Item 1. BUSINESS - ------ --------
This report on Form 10-K contains certain forward looking statements regarding future events with respect to Valley Forge Scientific Corp. ("Valley Forge Scientific", "we", "us" and "our" refer to Valley Forge Scientific Corp., a Pennsylvania corporation, unless the context otherwise requires). Actual events or results could differ materially due to a number of factors, including, those described herein and in the documents incorporated herein by reference and those factors described under the heading "Forward Looking Statements" in this Item 1 and under the heading "Additional Cautionary Statements" in Item 7.
Nature of Our Business
Valley Forge Scientific, which was incorporated on March 27, 1980, designs, develops, manufactures and sells medical devices. Our core business is in our bipolar electrosurgical generators and related instrumentation, based on our DualWave(TM) technology. Our DualWave(TM) technology involves the use of two waveforms, one to perform bipolar cutting of tissue and the other to perform bipolar coagulation, or sealing, of blood vessels. Our bipolar systems are designed to replace other surgical tools, such as monopolar systems, lasers and conventional scalpels used in soft tissue surgery, and for other applications.
All electrosurgical units utilize handheld instruments to deliver the current from the generator to the patient's tissue. Traditional monopolar instruments have a single, monopolar, electrode tip that advances a spark between the electrode tip and the tissue. The electrical current generated is attracted to a grounding pad attached to the patient's thigh or buttock and electrical current and heat are diffused to tissues between the surgical site and the site of the grounding pad. This can result in heat damage, charring and unpredictable/prolonged healing in the surgical area, as well as collateral damage to tissues along the electrical pathway to the grounding pad. The monopolar method of cutting and coagulation is also rendered obsolete in delicate areas of the human body, specifically the brain and spine, due to the inability to control current and heat spread.
Bipolar electrosurgery is descriptive of the means of current delivery to the patient. Bipolar electrosurgery employs a unique delivery system to overcome the safety hazards associated with the grounding pad in monopolar electrosurgery. In bipolar electrosurgery a handheld instrument with two electrodes is used to deliver the current to soft tissue and blood vessels. The electrodes are closely juxtaposed, so that current flows only between the electrodes, affecting only the tissue or blood vessel between the electrodes. Current is confined to the immediate surgical site so that no grounding pad is required and peripheral tissue damage is virtually eliminated.
Our bipolar electrosurgery system, provides the surgeon one waveform to safely and precisely cut, core and divide tissue and another waveform to provide a gentle and precise coagulation. Our cutting waveform uses molecular resonance to cut, instead of heat through an advancing spark, which is used in monopolar systems. With the virtual elimination of heat and current spread, our technology
can be used anywhere in the human body safely, specifically in the most sensitive areas, the brain and spine. Our unique coagulation waveform uses a totally aperiodic and non-rhythmic waveform, eliminating the molecular resonance and the possibility of inadvertently cutting tissue when the surgeon intends to coagulate. These precise and differentiated waveforms allow surgeons to work in direct contact with nerves, blood vessels, bone and metal implants without the inherent dangers associated with other methods of electrosurgery.
Our bipolar systems consist of a solid state microprocessor controlled generator, utilizing our DualWave(TM) bipolar circuitry technology, an array of disposable hand-held instruments to perform a variety of surgical procedures, single-use disposable cords which attach the hand-held bipolar instrument to the generator and other modules and accessories.
We have chosen not to market or sell our products directly to the end-users. Our neurosurgery bipolar systems, which are used by neurosurgeons worldwide, are marketed and sold by Codman & Shurtleff, Inc., a subsidiary of Johnson & Johnson, Inc. to end-users. We sell our Bident(R) bipolar dental system to national dental product dealers who then sell our products to end-users.
Our strategy is to increase our sales in neurosurgery with expanded product offerings, increase sales in the dental market by expanding the base of national dental product dealers for our Bident(R) Bipolar Tissue Management System for dental applications and expand into other clinical and surgical markets that have a need for bipolar electrosurgery through alliances and agreements with other medical device companies. Our strategy also includes using our DualWave(TM) technology and sales of our bipolar generators to drive sales of complementary disposable hand-held instruments, tubing sets and other products.
Our neurosurgery bipolar systems, which were first introduced into the market by Codman & Shurtleff in 1983, account for a significant amount of our sales.
We have 510(k) clearance to market our bipolar electrosurgical generators and disposable instrumentation, based on our DualWave(TM) technology, from the United States Food and Drug Administration, the FDA. Our Bident(R) bipolar dental system has also been granted 510(k) clearance to market by the FDA. Our neurosurgery bipolar system is CE marked, which is a requirement to sell the product in most of Western Europe.
To complement the sales of our bipolar systems, we also manufacture for sale titanium surgical mesh for repair of the skull and a natural dental preparation for use in healing and lessening post surgical discomfort. As markets for our bipolar systems expand, we may manufacture and sell other complementary products.
Our Business Strategy
Our objective is to expand upon the success of our DualWave(TM) technology in neurosurgery and to broaden the market for our bipolar systems in the dental market and other clinical and surgical markets. Our strategies to achieve this goal are as follows:
Expansion of Our Product Base. We plan to continue to aggressively proceed in the development of additional products based on our DualWave(TM) technology and develop new technologies to satisfy the needs of the medical community. By working with distributors of medical devices and leading practitioners in their fields, we plan to refine existing features and develop new features, enhancements and new instrumentation to provide surgeons with more functionality.
Expansion of the Use of Our Bipolar Systems Based on Our DualWave(TM) Technology. Building upon our DualWave(TM) technology and its use in neurosurgery, we continue to pursue product refinement opportunities for additional clinical applications. Potential fields include: general surgery, minimally invasive applications in various clinical fields, maxillofacial surgery, ENT, plastic surgery and other applications.
Use Our Generators to Drive Disposable Product Sales. The sales of our disposable hand-held instruments and disposable tubing sets are influenced by three factors: the increased installed base of our bipolar generators, the increased product offerings of disposables and physician acceptance of our products. As new types of disposable hand-held instruments are introduced into the neurosurgery market and as more bipolar generators are sold in the dental market and other clinical markets, we expect sales of complementary disposable hand-held instruments and cord and tubing sets, which attach the hand-held instrument to the bipolar generator, to increase.
Continue to Improve Distribution of our Products to End-Users. To date, we have used third parties to sell our products to end-users.
o In neurosurgery, since 1983 we have chosen to contract with Codman & Shurtleff, Inc., a subsidiary of Johnson & Johnson, Inc., to market and distribute our products. The term of our current distribution agreement with Codman & Shurtleff, Inc. was recently extended from December 31, 2003 to March 31, 2004 to allow the parties time to continue to discuss the terms of a new distribution agreement.
o In the dental market, we continue to expand on the number of dental product distributors that sell our Bident(R) Bipolar Tissue Management System for dental applications to end-users.
o In September 2002, we entered into a development agreement with Stryker Corporation for a new product for use in a field outside of the neurosurgery and the dental fields. The term of this development agreement was recently extended until February 28, 2004.
In neurosurgery, there are numerous published clinical reports and follow-up studies on the use of our system, which support the marketing efforts of our neurosurgery bipolar systems. In dentistry, leading practitioners have written numerous articles and clinical reports supporting the use of our system. We will need recommendations and endorsements by influential surgeons for market acceptance of our disposable hand-held instruments and other new product offerings in the field of neurosurgery and for market acceptance of our bipolar systems in fields other than neurosurgery.
Electrosurgery
Surgical procedures are performed using a variety of methods and instruments, including electrosurgical generators. Electrosurgical generators perform two specific functions, tissue cutting and coagulation (sealing) of blood vessels.
The application of hot cautery to seal blood vessels has been in existence for more than 5,000 years. Early cauterization techniques employed iron instruments heated in an open flame, then introduced into the wound. The electrosurgical generator was first introduced in 1924, by noted neurosurgeon, Dr. Harvey Cushing, who partnered with a Harvard University physicist, Dr. William Bovie, to design a spark gap electrosurgical generator. The generator worked by advancing a spark to tissue, to generate heat, providing cauterization.
Today's electrosurgical generators have become more sophisticated, utilizing radiofrequency, or RF, waves to cut and coagulate tissue. Modern electrosurgical generators are distinguished as either "monopolar" or "bipolar". The classification refers to the method by which electricity is delivered to the patient and returned to the generator. Fundamental electrical principles apply. Electricity must complete a circle. It must have a beginning point, a return path, and an ending point.
Monopolar Electrosurgical Systems
In monopolar electrosurgery, a single RF sine wave is created in the generator to provide cutting and coagulation. Connected to the generator is an insulated, hand held instrument with only one tip. This is the "active electrode". The return path of this applied electricity is through the patient's body, to a grounding pad attached to the patient's body, usually the thigh or buttocks, which returns the electricity to the generator, completing the circuit. Traditional monopolar electrosurgical cutting uses high temperature heat to burn away targeted tissue. This typically results in thermal (heat) damage, charring and unpredictable/prolonged healing in the surgical area. Monopolar cutting does not work well in a wet field due to short circuiting, which exacerbates tissue damage due to heat and dryness.
There are three significant safety hazards recognized with the monopolar system:
o There is considerable heat buildup at the surgical site; o The electricity must travel through the patient's body to reach the grounding pad, which can damage healthy blood vessels and tissue along its path; and o The patient can be burned by the electricity leaving the body at the site of the grounding pad.
Monopolar units do not provide a separate waveform or delivery system for coagulation. The surgeon changes the angle of the instrument touching tissue, using the heat buildup of the instrument itself to coagulate tissue.
Bipolar Electrosurgical Systems
Bipolar electrosurgery is descriptive of the means of current delivery to the patient. In bipolar systems, the RF sine wave is generated, and delivered to the surgical site via a handheld instrument that provides the "active" and "return" electrodes. The electricity generated is applied only to the tissue between the two electrodes of the instrument. The electricity is returned to the generator through the instrument, removing the patient from the electrical circuit and eliminating not only the need for a grounding pad, but the inherent safety hazards associated with monopolar electrosurgery.
Our DualWave(TM) bipolar electrosurgical generators, which use two waveforms to perform the two separate and distinct functions of cutting and coagulation are distinguished from other electrosurgical systems. We believe that the use of two separate waveforms is much safer than using a single waveform to perform the distinct functions of cutting and coagulation. With the use of one waveform, there is the potential that a surgeon may cut or perforate a blood vessel inadvertently while he is trying to coagulate a blood vessel. By contrast, in our bipolar systems, a surgeon can not cut a blood vessel while he is using the system in the coagulation mode.
Valley Forge Scientific Technology
The foundation of our bipolar electrosurgical systems lies in our DualWave(TM) technology. Using our DualWave(TM) technology, our bipolar generators are able to deliver two separate waveforms to perform the two separate and distinct functions of cutting and coagulation.
We do not believe that it is either safe or effective to use the same waveform for coagulation that is used for cutting. With the virtual elimination of heat and current spread, our technology can be used in direct contact with nerves, bones, blood vessels and metal implants, and can be used anywhere in the human body safely, specifically the brain and spine.
Our bipolar systems consist of a solid state microprocessor controlled generator, utilizing our DualWave(TM) technology, an array of disposable hand-held bipolar instruments, which perform a variety of surgical and dental procedures, and single-use disposable cords, which attach the hand-held bipolar instrument to the generator. We also develop, manufacture and sell modules and other accessories to handle specific functions required by a particular surgical discipline. For example, in neurosurgery we sell an irrigation module, which allows the neurosurgeon to pump a saline solution into the surgical field while cutting tissue or coagulating blood vessels, and a specially designed single-use plastic tube set, which connects the electrical current from the generator and fluid from the irrigation module to the hand-held instrument.
Our cutting waveform uses molecular resonance to cut, rather than heat through an advancing spark. Our generator contains a rigidly stabilized voltage control to provide an extremely gentle cut, using about one fifth the power of other generators. The cutting current, which is delivered only to the tissue between the two electrodes of the instrument, offers safety advantages by the absence of current spread and markedly reduced heating of adjacent tissues. This makes our product safe to use in all areas of the human body, specifically in the most sensitive areas, the brain and the spine.
Our coagulation waveform is unique in that it is totally aperiodic and nonrhythmic. The timing of electrical bursts within the waveform are randomly spaced, and the waveform itself is random in timing so that it is truly aperiodic. Regardless of how high the voltage setting of the unit, or how long the surgeon applies the current, the coagulation waveform simply will not cut. Our strictly regulated constant voltage supply allows for precise, gentle and progressive coagulation in either totally dry or fully irrigated fields, including fields totally submerged in saline. These effects are produced in our generators through the lowest possible output impedance.
Our bipolar electrosurgical generators deliver both cutting and coagulation through bipolar handheld instruments, providing both the active electrode and the return path through the handheld instrument back to the generator. The performance of our bipolar disposable handheld instruments is also enhanced by an irrigated field, further minimizing the risk of heat buildup and correlating tissue damage. Our bipolar systems are designed to replace other surgical tools, such as monopolar electrosurgical systems, lasers and conventional instruments, such as scalpels, used in soft tissue surgery.
We believe that our bipolar systems, using our DualWave(TM) technology, can be used in all procedures involving cutting tissue or coagulating blood vessels throughout the human body.
Our neurosurgery bipolar systems, which were first introduced into the market by Codman & Shurtleff in 1983, accounted for almost all of our sales in 2003. To date, a total of seven neurosurgical disposable hand-held instruments utilizing our DualWave(TM) technology have been developed. We are discussing with Codman & Shurtleff, Inc. refining and expanding our disposable instrument product offering for re-introduction in 2004.
