UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-KSB
(Mark One)
[X] ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934 For the fiscal year ended: December 31, 2003
OR
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the transition period from _________________ to _______________.
Commission file number: 0-26520
NEOPROBE CORPORATION
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(Name of Small Business Issuer in Its Charter)
DELAWARE 31-1080091
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(State or Other Jurisdiction of (I.R.S. Employer Identification
Incorporation or Organization) No.)
425 Metro Place North, Suite 300, Dublin, Ohio 43017-1367
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(Address of Principal Executive Offices) (Zip Code)
Issuer's telephone number, including area code: (614) 793-7500 Securities
registered pursuant to Section 12(b) of the Act: None Securities registered
pursuant to Section 12(g) of the Act:
Common Stock, par value $.001 per share
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(Title of Class)
Rights to Purchase Series A Junior Participating Preferred Stock
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(Title of Class)
Check whether the Registrant: (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 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 [ ]
Check if there is no disclosure of delinquent filers pursuant to Item 405 of
Regulation S-B contained herein and no disclosure will be contained, to the best
of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-KSB or any amendment to
this Form 10-KSB. [ ]
The issuer's revenues for the fiscal year ended December 31, 2003 were
$6,509,908.
The aggregate market value of shares of common stock held by non-affiliates of
the registrant on March 15, 2004 was $30,384,344.
The number of shares of common stock outstanding on March 15, 2004 was
53,881,696.
Transitional Small Business Disclosure Format (check one): Yes [ ] No [X]
DOCUMENTS INCORPORATED BY REFERENCE
None.
PART I
ITEM 1. DESCRIPTION OF BUSINESS
DEVELOPMENT OF THE BUSINESS
We are a biomedical technology company providing innovative surgical and
diagnostic products that enhance patient care by meeting the critical
decision-making needs of healthcare professionals. We were originally
incorporated in Ohio in 1983 and reincorporated in Delaware in 1988. Our
executive offices are located at 425 Metro Place North, Suite 300, Dublin, Ohio
43017. Our telephone number is (614) 793-7500.
From our inception through the end of 2001, we devoted substantially all of our
efforts and resources to the research and clinical development of innovative
systems for the intraoperative diagnosis and treatment of cancers. Following an
evaluation of our business plan during early 2001, however, we determined that
we needed to expand our product portfolio and consider synergistic products
outside the cancer or oncology fields.
In December 2001, we acquired Biosonix Ltd., a private Israeli company limited
by shares. In February 2002, Biosonix Ltd. changed its name to Cardiosonix Ltd.
(Cardiosonix). Cardiosonix is developing and commercializing a unique line of
blood flow measurement devices for a variety of diagnostic and surgical
applications. The decision to expand beyond our product focus on oncology was
based on our belief that the Cardiosonix products would diversify our customer
base through a product line we believe has great market potential and a path of
market adoption similar to our gamma detection devices, but one that also has
significant operational synergies in the development, regulation and manufacture
to that of our existing gamma devices.
Although we have expanded our strategic focus to include blood flow medical
devices, we intend to continue to execute many of the strategies outlined in
prior years related to the internal development of gamma detection medical
devices and to continue supporting development of our other complementary
procedural-based technologies. Based upon information that we have recently
become aware of, we are considering reactivating development activities
concerning radioimmuguided surgery (RIGS(R)). In addition, we are preparing to
begin the pivotal stage in the development of our proprietary lymphatic
targeting agent, LYMPHOSEEK(TM).
Our business goals are to maximize the market potential of Cardiosonix' blood
flow products as leaders in the measurement of blood flow in both clinical and
surgical settings to supplement our leadership position in the current
intraoperative gamma detection market. We believe our core device business lines
will provide us with a strong operating foundation and enable us to judiciously
evaluate and develop complementary procedural products with a recurring revenue
stream. To that end, we intend to continue to pursue the development of
LYMPHOSEEK and to evaluate potential development plan for RIGS.
OUR TECHNOLOGY
Gamma Detection Devices
Through 2003, substantially all of our revenue has been generated from the sale
of a line of gamma radiation detection devices and related products used by
surgeons in the diagnosis and treatment of cancer and related diseases. Our
currently-marketed line of gamma detection devices has been cleared by the FDA
and other international regulatory agencies for marketing and commercial
distribution throughout most major global commercial markets.
Our patented gamma detection devices consist of hand-held detector probes and a
control unit. The detection device in the tip of the probe is a highly
radiosensitive crystal that relays a signal through a preamplifier to the
control unit to produce both a digital readout and an audible signal. The
detector element fits into a housing approximately the size of a pocket
flashlight. The NEO2000(R) Gamma Detection
2
System, originally released in 1998, is the third generation of our gamma
detection systems. The NEO2000 is designed as a platform for future growth of
our instrument business. The neo2000 is software upgradeable and is designed to
support future surgical targeting probes without the necessity of costly
remanufacture. Since 1998, we have developed and released three major software
upgrades for customer units designed to improve the utility of the system and/or
offer the users additional features.
Surgeons are using our gamma detection devices in a surgical application
referred to as sentinel lymph node biopsy (SLNB) or intraoperative lymphatic
mapping (lymphatic mapping or ILM). ILM helps trace the lymphatic patterns in a
cancer patient to evaluate potential tumor drainage and cancer spread in
lymphatic tissue. The technique does not detect cancer; rather it helps surgeons
identify the lymph node(s) to which a tumor is likely to drain and spread. The
lymph node(s) (sometimes referred to as the "sentinel" node(s)) may provide
critical information about the stage of a patient's disease. ILM begins when a
patient is injected at the site of the main tumor with a commercially available
radioactive tracing agent. The agent is intended to follow the same lymphatic
flow as the cancer would if it had metastasized. The surgeon may then track the
agent's path with a hand-held gamma-radiation-detection probe, thus following
the potential avenues of metastases and identifying lymph nodes to be biopsied
for evaluation and determination of cancer spread.
Numerous clinical studies, involving a total of nearly two thousand patients and
published in peer-reviewed medical journals such as Oncology (January 1999) and
The Journal of The American College of Surgeons (December 2000), have indicated
ILM is approximately 97% accurate in predicting the presence or absence of
disease spread in melanoma and breast cancers. Consequently, it is estimated
that more than 80% of breast cancer patients who would otherwise have undergone
full axillary lymph node dissections (ALND), involving the removal of as many as
20 - 30 lymph nodes, might be spared this radical surgical procedure if the
sentinel node was found to be free of cancer. Surgeons practicing ILM have found
that our gamma-detection probes are well suited to the procedure.
Lymphatic mapping has become the standard of care for treating patients with
melanoma at many institutions. For breast cancer, the technique appears to be
moving toward standard of care status at major cancer centers. Our marketing
partner has seen continued growth in sales due partially to increased adoption
of the ILM procedure and changes in the competitive landscape. Lymphatic mapping
in breast cancer is the subject of national and international clinical trials,
including studies sponsored by the U.S. Department of Defense, the NCI and the
American College of Surgeons. Although we have been selling gamma detection
devices for use in surgical oncology for over seven years, we believe many
surgeons, both in the U.S. and the rest of the world have delayed adoption of
lymphatic mapping pending the outcome of these important trials. We believe that
once data from these trials are published; there will be an additional demand
for our devices. We continue to monitor these trials and to work with our
marketing partners and thought leaders in the surgical community to set up and
support training courses internationally for lymphatic mapping. We also believe,
based on anecdotal market intelligence, that over half of the potential global
market for devices such as ours remains untapped. Courses showcasing our
instruments continue to be held at many nationally and internationally renowned
cancer-specializing and teaching institutions. These courses appear to be
positively impacting the adoption of lymphatic mapping, albeit not as rapidly as
we would like to see.
In addition to lymphatic mapping, surgeons are investigating the use of our
device for other gamma guided surgery applications, such as evaluating the
thyroid function, in determining the state of disease in patients with vulvar
and penile cancers, and in SLNB in gastric and non-small cell lung cancers.
Expanding the application of ILM beyond the current primary uses in the
treatment of breast cancer and melanoma is the primary focus of our strategy
regarding our gamma guided surgery products. To support that expansion, we
continue to work with our marketing and distribution partners to develop
software-based enhancements to the NEO2000 platform as well as probes such as
the laparoscopic probe introduced in 2002 that supports the minimally invasive
emphasis in today's practice of surgery. To that end, our primary goals for our
gamma device business for 2004 center around working with our marketing partners
to improve the market position of our laparoscopic approach and increase
awareness of independent research being done to expand the application of ILM to
other indications.
3
Blood Flow Measurement Devices
Accurate blood flow measurement is required for various clinical needs,
including:
- real-time monitoring;
- intra-operative quantification;
- non-invasive diagnostics; and
- evaluation of cardiac function.
Currently, the medical community has no simple, immediate, real-time means to
quantify the adequacy of organ perfusion, that is, the direct measurement of
blood flow into the organ. Devices do exist that visually show perfusion of a
target organ. We are unaware, however, of any device that provides an accurate,
real-time measurement of blood flow in as many applications without having to
isolate target vessels or conduct other invasive procedures.
In addition, blood flow velocity measurements are often confused with volume
blood flow. These two variables, however, are normally different parameters that
respond differently to pathological conditions and provide different data. Blood
flow velocity is used primarily for determining the existence of a stenosis
(narrowing or obstruction) in the vascular surgery setting, while the
applications of blood flow volume have potential impact across a much broader
range of medical disciplines.
Cardiosonix is developing and commercializing the QUANTIX(R) line of products
that employ a unique and proprietary Angle-independent Doppler Blood Flow
(ADBF(TM)) technology that allows for blood flow volume and velocity readings.
Most current applications of Doppler technology to blood flow measurement are
angle-dependent and therefore more prone to estimation errors and potential
inaccuracy. ADBF eliminates calculation estimation and permits real-time
measurement of volume blood flow.
The ADBF technology utilizes a special application of the Doppler method through
simultaneous projection of a combination of narrow beams with a known angle
between them. Thus, based on trigonometric and Doppler considerations, the angle
of insonation can be obtained, resulting in accurate, angle-independent blood
flow velocity measurements that do not require the use of complicated, expensive
imaging systems. In order to obtain high-resolution velocity profiles, the
QUANTIX devices use a multi-gated pulse wave Doppler beam. With this method,
specific sample volumes along the ultrasound beam can be separately evaluated,
and the application of a flow/no flow criterion can be made. The Cardiosonix
technology applies a special use of digital Doppler technology, which with the
digital signal processing power of the system allows hundreds of sample volumes
to be sampled and processed simultaneously, thus providing high resolution
velocity profiles for both angle and vascular diameter calculations, and
subsequently volume blood flow measurements. At present, Cardiosonix has two
products in the early stages of commercialization and one still in development
that are designed to provide blood flow measurement and cardiac output
information to physicians in cardiac/vascular surgery, neurosurgery and critical
care settings.
QUANTIX/ND(TM) is designed to allow neurosurgeons and neurologists, as well as
intensive care unit or emergency room physicians, to non-invasively measure
carotid artery blood flow in a simple and real-time manner. QUANTIX/ND consists
of a control unit and an angle-independent ultrasound probe that obtains signals
directly from the carotid artery in a non-invasive manner. QUANTIX/ND is
designed primarily for use in monitoring head trauma patients in neuro-intensive
care units and emergency rooms. Periodic blood flow measurements minimize the
risk of brain impairment. We are unaware of any measurement system on the market
today that provides real-time, bedside, non-invasive, continuous, direct and
accurate measurements of complete hemodynamic parameters including blood flow.
Other modalities that do monitor capabilities of the brain are significantly
more invasive, expose the patient to incremental risk or are inherently
complicated, offering only indirect estimation of perfusion conditions. Some
medical devices use an estimated measurement of blood flow velocity to create an
index of blood flow but do not account for instantaneous changes in vascular
cross-sectional area. In most competing devices, however, blood flow velocity is
angle-dependent and cannot be measured accurately. The QUANTIX/ND device, as
well as its predecessor device, the FLOWGUARD(TM), has received CE mark
regulatory clearance
4
for marketing in the European Union (EU) as well as FDA 510(k) clearance for
marketing in the United States.
QUANTIX/OR(TM) is designed to permit cardiovascular surgeons and assisting
physicians to obtain intraoperative volume blood flow readings in various
targeted blood vessels within seconds. The system consists of an
angle-independent ultrasound probe and digital numerical displays of blood flow
rate. Thus, the surgeon obtains immediate, real-time and quantitative readings
while focused on the target vessel. Quantifying blood flow is crucial during
anastomostic or other bypass graft procedures to determine adequate blood flow.
While measurement is advisable whenever a blood vessel is exposed
intra-operatively, generally this is not the current practice.
Ultimately, in practice, the surgeon generally resorts to using his eyes and
fingers in a process called finger palpation to qualitatively assess vessel
flow. The QUANTIX/OR offers the surgeon immediate and simple quantitative
assessment of blood flow in multiple blood vessels and grafts. The primary
advantage of finger palpation is that it is fast and simple; the disadvantages
are that it requires a good deal of experience, it is difficult to perform in
vessels embedded in tissue, it can become difficult to interpret in large
vessels, and it permits only a very qualitative and subjective assessment. A
significant partial occlusion (or even a total occlusion) will result in
significant vessel "inflation" and strong palpations that could mislead the
surgeon. Instead of such a subjective clinical practice that is highly
experience-dependent, the QUANTIX/OR is designed to allow the surgeon to rely on
more evidence-based medicine.
We believe that QUANTIX/OR represents a significant improvement over existing
technologies to directly measure blood flow intraoperatively. Other technologies
that attempt to measure intraoperative blood flow directly are generally more
invasive and are impractical when multiple vessel measurements are required.
They are, therefore, not used routinely in the operating room, so surgeons most
often resort to finger palpation to qualitatively, rather than quantitatively,
measure vessel perfusion. The QUANTIX/OR device has received CE mark regulatory
clearance for marketing in the EU and FDA 510(k) clearance for marketing in the
United States.
QUANTIX/TE(TM) is being designed as a transesophageal cardiac function monitor
for measuring blood flow in the descending aorta in critical care settings. The
system employs a special transesophageal catheter for quantitative assessment of
blood flow in the descending aorta for cardiac output calculations. The system
is designed for bedside use in intensive care settings. Cardiac output and
function monitoring is essential in critical care and trauma patients. The
procedure of transesophageal monitoring is a well-recognized clinical modality,
particularly for echocardiography of the heart. Only highly invasive methods of
cardiac output via thermodilution techniques are currently available, or
indirect and non-invasive methods such as bioimpedance with an unknown degree of
clinical significance. The QUANTIX/TE is still in the early stages of
development and is not currently cleared for commercial sale in any market.
Our strategy related to Cardiosonix products for 2004 continues to emphasize the
three primary objectives we established in 2003:
- to promote and expand the clinical evaluation of the
QUANTIX/ND and QUANTIX/OR with thought leaders in the
neurosurgical and cardiac arenas;
- to secure and train additional marketing and distribution
partners for key global markets for the QUANTIX/ND and
QUANTIX/OR devices; and
- to achieve commercial sales of Cardiosonix' Quantix products
beyond demonstration unit sales that would demonstrate the
initial market acceptance of the products.
We cannot assure you, however, that any of Cardiosonix' products will achieve
market acceptance. See also Risk Factors.
Lymphoseek
Our gamma detection devices are primarily capital in nature; as such, they
generate revenue only on the initial sale. To complement the one-time revenue
stream related to capital products, we are working on
5
developing recurring revenue or "procedural" products that would generate
revenue based on each procedure in which they were used. Our primary efforts in
this area involve an exclusive worldwide license agreement with the University
of California, San Diego (UCSD) for a proprietary compound we refer to as
LYMPHOSEEK. We believe LYMPHOSEEK, if proven effective, could be used as a lymph
node locating agent in ILM procedures. Neoprobe and UCSD completed pre-clinical
evaluations of LYMPHOSEEK in 2001 and completed a Phase I trial in the treatment
of breast cancer in humans. The initial Phase I studies of LYMPHOSEEK in breast
cancer were funded through a research grant from the Susan G. Komen Breast
Cancer Research Foundation. Preliminary results from the Phase I breast trial
were presented at the Spring 2002 meeting of the Society of Nuclear Medicine.
A Phase I/II clinical trial in melanoma patients was completed during the third
quarter of 2003. The Phase I/II melanoma trial was funded through a research
grant from the American College of Surgeons. Our discussions held to date with
potential strategic partners to assist in the further development and
commercialization of LYMPHOSEEK have focused on gaining a better understanding
of the regulatory approval process related to LYMPHOSEEK. To that end, we held a
meeting in November 2003 with the Interagency Council on Biomedical Imaging in
Oncology (Interagency Council), an organization representing the FDA, the NCI
and the Centers for Medicare and Medicaid Services to discuss the regulatory
approval process and to determine the objectives for the next clinical trial
involving LYMPHOSEEK. As a result of that meeting, we are preparing for the
submission of a clinical protocol to the FDA for a pivotal trial to support the
marketing approval of LYMPHOSEEK. We expect to submit the protocol to the FDA
before the end of the third quarter of 2004. We cannot assure you, however, that
this product will achieve regulatory approval, or if approved, that it will
achieve market acceptance. See also Risk Factors.
RIGS
From inception until 1998, Neoprobe devoted significant efforts and resources to
the development of its proprietary RIGS technology. The RIGS system combines a
patented hand-held gamma radiation detection probe, proprietary radiolabeled
cancer targeting agents, and patented surgical methods to provide surgeons with
real-time information to locate tumor deposits not detectable by conventional
methods, and to assist in more thorough removal of the cancer. The RIGS system
is designed to assist the surgeon in the more thorough removal of the cancer,
thereby leading to improved surgical treatment of the patient. The targeting
agents used in the RIGS process are monoclonal antibodies, labeled with a
radioactive isotope that emits low energy gamma rays. The device used is a very
sensitive radiation detection instrument that is capable of detecting small
amounts of radiation bound to the targeting agent. Before surgery, a cancer
patient is injected with one of the targeting agents which circulates throughout
the patient's body and binds specifically to cancer cell antigens or receptors.
Concentrations of the targeting agent are then located during surgery by
Neoprobe's gamma-detection device, which emits an audible tone to direct the
surgeon to targeted tissue.
RIGSCAN CR49 is an intraoperative radiodiagnostic agent consisting of a
radiolabeled murine monoclonal antibody (MAb CC49). The radiolabel used is 125I,
a 27 - 35 KeV emitting isotope. The MAb used in RIGSCAN CR49 is the CC49 MAb
developed by the NCI and licensed to Neoprobe by the NIH. The CC49 MAb is
produced from a murine cell line generated by the fusion of splenic lymphocytes
from mice immunized with tumor-associated glycoprotein-72 (TAG-72) with
non-immunoglobulin secreting P3-NS-1-Ag4 myeloma cells. The CC49 MAb localizes
or binds to TAG-72 and shows a strong reactivity with both LS-174T colon cancer
extract and to a breast cancer extract.
RIGSCAN CR49 is the biologic component for the RIGS system to be used in
patients with colon or rectal cancer. The RIGS system is designed to be a
diagnostic aid in the intraoperative detection of clinically occult disease.
RIGSCAN CR49 is intended to be used in conjunction with other diagnostic
methods, for the detection of the extent and location of tumor in patients with
colorectal cancer. The detection of clinically occult tumor provides the surgeon
with a more accurate assessment of the extent of disease and, therefore, may
impact the surgical and therapeutic management of the patient. Clinical trials
suggest that RIGSCAN CR49 provides additional information outside that provided
by standard diagnostic modalities (including surgical exploration) that may aid
in patient management. Specifically, RIGSCAN
6
CR49 used as a component of the RIGS system confirms the location of surgically
suspicious metastases, evaluates the margins of surgical resection, and detects
occult tumor in perihepatic (portal and celiac axis) lymph nodes.
Neoprobe conducted two Phase III studies, NEO2-14 and NEO2-13, of RIGSCAN CR49
in patients with colorectal cancer. Both studies were multi-institutional
involving cancer treatment institutions in the United States, Israel, and
Europe. The primary endpoint of both studies was to demonstrate that RIGSCAN
CR49 detected pathology-confirmed disease that had been undetected by
traditional preoperative (i.e., CT Scans) or intraoperative (i.e., surgeon's
visual observations and palpation) means. That is, the trials were intended to
show that the use of RIGSCAN CR49 assisted the surgeon in the detection of
occult tumor. In December 1996, Neoprobe submitted applications to the European
Agency for the Evaluation of Medicinal Products (EMEA) and the FDA for marketing
approval of RIGSCAN CR49 for the detection of metastatic colorectal cancer.
Clinical study NEO2-14, which was submitted to the FDA in the RIGSCAN CR49
Biologic License Application (BLA), enrolled 151 colorectal cancer patients with
either suspected metastatic primary colorectal disease or recurrent colorectal
disease. During the FDA's review of the BLA, 109 of the enrolled patients were
determined to be evaluable patients. Clinical study NEO2-13 was conducted in 287
enrolled patients with primary colorectal disease. The primary end-point for
clinical study NEO2-13 was the identification of occult tumor.
NEO2-14 was the pivotal study submitted with Neoprobe's referenced BLA. Two
additional studies evaluating patients with either primary or metastatic
colorectal disease, NEO2-11 (a multi-center study) and NEO2-18 (a single
institution study), were included in the BLA and provided supportive proof of
concept (i.e., localization and occult tumor detection) and safety data. A study
report for NEO2-13 was not submitted under the BLA and the FDA undertook no
formal review of the study.
Following review of its applications, we received requests for further
information from the FDA and from the European Committee for Proprietary
Medicinal Products (CPMP) on behalf of the EMEA. Both the FDA and EMEA
acknowledged that our studies met the diagnostic endpoint of the Phase III
clinical study, which was to provide incremental information to the surgeon
regarding the location of hidden tumor. However, both agencies wanted to know
how the finding of additional tumor provided clinical benefit that altered
patient management or outcome. In a series of conversations with the FDA the
product claims were narrowed to the intraoperative detection of hepatic and
perihepatic disease in patients with advanced colorectal cancer and patients
with recurrent colorectal cancer.
The FDA determined during its review of the BLA review that the clinical studies
of RIGSCAN CR49 needed to demonstrate clinical utility in addition to
identifying additional pathology confirmed disease. In discussions between
Neoprobe and the agency, an FDA driven post hoc analysis plan was developed to
limit the evaluation of RIGSCAN CR49 to patients with hepatic and perihepatic
disease with known metastasis to the liver. Findings of "occult" disease and
subsequent changes in patient management (i.e., abandoning otherwise risky
hepatic resections) in this limited population would serve as a measure of
patient benefit. The FDA's analysis of the patients enrolled in NEO2-14 matching
the limited criteria was evaluated with a determination to confirm the surgical
resection abandonment outcome. The number of evaluable patients in this
redefined patient population was deemed too small by the agency and the lack of
pre-stated protocol guidance precluded consistent sets of management changes
given similar occult findings. The number of evaluable patients for any measure
of clinical utility, therefore, was too small to meet relevant licensing
requirements and the FDA ultimately issued a not approvable letter for the BLA
on December 22, 1997, describing certain clinical and manufacturing
deficiencies. Neoprobe also withdrew its application to the EMEA in November
1997.
We developed a clinical response plan for both agencies during the first half of
1998. However, following our analysis of the regulatory pathways for approval
that existed at that time, we determined that we did not have sufficient
financial resources to conduct the additional studies requested and sought to
identify others with an interest in continuing the development process.
7
Over the last several years, we have held preliminary discussions with several
parties potentially interested in continuing the RIGS development; however, only
one of those discussions resulted in an arrangement that attempted to restart
the development of RIGS. During 2000, we executed and amended an agreement with
OncoSurg Ltd. (OncoSurg, formerly NuRIGS Ltd.), that provided OncoSurg with an
option exercisable through December 31, 2001 to license the RIGS technology for
use in the diagnosis and treatment of colorectal cancer. During 2001, OncoSurg
conducted pre-clinical testing and sponsored a Phase I physician's
Investigational New Device (IND) clinical trial for colorectal cancer using a
second-generation humanized version of our RIGSCAN CR49 antibody. However,
OncoSurg did not exercise its option to continue development at the end of 2001
due to a lack of funding which we believe is unrelated to the pending clinical
results of the current Phase I trial. The physician-IND researchers reported
favorable results of the Phase I trial during fourth quarter of 2003.
We recently obtained results of a third party's survival analysis suggesting
that RIGSCAN CR49 may be predictive of, or actually contribute to, a positive
outcome when measuring survival of the patients that participated in our
original BLA studies. The data or its possible significance was unknown at the
time of the BLA review given the limited maturity of the follow-up experience.
The data includes publication by some of the primary investigators involved in
the Phase III RIGS trials who have independently conducted survival follow-up
analyses to their own institution's RIGS trial patients with apparently
favorable results relating to the long-term survival prognosis of patients who
were treated with RIGS. In addition, we have recently learned that the FDA has
held the BLA originally filed with the FDA in 1996 open. Based primarily on
these pieces of information, we requested, and have been granted, a meeting with
the FDA to discuss the possible next steps for evaluating the survival related
to our previous Phase III clinical trials as well as the possible submission of
this data, if acceptable, as a prospective analysis in response to questions
originally asked by the FDA in response to our original BLA. Our meeting with
the FDA has been scheduled for April 15, 2004.
If our plan for evaluating the survival data is received positively, we intend
to engage the services of a clinical research organization (CRO) to review these
survival findings related to all evaluable patients from our Phase III primary
and metastatic colorectal cancer clinical trials. The analysis of this data may
answer some of the questions raised by the FDA in response to our original
application; however, the RIGSCAN CR49 drug has not been produced for several
years and we believe it is likely we would have to perform some additional work
related to ensuring the drug cell line is still viable and submit this data to
the FDA for their evaluation before approval could be considered. Neoprobe is in
the process of initiating discussions with established biologic manufacturing
organizations to determine the costs and timelines associated with the
production of commercial quantities of the CC49 antibody. In addition, we will
need to establish a process for radiolabeling the CC49 antibody in order to meet
the regulatory needs for the RIGSCAN CR49 product. At this time, we have not
examined the possible steps towards a similar re-invigoration of the process for
approval with the EMEA. We intend to re-evaluate that situation once the
approval process with the FDA has been clarified.
We are encouraged by the recent developments regarding RIGS and believe that a
positive outcome from our upcoming meeting with the FDA could represent a
dramatic turnaround in the development for RIGS. We believe we would need to
obtain additional funding and/or identify a development partner in order to
carry out all the activities necessary for commercialization. We do not have any
agreements in place or pending with third parties that would ensure the
continued development of the RIGS process beyond the FDA meeting scheduled for
April 15th and the completion of the survival analysis being proposed to the FDA
at the April 15th meeting. In addition, even if we are able to make such
arrangements on satisfactory terms, we believe that the time required for
continued development, regulatory approval and commercialization of a RIGS
product would likely be a minimum of two years before we receive any
significant product-related royalties or revenues. However, we cannot assure you
that we will be able to complete definitive agreements with a development
partner for the RIGS technology and does not know if a partner will be obtained
on a timely basis on terms acceptable to us, or at all. We cannot assure you
that the FDA or the EMEA will approve our RIGS products for marketing, or that
any such products will be successfully introduced or achieve market acceptance.
See Risk Factors.
8
Activated Cellular Therapy
We have performed early stage research on another technology platform, activated
cellular therapy (ACT), based on work originally done in conjunction with the
RIGS technology. ACT is intended to boost the patient's own immune system by
removing lymph nodes identified during surgery and then, in a cell processing
technique, activating and expanding "helper" T-cells found in the nodes. Within
10 to 14 days, the patient's own immune cells, activated and numbering more than
20 billion, are infused into the patient in an attempt to trigger a more
effective immune response to the cancer.
During the second quarter of 2001, we announced a research collaboration with
Aastrom Biosciences, Inc. (Aastrom) intended to determine whether Aastrom's
Replicell(TM) system would be able to duplicate cell expansion results
experienced in previous Phase I clinical testing of our ACT technology for
oncology. Unfortunately, we experienced delays in completing the evaluation in
2001 due to a lack of available tissue for testing purposes and since that time
have not had the funding available to move the research forward. From time to
time, we have engaged investment banking firms as we did for the RIGS technology
to assist us in identifying parties to license or purchase the ACT technology.
However, these efforts have not resulted in the identification of a development
partner, purchaser or licensee to date. We do not know if a partner will be
identified on a timely basis, on terms acceptable to us, or at all. Although the
prospects for ACT may be improved depending on the outcome of a decision to
renew development efforts for RIGS, we currently do not intend to fund any
significant ACT-related research and development without a partner. We cannot
assure you that any ACT products will be successfully developed, tested or
licensed, or that any such products will gain market acceptance. See also Risk
Factors.
MARKET OVERVIEWS
The medical device marketplace is a fast growing market. Medical Device &
Diagnostic Industry magazine reports an annual medical device and diagnostic
market of $75 billion in the U.S. and $169 billion internationally.
Cancer Market Overview
Cancer is the second leading cause of death in the U.S. and Western Europe and
is responsible for over half a million deaths annually in the U.S. alone. The
NIH estimates the overall annual costs for cancer (the primary focus of our
products) for the U.S. in the year 2003 at $189.5 billion: $64.2 billion for
direct medical costs, $16.3 billion for indirect morbidity, and $109 billion for
indirect mortality. Our line of gamma detection systems is currently used
primarily in the application of ILM in breast cancer and melanoma which,
according the American Cancer Society (ACS), are expected to account for 16% and
4%, respectively, of new cancer cases in the U.S. in 2004.
NIH has estimated that breast cancer will annually affect approximately 500,000
women in North America, Western Europe, and other major economic markets. Breast
cancer is the leading cause of death from cancer in the United States among the
30 million women between the ages of 40 and 55 and the second leading cause of
death from cancer among all women. According to the ACS, over 200,000 new cases
of invasive breast cancer are expected to be diagnosed and over 40,000 women are
expected to die from the disease during 2004 in the U.S. alone. The incidence of
breast cancer increases with age, rising from about 100 cases per 100,000 women
at age 40 to about 400 cases per 100,000 women at age 65. Thus, we believe that
the significant aging of the population, combined with improved education and
awareness of breast cancer and diagnostic methods, will lead to an increased
number of breast cancer surgical diagnostic procedures.
