SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934.
For the fiscal year ended September 30, 2004
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934.
For the transition period from ____________________ to ________________
Commission File Number: 001-10382
VALLEY FORGE SCIENTIFIC CORP.
(Exact name of registrant as specified in its charter)
PENNSYLVANIA 23-2131580
(State or other jurisdiction of (I.R.S. employer
incorporation or organization) identification no.)
136 Green Tree Road, Oaks, Pennsylvania 19456
(Address of principal executive offices and zip code)
Telephone: (610) 666-7500
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Name of Each Exchange
Title of Each Class on which Registered
------------------- -------------------
Common Stock, no par value Boston Stock Exchange
Securities registered pursuant to Section 12(g) of the Act: None
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-K 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-K or any amendment to this
Form 10-K. [X]
Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2).
Yes [ ] No [X]
The aggregate market value of voting stock held by non-affiliates of the
Registrant, computed by reference to the closing bid and ask prices as reported
by The Nasdaq Stock Market on December 16, 2004 was $7,509,116.
At December 16, 2004 there were 7,913,712 shares of the Registrant's Common
Stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Certain information required by Items 10, 11, 12, 13 and 14 of Form 10-K is
incorporated by reference from the Definitive Proxy Statement for the Annual
Meeting of Stockholders of the Registrant, or an Amendment to this Annual Report
on Form 10-K, to be filed within 120 days after the end of the fiscal year
covered by this Annual Report on Form 10-K.
VALLEY FORGE SCIENTIFIC CORP.
FORM 10-K
FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 2004
TABLE OF CONTENTS
PART I
PAGE
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Item 1. Business 1
Item 2. Properties 23
Item 3. Legal Proceedings 24
Item 4. Submission of Matters to a Vote of Security Holders 24
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters and Issuer Repurchases of Equity
Securities 25
Item 6. Selected Financial Data 26
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operation 27
Item 7A. Quantitative and Qualitative Disclosures About Market Risk 35
Item 8. Financial Statements and Supplementary Data 35
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure 35
Item 9A. Controls and Procedures 35
PART III
Item 10. Directors and Executive Officers of the Registrant 36
Item 11. Executive Compensation 36
Item 12. Security Ownership of Certain Beneficial Owners and
Management and Related Stockholder Matters 36
Item 13. Certain Relationships and Related Transactions 36
Item 14. Principal Accountant Fees and Services 36
PART IV
Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K 37
(i)
VALLEY FORGE SCIENTIFIC CORP.
PART I
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Item 1. BUSINESS
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This report on Form 10-K contains certain forward looking statements
regarding future events with respect to Valley Forge Scientific Corp. ("Valley
Forge", "we", "us" and "our" refer to Valley Forge Scientific Corp., a
Pennsylvania corporation, unless the context otherwise requires). Actual events
or results could differ materially due to a number of factors, including, those
described herein and in the documents incorporated herein by reference and those
factors described under "Factors that Might Affect Future Results."
Overview
Valley Forge is a medical device company that develops, manufactures
and sells medical devices for use in surgery and other healthcare applications.
Our core business is the sale of bipolar electrosurgical generators and other
bipolar generators, based on our proprietary DualWave(TM) technology, and
complementary instrumentation and disposable products.
Since our formation in 1980, the primary focus of our technology has
been directed to the field of neurosurgery. For over 20 years, we have entered
into distribution agreements with Codman & Shurtleff, Inc., a Johnson & Johnson
affiliate, to market and sell our neurosurgery products. In 1999, we entered the
dental market with the development of our Bident(R) Bipolar Tissue Management
System. On October 25, 2004, we entered into an agreement with Stryker
Corporation for the distribution and sale of a lesion generator for the
percutaneous treatment of pain based on our proprietary technology. In fiscal
2005 and beyond, we plan to expand the market for our products with our new
multifunctional bipolar electrosurgical generator and new proprietary single-use
hand switching bipolar instruments, new products based on our proprietary lesion
generator technology, and other products and product refinements.
Recent Events
Agreement with Codman & Shurtleff, Inc. On October 15, 2004, we entered
into a new agreement with Codman & Shurtleff, Inc. ("Codman"), our principal
customer, that defines our business relationship from October 1, 2004 to
December 31, 2005. Under the agreement, Codman is given distribution rights to
our existing products in the fields of neurocranial and neurospinal surgery as
well as a limited right of first refusal until March 31, 2005 regarding the
marketing of our new multifunctional electrosurgical generator and single use
hand-switching bipolar instruments in the fields of neurocranial and neurospinal
surgery. Under the agreement, Codman continues to be the exclusive worldwide
distributor of our existing products in the fields of neurocranial and
neurospinal surgery through March 31, 2005, and the nonexclusive distributor in
those fields until December 31, 2005, as those terms may be extended by mutual
agreement of the parties. For the period from October 1, 2004 to March 31, 2005,
Codman has agreed to make minimum purchases of $1 million per calendar quarter.
Supply and Distribution Agreement with Stryker Corporation. On October
25, 2004, we entered into a supply and distribution agreement with Stryker
Corporation ("Stryker") for the distribution and sale of a lesion generator for
1
the percutaneous treatment of pain . The supply and distribution agreement is
the culmination of over two years of collaborative efforts with Stryker. The
term of the agreement is for slightly over five years, commencing on November
11, 2004 and ending on December 31, 2009, and grants Stryker exclusive worldwide
marketing rights for distribution and sale of the lesion generator for use in
percutaneous treatment of pain. In the first agreement year, Stryker has agreed
to make minimum purchases in excess of $900,000 for a combination of sales
demonstration units and commercial sales units. In the second and third
agreement years, Stryker has agreed to make minimum purchases of approximately
$500,000 per year for commercial sales units. Minimum purchase requirements for
agreement years four and five are to be determined by the parties based on
market conditions and other factors. The agreement also provides Stryker certain
rights for other new product concepts developed by Valley Forge in both pain
control and expanded market areas.
Option Agreement to acquire Malis(R) Trademark. On October 22, 2004, we
entered into an option agreement with Dr. Leonard Malis, Professor and Chairman
Emeritus of Mount Sinai School of Medicine Department of Neurosurgery and one of
Valley Forge's directors. Under the option agreement Valley Forge is granted an
option to acquire the Malis(R) trademark, which is owned by Dr. Leonard I.
Malis, at any time over a period of five years. The Malis(R) trademark is a name
widely recognized and respected in the neurosurgery field. Dr. Malis has in the
past licensed, and currently is licensing, the Malis(R) trademark to Codman in
connection with products sold by Codman to end users, which includes products
that Valley Forge sells to Codman. We paid Dr. Leonard I. Malis $35,000 for the
option and are required to pay an annual fee before each anniversary of the
option agreement of $20,000 for each of the first two anniversaries and
increasing to $60,000 before the fourth anniversary in order to continue the
option in effect from year to year. In the event that we decide to exercise the
option, Dr. Malis will be paid $4,157,504, which includes interest, in twenty
six equal quarterly installments of $159,904, and which will be evidenced by a
promissory note secured by a security interest in the trademark and certain of
our patents.
Strategy
Our goal is to become a global leader in the development and marketing
of bipolar medical devices and other products for use in specialty surgical and
healthcare fields and then expand the use of our bipolar electrosurgical
products into general surgery. The key elements of our strategy include the
following:
Increasing Revenues in the Neurosurgery Field with Our New
Multifunctional Bipolar Electrosurgical System. Our new multifunctional bipolar
electrosurgical system, which includes a new state-of-the-art bipolar generator
and our new proprietary single use hand-switching bipolar instruments, is
designed to perform an expanded array of procedures with its enhanced features
and functionality. We are completing the development of this product and are in
the process of evaluating distribution channels.
Expanding the Use of Our New Multifunctional Bipolar Electrosurgical
System into Other Surgical Markets. The increased power and functionality of our
new multifunctional bipolar electrosurgical system is designed to allow a
surgeon to perform functions similar to as traditional monopolar systems,
without the inherent safety issues and other limitations of monopolar systems.
This new system is reported to have applications in surgical markets such as
2
spine, maxillofacial, ear, nose and throat (ENT), orthopedic and general
surgery. Our current plan is to sell this system to end-users through marketing,
distribution or other alliances with healthcare companies that specialize in
these surgical areas.
Expanding Our Product Line. We plan to introduce other products and
disposable instruments we have developed or are developing for other specialized
procedures. For example, we recently commenced selling to Stryker Corporation a
new lesion generator for the percutaneous treatment of pain, based on our
proprietary technology. We also continue to review market potential and product
refinement opportunities for other applications of our lesion generator
technology, including intracranial applications.
Valley Forge Technology
The foundation of our bipolar electrosurgical systems lies in our
proprietary DualWave(TM) technology. Using our DualWave(TM) technology, our
bipolar generators are able to deliver two separate waveforms to perform the two
separate and distinct functions of cutting and coagulation. We do not believe
that it is either safe or effective to use the same waveform for coagulation
that is used for cutting. With the virtual elimination of heat and current
spread, our technology can be used in direct contact with nerves, bones, blood
vessels and metal implants, and can be used in virtually all areas of the human
body safely.
Our bipolar electrosurgical systems consist of a solid state
microprocessor controlled generator, utilizing our DualWave(TM) technology,
single-use disposable cords, which attach the hand-held bipolar instrument to
the generator, and single-use instruments, which we are selling in the dental
field and which we have developed for use in surgical fields. We also develop,
manufacture and sell modules and other accessories to handle specific functions
required by a particular surgical discipline. For example, in neurosurgery we
sell irrigation modules, which allow the neurosurgeon to pump a saline solution
into the surgical field while cutting tissue or coagulating blood vessels, and a
specially designed single-use plastic tube set, which connects the electrical
current from the generator and fluid from the irrigation module to the hand-held
instrument.
Our cutting waveform uses molecular resonance to cut, rather than heat
through an advancing spark. Our generators contains a rigidly stabilized voltage
control to provide an extremely gentle cut, using about one fifth the power of
other generators. The cutting current, which is delivered only to the tissue
between the two electrodes of the instrument, offers safety advantages by the
absence of current spread and markedly reduced heating of adjacent tissues. This
makes our product safe to use in virtually all areas of the human body.
Our coagulation waveform is unique in that it is totally aperiodic and
nonrhythmic. The timing of electrical bursts within the waveform are randomly
spaced, and the waveform itself is random in timing so that it is truly
aperiodic. Regardless of how high the voltage setting of the unit, or how long
the surgeon applies the current, the coagulation waveform simply will not cut.
Our strictly regulated constant voltage supply allows for precise, gentle and
progressive coagulation in either totally dry or fully irrigated fields,
including fields totally submerged in saline. These effects are produced in our
generators through the lowest practical output impedance.
3
Our bipolar electrosurgical generators deliver both cutting and
coagulation through bipolar handheld instruments, providing both the active
electrode and the return path through the handheld instrument back to the
generator. The performance of bipolar disposable handheld instruments is also
enhanced by an irrigated field, further minimizing the risk of heat buildup and
tissue damage. Our bipolar electrosurgical systems are designed to replace other
surgical tools, such as monopolar electrosurgical systems, lasers and ultrasonic
aspirators used in soft tissue surgery.
Electrosurgery
Surgical procedures are performed using a variety of methods and
instruments, including electrosurgical generators. Electrosurgical generators
perform two specific functions, tissue cutting and coagulation (sealing) of
blood vessels.
The application of hot cautery to seal blood vessels has been in
existence for more than 5,000 years. Early cauterization techniques employed
iron instruments heated in an open flame, then introduced into the wound. The
electrosurgical generator was first introduced in 1924, by noted neurosurgeon,
Dr. Harvey Cushing, who partnered with a Harvard University physicist, Dr.
William Bovie, to design a spark gap electrosurgical generator. The generator
worked by advancing a spark to tissue, to generate heat, providing
cauterization.
Today's electrosurgical generators have become more sophisticated,
utilizing high voltage, radiofrequency or RF, currents to cut and coagulate
tissue. Modern electrosurgical generator outputs are distinguished as either
"monopolar" or "bipolar." Both generate high frequency electrical current in
defined wave forms for surgical purposes. A single generator may deliver both
monopolar and bipolar outputs from different instrument connecting points. The
distinction between monopolar and bipolar refers to the manner in which the
current is delivered to and removed from the patient's body.
Fundamental electrical circuitry principles apply to the use of high
voltage, high frequency currents for surgical applications. The current must be
generated within the electrosurgical generator in an appropriate form, delivered
to the patient through a delivery system consisting of cables and
electrosurgical instruments, pass through some portion of the patient's body the
extent of which depends upon whether the output system is monopolar or bipolar,
exit the patient's body through a return path consisting of a return electrode
and cables, and return to the generator to complete the circuit. Modern
electrosurgical generators are "isolated," meaning they are electrically
separated from common ground circuits so that the current must return to the
generator, not to a random ground point, for the circuit to be completed and the
generator to operate. This is a key safety factor.
Monopolar Electrosurgery Systems
Monopolar electrosurgical systems typically create sine wave periodic
outputs for cutting and coagulation purposes. This output is delivered to the
surgical site by means of an insulated, hand held electrode with a very small
tip designed to concentrate the current at a specific contact point for the
purpose of surgical cutting or coagulation. This is known as the "active
electrode". The concentration of current at a point is necessary for a surgical
effect to occur. This current must then be removed from the body and returned to
the generator. This is accomplished by collecting the current at another point
4
on the patient's body distant from the surgical site, usually the thigh or
buttock. The current passes through the patient's body to the return point of
collection, dispersing over a large area of the body between the surgical site
and the return point. The current is collected over a large surface area
electrode known as a dispersive, or "return, electrode". In monopolar
electrosurgery, the dispersion of current over an electrode with large area, as
opposed to a point source, during the collection is used to prevent unintended
burn or damage being performed at the return electrode site.
Traditional monopolar electrosurgery results in generation of high
temperatures at the surgical site due to the requirements of the cutting
technology and the high current levels required. This may result in thermal
injury to surrounding tissue, including charring, drying, and other effects that
may impair healing. There are three significant safety hazards associated with
monopolar electrosurgey:
o Heat Build-up. Considerable heat buildup may occur in tissue
surrounding the surgical site, the hazards of which vary depending upon
the surgical site involved. There are no recognized methods of
controlling this risk other than the surgeon's choice of power setting
and his skill in use of the instrument.
o Current Passes Through Human Body. The electrical current must
pass through significant areas of the patient's body between the
surgical site and the return electrode. It is recognized that this
dispersion of electrical current in the body can cause damage to
tissue, blood vessels and nerves along the path of current travel. This
is controllable only by careful selection of the return electrode site
and the power settings chosen by the surgeon.
o Unintended Tissue Damage. Tissue damage can occur at the
return electrode site, commonly called a "return electrode burn", if
the return electrode is improperly placed, or not fully in contact with
the body, the conductive gel on the electrode has dried out, and for
many other reasons. This occurs when the surface area over which the
current is collected shrinks, creating an alternate point for the
concentration of current, which results in burns at the point where the
current exits the human body. Modern monopolar generators employ
monitoring circuitry to attempt to ensure the adequacy of the return
electrode surface area.
Bipolar Electrosurgical Systems
Bipolar electrosurgery also employs an active electrode and a return
electrode for delivery of current to the patient's body for surgical purposes
and for removal of that current from the patient's body. The distinctive
difference is that both the active electrode and the return electrode are
contained in the same hand held instrument, eliminating the need for the current
to pass through the patient's body between the surgical site and the return
electrode. This is accomplished by the design of the hand held instrument to
create two electrical poles (hence "bipolar") in the instrument in contact with
the patient. The current can only flow between these two contact points, which
are typically only millimeters apart. This, coupled with an aperiodic wave form
results in a requirement for lower current levels entering the patient's body,
5
limits the heat buildup at the surgical site to eliminate the risk of
surrounding tissue damage, eliminates the flow of current through non surgical
areas of the patient's body, and eliminates any risk of damage at a secondary
site.
The Neurosurgery Market
There are an estimated 3,600 Board Certified Neurological Surgeons in
the United States, and an estimated 15,000 neurosurgeons worldwide. Neurological
surgery is a medical specialty dealing with disorders of the brain, skull,
spinal cord, cranial and spinal nerves, the autonomic nervous system and the
pituitary gland. It is estimated that approximately 500,000 brain and spine
surgery procedures are performed each year in the United States.
A prominent use of bipolar electrosurgical instrumentation in
neurosurgery is tumor removal. There are over 100 different types of brain
tumors and more than 180,000 Americans are diagnosed with brain tumors each
year. The most common brain tumors in adults are: glioblastoma, meningioma, and
oligodendroglioma. Approximately 2,200 children are also diagnosed with a brain
tumor each year, with the most common being medulloblastoma and astrocytoma.
For each bipolar neurosurgical procedure, the neurosurgeon needs
hand-held instruments that will cut, divide, core or remove tissue and tumors
and coagulate blood vessels. The neurosurgeon also needs to connect that
instrument with a cord/tubing set to the bipolar generator and irrigation unit,
which provides fluids to the surgical site.
In neurosurgery, a bipolar electrosurgical system is the modality of
choice, largely due to the efforts of Dr. Leonard I. Malis, one of our
directors. Dr. Malis, who is Professor and Chairman Emeritus of the Mount Sinai
School of Medicine Department of Neurosurgery, designed and developed the first
commercial bipolar coagulator in 1955, and pioneered the use of bipolar
electrosurgery for use in the brain. Dr. Malis is a frequent author and lecturer
on neurosurgery and bipolar electrosurgery.
Our Neurosurgery Bipolar Systems.
--------------------------------
Our neurosurgery bipolar systems, which were developed in conjunction
with Dr. Leonard I. Malis, are used to cut, core and divide tissue and tumors
and coagulate blood vessels in the brain and spine. Our neurosurgery bipolar
systems, which are currently marketed and sold by Codman & Shurtleff, Inc. to
end-users under the Malis(R) tradename, a tradename owned by Dr. Leonard I.
Malis, are used by neurosurgeons worldwide.
Our neurosurgery bipolar systems are surgical devices intended to
perform two separate functions: bipolar cutting of tissue and bipolar
coagulation of blood vessels. Our systems are typically comprised of the bipolar
electrosurgical generator, an irrigation module, a foot pedal control,
connecting cables and tubing sets. In conjunction with our new multifunctional
bipolar electrosurgical generator, we are developing an array of single use hand
switching bipolar instrumentats in varying sizes and shapes that will connect to
the generator via a single-use disposable bipolar cord and tubing sets.
