<PAGE>
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-KSB
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended March 31, 1997
Commission File No. 0-28604
ELECTROSCOPE, INC.
----------------------
(Exact name of Issuer as specified in its charter)
Colorado 84-1162056
------------------------------------------------------------
(State or other jurisdiction of (I.R.S. Identification Number)
incorporation or organization)
4828 Sterling Drive, Boulder, Colorado 80301
-----------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
Issuer's telephone number, including area code: (303) 444-2600
--------------
Securities registered pursuant to Section 12(b) of the Act: None
----
Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK, NO PAR VALUE
--------------------------
Check whether the Issuer (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding
12 months (or for such shorter period that the Issuer 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 pursuant to Item 405 of
Regulation S-K (Section 229.405 of this chapter) in this form, and no
disclosure will be contained, to the best of Issuer'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 had total revenues of $ 1,398,184 for its fiscal year ended March 31,
1997.
As of May 19, 1997, assuming as a market value the price of 2 3/8 per share (the
last sales price of the Issuer's Common Stock on the NASDAQ market) the
aggregate market value of shares held by non-affiliates was $8,423,940.
As of May 19, 1997, the Issuer has outstanding 5,352,507 shares of Common Stock,
no par value.
Documents Incorporated by Reference: Definitive Proxy Statement for the 1997
Annual Shareholders' meeting to be filed with the Commission and incorporated by
reference as described in Part III and certain exhibits contained in
Registration Statement #333-4118-D declared effective with the SEC on June 25,
1996. The 1997 Proxy Statement will be filed within 120 days after the end of
the fiscal year ended March 31, 1997.
<PAGE>
PART I
ITEM 1. BUSINESS.
THE COMPANY
Electroscope, Inc. ("Electroscope" or the "Company") was founded in 1991
to address product opportunities in support of the increased usage of
laparoscopic (a type of minimally invasive surgery, or "MIS") monopolar
electrosurgery. The Company's initial approach to the market was to design,
develop, manufacture and market a patented monopolar electrosurgical
shielding system, supplemented by integrated electrosurgical instruments.
The initial market opportunity was created by the inherent risks of
electrical burns to a patient undergoing laparoscopic surgery. The Company's
patented Active Electrode Monitoring ("AEM-Registered Trademark-") concept
provides the basis for the Electroshield-Registered Trademark-Monitoring
System ("EMS") which protects the surgical patient against stray electrical
energy that can cause injury by actively and continuously monitoring current
flow from the electrosurgical generator through the electrosurgical
instrument. The EMS allows surgeons to perform, more safely and more
efficaciously, a broad range of surgical procedures using laparoscopic
monopolar electrosurgery.
Electrosurgery utilizes radio frequency ("RF") electrical energy to perform
surgical incisions and to control bleeding during surgery. Electrosurgical
techniques have been used in medicine since the 1930s in a broad range of open
surgical procedures and are now an integral part of virtually every surgeon's
practice. During the 1970s, gynecologists began using electrosurgery in MIS
procedures. Up until the late 1980s however, laparoscopic surgery - one of the
most common forms of minimally invasive surgery - was mainly limited to these
gynecological procedures (e.g. tubal ligation and the lysis of pelvic
adhesions). The development of the micro-camera, however, opened the door to
laparoscopic surgical procedures in a large number of other specialties,
including urologic, gastrointestinal, thoracic, general and orthopedic surgery.
Laparoscopy now accounts for an estimated 15% of all surgical procedures
performed in the United States. Because of the significant benefits of minimally
invasive surgery, the number of electrosurgically-based MIS procedures is
expected to continue to grow.
In MIS, the surgeon operates from outside the patient's body using
electrosurgical instruments and camera systems that are introduced through small
access ports. By nature of the camera system used, the surgeon is limited to a
small field of vision which may be only 1" - 2" in diameter. Given the
surgeon's restricted field of vision, there is the potential for unintended and
unobserved tissue burns from stray electrical current at non-targeted sites
outside the surgeon's viewing area. Stray electrical current can result from
insulation failure and/or capacitive coupling. These tissue and organ burns are
particularly dangerous because they may lead to unrecognized perforation,
infection and possible death.
The market for electrosurgical MIS equipment currently is estimated to be
approximately $450 million annually, represented by approximately 90,000
operating rooms in the U.S. and in nine other industrial countries. The
Company's main approach to this market is to develop a direct sales force,
including both employees and independent sales representative organizations, and
to increase market awareness of the inherent hazards of laparoscopic surgical
procedures. The Company previously sought to market the products using an
exclusive distribution agreement with Valleylab, Inc. a part of the Hospital
Products Group of Pfizer, Inc. This agreement, requiring Valleylab to meet
minimum purchase levels to retain exclusivity, was expected to provide both
quicker access to a wider market than the Company could develop on its own, and
to generate sufficient direct contact with customers to provide important
feedback on how the end user perceived the products and their use in surgical
procedures. The development of a separate sales force resulted from Valleylab
not meeting the minimum purchase requirements in calendar year 1996, and hence
losing its exclusivity.
In addition to continuing to market and sell the original product line, the
Company is actively engaged in developing a line of disposable products, both
for the current surgical procedures that the Company addresses and for other
types of MIS procedures. The Company expects to introduce new products in the
later part of fiscal year
<PAGE>
1998 and to continue to do so periodically thereafter. The Company will pursue
developing new products both internally and through acquisition of existing
product lines from third parties. The Company is not currently engaged in any
negotiations to acquire such products, and has not reached any definitive
agreements to do so.
Market Development Overview
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 supplement a direct sales effort with the Valleylab sales
force. As noted above, this Agreement did not meet its objectives and the
Company has taken steps to develop a 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 who has 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. Management does not expect that profitable operating
levels will be reached in fiscal year 1998, and there can be no assurance given
that these measures, or any other that the company may adopt, will result in
either increased revenues or profitable operations.
The Company was incorporated in February 1991. The Company's principal
offices are located at 4828 Sterling Drive, Boulder, CO 80301, and its telephone
number is (303) 444-2600.
THE PROBLEM: PATIENT SAFETY
INTRODUCTION
Minimally Invasive Surgery (MIS) offers substantial advantages over
traditional open surgery. These advantages, which have led to the widespread
adoption of this surgical technique, include less patient trauma due to minimal
incisions, and shorter periods of hospitalization and post-operative recovery.
However, the Company believes that there is a growing awareness in the medical
community and insurance industry about patient safety during the use of
monopolar MIS electrosurgical procedures because of the potential for internal
injuries. It has been determined that such injuries are sometimes caused by
burns to non-targeted tissue or organs at locations that can not be observed by
the surgeon during the surgical procedure. Further clinical investigation has
demonstrated that the burns result from failure of the insulation of the
surgical instruments or from a phenomenon known as capacitive coupling.
The shaft of the instrument (active electrode) used for delivery of the
electrosurgical energy to the surgical site is covered with an insulating
material. Approximately 90% of the insulated portion of the shaft is beyond the
surgeon's view during the procedure. A breakdown in the insulation or an
incidence of capacitive coupling (through intact insulation) along the shaft can
create stray electrical energy, which can produce a severe burn to the patient
at a non-targeted site outside the surgeon's viewing area. In many cases this
injury cannot be detected by the surgeon at the time of the procedure. The
complication may present itself three to four days later in the form of a severe
infection, which nearly always results in a return to the hospital.
Breakdowns in insulation can occur through normal wear, improper handling,
or by the instrument being placed against trocar edges, or other sharp
instruments, during normal use. In addition, corona heating associated with
high frequency and high voltage has been documented to melt the insulation and
result in premature insulation breakdown on some instruments. Tiny insulation
defects are difficult to detect visually. Furthermore, tiny defects provide a
more concentrated current than larger defects. Tissue heating increases in
direct proportion to the concentration of the current. Accordingly, the
more-difficult-to-detect tiny defects may present more potential for
unrecognized tissue burns than larger insulation defects.
<PAGE>
A second concern is capacitive coupling, which can occur when two
conductors are separated by a non-conductor (insulation). In MIS, the
conductors are the instrument shaft and the metal cannula (through which the
electrosurgical instruments are introduced into the body), and the shaft
insulation is the non-conductor. Once a capacitor has been created, it is
possible for electrical current to transfer into the metal cannula and adjacent
tissue, even though the insulation is intact.
THE ELECTROSHIELD-Registered Trademark- SYSTEM SOLUTION
The Company has addressed the growing concern over stray energy injuries
by developing the Electroshield-Registered Trademark- Monitoring System, an
innovative, safe, and cost effective solution for use with monopolar
electrosurgery, the predominant method for minimally invasive surgical
applications. The EMS allows the free passage of RF electrical energy to the
cutting or coagulating tips of the electrosurgical instruments while
protecting the patient against dangerous stray energy by continuously
monitoring current flow in the patented instrument shield. Whenever abnormal
electrical current conditions are detected, the monitor signals the
electrosurgical generator to deactivate and sounds an alarm to notify the
surgeon.
The EMS is based on the concept of Active Electrode Monitoring
(AEM-Registered Trademark-), developed and patented by the Company. Using
AEM-Registered Trademark-, the EMS dynamically monitors for stray electrical
energy flowing in the shield along the shaft of the instrument. Whenever
abnormal electrical current conditions are detected, the monitor signals the
electrosurgical generator to deactivate and sounds an alarm to notify the
surgeon. The Company's EMS operates somewhat like a "ground fault interrupt
circuit breaker" commonly found in home bathrooms and garages to protect
users of electrical appliances against stray current. Most importantly, the
EMS protects the patient from a risk that is out of the surgeon's view.
The Company provides a safe and efficacious solution to the risks presented
by the use of monopolar electrosurgery which is transparent to the surgeon and
is cost effective. The Company's EM-2+ Electronic Monitoring units plug
directly into an operating room's existing electrosurgical generator without any
modifications. In addition, the Company's shielded electrosurgical instruments
function virtually identically to unshielded instruments currently in use. The
Company's approach therefore requires no change in the surgeon's technique and
little surgical staff training.
PRODUCTS
THE ELECTROSHIELD-Registered Trademark- MONITORING SYSTEM
The Company's Electroshield-Registered Trademark- Monitoring System is
based on the AEM-Registered Trademark- concept. The complete system consists
of the Company's EM-2 Electronic Monitor, which plugs directly into a
standard electrosurgical generator, and integrated electrosurgical
instruments manufactured by the Company that incorporate the Company's
shielding technology. The Company also has developed a protective sheath
incorporating its AEM-Registered Trademark- technology for use with
unshielded laparoscopic and specialty instruments not manufactured by the
Company. The AEM-Registered Trademark- system is transparent to the surgeon,
providing enhanced safety without any change in the methodology used to
perform MIS electrosurgery. The system's attributes include:
- No change in surgical technique in most cases.
- Very little additional training for the surgeon. The use of the
Electroshield-Registered Trademark- instruments is identical to those now
being used, and are thus transparent to the surgeon.
- Very low additional capital equipment cost.
- No increase in the instrument cost per surgical procedure. The
Electroshield-Registered Trademark- instruments are comparable in cost to
other manufacturers', unshielded, reusable instruments which are now being
used.
<PAGE>
THE EM-2+ ELECTRONIC MONITOR
The EM-2+ Electronic Monitor (EM-2+) (a second generation product developed
by the Company) protects the patient against stray electrical energy that can
cause injury by actively and continuously monitoring current flow from the
electrosurgical generator through the electrosurgical instrument. The EM-2+
dynamically protects against stray electrical energy beyond the surgeon's field
of vision during minimally invasive surgical procedures. The EM-2+ is the only
device now available to actively detect stray electrosurgical energy out of the
view of the laparoscope. It signals the electrosurgical unit to deactivate and
alerts the surgeon when a fault is detected.
The EM-2+ is designed to be used with standard electrosurgical generators
that have return electrode monitoring capability. The EM-2+ is based on an
advanced modular design with sophisticated, proprietary electronic circuitry.
The Company also offers standard electrosurgical cords that are used to connect
the EM-2+ to the electrosurgical instruments.
ELECTROSURGICAL INSTRUMENTS
Electroscope designs and manufactures an array of the most common fixed
tip and hinged electrosurgical instruments, all of which incorporate
AEM-Registered Trademark- into the design. Examples of fixed tip instruments
manufactured by the Company include hooks, spatulas, and needles. Examples
of hinged instruments manufactured by the Company include scissors, graspers
and dissectors. The instruments are designed to replace other manufacturers'
unshielded electrosurgical instruments. The advanced design of the Company's
instruments is such that they have a similar look and feel of other
manufacturers' unshielded instruments, including similar dimensions and use
of a single connecting cord. Each of the instruments, fixed tip and hinged,
are modular in design, which permits disassembly for replacement of worn or
damaged parts when necessary and for effective cleaning and sterilization
between uses. Individual components are a fraction of the complete
instrument cost. The Company offers its electrosurgical instruments at
prices comparable to other manufacturers' unshielded, reusable instruments.
ADAPTIVE ELECTROSHIELD-Registered Trademark- SHEATHS
The Company also offers adaptive sheaths that permit unshielded
electrosurgical instruments and specialty instruments to utilize the
Company's AEM-Registered Trademark- technology. These adaptive sheaths allow
the surgeon to offer a uniform standard of care to all patients.
OTHER PRODUCTS
The Company has begun development on a series of new products to expand
the product line offered by the Company's sales force. These new products
(for which 510(k) approval has been applied for but not yet received from the
United States Food and Drug Administration) will take advantage of the
Company's expertise in understanding MIS procedures and the needs of surgeons
performing those procedures. The products will be targeted at areas other
than those served by AEM-Registered Trademark- technology and will reduce the
Company's dependence on market acceptance of AEM-Registered Trademark-
technology. Any adverse determination or request for additional information
by the FDA could delay market introduction and have an adverse effect on the
Company's continued operations.
<PAGE>
MARKETING AND SALES
In an attempt to penetrate the market for electrosurgical equipment quickly
and effectively the Company decided to supplement its initial direct sales
efforts by entering into an exclusive Distribution Agreement in September 1995
with Valleylab Inc., a part of the Hospital Products Group of Pfizer, Inc. This
appeared to be an opportunity to leverage the significant market presence and
distribution channel already established by Valleylab. The initial relationship
provided Valleylab with exclusive, worldwide distribution rights subject to
certain minimum purchase requirements. Due to Valleylab's failure to meet the
minimum purchase requirements, the Agreement has become non-exclusive for
calendar years 1997 and 1998.
The Company has found a mixed reception in the marketplace for the EM-2+
and related products. In certain instances, customers recognized the problem
associated with monopolar electrosurgery, and have readily accepted the
Company's solution to the problem. However, acceptance has not been universal,
and the Company has found that selling the EM-2+ product has been more
difficult, and takes longer, than originally believed. This is due to a variety
of factors, including the necessity to make surgeons and hospital risk managers
aware of the potential for electrical burns (with the resultant increase in
potential litigation resulting from such burns), the overall lack of single
purchasing points in the industry (both surgeons and hospitals need to be in
substantial agreement as to potential for injury) and the consequent need to
make multiple sales calls on those with the ability to commit to additional
capital expenditures in the current medical economic environment.
The Company has hired and substantially trained a direct sales force to
begin to supplement the Valleylab sales force. To expand market coverage while
keeping costs under control the Company has begun to contract with and train a
network of independent sales representative organizations (each with several
sales representatives) across the U.S. The Company believes that the
combination of direct sales representatives with substantial experience in
selling products addressing patient safety issues related to monopolar
electrosurgery, and independent sales representative organizations, with the
capability of addressing markets beyond the laparoscopic field, offers the
Company the best opportunity to broaden the acceptance of its product line, and
to generate increased revenues.
