<PAGE>
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
____________________________
FORM 10-KSB
AMENDMENT NO. 1
/X/ Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 for the fiscal year ended December 31, 1996
OR
/ / Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
0-25828
--------------------
(Commission File No.)
ELECTROPHARMACOLOGY, INC.
-----------------------------------------------------------------
(Exact name of Small Business Issuer as specified in its charter)
Delaware 954315412
---------------------------- ---------------------
(State or other jurisdiction (I.R.S. Employer
of incorporation) Identification No.)
2301 N.W. 33RD COURT, SUITE 102, POMPANO BEACH, FLORIDA 33069
(Address of principal executive offices including zip code)
Registrant's telephone number, including area code: (954) 975-9818
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK, $.01 PAR VALUE
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports) and (2) has been subject to such filing
requirements for the past 90 days. Yes /X/ No / /
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-B is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-KSB or any amendment to
this Form 10-KSB. / /
The issuer's revenues for the fiscal year ended December 31, 1996 is 2,149,011.
The aggregate market value of the registrant's Common Stock held by non-
affiliates as of March 27, 1997 was approximately $1,667,174. As of March
27, 1997 there were 3,540,179 shares of the registrant's Common Stock
outstanding.
Documents Incorporated by Reference:
NONE
______________________________________________________________________________
<PAGE>
PART I
ITEM 1. DESCRIPTION OF BUSINESS
GENERAL
Electropharmacology, Inc. (the "Company") is engaged in developing,
manufacturing and marketing medical devices that deliver pulsed electromagnetic
signals ("PEMS-TM-") in the radio frequency range. The Company was incorporated
under the laws of the State of California in August 1990 under the name Magnetic
Resonance Therapeutics, Inc., and was reorganized through a merger with and into
Electropharmacology, Inc., a Delaware corporation, in February 1995. The
Company's executive offices are located at 2301 NW 33rd Court, Suite 102,
Pompano Beach, Florida 33069, and its telephone number is (954) 975-9818.
The Company's product, which is marketed under the name SofPulse-TM-, is an
easy to operate, non-invasive device that delivers pulsed radiofrequency ("PRF")
energy. The Company has focused on PEMS-TM- that combine selected pulse forms
and amplitudes to produce certain radio frequency energy fields that are
believed to affect superficial soft tissues. In January 1991, the FDA advised
the Company of its determination, pursuant to the premarket notification
provisions under Section 510(k) of the FDC Act, to treat the MRT100, the first
model of the SofPulse-TM-, as a class III device. (See "Description of
Business -- Government Regulation"). To date, the Company's focus has been the
application of PEMS-TM- as an adjunct in the palliative treatment of pain and
edema associated with various medical conditions that involve superficial soft
tissue injury. Edema is localized tissue swelling resulting from an abnormal
accumulation of fluid in the tissue and frequently represents an obstacle to the
achievement of effective healing of soft tissue damages from conventional
medical treatment. Edema can also result in a permanent loss of range of
motion. Since PRF can be administered through clothing, casts or dressings, the
SofPulse-TM- can be conveniently used immediately following trauma or surgery.
The Company believes that the SofPulse-TM- is a cost-effective adjunct for the
palliation of pain and edema without any known significant adverse effects.
PEMS-TM- treatment is based on broadcasting pulsed electromagnetic fields
to achieve therapeutic benefits when applied to superficial soft tissue. To
date, the SofPulse-TM- has been used as an adjunct for palliative treatment of
postoperative pain and edema in various superficial soft tissues that suffer
damage in medical conditions such as acute or chronic (non-healing or
recalcitrant) skin ulcers, edema and pain resulting from trauma of hand and
ankle, pain associated with sprains of the lower back, and pain and edema
following reconstructive and plastic surgery. The traditional treatment of pain
and edema generally involves a combination of analgesic and anti-inflammatory
drugs and superficial approaches such as the application of ice packs. PEMS-TM-
has been used by clinicians as an adjunct to these other approaches.
The Company's principal marketing efforts are directed toward health care
professionals and providers engaged in medical and health care practices. The
Company's strategy has been to market the SofPulse-TM- to nursing homes and
hospitals with access to substantial numbers of patients and, to a lesser
extent, to plastic, reconstructive and orthopedic surgeons. The Company has
focused on promoting rentals as part of its pricing and marketing strategies
whereby the user is billed by the Company, on a monthly basis, for the actual
length of time that the SofPulse-TM- is used by the clinicians to treat
patients. As part of its education, marketing and promotional strategy, the
Company disseminates information it receives from the clinicians to the medical
community through summary case reports, Continuing Educational Unit courses and
advertisements in professional journals. (See "Description of Business --
Marketing and Sales").
The Company's objective is to establish PEMS-TM- delivery by the
SofPulse-TM- as a recognized modality used by physicians and other health care
practitioners, including physical therapists, occupational therapists and other
professionals, to treat postoperative pain and edema. Since its introduction in
commercial marketing, the SofPulse-TM- has been used to administer more than
250,000 treatments to thousands of patients. In order to expand further the use
of this non-invasive treatment modality, the Company has continued to expand its
technology base so that it may design proprietary devices suitable for the
delivery of various signals to (i)
<PAGE>
different anatomical locations of the body, and (ii) aid in the
healing or regeneration of damaged tissues. The Company intends to
conduct clinical evaluations of specific PEMS-TM- in medical
conditions where the reduction of pain and edema is desirable for
improved patient outcomes as well as in additional markets that may be
addressed by broader use of its proprietary signals in tissue
regeneration. In order to improve its competitive advantage in the
expanded market segments in the future, the Company intends to expand
its patent portfolio, which currently consists of two issued U.S.
patents and several pending patent applications in the U.S. and in
certain foreign countries. (See "Management's Discussion and Analysis
of Financial Condition and Results of Operations" and "Description of
Business -- Patent Protection and Proprietary Information").
The Company's principal sources of revenue have been rental fees charged to
nursing homes and hospitals for the use of the SofPulse-TM- and revenue
generated from sales of the SofPulse-TM- to certain distributors and surgeons.
(See "Description of Business -- Company Revenue"). As of March 31, 1997, the
Company had 364 of the SofPulse-TM- devices under rental agreements, and sold an
additional 104 SofPulse-TM- devices. To date, the Company has generated limited
revenue from sales and rentals of the SofPulse-TM-, which has achieved only
limited market acceptance. Expanding market penetration for the SofPulse-TM- is
expected to require substantial marketing efforts and the expenditure of
significant funds in order to demonstrate the technological advantage and
clinical benefit of the PEMS-TM- modality to the clinicians. There can be no
assurance that the therapeutic use of PRF energy underlying the PEMS-TM-
modality will become a generally accepted medical practice for which
reimbursement by third party payors is available. Further, there can be no
assurance that the Company's efforts will result in successful market
penetration and increased revenue from sales and rentals of its products, or
that the Company will be successful in expanding its technology base.
RECENT DEVELOPMENTS
In March 1997, the Company, in an effort to reduce expenses, reorganized
the responsibilities of its personnel and reduced the number of employees from
27 to 18. In order to minimize the adverse effect such reduction in personnel
may have on the Company's ability to generate revenue from marketing and sales
activities, the Company allocated three of its research and development
personnel to provide marketing support.
On March 26, 1997, Donald Soldatis resigned from his position as Chief
Financial Officer, Treasurer and Secretary of the Company. The resignation did
not result from any disagreement over accounting principles, practices or
financial statement disclosure. The Board of Directors appointed David Saloff,
who is Vice Chairman and Executive Vice President of Corporate Development of
the Company, as its acting Chief Financial Officer until a permanent replacement
can be found.
On April 1, 1997, Joseph Mooibroek resigned from his positions as Chairman
of the Board, President and Chief Executive Officer of the Company and entered
into a severance agreement with the Company. (See "Executive Compensation --
Employment Contracts, Terminations of Employment and Change of Control
Agreements"). The Board of Directors appointed Dr. Arup Sen, who was serving as
Executive Vice President of Research, Development, Regulatory and Clinical
Studies of the Company, as the new Chairman of the Board, President, Chief
Executive Officer and Secretary of the Company.
BACKGROUND OF PEMS-TM- TECHNOLOGY
Low frequency pulsed electromagnetic fields ("PEMF") have been used since
1977 in the treatment of nonunion bone fractures (i.e., fractures which refuse
to heal) and is administered principally through the use of coils attached to
(or implanted in) the patient in close proximity to the site of the fracture.
Over the past 20 years, clinical research in the field of PEMF has reported that
the use of pulsed electromagnetic fields promotes the healing of non-union bone
fractures. Although, the efficacy of this modality is not well established with
detailed scientific research. The U.S. Food and Drug Administration (the "FDA")
has granted a number of PEMF related product approvals in response to premarket
approval ("PMA") applications submitted by various companies. Direct electrical
stimulation ("E-Stim") by galvanic currents, which has been used since the
1960's to achieve beneficial effects on muscle
-2-
<PAGE>
and other soft tissues, is administered by placing electrodes in
direct contact with the tissue by the use of conductive gels and
garments. By contrast, the SofPulse-TM- utilizes a radio frequency
generator to create high frequency pulsed electromagnetic energy
fields, or PRF, that can be delivered to the patient's injury site
without actual physical contact, since PRF energy can radiate through
non-conductive media.
The majority of radiofrequency treatments utilizing PEMS-TM- technology
(pulsed and continuous fields) is presumed to cause tissue heating and is
accordingly referred to as "diathermy." Published research studies in
laboratory animal models and reports from clinicians who have used PRF in
various clinical situations over the past 30 years indicates that, depending on
the frequency or the amplitude and the total dosage of PRF fields delivered,
varying degrees of tissue heating may be achieved. By contrast, the
SofPulse-TM- delivers pulsed energy fields that are believed not to cause such
heating and, as such, this modality is called "diathermy - nonthermal." As a
result, many of the contraindications (i.e., clinical indications where a
product may not be used) that are based upon potential adverse effects
associated with tissue heating (for example, hemorrhage and use with wet
dressings or bandages) caused by the use of traditional shortwave diathermy
devices are not encountered with the use of the SofPulse-TM-.
THE SOFPULSE-TM-
The SofPulse-TM- is a compact, easy to operate, non-invasive medical device
designed to deliver pulsed electromagnetic energy fields to soft tissue for the
postoperative treatment of pain and edema. The Company markets the SofPulse-TM-
as a device for treating pain and edema in soft tissue without any known
significant adverse effects.
The SofPulse-TM- consists of a compact electronic console ("Generator") and
a nine-inch diameter circular treatment head ("Applicator") that can be combined
to fit an arm (to mount the Applicator) and a cart (to mount the arm and house
the Generator) assembly designed by the Company. The Generator, which weighs
under 14 pounds and measures 12" x 12" x 7", is a solid state RF generator that
operates at a frequency of 27.12 MHz. This frequency is approved by the Federal
Communications Commission ("FCC") and is recognized in the industry as the radio
frequency band for medical applications. The Generator supplies radio frequency
power to a coil in the Applicator that produces a PRF field able to penetrate
into superficial soft tissues. The Generator also contains controls that can be
used to adjust (i) the number of pulses per second, (ii) the peak power output,
(iii) the length of treatment, and (iv) a clock counter that records the total
time use of the SofPulse-TM-. The SofPulse-TM- offers six settings for
controlling pulses per second, which settings range between 80 and 600 pulses
per second. There are also six settings for controlling peak power output,
which settings range between 174 and 363 watts. The pulse width is 65
microseconds. The combination of pulse and power settings is used by the
clinician to estimate the total amount of energy that is applied to the
treatment area. Because the energy is pulsed (i.e., on for 65 microseconds,
then off for a longer period, then on again, etc.), at the highest repetition
rate of 600 pulses per second, the SofPulse-TM- will emit energy for only
approximately 4% of the time during use. Accordingly, the SofPulse-TM-
treatment is sometimes referred to as nonthermal diathermy since it is not
expected to produce the deep tissue heating that is generally produced by
traditional diathermy devices, which carry certain contraindications and
warnings associated with the adverse effects of tissue heating.
To use the SofPulse-TM-, a licensed clinician places the center of the
Applicator in close proximity to the superficial tissue site where the patient
presents pain or edema. PEMS-TM- is administered through clothing, casts and
dressings, permitting convenient use even immediately following surgery or the
application of a new dressing. Each treatment is typically 30 minutes in
duration. The number of treatments is dependent upon the medical diagnosis made
by the licensed clinician who is responsible for and monitors the progress of
the patient.
Since receiving the right to commercialize its device under FDA regulations
(see "Description of Business -- Government Regulation"), the Company has
continued to improve certain features related to the reliability, safety and
ease of use of its product, including (i) design improvements that require less
power to
-3-
<PAGE>
generate the intended electromagnetic field, (ii) reduction of weight
of the Generator, (iii) reduction of the cost of manufacturing, (iv) reduction
of magnetic interference, and (v) introduction of an integrated output meter
that can inform the user of the electromagnetic field being produced by a unit.
The Company commenced production and marketing of the current SofPulse-TM- Model
912 in October 1993, replacing previous models designated 911 and MRT100. The
Company is developing a new model that it expects will require less power and,
thus, its Generator would be able to deliver power to more than one Applicator
to treat multiple sites simultaneously. (See "Description of Business --
Research and Development").
The Company warrants the SofPulse-TM- to be free from defects in
materials and workmanship for a one-year period. The Company services
the SofPulse-TM-units, at its expense, during the term of any rental.
Replacement parts are furnished to customers if it is determined that
the service is relatively minor (such as the replacement of a cable or
fuse). All other repairs generally require replacing the unit and
repairing the product at the Company's facility in Florida. To date,
the Company estimates that its service related expenses are about $40
per unit.
COMPANY REVENUE
The Company's principal sources of revenue have been rental fees charged to
nursing homes for use of the SofPulse-TM- and revenue generated from sales of
the SofPulse-TM- to certain distributors and surgeons. The Company's pricing
and marketing strategies are market dependent and include rentals and sales.
The Company intends to evaluate and modify, if necessary, such strategies for
corporate alliance opportunities for marketing or distribution of the
SofPulse-TM-.
The Company's pricing policy is based on several factors that include
reimbursement by third party payors, private health care insurers, U.S. or
international market variations, volume, national contracts and other
variables. Rental charges are determined on a per "use" basis and typically a
30 minute treatment is billed at $18.00 to the user. At the present time,
the average monthly rental charges billed to the users is approximately $600
per device. Based on the Company's experience to date, the Company believes
that it may be able to recoup its cost of manufacturing the SofPulse-TM-
unit within about four months of renting the unit.
The Company rents SofPulse-TM- devices to nursing homes, hospitals, pain
clinics, rehabilitation centers and plastic/reconstructive and orthopedic
surgeons, all of which are billed on a per "use" basis. Rental agreements with
its customers are generally on a month-to-month basis. A tamper-proof time
clock in the SofPulse-TM- enables the Company to monitor and bill for rental
usage of the device. Company personnel and independent sales representatives
monitor clock readings and transmit results to the Company on a monthly basis.
The SofPulse-TM- Model 912 carries a sales list price of $28,000, although the
Company offers discounts in most cases where a distributor or a customer orders
multiple units. As of March 31, 1997, the Company had sold 104 of the
SofPulse-TM- units at an average price of $15,000 per unit.
MARKETING AND SALES
STRATEGY. The Company's principal marketing efforts are directed toward
health care professionals. The Company's goal is to market the SofPulse-TM- to
nursing homes and hospitals where substantial numbers of patients may benefit
from the SofPulse-TM- treatment, to the home health care market where patients
may continue the SofPulse-TM- treatment after being released from hospitals, and
to surgeons in several subspecialties (maxillofacial, aesthetic, emergency and
reconstructive) where the SofPulse-TM- may help in treating edema or pain and
help patients to recover from their medical condition. The Company's marketing
strategy is based to a significant extent upon the availability of reimbursement
by third party or private payors for the cost of using the SofPulse-TM-. (See
"Description of Business -- Third Party Reimbursement"). The Company's
objective is to establish the SofPulse-TM- therapy as a standard treatment that
physicians and other health care providers use for postoperative pain and edema.
-4-
<PAGE>
TARGET MARKETS. The Company has focused its initial marketing efforts on
nursing homes and selected surgeon subspecialties. Potential markets identified
by the Company include hospitals and individuals receiving home care.
NURSING HOMES. The Company believes that nursing homes utilize various
therapies intended to improve patient care, the costs of which are
reimbursable. The Company markets the SofPulse-TM- to doctors, nurses,
physical therapists and nursing home administrators through on-sight
presentations by Company personnel and independent sales representatives.
The Company believes there are currently approximately 16,000 nursing homes
operating in the U.S.
SURGEONS. The Company believes that the SofPulse-TM- may have a potential
market in a number of surgical subspecialties. The Company intends to
market the SofPulse-TM- to more than 25,000 plastic/reconstructive and
orthopedic surgeons practicing in the U.S. To date, the cost of the
SofPulse-TM- therapy following plastic/reconstructive and orthopedic
surgery has been reimbursed by Medicare, private insurance carriers, and
private payors.
HOSPITALS. The Company has identified hospitals as a potential market for
the SofPulse-TM-. However, a hospital's decision to purchase or rent new
medical equipment is often lengthy and requires the approval of hospital
administration. Consequently, there can be no assurance that the Company
will be able to achieve significant, if any, penetration in the hospital
market.
HOME CARE. The Company has also identified the large number of patients
receiving home care as a possible market for the SofPulse-TM-. A few
selective treating physicians have prescribed the SofPulse-TM- for home use
on a new indication basis. Medicare currently does not provide
reimbursement for the cost of the SofPulse-TM- for home use. (See
"Description of Business -- Third Party Reimbursement").
SALES AND RENTALS. The Company engages independent sales representatives,
direct sales representatives and independent distributor groups in various
regions throughout the U.S. for marketing the SofPulse-TM-. Sales
representatives and distributors are paid on a commission basis (generally 20 to
25% of the Company's revenue attributable to the SofPulse-TM- revenue) and are
generally responsible in their respective geographic markets for identifying,
placing and promoting the utilization of the SofPulse-TM- devices in nursing
homes and hospitals, and with physicians and other health care providers. As of
March 31, 1997, the Company had agreements with 4 independent sales
representatives, 2 direct sales representatives and 14 distributor groups. The
Company's independent sales representatives and distributors represent and deal
in various medical product lines, none of which, in the opinion of the Company's
management, compete directly with the Company's products.