Approximately 80% of the patients diagnosed with breast cancer undergo a lymph
node dissection (either ALND or SLNB) to determine if the disease has spread.
While many breast cancer patients are treated in large cancer centers or
university hospitals, regional and/or community hospitals currently treat the
majority of breast cancer patients. Over 10,000 hospitals are located in the
markets targeted for our gamma detection ILM products. While we are aware of no
published statistics on the number of institutions that currently are using
gamma detection devices in ILM, we believe that approximately fifty
9
percent of the total potential global market for gamma detecting devices remains
to be penetrated at this time. However, if the potential of LYMPHOSEEK as a
radioactive tracing agent is ultimately realized, it has the potential to
address not only the current breast and melanoma markets on a procedural basis,
but to also assist in the clinical evaluation and staging of solid tumor cancers
and expanding ILM to additional indications, such as gastric, non-small cell
lung and other solid tumor cancers.
We estimate the total market potential for LYMPHOSEEK, if ultimately approved
for all of these indications, could exceed $200 million. However, we cannot
assure you that LYMPHOSEEK will be approved, or if approved, that it will
achieve the prices or sales we have estimated.
The ACS estimates that over 174,000 new incidences of colorectal and related
cancers will occur in the U.S. in 2004. Based on an assumed recurrence rate of
40%, this would translate into total potential surgical procedures of over
240,000 annually in the U.S. alone. We believe the number of procedures in
other markets of the world to be approximately two times the estimated U.S.
market. As a result, we believe the total potential global market for RIGSCAN
CR49 could, depending on the reimbursement allowed for RIGSCAN CR49, be in
excess of $1 billion annually. However, we cannot assure you that RIGSCAN CR49
will be approved, or if approved, that it will receive the reimbursement or
achieve the level of sales we have currently estimated.
Blood Flow Market Overview
Cardiovascular disease is the number one killer of men and women in the U.S. and
in a majority of countries in the rest of the world that track such statistics.
In the U.S. alone, the Centers for Disease Control (CDC) estimated that there
were over 65 million physician office visits and over 6.8 million outpatient
department visits in 2000 with a primary diagnosis of cardiovascular disease.
The CDC registered over 5.9 million inpatient cardiovascular procedures in the
U.S. during 2000 that directly involve cardiovascular circulation. We, as well
as our competitors and other industry analysts, generally estimate the rest of
the world's incidence of such modalities at roughly twice U.S. estimates.
The American Heart Association (AHA) estimates the total cost of cardiovascular
diseases and stroke in the United States will exceed $368.4 billion in 2004. A
substantial portion of these expenditures is expected to be for non-invasive
image and intravascular examination. In 1999, these modalities, employed in
approximately 99 million diagnostic procedures, generated more than $2.4 billion
worldwide in product sales. Industry analysts have also estimated the worldwide
market for multi-functional patient monitoring equipment totaled $6.6 billion in
1999.
We have identified three distinct markets within the hospital setting for
Cardiosonix' products:
- non-invasive diagnostics (QUANTIX/ND);
- intraoperative assessment (QUANTIX/OR); and
- critical care monitoring (QUANTIX/TE).
The American Hospital Association has estimated there are approximately 6,000
hospitals in the U.S., over half of which house one hundred beds or more (i.e.,
large hospitals). The American Association of Operating Room Nurses has
estimated there are approximately 30,000 operating rooms in the U.S. Based on
these estimates, information obtained from industry sources and data published
by our competitors and other medical device companies, we estimate the worldwide
totals for hospitals and operating rooms to be approximately two to
two-and-a-half times the U.S. totals. In addition, the NCHS estimates that
516,000 cardiac bypass grafts were performed in the U.S. in 2001 on 305,000
patients.
Based on the above number of institutions and procedures, assuming the larger
hospitals could use two or more systems of each type to support their
activities, and assuming we are able to achieve market prices that are
comparable to what our competitors are achieving (estimated at averaging $25,000
to $30,000 per system or up to $180 per procedural use), we believe the
worldwide market potential for blood flow measurement products, such as those
being developed by Cardiosonix, to be more than $1.5 billion. We believe that
gaining even a modest share of this market would result in significant annual
revenues for our company. We cannot assure you, however, that Cardiosonix
products will achieve market acceptance and generate the level of sales or
prices anticipated.
MARKETING AND DISTRIBUTION
Gamma Detection Devices
We began marketing the current generation of our gamma detection systems, the
NEO2000, in October 1998. Since October of 1999, our gamma detection systems
have been marketed and distributed throughout most of the world through Ethicon
Endo-Surgery, Inc. (EES), a Johnson and Johnson company. In Japan, however, we
market our products through a pre-existing relationship with Century Medical,
Inc. (CMI).
10
The heart of the NEO2000 system is a control unit that is software-upgradeable,
permitting product enhancements without costly remanufacturing. Since the
original launch of the NEO2000 system, we have introduced an enhanced version of
our 14mm reusable probe optimized for lymphatic mapping procedures and a
laparoscopic probe intended for certain minimally invasive procedures. We have
also developed three major software version upgrades for the system that have
been made available for sale to customers. We intend to continue developing
additional ILM-related probes and instrument products in cooperation with EES to
maintain our leadership position in the ILM field.
Physician training is critical to the use and adoption of ILM products by
surgeons and other medical professionals. Our company and our marketing partners
have established relationships with leaders in the ILM surgical community and
have established and supported training courses internationally for lymphatic
mapping. We intend to continue to work with our partners to expand the number of
ILM training courses available to surgeons.
We entered into our current distribution agreement with EES effective October 1,
1999 for an initial five-year term with options to extend for two successive
two-year terms. EES recently notified us of their desire to exercise their
option for the first of the two-year term extensions, thus extending the term of
our current agreement through December 31, 2006. Under this agreement, we
manufacture and sell our ILM products almost exclusively to EES, who distributes
the products globally (except for Japan). EES agreed to purchase minimum
quantities of our products over the first three years of the five-year original
term of the agreement and to reimburse us for certain research and development
costs during the first three years and a portion of our warranty costs. EES'
minimum purchase and reimbursement commitments were satisfied during 2002. EES
has no ongoing purchase or reimbursement commitments to us other than the
rolling four-month binding purchase commitment for gamma detection devices as
outlined in the distribution agreement. Our agreement with EES also contains
certain termination provisions and licenses to our intellectual property that
take effect only in the event we fail to supply product, or for other reasons
such as a change of control. See also Risk Factors.
Gamma Detection Radiopharmaceuticals
Due to the recency of the reinvigoration of our development efforts related to
RIGSCAN CR49, we have not established a marketing or distribution channel for
this product. We anticipate initiating such discussions following the
establishment of a development timeline following our April 15, 2004 meeting
with the FDA. We have had initial discussions with parties who may be interested
in marketing and distribution of LYMPHOSEEK; however, such discussions to date
have been preliminary in nature and have not resulted in any definitive
arrangements at this time. We cannot assure you that we will be able to secure
marketing and distribution partners for RIGS or LYMPHOSEEK, or if secured, that
such arrangements will result in significant sales of either product.
Blood Flow Measurement Devices
During late 2002, we received regulatory clearance to market QUANTIX/ND in the
U.S. and the EU and placed a small number of devices with two distributors
covering three countries for their demonstration purposes. Since the end of
2002, we have received CE Mark clearance to market the QUANTIX/OR in the EU and
510(k) clearance to market the device in the U.S. Currently, we have five
distributors covering seven countries for the QUANTIX/ND and nine distributors
covering over fifteen countries for the QUANTIX/OR. We are in active dialogue
for marketing and distribution rights with a number of parties, primarily
independent distributors which have territory or country-specific sales forces.
The majority of the distributors signed to date are in the EU, South America and
the Pacific Rim. In the United States, we are engaging independent
cardiovascular sales organizations to sell and promote the use of the
QUANTIX/OR. We have agreements completed or pending for a majority of states in
the U.S.
We anticipate spending a significant amount of time and effort in 2004 to
penetrate the end-user market. We will need to complete the training of our
distributors and independent sales agents and work through them with thought
leaders in the cardiac and neurosurgical fields to gain penetration at the
end-user level. We anticipate placing some additional blood flow systems with
industry thought leaders to obtain critical
11
pre-commercialization feedback; however, we plan to continue working with the
thought leaders already identified to promote publication in support of more
widespread market launch. To date, we have placed a small number of devices with
thought leaders in the U.S. and EU to support clinical investigations by their
institutions. We are also investigating different sales models that include both
capital sales and per use or lease-type transactions. We expect the sales model
will evolve over the initial months of sales. The market education process we
envision will likely take some time to develop in the manner we desire. In
addition, the sales cycle for capital medical devices such as our blood flow
products is typically a four to six month cycle. As such, significant end
customer sales, if they occur, will likely lag the signing of distribution
arrangements.
MANUFACTURING
Gamma Detection Devices
We rely on independent contract manufacturers, some of which are single-source
suppliers, for the manufacture of the principal components of our current line
of gamma detection system products. See also Risk Factors. The NEO2000 system is
comprised of a software-upgradeable NEO2000 control unit, a hand-held gamma
detection probe and some accessories. We currently market a 14mm reusable probe
and a laparoscopic reusable probe.
We have devoted significant resources to develop production capability for our
gamma detection systems at qualified contract manufacturers. Production of the
NEO2000 control unit, the 14mm probe and the laparoscopic probe involve the
manufacture of components by a combination of subcontractors, including but not
limited to eV Products, a division of II-VI Corporation (eV), and TriVirix
International, Inc. (TriVirix). Currently, we have manufacturing and supply
agreements with eV for the production of crystal modules used in the detector
probes and for the manufacture of the 14mm probe and the NEO2000 control unit at
TriVirix. We also purchase certain accessories for our line of gamma detection
systems from other qualified manufacturers.
In December 1997, we entered into a supply agreement with eV for the supply of
certain crystals and associated electronics to be used in the manufacture of our
proprietary line of hand-held gamma detection probes. The original term of the
agreement expired on December 31, 2002, but was automatically extended through
December 31, 2005; however, the agreement is no longer exclusive for the last
three years. eV supplies 100% of the crystals used in our products. While eV is
not the only potential supplier of such crystals, any prolonged interruption of
this source could restrict the availability of our probe products, which would
adversely affect our operating results.
In October 2001, we entered into a manufacturing and supply agreement with UMM
Electronics, Inc. (UMM) for the exclusive manufacture of our 14mm probe and
NEO2000 control unit. The original term of the agreement was to expire in
February 2005; however, we terminated our relationship with UMM during the
fourth quarter of 2003. In the process of evaluating contract manufacturers for
the QUANTIX product line, we had identified a different contract manufacturer,
TriVirix, and concluded that it would be financially and operationally
beneficial to us to have the NEO2000 and 14mm probe manufactured at the same
location as the QUANTIX products.
In February 2004, we executed a Product Supply Agreement with TriVirix for the
manufacture of the NEO2000 and 14mm probe. We have now completed the transfer of
the manufacturing for the NEO2000 and 14mm probes to TriVirix. TriVirix began
providing 14mm probes during February and the NEO2000 control unit during March
2004 for shipment to EES
We cannot assure you that we will be able to maintain agreements with our
subcontractors on terms acceptable to us, or that our subcontractors will be
able to meet our production requirements on a timely basis, at the required
levels of performance and quality. In the event that any of our subcontractors
is unable or unwilling to meet our production requirements, we cannot assure you
that an alternate source of supply could be established without significant
interruption in product supply or without significant adverse impact to product
availability or cost. Any significant supply interruption or yield problems that
we or our
12
subcontractors experience would have a material adverse effect on our ability to
manufacture our products and, therefore, a material adverse effect on our
business, financial condition, and results of operations until a new source of
supply is qualified. See also Risk Factors.
Gamma Detection Radiopharmaceuticals
Due to the recency of the reinvigoration of our development efforts related to
RIGSCAN CR49, we have not established a marketing or distribution channel for
this product. We will need to establish biologic production and radiolabeling
capabilities for the RIGS product before RIGSCAN CR49 can be commercialized. We
have held initial discussions with parties who may assist in the manufacturing
validation of the RIGSCAN product; however, these discussions have been
preliminary in nature and we cannot assure you that the parties we have
contacted will ultimately participate in the manufacture of RIGSCAN CR49. We
anticipate continuing such discussions following the establishment of a
development timeline following our April 15, 2004 meeting with the FDA. We have
had initial discussions with parties who may be interested in producing
LYMPHOSEEK; however, such discussions to date have been preliminary in nature
and have been primarily related to manufacturing validation efforts. We cannot
assure you that we will be successful in securing the necessary biologic product
and/or radiolabeling capabilities.
Blood Flow Measurement Devices
Currently, the QUANTIX products being distributed are being manufactured at
Cardiosonix' facility in Israel. However, consistent with our stated objectives,
we evaluated different contract manufacturers for the control unit portion of
the QUANTIX product line during the first quarter of 2003 and solicited
competitive bids. During the second quarter of 2003, we selected TriVirix to
assemble the control unit portion of the QUANTIX line. In February 2004, we
executed a Product Supply Agreement for the assembly of the blood flow control
units with TriVirix; however, we are working with TriVirix to maintain some
level of component sourcing from Israel that will satisfy our royalty
requirements to the Israeli government (See Risk Factors).. Assembly of the
QUANTIX control units at TriVirix is expected to start during the second half of
2004. The ultrasound probes distributed with the QUANTIX control units, while
assembled at Cardiosonix' facility, use ultrasound transducers manufactured by
Vermon S.A. (Vermon) of France. We currently purchase the ultrasound transducer
modules from Vermon under purchase orders. We are in the process of evaluating
subcontractors to manufacture the ultrasound probes and other accessories
associated with the QUANTIX product line.
We cannot assure you that we will be able to finalize supply and service
agreements with Vermon or other subcontractors for the QUANTIX products, that we
will be able to maintain our agreement with TriVirix, or that our subcontractors
will be able to meet our production requirements on a timely basis, at the
required levels of performance and quality. In the event that any of our
subcontractors is unable or unwilling to meet our production requirements, we
cannot assure you that an alternate source of supply could be established
without significant interruption in product supply or without significant
adverse impact to product availability or cost. Any significant supply
interruption or yield problems that we or our subcontractors experience would
have a material adverse effect on our ability to manufacture our products and,
therefore, a material adverse effect on our business, financial condition, and
results of operations until a new source of supply is qualified. See also Risk
Factors.
In addition, we determined that development of the QUANTIX line had progressed
to the point where we did not need the number of development staff we had in
order to support the final development phases and to support our
commercialization efforts. As such, we reduced employment at our Cardiosonix
subsidiary during the fourth quarter of 2003. We have entered into new
employment arrangements with certain key personnel in Israel in order to
continue to provide limited developmental and commercial support for the QUANTIX
products.
13
COMPETITION
We face competition from medical product and biotechnology companies, as well as
from universities and other non-profit research organizations in the field of
cancer diagnostics and treatment. Many emerging medical product companies have
corporate partnership arrangements with large, established companies to support
the research, development, and commercialization of products that may be
competitive with our products. In addition, a number of large established
companies are developing proprietary technologies or have enhanced their
capabilities by entering into arrangements with or acquiring companies with
technologies applicable to the detection or treatment of cancer and the
measurement of blood flow. Many of our existing or potential competitors have
substantially greater financial, research and development, regulatory,
marketing, and production resources than we have. Other companies may develop
and introduce products and processes competitive with or superior to those of
ours. See also Risk Factors.
For our products, an important factor in competition is the timing of market
introduction of our products or those of our competitors' products. Accordingly,
the relative speed with which we can develop products, complete the regulatory
clearance processes and supply commercial quantities of the products to the
market is an important competitive factor. We expect that competition among
products cleared for marketing will be based on, among other things, product
efficacy, safety, reliability, availability, price, and patent position.
Gamma Detection Devices
With the emergence of ILM, a number of companies have begun to market gamma
radiation detection instruments. Most of the competitive products have been
designed from an industrial or nuclear medicine perspective rather than being
developed initially for surgical use. Through 2002, the principal competitive
product in both the United States and Europe was a gamma detection system
marketed by US Surgical Corporation, a subsidiary of Tyco International Ltd.;
however, we believe, based on competitive intelligence, that US Surgical has
retreated from the sale of gamma detection devices in the U.S. and certain other
global markets. We also compete with products produced by Care Wise Medical
Products Corporation, PI Medical Diagnostic Equipment B.V., Pol.Hi.Tech. Srl,
Silicon Instruments GmbH and other companies.
It is often difficult to glean accurate competitive information within the
lymphatic mapping field, primarily because most of our competitors are either
subsidiaries of a large corporation (i.e., U.S. Surgical) or privately held
corporations, whose sales revenue or volume data is, therefore, not readily
available or determinable. In addition, lymphatic mapping does not currently
have a separate reimbursement code in most healthcare systems. As such,
determining trends in the actual number of procedures being performed is
difficult. We believe, based on our understanding of EES' success rate in
competitive bid situations, that our market share has remained relatively
constant or increased slightly in light of changes in the competitive landscape
over the past few years. As we have discussed, we believe that current sales
levels indicate that some prospective customers may be waiting on the results of
important international clinical trials prior to adoption the ILM procedure and
purchasing a gamma detection device. We expect the results from these trials,
when announced, will likely have a positive impact on sales volumes. We believe
our intellectual property portfolio will be a barrier to competitive products;
we cannot assure you, however, that competitive products will not be developed
and be successful in eroding our market share or the prices we receive for our
gamma detection devices. See also Risk Factors.
Gamma Detection Radiopharmaceuticals
We do not believe there are any directly competitive intraoperative diagnostic
radiopharmaceuticals with RIGSCAN CR49 that would be used intraoperatively in
the colorectal cancer application that RIGSCAN CR49 is initially targeted for.
There are other radiopharmaceuticals that are used as preoperative imaging
agents; however, we are unaware of any that could be used as a real-time
diagnostic aid during surgery such as RIGSCAN CR49. Surgeons who practice the
lymphatic mapping procedure that LYMPHOSEEK is intended for currently use other
radiopharmaceuticals such as sulphur-colloid compound in the U.S. and other
colloid compounds in other markets. However, these drugs are being used
"off-label" (i.e., they are
14
not specifically indicated for use as a lymphatic targeting agent). As such, we
believe that LYMPHOSEEK, if ultimately approved, would be the first drug
specifically labeled for use as a lymphatic targeting agent.
Blood Flow Measurement Devices
There are several technologies on the market that measure or claim to measure
indices of blood flow. These products can be categorized as devices that measure
blood flow directly and devices that only obtain an estimation of flow
conditions.
Direct Blood Flow Measurement Devices
- Transit Time Ultrasound (TT) Flowmetry is the leading modality in the
operating room today. TT systems monitor blood flow invasively, and are
restricted to isolated vessels. They require probe adaptation to the
vessel size, and do not provide additional vascular parameters. The
technology requires the operator to encircle the blood vessel with a
probe that includes two ultrasound transmitters/receivers on one side,
and a mirror reflector on the opposite side of the vessel. By measuring
the transit time of the ultrasound beam in the upstream and downstream
directions, volume blood flow estimates can be evaluated.
- Electromagnetic Flowmeters (EMF) are probably the oldest modality to
quantify blood flow (other than timed collection). These devices
monitor blood flow invasively, are impractical for multiple readings on
different vessels, require precise sizing of probes to blood vessels,
and do not provide additional hemodynamic parameters. The technology
requires the operator to encircle the blood vessel with an
electromagnetic probe. The probe generates an electromagnetic field,
and the voltage measured due to the blood flow is translated into
volume flow estimates. In practice, however, this technology is
generally considered outdated.
- Doppler technology has been around for several decades, and is being
widely used in non-invasive vascular diagnostics. Duplex ultrasound
systems have the potential to measure blood flow non-invasively. Duplex
systems are designed for imaging the anatomical severity of pathology.
This method is technician-dependent, cumbersome, inaccurate and does
not offer monitoring capabilities. However, plain Doppler systems
provide only blood flow velocity rather than volume flow.
Indirect Blood Flow Measurement Devices
- Cardiac Output (CO) Monitors include various means to monitor CO such
as Thermal Dilution, Bio Impedance, and the Fick Method. These methods
are either invasive or indirect in their measurement. Thermal Dilution,
primarily through pulmonary artery catheterization, is the standard of
care today for cardiac output measurements. This technology is not
applicable to other intraoperative blood flow applications. The patient
is injected with cold saline at a fixed temperature, and a
temperature-sensitive transducer that is placed at the site of interest
(usually the pulmonary artery) measures the time to return to baseline
temperature, which is proportional to the blood flow rate. There are
many limitations to this technology, including the relatively large
inaccuracies of cardiac output measurements, the fact that it is not
truly real-time, and the fact that this method is highly invasive, and
is being linked to increased morbidity and mortality (JAMA, Connors et
al., 1996).
- Computed Tomography, Magnetic Resonance Imaging and Single Photon
Emission Computed Tomography techniques show target organ perfusion,
but lack the ability to monitor or to provide real-time information.
They are technician-dependent, impractical for bedside usage and very
expensive.
- Laser Doppler Flowmeters monitor skin blood flow non-invasively. They
are applicable only to superficial and tiny vessels and do not provide
additional hemodynamic parameters.
15
- Transcranial Doppler (TCD) monitors cerebral blood velocity rather than
direct blood flow. TCD is non-invasive and provides continuous
measurement of blood flow velocity in the vessels of the brain. TCD is
technician-dependent and cannot be used on every patient.
- Plethysmography indirectly measures an index of blood flow and is
limited primarily to limb assessment. Measurement depends upon many
factors and output is accordingly inaccurate.
- Jugular Bulb Saturation measures the efficiency of oxygen use by the
brain. It is invasive, and provides global results.
- NIRS is a non-invasive method utilizing near infrared spectroscopy to
provide regional perfusion in the brain.
Potentially Competitive Blood Flow Measurement Devices
Cardiosonix products are designed to address blood flow measurement
across a variety of clinical and surgical settings, and there are a
number of companies already in the marketplace that offer products
related to blood flow measurement. However, most of these products do
not directly compete with Cardiosonix products. The companies that do
offer potentially competitive products are, for the most part, smaller,
privately held companies, with which we believe we can effectively
compete. Indeed, due to our belief in the technical superiority of our
products, we believe the existence of competitors will help to educate
the marketplace regarding the importance of blood flow measurement. As
we have discussed, adoption of blood flow monitoring devices for the
measurement of hemodynamic status will likely take an involved
education process as it often involves a change in clinical or surgical
management. While there is not a clear leader in these markets, the
following companies compete most directly with Cardiosonix:
- Intraoperative applications: Carolina Medical, Inc. (EMF), Transonic
Systems, Inc. and Medi-Stim AS (TT).
- Neurosurgery applications: HADECO, Hayashi Denki Co., Ltd. (Doppler
based), DWL Elektronische Systeme GmbH and Nicolet Biomedical (TCD).
- Critical care monitoring: Deltex Medical Ltd. Arrow International, Inc.
(Transesophageal Doppler), and CardioDynamics International Corp. (Bio
Impedance).
PATENTS AND PROPRIETARY RIGHTS
We regard the establishment of a strong intellectual property position in our
technology as an integral part of the development process. We attempt to protect
our proprietary technologies through patents and intellectual property
positions, in the United States as well as major foreign markets. Specifically,
twenty instrument patents have been issued in the United Sates as well as major
foreign markets protect our ILM technology.
Cardiosonix has also applied for patent coverage for the key elements of its
ADBF technology in the EU and the U.S. The first of the two patents covering
Cardiosonix ADBF technology was issued in the U.S. in January 2003 and claims
for the second patent have been allowed. Two patents have been filed in the EU
and the claims of one patent have been allowed and the claims of the second
patent are in the late stage of review by the relevant governing bodies.
LYMPHOSEEK is also the subject of patent applications in the United States and
certain major foreign markets. The first composition of matter patent covering
LYMPHOSEEK was issued in the U.S. in June 2002. The claims of the composition of
matter patent covering LYMPHOSEEK have been allowed in the EU.
16
We continue to attempt to maintain proprietary protection for the products
related to RIGS and ACT in major global markets such as the U.S. and the EU,
which although not currently integral to our near-term business plans, may be
important to a potential RIGS or ACT development partner. Certain aspects of our
RIGS technology are claimed in the United States in U.S. Patent No. 4,782,840,
which expires in 2005, unless extended. In addition to the RIGS patent,
composition of matter patents that have been issued in the U.S. and EU cover the
antibodies used in clinical studies. The most recent of these patents issued in
2003.
The patent position of biotechnology and medical device firms, including our
company, generally is highly uncertain and may involve complex legal and factual
questions. Potential competitors may have filed applications for, or may have
been issued patents, or may obtain additional patents and proprietary rights
relating to products or processes in the same area of technology as that used by
our company. The scope and validity of these patents and applications, the
extent to which we may be required to obtain licenses thereunder or under other
proprietary rights, and the cost and availability of licenses are uncertain. We
cannot assure you that our patent applications will result in additional patents
being issued or that any of our patents will afford protection against
competitors with similar technology; nor can we assure you that any of our
patents will not be designed around by others or that others will not obtain
patents that we would need to license or design around. See also Risk Factors.
We also rely upon unpatented trade secrets. We cannot assure you that others
will not independently develop substantially equivalent proprietary information
and techniques, or otherwise gain access to our trade secrets, or disclose such
technology, or that we can meaningfully protect our rights to our unpatented
trade secrets.
We require our employees, consultants, advisers, and suppliers to execute a
confidentiality agreement upon the commencement of an employment, consulting or
manufacturing relationship with us. The agreement provides that all confidential
information developed by or made known to the individual during the course of
the relationship will be kept confidential and not disclosed to third parties
except in specified circumstances. In the case of employees, the agreements
provide that all inventions conceived by the individual will be the exclusive
property of our company. We cannot assure you, however, that these agreements
will provide meaningful protection for our trade secrets in the event of an
unauthorized use or disclosure of such information.
GOVERNMENT REGULATION
Most aspects of our business are subject to some degree of government regulation
in the countries in which we conduct our operations. As a developer,
manufacturer and marketer of medical products, we are subject to extensive
regulation by, among other governmental entities, the FDA and the corresponding
state, local and foreign regulatory bodies in jurisdictions in which our
products are sold. These regulations govern the introduction of new products,
the observance of certain standards with respect to the manufacture, safety,
efficacy and labeling of such products, the maintenance of certain records, the
tracking of such products and other matters.
Failure to comply with applicable federal, state, local or foreign laws or
regulations could subject us to enforcement action, including product seizures,
recalls, withdrawal of marketing clearances, and civil and criminal penalties,
any one or more of which could have a material adverse effect on our business.
We believe that we are in substantial compliance with such governmental
regulations. However, federal, state, local and foreign laws and regulations
regarding the manufacture and sale of medical devices are subject to future
changes. We cannot assure you that such changes will not have a material adverse
effect on our company.
For some products, and in some countries, government regulation is significant
and, in general, there is a trend toward more stringent regulation. In recent
years, the FDA and certain foreign regulatory bodies have pursued a more
rigorous enforcement program to ensure that regulated businesses, like ours,
comply with applicable laws and regulations. We devote significant time, effort
and expense addressing
17
the extensive governmental regulatory requirements applicable to our business.
To date, we have not received any notifications or warning letters from the FDA
or any other regulatory bodies of alleged deficiencies in our compliance with
the relevant requirements, nor have we recalled or issued safety alerts on any
of our products. However, we cannot assure you that a warning letter, recall or
safety alert, if it occurred, would not have a material adverse effect on our
company.
In the early to mid 1990s, the review time by the FDA to clear medical products
for commercial release lengthened and the number of marketing clearances
decreased. In response to public and congressional concern, the FDA
Modernization Act of 1997 (the 1997 Act) was adopted with the intent of bringing
better definition to the clearance process for new medical products. While FDA
review times have improved since passage of the 1997 Act, we cannot assure you
that the FDA review process will not continue to delay our company's
introduction of new products in the U.S. in the future. In addition, many
foreign countries have adopted more stringent regulatory requirements that also
have added to the delays and uncertainties associated with the release of new
products, as well as the clinical and regulatory costs of supporting such
releases. It is possible that delays in receipt of, or failure to receive, any
necessary clearance for our new product offerings could have a material adverse
effect on our business, financial condition or results of operations.
While we are unable to predict the extent to which our business may be affected
by future regulatory developments, we believe that our substantial experience
dealing with governmental regulatory requirements and restrictions on our
operations throughout the world, and our development of new and improved
products, should enable us to compete effectively within this environment.
Gamma Detection and Blood Flow Measurement Devices
As a manufacturer of medical devices sold in various global markets, we are
required to manufacture the devices under quality system regulations (QSR) and
maintain appropriate technical files and quality records. Our medical devices
are regulated in the United States by the FDA. Our medical devices are regulated
in the EU according to the Medical Device Directive (93/42/EEC). Under this
regulation, we must obtain CE Mark status for all products exported to the EU.
Our initial generation gamma detection instruments received 510(k) marketing
clearance from the FDA in December 1986 with modified versions receiving similar
clearances in 1992 through 1997. In 1998, the FDA reclassified "nuclear uptake
detectors" as being exempt from the 510(k) process. We believe the NEO2000
device is exempt from the 510(k) process because it is substantially equivalent
to previously cleared predecessor devices. We obtained the CE Mark for the
neo2000 device in January 1999, and therefore, must continue to manufacture the
devices under a quality system compliant to the requirements of ISO 9001/EN
46001 and maintain appropriate technical files. We maintain a license to import
our gamma devices into Canada, and therefore must continue to manufacture the
devices under a quality system compliant to the requirements of ISO 13485 and
CMDCAS.
