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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 December 31, 2003
[ ] 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.
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(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
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(Address of principal executive offices and zip code)
Telephone: (610) 666-7500
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 February 9, 2004 there were 7,913,712 shares outstanding of the Registrant's
no par value Common Stock.
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VALLEY FORGE SCIENTIFIC CORP.
INDEX TO FORM 10-Q
December 31, 2003
Page
Number
------
Part I - Financial Information
Item 1. Financial Statements:
Balance Sheets - December 31, 2003 and September 30, 2003. 1
Statements of Operations for the three months
ended December 31, 2003 and December 31, 2002. 2
Statements of Cash Flows for the three months
ended December 31, 2003 and December 31, 2002. 3
Notes to Financial Statements. 4
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations. 9
Item 4. Controls and Procedures 17
Part II - Other Information 18
(i)
VALLEY FORGE SCIENTIFIC CORP. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
December 31, September 30,
ASSETS 2003 2003
------ ------------ ------------
(Unaudited) (Audited)
Current Assets:
Cash and cash equivalents $ 2,426,729 $ 2,305,556
Accounts receivable, net 466,335 376,915
Inventory 691,516 775,183
Prepaid items and other current assets 283,730 268,371
Deferred tax assets 52,749 51,431
------------ ------------
Total Current Assets 3,921,059 3,777,456
Property, Plant and Equipment, Net 150,842 156,697
Goodwill 153,616 153,616
Intangible Assets, Net 246,606 256,681
Other Assets 25,549 29,963
------------ ------------
Total Assets $ 4,497,672 $ 4,374,413
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
Current Liabilities:
Accounts payable and accrued expenses $ 245,361 $ 216,457
Deferred revenue 22,310 --
------------ ------------
Total Current Liabilities 267,671 216,457
Deferred Tax Liability 19,016 19,950
------------ ------------
Total Liabilities 286,687 236,407
------------ ------------
Commitments and Contingencies
Stockholders' Equity:
Preferred stock -- --
Common stock (no par, 20,000,000 shares
authorized, shares issued and outstanding
at December 31, 2003 and September 30,
30, 2003 - 7,913,712) 3,528,530 3,528,530
Retained earnings 682,455 609,476
------------ ------------
4,210,985 4,138,006
------------ ------------
Total Liabilities and Stockholders' Equity $ 4,497,672 $ 4,374,413
============ ============
--------------------
See accompanying notes to consolidated financial statements.
-1-
VALLEY FORGE SCIENTIFIC CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
For the Three Months Ended
December 31,
2003 2002
------------ ------------
Net Sales $ 1,199,469 $ 1,019,942
Cost of Sales 555,304 529,272
------------ ------------
Gross Profit 644,165 490,670
------------ ------------
Other Costs:
Selling, general and administrative 398,337 330,618
Research and development 113,895 89,338
Amortization 10,075 10,075
------------ ------------
Total Other Costs 522,307 430,031
------------ ------------
Income from Operations 121,858 60,639
Other Income, Net 5,669 8,989
------------ ------------
Income before Income Taxes 127,527 69,628
Provision for Income Taxes 54,548 29,489
------------ ------------
Net Income $ 72,979 $ 40,139
============ ============
Income per Share:
Basic income per common share $ 0.01 $ 0.01
============ ============
Diluted income per common share $ 0.01 $ 0.01
============ ============
Basic weighted average common shares
outstanding 7,913,712 8,013,875
Diluted weighted average common shares
outstanding 7,965,977 8,043,858
--------------------
See accompanying notes to consolidated financial statements.
