
useful lives in the 15-year range. The principal causes of implant failure
are the loosening of the implant over time and polyethylene wear. Many of
the technological improvements in surgical techniques and implant designs in
recent years have focused upon various means of reducing component loosening
and wear.
Medicare beneficiaries, persons 65 and older, are the primary group
undergoing joint implantation surgery. Surgeons, rather than patients,
generally have been the decision makers in choosing the device to be used.
Patient activity demand levels and age also play an important part in the
type of implant selected. Hospitals, the primary purchasers of the devices,
typically rely on a predetermined rate of reimbursement from third party
payors for the procedures using the implant devices. Because of increasing
cost pressures, hospitals have begun to influence surgeon choice to the
extent that cost issues are involved.
THE CONSENSUS JOINT IMPLANT SYSTEMS
The Company's Consensus-Registered Trademark- Bipolar, Consensus Hip
System and Consensus Knee System were being marketed internationally and
domestically. The Consensus Knee System was first introduced to the domestic
market in the third quarter of 1995 and to the international market in the
fourth quarter of 1994. Line extensions such as the small size All-Poly
Patellar Component, No-Hole Acetabular Shell, All-Poly Acetabular Cup and
Unipolar were released in the first half of 1996.
THE CONSENSUS BIPOLAR SYSTEM. The Consensus Bipolar System consists of
a partial hip replacement prosthesis and related surgical instruments. A
bipolar prosthesis is an endoprosthetic device typically used, together with
a femoral stem prosthesis, in the case of a fracture of the neck/head area of
the femur. This is usually referred to as a hip fracture and may lead to the
degeneration of the femoral head tissue due to the loss of blood supply to
the femoral head. To correct this problem, the surgeon typically will replace
only the affected side of the joint, (i.e., the femoral side), leaving the
natural cartilage of the acetabulum intact. This requires the use of a
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bipolar hip implant to replace the natural femoral head, allowing for the
implant to articulate with the natural cartilage of the acetabulum. The
bipolar device derives its name from the fact that it is characterized by its
two different articulating surfaces, one at the femoral head
component/bipolar insert interface (primary articulation), and the other at
the bipolar head component/acetabulum interface (secondary articulation),
increasing the range of motion and wear characteristics.
The Company received a patent on the Consensus-Registered
Trademark-Bipolar locking feature, which securely joins the polyethylene
insert to the bipolar head, yet allows ease of separation and removal if
necessary. The patent affords the Company the opportunity to license this
product to other companies as well as marketing the product through the
Company's existing methods.
On December 11, 1995, the Company entered into a cross-licensing
agreement with Stelkast, Inc., which grants Stelkast a non-exclusive,
non-transferable, worldwide license under the Company's patent to purchase
goods or manufacture the Consensus Bipolar and to market and distribute under
the Stelkast name. In return, the agreement grants the Company a
non-exclusive, non-transferable, worldwide license to purchase goods or
manufacture the Stelkast Unipolar head and all-poly cup and to market and
distribute under the Company's brand name.
THE CONSENSUS HIP SYSTEM. The Consensus Hip System consists of a
Consensus Primary Hip and related surgical instruments. A Consensus Hip
typically is used in the case of degenerative or rheumatoid arthritis, where
the cartilage in the joint area is worn, causing the painful rubbing of bone
against bone. The Consensus Hip derives its name from the fact that all the
articulating surfaces of the hip are replaced by the use of artificial joints
or implant devices. The Consensus Hip implants consist of various
components that are assembled at the time of surgery to best fit the
patient's anatomy. The principal components of the Consensus Hip are the
acetabular shell, the acetabular insert, the femoral stem and the femoral
head.
The Consensus Hip System includes five variations of the femoral stem:
(i) Cobalt Chrome ("CoCr") Collared Stem for cemented application, (ii)
Titanium ("Ti") Collarless Non Porous Stem for press fit application, (iii)
Hydroxyapatite ("HA") Ti Collarless Non Porous Stem for press fit
application, (iv) Porous Coated Collared Ti Stem for press fit application
and (v) Porous Coated Collarless Ti Stem for press fit application. All stem
types use a common set of hip instrumentation.
A FDA 510(k) finding of substantial equivalence of the Consensus Primary
Hip with a cobalt chrome femoral stem was received on July 21, 1993. The
Company began international marketing of its Consensus Hip System in mid-1992
and began domestic marketing in July, 1993. On May 18, 1994, the Company
received a FDA finding of substantial equivalence for its titanium femoral
stem for use with the Consensus Primary Hip, and added this product to
marketing at that time. Additional substantial equivalence findings were
issued by the FDA, for the HA-coated stem on July 18, 1994, and for the
porous coated femoral stem on August 18, 1994. These additional Consensus
Hip System devices respectively use (i) Ti as the primary metal in the
femoral stem, (ii) a porous Ti coating to facilitate bone ingrowth into the
implant, and (iii) a HA coating, which is reported to promote bone apposition
(attachment). The Company has also received U.S. patents for two of the
surgical instruments developed for use in the implantation of the Consensus
Hip System.
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THE CONSENSUS-Registered Trademark -KNEE SYSTEM. The Consensus Knee
System consists of the Consensus Primary Knee and related surgical
instruments. The Consensus Primary Knee is used in primary surgical cases of
osteoarthritis or rheumatoid arthritis where the cartilage in the joint area
is worn, causing painful rubbing of bone against bone and malalignment of the
joint. The articulating surfaces of the knee are resurfaced with metallic
and polyethylene components. The Consensus Knee System consists of various
components which are assembled at the time of surgery to best fit the
patient's anatomy. The principal components of the Consensus Knee System are
the knee femoral component, the tibial baseplate, the polyethylene tibial
insert and the patella. The femoral and tibial components are available in
porous coated and non porous configurations to meet varied surgeon
preferences.
In September, 1994, the Company received a FDA 510(k) finding of
substantial equivalence for the Consensus Knee implants. The Company began
limited preliminary implantation of the Consensus Knee in 1994. The system
became fully available domestically and internationally in the fourth quarter
of 1995.
The Company received a U.S. Patent for the Consensus Knee Stemmed Tibial
Baseplate and has filed for patents on certain features of the Consensus Knee
System instruments. These instruments are used in the preparation and
alignment of the bony anatomy of the tibia and patella.
The FDA has determined that the Consensus-Registered Trademark- Bipolar,
Consensus Hip and Consensus Knee Systems are substantially equivalent to
devices marketed in interstate commerce prior to May 28, 1976. This
determination has enabled the Company to market these products domestically
in interstate commerce. The Company currently has other line extensions to
these primary systems that have been cleared by the FDA for determination of
substantial equivalence. These devices include the Posterior Stabilized
Knee, PCL Substituting Tibial Insert, All-Poly Tibia, and the No-Hole
Acetabular Shell.
MARKETING
The Company had implemented its marketing strategy domestically by
contracting with sales agents and distributors experienced in orthopedic
device sales. At December 31, 1996, the Company had entered into agreements
with eight agents and one distributor in the United States. International
agreements existed for distribution in four European markets. In early 1996,
the Company also entered into agreements with four additional agents in the
United States as well as an agreement to distribute products to the
government of Poland. The Company had contracts for domestic distribution in
Texas, Ohio, Oregon, Pennsylvania, Florida, Arizona, Nevada, New Jersey,
Oklahoma, and Louisiana. International distribution contracts existed
covering Germany, Switzerland, Italy, Turkey, and Mexico. In November, 1996,
the Company's Consensus Knee System was approved for sale in Canada. On
January 15, 1997, the Company entered into an exclusive domestic distribution
agreement with National Medical Specialty, Inc., a subsidiary of Hayes
Medical, a California corporation. On February 1, 1997, this agreement extended
to worldwide distribution.
