<PAGE>
U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1997
For the transaction period from __________ to________
Commission file number 0-28604
----------
ELECTROSCOPE, INC.
-----------------------------------------------------------------
(Exact name of small business issuer as specified in its charter)
COLORADO 84-1162056
- -------------------------------- ------------------------------------
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
4828 STERLING DRIVE, BOULDER, COLORADO 80301
---------------------------------------------
(Address of principal executive offices)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (303) 444-2600
-------------------------------------------------------------------
(Issuer's telephone number)
CHECK WHETHER THE ISSUER (1) FILED ALL REPORTS REQUIRED TO BE FILED BY SECTION
13 OF 15(d) OF THE EXCHANGE ACT DURING THE PAST 12 MONTHS (OR FOR SUCH SHORTER
PERIOD THAT THE REGISTRANT WAS REQUIRED TO FILE SUCH REPORTS), AND (2) HAS BEEN
SUBJECT TO SUCH FILING REQUIREMENTS FOR THE PAST 90 DAYS.
YES X NO
----- -----
STATE THE NUMBER OF SHARES OUTSTANDING OF EACH OF THE ISSUER'S CLASSES OF
COMMON EQUITY, AS OF THE LATEST PRACTICABLE DATE:
COMMON STOCK, NO PAR VALUE SHARES 5,383,507
-------------------------- ---------------------------------
Class (outstanding at October 24, 1997)
TRANSITIONAL SMALL BUSINESS DISCLOSURE FORMAT
YES NO X
----- -----
1
<PAGE>
ELECTROSCOPE, INC.
FORM 10-QSB
FOR THE QUARTER ENDED SEPTEMBER 30, 1997
INDEX
Page
Number
------
PART I. FINANCIAL INFORMATION
ITEM 1 - Condensed Interim Financial Statements 3
- Condensed Balance Sheets as of September 30,
1997 and March 31, 1997 3
- Condensed Statements of Operations for
the Three Months Ended September 30, 1997 and 1996 4
- Condensed Statements of Operations for
the Six Months Ended September 30, 1997 and 1996 5
- Condensed Statements of Cash Flows for
the Six Months Ended September 30, 1997 and 1996 6
- Notes to Condensed Interim Financial
Statements 7
ITEM 2 - Management's Discussion and Analysis
of Financial Condition and Results of Operations 11
PART II. OTHER INFORMATION
ITEM 1 Legal Proceedings 16
ITEM 2 - Changes in Securities 16
ITEM 4 - Submission of Matters to a Vote of Security Holders 17
ITEM 6 - Exhibits and Reports on Form 8-K 17
SIGNATURES 18
EXHIBIT INDEX 19
2
<PAGE>
PART I. FINANCIAL INFORMATION
ITEM 1 - CONDENSED INTERIM FINANCIAL STATEMENTS
ELECTROSCOPE, INC.
CONDENSED BALANCE SHEETS
<TABLE>
September 30, March 31,
1997 1997
------------- -----------
(Unaudited)
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 4,603,498 $ 527,015
Short-term investments 2,989,740 9,631,427
Accounts receivable, net of allowance for doubtful
accounts of $10,000 and $25,000, respectively 183,743 155,446
Inventory, net of reserve for obsolescence of $92,943
and $102,596, respectively 691,002 521,696
Prepaid expenses 68,012 110,777
----------- -----------
Total current assets 8,535,995 10,946,361
----------- -----------
EQUIPMENT, at cost:
Furniture, fixtures and equipment 647,952 503,871
Less - Accumulated depreciation (321,145) (258,983)
----------- -----------
Equipment, net 326,807 244,888
----------- -----------
PATENTS, net of accumulated amortization
of $10,550 and $9,270 respectively 148,695 138,078
OTHER ASSETS 11,450 11,450
----------- -----------
Total assets $ 9,022,947 $11,340,777
----------- -----------
----------- -----------
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 246,463 $ 327,682
Accrued compensation 136,996 155,908
Other accrued liabilities 244,135 454,295
Customer deposits 15,737 20,223
Other current liabilities 6,639 6,639
----------- -----------
Total current liabilities 649,970 964,747
----------- -----------
LONG-TERM LIABILITIES:
Other long-term liabilities 14,273 17,593
----------- -----------
Total long-term liabilities 14,273 17,593
COMMITMENTS AND CONTINGENCIES (Notes 1 and 4)
SHAREHOLDERS' EQUITY:
Preferred stock, no par value, 10,000,000 shares
authorized, no shares outstanding - -
Common stock, no par value, 100,000,000 shares authorized,
5,383,507 and 5,389,986 shares outstanding, respectively 16,941,317 16,997,282
Warrants to purchase common stock 290,400 290,400
Accumulated deficit (8,873,013) (6,929,245)
----------- -----------
Total shareholders' equity 8,358,704 10,358,437
----------- -----------
Total liabilities and shareholders' equity $ 9,022,947 $11,340,777
----------- -----------
----------- -----------
</TABLE>
The accompanying notes are an integral part of these balance sheets.
3
<PAGE>
ELECTROSCOPE, INC.