To further increase the Company's ability to expand its market presence and
respond more effectively to market requirements, subsequent to the end of fiscal
year 1997, the Company hired a President and Chief Executive Officer with broad
general management and sales and marketing experience in the medical device
industry. The Company has also engaged the services of a specialty marketing
communications firm to increase market awareness of the problems inherent in
monopolar electrosurgery.
RESEARCH & DEVELOPMENT
The Company employs seven engineers in its research and product development
efforts. The current focus of this group is to broaden the product line that
the Company can offer to its sales force. This includes developing products for
other than laparoscopic procedures in addition to increasing the styles of
electrosurgical instruments available for MIS applications. The Company
believes that as MIS techniques are applied to additional types of surgery,
there will be a need to develop instruments capable of performing such
surgeries. The Company also believes that other surgical equipment that uses RF
electrical energy should be shielded and actively monitored in order to make
them safer. Future research and development efforts will address such
opportunities.
The Company recognizes that there are opportunities for new product
development beyond those that the company can pursue internally. The Company
intends to be active in exploring opportunities, including acquisitions to
broaden the scope of products offered by the Company's sales force.
<PAGE>
MANUFACTURING, REGULATORY AFFAIRS AND QUALITY ASSURANCE
The Company engages in various manufacturing and assembly activities at its
facility in Boulder, Colorado. These operations include assembly of the EM-2+
Electronic Monitors and fabrication, assembly and test operations for the
electrosurgical instruments, adaptive sheaths and cords. The Company also has
relationships with a number of outside suppliers which provide primary
sub-assemblies in addition to various electronic and sheet metal components,
machined and molded parts used in the Company's products. The Company has made
plans for the production, assembly and test operations required for the new
products that the Company plans to introduce in fiscal year 1998. The plans
include both expanding internal operations and outsourcing various preliminary
steps in the production process.
The Company believes that the use of both internal and external
manufacturing capabilities allows for increased flexibility in meeting its
customer delivery requirements, and significantly reduces the need for
investment in specialized or expensive capital equipment. The Company has
developed multiple sources of supply where possible and will continue to do so
as the Company expands its product offerings. The relationship between the
Company and its suppliers is generally limited to individual purchase order
agreements, supplemented as appropriate by contractual relationships to ensure
availability of certain products.
All components, materials and subassemblies used in the Company's products,
whether produced in-house or obtained from others, are inspected to ensure
compliance with Company specifications. All finished products are subjected to
quality assurance and performance testing procedures by Company personnel. As
discussed under the section on Government regulation, the Company is subject to
the rules and regulations of the United States Food and Drug Administration. At
March 31, 1997 the production staff consists of nine people and the regulatory
affairs and quality assurance staff consists of eight people.
The Company's leased facility of 11,250 square feet contains 7,150 square
feet of manufacturing, regulatory affairs and quality assurance space. The
Company believes that its current facility is adequate to meet its manufacturing
and quality assurance needs for fiscal year 1998. The Company also has the right
of first refusal to lease additional space adjacent to its current space.
The facility is designed to comply with current Good Manufacturing
Practices (GMP) as specified in published FDA regulations. As noted below
(Government Regulation) the Company's facility has been inspected by the FDA and
has been found to be "...in substantial compliance with Good Manufacturing
Practices..." as of the most recent inspection.
<PAGE>
PATENTS, PATENT APPLICATIONS AND PROPRIETARY RIGHTS
The Company's technical progress depends to a significant degree on its
ability to maintain patent protection for products and processes, to preserve
its trade secrets and to operate without infringing the proprietary rights of
third parties. The Company's policy is to attempt to protect its technology by,
among other things, filing patent applications for technology that it considers
important to the development of its business. The Company was granted a United
States patent having 42 claims on May 17, 1994. This patent relates to the
basic shielding and monitoring technologies that the Company now incorporates in
its products. The Company was granted a United States Patent on January 7, 1997
relating to specific implementations of shielding and monitoring in instruments.
Three additional United States patent applications are pending, one relating to
the incorporation of the shielding and monitoring technologies in various other
instrument configurations and two relating to bipolar laparoscopic devices.
Foreign patent applications relating to the basic shielding and monitoring
technologies have been filed in Australia, Canada, Japan and several European
countries and have been allowed in Australia, Canada and Japan. The validity
and breadth of claims covered in medical technology patents involve complex
legal and factual questions and, therefore, may be highly uncertain. No
assurance can be given that the Company's pending applications will result in
patents being issued or, if issued, that such patents, or the Company's existing
patents, will provide a competitive advantage, or that competitors of the
Company will not design around any patents issued to the Company.
The Company requires its employees to execute non-disclosure agreements
upon commencement of employment with the Company. These agreements generally
provide that all confidential information developed or made known to the
individual by the Company during the course of the individual's employment with
the Company is to be kept confidential and not disclosed to third parties.
COMPETITION
The electrosurgical products market is intensely competitive and tends to
be dominated by a relatively small group of large and well financed companies.
The Company competes directly for customers with those companies that currently
make unshielded monopolar electrosurgical instruments that are not actively
monitored for stray electrical energy. Several larger competitors include Karl
Storz Endoscopy America, Inc., Richard Wolf Medical Instruments Corp., United
States Surgical Corporation and Ethicon Endo-Surgery (a Division of Johnson &
Johnson, Inc.). While the Company knows of no other company (including those
referred to above) that provides for active electrode monitoring for stray
energy, it can be expected that the manufacturers of unshielded instruments will
fiercely resist any loss of market share which might result from the presence of
the Company's shielded products in the market.
The Company also believes that manufacturers of products based upon
surgical techniques that are alternatives to monopolar electrosurgery are
competitors of the Company. These techniques include bipolar electrosurgery,
laser surgery and the harmonic scalpel. Leading manufacturers include Everest
Medical Corporation (bipolar electrosurgery), Laserscope (laser surgery) and the
UltraCision Division of Johnson & Johnson, Inc., (harmonic scalpel). The
Company believes that monopolar electrosurgery currently offers certain
competitive advantages over the alternative methods that are available. No
assurance can be given, however, that the alternative techniques will not gain
greater market share or that new competitive techniques will not be developed
and introduced.
As mentioned in the Marketing and Sales discussion, the competitive issues
involved in selling the Company's original EM-2 product line do not primarily
revolve around a comparison of cost or features, but rather involve generating
an awareness of the inherent hazards of monopolar electrosurgery and the
potential for injury to the patient. This involves selling concepts, rather
than just a product, which results in higher sales costs than had been
originally anticipated by the Company. There can be no assurance that the
Company's efforts to increase market awareness of these hazards will be
successful, or that the Company's competitors will not develop alternative
strategies to counter the Company's marketing efforts.
<PAGE>
Many of the Company's competitors and potential competitors have
significantly greater financial, technical, product development, marketing and
other resources and market recognition than the Company. There can be no
assurance that the Company will be able to compete successfully against current
and future competitors or that competitive pressures faced by the Company will
not materially adversely affect its business, operating results or financial
condition.
GOVERNMENT REGULATION
Government regulation in the United States and other countries is a
significant factor in the development and marketing of the Company's products
and in the Company's ongoing manufacturing, research and development activities.
The Company and its products are regulated by the FDA under a number of
statutes, including the Food, Drug and Cosmetics (FDC) Act.
Under the FDC Act, medical devices are classified as Class I, II or III on
the basis of the controls deemed necessary to reasonably ensure their safety and
effectiveness. Class I devices are subject to the least extensive controls, as
their safety and effectiveness can be reasonably assured through general
controls (e.g., labeling, pre-market notification and adherence to GMP). For
Class II devices, safety and effectiveness can be assured through the use of
special controls (e.g., performance standards, post-market surveillance, patient
registries and FDA guidelines). Class III devices (i.e., life-sustaining or
life-supporting implantable devices, or new devices which have been found not to
be substantially equivalent to legally marketed devices) require the highest
level of control, generally requiring pre-market approval by the FDA to ensure
their safety and effectiveness.
If a manufacturer or distributor of medical devices can establish that a
proposed device is "substantially equivalent" to a legally marketed Class I
or Class II medical device or to a Class III medical device for which the FDA
has not required a Pre Market Approval application, the manufacturer or
distributor may seek FDA marketing clearance for the device by filing a
510(k) pre-market notification. Following submission of the 510(k)
notification, the manufacturer or distributor may not place the device into
commercial distribution in the United States until an order has been issued
by the FDA. The FDA's target for issuing such orders is within 90 days of
submission, but the process can take significantly longer. The order may
declare the FDA's determination that the device is "substantially equivalent"
to another legally marketed device and allow the proposed device to be
marketed in the United States. The FDA may, however, determine that the
proposed device is not substantially equivalent or may require further
information, such as additional test data, before making a determination
regarding substantial equivalence. Any adverse determination or request for
additional information could delay market introduction and have a materially
adverse effect on the Company's continued operations. The Company has
received 510(k) notification for its EM-2 Electronic Monitor, monopolar MIS
electrosurgical instruments with Electroshield-Registered Trademark-, and its
Electroshield-Registered Trademark- Monitoring System, all of which are
designated as Class II medical devices.
Labeling and promotional activities are subject to scrutiny by the FDA and,
in certain instances, by the Federal Trade Commission. The FDA also imposes
post-marketing controls on the Company and its products, and registration,
listing, medical device reporting, post-market surveillance, device tracking and
other requirements on medical devices. Failure to meet these pervasive FDA
requirements or adverse FDA determinations regarding the Company's clinical and
preclinical trials could subject the Company and/or its employees to injunction,
prosecution, civil fines, seizure or recall of products, prohibition of sales or
suspension or withdrawal of any previously granted approvals.
The FDC Act regulates the Company's quality control and manufacturing
procedures by requiring the Company and its contract manufacturers to
demonstrate compliance with current GMP as specified in published FDA
regulations. The FDA monitors compliance with GMP by requiring manufacturers to
register with the FDA, which subjects them to periodic unannounced FDA
inspections of manufacturing facilities. If violations of applicable
regulations are noted during FDA inspections of the Company's manufacturing
facilities or the facilities of its contract manufacturers, the continued
marketing of the Company's products may be adversely affected. Such
<PAGE>
regulations are subject to change and depend heavily on administrative
interpretations. There can be no assurance that future changes in regulations
or interpretations made by the FDA or other regulatory bodies, with possible
retroactive effect, will not adversely affect the Company. In April 1995, the
FDA conducted a reinspection of the Company's facilities for compliance with
GMP. All prior citations were cleared and no new citations were noted. The
Company believes it has the internal talents and processes in place to be
reasonably assured that it will be able to comply with all applicable
regulations regarding the manufacture and sale of medical devices.
Sales of medical devices outside of the United States are subject to United
States export requirements and foreign regulatory requirements. Legal
restrictions on the sale of imported medical devices vary from country to
country. The time required to obtain approval by a foreign country may be
longer or shorter than that required for FDA approval, and the requirements may
differ. The Company has obtained a Certificate of Export from the United States
Department of Health and Human Services, however there can be no assurance that
a specific foreign country in which the Company wishes to sell its products will
accept or continue to accept the Export Certificate. This Certificate states
that the Company has been found to be "...in substantial compliance with Good
Manufacturing Practices..." based on the most recent inspection.
EMPLOYEES
As of March 31, 1997, the Company employed 39 individuals, 7 of which are
engaged directly in research, development and regulatory activities, 17 in
manufacturing, 10 in marketing and sales and 5 in administrative positions.
None of the Company's employees is covered by a collective bargaining agreement,
and the Company considers its relations with its employees to be good.
ITEM 2. PROPERTIES.
The Company leases 11,246 square feet of office and manufacturing space at
4828 Sterling Drive, Boulder, Colorado 80301. This lease expires in October
31, 1998, but provides for a three year renewal option.
ITEM 3. 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 Avrom 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.
<PAGE>
The Company intends to vigorously defend this litigation. 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 of the loss of management time needed
to deal with the lawsuit.
Various disputes arose between the Company and a former officer of the
Company during 1997. These disputes were resolved and a Settlement Agreement
was signed on May 5, 1997, effective March 2, 1997. The terms of the resolution
provided in general for the repurchase of common stock and other securities held
by the former Officer and for a severance package. All of the expenses related
to the settlement were accrued in fiscal year 1997.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
There were no matters submitted to a shareholder vote during the fourth
quarter of the fiscal year ended March 31, 1997.
<PAGE>
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
The Company's Common Stock is traded in the over-the-counter market on the
NASDAQ National Market system under the symbol ESCP. The quotations presented
below reflect inter-dealer prices, without retail mark-up, mark-down or
commissions and may not necessarily represent actual transactions. The
following table sets forth for the periods indicated, the high and low closing
sale prices for the Common Stock:
HIGH LOW
- --------------------------------------------------------------------------------
FISCAL YEAR ENDED MARCH 31, 1997
First Quarter through June 30, 1996 10 3/4 10
Second Quarter through September 30, 1996 10 1/2 8
Third Quarter through December 31, 1996 9 4
Fourth Quarter through March 31, 1997 5 3 1/2
As of March 31, 1997, there were approximately 203 holders of record of the
Common Stock. This number does not reflect stockholders who beneficially own
Common Stock held in nominee or street name.
DIVIDEND POLICY
The Company has not paid cash dividends in the past and does not intend to
pay cash dividends in the foreseeable future. The Company presently intends to
retain any cash generated from operations in the future for use in its business,
with any future decision to pay cash dividends dependent upon the Company's
growth, profitability, financial condition, and other factors the Board of
Directors may deem relevant.
ITEM 6. 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. The Company believes
that its patented Electroshield-Registered Trademark- 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.
Stray electrical energy has been shown to cause unintended burns which may
result in hospitalization or death. 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 1997. To supplement 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.
<PAGE>
The Company recognizes that market awareness and acceptance of the hazards
inherent in monopolar electrosurgery 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, 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, and intends to explore product development and
acquisition opportunities from third parties.
The Company recognizes that its efforts to develop its own sales force,
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 either has attracted or can 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
Section 3, a class action lawsuit has been filed in the United States District
Court in Minnesota. While the Company believes that the suit is without merit,
defense against such suits will take management time and legal resources.
Should the lawsuit result in a significant payment to the plaintiff(s), such
payment could have a material adverse impact on the Company's liquidity.
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 protective
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. In 1993, the Company hired a vice president of
sales and marketing and recruited clinical sales specialists. 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 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 rapidly as the
sales organization becomes more familiar with the Electroshield-Registered
Trademark- Monitoring System and sell the system to their customers. The
approximate number of EM-2 and EM-2+ Electronic Monitors sold were 321, 567,
and 257 in the fiscal years ended March 31, 1995, 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 reduce its dependence on products
involving AEM-Registered Trademark- 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 supplement a direct sales effort with the Valleylab sales
force. As noted above, this Agreement did not meet its objectives and the
Company has taken steps to develop a direct sales force, made up of Company
employees and independent sales representative organizations,
<PAGE>
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 who
has 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. Management does not expect that
profitable operating levels will be reached in fiscal year 1998, and there can
be no assurance given 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 $6,929,245 as of March 31, 1997. Due to the need to
develop and train 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 quarterly basis as a result of the
size and frequency of sales through the independent sales network and the
expansion 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
NET REVENUES. Revenues for the fiscal year ended March 31, 1997 ("FY 1997")
were $1,398,184, a decrease of 36% from the fiscal year ended March 31, 1996
("FY 1996"). Revenue from Valleylab represented $1,145,900 of FY 1997
revenue. The decrease in FY 1997 revenues was due to the transition from the
exclusive Valleylab Agreement to a direct sales organization more under the
direct control of the Company. The Company anticipates a return to revenue
growth for the fiscal year ended March 31, 1998 ("FY 1998") as the Company's
sales force expands the installed base of Electroshield-Registered Trademark-
Monitoring Systems with resulting increases in sales of electrosurgical
instruments and adaptive sheaths used by this installed equipment and as a
result of the introduction of new products during the fiscal year.