During 1996, the Company consigned inventory to its domestic sales
agents and sold its products to distributors. At the time of every implant
procedure, the surgeon must have access to a
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wide array of product components and sizes in order to ensure optimal fit of
the implant. Therefore, each distributor and sales representative must
maintain an extensive inventory. Distributors generally pay for their
inventory on standard terms. Products sold through sales agents and
representatives, in accordance with industry practice, were typically paid
for by the purchasing hospital only when actually used. As a result, the
Company was required to produce inventory for which it received payment
substantially after the product was manufactured and shipped. Under the
current worldwide distribution agreement, all inventory is sold to one
distributor and payments are made on standard terms.
MANUFACTURING
The Company's Consensus-Registered Trademark- Products are required to
be manufactured in compliance with applicable regulatory requirements and at
acceptable costs. Many of the Company's competitors rely on third party
manufacturers to produce and assemble some or all of the components of their
products. The Company does not manufacture or assemble the components of its
products, although the Company generally inspects, cleans, packages and
verifies sterilization of its products at its own facilities. Currently,
approximately 15 primary vendors produce various components of the Company's
products to its specifications. The Company depends, to a material degree,
upon its ability to contract with third parties to manufacture the Company's
products according to the Company's designs and specifications, in accordance
with applicable regulations, and at a unit cost to the Company that will
permit the Company to market its products at an acceptably competitive
purchase price to its customers.
QUALITY CONTROL
The Company requires that all such third-party manufacturers exercise
quality control procedures that meet or exceed applicable FDA regulatory
requirements. Required product testing has been performed by an independent
third-party vendor and by the Company, with final product inspection,
cleaning, packaging and overall quality control procedures generally being
performed internally by the Company's own personnel. Product sterilization
is performed by outside vendors and verified by the Company. Such
sterilization services are readily available.
GOVERNMENT REGULATION
Regulation by governmental authorities in the United States and other
countries is a significant factor in the production and marketing of medical
devices such as the Company's Consensus Products. Existing laws and
regulations, particularly those regarding FDA product approvals and the
administration of the Medicare and state health care programs, have a direct
bearing upon the operations of the Company.
PRODUCT REGULATION. Medical devices such as those produced by the
Company must be approved by the FDA prior to being marketed domestically. In
addition, some foreign markets require FDA approval prior to approval for
marketing in those countries. Depending upon its nature and intended use, a
new device, unless investigational, will be subject to the 510(k) regulations
or the Premarket Approval regulations of the FDA. Similar regulations are
administered by the health
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authorities of many foreign countries and must be complied with before
medical products can be marketed in those countries.
Medical products that are deemed to be substantially equivalent to
products already available in the marketplace are eligible for clearance in
the United States under the FDA's 510(k) regulations. This process involves
a submission to the FDA demonstrating the requisite substantial equivalency
of the product to products already available in the marketplace. After
introduction of a new medical device, the FDA requires in some cases that the
manufacturers and distributors of the device exercise continuing "post-market
surveillance" to provide early warning of problems that arise from the use of
the device. Accordingly, the Company may be required to maintain procedures
to monitor and report any complaints or other evidence of product defects or
problems that arise after its products are sold and implanted. The Company
is continuing its implementation of computer-based systems designed to
support compliance with all applicable post-market surveillance requirements.
REGULATION OF MANUFACTURING. The current products of the Company are
subject to FDA regulations, which, among other things, require adherence to
strict quality control procedures, including conformance to Good
Manufacturing Practices ("GMPs"), ISO 9001, EN 46001, and MDD Annex II.
These regulations require documentation of all aspects of the manufacturing
process to demonstrate that products are made by a "controlled" process which
ensures consistency and reliability of the end product. On August 2, 1996,
the Company successfully completed a certification assessment of their
quality system implementation resulting in the Company being ISO 9001, EN
46001, and Medical Devices Directive Annex II and Annex V certified.
Products are also required to be tested according to regulated procedures to
ensure that quality standards are maintained. The Company's contracts with
third parties to manufacture and test its products require that such
procedures be performed in accordance with all applicable regulatory
requirements.
The FDA conducts periodic inspections or audits of medical device
manufacturers to determine compliance with GMPs. The failure of a medical
device manufacturer to be able to show that it has adequately complied with
GMPs can result in penalties or enforcement proceedings being imposed. These
procedures may include a recall of a product or a "cease distribution" order
which would require the manufacturer to direct its distributors and sales
agents to stop selling its products, both domestically and internationally.
THIRD PARTY COVERAGE, REIMBURSEMENT AND RELATED HEALTH CARE REGULATIONS
The market for the Company's products is affected significantly by the
amount which Medicare or other governmental third party payors, and private
insurance companies, will reimburse physicians, hospitals and other providers
for procedures using the Company's products. The health care industry has
changed dramatically in reaction to changes in third party reimbursement
systems designed to contain health care costs. Relevant third party
reimbursement issues include whether the procedures using the Company's
products will continue to be covered procedures and, if so, the level of
reimbursement which will be allowable.
Each state Medicaid program has individual requirements that affect
coverage and reimbursement decisions for certain health care providers and
recipients. Private insurance
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companies also set their own coverage and reimbursement policies. Private
insurance companies and state Medicaid programs are influenced by the Health
Care Financing Administration ("HCFA") requirements which are established for
the federal Medicare program.
The market for the Company's products is also materially affected by the
amount of reimbursement provided by third party payors to hospitals for
procedures performed using such products. Reimbursement rates from private
insurance companies vary depending upon the procedure performed, the
third-party payor, the insurance plan, and other factors. Medicare generally
reimburses hospitals that are expected to purchase the Company's products for
their operating costs for inpatients on a prospectively-determined fixed
amount for the costs associated with an inpatient hospital stay based on the
patient's discharge diagnosis, regardless of the actual costs incurred by the
hospital in furnishing care. The willingness of hospitals to purchase the
Company's products could be materially and adversely affected if such
purchasers determine that the payment amount to be received for the
procedures for which the Company's products are used would be inadequate to
cover the hospitals' costs associated with performing such procedures, or
that the use of the Company's products is less profitable than using an
alternative procedure or product for the same condition.
The Company intends to incorporate in each of its new products design
features and materials which have generally become standardized in the
current market for implant products and which do not infringe upon the
proprietary rights of competing firms. The Company anticipates, although
there can be no assurance, that, like its Consensus Bipolar, Hip, and Knee
Systems, other new products will be determined to be "substantially
equivalent" to other similar products already available on the market.
SCIENTIFIC ADVISORY BOARD; RESEARCH AND DEVELOPMENT
The Company's Scientific Advisory Board ("SAB") is presently comprised
of 6 orthopedic surgeons who consult with the Company on product design and
marketing issues.
The Company's research and development activities are conducted
primarily by the Company's Engineering staff. As of December 31, 1996, the
Engineering staff consisted of one product development engineer, one
engineering designer and three design drafters. Occasionally, the Company
contracts with outside researchers and engineers on a specific project.
PROPRIETARY INFORMATION AND PATENTS
The Company has filed for United States patents with the United States
Patent and Trademark Office relating to specialized design features of its
products. Five patents have been awarded to date and one other is pending.
The patents granted to date include one relating to the placement of the stem
on the Tibial Baseplate of the Consensus-Registered Trademark- Knee System,
two for surgical instruments for the Consensus Hip System, one for the
locking feature of the Consensus Bipolar Component, and one for a surgical
instrument for the Consensus Knee System.
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The Company is unaware of the existence of any claim made by a third
party of patent infringement with respect to its products. However, no
assurance can be given that challenges to Company patents, if granted, or
claims will not be asserted in the future. Although there is a statutory
presumption as to a patent's validity, the issuance of a patent is not
conclusive as to such validity, or as to the enforceable scope of the claims
of the patent.
The Company requires each of its employees, consultants and advisors to
execute a confidentiality and assignment of proprietary rights agreement upon
the commencement of an employment or consulting relationship with the
Company. These arrangements generally provide that all inventions, ideas, and
improvements made or conceived by the individual arising out of their
employment or consulting relationship shall be the exclusive property of the
Company. This information shall be kept confidential and not disclosed to
third parties except by consent of the Company or in other specified
circumstances. There can be no assurance, however, that these agreements
will provide effective protection for the Company's proprietary information
in the event of unauthorized use or disclosure of such information.