CONDENSED STATEMENTS OF OPERATIONS
(Unaudited)
For the Three Months
Ended September 30,
------------------------
1997 1996
----------- ----------
REVENUE, net $ 329,179 $ 359,287
COST OF SALES 312,323 315,330
----------- ----------
Gross profit 16,856 43,957
----------- ----------
OPERATING EXPENSES:
Sales and marketing 497,567 237,550
General and administrative 340,674 187,937
Research and development 180,105 159,128
----------- ----------
Total operating expenses 1,018,346 584,615
----------- ----------
INCOME (LOSS) FROM OPERATIONS (1,001,490) (540,658)
OTHER INCOME:
Interest income 110,690 164,065
Other income (expense) (7,090) 4,630
----------- ----------
NET INCOME (LOSS) $ (897,890) $ (371,963)
----------- ----------
----------- ----------
NET INCOME (LOSS) PER SHARE (Note 3):
Net income (loss) per common share and
common equivalent share $ (0.17) $ (0.07)
----------- ----------
----------- ----------
Shares used in computing net income (loss) per
common share and common equivalent share 5,368,007 5,295,253
----------- ----------
----------- ----------
The accompanying notes are an integral part of these statements.
4
<PAGE>
ELECTROSCOPE, INC.
CONDENSED STATEMENTS OF OPERATIONS
(Unaudited)
For the Six Months
Ended September 30,
------------------------
1997 1996
----------- ----------
REVENUE, net $ 640,743 $ 772,929
COST OF SALES 587,285 624,846
----------- ----------
Gross profit 53,458 148,083
----------- ----------
OPERATING EXPENSES:
Sales and marketing 1,059,306 420,777
General and administrative 749,254 343,505
Research and development 389,779 285,830
----------- ----------
Total operating expenses 2,198,339 1,050,112
----------- ----------
INCOME (LOSS) FROM OPERATIONS (2,144,881) (902,029)
OTHER INCOME:
Interest income 223,639 172,860
Other income (expense) (22,524) 11,889
----------- ----------
NET INCOME (LOSS) $(1,943,766) $ (717,280)
----------- ----------
----------- ----------
NET INCOME (LOSS) PER SHARE (Note 3):
Net income (loss) per common share and common
equivalent share $ (0.36) $ (0.15)
----------- ----------
----------- ----------
Shares used in computing net income (loss) per
common share and common equivalent share 5,371,479 4,753,035
----------- ----------
----------- ----------
The accompanying notes are an integral part of these statements.
5
<PAGE>
ELECTROSCOPE, INC.
CONDENSED STATEMENTS OF CASH FLOWS
(Unaudited)
For the Six Months
Ended September 30,
---------------------------
1997 1996
------------ -------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $(1,943,766) $ (717,280)
Adjustments to reconcile net income (loss) to
net cash used in operating activities-
Depreciation and amortization 93,770 42,757
Amortization of discount (130,569) ---
Common stock issued in lieu of cash 100,750 ---
Inventory Reserves (9,653) ---
Changes in operating assets and liabilities-
Accounts receivable (28,297) (77,302)
Inventory (159,653) 97,885
Accrued Interest and other current assets 42,765 (225,963)
Other assets --- 24,959
Accounts payable (81,219) (32,008)
Accrued compensation and other accrued
liabilities (229,072) (65,242)
Customer deposits (4,486) (85,360)
Deferred revenue --- (12,909)
Other liabilities (3,320) (3,520)
------------ ------------
Net cash used in operating activities (2,352,750) (1,053,983)
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of equipment (174,411) (50,436)
Patent costs (11,897) (14,415)
Purchases of short-term investments (1,611,743) (10,469,748)
Sale of short-term investments 8,383,999 ---
------------ ------------
Net cash provided by (used in) investing
activities 6,585,948 (10,534,599)
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock --- 13,224,552
Repurchase of common stock (156,715) ---
Proceeds from issuance of warrants --- 50
Stock issuance costs --- (1,346,812)
------------ ------------
Net cash (used in) provided by financing
activities (156,715) 11,877,790
------------ ------------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 4,076,483 289,208
CASH AND CASH EQUIVALENTS, beginning of period 527,015 538,708
------------ ------------
CASH AND CASH EQUIVALENTS, end of period $ 4,603,498 $ 827,916
------------ ------------
------------ ------------
The accompanying notes are an integral part of these statements.
6
<PAGE>
ELECTROSCOPE, INC.
NOTES TO CONDENSED INTERIM FINANCIAL STATEMENTS
SEPTEMBER 30, 1997
(Unaudited)
(1) ORGANIZATION AND NATURE OF BUSINESS
Electroscope, Inc. (the "Company") was incorporated as a Colorado corporation
on February 1, 1991. The Company designs, develops, manufactures and markets
a patented monopolar electrosurgical shielding system and integrated surgical
instruments, which are designed to provide greater safety to patients who
undergo laparoscopic surgery. The products can be used with most
electrosurgical instruments available today in the USA. It has also
developed and is marketing its own line of integrated, shielded, five
millimeter diameter electrosurgical instruments which incorporate the
Company's proprietary technology. These products monitor for stray
electrical energy during laparoscopy and deactivate the electrosurgical unit
when this energy creates potentially dangerous conditions. At the end of the
three months ended September 30, 1997 the Company introduced a disposable
scissors product. The Company's sales to date have been made principally in
the United States and have been made primarily to one customer for the past
two fiscal years. During the six months ended September 30, 1997, sales to
this customer were not significant.
