-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, SvkCey+wUmLQdLfEqYavnocX6zkoYNgDWfMXZW/XEBqiA38Yu2ndOjBzmota0/VA 6n7evAQT/q4V9vcf7GmQJA== 0000836429-98-000013.txt : 19981228 0000836429-98-000013.hdr.sgml : 19981228 ACCESSION NUMBER: 0000836429-98-000013 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 19980930 FILED AS OF DATE: 19981224 FILER: COMPANY DATA: COMPANY CONFORMED NAME: VALLEY FORGE SCIENTIFIC CORP CENTRAL INDEX KEY: 0000836429 STANDARD INDUSTRIAL CLASSIFICATION: ELECTROMEDICAL & ELECTROTHERAPEUTIC APPARATUS [3845] IRS NUMBER: 232131580 STATE OF INCORPORATION: PA FISCAL YEAR END: 0930 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 001-10382 FILM NUMBER: 98775705 BUSINESS ADDRESS: STREET 1: 136 GREENTREE RD STE 100 CITY: OAKS STATE: PA ZIP: 19456 BUSINESS PHONE: 6106667500 MAIL ADDRESS: STREET 1: 136 GREEN TREE ROAD STREET 2: STE 100 CITY: OAKS STATE: PA ZIP: 19456 10-K 1 1 SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K (Mark One) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934. For the fiscal year ended September 30, 1998. OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934. [FEE REQUIRED] For the transition period from ____________________ to ________________ Commission File Number: 001-10382 VALLEY FORGE SCIENTIFIC CORP. (Exact name of registrant as specified in its charter) PENNSYLVANIA 23-2131580 (State or other jurisdiction of (I.R.S. employer incorporation or organization) identification no.) 136 Green Tree Road, Oaks, Pennsylvania 19456 (Address of principal executive offices and zip code) Telephone: (610) 666-7500 (Registrant's telephone number, including area code) Securities registered pursuant to Section 12(b) of the Act: Name of Each Exchange Title of Each Class on which Registered Common Stock, no par value Boston Stock Exchange Securities registered pursuant to Section 12(g) of the Act: None Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No _____ Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not 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-K or any amendment to this Form 10-K. X The aggregate market value of voting stock held by non-affiliates of the registrant, computed by reference to the closing bid and ask prices as reported by the Nasdaq system on November 18, 1998 as $23,962,360. At December 21, 1998 there were 8,229,384 shares of the Registrant's Common Stock outstanding. 2 DOCUMENTS INCORPORATED BY REFERENCE As stated in Part III of this annual report on Form 10-K, portions of the following documents are incorporated herein by reference: Definitive Proxy Statement for the Annual Meeting of Stockholders of the Registrant, or an Amendment to this Annual Report on Form 10-K, to be filed within 120 days after the end of the fiscal year covered by this Annual Report on Form 10-K. -2- 3 PART I Item 1. BUSINESS Nature of Business Valley Forge Scientific Corp. and its subsidiaries (collectively referred to as the "Company") is principally engaged in the development and manufacture of medical devices and other health care products. The Company is a leading manufacturer of bipolar electrosurgical products. Through its new generation of products, the Company is broadening the market for its products from neurosurgery to other surgical disciplines. The Company sells its products to or through national and international distributors, which include affiliates of major health care corporations. The Company was incorporated in the Commonwealth of Pennsylvania on March 27, 1980. The Company's principal products consist of bipolar electrosurgical systems, disposable instrumentation and accessories, and related products and accessories. These bipolar electrosurgical systems are based on patented circuitry and allow a surgeon to coagulate blood vessels and/or cut tissue. Bipolar coagulation and cutting are conducted through the use of a surgical hand-held instrument, which is connected via a bipolar cord to a solid state microprocessor controlled generator. In bipolar electrosurgery, the current flow occurs at the tips of a bipolar instrument. This is quite different from conventional monopolar electrosurgical systems, in which the current passes from an active pen electrode through the patient to a grounding pad which acts as a dispersive electrode. The Company's bipolar electrosurgical systems enable a surgeon to bloodlessly cut, core and divide tissue without the use of a grounding pad and its inherent safety hazards. The Company has developed disposable bipolar instruments which are to be used with the Company's bipolar electrosurgical generators for hospital and office procedures in the fields of neurosurgery, gynecology, dentistry, arthroscopy, general and laparoscopic surgery and plastic surgery. These instruments are available in twelve separate and distinct patterns and allow the practitioner to perform essentially bloodless procedures in each of the foregoing disciplines. The disposable bipolar instruments are connected to the bipolar electrosurgical generator through a single-use bipolar cord or bipolar cord/irrigation tubing set ("C/T Set"), which are sold by the Company. To provide irrigation for the bipolar electrosurgical systems, the Company also manufactures and sells the MALIS Irrigation System. The irrigation system provides controlled irrigation for bipolar cutting and coagulation in a wet surgical field. The irrigation system is connected to the bipolar electrosurgical system and bipolar instrument through a single-use C/T Set, which is sold by the Company. The Company also manufactures and sells surgical magnifying loupes, a microsurgical stool and titanium surgical mesh. Of the Company's sales of $3,879,977 in fiscal 1998, approximately 93% were made to Johnson & Johnson Professional, Inc. ("J & J"), formerly known as Codman & Shurtleff, Inc., as compared to 92% and 89% in fiscal 1997 and 1996, respectively. The bipolar electrosurgical systems and the irrigation system accounted for approximately 64% of the Company's sales in fiscal 1998 and approximately 76% and 54% of the sales in fiscal 1997 and 1996, respectively. Sales of C/T Sets and bipolar cord sets accounted for -3- 4 approximately 33% of the Company's sales in fiscal 1998 and approximately 21% and 35% in 1997 and 1996, respectively. Sales of disposable instruments accounted for approximately 2% of the Company's sales in fiscal 1998. Developments In September 1998, the Company agreed to extend the term of its existing distribution agreement with J&J from December 31, 1998 to December 31, 1999 in exchange for J&J agreeing to make minimum purchases of the Company's products for the 1999 calendar year in the amount of $5,000,000. The distribution agreement which was entered into in May 1991, required J&J to make minimum purchases of $1,100,000 for the 1998 calendar year. On March 31, 1998, the Company was issued a patent by the United States Patent and Trademark Office for its bipolar cutting loop electrodes, which are used in the Company's disposable bipolar electrosurgical instruments. On February 18, 1998, the Company licensed the technology and production molds associated with its CPR Mask System to Medical Products Manufacturing, L.L.C. in exchange for a license fee of ten percent of gross sales of the CPR Mask System and other products utilizing the technology. In the fourth quarter of 1998, the Company received permission from the United States Food and Drug Administration ("FDA") to market its Bi-Dent bipolar generator and disposable instrumentation for dental procedures. Subsequent to the end of the Company's 1998 fiscal year, the Company entered into a Supply and Distribution Agreement with Garfield Refining Company for the sale of the company's Bi-Dent bipolar generator and disposable instrumentation and accessory products in the field of Dentistry. Products The Company's business constitutes a single business segment. Bipolar Electrosurgical Systems MALIS* CMC-III High Power Bipolar Cutting/Coagulation System. This third generation system was first introduced into the neurosurgery market by J & J in October 1991 and is marketed by J&J under an existing distribution agreement. The MALIS* CMC-III High Power Cutting/Coagulation System provides high power in the cutting mode and allows the surgeon to cut through any tissue. MALIS* CMC-III -IEC Bipolar Cutting/Coagulation System. This system incorporates the same features as the MALIS* CMC-III, with certain modifications in order to meet the current standards for marketing the unit worldwide. The unit has received IEC-601 certification and bears the international "CE" mark. This unit is marketed by J&J under an existing distribution agreement MALIS* Bipolar Synergy System. A 50 watt coagulator for neurosurgical use with updated coagulation technology. This system is marketed by J&J under an existing distribution agreement. Bipolar Endoscopic Coagulator. These generators are used as a coagulators in endoscopic procedures, and are the subject of an existing distribution agreement with Boston Scientific Corporation. The products are marketed by the Microvasive division of Boston Scientific Corporation under its "Symmetry Endo-Bipolar Generator" and "MINI-SYMM" trade names. -4- 5 Bi-Safe-I Cutter/Coagulator for Office Gynecological Procedures. This generator meets the need for the bipolar modality in the physician's office and offers significant cost and time savings over other available equipment. This generator is being marketed by BEI Medical Systems, Inc. ("BEI") pursuant to an existing supply and distribution agreement. VFS 200 Bipolar System. This system is now being marketed under the MALIS* CMC- III- IEC trade name by J&J. The system is used in magnetic imaging therapy, which uses magnetic resonance imaging equipment in conjunction with operative procedures, generally a tumor biopsy. To the Company's knowledge, the VFS 200, with its unique circuitry, is the only electrosurgical system which can be used in the same room with MRI equipment. Bi-Dent Cutter/Coagulator for Dentistry. This generator has been developed for use by the dental practitioner, and it is being marketed by Garfield Refining Company pursuant to a distribution agreement entered into on October 8, 1998. Disposable Instrumentation Bipolar Electrosurgical Pen. The pen is a hand-held single-use instrument designed to be used with any of the Company's bipolar cutting generators. Bipolar Myoma Coagulation Electrodes for Laparoscopic Use. The bipolar myoma coagulation electrodes are single-use instruments to be used in conjunction with the Bi-Safe I and Bi-Safe-II Systems for gynecological procedures, which are being marketed by BEI. Bipolar Cutting Loop Electrodes. The bipolar loop electrodes are single use instruments with modifications of the alloy to provide faster and cleaner cutting. The loop electrodes are to be used in conjunction with the Company's bipolar cutting/coagulation systems. Bipolar Coagulation Ball Electrodes. The bipolar ball electrodes are single use instruments to be used for coagulation in conjunction with the Company's bipolar cutting/coagulation systems in various surgical disciplines. MALIS* Irrigation System The MALIS* Irrigation System is principally used in conjunction with the Company's bipolar electrosurgical systems to provide controlled irrigation for bipolar coagulation and cutting in a wet surgical field. The system consists of an impulse pumped electrical generator which pumps and regulates the flow of liquid through irrigation tubing, including, the disposable MALIS* C/T Set, which is manufactured and sold by the Company. The irrigation system may also be used as a stand-alone unit. -5- Other Products MALIS* Bipolar Cord/Irrigation Tubing Set. A disposable coextruded bipolar forceps cord combined with an irrigation tubing set which simultaneously delivers electrical current and irrigation fluid to a surgical hand-held instrument. A new C/T Set is used for each surgical procedure. The C/T Set, which is marketed by J & J, is used in conjunction with the Company's bipolar electrosurgical systems, the irrigation system, and disposable instrumentation. Bipolar Cord Set. A single-use bipolar cord set which provides electrical current, without irrigation, from the Company's bipolar generators to the Company's disposable bipolar instruments. Titanium Surgical Mesh. Interwoven titanium used in neurosurgery for the repair of skull and