6
Our bipolar generator delivers our DualWave(TM) bipolar cutting and
bipolar coagulation through radio frequency waveforms. Our irrigation modules
deliver fluids, such as saline, to the surgical field through a hand-held
instrument. With the use of bipolar hand-held instruments connected to our
bipolar generator, a surgeon can cut tissue and seal blood vessels in an
irrigated surgical field. The surgeon can control the mode of operation with the
foot pedal control and power setting with keys on the front panel of the
controller.
Codman markets and sells our current line of neurosurgery products
under the following product names:
Generators/Irrigators
---------------------
- Malis(R) CMC(R)-III Bipolar Generator (High power cutting/
coagulation)
- Malis(R) Bipolar Synergy(R) Generator (Low power coagulation)
- Malis(R) CMC(R)-III Irrigation Module
- Malis(R) 1000 Irrigation Module
Disposable Cord Sets
--------------------
- Malis(R) Bipolar Cord/Irrigation Tubing Set
- Malis(R) Bipolar Cord
Other Products
--------------
- Malis(R) Titanium Surgical Mesh
Our new multifunctional bipolar system, which we expect to commence
selling in fiscal 2005, consists of the following components:
- Multifunctional bipolar electrosurgical generator
- Single use hand-switching instruments of various configurations
and shapes
- Disposable connecting cables and cord/tubing sets
Other Surgical and Medical Markets
Bipolar Electrosurgical Generators
----------------------------------
Building upon our DualWave(TM) technology used in bipolar
electrosurgical generators in neurosurgery, our strategy is to expand the market
for our new multifunctional bipolar electrosurgical generator and single use
hand-switching bipolar instruments in other clinical and surgical markets that
have a need for bipolar electrosurgery. We also continue to research market
potential and product refinement opportunities for additional clinical
applications of our bipolar electrosurgical generators using our DualWave(TM)
technology. Potential additional fields for our multifunctional bipolar
electrosurgical system include: general surgery, minimally invasive applications
in various clinical fields, maxillofacial surgery, ENT, plastic surgery and
general surgery.
7
Lesion Generators
-----------------
On October 25, 2004, we entered into a supply and distribution
agreement with Stryker Corporation for the sale to Stryker Corporation of a
lesion generator for the percutaneous treatment of pain, which culminated over
two years of collaborative efforts with Stryker Corporation. The agreement with
Stryker currently covers the manufacture and supply of a lesion generator unit
and certain accessories.
The lesion generator for the percutaneous treatment of pain is designed
to coagulate living human tissue for interventional pain treatment. The system
provides an electrical stimulator for nerve localization and various coagulating
outputs that are selectable based on the procedure undertaken. The generator is
configured for bipolar output, to minimize current leakage, but is also be
capable of monopolar operation. An electrode is used to deliver coagulation
energy to the targeted tissue. The electrode is connected to the generator by
means of a connecting cable. We are in the process of developing bipolar
electrodes to be used with the generator unit.
We also continue to review market potential and product refinement
opportunities for other applications of our lesion generator technology,
including intracranial applications.
The Dental Market
There are an estimated 150,000 professionally active dentists in the
United States. As primary oral health care providers, approximately 80% of
dentists are generalists, and approximately 20% are specialists. More than 90%
of active dentists are in private practice.
There are currently more than 20 different procedures with the American
Dental Association, ADA, codes eligible for insurance reimbursement, for which
bipolar electrosurgery can be used. Examples of commonly performed procedures
include:
o Gingivectomey / Gingivoplasty (surgical treatment of gingivitis),
o Connective tissue graft,
o Surgical removal of residual tooth roots,
o Crown and bridge preparation,
o Biopsy of oral tissue,
o Excision of cysts or tumors, benign and malignant, and
o Surgical removal of impacted or erupted tooth.
Our Bident(R) Bipolar Tissue Management System
-----------------------------------------------
Our Bident(R) Bipolar Tissue Management System uses the same
DualWave(TM) technology used in our neurosurgery bipolar systems to allow
dentists to work in direct contact with metal implants, nerves, bone and blood
vessels, essentially eliminating collateral tissue damage from current spread
and heat buildup.
Dentists are particularly affected by the limitations of monopolar
electrosurgical systems to work safely around metal implants, bone, nerves and
blood vessels due to the nature of delicate structures they work within. We
believe, the elimination of the grounding pad through bipolar delivery of our
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current to cut and coagulate in our Bident(R) Bipolar Tissue Management System
is also an important factor to dentists concerned with both safety, and patient
perception/fear of the equipment used in the general dentistry setting.
Our Bident(R) Bipolar Tissue Management System is a surgical device,
which performs two separate functions: bipolar tissue cutting and bipolar
coagulation of blood vessels. The size, features and overall power output of the
generator itself is different than our neurosurgery bipolar system, to meet the
need for a cost effective, office style generator for the dentist. The system is
comprised of the electrosurgical generator, a foot pedal control, connecting
cables and an array of disposable bipolar hand-held instruments, which are
attached to the generator via a single use bipolar cord.
Dentists can use our disposable bipolar hand-held instruments to cut
tissue and to seal blood vessels. The dentist can control the mode of operation
with the foot pedal and power setting with knobs on the front panel of the
generator.
Our disposable bipolar hand-held instruments are available in various
tip sizes, shapes and angles to perform the varying procedures performed by the
dentist. We currently sell sixteen different models of disposable bipolar
hand-held instruments for dental procedures. We believe that the typical use for
each dental surgical procedure is one to two disposable instruments and one
disposable cord set.
Our current bipolar dental products, which we sell directly to dentists
and through distributors consist of the following:
Generator
---------
- Bident(R) Bipolar Surgical Generator
Bipolar Instrument and Cord Sets
--------------------------------
- Bident(R) Bipolar Flap Access Pen
- Bident(R) Bipolar Gingivoplasty Pen
- Bident(R) Bipolar Gingivectomy Pen
- Bident(R) Bipolar Gingival Troughing Pen 5 mm (.012")
- Bident(R) Bipolar Gingivectomy Pen (.020")
- Bident(R) Bipolar Coagulating Ball 3mm
- Bident(R) Bipolar Coagulating Ball 3mm (30(Degree))
- Bident(R) Bipolar Gingivoplasty Loop 1.5x9mm
- Bident(R) Bipolar Gingivoplasty Loop 1.5x9mm (30(Degree))
- Bident(R) Bipolar Gingivoplasty Loop 3x5mm
- Bident(R) Bipolar Gingivoplasty Loop 3x5mm (30(Degree))
- Bident(R) Bipolar Gingivoplasty Loop 3x8mm
- Bident(R) Bipolar Gingivoplasty Loop 3x8mm (30(Degree))
- Bident(R) Bipolar Gingivoplasty Loop 5x5mm
- Bident(R) Bipolar Gingivoplasty Loop 5x5mm (30(Degree))
- Bident(R) Bipolar Cord Set
9
Manufacturing and Supplies
We conduct the manufacturing of our bipolar generators and irrigation
systems in our facility in Philadelphia, Pennsylvania. Our products are
manufactured from raw materials and components supplied to us by third parties.
Most of the raw material and components we use in the manufacture of our
products are available from more than one supplier. For some components,
however, there are relatively few alternate sources of supply and we rely upon
single source suppliers or contract manufacturers. For example, we currently
subcontract the manufacturing of our disposable instruments with a single
contract manufacturer and we subcontract the manufacture of our disposable cord
and tube sets with a single manufacturer. Our profit margins and our ability to
develop and deliver such products on a timely basis may be adversely affected by
the lack of alternative sources of supply in the required timeframe.
Our manufacturing process is subject to the regulatory requirements of
the Federal Good Manufacturing Practice Regulations as promulgated by the
Federal Food and Drug Administration, commonly referred to as the FDA, as well
as other regulatory requirements of the FDA, which mandate detailed quality
assurance and record-keeping procedures and subjects us to unscheduled periodic
regulatory inspections. We conduct quality assurance audits throughout the
manufacturing process and believe that we are in compliance with all applicable
government regulations.
Marketing and Sales
To date, with the exception of our dental products, we have sold our
products to third party distributors pursuant to agreements or other alliances,
who in turn sell our products to end-users.
Codman & Shurtleff, Inc. For over twenty years, we have entered into
distribution agreements with Codman to sell and distribute our products in the
field of neurosurgery. During the 2004 fiscal year, we extended the term of a
distribution agreement, which we originally entered into on December 11, 2000,
until September 30, 2004. Under that distribution agreement, as extended, Codman
was granted the exclusive worldwide right to sell our then existing neurosurgery
products in the fields of neurocranial and neurospinal surgery on the condition
that Codman & Shurtleff, Inc. make agreed upon minimum purchases.
On October 15, 2004, we entered into a new agreement with Codman, that
defines our business relationship with Codman from October 1, 2004 through
December 31, 2005. Under this new agreement, Codman is given distribution rights
to our existing neurosurgery products in the fields of neurocranial and
neurospinal surgery as well as a limited right of first refusal until March 31,
2005 regarding the marketing of our new multifunctional electrosurgical
generator and single use hand-switching bipolar instruments in the fields of
neurocranial and neurospinal surgery. Codman continues to be the exclusive
worldwide distributor of our existing products in the fields of neurocranial and
neurospinal surgery through March 31, 2005, and the nonexclusive distributor in
those fields until December 31, 2005, as those terms may be extended by mutual
agreement of the parties. For the period from October 1, 2004 to March 31, 2005,
Codman has agreed to make minimum purchases of $1 million per calendar quarter.
We perform product development, manufacturing and clinical and regulatory
functions for our neurosurgery bipolar systems.
10
For the 2004, 2003 and 2002 fiscal years, we had sales to Codman of
approximately $4,099,000, $4,231,000 and $4,515,000, respectively. In fiscal
2004, approximately 86% of our sales were derived from sales to Codman and in
fiscal 2003 and 2002 approximately 95% and 90% of our sales, respectively, were
derived from sales to Codman. Codman also sells its own passive hand-held
instruments under the Malis(R) tradename, which it licenses directly from Dr.
Leonard I. Malis, which are used in conjunction with our neurosurgery bipolar
systems, and for which we do not receive any revenues.
Stryker Corporation. On October 25, 2004, we entered into a supply and
distribution agreement with Stryker Corporation for the distribution and sale of
a percutaneous pain control generator. The supply and distribution agreement is
the culmination of over two years of collaborative effort with Stryker. The term
of the agreement is for slightly over five years, commencing November 11, 2004
and ending on December 31, 2009, and grants Stryker exclusive worldwide
marketing rights for distribution and sale of a lesion generator for use in
percutaneous treatment of pain. In the first agreement year, Stryker has agreed
to make minimum purchases in excess of $900,000 for a combination of sales
demonstration units and commercial sales units. In the second and third
agreement years, Stryker has agreed to make minimum purchases of approximately
$500,000 per year for commercial sales units. Minimum purchase requirements for
agreement years four and five are to be determined by the parties based on
market conditions and other factors. The agreement also provides Stryker certain
rights for other new product concepts developed by Valley Forge in both pain
control and expanded market areas. Approximately 6% of our sales in fiscal 2004
were derived from sales to Stryker.
Boston Scientific Corporation. In February 2002, we entered into an
agreement with Boston Scientific Corporation to provide primarily product
support for the installed base of Boston Scientific's "Symmetry Endo-Bipolar
Generator" and the Mini-SymmetryTM generators, which we had previously
manufactured for Boston Scientific Corp.
Our neurosurgery bipolar systems are sold in certain foreign markets by
Codman. Prior to sales in certain foreign markets, we are required to comply
with applicable foreign government regulations.
Our business is not affected to any material extent by seasonal
factors.
Competition
We believe that principal competitive factors with our bipolar
electrosurgical products are product features, quality, safety, ease of use,
cost, acceptance by leading physicians, and other clinical benefits. We believe
that our proprietary DualWave(TM) technology, which delivers both bipolar
cutting and bipolar coagulation with two separate waveforms, distinguishes our
bipolar electrosurgical systems from electrosurgical systems sold by other
entities, which do not offer both bipolar cutting and bipolar coagulation. We
believe that our unique bipolar electrosurgical products offer enhanced
capabilities and safety advantages as compared to monopolar electrosurgical
systems.
The medical device industry is intensely competitive in almost all
segments and tends to be dominated in large more mature markets by a relatively
small group of large and well financed companies. We also compete with smaller,
11
entrepreneurial companies. There can be no assurance that these or other
companies will not succeed in developing, or have not already developed,
technologies or products that are more effective than ours or that would render
our technology or products obsolete or uncompetitive.
Neurosurgery
------------
In neurosurgery, we believe that we are the principal manufacturer of
bipolar electrosurgical systems. Our neurosurgery bipolar electrosurgical
systems which are sold and distributed by Codman compete against manufacturers
of electrosurgical systems, including the Valleylab division of Tyco
International Ltd., Erbe and the Aesculap division of B. Braun. In addition, our
products compete with smaller specialized companies and larger companies that do
not otherwise focus on neurosurgery. Our products also compete with other
technologies, such as lasers, ultrasonic aspirators, handheld instruments and a
variety of tissue removal systems designed for removing brain and cranial-based
tumors, such as an ultrasonic tissue aspiration system also manufactured by the
Valleylab division of Tyco International Ltd.
Dental Market
-------------
We believe that we are the only manufacturer of bipolar electrosurgical
systems serving the dental market. Our Bident(R) Bipolar Tissue Management
System competes with monopolar electrosurgical systems manufactured by Ellman,
and laser and other monopolar electrosurgical systems manufactured by several
other companies including Parkell.
Other Markets
-------------
In other markets, our bipolar electrosurgical generators and disposable
products will compete with large companies, such as the Valleylab division of
Tyco International Ltd. and Conmed, which manufacture and sell electrosurgical
medical devices. Our bipolar electrosurgical systems will also compete with
laser systems, traditional hand-held scalpels, and other technologies. The
lesion generator for the percutaneous treatment of pain competes with other pain
control devices as well as pain control medications. We cannot assure you that
we, or the companies with whom we contract to sell our products, can effectively
convince physicians and surgeons to purchase our products in the face of
competition.
Research and Development Strategy
Our research and development primarily focuses on developing new
products based on our proprietary Dual Wave(TM) technology and our expertise in
bipolar electrosurgery. We are continually working on new products and
instrumentation as well as enhancements to existing products to meet the needs
of surgeons in various surgical disciplines. In September 2002, we entered into
a development agreement with Stryker Corporation for the development of a lesion
generator for use in the percutaneous treatment of pain, which resulted in our
entering into a supply and distribution agreement with Stryker Corporation for
that generator on October 25, 2004.
For the 2004, 2003 and 2002 fiscal years, we expended $508,287,
$489,930 and $360,111, respectively, for research and development. We anticipate
that we will continue to incur research and development costs in connection with
12
development of products. Substantially all of our research and development is
conducted internally. In the 2005 fiscal year, we anticipate that we will fund
all our research and development with current assets and cash flows from
operations. From time-to-time we review our research and development programs to
ensure that they remain consistent with and supportive of our growth strategies.
Government Regulation
The marketing and sale of our products in the United States is governed
by the Federal Food, Drug and Cosmetic Act administered by the FDA, as well as
varying degrees of regulation by a number of state and foreign governmental
agencies.
FDA regulations are wide ranging and govern the introduction of new
medical devices, the observance of certain standards with respect to the design,
manufacture, testing, labeling and promotion of devices, the maintenance of
certain records, the ability to track devices in distribution, the reporting of
potential product defects and patient incidents, the export of devices and other
matters.
All medical devices introduced into the market since 1976, which
include substantially all of our products, are required by the FDA as a
condition of sale and marketing to secure either a 510(k) Premarket Notification
clearance or an approved Premarket Approval (PMA) application. A Premarket
Notification clearance indicates FDA agreement with an applicant's determination
that the product for which clearance has been sought is substantially equivalent
to another medical device that was on the market prior to 1976 or that has
received 510(k) Premarket Notification clearance. The process of obtaining a
Premarket Notification clearance can take several months and commonly involves
the submission of limited clinical data and supporting information, while the
PMA process can take up to several years and typically requires the submission
of significant quantities of clinical data and manufacturing information.
Federal, state and foreign regulations regarding the manufacture and
sale of medical devices are subject to future changes. We cannot predict the
impact, if any, these changes might have. These changes, however, could have
material impact on our business.
We may not receive the necessary regulatory approvals or clearances,
including approval for product improvements and new products, on a timely basis,
if at all. Delays in receipt of, or failure to receive regulatory clearances or
approvals could have a material adverse effect on our business. In addition,
even after clearance is given, if a product is hazardous or defective, the FDA
has the power to withdraw the clearance or require us to change the device, its
manufacturing process or its labeling, to supply additional proof of its safety
and effectiveness or to recall, repair, replace or refund the cost of a medical
device. To comply with the FDA regulations, we may incur substantial costs
relating to laboratory and clinical testing of new and existing products and the
preparation and filing of documents in formats required by the FDA.
Under FDA regulations, after a device receives 510(k) clearance, any
modification that could significantly affect its safety or effectiveness, or
that would constitute a major change in the intended use of the device,
technology, materials, packaging, and certain manufacturing process requires a
new 510(k) clearance. The FDA requires a manufacturer to make this determination
in the first instance, but the FDA can review any such decision, and if it
13
disagrees it can require a manufacturer to obtain a new 510(k) clearance or it
can seek enforcement action against the manufacturer.
We are also required to register with the FDA as a device manufacturer
and are required to maintain compliance with the FDA's Quality System
Regulations, or QSRs. The QSRs incorporate the requirements of Good
Manufacturing Practice and relate to product design, testing, and manufacturing
quality assurance, as well as the maintenance of records and documentation. The
FDA enforces the QSRs through inspections. We cannot assure you that we or our
key component suppliers will not encounter any manufacturing difficulties, or
that we or any of our subcontractors or key component suppliers will be able to
maintain compliance with regulatory requirements.
We may not promote or advertise our products for uses not within the
scope of our clearances or approvals or make unsupported safety and
effectiveness claims. Further, we are required to comply with various FDA
requirements for labeling and promotion. The Medical Device Reporting
regulations require that we provide information to the FDA whenever there is
evidence to reasonably suggest that one of our devices may have caused or
contributed to a death or serious injury or, if a malfunction were to recur,
could cause or contribute to a death or serious injury. In addition, the FDA
prohibits us from promoting a medical device before marketing clearance has been
received or promoting a cleared device for unapproved indications. Noncompliance
with applicable regulatory requirements can result in enforcement action, which
may include:
o warning letters;
o fines, injunctions and civil penalties against us;
o recall or seizure of our products;
o operating restrictions, partial suspension or total shutdown of
our production;
o refusing our requests for premarket clearance or approval of new
products;
o withdrawing product approvals already granted; and
o criminal prosecution.
