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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended June 30, 2005
[ ] 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.)
3600 Horizon Drive, King of Prussia, Pennsylvania 19406
(Address of principal executive offices and zip code)
Telephone: (484) 690-9000
136 Green Tree Road, Oaks, Pennsylvania 19456
(Former address of Registrant)
Indicate by check mark [X] 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 whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes [ ] No [X]
At August 11, 2005 there were 7,939,712 shares outstanding of the Registrant's
no par value Common Stock.
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VALLEY FORGE SCIENTIFIC CORP.
INDEX TO FORM 10-Q
June 30, 2005
Page
Number
------
Part I - Financial Information
Item 1. Financial Statements:
Balance Sheets - June 30, 2005 (unaudited) and
September 30, 2004 (audited) 1
Unaudited Statements of Operations for the three and nine
months ended June 30, 2005 and June 30, 2004 2
Unaudited Statements of Cash Flows for the nine months
ended June 30, 2005 and June 30, 2004 3
Notes to Financial Statements 4
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations. 15
Item 4. Controls and Procedures 32
Part II - Other Information 33
(i)
VALLEY FORGE SCIENTIFIC CORP. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
June 30, September 30,
2005 2004
(Unaudited) (Audited)
------------- -------------
ASSETS
Current Assets:
Cash and cash equivalents $ 2,386,742 $ 2,322,559
Accounts receivable - net 941,778 646,224
Inventory 792,385 781,604
Loans receivable - stockholder/officer 14,100 41,792
Prepaid items and other current assets 107,510 104,619
Deferred tax assets 89,242 79,752
------------- -------------
Total Current Assets 4,331,757 3,976,550
Property, plant and equipment - net 221,101 147,967
Goodwill 153,616 153,616
Intangible assets - net 187,875 218,398
Loans receivable - stockholder/officer 22,182 -
Other assets 27,477 26,707
------------- -------------
Total Assets $ 4,944,008 $ 4,523,238
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable and accrued expenses $ 423,890 $ 245,828
Income taxes payable 55,713 6,491
Deferred revenue - 5,750
------------- -------------
Total Current Liabilities 479,603 258,069
Deferred Tax Liability 15,313 15,743
------------- -------------
Total Liabilities 494,916 273,812
------------- -------------
Commitment
Stockholders' Equity:
Preferred stock - -
Common stock (no par, 20,000,000 shares authorized,
shares issued and outstanding at June 30, 2005 - 7,939,712 and
September 30, 2004 - 7,913,712) 3,589,130 3,528,530
Retained earnings 859,962 720,896
------------- -------------
Total Stockholders' Equity 4,449,092 4,249,426
------------- -------------
Total Liabilities and Stockholders' Equity $ 4,944,008 $ 4,523,238
============= =============
-1-
--------------------
See accompanying notes to consolidated financial statements.
VALLEY FORGE SCIENTIFIC CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
For the Three Months Ended For the Nine Months Ended
June 30, June 30,
-----------------------------------------------------------
2005 2004 2005 2004
------------ ------------ ------------ ------------
Net Sales $ 1,697,982 $ 1,274,389 $ 4,926,387 $ 3,606,629
Cost of Sales 738,347 622,068 2,221,128 1,689,236
------------ ------------ ------------ ------------
Gross Profit 959,635 652,321 2,705,259 1,917,393
------------ ------------ ------------ ------------
Other Costs:
Selling, general and administrative 526,223 417,699 1,446,665 1,286,244
Merger related professional fees 436,729 - 518,965 -
Research and development 108,307 114,754 454,752 355,662
Amortization 10,175 10,147 30,523 30,296
------------ ------------ ------------ ------------
Total Other Costs 1,081,434 542,600 2,450,905 1,672,202
------------ ------------ ------------ ------------
Income (Loss) from Operations (121,799) 109,721 254,354 245,191
------------ ------------ ------------ ------------
Other Income (Expense)
Settlement of lawsuit - - (150,000) -
Gain from disposition of property 111,674 - 111,674 -
Interest income 11,197 5,868 28,121 16,906
------------ ------------ ------------ ------------
Total Other Income (Expense) 122,871 5,868 (10,205) 16,906
------------ ------------ ------------ ------------
Income before Income Taxes 1,072 115,589 244,149 262,097
Provision for Income Taxes 890 50,583 105,083 116,533
------------ ------------ ------------ ------------
Net Income $ 182 $ 65,006 $ 139,066 $ 145,564
============ ============ ============ ============
Income per Share:
Basic income per common share $ 0.00 $ 0.01 $ 0.02 $ 0.02
============ ============ ============ ============
Diluted income per common share $ 0.00 $ 0.01 $ 0.02 $ 0.02
============ ============ ============ ============
Basic weighted average common shares outstanding 7,919,250 7,913,712 7,915,558 7,913,712
Diluted weighted average common shares outstanding 8,071,672 7,994,955 8,000,895 7,979,467
-2-
--------------------
See accompanying notes to consolidated financial statements.
VALLEY FORGE SCIENTIFIC CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
For the Nine Months Ended
June 30,
----------------------------
2005 2004
------------ ------------
Cash Flows from Operating Activities:
Net income $ 139,066 $ 145,564
Adjustments to reconcile net income to net cash
(used in) operating activities:
Depreciation and amortization 54,571 52,659
Gain from disposition of property (111,674) -
Interest accrued on loans and advances to
employees and related parties (1,540) (1,722)
Provision for obsolete and slow-moving inventory - 58,761
Deferred income taxes (9,490) (28,562)
Changes in assets and liabilities:
(Increase) decrease in:
Accounts receivable (295,554) (393,334)
Inventory (10,781) (127,033)
Prepaid items and other current assets (2,891) 136,482
Other assets (770) (1,158)
Increase (decrease) in:
Accounts payable and accrued expenses
and income taxes payable 227,284 70,320
Deferred tax liabilities (430) (504)
Deferred revenue (5,750) 9,660
------------ ------------
Net cash (used in) operating activities (17,959) (78,867)
------------ ------------
Cash Flows from Investing Activities:
Purchases of property, plant and equipment (171,296) (9,842)
Proceeds from disposition of property (net of closing cost) 185,788 -
Proceeds from repayments of loans to stockholder 7,050 6,500
Costs related to patent application - (1,385)
------------ ------------
Net cash provided by (used in) investing activities 21,542 (4,727)
------------ ------------
Cash Flows from Financing Activities:
Proceeds from exercise of options 60,600 -
------------ ------------
Net cash provided by financing activities 60,600 -
------------ ------------
Net Change in Cash and Cash Equivalents 64,183 (83,594)
Cash and Cash Equivalents - Beginning of Period 2,322,559 2,305,556
------------ ------------
Cash and Cash Equivalents - End of Period $ 2,386,742 $ 2,221,962
============ ============
Schedule of non-cash operating and investing activities:
Use of deposit for acquisition of property,
plant and equipment $ 14,400 $ -
============ ============
Supplemental Disclosures of Cash Flow Information:
Cash paid during the period for:
Income taxes $ 70,056 $ 11,700
Interest - -
-3-
--------------------
See accompanying notes to consolidated financial statements.