Cardiosonix has received 510(k) and CE mark clearance to market the QUANTIX/ND
device in the U.S. and EU for non-invasive applications. The QUANTIX/OR has also
received CE Mark clearance to market in the EU and 510(k) clearance in the U.S.
Our distribution partners in certain foreign markets other than the EU are
seeking marketing clearances, as required, for both the QUANTIX/ND and
QUANTIX/OR. We intend to submit additional applications for clearance or
amendments, as appropriate, for the QUANTIX/TE in the future.
Gamma Detection Radiopharmaceuticals (LYMPHOSEEK and RIGS)
Our radiolabeled targeting agents and biologic products, if developed, would
require a regulatory license to market by the FDA and by comparable agencies in
foreign countries. The process of obtaining regulatory licenses and approvals is
costly and time consuming, and we have encountered significant impediments and
delays related to our previously proposed biologic products.
18
The process of completing pre-clinical and clinical testing, manufacturing
validation and submission of a marketing application to the appropriate
regulatory bodies usually takes a number of years and requires the expenditure
of substantial resources, and we cannot assure you that any approval will be
granted on a timely basis, if at all. Additionally, the length of time it takes
for the various regulatory bodies to evaluate an application for marketing
approval varies considerably, as does the amount of preclinical and clinical
data required to demonstrate the safety and efficacy of a specific product. The
regulatory bodies may require additional clinical studies that may take several
years to perform. The length of the review period may vary widely depending upon
the nature and indications of the proposed product and whether the regulatory
body has any further questions or requests any additional data. Also, the
regulatory bodies will likely require postmarketing reporting and surveillance
programs to monitor the side effects of the products. We cannot assure you that
any of our potential drug or biologic products will be approved by the
regulatory bodies or approved on a timely or accelerated basis, or that any
approvals received will not subsequently be revoked or modified.
In addition to regulations enforced by the FDA, the manufacture, distribution,
and use of radioactive targeting agents, if developed, are also subject to
regulation by the Nuclear Regulatory Commission (NRC), the Department of
Transportation and other federal, state, and local government authorities. We,
or our manufacturer of the radiolabeled antibodies, must obtain a specific
license from the NRC to manufacture and distribute radiolabeled antibodies, as
well as comply with all applicable regulations. We must also comply with
Department of Transportation regulations on the labeling and packaging
requirements for shipment of radiolabeled antibodies to licensed clinics, and
must comply with federal, state, and local governmental laws regarding the
disposal of radioactive waste. We cannot assure you that we will be able to
obtain all necessary licenses and permits and be able to comply with all
applicable laws. The failure to obtain such licenses and permits or to comply
with applicable laws would have a materially adverse effect on our business,
financial condition, and results of operations.
EMPLOYEES
As of March 15, 2004, we had 19 full-time employees, including those of our
subsidiary, Cardiosonix. We consider our relations with our employees to be
good.
RISK FACTORS
An investment in our common stock is highly speculative, involves a high degree
of risk, and should be made only by investors who can afford a complete loss.
Investors should carefully consider the following risk factors, together with
the other information in this Annual Report on Form 10-KSB, including our
financial statements and the related notes, before you decide to buy our common
stock. Our most significant risks and uncertainties are described below;
however, they are not the only risks we face. If any of the following risks
actually occur, our business, financial condition, or results of operations
could be materially adversely affected, the trading of our common stock could
decline, and you may lose all or part of your investment therein.
We have suffered significant operating losses for several years in our history
and we may not be able to again achieve profitability.
We had an accumulated deficit of approximately $123 million as of December 31,
2003. Although we were profitable in 2000 and in 2001, we incurred substantial
losses in the years prior to that, and in 2002 and 2003. The deficit resulted
because we expended more money in the course of researching, developing and
enhancing our technology and products and establishing our marketing and
administrative organizations than we generated in revenues. We expect to
continue to incur significant operating expenses in the foreseeable future,
primarily related to the completion of development and commercialization of the
Cardiosonix product line but also potentially related to RIGS and LYMPHOSEEK. As
a result, we are sustaining substantial operating and net losses, and it is
possible that we will never be able to sustain or develop the revenue levels
necessary to again attain profitability.
19
Our products may not achieve the broad market acceptance they need in order to
be a commercial success.
Widespread use of our gamma detection devices is currently limited to a surgical
procedure (ILM) used in the treatment and diagnosis of two primary types of
cancer: melanoma and breast cancer. The success of our gamma detection devices
greatly depends on the medical community's acceptance of ILM, and on our devices
for use in ILM as a reliable, safe and cost effective alternative to current
treatments and procedures. The adoption rate for ILM appears to be leveling off
and may not meet our growth expectations. Although we continue to believe that
ILM has significant advantages over other currently competing procedures,
broad-based clinical adoption of ILM will likely not occur until after the
completion of ongoing international trials related to breast cancer. Even if the
results of these trials are positive, we cannot assure you that ILM will attain
rapid and widespread acceptance. Our efforts and those of our marketing and
distribution partners may not result in significant demand for our products, and
the current demand for our products may decline.
Our future success now also greatly depends on the success of the Cardiosonix
product line. Cardiosonix' products are just beginning to be marketed
commercially. The market for these products is in an early stage of development
and may never fully develop as we expect. The long-term commercial success of
the Cardiosonix product line will require widespread acceptance of our products
as safe, efficient and cost-effective. Widespread acceptance would represent a
significant change in medical practice patterns. Other cardiac monitoring
procedures, such as pulmonary artery catheterization, are generally accepted in
the medical community and have a long standard of use. It is possible that the
Cardiosonix product line will never achieve the broad market acceptance
necessary to become a commercial success.
We rely on third parties for the worldwide marketing and distribution of our
gamma detection devices, who may not be successful in selling our products.
We currently distribute our gamma detection devices in most global markets
through two partners who are solely responsible for marketing and distributing
these products. The partners assume direct responsibility for business risks
related to credit, currency exchange, foreign tax laws or tariff and trade
regulation. While we believe that our distribution partners intend to continue
to aggressively market our products, we cannot assure you that the distribution
partners will succeed in marketing our products on a global basis. We may not be
able to maintain satisfactory arrangements with our marketing and distribution
partners, who may not devote adequate resources to selling our gamma detection
devices. If this happens, we may not be able to successfully market our
products, which would decrease our revenues.
We do not have experience in marketing blood flow devices and we have not yet
established long-term strategic relationships with a significant number of
potential marketing partners.
We completed the Cardiosonix acquisition on December 31, 2001, and to date we
have limited marketing and distribution experience with the QUANTIX line of
blood flow products covering only a limited number of countries. We believe the
adoption path for Cardiosonix' products will be similar to that of our gamma
detection devices, but we have no direct experience in marketing or selling
blood flow measurement devices and will likely be working with pricing
structures such as per-use or leasing with which we have little direct
experience. Further, we may not be successful in creating the necessary
infrastructure, either internally or through third parties, to support the
successful marketing and sales of Cardiosonix products.
We may have difficulty raising additional capital, which could deprive us of
necessary resources.
We expect to continue to devote capital resources to fund research and
development and to maintain existing and secure new manufacturing capacity. In
order to support the initiatives envisioned in our business plan, we may need to
raise additional funds through the sale of assets, public or private financing,
collaborative relationships or other arrangements. Our ability to raise
additional financing depends on many factors beyond our control, including the
state of capital markets, the market price of
20
our common stock and the development or prospects for development of competitive
technology by others. Because our common stock is not listed on a major stock
market, many investors may not be willing or allowed to purchase it or may
demand steep discounts. Sufficient additional financing may not be available to
us or may be available only on terms that would result in further dilution to
the current owners of our common stock. At current market prices, the limited
number of shares we have available to sell severely limits our ability to use
equity as a method of raising capital. If we are unable to raise additional
funds when we need them, we may have to severely curtail our operations.
The sale of the shares of common stock acquired in private placements could
cause the price of our common stock to decline.
During 2003, we completed several financings in which we issued common stock,
warrants and other securities convertible into common stock to certain private
investors and as required under the terms of those transactions, we filed a
registration statement with the United States Securities and Exchange Commission
(SEC) under which the investors may resell common stock acquired in these
transactions to the public. We have also filed a registration statement covering
the resale of common stock issued to former stockholders of Cardiosonix in
connection with our acquisition of that business.
The selling stockholders under these registration statements may sell none, some
or all of the shares of common stock acquired from us, as well as common stock
acquired on the exercise of the warrants and convertible securities held by
them. We have no way of knowing whether the selling stockholders will sell the
shares covered by these registration statements. Depending upon market liquidity
at the time, a sale of shares covered by these registration statements at any
given time could cause the trading price of our common stock to decline. The
sale of a substantial number of shares of our common stock under this
prospectus, or anticipation of such sales, could make it more difficult for us
to sell equity or equity-related securities in the future at a time and at a
price that we might otherwise wish to effect sales.
We rely on third parties to manufacture our products and our business will
suffer if they do not perform.
We rely on independent contract manufacturers for the manufacture of our current
line of gamma detection systems and for our QUANTIX line of blood flow
monitoring products. Our business will suffer if our contract manufacturers have
production delays or quality problems. Furthermore, medical device manufacturers
are subject to the QSR regulations of the FDA, international quality standards,
and other regulatory requirements. If our contractors do not operate in
accordance with regulatory requirements and quality standards, our business will
suffer. We use or rely on components and services used in our devices that are
provided by sole source suppliers. The qualification of additional or
replacement vendors is time consuming and costly. If a sole source supplier has
significant problems supplying our products, our sales and revenues will be hurt
until we find a new source of supply. In addition, our distribution agreement
with EES for gamma devices contains failure to supply provisions, which, if
triggered, could have a significant negative impact on our business.
We may lose out to larger and better-established competitors.
The medical device and biotechnology industries are intensely competitive. Some
of our competitors have significantly greater financial, technical,
manufacturing, marketing and distribution resources as well as greater
experience in the medical device industry than we have. The particular medical
conditions our product lines address can also be addressed by other medical
devices, procedures or drugs. Many of these alternatives are widely accepted by
physicians and have a long history of use. Physicians may use our competitors'
products and/or our products may not be competitive with other technologies. If
these things happen, our sales and revenues will decline. In addition, our
current and potential competitors may establish cooperative relationships with
large medical equipment companies to gain access to greater research and
development or marketing resources. Competition may result in price reductions,
reduced gross margins and loss of market share.
21
Our products may be displaced by newer technology.
The medical device and biotechnology industries are undergoing rapid and
significant technological change. Third parties may succeed in developing or
marketing technologies and products that are more effective than those developed
or marketed by us, or that would make our technology and products obsolete or
non-competitive. Additionally, researchers could develop new surgical procedures
and medications that replace or reduce the importance of the procedures that use
our products. Accordingly, our success will depend, in part, on our ability to
respond quickly to medical and technological changes through the development and
introduction of new products. We may not have the resources to do this. If our
products become obsolete and our efforts to develop new products do not result
in any commercially successful products, our sales and revenues will decline.
We are in a highly regulated business and could face severe problems if we do
not comply with all regulatory requirements in the global markets in which our
products are sold.
The FDA regulates our products in the United States. Foreign countries also
subject our products to varying government regulations. In addition, such
regulatory authorities may impose limitations on the use of our products. FDA
enforcement policy strictly prohibits the marketing of FDA cleared medical
devices for unapproved uses. Within the European Union, our products are
required to display the CE Mark in order to be sold. We have obtained FDA
clearance to market and European certification to display the CE Mark on our
current line of gamma detection systems and on two of Cardiosonix' products, the
QUANTIX/ND and QUANTIX/OR. We may not be able to obtain clearance to market for
any new products in a timely manner, or at all. Failure to comply with these and
other current and emerging regulatory requirements in the global markets in
which our products are sold could result in, among other things, warning
letters, fines, injunctions, civil penalties, recall or seizure of products,
total or partial suspension of production, refusal of the government to grant
pre-market clearance for devices, withdrawal of clearances, and criminal
prosecution.
Our intellectual property may not have or provide sufficient legal protections
against infringement or loss of trade secrets.
Our success depends, in part, on our ability to secure and maintain patent
protection, to preserve our trade secrets, and to operate without infringing on
the patents of third parties. While we seek to protect our proprietary positions
by filing United States and foreign patent applications for our important
inventions and improvements, domestic and foreign patent offices may not issue
these patents. Third parties may challenge, invalidate, or circumvent our
patents or patent applications in the future. Competitors, many of which have
significantly more resources than we have and have made substantial investments
in competing technologies, may apply for and obtain patents that will prevent,
limit, or interfere with our ability to make, use, or sell our products either
in the United States or abroad.
In the United States, patent applications are secret until patents issue, and in
foreign countries, patent applications are secret for a time after filing.
Publications of discoveries tend to significantly lag the actual discoveries and
the filing of related patent applications. Third parties may have already filed
applications for patents for products or processes that will make our products
obsolete or will limit our patents or invalidate our patent applications.
We typically require our employees, consultants, advisers and suppliers to
execute confidentiality and assignment of invention agreements in connection
with their employment, consulting, advisory, or supply relationships with us.
They may breach these agreements and we may not obtain an adequate remedy for
breach. Further, third parties may gain access to our trade secrets or
independently develop or acquire the same or equivalent information.
Agencies of the United States government conducted some of the research
activities that led to the development of antibody technology that some of our
proposed antibody-based surgical cancer detection products use. When the United
States government participates in research activities, it retains rights that
include the right to use the technology for governmental purposes under a
royalty-free license, as well as
22
rights to use and disclose technical data that could preclude us from asserting
trade secret rights in that data and software.
Conditions in Israel may affect the operations of Cardiosonix and may limit our
ability to complete development of its products.
Our Cardiosonix subsidiary is incorporated in Israel, and its offices and
research and development facilities are located there. In concert with the plan
to transfer or manufacturing of the QUANTIX products to a contract manufacturer
located in the United States, certain manufacturing and development activities
underway in Israel have been or will be curtailed or discontinued. While we have
reduced our activities in Israel, continued adverse political, economic and
military conditions in Israel may directly affect our operations. Since the
establishment of the State of Israel in 1948, a number of armed conflicts have
taken place between Israel and its Arab neighbors and a state of hostility,
varying in degree and intensity, has led to security and economic problems for
Israel. Despite past progress towards peace between Israel and its Arab
neighbors, the future of these peace efforts is uncertain. Any armed conflict,
political instability or continued violence in the region could have a negative
effect on the activities of Cardiosonix and the completion of development and
commercialization of our blood flow monitoring products.
The government grants Cardiosonix has received for research and development
expenditures restrict our ability to manufacture blood flow monitoring products
and transfer technologies outside of Israel and require us to satisfy specified
conditions. If we fail to satisfy these conditions, we may be required to refund
grants previously received together with interest and penalties, and may be
subject to criminal charges.
Cardiosonix received grants from the government of Israel through the Office of
the Chief Scientist of the Ministry of Industry and Trade for the financing of a
portion of its research and development expenditures associated with our blood
flow monitoring products. From 1998 to 2001, Cardiosonix received grants
totaling $775,000 from the OCS. The terms of the OCS grants may affect our
efforts to transfer manufacturing of products developed using these grants
outside of Israel without special approvals. The OCS issued a letter to Neoprobe
in December 2001, prior to the acquisition of Cardiosonix, consenting to the
transfer of manufacturing as long as Neoprobe consented to the terms of the OCS
statutes under Israeli law. As a result of our efforts to transfer a significant
portion of the manufacture of our blood flow products out of Israel, we will
likely be required to pay an increased amount of royalties, which may be up to
300% of the grant amount, depending on the manufacturing volume that is
performed outside of Israel. This may impair our ability to effectively
outsource manufacturing or engage in similar arrangements for those products or
technologies. In addition, if we fail to comply with any of the conditions
imposed by the OCS, we may be required to refund any grants previously received
together with interest and penalties, and may be subject to criminal charges. In
recent years, the government of Israel has accelerated the rate of repayment of
OCS grants and may further accelerate them in the future.
Our product sales may be adversely affected by healthcare pricing regulation and
reform activities.
The healthcare industry is undergoing fundamental changes resulting from
political, economic and regulatory influences. In the United States,
comprehensive programs have been proposed that seek to increase access to
healthcare for the uninsured, control the escalation of healthcare expenditures
within the economy and use healthcare reimbursement policies to balance the
federal budget.
We expect that Congress and state legislatures will continue to review and
assess healthcare proposals, and public debate of these issues will likely
continue. We cannot predict which, if any, of such reform proposals will be
adopted and when they might be adopted. Other countries also are considering
healthcare reform. Significant changes in healthcare systems could have a
substantial impact on the manner in which we conduct our business and could
require us to revise our strategies.
23
We could be damaged by product liability claims.
Our products are used or intended to be used in various clinical or surgical
procedures. If one of our products malfunctions or a physician misuses it and
injury results to a patient or operator, the injured party could assert a
product liability claim against our company. We currently have product liability
insurance with a $10 million per occurrence limit, which we believe is adequate
for our current activities. However, we may not be able to continue to obtain
insurance at a reasonable cost. Furthermore, insurance may not be sufficient to
cover all of the liabilities resulting from a product liability claim, and we
might not have sufficient funds available to pay any claims over the limits of
our insurance. Because personal injury claims based on product liability in a
medical setting may be very large, an underinsured or an uninsured claim could
financially damage our company.
We may have trouble attracting and retaining qualified personnel and our
business may suffer if we do not.
Our business has experienced developments the past two years that have resulted
in several significant changes in our strategy and business plan, including the
shifting of resources to support our current product initiatives and downsizings
to what we consider to be the minimal support structure necessary to operate a
publicly traded company. Our management will need to remain flexible to support
our business model over the next few years. However, losing members of the
Neoprobe management team could have an adverse effect on our operations. Our
success depends on our ability to attract and retain technical and management
personnel with expertise and experience in the medical device business. The
competition for qualified personnel in the medical device industry is intense
and we may not be successful in hiring or retaining the requisite personnel. If
we are unable to attract and retain qualified technical and management
personnel, we will suffer diminished chances of future success.
Under the terms of our 2003 bridge financings, we have or may be required to
grant partial or complete liens on substantially all of our assets.
Under the terms of the bridge loan agreements we entered into with an
unaffiliated investor and our President and CEO in 2003, we granted them a
security interest in certain of our assets, including our intellectual property.
We believe this is customary in such transactions. The unaffiliated investor
converted his loan to equity in early 2004, so only the security interest held
by our President and CEO remains in effect. In the event of a default by us
under the terms of the loan, the holder could foreclose on the security interest
in our assets. If this were to happen, we may be required to file a petition
under Chapter 11 of the Bankruptcy Code seeking protection, or file a petition
under Chapter 7 and liquidate.
Our common stock is traded over the counter, which may deprive stockholders of
the full value of their shares.
Our common stock is quoted via the National Association of Securities Dealers'
Over The Counter Bulletin Board (OTCBB). As such, our common stock may have
fewer market makers, lower trading volumes and larger spreads between bid and
asked prices than securities listed on an exchange such as the New York Stock
Exchange or the Nasdaq Stock Market. These factors may result in higher price
volatility and less market liquidity for the common stock.
A low market price may severely limit the potential market for our common stock.
Our common stock is currently trading at a price substantially below $5.00 per
share, subjecting trading in the stock to certain SEC rules requiring additional
disclosures by broker-dealers. These rules generally apply to any non-NASDAQ
equity security that has a market price share of less than $5.00 per share,
subject to certain exceptions (a "penny stock"). Such rules require the
delivery, prior to any penny stock transaction, of a disclosure schedule
explaining the penny stock market and the risks associated therewith and impose
various sales practice requirements on broker-dealers who sell penny stocks to
persons other than established customers and institutional or wealthy investors.
For these types of transactions, the broker-dealer must make a special
suitability determination for the purchaser and have received the
24
purchaser's written consent to the transaction prior to the sale. The
broker-dealer also must disclose the commissions payable to the broker-dealer,
current bid and offer quotations for the penny stock and, if the broker-dealer
is the sole market maker, the broker-dealer must disclose this fact and the
broker-dealer's presumed control over the market. Such information must be
provided to the customer orally or in writing before or with the written
confirmation of trade sent to the customer. Monthly statements must be sent
disclosing recent price information for the penny stock held in the account and
information on the limited market in penny stocks. The additional burdens
imposed upon broker-dealers by such requirements could discourage broker-dealers
from effecting transactions in our common stock.
The price of our common stock has been highly volatile due to several factors
that will continue to affect the price of our stock.
Our common stock has traded as low as $0.10 per share and as high as $0.89 per
share in the last twelve months. Some of the factors leading to the volatility
include:
- price and volume fluctuations in the stock market at large
which do not relate to our operating performance;
- fluctuations in our operating results;
- financing arrangements we may enter that require the issuance
of a significant number of shares in relation to the number of
shares currently outstanding;
- announcements of technological innovations or new products
which we or our competitors make;
- FDA and/or international regulatory actions;
- developments with respect to patents or proprietary rights;
- public concern as to the safety of products that we or others
develop; and,
- fluctuations in market demand for and supply of our products.
An investor's ability to trade our common stock may be limited by trading
volume.
Until recently, the trading volume for our common stock has been relatively
limited. A consistently active trading market for our common stock may not occur
on the OTCBB. The average daily trading volume for our common stock on the OTCBB
for the twelve-month period ended March 15, 2004 was approximately 359,300
shares. Daily volume during that period ranged from 0 shares to 4,440,870
shares.
Our stockholder rights plan, some provisions of our organizational and governing
documents and an agreement with selling stockholders, may have the effect of
deterring third parties from making takeover bids for control of our company or
may be used to hinder or delay a takeover bid.
Our certificate of incorporation authorizes the creation and issuance of "blank
check" preferred stock. Our Board of Directors may divide this stock into one or
more series and set their rights. The Board of Directors may, without prior
stockholder approval, issue any of the shares of "blank check" preferred stock
with dividend, liquidation, conversion, voting or other rights, which could
adversely affect the relative voting power or other rights of the common stock.
Preferred stock could be used as a method of discouraging, delaying, or
preventing a take-over of our company. If we issue "blank check" preferred
stock, it could have a dilutive effect upon our common stock. This would
decrease the chance that our stockholders would realize a premium over market
price for their shares of common stock as a result of a takeover bid.
Because we will not pay dividends, stockholders will only benefit from owning
common stock if it appreciates.
We have never paid dividends on our common stock and we do not intend to do so
in the foreseeable future. We intend to retain any future earnings to finance
our growth. Accordingly, any potential investor who anticipates the need for
current dividends from his investment should not purchase our common stock.
25
CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
This report contains forward-looking statements within the meaning of Section
27A of the Securities Act and Section 21E of the Exchange Act. We have based
these forward-looking statements largely on our current expectations and
projections about future events and financial trends affecting the financial
condition of our business. These forward-looking statements are subject to a
number of risks, uncertainties and assumptions, including, among other things:
- general economic and business conditions, both nationally and
in our markets,
- our history of losses,
- our expectations and estimates concerning future financial
performance, financing plans and the impact of competition,
- our ability to implement our growth strategy,
- anticipated trends in our business,
- advances in technologies, and
- other risk factors set forth under "Risk Factors" in this
report.
In addition, in this report, we use words such as "anticipates," "believes,"
"plans," "expects," "future," "intends," and similar expressions to identify
forward-looking statements.
We undertake no obligation to update publicly or revise any forward-looking
statements, whether as a result of new information, future events or otherwise
after the date of this report. In light of these risks and uncertainties, the
forward-looking events and circumstances discussed in this report may not occur
and actual results could differ materially from those anticipated or implied in
the forward-looking statements.
ITEM 2. DESCRIPTION OF PROPERTY
We currently lease our office at 425 Metro Place North, Dublin, Ohio. We
executed a lease agreement, commencing on September 1, 2003 and ending in
September 2006, with the landlord of these facilities for approximately 9,000
square feet. The lease provides for a monthly base rent of approximately $6,200
in 2004. We must also pay a pro-rata portion of the operating expenses and real
estate taxes of the building. We believe these facilities are in good condition
and will be adequate for our needs for the foreseeable future.
Our subsidiary, Cardiosonix Ltd., currently leases its office in the Millennium
Building at 3 Ha'Tidhar Street, Ra'anana, Israel. The lease covers approximately
470 square meters of space and expires in April 2005. The lease provides for a
monthly base rent of $2,400 through the expiration of the lease.
ITEM 3. LEGAL PROCEEDINGS
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
26
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Our common stock trades on the OTCBB under the trading symbol NEOP. The prices
set forth below reflect the quarterly high, low and closing sales prices for
shares of our common stock during the last two fiscal years as reported by
Reuters Limited. These quotations reflect inter-dealer prices, without retail
markup, markdown or commission, and may not represent actual transactions.
HIGH LOW CLOSE
---- --- -----
Fiscal Year 2003:
First Quarter $ 0.17 $ 0.10 $ 0.11
Second Quarter 0.26 0.10 0.17
Third Quarter 0.50 0.14 0.29
Fourth Quarter 0.43 0.24 0.31
Fiscal Year 2002:
First Quarter $ 0.55 $ 0.35 $ 0.38
Second Quarter 0.42 0.25 0.28
Third Quarter 0.30 0.08 0.12
Fourth Quarter 0.31 0.05 0.13
As of March 15, 2004, we had approximately 853 holders of common stock of
record.
We have not paid any dividends on our common stock and do not anticipate paying
cash dividends in the foreseeable future. We intend to retain any earnings to
finance the growth of our business. We cannot assure you that we will ever pay
cash dividends. Whether we pay cash dividends in the future will be at the
discretion of our Board of Directors and will depend upon our financial
condition, results of operations, capital requirements and any other factors
that the Board of Directors decides are relevant. See Management's Discussion
and Analysis of Financial Condition and Results of Operations, below.
Recent Sales of Unregistered Securities
The following sets forth certain information regarding the sale of equity
securities of our company during the period covered by this report that were not
registered under the Securities Act of 1933 (the Securities Act).
In March 2003 and March 2002, our Board of Directors authorized the issuance of
100,327 and 53,116 shares of common stock, respectively, to the trustees of our
401(k) employee benefit plan (the Plan) without registration. Such issuance is
exempt from registration under the Securities Act under Section 3(a)(2). The
Plan is a pension, profit sharing or stock bonus plan that is qualified under
Section 401 of the Internal Revenue Code. The assets of the Plan are held in a
single trust fund for the benefit of our employees, which does not hold assets
for the benefit of the employees of any other employer. All of the contributions
to the Plan from our employees have been invested in assets other than our
common stock. We have contributed all of the Neoprobe common stock held by the
Plan as a matching contribution that has been less in value at the time it was
contributed to the Plan than the employee contributions that it matches.
On November 19, 2001, we entered into a common stock purchase agreement with an
investment fund, Fusion Capital Fund II, LLC (Fusion) for the issuance and
purchase of our common stock. Under the stock purchase agreement, Fusion
committed to purchase up to $10 million of our common stock over a forty-month
period that commenced in May 2002. A registration statement registering for
resale up to 5 million shares of our common stock was declared effective on
April 15, 2002. Under the terms of the agreement, we can request daily
drawdowns,
27
subject to a daily base amount currently set at $12,500. The number of shares we
are to issue to Fusion in return for that money is based on the lower of (a) the
closing sale price for our common stock on the day of the draw request or (b)
the average of the three lowest closing sales prices for our common stock during
a twelve-day period prior to the draw request. However, no shares may be sold to
Fusion at lower than a floor price currently set at $0.30, which may be reduced
by us, but in no case below $0.20 without Fusion's prior consent. Upon execution
of the common stock purchase agreement, we issued 449,438 shares of our common
stock to Fusion as a commitment fee. During the second half of 2003, we sold
Fusion a total of 473,869 shares of common stock and realized net proceeds of
$143,693. In addition, we issued Fusion another 6,462 shares of common stock for
commitment fees due to Fusion related to the sales of our common stock to them
during the second half of 2003. During the first quarter of 2004 to date, we
sold Fusion a total of 2,100,000 shares of common stock and realized proceeds of
$1,271,334. We issued Fusion 57,140 shares of common stock for commitment fees
due to Fusion related to the sales of our common stock to them during the first
quarter of 2004. The issuances of the shares of common stock to Fusion pursuant
to the common stock purchase agreement were exempt from registration under
Sections 4(2) and 4(6) of the Securities Act and Regulation D.
On December 31, 2001, we acquired 100 percent of the outstanding common shares
of Cardiosonix Ltd. (Cardiosonix), formerly Biosonix Ltd., an Israeli company
limited by shares, from the Cardiosonix selling stockholders pursuant to the
terms of a stock purchase agreement dated November 29, 2001 (the Stock Purchase
Agreement). Under the terms of the Stock Purchase Agreement, at closing we
issued to the selling stockholders 9,714,737 shares of shares of our common
stock, $.001 par value. On December 30, 2002, we issued an additional 2,085,826
shares of common stock to the selling stockholders due to the achievement of a
milestone involving Cardiosonix product development activity. The issuance of
the shares of common stock to the selling stockholders was exempt from
registration under Section 4(2) of the Securities Act and Regulation D. As
required under the terms of the Stock Purchase Agreement, in June 2003 we filed
a registration statement under which the Cardiosonix selling shareholders may
resell their common stock to the public.
During April 2003, we completed a bridge loan agreement with our President and
CEO, David Bupp. Under the terms of the agreement, Mr. Bupp advanced us
$250,000. In consideration for the loan, we issued Mr. Bupp 375,000 warrants,
expiring in April 2008, to purchase shares of our common stock at an exercise
price of $0.13 per share. Interest accrues on the note at the rate of 8.5% per
annum, payable monthly, and the note was due on June 30, 2004. On March 8, 2004,
the due date of the note to Mr. Bupp was extended to June 30, 2005. In exchange
for extending the due date of the note, we issued Mr. Bupp an additional 375,000
warrants, expiring in March 2009, to purchase our common stock at an exercise
price of $0.50 per share. The issuances of the note and warrants to Mr. Bupp
were exempt from registration under Sections 4(2) and 4(6) of the Securities Act
and Regulation D.