The Company has incurred losses since its inception and has an accumulated
deficit of $8,873,013 at September 30, 1997. During fiscal year 1997, which
ended March 31, 1997, the formerly exclusive distributor of the Company's
products did not purchase products from the Company in sufficient amounts to
maintain the distributor's exclusivity. As a result, the sales, marketing
and market development activities conducted by this distributor have now
become the responsibility of the Company. The Company's operations are
subject to certain risks and uncertainties, which include the following:
Commercial acceptance of the Company's products will have to occur in the
marketplace, in significant volumes, before the Company can attain profitable
operations; the possibility of continued substantial operating losses; the
need to develop a distribution channel for the Company's products; current
and potential competitors with greater financial, technical and marketing
resources; management's plans for growth and expansion; and the Company's
limited manufacturing experience for large-scale production. In addition, a
class action lawsuit regarding the Company's initial public offering was
filed against the Company and certain individuals associated with the Company
on June 4, 1997. The Company believes that the claims are without merit and
intends to vigorously defend itself against the claims filed (See Part II,
Item 1, Legal Proceedings).
As discussed above, in September 1995, the Company entered into an exclusive
Distribution Agreement for the Company's products with Valleylab Inc., a part
of Hospital Products Group of Pfizer, Inc. ("Valleylab"). The terms of this
agreement required Valleylab to purchase minimum amounts of the Company's
products in specified time frames, in order to maintain exclusivity.
Valleylab did not meet the minimum purchase requirements for calendar year
1996, and the agreement has now become non-exclusive for the remainder of its
term through 1998.
7
<PAGE>
During the second quarter of fiscal year 1997, sales to Valleylab accounted
for essentially all of the Company's revenue. Sales to Valleylab in the
second quarter of fiscal year 1998 were not significant.
(2) INITIAL PUBLIC OFFERING
In June 1996, the Company completed an initial public offering (IPO) of
1,200,000 shares of its common stock at a price per share of $10.50, of which
all shares were sold by the Company. After underwriting discounts,
commissions and other expenses, net proceeds to the Company from the offering
were approximately $11.4 million.
In connection with the IPO, the Company sold, for a nominal purchase price, a
five-year warrant to purchase up to 120,000 shares of common stock,
exercisable at 120% of the initial offering price, or $12.60 per share. In
accordance with Statement of Financial Accounting Standards No. 123 (SFAS No.
123), "Accounting for Stock-Based Compensation," the fair value of the
warrant sold is estimated using an option-pricing model. In accordance with
SFAS No. 123, the option-pricing model takes into account as of the date the
warrant is issued the exercise price, life of the warrant, current price of
the common stock, expected common stock volatility and the risk-free interest
rate for the expected term of the warrant. Based on this valuation
methodology, the Company has recorded the fair value of the warrant sold at
$290,400. The difference between the fair value of the warrant and the
nominal purchase price has been recorded as a deduction from the net proceeds
to the Company from the offering.
(3) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
USE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions.
Such estimates and assumptions affect the reported amounts of assets and
liabilities as well as disclosure of contingent assets and liabilities at the
date of the financial statements, and the reported amounts of revenue and
expense during the reporting period. Actual results could differ from those
estimates.
CASH AND EQUIVALENTS
For purposes of the statements of cash flows, the Company considers all cash
and highly liquid investments with an original maturity of three months or
less to be cash equivalents.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The Company's financial instruments consist of cash, short-term investments
and short-term trade receivables and payables. The carrying values of cash,
short-term investments and short-term receivables and payables approximate
their fair value.
SHORT-TERM INVESTMENTS
As required under Statement of Financial Accounts Standards No. 115,
"Accounting for Certain Investments in Debt and Equity Securities," (SFAS
115) management determines the appropriate classification of its investments
in debt securities at the time of purchase. At September 30, 1997, the
Company's short-term investments consist primarily of government and
corporate securities which the Company classifies as held-to-maturity.
8
<PAGE>
The amortized cost of debt securities classified as held-to-maturity is
adjusted for amortization of premiums and accretion of discounts to maturity.
Such amortization and accretion of discounts are included in interest income.
INVENTORY
Inventory consists primarily of component parts and raw materials, and is
valued at the lower of cost (first-in, first-out basis) or market. Inventory
consists of the following:
September 30, March 31,
1997 1997
------------- ---------
Raw materials $198,703 $266,299
Work in process 236,457 225,353
Finished goods 348,785 132,640
-------- --------
783,945 624,292
Less- Reserve for obsolescence (92,943) (102,596)
-------- --------
$691,002 $521,696
-------- --------
-------- --------
INCOME TAXES
The Company accounts for income taxes under the provisions of Statement of
Financial Accounting Standards No. 109, "Accounting for Income Taxes" ("SFAS
No. 109"). SFAS No. 109 requires recognition of deferred income tax assets
and liabilities for the expected future income tax consequences, based on
enacted tax laws, of temporary differences between the financial reporting
and tax bases of assets and liabilities. SFAS No. 109 requires recognition
of deferred tax assets for the expected future tax effects of all deductible
temporary differences, loss carryforwards and tax credit carryforwards.
Deferred tax assets have been completely offset by a valuation allowance
because the realization criteria set forth in SFAS 109 are not currently
satisfied, primarily due to the Company's history of operating losses.
NEW ACCOUNTING PRONOUNCEMENT
In February 1997, the Financial Accounting Standards Board, ("FASB") issued
Statement of Financial Accounting Standards No. 128, "Earnings Per Share".