COMPETITION
Competition in the overall domestic joint replacement market has
increased substantially in recent years. At present more than fifteen
companies participate in the market in varying degrees. Based upon market
audits conducted in 1995 by MediFacts International, the two largest vendors,
Zimmer, Inc. (Bristol Meyers Squibb) and Howmedica, held market shares of
approximately 17% and 12%, respectively, with the next four largest companies
in the field holding a combined market share of approximately 39%. With some
variation in market shares, all of the major competitors in the overall joint
replacement market compete both in the market for total hip and total knee
products.
The international market for joint prostheses involves a number of
competitive companies. Companies based in the United States hold a large
part of the world market share. In Europe, Protek, Ltd. (a Swiss subsidiary
of Sulzer-Medica) is one of the largest vendors. Other large vendors include
Howmedica, Inc. and Zimmer, Inc. Kyocera Corp. is the largest Japanese
manufacturer. Locally manufactured hip prostheses tend to be favored in the
European market, while United States designed and manufactured knee implants
tend to be preferred worldwide. Japan favors both U.S. hip and knee designs.
The principal variables among competing products relate to the type of
metal used for metallic components (namely titanium or cobalt-chromium
alloys), geometry of the hip stem, and whether components are porous or
nonporous or coated with a substance to facilitate bone ingrowth. Overall
design variations among certain competing orthopedic implant devices may be
limited, particularly among hip devices, because of anatomical and regulatory
constraints. However, slight variations in design are often important in
accommodating the preferences of orthopedic surgeons, and technological
advances in various implant products continue to differentiate devices and
influence market acceptance. In addition, each manufacturer's various implant
devices require the surgeon to use a set of surgical instruments designed
specifically for use with that device. Companies continually try to achieve
greater ease of use in their instrument designs and can readily
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make such changes since regulatory or pre-market approval for instrument
design is not generally required.
Most competing implant systems are subject to individual trade name
registrations but are not subject to overall design patents, although
particular components or materials utilized within a component may embody
elements or manufacturing techniques that are proprietary to the individual
manufacturer. Most of the major manufacturers of implant products are engaged
in continuous research and development programs focused upon product
innovations, including developing new materials such as carbon composites,
ceramics and thermoplastics for use in implants.
EMPLOYEES AND CONSULTANTS
On December 31, 1996, the Company had 24 full-time employees, of which
one was in general executive position, thirteen were in operations, five were
in engineering involved in research and development, two were engaged in
sales and marketing and three were in administration and finance. None of
the Company's employees is represented by a collective bargaining agreement,
and the Company considers its employee relations to be satisfactory.
The Company experienced a number of changes in management during 1996.
Mr. Frederick Mindermann joined the Company in August, 1996 as Chief
Executive Officer and Director of the Board. Mr. Mindermann was preceded by
Mr. J. Melville Engle who resigned from the Company in August, 1996, as its
President and Chief Executive Officer. Mr. Engle also resigned as a Director
of the Company. In November, 1996, Mr. Gary Mermelstein, Vice President -
Sales and Marketing, Mr. Steven I. Whitlock, Vice President - Engineering and
Mr. Daniel W. Thompson, Vice President - Finance and Administration resigned
from the Company. For changes in the Board of Directors, see Item 9 below.
ITEM 2. DESCRIPTION OF PROPERTY
The Company's offices are located at 12201 Technology Blvd., Suite 100,
Austin, Texas. The Company signed a three year lease, ending July 29, 1998,
for 14,475 square feet of space for its operations at an average monthly rent
of approximately $8,865, beginning July 29, 1995.
ITEM 3. LEGAL PROCEEDINGS
The Company is involved in litigation arising in the normal course of
business. The Company believes, although there can be no assurance, that
the ultimate resolution of these matters will not have a material adverse
effect on its business, financial position or results of operations.
ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted during the quarter ended December 31, 1996,
that required a vote of the Company's shareholders.
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PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
The following table sets forth high and low trade prices of the shares
of Common Stock of the Company for each quarterly fiscal period of 1996 and
1995, based on information received from the Boston Stock Exchange. As of
July 1997, the number of beneficial owners of the Company's Common Stock known
to the Company was 554, and the number of record holders was 165.
HIGH LOW
---- ---
1996
First Quarter 5/8 7/32
Second Quarter 1/2 1/2
Third Quarter 5/16 5/16
Fourth Quarter 1/4 1/4
1995
First Quarter n/a(1) n/a(1)
Second Quarter 19/32 1/2
Third Quarter 5/8 7/16
Fourth Quarter 3/16 3/16
(1) There was no active trading during the first quarter of 1995.
The Board of Directors declared no dividends during 1996 and does not
expect to declare dividends in the foreseeable future.
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
REVENUE. The Company's total revenue increased from $2,041,089 in 1995
to $4,149,660 in 1996. The Company's revenue is primarily derived from the
sale of orthopedic implant devices together with corresponding surgical
instruments. The increase in total revenue from 1995 to 1996 was primarily
attributable to the introduction of the Company's Consensus-Registered
Trademark- Knee System, during the last quarter of 1995, and the ability to
obtain more domestic and international distributors due to its expanded
product line.
COSTS OF GOODS SOLD. Costs of goods sold decreased from $1,913,758 in
1995 to $1,719,918 in 1996. Costs of goods sold includes the cost of
materials, manufacturing costs, related production costs and allocated
overhead costs. The decrease in costs of goods sold from 1995 to 1996 was
primarily due to the reduction in inventory shrinkage due to improved
controls over inventory. As a result of these improved inventory controls the
Company's book-to-physical adjustment in 1996 was a positive adjustment of
$11,250 compared to a negative adjustment of approximately $400,000 in 1995.
The company has revised its management discussion and analysis regarding cost
of sales to reflect this.
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SALES AND MARKETING. Sales and marketing expense increased from
$959,945 in 1995 to $1,846,527 in 1996. The primary components of sales and
marketing expense were salaries, participation at industry shows, promotional
materials and travel. The increase in sales and marketing expense from 1995
to 1996 is primarily attributable to sales commissions.
RESEARCH AND DEVELOPMENT. Research and development expense increased
from $692,798 in 1995 to $880,796 in 1996. The increase in research and
development expense is primarily attributable to efforts to expand the
product offerings of the Company and the further development and refinement
of the Company's existing products. The primary components of research and
development expense in 1996 were salaries and development costs associated
with the primary knee implant/instrument system. The development costs
include creation of models, prototypes, test parts, product testing and
preproduction clinical implants and instruments for evaluation of the knee
system prior to final production release.
GENERAL AND ADMINISTRATIVE. General and administrative expense
decreased from $1,624,289 in 1995 to $1,422,632 in 1996. The primary
components of general and administrative expense in 1996 were salaries,
including those for the Company's finance and administration staff, and all
components of corporate overhead not charged to inventory.
The Company incurred a net loss in 1996 of $5,451,513, or ($0.37) per
share. This net loss compares to the loss in 1995 of $3,357,279, or ($0.61)
per share.
OTHER. Effective February 1, 1997, the Company entered into a
"worldwide exclusive distribution agreement" with National Medical Specialty,
Inc. (the "Distributor"), a subsidiary of Hayes Medical. In conjunction with
this agreement, the Company sold to the Distributor inventory with a book
value of $1.78 million dollars in exchange for a cash purchase price of
56.25% of the net book value of such inventory ($1.0 million). The
Distributor also agreed to purchase additional inventory with a net book
value of $.533 million in exchange for a cash purchase price of 56.25% of the
inventory's book value ($.3 million dollars). On April 7, 1997, the Company
signed an amendment to the "world wide exclusive distribution agreement,"
whereby up to an additional $700,000 of inventory may be purchased at a price
of 30% above cost (prior to valuation reserves) for new inventory or 56.25%
of historical cost (prior to valuation reserves) for existing inventory.
