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, 2000
Commission File No. 0-28604
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ELECTROSCOPE, INC.
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(Exact name of Issuer as specified in its charter)
COLORADO 84-1162056
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(State or other jurisdiction of (I.R.S. Identification Number)
incorporation or organization)
4828 STERLING DRIVE, BOULDER, COLORADO 80301
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(Address of principal executive offices) (Zip Code)
Issuer's telephone number, including area code: (303) 444-2600
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Securities registered pursuant to Section 12(b) of the Act: NONE
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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
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Check if there is no disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K (ss.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. [X]
The Issuer had total revenues of $2,002,119 for its fiscal year ended March 31,
2000.
As of June 1, 2000 assuming as a market value the price of $1.19 per share (the
last sales price of the Issuer's Common Stock on the NASDAQ Over the Counter
Bulletin Board) the aggregate market value of shares held by non-affiliates was
$2,578,595.
As of June 1, 2000 the Issuer had outstanding 5,383,507 shares of Common Stock,
no par value.
Documents Incorporated by Reference: Definitive Proxy Statement for the 2000
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 2000 Proxy Statement will be filed within 120 days after the end of
the fiscal year ended March 31, 2000.
This Form 10-K consists of 37 pages.
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PART I
ITEM 1. BUSINESS.
READERS OF THIS FORM 10-KSB ARE ENCOURAGED TO READ THIS SECTION ON BUSINESS IN
CONNECTION WITH THE SECTION ENTITLED "RISK FACTORS WHICH MAY AFFECT FUTURE
PERFORMANCE".
THE COMPANY
Electroscope, Inc. ("Company") was founded in 1991 to address product
opportunities created by the increase in minimally invasive surgery ("MIS"). Our
specific focus is on laparoscopy, the most common type of MIS procedure, and the
widespread preference for electrosurgery devices in these procedures.
During laparoscopic surgical procedures, the surgeon operates from outside
the patient's body, introducing cameras and instruments through small access
ports to perform the surgical intervention. MIS has proven to greatly enhance
the patient's post-operative course of recovery and is now the preferred
surgical approach in over 50% of abdominal surgeries.
The market opportunity was created by the surgeons' continued demand for
monopolar electrosurgery tools, which they have preferred using in "open"
procedures, combined with certain inherent risks of this technology in MIS. The
risk of "unintended" electrosurgical burns to the patient in laparoscopic
monopolar electrosurgery has been well documented.
The Company's approach to the market opportunity was to design and develop
a laparoscopic instrument system that helps to prevent unintended
electrosurgical burns. The Company's patented AEM(R) Laparoscopic Instrument
System provides the surgeon with the tissue effects they demand while helping to
prevent stray electrical energy which can cause unintended and unseen tissue
injury. The AEM Instruments incorporate active electrode monitoring technology
to dynamically and continuously monitor the flow of electrosurgical current,
thereby helping to prevent patient injury. With the AEM System, surgeons are
able to perform a broad range of electrosurgical procedures more safely and
efficaciously than is possible using conventional laparoscopic instruments.
THE PROBLEM: STRAY ELECTRICAL ENERGY
Electrosurgical technology is a valuable and popular resource for the
surgeon. Since its introduction in the 1930s it has continually evolved and
today is utilized in over 75% of all surgeries.
The primary form of electrosurgery, "monopolar" electrosurgery, is a
standard tool for General Surgeons throughout the world. In monopolar
electrosurgery, the surgeon uses an instrument (typically scissors, spatula
blades or grasper/dissectors) to deliver electrical current to patient tissue.
This "active electrode" provides the surgeon the ability to cut, coagulate or
ablate tissue as needed during the surgery. With the advent of MIS procedures,
General Surgeons have maintained their preference for using monopolar
electrosurgery as their primary tool for hemostatic incision, excision and
ablation.
Unfortunately, the micro-camera system used in laparoscopy limits the
surgical field-of-view. Ninety percent of the active electrode may be outside
the surgeon's field-of-view at any given time during the surgery. Since stray
electrical energy can occur at any point along the shaft of the instrument, the
potential for burns occurring to tissue outside the surgeon's field-of-view is
of great concern. Such burns to non-targeted tissue are dangerous as they are
likely to go unrecognized and may lead to complications, such as perforation or
infection of adjacent tissues or organs, and this can cause a cascade of adverse
events. Reports indicate that this situation has even resulted in fatalities.
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In many cases, the surgeon cannot detect stray electrical burns at the time
of the procedure. The resulting complication usually presents itself three to
seven days later in the form of a severe infection, which often results in a
return to the hospital and a difficult course of recovery.
Stray electrosurgical energy can result from two primary causes --
insulation failure and capacitive coupling. Instrument insulation failure is a
common occurrence in laparoscopy. All conventional active electrodes for
laparoscopy are designed with the same basic construction -- a single conductive
element and an outer insulation coating. Unfortunately, this insulation can fail
during the natural course of normal use during surgery. It is also possible for
instrument insulation to become flawed during the cleaning and sterilization
process. This common insulation failure can allow electrical currents to "leak"
from the active electrode to unintended and unseen tissue with potentially
serious results.
Capacitive coupling is another way stray energy can cause unintended burns
during laparoscopy. Capacitive coupling is an electrical phenomenon that occurs
when current is induced from the active electrode to nearby tissue despite
intact instrument insulation. This potential for capacitive coupling is present
in all laparoscopic surgeries that utilize monopolar electrosurgery devices and
is likely to occur outside the surgeon's field-of-view.
Insulation failure and capacitive coupling are the primary cause of stray
electrosurgical burns in laparoscopy and are the two events over which the
operative team has traditionally had little, if any, control.
THE SOLUTION: THE AEM LAPAROSCOPIC INSTRUMENT SYSTEM
Active electrode monitoring eliminates the risk of stray electrical energy
caused by insulation failure and capacitive coupling and thus helps to prevent
unintended internal burns to the patient.
AEM Laparoscopic Instruments have a patented, multi-layered design with a
built-in "shield", much like the third-wire ground in standard electrical cords.
The shield in these instruments is referenced back to a "monitor" at the
Electrosurgical Generator. In the event of a harmful level of stray electrical
energy, the monitor shuts down the power at the source, ensuring patient safety.
For instance, if instrument insulation failure should occur, the AEM system,
while continually monitoring the instrument, immediately shuts down the
electrosurgical generator, turning off the electrical current and alerting the
surgical staff. The AEM system protects against capacitive coupling by providing
a neutral return path for any "capacitively coupled" electrical current.
Capacitively coupled energy is continually drained away from the instrument and
away from the patient through the protective shield built into the AEM
instrument.
The AEM system is an innovative solution to stray electrosurgical burns in
laparoscopy designed to be transparent to the surgeon. It directs
electrosurgical energy where it is needed, while continuously monitoring the
current flow to prevent stray electrical energy from insulation failure or
capacitive coupling.
The AEM system consists of shielded 5mm AEM instruments and an AEM monitor.
The AEM instruments are designed to function identically to the conventional 5mm
instruments that the surgeon is familiar with, but with the added benefit of
patient safety. The Company's entire line of laparoscopic instruments have the
integrated AEM design and includes the full breadth of instruments that are
common in laparoscopy today. The AEM monitor is compatible with most
electrosurgical generators. Thus, implementation of the AEM Laparoscopic
Instrument system requires no change in surgical technique or operating room
staff protocols. Active electrode monitoring provides enhanced patient safety,
requires no change in surgeon technique and is cost effective.
The Company continues to develop new products that will expand the AEM
product line. These new AEM product initiatives will take advantage of the
Company's expertise in MIS procedures and the needs of the surgeons who perform
those procedures. This includes the expansion into MIS endoscopic procedures
beyond laparoscopy.
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THE MARKET
In the 1990s, surgeons began widespread use of minimally-invasive surgical
techniques. The benefits of MIS are substantial and include reduced trauma for
the patient, reduced hospital stay, shorter recovery time and lower medical
costs.
With the improvements in the micro-camera and in the variety of available
instruments, Laparoscopic Surgery became very popular among General and
Gynecologic Surgeons. Laparoscopy now accounts for the majority of MIS
procedures and accounts for a large percentage of all surgical procedures
performed in the United States.
There are over 2.3 million laparoscopic procedures performed annually in
the US and this number is rising at a rate of 2-3% per year. (Market statistics
from Medical Data International)
By the year 2010, total laparoscopic procedures in the US are projected to
exceed 3 million. The market outside the US is rising at a higher rate than the
domestic market and is estimated to equal the domestic market in procedure
volume. This surgical category - Laparoscopic Surgery -- is the primary market
for the Company's technology.
The market for Laparoscopic Instrumentation is currently estimated to be
over $1 billion annually in the US. Of that market, $200 million annually is in
Laparoscopic Hand Instruments: scissors, graspers, dissectors, forceps and other
surgical hand instruments of various designs to perform a variety of tissue
effects.
Of the market for Laparoscopic Hand Instruments, over 75% are designed for
electrosurgical utility. The resulting market for Laparoscopic Electrosurgical
Instruments is estimated to exceed $150 million annually in the US alone.
International revenue is estimated to be equal to the US market. The total
worldwide market would then represent $300 million annually.
Of that worldwide market, 80% is comprised of "monopolar" electrosurgical
instruments. This annual market of $240 million -- Laparoscopic Monopolar
Electrosurgical Instruments -- is the market the Company is addressing with AEM
Laparoscopic Instruments. The Company's proprietary AEM product line replaces
the standard monopolar electrosurgical laparoscopic instrumentation commonly
used today.
In addition, there is an $18 million US market in Laparoscopic Instrument
Refurbishment of which the vast majority is for repairing flaws in the
instrument insulation. This insulation refurbishment market is unnecessary with
the advent of the AEM instruments. Hospitals currently spending on instrument
"re-coating" will be spared this activity and cost when converting to the AEM
system.