We have received Premarket Notification 510(k) clearance for our
existing bipolar electrosurgical generators and disposable instrumentation. We
have filed and also expect to file new applications during the fiscal 2005 year
to cover new products and variations on existing products. We cannot assure you
that we will be able to obtain necessary clearances or approvals to market any
other products, or existing products for new intended uses, on a timely basis,
if at all. Delays in receipt or failure to receive clearances or approvals, the
loss of previously received clearances or approvals, or failure to comply with
existing or future regulatory requirements could have a material adverse effect
on business, financial condition, results of operations and future growth
prospects.
Medical device regulations also are in effect in many of the countries
outside the United States in which our products are sold. These laws range from
comprehensive device approval and quality system requirements for some or all of
our medical device products to simpler requests for product data or
certifications. The number and scope of these requirements are increasing. In
June 1998, the European Union Medical Device Directive became effective, and all
medical devices sold in the European common market must meet the Medical Device
14
Directive standards. For European common market distribution, we have received
ISO 9001 certification for the IEC version of our neurosurgery bipolar system
(marketed by Codman under the name CMC(R)-III-IEC) and that unit bears a CE
mark. Failure to maintain the CE Mark will preclude our distributor from selling
our products in Europe. We cannot assure you that we will be successful in
maintaining certification requirements.
We believe that we are in material compliance with regulations
promulgated by the FDA, and that such compliance has been and is anticipated to
be without adverse effect on our business.
Patents and Intellectual Property
Valley Forge Patents and Intellectual Property
----------------------------------------------
Our ability to compete in an effective manner depends primarily on
developing, improving and maintaining proprietary aspects of our bipolar
technology. There are two principal United States patents that are directed
towards our DualWave(TM) bipolar technology used in our bipolar electrosurgical
systems. Our first patent, which was issued on May 27, 1986, expired on May 27,
2003. Our second patent was issued on June 17, 1994. We are also in the process
of seeking patent protection for certain aspects of our new multifunctional
bipolar electrosurgical system. Our bipolar electrosurgical generators are based
on the combination of both of these patents and other know-how and trade
secrets. We also own two United States patents, which are used in our disposable
hand-held bipolar instruments, and we have applied for United States patents on
additional disposable instrumentation and electronic circuitry.
We seek patent protection of our key technology, products and product
improvements in the United States and may seek patent protection in selected
foreign countries. When determined appropriate, we will enforce and defend our
patent rights. In general, however, we do not rely exclusively on our patents to
provide us with any significant competitive advantages as it relates to our
existing product lines. We also rely upon trade secrets, know-how, and
continuing technological innovations to develop and maintain our competitive
advantage. In an effort to protect our trade secrets, we generally require our
employees, consultants and advisors to execute proprietary information and
invention assignment agreements upon commencement of employment or consulting
relationships with us. These agreements typically provide that all confidential
information developed or made known to the individual during the course of their
relationship with us must be kept confidential, except in specified
circumstances. We cannot assure you that employees or consultants will not
breach the agreements, that we would have adequate remedies for any breach or
that our trade secrets will not otherwise become known to or be independently
developed by competitors.
We cannot assure you that the patents we have obtained, or any patents
that we may obtain as a result of our patent applications, will provide any
competitive advantages for our products or that they will not be successfully
challenged, invalidated or circumvented in the future. In addition, we cannot
assure you that competitors, many of whom have substantial resources and have
made substantial investments in competing technologies, will not seek to apply
for and obtain patents that will prevent, limit or interfere with our ability to
make, use and sell our products either in the United States or in international
markets.
15
Other companies and entities have filed patent applications or have
been issued patents relating to monopolar and/or bipolar electrosurgical methods
and devices. We do not believe that our products currently infringe any valid
and enforceable claims of others. We cannot assure you that we will not have to
defend ourselves in court against allegations of infringement of third-party
patents.
DualWave(TM), Bident(R), Bi-Safe(TM), Gentle Gel(R) and the Finest
Energy Source Available for Surgery(R) are some of the trademarks of Valley
Forge. All other brand names, trademarks and service marks appearing in this
report not identified as trademarks of Valley Forge are the property of their
respective holders.
Option Agreement to acquire Malis(R) Trademark
----------------------------------------------
On October 22, 2004, we entered into an agreement with Dr. Leonard
Malis, Professor and Chairman Emeritus of Mount Sinai School of Medicine
Department of Neurosurgery and one of Valley Forge's directors, under which we
are granted an option to acquire the Malis(R) trademark, which is owned by Dr.
Malis, at any time over a period of five years. The Malis(R) trademark is a name
widely recognized and respected in the neurosurgery field. Dr. Malis has in the
past licensed, and currently is licensing, the Malis(R) trademark to Codman in
connection with products sold by Codman to end users, which includes products
that we sell to Codman. We paid Dr. Malis $35,000 for the option and are
required to pay an annual fee before each anniversary of $20,000 for each of the
first two anniversaries of the option agreement and increasing to $60,000 before
the fourth anniversary in order to continue the option in effect from year to
year. In the event we decide to exercise the option, Dr. Malis will be paid
$4,157,504, which includes interest, in twenty six equal quarterly installments
of $159,904, and which will be evidenced by a promissory note secured by a
security interest in the trademark and certain of our patents.
Product Liability Risk and Insurance Coverage
The development, manufacture, sale and use of medical products entail
significant risk of product liability claims. We maintain product liability
coverage at levels we have determined are reasonable. We cannot assure you that
such coverage limits are adequate to protect us from any liabilities we might
incur in connection with the development, manufacture, sale or use of our
products. In addition, we may require increased product liability coverage as
our sales increase in their current applications and new applications. Product
liability insurance is expensive and in the future may not be available on
acceptable terms, if at all. A successful product liability claim or series of
claims brought against us in excess of our insurance coverage could have a
material adverse affect on our business, prospects, financial condition and
results of operations.
Employees
At September 30, 2004, we and our subsidiaries had 22 full-time
employees, including executive officers. From time to time we retain part-time
employees, engineering consultants, scientists and other consultants. All
full-time employees participate in our health benefit plan. None of our
employees are represented by a union or covered by a collective bargaining
agreement. We consider our relationship with our employees to be satisfactory.
16
SPECIAL NOTE REGARDING FORWARD LOOKING STATEMENTS
The information provided in this Annual Report on Form 10-K, including
statements under "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and "Business" contain in addition to historic
information, "forward looking" statements or statements which arguably imply or
suggest certain things about our future. Statements which express that we
"believe", "anticipate", "expect", or "plan to" as well as other statements
which are not historical fact, are forward looking statements within the meaning
of the Private Securities Litigation Reform Act of 1995. These include, but are
not limited to statements about: any competitive advantage we may have as a
result of our installed base of electrosurgical generators in the neurosurgery
market; our belief that our products exceed industry standards or favorably
compete with other companies' new technological advancements; and the future
success of our new products and disposable instrumentation in the neurosurgery
and other markets; our ability, along with the third parties with whom we
contract, to effectively distribute and sell our products and the continued
acceptance of our products in the marketplace. These statements are based on
assumptions that we believe are reasonable, but a number of factors could cause
our actual results to differ materially from those expressed or implied by these
statements including:
o general economic and business conditions;
o our expectations and estimates concerning future
financial performance of our products and the impact of
competition;
o existing and future regulations affecting our business;
o other risk factors described in the sections entitled
"Factors that Might Affect Future Results" in this
report.
We do not intend to update or revise these forward looking statements.
FACTORS THAT MIGHT AFFECT FUTURE RESULTS
The Medical Device Industry Is Highly Competitive, And We May Be Unable to
Compete Effectively with Other Companies.
In general, the medical technology industry is characterized by intense
competition. We compete with established medical technology and pharmaceutical
companies. Competition also comes from early stage companies that have
alternative solutions for the markets we serve or intend to serve. Many of our
competitors have access to greater financial, technical, research and
development, marketing, manufacturing, sales, distribution services and other
resources than we do. Further, our competitors may be more effective at
implementing their technologies to develop commercial products.
Our competitive position will depend on our ability to achieve market
acceptance for our products, develop new products, implement production and
marketing plans, secure regulatory approval for products under development, and
protect our intellectual property. We may need to develop new applications for
our products to remain competitive. Technological advances by one or more of our
current or future competitors could render our present or future products
obsolete or uneconomical. Our future success will depend upon our ability to
17
compete effectively against current technology as well as to respond effectively
to technological advances. Competitive pressures could adversely affect our
profitability.
The largest competitor for our neurosurgical generator is the Valleylab
division of Tyco International Ltd. In addition, our product lines could compete
with smaller specialized companies or larger companies that do not otherwise
focus on neurosurgery. Our dental business is small compared to its principal
competitors, which sell laser devices. Our new multi-functional bipolar
electrosurgical system will compete with monopolar devices manufactured by the
Valleylab division of Tyco International Ltd. Finally, in certain cases our
products compete primarily against medical practices that treat a condition with
medications.
Our Business Depends Significantly On Key Relationships With Third Parties,
Which We May Be Unable To Establish And Maintain.
Our current business model depends on our entering into and maintaining
distribution or alliance agreements with third parties concerning product
marketing and sales. Our most important agreement is with the Codman &
Shurtleff, Inc., an affiliate of Johnson & Johnson, for the sale of our
neurosurgery products. Sales to Codman accounted for 86% of our sales in fiscal
2004, and 95% and 90% of our sales in fiscal 2003 and 2004, respectively. On
October 15, 2004, we entered into a new agreement with Codman extending an
exclusive distributorship relationship until March 31, 2005 and a nonexclusive
distribution relationship until December 31, 2005. Termination or nonrenewal of
this relationship would require us to develop other means to distribute our
neurosurgery products and could adversely affect our sales, operations and
growth.
Our ability to enter into agreements with third parties depends in part
on convincing them that our technology can help them achieve their goals and
execute their strategies. This may require substantial time, effort and expense
on our part with no guarantee that a relationship will result. We may not be
able to establish or maintain these relationships on commercially acceptable
terms. Our future agreements may not ultimately be successful. Even if we enter
into distribution or alliance agreements, the contracting parties could
terminate these agreements, or these agreements could expire before meaningful
milestones are reached. The termination or expiration of any of these
relationships could have a material adverse effect on our business.
Much of the revenue that we may receive under third party distribution
or alliance agreements will depend upon our distributors' ability to
successfully introduce, market and sell our products. Our success depends in
part upon the performance by these distributors of their responsibilities under
these agreements. Some distributors may not perform their obligations when and
as we expect. Thus, revenues to be derived from distributors may vary
significantly over time and be difficult to forecast. Some of the companies we
currently have distribution agreements with or are targeting as potential allies
offer products competitive with our products or may develop competitive
production technologies or competitive products without our participation, which
could have a material adverse effect on our competitive position.
Our Operating Results May Fluctuate
We have experienced operating losses at various times since our
inception. Our operating results, including components of operating results,
such as gross margin on product sales, may fluctuate from time-to-time which
18
could affect our stock price. Our operating results have fluctuated in the past
and can be expected to fluctuate from time-to-time in the future. Some of the
factors that may cause these fluctuations include, but are not limited to:
o the introduction of new product lines;
o the level of market acceptance of our products;
o the timing of research and development expeditures;
o timing of the receipt of orders from, and product shipments
to, distributors and customers;
o timing of expenditures;
o changes in the distribution arrangements for our products;
o manufacturing or supply delays;
o the time needed to educate and train a distributor's sales
force;
o costs associated with product introduction;
o product returns; and
o receipt of necessary regulation approvals.
Our Products May Not Be Accepted In The Market Or May Not Effectively Compete
With Other Products Or Technologies.
We cannot be certain that our current products or any other products
that we may develop or market will achieve or maintain market acceptance.
Certain of the medical indications that can be treated by our devices can also
be treated by other medical devices or by medical practices that do not include
a device. The medical community widely accepts many alternative treatments, and
certain of these other treatments have a long history of use.
We cannot be certain that our devices and procedures will be able to
replace those established treatments or that either physicians or the medical
community in general will accept and utilize our devices or any other medical
products that we may develop. For example, we cannot be certain that the medical
community will accept our new multifunctional electrosurgical generator and
proprietary hand-switching bipolar electrosurgical instruments over traditional
monopolar electrosurgical generators.
In addition, our future success depends, in part, on our ability to
develop additional products. Competitors may develop products that are more
effective, cost less, or are ready for commercial introduction before our
products. If we are unable to develop additional commercially viable products,
our future prospects could be adversely affected.
Market acceptance of our products depends on many factors, including
our ability to convince third party distributors and customers that our
technology is an attractive alternative to other technologies, to manufacture
products in sufficient quantities and at acceptable costs, and to supply and
service sufficient quantities of our products directly or through our
distribution alliances. In addition, limited funding available for product and
technology acquisitions by end users of our products, as well as internal
obstacles to end user approval of purchases of our products, could harm
acceptance of our products. The industry is subject to rapid and continuous
change arising from, among other things, consolidation and technological
improvements. One or more of these factors may vary unpredictably, which could
19
materially adversely affect our competitive position. We may not be able to
adjust our plan of development to meet changing market demands.
Changes In The Health Care Industry May Require Us To Decrease The Selling Price
For Our Products Or Could Result In A Reduction In The Size Of The Market For
Our Products, Each Of Which Could Have A Negative Impact On Our Financial
Performance.
Trends toward managed care, health care cost containment, and other
changes in government and private sector initiatives in the United States and
other countries in which we do business are placing increased emphasis on the
delivery of more cost-effective medical therapies that could adversely affect
the sale and/or the prices of our products. For example:
o there has been a consolidation among health care facilities and
purchasers of medical devices in the United States who prefer to limit
the number of suppliers from whom they purchase medical products, and
these entities may decide to stop purchasing our products or demand
discounts on our prices;
o major third-party payors of hospital services, including Medicare,
Medicaid and private health care insurers, have substantially revised
their payment methodologies, which has resulted in stricter standards
for reimbursement of hospital charges for certain medical procedures;
o Medicare, Medicaid and private health care insurer cutbacks could
create downward price pressure on our products;
o numerous legislative proposals have been considered that would result
in major reforms in the U.S. health care system that could have an
adverse effect on our business;
o there is economic pressure to contain health care costs in
international markets; and
o there have been initiatives by third-party payors to challenge the
prices charged for medical products that could affect our ability to
sell products on a competitive basis.
Both the pressures to reduce prices for our products in response to
these trends and the decrease in the size of the market as a result of these
trends could adversely affect our levels of revenues and profitability of sales.
To Market Our Products under Development We Will First Need To Obtain Regulatory
Approval. A Failure To Comply With Extensive Governmental Regulations Could
Subject Us To Penalties And Could Preclude Us From Marketing Our Products.
Our research and development activities and the manufacturing,
labeling, distribution and marketing of our existing and future products are
subject to regulation by numerous governmental agencies in the United States and
in other countries. The Food and Drug Administration (FDA) and comparable
agencies in other countries impose mandatory procedures and standards for the
conduct of clinical trials and the production and marketing of products for
diagnostic and human therapeutic use.
Products we have under development are subject to FDA approval or
clearance prior to marketing for commercial use. The process of obtaining
necessary FDA approvals or clearances can take years and is expensive and full
of uncertainties. Our inability to obtain required regulatory approval or
clearance on a timely or acceptable basis could harm our business. Further,
20
approval or clearance may place substantial restrictions on the indications for
which the product may be marketed or to whom it may be marketed. Further studies
may be required to gain approval or clearance for the use of a product for
clinical indications other than those for which the product was initially
approved or cleared or for significant changes to the product.
Furthermore, another risk of application to the FDA relates to the
regulatory classification of new products or proposed new uses for existing
products. In the filing of each application, we are required to make a judgment
about the appropriate form and content of the application. If the FDA disagrees
with our judgment in any particular case and, for example, requires us to file a
PMA application rather than allowing us to market for approved uses while we
seek broader approvals or requires extensive additional clinical data, the time
and expense required to obtain the required approval might be significantly
increased or approval might not be granted. Approved and cleared products are
subject to continuing FDA requirements relating to quality control and quality
assurance, maintenance of records, reporting of adverse events and product
recalls, documentation, and labeling and promotion of medical devices.
The FDA as well as foreign regulatory authorities require that our
products be manufactured according to rigorous standards. These regulatory
requirements may significantly increase our production costs and may even
prevent us from making our products in amounts sufficient to meet market demand.
If we change our approved manufacturing process, the FDA may need to review the
process before it may be used. Failure to develop our manufacturing capability
may mean that even if we develop promising new products, we may not be able to
produce them profitably, as a result of delays and additional capital investment
costs. In addition, failure to comply with applicable regulatory requirements
could subject us to enforcement action, including product seizures, recalls,
withdrawal of clearances or approvals, restrictions on or injunctions against
marketing our product or products based on our technology, and civil and
criminal penalties. See "Business-Government Regulation".
Our Intellectual Property Rights May Not Provide Meaningful Commercial
Protection For Our Products And Could Adversely Affect Our Ability To Compete In
The Market.
Our ability to compete effectively depends in part, on our ability to
maintain the proprietary nature of our technologies and manufacturing processes,
which includes the ability to obtain, protect and enforce patents on our
technology and to protect our trade secrets. We own patents that cover
significant aspects of our products. Certain of our patents have expired and
others will expire in the future. In addition, challenges may be made to our
patents and, as a result, our patents could be narrowed, invalidated or rendered
unenforceable. Competitors may develop products similar to ours that our patents
do not cover. In addition, our current and future patent applications may not
result in the issuance of patents in the United States or foreign countries.
Further, there is a substantial backlog of patent applications at the U.S.
Patent and Trademark Office, and the approval or rejection of patent
applications may take several years.
Our Competitive Position Depends, In Part, Upon Unpatented Trade Secrets Which
We May Be Unable To Protect.
Our competitive position is furthermore dependent upon unpatented trade
secrets. Trade secrets are difficult to protect. We cannot assure you that
others will not independently develop substantially equivalent proprietary
information and techniques or otherwise gain access to our trade secrets, that
21
our trade secrets will not be disclosed, or that we can effectively protect our
rights to unpatented trade secrets.