Additional future purchases made under this agreement, if any, will be made at
a price to be agreed upon by both parties.
The Company is currently negotiating to sell substantially all of its
existing assets to Hayes Medical at approximately 56.25% of historical cost
less certain liabilities to be assumed by Hayes Medical at the closing. While
there can be no assurance that this sale will be consummated, it indicates an
impairment in value of the Company's assets. As a result, the Company has
recorded a writedown of inventory and fixed assets of $3,325,000 for the year
ended December 31, 1996.
LIQUIDITY AND CAPITAL RESOURCES
The Company has funded its operations during 1996 primarily through the
issuance of certain promissory notes to Smith Management Company, Inc. or
affiliated companies (formerly the majority shareholder). The Company's cash
requirements have been significantly exceeding its capital resources and cash
generated from operations due to its expenditures related to research and
development, obtaining FDA approvals or clearances to market its products,
obtaining and maintaining manufacturing and distribution arrangements,
maintaining its inspection and clean room facilities, product introductions
and expenses related to the manufacture and sale of its products.
ITEM 7. FINANCIAL STATEMENTS
The response to this item is submitted as a separate section of this
Form 10-KSB Annual Report. See index.
12
<PAGE>
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE
None.
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS, AND CONTROL
PERSONS; COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE
ACT
The following table sets forth certain information concerning each of
the persons who served as executive officers and directors of the Company
during the period January 1, 1996 to December 31, 1996. The Company's
executive officers are elected to serve in such capacities until the earlier
to occur of the election and qualification of their respective successors or
until their respective deaths, resignations or removals by the Company's
Board of Directors from such positions. The Company's directors are elected
to serve in such capacities until the earlier to occur of the election and
qualification of their respective successors or their respective deaths,
resignations, or removals by the Company's stockholders from such positions.
NAME AGE POSITIONS AND OFFICES HELD DURING 1996
- ------------------- --- --------------------------------------
Frederick Mindermann 35 Chief Executive Officer
(August 21, 1996 - present)
Director
(August 21, 1996 - present)
Thomas Otto 45 President
(August 21, 1996 - present)
Director
(August 21, 1996 - present)
Heinz Bucher 55 Director
(August 21, 1996 - present)
J. Melville Engle 47 President and Chief Executive Officer
(January 1, 1996 - August 21, 1996)
Director
(January 1, 1996 - August 21, 1996)
13
<PAGE>
Gary A. Mermelstein 44 Vice President - Sales and Marketing
(January 1, 1996 - November 15, 1996)
Jeffrey A. Smith 51 Chairman of the Board
(January 1, 1996 - August 21, 1996)
Director
(January 1, 1996 - August 21, 1996)
Edward Z. Safady 39 Director
(January 1, 1996 - August 21, 1996)
Thomas G. FitzGerald 28 Director
(January 1, 1996 - August 21, 1996)
Robert Bernstein, M.D. 76 Director
(January 1, 1996 - August 21, 1996)
Steven I. Whitlock 34 Vice President - Engineering
(January 1, 1996 - November 15, 1996)
Daniel W. Thompson 44 Vice President - Finance and
Administration
(January 1, 1996 - November 15, 1996)
The principal occupation and business experience of each director and
executive officer is set forth below.
FREDERICK MINDERMANN. Mr. Mindermann has served as the Company's Chief
Executive Officer since August 1996. Since that time he has also served as
Vice President/General Manager and Director of Metrax Medical, a Delaware
corporation, which wholly owns Metrax GmbH. Mr. Mindermann earned a masters
degree in business administration, bachelors of science degree in business
administration, associates degree of science in respiratory medicine and a
histotechnology diploma. Following his medical education he worked in
various hospital settings then spent 7 years with Siemens Medical Systems in
various capacities including sales, sales management, special projects and a
two year international assignment in Stockholm Sweden. He then spent over 2
years with British Oxygen Corporation as Senior Product Manager for the
Anesthesia Systems Division before joining American HomePatient, a home
healthcare service provider, as Director of Marketing for the Respiratory
Business Division. Recently he was the National Accounts Manager with Allied
Healthcare Products and is President of Health Source One which is a
healthcare think tank currently working on various projects including the
writing of a respiratory home care book which is under contract with a major
medical book publisher.
THOMAS OTTO. Mr. Otto has served as the Company's President and
Director since August 1996. He also serves as Vice-President of Metrax GmbH,
and is the President and a director of Metrax Medical. After his education to
be a chemical laboratory assistant and after his three-years
14
<PAGE>
occupation with BASF, Mr. Otto concluded his studies of business management
at the University of Kalserslautern and is now a diploma'd lecturer in adult
education. During his 12 years in the Volkswagen group, he acted as
marketing, sales and operational manager and spent the further 3 years as
director with operative responsibility for the American Gelco Group in
Germany, Austria and in Switzerland. After an additional 8 years as
management consultant, Thomas Otto entered Metrax in 1993. His promotion to
the Vice-President of Metrax GmbH took place in 1994.
HEINZ BUCHER. Mr. Bucher has been a director of the Company since
August 1996. He is the founder and President of Metrax GmbH, and serves as
the Chairman and Chief Executive Officer of Metrax Medical Inc. As
electrical engineer of the University of Stuttgart, Mr. Bucher started his
professional career with the clock factory Junghans in Schramberg, Germany.
The experiences he could gather as production manager of the watch factory
Hernie in Gosheim, Germany, enabled Heinz Bucher to rise to the management of
the Heddenheimer Metallwarenfabrik AG in Frankfurt.
J. MELVILLE ENGLE. Mr. Engle joined the Company in July, 1995, as
President and Chief Executive Officer. He was elected to the Board of
Directors August 9, 1995. Mr. Engle holds a MBA from the University of
Southern California and a BS from Colorado University. Before joining the
Company, Mr. Engle held various senior management positions at Allergan,
Inc., beginning in 1980. Allergan is an ophthalmic medical device, eye and
skin care pharmaceutical and contact lens care product company. He was most
recently Senior Vice President of U.S. Sales. He previously held the
positions of Senior Vice President-Latin America/Canada and Managing
Director-Canada, respectively. Soon after joining Allergan, Mr. Engle was
named the firm's Chief Financial Officer, a post he held for three years
prior to becoming Managing Director-Canada. Mr. Engle resigned as Director
and CEO of US Medical Products on August 21, 1996.
GARY A. MERMELSTEIN. Mr. Mermelstein joined the Company in 1991 as
Vice President of Sales and Marketing. Mr. Mermelstein holds a BA degree
from Indiana University. He has over 14 years of experience in medical sales
and marketing with several companies. From July, 1987, through July, 1991,
Mr. Mermelstein was employed by Intermedics Orthopedics, a subsidiary of
Sulzer-Medica, where he was a Product Manager for that company's knee implant
product until late 1989, a Group Product Manager for such product until late
1990, and Director of Marketing thereafter. Mr. Mermelstein was appointed
Acting Chief Executive Officer of the Company upon the resignation of R.
Michael Allen in March, 1995, and resumed his position as Vice President of
Sales and Marketing upon the appointment of J. Melville Engle as the
Company's Chief Executive Officer in July, 1995. Mr. Mermelstein resigned as
Vice President of Sales and Marketing on November 15, 1996.
JEFFREY A. SMITH. Mr. Smith has been Executive Vice President of Smith
Management since 1986, and has been an officer and director of several
privately held companies affiliated with Smith Management. He currently
serves as a director of Greater Boston Bank (Boston), First National Bank
(San Diego), and Western Water Corp. (La Jolla, California). Mr. Smith
resigned as Chairman of the Board and Director on August 21, 1996.
15
<PAGE>
EDWARD Z. SAFADY. Mr. Safady is a Vice President of Smith Management.
Prior to joining Smith Management, he was President, Chief Executive Officer
and director of Liberty National Bank ("Liberty"), Austin, Texas. Mr.