Active electrode monitoring is emerging as a 'Standard of Care'. This
technology has recently been cited in publications representing all the
communities involved in laparoscopic surgery: Surgeons, Nurses, Biomeds,
Medicolegal professionals, Risk Managers and even other manufacturers of
electrosurgical devices. This includes the recent recognition as an AORN
RECOMMENDED PRACTICE by the Association of Operating Room Nurses.
The Company aims to further develop the market, continuing to educate
healthcare professionals about the benefits of active electrode monitoring to
prevent stray energy burns. The Company continues to optimize the Field Sales
force to reach the decision makers who purchase laparoscopic electrosurgical
equipment.
HISTORICAL PERSPECTIVE
The Company was organized in February 1991 and in the first two years
developed the AEM system and protective sheaths to adapt to traditional
electrosurgical instruments. During this period, the Company applied for patents
with the United States Patent Office and conducted product trials.
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As the Company evolved, it was clear that the active electrode monitoring
technology needed to be integrated into the standard laparoscopic instrument
design. As the development program proceeded, it also 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 complex than expected. As a result, instruments with
integrated AEM technology were not completed until many years later. It was not
until FY 2000 that a sufficiently broad AEM instrument line was introduced to
provide the operating rooms with a Standard of Care -- AEM instruments for all
of their electrified monopolar instrumentation in laparoscopic surgery. Prior to
offering the full breadth of laparoscopic instrumentation, it was difficult for
hospitals to commit to converting to the AEM solution, as there were not
adequate comparable surgical instrument options to match what the surgeon
demanded.
With the broad array of AEM instruments now available, the surgeon has a
full choice of instrument options and does not have to change surgical
technique. The hospital can now universally convert, thus providing all of their
laparoscopic patients the highest level of safety.
SALES AND MARKETING OVERVIEW
It is the Company's belief that AEM technology should be the Standard of
Care in laparoscopic surgery worldwide.
The Company continues to expand and optimize the distribution network that
is made up of Company employees, independent sales representative organizations
and stocking distributors. Together this network provides market presence
throughout the United States (U.S.). In addition, the Company has begun to
develop a distribution network outside the U.S. The Company believes that such
measures, along with the culmination of the breadth of clinical endorsements
behind the AEM technology and the recent introduction of new AEM products will
provide the basis for increased revenues and will ultimately lead to profitable
operations. However, these measures, or any others that the Company may adopt,
may not result in either increased revenues or profitable operations.
In some instances customers have recognized the patient safety risks
inherent in monopolar electrosurgery and readily accepted the AEM System as the
way to eliminate those risks. In other instances, the Company has found selling
the concept behind the AEM System more difficult. This is due to several
factors, including the necessity to make surgeons, perioperative nurses and
hospital risk managers aware of the potential for unintended electrical burns
(which exists when conventional instruments are used during laparoscopic
monopolar electrosurgery) and the increased medicolegal exposure that results.
Additionally, the Company has to contend with the overall lack of single
purchasing points in the industry (both surgeons and hospitals have to be in
substantial agreement as to the benefits of the AEM System), and the consequent
need to make multiple sales calls on those personnel with the authority to
commit to hospital expenditures. Other challenges include the fact that many
hospitals have contractual agreements with manufacturers of competing surgical
instruments which makes selling the Company's products more difficult.
All of the above issues have been lessened, however, in light of recent
clinical recommendations concerning active electrode monitoring, most notably
the fact that active electrode monitoring has been declared an AORN RECOMMENDED
PRACTICE for Endoscopic MIS by the Association of Operating Room Nurses. The
Company's marketing efforts are focused toward capitalizing on the substantial
independent endorsements for the technology from sources in every community
involved with the surgery. These third-party endorsements of active electrode
monitoring advocate utilizing this technology for advancing patient safety in
laparoscopy.
To cost-effectively expand market coverage, the Company has contracted with
and trained a network of independent distributors (each with several sales
representatives) across the U.S. The Company believes that this network has
experience selling into the hospital operating room environment and offers the
Company the best opportunity to broaden acceptance of its product line and
generate increased revenues. Supplementing efforts to broaden market acceptance
in the United States, the Company has contracted with independent distributors
in Australia, Canada and elsewhere to market the Company's products
internationally. While the Company believes that this sales organization will
result in additional and increasing revenues, these efforts by the Company may
not be successful in generating such additional revenues.
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The Company is pursuing CE marking to allow launching into the European
marketplace and anticipates receiving this certification by mid-fiscal year. CE
is an abbreviation of the phrase Conformite Europeene indicating that a
manufacturer has conformed to all of the obligations imposed by European health,
safety and environmental legislation. CE certification opens up incremental
markets where the Company previously could not sell its product.
RESEARCH & DEVELOPMENT
The Company employs full-time engineers and uses independent contractors
from time to time in its research and product development efforts. This group is
exploring ways to broaden the product line that the Company can offer to its
sales force. The Company is continually expanding the AEM product line to
satisfy the evolving needs of surgeons. For AEM technology to fully become
Standard of Care, the Company must satisfy the surgeons' preferred instrument
styles with integrated AEM technology. This commitment includes expanding the
styles of electrosurgical instruments available for MIS applications so that the
conversion to AEM technology is transparent to the surgeon and would not require
a change in their current techniques. The Company believes that as MIS
techniques are applied to additional types of surgery, there will be a need to
develop AEM instruments capable of performing such surgeries. As this happens,
the Company believes the medical community will expect that all surgical
equipment using monopolar electrical energy should be shielded and actively
monitored to make it safe. Future research and development efforts will address
such opportunities.
The Company plans to introduce additional products from time to time and
this includes both disposable and reusable products. 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
such opportunities to broaden the scope of products offered by the Company's
sales force. The Company's financial condition will effect the timing and
commitment for new product R&D initiatives, especially those outside the AEM and
laparoscopic focus.
MANUFACTURING, REGULATORY AFFAIRS AND QUALITY ASSURANCE
The Company engages in various manufacturing and assembly activities at its
facility in Boulder, Colorado. These operations include manufacturing and
assembly of the AEM Laparoscopic Instrument System as well as fabrication,
assembly and test operations for instruments and accessories. 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 2001. The plans
include both optimizing 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
the availability and low cost 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. Company personnel subject all finished
products to quality assurance and performance testing procedures. 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 ("FDA"). At
March 31, 2000, the operations staff consisted of five people and the regulatory
affairs and quality assurance staff consisted of three people.
The Company's leased facility of 11,455 square feet contains approximately
6,500 square feet of manufacturing, regulatory affairs and quality assurance
space. The facility is designed to comply with the Quality System Regulation
("QSR") as specified in published FDA regulations. As noted below (Government
Regulation), in the latest inspection
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by the FDA (November, 1998), the Company's facility has been found to be "...in
substantial compliance with the Quality System Regulation...".
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
AEM products. The Company was granted United States Patents on January 7, 1997
and June 23, 1998, relating to specific implementations of shielding and
monitoring in instruments. Additional United States patent applications are
pending, one relating to the incorporation of the shielding and monitoring
technologies in various other instrument configurations. Foreign patent
applications relating to the basic shielding and monitoring technologies have
been issued in Australia, Canada, Japan and are pending in several European
countries. The validity and breadth of claims covered in medical technology
patents involve complex legal and factual questions and, therefore, may be
highly uncertain. Even with the patents held by the Company, others might copy
the Company's technology or otherwise be able to incorporate the technology in
their products.
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 the Company's property and is to be kept confidential and not
disclosed to third parties.
COMPETITION
READERS OF THIS FORM 10-KSB ARE ENCOURAGED TO READ THIS SECTION ON COMPETITION
IN CONNECTION WITH THE SECTION ENTITLED "RISK FACTORS WHICH MAY AFFECT FUTURE
PERFORMANCE".
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 conventional electrosurgical instruments. Larger competitors include US
Surgical Corporation (a Division of Tyco) and Ethicon Endo-Surgery (a Division
of Johnson & Johnson). While the Company knows of no competitor (including those
referred to above) that can provide an absolute, continuous solution to stray
energy, the manufacturers of conventional (non-monitored, non-shielded)
instruments will resist any loss of market share resulting from the presence of
the Company's products in the market.
The Company also believes that manufacturers of products based upon
technology that are alternatives to monopolar electrosurgery are competitors of
the Company; these technologies include Bipolar electrosurgery, laser surgery
and the harmonic scalpel. Leading manufacturers include Everest Medical
Corporation (bipolar electrosurgery), Coherent (laser surgery) and the Ethicon
Endo-Surgery (harmonic scalpel).
The Company believes that monopolar electrosurgery offers substantial
competitive advantages over the alternative technologies that are available.
However, the risk exists that these alternative technologies may gain greater
market share and new competitive techniques may be developed and introduced.
As mentioned in the Marketing and Sales discussion, the competitive issues
involved in selling the Company's AEM 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 a longer sales cycle and higher sales costs. Recent
clinical recommendations concerning active electrode monitoring technology have
greatly enhanced the clinical credibility of the
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AEM System. However, the Company's efforts to increase market awareness of this
technology may not be successful, and the Company's competitors may develop
alternative strategies to counter the Company's marketing efforts.
The Company's constrained liquidity position puts it at a competitive
disadvantage. Many of the Company's competitors and potential competitors have
widely accepted products and significantly greater financial, technical, product
development, marketing and other resources than the Company. The Company may not
be able to compete successfully against current and future competitors and
competitive pressures faced by the Company may materially adversely affect its
business, operating results and 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 FDA regulates the Company and its products under a number of statutes,
including the Federal Food, Drug and Cosmetics Act (the "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 QSR). 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 EM2 model AEM monitor, the monopolar MIS
electrosurgical instruments with AEM technology, and its Electroshield(R)
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, which could lead
to a material adverse impact on the Company's financial position and results of
operations.
The FDA regulates the Company's quality control and manufacturing
procedures by requiring the Company and its contract manufacturers to
demonstrate compliance with the QSR as specified in published FDA regulations.