spinal column defects, which is marketed by J&J. Surgical Magnifying Loupes. The loupes enable the surgeon to magnify the surgical field. The product's multi-lens design provides correction of spherical and color aberrations and maximum depth of field. The loupes are presently available at powers of 2.5x, 3.25x and 4.0x magnification. The loupes are sold under the MALIS* and NEUROPTIC trademarks. Surgical Stool. A battery operated electrically controlled stool which allows the surgeon to adjust his seating position up or down as the microscope is raised or lowered throughout the surgical procedure. The product has been designed for surgeons in all disciplines who operate with a microscope. The surgical stool is sold under the MALIS* and SCOPEMATE trademarks. CPR Mask System. This is a single-use disposable cardiopulmonary resuscitation (CPR) mask system. In 1996, the Company was granted a United States patent on the mask system. The mask system is currently manufactured and marketed by Medical Products Manufacturing, L.L.C. pursuant to a License Agreement. New Products to be Introduced into the Market The Company has developed several new bipolar generators, which are based on the technology employed in the MALIS* High Power Bipolar Cutting and Coagulation System, as well as a bipolar accessory products which are to be used in conjunction with these new generators. These products are designed to be sold in the neurosurgery, orthopedic, laparoscopic, urology, gynecology and plastic surgery fields. Bi-Safe-II High Power Bipolar Cutter/Coagulator for OB/GYN Procedures. The Company has developed a unique high power bipolar cutter/coagulator for use in OB/GYN hospital procedures. This generator has features which are unique and are designed to reduce the time required for surgical procedures. The Company has received FDA permission to market the generator. This generator will be marketed by BEI through an existing supply and distribution agreement. * A registered trademark of Dr. Leonard I. Malis -6- VFS 300 High Power Bipolar Cutter/Coagulator. This unit has a technology which enables the physician to cut tissue and/or coagulate blood vessels while the electrodes are totally submerged in electrically conducted fluids, such as saline. The Company has received FDA permission to market this system and intends to market the system for use in arthroscopy and other surgical disciplines. MALIS* Bipolar Lesion Generation System. The Company has developed a final pre-production prototype of a bipolar lesion generation system which precisely controls interruption of nervous system pathways in order to alleviate symptoms of diseases such as Parkinsonism and other movement disorders, trigeminal neuralgia, and the pain of intractable cancer. MALIS* Disposable Lesion Electrodes. The Company has developed final pre-production prototypes of electrodes in various sizes and tip geometries for use in conjunction with the MALIS* Bipolar Lesion Generation System. Manufacturing and Supplies For over 14 years, prior to August 31, 1994, the manufacturing, assembly and packaging of the Company's electrosurgical products were subcontracted to Diversified Electronic Corporation ("Diversified"), a specialty electronics manufacturer, which provided contract manufacturing and research and development to an established base of customers. On August 31, 1994, the Company vertically integrated the manufacturing, assembly and packaging of its electrosurgical generators by acquiring Diversified. Since August 31, 1994, Diversified Electronics Company, Inc. ("DEC"), a wholly owned subsidiary of the Company, has conducted the operations of Diversified. In 1998, DEC concentrated its manufacturing efforts almost exclusively on the Company's products. The Company currently contracts the manufacturing of its bipolar C/T Set, bipolar cord set, and disposable bipolar instrumentation with third parties. Each product is currently manufactured by a single contract manufacturer. The Company and its contract manufacturers purchase product components from multiple sources. The Company's manufacturing process is subject to the regulatory requirements of the Federal Good Manufacturing Practice Regulations as promulgated by the FDA, which mandates detailed quality assurance and record-keeping procuedures and subjects the Company to unscheduled periodic regulatory inspections. The Company conducts quality assurance audits throughout the entire manufacturing process to ensure that all medical products comply with the applicable government regulations. Marketing and Sales The Company does not directly market or sell its principal products to end-users. Instead, the Company sells almost all of its products to or through national or international distributors which include affiliates of major health care corporations. In May 1991, the Company entered into a distribution agreement with J & J, under which J & J is granted the exclusive right to sell the Company's bipolar electrosurgical systems, irrigation system, C/T Sets, titanium surgical mesh and other products developed by the Company in the field of neurosurgery through December 31, 1998. Under the terms of the distribution agreement, J & J is required to purchase no less than $1,100,000 in 1994 and subsequent years. In September 1998, the term of this distribution agreement was extended by the Company to December 31, 1999 in exchange for J&J agreeing to make minimum purchases of the Company's products for calendar year 1999 in the amount of $5,000,000. -7- 8 For the 1998, 1997 and 1996 fiscal years, the Company had sales to J & J of $3,616,778, $3,659,557 and $3,055,531, respectively. Orders are generally filled on a current basis in each calendar year. Approximately 93% of the Company's sales were derived from sales to J & J in fiscal 1998 and approximately 92% and 89% of sales were made to J & J in fiscal 1997 and 1996, respectively. Under the terms of a development agreement with J & J, the Company has agreed to pay J & J through December 31, 1998 a royalty of 2-1/2% of the net sales of the high power bipolar electrosurgical system and 2% of the net sales of the C/T Sets outside of the field of neurosurgery. The Company has entered into a supply and distribution agreement with Boston Scientific Corporation covering the exclusive sale of bipolar electrosurgical coagulators developed by the Company for use in the fields of gastroenterology and endoscopy for hospital, outpatient clinic and office based procedures involving flexible endoscopy through March 2002. Under the agreement, Boston Scientific Corporation has agreed to purchase the "Symmetry Endo-Bipolar Generator" and, upon regulatory approval in Japan and Europe, the new MINI-SYMMTM generator for worldwide distribution. In the fourth quarter of 1997, the Company entered into an exclusive, five-year worldwide supply and distribution agreement with BEI. Under the agreement, BEI has agreed to distribute the Bi-Safe I and Bi-Safe II bipolar electrosurgical systems and the Company's single use bipolar instruments for use in gynecology and gynecological laparoscopic surgery in hospitals, outpatient clinics and physician offices. BEI plans to market the system in the United States through their internal sales force, its U.S. distribution network and direct market catalogue and overseas through a network of overseas distributors that specialize in selling OB/GYN products. Initial shipments of generators and certain disposable instruments under this agreement commenced in 1998. The Company's distribution agreement with Padgett Instruments, Inc. for a bipolar coagulation and cutting system in the plastic and reconstructive surgery market expired in August 1998 and has not been renewed. While the Company's products are sold in foreign markets by J & J, the Company is not aware of the amount of products which are sold in those markets. Prior to sales in certain foreign markets, the Company will need to comply with applicable foreign government regulations. The Company currently markets the surgical magnifying loupes and the surgical stool through independent distributors. The Company's business is not affected to any material extent by seasonal factors. Competition The unique circuitry and patented waveform of the Company's bipolar electrosurgical systems are distinguished from bipolar electrosurgical systems sold by other entities. In the neurosurgery market, the Company believes that it is the principal manufacturer of bipolar electrosurgical systems. In other medical areas, the Company's products will compete with monopolar electrosurgical systems, as well as products based on other technologies, such as laser devices. The Company believes that its bipolar electrosurgical products offer enhanced capabilities and safety advantages as compared to monopolar electrosurgical systems and laser devices. -8- 9 The principal manufacturers of monopolar electrosurgical systems (currently the standard electrosurgical device used in the general surgery fields) are Valleylab, an affiliate of U.S. Surgical Corporation, and Birtcher Medical Systems, Inc. An ultrasound device is sold by Valleylab and laser devices are sold by companies such as Surgical Laser Technology. A number of major medical product suppliers, including U.S. Surgical Corporation, Ethicon, Inc. (a subsidiary of Johnson & Johnson), and Bard Endoscopic (a division of C.R. Bard) are selling or preparing to sell laparoscopic or endoscopic instruments for use with monopolar electrosurgical systems or other modalities. Certain of the laser surgical devices currently marketed by such firms as Surgical Laser Technology and Laserscope are also being used for general surgery. Research and Development For the 1998, 1997 and 1996 fiscal years, the Company expended $292,165, $307,071and $87,536, respectively, for research and development. The Company anticipates that it will continue to incur research and development costs in connection with development of products. Prior to fiscal 1995, the Company's research and development was conducted internally as well as subcontracted to third parties. As a result of the acquisition of Diversified, the Company's future research and development has been conducted internally. Clinical testing of the products is conducted by physicians, including, Dr. Leonard I. Malis, a principal shareholder and director of the Company. In the 1999 fiscal year, the Company anticipates that it will fund all its research and development with current assets and revenues from operations. Government Regulation The marketing and sale of the Company's products is governed by the Federal Food, Drug and Cosmetic Act (the "Act") administered by the FDA, as well as varying degrees of regulation by a number of state and foreign governmental agencies. The Act requires certain clearances from the FDA before medical devices can be marketed. All medical devices introduced into the market since 1976, which include substantially all of the Company's products, are required by the FDA as a condition of sale and marketing to secure either a 510(k) premarket notification clearance or an approved Premarket Approval application ("PMA"). A 510(k) premarket notification clearance indicates FDA agreement with an applicant's determination that the product for which clearance has been sought is substantially equivalent to another medical device that was on the market prior to 1976 or that has received 510(k) premarketing notification clearance. In general, the process of obtaining a 510(k) clearance typically takes several months and involves the submission of limited clinical data and supporting information while the PMA process typically will last more than a year and requires the submission of significant quantities of clinical data and manufacturing information. To comply with the FDA regulations, the Company incurs substantial costs relating to laboratory and clinical testing of new and existing products and the preparation and filing of documents in formats -9- 10 required by the FDA. From time to time, the Company may also encounter delays in bringing new or existing devices to market as a result of being required by the FDA and foreign governmental authorities to conduct and document additional investigations of product safety and effectiveness. The Company believes that it is in material compliance with regulations promulgated by the FDA and foreign