During April 2003, we also completed a convertible bridge loan agreement with
Donald E. Garlikov for an additional $250,000. In consideration for the loan, we
issued Mr. Garlikov 500,000 warrants, expiring in April 2008, to purchase shares
of our common stock at an exercise price of $0.13 per share. Under the terms of
the agreement, the note bore interest at 9.5% per annum, payable monthly, and
was due on June 30, 2004. During January 2004, Mr. Garlikov converted the entire
balance of the note into 1.1 million shares of common stock according to the
conversion terms of the agreement. Mr. Garlikov's 500,000 warrants remain
outstanding. The issuances of the note and warrants to Mr. Garlikov were exempt
from registration under Sections 4(2) and 4(6) of the Securities Act and
Regulation D. As further consideration for the loans, we agreed to file a
registration statement under which Mr. Bupp and Mr. Garlikov could resell to the
public shares of common stock issuable on exercise of the warrants and
conversion of Mr. Garlikov's note. The shares were included in a registration
statement filed in December 2003.
During the second and third quarters of 2003, we engaged the services of two
investment banking firms to assist us in raising capital, Alberdale Capital, LLC
(Alberdale) and Trautman Wasserman & Company, Inc. (Trautman Wasserman). In
exchange for Alberdale's services, we agreed to pay them a monthly retainer of
$10,000, half payable in cash and half payable in common stock, and we agreed to
pay them additional compensation upon the successful completion of a private
placement of our securities. We
28
terminated the agreement with Alberdale effective September 23, 2003, but agreed
to issue them a total of 150,943 shares of common stock in payment for one half
of their retainer, plus warrants to purchase 78,261 shares of common stock in
exchange for their assistance in arranging an accounts receivable financing
transaction. The warrants have an exercise price of $0.28 per share.
In exchange for the services of Trautman Wasserman, we agreed to pay a retainer
of $10,000, payable in cash and stock, and to pay further compensation on
successful completion of a private placement. We issued Trautman Wasserman a
total of 27,199 shares of common stock in payment for one half of their
retainer. The issuances of the shares and warrants to Alberdale and Trautman
Wasserman were exempt from registration under Sections 4(2) and 4(6) of the
Securities Act and Regulation D.
During October and November 2003, we executed common stock purchase agreements
with third parties introduced to us by a third investment banking firm,
Rockwood, Inc., for the purchase of 12,173,914 shares of our common stock at a
price of $0.23 per share for net proceeds of $2.4 million. In addition, we
issued the purchasers warrants to purchase 6,086,959 shares of common stock at
an exercise price of $0.28 per share and issued the placement agents warrants to
purchase 1,354,348 shares of our common stock on similar terms. All warrants
issued in connection with the transaction expire in October 2008. The issuances
of the shares and warrants to the purchasers and the placement agents were
exempt from registration under Sections 4(2) and 4(6) of the Securities Act and
Regulation D. As required under terms of the stock purchase agreements, in
December 2003 we filed a registration statement under which the investors and
placement agents may resell the shares of common stock to the public.
29
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion should be read together with our Consolidated Financial
Statements and the Notes related to those statements, as well as the other
financial information included in this Form 10-KSB. Some of our discussion is
forward-looking and involves risks and uncertainties. For information regarding
risk factors that could have a material adverse effect on our business, refer to
Item 1 of this Form 10-KSB, Description of Business - Risk Factors.
THE COMPANY
Neoprobe Corporation is a biomedical technology company that provides innovative
surgical and diagnostic products that enhance patient care by meeting the
critical decision-making needs of healthcare professionals. Prior to the
acquisition of Cardiosonix on December 31, 2001, our marketable products were
limited to a line of gamma detection devices used in the surgical application of
intraoperative lymphatic mapping (ILM). The acquisition of Cardiosonix expanded
our potential product offerings beyond the oncology arena and into the area of
blood flow measurement and cardiac care. Cardiosonix is in the process of
developing and commercializing a unique line of proprietary blood flow
monitoring devices for a variety of diagnostic and surgical applications.
Cardiosonix has received marketing clearance for two of its products,
QUANTIX/ND((TM)) and QUANTIX/OR((TM)), in Europe and in the U.S.
OVERVIEW AND OUTLOOK
This Overview and Outlook section contains a number of forward-looking
statements, all of which are based on current expectations. Actual results may
differ materially. Our financial performance is highly dependent on our ability
to continue to generate income and cash flow from our gamma device product line
and on our ability to successfully commercialize the blood flow products of our
subsidiary, Cardiosonix. We cannot assure you, however, that we will achieve the
volume of sales anticipated, or if achieved, that the margin on such sales will
be adequate to produce positive operating cash flow. We continue to be
optimistic about the longer-term potential for our other proprietary,
procedural-based technologies such as LYMPHOSEEK((TM)) and RIGS(R) ; however,
these technologies are not anticipated to generate any significant revenue for
us during 2004.
We are continually assessing our business plan based on events in the
marketplace as well as from our product development efforts. We believe that the
commercial prospects for Neoprobe have improved significantly over the prior
year due to progress we have made in a number of areas. In December 2003, we
made significant reductions in the staffing of our subsidiary, Cardiosonix,
based on our belief that the development for the QUANTIX/ND and QUANTIX/OR
systems were substantially at or near completion. We anticipate marketing
expenses in 2004 for our blood flow products will exceed $1 million. In
addition, we expect to incur expenses in 2004 related to radiopharmaceutical
development for RIGS and LYMPHOSEEK, although it is difficult to estimate the
amount of such expenses until additional feedback is obtained from the FDA and
decisions are made regarding internal funding of development for these products
versus development through potential partnership relationships. As a result,
although we expect to see positive movement in all our lines of business in
2004, we will likely yet show a loss for the year due to our market and product
development efforts.
We are not actively engaged in looking for additional investment related to our
current device product initiatives; however, we believe that additional funding
will be necessary to move the RIGS and LYMPHOSEEK products to commercial
viability. We intend to move both RIGS and LYMPHOSEEK forward with internal
resources until the regulatory pathway for both products has been clarified. A
determination as to the most appropriate way to fund development has not been
made at this time, but we are considering both internal and external financing
sources. We may decide to develop one or more of these technologies through
partnering, joint ventures, etc. As of December 31, 2003, our cash on-hand was
$1.6 million. During 2003, we used $1.8 million in cash to fund our operations.
We believe our currently available capital resources will be adequate to sustain
our device operations at current levels into 2005; however, to the extent we
decide to fund radiopharmaceutical development internally, we may need to seek
additional funding. If we decide to seek additional funding to support the
development of radiopharmaceutical products and additional financing is not
available when required or is not available on acceptable terms, or we are
unable to arrange a suitable strategic opportunity, we may need to modify
30
our business plan. We cannot assure you that the additional capital we require
will be available on acceptable terms, if at all. We cannot assure you that we
will be able to successfully commercialize products or that we will achieve
significant product revenues from our current or potential new products. In
addition, we cannot assure you that we will achieve or sustain profitability in
the future.
OUR OUTLOOK FOR OUR GAMMA DETECTION DEVICE PRODUCTS
Numerous articles have been published in recent years in peer-reviewed journals
on the topics of sentinel lymph node biopsy and ILM. Furthermore, a number of
thought leaders and cancer treatment institutions have recognized and embraced
the technology as standard of care for melanoma and, in some cases, for breast
cancer. However, as the melanoma market represents less than 10% of the breast
care market, standard of care recognition related to breast care is much more
important to us. Standard of care designation for breast cancer is most likely
dependent on completion of several large multi-center clinical trials in the
U.S. and abroad. Final data from these studies likely will not be presented for
two to three years, at the earliest. However, we believe that the surgical
community will continue to adopt the ILM application while the standard of care
determination is still pending. We also believe that LYMPHOSEEK, the lymphatic
targeting agent being developed for us by the University of California, San
Diego (UCSD), if it should become commercially available, could improve the
adoption of ILM in future years.
We continue to be encouraged by the attention focused on ILM by the medical
community at surgical conferences, especially related to investigations into
other applications beyond melanoma and breast cancer. We also believe the
results from ongoing multinational clinical trials regarding the use of ILM in
breast cancer, when announced, will have a positive impact on helping us to
penetrate the remaining market for breast cancer and melanoma. We believe the
introduction of our laparoscopic probe will ultimately assist surgeons in
expanding into areas such as gastric and colon cancers. We also believe the
market focus in all major global markets for hand-held gamma detection devices
will continue to be among local/community hospitals, which typically lag behind
leading research centers and major hospitals in adapting to new technologies. A
slower than anticipated adoption rate may negatively impact our sales volumes,
and therefore, revenues and net income in 2004.
We have recently received notification from our primary marketing partner,
Ethicon Endo-Surgery, Inc. (EES), a Johnson and Johnson company, that they wish
to exercise their option to extend the termination date of our distribution
agreement with them through the end of 2006. As of December 31, 2003, we had
approximately $1.6 million in committed orders from EES that extend through late
April, 2004. We believe that total 2004 purchases of base NEO2000(R) systems by
EES should be consistent with their 2003 purchase levels. However, as of March
30, 2004, we are in a backorder position to EES of approximately $160,000 due to
our new contract manufacturer, TriVirix, being in backorder to us. We expect our
backorder to EES to be cleared by mid-April. We cannot assure you that EES'
product purchases beyond those firmly committed through mid-2004 will indeed
occur.
Under the terms of our distribution agreement with EES, the transfer prices we
receive on product sales to EES are based on a percentage of their end-customer
sales price, subject to a floor transfer price. To date, our products have
commanded a price premium in most of the markets in which they are sold, which
we believe is due to their superior performance and ease of use. While we
continue to believe in the technical and user-friendly superiority of our
products, competitors continue to innovate and we may lose market share as a
result. A loss of market share would likely have a direct negative impact on net
income. Although the end-customer average sales price (ASP) may decline due to
external market pressures and competition, we do not expect the percentage of
ASP shared to change again under the terms of the current distribution
agreement. Prices for our gamma detection devices, helped by international
exchange rates, have increased over the course of 2003. The price that we
received during 2003 was 20% above the floor pricing for base systems, so we
believe there is some level of downside pricing risk associated with future
sales of our gamma detection devices to EES that we will need to continue to
monitor.
We believe the anticipated steady volumes coupled with the reductions in our
manufacturing cost that we expect in 2004 will result in improvement in the
profitability of our gamma device business line for the year.
OUR OUTLOOK FOR OUR GAMMA DETECTION RADIOPHARMACEUTICALS
Our outlook for the two potential products in our radiopharmaceutical portfolio
has significantly evolved over the last several months. Our RIGS technology,
which had been essentially inactive since the failure
31
to gain approval following our original license application in 1997, has sparked
renewed interest due primarily to the analysis of survival data related to
patients who participated in the original Phase III clinical studies that were
completed in 1996. The information seems to suggest a potential for a survival
differential for patients whose colorectal cancer was evaluated with RIGSCAN(R)
CR49. While this renewed interest is by no means an assurance that full-scale
development will be invigorated, we have scheduled a meeting for April 15, 2004
to review some of this information with the U.S. Food and Drug Administration
(FDA), to determine the appropriate next steps for the development of the
product and to outline a possible development timeline. We will provide
information after the April 15th meeting as is appropriate in cooperation with
the FDA in order to reactivate the currently stalled development plan for
RIGSCAN CR49. We have also recently determined that our Biologic License
Application (BLA) for RIGSCAN CR49 remains active and that it may be possible
for us to provide supplemental clinical data that may address the FDA's patient
efficacy questions concerning the product. If the discussions with the FDA on
April 15th are positive, Neoprobe expects to conduct a formal survival analysis
of all of our evaluable Phase III patients with either primary or metastatic
colorectal cancer and to submit the related data to the FDA later this year. If
survival data from the original Phase III trials were to be viewed by the FDA as
a prospective analysis in response to our original BLA, this may affect our 1998
conclusion that an additional Phase III clinical trial would be necessary in
order to gain approval.
During 2003, researchers from the University of California, San Diego (UCSD)
continued to work with us in the development of LYMPHOSEEK. LYMPHOSEEK would be
the first radiopharmaceutical specifically designed to target lymphatic tissue.
Favorable research data from the clinical evaluation of LYMPHOSEEK in breast
cancer patients was published in The Annals of Surgical Oncology in June 2003.
Evaluation of LYMPHOSEEK in other cancers including gastric and prostate are
currently underway. The success of the clinical evaluations of LYMPHOSEEK
encouraged Neoprobe to seek regulatory guidance on whether the product was ready
to begin pivotal clinical evaluation.
To that end, in November 2003 we met with the Interagency Council on Biomedical
Imaging in Oncology (the Interagency Council). The Interagency Council is
comprised of representatives of the FDA, the National Cancer Institute and
Centers for Medicare and Medicaid Services. The Interagency Council is designed
to provide guidance to the radiopharmaceutical industry in the development of
oncology imaging products. As a result of the meeting, we are preparing a formal
submission to the FDA to propose the design of the pivotal evaluation of
LYMPHOSEEK as a lymphatic targeting agent. The timing of the submission will be
dependent upon the receipt of manufacturing data for LYMPHOSEEK from UCSD and
upon the successful transfer of that data to a contract manufacturer for the
production of LYMPHOSEEK to support a pivotal clinical study.
OUR OUTLOOK FOR OUR BLOOD FLOW PRODUCTS
Our efforts concerning the QUANTIX(R) products in 2004 will include some
developmental refinements to the Quantix/ND and Quantix/OR systems; however the
primary effort will be focused on in the marketing and sales-related activities.
Both the Quantix/ND and the Quantix/OR have regulatory clearance to market in
the U.S. and EU as well as certain other foreign markets. Currently, we have
five (5) distributors covering seventeen (17) countries for the QUANTIX/ND and
nine (9) distributors covering over fifteen (15) countries for the QUANTIX/OR.
In addition, we have agreements completed or pending with independent
cardiovascular sales organizations for the majority of states in the U.S. market
for the QUANTIX/OR. Our primary focus is to secure marketing and distribution
partners who possess appropriate expertise in marketing medical devices,
preferably ultrasound or cardiac care devices, into our primary target markets,
the cardiac care and neurosurgical markets.
We anticipate spending a significant amount of time and effort in 2004 to market
the Cardiosonix blood flow products to a wider market. We will need to continue
to work with our distributors to manage relationships with thought leaders in
the cardiac and neurosurgical fields to gain broader exposure to the advantages
of our technology. We anticipate placing blood flow systems with industry
thought leaders to obtain critical pre-commercialization feedback prior to
widespread market launch. The market education process we envision will likely
take some time to develop in the manner we desire. In addition, the sales cycle
for
32
medical devices such as our blood flow products is typically a four to six month
cycle. As such, significant end customer sales, if they occur, will likely lag
the signing of distribution arrangements.
We expect sales of blood flow products for 2004 to be higher than 2003 although
such sales are difficult to gauge in situations where the use of the product is
dependent on changes in surgical practice as well as subject to the sales
cycles, etc. outlined above. We are also investigating alternative pricing
strategies such as per use fees or leasing that may affect the adoption rates
for our blood flow measurement devices. As a result, we anticipate that the
product development and market support costs we will incur in 2004 will be
greater than the revenue we generate from the sales of blood flow devices. We
expect to continue to incur losses from our blood flow operations for 2004.
SUMMARY
The strengthening of our gamma product (device and drug) portfolio coupled with
the introduction of the Cardiosonix blood flow products should position us to
achieve long-term profitable operating performance. However, overall profitable
operational results may be adversely affected to the extent we decide to fund
either RIGS or LYMPHOSEEK development activities internally to any significant
degree.
We anticipate generating a net profit from the sale of our gamma detection
devices in 2004; however, we expect to show a loss for our blood flow device
product line for 2004 due to continued research and development, increased
marketing and administrative support costs that are still required to
commercialize the product line. Currently, we expect the loss on blood flow
products for 2004 to be less than the loss incurred in 2003. However, this
expectation is based to a large degree on our anticipation that we will achieve
the necessary developmental milestones required to achieve significant
commercial sales of our QUANTIX/OR product in a timely manner. The overall
operating results for 2004 will be affected by the amount of development for
RIGS and LYMPHOSEEK to be funded by development partners. If we are unsuccessful
in achieving significant commercial sales of the QUANTIX/OR product in 2004, or
if we modify our business plan and decide to carry out RIGS or Lymphoseek
development internally, our estimates and our business plan will likely need to
be modified.
Depending on the success of our QUANTIX product line and the timing of new
product development and regulatory approval cycles, and assuming we do not fund
significant RIGS or LYMPHOSEEK development activities internally, we expect to
achieve an operating profit on a monthly basis before the end of 2004. However,
we cannot assure you that our current or potential new products will be
successfully commercialized or that we will achieve significant product
revenues. In addition, we cannot assure you that we will achieve or be able to
sustain profitability in the future.
RESULTS OF OPERATIONS
We reported revenues for 2003 of $6.5 million compared to $4.9 million in the
prior year. The increase in revenue in 2003 versus 2002 is the direct result of
an approximately 55% increase in demand from our primary distributor, EES,
coupled with a 9% increase in prices received for our gamma detection products.
We attribute the increase in demand primarily to EES eliminating their overstock
position of base NEO2000 systems that existed throughout most of 2002. Exact
market penetration for our products is difficult to gauge, as there are no
widely published use statistics on this specific type of device or the
application of sentinel lymph node biopsy. However, we believe, based on
anecdotal information, that the application of ILM has increased steadily over
the past few years, but that the global adoption rate for lymphatic mapping may
be slowing pending the outcome of major international trials in breast care.
Our overall gross profit for fiscal year 2003 remained steady with the prior
year at 52% of gross revenue. Gross margins on net product sales were 44% of net
sales in 2003, as compared to 30% of net product sales in 2002. The increase in
gross margins was due primarily to a 9% increase in prices received for our
gamma detection products coupled with a 13% decrease in manufacturing cost per
gamma detection system for the year. Margins on our blood flow device sales for
2003 were approximately 35%. In addition, we recorded a $214,000 impairment
charge during the third quarter of 2002 related to BLUETIP(R) probe-related
inventory that we did not believe had ongoing value to the business. The
impairment charge had a 7% negative effect on our gross margins for 2002.
33
Results for 2003 also reflect the significant efforts made in the marketing
development of Cardiosonix' Angle-independent Doppler Blood Flow (ADBF(TM))
technology; however, the increase in marketing related costs was offset by
decreases in our research and development costs for blood flow products.
Accordingly, our research and development costs for 2003 decreased to $1.9
million compared to $2.3 million in 2002. In addition, consolidated
administrative expenses decreased over the prior year with the affect of
headcount reductions offsetting the absorption of additional market development
and other overhead costs associated with Cardiosonix' operations.
Major expense categories as a percentage of net sales decreased from 2002 to
2003 due to the increase in sales of our gamma detection products and initial
sales of our blood flow products, coupled with a lower overall cost structure
for our gamma business. Research and development expenses, as a percentage of
sales, decreased to 34% in 2003 from 69% in 2002 due to the increase in net
sales, workforce reductions in our gamma product development and support staff,
and decreased incremental development costs associated with the QUANTIX line of
blood flow products. Selling, general and administrative expenses, as a
percentage of sales, decreased to 56% in 2003 from 97% in 2002 due largely to
the increase in net sales coupled with headcount reductions in our gamma product
support staff during the third and fourth quarters of 2002. Controlling our
costs remains a high priority for us as we endeavor to return to profitability.
We believe these major expense categories, as a percentage of sales, will
decrease in 2004 as compared to 2003 due to anticipated increases in sales;
however, this decrease will depend greatly on our success in achieving
commercial sales of our blood flow products and continuing positive trends for
our gamma detection products.
YEARS ENDED DECEMBER 31, 2003 AND 2002
Net Sales and Margins. Net sales increased $2.2 million, or 64%, to $5.6 million
in 2003 from $3.4 million in 2002. Gross margins on net sales increased to 44%
of net sales for 2003 compared to 30% of net sales for 2002. During the third
quarter of 2002, we recorded an inventory impairment charge of $214,000 related
to our BLUETIP probe product. This charge adversely affected our gross margins
for 2002 by 7 percentage points.
Approximately $1.9 million of the increase in net sales was the result of
increased revenue related to our gamma detection products with the remaining
$245,000 generated from our blood flow products. We had only $59,000 in revenues
from blood flow products during 2002. Of the increased revenue from gamma
detection products, approximately 20% was due to increased prices realized on
our neo2000 control unit and 14mm probes, with approximately 70% due to
increased sales volumes of these products. The remaining 10% was due to various
changes in other products and product mix. The price at which we sell our gamma
detection products to EES is based on a percentage of the global ASP received by
EES on sales of Neoprobe products to end customers, subject to a minimum floor
price. The increase in gross margins was primarily due to the higher recorded
revenue per gamma detection system combined with lower capitalized internal
manufacturing costs as a result of headcount reductions during the third and
fourth quarters of 2002 that contributed to lower average costs.
License and Other Revenue. License and other revenue for 2003 and 2002 included
$800,000 from the pro-rata recognition of license fees related to the
distribution agreement with EES and $146,000 and $520,000, respectively, from
the reimbursement by EES of certain product development costs. License and other
revenue in 2002 also included $218,000 from EES' waiver of certain warranty
costs due from us in exchange for a release from contractual minimum purchase
requirements.
Research and Development Expenses. Research and development expenses decreased
$430,000, or 19%, to $1.9 million during 2003 from $2.3 million in 2002. The
decrease was primarily due to $425,000 in lower compensation costs resulting
from headcount reductions of gamma product line personnel in the third and
fourth quarters of 2002, coupled with decreased use of external design
consultants and decreased prototype expenses related to the blood flow product
line. 2003 and 2002 also included $27,000 and $50,000, respectively, of license
fees related to the LYMPHOSEEK targeting agent.
34
Selling, General and Administrative Expenses. Selling, general and
administrative expenses decreased $165,000, or 5%, to $3.1 million during 2003
from $3.3 million during 2002. The decrease was primarily due to $232,000 in
lower compensation costs resulting from headcount reductions of gamma product
line personnel in the third and fourth quarters of 2002, offset by increases in
certain overhead costs such as bad debts and insurance and increased selling,
general and administrative expenses incurred in the operation and support of
Cardiosonix. Selling, general and administrative expenses in 2003 and 2002
included $30,000 and $138,000, respectively, in impairment expense related to
production equipment and intellectual property that we did not believe had
ongoing value to our business. Selling, general and administrative expenses in
2002 also included $79,000 for the transfer of manufacturing of certain
components of the neo2000 gamma detection system to UMM.
Other Income (Expenses). Other income decreased $217,000 resulting in other
expenses of $188,000 during 2003 compared to other income of $29,000 during
2002. Other expenses during 2003 consisted primarily of interest expense,
amortized discount on our notes payable and interest expense related to the
financing of our accounts receivable. Other income during 2002 consisted
primarily of interest income. Our interest income decreased because we
maintained a lower balance of cash and investments during 2003 as compared to
2002.
LIQUIDITY AND CAPITAL RESOURCES
Operating Activities. Cash used in operations decreased $1.2 million to $1.8
million during 2003 from $3.0 million during 2002. Working capital increased
$1.4 million to $2.5 million at December 31, 2003 as compared to $1.1 million at
December 31, 2002. The current ratio increased to 2.6:1 at December 31, 2003
from 1.6:1 at December 31, 2002. The increase in working capital was primarily
related to cash received from the sale of common stock.
Cash balances increased to $1.6 million at December 31, 2003 from $701,000 at
December 31, 2002, primarily due to the cash generated from debt financing
arrangements, sales of common stock and the increased net sales experienced
during 2003, offset by the requirement to support the operations of Cardiosonix.
Accounts receivable increased to $1.1 million at December 31, 2003 from $746,000
at December 31, 2002 due primarily to greater sales in December 2003 than
December 2002. During the third quarter of 2003, we entered into an accounts
receivable financing facility under which certain of our U.S. accounts
receivable were factored at an advance rate of 80% and with recourse to a third
party financing company. The factoring arrangement was wound down during the
fourth quarter of 2003 and at December 31, 2003 there were no amounts
outstanding under this facility. Accounts receivable at December 31, 2003 also
included approximately $350,000 related primarily to our annual transfer price
reconciliation with EES. We expect overall receivable levels will continue to
fluctuate in 2004 depending on the timing of purchases and payments by EES.
However, on average, we expect accounts receivable balances will start to
increase commensurate with anticipated increases in sales of blood flow products
to our distributors, many of whom are foreign-domiciled entities who typically
pay at a slower rate than domestic companies. Such increases, if any, will
require the increased use of our cash resources over time.
Inventory levels decreased to $1.0 million at December 31, 2003 from $1.2
million at December 31, 2002. Our stock of finished goods of gamma detection
products decreased at the end of 2003 more than originally anticipated due to
increased demand from EES. In addition, our inventory of gamma device finished
goods was lower than normal at the end of 2003 because we are in the process of
changing contract manufacturers of our gamma detection devices to a new contract
manufacturer. Gamma-related raw materials have also continued to decrease
compared to prior period due to usage of certain long-lead gamma detection
device components that were built up in prior periods to take advantage of
quantity price breaks. These decreases were offset by the build-up of raw
material and finished goods inventory related to our blood flow products as we
continue market launch preparations. We expect inventory levels to increase
during the remainder of 2004 as we restore our normal safety stock of inventory
of gamma detection equipment and complete finished blood flow devices from our
inventory of raw materials.
35
Investing Activities. Cash used in investing activities decreased to $109,000
during 2003 from $315,000 during 2002. During February and March 2002, we
invested in $2.5 million of available-for-sale securities. Capital expenditures
during 2003 were primarily purchases of production tools and equipment related
to the manufacture of our QUANTIX line of blood flow measurement equipment.
Capital expenditures during 2002 were primarily for purchases of production
tools and equipment, product development equipment, and technology
infrastructure. Capital needs for 2004 are expected to increase over 2003 as we
start up blood flow product production at our contract manufacturer.
Financing Activities. Financing activities provided $2.9 million in cash in 2003
versus using $256,000 during 2002. Proceeds from sales of accounts receivable
and subsequent repayments totaled $914,000 during 2003. Payments of notes
payable were $10,000 higher during 2003 as compared to the same period in 2002
due to the increased cost of financed insurance.
On November 19, 2001, we entered into a common stock purchase agreement with an
investment fund, Fusion Capital Fund II, LLC (Fusion) for the issuance and
purchase of our common stock. Under the stock purchase agreement, Fusion
committed to purchase up to $10 million of our common stock over a forty-month
period that commenced in May 2002. A registration statement registering for
resale up to 5 million shares of our common stock became effective on April 15,
2002. Under the terms of the agreement, we can request daily drawdowns, subject
to a daily base amount currently set at $12,500. The number of shares we are to
issue to Fusion in return for that money is based on the lower of (a) the
closing sale price for our common stock on the day of the draw request or (b)
the average of the three lowest closing sales prices for our common stock during
a twelve-day period prior to the draw request. However, no shares may be sold to
Fusion at lower than a floor price currently set at $0.30, which may be reduced
by us, but in no case below $0.20 without Fusion's prior consent. Upon execution
of the common stock purchase agreement, we issued 449,438 shares of our common
stock to Fusion as a commitment fee. During the second half of 2003, we sold
Fusion a total of 473,869 shares of common stock and realized net proceeds of
$143,693. We issued Fusion 6,462 shares of common stock for commitment fees due
to Fusion related to the sales of our common stock to them during 2003. During
the first quarter of 2004 to date, we sold Fusion a total of 2,100,000 shares of
common stock and realized proceeds of $1,271,334. We issued Fusion 57,140 shares
of common stock for commitment fees due to Fusion related to the sales of our
common stock to them during the first quarter of 2004.
During April 2003, we completed a bridge loan agreement with our President and
CEO, David Bupp. Under the terms of the agreement, Mr. Bupp advanced us
$250,000. In consideration for the loan, we issued Mr. Bupp 375,000 warrants,
expiring in April 2008, to purchase shares of our common stock at an exercise
price of $0.13 per share. The per share fair value of these warrants was $0.10
on the date of issuance using the Black-Scholes option pricing model with the
following assumptions: an average risk-free interest rate of 2.9%, volatility of
139% and no expected dividend rate. Interest accrues on the note at the rate of
8.5% per annum, payable monthly, and was due on June 30, 2004. On March 8, 2004,
we extended the due date of the note due to Mr. Bupp to June 30, 2005. In
exchange for extending the due date of the note, we issued Mr. Bupp an
additional 375,000 warrants, expiring in March 2009, to purchase our common
stock at an exercise price of $0.50 per share. The per share fair value of these
warrants was $0.46 on the date of issuance using the Black-Scholes option
pricing model with the following assumptions: an average risk-free interest rate
of 2.7%, volatility of 152% and no expected dividend rate.
During April 2003, we also completed a convertible bridge loan agreement with
Donald E. Garlikov for an additional $250,000. In consideration for the loan, we
issued Mr. Garlikov 500,000 warrants, expiring in April 2008, to purchase shares
of our common stock at an exercise price of $0.13 per share. The per share fair
value of these warrants was $0.10 on the date of issuance using the
Black-Scholes option pricing model with the following assumptions: an average
risk-free interest rate of 2.9%, volatility of 139% and no expected dividend
rate. Under the terms of the agreement, the note bore interest at 9.5% per
annum, payable monthly, and was due on June 30, 2004. During January 2004, Mr.
Garlikov converted the entire balance of the note into 1.1 million shares of
common stock according to the conversion terms of the agreement. Mr. Garlikov's
500,000 warrants remain outstanding.