The Company has received certification from the Canadian Standards
Association to market the SofPulse-TM- in Canada, and has received a notice of
completion of investigation stating that the SofPulse-TM- complies with
applicable requirements to receive the certification, UL marking, by the
Underwriter Laboratories, Inc. The Company plans to enter into other foreign
markets and, therefore, will be subject to the risks associated with foreign
sales, including economic or political instability, shipping delays,
fluctuations in foreign currency exchange rates, customs duties and export
quotas and other trade restrictions, as well as foreign regulation applicable to
the sale of medical devices, all of which could require significant funds and
have a significant impact on the Company's success in international markets.
The Company has plans to add to its management staff personnel experienced in
international marketing as and when sufficient funds are available to the
Company. (See "Management's Discussion and Analysis of Financial Condition and
Results of Operations").
PROMOTIONAL ACTIVITIES. The Company believes that product recognition by
physicians and other health care providers is an important factor in marketing
the Company's products. The Company is focusing its marketing efforts and
promotional activities on disseminating information relating to the value of PRF
therapy and intends to promote the SofPulse-TM- by highlighting research and
clinical studies that demonstrate its efficacy. (See "Description of
Business -- Research and Development"). Other marketing efforts include
preparation of promotional brochures and participation in industry conferences
and trade shows.
-5-
<PAGE>
The Company's marketing efforts are directed toward adding a non-invasive
method to the currently available remedies used by clinicians to treat pain and
edema. As is typically the case with an emerging medical treatment, demand and
market acceptance for newly introduced medical products is subject to a high
level of uncertainty. Physicians are generally reluctant to use new medical
technology until its safety, efficacy and cost-effectiveness have been
demonstrated by clinical studies published in respected scientific and medical
journals. There can be no assurance that the SofPulse-TM- therapy will become
an accepted medical practice or that the Company's efforts will result in
successful product commercialization of the SofPulse-TM-.
RESEARCH AND DEVELOPMENT
Since 1992, the Company has engaged various independent research groups and
also conducted certain research studies in-house aimed at the development and
evaluation of various PEMS-TM- in laboratory test systems and in animal models.
These efforts have led to the development of certain know-how relating to the
biological effects of PEMS-TM- that may have clinical utility in tissue healing
either by directly promoting cell growth or by indirect mechanisms such as an
increase in blood supply to treated areas. The Company intends to conduct
additional studies of PEMS-TM- in order to identify its commercial feasibility,
although there can be no assurance that any commercial applications will be
found or that, if found, such applications can be commercialized to the
Company's benefit. In order to pursue the potential of PEMS-TM- in a broad
range of medical applications that the Company believes to be feasible, the
Company intends to seek research grants, including Small Business Innovations
Research grants from governmental agencies and strategic corporate partnerships
for joint research and development programs, although there can be no assurance
that the Company will be successful in any such effort. Even if the results of
the Company's research indicate the potential for additional medical
applications of PEMS-TM-, significant additional funds and time will be required
to commercialize successfully potential products in the large, potentially world
wide markets of tissue healing. (See "Description of Business -- Government
Regulation").
From August 1994 to December 1995, in anticipation of a potential order
from the FDA requiring the submission of an application documenting the safety
and effectiveness of the Company's SofPulse-TM- product (the "PMA application"),
the Company designed and conducted through third party researchers at various
university and hospital sites in the U.S. and Canada a double-blind, randomized,
multi-center clinical study aimed at evaluating the safety and efficacy of the
SofPulse's-TM- treatment of pain and edema in grades I and II ankle sprains. In
1996, the Company issued press releases and stated in certain scientific
publications submitted by the Company's personnel and affiliates that a
statistically significant or "robust" effect was observed with respect to the
reduction of edema as a result of the treatment as compared to the control group
in a sub-population of patients. Based on such initial analyses, the Company
also had contemplated conducting certain small-scale, confirmatory studies that
the Company had believed could yield results with respect to the efficacy of the
SofPulse-TM- treatment of pain for a proposed submission of a PMA application if
required by the FDA. In February 1997, the Company completed, and publicly
announced, a rigorous and detailed evaluation of the results of this clinical
study and concluded that the earlier claims of statistically significant or
"robust" reduction of edema in Grades I and II ankle sprain by the SofPulse-TM-
treatment could not be substantiated, that published reports (including one in
the Journal of Athletic Training) claiming edema reduction presumably were based
on the inclusion of patient data with incorrect measurements and that the
results of this clinical study or any supplementary confirmatory study
contemplated by the Company would not support a satisfactory application if
required by the FDA. The Company has discontinued any further effort with, or
use of results from, this clinical study and intends to conduct new clinical
trials for one or more submissions to the FDA, if required. However, there can
be no assurance that such trials can be completed and that, if completed, would
yield results that would support the submission of a satisfactory application
to the FDA if required. The Company paid, excluding internal expenses, an
aggregate of approximately $650,000 in payments to outside third parties in
connection with agreements with institutions and outside consultants and other
expenses with respect to this clinical study.
From late 1992 to September 1996, Dr. Arthur A. Pilla, a former director
and former Chairman of the Company's Scientific and Medical Advisory Board,
conducted, supervised, reviewed and analyzed research for the Company at Mount
Sinai Medical Center, primarily in connection with evaluating the effectiveness
of different electromagnetic signals on an animal model that assesses bone
fracture healing. Dr. Pilla has communicated to the
-6-
<PAGE>
Company, based on such research, that certain of the SofPulse-TM-
signals increase the healing of animal tissue and bone repair which
results are currently being evaluated by the Company. Dr. Pilla also
presented certain reports, based on his analysis of the Company's
clinical trials, that claimed a statistically significant reduction in
edema by SofPulse-TM- treatment. These claims have subsequently been
determined by the Company to be incorrect. To date, the Company has
paid approximately $750,000 in connection with such research and
consulting services. The Company notified Dr. Pilla in January 1997
of its intent to terminate the Company's agreements with Dr. Pilla,
which termination has been confirmed by Dr. Pilla. However, there are
certain outstanding disagreements that have yet to be resolved between
Dr. Pilla and the Company.
Pursuant to a research agreement executed by the Company in late 1993,
certain laboratory research was conducted at the University of Kentucky on nerve
cell and nerve fiber growth and regeneration. The Company paid approximately
$100,000 for this research. The Company is evaluating such results but does not
know if they will have commercial feasibility. Starting in August 1993, the
Microvascular and Physiological Studies Unit conducted a preliminary research
study at the Miami Heart Institute to document the effects of PRF therapy on
healthy subjects and vascularly impaired patients with wounds to determine
whether and to what extent PRF therapy increases blood flow in such patients.
The results of the first two studies, published in peer-reviewed scientific
journals, indicate that PRF signals may increase blood flow in healthy subjects
and vascularly impaired patients. The Company paid approximately $40,000 in
connection with these studies.
For the years ended December 31, 1994, 1995 and 1996, the Company expended
approximately $949,820, $1,690,163 and $815,722, respectively, on research and
development, primarily in connection with its PMA application and new product
development. There can be no assurance that the Company will be able, for
financial or other reasons, to complete its research and clinical studies and
file a PMA application for the SofPulse-TM- for any of its intended uses.
The Company's future growth depends on the successful development and
introduction of new products, the enhancement of existing products, including
the development of portable units and products complemented with novel software,
and the adaptation of existing products for new clinical indications. The
Company intends to enhance continually its products and adapt its products for
specific market applications. The Company's proposed products include:
SOFTWARE BASED SOFPULSE-TM-. The Company has developed prototypes for a
second generation of the SofPulse-TM- 912 with certain software that
control and monitor certain of the functions of the device. The prototype
is currently under evaluation by the Company.
SOFDOSE-TM-. The Company is developing a portable hand-held SofPulse-TM-
and a miniaturized, battery operated SofPulse-TM- model that would use
smaller Applicators. The Company intends to incorporate in the SOFDOSE
device the ability to deliver PEMS-TM- that may have additional market
applications, including convenience for home use and promotion of healing
of tissues and bone fractures. The Company may seek a relationship with a
corporate partner for the development and commercialization of one or more
market applications of such product(s), although there can be no assurance
that such a partner can be found.
To the extent the Company proposes to market new medical devices, if
successfully developed, or adapt its existing products for new uses, the
Company may be required to comply with the requirements, among others, to
conduct preclinical and clinical studies necessary to determine the safety
and effectiveness of its products for such intended uses and submit
information based on such studies to the FDA, which has the sole authority to
determine whether a device is safe and effective for its intended use prior
to marketing. (See "Description of Business -- Government Regulation").
The Company's agreements with its consultants generally provide that
title to any reports, inventions, discoveries, improvements or modifications,
whether patentable or not, that are conceived or reduced to practice by the
consultant and that are used or usable by the Company shall be the property
of the Company. Generally, pursuant to the Company's research and study
agreements with institutions, title to all inventions and discoveries made by
an institution resulting from the research performed will be property of the
Company, provided that the Company grants
-7-
<PAGE>
the institution an option to negotiate royalty-bearing licenses in
non-competitive areas to commercialize any product resulting from such
invention or discovery conceived or reduced to practice. The Company has
filed patent applications in the U.S. Patent & Trademark Office and in
certain foreign countries, claiming certain products, methods and the like
based on the results of some of the research and development conducted by or
on behalf of the Company. The Company is the assignee of two issued U.S.
patents and certain patent applications in the U.S. and certain foreign
countries. (See "Description of Business -- Patents and Proprietary
Information").
MANUFACTURING AND SUPPLIERS
The Company will continue to use third party suppliers for the supply of
components incorporated in the SofPulse-TM-. The Company has used a contract
manufacturer for the supply of some of the SofPulse-TM- units that have been
marketed by the Company. The carts, plastic molded cradles and
counter-balanced arms incorporated into the SofPulse-TM- are manufactured and
obtained from sole suppliers. The Company has been informed by the
manufacturer of the counter-balanced arm that the manufacturer will
discontinue manufacturing the arm during 1997. Therefore, the Company is
seeking other alternatives in design and supply of the arm. However,
management does not believe failure by its suppliers to continue to supply
the Company with components would have a material adverse effect on the
Company. While the Company believes that alternative sources are currently
available for all components of the SofPulse-TM-, including RF Generators and
Applicators, the Company's business is generally subject to the risk of price
fluctuations and periodic shortages of components. The Company has no
long-term supply agreements with any of its suppliers and, accordingly,
purchases components pursuant to purchase orders placed from time to time in
the ordinary course of business. Failure or delay by suppliers in supplying
necessary components to the Company could adversely impact the Company's
ability to obtain and deliver products on a timely basis.
The Company has previously purchased about 255 units of MRT SofPulse-TM-
Model 912 devices and discussed certain terms for the future purchase of
SofPulse-TM- devices from a third party vendor who is a manufacturer of
electronic devices. The Company's discussions relating to such purchase have
included terms for mutual exclusivity, use of proprietary design features,
production in compliance with regulatory guidelines, possible royalty payments
for use of the vendor's proprietary features, if any, and the like. However,
no royalty rates or alternative minimum purchase orders have been agreed upon
between the Company and the vendor and the Company has not accrued any reserves
for royalty payments owed, if any, or provisions for minimum purchase beyond the
requirements of the Company in its normal course of business. Each of the
Company and the vendor has continued to improve upon the documentation and other
manufacturing practices in order to comply with regulatory guidelines.
The Company currently employs one individual engaged in quality control and
inspections of the Company's products for conformity with the Company's
specifications. The Company oversees manufacturing of its products, third party
suppliers and manufacturers to ensure compliance with the FDA's Good
Manufacturing Practices. The Company's quality control operation involves the
certification of each component, a series of quality specification measurements,
and various other tests to verify final performance specifications. (See
"Description of Business -- Government Regulation").
COMPETITION
The medical products market is highly competitive. Diapulse Corporation of
America, Inc. manufactures and markets devices that are substantially equivalent
to the Company's SofPulse-TM- device. (See "Legal Proceedings"). A number of
other manufacturers, both domestic and foreign, and distributors market
shortwave diathermy devices that produce deep tissue heat and that may be used
for the treatment of certain of the medical conditions in which the Company's
SofPulse-TM- device is also indicated. These other devices have certain
limitations to their clinical use imposed by the FDA and carry certain
contraindications associated with tissue heating. There can be no assurance
that other technologies or products that are functionally similar to those of
the Company are not currently under development. The Company's products also
face competition from other forms of treatment such as hyperbaric oxygen
chambers, thermal therapies and hydrotherapy. Other companies with
substantially larger expertise or resources than that available to the Company
may develop or market new products that directly market the SofPulse-TM-. In
addition, other
-8-
<PAGE>
forms of treatment that compete with the Company's PRF treatment may
achieve rapid acceptance in the medical community.
Several other companies manufacture medical devices based on the
principle of electromagnetic force technologies for applications in bone
healing and spinal fusion, and may adapt their technologies or products to
compete directly with the SofPulse-TM-. These companies include Orthologic
Corp., Electro-Biology, Inc., a subsidiary of Biomet, Inc., Orthofix, Ltd.,
and Biomagnetics, Inc. The Company is also aware of other companies that
manufacture and market thermal devices in the same target markets as the
Company. Certain of these companies have significant product sales and may
have greater financial, technical, personnel and other resources than the
Company. Also, universities and research organizations may actively engage
in research and development to develop technologies or products that will
compete with the Company's products.
The medical products market is characterized by rapidly changing technology
that may result in product obsolescence or short product life cycles. The
Company's ability to compete will be dependent on the Company's ability to
enhance continually and improve its products and to develop successfully or
acquire and market new products. There can be no assurance that the Company
will be able to compete successfully, that competitors will not develop
technologies or products that render the Company's products obsolete or less
marketable or that the Company will be able to enhance successfully its existing
products or develop or acquire new products.
The Company competes on the basis of the strength of its marketing and
sales force and to a lesser extent on price, quality and service. The Company
believes that the SofPulse-TM- offers advantages over competing products,
including size, reliability and ease of use. The Company also believes that it
will have a significant marketing advantage over competitors seeking to enter
markets if the Company is successful in filing and obtaining product approval,
based on a PMA application, from the FDA. (See "Description of Business --
Government Regulation").
GOVERNMENT REGULATION
The manufacture and marketing of medical devices, including the Company's
products, is subject to various federal and state regulations in the U.S. and in
foreign countries. The U.S. Food, Drug and Cosmetic Act (the "FDC Act"), the
Public Health Service Act, the Safe Medical Devices Act and its amendments, the
Federal Communications Commission regulations, the Occupational Safety and
Health Act and other federal and state statutes and regulations govern or
influence various aspects of the Company's operations, including the
commercialization of its products. Non-compliance with applicable regulations
can result in fines, civil penalties, injunctions, suspension or loss of
regulatory approvals, recall or seizure of products, revocation of the right to
market products, operating restrictions or restrictions on the ability of the
Company to enter into supply contracts, and the right to promote products in one
or more market segments.
Under the FDC Act, all medical devices are classified into three
categories, class I, II or III devices. A class II device is a device whose
safety and efficacy can be verified by established and currently accepted
standards. A class III device, on the other hand, is subject to the most
stringent review among medical devices, requiring that the safety and efficacy
of a device for its intended use be established through a PMA application filed
with the FDA before commencement of marketing, sales and distribution in the
U.S. However, the FDA has permitted the marketing, without having to obtain
prior approval upon filing of a PMA application, of certain class III medical
devices in cases in which it finds, pursuant to a premarket notification under
Section 510(i) of the FDC Act, that the subject device is "substantially
equivalent" to a device lawfully marketed for the selected indication prior to
1976.
In January 1991, the FDA advised the Company of the FDA's determination,
pursuant to the premarket notification provisions under Section 510(k) of the
FDC Act, to treat the MRT100, the first model of the SofPulse-TM-, as a class
III device. However, in April 1994, the FDA's Office of Device Evaluation
published a notification that may require the Company to submit information
based on clinical studies to establish independently that the SofPulse-TM- is
safe and effective for its intended use. In accordance with the FDC Act, the
FDA's rule making activities involve the publication of proposed regulations,
followed by solicitation of comments from the public and, thereafter, the
adoption of final regulations. As of March 31, 1997, the FDA had not yet
published proposed regulations indicating whether
-9-
<PAGE>
the Company will be required to comply with the FDA's PMA application
requirements. If the adoption of the final regulations with regard to
all class III medical devices requires the submission of satisfactory
PMA applications, then the Company would have the option to submit a
summary of and citation to information known or available to the
Company concerning the device, including information on its safety and
effectiveness, if available. After reviewing the data, the FDA would
issue proposed regulations determining whether the subject device will
remain in class III or be down-classified into class II. If the
SofPulse-TM- is deemed to be a class III device after such review,
then the Company would be required to submit a PMA application with
the FDA within 90 days of such proposed regulation. The inability of
the Company to submit a satisfactory PMA application within 90 days
of such decision, or a subsequent determination by the FDA that the
data provided by the Company in the PMA application does not satisfy
the requirement relative to the safety and effectiveness of the
SofPulse-TM- for its intended use, would prevent the Company from
continuing to market the SofPulse-TM-. Inability to market the
SofPulse-TM- would have a material adverse effect on the Company,
including possibly the need to curtail substantially its operations.
There can be no assurance that the Company will be able, for financial
or other reasons, to complete successfully clinical studies and file a
PMA application within the time ultimately prescribed by the FDA.
Failure to complete research and clinical studies and file such PMA
application could result in the revocation of the Company's Section
510(k) approval and otherwise prevent the Company from marketing and
generating any revenue from sales and rentals of the SofPulse-TM-
until a PMA application is filed and approved by the FDA. The FDC Act
provides that if the Company files its PMA application within 90 days
following the adoption of final regulations by the FDA, it will be
able to continue to market the SofPulse-TM- pending FDA approval.
