Filed Pursuant to Rule 424(b)(3)
Registration No. 333-84782
PROSPECTUS SUPPLEMENT
NUMBER 4
TO
PROSPECTUS DATED MAY 3, 2002 AND PROSPECTUS SUPPLEMENTS
DATED MAY 15, 2002, SEPTEMBER 10, 2002 AND NOVEMBER 21, 2002
OF
NEOPROBE CORPORATION
5,898,876 SHARES OF COMMON STOCK
Attached hereto and hereby made a part of the Prospectus is the Annual
Report on Form 10-KSB of Neoprobe Corporation (the "Company") for the year ended
December 31, 2002, filed by the Company with the Securities and Exchange
Commission on March 31, 2003. This Prospectus Supplement No. 4 should be read in
conjunction with the prospectus supplements dated May 15, 2002, September 10,
2002 and November 21, 2002.
--------------------------
You should only rely on the information provided in the prospectus, this
prospectus supplement or any additional supplement. We have not authorized
anyone else to provide you with different information. You should not assume
that the information in the prospectus or this prospectus supplement or any
additional supplement is accurate as of any date other than the date on the
front of those documents.
--------------------------
Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved of these securities or passed upon the
adequacy or accuracy of the prospectus or this prospectus supplement. Any
representation to the contrary is a criminal offense.
--------------------------
The date of this Prospectus Supplement No. 4 is April 1, 2003.
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
--------------------------
FORM 10-KSB
(Mark One)
|X| ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934 For the fiscal year ended: December 31, 2002
OR
|_| TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from _________________ to _______________.
Commission file number: 0-26520
NEOPROBE CORPORATION
--------------------------------------------------------------------------------
(Name of Small Business Issuer in Its Charter)
DELAWARE 31-1080091
----------------------------------- -----------------------------------
(State or Other Jurisdiction (I.R.S. Employer Identification No.)
of Incorporation or Organization)
425 Metro Place North, Suite 300, Dublin, Ohio 43017-1367
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(Address of Principal Executive Offices) (Zip Code)
Issuer's telephone number, including area code: (614) 793-7500
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $.001 per share
----------------------------------------------------------------
(Title of Class)
Rights to Purchase Series A Junior Participating Preferred Stock
----------------------------------------------------------------
(Title of Class)
Check whether the Registrant: (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such
shorter period that the registrant was required to file such reports), and (2)
has been subject to such filing requirements for the past 90 days.
Yes |X| No |_|
Check if there is no disclosure of delinquent filers pursuant to Item 405 of
Regulation S-B contained herein and no disclosure will be contained, to the best
of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-KSB or any amendment to
this Form 10-KSB. |_|
The issuer's revenues for the fiscal year ended December 31, 2002 were
$4,920,940.
The aggregate market value of shares of common stock held by non-affiliates of
the registrant on March 7, 2003 was $4,435,968.
The number of shares of common stock outstanding on March 25, 2003 was
38,589,009.
Transitional Small Business Disclosure Format (check one): Yes |_| No |X|
DOCUMENTS INCORPORATED BY REFERENCE
None.
PART I
ITEM 1. DESCRIPTION OF BUSINESS
DEVELOPMENT OF THE BUSINESS
Neoprobe Corporation (Neoprobe or we) is a biomedical technology company that
provides innovative surgical and diagnostic products that enhance patient care
by meeting the critical decision-making needs of healthcare professionals. We
were originally incorporated in Ohio in 1983 and reincorporated in Delaware in
1988. Our executive offices are located at 425 Metro Place North, Suite 300,
Dublin, Ohio 43017. Our telephone number is (614) 793-7500.
From our inception through the end of 2001, we devoted substantially all of our
efforts and resources to the research and clinical development of innovative
systems for the intraoperative diagnosis and treatment of cancers. Following an
evaluation of our business plan during early 2001, however, we determined that
we needed to expand our product portfolio and consider synergistic products
outside the cancer or oncology fields.
In December 2001, we acquired Biosonix Ltd., a private Israeli company limited
by shares. In February 2002, Biosonix Ltd. changed its name to Cardiosonix Ltd.
(Cardiosonix). Cardiosonix is developing and commercializing a unique line of
blood flow measurement devices for a variety of diagnostic and surgical
applications. The decision to expand beyond our product focus on oncology was
based on our belief that the technology platform underlying the Cardiosonix line
of products has tremendous market potential and has a number of commonalities
with our gamma detection device product line. We intend to take advantage of
those synergies in the development, regulation and manufacture of Cardiosonix'
devices. We believe that the path of market adoption for the Cardiosonix devices
will be similar to the path we have experienced with our gamma detection
devices.
Although we have expanded our strategic focus to include blood flow medical
devices, we intend to continue many of the strategies outlined in prior years
related to the internal development of gamma detection medical devices and to
continue promoting development of our other complementary technologies through
strategic partnerships and alliances. Our primary goals are to maximize the
market potential of Cardiosonix' blood flow products as leaders in the
measurement of blood flow in both clinical and surgical settings to supplement
our leadership position in the current intraoperative gamma detection market.
OUR TECHNOLOGY
GAMMA DETECTION DEVICES
Through 2002, substantially all of our revenue has been generated from the sale
of a line of gamma radiation detection devices and related products used by
surgeons in the diagnosis and treatment of cancer and related diseases. Our
currently marketed line of gamma detection devices has been cleared by the U.S.
Food and Drug Administration ( U.S. FDA) and other international regulatory
agencies for marketing and commercial distribution throughout most major global
commercial markets.
Our patented gamma detection devices consist of hand-held detector probes
and a control unit. The detection device in the tip of the probe is a highly
radiosensitive crystal that relays a signal through a preamplifier to the
control unit to produce both a digital readout and an audible signal. The
detector element fits into a housing approximately the size of a pocket
flashlight. The NEO2000(R) Gamma Detection System, originally released in 1998,
is the third generation of our gamma detection systems. The NEO2000 is designed
as a platform for future growth of our instrument business. The NEO2000 is
software upgradeable and is designed to support future surgical targeting probes
without the necessity of costly remanufacture. Since 1998, we have developed two
software releases that are currently available for upgrade of customer units. We
anticipate a third major release will be made available during the second
quarter of 2003.
2
Surgeons are using our gamma detection systems in a surgical application
referred to as sentinel lymph node biopsy (SLNB) or intraoperative lymphatic
mapping (lymphatic mapping or ILM). ILM helps trace the lymphatic patterns in a
cancer patient to evaluate potential tumor drainage and cancer spread in
lymphatic tissue. The technique does not detect cancer; rather it helps surgeons
identify the lymph node(s) to which a tumor is likely to drain and spread. The
lymph node(s) (sometimes referred to as the "sentinel" node(s)) may provide
critical information about the stage of a patient's disease. ILM begins when a
patient is injected at the site of the main tumor with a commercially available
radioactive tracing agent. The agent is intended to follow the same lymphatic
flow as the cancer would if it had metastasized. The surgeon may then track the
agent's path with a hand-held gamma-radiation-detection probe, thus following
the potential avenues of metastases and identifying lymph nodes to be biopsied
for evaluation and determination of cancer spread.
Numerous clinical studies, involving a total of nearly two thousand patients and
published in peer-review medical journals such as Oncology (January 1999) and
The Journal of The American College of Surgeons (December 2000), have indicated
ILM is approximately 97% accurate in predicting the presence or absence of
disease spread in melanoma or breast cancers. Consequently, it is estimated that
more than 80% of women who would otherwise have undergone full axillary lymph
node dissections (ALND), involving the removal of as many as 20 - 30 lymph
nodes, might be spared this radical surgical procedure if the sentinel node was
found to be free of cancer. Surgeons practicing ILM have found that our
gamma-detection probes are well suited to the procedure.
Lymphatic mapping has become the standard of care for treating patients with
melanoma at many institutions. For breast cancer, the technique appears to be
moving toward standard of care status at major cancer centers and is the subject
of national and international clinical trials, including studies sponsored by
the U.S. Department of Defense, the National Cancer Institute and the American
College of Surgeons. While we believe many thought leaders in surgical oncology
have adopted lymphatic mapping, the rate of growth in the application of ILM
appears to have slowed over the past two years, thus affecting the demand for
our gamma detection devices. We believe this is due to a number of surgeons
delaying adoption of lymphatic mapping pending the outcome of these important
trials. We are also concerned that the completion of these trials may be delayed
because some patients participating in clinical trials may perceive that if they
are assigned to a particular study's control group and receive a full ALND, that
they may not be receiving the best and latest care. We continue to monitor these
trials and we continue to work with our marketing partners and thought leaders
in the surgical community to set up and support training courses internationally
for lymphatic mapping. Courses showcasing our instruments continue to be held at
many nationally and internationally renowned cancer-specializing and teaching
institutions. These courses appear to be positively impacting the adoption of
lymphatic mapping, albeit not as rapidly as we would like to see.
In addition to lymphatic mapping, surgeons are investigating the use of our
device for other gamma guided surgery applications, such as evaluating the
thyroid function, in determining the state of disease in patients with vulvar
and penile cancers, and in SLNB in gastric and non-small cell lung cancers. At
the 3rd International Conference on Lymphatic Mapping held in Japan in 2002,
over half of the presentations were related to investigations of the use of ILM
in applications other than breast cancer and melanoma.
Expanding the application of ILM beyond the current primary uses in the
treatment of breast cancer and melanoma is the primary focus of our strategy
regarding our gamma guided surgery products. To support that expansion, we
continue to work with our marketing and distribution partners to develop
software-based enhancements to the NEO2000 platform as well as probes such as
the laparoscopic probe introduced in 2002 that supports the minimally invasive
emphasis in today's practice of surgery. To that end, our primary goals for our
gamma device business for 2003 center around working with our marketing partners
to improve the market position of our laparoscopic approach and increase
awareness of independent research being done to expand the application of ILM to
other indications.
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BLOOD FLOW DEVICES
Accurate blood flow measurement is required for various clinical needs,
including:
- real-time monitoring;
- intra-operative quantification;
- non-invasive diagnostics; and
- evaluation of cardiac function.
Currently, the medical community has no simple, immediate, real-time means to
quantify the adequacy of organ perfusion, that is, the direct measurement of
blood flow into the organ. Devices do exist that visually show perfusion of a
target organ. We are unaware, however, of any device that provides an accurate,
real-time measurement of blood flow in as many applications without having to
isolate target vessels or conduct other invasive procedures.
In addition, blood flow velocity measurements are often confused with volume
blood flow. These two variables, however, are normally different parameters that
respond differently to pathological conditions and provide different data. Blood
flow velocity is used primarily for determining the existence of a stenosis
(narrowing or obstruction) in the vascular surgery setting, while the
applications of blood flow volume have potential impact across a much broader
range of medical disciplines.
Cardiosonix is developing and commercializing the QUANTIX(TM) line of products
that employ a unique and proprietary Angle-independent Doppler Blood Flow
(ADBF(TM)) technology that allows for blood flow volume and velocity readings.
Most current applications of Doppler technology to blood flow measurement are
angle-dependent and therefore more prone to estimation errors and potential
inaccuracy. ADBF eliminates calculation estimation and permits real-time
measurement of volume blood flow.
The ADBF technology utilizes a special application of the Doppler method through
simultaneous projection of a combination of narrow beams with a known angle
between them. Thus, based on trigonometric and Doppler considerations, the angle
of insonation can be obtained, resulting in accurate, angle-independent blood
flow velocity measurements that do not require the use of complicated, expensive
imaging systems. In order to obtain high-resolution velocity profiles, the
QUANTIX devices use a multi-gated pulse wave Doppler beam. With this method,
specific sample volumes along the ultrasound beam can be separately evaluated,
and the application of a flow/no flow criterion can be applied. The Cardiosonix
technology applies a special use of digital Doppler technology, which with the
digital signal processing power of the system allows hundreds of sample volumes
to be sampled and processed simultaneously, thus providing high resolution
velocity profiles for both angle and vascular diameter calculations, and
subsequently volume blood flow measurements. At present, Cardiosonix has two
products in the early stages of commercialization and one still in development
that are designed to provide blood flow measurement and cardiac output
information to physicians in cardiac/vascular surgery, neurosurgery and critical
care settings.
QUANTIX/ND(TM) is designed to allow neurosurgeons and neurologists, as well as
intensive care unit or emergency room physicians, to non-invasively measure
carotid artery blood flow in a simple and real-time manner. QUANTIX/ND consists
of a control unit and an angle-independent ultrasound probe that obtains signals
directly from the carotid artery in a non-invasive manner. QUANTIX/ND is
designed primarily for use in monitoring head trauma patients in neuro-intensive
care units and emergency rooms. Periodic blood flow measurements minimize the
risk of brain impairment. We are unaware of any measurement system on the market
today that provides real-time, bedside, non-invasive, continuous, direct and
accurate measurements of complete hemodynamic parameters including blood flow.
Other modalities that do monitor capabilities of the brain are significantly
more invasive, expose the patient to incremental risk or are inherently
complicated, offering only indirect estimation of perfusion conditions. Some
medical devices use an estimated measurement of blood flow velocity to create an
index of blood flow but do not account for instantaneous changes in vascular
cross-sectional area. In most competing devices, however, blood flow velocity is
angle-dependent and cannot be measured accurately. The QUANTIX/ND device, as
well as its predecessor device, the FlowGuard(TM), has received CE mark
regulatory clearance for marketing in the European Union (EU) as well as
4
U.S. FDA 510(k) clearance for marketing in the United States. Neoprobe has begun
commercial shipment of the QUANTIX/ND to distributors in Europe and Asia.
QUANTIX/OR(TM) is designed to permit cardiovascular surgeons and assisting
physicians to obtain intraoperative volume blood flow readings in various
targeted blood vessels within seconds. The system consists of an
angle-independent ultrasound probe and digital numerical displays of blood flow
rate. Thus, the surgeon obtains immediate, real-time and quantitative readings
while focused on the target vessel. Quantifying blood flow is crucial during
anastomostic or other bypass graft procedures to determine adequate blood flow.
While measurement is advisable whenever a blood vessel is exposed
intra-operatively, generally this is not the current practice.
Ultimately, in practice, the surgeon generally resorts to using his eyes and
fingers in a process called finger palpation to qualitatively assess vessel
flow. The QUANTIX/OR offers the surgeon immediate and simple quantitative
assessment of blood flow in multiple blood vessels and grafts. The primary
advantage of finger palpation is that it is fast and simple; the disadvantages
are that it requires a good deal of experience, it is difficult to perform in
vessels embedded in tissue, it can become difficult to interpret in large
vessels, and it permits only a very qualitative and subjective assessment. A
significant partial occlusion (or even a total occlusion) will result in a
significant vessel "inflation" and strong palpations that could mislead the
surgeon. Instead of such a subjective clinical practice that is highly
experience-dependent, the QUANTIX/OR is designed to allow the surgeon to rely on
more evidence-based medicine.
We believe that QUANTIX/OR represents a significant improvement over existing
technologies to directly measure blood flow intraoperatively. Other technologies
that attempt to measure intraoperative blood flow directly are generally more
invasive and are impractical when multiple vessel measurements are required.
They are, therefore, not used routinely in the operating room, so surgeons most
often resort to finger palpation to qualitatively, rather than quantitatively,
measure vessel perfusion. The QUANTIX/OR device has received CE mark regulatory
clearance for marketing in the EU and is pending U.S. FDA 510(k) clearance for
marketing in the United States.
QUANTIX/TE(TM) is being designed as a transesophageal cardiac function monitor
for measuring blood flow in the descending aorta in critical care settings. The
system employs a special transesophageal catheter for quantitative assessment of
blood flow in the descending aorta for cardiac output calculations. The system
is designed for bedside use in intensive care settings. Cardiac output and
function monitoring is essential in critical care and trauma patients. The
procedure of transesophageal monitoring is a well-recognized clinical modality,
particularly for echocardiography of the heart. Only highly invasive methods of
cardiac output via thermodilution techniques are currently available, or
indirect and non-invasive methods such as bioimpedance with an unknown degree of
clinical significance. The QUANTIX/TE is not currently cleared for commercial
sale in any market.
Our strategy related to Cardiosonix products for 2003 has four primary
objectives:
- to obtain regulatory clearance to market the QUANTIX/OR in the U.S.;
- to promote and expand the critical evaluation of the QUANTIX/ND and
QUANTIX/OR with thought leaders in the neurosurgical and cardiac
arenas;
- to secure and train additional marketing and distribution partners for
key global markets for the QUANTIX/ND and QUANTIX/OR devices; and,
- to achieve commercial sales of Cardiosonix' Quantix products beyond
demonstration unit sales which would demonstrate the initial market
acceptance of the products.
We cannot assure you, however, that any of Cardiosonix' products will achieve
additional regulatory clearance, or if cleared, that such products will achieve
market acceptance. See also Risk Factors.
THE LYMPHOSEEK(TM) PROCEDURAL PRODUCT
Our gamma detection devices are primarily capital in nature; as such, they
generate revenue only on the initial sale. To complement the one-time revenue
stream related to capital products, we are working on
5
developing recurring revenue or "procedural" products that would generate
revenue based on each procedure in which they were used. Our primary efforts in
this area involve an exclusive worldwide license agreement with the University
of California, San Diego (UCSD) for a proprietary compound we refer to as
Lymphoseek. We believe Lymphoseek, if proven effective, could be used as a lymph
node locating agent in ILM procedures. Neoprobe and UCSD completed pre-clinical
evaluations of Lymphoseek in 2001 and completed a Phase I trial in the treatment
of breast cancer in humans. The initial Phase I studies of Lymphoseek in breast
cancer were funded through a research grant from the Susan G. Komen Breast
Cancer Research Foundation. Preliminary results from the Phase I breast trial
were presented at the Spring 2002 meeting of the Society of Nuclear Medicine.
A Phase II clinical trial in melanoma patients is underway and is expected to be
completed during the second or third quarter of 2003. The Phase II melanoma
trial is being funded through a research grant from the American College of
Surgeons. Our discussions held to date with potential strategic partners to
assist in the further development and commercialization of Lymphoseek have
focused on gaining a better understanding of the regulatory approval process
related to Lymphoseek. As such, following the completion of the Phase II
melanoma trial, we intend to prepare for and request a meeting with the U.S. FDA
to discuss the regulatory approval process and determine the objectives for the
next clinical trial involving Lymphoseek. We cannot assure you, however, that
any such products will achieve regulatory approval, or if approved, that such
products will achieve market acceptance. See also Risk Factors.
THE RIGS(R) TECHNOLOGY
Our radioimmunoguided surgery (RIGS) system is an investigational technology
that combines our patented hand-held gamma radiation detection probe,
proprietary disease-specific radiolabeled cancer targeting agents, and a
patented surgical method to provide surgeons with real-time information to
locate tumor deposits that may not be detectable by conventional methods, and to
assist in more thorough removal of the cancer. Before surgery, a cancer patient
is injected with one of the targeting agents, which circulates throughout the
patient's body and binds specifically to cancer cell antigens or receptors.
Concentrations of the targeting agent are then located during surgery by our
gamma-detection instrument, which emits an audible tone to direct the surgeon to
targeted tissue.
We conducted several clinical trials related to the first generation drug of our
RIGS technology in past years, but were unsuccessful in gaining the necessary
regulatory approvals. Since discontinuing internal development efforts in 1998,
we have been working to secure a partner to assume financial and regulatory
responsibility for the ongoing development of the RIGS technology. While we
continue to be interested in obtaining a development partner, we have engaged an
investment banking firm to help us sell or license our RIGS assets in the event
a partner is not identified.
At this time, we cannot assure you that any potential development partner will
have a continuing interest in developing the RIGS technology. In addition,
should such a partner ultimately decide to move forward with development of a
RIGS product and be able to reach a satisfactory agreement, we believe that it
would take at least four to five years to complete development, regulatory and
commercialization activities for a RIGS product. We cannot assure you, however,
that we will be able to complete license or sales agreements with another
development partner for the RIGS technology on terms acceptable to us, or at
all. Also, we cannot assure you that the regulatory authorities will clear our
RIGS products for marketing, or that any such products will be successfully
introduced or achieve market acceptance. See also Risk Factors.
ACTIVATED CELLULAR THERAPY
We have performed early stage research on another technology platform, activated
cellular therapy (ACT), based on work originally done in conjunction with the
RIGS technology. ACT is intended to boost the patient's own immune system by
removing lymph nodes identified during surgery and then, in a cell processing
technique, activating and expanding "helper" T-cells found in the nodes. Within
10 to 14 days, the patient's own immune cells, activated and numbering more than
20 billion, are infused into the patient in an attempt to trigger a more
effective immune response to the cancer.
6
During the second quarter of 2001, we announced a research collaboration with
Aastrom Biosciences (Aastrom) intended to determine whether Aastrom's
Replicell(TM) system would be able to duplicate cell expansion results
experienced in previous Phase I clinical testing of our ACT technology for
oncology. Unfortunately, we experienced delays in completing the evaluation in
2001 due to a lack of available tissue for testing purposes and since that time
have not had the funding available to move the research forward. We engaged the
same investment banking firm as we did for the RIGS technology to assist us in
identifying parties to license or purchase the ACT technology. We do not know if
a partner will be identified on a timely basis, on terms acceptable to us, or at
all. We do not intend to fund any significant ACT-related research and
development without a partner. We cannot assure you that any ACT products will
be successfully developed, tested or licensed, or that any such products will
gain market acceptance. See also Risk Factors.
MARKET OVERVIEWS
The medical device marketplace is a fast-growing market. Medical Device &
Diagnostic Industry magazine reports an annual medical device and diagnostic
market of $75 billion in the U.S. and $169 billion internationally.
CANCER MARKET OVERVIEW
Cancer is the second leading cause of death in the U.S. and Western Europe and
is responsible for over half a million deaths annually in the U.S. alone. The
National Institutes of Health (NIH) estimate the overall annual costs for cancer
(the primary focus of our products) for the U.S. in the year 2002 at $171.6
billion: $60.9 billion for direct medical costs, $15.5 billion for indirect
morbidity, and $95.2 billion for indirect mortality. Our line of gamma detection
systems is currently used primarily in the application of ILM in breast cancer
and melanoma which, according the American Cancer Society (ACS), are expected to
account for 16% and 4%, respectively, of new cancer cases in the U.S. in 2003.
NIH has estimated that breast cancer will annually affect approximately 500,000
women in North America, Western Europe, and other major economic markets. Breast
cancer is the leading cause of death from cancer in the United States among the
30 million women between the ages of 40 and 55 and the second leading cause of
death from cancer among all women. According to the ACS, over 200,000 new cases
of invasive breast cancer are expected to be diagnosed and over 40,000 women are
expected to die from the disease during 2003 in the U.S. alone. The incidence of
breast cancer increases with age, rising from about 100 cases per 100,000 women
at age 40 to about 400 cases per 100,000 women at age 65. Thus, we believe that
the significant aging of the population, combined with improved education and
awareness of breast cancer and diagnostic methods, will lead to an increased
number of breast cancer surgical diagnostic procedures.
Approximately 80% of the patients diagnosed with breast cancer undergo a lymph
node dissection (either ALND or SLNB) to determine if the disease has spread.
While many breast cancer patients are treated in large cancer centers or
university hospitals, regional and/or community hospitals currently treat the
majority of breast cancer patients. Over 10,000 hospitals are located in the
markets targeted for our gamma detection ILM products. While we are aware of no
published statistics on the number of institutions that currently are using
gamma detection devices in ILM, we believe that approximately fifty percent of
the total potential global market for gamma detecting devices remains to be
penetrated at this time. However, if the potential of Lymphoseek as a
radioactive tracing agent is ultimately realized, it has the potential to
address not only the current breast and melanoma markets on a procedural basis,
but to also assist in the clinical evaluation and staging of solid tumor cancers
and expanding ILM to additional indications, such as gastric, non-small cell
lung and other solid tumor cancers.
BLOOD FLOW MARKET OVERVIEW
Cardiovascular disease is the number one killer of men and women in the U.S. and
in a majority of countries in the rest of the world that track such statistics.
In the U.S. alone, the Centers for Disease
7
Control (CDC) estimated that there were over 65 million physician office visits
and over 6.8 million outpatient department visits in 2000 with a primary
diagnosis of cardiovascular disease. The CDC registered over 5.9 million
inpatient cardiovascular procedures in the U.S. during 2000 that directly
involve cardiovascular circulation. We, as well as our competitors and other
industry analysts, generally estimate the rest of the world's incidence of such
modalities at roughly twice U.S. estimates.
The American Heart Association (AHA) estimates the total cost of cardiovascular
diseases and stroke in the United States will exceed $350 billion in 2003. A
substantial portion of these expenditures is expected to be for non-invasive
image and intravascular examination. In 1999, these modalities, employed in
approximately 99 million diagnostic procedures, generated more than $2.4 billion
worldwide in product sales. Industry analysts have also estimated the worldwide
market for multi-functional patient monitoring equipment totaled $6.6 billion in
1999. This market is forecasted to grow at a compound annual rate of 11.5% over
the next five years.
We have identified three distinct markets within the hospital setting for
Cardiosonix' products:
- non-invasive diagnostics (QUANTIX/ND);
- intraoperative assessment (QUANTIX/OR); and
- critical care monitoring (QUANTIX/TE).
The American Hospital Association has estimated there are approximately 6,000
hospitals in the U.S., over half of which house one hundred beds or more (i.e.,
large hospitals). The American Association of Operating Room Nurses has
estimated there are approximately 30,000 operating rooms in the U.S. Based on
these estimates and information obtained from industry sources and data
published by our competitors and other medical device companies, we estimate
that the worldwide totals for hospitals and operating rooms to be approximately
two to two-and-a-half times the U.S. totals.
Based on the above number of institutions, assuming the larger hospitals could
use two or more systems of each type to support their activities, and assuming
we are able to achieve market prices that are comparable to what our competitors
are achieving (currently averaging $25,000 to $30,000 per system), we believe
the worldwide market potential for blood flow measurement products, such as
those being developed by Cardiosonix, to be more than $1.5 billion. We believe
that gaining even a modest share of this market would result in significant
annual revenues for our company. We cannot assure you, however, that Cardiosonix
products will achieve market acceptance and generate the level of sales or
prices anticipated.
MARKETING AND DISTRIBUTION
GAMMA DETECTION DEVICES
We began marketing the current generation of our gamma detection systems, the
NEO2000, in October 1998. Since October of 1999, our gamma detection systems
have been marketed and distributed throughout most of the world through Ethicon
Endo-Surgery, Inc. (EES), a Johnson and Johnson company. In Japan, however, we
market our products through a pre-existing relationship with Century Medical,
Inc. (CMI).
The heart of the NEO2000 system is a control unit that is software-upgradeable,
permitting product enhancements without costly remanufacturing. Since the
original launch of the NEO2000 system, we have introduced an enhanced version of
our 14mm reusable probe optimized for lymphatic mapping procedures and a
laparoscopic probe intended for certain minimally invasive procedures. We have
also developed three major software version upgrades for the system that have
been or will soon be made available to customers. We intend to continue
developing additional ILM-related probes and instrument products in cooperation
with EES to maintain our leadership position in the ILM field.
Physician training is critical to the use and adoption of ILM products by
surgeons and other medical professionals. Our company and our marketing partners
have established relationships with leaders in the
8
ILM surgical community and have established and supported training courses
internationally for lymphatic mapping. We intend to continue to work with our
partners to expand the number of ILM training courses available to surgeons.
We entered into our current distribution agreement with EES effective October 1,
1999 for an initial five-year term with options to extend for two successive
two-year terms. Under this agreement, we manufacture and sell our ILM products
almost exclusively to EES, who distributes the products globally (except for
Japan). EES agreed to purchase minimum quantities of our products over the first
three years of the five-year original term of the agreement and to reimburse us
for certain research and development costs during the first three years and a
portion of our warranty costs. EES' minimum purchase and reimbursement
commitments were satisfied during 2002. EES has no ongoing purchase or
reimbursement commitments to us other than the rolling four-month binding
purchase commitment for gamma detection devices as outlined in the distribution
agreement. Our agreement with EES also contains certain termination provisions
and licenses to our intellectual property that take effect only in the event we
fail to supply product, or for other reasons such as a change of control. See
also Risk Factors.