During the second and third quarters of 2003, we engaged the services of two
investment banking firms to assist us in raising capital, Alberdale Capital, LLC
(Alberdale) and Trautman Wasserman & Company, Inc. (Trautman Wasserman). In
exchange for Alberdale's services, we agreed to pay them a monthly retainer of
$10,000, half payable in cash and half payable in common stock, and we agreed to
pay them additional compensation upon the successful completion of a private
placement of our securities. We terminated the agreement with Alberdale
effective September 23, 2003, but agreed to issue them a total of 150,943 shares
of common stock in payment for one half of their retainer, plus warrants,
expiring in
36
October 2008, to purchase 78,261 shares of common stock in exchange for their
assistance in arranging an accounts receivable financing transaction. The
warrants have an exercise price of $0.28 per share. The per share fair value of
these warrants was $0.33 on the date of issuance using the Black-Scholes option
pricing model with the following assumptions: an average risk-free interest rate
of 3.1%, volatility of 150% and no expected dividend rate.
In exchange for the services of Trautman Wasserman, we agreed to pay a retainer
of $10,000, payable in cash and stock, and to pay further compensation on
successful completion of a private placement. We agreed to issue Trautman
Wasserman a total of 27,199 shares of common stock in payment for one half of
their retainer.
During October and November 2003, we executed common stock purchase agreements
with third parties introduced to us by a third investment banking firm,
Rockwood, Inc., for the purchase of 12,173,914 shares of our common stock at a
price of $0.23 per share for net proceeds of $2.4 million. In addition, we
agreed to issue the purchasers warrants to purchase 6,086,959 shares of common
stock at an exercise price of $0.28 per share and agreed to issue the placement
agents warrants to purchase 1,354,348 shares of our common stock on similar
terms. All warrants issued in connection with the transaction expire in October
2008. The per share fair value of these warrants was $0.31 on the date of
issuance using the Black-Scholes option pricing model with the following
assumptions: an average risk-free interest rate of 3.2%, volatility of 151% and
no expected dividend rate.
Our future liquidity and capital requirements will depend on a number of
factors, including our ability to raise additional capital in a timely manner
through additional investment, expanded market acceptance of our current
products, our ability to complete the commercialization of new products such as
our blood flow product line, our ability to monetize our investment in non-core
technologies, our ability to obtain milestone or development funds from
potential development and distribution partners, regulatory actions by the FDA
and other international regulatory bodies, and intellectual property protection.
Throughout 2002 and the first three quarters of 2003, we made modifications to
our operating plan and reduced or delayed planned development and market-support
expenditures due primarily to our delayed ability to secure additional sources
of financing. We believe our inability to raise financing did not significantly
impact our ability to meet the operational milestones we had set for the first
half of 2003; however, we believe the effects of the delay in raising financing,
coupled with the delay in receiving 510(k) marketing clearance for the
QUANTIX/OR until September 2003, hampered our marketing and commercialization
efforts for blood flow products during the second half of 2003. Planned
resources to support marketing and post-launch development activities were
delayed until the completion of the recent financing activities. We had to
continually re-assess the timing of our goals and objectives for the second half
of 2003 and for calendar year 2004, but believe we now have adequate capital to
assure that we can properly support our current business goals and objectives
for 2004. Our near-term priorities are the thought leader evaluation and launch
of the QUANTIX products in the U.S. and the continued support of such activities
ongoing in other markets. In addition, we are considering ways to re-invigorate
development of other products in our pipeline such as RIGS. We cannot assure you
that we will be able to achieve significant product revenues from our current or
potential new products. We also cannot assure you that we will achieve
profitability again in 2004.
37
CONTRACTUAL OBLIGATIONS AND COMMERCIAL COMMITMENTS
The following table presents our contractual obligations and commercial
commitments as of December 31, 2003.
PAYMENTS DUE BY PERIOD
-----------------------------------------------------------------------------------
CONTRACTUAL CASH LESS THAN 1 - 3 4 - 5 AFTER
OBLIGATIONS TOTAL 1 YEAR YEARS YEARS 5 YEARS
----------------------------- ---------- ----------- --------- --------- -------
Capital Leases $ 74,854(1) $ 21,436 $ 36,616 $ 16,802 $ -
Operating Leases 283,916(2) 138,610 145,306 - -
Unconditional
Purchase Obligations 2,147,220(3) 2,147,220 - - -
Long-Term Debt 500,000 250,000(4) 250,000(5) - -
---------- ----------- --------- --------- -------
Total Contractual
Cash Obligations $3,005,990 $ 2,557,266 $ 431,922 $ 16,802 $ -
========== =========== ========= ========== =======
(1) In February 2004, we entered into two (2) three-year capital lease
agreements for office equipment. The lease payments total approximately
$10,000 per year.
(2) In February 2004, we entered into a six-month operating lease agreement for
storage space. The lease payments total approximately $17,000 in 2004.
(3) This amount represents purchases under binding purchase orders for which we
are required to take delivery of the product under the terms of the
underlying supply agreements going out approximately one year.
(4) In January 2004, Mr. Garlikov converted the entire balance of the note
into 1.1 million shares of common stock according to the conversion terms
of the agreement.
(5) In March 2004, the due date of the note to Mr. Bupp was extended to June
30, 2005 under the same terms.
NEW ACCOUNTING PRONOUNCEMENTS
In June 2001, the Financial Accounting Standards Board (FASB) issued Statement
of Financial Accounting Standards (SFAS) No. 143, Accounting for Asset
Retirement Obligations. SFAS No. 143 requires us to record the fair value of an
asset retirement obligation as a liability in the period in which it incurs a
legal obligation associated with the retirement of tangible long-lived assets
that result from the acquisition, construction, development, and/or normal use
of the assets. We would also be required to record a corresponding asset that is
depreciated over the life of the asset. Subsequent to the initial measurement of
the asset retirement obligation, the obligation will be adjusted at the end of
each period to reflect the passage of time and changes in the estimated future
cash flows underlying the obligation. We adopted SFAS No. 143 on January 1,
2003. The adoption of SFAS No. 143 did not have a material effect on our
financial statements.
In November 2002, the FASB issued Interpretation No. 45, Guarantor's Accounting
and Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness to Others, an interpretation of FASB Statement Nos. 5, 57 and 107
and a rescission of FASB Interpretation No. 34. This Interpretation elaborates
on the disclosures to be made by a guarantor in its interim and annual financial
statements about its obligations under guarantees issued. The Interpretation
also clarifies that a guarantor is required to recognize, at inception of a
guarantee, a liability for the fair value of the obligation undertaken. The
initial recognition and measurement provisions of the Interpretation are
applicable to guarantees issued or modified after December 31, 2002. The
disclosure requirements are effective for financial statements of interim and
annual periods ending after December 15, 2002. The adoption of Interpretation
No. 45 did not have a material effect on our financial statements.
In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial
Instruments with Characteristics of Both Liabilities and Equity. The Statement
requires issuers to classify as liabilities (or assets in some circumstances)
three classes of freestanding financial instruments that embody obligations for
the issuer. Generally, the Statement is effective for financial instruments
entered into or
38
modified after May 31, 2003 and is otherwise effective at the beginning of the
first interim period beginning after June 15, 2003. We adopted the applicable
provisions of the Statement on July 1, 2003. The adoption of SFAS No. 150 did
not have a material effect on our financial statements.
CRITICAL ACCOUNTING POLICIES
The following accounting policies are considered by us to be critical to our
results of operations and financial condition.
Revenue Recognition Related to Net Sales. We currently generate revenue
primarily from sales of our gamma detection products; however, sales of blood
flow products constituted approximately 4% of total revenues for 2003 and are
expected to increase in the future. We generally recognize sales revenue related
to sales of our products when the products are shipped and the earnings process
has been completed. Our customers have no right to return products purchased in
the ordinary course of business. However, in cases where product is shipped but
the earnings process is not yet completed, revenue is deferred until it has been
determined that the earnings process has been completed. We also generate
revenue from the service and repair of out-of-warranty products. Fees charged
for service and repair on products not covered by an extended service agreement
are recognized on completion of the service process when the serviced or
repaired product has been returned to the customer. Fees charged for service or
repair of products covered by an extended warranty agreement are deferred and
recognized as revenue ratably over the life of the extended service agreement.
The prices we charge our primary customer, EES, related to sales of products are
subject to retroactive annual adjustment based on a fixed percentage of the
actual sales prices achieved by EES on sales to end customers made during each
fiscal year. To the extent that we can reasonably estimate the end-customer
prices received by EES, we record sales to EES based upon these estimates. If we
are unable to reasonably estimate end customer sales prices related to certain
products sold to EES, we record revenue related to these product sales at the
minimum (i.e., floor) price provided for under our distribution agreement with
EES. During 2003, we continued to see improvement in global ASP following a
trend that started in the fourth quarter of 2002. As such, management believed
it was appropriate to record revenue for 2003 at the estimated sales prices
calculated consistently with prior periods per the terms of the distribution
agreement.
Impairment or Disposal of Long-Lived Assets. We account for long-lived assets in
accordance with the provisions of SFAS No. 144. This Statement requires that
long-lived assets and certain identifiable intangibles be reviewed for
impairment whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable. The recoverability of assets
to be held and used is measured by a comparison of the carrying amount of an
asset to future net undiscounted cash flows expected to be generated by the
asset. If such assets are considered to be impaired, the impairment to be
recognized is measured by the amount by which the carrying amount of the assets
exceeds the fair value of the assets. Assets to be disposed of are reported at
the lower of the carrying amount or fair value less costs to sell. As of
December 31, 2003, the most significant long-lived assets on our balance sheet
relate to assets recorded in connection with the acquisition of Cardiosonix and
gamma detection device patents related to ILM. The recoverability of these
assets is based on the financial projections and models related to the future
sales success of Cardiosonix' products and the continuing success of our gamma
detection product line. As such, these assets could be subject to significant
adjustment should the Cardiosonix technology not be successfully commercialized
or the sales amounts in our current projections not be realized.
Inventory Reserves. We value our inventory at the lower of cost (first-in,
first-out method) or market. Reserves are estimated for excess, slow moving and
obsolete inventory as well as inventory with a carrying value in excess of its
net realizable value. Write-offs are recorded when product is removed from
saleable inventory. We review inventory on hand at least quarterly and record
provisions for excess and obsolete inventory based on several factors, including
current assessment of future product demand, anticipated release of new products
into the market, historical experience and product expiration. Our industry is
characterized by rapid product development and frequent new product
introductions. Uncertain timing of product approvals, variability in product
launch strategies, product recalls and variation in product utilization all
impact the estimates related to excess and obsolete inventory.
Allowance for Doubtful Accounts. We maintain an allowance for doubtful accounts
receivable to cover estimated losses resulting from the inability of our
customers to make required payments. We determine the adequacy of this allowance
by regularly reviewing our accounts receivable aging and evaluating individual
customer receivables, considering customer's credit and financial condition,
payment history and relevant economic conditions. If the financial condition of
our customers were to deteriorate, resulting in an impairment of their ability
to make payments, additional allowances for doubtful accounts may be required.
OTHER ITEMS AFFECTING FINANCIAL CONDITION
At December 31, 2003, we had U.S. net operating tax loss carryforwards and tax
credit carryforwards of approximately $90.6 million and $4.3 million,
respectively, available to offset or reduce future income tax liability, if any,
through 2023. However, under Sections 382 and 383 of the Internal Revenue Code
of 1986, as amended, use of prior tax loss and credit carryforwards may be
limited after an ownership change. As a result of ownership changes as defined
by Sections 382 and 383,
39
which have occurred at various points in our history, we believe utilization of
our tax loss carryforwards and tax credit carryforwards may be significantly
limited.
ADDITIONAL INFORMATION
For additional information about our operations, cash flows, liquidity and
capital resources, please refer to the information on pages 33 through 37 of
this report.
ITEM 7. FINANCIAL STATEMENTS
Our consolidated financial statements, and the related notes, together with the
report of KPMG LLP dated March 29, 2004, are set forth at pages F-1 through
F-22 attached hereto.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
ITEM 8A. CONTROLS AND PROCEDURES.
Under the supervision and with the participation of our management, including
our Chief Executive Officer and Chief Financial Officer, we evaluated the
effectiveness of the design and operation of our disclosure controls and
procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of
1934 (the "Exchange Act")). Based on that evaluation, our Chief Executive
Officer and Chief Financial Officer have concluded that, as of the end of the
period covered by this report, our disclosure controls and procedures are
adequately designed to ensure that the information required to be disclosed by
us in the reports we file or submit under the Exchange Act is recorded,
possessed, summarized and reported, within the time periods specified in the
applicable rules and forms. During the period covered by this Annual Report on
Form 10-KSB, there was no change in our internal control over financial
reporting (as defined in Rule 13a-15(f) under the Exchange Act) that materially
effected, or is reasonably likely to materially effect, our internal control
over financial reporting.
40
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE
WITH SECTION 16(a) OF THE EXCHANGE ACT
DIRECTORS
THE FOLLOWING DIRECTORS' TERMS CONTINUE UNTIL THE 2004 ANNUAL MEETING:
REUVEN AVITAL, age 52, has served as a director of our company since January
2002. Mr. Avital is a partner and general manager of Ma'Aragim Enterprises Ltd.,
an investment company in Israel, through which he is a member of the board of
Neoprobe as well as a number of privately-held Israeli companies, three of them
in the medical device field. Mr. Avital was a board member of Cardiosonix, Ltd.
from April 2001 through December 31, 2001, when we acquired the company.
Previously, Mr. Avital served in the Israeli government in a variety of middle
and senior management positions. He is also chairman or board member in several
not-for-profit organizations, mainly involved in education for the
under-privileged and international peace-building. Mr. Avital has B.A. degrees
in The History of the Middle East and International Relations from the Hebrew
University of Jerusalem, and a M.P.A. from the Kennedy School of Government at
Harvard University.
DAVID C. BUPP, age 54, has served as President and a director of our company
since August 1992 and as Chief Executive Officer since February 1998. From
August 1992 to May 1993, Mr. Bupp served as our Treasurer. In addition to the
foregoing positions, from December 1991 to August 1992, he was Acting President,
Executive Vice President, Chief Operating Officer and Treasurer, and from
December 1989 to December 1991, he was Vice President, Finance and Chief
Financial Officer. From 1982 to December 1989, Mr. Bupp was Senior Vice
President, Regional Manager for AmeriTrust Company National Association, a
nationally chartered bank holding company, where he was in charge of commercial
banking operations throughout Central Ohio. Mr. Bupp has a B.A. degree in
Economics from Ohio Wesleyan University. Mr. Bupp completed a course of study at
Stonier Graduate School of Banking at Rutgers University.
JULIUS R. KREVANS, M.D., age 79, has served as a director of our company since
May 1994 and as Chairman of the Board of Directors of our company since February
1999. Dr. Krevans served as Chancellor of the University of California, San
Francisco from July 1982 until May 1993. Prior to his appointment as Chancellor,
Dr. Krevans served as a Professor of Medicine and Dean of the School of Medicine
at the University of California, San Francisco from 1971 to 1982. Dr. Krevans is
a member of the Institute of Medicine, National Academy of Sciences, and led its
committee for the National Research Agenda on Aging until 1991. Dr. Krevans has
a B.S. degree and a M.D. degree, both from New York University. Dr. Krevans also
serves on the Board of Directors and the compensation committee of the Board of
Directors of Calypte Biomedical Corporation, a publicly held corporation.
41
THE FOLLOWING DIRECTORS' TERMS CONTINUE UNTIL THE 2005 ANNUAL MEETING:
NANCY E. KATZ, age 44, has served as a director of our company since January
2001. Ms. Katz is an independent health care business consultant. Ms. Katz
served as President, Chief Executive Officer and a director of Calypte until
June 2003. Ms. Katz joined Calypte in October 1999 as President, Chief Operating
Officer and Chief Financial Officer. Prior to joining Calypte, Ms. Katz served
as President of Zila Pharm Inc. From 1997 to 1998, Ms. Katz served as Vice
President of Sales & Marketing of LifeScan (the diabetes testing division of
Johnson & Johnson) and Vice President of U.S. Marketing, directing LifeScan's
marketing and customer call center departments from 1995 to 1997. During her
seven-year career at Schering-Plough Healthcare Products from 1987 to 1994, she
held numerous positions including Senior Director & General Manager, Marketing
Director for Footcare New Products, and Product Director of OTC New Products.
Ms. Katz also held various product management positions at American Home
Products from 1981 to 1987. Ms. Katz received her B.A. in Business
Administration from the University of South Florida.
FRED B. MILLER, age 64, has served as a director of our company since January
2002. Mr. Miller serves as Chairman of the Audit Committee, and the Board of
Directors has determined that he (i) meets the requirements of a "financial
expert" as set forth in Section 401(e) of Regulation S-B promulgated by the SEC,
and (ii) is independent as independence is defined in NASD Rule 4200(a)(15) and
Rule 10A-3(b)(1) of the Securities Exchange Act of 1934, as amended. Mr. Miller
is the President and Chief Operating Officer of Seicon, Limited, a privately
held company that specializes in developing, applying and licensing technology
to reduce seismic and mechanically induced vibration. Mr. Miller also serves on
the boards of two other privately-held companies. Until his retirement in 1995,
Mr. Miller had been with Price Waterhouse LLP since 1962. Mr. Miller is a
Certified Public Accountant, a member of the American Institute of Certified
Public Accountants (AICPA), a past member of the Council of the AICPA and a
member and past president of the Ohio Society of Certified Public Accountants.
He also has served on the boards or advisory committees of several universities
and not-for-profit organizations. Mr. Miller has a B.S. degree in Accounting
from the Ohio State University.
THE FOLLOWING DIRECTOR'S TERM CONTINUES UNTIL THE 2006 ANNUAL MEETING:
J. FRANK WHITLEY, JR., age 61, has served as a director of our company since May
1994. Mr. Whitley was Director of Mergers, Acquisitions and Licensing at The Dow
Chemical Company (Dow), a multinational chemical company, from June 1993 until
his retirement in June 1997. After joining Dow in 1965, Mr. Whitley served in a
variety of marketing, financial, and business management functions. Mr. Whitley
has a B.S. degree in Mathematics from Lamar State College of Technology.
EXECUTIVE OFFICERS
In addition to Mr. Bupp, the following individuals are executive officers of our
company and serve in the position(s) indicated below:
NAME AGE POSITION
---- --- --------
Carl M. Bosch 47 Vice President, Instrument Development
Rodger A. Brown 53 Vice President, Regulatory Affairs
and Quality Assurance
Brent L. Larson 40 Vice President, Finance; Chief Financial Officer;
Treasurer and Secretary
Richard N. Linder 52 Vice President, Sales and Marketing
CARL M. BOSCH has served as Vice President, Instrument Development of our
company since March 2000. Prior to that, Mr. Bosch served as our Director,
Instrument Development from May 1998 to March 2000. Before joining our company,
Mr. Bosch was employed by GE Medical Systems from 1994 to 1998 where he served
as Manager, Nuclear Programs. From 1977 to 1994, Mr. Bosch was employed by GE
Aerospace in several engineering and management functions. Mr. Bosch has a B.S.
degree in Electrical Engineering from Lehigh University and a M.S. degree in
Systems Engineering from the University of Pennsylvania.
42
RODGER A. BROWN has served as Vice President, Regulatory Affairs and Quality
Assurance of our company since November 2000. From July 1998 through November
2000, Mr. Brown served as our Director, Regulatory Affairs and Quality
Assurance. Prior to joining our company, Mr. Brown served as Director of
Operations for Biocore Medical Technologies, Inc. from April 1997 to April 1998.
From 1981 through 1996, Mr. Brown served as Director, Regulatory Affairs/Quality
Assurance for E for M Corporation, a subsidiary of Marquette Electronics, Inc.
BRENT L. LARSON has served as Vice President, Finance and Chief Financial
Officer of our company since February 1999. Prior to that, he served as our Vice
President, Finance from July 1998 to January 1999 and as Controller from July
1996 to June 1998. Before joining our company, Mr. Larson was employed by Price
Waterhouse LLP. Mr. Larson has a B.B.A. degree in Accounting from Iowa State
University of Science and Technology and is a Certified Public Accountant.
RICHARD N. LINDER has served as Vice President, Marketing and Sales of our
company since November 2003. Before joining our company, Mr. Linder was employed
by XLTEK, Ltd. where he served as Vice President of Sales, Worldwide. From 1999
- 2002, Mr. Linder was employed by Digirad Corporation as Eastern Region Sales
Director. From 1997 - 1999, Mr. Linder was employed by Chiron Diagnostics/Bayer
Diagnostics in various marketing and sales management functions. Mr. Linder was
also employed by i-Stat Corporation from 1991 - 1997 as South Central Regional
Sales Director and held various sales positions with other medical device
companies from 1978 - 1991. Mr. Linder has a B.S. Degree in Education with
endorsements in Biology and Chemistry from Memphis State University.
SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Section 16(a) of the Securities Act of 1934 requires our officers and directors,
and greater than 10% stockholders, to file reports of ownership and changes in
ownership of our securities with the Securities and Exchange Commission. Copies
of the reports are required by SEC regulation to be furnished to us. Based on
our review of these reports and written representations from reporting persons,
we believe that all reporting persons complied with all filing requirements
during the fiscal year ended December 31, 2003, except for one late Form 4
filing for each of Mr. Linder.
CODE OF CONDUCT AND ETHICS
We have adopted a code of conduct and ethics that applies to our directors,
officers and all employees. The code of conduct and ethics will be posted on our
website at www.neoprobe.com by the date of the Annual Meeting of Shareholders,
or shortly thereafter. Until that time, the code of business conduct and ethics
may be obtained free of charge by writing to Neoprobe Corporation, Attn: Chief
Financial Officer, 425 Metro Place North, Suite 300, Dublin, Ohio 43017.
43
ITEM 10. EXECUTIVE COMPENSATION
SUMMARY COMPENSATION TABLE
The following table sets forth certain information concerning the annual and
long-term compensation of our Chief Executive Officer and our other three
executive officers having annual compensation in excess of $100,000 during the
last fiscal year (the Named Executives) for the last three fiscal years.
LONG TERM
COMPENSATION
AWARDS
------------------------
SECURITIES
RESTRICTED UNDER-
ANNUAL COMPENSATION STOCK LYING
-------------------------------- AWARDS OPTIONS ALL OTHER
NAME AND PRINCIPAL POSITION YEAR SALARY BONUS ($) (#) COMPENSATION
--------------------------- -------------------------------- --- --- ------------
Carl M. Bosch, 2003 $135,125 $ - - 70,000 $ 6,573(a)
Vice President, 2002 129,375 - - 50,000 3,093(a)
Instrument Development 2001 129,375 25,250 - 45,000 3,081(a)
Rodger A. Brown, 2003 $125,316 $ - - 70,000 $ -
Vice President, Regulatory Affairs/ 2002 105,417 - - 50,000 -
Quality Assurance 2001 99,875 19,000 - 45,000 -
David C. Bupp, 2003 $222,167 $ 32,500 - 170,000 $ 31,090(b)
President and 2002 297,083 - - 180,000 5,738(b)
Chief Executive Officer 2001 310,000 46,500 - 180,000 5,161(b)
Brent L. Larson, 2003 $135,125 $ - - 70,000 $ 11,733(c)
Vice President, Finance and 2002 129,375 - - 50,000 2,993(c)
Chief Financial Officer 2001 131,250 20,250 - 60,000 3,400(c)
Dan Manor, 2003 $145,000 $ - - 40,000 $ 15,443(e)
President and Chief Executive 2002 145,000 - - 50,000 14,248(e)
Officer, Cardiosonix Ltd.(d) 2001 - - - - -
(a) Amounts represent solely matching contribution under the Neoprobe
Corporation 401(k) Plan (the Plan), except for 2003 which includes
$2,703 related to the vesting of restricted stock. Eligible employees
may make voluntary contributions and we may, but are not obligated to,
make matching contributions based on 40 percent of the employee's
contribution, up to five percent of the employee's salary. Employee
contributions are invested in mutual funds administered by an
independent plan administrator. Company contributions, if any, are made
in the form of shares of common stock. The Plan is intended to qualify
under section 401 of the Internal Revenue Code, which provides that
employee and company contributions and income earned on contributions
are not taxable to the employee until withdrawn from the Plan, and that
we may deduct our contributions when made.
(b) Amounts represent matching contribution under the Plan, except for
2003, which includes $27,090 related to the vesting of restricted stock
and social luncheon club dues.
(c) Amounts represent solely matching contribution under the Plan, except
for 2003 which includes $9,070 related to the vesting of restricted
stock.
(d) Mr. Manor began his employment with our company on January 1, 2002, in
connection with our acquisition of Cardiosonix Ltd. (formerly Biosonix
Ltd.) and ended his employment on December 31, 2003.
(e) Amounts represent reimbursements for a company car leased for Mr.
Manor's use.
44
OPTION GRANTS IN LAST FISCAL YEAR
The following table presents certain information concerning stock options
granted to the Named Executives under the 2002 Stock Incentive Plan during the
2003 fiscal year.
INDIVIDUAL GRANTS
-----------------
PERCENT OF
NUMBER OF TOTAL
SECURITIES OPTIONS GRANTED
UNDERLYING OPTIONS TO EMPLOYEES IN EXERCISE PRICE EXPIRATION
NAME GRANTED (SHARES) FISCAL YEAR PER SHARE DATE (d)
---- --------------- ----------- --------- --------
Carl M. Bosch 40,000(a) 3.9% $ 0.14(b) 1/15/13
30,000(a) 2.9% $ 0.13(c) 2/15/13
Rodger A. Brown 40,000(a) 3.9% $ 0.14(b) 1/15/13
30,000(a) 2.9% $ 0.13(c) 2/15/13
David C. Bupp 100,000(a) 9.7% $ 0.14(b) 1/15/13
70,000(a) 6.8% $ 0.13(c) 2/15/13
Brent L. Larson 40,000(a) 3.9% $ 0.14(b) 1/15/13
30,000(a) 2.9% $ 0.13(c) 2/15/13
Dan Manor 40,000(a) 3.9% $ 0.14(b) 1/15/13
(a) Vests as to one-third of these shares on each of the first three
anniversaries of the date of grant.
(b) The per share weighted average fair value of these stock options during
2003 was $0.12 on the date of grant using the Black-Scholes option
pricing model with the following assumptions: an expected life of 4
years, an average risk-free interest rate of 2.7%, volatility of 146%
and no expected dividend rate.
(c) The per share weighted average fair value of these stock options during
2003 was $0.11 on the date of grant using the Black-Scholes option
pricing model with the following assumptions: an expected life of 4
years, an average risk-free interest rate of 2.5%, volatility of 146%
and no expected dividend rate.
(d) The options terminate on the earlier of the expiration date, nine
months after death or disability, 90 days after termination of
employment without cause or by resignation or immediately upon
termination of employment for cause.
FISCAL YEAR-END OPTION NUMBERS AND VALUES
The following table sets forth certain information concerning the number and
value of unexercised options held by the Named Executives at the end of the last
fiscal year (December 31, 2003). There were no stock options exercised by the
Named Executives during the fiscal year ended December 31, 2003.
NUMBER OF SECURITIES VALUE OF UNEXERCISED
UNDERLYING UNEXERCISED IN-THE-MONEY OPTIONS
OPTIONS AT FISCAL YEAR-END: AT FISCAL YEAR-END:
NAME EXERCISABLE/UNEXERCISABLE EXERCISABLE/UNEXERCISABLE (1)
---- --------------------------- -----------------------------
Carl M. Bosch 121,667 / 118,333 $0 / $12,200
Rodger A. Brown 116,167 / 118,333 $0 / $12,200
David C. Bupp 410,000 / 450,000 $0 / $12,200
Brent L. Larson 173,867 / 123,333 $0 / $29,600
Dan Manor 16,667 / 33,333 $0 / $ 6,800
(1) Represents the total gain which would be realized if all in-the-money
options held at year end were exercised, determined by multiplying the number of
shares underlying the options by the difference between the per share option
exercise price and the per share fair market value at year end of $0.31. An
option is in-the-money if the fair market value of the underlying shares exceeds
the exercise price of the option.
45
COMPENSATION OF NON-EMPLOYEE DIRECTORS
During 2003, the Board of Directors of our company received no cash compensation
for board participation or meeting attendance. Each non-employee director
received options to purchase 20,000 shares of common stock as a part of our
annual stock incentive grants. Options granted to directors to purchase common
stock vest on an annual basis over a one-to-three year periods and have exercise
prices equal to no less than the market price of common stock at the date of
grant.
Directors who are also officers or employees of our company do not receive any
compensation for their services as directors.
COMPENSATION OF MR. BUPP
Employment Agreement. David C. Bupp is employed under a thirty-six month
employment agreement effective January 1, 2004. The employment agreement
provides for an annual base salary of $271,250.
The Board of Directors will, on an annual basis, review the performance of our
company and of Mr. Bupp and will pay a bonus to Mr. Bupp as it deems
appropriate, in its discretion. Such review and bonus will be consistent with
any bonus plan adopted by the Compensation Committee that covers the executive
officers of our company generally. Mr. Bupp was paid a bonus of $32,500 relating
to fiscal year 2003.
If a change in control occurs with respect to our company and the employment of
Mr. Bupp is concurrently or subsequently terminated:
- by our company without cause (cause is defined as any willful
breach of a material duty by Mr. Bupp in the course of his
employment or willful and continued neglect of his duty as an
employee);
- the term of Mr. Bupp's employment agreement expires; or
- Mr. Bupp resigns because his authority, responsibilities or
compensation have materially diminished, a material change
occurs in his working conditions or we breach the agreement;
then, Mr. Bupp will be paid a severance payment of $650,000 (less amounts paid
as Mr. Bupp's salary and benefits that continue for the remaining term of the
agreement if his employment is terminated without cause). If any such
termination occurs after the substantial completion of the liquidation of our
assets, the severance payment shall be increased by $81,250.