The process of submitting a satisfactory PMA application is significantly
more expensive, complex and time consuming than the process of establishing
"substantial equivalence" to a device marketed prior to 1976 pursuant to the
Section 510(k) premarket notification, and requires extensive research and
clinical studies. Randomized, placebo-controlled, double-blind clinical studies
may need to be performed under a clinical protocol with assurance of adherence
to the protocol, informed consent from subjects enrolled in the study, approval
of the Institutional Review Board at each of the centers where the study is
being conducted, maintenance of required documentation, proper monitoring and
recording of all data, and sufficient statistical evaluation to determine if the
results of the treatment with the device are statistically significant in
improving patient outcome compared to the patients who did not receive the
treatment. Upon completion of these tasks, an applicant is required to assemble
and submit to the FDA all relevant clinical, animal testing, manufacturing,
laboratory specifications and other information. The submission is reviewed at
the FDA, which determines whether or not to accept the application for filing.
If accepted for filing, the application is further reviewed by the FDA and
subsequently may be reviewed by an FDA scientific advisory panel comprised of
physicians, statisticians and other qualified personnel. A public meeting may
be held before the advisory panel in which the PMA application is reviewed and
discussed. Upon completion of such process, the advisory panel issues a
favorable or unfavorable recommendation to the FDA or recommends approval with
conditions. The FDA is not bound by the opinion of the advisory panel. The FDA
may conduct an inspection to determine whether the Company conforms with current
Good Manufacturing Practice ("GMP") regulations. If the FDA's evaluation is
favorable, the FDA will subsequently publish a letter approving the PMA
application for the device for a mutually agreed upon indication of use.
Interested parties can file comments on the order and seek further FDA review.
The PMA process may take several years and no assurance can be given concerning
the ultimate outcome of PMA applications submitted by an applicant.
In the event the Company proposes to market new medical devices, if
developed or acquired, or adapt its current products for a new use, the FDA may
require the Company to comply with Section 510(k) or PMA requirements to
establish independently that a device is safe and effective for its intended
use.
After regulatory approvals are obtained, a marketed product and its
manufacturer are subject to continuing regulatory review. The manufacture of
the SofPulse-TM- is subject to GMP regulations of, and periodic compliance
inspections by, the FDA. The Company may become subject to pre-approval
inspections by the FDA prior to commercial manufacture of future products. The
Company is required to register as a medical device manufacturer with the FDA
and state agencies. The Company is also subject to inspection of radiation
control by the State of Florida. Under GMP regulations, the Company is subject
to certain procedural and documentation requirements with respect to
manufacturing and control activities. The Company's suppliers may be subject to
periodic inspections by the FDA, as well as by state and foreign regulatory
authorities. The Company believes its suppliers' and
-10-
<PAGE>
manufacturer's manufacturing facilities are in compliance in all
material respects with all applicable local, state and federal
regulations. Failure to comply with GMP regulations, or to satisfy
FDA regulations or inspections, could subject the Company to civil
remedies, including fines, injunctions, recalls or seizures, as well
as potential sanctions, which could have a material adverse effect on
the Company.
The Company is also subject to various FDA regulations and Good Laboratory
Practices, which govern or influence the research, testing, manufacture, safety,
labeling, storage, record keeping, advertising and promotion of medical devices.
Sales of medical devices outside the U.S. are subject to foreign regulatory
requirements that vary widely from country to country. The Company has obtained
approval from the Canadian Standards Association ("CSA") to market the
SofPulse-TM- in Canada and received notification from the Underwriters
Laboratories Inc. ("UL") that the SofPulse-TM- complies with applicable
requirements for UL marking. The CSA and UL marking signify compliance with
certain national standards deemed desirable for electronic equipment, although
any benefit to sales or marketing of the SofPulse-TM- device cannot be assured
by the Company. The Company has initiated quality systems review for ISO 9000
certification and has plans to seek a CE mark for European product sales
required in 1998. There can be no assurance that the Company will be successful
in obtaining and maintaining necessary approvals to market the SofPulse-TM-, or
additional products that are developed or acquired by the Company, in foreign
markets.
THIRD PARTY REIMBURSEMENT
In the U.S., health care providers, such as hospitals and physicians, that
purchase or lease medical devices such as the Company's products generally rely
on third party payors, principally Medicare, Medicaid and private health
insurance plans, including health maintenance organizations, to reimburse all or
part of the cost of the treatment for which the medical device is being used.
Successful commercialization of the Company's products will depend in part upon
the continuing availability of reimbursement for the cost of the treatment from
third party health care payors such as Medicare, Medicaid and private health
insurance plans, including health maintenance organizations. Such third party
payors have increasingly challenged the costs of medical products and services,
which have and could continue to have a significant effect on the ratification
of such products and services by many health care providers. Several proposals
have been made by federal and state government officials that may lead to health
care reforms, including a government directed national health care system and
health care cost-containment measures. The effect of changes in the health care
system or method of reimbursement for the Company's SofPulse-TM- product or
future products cannot be determined.
While third party payors generally make their own decisions regarding which
medical procedures and services to cover, Medicaid and other third party payors
may apply standards similar to those used by Medicare in determining whether to
provide coverage for a particular procedure or service. The Medicare statute
prohibits payment for any medical procedures or services that are not reasonable
and necessary for the diagnosis or treatment of illness or injury. The Health
Care Financing Administration ("HCFA"), an agency within the Department of
Health and Human Services that is responsible for administering the Medicare
program, has interpreted this provision to prohibit Medicare coverage of
procedures that, among other things, are not deemed safe and effective
treatments for the conditions for which they are being used, or which are still
investigational.
Although a limited number of national coverage decisions are made by HCFA,
in general, the determination of whether a procedure satisfies these standards
is made by the Medicare carrier or fiscal intermediary that processes claims for
reimbursement within that carrier's or intermediary's jurisdiction. Medicare
currently uses fiscal intermediaries for payment to the nursing home industry.
To date, 12 fiscal intermediaries have approved payment for the PRF treatment
delivered by the SofPulse-TM-, while several others have not made a decision and
some have denied payment. The current primary customers of the SofPulse-TM-
device are nursing homes who undergo changes with respect to fiscal
intermediaries that determine reimbursements for treatments used by the nursing
home chains. If and when additional fiscal intermediaries decide to reimburse
for PRF treatment or additional nursing home chains use one of the fiscal
intermediaries that has approved payment for PRF treatment, then the Company may
benefit from its ability to rent the SofPulse-TM- devices to additional nursing
homes, although there can be no assurance thereof.
-11-
<PAGE>
Although a significant number of private health insurance plans also
have made payments, this does not necessarily mean that a coverage
determination has been made by these payors. There can be no assurance
that coverage of the SofPulse-TM- will be continued or expanded by
Medicare, Medicaid or any other third party payor. The unavailability
of third party coverage or inadequacy of third party reimbursement for
PRF treatment could adversely affect the Company's ability to market
the SofPulse-TM-, particularly to providers, such as office-based
practitioners and nursing homes, who may rely on such factors before
making the decision to purchase or rent the SofPulse-TM-. Other than
one fiscal intermediary for Medicare, the Company is not aware of
instances in which coverage has been denied for properly documented
procedures performed with the SofPulse-TM-. Such fiscal intermediary
has, however, approved reimbursement for the SofPulse-TM- in its
capacity as a third party health care payor.
The Company is unable to predict what additional legislation or
regulations, if any, may be enacted or adopted in the future relating
to the Company's business or the health care industry, including third
party coverage and reimbursement, or what effect any such legislation
or regulations may have on the Company. Additionally, significant
uncertainty exists as to the reimbursement status of newly approved
health care products, and there can be no assurance that adequate
third party coverage will be available with respect to any of the
Company's products in the future. Failure by physicians, hospitals,
nursing homes and other users of the Company's products to obtain
sufficient reimbursement for treatments using the Company's products
could have a material adverse effect on the Company.
PATENT PROTECTION AND PROPRIETARY INFORMATION
The Company is the assignee of two Patents (No. 5,370,680 and No.
5,584,863) issued by the U.S. Patents & Trademark Office and has certain patent
applications pending in the U.S. and certain foreign countries. The Company
believes that patent protection is of material importance to its business and
anticipates that it will apply for additional patents as it deems appropriate
and seek to obtain licenses to patents and patent applications from others.
There can be no assurance, however, that patents will issue from any present or
future applications or, if patents issue, that any claims allowed will be
sufficiently broad to protect the Company's technology. In addition, there can
be no assurance that the patents issued to the Company will not be challenged,
invalidated or circumvented, or that the rights granted thereunder will provide
proprietary protection to the Company. Further, the medical products industry
is covered by many issued patents and patent applications. Patent applications
in the U.S. remain confidential until a patent is issued and, therefore, the
Company's products could in the future be found to infringe third party patents
of which the Company is not currently aware. If the Company's products are
suspected of using technology, processes or other subject matter that is claimed
under other existing U.S. or foreign patents, or if other companies obtain
patents claiming subject matter utilized by the Company, such companies may
bring infringement actions against the Company. Because many holders of patents
in the medical products industry have substantially greater resources than the
Company and because historically patent litigation is very expensive, the
Company may not have the resources necessary to challenge successfully the
validity of such third party patents or withstand claims of infringement of
challenges to its patents in cases where the Company's position has merit.
Even if the Company is successful in prevailing in such actions, the cost of
such litigation could have material adverse effect on the Company's business,
financial condition and results of operations. An adverse outcome in any
future patent dispute could subject the Company to significant liabilities to
third parties, require disputed rights to be licensed or require the Company to
cease using the infringed technology. There can be no assurance that the
Company will be able to obtain such licenses or that such licenses, if
available, can be obtained on commercially reasonable terms. Although the
Company believes that its products do not and will not infringe patents or
violate proprietary rights of others and the Company has not been notified of
infringement by the SofPulse-TM- on other patents, in the event the Company's
products infringe patents or proprietary rights of others, the Company may be
required to modify the design of its products or obtain a license.
The Company also relies on trade secret and copyright law, employee and
third party nondisclosure agreements and other protective measures to protect
its intellectual property rights pertaining to its products and technology.
There can be no assurance that these agreements and measures will provide
meaningful protection of the Company's trade secrets, know-how, or other
proprietary information in the event of any unauthorized use, misappropriation
or disclosure. In addition, the laws of certain foreign countries do not
protect the Company's intellectual property rights to the same extent as do the
laws of the U.S. There can be no assurance that the Company will be able to
protect successfully its intellectual property.
-12-
<PAGE>
Furthermore, although the Company has confidentiality agreements with its
employees and appropriate vendors, certain of these agreements are due to
expire over the next three to five years. Accordingly, there can be no
assurance that such arrangements will adequately protect certain of the
Company's proprietary information beyond the next two to five years.
"MRT-TM-" is a registered trademark of the Company that the Company
previously used on the SofPulse-TM- machine. The Company also has filed
trademark applications to register the marks "SofPulse-TM-" and "PRF-TM-",
and intends to file for "SofDose-TM-."
INSURANCE
The Company may be exposed to potential product liability claims by
patients who use the Company's products. Therefore, the Company maintains a
general liability insurance policy, which includes aggregate product
liability coverage of $3,000,000. The Company believes that its present
insurance coverage is adequate for the types of products currently marketed.
There can be no assurance, however, that such insurance will be sufficient to
cover potential claims or that the present level of coverage will be
available in the future at a reasonable cost. The Company has named the
SofPulse-TM- manufacturer and certain representatives as additional insureds.
The Company has also indemnified the Miami Heart Institute ("MHI") against
any claims, damages or liabilities incurred by MHI in connection with its use
of the SofPulse-TM- in a clinical study that was completed two years ago from
which no adverse effects have been reported. The Company may be required to
indemnify other research institutions against certain liabilities incurred by
them as a result of the use of the Company's products in research and
clinical studies. In the event a claim that is partially or completely
uninsured is successfully made against the Company, or in the event an
indemnification claim is made against the Company and is partially or
completely uninsured, the Company's business and financial condition could be
materially adversely affected.
The Company warrants its products to be free from defects in materials
and workmanship for a one-year period. The Company believes that with the
quality record of the product and the majority of products in a rental pool,
future warranty expenses will not have a material adverse effect on the
Company, although there can be no assurance thereof.
EMPLOYEES
As of March 31, 1997, the Company had 18 full-time employees and no
part-time employees subsequent to a down-sizing of the Company's personnel in
March 1997. The Company believes that its relations with such personnel are
satisfactory. The Company is not a party to any collective bargaining
agreement.
ITEM 2. DESCRIPTION OF PROPERTY
The Company's current executive and administrative offices are located at
2301 NW 33rd Court, Suite 102, Pompano Beach , Florida, 33069, where it
leases approximately 8,000 square feet of office and warehouse space under a
lease that provides for rental payments of $3,300 per month and that expired
in March 1997. The lease provides for a one-year renewal option. The Company
has a month to month lease. The landlord has, as of this date, verbally
agreed to the Company's current lease extension with substantially the same
terms.
ITEM 3. LEGAL PROCEEDINGS
In February 1993, Diapulse Corporation of America, Inc. ("Diapulse") filed
a citizen's petition requesting that the FDA revoke the substantial equivalence
finding for the SofPulse-TM- and prevent the Company from making certain
labeling claims. The Company believes, based upon the advice of regulatory
counsel, that Diapulse's petition is without merit. The Company has responded
to the petition. The Company, however, in response to comments received by
-13-
<PAGE>
the Company from the FDA, has made revisions in its promotional
materials to obviate any claim that such material is inconsistent with
FDA regulations. The Company has received an opinion of regulatory
counsel stating that the petition is lacking in merit and that it is
highly unlikely that the FDA will grant the petition. Nevertheless,
in the event that the FDA were to grant the petition, the Company's
business and prospects would be materially adversely affected. In
October 1993, Diapulse submitted additional information to the FDA in
support of its petition and the Company responded. As of the date
hereof, the FDA has not notified the Company as to any action with
respect to the aforementioned petition.
In August 1994, Diapulse filed a lawsuit in the Supreme Court of the
State of New York, Nassau County ("The Court"), captioned DIAPULSE CORPORATION
OF AMERICA V. MAGNETIC RESONANCE THERAPEUTICS, INC. ET AL., alleging that the
defendants Magnetic Resonance Therapeutics, Inc., a legal predecessor to the
Company, Bio-Sales, Inc., the Company, and certain of the Company's present and
former directors and officers, including Joshua Barnum ("Barnum"), David Mills
("Mills"), Arthur Pilla ("Pilla"), David Saloff ("Saloff"), and David Winter
("Winer"), engaged in deceptive acts and practices, false advertising and
unfair competition in the marketing of a medical device. The complaint also
alleges that Barnum and Mills breached confidentiality and noncompetition
agreements with Diapulse and that the Company, Barnum and Pilla aided in the
alleged tortious breach of the agreements. Diapulse seeks unspecified
compensatory damages, disgorgement of profits realized by the defendants as a
result of their alleged acts, treble damages, punitive damages and reasonable
attorneys' fees. Diapulse also seeks unspecified injunctive relief prohibiting
the defendants from engaging in the alleged acts and ordering the defendants to
take remedial action to rectify the effects on consumers and Diapulse caused by
the defendants' alleged acts. The defendants jointly moved to dismiss the
complaint on jurisdictional and substantive grounds. The Court dismissed Winer
from the case based on lack of personal jurisdiction. The Court also dismissed
certain claims, as to the remaining individual defendants, including deceptive
acts and practices, false advertising and unfair competition. As to the claims
remaining against the individual defendants, certain of such claims may be
indemnified by the Company. As to the Company, the Court denied the motion to
dismiss. The Company answered the complaint, denied all material allegations,
asserted various affirmative defenses and counterclaimed against Diapulse and
Jesse Ross, individually. The counterclaims allege causes of action against
Diapulse and Jesse Ross for federal unfair competition and tortious
interference of existing and contractual business relations. In addition, the
Company has asserted claims against Diapulse for deceptive acts and unfair
trade practices, and trade disparagement. In its counterclaims, the Company
seeks compensatory and punitive damages in an amount to be proved at trial.
This lawsuit is in a preliminary stage and its outcome is uncertain. Although
the Company believes that it has meritorious defenses that it will vigorously
pursue, there can be no assurance that the outcome of such action will be
resolved favorably to the Company or that such litigation will not have an
adverse effect on the Company's liquidity, financial condition and results of
operations.
On March 27, 1997, Ancillary Provider Services, Inc. ("APS") filed a
complaint entitled ANCILLARY PROVIDER SERVICES, INC. V. CHRISTIAN BOWMAN, HIRSCH
MEDICAL SERVICES, INC., ELECTROPHARMACOLOGY, INC. AND DOES 1 THROUGH 100 in the
Superior Court in Los Angeles, California against Christian Bowman, a former APS
employee, Hirsch Medical Services, Inc. ("Hirsch") and the Company. The
complaint alleges causes of action for misappropriation of trade secrets, breach
of fiduciary duty, unfair business practices, tortious inducement to breach
contracts, tortious interference with prospective economic advantage, breach of
contract and breach of covenant of good faith and fair dealing and seeks
unspecified actual, consequential, incidental and punitive damages, an
accounting, restitution and an injunction prohibiting the defendants from
contacting or doing business with APS's customers. Simultaneous with filing the
complaint, APS moved by order to show cause for a preliminary injunction against
the defendants to prevent them from contacting or doing business with APS's
customers. The hearing on the motion for preliminary injunction will be on
April 23, 1997. The complaint alleges that beginning in October 1995, APS was
the exclusive distributor in Southern California of the Company's MRT device.
The complaint further alleges that in June 1996, APS hired defendant Bowman,
formerly of the Company, to assist APS in its efforts to distribute the MRT
device. According to the complaint Bowman entered into an employment agreement
with APS that included a confidentiality provision and a non-compete clause.
APS asserts that the Company improperly terminated the APS distributorship
agreement and replaced APS with defendant Hirsch as the MRT distributor in
California. Thereafter, APS alleges that Bowman resigned from APS on March 14,
1997, joined Hirsch and that defendants misappropriated confidential trade
secrets from APS including, among other things, its proprietary customer lists.