-2-
VALLEY FORGE SCIENTIFIC CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
For the Three Months Ended
December 31,
2003 2002
------------ ------------
Cash Flows from Operating Activities:
Net income $ 72,979 $ 40,139
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Depreciation and amortization 17,732 15,190
Interest accrued on loans and advances to
employees and related parties (616) (583)
Changes in assets and liabilities:
Increase in accounts receivable, net (89,420) (170,822)
Decrease in inventory 83,667 79,203
(Increase) decrease in deferred tax assets (1,318) 14,115
(Increase) decrease in other assets 4,414 691
Increase in prepaid items and other
current assets (14,743) (50,067)
Increase (decrease) in accounts payable and
accrued expenses and income taxes payable 28,904 (95,096)
Increase in deferred revenue 22,310 --
Decrease in deferred tax liability (934) (327)
------------ ------------
Net cash provided by (used in) operating
activities 122,975 (167,557)
------------ ------------
Cash Flows from Investing Activities:
Proceeds from repayment of employee loans 10,000
Purchases of property, plant and equipment (1,802) (4,090)
------------ ------------
Net cash provided by (used in) investing
activities (1,802) 5,910
------------ ------------
Cash Flows from Financing Activities:
Repurchase of common stock -- (81,631)
------------ ------------
Net cash used in financing activities -- (81,631)
------------ ------------
Net Increase (Decrease) in Cash and
Cash Equivalents 121,173 (243,278)
Cash and Cash Equivalents, beginning of period 2,305,556 2,543,898
------------ ------------
Cash and Cash Equivalents, end of period $ 2,426,729 $ 2,300,620
============ ============
Supplemental Disclosures of Cash Flow Information:
Cash paid during the period for:
Interest $ -- $ --
============ ============
Income taxes $ -- $ 190,000
============ ============
--------------------
See accompanying notes to consolidated financial statements.
-3-
VALLEY FORGE SCIENTIFIC CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
DECEMBER 31, 2003
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".
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. Certain amounts from prior years have
been reclassified to conform to the current year presentation.
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, 2003.
The statements of operations for the three months ended December 31, 2003 and
2002 are not necessarily indicative of results for the full year.
Earnings (Loss) per Share
-------------------------
The Company computes earnings or loss 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.
Recently Issued Accounting Standards
------------------------------------
In January 2003, the Financial Accounting Standards Board ("FASB") issued
Interpretation No. 46, "Consolidation of Variable Interest Entities - an
interpretation of ARB No. 51, which provides guidance on the identification of
and reporting for variable interest entities. In December 2003, the FASB issued
a revised interpretation No. 46, which expands the criteria for consideration in
determining whether a variable interest entity should be consolidated.
Interpretation No. 46 is effective for the Company in the third quarter of 2004.
The Company does not expect adoption of Interpretation No. 46 to have a
significant impact on its future results of operations or financial condition.
-4-
VALLEY FORGE SCIENTIFIC CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
DECEMBER 31, 2003
(Continued)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
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 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 No. 148
amends 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 is 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 No. 148 did
not have a significant impact on the Company's results of operations or
financial position.
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. 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:
For the Three Months Ended
December 31,
2003 2002
-------- --------
Net income, as reported $ 72,979 $ 40,139
Less: Total stock based compensation
expense, determined under
fair value based method, net
of tax effect -- 13,226
-------- --------
Pro forma net income $ 72,979 $ 26,913
======== ========
Pro forma income per share:
Basic $ 0.01 $ 0.00
Diluted $ 0.01 $ 0.00
-5-
VALLEY FORGE SCIENTIFIC CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
DECEMBER 31, 2003
(Continued)
3. SUPPLEMENTAL BALANCE SHEET INFORMATION
Accounts Receivable, Net
------------------------
December 31, September 30,
2003 2003
------------ ------------
Accounts receivable $ 472,279 $ 378,786
Less: Allowances 5,944 1,871
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$ 466,335 $ 376,915
============ ============
Inventory
---------
December 31, September 30,
2003 2003
------------ ------------
Finished goods $ 51,283 $ 88,401
Work-in-process 286,776 316,600
Materials and parts 432,575 433,459
Less: Allowance for slow moving
and obsolete inventory 79,118 63,277
------------ ------------
$ 691,516 $ 775,183
============ ============
Property, Plant and Equipment, Net
----------------------------------
Useful Life December 31, September 30,
(Years) 2003 2003
------------ ------------ ------------
Land - $ 11,953 $ 11,953
Buildings and improvements 15 - 39 94,832 94,832
Furniture and fixtures 5 - 7 17,953 17,953
Laboratory equipment 5 - 10 370,119 370,119
Office equipment 5 183,120 181,318
Leasehold improvements 3 - 5 9,413 9,413
------------ ------------
687,390 685,588
Less: Accumulated depreciation
and amortization 536,548 528,891
------------ ------------
$ 150,842 $ 156,697
============ ============
-6-
VALLEY FORGE SCIENTIFIC CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
DECEMBER 31, 2003
(Continued)
3. 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 changes
were made to the carrying amount of goodwill for the quarter ended December 31,
2003. The Company completed its transitional impairment test during the quarter
ending March 31, 2002, indicating that goodwill was not impaired. An additional
annual test was performed during the quarter ending March 31, 2003 and no
impairment adjustment was required.