governmental authorities, and that such compliance has been and is anticipated to be without adverse effect on its business. Patents and Trademarks The Company owns two United States patents for bipolar electrosurgery relating to the circuitry employed by the Company's bipolar electrosurgical systems. The first of the patents was issue in 1986 and was expanded upon with a second patent issued in June 1994. The patents together cover 109 claims and are an important aspect of the Company's bipolar electrosurgical systems. On March 31, 1998, the Company was issued a United States patent for its bipolar cutting loop electrodes, which are used in the Company's disposable bipolar electrosurgical instruments. In November 1995, the Company was issued a United States patent for its CPR mask system. The Company has applied for United States patents on additional disposable instrumentation and electronic circuitry. The Company's practice is to apply for patents which are important to the development or sale of a product. Dr. Leonard Malis has entered into an agreement with the Company to license the "MALIS" trademark to the Company, at no cost to the Company, to the extent the name has not been licensed to Johnson & Johnson. Employees At September 30, 1998, the Company and its subsidiaries had 32 full-time employees, including executive officers. The Company from time to time retains part-time employees, engineering consultants, scientists and other consultants. All full-time employees participate in the Company's health benefit plan. None of the Company's employees are represented by a union or covered by a collective bargaining agreement. The Company considers its relationship with its employees to be satisfactory. Forward Looking Statements The information provided in this report may contain forward looking statements or statements which arguably imply or suggest certain things about the Company's future. These include, but are not limited to statements about: (1) any competitive advantage the Company may have as a result of its installed base of electrosurgical generators in the field neurosurgery; (2) the Company's belief that its products exceed industry standards or favorably compete with other companies' new technological advancements; and (3) the anticipated success of certain recently introduced products or products scheduled to be released in the near future for use in neurosurgery, other surgical disciplines, and the dental market. These statements are based on assumptions that the Company believes are reasonable, but a number of factors could cause the Company's actual results to differ materially from those expressed or implied by these statements. Investors are advised to review the -10- 11 Additional Cautionary Statements section, which follows the Management's Discussion and Analysis of Financial Condition and Results of Operations section (Item 7) of this Report, for more information about risks that could affect the financial results of the Company. Item 2. PROPERTIES. The Company currently leases approximately 4,200 square feet of office and warehouse space at a base monthly rent of $4,618 (with increases based on increases in the consumer price index) in an office building in Oaks, Pennsylvania, approximately 12 miles northwest of Philadelphia, Pennsylvania. The current lease is for a term of five years ending on June 30, 2000. On August 31, 1994, the Company acquired a building with approximately 15,000 square feet of manufacturing and warehouse space in Philadelphia, Pennsylvania. Item 3. LEGAL PROCEEDINGS. As of September 30, 1998, there are no material pending legal proceedings to which the Company is a party or to which any of its property is the subject. Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. No matters were submitted to a vote of the shareholders during the fourth quarter of fiscal year 1998. PART II Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS. The Company's Common Stock is quoted on the Boston Stock Exchange under the symbol VLF, and traded in the over-the-counter market, and is included in the National Association of Securities Dealers Automated Quotation (NASDAQ) System - Small Cap Issues under the symbol VLFG. The table below sets forth the range of high and low closing bid quotations per share of Common Stock as reported on the NASDAQ System. Quotations represent prices between dealers and do not necessarily represent actual transactions. None of the prices shown reflect retail mark-ups, mark-downs, or commissions. COMMON STOCK High-Bid Low-Bid Fiscal 1997: First Quarter ..........................$ 3 3/8 $2 Second Quarter.......................... 3 5/8 2 1/16 Third Quarter........................... 5 1/16 2 1/8 Fourth Quarter.......................... 5 1/16 3 1/8 Fiscal 1998: First Quarter .......................... 4 1/4 2 9/16 Second Quarter.......................... 4 3/3 3 3/16 Third Quarter........................... 6 7/8 4 1/8 Fourth Quarter.......................... 5 3/4 2 3/8 -11- 12 At December 15, 1998, the Company had 106 shareholders of record. The Company believes that there are in excess of 1,000 beneficial shareholders of its Common Stock. The Company has not paid any dividends to date, nor does it expect to do so in the foreseeable future.
Item 6. SELECTED FINANCIAL DATA VALLEY FORGE SCIENTIFIC CORP. AND SUBSIDIARIES Statement of Operations Data: 1998 1997 1996 1995 1994(1) - ------------------ ---- ---- ---- ---- ------- Net Sales $3,879,977 $3,977,965 $3,424,589 $2,688,427 $3,587,379 Income (loss) from Operations (63,521) 19,701 (96,285) (368,415) 694,159 Net Income (loss) $(34,374) $6,533 $(75,116) ($215,574) $547,615 ========= ====== ========= ========== ======== Primary Earnings (loss) per share $(.00) $.00 $(.01) $(.03) $.07 ====== ==== ====== ====== ==== Fully Diluted Earnings (loss) per share $(.00) $.00 $(.01) $(.03) $.07 ====== ==== ====== ====== Balance Sheet Data: At September 30, 1998 1997 1996 1995 1994 - ------------------- ---- ---- ---- ---- ---- Current Assets $3,216,510 $3,139,256 $2,987,502 $3,052,414 $3,429,443 Total Assets 4,204,211 4,254,070 4,217,958 4,379,866 4,884,525 Current Liabilities 161,120 187,817 164,595 256,123 353,891 Long Term Liabilities 18,445 11,093 4,736 0 170,775 Retained Earnings (deficit) (30,912) 3,462 (3,071) 72,045 287,619 Stockholders' Equity 4,024,646 4,055,160 4,048,627 4,123,743 4,359,859
(1) On August 31, 1994, the Company acquired Diversified Electronic Corporation pursuant to an Agreement and Plan of Merger. After September 1, 1994, the operations of Diversified Electronic Corporation were conducted by the Company's Diversified Electronics Company, Inc., wholly owned subsidiary. The results of operations of Diversified Electronics Company, Inc. from September 1, 1994 are included in the results of operations of the Company. -12- 13 Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Results of Operations 1998 and 1997 Fiscal Year Compared Sales of $3,879,977 for 1998 were $97,988 (2.5%) less than sales for 1997. The sales decrease was due to changes in sales patterns to Johnson & Johnson Professional, Inc. ("J&J"), the Company's principal customer. In 1998, J&J accounted for 93% of the Company's sales, as compared to 92% and 89% of the sales in 1997 and 1996, respectively. Sales to J&J in 1999 are expected to increase significantly as a result of the Company's September 2, 1998 agreement with J&J, which amends the Company's existing distribution agreement with J&J. In the amendment, the Company agreed to extend the term of the existing distribution agreement from December 31, 1998 to December 31, 1999 in exchange for J&J agreeing to make minimum purchases of the Company's products for the 1999 calendar year in the amount of $5,000,000. For 1998, the minimum purchases under the distribution agreement were $1,100,000. Sales of disposable instrumentation for use in the field of gynecology accounted for approximately 2% of the Company's sales in 1998. The Company anticipates a significant increase in the dollar amount of sales of disposable instruments in 1999 with the release of new disposable instruments in the fields of neurosurgery, gynecology and dentistry. Subsequent to the end of the fiscal 1998, the Company entered into a supply and distribution agreement with Garfield Refining Company for the sale of the Company's Bi-Dent bipolar generator and disposable instrumentation and accessory products in the field of Dentistry. The Company believes that this agreement will enable the Company's products to enter into the dental market in 1999. During 1998, the Company's wholly-owned subsidiary, Diversified Electronics Company, Inc., concentrated its manufacturing efforts almost exclusively on the Company's products. In 1999, the Company anticipates this trend to continue as a result of J&J's commitment to purchase a minimum of $5,000,000 of the Company's products in the 1999 calendar year and the production of the Company's newest generators for use in the fields of neurosurgery, gynecology, orthopedic surgery and dentistry. Approximately 64% of the Company's 1998 sales related to sales of the bipolar electrosurgical and irrigation systems as compared to approximately 76% and 54% of the sales in fiscal 1997 and 1996, respectively. Sales of C/T Sets and bipolar cords accounted for approximately 33% of the Company's sales in 1998 and approximately 21% and 35% in 1997 and 1996, respectively. The Company's gross profit margin was 48% for 1998 as compared to gross profit margin of 51% and 46% for 1997 and 1996, respectively. Selling, general and administrative expenses decreased by $78,492 (4.9%) in 1998 as compared to the amounts for 1997. Research and development expenses decreased by $14,906 (4.9%) to $292,165 in 1998. The research and development expense in 1998 reflects the Company's continued efforts in developing additional disposable instrumentation and accessory products for its bipolar generators as well as refining bipolar generators for the neurosurgery, dentistry, and the laparoscopic arthroscopic and general surgery markets. The Company had a loss from operations of $63,521 for 1998 as compared to income from operations of $19,701 for 1997. The Company had a loss before taxes of $36,596 in 1998 as compared to -13- 14 income before taxes of $28,768 in 1997. The Company had a benefit of income taxes of $2,224 in 1998 as compared to a provision for income taxes of $22,235 in 1997. As a result of the foregoing, the Company had a net loss of $34,374 in 1998 as compared to net income of $6,533 for 1997. Basic and diluted loss per share was ($.00) for 1998 compared to earnings per share of $.00 for 1997. 