Safady formerly served as an independent consultant to a number of banks in
Texas, including Liberty, and as a National Bank Examiner in the Office of
the Comptroller of the Currency. He holds a BA in Business Administration
from Texas Tech University. Mr. Safady resigned from the Board of Directors
on August 21, 1996.
THOMAS G. FITZGERALD. Mr. FitzGerald is an Associate with Smith
Management. Prior to joining Smith Management, he was a senior consultant
with Price Waterhouse in their Reorganization and Litigation Services Group
in New York and a Staff Accountant with R.J. McCarthy & Company, Certified
Public Accountants, in New York. He holds a BS in Financial Management and
a MBA in Finance and Accounting from Fordham University. Mr. FitzGerald
resigned from the Board of Directors in August, 1996.
ROBERT BERNSTEIN, M.D. Dr. Bernstein was elected as director of the
Company in February, 1994. He is a retired Major General of the United
States Army. From 1980 through 1991, Dr. Bernstein was Commissioner of
Health for the State of Texas. Prior to 1980, he served in several positions
in the U.S. Army, including Commander of the Walter Reed Army Medical Center.
Dr. Bernstein graduated from Vanderbilt University and received his medical
degree from the University of Louisville. Mr. Bernstein resigned from the
Board of Directors on August 21, 1996.
STEVEN I. WHITLOCK. Mr. Whitlock joined the Company as Product
Development Manager in August, 1991. He holds a MBA from Embry-Riddle
Aeronautical University, Florida and a BS in Mechanical Engineering from
Texas A&M University. Prior to joining the Company, he was with Intermedics
Orthopedics where he was Product Development Engineer with the Knee Group.
Mr. Whitlock accepted the position of Vice President of Engineering and was
appointed as an Officer of the Company on August 9, 1995. Mr. Whitlock
resigned from the Company on November 15, 1996.
DANIEL W. THOMPSON. Mr. Thompson joined the Company in October, 1995,
as Vice President - Finance and Administration. Prior to joining the Company,
Mr. Thompson served as Senior Vice President, Chief Financial Officer and
Cashier of Liberty National Bank, Austin, Texas. Mr. Thompson has previously
served in senior management positions of three banks, and as the General
Manager of another start-up company. Mr. Thompson holds a B.F. in Finance
from the University of Oklahoma. Mr. Thompson resigned from the Company on
November 15, 1996.
Messrs. Mindermann, Otto and Bucher, who do not own any of the Company's
Common Stock, did not file timely Initial Statements of Beneficial Ownership
of Securities on Form 3.
ITEM 10. EXECUTIVE COMPENSATION
The following table sets forth the cash compensation, as well as certain
other compensation paid or accrued, by the Company to the Company's President
and Chief Executive Officer for the period from January 1, 1996 to December
31, 1996. No other executive officer had a total annual salary and bonus in
excess of $100,000 during the reported periods.
16
<PAGE>
Long Term
Annual Compensation Compensation
------------------------------------ ----------
Securities
Name and Underlying
Principal Position Year Salary Bonus Other Options
- ------------------ ---- ------ ----- ----- ----------
J. Melville Engle 1996 $175,000 -0- $7,708 649,903
President and Chief Executive Officer(1)
Frederick Mindermann 1996 $ 41,250
Chief Executive Officer(2)
(1) Mr. Engle resigned from the Company August 21, 1996, and received a one
year severance allowance.
(2) Mr. Mindermann served as the Company's Chief Executive Officer beginning
on August 21, 1996.
COMPENSATION OF DIRECTORS
The Company does not have any standard arrangements pursuant to which
directors are compensated.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT
The following table sets forth information, as of December 31, 1996, with
respect to the ownership of the Company's Common Stock by each person, or
entity, known by the Company to be the beneficial owner of more than 5% of the
Company's Common Stock.
As of December 31, 1996
----------------------------------
Shares of Percent of
Common Outstanding
Stock Common Stock
------------- --------------
Metrax Medical Inc. 12,998,060(1) 80%
Cool Springs Executive Center
1749 Mallory Lane, Suite 250
Brentwood, TN 37027
Heinz Bucher 12,998,060(1)(2) 80%
17
<PAGE>
Frederick Mindermann 12,998,060(1)(2) 80%
Thomas Otto 12,998,060(1)(2) 80%
Directors and executive officers 12,998,060(2) 80%
___________
(1) Does not include 17,270,948 Class A Warrants to acquire, in the aggregate,
17,270,948 shares of Common Stock.
(2) Messrs. Bucher, Mindermann, and Otto are executive officers of Metrax
Medical. Consequently, for each of these individuals, the table includes
the 12,998,060 shares of Common Stock held by Metrax Medical, although
each of these individuals disclaims individual ownership of such shares.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
On February 29, 1996, the Company announced the termination of an
agreement between the Company and Smith Management, whereby the Company would
have become a wholly-owned subsidiary of Smith Management, the Company's then
majority shareholder. Under the terms of the proposal, the shareholders of
the Company (other than Smith Management) would have received $0.35 per
share, all options and warrants would have been extinguished, and those
options and warrants with an exercise price below the merger price would have
received a cash payment equal to the excess of the merger price over the
exercise price.
Subsequent to December 31, 1995, the Company issued demand notes in
favor of Smith Management in amounts of $293,022 and $5,000,000. The note in
the amount of $293,022 was utilized to capitalize interest then due and
owning to Smith Management. A portion of the proceeds of the $5,000,000 note
was used to discharge the principal balances of other promissory notes to
Smith Management then outstanding. In August 1996, the remaining debt
balance of $4,980,731 was contributed to the Company's capital.
Effective February 29, 1996, Smith Management transferred its holdings
in the Company, including promissory notes then outstanding in favor of Smith
Management, to Durian Securities, Inc. ("Durian Securities"), a related,
private investment company, managed and administered by Smith Management.
Subsequent to the transfer, Durian Securities increased its equity position
in the Company from 53% to 80% through the conversion of $1,849,449 of
convertible debt into 9,307,994 shares of Common Stock and 10,492,046 Class A
Warrants. At March 22, 1996, after allowance for the conversion by Durian
Securities of convertible debt, the face amount of the promissory notes
issued by the Company in favor of Durian Securities was $5,293,021 of which
the principal amount of $4,289,021 was outstanding. The Company also
obtained a commitment from Durian Securities for additional borrowings of up
to $500,000, if needed, to fund working capital requirements.
On August 19, 1996, Metrax Medical acquired from Durian Securities
12,998,060 shares of the Company's Common Stock, 17,270,948 Class A Warrants
to acquire, in the aggregate,
18
<PAGE>
17,270,948 shares of the Common Stock, and a note issued by the Company in
favor of Durian Securities, dated as of August 19, 1996 in the principal
amount of $1,100,000. The note bears interest at 10% and is secured. One
million dollars of this note was paid in January 1997. Metrax Medical used a
majority of these proceeds to satisfy its obligations to Durian, thereby
removing the encumbrances on the Company's assets which were collaterizing
Metrax Medical's note payable to Durian, and loaned $165,000 to the Company
to reduce accounts payable.
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
Exhibit
Number Description of Exhibit
------- ----------------------
3(i) Articles of Incorporation (incorporated by reference to
Exhibit 1 to the Company's Annual Report on Form 10-KSB for
the year ended December 31, 1995)
3(ii) By-Laws of the Company (incorporated by reference to
Exhibit 2 to the Company's Annual Report on Form 10-KSB for
the year ended December 31, 1995)
27 Financial Data Schedule
(b) Reports on Form 8-K
1. Report on Form 8-K filed February 22, 1996.
19
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be filed on its behalf by the
undersigned thereunto duly authorized.
U.S. Medical Products, Inc.