This statement establishes standards for computing and presenting earnings
per share. The Company will adopt this standard for its third fiscal quarter
ending December 31, 1997, and does not expect that adoption will have a
material impact on reported earnings per share and required financial
statement disclosures.
LOSS PER COMMON SHARE AND COMMON EQUIVALENT SHARE
Loss per common share and common equivalent share for all fiscal years
presented is computed using the sum of the weighted average number of shares
of common stock and common stock equivalent shares from common stock options
and warrants. Pursuant to Securities and Exchange Commission Staff
Accounting Bulletin No. 83, common stock and common stock equivalent shares
issued by the Company during the period beginning twelve months prior to the
filing of the Company's initial public offering at prices significantly below
the public offering price have been included in the earnings per share
calculation as if they were outstanding for all periods prior to the initial
public offering (using the treasury stock method and the initial public
offering price of
9
<PAGE>
$10.50 per share for stock options and warrants) regardless of whether they
are antidilutive. Options and warrants for the Company's common stock issued
other than in this one-year period have been excluded as they are
antidilutive. For the first and second quarters of fiscal years 1997,
(subsequent to the effective date of the IPO) and 1998, the Company has
reported earnings per share in accordance with Accounting Principles Board
Opinion No. 15, "Earnings per Share".
(4) COMMITMENTS AND CONTINGENCIES
The Company is subject to regulation by the United States Food and Drug
Administration ("FDA"). The FDA provides regulations governing the
manufacture and sale of the Company's products and regularly inspects the
Company and other manufacturers to determine their compliance with these
regulations.
Under the terms of the Distribution Agreement, after termination, Valleylab
may sell for a period of six months, any inventory of products held by it at
the date of termination. In the event of termination, the Company has the
obligation to purchase from Valleylab products held in Valleylab's inventory,
if any, to the extent such products are salable and non-obsolete and have
been received by Valleylab within nine months of the latter of the date of
termination or the post-termination sales period. Valleylab has not notified
the Company of any intent to terminate the Agreement.
Because of seasonal and other factors including the continuing development of
the sales force and the changes in management discussed in Item 2, Historical
Perspective and Outlook, Results of Operations, the results of operations for
the quarter ended September 30, 1997, should not be taken as an indication of
the results of operations for all or any part of the balance of the year.
On June 4, 1997, as discussed more fully in Part II, Item 1, Legal
Proceedings, a class action lawsuit was filed naming the Company and certain
individuals associated with the Company as defendants. The Company believes
that the claims of such lawsuit are without merit, and intends to defend
itself vigorously against such claims.
(5) MANAGEMENT'S REPRESENTATIONS
The condensed interim financial statements included herein have been prepared
by the Company, without audit, pursuant to the rules and regulations of the
Securities and Exchange Commission. Certain information and footnote
disclosures normally included in financial statements prepared in accordance
with generally accepted accounting principles have been condensed or omitted
pursuant to such rules and regulations, although the Company believes that
the disclosures made are adequate to make the information presented not
misleading. The condensed interim financial statements and notes thereto
should be read in conjunction with the financial statements and the notes
thereto, included in the Company's Annual Report to the Securities Exchange
Commission, for the fiscal year ended March 31, 1997, filed on Form 10-KSB.
The accompanying condensed interim financial statements have been prepared,
in all material respects, in conformity with the standards of accounting
measurements set forth in Accounting Principles Board Opinion No. 28 and
reflect, in the opinion of management, all adjustments, which are of a normal
recurring nature, necessary to summarize fairly the financial position and
results of operations for such periods. The results of operations for such
interim periods are not necessarily indicative of the results to be expected
for the full year.
10
<PAGE>
ITEM 2 -- MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
GENERAL
The Company manufactures and markets a line of proprietary electrosurgical
products that are designed to provide greater safety to patients who undergo
minimally invasive electrosurgery (MIS). The Company believes that its
patented Electroshield Monitoring System offers surgeons significant
advantages compared to other electrosurgical systems in use because of its
ability to monitor dynamically for stray electrical energy out of the view of
the surgeon during MIS procedures. The Company has received three FDA Form
510(k) notifications for its products and obtained patent protection for its
products' basic shielding and monitoring features.
In September 1995, the Company entered into an exclusive worldwide
Distribution Agreement (the "Agreement") with Valleylab, part of the Hospital
Products Group of Pfizer, Inc., pursuant to which Valleylab was required to
make minimum purchases through calendar year 1998 in order to retain its
exclusive distribution rights. Valleylab did not meet its minimum purchase
requirements in calendar 1996 and the Agreement has become a non-exclusive
distribution arrangement for calendar year 1997. To replace the Valleylab
distribution resources, the Company has hired and trained a direct sales
force, and has begun to contract with a network of independent sales
representative organizations across the U.S. In addition, the Company has
engaged a specialized marketing communications firm to broaden the awareness
of the hazards inherent in monopolar electrosurgery.
The Company recognizes that market awareness and acceptance of the hazards
inherent in monopolar electrosurgery and acceptance of the Company's products
to address such hazards has been slower to occur than the Company had
believed would be the case. The Company has modified its marketing
strategies, including the engagement of the marketing communications firm
referred to above and the significant expansion of the Company's sales and
marketing functions, to address the issues of market acceptance of the
technology. The Company has also undertaken efforts to broaden the product
line offerings beyond the original EM-2 product and its accessories. The
Company is developing a line of disposable products, introduced the first of
such disposable products at the end of the second quarter of Fiscal Year 1998
and intends to explore additional product development and acquisition
opportunities from third parties.