VALLEY FORGE SCIENTIFIC CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
JUNE 30, 2005
NOTE 1 - DESCRIPTION OF BUSINESS:
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 Electronic Corporation, a company which was merged with and into
VFSC on August 31, 1994. Collectively, VFSC and DEC are referred to herein as
the "Company".
On May 2, 2005, the Company entered into a merger agreement with Synergetics,
Inc. ("Synergetics"), a privately-held corporation, to combine the two
companies. Under the terms of the merger agreement, the stockholders of
Synergetics' will receive approximately 16 million shares of the Company's
common stock. As a result of the merger, the former stockholders of Synergetics
will represent approximately 66% of the Company's outstanding common stock on a
fully diluted basis. The merger is subject to the satisfaction of a number of
closing conditions, including stockholder and regulatory approvals.
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
Principles of Consolidation and Basis of Presentation
-----------------------------------------------------
The accompanying financial statements consolidate the accounts of VFSC and its
wholly-owned subsidiary. All significant intercompany accounts and transactions
have been eliminated in consolidation.
The accompanying unaudited consolidated financial statements have been prepared
pursuant to rules and regulations of the Securities and Exchange Commission and,
therefore, do not include all information and footnote disclosures normally
included in audited financial statements. However, in the opinion of management,
all adjustments that are of a normal and recurring nature, necessary to present
fairly the results of operations, financial position, and cash flows have been
made. It is suggested that these statements be read in conjunction with the
financial statements included in the Company's Annual Report on Form 10-K for
the year ended September 30, 2004.
The statements of operations for the three and nine months ended June 30, 2005
are not necessarily indicative of results for the full year.
-4-
VALLEY FORGE SCIENTIFIC CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
JUNE 30, 2005
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED):
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 are computed by dividing income available to common
stockholders by the weighted average number of common shares outstanding.
Diluted earnings per share reflect 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.
Recently Issued Accounting Standards
------------------------------------
In December 2004, the FASB issued SFAS No. 123(R), "Share-Based Payment," which
replaces SFAS 123, "Accounting for Stock-Based Compensation" ("SFAS No. 123"),
and supersedes Accounting Principles Board Opinion No. 25, "Accounting for Stock
Issued to Employees" ("APB No. 25"). SFAS 123(R) requires companies to recognize
in their income statement the grant-date fair value of stock options and other
equity-based compensation issued to employees. The Company is required to adopt
SFAS 123(R) beginning January 1, 2006. Grant-date fair value will be determined
using one of two acceptable valuation models. This Standard requires that
compensation expense for most equity-based awards be recognized over the
requisite service period, usually the vesting period; while compensation expense
for liability-based awards (those usually settled in cash rather than stock) be
re-measured to fair-value at each balance sheet date until the award is settled.
The Standard also provides guidance as to the accounting treatment for income
taxes related to such compensation costs, as well as transition issues related
to adopting the new Standard. The Company has been using the intrinsic value
method as set forth under APB No. 25 with no stock-based compensation cost
reflected in net earnings while complying with footnote disclosure requirements
of SFAS No. 123 setting forth the pro forma effect on net earnings of applying
fair value recognition to stock based awards. The Company is currently
evaluating the impact on its operations of the adoption SFAS 123(R).
In December 2004, the FASB issued SFAS No. 153, "Exchange of Non-monetary Assets
an amendment of APB Opinion No. 29." This Statement precludes companies from
using the "similar productive assets" criteria to account for non-monetary
exchanges at book value with no gain or loss being recognized. Effective for
fiscal periods beginning after June 15, 2005, all companies will be required to
use fair value for most non-monetary exchanges, recognizing gain or loss, if the
transaction meets commercial, substance criteria. The Company does not expect
this Standard to have a significant impact on its current consolidated financial
statements.
-5-
VALLEY FORGE SCIENTIFIC CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
JUNE 30, 2005
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED):
Recently Issued Accounting Standards (Continued)
------------------------------------------------
In November 2004, the FASB issued Statement No. 151, "Inventory Costs, an
amendment of ARB 43, Chapter 4" ("SFAS 151"), to clarify the accounting for
abnormal amounts of idle facility expense, freight, handling costs, and wasted
materials (spoilage). ARB 43 allowed some of these "abnormal costs" to be
carried as inventory, whereas the new Standard requires that these costs be
expensed as incurred. This Statement is effective for fiscal years beginning
after June 15, 2005. The Company is currently evaluating what effect, if any,
this standard will have on its current consolidated financial statements.
In December 2004, the FASB issued FSP FAS 109-1, "Application of FASB Statement
No. 109, "Accounting for Income Taxes," to the "Tax Deduction on Qualified
Production Activities Provided by the American Jobs Creation Act of 2004" to
provide accounting guidance on the appropriate treatment of tax benefits
generated by the enactment of the Act. The FSP requires that the manufacturer's
deduction be treated as a special deduction in accordance with SFAS 109 and not
as a tax rate reduction. The Company is awaiting final tax regulations from the
IRS before completing its assessment of the impact of adopting FSP FAS 109-1 on
its current consolidated financial statements.
Stock-Based Compensation
------------------------
In December 2002, the FASB issued Statement of Financial Accounting Standards
("SFAS") No. 148, "Accounting for Stock-Based Compensation - Transition and
Disclosure - an amendment of FASB Statement No. 123." SFAS No. 148 amended SFAS
No. 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 No. 148
amended the disclosure requirements of SFAS No. 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 No. 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. Accordingly, the adoption of SFAS No. 148 did not
have a significant impact on the Company's results of operations or financial
position.
-6-
VALLEY FORGE SCIENTIFIC CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
JUNE 30, 2005
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED):
Stock-Based Compensation (Continued)
------------------------------------
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 addition, option pricing models require the input
of highly subjective assumptions, including expected stock price volatility.