BLOOD FLOW DEVICES
During late 2002, we received regulatory approval to market QUANTIX/ND in the
U.S. and the EU and placed a small number of devices with two distributors
covering three countries for their demonstration purposes. Since the end of
2002, we have received CE Mark clearance to market the QUANTIX/OR in the EU and
have 510(k) clearance pending in the U.S. Currently, we have six distributors
covering seven countries for the QUANTIX/ND and five distributors covering six
countries for the QUANTIX/OR. We are in active dialogue for marketing and
distribution rights with a number of parties of varying sizes and with varying
market expertise. The majority of the distributors signed to date are in the EU
and the Pacific Rim. We have not yet signed a distributor for the QUANTIX/ND or
QUANTIX/OR covering the U.S. or other large European markets.
Our goal in securing marketing and distribution partners is to first identify
parties who possess appropriate expertise in marketing medical devices,
preferably ultrasound or cardiac care devices, into our primary target markets,
the cardiac care and neurosurgical markets. If possible, we will try to secure
partners with broad global reach similar to the path we have followed for our
gamma detection devices. If such a partner is not available for a given market
or if a territory-specific partner has expertise that we believe outweighs the
value of a global market reach, we will enter into territory-specific
arrangements as necessary.
We anticipate spending a significant amount of time and effort in 2003 to bring
the Cardiosonix blood flow products to a wider market. We will need to continue
to train our distributors and work through them with thought leaders in the
cardiac and neurosurgical fields to gain broader exposure to the advantages of
our technology. We anticipate placing blood flow systems with industry thought
leaders to obtain critical pre-commercialization feedback prior to widespread
market launch. To date, we have placed a small number of devices with thought
leaders in the U.S. and EU to support clinical investigations by their
insititutions. The devices placed to date have been primarily Quantix/ND and its
predecessor device, the FlowGuard. The market education process we envision
will likely take some time to develop in the manner we desire. In addition, the
sales cycle for capital medical devices such as our blood flow products is
typically a four to six month cycle. As such, significant end customer sales, if
they occur, will likely lag the signing of distribution arrangements.
MANUFACTURING
GAMMA DETECTION DEVICES
We rely on independent contract manufacturers, some of which are single-source
suppliers, for the manufacture of the principal components of our current line
of gamma detection system products. See also Risk Factors. The NEO2000 system is
comprised of a software-upgradeable NEO2000 control unit, a
9
hand-held gamma detection probe and some accessories. We currently market a 14mm
reusable probe and a laparoscopic reusable probe.
We have devoted significant resources to develop production capability for our
gamma detection systems at qualified contract manufacturers. Production of the
NEO2000 control unit, the 14mm probe and the laparoscopic probe involve the
manufacture of components by a combination of subcontractors, including but not
limited to eV Products, a division of II-VI Corporation (eV) and UMM
Electronics, Inc., a Leach Technology Group company (UMM). Currently, we have
manufacturing and supply agreements with eV for the production of crystal
modules used in the detector probes and with UMM for the manufacture of the 14mm
probe and the NEO2000 control unit. We also purchase certain accessories for our
line of gamma detection systems from other qualified manufacturers.
In December 1997, we entered into a supply agreement with eV for the supply of
certain crystals and associated electronics to be used in the manufacture of our
proprietary line of hand-held gamma detection probes. The original term of the
agreement expired on December 31, 2002, but was automatically extended through
December 31, 2005; however, the agreement is no longer exclusive for the last
three years. eV supplies 100% of the crystals used in our products. While eV is
not the only potential supplier of such crystals, any prolonged interruption of
this source could restrict the availability of our probe products, which would
adversely affect our operating results.
In October 2001, we entered into a manufacturing and supply agreement with UMM
for the exclusive manufacture of our 14mm probe and NEO2000 control unit. The
original term of the agreement expires in February 2005 but will be
automatically extended for additional one-year periods unless either party
provides written notice of non-renewal at least six months prior to the end of
the then-current term. Either party has the right to terminate the agreement at
any time on six months written notice, or may immediately terminate the
agreement upon a breach by the other. UMM may also terminate the agreement if
our orders for a given product fall below certain minimum quarterly amounts for
two successive quarters.
We cannot assure you that we will be able to maintain agreements with our
subcontractors on terms acceptable to us, or that our subcontractors will be
able to meet our production requirements on a timely basis, at the required
levels of performance and quality. In the event that any of our subcontractors
is unable or unwilling to meet our production requirements, we cannot assure you
that an alternate source of supply could be established without significant
interruption in product supply or without significant adverse impact to product
availability or cost. Any significant supply interruption or yield problems that
we or our subcontractors experience would have a material adverse effect on our
ability to manufacture our products and, therefore, a material adverse effect on
our business, financial condition, and results of operations until a new source
of supply is qualified. See also Risk Factors.
BLOOD FLOW DEVICES
We do not currently have any long-term arrangements covering the manufacture of
Cardiosonix products. Manufacturing of the initial lots of product to support
the product launches is currently being performed at Cardiosonix' facility in
Israel. We have requested bids from potential contract manufacturers and intend
to move production of Cardiosonix products to such a facility for large-scale
manufacturing of the products. While we are currently working with a limited
number of manufacturers of components for Cardiosonix products during the
development and early-stage product launch phases, we do not believe that we
will be subject to significant sole source supply risks once we reach larger
commercial manufacturing quantities.
COMPETITION
We face competition from medical product and biotechnology companies, as well as
from universities and other non-profit research organizations in the field of
cancer diagnostics and treatment. Many emerging medical product companies have
corporate partnership arrangements with large, established companies to support
the research, development, and commercialization of products that may be
competitive with our products. In addition, a number of large established
companies are developing proprietary technologies
10
or have enhanced their capabilities by entering into arrangements with or
acquiring companies with technologies applicable to the detection or treatment
of cancer and the measurement of blood flow. Many of our existing or potential
competitors have substantially greater financial, research and development,
regulatory, marketing, and production resources than we have. Other companies
may develop and introduce products and processes competitive with or superior to
those of ours. See also Risk Factors.
For our products, an important factor in competition is the timing of market
introduction of our products or those of our competitors' products. Accordingly,
the relative speed with which we can develop products, complete the regulatory
clearance processes and supply commercial quantities of the products to the
market is an important competitive factor. We expect that competition among
products cleared for marketing will be based on, among other things, product
efficacy, safety, reliability, availability, price, and patent position.
GAMMA DETECTION DEVICES
With the emergence of ILM, a number of companies have begun to market gamma
radiation detection instruments. Most of the competitive products have been
designed from an industrial or nuclear medicine perspective rather than being
developed initially for surgical use. Through 2002, the principal competitive
product in both the United States and Europe has been a gamma detection system
marketed by US Surgical Corporation, a subsidiary of Tyco International Ltd. In
addition to Tyco's products, we also compete with products produced by Care Wise
Medical Products Corporation, PI Medical Diagnostic Equipment B.V., Pol.Hi.Tech.
Srl, Silicon Instruments GmbH and other companies.
It is often difficult to glean accurate competitive information within the
lymphatic mapping field, primarily because most of our competitors are either
subsidiaries of a large corporation (i.e., U.S. Surgical) or privately held
corporations, whose sales revenue or volume data is, therefore, not readily
available or determinable. In addition, lymphatic mapping does not currently
have a separate reimbursement code in most healthcare systems. As such,
determining trends in the actual number of procedures being performed is
difficult. We believe, based on our understanding of EES' success rate in
competitive bid situations, that our market share has remained relatively
constant despite the increased competition over the past few years. We have
experienced some erosion in market prices, however. Additionally, as we have
discussed, we also believe that the current plateau in sales is evidence that
some prospective customers are awaiting results of important international
clinical trials. We expect the results from these trials, when announced, will
likely have a positive impact on sales volumes. We believe our intellectual
property portfolio will be a barrier to competitive products; we cannot assure
you, however, that competitive products will not be developed and be successful
in eroding our market share or the prices we receive for our gamma detection
devices. See also Risk Factors.
BLOOD FLOW DEVICES
There are several technologies on the market that measure or claim to measure
indices of blood flow. These products can be categorized as devices that measure
blood flow directly and devices that only obtain an estimation of flow
conditions.
DIRECT BLOOD FLOW MEASUREMENT DEVICES
- Transit time ultrasound (TT) flowmetry is the leading modality in the
operating room today. TT systems monitor blood flow invasively, and are
restricted to isolated vessels. They require probe adaptation to the
vessel size, and do not provide additional vascular parameters. The
technology requires the operator to encircle the blood vessel with a probe
that includes two ultrasound transmitters/receivers on one side, and a
mirror reflector on the opposite side of the vessel. By measuring the
transit time of the ultrasound beam in the upstream and downstream
directions, volume blood flow estimates can be evaluated.
- Electromagnetic flowmeters (EMF) are probably the oldest modality to
quantify blood flow (other than timed collection). These devices monitor
blood flow invasively, are impractical for multiple readings
11
on different vessels, require precise sizing of probes to blood vessels,
and do not provide additional hemodynamic parameters. The technology
requires the operator to encircle the blood vessel with an electromagnetic
probe. The probe generates an electromagnetic field, and the voltage
measured due to the blood flow is translated into volume flow estimates.
In practice, however, this technology is generally considered outdated.
- Doppler technology has been around for several decades, and is being
widely used in non-invasive vascular diagnostics. Duplex ultrasound
systems have the potential to measure blood flow non-invasively. Duplex
systems are designed for imaging the anatomical severity of pathology.
This method is technician-dependent, cumbersome, not accurate and does not
offer monitoring capabilities. However, plain Doppler systems provide only
blood flow velocity rather than volume flow.
INDIRECT BLOOD FLOW MEASUREMENT DEVICES
- Cardiac Output (CO) Monitors include various means to monitor CO such as
Thermal Dilution, Bio Impedance, and the Fick Method. These methods are
either invasive or indirect in their measurement. Thermal dilution,
primarily through pulmonary artery catheterization (PAC), is the standard
of care today for cardiac output measurements. This technology is not
applicable to other intraoperative blood flow applications. The patient is
injected with cold saline at a fixed temperature, and a
temperature-sensitive transducer that is placed at the site of interest
(usually the pulmonary artery) measures the time to return to baseline
temperature, which is proportional to the blood flow rate. There are many
limitations to this technology, including the relatively large
inaccuracies of cardiac output measurements, the fact that it is not truly
real-time, and the fact that this method is highly invasive, and is being
linked to increased morbidity and mortality (JAMA, Connors et al., 1996).
- Computed Tomography, Magnetic Resonance Imaging and Single Photon Emission
Computed Tomography techniques show target organ perfusion, but lack the
ability to monitor or to provide real-time information. They are
technician-dependent, impractical for bedside usage and very expensive.
- Laser Doppler Flowmeters monitor skin blood flow non-invasively. They are
applicable only to superficial and tiny vessels and do not provide
additional hemodynamic parameters.
- Transcranial Doppler (TCD) monitors cerebral blood velocity rather than
direct blood flow. TCD is non-invasive and provides continuous measurement
of blood flow velocity in the vessels of the brain. TCD is
technician-dependent and cannot be used on every patient.
- Plethysmography indirectly measures an index of blood flow and is limited
primarily to limb assessment. Measurement depends upon many factors and
output is accordingly inaccurate.
- Jugular Bulb Saturation measures the efficiency of oxygen use by the
brain. It is invasive, and provides global results.
- NIRS is a non-invasive method utilizing near infrared spectroscopy to
provide regional perfusion in the brain.
POTENTIALLY COMPETITIVE BLOOD FLOW MEASUREMENT DEVICES
Cardiosonix products are designed to address blood flow measurement across a
variety of clinical and surgical settings, and there are a number of companies
already in the marketplace that offer products related to blood flow
measurement. However, most of these products do not directly compete with
Cardiosonix products. The companies that do offer potentially competitive
products are, for the most part, smaller, privately held companies, with which
we believe we can effectively compete. Indeed, due to our belief in the
technical superiority of our products, we believe the existence of competitors
will help to educate the marketplace regarding the importance of blood flow
measurement. As we have discussed,
12
adoption of blood flow monitoring devices for the measurement of hemodynamic
status will likely take an involved education process as it often involves a
change in clinical or surgical management. While there is not a clear leader in
these markets, the following companies compete most directly with Cardiosonix:
- Intraoperative applications: Carolina Medical, Inc. (EMF), and Transonic
Systems, Inc. and Medi-Stim AS (TT).
- Neurosurgery applications: HADECO, Hayashi Denki Co., Ltd. (Doppler
based), and DWL Elektronische Systeme GmbH and Nicolet Biomedical (TCD).
- Critical care monitoring: Deltex Medical Ltd. and Arrow International,
Inc. (Transesophageal Doppler), and CardioDynamics International Corp.
(bioimpedance).
PATENTS AND PROPRIETARY RIGHTS
We regard the establishment of a strong intellectual property position in our
technology as an integral part of the development process. We attempt to protect
our proprietary technologies through patents and intellectual property
positions, in the United States as well as major foreign markets. Specifically,
our ILM technology is protected by twenty instrument patents that have been
issued in the United States as well as major foreign markets.
Cardiosonix has also applied for patent coverage for the key elements of its
ADBF technology in the EU and the U.S. The first of the two patents covering
Cardiosonix ADBF technology issued in the U.S. in January 2003 and claims for
the second patent have been allowed. These two patents have also been filed in
the EU and are in various stages of review by the relevant governing bodies.
Lymphoseek is also the subject of patent applications in the United States and
certain major foreign markets. The first composition of matter patent covering
Lymphoseek was issued in the U.S. in June 2002.
We continue to attempt to maintain proprietary protection for the products
related to RIGS and ACT in major global markets such as the U.S. and the EU,
which although not currently integral to our near-term business plans, may be
important to a potential RIGS or ACT development partner. Certain aspects of our
RIGS technology are claimed in the United States in U.S. Patent No. 4,782,840,
which expires in 2005, unless extended. In addition to the RIGS patent, the
antibodies used in clinical studies are covered by patents that have been issued
in the U.S. and EU.
The patent position of biotechnology and medical device firms, including our
company, generally is highly uncertain and may involve complex legal and factual
questions. Potential competitors may have filed applications for, or may have
been issued patents, or may obtain additional patents and proprietary rights
relating to products or processes in the same area of technology as that used by
our company. The scope and validity of these patents and applications, the
extent to which we may be required to obtain licenses thereunder or under other
proprietary rights, and the cost and availability of licenses are uncertain. We
cannot assure you that our patent applications will result in additional patents
being issued or that any of our patents will afford protection against
competitors with similar technology; nor can we assure you that any of our
patents will not be designed around by others or that others will not obtain
patents that we would need to license or design around. See also Risk Factors.
We also rely upon unpatented trade secrets. We cannot assure you that others
will not independently develop substantially equivalent proprietary information
and techniques, or otherwise gain access to our trade secrets, or disclose such
technology, or that we can meaningfully protect our rights to our unpatented
trade secrets.
We require our employees, consultants, advisers, and suppliers to execute a
confidentiality agreement upon the commencement of an employment, consulting or
manufacturing relationship with us. The agreement provides that all confidential
information developed by or made known to the individual during
13
the course of the relationship will be kept confidential and not disclosed to
third parties except in specified circumstances. In the case of employees, the
agreements provide that all inventions conceived by the individual will be the
exclusive property of our company. We cannot assure you, however, that these
agreements will provide meaningful protection for our trade secrets in the event
of an unauthorized use or disclosure of such information.
GOVERNMENT REGULATION
Most aspects of our business are subject to some degree of government regulation
in the countries in which we conduct our operations. As a developer,
manufacturer and marketer of medical products, we are subject to extensive
regulation by, among other governmental entities, the U.S. FDA and the
corresponding state, local and foreign regulatory bodies in jurisdictions in
which our products are sold. These regulations govern the introduction of new
products, the observance of certain standards with respect to the manufacture,
safety, efficacy and labeling of such products, the maintenance of certain
records, the tracking of such products and other matters.
Failure to comply with applicable federal, state, local or foreign laws or
regulations could subject us to enforcement action, including product seizures,
recalls, withdrawal of marketing clearances, and civil and criminal penalties,
any one or more of which could have a material adverse effect on our business.
We believe that we are in substantial compliance with such governmental
regulations. However, federal, state, local and foreign laws and regulations
regarding the manufacture and sale of medical devices are subject to future
changes. We cannot assure you that such changes will not have a material adverse
effect on our company.
For some products, and in some countries, government regulation is significant
and, in general, there is a trend toward more stringent regulation. In recent
years, the U.S. FDA and certain foreign regulatory bodies have pursued a more
rigorous enforcement program to ensure that regulated businesses, like ours,
comply with applicable laws and regulations. We devote significant time, effort
and expense addressing the extensive governmental regulatory requirements
applicable to our business. To date, we have not received any notifications or
warning letters from the U.S. FDA or any other regulatory bodies of alleged
deficiencies in our compliance with the relevant requirements, nor have we
recalled or issued safety alerts on any of our products. However, we cannot
assure you that a warning letter, recall or safety alert, if it occurred, would
not have a material adverse effect on our company.
In the early to mid 1990s, the review time by the U.S. FDA to clear medical
products for commercial release lengthened and the number of marketing
clearances decreased. In response to public and congressional concern, the U.S.
FDA Modernization Act of 1997 (the 1997 Act) was adopted with the intent of
bringing better definition to the clearance process for new medical products.
While U.S. FDA review times have improved since passage of the 1997 Act, we
cannot assure you that the U.S. FDA review process will not continue to delay
our company's introduction of new products in the U.S. in the future. In
addition, many foreign countries have adopted more stringent regulatory
requirements that also have added to the delays and uncertainties associated
with the release of new products, as well as the clinical and regulatory costs
of supporting such releases. It is possible that delays in receipt of, or
failure to receive, any necessary clearance for our new product offerings could
have a material adverse effect on our business, financial condition or results
of operations.
While we are unable to predict the extent to which our business may be affected
by future regulatory developments, we believe that our substantial experience
dealing with governmental regulatory requirements and restrictions on our
operations throughout the world, and our development of new and improved
products, should enable us to compete effectively within this environment.
GAMMA DETECTION AND BLOOD FLOW MEDICAL DEVICES
As a manufacturer of medical devices sold in various global markets, we are
required to manufacture the devices under quality system regulations (QSR) and
maintain appropriate technical files and quality records. Our medical devices
are regulated in the United States by the U.S. FDA. Our
14
medical devices are regulated in the EU according to the Medical Device
Directive (93/42/EEC). Under this regulation, we must obtain CE Mark status for
all products exported to the EU.
Our initial generation gamma detection instruments received 510(k) marketing
clearance from the U.S. FDA in December 1986 with modified versions receiving
similar clearances in 1992 through 1997. In 1998, the U.S. FDA reclassified
"nuclear uptake detectors" as being exempt from the 510(k) process. We believe
the NEO2000 device is exempt from the 510(k) process because it is substantially
equivalent to previously cleared predecessor devices. We obtained the CE Mark
for the NEO2000 device in January 1999, and therefore, must continue to
manufacture the devices under a quality system compliant to the requirements of
ISO 9001/EN 46001 and maintain appropriate technical files. We maintain a
license to import our gamma devices into Canada, and therefore must continue to
manufacture the devices under a quality system compliant to the requirements of
ISO 13485 and CMDCAS.
Cardiosonix has received 510(k) and CE mark clearance to market the QUANTIX/ND
device in the U.S. and EU for non-invasive applications. The QUANTIX/OR has also
received clearance to market in the EU and is pending 510(k) clearance in the
U.S. We intend to submit additional applications for clearance or amendments, as
appropriate, for the QUANTIX/TE in the future.
PHARMA/BIOLOGIC PRODUCTS (LYMPHOSEEK AND RIGS)
Our radiolabeled targeting agents and biologic products, if developed, would
require a regulatory license to market by the U.S. FDA and by comparable
agencies in foreign countries. The process of obtaining regulatory licenses and
approvals is costly and time consuming, and we have encountered significant
impediments and delays related to our previously proposed biologic products.
The process of completing pre-clinical and clinical testing, manufacturing
validation and submission of a marketing application to the appropriate
regulatory bodies usually takes a number of years and requires the expenditure
of substantial resources, and we cannot assure you that any approval will be
granted on a timely basis, if at all. Additionally, the length of time it takes
for the various regulatory bodies to evaluate an application for marketing
approval varies considerably, as does the amount of preclinical and clinical
data required to demonstrate the safety and efficacy of a specific product. The
regulatory bodies may require additional clinical studies that may take several
years to perform. The length of the review period may vary widely depending upon
the nature and indications of the proposed product and whether the regulatory
body has any further questions or requests any additional data. Also, the
regulatory bodies will likely require postmarketing reporting and surveillance
programs to monitor the side effects of the products. We cannot assure you that
any of our potential drug or biologic products will be approved by the
regulatory bodies or approved on a timely or accelerated basis, or that any
approvals received will not subsequently be revoked or modified.
In addition to regulations enforced by the U.S. FDA, the manufacture,
distribution, and use of radioactive targeting agents, if developed, are also
subject to regulation by the Nuclear Regulatory Commission (NRC), the Department
of Transportation and other federal, state, and local government authorities.
We, or our manufacturer of the radiolabeled antibodies, must obtain a specific
license from the NRC to manufacture and distribute radiolabeled antibodies, as
well as comply with all applicable regulations. We must also comply with
Department of Transportation regulations on the labeling and packaging
requirements for shipment of radiolabeled antibodies to licensed clinics, and
must comply with federal, state, and local governmental laws regarding the
disposal of radioactive waste. We cannot assure you that we will be able to
obtain all necessary licenses and permits and be able to comply with all
applicable laws. The failure to obtain such licenses and permits or to comply
with applicable laws would have a materially adverse effect on our business,
financial condition, and results of operations.
EMPLOYEES
As of March 15, 2003, we had 25 full-time employees, including those of our
wholly-owned subsidiary, Cardiosonix. We consider our relations with our
employees to be good.
15
RISK FACTORS
The discussion in this Report contains forward-looking statements that involve
risks and uncertainties. Our actual results may differ significantly from the
prospects discussed in the forward-looking statements. Factors that could cause
or contribute to such differences include, but are not limited to, those listed
below.
If we are unable to obtain additional funds we may have to significantly curtail
the scope of our operations and alter our business model.
As of December 31, 2002, our cash on-hand was $701,000. During the fourth
quarter of 2002, we used $479,000 in cash to fund our operations. We believe,
based on currently available financing and forecasted sales and expenses, that
our funding will be adequate to sustain operations through the end of 2003.
During March 2003 we entered into agreements for bridge financing loans totaling
$500,000 ($250,000 of which will be obtained from our President and CEO);
however, we do not know if we will succeed in raising additional funds through
further offerings of debt or equity. We believe that unless additional financing
is arranged, we would likely have to make significant changes to our business
plan during the third or fourth quarter of 2003. Such changes would likely
delay the successful launch of our blood flow product line. We must ultimately
achieve profitability from our blood flow product line for our business model to
succeed. In the absence of significant revenue from our blood flow product line,
we believe that we will need to arrange financing of at least $1.5 million
(including the $500,000 bridge loan) by the end of 2003 in order to sustain our
operations at current levels into 2004. However, we cannot assure you that
subsequent additional financings will be available to us on a timely basis or
that the additional capital that we require will be available on acceptable
terms, if at all. The terms of a subsequent financing may involve the
authorization of additional shares of our common stock that may result in a
significant dilution, a change of control and/or require stockholder approval.
We have been, and continue to be, actively engaged in seeking additional
financing in a variety of venues and formats and we continue to impose actions
designed to minimize our operating losses. We would consider strategic
opportunities, including additional investments in Neoprobe, a merger or other
comparable transaction, to sustain our operations. We do not currently have any
agreements in place with respect to such strategic opportunity, and we cannot
assure you that additional capital will be available to us on acceptable terms,
or at all. If additional financing is not available when required or is not
available on acceptable terms, or we are unable to arrange a suitable strategic
opportunity, we will be in significant financial jeopardy and we may be unable
to continue our operations at current levels, or at all.
We have suffered significant operating losses for several years in our history
and we may not be able to again achieve profitability.
We had an accumulated deficit of approximately $121 million as of December 31,
2002. Although we were profitable in 2000 and in 2001, we incurred substantial
losses in the years prior to that and in 2002. The deficit resulted because we
expended more money in the course of researching, developing and enhancing our
technology and products and establishing our marketing and administrative
organizations than we generated in revenues. We expect to continue to incur
significant operating expenses in the foreseeable future, primarily related to
the development and commercialization of the Cardiosonix product line. As a
result, it is likely that we will sustain substantial operating and net losses
in 2003, and it is possible that we will never be able to sustain or develop the
revenue levels necessary to again attain profitability.
We may have difficulty raising additional capital, which could deprive us of
necessary resources.
We expect to continue to devote substantial capital resources to fund research
and development, especially related to our Cardiosonix products and to maintain
existing and secure new manufacturing capacity. In order to support the
initiatives envisioned in our business plan, we will need to raise additional
funds through the sale of assets, public or private financing, collaborative
relationships or other arrangements. Our ability to raise additional financing
depends on many factors beyond our control, including the state of capital
markets, the market price of our common stock and the development or prospects
for development of competitive technology by others. Because our common stock is
not listed
16
on a major stock exchange, many investors may not be willing or allowed to
purchase it or may demand steep discounts. The necessary additional financing
may not be available to us or may be available only on terms that would result
in further dilution to the current owners of our common stock. In addition, we
have attempted to obtain authorization from our stockholders twice in the last
five years to increase the authorized shares of our common stock, but we have
failed to gain such approval. At current market prices, the limited number of
shares we have available to sell severely limits our ability to use equity as a
method of raising capital. If we are unable to raise additional funds when we
need them, we may have to severely curtail our operations.
We have a limited number of shares of common stock available for issuance in
support of future financings.
Our certificate of incorporation presently provides for 50,000,000 shares of
common stock $.001 par value. We currently have 38,588,725 shares outstanding
and have reserved 3,343,124 shares for issuance related to outstanding options
and warrants. At our current trading prices, the number of shares we have
available to sell or for issuance related to future convertible securities are
not adequate to raise the amount of funds we have indicated are necessary to
execute our current business plan. We intend to ask our stockholders to approve
an increase in the number of authorized shares in connection with this year's
annual meeting, currently scheduled for June 12, 2003. However, our stockholders
have failed to approve adjustments to our authorized shares twice in the last
five years. If we are unable to obtain approval for the issuance of additional
shares when required, it will place us in significant financial jeopardy and we
may be unable to continue our operations at current levels, or at all.
Our products may not achieve the broad market acceptance they need in order to
be a commercial success.
Widespread use of our gamma detection devices is currently limited to a surgical
procedure (ILM) used in the treatment and diagnosis of two primary types of
cancer: melanoma and breast cancer. The success of our gamma detection devices
greatly depends on the medical community's acceptance of ILM, and on our devices
for use in ILM as a reliable, safe and cost effective alternative to current
treatments and procedures. The adoption rate for ILM appears to be leveling off
and may not meet our expectations. Although we continue to believe that ILM has
significant advantages over other currently competing procedures, broad-based
clinical adoption of ILM will likely not occur until after the completion of
ongoing international trials related to breast cancer. Even if the results of
these trials are positive, we cannot assure you that ILM will attain rapid and
widespread acceptance. Our efforts and those of our marketing and distribution
partners may not result in significant demand for our products, and the current
demand for our products may decline.
Our future success now also greatly depends on the success of the Cardiosonix
product line. Cardiosonix' products are just beginning to be marketed
commercially. The market for these products is in an early stage of development
and may never fully develop as we expect. The long-term commercial success of
the Cardiosonix product line will require widespread acceptance of our products
as safe, efficient and cost-effective. Widespread acceptance would represent a
significant change in medical practice patterns. Other cardiac monitoring
procedures, such as pulmonary artery catheterization, are generally accepted in
the medical community and have a long standard of use. It is possible that the
Cardiosonix product line will never achieve the broad market acceptance
necessary to become a commercial success.
Our auditors have issued a "Going Concern" opinion on our financial statements.
We have suffered recurring losses from operations and may need substantial
amounts of additional capital to finance our operations. The report of KPMG LLP
dated February 7, 2003, except Notes 16 and 17 as to which the date is March 26,
2003, covering the December 31, 2002 consolidated financial statements has been
modified to include an explanatory paragraph stating that, in their opinion,
there is substantial doubt about our ability to continue as a going concern. The
consolidated financial statements do not include any adjustments that might
result from the outcome of this uncertainty.
17
This opinion may make it much harder for us to secure marketing and
distribution partners for our blood flow product line and market our products.