1997 and 1996 Fiscal Year Compared Sales of $3,977,965 for 1997 were 16% greater than sales for 1996. The sales increase primarily resulted from increased sales to J&J. In 1997, J&J accounted for 92% of the Company's sales, as compared to 89% and 76% of the sales in 1996 and 1995, respectively. The sales gains reflect increased shipments of the Company's bipolar generators, including the two newest neurosurgical generators. During 1997, the Company's wholly-owned subsidiary Diversified Electronics Company, Inc. concentrated its manufacturing efforts almost exclusively on the Company's products. Approximately 76% of the Company's 1997 sales related to sales of the bipolar electrosurgical and irrigation systems as compared to approximately 54% and 69% of the sales in fiscal 1996 and 1995, respectively. Sales of C/T Sets accounted for approximately 21% of the Company's sales in 1997 and approximately 35% and 28% in 1996 and 1995, respectively. The Company's gross profit margin was 51% for 1997 as compared to gross profit margin of 46% and 47% for 1996 and 1995, respectively. Selling, general and administrative expenses increased by 7% in 1997 as compared to the amounts for 1996. Selling, general and administrative expenses were impacted by higher sales levels. Research and development expenses increased by 251% to $307,071 in 1997. The Company's research and development included the further development and refinement of generators and instrumentation in preparation for their introduction into the gynecology market and other markets. In the fourth quarter of 1997, the Company entered into an exclusive, five-year worldwide supply and distribution agreement with BEI Medical Systems Company, Inc. ("BEI"). Under the agreement, BEI has agreed to distribute the Bi-Safe I and Bi-Safe II bipolar electrosurgical systems and the Company's single-use bipolar instruments for use in gynecology and gynecological laparoscopic surgery in hospitals, outpatient clinics and physician offices. The Company had income from operations of $19,701 for 1997 as compared to a loss from operations of $96,285 for 1996. The Company had income before taxes of $28,768 in 1997 as compared to a loss before taxes of $88,095 in 1996. The Company made a provision for income taxes of $22,235 in 1997 as compared to a tax benefit of $12,979 in 1996. As a result of the foregoing, the Company had a net income of $6,533 in 1997 as compared to a net loss of $75,116 for 1996. Primary and fully diluted earnings per share was $.00 for 1997 compared to loss per share of $.01 for 1996. Liquidity and Capital Resources The primary measures of the Company's liquidity are cash balances (including short-term investments), accounts receivable and inventory balances, as well as its borrowing ability. During 1998, the Company's working capital increased by $103,951 to $3,055,390. -14- 15 For the 1998 fiscal year, the Company provided net cash of $248,524 from operating activities, which primarily reflected a $205,547 decrease in inventory, reduced by a $54,258 increase in accounts receivable and a $26,697 decrease in accounts payable. During 1998, the Company used $5,854 for the purchase of property, plant, and equipment and $1,817 for intangible assets. Cash increased by $240,853 to $873,757 at September 30, 1998. For the 1997 fiscal year, the Company provided net cash of $494,496 from operating activities, which primarily reflected a $277,270 decrease in inventory, a $14,748 decrease in accounts receivable and an increase of $23,222 in accounts payable and accrued expenses. The decrease in accounts receivable and decrease in inventory was primarily due to higher sales levels. Investing activities for 1997 used $24,353 for an increase in intangible assets of $10,296 and for the purchase of equipment in the amount of $14,057. Cash increased by $470,143 in 1997 leaving a balance of $632,904 in the Company's cash and cash equivalents at September 30, 1997. On March 1, 1996, the Company and Bernard H. Shuman, a director and Vice President-Technology of the Company, modified the payment terms of a note originally issued to Mr. Shuman in connection with the Company's merger with Diversified Electronic Corporation in August 1994, which was due on March 1, 1996. Pursuant to the modification, the Company paid Mr. Shuman $100,000 to reduce the principal balance for the note on March 1, 1996, $15,000 in April, 1996 and $70,000 on August 1, 1996. On August 1, 1996, the note was canceled. The Company has a line of credit of $1,000,000 with First Union National Bank which calls for interest to be charged at the bank's national commercial rate. The credit accommodation is unsecured and requires the Company to have a tangible net worth of no less than $3,000,000. At September 30, 1998, there was no outstanding balance on this line. At September 30, 1998, the Company had no debt. The Company believes it has available all funds needed for operations, research and development and capital expenditures as they may arise in the future. However, should it be necessary, the Company believes it could borrow adequate funds at competitive rates and terms. Acquisition of Diversified On August 31, 1994, the Company acquired Diversified Electronic Corporation ("Diversified"), a company wholly owned by Bernard H. Shuman, pursuant to a Merger Agreement, in which the Company was the surviving corporation. After the merger, Diversified Electronics Company, Inc., a wholly owned subsidiary of the Company, conducted the operations of Diversified. In the Merger Agreement, the Company issued the following consideration: (i) cash in the amount of $161,500; (ii) a noninterest bearing note in the amount of $185,000 payable on March 1, 1996; (iii) a noninterest bearing note in the amount of $47,188 which was paid upon the collection of certain accounts receivable of Diversified; and (iv) 139,334 shares of unregistered common stock of the Company. The cash portion of the consideration was funded with the Company's available cash on hand. The assets of Diversified consisted primarily of equipment, fixtures, inventory, and intellectual property. Prior to the merger, Diversified Electronics Company, Inc., a wholly owned subsidiary of the Company, acquired the real property and building, which constituted Diversified's manufacturing facility, for $95,000 in cash. -15- 16 Year 2000 Compliance The Company has conducted an evaluation of its internal management information system and software relating to year 2000 compliance issues. In addition, the Company's Manufacturing and Research and Development staffs have evaluated manufacturing processes and manufactured products and are evaluating secondary compliance issues with vendors related to the year 2000. At the present time, the Company has not identified any compliance issues that can not be resolved within the required time frames or will have a material impact on the Company's business or financial results. Forward Looking Statements Statements in this Annual Report on Form 10-K which express that the Company "believes", "anticipates", or "plans to," as well as other statements which are not historical fact, are forward looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Actual events or results may differ materially as a result of risks and uncertainties, including in particular, those described elsewhere in this Form 10-K. Additional Cautionary Statements Competition and Risk of Obsolescence from Technological Advances The markets in which the Company's products compete are characterized by continuing technical innovation and increasing competition. Some surgical procedures which utilize or could utilize the Company's products could potentially be replaced or reduced in importance by alternative medical procedures or new drugs which may adversely affect the Company's business. Government Regulation The process of obtaining and maintaining required regulatory approvals is lengthy, expensive and uncertain. Although the Company has not experienced any substantial regulatory delays to date, there is no assurance that delays will not occur in the future, which could have a significant adverse effect on the Company's ability to introduce new products on a timely basis. Regulatory agencies periodically inspect the Company's manufacturing facilities to ascertain compliance with "good manufacturing practices" and can subject approved products to additional testing and surveillance programs. Failure to comply with applicable regulatory requirements can, among other things, result in fines, suspensions of regulatory approvals, product recalls, operating restrictions and criminal penalties. While the Company believes they are currently in compliance, if the Company fails to comply with regulatory requirements, it could have an adverse effect on the Company's results of operations and financial condition. Uncertainties within the Health Care Markets Political, economic and regulatory influences are subjecting the health care industry in the United States to rapid, continuing and fundamental change. Although Congress has not passed comprehensive health care reform legislation to date, it is believed that Congress, state legislatures and the private sector will continue to review and assess alternative health care delivery and payment systems. Responding to increased costs and to pressure from the government and from insurance companies to reduce patient charges, health care providers have demanded, and in many cases received, reduced prices on medical devices. These customers are expected to continue to demand lower prices in the future. The Company cannot predict what impact the adoption of any federal or state health care reform measures, private sector -16- 17 reform or market forces may have on its business. However, pricing pressure is expected to continue to adversely affect profit margins. Product Liability Risk The Company's products involve a risk of product liability. Although the Company maintains product liability insurance at coverage levels which it believes are adequate, there is no assurance that, if the Company were to incur substantial liability for product liability claims, insurance would provide adequate coverage against such liability. Product Acceptance and New Products The Company's growth depends in part on the acceptance of its products in the marketplace, the market penetration achieved by the companies which the Company has contracted with, and relies on, to distribute its products, and its ability to introduce new and innovative products that meet the needs of medical professionals. There can be no assurance that the Company will be able to continue to introduce new and innovative products or that the products the Company introduces, or has introduced, will be widely accepted by the marketplace, or that companies which the Company has contracted to distribute its products will achieve market penetration in the surgical disciplines and markets outside of neurosurgery. The failure of the Company to continue to introduce new products or gain wide spread acceptance of its products would adversely affect the Company's operations. Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. Not Applicable. Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. A. Quarterly Results of Operations. Not applicable. B. Financial Statements and Financial Statement Schedules. See Index to Financial Statements and Financial Statement Schedules on page F-1 herein. Item 9. DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. Not applicable. -17- 18 PART III Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT. The information concerning directors and officers called for by Item 10 of Form 10-K will be set forth either: (i) in the Company's Definitive Proxy Statement for its Annual Meeting of Stockholders, or (ii) in an amendment to this Annual Report on Form 10-K, which in either case will be filed within 120 days after the end of the fiscal year covered by this Annual Report on Form 10-K, and is incorporated herein by reference. Item 11. EXECUTIVE COMPENSATION. Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT. Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. The information called for by Items 11, 12 and 13 of Form 10-K will be set forth either: (i) in the Company's Definitive Proxy Statement for its Annual Meeting of Stockholders, or (ii) in an amendment to this Annual Report on Form 10-K, which in either case will be filed within 120 days after the end of the fiscal year covered by this Annual Report on Form 10-K, and is incorporated herein by reference. -18- 19 PART IV Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K. a. and d. Financial Statements and Financial Statement Schedules. See Index to Financial tatements and Financial Statement Schedules on Page F-1, herein. b. Reports on Form 8-K. None. c. Exhibits The following is a list of exhibits filed as part of this annual report on Form 10-K. Where so indicated by footnote, exhibits which were previously filed are incorporated by reference. For exhibits incorporated by reference, the location of the exhibit in the previous filing is indicated in parentheses. (2) Agreement and Plan of Merger. (a) Agreement and Plan of Merger between Valley Forge Scientific Corp. and Diversified Electronic Corporation dated August 31, 1994. (4) (3) Articles of Incorporation and By-Laws. (a) Articles of Incorporation, as amended - (1) (Exhibit 3(a)). (b) By-Laws of the Company, as amended - (1) (Exhibit 3(b)). (4) Instruments defining the Rights of Security Holders, including Indentures. (a) Form of Common Stock Certificate - (1) (Exhibit 4(a)). (10) Material Contracts. (a) Non-Qualified Employee Stock Option Plan - (1) (Exhibit 10(a)). (b) Assignment of Know-How Agreement, dated June 30, 1989 - (1) (Exhibit 10(g)). (c) Assignment of Patents - Bipolar Electrosurgical Systems, June 30, 1989 - (1) (Exhibit 10(h)). (d) Assignment of Patents - Binocular Magnification System, June 30, 1989 -(1) (Exhibit 10(i)). (e) Assignment of Malis trade name, dated June 30, 1989 - (1) (Exhibit 10(j)). -19- 20 (f) 401(k) and Profit-Sharing Plan - (2) (Exhibit 