For purposes of pro forma disclosures, the estimated fair value of the options
is amortized to expense over the options' vesting period. In accordance with
SFAS 123 and 148, only stock options granted after September 30, 1995, have been
included for the Company's pro forma information as follows:
Three Months Ended Nine Months Ended
June 30, June 30,
---------------------- ---------------------
2005 2004 2005 2004
--------- --------- --------- ---------
Net income - as reported $ 182 $ 65,006 $ 139,066 $ 145,564
Less: total compensation expense
determined under fair value
based method - net of tax effect 51,545 9,839 70,131 54,981
--------- --------- --------- ---------
Pro Forma Net Income (Loss) $ (51,363) $ 55,167 $ 68,935 $ 90,583
========= ========= ========= =========
Pro Forma Income (Loss) Per Share:
Basic $ (0.01) $ 0.01 $ 0.01 $ 0.01
Diluted $ (0.01) $ 0.01 $ 0.01 $ 0.01
Revenue Recognition
-------------------
Product revenue is recognized when the product has been shipped, which is when
title and risk of loss has been transferred to the customer.
-7-
VALLEY FORGE SCIENTIFIC CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
JUNE 30, 2005
NOTE 3 - DISTRIBUTION AGREEMENTS:
The Company sells its products to U.S. based national and international
distributors and dealers including those as described below:
Codman and Shurtleff, Inc. ("Codman")
-------------------------------------
A significant part of the Company's sales were made pursuant to a distribution
agreement with Codman, an affiliate of a major medical company and the Company's
largest customer. On October 15, 2004, the Company executed a new agreement with
Codman for the period October 1, 2004 through December 31, 2005. The agreement,
as amended, provides for exclusive worldwide distribution rights of the
Company's existing neurosurgery products in the fields of neurocranial and
neurospinal surgery until July 15, 2005, and non-exclusive rights in these
fields from July 15, 2005 through December 31, 2005. The agreement also provides
that the distribution agreement can each be extended by mutual consent of the
parties.
Stryker Corporation ("Stryker")
-------------------------------
On October 25, 2004, the Company executed a Supply and Distribution Agreement
("the Agreement") with Stryker (a Michigan corporation) 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.
-8-
VALLEY FORGE SCIENTIFIC CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
JUNE 30, 2005
NOTE 3 - DISTRIBUTION AGREEMENTS (CONTINUED):
Stryker Corporation ("Stryker") (Continued)
-------------------------------------------
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
$900,000 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 $500,000 of commercial sales units. After only eight months into the
first Agreement Year, Stryker has already exceeded the minimum purchases for the
first Agreement Year.
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. 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.
NOTE 4 - OPTION AGREEMENT:
On October 22, 2004, the Company entered into 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 (R) trademark at any time over a
period of five years. The Company paid Dr. Malis $35,000 for the option and is
required to pay an annual fee before each anniversary of the option agreement in
the amount of $20,000 for each of the first two anniversaries and increasing to
$60,000 before the fourth anniversary in order to keep the option in effect from
year to year. The exercise price of the option is $4,157,504, which includes
interest, and will be payable in 26 quarterly installments of $159,904, which
will be evidenced by a promissory note payable to Dr. Malis. This note would be
secured by a security interest in the Company's rights to the Malis (R)
trademark and certain of the Company's patents.
-9-
VALLEY FORGE SCIENTIFIC CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
JUNE 30, 2005
NOTE 5 - SUPPLEMENTAL BALANCE SHEET INFORMATION:
Accounts Receivable - Net
-------------------------
June 30, September 30,
2005 2004
------------ ------------
(Unaudited) (Audited)
Accounts receivable $ 957,258 $ 661,704
Less: Allowances 15,480 15,480
------------ ------------
Accounts receivable - net $ 941,778 $ 646,224
============ ============
Inventory
---------
June 30, September 30,
2005 2004
------------ ------------
(Unaudited) (Audited)
Finished goods $ 57,178 $ 94,405
Work-in-process 371,858 396,810
Materials and parts 516,165 424,052
------------ ------------
945,201 915,267
Less: Allowances for slow moving
and obsolete inventory 152,816 133,663
------------ ------------
$ 792,385 $ 781,604
============ ============
-10-
VALLEY FORGE SCIENTIFIC CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
JUNE 30, 2005
NOTE 5 - SUPPLEMENTAL BALANCE SHEET INFORMATION (CONTINUED):
Property, Plant and Equipment - Net
-----------------------------------
Useful Life June 30, September 30,
(Years) 2005 2004
--------------- --------------- --------------
(Unaudited) (Audited)
Furniture and fixtures 5 - 7 $ 17,953 $ 17,953
Laboratory equipment 5 - 10 463,652 378,159
Office equipment 5 193,312 185,530
Leasehold improvements 3 - 5 87,194 9,413
Land - - 11,953
Buildings and improvements 15 - 39 - 103,467
--------------- --------------
762,111 706,475
Less: Accumulated depreciation
and amortization 541,010 558,508
--------------- --------------
$ 221,101 $ 147,967
=============== ==============
Depreciation amounted to $8,609 and $7,318 for the three months ended June 30,
2005 and 2004, respectively, and $24,048 and $22,363 for the nine months ended
June 30, 2005 and 2004, respectively.
On June 27, 2005, the Company sold all of the property and certain equipment of
DEC for $185,788. The income recognized by the Company is $111,674, before
moving costs and taxes.
-11-
VALLEY FORGE SCIENTIFIC CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
JUNE 30, 2005
NOTE 5 - SUPPLEMENTAL BALANCE SHEET INFORMATION (CONTINUED):
Goodwill and Intangible Assets
------------------------------
In accordance with SFAS 142, goodwill has been reflected on the balance sheet
separate from other intangible assets which continue to be amortized. No change
in the carrying amount of goodwill was made for the quarter ended June 30, 2005.
The Company completed its annual impairment test during the quarter ended March
31, 2005 and no impairment was identified.
Information regarding the Company's other intangible assets is as follows:
Goodwill and Intangible Assets
------------------------------
June 30, 2005 (Unaudited) September 30, 2004 (Audited)
--------------------------------------- ---------------------------------------
Gross Gross
Carrying Accumulated Carrying Accumulated
Value Amortization Net Value Amortization Net
----------- ----------- ----------- ----------- ----------- -----------
Patents, trademarks and
licensing agreements $ 573,804 $ 511,583 $ 62,221 $ 573,804 $ 503,678 $ 70,126
Proprietary know-how 452,354 326,700 125,654 452,354 304,082 148,272
Acquisition costs 55,969 55,969 - 55,969 55,969 -
----------- ----------- ----------- ----------- ----------- -----------
$ 1,082,127 $ 894,252 $ 187,875 $ 1,082,127 $ 863,729 $ 218,398
=========== =========== =========== =========== =========== ===========
Amortization expense of intangible assets amounted to $10,175 and $10,147 for
the three months ended June 30, 2005 and 2004, respectively, and $30,523 and
$30,296 for the nine months ended June 30, 2005 and 2004, respectively.