The complaint alleges that the defendants continue to interfere with APS's
contractual relations with its customers and solicit such customers to do
business with Hirsch. This lawsuit is in the preliminary stage and, therefore,
the outcome of this litigation is uncertain. The Company believes that it has
meritorious defenses that it will pursue vigorously. Pursuant to a provision in
the 1996
-14-
<PAGE>
distributorship agreement between APS and the Company requiring all disputes
between APS and the Company be resolved by arbitration, the Company initiated,
on April 3, 1997, an arbitration proceeding before the American Arbitration
Association in Miami, Florida seeking a declaration that the 1996
distributorship agreement governs APS and the Company, that the Company has
no continuing obligations to APS pursuant to such agreement, and that any
claims arising out of or relating to the 1996 agreement or the alleged breach
thereof are meritless.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Company submitted several matters to a vote of security holders at
the Company's 1996 Annual Meeting of Stockholders held on November 1, 1996.
At the Annual Meeting, Messrs. Joseph Mooibroek, David Saloff, Bruce Benner,
Larry Haimovitch, Murray Feldman, and Steven Mayer were elected to serve as
directors of the Company for one-year terms ending at the 1997 Annual Meeting
of Stockholders. Mr. Benner subsequently resigned from his position as a
director on February 18, 1997. Mr. Mooibroek resigned from his position as
Chairman of the Board on April 1, 1997. The Board of Directors has not
appointed or elected anyone to fill the vacancies created by such
resignations.
At the 1996 Annual Meeting, stockholders approved an amendment to the
Company's Stock Option Plan to increase the number of shares of Common Stock
reserved for issuance thereunder from 322,840 to 1,500,000 shares with 2,763,265
votes cast for, 58,193 votes cast against and 4,475 votes abstaining.
Stockholders also approved an amendment to the Company's Certificate of
Incorporation to increase the number of authorized shares of Common Stock from
10,000,000 shares to 30,000,000 shares and the number of authorized shares of
Preferred Stock from 1,000,000 shares to 10,000,000 shares with 2,631,364 votes
of Common Stock cast for and 421,950 votes of Preferred Stock cast for.
-15-
<PAGE>
PART II
ITEM 5. MARKET FOR THE COMPANY'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
The Company's Common Stock is traded on the Nasdaq Small Cap Market under
the symbol "EPHI." The following table sets forth, for the periods indicated,
the range of high and low bid quotations for the Common Stock as reported by
Nasdaq. However, the Company's Common Stock generally is not actively traded
or is traded in low volumes, and accordingly there can be no assurance that
market quotations for the Common Stock are indicative of prices at which
actual sales thereof may be made. These quotations represent inter-dealer
prices, without retail markup, markdown or commissions, and do not
necessarily represent actual transactions.
Fiscal year ended December 31, 1995: High Low
- ----------------------------------- -------- -------
Second Quarter (commencing May 12) $5.75 $5.125
Third Quarter $6.50 $5.25
Fourth Quarter $8.25 $6.00
Fiscal year ended December 31, 1996:
- -----------------------------------
First Quarter $7.875 $6.25
Second Quarter $6.75 $5.50
Third Quarter $6.00 $5.50
Fourth Quarter $6.00 $2.00
Fiscal year ended December 31, 1997:
- -----------------------------------
First Quarter (through March 27) $6.50 $2.00
There are certain capital and other requirements that the Company must
exceed or maintain in order for the Company's Common Stock to continue to be
listed on Nasdaq. If the Company is unable to obtain additional financing or
otherwise find ways to meet its cash requirements (see "Management's
Discussion and Analysis of Financial Condition and Results of Operations --
Liquidity and Capital Resources"), the Company will soon be in violation of
the Nasdaq listing requirements and Nasdaq may de-list the Common Stock of
the Company. Accordingly, there can be no assurance that a public trading
market for the Company's Common Stock will continue to exist.
On March 27, 1997, the last full trading day prior to the date of this
annual report, the closing price of the Common Stock on Nasdaq was $2.00 per
share. As of March 27, 1997, there were approximately 91 registered
stockholders of record of the Common Stock. The Company has not declared or
paid any cash dividends on its Common Stock.
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
GENERAL
The Company was organized in August 1990 and commenced commercially
marketing the SofPulse-TM- device in early 1992. To date, the Company has
generated only modest revenue from sales and rentals of the SofPulse-TM-, which
has achieved only limited market acceptance. Since inception, the Company's
expenses have exceeded revenue, resulting in losses of $3,069,586 and
$2,927,990, respectively, for the years ended December 31, 1995 and 1996. As of
December 31, 1996, the Company had an accumulated deficit of $10,118,169.
Losses incurred since inception have been primarily attributable to costs
incurred in connection with the design and development of the Company's
products, research and clinical studies on the SofPulse-TM-, manufacturing,
marketing literature and advertisement for the
-16-
<PAGE>
SofPulse-TM-, and the hiring of personnel necessary to support the Company's
operations. The Company continues to have high levels of operating expenses
(including salaries of management, research and development, manufacturing
and marketing personnel) and will be required to incur significant expenses
in connection with research and clinical studies and the purchase of
materials to manufacture the SofPulse-TM- devices. Once manufactured, it may
take several months for a SofPulse-TM- device to produce any rental revenue
for the Company. Accordingly, the Company anticipates that it will continue
to incur significant losses until, at the earliest, the Company generates
sufficient revenue to support its operations. The Company believes that
generation of a level of revenue sufficient to support operations is
dependent upon, among other things, the Company's ability to demonstrate
successfully and objectively SofPulse's-TM- clinical utility through
controlled clinical studies; build an effective sales and marketing
infrastructure to increase significantly the sale and rental of the
SofPulse-TM- devices in the existing and the target markets; continue to
obtain reimbursement for the SofPulse-TM- treatment by third party payors;
and develop and introduce new products and enhance existing products. There
can be no assurance that the Company will be able to achieve any of the
foregoing, which could have a material adverse effect on the Company's
business, financial condition, cash flows, results of operations and
prospects.
RESULTS OF OPERATIONS
YEAR ENDED DECEMBER 31, 1996 COMPARED TO YEAR ENDED DECEMBER 31, 1995
Revenue for 1996 was $2,149,011 compared to $1,996,663 for 1995, or an
increase of $152,348. This 7.6% increase was primarily attributable to
increased SofPulse-TM- rental revenue during the last half of 1996. Revenue
growth during the first half of 1996 was adversely affected by the
reorganization of the Company's sales organization. That reorganization has
been completed and the Company began to experience improvement from those
changes beginning in October 1996. The Company then expanded its domestic
geographic coverage and contracted with four additional independent
representative organizations. As a result, during the second half of 1996,
monthly rental revenue increased from $112,000 in June 1996 to $202,000 in
December 1996, an increase of $90,000, or 80.4%. By the end of 1996, there
were 278 units under rental contracts, compared to 168 units at the end of
1995.
Revenue from the sale of units decreased 33.1% from $612,846 in 1995 to
$409,818 in 1996. The Company is placing more emphasis on expanding the
rental base of its SofPulse-TM- device.
Cost of revenue in 1996 increased $152,042 to $376,197, compared to
$224,155 in 1995. This 67.8% increase reflects additional depreciation
associated with the expanded SofPulse-TM- rental base.
Selling general and administrative expenses were $3,941,235 in 1996,
compared to $2,813,389 in 1995, an increase of $1,127,846, or 40.1%. This
cost increase reflects the salaries and related benefits for additional
personnel to support the Company's operations. In the first half of 1996,
the Company redirected its focus from research and development to sales and
marketing. Three full-time physical therapists, a product manager, a national
sales director and two regional sales directors joined the Company, adding to
the Company's payroll expenses. Later in 1996, Joseph Mooibroek joined the
Company as its new Chairman of the Board, President and Chief Executive
Officer. (See "Description of Business -- Recent Developments" regarding Mr.
Mooibroek's recent resignation). Mr. Mooibroek received as compensation
during fiscal 1996 an aggregate of $224,404 in cash compensation, 32,903
shares of Common Stock valued on the date of grant at $94,596, and 592,086
options to purchase shares of Common Stock of the Company.
Research and development expenses decreased to $815,722 in 1996, compared
to $1,690,163 in 1995, a decrease of $874,441, or 51.7%. This decrease was
primarily attributable to the completion in early 1996 of the Company's
initial clinical trials in connection with the Company's PMA application (see
"Description of Business -- Research and Development"), as well as the
reduction of basic scientific research involving PRF and PEMS-TM-
technologies.
Interest expense in 1996 decreased to $8,933 from $463,172 in 1995. This
$454,239 or 98.1% decrease resulted from eliminating substantially all
outstanding debt after the Company completed its initial public stock offering
in May
-17-
<PAGE>
1995 and changed its capital structure by issuing Preferred Stock and
converting $1,000,000 of debt to Common Stock in November 1995. With the
exception of obligations under capital equipment leases, the Company had no
debt outstanding at December 31, 1996.
Interest income in 1996 decreased to $65,086, compared to $124,630 in
1995, a decrease of $59,544, or 47.8%. This decrease resulted from the lack
of funds of the Company available for short term investment.
As a consequence of the Company's deteriorating cash position and its
unsuccessful efforts to consummate a financing in late 1996 and early 1997,
in March 1997 the Company underwent a reduction in personnel from 27 to 18
employees, or 33%. In order to minimize the adverse effect such reduction in
personnel may have on the Company's ability to generate revenue from
marketing and sales activities, the Company has reallocated three of its
research and development personnel to provide marketing support until
additional funds are available. The Company also is focusing its sales
efforts mostly in geographic areas where the Company has achieved reasonable
market presence. The Company intends to redistribute the approximately 200
SofPulse-TM- devices in its rental fleet that are not generating sufficient
rental revenue to areas where higher utilization of the devices is expected.
The Company also has in its current inventory about 60 finished devices with
which it can fill future orders for the sale or rental of the product. If
the Company receives orders for more than the approximately 260 devices that
are being re-distributed or are in current inventory, the Company will have
to manufacture additional devices. (See "Description of the Business --
Manufacturing and Suppliers"). The Company cannot predict the results these
changes will have on its ongoing revenue and intends to replace terminated
employees and expand its operations when, and if, new financing is
consummated.
LIQUIDITY AND CAPITAL RESOURCES
The Company's cash requirements have been and will continue to be
significant. Since its inception, the Company has satisfied its operating
requirements primarily through the issuance of equity and debt securities and
loans from stockholders. At December 31, 1996, the Company had working
capital of $192,837.
Net cash used in 1996 operating activities was $2,630,218, as compared to
$3,193,078 in 1995. Net cash was used primarily to fund the losses from
operations. Net cash used in 1996 investing activities was $49,690, which
was used to purchase equipment. At December 31, 1996, the Company did not
have any material commitments for capital expenditures. Net cash used in
financing activities was $166,317 for 1996, compared to $5,937,555 of cash
provided by these activities in 1995. Financing activities in 1996 included
repayment of notes payable to related parties and payments of capital lease
obligations. At December 31, 1996, the Company had cash of $223,523.
At December 31, 1996, the Company had a net operating loss ("NOL")
carryforward of $9,013,000 available to offset future taxable income, if any,
through the year 2011. In the event a 50% or greater change in ownership
occurs, a substantial annual limitation would be imposed upon the future
utilization of these loss carryforwards. At this point in time, the Company
has not completed a change in ownership study and any limitations are not
known.
Under the present circumstances, the Company's ability to continue as a
going concern depends on its ability to restructure, improve its operations,
and ultimately, to obtain additional financing. The Company has taken steps
that include reductions in operating costs, including stringent cost
controls, personnel reductions and redeployments, and the deferral of the
majority of research and development activities until after 1997. There can
be no assurance that these measures will be successful. Moreover, deferring
research and development activities will delay the development of new
products. The Company will also defer, until after 1997, conducting
definitive clinical studies that document the effectiveness of the
SofPulse-TM- treatment for its intended use. This deferral of clinical
studies may adversely affect the continued acceptance or use of the
SofPulse-TM- device and negatively affect the Company in the longer term.
However, at the present time, the Company believes these actions are
necessary to reduce near term cash requirements and to fund other operating
activities.
The Company is continuing to expand the number of SofPulse-TM- devices that
are under rental agreements generating revenue and will continue to allocate
more devices to those geographic areas where it believes it can
-18-
<PAGE>
produce higher monthly revenue per device based on higher utilization. The
Company believes that these efforts will increase its monthly revenue,
although there can be no assurance whether sufficient revenue growth can be
achieved over the long-term.
The Company is also exploring alternative sources of additional
financing. No definitive sources of additional financing have been identified
at this time, nor can there be any assurance that additional financing will
be obtained or obtained on favorable terms. There are certain capital and
other requirements that the Company must exceed or maintain in order for the
Company's Common Stock to continue to be listed on Nasdaq. If the Company is
unable to obtain additional financing or otherwise find ways to meet its cash
requirements (see "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Liquidity and Capital Resources,") the
Company will soon be in violation of the Nasdaq listing requirements and
Nasdaq may de-list the Common Stock of the Company. Accordingly, there can
be no assurance that a public trading market for the Company's Common Stock
will continue to exist.
The Company cannot predict whether the operating and financing strategies
described above will be successful. If the Company is unable to restructure
and improve its operations and is unable to ultimately obtain additional
financing, it may not be able to continue as a going concern.
ITEM 7. FINANCIAL STATEMENTS
The financial statements appear in a separate section of this report
following Part III.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS AND FINANCIAL
DISCLOSURE
On January 18, 1995, the Company discontinued the services of KPMG Peat
Marwick LLP as its principal independent accountant. The report of KPMG Peat
Marwick LLP covering the December 31, 1993 financial statements contains an
explanatory paragraph which stated that the Company's recurring losses from
operations raised substantial doubt as to its ability to continue as a going
concern. Other than described above, KPMG Peat Marwick LLP's report on the
financial statements of the Company for the year ended December 31, 1993, did
not contain an adverse opinion or a disclaimer of opinion, nor was it
qualified or modified as to uncertainty, audit scope, or accounting
principles. In connection with the audit of the fiscal year ended December
31, 1993, and during the period from January 1, 1995 through January 18,
1995, there were no disagreements with KPMG Peat Marwick LLP on any matter of
accounting principles or practices, financial statement disclosure, or
auditing scope or procedures, which disagreements if not resolved to their
satisfaction would have caused them to make reference in connection with
their opinion to the subject matter of the disagreement. The Board of
Directors approved the Company's decision to change accountants. The Company
then retained BDO Seidman, LLP as its principal independent accountant.
On November 14, 1996, the Company discontinued the services of BDO
Seidman, LLP as its principal independent accountant. The report of BDO
Seidman, LLP on the financial statements of the Company for the year ended
December 31, 1995, did not contain an adverse opinion or a disclaimer of
opinion, nor was it qualified or modified as to uncertainty, audit scope, or
accounting principles. In connection with the audit of the fiscal year ended
December 31, 1995 and during the period from January 1, 1996 through November
14, 1996, there were no disagreements with BDO Seidman, LLP on any matter of
accounting principles or practices, financial statement disclosure, or
auditing scope or procedures or any reportable events. The accountant's
report of BDO Seidman, LLP on the financial statements of the Company, as of
and for the year ended December 31, 1994, was modified to raise substantial
doubt about the Company's ability to continue as a going concern. BDO
Seidman, LLP changed its accountant's report to an unqualified opinion in
connection with the issuance of the December 31, 1995, financial statements.
The decision to change accountants was approved by the Company's Board of
Directors.
The Company has retained Ernst & Young, LLP as the new auditing firm to
act as the Company's principal independent accountant. The Company selected
Ernst & Young because of its breadth of experience in the health care
industry.
-19-
<PAGE>
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS, AND CONTROL PERSONS;
COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT.
DIRECTORS AND EXECUTIVE OFFICERS
The directors and executive officers of the Company as of April 2, 1997
were as follows:
NAME AGE POSITION
- ---- --- --------
Arup Sen, Ph.D. 45 Chairman of the Board, President, Chief Executive
Officer and Secretary
David Saloff 44 Vice Chairman of the Board, Chief Financial Officer &
Executive Vice President of Corporate Development
Murray Feldman 62 Director
Larry Haimovitch 50 Director
Steven Mayer 36 Director
ARUP SEN, PH.D. has served as Chairman of the Board, President, Chief
Executive Officer and Secretary since April 1, 1997. He served as a Director
and as Executive Vice President of Research, Development, Regulatory, and
Clinical Studies of the Company from November 1996 until April 1, 1997. He
also serves as the Chairman of the Board of Health Tech Development Inc., a
biotechnology development company, and has served as such since December
1993. Dr. Sen served as the Chief Executive Officer and President of Dallas
BioMedical, Inc., a development stage company specializing in technologies
for the diagnosis and treatment of cancer and other diseases, from June 1992
to July 1993. Prior to that, Dr. Sen was Vice President of the
Immunoconjugate Division of Sterling Drug, formerly a subsidiary of Eastman
Kodak. Over the past five years, Dr. Sen's responsibilities have included
overall business management, new product development and corporate
partnership negotiations. (See "Description of Business -- Recent
Developments" regarding Dr. Sen's recent appointment to his current
positions).
DAVID SALOFF has served as Vice Chairman, and Executive Vice President of
Corporate Development for the Company since August 1996. Since April 1, 1997,
he has served as Chief Financial Officer. He served as Chairman of the
Board, President and Chief Executive Officer since founding the Company in
August 1990 to August 1996. From 1982 to 1986, Mr. Saloff served as
President of Akros Manufacturing, Inc., a medical equipment company. Mr.
Saloff served as Managing Director for Lumex from December 1986 to December
1989. He served as a consultant and Vice President of Operations to Xsirius
Inc., a research and development company, from December 1989 to May 1992.
Mr. Saloff served as a Director and the Vice President of Marketing for
Advanced Photonix Inc., a manufacturer of fiber optics components from May
1990 to February 1992. Mr. Saloff is the nephew of Murray Feldman, a
director of the Company.