It may also depress the price of our common stock and adversely affect our
ability to raise additional capital.
We rely on third parties for the worldwide marketing and distribution of our
gamma detection devices, who may not be successful in selling our products.
We currently distribute our gamma detection devices in most global markets
through two partners who are solely responsible for marketing and distributing
these products. The partners assume direct responsibility for business risks
related to credit, currency exchange, foreign tax laws or tariff and trade
regulation. While we believe that our distribution partners intend to continue
to aggressively market our products, we cannot assure you that the distribution
partners will succeed in marketing our products on a global basis. We may not be
able to maintain satisfactory arrangements with our marketing and distribution
partners, who may not devote adequate resources to selling our gamma detection
devices. If this happens, we may not be able to successfully market our
products, which would decrease our revenues.
We do not have experience in marketing blood flow products and we have not yet
established strategic relationships with potential marketing partners.
We completed the Cardiosonix acquisition on December 31, 2001, and to date have
entered into arrangements covering only seven countries to distribute the
Quantix line of blood flow products. We believe the adoption path for
Cardiosonix' products will be similar to that of our gamma detection devices,
but we have no direct experience in marketing or selling blood flow measurement
devices. We may not be successful in creating the necessary infrastructure,
either internally or through third parties, to support the successful marketing
and sales of Cardiosonix products.
We rely on third parties to manufacture our products and our business will
suffer if they do not perform.
We rely on independent contract manufacturers for the manufacture of our current
line of gamma detection systems. Our business will suffer if our contract
manufacturers have production delays or quality problems. Furthermore, medical
device manufacturers are subject to the QSR regulations of the U.S. FDA,
international quality standards, and other regulatory requirements. If our
contractors do not operate in accordance with regulatory requirements and
quality standards, our business will suffer. We use or rely on components and
services used in our devices that are provided by sole source suppliers. The
qualification of additional or replacement vendors is time consuming and costly.
If a sole source supplier has significant problems supplying our products, our
sales and revenues will be hurt until we find a new source of supply. In
addition, our distribution agreement with EES contains failure to supply
provisions, which, if triggered, could have a significant negative impact on our
business.
We may lose out to larger and better-established competitors.
The medical device and biotechnology industries are intensely competitive. Some
of our competitors have significantly greater financial, technical,
manufacturing, marketing and distribution resources as well as greater
experience in the medical device industry than we have. The particular medical
conditions our product lines can address can also be addressed by other medical
devices, procedures or drugs. Many of these alternatives are widely accepted by
physicians and have a long history of use. Physicians may use our competitors'
products and/or our products may not be competitive with other technologies. If
these things happen, our sales and revenues will decline. In addition, our
current and potential competitors may establish cooperative relationships with
large medical equipment companies to gain access to greater research and
development or marketing resources. Competition may result in price reductions,
reduced gross margins and loss of market share.
18
Our products may be displaced by newer technology.
The medical device and biotechnology industries are undergoing rapid and
significant technological change. Third parties may succeed in developing or
marketing technologies and products that are more effective than those developed
or marketed by us, or that would make our technology and products obsolete or
non-competitive. Additionally, researchers could develop new surgical procedures
and medications that replace or reduce the importance of the procedures that use
our products. Accordingly, our success will depend, in part, on our ability to
respond quickly to medical and technological changes through the development and
introduction of new products. We may not have the resources to do this. If our
products become obsolete and our efforts to develop new products do not result
in any commercially successful products, our sales and revenues will decline.
We are in a highly regulated business and we could face severe problems if we do
not comply with all regulatory requirements in the global markets in which our
products are sold.
The U.S. FDA regulates our products in the United States. Foreign countries also
subject our products to varying government regulations. In addition, such
regulatory authorities may impose limitations on the use of our products. U.S.
FDA enforcement policy strictly prohibits the marketing of U.S. FDA cleared
medical devices for unapproved uses. Within the European Union, our products are
required to display the CE mark in order to be sold. We have obtained U.S. FDA
clearance to market our medical device products and European certification to
display the CE mark on our current line of gamma detection systems and on two of
Cardiosonix' products, the QUANTIX/ND and QUANTIX/OR. We may not be able to
obtain certification for any new products in a timely manner, or at all. Failure
to comply with these and other current and emerging regulatory requirements in
the global markets in which our products are sold could result in, among other
things, warning letters, fines, injunctions, civil penalties, recall or seizure
of products, total or partial suspension of production, refusal of the
government to grant pre-market clearance for devices, withdrawal of clearances,
and criminal prosecution.
Our intellectual property may not have or provide sufficient legal protections
against infringement or loss of trade secrets.
Our success depends, in part, on our ability to secure and maintain patent
protection, to preserve our trade secrets, and to operate without infringing on
the patents of third parties. While we seek to protect our proprietary positions
by filing United States and foreign patent applications for our important
inventions and improvements, domestic and foreign patent offices may not issue
these patents. Third parties may challenge, invalidate, or circumvent our
patents or patent applications in the future. Competitors, many of which have
significantly more resources than we have and have made substantial investments
in competing technologies, may apply for and obtain patents that will prevent,
limit, or interfere with our ability to make, use, or sell our products either
in the United States or abroad.
In the United States, patent applications are secret until patents issue, and in
foreign countries, patent applications are secret for a time after filing.
Publications of discoveries tend to significantly lag the actual discoveries and
the filing of related patent applications. Third parties may have already filed
applications for patents for products or processes that will make our products
obsolete or will limit our patents or invalidate our patent applications.
We typically require our employees, consultants, advisers and suppliers to
execute confidentiality and assignment of invention agreements in connection
with their employment, consulting, advisory, or supply relationships with us.
They may breach these agreements and we may not obtain an adequate remedy for
breach. Further, third parties may gain access to our trade secrets or
independently develop or acquire the same or equivalent information.
Agencies of the United States government conducted some of the research
activities that led to the development of antibody technology that some of our
proposed antibody-based surgical cancer detection products use. When the United
States government participates in research activities, it retains rights that
include the right to use the technology for governmental purposes under a
royalty-free license, as well as
19
rights to use and disclose technical data that could preclude us from asserting
trade secret rights in that data and software.
Conditions in Israel may affect the operations of Cardiosonix and may limit our
ability to complete development of its products.
Our Cardiosonix subsidiary is incorporated in Israel, and its offices and
research and development facilities are located there. Political, economic and
military conditions in Israel may directly affect its operations. Since the
establishment of the State of Israel in 1948, a number of armed conflicts have
taken place between Israel and its Arab neighbors and a state of hostility,
varying in degree and intensity, has led to security and economic problems for
Israel. Despite past progress towards peace between Israel and its Arab
neighbors, the future of these peace efforts is uncertain. Any armed conflict,
political instability or continued violence in the region could have a negative
effect on the activities of Cardiosonix and the completion of development and
commercialization of our blood flow monitoring products.
Cardiosonix' operations could be disrupted as a result of the obligation of key
personnel in Israel to perform military service.
Some of Cardiosonix employees, including key officers, may currently be
obligated to perform annual reserve duty. These employees could also be called
to active duty in the event of a national emergency. Cardiosonix' operations
could be disrupted by their absence for a significant period due to military
service.
The government grants Cardiosonix has received for research and development
expenditures restrict our ability to manufacture blood flow monitoring products
and transfer technologies outside of Israel and require us to satisfy specified
conditions. If we fail to satisfy these conditions, we may be required to refund
grants previously received together with interest and penalties, and may be
subject to criminal charges.
Cardiosonix received grants from the government of Israel through the Office of
the Chief Scientist of the Ministry of Industry and Trade for the financing of a
portion of its research and development expenditures associated with our blood
flow monitoring products. From 1998 to 2001, Cardiosonix received grants
totaling $775,000 from the Office of the Chief Scientist. The terms of the Chief
Scientist grants may prohibit us from manufacturing products or transferring
technologies developed using these grants outside of Israel without special
approvals. Even if we receive approval to manufacture our blood flow monitoring
products outside of Israel, we may be required to pay an increased total amount
of royalties, which may be up to 300% of the grant amount plus interest,
depending on the manufacturing volume that is performed outside of Israel. This
restriction may impair our ability to outsource manufacturing or engage in
similar arrangements for those products or technologies. In addition, if we fail
to comply with any of the conditions imposed by the Office of the Chief
Scientist, we may be required to refund any grants previously received together
with interest and penalties, and may be subject to criminal charges. In recent
years, the government of Israel has accelerated the rate of repayment of Chief
Scientist grants and may further accelerate them in the future.
The placement of our common stock with Fusion Capital may cause dilution and the
sale of the shares of common stock acquired by Fusion Capital could cause the
price of our common stock to decline.
On November 19, 2001, we entered into a common stock purchase agreement with an
investment fund, Fusion Capital Fund II, LLC (Fusion) for the issuance and
purchase of our common stock. The stock purchase agreement established an equity
line of credit or draw-down facility. Under the agreement, Fusion committed to
purchase up to $10 million of our common stock over a forty-month period that
commenced in May 2002. A registration statement registering for resale up to 5
million shares of our common stock was declared effective on April 15, 2002.
Depending upon market liquidity at the time, a sale of shares under the
registration statement could cause the trading price of our common stock to
decline, thus affecting the value that our other stockholders can obtain for
their shares. Additionally, the sale of a substantial number of shares of our
common stock by Fusion, or anticipation of such sales, could make it more
difficult for us to sell equity or equity-related securities in the future at a
time and at a price
20
that we might otherwise wish to effect sales, and we may be forced to effect
such sales at depressed market prices. The market price for our common stock
also traded under $0.20 per share for a significant portion of 2002 below which
price Fusion is not required to purchase our common stock.
Our product sales may be adversely affected by healthcare pricing regulation and
reform activities.
The healthcare industry is undergoing fundamental changes resulting from
political, economic and regulatory influences. In the United States,
comprehensive programs have been proposed that seek to increase access to
healthcare for the uninsured, control the escalation of healthcare expenditures
within the economy and use healthcare reimbursement policies to balance the
federal budget.
We expect that Congress and state legislatures will continue to review and
assess healthcare proposals, and public debate of these issues will likely
continue. We cannot predict which, if any, of such reform proposals will be
adopted and when they might be adopted. Other countries also are considering
healthcare reform. Significant changes in healthcare systems could have a
substantial impact on the manner in which we conduct our business and could
require us to revise our strategies.
We could be damaged by product liability claims.
Our products are used or intended to be used in various clinical or surgical
procedures. If one of our products malfunctions or a physician misuses it and
injury results to a patient or operator, the injured party could assert a
product liability claim against our company. We currently have product liability
insurance with a $10 million per occurrence limit, which, we believe, is
adequate for our current activities. However, we may not be able to continue to
obtain insurance at a reasonable cost. Furthermore, insurance may not be
sufficient to cover all of the liabilities resulting from a product liability
claim, and we might not have sufficient funds available to pay any claims over
the limits of our insurance. Because personal injury claims based on product
liability in a medical setting may be very large, an underinsured or an
uninsured claim could financially damage our company.
We may have trouble attracting and retaining qualified personnel and our
business may suffer if we do not.
Our business has experienced developments the past two years that have resulted
in several significant changes in our strategy and business plan, including the
shifting of resources to support our current product initiatives and downsizings
to what we consider to be the minimal support structure necessary to operate a
publicly traded company. Our management will need to remain flexible to support
our business model over the next few years. However, losing any member of the
Neoprobe management team or the Cardiosonix development team could have an
adverse effect on our operations. Our success depends on our ability to attract
and retain technical and management personnel with expertise and experience in
the medical device business. The competition for qualified personnel in the
medical device industry is intense and we may not be successful in hiring or
retaining the requisite personnel. If we are unable to attract and retain
qualified technical and management personnel, we will suffer diminished chances
of future success.
Under the terms of our recent bridge financings, we have or may be required to
grant partial or complete liens on substantially all of our assets.
In the event of a default under the terms of the bridge loan agreements we
entered into with our President and another investor, we will grant each of the
note holders a security interest in certain of our assets, including our
intellectual property. We believe this is customary in the types of arrangements
we have entered into; however, the security holders can typically foreclose on
the security interest in our assets in the event of default under the terms of
the notes. If this were to happen, we may be required to file a petition under
Chapter 11 of the Bankruptcy Code seeking protection, or file Chapter 7 and
liquidate.
21
Our common stock is traded over the counter, which may deprive stockholders of
the full value of their shares.
Our common stock is quoted via the National Association of Securities Dealers'
Over the Counter Bulletin Board (OTCBB). As such, our common stock may have
fewer market makers, lower trading volumes and larger spreads between bid and
asked prices than securities listed on an exchange such as the New York Stock
Exchange or the NASDAQ. These factors may result in higher price volatility and
less market liquidity for the common stock.
A low market price may severely limit the potential market for our common stock.
Our common stock is currently trading at a price substantially below $5.00 per
share, subjecting trading in the stock to certain SEC rules requiring additional
disclosures by broker-dealers. These rules generally apply to any non-NASDAQ
equity security that has a market price share of less than $5.00 per share,
subject to certain exceptions (a "penny stock"). Such rules require the
delivery, prior to any penny stock transaction, of a disclosure schedule
explaining the penny stock market and the risks associated therewith and impose
various sales practice requirements on broker-dealers who sell penny stocks to
persons other than established customers and institutional or wealthy investors.
For these types of transactions, the broker-dealer must make a special
suitability determination for the purchaser and have received the purchaser's
written consent to the transaction prior to the sale. The broker-dealer also
must disclose the commissions payable to the broker-dealer, current bid and
offer quotations for the penny stock and, if the broker-dealer is the sole
market maker, the broker-dealer must disclose this fact and the broker-dealer's
presumed control over the market. Such information must be provided to the
customer orally or in writing before or with the written confirmation of trade
sent to the customer. Monthly statements must be sent disclosing recent price
information for the penny stock held in the account and information on the
limited market in penny stocks. The additional burdens imposed upon
broker-dealers by such requirements could discourage broker-dealers from
effecting transactions in our common stock.
The price of our common stock has been highly volatile due to several factors
that will continue to affect the price of our stock.
Our common stock has traded as low as $0.05 per share and as high as $0.55 per
share in the twelve months ended December 31, 2002. Some of the factors leading
to the volatility include:
- price and volume fluctuations in the stock market at large which do
not relate to our operating performance;
- fluctuations in our operating results;
- financing arrangements we may enter that require the issuance of a
significant number of shares in relation to the number of shares
currently outstanding;
- announcements of technological innovations or new products which we
or our competitors make;
- U.S. FDA and international regulatory actions;
- developments with respect to patents or proprietary rights;
- public concern as to the safety of products that we or others
develop; and,
- fluctuations in market demand for and supply of our products.
An investor's ability to trade our common stock may be limited by trading
volume.
The trading volume for our common stock has been relatively limited. A
consistently active trading market for our common stock may not occur on the
OTCBB. The average daily trading volume for our common stock on the OTCBB for
the twelve-month period ended December 31, 2002 was approximately 57,528 shares.
Daily volume during that period ranged from 400 shares to 1,002,400 shares.
22
Our stockholder rights plan, some provisions of our organizational and governing
documents and an agreement with the former Cardiosonix stockholders, may have
the effect of deterring third parties from making takeover bids for control of
our company or may be used to hinder or delay a takeover bid.
Our certificate of incorporation authorizes the creation and issuance of "blank
check" preferred stock. Our Board of Directors may divide this stock into one or
more series and set their rights. The Board of Directors may, without prior
stockholder approval, issue any of the shares of "blank check" preferred stock
with dividend, liquidation, conversion, voting or other rights, which could
adversely affect the relative voting power or other rights of the common stock.
Preferred stock could be used as a method of discouraging, delaying, or
preventing a take-over of our company. If we issue "blank check" preferred
stock, it could have a dilutive effect upon our common stock. This would
decrease the chance that our stockholders would realize a premium over market
price for their shares of common stock as a result of a takeover bid.
Also, in connection with the Cardiosonix acquisition, the former stockholders of
Cardiosonix entered into an agreement with us that for a period of two years
following the acquisition, they would not participate in certain actions and
transactions that would lead to a change in control of our company, and to vote
their shares in conformity with the recommendations of our Board of Directors as
to certain matters, including the approval of transactions that would result in
a change in control. These provisions could have the effect of discouraging,
delaying or preventing a takeover of our company.
Because we will not pay dividends, stockholders will only benefit from owning
common stock if it appreciates.
We have never paid dividends on our common stock and we do not intend to do so
in the foreseeable future. We intend to retain any future earnings to finance
our growth. Accordingly, any potential investor who anticipates the need for
current dividends from his investment should not purchase our common stock.
ITEM 2. DESCRIPTION OF PROPERTY
We currently lease our office at 425 Metro Place North, Dublin, Ohio. We
executed a lease agreement, commencing on January 1, 1997 and ending in August
2003, with the landlord of these facilities for approximately 25,000 square
feet. The lease provides for a monthly base rent of approximately $21,000 in
2003. During December 1998, February 1999, and April 2000, we executed three
lease agreements to sublease approximately 2,600 square feet, 4,600 square feet,
and 6,750 square feet of our office space, respectively. The three subleases are
expected to generate sublease income of approximately $82,000 in 2003. Our
company and our subtenants must also pay a pro-rata portion of the operating
expenses and real estate taxes of the building. We believe these facilities are
in good condition and will be adequate for our needs for the foreseeable future.
We intend to evaluate current conditions in our local real estate market and
either renew our current lease or enter into a lease for a similar amount of
office space, net of our subleased space.
Our subsidiary, Cardiosonix Ltd., currently leases its office in the Millennium
Building at 3 Ha'Tidhar Street, Ra'anana, Israel. The lease covers approximately
470 square meters of space and expires in April 2004. The lease provides for a
monthly base rent of $4,700 through the expiration of the lease.
ITEM 3. LEGAL PROCEEDINGS
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
23
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Our common stock trades on the OTC Bulletin Board under the trading symbol NEOP.
The prices set forth below reflect the quarterly high, low and closing sales
prices for shares of our common stock during the last two fiscal years as
reported by Reuters Limited. These quotations reflect inter-dealer prices,
without retail markup, markdown or commission, and may not represent actual
transactions.
HIGH LOW CLOSE
---- --- -----
Fiscal Year 2002
First Quarter $ 0.55 $ 0.35 $ 0.38
Second Quarter 0.42 0.25 0.28
Third Quarter 0.30 0.08 0.12
Fourth Quarter 0.31 0.05 0.13
Fiscal Year 2001
First Quarter $ 0.69 $ 0.41 $ 0.48
Second Quarter 1.05 0.40 0.70
Third Quarter 0.77 0.35 0.37
Fourth Quarter 0.51 0.34 0.42
As of March 25, 2003, we had approximately 766 holders of common stock of
record.
We have not paid any dividends on our common stock and do not anticipate paying
cash dividends in the foreseeable future. We intend to retain any earnings to
finance the growth of our business. We cannot assure you that we will ever pay
cash dividends. See Item 6, "Management's Discussion and Analysis of Financial
Condition and Results of Operations."
Recent Sales of Unregistered Securities
The following sets forth certain information regarding the sale of equity
securities of our company during the period covered by this report that were not
registered under the Securities Act of 1933 (the Securities Act).
In March 2002 and March 2001, our Board of Directors authorized the issuance of
53,116 and 19,122 shares of common stock, respectively, to the trustees of our
401(k) employee benefit plan (the Plan) without registration. Such issuance is
exempt from registration under the Securities Act under Section 3(a)(2). The
Plan is a pension, profit sharing or stock bonus plan that is qualified under
Section 401 of the Internal Revenue Code. The assets of the Plan are held in a
single trust fund for the benefit of our employees, which does not hold assets
for the benefit of the employees of any other employer. All of the contributions
to the Plan from our employees have been invested in assets other than our
common stock. We have contributed all of the Neoprobe common stock held by the
Plan as a matching contribution that has been less in value at the time it was
contributed to the Plan than the employee contributions that it matches.
24
On November 19, 2001, we entered into a common stock purchase agreement with an
investment fund, Fusion Capital Fund II, LLC (Fusion) for the issuance and
purchase of our common stock. Under the stock purchase agreement, Fusion
committed to purchase up to $10 million of our common stock over a forty-month
period that commenced in May 2002. A registration statement registering for
resale up to 5 million shares of our common stock was declared effective by the
Securities and Exchange Commission (the SEC) on April 15, 2002. Under the terms
of the agreement, we can request daily drawdowns, subject to a daily base amount
(currently set at $12,500) and subject to certain floor prices as discussed
below. The number of shares we will issue to Fusion in return for that money is
based on the lower of (a) the closing sale price for our common stock on the day
of the draw request or (b) the average of the three lowest closing sales prices
of our common stock during a twelve-day period prior to the draw request. No
shares may be sold to Fusion at lower than a floor price currently set at $0.30,
but in no case below $0.20 without Fusion's prior consent. Upon execution of the
common stock purchase agreement, we issued 449,438 shares of our common stock to
Fusion as a commitment fee. Market conditions (i.e., our low share price) have
effectively prohibited us from drawing funds under the Fusion facility during
2002, and in the absence of a change in those conditions, the Fusion facility is
unlikely to be drawn on in the foreseeable future.
25
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion should be read together with our Consolidated Financial
Statements and the Notes related to those statements, as well as the other
financial information included in this Form 10-KSB. Some of our discussion is
forward-looking and involves risks and uncertainties. For information regarding
risk factors that could have a material adverse effect on our business, refer to
Item I of this Form 10-KSB, Description of Business - Risk Factors.
THE COMPANY
Neoprobe Corporation (Neoprobe or we) is a biomedical technology company that
provides innovative surgical and diagnostic products that enhance patient care
by meeting the critical decision-making needs of healthcare professionals. Prior
to the acquisition of Cardiosonix Ltd. (Cardiosonix) on December 31, 2001, our
marketable products were limited to a line of gamma detection devices used in
the surgical application of intraoperative lymphatic mapping (ILM). The
acquisition of Cardiosonix significantly expanded the potential of our product
offerings. Cardiosonix is in the process of developing and commercializing a
unique line of proprietary blood flow monitoring devices for a variety of
diagnostic and surgical applications. Cardiosonix has received marketing
clearance for two of its products, QUANTIX/ND(TM) and QUANTIX/OR(TM), in Europe
and for the QUANTIX/ND in the U.S.
OUTLOOK AND OVERVIEW
This Overview and Outlook section contains a number of forward-looking
statements, all of which are based on current expectations. Actual results may
differ materially. Our financial performance is highly dependent on our ability
to continue to generate income and cash flow from our gamma device product line
and on our ability to successfully commercialize the blood flow products of our
subsidiary, Cardiosonix. We cannot assure you, however, that we will achieve the
volume of sales anticipated, or if achieved, that the margin on such sales will
be adequate to produce positive operating cash flow. While we remain optimistic
about the longer-term potential for our other proprietary technologies such as
Lymphoseek(TM), RIGS(R)and ACT, these technologies are not anticipated to
generate any significant revenue for us during 2003. We have tried
unsuccessfully to identify development partners for RIGS and ACT over the past
few years and as such, we have recently engaged an investment banker to assist
us in selling or licensing the RIGS and ACT technologies.
We continue to assess our business plan and the challenges we face, including
our future capital requirements. Although during March 2003 we entered into
agreements for bridge financing loans for a total of $500,000 ($250,000 of
which will be obtained from our President and CEO), we do not know if we will
succeed in raising additional funds through further offerings of debt or
equity. We believe our currently available financing, including the recent
bridge loans, will be adequate to sustain operations through the end of 2003.
However, our independent auditors have issued an opinion that indicates
that they have substantial doubt about our ability to continue our business
operations as a going concern. We believe that unless additional financing is
arranged, we would likely have to make significant changes to our business plan
during the third or fourth quarter of 2003 in order to sustain our operations
into 2004. Such changes would likely delay the successful launch of our blood
flow product line or force us to significantly curtail our blood flow
operations thus jeopardizing our future. We must achieve profitability starting
in 2004 for our business model to succeed. Prior to accomplishing this goal,
we believe that we will need to arrange an additional capital infusion of at
least $1.5 million (including funds to pay off the $500,000 in bridge loans)
in order to realize the goals in our current business plan. While such capital
infusion could include financings under our share purchase agreement with
Fusion Capital, current market prices preclude our use of that facility. We
cannot assure you that subsequent additional capital infusions will be made
available to us on a timely basis or that the additional capital that we
require will be available on acceptable terms, if at all. The terms of a
subsequent financing may involve a change of control and/or require
stockholder approval. In order for additional financing to be available to us,
we will likely need to receive stockholder approval of an increase in the
number of authorized shares of our common stock. If such approval is not
obtained, we will likely need to modify our business plan.
26
During 2002, we implemented a number of cost saving measures including workforce
reductions of over 50% in our gamma product development and support staff during
the third and fourth quarters of 2002. In addition, starting in August 2002, we
began implementing voluntary salary deferments for our officers. In February
2003, the deferment of our President's salary was amended at his direction to
decrease his salary by 40% for the remainder of his existing contract and
Neoprobe's other officers accepted new employment agreements that defer 20% of
their previous base salaries until our financial condition improves.
As of December 31, 2002, our cash on-hand was $701,000. During the fourth
quarter of 2002, we used $479,000 in cash to fund our operations. We are
actively engaged in seeking additional financing in a variety of venues and
formats and we continue to impose actions designed to minimize our operating
losses. In addition, although we have no current plans to do so, we may be
forced to consider strategic opportunities such as a merger or other comparable
transaction, to sustain our operations. We do not currently have any agreements
in place with respect to any such strategic opportunity, and we cannot assure
you that additional capital will be available to us on acceptable terms, or at
all. If additional financing is not available when required or is not available
on acceptable terms, or we are unable to arrange a suitable strategic
opportunity, we may be unable to continue our operations at current levels, or
at all.
We cannot assure you that the additional capital we require will be available on
acceptable terms, if at all. We cannot assure you that we will be able to
successfully commercialize Cardiosonix' products or that we will achieve
significant product revenues from our current or potential new products. In
addition, we cannot assure you that we will achieve or sustain profitability in
the future.
OUR OUTLOOK FOR OUR GAMMA DETECTION PRODUCTS
Numerous articles have been published in recent years in peer-reviewed journals
on the topics of sentinel lymph node biopsy and ILM, and a number of thought
leaders and cancer treatment institutions have recognized and embraced the
technology as standard of care for melanoma and, in some cases, for breast
cancer. However, as the melanoma market represents less than 10% of the breast
care market, standard of care recognition related to breast care is much more
important to us. Standard of care designation for breast cancer is most likely
dependent on completion of several large multi-center clinical trials in the
U.S. and abroad. Final data from these studies likely will not be presented for
two to three years, at the earliest. However, we believe that the surgical
community will continue to adopt the ILM application while the standard of care
determination is still pending. We also believe the lymphatic targeting agent
being developed by the University of California, San Diego (UCSD) for us, if it
should become commercially available, could improve the adoption of ILM in
future years.
Despite the lower than expected demand for our gamma detection products that we
and our marketing and distribution partners experienced in 2002, we continue to
be encouraged by the attention focused on ILM by the medical community at
surgical conferences, especially related to investigations into other
applications beyond melanoma and breast cancer. We believe the introduction of
our laparoscopic probe will greatly assist surgeons in expanding into areas such
as gastric and colon cancers. We also believe the market focus in all major
global markets for hand-held gamma detection devices will continue to be among
local/community hospitals, which typically lag behind leading research centers
and major hospitals in adapting to new technologies. A slower than anticipated
adoption rate may negatively impact our sales volumes, and therefore, revenues
and net income in 2003. The contractual minimum purchase requirements from our
1999 distribution agreement with Ethicon Endo-Surgery, Inc. (EES), a Johnson and
Johnson company, were met during the fourth quarter of 2002; however, we believe
that EES' total purchases of base NEO2000(R) systems for 2003 may be as much as
25% - 30% greater than 2002 based on their current forecast and the fact that
their overstock position had been eliminated as of the end of 2002. We cannot
assure you, however, that EES' sales will indeed increase and result in
increased demand for our products.
27
In addition, under the terms of our marketing agreement with EES, the transfer
prices we receive on product sales to EES are based on a percentage of their
end-customer sales price, subject to a floor transfer price. To date, our
products have commanded a price premium in most of the markets in which they are
sold, which we believe is due to their superior performance and ease of use.