Our Bident(R) Bipolar Tissue Management System for dental applications was introduced into the dental market in 1999. In the second quarter of fiscal 2003, we implemented a new marketing plan for our Bident(R) Bipolar Tissue Management System focusing on direct marketing and sales to national dental product dealers. These dental product dealers then sell our products to dentists, oral surgeons and periodontists. During fiscal 2003, our marketing efforts included demonstrating our dental products at numerous dental trade shows, sponsoring training seminars and advertising our dental products in leading trade journals. Also, in the fourth quarter of fiscal 2003, we hired a dental product manager to provide training and assistance and expand our marketing efforts with the key dental product distributors.
The Neurosurgery Market
There are more than 3,600 Board Certified Neurological Surgeons in the United States, and more than 15,000 neurosurgeons worldwide. Neurological surgery is a medical specialty dealing with disorders of the brain, skull, spinal cord, cranial and spinal nerves, the autonomic nervous system and the pituitary gland. It is believed that approximately 500,000 brain and spine surgery procedures are performed each year in the United States.
A prominent use of bipolar electrosurgical instrumentation in neurosurgery is tumor removal. There are over 100 different types of brain tumors and more than 180,000 Americans are diagnosed with brain tumors each year. The most common brain tumors in adults are: glioblastoma, meningioma, and oligodendroglioma. Approximately 2,200 children are also diagnosed with a brain tumor each year, with the most common being medulloblastoma and astrocytoma. The first line of treatment for these tumors is typically surgical removal of the tumor.
For each bipolar neurosurgical procedure, the neurosurgeon needs a hand-held instrument that will cut, divide, core or remove tissue and tumors and coagulate blood vessels. The neurosurgeon also needs to connect that instrument with a cord/tubing set to the bipolar generator and irrigation unit, which provides fluids to the surgical site. This area of practice demands that the cord/tubing sets be single-use. We believe that as neurosurgeons are educated on the functionality and cost advantages of our disposable neurosurgical hand-held instruments, our sales of these instruments will increase.
In neurosurgery, a bipolar electrosurgical system is the modality of choice, largely due to the efforts of Dr. Leonard I. Malis, one of our directors. Dr. Malis, who is Professor and Chairman Emeritus of the Mount Sinai School of Medicine Department of Neurosurgery, designed and developed the first commercial bipolar coagulator in 1955, and pioneered the use of bipolar electrosurgery for use in the brain. Dr. Malis is a frequent author and lecturer on neurosurgery and bipolar electrosurgery.
Our Neurosurgery Bipolar Systems. - --------------------------------
Our neurosurgery bipolar systems, which were developed in conjunction with Dr. Malis, are used to cut, core and divide tissue and tumors and coagulate blood vessels in the brain and spine. Our neurosurgery bipolar systems, which are currently marketed and sold by Codman & Shurtleff, Inc. to end-users under the MALIS(R) tradename, are used by neurosurgeons worldwide.
Our neurosurgery bipolar system is a surgical device intended to perform two separate functions: bipolar cutting of tissue and bipolar coagulation of blood vessels. Our system is comprised of the bipolar electrosurgical generator, an irrigation module, foot pedal, connecting cables, and an array of disposable bipolar hand-held instrumentation in varying sizes and shapes connected to the generator via a single-use disposable bipolar cord and tubing set.
Our bipolar generator delivers our DualWave(TM) bipolar cutting and bipolar coagulation through radio frequency waveforms. Our irrigation modules deliver fluids, such as saline, to the surgical field through a hand-held instrument. Surgeons can use our disposable bipolar hand-held instruments to cut tissue and to seal blood vessels in an irrigated surgical field. The surgeon can control the mode of operation with the foot pedal and power setting with keys on the front panel of the controller.
Our disposable bipolar hand-held instruments are approved for sale in various tip sizes and shapes. We have developed seven different models of disposable hand-held instruments for neurosurgery, which provide the surgeon control and precision for different procedures during surgery. We believe that the typical use per surgical procedure will be one to two disposable instruments and one disposable cord/tubing set.
Our current neurosurgery products consist of the following:
Generators/Irrigators ---------------------
- MALIS(R)CMC-III Bipolar Generator (High power cutting/coagulation) - MALIS(R)Bipolar Synergy Generator (Low power coagulation) - MALIS(R)Irrigation Module
Disposable Instrumentation and Cord sets ----------------------------------------
- MALIS(R)Bipolar Cord/Irrigation Tubing Set - MALIS(R)Bipolar Cord - MALIS(R)Bipolar Cutting Loops - 3x5mm - MALIS(R)Bipolar Cutting Loops - 5x5mm - MALIS(R)Bipolar Cutting Loops - 5x10mm - MALIS(R)Bipolar Cutting Loops - 10x10mm - MALIS(R)Bipolar Cutting Pen - MALIS(R)Bipolar Coagulation Ball - 3mm - MALIS(R)Bipolar Coagulation Ball - 5mm
The Dental Market
There are an estimated 150,000 professionally active dentists in the United States. As primary oral health care providers, approximately 80% of dentists are generalists, and approximately 20% are specialists. More than 90% of active dentists are in private practice.
There are currently more than 20 different bipolar electrosurgical procedures with American Dental Association, ADA, codes eligible for insurance reimbursement. Examples of commonly performed procedures include:
o Gingivectomey / Gingivoplasty (surgical treatment of gingivitis), o Connective tissue graft, o Surgical removal of residual tooth roots, o Crown and bridge preparation, o Biopsy of oral tissue, o Excision of cysts or tumors, benign and malignant, and o Surgical removal of impacted or erupted tooth.
Our Bident(R) Bipolar Tissue Management System - ----------------------------------------------
Our Bident(R) Bipolar Tissue Management System uses the same DualWave(TM) technology used in our neurosurgery bipolar systems to allow dentists to work in direct contact with metal implants, nerves, bone and blood vessels, essentially eliminating collateral tissue damage from current spread and heat buildup.
Dentists, similar to neurosurgeons, are particularly affected by the limitations of monopolar electrosurgical systems to work safely around metal implants, bone, nerves and blood vessels due to the nature of delicate structures they work within. We believe, the elimination of the grounding pad through bipolar delivery of our current to cut and coagulate in our Bident(R) Bipolar Tissue Management System is also an important factor to dentists concerned with both safety, and patient perception/fear of the equipment used in the general dentistry setting.
Our Bident(R) Bipolar Tissue Management System is a surgical device, which performs two separate functions: bipolar tissue cutting and bipolar coagulation of blood vessels. The size, features and overall power output of the generator itself is different than our neurosurgery bipolar system, to meet the need for a cost effective, office style generator for the dentist. The system is comprised of the electrosurgical generator, foot pedal, connecting cables and an array of disposable bipolar hand-held instruments, which are attached to the generator via a single use bipolar cord.
Dentists can use our disposable bipolar hand-held instruments to cut tissue and to seal blood vessels. The dentist can control the mode of operation with the foot pedal and power setting with keys on the front panel of the generator.
Our disposable bipolar hand-held instruments are available in various tip sizes, shapes and angles to perform the varying procedures performed by the dentist. We currently sell sixteen different models of disposable bipolar hand-held instruments for dental procedures. We believe that the typical use for each dental surgical procedure is one to two disposable instruments and one disposable cord set.
Our current bipolar dental products consist of the following:
Generator --------- - Bident(R) Bipolar Surgical System
Bipolar Instrument and Cord Sets -------------------------------- - Bipolar Flap Access Pen - Bipolar Gingivoplasty Pen - Bipolar Gingivectomy Pen - Bipolar Gingival Troughing Pen 5 mm (.012") - Bipolar Gingivectomy Pen (.020") - Bipolar Coagulating Ball 3mm - Bipolar Coagulating Ball 3mm (30(Degree)) - Bipolar Gingivoplasty Loop 1.5x9mm - Bipolar Gingivoplasty Loop 1.5x9mm (30(Degree)) - Bipolar Gingivoplasty Loop 3x5mm - Bipolar Gingivoplasty Loop 3x5mm (30(Degree)) - Bipolar Gingivoplasty Loop 3x8mm - Bipolar Gingivoplasty Loop 3x8mm (30(Degree)) - Bipolar Gingivoplasty Loop 5x5mm - Bipolar Gingivoplasty Loop 5x5mm (30(Degree)) - Bipolar Cord Set
Other Surgical Markets
Building upon our DualWave(TM) technology and its use in neurosurgery, our strategy is to expand the market for our bipolar systems and disposable bipolar products in other clinical and surgical markets that have a need for bipolar electrosurgery. We continue to research market potential and product refinement opportunities for additional clinical applications of our DualWave(TM) technology. Potential fields include: general surgery, minimally invasive applications in various clinical fields, maxillofacial surgery, ENT, plastic surgery and other intracranial applications. As we open new markets, we plan to select leading national/international medical sales organizations specializing in the applicable field(s) to launch our bipolar systems in the market place and to sell our product offerings to end-users.
Manufacturing and Supplies
We conduct the manufacturing of our bipolar generators and irrigation systems in our facility in Philadelphia, Pennsylvania in conjunction with our wholly owned subsidiary, Diversified Electronics Company, Inc. Our products are manufactured from raw materials and components supplied to us by third parties. Most of the raw material and components we use in the manufacture of our products are available from more than one supplier. For some components, however, there are relatively few alternate sources of supply and we rely upon single source suppliers or contract manufacturers. For example, we currently subcontract the manufacturing of our disposable instruments with a single contract manufacturer and we subcontract the manufacture of our disposable cord and tube sets with a single manufacturer. Our profit margins and our ability to develop and deliver such products on a timely basis may be adversely affected by the lack of alternative sources of supply.
Our manufacturing process is subject to the regulatory requirements of the Federal Good Manufacturing Practice Regulations as promulgated by the FDA, which mandate detailed quality assurance and record-keeping procedures and subjects us to unscheduled periodic regulatory inspections. We conduct quality assurance audits throughout the manufacturing process and believe that we are in compliance with all applicable government regulations.
Marketing and Sales
We have chosen not to directly market or sell our products to end-users. Instead, we sell all of our products to or through national/international distributors.
Codman & Shurtleff, Inc. For over twenty years, we have entered into distribution agreements with Codman & Shurtleff, Inc. to sell and distribute our products in the field of neurosurgery. On December 11, 2000, we entered into our current distribution agreement with Codman & Shurtleff, Inc. under which Codman & Shurtleff, Inc. was granted the exclusive worldwide right to sell our bipolar neurosurgery system and certain other products in the fields of neurocranial and neurospinal surgery on the condition that Codman & Shurtleff, Inc. makes minimum purchases of $4,000,000 per calendar year, as may be adjusted by mutual agreement of the parties. If Codman & Shurtleff, Inc. fails to satisfy the minimum purchase obligations, our remedy is to terminate the agreement or convert it to a nonexclusive agreement. The term of our current distribution agreement with Codman & Shurtleff, Inc. was recently extended from December 31, 2003 to March 31, 2004 to allow the parties time to discuss the terms of a new distribution agreement. We primarily perform product development, manufacturing and clinical and regulatory functions for our neurosurgery bipolar systems.
For the 2003, 2002 and 2001 fiscal years, we had sales to Codman & Shurtleff, Inc. of approximately $4,236,000, $4,515,000, and $4,169,000, respectively. In fiscal 2003, approximately 95% of our sales revenue was derived from sales to Codman & Shurtleff, Inc. and in fiscal 2002 and 2001 approximately 90% and 79% of our sales, respectively, were derived from sales to Codman & Shurtleff, Inc.. Codman & Shurtleff, Inc. also sells its own passive hand-held instruments under the MALIS(R) tradename which are used in conjunction with our neurosurgery bipolar system.
Boston Scientific Corporation. In 1993, we entered into a supply and distribution agreement with Boston Scientific Corporation covering the exclusive worldwide marketing rights of our bipolar coagulators for use in the fields of gastroenterology and endoscopy, through March 2002. In Feburary 2002, we terminated this agreement by mutual consent and entered into a new agreement with Boston Scientific Corporation to provide primarily product support for the installed base of Boston Scientific's "Symmetry Endo-Bipolar Generator" and the Mini-SymmetryTM generators.
Our neurosurgery bipolar systems are sold in certain foreign markets by Codman & Shurtleff, Inc. Prior to sales in certain foreign markets, we are required to comply with applicable foreign government regulations.
Our business is not affected to any material extent by seasonal factors.
Competition
We believe that principal competitive factors with our bipolar products are product features and quality, safety, ease of use, cost, acceptance by leading physicians, and improved patient outcomes. We believe that our DualWave(TM) technology, which delivers both bipolar cutting and bipolar coagulation with two separate waveforms, distinguishes our bipolar electrosurgical systems from electrosurgical systems sold by other entities, which do not offer both bipolar cutting and bipolar coagulation. We believe that our unique bipolar electrosurgical products offer enhanced capabilities and safety advantages as compared to other electrosurgical systems.
The medical device industry is intensely competitive in almost all segments and tends to be dominated in large more mature markets by a relatively small group of large and well financed companies. We also compete with smaller, entrepreneurial companies. There can be no assurance that these or other companies will not succeed in developing, or have not already developed, technologies or products that are more effective than ours or that would render our technology or products obsolete or uncompetitive.