MURRAY FELDMAN has served as a director of the Company since September
1996. From June 1982 to present, Mr. Feldman has served as President of
Murray Financial Associates, Inc., a company primarily engaged in
originating, selling, and servicing residential mortgages. Mr. Feldman is
the uncle of David Saloff, the Vice Chairman and Executive Vice President of
the Company.
LARRY HAIMOVITCH has served as a director of the Company since September
1993. Since July 1991, Mr. Haimovitch has been President of Haimovitch
Medical Technology Consultants, a medical technologies consulting company.
From July 1989 to December 1990, Mr. Haimovitch was a medical device analyst
at Furrnan Selz, an investment banking firm. Mr. Haimovitch is a frequent
moderator of Biomedical Business International Medical Device Conferences and
a regular contributor to its newsletter. Mr. Haimovitch also serves on the
Board of Directors of other medical product and technology companies.
STEVEN MAYER has served as a director of the Company since September 1996.
Mr. Mayer also currently serves as managing director for Libra Investors, Inc.
From June 1994 to November 1996, he served as President and Managing Director of
Aries Capital Group, a private investment firm. From March 1992 until June
1994, Mr. Mayer was an investment banker with Apollo Advisors, L.P. and Lion
Advisors, L.P., affiliated private investment firms.
-20-
<PAGE>
While at Apollo and Lion, Mr. Mayer was responsible for equity and debt
investments encompassing a wide range of industries. Prior to that time, Mr.
Mayer was a lawyer with Sullivan & Cromwell specializing in mergers,
acquisitions, divestitures, leveraged buyouts and corporate finance. Mr.
Mayer currently serves as a member of the Boards of Directors of Mednet, MPC
Corporation, a prescription benefit management company, Dove Audio, Inc., a
book and audio tape publisher and television producer, and Chicago Pizza &
Brewery, Inc., a restaurant owner and manager.
SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE.
Section 16(a) of the Securities Exchange Act of 1934, as amended,
requires the Company's officers and directors, and persons who own more than
10% of a registered class of the Company's equity securities to file initial
reports of ownership and reports of changes in ownership with the Securities
and Exchange Commission (the "SEC"). Such persons are required by SEC
regulation to furnish the Company with copies of all Section 16(a) forms they
file.
Based solely on its review of the copies of such forms received by it
with respect to fiscal 1995, or written representations from certain
reporting persons, the Company believes that its officers and directors, and
persons who own more than 10% of a registered class of the Company's equity
securities, have complied with all applicable filing requirements, except
that during fiscal 1995, Messrs. Bruce Benner, Joshua E. Barnum, Stanley
Beck, and Dr. Arthur A. Pilla inadvertently failed to file timely an Initial
Statement of Beneficial Ownership of Securities and Messrs. Bruce Benner and
Murray Feldman inadvertently failed to file timely a Statement of Changes of
Beneficial Ownership of Securities. During fiscal 1996, Messrs. Joseph
Mooibroek and Donald F. Soldatis and Dr. Arup Sen inadvertently failed to
file timely an Initial Statement of Beneficial Ownership of Securities and
Messrs. Murray Feldman and Norton Herrick inadvertently failed to file timely
a Statement of Changes of Beneficial Ownership of Securities.
ITEM 10. EXECUTIVE COMPENSATION
SUMMARY COMPENSATION TABLE
The following table sets forth certain information regarding compensation
paid during each of the Company's last three fiscal years to the Company's
President and Chief Executive Officer and the Company's most highly compensated
executive officer employed by the Company (the "Named Executives"). No
executive officers other than the Named Executives received compensation in
excess of $100,000 during fiscal 1996.
<TABLE>
LONG-TERM COMPENSATION
-----------------------------------
ANNUAL COMPENSATION AWARDS PAYOUTS
----------------------------------- ------------------------ ----------
SECURITIES
OTHER ANNUAL RESTRICTED UNDERLYING ALL OTHER
FISCAL COMPENSATION STOCK OPTIONS/ LTIP COMPENSATION
NAME AND PRINCIPAL POSITION YEAR SALARY($) BONUS($) ($) AWARDS($) SARS(#) PAYOUTS($) ($)
- --------------------------- ---- --------- -------- --- --------- ------- ---------- ------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Joseph Mooibroek (1) 1996 112,644 -- 70,396(2) 94,596(3) 592,086 -- 68,616(4)
Chairman, President & Chief 1995 -- -- -- -- -- -- --
Executive Officer (resigned 1994 -- -- -- -- -- -- --
April 1, 1997)
David Saloff (5) 1996 143,297 -- 8,500 -- 100,000 -- --
Vice Chairman & Executive 1995 126,000 -- 6,000 -- -- -- --
Vice President 1994 120,000 -- 6,000 -- -- -- --
</TABLE>
- ---------------------------
(1) Mr. Mooibroek was appointed Chairman, President and Chief Executive Officer
on August 5, 1996. Mr. Mooibroek resigned from such positions on April 1,
1997 and as of April 12, 1997 entered into a severance agreement with the
Company. Dr. Arup Sen was appointed Chairman, President, Chief Executive
Officer and
-21-
<PAGE>
Secretary on April 1, 1997. (See "Executive Compensation --
Employment Contracts, Terminations of Employment and Change of Control
Agreements").
(2) Includes a $5,000 car allowance and $36,788 as reimbursement for the
payment of taxes. Also includes $28,608 of deferred compensation. In
lieu of cash compensation, Mr. Mooibroek elected to receive 5,555
shares of Common Stock valued at $28,608 at December 31, 1996. These
shares were not issued as of December 31, 1996 but have been authorized
for issuance.
(3) Represents the value on the date of grant of 32,903 shares of Common Stock
received by Mr. Mooibroek.
(4) Includes $68,616 received as reimbursement for Mr. Mooibroek's relocation
expenses.
(5) Effective August 5, 1996, Mr. Saloff resigned from his position as Chairman
of the Board, President and Chief Executive Officer and was appointed Vice
Chairman and Executive Vice President of Corporate Development.
OPTION GRANTS DURING 1996 FISCAL YEAR
The following table provides information related to options granted to the
Named Executives during fiscal 1996.
<TABLE>
POTENTIAL REALIZABLE
VALUE AT ASSUMED ANNUAL RATES
OF STOCK PRICE APPRECIATION
INDIVIDUAL GRANTS FOR OPTION TERM (1)
- ---------------------------------------------------------------------------------- ----------------------------
NUMBER OF % OF TOTAL
SECURITIES OPTIONS/SARS
UNDERLYING GRANTED TO EXERCISE OR
OPTIONS/SARS EMPLOYEES IN BASE PRICE EXPIRATION
NAME GRANTED (#)(2) FISCAL YEAR ($/SH) DATE 5%($) 10%($)
---- -------------- ------------ ----------- ---------- --------- ---------
<S> <C> <C> <C> <C> <C> <C>
Joseph Mooibroek. . . . . 592,086(3) 61.73% 5.50 08/05/06 2,047,978 5,189,979
David Saloff. . . . . . . 100,000(4) 10.43% 5.50 08/05/06 345,892 876,558
</TABLE>
- --------------------
(1) The potential realizable value portion of the foregoing table illustrates
value that might be realized upon exercise of the options immediately prior
to the expiration of their term, assuming the specified compounded rates of
appreciation on the Company's Common Stock over the term of the options.
These numbers do not take into account provisions of certain options
providing for termination of the option following termination of
employment, nontransferability or vesting over periods. The use of the
assumed 5% and 10% returns is established by the SEC and is not intended by
the Company to forecast possible future appreciation of the price of the
Common Stock.
(2) Options to acquire shares of Common Stock.
(3) Options with respect to 20% of the underlying shares are currently
exercisable, options with respect to 20% of the underlying shares will
become exercisable on each of August 5, 1997, August 5, 1998, August 5,
1999, and August 5, 2000.
(4) Options with respect to all (100%) of the underlying shares are currently
exercisable.
OPTION EXERCISES DURING 1996 FISCAL YEAR AND FISCAL YEAR END OPTION VALUES
The following table provides information related to options held by the
Named Executives. No stock options were exercised by a Named Executive during
fiscal 1996. Because the option exercise price exceeds the closing price
-22-
<PAGE>
for the Company's Common Stock on December 31, 1996, no options held by Named
Executives are considered in-the-money at December 31, 1996. The Company does
not have any outstanding stock appreciation rights.
<TABLE>
NUMBER OF SECURITIES VALUE OF UNEXERCISED
UNDERLYING UNEXERCISED IN-THE-MONEY OPTIONS/SARS
OPTIONS/SARS AT FY-END(#) AT FY-END($)(1)
--------------------------- --------------------------
VALUE
NAME SHARES ACQUIRED REALIZED($)(2) EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
- ---- --------------- -------------- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C>
Joseph Mooibroek . . . . . . . . 0 -- 118,417 473,669 -- --
David Saloff . . . . . . . . . . 0 -- 100,000 -- -- --
</TABLE>
- --------------------
(1) The closing price for the Company's Common Stock as reported through The
Nasdaq National Market System on December 31, 1996, the last trading day of
the 1996 fiscal year, was $2.50. Value is calculated on the basis of the
difference between the option exercise price and $2.50 multiplied by the
number of shares of Common Stock underlying the option.
(2) Value is calculated based on the difference between the option exercise
price and the closing market price of the Common Stock on the date of
exercise multiplied by the number of shares to which the exercise relates.
COMPENSATION OF DIRECTORS
Pursuant to the Company's Non-Employee Directors' Equity Compensation Plan,
the Company pays each non-employee director $2,500 per fiscal quarter in Common
Stock priced at the closing on the last business day of trading in such quarter,
payable after January 1 of the following year. Each non-employee director also
receives a stock option of 2,500 shares of Common Stock, which option is granted
on the last trading day of the year, immediately vests and has a term of five
years. At the time that a non-employee director joins the Board of Directors,
the director is granted a stock option of 15,000 shares of Common Stock, which
option is granted upon the directors attendance at the first meeting of the
Board of Directors, vests with respect to 20% of the underlying shares vest
immediately and with respect to the remaining shares vests an additional 20% of
the shares upon each anniversary year thereafter.
Directors who are also employees of the Company do not receive compensation
for their participation as members of the Board of Directors of the Company.
On August 5, 1996, the Company granted to Mr. Mooibroek, for his service as
Chairman of the Board, President and Chief Executive Officer (positions from
which Mr. Mooibroek resigned on April 1, 1997), a ten year option to purchase
592,086 shares of Common Stock at an exercise price of $5.50 per share pursuant
to the Company's incentive stock option plan, 20% of which option was
immediately exercisable with respect to the underlying shares and 20% of which
will become exercisable on each of August 5, 1997, August 5, 1998, August 5,
1999, and August 5, 2000, with respect to the underlying shares. (See
"Executive Compensation -- Employment Contracts, Terminations of Employment, and
Change of Control Agreements" regarding the vesting or cancellation of certain
of these options). On August 5, 1996, the Company granted to Mr. Saloff, for
his service as Vice Chairman of the Board and Executive Vice President of
Corporate Development, a ten year option to purchase 100,000 shares of Common
Stock at an exercise price of $5.50 per share pursuant to the Company's
incentive stock option plan, fully vested. On November 11, 1996, the Company
granted to Dr. Sen for his service as a Director and as Executive Vice President
of Research, Development, Regulatory, and Clinical Studies, a ten year option to
purchase 75,000 shares of Common Stock at an exercise price of $4.75 per share
pursuant to the Company's incentive stock option plan, with 25,000 of the
underlying shares being immediately exercisable, with 20,000 of the underlying
shares becoming exercisable on November 11, 1997, and 10,000 of the underlying
share becoming exercisable on each of November 11, 1998, November 11, 1999, and
November 11, 2000. On December 13, 1996, the Company granted to each of Mr.
Feldman and Mr. Mayer, for their service as Directors, a five year option to
purchase 15,000 shares of Common Stock at an
-23-
<PAGE>
exercise price of $2.875 per share pursuant to the Company's non-statutory
stock option plan, 3,000 of the underlying shares of which option was
immediately exercisable and 3,000 of the underlying shares of which will
become exercisable on each of January 1, 1998, January 1, 1999, January 1,
2000 and January 1, 2001.
EMPLOYMENT CONTRACTS, TERMINATIONS OF EMPLOYMENT, AND CHANGE OF CONTROL
AGREEMENTS
The Company entered into an employment agreement with Joseph Mooibroek,
dated August 5, 1996, for a term of five 5 years and for the position of
Chairman of the Board, President and Chief Executive Officer. The agreement
provided for a base salary of not less than $275,000 (up to 25% of which
could have been deferred to be repaid, with interest, on the first day of the
following year in either cash or in Company Common Stock at the discretion of
the Board of Directors), reimbursement of relocation expenses of up to
$200,000, benefits, a term life contract, an automobile allowance and four
weeks vacation per year. The agreement also provided that the Company would
grant to Mr. Mooibroek on the date of the agreement an option to purchase
592,086 shares of Common Stock with 20% of the shares covered thereby vesting
immediately and an additional 20% of the shares covered thereby vesting on
each of the first, second, third and fourth anniversaries of the date of the
agreement. The agreement provided that upon the exercise of warrants to
purchase Common Stock of the Company by Mr. Norton Herrick, the Company would
grant to Mr. Mooibroek an option to purchase one-tenth of the number of
shares of Common Stock of the Company as to which Mr. Herrick exercised his
warrant. The agreement also provided that, if Mr. Mooibroek's employment was
terminated by him by permitted resignation or by the Company other than for
cause, Mr. Mooibroek would receive an amount equal to two times the sum of
his highest annual base salary and the average annual bonus received by him
and that he would continue to receive benefits pursuant to the Company's
welfare programs and perquisite plans for a period of two years. The amounts
received upon termination were to vary depending upon the amount of time
remaining in the term of the agreement.
Mr. Mooibroek resigned from his position as Chairman, President and Chief
Executive officer on April 1, 1997. As of April 12, 1997 the Company and Mr.
Mooibroek entered into a severance agreement that provides, among other
things, in settlement of all rights under his employment agreement with the
Company, for a cash payment of $128,700 to Mr. Mooibroek over approximately
five months, the issuance of 5,555 shares of Common Stock of the Company
that were assigned to Mr. Mooibroek in lieu of a portion of his salary during
1996, the grant to Mr. Mooibroek of a 10-year warrant to purchase 25,000
shares of Common Stock of the Company at $2.25 per share and the
cancellation of 384,850 options to purchase shares of Common Stock of the
Company that were previously granted to Mr. Mooibroek, leaving Mr. Mooibroek
with 207,236 fully vested options to purchase shares of Common Stock of the
Company. The severance agreement also provides for the cancellation of Mr.
Mooibroek's right to be granted an option to purchase one-tenth of the number
of shares of Common Stock of the Company as to which Mr. Herrick exercised
his warrant. Mr. Mooibroek further agreed to assign to the Company patent
protection on inventions made by Mr. Mooibroek and to cooperate with the
Company in obtaining such patent protection.
The Company entered into an employment agreement with David Saloff, dated
August 5, 1996, for a term expiring on December 31, 2001. The agreement
provides for a base salary of not less than $132,000, an incentive bonus,
benefits, a term life insurance contract, an automobile allowance and four
weeks vacation per year. The agreement also provides that if Mr. Saloff's
employment is terminated by him by permitted resignation or by the Company
other than for cause, Mr. Saloff will receive an amount equal to the sum of
his annual base salary and the average annual bonus received by him and that
he will continue to receive benefits pursuant to the Company's welfare
programs and perquisite plans for a period of one year. The amounts received
upon termination may vary depending upon the amount of time remaining in the
term of the agreement.
The Company entered into an employment agreement with Arup Sen, dated
November 11, 1996, for a term expiring on December 31, 1999. Dr. Sen was
appointed Chairman of the Board, President and Chief Executive Officer of the
Company on April 1, 1997. The employment agreement entered into in November
is still in effect. The agreement provides for a base salary of not less
than $180,000 (up to 33% of which may be deferred to be repaid, with
interest, on the first day of the following year in either cash or in Company
Common Stock at the discretion of the Board of Directors), reimbursement of
relocation expenses of up to $50,000, benefits, a term life contract, an
automobile allowance and three weeks vacation per year. The agreement also
provides that the Company would grant
-24-
<PAGE>
to Dr. Sen on the date of the agreement an option to purchase 75,000 shares
of Common Stock with 25,000 of the shares covered thereby vesting
immediately, 20,000 of the shares covered thereby vesting on the first
anniversary of the agreement and an additional 10,000 of the shares covered
thereby vesting on each of the second, third and fourth anniversaries of the
date of the agreement. The agreement also provides that if Dr. Sen's
employment is terminated by him by permitted resignation or by the Company
other than for cause, Dr. Sen will receive an amount equal to the sum of his
annual base salary and the average annual bonus received by him and that he
will continue to receive benefits pursuant to the Company's welfare programs
and perquisite plans for a period of one year. The amounts received upon
termination may vary depending upon the amount of time remaining in the term
of the agreement.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth information as of March 27, 1997,
regarding the beneficial ownership of Common Stock by each person known by
the Company to own 5% or more of the outstanding shares of Common Stock, each
director of the Company, the Named Executives, and the directors and
executive officers of the Company as a group. The persons named in the table
have sole voting and investment power with respect to all shares of Common
Stock owned by them, unless otherwise noted. The address for each person
below listed is c/o the Company, 2301 NW 33rd Court, Suite 102, Pompano
Beach, Florida 33069.