While we continue to believe in the technical and user-friendly superiority of
our products, competitors continue to innovate and we may lose market share as a
result. A loss of market share would likely have a direct negative impact on net
income. Although the end-customer average sales price (ASP) may decline due to
external market pressures and competition, the percentage of ASP shared with us
will not change again under the terms of the current distribution agreement. In
addition, the price that we received during 2002 was only 11% above the floor
pricing for base systems, so we believe there is little downside pricing risk
associated with future sales of our gamma detection devices to EES.
EES has also reimbursed us for a flat amount per quarter ($125,000) related to
research and development expenses incurred on EES' behalf. This flat
reimbursement ended at the end of the third quarter of 2002. Since that time, we
have performed development activities on behalf of EES that are being evaluated
and reimbursed on a project-by-project basis. We currently have one such project
underway that is expected to be completed by mid-2003. We cannot assure you that
we will be successful in negotiating additional reimbursement from EES covering
product development at terms acceptable to us, or at all.
Despite the declines experienced in our gamma detection business line in 2002,
we believe the anticipated increase in volumes, coupled with the reductions in
our overhead structure, will result in our gamma business line being profitable
in 2003.
OUR OUTLOOK FOR OUR BLOOD FLOW PRODUCTS
Our primary efforts concerning the QUANTIX products in 2003 will include
significant continued development and product refinement, regulatory approval
efforts, pre-commercialization market preparation, distribution, marketing and
administrative support activities. During late 2002, we received regulatory
approvals to market the QUANTIX/ND in the U.S. and the EU. We placed a small
number of devices with two distributors covering three countries for their
demonstration purposes. Since the end of 2002, we have received CE Mark
clearance to market the QUANTIX/OR in the EU and have a 510(k) pending in the
U.S. Currently, we have six distributors covering seven countries for the
QUANTIX/ND and five distributors covering six countries for the QUANTIX/OR.
We have not yet commenced commercial shipment of the QUANTIX/OR; however, we
anticipate doing so in the near future. We are in active dialogue for marketing
and distribution rights with a number of parties of varying sizes and with
varying market expertise for additional markets including the U.S. The majority
of the distributors signed up to date are in the EU and the Pacific Rim. We have
not yet signed a distributor for the QUANTIX/ND or QUANTIX/OR covering the U.S.
or other large European markets. Our goal in securing marketing and distribution
partners is to first identify parties who possess appropriate expertise in
marketing medical devices, preferably ultrasound or cardiac care devices, into
our primary target markets, the cardiac care and neurosurgical markets. If
possible, we will try to secure partners with broad global reach similar to the
path we have followed for our gamma detection devices. If such a partner is not
available for a given market or if a territory-specific partner has expertise
that we believe outweighs the value of a global market reach, we will enter into
territory-specific arrangements as necessary.
We anticipate spending a significant amount of time and effort in 2003 to bring
the Cardiosonix blood flow products to a wider market. We will need to continue
to train our distributors and work through them with thought leaders in the
cardiac and neurosurgical fields to gain broader exposure to the advantages of
our technology. We anticipate placing blood flow systems with industry thought
leaders to obtain critical pre-commercialization feedback prior to widespread
market launch. The market education process we envision will likely take some
time to develop in the manner we desire. In addition, the sales cycle for
medical devices such as our blood flow products is typically a four to six month
cycle. As such, significant end customer sales, if they occur, will likely lag
the signing of distribution arrangements. Our sales of blood flow products for
the first two to three quarters of 2003 will likely consist primarily of
demonstration units sold to distributors. As a result, we anticipate that the
product development and market support costs we
28
will incur in 2003 will be greater than the revenue we generate from the sales
of blood flow devices. We expect a significant loss from our blood flow
operations for 2003.
SUMMARY
The strengthening of our gamma business portfolio coupled with the introduction
of the Cardiosonix blood flow products should position Neoprobe to achieve
long-term profitable operating performance beginning in late 2003 or early 2004.
However, as we have previously stated, we are in critical need of additional
capital in order to give us greater assurance that we will be able to fund the
remaining research and market development activities associated with our blood
flow line and to allow us to meet our business objectives in the timeframe we
have set out in our business plan. Our future liquidity and capital requirements
will depend on numerous factors, including the ability to raise additional
capital in a timely manner through additional investment, a potential merger, or
similar transaction, as well as expanded market acceptance of our current
products, improvements in the costs and efficiency of our manufacturing
processes, our ability to develop and commercialize new products, regulatory
actions by the U.S. FDA and other international regulatory bodies, and
intellectual property protection.
We anticipate generating a net profit from our gamma detection devices in 2003;
however, we expect our overall operating and net results for 2003 to show a loss
due to significant research and development, marketing and administrative
support costs that are still required to commercialize our blood flow product
line. Currently, we expect the loss for 2003 to be less than the loss incurred
in 2002. However, this expectation is based to a large degree on our
anticipation that we will achieve the necessary developmental and regulatory
milestones necessary to achieve significant commercial sales of our QUANTIX/OR
product in a timely manner. If we are unsuccessful in achieving significant
commercial sales of the OR product in 2003 or additional funding, our estimates
and our business plan may need to be significantly modified or curtailed.
Depending on the success of our Quantix product line and the timing of new
product development and regulatory approval cycles, we expect to achieve a small
operating profit no earlier than mid-2004. However, we cannot assure you that
our current or potential new products will be successfully commercialized or
that we will achieve significant product revenues. In addition, we cannot assure
that we will achieve or sustain profitability in the future.
RESULTS OF OPERATIONS
Neoprobe reported revenues for 2002 of $4.9 million compared to $8.2 million in
the prior year. The decline in revenue in 2002 versus 2001 is the direct result
of a decline in demand from our primary distributor, EES. We attribute this
decline in demand primarily to three factors: EES was overstocked of base
NEO2000 systems for most of 2002 and finally eliminated its overstock position
by year end; a lack of success to date in placing our BlueTip(R) products with
end users; and, the timing of the reporting of results from multinational
clinical trials regarding the use of ILM in breast cancer. Exact market
penetration for our products is difficult to gauge, as there are no widely
published use statistics on this specific type of device or the application of
sentinel lymph node biopsy. We believe, based on anecdotal information, that the
application of ILM has increased steadily over the past few years, but that the
global adoption rate for lymphatic mapping may be slowing pending the outcome of
major international trials in breast care. In 2000 and 2001, EES' end-customer
device placements of our base gamma detection systems increased over the
respective prior years. In 2002, the sales rate was relatively flat compared to
the prior year. Although EES' minimum purchase commitments were fully satisfied
by the end of 2002, we believe, based on EES' current committed and forecast
demand, that 2003 demand may be as much as 25% - 30% higher than 2002 demand
for base NEO2000 systems. During the fourth quarter of 2002, EES experienced a
return to historical levels of placements of our gamma detection equipment.
Neoprobe's overall gross profit for fiscal year 2002 improved to 52% of gross
revenue as compared to 46% for fiscal year 2001. Our gross profit percentage
increased over the prior year primarily due to our principal distribution
partner's ability to maintain the premium pricing position of our gamma
detection products in the marketplace. In addition, increases in revenue from
extended warranty sales coupled with
29
decreases in overhead associated with our continuing efforts to reduce our cost
structure contributed to the improvement. Gross margins on net product sales
were 30% of net sales in 2002, as compared to 35% of net product sales in 2001.
The decline in gross margins was due to a $214,000 impairment charge we recorded
during the third quarter of 2002 related to BlueTip probe-related inventory that
we did not believe had ongoing value to the business. The impairment charge had
a 7% negative effect on our gross margins for the year. Excluding the impairment
charge, our gross margins for 2002 would have increased for the year due in
large part to a recovery in the average prices EES received from end customers
for gamma detection products. Our distribution agreement with EES provides for
our transfer prices to be based on a percentage of the end-customer ASP they
receive, subject to a floor transfer price. During the first three quarters of
2002, we recorded revenue based on the floor transfer price; however, during the
fourth quarter, we negotiated final transfer prices for our 2002 sales to EES
and recorded a positive adjustment to revenue of $193,000.
Results for 2002 also reflect the significant efforts made in the development of
Cardiosonix' Angle-independent Doppler Blood Flow (ADBF(TM)) technology.
Accordingly, our research and development costs for 2002 increased to $2.3
million compared to $948,000 in 2001. In addition, consolidated administrative
expenses increased over the prior year with the absorption of market
development and other overhead costs associated with Cardiosonix' operations.
We were able to achieve better than expected results for 2002 while continuing
our development of the Cardiosonix blood flow measurement products. The
development activities culminated with the shipment of the first Cardiosonix
blood flow demonstration units to distributors in the fourth quarter.
Our major expense categories as a percentage of sales increased from 2001 to
2002 due in large part to the decline in overall sales between the two periods.
Research and development expenses, as a percentage of sales, increased to 69% in
2002 from 14% in 2001 due also to the incremental development costs associated
with the Quantix line of blood flow products. Selling, general and
administrative expenses, as a percentage of sales, increased to 97% in 2002 from
34% in 2001 due largely to the decline in net sales but also due to the
amortization of intangible assets and other general and administrative charges
following our acquisition of Cardiosonix. We believe these major expense
categories, as a percentage of sales, will decrease in 2003 as compared to 2002
due to anticipated increases in sales coupled with a lower overall cost
structure for our gamma business; however, this decrease will depend greatly on
our success in achieving commercial sales of our blood flow products.
YEARS ENDED DECEMBER 31, 2002 AND 2001
Net Sales and Margins. Net product sales, primarily of our gamma detection
systems, decreased $3.4 million or 50% to $3.4 million in 2002 from $6.8 million
in 2001. Gross margins on net product sales were 30% of net sales in 2002, as
compared to 35% of net product sales in 2001. However, our gross margins on net
sales for 2002 included an impairment charge of $214,000 we recorded during the
third quarter related to BlueTip probe-related inventory that we did not believe
had ongoing value to the business. The impairment charge had a 7% negative
effect on our gross margins for the year. Excluding the impairment charge, our
gross margins for 2002 would have increased for the year due in large part to a
recovery in the average prices EES received from end customers for gamma
detection products.
The decline in net product sales was the result of lower overall demand from EES
for the base NEO2000 gamma detection system (i.e., a 14mm probe and NEO2000
control unit) during 2002 as compared to 2001. End-customer (i.e., hospital)
demand for these base systems appears to have flattened in 2002 as compared to
2001. In addition, BlueTip probes did not achieve the end customer acceptance
originally anticipated when EES' initial stocking orders were delivered in the
first half of 2001, and as a result, EES notified us during the third quarter of
2002 of their intent to shift product sales emphasis to the 14mm probe and away
from the BlueTip probes during 2003. The decline in demand below EES' original
expectations for NEO2000 systems and for BlueTip probes, coupled with purchases
they were required to make under the terms of the distribution agreement,
resulted in an overstock position for probes and control units at EES at the end
of 2001 that was not corrected until the end of 2002. These factors resulted in
a net decrease in probe sales (i.e., BlueTip probes and 14mm probes) of
30
71% during 2002 as compared to 2001. Our sales of control units were also
affected by the decline in demand from EES, resulting in a net decrease of 39%
in control unit sales volumes over the two periods.
The decline in gross margins on net product sales was almost entirely due to the
obsolescence charge for $214,000 in BlueTip probe-related materials and finished
goods inventory. The impairment charge had a 7% negative effect on our gross
margins for the year. Excluding the impairment charge, our gross margins for
2002 would have increased for the year due in large part to a recovery in the
average prices EES received from end customers for NEO2000 systems.
License and Other Revenue. License and other revenue in 2002 and 2001 included
$800,000 from the pro-rata recognition of license fees related to the
distribution agreement with EES and $520,000 and $603,000, respectively, from
the reimbursement by EES of certain product development costs. License and other
revenue in 2002 also included $218,000 from EES' waiver of certain warranty
costs due from us in exchange for a release from contractual minimum purchase
requirements.
Research and Development Expenses. Research and development expenses increased
$1.4 million or 145% to $2.3 million in 2002 from $948,000 in 2001. The increase
is primarily due to product development efforts related to the Cardiosonix line
of blood flow measurement products and $54,000 in gamma detection drug
development costs, offset by lower compensation costs resulting from headcount
reductions of gamma product line personnel in the third and fourth quarters of
2002.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased $946,000 or 41% to $3.3 million in 2002 from
$2.3 million in 2001. The increase was primarily a result of the general and
administrative costs incurred in the operation and support of Cardiosonix,
$360,000 in amortization of intangible assets related to the acquisition of
Cardiosonix, increased consulting and professional services incurred related to
Cardiosonix, the transfer of manufacturing of certain components of the NEO2000
gamma detection system to a new contract manufacturer, and $138,000 in
impairment of production equipment and intellectual property that we did not
believe had ongoing value to the business. These increases were offset by
decreases in certain overhead costs, such as compensation and warranty expenses.
Acquired In-Process Research and Development. In 2001, we recorded an $885,000
expense representing the portion of the purchase price of Cardiosonix that was
allocated to in-process research and development (IPR&D) for the QUANTIX/OR
product as estimated at the date of acquisition. Our original recording of the
acquisition in 2001 also included recording the assets and liabilities acquired
along with some contingent consideration related to the future achievement of a
developmental milestone by Cardiosonix. We recorded the contingent consideration
at December 31, 2001, based on the value of our common stock at that time. The
contingent consideration we had recorded at the end of last year was re-valued
at the date the milestone was achieved and the contingency satisfied. In
reflecting the satisfaction of the contingency on our books, we adjusted the
final purchase price paid for Cardiosonix according to generally accepted
accounting principles. As a result, the $885,000 IPR&D charge recorded in 2001
was decreased by $28,000 in 2002.
Other Income. Other income decreased $341,000 or 92% to $28,000 during 2002 from
$370,000 during 2001. Other income in 2002 consisted primarily of interest
income. Our interest income decreased because we maintained a lower balance and
received a lower interest rate on our cash and investments during 2002 as
compared to 2001, consistent with marketplace activity over the two periods.
Other income during 2001 consisted primarily of a $238,000 refund of a portion
of the limited guarantee that we made related to a loan made by a bank to our
former subsidiary, Neoprobe (Israel) Ltd. (Neoprobe Israel). We had previously
put cash on deposit with the bank as security for the limited guarantee. The
full amount of the limited guarantee was written off in 1998 in conjunction with
our decision to liquidate Neoprobe Israel, as we did not expect to receive any
of the cash deposit back from the bank. In connection with the refunded cash
deposit, the bank also granted us a general release from all obligations related
to the loan.
31
LIQUIDITY AND CAPITAL RESOURCES
Operating Activities. Cash used in operations increased $2.7 million to $3.0
million in 2002 from $277,000 used in operations in 2001. Working capital
decreased to $1.1 million at December 31, 2002, as compared to $4.1 million at
December 31, 2001. The current ratio decreased to 1.6:1 at December 31, 2002
from 2.7:1 at December 31, 2001. The decrease in working capital was primarily
related to cash used to fund development activities.
Cash balances decreased to $701,000 at December 31, 2002, from $4.3 million at
December 31, 2001, primarily due to the requirements of supporting the
operations of Cardiosonix and the decrease in net sales during 2002.
Accounts receivable increased to $746,000 at December 31, 2002 from $558,000 at
December 31, 2001. We expect receivable levels to continue to fluctuate in 2003
depending on the timing of purchases and payments by EES.
Inventory levels decreased to $1.2 million at December 31, 2002, as compared to
$1.4 million at December 31, 2001, primarily due to the write-off of $214,000 of
inventory that we did not believe had ongoing value to the business and the use
of certain long-lead gamma detection device components that were built up during
2001 to take advantage of quantity price breaks. These decreases were offset by
the build-up of inventory of materials related to our blood flow products in
preparation for market launch. During 2003, we will continue to work through our
carryover stock of certain long-lead components of gamma detection materials. We
expect inventory levels to increase during 2003 as the use of these long-lead
components is offset by the building of initial inventory of blood flow
products.
Investing Activities. Cash used in investing activities increased to $315,000 in
2002 from $109,000 provided in 2001. During 2002, we invested in $2.5 million of
available-for-sale securities, offset by sales and maturities of
available-for-sale securities of $2.5 million. Capital expenditures in 2002 were
primarily for purchases of production tools and equipment, product development
equipment, and technology infrastructure. Capital expenditures in 2001 consisted
primarily of technology infrastructure, production tooling, and loaner device
upgrades. Capital needs for 2003 are expected to increase over 2002 to support
blood flow product development and manufacturing activities, although it is our
intent to initially outsource manufacturing of blood flow products as much as
possible as is currently done for our gamma devices. We estimate that the
additional costs to complete planned development activities, respond to initial
customer feedback and support initial marketing efforts for our blood flow
products for 2003 could approach $2 million.
Financing Activities. Financing activities used $256,000 in cash in 2002 versus
$188,000 in 2001. During the second and third quarters of 2002, we drew a total
of $2.0 million under a line of credit for working capital purposes that was
fully paid off during the fourth quarter of 2002. Payments of notes payable were
$62,000 higher during 2002 as compared to 2001 due to the increased cost of
financed insurance.
On November 19, 2001, we entered into a common stock purchase agreement with an
investment fund, Fusion Capital Fund II, LLC (Fusion) for the issuance and
purchase of our common stock. Under the stock purchase agreement, Fusion
committed to purchase up to $10 million of our common stock over a forty-month
period that commenced in May 2002. A registration statement registering for
resale up to 5 million shares of our common stock was declared effective by the
SEC on April 15, 2002. Under the terms of the agreement we can request daily
drawdowns, subject to a daily base amount currently set at $12,500. The number
of shares we are to issue to Fusion in return for that money will be based on
the lower of (a) the closing sale price for our common stock on the day of the
draw request or (b) the average of the three lowest closing sales prices for our
common stock during a twelve-day period prior to the draw request. However, no
shares may be sold to Fusion at lower than a floor price currently set at $0.30,
but in no case below $0.20 without Fusion's prior consent. Upon execution of the
common stock purchase agreement, we issued 449,438 shares of our common stock to
Fusion as a commitment fee. Market conditions (i.e., share price) have
effectively prohibited us from drawing funds under the Fusion facility
32
during 2002, and in the absence of a change in those conditions, the Fusion
facility is unlikely to be drawn on in the foreseeable future.
During February 2002, we entered into a line of credit facility with an
investment management company. The facility provided for a maximum line of
credit of $2.0 million and was fully collateralized by pledged cash and
investments on deposit with the investment management company. The line of
credit was paid in full and terminated in the fourth quarter of 2002.
During March 2003, we entered into a bridge loan agreement with our President
and CEO, David Bupp. Under the terms of the agreement, Mr. Bupp will advance us
$250,000. Interest will be payable on the note at 8.5%, payable monthly, and the
note will be due on June 30, 2004. In consideration for the loan, we will issue
Mr. Bupp 375,000 warrants to purchase our common stock at an exercise price
based on the average market price of our common stock for the 30 days preceding
the date of issuance.
During March 2003, we also entered into a bridge loan agreement with an outside
investor for an additional $250,000. Under the terms of the agreement, interest
will be payable at 9.5%, payable monthly, and the note will be due on June 30,
2004. In consideration for the loan, we will issue the investor 500,000 warrants
to purchase our common stock at an exercise price based on the average market
price of our common stock for the 30 days preceding the date of issuance. The
notes are also convertible into common stock of the Company, beginning on July
1, 2003. Half of the principal will be convertible into common stock at a 15%
discount to the 20-day average market price preceding the conversion, but in no
case greater than a $0.20 ceiling conversion price or less than a $0.10 floor
conversion price. The remaining half of the principal will also be convertible
at a 15% discount to a 20-day average market price preceding the conversion,
subject only to the $0.10 floor conversion price.
Our future liquidity and capital requirements will depend on a number of
factors, including our ability to raise additional capital in a timely manner
through additional investment, expanded market acceptance of our current
products, our ability to commercialize new products such as our blood flow
product line, our ability to monetize our investment in non-core technologies,
our ability to obtain milestone or development funds from potential development
and distribution partners, regulatory actions by the U.S. FDA and other
international regulatory bodies, and intellectual property protection.
Throughout 2002, we made modifications to our operating plan and cut or delayed
planned expenditures as a result of delays in our ability to obtain additional
sources of financing. To this point, such changes and cuts have not had a
significant impact on our ability to meet the operational milestones we set at
the beginning of the year. Despite the bridge loans we entered into with Mr.
Bupp and the outside investor, we continue to believe we will need to raise
additional funds to ensure we can complete the commercialization of the
Cardiosonix product line. We are in discussions with several potential financing
sources; however, we cannot assure you that additional capital will be available
on acceptable terms, if at all. If additional funding is not secured in the near
future, we will have to further modify and/or significantly curtail our current
strategic and operating plans. Any incremental equity-based financing would also
likely require our stockholders to approve an increase in the number of
authorized shares of our common stock that we can issue. However, our
stockholders have failed to approve such a measure twice in the last five years
and we cannot assure you that they will approve such a measure if proposed at
this year's annual meeting. We cannot assure you that we will be able to achieve
significant product revenues from our current or potential new products. In
addition, we cannot assure you that we will achieve profitability again in the
future.
Contractual Obligations and Commercial Commitments. The following table presents
our contractual obligations and commercial commitments as of December 31, 2002.
33
PAYMENTS DUE BY PERIOD
CONTRACTUAL CASH LESS THAN 1 - 3 4 - 5 AFTER
OBLIGATIONS TOTAL 1 YEAR YEARS YEARS 5 YEARS
----------------------------- -------- -------- -------- ----- -------
Capital Lease Obligation $ 21,888 $ 16,417 $ 5,471 $-- $--
Operating Leases 397,043 205,954 191,089 -- --
Unconditional
Purchase Obligations(1) 742,772 742,772 -- -- --
Other Long-Term
Obligations -- -- -- -- --
---------- -------- -------- ----- -----
Total Contractual
Cash Obligations $1,161,703 $965,143 $196,560 $-- $--
========== ======== ======== ===== =====
(1) This amount represents purchases under binding purchase orders for which we
are required to take delivery of the product under the terms of the underlying
supply agreements going out approximately four to five months. In addition, we
have annual minimum purchase commitments for an another $714,000 in finished
medical devices that are not currently covered by binding purchase orders, but
for which we must either submit binding purchase orders on a monthly basis or
reimburse the contract manufacturer for any non-cancellable, non-returnable
materials. We believe the amount of non-cancellable, non-returnable materials to
be less than half of the remaining commitment amount at any point in time.
New Accounting Pronouncements. In June 2001, Financial Accounting Standards
Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 143,
Accounting for Asset Retirement Obligations. SFAS No. 143 requires us to
record the fair value of an asset retirement obligation as a liability in the
period in which it incurs a legal obligation associated with the retirement of
tangible long-lived assets that result from the acquisition, construction,
development, and/or normal use of the assets. We would also be required to
record a corresponding asset that is depreciated over the life of the asset.
Subsequent to the initial measurement of the asset retirement obligation, the
obligation will be adjusted at the end of each period to reflect the passage of
time and changes in the estimated future cash flows underlying the obligation.
We are required to adopt SFAS No. 143 on January 1, 2003. The adoption of SFAS
No. 143 is not expected to have a material effect on our financial statements.
In July 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated with
Exit or Disposal Activities. SFAS 146 will require us to disclose information
about our exit and disposal activities, the related costs, and changes in those
costs in the notes to the interim and annual financial statements that include
the period in which an exit or disposal activity is initiated. SFAS 146 will
require us to disclose, for each reportable segment, the exit or disposal
activity costs incurred in the period and the cumulative amount incurred, net of
any changes in the liability, with an explanation of the reasons for the
changes. SFAS 146 will also require us to disclose the total amount of costs
expected to be incurred in connection with the exit or disposal activity. The
new requirements are effective prospectively for exit and disposal activities
initiated after December 31, 2002. We do not anticipate that adoption of SFAS
146 will have a material impact on our financial condition or results of
operations.
In November 2002, the FASB issued Interpretation No. 45, Guarantor's Accounting
and Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness to Others, an interpretation of FASB Statements No. 5, 57 and 107
and a rescission of FASB Interpretation No. 34. This Interpretation elaborates
on the disclosures to be made by a guarantor in its interim and annual financial
statements about its obligations under guarantees issued. The Interpretation
also clarifies that a guarantor is required to recognize, at inception of a
guarantee, a liability for the fair value of the obligation undertaken. The
initial recognition and measurement provisions of the Interpretation are
applicable to guarantees issued or modified after December 31, 2002, and are not
expected to have a material effect on our financial statements. The disclosure
requirements are effective for financial statements of interim and annual
periods ending after December 15, 2002.
34
Critical Accounting Policies. The following accounting policies are considered
to be critical to our results of operations and financial condition.
Revenue Recognition Related to Net Product Sales. We currently generate revenue
primarily from sales of our gamma detection devices. We recognize sales revenue
when the products are shipped and the earnings process has been completed. Our
customers have no right to return products purchased in the ordinary course of
business. The prices we charge our primary customer, EES, are subject to
retroactive annual adjustment based on a fixed percentage of the actual sales
prices achieved by EES on sales to end customers made during each fiscal year.
To the extent that we can reasonably estimate the end-customer prices received
by EES, we record sales to EES based upon these estimates. If we are unable to
reasonably estimate end customer sales prices related to certain products sold
to EES, we record revenue related to these product sales at the minimum price
provided for under our distribution agreement with EES. Due to uncertainty
regarding end customer prices during 2002 and 2001, we recorded revenue at the
minimum prices for most of the year until the final reconciliation was completed
with EES. The completion of the reconciliation resulted in our recording
approximately $193,000 and $60,000, respectively, in additional revenue in the
fourth quarters of 2002 and 2001 related to sales made during the first, second
and third quarters of 2002 and the second and third quarters of 2001. Final
adjusted prices for 2002 and 2001 were approximately 11% and 4%, respectively,
above the floor prices. The final adjusted prices for 2002 serve as the basis
for provisional prices to be charged EES for sales in 2003. As such, we believe
we have only a small amount of price exposure related to sales to EES in 2003
and beyond related to currently marketed products.
Impairment or Disposal of Long-Lived Assets. We account for long-lived assets in
accordance with the provisions of SFAS No. 144. This Statement requires that
long-lived assets and certain identifiable intangibles be reviewed for
impairment whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable. The recoverability of assets
to be held and used is measured by a comparison of the carrying amount of an
asset to future net undiscounted cash flows expected to be generated by the
asset. If such assets are considered to be impaired, the impairment to be
recognized is measured by the amount by which the carrying amount of the assets
exceeds the fair value of the assets. Assets to be disposed of are reported at
the lower of the carrying amount or fair value less costs to sell. As of
December 31, 2002, the most significant long-lived assets on our balance sheet
relate to assets recorded in connection with the acquisition of Cardiosonix and
gamma detection device patents related to ILM. The recoverability of these
assets is based on the financial projections and models related to future sales
of Cardiosonix' products which have yet to begin and the continuing success of
our gamma detection product line. As such, these assets could be subject to
significant adjustment should the Cardiosonix technology not be successfully
commercialized or the sales amounts in our current projections not be realized.
Other Items Affecting Financial Condition. At December 31, 2002, we had U.S. net
operating tax loss carryforwards and tax credit carryforwards of approximately
$92.4 million and $4.3 million, respectively, available to offset or reduce
future income tax liability, if any, through 2022. However, under Sections 382
and 383 of the Internal Revenue Code of 1986, as amended, use of prior tax loss
and credit carryforwards may be limited after an ownership change. As a result
of ownership changes as defined by Sections 382 and 383, which have occurred at
various points in our history, we believe utilization of our tax loss
carryforwards and tax credit carryforwards may be limited.
FORWARD-LOOKING STATEMENTS
The Private Securities Litigation Reform Act of 1995 (the Act) provides a safe
harbor for forward-looking statements made by or on behalf of our company. Our
representatives and we may from time to time make written or verbal
forward-looking statements, including statements contained in this report and
other company filings with the SEC and in our reports to stockholders.
Statements that relate to other than strictly historical facts, such as
statements about our plans and strategies, expectations for future financial
performance, new and existing products and technologies, and markets for our
products are forward-looking statements within the meaning of the Act.
Generally, the words "believe," "expect," "intend,"
35
"estimate," "anticipate," "will" and other similar expressions identify
forward-looking statements. The forward-looking statements are and will be based
on our then-current views and assumptions regarding future events and operating
performance, and speak only as of their dates. We undertake no obligation to
publicly update or revise any forward-looking statements, whether as a result of
new information, future events or otherwise. See the Risk Factors section of
this report for a discussion of events and circumstances that could affect our
financial performance or cause actual results to differ materially from
estimates contained in or underlying our forward-looking statements.