Information regarding the Company's other intangible assets is as follows:
December 31, 2003 September 30, 2003
------------------------------------------ ------------------------------------------
Gross Gross
Carrying Accumulated Carrying Accumulated
Amount Amortization Net Amount Amortization Net
------------ ------------ ------------ ------------ ------------ ------------
Patents, trademarks,
licensing agreements $ 571,617 $ 495,900 $ 75,717 $ 571,617 $ 493,365 $ 78,252
Proprietary know-how 452,354 281,465 170,889 452,354 273,925 178,429
Acquisition costs 55,969 55,969 -- 55,969 55,969 --
------------ ------------ ------------ ------------ ------------ ------------
$ 1,079,940 $ 833,334 $ 246,606 $ 1,079,940 $ 823,259 $ 256,681
============ ============ ============ ============ ============ ============
Amortization expense of intangible assets was $10,075 for the three months ended
December 31, 2003 and 2002. Annual amortization expense for intangible assets
held as of December 31, 2003, is estimated to be $40,300 for 2004, $40,300 for
2005, $40,300 for 2006, $40,000 for 2007 and $39,000 for 2008.
4. COMMITMENTS AND CONTINGENCIES
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 an unspecified amount of damages for alleged injuries sustained
in a surgery that took place in June 2000. The Company's product liability
insurance carrier is providing the Company's defense in this matter. This
insurance coverage, which provided a policy limit of $1,000,000 per occurrence
at the time of this claim, has a $10,000 deductible that applies to attorney
fees and damages, which have 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 liability.
The Company believes the claim is without merit and will vigorously defend
itself in this action.
-7-
VALLEY FORGE SCIENTIFIC CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
DECEMBER 31, 2003
(Continued)
5. EARNINGS PER SHARE
For the Three Months Ended
December 31,
2003 2002
------------ ------------
Income available to common
shareholders $ 72,979 $ 40,139
============ ============
Weighted average common shares
outstanding - basic 7,913,712 8,013,875
Net effect of dilutive shares issuable
in connection with stock plans 52,265 29,983
------------ ------------
Weighted average common shares
outstanding - diluted 7,965,977 8,043,858
============ ============
Earnings per share:
Basic $ 0.01 $ 0.01
Diluted $ 0.01 $ 0.01
Options to purchase 477,750 and 527,850 shares of common stock were outstanding
at December 31, 2003 and 2002, respectively, and 425,485 and 497,867 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.
-8-
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 three months ended
December 31, 2003 and 2002. 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,
2003, which has been filed with the Securities and Exchange Commission. Unless
the context requires otherwise, references to "we", "us", "our", and "Valley
Forge Scientific" refer to Valley Forge Scientific Corp.