The FDA requires manufacturers to register with the FDA, which subjects them to
periodic 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
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adversely affected. Such regulations are subject to change and depend heavily on
administrative interpretations. In November 1998, the FDA conducted a Quality
System Regulation Inspection of the Company's facilities, with no regulatory
follow-up indicated. The Company believes it has the internal resources and
processes in place to be reasonably assured that it is in compliance with all
applicable regulations regarding the manufacture and sale of medical devices.
However, if the Company were found not to be in compliance with the QSR, such
findings could result in a material adverse impact on the Company's financial
condition, results of operations and cash flows.
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.
Entry into the European Economic Area market also requires prior certification
of the Company's quality system and product documentation. The Company has
obtained a Certificate of Export from the United States Department of Health and
Human Services that states that the Company has been found to be "...in
substantial compliance with Good Manufacturing Practices..." based on the most
recent inspection. However a specific foreign country in which the Company
wishes to sell its products may not accept or continue to accept the Export
Certificate.
ENVIRONMENTAL LAWS AND REGULATIONS
From time to time the Company receives materials returned from customers,
sales representatives and other sources which are potentially biologically
hazardous. These materials are segregated and handled in accordance with
specific procedures that minimize the potential exposure for employees. Such
materials are disposed of in accordance with specific procedures. The costs of
compliance with these procedures are not significant.
EMPLOYEES
As of March 31, 2000, the Company employed 24 individuals, 8 of which are
engaged directly in research, development and regulatory activities, 5 in
manufacturing/operations, 7 in marketing and sales and 4 in administrative
positions. None of the Company's employees are covered by a collective
bargaining agreement, and the Company considers its relations with its employees
to be good. All employees are employed in an "at will" relationship.
ITEM 2. PROPERTIES.
The Company leases 11,455 square feet of office and manufacturing space at
4828 Sterling Drive, Boulder, Colorado 80301. This lease expires on October 31,
2001.
ITEM 3. LEGAL PROCEEDINGS.
The Company is not involved in any legal proceedings, nor is it aware of
any pending legal proceedings. The Company may become involved in litigation in
the future in the normal course of business.
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, 2000.
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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 Bulletin Board
under the symbol ESCP.OB. 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
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FISCAL YEAR ENDED MARCH 31, 1999
First Quarter through June 30, 1998 1.81 1.00
Second Quarter through September 30, 1998 1.25 0.50
Third Quarter through December 31, 1998 0.66 0.45
Fourth Quarter through March 31, 1999 0.56 0.22
FISCAL YEAR ENDED MARCH 31, 2000
First Quarter through June 30, 1999 0.53 0.31
Second Quarter through September 30, 1999 0.44 0.25
Third Quarter through December 31, 1999 0.59 0.34
Fourth Quarter through March 31, 2000 1.56 0.53
As of March 31, 2000, there were approximately 167 holders of record of the
Common Stock. This number does not reflect stockholders who beneficially own
Common Stock held in nominee or street name, which as of June 1, 2000,
approximated 570 stockholders.
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.
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 effectivity and
safety to patients who undergo minimally invasive electrosurgery ("MIS"). The
Company believes that its patented active electrode monitoring system offers
surgeons significant advantages compared to conventional electrosurgical systems
because of its ability to continually and dynamically monitor for stray
electrical energy during MIS procedures. Stray electrical energy has been shown
to cause unintended burns that may result in hospitalization or death. The
Company has received four FDA Form 510(k) notifications for its products and has
obtained patent protection for its products' core shielding and monitoring
features
The Company recognizes that market awareness and acceptance of the
hazards inherent in monopolar electrosurgery has been somewhat slow to occur.
The Company has modified its marketing strategies to address the issues of
market acceptance of the technology, and has undertaken efforts to broaden the
product line offerings beyond the original AEM products and accessories.
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HISTORICAL PERSPECTIVE
After the Company was organized in February 1991 and in its first two
years the Company developed the AEM system 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
product trials.
As the Company evolved it was clear that the AEM technology needed to
be integrated into the standard laparoscopic instrument design. As the
development program proceeded it became apparent that the merging of electrical
and mechanical engineering in the development process for the Company's
patented, integrated electrosurgical instruments was more complex than expected.
As a result, the development of the instruments with integrated AEM technology
was not completed until many years later. It was not until FY 2000 that a
sufficiently broad AEM instrument line was introduced to provide the operating
rooms with a Standard of Care -- AEM instruments for all of their electrified
monopolar instrumentation in laparoscopic surgery. Prior to offering the full
breadth of laparoscopic instrumentation it was difficult for hospitals to commit
to converting to the AEM solution, as there were not adequate comparable
surgical instrument options to match what the surgeon demanded.
With the broad array of AEM instruments now available, the surgeon has
a full choice of instrument options and does not have to change surgical
technique. The hospital can now universally convert to AEM instruments, thus
providing all of their laparoscopic patients the highest level of safety.
OUTLOOK
STATEMENTS CONTAINED IN THIS SECTION ON OUTLOOK ARE NOT HISTORICAL
FACTS, INCLUDING STATEMENTS ABOUT THE COMPANY'S STRATEGIES AND EXPECTATIONS
ABOUT NEW AND EXISTING PRODUCTS AND MARKET DEMAND AND ACCEPTANCE OF NEW AND
EXISTING PRODUCTS, TECHNOLOGIES AND OPPORTUNITIES, MARKET AND INDUSTRY SEGMENT
GROWTH, AND RETURN ON INVESTMENTS IN PRODUCTS AND MARKETS. THESE STATEMENTS ARE
FORWARD LOOKING STATEMENTS WITHIN THE MEANING OF THE PRIVATE SECURITIES
LITIGATION REFORM ACT OF 1995 AND INVOLVE SUBSTANTIAL RISKS AND UNCERTAINTIES
THAT MAY CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE INDICATED BY THE
FORWARD LOOKING STATEMENTS. ALL FORWARD LOOKING STATEMENTS IN THIS SECTION ON
OUTLOOK ARE BASED ON INFORMATION AVAILABLE TO THE COMPANY ON THE DATE OF THIS
DOCUMENT, AND THE COMPANY ASSUMES NO OBLIGATION TO UPDATE SUCH FORWARD LOOKING
STATEMENTS. READERS OF THIS FORM 10-KSB ARE STRONGLY ENCOURAGED TO REVIEW THE
SECTION ENTITLED "RISK FACTORS WHICH MAY AFFECT FUTURE PERFORMANCE".
INSTALLED BASE OF MONITORING EQUIPMENT: The Company believes that the installed
base of AEM monitors has the potential for increasing as the inherent risks
associated with monopolar laparoscopic surgery become more widely acknowledged
and as the network of independent sales representatives become more adept at
selling the AEM system to their customers. The Company expects that the
continual sales of electrosurgical instruments and accessories should increase
as additional AEM monitors are installed. The Company believes that the measures
taken to increase the number of quality sales representatives carrying the AEM
product line, along with increased marketing efforts and the introduction of new
products, may provide the basis for increased revenues and may ultimately lead
to profitable operations. However these measures, or any others that the Company
may adopt, may not result in either increased revenues or profitable operations.
PROBABILITY OF CONTINUED OPERATING LOSSES: The Company has incurred losses from
operations since inception and has an accumulated deficit of $14,269,649 as of
March 31, 2000. Due to the ongoing need to develop, optimize and train the sales
distribution network and the need to increase revenues to a level adequate to
cover fixed manufacturing costs, the Company believes that it may continue to
operate at a net loss for several quarters.
REVENUE GROWTH: The Company expects to introduce additional new products in
fiscal year 2001 which are expected to contribute to increased revenues in
fiscal 2001 and beyond. The Company expects to generate increased revenues in
the U.S. from sales to stocking distributors and to new hospital customers as
the independent network of representatives becomes more proficient with the
product and expands the installed base of AEM systems. The Company also believes
that the visibility and credibility of the clinical endorsements behind the AEM
technology will contribute to increased revenues in FY 2001.
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The Company also expects to increase the volume of product sold internationally.
The Company plans to attain EN 46001 certification (Medical Device
Implementation of ISO 9001) in early FY 2001 and plans to qualify its products
for CE mark status (demonstrating compliance with the European Medical Device
Directive) which will allow the Company to market its products in Europe.
GROSS PROFIT AND GROSS MARGINS: Gross profit and gross margin can be expected to
fluctuate from quarter to quarter, as a result of product sales mix and sales
volume. Gross margins on products manufactured or assembled by the Company are
expected to be higher at higher levels of production and sales.
SALES AND MARKETING EXPENSES: The Company will continue its efforts to expand
its domestic and international distribution capability. The Company also
believes that sales and marketing expenses will decrease as a percentage of net
revenue with increasing sales volume.
RESEARCH AND DEVELOPMENT EXPENSES: New additions to the AEM product line are
planned for introduction in Fiscal Year 2001. Research and development expenses
are expected to increase modestly in to support the Company's development of new
AEM products, further expanding the instrument options for the surgeon.
LIQUIDITY AND CAPITAL RESOURCES: As of March 31, 2000, the Company had
$2,173,953 in cash and cash equivalents and short-term investments available to
fund future operations.
RISK FACTORS WHICH MAY AFFECT FUTURE PERFORMANCE:
Among the factors that could cause future results to be materially
different from expectations are:
UNCERTAINTY OF MARKET ACCEPTANCE: The Company's success is dependent upon
acceptance of its products by the medical community as reliable, safe and
cost-effective for use in minimally invasive surgical ("MIS") procedures, as
well as the recognition that current practices may not be entirely safe. The
Company is unable to predict how quickly or how broadly its products will be
accepted by the medical community, or if accepted, the number of MIS procedures
that will be performed using the Company's products. Achieving market acceptance
will require the Company to continue to educate the marketplace about the
potential hazards involved in the use of existing electrosurgical products
during MIS procedures and the expected benefits associated with the use of the
Company's products. It may also require additional data to be accepted by the
medical community as evidence of the occurrence of such hazards. The Company may
not be successful in educating the marketplace about its products and available
data concerning these hazards may not create a demand by hospitals and surgeons
for the Company's products. The Company's future financial viability will depend
in large part on the extent to which the Company's products and enhancements are
accepted by the market in commercially viable quantities during Fiscal Year
2001. If the Company's products do not achieve market acceptance in these
quantities during Fiscal Year 2001, the Company's business viability, financial
condition, operating results and cash flows will be materially adversely
affected. This risk is heightened by the Company's diminishing sources of
liquidity.