10(x)). (g) Distribution Agreement between Codman & Shurtleff, Inc. (Johnson & Johnson Professional, Inc.) and the Company (3)(Exhibit 10(b)). (h) Amended and Restated Registration Rights Agreement, dated April 3, 1991 - (3)(Exhibit 10(g)). (i) Promissory Note from Jerry L. Malis to the Company. (6) (Exhibit 10(k)) (j) Promissory Note from the Company to Bernard H. Shuman. (6) (Exhibit 10(l)) (k) Employment Agreement Jerry L. Malis. (6) (Exhibit 10(m)) (l) Employment Agreement Thomas J. Gilloway. (6) (Exhibit 10(n)) (m) Employment Agreement Bernard H. Shuman. (6) (Exhibit 10(o)) (n) Registration Rights Agreement between the Company and Bernard H. Shuman (6) (Exhibit 10(p)) (o) Commercial Lease Agreement between GMM Associates and the Company dated July 1, 1995 (7) (Exhibit 10(p)) (p) Promissory Note from Jerry L. Malis to the Company. (q) Amendment to Distribution Agreement with Codman & Shurtleff, Inc. (Johnson & Johnson Professional, Inc.), dated September 2, 1998. (21) Subsidiaries of Registrant Subsidiaries of Valley Forge Scientific Corp. (8) (Exhibit 21) (23) Consent of Samuel Klein & Company (1) Previously filed with the Registration Statement of the Company on Form S-18, Registration No. 33-31008-NY, and incorporated herein by reference. (2) Previously filed with the Registration Statement of the Company on Form S-18, Registration No. 33-35668-NY, and incorporated herein by reference. (3) Previously filed with the Registration Statement of the Company on Form S-1, Registration No. 33-40545, and incorporated herein by reference. (4) Previously filed with the Company's Form 8-K dated August 31, 1994, and incorporated herein by reference. (5) Previously filed with the Company's Form 10-K for the year ended September 30, 1993, and incorporated herein by reference. (6) Previously filed with the Company's Form 10-K for the year ended September 30, 1994, and incorporated herein by reference. (7) Previously filed with the Company's Form 10-K for the year ended September 30, 1995, and incorporated herein by reference. (8) Previously filed with the Company's Form 10-K for the year ended September 30, 1997, and incorporated herein by reference. -20- 21 SIGNATURES Pursuant to the requirements of the Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized on this 22nd day of December, 1998 VALLEY FORGE SCIENTIFIC CORP. By: /s/ Jerry L. Malis Jerry L. Malis, President Pursuant to the requirements of the Securities Act of 1934, this report has been signed by the following persons on behalf of the Registrant and in the capacities and on the dates indicated. Signature Title Date /s/ Jerry L. Malis Chairman of the Board, December 22, 1998 Jerry L. Malis President (chief executive officer and principal financial and accounting officer) /s/ Thomas J. Gilloway Executive Vice President, December 22, 1998 Thomas J. Gilloway Secretary, Treasurer, Director /s/ Leonard I. Malis Director December 22, 1998 Leonard I. Malis /s/ Bruce A. Murray Director December 22, 1998 Bruce A. Murray /s/ Bernard H. Shuman Vice President -Technology, December 22, 1998 Bernard H. Shuman Director /s/ Robert H. Dick Director December 22, 1998 Robert H. Dick -21- F-1 VALLEY FORGE SCIENTIFIC CORP. Index to Financial Statements and Financial Statement Schedules Independent Auditor's Report F-2 Balance Sheets - September 30, 1998 and 1997 F-3 Statements of Operations - Years Ended September 30, 1998, 1997 F-4 and 1996 Statements of Stockholders' Equity - Years ended September 30, 1998 F-5 1997 and 1996 Statements of Cash Flows - Years ended September 30, 1998, 1997 and 1996 F-6 Notes to Financial Statements F-7 ___________________ All other schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are not required under the related instructions or are inapplicable, and therefore have been omitted. F-1 F-2 INDEPENDENT AUDITOR'S REPORT The Board of Directors and Stockholders Valley Forge Scientific Corp. and Subsidiaries Oaks, Pennsylvania We have audited the accompanying consolidated balance sheets of Valley Forge Scientific Corp. and Subsidiaries as of September 30, 1998 and 1997 and the related consolidated statements of operations, stockholders' equity and cash flows for each of the three years in the period ended September 30, 1998. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Valley Forge Scientific Corp. and Subsidiaries as of September 30, 1998 and 1997, and the results of operations and cash flows for each of the three years in the period ended September 30, 1998, in conformity with generally accepted accounting principles. SAMUEL KLEIN AND COMPANY Newark, New Jersey December 3, 1998 F-2 F-3 VALLEY FORGE SCIENTIFIC CORP. AND SUBSIDIARIES BALANCE SHEETS September 30, ASSETS 1998 1997 - ------ ---- ---- Current Assets: Cash and cash equivalents $ 873,757 $ 632,904 Accounts receivable, net 911,158 856,900 Inventory 1,204,980 1,410,527 Prepaid items and other current assets 68,996 91,393 Recoverable income taxes 4,636 8,352 Deferred income tax benefit 152,983 139,180 --------- --------- Total Current Assets 3,216,510 3,139,256 Property, Plant and Equipment, net 229,687 267,612 Intangible Assets, net 753,542 842,730 Other Assets 4,472 4,472 --------- --------- Total Assets $4,204,211 $4,254,070 ========= ========= LIABILITIES AND STOCKHOLDERS' EQUITY Current Liabilities: Accounts payable and accrued expenses $ 160,607 $ 187,817 Income taxes payable 513 - --------- ---------- Total Current Liabilities 161,120 187,817 Deferred Income Tax Liability 18,445 11,093 -------- ---------- Total Liabilities 179,565 198,910 -------- ---------- Commitments and Contingencies Stockholders' Equity: Preferred stock - - Common stock (no par, 10,000,000 shares authorized, 8,229,384 shares issued and outstanding at September 30, 1998 and 1997) 4,055,558 4,051,698 Retained earnings (deficit) (30,912) 3,462 --------- --------- Total Stockholders' Equity 4,024,646 4,055,160 --------- --------- Total Liabilities and Stockholders' Equity $4,204,211 $4,254,070 ========= ========= ____________________ The accompanying notes are an integral part of these financial statements. VALLEY FORGE SCIENTIFIC CORP. AND SUBSIDIARIES F-3
F-4 VALLEY FORGE SCIENTIFIC CORP. AND SUBSIDIARIES STATEMENTS OF OPERATIONS For the Years Ended September 30, 1998 1997 1996 ---- ---- ---- Net Sales $3,879,977 $3,977,965 $3,424,589 Cost of Sales 2,029,145 1,951,342 1,840,130 --------- --------- --------- Gross Profit 1,850,832 2,026,623 1,584,459 --------- --------- --------- Other Costs: Selling, general and administrative 1,531,183 1,609,615 1,503,000 Research and development 292,165 307,071 87,536 Amortization 91,005 90,236 90,208 --------- --------- --------- Total Other Costs 1,914,353 2,006,922 1,680,744 --------- --------- --------- Income (Loss) from Operations (63,521) 19,701 (96,285) Other Income (Expense): Interest income (expense) 26,923 9,067 8,190 --------- --------- --------- Income (Loss) Before Income Taxes (36,598) 28,768 (88,095) Provision for (Benefit of) Income Taxes (2,224) 22,235 (12,979) --------- --------- --------- Net Income (Loss) $ (34,374) $ 6,533 $ (75,116) ========= ========= ========= Earnings (Loss) Per Share: Basic earnings (loss) per common share $ (.00) $ .00 $ (.01) ========= ========= ========= Diluted earnings (loss) per common share $ (.00) $ .00 $ (.01) ========= ========= ========= Basic common shares outstanding 8,229,384 8,229,384 8,229,384 Diluted common shares outstanding 8,229,384 8,320,840 8,229,384 ____________________ The accompanying notes are an integral part of these financial statements. F-4
F-5 VALLEY FORGE SCIENTIFIC CORP. AND SUBSIDIARIES STATEMENTS OF STOCKHOLDERS' EQUITY FOR THE YEARS ENDED SEPTEMBER 30, 1998, 1997 AND 1996 Common Stock No Par Value ------------------------------- Retained Total Number of Common Earnings Stockholders' Shares Stock Amount (Deficit) Equity ---------- ------------ --------- ------------- Balances, October 1, 1995 8,229,384 $4,051,698 $ 72,045 $4,123,743 Net Loss for the Year Ended September 30, 1996 - - (75,116) (75,116) ---------- ----------- --------- ---------- Balances, September 30, 1996 8,229,384 4,051,698 (3,071) 4,048,627 Net Income for the Year Ended September 30, 1997 - - 6,533 6,533 ---------- --------- --------- ---------- Balances, September 30, 1997 8,229,384 4,051,698 3,462 4,055,160 Issuance of Non-Qualified Options to a Consultant - 3,860 - 3,860 Net Loss for the Year Ended September 30, 1998 - - (34,374) (34,374) ---------- --------- --------- ---------- Balances, September 30, 1998 8,229,384 $4,055,558 $ (30,912) $4,024,646 ========== ========= ========= ========== ____________________ The accompanying notes are an integral part of these financial statements. F-5
F-6 VALLEY FORGE SCIENTIFIC CORP. AND SUBSIDIARIES STATEMENTS OF CASH FLOWS For the Years Ended September 30, 1998 1997 1996 Cash Flows from Operating Activities: ---- ---- ---- Net income (loss) $ (34,374) $ 6,533 $ (75,116) Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: Depreciation and amortization 134,784 140,095 142,275 Stock options issued to a consultant 3,860 - - Changes in assets and liabilities, net of effect from: (Increase) decrease in accounts receivable (54,258) 14,748 (166,636) (Increase) decrease in inventory 205,547 277,270 (239,432) (Increase) decrease in recoverable income taxes 3,716 4,537 157,482 (Increase) decrease in deferred income tax benefit (13,803) 25,969 (11,547) (Increase) decrease in other assets - (100) - (Increase) decrease in prepaid items and other current assets 22,397 (4,135) (27,014) Increase (decrease) in accounts payable and accrued expenses and income taxes payable (26,697) 23,222 89,150 Increase in deferred tax liability 7,352 6,357 4,736 ------- ------- ------- Net cash provided by (used in) operating activities 248,524 494,496 (126,102) ------- ------- ------- Cash Flows from Investing Activities: Increase in intangible assets (1,817) (10,296) (14,508) Purchase of property, plant and equipment (5,854) (14,057) (31,185) Net cash used in investing ------- ------- ------- activities (7,671) (24,353) (45,693) ------- ------- ------- Cash Flows from Financing Activities: Net reduction in notes payable - - (180,678) ------- ------- ------- Net cash used in financing activities - - (180,678) ------- ------- ------- Net Increase (Decrease) in Cash and Cash Equivalents 240,853 470,143 (352,473) Cash and Cash Equivalents, beginning of year 632,904 162,761 515,234 ------- ------- ------- Cash and Cash Equivalents, end of year $ 873,757 $ 632,904 $ 162,761 ======= ======= ======= Supplemental Disclosures of Cash Flow Information: Cash paid during the year for: Interest $ - $ - $ 14,225 ======= ======== ======== Income taxes $ - $ 2,500 $ - ======= ======== ======== ____________________ The accompanying notes are an integral part of these financial statements. F-6