For purposes of Mr. Bupp's employment agreement, a change in control includes:
- the acquisition, directly or indirectly, by a person (other
than our company or an employee benefit plan established by
the Board of Directors) of beneficial ownership of 15 percent
or more of our securities with voting power in the next
meeting of holders of voting securities to elect the
directors;
- a majority of the directors elected at any meeting of the
holders of our voting securities are persons who were not
nominated by our then current Board of Directors or an
authorized committee thereof;
- our stockholders approve a merger or consolidation of our
company with another person, other than a merger or
consolidation in which the holders of our voting securities
outstanding immediately before such merger or consolidation
continue to hold voting securities in the surviving or
resulting corporation (in the same relative proportions to
each other as existed before such event) comprising eighty
percent (80%) or more of the voting power for all purposes of
the surviving or resulting corporation; or
- our stockholders approve a transfer of substantially all of
our assets to another person other than a transfer to a
transferee, eighty percent (80%) or more of the voting power
of which is owned or controlled by us or by the holders of our
voting securities outstanding immediately before such transfer
in the same relative proportions to each other as existed
before such event.
Mr. Bupp will be paid a severance amount of $406,250 if his employment is
terminated at the end of his employment agreement or without cause and his
benefits will continue for the longer of twenty-four months or the full term of
the agreement.
46
Restricted Stock Agreements. Mr. Bupp holds 100,000, 35,000, 45,000 and 30,000
shares of our common stock that was originally granted as restricted stock
grants on March 22, 2000, April 30, 1999, May 20, 1998 and June 1, 1996,
respectively, pursuant to restricted stock purchase agreements of the same
dates. The original grants did not allow Mr. Bupp to transfer or sell any of the
restricted shares unless and until they vested and contained certain change of
control provisions. However, in connection with the February 1, 2003 amendment
to Mr. Bupp's previous employment agreement, we vested Mr. Bupp's interest in
the shares. We recognized $27,090 in compensation expense related to the vesting
of the restricted stock in 2003 which occurred as a result of the execution of a
February 1, 2003 amendment to Mr. Bupp's previous employment agreement.
COMPENSATION AGREEMENTS WITH OTHER NAMED EXECUTIVES
Carl M. Bosch
Employment Agreement. Carl Bosch is employed under a twelve-month employment
agreement effective January 1, 2004. The employment agreement provides for an
annual base salary of $135,000, and the Company has agreed to review Mr. Bosch's
salary by July 1, 2004.
The Compensation Committee will, on an annual basis, review the performance of
our company and of Mr. Bosch and we will pay a bonus to Mr. Bosch as we deem
appropriate, in our discretion. Such review and bonus will be consistent with
any bonus plan adopted by the Compensation Committee that covers the executive
officers of our company generally. No bonus was paid to Mr. Bosch relating to
fiscal year 2003. Mr. Bosch was paid $26,000 in salary during 2003 that was
deferred under the terms of his previous employment agreement.
If a change in control occurs with respect to our company and the employment of
Mr. Bosch is concurrently or subsequently terminated:
- without cause (cause is defined as any willful breach of a
material duty by Bosch in the course of his employment or
willful and continued neglect of his duty as an employee);
- the term of Mr. Bosch's employment agreement expires; or
- Mr. Bosch resigns because his authority, responsibilities or
compensation have materially diminished, a material change
occurs in his working conditions or we breach the agreement;
then, Mr. Bosch will be paid a severance payment of $270,000 and will continue
his benefits for the longer of twelve months or the remaining term of his
employment agreement.
For purposes of Mr. Bosch's employment agreement, a change in control includes:
- the acquisition, directly or indirectly, by a person (other
than our company or an employee benefit plan established by
the Board of Directors) of beneficial ownership of 30 percent
or more of our securities with voting power in the next
meeting of holders of voting securities to elect the
directors;
- a majority of the directors elected at any meeting of the
holders of our voting securities are persons who were not
nominated by our then current Board of Directors or an
authorized committee thereof;
- our stockholders approve a merger or consolidation of our
company with another person, other than a merger or
consolidation in which the holders of our voting securities
outstanding immediately before such merger or consolidation
continue to hold voting securities in the surviving or
resulting corporation (in the same relative proportions to
each other as existed before such event) comprising eighty
percent (80%) or more of the voting power for all purposes of
the surviving or resulting corporation; or
- our stockholders approve a transfer of substantially all of
the assets of our company to another person other than a
transfer to a transferee, eighty percent (80%) or more of the
voting power of which is owned or controlled by us or by the
holders of our voting securities outstanding immediately
before such transfer in the same relative proportions to each
other as existed before such event.
47
Mr. Bosch will be paid a severance amount of $135,000 if his employment is
terminated at the end of his employment agreement or without cause, and his
benefits will be continued for up to twelve months.
Restricted Stock Agreement. Mr. Bosch also holds 30,000 shares of our common
stock that were originally granted to him as restricted stock on March 22, 2000,
pursuant to a restricted stock purchase agreement with our company as of the
same date. Under the original terms of the underlying restricted stock purchase
agreement, Mr. Bosch could not transfer or sell any of the restricted shares
unless and until they vest. However, in connection with the execution of his
previous employment agreement that was effective from February 1, 2003 through
December 31, 2003 and Mr. Bosch's waiver of amounts previously deferred under an
August 1, 2002 amendment to another previous employment agreement, we vested Mr.
Bosch's interest in the shares. We recognized $3,870 in compensation expense
related to the vesting of the restricted stock in 2003 concurrent with the
execution of Mr. Bosch's previous employment agreement.
Rodger A. Brown
Employment Agreement. Rodger Brown is employed under a twelve-month employment
agreement effective January 1, 2004. The employment agreement provides for an
annual base salary of $115,000, and the Company has agreed to review Mr. Brown's
salary by July 1, 2004. Mr. Brown was paid $32,733 in salary during 2003 that
was deferred under the terms of his previous employment agreements.
The terms of Mr. Brown's employment agreement are substantially identical to Mr.
Bosch's employment agreement except that Mr. Brown would be paid $172,500 if
terminated due to a change of control and $115,000 if terminated at the end of
his employment or without cause.
The Compensation Committee will, on an annual basis, review the performance of
our company and of Mr. Brown and we will pay a bonus to Mr. Brown as we deem
appropriate, in our discretion. Such review and bonus will be consistent with
any bonus plan adopted by the Compensation Committee that covers the executive
officers of our company generally. No bonus was paid to Mr. Brown relating to
fiscal year 2003.
Brent L. Larson
Employment Agreement. Brent Larson is employed under a twelve-month employment
agreement effective January 1, 2004. The employment agreement provides for an
annual base salary of $135,000 and the Company has agreed to review Mr. Larson's
salary by July 1, 2004. Mr. Larson was paid $26,000 in salary during 2003 that
was deferred under the terms of his previous employment agreement.
The terms of Mr. Larson's employment agreement are substantially identical to
Mr. Bosch's employment agreement. The Compensation Committee will, on an annual
basis, review the performance of our company and of Mr. Larson and we will pay a
bonus to Mr. Larson as we deem appropriate, in our discretion. Such review and
bonus will be consistent with any bonus plan adopted by the Compensation
Committee that covers the executive officers of our company generally. No bonus
was paid to Mr. Larson relating to fiscal year 2003.
Restricted Stock Agreement(s). Mr. Larson also holds 40,000, 20,000 and 10,000
shares of our common stock that were originally granted to him as restricted
stock granted to him at a price of $0.001 per share on March 22, 2000, April 30,
1999 and October 23, 1998, respectively, pursuant to restricted stock purchase
agreements of the same dates. The terms of Mr. Larson's restricted stock
purchase agreement are identical to those contained in Mr. Bosch's restricted
stock purchase agreement discussed above regarding vesting, forfeiture and
rights of ownership. However, in connection with the execution of his previous
employment agreement that was effective from February 1, 2003 through December
31, 2003 and Mr. Larson's waiver of amounts previously deferred under an August
1, 2002 amendment to another previous employment agreement, we vested Mr.
Larson's interest in the shares. We recognized $9,030 in compensation expense
related to the vesting of the restricted stock in 2003 concurrent with the
execution of Mr. Larson's previous employment agreement.
48
Richard N. Linder
Employment Agreement. Richard N. Linder is employed under a fourteen-month
employment agreement effective November 1, 2003. The employment agreement
provides for an annual base salary of $165,000. In exchange for entering into
his employment agreement, Mr. Linder received 200,000 options to purchase our
common stock with an exercise price of $0.30 per share that vest one third
annually on the anniversary of the date of grant. The terms of Mr. Linder's
employment agreement are substantially identical to Mr. Bosch's employment
agreement except that Mr. Linder would be paid $165,000 if terminated due to a
change of control and $82,500 if terminated at the end of his employment or
without cause.
The Compensation Committee will, on an annual basis, review the performance of
our company and of Mr. Linder and we will pay a bonus to Mr. Linder as we deem
appropriate, in our discretion. Such review and bonus will be consistent with
any bonus plan adopted by the Compensation Committee that covers the executive
officers of our company generally. No bonus was paid to Mr. Linder relating to
fiscal year 2003.
Dan Manor
Dan Manor was employed by our subsidiary, Cardiosonix Ltd., as its President
under a two-year employment agreement effective January 1, 2002. The employment
agreement provided for a monthly basic salary of $12,083 and automatically
renewed for one-year increments unless written notice was given ninety days
prior to the end of the then term of the agreement. Dr. Manor will also receive
one third of 1% of the Net Revenues (as defined in Dr. Manor's employment
agreement) from Cardiosonix products for up to five years from the effective
date of the agreement. Cardiosonix also provided Dr. Manor with an automobile
allowance, and provided certain statutory benefits under the laws of the State
of Israel. Neoprobe and Dr. Manor agreed in September 2003 not to renew his
employment agreement following the expiration of its initial term on December
31, 2003; however, the royalty provisions of his agreement survive the end of
his employment with Cardiosonix and continue through December 31, 2006.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
EQUITY COMPENSATION PLAN INFORMATION
The following table sets forth additional information as of December 31, 2003,
concerning shares of our common stock that may be issued upon the exercise of
options and other rights under our existing equity compensation plans and
arrangements, divided between plans approved by our stockholders and plans or
arrangements not submitted to our stockholders for approval. The information
includes the number of shares covered by, and the weighted average exercise
price of, outstanding options and other rights and the number of shares
remaining available for future grants excluding the shares to be issued upon
exercise of outstanding options, warrants, and other rights.
NUMBER OF SECURITIES
REMAINING AVAILABLE
NUMBER OF SECURITIES FOR ISSUANCE UNDER
TO BE ISSUED UPON WEIGHTED-AVERAGE EQUITY COMPENSATION
EXERCISE OF EXERCISE PRICE OF PLANS (EXCLUDING
OUTSTANDING OPTIONS, OUTSTANDING OPTIONS, SECURITIES REFLECTED
WARRANTS AND RIGHTS WARRANTS AND RIGHTS IN COLUMN (a))
(a) (b) (c)
---------------------- ----------------------- ----------------------
Equity compensation plans
approved by security holders 2,931,308 $0.56 2,830,283
Equity compensation plans
not approved by security
holders - - -
--------- ----- ---------
Total 2,931,308 $0.56 2,830,283
========= ===== =========
49
SECURITY OWNERSHIP OF PRINCIPAL STOCKHOLDERS, DIRECTORS, NOMINEES AND EXECUTIVE
OFFICERS AND RELATED STOCKHOLDER MATTERS
The following table sets forth, as of March 15, 2004, certain information with
respect to the beneficial ownership of shares of common stock by (i) each person
known to us to be the beneficial owner of more than 5 percent of our outstanding
shares of common stock, (ii) each director of our company, (iii) each of the
Named Executives (see Item 10, Executive Compensation--Summary Compensation
Table), and (iv) our directors and executive officers as a group.
NUMBER OF
SHARES
BENEFICIALLY PERCENT OF
BENEFICIAL OWNER OWNED(*) CLASS
---------------- ---------------- -------------
Reuven Avital 2,808,457(a) 5.0%
Carl M. Bosch 255,286(b) (n)
Rodger A. Brown 171,168(c) (n)
David C. Bupp 1,710,018(d) 3.1%
Nancy E. Katz 53,334(e) (n)
Julius R. Krevans 197,001(f) (n)
Brent L. Larson 348,324(g) (n)
Richard N. Linder 21,000(h) (n)
Fred B. Miller 24,334(i) (n)
J. Frank Whitley, Jr. 114,334(j) (n)
All directors and officers as a group 5,703,256(k) 9.6%
(9 persons)
Dan Purjes, et al. 4,463,956(l) 8.0%
Sands Brothers Venture Funds 3,260,870(m) 5.9%
(*) Beneficial ownership is determined in accordance with the rules of the
Securities and Exchange Commission which generally attribute beneficial
ownership of securities to persons who possess sole or shared voting power
and/or investment power with respect to those securities. Unless otherwise
indicated, voting and investment power are exercised solely by the person
named above or shared with members of such person's household.
(**)Percent of class is calculated on the basis of the number of shares
outstanding on March 15, 2004, plus the number of shares the person has the
right to acquire within 60 days of March 15, 2004.
(a) This amount consists of 2,785,123 shares of our common stock owned by
Ma'Aragim Enterprises Ltd., an investment fund under the management and
control of Mr. Avital, and 23,334 shares issuable upon exercise of options
which are exercisable within 60 days but does not include 61,666 shares
issuable upon exercise of options which are not exercisable within 60 days.
(b) This amount includes 176,668 shares issuable upon exercise of options which
are exercisable within 60 days and 38,618 shares in Mr. Bosch's account in
the 401(k) Plan, but does not include 133,332 shares issuable upon exercise
of options which are not exercisable within 60 days. Mr. Bosch is one of
three trustees of the 401(k) Plan and may, as such, share investment power
over common stock held in such plan. The 401(k) Plan holds an aggregate
total of 274,648 shares of common stock. Mr. Bosch disclaims any beneficial
ownership of shares held by the 401(k) Plan that are not allocated to his
personal account.
(c) This amount includes 176,168 shares issuable upon exercise of options which
are exercisable within 60 days, but does not include 133,332 shares
issuable upon exercise of options which are not exercisable within 60 days
(d) This amount includes 586,668 shares issuable upon exercise of options which
are exercisable within 60 days and 56,850 shares in Mr. Bupp's account in
the 401(k) Plan, but it does not include 423,332 shares issuable upon
exercise of options which are not exercisable within 60 days. This amount
also includes 375,000 warrants held by Mr. Bupp exercisable at $0.13 and
375,000 warrants to purchase common stock exercisable at $0.52. Mr. Bupp is
one of three trustees of the 401(k) Plan and may, as such, share investment
power over common stock held in such plan. The 401(k) Plan holds an
aggregate total of 274,648 shares of common stock. Mr. Bupp disclaims any
beneficial ownership of shares held by the 401(k) Plan that are not
allocated to his personal account.
(e) This amount includes 53,334 shares issuable upon exercise of options which
are exercisable within 60 days, but does not include 61,666 shares issuable
upon the exercise of options which are not exercisable within 60 days.
(f) This amount includes 195,001 shares issuable upon exercise of options which
are exercisable within 60 days, but does not include 104,999 shares
issuable upon exercise of options which are not exercisable within 60 days.
50
(g) This amount includes 233,868 shares issuable upon exercise of options which
are exercisable within 60 days and 22,889 shares in Mr. Larson's account in
the 401(k) Plan, but it does not include 133,332 shares issuable upon
exercise of options which are not exercisable within 60 days. Mr. Larson is
one of three trustees of the 401(k) Plan and may, as such, share investment
power over common stock held in such plan. The 401(k) Plan holds an
aggregate total of 274,648 shares of common stock. Mr. Larson disclaims any
beneficial ownership of shares held by the 401(k) Plan that are not
allocated to his personal account.
(h) This amount includes 21,000 shares acquired by Mr. Linder prior to his
employment with the company, but does not include 200,000 shares issuable
upon exercise of options which are not exercisable within 60 days.
(i) This amount includes 23,334 shares issuable upon exercise of options which
are exercisable within 60 days and 1,000 shares held by Mr. Miller's wife
for which he disclaims beneficial ownership, but does not include 101,666
shares issuable upon the exercise of options which are not exercisable
within 60 days.
(j) This amount includes 113,334 shares issuable upon exercise of options which
are exercisable within 60 days, but does not include 61,666 shares issuable
upon exercise of options which are not exercisable within 60 days.
(k) This amount includes 1,576,709 shares issuable upon exercise of options
which are exercisable within 60 days, 750,000 shares issuable upon the
exercise of warrants which are exercisable within 60 days and 134,424
shares held in the 401(k) Plan, but it does not include 1,214,991 shares
issuable upon the exercise of options which are not exercisable within 60
days. Certain executive officers of our company are the trustees of the
401(k) Plan and may, as such, share investment power over common stock held
in such plan. Each trustee disclaims any beneficial ownership of shares
held by the 401(k) Plan that are not allocated to his personal account. The
401(k) Plan holds an aggregate total of 274,648 shares of common stock.
(l) This amount is based on information provided to us in connection with the
purchase of these securities in a private placement and subsequent filing
of the registration statement and represents the best information
available to us at the time of this filing. This amount includes 434,783
shares owned by MFW Associates (of which Mr. Purjes is Managing Director)
and 217,391 shares issuable to MFW Associates on the exercise of warrants
that are exercisable within 60 days, 869,565 shares owned by Dan and Edna
Purjes and 434,783 shares issuable to Dan and Edna Purjes on the exercise
of warrants that are exercisable within 60 days, 217,391 shares owned by Y
Securities Management Ltd. (of which Mr. Purjes is Managing Director) and
108,696 shares issuable to Y Securities Management Ltd. on the exercise of
warrants that are exercisable within 60 days, 217,391 shares owned by The
Purjes Foundation and 108,696 shares issuable to The Purjes Foundation on
the exercise of warrants that are exercisable within 60 days, 869,565
shares owned by Dan Purjes IRA and 434,783 shares issuable to Dan Purjes
IRA on the exercise of warrants that are exercisable within 60 days, and
550,913 shares issuable upon the exercise of warrants that are exercisable
within 60 days. Mr. Purjes disclaims beneficial ownership of shares held
by The Purjes Foundation.
(m) This amount is based on information provided to us in connection with the
purchase of these securities in a private placement and subsequent filing
of the registration statement and represents the best information
available to us at the time of this filing. This amount includes 217,391
shares owned by Sands Brothers Venture Capital I, LLC and 108,696 shares
issuable to Sands Brothers Venture Capital I, LLC on the exercise of
warrants that are exercisable within 60 days, 217,391 shares owned by Sands
Brothers Venture Capital II, LLC and 108,696 shares issuable to Sands
Brothers Venture Capital II, LLC on the exercise of warrants that are
exercisable within 60 days, 1,304,348 shares owned by Sands Brothers
Venture Capital III, LLC and 652,174 shares issuable to Sands Brothers
Venture Capital III, LLC on the exercise of warrants that are exercisable
within 60 days, and 434,783 shares owned by Sands Brothers Venture Capital
IV, LLC and 217,391 shares issuable to Sands Brothers Venture Capital IV,
LLC on the exercise of warrants that are exercisable within 60 days.
(n) Less than one percent.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
See "Liquidity and Capital Resources" in Part II, Item 6 of this Form 10-KSB for
information about our related party transactions.
51
ITEM 13. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
Exhibit
Number Exhibit Description
------- -------------------
2.1 Stock Purchase Agreement, dated as of November 29, 2001,
by and among Neoprobe Corporation, Biosonix, Ltd., and the
shareholders of Biosonix, Ltd. Named therein (filed as
Exhibit 99(b) to the Company's Current Report on Form 8-K
dated November 29, 2001, and incorporated herein by
reference).
3.1 Amended and Restated Certificate of Incorporation of
Neoprobe Corporation (incorporated by reference to Exhibit
3.1 to the Company's September 30, 2001 Form 10-QSB).
3.2 Amended and Restated By-Laws dated July 21, 1993, as
amended July 18, 1995 and May 30, 1996 (filed as Exhibit
99.4 to the Company's Current Report on Form 8-K dated
June 20, 1996, and incorporated herein by reference).
10.1 Rights Agreement between the Company and Continental Stock
Transfer & Trust Company dated as of July 18, 1995
(incorporated by reference to Exhibit 1 to the
Registration Statement of Form 8-A, Commission file No.
0-26520).
10.2 Amendment Number 1 to the Rights Agreement between the
Company and Continental Stock Transfer & Trust Company
dated February 16, 1999 (incorporated by reference to
Exhibit 4.4 to the Company's April 1, 1999 Form 10-K).
10.3 Common Stock Purchase Agreement between the Company and
Fusion Capital Fund II, LLC dated November 19, 2001
(incorporated by reference to Exhibit 99(b) of the
Company's December 3, 2001 Form 8-K).
10.4 Shareholder Agreement, dated as of December 31, 2001, by
and among Neoprobe Corporation and the shareholders of
Biosonix, Ltd. named therein (incorporated by reference to
Exhibit 99(c) to the Company's Current Report on Form 8-K
dated November 29, 2001).
10.5 Amended and Restated Stock Option and Restricted Stock
Purchase Plan dated March 3, 1994 (incorporated by
reference to Exhibit 10.2.26 to the Company's December 31,
1993 Form 10-K).
10.6 Restricted Stock Purchase Agreement dated June 5, 1996
between the Company and David C. Bupp (incorporated by
reference to Exhibit 10.2.35 to the Company's December 31,
1997 Form 10-K).
10.7 1996 Stock Incentive Plan dated January 18, 1996 as
amended March 13, 1997 (incorporated by reference to
Exhibit 10.2.37 to the Company's December 31, 1997 Form
10-K).
10.8 Restricted Stock Purchase Agreement between the Company
and David C. Bupp dated May 20, 1998 (incorporated by
reference to Exhibit 10.2.45 to the Company's June 30,
1998 Form 10-Q).
10.9 Restricted Stock Agreement dated October 23, 1998 between
the Company and Brent L. Larson (incorporated by reference
to Exhibit 10.2.48 to the Company's December 31, 1998 Form
10-K/A).
10.10 Restricted Stock Agreement dated April 30, 1999 between
the Company and David C. Bupp. This Agreement is one of
three substantially identical agreements and is
accompanied by a schedule identifying the other agreements
omitted and setting forth the material details in which
such agreements differ from the one that is filed
52
herewith (incorporated by reference to Exhibit 10.2.50 to
the Company's June 30, 1999 Form 10-Q).
10.11 Restricted Stock Agreement dated March 22, 2000 between
the Company and David C. Bupp. This Agreement is one of
three substantially identical agreements and is
accompanied by a schedule identifying the other agreements
omitted and setting forth the material details in which
such agreements differ from the one that is filed herewith
(incorporated by reference to Exhibit 10.2.54 of the
Company's March 31, 2000 Form 10-Q).
10.12 Employment Agreement between the Company and David C.
Bupp, dated January 1, 2004.*
10.13 Employment Agreement between the Company and Carl M.
Bosch, dated January 1, 2004. This Agreement is one of
three substantially identical agreements and is
accompanied by a schedule identifying the other agreements
omitted and setting forth the material details in which
such agreements differ from the one that is filed
herewith.*
10.14 Employment Agreement between Cardiosonix Ltd. (formerly
Biosonix Ltd.) and Dan Manor, dated January 1, 2002
(incorporated by reference to Exhibit 10.2.61 to the
Company's December 31, 2001 Form 10-KSB).
10.15 Technology Transfer Agreement dated July 29, 1992 between
the Company and The Dow Chemical Corporation (portions of
this Exhibit have been omitted pursuant to a request for
confidential treatment and have been filed separately with
the Commission), (incorporated by reference to Exhibit
10.10 to the Company's Form S-1 filed October 15, 1992).
10.16 Cooperative Research and Development Agreement between the
Company and the National Cancer Institute (incorporated by
reference to Exhibit 10.3.31 to the Company's September
30, 1995 Form 10-QSB).
10.17 License dated May 1, 1996 between the Company and The Dow
Chemical Company (incorporated by reference to Exhibit
10.3.45 to the Company's June 30, 1996 Form 10-QSB).
10.18 License Agreement dated May 1, 1996 between the Company
and The Dow Chemical Company (portions of this Exhibit
have been omitted pursuant to a request for confidential
treatment and have been filed separately with the
Commission), (incorporated by reference to Exhibit 10.3.46
to the Company's June 30, 1996 Form 10-QSB).
10.19 Supply Agreement between the Company and eV Products dated
December 8, 1997 (portions of this Exhibit have been
omitted pursuant to a request for confidential treatment
and have been filed separately with the Commission),
(incorporated by reference to Exhibit 10.4.32 to Amendment
2 to the Company's December 31, 1997 Form 10-K).
10.20 Distribution Agreement between the Company and Ethicon
Endo-Surgery, Inc. dated October 1, 1999 (portions of this
Exhibit have been omitted pursuant to a request for
confidential treatment and have been filed separately with
the Commission), (incorporated by reference to Exhibit
10.4.39 to the Company's September 30, 1999 Form 10-Q).
10.21 Product Supply Agreement between the Company and UMM
Electronics, Inc., dated October 25, 2001 (portions of
this Exhibit have been omitted pursuant to a request for
confidential treatment and have been filed separately with
the Commission), (incorporated by reference to Exhibit
10.4.49 to the Company's December 31, 2001
53
Form 10-KSB).
10.22 Product Supply Agreement between the Company and TriVirix
International, Inc., dated February 5, 2004 (portions of
this Exhibit have been omitted pursuant to a request for
confidential treatment and have been filed separately with
the Commission).*
10.23 Senior Secured Note Purchase Agreement dated March 26,
2003 between the Company and David C. Bupp. (Incorporated
by reference to Exhibit 99(b) to the Company's Current
Report on Form 8-K filed April 2, 2003).
10.24 8.5% Senior Note dated April 2, 2003 between the Company
and David C. Bupp, as amended March 8, 2004.*
10.25 Convertible Preferred Note Purchase Agreement dated March
26, 2003 between the Company and Donald E. Garlikov
(Incorporated by reference to Exhibit 99(d) to the
Company's Current Report on Form 8-K filed April 2, 2003).
10.26 9.5% Convertible Secured Note dated April 2, 2003 between
the Company and Donald E. Garlikov (Incorporated by
reference to Exhibit 99(e) to the Company's Current Report
on Form 8-K filed April 2, 2003).
10.27 Warrant to Purchase Common Stock of Neoprobe Corporation
dated April 2, 2003 between the Company and David C. Bupp
(Incorporated by reference to Exhibit 99(f) to the
Company's Current Report on Form 8-K filed April 2, 2003).
10.28 Warrant to Purchase Common Stock of Neoprobe Corporation
dated March 8, 2004 between the Company and David C.
Bupp.*
10.29 Warrant to Purchase Common Stock of Neoprobe Corporation
dated April 2, 2003 between the Company and Donald E.
Garlikov (Incorporated by reference to Exhibit 99(g) to
the Company's Current Report on Form 8-K filed April 2,
2003).
10.30 Security Agreement dated April 2, 2003 between the
Company, David C. Bupp and Donald E. Garlikov
(Incorporated by reference to Exhibit 99(h) to the
Company's Current Report on Form 8-K filed April 2, 2003).
10.31 Registration Rights Agreement dated April 2, 2003 between
the Company, David C. Bupp and Donald E. Garlikov
(Incorporated by reference to Exhibit 99(i) to the
Company's Current Report on Form 8-K filed April 2, 2003).
10.32 Stock Purchase Agreement dated October 22, 2003 between
the Company and Bridges & Pipes, LLC. (Incorporated by
reference to Exhibit 10.32 to the Company's registration
statement on Form SB-2 filed December 2, 2003).
10.33 Registration Rights Agreement dated October 22, 2003
between the Company and Bridges & Pipes, LLC (Incorporated
by reference to Exhibit 10.33 to the Company's
registration statement on Form SB-2 filed December 2,
2003).
10.34 Series R Warrant Agreement dated October 22, 2003 between
the Company and Bridges & Pipes, LLC (Incorporated by
reference to Exhibit 10.34 to the Company's registration
statement on Form SB-2 filed December 2, 2003).
10.35 Series S Warrant Agreement dated November 21, 2003 between
the Company and Alberdale Capital, LLC (Incorporated by
reference to Exhibit 10.35 to the Company's registration
statement on Form SB-2 filed December 2, 2003).
23.1 Consent of KPMG LLP.*
24.1 Powers of Attorney.*
54
31.1 Certification of Chief Executive Officer pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002.*
31.2 Certification of Chief Financial Officer pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002.*
32.1 Certification of Chief Executive Officer of Periodic Financial
Reports pursuant to Section 906 of the Sarbanes-Oxley Act of 2002,
18 U.S.C. Section 1350.*
32.2 Certification of Chief Financial Officer of Periodic Financial
Reports pursuant to Section 906 of the Sarbanes-Oxley Act of 2002,
18 U.S.C. Section 1350.*
* Filed herewith.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
AUDIT FEES. The aggregate fees billed for professional services rendered by KPMG
LLP, for the audits of the Company's annual consolidated financial statements
for the 2003 fiscal year and the reviews of the financial statements included in
the Company's Quarterly Reports on Form 10-QSB for the fiscal year were $128,900
(including direct engagement expenses). The aggregate fees billed for
professional services rendered by KPMG LLP for the audits of the Company's
annual consolidated financial statements for the 2002 fiscal year and the
reviews of the financial statements included in the Company's Quarterly Reports
on Form 10-QSB for the fiscal year were $110,730 (including direct engagement
expenses).
AUDIT-RELATED FEES. The aggregate fees billed by KPMG LLP for audit-related
services rendered for the Company for the 2003 fiscal year were $11,500. The
aggregate fees billed KPMG LLP for audit-related services rendered for the
Company and its subsidiaries for the 2002 fiscal year were $15,500.
Audit-related fees generally include fees in support of the company's filing of
registration statements with the SEC and similar matters.
TAX FEES. The aggregate fees billed by KPMG LLP for tax-related services
rendered for the Company for the 2003 fiscal year were $6,525. The aggregate
fees billed by KPMG LLP for tax-related services rendered for the Company and
its subsidiaries for the 2002 fiscal year were $8,500. The tax-related services
were all in the nature of tax compliance and tax planning.
ALL OTHER FEES. The aggregate fees billed for services rendered to the Company
by KPMG LLP, other than the audit services, audit-related services, and tax
services, were $0 for the 2003 fiscal year and $0 for the 2002 fiscal year.