ABILITY TO INCREASE REVENUES: The Company's attempts to develop and train a
network of independent sales representatives in the U.S. and to expand its
international distribution efforts may take longer than expected, may not be as
successful as the Company anticipates and, due to the nature of the independent
selling organizations in the U.S., may result in considerable amounts of
retraining effort as the organizations change their product lines and their
personnel. The Company may not be able to obtain full coverage of the U.S. by
independent sales representatives and stocking distributors as quickly as it
currently anticipates. The Company may also encounter more difficulties than
anticipated in developing its international presence, due to regulatory issues
and its ability to successfully manage international operations.
HISTORY OF OPERATING LOSSES AND CAPITAL AVAILABILITY: The Company was formed in
1991, and has incurred losses since its inception in excess of $14 million. The
Company has primarily financed its research, development, and operational
activities with sales of common stock.
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At March 31, 2000, the Company had $2,173,953 in Cash and Cash Equivalents and
Short Term Investments available to fund future operations. The Company believes
it has sufficient cash available and budget controls to fund operations through
fiscal year 2001, however, at that time, if sales have not significantly
increased with a corresponding decrease in net loss, the Company's liquid assets
would be substantially diminished, which could result in substantial decrease in
all areas of the Company's activities.
COMPETITION: The electrosurgical products market is intensely competitive. While
the Company knows of no other Company that markets electrosurgical products that
incorporate active electrode monitoring for stray electrical energy, it can be
expected that the manufacturers of unshielded electrosurgical instruments will
resist any loss of market share that might result from the presence of the
Company's shielded products in the market. The Company also believes that
manufacturers of products that are based upon surgical techniques that are
alternatives to monopolar electrosurgery are competitors of the Company. These
techniques include bipolar electrosurgery and laser surgery. The alternative
techniques may gain greater market share and new competitive techniques may be
developed and introduced. Many of the Company's competitors and potential
competitors have significantly greater financial, technical, product
development, marketing and other resources than the Company. Many of the
Company's competitors also currently have, or may develop or acquire substantial
installed customer bases in the medical products market and have significantly
greater market recognition. As a result of these factors, the Company's
competitors may be able to respond more quickly to new or emerging technologies
and changes in customer requirements or to devote greater resources to the
development, promotion and sale of their products than the Company. It is
possible that new competitors or new alliances among competitors may emerge and
rapidly acquire significant market share. The Company may not be able to compete
successfully against current and future competitors and competitive pressures
faced by the Company may materially adversely affect its financial position,
results of operations and cash flows. The Company's constrained financial
resources may hinder its ability to respond to competitive threats.
DEPENDENCE ON NEW PRODUCT DEVELOPMENT: The Company's future success and
financial performance will depend in part on the Company's ability to meet the
increasingly sophisticated needs of customers through the timely development and
successful introduction of product upgrades, enhancements and new products. Such
upgrades, enhancements and new products are subject to significant technical
risks. The medical device market is subject to rapid technological change,
resulting in frequent new product introductions and enhancements of existing
products, as well as the risk of product obsolescence. While the Company is
currently developing new products and enhancing its existing product lines, the
Company may not be successful in completing the development of such new products
or enhancements. In addition, to be competitive, the Company must also respond
effectively to technological changes by continuing to enhance its existing
products to incorporate emerging or evolving standards. The Company may not be
successful in developing and marketing product enhancements or new products that
respond to technological changes or evolving industry standards. The Company may
experience difficulties that could delay or prevent the successful development,
introduction and marketing of those products, and its new products and product
enhancements may not adequately meet the requirements of the marketplace and
achieve commercially viable levels of market acceptance. If any potential new
products, upgrades, or enhancements are delayed, or if any potential new
products, upgrades, or enhancements experience quality problems or do not
achieve such market acceptance, the Company's financial position, results of
operations and cash flows would be materially adversely effected.
POTENTIAL NEGATIVE IMPACT OF CHANGES IN OR FAILURE TO COMPLY WITH GOVERNMENT
REGULATIONS: The Company's research, manufacturing, marketing and distribution
of its products in the United States and other countries are subject to
extensive regulation by numerous governmental authorities including, but not
limited to, the Food and Drug Administration ("FDA"). The FDA administers the
Federal Food, Drug and Cosmetic Act (the "FDC Act"). Under the FDC Act, medical
devices must receive FDA clearance through the Section 510(k) pre-market
notification process or through the more lengthy pre-market approval ("PMA")
process before they can be sold in the United States. The Company has received
four 510(k) notifications covering its products. The process of obtaining FDA
and other required regulatory approvals is lengthy, has required, and will
continue to require the expenditure of substantial resources. There can be no
assurance that the Company will be able to continue to obtain the necessary
approvals. As an important part of its strategy, the Company also intends to
pursue commercialization of its products in international markets. The Company's
products are subject to regulations that vary from country to country. The
process of obtaining foreign regulatory approvals in certain countries can be
lengthy and require the expenditure of substantial resources. The Company may
not be able to obtain necessary regulatory approvals or clearances on a timely
basis or at all, and delays in receipt of or
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failure to receive such approvals or clearances, or failure to comply with
existing or future regulatory requirements, might cause the Company to miss
market opportunities, and would have a material adverse effect on the Company's
financial position, results of operations and cash flows.
MANUFACTURING SUBJECT TO GOVERNMENTAL REGULATIONS: Manufacturing of the
Company's products is subject to extensive regulatory requirements administered
by the FDA and other regulatory bodies. The Company believes it is in compliance
with the Current Good Manufacturing Practices ("CGMP") required by the FDA, and
passed its last inspection by the FDA in November of 1998. FDA inspections can
be conducted at any time, without notice. Failure to comply with CGMP and these
regulatory requirements could, among other things, result in fines, suspensions
or withdrawals of regulatory approvals, product recalls, suspension of
manufacturing, operating restrictions and criminal prosecution. In addition,
future changes in regulations or interpretations made by the FDA or other
regulatory bodies, with possible retroactive effect, could adversely affect the
Company. Furthermore, changes in existing regulations or adoption of new
regulation or policies could prevent the Company from obtaining, or affect the
timing of, future regulatory approvals or clearances. The Company may not be
able to obtain necessary regulatory approvals or clearances on a timely basis in
the future, or at all. Delays in receipt of or failure to receive such approvals
or clearances, or failure to comply with existing or future regulatory
requirements, would have a material adverse effect on the Company's financial
position, results of operations and cash flows.
DEPENDENCE ON PATENTS, PATENT APPLICATION AND PROPRIETARY RIGHTS: The Company's
success depends, and will continue to depend in part, on its ability to maintain
patent protection for its products and processes, to preserve its trade secrets
and to operate without infringing the proprietary rights of third parties. The
Company has three issued US patents on several technologies embodied in its AEM
System and related accessories and has applied for additional US patents. In
addition, the Company has three issued foreign patents and one foreign patent
application pending. The validity and breadth of claims coverage in medical
technology patents involve complex legal and factual questions and, therefore,
may be highly uncertain. The Company's current patents may not provide a
competitive advantage, the pending applications may not result in patents being
issued, and competitors of the Company may design around any patents issued to
the Company. Furthermore, the Company's non-disclosure agreements and invention
assignment agreements may not protect its proprietary information and know-how
or provide adequate remedies for the Company in the event of unauthorized use or
disclosure of such information, and others may be able to develop independently
such information. There has been substantial litigation regarding patent and
other intellectual property rights in the medical device industry. Litigation
may be necessary to enforce patents issued to the Company, to protect trade
secrets or know-how owned by the Company, to defend the Company against claimed
infringement of the rights of others or to determine the ownership, scope or
validity of the proprietary rights of the Company and others. Any such claims
may require the Company to incur substantial litigation expenses and to divert
substantial time and effort of management personnel. An adverse determination in
litigation involving the proprietary rights of others could subject the Company
to significant liabilities to third parties, could require the Company to seek
licenses from third parties, and could prevent the Company from manufacturing,
selling or using its products. The occurrence of such litigation or the effect
on the Company's business of such litigation may materially adversely affect the
Company's financial position, results of operations and cash flows.
DEPENDENCE ON SINGLE SOURCE SUPPLIERS AND SUB-CONTRACTORS: The Company depends
on single source suppliers for certain of the key components used in
manufacturing its products. Although the Company believes that there are
alternative suppliers, any interruption in the supply of key components could
have a material adverse effect on the Company's ability to manufacture its
products until a new source of supply is located. The Company intends to carry
an appropriate inventory of critical materials, however, a sudden increase in
demand may create a backorder situation as lead times for some of the Company's
critical materials are in excess of 12 weeks. The Company relies on
sub-contractors to provide much of its product, either in the form of finished
goods or sub-assemblies that the Company then assembles and tests. While these
sub-contractors reduce the cost of carrying manufacturing capabilities inside
the Company, they may not be as responsive to increased demand as the Company
would be if it had its manufacturing capacity entirely in-house.
LIMITED MANUFACTURING EXPERIENCE FOR LARGE SCALE PRODUCTION: For the Company to
be financially successful, it must manufacture its products in accordance with
regulatory requirements, in commercial quantities, at appropriate quality levels
and at acceptable costs. The Company has not yet been required to produce its
products in large quantities at
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competitive costs, and it may not be able to do so. The Company may not be
successful in making the transition to large-scale commercial production. The
Company's failure to manufacture its product in commercial quantities at
acceptable costs would have a material adverse effect on the Company's financial
position, results of operations and cash flows.