Cautionary Note Regarding Forward Looking Statements
This Management's Discussion and Analysis of Financial Condition and
Results of Operations contains, 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 forward looking statements
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; the
future success of our products and disposable instrumentation in the
neurosurgery and dental markets; and our ability, along with the third parties
with whom we contract, to distribute and sell our products both in and outside
of the neurosurgery market, and the continued acceptance of our products in the
neurosurgery market and the acceptance of our products in the dental market and
outside of the neurosurgery market. 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. We do not intend to update these forward looking statements after
the date of this report. You are advised to review the "Additional Cautionary
Statements" section below for more information about risks and uncertainties
that could affect the financial results of Valley Forge Scientific.
Overview
We design, develop, manufacture and sell medical and dental devices.
Our core business is in our bipolar electrosurgical generators and related
instrumentation, based on our DualWave(TM) technology. Our bipolar systems 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, bone and metal implants. Our bipolar systems are designed to replace
other surgical tools, such as monopolar electrosurgery systems, lasers and
conventional instruments, used in soft tissue surgery.
Our DualWave(TM) technology is applicable to many surgical markets. Our
bipolar systems are currently used to perform many types of neurosurgery, spine
surgery and dental surgery. We have had worldwide exclusive distribution
-9-
agreements with Codman & Shurtleff, Inc., a subsidiary of Johnson & Johnson,
Inc., to market our neurosurgery bipolar systems since 1983. During the first
quarter of fiscal 2004, the term for our current distribution agreement with
Codman & Shurtleff, Inc. was extended from December 31, 2003 to March 31, 2004
to allow the parties time to continue to discuss the terms of a new distribution
agreement.
Historically, we have derived a significant portion of our sales from
our neurosurgery bipolar system. Sales revenue from our Bident(R) Bipolar Tissue
Management System for dental applications commenced in the 2000 fiscal year. Our
current strategy is to increase sales of our Bident(R) Bipolar Tissue Management
System by selling it directly to an expanded base of national dental product
dealers, expand the offerings of products in the field of neurosurgery and
broaden the market for our products in other clinical and surgical markets that
have a need for bipolar electrosurgery. Our strategy also includes using our
DualWave(TM) technology and sales of our bipolar generators to drive sales of
complementary disposable hand-held instruments and products.
Critical Accounting Policies and Estimates
The following "Management's Discussion and Analysis of Financial
Condition and Results of Operations", as well as disclosures included elsewhere
in this Form 10-Q, are based upon our unaudited consolidated financial
statements, which have been prepared in accordance with accounting principles
generally accepted in the United States. The preparation of these financial
statements requires us to make estimates and judgments that affect the reported
amounts of assets, liabilities, revenues and expenses, and related disclosure of
contingencies. On an on-going basis, we evaluate the estimates used, including
those related to product returns, bad debts, inventory valuation, impairments of
tangible and intangible assets, income taxes, warranty obligations, other
accruals, contingencies and litigation. We base our estimates on historical
experience, current conditions and on various other assumptions that are
believed to be reasonable under the circumstances, the results of which form the
basis for making judgments about the carrying values of assets and liabilities
that are not readily apparent from other sources as well as identifying and
assessing our accounting treatment with respect to commitments and
contingencies. Actual results may differ from these estimates under different
assumptions or conditions. We believe the following critical accounting policies
involve more significant judgments and estimates used in the preparation of the
consolidated financial statements.
We maintain an allowance for doubtful accounts for estimated losses
resulting from the potential inability of our customers to make required
payments. If the financial condition of our customers were to deteriorate,
resulting in an impairment of their ability to make payments, additional
allowances may be required.
We provide for the estimated cost of product returns based upon
historical experience and any known conditions or circumstances. Our warranty
obligation is affected primarily by product that does not meet specifications
and performance requirements within the applicable warranty period and any
related costs of addressing such matters. Should actual incidences of product
not meeting specifications and performance requirements differ from our
estimates, revisions to the estimated warranty liability may be required.