AMOUNT AND
NATURE OF
NAME OF BENEFICIAL OWNER OR BENEFICIAL PERCENT
NUMBER OF PERSONS IN GROUP OWNERSHIP OF CLASS
- --------------------------- ------------ --------
Arup Sen . . . . . . . . . . . . . . . . . 37,526 (1) 1.06
David Saloff . . . . . . . . . . . . . . . 1,052,663 (2) 29.73
Murray Feldman . . . . . . . . . . . . . . 1,108,161 (3) 31.30
Larry Haimovitch . . . . . . . . . . . . . 1,355 *
Steven Mayer . . . . . . . . . . . . . . . 3,551 *
Joseph Mooibroek . . . . . . . . . . . . . 156,875 (4) 4.43
Norton Herrick . . . . . . . . . . . . . . 1,993,900 (5) 56.32
Bear, Stearns & Co. .. . . . . . . . . . . 689,902 19.49
Spear, Leeds & Kellogg LLC . . . . . . . . 736,187 20.80
Paragon Capital Corporation. . . . . . . . 187,500 (6) 5.30
All directors, executive officers, and
Named Executives as a group (6 persons). . 1,666,577 47.08
* Less than 1%
(1) Includes 25,000 shares subject to presently exercisable options.
(2) Includes 100,000 shares subject to presently exercisable options; 693,554
shares of Common Stock over which Mr. Saloff has the sole power to vote or
to direct the vote pursuant to a proxy, which is terminable at will,
granted to Mr. Saloff by Mr. Murray Feldman.
(3) Includes 414,607 shares subject to presently exercisable warrants.
-25-
<PAGE>
(4) Includes 118,417 shares subject to presently exercisable options. (See
"Executive Compensation -- Employment Contracts, Terminations of
Employment and Change of Control Agreements").
(5) Includes 421,950 shares of Common Stock issuable upon the conversion of
Series A Preferred Stock, 1,300,000 shares subject to presently exercisable
warrants. Mr. Herrick disclaims beneficial ownership of 60,000 shares of
common stock owned by Rozel International Holdings, which shares are
pledged to Mr. Herrick as security for a loan. Mr. Herrick also disclaims
beneficial ownership over 972,753 shares of Common Stock over which he
shares the power to vote or to direct the vote because such voting power is
limited to the election of certain nominees of the Board of Directors of
the Company.
(6) Shares subject to presently exercisable warrants.
ITEM 12. CERTAIN TRANSACTIONS
In March 1995 and May 1995, the Company borrowed an aggregate of $400,000
from Mr. David Saloff, a Director and the Executive Vice President of
Corporate Development. Such indebtedness was repaid in May 1995. The
Company also borrowed $75,000 from Ms. Phyllis Saloff, Mr. Saloff's mother
and $45,000 from Mr. Lawrence Schlesinger, a former Director of the Company.
The Company repaid such indebtedness in January 1996.
In November 1995, the Company entered into a Preferred Stock and Warrant
Subscription Agreement with Mr. Norton Herrick, an investor in the Company
beneficially owning greater than 10% of the Common Stock of the Company,
whereby the Company issued to Mr. Herrick (i) 421,950 shares of Series A
Convertible Preferred Stock (the "Preferred Stock") and (ii) warrants to
purchase an aggregate of 1,721,950 shares of Common Stock in consideration of
$2,000,000. Each share of Preferred Stock is convertible, at the option of
the holder, into one share of Common Stock (subject to adjustment in certain
circumstances) at any time until November 13, 2000, at which time outstanding
shares of Preferred Stock automatically convert into Common Stock. Shares of
Preferred Stock have votes equal to those of the Common Stock into which they
are convertible and, subject to certain exceptions and except as required by
law, vote together with the Common Stock as a single class. The Preferred
Stock is entitled to receive non-cumulative cash dividends when, as and if
declared by the Board of Directors of the Company and has a liquidation
preference of $4.74 per share. The Warrants consisted of warrants to
purchase (i) 421,950 shares of Common Stock at an exercise price of $.01 per
share; (ii) 800,000 shares of Common Stock at an exercise price of $6.00 per
share; (iii) 250,000 shares of Common Stock at an exercise price of $7.50 per
share; and (iv) Series A Convertible Preferred Stock at an exercise price of
$9.00 per share. The Warrants are exercisable at any time until November 13,
2005. Mr. Herrick has exercised warrants to purchase 421,950 shares of
Common Stock. Mr. Herrick has registration rights with respect to the shares
of Common Stock issuable upon conversion of the Preferred Stock or upon
exercise of the warrants. Additionally, the Company granted Mr. Herrick a
right of first refusal with respect to any sale by the Company of Common
Stock, options, warrants or other securities convertible into Common Stock.
In connection with Mr. Herrick's investment, the Company entered into a
Stockholders Agreement with Mr. Herrick and Mr. David Saloff whereby Mr.
Herrick was given the right to nominate two individuals for election as
directors and to require the Company to increase the number of directors to
nine persons. Mr. Saloff agreed to vote all of his shares of Common Stock
for the persons nominated by Mr. Herrick and to take all other actions
necessary in his capacity as a stockholder to cause the election to the Board
of Directors of the persons nominated by Mr. Herrick.
Also in connection with Mr. Herrick's investment, the Company paid
$60,000 to Whale Securities Co., L.P. ("Whale") and $40,000 to Millennium
Capital Corporation and agreed to issue five-year warrants to purchase
100,000 shares at an exercise price of $5.50 per share to Whale and its
designees for introducing Mr. Herrick to the Company. The Company has issued
to Whale 40,000 shares of Common Stock subject to presently exercisable
warrants, to Mr. Craig Shapiro, a designee of Whale, 40,000 shares of Common
Stock subject to presently exercisable warrants, and to Mr. Gordon Segal, a
designee of Whale, 20,000 shares of Common Stock subject to presently
exercisable warrants.
In November 1995, Murray Feldman, the uncle of Mr. Saloff, converted an
aggregate of $1,000,000 principal amount promissory notes into 195,945 shares of
Common Stock. In consideration of such conversion, the Company granted to Mr.
Feldman five-year warrants to purchase 300,000 shares of Common Stock at a price
of $6.25 per share,
-26-
<PAGE>
subject to adjustment in certain circumstances. Subject to certain
limitations and exclusions, the Company agreed to include the shares
underlying the warrants in appropriate registration statements filed by the
Company.
In December 1995, the Company repurchased 10,943 shares of Common Stock
for $60,000 in connection with the resignation of Mr. Wasserman as the
Company's Chief Operating Officer.
ITEM 13. EXHIBITS, LISTS AND REPORTS ON FORM 8-K
(a) EXHIBITS
1.1 Underwriting Agreement, dated May 12, 1995, from Paragon Capital
Corporation for 1,250,000 shares of Common Stock and warrants to
purchase 625,000 shares of Common Stock of the Company. (1)
2.1 Agreement and Plan of Merger, dated November 14, 1994, between
Magnetic Resonance Therapeutics, Inc. and the Company. (1)
3.1 Certificate of Incorporation, as amended. (2)
3.2 By-Laws. (1)
4.1 Preferred Stock and Warrant Subscription Agreement, dated November 13,
1995, between the Company and Norton Herrick. (3)
4.2 Warrant Agreement, dated May 12, 1995, between the Company and Paragon
Capital Corporation. (1)
4.3 Warrant Agreement between North American Transfer Co., Paragon Capital
Corporation and the Company. (4)
4.4 Warrant Agreement between the Company and Norton Herrick. (3)
4.5 Registration Rights Agreement, dated November 13, 1995, between the
Company and Norton Herrick. (3)
4.6 Conversion of Debt into Equity Agreement, dated August 30, 1993,
between the Company and Murray Feldman. (1)
4.7 First Amendment and Restated Convertible Promissory Note, dated
September 22, 1994, between the Company and Murray Feldman. (1)
4.8 Warrant Agreement, dated as of May 26, 1993, between the Company and
Whale Securities Co., L.P. (1)
9.1 Stockholder Agreement, dated November 13, 1995, among the Company,
David Saloff and Norton Herrick. (3)
9.2 Proxy to Vote Corporate Shares, dated November 9, 1994, by and among
David Saloff and Murray Feldman. (4)
-27-
<PAGE>
10.1 Employment Agreement, dated July 1, 1993, between the Company and Dr.
Walter L. Wasserman; and First Amendment thereto, dated September 13,
1994. (1)
10.2 Employment Agreement, dated January 1, 1993, between the Company and
Joshua Barnum; Addendum thereto, dated August 24, 1994; and Second
Amendment thereto, dated September 13, 1994. (1)
10.3 Employment Agreement, dated January 1, 1993, between the Company and
David S. Winer; Addendum thereto, dated January 13, 1994; and First
Amendment thereto, dated September 13, 1994. (1)
10.4 Employment Agreement, dated August 5, 1996, between the Company and
Joseph Mooibroek. (5)
10.5 Employment Agreement, dated August 5, 1996, between the Company and
David Saloff. (2)
10.6 Employment Agreement, dated November 11, 1996, between the Company and
Dr. Arup Sen. (2)
10.7 Commercial Security Agreement, dated June 3, 1994, between the Company
and Murray Feldman; Letter Agreement, dated November 22, 1994, between
Murray Feldman and Paragon Capital Corporation; and Amendment No. 1 to
Commercial Security Agreement. (1)
10.8 Office Warehouse Lease, dated March 31, 1993, between the Company and
Anthony Lo Fria; and Addendum to Office Warehouse Lease, dated March
31, 1993. (1)
10.9 Form of Non-Employee Directors' Equity Compensation Plan, effective as
of January 1, 1996. (2)
10.10 Performance Sharing Program, dated December 13, 1996. (2)
10.11 Consultant's Agreement, dated January 1, 1993, between the
Company and Arthur A. Pilla, Ph.D.; and Addendum thereto, dated
August 1, 1994. (1)
10.12 Clinical Research and Study Agreement, dated October 27, 1994,
between the Company and Pilla Consulting. (1)
10.13 Indemnification Agreement, between the Company and Miami Heart
Research Institute, Inc. (4)
10.14 Form of Certificate of Designations of Series A Convertible
Preferred Stock of the Company. (3)
10.15 Letter Agreement, dated March 19, 1997, between the Company and
M. Kane & Co. (2)
10.16 Agreement, dated April 12, 1997, between the Company and Joseph
Mooibroek. (2)
16.1 Letter from KPMG Peat Marwick, LLP regarding response to Change in
Certifying Accountants. (6)
16.2 Letter from BDO Seidman, LLP regarding response to Change in
Certifying Accountants, dated January 8, 1997. (7)
24.1 Power of Attorney. (2)
27.1 Financial Data Schedule. (8)
- -------------
(1) Previously filed as an exhibit to the Company's Registration Statement
on Form SB-2 (No. 33-87934-A).
-28-
<PAGE>
(2) Previously filed as an exhibit to the Company's Annual Report on
Form 10-KSB for the year ended December 31, 1996.
(3) Previously filed as an exhibit to the Company's Current Report on Form
8-K dated November 13, 1995.
(4) Previously filed as an exhibit to the Company's Annual Report on Form
10-KSB for the year ended December 31, 1995.
(5) Previously filed as an exhibit to the Company's Current Report on Form
8-K dated August 5, 1996.
(6) Will be filed within ten business days of the date hereof.
(7) Previously filed as an exhibit to the Company's Current Report on
Form 8-K dated December 13, 1996.
(8) Filed herewith.
(b) REPORTS ON FORM 8-K
The Company filed a Current Report on Form 8-K, dated December 13, 1996,
regarding the Company's decision to change accountants.
-29-
<PAGE>
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the
registrant caused this Amendment No. 1 to the registrant's Annual Report on
Form 10-KSB to be signed on its behalf by the undersigned, thereunto duly
authorized.
ELECTROPHARMACOLOGY, INC.
By: /s/ ARUP SEN
------------------------------------
Arup Sen
Chief Executive Officer
In accordance with the Exchange Act, this Amendment No. 1 to the
registrant's Annual Report on Form 10-KSB has been signed below by the
following persons on behalf of the registrant and in the capacities and on
the dates indicated.
Signatures Title
- ---------- -----
/s/ ARUP SEN
- ----------------------- Chairman of the April 15, 1997
Arup Sen Board and Chief Executive Officer
/s/ DAVID SALOFF
- ----------------------- Chief Financial Officer April 15, 1997
David Saloff (Principal Financial and
Accounting Officer)
/s/ MURRAY FELDMAN
- ----------------------
Murray Feldman Director April 15, 1997
/s/ LARRY HAIMOVITCH
- ----------------------
Larry Haimovitch Director April 15, 1997
/s/ STEVEN MAYER
- ----------------------
Steven Mayer Director April 15, 1997
-30-
<PAGE>
INDEX TO EXHIBITS
Exhibit
Number Description of Exhibit
------- ----------------------
1.1 Underwriting Agreement, dated May 12, 1995, from Paragon Capital
Corporation for 1,250,000 shares of Common Stock and warrants to
purchase 625,000 shares of Common Stock of the Company. (1)
2.1 Agreement and Plan of Merger, dated November 14, 1994, between
Magnetic Resonance Therapeutics, Inc. and the Company. (1)
3.1 Certificate of Incorporation, as amended. (2)
3.2 By-Laws. (1)
4.1 Preferred Stock and Warrant Subscription Agreement, dated November
13, 1995, between the Company and Norton Herrick. (3)
4.2 Warrant Agreement, dated May 12, 1995, between the Company and
Paragon Capital Corporation. (1)
4.3 Warrant Agreement between North American Transfer Co., Paragon Capital
Corporation and the Company. (4)
4.4 Warrant Agreement between the Company and Norton Herrick. (3)
4.5 Registration Rights Agreement, dated November 13, 1995, between the
Company and Norton Herrick. (3)
4.6 Conversion of Debt into Equity Agreement, dated August 30, 1993,
between the Company and Murray Feldman. (1)
4.7 First Amendment and Restated Convertible Promissory Note, dated
September 22, 1994, between the Company and Murray Feldman. (1)
4.8 Warrant Agreement, dated as of May 26, 1993, between the Company and
Whale Securities Co., L.P. (1)
9.1 Stockholder Agreement, dated November 13, 1995, among the Company,
David Saloff and Norton Herrick. (3)
9.2 Proxy to Vote Corporate Shares, dated November 9, 1994, by and among
David Saloff and Murray Feldman. (4)
10.1 Employment Agreement, dated July 1, 1993, between the Company and
Dr. Walter L. Wasserman; and First Amendment thereto, dated September
13, 1994. (1)
10.2 Employment Agreement, dated January 1, 1993, between the Company
and Joshua Barnum; Addendum thereto, dated August 24, 1994; and
Second Amendment thereto, dated September 13, 1994. (1)
-31-
<PAGE>
Exhibit
Number Description of Exhibit
------- ----------------------
10.3 Employment Agreement, dated January 1, 1993, between the Company
and David S. Winer; Addendum thereto, dated January 13, 1994; and First
Amendment thereto, dated September 13, 1994. (1)
10.4 Employment Agreement, dated August 5, 1996, between the Company and
Joseph Mooibroek. (5)
10.5 Employment Agreement, dated August 5, 1996, between the Company and
David Saloff. (2)
10.6 Employment Agreement, dated November 11, 1996, between the Company and
Dr. Arup Sen. (2)
10.7 Commercial Security Agreement, dated June 3, 1994, between the
Company and Murray Feldman; Letter Agreement, dated November 22, 1994,
between Murray Feldman and Paragon Capital Corporation; and Amendment
No. 1 to Commercial Security Agreement. (1)
10.8 Office Warehouse Lease, dated March 31, 1993, between the Company
and Anthony Lo Fria; and Addendum to Office Warehouse Lease, dated
March 31, 1993. (1)
10.9 Form of Non-Employee Directors' Equity Compensation Plan, effective as
of January 1, 1996. (2)
10.10 Performance Sharing Program, dated December 13, 1996. (2)
10.11 Consultant's Agreement, dated January 1, 1993, between the Company
and Arthur A. Pilla, Ph.D.; and Addendum thereto, dated August 1,
1994. (1)
10.12 Clinical Research and Study Agreement, dated October 27, 1994,
between the Company and Pilla Consulting. (1)
10.13 Indemnification Agreement, between the Company and Miami Heart
Research Institute, Inc. (4)
10.14 Form of Certificate of Designations of Series A Convertible
Preferred Stock of the Company. (3)
10.15 Letter Agreement, dated March 19, 1997, between the Company and M.
Kane & Co. (2)
10.16 Agreement, dated April 12, 1997, between the Company and Joseph
Mooibroek. (2)
16.1 Letter from KPMG Peat Marwick, LLP regarding response to Change in
Certifying Accountants. (6)
16.2 Letter from BDO Seidman, LLP regarding response to Change in
Certifying Accountants, dated January 8, 1997. (7)
24.1 Power of Attorney. (2)
27.1 Financial Data Schedule. (8)
- -----------------
(1) Previously filed as an exhibit to the Company's Registration Statement
on Form SB-2 (No. 33-87934-A).
(2) Previously filed as an exhibit to the Company's Annual Report on
Form 10-KSB for the year ended December 31, 1996.
(3) Previously filed as an exhibit to the Company's Current Report on Form
8-K dated November 13, 1995.
-32-
<PAGE>
(4) Previously filed as an exhibit to the Company's Annual Report on Form
10-KSB for the year ended December 31, 1995.
(5) Previously filed as an exhibit to the Company's Current Report on Form
8-K dated August 5, 1996.
(6) Will be filed within ten business days of the date hereof.
(7) Previously filed as an exhibit to the Company's Current Report on Form
8-K dated December 13, 1996.
(8) Filed herewith.
-33-
<PAGE>
Electropharmacology, Inc.
Audited Financial Statements
Year ended December 31, 1996
CONTENTS
Report of Independent Certified Public Accountants . . . . . . 1
Audited Financial Statements
Balance Sheet. . . . . . . . . . . . . . . . . . . . . . . . . 3
Statements of Operations . . . . . . . . . . . . . . . . . . . 4
Statements of Shareholders' Equity . . . . . . . . . . . . . . 5
Statements of Cash Flows . . . . . . . . . . . . . . . . . . . 6
Notes to Financial Statements. . . . . . . . . . . . . . . . . 8
<PAGE>
Report of Independent Certified Public Accountants
Board of Directors
Electropharmacology, Inc.
We have audited the accompanying balance sheet of Electropharmacology, Inc.
(the Company) as of December 31, 1996 and the related statements of
operations, shareholders' equity and cash flows for the year then ended.
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 audit. The financial statements of
Electropharmacology, Inc. for the year ended December 31, 1995, were audited
by other auditors whose report dated April 2, 1996, expressed an unqualified
opinion on those statements.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements.