The Company recognizes that its efforts to develop its own sales force,
including both direct sales representatives and independent representative
organizations, will require increased use of cash and additional management
resources beyond those which were necessary while Valleylab had an exclusive
right to distribute the Company's products. The Company believes that it has
sufficient cash resources on hand to successfully complete the development of
the sales force, and that it has attracted and can continue to attract the
additional human resources necessary to manage the development of the sales
force, the increased marketing efforts, and the general growth of the
business. There can be no assurance however, that the Company's efforts in
this area will result in increased revenues or the achievement of
profitability.
As more fully discussed in Part II, Item 1, Legal Proceedings, a class action
lawsuit has been filed in the United States District Court in Minnesota.
While the Company believes that this suit is without merit, defense against
such suit will take management time, legal resources and could result in
significant expenditures. Should the lawsuit result in a significant payment
to the plaintiff(s) or significant legal fees beyond the coverage of such
fees provided by insurance carried by the Company, such payments could have a
material adverse impact on the Company's liquidity.
11
<PAGE>
Statements herein that are not historical facts, including statements about
the Company's strategies and expectations about new and existing products,
technologies and opportunities, market and industry segment growth, demand
and acceptance of new and existing products, and return on investments in
products and markets are forward looking statements that involve substantial
risks.
HISTORICAL PERSPECTIVE AND OUTLOOK
The Company was organized in February 1991. During its first two years, the
Company developed the EM-2 Electronic Monitor and adaptive sheaths to work
with traditional electrosurgical instruments. During this period, the
Company applied for patents with the United States Patent Office and
conducted clinical trials. The Company also continued work on its patent
applications and formulated development plans for shielded hinged tip and
fixed tip electrosurgical instruments. As this development program proceeded
it became apparent that the merging of electrical and mechanical engineering
skills in the instrument development process for the Company's patented,
integrated electrosurgical instruments was more difficult than was expected
at first. As a result, the development of the instruments with the
Electroshield-Registered Trademark- AEM-Registered Trademark- technology was
not completed until 1995. The Company introduced integrated instruments for
the Electroshield-Registered Trademark- Monitoring System (EMS) in November
1995.
The installed base of the Company's EM-2 Electronic Monitor has continued to
increase since the introduction of the product in 1994. The Company believes
such installed base has the potential for increasing as the sales
representatives of the Company and the network of independent sales
representatives become familiar with the EMS and sell the system to their
customers. The approximate number of EM-2 Electronic Monitors sold were 567
and 257 in the fiscal years ended March 31, 1996 and 1997, respectively. The
Company expects that the sales of electrosurgical instruments and accessories
should increase as additional EM-2 Electronic Monitors are installed. The
Company continues to devote resources to increasing market awareness of the
inherent hazards of monopolar electrosurgery. There can be no assurance,
however, as to the rate of market acceptance of the EMS. Given the system's
short history of usage, the Company cannot predict the rate of its
electrosurgical instrument sales. As a result of the lack of immediate
market acceptance of the EM-2+ EMS, the Company has broadened its R&D efforts
to possibly reduce its dependence on products involving AEM technology.
The Company believed that the most cost effective way to educate the market
to the hazards of monopolar electrosurgery and to generate significant
revenues for the Company was to utilize the Valleylab sales force,
supplemented by support from the Company. As noted above, this Agreement did
not meet its objectives and the Company has taken steps to develop its own
direct sales force, made up of Company employees and independent sales
representative organizations, which together provide market presence in most
of the major market areas in the United States. In addition, the Company has
hired a Chief Executive Officer with substantial experience in the medical
device industry. The Company believes that such measures, along with
increased marketing efforts and the introduction of new products, will
provide the basis for increased revenues and will ultimately lead to
profitable operations. The Company believes that selling the Company's
products directly will generate additional gross profits as the Company will
be retaining the margins formerly recorded by the Company's distributor.
Management does not expect that profitable revenue levels will be reached in
fiscal year 1998, and there can be no assurance that these measures, or any
others that the Company may adopt, will result in either increased revenues
or profitable operations.
The Company has incurred losses from operations since inception and has an
accumulated deficit of $8,873,013 as of September 30, 1997. Due to the need
to continue the development and training of a sales and distribution network
the Company believes that it may continue to operate at a net loss for
several quarters. The Company believes its results of operations may
fluctuate on a
12
<PAGE>
quarterly basis as a result of the size and frequency of sales through the
independent sales network and the development of its internal sales force,
resulting in increased sales expenses. Such fluctuations may be significant,
and may result in the Company operating at a loss in any one period even
after a period of profitability.
RESULTS OF OPERATIONS
FOR THE THREE MONTHS ENDED SEPTEMBER 30, 1997 COMPARED TO THE THREE MONTHS
ENDED SEPTEMBER 30, 1996.