-10-
We value inventory at the lower of cost or market and write down the
value of inventory for estimated obsolescence or unmarketable inventory. An
inventory reserve is maintained based upon historical data of actual inventory
written off and for known conditions and circumstances. Should actual product
marketability be affected by conditions that are different from those projected
by management, revisions to the estimated inventory reserve may be required.
Our deferred tax assets and liabilities are determined based on the
differences between the financial statement and tax based 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 at
the time that a determination can be made that it is more likely than not that a
portion or all of the related tax assets will not be realized.
In accordance with the provisions of Statement of Financial Accounting
Standards ("SFAS") No. 123, "Accounting for Stock-Based Compensation" ("SFAS
123") and SFAS No. 148, "Accounting for Stock-Based Compensation - Transition
and Disclosure - An Amendment of FASB Statement No. 123" ("SFAS 148"), we have
elected to account for stock-based compensation plans in accordance with
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees" ("APB 25"), and related interpretations.
Results of Operations
Results of Operations for the Three Months Ended December 31, 2003
compared to the Three Months Ended December 31, 2002.
Summary
Sales of $1,199,469 for the three months ended December 31, 2003 were
18% greater than sales of $1,019,942 for the three months December 31, 2002. Net
income for the three months ended December 31, 2003 of $72,979 was 82% greater
than net income of $40,139 for the three months ended December 31, 2002.
Revenues
Sales of $1,199,469 for the three months ended December 31, 2003
reflect an increase in sales volume of our Bident(R) Bipolar Tissue Management
System. For the three months ended December 31, 2003, sales of our Bident(R)
Bipolar Tissue Management System accounted for $170,049, or 14% of our sales, as
compared to no sales for the three months ended December 31, 2002. Sales to
Codman & Shurtleff, Inc. for the three months ended December 31, 2003 accounted
for $1,025,965, or 85% of our sales, as compared to $1,012,000, or 99% of our
sales.
In the first quarter of fiscal 2004, we extended the term of our
distribution agreement with Codman & Shurtleff, Inc. from December 31, 2003 to
March 31, 2004 in order to provide more time to continue discussions on the
terms of a new distribution agreement for both our existing products and the
next generation of neurosurgical products and disposable instruments, including
-11-
our new irrigation unit and related disposable tubing sets, which began
production in the first quarter of fiscal 2004, and our next generation
neurosurgical generator and disposable instrumentation which we anticipate
having ready for introduction into the market in the first six months of
calendar 2004.
In the first quarter of fiscal 2004, we saw a greater contribution from
the sales our dental products as leads we received during fiscal 2003 began to
turn into sales. We are continuing training the largest dental distributors of
our dental products on the uses of the Bident(R) Bipolar Tissue Management
System and are providing marketing support to the distributors through print
advertisements, active participation in tradeshows and informational CD-ROMs. We
expect sales of our dental products in fiscal 2004 to be at greater levels than
sales reported in fiscal 2003. Sales, however, may fluctuate from
quarter-to-quarter based on the timing of orders we receive from distributors
and direct sales.
For the three months ended December 31, 2003, 59% of our sales of
neurosurgical products related to sales of bipolar electrosurgical generators,
irrigators and accessories as compared to approximately 49% of our sales for the
corresponding period in fiscal 2002. Sales of disposable products, primarily
cord and tubing sets, accounted for approximately 36% of our sales of
neurosurgical products, in the three months ended December 31, 2003 as compared
to approximately 42% of our sales for the corresponding period in fiscal 2002.
For the three months ended December 31, 2003, approximately 89% of our
sales of dental products related to sales of bipolar electrosurgical generators.
Sales of disposable hand-held instruments accounted for approximately 11% of our
dental product sales.
Cost of Product Sales
Cost of sales was $555,304, or 46% of sales, for the three months ended
December 31, 2003, as compared with $529,272, or 52% of sales, for the three
months ended December 31, 2002. Gross margin was 54% for the three months ended
December 31, 2003 as compared to 48%, for the three months ended December 31,
2002.