ADDITIONAL INFORMATION
For additional information about our operations, cash flows, liquidity and
capital resources, please refer to the information on pages 26 through 34 of
this report.
ITEM 7. FINANCIAL STATEMENTS
Our consolidated financial statements, and the related notes, together with the
report of KPMG LLP dated February 7, 2003, except Notes 16 and 17 as to
which the date is March 26, 2003, are set forth at pages F-1 through F-23
attached hereto.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
36
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE
WITH SECTION 16(A) OF THE EXCHANGE ACT.
DIRECTORS
THE FOLLOWING DIRECTORS' TERMS SHALL CONTINUE UNTIL THE 2003 ANNUAL MEETING:
JOHN S. CHRISTIE, age 53, has served as a director of our company since May
1997. Mr. Christie has served as President, Chief Operating Officer and a
director of Worthington Industries, Inc. since June 1999. Mr. Christie served as
President of JMAC, Inc., an investment holding company, from September 1995 to
June 1999. From August 1988 until September 1995, he was a Senior Vice President
of Battelle Memorial Institute. Mr. Christie also serves as a director of
Karrington Health, Inc. Mr. Christie has a B.S. degree in Business
Administration from Miami University and a MBA from Emory University.
DAN MANOR, PH.D., age 43, has served as a director of our company since January
2002. Dr. Manor also serves as the President and Chief Executive Officer of
Cardiosonix, Ltd., our wholly owned subsidiary. Prior to founding Cardiosonix in
1998, Dr. Manor served as Managing Director of Medical Dynamics Ltd., a
privately-held Israeli company specializing in developing pneumatic blood flow
assist devices, from founding in 1996 through its sale in 1998. From 1995
through 1996, Dr. Manor served as Products Manager and Medical Director of an
ultrasound company. Dr. Manor started his career as a researcher, working at
various institutions, including Rambam Medical Center and the Heart Research
Center, Technion-Israel Institute of Technology (IIT), Haifa, Israel. He spent
the next several years at the Department of Physiology, University of North
Texas Health Science Center at Fort Worth, Texas as a Research Assistant
Professor. Dr. Manor has a B.Sc. in Aeronautical Engineering, a M.S. and a Ph.D.
in Biomedical Engineering from the Technion-IIT. He is the recipient of numerous
awards including the Wolf Foundation award for excellence in research.
J. FRANK WHITLEY, JR., age 60, has served as a director of our company since May
1994. Mr. Whitley was Director of Mergers, Acquisitions and Licensing at The Dow
Chemical Company (Dow), a multinational chemical company, from June 1993 until
his retirement in June 1997. After joining Dow in 1965, Mr. Whitley served in a
variety of marketing, financial, and business management functions. Mr. Whitley
has a B.S. degree in Mathematics from Lamar State College of Technology.
THE FOLLOWING DIRECTORS' TERMS SHALL CONTINUE UNTIL THE 2004 ANNUAL MEETING:
REUVEN AVITAL, age 51, has served as a director of our company since January
2002. Mr. Avital is a partner and general manager of Ma'Aragim Enterprises Ltd.,
an investment company in Israel, through which he is a member of the board of
Neoprobe as well as a number of privately-held and Israeli public companies,
three of them in the medical device field. Mr. Avital was a board member of
Cardiosonix, Ltd. from April 2001 through December 31, 2001, when we acquired
the company. Previously, Mr. Avital served in the Israeli government in a
variety of middle and senior management positions. He is also chairman or board
member in several not-for-profit organizations, mainly involved in education for
the under-privileged and international peace-building. Mr. Avital has B.A.
degrees in The History of the Middle East and International Relations from the
Hebrew University of Jerusalem, and a M.P.A. from the Kennedy School of
Government at Harvard University.
DAVID C. BUPP, age 53, has served as President and a director of our company
since August 1992 and as Chief Executive Officer since February 1998. From
August 1992 to May 1993, Mr. Bupp served as our Treasurer. In addition to the
foregoing positions, from December 1991 to August 1992, he was Acting President,
Executive Vice President, Chief Operating Officer and Treasurer, and from
December 1989 to
37
December 1991, he was Vice President, Finance and Chief Financial Officer. From
1982 to December 1989, Mr. Bupp was Senior Vice President, Regional Manager for
AmeriTrust Company National Association, a nationally chartered bank holding
company, where he was in charge of commercial banking operations throughout
Central Ohio. Mr. Bupp has a B.A. degree in Economics from Ohio Wesleyan
University. Mr. Bupp completed a course of study at Stonier Graduate School of
Banking at Rutgers University.
JULIUS R. KREVANS, M.D., age 78, has served as a director of our company since
May 1994 and as Chairman of the Board of Directors of our company since February
1999. Dr. Krevans served as Chancellor of the University of California, San
Francisco from July 1982 until May 1993. Prior to his appointment as Chancellor,
Dr. Krevans served as a Professor of Medicine and Dean of the School of Medicine
at the University of California, San Francisco from 1971 to 1982. Dr. Krevans is
a member of the Institute of Medicine, National Academy of Sciences, and led its
committee for the National Research Agenda on Aging until 1991. He is Chairman
of the Bay Area Economic Forum, a member of the Medical Panel of A.P. Giannini
Foundation, and a member of the Board of Directors of the Bay Area BioScience
Center. Dr. Krevans has a B.S. degree and a M.D. degree, both from New York
University. Dr. Krevans also serves on the Board of Directors and the
compensation committee of the Board of Directors of Calypte Biomedical
Corporation (Calypte), a publicly held corporation, and on the Board of
Directors and nominating committee of AccuImage Diagnostics Corp., a publicly
held company. Nancy E. Katz, a director of our company, is President and Chief
Executive Officer of Calypte.
THE FOLLOWING DIRECTORS' TERMS SHALL CONTINUE UNTIL THE 2005 ANNUAL MEETING:
NANCY E. KATZ, age 43, has served as a director of our company since January
2001. Ms. Katz currently serves as President, Chief Executive Officer and a
director of Calypte. Ms. Katz joined Calypte in October 1999 as President, Chief
Operating Officer and Chief Financial Officer. Prior to joining Calypte, Ms.
Katz served as President of Zila Pharm Inc. From 1997 to 1998, Ms. Katz served
as Vice President of Sales & Marketing of LifeScan (the diabetes testing
division of Johnson & Johnson) and Vice President of U.S. Marketing, directing
LifeScan's marketing and customer call center departments from 1995 to 1997.
During her seven-year career at Schering-Plough Healthcare Products from 1987 to
1994, she held numerous positions including Senior Director & General Manager,
Marketing Director for Footcare New Products, and Product Director of OTC New
Products. Ms. Katz also held various product management positions at American
Home Products from 1981 to 1987. Ms. Katz received her B.A. in Business
Administration from the University of South Florida.
FRED B. MILLER, age 63, has served as a director of our company since January
2002. Mr. Miller is the President and Chief Operating Officer of Seicon,
Limited, a privately held company that specializes in developing, applying and
licensing technology to reduce seismic and mechanically induced vibration. Mr.
Miller also serves on the boards of two other privately-held companies. Until
his retirement in 1995, Mr. Miller had been with Price Waterhouse LLP since
1962. Mr. Miller is a Certified Public Accountant, a member of the American
Institute of Certified Public Accountants (AICPA), a past member of the Council
of the AICPA and a member and past president of the Ohio Society of Certified
Public Accountants. He also has served on the boards or advisory committees of
several universities and not-for-profit organizations. Mr. Miller has a B.S.
degree in Accounting from the Ohio State University.
38
EXECUTIVE OFFICERS
In addition to Mr. Bupp, the following individuals are executive officers of our
company and serve in the position(s) indicated below:
NAME AGE POSITION
---- --- --------
Carl M. Bosch 46 Vice President, Instrument Development
Rodger A. Brown 52 Vice President, Regulatory Affairs
and Quality Assurance
Brent L. Larson 39 Vice President, Finance; Chief Financial Officer;
Treasurer and Assistant Secretary
Carl M. Bosch has served as Vice President, Instrument Development of our
company since March 2000. Prior to that, Mr. Bosch served as our Director,
Instrument Development from May 1998 to March 2000. Before joining our company,
Mr. Bosch was employed by GE Medical Systems from 1994 to 1998 where he served
as Manager, Nuclear Programs. From 1977 to 1994, Mr. Bosch was employed by GE
Aerospace in several engineering and management functions. Mr. Bosch has a B.S.
degree in Electrical Engineering from Lehigh University and a M.S. degree in
Systems Engineering from the University of Pennsylvania.
Rodger A. Brown has served as Vice President, Regulatory Affairs and Quality
Assurance of our company since November 2000. From July 1998 through November
2000, Mr. Brown served as our Director, Regulatory Affairs and Quality
Assurance. Prior to joining our company, Mr. Brown served as Director of
Operations for Biocore Medical Technologies, Inc. from April 1997 to April 1998.
From 1981 through 1996, Mr. Brown served as Director, Regulatory Affairs/Quality
Assurance for E for M Corporation, a subsidiary of Marquette Electronics, Inc.
Brent L. Larson has served as Vice President, Finance and Chief Financial
Officer of our company since February 1999. Prior to that, he served as our Vice
President, Finance from July 1998 to January 1999 and as Controller from July
1996 to June 1998. Before joining our company, Mr. Larson was employed by Price
Waterhouse LLP. Mr. Larson has a B.B.A. degree in Accounting from Iowa State
University of Science and Technology and is a Certified Public Accountant.
SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Section 16(a) of the Securities Act of 1934 requires our officers and directors,
and greater than 10% stockholders, to file reports of ownership and changes in
ownership of our securities with the Securities and Exchange Commission. Copies
of the reports are required by SEC regulation to be furnished to us. Based on
our review of these reports and written representations from reporting persons,
we believe that all reporting persons complied with all filing requirements
during the fiscal year ended December 31, 2002, except for one late Form 4
filing for each of Messrs. Bosch, Bupp and Larson.
39
ITEM 10. EXECUTIVE COMPENSATION.
SUMMARY COMPENSATION TABLE
The following table sets forth certain information concerning the annual and
long-term compensation of our Chief Executive Officer and our other three
highest paid executive officers having annual compensation in excess of $100,000
during the last fiscal year (the Named Executives) for the last three fiscal
years.
LONG TERM
COMPENSATION
AWARDS
--------------------------
SECURITIES
RESTRICTED UNDER-
ANNUAL COMPENSATION STOCK LYING
------------------------- AWARDS OPTIONS ALL OTHER
NAME AND PRINCIPAL POSITION YEAR SALARY BONUS ($) (#) COMPENSATION
--------------------------- ------- --------- ------ --- --- ------------
Carl M. Bosch, 2002 $129,375 $ - - 50,000 $ 3,093(c)
Vice President, 2001 129,375 25,250 - 45,000 3,081(c)
Instrument Development(a) 2000 125,625 68,325 42,180(b) 45,000 1,643(c)
Rodger A. Brown, 2002 $105,417 $ - - 50,000 -
Vice President, Regulatory Affairs/ 2001 99,875 19,000 - 45,000 -
Quality Assurance(d) 2000 83,534 33,240 - 35,000 -
David C. Bupp, 2002 $297,083 $ - - 180,000 $ 5,738(f)
President and 2001 310,000 46,500 - 180,000 5,161(f)
Chief Executive Officer 2000 304,769 106,300 140,600(e) 180,000 3,298(f)
Brent L. Larson, 2002 $129,375 $ - - 50,000 $ 2,993(c)
Vice President, Finance and 2001 131,250 20,250 - 60,000 3,400(c)
Chief Financial Officer 2000 126,250 44,900 56,240(g) 60,000 1,313(c)
Dan Manor, 2002 $145,000 $ - - 50,000 $14,000(i)
President and Chief Executive 2001 - - - - -
Officer, Cardiosonix Ltd.(h) 2000 - - - - -
(a) Mr. Bosch began his employment with our company in May 1998 and was
promoted to Vice President in March 2000.
(b) The aggregate number of Mr. Bosch's restricted stock holdings at December
31, 2002 was 30,000 shares with an aggregate value of $3,900. Mr. Bosch
has the right to receive dividends other than dividends on or
distributions of shares of any class of stock issued by our company which
dividends or distributions will be delivered to us under the same
restrictions on transfer and possibility of forfeitures as the shares of
restricted stock from which they derive.
(c) Amounts represent matching contribution under the Neoprobe Corporation
401(k) Plan (the Plan). Eligible employees may make voluntary
contributions and we may, but are not obligated to, make matching
contributions based on 40 percent of the employee's contribution, up to
five percent of the employee's salary. Employee contributions are invested
in mutual funds administered by an independent plan administrator. Company
contributions, if any, are made in the form of shares of common stock. The
Plan is intended to qualify under section 401 of the Internal Revenue
Code, which provides that employee and company contributions and income
earned on contributions are not taxable to the employee until withdrawn
from the Plan, and that we may deduct our contributions when made.
(d) Mr. Brown began his employment with our company in July 1998 and was
promoted to Vice President in November 2000.
(e) The aggregate number of Mr. Bupp's restricted stock holdings at December
31, 2002, was 210,000 shares with an aggregate value of $27,300. Mr. Bupp
has the right to receive dividends other than dividends on or
distributions of shares of any class of stock issued by our company which
dividends or distributions will be delivered to us under the same
restrictions on transfer and possibility of forfeitures as the shares of
restricted stock from which they derive.
(f) Amounts represent matching contribution under the Neoprobe Corporation
401(k) Plan (the Plan) and social luncheon club dues. Eligible employees
may make voluntary contributions and we may, but are not obligated to,
make matching contributions based on 40 percent of the employee's
contribution, up to five percent of the employee's salary. Employee
contributions are invested in mutual funds by an independent plan
administrator. Company contributions, if any, are made
40
in the form of shares of common stock. The Plan is intended to qualify
under section 401 of the Internal Revenue Code, which provides that
employee and company contributions and income earned on contributions are
not taxable to the employee until withdrawn from the Plan, and that we may
deduct our contributions when made.
(g) The aggregate number of Mr. Larson's restricted stock holdings at December
31, 2002 was 70,000 shares with an aggregate value of $9,100. Mr. Larson
has the right to receive dividends other than dividends on or
distributions of shares of any class of stock issued by our company which
dividends or distributions will be delivered to us under the same
restrictions on transfer and possibility of forfeitures as the shares of
restricted stock from which they derive.
(h) Mr. Manor began his employment with our company on January 1, 2002, in
connection with our acquisition of Cardiosonix Ltd. (formerly Biosonix
Ltd.).
(i) Amounts represent reimbursements for a company car leased for Mr. Manor's
use.
OPTION GRANTS IN LAST FISCAL YEAR
The following table presents certain information concerning stock options
granted to the Named Executives under our Amended and Restated Stock Option and
Restricted Stock Purchase Plan during the 2002 fiscal year .
INDIVIDUAL GRANTS
------------------------------------------------------------------------------------------------
PERCENT OF
NUMBER OF TOTAL
SECURITIES OPTIONS GRANTED
UNDERLYING OPTIONS TO EMPLOYEES IN EXERCISE PRICE EXPIRATION
NAME GRANTED (SHARES) FISCAL YEAR PER SHARE DATE
---- --------------- ----------- --------- ----
Carl M. Bosch 50,000(a) 6% $0.42(b) 1/7/12(c)
Rodger A. Brown 50,000(a) 6% $0.42(b) 1/7/12(c)
David C. Bupp 180,000(a) 20% $0.42(b) 1/7/12(c)
Brent L. Larson 50,000(a) 6% $0.42(b) 1/7/12(c)
Dan Manor 50,000(a) 6% $0.42(b) 1/7/12(c)
(a) Vests as to one-third of these shares on each of the first three
anniversaries of the date of grant.
(b) The per share weighted average fair value of these stock options during
2002 was $0.36 on the date of grant using the Black-Scholes option pricing
model with the following assumptions: an expected life of 4 years, an
average risk-free interest rate of 4.00%, volatility of 145% and no
expected dividend rate.
(c) The options terminate on the earlier of the expiration date, nine months
after death or disability, 90 days after termination of employment without
cause or by resignation or immediately upon termination of employment for
cause.
41
FISCAL YEAR-END OPTION NUMBERS AND VALUES
The following table sets forth certain information concerning the number and
value of unexercised options held by the Named Executives at the end of the last
fiscal year (December 31, 2002). There were no stock options exercised by the
Named Executives during the fiscal year ended December 31, 2002.
NUMBER OF SECURITIES VALUE OF UNEXERCISED
UNDERLYING UNEXERCISED IN-THE-MONEY OPTIONS
OPTIONS AT FISCAL YEAR-END: AT FISCAL YEAR-END:
NAME EXERCISABLE/UNEXERCISABLE EXERCISABLE/UNEXERCISABLE
---- ------------------------- -------------------------
Carl M. Bosch 75,000 / 95,000 0 / 0
Rodger A. Brown 72,834 / 91,666 0 / 0
David C. Bupp 230,000 / 460,000 0 / 0
Brent L. Larson 117,200 / 110,000 0 / 0
Dan Manor 0 / 50,000 0 / 0
COMPENSATION OF NON-EMPLOYEE DIRECTORS
Through September 2002, the Chairman of the Board of Directors of our company
received $2,000 per board meeting attended in person and other non-employee
directors received $1,000 each per meeting attended in person. We also paid
directors $500 each per committee meeting attended in person through September
2002. After September 2002, non-employee directors waived fees for attendance at
board or committee meetings until further notice. We did not pay directors for
telephonic participation in board or committee meetings in 2002. We also
reimbursed non-employee directors for travel expenses for meetings attended
during 2002. In addition, the Chairman and each non-employee director received
35,000 and 25,000 options, respectively, to purchase common stock as a part of
our annual stock incentive grants. Options granted to purchase common stock vest
on an annual basis over a three-year period and have an exercise price equal to
no less than the market price of common stock at the date of grant.
Directors who are also officers or employees of our company do not receive any
compensation for their services as directors.
COMPENSATION OF MR. BUPP
Employment Agreement. David C. Bupp is employed under a thirty-six month
employment agreement effective July 1, 2001. The employment agreement originally
provided for an annual base salary of $310,000 with an increase to $325,000 on
July 1, 2003. On August 1, 2002, Mr. Bupp agreed to amend the terms of his 2001
employment agreement to defer 10% of his then annual base salary until the
satisfaction of certain milestones relating to our financial condition.
Effective February 1, 2003, Mr. Bupp agreed to a new amendment his employment
agreement to reduce his annual base salary to $217,000 for the remainder of the
term of his employment agreement. In exchange for his agreement to waive the
salary deferred under the previous amendment to his employment agreement, the
Compensation Committee agreed to vest Mr. Bupp's interest in 210,000 shares of
previously restricted stock and to authorize the removal of the restrictive
legend on such shares of our common stock. In exchange for agreeing to the
amendment lowering his annual base salary, Mr. Bupp received 70,000 options to
purchase our common stock with an exercise price of $0.13 per share that vest
one third annually on the anniversary of the date of grant.
The Compensation Committee of the Board of Directors will, on an annual basis,
review the performance of our company and of Mr. Bupp and will pay a bonus to
Mr. Bupp as it deems appropriate, in its
42
discretion. Such review and bonus will be consistent with any bonus plan adopted
by the Compensation Committee that covers the executive officers of our company
generally. No bonus was paid to Mr. Bupp relating to fiscal year 2002.
If a change in control occurs with respect to our company and the employment of
Mr. Bupp is concurrently or subsequently terminated:
- by our company without cause (cause is defined as any willful breach
of a material duty by Mr. Bupp in the course of his employment or
willful and continued neglect of his duty as an employee);
- the term of Mr. Bupp's employment agreement expires; or
- Mr. Bupp resigns because his authority, responsibilities or
compensation have materially diminished, a material change occurs in
his working conditions or we breach the agreement;
then, Mr. Bupp will be paid a severance payment of $650,500 (less amounts paid
as Mr. Bupp's salary and benefits that continue for the remaining term of the
agreement if his employment is terminated without cause). If any such
termination occurs after the substantial completion of the liquidation of our
assets, the severance payment shall be increased by $81,250.
For purposes of Mr. Bupp's employment agreement, a change in control includes:
- the acquisition, directly or indirectly, by a person (other than our
company or an employee benefit plan established by the Board of
Directors) of beneficial ownership of 15 percent or more of our
securities with voting power in the next meeting of holders of
voting securities to elect the directors;
- a majority of the directors elected at any meeting of the holders of
our voting securities are persons who were not nominated by our then
current Board of Directors or an authorized committee thereof;
- our stockholders approve a merger or consolidation of our company
with another person, other than a merger or consolidation in which
the holders of our voting securities outstanding immediately before
such merger or consolidation continue to hold voting securities in
the surviving or resulting corporation (in the same relative
proportions to each other as existed before such event) comprising
eighty percent (80%) or more of the voting power for all purposes of
the surviving or resulting corporation; or
- our stockholders approve a transfer of substantially all of our
assets to another person other than a transfer to a transferee,
eighty percent (80%) or more of the voting power of which is owned
or controlled by us or by the holders of our voting securities
outstanding immediately before such transfer in the same relative
proportions to each other as existed before such event.
Mr. Bupp's compensation will continue for the longer of twenty-four months or
the full term of the agreement if his employment is terminated without cause.
Restricted Stock Agreements. Mr. Bupp holds 100,000, 35,000, 45,000 shares and
30,000 shares of our common stock that was originally granted as restricted
stock granted on March 22, 2000, April 30, 1999, May 20, 1998 and June 1, 1996,
respectively, pursuant to restricted stock purchase agreements of the same
dates. The original grants did not allow Mr. Bupp to transfer or sell any of the
restricted shares unless and until they vest and contained certain change of
control provisions. However, in connection with the February 1, 2003 amendment
to Mr. Bupp's employment agreement, we vested Mr. Bupp's interest in the shares
and authorized the removal of the restricted legend. We will recognize
compensation expense related to the vesting of the restricted stock in 2003
concurrent with the execution of the amendment.
43
COMPENSATION AGREEMENTS WITH OTHER NAMED EXECUTIVES
Carl M. Bosch
Employment Agreement. Carl Bosch is employed under an eleven-month employment
agreement effective February 1, 2003. The employment agreement provides for an
annual base salary of $135,000; however, receipt of 20% of the base amount has
been deferred until the satisfactory achievement of certain milestones relating
to our financial position or until or unless Mr. Bosch is terminated by us or we
become financially insolvent. In exchange for entering into a new agreement with
a portion of his annual base salary deferred, Mr. Bosch received 30,000 options
to purchase our common stock with an exercise price of $0.13 per share that vest
one third annually on the anniversary of the date of grant.
Mr. Bupp will, on an annual basis, review the performance of our company and of
Mr. Bosch and we will pay a bonus to Mr. Bosch as we deem appropriate, in our
discretion. Such review and bonus will be consistent with any bonus plan adopted
by the Compensation Committee that covers the executive officers of our company
generally. No bonus was paid to Mr. Bosch relating to fiscal year 2002. If a
change in control occurs with respect to our company and the employment of
Mr. Bosch is concurrently or subsequently terminated:
- without cause (cause is defined as any willful breach of a material
duty by Bosch in the course of his employment or willful and
continued neglect of his duty as an employee);
- the term of Mr. Bosch's employment agreement expires; or
- Mr. Bosch resigns because his authority, responsibilities or
compensation have materially diminished, a material change occurs in
his working conditions or we breach the agreement;
then, Mr. Bosch will be paid a severance payment of $202,500 and will continue
his benefits for the longer of six months or the remaining term of his
employment agreement.
For purposes of Mr. Bosch's employment agreement, a change in control includes:
- the acquisition, directly or indirectly, by a person (other than our
company or an employee benefit plan established by the Board of
Directors) of beneficial ownership of 30 percent or more of our
securities with voting power in the next meeting of holders of
voting securities to elect the directors;
- a majority of the directors elected at any meeting of the holders of
our voting securities are persons who were not nominated by our then
current Board of Directors or an authorized committee thereof;
- our stockholders approve a merger or consolidation of our company
with another person, other than a merger or consolidation in which
the holders of our voting securities outstanding immediately before
such merger or consolidation continue to hold voting securities in
the surviving or resulting corporation (in the same relative
proportions to each other as existed before such event) comprising
eighty percent (80%) or more of the voting power for all purposes of
the surviving or resulting corporation; or
- our stockholders approve a transfer of substantially all of the
assets of our company to another person other than a transfer to a
transferee, eighty percent (80%) or more of the voting power of
which is owned or controlled by us or by the holders of our voting
securities outstanding immediately before such transfer in the same
relative proportions to each other as existed before such event.
Mr. Bosch will be paid a severance amount of $135,000 if his employment is
terminated at the end of his employment agreement or without cause, and his
benefits will be continued for up to twelve months.
44
Restricted Stock Agreement. Mr. Bosch also holds 30,000 shares of our common
stock that were originally granted to him as restricted stock on March 22, 2000,
pursuant to a restricted stock purchase agreement with our company as of the
same date. Under the original terms of the underlying restricted stock purchase
agreement, Mr. Bosch could not transfer or sell any of the restricted shares
unless and until they vest. However, in connection with the execution of his new
employment agreement effective February 1, 2003 and Mr. Bosch's agreement to
waive receipt of amounts previously deferred under an August 1, 2002 amendment
to his previous employment agreement, we vested Mr. Bosch's interest in the
shares and authorized the removal of the restricted legend. We will recognize
compensation expense related to the vesting of the restricted stock in 2003
concurrent with the execution of the new employment agreement.
Rodger A. Brown
Employment Agreement. Rodger Brown is employed under an eleven-month employment
agreement effective February 1, 2003. The employment agreement provides for an
annual base salary of $115,000; however, receipt of 20% of the base amount has
been deferred until the satisfactory achievement of certain milestones relating
to our financial position or until or unless Mr. Brown is terminated by us or
we become financially insolvent. In exchange for entering into a new agreement
with a portion of his salary deferred, Mr. Brown received 30,000 options to
purchase our common stock with an exercise price of $0.13 per share that vest
one third annually on the anniversary of the date of grant. The terms of Mr.
Brown's employment agreement are substantially identical to Mr. Bosch's
employment agreement except that Mr. Brown would be paid $172,500 if terminated
due to a change of control and $115,000 if terminated at the end of his
employment agreement or without cause.
Mr. Bupp will, on an annual basis, review the performance of our company and of
Mr. Brown and we will pay a bonus to Mr. Brown as we deem appropriate, in our
discretion. Such review and bonus will be consistent with any bonus plan
adopted by the Compensation Committee that covers the executive officers of our
company generally. No bonus was paid to Mr. Brown relating to fiscal year 2002.
Brent L. Larson
Employment Agreement. Brent Larson is employed under an eleven-month employment
agreement effective February 1, 2003. The employment agreement provides for an
annual base salary of $135,000; however, receipt of 20% of the base amount has
been deferred until the satisfactory achievement of certain milestones relating
to our financial position or until or unless Mr. Larson is terminated by us or
we become financially insolvent. In exchange for entering into a new agreement
with a portion of his annual base salary deferred, Mr. Larson received 30,000
options to purchase our common stock with an exercise price of $0.13 per share
that vest one third annually on the anniversary of the date of grant. The terms
of Mr. Larson's employment agreement are substantially identical to Mr. Bosch's
employment agreement.
Mr. Bupp will, on an annual basis, review the performance of our company and of
Mr. Larson and we will pay a bonus to Mr. Larson as we deem appropriate, in our
discretion. Such review and bonus will be consistent with any bonus plan adopted
by the Compensation Committee that covers the executive officers of our company
generally. No bonus was paid to Mr. Larson relating to fiscal year 2002.
Restricted Stock Agreement(s). Mr. Larson also holds 40,000 shares, 20,000
shares and 10,000 shares of our common stock that were originally granted to him
as restricted stock granted to him at a price of $0.001 per share on March 22,
2000, April 30, 1999 and October 23, 1998, respectively, pursuant to restricted
stock purchase agreements of the same dates. The terms of Mr. Larson's
restricted stock purchase agreement are identical to those contained in Mr.