An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
In our opinion, the 1996 financial statements referred to above present
fairly, in all material respects, the financial position of
Electropharmacology, Inc. at December 31, 1996 and the results of its
operations and its cash flows for the year then ended, in conformity with
generally accepted accounting principles.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As more fully described in Note 2
to the financial statements, the Company incurred significant recurring
operating losses and negative operating cash flows. These conditions raise
substantial doubt about the Company's ability to continue as a going concern.
Management's plans regarding these matters are also described in Note 2.
The financial statements do not include any adjustments to reflect the
possible future effects on the recoverability and classification of assets or
the amounts and classification of liabilities that might result from the
outcome of this uncertainty.
/s/ ERNST & YOUNG LLP
- -----------------------------
Ernst & Young LLP
West Palm Beach, Florida
February 9, 1997, except for the last paragraph of
Note 2, as to which the date is April 7, 1997,
the third paragraph of Note 10, as to which the
date is April 12, 1997, and the sixth paragraph
of Note 11, as to which the date is March 27,
1997
1
<PAGE>
Report of Independent Certified Public Accountants
The Board of Directors
Electropharmacology, Inc.
We have audited the accompanying statements of operations, shareholders'
equity (capital deficit) and cash flows for the year ended December 31, 1995.
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 audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements.
An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the results of operations, changes in stockholders'
equity (capital deficit) and cash flows of Electropharmacology, Inc. for the
year ended December 31, 1995 in conformity with generally accepted accounting
principles.
/s/ BDO Seidman, LLP
--------------------------------
BDO Seidman, LLP
Miami, Florida
April 2, 1996
2
<PAGE>
Electropharmacology, Inc.
Balance Sheet
December 31, 1996
ASSETS
Current assets:
Cash $ 223,523
Trade accounts receivable, net of allowance
for doubtful accounts of $134,000 572,202
Inventory 94,164
Trade notes receivable 248,190
Prepaid expenses 50,127
----------
Total current assets 1,188,206
Rental and other equipment, net 945,058
Deposits and other assets 79,816
----------
Total assets $2,213,080
==========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 316,746
Accrued expenses 513,130
Accrued commissions 30,845
Accrued payroll 104,701
Customer deposits 7,561
Current maturities of obligations under
capital leases 22,386
----------
Total current liabilities 995,369
Obligations under capital leases, less current
maturities 3,336
----------
Total liabilities 998,705
Commitments and contingencies
Shareholders' equity:
Preferred stock, $.01 par value--10,000,000
authorized shares; issued and outstanding 421,950
(entitled to $2,000,043 in liquidation) 4,220
Common stock, $.01 par value--30,000,000 authorized
shares; 3,540,165 shares issued and 3,529,672
outstanding 35,402
Additional paid-in capital 11,352,922
Treasury stock, at cost, 10,493 common shares (60,000)
Deficit (10,118,169)
----------
Total shareholders' equity 1,214,375
----------
Total liabilities and shareholders' equity $2,213,080
==========
SEE ACCOMPANYING NOTES.
3
<PAGE>
Electropharmacology, Inc.
Statements of Operations
YEAR ENDED DECEMBER 31
1996 1995
-----------------------------
Revenue:
Rentals $ 1,739,193 $ 1,383,817
Sales 409,818 612,846
-----------------------------
Total revenue 2,149,011 1,996,663
Operating expenses:
Cost of revenue 376,197 224,155
Selling, general and administrative 3,941,235 2,813,389
Research and development 815,722 1,690,163
-----------------------------
Total operating expenses 5,133,154 4,727,707
-----------------------------
Loss from operations (2,984,143) (2,731,044)
=============================
Other income (expense):
Interest expense (8,933) (463,172)
Interest income 65,086 124,630
-----------------------------
Total other income (expense) 56,153 (338,542)
-----------------------------
Net loss $(2,927,990) $(3,069,586)
=============================
Net loss per common share $ (.89) $ (1.26)
=============================
Weighted average number of common shares
outstanding 3,298,849 2,429,880
=============================
SEE ACCOMPANYING NOTES.
4
<PAGE>
Electropharmacology, Inc.
Statements of Shareholders' Equity
<TABLE>
PREFERRED STOCK COMMON STOCK ADDITIONAL TOTAL
------------------ ---------------- PAID-IN TREASURY SHAREHOLDERS'
SHARES AMOUNT SHARES AMOUNT CAPITAL STOCK DEFICIT EQUITY
-----------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balance at January 1, 1995 $ 0 1,628,529 $16,285 $ 3,027,824 $ 0 $ (4,120,593) $(1,076,484)
Issuance of common stock in
connection with initial
public offering 1,250,000 12,500 5,091,457 5,103,957
Note payable to related party
converted to common stock 195,945 1,960 998,040 1,000,000
Issuance of preferred stock 421,950 4,220 1,895,780 1,900,000
Repurchase of common stock (60,000) (60,000)
Issuance of warrants to
consultant for services 214,500 214,500
Net loss (3,069,586) (3,069,586)
-----------------------------------------------------------------------------------------------
Balance at December 31, 1995 421,950 4,220 3,074,474 30,745 11,227,601 (60,000) (7,190,179) 4,012,387
Exercise of warrants 421,950 4,220 4,220
Issuance of common stock for
services 43,741 437 125,321 125,758
Net loss (2,927,990) (2,927,990)
-----------------------------------------------------------------------------------------------
Balance at December 31, 1996 421,950 $4,220 3,540,165 $35,402 $11,352,922 $(60,000) $(10,118,169) $ 1,214,375
===============================================================================================
</TABLE>
SEE ACCOMPANYING NOTES.
5
<PAGE>
Electropharmacology, Inc.
Statements of Cash Flows
<TABLE>
YEAR ENDED DECEMBER 31
1996 1995
--------------------------
<S> <C> <C>
OPERATING ACTIVITIES
Net loss $(2,927,990) $(3,069,586)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation 286,037 221,162
Amortization 3,516 310,335
Issuance of common stock and warrants for
services 125,758 214,500
Loss on disposal of office equipment 6,426 0
Provision for doubtful accounts 93,000 45,728
Discount on trade note receivable 21,982 0
Changes in operating assets and liabilities:
Trade notes receivable 273,162 (543,334)
Inventory (47,893) (139,271)
Accounts receivable (315,370) (110,007)
Prepaid expenses 14,532 (59,291)
Accounts payable 65,537 (175,870)
Accrued payroll 44,369 (24,406)
Accrued expenses, commissions and customer
deposits 194,543 85,008
Rental equipment (SofPulse-TM- units) (467,827) 51,954
--------------------------
Net cash used in operating activities (2,630,218) (3,193,078)
INVESTING ACTIVITIES
Purchases of property and equipment (32,548) (169,058)
Deposits and other assets (17,142) 15,426
--------------------------
Net cash used in investing activities (49,690) (153,632)
FINANCING ACTIVITIES
Net proceeds from issuance of preferred stock 0 1,900,000
Repayment of long-term notes payable and capitalized
lease obligations (50,537) (48,945)
Net proceeds from issuance of notes payable 0 400,000
Repayment of notes payable to related parties (120,000) (1,562,000)
Proceeds from sale of common stock 4,220 5,248,500
--------------------------
Net cash (used in) provided by financing activities (166,317) 5,937,555
--------------------------
Net (decrease) increase in cash (2,846,225) 2,590,845
Cash at beginning of year 3,069,748 478,903
--------------------------
Cash at end of year $ 223,523 $ 3,069,748
==========================
</TABLE>
6
<PAGE>
Electropharmacology, Inc.
Statements of Cash Flows
<TABLE>
YEAR ENDED DECEMBER 31
1996 1995
--------------------------
<S> <C> <C>
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid during the period for interest, net $ 6,596 $ 162,154
=======================
SUPPLEMENTAL DISCLOSURES OF NONCASH INVESTING AND
FINANCING ACTIVITIES
Issuance of common stock for services $ 125,758 $ 0
Notes payable to related party converted to common
stock 0 1,000,000
Prepaid offering costs reclassified to additional
paid-in capital 0 144,543
Liability incurred for the repurchase of common stock 0 60,000
</TABLE>
SEE ACCOMPANYING NOTES.
7
<PAGE>
Electropharmacology, Inc.
Notes to Financial Statements
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
NATURE OF BUSINESS AND MAJOR SUPPLIERS
Electropharmacology, Inc. (the Company) was incorporated on August 31, 1990
under the laws of the State of California under the name Magnetic Resonance
Therapeutics, Inc. and reorganized through a merger with and into
Electropharmacology, Inc., a Delaware Corporation, in February 1995. The
Company is engaged in designing, developing, manufacturing and marketing
medical devices that deliver pulsed electromagnetic signals in the radio
frequency range. The Company's current product is SofPulse-TM-.
The Company is dependent on four suppliers to supply all the major components
of its products. Management believes that alternative sources are presently
available if the current supply of any of its product's components are
discontinued, limited or delayed.
REVENUE RECOGNITION
Rental revenue is recognized over the month-to-month period in which the
related equipment is under lease to a customer, primarily on a per use basis.
Sales revenue is recognized upon shipment and the transfer of ownership of
the product.
INVENTORY
Inventory, which consists of raw materials and work-in-process, is valued at
the lower of cost (average cost method) or market. Upon completion, finished
goods are transferred to property and equipment.
OTHER ASSETS
Other assets are amortized using the straight-line method and consist
principally of patent costs, amortized over 17 years from the date of
issuance of the patent.
8
<PAGE>
Electropharmacology, Inc.
Notes to Financial Statements (continued)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
RENTAL AND OTHER EQUIPMENT AND DEPRECIATION AND AMORTIZATION
Rental and other equipment is carried at cost. Depreciation and amortization is
computed using the straight-line method over the estimated useful lives (or
lease term if shorter life) of the related assets as follows:
Rental equipment 5 years
Leasehold improvements 3 years
Office equipment 4 to 7 years
Laboratory equipment 4 to 7 years
STOCK BASED COMPENSATION
The Company has elected to follow Accounting Principles Board (APB) Opinion
No. 25, ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES, and related interpretations
in accounting for its employee stock options because the alternative fair
value accounting provided for under Financial Accounting Standards Board
(FASB) Statement No. 123, ACCOUNTING FOR STOCK-BASED COMPENSATION, requires
use of option valuation models that were not developed for use in valuing
employee stock options. Under APB No. 25, because the exercise price of the
Company's employee stock options equals the market price of the underlying
stock on the date of grant, no compensation expense is recognized.
ADVERTISING COSTS
Advertising costs, included in selling, general and administrative expenses,
are expensed as incurred and were $62,000 and $36,000 for 1996 and 1995,
respectively.
USE OF ESTIMATES AND CONCENTRATION OF CREDIT RISK
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenue and expenses during the reporting period.
Actual results could differ from those estimates.
9
<PAGE>
Electropharmacology, Inc.
Notes to Financial Statements (continued)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
The Company sells and/or rents its product to healthcare providers such as
nursing homes, hospitals and physician practices with no specific geographic
concentration and extends credit based on an evaluation of the customer's
financial condition, generally without requiring collateral. Exposure to
losses on receivables is principally dependent on each customer's financial
condition. The Company monitors its exposure for credit losses and maintains
allowances for anticipated losses.
INCOME TAXES
The Company provides for income taxes under the provisions of FASB Statement
No. 109, ACCOUNTING FOR INCOME TAXES, which requires the asset and liability
method of accounting for income taxes. Under the asset and liability method
of FASB Statement No. 109, deferred tax assets and liabilities are recognized
for the future tax consequences attributable to differences between the
financial statement carrying amounts of existing assets and liabilities and
their respective tax bases. Deferred tax assets and liabilities are measured
using the enacted tax rates expected to apply to taxable income in the years
in which those temporary differences are expected to be recovered or settled.
NET LOSS PER COMMON SHARE
For the years ended December 31, 1996 and 1995, options and warrants are
excluded from the computation of net loss per share because the effect of
inclusion would be antidilutive due to the Company's net operating losses.
2. LIQUIDITY AND BASIS OF PRESENTATION
The accompanying financial statements have been prepared on a going-concern
basis, which contemplates the realization of assets and the satisfaction of
liabilities and commitments in the normal course of business.
The Company reported a net loss of $2,927,990 for the year ended December 31,
1996 and has incurred losses aggregating $10,118,169 through December 31,
1996. At December 31, 1996, the Company had working capital of $192,837 and
shareholder's equity of $1,214,375.
10
<PAGE>
Electropharmacology, Inc.
Notes to Financial Statements (continued)
2. LIQUIDITY AND BASIS OF PRESENTATION (CONTINUED)
The Company's 1997 operating plan contemplates focusing activities on
expanding rental revenue by both increasing the number of SofPulse-TM-
devices in markets where it has achieved reasonable market presence and
redeploying certain devices into markets where their expected use would be at
increased levels. It also contemplates stringent cost controls, personnel
reductions and the deferral of the majority of research and development
activities until after 1997. The Company is also exploring alternative
sources of additional financing. No definitive sources of additional
financing have been identified at this time.
The Company cannot predict whether the operating and financing plans
described above will be successful. If the Company is unable to restructure
and improve its operations and is unable to ultimately obtain additional
financings, it may not be able to continue as a going concern. If the Company
is unsuccessful in its efforts, it may be unable to meet its obligations,
making it necessary to undertake such other actions as may be appropriate to
preserve asset values.
3. INVENTORY
The components of inventory at December 31, 1996 are summarized as follows:
Work-in-process $24,940
Raw material 69,224
-------
$94,164
=======
4. TRADE NOTES RECEIVABLE
During 1995, the Company received two promissory notes in connection with the
sale of SofPulse-TM- devices. These trade notes receivable consist of the
following:
- - Three year noninterest bearing term note in the amount of $218,400 (less
discount of $27,937 at December 31, 1995), payable at $7,800 monthly,
interest imputed at 12%, collateralized by equipment sold.
- - Three year noninterest bearing term note in the amount of $392,400 (less
discount of $39,529 at December 31, 1995), payable at $16,200 monthly,
interest imputed at 12%, collateralized by equipment sold (the final four
payments will total $29,700).
11
<PAGE>
Electropharmacology, Inc.
Notes to Financial Statements (continued)
4. TRADE NOTES RECEIVABLE (CONTINUED)
In January 1997, the Company agreed to accept $248,190 in full payment of
these notes, which had an outstanding balance of $270,172 at the time of the
agreement. The notes were repaid in 1997, resulting in a discount of $21,982.
This discount was recognized in the statement of operations for the year
ended December 31, 1996.
5. RENTAL AND OTHER EQUIPMENT
A summary of rental and other equipment at December 31, 1996 is as follows:
Rental equipment $1,107,925
Leasehold improvements 68,270
Office equipment under capital lease 153,580
Office equipment 118,530
Lab equipment 69,763
----------
1,518,068
Less accumulated depreciation and amortization (573,010)
----------
Net rental and other equipment $ 945,058
==========
6. INCOME TAXES
As of December 31, 1996, the Company has net operating loss carryforwards of
approximately $9,013,000 available to offset future taxable income. Such
carryforwards, which may provide future tax benefits, expire as follows:
2008--$1,206,000; 2009--$2,064,000; 2010--$2,901,000; 2011--$2,842,000. It
appears that a change in ownership of greater than 50% may have occurred as a
result of the Company issuing equity securities. As a result, a substantial
annual limitation may be imposed upon the future utilization of its net
operating loss carryforwards. At this point in time, the Company has not
completed a change in ownership study and the exact effects of any such
limitations are not known.
12
<PAGE>
Electropharmacology, Inc.
Notes to Financial Statements (continued)
6. INCOME TAXES (CONTINUED)
Significant components of the Company's deferred income taxes at December 31,
1996 are as follows:
Net operating loss carryforwards $ 3,392,000
Other, net 158,600
-----------
Deferred tax assets 3,550,600
Deferred tax liabilities--equipment (75,300)
-----------
3,475,300
Less valuation allowance (3,475,300)
-----------
Net deferred tax assets $ 0
===========
The net change in the valuation allowance for the year ended December 31,
1996 was an increase of approximately $1,075,300.
Income tax expense differs from the expected rate for the year ended
December 31, 1996, primarily as a result of excluding benefits related
to net operating loss carryforwards because of the uncertainty of their
realization at this time.
7. SHAREHOLDERS' EQUITY AND WARRANTS
On November 1, 1996, the Company's stockholders approved proposals to
increase the Company's authorized capital stock from 10,000,000 to 30,000,000
shares of $.01 par value common stock and from 1,000,000 to 10,000,000 shares
of $.01 par value preferred stock.
On May 12, 1995, the Company consummated its initial public offering of
securities on the NASDAQ SmallCap Market and sold 1,250,000 shares of common
stock at $5.00 per share. Additionally, 718,750 redeemable warrants to purchase
common stock were issued and sold for $.10 per warrant. Each warrant entitles
the registered holder thereof to purchase one share of common stock at a price
of $6.00, subject to adjustment in certain circumstances, at any time commencing
June 12, 1996 through May 12, 1998. Net proceeds of this offering, after the
underwriter's commissions and all expenses, were $5,103,957.
For an aggregate of $187.50, the underwriter was issued warrants to purchase
125,000 shares of common stock at $7.00 per share and 62,500 warrants to
purchase warrants at $.14 each to purchase common stock at $6.00 per share.
No warrants have been exercised.
13
<PAGE>
Electropharmacology, Inc.
Notes to Financial Statements (continued)
7. SHAREHOLDERS' EQUITY AND WARRANTS (CONTINUED)
During June 1995, the Company issued warrants to purchase 30,000 shares of
common stock at $4.00 per share and 12,000 shares of common stock at $5.25
per share to consultants of the Company for certain investor relations work.
Each of these warrants vested immediately and expires in five years. Further,
a four-year warrant to purchase 25,000 shares of common stock at $5.25 per
share was issued to a consultant to the Company for certain scientific
contributions to the Company. No warrants have been exercised.