Revenues for FY 1996 were $2,173,785 compared to $1,084,226 for the
fiscal year ended March 31, 1995 ("FY 1995"), an increase of 100%. Revenue
from Valleylab represented $2,002,600 of FY 1996 revenue, of which $1,540,100
was recorded under the Agreement. This increase was due to a combination of
factors, including initial stocking orders from Valleylab after signing the
Agreement. Also contributing to the increase were increased sales of
fixed-tip electrosurgical instruments and sheaths.
GROSS PROFIT. The lower revenue levels in FY 1997 resulted in costs of
production exceeding revenue by $23,821, which was a decrease of $746,529
from FY 1996 gross profit of $722,708. This decrease is primarily due to the
lower revenue in FY 1997, which was not adequate to fully cover manufacturing
expenses. The decrease was also attributable to costs incurred and expenses
related to excess manufacturing capacity, which resulted from expansions in
facilities and manufacturing staff in anticipation of higher future
production volumes, as well as higher manufacturing costs associated with
early stage production of hinged tip instruments. Gross profit as a
percentage of revenue decreased from 33% in FY 1996 to a negative percentage
in FY 1997. Gross profit can be expected to fluctuate from quarter to
quarter as a result of product sales mix and sales volume.
The gross profit for FY 1996 of $722,708 increased by $172,392, or 31% from
the gross profit for FY 1995. The increase in gross profit was primarily due to
the increased revenues of FY 1996 over FY 1995. Gross profit as a percentage of
revenues decreased from 51% to 33%. This decrease was primarily attributable to
pricing terms specified in the Valleylab exclusive Distribution Agreement. The
decrease was also attributable to costs incurred and expenses related to excess
manufacturing capacity, which resulted from expansions in facilities and
manufacturing staff in anticipation of higher future production volumes, as well
as higher manufacturing costs associated with early stage production of hinged
tip instruments.
SALES AND MARKETING EXPENSES. Sales and marketing expenses of $1,511,190 in FY
1997 increased by $539,352 (a 55% increase) compared to FY 1996, primarily as a
result of the Company's efforts to strengthen its own sales capability and
develop its own distribution network. The Company believes that sales and
marketing expenses will continue to increase as the Company develops its own
sales force and increases its marketing programs. The Company
<PAGE>
also 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.
Sales and marketing expenses of $971,838 in FY 1996 increased by
$244,408, or 34%, compared to FY 1995 consistent with the Company's increased
emphasis on sales and marketing activities.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
increased 134% from $576,802 in FY 1996 to $1,349,371 in FY 1997. This
increase was primarily due to overall increased levels of business activity,
including activities related to being a public company. An additional factor
in the increase was a severance settlement reached with a former
vice-president of Sales and Marketing. Other contributors to the increase
were expenditures for business strategy consultants, increases in regulatory
affairs headcount, and an increase in expenses related to Board of Directors
activities.
General and administrative expenses increased 48% from $390,083 in FY 1995
to $576,802 in FY 1996. This increase was primarily attributable to increased
staffing for the regulatory and compliance department.
General and administrative expenses are expected to increase in FY 1998,
reflecting the addition of a new Chief Executive Officer and President, the
anticipated replacement of the Chief Financial Officer and increased travel
expenses on the part of senior management to reinforce the increased sales and
marketing efforts. General and Administrative expenses are expected to decrease
as a percentage of net revenue with increasing sales volume. There can be no
assurance, however, that such decrease will occur.
RESEARCH AND DEVELOPMENT. Research and development expenses increased 20% from
FY 1996 to $616,730 in FY 1997, reflecting additional technical personnel
dedicated to product development.
Research and development expenses increased from $461,675 in FY 1995 to
$512,541 in FY 1996 which reflected the Company's ongoing product development
efforts.
Research and development expenses are expected to increase in FY 1998 to
support the Company's development of new products.
NET LOSS. The net loss of $2,903,632 in FY 1997 represents an increase of
$1,598,357 from the $1,305,275 net loss in FY 1996, which was an increase of
$298,804 from the $1,006,471 net loss in FY 1995. The FY 1997 net loss resulted
from the decline in revenue with the resulting elimination of gross profits, the
transition from the exclusive Agreement with Valleylab, the costs of developing
an independent sales force, and the increased General and Administrative
expenses.
LIQUIDITY AND CAPITAL RESOURCES
To date, operating funds have been provided primarily by sales of Common
Stock and Warrants to purchase Common Stock, which totaled $17,287,682 through
March 31, 1997, and, to a lesser degree, funds provided by sales of the
Company's products. The Company used $2,283,765 of cash in its operations in
Fiscal Year 1997, $1,674,263 in Fiscal Year 1996, and $899,733 in FY 1995, which
relate primarily to the funding of the Company's annual net losses. The Company
raised $13,437,102, $1,469,239, and $1,408,000 from issuance's of its Common
Stock in each of Fiscal Years 1997, 1996 and 1995, respectively.
The Company anticipates that it will invest a significant amount of cash in
the development of its direct sales force, which will include substantial
amounts of training and an investment in demonstration equipment, and the
increased emphasis on marketing programs. The Company also anticipates that
such investments will generate increased sales and will ultimately lead to
profitable operations, although management does not anticipate that this level
of operations will be reached in FY 1998.
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
<PAGE>
hand and net cash provided by its sales will be sufficient to fund its
operations, working capital and capital requirements until at least March 31,
1998.
INCOME TAXES
Net operating loss carryforwards totaling approximately $6,298,304 are
available to reduce taxable income as of March 31, 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.
<PAGE>
ITEM 7. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The following financial statements are included in this Report:
Page
----
Independent Auditors' Report . . . . . . . . . . . . F-1
Consolidated Balance Sheets as of March 31, 1997
and 1996 . . . . . . . . . . . . . . . . . . . . . . F-2
Consolidated Statements of Operations for the
years ended March 31, 1997, 1996 and 1995. . . . . . F-3
Consolidated Statements of Stockholders' Equity for
the years ended March 31, 1997, 1996 and 1995. . . . F-4
Consolidated Statements of Cash Flows for the years
ended March 31, 1997, 1996 and 1995. . . . . . . . . F-5
Notes to Consolidated Financial Statements for the years
ended March 31, 1997, 1996 and 1995. . . . . . . . . F-6
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Electroscope, Inc.:
We have audited the accompanying balance sheets of ELECTROSCOPE, INC. (a
Colorado corporation) as of March 31, 1997 and 1996, and the related statements
of operations, shareholders' equity and cash flows for each of the three fiscal
years in the period ended March 31, 1997. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based 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 Electroscope, Inc. as of March
31, 1997 and 1996, and the results of its operations and its cash flows for each
of the three fiscal years in the period ended March 31, 1997, in conformity with
generally accepted accounting principles.
ARTHUR ANDERSEN LLP
Denver, Colorado,
June 10, 1997.
F-1
<PAGE>
ELECTROSCOPE, INC.
BALANCE SHEETS
MARCH 31, 1997 AND 1996
<TABLE>
<CAPTION>
ASSETS 1997 1996
---- ----
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents $ 527,015 $ 538,708
Short-term investments, net of discount of $138,573 (Note 2) 9,631,427 -
Accounts receivable, net of allowance for doubtful
accounts of $25,000 and $33,428, respectively 155,446 110,465
Inventory, net of reserve for obsolescence of $102,596
and $65,000, respectively 521,696 803,417
Prepaid expenses 110,777 -
------------- -------------
Total current assets 10,946,361 1,452,590
------------- -------------
EQUIPMENT, at cost:
Furniture, fixtures and equipment 503,871 304,735
Less- Accumulated depreciation (258,983) (111,265)
------------- -------------
Equipment, net 244,888 193,470
------------- -------------
PATENTS, net of accumulated amortization of $9,270 138,078 99,161
and $2,315 respectively
OTHER ASSETS 11,450 80,739
------------- -------------
Total assets $11,340,777 $1,825,960
------------- -------------
------------- -------------
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 327,682 $ 130,368
Accrued compensation 155,908 94,448
Other accrued liabilities 454,295 93,109
Customer deposits 20,223 116,521
Other current liabilities 6,639 6,639
------------- -------------
Total current liabilities 964,747 441,085
------------- -------------
LONG-TERM LIABILITIES:
Deferred revenue (Note 2) - 135,703
Other long-term liabilities 17,593 19,746
------------- -------------
Total long-term liabilities 17,593 155,449
------------- -------------
COMMITMENTS AND CONTINGENCIES (Notes 1, 4 and 6)
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,
5,389,986 and 3,893,402 shares outstanding, respectively 16,997,282 5,255,039
Warrants for common stock 290,400 -
Accumulated deficit (6,929,245) (4,025,613)
------------- -------------
Total shareholders' equity 10,358,437 1,229,426
------------- -------------
Total liabilities and shareholders' equity $11,340,777 $1,825,960
------------- -------------
------------- -------------
</TABLE>
The accompanying notes to financial statements are an
integral part of these statements.
F-2
<PAGE>
ELECTROSCOPE, INC.
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
For The Fiscal Year Ended March 31
----------------------------------------
1997 1996 1995
---------- ---------- ----------
<S> <C> <C> <C>
REVENUE, net $ 1,398,184 $ 2,173,785 $ 1,084,226
COST OF SALES 1,422,005 1,451,077 533,910
----------- ----------- -----------
Gross profit (loss) (23,821) 722,708 550,316
----------- ----------- -----------
OPERATING EXPENSES:
Sales and marketing 1,511,190 971,838 727,430
General and administrative 1,349,371 576,802 390,083
Research and development 616,730 512,541 461,675
----------- ----------- -----------
Total operating expenses 3,477,291 2,061,181 1,579,188
----------- ----------- -----------
INCOME (LOSS) FROM OPERATIONS (3,501,112) (1,338,473) (1,028,872)
OTHER INCOME:
Interest income 463,854 18,901 21,173
Other income 133,626 14,297 1,228
----------- ----------- -----------
NET INCOME (LOSS) $(2,903,632) $(1,305,275) $(1,006,471)
----------- ----------- -----------
----------- ----------- -----------
NET INCOME (LOSS) PER SHARE (Note 2):
Net income (loss) per common share and common
equivalent share $ (0.57) $ (0.33) $ (0.27)
----------- ----------- -----------
----------- ----------- -----------
Shares used in computing net income (loss) per
common share and common equivalent share 5,094,810 3,949,766 3,716,915
----------- ----------- -----------
----------- ----------- -----------
</TABLE>
The accompanying notes to financial statements
are an integral part of these statements.
F-3
<PAGE>
ELECTROSCOPE, INC.
STATEMENTS OF SHAREHOLDERS' EQUITY
FOR THE FISCAL YEARS ENDED MARCH 31, 1997, 1996 AND 1995
<TABLE>
<CAPTION>
Accumulated
Shares Amount Warrants Deficit Total
---------- ---------- ---------- ----------- ----------
<S> <C> <C> <C> <C> <C>
BALANCES, March 31, 1994 3,309,162 $ 2,383,877 $ - $(1,713,867) $ 670,010
Issuance of common stock for cash
($5.00 per share), net of offering costs
of $2,945, in September - December 1994 280,000 1,397,055 - - 1,397,055
Exercise of options for common stock for
cash ($2.50 per share), in September 1994 3,200 8,000 - - 8,000
Net income (loss) - - - (1,006,471) (1,006,471)
----------- ------------- ----------- ----------- ----------
BALANCES, March 31, 1995 3,592,362 3,788,932 - (2,720,338) 1,068,594
Issuance of common stock for cash
($6.00 per share), net of offering costs
of $3,132, in June 1995 - February 1996 200,000 1,196,868 - - 1,196,868
Exercise of options for common stock for
cash ($2.50 per share), in November 1995
and March 1996 67,762 169,405 - - 169,405
Exercise of warrants for common stock
for cash ($3.00 per share), in March 1996 33,278 99,834 - - 99,834
Net income (loss) - - - (1,305,275) (1,305,275)
----------- ------------- ----------- ----------- ----------
BALANCES, March 31, 1996 3,893,402 5,255,039 - (4,025,613) 1,229,426
Exercise of warrants for common stock for
cash ($3.00 per share), in April 1996 186,984 560,952 - - 560,952
Sale of common stock on initial public
offering in June 1996, net of offering
costs of $1,404,459 1,200,000 11,195,541 - - 11,195,541
Exercise of options for common stock for
cash ($2.50 per share), in April 1996-
December 1996 109,000 272,500 - - 272,500
Exercise of options for common stock for
cash ($6.00 per share), in September 1996 600 3,600 - - 3,600
Value of warrants to purchase common stock
for $12.50 per share, in conjunction with
initial public offering - - 290,400 - 290,400
Reduction of proceeds for value of warrants
issued in conjunction with initial
public offering (net of cash received) - (290,350) - - (290,350)
Net income (loss) - - - (2,903,632) (2,903,632)
----------- ------------- ----------- ----------- ----------
BALANCES, March 31, 1997 5,389,986 $16,997,282 $290,400 $(6,929,245) $10,358,437
----------- ------------- ----------- ----------- ----------
----------- ------------- ----------- ----------- ----------
</TABLE>
The accompanying notes to financial statements
are an integral part of these statements.
F-4
<PAGE>
ELECTROSCOPE, INC.
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
For The Fiscal Year Ended March 31
----------------------------------------
1997 1996 1995
---------- ---------- ----------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $(2,903,632) $(1,305,275) $(1,006,471)
Adjustments to reconcile net income (loss) to net
cash used in operating activities-
Depreciation and amortization 154,673 68,574 24,890
Amortization of discount, net (115,864) - -
Inventory reserve 37,596 55,000 -
Changes in operating assets and liabilities-
Accounts receivable (44,981) 15,034 73,138
Inventory 244,125 (487,131) (177,361)
Other assets (41,488) (49,983) (4,953)
Accounts payable 197,314 (116,288) 116,049
Accrued compensation and other accrued
liabilities 422,646 (91,242) 33,414
Customer deposits (96,298) 74,960 41,561
Deferred revenue (135,703) 135,703 -
Other liabilities (2,153) 26,385 -
---------- ---------- ----------
Net cash used in operating activities (2,283,765) (1,674,263) (899,733)
---------- ---------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of short-term investment, net of discounts (20,980,563) - -
Sale of short-term investments 11,465,000 - -
Purchases of equipment (199,136) (182,256) (57,706)
Patent costs (45,872) (26,608) (10,709)
---------- ---------- ----------
Net cash used in investing activities (9,760,571) (208,864) (68,415)
---------- ---------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock and warrants 13,437,102 1,469,239 1,408,000
Stock issuance costs (1,404,459) (3,132) (2,945)
---------- ---------- ----------
Net cash provided by financing activities 12,032,643 1,466,107 1,405,055
---------- ---------- ----------
NET (DECREASE) INCREASE IN CASH AND
CASH EQUIVALENTS (11,693) (417,020) 436,907
CASH AND CASH EQUIVALENTS,
beginning of period 538,708 955,728 518,821
---------- ---------- ----------
CASH AND CASH EQUIVALENTS, end of period $ 527,015 $ 538,708 $ 955,728
---------- ---------- ----------
---------- ---------- ----------
</TABLE>
The accompanying notes to financial statements
are an integral part of these statements.
F-5
<PAGE>
ELECTROSCOPE, INC.