Annual amortization expense is estimated to be $40,800 for fiscal 2005, $40,800
for fiscal 2006, $40,700 for fiscal 2007, $40,100 for fiscal 2008, $34,900 for
fiscal 2009 and $21,100 thereafter.
-12-
VALLEY FORGE SCIENTIFIC CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
JUNE 30, 2005
NOTE 6 - LOANS RECEIVABLE - STOCKHOLDER/OFFICER:
Loans receivable - stockholder/officer represent various loans to Jerry L.
Malis, a principal stockholder, director and officer of the Company. The loans
bear interest at rates of 4.83% to 6.97% and are payable in either quarterly
installments of $3,525 or annual installments of $14,100 until the principal and
accrued interest have been repaid. At June 30, 2005, loans receivable -
stockholder amounted to $36,282. At June 30, 2005, the stockholder/officer was
current on the loan receivable.
Loans receivable - stockholder/officer are partially secured by 5,833 shares of
the Company's common stock. At June 30, 2005, the pledged common stock has a
value of $23,215.
NOTE 7 - COMMITMENT:
Operating Lease
---------------
The Company leased approximately 4,200 square feet of office and warehouse space
from a general partnership whose partners are Jerry L. Malis, Leonard I. Malis
(principal stockholders, directors and officers of the Company) and the Frances
W. Gilloway Marital Trust. The lease expired June 30, 2005.
The Company entered into a combination sublease and lease commencing on May 1,
2005 for a term of four and one-half years, for office, assembly and
manufacturing space in King of Prussia, Pennsylvania, with an initial annual
rental of $74,858, increasing to $129,437, plus annual operating expenses.
Rent expense amounted to $33,383 and $64,317 for three and nine months ended
June 30, 2005, respectively, and $15,017 and $45,050 for the three and nine
months ended June 30, 2004, respectively. Rent expense to the related entity
amounted to $15,599 and $46,533 for three and nine months ended June 30, 2005,
respectively, and $15,017 and $45,050 for the three and nine months ended June
30, 2004, respectively.
-13-
VALLEY FORGE SCIENTIFIC CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
JUNE 30, 2005
NOTE 8 - EARNINGS PER SHARE:
Three Months Ended Nine Months Ended
June 30, June 30,
------------------------- -------------------------
2005 2004 2005 2004
----------- ----------- ----------- -----------
Income available to common stockholders $ 182 $ 65,006 $ 139,066 $ 145,564
=========== =========== =========== ===========
Weighted average common shares
outstanding - basic 7,919,250 7,913,712 7,915,558 7,913,712
Net effect of dilutive shares issuable in
connection with stock plans 152,422 81,243 85,337 65,755
----------- ----------- ----------- -----------
Weighted average common shares
outstanding - diluted 8,071,672 7,994,955 8,000,895 7,979,467
=========== =========== =========== ===========
Earnings Per Share:
Basic $ 0.00 $ 0.01 $ 0.02 $ 0.02
Diluted $ 0.00 $ 0.01 $ 0.02 $ 0.02
Options to purchase 431,500 and 507,250 shares of common stock were outstanding
on June 30, 2005 and 2004, respectively. Of these shares, 279,078 and 426,007
shares were not included in the computation of diluted earnings per share for
the three months ended June 30, 2005 and 2004, and 346,163 and 441,496 of these
shares were not included in the computation of diluted earnings per share for
the nine months ended June 30, 2005 and 2004, respectively, in accordance with
SFAS 128, as the issuance prices were in excess of the average market price for
the period.
-14-
Item 2. 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 quarterly and nine
month periods ended June 30, 2005 and 2004. This section should be read in
conjunction with the financial statements and related notes in Item 1 of this
report and Valley Forge Scientific Corp.'s annual report on Form 10-K for the
year ended September 30, 2004, which has been filed with the Securities and
Exchange Commission. 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". Unless the context requires otherwise, references
to "we", "us", "our" and "Valley Forge Scientific" refer to Valley Forge
Scientific Corp.
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
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. In the first quarter
of fiscal 2005, we commenced selling to Stryker Corporation a lesion generator
for the percutaneous treatment of pain. We plan to expand the market for our
products with the introduction of 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 is designed to replace other surgical tools, such as
monopolar electrosurgical systems and lasers, in certain applications.
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 in irrigated fields.
Merger Agreement with Synergetics, Inc.
---------------------------------------
On May 2, 2005, we entered into a merger agreement with Synergetics, Inc.,
a privately-held corporation, that is involved in the development, manufacture,
distribution and sale of durable and disposable instruments for use in retina
surgery, neurosurgery and other microsurgery markets. Pursuant to the terms of
the merger agreement, Synergetics' shareholders will receive, in the
-15-
aggregate, approximately 16 million fully paid and nonassessable shares of
Valley Forge's common stock, no par value, or approximately 66% of Valley
Forge's then outstanding common stock on a fully diluted basis. Completion of
the merger is subject to several conditions, including approval by shareholders
of each company, effectiveness of a Form S-4 registration statement, and other
customary closing conditions. Additionally, the merger agreement may be
terminated by Valley Forge or Synergetics upon the occurrence or failure to
occur of certain events, including a failure of the merger to be consummated by
September 30, 2005. In the event of such termination, under certain
circumstances, Valley Forge and Synergetics may be required to pay each other a
break-up fee of $1 million as set forth in the merger agreement.
The merger agreement provides that the board of directors of Valley Forge
following the merger will consist of seven directors including two current
directors of each of Synergetics and Valley Forge and three additional
independent directors. Four of the seven directors will be independent.
Certain directors, executive officers and shareholders of Valley Forge
holding approximately 35 percent of outstanding shares of Valley Forge's common
stock and directors and executive officers of Synergetics holding approximately
19 percent of shares of Synergetics' common stock have agreed to vote in favor
of the merger, pursuant to voting agreements dated May 2, 2005. A majority of
the outstanding shares of the Valley Forge common stock, and two-thirds of the
outstanding shares of Synergetics' common stock, are required to approve the
merger.