Neurosurgery - ------------
In neurosurgery, we believe that we are the principal manufacturer of bipolar electrosurgical systems. Our neurosurgery bipolar system competes against manufacturers of electrosurgical systems, including ValleyLab and Erbe. In addition, we compete with other technologies and a variety of tissue removal systems designed for removing brain and cranial-based tumors, such as an ultrasonic tissue aspiration system also manufactured by ValleyLab.
Dental Market - -------------
We believe that we are the only manufacturer of bipolar electrosurgical systems serving the dental market. Our Bident(R) Bipolar Tissue Management System competes with monopolar electrosurgical systems manufactured by Ellman, and laser and other monopolar electrosurgical systems manufactured by other companies.
Other Surgical Markets - ----------------------
In other surgical markets, our bipolar generator and disposable instruments will compete with large companies, such as ValleyLab, Ellman and Conmed, which manufacture and sell electrosurgical medical devices. Our systems will also compete with laser systems and other technologies manufactured or utilized by other companies. We cannot assure you that we, or the companies we contract with to sell our products, can effectively convince physicians and surgeons to purchase our products in the face of competition.
Research and Development
We are continually working on enhancements to our generator products and on new disposable instrumentation along with other products to meet the needs of surgeons in various surgical disciplines. We also are exploring new applications for our DualWave(TM) technology in other clinical and surgical markets. In September 2002, we entered into a development agreement with Stryker Corporation for a new product for use in a field outside of the neurosurgery and dental fields.
For the 2003, 2002 and 2001 fiscal years, we expended $489,930, $360,111, and $352,773, respectively, for research and development. We anticipate that we will continue to incur research and development costs in connection with development of products.
Substantially all of our research and development is conducted internally. In the 2004 fiscal year, we anticipate that we will fund all our research and development with current assets and cash flows from operations.
Government Regulation
The marketing and sale of our products in the United States is governed by the Federal Food, Drug and Cosmetic Act (the "Act") administered by the FDA, as well as varying degrees of regulation by a number of state and foreign governmental agencies. The Act requires certain clearances from the FDA before medical devices can be marketed.
FDA regulations are wide ranging and govern, among other things:
o product design and development; o product testing; o product labeling; o product storage; o premarket clearance or approval; o advertising and promotion; and o product sales and distribution.
Noncompliance with applicable regulatory requirements can result in enforcement action, which may include:
o warning letters; o fines, injunctions and civil penalties against us; o recall or seizure of our products; o operating restrictions, partial suspension or total shutdown of our production; o refusing our requests for premarket clearance or approval of new products; o withdrawing product approvals already granted; and o criminal prosecution.
All medical devices introduced into the market since 1976, which include substantially all of our products, are required by the FDA as a condition of sale and marketing to secure either a 510(k) premarket notification clearance or an approved premarket approval application ("PMA"). A 510(k) premarket notification clearance indicates FDA agreement with an applicant's determination that the product for which clearance has been sought is substantially equivalent to another medical device that was on the market prior to 1976 or that has received 510(k) premarketing notification clearance. The process of obtaining a 510(k) premarket notification clearance can typically take several months and commonly involves the submission of limited clinical data and supporting information while the PMA process typically will last more than a year and requires the submission of significant quantities of clinical data and manufacturing information.
To comply with the FDA regulations, we may incur substantial costs relating to laboratory and clinical testing of new and existing products and the preparation and filing of documents in formats required by the FDA. In addition, we may also encounter delays in bringing new or existing devices to market as a result of being required by the FDA and foreign governmental authorities to conduct and document additional investigations of product safety and effectiveness.
For European distribution, we have received ISO 9001 certification for our neurosurgery bipolar system and are allowed to use the CE mark on our neurosurgery bipolar system after assembling appropriate documentation. Failure to maintain the CE Mark will preclude our distributor from selling our products in Europe. We cannot assure you that we will be successful in maintaining certification requirements.
We have received 510(k) clearance to market our bipolar electrosurgical generator and disposable instrumentation. We have also received clearance to market our Bident(R) Bipolar Tissue Management System for dental procedures. We cannot assure you that we will be able to obtain necessary clearances or approvals to market any other products, or existing products for new intended uses, on a timely basis, if at all. Delays in receipt or failure to receive clearances or approvals, the loss of previously received clearances or approvals, or failure to comply with existing or future regulatory requirements could have a material adverse effect on business, financial condition, results of operations and future growth prospects.
Under FDA regulations, after a device receives 510(k) clearance, any modification that could significantly affect its safety or effectiveness, or that would constitute a major change in the intended use of the device, technology, materials, packaging, and certain manufacturing process may require a new 510(k) clearance. The FDA requires a manufacturer to make this determination in the first instance, but the FDA can review any such decision, and if it disagrees it can require a manufacturer to obtain a new 510(k) clearance or it can seek enforcement action against the manufacturer.
We are also required to maintain compliance with the Quality System Regulation, or QSR. The QSR incorporates the requirements of Good Manufacturing Practice and relates to product design, testing, and manufacturing quality assurance, as well as the maintenance of records and documentation. The FDA enforces the QSR through inspections. We cannot assure you that we or our key components suppliers are or will continue to be in compliance, will not encounter any manufacturing difficulties, or that we or any of our subcontractors or key component suppliers will be able to maintain compliance with regulatory requirements. Failure to do so will have a material adverse effect on our business, financial condition, results of operations and future growth prospects.
We may not promote or advertise our products for uses not within the scope of our clearances or approvals or make unsupported safety and effectiveness claims. We believe that we are in material compliance with regulations promulgated by the FDA, and that such compliance has been and is anticipated to be without adverse effect on our business.
Patents and Trademarks
Our ability to compete in an effective manner depends in part on developing and maintaining proprietary aspects of our bipolar technology. We own two principal United States patents that are directed towards our DualWave(TM) bipolar technology used in our bipolar electrosurgical systems. Our first patent, which was issued on May 27, 1986, expired on May 27, 2003. Our second patent was issued on June 17, 1994. Since our current bipolar electrosurgical generators are based on the combination of both of these patents and other know-how and trade secrets, we do not believe that the expiration of our first patent will adversely affect our business.
We also own two United States patents, which are used in our disposable hand-held bipolar instruments, and we have applied for United States patents on additional disposable instrumentation and electronic circuitry. Our practice and experience is to apply for patents that are important to the development or sale of a product.
Dr. Leonard I. Malis, one our principal shareholders and directors, has also entered into an agreement with us to license the MALIS(R) trademark to us, at no cost, to the extent the name has not been licensed to Codman & Shurtleff, Inc.
We cannot assure you that the patents we have obtained, or any patents that we may obtain as a result of our patent applications, will provide any competitive advantages for our products or that they will not be successfully challenged, invalidated or circumvented in the future. In addition, we cannot assure you that competitors, many of whom have substantial resources and have made substantial investments in competing technologies, will not seek to apply for and obtain patents that will prevent, limit or interfere with our ability to make, use and sell our products either in the United States or in international markets.
Other companies and entities have filed patent applications or have been issued patents relating to monopolar and/or bipolar electrosurgical methods and devices. We do not believe that our products currently infringe any valid and enforceable claims of the issued patents that we have reviewed. We cannot assure you that we will not have to defend ourselves in court against allegations of infringement of third-party patents.
In addition to patents, we rely on trade secrets and proprietary know-how, which we seek to protect, in part, through confidentiality and proprietary information agreements. We require our key employees and consultants to execute confidentiality agreements upon the commencement of an employment or consulting relationship with us. These agreements generally provide that all confidential information developed or made known to the individual by us during the course of the individual's relationship with us, is to be kept confidential and not disclosed to third parties. These agreements also generally provide that inventions conceived by the individual in the course of rendering services to us shall be our exclusive property. We cannot assure you that employees will not breach the agreements, that we would have adequate remedies for any breach or that our trade secrets will not otherwise become known to or be independently developed by competitors.
Product Liability Risk and Insurance Coverage
The development, manufacture, sale and use of medical products entail significant risk of product liability claims. Our current product liability coverage limits are $5,000,000 per occurrence and $6,000,000 in the aggregate. We cannot assure you that such coverage limits are adequate to protect us from any liabilities we might incur in connection with the development, manufacture, sale or use of our products. In addition, we may require increased product liability coverage as our sales increase in their current applications and new applications. Product liability insurance is expensive and in the future may not be available on acceptable terms, if at all. A successful product liability claim or series of claims brought against us in excess of our insurance coverage could have a material adverse affect on our business, prospects, financial condition and results of operations.
Employees
At September 30, 2003, we and our subsidiaries had 20 full-time employees, including executive officers. From time to time we retain part-time employees, engineering consultants, scientists and other consultants. All full-time employees participate in our health benefit plan. None of our employees are represented by a union or covered by a collective bargaining agreement. We consider our relationship with our employees to be satisfactory.
Forward Looking Statements
The information provided in this Annual Report on Form 10-K contains in addition to historic information, "forward looking" statements or statements which arguably imply or suggest certain things about our future. Statements which express that we "believe", "anticipate", "expect", or "plan to" as well as other statements which are not historical fact, are forward looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These include, but are not limited to statements about: any competitive advantage we may have as a result of our installed base of electrosurgical generators in the neurosurgery market; our belief that our products exceed industry standards or favorably compete with other companies' new technological advancements; the future success of our products and disposable instrumentation in the neurosurgery and dental markets; our ability, along with the third parties with whom we contract, to distribute and sell our products both in and outside of the neurosurgery market; and the continued acceptance of our products in the neurosurgery market and the acceptance of our products in the dental market and outside the neurosurgery market. These statements are based on assumptions that we believe are reasonable, but a number of factors could cause our actual results to differ materially from those expressed or implied by these statements. We do not intend to update these forward looking statements. You are advised to review the Additional Cautionary Statements section, which follows the Management's Discussion and Analysis of Financial Condition and Results of Operations section (Item 7) of this Annual Report, for more information about risks and uncertainties that could affect our financial results.
Item 2.
Item 2. PROPERTIES. - ------ ----------
We currently lease approximately 4,200 square feet of office and warehouse space at a base monthly rent of $4,716 (with increases based on increases in the producer price index) in an office building in Oaks, Pennsylvania, approximately 12 miles northwest of Philadelphia, Pennsylvania. The current lease term ends on June 30, 2005. Our manufacturing operations are conducted in a building owned by our wholly owned subsidiary, Diversified Electronics Company, Inc., with approximately 15,000 square feet in Philadelphia, Pennsylvania.
Item 3.
Item 3. LEGAL PROCEEDINGS. - ------ -----------------
From time to time we are subject to litigation claims. As of September 30, 2003, there are no material pending legal proceedings to which we are a party or to which any of our property is the subject.
On September 19, 2002, we were served with a Complaint that was filed in the Superior Court of the State of Arizona, County of Maricopa entitled Jeffrey Turner and Cathryn Turner, husband and wife, individually, and on behalf of Morgan Rose Turner, a Minor v. Phoenix Children's Hospital, Inc., Valley Forge Scientific Corp., et al (CV 2002-010791) in which we are named as one of the defendants. The plaintiff seeks an unspecified amount of damages for alleged injuries sustained in a surgery that took place in June 2000. Our products liability insurance carrier is providing our defense in this matter. We have denied liability and we are vigorously defending ourselves.
Item 4.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. - ------ ---------------------------------------------------
No matters were submitted to a vote of the securityholders during the fourth quarter of fiscal year 2003.
PART II -------
Item 5.
Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY - ------ ------------------------------------- AND RELATED STOCKHOLDER MATTERS. -------------------------------
Our Common Stock, no par value, is quoted on the Boston Stock Exchange under the symbol VLF, and traded in the over-the-counter market, and is included in the Nasdaq - Small Cap Issues under the symbol "VLFG." The table below sets forth the range of high and low closing bid quotations per share of Common Stock as reported on Nasdaq. Quotations represent prices between dealers and do not necessarily represent actual transactions. None of the prices shown reflect retail mark-ups, mark-downs, or commissions.
COMMON STOCK High-Bid Low-Bid -------- -------
Fiscal 2003 First Quarter $1.88 $1.23 Second Quarter 1.54 1.05 Third Quarter 1.57 1.10 Fourth Quarter 1.75 1.15
Fiscal 2002: First Quarter ................ $2.95 $2.20 Second Quarter................ 3.15 2.20 Third Quarter................. 3.05 2.38 Fourth Quarter................ 2.60 1.26
At December 9, 2003, we had 109 shareholders of record.
We have not paid any dividends to date, nor do we expect to do so in the foreseeable future.
Item 6.
Item 6. SELECTED FINANCIAL DATA -----------------------
The selected financial data set forth below should be read in conjunction with the "Management's Discussion and Analysis of Financial Condition and Results of Operations" and our consolidated financial statements and notes thereto appearing elsewhere in this Form 10-K. The statement of
operations data for the year ended September 30, 2003, 2002 and 2001 and the balance sheet data as of September 30, 2003 and 2002 have been derived from audited consolidated financial statements included elsewhere in this report. The consolidated statement of operations for the years ended September 30, 2000 and 1999 and the balance sheet data as of September 30, 2001, 2000 and 1999 have been derived from audited consolidated financial statements that are not included in this report. The historical results are not necessarily indicative of the results of operations to be expected in the future.
Item 7.
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION - ------ ----------------------------------------------------------- AND RESULTS OF OPERATIONS - -------------------------
The following is a discussion and analysis of Valley Forge Scientific Corp.'s financial condition and results of operations for the fiscal years ended September 30, 2003, 2002 and 2001. This section should be read in conjunction with the financial statements and related notes thereto appearing elsewhere in this Form 10-K.