NET REVENUES. Revenues for the three months ended September 30, 1997, were
$329,179, compared to $359,287 for the three months ended September 30, 1996,
a decrease of 8%. The decrease is attributable to the Company having to
develop its own sales and marketing efforts to replace those provided by
Valleylab in the second quarter of fiscal year 1997. The Company anticipates
revenue growth for the fiscal year ended March 31, 1998 ("Fiscal Year 1998")
compared to fiscal year 1997 as the Company's efforts to develop an
independent sales force and marketing program mature and result in increased
market coverage and increased sales. The company also expects to introduce
new products during fiscal year 1998 which are expected to contribute to
increased revenues. There can be no assurance, however, that the Company's
sales and marketing efforts will lead to increased revenues, or that the new
products will find adequate market acceptance to generate significant
revenues.
GROSS PROFIT. Gross profit for the three months ended September 30, 1997 was
$16,856, a decrease of $27,101 from the three months ended September 30, 1996
gross profit of $43,957. Gross profit as a percentage of revenue (Gross
Margin) decreased from 12.2% for the three months ended September 30, 1996 to
5.1% in the three months ended September 30, 1997. Gross profit and gross
margin can be expected to fluctuate from quarter to quarter, as a result of
product sales mix and sales volume. Gross margins are expected to be higher
at higher levels of production and sales. These higher gross margins are
currently not being achieved because of the expenses related to manufacturing
capacity, which is currently underutilized due to the reduced levels of
product revenues and other, generally fixed, manufacturing costs.
SALES AND MARKETING EXPENSES. Sales and marketing expenses of $497,567 for
the three months ended September 30, 1997 increased by $260,017 (a 109%
increase) compared to $237,550 for the three months ended September 30, 1996.
The increase is the result of the Company's efforts to develop its own
direct sales force and group of independent sales representatives after the
exclusive distribution agreement with Valleylab converted to a non-exclusive
arrangement. The Company is also investing in a significant marketing
communications effort to increase market awareness of the hazards inherent in
monopolar electrosurgery. The Company believes that sales and marketing
expenses will decrease as a percentage of net revenue with increasing sales
volume. There can be no assurance, however, that such decrease will occur.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
increased $152,737 (81%) from $187,937 for the three months ended September
30, 1996 to $340,674 for the three months ended September 30, 1997. This
increase was primarily due to the addition of a Chief Executive Officer, the
hiring of a new Chief Financial Officer, increased legal expenses, primarily
related to the shareholder lawsuit filed in June of 1997. (See Part II, Item
1, Legal Proceedings), costs associated with the annual meeting of
shareholders and directors compensation.
RESEARCH AND DEVELOPMENT. Research and development expenses increased to
$180,105 from $159,128 for the three months ended September 30, 1996, a 13%
increase, reflecting the Company's ongoing product development efforts
related to both the current product line and new products, one of which was
introduced at the end of the quarter ended September 30, 1997, and others
which are anticipated to be introduced later in fiscal year 1998.
13
<PAGE>
LIQUIDITY AND CAPITAL RESOURCES
The Company has historically satisfied its cash requirements principally
through sales of Common Stock which approximated $17.1 million through
September 30, 1997, and, to a substantially lesser degree, funds provided by
sales of the Company's products. In the first quarter of Fiscal Year 1997,
the Company completed its initial public offering, raising net proceeds of
$11.4 million, and raised an additional $585,000 in cash from the exercise of
warrants issued in connection with previous sales of Common Stock.
Historically, these funds have been used for working capital and general
corporate purposes including research and development. The Company may use
working capital to build inventories, to ensure that orders can be filled in
a timely manner, to support the sales efforts of the Company's sales force
and to accommodate anticipated growth. While net proceeds from the Company's
initial public offering are currently invested primarily in money market
instruments and government securities, the Company may also use a substantial
portion of the net proceeds for the acquisition or development of
complementary products or businesses, if such acquisition or development
opportunities arise. The Company currently has no understanding, commitment
or agreement with respect to any such acquisition or development program.
Capital expenditures historically have been relatively minor, and have
consisted of specialized equipment, manufacturing equipment, office equipment
and leasehold improvements. The Company anticipates that its cash on hand
will be sufficient to fund its operations, working capital and capital
requirements for at least the next twelve months.
INCOME TAXES
Net operating loss carryforwards totaling approximately $6.3 million are
available to reduce taxable income as of September 30, 1997. The net
operating loss carryforwards expire, if not previously utilized, at various
dates beginning in the year 2006. The Company has not paid income taxes
since its inception. The Tax Reform Act of 1986 and other income tax
regulations contain provisions which may limit the net operating loss
carryforwards available to be used in any given year, if certain events
occur, including changes in ownership interests. The Company has established
a valuation allowance for the entire amount of its deferred tax asset since
inception due to its history of operating losses.
RESULTS OF OPERATIONS
FOR THE SIX MONTHS ENDED SEPTEMBER 30, 1997 COMPARED TO THE SIX MONTHS ENDED
SEPTEMBER 30, 1996.
NET REVENUES. Revenues for the six months ended September 30, 1997, were
$640,743, compared to $772,929 for the six months ended September 30, 1996, a
decrease of 17%. The decrease is attributable to the Company developing its
own sales and marketing efforts to replace those provided by Valleylab in the
first six months of fiscal year 1997. The Company anticipates revenue growth
for the fiscal year ended March 31, 1998 ("Fiscal Year 1998") compared to
fiscal year 1997 as the Company's efforts to develop an independent sales
force and marketing program mature and result in increased market coverage
and increased sales. The company also expects to introduce new products
during fiscal year 1998 which are expected to contribute to increased
revenues. There can be no assurance, however, that the Company's sales and
marketing efforts will lead to increased revenues, or that the new products
will find adequate market acceptance to generate significant revenues.