The difference in gross margin as a percentage of sales is attributable
to an increase in direct sales of our dental products, changes in product mix
and increased sales levels. 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 $398,337, or
33% of sales, for the three months ended December 31, 2003, from $330,618, or
32% of sales, for the three months ended December 31, 2002. Selling, general and
administrative expenses reflect increased selling and marketing expenses that we
incurred in connection with implementing our sales and marketing efforts for the
direct marketing of our Bident(R) Bipolar Tissue Management System to dental
product distributors.
-12-
Research and development expenses for the three months ended December
31, 2003 were $113,895, or 10% of sales, as compared to $89,338, or 9% of sales,
for the three months ended December 31, 2002. We continue to invest in research
and development to expand our technological base for use in both existing and
additional clinical areas. The increase was primarily related to the development
of our next generation neurosurgical generator and instrumentation. We also
devoted resources to the final stages of development of a product outside of the
neurosurgery and dental markets pursuant to a development agreement we entered
into with Stryker Corporation in September 2002. In the first quarter of fiscal
2004, we extended the term of that development agreement until February 28,
2004.
Other Income/Expense, net
Other income and expense, net, decreased slightly to $5,669 for the
three months ended December 31, 2003 as compared to $8,989 for the three months
ended December 31, 2002. At December 31, 2003, we had $2,426,726 in cash and
cash equivalents as compared to $2,300,620 at December 31, 2002.
Income Tax Provision
The provision for income taxes was $54,548 for the three months ended
December 31, 2003 as compared to a provision of $29,489 for the three months
ended December 31, 2002.
Net Income
As a result of the foregoing, for the three months ended December 31,
2003 our net income was $72,979, or an 82% increase from net income of $40,139
for the three months ended December 31, 2002. Basic and diluted income per share
was $.01 for both the three months ended December 31, 2003 and the three months
ended December 31, 2002. Due to our operating history and numerous other
factors, we cannot be sure that we can sustain profitability or achieve revenue
growth.
Liquidity and Capital Resources
At December 31, 2003, we had $3,653,388 in working capital compared to
$3,560,999 at September 30, 2003. 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 $122,975 for the three
months ended December 31, 2003, as compared to cash used by operating activities
of $167,557 for the three months ended December 31, 2002. The cash provided by
operating activities for the three months ended December 31, 2003 was mainly
attributable to our operating profit net of adjustments for non-cash items of
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$72,979, a decrease in inventory of $83,667, an increase in accounts payable,
accrued expenses and income taxes payable of $28,904, and an increase in
deferred revenue of $22,310. This was partially offset by an increase in
accounts receivable of $89,420.
During the three months ended December 31, 2003, inventories decreased
by $83,667 to a total of $691,516 at December 31, 2003 compared to $775,183 at
September 30, 2003. At December 31, 2002, inventories were $803,629. The
decrease was primarily due to improved inventory management. Inventories were
kept at these levels primarily to support anticipated future sales activities.
In the first quarter of fiscal 2004, accounts receivable net of
allowances increased by $89,420 to a total of $466,335 at December 31, 2003 as
compared to $376,915 at September 30, 2003. At December 31, 2002, our accounts
receivable net of allowances was $508,761. The increase in accounts receivable
in the first quarter of 2004 was primarily due to timing of sales and an
increase in sales of our dental products during the quarter.
During the three months ended December 31, 2003, we purchased property,
plant and equipment of $1,802. Net property and equipment increased to $150,842
at December 31, 2003 as compared to $135,106 at December 31, 2002.
At December 31, 2003, we had cash and cash equivalents of $2,426,729.
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 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 tangible net worth at December 31, 2003 was
$3,810,763. There was no outstanding balance on this line as of December 31,
2003.