Cautionary Note Regarding Forward Looking Statements
This Management's Discussion and Analysis of Financial Condition and Results of Operations contains, in addition to historic information, "forward looking" statements or statements which arguably imply or suggest certain things about our future. Statements which express that we "believe", "anticipate", "expect", or "plan to" as well as other statements which are not historical fact, are forward looking statements within the meaning of the Private
Securities Litigation Reform Act of 1995. These forward looking statements include, but are not limited to statements about: any competitive advantage we may have as a result of our installed base of electrosurgical generators in the neurosurgery market; our belief that our products exceed industry standards or favorably compete with other companies' new technological advancements; the future success of our products and disposable instrumentation in the neurosurgery and dental markets; and our ability, along with the third parties with whom we contract, to distribute and sell our products both in and outside of the neurosurgery market, and the continued acceptance of our products in the neurosurgery market and the acceptance of our products in the dental market and outside of the neurosurgery market. These statements are based on assumptions that we believe are reasonable, but a number of factors could cause our actual results to differ materially from those expressed or implied by these statements. We do not intend to update these forward looking statements after the date of this report. You are advised to review the "Additional Cautionary Statements" section below for more information about risks and uncertainties that could affect the financial results of Valley Forge Scientific Corp.
Overview
We design, develop, manufacture and sell medical and dental devices. Our core business is in our bipolar electrosurgical generators and related instrumentation, based on our DualWave(TM) technology. Our bipolar systems allow a surgeon or dentist to cut tissue in a manner that minimizes collateral damage to surrounding healthy tissue and to coagulate blood vessels quickly, safely and efficiently. By substantially reducing damage to surrounding healthy tissue, the surgeon or dentist can work safely in close proximity with nerves, blood vessels, bone and metal implants. Our bipolar systems are designed to replace other surgical tools, such as monopolar electrosurgery systems, lasers and conventional instruments, used in soft tissue surgery.
Our DualWave(TM) technology is applicable to many surgical markets. Our bipolar systems are currently used to perform many types of neurosurgery, spine surgery and dental surgery. We have had worldwide exclusive distribution agreements with Codman & Shurtleff, Inc., a subsidiary of Johnson & Johnson, Inc., to market our neurosurgery bipolar systems since 1983. The term for our current distribution agreement with Codman & Shurtleff, Inc. was recently extended from December 31, 2003 to March 31, 2004 to allow the parties time to continue to discuss the terms of a new distribution agreement.
Historically, we have derived a significant portion of our sales from our neurosurgery bipolar system. Sales revenue from our Bident(R) Bipolar Tissue Management System for dental applications commenced in the 2000 fiscal year. Our current strategy is to increase sales of our Bident(R) Bipolar Tissue Management System by selling it directly to an expanded base of national dental product dealers, expand the offerings of products in the field of neurosurgery and broaden the market for our products in other clinical and surgical markets that have a need for bipolar electrosurgery. Our strategy also includes using our DualWave(TM) technology and sales of our bipolar generators to drive sales of complementary disposable hand-held instruments and products.
Critical Accounting Policies and Estimates
The following "Management's Discussion and Analysis of Financial Condition and Results of Operations", as well as disclosures included elsewhere in this Form 10-K, are based upon our audited consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingencies. On an on-going basis, we evaluate the estimates used, including those related to product returns, bad debts, inventory valuation, impairments of tangible and intangible assets, income taxes, warranty obligations, other accruals, contingencies and litigation. We base our estimates on historical experience, current conditions and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources as well as identifying and assessing our accounting treatment with respect to commitments and contingencies. Actual results may differ from these estimates under different assumptions or conditions. We believe the following critical accounting policies involve more significant judgments and estimates used in the preparation of the consolidated financial statements.
We maintain an allowance for doubtful accounts for estimated losses resulting from the potential inability of our customers to make required payments. If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required.
We provide for the estimated cost of product returns based upon historical experience and any known conditions or circumstances. Our warranty obligation is affected primarily by product that does not meet specifications and performance requirements within the applicable warranty period and any related costs of addressing such matters. Should actual incidences of product not meeting specifications and performance requirements differ from our estimates, revisions to the estimated warranty liability may be required.
We value inventory at the lower of cost or market and write down the value of inventory for estimated obsolescence or unmarketable inventory. An inventory reserve is maintained based upon historical data of actual inventory written off and for known conditions and circumstances. Should actual product marketability be affected by conditions that are different from those projected by management, revisions to the estimated inventory reserve may be required.
Our deferred tax assets and liabilities are determined based on the differences between the financial statement and tax based assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. Deferred tax assets are reduced by a valuation allowance at the time that a determination can be made that it is more likely than not that a portion or all of the related tax assets will not be realized.
In accordance with the provisions of Statement of Financial Accounting Standards ("SFAS") No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123") and SFAS No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure - An Amendment of FASB Statement No. 123" ("SFAS 148"), we have elected to account for stock-based compensation plans in accordance with Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25"), and related interpretations.
Results of Operations
Summary
Sales of $4,474,308, for fiscal 2003 were 11% less than sales of $5,021,931 for fiscal 2002 and 15% less than sales of $5,263,485 for fiscal 2001. Operating income was $155,427 in fiscal 2003 as compared to $632,000 in fiscal 2002 and $485,746 in fiscal 2001. Net income for fiscal 2003 was $108,925 as compared to $380,527 for fiscal 2002 and $330,221 for fiscal 2001.
Revenues
Sales of $4,474,308 in fiscal 2003 reflect a decrease in sales volume to Codman & Shurtleff, Inc., the distributor of our products in the neurosurgery market, and a decrease in sales of our Bident(R) dental products. In fiscal 2003, Codman & Shurtleff, Inc. accounted for 95% of our sales, as compared to 90% of sales for fiscal 2002 and 79% of our sales for fiscal 2001. Sales of the Bident(R) Bipolar Tissue Management System for dental applications were 4% of total sales for fiscal 2003 as compared to 7% of sales for fiscal 2002 and 19% of our sales for fiscal 2001.
Sales of our neurosurgical products to Codman & Shurtleff, Inc. decreased by $284,090 in fiscal 2003. This was primarily due to reduced sales of generators in anticipation of the release of a new neurosurgical generator and instrumentation in 2004. Sales volume of our disposable cord/tubing sets in fiscal 2003 increased compared to sales volume in fiscal 2002. We recently extended the term of our distribution agreement with Codman & Shurtleff, Inc. from December 31, 2003 to March 31, 2004 under the same terms as are currently in place in order to provide more time to continue discussions on the terms of a new distribution agreement for both our existing products and other products and disposable instruments, which are or will be ready for introduction into the market. In addition to the new irrigation unit and related disposable tubing sets, which began production after the end of the 2003 fiscal year, we anticipate completing a new neurosurgical generator and disposable instrumentation in the first six months of calendar 2004.
In the second quarter of fiscal 2003, we implemented a new marketing plan for our Bident(R) Bipolar Tissue Management System for dental applications focusing on direct marketing and sales to national dental product dealers. These dental product dealers then sell our products to dentists, oral surgeons and periodontists. During the 2003 fiscal year, our marketing efforts included demonstrating our dental products at numerous dental trade shows, sponsoring training seminars and advertising our dental products in leading trade journals. In addition, with a new dental product manager, which we hired in the fourth quarter of fiscal 2003, we are expanding our marketing efforts with the key dental product distributors. In the first quarter of 2004 and beyond, we anticipate seeing a greater contribution from the sales of our dental products as the leads we are receiving turn to sales.
In fiscal 2003, 51% of our sales related to sales of bipolar electrosurgical generators, irrigators and accessories as compared to approximately 59% and 57% of our sales in fiscal 2002 and 2001, respectively. Sales of disposable products accounted for approximately $1,934,400, or 43% of our sales, in fiscal 2003 as compared to approximately $1,699,000, or 33% of our
sales, in fiscal 2002 and approximately $1,999,000, or 38% of our sales, in fiscal 2001. The increased sales levels of disposable products reflect increased sales of neurosurgery disposable tubing sets.
Cost of Product Sales
Cost of sales for fiscal 2003 was $2,264,902, or 51% of sales, compared with $2,463,209, or 49% of sales, for fiscal 2002. During fiscal 2001, cost of sales was $2,692,036, or 51% of sales. Gross margin was 49% for fiscal 2003 as compared to 51% for fiscal 2002 and 49% for fiscal 2001.
The decrease in gross margin as a percentage of sales is primarily attributable to decreased sales volume and an increase in our inventory obsolescence provisions. We cannot be sure that gross margins will remain at current levels or show improvement in the future due to the distribution channels used, product mix, and fluctuation in manufacturing production levels and overhead costs as new products are introduced. In addition, inefficiencies in manufacturing new products and the distribution channels utilized to sell those products may adversely impact gross margin.
Operating Expenses
Selling, general and administrative expenses increased slightly to $1,523,751, or 34% of sales, in fiscal 2003, from $1,503,001, or 30% of sales, in fiscal 2002, and from $1,652,289, or 31% of sales, in fiscal 2001. Selling, general and administrative expenses reflect increased selling and marketing expenses incurred in connection with implementing the sales and marketing plan, which we commenced in fiscal 2003, for the Bident(R) Bipolar Tissue Management System.
Research and development expenses were $489,930, or 11% of sales, in fiscal 2003, $360,111, or 7% of sales, in fiscal 2002, and $352,773, or 7% of sales, in fiscal 2001. We will continue to invest in research and development to expand our technological base for use in both existing and additional clinical areas. The increase was primarily related to our reaching the final stages of development of our new surgical irrigator system and increased resources directed towards the development of a new generator and instrumentation for neurosurgery. During the year, we also expended additional funds to reach the final stages of development for a product outside of the neurosurgery and dental markets pursuant to a development agreement we entered into with Stryker Corporation in September 2002. After the end of our 2003 fiscal year, we extended the term of that development agreement until February 28, 2004.
Other Income and Expense, net
Other income and expense, net, decreased for fiscal 2003 to $11,451 from $23,111 for fiscal 2002 and from $39,428 for fiscal 2001 due primarily to lower interest rates on the short-term investments for our cash balances and the write down of certain molding equipment to its estimated fair value. At the end of fiscal 2003, we had $2,305,556 in cash and cash equivalents as compared to $2,543,898 at the end of fiscal 2002 and $1,500,622 at the end of fiscal 2001.
Income Tax Provision
The provision for income taxes was $57,953 for fiscal 2003 as compared to $274,584 for fiscal 2002 and $194,953 for fiscal 2001. Our effective tax rate in fiscal 2003 was approximately 35% as compared to approximately 42% in fiscal 2002 and approximately 37% in fiscal 2001.
Net Income
Net income decreased to $108,925 for fiscal 2003, as compared to net income of $380,527 for fiscal 2002, and net income of $330,221 for fiscal 2001. Basic and diluted income per share was $0.01 for fiscal 2003 as compared to basic and diluted income per share of $.05 for fiscal 2002 and $.04 for fiscal 2001. Although we have been profitable on a quarterly basis since the third quarter of fiscal 2000, we cannot be sure that we can sustain profitability or achieve revenue growth.
Liquidity and Capital Resources
At the end of fiscal 2003, we had $3,560,999 in working capital compared to $3,628,465 at the end of fiscal 2002 and $3,233,806 at the end of fiscal 2001. The primary measures of our liquidity are cash, cash equivalents, accounts receivable and inventory balances, as well as our borrowing ability. The cash equivalents are highly liquid with original maturities of ninety days or less.
Cash used by operating activities was $9,009 for fiscal 2003 as compared to $1,059,755 generated in fiscal 2002. The cash used by operating activities was mainly attributable to increases in prepaid items of $135,205 and accounts receivable of $38,976 and a decrease in accounts payable and other expenses of $136,824, offset by operating profits net of adjustments for non-cash items and a decrease in inventory of $107,649.
In fiscal 2003, accounts receivable net of allowances increased by $38,796 to a total of $376,915 at the end of fiscal 2003. The increase in accounts receivable was principally due to the timing of shipments.
In fiscal 2003, inventories decreased by $107,649 to a total of $775,183 at the end of fiscal 2003 compared to $882,832 at the end of fiscal 2002. The decrease was primarily due to improved inventory management and reduced sales levels for fiscal 2003. Inventories were kept at these levels primarily to support anticipated future sales activity.
In fiscal 2003, we received net proceeds of $10,000 from the repayment of employee loans. We also used $66,017 for the purchase of equipment and intangible assets used in connection with the sale and marketing of the Bident(R) dental products and in connection with our manufacturing operations. Net property and equipment increased to $156,697 at the end of fiscal 2003 as compared to $136,131 for fiscal 2002.
In August 2002, our Board of Directors terminated our then existing stock repurchase plan and authorized a new repurchase plan to purchase up to 200,000 shares of our common stock. Cash used for financing activities was $173,316 in fiscal 2003 as a result of the repurchase of 127,600 shares of our common stock in fiscal 2003 pursuant to the stock repurchase plan. All 127,600 shares of common stock repurchased were retired or were in the process of being retired as of September 30, 2003. To date, we have repurchased 154,100 shares of
our common stock under the plan, leaving a balance of 45,900 that are available for repurchase under the plan.
At September 30, 2003, we had cash and cash equivalents of $2,305,556. We plan to finance our operating and capital needs principally with cash flows from operations and existing balances of cash and cash equivalents, which we believe will be sufficient to fund our operations in the near future. However, should it be necessary, we believe we could borrow adequate funds at competitive rates and terms. Our future liquidity and capital requirements will depend on numerous factors, including the funds we expend in marketing, selling and distributing our products, the success in commercializing our existing products, development and commercialization of products in other clinical markets, the ability of our suppliers to continue to meet our demands at current prices, the status of regulatory approvals and competition.