In an effort to protect our trade secrets, we generally require our
employees, consultants and advisors to execute proprietary information and
invention assignment agreements upon commencement of employment or consulting
relationships with us. These agreements typically provide that, except in
specified circumstances, all confidential information developed or made known to
the individual during the course of their relationship with us must be kept
confidential. We cannot assure you, however, that these agreements will provide
meaningful protection for our trade secrets or other proprietary information in
the event of the unauthorized use or disclosure of confidential information.
We May Become Subject to a Patent Litigation
The medical device industry has been characterized by extensive
litigation regarding patents and other intellectual property rights, and
companies in the medical device industry have employed intellectual property
litigation to gain a competitive advantage. We cannot assure you that we will
not become subject to patent infringement claims or litigation or interference
proceedings declared by the United States Patent and Trademark Office to
determine the priority of invention.
It May Be Difficult To Replace Some Of Our Suppliers.
Outside vendors, some of whom are sole-source suppliers, provide key
components and raw materials used in the manufacture of our products. For
example, we currently subcontract the manufacturing of our disposable cord and
tubing sets with a single manufacturer. Although we believe that alternative
sources for many of these components and raw materials are available, any supply
interruption could harm our ability to manufacture our products until a new
source of supply is identified and qualified. In addition, an uncorrected defect
or supplier's variation in a component or raw material, either unknown to us or
incompatible with our manufacturing process, could harm our ability to
manufacture products. We may not be able to find a sufficient alternative
supplier in a reasonable time period, or on commercially reasonable terms, if at
all, and our ability to produce and supply our products could be impaired. If we
were suddenly unable to purchase products from one or more of our suppliers, we
could need a significant period of time to qualify a replacement, and the
production of any affected products could be disrupted. While it is our policy
to maintain sufficient inventory of components so that our production will not
be significantly disrupted even if a particular component or material is not
available for a period of time, we remain at risk that we will not be able to
qualify new components or materials quickly enough to prevent a disruption if
one or more of our suppliers ceases production of important components or
materials.
If Our Manufacturing Facility Was Damaged And/Or Our Manufacturing Processes
Interrupted, We Could Experience Lost Revenues And Our Business Could Be
Adversely Affected.
We manufacture our bipolar generators and irrigators at one facility.
Damage to this facility due to fire, natural disaster, power loss,
communications failure, unauthorized entry or other events could cause us to
22
cease development and manufacturing of some or all of these products. Although
we maintain property damage and business interruption insurance coverage on this
facility, we may not be able to renew or obtain such insurance in the future on
acceptable terms with adequate coverage or at reasonable costs.
We May have Product Liability Claims and Our Insurance May Not Cover All Claims
Our products involve a risk of product liability claims. We may not be
able to obtain insurance for the potential liability on acceptable terms with
adequate coverage or at reasonable costs. Any potential product liability claims
could exceed the amount of our insurance coverage or may be excluded from
coverage under the terms of the policy. Further, our insurance may not be
renewed at a cost and level of coverage comparable to that then in effect.
The Market Price of Our Stock May be Highly Volatile
During the 2003 and 2004 fiscal years, our common stock has traded in a
range of $1.05 and $2.40 per share. The market price of our common stock could
continue to fluctuate substantially due to a variety of factors, including:
o Our ability to successfully commercialize our products;
o The execution of new agreements and material changes in our
relationships with companies with whom we contract;
o Quarterly fluctuations in results of operations;
o Announcements regarding technological innovations or new commercial
products by us or our competitors or the results of regulatory
approval filings;
o Market reaction to trends in sales, marketing and research and
development and reaction to acquisitions;
o Sales of common stock by existing stockholders; and
o Economic and political conditions.
The Loss Of Key Personnel Could Harm Our Business.
We believe our success depends on the contributions of a number of our
key personnel, including Jerry L. Malis, our President and Chief Executive
Officer. If we lose the services of key personnel, those losses could materially
harm our business. We do not maintain any significant key person life insurance
on Mr. Malis.
Item 2. PROPERTIES.
------ ----------
We currently lease approximately 4,200 square feet of office and
warehouse space at a base monthly rent of $4,643 (with increases based on
increases in the producer price index) in an office building in Oaks,
Pennsylvania, approximately 12 miles northwest of Philadelphia, Pennsylvania.
The current lease term ends on June 30, 2005. Our manufacturing operations are
conducted in a building owned by our wholly owned subsidiary, Diversified
Electronics Company, Inc., with approximately 15,000 square feet in
Philadelphia, Pennsylvania. We are in the process of negotiating a lease for a
new facility, which will combine our operations into a single facility.
23
Item 3. LEGAL PROCEEDINGS.
------ -----------------
From time to time we may be subject to litigation claims.
Valley Forge is one of the defendants in a lawsuit entitled Jeffrey
Turner and Cathryn Turner, on behalf of Morgan Rose Turner v. Phoenix Children's
Hospital, Inc., et al. which was filed in the Superior Court of the State of
Arizona, Maricopa County (No. CV2002-010791) on September 19, 2002. This lawsuit
is currently in the discovery process. The plaintiffs seek damages against the
defendants for permanent brain damage suffered by one of the plaintiffs, a four
year old girl, during surgery in June 2000. The claim against Valley Forge is a
product liability claim. We deny any wrongdoing and will vigorously defend
ourself in this matter. We have a $1 million product liability insurance policy,
which has a $10,000 deductible, that applies to damages and attorney fees. The
damages being claimed by the plaintiffs against all defendants exceeds our then
in effect policy limits and our current net worth.
An outcome of the above described litigation matter that adversely
impacts Valley Forge's financial condition or results of operation is not
considered probable. We record a liability when a loss is known or considered
probable and the amount can be reasonably estimated. If a loss is not probable a
liability is not recorded.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
------ ---------------------------------------------------
No matters were submitted to a vote of the security holders during the
fourth quarter of fiscal year 2004.
ADDITIONAL INFORMATION
The following information is furnished in this Part I pursuant to Item
401(b) of Regulation S-K.
Executive Officers Of The Company
The executive officers of Valley Forge are elected annually and serve
at the discretion of the Board of Directors. The only family relationship
between any of the executive officers and our Board of Directors is that Jerry
L. Malis is the brother of Dr. Leonard I. Malis, a member of the Board of
Directors. The following information indicates the position and age of our
executive officers as of the date of this report and their previous business
experience.
Name Age Position with Valley Forge
---- --- --------------------------
Jerry L. Malis 72 Chairman of the Board, Chief Executive Officer
and President
Marguerite Ritchie 66 Vice President-Operations, Secretary
Michael Ritchie 41 Vice President-General Manager, Treasurer
24
Jerry L. Malis, has served as our Chief Executive Officer, President or
Vice-President and a Director since our inception in March 1980. As of June 30,
1989, Mr. Malis was elected as our Chairman of the Board. He has published over
fifty articles in the biological science, electronics and engineering fields,
and has been issued twelve United States patents. Mr. Malis coordinates and
supervises the development, engineering and manufacturing of our products and is
in charge of our daily business operations. He devotes substantially all his
business time to the business of the Valley Forge.
Marguerite Ritchie, Secretary of Valley Forge, has been employed by us
since 1985. In addition to being Secretary, Ms. Ritchie is Vice-President of
Operations in charge of our production and regulatory matters. Prior to becoming
Vice-President of Operations, she held several other administrative and
operations positions with Valley Forge.
Michael Ritchie, Treasurer of Valley Forge, has been employed by us
since 1994. In addition to being the Treasurer of the Company, Mr. Ritchie is
Vice-President-General Manager responsible for financial reporting and contract
administration. Mr. Ritchie has also held positions of General Manager and
Purchasing Manager. He received a B.S. degree in accounting from LaSalle
University and a B.S. degree in engineering from Drexel University.
PART II
-------
Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY
------ -------------------------------------
AND RELATED STOCKHOLDER MATTERS.
-------------------------------
Our Common Stock, no par value, is quoted on the Boston Stock Exchange
under the symbol VLF, and traded in the over-the-counter market, and is included
in the Nasdaq - Small Cap Issues under the symbol "VLFG." The table below sets
forth the range of high and low closing bid quotations per share of Common Stock
as reported on Nasdaq. Quotations represent prices between dealers and do not
necessarily represent actual transactions. None of the prices shown reflect
retail mark-ups, mark-downs, or commissions.
COMMON STOCK High-Bid Low-Bid
-------- -------
Fiscal 2003
First Quarter............. $1.88 $1.23
Second Quarter............ 1.54 1.05
Third Quarter............. 1.57 1.10
Fourth Quarter............ 1.75 1.15
Fiscal 2004:
First Quarter............. $2.40 $1.31
Second Quarter............ 2.16 1.50
Third Quarter............. 2.20 1.84
Fourth Quarter............ 2.03 1.43
For purposes of calculating the aggregate market value of shares of
voting stock of Valley Forge held by non-affiliates, as shown on the cover page
of this report, we have assumed that all outstanding shares not held by our
directors and executive officers and stockholders owning 5% or more of
25
outstanding shares were held by non-affiliates. However, this should not be
deemed to constitute an admission that any such person are, in fact, affiliates
of Valley Forge. Further information concerning ownership of Valley Forge's
voting stock by executive officers, directors and principal stockholders will be
included in our definitive proxy statement to be filed with the Securities and
Exchange Commission.
The number of stockholders of record as of December 16, 2004 was
approximately 105, which includes stockholders whose shares were held in nominee
name. The number of beneficial stockholders at that date is estimated to be in
excess of 1,100.
We have not paid any dividends to date, nor do we expect to do so in
the foreseeable future.
Item 6. SELECTED FINANCIAL DATA
------ -----------------------
The selected financial data set forth below should be read in
conjunction with the "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and our consolidated financial statements
and notes thereto appearing elsewhere in this Form 10-K. The statement of
operations data for the year ended September 30, 2004, 2003 and 2002 and the
balance sheet data as of September 30, 2004 and 2003 have been derived from
audited consolidated financial statements included elsewhere in this report. The
consolidated statement of operations for the years ended September 30, 2001 and
2000 and the balance sheet data as of September 30, 2002, 2001 and 2000 have
been derived from audited consolidated financial statements that are not
included in this report. The historical results are not necessarily indicative
of the results of operations to be expected in the future.
Statement of Operations Data:
For Fiscal Year Ended: 2004 2003 2002 2001 2000
---------------------- ------------ ------------ ------------ ------------ ------------
Net Sales $ 4,756,439 $ 4,474,308 $ 5,021,931 $ 5,263,485 $ 4,397,939
Income (loss) from Operations 178,054 155,427 632,000 485,746 (110,817)
Net Income (loss) $ 111,420 $ 108,925 $ 380,527 $ 330,221 $ (54,312)
============ ============ ============ ============ ============
Basic Earnings (loss) per share $ 0.01 $ 0.01 $ 0.05 $ 0.04 $ (0.01)
============ ============ ============ ============ ============
Diluted Earnings (loss)per $ 0.01 $ 0.01 $ 0.05 $ 0.04 $ (0.01)
share ============ ============ ============ ============ ============
Balance Sheet Data:
At September 30, 2004 2003 2002 2001 2000
---------------- ------------ ------------ ------------ ------------ ------------
Current Assets $ 3,976,550 $ 3,777,456 $ 3,981,746 $ 3,516,992 $ 3,093,698
Total Assets 4,523,238 4,374,413 4,570,035 4,171,214 3,852,079
Current Liabilities 258,069 216,457 353,281 283,186 182,185
Long Term Liabilities 15,743 19,950 14,357 19,280 20,661
Retained Earnings (deficit) 720,896 609,476 500,551 120,024 (210,197)
Stockholders' Equity 4,249,426 4,138,006 4,202,397 3,868,746 3,649,233
26
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
------ -----------------------------------------------------------
AND RESULTS OF OPERATIONS
-------------------------
The following is a discussion and analysis of Valley Forge Scientific
Corp.'s financial condition and results of operations for the fiscal years ended
September 30, 2004, 2003 and 2002. This section should be read in conjunction
with the financial statements and related notes thereto appearing elsewhere in
this Form 10-K. This discussion and analysis contains forward-looking statements
that involve risks, uncertainties and assumptions. Our actual results may differ
materially from those anticipated in these forward looking statements as a
result of many factors including but not limited to those under the headings
"Special Note Regarding Forward Looking Statements" and "Factors That Might
Affect Future Results" in Item 1 of this Report.
Overview
Valley Forge is a medical device company that develops, manufactures
and sells medical devices for use in surgery and other healthcare applications.
Our core business involves the sale of bipolar electrosurgical generators and
other bipolar generators, based on our DualWave(TM) technology, and
complementary instrumentation and disposable products.
Our current line of bipolar electrosurgical products are used in
neurosurgery and spine surgery and in dental applications. We also recently
commenced selling a lesion generator for the percutaneous treatment of pain. In
fiscal 2005 and beyond, we plan to expand the market for our products with our
new multifunctional bipolar electrosurgical generator and new proprietary
single-use hand-switching bipolar instruments, new products based on our
proprietary lesion generator technology, and other products and product
refinements. Our new multifunctional bipolar electrosurgical system, which is
expected to be introduced in the market in fiscal 2005, is designed to replace
other surgical tools, such as monopolar electrosurgical systems, lasers and
ultrasonic aspirators.
We believe our DualWave(TM) technology distinguishes our products from
our competitors. With appropriate technique, our bipolar electrosurgical systems
based on our DualWave(TM) technology allow a surgeon or dentist to cut tissue in
a manner that minimizes collateral damage to surrounding healthy tissue and to
coagulate blood vessels quickly, safely and efficiently. By substantially
reducing damage to surrounding healthy tissue, the surgeon or dentist can work
safely in close proximity with nerves, blood vessels and bone. Our bipolar
electrosurgical systems can also be used in close proximity with metal implants
and irrigated fields.
For over 20 years, we have had worldwide exclusive distribution
agreements with Codman & Shurtleff, Inc., a subsidiary of Johnson & Johnson,
Inc., ("Codman") to market our neurosurgery bipolar electrosurgical systems and
other products. During 2004 fiscal year, we extended the term of a distribution
agreement, which we originally entered into with Codman on December 11, 2000,
until September 30, 2004. On October 15, 2004, we entered into a new agreement
with Codman defining our business relationship from October 1, 2004 through
December 31, 2005. Under the agreement, Codman continues to be the exclusive
worldwide distributor of our existing products in the fields of neuorcranial and
neurospinal surgery through March 31, 2005 and the nonexclusive distributor in
those fields until December 31, 2005, as those terms may be extened by mutual
27
agreement of the parties. Under the agreement, Codman is also given a limited
right of first refusal until March 31, 2005 regarding the marketing of our new
multifunctional electrosurgical generator and single use hand switching bipolar
instruments in the fields of neurospinal and neurocranial surgery. Historically,
we have derived a significant portion of our sales from sales to Codman. For the
2004 fiscal year, 86% of our revenue was derived from sales to Codman.
Our goal is to be the global leader in the development of bipolar
medical devices and other products in specialty surgical and healthcare fields
and then expand the use of our bipolar electrosurgical products into general
surgery. The key elements of our strategy include:
o Expanding the use of our new multifunctional bipolar
electrosurgical system into other surgical markets, such as
spine maxillofacial, ENT, orthopedic and general surgeries.
o Increasing revenues in the neurosurgery field with our new
multifunctional bipolar electrosurgical system.
o Expanding our product lines with new products, including a
new lesion generator for the percutaneous treatment of pain
and other applications of our bipolar lesion technology.
Results of Operations
Summary
Sales of $4,756,439, for fiscal 2004 were 6% greater than sales of
$4,474,308 for fiscal 2003 and 5% less than sales of $5,021,931 for fiscal 2002.
Operating income was $178,054 in fiscal 2004 as compared to $155,427 in fiscal
2003 and $632,000 in fiscal 2002. Net income for fiscal 2004 was $111,420 as
compared to $108,925 for fiscal 2003 and $380,527 for fiscal 2002.
Sales
Total Sales and Gross Margin on Sales:
2004 2003 2002
---------- ---------- ----------
Total sales: $4,756,439 $4,474,308 $5,021,931
Cost of sales: 2,316,304 2,264,902 2,463,209
Gross profit on sales: 2,440,135 2,209,406 2,558,722
Gross profit as a percentage of sales: 51% 49% 51%
The increase in sales in fiscal 2004 as compared to fiscal 2003
reflects an increase in sales of our Bident(R) Bipolar Tissue Management System
for dental applications and new sales to Stryker Corporation of a lesion
generator we developed for the percutaneous treatment of pain, which was
partially offset by a decrease in sales to Codman & Shurtleff, Inc. The decrease
in sales in fiscal 2004 compared to fiscal 2002 reflects a decrease in sales to
Codman.
Sales of our neurosurgical products to Codman & Shurtleff, Inc.
decreased to $4,099,000 in fiscal 2004 as compared to sales of $4,231,000 in
fiscal 2003 and sales of $4,515,000 in fiscal 2002. The decreased sales reflect
a decrease in sales volume of neurosurgical products. Included in sales to
28
Codman for fiscal 2004 is a one-time payment of $57,920 in the second quarter of
fiscal 2004 that Codman made to satisfy its minimum purchase obligation under
the first three month extension of the term of the then existing distribution
agreement.
During fiscal 2004, we extended a distribution agreement with Codman on
a quarterly basis until September 30, 2004. On October 15, 2004, we entered into
a new agreement with Codman which defines our business relationship from October
1, 2004 to December 31, 2005. Under the new agreement, Codman continues to be
the exclusive worldwide distributor of our existing products in the fields of
neurocranial and neurospinal surgery through March 31, 2005, and the
nonexclusive distributor in those fields until December 31, 2005, as those terms
may be extended by mutual agreement of the parties. For the period from October
1, 2004 to March 31, 2005, Codman has agreed to make minimum purchases of $1
million per calendar quarter.
For fiscal 2004, sales of the Bident(R) Bipolar Tissue Management
System for dental applications were $422,000, or 9% of sales as compared to
approximately $185,000, or 4% of sales, for fiscal 2003 and approximately
$347,000, or 7% of our sales, for fiscal 2002. Sales of the Bident(R) Tissue
Management System of $35,250 in the fourth quarter of 2004 decreased as compared
to the sales in the third quarter of fiscal 2004 as we directed more of our
resources towards the completion of a new lesion generator for the percutaneous
treatment of pain and our distribution arrangement with Stryker Corporation for
that product. For fiscal 2005, we are considering product modifications and
other strategies for our dental products.