F-7 VALLEY FORGE SCIENTIFIC CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES The Company Valley Forge Scientific Corp. ("VFSC") was incorporated on March 27, 1980 in the Commonwealth of Pennsylvania and is engaged in the business of developing, manufacturing and selling medical devices and products. On August 18, 1994, VFSC formed a wholly-owned subsidiary, Diversified Electronics Company, Inc. ("DEC"), a Pennsylvania corporation, in order to continue the operations of Diversified Electronic Corporation, a company which was merged with and into VFSC on August 31, 1994. In January 1993, VFSC formed a wholly - owned subsidiary, Valley Consumer Products, Inc. ("VCP") to market specific product lines. During 1996, VCP commenced initial operations and began marketing the CPR mask system developed by VFSC. As referred to in Note 2, during 1998 the Company entered into a license agreement for the manufacture and distribution of the CPR Mask. Collectively, VFSC, DEC and VCP are referred to herein as the "Company". Cash and Cash Equivalents The Company considers cash equivalents to be all highly liquid investments with original maturities of three months or less. Principals of Consolidation and Basis of Presentation The accompanying financial statements consolidate the accounts of the parent company and its wholly-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation. Use of Management Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Revenue Recognition The Company currently sells its products to or through national or international distributors which include affiliates of major health care corporations. A significant part of the Company's sales are made pursuant to a distribution agreement, as amended September 2, 1998, in the field of neurosurgery effective through December 31, 1999. Revenues from sales are recorded on the accrual basis of accounting, when goods are shipped or when services are provided. Revenues from license and royalty fees are recorded when earned. Inventory Inventory is stated at the lower of cost, determined by the moving average cost method, or market. Property, Plant and Equipment Property, plant and equipment are recorded at cost. Depreciation is computed by the straight-line method over the estimated useful lives of the assets, which vary from three to forty years. Leasehold improvements are being amortized over the related lease term or estimated useful lives, whichever is shorter. F-7 F-8 VALLEY FORGE SCIENTIFIC CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 1. THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) Property, Plant and Equipment (Continued) Upon retirement or other disposition of these assets, the cost and related accumulated depreciation are removed from the accounts and the resulting gains or losses are reflected in the results of operations. Routine maintenance and repairs are charged to expense as incurred. Intangible Assets Intangible assets, consisting of patents, licensing agreements, proprietary know-how, cost of acquisition and goodwill are amortized to operations under the straight-line method over their estimated useful lives or statutory lives, whichever is shorter. Goodwill representing the excess of the purchase price paid over the fair market value of net assets acquired is being amortized over 20 years. Acquisition costs have been capitalized and are being amortized over 5 years. Impairment of Long-Lived Assets Effective October 1, 1996, the Company adopted Statement of Financial Accounting Standards No. 121 (SFAS 121), "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of." SFAS 121 requires that if facts and circumstances indicate that the cost of fixed assets or other assets may be impaired, an evaluation of recoverability would be performed by comparing the estimated future undiscounted pre-tax cash flows associated with the asset to the asset's carrying value to determine if a write-down to market value or discounted pre-tax cash flow value would be required. Research and Development Costs associated with development of new products are charged to operations as incurred. Advertising Costs Advertising expenditures relating to the manufacturing and marketing of the Company's products and services are expensed in the period the advertising costs are incurred. Substantially all cost of such advertising has been born by the Company's major distributors. Income Taxes Tax provisions and credits are recorded at enacted tax rates for taxable items included in the consolidated statements of operations regardless of the period for which such items are reported for tax purposes. Deferred tax assets and liabilities are determined based on the differences between the financial statement and tax bases of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. Deferred tax assets are reduced by a valuation allowance when the determination can be made that it is more likely than not that some portion or all of the related tax asset will not be realized. F-8 F-9 VALLEY FORGE SCIENTIFIC CORP. AND SUBSIDIARIES NOTES TO FINANCIAL STATEMENTS (Continued) 1. THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) Comprehensive Income For the year ended September 30, 1998, the Company adopted SFAS No. 130, Reporting Comprehensive Income ("SFAS 130"). This statement establishes rules for the reporting of comprehensive income and its components which require that certain items such as foreign currency translation adjustments, unrealized gains and loses on certain investments in debt and equity securities, minimum pension liability adjustments and unearned compensation expense related to stock issuances to employees be presented as separate components of stockholders' equity. The adoption of SFAS 130 had no impact on total shareholders' equity for any of the years presented in these financial statements. Earnings (loss) per Share As of December 31, 1997, the Financial Accounting Standards Board issued Statement No. 128 "Earnings Per Share" ("SFAS 128") replacing the calculation of primary and fully diluted earnings per share with Basic and Diluted earnings per share. Unlike primary earnings per share, basic earnings per share excludes the dilutive effects of options, warrants and convertible securities and thus is computed by dividing income available to common stockholders by the weighted average number of common shares outstanding. Diluted earnings per share is similar to the previously fully diluted earnings per share. Diluted earnings per share reflects the potential dilution that could occur if securities or other agreements to issue common stock were exercised or converted into common stock. Dilutive earnings per share is computed based upon the weighted average number of common shares and dilutive common equivalent shares outstanding. Accounting for Stock-Based Compensation Effective for the year ending September 30, 1997, the Company adopted the disclosure provisions of Statement of Financial Accounting Standards No. 123 ("SFAS 123"), "Accounting for Stock-Based Compensation." As permitted under SFAS 123, the Company has continued to apply accounting prescribed by Accounting Principle Board Opinion No. 25 ("APB 25"). Under APB 25, compensation expense is determined on the measurement date, that is,the first date on which both the number of shares the employee is entitled to receive and the exercise price, if any, are known. Compensation expense, if any, is the excess of the market price of the stock over the exercise price on the measurement date. In accounting for options granted to persons other than employees (as defined under SFAS 123), the provisions of SFAS 123 were applied. According to SFAS 123, the fair value of these options was estimated at the grant date using Black-Scholes option pricing model. Reclassifications Certain reclassifications have been made to the prior year balances to conform to the current year's presentation. F-9 F-10 VALLEY FORGE SCIENTIFIC CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 2. LICENSE AGREEMENT On February 18, 1998, as amended on March 30, 1998, the Company entered into a license agreement with Medical Products Manufacturing, LLC ("MPM"), a manufacturer and distributor of emergency medical equipment, whereby the Company granted to MPM an exclusive, non-transferable license to use the Company's equipment and technology of the Company's CPR Masks. In connection with this agreement the Company sold its remaining CPR Mask inventory to MPM. The Company will receive a license fee equal to 10% of gross sales of any and all products that MPM or its affiliates sell utilizing the mask technology with a minimum annual license fee. 3. ACCOUNTS RECEIVABLE Accounts receivable are comprised of the following: September 30, 1998 1997 ---- ---- Accounts receivable $1,029,456 $ 975,292 Less: Allowance for doubtful accounts and contractual allowances 118,298 118,392 --------- -------- $ 911,158 $ 856,900 ========= ======== 4. INVENTORY Inventory consists of the following: September 30, 1998 1997 ---- ---- Finished goods $ 21,080 $ 32,958 Work-in-process 757,468 1,098,436 Materials and parts 426,432 279,133 --------- --------- $1,204,980 $1,410,527 ========= =========
F-10 F-11 VALLEY FORGE SCIENTIFIC CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 5. PROPERTY, PLANT AND EQUIPMENT Property, plant and equipment consist of the following: September 30, 1998 1997 ---- ---- Land $ 11,953 $ 11,953 Building and improvements 86,917 86,917 Furniture and fixtures 16,669 16,669 Laboratory equipment 369,579 364,744 Office equipment 97,164 96,145 Leasehold improvements 9,413 9,413 ------- ------- 591,695 585,841 Less: Accumulated depreciation and amortization 362,008 318,229 ------- ------- $229,687 $267,612 ======= ======= Depreciation is reflected in both cost of sales and selling, general and administrative expenses. Total depreciation for the years ended September 30, 1998, 1997 and 1996 is $43,779, $49,859 and $52,067, respectively. 6. INTANGIBLE ASSETS Intangible assets consist of the following:
September 30, 1998 1997 Patents/trademarks/licensing ---- ---- agreements $ 558,972 $ 557,155 Proprietary know-how 452,354 452,354 Acquisition costs 55,969 55,969 Excess of purchase price over net assets acquired in connection with the acquisition of Technical Medical Industries, Inc. 351,123 351,123 ------- ------- 1,418,418 1,416,601 Less: Accumulated amortization 664,876 573,871 $ 753,542 $ 842,730 ======== ========
F-11 F-12 VALLEY FORGE SCIENTIFIC CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 7. RELATED PARTY TRANSACTIONS Loans Receivable On July 6, 1998, Jerry L. Malis, a principal shareholder, director and officer of the Company borrowed $15,015 from the Company. The note is payable on demand and has a stated rate of interest of 5.42%, the then current "Applicable Federal Rate" as set forth under the Internal Revenue Code. The Company has additional loans due from Jerry L. Malis payable on demand with similar interest terms as stated above ranging from 4.83% to 6.97%. The collective loans are secured by 5,833 shares of common stock of the Company. The balance of these loans is reflected in other current assets and as of September 30, 1998 and 1997 was $41,921 and $25,092 respectively, including accrued interest of $4,086 and $2,272, respectively. Consulting Services During 1998, the Company entered into an agreement with R.H. Dick and Company, a corporation owned by Robert Dick, a director of the Company, under which R.H. Dick and Company agreed to provide certain investment banking and consulting services for the years 1998 and 1999. During October 1998, the Company paid R.H. Dick and Company $10,000 for these services of which $5,000 was expensed for the year ended September 30, 1998. 8. NOTES PAYABLE The Company has a line of credit of $1,000,000 with First Union bank (formerly Meridian Bank) which calls for interest to be charged equal to the bank's national commercial rate. The unsecured loan is payable on demand requiring monthly interest payments on the unpaid principal and reduction of the loan balance to zero for a minimum of thirty consecutive days during each twelve month period. In addition the loan covenant calls for a minimum tangible net worth of no less than $3,000,000 during the term of the loan. At September 30, 1998 and 1997 there were no outstanding balances on this line. 9. COMMITMENTS AND CONTINGENCIES The Company is subject to litigation arising from the normal course of business. In management's opinion, any such contingencies are covered under its existing insurance policies or do not materially affect the Company's financial position. The Company is subject to regulatory requirements throughout the world. In the normal course of business, these regulatory agencies may require companies in the medical industry to change their products or operating procedures, which could affect the Company. The Company regularly incurs expenses to comply with these regulations and may be required to incur additional expenses. Management is not able to estimate any additional expenditure outside the normal course of operations which will be incurred by the Company in future periods in order to comply with these regulations. F-12 F-13 VALLEY FORGE SCIENTIFIC CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 9. COMMITMENTS AND CONTINGENCIES (Continued) Employment Agreements Effective July 1, 1994, the Company entered into employment agreements with Jerry L. Malis and Thomas J. Gilloway, for terms of 63 months. The agreements provided for annual base salaries to Mr. Malis and Mr. Gilloway of $148,720 and $126,940, respectively, with annual base salary increases at 10% commencing October 1, 1994. In addition, the agreements provide that Messrs. Malis and Gilloway may each receive such other cash and stock bonuses and benefits as may be determined from time to time by the Board of Directors. For the year ended September 30, 1996, the officers waived their right to the 10% increase of base salary for that year. For the year ended September 30, 1998, the officers waived their right to a full 10% increase of base salary, opting to reduce the annual base salary increase from 10% to 5% for 1998. The base salaries for the years ended September 30, 1998, 1997 and 1996 were $188,949, $179,951 and $163,592 for Jerry L. Malis and $161,278, $153,598 and $139,634 for Thomas J. Gilloway, respectively. On August 31, 1994, pursuant to the merger agreement with Diversified, the Company entered into an employment agreement with Bernard H. Shuman, the former President of Diversified and a current Vice President of the Company, for a term of 59 months commencing September 1, 1994. The agreement provided for a salary of $50,000 per annum through July 31, 1995 and thereafter at $105,000 per annum through July 31, 1999. In addition, the agreement provided that Mr. Shuman may receive such other compensation and benefits as the Board of Directors of the Company may decide. The employment agreement may be terminated for cause. The base salary for Bernard H. Shuman for each of the years ended September 30, 1998, 1997 and 1996 was $105,000. 