We have a line of credit of $1,000,000 with Wachovia Bank, N.A. which calls for interest to be charged at the bank's national commercial rate. The credit accommodation is unsecured and requires us to have a tangible net worth of no less than $3,000,000. Our current tangible net worth exceeds $3,000,000 at September 30, 2003. There was no outstanding balance on this line.
Non-Audit Services Performed by External Auditors
Pursuant to Section 10A(i)(2) of the Securities Exchange Act of 1934, as added by Section 202 of the Sarbanes-Oxley Act of 2002, we are responsible for disclosing to investors the non-audit services approved by our Audit Committee to be performed by Samuel Klein and Company, our external auditor. Non-audit services are defined in the law as services other than those provided in connection with an audit or a review of the financial statements of the company. During the period covered by this filing, our Audit Committee approved non-audit tax compliance services in connection with the preparation of our tax returns, which subsequently were or are being performed by Samuel Klein and Company.
Additional Cautionary Statements
We Face Intense Competition - ---------------------------
The markets for our current and potential products are intensely competitive. Some surgical procedures which utilize or could utilize our products could potentially be replaced or reduced in importance by products sold by other companies or alternative medical procedures or new drugs which could render our products obsolete or uncompetitive in the markets which we sell, or in the future may sell, our products.
We are Dependent Upon Sales of Our Neurosurgery System - Almost All of Our - -------------------------------------------------------------------------- Business in Fiscal 2003 Comes From One Customer - -----------------------------------------------
Codman & Shurtleff, Inc., which sells our products in the neurosurgery market, accounted for 95% of our sales in fiscal 2003, and 90% and 79% of our sales in fiscal 2002 and 2001, respectively. Any cancellation, deferral or significant reduction in sales in the neurosurgery market could seriously harm our business, financial condition and results of operations. The term or our current distribution agreement with Codman & Shurtleff, Inc. was recently extended from December 31, 2003 to March 31, 2004 to allow the parties time to continue to discuss the terms of a new distribution agreement. Increased sales
in the neurosurgery market are dependent on the acceptance of our new neurosurgical generators and disposable hand-held instruments in the marketplace.
Commercial Success of our Non-Neurosurgical Products is Uncertain - -----------------------------------------------------------------
Our growth depends on the acceptance of our products in the marketplace, the market penetration achieved by the companies that we utilize, sell to, and rely on, to sell and distribute our products, and our ability to introduce new and innovative products that meet the needs of medical professionals. There can be no assurance that we will be able to continue to introduce new and innovative products or that the products we introduce, or have introduced, will be widely accepted, or continue to be accepted, in the marketplace, or that we or companies, which we may contract with to distribute or sell our products, achieve market penetration. While we have developed several applications for our DualWave technology outside of neurosurgery and we believe that the products based on our technology offer advantages over other products, we cannot assure you that these advantages will be realized, or if realized, that these products will result in any meaningful benefits to physicians or patients.
We Have Limited Marketing and Sales Experience - ----------------------------------------------
We currently have limited experience in marketing and selling our products. To the extent that we have established or will enter into distribution arrangements for the sale of our products, we are and will be dependent upon the efforts of third parties. We have entered into a distribution agreement with Codman & Shurtleff, Inc. to sell our products in the neurosurgery market and we sell our Bident(R) Bipolar Tissue Management System through independent dental product dealers. We cannot assure you that these distributors and dealers will commit the necessary resources to effectively market and sell our neurosurgery and dental product lines, or that they will be successful in selling our products. To the extent our marketing and sales efforts are unsuccessful, our business, financial condition, results of operations and future growth prospects may be materially adversely affected.
Our Products are Extensively Regulated Which Could Delay Product Introduction or - -------------------------------------------------------------------------------- Halt Sales - ----------
The process of obtaining and maintaining required regulatory approvals is lengthy, expensive and uncertain. Although we have not experienced any substantial regulatory delays to date, there is no assurance that delays will not occur in the future, which could have a significant adverse effect on our ability to introduce new products on a timely basis. Regulatory agencies periodically inspect our manufacturing facilities to ascertain compliance with "good manufacturing practices" and can subject approved products to additional testing and surveillance programs. Failure to comply with applicable regulatory requirements can, among other things, result in fines, suspensions of regulatory approvals, product recalls, operating restrictions and criminal penalties. While we believe that we are currently in compliance, if we fail to comply with regulatory requirements, it could have an adverse effect on our results of operations and financial condition.
We are Dependent on Key Suppliers - ---------------------------------
For some of the components we use in our products we rely upon single source suppliers or a single contract manufacturer. For example, we currently subcontract the manufacturer of our disposable cord and tubing sets with a
single manufacturer. While we believe there are alternative sources available, we would be required to qualify and validate a new supplier(s) or contractor(s), which could lead to a disruption in our operations and ability to supply product for a period of time.
We Face Uncertainty Over Reimbursement - --------------------------------------
Failure by physicians, hospitals and other users of our products to obtain sufficient reimbursement from health care payors for procedures in which our products are used or adverse changes in governmental and private third-party payors' policies toward reimbursement for such procedures would have a material adverse effect on our business, financial condition, results of operations and future growth prospects.
We May Be Unable to Effectively Protect Our Intellectual Property - -----------------------------------------------------------------
Our ability to compete effectively depends in part on developing and maintaining the proprietary aspects of our bipolar technology. We cannot assure you that the patents we have obtained, or any patents we may obtain, will provide any competitive advantages for our products, or that we will be able to maintain a competitive advantage after our patents expire. We also cannot assure you that those patents will not be successfully challenged, invalidated or circumvented in the future. In addition, we cannot assure you that competitors, many of which have substantial resources and have made substantial investments in competing technologies, have not already applied for or obtained, or will not seek to apply for and obtain, patents that will prevent, limit or interfere with our ability to make, use and sell our products either in the United States or in international markets. Patent applications are maintained in secrecy for a period after filing. We may not be aware of all of the patents and patent applications potentially adverse to our interests.
We May Become Subject to a Patent Litigation - --------------------------------------------
The medical device industry has been characterized by extensive litigation regarding patents and other intellectual property rights, and companies in the medical device industry have employed intellectual property litigation to gain a competitive advantage. We cannot assure you that we will not become subject to patent infringement claims or litigation or interference proceedings declared by the United States Patent and Trademark Office to determine the priority of invention.
We May have Product Liability Claims - ------------------------------------
Our products involve a risk of product liability claims. Although we maintain product liability insurance at coverage levels, which we believe are adequate, there is no assurance that, if we were to incur substantial liability for product liability claims, insurance would provide adequate coverage against such liability.
Our Operating Results May Fluctuate - -----------------------------------
We have experienced operating losses at various times since our inception. Our results of operations may fluctuate significantly from quarter to quarter based on numerous factors including the following:
o the introduction of new product lines; o the level of market acceptance of our products; o achievement of research and development milestones; o timing of the receipt of orders from, and product shipments to, distributors and customers; o timing of expenditures; o changes in the distribution of our products; o manufacturing or supply delays; o the time needed to educate and train a distributor's sales force; o costs associated with product introduction; o product returns; and o receipt of necessary regulation approvals.
The Market Price of Our Stock May be Highly Volatile - ----------------------------------------------------
During the fiscal year ended September 30, 2003, our common stock has traded in a range of $1.15 and $1.88 per share. The market price of our common stock could continue to fluctuate substantially due to a variety of factors, including:
o Our ability to successfully commercialize our operations; o The execution of new agreements and material changes in our relationships with companies with whom we contract; o Quarterly fluctuations in results of operations; o Announcements regarding technological innovations or new commercial products by us or our competitiors or the results of regulatory approval filings; o Market reaction to trends in sales, marketing and research and development and reaction to acquisitions; o Sales of common stock by existing stockholders; and o Economic and political conditions.
Item 7A.
Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. - ------- ----------------------------------------------------------
Not Applicable.
Item 8.
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. - ------ -------------------------------------------
See Index to Financial Statements and Financial Statement Schedules on page herein. Selected quarterly financial data is set forth in Note 16 to the Financial Statements.
Item 9.
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING - ------ ----------------------------------------------------------- AND FINANCIAL DISCLOSURE. - ------------------------
Not applicable.
Item 9A.
Item 9A. CONTROLS AND PROCEDURES - ------- -----------------------
We maintain disclosure controls and procedures (as defined in Securities Exchange Act 1934 Rules 13a-14(c) and 15d-14(c)) that are designed to ensure that the information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission's rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding disclosure. In designing and evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management necessarily was required to apply its judgment in evaluating the cost benefit relationship of possible controls and procedures.
Within 90 days prior to the filing of this annual report, we carried out an evaluation, under the supervision and with the participation of the Company's management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures. Based on the foregoing, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective. There have been no significant changes in the Company's internal controls or in other factors that could significantly affect internal controls subsequent to the date of his evaluation. There were no significant deficiencies or material weaknesses, and therefore no corrective actions were taken.
PART III --------
Item 10.
Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT. - ------- --------------------------------------------------
The information concerning directors and executive officers of Valley Forge Scientific Corp. is incorporated by reference to the information set forth either: (i) in our Definitive Proxy Statement for our 2004 Annual Meeting of Stockholders, or (ii) in an amendment to this Annual Report on Form 10-K (collectively the "2003 Proxy Information"), which in either case will be filed within 120 days after the end of the fiscal year covered by this Annual Report on Form 10-K.
Item 11.
Item 11. EXECUTIVE COMPENSATION. - ------- ----------------------
The information regarding executive compensation is incorporated by reference to the information set forth in the 2003 Proxy Information.
Item 12.
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT - ------- -------------------------------------------------------------- AND RELATED STOCKHOLDER MATTERS. - -------------------------------
The information concerning the security ownership of certain beneficial owners and management and related stockholder matters is incorporated by reference to the information set forth in the 2003 Proxy Information.
Item 13.
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. - ------- ----------------------------------------------
The information concerning certain relationships and related transactions is incorporated by reference to the information set forth in the 2003 Proxy Information.
Item 14.
Item 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES - ------- --------------------------------------
The information required to be disclosed concerning principal accountant fees and services is incorporated by reference to the information set forth in the 2003 Proxy Information.
PART IV -------
Item 15
Item 15 EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM - ------- ----------------------------------------------------------- 8-K. - ---
a. and d. Financial Statements and Financial Statement Schedules.
See Index to Financial Statements and Financial Statement Schedules on Page, herein.
b. Reports on Form 8-K.
On August 12, 2003, Valley Forge Scientific Corp. filed a report on Form 8-K regarding a press release regarding third quarter and nine month operating results for fiscal 2003
c. Exhibits
The following is a list of exhibits filed as part of this annual report on Form 10-K. Where so indicated by footnote, exhibits which were previously filed are incorporated by reference. For exhibits incorporated by reference, the location of the exhibit in the previous filing is indicated in parentheses.
2.1 Agreement and Plan of Merger between Valley Forge Scientific Corp. and Diversified Electronic Corporation dated August 31, 1994. (3)
3.1 Articles of Incorporation, restated to include amendment to Articles of Incorporation dated August 26, 1999. (8) (Exhibit 3(a))
3.2 Second Amended and Restated By-Laws of the Company. (12)
4.1 Form of Common Stock Certificate - (1) (Exhibit 4(a)).
10.1 Valley Forge Scientific Corp. 2001 Stock Plan (10)
10.2 Valley Forge Scientific Corp. 2000 Nonemployee Directors Stock Option Plan (11)
10.3 Assignment of Know-How Agreement, dated June 30, 1989 - (1) (Exhibit 10(g)).
10.4 Assignment of Patents - Bipolar Electrosurgical Systems, June 30, 1989 - (1) (Exhibit 10(h)).
10.5 Assignment of Patents - Binocular Magnification System, June 30, 1989 -(1) (Exhibit 10(i)).
10.6 Assignment of Malis trade name, dated June 30, 1989 - (1) (Exhibit 10(j)).
10.7 401(k) and Profit-Sharing Plan - (2) (Exhibit 10(x)).
10.8 Promissory Note from Jerry L. Malis to the Company. (4) (Exhibit 10(k))
10.9 Commercial Lease Agreement between GMM Associates and the Company dated July 1, 1995 (5) (Exhibit 10(p))
10.10 Promissory Note from Jerry L. Malis to the Company (7) (Exhibit 10(p)).
10.11 Distribution Agreement between the Company and Codman & Shurtleff, Inc., dated December 11, 2000 (9) (Exhibit 10.1)
10.12 Addendum to Commercial Lease Agreement between the Company and GMM Associates dated as of July 1, 2000 (9) (Exhibit 10.2)
10.13 Extension of Distribution Agreement with Codman & Shurtleff, Inc. dated November 21, 2003
21 Subsidiary of Registrant
23 Consent of Samuel Klein and Company
31.1 Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1 Certification of the Chief Executive Officer to Section 906 of the Sarbanes- Oxley Act of 2002.
- -----------------
(1) Previously filed with the Registration Statement of the Company on Form S-18, Registration No. 33-31008-NY, and incorporated herein by reference. (2) Previously filed with the Registration Statement of the Company on Form S-18, Registration No. 33-35668-NY, and incorporated herein by reference. (3) Previously filed with the Company's Form 8-K dated August 31, 1994, and incorporated herein by reference.