GROSS PROFIT. Gross Profit for the six months ended September 30, 1997 was
$53,458 a decrease of $94,625 from the six months ended September 30, 1996
gross profit of $148,083. Gross profit as a percentage of revenue (Gross
Margin) decreased from 19.2% for the six months ended September 30, 1996 to
8.3% in the six months ended September 30, 1997. Gross profit and gross
margin can be expected to fluctuate from quarter to quarter, as a result of
product sales mix and sales volume.
14
<PAGE>
Gross margins are expected to be higher at higher levels of production and
sales. These higher gross margins are currently not being achieved because
of the expenses related to manufacturing capacity, which is currently
underutilized due to the reduced levels of product sales and other, generally
fixed, manufacturing costs.
SALES AND MARKETING EXPENSES. Sales and marketing expenses of $1,059,306 for
the six months ended September 30, 1997 increased by $638,529 (a 152%
increase) compared to $420,777 for the six months ended September 30, 1996.
The increase is the result of the Company's efforts to develop its own direct
sales force and group of independent sales representatives after the
exclusive distribution agreement with Valleylab converted to a non-exclusive
arrangement. In addition, the Company made substantial investments in
developing its own marketing programs to replace the marketing efforts of
Valleylab. The Company believes that sales and marketing expenses will
decrease as a percentage of net revenue with increasing sales volume. There
can be no assurance, however, that such decrease will occur.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
increased $405,749 (118%) from $343,505 for the six months ended September
30, 1996 to $749,254 for the six months ended September 30, 1997. This
increase was primarily due to the addition of a Chief Executive Officer, the
hiring of a new Chief Financial Officer, increased legal expenses, primarily
related to the shareholder lawsuit filed in June of 1997. (See Part II, Item
1, Legal Proceedings), costs associated with the annual shareholders meeting,
directors compensation and increased spending on regulatory matters
associated with new product development.
RESEARCH AND DEVELOPMENT. Research and development expenses increased
$103,949 from $285,830 for the six months ended September 30, 1996, a 36%
increase, reflecting the Company's ongoing product development efforts
related to both the current product line and new products, one of which was
introduced at the end of the quarter ended September 30, 1997, and others
which are anticipated to be introduced later in fiscal year 1998.
15
<PAGE>
PART II. OTHER INFORMATION
ITEM 1 -- LEGAL PROCEEDINGS
On June 4, 1997 a class action lawsuit was filed in the United States
District Court for the District of Minnesota against the Company, the members
of the Board of Directors as of the date of the Company's initial public
offering, and John G. Kinnard and Company, Inc., the underwriter of the
Company's initial public offering. The complaint was filed by Avron Gart, a
former shareholder of the Company, individually and on behalf of all others
similarly situated. The complaint alleges that the Company's Registration
Statement which became effective on or about June 25, 1996, of which the
prospectus was a part, was materially false and misleading, contained untrue
statements of material facts, omitted to state other facts necessary to make
the statements therein not misleading, and failed to disclose adequately
material facts.
The plaintiff alleges in the complaint that the Company's prospectus failed
to disclose, among other things, the fact that stock-in sales to Valleylab
were non-repetitive sales, that the growth rate shown in the prospectus was
already reversing itself and that the reduced revenues would be reported for
the first fiscal quarter ended three business days after the offering. The
plaintiff requests, on behalf of himself and the class, the difference
between the price they paid for the Company's stock and either the current
market value of such stock if currently held or the price at which such stock
was disposed of in the market if disposed of before the commencement of the
action, together with costs and expenses of the litigation, including
reasonable attorney's fees and experts' fees and other costs.
The Company's Directors and Officers Liability Insurance provides coverage
for up to $1,000,000 of the cost of defense against and costs associated with
the complaint, with a retention of $200,000.
The Company intends to vigorously defend itself against this litigation. The
Company has filed a Motion to Dismiss the suit, and expects a hearing on the
motion in the fourth quarter of Fiscal Year 1998. The lawsuit may have a
material adverse effect on the business and financial condition of the
Company in terms of legal fees and costs incurred to defend the claims, the
possibility of an award of damages, and the loss of management time needed to
deal with the lawsuit.
ITEM 2 -- CHANGES IN SECURITIES
(a) On August 15, 1997, The Board of Directors approved the
issuance of 16,000 shares of common stock as compensation for certain outside
directors for the Fiscal Year ended March 31, 1998. The Board also approved
the issuance of 15,000 shares of common stock as payment in full for services
rendered by a vendor in the prior fiscal year. These transactions were exempt
from registration under the Securities Act of 1933 by virtue of the
provisions of Section 4(2) thereof.