During fiscal 2004, we had sales to Stryker of $189,160, which includes
sales of demonstration units of a lesion generator for percutaneous treatment of
pain. On October 25, 2004, we entered into a supply and distribution agreement
with Stryker Corporation for that generator. The supply and distribution
agreement is for a term commencing on November 11, 2004 and ending on December
31, 2009, under which Stryker has agreed to make minimum purchases of
approximately $900,000 in the first agreement year for a combination of sales
demonstration units and commercial sale units and minimum purchases of
approximately $500,000 per year for commercial sale units in the each of the
second and third agreement years. Minimum purchase requirements for agreement
years four and five are to be determined by the parties based on market
conditions and other factors. The agreement also provides Stryker certain rights
for other new product concepts developed by Valley Forge in both pain control
and expanded market areas.
Sales by Medical Field:
The table below sets forth our sales by medical field of "Generators,
Irrigators and Other Products" and "Disposable Products" for fiscal 2004, 2003
and 2002. Sales of "Generators, Irrigators and Other Products" in "Other fields"
represent sales to Stryker Corporation and sales of "Disposable Products" in
"Other fields" represent sales to Boston Scientific Corporation and direct sales
to hospitals.
29
----------------------------------------------------------------------------------------------
2004 2003 2002
------------ ------------ ------------
----------------------------------------------------------------------------------------------
Generators, Irrigators
----------------------
and Other Products
------------------
----------------------------------------------------------------------------------------------
Neurosurgery field $ 2,115,536 $ 2,092,830 $ 2,627,233
----------------------------------------------------------------------------------------------
Dental field $ 366,795 $ 168,338 $ 347,000
----------------------------------------------------------------------------------------------
Other fields $ 187,750 -- --
------------ ------------ ------------
----------------------------------------------------------------------------------------------
Total of all fields: $ 2,670,081 $ 2,261,168 $ 2,974,233
----------------------------------------------------------------------------------------------
Disposable Products
-------------------
----------------------------------------------------------------------------------------------
Neurosurgery field $ 1,754,276 $ 1,894,743 $ 1,584,230
----------------------------------------------------------------------------------------------
Dental field $ 68,810 $ 16,160
----------------------------------------------------------------------------------------------
Other fields $ 31,929 $ 23,505 $ 31,850
------------ ------------ ------------
----------------------------------------------------------------------------------------------
Total of all fields: $ 1,855,015 $ 1,934,408 $ 1,616,000
----------------------------------------------------------------------------------------------
In fiscal 2004, 56% of our sales related to sales of bipolar
electrosurgical generators, irrigators and accessories as compared to
approximately 51% and 59% of our sales in fiscal 2003 and 2002, respectively.
Sales of disposable products accounted for approximately 39% of our sales in
fiscal 2004 as compared to approximately 43% of our sales in fiscal 2003 and
approximately 32% of our sales in fiscal 2002.
Cost of Sales
Cost of sales for fiscal 2004 was 49% of sales, compared with 51% of
sales, for fiscal 2003. During fiscal 2002, cost of sales was 49% of sales.
Gross margin was 51% for fiscal 2004 as compared to 49% for fiscal 2003 and 51%
for fiscal 2002.
The increase in gross margin as a percentage of sales in fiscal 2004 as
compared to fiscal 2003 is primarily attributable to increased sales volume. We
cannot be sure that gross margins will remain at current levels or show
improvement in the future due to the distribution channels used, product mix,
and fluctuation in manufacturing production levels and overhead costs as new
products are introduced. In addition, inefficiencies in manufacturing new
products and the distribution channels utilized to sell those products may
adversely impact gross margin.
Operating Expenses
Selling, general and administrative expenses increased to $1,713,325,
or 36% of sales, in fiscal 2004, from $1,523,751, or 34% of sales, in fiscal
2003, and from $1,503,001, or 30% of sales, in fiscal 2002. Selling, general and
administrative expenses reflect increased selling and marketing expenses
incurred in connection with implementing the sales and marketing plan, which we
commenced in fiscal 2003, for the Bident(R) Bipolar Tissue Management System and
increased transactional legal fees incurred during the fourth quarter of fiscal
2004.
Research and development expenses were $508,287, or 11% of sales, in
fiscal 2004, $489,930, or 11% of sales, in fiscal 2003, and $360,111, or 7% of
sales, in fiscal 2002. We will continue to invest in research and development to
expand our technological base for use in both existing and additional clinical
areas. The increase in research and development expenses in fiscal 2004 was
primarily related to the continued development of our new multifunction bipolar
electrosurgical generator and instrumentation and the completion of the lesion
30
generator for use in the percutaneous treatment of pain for which we entered
into a supply and distribution agreement with Stryker Corporation on October 25,
2004.
Other Income and Expense, net
Other income and expense, net, increased for fiscal 2004 to $23,030
from $11,451 for fiscal 2003 and decreased from $23,111 for fiscal 2002 due
primarily to interest income. At the end of fiscal 2004, we had $2,322,559 in
cash and cash equivalents as compared to $2,305,556 at the end of fiscal 2003
and $2,543,898 at the end of fiscal 2002.
Income Tax Provision
The provision for income taxes was $89,664 for fiscal 2004 as compared
to $57,953 for fiscal 2003 and $274,584 for fiscal 2002. Our effective tax rate
in fiscal 2004 was approximately 45% as compared to approximately 35% in fiscal
2003 and approximately 42% in fiscal 2002.
Net Income
Net income increased slightly to $111,420 for fiscal 2004, as compared
to net income of $108,925 for fiscal 2003. Net income was $380,527 for fiscal
2002. Basic and diluted income per share was $0.01 for fiscal 2004 as compared
to basic and diluted income per share of $0.01 for fiscal 2003 and $0.05 for
fiscal 2002.
Liquidity and Capital Resources
At September 30, 2004, we had $3,718,481 in working capital compared to
$3,560,999 at the end of fiscal 2003 and $3,628,465 at the end of fiscal 2002.
The primary measures of our liquidity are cash, cash equivalents, accounts
receivable and inventory balances, as well as our borrowing ability. The cash
equivalents are highly liquid with original maturities of ninety days or less.
Cash provided by operating activities was $33,577 for fiscal 2004 as
compared to $9,009 used in fiscal 2003. The cash provided by operating
activities was mainly attributable to operating profits net of adjustments for
non-cash items, a decrease in prepaid items and other current assets of $117,773
and an increase in accounts payable, accrued expenses and income taxes payable
of $35,862 offset by increases of $282,918 in accounts receivable, $76,807 in
inventory and $28,321 in deferred tax assets.
In fiscal 2004, accounts receivable net of allowances increased by
$282,918 to a total of $646,224 at the end of fiscal 2004. The increase in
accounts receivable was principally due to the timing of shipments and increased
sales during fiscal 2004.
In fiscal 2004, inventories increased by $76,807 to a total of $781,604
at the end of fiscal 2004 compared to $775,183 at the end of fiscal 2003. The
increase was primarily due to increased inventory to meet anticipated sales of
the lesion generator for the percutaneous treatment of pain. Inventories were
kept at these levels primarily to support anticipated future sales activity.
31
In fiscal 2004, we used $20,887 for the purchase of equipment and
building improvements in connection with our manufacturing operations. Net
property and equipment decreased to $147,967 at the end of fiscal 2004 as
compared to $156,697 for fiscal 2003 and $136,131 for fiscal 2002.
In August 2002, our Board of Directors terminated our then existing
stock repurchase plan and authorized a new repurchase plan to purchase up to
200,000 shares of our common stock. We did not purchase any of our stock in
fiscal 2004 pursuant to this plan. In fiscal 2003, we used $173,216 to
repurchase 127,600 shares of our common stock pursuant to the stock repurchase
plan. All the shares of common stock repurchased were retired. To date, we have
repurchased 154,100 shares of our common stock under the plan, leaving a balance
of 45,900 that is available for repurchase under the plan.
On October 22, 2004, we entered into an option agreement to purchase
the Malis(R) trademark from Leonard I. Malis. Under the option agreement, we are
granted an option to acquire the Malis(R) trademark at any time over a period of
five years. We paid Dr. Leonard I. Malis $35,000 for the option and are required
to pay an annual fee before each anniversary of the option agreement of $20,000
for each of the first two anniversaries and increasing to $60,000 before the
fourth anniversary in order to continue the option in effect from year to year.
In the event that we decide to exercise the option, we will pay Dr. Leonard I.
Malis $4,157,054, which includes interest, in twenty-six equal quarterly
installments of $159,104, and which will be evidenced by a promissory note
secured with a security interest in the trademark and certain of our patents.
At September 30, 2004, we had cash and cash equivalents of $2,322,559.
We plan to finance our operating and capital needs principally with cash flows
from operations and existing balances of cash and cash equivalents, which we
believe will be sufficient to fund our operations in the near future. However,
should it be necessary, we believe we could borrow adequate funds at competitive
rates and terms. Our future liquidity and capital requirements will depend on
numerous factors, including the funds we expend in marketing, selling and
distributing our products, the success in commercializing our existing products,
development and commercialization of products in other clinical markets, the
ability of our suppliers to continue to meet our demands at current prices, the
status of regulatory approvals and competition.
We have a line of credit of $1,000,000 with Wachovia Bank, N.A. which
calls for interest to be charged at the bank's national commercial rate. The
credit accommodation is unsecured and requires us to have a tangible net worth
of no less than $3,000,000. Our current tangible net worth exceeds $3,000,000 at
September 30, 2004. As of September 30, 2004, there was no outstanding balance
on this line.
32
USE OF ESTIMATES AND CRITICAL ACCOUNTING POLICIES
The preparation of financial statements and related disclosures in
conformity with accounting principles generally accepted in the United States
requires management to make judgments, assumptions, and estimates that affect
the amounts reported in the Consolidated Financial Statements and accompanying
notes. Note 1 to the Consolidated Financial Statements describes the significant
accounting policies and methods used in the preparation of the Consolidated
Financial Statements. Estimates are used for, but not limited to, the accounting
for the allowance for doubtful accounts and sales returns, inventory allowances,
warranty costs, contingencies and other special charges, and taxes. Actual
results could differ materially from these estimates. The following critical
accounting policies are impacted significantly by judgments, assumptions, and
estimates used in the preparation of the Consolidated Financial Statements.
Allowances For Doubtful Accounts, Sales Returns and Warranty Costs
We evaluate the collectibility of accounts receivable based on a
combination of factors. In circumstances where a specific customer is unable to
meet its financial obligations to us, we record an allowance against amounts due
to reduce the net recognized receivable to the amount that we reasonably expect
to collect. For all other customers, we record allowances for doubtful accounts
based on the length of time the receivables are past due, the current business
environment and our historical experience. If the financial condition of
customers or the length of time that receivables are past due were to change, we
may change the recorded amount of allowances for doubtful accounts in the
future. We record a provision for estimated sales returns and allowances on
product revenues in the same period as the related revenues are recorded. We
base these estimates on historical sales returns and other known factors. Actual
returns could be different from our estimates and the related provisions for
sales returns and allowances, resulting in future changes to the sales returns
and allowances provision. Our warranty obligation is affected primarily by
product that does not meet specifications within the applicable warranty period
and any related costs to repair or replace such products. Should our actual
experience of warranty claims differ from our estimates of such obligations, our
provision for warranty costs could change.
Inventories
Inventories, consisting of purchased materials, direct labor and
manufacturing overhead, are stated at the lower of cost, determined by the
moving average method, or market. At each balance sheet date, we evaluate
inventories for excess quantities and identified obsolescence. Our evaluation
includes an analysis of historical sales levels by product and projections of
future demand, as well as estimates of quantities required to support warranty
and other repairs. To the extent that we determine there are excess quantities
based on our projected levels of sales and other requirements, or obsolete
material in inventory, we record valuation reserves against all or a portion of
33
the value of the related parts or products. If future demand or market
conditions are different than our projections, a change in recorded inventory
valuation reserves may be required and would be reflected in cost of revenues in
the period the revision is made.
Amortization Periods
We record amortization of intangible assets using the straight-line
method over the estimated useful lives of these assets. We base the
determination of these useful lives on the period over which we expect the
related assets to contribute to our cash flows or in the case of patents, their
legal life, whichever is shorter. If our assessment of the useful lives of
intangible assets changes, we may change future amortization expense.
Deferred Tax Assets and Liabilities
Our deferred tax assets and liabilities are determined based on
differences between the financial statement and tax bases of assets and
liabilities using enacted tax rates in effect for the year in which the
differences are expected to reverse. Deferred tax assets are reduced by a
valuation allowance when a determination is made that it is more likely than not
that a portion or all of the deferred tax assets will not be realized.
Loss Contingencies
We are subject to claims and lawsuits in the ordinary course of our
business, including claims by employees or former employees, with respect to our
products and involving commercial disputes. Our financial statements do not
reflect any material amounts related to possible unfavorable outcomes of claims
and lawsuits to which we are currently a party because we currently believe that
such claims and lawsuits are either adequately covered by insurance or otherwise
indemnified, and are not expected, individually or in the aggregate, to result
in a material adverse effect on our financial condition. However, it is possible
that our results of operations, financial position and cash flows in a
particular period could be materially affected by these contingencies if we
change our assessment of the likely outcome of these matters
Goodwill Impairment
We perform goodwill impairment tests on an annual basis and between
annual tests to determine if events or circumstances indicate that goodwill may
have been impaired. In response to changes in industry and market conditions, we
may be required to strategically realign our resources and consider
restructuring, disposing, or otherwise exiting businesses, which could result in
an impairment of goodwill. Impairment is measured by the difference between the
recorded value of goodwill and its implied fair value when the fair value of the
reporting unit is less than its net book value.
34
Impairment of Long-Lived Assets
Long-lived assets and certain identifiable intangible assets to be held
and used are reviewed for impairment whenever events or changes in circumstances
indicate that the carrying amount of such assets may not be recoverable.
Determination of recoverability is based on an estimate of undiscounted future
cash flows resulting from the use of the group of assets and their eventual
disposition. Measurement of an impairment loss for long-lived assets and certain
identifiable intangible assets that management expects to hold and use is based
on the fair value of the asset. Long-lived assets and certain identifiable
intangible assets to be disposed of are reported at the lower of carrying amount
or fair value less costs to sell.
Stock-Based Compensation
We account for stock-based employee compensation using the intrinsic
value method of accounting. Under this method, employee stock-based compensation
expense is based on the difference, if any, on the date of the grant between the
fair value of the Company's stock and the exercise price of the award. We
account for stock options issued to non-employees using the fair value method of
accounting, which requires us to assign a value to the stock options issued
based on an option pricing model, and to record that value as compensation
expense. We use the Black-Scholes option pricing model. If we were to account
for stock options issued to employees using the fair value method of accounting
rather than the intrinsic value method, our results of operations would be
significantly affected.
Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
------- ----------------------------------------------------------
Not Applicable.
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
------ -------------------------------------------
Financial statements and financial statement schedules specified by
this Item, together with the report thereon of Samuel Klein and Company, are
presented following Item 15 of this report.
Information on quarterly results of operations is set forth in our
financial statement under notes to consolidated financial statements, Note 15
Quarterly Results (unaudited).
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
------ -----------------------------------------------------------
AND FINANCIAL DISCLOSURE.
------------------------
Not applicable.
Item 9A. CONTROLS AND PROCEDURES
------- -----------------------
Our management, including our Chief Executive Officer/Principal
Financial Officer, conducted an evaluation of the effectiveness of our
disclosure controls and procedures as of September 30, 2004. Based on that
evaluation, our management, including our Chief Executive Officer/Principal
Financial Officer, has concluded that our disclosure controls and procedures are
effective. During the period covered by this report, there was no change in our
internal control over financial reporting that has materially affected, or is
reasonably likely to materially affect, our internal control over financial
reporting.
35
PART III
--------
Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
------- --------------------------------------------------
The information concerning directors and executive officers of Valley
Forge Scientific Corp. is incorporated by reference to the information set forth
either: (i) in our Definitive Proxy Statement for our 2005 Annual Meeting of
Stockholders, or (ii) in an amendment to this Annual Report on Form 10-K
(collectively the "2004 Proxy Information"), which in either case will be filed
within 120 days after the end of the fiscal year covered by this Annual Report
on Form 10-K.
Item 11. EXECUTIVE COMPENSATION.
------- ----------------------
The information regarding executive compensation is incorporated by
reference to the information set forth in the 2004 Proxy Information.
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
------- --------------------------------------------------------------
AND RELATED STOCKHOLDER MATTERS.
-------------------------------
The information concerning the security ownership of certain beneficial
owners and management and related stockholder matters is incorporated by
reference to the information set forth in the 2004 Proxy Information.
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
------- ----------------------------------------------
The information concerning certain relationships and related
transactions is incorporated by reference to the information set forth in the
2004 Proxy Information.
Item 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
------- --------------------------------------
The information required to be disclosed concerning principal
accountant fees and services is incorporated by reference to the information set
forth in the 2004 Proxy Information.
36
PART IV
-------
Item 15 EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM
------- -----------------------------------------------------------
8-K.
---
(a) and (d) Financial Statements and Financial Statement Schedules.
See Index to Financial Statements and Financial Statement Schedules on
Page F-1, herein.
(b) Reports on Form 8-K.
On August 12, 2004, Valley Forge Scientific Corp. filed a report on
Form 8-K regarding a press release for our the third quarter and nine months
operating results for fiscal 2004.
(c) Exhibits
The following is a list of exhibits filed as part of this annual report
on Form 10-K. Where so indicated by footnote, exhibits which were previously
filed are incorporated by reference. For exhibits incorporated by reference, the
location of the exhibit in the previous filing is indicated in parentheses.
2.1 Agreement and Plan of Merger between Valley Forge
Scientific Corp. and Diversified Electronic
Corporation dated August 31, 1994. (4) (Exhibit 2.1)
3.1 Articles of Incorporation, restated to include
amendment to Articles of Incorporation dated August
26, 1999. (8) (Exhibit 3(a))
3.2 Second Amended and Restated By-Laws of the Company.
(13)
4.1 Form of Common Stock Certificate - (2) (Exhibit
4(a)).
10.1 Valley Forge Scientific Corp. 2001 Stock Plan (11)
10.2 Valley Forge Scientific Corp. 2000 Nonemployee
Directors Stock Option Plan (11)
10.3 Assignment of Know-How Agreement, dated June 30, 1989
- (2) (Exhibit 10(g)).