NOTES TO FINANCIAL STATEMENTS
MARCH 31, 1997, 1996 AND 1995
(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
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 is detected
under potentially dangerous conditions. 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
The Company has incurred losses since its inception and has an accumulated
deficit of $6,929,245 at March 31, 1997. During fiscal year 1997, the 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. Other risks and uncertainties include 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 IPO was filed against the Company on June 4, 1997 (See Note 6).
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.
During fiscal years 1997, 1996 and 1995, Valleylab accounted for approximately
$1,145,900, $2,002,600 and $1,138,900 of the total sales revenue of
approximately $1,398,000, $2,215,900 and
F-6
<PAGE>
$1,196,400, respectively.
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
STOCK SPLIT
On March 26, 1996, the Company approved a two for one share common stock split
to be effective March 29, 1996. Common stock amounts, equivalent share amounts
and per share amounts have been adjusted retroactively for all periods presented
to give effect to this stock split.
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 March 31, 1997, the short-term investments consist
primarily of government securities which the Company classifies as
held-to-maturity.
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.
CONCENTRATION OF CREDIT RISK
The Company has no significant off-balance sheet concentrations of credit risk
such as foreign exchange contracts, options contracts or other foreign hedging
arrangements. The Company maintains the majority of its cash balances with two
financial institutions, in the form of demand deposits and short-term
investments, primarily government securities.
F-7
<PAGE>
The Company's accounts receivable balances are all domestic. The Company's
principal customer in 1997 and 1996, Valleylab, accounted for approximately 15%
and 74% of its total accounts receivable balance as of March 31, 1997 and 1996,
respectively.
INVENTORY
Inventories are stated at the lower of cost (first in, first out basis) or
market. At March 31, 1997 and 1996, inventory consisted of the following:
1997 1996
---------- ---------
Raw Materials $ 266,299 $286,331
Work in Process 225,353 437,856
Finished Goods 132,640 144,230
---------- ---------
624,292 868,417
Less - Reserve for Obsolescence (102,596) (65,000)
---------- ---------
$ 521,696 $803,417
---------- ---------
---------- ---------
EQUIPMENT
Equipment is stated at cost, with depreciation computed primarily on a
straight-line basis over the estimated useful life of the asset, generally three
to five years. Leasehold improvements are depreciated over the shorter of the
remaining lease term or the estimated useful life of the asset.
PATENTS
The costs of applying for patents are capitalized and amortized on a
straight-line basis over the lesser of the patent's economic or legal life
(17 years in the U.S.). Capitalized costs are expensed if patents are not
granted. The Company reviews the carrying value of its patents periodically
to determine whether the patents have continuing value.
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 are then reduced, if deemed necessary, by a valuation
allowance for the amount of any tax benefits which, more likely than not based
on current circumstances, are not expected to be realized (Note 5).
F-8
<PAGE>
REVENUE RECOGNITION
Revenue from product sales is recorded only when the product is shipped and the
earnings process is complete.
In September 1995, the Company received a $150,000 non-refundable payment from
Valleylab as part of the exclusive Distribution Agreement which was deferred and
was being recognized into income ratably over the term of the Distribution
Agreement. As Valleylab did not meet the minimum purchase requirements in
calendar year 1996 and the agreement has become non-exclusive, the remaining
balance of the non-refundable payment was recorded in income during the current
year.
STOCK BASED COMPENSATION
The Company has adopted the disclosure-only provisions of Statement of Financial
Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS
123"), but applies Accounting Principles Board Opinion No. 25, "Accounting for
Stock Issued to Employees" ("APB 25"), and related interpretations in accounting
for stock options granted to employees. The Company has made pro forma
disclosures of what net loss and net loss per common share would have been had
the provisions of SFAS 123, based upon the fair value method, been applied to
the Company's stock option grants (Note 3).
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 $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 fiscal year 1997, the
Company has reported earnings per share in accordance with Accounting Principles
Board Opinion No. 15, "Earnings per share."
F-9
<PAGE>
(3) SHAREHOLDERS' EQUITY
STOCK OPTION PLAN
In 1991, the Company adopted a stock option plan (the "Plan") to provide
directors, officers, other employees and consultants options to purchase shares
of the Company's common stock. Under the terms of the Plan, the Board of
Directors may grant either "nonqualified" or "incentive" stock options, as
defined by the Internal Revenue Code and related regulations. Under the terms
of the Plan, the purchase price of a nonqualified option may be less than the
then fair market value of the stock. The purchase price of the shares subject to
an incentive stock option will be the fair market value of the Company's common
stock on the date the option is granted. If the grantee owns more than 10% of
the total combined voting power or value of all classes of stock on the date of
grant, the purchase price of an incentive stock option shall be at least 110% of
the fair market value at the date of grant and the exercise term will be up to
five years from the date of grant. Generally, vesting of stock options is
either immediate or occurs such that 20% becomes exercisable at the date of
grant and 20% become exercisable each year thereafter. However, certain options
under the Plan vest after a specified period of time, and may be accelerated
based on achieving specified events. Generally, all incentive stock options
must be exercised within six years from the date granted. Other options granted
under the Plan are exercisable up to ten years from the date of grant, except as
otherwise determined. Through March 31, 1997, all nonqualified stock options
have been granted whereby they are exercisable up to eight years from the date
of grant.
In July 1995, the Company's Board of Directors and shareholders approved an
increase in the number of shares authorized under the Plan. The number of
shares authorized for incentive stock options was increased from 750,000 to
850,000 shares and the number of authorized shares for nonqualified stock
options was increased from 150,000 to 200,000 shares. On March 31, 1996 , the
Company's Board of Directors amended and restated the Plan, and designated an
additional 100,000 shares of the Company's common stock as reserved for future
issuance. This amendment was approved by the Company's shareholders on April
17, 1996.
On March 31, 1997 the Company's Board of Directors approved an increase of
500,000 in the number of shares authorized under the Plan, the shares to be
reserved for future issuance. This proposal will be presented to the
shareholders for their approval at the annual meeting of the Company.
STATEMENT OF FINANCIAL ACCOUNTING STANDARDS NO. 123
SFAS 123, "Accounting for Stock-Based Compensation," defines a fair value based
method of accounting for employee stock options or similar equity instruments.
However, SFAS 123 allows the continued measurement of compensation cost for such
plans using the intrinsic value method prescribed by APB 25, provided that pro
forma disclosures are made of net income or loss and net income or loss per
common share, assuming the fair value based method of SFAS 123 had been applied.
The Company has elected to account for its stock-based compensation plans for
employees under APB 25; accordingly, for purposes of the pro forma disclosures
presented below, the Company has computed the fair values of all options granted
during fiscal years 1997 and 1996, using the Black-Scholes option valuation
model and the following weighted average assumptions:
F-10
<PAGE>
1997 1996
---------- ----------
Risk-free interest rate 6.2 % 5.9 %
Expected lives 4.0 years 5.2 years
Expected volatility 56.065% 56.065%
Expected dividend yield 0% 0%
To estimate expected lives of options for this valuation, it was assumed options
will be exercised upon becoming fully vested at the end of four years. All
options are initially assumed to vest. Cumulative compensation cost recognized
in pro forma net income or loss with respect to options that are forfeited prior
to vesting is adjusted as a reduction of pro forma compensation expense in the
period of forfeiture. The volatility of the stock is based on the volatility of
the Company's stock since it has been publicly traded. Fair value computations
are highly sensitive to the volatility factor assumed; the greater the
volatility, the higher the computed fair value of options granted.
The total fair value of options granted was computed to be approximately
$173,848 and $1,173,848 for the years ended March 31, 1997 and 1996,
respectively. These amounts are amortized ratably over the vesting periods of
the options. Pro forma stock-based compensation, net of the effect of
forfeitures, was $193,564 and $120,665 for 1997 and 1996, respectively. Because
SFAS 123 has not been applied to options granted prior to March 31, 1995, the
resulting pro-forma compensation cost may not be representative of that to be
expected in future years. If the Company had accounted for its stock-based
compensation plans in accordance with SFAS 123, the Company's net loss and pro
forma net loss per common share would have been reported as follows:
Fiscal Year Ended
March 31,
-----------------------------
1997 1996
----------- --------------
Net Loss --
As reported $(2,903,632) $(1,305,275)
Pro forma $(3,097,196) $(1,425,940)
Pro Forma Net Loss per Common Share-
As reported $ (0.57) $ (0.33)
Pro forma $ (0.61) $ (0.36)
Weighted average shares used to calculate pro forma net loss per share were
determined as described in Note 2, except in applying the treasury stock method
to outstanding options, net proceeds assumed received upon exercise were
increased by the amount of compensation cost attributable to future service
periods and not yet recognized as pro forma expense.
The Black-Scholes option valuation model was developed for use in estimating the
fair value of traded options which have no vesting restrictions and are fully
transferable. In addition, option valuation models require the input of highly
subjective assumptions including the expected stock price volatility. Because
the Company's employee stock options have characteristics significantly
different than those of traded options, and because changes in the subjective
input assumptions can materially affect the fair value estimate, in management's
F-11
<PAGE>
opinion, the existing models do not necessarily provide a reliable single
measure of the fair value of its employee stock options.
The pro forma results may not be representative of the future impact of applying
SFAS 123 due to the phase-in provisions of the Statement and actual vesting
experience. A summary of the Company's stock option activity, and related
information for each of the three fiscal years ended March 31, 1997 is as
follows:
Weighted
Average
Exercise
Outstanding Price
----------- ---------
BALANCE, as of March 31, 1994 686,000 $2.59
Granted 182,800 $2.50
Exercised (3,200) $2.50
Canceled (10,000) $2.50
-------
BALANCE, as of March 31, 1995 855,600 $2.57
------- -----
------- -----
EXERCISABLE, as of March 31, 1995 340,467 $2.50
Granted 361,200 $5.92
Exercised (67,762) $2.50
Canceled (170,000) $2.85
--------
BALANCE, as of March 31, 1996 979,038 $3.76
------- -----
------- -----
EXERCISABLE, as of March 31, 1996 432,118 $3.03
Granted 62,000 $5.66
Exercised (109,600) $2.52
Canceled (208,038) $3.88
--------
BALANCE, as of March 31, 1997 723,400 $4.08
------- -----
------- -----
EXERCISABLE, as of March 31, 1997 368,720 $3.47
------- -----
------- -----
The weighted average exercise prices and weighted average fair values of options
granted during fiscal years 1997 and 1996 are as follows:
Fiscal Year 1997 Fiscal Year 1996
------------------------------ ----------------------------
Number of Fair Exercise Number of Fair Exercise
Options Value Price Options Value Price
------------------------------ ----------------------------
Exercise Price equal
to Market Price 62,000 $2.80 $5.66 361,200 $3.25 $5.92
F-12
<PAGE>
The following table summarizes information about employee stock options
outstanding and exercisable at March 31, 1997:
Options Outstanding Options Exercisable
------------------------------------- --------------------------
Number of Weighted
Options Average Weighted Number Weighted
Range of Outstanding Remaining Average Exercisable Average
Exercise At March 31, Contractual Exercise At March 31, Exercise
Prices 1997 Life in Years Price 1997 Price
- ------------ ------------- -------------- ---------- -------------- ------------
$2.50 382,600 2.24 $ 2.50 262,600 $2.50
$4.50-$6.00 328,800 3.84 $ 5.68 103,720 $5.75
$10.50 12,000 4.17 $10.50 2,400 $10.50
Of the 723,400 options for the Company's common stock at March 31, 1997, 172,200
represent nonqualified stock options and 551,200 represent incentive stock
options. The exercise price of all options granted through March 31, 1997 has
been equal to or greater than the fair market value, as determined by the
Company's Board of Directors or based upon publicly quoted market values of the
Company's common stock on the date of the grant. At March 31, 1997, options for
246,038 of the Company's common stock are available for grant under the plan.
PRIVATE PLACEMENT OFFERING
On May 10, 1995 the Company offered 200,000 shares of common stock at $6 per
share in a private placement in order to raise additional capital. The sale of
these shares was completed on February 28, 1996. This sale of common stock was
effected as a sale of units, each unit consisting of one share of common stock
and a two year warrant which allows the holder of such warrant to purchase
one-half of one share of the Company's common stock at a per share price of
$7.50. As of March 31, 1997 no warrants have been exercised. These warrants
expire on various dates ending February 28, 1998. No value was ascribed to the
warrants.
(4) COMMITMENTS AND CONTINGENCIES
The Company currently leases its office space under a noncancelable lease
agreement which requires payments of $7,966 per month from November 1, 1996
through October 31, 1997, and $8,435 per month from November 1, 1997 through
October 31, 1998, at which time the lease expires if not renewed by the Company.
Rent expense for the fiscal years ended March 31, 1997, 1996 and 1995 was
$116,011, $87,769 and $29,990 respectively.
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.
As a result of one such inspection in January-February 1994 the FDA issued a
Warning Letter to the Company, noting certain deficiencies of its Good
Manufacturing Practices ("GMP"). The Company believes it has adequately
addressed such deficiencies.
F-13
<PAGE>
The Company was last inspected in April 1995, and has not, at March 31, 1997,
been notified of any deficiencies from that inspection. FDA inspections are
conducted approximately every two years after approval is obtained or on a
more frequent basis, at the discretion of the FDA. The Company was granted
a Certificate to Foreign Government in December 1996 which states in part
that, based on the last periodic inspection, the Company was in substantial
compliance with current GMP.
Under the terms of the non-exclusive Distribution Agreement with Valleylab,
after 60 days written notice of termination of the Distribution Agreement,
Valleylab may sell for a period of six months any inventory of products held by
it at the date of termination. After such six month period, the Company has the
obligation to purchase from Valleylab products held in Valleylab's inventory, if
any, to the extent such products are saleable 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.
(5) INCOME TAXES
From its inception, the Company has generated losses for both financial
reporting and tax purposes. Deferred tax assets (approximately $2.2 million as
of March 31, 1997) for the Federal tax benefit of the net operating loss
carryforward and research and development carryovers have been completely offset
by a valuation allowance because the realization criteria set forth in SFAS
No. 109 are not currently satisfied, primarily due to the Company's history of
operating losses.
For income tax return reporting purposes, the Company may utilize approximately
$6.3 million of net operating loss carryforwards which expire, if not previously
utilized, at various dates beginning in the year 2006. The Tax Reform Act of
1986 contains 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. In addition, the Company also has certain
research and development tax credit forwards available to it.
The Company's effective tax rate differs from the Federal statutory tax rate
primarily due to non-deductible expenditures.
(6) LEGAL MATTERS
On June 4, 1997, a class action lawsuit was filed 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 Avrom 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.
F-14
<PAGE>
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 this litigation which has been
initiated in the United States District Court for the District of Minnesota.
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 of the loss of management
time needed to deal with the lawsuit. The Company's management is unable to
determine a possible range of loss, if any, at this time.
Various disputes arose between the Company and a former officer of the
Company during 1997. These disputes were resolved and a Settlement Agreement
was signed on May 5, 1997, effective March 2, 1997. The terms of the
resolution provided in general for the repurchase of common stock and other
securities held by the former Officer and for a severance package. The total
expenses to the Company related to the settlement were approximately
$275,000, all of which were accrued in fiscal year 1997.
(7) SUBSEQUENT EVENT
Effective May 5, 1997, the Company hired a Chief Executive Officer and
President. A provision of the employment agreement between the Company and the
Chief Executive Officer includes the award of 530,000 Incentive Stock Options
under the Company's Stock Option Plan. The majority of the options vest over a
three year period beginning June 30, 1998, while the balance of the options vest
based on the attainment of certain performance criteria for the 12 month periods
ending June 30, 1998 and 1999.
F-15
<PAGE>
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
There have been no disagreements between the Company and its independent
accountants on any matter of accounting principles or practices or financial
statement disclosure since the Company's inception.