Registrant
/s/ CHERYL SEALE
-------------------------------------
Cheryl Seale
Director - Finance and Administration
(Principal Financial Officer)
August 27, 1997
Pursuant to the requirements of the Securities Exchange Act of 1934, this
Report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
/s/ FREDERICK MINDERMANN
- ---------------------------- Chief Executive Officer; August 27, 1997
Frederick Mindermann Director
/s/ THOMAS OTTO
- ---------------------------- Director; President August 27, 1997
Thomas Otto
/s/ HEINZ BUCHER
- ---------------------------- Director August 27, 1997
Heinz Bucher
20
<PAGE>
INDEX TO FINANCIAL STATEMENTS
The following documents are filed as a part of this report in response to
item 7.
Page
----
Report of Independent Auditors F-1
Balance Sheet - December 31, 1996 F-2
Statement of Operations - years ended December 31, 1996 F-3
and December 31, 1995
Statement of Stockholder's Equity (Deficit) - years ended
December 31, 1996 and December 31, 1995 F-4
Statements of Cash Flows - years ended December 31, 1996
and December 31, 1995 F-5
Notes to Financial Statements F-7
21
<PAGE>
Report of Independent Auditors
Board of Directors
U.S. Medical Products, Inc.
We have audited the accompanying balance sheet of U.S. Medical Products, Inc.
as of December 31, 1996 and the related statements of operations, changes in
stockholders' equity (deficit) and cash flows for each of the two years in
the period ended December 31, 1996. These financial statements are the
responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements.
An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of U.S. Medical Products, Inc.
at December 31, 1996, and the results of its operations and its cash flows
for each of the two years in the period ended December 31, 1996 in conformity
with generally accepted accounting principles.
The accompanying financial statements have been prepared assuming that U.S.
Medical Products, Inc. will continue as a going concern. As more fully
described in Note 1, the Company has incurred recurring operating losses and
has a working capital deficiency. These conditions raise substantial doubt
about the Company's ability to continue as a going concern. (Management's
plans in regard to these matters are also described in Note 1.) The financial
statements do not include any adjustments to reflect the possible future
effects on the recoverability and classification of assets or the amounts and
classification of liabilities that may result from the outcome of this
uncertainty.
ERNST & YOUNG LLP
March 27, 1997 except for paragraph two
of Note 13, to which the date is April 17, 1997.
Austin, Texas
F-1
<PAGE>
U.S. Medical Products, Inc.
Balance Sheet
December 31, 1996
ASSETS
Current assets:
Cash and cash equivalents $ 25,102
Accounts receivable, net of allowance for doubtful accounts
of $28,760 681,028
Inventories, net 3,363,642
Prepaid expenses 144,233
Deferred tax asset 37,702
------------
Total current assets 4,251,707
Furniture and equipment, net--including $166,756 in
equipment under capital lease 803,240
Other assets, net 141,014
------------
Total assets $ 5,195,961
============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 2,555,769
Accrued expenses 294,616
Current portion of capital lease obligations 44,273
Current portion of notes payable 1,146,529
------------
Total current liabilities 4,041,187
Long-term portion of capital lease obligations 72,059
Deferred tax liability 469,966
Stockholders' equity:
Common stock, no par (40,000,000 shares authorized;
16,247,575 shares issued and outstanding) 15,838,008
Accumulated deficit (15,225,259)
------------
Total stockholders' equity 612,749
------------
Total liabilities and stockholders' equity $ 5,195,961
============
SEE ACCOMPANYING NOTES.
F-2
<PAGE>
U.S. Medical Products, Inc.
Statements of Operations
YEAR ENDED DECEMBER 31,
1996 1995
----------- -----------
Revenues $ 4,149,660 $ 2,041,089
Expenses:
Cost of goods sold 1,719,918 1,913,758
Sales and marketing 1,846,527 959,945
Research and development 880,796 692,798
General and administrative 1,422,632 1,624,289
Interest expense, net 406,300 207,578
Writedown of assets to net realizable value 3,325,000 -
----------- ----------
Total expenses (9,601,173) (5,398,368)
----------- ----------
Net loss $(5,451,513) $(3,357,279)
=========== ===========
Net loss per common share $ (.37) $ (.61)
=========== ==========
Weighted average shares outstanding 14,721,674 5,491,171
=========== ==========
SEE ACCOMPANYING NOTES.
F-3
<PAGE>
U.S. Medical Products, Inc.
Statements of Changes in Stockholders' Equity (Deficit)
<TABLE>
<CAPTION>
COMMON STOCK ACCUMULATED
SHARES AMOUNT DEFICIT TOTAL
---------- ----------- ------------ ---------
<S> <C> <C> <C> <C>
Balance at December 31, 1994 3,249,515 $ 7,858,277 $ (5,984,203) $1,874,074
Issuance of common stock and 5,304,652
Class A Warrants to majority shareholder
for conversion of note payable 2,432,534 899,551 - 899,551
Sale of common stock and 1,474,250 Class A
Warrants to majority shareholder 1,257,532 250,000 - 250,000
Net loss - - (3,357,279) (3,357,279)
---------- ---------- ------------ ---------
Balance at December 31, 1995 6,939,581 9,007,828 (9,341,482) (333,654)
Issuance of common stock and 10,492,046 Class A
Warrants to majority shareholder for
conversion of note payable 9,307,994 1,849,449 - 1,849,449
Contribution of debt to capital - 4,980,731 - 4,980,731
Distribution to former majority shareholder - - (432,264) (432,264)
Net loss - - (5,451,513) (5,451,513)
---------- ----------- ------------ ---------
Balance at December 31, 1996 16,247,575 $15,838,008 $(15,225,259) $ 612,749
========== =========== ============ ==========
</TABLE>
SEE ACCOMPANYING NOTES.
F-4
<PAGE>
U.S. Medical Products, Inc.
Statements of Cash Flows
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
1996 1995
----------- ------------
<S> <C> <C>
OPERATING ACTIVITIES
Net loss $(5,451,513) $(3,357,279)
Adjustments to reconcile net loss to net cash used
in operating activities:
Writedown of assets to net realizable value 3,325,000 -
Depreciation and amortization 555,867 484,282
Loss on sale of furniture and equipment 2,480 10,415
Changes in operating assets and liabilities:
Accounts receivable, net (347,673) (136,506)
Inventories (2,394,941) (1,722,619)
Prepaid expenses (2,375) (7,468)
Other assets (135,288) (103,606)
Accounts payable and accrued expenses 2,486,054 202,735
---------- ---------
Net cash used in operating activities (1,962,389) (4,630,046)
INVESTING ACTIVITIES
Purchase of furniture and equipment (965,579) (847,981)
---------- ---------
Net cash used in investing activities (965,579) (847,981)
</TABLE>
F-5
<PAGE>
U.S. Medical Products, Inc.
Statements of Cash Flows (continued)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
1996 1995
----------- -----------
<S> <C> <C>
FINANCING ACTIVITIES
Proceeds from the issuance of notes payable $ 2,902,108 $ 5,536,013
Payments on notes payable - (243,058)
Payments on capital lease obligations (38,410) (12,014)
Proceeds from the issuance of common stock, net - 250,000
----------- -----------
Net cash provided by financing activities 2,863,698 5,530,941
Net change in cash and cash equivalents (64,270) 52,914
Cash and cash equivalents at beginning of year 89,372 36,458
----------- -----------
Cash and cash equivalents at end of year $ 25,102 $ 89,372
=========== ===========
NONCASH TRANSACTIONS
Distribution to former majority shareholder $ 432,264 $ -
Stock issued upon conversion of note by majority
shareholder $ 1,849,449 $ 899,551
Contribution of debt to capital $ 4,980,731 $ -
Interest capitalized to principal $ 386,319 $ 138,410
Assets acquired from issuance of capital lease
obligations $ - $ 166,756
</TABLE>
SEE ACCOMPANYING NOTES.
F-6
<PAGE>
U.S. Medical Products, Inc.
Notes to Financial Statements
December 31, 1996
1. ORGANIZATION AND BASIS OF ACCOUNTING
U.S. Medical Products, Inc. (the "Company") was incorporated in Texas on
March 25, 1991. The Company was formed to develop, market and distribute hip
and knee prostheses, together with corresponding surgical instruments
utilized to implant such devices. The Company markets these products in the
United States, Italy, Germany, Switzerland, Austria and Turkey.