POTENTIAL FLUCTUATIONS IN FUTURE QUARTERLY RESULTS: The Company expects that its
operating results will fluctuate significantly from quarter to quarter in the
future and will depend upon a number of factors, many of which are outside the
Company's control. These factors include the extent to which the Company's
Active Electrode Monitoring system and related accessories gain market
acceptance; investments by the Company in marketing, sales, research and
development and administrative personnel necessary to support the Company's
anticipated growth; the ability of the Company to expand its market share; and,
general economic conditions.
PRODUCT LIABILITY RISK; LIMITED INSURANCE COVERAGE: The Company faces an
inherent business risk of exposure to product liability claims in the event that
the use of its products is alleged to have resulted in adverse effects to a
patient. The Company maintains a general liability insurance policy up to the
amount of $5,000,000 that includes coverage for product liability claims.
Liability claims may be excluded from such policy, may exceed the coverage
limits of such policy, and such insurance may not continue to be available on
commercially reasonable terms or at all. Consequently, a product liability claim
or other claim with respect to uninsured liabilities or in excess of insured
liabilities could have a material adverse effect on the Company's financial
position, results of operations and cash flows.
DEPENDENCE ON KEY PERSONNEL: The Company is highly dependent on a limited number
of key management personnel, particularly its President & Chief Executive
Officer James A. Bowman. The loss of key personnel to death, disability or
termination, or the inability to hire and retain qualified personnel, could have
a material adverse effect on the Company's financial position, results of
operations and cash flows.
RESULTS OF OPERATIONS
NET REVENUES. Revenues for the fiscal year ended March 31, 2000 ("FY 00") were
$2,002,119, an increase of 28% from the fiscal year ended March 31, 1999 ("FY
99"). The increase in FY 00 revenue is attributable to the Company continuing to
expand its product offering and improve its sales and marketing efforts.
Revenues for the fiscal year ended March 31, 1999 ("FY 99") were $1,568,428, an
increase of 19% from the fiscal year ended March 31, 1998 ("FY 98"). The
increase in FY 99 revenue is attributable to the Company continuing to develop
its own sales and marketing efforts, plus the introduction of new products
mid-way through FY 98, which were available for all of FY 99.
GROSS PROFIT. Gross profit in FY 00 was $721,196, which resulted in a gross
margin of 36% of revenue. This was an improvement of $274,466 from FY 99 gross
profit. The increase was primarily the result of increased unit sales, resulting
in increased utilization of fixed manufacturing overhead and reduced headcount.
Gross profit in FY 99 was $446,730, which resulted in a gross margin of 28.5% of
revenue. This was an improvement of $349,157, from FY 98 gross profit. The
increase was primarily the result of increased revenues, resulting in increased
utilization of fixed manufacturing overhead, reduced headcount and lower charges
for inventory reserves.
SALES AND MARKETING EXPENSES. Sales and marketing expenses were $1,404,213 in FY
00, an increase of 1% from FY 99. The increase was a result of expanded
marketing programs and initiatives, offset by the cost benefits of more
effective expense planning and controls.
Sales and marketing expenses were $1,393,719 in FY 99, a decrease of 24% from FY
98. The decrease was a result of lower spending on marketing programs, reduced
headcount and a change from direct sales employees, who were paid salaries and
commissions, and were reimbursed for travel and other expenses to a primarily
commission only sales force.
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GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses were
$820,918 in FY 00, a decrease of 12% from FY 99. The reduction was a result of
reduced headcount and improved expense controls.
General and administrative expenses were $933,642 in FY 99, a decrease of 22%
from FY 98. The reduction was a result of reduced headcount and improved expense
controls.
RESEARCH AND DEVELOPMENT. Research and development expenses were $578,744 in FY
00, a decrease of 1% from FY 99. This reflects a reduced number of development
projects.
Research and development expenses were $581,659 in FY 99, a decrease of 11% from
FY 98. This reflects reduced headcount and reduced levels of inventory usage to
support development projects. Offsetting some of the expense reductions was the
write-off of approximately $50,000 in previously capitalized costs relating to
patents on technology that the Company has elected not to pursue, in order to
concentrate on the AEM-Registered Trademark- program.
NET LOSS. Net Loss in FY 00 decreased by $213,044 (10%) compared to FY 99
primarily due to improved gross margins and lower levels of operating expenses.
Net Loss in FY 99 decreased $1,015,374 (32%) compared to FY 98 due to improved
gross margins and reduced operating 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 approximately $17,300,000
through March 31, 2000, and, to a lesser degree, funds provided by sales of the
Company's products. The Company used $2,028,466 of cash in its operations in FY
00, $1,922,165 in FY 99, and $3,769,642, in FY 98, which relate primarily to the
funding of the Company's annual net losses.
As of March 31, 2000, the Company had $2,173,953 in cash and cash equivalents
and short-term investments available to fund future operations. Working capital
was $2,598,689 at March 31, 2000 compared to $4,650,500 at March 31, 1999.
During fiscal year 2000, the Company instituted a cost containment program for
its operations as well as reduced its employee head count to conserve its cash
resources. The Company has also fully implemented its marketing and sales plan
to maintain a certain number of key sales representatives and entered into
exclusive agreements with stocking distributors and independent sales
representatives to sell the Company's products. These efforts are expected to
result in increased sales revenues for fiscal year 2001 and reduced operating
expenses. With increased sales in fiscal year 2001, the Company is expecting an
increase in the gross profit margin that will ultimately reduce the overall net
loss incurred from operations and conserve the Company's cash resources.
The fiscal year 2001 budget anticipates the use of approximately $1.2 million in
cash and cash equivalents on sales of approximately $2.5 million. This forecast
assumes that the Company's gross profit margin will increase from approximately
30% to 50% by the end of the fiscal year with an overall 45% gross profit margin
on sales revenues.
The Company used $2,028,466 of cash in its operations in fiscal year 2000 on
sales of $2,002,119, used $1,922,165 of cash in its operations in fiscal year
1999 on sales of $1,568,428, and used $3,769,642 of cash in its operations in
fiscal year 1998 on sales of $1,315,915. These amounts of cash used in
operations may or may not be indicative of the expected cash to be used in
operations in fiscal year 2001.
It is uncertain if the Company will be able to meet the operational and
financial requirements of the proposed fiscal year 2001 budget and limit the use
of cash and cash equivalents to approximately $1.2 million out of the
approximately available $2.2 million. The Company can not predict the expected
revenues, gross profit margin, net loss and usage of cash and cash equivalents
for fiscal year 2001.
If the Company is able to manage the business operations in line with the budget
expectations, the Company believes that its cash resources will be sufficient to
fund its operations for at least the next twelve months. If the Company is
unable to
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manage the business operations in line with the budget expectations, it could
have a material adverse effect on the Company's business viability, financial
position, results of operations and cash flows. However, if the Company is not
successful by the end of fiscal year 2001 in becoming cash flow break even,
additional capital resources will be required to maintain ongoing operations.
The Company has not yet pursued the possibility of obtaining additional
financing to fund its future operations. It is uncertain that the Company will
be able to obtain additional funding through a private placement of its common
stock or loans from financial institutions or other third parties. If additional
capital is unavailable, it could have a material adverse effect on the Company's
business viability, financial position, results of operations and cash flows. As
a result of the above factors, the report of independent public accountants
which accompany the Fiscal Year 2000 Financial Statements expresses substantial
doubt regarding the Company's ability to continue as a going concern.
The Company's Plans in FY 2001: In February, 2000 the Company appointed James A.
Bowman as President & CEO and implemented an expense reduction program to take
effect by the start of the new fiscal year, April 1, 2000. The expense
constraints were implemented across all of the Company's operations and resulted
in a 21% reduction in headcount and 20% reduction in the operating expense
budget compared to FY 2000. These budget constraints resulted in an expense
structure appropriate with the ongoing sales achievements while still allowing
the Company to move forward with a progressive plan in the marketplace.
To lay a foundation for future growth within the constraints of the Company's
financial resources, during FY 2000 the Company focused on: expansion of its
product line, expansion of independent clinical endorsements of the Company's
technology and an improved sales infrastructure. Progress in these critical
areas resulted in early indications of success with a revenue increase and
expense reduction from FY 1999.
PRODUCT LINE EXPANSIONS - The Company believes that its strategy of
incorporating AEM technology into the standard laparoscopic instrument styles
ensures that surgeons do not have to change their operative techniques. This
strategy advanced forward in late-FY 2000 with new AEM product line extensions.
These new products filled holes in the product line that were very important to
the General and Gynecologic Surgeons.
Management believes that the AEM Laparoscopic Instrument line now, for the first
time, includes a full array of instrument styles to meet the surgeons' demands
and allows them to implement AEM technology without changing their surgical
techniques or operating room protocols.
SALES INFRASTRUCTURE IMPROVEMENTS - In early FY 2000 the Company recognized the
need to improve its sales network of independent distributors by developing
relationships with distributors who represent synergistic products and whose
primary focus is Electrosurgery & MIS. This network was substantially overhauled
during FY 2000 and those new representatives are now trained and active in the
field. The Company believes that having the sales infrastructure efficiently
active for the entire FY 2001 will allow the Company the best opportunity for
sales growth. With the improved network of Independent Distributors, the Company
has also hired an experienced team of Regional Sales Managers to manage,
motivate, educate and direct the individual distributor sales representatives.
These new business managers were hired in mid-FY 2000 to focus on optimizing the
sales function in the field, to accelerate the sales accomplishments and
maximize revenue growth.