PRE-APPROVAL POLICY. The Audit Committee is required to pre-approve all auditing
services and permitted non-audit services (including the fees and terms thereof)
to be performed for the Company by its independent auditor or other registered
public accounting firm, subject to the de minimis exceptions for non-audit
services described in Section 10A(i)(1)(B) of the Securities Exchange Act of
1934 that are approved by the Audit Committee prior to completion of the audit.
55
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Company has duly caused this report to be signed on its behalf
by the undersigned, thereunto duly authorized.
Dated: March 30, 2004
NEOPROBE CORPORATION
(the Company)
By: /s/ David C. Bupp
---------------------------------
David C. Bupp, President and
Chief Executive Officer
SIGNATURE TITLE DATE
/s/David C. Bupp Director, President and March 30, 2004
---------------------------------- Chief Executive Officer
David C. Bupp (principal executive officer)
/s/ Brent L. Larson* Vice President, Finance and March 30, 2004
---------------------------------- Chief Financial Officer
Brent L. Larson (principal financial officer)
/s/ Reuven Avital* Director March 4, 2004
----------------------------------
Reuven Avital
/s/ Nancy E. Katz* Director March 4, 2004
----------------------------------
Nancy E. Katz
/s/ Julius R. Krevans* Chairman, Director March 4, 2004
----------------------------------
Julius R. Krevans
/s/ Fred B. Miller* Director March 4, 2004
----------------------------------
Fred B. Miller
/s/ J. Frank Whitley, Jr.* Director March 4, 2004
----------------------------------
J. Frank Whitley, Jr.
*By: /s/ David C. Bupp
-----------------------------
David C. Bupp, Attorney-in-fact
56
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
------------------------
NEOPROBE CORPORATION
------------------------
FORM 10-KSB ANNUAL REPORT
FOR THE FISCAL YEARS ENDED:
DECEMBER 31, 2003 AND 2002
----------------------------
FINANCIAL STATEMENTS
----------------------------
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
NEOPROBE CORPORATION AND SUBSIDIARY
INDEX TO FINANCIAL STATEMENTS
Audited Consolidated Financial Statements of Neoprobe Corporation
Independent Auditors' Report F-2
Consolidated Balance Sheets as of
December 31, 2003 and December 31, 2002 F-3
Consolidated Statements of Operations for the years ended
December 31, 2003 and December 31, 2002 F-5
Consolidated Statements of Stockholders' Equity for the years ended
December 31, 2003 and December 31, 2002 F-6
Consolidated Statements of Cash Flows for the years ended
December 31, 2003 and December 31, 2002 F-7
Notes to the Consolidated Financial Statements F-8
F-1
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders
Neoprobe Corporation:
We have audited the accompanying consolidated balance sheets of Neoprobe
Corporation and subsidiary as of December 31, 2003 and 2002, and the related
consolidated statements of operations, stockholders' equity, and cash flows for
the years then ended. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Neoprobe Corporation
and subsidiary as of December 31, 2003 and 2002, and the results of their
operations and their cash flows for the years then ended in conformity with
accounting principles generally accepted in the United States of America.
/s/ KPMG LLP
Columbus, Ohio
March 29, 2004
F-2
NEOPROBE CORPORATION AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
December 31, 2003 and 2002
2003 2002
---------- ----------
ASSETS
Current assets:
Cash and cash equivalents $1,588,760 $ 700,525
Accounts receivable, net 1,107,800 746,107
Inventory 1,008,326 1,191,918
Prepaid expenses and other 346,449 451,537
---------- ----------
Total current assets 4,051,335 3,090,087
---------- ----------
Property and equipment 2,237,741 2,346,445
Less accumulated depreciation and amortization 1,875,028 1,883,797
---------- ----------
362,713 462,648
---------- ----------
Patents and trademarks 3,156,101 3,129,031
Non-compete agreements 584,516 584,516
Acquired technology 237,271 237,271
---------- ----------
3,977,888 3,950,818
Less accumulated amortization 1,042,373 584,490
---------- ----------
2,935,515 3,366,328
---------- ----------
Other assets 35,479 160,778
---------- ----------
Total assets $7,385,042 $7,079,841
========== ==========
CONTINUED
F-3
NEOPROBE CORPORATION AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS, CONTINUED
2003 2002
------------- -------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Notes payable to finance companies $ 192,272 $ 172,381
Capital lease obligations, current 9,731 14,683
Accrued liabilities 227,306 397,161
Accounts payable 225,032 432,140
Deferred revenue, current 886,657 933,860
------------- -------------
Total current liabilities 1,540,998 1,950,225
------------- -------------
Note payable to CEO, net of discount 237,298 --
Note payable to investor, net of discount 217,504 --
Capital lease obligations 24,009 5,328
Deferred revenue 68,930 703,625
Contingent consideration for acquisition -- 288,053
Other liabilities 37,358 172,474
------------- -------------
Total liabilities 2,126,097 3,119,705
------------- -------------
Commitments and contingencies
Stockholders' equity:
Preferred stock; $.001 par value; 5,000,000 shares authorized at
December 31, 2003 and 2002; none issued and outstanding (500,000
shares designated as Series A, $.001 par
value, at December 31, 2003 and 2002; none outstanding) -- --
Common stock; $.001 par value; 75,000,000 shares
authorized; 51,520,723 shares issued and
outstanding at December 31, 2003; 36,502,183
shares issued and outstanding at December 31, 2002 51,521 36,502
Additional paid-in capital 127,684,555 124,601,770
Accumulated deficit (122,477,131) (120,678,136)
------------- -------------
Total stockholders' equity 5,258,945 3,960,136
------------- -------------
Total liabilities and stockholders' equity $ 7,385,042 $ 7,079,841
============= =============
See accompanying notes to consolidated financial statements.
F-4
NEOPROBE CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31,
----------------------------
2003 2002
------------ ------------
Revenues:
Net sales $ 5,564,275 $ 3,382,707
License and other revenue 945,633 1,538,233
------------ ------------
Total revenues 6,509,908 4,920,940
------------ ------------
Cost of goods sold 3,124,978 2,351,169
------------ ------------
Gross profit 3,384,930 2,569,771
------------ ------------
Operating expenses:
Research and development 1,893,520 2,323,710
Selling, general and administrative 3,102,535 3,267,361
Acquired in-process research and development -- (28,368)
------------ ------------
Total operating expenses 4,996,055 5,562,703
------------ ------------
Loss from operations (1,611,125) (2,992,932)
------------ ------------
Other income (expense):
Interest income 9,423 74,257
Interest expense (186,912) (31,946)
Other (10,381) (13,104)
------------ ------------
Total other (expenses) income (187,870) 29,207
------------ ------------
Net loss $ (1,798,995) $ (2,963,725)
============ ============
Net loss per common share:
Basic $ (0.04) $ (0.08)
Diluted $ (0.04) $ (0.08)
Weighted average shares outstanding:
Basic 40,337,679 36,045,196
Diluted 40,337,679 36,045,196
See accompanying notes to consolidated financial statements.
F-5
NEOPROBE CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Common Stock Additional
---------------------------- Paid-in Accumulated
Shares Amount Capital Deficit Total
---------- -------------- --------------- ---------------- ---------------
Balance, December 31, 2001 36,449,067 $ 36,449 $ 124,581,800 $ (117,714,411) $ 6,903,838
Issued to 401(k) plan at $0.46 53,116 53 24,579 -- 24,632
Issued warrants as fees to investor -- -- 14,018 -- 14,018
relations firm
Registration costs paid in connection
with stock purchase agreement -- -- (24,418) -- (24,418)
Registration costs paid in connection
with acquisition of subsidiary -- -- 5,791 -- 5,791
Net loss -- -- -- (2,963,725) (2,963,725)
---------- --------------- --------------- --------------- ---------------
Balance, December 31, 2002 36,502,183 36,502 124,601,770 (120,678,136) 3,960,136
Issued contingent shares related to
2001 acquisition of subsidiary 2,085,826 2,086 283,100 -- 285,186
Removed restrictions on stock
issued to executives -- -- 39,990 -- 39,990
Issued warrants in connection with
issuance of notes payable -- -- 112,994 -- 112,994
Issued to 401(k) plan at $0.26 100,327 100 25,852 -- 25,952
Issued shares in connection with
stock purchase agreement, net
of offering costs 480,331 481 143,212 -- 143,693
Issued shares and warrants in
connection with private placement,
net of offering costs 12,173,914 12,174 2,420,742 -- 2,432,916
Issued shares and warrants as fees to
investment banking firms 178,142 178 56,895 -- 57,073
Net loss -- -- -- (1,798,995) (1,798,995)
---------- --------------- --------------- --------------- ---------------
Balance, December 31, 2003 51,520,723 $ 51,521 $ 127,684,555 $ (122,477,131) $ 5,258,945
========== =============== =============== =============== ===============
See accompanying notes to consolidated financial statements.
F-6
NEOPROBE CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31,
--------------------------
2003 2002
----------- -----------
Cash flows from operating activities:
Net loss $(1,798,995) $(2,963,725)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation of property and equipment 246,975 402,878
Amortization of intangible assets 429,360 393,953
Provision for bad debts 49,582 28,751
Net loss on disposal and abandonment of assets 55,235 130,380
Amortization of debt discount and offering costs 81,449 --
Acquired in-process research and development -- (28,368)
Other 134,332 64,123
Change in operating assets and liabilities:
Accounts receivable (411,275) (216,429)
Inventory 169,135 213,948
Prepaid expenses and other assets 471,958 65,628
Accrued liabilities and other liabilities (353,186) (377,512)
Accounts payable (207,108) (57,548)
Deferred revenue (681,897) (672,356)
----------- -----------
Net cash used in operating activities (1,814,435) (3,016,277)
----------- -----------
Cash flows from investing activities:
Purchases of available-for-sale securities -- (2,491,361)
Proceeds from sales of available-for-sale securities -- 1,687,305
Proceeds from maturities of available-for-sale securities -- 805,000
Purchases of property and equipment (75,456) (263,012)
Proceeds from sales of property and equipment 250 618
Patent and trademark costs (34,270) (29,256)
Subsidiary acquisition costs -- (24,028)
----------- -----------
Net cash used in investing activities (109,476) (314,734)
----------- -----------
Cash flows from financing activities:
Proceeds from issuance of common stock 2,943,797 --
Payment of offering costs (370,056) (48,627)
Proceeds from line of credit -- 2,000,000
Payments under line of credit -- (2,000,000)
Proceeds from notes payable, net of offering costs 458,334 --
Payment of notes payable (204,983) (194,024)
Payments under capital leases (14,946) (12,914)
----------- -----------
Net cash provided by (used in) financing activities 2,812,146 (255,565)
----------- -----------
Net increase (decrease) in cash and cash equivalents 888,235 (3,586,576)
Cash and cash equivalents, beginning of year 700,525 4,287,101
----------- -----------
Cash and cash equivalents, end of year $ 1,588,760 $ 700,525
=========== ===========
See accompanying notes to consolidated financial statements.
F-7
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
a. ORGANIZATION AND NATURE OF OPERATIONS: Neoprobe Corporation (Neoprobe
or we), a Delaware corporation, is engaged in the development and
commercialization of innovative surgical and diagnostic products that
enhance patient care by meeting the critical decision making needs of
healthcare professionals. We currently manufacture two lines of medical
devices: the first is a line of gamma radiation detection equipment
used in the application of intraoperative lymphatic mapping (ILM), and
the second is a line of blood flow monitoring devices for a variety of
diagnostic and surgical applications.
Our gamma detection device products are marketed throughout most of the
world through a distribution arrangement with Ethicon Endo-Surgery,
Inc. (EES), a Johnson and Johnson company. For the years ended December
31, 2003 and 2002, 91% of net sales were made to EES. The loss of this
customer would have a significant adverse effect on our operating
results.
Our blood flow measurement device product line is in the early stages
of commercialization. Our activity with this product line was initiated
with our acquisition of Cardiosonix Ltd. (Cardiosonix, formerly
Biosonix Ltd.), located in Ra'anana, Israel, on December 31, 2001.
We also have developmental and/or intellectual property rights related
to two drugs that might be used in connection with gamma detection
devices in cancer surgeries. The first, RIGScan(R) CR49, is intended to
be used to help surgeons locate cancerous tissue during colorectal
cancer surgeries. The second, Lymphoseek(TM), is intended to be used in
tracing the spread of certain solid tumor cancers. Both of these drug
products are still in development and must be approved by the
appropriate regulatory bodies before they can be sold in any markets.
b. PRINCIPLES OF CONSOLIDATION: Our consolidated financial statements
include the accounts of our company and our wholly-owned subsidiary.
All significant inter-company accounts were eliminated in
consolidation.
c. FAIR VALUE OF FINANCIAL INSTRUMENTS: The following methods and
assumptions were used to estimate the fair value of each class of
financial instruments:
(1) Cash and cash equivalents, accounts receivable, accounts payable,
and accrued liabilities: The carrying amounts approximate fair
value because of the short maturity of these instruments.
(2) Notes payable to finance companies: The fair value of our debt is
estimated by discounting the future cash flows at rates currently
offered to us for similar debt instruments of comparable maturities
by banks or finance companies. At December 31, 2003 and 2002, the
carrying values of these instruments approximate fair value.
(3) Note payable to CEO: The fair value of our debt is presented as the
face amount of the note less the unamortized discount related to
the warrants to purchase common stock issued in connection with the
note. At December 31, 2003, the carrying value of the note
approximates fair value.
(4) Note payable to outside investor: The fair value of our debt is
presented as the face amount of the note less the unamortized
discounts related to the conversion feature and the warrants to
purchase common stock in connection with the note. At December 31,
2003, the carrying value of the note approximates fair value.
d. CASH AND CASH EQUIVALENTS: There were no cash equivalents at December
31, 2003 or 2002. None of the cash presented in the December 31, 2003
and 2002 balance sheets is pledged or restricted in any way.
e. INVENTORY: All components of inventory are valued at the lower of cost
(first-in, first-out) or market. We adjust inventory to market value
when the net realizable value is lower than the carrying cost of the
inventory. Market value is determined based on recent sales activity
and margins achieved.
F-8
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
The components of net inventory at December 31, 2003 and 2002 are as
follows:
2003 2002
---------- ----------
Materials and component parts $ 747,788 $ 760,540
Work in process -- 59,888
Finished goods 260,538 371,490
---------- ----------
$1,008,326 $1,191,918
========== ==========
During 2003, we wrote off $70,000 of excess and obsolete
Quantix(R)-related materials, primarily due to potential design
changes. During 2002, we wrote off $214,000 of BlueTip(R) probe-related
inventory that we did not believe had ongoing value to the business.
f. PROPERTY AND EQUIPMENT: Property and equipment are stated at cost.
Property and equipment under capital leases are stated at the present
value of minimum lease payments. Depreciation is computed using the
straight-line method over the estimated useful lives of the depreciable
assets ranging from 2 to 7 years, and includes amortization related to
equipment under capital leases. Maintenance and repairs are charged to
expense as incurred, while renewals and improvements are capitalized.
Property and equipment includes $80,000 and $51,000 of equipment under
capital leases with accumulated amortization of $48,000 and $30,000 at
December 31, 2003 and 2002, respectively. During 2003 and 2002, we
recorded losses of $20,000 and $2,000, respectively, on the disposal of
property and equipment. During 2002, we recorded general and
administrative expenses of $71,000 related to the impairment of BlueTip
probe production equipment that we did not believe had ongoing value to
the business.
The major classes of property and equipment are as follows:
2003 2002
---------- ----------
Production machinery and equipment $1,050,806 $ 981,355
Other machinery and equipment, primarily
computers and research equipment 599,193 761,698
Furniture and fixtures 358,760 358,155
Leasehold improvements 117,547 121,808
Software 111,435 123,429
---------- ----------
$2,237,741 $2,346,445
========== ==========
g. INTANGIBLE ASSETS: Intangible assets consist primarily of patents and
other acquired intangible assets. Intangible assets are stated at cost,
less accumulated amortization. Patent costs are amortized using the
straight-line method over the estimated useful lives of the patents of
5 to 15 years. Patent application costs are deferred pending the
outcome of patent applications. Costs associated with unsuccessful
patent applications and abandoned intellectual property are expensed
when determined to have no recoverable value. Non-compete agreements
and acquired technology are amortized using the straight-line method
over their estimated useful lives of four years and seven years,
respectively. We evaluate the potential alternative uses of all
intangible assets, as well as the recoverability of the carrying values
of intangible assets on a recurring basis. (See also Note 10(b)
regarding purchase price adjustments made in 2002 affecting intangible
assets acquired as a part of our acquisition of Cardiosonix.)
F-9
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
The major classes of intangible assets are as follows:
DECEMBER 31, 2003 DECEMBER 31, 2002
-------------------------------------- -----------------------------------
GROSS CARRYING ACCUMULATED GROSS CARRYING ACCUMULATED
AMOUNT AMORTIZATION AMOUNT AMORTIZATION
----------------- ---------------- ---------------- -------------
Patents and trademarks $3,156,101 $ 678,160 $ 3,129,031 $ 398,501
Non-compete agreements 584,516 295,486 584,516 150,970
Acquired technology 237,271 68,727 237,271 35,019
---------- ---------- ----------- ----------
Total $3,977,888 $ 1,042,373 $ 3,950,818 $ 584,490
========== =========== =========== ==========
During 2003 and 2002, we recorded general and administrative expenses
of $458,000 and $462,000, respectively, of intangible asset
amortization expense. Of those amounts, $30,000 and $68,000,
respectively, related to the abandonment of gamma detection patents and
patent applications that were deemed no longer recoverable or part of
our ongoing business.
The estimated future amortization expenses for the next five fiscal
years are as follows:
ESTIMATED
AMORTIZATION EXPENSE
---------------------
For the year ended 12/31/2004 $ 427,285
For the year ended 12/31/2005 427,285
For the year ended 12/31/2006 282,770
For the year ended 12/31/2007 214,545
For the year ended 12/31/2008 204,002
h. REVENUE RECOGNITION
(1) PRODUCT SALES: We derive revenues primarily from sales of our
medical devices. We generally recognize sales revenue when the
products are shipped and the earnings process has been completed.
Our customers have no right to return products purchased in the
ordinary course of business.
Sales prices on gamma detection products sold to EES are subject to
retroactive annual adjustment based on a fixed percentage of the
actual sales prices achieved by EES on sales to end customers made
during each fiscal year, subject to a minimum (i.e., floor) price.
To the extent that we can reasonably estimate the end customer
prices received by EES, we record sales to EES based upon these
estimates. To the extent that we are not able to reasonably
estimate end customer sales prices related to certain products sold
to EES, we record revenue related to these product sales at the
floor price provided for under our distribution agreement with EES.
We recognize revenue related to the sales of products to be used
for demonstration units when products are shipped and the earnings
process has been completed. Our distribution agreements do not
permit return of demonstration units in the ordinary course of
business nor do we have any performance obligations other than
normal product warranty obligations. To the extent that the
earnings process has not been completed, revenue is deferred. To
the extent we enter into multiple-element arrangements, we
allocate revenue based on the relative fair value of the elements.
(2) EXTENDED WARRANTY REVENUE: We derive revenues from the sale of
extended warranties covering our medical devices over periods of
one to four years. We recognize revenue from extended warranty
sales on a pro-rata basis over the period covered by the extended
warranty. Expenses related to the extended warranty are recorded
when incurred.
F-10
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(3) SERVICE REVENUE: We derive revenues from the repair and service of
our medical devices that are in use beyond the term of the original
twelve-month warranty and that are not covered by an extended
warranty. We recognize revenue from repair and service activities
once the activities are complete and the repaired or serviced
device has been returned to the customer.
(4) LICENSE REVENUE: We recognize license revenue in connection with
our distribution agreement with EES on a straight-line basis over
the five-year initial term of the agreement based on our
obligations to provide ongoing support for the intellectual
property being licensed such as patent maintenance and regulatory
filings. As the license relates to intellectual property held or
in-licensed by us, we incur no significant cost associated with the
recognition of this revenue.
i. RESEARCH AND DEVELOPMENT COSTS: All costs related to research and
development are expensed as incurred.
j. INCOME TAXES: Income taxes are accounted for under the asset and
liability method. Deferred tax assets and liabilities are recognized
for the future tax consequences attributable to differences between the
financial statement carrying amounts of existing assets and
liabilities, and their respective tax bases and operating loss and tax
credit carryforwards. Deferred tax assets and liabilities are measured
using enacted tax rates expected to apply to taxable income in the
years in which those temporary differences are expected to be recovered
or settled. The effect on deferred tax assets and liabilities of a
change in tax rates is recognized in income in the period that includes
the enactment date.
k. STOCK OPTION PLANS: At December 31, 2003, we have three stock-based
employee compensation plans (See Note 8(a).). We apply the intrinsic
value-based method of accounting prescribed by Accounting Principles
Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees,
and related Interpretations, in accounting for our stock options. As
such, compensation expense is recorded on the date of grant and
amortized over the period of service only if the current market price
of the underlying stock exceeds the exercise price. No stock-based
employee compensation cost related to options is reflected in net
income (loss), as all options granted under those related to options
plans had an exercise price equal to the market value of the underlying
common stock on the date of grant. However, we did incur $39,990 of
compensation expense related to the vesting of restricted stock.
The following table illustrates the effect on net income (loss) and
earnings (loss) per share if compensation cost for our stock-based
compensation plans had been determined based on the fair value at the
grant dates for awards under those plans consistent with Statement of
Financial Accounting Standards (SFAS) No. 123, Accounting for
Stock-Based Compensation:
YEARS ENDED DECEMBER 31,
--------------------------
2003 2002
----------- -----------
Net loss, as reported $(1,798,995) $(2,963,725)
Add: Total stock-based employee
compensation expense included
in reported net loss 39,990 -
Deduct: Total stock-based employee
compensation expense determined
under fair value based method
for all awards (241,437) (279,161)
----------- -----------
Pro forma net loss $(2,000,442) $(3,242,886)
=========== ===========
Loss per common share:
As reported (basic and diluted) $ (0.04) $ (0.08)
Pro forma (basic and diluted) $ (0.05) $ (0.09)
l. EQUITY ISSUED TO NON-EMPLOYEES: We account for equity instruments
granted to non-employees in accordance with the provisions of SFAS No.
123 and Emerging Issues Task Force Issue No. 96-18, Accounting for
Equity Instruments that are Issued to Other Than Employees for
Acquiring, or in Conjunction with Selling, Goods or Services. All
transactions in which goods or services are the consideration received
for the issuance of equity instruments are accounted for based on the
fair value
F-11
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
of the consideration received or the equity instrument issued,
whichever is more reliably measurable. The measurement date of the fair
value of the equity instrument issued is the earlier of the date on
which the counterpart's performance is complete or the date on which it
is probable that performance will occur.
m. USE OF ESTIMATES: The preparation of financial statements in conformity
with accounting principles generally accepted in the United States of
America requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
n. COMPREHENSIVE INCOME (LOSS): We had no accumulated other comprehensive
income (loss) activity during the years ended December 31, 2003 and
2002.
o. IMPAIRMENT OR DISPOSAL OF LONG-LIVED ASSETS: We account for long-lived
assets in accordance with the provisions of SFAS No. 144, Accounting
for the Impairment or Disposal of Long-Lived Assets. This Statement
requires that long-lived assets and certain identifiable intangibles be
reviewed for impairment whenever events or changes in circumstances
indicate that the carrying amount of an asset may not be recoverable.
Recoverability of assets to be held and used is measured by a
comparison of the carrying amount of an asset to future net
undiscounted cash flows expected to be generated by the asset. If such
assets are considered to be impaired, the impairment recognized is
measured by the amount by which the carrying amount of the assets
exceeds the fair value of the assets. Assets to be disposed of are
reported at the lower of the carrying amount or fair value less costs
to sell.
2. EARNINGS PER SHARE:
Basic earnings (loss) per share are calculated using the weighted average
number of common shares outstanding during the periods. Diluted earnings
(loss) per share is calculated using the weighted average number of common
shares outstanding during the periods, adjusted for the effects of
convertible securities, options and warrants, if dilutive.
YEAR ENDED YEAR ENDED
DECEMBER 31, 2003 DECEMBER 31, 2002
---------------------------------- -----------------------------------
BASIC DILUTED BASIC DILUTED
EARNINGS EARNINGS EARNINGS EARNINGS
PER SHARE PER SHARE PER SHARE PER SHARE
--------------- --------------- --------------- --------------
Outstanding shares 51,520,723 51,520,723 36,502,183 36,502,183
Effect of weighting changes
in outstanding shares (11,053,044) (11,053,044) (16,987) (16,987)
Contingently issuable shares (130,000) (130,000) (440,000) (440,000)
---------- ---------- ---------- ----------
Adjusted shares 40,337,679 40,337,679 36,045,196 36,045,196
========== ========== ========== ==========
There is no difference in basic and diluted loss per share related to 2003
or 2002. Basic and diluted loss per share for the year ended December 31,
2002 include 2,085,826 common shares that became issuable to Cardiosonix
upon satisfaction of a certain developmental milestone event on December
30, 2002 (See Note 10(b).). The net loss per common share for 2003 and 2002
excludes the number of common shares issuable upon exercise of outstanding
stock options and warrants into our common stock since such inclusion would
be anti-dilutive.
F-12
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
3. ACCOUNTS RECEIVABLE AND CONCENTRATIONS OF CREDIT RISK:
Accounts receivable at December 31, 2003 and 2002, net of allowance for
doubtful accounts of $46,000 and $29,095, respectively, consist of the
following:
2003 2002
---------- ----------
Trade $1,063,614 $ 623,213
Other 44,186 122,894
---------- ----------
$1,107,800 $ 746,107
========== ==========
At December 31, 2003 and 2002, approximately 85% and 86%, respectively, of
net accounts receivable are due from EES. We do not believe we are exposed
to significant credit risk related to EES based on the overall financial
strength and credit worthiness of the customer and its parent company. We
believe that we have adequately addressed other credit risks in estimating
the allowance for doubtful accounts.
We estimate an allowance for doubtful accounts based on a review and
assessment of specific accounts receivable and write off accounts when
deemed uncollectible. The activity in the allowance for doubtful accounts
for the years ended December 31, 2003 and 2002 is as follows:
2003 2002
-------- --------
Allowance for doubtful accounts at beginning of year $ 29,095 $ 39,670
Provision for bad debts 49,582 28,751
Write-offs charged against the allowance (32,677) (39,326)
-------- --------
Allowance for doubtful accounts at end of year $ 46,000 $ 29,095
======== ========
4. ACCRUED LIABILITIES AND ACCOUNTS PAYABLE:
Accrued liabilities at December 31, 2003 and 2002 consist of the following:
2003 2002
-------- --------
Contracted services and other $107,843 $164,634
Compensation 66,463 177,991
Warranty reserve 53,000 35,000
Inventory purchases -- 19,536
-------- --------
$227,306 $397,161
======== ========
Accounts payable at December 31, 2003 and 2002 consist of the following:
2003 2002
-------- --------
Trade $146,117 $391,858
Other 78,915 40,282
-------- --------
$225,032 $432,140
======== ========
5. PRODUCT WARRANTY:
We warrant our products against defects in design, materials, and
workmanship generally for a period of one year from the date of sale to the
end customer. Our accrual for warranty expenses is adjusted periodically to
reflect actual experience. EES also reimburses us for a portion of warranty
expense incurred based on end customer sales they make during a given
fiscal year. Payments charged against the reserve are disclosed net of EES'
reimbursement.
F-13
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
The activity in the warranty reserve account for the years ended December
31, 2003 and 2002 is as follows:
2003 2002
-------- --------
Warranty reserve, at beginning of year $ 35,000 $ 90,000
Provision for warranty claims and
changes in reserve for warranties 18,464 31,043
Payments charged against the reserve (464) (86,043)
-------- --------
Warranty reserve, at end of year $ 53,000 $ 35,000
======== ========
6. NOTES PAYABLE:
During April 2003, we completed a bridge loan agreement with our President
and CEO, David Bupp. Under the terms of the agreement, Mr. Bupp advanced us
$250,000. In consideration for the loan, we issued a note in the principal
amount of $250,000. The note was secured by general assets of the company,
excluding accounts receivable. Interest accrues on the note at 8.5% per
annum, payable monthly, and the note was originally due on June 30, 2004.
In addition, we issued Mr. Bupp 375,000 warrants to purchase common stock
at an exercise price of $0.13 per share. See Note 16(b).
During April 2003, we also completed a bridge loan agreement with an
outside investor for an additional $250,000. In consideration for the loan,
we issued a note in the principal amount of $250,000. The note was secured
by general assets of the company, excluding accounts receivable. The note
bore interest at 9.5% per annum, payable monthly, was convertible into
common stock and was due on June 30, 2004. Fifty percent of the principal
and accrued interest of the note was convertible into common stock at a 15%
discount to the closing market price on the date of conversion, subject to
a floor conversion price of $0.10. The remaining 50% of the principal and
accrued interest was convertible into common stock based on a 15% discount
to the closing market price on the date of conversion, subject to a floor
conversion price of $0.10 and a ceiling conversion price of $0.20. In
addition, we issued the investor 500,000 warrants to purchase common stock
at an exercise price of $0.13 per share. See Note 16(b).
The per share value of the warrants issued to Mr. Bupp and the outside
investor was $0.10 on the date of issuance using the Black-Scholes option
pricing model with the following assumptions: an average risk-free interest
rate of 2.9%, volatility of 139% and no expected dividend rate. The total
estimated fair values for the warrants issued to Mr. Bupp and the outside
investor were $31,755 and $40,620, respectively. These amounts were
recorded as a discount on the notes and are being amortized over the period
of the notes. At December 31, 2003, the unamortized discounts related to
Mr. Bupp's note and the note to the outside investor totaled $12,702 and
$16,248, respectively. The intrinsic value of the conversion feature of the
note to the outside investor was estimated at $40,620 based on the
effective conversion price at the date of issuance and was recorded as an
additional discount on the note. The additional discount related to the
conversion feature is being amortized over the period of the note. At
December 31, 2003 the additional unamortized discount related to the
conversion feature totaled $16,248.