At December 31, 1995, Smith Management Co., Inc. and related entities
("Smith") controlled, on a fully diluted basis, 80% of the Company through
ownership of Class A warrants, a convertible installment note and common
stock. In February 1996, Smith transferred its holdings in the Company to
Durian Securities, Inc. ("Durian"), a private investment company managed and
administered by Smith. On August 19, 1996, Durian sold its holdings in the
Company, and its note receivable from the Company with a face value of
$1,100,000, to Metrax Medical, Inc. (MMI).
For the years ended December 31, 1996 and 1995, the Company reported net
losses of $5,451,513 and $3,357,279, respectively. The Company has signed a
letter of intent to sell substantially all of its assets at approximately 56
percent of historical cost. While there can be no assurance that this
transaction will be consummated, it indicates an impairment in value of the
Company's assets. Accordingly, the Company has recorded a writedown of
$3,325,000 ($2,615,000 to inventory, $625,000 to fixed assets, and $85,000 to
other assets) in the year ended December 31, 1996, to reflect this impairment.
Once the asset sale is completed, the Company contemplates a downstream
merger of the Company with MMI, resulting in Metrax GmbH, an entity related
to MMI through common ownership, becoming a wholly-owned subsidiary of the
Company. As a result of these transactions, the operations of the Company are
expected to be significantly different in the future.
F-7
<PAGE>
U.S. Medical Products, Inc.
Notes to Financial Statements (continued)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
CASH EQUIVALENTS
The Company considers investments purchased within three months of maturity
or with an original maturity of three months or less to be cash equivalents.
INVENTORY
Inventory is stated at the lower of cost or market and is costed using the
average cost method. Inventory consists of finished goods, work-in-process,
raw materials and packaging supplies.
FURNITURE AND EQUIPMENT
Furniture and equipment are recorded at cost, less accumulated depreciation.
Depreciation expense is recorded using the straight-line method over the
useful lives of the assets (including assets recorded under capital leases),
generally three to five years. Leasehold improvements are amortized over the
shorter of the useful lives of the assets or the lease term.
INCOME TAXES
The Company accounts for income taxes under Financial Accounting Standards
No. 109 (FAS 109), "Accounting for Income Taxes," which requires recognition
of deferred tax assets and liabilities based on differences between financial
reporting bases and tax bases of assets and liabilities and are measured
using enacted tax rates and laws that are expected to be in effect when the
differences are expected to reverse.
REVENUE RECOGNITION
Revenue is generally recognized upon product shipment. Revenues and cost
relating to sales with extended, nonestimable return privileges are deferred
until the return privilege expires or the amount of returns is estimable,
whichever occurs first.
F-8
<PAGE>
U.S. Medical Products, Inc.
Notes to Financial Statements (continued)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
NET LOSS PER COMMON SHARE
Net loss per common share is based on the weighted average of common shares
outstanding during the period. The effect of common stock equivalents is
antidilutive and, accordingly, common stock equivalents are not included in
the computation of net loss per share. If the debt to equity conversions
occurring in February 1996 and in May 1995 had occurred at the beginning of
1995, the 1996 and 1995 net loss per common share would have been $(.34) and
$(.21), respectively.
CONCENTRATION OF CREDIT RISK
Accounts receivable potentially expose the Company to concentrations of
credit risk, as defined by Statement of Financial Accounting Standard No.
105, "Disclosure of Information about Financial Instruments with
Off-Balance-Sheet Risk and Financial Instruments with Concentrations of
Credit Risk."
The Company provides credit, in the normal course of business, to customers
concentrated in the orthopedic implant industry. The Company performs ongoing
credit evaluations of its customers and maintains appropriate allowances for
potential credit losses.
STOCK-BASED COMPENSATION
In October 1995, the FASB issued Statement No. 123, "Accounting for
Stock-Based Compensation," which prescribes accounting and reporting
standards for all stock-based compensation plans, including employee stock
options. As allowed by Statement No. 123, the Company has elected to continue
to account for its employee stock-based compensation in accordance with
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees" (APB 25).
F-9
<PAGE>
U.S. Medical Products, Inc.
Notes to Financial Statements (continued)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
USE OF ESTIMATES
The preparation of the financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.
RECLASSIFICATIONS
For comparative purposes, certain reclassifications have been made to amounts
presented for 1995.
3. INVENTORY
Inventory at December 31, 1996 consists of the following:
Raw materials $ 78,404
Work-in-process 859,017
Finished goods 2,426,221
----------
$3,363,642
==========
4. FURNITURE AND EQUIPMENT
Furniture and equipment consist of the following at December 31, 1996:
Instrument sets $1,019,489
Machinery and equipment 454,427
Leasehold improvements 109,518
Furniture and fixtures 53,019
----------
1,636,453
Accumulated depreciation (833,213)
----------
$ 803,240
==========
F-10
<PAGE>
U.S. Medical Products, Inc.
Notes to Financial Statements (continued)
5. NOTES PAYABLE
At December 31, 1996, the Company has a $1,100,000 note payable to MMI, its
majority owner. The Note bears interest at 10% and is unsecured. One million
dollars of this note was paid in January 1997 (see Note 13). The remaining debt
in the amount of $46,529 relates to installment notes for insurance premiums.
6. INCOME TAXES
The Company had cumulative net operating loss carryforwards of approximately
$203,000 at December 31, 1996 for federal tax reporting purposes, which expire
in varying amounts beginning in 2011.
Due to changes in the Company's ownership during 1996, the cumulative net
operating loss and tax credit carryforwards arising prior to the ownership
change have been eliminated. In addition, a distribution of $432,264 to the
majority shareholder was recorded for the benefit that shareholder received for
the use of the approximately $1.2 million current tax loss incurred through the
date of the sale of 80% of the Company to MMI (see Note 1). A tax election
made jointly by the majority shareholder and MMI allowed the majority
shareholder to utilize an approximate $5.1 million tax loss on the deemed
sale of the assets. As a result, the tax basis of the Company's assets have been
significantly reduced. Significant components of deferred tax assets and
liabilities at December 31, 1996 are as follows:
Deferred tax liabilities:
Book/tax differences in asset bases $545,096
Deferred tax assets
Research and development expenses
capitalized for tax -
Net operating loss carryforwards 75,130
Reserves and allowances 37,702
Other -
--------
112,832
--------
Total net deferred tax liability $432,264
========
F-11
<PAGE>
U.S. Medical Products, Inc.
Notes to Financial Statements (continued)
6. INCOME TAXES (CONTINUED)
Significant components of the provision for income taxes attributable to
continuing operations are as follows:
1996 1995
----------- -------
Current $ 432,264 $ -
Deferred (432,264) -
----------- -----
Total benefit $ - $ -
=========== =====
The differences between the effective tax rate and the U.S. federal statutory
rate of 34% are reconciled as follows:
1996 1995
------ ------
Tax benefit at the federal statutory rate (34)% (34)%
Increase in rate resulting from:
Increase in valuation allowance 34 33
Other - 1
------ ----
Total income tax benefit - % - %
====== ====
7. CAPITAL STOCK
In May 1995, the majority shareholder converted $899,551 of debt for
2,432,534 shares of common stock and 5,304,652 Class A Warrants. On June 16,
1995, the majority shareholder purchased 1,257,532 shares of common stock and
1,474,250 Class A Warrants for $250,000.
F-12
<PAGE>
U.S. Medical Products, Inc.
Notes to Financial Statements (continued)
7. CAPITAL STOCK (CONTINUED)
At December 31, 1995, approximately 10,184,812 Class A Warrants were
outstanding and 141,448 underwriter warrants were outstanding. Each Class A
Warrant entitles the holder to purchase one share of common stock at the
price of $3.60 per share, exercisable until May 10, 1999. The Company may
repurchase the Class A Warrants at a price of $0.05 per Class A Warrant at
any time after the price of the common stock has exceeded $5.00 per share for
10 consecutive business days.