Bosch's restricted stock purchase agreement discussed above regarding vesting,
forfeiture and rights of ownership. However, in connection with the execution of
his new employment agreement effective February 1, 2003 and Mr. Larson's
agreement to waive receipt of amounts previously deferred under an August 1,
2002 amendment to his previous employment agreement, we vested Mr. Larson's
interest in the shares and authorized the removal of the restricted legend. We
will recognize compensation expense related to the vesting of the restricted
stock in 2003 concurrent with the execution of the new employment agreement.
Dan Manor
Dan Manor is employed by our subsidiary, Cardiosonix Ltd. as its President under
a two year employment agreement effective January 1, 2002. The employment
agreement provides for a monthly basic salary of $12,083 and automatically
renews for one year increments unless written notice is given ninety days prior
to the end of the then term of the agreement. The Compensation Committee of our
Board of Directors will, on an annual basis, review the performance of our
company and of Mr. Manor and he will be paid a bonus as is deemed appropriate,
in the Committee's discretion. Such review and bonus will be consistent with any
bonus plan adopted by the Compensation Committee that covers the executive
officers of our company generally. No bonus was paid to Mr. Manor relating to
fiscal year 2002. Mr. Manor will also receive one third of 1% of the Net
Revenues (as defined in Mr. Manor's employment agreement) from Cardiosonix
products for up to five years from the effective date of the agreement.
Cardiosonix also provides Mr. Manor with an automobile allowance not to exceed
$450 per month, and provides certain statutory benefits under the laws of the
State of Israel.
45
Mr. Manor will be paid a severance payment of the greater of $145,000 or the
then statutorily determined amount if he is terminated by Cardiosonix without
cause prior to the end of the term of the agreement.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
EQUITY COMPENSATION PLAN INFORMATION
The following table sets forth additional information as of December 31, 2002,
concerning shares of our common stock that may be issued upon the exercise of
options and other rights under our existing equity compensation plans and
arrangements, divided between plans approved by our stockholders and plans or
arrangements not submitted to our stockholders for approval. The information
includes the number of shares covered by, and the weighted average exercise
price of, outstanding options and other rights and the number of shares
remaining available for future grants excluding the shares to be issued upon
exercise of outstanding options, warrants, and other rights.
NUMBER OF SECURITIES
REMAINING AVAILABLE
NUMBER OF SECURITIES WEIGHTED-AVERAGE FOR ISSUANCE UNDER
TO BE ISSUED UPON EXERCISE PRICE OF EQUITY COMPENSATION
EXERCISE OF OUTSTANDING OPTIONS, PLANS (EXCLUDING
OUTSTANDING OPTIONS, WARRANTS AND RIGHTS SECURITIES REFLECTED
WARRANTS AND RIGHTS (B) IN COLUMN (A))
(A) (C)
-------------------- ------------------- --------------------
Equity compensation plans approved
by security holders 2,317,725 $0.70 3,443,866
Equity compensation plans not
approved by security holders - $ - -
--------- ----- ---------
Total 2,317,725 $0.70 3,443,866
========= ===== =========
46
SECURITY OWNERSHIP OF PRINCIPAL STOCKHOLDERS, DIRECTORS, NOMINEES AND EXECUTIVE
OFFICERS AND RELATED STOCKHOLDER MATTERS.
The following table sets forth, as of March 7, 2003, certain information with
respect to the beneficial ownership of shares of common stock by (i) each person
known to us to be the beneficial owner of more than 5 percent of our outstanding
shares of common stock, (ii) each director or nominee for director of our
company, (iii) each of the Named Executives (see Item 10, Executive
Compensation--Summary Compensation Table), and (iv) our directors and executive
officers as a group.
NUMBER OF
SHARES
BENEFICIALLY PERCENT
BENEFICIAL OWNER OWNED(*) OF CLASS(**)
------------------------------------------------- ------------------ ---------------
Reuven Avital 2,793,457(a) 7.0%
Carl M. Bosch 184,218(b) (o)
Rodger A. Brown 120,498(c) (o)
David C. Bupp 757,237(d) 1.9%
John S. Christie 89,034(e) (o)
Nancy E. Katz 28,334(f) (o)
Julius R. Krevans 158,667(g) (o)
Brent L. Larson 272,656(h) (o)
Dan Manor 1,261,410(i) 3.2%
Fred B. Miller 9,334(j) (o)
J. Frank Whitley, Jr. 89,334(k) (o)
All directors and officers as a group 5,763,779(l) 14.4%
(11 persons)
First Istratech Fund LLC 2,568,133(m) 6.4%
Greatway Commercial, et al. 2,567,952(n) 6.4%
(*) Beneficial ownership is determined in accordance with the rules of the
Securities and Exchange Commission which generally attribute beneficial
ownership of securities to persons who possess sole or shared voting power
and/or investment power with respect to those securities. Unless otherwise
indicated, voting and investment power are exercised solely by the person
named above or shared with members of such person's household.
(**) "Percent of Class" is calculated on the basis of the number of shares
outstanding on March 7, 2003, plus the number of shares the person has the
right to acquire within 60 days of March 7, 2003.
(a) This amount consists of 2,785,123 shares of our common stock owned by N.
Assia Trusteeship Ltd, Trustee for Ma'Aragim Enterprises Ltd., an
investment fund under the management and control of Mr. Avital, and 8,334
shares issuable upon exercise of options which are exercisable within 60
days but does not include 36,666 shares issuable upon exercise of options
which are not exercisable within 60 days. Of the shares held by N. Assia
Trusteeship Ltd., 2,286,712 were acquired by Ma'Aragim in exchange for
surrendering its shares in Cardiosonix Ltd. on December 31, 2001 in
connection with our acquisition of Cardiosonix and 498,411 were acquired
by Ma'Aragim based on the satisfaction of certain developmental milestones
on December 30, 2002 associated with our acquisition of Cardiosonix.
(b) This amount includes 121,667 shares issuable upon exercise of options
which are exercisable within 60 days and 22,551 shares in Mr. Bosch's
account in the 401(k) Plan, but does not include 118,333 shares issuable
upon exercise of options which are not exercisable within 60 days. Mr.
Bosch is one of three trustees of the 401(k) Plan and may, as such, share
investment power over common stock held in such plan. The 401(k) Plan
holds an aggregate total of 205,858 shares of common stock. Mr. Bosch
disclaims any beneficial ownership of shares held by the 401(k) Plan that
are not allocated to his personal account.
(c) This amount includes 116,167 shares issuable upon exercise of options
which are exercisable within 60 days and 4,331 shares held in the 401(k)
Plan by Mr. Brown's wife, but does not include 118,333 shares issuable
upon exercise of options which are not exercisable within 60 days. Mr.
Brown disclaims beneficial ownership of the shares in his wife's 401(k)
account.
(d) This amount includes 410,000 shares issuable upon exercise of options
which are exercisable within 60 days and 30,737 shares in Mr. Bupp's
account in the 401(k) Plan, but it does not include 450,000 shares
issuable upon exercise of options which are not exercisable within 60
days. Mr. Bupp is one of three trustees of the 401(k) Plan and may, as
such, share investment power over common stock held in such plan. The
401(k) Plan holds an aggregate total of 205,858 shares of common stock.
Mr. Bupp disclaims any beneficial ownership of shares held by the 401(k)
Plan that are not allocated to his personal account.
47
(e) This amount includes 88,334 shares issuable upon exercise of options which
are exercisable within 60 days, but does not include 46,666 shares
issuable upon exercise of options which are not exercisable within 60
days.
(f) This amount includes 28,334 shares issuable upon exercise of options which
are exercisable within 60 days, but does not include 46,666 shares
issuable upon the exercise of options which are not exercisable within 60
days.
(g) This amount includes 156,667 shares issuable upon exercise of options
which are exercisable within 60 days, but does not include 63,333 shares
issuable upon exercise of options which are not exercisable within 60
days.
(h) This amount includes 173,867 shares issuable upon exercise of options
which are exercisable within 60 days and 22,889 shares in Mr. Larson's
account in the 401(k) Plan, but it does not include 123,333 shares
issuable upon exercise of options which are not exercisable within 60
days. Mr. Larson is one of three trustees of the 401(k) Plan and may, as
such, share investment power over common stock held in such plan. The
401(k) Plan holds an aggregate total of 205,858 shares of common stock.
Mr. Larson disclaims any beneficial ownership of shares held by the 401(k)
Plan that are not allocated to his personal account.
(i) This amount includes 16,667 shares issuable upon exercise of options which
are exercisable within 60 days, but does not include 73,333 shares
issuable upon exercise of options which are not exercisable within 60
days. Mr. Manor acquired 1,021,990 of his shares in exchange for
surrendering his shares in Cardiosonix Ltd. on December 31, 2001, in
connection with our acquisition of Cardiosonix. An additional 222,753
shares were acquired by Mr. Manor based on the satisfaction of certain
developmental milestones on December 30, 2002, associated with our
acquisition of Cardiosonix.
(j) This amount includes 8,334 shares issuable upon exercise of options which
are exercisable within 60 days and 1,000 shares held by Mr. Miller's wife
for which he disclaims beneficial ownership, but does not include 36,666
shares issuable upon the exercise of options which are not exercisable
within 60 days.
(k) This amount includes 88,334 shares issuable upon exercise of options which
are exercisable within 60 days, but does not include 46,666 shares
issuable upon exercise of options which are not exercisable within 60
days.
(l) This amount includes 1,216,705 shares issuable upon exercise of options
which are exercisable within 60 days and 80,508 shares held in the 401(k)
Plan, but it does not include 1,159,995 shares issuable upon the exercise
of options which are not exercisable within 60 days. Certain executive
officers of our company are the trustees of the 401(k) Plan and may, as
such, share investment power over common stock held in such plan. Each
trustee disclaims any beneficial ownership of shares held by the 401(k)
Plan that are not allocated to his personal account. The 401(k) Plan holds
an aggregate total of 205,858 shares of common stock.
(m) This amount consists of 1,698,405 shares owned by First Isratech Fund LLC,
546,420 shares owned by First Isratech Fund LP and 323,308 shares owned by
First Isratech Fund Norway AS. First Isratech Fund LLC is the general or
managing partner of First Isratech Fund LP and First Isratech Fund Norway
AS (collectively, the First Isratech Funds). Although these shares have
not been so reported under SEC Regulation 13D, management believes they
are beneficially owned by First Isratech Fund LLC. The First Isratech
Funds acquired 2,108,555 of these shares in exchange for surrendering its
shares in Cardiosonix Ltd. on December 31, 2001 in connection with our
acquisition of Cardiosonix. The remaining 222,753 shares were acquired by
the First Isratech Funds based on the satisfaction of certain
developmental milestones on December 30, 2002 associated with our
acquisition of Cardiosonix.
(n) This amount consists of 197,549 shares owned by Greatway Commercial, Inc.,
398,097 shares owned by Uzi Zucker, 987,743 shares owned by Caremi
Partners and 987,743 shares owned by Emicar LLC(collectively, Greatway
Commercial et al.). Although these shares have not been so reported under
SEC Regulation 13D, management believes they are under common management
and has therefore grouped them for purposes of reporting our beneficial
ownership. Greatway Commercial et al. acquired 2,108,554 of these shares
in exchange for surrendering its shares in Cardiosonix Ltd. on December
31, 2001 in connection with our acquisition of Cardiosonix. The remaining
222,753 shares were acquired by Greatway Commercial et al. based on the
satisfaction of certain developmental milestones on December 30, 2002
associated with our acquisition of Cardiosonix.
(o) Less than one percent.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
See "Liquidity and Capital Resources" in Part II, Item 6 of this Form
10-KSB for information about our related party transactions.
48
ITEM 13. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
(A)LIST OF EXHIBITS AND FINANCIAL STATEMENTS FILED AS PART OF THIS REPORT
(3) ARTICLES OF INCORPORATION AND BY-LAWS
3.1. Complete Restated Certificate of Incorporation of Neoprobe
Corporation, as corrected February 18, 1994 and as amended
June 27, 1994, July 25, 1995, June 3, 1996, March 17, 1999,
and May 9, 2000 (incorporated by reference to Exhibit 3.1 to
the Company's March 31, 2000 Form 10-Q).
3.2. Amended and Restated By-Laws dated July 21, 1993, as amended
July 18, 1995 and May 30, 1996 (incorporated by reference to
Exhibit 99.4 to the Company's Current Report on Form 8-K dated
June 20, 1996).
3.3. Certificate of Elimination of Neoprobe Corporation filed on
May 9, 2000 with the Secretary of State of the State of
Delaware (incorporated by reference to Exhibit 3.3 to the
Company's March 31, 2000 Form 10-Q).
(4) INSTRUMENTS DEFINING THE RIGHTS OF HOLDERS, INCLUDING
INDENTURES
4.1. See Articles FOUR, FIVE, SIX and SEVEN of the Restated
Certificate of Incorporation of the Company (see Exhibit 3.1).
4.2. See Articles II and VI and Section 2 of Article III and
Section 4 of Article VII of the Amended and Restated By-Laws
of the Company (see Exhibit 3.2).
4.3. Rights Agreement dated as of July 18, 1995 between the Company
and Continental Stock Transfer & Trust Company (incorporated
by reference to Exhibit 1 of the Company's registration
statement on Form 8-A).
4.4. Amendment Number 1 to the Rights Agreement between the Company
and Continental Stock Transfer & Trust Company dated February
16, 1999 (incorporated by reference to Exhibit 4.4 to the
Company's December 31, 1998 Form 10-K/A).
(10) MATERIAL CONTRACTS (*indicates management contract or
compensatory plan or arrangement).
10.1.1. -- 10.1.24. Reserved.
10.1.25. Rights Agreement between the Company and Continental
Stock Transfer & Trust Company dated as of July 18, 1995
(see Exhibit 4.3).
10.1.26. -- 10.1.30. Reserved.
10.1.31. Amendment Number 1 to the Rights Agreement between the
Company and Continental Stock Transfer & Trust Company
dated February 16, 1999 (see Exhibit 4.4).
10.1.32. -- 10.1.38. Reserved.
10.1.39. Settlement Agreement among the Company, The Aries Master
Fund, The Aries Domestic Fund, L.P., Paramount Capital,
Inc., and Paramount Capital Asset Management, Inc. dated
January 20, 2000 (incorporated by reference to Exhibit
10.1.39 of the Company's March 31, 2000 Form 10-Q).
49
10.1.40. Reserved.
10.1.41. Common Stock Purchase Agreement between the Company and
Fusion Capital II, LLC dated November 19, 2001
(incorporated by reference to Exhibit 99(b) of the
Company's December 3, 2001 Form 8-K).
10.2.1. -- 10.2.25. Reserved.
10.2.26. Amended and Restated Stock Option and Restricted Stock
Purchase Plan dated March 3, 1994 (incorporated by
reference to Exhibit 10.2.26 to the Company's December
31, 1993 Form 10-K).*
10.2.27. -- 10.2.34. Reserved.
10.2.35. Restricted Stock Purchase Agreement dated June 5, 1996
between the Company and David C. Bupp (incorporated by
reference to Exhibit 10.2.35 to the Company's December
31, 1997 Form 10-K).*
10.2.36. Reserved.
10.2.37. 1996 Stock Incentive Plan dated January 18, 1996 as
amended March 13, 1997 (incorporated by reference to
Exhibit 10.2.37 to the Company's December 31, 1997 Form
10-K).*
10.2.38. -- 10.2.44. Reserved.
10.2.45. Restricted Stock Purchase Agreement between the Company
and David C. Bupp dated May 20, 1998 (incorporated by
reference to Exhibit 10.2.45 to the Company's June 30,
1998 Form 10-Q).*
10.2.46. -- 10.2.47. Reserved.
10.2.48. Restricted Stock Agreement dated October 23, 1998
between the Company and Brent L. Larson (incorporated by
reference to Exhibit 10.2.48 to the Company's December
31, 1998 Form 10-K/A).*
10.2.49. Reserved
10.2.50. Restricted Stock Agreement dated April 30, 1999 between
the Company and David C. Bupp. This Agreement is one of
three substantially identical agreements and is
accompanied by a schedule identifying the other
agreements omitted and setting forth the material
details in which such agreements differ from the one
that is filed herewith (incorporated by reference to
Exhibit 10.2.50 to the Company's June 30, 1999 Form
10-Q).*
10.2.51. -- 10.2.53. Reserved.
10.2.54. Restricted Stock Agreement dated March 22, 2000 between
the Company and David C. Bupp. This Agreement is one of
three substantially identical agreements and is
accompanied by a schedule identifying the other
agreements omitted and setting
50
forth the material details in which such agreements
differ from the one that is filed herewith (incorporated
by reference to Exhibit 10.2.54 of the Company's March
31, 2000 Form 10-Q).*
10.2.55. Agreement, Release and Waiver between the Company and
Matthew F. Bowman, dated March 31, 2000 (incorporated by
reference to Exhibit 10.2.55 to the Company's March 31,
2000 Form 10-Q).*
10.2.56. -- 10.2.58. Reserved.
10.2.59. Employment Agreement between the Company and David C.
Bupp, dated July 1, 2001 (incorporated by reference to
Exhibit 10.2.59 to the Company's September 30, 2001 Form
10-QSB).*
10.2.60. Employment Agreement between the Company and Carl M.
Bosch, dated October 1, 2001. This Agreement is one of
three substantially identical agreements and is
accompanied by a schedule identifying the other
agreements omitted and setting forth the material
details in which such agreements differ from the one
that is filed herewith (incorporated by reference to
Exhibit 10.2.60 to the Company's December 31, 2001 Form
10-KSB).*
10.2.61. Employment Agreement between Cardiosonix Ltd. (formerly
Biosonix Ltd.) and Dan Manor, dated January 1, 2002
(incorporated by reference to Exhibit 10.2.61 to the
Company's December 31, 2001 Form 10-KSB).*
10.2.62. Amendment to Employment Agreement between the Company
and David C. Bupp, dated February 1, 2003.*/**
10.2.63. Employment Agreement between the Company and Carl M.
Bosch, dated February 1, 2003. This Agreement is one of
three substantially identical agreements and is
accompanied by a schedule identifying the other
agreements omitted and setting forth the material
details in which such agreements differ from the one
that is filed herewith.*/**
10.3.1. Technology Transfer Agreement dated July 29, 1992
between the Company and The Dow Chemical Corporation
(portions of this Exhibit have been omitted pursuant to
a request for confidential treatment and have been filed
separately with the Commission), (incorporated by
reference to Exhibit 10.10 to the Company's Form S-1).
10.3.2. -- 10.3.30. Reserved.
10.3.31. Cooperative Research and Development Agreement between
the Company and the National Cancer Institute
(incorporated by reference to Exhibit 10.3.31 to the
Company's September 30, 1995 Form 10-QSB).
10.3.32. -- 10.3.44. Reserved.
10.3.45. License dated May 1, 1996 between the Company and The
Dow Chemical Company (incorporated by reference to
Exhibit 10.3.45 to the Company's June 30, 1996 Form
10-QSB).
10.3.46. License Agreement dated May 1, 1996 between the Company
and The Dow Chemical Company (portions of this Exhibit
have been omitted pursuant to a request for confidential
treatment and have been filed separately with the
Commission),
51
(incorporated by reference to Exhibit 10.3.46 to the
Company's June 30, 1996 Form 10-QSB).
10.3.47. License and Option Agreement between the Company and
Cira Technologies, Inc. dated April 1, 1998
(incorporated by reference to Exhibit 10.3.47 to the
Company's June 30, 1998 Form 10-Q).
10.3.48. Restated Subscription and Option Agreement between the
Company, Cira Technologies, Inc., Richard G. Olsen, John
L. Ridihalgh, Richard McMorrow, James R. Blakeslee,
Mueller & Smith, Ltd., Pierre Triozzi and Gregory Noll,
dated April 17, 1998 (incorporated by reference to
Exhibit 10.3.48 to the Company's June 30, 1998 Form
10-Q).
10.3.49. Restated Stockholders Agreement with the Company, Cira
Technologies, Inc., Richard G. Olsen, John L. Ridihalgh,
Richard McMorrow, James R. Blakeslee, Mueller & Smith,
Ltd., Pierre L. Triozzi and Gregory Noll, dated April
17, 1998 (incorporated by reference to Exhibit 10.3.49
to the Company's June 30, 1998 Form 10-Q).
10.3.50. Share Purchase Agreement between the Company and
Biomedical Investments (1997) Ltd. dated January 19,
2000 (incorporated by reference to Exhibit 10.3.50 to
the Company's March 31, 2000 Form 10-Q).
10.3.51. Reserved.
10.3.52. Participation Agreement between the Company and Cira,
LLC dated November 30, 2000 (incorporated by reference
to Exhibit 10.3.52 to the Company's December 31, 2000
Form 10-KSB).
10.4.1. -- 10.4.32. Reserved.
10.4.32. Supply Agreement between the Company and eV Products
dated December 8, 1997 (portions of this Exhibit have
been omitted pursuant to a request for confidential
treatment and have been filed separately with the
Commission), (incorporated by reference to Exhibit
10.4.32 to Amendment 2 to the Company's December 31,
1997 Form 10-K).
10.4.33. -- 10.4.38. Reserved.
10.4.39. Distribution Agreement between the Company and Ethicon
Endo-Surgery, Inc. dated October 1, 1999 (portions of
this Exhibit have been omitted pursuant to a request for
confidential treatment and have been filed separately
with the Commission), (incorporated by reference to
Exhibit 10.4.39 to the Company's September 30, 1999 Form
10-Q).
10.4.48. 10.4.40.--10.4.48. Reserved.
10.4.49. Product Supply Agreement between the Company and UMM
Electronics, Inc., dated October 25, 2001 (portions of
this Exhibit have been omitted pursuant to a request for
confidential treatment and have been filed separately
with the Commission) (incorporated by reference to
Exhibit 10.4.49 to the Company's December 31, 2001 Form
10-KSB).
52
(21) SUBSIDIARIES OF THE COMPANY.
21.1. Subsidiaries of the Company.**
(23) CONSENT OF EXPERTS AND COUNSEL.
23.1. Consent of KPMG LLP.**
(24) POWERS OF ATTORNEY.
24.1. Powers of Attorney.**
(99) ADDITIONAL EXHIBITS.
99.1. Certification of Chief Executive
Officer pursuant to Section 906
of the Sarbanes-Oxley Act of
2002.**
99.2. Certification of the Chief
Financial Officer pursuant to
Section 906 of the
Sarbanes-Oxley Act of 2002.**
** Filed with this report
(B) REPORTS ON FORM 8-K.
None.
ITEM 14. CONTROLS AND PROCEDURES
Within the 90 days prior to the date of this report, the Company carried out an
evaluation, under the supervision and with the participation of its management,
including its Chief Executive Officer and Chief Financial Officer, of the
effectiveness of the design and operation of its disclosure controls and
procedures pursuant to Exchange Act Rule 13a-14. Based upon that evaluation, the
Chief Executive Officer, along with the Chief Financial Officer, concluded that
the Company's disclosure controls and procedures are effective in timely
alerting them to material information relating to the Company (including its
consolidated subsidiary) required to be included in its periodic SEC filings. It
should be noted that the design of any system of controls is based in part upon
certain assumptions about the likelihood of future events, and there can be no
assurance that any design will succeed in achieving its stated goals under all
potential future conditions, regardless of how remote.
Since the date of our evaluation to the filing date of this Annual Report, there
have been no significant changes in our internal controls or in other factors
that could significantly affect internal controls, including any corrective
actions with regard to significant deficiencies and material weaknesses.
53
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Company has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
Dated: March 31, 2003
NEOPROBE CORPORATION
(the Company)
By: /s/ David C. Bupp
----------------------------------
David C. Bupp, President and
Chief Executive Officer
SIGNATURE TITLE DATE
/s/David C. Bupp Director, President and March 24, 2003
------------------------------------- Chief Executive Officer
David C. Bupp (principal executive officer)
/s/ Brent L. Larson* Vice President, Finance and March 20, 2003
------------------------------------- Chief Financial Officer
Brent L. Larson (principal financial officer)
/s/ Reuven Avital* Director March 21, 2003
-------------------------------------
Reuven Avital
/s/ John S. Christie* Director March 21, 2003
-------------------------------------
John S. Christie
/s/ Nancy E. Katz* Director March 21, 2003
-------------------------------------
Nancy E. Katz
/s/ Julius R. Krevans* Chairman, Director March 20, 2003
-------------------------------------
Julius R. Krevans
/s/ Dan Manor* Director March 21, 2003
-------------------------------------
Dan Manor
/s/ Fred B. Miller* Director March 20, 2003
-------------------------------------
Fred B. Miller
/s/ J. Frank Whitley, Jr.* Director March 25, 2003
-------------------------------------
J. Frank Whitley, Jr.
*By: /s/ David C. Bupp
---------------------------
David C. Bupp, Attorney-in-fact
54
CERTIFICATIONS
I, David C. Bupp, certify that:
1. I have reviewed this annual report on Form 10-KSB of Neoprobe
Corporation;
2. Based on my knowledge, this annual report does not contain any
untrue statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by this
annual report;
3. Based on my knowledge, the financial statements, and other
financial information included in this annual report, fairly present in all
material respects the financial condition, results of operations and cash flows
of the registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officer and I are responsible
for establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
(a) designed such disclosure controls and procedures to
ensure that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us by
others within those entities, particularly during the period in
which this annual report is being prepared;
(b) evaluated the effectiveness of the registrant's
disclosure controls and procedures as of a date within 90 days prior
to the filing date of this annual report (the "Evaluation Date");
and
(c) presented in this annual report our conclusions
about the effectiveness of the disclosure controls and procedures
based on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed,
based on our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent functions):
(a) all significant deficiencies in the design or
operation of internal controls which could adversely affect the
registrant's ability to record, process, summarize and report
financial data and have identified for the registrant's auditors any
material weaknesses in internal controls; and
(b) any fraud, whether or not material, that involves
management or other employees who have a significant role in the
registrant's internal controls; and
6. The registrant's other certifying officer and I have indicated
in this annual report whether there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
/s/ David C. Bupp
--------------------------------------------
David C. Bupp
President and Chief Executive Officer
March 31, 2003
55
I, Brent L. Larson, certify that:
1. I have reviewed this annual report on Form 10-KSB of Neoprobe
Corporation;
2. Based on my knowledge, this annual report does not contain any
untrue statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by this
annual report;
3. Based on my knowledge, the financial statements, and other
financial information included in this annual report, fairly present in all
material respects the financial condition, results of operations and cash flows
of the registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officer and I are responsible
for establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
(a) designed such disclosure controls and procedures to
ensure that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us by
others within those entities, particularly during the period in
which this annual report is being prepared;
(b) evaluated the effectiveness of the registrant's
disclosure controls and procedures as of a date within 90 days prior
to the filing date of this annual report (the "Evaluation Date");
and
(c) presented in this annual report our conclusions
about the effectiveness of the disclosure controls and procedures
based on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed,
based on our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent functions):
(a) all significant deficiencies in the design or
operation of internal controls which could adversely affect the
registrant's ability to record, process, summarize and report
financial data and have identified for the registrant's auditors any
material weaknesses in internal controls; and
(b) any fraud, whether or not material, that involves
management or other employees who have a significant role in the
registrant's internal controls; and
6. The registrant's other certifying officer and I have indicated
in this annual report whether there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
/s/ Brent L. Larson
------------------------------------------------
Brent L. Larson
Vice President, Finance and Chief Financial Officer
March 31, 2003
56
============================================================================
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
------------------------
NEOPROBE CORPORATION
------------------------
FORM 10-KSB ANNUAL REPORT
FOR THE FISCAL YEARS ENDED:
DECEMBER 31, 2002 AND 2001
----------------------------
FINANCIAL STATEMENTS
----------------------------
============================================================================
NEOPROBE CORPORATION AND SUBSIDIARY
INDEX TO FINANCIAL STATEMENTS
Audited Consolidated Financial Statements of Neoprobe Corporation
Independent Auditors' Report F-2
Consolidated Balance Sheets as of
December 31, 2002 and December 31, 2001 F-3
Consolidated Statements of Operations for the years ended
December 31, 2002 and December 31, 2001 F-5
Consolidated Statements of Stockholders' Equity for the years ended
December 31, 2002 and December 31, 2001 F-6
Consolidated Statements of Cash Flows for the years ended
December 31, 2002 and December 31, 2001 F-7
Notes to the Consolidated Financial Statements F-8
F-1
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders
Neoprobe Corporation
We have audited the accompanying consolidated balance sheets of Neoprobe
Corporation and subsidiary as of December 31, 2002 and 2001, and the related
consolidated statements of operations, stockholders' equity, and cash flows for
the years then ended. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Neoprobe Corporation
and subsidiary as of December 31, 2002 and 2001, and the results of their
operations and their cash flows for the years then ended in conformity with
accounting principles generally accepted in the United States of America.