(4) Previously filed with the Company's Form 10-K for the year ended September 30, 1994, and incorporated herein by reference. (5) Previously filed with the Company's Form 10-K for the year ended September 30, 1995, and incorporated herein by reference. (6) Previously filed with the Company's Form 10-K for the year ended September 30, 1997, and incorporated herein by reference. (7) Previously filed with the Company's Form 10-K for the year ended September 30, 1998 and incorporated herein by reference. (8) Previously filed with the Company's Form 10-K for the year ended September 30, 1999 and incorporated herein by reference. (9) Previously filed with the Company's Form 10-Q for the quarter ended December 31, 2000, and incorporated herein by reference. (10) Previously filed with the Registration Statement of the Company on Form S-8 Registration No.333-72296, filed on October 26, 2001 and incorporated herein by reference (11) Previously filed with the Registration Statement of the Company on Form S-8 Registration No.333-72134, filed on October 24, 2001 and incorporated herein by reference. (12) Previously filed with the Company's Form 10-K for the year ended December 31, 2001 and incorporated herein by reference.
SIGNATURES
Pursuant to the requirements of the Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized on this 19th day of December, 2003
VALLEY FORGE SCIENTIFIC CORP.
By: /s/ JERRY L. MALIS ----------------------------------- Jerry L. Malis, President
Pursuant to the requirements of the Securities Act of 1934, this report has been signed by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
Signature Title Date --------- ----- ----
/s/ JERRY L. MALIS Chairman of the Board, December 19, 2003 - --------------------- President (chief executive Jerry L. Malis officer and principal financial and accounting officer)
/s/ LOUIS UCHITEL Director December 19, 2003 - --------------------- Louis Uchitel
/s/ LEONARD I. MALIS Director December 19, 2003 - --------------------- Leonard I. Malis
/s/ BRUCE A. MURRAY Director December 19, 2003 - --------------------- Bruce A. Murray
/s/ ROBERT H. DICK Director December 19, 2003 - --------------------- Robert H. Dick
VALLEY FORGE SCIENTIFIC CORP. For Fiscal Year Ended September 30, 2003 FORM 10-K Index to Financial Statements and Financial Statement Schedules
Independent Auditor's Report
Balance Sheets - September 30, 2003 and 2002
Statements of Operations - Years ended September 30, 2003, 2002 and 2001
Statements of Stockholders' Equity - Years ended September 30, 2003, 2002 and 2001
Statements of Cash Flows - Years ended September 30, 2003, 2002 and 2001
Notes to Financial Statements
- --------------
All other schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are not required under the related instructions or are not applicable, and therefore have been omitted.
INDEPENDENT AUDITOR'S REPORT
The Board of Directors and Stockholders Valley Forge Scientific Corp. and Subsidiary Oaks, Pennsylvania
We have audited the accompanying consolidated balance sheets of Valley Forge Scientific Corp. and Subsidiary as of September 30, 2003 and 2002 and the related consolidated statements of operations, stockholders' equity and cash flows for each of the three years in the period ended September 30, 2003. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Valley Forge Scientific Corp. and Subsidiary as of September 30, 2003 and 2002, and the results of operations and cash flows for each of the three years in the period ended September 30, 2003, in conformity with accounting principles generally accepted in the United States of America.
/s/ Samuel Klein and Company
SAMUEL KLEIN AND COMPANY
Newark, New Jersey December 5, 2003
VALLEY FORGE SCIENTIFIC CORP. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
September 30, ----------------------- ASSETS 2003 2002 - ------ ---------- ----------
Current Assets: Cash and cash equivalents $2,305,556 $2,543,898 Accounts receivable, net 376,915 337,939 Inventory 775,183 882,832 Prepaid items and other current assets 268,371 140,784 Deferred tax assets 51,431 76,293 ---------- ---------- Total Current Assets 3,777,456 3,981,746
Property, Plant and Equipment, Net 156,697 136,131 Goodwill 153,616 153,616 Intangible Assets, Net 256,681 294,371 Other Assets 29,963 4,171 ---------- ----------
Total Assets $4,374,413 $4,570,035 ========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY - ------------------------------------
Current Liabilities: Accounts payable and accrued expenses $ 216,457 $ 200,972 Income taxes payable -- 152,309 ---------- ---------- Total Current Liabilities 216,457 353,281
Deferred Tax Liability 19,950 14,357 ---------- ----------
Total Liabilities 236,407 367,638 ---------- ----------
Commitments and Contingencies
Stockholders' Equity: Preferred stock -- -- Common stock (no par, 20,000,000 shares authorized, shares issued and outstanding at September 30, 2003 - 7,913,712 and at September 30, 2002 - 8,041,312) 3,528,530 3,701,846 Retained earnings 609,476 500,551 ---------- ---------- 4,138,006 4,202,397 ---------- ----------
Total Liabilities and Stockholders' Equity $4,374,413 $4,570,035 ========== ==========
- --------------------
The accompanying notes are an integral part of these financial statements.
VALLEY FORGE SCIENTIFIC CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
For the Years Ended September 30, ------------------------------------ 2003 2002 2001 ---------- ---------- ----------
Net Sales $4,474,308 $5,021,931 $5,263,485
Cost of Sales 2,264,902 2,463,209 2,692,036 ---------- ---------- ----------
Gross Profit 2,209,406 2,558,722 2,571,449 ---------- ---------- ----------
Other Costs: Selling, general and administrative 1,523,751 1,503,001 1,652,289 Research and development 489,930 360,111 352,773 Amortization 40,298 63,610 80,641 ---------- ---------- ---------- Total Other Costs 2,053,979 1,926,722 2,085,703 ---------- ---------- ----------
Income from Operations 155,427 632,000 485,746
Other Income (Expense), Net 11,451 23,111 39,428 ---------- ---------- ----------
Income before Income Taxes 166,878 655,111 525,174
Provision for Income Taxes 57,953 274,584 194,953 ---------- ---------- ----------
Net Income $ 108,925 $ 380,527 $ 330,221 ========== ========== ==========
Income per Share: Basic income per common share $ 0.01 $ 0.05 $ 0.04 ========== ========== ==========
Diluted income per common share $ 0.01 $ 0.05 $ 0.04 ========== ========== ==========
Basic weighted average common shares outstanding 7,960,676 8,067,286 8,081,890
Diluted weighted average common shares outstanding 7,986,448 8,154,570 8,152,946
- --------------------
The accompanying notes are an integral part of these financial statements.
VALLEY FORGE SCIENTIFIC CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED SEPTEMBER 30, 2003, 2002 AND 2001
- --------------------
The accompanying notes are an integral part of these financial statements.
VALLEY FORGE SCIENTIFIC CORP. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
- --------------------
The accompanying notes are an integral part of these financial statements.
VALLEY FORGE SCIENTIFIC CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The Company - -----------
Valley Forge Scientific Corp. ("VFSC") was incorporated on March 27, 1980 in the Commonwealth of Pennsylvania and is engaged in the business of developing, manufacturing and selling medical devices and products. On August 18, 1994, VFSC formed a wholly-owned subsidiary, Diversified Electronics Company, Inc. ("DEC"), a Pennsylvania corporation, in order to continue the operations of Diversified Electronics Corporation, a company which was merged with and into VFSC on August 31, 1994. VFSC and DEC are referred to herein as the "Company".
Principles of Consolidation and Basis of Presentation - -----------------------------------------------------
The accompanying financial statements consolidate the accounts of the parent company and its wholly-owned subsidiary. All significant intercompany accounts and transactions have been eliminated in consolidation.
Use of Management's Estimates - -----------------------------
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Cash and Cash Equivalents - -------------------------
The Company considers cash equivalents to be all highly liquid investments with original maturities of three months or less. Substantially all cash and cash equivalents are held in one major financial institution.
Segment Information - -------------------
The Company has one operating segment comprised of its bipolar electrical generators and instrumentation products. The Company's business is conducted entirely in the United States. Major customers are discussed elsewhere in Note 11.
Fair Value of Financial Instruments - -----------------------------------
Carrying amounts of certain of the Company's financial instruments, including cash and cash equivalents, trade receivables, accounts payable and other accrued expenses approximate fair value because of their short maturities.
Revenue Recognition - -------------------
The Company sells its products to U.S. based national and international dealers and distributors which include an affiliate of a major medical products company. A significant part of the Company's sales are made pursuant to distribution agreements with these Companies which typically provide exclusive distribution rights of specified products in a defined medical field, within a territory or territories, during the term of such agreements. The agreements typically include a price list for the specified product or products which is fixed for a period of time, after which these prices are subject to adjustment by the Company due to changes in manufacturing cost or technological improvements to the products.
VALLEY FORGE SCIENTIFIC CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
1. THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Revenue Recognition (Continued) - -------------------
Product revenue is recognized when the product has been shipped which is when the title and risk of loss has been transferred to the customer. Service revenue substantially relates to repairs of product and is recognized when the service has been completed. Revenues from license and royalty fees are recorded when earned.
The Company reduces revenue for customer returns and allowances. In addition, the Company accrues for warranty cost and other allowances based on its experience and reflects these accruals in cost of sales or administrative expense as applicable.
The Company adopted Staff Accounting Bulletin No. 101 "Revenue Recognition in Financial Statements" (SAB 101) in the first quarter of fiscal year ended September 30, 2001. The adoption of SAB 101 did not have a material impact on the Company's financial position or results of operations.
Inventory - ---------
Inventory is stated at the lower of cost, determined by the moving average cost method, or market. The Company provides inventory allowances based on slow-moving and obsolete inventories.
Property, Plant and Equipment - -----------------------------
Property, plant and equipment are recorded at cost. Depreciation is computed by the straight-line method over the estimated useful lives of the assets, which vary from three to thirty-nine years. Leasehold improvements are being amortized over the related lease term or estimated useful lives, whichever is shorter.
Upon retirement or other disposition of these assets, the cost and related accumulated depreciation are removed from the accounts and the gains or losses are reflected in the results of operations. Routine maintenance and repairs are charged to expense as incurred.
Intangible Assets and Goodwill - ------------------------------
Intangible assets, consisting of patents, licensing agreements, proprietary know-how, logos and cost of acquisition are amortized to operations under the straight-line method over their estimated useful lives or statutory lives, whichever is shorter. Acquisition costs have been capitalized and are being amortized over 5 years. All other intangible assets, except for goodwill, are being amortized over periods ranging from 15 to 17 years.
As of October 1, 2001, the Company early-adopted Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets" (SFAS 142), which addresses the financial accounting and reporting standards for goodwill and other intangible assets subsequent to their acquisition. This accounting standard requires that goodwill no longer be amortized, and instead, be tested for impairment on a periodic basis. Pursuant to adoption of this accounting standard, a transitional impairment test was completed, and no impairment was identified.
In accordance with SFAS 142, the Company discontinued the amortization of goodwill effective October 1, 2001.
VALLEY FORGE SCIENTIFIC CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
1. THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Intangible Assets and Goodwill (Continued) - ------------------------------
A reconciliation of previously reported net income and earnings per share to the amounts adjusted for the exclusion of goodwill amortization, net of the related income tax effect, is shown in Note 5.
Impairment of Long-Lived Assets - -------------------------------
As of October 1, 2002, the Company adopted Statement of Financial Accounting Standards No. 144, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of", (SFAS 144). Pursuant to SFAS 144 long-lived assets, or asset groups and certain identifiable intangible assets to be held and used are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable. Determination of recoverability is based on an estimate of undiscounted cash flows resulting from the use of the asset, or asset groups, and its eventual disposition. Measurement of an impairment loss for long-lived assets, or asset groups, and certain identifiable intangible assets that management expects to hold and use is based on the fair value of the asset. Long-lived assets, or asset groups and certain identifiable intangible assets to be disposed of are reported at the lower of carrying amount or fair value less costs to sell.
Research and Development - ------------------------
Costs associated with development of new products are charged to operations as incurred.
Advertising Costs - -----------------
Advertising expenditures relating to the advertising and marketing of the Company's products and services are expensed in the period the advertising costs are incurred. Prior to 2003, substantially all cost of such product marketing and advertising had been borne by the Company's major distributors. During the year ended September 30, 2003, due to the Company's strategy shift to market and sell the Bident Dental Products utilizing the Company's proprietary resources, the Company incurred marketing and advertising costs of approximately $161,000.
Income Taxes - ------------
Tax provisions and credits are recorded at enacted tax rates for taxable items included in the consolidated statements of operations regardless of the period for which such items are reported for tax purposes. Deferred tax assets and liabilities are determined based on the differences between the financial statement and tax bases of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. Deferred tax assets are reduced by a valuation allowance when the determination can be made that it is more likely than not that some portion or all of the related tax assets will not be realized.
Comprehensive Income - --------------------
The Company reports components of comprehensive income under the requirements of Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income" (SFAS 130). This statement establishes rules for the reporting of comprehensive income and its components which require that certain items such as foreign currency translation adjustments, unrealized gains and losses on certain investments in debt and equity securities, minimum pension liability adjustments and unearned compensation expense related to stock issuances to employees be presented as separate components of stockholders' equity.
VALLEY FORGE SCIENTIFIC CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
1. THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Earnings per Share - ------------------
The Company computes earnings per share in accordance with Statement of Financial Accounting Standards No. 128, "Earnings Per Share" (SFAS 128). Basic earnings per share is computed by dividing income available to common stockholders by the weighted average number of common shares outstanding. Diluted earnings per share reflects the potential dilution that could occur if securities or other agreements to issue common stock were exercised or converted into common stock. Diluted earnings per share is computed based upon the weighted average number of common shares and dilutive common equivalent shares outstanding, which include convertible debentures, stock options and warrants.