In November 1995, in consideration of $2,000,000, the Company issued to an
investor (i) 421,950 shares of Series A Convertible Preferred Stock (the
Preferred Stock) and (ii) warrants to purchase an aggregate of 1,721,950
shares of common stock. In connection with the transaction, the Company paid
a $100,000 commission to two investment bankers and issued five-year warrants
to purchase 100,000 shares of common stock at an exercise price of $5.50 per
share.
Each share of Preferred Stock is convertible, at the option of the holder,
into one share of common stock, subject to adjustment in certain
circumstances, at any time until November 13, 2000, at which time outstanding
shares of Preferred Stock automatically convert into common stock. Shares of
Preferred Stock have votes equal to those of common stock into which they are
convertible and, subject to certain exceptions and except as required by law,
vote together with the common stock as a single class. The Preferred Stock
votes as a single class on certain matters including the incurrence of
secured indebtedness by the Company, changes in the number and the terms of
the directors of the Company and the issuance of cash dividends and
redemptions or repurchase of securities by the Company. The Preferred Stock
is entitled to receive noncumulative cash dividends, when, as and if declared
by the Board of Directors of the Company and has a liquidation preference of
$4.74 per share.
The warrants consist of warrants to purchase: (i) 421,950 shares of common stock
at an exercise price of $.01 per share; (ii) 800,000 shares of common stock at
an exercise price of $6.00 per share; (iii) 250,000 shares of common stock at an
exercise price of $7.50 per share; and (iv) 250,000 shares of common stock at an
exercise price of $9.00 per share. The warrants are exercisable at any time
until November 13, 2005. The exercise price and number of shares issuable upon
exercise of the warrants are subject to adjustment in certain circumstances,
including the issuance of securities for a price less than the current market
value of the common stock. In June 1996, for proceeds to the Company of $4,220,
the investor exercised 421,950 warrants to purchase common stock at an exercise
price of $.01 per share.
14
<PAGE>
Electropharmacology, Inc.
Notes to Financial Statements (continued)
7. SHAREHOLDERS' EQUITY AND WARRANTS (CONTINUED)
In November 1995, a family member of an officer and current member of the
Board of Directors of the Company, converted an aggregate of $1,000,000
principle amount of promissory notes into 195,945 shares of common stock. In
consideration for such conversion, the Company granted five-year warrants to
purchase 300,000 shares of common stock at a price of $6.25 per share,
subject to adjustment in certain circumstances. Subject to certain
limitations and exclusions, the Company agreed to include the shares
underlying the warrants in an appropriate registration statement filed by the
Company. No warrants have been exercised.
In December 1995, five-year warrants to purchase 65,000 shares of common
stock at $1.00 were issued to a consultant of the Company as full
consideration for a three-year financial consulting agreement. The Company
recorded an expense of $214,500 in connection with this transaction. Also,
five-year warrants to purchase 100,000 shares of common stock at $5.79 per
share were issued to a management consultant to the Company. No warrants have
been exercised.
In December 1995, the Company repurchased 10,493 shares of common stock for
$60,000 in connection with the resignation of the Company's chief operating
officer.
In December 1996, the Company issued 43,741 shares of common stock to
officers of the Company in lieu of cash for payment of outstanding employment
related liabilities.
The Company currently has 421,950 shares of Class A Preferred Stock and
3,540,165 shares of common stock issued and outstanding. Further, warrants to
purchase an aggregate of 3,012,707 shares of common stock have been issued to
date. With exception of the 421,950 warrants exercised in June 1996, no
warrants have been exercised.
At December 31,1996, shares of the Company's authorized but unissued common
stock were reserved for issuance as follows:
NUMBER OF
SHARES
----------
Exercise of warrants 3,012,707
Employee stock option plans (see Note 8) 1,113,860
Convertible preferred stock 421,950
----------
4,548,517
==========
Such exercise and conversion would result in gross proceeds of $33,343,211.
15
<PAGE>
Electropharmacology, Inc.
Notes to Financial Statements (continued)
7. SHAREHOLDERS' EQUITY AND WARRANTS (CONTINUED)
Effective November 1, 1996, the Board of Directors approved an Employee Stock
Purchase Plan (ESPP) covering all employees who meet service period
requirements. The ESPP provides for the sale of common stock to employees of
the Company at a price equal to 85% of the lesser of the market value at the
end of or beginning of each respective quarter. No shares have been issued
under the ESPP during 1996 as the plan is pending shareholder approval.
Effective January 1, 1996, the Company established the Electropharmacology,
Inc. 1996 Non-Employee Director's Equity Compensation Plan (the Compensation
Plan). The Compensation Plan provides for the issuance of common shares as
compensation for serving as a director of the Company. No shares were issued
under the Compensation Plan during 1996.
8. STOCK OPTIONS
The Company has adopted a stock option plan which was amended on November 1,
1996 (the Plan) for officers, directors, employees and consultants. Under the
Plan, the options granted may be either "incentive stock options" (for
officers and employees only) within the meaning of Section 422A of the
Internal Revenue Code, and/or nonqualified stock options (for officers,
employees, directors and consultants). The exercise price of incentive stock
options may not be less than 100% of the fair market value of the Company's
common stock as of the date of grant (110% of the fair market value if the
grant is to an employee who owns more than 10% of the outstanding common
stock). Nonqualified stock options may be granted under the Plan at an
exercise price less than fair market value of the common stock on the date of
grant.
As of December 31, 1996, the Board of Directors has authorized the granting
of options for up to 1,500,000 shares of common stock. Grants of options to
purchase 1,113,860 common shares, (1,043,860 of which are considered
incentive stock options), have been formalized under the Plan. The options
generally vest with a range from immediately to ratably up to five years on
differing vesting schedules. The aggregate proceeds to the Company upon
exercise of all options vested (incentive stock options and nonqualified
stock options, respectively) as of December 31, 1996 is $1,906,826. The
aggregate proceeds to the Company upon exercise of all options outstanding as
of December 31, 1996 is $5,543,616. The options expire at dates ranging from
two to ten years after date of grant.
16
<PAGE>
Electropharmacology, Inc.
Notes to Financial Statements (continued)
8. STOCK OPTIONS (CONTINUED)
As required by Statement No. 123, pro forma information regarding net income
and earnings per share has been determined as if the Company had accounted
for its employee stock options under the fair value method of that statement.
The fair value for these options was estimated at the date of grant using a
Black-Scholes option pricing model with the following weighted-average
assumptions for 1996: risk-free rate of return of 5.200%; dividend yield of
0.000%; volatility factor of the expected market price of the Company's
common stock of .775 and a weighted-average expected life of the options of
ten years.
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 from those traded options, and because changes in the
subjective input assumptions can materially affect the fair value estimate,
the existing models, in management's opinion, do not necessarily provide a
reliable single measure of the fair value of its employee stock options.
Transactions under the Plan are summarized as follows:
WEIGHTED
AVERAGE
NUMBER EXERCISE
OF PRICE PER
SHARES SHARE
------- ---------
Outstanding January 1, 1995 203,712
Exercised 0
Expired 0
Forfeited 0
Canceled (99,438)
Granted 87,500
---------
Outstanding December 31, 1995 191,774 $4.87
Exercised 0 0
Expired 0 0
Forfeited 0 0
Canceled (37,000) $8.09
Granted 959,086 $5.12
---------
Outstanding December 31, 1996 1,113,860 $4.98
========= =====
17
<PAGE>
Electropharmacology, Inc.
Notes to Financial Statements (continued)
8. STOCK OPTIONS (CONTINUED)
Exercisable at December 31, 1996 397,985
=======
Reserved for future option grants at
December 31, 1996 386,140
=======
Weighted average for fair value of options
granted during 1996 $4.26
=====
FASB Statement No. 123 requires disclosure of the weighted average exercise
prices for the current year only in the initial year of adoption.
For the purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the options' vesting period. The
Company's 1996 and 1995 pro forma information follows:
1996 1995
----------- ------------
Net loss $(3,665,506) $(3,109,269)
=========== ===========
Loss per common share $ (1.11) $ (1.28)
=========== ===========
The 1996 pro forma effect on net loss is not necessarily representative of
the effect in the future years because it does not take into consideration
pro forma compensation expense related to grants made prior to 1995.
The exercise price of options outstanding at December 31, 1996, ranged
between $2.875 and $6.375. The weighted-average remaining contractual life of
those options for 1996 is 7.8 years.
9. LEASE COMMITMENTS
The Company leases certain office equipment and administrative facilities on
a month-to-month basis. The administrative facilities are leased at a monthly
rate of $3,300 under a three-year agreement which expires on March 31, 1997.
Rent expense under operating leases approximated $62,475 and $51,083 for the
years ended December 31, 1996 and 1995, respectively.
The Company leases certain equipment under capital leases expiring in July
1998.
18
<PAGE>
Electropharmacology, Inc.
Notes to Financial Statements (continued)
9. LEASE COMMITMENTS (CONTINUED)
Future minimum lease payments under capital leases are as follows:
Year ending December 31,
1997 $23,440
1998 3,706
--------
Total minimum lease payments 27,146
Less amount representing interest (1,424)
Less current maturities (22,386)
--------
Long-term obligations $ 3,336
========
10. EMPLOYMENT AGREEMENTS
As of December 31, 1996, the Company has employment agreements with certain
executive officers, the terms of which expire at various times through
December 31, 2001.
The President of the Company (the "President") had a five year employment
agreement expiring on August 4, 2001 which provided for a current annual base
salary of $275,000, one-fourth of which could be deferred and/or paid in
stock, at the Board's discretion, an annual increase in the base salary tied
to the Consumer Price Index, and options to purchase up to 592,086 shares of
common stock at an exercise price of $5.50 per share. The agreement also
provided that, upon the exercise of certain warrants owned by another
shareholder of the Company, the Company would grant the President an option
to purchase 10% of the number of shares acquired upon the exercise of such
warrants by such shareholder. The agreement also provided that if the
President's employment was terminated other than for cause, he would receive
an amount equal to the sum of the highest annual base salary and the average
annual bonus received by him and that he would continue to receive benefits
pursuant to the Company's welfare programs and perquisite programs for a
period of two years.
The President resigned on April 1, 1997. As of April 12, 1997, the Company and
the President entered into a severance agreement that provides, among other
things, a settlement of all rights under his employment agreement with the
Company, a cash payment by the Company of $128,700 over approximately five
months, the issuance of 5,555 shares of common stock of the Company that were
assigned to the President in lieu of a portion of his salary during 1996, the
grant to the President of a ten-year warrant to purchase 25,000 shares of common
stock of the company at $2.25 per share and the cancellation of 384,850 options
to purchase shares of common stock of the Company that were previously granted
to the President, leaving the
19
<PAGE>
Electropharmacology, Inc.
Notes to Financial Statements (continued)
President with 207,236 fully vested options to purchase shares of common
stock of the Company. The severance agreement also provides for the
cancellation of the President's right to be granted an option to purchase
one-tenth of the number of shares of common stock of the Company as to which
the shareholder referred to above exercised his warrants. The President
further agreed to assign to the Company patent protection on inventions made
by him and to cooperate with the Company in obtaining such patent protection.
The Executive Vice President of Corporate Development of the Company has an
employment agreement expiring on December 31, 2001, which provides for a
current annual base salary of $139,000 and options to purchase up to 100,000
shares of common stock at an exercise price of $5.50 per share. The agreement
also provides that if employment is terminated other than for cause, this
individual will receive an amount equal to the sum of his annual base salary
and the average annual bonus received by him and that he will continue to
receive benefits pursuant to the Company's welfare programs and perquisite
programs for a period of one year.
The Executive Vice President of Research and Development of the Company has
an employment agreement expiring on December 31, 1999 which provides for a
current annual base salary of $180,000, one third of which may be deferred
and/or paid in stock, at the Board's discretion, an annual increase in the
base salary tied to the Consumer Price Index, and options to purchase up to
75,000 shares of common stock at an exercise price of $4.75 per share. The
agreement also provides that if employment is terminated other than for
cause, this individual will receive an amount equal to the sum of his annual
base salary and the average annual bonus received by him and that he will
continue to receive benefits pursuant to the Company's welfare programs and
perquisite programs for a period of one year.
The Chief Financial Officer of the Company has an employment agreement
expiring on December 31, 1997 which provides for a current annual base salary
of $75,000, one third of which may be deferred and/or paid in stock, at the
Board's discretion and options to purchase up to 30,000 shares of common
stock at an exercise price of $2.875 per share. The agreement also provides
that if employment is terminated other than for cause, this individual will
receive an amount equal to the sum of his annual base salary and the average
annual bonus received by him and that he will continue to receive benefits
pursuant to the Company's welfare programs and perquisite programs for a
period of one year.
For the year ended December 31, 1996, approximately $37,000 of compensation
was paid in common stock.
20
<PAGE>
Electropharmacology, Inc.
Notes to Financial Statements (continued)
11. CONTINGENCIES
PROPOSED FEDERAL FOOD AND DRUG ADMINISTRATION REGULATIONS
The Company and its products are regulated by the Federal Food and Drug
Administration (the "FDA") which has determined that the Company's products
are Class III medical devices. In April 1994, the FDA proposed the adoption
of new regulations requiring the submission of premarket approval (the PMA)
applications for Class III medical devices.
The Company believes that such proposed regulations, if adopted, could require
a PMA submission in 1998 for continued marketing of the SofPulse-TM- device
although significant additional events need to occur prior to enactment and
enforcement of such new regulations. In addition, the Company will be
provided an opportunity to seek reclassification of its device to Class II.
The PMA requires medical device manufacturers to provide information
establishing the safety and effectiveness of medical devices based on
controlled trials. The PMA process is lengthy, expensive and complex, and
will require the submission to the FDA of substantial clinical data and
statistical analysis demonstrating significant effects. The Company plans to
conduct new clinical trials, as the basis for seeking a PMA from the FDA for
its SofPulse-TM- device, but there can be no assurance that the Company will
be able, for financial or other reasons, to successfully complete required
studies and file its PMA application on a timely basis, or at all.
Failure to file a PMA application within 90 days following the adoption of
final regulations by the FDA, or failing to be granted a reclassification of
the Company's device to Class II by the FDA would result in the revocation of
the Company's Section 510(k) approval and otherwise prevent the Company from
marketing and, consequently, generating any revenue from sales or rentals of
the SofPulse-TM- in the United States until a PMA application is filed and
approved by the FDA. The inability to file and obtain a PMA approval, if and
when required by the FDA, and the inability to obtain reclassification to
Class II would have a material adverse effect on the Company, including
possibly requiring the Company to significantly curtail its operations.
The Company believes that it is taking reasonable measures in order to
maintain its right to continue to market its product in the United States for
the foreseeable future.
LITIGATION
In August 1994, a competitor of the Company filed a lawsuit against the Company
and certain of its present and former directors and officers alleging the
defendants had engaged in deceptive acts and practices, false advertising,
unfair competition, breach of contracts of fiduciary duties between the
plaintiff and certain of the Company's employees, and the Company's involvement
21
<PAGE>
Electropharmacology, Inc.
Notes to Financial Statements (continued)
in facilitating or participating in the breach of contracts. The plaintiff is
seeking an injunction to rectify the effects of the misconduct, an
unspecified amount of compensatory damages, disgorgement of profits, treble
damages, punitive damages and attorney's fees. The plaintiff also seeks
unspecified injunctive relief prohibiting the Company from engaging in the
alleged acts and ordering the defendants to take remedial action to rectify
the effects on consumers and the plaintiff caused by the alleged acts.
Although the Company believes that it has meritorious defenses which it will
pursue vigorously, there can be no assurance that the ultimate outcome of
such action will not have a material adverse effect on the Company's
liquidity, financial condition and results of operations. As of December 31,
1996, the Company has not accrued any loss contingencies or related expenses
in connection with this lawsuit.
On March 27, 1997 a former distributor for the Company filed a complaint
against the Company and other defendants alleging, among other things,
misappropriation of trade secrets, breach of fiduciary duty, unfair business
practices, tortious inducement to breach contracts, tortious interference
with prospective economic advantage and breach of contract. The plaintiff
seeks unspecified damages, restitution and an injunction prohibiting the
defendants from contacting or doing business with the plaintiff's customers.
Although the Company believes that it has meritorious defenses which it will
pursue vigorously, there can be no assurance that the ultimate outcome of
such action will not have a material adverse effect on the Company's
liquidity, financial condition and results of operations. As of December 31,
1996, the Company has not accrued any loss contingencies or related expenses
in connection with this lawsuit.
Management is unable to make a meaningful estimate of the likelihood or
amount or range of loss that could result from an unfavorable outcome of the
pending litigation. It is possible that the Company's results of operations
or cash flows in a particular quarter or annual period or its financial
position could be materially affected by an unfavorable outcome.
Other claims have been asserted by various claimants. The claims are in
various stages of processing and may ultimately be brought to trial. Based on
discussions with counsel, management has accrued its best estimate of the
ultimate expense of these contingent losses.
12. FINANCIAL INSTRUMENTS
The carrying amount of financial instruments including cash, accounts
receivable, notes receivable from customers and accounts payable approximate
fair value as of December 31, 1996 because of the short maturity of these
items.
22
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> DEC-31-1996
<CASH> 223,523
<SECURITIES> 0
<RECEIVABLES> 706,202
<ALLOWANCES> 134,000
<INVENTORY> 94,164
<CURRENT-ASSETS> 1,188,206
<PP&E> 1,518,068
<DEPRECIATION> 573,010
<TOTAL-ASSETS> 2,213,080
<CURRENT-LIABILITIES> 995,369
<BONDS> 0
4,220
0
<COMMON> 35,402
<OTHER-SE> 1,174,753
<TOTAL-LIABILITY-AND-EQUITY> 2,213,080
<SALES> 409,818
<TOTAL-REVENUES> 2,149,011
<CGS> 376,197
<TOTAL-COSTS> 376,197
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 8,933
<INCOME-PRETAX> (2,927,990)
<INCOME-TAX> 0
<INCOME-CONTINUING> (2,927,990)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (2,927,990)
<EPS-PRIMARY> (.89)
<EPS-DILUTED> 0
</TABLE>