Additional Cautionary Statements
We Face Intense Competition
---------------------------
The markets for our current and potential products are intensely
competitive. Some surgical procedures which utilize or could utilize our
products could potentially be replaced or reduced in importance by products sold
by other companies or alternative medical procedures or new drugs which could
render our products obsolete or uncompetitive in the markets which we sell, or
in the future may sell, our products.
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We are Dependent Upon Sales of Our Neurosurgery System - Substantially All of
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Our Business Comes From One Customer
------------------------------------
Codman & Shurtleff, Inc., which sells our products in the neurosurgery
market, accounted for 85% of our sales in the first quarter of fiscal 2004, and
95% and 90% of our sales in fiscal 2003 and 2002, respectively. Any
cancellation, deferral or significant reduction in sales in the neurosurgery
market could seriously harm our business, financial condition and results of
operations. The term or our current distribution agreement with Codman &
Shurtleff, Inc. was recently extended from December 31, 2003 to March 31, 2004
to allow the parties time to continue to discuss the terms of a new distribution
agreement. Increased sales in the neurosurgery market are dependent on the
acceptance of our new neurosurgical generator and disposable hand-held
instruments in the marketplace.
Commercial Success of our Non-Neurosurgical Products is Uncertain
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Our growth depends on the acceptance of our products in the
marketplace, the market penetration achieved by the companies that we utilize,
sell to, and rely on, to sell and distribute our products, and our ability to
introduce new and innovative products that meet the needs of medical
professionals. There can be no assurance that we will be able to continue to
introduce new and innovative products or that the products we introduce, or have
introduced, will be widely accepted, or continue to be accepted, in the
marketplace, or that we or the companies, which we may contract with to
distribute or sell our products, achieve market penetration. While we have
developed several applications for our DualWave(TM) technology outside of
neurosurgery and we believe that the products based on our technology offer
advantages over other products, we cannot assure you that these advantages will
be realized, or if realized, that these products will result in any meaningful
benefits to physicians or patients.
We Have Limited Marketing and Sales Experience
----------------------------------------------
We currently have limited experience in marketing and selling our
products. To the extent that we have established or will enter into distribution
arrangements for the sale of our products, we are and will be dependent upon the
efforts of third parties. We have entered into a distribution agreement with
Codman & Shurtleff, Inc. to sell our products in the neurosurgery market and we
sell our Bident(R) Bipolar Tissue Management System through independent dental
product dealers. We cannot assure you that these distributors and dealers will
commit the necessary resources to effectively market and sell our neurosurgery
and dental product lines, or that they will be successful in selling our
products. To the extent our marketing and sales efforts are unsuccessful, our
business, financial condition, results of operations and future growth prospects
may be materially adversely affected.
Our Products are Extensively Regulated Which Could Delay Product Introduction or
--------------------------------------------------------------------------------
Halt Sales
----------
The process of obtaining and maintaining required regulatory approvals
is lengthy, expensive and uncertain. Although we have not experienced any
substantial regulatory delays to date, there is no assurance that delays will
not occur in the future, which could have a significant adverse effect on our
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ability to introduce new products on a timely basis. Regulatory agencies
periodically inspect our manufacturing facilities to ascertain compliance with
"good manufacturing practices" and can subject approved products to additional
testing and surveillance programs. Failure to comply with applicable regulatory
requirements can, among other things, result in fines, suspensions of regulatory
approvals, product recalls, operating restrictions and criminal penalties. While
we believe that we are currently in compliance, if we fail to comply with
regulatory requirements, it could have an adverse effect on our results of
operations and financial condition.
We are Dependent on Key Suppliers
---------------------------------
For some of the components we use in our products we rely upon single
source suppliers or a single contract manufacturer. For example, we currently
subcontract the manufacturer of our disposable cord and tubing sets with a
single manufacturer. While we believe there are alternative sources available,
we would be required to qualify and validate a new supplier(s) or contractor(s),
which could lead to a disruption in our operations and ability to supply product
for a period of time.