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT
Information in response to this item is incorporated by reference from
the Registrant's Definitive Proxy Statement to be filed within 120 days after
the close of the Registrant's fiscal year.
ITEM 10. EXECUTIVE COMPENSATION.
Information in response to this item is incorporated by reference from
the Registrant's Definitive Proxy Statement to be filed within 120 days after
the close of the Registrant's fiscal year.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
Information in response to this item is incorporated by reference from
the Registrant's Definitive Proxy Statement to be filed within 120 days after
the close of the Registrant's fiscal year.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
Information in response to this item is incorporated by reference from
the Registrant's Definitive Proxy Statement to be filed within 120 days after
the close of the Registrant's fiscal year.
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits - The following exhibits are attached to this report on
Form 10KSB or are incorporated by reference:
...............................................
3.1 Articles of Incorporation of the Company, as amended (Incorporated by
reference from Registration Statement #333-4118-D dated June 25, 1996.)
3.2 Bylaws of the Company. (Incorporated by reference from Registration
Statement #333-4118-D dated June 25, 1996)
4.1 Form of certificate for shares of Common Stock. (Incorporated by
reference from Registration Statement #333-4118-D dated June 25, 1996)
10.1 Distribution Agreement dated September 8, 1995 between Electroscope, Inc.
and Valleylab Inc.(Incorporated by reference from Registration Statement
#333-4118-D dated June 25, 1996)
10.2 Lease Agreement dated September 11, 1995 between Electroscope, Inc. and
Sterling Partnership.(Incorporated by reference from Registration
Statement #333-4118-D dated June 25, 1996)
10.3 Electroscope, Inc. Stock Option Plan, as amended. (Incorporated by
reference from Registration Statement #333-4118-D dated June 25, 1996)
10.4 Employment Agreement dated May 5, 1997, with Patrick F. Crane.
11.1 Statement of computation of per share earnings.
(b) Reports on Form 8-K. No reports on Form 8-K were filed during the
last quarter of the period covered by this report.
E-1
<PAGE>
SIGNATURES
In accordance with the Exchange Act, the registrant caused this Report to
be signed on its behalf by the undersigned, thereunto duly authorized.
Dated: June 27, 1997. ELECTROSCOPE, INC.
By: /s/ PATRICK F. CRANE
----------------------------------------
Patrick F. Crane
Chief Executive Officer and President
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/ PATRICK F. CRANE
- -------------------------
Patrick F. Crane Chief Executive Officer (Principal
Executive Officer) and Director June 26, 1997
/s/ ROGER C. ODELL Chairman of the Board June 26, 1997
- ----------------------
Roger C. Odell
/s/ DAVID W. NEWTON Vice President, Research and
- ------------------------- Development and Director June 26, 1997
David W. Newton
/s/ MARCIA K. MCHAFFIE Controller (Principal Financial
- ------------------------- and Accounting Officer) June 26, 1997
Marcia K. McHaffie
/s/ DAVID AUTH Director June 24, 1997
- ----------------------
David Auth
/s/ DONALD R. TEMPLE Director June 23, 1997
- ----------------------
Donald R. Temple, M.D.
/s/ JOE W. TIPPETT Director June 23, 1997
- ----------------------
Joe W. Tippett, M.D.
Director June , 1997
- ----------------------
Robert D. Tucker, M.D.
/s/ C. RANDLE VOYLES Director June 23, 1997
- ----------------------
C. Randle Voyles, M.D.
E-2
<PAGE>
EMPLOYMENT AGREEMENT
This Agreement is entered into this 5th day of May, 1997 by and between
Electroscope, Inc., a Colorado corporation with its principal offices located at
4828 Sterling Drive, Boulder CO 80301 (hereinafter the "Company") and Patrick
Crane residing at 4453 Rustic Trail., Boulder CO 80301 (hereinafter the
"Officer").
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 (the "Business"). The Company desires to
secure and retain the services of Officer and such services are considered by
the Company to be valuable with regard to the Business. The Company, through
its Board of Directors, agrees to employ the Officer in the office of President
and Chief Executive Officer of the Company for the Term, and Officer agrees to
accept such employment and office upon the terms and conditions set forth
herein.
1. TERM. Subject to the provisions for renewal and termination as hereinafter
provided, the term of this Agreement shall commence on May 5, 1997 and
terminate on April 30, 1998. Officer shall be employed on a part-time basis
based upon time worked until May 18, 1997. This Agreement will be renewed
automatically, upon the same terms and conditions, for successive periods
of one year each, until either party at least sixty days prior to the
expiration of the original term or any extended term, shall give written
notice to the other of its intention not to renew such employment. Officer
shall remain an employee during the sixty day notice period. Any election
not to renew or to terminate by the Company shall be effected by a duly
adopted resolution of the Company's Board of Directors. Unless otherwise
stated, any notice of nonrenewal shall be treated as a termination without
cause. The obligations of the Officer under Sections 9 and 10 shall survive
termination or expiration of this Agreement. The obligations of the
Company under the Agreement that by their terms are to be paid or to
continue after termination of the Agreement, shall also survive such
termination or expiration.
2. DUTIES. The Company agrees to employ the Officer as President and Chief
Executive Officer of the Company and agrees to elect the Officer as a
member of the Board of Directors as of the date of this Agreement and for
so long as he is so employed. The responsibilities of the Officer shall be
as set forth in the Company's Bylaws attached hereto as Exhibit A, as
otherwise directed by the Company's Board of Directors and as more
specifically set forth in Section 3 of this Agreement. The Officer shall
report to the Board of Directors and all other officers of the Company
shall report to him or as he shall direct. The Officer shall have primary
accountability for the performance of the Company. He shall be responsible
for the overall revenue and profit of the Company; establishing short-term
and long-range objectives, plans and policies subject to the approval of
the Board of Directors. He shall be responsible for representing the
organization with major customers, the financial community, and the public.
If the overall revenue and profit of the Company is not satisfactory, as
determined by the Board of Directors, in no event shall this occurrence
give rise to justification for termination of the Officer for cause.
<PAGE>
3. OUTSIDE COMMITMENTS. The Officer shall not be constrained from
continuation of limited outside business commitments so long as such
commitments do not interfere or conflict with the performance of his duties
as President and Chief Executive Officer of the Company. It is recognized
that the Officer currently serves as a member of the Board of Directors of
Staodyn, Inc., a publicly traded company based in Longmont, CO. A prior
commitment exists to serve as a Board Member for a private company based in
Redwood City, California. Any additional outside business activities which
involve remuneration to the Officer, shall require the prior approval of
the Board of Directors. Such approval shall not be unreasonably withheld
so long as the outside commitment does not conflict with the Officer's
responsibilities to the Company.
4. COMPENSATION. For all services rendered by the Officer under this
Agreement, the Company shall pay to the Officer base cash compensation of
$150,000 for the first 12 month period. Beyond May 5, 1998 compensation is
subject to such increases as may be granted from time to time by the Board
of Directors, but in no event shall such increase be less than the average
percentage increase granted to the top ten salaried employees of the
Company, unless mutually agreed upon by Officer and the Company. Such
compensation shall be payable biweekly in equal installments. The Company
will provide life insurance of $300,000 payable to a beneficiary of the
Officer's choice, provided that Officer passes the physical examination
required for said insurance and the annual premium cost for said insurance
is less than $1,500. The Officer will be eligible for participation,
according to the eligibility requirements of the plans, for participation
in all other employee benefit programs including, but not limited to,
medical, dental, workers compensation and disability insurance, as well as
any 401(k) plan and existing or future pension or other employee benefits.
Any additional benefits desired by the Officer may be, at the Officer's
discretion, deducted from the base compensation in lieu of payment by the
Officer thereof.
STOCK OPTIONS. The Officer is hereby granted Incentive Stock Options to
purchase 330,000 shares of the Company's Common Stock. Of this amount,
Incentive Stock Options to purchase 130,000 shares will be subject to
shareholder approval of an increase in the Company's Stock Option Plan at
the annual shareholder's meeting to be held in 1997. In the event
shareholder approval of the increase in the Company's Stock Option Plan is
not obtained in 1997, the Incentive Stock Option to purchase 130,000 shares
will automatically convert into a Non-Statutory Stock Option to purchase
130,000 shares on the same terms and conditions. As long as the Officer is
employed by the Company, the options shall vest in three equal annual
increments commencing one year from the date of grant and shall expire
seven years from the date of initial grant. The option price shall be set
at the Fair Market Value of the Company's Common Stock on May 5, 1997.
Fair Market Value shall be defined as the closing bid price of the
Company's Common Stock.
STARTUP EXPENSES. In recognition of certain expenses associated with the
onset of this Agreement, the Officer shall receive a one time payment of
$40,000 on May 5, 1997. The Officer, at his sole discretion, may elect to
receive equivalent amounts of restricted shares of the Company's Common
Stock at 80% of Fair Market Value in lieu of cash compensation for this
payment.
2
<PAGE>
STOCK BONUS PLAN. The Officer is hereby granted two Incentive Stock
Options to purchase 100,000 shares each. The option grants are subject to
upon shareholder approval of an increase in the Company's Stock Option Plan
at the annual shareholder meeting to be held in 1997. In the event
shareholder approval of the increase in the Company's Stock Option Plan is
not obtained in 1997, the Incentive Stock Options will automatically
convert into Non-Statutory Stock Options and the performance criteria will
be waived. As long as the Officer is an employee, the options shall vest
as follows: linearly from 70,000 to 100,000 shares if the Company's gross
revenues exceed from $2.1 million to $3.0 million for the period July 1,
1997, through June 30, 1998; linearly from 70,000 to 100,000 shares if the
Company's gross revenues exceed from $3.85 million to $5.5 million for the
period July 1, 1998 through June 30, 1999. The calculation of gross
revenues for the periods shall be determined by the Company's auditors
according to GAAP.
DILUTION. If the Board of Directors sells additional shares of Common
Stock beyond those issued and outstanding as of April 30, 1997, other than
shares issued pursuant to the exercise of options granted under the
Company's Stock Option Plan, the Officer shall have the right, at his sole
discretion, to purchase his pro rata share of the newly issued shares at
the price as the newly offered shares. The intent of this provision is to
allow the Officer to maintain ownership, or an option position, on a
minimum percentage of the Company's common stock.
5. EXPENSES. The Officer shall be entitled to reimbursement for all
reasonable expenses including travel, entertainment and similar items which
may be incurred in connection with performance of his duties. Expenses
incurred by the Officer pursuant to this section will be reimbursed by the
Company upon presentation by the Officer from time to time of an itemized
account of such expenditures in a form reasonably acceptable to the
Company's chief financial officer or accounting manager. The Board of
Directors has the right to review these expenses at any time.
6. WORKING FACILITIES. The Officer shall be furnished with all such
facilities and services suitable to his position and adequate for the
performance of his duties at the Company's executive offices in Boulder,
Colorado. The Officer's principal business activities shall be at such
office or other location within 25 miles of Boulder, CO.
7. VACATION. The Officer shall be entitled each year to a vacation of four
weeks (20 days) per year, during which time his compensation will be paid
in full. Vacation shall accrue at a rate of 6.15 hours per payroll from
the date of hire. Unused vacation may carry over for one additional year,
but in no case shall the Officer have vacation accrued in excess of eight
weeks.
8. TERMINATION.
a) The Company may terminate this Agreement for cause at any time on 30
days written notice to the other party thereof. In any termination
for cause by the Company, "cause" shall mean: (i) gross misconduct,
such as, but not limited to dishonesty, theft or embezzlement with
regard to material property of the Company; (ii) excessive
3
<PAGE>
unauthorized absenteeism, after written notification from the Board of
Directors of such absenteeism, and the Officer's failure to cure the
problem; (iii) any of the following acts which have a material,
negative impact on the financial condition of the Company: (a) actual
fraud or other material acts of dishonesty in conducting the Company's
business or in the fulfillment by the Officer or his assigned
responsibilities; (b) the destruction of any material amount of the
Company's property willfully or through the Officer's gross neglect;
(c) the unauthorized willful disclosure of any Proprietary Information
of the Company to any person, business or entity in violation of this
Agreement or (d) a violation of internal controls or procedures. If
the Officer is terminated for cause as defined in this section, all
benefits and entitlements provided under this Agreement, including but
not limited to, the vesting of options and payment of compensation,
shall terminate as of the date of notification of termination for
cause.
b) If the Officer voluntarily terminates before May 5, 1998, the Officer
will be required to reimburse the Company the amount of $40,000. If
the Officer terminates this Agreement without cause at any time after
May 5, 1998, he shall provide 30 days notice to the Company and shall
be entitled to accrued salary, benefits through the notice period and
optional COBRA coverage as authorized by current law but he shall in
no event be entitled to severance pay or bonus compensation for the
period through the date of termination.
c) In the event of a change in control of the Company, regardless of
whether such control has received the endorsement or recommendation of
the Board of Directors of the Company, the Officer shall be paid
compensation as set forth in the Change of Control Agreement attached
to this Agreement as Exhibit B.
d) If the Company terminates the Officer without cause, the Officer shall
receive 24 months salary if such termination occurs prior to May 5,
1998. If such termination occurs subsequent to May 5, 1998, the
Officer shall receive no less than 12 months salary. Stock options to
purchase 330,000 shares will continue to vest during the 24 or 12
month period as defined above. The Officer shall have the option of
selecting regular biweekly payments or a lump sum payment within 30
days of the notice of termination without cause. Should the Officer
be terminated without cause prior to June 30, 1999, the 200,000 stock
options granted in Section 4 under Stock Bonus Plan will vest
contingent on Company performance for the period from July 1 to the
end of any interim quarterly period immediately prior to the date of
termination as reported to the Securities and Exchange Commission.
The Officer will be entitled to a prorated amount of options based
upon meeting a prorated gross earnings level for the period. For
example, should termination occur on or after April 2, 1999, options
will be granted to purchase 75,000 shares if the Company's gross
revenues exceed $4,125,000 for the nine month period ended March 31,
1999. Likewise, should termination occur on or after October 1, 1998,
options will be granted to purchase 50,000 shares if the Company's
gross revenues exceed $1,375,000 for the quarter ended September 30,
1998.
4
<PAGE>
9. NONCOMPETITION AGREEMENT. Officer acknowledges that the Company has trade
secrets and confidential information that, as President and Chief Executive
Officer, he will have access to all such trade secrets and confidential
information. Therefore, in consideration for the severance benefits set
forth above, the Officer agrees that for a period of the greater of (i) six
months subsequent to the Termination Date or (ii) the severance pay period
provided for in Section 8d), the Officer will not, directly or indirectly:
a) Call upon any person or entity which was a customer of the Company
immediately prior to the Termination Date for the purpose of
diverting, taking away business of, or selling products or services
competitive with significant products or services provided by the
Company on the Termination Date.
b) Alone or in any capacity solicit or in any manner to solicit or induce
any persons or persons employed by the Company within one year prior
to the Termination Date to leave such employment.
c) Within the United States of America, either as an employee, employer,
consultant, agent, principal, partner, more that 5% shareholders,
corporate officer, director, or in any other individual or
representative capacity, engage or participate in any business that
designs, develops, manufactures or markets electrosurgical products,
electrosurgical instruments, laser surgical products or instruments,
or the harmonic scalpel, or that is in competition in any significant
manner with any Material Business conducted by the Company subsequent
to the date of this Agreement and in which the Company is involved on
the Termination Date. Material Business shall be defined as that
business which comprises in excess of 20% of the Company's revenue for
the prior 12-month period.