CLINICAL ENDORSEMENTS - FY 2000 represented the culmination of a series of
independent clinical endorsements of the Company's proprietary technology. With
its recent recognition as an AORN RECOMMENDED PRACTICE (by the Association of
Operating Room Nurses) the Company's technology is now recommended by sources
representing all groups involved with minimally-invasive surgery: Surgeons,
Nurses, Biomed Engineers, Medicolegal professionals and other electrosurgery
device manufacturers.
The Company believes that gaining broad clinical endorsements is a demonstrated
and successful process for surgical technology to traditionally advance in the
marketplace. From a concern or problem in surgery, the medical device industry
develops a technological solution and this solution evolves to gain the breadth
of endorsements. Once this occurs the technology is then employed by the
hospital to benefit the patient, surgeon and operating room staff. Management
believes that AEM technology is following the same path as previous revolutions
in electrosurgery. As
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with "Isolated" ESU generators in the 1970s and with "REM" technology in the
1980s, AEM technology is receiving the broad clinical endorsements that drove
previous new technology to market acceptance.
The Company believes the unique performance of the AEM technology and its
breadth of clinical endorsements provides an opportunity for market growth.
Management feels that the market visibility and awareness of the AEM technology
and its independent surgical endorsements was substantially improved in late FY
2000 and that this will benefit the sales efforts in FY 2001.
In addition to the above, the Company has been informed that CE accreditation is
expected in mid-fiscal year 2001 and this allows the Company to launch into new
markets in Europe. The market for the Company's products internationally
represents incremental sales opportunities during FY 2001.
Management believes that the Company heads into FY 2001 having achieved
improvements in expense controls, sales infrastructure, product line expansion
and the clinical credibility of its technology. Management's focus and
commitment in FY 2001 is to maintain expense controls while optimizing sales
execution in the field, developing widespread market awareness of the technology
and expanding into the International market.
INCOME TAXES
As of March 31, 2000, net operating loss carryforwards totaling
approximately $14,300,000 are available to reduce taxable income. The net
operating loss carryforwards expire, if not previously utilized, at various
dates beginning in the year 2011. 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.
18
<PAGE>
ITEM 7. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
------- --------------------------------------------
The following financial statements are included in this Report:
PAGE
----
Report of Independent Public Accountants........................ F-1
Consolidated Balance Sheets as of March 31, 2000 and 1999....... F-2
Consolidated Statements of Operations for the fiscal
years ended March 31, 2000, 1999 and 1998....................... F-3
Consolidated Statements of Shareholders' Equity for
the fiscal years ended March 31, 2000, 1999 and 1998............ F-4
Consolidated Statements of Cash Flows for the fiscal years
ended March 31, 2000, 1999 and 1998............................. F-5
Notes to Consolidated Financial Statements...................... F-6
19
<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, 2000 and 1999, and the related statements
of operations, shareholders' equity and cash flows for each of the three fiscal
years in the period ended March 31, 2000. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
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, 2000 and 1999, and the results of its operations and its cash flows for each
of the three fiscal years in the period ended March 31, 2000, are in conformity
with accounting principles generally accepted in the United States.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note 1 to the
financial statements, the Company has suffered recurring losses from operations
since inception and its operations have been financed primarily through issuance
of equity. The Company's liquidity has substantially diminished because of such
continuing operating losses and the Company may be required to seek additional
capital to continue operations. These matters raise substantial doubt about its
ability to continue as a going concern. Management's plans in regard to these
matters are also discussed in Note 1. The financial statements do not include
any adjustments that might result from the outcome of this uncertainty.
Denver, Colorado, ARTHUR ANDERSEN LLP
May 7, 2000.
F-1
<PAGE>
ELECTROSCOPE, INC.
------------------
BALANCE SHEETS
--------------
<TABLE>
<CAPTION>
MARCH 31,
---------------------------
ASSETS 2000 1999
------ ---------- ----------
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents $ 446,473 $ 1,188,867
Short-term investments, net of discount of $9,226 (2000) and $12,258
(1999) 1,727,480 3,172,792
Accounts receivable, net of allowance for doubtful
accounts of $7,000 (2000) and $7,500 (1999) 286,027 278,533
Inventory, net of reserve for obsolescence of $145,000 (2000)
and $125,000 (1999) 594,514 439,218
Prepaid expenses 22,180 69,112
------------- -------------
Total current assets 3,076,674 5,148,522
------------- -------------
PROPERTY AND EQUIPMENT, at cost:
Furniture, fixtures and equipment 745,527 600,495
Less- Accumulated depreciation (565,769) (455,426)
------------- -------------
Property and equipment, net 179,758 145,069
------------- -------------
PATENTS, net of accumulated amortization of $22,852 (2000) 121,507 121,676
and $17,204 (1999)
OTHER ASSETS 13,472 13,472
------------- -------------
Total assets $ 3,391,411 $5,428,739
============== =============
LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------
CURRENT LIABILITIES:
Accounts payable $ 179,967 $ 144,212
Accrued compensation 82,530 135,996
Accrued liabilities 205,388 207,854
Other current liabilities 10,100 9,960
------------- -------------
Total current liabilities 477,985 498,022
------------- -------------
LONG-TERM LIABILITIES:
Other long-term liabilities - 2,335
------------- -------------
COMMITMENTS AND CONTINGENCIES
SHAREHOLDERS' EQUITY:
Preferred stock, no par value, 10,000,000 shares
authorized, no shares outstanding - -
Common stock, no par value, 100,000,000 shares authorized,
5,383,507 (2000) and 5,383,507 (1999) shares outstanding 16,941,317 16,941,317
Warrants for common stock 290,400 290,400
Accumulated other comprehensive loss (48,642) -
Accumulated deficit (14,269,649) (12,303,335)
------------- -------------
Total shareholders' equity 2,913,426 4,928,382
------------- -------------
Total liabilities and shareholders' equity $ 3,391,411 $ 5,428,739
============== =============
</TABLE>
The accompanying notes to financial statements are an integral part of these
balance sheets.
F-2
<PAGE>
ELECTROSCOPE, INC.
------------------
STATEMENTS OF OPERATIONS
------------------------
<TABLE>
<CAPTION>
For The Fiscal Year Ended March 31,
----------------------------------------------------
2000 1999 1998
------------- -------------- ---------------
<S> <C> <C> <C>
REVENUE, NET $2,002,119 $1,568,428 $1,315,915
COST OF SALES 1,280,923 1,121,698 1,218,342
------------- ------------- -------------
Gross profit (loss) 721,196 446,730 97,573
------------- ------------- -------------
OPERATING EXPENSES:
Sales and marketing 1,404,213 1,393,719 1,834,806
General and administrative 820,918 933,642 1,200,572
Research and development 578,744 581,659 652,298
------------- ------------- -------------
Total operating expenses 2,803,875 2,909,020 3,687,676
------------- ------------- -------------
INCOME (LOSS) FROM OPERATIONS (2,082,679) (2,462,290) (3,590,103)
OTHER INCOME (EXPENSE):
Interest income 126,274 291,467 413,252
Other income (expense) (9,909) (8,535) (17,881)
------------- ------------- -------------
NET INCOME (LOSS) $(1,966,314) $(2,179,358) $(3,194,732)
============= ============= =============
NET INCOME (LOSS) PER SHARE
Basic and diluted net income (loss) per common
share $ (0.37) $ (0.40) $ (0.59)
============= ============= =============
Basic and diluted weighted average shares used
in computing net income (loss) per common share 5,383,507 5,383,507 5,377,493
============= ============= =============
</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, 2000, 1999 AND 1998
--------------------------------------------------------
<TABLE>
<CAPTION>
Accumulated
Other
Comprehensive
Shares Amount Warrants Income (Loss) Deficit Total
---------- ------------ ---------- -------------- ------------- -------------
<S> <C> <C> <C> <C> <C> <C>
BALANCES, March 31, 1997 5,389,986 $ 16,997,282 $290,40 $ - $ (6,929,245) $ 10,358,437
Repurchase of shares from former officer (59,701) (156,715) - - - (156,715)
Issuance of common stock in lieu of
cash as a hiring bonus in May 1997 22,222 40,000 - - - 40,000
Issuance of common stock in lieu of
cash payment to vendor 15,000 33,750 - - - 33,750
Issuance of common stock to directors
as compensation for services 16,000 27,000 - - - 27,000
Net income (loss) - - - - (3,194,732) (3,194,732)
---------- ------------ -------- -------- ------------ ------------
BALANCES, March 31, 1998 5,383,507 16,941,317 290,400 - (10,123,977) 7,107,740
Net income (loss) - - - - (2,179,358) (2,179,358)
---------- ------------ -------- -------- ------------ ------------
BALANCES, March 31, 1999 5,383,507 16,941,317 290,400 - (12,303,335) 4,928,382
Short-term investment valuation - - - (48,642) - (48,642)
Net income (loss) - - - - (1,966,314) (1,966,314)
---------- ------------ -------- -------- ------------ ------------
BALANCES, March 31, 2000 5,383,507 $ 16,941,317 $290,400 $(48,642) $(14,269,649) $ 2,913,426
========== ============ ======== ======== ============ ============
</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
--------------------------------------------------
2000 1999 1998
------------- ------------- --------------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $(1,966,314) $(2,179,358) $(3,194,732)
Adjustments to reconcile net income (loss) to net
cash used in operating activities-
Depreciation and amortization 145,604 226,862 187,586
Amortization of discount, net (69,526) (150,274) (199,692)
Common stock issued in lieu of cash - - 100,750
Inventory reserve 20,000 (15,000) 37,404
Changes in operating assets and liabilities-
Accounts receivable (7,494) 42,617 (165,704)
Inventory (175,296) 118,788 (58,714)
Prepaid expenses and other 46,932 (7,875) 47,518
Accounts payable 35,755 44,782 (228,252)
Accrued compensation and accrued
liabilities (55,932) 1,344 (267,697)
Customer deposits - (4,376) (15,847)
Other liabilities (2,195) 325 (12,262)
-------------- -------------- -------------
Net cash used in operating activities (2,028,466) (1,922,165) (3,769,642)
-------------- -------------- -------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of short-term investments, net of discounts (3,318,552) (7,852,359) (4,813,473)
Sale of short-term investments 4,784,748 8,500,084 10,969,999
Capital expenditures (174,645) (46,501) (181,223)
Patent costs (5,479) (15,218) (50,935)
-------------- -------------- -------------
Net cash provided by
investing activities 1,286,072 586,006 5,924,368
-------------- -------------- -------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Repurchase of Common Stock - - (156,715)
-------------- -------------- -------------
Net cash used in
financing activities - - (156,715)
-------------- -------------- -------------
NET (DECREASE) INCREASE IN CASH AND
CASH EQUIVALENTS (742,394) (1,336,159) 1,998,011
CASH AND CASH EQUIVALENTS,
beginning of period 1,188,867 2,525,026 527,015
-------------- -------------- -------------
CASH AND CASH EQUIVALENTS, end of period $ 446,473 $ 1,188,867 $ 2,525,026
============== ============== =============
</TABLE>
The accompanying notes to financial statements are an integral part of these
statements.