In February 1996, the Company's previous majority shareholder converted
(under pre-existing conversion terms) its convertible debt in the amount of
$1,849,449 into 9,307,994 shares of common stock and 10,492,046 Class A
warrants.
In August 1996, the Company's previous majority shareholder contributed
$4,980,731 of debt payable from the Company to capital.
8. LEASES
The Company is obligated under capital and operating lease agreements
covering certain facilities and office equipment. Rental expense was
approximately $129,000 and $162,000 for the years ended December 31, 1996 and
December 31, 1995, respectively. Future minimum payments by year and in the
aggregate for all noncancelable capital and operating leases with initial
terms of one year or more consist of the following at December 31, 1996:
Capital Operating
Leases Leases
--------- --------
1997 $ 59,435 $106,380
1998 50,975 62,055
1999 24,727 -
2000 8,424 -
--------- --------
Total minimum lease payments 143,561 $168,435
========
Less: amount representing interest (27,229)
---------
Present value of net minimum
lease payments 116,332
Less: current maturities (44,273)
---------
$ 72,059
=========
F-13
<PAGE>
U.S. Medical Products, Inc.
Notes to Financial Statements (continued)
9. RELATED PARTY TRANSACTIONS
The financial statements of the Company contain the following significant
transactions and balances attributable to transactions with the current and
former majority shareholder, MMI and Smith, respectively, and a minority
shareholder.
1996 1995
---------- ----------
Note payable to current majority shareholder
(NOTE 5) $1,100,000 $ -
Interest expense related to note payable to
current majority shareholder 40,639 -
Interest payable to current majority shareholder 40,639 -
Debt payable to former majority shareholder - 4,637,859
Revenues from a minority shareholder 543,745 606,404
Interest expense related to notes with former
majority shareholder 340,292 184,000
Interest payable to former majority shareholde - 46,000
10. STOCK OPTIONS
The Company's 1993 and 1996 Stock Option Plans provide for the granting of
options to officers, other employees, directors and consultants to purchase,
after a certain period of time, shares of the Company's common stock. The
purchase price of stock issued under each option is determined by the Board
of Directors, but the purchase price for an Incentive Stock Option is no less
than the fair market value of such stock on the date the option is granted.
The purchase price for an employee who owns more than 10% of the total
combined voting power of all classes of outstanding stock of the Company is
no less than 110% of the fair market value of such stock on the date of
grant. Options for up to 577,308 shares may be granted under the 1993 Plan.
Options for up to 1,543,521 shares may be granted under the 1996 Plan.
In 1994, the Company granted options under the 1993 Plan to purchase shares
of the Company's common stock to certain Directors and Advisors of the
Company which vest through 1996.
F-14
<PAGE>
U.S. Medical Products, Inc.
Notes to Financial Statements (continued)
10. STOCK OPTIONS (CONTINUED)
Pro forma information regarding net income and earnings per share is required
for 1996 and 1995 by Statement No. 123, and has been determined as if the
Company had accounted for its employee stock options under the fair value
method of that Statement. The fair value for these options was estimated at
the date of grant using the Black-Scholes method with the following
weighted-average assumptions:
Risk-free interest rate 6.25%
Dividend yield 0%
Weighted-average expected life of the options 5 years
Volatility 1.33
Option valuation models require the input of highly subjective assumptions.
Because changes in the subjective input assumptions can materially affect the
fair value estimate, the existing models do not necessarily provide a
reliable single measure of the fair value of the Company's employee stock
options.
Based on the minimum value pricing model and assumptions used, the pro forma
net loss and pro forma loss per share would not differ materially from net
loss and loss per share as reported.
F-15
<PAGE>
U.S. Medical Products, Inc.
Notes to Financial Statements (continued)
10. STOCK OPTIONS (CONTINUED)
A summary of changes in common stock options during 1996 and 1995 is as
follows:
<TABLE>
<CAPTION>
WEIGHTED-
AVERAGE
RANGE OF EXERCISE
SHARES PRICES PRICE
-------- ------------- -------
<S> <C> <C> <C>
Options outstanding, December 31, 1994 911,539 $.625 - $9.51 $2.36
Granted - - -
Exercised - - -
Canceled (639,991) $.625 - $5.00 $1.98
Expired (1,000) $5.00 $5.00
--------- ------------- -----
Options outstanding, December 31, 1995 270,548 $1.50 - $9.51 $3.25
Granted 1,543,521 $.23 $ .23
Exercised - - -
Canceled - - -
Expired (1,462,283) $.23 $ .23
--------- ------------- -----
Options outstanding, December 31, 1996 351,786 $.23 - $9.51 $2.55
========== ============= =====
</TABLE>
At December 31, 1996 and 1995, respectively, 351,786 and 270,548 shares of
common stock were reserved for future issuance and 314,590 and 261,149
options were exercisable under the stock option plans.
F-16
<PAGE>
U.S. Medical Products, Inc.
Notes to Financial Statements (continued)
10. STOCK OPTIONS (CONTINUED)
A summary of option information by exercise price as of December 31, 1996
follows:
WEIGHTED-
AVERAGE
NUMBER OF REMAINING NUMBER OF
EXERCISE OPTIONS CONTRACTUAL OPTION
PRICE OUTSTANDING LIFE (YEARS) EXERCISABLE
----- ----------- ------------ -----------
$0.23 81,238 8.5 48,741
1.50 10,000 5.6 10,000
2.63 45,000 7.6 45,000
3.25 196,348 7.0 191,649
4.75 15,500 5.9 15,500
9.51 3,700 6.1 3,700
------------- ------- --- -------
$0.23 - $9.51 351,786 7.3 314,590
============= ======= === =======
At December 31, 1996, the weighted average exercise price of outstanding
options is $2.55 and the weighted-average exercise price of exercisable
options is $2.78.
In 1996, 1,543,521 options were granted to officers and consultants under the
1996 Plan. Upon the resignation of the officers in 1996, options for
1,462,283 shares expired. The weighted-average fair value of these options is
approximately $.49 per option.
Each remaining option may be exercised for one share of common stock.
11. SUPPLEMENTAL CASH FLOW INFORMATION
Interest paid during 1996 and 1995 was approximately $26,000 and $23,000,
respectively. No income taxes were due or paid during 1996 and 1995.
F-17
<PAGE>
U.S. Medical Products, Inc.
Notes to Financial Statements (continued)
12. LEGAL MATTERS
The Company is involved in certain claims arising in the normal course of
business. The Company believes that the ultimate resolution of these matters
will not have a material adverse effect on its financial position or results
of operations.
13. SUBSEQUENT EVENTS
Effective February 1, 1997, U.S. Medical Products, Inc. entered into a
"worldwide exclusive distribution agreement" with an unrelated third-party
("distributor"). In conjunction with this arrangement, the Company sold the
distributor inventory with a book value of $1.78 million dollars in exchange
for $1.0 million in cash. The distributor also agreed to pay an additional
$.3 million dollars for inventory with a historical cost of $.533 million.
All additional purchases pursuant to this arrangement will be made at 60% of
the Company's list price.
On April 7, 1997, the Company signed an amendment to the "world wide
exclusive distribution agreement," whereby up to an additional $700,000 of
inventory may be purchased at a price of 30% above cost (prior to valuation
reserves) for new inventory or 56.25% of historical cost (prior to valuation
reserves) for existing inventory. Additional future purchases made under this
agreement, if any, will be made at a price to be agreed upon by both parties.
The Company is currently in negotiations to sell its assets to this
distributor. See Note 1.
In January 1997, the Company paid $1,000,000 to MMI as a payment on its
$1,100,000 debt to MMI (see Note 5). MMI used a majority of these proceeds to
satisfy its obligations to Durian, thereby removing the encumbrances on the
Company's assets which were collateralizing the MMI's note payable to Durian,
and loaned $165,000 to the Company to reduce accounts payable. (see Note 1)
F-18