Codman Agreement
----------------
For over 20 years, we have had worldwide exclusive distribution agreements
with Codman & Shurtleff, Inc. ("Codman"), a subsidiary of Johnson & Johnson,
Inc., to market our neurosurgery bipolar electrosurgical systems and other
products in the fields of neurocranial and neurospinal surgery. On October 15,
2004, we entered into a new agreement with Codman defining our business
relationship from October 1, 2004 through December 31, 2005. This Agreement was
amended effective March 1, 2005. Pursuant to that amendment, on July 15, 2005,
the distribution agreement with Codman became a nonexclusive agreement.
Historically, we have derived a significant portion of our sales from sales
to Codman. For the three and nine months ended June 30, 2005, 85% and 74%,
respectively, of our revenue was derived from sales to Codman, and for the
fiscal year ended September 30, 2004, 86% of our revenue was derived from sales
to Codman.
Stryker Agreement
-----------------
On October 25, 2004, we entered into a supply and distribution agreement
with Stryker Corporation for the distribution and sale of a lesion generator
manufactured by Valley Forge for 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 supply and distribution agreement is for
slightly over five years, commencing on November 11, 2004 and ending on March
31, 2009, and grants Stryker exclusive worldwide marketing rights for
distribution and sale of the lesion generator
-16-
for use in percutaneous treatment of pain. In the first year of the agreement,
Stryker has agreed to make minimum purchases of approximately $900,000 for a
combination of sales demonstration units and commercial sale units. In the
second and third years, Stryker has agreed to make minimum purchases of
approximately $500,000 per year for commercial sale units. Minimum purchase
requirements for agreement years four and five are to be determined by the
parties based on market conditions and other factors. After only eight months
into the first year of the supply and distribution agreement, Stryker has
already exceeded the first year minimum purchases of $900,000 as set forth in
that agreement. The agreement also provides Stryker certain rights for other new
product concepts developed by Valley Forge in both pain control and expanded
market areas.
Results of Operations
Results of Operations for the Three and Nine Months Ended June 30, 2005
compared to the Three and Nine Months Ended June 30, 2004.
Summary
Sales of $1,697,982, for the three months, and $4,926,387 for the nine
months, ended June 30, 2005 were 33% and 37% greater, respectively, than sales
of $1,274,389 and $3,606,629, respectively, for the three and nine months ended
June 30, 2004. Primarily as a result of one-time merger related professional
fees of $436,729 for the third quarter of fiscal 2005 and $518,895 for the first
nine months of fiscal 2005, we had an operating loss of $121,799 for third
quarter of fiscal 2005 and operating income of $254,354, as compared to
operating income of $109,721 and $245,191 for the corresponding periods in
fiscal 2004 Net income for the three and nine months ended June 30, 2005 was
$182 and $139,066, respectively, as compared to net income of $65,006 and
$145,564, respectively, for the corresponding periods in fiscal 2004.
Sales
Total Sales and Gross Profit on Sales:
Unaudited Unaudited
Three Months Ended Nine Months Ended
June 30, June 30,
2005 2004 2005 2004
---- ---- ---- ----
Total sales: $1,697,982 $1,274,389 $4,926,387 $3,606,629
Cost of sales: 738,347 622,068 2,221,128 1,689,236
Gross profit on sales: 959,635 652,321 2,705,259 1,917,393
Gross profit as a percentage of sales: 57% 51% 55% 53%
The increase in sales in the third quarter and first nine months of the
2005 fiscal year as compared to the third quarter and first nine months of the
2004 fiscal year reflects increased sales to Stryker of a lesion generator model
we developed for the percutaneous treatment of pain, and increased sales to
Codman. Sales for our dental products decreased for the third quarter and the
first nine months of fiscal 2005.
-17-
For the third quarter of fiscal 2005, sales to Codman accounted for 85% of
our sales and sales to Stryker accounted for 10% of our sales, as compared to
82% and 9%, of our sales, respectively, for the third quarter of fiscal 2004.
For the first nine months of fiscal 2005, sales to Codman accounted for 74% of
our sales and sales to Stryker accounted for 20% of our sales, as compared to
84% and 4% of our sales, respectively, for the first nine months of fiscal 2004.
During the third quarter and first nine months of fiscal 2005, we had sales
to Stryker of $177,730 and $965,779, respectively, pursuant to a supply and
distribution agreement, which we entered into on October 25, 2004. There were
sales of $120,000 and $135,000, respectively, of this product during the third
quarter and first nine months of fiscal 2004. After only eight months into the
first year of the supply and distribution agreement, Stryker has already
exceeded the first year minimum purchases of $900,000 as set forth in that
agreement.
Sales of our neurosurgical products and related services to Codman
increased to $1,438,304 for the three months, and $3,628,436 for the nine
months, ended June 30, 2005 as compared to sales of $1,040,347 and $3,044,868
for the three and nine months ended June 30, 2004. During this time, Codman was
the exclusive distributor of our existing products in fields of neurocranial and
neurospinal surgery. Subsequent to the end of the quarter, effective July 15,
2005, Codman became the nonexclusive worldwide distributor of our existing
products in the fields of neurocranial and neurospinal surgery until December
31, 2005. We anticipate that sales to Codman in the fourth quarter of fiscal
2005 will be at a lower level than the sales to Codman for the third quarter of
fiscal 2005.
For the three and nine months ended June 30, 2005, sales of the Bident(R)
Bipolar Tissue Management System for dental applications were $79,708 and
$298,879, respectively, or 5% and 6% of sales, respectively, as compared to
$107,948, or 8% of sales, and $398,563, or 11% of sales, respectively, for the
corresponding periods in 2004. We are considering product modifications and
other strategies for our dental products.
-18-
Sales by Medical Field:
The table below sets forth our sales by medical field of "Generators,
Irrigators and Other Products" and "Disposable Products" for the three months
and nine months ended June 30, 2005, and 2004. Sales of "Disposable Products" in
"Other fields" represent sales to Boston Scientific Corporation and direct sales
to hospitals.