7. INCOME TAXES:
As of December 31, 2003, our net deferred tax assets in the U.S. were
approximately $35.7 million. Approximately $30.8 million of the deferred
tax assets relate principally to net operating loss carryforwards of
approximately $90.6 million available to offset future taxable income, if
any, through 2023. An additional $4.3 million relates to tax credit
carryforwards (principally research and development) available to reduce
future income tax liability after utilization of tax loss carryforwards, if
any, through 2023. The remaining $596,000 relates to temporary differences
between the carrying amount of assets and liabilities and their tax bases.
Due to the uncertainty surrounding the realization of these favorable tax
attributes in future tax returns, all of the net deferred tax assets have
been fully offset by a valuation allowance at December 31, 2003.
As of December 31, 2003, Cardiosonix had net deferred tax assets in Israel
of approximately $1.8 million, primarily related to net operating loss
carryforwards of approximately $3.7 million available to offset future
taxable income, if any. Under current Israeli tax law, net operating loss
carryforwards do not expire. Due to the uncertainty surrounding the
realization of these favorable tax attributes in future tax returns, all of
the net deferred tax assets have been fully offset by a valuation allowance
at December 31, 2003. Since a valuation allowance was recognized for the
deferred tax asset for Cardiosonix' deductible temporary differences and
operating loss carryforwards at the acquisition date, the tax benefits for
those items that are first recognized (that is, by elimination of the
valuation allowance) in financial statements after the acquisition date
shall be applied (a) first to reduce to zero other noncurrent intangible
assets related to the acquisition and (b) second to reduce income tax
expense.
Under Sections 382 and 383 of the Internal Revenue Code (IRC) of 1986, as
amended, the utilization of U.S. net operating loss and tax credit
carryforwards may be limited under the change in stock ownership rules of
the IRC. As a result of ownership changes as defined by Sections 382 and
383, which have occurred at various points in our history, we believe
utilization of our net operating loss carryfowards and tax credit
carryforwards may be limited under certain circumstances.
F-14
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
8. EQUITY:
a. STOCK OPTIONS: At December 31, 2003, we have three stock-based
compensation plans. Under the Amended and Restated Stock Option and
Restricted Stock Purchase Plan (the Amended Plan), the 1996 Stock
Incentive Plan (the 1996 Plan), and the 2002 Stock Incentive Plan (the
2002 Plan), we may grant incentive stock options, nonqualified stock
options, and restricted stock awards to full-time employees, and
nonqualified stock options and restricted awards may be granted to our
consultants and agents. Total shares authorized under each plan are 2
million shares, 1.5 million shares and 3 million shares, respectively.
Under all three plans, the exercise price of each option is greater
than or equal to the closing market price of our common stock on the
day prior to the date of the grant.
Options granted under the Amended Plan, the 1996 Plan and the 2002 Plan
generally vest on an annual basis over three years. Outstanding options
under the plans, if not exercised, generally expire ten years from
their date of grant or 90 days from the date of an optionee's
separation from employment with us.
The fair value of each option grant was estimated on the date of the
grant using the Black-Scholes option-pricing model with the following
assumptions for 2003 and 2002, respectively: average risk-free interest
rates of 2.6% and 4.0%; expected average lives of three to four years
for each of the years presented; no dividend rate for any year; and
volatility of 146% for 2003 and 145% for 2002. The weighted average
fair value of options granted in 2003 and 2002 was $0.16 and $0.36,
respectively.
A summary of the status of stock options under our stock option plans
as of December 31, 2003 and 2002, and changes during the years ended on
those dates is presented below:
2003 2002
----------------------------- ------------------------------
WEIGHTED WEIGHTED
AVERAGE AVERAGE
EXERCISE EXERCISE
OPTIONS PRICE OPTIONS PRICE
--------- ------ --------- ------
Outstanding at
beginning of year 2,317,725 $ 0.70 1,862,123 $ 0.81
Granted 1,030,000 $ 0.18 905,000 $ 0.42
Forfeited (416,417) $ 0.41 (449,398) $ 0.57
Exercised - - - -
--------- ---------
Outstanding at
end of year 2,931,308 $ 0.56 2,317,725 $ 0.70
========= =========
Included in outstanding options as of December 31, 2003, are 100,000
options exercisable at an exercise price of $2.50 per share that vest
on the meeting of certain company achievements.
The following table summarizes information about our stock options
outstanding at December 31, 2003:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------------------------------ --------------------------------
NUMBER WEIGHTED NUMBER
OUTSTANDING AS AVERAGE WEIGHTED EXERCISABLE AS WEIGHTED
OF REMAINING AVERAGE OF AVERAGE
RANGE OF EXERCISE DECEMBER 31, CONTRACTUAL EXERCISE DECEMBER 31, EXERCISE
PRICES 2003 LIFE PRICE 2003 PRICE
------------------- ----------------- -------------- ------------ ----------------- -----------
$ 0.13 - $ 0.40 906,667 9 years $ 0.19 40,001 $ 0.30
$ 0.41 - $ 0.50 1,526,668 7 years $ 0.44 980,008 $ 0.45
$ 0.60 - $ 1.50 325,773 6 years $ 1.04 314,107 $ 1.05
$ 2.50 - $ 5.63 172,200 1 year $ 2.67 72,200 $ 2.92
--------- ---------
2,931,308 7 years $ 0.56 1,406,316 $ 0.71
========= =========
F-15
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
b. RESTRICTED STOCK: During the first quarter of 2003, we vested 310,000
shares of previously restricted stock related to new or amended
employment agreements of three of our officers. We recognized $39,990
of compensation expense related to this transaction in the first
quarter of 2003. At December 31, 2003, we have 130,000 restricted
shares outstanding, all of which are pending cancellation due to
failure to vest under the terms of issuance of these shares. Restricted
shares, if any, generally vest on a change of control of our company as
defined in the specific grant agreements. As a result, we have not
recorded any deferred compensation related to past grants of restricted
stock due to the inability to assess the probability of the vesting
event.
c. STOCK WARRANTS: At December 31, 2003, there are 8.5 million warrants
outstanding to purchase our common stock. The warrants are exercisable
at prices ranging from $0.13 to $5.00 per share with a weighted average
exercise price per share of $0.30. See Note 16 (b), (e) and (f).
The following table summarizes information about our outstanding
warrants at December 31, 2003:
EXERCISE NUMBER OF
PRICE WARRANTS EXPIRATION DATE
-------- --------- ---------------
Series M $ 5.00 50,000 February 2004
Series O $ 0.75 25,000 October 2005
Series O $ 0.75 25,000 October 2006
Series P $ 0.30 50,000 June 2005
Series Q $ 0.13 875,000 April 2008
Series R $ 0.28 6,086,959 October 2008
Series S $ 0.28 1,432,609 October 2008
-----------
$ 0.30 8,544,568
===========
d. COMMON STOCK RESERVED: Shares of authorized common stock have been
reserved for the exercise of all options and warrants outstanding.
e. COMMON STOCK PURCHASE AGREEMENT: On November 19, 2001, we entered into
a common stock purchase agreement with an investment fund, Fusion
Capital Fund II, LLC (Fusion) for the issuance and purchase of our
common stock. Under the stock purchase agreement, Fusion committed to
purchase up to $10 million of our common stock over a forty-month
period that commenced in May 2002. A registration statement registering
for resale up to 5 million shares of our common stock became effective
on April 15, 2002. Under the terms of the agreement, we can request
daily drawdowns, subject to a daily base amount currently set at
$12,500. The number of shares we are to issue to Fusion in return for
that money will be based on the lower of (a) the closing sale price for
our common stock on the day of the draw request or (b) the average of
the three lowest closing sales prices for our common stock during a
twelve day period prior to the draw request. However, no shares may be
sold to Fusion at lower than a floor price currently set at $0.30,
which may be reduced by us, but in no case below $0.20 without Fusion's
prior consent. Upon execution of the common stock purchase agreement in
2001, we issued 449,438 shares of our common stock to Fusion as a
partial payment of the commitment fee. During 2003, we sold Fusion a
total of 473,869 shares of common stock and realized net proceeds of
$143,693. We issued Fusion 6,462 shares of common stock during 2003 for
commitment fees due to Fusion related to the sales of our common stock
to them. See Note 16(e).
f. PRIVATE PLACEMENT: During the second and third quarters of 2003, we
engaged the services of two investment banking firms to assist us in
raising capital, Alberdale Capital, LLC (Alberdale) and Trautman
Wasserman & Company, Inc. (Trautman Wasserman). In exchange for
Alberdale's services, we agreed to pay them a monthly retainer of
$10,000, half payable in cash and half payable in common stock, and we
agreed to pay them additional compensation upon the successful
completion of a private placement of our securities. We terminated the
agreement with Alberdale in September 2003, but agreed to issue them a
total of 150,943 shares of common stock in payment for one half of
their retainer. The fair market value of $26,000 related to the shares
issued to Alberdale was recorded as general and administrative expense
in 2003. In addition, Series S warrants to purchase 78,261 shares of
common stock were issued in exchange for their assistance in arranging
an accounts receivable financing transaction. The warrants have an
exercise price of $0.28 per share. The per share value of these
warrants was $0.33 on the date of issuance using the Black-Scholes
option pricing model with the following assumptions: an average
risk-free interest rate of 3.1%, volatility of 150% and no expected
dividend rate. We recorded the estimated fair market value of the
warrants issued as additional interest expense. In exchange for the
services of Trautman Wasserman, we agreed to pay a retainer of $10,000,
payable in cash and common stock, and to pay further compensation on
successful completion of a private placement. We agreed to issue
Trautman Wasserman a total of 27,199 shares of common stock in payment
for one half of their retainer. The fair market value of $5,000 related
to the shares issued to Trautman Wasserman was recorded as general and
administrative expense in 2003. The services of Trautman Wasserman were
terminated in September 2003.
In November 2003, we completed a $2.8 million placement of common stock
and warrants for net proceeds of $2.4 million. In the placement,
12,173,914 shares of common stock were issued at $0.23 per share, and
Series R warrants were issued to purchase an additional 6,086,959
shares of common stock at $0.28 per share. In addition, we paid
$291,000 in cash and issued 1,354,348 Series S warrants to purchase
common stock at $0.28 per share as fees to the placement agents. All
warrants issued in connection with the placement expire in October
2008. The per share value of these warrants was $0.31 on the date of
issuance using the Black-Scholes option pricing model with the
following assumptions: an average risk-free interest rate of 3.2%,
volatility of 151% and no expected dividend rate. A registration
statement registering for resale the common stock and warrants issued
in the private placement was declared effective on December 17, 2003.
See Note 16(e).
9. SHAREHOLDER RIGHTS PLAN:
During July 1995, our board of directors adopted a shareholder rights plan.
Under the plan, one "Right" is to be distributed for each share of common
stock held by shareholders on the close of business on August 28, 1995. The
Rights are exercisable only if a person and its affiliate commences a
tender offer or exchange offer for 15% or more of our common stock, or if
there is a public announcement that a person and its affiliate has acquired
beneficial ownership of 15% or more of the common stock, and if we do not
redeem the Rights during the specified redemption period. Initially, each
Right, upon becoming exercisable, would entitle the holder to purchase from
us one unit consisting of 1/100th of a share of Series A Junior
Participating preferred stock at an exercise price of $35 (which is subject
to adjustment). Once the Rights become exercisable, if any person,
including its affiliate, acquires 15% or more of our common stock, each
Right other than the Rights held by the acquiring person and its affiliate
becomes a right to
F-16
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
acquire common stock having a value equal to two times the exercise price
of the Right. We are entitled to redeem the Rights for $0.01 per Right at
any time prior to the expiration of the redemption period. The shareholder
rights plan and the Rights will expire on August 28, 2005. The board of
directors may amend the shareholder rights plan, from time to time, as
considered necessary.
10. SEGMENTS AND SUBSIDIARY INFORMATION:
a. SEGMENTS: We own or have rights to intellectual property involving two
primary types of medical device products, including gamma detection
instruments currently used primarily in the application of ILM, and
blood flow measurement devices.
The information in the following table is derived directly from each
segments' internal financial reporting used for corporate management
purposes. Selling, general and administrative costs and other income,
including amortization, interest and other costs that relate primarily
to corporate activity, are not currently allocated to the operating
segments for financial reporting purposes.
GAMMA BLOOD
($ AMOUNTS IN THOUSANDS) DETECTION FLOW UNALLOCATED TOTAL
---------------------------------------------------------------------------------------------------------
2003
Net sales:
United States(1) $ 5,284 $ - $ - $ 5,284
International 35 245 - 280
License and other revenue 946 - - 946
Research and development expenses (668) (1,226) - (1,894)
Selling, general and administrative
expenses - - (3,103) (3,103)
Income (loss) from operations(2) 2,657 (1,165) (3,103) (1,611)
Other expenses - - (188) (188)
Total assets, net of depreciation and
amortization:
United States 1,728 146 1,965 3,839
Cardiosonix Ltd. - 3,546 - 3,546
Capital expenditures 13 50 12 75
2002
Net sales
United States(1) $ 3,234 $ - $ - $ 3,234
International 90 59 - 149
License and other revenue 1,538 - - 1,538
Research and development expenses (974) (1,350) - (2,324)
Selling, general and administrative
Expenses - - (3,267) (3,267)
Acquired in-process research and
development - 28 - 28
Income (loss) from operations(2) 1,554 (1,280) (3,267) (2,993)
Other income - - 29 29
Total assets, net of depreciation and
amortization:
United States 2,010 6 1,221 3,237
Cardiosonix Ltd. - 3,843 - 3,843
Capital expenditures 61 119 83 263
(1) All sales to EES are made in the United States. EES distributes the product
globally through its international affiliates.
(2) Income (loss) from operations does not reflect the allocation of selling,
general and administrative costs to the operating segments.
b. SUBSIDIARY: On December 31, 2001, we acquired 100 percent of the
outstanding common shares of Cardiosonix, an Israeli company, for $4.5
million. We accounted for the acquisition under SFAS No. 141, Business
Combinations, and certain provisions of SFAS No. 142, Goodwill and
Other Intangible Assets. The results of Cardiosonix' operations have
been included in our consolidated results from the date of acquisition.
Cardiosonix is involved in the development and commercialization of
blood
F-17
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
flow measurement technology. Cardiosonix currently has two products in
the early stages of commercialization and another product in
development.
The aggregate purchase price included common stock valued at
$4,271,095; payment of vested options of Cardiosonix employees in the
amount of $17,966; and acquisition costs of $167,348. The value of the
9,714,737 common shares issued on December 31, 2001 was determined
based on the average market price of our common shares over the
five-day period before and after the terms of the acquisition were
agreed to and announced. A contingent payment of 2,085,826 common
shares was also due upon the satisfaction of a certain developmental
milestone event.
In accordance with SFAS No. 141, we recorded the contingent amount
as if it were a liability in the amount of $453,602 at the date of
acquisition. As a result of the decline in the trading price of our
common stock during 2002, the contingent payment was re-valued at
$288,053 upon satisfaction of the milestone event on December 30, 2002.
The value of the contingent consideration was determined based on the
market price of our common shares. The re-valuation of the contingent
shares and additional acquisition costs of $24,000 required us to
adjust the final purchase price, resulting in the pro-rata adjustment
of certain assets acquired in the acquisition as well as the charge
recorded related to in-process research and development (IPR&D). As a
result of the adjustment, the balances recorded at December 31, 2001
for patents and trademarks, non-compete agreements, acquired
technology, IPR&D and property and equipment were decreased by $84,000,
$19,000, $8,000, $28,000 and $2,000, respectively, as of December 31,
2002.
As a part of the acquisition, we also entered into a royalty agreement
with the three founders of Cardiosonix. Under the terms of the royalty
agreement, which expires December 31, 2006, we are obligated to pay the
founders an aggregate one percent royalty on up to $120 million in net
revenue generated by the sale of Cardiosonix blood flow products
through 2006.
11. AGREEMENTS:
a. SUPPLY AGREEMENTS: In December 1997, we entered into an exclusive
supply agreement with eV Products (eV), a division of II-VI
Incorporated, for the supply of certain crystals and associated
electronics to be used in the manufacture of our proprietary line of
hand-held gamma detection instruments. The original term of the
agreement expired on December 31, 2002 and was automatically extended
during 2002 through December 31, 2005; however, the agreement is no
longer exclusive for the final three years. During 2001, we built up
our stock of crystal modules in order to take advantage of significant
quantity price breaks. Our stock of crystal modules was consumed during
2003; therefore we resumed purchasing crystal modules in the fourth
quarter of 2003. As a result, total purchases under the supply
agreement were $138,000 and $82,000 for the years ended December 31,
2003 and 2002, respectively. We have issued a purchase order for
$298,000 of crystal modules for delivery of product through September
2004.
In October 2001, we entered into a manufacturing and supply agreement
with UMM Electronics, Inc. (UMM), a Leach Technology Group company, for
the exclusive manufacture of the neo2000(R) control unit and 14mm
probe. During 2003, we terminated our agreement with UMM for the
manufacture of the neo2000 control unit and 14mm probe. As a part of
the termination, we were required to purchase $97,000 in residual
materials that were not used by UMM, a portion of which will be used in
production at a new contract manufacturer. Total purchases under the
manufacturing and supply agreement were $1.5 million and $1.2 million
for the years ended December 31, 2003 and 2002, respectively.
b. MARKETING AND DISTRIBUTION AGREEMENTS: During 1999, we entered into a
distribution agreement with EES covering our gamma detection devices
used in ILM. The initial five-year term expires December 31, 2004, with
options to extend for two successive two-year terms (See Note 16(d).).
Under the agreement, we manufacture and sell our current line of ILM
products exclusively to EES, who distributes the products globally. EES
agreed to purchase minimum quantities of our products over the first
three years of the term of the agreement and to reimburse us for
certain research and development costs and a portion of our warranty
costs. EES satisfied both its minimum purchase and reimbursement
F-18
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
requirements during 2002. We are obligated to continue certain product
maintenance activities and to provide ongoing regulatory support for
the products.
EES may terminate the agreement if we fail to supply products for
specified periods, commit a material breach of the agreement, suffer a
change of control to a competitor of EES, or become insolvent. If
termination were due to failure to supply or a material breach by us,
EES would have the right to use our intellectual property and
regulatory information to manufacture and sell the products exclusively
on a global basis for the remaining term of the agreement with no
additional financial obligation to us. If termination is due to
insolvency or a change of control that does not affect supply of the
products, EES has the right to continue to sell the products on an
exclusive global basis for a period of six months or require us to
repurchase any unsold products in its inventory.
Under the agreement, EES received a non-exclusive worldwide license to
our ILM intellectual property to make and sell other products that may
be developed using our ILM intellectual property. The term of the
license is the same as that of the agreement. EES paid us a
non-refundable license fee of $4 million. We are recognizing the
license fee as revenue on a straight-line basis over the five-year
initial term of the agreement. If we terminate the agreement as a
result of a material breach by EES, they would be required to pay us a
royalty on all products developed and sold by EES using our ILM
intellectual property. In addition, we are entitled to a royalty on any
ILM product commercialized by EES that does not infringe any of our
existing intellectual property.
c. RESEARCH AND DEVELOPMENT AGREEMENTS: Cardiosonix' research and
development efforts have been partially financed through grants from
the Office of the Chief Scientist of the Israeli Ministry of Industry
and Trade (the OCS). In return for the OCS's participation, Cardiosonix
is committed to pay royalties to the Israeli Government at a rate of 3%
to 5% of the sales if its products, up to 100% of the amount of the
grants received (for grants received under programs approved subsequent
to January 1, 1999 - 100% plus interest at LIBOR). Cardiosonix is
entitled to the grants only upon incurring research and development
expenditures. Cardiosonix is not obligated to repay any amount received
from the OCS if the research effort is unsuccessful or if no products
are sold. There are no future performance obligations related to the
grants received from the OCS. However, under certain limited
circumstances, the OCS may withdraw its approval of a research program
or amend the terms of its approval. Upon withdrawal of approval, the
grant recipient may be required to refund the grant, in whole or in
part, with or without interest, as the OCS determines. Cardiosonix'
total potential obligation for royalties, based on royalty-bearing
government participation, was approximately $775,000 as of December 31,
2003.
During January 2002, we completed a license agreement with the
University of California, San Diego (UCSD) for a proprietary compound
that we believe could be used as a lymph node locating agent in ILM
procedures. The license agreement is effective until the later of the
expiration date of the longest-lived underlying patent or January 30,
2023. Under the terms of the license agreement, UCSD has granted us the
exclusive rights to make, use, sell, offer for sale and import licensed
products as defined in the agreement and to practice the defined
licensed methods during the term of the agreement. We may also
sublicense the patent rights, subject to the approval of certain
sublicense terms by UCSD. In consideration for the license rights, we
agreed to pay UCSD a license issue fee of $25,000 and license
maintenance fees of $25,000 per year. We also agreed to pay UCSD
milestone payments related to successful regulatory clearance for
marketing of the licensed products, a royalty on net sales of licensed
products subject to a $25,000 minimum annual royalty, fifty percent of
all sublicense fees and fifty percent of sublicense royalties. We also
agreed to reimburse UCSD for all patent-related costs. Total costs
related to the UCSD license agreement were $29,000 and $54,000 in 2003
and 2002, respectively, and were recorded in research and development
expenses.
UCSD has the right to terminate the agreement or change the nature of
the agreement to a non-exclusive agreement if it is determined that we
have not been diligent in developing and commercializing the covered
products, marketing the products within six months of receiving
F-19
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
regulatory approval, reasonably filling market demand or obtaining all
the necessary government approvals.
d. EMPLOYMENT AGREEMENTS: We maintain employment agreements with five of
our officers. The employment agreements contain change in control
provisions that would entitle each of the officers to two times their
current annual salaries, vest outstanding restricted stock and options
to purchase common stock, and continue certain benefits if there is a
change in control of our company (as defined) and their employment
terminates. Our maximum contingent liability under these agreements in
such an event is approximately $1.7 million. The employment agreements
also provide for severance, disability and death benefits. See Note
16(a).
Cardiosonix also maintains employment agreements with three key
employees. The employment agreements contain provisions that would
entitle the employees to the greater of one year's salary or the amount
due under Israeli law if the employee were terminated without cause.
The agreements also provide for royalty payments to the employees (See
Note 10(b).). The maximum contingent liability under the agreements,
excluding the potential royalty, is approximately $69,000.
12. LEASES:
We lease certain office equipment under capital leases which expire
from 2004 to 2008. In December 1996, we entered into an operating lease
agreement for office space, which expired in August 2003. In August
2003, we entered into an operating lease agreement for office space,
which expires in September 2006. In April 2002, Cardiosonix entered
into an operating sublease agreement for office and parking space,
expiring in April 2004. In addition, Cardiosonix leases four
automobiles under three-year operating leases.
The future minimum lease payments, net of sublease rentals, for the years
ending December 31 are as follows:
CAPITAL OPERATING
LEASES LEASES
---------- ----------
2004 $ 13,436 $ 121,732
2005 7,964 86,738
2006 7,964 58,568
2007 7,964 -
2008 7,300 -
---------- ----------
44,627 $ 267,039
Less amount representing interest 10,959 ==========
----------
Present value of net minimum
lease payments 33,740
Less current portion 9,731
----------
Capital lease obligations,
excluding current portion $ 24,009
==========
Total rental expense, net of sublease rental income of $82,000 and
$132,000, was $238,000 and $213,000 for the years ended December 31, 2003
and 2002, respectively.
13. EMPLOYEE BENEFIT PLAN:
We maintain an employee benefit plan under Section 401(k) of the Internal
Revenue Code. The plan allows employees to make contributions and we may,
but are not obligated to, match a portion of the employee's contribution
with our common stock, up to a defined maximum. We accrued expenses of
$14,000 and $26,000 during 2003 and 2002, respectively, related to common
stock to be subsequently contributed to the plan.
F-20
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
14. SUPPLEMENTAL DISCLOSURE FOR STATEMENTS OF CASH FLOWS:
We paid interest aggregating $94,000 and $32,000 for the years ended
December 31, 2003 and 2002, respectively. During 2002, we received a net
refund of $700 related to overpayment of estimated 2001 income taxes.
During 2003, we purchased equipment under a capital lease totaling $29,000.
During 2003 and 2002, we transferred $14,000 and $25,000, respectively, in
inventory to fixed assets related to the creation of a pool of service
loaner equipment. Also during 2003 and 2002, we prepaid $225,000 and
$205,000, respectively, in insurance through the issuance of notes payable
with weighted average interest rates of 6%. The notes issued in 2003 mature
in July and August 2004.
15. CONTINGENCIES:
We are subject to legal proceedings and claims that arise in the ordinary
course of business. In our opinion, the amount of ultimate liability, if
any, with respect to these actions will not materially affect our financial
position.
16. SUBSEQUENT EVENTS:
a. EMPLOYMENT AGREEMENTS: Effective January 1, 2004, we entered into new
employment agreements with our President and CEO and three other
executive officers. The new agreements have substantially similar terms
to the previous agreements. The maximum contingent liability under
these agreements in the event of termination is $1.5 million. See
Note 11(d).
b. NOTES PAYABLE: On March 8, 2004, the due date of the note to our
President and CEO, David Bupp, was extended from June 30, 2004 to June
30, 2005 with the same terms. In exchange for extending the due date of
the note, we issued Mr. Bupp an additional 375,000 warrants, expiring
in March 2009, to purchase our common stock at an exercise price of
$0.50 per share. The per share value of these warrants was $0.46 on the
date of issuance using the Black-Scholes option pricing model with the
following assumptions: an average risk-free interest rate of 2.7%,
volatility of 152% and no expected dividend rate. See Note 6.
During January 2004, the outside investor converted the entire balance
of the note into 1.1 million shares of common stock according to the
conversion terms of the agreement. The total value of shares issued in
conversion of the note was $378,955 based on the closing market prices
for our common stock on the dates of conversion. See Note 6.
c. AGREEMENTS: In February 2004, we entered into a product supply
agreement with TriVirix International (TriVirix) for the manufacture of
the neo2000 control unit, 14mm probe, 11mm laparoscopic probe,
Quantix/OR control unit and Quantix/ND control unit. The initial term
of the agreement expires in January 2007, but may be automatically
extended for successive one-year periods. Either party has the right to
terminate the agreement at any time upon one hundred eighty (180) days
prior written notice, or may terminate the agreement upon a material
breach or repeated non-material breaches by the other. We have issued
purchase orders for $1.8 million of neo2000 control units, 14mm probes
and Quantix control units for delivery of product through December
2004.
d. DISTRIBUTION AGREEMENT: In March 2004, we were notified by EES that
they were exercising their option to renew their distribution agreement
with us covering our gamma detection devices through the end of 2006.
See Note 11(b).
e. COMMON STOCK PURCHASE AGREEMENT: From January 1 through March 29, 2004,
we sold Fusion a total of 2,100,000 shares of common stock and realized
proceeds of $1,271,334. We issued Fusion 57,140 shares of common stock
during the first quarter of 2004 for commitment fees due to Fusion
related to the sale of our common stock to them. See Note 8(e).
f. WARRANT EXERCISES: During the first quarter of 2004, certain investors
exercised a total of 1.6 million warrants to purchase our common stock
and we realized proceeds of $457,000. See Note 8(c).
F-21
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
17. SUPPLEMENTAL INFORMATION (UNAUDITED):
The following summary financial data are derived from our consolidated
financial statements that have been audited by our independent public
accountants. These data are qualified in their entirety by, and should be
read in conjunction with, our Consolidated Financial Statements and Notes
thereto included herein.
(Amounts in thousands, except per share data) YEARS ENDED DECEMBER 31,
-------------------------------------------------------------------
2003 2002 2001 2000 1999
---------- --------- -------- -------- ---------
Statement of Operations Data:
Net sales $ 5,564 $ 3,383 $ 6,764 $ 8,835 $ 9,246
License and other revenue 946 1,538 1,428 1,395 325
Gross profit 3,385 2,570 3,802 5,240 5,063
Research and development expenses 1,894 2,324 948 993 1,513
Selling, general and administrative 3,103 3,267 2,321 2,911 8,131
expenses
Acquired in-process research and - (28) 885 - -
development
Losses related to subsidiaries in - - - - 475
liquidation
---------- --------- -------- -------- ---------
(Loss) income from operations (1,611) (2,993) (352) 1,336 (5,057)
Other (expenses) income (188) 29 370 504 883
---------- --------- -------- -------- ---------
Net (loss) income $ (1,799) $ (2,964) $ 15 $ 1,840 $ (4,174)
---------- --------- -------- -------- ---------
(Loss) income attributable to common
stockholders $ (1,799) $ (2,964) $ 15 $ 1,075 $ (7,895)
========== ========= ======== ======== =========
(Loss) Income per common share:
Basic $ (0.04) $ (0.08) $ 0.00 $ 0.04 $ (0.34)
Diluted $ (0.04) $ (0.08) $ 0.00 $ 0.04 $ (0.34)
Shares used in computing (loss) income per
common share: (1)
Basic 40,338 36,045 25,899 25,710 23,003
Diluted 40,338 36,045 26,047 26,440 23,003
AS OF DECEMBER 31,
-------------------------------------------------------------
2003 2002 2001 2000 1999
--------- --------- --------- --------- ---------
Balance Sheet Data:
Total assets $ 7,385 $ 7,080 $ 11,329 $ 7,573 $ 10,323
Long-term obligations 585 1,169 1,981 2,233 4,314
Accumulated deficit (122,477) (120,678) (117,714) (117,729) (119,569)
(1) Basic earnings (loss) per share are calculated using the weighted average
number of common shares outstanding during the periods. Diluted earnings
(loss) per share is calculated using the weighted average number of common
shares outstanding during the periods, adjusted for the effects of
convertible securities, options and warrants, if dilutive.
F-22