10. NONDISCLOSURE OF PROPRIETARY INFORMATION. In view of the fact that
Officer's employment by the Company will bring him into contact with
certain confidential matters of the Company, its customers and suppliers,
including, without limitation, matters of a technical nature (such as
information about costs, profits, markets, price lists, sales, data files,
mailing lists and lists of customers) and any other information of a
similar nature to the extent not available to the public (the "Confidential
Matters"), Officer agrees not to disclose, either during his employment or
for a period of three years thereafter, any Confidential Matters of the
Company, whether or not developed, to any person except with the Company's
prior written consent and then only after such person has signed an
agreement similar to this Agreement, or an agreement approved by the
Company prior to such disclosure. In the event that the Board of Directors
determines that the Officer possesses a significant Confidential Matter in
the nature of a trade secret or other proprietary information that will not
be in the public domain at the end of the three year period, upon written
notification from the Board of Directors prior to the end of the three year
period, the Officer agrees to keep that matter confidential indefinitely.
In the event Officer has some question as to whether or not certain
information is covered by this paragraph, Officer shall treat the
information as within this paragraph until told otherwise by the Company,
in writing. Officer further agrees to deliver to the Company, on the date
of termination of his employment, for whatever reason, all
5
<PAGE>
memoranda, notes, records, reports, manuals, drawings, sketches,
blueprints, bulletins, writings, proposals, notebooks, manuals and other
documents containing confidential information of the Company, including
all copies or summaries thereof, which Officer may possess or have in his
control.
It is agreed that Officer's services to the Company and his knowledge of
the Company's activities are unique in that any breach or threatened breach
by Officer of this Section cannot be remedied solely by damages.
Accordingly, the breach of, or threatened breach by, Officer of the
provisions of this Section shall allow the Company to seek injunctive
relief restraining the Officer and any business, firm, partnership, or
corporation from participating in such breach or anticipated breach, or
engaging in any activity which shall constitute a breach of the provisions
of this Section. The Company shall also have the right to bring an action
to obtain monetary damages to which it may be entitled from Officer or any
party who is involved in the use or dissemination of such confidential
information.
11. OFFICER INDEMNIFICATION. Attached hereto as Exhibit C is an agreement to
hold harmless and to indemnify the Officer from claims made by third
parties or by shareholders on behalf of the Company against the Officer
and/or the Company to the fullest extent allowable under Colorado law for
all actions or omissions by the Officer in his position with the Company.
The Company agrees to reimburse Officer up to $1,500 annually for the
premium cost of any umbrella liability insurance policy purchased by the
Officer which covers any such claims which may be made against him in
connection with his positions with the Company.
12. NOTICES. All notices and other communications hereunder shall be in
writing and shall be deemed to have been duly given or delivered if (i)
delivered personally; (ii) mailed by certified mail, return receipt
requested, with property postage prepaid; or (iii) delivered by recognized
courier contracting for same day or next day delivery with signed receipt
acknowledgment to the Company or the Officer.
If to the Company: Board of Directors
Electroscope, Inc.
4828 Sterling Drive
Boulder, CO 80301
If to the Officer: Patrick Crane
4453 Rustic Tr.
Boulder, CO. 80301
or at such other address as either party may specify from time to time in
writing to the other.
13. ASSIGNMENT OF INVENTIONS. The Officer agrees to assign patent rights
related to medical products developed during the term of this Agreement to
the Company. Should the Company, by agreement of the Board of Directors,
waive their right to assignment of any given patent, the Officer will
retain ownership of said intellectual property.
6
<PAGE>
14. ARBITRATION. Except as provided below, any and all disputes arising under
or related to this Agreement which cannot be resolved through negotiations
between the parties shall be submitted to binding arbitration. If the
parties fail to reach a settlement of their dispute within fifteen (15)
days after the earliest date upon which one of the parties notified the
other(s) of its desire to attempt to resolve the dispute, then the dispute
shall be promptly submitted to arbitration by a single arbitrator through
the Judicial Arbiter Group ("JAG"), any successor of the JAG, or any
similar arbitration provider who can provide a former judge to conduct such
arbitration if JAG is no longer in existence. The arbiter shall be
selected by JAG on the basis, if possible, of his or her expertise in the
subject matter(s) of the dispute. The decision of the arbitrator shall be
final, nonappealable and binding upon the parties, and it may be entered in
any court of competent jurisdiction. The arbitration shall take place in
Boulder, Colorado. The arbitrator shall be bound by the laws of the State
of Colorado applicable to the issues involved in the arbitration and all
Colorado rules relating to the admissibility of evidence, including,
without limitation, all relevant privileges and the attorney work product
doctrine. All discovery shall be completed in accordance with the time
limitations prescribed in the Colorado rules of civil procedure, unless
otherwise agreed by the parties or ordered by the arbitrator on the basis
of strict necessity adequately demonstrated by the party requesting an
extension of time. The arbitrator shall have the power to grant equitable
relief where applicable under Colorado law, and shall be entitled to make
an award of punitive damages when applicable under Colorado law. The
arbitrator shall issue a written opinion setting forth his or her decision
and the reasons therefor within thirty (30) days after the arbitration
proceeding is concluded. The obligation of the parties to submit any
dispute arising under or related to this Agreement to arbitration as
provided in this Section shall survive the expiration or earlier
termination of this Agreement. Notwithstanding the foregoing, either party
may seek and obtain an injunction or other appropriate relief from a court
to preserve or protect trademarks, trade names, copyrights, patents, trade
secrets or other intellectual property or confidential information or to
preserve the status quo with respect to any matter pending conclusion of
the arbitration proceeding, but no such application to a court shall in any
way be permitted to stay or otherwise impede the progress of the
arbitration proceeding.
In the event of any arbitration or litigation being filed or instituted
between the parties concerning this Agreement, the prevailing party will be
entitled to receive from the other party or parties its attorneys' fees,
witness fees, costs and expenses, court costs and other reasonable
expenses, whether or not such controversy, claim or action is prosecuted to
judgment or other form of relief.
15. GENERAL PROVISIONS. This Agreement shall be governed by and construed
under the laws of the state of Colorado, withing giving effect to its
conflict of law principles. The terms of this Agreement shall be binding
upon and inure to the benefit of the Company and its successors and
assigns. Neither party may assign his or its obligations under this
Agreement to any other party.
16. SEVERABILITY. If any provision of this Agreement is held to be invalid or
unenforceable by any court of competent jurisdiction, such holdings shall
not affect the enforceability of any other provision of this Agreement, and
all other provisions shall continue in full force and effect.
7
<PAGE>
IN WITNESS WHEREOF, the parties have executed this Agreement as of the day and
year first above written.
The Officer: The Company:
Electroscope, Inc.
/s/ PATRICK CRANE By: /s/ DR. DONALD R. TEMPLE
- ----------------------------------- ------------------------------
Patrick Crane Dr. Donald R. Temple
Management Committee Member
By: /s/ ROGER ODELL
------------------------------
Roger Odell
Management Committee Member
By: /s/ DR. WAYNE J. TIPPETT
------------------------------
Dr. Wayne J. Tippett
Management Committee Member
8
<PAGE>
CONFIDENTIAL
DIRECTOR AND OFFICER INDEMNIFICATION AGREEMENT
THIS AGREEMENT is made effective as of May 5th, 1997, between Electroscope,
Inc., a Colorado corporation ("THE CORPORATION") and Patrick Crane
("INDEMNITEE").
WITNESSETH THAT:
WHEREAS, Indemnitee is a Director, officer, employee or agent of the
Corporation and/or is serving in such a capacity with another enterprise at the
request of the Corporation, and in each such capacity is performing a valuable
service from which the Corporation receives a benefit;
WHEREAS, the Board of Directors of the Corporation have adopted Bylaws (the
"BYLAWS") providing for the indemnification of the officers, directors, agents,
and employees of the Corporation and those who serve in such capacities with
other enterprises to the maximum extent authorized by the Colorado Business
Corporation Act, as amended to date or hereafter amended, and any successor or
similar statute concerning the indemnification of indemnitees (the "STATE
STATUTE"); and
WHEREAS, the Articles of Incorporation of the Corporation, (the
"CERTIFICATE") as in effect on the date hereof, do not prohibit any form of
Indemnification.
WHEREAS, such Bylaws, and the State Statute as in effective on the date
hereof, specifically provide that they are not exclusive in at least certain
respects, and thereby contemplate that contracts may be entered into between the
Corporation and the members of its Board of Directors and/or Officers with
respect to indemnification of such persons; and
WHEREAS, although authorized to do so by the State Statute as in effect on
the date hereof, the Corporation has not purchased, does not presently maintain
and does not presently intend to purchase and maintain a policy or policies of
Directors and Officers Liability Insurance ("D & O INSURANCE") due to the
restrictive terms and difficulty in offering suitable D & O Insurance; and
WHEREAS, the Corporation is concerned about recent developments with
respect to the application, amendment and enforcement of statutory and bylaw
indemnification provisions, all of which generally have raised questions
concerning the adequacy and reliability of the protection afforded to
indemnitees thereby; and
WHEREAS, in order to resolve such questions and thereby induce Indemnitee
to continue to serve in one or more of the above described capacities, the
Corporation has determined and agreed to enter into this contract with
Indemnitee;
<PAGE>
NOW THEREFORE, in consideration of Indemnitees continued service as a
Director and/or officer after the date hereof, the parties agree as follows:
1. INDEMNITY OF INDEMNITEE. The Corporation hereby agrees to defend,
hold harmless and indemnify (collectively "INDEMNIFY") Indemnitee to the full
extent authorized or permitted by the provisions of the State Statute, or other
state, federal or other statutory, or regulatory provisions from time to time in
effect authorizing or permitting such indemnification (collectively "OTHER
LAWS"), or any provision in the Articles as in effect from time to time, or the
Bylaws. Provided, however, that an amendment to State Statute (except as
specifically mandated by such amendment), Other Laws (except as specifically
mandated by such amendment), the Articles, or the Bylaws, shall not: (i) reduce
any rights or benefits of Indemnitee existing under this Agreement; or (ii)
reduce any rights or benefits of Indemnitee concerning indemnification in any
State Statute, Other Laws, Certificate or Bylaws, as in effect after the date of
this Agreement but before the particular amendment.
2. INSURANCE AND SELF INSURANCE.
(a) The Corporation represents that it presently does not have in
force and effect policies of D & 0 Insurance because of the disproportionate
cost and limited benefits of such insurance coverage.
(b) The Corporation shall inform Indemnitee of the terms of any such
insurance acquired in the future and endeavor to provide Indemnitee at least
fifteen (15) days advance notice of any change in, or termination of, such
insurance (if any).
3. ADDITIONAL INDEMNITY. Subject only to the exclusions set forth in
Section 4 hereof, the Corporation hereby further agrees to indemnify Indemnitee:
(a) Against: (i) Expenses (as defined below); and (ii) judgments,
fines (including an excise tax assessed with respect to an employee benefit
plan) and amounts paid in settlement (collectively "LIABILITIES"), actually
incurred by Indemnitee in connection with any threatened, pending or completed
action, suit, arbitration, mediation, or proceeding, whether civil, criminal,
administrative or investigative, whether formal or informal (including an action
by or in the right of the Corporation) (collectively "CLAIM") to which
Indemnitee is, was or at any time becomes, a party, or is threatened to be made
a party, by reason of the fact that Indemnitee is, was or at any time becomes a
director, officer, employee, fiduciary, trustee, or agent of the Corporation or
is or was serving or at any time serves at the request of the Corporation as a
director, officer, partner, employee, fiduciary, trustee, or agent of any other
foreign or domestic corporation, or any partnership, joint venture, trust,
limited liability company, other enterprise or employee benefit plan; and
2
<PAGE>
(b) Otherwise to the fullest extent as may be provided to Indemnitee
by the Corporation under the nonexclusivity provisions of the Bylaws, pursuant
to the non-exclusivity provisions in the Articles, and under the State Statute
and Other Laws.
(c) Indemnitee shall also be entitled to payment (subject to any tax
or other governmental or benefit plan withholding requirements) at his or her
normal equivalent rate of compensation for all time spent in preparing for the
defense of or in defending, or in connection with preparation in anticipation
of, a claim, or in connection with discovery (as a witness or otherwise),
concerning any Claim, including but not limited to any deposition, interrogatory
or discovery request, unless Indemnitee is otherwise being compensated as a full
time employee of the Corporation. In any event, however, such compensation
shall be at a rate of not less than $15.00 per hour or more than $100.00 per
hour.
(d) Expenses incurred by Indemnitee which are indemnifiable by the
Corporation, shall be advanced by the Corporation to Indemnitee upon: (i)
execution of an undertaking by Indemnitee to the Corporation to repay such
advances if he is found not to be entitled to indemnification of Expenses, which
undertaking shall include an representation that he believes he is entitled to
indemnification under the terms hereof and applicable law; and (ii) presentation
of proper invoices (including requests for retainers not yet paid) to be paid by
the Corporation. Provided, however, that the repayment obligation in this
subparagraph shall apply only as to the specific amounts for which
indemnification is found improper.
(e) Amounts to be indemnified hereunder include all interest,
assessments and other charges paid or payable in connection with, or in respect
of, Expenses and other Liabilities. Amounts advanced by the Corporation shall
include reasonable retainers and other prepayments required by third parties.
(f) "EXPENSES" include any and all actually and reasonably incurred
expenses (including attorneys and expert witness fees and expenses, bonding
costs, telephone, travel and delivery fees, witness fees, transcript and court
costs, and other costs) concerning or related to a Claim, including in
preparation of the defense of anticipated Claims not yet asserted, of a type
typically or reasonably incurred in proceedings or events similar to those of
the nature of the Claim.
4. LIMITATIONS ON ADDITIONAL INDEMNITY. No indemnity pursuant to Section
3 hereof shall be paid by the Corporation:
(a) In respect to remuneration paid to Indemnitee if it shall be
determined by a final judgment, or other final adjudication that such
remuneration was in violation of law (the inability of the Corporation to deduct
the remuneration from its Federal or any state or other taxable income or other
tax effect, shall not be considered a violation of law for purposes of this
provision);
3
<PAGE>
(b) On account of any suit in which judgment is rendered against a
Indemnitee for an accounting of profits made from the purchase or sale by
Indemnitee of securities of the corporation pursuant to the provisions of
Section 16(b) of the Securities Exchange Act of 1934 and amendments thereto or
similar provisions of any federal, state or local law;
(c) On account of Indemnitee's conduct which is finally adjudged to
have been knowingly fraudulent, deliberately dishonest or knowingly willful
grossly inappropriate misconduct; or
(d) If a final decision by a Court or arbitration body under this
Agreement having jurisdiction in the matter shall determine that such
indemnification is not lawful.
5. PROCEDURE FOR SEEKING INDEMNIFICATION.
(a) The Corporation shall indemnify Indemnitee as soon as possible
after a written demand is properly presented by Indemnitee to the Corporation,
but in any event within thirty (30) days of such demand.
(b) Notwithstanding the foregoing, the Corporation shall reimburse or
advance all Expenses within ten (10) days after written demand is properly
presented by Indemnitee to the Corporation.
(c) All decisions as to indemnification shall be made by the
Reviewing Party (as defined below) except that (i) this provision does not
permit the Corporation to not comply with any indemnification obligation more
favorable to Indemnitee which it may have by State Statue, Other Laws, By-law or
the Articles, and (ii) the Chief Financial Officer or Company controller shall
be entitled to authorize the Corporation to make indemnification payments
(including advances of Expenses) other than to himself or herself of up to
$10,000 in the aggregate to Indemnitee without action of Reviewing Party,
provided, however, that such amount shall be immediately repaid by Indemnitee if
Reviewing Party determines such amount should not have been so paid.
(d) Nothing herein prohibits Indemnitee from applying for
indemnification with a Court or arbitration body.