Accounting for Stock-Based Compensation - ---------------------------------------
In December, 2002, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure - an amendment of FASB Statement No. 123" (SFAS 148). SFAS 148 amends SFAS 123, "Accounting for Stock-Based Compensation", to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, SFAS 148 amends the disclosure requirements of SFAS 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. SFAS 148 was effective for the Company as of January 1, 2003. The Company has not elected a voluntary change in accounting to the fair value based method, and accordingly, the adoption of SFAS 148 did not have any impact on the Company's results of operations or financial position.
Employee stock plans are accounted for using the intrinsic value method prescribed by Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees", (APB 25). The Company utilizes the Black-Scholes option valuation model to value stock options for pro forma presentation of income and per share data as if the fair value based accounting method in SFAS 123 had been used to account for stock-based compensation. For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options' vesting periods. In accordance with SFAS 123, only stock options granted after September 30, 1995 have been included for the Company's pro forma information as follows:
For the Years Ended September 30, --------------------------------------- 2003 2002 2001 ----------- ----------- -----------
Additional compensation expense, net of tax effect $ 57,180 $ 89,333 $ 56,328 Pro forma net income 51,745 $ 291,194 $ 273,893 Pro forma income per share: Basic 0.01 0.04 0.03 Diluted 0.01 0.04 0.03
VALLEY FORGE SCIENTIFIC CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
1. THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Recent Accounting Pronouncements - --------------------------------
In January, 2003, the FASB issued Interpretation No. 46, "Consolidation of Variable Interest Entities - an Interpretation of ARB No. 51, which provides guidance on the identification of and reporting for variable interest entities. Interpretation No. 46 expands the criteria for consideration in determining whether a variable interest entity should be consolidated. Interpretation No. 46 is effective immediately for variable interest entities created after January 31, 2003, and to variable interest entities in which an enterprise obtains an interest after that date. The Company does not expect the adoption of Interpretation No. 46 to have a significant impact on its future results of operations or financial position.
In May, 2003, the FASB issued SFAS 150, "Accounting for Certain Financial Instruments with characteristics of both Liabilities and Equity." SFAS 150 requires that certain financial instruments, which under previous guidance could be accounted for as equity, be classified as liabilities in statements of financial position (balance sheets). SFAS 150 is effective for financial instruments entered into or modified after May 31, 2003, and is otherwise effective for the Company in the first quarter of the year ending September 30, 2004. The adoption of SFAS 150 had no impact on the Company's financial position or results of operations for the year ended September 30, 2003, and the Company does not expect the adoption of this pronouncement to have any impact on its future financial position or results of operations.
2. ACCOUNTS RECEIVABLE
The Company provides an allowance for doubtful accounts equal to the estimated uncollectible amounts. The Company's estimate is based on historical collection experience and a review of the current status of trade accounts receivable. It is reasonably possible that the Company's estimate of the allowance for doubtful accounts will change. Accounts receivable consists of the following:
September 30, ----------------------- 2003 2002 ---------- ----------
Accounts receivable $ 378,786 $ 385,483 Less: Allowances 1,871 47,544 ---------- ----------
$ 376,915 $ 337,939 ========== ==========
The Company provided for estimated doubtful accounts through charges to selling, general and administrative expenses for $ - 0 - , $50,003 and $26,316 for the years ended September 30, 2003, 2002 and 2001, respectively, and wrote-off $ - 0 - - , $34,375 and $19,400, respectively, against this allowance for these periods.
In addition, during the year ended September 30, 2003, the Company recorded a benefit of $43,000 arising from the collection of an account receivable which had been previously provided for, and further reduced the allowance by approximately $2,700.
VALLEY FORGE SCIENTIFIC CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
3. INVENTORY
The Company provides an allowance for slow moving and potentially obsolete inventories. Inventory consists of the following:
September 30, ----------------------- 2003 2002 ---------- ----------
Finished goods $ 88,401 $ 87,748 Work-in-process 316,600 368,068 Materials and parts 433,459 515,586 Less: Allowance for slow moving and obsolete inventory 63,277 88,570 ---------- ----------
$ 775,183 $ 882,832 ========== ==========
The Company provided for obsolete and slow moving inventory through charges to cost of sales for $109,635, $52,875 and $22,500 in the years ended September 30, 2003, 2002 and 2001, respectively, and wrote off $134,928, $41,183 and $110,621, respectively, against this allowance in these periods.
4. PROPERTY, PLANT AND EQUIPMENT
September 30, Useful Life ----------------------- (Years) 2003 2002 ------- ---------- ----------
Land - $ 11,953 $ 11,953 Buildings and improvements 15 - 39 94,832 94,832 Furniture and fixtures 5 - 7 17,953 17,953 Laboratory equipment 5 - 10 370,119 357,544 Office equipment 5 181,318 146,984 Leasehold improvements 3 - 5 9,413 9,413 ---------- ---------- 685,588 638,679 Less: Accumulated depreciation and amortization 528,891 502,548 ---------- ----------
$ 156,697 $ 136,131 ========== ==========
Depreciation is reflected in both cost of sales and selling, general and administrative expenses. Total depreciation for the years ended September 30, 2003, 2002 and 2001 was $26,343, $21,174 and $37,961, respectively. In addition, in accordance with SFAS 144, the Company wrote down certain molding equipment intended to be utilized in the production of certain disposable surgical products, to their estimated fair values. For the years ended September 30, 2003, 2002 and 2001, the Company wrote down $16,500, $5,300 and $ - 0 - , respectively. These write downs are reflected in the statement of operations under the caption "Other Income (Expense), Net".
VALLEY FORGE SCIENTIFIC CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
5. GOODWILL
As indicated in Note 1 - Significant Accounting Policies, pursuant to SFAS 142, the Company discontinued the amortization of goodwill effective October 1, 2001, and completed the transitional test for impairment of the carrying value of this asset as of March 31, 2002. Another impairment test was conducted as of March 31, 2003, and no impairment was identified.
As required by SFAS 142, a reconciliation of previously reported net income and earnings per share to the amounts adjusted for the exclusion of goodwill amortization, net of related income tax effect follows:
6. INTANGIBLE ASSETS
Intangible assets consist of the following:
September 30, Useful Life ----------------------- (Years) 2003 2002 ------- ---------- ----------
Patents/trademarks/logos, licensing agreements 17 $ 571,617 $ 569,009 Proprietary know-how 15 452,354 452,354 Acquisition costs 5 55,969 55,969 ---------- ---------- 1,079,940 1,077,332 Less: Accumulated amortization 823,259 782,961 ---------- ----------
$ 256,681 $ 294,371 ========== ==========
Total amortization for the years ended September 30, 2003, 2002 and 2001 was $40,298, $63,610 and $63,084, respectively. Amortization for the years ended September 30, 2004, 2005, 2006, 2007 and 2008 is estimated to be $40,298, $40,298, $40,280, $39,939 and $39,939, respectively.
VALLEY FORGE SCIENTIFIC CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
6. INTANGIBLE ASSETS (Continued)
During the current fiscal year a patent for the technology underlying the "aperiodic" wave form utilized in some of the Company's products expired. The remaining patent, which relates to the Company's current bi-polar generators expires in the fiscal year ending September 30, 2011.
7. OTHER RECEIVABLES
The Company from time to time has made advances and loans to certain employees. These loans and advances are unsecured, payable on demand and have stated interest rates ranging from 4.57% to 8.20%, the then current "Applicable Federal Rate" as set forth under the Internal Revenue Code as of each date of advance or loan. During the fourth quarter of fiscal year ending September 30, 2001, as a result of the termination subsequent to year end of an employee from whom approximately $49,500 remained outstanding, the Company recorded an allowance of approximately $48,400 against the amount owed by this individual. The outstanding balance was received in the first quarter of the subsequent fiscal year.
As of September 30, 2003 and 2002, the balance of these loans net of the allowances was $ - and $ - , respectively.
8. RELATED PARTY TRANSACTIONS
Loans Receivable - ----------------
On July 6, 1998, Jerry L. Malis, a principal shareholder, director and officer of the Company, borrowed $15,015 from the Company. The note is payable on demand and has a stated rate of interest of 5.42%, the then current "Applicable Federal Rate" as set forth under the Internal Revenue Code. The Company has additional loans due from Jerry L. Malis payable on demand with similar interest terms as stated above ranging from 4.83% to 6.97%. The collective loans, which total $45,979 as of September 30, 2003, are partially secured by 5,833 shares of common stock of the Company. As of September 30, 2003 the pledged stock had a value of approximately $8,750.
The balance of these loans is reflected on the balance sheet under the caption "prepaid expenses and other current assets" and as of September 30, 2003 and 2002, was $45,979 and $53,597, respectively, which includes accrued interest of $18,148 and $15,762, respectively.
Consulting Services - -------------------
During 2003, 2002 and 2001 the Company engaged R.H. Dick and Company, Inc., a corporation owned by Robert H. Dick, a director of the Company, to provide certain investment banking and consulting services. For the years ended September 30, 2003, 2002 and 2001 the Company incurred consulting fees for these services, excluding reimbursement of out-of-pocket expenses in an amount totaling $10,000, $10,000 and $15,000, respectively. As of September 30, 2003 and 2002, the Company owed R.H. Dick and Company $5,000 and $2,500, respectively. The liability is reflected on the balance sheet under the caption "accounts payable and accrued expenses".
VALLEY FORGE SCIENTIFIC CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
9. LINE OF CREDIT
The Company has a line of credit of $1,000,000 with Wachovia Bank, formerly First Union National Bank, which calls for interest to be charged on any loans under this line equal to the bank's national commercial rate. The line is unsecured and any borrowing under the line would be payable on demand, require monthly interest payments on any unpaid principal and a reduction of any loan balance to zero for a minimum of thirty consecutive days during each twelve month period. In addition, the loan covenant calls for a minimum tangible net worth of no less than $3,000,000 during the term of the extended line of credit. At September 30, 2003 and 2002, there were no outstanding balances under this line.
10. COMMITMENTS AND CONTINGENCIES
Litigation - ----------
The Company is subject from time to time to litigation arising from the normal course of business. In management's opinion, any such contingencies would be covered under its existing insurance policies or would not materially affect the Company's financial position or results of operations.
On July 25, 2001 the Company was named as a defendant in a lawsuit filed in the United States District Court for the Eastern District of Pennsylvania by a former employee alleging gender discrimination and sexual harassment. On March 2, 2002 the Company, without admitting any liability, entered into a settlement agreement and pursuant to this agreement, paid the plaintiff $37,000, an amount which was net of certain amounts due from this party. This payment is reflected in other costs under selling, general and administrative expenses for the year ended September 30, 2002.
On September 19, 2002, the Company was served with a complaint that was filed in the Superior Court of the State of Arizona, County of Maricopa, entitled Jeffrey Turner and Cathryn Turner et al v. Phoenix Children's Hospital, Inc., et al, (CV 2002-010791) in which the Company was named as one of the defendants. The plaintiffs seek an unspecified amount of damages for alleged injuries sustained in a surgery that took place in June 2000. The Company's product liability insurance carrier is providing the Company's defense in this matter. This insurance coverage has a $10,000 deductible that applies to attorney fees and damages which has been provided for in other costs under selling, general and administrative expense for the year ended September 30, 2002. In an answer that was filed on November 26, 2002, the Company denied any liability. The Company believes the claim is without merit and will vigorously defend itself in this action.
Regulatory Compliance - ---------------------
The Company is subject to regulatory requirements throughout the world. In the normal course of business, these regulatory agencies may require companies in the medical industry to change their products or operating procedures, which could affect the Company. The Company regularly incurs expenses to comply with these regulations and may be required to incur additional expenses. Management is not able to estimate any additional expenditures outside the normal course of operations which will be incurred by the Company in future periods in order to comply with these regulations.
VALLEY FORGE SCIENTIFIC CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
10. COMMITMENTS AND CONTINGENCIES (Continued)
Employment Agreements - ---------------------
On September 30, 1999, the Company entered into one year employment agreements with Messrs. Malis and Gilloway effective October 1, 1999. Under the terms, the agreements provided for an annual base salary of $198,950 for Jerry L. Malis and $90,000 for Thomas J. Gilloway. Although the agreements for Messrs. Malis and Gilloway had not been further extended, the Company continued to provide compensation to them at the annual rate of $198,950 and $90,000, respectively. Effective October 1, 2002 the Compensation Committee of the Board of Directors approved an increase of Mr. Malis's base salary to $220,000. The base salaries for the years ended September 30, 2003, 2002 and 2001 were approximately $220,000, $199,000 and $199,000 for Jerry L. Malis and approximately $ - , $ - and $69,000 for Thomas J. Gilloway, respectively. Mr. Gilloway passed away on February 18, 2001 and the Company continued to pay his salary to his spouse until June 29, 2001. The amount reflected as paid to him for the year ended September 30, 2001 includes the amount paid to his spouse subsequent to his death.
Subsequent to September 30, 2002, the Compensation Committee of the Board of Directors approved a $25,000 cash bonus to Mr. Malis for services rendered during the year ended September 30, 2002. The bonus was accrued for the year ended September 30, 2002 and is reflected on the balance sheet under the caption "accounts payable and accrued expenses".