For the Three Months For the Nine Months
Ended Ended
June 30, June 30,
2005 2004 2005 2004
---- ---- ---- ----
Generators, Irrigators and
Accessory Products
Neurosurgery field $ 904,770 $ 503,852 $2,122,702 $1,552,478
Dental field 64,583 85,125 251,858 341,755
Pain Control fields 150,000 120,000 937,500 135,000
---------- ---------- ---------- ----------
Total of all fields: $1,119,353 $ 708,977 $3,312,060 $2,029,233
========== ========== ========== ==========
Disposable Products
Neurosurgery field $ 480,484 $ 508,306 $1,338,857 $1,313,030
Dental field 13,960 24,572 43,492 56,809
Other fields 2,240 1,963 15,476 30,218
---------- ---------- ---------- ----------
Total of all fields: $ 496,684 $ 534,841 $1,397,825 $1,400,057
========== ========== ========== ==========
For the third quarter of fiscal 2005, 66% of our sales related to sales of
bipolar electrosurgical generators, irrigators and accessories as compared to
approximately 56% of our sales for the third quarter of fiscal 2004. Sales of
disposable products accounted for approximately 29% of our sales in the third
quarter of fiscal 2005 as compared to approximately 42% of our sales in the
third quarter of fiscal 2004.
For the first nine months of fiscal 2005, 67% of our sales related to sales
of bipolar electrosurgical generators, irrigators and accessories as compared to
approximately 56% of our sales for the first nine months of fiscal 2004. Sales
of disposable products accounted for approximately 28% of our sales in the first
nine months of fiscal 2005, as compared to approximately 39% of our sales in the
first nine months of fiscal 2004.
Cost of Sales
Cost of sales was 43% of sales for the three months, and 45% for the nine
months, ended June 30, 2005 as compared to 49% and 47% of sales for the three
months and nine months ended June 30, 2004. Gross margin was 57% for the three
months, and 55% for the nine months, ended June 30, 2005 as compared to 51% for
the three months, and 53% for the nine months, ended June 30, 2004. The higher
gross margin for the three months and nine months ended June 30, 2005 reflects
higher sales volume and different product mix.
-19-
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 by 26%, or $108,524,
to $526,223 for the third quarter and by 12%, or $160,421, to $1,446,665 for the
first nine months of fiscal 2005, as compared to $417,699 and $1,286,244,
respectively, for the comparable periods in fiscal 2004. For the third quarter
of fiscal 2005, rent expense increased as a result of our entering into a lease
for new corporate offices and assembly, engineering and manufacturing facility
in King of Prussia, Pennsylvania effective May 1, 2005. The increase in selling,
general and administrative expenses also reflects one-time expenses, which we
incurred in the third quarter of fiscal 2005, in connection with relocating to
this facility in late June and early July of 2005. Our future rent expense under
this new lease will be greater than our rent expense for the facilities that it
replaced.
We incurred professional fees in connection with the merger agreement with
Synergetics of approximately $437,000 for the third quarter, and $519,000 for
the first nine months, of fiscal 2005. It is expected that we will incur
additional professional fees and printing costs in connection with the merger in
the fourth quarter of fiscal 2005.
Research and development expenses were $108,307 for the three months, and
$454,752 for the nine months, ended June 30, 2005, as compared to $114,754 for
the three months, and $355,662 for the nine months, ended June 30, 2004. We will
continue to invest in research and development to expand our technological base
for use in both existing and additional clinical fields.
Other Income (Expenses)
In the third quarter of fiscal 2005, we realized a gain of $111,674 from
the sale of our assembly, engineering and manufacturing in Philadelphia,
Pennsylvania by our wholly-owned subsidiary, Diversified Electronics Company,
Inc.
In the second quarter of fiscal 2005, we recorded an expense of $150,000 in
connection with the lawsuit entitled Jeffrey Turner and Cathryn Turner v.
Phoenix Children's Hospital, Inc. , et al., in which Valley Forge was one of the
defendants. In April 2005, without admitting liability in this disputed claim,
and as a precondition to Valley Forge's merger agreement with Synergetics, a
settlement agreement and release was entered into in which we paid $150,000
towards plaintiff's expenses in the lawsuit.
-20-
Income Tax Provision
The provision for income taxes was $890 for the three months, and $105,083
for the nine months, ended June 30, 2005 as compared to $50,583 for the three
months, and $116,533 for the nine months, ended June 30, 2004.
Net Income
Net income decreased to $182 for the three months, and $139,066 for the
nine months, ended June 30, 2005, as compared to net income of $65,006 for the
three months, and $145,564 for the nine months, ended June 30, 2004. Basic and
diluted income per share was $0.00 for the three months, and $0.02 for the nine
months, ended June 30, 2005 as compared to $0.01 for the three months, and $0.02
for the nine months, ended June 30, 2004.
Liquidity and Capital Resources
At June 30, 2005, we had $3,852,154 in working capital compared to
$3,718,481 at September 30, 2004 and $3,746,333 at June 30, 2004. The primary
measures of our liquidity are cash, cash equivalents, accounts receivable and
inventory balances. The cash equivalents are highly liquid with original
maturities of ninety days or less.
Cash used in operating activities was $17,959 for the nine months ended
June 30, 2005 as compared to cash used of $78,867 for the nine months ended June
30, 2004. The cash used in operating activities for the first nine months of
fiscal 2005 was mainly attributable to an increase in accounts receivable of
$295,554 and an increase in inventory of $10,781, partially offset by an
increase in accounts payable, accrued expenses and income taxes payable of
$227,284.
In the first nine months of fiscal 2005, accounts receivable net of
allowances increased by $295,554 to $941,778 at June 30, 2005 from $646,224 at
September 30, 2004. The increase in accounts receivable was principally due to
increased sales.
In the first nine months of fiscal 2005, inventories increased by $10,781
to $792,385 at June 30, 2005 from $781,604 at September 30, 2004.
The increase in accounts payable reflects increases in material purchases
due to increased sales volume and merger related expenses.
For the nine months ended June 30, 2005, our investing activities provided
$21,542, which was attributable primarily to the net proceeds of $185,788 we
received from the disposition of our manufacturing facility in Philadelphia,
Pennsylvania by our wholly-owned subsidiary, Diversified Electronics Company,
Inc., net of $171,296 primarily for the purchase of equipment and building
improvements in connection with the lease of our new facility in King of
Prussia, Pennsylvania. Net property and equipment increased to $221,101 at June
30, 2005 as compared to $147,967 at September 30, 2004.
-21-
In the third quarter of fiscal 2005, we entered into a combination sublease
and lease, commencing on May 1, 2005, for a term of four and one-half years, for
approximately 13,500 square feet of office, assembly, engineering and
manufacturing space in King of Prussia, Pennsylvania, with an initial annual
rent of $74,858, increasing to $129,437, plus annual operating expenses. In late
June and early July 2005, we moved both our Philadelphia, Pennsylvania
manufacturing, engineering and assembly facility and our Oaks, Pennsylvania
offices into this facility.
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 the third
quarter of fiscal 2005 pursuant to this plan. 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.