6. CONTINUATION OF INDEMNITY. All agreements and obligations of the
Corporation to Indemnitee in any capacity contained herein shall continue during
the period Indemnitee holds the position for which he or she would be entitled
to indemnification hereunder and shall continue thereafter so long as Indemnitee
shall be subject to any possible Claim by reason of the fact that Indemnitee was
a director and/or officer of the Corporation or served in any other capacity
referred to herein as entitling such person to indemnification hereunder.
4
<PAGE>
PROVIDED, HOWEVER, THAT THE CORPORATION MAY TERMINATE THIS AGREEMENT
ON A DATE (THE "TERMINATION DATE") NOT LESS THAN TEN (10) DAYS AFTER NOTICE OF
TERMINATION IS GIVEN TO THE INDEMNITEE, AS TO EVENTS WHICH FIRST OCCUR AND AS TO
WHICH NO CLAIM MAY BE MADE FOR ANY TIME PRIOR TO THE "TERMINATION DATE" IN THE
FOLLOWING FASHION: (1) If Indemnitee is not a Director of the Corporation, the
Corporation may terminate this Agreement with the above affect by notice to the
Indemnitee; (2) If Indemnitee is a Director of the Corporation, the Corporation
may terminate this Agreement with the above affect by notice to the Indemnitee
IF all other Directors of the Corporation are similarly no longer entitled to
rights of indemnification as a matter of agreement with the Corporation or its
affiliates or all Directors of the Corporation are offered the same new or
restated rights of indemnification from the Corporation.
7. NOTIFICATION AND DEFENSE OF CLAIM. Within fifteen (15) calendar days
after receipt by Indemnitee of notice of the commencement of any action, suit or
proceeding, Indemnitee will, if a claim in respect thereof is to be made against
the Corporation under this Agreement, notify the Corporation of the commencement
thereof; but the omission so to notify the Corporation will not relieve the
Corporation from any liability which it may have to Indemnitee otherwise than
under this Agreement. With respect to any such action, suit or proceeding as to
which Indemnitee notifies the Corporation of the commencement thereof:
(a) the Corporation will be entitled to participate therein at its
own expense; and
(b) Except as otherwise provided below, to the extent that it may
wish, the Corporation jointly with any other indemnifying party similarly
notified will be entitled to assume the defense thereof, with counsel
satisfactory to Indemnitee. Indemnitee will not unreasonably withhold its
acceptance of any such counsel. After notice from the Corporation to Indemnitee
of its election so to assume the defense thereof, the Corporation will not be
liable to Indemnitee under this Agreement for any legal expenses or legal fees
subsequently incurred by Indemnitee in connection with the defense thereof other
than reasonable costs and fees of investigation and monitoring of the
proceedings or as otherwise provided below. Indemnitee shall have the right to
employ its own counsel in such action, suit or proceeding, but the fees and
expenses of such counsel incurred after notice from the Corporation of its
assumption of the defense thereof shall be at the expense of Indemnitee unless:
(i) the employment of counsel by Indemnitee has been authorized by the
Corporation; or (ii) Indemnitee shall at any time have reasonably concluded that
there may be a conflict of interest between the Corporation and Indemnitee in
the conduct of the defense of such action; or (iii) the Corporation shall not in
fact have employed counsel to assume the defense of such action; in each of
which cases the fees and expenses of counsel shall be at the expense of the
Corporation. The Corporation shall not be entitled to assume the defense of any
action, suit or proceeding brought by or on behalf of the Corporation or as to
which Indemnitee shall have made the conclusion provided for in (ii) above.
5
<PAGE>
(c) The Corporation shall not be required to indemnify Indemnitee
under this Agreement for any amounts paid in settlement of any Claim effected
without the Corporations' written consent. The Corporation shall not settle any
action or claim in any manner which would impose any penalty or limitation on
Indemnitee without Indemnitee's written consent. Neither the Corporation nor
Indemnitee will unreasonably withhold their consent to any proposed settlement.
If the Corporation refuses its consent for a settlement, and the ultimate
judgment or settlement is less advantageous to Indemnitee, as an obligation
separate from any other obligation herein the Corporation shall promptly pay the
difference in value to Indemnitee.
8. REPAYMENT OF EXPENSES. Indemnitee will reimburse the Corporation for
all reasonable expenses paid by the Corporation in defending any civil or
criminal action, suit or proceeding against Indemnitee in the event and only to
the extent that it shall be ultimately determined that Indemnitee is not
entitled to be indemnified by the Corporation for such expenses.
9. INDUCEMENT TO SERVE. The Corporation expressly confirms and agrees
that it has entered into this Agreement and assumed the obligations imposed on
the Corporation hereby in order to induce Indemnitee to continue as a director
and/or officer of the Corporation, or in such other capacity as Indemnitee is
entitled to indemnification hereunder, and acknowledges that Indemnitee is
relying upon this Agreement in continuing such capacity.
10. SEPARABILITY. Each of the provisions of this Agreement is a separate
and distinct agreement and independent of the others, so that if any provision
hereof shall be held to be invalid or unenforceable for any reason, such
invalidity or unenforceability shall not affect the validity or enforceability
of the other provisions hereof.
11. INTEREST. Any amounts owed hereunder by the Corporation to Indemnitee
shall bear simple interest from the date the request for reimbursement in a
specific amount was properly submitted to the Corporation by Indemnitee to the
date reimbursement is made. The rate of such interest shall be the "Prime Rate"
as reported in the Money Rates section of the Wall Street Journal, or, if such
rate is not available, the "Base Rate" reported by Bank One, Boulder, CO, in
each case being adjusted on the first calendar day of each calendar month to the
rate as in effect on the preceding business day. Provided, however, that no
interest shall be owing on principal amounts of $100,000 or less that are
outstanding for less than thirty (30) days.
12. INDEMNIFICATION FOR ADDITIONAL EXPENSES.
(a) The Corporation shall indemnify Indemnitee against any and all
expenses (including attorneys' and expert witness fees and expenses) and, if
requested by Indemnitee, shall (within five (5) business days of such request)
advance such expenses to Indemnitee, which are reasonably incurred by Indemnitee
in connection with any claim asserted or action brought by Indemnitee for
recovery under any D & 0 Insurance maintained by the corporation, regardless of
whether Indemnitee ultimately is determined to be entitled to such
indemnification, advance expense
6
<PAGE>
payment or insurance recovery, as the case may be, unless and to the extent a
court or arbitration body determines such claim was frivolous.
(b) In the sole and absolute discretion of the Reviewing Party which
is not Independent Counsel, the Corporation may provide contribution to
Indemnitee in any circumstance set forth in any portion of this Agreement in
which the Corporation would be prohibited from providing indemnification.
(c) No provision herein permits the Corporation to deny contribution
to which Indemnitee may otherwise be entitled.
13. PARTIAL INDEMNITY, ETC. If Indemnitee is entitled under any provision
of this Agreement to indemnification by the Corporation for a portion of the
Expenses or other indemnification, but not, however, for all of the total
thereof, the Corporation shall nevertheless indemnify Indemnitee for the portion
thereof to which Indemnitee is entitled. Moreover, notwithstanding any other
provision of this Agreement, to the extent that Indemnitee has been successful
on the merits or otherwise in defense of any or all Claims or in defense of any
issue or matter therein, including dismissal without prejudice, Indemnitee shall
be indemnified, to the extent permitted by law, against all Expenses incurred in
connection with such Claim.
14. BURDEN OF PROOF. In connection with any determination by the
Reviewing Party or otherwise as to whether Indemnitee is entitled to be
indemnified hereunder the burden of proof shall be on the Corporation to
establish that Indemnitee is not so entitled.
15. NO PRESUMPTION. For purposes of this Agreement, the termination of
any claim, action, suit or proceeding, whether civil or criminal, by judgment,
order, settlement (whether with or without court approval) or conviction, or
upon a plea of nolo contenders, or its equivalent, is not of itself
determinative, and shall not create a presumption, that Indemnitee did not meet
any particular standard of conduct or have any particular belief or that a court
or other body has determined that indemnification is not permitted by applicable
law.
16. NONEXCLUSIVITY, ETC. The rights of the Indemnitee hereunder shall be
in addition to any other rights Indemnitee may have under the Bylaws, the
Articles, State Statute, Other Laws or otherwise. To the extent that a change
in applicable law (whether by statute or judicial decision) permits greater
indemnification by agreement than would be afforded currently under the Bylaws,
Articles, Other Laws, State Statute and this Agreement, it is the intent of the
parties hereto that Indemnitee shall enjoy by this Agreement the greater
benefits so afforded by such change.
17. LIABILITY INSURANCE. If the Indemnitee is an Officer or Director of
the Corporation, to the extent the Corporation maintains D & 0 Insurance,
Indemnitee shall be provided coverage by such policy or policies, in accordance
with its or their terms, to the maximum extent
7
<PAGE>
reasonably possible, at least equal to the coverage provided to any other
Director or Officer of the Corporation.
18. SUBROGATION. In the event of payment under this Agreement to
Indemnitee, the Corporation shall be subrogated to the extent of such payment to
all of the rights of recovery of Indemnitee, who shall execute all papers
required and shall do everything that may be necessary to secure such rights,
including the execution of such documents necessary to enable the Corporation
effectively to bring suit to enforce such rights. The Corporation shall pay
over to Indemnitee any recovery under its subrogation rights (whether under this
Agreement or otherwise) to the extent Indemnitee does not fully recover all sums
to which it is entitled in respect of the matters from which the subrogation
claim arose. It is the intent of this Section that Indemnitee receive a
recovery of all his or her Expenses and Liabilities before the Corporation
receives any recovery in respect of its subrogation rights.
19. NO DUPLICATION OF PAYMENTS. The Corporation shall not be liable under
this Agreement to make any payment in connection with any Claim made against
Indemnitee to the extent Indemnitee has otherwise actually received and is
entitled to retain full payment (under any insurance policy, By-law, Articles,
State Statute, Other Laws or otherwise) of the amounts otherwise indemnifiable
hereunder.
20. SPECIFIC PERFORMANCE. The parties recognize that if any provision of
this Agreement is violated by the Corporation Indemnitee may be without an
adequate remedy at law. Accordingly, in the event of any such violation,
Indemnitee shall be entitled, if Indemnitee so elects, to institute proceedings,
in law, at equity or otherwise, to obtain damages, to enforce specific
performance, to enjoin such violation, or to obtain any other relief or any
combination of the foregoing as Indemnitee may elect to pursue.
21. COOPERATION. Except to the extent such action would not be in the
best interest of Indemnitee, Indemnitee shall cooperate with the Corporation in
the defense of Claims asserted by persons other than the Corporation or its
affiliates or associates.
22. NO AMENDMENT OF ARTICLES OR BYLAWS. No amendment to the Articles or
Bylaws shall be effective to reduce the rights or benefits of Indemnitee herein,
and the Corporation hereby agrees not to adopt any amendment to its Articles or
Bylaws to attempt to reduce such rights or benefits. The Corporation will not
avoid or reduce the effectiveness of this provision by merging, consolidating or
otherwise adopting governing documents with such effect, provided, however, that
the only remedy of an Indemnitee for a breach of this sentence shall be a claim
for damages and Indemnitee shall have no claim to specific performance or to
enjoin such corporate event described in this sentence.
8
<PAGE>
23. GOVERNING LAWS: BINDING EFFECT: AMENDMENT AND TERMINATION;
DEFINITIONS; GOOD FAITH; INTERPRETATION; NOTICE.
(a) THIS AGREEMENT SHALL BE INTERPRETED AND ENFORCED IN ACCORDANCE
WITH THE LAWS OF THE STATE OF COLORADO APPLICABLE TO CONTRACTS ENTERED INTO IN
THAT STATE BETWEEN RESIDENTS OF THAT STATE, WHICH IS TO BE WHOLLY PERFORMED IN
THAT STATE. The parties recognize the importance and reasonableness of this
provision as the Corporation is a Colorado corporation.
(b) This Agreement shall be binding upon Indemnitee and upon the
Corporation, its successors and assigns (including any direct or indirect
successor by purchase, merger, consolidation or otherwise to all or
substantially all of the business and/or assets of the Corporation), and shall
inure to the benefit of Indemnitee, his or her heirs, personal representatives,
executors, administrators, estate and assigns and to the benefit of the
Corporation, its successors and assigns.
(c) No amendment, modification, termination or cancellation of this
Agreement shall be effective unless in writing signed by both parties hereto.
(d) "INDEPENDENT COUNSEL" means a law firm with more than ten (10)
full time attorneys, authorized to practice in the State of incorporation of the
Corporation, that is experienced in matters of corporation law and neither
presently is, nor in the past five (5) years has been, retained to represent:
(i) the Corporation or Indemnitee in any matter, or (ii) any other party to the
Claim giving rise to a claim for indemnification hereunder. Notwithstanding the
foregoing, "INDEPENDENT COUNSEL" shall not mean any person who, under the
applicable standards of professional conduct then prevailing in the jurisdiction
in which such person practices or the State of Colorado, would have a conflict
of interest in representing either the Corporation or Indemnitee in an action to
determine Indemnitee's right hereunder.
(e) "CHANGE IN CONTROL" means that fifty percent or more of the
voting stock entitled to vote for the election of directors of the Corporation
(or if there is more than one class of stock, stock entitled to elect a majority
of the directors) is beneficially held by persons who beneficially hold none or
less than five percent (5%) of such stock on the date hereof.
(f) The parties will act in good faith in connection with this
Agreement.
(g) This Agreement shall be interpreted in all cases to the benefit
of Indemnitee.
(h) All notices to be given hereunder shall be in writing and shall
be considered delivered when received. Notices to the Corporation shall be
given at the corporate headquarters of the company marked "Attn. Chief
Financial Officer". Notices to Indemnitee shall be given to the last address of
the Indemnitee known to the Corporation. Notice may be delivered in hand,
9
<PAGE>
by responsible courier (such as Federal Express), or by U.S. mail, but not by
telecopy unless authorized in writing by the intended recipient.
24. ARBITRATION. Except as provided below, any and all disputes arising
under or related to this Agreement which cannot be resolved through negotiations
between the parties shall be submitted to binding arbitration. If the parties
fail to reach a settlement of their dispute within fifteen (15) days after the
earliest date upon which one of the parties notified the other(s) of its desire
to attempt to resolve the dispute, then the dispute shall be promptly submitted
to arbitration by a single arbitrator through the Judicial Arbiter Group, any
successor of the Judicial Arbiter Group, or any similar arbitration provider who
can provide a former judge to conduct such arbitration if JAG is no longer in
existence ("JAG"). The arbiter shall be selected by JAG on the basis, if
possible, of his or her expertise in the subject matter(s) of the dispute. The
decision of the arbitrator shall be final, nonappealable and binding upon the
parties, and it may be entered in any court of competent jurisdiction. The
arbitration shall take place in Boulder, Colorado. The arbitrator shall be
bound by the laws of the State of Colorado applicable to the issues involved in
the arbitration and all Colorado rules relating to the admissibility of
evidence, including, without limitation, all relevant privileges and the
attorney work product doctrine. All discovery shall be completed in accordance
with the time limitations prescribed in the Colorado rules of civil procedure,
unless otherwise agreed by the parties or ordered by the arbitrator on the basis
of strict necessity adequately demonstrated by the party requesting an extension
of time. The arbitrator shall have the power to grant equitable relief where
applicable under Colorado law, and shall be entitled to make an award of
punitive damages when applicable under Colorado law. The arbitrator shall issue
a written opinion setting forth his or her decision and the reasons therefor
within thirty (30) days after the arbitration proceeding is concluded. The
obligation of the parties to submit any dispute arising under or related to this
Agreement to arbitration as provided in this Section shall survive the
expiration or earlier termination of this Agreement. Notwithstanding the
foregoing, either party may seek and obtain an injunction or other appropriate
relief from a court to preserve or protect trademarks, tradenames, copyrights,
patents, trade secrets or other intellectual property or proprietary information
or to preserve the status quo with respect to any matter pending conclusion of
the arbitration proceeding, but no such application to a court shall in any way
be permitted to stay or otherwise impede the progress of the arbitration
proceeding.