F-5
<PAGE>
ELECTROSCOPE, INC.
------------------
NOTES TO FINANCIAL STATEMENTS
-----------------------------
(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
patented electrosurgical instruments, which are designed to provide greater
safety to patients who undergo minimally-invasive surgery. The products can be
used with most electrosurgical generator systems available today in the U.S. It
has developed and is marketing its own line of integrated, shielded
five-millimeter electrosurgical instruments that 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 U.S.
The Company has incurred losses since its inception and has an accumulated
deficit of $14,269,649 at March 31, 2000 and its operations have been financed
primarily through issuance of equity. The Company's liquidity has substantially
diminished because of such continuing operating losses and the Company may be
required to seek additional capital to continue operations.
The Company's operations are subject to certain risks and uncertainties,
including that commercial acceptance of the Company's products will have to
occur in the marketplace before the Company can attain profitable operations and
that continued operating losses and use of cash resources will continue during
fiscal year 2001 which will significantly impact the Company's ongoing
operations and business viability.
As of March 31, 2000, the Company had $2,173,953 in cash and cash equivalents
and short-term investments available to fund future operations.
During fiscal year 2000, the Company instituted a cost containment program for
its operations as well as reduced its employee head count to conserve its cash
resources. The Company has also fully implemented its marketing and sales plan
to maintain a certain number of key sales representatives and entered into
exclusive agreements with stocking distributors and independent sales
representatives to sell the Company's products. These efforts are expected to
result in increased sales revenues for fiscal year 2001 and reduced operating
expenses. With increased sales in fiscal year 2001, the Company is expecting an
increase in the gross profit margin that will ultimately reduce the overall net
loss incurred from operations and conserve the Company's cash resources.
The fiscal year 2001 budget anticipates the use of approximately $1.2 million in
cash and cash equivalents on sales of approximately $2.5 million. This forecast
assumes that the Company's gross profit margin will increase from approximately
30% to 50% by the end of the fiscal year with an overall 45% gross profit margin
on sales revenues.
It is uncertain if the Company will be able to meet the operational and
financial requirements of the proposed fiscal year 2001 budget and limit its use
of cash and cash equivalents to approximately $1.2 million out of the
approximately available $2.2 million. The Company can not predict the expected
revenues, gross profit margin, net loss and usage of cash and cash equivalents
for fiscal year 2001.
If the Company is able to manage the business operations in line with the budget
expectations, the Company believes that its cash resources will be sufficient to
fund its operations for at least the next twelve months. If the Company is
unable to manage the business operations in line with the budget expectations,
it could have a material adverse effect on the Company's business viability,
financial position, results of operations and cash flows. If the Company is not
F-6
<PAGE>
successful by the end of fiscal year 2001 in becoming cash flow break even
additional capital resources will be required to maintain ongoing operations.
The Company's Plans in FY 2001: In February, 2000 the Company appointed James A.
Bowman as President & CEO and implemented an expense reduction program to take
effect by the start of the new fiscal year, April 1, 2000. The expense
constraints were implemented across all of the Company's operations and resulted
in a 21% reduction in headcount and 20% reduction in the operating expense
budget compared to FY 2000. These budget constraints resulted in an expense
structure appropriate with the ongoing sales achievements while still allowing
the Company to move forward with a progressive plan in the marketplace.
To lay a foundation for future growth within the constraints of the Company's
financial resources, during FY 2000 the Company focused on: expansion of its
product line, expansion of independent clinical endorsements of the Company's
technology and an improved sales infrastructure. Progress in these critical
areas resulted in early indications of success with a revenue increase and
expense reduction from FY 1999.
PRODUCT LINE EXPANSIONS - The Company believes that its strategy of
incorporating AEM technology into the standard laparoscopic instrument styles
ensures that surgeons do not have to change their operative techniques. This
strategy advanced forward in late-FY 2000 with new AEM product line extensions.
These new products filled holes in the product line that were very important to
the General and Gynecologic Surgeons.
Management believes that the AEM Laparoscopic Instrument line now, for the first
time, includes a full array of instrument styles to meet the surgeons' demands
and allows them to implement AEM technology without changing their surgical
techniques or operating room protocols.
SALES INFRASTRUCTURE IMPROVEMENTS - In early FY 2000 the Company recognized the
need to improve its sales network of independent distributors by developing
relationships with distributors who represent synergistic products and whose
primary focus is Electrosurgery & MIS. This network was substantially overhauled
during FY 2000 and those new representatives are now trained and active in the
field. The Company believes that having the sales infrastructure efficiently
active for the entire FY 2001 will allow the Company the best opportunity for
sales growth. With the improved network of Independent Distributors, the Company
has also hired an experienced team of Regional Sales Managers to manage,
motivate, educate and direct the individual distributor sales representatives.
These new business managers were hired in mid-FY 2000 to focus on optimizing the
sales function in the field, to accelerate the sales accomplishments and
maximize revenue growth.
CLINICAL ENDORSEMENTS - FY 2000 represented the culmination of a series of
independent clinical endorsements of the Company's proprietary technology. With
its recent recognition as an AORN RECOMMENDED PRACTICE (by the Association of
Operating Room Nurses) the Company's technology is now recommended by sources
representing all groups involved with minimally-invasive surgery: Surgeons,
Nurses, Biomed Engineers, Medicolegal professionals and other electrosurgery
device manufacturers.
The Company believes that gaining broad clinical endorsements is a demonstrated
and successful process for surgical technology to traditionally advance in the
marketplace. From a concern or problem in surgery, the medical device industry
develops a technological solution and this solution evolves to gain the breadth
of endorsements. Once this occurs the technology is then employed by the
hospital to benefit the patient, surgeon and operating room staff. Management
believes that AEM technology is following the same path as previous revolutions
in electrosurgery. As with "Isolated" ESU generators in the 1970s and with "REM"
technology in the 1980s, AEM technology is receiving the broad clinical
endorsements that drove previous new technology to market acceptance.
The Company believes the unique performance of the AEM technology and its
breadth of clinical endorsements provides an opportunity for market growth.
Management feels that the market visibility and awareness of the AEM technology
and its independent surgical endorsements was substantially improved in late FY
2000 and that this will benefit the sales efforts in FY 2001.
F-7
<PAGE>
In addition to the above, the Company has been informed that CE accreditation is
expected in mid-fiscal year 2001 and this allows the Company to launch into new
markets in Europe. The market for the Company's products internationally
represents incremental sales opportunities during FY 2001.
Management believes that the Company heads into FY 2001 having achieved
improvements in expense controls, sales infrastructure, product line expansion
and the clinical credibility of its technology. Management's focus and
commitment in FY 2001 is to maintain expense controls while optimizing sales
execution in the field, developing widespread market awareness of the technology
and expanding into the International market.
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
------------------------------------------
Use of Estimates in the Preparation of Financial Statements
-----------------------------------------------------------
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions.
Such estimates and assumptions affect the reported amounts of assets and
liabilities as well as disclosure of contingent assets and liabilities at the
date of the financial statements, and the reported amounts of revenue and
expense during the reporting period. Actual results could differ from those
estimates.
Cash and Cash Equivalents
-------------------------
For purposes of reporting 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," management determines
the appropriate classification of its investments in debt securities at the time
of purchase. At March 31, 2000, the Company's short-term investments consist
primarily of government securities that the Company classifies as available for
sale.
The amortized cost of debt securities classified as available for sale is
adjusted for amortization of premiums and accretion of discounts to maturity.
Such amortization and accretion of discounts are included in interest income.
Since the Company will be required to sell certain of its debt securities prior
to their maturity, the Company has elected to classify its short-term
investments as available for sale. As a result, the Company has recorded an
unrealized holding loss of $48,642, which is included as a component of Other
Comprehensive 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 and corporate securities.
F-8
<PAGE>
The accounts receivable balance at March 31, 2000, of $286,027 included $93,186,
or approximately 33%, from two customers. The Company's accounts receivable
balances are primarily domestic and are concentrated among distributors of
medical equipment.
Inventory
---------
Inventories are stated at the lower of cost (first in, first out basis) or
market. At March 31, 2000 and 1999, inventory consisted of the following:
2000 1999
----------- -----------
Raw Materials $526,195 $393,606
Finished Goods 213,319 170,612
----------- -----------
739,514 564,218
Less - Reserve for Obsolescence (145,000) (125,000)
----------- -----------
$594,514 $ 439,218
=========== ===========
Property and Equipment
----------------------
Property and Equipment are 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. In fiscal year 1999 the Company
expensed approximately $50,000 of costs that had been previously capitalized as
patent application costs after it decided not to pursue development of the
related technology in order to focus on the Company's proprietary AEM
technology opportunities.
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).
Revenue Recognition
-------------------
Revenue from product sales is recorded when the Company ships the product and
the earnings process is complete. The Company recognizes revenue from sales to
stocking distributors when there is no right of return, other than for normal
warranty claims.