The accompanying consolidated financial statements have been prepared assuming
that the Company will continue as a going concern. As discussed in Note 16 to
the consolidated financial statements, the Company has suffered recurring losses
from operations and needs to raise additional capital within the next 12 months.
These matters raise substantial doubt about its ability to continue as a going
concern. Management's plans in regard to these matters are also described in
Note 16. The consolidated financial statements do not include any adjustments
that might result from the outcome of this uncertainty.
/s/ KPMG LLP
Columbus, Ohio
February 7, 2003, except Notes 16 and 17 as to which
the date is March 26, 2003
F-2
NEOPROBE CORPORATION AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
December 31, 2002 and 2001
ASSETS 2002 2001
----------------- ------------------
Current assets:
Cash and cash equivalents $ 700,525 $ 4,287,101
Accounts receivable, net 746,107 558,429
Inventory, net 1,191,918 1,430,908
Prepaid expenses and other 451,537 271,145
----------------- ------------------
Total current assets 3,090,087 6,547,583
----------------- ------------------
Property and equipment 2,346,445 2,171,788
Less accumulated depreciation and amortization 1,883,797 1,502,676
----------------- ------------------
462,648 669,112
----------------- ------------------
Patents and trademarks 3,129,031 3,183,639
Non-compete agreements 584,516 603,880
Acquired technology 237,271 245,131
----------------- ------------------
3,950,818 4,032,650
Less accumulated amortization 584,490 122,697
----------------- ------------------
3,366,328 3,909,953
----------------- ------------------
Other assets 160,778 202,258
----------------- ------------------
Total assets $ 7,079,841 $ 11,328,906
================= ==================
CONTINUED
F-3
NEOPROBE CORPORATION AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS, CONTINUED
LIABILITIES AND STOCKHOLDERS' EQUITY 2002 2001
------------------- -------------------
Current liabilities:
Notes payable to finance company $ 172,381 $ 161,865
Capital lease obligation, current 14,683 12,914
Accrued liabilities 397,161 901,654
Accounts payable 432,140 489,688
Deferred revenue, current 933,860 877,843
------------------- -------------------
Total current liabilities 1,950,225 2,443,964
------------------- -------------------
Capital lease obligation 5,328 20,011
Deferred revenue 703,625 1,431,998
Contingent consideration for acquisition 288,053 453,602
Other liabilities 172,474 75,493
------------------- -------------------
Total liabilities 3,119,705 4,425,068
------------------- -------------------
Commitments and contingencies
Stockholders' equity:
Preferred stock; $.001 par value; 5,000,000 shares authorized at
December 31, 2002 and 2001; none issued and outstanding (500,000
shares designated as Series A, $.001 par
value, at December 31, 2002 and 2001; none outstanding) - -
Common stock; $.001 par value; 50,000,000 shares
authorized; 36,502,183 shares issued and
outstanding at December 31, 2002; 36,449,067
shares issued and outstanding at December 31, 2001 36,502 36,449
Additional paid-in capital 124,601,770 124,581,800
Accumulated deficit (120,678,136) (117,714,411)
------------------- -------------------
Total stockholders' equity 3,960,136 6,903,838
------------------- -------------------
Total liabilities and stockholders' equity $ 7,079,841 $ 11,328,906
=================== ===================
See accompanying notes to consolidated financial statements.
F-4
NEOPROBE CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31,
-------------------------------------------
2002 2001
------------------- ------------------
Revenues:
Net sales $ 3,382,707 $ 6,764,320
License and other revenue 1,538,233 1,428,473
------------------- ------------------
Total revenues 4,920,940 8,192,793
------------------- ------------------
Cost of goods sold 2,351,169 4,390,722
------------------- ------------------
Gross profit 2,569,771 3,802,071
------------------- ------------------
Operating expenses:
Research and development 2,323,710 948,483
Selling, general and administrative 3,267,361 2,321,115
Acquired in-process research and development (28,368) 884,678
------------------- ------------------
Total operating expenses 5,562,703 4,154,276
------------------- ------------------
Loss from operations (2,992,932) (352,205)
------------------- ------------------
Other income (expense):
Interest income 74,257 127,657
Interest expense (31,946) (11,100)
Other (13,830) 253,217
------------------- ------------------
Total other income 28,481 369,774
------------------- ------------------
Net (loss) income before income taxes (2,964,451) 17,569
(Benefit from) provision for income taxes (726) 2,616
------------------- ------------------
Net (loss) income $ (2,963,725) $ 14,953
=================== ==================
(Loss) income per common share:
Basic $ (0.08) $ 0.00
Diluted $ (0.08) $ 0.00
Weighted average shares outstanding:
Basic 36,045,196 25,899,499
Diluted 36,045,196 26,047,485
See accompanying notes to consolidated financial statements.
F-5
NEOPROBE CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Common Stock Additional
------------------------------- Paid-in Accumulated
Shares Amount Capital Deficit Total
-------------- ------------- --------------- ---------------- -------------
Balance, December 31, 2000 26,264,103 $ 26,264 $ 120,668,639 $ (117,729,364) $ 2,965,539
Exercise of employee stock options
at $0.50 per share 1,667 2 832 - 834
Issued to 401(k) plan at $0.68 19,122 19 13,006 - 13,025
Issued warrants to investor relations
firm - - 1,311 - 1,311
Issued commitment fee in connection
with equity line of credit, net of
costs 449,438 449 (45,315) - (44,866)
Issued in connection with acquisition,
net of costs 9,714,737 9,715 3,943,327 - 3,953,042
Net income - - - 14,953 14,953
-------------- ------------- --------------- ---------------- -------------
Balance, December 31, 2001 36,449,067 36,449 124,581,800 (117,714,411) 6,903,838
Issued to 401(k) plan at $0.46 53,116 53 24,579 - 24,632
Issued warrants to investor relations
firm - - 14,018 - 14,018
Registration costs paid in connection
with equity line of credit - - (24,418) - (24,418)
Registration costs paid in connection
with acquisition of subsidiary - - 5,791 - 5,791
Net loss - - - (2,963,725) (2,963,725)
-------------- ------------- --------------- ---------------- -------------
Balance, December 31, 2002 36,502,183 $ 36,502 $ 124,601,770 $ (120,678,136) $ 3,960,136
============== ============= =============== ================ =============
See accompanying notes to consolidated financial statements.
F-6
NEOPROBE CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31,
-------------------------------------
2002 2001
----------------- ----------------
Cash flows from operating activities:
Net (loss) income $ (2,963,725) $ 14,953
Adjustments to reconcile net (loss) income to net cash
used in operating activities:
Depreciation of property and equipment 402,878 399,241
Amortization of intangible assets 393,953 23,876
Provision for bad debts 28,751 13,313
Net loss on disposal and abandonment of assets 130,380 83,192
Acquired in-process research and development (28,368) 884,678
Other 64,123 (33,630)
Change in operating assets and liabilities:
Accounts receivable (216,429) (127,687)
Inventory 213,948 (570,558)
Prepaid expenses and other assets 65,628 9,550
Accrued liabilities and other liabilities (377,512) 121,905
Accounts payable (57,548) (295,834)
Deferred revenue (672,356) (800,000)
----------------- ----------------
Net cash used in operating activities (3,016,277) (277,001)
----------------- ----------------
Cash flows from investing activities:
Purchases of available-for-sale securities (2,491,361) -
Proceeds from sales of available-for-sale securities 1,687,305 -
Proceeds from maturities of available-for-sale securities 805,000 -
Purchases of property and equipment (263,012) (72,028)
Proceeds from sales of property and equipment 618 2,175
Patent and trademark costs (29,256) (16,985)
Subsidiary acquisition costs (24,028) -
Net cash acquired through acquisition of subsidiary - 195,426
----------------- ----------------
Net cash (used in) provided by investing activities (314,734) 108,588
----------------- ----------------
Cash flows from financing activities:
Proceeds from issuance of common stock - 834
Payment of offering costs (48,627) (44,866)
Proceeds from line of credit 2,000,000 -
Payments under line of credit (2,000,000) -
Payment of notes payable (194,024) (132,442)
Payments under capital leases (12,914) (11,359)
----------------- ----------------
Net cash used in financing activities (255,565) (187,833)
----------------- ----------------
Net decrease in cash and cash equivalents (3,586,576) (356,246)
Cash and cash equivalents, beginning of year 4,287,101 4,643,347
----------------- ----------------
Cash and cash equivalents, end of year $ 700,525 $4,287,101
================= ================
See accompanying notes to consolidated financial statements.
F-7
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
a. ORGANIZATION AND NATURE OF OPERATIONS: Neoprobe Corporation (Neoprobe
or we), a Delaware corporation, is engaged in the development and
commercialization of innovative surgical and diagnostic products that
enhance patient care by meeting the critical decision making needs of
healthcare professionals. We currently manufacture two lines of
medical devices: the first is a line of gamma radiation detection
equipment used in the application of intraoperative lymphatic mapping
(ILM), and the second is a line of blood flow monitoring devices for a
variety of diagnostic and surgical applications.
Our ILM products are marketed throughout most of the world through a
distribution arrangement with Ethicon Endo-Surgery, Inc. (EES), a
Johnson and Johnson company. For the years ended December 31, 2002 and
2001, 91% and 96% of net sales, respectively, were made to EES. The
loss of this customer would have a significant adverse effect on our
operating results.
Our second product line, blood flow measurement devices, is in the
early stages of commercialization. Our activity with this product line
was initiated with our acquisition of Cardiosonix Ltd. (Cardiosonix,
formerly Biosonix Ltd.), located in Ra'anana, Israel, on December 31,
2001.
b. PRINCIPLES OF CONSOLIDATION: Our consolidated financial statements
include the accounts of our company and our wholly owned subsidiary
beginning December 31, 2001 (See Note 10(b).). All significant
inter-company accounts were eliminated in consolidation for 2002 and
2001.
c. FAIR VALUE OF FINANCIAL INSTRUMENTS: The following methods and
assumptions were used to estimate the fair value of each class of
financial instruments:
(1) Cash and cash equivalents, accounts receivable, accounts payable,
and accrued liabilities: The carrying amounts approximate fair
value because of the short maturity of these instruments.
(2) Notes payable to finance company: The fair value of our debt is
estimated by discounting the future cash flows at rates currently
offered to us for similar debt instruments of comparable
maturities by banks or finance companies. At December 31, 2002
and 2001, the carrying values of these instruments approximate
fair value.
d. CASH AND CASH EQUIVALENTS: There were no cash equivalents at December
31, 2002 or 2001. None of the cash presented in the December 31, 2002
and 2001 balance sheets is pledged or restricted in any way.
e. INVENTORY: All components of inventory are valued at the lower of cost
(first-in, first-out) or market. We adjust inventory to market value
when the net realizable value is lower than the carrying cost of the
inventory. Market value is determined based on recent sales activity
and margins achieved.
The components of net inventory at December 31, 2002 and 2001, are as
follows:
2002 2001
---------------- ---------------
Materials and component parts $ 760,540 $ 807,393
Work in process 59,888 -
Finished goods 371,490 623,515
---------------- ---------------
$1,191,918 $1,430,908
================ ===============
During 2002, we wrote off $214,000 of BlueTip(R) probe-related
inventory that we did not believe had ongoing value to the business.
f. PROPERTY AND EQUIPMENT: Property and equipment are stated at cost.
Property and equipment under capital leases are stated at the present
value of minimum lease payments. Depreciation is computed using the
straight-line method over the estimated useful lives of the
depreciable assets
F-8
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
ranging from 2 to 7 years, and includes amortization related to
equipment under capital leases. Maintenance and repairs are charged to
expense as incurred, while renewals and improvements are capitalized.
Property and equipment includes $51,000 of equipment under capital
leases with accumulated amortization of $30,000 and $19,000 at
December 31, 2002 and 2001, respectively. During 2002 and 2001, we
recorded losses of $2,000 and $13,000, respectively, on the disposal
of property and equipment. During 2002, we recorded general and
administrative expenses of $71,000 related to the impairment of
BlueTip probe production equipment that we did not believe had ongoing
value to the business.
The major classes of property and equipment are as follows:
2002 2001
------------------ -----------------
Production machinery and equipment $ 981,355 $ 818,047
Other machinery and equipment, primarily
computers and research equipment 761,698 790,888
Furniture and fixtures 358,155 357,131
Leasehold improvements 121,808 105,166
Software 123,429 100,556
------------------ -----------------
$ 2,346,445 $ 2,171,788
================== =================
g. INTANGIBLE ASSETS: Intangible assets consist primarily of patents and
other acquired intangible assets. Intangible assets are stated at
cost, less accumulated amortization. Patent costs are amortized using
the straight-line method over the estimated useful lives of the
patents of 15 to 20 years. Patent application costs are deferred
pending the outcome of patent applications. Costs associated with
unsuccessful patent applications and abandoned intellectual property
are expensed when determined to have no recoverable value. Non-compete
agreements and acquired technology are amortized using the
straight-line method over their estimated useful lives of four years
and seven years, respectively. We evaluate the potential alternative
uses of all intangible assets, as well as the recoverability of the
carrying values of intangible assets on a recurring basis. (See also
Note 10(b) regarding purchase price adjustments made in 2002 affecting
intangible assets acquired as a part of our acquisition of
Cardiosonix.)
The major classes of intangible assets are as follows:
DECEMBER 31, 2002 DECEMBER 31, 2001
--------------------------------------- -------------------------------------
GROSS CARRYING ACCUMULATED GROSS CARRYING AMOUNT
AMOUNT AMORTIZATION ACCUMULATED AMORTIZATION
----------------- ----------------- ---------------- -----------------
Patents and trademarks $ 3,129,031 $ 398,501 $ 3,183,639 $ 122,697
Non-compete agreements 584,516 150,970 603,880 -
Acquired technology 237,271 35,019 245,131 -
----------------- ----------------- ---------------- -----------------
Total $ 3,950,818 $ 584,490 $ 4,032,650 $ 122,697
================= ================= ================ =================
During 2002 and 2001, we recorded general and administrative expenses
of $462,000 and $94,000, respectively, of intangible asset
amortization expense. Of those amounts, $68,000 and $70,000,
respectively, related to the abandonment of gamma detection patents
and patent applications that were deemed no longer recoverable or part
of our ongoing business.
F-9
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
The estimated future amortization expenses for the next five fiscal
years are as follows:
ESTIMATED
AMORTIZATION EXPENSE
---------------------
For the year ended 12/31/2003 454,180
For the year ended 12/31/2004 424,169
For the year ended 12/31/2005 420,144
For the year ended 12/31/2006 264,180
For the year ended 12/31/2007 232,852
h. REVENUE RECOGNITION
(1) PRODUCT SALES: We derive revenues primarily from sales of our medical
devices. We recognize sales revenue when the products are shipped and
the earnings process has been completed. Our customers have no right
to return products purchased in the ordinary course of business.
Sales prices on gamma detection products sold to EES are subject to
retroactive annual adjustment based on a fixed percentage of the
actual sales prices achieved by EES on sales to end customers made
during each fiscal year, subject to a minimum (i.e., floor) price. To
the extent that we can reasonably estimate the end customer prices
received by EES, we record sales to EES based upon these estimates. To
the extent that we are not able to reasonably estimate end customer
sales prices related to certain products sold to EES, we record
revenue related to these product sales at the floor price provided for
under our distribution agreement with EES.
We recognize revenue related to the sales of products to be used for
demonstration units when products are shipped and the earnings process
has been completed. Our distribution agreements do not permit return
of demonstration units in the ordinary course of business nor do we
have any performance obligations other than normal product warranty
obligations. To the extent that the earnings process has not been
completed, revenue is deferred.
(2) EXTENDED WARRANTY REVENUE: We derive revenues from the sale of
extended warranties covering our medical devices over periods of one
to four years. We recognize revenue from extended warranty sales on a
pro-rata basis over the period covered by the extended warranty.
Expenses related to the extended warranty are recorded when incurred.
(3) SERVICE REVENUE: We derive revenues from the repair and service of our
medical devices that are in use beyond the term of the original
twelve-month warranty and that are not covered by an extended
warranty. We recognize revenue from repair and service activities once
the activities are complete and the repaired or serviced device has
been returned to the customer.
(4) LICENSE REVENUE: We recognize license revenue in connection with our
distribution agreement with EES on a straight-line basis over the
five-year initial term of the agreement based on our obligations to
provide ongoing support for the intellectual property being licensed
such as patent maintenance and regulatory filings. As the license
relates to intellectual property held or in-licensed by us, we incur
no significant cost associated with the recognition of this revenue.
i. RESEARCH AND DEVELOPMENT COSTS: All costs related to research and
development are expensed as incurred.
j. INCOME TAXES: Income taxes are accounted for under the asset and liability
method. Deferred tax assets and liabilities are recognized for the future
tax consequences attributable to differences between the financial
statement carrying amounts of existing assets and liabilities, and their
respective tax bases and operating loss and tax credit carryforwards.
Deferred tax assets and liabilities are measured using enacted tax rates
expected to apply to taxable income in the years in which those temporary
differences are expected to be recovered or settled. The effect on deferred
tax assets and
F-10
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
liabilities of a change in tax rates is recognized in income in the period
that includes the enactment date.
k. STOCK OPTION PLANS: At December 31, 2002, we have three stock-based
employee compensation plans (See Note 8(a).). We apply the intrinsic
value-based method of accounting prescribed by Accounting Principles Board
(APB) Opinion No. 25, Accounting for Stock Issued to Employees, and related
Interpretations, in accounting for our stock options. As such, compensation
expense is recorded on the date of grant and amortized over the period of
service only if the current market price of the underlying stock exceeds
the exercise price. No stock-based employee compensation cost is reflected
in net income (loss), as all options granted under those plans had an
exercise price equal to the market value of the underlying common stock on
the date of grant.
The following table illustrates the effect on net income (loss) and
earnings (loss) per share if compensation cost for our stock-based
compensation plans had been determined based on the fair value at the grant
dates for awards under those plans consistent with Statement of Financial
Accounting Standards (SFAS) No. 123, Accounting for Stock-Based
Compensation:
YEARS ENDED DECEMBER 31,
-------------------------------------
2002 2001
---------------- ----------------
Net (loss) income, as reported $ (2,963,725) $ 14,953
Deduct: Total stock-based employee
compensation expense determined under fair
value based method for all awards, net of
related tax effects (279,161) (299,820)
---------------- ----------------
Pro forma net loss $ (3,242,886) $ (284,867)
================ ================
(Loss) income per common share:
As reported (basic and diluted) $ (0.08) $ 0.00
Pro forma (basic and diluted) $ (0.09) $ (0.01)
l. EQUITY ISSUED TO NON-EMPLOYEES: We account for equity instruments granted
to non-employees in accordance with the provisions of SFAS No. 123 and
Emerging Issues Task Force Issue No. 96-18, Accounting for Equity
Instruments that are Issued to Other Than Employees for Acquiring, or in
Conjunction with Selling, Goods or Services. All transactions in which
goods or services are the consideration received for the issuance of equity
instruments are accounted for based on the fair value of the consideration
received or the equity instrument issued, whichever is more reliably
measurable. The measurement date of the fair value of the equity instrument
issued is the earlier of the date on which the counterpart's performance is
complete or the date on which it is probable that performance will occur.
m. USE OF ESTIMATES: The preparation of financial statements in conformity
with accounting principles generally accepted in the United States of
America requires management to make estimates and assumptions that affect
the reported amounts of assets and liabilities and disclosure of contingent
assets and liabilities at the date of the financial statements and the
reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
n. COMPREHENSIVE INCOME (LOSS): We had no accumulated other comprehensive
income (loss) activity during the years ended December 31, 2002 and 2001.
o. IMPAIRMENT OR DISPOSAL OF LONG-LIVED ASSETS: We account for long-lived
assets in accordance with the provisions of SFAS No. 144, Accounting for
the Impairment or Disposal of Long-Lived Assets. This Statement requires
that long-lived assets and certain identifiable intangibles be reviewed for
impairment whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable. Recoverability of
assets to be held and used is measured by a comparison of the carrying
amount of an asset to future net undiscounted cash flows expected to be
F-11
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
generated by the asset. If such assets are considered to be impaired, the
impairment recognized is measured by the amount by which the carrying
amount of the assets exceeds the fair value of the assets. Assets to be
disposed of are reported at the lower of the carrying amount or fair value
less costs to sell.
p. RECLASSIFICATION: Certain prior years' amounts have been reclassified to
conform to the 2002 presentation.
2. EARNINGS PER SHARE:
Basic earnings (loss) per share is calculated using the weighted average
number of common shares outstanding during the periods. Diluted earnings
(loss) per share is calculated using the weighted average number of common
shares outstanding during the periods, adjusted for the effects of
convertible securities, options and warrants, if dilutive.
YEAR ENDED YEAR ENDED
DECEMBER 31, 2002 DECEMBER 31, 2001
----------------------------------- ------------------------------------
BASIC DILUTED BASIC DILUTED
EARNINGS EARNINGS EARNINGS EARNINGS
PER SHARE PER SHARE PER SHARE PER SHARE
--------------- --------------- ---------------- ----------------
Outstanding shares 36,502,183 36,502,183 36,449,067 36,449,067
Effect of weighting changes
in outstanding shares (16,987) (16,987) (10,109,568) (10,109,568)
Contingently issuable shares (440,000) (440,000) (440,000) (440,000)
Stock options - - - 147,986
--------------- --------------- ---------------- ----------------
Adjusted shares 36,045,196 36,045,196 25,899,499 26,047,485
=============== =============== ================ ================
There is no difference in basic and diluted loss per share related to 2002.
Basic and diluted loss per share for this period include 2,085,826 common
shares that became issuable to Cardiosonix upon satisfaction of a certain
developmental milestone event on December 30, 2002 (See Note 10(b).). The
net loss per common share for 2002 excludes the number of common shares
issuable upon exercise of outstanding stock options and warrants into our
common stock since such inclusion would be anti-dilutive.
The following table summarizes options to purchase our common stock which
were outstanding during the year ended December 31, 2001, but which were
not included in the computation of diluted income per share because their
effect was anti-dilutive.
YEAR ENDED
DECEMBER 31, 2001
-----------------------------------------------
EXERCISE OPTIONS
PRICE OUTSTANDING
------------------------ ------------------
$ 0.60 - $ 1.25 393,169
$ 1.50 - $ 2.50 227,443
$ 3.25 - $ 6.00 145,871
$13.38 - $15.75 47,137
------------------
813,620
==================
F-12
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
3. ACCOUNTS RECEIVABLE AND CONCENTRATIONS OF CREDIT RISK:
Accounts receivable at December 31, 2002 and 2001, net of allowance for
doubtful accounts of $29,095 and $39,670, respectively, consist of the
following:
2002 2001
---------------- ---------------
Trade $ 623,213 $ 226,925
Other 122,894 334,204
---------------- ---------------
$ 746,107 $ 561,129
================ ===============
At December 31, 2002 and 2001, approximately 86% and 57%, respectively, of
net accounts receivable are due from EES. We do not believe we are exposed
to significant credit risk related to EES based on the overall financial
strength and credit worthiness of the customer and its parent company. We
believe that we have adequately addressed other credit risks in estimating
the allowance for doubtful accounts.
We estimate an allowance for doubtful accounts based on a review and
assessment of specific accounts receivable and write off accounts when
deemed uncollectible. The activity in the allowance for doubtful accounts
for the years ended December 31, 2002 and 2001 is as follows:
2002 2001
--------------- ---------------
Allowance for doubtful accounts at beginning of year $ 39,670 $ 26,357
Provision for bad debts 28,751 13,313
Write-offs charged against the allowance (39,326) -
--------------- ---------------
Allowance for doubtful accounts at end of year $ 29,095 $ 39,670
=============== ===============
4. ACCRUED LIABILITIES AND ACCOUNTS PAYABLE:
Accrued liabilities at December 31, 2002 and 2001 consist of the following:
2002 2001
----------------- -----------------
Contracted services and other $ 164,634 $ 494,416
Compensation 177,991 306,216
Warranty reserve 35,000 90,000
Inventory purchases 19,536 11,022
----------------- -----------------
$ 397,161 $ 901,654
================= =================
Accounts payable at December 31, 2002 and 2001 consist of the following:
2002 2001
------------------ ----------------
Trade $ 391,858 $ 359,608
Other 40,282 130,080
------------------ ----------------
$ 432,140 $ 489,688
================== ================
5. PRODUCT WARRANTY:
We warrant our products against defects in design, materials, and
workmanship generally for a period of one year from the date of sale to the
end customer. Our accrual for warranty expenses is adjusted periodically to
reflect actual experience. EES also reimburses us for a portion of warranty
expense incurred based on end customer sales they make during a given
fiscal year.
F-13
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
The activity in the warranty reserve account for the year ended December
31, 2002 is as follows:
2002
---------------
Warranty reserve at beginning of year $ 90,000
Provision for warranty claims and
changes in reserve for warranties 31,043
Payments charged against the reserve (86,043)
---------------
Warranty reserve at end of year $ 35,000
===============
6. LINE OF CREDIT:
During February 2002, we entered into a line of credit facility with an
investment management company. The facility provided for a maximum line of
credit of $2.0 million and was fully collateralized by pledged cash and
investments on deposit with the investment management company. Availability
under the facility was based on advance rates varying from 80% to 92% of
the underlying available collateral. Outstanding amounts under the facility
bore interest at LIBOR plus 175 basis points. The line of credit was fully
paid off and the agreement was terminated in October 2002.
7. INCOME TAXES:
As of December 31, 2002, our net deferred tax assets in the U.S. were
approximately $36.6 million. Approximately $31.4 million of the deferred
tax assets relate principally to net operating loss carryforwards of
approximately $92.4 million available to offset future taxable income, if
any, through 2022. An additional $4.3 million relates to tax credit
carryforwards (principally research and development) available to reduce
future income tax liability after utilization of tax loss carryforwards, if
any, through 2022. The remaining $860,000 relates to temporary differences
between the carrying amount of assets and liabilities and their tax bases.
Due to the uncertainty surrounding the realization of these favorable tax
attributes in future tax returns, all of the net deferred tax assets have
been fully offset by a valuation allowance at December 31, 2002.
As of December 31, 2002, Cardiosonix had net deferred tax assets in Israel
of approximately $1.3 million, primarily related to net operating loss
carryforwards of approximately $3.6 million available to offset future
taxable income, if any. Under current Israeli tax law, net operating loss
carryforwards do not expire. Due to the uncertainty surrounding the
realization of these favorable tax attributes in future tax returns, all of
the net deferred tax assets have been fully offset by a valuation allowance
at December 31, 2002. Since a valuation allowance was recognized for the
deferred tax asset for Cardiosonix' deductible temporary differences and
operating loss carryforwards at the acquisition date, the tax benefits for
those items that are first recognized (that is, by elimination of the
valuation allowance) in financial statements after the acquisition date
shall be applied (a) first to reduce to zero other noncurrent intangible
assets related to the acquisition and (b) second to reduce income tax
expense.
Under Sections 382 and 383 of the Internal Revenue Code (IRC) of 1986, as
amended, the utilization of U.S. net operating loss and tax credit
carryforwards may be limited under the change in stock ownership rules of
the IRC. As a result of ownership changes as defined by Sections 382 and
383, which have occurred at various points in our history, we believe
utilization of our net operating loss carryfowards and tax credit
carryforwards may be limited under certain circumstances.
8. EQUITY:
a. STOCK OPTIONS: At December 31, 2002, we have three stock-based
compensation plans. Under the Amended and Restated Stock Option and
Restricted Stock Purchase Plan (the Amended Plan), the 1996 Stock
Incentive Plan (the 1996 Plan), and the 2002 Stock Incentive Plan (the
2002 Plan), we may grant incentive stock options, nonqualified stock
options, and restricted stock awards to full-time employees, and
nonqualified stock options and restricted awards may be granted to our
consultants and agents. Total shares authorized under each plan are 2
million shares, 1.5 million shares and 3
F-14
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
million shares, respectively. Under all three plans, the exercise price
of each option is greater than or equal to the closing market price of
our common stock on the day prior to the date of the grant.