At June 30, 2005, we had cash and cash equivalents of $2,386,742. 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 $3,400,000. Our current tangible net worth exceeds $3,400,000 at June
30, 2005. As of June 30, 2005, there was no outstanding balance on this line.
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.
-22-
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, which consist of raw materials, work-in-process and finished
goods, and include purchased materials, direct and indirect labor and direct and
indirect 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
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 sales 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
-23-
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 may be 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, as we are not aware of any such claims or lawsuits. Our financial
statements do reflect the settlement of the lawsuit entitled Jeffrey Turner and
Cathryn Turner v. Phoenix Children's Hospital, Inc., et al.
Goodwill Impairment
We perform goodwill impairment tests on an annual basis and as needed 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.
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.
-24-
SPECIAL NOTE REGARDING FORWARD LOOKING STATEMENTS
-------------------------------------------------
The information provided in this Quarterly Report on Form 10-Q 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 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 competitive, regulatory and market conditions;
o the performance of new products and the continued acceptance of
current products in the marketplace;
o the execution of strategic initiatives and alliances;
o disruptions caused by moving our assembly, engineering and
manufacturing facility;
o the market penetration by third parties who distribute and sell our
products;
o our ability to maintain a sufficient supply of products;
o product liability claims;
o the uncertainties associated with intellectual property protection for
our products;
o the possibility that the merger transaction with Synergetics will not
close or that the closing will be delayed due to the regulatory review
or other factors;
o the challenges and costs of combining the operations and personnel of
Synergetics with Valley Forge after a closing of the merger agreement;
o the ability to attract and retain highly qualified employees;
o competitive factors, including pricing pressures;
o reactions of customers of Valley Forge and Synergetics and end-users
of Valley Forge and Synergetics products to the merger transaction and
related risks of maintaining pre-existing relationships of Valley
Forge and Synergetics;
o adverse changes in general economic or market conditions;
o other one-time events;
o other important factors disclosed previously and from time to time in
Valley Forge's filings with the SEC; and
o other risk factors described in the sections entitled "Factors That
Might Affect Future Results" in this report.
Readers are cautioned not to rely on these forward looking statements. We
do not intend to update or revise these forward looking statements.
-25-
FACTORS THAT MIGHT AFFECT FUTURE RESULTS
----------------------------------------
We currently rely on our relationship with a single customer for a significant
portion of our revenues, which makes our financial position and operating
results vulnerable to the loss of that customer.
Our most important relationship is with Codman, an affiliate of Johnson &
Johnson, for the sale of our neurosurgery products. Sales to Codman accounted
for 85% of our sales for the first nine months of fiscal 2005, 86% of our sales
in fiscal year 2004, and 95% and 90% of our sales in fiscal years 2003 and 2002,
respectively. Under our agreement with Codman, our exclusive distributorship
relationship expired on July 15, 2005. In addition, the agreement will expire on
December 31, 2005, or earlier, pursuant to the terms of the agreement.
The impact to us of the expiration of our exclusive relationship with
Codman, and the corresponding termination of Codman's minimum purchase
obligations under the agreement, is uncertain. If we are unable to establish
alternative or additional channels of distribution for our products, we may be
unable to achieve the same revenue levels as those that have historically
resulted from our relationship with Codman. In addition, any continuation of the
distribution agreement with Codman beyond December 31, 2005 could be on terms
less favorable than the existing distribution agreement with Codman.
If any of our single source suppliers were to cease providing components, we may
not be able to produce our products.
We currently subcontract for the manufacturing of our disposable cord and
tubing sets with a single manufacturer. If this supplier becomes unwilling or
unable to provide products or components in the required volumes and quality
levels or in a timely manner, we would be required to locate and contract with
substitute suppliers. Although we believe that alternative sources for many of
these components and raw materials are available, we could have difficulty
identifying a substitute supplier in a timely manner or on commercially
reasonable terms and may have to pay higher prices to obtain the necessary
materials. Any supply interruption could harm our ability to manufacture our
products until a new source of supply is identified and qualified.
We have also become aware that the manufacturers of several parts used in
our currently available bipolar electrosurgical generator models will no longer
be manufacturing these parts in the near future. While we have arranged to
purchase and maintain a significant inventory of these parts and are developing
alternatives for these parts, our efforts may not be sufficient depending on our
unit sales. Alternative parts, if available, would require engineering redesign
and may require regulatory approval before the manufacture of additional new
units. In addition, in the event that we determine to continue the manufacture
and sale of the existing product line together with our new multifunctional
bipolar electrosurgical generator, such redesign, part sourcing and regulatory
approval may also be required.
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The medical device industry is highly competitive, and we may be unable to
compete effectively with other companies.
The medical technology industry is characterized by intense competition. We
compete with established medical technology and 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. 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 treatments have a long history of use.
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
compete effectively against current technology as well as to respond effectively
to technological advances.
Our future results are dependent, in part, upon the successful introduction of
our new multifunctional bipolar electrosurgical generator.
Our future success, in a large part, may depend upon the successful launch
of our new multifunctional bipolar electrosurgical generator and new proprietary
single-use, hand-switching bipolar instruments. While we believe that this new
generator and related instruments represent significant advancements in
technology and performance and will replace other surgical tools in certain
applications, such as monopolar electrosurgical systems and lasers, their
success in the marketplace is dependent upon several factors including:
o the completion of the design and testing;
o their acceptance by surgeons;
o the recognition by hospitals and surgical centers that the new
generator and instruments are sufficiently improved and beneficial to
warrant the cost of acquisition and training;
o our ability to create a sales network;
o our ability to sustain our average selling price through this network;
and
o the reaction of our competitors in this market.
Our products may not be accepted in the market.
We cannot be certain that our current products or any other products that
we may develop or market will achieve or maintain market acceptance. We cannot
be certain that our devices and procedures they perform 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
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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.
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.
If we do not introduce new commercially successful products in a timely manner,
our products may become obsolete over time, thereby decreasing our revenue and
profitability.
Demand for our products may change because of evolving customer needs, the
introduction of new products and technologies, the discovery of cures for
certain medical problems, evolving surgical practices and evolving industry
standards. Without the timely introduction of new commercially successful
products and enhancements, our products may become obsolete over time, causing
our sales and operating results to suffer. The success of our new products will
depend on several factors, including our ability to:
o properly identify and anticipate customer needs;
o commercialize new products in a cost-effective and timely manner;
o manufacture and deliver products in sufficient volumes on time;
o obtain regulatory approval for new products;
o differentiate our products from those of competitors;
o achieve positive clinical outcomes;
o satisfy the increased demands by health care payors, providers and
patients for lower-cost procedures and shorter hospital stays and
recovery times;
o innovate and develop new materials, product designs and surgical
techniques; and
o provide adequate medical and/or customer education relating to new
products and attract key surgeons to advocate these new products.