401(k) Plan and Profit Sharing Plan The Company's 401(k) Plan and Profit Sharing Plan cover full-time employees who have attained the age of 21 and have completed at least one year of service with the Company. Under the 401(k) Plan, an employee may contribute an amount up to 25% of his compensation to the 401(k) Plan on a pre-tax basis not to exceed the current Federal limitation of $10,000 per year (as adjusted for cost of living increase). Amounts contributed to the 401(k) Plan are nonforfeitable. Under the Profit Sharing Plan, a participant in the plan participates in the Company's contributions to the Plan as of December 31 in any year, with allocations to individual accounts based on annual compensation. An employee does not fully vest in the plan until completion of three years of employment. The Board of Directors determine the Company's contributions to the plan on a discretionary basis. The Company has not made any contributions to date. Stock Option Plan On July 6, 1988, the Company adopted a non-qualified employee stock option plan (the "Plan") pursuant to which 500,000 shares of Common Stock have been reserved for issuance to employees, officers, directors or consultants of the Company. Options granted pursuant to this plan will be non-transferrable and expire if not exercised after ten years from the date of grant or for such lesser term as approved by the Board of Directors. Options may be granted in such amounts and at such prices as determined by the Board of Directors, but the price per share shall not be less than the fair market value of the Company's Common Stock as of the date of grant. On October 24, 1994, the Company granted to employees and a board member stock options to purchase 20,000 shares of common stock pursuant to the plan, at $2.50 per share (the closing bid price on the NASDAQ small-cap market on October 24, 1994). Options granted expire if not exercised within ten years, commencing October 24, 1994. F-13 F-14 VALLEY FORGE SCIENTIFIC CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 9. COMMITMENTS AND CONTINGENCIES (Continued) Stock Option Plan (Continued) On December 22, 1994, the Company granted to each of Jerry L. Malis and Thomas J. Gilloway stock options to purchase 50,000 shares of Common Stock pursuant to the Plan at $2.38 per share (the closing bid price on the NASDAQ small-cap market on December 22, 1994). Options granted expire if not exercised within ten years, commencing December 22, 1994. On December 22, 1995, the Company granted to its employees stock options to purchase a total of 8,000 shares of Common Stock pursuant to the Plan at $2.13 per share (the closing bid price on the NASDAQ small-cap market on December 22, 1995). Options granted expire if not exercised within ten years, commencing December 22, 1995. On July 26, 1996, the Company granted to its employees stock options to purchase a total of 44,000 shares of Common Stock pursuant to the Plan at $2.31 per share (the closing bid price on the NASDAQ small-cap market on July 26, 1996). Options granted expire if not exercised within five years, commencing July 26, 1996. On November 14, 1997, the Company granted to two directors and one consultant stock options to each purchase 2,000 shares of Common Stock pursuant to the plan at $3.38 per share (the closing bid price on the NASDAQ small-cap market on November 14, 1997). In accordance with FAS 123 the fair value of the 2,000 options issued to the consultant was estimated at the grant date using the Black-Scholes Value option pricing model resulting in the recording of $3,860 as consulting expense. At September 30, 1998, no stock options have been exercised. As referred to in Note 1, the Company has adopted the disclosure provisions of SFAS 123, "Accounting for Stock Based Compensation." As permitted under this statement the Company retained its current method of accounting for stock compensation in accordance with APB 25. F-14 F-15 VALLEY FORGE SCIENTIFIC CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 9. COMMITMENTS AND CONTINGENCIES (Continued) Stock Option Plan (Continued) Following is a summary of the Company's non-qualified employee stock option plan: Weighted Weighted Exercise Average Average Price Exercise Remaining Shares Per Share Price Life (Years) -------- ----------- -------- ------------ Options outstanding at October 1, 1995 343,400 $1.56 - $5.13 $ 2.58 6.24 Granted 52,000 $2.13 - $2.31 2.28 9.74 Exercised - - - - Surrendered, forfeited or expired - - - - ------- ------------ ---- ---- Options outstanding at September 30, 1996 395,400 $1.56 - $5.13 2.54 6.70 Granted - - - - Exercised - - - - Surrendered, forfeited or expired (4,500) $2.31 - $2.50 2.39 8.06 -------- ------------- ---- ---- Options outstanding at September 30, 1997 390,900 $1.56 - $5.13 2.54 5.66 Granted 6,000 3.38 3.38 9.79 Exercised - - - - Surrendered, forfeited or expired - - - - ------- ------------ ---- ---- Options outstanding at September 30, 1998 396,900 $1.56 - $5.13 $ 2.56 4.61 ======= ============ ==== ==== All options outstanding for each of the years ended September 30, 1998, 1997 and 1996 were exercisable.
F-15 F-16 VALLEY FORGE SCIENTIFIC CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 9. COMMITMENTS AND CONTINGENCIES (Continued) Stock Option Plan (Continued) Pro forma information regarding net income and earnings per share is required by FASB 123, and has been determined as if the Company had accounted for the employee stock options under the fair value method of that statement. The fair value for options granted during the years ended September 30, 1998 and 1997 was estimated at the date of grant while the fair value for the options granted during the year ending September 30, 1996 was estimated at the date of implementation of FASB 123. The fair value of these options was estimated using a Black-Scholes option pricing model with the following weighted average assumptions: September 30, 1998 1997 1996 ---- ---- ---- Risk-Free interest (based on U.S. Government strip bonds on the date of grant with maturities approximating the expected option term) 5.82% - 6.43% Dividend yields 0% - 0% Volatility factors of the expected market price of the Company's Common Stock (based on historical data) 60.5% - 58.3% Expected life of options 5 years - 5.5 years
The weighted average fair value of options granted during the years ended September 30, 1998, 1997 and 1996 were $1.93, $ - and $1.34. The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because the Company's stock options have characteristics significantly different from those of traded options, and because changes in subjective input assumptions can materially affect the fair value estimated, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its stock options. In management's opinion existing stock option valuation models do not provide a reliable single measure of the fair value of employee stock options that have vesting provisions and are not transferable. In addition, option pricing models require the input of highly subjective assumptions, including expected stock price volatility. F-16 F-17 VALLEY FORGE SCIENTIFIC CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 9. COMMITMENTS AND CONTINGENCIES (Continued) Stock Option Plan (Continued) For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options' vesting period. In accordance with SFAS 123, only stock options granted during the years ended September 30, 1998, 1997 and 1996 have been included for the Company's pro forma information as follows: September 30, 1998 1997 1996 ---- ---- ---- Additional compensation expense, net of tax effect $ (4,586) $ - $ (41,445) Pro forma net loss $ (38,960) $ - $ (116,561) Pro forma loss per share: Basic $ (.00) $ - $ (.01) Diluted $ (.00) $ - $ (.01)
Operating Leases The Company currently leases approximately 4,200 square feet of office and warehouse space in an office building in Oaks, Pennsylvania, from GMM Associates, a Pennsylvania general partnership, whose partners are Jerry L. Malis, Thomas J. Gilloway and Leonard I. Malis, principal shareholders, directors and/or officers of the Company. The lease is for a term of five years which commenced on July 1, 1995 and calls for a base rent of $4,618 (with increases based on increases in the consumer price index) which include costs associated with real estate taxes, maintenance and utilities. The related expense for this lease for the years ended September 30, 1998, 1997 and 1996 was $54,899, $52,937 and $51,565, respectively. As of September 30, 1998, the Company was current on all rental obligations due the related party. The Company has also entered into leases for certain equipment under operating lease agreements with terms ranging between two and three years. A schedule of future minimum payments under operating leases is as follows: Year ending September 30, Related Other Party Operating ------ --------- 1999 $ 55,411 $ 31,039 2000 41,558 20,538 2001 - - 2002 - - 2003 - - ------ ------ $ 96,969 $ 51,577 ====== ====== F-17 F-18 VALLEY FORGE SCIENTIFIC CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 9. COMMITMENTS AND CONTINGENCIES (Continued) Year 2000 Compliance As has been widely reported, many computer systems process dates based on two digits for the year of a transaction and are unable to process dates in the year 2000 and beyond. The Company primarily uses licensed software products in its operations with a significant portion of processes and transactions centralized in one particular software package. During 1999, management plans to upgrade to the most current version of this software package which, among other things, is Year 2000 compliant. In addition the Company has previously replaced or modified other systems that were not Year 2000 compliant. These systems have been assessed, and detailed plans have been developed and are being implemented to make the necessary modifications to insure year 2000 compliance. The financial impact of making the required system changes for year 2000 compliance are not expected to have a material effect on the Company's financial statements. The Company is continuing its process of formal communication with all of its significant suppliers and customers to determine the extent to which the Company is vulnerable to potential third parties failure to remediate their own year 2000 issued. The Company can give no guarantee that the systems of other companies on which the Company's systems rely will be remedied for the year 2000 issues on time or that a failure to remedy the problem by another company would not have a material adverse effect on the Company. 