In the event of any arbitration or litigation being filed or instituted
between the parties concerning this Agreement, the prevailing party will be
entitled to receive from the other party or parties its attorneys' fees, witness
fees, costs and expenses, court costs and other reasonable expenses, whether or
not such controversy, claim or action is prosecuted to judgment or other form of
relief.
25. REVIEWING PARTY. The "REVIEWING PARTY" shall (i) be the Board of
Directors acting by majority vote of a quorum consisting of directors who are
not parties to the particular Claim with respect to which Indemnitee is seeking
indemnification, or (ii), if such a quorum is not obtainable, by a majority vote
of a committee of the Board of Directors designated by the Board
10
<PAGE>
of Directors, which committee shall consist of two or more directors not
parties to the Claim (except that directors who are parties to the claim may
participate in the designation of directors for the committee). If such
quorum cannot be obtained or the committee cannot be so established, or, even
if obtainable a quorum of disinterested directors so directs, the Reviewing
Party shall be Independent Counsel who shall render a written opinion, and,
if not determined by any of the above means, the Reviewing Party shall be the
shareholders of the Corporation.
Provided, however, that after a Change in Control, Indemnitee may require
that the Board of Directors act in accordance with the written opinion of
Independent Counsel selected by Indemnitee and approved by the Corporation and
not use any other method for making its determination. The Corporation shall
object to Indemnitees choice of Independent Counsel within seven (7) days of its
selection or shall lose all rights to object thereto in the future unless it is
later discovered that such counsel has a conflict of interest that would render
its representation inappropriate under the rules of ethics than in effect in the
state in which such counsel practices. If Indemnitee and the Corporation cannot
agree on Independent Counsel after two (2) selections, Independent Counsel shall
be selected by arbitration conducted under the arbitration clause of this
Agreement. Independent Counsel in all cases, among other things, shall render
its written opinion to the Corporation, the Board of Directors and Indemnitee
within ninety (90) days after it is retained. The Corporation agrees to at
least monthly pay the reasonable fees and expenses of Independent Counsel and to
fully indemnify such counsel against any and all reasonable expenses (including
attorneys' fees), claims, liabilities and damages arising out of or relating to
this Agreement or its engagement pursuant hereto.
Both parties will provide reasonable information requested by the Reviewing
Party to assist in its determination.
If it is contrary to State Statute or other applicable law to require that
the binding decision be made by Independent Counsel, in circumstances where
Independent Counsel is to render a decision hereunder, Independent Counsel shall
nevertheless be retained to, and shall, render such opinion as above provided
and such opinion shall be provided to the Reviewing Party, Indemnitee and the
Board of Directors of the Corporation.
If Independent Counsel is the Reviewing Party, it will also render its non-
binding opinion on whether the Expenses requested are reasonable.
26. ATTORNEY'S FEES. If any action is brought by Indemnitee to enforce or
interpret any of the terms hereof, Indemnitee shall be entitled to be paid all
costs and expenses, including reasonable attorney's and expert witness fees,
incurred by Indemnitee with respect to such action, except to the extent that a
court or arbitration body determines that a particular claim was frivolous, in
which case no expenses shall be paid attributable to the additional expenses of
asserting the particular claim. If a action is brought by or in the name of the
Corporation to enforce or interpret any of the terms of this Agreement,
Indemnitee shall be entitled to be paid all costs and expenses, including
reasonable expert witness and attorney's fees, incurred by
11
<PAGE>
Indemnitee in defending against such claim and in asserting any mandatory
counterclaims or any cross-claims in such action, except to the extent that a
court or arbitration body determines that a particular defense, counterclaim
or crossclaim was frivolous, in which case no expenses shall be paid
attributable to the additional expenses of asserting the particular defense,
counterclaim, or cross-claim.
27. TRUST. Nothing herein prohibits the Corporation from establishing one
or more trusts or similar arrangements, from time to time, to provide or hold a
source of funds for indemnification hereunder.
28. SUBSEQUENT INSTRUMENTS AND ACTS. The parties shall execute and
deliver further instruments and perform any acts that may reasonably become
necessary from time to time to carry out the terms and intent of this Agreement.
29. INDEMNITEE HAS CONSULTED OWN ADVISORS. Indemnitee is aware that the
Courts and State Statute, as well as the policy or law of federal and possibly
state and local governmental agencies and bodies, may restrict or prohibit the
indemnification, including of Expenses, of Indemnitee by the Corporation. This
could include claims under various securities laws and the Employee Retirement
Income Security Act ("ERISA"). Indemnitee has had an opportunity to review this
agreement with legal counsel of his choosing and understands that he may not be
entitled as a matter of law to all the benefits of this Agreement.
IN WITNESS WHEREOF, the parties have executed this Agreement on and as of
the day and year first above written.
The Officer: The Company:
Electroscope, Inc.
/s/ PATRICK CRANE By: /s/ DR. DONALD R. TEMPLE
- ------------------------------- ---------------------------------
Patrick Crane Dr. Donald R. Temple
Management Committee Member
By: /s/ ROGER ODELL
---------------------------------
Roger Odell
Management Committee Member
By: /s/ DR. WAYNE J. TIPPETT
---------------------------------
Dr. Wayne J. Tippett
Management Committee Member
12
<PAGE>
CHANGE OF CONTROL AGREEMENT
AGREEMENT made as of this 5th day of May, 1997, by and between Electroscope,
Inc., a Colorado corporation, with its principal offices located at 4828
Sterling Drive, Boulder, CO 80301, (hereinafter the "Company"), and Patrick
Crane, residing at 4453 Rustic Trail, Boulder, CO 80301 (hereinafter the
"Officer").
1. DEFINITIONS. For purposes of this Agreement, the following terms shall
have the meanings set forth below:
(a) For the purposes of this Agreement, a "Change of Control" shall be
deemed to have occurred if (a) any "person" or "group" (within the
meaning of Sections 13(d) and 14(d)(2) of the Securities Exchange Act
of 1934) other than a trustee or other fiduciary holding securities
under an employee benefit plan of the Company, beneficially owns 50%
or more of the Company's voting common stock; or, (b) at any time
during the period of three consecutive years (not including any period
prior to the date hereof), individuals who at the beginning of such
period constitute the Board (and any new director whose election by
the Board or whose nomination for election by the Company's
stockholders were approved by a vote of at least two-thirds of the
directors then still in office who either were directors at the
beginning of such period or whose election or nomination for election
was previously so approved) cease for any reason to constitute a
majority thereof; or (c) the stockholders of the Company approve a
merger or consolidation of the Company with any other corporation,
other than a merger or consolidation in which both (i) a majority of
the directors of the surviving entity were directors of the Company
prior to such consolidation or merger, and (ii) which would result in
the voting securities of the Company outstanding immediately prior
thereto continue to represent (either by remaining outstanding or by
being changed into voting securities of the surviving entity) at least
51% of the combined voting power of the voting securities of the
surviving entity outstanding immediately after such merger or
consolidation; or (d) the stockholders approve a plan of complete
liquidation of the Company or an agreement for the sale or disposition
by the Company of all or substantially all of the Company's assets.
(b) "Termination Date" shall mean the date following a Change of Control
when the Officer receives written notice that his employment is
terminated without Cause as defined in the Employment Agreement, or,
if later, such other termination date specified in the written notice.
(c) "Terminate" shall mean not only a complete termination of employment
by the Company or its successor but also a significant negative change
in the terms of
1
<PAGE>
employment with the Company or its successor, including but not
limited to a requirement to relocate or a significant reduction in
salary and benefits.
(d) "Termination Following a Change of Control" shall mean a termination
without Cause by the Company following or in connection with a change
of control or a termination by the Officer for "Good Reason" of the
Officer's employment with the Company within two years following a
"Change of Control" (as defined below).
(e) For purposes of this Agreement, "Good Reason" shall include, but not
be limited to, any of the following (without the Officer's express
written consent):
i) the assignment to the Officer by the Company of duties
inconsistent with or a substantial alteration in the nature or
status of, the Officer's responsibilities as in effect
immediately prior to a Change of Control;
ii) a reduction by the Company in the Officer's compensation or
benefits as in effect immediately prior to the date of a Change
of Control;
iii) a relocation of the Company's principal offices beyond 25 miles
from the present Boulder, Colorado location, or the Officer's
relocation to any place other than the Boulder, Colorado offices
of the Company, except for reasonably required travel by the
Officer on the Company's business;
iv) any material breach by the Company of any provision of this
Agreement if such material breach has not been cured within
thirty (30) days following written notice of such breach by the
Officer to the Company setting forth with specificity the nature
of the breach; or
v) any failure by the Company to obtain the assumption and
performance of the Employment Agreement and this Agreement by any
successor (by merger, consolidation or otherwise) or assignee of
the Company.
2. SEVERANCE BENEFITS. In the event there is a Termination Following a Change
of Control, the Officer shall be entitled to the following severance
benefits for a period of 12 months after the Termination Date:
(a) Continued base salary in regular biweekly payments, or if so elected
by the Officer, a lump sum payable within 30 days of the Officer's
election.
(b) Bonus payable in such amount as would be payable to the Officer had he
been employed by the Company for the full fiscal year during which the
termination occurred, and the Company had achieved Plan performance
for such fiscal year. Such bonus shall be paid in the same manner as
elected by the Officer in (a) above;
(c) Continued medical, dental, life and disability insurance benefits; and
2
<PAGE>
(d) Continued retirement benefits, including 401(k) plan.
Such benefits shall be identical to the salary, bonus, insurance and
retirement plan benefits to which the Officer was entitled immediately
prior to the Change of Control. During such 12-month period, the Officer
shall continue to be an employee of the Company for purposes of
participation in the plans which provide the benefits described in
subsections (c) and (d) above but shall have no further responsibilities as
an employee and shall not be required or permitted to continue his former
duties. Subject to Section 3, the Officer shall be free to accept other
employment during such period, and there shall be no offset of any
employment compensation earned by Officer in such other employment during
such period against payments due the Officer hereunder, and there shall be
no offset in any compensation or benefits received from such other
employment against the continued salary and benefits set forth above.
3. STOCK OPTION VESTING. In the event of a Termination Following a Change of
Control, all outstanding stock options held by the Officer which are not
then exercisable, shall become exercisable in their entirety as of the date
immediately preceding the Termination Date.
4. NONCOMPETITION AGREEMENT. Officer acknowledges that the Company has trade
secrets and confidential information, that as President and Chief Executive
Officer he will have access to all such trade secrets and confidential
information and that in performing duties in an executive position for
another company he might necessarily use and divulge such trade secrets and
confidential information. Therefore, in consideration for the severance
benefits set forth above, the Officer agrees that for a period of 12 months
subsequent to the Termination Date, the Officer will not, directly or
indirectly:
(a) Call upon any person or entity which was a customer of the Company
immediately prior to the Termination Date for the purpose of
diverting, taking away the business of, or selling products or
services competitive with significant products or services provided by
the Company;
(b) In any manner, misuse or divulge to any person any list of customers,
confidential information or trade secrets of the Company;
(c) Alone or in any capacity solicit or in any manner attempt to solicit
or induce any person or persons employed by the Company within one
year prior to the Termination Date to leave such employment;
(d) Within the United States of America, either as an employee, employer,
consultant, agent principal, partner, more than 5% stockholder,
corporate officer, director, or in any other individual or
representative capacity, engage or participate in any business that is
in competition in any significant manner with any material business
conducted by the Company on the Termination Date.
3
<PAGE>
5. TERMINATION. This Agreement may be terminated only as follows:
(a) by mutual written agreement of the parties;
(b) upon termination of Officer's employment prior to, and not in
connection with, a Change of Control.
(c) when the Officer attains age 65.
6. SEVERABILITY. Should a court or other body of competent jurisdiction
determine that any provision of this Agreement is excessive in scope or
otherwise invalid or unenforceable, such provision shall be adjusted rather
than voided, if possible, so that it is enforceable to the maximum extent
possible, and all other provisions of the Agreement shall be deemed valid
and enforceable to the extent possible.
7. ASSIGNMENT. The parties may assign their economic rights under this
Agreement but shall not assign any personal obligations from this
Agreement.
8. MISCELLANEOUS. This Agreement: (a) contains the entire agreement among the
parties regarding the subject matter hereof and supersedes any prior
agreements on this subject between the parties; (b) may not be amended nor
may any rights hereunder be waived except by an instrument in writing
signed by the party sought to be charged with such amendment or waiver; (c)
shall be construed in accordance with, and governed by, the laws of
Colorado; and (d) shall be binding upon and shall inure to the benefit of
the parties and their respective personal representatives and permitted
assigns, including, without limitation, any successor to the business of
the Company.
IN WITNESS WHEREOF, the parties have executed this Agreement as of the day
and year first above written.
THE OFFICER: THE COMPANY:
Electroscope, Inc.
/s/ PATRICK CRANE By: /s/ DR. DONALD R. TEMPLE
- ------------------------------ -------------------------------------
Patrick Crane Dr. Donald R. Temple
Management Committee Member
By: /s/ ROGER ODELL
-------------------------------------
Roger Odell
Management Committee Member
By: /s/ DR. WAYNE J. TIPPETT
-------------------------------------
Dr. Wayne J. Tippett
Management Committee Member
4
<PAGE>
EXHIBIT 11.1
ELECTROSCOPE, INC.
COMPUTATION OF NET LOSS PER COMMON SHARE
(Unaudited)
<TABLE>
<CAPTION>
For the fiscal year ended March 31
1997 1996 1995
-------------------------------------------
<S> <C> <C> <C>
NET LOSS $(2,903,632) $(1,305,275) $(1,006,471)
SHARES USED IN SHARE COMPUTATION-
Common stock shares outstanding (weighted average) 5,045,128 3,704,031 3,427,274
Treasury stock effect of common stock and equivalents issued within one
year of the public offering at prices less than the public offering price 49,682 245,735 289,636
-------------------------------------------
Shares used in computation 5,094,810 3,949,766 3,716,915
--------- --------- ---------
NET LOSS PER COMMON SHARE AND COMMON
SHARE EQUIVALENT $(0.57) $(0.33) $(0.27)
------- ------- -------
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> MAR-31-1997
<PERIOD-START> APR-01-1996
<PERIOD-END> MAR-31-1997
<CASH> 527,015
<SECURITIES> 9,631,427
<RECEIVABLES> 155,446
<ALLOWANCES> 25,000
<INVENTORY> 521,696
<CURRENT-ASSETS> 10,946,361
<PP&E> 503,871
<DEPRECIATION> 258,983
<TOTAL-ASSETS> 11,340,777
<CURRENT-LIABILITIES> 964,747
<BONDS> 0
0
0
<COMMON> 16,997,282
<OTHER-SE> (6,638,845)
<TOTAL-LIABILITY-AND-EQUITY> 11,340,777
<SALES> 1,398,184
<TOTAL-REVENUES> 1,398,184
<CGS> 1,422,005
<TOTAL-COSTS> 1,422,005
<OTHER-EXPENSES> 3,477,291
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 2,577
<INCOME-PRETAX> (2,264,373)
<INCOME-TAX> 0
<INCOME-CONTINUING> (2,264,373)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (2,264,373)
<EPS-PRIMARY> (0.57)
<EPS-DILUTED> (0.57)
</TABLE>