New products and enhancements usually require a substantial investment in
research and development before we can determine the viability of the product,
and we may not have the financial resources necessary to fund this research and
development. Moreover, new products and enhancements may not produce revenues in
excess of the research and development costs, and they may be quickly obsolete
by changing customer preferences or the introduction by our competitors of new
technologies or features.
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 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:
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o the introduction of new product lines;
o product modifications;
o the level of market acceptance of our products;
o the timing of research and development expenditures;
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.
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 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.
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We will first need regulatory approval to market our products under development.
We may be subject to penalties and may be precluded from marketing our products
if we fail To comply with extensive governmental regulations.
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, 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
premarket approval (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.
-30-
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. We may become subject to patent
infringement claims or litigation or interference proceedings declared by the
U.S. Patent and Trademark Office to determine the priority of inventions.
Our competitive position depends, in part, upon unpatented trade secrets,
which are difficult to protect. Others may independently develop substantially
equivalent proprietary information and techniques or otherwise gain access to
our trade secrets. In an effort to protect our trade secrets, we generally
require certain of 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. Some jurisdictions limit the
enforceability and scope of these agreements and these agreements may not
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 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 first nine months of fiscal 2005 and during fiscal 2004 and
2003, our common stock has traded in a range of $1.05 and $5.25 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;
-31-
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;
o economic and political conditions; and
o fluctuations in the United States financial markets.
Historically, the trading volume for our common stock has been limited.
Our common stock is thinly traded in comparison to companies with greater
market capitalization. As a result, large sell trades, negative news and general
economic pressures on the stock market can have an impact on the price of our
common stock that is more pronounced than securities of other issuers with
larger listed stock volume or higher prices per share. Further, our common stock
has a limited float. A large percentage of our outstanding common stock is held
by management and insiders, so the float is limited and the stock is much less
liquid.
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 4. 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 June 30, 2005. 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.
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PART II. OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS
In April 2005, without admitting liability and as a precondition to Valley
Forge's merger agreement with Synergetics, Inc., Valley Forge settled the
lawsuit entitled Jeffrey Turner and Cathryn Turner v. Phoenix Children's
Hospital, Inc. , et al., in which Valley Forge was one of the defendants, and
paid $150,000 towards plaintiff's expenses in the lawsuit.
Item 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
Exhibit 2.1 Agreement and Plan of Merger by and among Valley
Forge Scientitific Corp., Synergetics Acquisition
Corporation and Synergetics, Inc. dated May 2, 2005.
(1)
Exhibit 2.2 Amendment No. 1 to Agreement and Plan of Merger by
and among Valley Forge Scientitific Corp.,
Synergetics Acquisition Corporation and Synergetics,
Inc. dated June 2, 2005. (2)
Exhibit 2.3 Amendment No. 2 to Agreement and Plan of Merger by
and among Valley Forge Scientitific Corp.,
Synergetics Acquisition Corporation and Synergetics,
Inc. dated July 15, 2005. (3)
Exhibit 9.1 Valley Forge Voting Agreement among certain
shareholders of Valley Forge Scientific Corp.,
Valley Forge Scientific Corp. and Synergetics, Inc.
dated May 2, 2005. (1)
Exhibit 9.2 Synergetics Voting Agreement among certain
shareholders of Synergetics, Inc., Valley Forge
Scientific Corp. and Synergetics, Inc. dated May 2,
2005. (1)
Exhibit 10.16 Agreement and Lease between Liberty Property Limited
Partnership and Valley Forge Scientific Corp. (4)
Exhibit 10.17 Agreement for Sale of Commercial Real Estate between
Diversified Electronics Company, Inc. and Stan Smith
dated April 21, 2005. (4)
Exhibit 31.1 Certification of the Chief Executive Officer
Pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.
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Exhibit 32.1 Certification of the Chief Executive Officer
Pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
--------------------------------------------------------------------------------
(1) Previously filed with Valley Forge's Current Report on Form 8-K filed
on May 4, 2005 and incorporated herein by reference.
(2) Previously filed with Valley Forge's Current Report on Form 8-K filed
on June 3, 2005 and incorporated herein by reference.
(3) Previously filed with Valley Forge's Current Report on Form 8-K filed
on July 15, 2005 and incorporated herein by reference.
(4) Previously filed with Valley Forge's Form S- 4 Registration Statement
(Registration No. 333-125521) and incorporated herein by reference.
(b) Current Reports on Form 8-K
On May 4, 2005, Valley Forge Scientific Corp. filed a report on Form
8-K regarding a merger agreement with Synergetics, Inc.
On May 11, 2005, Valley Forge Scientific Corp. filed a report on Form
8-K regarding an amendment to an agreement with Codman & Shurtleff,
Inc.
On May 13, 2005, Valley Forge Scientific Corp. filed a report on Form
8-K regarding its results of operations.
On May 24, 2005, Valley Forge Scientific Corp. filed a report
regarding a determination by The Nasdaq Stock Market that the merger
with Synergetics, Inc. constitutes a "reverse merger."
On June 3, 2005, Valley Forge Scientific Corp. filed a report on Form
8-K regarding an amendment to the merger agreement with Synergetics,
Inc.
Subsequent to the end of the quarter, on July 15, 2005, Valley Forge
Scientific Corp. filed a report on Form 8-K regarding an amendment to
the merger agreement with Synergetics, Inc.
Subsequent to the end of the quarter, on August 11, 2005, Valley Forge
Scientific Corp. filed a report on Form 8-K regarding its results of
operations.
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VALLEY FORGE SCIENTIFIC CORP.
SIGNATURES
----------
Pursuant to the requirements of the Securities Act of 1934, the registrant
has duly caused this report to be signed on its behalf by the undersigned
thereunto duly authorized.
VALLEY FORGE SCIENTIFIC CORP.
Date: August 15, 2005 By: /s/ JERRY L. MALIS
------------------------------
Jerry L. Malis, President and
Chief Executive Officer
(principal financial officer)
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VALLEY FORGE SCIENTIFIC CORP.
For Quarterly Period Ended June 30, 2005
FORM 10-Q
EXHIBIT INDEX
Exhibit 31.1 Certification of the Chief Executive Officer Pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002
Exhibit 32.1 Certification of the Chief Executive Officer Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002
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