We Face Uncertainty Over Reimbursement
--------------------------------------
Failure by physicians, hospitals and other users of our products to
obtain sufficient reimbursement from health care payors for procedures in which
our products are used or adverse changes in governmental and private third-party
payors' policies toward reimbursement for such procedures would have a material
adverse effect on our business, financial condition, results of operations and
future growth prospects.
We May Be Unable to Effectively Protect Our Intellectual Property
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Our ability to compete effectively depends in part on developing and
maintaining the proprietary aspects of our bipolar technology. We cannot assure
you that the patents we have obtained, or any patents we may obtain, will
provide any competitive advantages for our products, or that we will be able to
maintain a competitive advantage after our patents expire. We also cannot assure
you that those patents will not be successfully challenged, invalidated or
circumvented in the future. In addition, we cannot assure you that competitors,
many of which have substantial resources and have made substantial investments
in competing technologies, have not already applied for or obtained, or 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. Patent applications are maintained in secrecy for a
period after filing. We may not be aware of all of the patents and patent
applications potentially adverse to our interests.
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.
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We May have Product Liability Claims
------------------------------------
Our products involve a risk of product liability claims. Although we
maintain product liability insurance at coverage levels, which we believe are
adequate, there is no assurance that, if we were to incur substantial liability
for product liability claims, insurance would provide adequate coverage against
such liability.
Our Operating Results May Fluctuate
-----------------------------------
We have experienced operating losses at various times since our
inception. Our results of operations may fluctuate significantly from quarter to
quarter based on numerous factors including the following:
o the introduction of new product lines;
o the level of market acceptance of our products;
o achievement of research and development milestones;
o timing of the receipt of orders from, and product shipments
to, distributors and customers;
o timing of expenditures;
o changes in the distribution of 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.
The Market Price of Our Stock May be Highly Volatile
----------------------------------------------------
During the fiscal year ended September 30, 2003 and the first quarter
of fiscal 2004, 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 operations;
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 competitiors 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.
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Item 4. CONTROLS AND PROCEDURES
------
We maintain disclosure controls and procedures (as defined in
Securities Exchange Act 1934 Rules 13a-15(c)) that are designed to ensure that
the information required to be disclosed in our Exchange Act reports is
recorded, processed, summarized and reported within the time periods specified
in the Securities and Exchange Commission's rules and forms, and that such
information is accumulated and communicated to our management, including our
Chief Executive Officer and Chief Financial Officer, as appropriate, to allow
timely decisions regarding disclosure. In designing and evaluating the
disclosure controls and procedures, management recognized that any controls and
procedures, no matter how well designed and operated, can provide only
reasonable assurance of achieving the desired control objectives, and management
necessarily was required to apply its judgment in evaluating the cost benefit
relationship of possible controls and procedures.
As of the end of the quarter ended December 31, 2003, we carried out an
evaluation, under the supervision and with the participation of Valley Forge
Scientific's management, including our Chief Executive Officer and Chief
Financial Officer, of the effectiveness of the design and operation of our
disclosure controls and procedures. Based on the foregoing, our Chief Executive
Officer and Chief Financial Officer concluded that our disclosure controls and
procedures were effective as of the end of the period covered by this quarterly
report. There have been no significant changes in our internal controls or in
other factors that have materially affected, or are reasonably likely to affect,
our internal control over financial reporting.
PART II. OTHER INFORMATION
Item 6. EXHIBITS AND REPORTS ON FORM 8-K
------
(a) Exhibits
The following is a list of the Exhibits filed as part of this
quarterly report on Form 10Q.
Exhibit Number Exhibit Name
-------------- ------------
31.1 Certification of the Chief Executive
Officer Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
32.1 Certification of the Chief Executive
Officer Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
(b) Current Reports on Form 8-K
On December 8, 2003, Valley Forge Scientific Corp. filed a
report on Form 8-K regarding a press release concerning fourth
quarter and year end operating results for fiscal 2003.
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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: February 11, 2004 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 Fiscal Period Ended December 31, 2003
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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