401(k) Profit Sharing Plans - ---------------------------
The Company's 401(k) Plan and Profit Sharing Plan cover full-time employees who have attained the age of 21 and have completed at least one year of service with the Company. Under the 401(k) Plan, an employee may contribute an amount up to 25% of his compensation to the Plan on a pretax basis not to exceed the current Federal limitation per year (as adjusted for cost of living increases). Amounts contributed to the 401(k) Plan are nonforfeitable.
Under the Profit Sharing Plan, a member in the plan participates in the Company's contributions to the Plan as of December 31 in any year, with allocations to individual accounts based on annual compensation. An employee does not fully vest in the plan until completion of three years of employment. The Board of Directors determines the Company's contributions to the plan on a discretionary basis. The Company has not made any contributions to date.
Stock Option Plans - ------------------
On July 6, 1988, the Company adopted a Nonqualified Employee Stock Option Plan (the "1988 Plan") pursuant to which 500,000 shares of Common Stock have been reserved for issuance to employees, officers, directors or consultants of the Company. Options granted pursuant to this plan were nontransferable and expired if not exercised after ten years from the date of grant or for such lesser term as approved by the Board of Directors. Options may be granted in such amounts and at such prices as determined by the Board of Directors, but the price per share shall not be less than the fair market value of the Company's Common Stock as of the date of grant.
On January 16, 2001, pursuant to the adoption of the 2001 Stock Plan (the "2001 Plan"), the 1988 plan was terminated. As of the date the plan was terminated, a total of 404,800 options had been granted and were outstanding.
VALLEY FORGE SCIENTIFIC CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
10. COMMITMENTS AND CONTINGENCIES (Continued)
Stock Option Plans (Continued) - ------------------
On December 12, 2000, the Company adopted a Non-employee Directors Stock Option Plan ("Directors Plan") pursuant to which 150,000 shares of Common Stock have been reserved for issuance to non-employee directors of the Company. The Directors Plan was approved by the Company's stockholders on March 14, 2001. Shares issued pursuant to options granted under this plan may be issued from shares held in the Company's treasury or from authorized and unissued shares. Under this plan, each Director, on an annual basis, shall be automatically granted 10,000 options upon the first business day after being elected a director. The options are immediately vested on the date of grant. Discretionary options granted pursuant to this plan shall be determined by the Board of Directors or a duly appointed stock option committee (the "Committee"). Options granted pursuant to this plan shall be nonqualified stock options as defined in Section 422 of the Internal Revenue Code, will be nontransferable and expire if not exercised after ten years from the date of grant or for such lesser term as approved by the Committee. All options shall be issued at a price per share equal to the fair market value of the Company's Common Stock as of the date of grant.
On January 16, 2001, the Company adopted the 2001 Stock Plan (the "2001 Plan") pursuant to which 345,000 shares of Common Stock have been reserved for issuance to employees, officers and consultants of the Company. The 2001 plan was approved by the Company's stockholders on March 14, 2001. Shares issued pursuant to this plan may be issued from shares held in the Company's treasury or from authorized and unissued shares. Options granted pursuant to this plan are generally nontransferable, except in the event of a participant's death, in which case the options shall be transferable to the participant's designated beneficiary or as permitted by law. The options shall expire if not exercised after ten years from the date of grant or for such lesser term as approved by the Board of Directors or a duly appointed committee. Options issued to employees who are then later terminated for cause generally are immediately forfeited. Options may be granted in such amounts and at such prices as determined by the Board of Directors or the duly appointed committee, but the price per share shall not be less than the fair market value of the Company's Common Stock as of the date of grant in the case of an incentive stock option and not less than 85% of the fair market value of the Company's Common Stock as of the date of grant in the case of a non-qualified stock option, as defined in section 422 of the Internal Revenue Code.
As referred to in Note 1, the Company has adopted the disclosure provisions of SFAS 123, and SFAS 148. As permitted under these statements, the Company retained its current method of accounting for stock compensation in accordance with APB 25.
VALLEY FORGE SCIENTIFIC CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
10. COMMITMENTS AND CONTINGENCIES (Continued)
Following is a summary of the Company's various stock option plans:
As of September 30, 2003, 356,850 of these options outstanding are vested and are exercisable at prices ranging from $1.06 to $4.25 which correspond to a weighted average exercise price of $2.25 and a weighted average remaining contractual life of 7.57 years.
VALLEY FORGE SCIENTIFIC CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
10. COMMITMENTS AND CONTINGENCIES (Continued)
Assumptions used in the Black-Scholes option valuation model to estimate the value of the Company's options included in pro forma amounts in Note 1 are as follows:
The weighted average fair value of options granted during the years ended September 30, 2003, 2002 and 2001 were as follows:
2003 2002 2001 ------ ------ ------
Stock Prices Equal to Exercise Price $ 1.21 $ 2.40 $ 1.77
Stock Prices in Excess of Exercise Price $ -- $ -- $ --
Stock Prices Less than Exercise Price $ -- $ -- $ 2.10
The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because the Company's stock options have characteristics significantly different from those of traded options, and because changes in subjective input assumptions can materially affect the fair value estimated, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its stock options. In management's opinion existing stock option valuation models do not provide a reliable single measure of the fair value of employee stock options that have vesting provisions and are not transferable.
VALLEY FORGE SCIENTIFIC CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
10. COMMITMENTS AND CONTINGENCIES (Continued)
Operating Leases - ----------------
The Company leases approximately 4,200 square feet of office and warehouse space in an office building in Oaks, Pennsylvania, from GMM Associates, a Pennsylvania general partnership, whose partners are Jerry L. Malis, Leonard I. Malis, (principal shareholders, directors, and/or officers of the Company), and the Francis W. Gilloway Marital Trust, the successor in interest to Thomas Gilloway, an officer of the Company until the time of his death on Feburary 18, 2001. The lease which commenced on July 1, 1995 for a term of five years provided for a monthly base rent of $4,716 (with increases based on increases in the consumer price index) which include costs associated with real estate taxes, maintenance and utilities. During December 2000 the lease was extended for an additional term of five years effective as of July 1, 2000 and calls for a monthly base rent of $4,643 (with increases on June 30th of each year based on increases in the Producer Price Index). All other terms remain the same. The related expense for this lease for the years ended September 30, 2003, 2002 and 2001 was $59,608, $57,740 and $56,115, respectively. As of September 30, 2003, the Company was current on all rental obligations due the related party.
The Company has also entered into leases for certain equipment under operating lease agreements with terms ranging between two and four years.
A schedule of future minimum payments under operating leases is as follows:
Years ending September 30, --------------------------
Related Other Party Operating --------- ---------
2004 $ 61,569 $ 15,446 2005 48,600 14,087 2006 -- 6,801 2007 -- 989 --------- ---------
$ 110,169 $ 37,323 ========= =========
11. MAJOR CUSTOMERS
For the years ended September 30, 2003, 2002 and 2001, a significant part of the Company's revenues were derived from one major customer pursuant to a distribution agreement under which the Company granted the exclusive right to sell its electrosurgical systems and other products developed by the Company in the field of neurosurgery. Revenues derived from this customer are approximately as follows:
Percent of Total Revenues Revenues -------- --------
Year ended September 30, 2003 $ 4,231,000 95% Year ended September 30, 2002 $ 4,515,000 90% Year ended September 30, 2001 $ 4,169,000 79%
VALLEY FORGE SCIENTIFIC CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
11. MAJOR CUSTOMERS (Continued)
In addition, for the years ended September 30, 2003, 2002 and 2001, revenue derived from another customer totaled approximately $4,000, $347,000 and $1,009,000, respectively, representing approximately 0%, 7% and 19%, respectively of the Company's total revenues.
At September 30, 2003 and 2002, the Company's largest customer accounted for approximately 93% and 99%, respectively, of the Company's accounts receivable.
12. STOCKHOLDERS' EQUITY
Common Stock - ------------
On August 26, 1999, the Company filed an amended and restated Certificate of Incorporation increasing the shares of Common Stock the Company is authorized to issue from 10,000,000 to 20,000,000 shares with no stated par value.
The holders of Common Stock have no preemptive rights and the Common stock has no redemption, sinking fund or conversion provisions. Each share of Common Stock is entitled to one vote on any matter submitted to the holders and to equal rights in the assets of the Company upon liquidation. All of the outstanding shares of Common Stock are fully paid and nonassessable.
In April 2000, the Board of Directors of the Company approved a stock repurchase program continuing a prior program whereby the Company may, from time to time, repurchase on the open market up to 200,000 shares of the Company's Common Stock. In August 2002, the Board of Directors of the Company voted to terminate the then existing program and approved a new program for the repurchase of up to 200,000 shares of the Company's Common Stock. During the fiscal years ended September 30, 2003, 2002 and 2001, the Company repurchased for retirement 127,600, 26,500 and 84,050 shares at an aggregate cost of $173,316, $46,878 and $110,706, respectively.
Preferred Stock - ---------------
The Company is authorized to issue 487 shares of preferred stock, $1,000 par value. The holders of the preferred stock would have no voting rights or preemptive rights. Upon liquidation of the Company, a $1,000 per share liquidating dividend must be paid upon each issued and outstanding share of preferred stock before any liquidating dividend is paid on the Common Stock. For each of the years ended September 30, 2002, 2001 and 2000, there were no issued or outstanding preferred shares, and the Company has no intention to issue any preferred stock in the immediate future.
VALLEY FORGE SCIENTIFIC CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
13. EARNINGS PER SHARE
For the Years Ended September 30, ------------------------------------ 2003 2002 2001 ---------- ---------- ----------
Basic Income Per Share: Income available to common shareholders $ 108,925 $ 380,527 $ 330,221 ========== ========== ==========
Weighted average shares outstanding 7,960,676 8,067,286 8,081,890 ========== ========== ==========
Basic Income Per Share $ 0.01 $ 0.05 $ 0.04 ========== ========== ==========
Diluted Income Per Share: Income available to common shareholders $ 108,925 $ 380,527 $ 330,221 ========== ========== ==========
Weighted average shares outstanding 7,960,676 8,067,286 8,081,890
Dilutive shares issuable in connection with stock plans 25,772 87,284 71,056 ---------- ---------- ----------
Diluted weighted average common shares outstanding 7,986,448 8,154,570 8,152,946 ========== ========== ==========
Diluted Income Per Share $ 0.01 $ 0.05 $ 0.04 ========== ========== ==========
Options to purchase 479,850, 517,850 and 483,075 shares of common stock were outstanding at September 30, 2003, 2002 and 2001, respectively, and 314,850 , 68,100 and 70,200 of these shares were not included in the computation of diluted earnings per share in accordance with SFAS 128, as the potential shares are considered anti-dilutive.
VALLEY FORGE SCIENTIFIC CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
14. PROVISION FOR INCOME TAXES
Provision for income taxes is as follows:
For the Years Ended September 30, ------------------------------------ 2003 2002 2001 ---------- ---------- ----------
Current: Federal $ 19,075 $ 204,500 $ 74,100 State 12,790 40,200 17,300 ---------- ---------- ---------- 31,865 244,700 91,400 ---------- ---------- ----------
Deferred: Federal 18,392 20,703 93,840 State 7,696 9,181 9,713 ---------- ---------- ---------- 26,088 29,884 103,553 ---------- ---------- ----------
$ 57,953 $ 274,584 $ 194,953 ========== ========== ==========
The Company's effective tax rate was 34.7%, 41.9% and 37.2% for the years ended September 30, 2003, 2002 and 2001, respectively. Reconciliation of income tax at the statutory rate to the Company's effective rate is as follows:
For the Years Ended September 30, ------------------------------- 2003 2002 2001 -------- -------- --------
Computed at the expected statutory rate 28.3 % 34.0 % 34.0 % State taxes net of federal tax benefit 7.2 6.6 5.9 Other (0.8) 1.3 (2.7) -------- -------- --------
34.7 % 41.9 % 37.2 % ======== ======== ========
VALLEY FORCE SCIENTIFIC CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
14. PROVISION FOR INCOME TAXES (Continued)
Certain items of income and expense are recognized in different years for financial reporting and income tax purposes. Deferred income taxes are provided in recognition of these temporary differences. The items that give rise to the deferred income tax assets and deferred income tax liability are as follows:
15. CONCENTRATION OF CREDIT RISK
Financial instruments which potentially subject the Company to concentration of credit risk consist principally of short-term cash investments and trade receivables. The Company maintains substantially all of its banking activities with one bank and cash balances throughout the year generally exceeded the federally insured limits of the FDIC and SIPC of $100,000. The Company typically invests cash balances which exceed $100,000 in money market accounts, money market mutual funds or short-term municipal securities. At September 30, 2003 and 2002, the balances the Company held in these securities was approximately $2,163,000 and $2,278,000, respectively. Management believes that its customer acceptance, billing and collection policies are adequate to minimize potential credit risk associated with trade receivables, which are principally due from one customer.
VALLEY FORGE SCIENTIFIC CORP. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
16. QUARTERLY RESULTS (UNAUDITED)
The following table presents selected unaudited quarterly operating results for the Company's eight quarters ended September 30, 2003 for continuing operations. The Company believes that all necessary adjustments have been made to present fairly the related quarterly results.
VALLEY FORGE SCIENTIFIC CORP. For Fiscal Year Ended September 30, 2003 FORM 10-K EXHIBIT INDEX
Exhibit 10.13 Extension of Distribution Agreement with Codman & Shurtleff, Inc. dated November 21, 2003
Exhibit 21 Subsidiary of Registrant
Exhibit 23 Consent of Samuel Klein and Company
Exhibit 31.1 Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
Exhibit 32.1 Certification of the Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002