10.4 Assignment of Patents - Bipolar Electrosurgical
Systems, June 30, 1989 - (2) (Exhibit 10(h)).
10.5 Assignment of Patents - Binocular Magnification
System, June 30, 1989 -(2) (Exhibit 10(i)).
37
10.6 Assignment of Malis trade name, dated June 30, 1989 -
(2) (Exhibit 10(j)).
10.7 401(k) and Profit-Sharing Plan - (3) (Exhibit 10(x)).
10.8 Promissory Note from Jerry L. Malis to the Company.
(5) (Exhibit 10(k))
10.9 Commercial Lease Agreement between GMM Associates and
the Company dated July 1, 1995 (6) (Exhibit 10(p))
10.10 Promissory Note from Jerry L. Malis to the Company
(7) (Exhibit 10(p)).
10.11 Addendum to Commercial Lease Agreement between the
Company and GMM Associates dated as of July 1, 2000
(9) (Exhibit 10.2).
10.12 Agreement with Codman & Shurtleff, Inc. dated October
15, 2004 (1).
10.13 Supply and Distribution Agreement with Stryker
Corporation dated October 25, 2004 (1).
10.14 Option Agreement for Malis Trademark with Leonard I.
Malis dated October 22, 2004 (1).
21 Subsidiary of Registrant (13) (Exhibit 22).
23 Consent of Samuel Klein and Company (1).
31.1 Certification of the Chief Executive Officer and
Principal Financial Officer pursuant to Section 302
of the Sarbanes-Oxley Act of 2002 (1).
32.1 Certification of the Chief Executive Officer and
Principal Financial Officer to Section 906 of the
Sarbanes-Oxley Act of 2002 (1).
-----------------
(1) Filed herewith
(2) Previously filed with the Registration Statement of the
Company on Form S-18, Registration No. 33-31008-NY, and
incorporated herein by reference.
(3) Previously filed with the Registration Statement of the
Company on Form S-18, Registration No. 33-35668-NY, and
incorporated herein by reference.
(4) Previously filed with the Company's Form 8-K dated August 31,
1994, and incorporated herein by reference.
(5) Previously filed with the Company's Form 10-K for the year
ended September 30, 1994, and incorporated herein by
reference.
(6) Previously filed with the Company's Form 10-K for the year
ended September 30, 1995, and incorporated herein by
reference.
(7) Previously filed with the Company's Form 10-K for the year
ended September 30, 1998 and incorporated herein by reference.
38
(8) Previously filed with the Company's Form 10-K for the year
ended September 30, 1999 and incorporated herein by reference.
(9) Previously filed with the Company's Form 10-Q for the quarter
ended December 31, 2000, and incorporated herein by reference.
(10) Previously filed with the Registration Statement of the
Company on Form S-8 Registration No.333-72296, filed on
October 26, 2001 and incorporated herein by reference
(11) Previously filed with the Registration Statement of the
Company on Form S-8 Registration No.333-72134, filed on
October 24, 2001 and incorporated herein by reference.
(12) Previously filed with the Company's Form 10-K for the year
ended December 31, 2001 and incorporated herein by reference.
(13) Previously filed with the Company's Form 10-K for the year
ended December 31, 2003 and incorporated herein by reference.
39
SIGNATURES
Pursuant to the requirements of the Section 13 or 15(d) of the
Securities Exchange Act of 1934, the Registrant has duly caused this report to
be signed on its behalf by the undersigned, thereunto duly authorized on this
22nd day of December, 2004
VALLEY FORGE SCIENTIFIC CORP.
By: /s/ JERRY L. MALIS
-------------------------------
Jerry L. Malis, President
Pursuant to the requirements of the Securities Act of 1934, this report
has been signed by the following persons on behalf of the Registrant and in the
capacities and on the dates indicated.
Signature Title Date
--------- ----- ----
/s/ JERRY L. MALIS Chairman of the Board, December 22, 2004
-------------------------- President (chief executive
Jerry L. Malis officer and principal
financial and accounting
officer)
/s/ LOUIS UCHITEL Director December 22, 2004
--------------------------
Louis Uchitel
/s/ LEONARD I. MALIS Director December 22, 2004
--------------------------
Leonard I. Malis
/s/ BRUCE A. MURRAY Director December 22, 2004
--------------------------
Bruce A. Murray
/s/ ROBERT H. DICK Director December 22, 2004
--------------------------
Robert H. Dick
VALLEY FORGE SCIENTIFIC CORP.
For Fiscal Year Ended September 30, 2004
FORM 10-K
Index to Financial Statements and Financial Statement Schedules
Independent Auditor's Report F-2
Balance Sheets - September 30, 2004 and 2003 F-3
Statements of Operations - Years ended September 30, 2004, 2003 and 2002 F-4
Statements of Stockholders' Equity - Years ended September 30, 2004, F-5
2003 and 2002
Statements of Cash Flows - Years ended September 30, 2004, 2003 and 2002 F-6
Notes to Financial Statements F-7
---------------
All other schedules for which provision is made in the applicable accounting
regulations of the Securities and Exchange Commission are not required under the
related instructions or are not applicable, and therefore have been omitted.
F-1
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Stockholders
Valley Forge Scientific Corp. and Subsidiary
Oaks, Pennsylvania
We have audited the accompanying consolidated balance sheets of Valley Forge
Scientific Corp. and Subsidiary as of September 30, 2004 and 2003 and the
related consolidated statements of operations, stockholders' equity and cash
flows for each of the three years in the period ended September 30, 2004. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audits 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 and significant estimates made by management, as well as evaluating
the overall financial statement presentation. We believe that our audits provide
a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Valley Forge Scientific Corp.
and Subsidiary as of September 30, 2004 and 2003, and the results of its
operations and its cash flows for each of the three years in the period ended
September 30, 2004, in conformity with U. S. generally accepted accounting
principles.
/s/ SAMUEL KLEIN AND COMPANY
SAMUEL KLEIN AND COMPANY
Newark, New Jersey
November 19, 2004
F-2
VALLEY FORGE SCIENTIFIC CORP. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
September 30,
-----------------------
ASSETS 2004 2003
------ ---------- ----------
Current Assets:
Cash and cash equivalents $2,322,559 $2,305,556
Accounts receivable, net 646,224 376,915
Inventory 781,604 775,183
Prepaid items and other current assets 146,411 268,371
Deferred income taxes 79,752 51,431
---------- ----------
Total Current Assets 3,976,550 3,777,456
Property, Plant and Equipment, Net 147,967 156,697
Goodwill 153,616 153,616
Intangible Assets, Net 218,398 256,681
Other Assets 26,707 29,963
---------- ----------
Total Assets $4,523,238 $4,374,413
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
Current Liabilities:
Accounts payable and accrued expenses $ 245,828 $ 216,457
Deferred revenue 5,750 --
Income taxes payable 6,491 --
---------- ----------
Total Current Liabilities 258,069 216,457
Deferred Income Taxes 15,743 19,950
---------- ----------
Total Liabilities 273,812 236,407
---------- ----------
Commitments and Contingencies
Stockholders' Equity:
Preferred stock -- --
Common stock (no par, 20,000,000 shares
authorized, shares issued and outstanding
at September 30, 2004 and 2003 -
7,913,712 3,528,530 3,528,530
Retained earnings 720,896 609,476
---------- ----------
4,249,426 4,138,006
---------- ----------
Total Liabilities and Stockholders' Equity $4,523,238 $4,374,413
========== ==========
--------------------
The accompanying notes are an integral part of these financial statements.
F-3
VALLEY FORGE SCIENTIFIC CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
For the Years Ended September 30,
------------------------------------
2004 2003 2002
---------- ---------- ----------
Net Sales $4,756,439 $4,474,308 $5,021,931
Cost of Sales 2,316,304 2,264,902 2,463,209
---------- ---------- ----------
Gross Profit 2,440,135 2,209,406 2,558,722
---------- ---------- ----------
Other Costs:
Selling, general and administrative 1,713,325 1,523,751 1,503,001
Research and development 508,287 489,930 360,111
Amortization 40,469 40,298 63,610
---------- ---------- ----------
Total Other Costs 2,262,081 2,053,979 1,926,722
---------- ---------- ----------
Income from Operations 178,054 155,427 632,000
Other Income (Expense), Net 23,030 11,451 23,111
---------- ---------- ----------
Income before Income Taxes 201,084 166,878 655,111
Provision for Income Taxes 89,664 57,953 274,584
---------- ---------- ----------
Net Income $ 111,420 $ 108,925 $ 380,527
========== ========== ==========
Income per Share:
Basic income per common share $ 0.01 $ 0.01 $ 0.05
========== ========== ==========
Diluted income per common share $ 0.01 $ 0.01 $ 0.05
========== ========== ==========
Basic weighted average common shares
outstanding 7,913,712 7,960,676 8,067,286
Diluted weighted average common shares
outstanding 7,976,833 7,986,448 8,154,570
--------------------
The accompanying notes are an integral part of these financial statements.
F-4
VALLEY FORGE SCIENTIFIC CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED SEPTEMBER 30, 2004, 2003 AND 2002
Common Stock
No Par Value
----------------------------
Number Common Total
of Stock Retained Stockholders'
Shares Amount Earnings Equity
------------ ------------ ------------ ------------
Balances, October 1, 2001 8,067,812 $ 3,748,724 $ 120,024 $ 3,868,748
Purchases and Retirement of
Common Shares (26,500) (46,878) -- (46,878)
Net Income for the Year Ended
September 30, 2002 -- -- 380,527 380,527
------------ ------------ ------------ ------------
Balances, September 30, 2002 8,041,312 3,701,846 500,551 4,202,397
Purchases and Retirement of
Common Shares (127,600) (173,316) -- (173,316)
Net Income for the Year Ended
September 30, 2003 -- -- 108,925 108,925
------------ ------------ ------------ ------------
Balances, September 30, 2003 7,913,712 3,528,530 609,476 4,138,006
Net Income for the Year Ended
September 30, 2004 -- -- 111,420 111,420
------------ ------------ ------------ ------------
Balances, September 30, 2004 7,913,712 $ 3,528,530 $ 720,896 $ 4,249,426
============ ============ ============ ============
--------------------
The accompanying notes are an integral part of these financial statements.
F-5
VALLEY FORGE SCIENTIFIC CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Years Ended September 30,
--------------------------------------------
2004 2003 2002
------------ ------------ ------------
Cash Flows from Operating Activities:
Net income $ 111,420 $ 108,925 $ 380,527
Adjustments to reconcile net income to net
cash provided by (used in) operating activities:
Depreciation and amortization 70,087 66,641 84,784
Writedown of property, plant and equipment -- 16,500 5,300
Reduction of allowance for loans and advances
to employee -- -- (47,790)
Interest accrued on loans and advances to
employees and related parties (2,313) (2,382) (2,810)
Provision for obsolete and slow moving inventory 70,386 109,635 52,875
Provision for (recovery of) bad debts, returns
and allowances 13,609 (43,000) 50,003
Changes in assets and liabilities:
(Increase) decrease in accounts receivable, net (282,918) 4,024 217,208
(Increase) decrease in inventory (76,807) (1,986) 263,829
(Increase) decrease in deferred tax assets (28,321) 24,862 28,087
(Increase) decrease in other assets 3,256 (25,792) 1,275
(Increase) decrease in prepaid items and other
current assets 117,773 (135,205) (38,705)
Increase (decrease) in accounts payable and
accrued expenses and income taxes payable 35,862 (136,824) 70,095
Increase in deferred revenue 5,750 -- --
Increase (decrease) in deferred tax liability (4,207) 5,593 (4,923)
------------ ------------ ------------
Net cash provided by (used in) operating
activities 33,577 (9,009) 1,059,755
------------ ------------ ------------
Cash Flows from Investing Activities:
Proceeds from repayment of employee loans 6,500 10,000 57,261
Loans and advances to employees -- -- (1,436)
Acquisition of intangible assets (2,187) (2,608) (8,621)
Purchases of property, plant and equipment (20,887) (63,409) (16,805)
------------ ------------ ------------
Net cash provided by (used in) investing
activities (16,574) (56,017) 30,399
------------ ------------ ------------
Cash Flows from Financing Activities:
Repurchase of common stock -- (173,316) (46,878)
------------ ------------ ------------
Net cash used in financing activities -- (173,316) (46,878)
------------ ------------ ------------
Net Increase (Decrease) in Cash and Cash
Equivalents 17,003 (238,342) 1,043,276
Cash and Cash Equivalents, beginning of year 2,305,556 2,543,898 1,500,622
------------ ------------ ------------
Cash and Cash Equivalents, end of year $ 2,322,559 $ 2,305,556 $ 2,543,898
============ ============ ============
F-6
VALLEY FORGE SCIENTIFIC CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Continued)
For the Years Ended September 30,
------------------------------------------
2004 2003 2002
------------ ------------ ------------
Supplemental Disclosures of Cash Flow Information:
Cash paid during the year for:
Interest $ -- $ -- $ --
============ ============ ============
Income taxes $ 21,400 $ 271,300 $ 186,960
============ ============ ============
--------------------
The accompanying notes are an integral part of these financial statements.
F-7
VALLEY FORGE SCIENTIFIC CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The Company
-----------
Valley Forge Scientific Corp. ("VFSC") was incorporated on March 27, 1980 in the
Commonwealth of Pennsylvania and is engaged in the business of developing,
manufacturing and selling medical devices and products. On August 18, 1994, VFSC
formed a wholly-owned subsidiary, Diversified Electronics Company, Inc. ("DEC"),
a Pennsylvania corporation, in order to continue the operations of Diversified
Electronics Corporation, a company which was merged with and into VFSC on August
31, 1994. VFSC and DEC are referred to herein as the "Company".
Principles of Consolidation and Basis of Presentation
-----------------------------------------------------
The accompanying financial statements consolidate the accounts of the parent
company and its wholly-owned subsidiary. All significant intercompany accounts
and transactions have been eliminated in consolidation.
Use of Management's Estimates
-----------------------------
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 revenues and expenses during the reporting period.
Actual results could differ from those estimates.
Cash and Cash Equivalents
-------------------------
The Company considers cash equivalents to be all highly liquid investments with
original maturities of three months or less. Substantially all cash and cash
equivalents are held in one major financial institution.
Segment Information
-------------------
The Company has one operating segment comprised of its bipolar electrosurgical
generators and instrumentation products. The Company's business is conducted
entirely in the United States. Major customers are discussed in Note 10.
Fair Value of Financial Instruments
-----------------------------------
Carrying amounts of certain of the Company's financial instruments, including
cash and cash equivalents, receivables, accounts payable and other accrued
expenses approximate fair value because of their short maturities.
Reclassifications
-----------------
Certain reclassifications have been made to prior year balances to conform to
the current presentation.
F-8
VALLEY FORGE SCIENTIFIC CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
1. THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Revenue Recognition
-------------------
The Company sells its products to U.S. based national and international
distributors and dealers which include Codman and Shurtleff, Inc. ("Codman"), an
affiliate of a major medical company. A significant part of the Company's sales
are made pursuant to a distribution agreement with Codman, the Company's largest
customer, which provides for worldwide exclusive distribution rights of
neurosurgery products during the term of this agreement. This distribution
agreement includes a minimum purchase obligation which is adjusted annually
during the term of the agreement. It also includes a price list for the
specified products, which is fixed for a period of time, after which these
prices are subject to adjustment by the Company due to changes in manufacturing
cost or technological improvements to the products. In November, 2003 this
agreement was extended for three months to March 31, 2004, with a minimum
purchase obligation during this period of $1,000,000. In March, 2004 the
agreement was further extended for three months through June 30, 2004, with a
minimum purchase obligation during that period of $1,000,000 and on June 29,
2004 it was extended again through September 30, 2004 with the same $1,000,000
minimum purchase obligation during that period. All other terms of the
distribution agreement remained in full force and effect for the year ended
September 30, 2004. (See Subsequent Events for explanation of a new agreement
with this customer).
During the three months ended March 31, 2004, Codman elected to pay the Company
$57,920, pursuant to the distribution agreement in lieu of purchasing
approximately $116,000 of product which would have been required to meet the
minimum purchase obligation under the agreement, as extended, for the period.
The Company received the payment on April 16, 2004. The amount received is
included in sales for the year ended September 30, 2004. Had this amount not
been recorded, sales would have been $4,698,519 for the year ended September 30,
2004 and gross profit would have been $2,382,215 (50.7% of sales). No such
payment to the Company was required in the quarters ended June 30, 2004 or
September 30, 2004.
Product revenue is recognized when the product has been shipped which is when
title and risk of loss has been transferred to the customer. Service revenue
substantially relates to repairs of products and is recognized when the service
has been completed. Revenues from license and royalty fees are recorded when
earned.
The Company reduces revenue for customer returns and allowances. In addition,
the Company accrues for warranty cost and other allowances based on its
experience and reflects these accruals in cost of sales or administrative
expense as applicable.
Inventory
---------
Inventory is stated at the lower of cost, determined by the moving average cost
method, or market. The Company provides inventory allowances based on
slow-moving and obsolete inventories.
Property, Plant and Equipment
-----------------------------
Property, plant and equipment are recorded at cost. Depreciation is computed by
the straight-line method over the estimated useful lives of the assets, which
vary from three to thirty-nine years. Leasehold improvements are being amortized
over the related lease term or estimated useful lives, whichever is shorter.
F-9
VALLEY FORGE SCIENTIFIC CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
1. THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Property, Plant and Equipment (Continued)
-----------------------------------------
Upon retirement or other disposition of these assets, the cost and related
accumulated depreciation are removed from the accounts and the gains or losses
are reflected in the results of operations. Routine maintenance and repairs are
charged to expense as incurred.
Intangible Assets and Goodwill
------------------------------
Intangible assets, consisting of patents, licensing agreements, proprietary
know-how, logos and cost of acquisition are amortized to operations under the
straight-line method over their estimated useful lives or statutory lives,
whichever is shorter. Acquisition costs have been capitalized and are being
amortized over 5 years. All other intangible assets, except for goodwill, are
being amortized over periods ranging from 10 to 17 years.