F-9
<PAGE>
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"), and 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).
Comprehensive Income
--------------------
The Company adopted the provisions of Statement of Financial Accounting
Standards No. 130, "Reporting Comprehensive Income" ("SFAS No. 130") as of April
1, 1998. SFAS No. 130 establishes standards for reporting and display of
comprehensive income and its components in a full set of general-purpose
financial statements. Other Comprehensive Income was reported in the Statements
of Shareholders' Equity and consists of adjustments to the fair value of
short-term investments.
Segment Reporting
-----------------
The Company adopted the provisions of Statement of Financial Accounting
Standards No. 131, "Disclosures About Segments of an Enterprise and Related
Information" ("SFAS No. 131") in the quarter ended December 31, 1998. SFAS No.
131 establishes standards for reporting information about the segments of
enterprises' business. The adoption of this statement had no impact on the
Company's financial statements as there are no material differences between
information reported to management and that contained in the financial
statements of the Company.
Basic and Diluted Loss Per Common Share
---------------------------------------
Basic and diluted 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. Shares of common stock issuable under options and warrants
have been excluded from diluted loss per share as they are antidilutive.
Recently Issued Accounting Standards
------------------------------------
In June 1999, the FASB issued Statement of Financial Accounting Standards No.
137, "Accounting for Derivative Instruments and Hedging Activities - Deferral of
the Effective Date of FASB Statement No. 133 - An Amendment of FASB Statement
No. 133" ("SFAS 137"). SFAS 137 delays the effective date of SFAS 133 to
financial quarters and financial years beginning after June 15, 2000. SFAS 133
establishes accounting and reporting standards for derivative instruments,
including certain derivative instruments embedded in other contracts and for
hedging activities. It requires that an entity recognizes all derivatives as
either assets or liabilities in the statement of financial position and measures
those instruments at fair value. Management believes that the adoption of SFAS
133 will not have a significant impact on the Company's financial condition and
results of operations.
In December 1999, the Securities and Exchange Commission ("SEC") issued Staff
Accounting Bulletin No. 101, "Revenue Recognition ("SAB 101"). SAB 101 provides
guidance on recognition, presentation, and disclosures related to revenue in the
financial statements. The Company is required to adopt this standard as of
January 1, 2001. Management does not believe the adoption of SAB 101 will have a
significant impact on the results of operations or financial position of the
Company.
In March 2000, The Financial Accounting Standards Board Issued FASB
Interpretation No. 44, "Accounting for Certain Transactions Involving Stock
Compensation" ("FIN No. 44"). FIN No. 44 clarifies the application of APB No. 25
for certain issues related to equity-based instruments issued to employees. FIN
No. 44 is effective on July 1,
F-10
<PAGE>
2000, except for certain transactions, and will be applied on a prospective
basis. Management believes that FIN No. 44 will not have a significant impact on
its financial statements.
(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% becomes 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 stock options must be exercised
within ten years from the date granted.
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 a 1997 Stock Option
Plan, which provided for an additional 800,000 shares. This Plan was approved by
the Company's shareholders on August 15, 1997.
Statement of Financial Accounting Standards No. 123
---------------------------------------------------
SFAS No. 123, "Accounting for Stock-Based Compensation," defines a fair value
based method of accounting for employee stock options or similar equity
instruments. However, SFAS No. 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 No. 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 2000 and 1999, using
the Black-Scholes option valuation model and the following weighted average
assumptions:
2000 1999
-------- --------
Risk-free interest rate 5.85 % 6.3 %
Expected lives 4.0 3.8 years
Expected volatility 149% 88 %
Expected dividend yield 0% 0%
To estimate expected lives of options for this valuation, it was assumed options
would be exercised upon becoming fully vested at the end of four and 3.8 years
respectively. 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
F-11
<PAGE>
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
$149,661, $39,771 and $1,619,547 for the years ended March 31, 2000, 1999 and
1998, 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 $(6,137), $218,408 and $672,271 for 2000, 1999 and 1998,
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:
<TABLE>
<CAPTION>
Fiscal Year Ended March 31,
2000 1999 1998
--------------------------------------------------------
<S> <C> <C> <C>
Net Loss
As Reported $(1,966,314) $(2,179,358) $(3,194,732)
Pro forma $(1,960,177) $(2,397,766) $(3,867,003)
Pro Forma Net Loss Per Common Share
As Reported $ (0.37) $ (0.40) $ (0.59)
Pro Forma $ (0.36) $ (0.45) $ (0.72)
</TABLE>
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 that 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
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 No. 123 due to the phase-in provisions of the Statement and actual vesting
experience.
F-12
<PAGE>
A summary of the Company's stock option activity, and related information for
each of the three fiscal years ended March 31, 2000 is as follows:
<TABLE>
<CAPTION>
Weighted Weighted
Average Average
Exercise Fair
Outstanding Price Value
----------- ----- -----
<S> <C> <C> <C>
BALANCE, as of March 31, 1997 723,400 $4.08
========== ====
EXERCISABLE, as of March 31, 1997 368,720 $3.47
========== ====
Granted 1,174,800 $3.16 $1.38
Exercised - -
Canceled (660,600) $4.25
----------
BALANCE, as of March 31, 1998 1,237,600 $3.12
========== ====
EXERCISABLE, as of March 31, 1998 470,044 $3.33
========== ====
Granted 60,000 $0.71 $0.71
Exercised -
Canceled (827,400) $2.91
----------
BALANCE, as of March 31, 1999 470,200 $3.18
========== ====
EXERCISABLE, as of March 31, 1999 254,265 $3.06
========== ====
Granted 433,000 $0.39 $0.35
Exercised - -
Canceled (406,000) $2.70
----------
BALANCE, as of March 31, 2000 497,200 $1.14
========== ====
EXERCISABLE, as of March 31, 2000 102,584 $3.95
========== ====
</TABLE>
F-13
<PAGE>
The following table summarizes information about employee stock options
outstanding and exercisable at March 31, 2000:
<TABLE>
<CAPTION>
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 2000 Life in Years Price 2000 Price
-------------------- --------------- ------------- --------- ------------- -----------
<S> <C> <C> <C> <C> <C>
$0.31-$1.44 400,000 4.5 $ 0.42 5,384 $ 0.44
$2.50 52,000 3.8 $ 2.50 52,000 $ 2.50
$4.50-$6.50 45,200 5.8 $ 6.03 45,200 $ 6.03
------ ------
497,200 $ 0.97 102,584 $ 3.95
======= =======
</TABLE>
Of the 497,200 options for the Company's common stock at March 31, 2000, 45,000
represent nonqualified stock options and 452,200 represent incentive stock
options. The exercise price of all options granted through March 31, 2000, 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, 2000, options for
1,272,238 of the Company's common stock are available for grant under the plan.
Outstanding Warrants
--------------------
In conjunction with the Company's Initial Public Offering (IPO) in June 1996,
the Company agreed to sell to John G. Kinnard and Company, Incorporated as the
representative of the several Underwriters, for a nominal purchase price, a
five-year warrant to purchase up to 120,000 shares of the Common Stock of the
Company, exercisable at 120% of the IPO price of $10.50 per share. As of March
31, 2000, none of the warrants had been exercised.
(4) COMMITMENTS AND CONTINGENCIES
-----------------------------
The Company currently leases and subleases its facilities under noncancelable
lease agreements that require payments of $5,244 per month through October 15,
2000, and $5,504 per month through October 15, 2001, at which time the lease
expires if not renewed by the Company. The Company has an option to renew the
lease for an additional three years.
Rent expense for the fiscal years ended March 31, 2000, 1999 and 1998 was
$94,663, $99,394, and $99,663, 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.
The Company was last inspected in November 1998, and has not, at March 31, 2000,
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 that states in part that,
based on the last periodic inspection, the Company was in substantial compliance
with CGMP.
F-14
<PAGE>
(5) INCOME TAXES
From its inception, the Company has generated losses for both financial
reporting and tax purposes. Deferred tax assets (approximately $5.0 million as
of March 31, 2000) for the Federal and state 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
$14.3 million of net operating loss carryforwards that expire, if not previously
utilized, at various dates beginning in the year 2011. 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 PROCEEDINGS
The Company is not engaged in any legal proceedings and is not aware of any
circumstances that would lead to legal proceedings. The Company may become
involved in litigation in the future in the normal course of business.
(7) RETIREMENT PLAN
On January 1, 1998, the Company adopted a 401(K) Profit Sharing Plan which
covers all full-time employees who have completed three months of full-time
continuous service and are age eighteen or older. Participants may defer up to
20% of their gross pay up to a maximum limit determined by law ($10,500 in
calendar 2000 and $10,000 in calendar 1999). Participants are immediately vested
in their contributions.
The Company may make discretionary contributions based on corporate financial
results for the fiscal year. Vesting in the profit sharing contribution account
(the Company's contribution) is based on years of service, with a participant
fully vested after five years of credited service.
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 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).
10.2 Electroscope, Inc. Stock Option Plan, as amended. (Incorporated by
reference from Registration Statement #333-4118-D dated June 25, 1996).
10.3 Electroscope, Inc. 1997 Stock Option Plan. (Incorporated by reference
from Proxy Statement dated July 15, 1997).
(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
F-16
<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 29, 2000. ELECTROSCOPE, INC.
By: /s/ James A. Bowman
-------------------------------
James A. Bowman
President & Chief Executive Officer
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/ James A. Bowman June 29, 2000
-----------------------------------
James A. Bowman
President & Chief Executive Officer
/s/ Vern D. Kornelsen June 29, 2000
-------------------------------
Vern D. Kornelsen
Director
/s/ Dave Newton June 29, 2000
-------------------------------
David W. Newton
Vice President - Technology
and Director
/s/ Roger C. Odell June 29, 2000
-------------------------------
Roger C. Odell
Vice President - Business Development
and Director