10. MAJOR CUSTOMERS For the years ended September 30, 1998, 1997 and 1996, a significant part of the Company's revenues were derived from one major customer pursuant to distribution agreements under which the Company granted the exclusive right to sell its electrosurgical systems and other products developed by the Company in the field of neurosurgery through December 31, 1998. This agreement was extended through December 31, 1999 and the minimum purchase requirement was increased to $5,000,000 for the 1999 calendar year. Revenues derived from this customer are as follows: Year ended September 30, 1998 $3,616,778 93% Year ended September 30, 1997 $3,659,557 92% Year ended September 30, 1996 $3,055,531 89% At September 30, 1998 and 1997, this customer accounted for approximately 69% and 80%, respectively, of the Company's accounts receivable while two other customers represented approximately 22% and 19%, respectively. F-18 F-19 VALLEY FORGE SCIENTIFIC CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 11. STOCKHOLDERS' EQUITY Common Stock The holders of Common Stock have no preemptive rights and the Common Stock has no redemption, sinking fund or conversion provisions. Each share of Common Stock is entitled to one vote on any matter submitted to the holders and to equal rights in the assets of the Company upon liquidation. All of the outstanding shares of Common Stock are fully paid and nonassessable. On October 14, 1992, the Board of Directors of the Company approved a stock repurchase plan whereby the Company may, from time to time, repurchase on the open market up to 100,000 shares of the Corporation's Common Stock. During the fiscal year ended September 30, 1995, the Company repurchased for retirement 10,000 shares at a price of $20,542 resulting in a total of 27,500 shares repurchased since the inception of the repurchase plan at an aggregate price of $99,924. Preferred Stock The Company is authorized to issue 487 shares of preferred stock, $1,000 par value. The holders of the preferred stock would have no voting rights or preemptive rights. Upon liquidation of the Company, a $1,000 per share liquidating dividend must be paid upon each issued and outstanding share of preferred stock before any liquidating dividend is paid on the Common Stock. As of September 30, 1998, there were no issued or outstanding preferred shares, and the Company has no intention to issue any preferred stock in the immediate future. 12. EARNINGS (LOSS) PER SHARE September 30, 1998 1997 1996 ---- ---- ---- Basic Earnings (Loss) Per Share: Income (loss) available to common shareholders $ (34,374) $ 6,533 $ (75,116) ========= ========== ========= Weighted average shares outstanding 8,229,384 8,229,384 8,229,384 ========= ========== ========= Basic Earnings (Loss) Per Share $ (.00) $ .00 $ (.01) ========= ========== ========= Diluted Earnings (Loss) Per Share: Income (loss) available to common shareholders $ (34,374) $ 6,533 $ (75,116) ========= ========== ========= Weighted average shares outstanding 8,229,384 8,229,384 8,229,384 Dilutive shares issuable in connection with stock plans - 91,456 - --------- --------- --------- Total shares 8,229,384 8,320,840 8,229,384 ========= ========= Diluted Earnings (Loss) Per Share $ (.00) $ .00 $ (.01) ========= ========= ======== F-19 F-20 VALLEY FORGE SCIENTIFIC CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 12. EARNINGS (LOSS) PER SHARE (Continued) Options to purchase 7,400 shares of common stock at exercise prices ranging from $4.25 to $5.13 per share were outstanding during the year ended September 30, 1997 but were not included in the computation of diluted earnings per share because the options' exercise prices were greater than the average market price of the common shares. Options to purchase 396,900 and 395,400 shares of common stock at exercise prices ranging from $3.38 to $5.13 per share were outstanding during the years ended September 30, 1998 and 1996, respectively, and were not included in the computation of diluted earnings per share in accordance with FAS 128, as the potential shares are considered anti-dilutive due to the Company's loss from continuing operations. 13. PROVISION FOR (BENEFIT OF) INCOME TAXES Provision for (benefit of) income taxes is as follows:
For the Years Ended September 30, 1998 1997 1996 Current: Federal $ - $ (8,911) $ 1,736 State 45 - - ------ ------- ----- 45 (8,911) 1,736 ------ ------- ----- Deferred: Federal (295) 27,104 (49,413) State (1,974) 4,042 11,304 ----- ------ ------- (2,269) 31,146 (38,109) ----- ------ ------- Adjustment of deferred tax asset for state income tax rate changes and expired net operating loss carryforwards net of Federal tax effect - - 23,394 ------ ------- ------- - - 23,394 ------ ------- ------- $(2,224) $22,235 $ (12,979) ====== ====== ======
In accordance with FASB 109, tax credits arising from net operating losses, which previously were reported as extraordinary items, have now been restated as offsets against the provision (benefit) for income taxes. F-20 F-21 VALLEY FORGE SCIENTIFIC CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 13. PROVISION FOR (BENEFIT OF) INCOME TAXES (Continued) The Company's effective tax rate was (6.1)%, 77.3% and (14.7)% for the years ended September 30, 1998, 1997 and 1996, respectively. Reconciliation of income tax at the statutory rate to the Company's effective rate is as follows: For the Years Ended September 30, 1998 1997 1996 ---- ---- ---- Computed at the expected statutory rate (15.0)% 34.0% (15.0)% State taxes net of federal tax benefit (6.1) 8.5 8.4 Reduction in state tax rate resulting from utilization of tax loss carryforwards - - (8.4) Non-deductible expenses 15.0 24.5 9.3 Other - 10.3 (9.0) ----- ----- ----- (6.1)% 77.3% (14.7)% ===== ===== =====
September 30, 1998 1997 ---- ---- Deferred Tax Asset: Difference in capitalization of inventory cost $ 75,995 $ 73,463 Difference in reporting bad debts 48,022 48,059 State of Pennsylvania net operating loss carryforward 23,208 22,603 Tax credits and other current assets 10,703 - ------- ------- Total deferred tax asset 157,928 144,125 Valuation allowance (4,945) (4,945) ------- ------- Net deferred tax asset $152,983 $139,180 ======= ======= Deferred Tax Liability: Difference in reporting depreciation $ 18,445 $ 11,093 ------- ------- Total Deferred Tax Liability $ 18,445 $ 11,093 ======= ======= The Company has state net operating loss carryforwards of approximately $352,000 available to reduce future state taxable income which expires in the year ended September 30, 2001. F-21 F-22 VALLEY FORGE SCIENTIFIC CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 14. CONCENTRATION OF CREDIT RISK Financial instruments which potentially subject the Company to concentration of credit risk consist principally of short- term cash investments and trade receivables. The Company maintains substantially all of its banking activities with one bank and cash balances throughout the year generally exceed the federally insured limit of $100,000. The Company invests overnight these cash balances which exceed $100,000 in U.S. Treasury Securities. At September 30, 1998 and 1997 the balances the Company held in these securities was $805,000 and $477,000, respectively. Management believes that the risk associated with trade receivables, which are principally due from two customers, is adequately provided for in the allowance for doubtful accounts. F-22 VALLEY FORGE SCIENTIFIC CORP. Form 10-K for the year ended September 30, 1998 INDEX TO EXHIBITS* Exhibit Number Description 10(p) Promissory Note from Jerry L. Malis to the Company 10(q) Amendment to Distribution Agreement with Codman & Shurtleff, Inc. (Johnson & Johnson Professional, Inc.), dated September 2, 1998 23 Consent of Samuel Klein & Company 27 Financial Data Schedule * Only the exhibits actually filed are listed. Exhibit incorporated by reference are set forth in th exhibit listing in Item 14 of the Report for Form 10-K.
EX-10.P 2 DEMAND PROMISSORY NOTE $15,015.00 Oaks, Pennsylvania July 6, 1998 FOR VALUE RECEIVED, Jerry L. Malis, an individual having an address at 3000 Valley Forge Circle, PH-43, King of Prussia, Pennsylvania 19406 ("Obligor") promises to pay to the order of Valley Forge Scientific Corp., having an address at 136 Greentree Road, Suite 100, Oaks, Pennsylvania 19456 (hereinafter "Payee"), the principal sum of Fifteen Thousand and Fifteen Dollars ($15,015.00) at the times hereinafter stated, under the following terms: 1. Payment of Principal and Interest. Principal and interest, computed at the "applicable federal rate" as set forth under the Internal Revenue Code of 1986, as amended, and the applicable regulations thereunder, shall be payable by Obligor to Payee on Demand. 2. Event of Default. An "Event of Default" shall occur upon the failure of Payee to make the payments set forth in paragraph 1, on the date set forth therein. Upon the occurrence of an Event of Default, a late charge of five (5%) percent of the amount due shall be added to the amount which is in default and Payee shall be entitled to all remedies available at law including those with regard to the Collateral, (as defined in paragraph 3, herein). 3. Security The Obligor acknowledges and agrees that the 5,833 shares of Valley Forge Scientific Corp. common stock ("Common Stock") that Payee pledged to secured Demand Promissory Notes to the Payee dated May 24, 1994 and February 6, 1994, shall also secure the obligations under this Note. 4. Waiver. Obligor waives presentment for payment, demand for payment, notice of protest, protest and notice of dishonor of this Note, and authorizes the Payee without notice to or consent of Obligor to grant extensions in the time of payment of and reduction in the rate of interest on any money owing on this Note. 5. Prepayment. This Note may be prepaid in whole or in part at any time without penalty. 6. No Additional Waiver Implied by One Waiver. The Payee shall not by any act be deemed to have waived any of its rights or remedies hereunder unless such waiver is in writing and signed by the Payee, and then only to the extent set forth therein. A waiver as to any one event shall in no way be construed as continuing or as preventing waiver of such rights or remedy on a subsequent event. 7. Tender of Payment. All payments due under this Note shall be paid to Payee at the address set forth on the first page of this Note, or such other address as Payee may inform the undersigned in writing. All payments on this Note shall be applied first to the payment of interest with any balance to the payment and reduction of principal. 8. Time of Payment. Whenever any payment to be made by Obligor to the Payee pursuant to the terms of this Note (i) shall be tendered by Obligor to the Payee in immediately available funds, during normal banking hours on any banking business day, then such payment shall be considered to have been made on that business day, or (ii) shall be stated to be due on a day which is not a banking business day, such payment may be made on the next succeeding banking business day. 9. Pennsylvania Law Governs. This Note and all matters relating thereto shall be governed by and construed and interpreted in accordance with the laws of the State of Pennsylvania. IN WITNESS WHEREOF, Obligor has caused this Note to be duly executed, attested and delivered by its authorized and empowered officer, as of the day and year first written above. WITNESS: ____________________ /s/ Jerry L. Malis ------------------ Jerry L. Malis EX-10.Q 3 Distribution Agreement Dated 9/17/91 Letter of Extension 1. The term of the Distribution Agreement dated September 17, 1991 by and between Codman and Shurtleff, Inc. and Valley Forge Scientific Corp. as set forth in Paragraph 16 of that Agreement is hereby extended until December 31, 1999. 2. Distributors shall make minimum dollar purchases of Established Products and New for the 1999 calendar year in the amount of five million dollars ($5,000,000) aggregate. 3. Capitalized terms not defined herein shall have the meaning ascribed to them in the Distribution Agreement. 4. All other terms of the Distribution Agreement shall remain in full force and effect. Johnson & Johnson Professional, Inc. Dated: September 2, 1998 By: /s/ David M. Hable -------------------------- David M. Hable, V.P. Sales & Marketing. Valley Forge Scientific Corp. Dated: September 2, 1998 By: /s/ Jerry L. Malis -------------------------- Jerry L. Malis, President EX-23 4 CONSENT OF SAMUEL KLEIN & COMPANY INDEPENDENT ACCOUNTANTS We consent to the incorporation by reference in the registration statement of Valley Forge Scientific Corp. on Form S-8 (file No. 333-63637) of our report dated December 3, 1998, on our audits of the financial statements of Valley Forge Scientific Corp. as of September 30, 1998 and 1997, and for each of the three years in the period ended September 30, 1998, which reports are included in this Annual Report on Form 10-K. SAMUEL KLEIN & COMPANY Newark, New Jersey December 22, 1998 -----END PRIVACY-ENHANCED MESSAGE-----