The Company accounts for goodwill in accordance with Statement of Financial
Accounting Standards No. 142, "Goodwill and Other Intangible Assets" (SFAS 142),
which addresses the financial accounting and reporting standards for goodwill
and other intangible assets subsequent to their acquisition. This accounting
standard requires that goodwill no longer be amortized, and instead, be tested
for impairment on a periodic basis. Pursuant to adoption of this accounting
standard, on October 1, 2001, a transitional impairment test was completed on
March 31, 2002, and no impairment was identified. Subsequent impairment tests
have been performed annually as of March 31, 2003 and 2004 and no impairment has
been identified. In accordance with SFAS 142, the Company discontinued the
amortization of goodwill effective October 1, 2001. Therefore, goodwill has not
been amortized in any year presented in these financial statements.
Impairment of Long-Lived Assets
-------------------------------
The Company has adopted Statement of Financial Accounting Standards No. 144,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
be Disposed of" (SFAS 144). Pursuant to SFAS 144 long-lived assets, or asset
groups and certain identifiable intangible assets to be held and used are
reviewed for impairment whenever events or changes in circumstances indicate
that the carrying amount of such assets may not be recoverable. Determination of
recoverability is based on an estimate of undiscounted cash flows resulting from
the use of the asset, or asset groups, and its eventual disposition. Measurement
of an impairment loss for long-lived assets, or asset groups, and certain
identifiable intangible assets that management expects to hold and use is based
on the fair value of the asset. Long-lived assets, or asset groups and certain
identifiable intangible assets to be disposed of are reported at the lower of
carrying amount or fair value less costs to sell.
Research and Development
------------------------
Costs associated with development of new products are charged to operations as
incurred.
F-10
VALLEY FORGE SCIENTIFIC CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
1. THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Advertising Costs
-----------------
Advertising expenditures relating to the advertising and marketing of the
Company's products and services are expensed in the period the advertising costs
are incurred. Prior to 2003, substantially all cost of such product marketing
and advertising had been borne by the Company's major distributors. During the
year ended September 30, 2003, due to the Company's strategy shift to market and
sell the Bident dental products utilizing the Company's proprietary resources,
the Company incurred marketing and advertising costs of approximately $161,000.
For the year ended September 30, 2004, these costs were approximately $130,000.
Income Taxes
------------
Tax provisions and credits are recorded at enacted tax rates for taxable items
included in the consolidated statements of operations regardless of the period
for which such items are reported for tax purposes. Deferred tax assets and
liabilities are determined based on the differences between the financial
statement and tax bases of assets and liabilities using enacted tax rates in
effect for the year in which the differences are expected to reverse. Deferred
tax assets are reduced by a valuation allowance when the determination can be
made that it is more likely than not that some portion or all of the related tax
assets will not be realized.
Comprehensive Income
--------------------
The Company reports components of comprehensive income under the requirements of
Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive
Income" (SFAS 130). This statement establishes rules for the reporting of
comprehensive income and its components which require that certain items such as
foreign currency translation adjustments, unrealized gains and losses on certain
investments in debt and equity securities, minimum pension liability adjustments
and unearned compensation expense related to stock issuances to employees be
presented as separate components of stockholders' equity.
Earnings per Share
------------------
The Company computes earnings per share in accordance with Statement of
Financial Accounting Standards No. 128, "Earnings Per Share" (SFAS 128). Basic
earnings per share is computed by dividing income available to common
stockholders by the weighted average number of common shares outstanding.
Diluted earnings per share reflects the potential dilution that could occur if
securities or other agreements to issue common stock were exercised or converted
into common stock. Diluted earnings per share is computed based upon the
weighted average number of common shares and dilutive common equivalent shares
outstanding, which include convertible debentures, stock options and warrants.
F-11
VALLEY FORGE SCIENTIFIC CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
1. THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Accounting for Stock-Based Compensation
---------------------------------------
In December, 2002, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure - an amendment of FASB Statement No.
123" (SFAS 148). SFAS 148 amends SFAS 123, "Accounting for Stock-Based
Compensation", to provide alternative methods of transition for a voluntary
change to the fair value based method of accounting for stock-based employee
compensation. In addition, SFAS 148 amends the disclosure requirements of SFAS
123 to require prominent disclosures in both annual and interim financial
statements about the method of accounting for stock-based employee compensation
and the effect of the method used on reported results. SFAS 148 was effective
for the Company as of January 1, 2003. The Company has not elected a voluntary
change in accounting to the fair value based method, and accordingly, the
adoption of SFAS 148 did not have any impact on the Company's results of
operations or financial position.
Employee stock plans are accounted for using the intrinsic value method
prescribed by Accounting Principles Board Opinion No. 25, "Accounting for Stock
Issued to Employees", (APB 25). The Company utilizes the Black-Scholes option
valuation model to value stock options for pro forma presentation of income and
per share data as if the fair value based accounting method in SFAS 123 had been
used to account for stock-based compensation. For purposes of pro forma
disclosures, the estimated fair value of the options is amortized to expense
over the options' vesting periods. In accordance with SFAS 123, only stock
options granted after September 30, 1995 have been included for the Company's
pro forma information as follows:
September 30,
------------------------------------------
2004 2003 2002
------------ ------------ ------------
Additional compensation expense,
net of tax effect $ 56,229 $ 57,180 $ 89,333
Pro forma net income 55,191 51,745 291,194
Pro forma income per share:
Basic 0.01 0.01 0.04
Diluted 0.01 0.01 0.04
Recent Accounting Pronouncement
-------------------------------
In November, 2004 the Financial Accounting Standards Board issued Statement of
Financial Accounting Standard No. 151, "Inventory Costs, an amendment of ARB No.
43, Chapter 4" (SFAS 151). SFAS 151 amends the guidance in ARB No. 43, Chapter
4, "Inventory Pricing", to clarify the accounting for abnormal amounts of idle
facility expense, freight, handling costs, and spoilage. This statement requires
that those items be recognized as current period charges regardless of whether
they meet the criterion of "so abnormal" which was the criterion specified in
ARB No. 43. In addition, this Statement requires that allocation of fixed
production overheads to the cost of production be based on normal capacity of
the production facilities. This pronouncement is effective for the Company
beginning October 1, 2005. The Company does not expect the adoption of this
pronouncement to have a material impact on its future financial condition or
results of operations.
F-12
VALLEY FORGE SCIENTIFIC CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
2. ACCOUNTS RECEIVABLE
The Company provides an allowance for doubtful accounts equal to the estimated
uncollectible amounts. The Company's estimate is based on historical collection
experience and a review of the current status of trade accounts receivable. It
is reasonably possible that the Company's estimate of the allowance for doubtful
accounts will change. Accounts receivable consists of the following:
September 30,
-----------------------
2004 2003
---------- ----------
Accounts receivable $ 661,704 $ 378,786
Less: Allowances 15,480 1,871
---------- ----------
$ 646,224 $ 376,915
========== ==========
The Company provided for estimated doubtful accounts through charges to selling,
general and administrative expenses for $5,179, $ - 0 - and $50,003 for the
years ended September 30, 2004, 2003 and 2002, respectively, and wrote-off $ - 0
- , $ - 0 - , and $34,375, respectively, against this allowance for these
periods.
In addition, during the year ended September 30, 2004 the Company increased the
allowance by approximately $8,400 based on its experience with sales returns,
primarily related to medical products and instruments.
During the year ended September 30, 2003, the Company recorded a benefit of
$43,000 arising from the collection of an account receivable which had been
previously provided for, and further reduced the allowance by approximately
$2,700.
3. INVENTORY
The Company provides an allowance for slow moving and potentially obsolete
inventory. Inventory consists of the following:
September 30,
-----------------------
2004 2003
---------- ----------
Finished goods $ 94,405 $ 88,401
Work-in-process 396,810 316,600
Materials and parts 424,052 433,459
---------- ----------
915,267 838,460
Less: Allowance for slow moving
and obsolete inventory 133,663 63,277
---------- ----------
$ 781,604 $ 775,183
========== ==========
The Company provided for obsolete and slow moving inventory through charges to
cost of sales for $70,386, $109,635 and $52,875 in the years ended September 30,
2004, 2003 and 2002, respectively, and wrote off $ - 0 - , $134,928 and $41,183,
respectively, against this allowance in these periods.
F-13
VALLEY FORGE SCIENTIFIC CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
4. PROPERTY, PLANT AND EQUIPMENT
September 30,
Useful Life ----------------------------------
(Years) 2004 2003
------- ------------- -------------
Land - $ 11,953 $ 11,953
Buildings and improvements 15 - 39 103,467 94,832
Furniture and fixtures 5 - 7 17,953 17,953
Laboratory equipment 5 - 10 378,159 370,119
Office equipment 5 185,530 181,318
Leasehold improvements 3 - 5 9,413 9,413
------------- -------------
706,475 685,588
Less: Accumulated depreciation
and amortization 558,508 528,891
------------- -------------
$ 147,967 $ 156,697
============= =============
Depreciation is reflected in both cost of sales and selling, general and
administrative expenses. Total depreciation for the years ended September 30,
2004, 2003 and 2002 was $29,617, $26,343 and $21,174, respectively. In addition,
in accordance with SFAS 144, the Company wrote down certain molding equipment
intended to be utilized in the production of certain disposable surgical
products, to their estimated fair values. For the years ended September 30,
2004, 2003 and 2002, the Company wrote down $ - 0 - , $16,500 and $5,300,
respectively. These write downs are included in the statement of operations
under the caption "Other Income (Expense), Net".
5. INTANGIBLE ASSETS
Intangible assets consist of the following:
September 30,
Useful Life -----------------------
(Years) 2004 2003
---------- ---------- ----------
Patents/trademarks/logos, licensing
agreements 17 $ 573,804 $ 571,617
Proprietary know-how 15 452,354 452,354
Acquisition costs 5 55,969 55,969
---------- ----------
1,082,127 1,079,940
Less: Accumulated amortization 863,729 823,259
---------- ----------
$ 218,398 $ 256,681
========== ==========
Total amortization for the years ended September 30, 2004, 2003 and 2002 was
$40,470, $40,298 and $63,610, respectively. Amortization for the years ended
September 30, 2005, 2006, 2007, 2008 and 2009 is estimated to be $40,778,
$40,778, $40,665, $40,131 and $34,902, respectively.
F-14
VALLEY FORGE SCIENTIFIC CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
5. INTANGIBLE ASSETS (Continued)
During the year ended September 30, 2003, a patent for the technology underlying
the "aperiodic" wave form utilized in some of the Company's products expired.
The remaining patent, which relates to the Company's current bipolar
electrosurgical generators, expires in the fiscal year ending September 30,
2011.
6. RELATED PARTY TRANSACTIONS
Loans Receivable
----------------
On July 6, 1998, Jerry L. Malis, a principal shareholder, director and officer
of the Company, borrowed $15,015 from the Company. The note is payable on demand
and has a stated rate of interest of 5.42%, the then current "Applicable Federal
Rate" as set forth under the Internal Revenue Code. The Company has additional
loans due from Jerry L. Malis payable on demand with similar interest terms as
stated above ranging from 4.83% to 6.97%. The collective loans, which total
$41,792 as of September 30, 2004, are partially secured by 5,833 shares of
common stock of the Company. As of September 30, 2004 the pledged stock had a
value of approximately $9,333.
The balance of these loans is included on the balance sheet under the caption
"prepaid items and other current assets" and as of September 30, 2004 and 2003,
was $41,792 and $45,979, respectively, which includes accrued interest of
$20,461 and $18,148, respectively.
Consulting Services
-------------------
During 2004, 2003 and 2002 the Company engaged R.H. Dick and Company, Inc., a
corporation owned by Robert H. Dick, a director of the Company, to provide
certain investment banking and consulting services. For the years ended
September 30, 2004, 2003 and 2002 the Company incurred consulting fees for these
services, excluding reimbursement of out-of-pocket expenses in an amount
totaling $7,500, $10,000 and $10,000, respectively. As of September 30, 2004 and
2003, the Company owed R.H. Dick and Company $ - 0 - and $5,000, respectively.
The liability is reflected on the balance sheet under the caption "accounts
payable and accrued expenses".
Also, commencing in June 2004 the Company engaged Bruce Murray, a director, to
provide certain business consulting services. The fees for these services
totaled $30,025, excluding reimbursements of out-of-pocket expenses. The amount
owed Bruce Murray at September 30, 2004 was $12,128 and is reflected on the
balance sheet under the caption "accounts payable and accrued expenses".
7. LINE OF CREDIT
The Company has a line of credit of $1,000,000 with Wachovia Bank, formerly
First Union National Bank, which calls for interest to be charged on any loans
under this line equal to the bank's national commercial rate. The line is
unsecured and any borrowing under the line would be payable on demand, require
monthly interest payments on any unpaid principal and a reduction of any loan
balance to zero for a minimum of thirty consecutive days during each twelve
month period. In addition, the loan covenant calls for a minimum tangible net
worth of no less than $3,000,000 during the term of the extended line of credit.
At September 30, 2004 and 2003, there were no outstanding balances under this
line.
F-15
VALLEY FORGE SCIENTIFIC CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
8. COMMITMENTS AND CONTINGENCIES
Litigation
----------
The Company is subject from time to time to litigation arising from the normal
course of business. In management's opinion, any such contingencies would be
covered under its existing insurance policies or would not materially affect the
Company's financial position or results of operations.
On July 25, 2001 the Company was named as a defendant in a lawsuit filed in the
United States District Court for the Eastern District of Pennsylvania by a
former employee alleging gender discrimination and sexual harassment. On March
2, 2002 the Company, without admitting any liability, entered into a settlement
agreement and pursuant to this agreement, paid the plaintiff $37,000, an amount
which was net of certain amounts due from this party. This payment is reflected
in other costs under selling, general and administrative expenses for the year
ended September 30, 2002.
On September 19, 2002, the Company was served with a complaint that was filed in
the Superior Court of the State of Arizona, County of Maricopa, entitled Jeffrey
Turner and Cathryn Turner et al v. Phoenix Children's Hospital, Inc., et al, (CV
2002-010791) in which the Company was named as one of the defendants. The
plaintiffs seek damages from all defendants for permanent brain damage suffered
by a four year old girl during a surgery that took place in June 2000. The
alleged damages sought by the plaintiffs against all parties are in excess of
the Company's product liability insurance policy limit of $1,000,000, and the
Company's net worth. The claim against the Company is a products liability
claim. The Company's product liability insurance carrier is providing the
Company's defense in this matter. This insurance coverage has a $10,000
deductible that applies to attorney fees and damages which has been provided for
in other costs under selling, general and administrative expense for the year
ended September 30, 2002. In an answer that was filed on November 26, 2002, the
Company denied any wrongdoing. The Company believes the claim is without merit
and is vigorously defending itself in this action. This case is currently in the
discovery process.
Regulatory Compliance
---------------------
The Company is subject to regulatory requirements throughout the world. In the
normal course of business, these regulatory agencies may require companies in
the medical industry to change their products or operating procedures, which
could affect the Company. The Company regularly incurs expenses to comply with
these regulations and may be required to incur additional expenses. Management
is not able to estimate any additional expenditures outside the normal course of
operations which will be incurred by the Company in future periods in order to
comply with these regulations.
Employment Agreement
--------------------
On October 1, 2002 the Compensation Committee of the Board of Directors approved
a base salary of $220,000 for Jerry L. Malis, the Chairman and CEO of the
Company. His base salary for the years ended September 30, 2004, 2003 and 2002
were approximately $220,000, $220,000 and $199,000.
F-16
VALLEY FORGE SCIENTIFIC CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
9. COMMITMENTS AND CONTINGENCIES (Continued)
Employment Agreement (Continued)
--------------------
Subsequent to September 30, 2002, the Compensation Committee of the Board of
Directors approved a $25,000 cash bonus to Mr. Malis for services rendered
during the year ended September 30, 2002. The bonus was accrued for the year
ended September 30, 2002 and is reflected on the statement of operations in
"selling, general and administrative expenses".
401(k) Profit Sharing Plans
---------------------------
The Company's 401(k) Plan and Profit Sharing Plan cover full-time employees who
have attained the age of 21 and have completed at least one year of service with
the Company. Under the 401(k) Plan, an employee may contribute an amount up to
25% of his compensation to the Plan on a pretax basis not to exceed the current
Federal limitation per year (as adjusted for cost of living increases). Amounts
contributed to the 401(k) Plan are nonforfeitable.
Under the Profit Sharing Plan, a member in the plan participates in the
Company's contributions to the Plan as of December 31 in any year, with
allocations to individual accounts based on annual compensation. An employee
does not fully vest in the plan until completion of three years of employment.
The Board of Directors determines the Company's contributions to the plan on a
discretionary basis. The Company has not made any contributions to date.
Stock Option Plans
------------------
On July 6, 1988, the Company adopted a Nonqualified Employee Stock Option Plan
(the "1988 Plan") pursuant to which 500,000 shares of Common Stock were reserved
for issuance to employees, officers, directors or consultants of the Company.
Options granted pursuant to this plan were nontransferable and expired if not
exercised after ten years from the date of grant or for such lesser term as
approved by the Board of Directors. Options were granted in such amounts and at
such prices as determined by the Board of Directors, but the price per share
could not be less than the fair market value of the Company's Common Stock as of
the date of grant.
On January 16, 2001, pursuant to the adoption of the 2001 Stock Plan (the "2001
Plan"), the 1988 plan was terminated. As of the date the plan was terminated, a
total of 404,800 options had been granted and were outstanding.
On December 12, 2000, the Company adopted a Non-employee Directors Stock Option
Plan ("Directors Plan") pursuant to which 150,000 shares of Common Stock have
been reserved for issuance to non-employee directors of the Company. The
Directors Plan was approved by the Company's stockholders on March 14, 2001.
Shares issued pursuant to options granted under this plan may be issued from
shares held in the Company's treasury or from authorized and unissued shares.
Under this plan, each Director, on an annual basis, shall be automatically
granted 10,000 options upon the first business day after being elected a
director. The options are immediately vested on the date of grant. Discretionary
options granted pursuant to this plan shall be determined by the Board of
Directors or a duly appointed stock option committee (the "Committee"). Options
granted pursuant to this plan shall be nonqualified stock options as defined in
Section 422 of the Internal Revenue Code, will be nontransferable and expire if
not exercised after ten years from the date of grant or for such lesser term as
approved by the Committee. All options shall be issued at a price per share
equal to the fair market value of the Company's Common Stock as of the date of
grant.