ITEM 3 -- Not Applicable
16
<PAGE>
ITEM 4 -- SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
(a) On August 15, 1997 the Annual Meeting of the shareholders of
the Company was held. The purpose of the meeting was to
elect Directors for the coming year, to approve the adoption
of the 1997 Stock Option Plan, and to ratify the appointment
of Arthur Andersen LLP as independent public accountants for
the Company. Results of the voting were:
(1) To Elect Directors:
Name Votes For Votes Withheld
---- --------- --------------
David C. Auth 4,298,440 14,731
Patrick F. Crane 4,298,440 14,731
David W. Newton 4,142,803 170,368
Roger C. Odell 4,141,603 171,568
Donald R. Temple 4,217,882 95,289
Joe W. Tippett 4,222,832 90,339
Robert D. Tucker 4,293,490 19,681
C. Randle Voyles 4,298,435 14,736
(2) To Approve the Adoption of the 1997 Stock Option Plan
which authorizes options to purchase 800,000 Shares:
Votes For: 2,328,791
Votes Against: 859,891
Abstain: 12,850
Not Voted: 1,111,639
(3) To Ratify the appointment of Arthur Andersen LLP as
independent public accountants for the Company:
Votes For: 4,297,198
Votes Against: 8,473
Abstain: 7,500
ITEM 5 -- Not Applicable
ITEM 6 -- EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
11(a) - Computation of Net Income (Loss) per Common Share and
Common Equivalent Share for the Three Months ended September
30, 1997.
11(b) - Computation of Net Income (Loss) per Common Share and
Common Equivalent Share for the Six Months ended September 30,
1997.
27 - Financial Data Schedule.
(b) The Registrant did not file any reports on Form 8-K during the
quarter ended September 30, 1997.
17
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, Electroscope has duly caused this report to be signed on its
behalf by the undersigned thereunto duly authorized.
Name Title Date
- --------------------- -------------------------------- ------------------
/s/ Karl D. Hawkins Chief Financial Officer October 30, 1997
Karl D. Hawkins (Principal Accounting Officer)
18
<PAGE>
EXHIBIT INDEX
Sequentially
Exhibit No. Description Numbered Page
- ----------- ----------- -------------
11(a) Computation of Net Income (Loss) per
Common Share and Common Equivalent Share
for the three months ended September 30, 1997
and 1996 20
11(b) Computation of Net Income (Loss) per
Common Share and Common Equivalent Share
For the Six months ended September 30, 1997
And 1996 21
27 Financial Data Schedule 22
19
<PAGE>
EXHIBIT 11(a)
ELECTROSCOPE, INC.
COMPUTATION OF NET INCOME (LOSS) PER COMMON SHARE
AND COMMON EQUIVALENT SHARE
(UNAUDITED)
For the Three Months Ended
-----------------------------
September 30, September 30,
1997 1996
------------- -------------
NET INCOME (LOSS) $ (897,890) $ (371,963)
----------- -----------
----------- -----------
SHARES USED IN SHARE COMPUTATION
Common stock shares outstanding (weighted
average) 5,368,007 5,295,253
Treasury stock effect of common stock and
equivalents issued within one year of the
public offering at prices less than the
public offering price --- ---
----------- -----------
Shares used in computation 5,368,007 5,295,253
----------- -----------
----------- -----------
NET INCOME (LOSS) PER COMMON SHARE AND
COMMON EQUIVALENT SHARE $(0.17) $(0.07)
----------- -----------
----------- -----------
20
<PAGE>
EXHIBIT 11(b)
ELECTROSCOPE, INC.
COMPUTATION OF NET INCOME (LOSS) PER COMMON SHARE
AND COMMON EQUIVALENT SHARE
(UNAUDITED)
For the Six Months Ended
-----------------------------
September 30, September 30,
1997 1996
------------- -------------
NET INCOME (LOSS) $ (1,943,766) $ (717,280)
------------- -----------
------------- -----------
SHARES USED IN SHARE COMPUTATION
Common stock shares outstanding (weighted
average) 5,371,479 4,724,850
Treasury stock effect of common stock and
equivalents issued within one year of the
public offering at prices less than the
public offering price --- 28,185
------------- -----------
Shares used in computation 5,371,479 4,753,035
------------- -----------
------------- -----------
NET INCOME (LOSS) PER COMMON SHARE AND
COMMON EQUIVALENT SHARE $(0.36) $(0.15)
------------- -----------
------------- -----------
21
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM
ELECTROSCOPE, INC. BALANCE SHEET AS OF SEPTEMBER 30, 1997 AND STATEMENTS OF
OPERATION AND CASH FLOWS FOR THE SIX MONTHS ENDED SEPTEMBER 30, 1997 AND IS
QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> MAR-31-1997
<PERIOD-END> SEP-30-1997
<CASH> 4,603,498
<SECURITIES> 2,989,740
<RECEIVABLES> 193,743
<ALLOWANCES> 10,000
<INVENTORY> 691,002
<CURRENT-ASSETS> 8,535,995
<PP&E> 647,952
<DEPRECIATION> (321,145)
<TOTAL-ASSETS> 9,022,947
<CURRENT-LIABILITIES> 649,970
<BONDS> 0
0
0
<COMMON> 16,941,317
<OTHER-SE> 290,400
<TOTAL-LIABILITY-AND-EQUITY> 9,022,947
<SALES> 640,743
<TOTAL-REVENUES> 640,743
<CGS> 587,285
<TOTAL-COSTS> 2,198,339
<OTHER-EXPENSES> (201,115)
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> (1,943,766)
<INCOME-TAX> 0
<INCOME-CONTINUING> (1,943,766)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (1,943,766)
<EPS-PRIMARY> (0.36)
<EPS-DILUTED> (0.36)
</TABLE>