Options granted under the Amended Plan, the 1996 Plan and the 2002 Plan
generally vest on an annual basis over three years. Outstanding options
under the plans, if not exercised, generally expire ten years from
their date of grant or 90 days from the date of an optionee's
separation from employment with us.
The fair value of each option grant was estimated on the date of the
grant using the Black-Scholes option-pricing model with the following
assumptions for 2002 and 2001, respectively: average risk-free interest
rates of 4.0% and 4.9%; expected average lives of three to four years
for each of the years presented; no dividend rate for any year; and
volatility of 145% for 2002 and 148% for 2001. The weighted average
fair value of options granted in 2002 and 2001 was $0.36.
A summary of the status of stock options under our stock option plans
as of December 31, 2002 and 2001, and changes during the years ended on
those dates is presented below:
2002 2001
---------------------------------- ----------------------------------
WEIGHTED WEIGHTED
AVERAGE AVERAGE
EXERCISE EXERCISE
OPTIONS PRICE OPTIONS PRICE
--------------- --------------- -------------- ----------------
Outstanding at
beginning of year 1,862,123 $ 0.81 1,635,273 $ 2.54
Granted 905,000 $ 0.42 715,000 $ 0.42
Forfeited (449,398) $ 0.57 (486,483) $ 6.06
Exercised - - (1,667) $ 0.50
--------------- --------------
Outstanding at
end of year 2,317,725 $ 0.70 1,862,123 $ 0.81
=============== ==============
On July 5, 2001, the directors voluntarily forfeited 337,500 options,
all of which were priced above $3.00 per share. Included in
outstanding options as of December 31, 2002, are 100,000 options
exercisable at an exercise price of $2.50 per share that vest on the
meeting of certain company achievements.
The following table summarizes information about our stock options
outstanding at December 31, 2002:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
---------------------------------------------------- ---------------------------------
NUMBER WEIGHTED NUMBER
OUTSTANDING AS AVERAGE WEIGHTED EXERCISABLE AS WEIGHTED
RANGE OF EXERCISE OF REMAINING AVERAGE OF AVERAGE
PRICES DECEMBER 31, CONTRACTUAL EXERCISE DECEMBER 31, EXERCISE
2002 LIFE PRICE 2002 PRICE
------------------- ----------------- -------------- ------------ ----------------- ------------
$ 0.25 - $ 0.41 553,334 8 years $ 0.41 178,335 $ 0.41
$ 0.42 720,000 9 years $ 0.42 - -
$ 0.50 501,668 7 years $ 0.50 340,004 $ 0.50
$ 0.60 - $ 1.50 370,523 7 years $ 1.04 330,524 $ 1.09
$ 2.50 - $ 5.63 172,200 2 years $ 2.67 72,200 $ 2.92
----------------- -----------------
2,317,725 7 years $ 0.70 921,063 $ 0.88
================= =================
b. RESTRICTED STOCK: At December 31, 2002, we have 440,000 restricted
shares issued and outstanding. All of the restricted shares granted
vest on a change of control of our company as defined in the specific
grant agreements. As a result, we have not recorded any deferred
compensation due to the inability to assess the probability of the
vesting event. Of the shares issued and outstanding, 75,000 also vest
under certain conditions of termination separate from a change of
control as defined in an officer's employment agreement (See Note
11(d) and Note 16.).
F-15
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
c. STOCK WARRANTS: At December 31, 2002, there are 3.2 million warrants
outstanding to purchase our common stock. The warrants are exercisable
at prices ranging from $0.30 to $5.00 per share with a weighted
average exercise price per share of $0.80. Three million of the
warrants expire in January 2003, 50,000 expire in February 2004,
50,000 expire in June 2005, 25,000 expire in November 2005, and 25,000
expire in November 2006.
d. COMMON STOCK RESERVED: Shares of authorized common stock have been
reserved for the exercise of all options and warrants outstanding.
e. COMMON STOCK PURCHASE AGREEMENT: On November 19, 2001, we entered into
a common stock purchase agreement with Fusion Capital Fund II, LLC,
(Fusion) pursuant to which Fusion agreed to purchase up to $10 million
of our common stock over a forty (40) month period that commenced in
May 2002 and expires in October 2005.
Subject to the limitations and termination rights described below, we
may require Fusion to purchase up to the daily base amount of $12,500
of our common stock at a purchase price based on the market price for
our common stock. The obligation of Fusion to purchase each month is
subject to customary conditions, all of which are outside the control
of Fusion, as is our right to suspend purchases as described below.
The selling price per share is equal to the lowest of (a) the lowest
sale price of our common stock on the day of submission of a purchase
notice by Fusion; or (b) the average of the three lowest closing sale
prices of our common stock during the 12 consecutive trading days
prior to the date of submission of a purchase notice by Fusion. The
selling price will be adjusted for any reorganization,
recapitalization, non-cash dividend, stock split or other similar
transaction occurring during the 15 trading days in which the closing
sale price is used to compute the purchase price.
If the closing sale price of our common stock is below the floor price
of $0.30, Fusion shall not have the right or obligation to purchase
shares. We may increase or decrease the floor price, but in no case
may the floor price be set below $0.20 without Fusion's consent. We
may, at any time, suspend purchases upon one day's written notice to
Fusion.
Notwithstanding the foregoing, Fusion may not purchase shares of
common stock under the stock purchase agreement if Fusion or its
affiliates would beneficially own more than 4.9% of our then aggregate
outstanding common stock immediately after the proposed purchases,
unless increased to 9.9% based on our written agreement.
Under the terms of the stock purchase agreement, Fusion received
449,438 shares of our common stock representing half of the total
commitment fee for the equity line. The remaining commitment shares
are to be issued on a pro-rata basis if, and when, we draw on the
equity line of credit. Market conditions (i.e., our low share price)
have effectively prohibited us from drawing funds under the Fusion
facility during 2002, and in the absence of a change in those
conditions, the Fusion facility is unlikely to be drawn on in the
foreseeable future.
9. SHAREHOLDER RIGHTS PLAN:
During July 1995, our board of directors adopted a shareholder rights plan.
Under the plan, one "Right" is to be distributed for each share of common
stock held by shareholders on the close of business on August 28, 1995. The
Rights are exercisable only if a person and its affiliate commences a
tender offer or exchange offer for 15% or more of our common stock, or if
there is a public announcement that a person and its affiliate has acquired
beneficial ownership of 15% or more of the common stock, and if we do not
redeem the Rights during the specified redemption period. Initially, each
Right, upon becoming exercisable, would entitle the holder to purchase from
us one unit consisting of 1/100th of a share of Series A Junior
Participating preferred stock at an exercise price of $35 (which is subject
to adjustment). Once the Rights become exercisable, if any person,
including its affiliate, acquires 15% or more of our common stock, each
Right other than the Rights held by the acquiring person and its affiliate
becomes a right to acquire common stock having a value equal to two times
the exercise price of the Right. We are entitled
F-16
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
to redeem the Rights for $0.01 per Right at any time prior to the
expiration of the redemption period. The shareholder rights plan and the
Rights will expire on August 28, 2005. The board of directors may amend the
shareholder rights plan, from time to time, as considered necessary.
10. SEGMENTS AND SUBSIDIARY INFORMATION:
a. SEGMENTS: We own or have rights to intellectual property involving two
primary types of medical device products, including gamma detection
instruments currently used primarily in the application of ILM, and
blood flow measurement devices.
The information in the following table is derived directly from each
segments' internal financial reporting used for corporate management
purposes. Selling, general and administrative costs and other income,
including amortization, interest and other costs that relate primarily
to corporate activity, are not currently allocated to the operating
segments for financial reporting purposes.
($ AMOUNTS IN THOUSANDS) GAMMA BLOOD
2002 DETECTION FLOW UNALLOCATED TOTAL
---- --------- ---- ----------- -----
Net sales:
United States(1) $ 3,234 $ -- $ -- $ 3,234
International 90 59 -- 149
License and other revenue 1,538 -- -- 1,538
Research and development expenses (974) (1,350) -- (2,324)
Selling, general and administrative
expenses -- -- (3,267) (3,267)
Acquired in-process research and
development -- 28 -- 28
Income (loss) from operations(2) 1,554 (1,280) (3,267) (2,993)
Other income -- -- 28 28
Total assets, net of depreciation and
amortization:
United States 2,010 6 1,221 3,237
Cardiosonix Ltd. -- 3,843 -- 3,843
Capital expenditures 61 119 83 263
2001
---------------------------------------
Net sales
United States(1) $ 6,543 $ -- $ -- $ 6,543
International 221 -- -- 221
License and other revenue 1,428 -- -- 1,428
Research and development expenses (948) -- -- (948)
Selling, general and administrative
expenses -- -- (2,321) (2,321)
Acquired in-process research and
development -- (885) -- (885)
Income (loss) from operations(2) 2,854 (885) (2,321) (352)
Other income -- -- 370 370
Total assets, net of depreciation and
amortization:
United States 2,661 -- 4,662 7,323
Cardiosonix Ltd. -- 4,006 -- 4,006
Capital expenditures 18 -- 54 72
(1) All sales to EES are made in the United States. EES distributes
the product globally through its international affiliates.
(2) Income (loss) from operations does not reflect the allocation of
selling, general and administrative costs to the operating
segments.
b. SUBSIDIARY: On December 31, 2001, we acquired 100 percent of the
outstanding common shares of Cardiosonix, an Israeli company, for $4.5
million. We accounted for the acquisition under SFAS No. 141, Business
Combinations, and certain provisions of SFAS No. 142, Goodwill and
Other Intangible Assets. The results of Cardiosonix' operations have
been included in our consolidated results
F-17
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
from the date of acquisition. Cardiosonix is involved in the
development and commercialization of blood flow measurement
technology. Cardiosonix currently has two products in the early stages
of commercialization and another product in development.
The aggregate purchase price included common stock valued at
$4,271,095; payment of vested options of Cardiosonix employees in the
amount of $17,966; and acquisition costs of $167,348. The value of the
9,714,737 common shares issued on December 31, 2001 was determined
based on the average market price of our common shares over the
five-day period before and after the terms of the acquisition were
agreed to and announced. A contingent payment of 2,085,826 common
shares was also due upon the satisfaction of a certain developmental
milestone event. In accordance with SFAS No. 141, we recorded the
contingent liability as if it were a liability in the amount of
$453,602 at the date of acquisition.
As a result of the decline in the trading price of our common stock
during 2002, the contingent payment was re-valued at $288,053 upon
satisfaction of the milestone event on December 30, 2002. The value of
the contingent consideration was determined based on the market price
of our common shares.
The re-valuation of the contingent shares and additional acquisition
costs of $24,000 required us to adjust the final purchase price,
resulting in the pro-rata adjustment of certain assets acquired in the
acquisition as well as the charge recorded related to in-process
research and development (IPR&D). As a result of the adjustment, the
balances recorded at December 31, 2001 for patents and trademarks,
non-compete agreements, acquired technology, IPR&D and property and
equipment were decreased by $84,000, $19,000, $8,000, $28,000 and
$2,000, respectively.
As a part of the acquisition, we entered into a royalty agreement with
the three founders of Cardiosonix. Under the terms of the royalty
agreement, which expires December 31, 2006, we are obligated to pay
the founders an aggregate one percent royalty on the first $120
million in net revenue generated by the sale of Cardiosonix blood flow
products.
11. AGREEMENTS:
a. SUPPLY AGREEMENTS: In December 1997, we entered into an exclusive
supply agreement with eV Products (eV), a division of II-VI
Incorporated, for the supply of certain crystals and associated
electronics to be used in the manufacture of our proprietary line of
hand-held gamma detection instruments. The original term of the
agreement expired on December 31, 2002 and was automatically extended
during 2002 through December 31, 2005; however, the agreement is no
longer exclusive for the final three years. During 2001, we built up
our stock of crystal modules in order to take advantage of significant
quantity price breaks. As a result, total purchases under the supply
agreement were $82,000 and $1.3 million for the years ended December
31, 2002 and 2001, respectively.
In May 1999, we entered into a supply agreement with The MedTech
Group, Inc. (MedTech) for the supply of BlueTip probes and related
accessories. The original term of the agreement expires on December
31, 2003, but may be automatically extended for an additional three
years. The agreement calls for us to deliver annual product forecasts
to MedTech and for us to purchase at least 75% of forecasted product
demand on a quarterly basis. Total purchases under the supply
agreement were $2,000 and $412,000 for the years ended December 31,
2002 and 2001, respectively. The agreement may be terminated by us
upon twelve months notice or in the event of failure to supply or by
either party due to material breach or by insolvency of the other.
In October 2001, we entered into a manufacturing and supply agreement
with UMM Electronics, Inc. (UMM), a Leach Technology Group company,
for the exclusive manufacture of the neo2000(R) control unit and 14mm
probe. The original term of the agreement expires in February 2005 but
will be automatically extended for additional one-year periods unless
either party provides written notice of non-renewal at least six
months prior to the end of the then-current term. Either party has the
right to terminate the agreement at any time on six months written
notice, or may immediately terminate the agreement upon a breach by
the other. UMM may also terminate the
F-18
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
agreement if our orders for a given product fall below certain minimum
quarterly amounts for two successive quarters. Total purchases under
the manufacturing and supply agreement were $1.2 million for the year
ended December 31, 2002. We made no purchases under this agreement in
2001. We have issued purchase orders for $743,000 of neo2000 control
units, 14mm probes and laparoscopic probes for delivery of product
through June 2003.
During 2001, we terminated our agreement with Plexus Corporation
(Plexus) for the manufacture of the neo2000 control unit and 14mm
probe. As a part of the termination, we were required to purchase
$92,000 in residual materials that were not used by Plexus, a portion
of which have been used in production at UMM. Total purchases under
the agreement were $2.4 million for the year ended December 31, 2001.
b. MARKETING AND DISTRIBUTION AGREEMENTS: During 1999, we entered into a
distribution agreement with EES covering our gamma detection devices
used in ILM. The initial five-year term expires September 20, 2004,
with options to extend for two successive two-year terms. Under the
agreement, we manufacture and sell our current line of ILM products
exclusively to EES, who distributes the products globally. EES agreed
to purchase minimum quantities of our products over the first three
years of the term of the agreement and to reimburse us for certain
research and development costs and a portion of our warranty costs.
EES satisfied both its minimum purchase and reimbursement requirements
during 2002. We are obligated to continue certain product maintenance
activities and to provide ongoing regulatory support for the products.
EES may terminate the agreement if we fail to supply products for
specified periods, commit a material breach of the agreement, suffer a
change of control to a competitor of EES, or become insolvent. If
termination is due to failure to supply or a material breach by us,
EES would have the right to use our intellectual property and
regulatory information to manufacture and sell the products
exclusively on a global basis for the remaining term of the agreement
with no additional financial obligation to us. If termination is due
to insolvency or a change of control that does not affect supply of
the products, EES has the right to continue to sell the products on an
exclusive global basis for a period of six months or require us to
repurchase any unsold products in its inventory.
Under the agreement, EES received a non-exclusive worldwide license to
our ILM intellectual property to make and sell other products that may
be developed using our ILM intellectual property. The term of the
license is the same as that of the agreement. EES paid us a
non-refundable license fee of $4 million. We are recognizing the
license fee as revenue on a straight-line basis over the five-year
initial term of the agreement. If we terminate the agreement as a
result of a material breach by EES, EES would be required to pay us a
royalty on all products developed and sold by EES using our ILM
intellectual property. In addition, we are entitled to a royalty on
any ILM product commercialized by EES that does not infringe any of
our existing intellectual property.
During 2002, we also entered into two distribution agreements for
Cardiosonix' products covering three countries in Europe.
c. RESEARCH AND DEVELOPMENT AGREEMENTS: Cardiosonix' research and
development efforts have been partially financed through grants from
the Office of the Chief Scientist of the Israeli Ministry of Industry
and Trade (the OCS). In return for the OCS's participation,
Cardiosonix is committed to pay royalties to the Israeli Government at
a rate of 3% to 5% of the sales if its products, up to 100% of the
amount of the grants received (for grants received under programs
approved subsequent to January 1, 1999 - 100% plus interest at LIBOR).
Cardiosonix is entitled to the grants only upon incurring research and
development expenditures. Cardiosonix is not obligated to repay any
amount received from the OCS if the research effort is unsuccessful or
if no products are sold. There are no future performance obligations
related to the grants received from the OCS. However, under certain
limited circumstances, the OCS may withdraw its approval of a research
program or amend the terms of its approval. Upon withdrawal of
approval, the grant recipient may be required to refund the grant, in
whole or in part, with or without interest, as the OCS determines.
Cardiosonix' total obligation for
F-19
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
royalties, based on royalty-bearing government participation, totaled
approximately $775,000 as of December 31, 2002.
During January 2002, we completed a license agreement with the
University of California, San Diego (UCSD) for a proprietary compound
that we believe could be used as a lymph node locating agent in ILM
procedures. The license agreement is effective until the later of the
expiration date of the longest-lived underlying patent or January 30,
2023. Under the terms of the license agreement, UCSD has granted us
the exclusive rights to make, use, sell, offer for sale and import
licensed products as defined in the agreement and to practice the
defined licensed methods during the term of the agreement. We may also
sublicense the patent rights, subject to the approval of certain
sublicense terms by UCSD. In consideration for the license rights, we
agreed to pay UCSD a license issue fee of $25,000 and license
maintenance fees of $25,000 per year. We also agreed to pay UCSD
milestone payments related to successful regulatory clearance for
marketing of the licensed products, a royalty on net sales of licensed
products subject to a $25,000 minimum annual royalty, fifty percent of
all sublicense fees and fifty percent of sublicense royalties. We also
agreed to reimburse UCSD for all patent-related costs. Patent-related
costs totaled $29,000 and $8,000 in 2002 and 2001, respectively, and
were recorded in research and development expenses.
UCSD has the right to terminate the agreement or change the nature of
the agreement to a non-exclusive agreement if it is determined that we
have not been diligent in developing and commercializing the covered
products, marketing the products within six months of receiving
regulatory approval, reasonably filling market demand or obtaining all
the necessary government approvals.
d. EMPLOYMENT AGREEMENTS: We maintain employment agreements with four of
our officers. The employment agreements contain change in control
provisions that would entitle each of the officers to two times their
current annual salaries, vest outstanding restricted stock and options
to purchase common stock, and continue certain benefits if there is a
change in control of our company (as defined) and their employment
terminates. Our maximum contingent liability under these agreements in
such an event is approximately $1.5 million. The employment agreements
also provide for severance, disability and death benefits (See Note
16.).
Cardiosonix also maintains employment agreements with three key
employees. The employment agreements contain provisions that would
entitle the employees to the greater of one year's salary or the
amount due under Israeli law if the employee is terminated without
cause. The agreements also provide for royalty payments to the
employees (See Note 10(b).). The maximum contingent liability under
the agreements, excluding the potential royalty, is approximately
$400,000.
12. LEASES:
We lease certain office equipment under a capital lease which expires in
2004. In December 1996, we entered into an operating lease agreement for
office space, expiring in August 2003. In April 2002, Cardiosonix entered
into an operating sublease agreement for office and parking space, expiring
in April 2004. In addition, Cardiosonix leases six automobiles under
three-year operating leases.
F-20
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
The future minimum lease payments, net of sublease rentals, for the years ending
December 31 are as follows:
CAPITAL OPERATING
LEASE LEASES
----------------- -----------------
2003 $ 16,417 $ 205,954
2004 5,471 108,040
2005 - 83,049
----------------- -----------------
21,888 $ 397,043
=================
Less amount representing interest 1,877
-----------------
Present value of net minimum
lease payments 20,011
Less current portion 14,683
-----------------
Capital lease obligations,
excluding current portion $ 5,328
=================
We expect rental income from subleases of $82,000 in 2003, based on three
subleases executed in December 1998, February 1999, and April 2000. Total
rental expense, net of sublease rental income, was $213,000 and $105,000
for the years ended December 31, 2002 and 2001, respectively.
13. EMPLOYEE BENEFIT PLAN:
We maintain an employee benefit plan under Section 401(k) of the Internal
Revenue Code. The plan allows employees to make contributions and we may,
but are not obligated to, match a portion of the employee's contribution
with our common stock, up to a defined maximum. We accrued expenses of
$26,000 and $25,000 during 2002 and 2001, respectively, related to common
stock to be subsequently contributed to the plan.
14. SUPPLEMENTAL DISCLOSURE FOR STATEMENTS OF CASH FLOWS:
We paid interest aggregating $32,000 and $11,000 for the years ended
December 31, 2002 and 2001, respectively. During 2002, we received a net
refund of $700 related to overpayment of estimated 2001 income taxes.
During 2002 and 2001, we transferred $25,000 and $81,000, respectively, in
inventory to fixed assets related to the creation of a pool of service
loaner equipment. Also during 2002 and 2001, we prepaid $205,000 and
$189,000, respectively, in insurance through the issuance of notes payable
with weighted average interest rates of 6% and 5%, respectively. On
December 31, 2001, we issued common stock to acquire the net assets of
Cardiosonix (See Note 10(b).).
15. CONTINGENCIES:
During the third quarter of 2001, we received a general release from a bank
in Israel that was a creditor of our previous Israeli subsidiary that is in
liquidation and was deconsolidated as of December 31, 1999. As a part of
the general release, the bank also refunded $238,000 as a partial return of
a limited guarantee that we had previously written off as a part of
deconsolidation. The cash refund was recognized in other income when it was
received in the third quarter of 2001. Due to the receipt of the general
release from the primary creditor and receiver of the subsidiary, we
believe the possibility is remote that we will be liable for any further
amounts related to the subsidiary.
We are also subject to legal proceedings and claims that arise in the
ordinary course of business. In our opinion, the amount of ultimate
liability, if any, with respect to these actions will not materially affect
our financial position.
F-21
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
16. LIQUIDITY:
As of December 31, 2002, our cash on-hand was $701,000. We believe our
currently available financing will be adequate to sustain operations
through the end of 2003. However, we must ultimately achieve profitability
from our blood flow product line for our business model to succeed. In the
absence of significant revenue, we believe that we will need to arrange
financing of at least $1.5 million by the end of 2003 in order to sustain
our operations through 2004. In the absence of such financing, we would
likely have to make significant changes to our business plan during the
third or fourth quarter of 2003. Such changes would likely delay the
successful launch of our blood flow product line or force us to
significantly curtail our blood flow operations thus jeopardizing our
future.
We continue to assess our business plan and capital requirements. We are
actively engaged in seeking additional financing in a variety of venues
and formats and we continue to impose actions designed to minimize our
operating losses. We cannot assure you that additional capital will be
available to us on acceptable terms, or at all. Although during March 2003
we entered into bridge financing loans for a total of $500,000
($250,000 of which will be obtained from our President and CEO) (See Note
17(b).), we do not know if we will succeed in raising additional funds
through further offerings of debt or equity. If additional financing is not
available when required or is not available on acceptable terms, or we are
unable to arrange a suitable strategic opportunity, we will be in
significant financial jeopardy and we may be unable to continue our
operations at current levels, or at all. We cannot assure you that
subsequent additional capital infusions will be made available to us on a
timely basis or that the additional capital that we require will be
available on acceptable terms, if at all. The terms of a subsequent
financing may involve a change of control and/or require stockholder
approval.
The strengthening of our gamma business portfolio coupled with the
introduction of the Cardiosonix blood flow products should position
Neoprobe to achieve long-term profitable operating performance beginning in
late 2003 or early 2004. However, as we have previously stated, we are in
critical need of additional capital in order to give us greater assurance
that we will be able fund the remaining research and market development
activities associated with our blood flow line and to allow us to meet our
business objectives in the timeframe we have set out in our business plan.
Our future liquidity and capital requirements will depend on numerous
factors, including stockholder approval of an increase in the number of
authorized shares of our common stock, the ability to raise additional
capital in a timely manner through additional investment, a potential
merger, or similar transaction, as well as expanded market acceptance of
our current products, improvements in the costs and efficiency of our
manufacturing processes, our ability to develop and commercialize new
products, regulatory actions by the U.S. FDA and other international
regulatory bodies, and intellectual property protection.
17. SUBSEQUENT EVENTS:
a. EMPLOYMENT AGREEMENTS: Effective February 1, 2003, we amended the
employment agreement with our President and CEO and entered into new
employment agreements with our three other officers. The amended
agreement and the new agreements have substantially similar terms to
the previous agreements, however the amendment and new agreements
effectively decreased and/or deferred significant portions of the
officers' salaries until such time as our financial condition has
improved to certain agreed-upon levels. The maximum contingent
liability under these agreements in the event of termination is $1.3
million.
b. BRIDGE FINANCING: During March 2003, we entered into a bridge loan
agreement with our President and CEO, David Bupp. Under the terms of
the agreement, Mr. Bupp will advance us $250,000. Interest
will be payable on the note at 8.5%, payable monthly, and the note
will be due on June 30, 2004. In consideration for the loan, we will
issue Mr. Bupp 375,000 warrants to purchase our common stock at an
exercise price of $0.13 per share. The fair value of the warrants will
be recorded as a debt discount and amortized as interest expense over
the life of the note.
During March 2003, we also entered into a bridge loan agreement with
an outside investor for an additional $250,000. Under the terms of the
agreement, interest will be payable
F-22
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
at 9.5%, payable monthly, and the note will be due on June 30, 2004.
In consideration for the loan, we will to issue the investor 500,000
warrants to purchase our common stock at an exercise price of $0.13
per share. The notes will also be convertible into our common stock,
beginning on July 1, 2003. Half of the principal will be convertible
into common stock at a 15% discount to the 20-day average market price
preceding the conversion, but in no case greater than a $0.20 ceiling
conversion price or less than a $0.10 floor conversion price. The
remaining half of the principal will be convertible at a 15% discount
to a 20-day average market price preceding the conversion, subject
only to the $0.10 floor conversion price. The fair value of the
warrants and the beneficial conversion feature of the note will be
recorded as a debt discount and amortized as interest expense over the
life of the note.
18. SUPPLEMENTAL INFORMATION (UNAUDITED):
The following summary financial data are derived from our consolidated
financial statements that have been audited by our independent public
accountants. These data are qualified in their entirety by, and should be
read in conjunction with, our Consolidated Financial Statements and Notes
thereto included herein.
(Amounts in thousands, except per share data) YEARS ENDED DECEMBER 31,
---------------------------------------------------------------------
2002 2001 2000 1999 1998
------------- ------------- ------------- ------------ ------------
Statement of Operations Data:
Net sales $ 3,383 $ 6,764 $ 8,835 $ 9,246 $ 5,833
License and other revenue 1,538 1,428 1,395 325 -
Gross profit 2,570 3,802 5,240 5,063 4,429
Research and development expenses 2,324 948 993 1,513 14,364
Selling, general and administrative
expenses 3,267 2,321 2,911 8,131 11,357
Acquired in-process research and
development (28) 885 - - -
Losses related to subsidiaries in
liquidation - - - 475 7,176
----------- ------------ ------------ ----------- -----------
(Loss) income from operations (2,993) (352) 1,336 (5,057) (28,468)
Other income 28 370 504 883 436
----------- ------------ ------------ ----------- -----------
Net income (loss) $ (2,964) $ 15 $ 1,840 $ (4,174) $(28,033)
----------- ------------ ------------ ----------- -----------
Income (loss) attributable to common
stockholders $ (2,964) $ 15 $ 1,075 $ (7,895) $(28,033)
=========== ============ ============ =========== ===========
Income (loss) per common share:
Basic $ (0.08) 0.00 $ 0.04 $ (0.34) $ (1.23)
Diluted $ (0.08) $ 0.00 $ 0.04 $ (0.34) $ (1.23)
Shares used in computing income (loss) per
common share: (1)
Basic 36,045 25,899 25,710 23,003 22,842
Diluted 36,045 26,047 26,440 23,003 22,842
AS OF DECEMBER 31,
---------------------------------------------------------------------
2002 2001 2000 1999 1998
------------ ------------- ------------- ------------ ------------
Balance Sheet Data:
Total assets $ 7,080 $ 11,329 $ 7,573 $ 10,323 $ 11,994
Long-term obligations 1,169 1,981 2,233 4,314 156
Accumulated deficit (120,678) (117,714) (117,729) (119,569) (115,395)
(1) Basic earnings (loss) per share is calculated using the weighted
average number of common shares outstanding during the periods.
Diluted earnings (loss) per share is calculated using the weighted
average number of common shares outstanding during the periods,
adjusted for the effects of convertible securities, options and
warrants, if dilutive.
F-23