F-17
VALLEY FORGE SCIENTIFIC CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
9. COMMITMENTS AND CONTINGENCIES (Continued)
Stock Option Plans (Continued)
------------------
On January 16, 2001, the Company adopted the 2001 Stock Plan (the "2001 Plan")
pursuant to which 345,000 shares of Common Stock have been reserved for issuance
to employees, officers and consultants of the Company. The 2001 plan was
approved by the Company's stockholders on March 14, 2001. Shares issued pursuant
to this plan may be issued from shares held in the Company's treasury or from
authorized and unissued shares. Options granted pursuant to this plan are
generally nontransferable, except in the event of a participant's death, in
which case the options shall be transferable to the participant's designated
beneficiary or as permitted by law. The options shall expire if not exercised
after ten years from the date of grant or for such lesser term as approved by
the Board of Directors or a duly appointed committee. Options issued to
employees who are then later terminated for cause generally are immediately
forfeited. Options may be granted in such amounts and at such prices as
determined by the Board of Directors or the duly appointed committee, but the
price per share shall not be less than the fair market value of the Company's
Common Stock as of the date of grant in the case of an incentive stock option
and not less than 85% of the fair market value of the Company's Common Stock as
of the date of grant in the case of a non-qualified stock option, as defined in
section 422 of the Internal Revenue Code.
As referred to in Note 1, the Company has adopted the disclosure provisions of
SFAS 123, and SFAS 148. As permitted under these statements, the Company
retained its current method of accounting for stock compensation in accordance
with APB 25.
F-18
VALLEY FORGE SCIENTIFIC CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
9. COMMITMENTS AND CONTINGENCIES (Continued)
Following is a summary of the Company's various stock option plans:
Weighted
Average
Range of Weighted Remaining
Exercise Average Contractual
Prices Exercise Life
Shares Per Share Price (Years)
------------ ------------ ------------ ------------
Options outstanding at October 1, 2001 483,075 $1.13 - 4.25 $ 2.29 7.39
Granted 47,500 1.85 - 2.75 2.42 9.64
Exercised -- -- --
Surrendered, forfeited or expired (12,725) 1.13 - 4.25 2.55 5.38
------------ ------------ ------------
Options outstanding at September 30, 2002 517,850 1.13 - 4.25 2.30 6.31
Granted 50,000 1.06 - 1.70 1.22 9.46
Exercised -- -- --
Surrendered, forfeited or expired (88,000) 1.50 - 3.63 3.11 2.47
------------ ------------ ------------
Options outstanding at September 30, 2003 479,850 1.06 - 4.25 2.04 6.55
Granted 30,000 1.79 1.79 9.50
Exercised -- -- -- --
Surrendered, forfeited or expired (2,600) 1.85 - 4.25 3.79 1.63
------------ ------------ ------------
Options outstanding at Setpember 30, 2004 507,250 $1.06 - 3.75 $ 2.01 5.96
============ ============ ============
As of September 30, 2004, 457,250 of these options outstanding are vested and
are exercisable at prices ranging from $1.06 to $3.75 which correspond to a
weighted average exercise price of $1.97 and a weighted average remaining
contractual life of 5.97 years.
F-19
VALLEY FORGE SCIENTIFIC CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
9. COMMITMENTS AND CONTINGENCIES (Continued)
Assumptions used in the Black-Scholes option valuation model to estimate the
value of the Company's options included in pro forma amounts in Note 1 are as
follows:
For the Years Ended
September 30,
-----------------------------------------------------
2004 2003 2002
---- ---- ----
Risk-free interest (based on U.S.
Government strip bonds on the
date of grant with maturities
approximating the expected
option term) 4.00% 3.65% - 4.00% 3.84% - 5.13%
Dividend yields 0% 0% 0%
Volatility factors of the expected
market price of the Company's
Common Stock (based on
historical data) 79.70% 158.4% - 163.9% 165.1% - 169.7%
Expected life of options 10 Years 10 Years 10 Years
The weighted average fair value of options granted during the years ended
September 30, 2004, 2003 and 2002 were as follows:
2004 2003 2002
-------- -------- --------
Stock Prices Equal to Exercise Price $ 1.49 $ 1.21 $ 2.40
Stock Prices in Excess of Exercise Price $ -- $ -- $ --
Stock Prices Less than Exercise Price $ -- $ -- $ --
The Black-Scholes option valuation model was developed for use in estimating the
fair value of traded options which have no vesting restrictions and are fully
transferable. In addition, option valuation models require the input of highly
subjective assumptions including the expected stock price volatility. Because
the Company's stock options have characteristics significantly different from
those of traded options, and because changes in subjective input assumptions can
materially affect the fair value estimated, in management's opinion, the
existing models do not necessarily provide a reliable single measure of the fair
value of its stock options. In management's opinion existing stock option
valuation models do not provide a reliable single measure of the fair value of
employee stock options that have vesting provisions and are not transferable.
F-20
VALLEY FORGE SCIENTIFIC CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
9. COMMITMENTS AND CONTINGENCIES (Continued)
Operating Leases
----------------
The Company leases approximately 4,200 square feet of office and warehouse space
in an office building in Oaks, Pennsylvania, from GMM Associates, a Pennsylvania
general partnership, whose partners are Jerry L. Malis, Leonard I. Malis,
(principal shareholders, directors, and/or officers of the Company), and the
Francis W. Gilloway Marital Trust, the successor in interest to Thomas Gilloway,
an officer of the Company until the time of his death on February 18, 2001. The
lease which commenced on July 1, 1995 for a term of five years provided for a
monthly base rent of $4,716 (with increases based on increases in the consumer
price index) which include costs associated with real estate taxes, maintenance
and utilities. During December 2000 the lease was extended for an additional
term of five years effective as of July 1, 2000 with a monthly base rent of
$4,643 (with increases on June 30th of each year based on increases in the
Producer Price Index). All other terms remain the same. The related expense for
this lease for the years ended September 30, 2004, 2003 and 2002 was $60,517,
$59,608 and $57,740, respectively. As of September 30, 2004, the Company was
current on all rental obligations due the related party.
The Company has also entered into leases for certain equipment under operating
lease agreements with terms ranging between two and four years.
A schedule of future minimum payments under all operating leases is as follows:
Years ending September 30,
--------------------------
Related Other
Party Operating
------------ ------------
2005 $ 46,400 $ 22,244
2006 -- 14,958
2007 -- 9,147
2008 -- 680
------------ ------------
$ 46,400 $ 47,029
============ ============
10. MAJOR CUSTOMERS
For the years ended September 30, 2004, 2003 and 2002, a significant part of the
Company's revenues were derived from one major customer pursuant to a
distribution agreement under which the Company granted the exclusive right to
sell its electrosurgical systems and other products developed by the Company in
the field of neurosurgery. Revenues derived from this customer are approximately
as follows:
Percent of
Total
Revenues Revenues
-------- --------
Year ended September 30, 2004 $ 4,099,000 86%
Year ended September 30, 2003 $ 4,231,000 95%
Year ended September 30, 2002 $ 4,515,000 90%
F-21
VALLEY FORGE SCIENTIFIC CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
10. MAJOR CUSTOMERS (Continued)
At September 30, 2004 and 2003, this customer accounted for approximately 87%
and 93%, respectively, of the Company's accounts receivable.
11. STOCKHOLDERS' EQUITY
Common Stock
------------
On August 26, 1999, the Company filed an amended and restated Certificate of
Incorporation increasing the shares of Common Stock the Company is authorized to
issue from 10,000,000 to 20,000,000 shares with no stated par value.
The holders of Common Stock have no preemptive rights and the Common Stock has
no redemption, sinking fund or conversion provisions. Each share of Common Stock
is entitled to one vote on any matter submitted to the holders and to equal
rights in the assets of the Company upon liquidation. All of the outstanding
shares of Common Stock are fully paid and nonassessable.
In April 2000, the Board of Directors of the Company approved a stock repurchase
program continuing a prior program whereby the Company may, from time to time,
repurchase on the open market up to 200,000 shares of the Company's Common
Stock. In August 2002, the Board of Directors of the Company voted to terminate
the then existing program and approved a new program for the repurchase of up to
200,000 shares of the Company's Common Stock. During the fiscal years ended
September 30, 2004, 2003 and 2002, the Company repurchased for retirement - 0 -
, 127,600 and 26,500 shares at an aggregate cost of $ - 0 - , $173,316 and
$46,878, respectively.
Preferred Stock
---------------
The Company is authorized to issue 487 shares of preferred stock, $1,000 par
value. The holders of the preferred stock would have no voting rights or
preemptive rights. Upon liquidation of the Company, a $1,000 per share
liquidating dividend must be paid upon each issued and outstanding share of
preferred stock before any liquidating dividend is paid on the Common Stock. For
each of the years ended September 30, 2004, 2003 and 2002, there were no issued
or outstanding preferred shares, and the Company has no intention to issue any
preferred stock in the immediate future.
F-22
VALLEY FORGE SCIENTIFIC CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
12. EARNINGS PER SHARE
For the Years Ended
September 30,
------------------------------------
2004 2003 2002
---------- ---------- ----------
Basic Income Per Share:
Income available to common
shareholders $ 111,420 $ 108,925 $ 380,527
========== ========== ==========
Weighted average shares outstanding 7,913,712 7,960,676 8,067,286
========== ========== ==========
Basic Income Per Share $ 0.01 $ 0.01 $ 0.05
========== ========== ==========
Diluted Income Per Share:
Income available to common
shareholders $ 111,420 $ 108,925 $ 380,527
========== ========== ==========
Weighted average shares outstanding 7,913,712 7,960,676 8,067,286
Dilutive shares issuable in connection
with stock plans 63,121 25,772 87,284
---------- ---------- ----------
Diluted weighted average common
shares outstanding 7,976,833 7,986,448 8,154,570
========== ========== ==========
Diluted Income Per Share $ 0.01 $ 0.01 $ 0.05
========== ========== ==========
Options to purchase 507,250, 479,850 and 517,850 shares of common stock were
outstanding at September 30, 2004, 2003 and 2002, respectively, and 302,250,
314,850 and 68,100 of these shares were not included in the computation of
diluted earnings per share in accordance with SFAS 128, as the potential shares
are considered anti-dilutive.
F-23
VALLEY FORGE SCIENTIFIC CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
13. PROVISION FOR INCOME TAXES
Provision for income taxes is as follows:
For the Years Ended
September 30,
-------------------------------------
2004 2003 2002
---------- ---------- ----------
Current:
Federal $ 81,350 $ 19,075 $ 204,500
State 32,550 12,790 40,200
---------- ---------- ----------
113,900 31,865 244,700
---------- ---------- ----------
Deferred:
Federal (21,840) 18,392 20,703
State (2,396) 7,696 9,181
---------- ---------- ----------
(24,236) 26,088 29,884
---------- ---------- ----------
$ 89,664 $ 57,953 $ 274,584
========== ========== ==========
The Company's effective tax rate was 44.6%, 34.7% and 41.9% for the years ended
September 30, 2004, 2003 and 2002, respectively. Reconciliation of income tax at
the statutory rate to the Company's effective rate is as follows:
For the Years Ended
September 30,
-------------------------------------------
2004 2003 2002
-------- -------- --------
Computed at the statutory rate 30.7 % 28.3 % 34.0 %
State taxes net of federal tax benefit 6.9 7.2 6.6
Other 7.0 (0.8) 1.3
-------- -------- --------
44.6 % 34.7 % 41.9 %
======== ======== ========
F-24
VALLEY FORCE SCIENTIFIC CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
13. PROVISION FOR INCOME TAXES (Continued)
Certain items of income and expense are recognized in different years for
financial reporting and income tax purposes. Deferred income taxes are provided
in recognition of these temporary differences. The items that give rise to
deferred income taxes are as follows:
September 30,
-----------------------
2004 2003
---------- ----------
Deferred Tax Assets:
Difference in capitalization of inventory cost $ 73,468 $ 50,670
Difference in reporting bad debts 6,284 761
---------- ----------
Total Deferred Income Taxes $ 79,752 $ 51,431
========== ==========
Deferred Tax Liability:
Difference in reporting depreciation and
amortization on long-term assets $ 15,743 $ 19,950
---------- ----------
Total Deferred Income Taxes $ 15,743 $ 19,950
========== ==========
14. CONCENTRATIONS OF CREDIT RISK
Financial instruments which potentially subject the Company to concentration of
credit risk consist principally of short-term cash investments and trade
receivables. The Company maintains substantially all of its banking activities
with one bank and cash balances throughout the year generally exceeded the
federally insured limits of the FDIC and SIPC of $100,000. The Company typically
invests cash balances which exceed $100,000 in money market accounts, money
market mutual funds or short-term municipal securities. At September 30, 2004
and 2003, the balances the Company held in these securities was approximately
$2,234,000 and $2,163,000, respectively. As indicated in Note 10, at September
30, 2004 and 2003, accounts receivable from the Company's largest customer
comprised approximately 87% and 93%, respectively, of its net accounts
receivable. Because these receivables are due from a subsidiary of a major
medical products company, and arose from sales pursuant to an agreement with
this company, management believes that its potential credit risk associated with
this receivable is minimal.
F-25
VALLEY FORGE SCIENTIFIC CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
15. QUARTERLY RESULTS (UNAUDITED)
The following table presents selected unaudited quarterly operating results for
the Company's eight quarters ended September 30, 2004 for continuing operations.
The Company believes that all necessary adjustments have been made to present
fairly the related quarterly results.
First Second Third Fourth
Fiscal 2004 Quarter Quarter Quarter Quarter Total
----------- ------------ ------------ ------------ ------------ ------------
Net sales $ 1,199,469 $ 1,132,771 $ 1,274,389 $ 1,149,810 $ 4,756,439
Gross profit 644,165 620,907 652,321 522,742 2,440,135
Income (loss) from
operations 121,858 13,612 109,721 (67,137) 178,054
Net income (loss) 72,979 7,579 65,006 (34,144) 111,420
Basic and diluted net
income (loss) per
common share $ 0.01 $ 0.00 $ 0.01 $ (0.00) $ 0.01
Fiscal 2003
-----------
Net sales $ 1,019,942 $ 1,289,136 $ 1,081,872 $ 1,083,358 $ 4,474,308
Gross profit 486,355 665,733 583,749 473,569 2,209,406
Income from operations 60,639 45,742 43,230 5,816 155,427
Net income 40,139 29,593 37,353 1,840 108,925
Basic and diluted net
income per common
share $ 0.01 $ 0.00 $ 0.01 $ 0.00 $ 0.01
16. SUBSEQUENT EVENTS
On October 22, 2004 the Company executed an Option Agreement with Dr. Leonard I.
Malis, a director and stockholder of the Company, giving the Company the right
to purchase from Dr. Malis his "Malis" trademark as registered with the U.S.
Patent and Trademark Office. The Company paid Dr. Malis $35,000 for this option
which terminates on September 30, 2005. This option is renewable on an annual
basis through October 1, 2008, and the agreement provides a schedule of amounts
that are required to be paid for each annual renewal period. If all renewal
periods are utilized the total that would be paid by the Company to extend the
option through September 30, 2009 would be $175,000. The exercise price of the
option is $4,157,504 that would be paid with an initial payment of $159,904, and
the execution of a note payable to Dr. Malis for $3,997,600 which includes
interest. This note would be secured by a security interest in the Company's
rights to the "Malis" trademark, and certain of the Company's patents.
F-26
VALLEY FORGE SCIENTIFIC CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
16. SUBSEQUENT EVENTS (Continued)
On October 25, 2004 the Company executed a Supply and Distribution Agreement
("the Agreement"), with Stryker Corporation (a Michigan corporation),
("Stryker"), which provides for the Company to supply to Stryker and for Stryker
to distribute exclusively, on a world-wide basis, a generator for the
percutaneous treatment of pain. The Agreement is for a term of five years after
the first acceptance of the generator by Stryker, which was on November 11,
2004.
There is a minimum purchase obligation that is specified by "Agreement Year".
The first Agreement Year commenced on the date of the first acceptance by
Stryker of a generator product delivered by the Company as ready for commercial
sale, which was November 11, 2004, and ends on the last day of the calendar
quarter in which the first anniversary date of such inception date occurs. In
the first Agreement Year Stryker is required to make minimum purchases of
$937,500 comprised of demonstration and commercial sales units. In the second
and third Agreement Years, Stryker is required to make minimum purchases in each
year of $487,500 of commercial sales units.
On or before the beginning of the last calendar quarter of the third Agreement
Year, and each Agreement Year thereafter, the Company and Stryker will conduct
good faith negotiations regarding the minimum purchase obligation for the next
Agreement Year. Also, during the first two months of the last calendar quarter
in any Agreement Year, the Company and Stryker will conduct good faith
negotiations regarding changes in prices that will take effect on the first day
of the ensuing Agreement Year. Any price increase is limited to 3% over the
price in effect for the preceding Agreement Year. The Agreement also provides
Stryker certain rights for other new product concepts developed by the Company
in both pain control and expanded market areas. The Agreement contains various
terms related to the provision of repair services for the product by the Company
and maintenance of spare parts, the distributor's obligation to market the
product, to provide training to sales personnel, and other provisions.
On October 15, 2004, the Company executed a new agreement with Codman &
Shurtleff, Inc., its largest customer, ("Codman"), for the period October 1,
2004 through December 31, 2005. The agreement provides for exclusive worldwide
distribution rights of the Company's existing neurosurgery products in the
fields of neurocranial and neurospinal surgery until March 31, 2005, and
non-exclusive rights in these fields from April 1, 2005 through December 31,
2005. The agreement also includes a price list for the specified products, and a
minimum purchase obligation of $1,000,000 per calendar quarter through March 31,
2005. There is no minimum purchase obligation for the period April 1, 2005
through December 31, 2005. The agreement also provides that the above-indicated
periods of exclusive and nonexclusive distribution rights can each be extended
by mutual consent of the parties.
F-27
VALLEY FORGE SCIENTIFIC CORP.
For Fiscal Year Ended September 30, 2004
FORM 10-K
EXHIBIT INDEX
Exhibit 10.12 Agreement with Codman & Shurtleff, Inc. dated
October 15, 2004.
Exhibit 10.13 Supply and Distribution Agreement with Stryker
Corporation dated October 25, 2004
Exhibit 10.14 Option Agreement for Malis Trademark with Leonard
I. Malis dated October 22, 2004
Exhibit 23 Consent of Samuel Klein and Company
Exhibit 31.1 Certification of Chief Executive Officer and
Principal Financial Officer pursuant to Section
302 of the Sarbanes-Oxley Act of 2002
Exhibit 32.1 Certification of the Chief Executive Officer and
Principal Financial Officer pursuant to Section
906 of the Sarbanes-Oxley Act of 2002